# Value Chain Concept Card: [Company and course] > A concept card for value chain analysis: how to break a firm into the activities that create value, find what drives > the cost of each activity and what makes it valuable to buyers, test whether the activities fit together into a > system rivals find hard to copy, and decide which activities to keep, change or outsource. It is for MBA students in > the core strategy and operations courses, case-competition teams and managers preparing cost reviews or sourcing > decisions. Source basis: Porter (1985) for the value chain and its cost and differentiation drivers, Porter (1996) > and Rivkin (2000) for activity-system fit, Stabell and Fjeldstad (1998) for value shops and value networks, and > Coase (1937) and Williamson (1975) for make-or-buy, all written up in original words, notation and examples. Replace > every [bracketed] value and every row marked *Example*. ## Document control | Field | Value | |---|---| | Learner or team | [Your name or learning team] | | Course or project | [Core strategy course / operations course / client project] | | Firm or business unit | [Name], [segment] | | Period and cost data source | [Fiscal year], [management accounts, ABC study, interviews] | | Peer benchmark source | [Peer set, data source, year] | | Reviewed by | [Learning-team member, mentor or instructor] | | Version | [0.1] | | Last updated | YYYY-MM-DD | ## Contents - [1. When to use it](#1-when-to-use-it) - [2. The idea in plain language](#2-the-idea-in-plain-language) - [3. Primary and support activities](#3-primary-and-support-activities) - [4. Cost drivers and differentiation drivers](#4-cost-drivers-and-differentiation-drivers) - [5. Formulas and notation](#5-formulas-and-notation) - [6. Activity-system fit](#6-activity-system-fit) - [7. Value chain, value shop and value network](#7-value-chain-value-shop-and-value-network) - [8. Outsourcing and vertical scope](#8-outsourcing-and-vertical-scope) - [9. Assumptions and limits](#9-assumptions-and-limits) - [10. How managers use it](#10-how-managers-use-it) - [11. Worked example A (fully solved): Northfield Outdoor Co.](#11-worked-example-a-fully-solved-northfield-outdoor-co) - [12. Worked example B (half solved): repair service as a differentiation driver](#12-worked-example-b-half-solved-repair-service-as-a-differentiation-driver) - [13. Exercise C (unsolved): a rival's activity map](#13-exercise-c-unsolved-a-rivals-activity-map) - [14. Connections to other cards](#14-connections-to-other-cards) - [15. Common mistakes and misconceptions](#15-common-mistakes-and-misconceptions) - [16. Self-test questions](#16-self-test-questions) - [17. My notes and next steps](#17-my-notes-and-next-steps) ## 1. When to use it Use value chain analysis when the question is about **a firm's own sources of cost and differentiation**: - diagnosing why a firm's margin is above or below its peers in the same industry; - deciding where to invest to support a cost or differentiation position (see `mba/mba-competitive-advantage-card`); - deciding which activities to perform in-house, outsource, share with another business unit or redesign; - testing whether a strategy is coherent: do the activities reinforce one another, or do they pull in different directions? - preparing a cost-reduction programme that does not damage what customers pay for. It is less useful on its own for firms whose value comes from solving individual client problems (consulting, hospitals, law) or from connecting users (banks, telecoms, platforms). For those, use the value shop or value network logic in section 7. ## 2. The idea in plain language Porter (1985) argued that competitive advantage cannot be understood by looking at a firm as a whole. A firm is a collection of discrete **activities**: buying inputs, moving goods, running stores, marketing, servicing, designing products, hiring people. Each activity costs money and each can contribute to what buyers are willing to pay. A firm has a **cost advantage** when it performs its activities, taken together, at lower cost than rivals, and a **differentiation advantage** when it performs them in a way that creates more buyer value than the extra cost. In Porter's language, **margin** is the difference between the total value buyers pay for (revenue) and the collective cost of performing all the activities, including purchased inputs. Every activity either lowers cost, raises buyer value, or should be questioned. The value chain is also a map of **linkages**. Activities affect each other: better product design can reduce service costs; tighter inbound logistics can reduce store stockouts; a good returns process lets marketing promise a generous returns policy. Linkages extend outside the firm to suppliers' and channels' value chains, which together form a **value system**. Much of the advantage that lasts comes from these linkages, because a rival can copy one activity but finds it hard to copy a whole system of mutually reinforcing activities. ## 3. Primary and support activities Porter (1985) divides activities into five primary categories (involved in creating, selling and supporting the product) and four support categories (that support the primary activities and each other): | Type | Category | What it covers | Retail example | |---|---|---|---| | Primary | Inbound logistics | Receiving, storing and distributing inputs | Receiving vendor shipments, distribution centre storage, allocation to stores | | Primary | Operations | Transforming inputs into the final product | Running stores, merchandising, in-store service | | Primary | Outbound logistics | Collecting, storing and physically distributing the product | E-commerce picking, packing and delivery | | Primary | Marketing and sales | Giving buyers a means and a reason to buy | Advertising, loyalty programme, pricing, website conversion | | Primary | Service | Maintaining or enhancing the product's value after sale | Repairs, returns, product clinics | | Support | Firm infrastructure | General management, planning, finance, legal, quality | Head office, finance, legal | | Support | Human resource management | Recruiting, training, development, compensation | Store staff training, hiring | | Support | Technology development | Know-how, procedures and technology in all activities | Product design for private label, e-commerce platform, data | | Support | Procurement | The function of purchasing inputs (not the inputs themselves) | Vendor negotiation, sourcing for private label | Two clarifications avoid most confusion. First, **procurement is an activity, but purchased inputs are costs spread across activities**: the merchandise a retailer buys is a purchased input, while the buyers who negotiate it perform procurement. In Worked example A, merchandise cost is shown separately for that reason. Second, the categories are generic. Adapt them to the industry: a software firm's "operations" is hosting and running the service, and its "technology development" is the largest activity of all. ## 4. Cost drivers and differentiation drivers **Cost drivers** are the structural factors that determine the cost of an activity. Porter (1985) lists scale, learning, the pattern of capacity utilisation, linkages, interrelationships with other business units, integration, timing, discretionary policies, location and institutional factors. Examples: | Activity | Likely cost drivers | Question to ask | |---|---|---| | Inbound logistics | Scale (volume per lane), location of distribution centres, order patterns | Is our cost per unit received higher because of volume or because of design? | | Operations (stores) | Capacity utilisation (sales per square metre), location, staffing policies | Which stores have low utilisation, and is that structural? | | Outbound logistics | Order density, scale, automation (integration), returns rate | What does one more order cost us? | | Technology development | Scale (fixed cost spread over sales), timing (first-mover or follower) | Which development spend serves differentiation, which only keeps pace? | **Differentiation drivers** are the factors that make an activity valuable to buyers: Porter (1985) lists policy choices (features, service levels, input quality), linkages (between design and service, between the firm and its channels), timing, location, interrelationships, learning, integration, scale and institutional factors. Differentiation pays only when the price premium, or the extra volume at the same price, exceeds the extra cost of being unique. A useful test: for each activity, name the buyer purchase criterion it affects (price, reliability, convenience, expertise, brand) and how you know buyers value it. ## 5. Formulas and notation **Margin and activity cost shares.** For a firm with revenue $R$, purchased inputs $M$ and activity costs $c_a$ for activities $a = 1, \dots, A$: $$\text{Margin} = R - M - \sum_{a=1}^{A} c_a, \qquad \text{share of activity costs}_a = \frac{c_a}{\sum_{a} c_a}, \qquad \text{intensity}_a = \frac{c_a}{R}$$ **Gap to a peer benchmark.** With the peer intensity $b_a$ (cost as a share of revenue): $$\text{Gap}_a = (\text{intensity}_a - b_a) \times R$$ A positive gap means the firm spends more than the peer on that activity for each unit of revenue. Whether the gap is a problem depends on what the spending buys. **Differentiation test.** Differentiation through activity $a$ pays when $$\Delta P \cdot Q + \Delta Q \cdot m > \Delta c_a$$ where $\Delta P$ is the price premium per unit, $\Delta Q$ the extra units sold, $m$ the contribution margin per unit and $\Delta c_a$ the extra cost of the activity. **Make or buy (relevant costs).** For an activity with avoidable fixed cost $F_{av}$, in-house variable cost $v$ per unit, supplier fee $p$ per unit and volume $Q$: $$\text{Annual saving from outsourcing} = F_{av} + vQ - pQ, \qquad Q^{*} = \frac{F_{av}}{p - v}$$ Outsourcing saves money when $Q < Q^{*}$ (provided $p > v$). One-off transition costs and the strategic factors in section 8 are added on top. | Symbol | Meaning | Unit | |---|---|---| | $R$ | Revenue | USD m per year | | $M$ | Purchased inputs (merchandise, materials) | USD m per year | | $c_a$ | Cost of activity $a$ | USD m per year | | $b_a$ | Peer cost of activity $a$ as a share of revenue | percent | | $\Delta P$, $\Delta Q$, $m$ | Price premium, extra units, contribution per unit | USD, units, USD | | $F_{av}$ | Fixed cost that disappears if the activity is outsourced | USD m per year | | $v$, $p$ | In-house variable cost and supplier fee per unit | USD per unit | | $Q$, $Q^{*}$ | Volume and break-even volume | units per year | ## 6. Activity-system fit Porter (1996) distinguished **operational effectiveness** (performing similar activities better than rivals) from **strategic positioning** (performing different activities, or similar activities in different ways). Operational effectiveness is necessary but rarely sufficient, because best practices spread quickly. A sustainable position rests on trade-offs (choices that make some activities incompatible with others) and on **fit** among activities. Porter described three orders of fit: simple consistency between each activity and the overall strategy; activities that reinforce one another; and optimisation of effort across activities (coordination and information exchange that eliminate redundancy). Fit matters for imitation. If an advantage rests on many interlocking activities, a rival must match the whole system, and getting most of it right yields little: Rivkin (2000) modelled how complex, interacting choices make strategies hard to imitate, and Porter and Siggelkow (2008) examined how the interaction of activities shapes how sustainable an advantage is. Siggelkow (2001) traced how a firm with strong fit struggled to change when its environment shifted: fit is also a source of inertia. ```mermaid flowchart LR T1["Theme: expert service"] --- A1["Trained store staff (HR)"] T1 --- A2["Repair and clinic service"] T2["Theme: durable private label"] --- A3["Product design (technology development)"] T2 --- A4["Sourcing with long-term vendors (procurement)"] A2 --- A3 A1 --- A2 T3["Theme: community"] --- A5["Loyalty programme and events (marketing)"] A5 --- A2 A4 --- A6["Inbound logistics with fewer, larger shipments"] ``` The diagram shows Northfield's core themes and the links between activities. The repair service is linked to staff training (who performs it), product design (repair data improves durability) and the loyalty programme (repairs are a reason to return). Removing it to cut cost would weaken three other activities. ## 7. Value chain, value shop and value network Stabell and Fjeldstad (1998), building on Thompson's typology of technologies, argued that the value chain is one of three value configurations: | Configuration | How value is created | Primary activities | Examples | Main cost and value drivers | |---|---|---|---|---| | Value chain | Transforming inputs into products (long-linked technology) | Inbound logistics, operations, outbound logistics, marketing and sales, service | Manufacturing, retail | Scale, capacity utilisation | | Value shop | Solving a client's specific problem (intensive technology) | Problem finding and acquisition, problem solving, choice, execution, control and evaluation | Consulting, hospitals, engineering | Reputation, expertise, learning | | Value network | Connecting clients who want to be linked (mediating technology) | Network promotion and contract management, service provisioning, infrastructure operation | Banks, telecoms, insurance, platforms | Scale and capacity utilisation of the network, the number and mix of users | A **value network** in this sense is a business model where customers gain value from each other, which links to the platform and network-effect material in `mba/mba-strategy-guide`. The term is also used more loosely for the set of firms (suppliers, partners, complementors) that create value together, close to Porter's value system and to the strategic networks of Gulati, Nohria and Zaheer (2000). Say which meaning you use. ## 8. Outsourcing and vertical scope Every activity can, in principle, be performed inside the firm or bought from the market. Coase (1937) asked why firms exist at all if markets can coordinate production; his answer was that using the market has costs. Williamson (1975) developed transaction cost economics: activities that require **specific assets**, face **uncertainty** and occur **frequently** are more efficiently governed inside the firm, because contracts cannot anticipate every contingency and a supplier with specific investments can hold the buyer up, or the reverse. Work through four questions: 1. **Relevant cost.** Which costs disappear if we outsource (avoidable fixed and variable costs), and what will we pay instead, including transition and contract-management costs? (See `mba/mba-relevant-costs-card`.) 2. **Strategic importance.** Is the activity a source of our cost or differentiation advantage, or does it link closely to one that is? Prahalad and Hamel (1990) warned that outsourcing activities tied to core competences can hollow out a firm's ability to create future products. 3. **Market quality.** Are there several capable suppliers, or would we depend on one? Is the specification easy to write and the performance easy to measure? 4. **Flexibility and risk.** Does outsourcing turn fixed costs into variable costs we need (volume uncertainty), or lock us into a contract when volume grows (when the per-unit fee exceeds our variable cost)? ```mermaid flowchart TD A["Activity under review"] --> B{"Source of advantage, or tightly linked to one?"} B -->|"Yes"| C["Keep in-house and invest"] B -->|"No"| D{"Several capable suppliers and a measurable specification?"} D -->|"No"| E["Keep in-house, or partner with safeguards"] D -->|"Yes"| F{"Relevant-cost saving over the contract period, after transition costs?"} F -->|"Yes"| G["Outsource with service levels and exit terms"] F -->|"No"| H["Keep in-house, renegotiate quote or redesign the activity"] ``` ## 9. Assumptions and limits - **Cost data rarely match activities.** Accounts are organised by department and by nature (salaries, rent), not by activity. Allocating shared costs needs judgement; activity-based costing (Cooper and Kaplan 1988) helps. - **Benchmarks are imperfect.** Peers differ in mix, scale and accounting choices. A gap is a question to investigate, not a verdict. - **Value is harder to measure than cost.** The cost side of the chain is usually quantified; the differentiation side often rests on surveys and experiments. Treat both with the same rigour. - **The chain fits manufacturing and retail best.** Service firms and platforms need the value shop or value network logic (section 7). - **It describes, it does not prescribe.** The map shows where cost and value sit; the strategy still needs a choice of position and a check against the industry forces. - **Linkages are easy to miss.** Cutting the cost of one activity can raise the cost of another, or remove value elsewhere. Always ask what each activity enables. ## 10. How managers use it - **Cost reviews.** Map activity costs, compare with peers, then separate gaps that buy differentiation from gaps that reflect inefficiency. - **Strategy coherence.** Check that the largest spending supports the chosen position. A cost leader spending heavily on brand-building, or a differentiator under-spending on the activities customers value, has a coherence problem. - **Sourcing and scope.** Decide which activities to outsource, insource or share across business units. - **Integration planning after an acquisition.** Identify where two value chains overlap (shared procurement, logistics) and where linkages could create value. - **Digital redesign.** Ask how data and automation change each activity's cost driver (for example, from staff hours to software scale) and which linkages they make possible. ## 11. Worked example A (fully solved): Northfield Outdoor Co. **Setting.** Northfield Outdoor Co. (fictional) is a mid-size outdoor-gear retailer and brand with stores and an e-commerce site. Revenue in the last fiscal year was USD 480.0m and operating profit USD 30.0m (6.25%), below a peer group of specialty retailers. Management asks: where does the cost gap come from, and should e-commerce fulfilment be outsourced to a third-party logistics provider (3PL)? **Exhibit A1. Activity-cost breakdown, USD m (fictional).** Merchandise (purchased inputs) is USD 252.0m, 52.50% of revenue, so revenue less merchandise is USD 228.0m (47.50%). | Activity | Type | Cost | Share of activity costs | % of revenue | Peer % of revenue | Gap vs peer, USD m | |---|---|---|---|---|---|---| | Inbound logistics | Primary | 19.20 | 9.70% | 4.00% | 3.60% | 1.92 | | Operations (stores) | Primary | 74.40 | 37.58% | 15.50% | 14.00% | 7.20 | | Outbound logistics (e-commerce fulfilment) | Primary | 26.40 | 13.33% | 5.50% | 4.60% | 4.32 | | Marketing and sales | Primary | 31.20 | 15.76% | 6.50% | 6.80% | -1.44 | | Service (repairs, returns, clinics) | Primary | 9.60 | 4.85% | 2.00% | 0.90% | 5.28 | | Firm infrastructure | Support | 14.40 | 7.27% | 3.00% | 3.20% | -0.96 | | Human resource management | Support | 6.00 | 3.03% | 1.25% | 1.10% | 0.72 | | Technology development | Support | 12.00 | 6.06% | 2.50% | 2.00% | 2.40 | | Procurement | Support | 4.80 | 2.42% | 1.00% | 1.00% | 0.00 | | **Total activities** | | **198.00** | **100.00%** | **41.25%** | **37.20%** | **19.44** | Excel: share `=C2/$C$11`, intensity `=C2/$C$12`, gap `=(D2-E2)*$C$12` with intensity and peer values as decimals, total `=SUM(C2:C10)`. Primary activities cost USD 160.8m, support activities USD 37.2m. Margin check: $480.0 - 252.0 - 198.0 = 30.0$, or 6.25% of revenue (`=C12-C13-C11`). ```vega-lite { "$schema": "https://vega.github.io/schema/vega-lite/v5.json", "description": "Northfield Outdoor Co. activity costs as percent of revenue versus peer median (fictional, Worked example A)", "width": 360, "height": 260, "data": {"values": [ {"activity": "Inbound logistics", "who": "Northfield", "pct": 4.00}, {"activity": "Inbound logistics", "who": "Peer", "pct": 3.60}, {"activity": "Operations (stores)", "who": "Northfield", "pct": 15.50}, {"activity": "Operations (stores)", "who": "Peer", "pct": 14.00}, {"activity": "Outbound logistics", "who": "Northfield", "pct": 5.50}, {"activity": "Outbound logistics", "who": "Peer", "pct": 4.60}, {"activity": "Marketing and sales", "who": "Northfield", "pct": 6.50}, {"activity": "Marketing and sales", "who": "Peer", "pct": 6.80}, {"activity": "Service", "who": "Northfield", "pct": 2.00}, {"activity": "Service", "who": "Peer", "pct": 0.90}, {"activity": "Firm infrastructure", "who": "Northfield", "pct": 3.00}, {"activity": "Firm infrastructure", "who": "Peer", "pct": 3.20}, {"activity": "Human resources", "who": "Northfield", "pct": 1.25}, {"activity": "Human resources", "who": "Peer", "pct": 1.10}, {"activity": "Technology development", "who": "Northfield", "pct": 2.50}, {"activity": "Technology development", "who": "Peer", "pct": 2.00}, {"activity": "Procurement", "who": "Northfield", "pct": 1.00}, {"activity": "Procurement", "who": "Peer", "pct": 1.00} ]}, "mark": "bar", "encoding": { "y": {"field": "activity", "type": "nominal", "title": null, "sort": null}, "yOffset": {"field": "who"}, "x": {"field": "pct", "type": "quantitative", "title": "Cost as % of revenue"}, "color": {"field": "who", "type": "nominal", "title": null} } } ``` **Interpretation of the gap.** Northfield spends 41.25% of revenue on activities against 37.20% for peers, a gap of 4.05 points or USD 19.44m, which more than explains the margin shortfall. The gap is not uniform: - **Service (+USD 5.28m)** and **technology development (+USD 2.40m)** are deliberate: they fund repairs, clinics and private-label design, the core of Northfield's differentiation. The question is whether they earn a premium (Worked example B). - **Operations (+USD 7.20m)** is the largest gap. Sales per square metre in the bottom stores suggest low capacity utilisation, a structural cost driver; this points to store-portfolio decisions, not to cutting staff, because trained staff carry the expert-service theme. - **Outbound logistics (+USD 4.32m)** is a candidate for redesign or outsourcing. - **Marketing and sales (-USD 1.44m)** is below peers: the community and loyalty programme brings customers back at lower cost. **Outsourcing e-commerce fulfilment.** Northfield ships 1.10 million orders a year. In-house fulfilment costs USD 9.9m fixed (distribution centre lease, systems, supervisors) plus USD 15.00 variable per order, so $9.9 + 15.00 \times 1.10 = 26.4$, USD 24.00 per order. A 3PL quotes USD 21.50 per order, with a one-off transition cost of USD 1.8m. Of the fixed cost, USD 7.5m is avoidable; USD 2.4m (the remaining lease term) is not. | Item | Value | Excel | |---|---|---| | Annual saving at 1.10m orders | $7.5 + (15.00 - 21.50) \times 1.10 = 0.35$, USD 0.35m | `=7.5+(15-21.5)*1.1` | | Break-even volume $Q^{*}$ | $7.5 / (21.50 - 15.00) = 1.1538$m orders | `=7.5/(21.5-15)` | | Savings, years 1 to 3 at 1.10m, 1.20m, 1.30m orders | USD 0.35m, -0.30m, -0.95m | `=7.5+(15-21.5)*B2` | | NPV at 9% after transition cost | USD -2.465m | `=NPV(9%,C2:C4)-1.8` | | NPV if volume falls to and stays at 1.00m orders | USD 0.731m | `=NPV(9%,1,1,1)-1.8` | | NPV at growing volume if the fee falls to USD 19.50 | USD 3.581m | `=NPV(9%,2.55,2.1,1.65)-1.8` | At today's volume, outsourcing saves a little; at the planned growth, the per-order fee above the in-house variable cost turns the saving negative once volume passes 1.154m orders, and the transition cost makes the three-year NPV clearly negative. The recommendation is to **keep fulfilment in-house** and redesign it (order density, packing automation, returns handling linked to the repair service), or to go back to the 3PL for a tiered fee: at USD 19.50 the case turns positive. Strategically, fulfilment is not a differentiator for Northfield, so a tiered 3PL contract with service levels and exit terms would be acceptable if the numbers worked. ## 12. Worked example B (half solved): repair service as a differentiation driver Of the USD 9.60m service cost, USD 3.20m is the repair programme; it earns USD 1.10m in repair fees. A loyalty-data study shows that 48,000 customers used the repair service last year and made 0.6 more purchase trips a year than similar customers who did not, with an average basket of USD 110. Use the revenue-less-merchandise ratio of 47.50% as the contribution margin on extra purchases. 1. Net cost of the repair programme: $3.20 - 1.10 =$ [ ] USD m. 2. Incremental contribution: $48{,}000 \times 0.6 \times 110 \times 0.475 =$ USD 1.5048m (Excel `=48000*0.6*110*0.475/1e6`). 3. Net contribution of the programme: [ ] USD m. Is it positive? 4. Number of repair users needed to break even: $2.10\text{m} / (0.6 \times 110 \times 0.475) =$ [ ] users. 5. Name two linkages that the calculation leaves out, one that would raise the programme's value and one that might lower it. [ ] 6. Recommendation in two sentences: keep, grow, redesign or close? [ ] ## 13. Exercise C (unsolved): a rival's activity map A rival specialty retailer, Rival R (fictional), has revenue of USD 150.0m and merchandise cost of USD 84.0m. Its activity costs (USD m) are: inbound logistics 6.3, operations 24.0, outbound logistics 4.2, marketing and sales 13.5, service 0.6, firm infrastructure 5.4, human resource management 1.5, technology development 2.1, procurement 1.2. 1. Compute Rival R's total activity cost, operating profit and operating margin. 2. Compute each activity's cost as a percentage of revenue and compare it with Northfield in Exhibit A1. 3. What strategy do Rival R's activity choices suggest (cost, differentiation or something else)? Use at least three activities as evidence. 4. Rival R's merchandise cost is a higher share of revenue than Northfield's. Give two possible explanations in terms of activities and cost drivers. 5. Draw a three-theme activity system for Rival R as you infer it. ## 14. Connections to other cards | Card or guide | Connection | |---|---| | `mba/mba-five-forces-card` | Industry average profitability; the value chain explains deviation from it | | `mba/mba-competitive-advantage-card` | Cost leadership and differentiation built from activities | | `mba/mba-resource-based-view-card` | Resources and capabilities that make activities hard to imitate | | `mba/mba-activity-based-costing-card` | Assigning costs to activities properly | | `mba/mba-relevant-costs-card` | Make-or-buy and avoidable costs in depth | | `mba/mba-process-analysis-card` | Capacity, bottlenecks and utilisation inside an activity | | `mba/mba-npv-irr-card` | Discounting multi-year sourcing decisions | | `mba/mba-strategy-guide` | Vertical integration, platforms and the Corvane make-or-buy case | | `finance/unit-economics-analysis` | Per-order and per-customer economics behind activity costs | ## 15. Common mistakes and misconceptions 1. **Copying the organisation chart.** Departments are not activities; map what is done, not who reports to whom. 2. **Treating procurement as the cost of purchased inputs.** Procurement is the buying activity; inputs are separate. 3. **Calling Porter's margin a gross margin.** The value chain margin is revenue less the cost of all activities and purchased inputs. 4. **Reading every gap to peers as waste.** Some gaps buy differentiation; test them with the differentiation formula. 5. **Ignoring linkages.** Cutting one activity can raise costs or remove value elsewhere (the repair example). 6. **Outsourcing on total cost instead of relevant cost.** Unavoidable fixed costs remain after outsourcing. 7. **Forgetting volume.** A per-unit fee above the in-house variable cost gets more expensive as volume grows. 8. **Forcing the chain onto a service firm or platform.** Use the value shop or value network configuration. 9. **Confusing operational effectiveness with strategy.** Doing the same activities better than rivals is valuable but easy to copy; a position needs different activities or trade-offs. 10. **Outsourcing a core competence because it is expensive.** The cost of losing future capability is not in the quote. ## 16. Self-test questions 1. Name Porter's five primary and four support activity categories. 2. Define "margin" in the value chain sense and explain how it differs from gross margin. 3. Give three cost drivers from Porter (1985) and an activity each one typically affects. 4. What is the difference between operational effectiveness and strategic positioning (Porter 1996)? 5. Why does fit among activities make a strategy harder to imitate? Why can it also slow change? 6. Classify a law firm, a mobile network operator and a furniture maker as value chain, value shop or value network, with a reason for each. 7. In Worked example A, why does the saving from outsourcing turn negative as volume grows? 8. An activity has avoidable fixed cost USD 4.0m, in-house variable cost USD 6 per unit and a supplier fee of USD 8 per unit. Compute the break-even volume and the annual saving at 1.5 million units. 9. Name three transaction characteristics that, according to Williamson, favour performing an activity inside the firm. 10. Northfield's marketing and sales cost is below peers while its service cost is above. Give a linkage that could explain both. ## 17. My notes and next steps | Item | My answer | |---|---| | Firm or unit I will map next | [Name] | | Activity with the largest unexplained gap | [Activity and gap] | | Data I need (ABC study, peer benchmark) | [Source and owner] | | Linkage I want to test | [Activity A affects activity B through which mechanism] | | Review dates | [Two days], [one week] | ## Sources and further reading **Primary works.** - Porter, M. E. (1985). *Competitive Advantage: Creating and Sustaining Superior Performance*. New York: Free Press. - Porter, M. E. (1996). What is strategy? *Harvard Business Review*, 74(6), 61-78. - Porter, M. E., and Siggelkow, N. (2008). Contextuality within activity systems and sustainability of competitive advantage. *Academy of Management Perspectives*, 22(2), 34-56. - Rivkin, J. W. (2000). Imitation of complex strategies. *Management Science*, 46(6), 824-844. - Siggelkow, N. (2001). Change in the presence of fit: The rise, the fall, and the renaissance of Liz Claiborne. *Academy of Management Journal*, 44(4), 838-857. - Stabell, C. B., and Fjeldstad, O. D. (1998). Configuring value for competitive advantage: On chains, shops, and networks. *Strategic Management Journal*, 19(5), 413-437. - Coase, R. H. (1937). The nature of the firm. *Economica*, 4(16), 386-405. - Williamson, O. E. (1975). *Markets and Hierarchies: Analysis and Antitrust Implications*. New York: Free Press. - Prahalad, C. K., and Hamel, G. (1990). The core competence of the corporation. *Harvard Business Review*, 68(3), 79-91. - Gulati, R., Nohria, N., and Zaheer, A. (2000). Strategic networks. *Strategic Management Journal*, 21(3), 203-215. - Cooper, R., and Kaplan, R. S. (1988). Measure costs right: Make the right decisions. *Harvard Business Review*, 66(5), 96-103. **Textbooks (further reading only).** Grant, *Contemporary Strategy Analysis* (Wiley); Besanko, Dranove, Shanley and Schaefer, *Economics of Strategy* (Wiley); Magretta, *Understanding Michael Porter* (Harvard Business Review Press, 2012). **Open resource.** OpenStax, *Principles of Management* (CC BY-NC-SA 4.0), chapters on strategy and strategic analysis. ## Answer key **Worked example B.** 1. Net cost $3.20 - 1.10 = 2.10$, USD 2.10m. 2. Given: USD 1.5048m. 3. Net contribution $1.5048 - 2.10 = -0.5952$, USD -0.60m. Negative on the direct measure. 4. Break-even users $2{,}100{,}000 / (0.6 \times 110 \times 0.475) = 66{,}986$ (`=2.1e6/(0.6*110*0.475)`), about 40% more users than today. 5. Raises value: repair data improve private-label durability (lower warranty and return costs, technology development linkage); repairs support the brand and the loyalty programme, which keeps marketing cost below peers. Might lower it: customers who repair may buy replacement gear less often, and the 0.6 extra trips may partly reflect who chooses to use repairs (self-selection), not the effect of the service. 6. Sample answer: keep and redesign rather than close. Raise usage towards 67,000 by bundling repairs into the loyalty programme and pricing simple repairs to cover their cost, and test the effect with a controlled trial before expanding; closing it would weaken the expert-service and community themes for a saving of about USD 0.6m. **Exercise C.** 1. Total activities $6.3 + 24.0 + 4.2 + 13.5 + 0.6 + 5.4 + 1.5 + 2.1 + 1.2 = 58.8$, USD 58.8m. Operating profit $150.0 - 84.0 - 58.8 = 7.2$, USD 7.2m; margin 4.80%. 2. Rival R as % of revenue: inbound 4.20, operations 16.00, outbound 2.80, marketing and sales 9.00, service 0.40, infrastructure 3.60, HR 1.00, technology 1.40, procurement 0.80. Against Northfield: higher marketing and sales (9.00 vs 6.50), much lower service (0.40 vs 2.00) and technology (1.40 vs 2.50), lower outbound logistics (2.80 vs 5.50, suggesting a smaller online business). 3. A brand-and-promotion retailer of third-party products: it buys customers through marketing rather than retaining them through service, does little product development (so it sells mostly branded goods) and has a small online operation. It is neither a cost leader (operations and infrastructure are high) nor a service differentiator. 4. Merchandise is 56.00% of revenue (84.0/150.0) against 52.50% for Northfield. Explanations: little private label (branded goods carry lower retail margins; technology development is low); weaker procurement scale (smaller volumes, procurement only 0.80% of revenue); heavier promotional discounting (high marketing spend). 5. Sample themes: wide branded assortment (procurement, inbound logistics), promotion-driven traffic (marketing, pricing), lean back office (low technology and HR). Check that each activity links to at least one theme. **Self-test.** 1. Primary: inbound logistics, operations, outbound logistics, marketing and sales, service. Support: firm infrastructure, human resource management, technology development, procurement. 2. Revenue less the cost of all activities and purchased inputs. Gross margin deducts only the cost of goods sold. 3. Scale (logistics, technology development), capacity utilisation (stores, plants), location (stores, distribution centres); other drivers from section 4 count. 4. Operational effectiveness is doing similar activities better; positioning is doing different activities or the same activities differently, with trade-offs. 5. A rival must copy many interdependent activities at once and partial copying yields little. The same interdependence makes changing one activity costly, so firms with strong fit can be slow to adapt. 6. Law firm: value shop (solves client-specific problems). Mobile operator: value network (connects users). Furniture maker: value chain (transforms inputs into products). 7. The 3PL fee (USD 21.50) is above the in-house variable cost (USD 15.00), so each extra order costs USD 6.50 more when outsourced; above 1.154m orders this exceeds the USD 7.5m avoidable fixed cost. 8. $Q^{*} = 4.0 / (8 - 6) = 2.0$ million units. Saving at 1.5m units: $4.0 + (6 - 8) \times 1.5 = 1.0$, USD 1.0m. 9. Asset specificity, uncertainty and frequency. 10. The repair service and clinics build loyalty and word of mouth, so fewer marketing dollars are needed to bring customers back. ## Revision history | Version | Date | Author | Change summary | |---|---|---|---| | 0.1 | YYYY-MM-DD | [Your name] | First copy for [firm] | | 0.2 | YYYY-MM-DD | [Your name] | *Example:* Replaced departmental budgets with ABC study costs, re-ran fulfilment decision | ## Standard and licence note Structure aligned with the value chain and activity-system concepts of Porter (1985, 1996), the value configurations of Stabell and Fjeldstad (1998) and the transaction cost reasoning of Coase (1937) and Williamson (1975). The explanations, diagrams, worked examples, exercises and answers are original; no textbook or published case text is copied or paraphrased, and Northfield Outdoor Co. and Rival R are fictional. This template is independent and not affiliated with or endorsed by any author, publisher or school. Template licence: MIT.