Businesses do things to make money. Peter Drucker once said “the purpose of business is to create and keep a customer” and what a business does to create the customer and then keep them (the actions they perform, the resources they use, the people they employ and the assets they own) are all considered part of the business’s value. In almost all instance businesses use processes within their operation and these processes are most often linear in nature.

For example, sales need stock and service needs sales to have been made. Each element (sales, stock control and service) relies on another to add value to the business.

This linearity first gave rise to the notion that value might be incremental and flow through processes. In his best-selling work Competitive Advantage: Creating and Sustaining Superior Performance (1985) Michael Ported first coined the term value chain to describe this flow of “value” through the business and ultimately to realize profit.

Value chains exist in everything a business does. Sometimes there may be only a few value chains, often there are many. What’s more, if a business deals with other businesses (and it is most often that they do) each of the other businesses has their own value chains that flow on to the business itself.

You might consider that a value chain is a chain of activities for a business operating in a specific industry group (albeit that there may be a number of value chains within the larger chain).

Products and services pass through all activities of the chain in order and at each activity the product gains some value. The chain of activities taken gives the products more added value than the sum of the independent activity’s value; creating a margin.

It is important not to mix the concept of the value chain with the costs occurring throughout the activities. A diamond cutter, as a profession, can be used to illustrate the difference of cost and the value chain. The cutting activity may have a low cost compared to the cost of the diamond itself, but the activity adds much of the value to the end product, since a rough diamond is significantly less valuable than a cut diamond.

To put it about as simply as it can be there are inputs (raw materials, products, expertise, etc.) that are processed in some way (manufacturing, presentation, assembly etc.) to produce outputs (products, retail sales, services etc.); the difference between the cost of inputs being processed to create outputs and the price a customer might be prepared to pay for those outputs is considered margin.

In the modern “information world” the traditional value chains of the business have been turned on their heads. The “tried and tested” inputs, processes and outputs no longer play as they did and in some cases, the whole process has been reversed. This is none more evident than in the sales value chain and we discuss this in depth in book one.

A modern business manager needs to understand the concept of value chains and, most importantly, work out how to manage them in this new world. Customer Wise will help you do that.

Porter, M. (1985). Competitive Advantage: Creating and Sustaining Superior Performance. The Free Press.