Porter’s Value Chain – SKCI Business Strategy Tool
Michael Porter designed a strategic chart to identify where the value is added into the organisation. The concept of Value Chain involves all aspects of the operational activities from sourcing of raw products all the way to when there is no further interaction with the customer. The Five stages are 1) Inbound Logistics, 2) Production, 3)Outbound Logistics, 4) Marketing and Sales 5) Services.
The greater the value created compared to the operational cost associated with the product, the greater the profit will be for the company.
Value Created and Captured – Cost to Create the Value = Profit Margin
When To Use The Value Chain
The Value Chain identifies opportunities for cost savings and differentiations in the production cycle which then gives the tools for the organisation to find their competitive advantages. The Value Chain doesn’t remain static and does need revisiting periodically. Competitive advantages come from perceiving changes in your entire production chain.
Porter’s Value chain should be used to identify:
- Which aspect of the organisation adds most value to the product/service. (Increase)
- Which aspect of the organisation adds no/limited value and costs too much. (Stop)
- If there is a misalignment to where value is actually added compared to where it was assumed to be added. (New Opportunity)
- The cost to value ratio.
- How to increase efficiency.
How To Use The Value Chain
The Value Chain has 5 primary stages where value can be added with 4 supporting themes that cross through each stage.
Inbound logistics is looking at the collection, storage and inventory of the raw materials and the nature of the relationship with the supplier.
Production includes all operations that process the raw materials into the finished sellable product including the labelling, branding and packaging.
Outbound logistics is everything to fulfil the customer’s order from storage of the finished product to distribution to the customer.
Marketing and sales include all the processes that enhances the product’s visibility to new clients. This will include client relationship management.
Services are all the additions that are involved after the sale. These include customer services, repairs, refunds and warranty fulfilment.
Company Infrastructure are those that support daily business operations such as administration, financial, and legal that enable all aspects of the company.
Human Resources Management includes the hiring, training, retaining talent, and termination of others. Also includes the motivation and determination to succeed.
Research and Development includes the technology incorporated in the company that automates, improves and streamlines the production process. May include payroll systems, customer services and distribution networks.
Procurement is the acquisition of the necessary goods and services including the purchase of equipment, buildings, offices and plant machinery. It will also include the raw materials and the negotiation of the purchase contracts.
Let’s look at the example of NewTechNow, an imaginary B2B software and hardware company that we have seen in previous examples.
Inbound Logistics – The company’s predominant product is software which is designed in house, with only very limited stock of actual physical goods. These are imported in partnership with another Tech company whose focus is hardware. There is a good, honest and enduring relationship with the supplier and on a quid pro quo basis. The hardware is bought at cost price.
Production – The white labelling of the equipment is a simple process carried out by the inhouse IT team. Once the software has been developed there is little production as the product is held on the cloud and sent electronically. All manuals are electronic and so there are no physical copies.
Outbound logistics – The hardware is delivered by an independent delivery firm as and when required. The cost is moderately high per delivery but there are no fixed overheads so in quiet times there is no cost. Software installers can operate remotely and train the clients through online lessons.
Marketing and Sales – 40% of the employees work in this department. 75% of revenue is direct sales to new customers from aggressive marketing campaigns online and through independent software specialists. 60% of the entire company cost is on marketing.
Services – Retention of clients is poor, with only 25% of clients buying a second product within 2 years. Customer services have historically been always focused on fixing immediate issues and assisting the clients remotely.
Company infrastructure – There is a barebones management structure with each department having one senior director. The accounts and legal department were external contractors but this was brought in house due to a previous attempt of cost savings and for the protection of the IP.
Human Resources Management – There has been a high turnover of sales staff for the past 2 years. Sales have increased but the cost of hiring and training have doubled.
Research and Development – This is the largest department in the company where 43% of the staff work. The company’s success is that it has retained top software engineers who develop market leading programs.
Procurement – The buildings are on a long lease and are top of the range in the centre of a tech focused town. The equipment bought is top of the range but is becoming more and more expensive with a shorter lifespan.
This analysis of the primary and the supporting stages allows each area to highlight where adjustments can be made. For example, the staff turnover is an issue. Clearly there are some social issues in the office which need to be addressed and may have some very simple solutions. A deeper dive into HR processes and the well-being of the staff will be needed.
Similarly, the procurement of expensive machines that have limited lifespans need to be critically looked at. The environmental impact of the fast turn over electronic waste as much as the costs will be noticed by competitors, employees and the public. This is unsustainable.
However, it is clear that the retention of the software engineers is clearly where you add tremendous value which makes the organisation a market leader. The hardware side of the business is very cheap to manage, but perhaps it is now a distraction from your main strength or is it an area that could be expanded at minimal cost.
How Does This Fit Into The 5KQ Strategy Framework?
SKCI’s unique 5 Key Question (5KQ) strategy framework gives our clients an effective way of managing strategy development. The value chain answers questions 1 and 3, ‘Where are we now?’ and ‘What are we going to do (differently)?’. Analysing your organisation across the whole spectrum really highlights where changes can be made.
Our framework allows you to ask the right questions at the right time and provides a clear structure for the development and maintenance of your strategy. By using the Value Chain you will have a clear overview of your organisation against your strategy.
Additional Strategy resources, including blank worksheets in PowerPoint and Word format, are available to download at the top of this webpage.