Value chain analysis: how to run Porter's model

Who should use it, and when not to

Use it when margins are thin and nobody can say which activities eat them, when deciding what to outsource, automate, or invest in, or after choosing a strategy, to check that daily work supports it. It also helps when a rival wins on cost or on a feature customers love: comparing activity by activity shows where the gap comes from.

It looks inside one business. It won't tell you whether the industry is profitable (use the five forces), and it works best once you know whether you compete on cost or on a difference (see Porter's generic strategies). Map one business unit at a time; a group with unrelated businesses has one chain per business.

The core ideas

In Porter's view, every cost, and most of what sets a company apart, traces back to specific activities and how the company runs them. So the unit of analysis is the activity, not the department or the product.

The categories are a checklist, not the answer. A useful map names the company's own activities, splitting a category when its parts have different costs or matter differently to buyers.

Activities also affect each other. A careful check at one step can save rework at the next, and a delivery promise only holds if production is scheduled for it. Porter's 1996 article describes three levels of fit: each activity is consistent with the strategy, activities reinforce one another, and effort is coordinated so nothing is done twice. A position built on a whole system of fitting activities is much harder to copy than one built on a single activity, because a rival has to match all of them at once.

Finally, a company's chain sits inside a larger value system that includes its suppliers' and channels' chains. Some of the best changes sit at those boundaries: what a supplier does for you, or what a distributor does instead of you.

How to run a value chain analysis

1. Pick the unit and the strategy. Name the business unit you're mapping and the strategy it's meant to serve, low cost or a specific difference. Every later judgment is against that strategy.
2. List the activities. Use the nine categories as a checklist and write the company's own activities under each. Put large purchased inputs on their own line.
3. Assign cost shares. Spread operating costs and people across the activities so the shares add to about 100%. Label estimates as estimates.
4. Find the cost drivers. For the largest activities, write what makes their cost rise or fall: volume, utilization, location, input prices, and choices in one activity that change cost in another.
5. Find the value drivers. For each activity, write what buyers notice and pay for, or leave over, using reviews, sales notes, or churn reasons.
6. Check fit. Mark the activities that reinforce each other, and the ones that pull against the strategy.
7. Pick two or three changes. Rank by cost or value at stake and by fit. For each, state the activity, the change, the expected effect, and what it gives up.

A worked mini example

Illustration: a made-up business; every fact is stated here. Nami Ceramics makes handmade tableware in a town of 30,000 people, with 11 staff. Its strategy: distinctive plates for restaurants that change their menus often, plus online sales to home cooks. Yearly costs: clay and glazes 12%, throwing and glazing 31%, kiln firing (gas) 14%, packing and shipping 15%, design of new pieces with chefs 7%, online shop and ads 9%, sales visits to restaurants 5%, admin 7%.

Where cost sits: throwing and glazing is the largest share, but it is also why restaurants buy, so cutting it would undercut the strategy. The waste is elsewhere. Kilns run half full because restaurant orders arrive at random, and breakage turns shipping into a second cost of every broken piece.

Fit: design with chefs and handmade production reinforce each other; restaurants reorder each menu change. Online sales pull against the strategy: one-off orders, the highest breakage, and kiln slots taken at short notice.

The changes: (1) fire on a fixed schedule, two set days a week, with restaurant orders booked into firings, which fills kilns and costs some flexibility on rush jobs; (2) redesign packaging and ship online orders in weekly batches, which cuts breakage but slows online delivery; (3) offer restaurants a seasonal design plan so design hours are paid for upfront, at the risk that some small restaurants won't sign. The value chain skill builds this map from your own figures.

Common mistakes

• The textbook diagram with generic labels. The categories without the company's own activities and numbers tell you nothing new.
• Departments instead of activities. One team doing three different things hides three different costs.
• Cutting the biggest cost by reflex. The largest activity is often where buyers' value comes from.
• One activity at a time. Most savings and most advantages sit in the links between activities.
• A list of twenty fixes. Pick the few that fit the strategy and say what each gives up.

Where it comes from

Michael E. Porter of Harvard Business School introduced the value chain, with its primary and support activities, in Competitive Advantage: Creating and Sustaining Superior Performance (Free Press, 1985). His HBR article "What Is Strategy?" (1996) extended it with the idea that advantage rests on how activities fit together. This page is an independent summary in our own words, not written, reviewed, or endorsed by Porter or his publishers. More frameworks are in the strategy books index.

Questions

What are the primary and support activities in Porter's value chain?

Primary: inbound logistics, operations, outbound logistics, marketing and sales, and service. Support: procurement, technology development, human resource management, and firm infrastructure.

What is the difference between a value chain and a supply chain?

A value chain maps one company's own activities and asks where each adds cost and value. Porter calls the wider stream that includes suppliers' and channels' chains the value system, which is closer to what people mean by a supply chain.

What should a value chain analysis produce?

An activity map with cost shares, cost drivers, and value to buyers, a check on how the activities fit the strategy, and the two or three changes worth making, each with what it gives up.