Advanced Performance Management · Performance improvement models and techniques

Value Chain Analysis and Activity-Based Management for APM

Updated 11 October 2026 · Fact-checked

Value chain analysis splits a business into primary and support activities to see where value is created and cost is incurred. Activity-based management uses activity analysis and cost drivers to remove non-value-added activities and cut cost. In APM, you identify activities, link them to drivers, then recommend specific improvements.

Understand Value Chain Analysis and Activity-Based Management

A value chain is the set of activities a firm performs to turn inputs into a product or service customers pay for. Porter split these into primary activities and support activities. Primary activities are inbound logistics, operations, outbound logistics, marketing and sales, and service. Support activities are procurement, technology development, human resource management and firm infrastructure. The difference between the value customers pay and the cost of performing all activities is the margin.

The point is to ask where the firm creates value and where it only adds cost. A firm gains competitive advantage by performing activities at lower cost (cost leadership) or in a way that customers value more (differentiation). You look at each activity and ask how it contributes. You also look at the linkages between activities. For example, spending more on design may cut production and service costs. Cutting one activity's cost may harm another.

The chain does not stop at the firm's boundary. The firm sits in a wider value system with suppliers, distributors and customers. Savings and value can come from working with these parties, for example through shared systems, joint scheduling or outsourcing activities others do better.

Activity-based management (ABM) uses activity information to manage and improve performance. You list the activities, find the cost driver for each (the factor that causes the activity's cost to change), and classify each activity. A value-added activity is one customers would pay for and that changes the product or service in a way they want. A non-value-added activity adds cost but no value the customer wants, such as storing stock, moving materials, inspection and rework. ABM aims to cut or remove non-value-added activities and to manage cost drivers.

ABM has two sides. Operational ABM is about doing activities more efficiently: removing waste, improving processes, cutting cost. Strategic ABM is about choosing which activities, products and customers to pursue, based on their true profitability. Link this to wider tools such as BPR, lean and benchmarking when you recommend change.

Key rules to remember

Margin in the value chain: Margin = Total value to customers − Total cost of value activities; Use it to show that improving value or cutting activity cost raises margin.
Cost driver rate: Cost driver rate = Activity cost pool ÷ Total volume of the cost driver; Used to trace activity cost to products or customers, for example cost per set-up or per purchase order.
Activity cost of a product: Activity cost = Cost driver rate × Number of driver units the product uses; Add the cost of each activity to get the product's total overhead.
Non-value-added cost share: NVA share = Cost of non-value-added activities ÷ Total activity cost × 100%; A rough guide to the scope for savings. Only classify an activity as NVA if customers would not pay for it.
Porter's activity groups: Primary: inbound logistics, operations, outbound logistics, marketing and sales, service. Support: procurement, technology development, HRM, firm infrastructure; Know these names and apply them to the scenario's business.

How to solve Value Chain Analysis and Activity-Based Management questions

Use this method for any question on value chain analysis or ABM. Work from the requirement, and tie every point to the scenario.

1Read the requirement. Decide whether it asks you to analyse the chain, identify non-value-added activities, calculate activity costs, or recommend improvements.
2List the relevant activities from the scenario. Use Porter's headings as a checklist, but only discuss the ones the scenario supports.
3For each key activity, identify its cost driver and whether it is value-added or non-value-added. Give a reason based on what the customer values.
4Look at linkages. Note where changing one activity affects another, and where suppliers, distributors or customers in the wider value system could help.
5Calculate if required. Compute cost driver rates first, then apply them to products or customers, and show your workings.
6Recommend specific actions: remove, reduce, redesign, outsource or share an activity. Explain how each links to cost or value.
7Judge the risks and limits: cost of the change, damage to value-added activities, staff resistance, and quality of data. Finish with a clear recommendation.

Quickest way: Activity, driver, value test

When to use it: Use when time is short and the question asks for a short list of improvements or a comment on activities in a scenario.

Underline each activity named in the scenario and label it primary or support.
Next to each, write the cost driver and mark it VA or NVA in one line.
Pick the two or three largest cost or value issues and attach one concrete action to each.
Add one linkage or value-system point and one risk, then write the answer in short paragraphs with headings.

Common mistakes in Value Chain Analysis and Activity-Based Management

Listing Porter's nine activities with no link to the scenario.
Students recall the model and write it out to feel safe.
Fix: Use the model as a checklist only. Write about the activities the scenario describes and use its facts.
Calling an activity non-value-added just because it costs money.
Students confuse cost with lack of value.
Fix: Apply the customer test. If customers would pay for it or it is needed to meet their requirements, it adds value. Inspection may be needed by law, so say so.
Choosing the wrong cost driver, such as machine hours for an ordering activity.
Students default to volume-based drivers.
Fix: Ask what causes the activity to happen. Ordering is driven by number of orders and set-ups by number of batches.
Ignoring linkages and recommending cuts in isolation.
Students treat each activity as separate.
Fix: State the effect of each change on other activities. Cutting inspection may raise service and warranty costs.
Stopping at analysis and giving no recommendations.
Students describe the problem and run out of time.
Fix: End each point with an action, its expected benefit and a risk. That also earns professional skills marks.
Errors in the activity cost calculation, such as dividing by the wrong volume.
Students rush and mix up cost pools and drivers.
Fix: Write the rate formula, state units, and check that rate × total driver volume equals the cost pool.

Worked examples

Example 1

A firm has an ordering activity costing $120,000 a year, driven by 2,400 purchase orders. Product X needs 300 orders and Product Y needs 500 orders. Calculate the ordering cost traced to each product, and comment briefly on how ABM could use the result.

Show the solution

Cost driver rate = $120,000 ÷ 2,400 orders = $50 per order.
Product X: 300 × $50 = $15,000.
Product Y: 500 × $50 = $25,000.
Comment: the rate shows what each order costs. Reducing the number of orders, for example by consolidating suppliers or using electronic ordering, directly reduces this cost. Ordering is largely non-value-added to the customer, so it is a target for savings.

Answer: Ordering cost is $15,000 for Product X and $25,000 for Product Y, at $50 per order. ABM would target fewer or cheaper orders to cut this non-value-added cost.

Example 2

A furniture maker's activities and annual costs are: design $200,000, cutting and assembly $600,000, finished goods storage $100,000, rework of faulty items $60,000, delivery to customers $140,000. Customers value design, cutting and assembly, and delivery. Classify the activities, calculate the share of cost that is non-value-added, and recommend two actions.

Show the solution

Total cost = 200,000 + 600,000 + 100,000 + 60,000 + 140,000 = $1,100,000.
Value-added: design, cutting and assembly, delivery. Non-value-added: storage and rework.
Non-value-added cost = 100,000 + 60,000 = $160,000.
Share = 160,000 ÷ 1,100,000 × 100% = 14.5% (to one decimal place).
Action 1: reduce rework by improving quality at the cutting and assembly stage, for example better training or checks at source. Linkage: this also cuts delivery returns.
Action 2: reduce storage by building to order or using just-in-time scheduling with suppliers. Risk: stock-outs and late delivery, which customers would notice, so link the change to reliable supplier scheduling.

Answer: Non-value-added activities (storage and rework) cost $160,000, which is 14.5% of total activity cost. Improve quality at source to cut rework and move to build-to-order to cut storage, managing the risk of late delivery.

Exam tips

Always tie each point to a fact in the scenario. Generic model descriptions score few technical marks and no professional skills marks.
Define value-added and non-value-added from the customer's view and say why you classed each activity that way.
Show linkages and value system points. Examiners reward analysis beyond one firm's own activities.
When calculating, show the rate formula and the units, then add a sentence of comment. A number alone rarely earns full marks.
Recommend actions with benefits and risks, and write in a clear, professional format suited to the stated reader.

Practice questions from Performance improvement models and techniques

Value Chain Analysis and Activity-Based Management in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Value Chain Analysis and Activity-Based Management: frequently asked questions

What is the difference between primary and support activities?

Primary activities are directly involved in creating and delivering the product or service: inbound logistics, operations, outbound logistics, marketing and sales, and service. Support activities help the primary ones work: procurement, technology development, HR management and firm infrastructure.

How do I decide if an activity is value-added?

Ask whether the customer would pay for it and whether it changes the product or service in a way they want. Storage, inspection, rework and internal movement usually do not. If an activity is required by law or is a necessary control, say so rather than simply calling it waste.

What is a cost driver?

A cost driver is the factor that causes the cost of an activity to change. Examples are number of purchase orders for ordering, number of set-ups for machine set-up and number of deliveries for distribution. Choosing the right driver is the key to accurate activity costing.

How is ABM different from activity-based costing?

Activity-based costing is a method of tracing overhead to products using activity cost pools and drivers. ABM uses that information, and wider activity analysis, to make decisions and improve operations, such as removing waste and choosing which products or customers to keep.