What is value chain in human resource management?

How does your organization create value?

How do you change business inputs into business outputs in such a way that they have a greater value than the original cost of creating those outputs?

This isn't just a dry question: it's a matter of fundamental importance to companies, because it addresses the economic logic of why the organization exists in the first place.

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Manufacturing companies create value by acquiring raw materials and using them to produce something useful. Retailers bring together a range of products and present them in a way that's convenient to customers, sometimes supported by services such as fitting rooms or personal shopper advice. And insurance companies offer policies to customers that are underwritten by larger re-insurance policies. Here, they're packaging these larger policies in a customer-friendly way, and distributing them to a mass audience.

The value that's created and captured by a company is the profit margin:

Value Created and Captured – Cost of Creating that Value = Margin

The more value an organization creates, the more profitable it is likely to be. And when you provide more value to your customers, you build competitive advantage.

Understanding how your company creates value, and looking for ways to add more value, are critical elements in developing a competitive strategy. Michael Porter discussed this in his influential 1985 book "Competitive Advantage," in which he first introduced the concept of the value chain.

A value chain is a set of activities that an organization carries out to create value for its customers. Porter proposed a general-purpose value chain that companies can use to examine all of their activities, and see how they're connected. The way in which value chain activities are performed determines costs and affects profits, so this tool can help you understand the sources of value for your organization.

Elements in Porter's Value Chain

Rather than looking at departments or accounting cost types, Porter's Value Chain focuses on systems, and how inputs are changed into the outputs purchased by consumers. Using this viewpoint, Porter described a chain of activities common to all businesses, and he divided them into primary and support activities, as shown below.

Primary Activities

Primary activities relate directly to the physical creation, sale, maintenance and support of a product or service. They consist of the following:

• Inbound logistics – These are all the processes related to receiving, storing, and distributing inputs internally. Your supplier relationships are a key factor in creating value here.
• Operations – These are the transformation activities that change inputs into outputs that are sold to customers. Here, your operational systems create value.
• Outbound logistics – These activities deliver your product or service to your customer. These are things like collection, storage, and distribution systems, and they may be internal or external to your organization.
• Marketing and sales – These are the processes you use to persuade clients to purchase from you instead of your competitors. The benefits you offer, and how well you communicate them, are sources of value here.
• Service – These are the activities related to maintaining the value of your product or service to your customers, once it's been purchased.

Support Activities

These activities support the primary functions above. In our diagram, the dotted lines show that each support, or secondary, activity can play a role in each primary activity. For example, procurement supports operations with certain activities, but it also supports marketing and sales with other activities.

• Procurement (purchasing) – This is what the organization does to get the resources it needs to operate. This includes finding vendors and negotiating best prices.
• Human resource management – This is how well a company recruits, hires, trains, motivates, rewards, and retains its workers. People are a significant source of value, so businesses can create a clear advantage with good HR practices.
• Technological development – These activities relate to managing and processing information, as well as protecting a company's knowledge base. Minimizing information technology costs, staying current with technological advances, and maintaining technical excellence are sources of value creation.
• Infrastructure – These are a company's support systems, and the functions that allow it to maintain daily operations. Accounting, legal, administrative, and general management are examples of necessary infrastructure that businesses can use to their advantage.

Companies use these primary and support activities as "building blocks" to create a valuable product or service.

Using Porter's Value Chain

To identify and understand your company's value chain, follow these steps.

Step 1 – Identify subactivities for each primary activity

For each primary activity, determine which specific subactivities create value. There are three different types of subactivities:

• Direct activities create value by themselves. For example, in a book publisher's marketing and sales activity, direct subactivities include making sales calls to bookstores, advertising, and selling online.
• Indirect activities allow direct activities to run smoothly. For the book publisher's sales and marketing activity, indirect subactivities include managing the sales force and keeping customer records.
• Quality assurance activities ensure that direct and indirect activities meet the necessary standards. For the book publisher's sales and marketing activity, this might include proofreading and editing advertisements.

Step 2 – Identify subactivities for each support activity.

For each of the Human Resource Management, Technology Development and Procurement support activities, determine the subactivities that create value within each primary activity. For example, consider how human resource management adds value to inbound logistics, operations, outbound logistics, and so on. As in Step 1, look for direct, indirect, and quality assurance subactivities.

Then identify the various value-creating subactivities in your company's infrastructure. These will generally be cross-functional in nature, rather than specific to each primary activity. Again, look for direct, indirect, and quality assurance activities.

Step 3 – Identify links

Find the connections between all of the value activities you've identified. This will take time, but the links are key to increasing competitive advantage from the value chain framework. For example, there's a link between developing the sales force (an HR investment) and sales volumes. There's another link between order turnaround times, and service phone calls from frustrated customers waiting for deliveries.

Step 4 – Look for opportunities to increase value

Review each of the subactivities and links that you've identified, and think about how you can change or enhance it to maximize the value you offer to customers (customers of support activities can be internal as well as external).

Your organization's value chain should reflect its overall generic business strategies. So, when deciding how to improve your value chain, be clear about whether you're trying to set yourself apart from your competitors or simply have a lower cost base.

Tip 2:

You'll inevitably end up with a huge list of changes. See our article on prioritization if you're struggling to choose the most important changes to make.

Tip 3:

This looks at the idea of a value chain from a broad, organizational viewpoint. Our separate article on value chain analysis takes different look at this topic, and uses an approach that is also useful at a team or individual level. Click here to explore this.

Porter's Value Chain is a useful strategic management tool.

It works by breaking an organization's activities down into strategically relevant pieces, so that you can see a fuller picture of the cost drivers and sources of differentiation, and then make changes appropriately.

A company is in essence a collection of activities that are performed to design, produce, market, deliver and support its product (or service). Its goal is to produce the products in such a way that they have a greater value (to customers) than the original cost of creating these products. The added value can be considered the profits and is often indicated as ‘margin’. A systematic way of examining all of these internal activities and how they interact is necessary when analyzing the sources of competitive advantage. A company gains competitive advantage by performing strategically important activities more cheaply or better than its competitors. Michael Porter’s value chain helps disaggregating a company into its strategically relevant activities, thereby creating a clear overview of the internal organization. Based on this overview managers are better able to assess where true value is created and where improvements can be made.

Figure 1: Porter’s Value Chain

One company’s value chain is embedded in a larger stream of activities that can be considered the supply chain or as Porter mentions it: the Value System. Suppliers have a value chain (upstream value) that create and deliver the purchased inputs. In addition, many products pass through the value chain of channels (channel value) on their way to the buyer. A company’s product eventually becomes part of its buyer’s value chain. This article will not go into the entire supply chain (from suppliers all the way to the end-consumer), but rather focuses on one organization’s value chain. The value chain activities can be divided into two broader types: primary activities and support activities.

Value Chain Analysis Video Tutorial

Primary activities

The first are primary activities which include the five main activities. All five activities are directly involved in the production and selling of the actual product. They cover the physical creation of the product, its sales, transfer to the buyer as well as after sale assistance. The five primary activities are inbound logistics, operations, outbound logistics, marketing & sales and service. Even though the importance of each category may vary from industry to industry, all of these activities will be present to some degree in each organization and play at least some role in competitive advantage.

Inbound Logistics

Inbound logistics is where purchased inputs such as raw materials are often taken care of. Because of this function, it is also in contact with external companies such as suppliers. The activities associated with inbound logistics are receiving, storing and disseminating inputs to the product. Examples: material handling, warehousing, inventory control, vehicle scheduling and returns to suppliers.

Operations

Once the required materials have been collected internally, operations can convert the inputs in the desired product. This phase is typically where the factory conveyor belts are being used. The activities associated with operations are therefore transforming inputs into the final product form. Examples: machining, packaging, assembly, equipment maintenance, testing, printing and facility operations.

Outbound Logistics

After the final product is finished it still needs to find its way to the customer. Depending on how lean the company is, the product can be shipped right away or has to be stored for a while. The activities associated with outbound logistics are collecting, storing and physically distributing the product to buyers. Examples: finished goods warehousing, material handling, delivery vehicle operations, order processing and scheduling.

Marketing & Sales

The fact that products are produced doesn’t automatically mean that there are people willing to purchase them. This is where marketing and sales come into place. It is the job of marketeers and sales agents to make sure that potential customers are aware of the product and are seriously considering purchasing them. Activities associated with marketing and sales are therefore to provide a means by which buyers can purchase the product and induce them to do so. Examples: advertising, promotion, sales force, quoting, channel selection, channel relations and pricing. A good tool to structure the entire marketing process is the Marketing Funnel.

Service

In today’s economy, after-sales service is just as important as promotional activities. Complaints from unsatisfied customers are easily spread and shared due to the internet and the consequences on your company’s reputation might be vast. It is therefore important to have the right customer service practices in place. The activities associated with this part of the value chain are providing service to enhance or maintain the value of the product after it has been sold and delivered. Examples: installation, repair, training, parts supply and product adjustment.

Support Activities

The second category is support activities. They go across the primary activities and aim to coordinate and support their functions as best as possible with each other by providing purchased inputs, technology, human resources and various firm wide managing functions. The support activities can therefore be divided into procurement, technology development (R&D), human resource management and firm infrastructure. The dotted lines reflect the fact that procurement, technology development and human resource management can be associated with specific primary activities as well as support the entire value chain.

Procurement

Procurement refers to the function of purchasing inputs used in the firm’s value chain, not the purchased inputs themselves. Purchased inputs are needed for every value activity, including support activities. Purchased inputs include raw materials, supplies and other consumable items as well as assets such as machinery, laboratory equipment, office equipment and buildings. Procurement is therefore needed to assist multiple value chain activities, not just inbound logistics.

Technology Development (R&D)

Every value activity embodies technology, be it know how, procedures or technology embodied in process equipment. The array of technology used in most companies is very broad. Technology development activities can be grouped into efforts to improve the product and the process. Examples are telecommunication technology, accounting automation software, product design research and customer servicing procedures. Typically, Research & Development departments can also be classified here.

Human Resource Management

HRM consists of activities involved in the recruiting, hiring (and firing), training, development and compensation of all types of personnel. HRM affects the competitive advantage in any firm through its role in determining the skills and motivation of employees and the cost of hiring and training them. Some companies (especially in the technological and advisory service industry) rely so much on talented employees, that they have devoted an entire Talent Management department within HRM to recruit and train the best of the best university graduates.

Firm Infrastructure

Firm infrastructure consists of a number of activities including general (strategic) management, planning, finance, accounting, legal, government affairs and quality management. Infrastructure usually supports the entire value chain, and not individual activities. In accounting, many firm infrastructure activities are often collectively indicated as ‘overhead’ costs. However, these activities shouldn’t be underestimated since they could be one of the most powerful sources of competitive advantage. After all, strategic management is often the starting point from which all smaller decisions in the firm are being based on. The wrong strategy will make it extra hard for people on the workfloor to perform well.

Linkages within the Value Chain

Although value activities are the building blocks of competitive advantage, the value chain is not a collection of independent activities. Rather, it is a system of interdependent activities that are related by linkages within the value chain. Decisions made in one value activity (e.g. procurement) may affect another value activity (e.g. operations). Since procurement has the responsibility over the quality of the purchased inputs, it will probably affect the production costs (operations), inspections costs (operations) and eventually even the product quality. In addition, a good working automated phone menu for customers (technology development) will allow customers to reach the right support assistant faster (service). Clear communication between and coordination across value chain activities are therefore just as important as the activities itself. Consequently, a company also needs to optimize these linkages in order to achieve competitive advantage. Unfortunately these linkages are often very subtle and go unrecognized by the management thereby missing out on great improvement opportunities.

Figure 2: Value Chain Linkages

Value Chain Analysis In Sum

In the end, Porter’s Value Chain is a great framework to examine the internal organization. It allows a more structured approach of assessing where in the organization true value is created and where costs can be reduced in order to boost the margins. It also allows to improve communication between departments. Combining the Value Chain with the VRIO Framework is a good starting point for an internal analysis. In case you are interested in the entire supply chain, you could repeat the process by adding the value chains of your company’s suppliers and buyers and place them in front and behind your own company’s value chain.

Further Reading: