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.

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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.

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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)

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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.
MORRISON, A.; PIETROBELLI, C.; RABELLOTTI, R. Global Value Chains and Technological Capabilities: A Framework to Study Learning and Innovation in Developing Countries. Oxford Development Studies, v. 36, n. 1, p. 39-58,  2008.
PORTER, M. Competitive Advantage: Creating and Sustaining Superior Performance.   Free Press, 2008.  ISBN 9781416595847.
READMAN, J.; GRANTHAM, A. Shopping for Buyers of Product Development Expertise:. How Video Games Developers Stay Ahead. European Management Journal, v. 24, n. 4, p. 256-269,  2006.
SCHMITZ, H. Local upgrading in Global Chains: Recent Findings..DRUID Summer Conference – Industrial, Dynamics, Innovation and Development 2004
SCHMITZ, H. Value Chain Analysis for Policy-makers and Practitioners.   International Labour Office, 2005.  ISBN 9789221177388.
STURGEON, T.; VAN BIESEBROECK, J.; GEREFFI, G. Value chains, networks and clusters: reframing the global automotive industry. Journal of Economic Geography, v. 8, n. 3, p. 297-321, May 1, 2008.
TOMASELLI, F. C.; DI SERIO, L. C. Supply Networks and Value Creation in High Innovation and Strong Network Externalities Industry. Journal of Technology Management & Innovation, v. 8, n. 4, p. 177-185,  2013.
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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.

A Dragon far from home: The rise of Chinese influence in Latin America and the reasons for South-South collaboration

article-logoOver the last years the world witnessed an impressive rise of the Chinese influence in Latin America, not only thru high-profile contracts but also large-scale investments: oil-for-cash deals with Venezuela, huge imports of commodities from Brazil and Argentina, billion-sized foreign direct investments in Brazil, Peru, Argentina and Ecuador. Taking into consideration that until recently Latin America has not been a traditional zone of Chinese influence such as Central and Southeast Asia, important questions arise: What are the reasons for such geopolitical and strategic movement? What does China seek in Latin America?

First, China is filling the void of the diminishing United States´ influence in the region. ISIS, Russia and Israel-Palestine conflict demand much more energy and attention that the southern countries in the American continent.  Second, weak local leadership provides additional explanation for Chinese growing influence because neither Brazil – Latin America´s main economy, nor Mercosur – regional trade bloc – has provided growth opportunities for Latin economies. This way, China is taking advantage of empty spaces left by region´s traditional historical leaders. Third, there is the center–left bias of current governments: Venezuela, Argentina, Ecuador, Bolivia and even Brazil turned their backs to US approaches. Fourth, Multinational companies from China follow the well-known theory of Eclectic Paradigm of internationalization, developed by John Dunning in the 90´s: China looks for new markets and new sources of resources in order to secure iron, oil, soybean, meat and rare earths, an effect Dunning called resource-seeking strategy. The demand from Chinese companies created what is commonly known as “The Latin American commodity boom”, which, as we just explained, was largely driven by new trade China, and concentrated in the petroleum, mineral extraction, and agricultural sectors. Figure 1 presents current Chinese investment and contracts in Latin America.

China Trade with LatAm

Figure 1: Chinese Chinese Investments and Contracts In Latin America 2005-2014, in US$ Billions, Source: American Enterprise Institute

A bold bet or a calculated risk?

Although China deals with somewhat risky country, both politically and financially, Chinese investments seem to be well-reasoned for two reasons: countries in the region desperately need to improve its crumbling infrastructure and China is an important destination for Latin America´s commodities. Therefore, a radical decision is unlikely from Latin countries. Table 1 presents main destinations of exports of several Latin countries.

 Brazil Argentina Venezuela Peru Colombia Chile Ecuador
 China Brazil China China US China US
 US Chile India US China US Chile
 Argentina China Singapore Switzerland Spain Japan Peru
 Netherlands US Spain Canada Panama South Korea Colombia
 Japan Spain US Japan Venezuela Brazil Venez´la
Table 1: Main destinations of exports of several Latin countries. Sources: Data from Globaledege (Michigan State University), except for Venezuela, from Observatory of economic complexity.

In conclusion, The chinese dragon has extended its zone of influence and Latin America is one of its targets. Global powers take advantage of voids and China is no exeception. In our next article we will discuss the sustainability of the Chinese strategy and its long-term impact in the Latin region.

Source of the picture: Evolving Globalization: http://evolving-globalisation.org/2014/03/24/an-overview-of-china-latin-america-economic-relations-who-are-the-winners-and-losers/