Term
Value chain
Breaking a company’s activities, from purchasing through production and sales to service, into steps that add value for the customer. It shows where margin is created and which activities are better outsourced.
Updated
What it means
The value chain is Michael Porter’s model breaking a company down into activities that create value for the customer. Primary activities are inbound logistics, operations, outbound logistics, marketing and sales, and after-sales service; support activities are procurement, technology, human resources and company infrastructure.
Margin arises as the difference between what the customer is willing to pay and the cost of all activities. The model helps find out which activities really add value and which merely cost money, and it builds on Porter’s analysis of competitive forces.
Today the term is also used more broadly, with the value chain extending to the company’s suppliers and customers. In that sense it is used in double materiality assessments and when calculating Scope 3 emissions, which arise outside the company.
How it works in practice
For clients we link the value chain to management accounting: we split costs by activity and cost centre and show what sales, delivery or administration cost per job. It often turns out that the most expensive activity is one nobody tracks.
The analysis informs decisions on outsourcing or, conversely, insourcing. Support activities that are not a source of competitive advantage, such as bookkeeping, payroll or IT, may be done better and more cheaply by an external partner.
The analysis is done together with a process map showing how activities connect. In job production the result is more accurate costing; in trade, better-organised logistics and warehousing.
What to watch out for
The model is useful only when filled with real figures. If the activities are merely listed and estimates assigned to costs, the result will confirm what management already thought and nothing will change.
Moving an activity outside is not automatically a saving. The decision must include the cost of managing the supplier, lost know-how and the risk of dependence. If the activity is the core of value for the customer, handing it over can take away exactly what sets the company apart.
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