The digital economy and network effects: value chains and multilateral platforms.

aparelhos-conectados

Introduction

“Airbnb’s market value: $ 30 billion, higher than the traditional Hyatt and Wyndham hotel chains.”

“Uber’s market value: $ 60 billion, higher than Ford or General Motors.” (Source: NYT, March 2016)

The information above shows two industries that suffered drastic structural movements. However, the changes that occurred in the mobile segment were even more dramatic. In 2007, the year Apple launched its iPhone, the top five handset manufacturers (Nokia, Samsung, Motorola, Sony Ericsson and LG) controlled the global market of the handset, but a few years later Apple gained the industry’s lead. Meanwhile, Motorola left the mobile segment after selling its manufacturing mobile device unit to China’s Lenovo and Nokia followed suit by selling its handset division to Microsoft.

How has the iPhone dramatically changed the structure of the mobile phone industry? Although Motorola, Samsung, and other manufacturers have classic strategic advantages such as first-mover advantages, economies of scale, proprietary technology, strong supply chain and established distribution channels, Apple outperformed its existing competitors by using the multi-platform business model, which will be explained bellow.

smartphones

What are multilateral platforms?

Business models based on multilateral platforms are the ones that connect producers and consumers to exchange goods, services, money of information. In the platform model, information and interactions between the participants are the main assets. With the increase in the number of participants, the value of the platform also increases, a phenomenon known as “network effect”. This fact is not new because it occurs with old-fashioned telephone lines, newspapers (each time the number of subscribers grows, circulation increases, more advertisers are attracted and consequently more subscribers join the newspaper) and shopping centers. Thus, a definition of the business model based on multilateral platforms is introduced below:

“[Platform] is a business model that creates value for multiple sides in a given market, by attracting both customers and suppliers, simplifying the purchase and remuneration processes of each network agent.”

Thus, a platform is a structure that creates value by allowing direct interaction between at least two distinct types of actors. With this definition, one can see that platforms have existed for a long time and do not necessarily have to be based on high technology: Barbie dolls serve as platforms for companies that sell plastic accessories for the doll, shopping centers unite consumers and merchants, and credit card companies connect consumers and retailers. The phenomenon that changed the concept of platforms was information technology (IT), which simplified and reduced the intrinsic cost of building multilateral platforms because it accelerated the entry of producers and users and annihilated the need for physical infrastructure and traditional assets. Uber and Airbnb are classic examples of multi-sided platforms because they unite car owners to passengers and apartment owners to travelers, even though both companies have no tangible assets (vehicles and apartments). Apple also understood the platform phenomenon because the company conceived the iPhone to connect participants on both sides of the ecosystem: developers of applications and end users.

Multilateral platforms are ecosystems

Marshal Alstyne, Geoffrey Parker and Sangeet Choudary, in their article “Pipelines, Platforms, and the New Rules of Strategy,” published in the April 2016 issue of the Harvard Business Review, present the idea that platforms are ecosystems formed by four actors: (i) owners (in charge of the governance of the platform), (ii) suppliers (setters of the platform interface with its participants), (iii) producers (suppliers of product or service in the platform) and (iv) consumers (users of the products or services offered by ecosystem).

It is interesting to note that actors can change roles. For example, passengers of Uber can work as drivers, travelers can offer their residences on Airbnb, job seekers look for jobs via LinkedIn but can also recruit potential candidates for their firms, and merchants who sell through credit cards can buy supplies through the same payment tool.

mundo-conectado

Economics 101: supply-side versus demand-side models

Exxon, Shell, American Airlines, Delta, Airbus, Boeing, General Motors, General Electric, Ford, Fiat, Siemens, Philips, hospitals and universities are examples of firms that base their business models on economies of scale; their high fixed costs mean that companies must increase sales to increase profitability, which will allow reducing prices, which will further improve sales. In supply-based business models, the rule of thumb is asset control (resources) and the ruthless pursuit of efficiency is a critical success factor.

On the other hand, the driving force behind demand-based models is the network effect, a phenomenon that is strengthened by technologies that enable network socialization, demand aggregation, and application development. In demand-driven business models, successful organizations are those that attract more participants to their platforms. This fact occurs because the more participants are in the ecosystem, the greater the possibilities of a combination of buyers and supplier. Companies like eBay, LinkedIn, Facebook, Google+, Tinder, Twitter and Instagram follow, to a greater or a lesser degree, to the demand-based model. Table I shows some differences between the first model, typical of the Industrial Economy, and the second model, paradigm of the Digital Economy. Some points presented in the table will be discussed in the following topics.

Industrial Economy Digital Economy
Focus Product Platform
Structure Value Chain Ecosystem
Source of Power Monitoring and control of the value chain Governance and architecture of the platform
Economic Model Economies of scale on the supply side Economies of scale on the demand side
Strategic assets Physical assets Ecosystem capacity, platform attractiveness
Market value Return on assets Return on transactions within the ecosystem
Source of growth Organic growth or acquisitions Network effects
Table 1 – Differences between models from the industrial and digital economies (Source: Techvision 2016, Accenture, adapted by the author)

From Value Chains to Multilateral Platforms

The value chain business model was the classic industrial paradigm for a few decades. Successful organizations were those who controlled a linear series of activities that began with product/service design, procurement of inputs, manufacturing, and marketing. Automobiles, electronic devices, clothing, refrigerators, locomotives, airplanes, and MBA courses are examples of products and services generated by value chains. The platform business model arises when companies create and govern environments (physical or virtual) in which content providers (such as Netflix) or applications (such as digital games) deal with their end users.

With the change of business models, from a value chain to that of a platform, the skills required for a company to succeed also change. First, rather than controlling resources (or assets), organizations must manage communities, made up of suppliers and consumers. Second, instead of seeking to maximize the value of an individual consumer, the ruler of a platform must maximize the value of a network of transactions. Finally, rather than monitoring a value chain, the governor of a platform must expand the ecosystem by attracting more consumers and producers. Table 2 shows how each model depends on the different types of assets.

Structure Economic Model Company and example if its platform Use of traditional assets Use of traditional and non-traditional assets Use of non-traditional assets
Traditional organizations, focusing on value chains and physical assets Industrial Economy, economies of scale on the supply side General Electric (Predix),
General Motors (connected vehicle)
High Low Low
Hybrid organizations, which use a combination of value chains and platforms Hybrid economic model that pursue economies of scale both on supply and demand sides Nintendo, Sony, Microsoft (digital gaming consoles such as PlayStation, Xbox, Wii) Average Average Average
Non-traditional organizations focused on platforms Digital Economy, economy of scale by demand side Google (Android), Airbnb, LinkedIn, Twitter (respective applications) Low Low High
Table 2 – Different organizational structures, economic models and asset types (Source: Techvision 2016, Accenture, adapted by the author)

Strategy, value chains, and platforms

The value chains used in the Porter´s 5-forces model are stable and the boundaries between consumers, suppliers and competitors are well defined; however, in multilateral platforms, the contours can change rapidly. Netflix is a content provider for digital platforms, however, it can become a competitor in case the firm starts to attract suppliers and content providers to a brand-new platform.

The development of strategies in the case of value chains is synonymous of building barriers, but in the case of digital platforms, the focus should be on the elimination of barriers for producers and consumers, to allow them to interact with each other. For digital platforms, however, the name of the game is about governance, that is, controlling what consumers, producers, and even competitors can do within the platform. Therefore, governance must address the openness of the network. In conclusion, digital platforms consist of rules and architectures. For example, in the digital games segment, Apple opted for a closed platform while Google (Android) offers an open platform.

It’s important to note that businesses based on platforms may fail due to a variety of reasons. First, the leadership requirements of a value chain are very different from those of an ecosystem. Second, decisions about the types of consumer and producer may be inadequate, Third, the platform may be very slow in acquiring consumers and producers. Fourth, the platform may be insufficiently convenient for one side, with Twitter being an example of this problem. Fifth, execution may imperfect. Finally, entry barriers are small for platforms and many companies can build ecosystems for the same industry. For example, Groupon and its numerous competitors in the collective purchasing segment show that too many platforms decrease the value of each of them. In this case, many ecosystems compete for the same commercial space (aggregation of purchases) without a dominant ecosystem. Like any model prior to it, platforms are not immune to the wrong business decisions

Conclusion

Multilateral platforms are: (i) business models suited to an evolving, double-sided digital economy; (ii) are based on economies of scale on the demand side; (iii) offer an alternative value proposition to the traditional value chain model because ecosystems do not require traditional resources, and (iv) require specific skills from the platform governor. However, like any business model, multilateral platforms are no guarantee of success and will certainly be surpassed by another paradigm in the future.

Recommended Literature:

1. Ph.D. thesis from Luiz Ojima Sakuda, Universidade de São Paulo.  www.teses.usp.br/teses/disponiveis/…/LuizOjimaSakudaCorr16.pdf
2. Van Alstyne MW, Parker, GG, Choudary, SP Pipelines, Platforms, and the New Rules of Strategy. Harvard Business Review, April 2016 (pp.54 – 60, 62)
3. Techvision 201 6, Accenture
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Report on Brazilian Multinationals

Two important academic Brazilian institutions, the University of São Paulo (USP) and Fundação Getúlio Vargas (FGV), published a few weeks ago a report about the strategies used by Brazilian multinationals. The study was a result of a research project which goal was to understand how Brazilian companies are conducting their international expansion.

As the project’s focus is both practical and academic, the authors divided the answers according to the main motivating factors for internationalization, namely: access to (new) markets; access to technology & knowledge; access to resources and proximity to customer, suppliers and partners.

Analysis of results

Figure 1 presents the results for the motivating factors for internationalization of Brazilian companies. Chart importanceFIGURE 1: FACTORS FOR INTERNATIONALIZATION (SOURCE: GINEBRA, 2015)

The results show that the most important driving forces to internationalization are the access to technology & knowledge and the access to resources aimed at optimization of efficiency. Additionally, the survey also shows that access to markets and proximity to customers, suppliers and partners are the least important motivators for the internationalization of Brazilian companies.

The high relevance of the access to technology reflects the view that Brazilian multinationals recognize the existing gap in relation to the most advanced technologies and the most dynamic markets. The authors also argue that the operational mode for international expansion has been the acquisition of other companies based on developed markets, in order to reduce the technological gap in relation to the most demanding customers.

Access to markets and proximity to customers, suppliers and partners are the least important factors for Brazilian multinationals. The results also show that only few multinationals sell directly to the international markets, which means that Brazilian firms are, in general, suppliers of inputs for various industries. Thus, an important part of Brazilian multinationals presents some kind of global production chain.

Brazilian Multinationals vs. Innovation

Approximately 40% of Brazilian multinational believe that innovation is key to obtain cost reduction, therefore innovation becomes and important piece in their technology strategy. This outcome is interesting because other reports also indicate that innovation in process is often considered one of the key strengths in Brazilian corporations.

Internationalization strategies

The competitive strategies most commonly found among brazilian multinationals are: Global Consolidator  and Global Partners. Companies in these two categories are part of international supply chains of goods and/or services, which results that Brazilian companies are often suppliers of input or parts of more complex products. This result is consistent with previous researches developed by of the authors. Table 1 below shows the distribution of Brazilian multinationals in the five categories of international strategies of multinational companies.

Table

TABLE 1: DISTRIBUTION OF BRAZILIAN COMPANIES 

The articles “Five internationalization strategies of multinationals from emerging markets” and “Country of Origin Effects and their impact on multinational from emerging markets” explain each of the categories identified above and the concept of effect of countries of origin and their impact on Brazilian multinationals.

Conclusions

The picture presented by the current research shows that significant changes have occurred in the group formed by Brazilian multinationals, namely:

  1. The number of Brazilian multinationals increased in the three economic sectors, but growth was most remarkable in the service sector. Although the total number of Brazilian multinationals is still modest compared to the number of multinationals from other emerging countries, the expansion observed seems to reveal that internationalization is being increasingly accepted by the local, native firms.
  2. Decisions for internationalization are taken individually, with few actions of encouragement and support from the local government, which is a marked contrast with the scenario found in other countries. For instance, internationalization of Chinese companies is part of a country-level strategy for international trade and foreign policy.
  3. The political and economic crisis that currently affects Brazil may become a motivator for internationalization of Brazilian firms.
  4. The observed strategies reveal that companies seek to enter and expand in international markets in order to consolidate positions in global value chains rather than to advance within the chains. In other words, Brazilian multinationals seek to strengthen current position in industries in which they are already strong. According to the authors, this strategy is different from the ones seen in other emerging countries, especially China, whose companies are making acquisitions to advance technologies and businesses in which they had no previous experience.

Authors on internationalization (Casanova,   Fleuryshow that the Brazilian multinationals are few and small compared with similar companies in other emerging countries. The psychic distance of Brazilian companies, inadequate infrastructure, and biased government support to the finger-pointed companies – the so called “national champions”, are explanations to the low degree of internationalization of Brazilian companies.

As usual, here comes a question for the restless minds:

Which Brazilian companies will continue their internationalization processes despite the current political and economic crisis?

Country-level branding: What should be Brazil´s message?

world_map___country_flags-1920x1080-1-1024x576

Brazil should be concerned with the message it sends to the world, in addition to the definition of regional targets for FDI (Foreign Direct Investment) and trade (link to previous post here). While some countries are stereotyped and a few others are not, many of them invest in very-focused, specific messages that they deliver to the world. An ordinary marketing expression applied to Brazil would be: The country needs to identify its brand and communicate it to global markets in order to facilitate business. Table 1 presents a simplified list of general strenghts and qualities associated with selected countries. From an international trade perspective, Brazil sends no clear message to investors worldwide.

Country Business strengths and messages associated with to country
India IT services, software programming, spiritual life
Germany Engineering, precision, rigor
Japan High technology, R&D, consumer electronics
US Innovation, capitalism, multinationals, top level universities, technology
UK Think-tanks, English language, Oxbridge, tradition, royalty, stability
France Aerospace  technology, wines, fashion, sophistication, gastronomy,
China Industry, multinationals, low-cost manufacturing
Italy Fashion, design, arts, gastronomy, history
Brazil Rain forest, exotic places.

Table 1: Messages delivered by several countries

CountryBrand Image

An interesting free report about country-level brands can be downloaded for free from FutureBrand (a consultancy) website. The material presents major points about the messages delivered by several countries and points out that Latin America has potential for strong country brands but currenly no country in the region developed a strong brand worldwide.

As usual, a question to my demanding readers: Do you know a country that positively changed its message over time?

Link to Country Brand Image report developed by FutureBrand here

Link to image of flags here

Image of country ranking taken from FutureBrand´s Country Brand Index 2014-2015.

Geopolitics of business: Where Brazil should go?

InternationalTradeThe economic science has taught that resources are finite. Therefore, prioritization is the name of the game for institutions, managers and even countries. Lourdes Casanova and Julian Kassum, in their great book “The Political Economy of an Emerging Global Power – In Search of the Brazil Dream” address the unfinished debate about the priorities of Brazilian foreign policy. The authors argue that Brazil needs to find its role on the global stage. Which regions or countries should Brazil focus its efforts to increase trade and invest in order to make a difference in the global arena?. As Prof Casanova and Mr. Kassum clearly puts: “Where Brazil should go?” The many geographical options include, but are not limited to, Brazil´s own neighbors – Latin America, Brazil´s traditional commercial partners – the US and EU, Brazil´s newest trade partner – China, other BRIC countries – Russia and India, and the newest trade frontier – Africa. Table 1 presents a brief, unilateral and unfinished comparison between the pros and cons for each option. As usual, this blogger kindly accepts any comments and criticism.

Pros Cons
Latin America Size of Brazilian economy compared to the economies of other countries; long history of intraregion trade; peaceful frontiers Diminishing intraregion trade over time, growing populism in the region; situation of Venezuela and Argentina
US Size of US domestic market; US as a source of technology and innovation Subsidies to local producers of steel and ethanol, among other items
EU Size of EU markets, strong presence in LatAm of EU multinationals from Germany, France, Italy, Spain and Sweden Subsidies to many agricultural products
China Size of Chinese domestic market Possible deceleration of chinese economy, very large CAGE distance
Other BRIC economies: Russia and India Size of market, alternative sources of technology (aerospace, computer science) Non-tariff trade barriers, large CAGE distance, different political agenda
Africa Potential trade frontier with the political and economic stabilization of the continent;  Brazil can be a source of technology and high-value services (expertise in large infrastructure projects, project management); strong cultural ties between Africa and Brazil Lack of knowledge of local markets, obscure regulations

Table 1: Brazil´s geographical options for investment and international trade

The crossroad that Brazil currently faces is not uncommon because many other countries had to make difficult decisions in the past. Japan became an industrialized country during the last century because it reshaped its foreign policy and South Korea is currently a rich country because invested heavily in education. It´s time for the latin giant to make choices. Brazil needs a plan to improve its position in the world and a strategy that answers a critical question: Where Brazil should go?

Brazil in Latam

As usual, I leave a question to the followers of this blog: Do you know any other country that survived a difficult scenario and succeeded after making hard choices?

Source of image of “International Trade” here; source of image of Brazil here

Development Banks and the Latin America and Caribbean region

international_offshore_bankingModern literature shows that development banks have supported the development of Latin America and the Caribbean (LAC) region, a part of the world with insufficient infrastructure and non-efficient capital markets. However, multilateral development banks could do better as market developers. Musacchio and Lazzarini (Reinventing State Capitalism: Leviathan in Business, Brazil and Beyond) present evidences from a very large development bank (Brazil´s BNDES) that this kind of financial institution causes mixed effects in the development of the recipients of loans and grants. Multilateral banks help governments and private sector when offer knowledge to governments, when spread best practices among debtors and when provide low-cost credit to the countries of the LAC region. However, the criticism about multilateral development banks includes: i) self-established risk-management policies that severely limit potential support to national governments, and ii) their preferred selection of companies with good political connections.   

How about the differences between the many multilateral institutions in the LAC region? Brief explanations are listed bellow together with some of their characteristics and contexts.

World Bank: The World Bank is a source of financial and technical assistance to developing countries around the world, not only the ones in the Latin America and Caribbean. An institution which is part of the United Nations, the World Bank provides low interest loans and credits as well as grants to developing countries. In additional to its financial services, the organization provides policy advice, research, analysis, and technical assistance. The World Bank has been criticized by the conditions imposed on borrowing countries and its bias towards a neoliberal model of growth. Despite the criticism, the World Bank is one of the most highly-regarded financial institutions in the world. In addition, its environmental standards for project evaluation became benchmark for project evaluation worldwide.

BNDES (Brazilian Development Bank) is the second largest development bank operating in Latin America, with US$ 303,3 Billion in assets and net income of US$ 3,2 Billions (as of Dec 14). Although the bank supports social initiatives in education, mass transportation, basic sanitization and small agriculture, this heavily subsidised development bank usually finance large-scale industrial groups. For example, 62% of the 2014 disbursements of US$ 79 Billion targeted large enterprises (defined by revenues above US$ 100 million).  Historically an important player in the industrial development of Brazil, a late-industrialized country, BNDES has been criticized for supporting the international expansion of “National Champions”, i.e. large, private companies that were cherry-picked but the Federal Government to receive large amounts of subsidized credit lines in order to increase the international relevance of Brazilian multinationals.

IDB (Inter-American Development Bank), a financial institution  focused on Latin American and Caribbean countries. IDB is an organization affiliated to the Organization of American States. The IDB makes loans to the governments of its member countries and has preferred creditor status, meaning that borrowers will repay loans to the IDB before repaying other obligations to other lenders such as commercial banks. According to its own website, IDB is not only the oldest and largest regional multilateral development bank but also the main source of multilateral financing for economic, social, and institutional development in Latin America and the Caribbean. The bank supports governments, private sector and small to medium-sized business.

CAF (Corporación Andina de Fomento, Development Bank of Latin America) was established to promote Andean development and integration serving public and private sectors. According to Financial Times (link) CAF funds more infrastructure projects In Latin America than World Bank and IDB together but is accused of opacity and low lending standards.   

CABEI (Central American Bank for Economic Integration) is Honduras-based development bank with total assets of US$ 8 billion, focused on lending to its founding member countries: Guatemala, Honduras, El Salvador, Nicaragua and Costa Rica. Due to its high portfolio concentration in only five countries and their low borrower quality of its members, CABEI holds the lowest credit rating among the multilateral development banks in the region.

FLAR (Fondo Latinoamericano de Reservas) and CDB (Caribbean Development Bank) are the smallest development banks of in Latin America and Caribbean region.  Both organizations maintain very strong capital position and ample liquidity to balance their negative aspects: the high concentration and credit risk embedded in their loan portfolio.  

In order to understand multilateral institutions, Figure 1 shows the differences between them. The x-axis presents the return-on-assets of the development banks, the y-axis their equity-to-loans ratio and the area of the circles shows their total assets.

Dev Banks 1Figure 1: comparison of multilateral banks in LAC. (Source: author)

As we can see from the graphic above, BNDES is more profitable (compared to total assets) than IDB and World Bank. This is explained by the fact that both multilateral banks are more risk averse (i.e. have better rating) than their Brazilian counterpart, as shown by Table 1.

Development banks

S&P
IDB
AAA
World Bank
AA+
CDB
AA
FLAR
AA
CAF
AA-
CABEI
A
BNDES
BBB-

Table 1:  S&P ratings for development banks in Latin America.

bank-of-international-settlements-warns-against-further-loose-monetary-policy

Regarding lending policies, BNDES disbursed almost eighteen times the total amount disbursed by the Word Bank and eight times the amount IDB did in 2014. This is explained by the aggressive lending policy pursued by BNDES to support Brazilian multinationals and the creation of Brazilian “national champions”. Picture 2 illustrates total lending compared to its counterparts.

Development Bank 2

Figure 2: Total disbursements 2014. (Source: author)

In conclusion, the current debate about multilateral development banks includes, but are not restricted to:

  1. Real vs. potential impact on regional growth due to the conditions imposed by such organizations to countries;
  2. Pro-market bias mostly by World Bank and IDB, and
  3. Focus on large and well-connected corporations in the case of BNDES, which is called “Lender of the first resort” for supporting national champions and the internalization process of Brazilian multinationals

Final question for the curious minds: How could multilateral companies mitigate currency and operational risk?

References:
  1. Center for Global Development:  Why Multilateral Development Bank Practices Are So Far from Their Potential
  2. Investors Relation websites: World Bank, IDB, BNDES, CAF, CABEI, CDB, FLAR
  3. Musacchio, A. Lazzarini S.G. Reinventing State Capitalism: Leviathan in Business, Brazil and Beyond (Harvard University Press, 2014)

Link to picture of globe and bills here; link to picture of bank here

Upgrading in global value chains (GVC)

upgrading question mark

The structure of a global value chain is not necessarily static, given that companies in global chains have economic reasons (increase in profitability) and non-economic motivations (increase of competences) to perform greater quantity of tasks and/or more complex ones. Accordingly, the second key concept of GVC – upgrading -, deserves further analysis. Barrientos, Gereffi and Rossi (2011) define upgrading as:

“(Upgrading) is the movement towards productive activities with higher value, technology, knowledge and skills and increased profits derived from participation in global production chains” (Barrientos Gereffi, ROSSI, 2011)

However, as the definition of is upgrading is not enough, Gereffi and other authors define four possible types of it (Gereffi et al., 2001):

1. Product Upgrading: occurs when there is an increase in quality, features or value of products. Usually this kind of improvement requires increase in competences in order to allow the manufacturing of products with superior performance.

2. Process Upgrading: more efficient transformation of inputs into outputs through the use of superior technology or reorganization of production systems. For example, the production reorientation involved in the change of craft to mass production, and from there to lean production (or just-in-time).

3. Functional Upgrading (or within the chain): involves different types of opportunities to gain new functions within the chain, such as moving to design or marketing. There may be also movements “forward or backward” in the different stages of the chain, changing the production of final produtcts to intermediate goods or raw materials, and vice-versa (a movement called vertical integration). Many studies illustrate the path that begins with the process control (OEM, Original Equipment Manufacturing), then the product (ODM,  Own Design Manufacturing), and finally the brand (OBM, Own Brand Manufacturing).

4. Upgrading between Chains: occurs when firms apply the skills acquired in a specific function in one chain (e.g. competence in production or marketing) to a new value chain (generally more advanced). For example, a company or a cluster of companies specialized in the manufacturing of internal combustion engines for heavy vehicles could develop engines for tractors or bulldozers.

An overlooked issue is the limited opportunity for growth provided by GVC. On the one hand global chains offer development opportunities for less industrialized countries to gain access to new markets (mainly in industrialized countries), new technologies and skills. On the other hand entry in GVC specializes to companies to provide low-cost subsets; additionally, firms become conformed to remain at this level of activity. This is because the chain leader has positioning advantages that allow it to allocate production plans and command the distribution of value between the participants of the chain. What companies from emerging countries should do to overcome this situation and command more value from the chains they belong? The answer: competences. Humphrey and Schmitz (2000) and Bazan and Navas-Aleman (2004) make it clear that upgrading opportunities occur more often in chains of modular, relational and captive types, and especially product and process upgrading, while functional uograding seems to be almost impossible.

images

Type of chain versus possibility of upgrading

The possibility of upgrading in GVC is dependent on the type of the chain. In the market and hierarchical types the probabilities of upgrading are lower than the ones in the intermediate chains (modular, relational and captive). Specifically for firms from emerging countries participants of the captive chains, the possibility of rapid upgrading is confined to products and processes. This is because this type of chain works under the leadership of major global producers, which provide parameters and obligations to their suppliers due to the following factors:

1. Product differentiation: As producers pursue the strategic option called “product differentiation” through design or branding, they need to provide precise specifications and monitor supplier´s compliance to these requirements.

2. Risk of failure of suppliers:The growth of competition based on factors such as quality, responsiveness and reliability, along with the increasing concerns about safety, make global buyers to become more vulnerable to deficiencies in the performance of their suppliers.

Thus, chain leaders transfer skills to the participants due to products with greater complexity and to risks. This sharing of knowledge helps suppliers because they benefit from the participation in environments that make upgrading possible. But, if on the one hand the leaders facilitate the development of new products and processes, on the other hand they do not allow their suppliers to migrate to other functions, i.e., there is no evidence on migration for functions such as design, branding and marketing. This occurs because of two types of obstacles: purchase power and necessity of resources.

  1. Purchase Power: the source of power in a supply chains is found in non-manufacturing activities such as branding, marketing, product development and coordination of relations between participants of the GVC. Leading firms concentrate in these activities because they are the firm´s main competences. Therefore it is not surprising that these companies do not share their competences with their suppliers. In some cases, leading firms even try to stop suppliers from acquiring such skills in order to avoid the rise of future competitors.
  2. Need for resources: Companies from developing countries seeking to develop their own global brands or to create marketing channels in most industrialized countries rarely succeed because they are not able to sustain these efforts due to the huge investment requirements, whether in tangible or in intangible assets.

chain

Is upgrading suited for everyone?

One aspect not totally discussed is whether upgrading is the most appropriate strategy over the long run for all firms because risks and competition are much higher in the upper segments of a GVC. In fact, some companies choose to stay in safer niches without even trying to upgrade. For a type of firms, keeping the status quo – their current position in the GVC – is their strategic option due to their own risk aversion and to the higher competition found in advanced segments of the value chain. According to Michael Porter (2008), the three generic competitive strategies (low cost, product differentiation and focus) tend to be mutually exclusive. This may explain why some companies are not successful with functional upgrading. An organization needs to develop competences in advance in case the firm moves to a new functional level. (Fleury, Fleury; 2008)

Duke

What is missing in the GVC analysis?

The increasing complexity of global supply chains has led to formulation of several theories to understand the phenomenon of global dispersion of manufacturing. While the GVC focuses on the analysis of value creation and different capture of value among the firms, Global Production Network (GPN) analyzes not only the interactions between leading companies and their suppliers but also a wide spectrum of actors that influence the global production, such as institutional and social actors, national governments, multilateral organizations, business associations, non-governmental organizations and policy makers.

REFERENCES
BAIR, J. Frontiers of Commodity Chain Research.   Stanford University Press, 2008.  ISBN 9780804759243.
FLEURY, A.; FLEURY, M. T. Alternatives for industrial upgrading in global value chains: The case of the plastics industry in Brazil. Ids Bulletin-Institute of Development Studies, v. 32, n. 3, p. 116-+, Jul 2001.
GEREFFI, G. Beyond the producer-driven/buyer-driven dichotomy: The evolution of global value chains in the internet era. IDS Bulletin, v. 32, n. 3, p. 30-40,  2001.
GEREFFI, G.; FERNANDEZ-STARK, K. The Offshore Services Global Value Chain. Center on Globalization, Governance & Competitiveness, Duke University, p.67. 2010
______. Global Value Chain Analysis: a Primer. Center on Globalization, Governance & Competitiveness (CGGC) – Duke University. Durham, North Carolina, p.40. 2011
GEREFFI, G.  et al. Introduction: Globalisation, Value Chains and Development. Institute of Development Studies. 2001
GEREFFI, G.; HUMPHREY, J.; STURGEON, T. The governance of global value chains. Review of International Political Economy, v. 12, n. 1, p. 78-104,  2005.
GIBBON, P.; BAIR, J.; PONTE, S. Governing global value chains: an introduction.Economy & Society, v. 37, n. 3, p. 315-338,  2008.
GRANTHAM, A.; KAPLINSKY, R. Getting the measure of the electronic games industry: developers and the management of innovation. International Journal of Innovation Management, v. 9, n. 2, p. 183-213,  2005.
______. Spreading the Gains from Globalization: What Can Be Learned from Value Chain Analysis? Institute of Development Studies. Brighton. 2000
KAPLINSKY, R.; MORRIS, M. Handbook for Value Chain Research: IDRC 2000.
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Organizational forms for Multinational Corporations: Bartlett, Ghoshal & Nohria.

9914653-background-concept-wordcloud-illustration-of-multinational-corporation-glowing-lightOne of the classical ideas in business administration is the principle of requisite complexity, which states that “the complexity of a firm´s structure must match the complexity of its environment”.  Easy to understand but hard to apply because firms became complex multinationals and local markets turned into global ones.

Initially, the “stages model” proposed by Stopford and Wells (Figure 1) explained how multidivisional companies are structured regarding two dimensions: the number of products sold internationally (“foreign products diversity”) and the importance of sales to the company (“foreign sales as a percentage of total sales”). According to this framework some companies facing substantial increases in foreign product diversity tend to adopt the worldwide product division structure (Pathway A), while companies that expanded their sales abroad without significantly increasing foreign product diversity typically adopted the area structure (Pathway B). In case both foreign sales and foreign product diversity were high, companies resorted to the global matrix.

StopfordWells final

Figure 1 –Stopford and Wells model (Stopford, Wells, 1972)

However, Stopford´s and Wells´ model does not explain how Multinational Corporations (MNC) respond to other forces e.g. adaptation to environments. As a consequence, two other frameworks are necessary: one to explain how multinationals adapt to the surrounding environment and another to explain how companies with global reach and many subsidiaries are structured.

Types of MNC Environments

Theory developed by Nitin Nohria (From Harvard Business School) and Sumantra Ghoshal (From MIT, deceased) shows that there are four distinct environments faced by multinationals: global environment (strong forces for global integration and weak forces for local responsiveness); multinational environment (strong forces for national responsiveness and weak forces for global integration); transnational environment (both contingencies are strong), and international environment (both contingencies are weak). Figure 2 shows how different industries are classified by according to global integration and local responsiveness:

Ghoshal and Nohria 2 Figure 2 – Environments of MNC and classification of industries (Ghoshal and Nohria, 1993)
Classification of structures and four patterns

The nature of headquarters-subsidiary relationship is key this classification. The authors explain that there are three basic governance mechanisms that underlie these relationships: centralization, formalization and normative integration, a special type of pattern which occurs when there is a set of shared goals, values, and beliefs that shape the perspective and behavior of managers. According to these dimensions there are four possible MNC structures:

  1. Structural uniformity: occurs when MNC shows little variance in how the subsidiaries are managed; there is a strong and uniform governance mechanism for the whole company. Overall integration is high and there is little attention to differentiation. There is a common “company way” for the governance of all headquarter-subsidiaries relationships.
  2. Differentiated fit: companies that adopt different governance modes to fit each subsidiary´s local context. When a company recognizes these differences, it can explicitly differentiate its headquarter-subsidiaries relationships to ensure that the management processes fit each local context.
  3. Integrated variety: This pattern occurs when a firm adopts the logic of differentiated fit but overlays the distinctly structured relationships with a dominant overall integrative mechanism — whether through strong centralization, formalization, or normative integration
  4. Ad Hoc Variation: This pattern exists when there is neither a dominant integrative mechanism nor an explicit pattern of differentiation to match local contexts.

The relationship between headquarters (HQ) and subsidiaries (SUBS) became a hot topic in International Business. Additional analysis developed by professors Christopher Bartlett (from Harvard Business School) and Sumantra Ghoshal identified four types of strategies pursued by MNC, each balancing the potential needs of global integration and global differentiation. According to the authors, MNCs should choose the strategic model that satisfies the needs of the environment in order to secure global competitiveness. The option for a specific strategic model should be made through an evaluation of forces towards global integration, global differentiation or both. The strategic choice must fit the pressures of the environment, where MNCs should try to build the strategic capabilities wanted by customers. Figure 3 presents the balance of forces between integration and differentiation, while the following paragraphs describe how the different corporate strategies are impacted by this balance.

Bartlett_Goshal

Figure 3 – Typology for MNC (from Bartlett and Ghosal, 1989)

Multidomestic (low pressure for integration – high pressure for differentiation): This strategy is based on responsiveness to local market demands and this is exactly one of its strenghts. The structure of the MNC will be a portfolio of autonomous national companies containing their entire value chain. The main weakness of this model comes from the circumstance that innovation and knowledge developed at these national companies will most likely stay there.

International (low pressure for integration – low pressure for differentiation): This strategy is based on home country expertise. The majority of the value chain will be maintained at the headquarter. The control of technologies used for production and general management systems will be structured and developed at home. The development of knowledge and innovation will stream from the home organization to the subsidiaries.

Global (high pressure for integration – low pressure for differentiation): This strategy is heavily based on economies of scale. The subsidiaries of the MNC are rather weak and a full value chain will only exist at the HQ. The subsidiaries are tightly coupled to the home organization, and are heavily dependent on resources and know-how from the home organization. Innovation and development will be created at home, and later diffused to remaining subsidiaries.

Transnational (high pressure for integration – High pressure for differentiation): This strategy tries to maximize both responsiveness and integration, where knowledge and innovation is developed and dispersed within the entire network. The MNC is regarded as a network, and each subsidiary is given responsibility compared to its capabilities and strategic mission. Relocation of managers across the MNC is critical because it allows the mutual development and dispersion of innovation and knowledge.

For the aficionados of visual representation, Figure 4 presents the four types of strategic options that MNCs pursue.

HRIS

Figure 4 –  Four strategies for MNC (Martin, Lexy and Beaman, 2000)

References:

Bartlett, C. A., and S. Ghoshal. Managing Across Borders: The Transnational Solution. Harvard Business School Press, 1989.

Ghoshal, S., and N. Nohria. “Horses for Courses: Organizational Forms for Multinational Corporations.” MIT Sloan Management Review 34, no. 2 (winter 1993): 23–35.

Martin, Lexy and Beaman.”leveraging HR Technology: From Global Saving to Transnational Value.2000. from Jeitosa Group International.

Stopford, John M., and L. T. Wells Jr. Managing the Multinational Enterprise: Organization of the Firm and Ownership of the Subsidiary. NY: Basic Books, 1972, French ed.