Porter's value chain: find out where your competitive advantage is made

The finance director of a technical wholesaler has a simple proposal: stop the early-morning deliveries. Vans that reach building sites before seven are the most expensive part of logistics, and a daytime round would cost a third less. What the spreadsheet does not show is that many installers buy here precisely because their materials are on site before the crew arrives. Cut the early round and you remove the reason customers come. Porter's value chain makes that visible.

The model splits a business into the activities that create value for the customer, so you can see per activity what it costs, what it delivers and how it connects to the rest. A cost discussion becomes a strategic one: which activities earn your margin, which only need to be good enough, and which someone else could do for you.

What is Porter's value chain?

Michael Porter introduced the value chain in Competitive Advantage (Free Press, 1985). The Institute for Strategy and Competitiveness at Harvard Business School describes it as the activities involved in delivering value to customers. Advantage comes from the separate things a company does: buying, making, delivering, selling and supporting. Each activity adds cost, and each can add value. Your margin is the gap between what customers will pay and what all activities together cost. Porter and Victor Millar applied the model to information technology the same year, and the chain is still a good map for deciding where software and data will pay off.

Primary and support activities in the value chain

Primary activities make the product and bring it to the customer. Support activities make the primary ones possible.

Treat the nine categories as a checklist, not a template. Give an activity its own line when it has its own cost structure or its own influence on what customers value. For a wholesaler, early site delivery and the trade counter are separate activities.

The value system: your value chain is one link

Porter placed every value chain inside a larger value system with the chains of your suppliers, channels and customers. You create value for a business customer by lowering its costs or improving its performance, both inside the customer's own chain. So learn how your customer works as well as what it buys.

Take an installer working in a crew of two, each costing €60 an hour. A trip to the trade counter for missing materials takes 45 minutes, so every trip costs €90 in hours. If materials on site before seven save three trips a week, the installer saves €270 a week, about €12,150 over 45 working weeks. That is worth far more than a small discount on the materials.

Fictitious Firmfocus example. The logic works in any currency.

Doing things better versus doing things differently

In "What Is Strategy?" (Harvard Business Review, November 1996), Porter separates operational effectiveness from strategy. Operational effectiveness means performing similar activities better than rivals. You need it, but competitors catch up because good practices spread. Strategy means performing different activities, or similar activities in different ways, and accepting the trade-offs. The value chain shows both: where you are less efficient than you could be, and where you deliberately differ. Porter adds the idea of fit: when activities reinforce each other, a rival has to copy the whole system rather than one activity.

How to do a value chain analysis in five steps

1. 01

   Split the business into activities

   Aim for eight to twelve activities in your own words, each with a clear output. Use Porter's nine categories to check that nothing is missing.

2. 02

   Allocate the costs

   Estimate each activity's cost as a share of revenue: staff hours, premises, vehicles, software, outsourced work and the time of owner and managers. The order of magnitude matters more than precision.

3. 03

   Determine the value to the customer

   Ask customers why they buy and what they would miss, and read lost quotes and complaints. Rate each activity high, medium or low on what you hear, not what you assume.

4. 04

   Find the linkages

   Note which activities depend on each other. A correct materials list makes picking faster; reliable delivery means fewer calls to sales. Linkages are where a saving in one place creates costs elsewhere.

5. 05

   Compare and choose

   Set your cost structure against industry figures where you can, then choose per activity: build out, keep at par or outsource.

Value chain analysis example: a technical wholesaler

Brightline Supply has 85 staff, a central warehouse and four branches with a trade counter. Its customers are mainly plumbing, heating and electrical installers in the region. Revenue is €30 million with a gross margin of 22%. The activities below cost 18.7% of revenue, which leaves an operating profit of 3.3%, or €990,000.

Fictitious Firmfocus example. Costs exclude the purchase value of goods sold; procurement and HR are included in management and the branches.

The three high-value activities form one system. The helpdesk checks the materials list with the installer, the warehouse packs a kit per site, and the van delivers it before the crew arrives. A rival can copy early delivery, but without the checked list and the kit it is just an expensive van. That is fit in practice.

Now the finance director's proposal. Delivery costs €1,080,000 a year, and a daytime round would save about a third, or €360,000. If one euro in ten of revenue leaves as a result, the wholesaler loses €3 million of revenue and €660,000 of gross margin. The saving is smaller than the loss. Better savings sit elsewhere: closing one of four counters, now that half of all orders arrive through the web shop, saves roughly a quarter of €960,000, or €240,000, and IT management can go to a specialist without customers noticing.

Outsource or keep in-house?

Before you outsource, ask what happens if the supplier fails or raises its price, and who then holds the know-how.

The value chain of a service business

For an accountancy firm, engineering consultancy or software agency, the primary activities become intake (scoping and quoting), delivery (the work itself), handover (the report or advice) and aftercare (follow-up questions and the next assignment). Measure costs in hours and record them per activity for a few weeks. The usual surprise is that intake and rework take far more time than budgeted, and that aftercare is given away.

Limits of Porter's value chain

The model assumes a pipeline business. Van Alstyne, Parker and Choudary (Harvard Business Review, April 2016) contrast firms that optimise activities they own or control with platforms, which create value from interactions between outside producers and users and grow through network effects. For a marketplace, the chain tells only part of the story. Two limits apply everywhere: costs per activity are estimates, because bookkeeping records wages and rent rather than activities, and the chain is a snapshot to redo when customers or technology change.

Small business or larger organisation

Pitfalls in a value chain analysis

• Cutting per activity: a saving that ignores the linkages and costs more elsewhere, as in the delivery example.
• Guessing customer value: ratings made at the management table without talking to customers.
• Forgetting your own time: owner and manager hours left out, so the activities they carry look free.
• Outsourcing the linkage: handing over an activity that looked like overhead but held the system together.

The value chain shows where advantage is made; core competences and VRIO tests whether it will last. Use the chain as the backbone of your internal analysis, link the choices to Porter's generic strategies and put money on them with the financial analysis for strategy. All tools are in strategic analysis, and the full theme is under Strategy.