Question

Explain the relationship of value and cost according to the Porter model. When does it make sense to add cost to a business process?

Answer 1

Porter's value chain model describes the steps involved in transforming the raw material into finished product to gain from it. It includes five primary activities namely, inbound logistics, process, outbound logistics, sales and marketing and services. In the value chain model of Porter, the relationship of value and cost is that the outputs are changed from the inputs in such a way that the value of the output is greater than the cost of creating the output. The value and cost of the output created from the input through the process are compared to know the profit made from that product. Value is created by using the raw materials acquired to produce something useful. But understanding the value of the output from this process is important because that value defines its profit margin and the cost of manufacturing the product helps in defining the value. If the cost is higher than the value then the company will face losses. And the higher the value is the higher will be the profit margin of the company.

Cost is added to business processes when the company is following the competitive strategy or low-cost leadership. In low-cost leadership, the company provides low prices and better quality to the customer and for this decreases the cost of making the product thus making profits from it through costs and not through sales revenues. This low cost increases demand of product and more the product is sold, more the profitable the business is. A company following differentiation staretgy cannot focus of low cost activities as they will make a product that will be unique and it may increase the costs of manufacturing. Hence costs can be added in the process in a low cost leadership strategy of business.