Integrating SMEs into Global and Regional Value Chains: Implications for Subregional Cooperation in the Greater Mekong Subregion
George Abonyi
[email protected]
Prepared for UNESCAP Bangkok November 2005
Table of Contents I. II.
III.
Introduction A Primer on Global Value Chains and International Production Networks 1. Introduction 2. Global Value Chains 3. International Production Networks 4. Increasing Importance of GVCs and IPNs 5. Accessing Global Markets Through GVCs/IPNs: Implications 6. How SMEs Fit Into GVCs/IPNs Accessing Selected GVCs: Constraints and Opportunities 1. Introduction 2.
Agribusiness: Fresh Fruit and Vegetable GVC
3.
Wood Furniture GVC
4.
Apparel GVC
5.
Automobile Components GVC
IV.
Preparing SMEs for Competing on International Markets 1. Accessing Global Markets: Constraints on SMEs 2. Loosening Constraints through Business Development Services (BDS) 3. The Role of Enterprise Clusters V. Recommendations for GMS Subregional Initiatives to Support SME Participation in Global Value Chains 1. Overview 2. Proposed Work Program for UNESCAP 3. Concluding Comments Selected References
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I.
Introduction
The challenge to developing economies in the GMS, both middle-income countries such as Thailand, and lagging poorer economies such as Lao PDR and Cambodia is two-fold: (i) how to access global markets; and (ii) how to do so in a way that provides for sustainable income growth (allowing for increasing pricing power or “value creation” over time). These are particularly serious challenges for producers from lagging economies, and at the firm level for small and medium enterprises (SMEs) who face significant constraints on their capabilities to compete effectively on global markets. It is important to underline the second dimension of the challenge to SMEs in accessing global markets, noted above: to ensure sustainable income growth. Given price pressure on exports, particularly manufactures, there is a danger that producers may be able to expand their presence in global markets, yet face falling returns unless they are able to upgrade to higher value added activities. This is a problem familiar to exporters of commodities, but it is increasingly also to be found in manufactured exports, especially labour intensive manufactures from developing economies, such as wood furniture, and of particular relevance to SMEs that generally have limited pricing power and limited capabilities and options to upgrade. Box 1. Wood Furniture Industry: Output Growth but Declining Income 1 The wood furniture industry is resource based, labour intensive, and plays an important role in many developing economies. At the same time, leading producers are from high wage developed economies, suggesting possibilities for allowing low-wage economies to move up the ladder of industry specialization and income. However, growing competition and falling prices in key segments of the industry are creating conditions for some developing country producers where they expand output, yet cannot achieve sustained income growth when they are unable to upgrade, i.e. move to higher value-added activities. Recent experience from a wide range of countries and industries indicates that SMEs can participate effectively in international production and access global markets. In particular, integration into the global economy increasingly means participation in “global value chains” (GVCs) by linking local producers, including SMEs, to “international production networks” (IPN). 2 However, this poses important new challenges for domestic producers, particularly SMEs, who must meet a wide range of increasingly stringent global standards--with respect to quality, price, timely delivery, flexibility. Furthermore, the competitive performance of lead firms in global markets depends ultimately on the performance of the entire network of production linkages in such value chains or networks, posing new challenges to GMS governments and firms. 1
See Section III for a discussion of the wood furniture global value chain, including this issue. See for example, USAID, Trade, Micro, and Small Enterprises, and Global Value Chains, United States Agency for International Development, microReport #25, February, 2005; UNIDO, Inserting Local Industries Into Global Value Chains and Global Production Networks, United Nations Industrial Development Organization, Vienna, 2004. 2
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Global value chains and international production networks are the product of two interrelated processes transforming the international economy—driven by increasing economic liberalization and technological development--with important implications for the competitiveness of companies, and the prosperity of nations. The first is the process of integration of product markets and relocation of economic activities within these markets: the internationalization of production. This is leading to the emergence of global value chains (GVC) in an increasingly broad range of product groups or industries; and integrating an expanding set of geographic locations. The second involves reorganization of firms’ activities around core competencies, involving ‘breaking up’ of production, marketing and distribution systems and moving them outside the firm and/or new locations. This is creating international production networks (IPN) involving the coordination and integration of production among geographically dispersed locations; more and more involving non-equity relationships among participating firms. This paper explores the implications of the emergence of global value chains and associated production networks for SMEs in the Greater Mekong Subregion. Section II discusses GVCs and IPNs, including what they are; why they are playing an increasingly important role in the global economy; and their key characteristics. Selected GVCs of particular relevance to the GMS are discussed in Section III, including their potential implications for SMEs. Given the challenges to SMEs of participating in such chains and networks, Section IV discusses ways in which the capabilities of SMEs may be enhanced, including through Business Development Services (BDS) and by cooperation through enterprise ‘clusters’. The final section, V, presents specific recommendations for subregional cooperation in the GMS to strengthen the capacity of SMEs to participate and upgrade in global value chains and networks, with a focus on initiatives where UNESCAP could potentially play an effective role.
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II.
A Primer on Global Value Chains and International Production Networks 3 1.
Introduction
The ideal is for individual GMS producers to access international markets directly by selling final products with ‘pricing power’ and ‘brand presence’ to international customers. This requires that enterprises, including SMEs, have significant capabilities including: information on existing conditions in markets, on available production technology, and on existing product-market competition; capabilities to design, produce, market, distribute, and service the product on global markets; and to respond effectively to changing market conditions, including evolving tastes, new competitors, etc. In practice, it is difficult for even larger enterprises from the GMS, let alone SMEs, to meet the above ideal conditions. Increasingly intense global competition in product-markets is forcing prices down; and production, technological, and management capabilities up. This is creating a difficult competitive environment for enterprises that do not possess the range of necessary capabilities. Furthermore, even successful enterprises may find it hard to stay competitive over time as domestic economic and global productmarket conditions change. In this context, global value chains and associated production networks may be seen as a ‘second best strategy’ for accessing global markets. Under some conditions, there may be little choice for enterprises but to participate in GVCs and associated production network. That is, as noted, in an increasingly wide range of product markets GVCs are becoming the dominant organizing framework for production, and associated trade and investment. 4 More generally, GVCs and associated production networks may provide more manageable opportunities for SMEs to access global markets and upgrade capabilities over time. For example, within the framework of such global value chains SMEs can specialize in a limited set of activities or components, and through membership in associated production networks access large regional and global markets. 2.
Global Value Chains
Value chains: A value chain refers to the full range of value-added activities required to bring a product from its conception, through design, sourcing raw materials and intermediate inputs, production, marketing, distribution and support to final consumer. It presents a ‘systemic perspective’ that incorporates all key activities related to the production, exchange, distribution, and after sales support for a given product or service. A value chain can span enterprises in a local economy, a national economy, a 3
This section draws on Abonyi, G., Challenges of Industrial Restructuring in a Globalizing World: Implications for Small- and Medium-scale Enterprises (SMEs) in Asia, ISEAS Working Paper: Visiting Researchers Series No. 3(2003), Institute of Southeast Asia, Singapore, 2003; and Abonyi, G., The New Face of Global Competition: Global Value Chains and International Production Networks, prepared for the Greater Mekong Subregion Investment Working Group, Asian Development Bank, July 2004. 4 See for example UNCTAD, World Investment Report 2002, United Nations Conference for Trade and Development, Geneva, 2002.
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subregional or regional grouping of economies such as the GMS or ASEAN, and the global economy. A simplified value chain is presented in Fig. 1. Fig. 1 A Simplified Value Chain 5
A particular firm may choose to focus on one specific activity (and associated products) in the value chain, such as manufacturing, or sales; or several activities—the ‘vertically integrated’ enterprise. A more comprehensive and complex picture of a generic value chain along with supporting inputs and institutions is presented in Fig. 2. Fig. 2 Generic Value Chain and Supporting Inputs 6
5
UNIDO, Inserting Local Industries into Global Value Chains and Global Production Networks, United Nations Industrial Development Organization, Vienna, 2004, p. 6. 6
Sturgeon, T.J, “How Do We Define Value Chains and Production Networks”, Industrial Peformance Centre, Massachusetts Institute of Technology, April 2001.
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A simplified representation of the wood furniture Global Value Chain is presented in Figure 3.
Fig. 3 The Wood Furniture Value Chain 7
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Source: Kaplinsky, R. and M. Morris, A Handbook for Value Chain Research, IDRC, Ottawa 2001
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Global value chains (GVC): Value chains become ‘global’, when their component activities are geographically dispersed across borders to multiple country locations. In general, the proportion of products conceived, manufactured, and consumed entirely within the geographic boundaries of a single country is shrinking. Even services, such as financial, consulting, and customer support services are becoming mobile across borders. The global apparel value chain presented in Figure 4 is an illustration, reflecting the internationalization of apparel production. Value chain vs. supply chain: A supply chain generally refers to inbound and outbound logistics of a particular firm. A value chain encompasses the entire range of productive activities associated with a given product or service, irrespective of firm
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boundaries. For example, in the apparel value chain in Fig. 4, the supply chain of a firm producing yarn would include the backward or input sourcing-related linkages to suppliers of natural fibres, and the forward or output delivery-related linkages to customers who are producers of fabrics. The apparel global value chain, however, includes the entire set or system of production-related activities from raw material inputs to sales, independent of particular firms involved. Value chains and industries: The value chain of the apparel industry in Fig. 4 also demonstrates potential differences between industry and value chain perspectives. Apparel production straddles more than one industry: it is closely linked to both agroindustry (e.g. wool, silk, cotton as inputs) and petrochemicals (e.g. for synthetics). These inter- or multi-industry linkages are reflected in the value chain representation whose focus is on key activities related to particular product groups, irrespective of industry or sector boundaries. Furthermore, value chain activities include manufacturing and services. In this context, non-manufacturing activities—increasingly with high ‘intellectual content’, such as R&D, engineering, design, sales, marketing, information systems, customer service—contribute most of the value added in many manufactured products. 8 . This is also reflected explicitly in the value chain representation.
8
See Quinn, J.B., The Intelligent Enterprise, The Free Press, New York 1992.
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Fig. 4 Apparel Global Value Chain 9
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Source: Fig. 1, Gereffi, G. and O. Memedovic, The Global Apparel Value Chain, UNIDO, Vienna 2003
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3.
International Production Networks
Production Networks: A production network represents linkages within or among a group of selected firms in a particular value chain (GVC) for producing specific products such as computers, mobile phones, or cars. It represents how lead firms in the network, such as Toyota, Cisco, or Nike organize their particular networks of subsidiaries, affiliates, or suppliers to produce a given product. What distinguishes lead firms from non-lead firms in a network is that they control access to key resources and activities that give them leverage over the enterprises in the production network--and often generate the most profitable returns (e.g. product design, new technologies, brand names, market access/consumer demand). An international production network (IPN) involves the distribution and coordination of geographically dispersed activities in multiple country locations. Box 2. A Production Network within the Global Apparel Value Chain To produce a line of garments, a global retailer such as Levi might purchase South Korean yarn that would be woven and dyed in Taiwan by a subsidiary; send the fabric to be cut in Bangladesh by a subcontractor; ship the pieces for final assembly to an affiliate in Thailand, where the garments would be matched with Japanese zippers, and deliver the finished product to geographically dispersed affiliated retailers in North America and Europe. This set of firm-specific linkages, within the framework of the global apparel value chain (Fig. 4) constitutes a particular international production network. 10 Intra-firm international production networks: A production network, such as the one described above, may be primarily internal to a firm, involving ownership linkages among subsidiaries and affiliates in different geographic location. This is the classic transnational or multinational, vertically integrated corporation. In this case the coordination and control of production and related activities is internalized within a particular firm, though it may stretch across borders. Box 3. Intra-firm International Production Network: Denso The Japanese company Denso is the world’s fourth largest automotive component manufacturer. It was spun off in 1949 by Toyota, which still retains a 23% ownership interest. Denso has a broad portfolio of automotive products related to thermal systems, powertrain control systems, electronic and electrical systems. It employs around 70,000 people in subsidiaries and affiliates in 25 countries, with two thirds in Japan, around 10% each in North America, Europe and India. Denso’s relies heavily on geographically distributed and coordinated production
10
See Brown, J.S., S. Durschlag, and J. Hagel III, “Loosening up: How process networks unlock the power of specialization”, McKinsey Quarterly, No. 2, 2002
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network, primarily in Asia. Denso’s regional production network in Southeast Asia is presented in Fig. 5. 11
Fig. 5 Denso’s Regional Production Network in Southeast Asia 12
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Based on Global Production Networks in Europe and East Asia: The Automotive Components Industry, GPN Working Paper 7, May 2003. 12 Ibid, p.51
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Inter-firm (non-equity based) production network: Increasingly, production networks involve non-equity linkages, in which formally independent enterprises-suppliers, producers, and retailers--are linked through a variety of relationships such as subcontracting, licensing, common technical standards, marketing contracts and shared network product- and process-related standards. In an increasing number of industries, producers sell into final markets through such non-equity based production networks; usually coordinated by lead firms who set the standards for participation. The term “international production network” or IPN will be used here, unless otherwise indicated, to generally refer to this type inter-firm network. A given firm may belong to more than one such network. For example, in the apparel GVC a firm specializing in dyeing may be part of the production network where the lead firms include Levi, Nike, and Wall Mart; and the major auto parts supplier, Lear, is a member of the production networks of a number of lead auto assemblers, including among others GM, Ford, Toyota, and VW. Box 4. Cisco, Nike and the role of ‘Lead Firms’ in Chains and Networks Cisco Systems and Nike act as lead firms in the telecommunications and the shoe industries, respectively. Although in very different industries, Cisco and Nike both play the critical role as ‘lead firms’ in setting product and process standards; determining which producers are incorporated into the network; which market segments a producer will serve; with what product mix; which functions producers will undertake, e.g. production, design, marketing; and in which areas a producer will be allowed to upgrade, e.g. move upstream from manufacturing to design. 13
4.
Increasing Importance of GVCs and IPNs
Challenge of coordination: Traditionally, one approach to the challenge of coordination of production has been to bring activities along the value chain within the control of a single firm, and coordinate them through ownership and direct management. This has resulted in the vertically integrated firm—together with subsidiaries, affiliates, and joint ventures--and coordination through hierarchy: the same firm retains ownership and control of inputs, components, and products as they are transformed along the value chain. The traditional hierarchical, vertically integrated automobile manufacturers such as GM and Ford provided, until recently clear examples. Alternatively, activities along a value chain may be ‘coordinated’ by ‘arms length’ transactions through markets. In this case products change ownership as they move between activities along the value chain, with no overall coordination of production among firms. An example in the apparel industry is a clothing manufacturer purchasing yarn on the open international market; or a supermarket purchasing fresh fruit on the market from any available supplier. Dismantling hierarchies: Increasing competitive and cost pressures are leading hierarchical, vertically integrated firms to focus on a few selected core activities through the ‘outsourcing’ of activities and the corresponding shedding of assets. Advances in 13
From Abonyi, G. “Linking Asia Together”, Asian Wall Street Journal, 5 December 2000.
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information and communication technology are reducing the need for ownership or equity-based control of activities in the value chain, allowing lead firms to ask much more of their suppliers in terms of rapid response, design collaboration, lower costs; and provide for closer product and process monitoring. At the same time, the rising competence of suppliers allows them to take on added responsibilities. As a consequence, firms are increasingly focusing on their ‘core competencies’—activities they see themselves doing well and that allow them to capture higher returns—while outsourcing non-core activities. This is transforming traditionally vertically integrated hierarchical firms in a variety of industries into ‘networks’. (e.g. Levi Strauss in apparel) or into a ‘hybrid’ forms of hierarchy with network characteristics (e.g. Ford and GM in the automotive industry).
Box 5. From producing globally to buying globally Levi Strauss, the most prominent brand name in jeans, has historically prided itself on its own global production structure. This was maintained even in the 1990s, as competitors in the industry increasingly outsourced production capacity. Toward the end of the 1990s, however, significant declines in both profits and market share forced the company to close half its 22 plants in North America. Production capacity was increasingly outsourced to contractors throughout the world, and by the first half of 2004 the US clothing giant shifted all of its company-owned North American manufacturing to outside suppliers in Asia and other low-cost areas of the world. However, Levi Strauss is retaining key value-added functions such as brand management, marketing, and product design, and defining standards for suppliers to participate in and upgrade in its ‘production network’. 14 GM and Ford were the classic example of the hierarchically integrated firm in the automotive industry. However, by the late 1990s both GM and Ford had spun off much of their parts-manufacturing operations to Delphi Automotive Systems and Visteon, respectively. Today, Ford, and GM mostly design and assemble vehicles, and their suppliers mostly make what goes into them. Although Levi Strauss and Ford are in very different industries, under the pressure of increasingly intense global competition, their transformation from vertically integrated hierarchical enterprises has meant moving noncore assets and activities to external suppliers, but within the framework of coordinated production networks. Controlling markets: Global buyers increasingly want more information and control with respect to their suppliers, and further back in the value chain. This is driven 14
From Abonyi, G., Challenges of Industrial Restructuring in a Globalizing World: Implications for Smalland Medium-scale Enterprises (SMEs) in Asia, ISEAS Working Paper: Visiting Researchers Series No. 3(2003), Institute of Southeast Asia, Singapore.
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by a number of factors. Competitive pressures are forcing firms to eliminate stocks and reduce ‘time-to-market’ to lower costs, and improve flexibility. Final product markets are increasingly characterized by a simultaneous consumer demand for higher quality, lower prices, speed (e.g. rapid response in production and distribution, shorter product lifecycles), flexibility (e.g. build-to-order, configure-to-order); as well as increasingly stringent standards, including general standards such as SA8000 on labour, industryspecific standards such as phytosanitary standards in agro-industry, and firm-specific standards such as the in-house brands of global retailers like Carrefour. Therefore in industries as diverse as electronics, computers, apparel, and fresh vegetables the trend is away from ‘arms length’ market-based transactions, toward production networks, involving some form of linkage or alliance among firms along the value chain. 15 Emergence of ‘network orchestrators’: The transformation of production is also creating conditions for firms to emerge from the outset as ‘networked firms’, such as Cisco, Dell, Nike, and Li & Fung. These are firms that never owned production facilities, and are essentially ‘network orchestrators’ whose basic role—and the basis for their competitive advantage--involves coordinating and integrating activities along a given value chain. The competitive success of such firms is reinforcing the increasing prevalence of the ‘network approach’ in a growing range of product-markets. For example, there is evidence indicating the superior competitive (financial) performance of such ‘network orchestrators’ in a variety of industries. 16 In general, because they own fewer assets and leverage the resources of partner companies, network orchestrators require less capital and generate higher revenues then traditional firms under both expanding and adverse market conditions.
5.
Accessing Global Markets Through GVCs/IPNs: Implications i.
A Link to Global Markets
Although many large transnational companies (TNCs) continue to provide a variety of products and services on global markets, they now increasingly purchase inputs and components from smaller companies in dispersed locations that serve particular niches. Global export markets increasingly involve exports of parts and components within GVCs. In this context, many companies, particularly smaller enterprises, are finding that success may be achieved through specialization, e.g. in activities/products and market niches. For example, even simple components, such as hubcaps, can be produced for regional and global markets in GVCs through an association with Toyota’s and Ford’s networks; and specialized niche markets, such as organic fruit and vegetables, can be regional and global in nature through access to a global retailer such as Carrefour. Therefore as the as the global production system evolves, the key role of GVCs and IPNs in a growing number of industries provides for SMEs an increasingly effective mechanism for accessing global and regional markets as suppliers within such ‘chains’
15 16
See for example discussion of the fresh fruit and vegetable industry in section III. Hacki, R. and J. Lighton, “The future of the networked company”, The McKinsey Quarterly, 2001, No. 3
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and ‘networks’. It is therefore useful to have an appreciation of the key characteristics of GVCs (and associated IPNs) and their implications for smaller suppliers. ii.
Types of GVCs
Simplifying somewhat, there are three general types of value chains and associated production networks, with the first two—producer-driven and buyer-driven chains as most prevalent. As will be illustrated in the context of particular GVCs (Section III), they have differing implications for participating SMEs. •
A producer-driven chain or network is one where the lead firm, often a large multinational manufacturer, plays a central role in exercising relatively close control in coordinating a geographically distributed network of subsidiaries, affiliates, and suppliers. This type of chain/network tends to be characteristic of capital- and technology-intensive industries such as automobiles, telecommunications, IT, and semiconductors. As a consequence, to be a supplier to this type of chain/network requires a certain level of technical capabilities and sophistication, and associated investments However, the technology and knowledge transfers can be important, as illustrated by the automotive parts and IT industries. As an example, Sony, sourcing worldwide, imposes very high standards on suppliers, requiring strong technological capabilities, flexibility in response, strong customer service orientation, and the capacity to work with its IT-based e-procurement system.
•
A buyer-driven chain or network is one where large retailers, marketers and brand manufacturers play the pivotal role in working with and sourcing from decentralized networks of independent suppliers, defining product and process specifications and standards. It tends to be characteristic of labour-intensive, consumer goods industries such as apparel, footwear, agro-industry, and consumer electronics. The participation requirements—although can be quite stringent as in the case of IKEA (see below)--are relatively low, offering many opportunities for developing country producers, including SMEs, capable of meeting the buyer’s requirements; and may provide opportunities for upgrading over time. As an example, IKEA, the Swedish home furnishing retailer has a worldwide sourcing strategy involving more than 2000 suppliers, governed by their own technical specifications, for example with respect to wood furnishings, that relate to international environmental and labour standards.
•
A hybrid chain or network—less prevalent—is more ‘horizontal’ in nature, involving multiple power centers in different parts of the value chain, and generally no overall dominant ‘lead firm’ with the power to determine the ultimate shape of the final product. For example, although Intel, Microsoft, and Dell are “lead firms” in their own production networks within the PC global value chain, a specific PC marketed by Dell reflects more a ‘balancing of forces’, shaped by Microsoft’s software strategy, Intel’s strategy in semiconductors, and Dell’s customer-based ‘branded’ assembly and marketing strategy.
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iii.
Key Characteristics of GVCs/IPNs
For firms wishing to access global markets as suppliers through GVCs/IPNs, the following issues are of particular importance: • • • •
Governance: strategies of lead firms, including with respect to role of suppliers; Upgrading and innovation: the basis for strengthening competitive performance, pricing power, and achieving sustainable returns within chains and networks; Standards: product and process standards both as market-driven requirements, and as the basis for ensuring consistency and reliability in the chain/network; and Emerging key role of global suppliers: emergence of ‘global suppliers’ as key players in organizing participation in value chains and production networks.
Governance: Generally, lead firms try to control the ‘rules of the game’ in a chain/network that govern the role of suppliers. This includes control of who can be a supplier; what will they produce (outputs of suppliers in the network); how it is to be produced (e.g. quality and other product and process standards—although some standards may also be externally set, for example as related to food and pharmaceuticals); how much is to be produced by each supplier, and when; which functions will the suppliers be allowed to undertake in the network (e.g. production, design, marketing); in which of these areas will suppliers be allowed to upgrade (e.g. moving from production, also into design, likely to add higher value). Lead firms often exert operational control through increasingly IT/e-commerce-based management and logistics systems that integrate activities within the network. In general, lead firms try to retain and guard value chain activities with the highest returns and value-added. For example, in the case of a producer-driven network such as automobiles, this means control by lead firms such as Toyota and Ford of functions such as basic R&D and fundamental product innovation— even if these are partially ‘outsourced’. In the case of a buyer-driven network such as apparel, this means control by firms such as Levi, Nike or IKEA of functions such as design, branding, marketing and distribution. Box 6. Governance strategies: Intel, Limited Brand, Toyota, Ericsson Intel: Semiconductors were the most dynamic products in world trade between 1985 and 2000, with exports growing from $26 billion to $235 billion. During this period, Intel vaulted from 7th to 1st in sales in the industry, and is today by far the largest chipmaker in the world. The firm has exploited its manufacturing competence by integrating its production network and establishing plants in a diversity of locations. Intel has kept its production process internalized, creating a producer-driven international network in which ownership (equity) links form the basis for network governance. It manages a hierarchical international production network, where individual affiliates specialize in particular stages of innovation or production, which are then closely integrated into Intel’s global production network.
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Limited Brands: Clothing remains an important component of world trade, increasing from $41 billion to $174 billion between 1985 and 2000. Limited Brands is a leading retailer of intimate and other apparel and non-apparel (e.g. beauty and personal care) products. Founded in the US in 1963, its net sales doubled from $5 billion in 1990 to $10 billion in 1999. Limited Brands established a buyer-driven network based on nonequity relationships, which it operates based on its two principal advantages: retail sales outlets and brand management. Toyota: The automobile industry has grown from $149 billion in 1985 to $486 billion in 2000. Unlike electronics, automobile production networks have tended to be national or regional, rather than global. Home markets continue to be central to automobile manufacturers, even though the production networks are becoming increasingly internationalized. Toyota, the third largest automobile manufacturer in the world by vehicle production (2001), has a mixture of equity and non-equity linkages in its IPN. In 1990 Japanese production accounted for 86% of its global sales. By 2000 foreign production increased to 30%, including 12 plants in Japan, and 43 plants in 26 other countries. In general, Toyota maintains its ownership advantage in the most modern and competitive part of its IPN. Parts are to a large degree outsourced. Toyota combines close links among its fully owned assembly subsidiaries with a multi-tiered network of formally independent subcontractors (e.g. Denso). As part of its network governance strategy, affiliates in the US and Thailand have been given ‘regional product mandates’ for certain product lines. Toyota has recently indicated that it will extend its production network around core regional markets to lower-cost sites such as Mexico for North America, and Turkey and Czech Republic for Europe. Ericsson: Telecom equipment was among the most dynamic exports during 1985-2000, exceeding $173 billion. A sharp downturn after the boom of the late 1990s has triggered dramatic restructuring of the telecom equipment global value chain. Against this backdrop, Ericsson, the world’s largest supplier of telecom equipment, has evolved from a largely equity-based production network, to an almost fully non-equity based IPN—while retaining direct control over product lines related to its core focus on innovation and design. It has reduced its production plants from about 70 to less than 10 worldwide, outsourcing previously in-house production to global contract manufacturers such as Flextronics and Solectron. It has retained two types of foreign affiliates in the equity-based part of its IPN: plants needed for the development and manufacturing of key new, non-standard products, and the most cost efficient plants for the more standardized products. Ericsson now focuses in the telecom equipment value chain on design, R&D, product development, and sales and marketing, outsourcing most manufacturing activities. 17
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UNCTAD, Part Two, World Investment Report 2002, United Nations, Geneva 2002
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Upgrading and innovation: Continuous innovation and upgrading throughout the value chain is becoming a requirement in an increasing range of product groups. This is the consequence of growing intensity of global competition, shortening of product life cycles, and falling barriers to entry in some industries. Innovation and upgrading by a given firm can allow it to reposition itself and improve its pricing power and competitive position within a given network or value chain. For example, a wood furniture manufacturer that upgrades from manufacturing to product design may strengthen its position in the value chain and network. Key innovations can also be the source of competitive advantage for a given production network as a whole within a global value chain. For example, Toyota’s strengthening of its competitive position through key product innovations (e.g. of its own, or combined with its 1st tier supplier, Denso) can strengthen the competitive position of the set of firms in the Toyota-led production network--including its lower tier auto parts suppliers--against other such networks, such as Ford’s, within the automobile industry. There are four general ways for a firm to improve its position in the value chain/network through innovation and upgrading: • • • •
Process innovation: increasing efficiencies in the production process, for example through improvements in production technology or labour productivity. Product innovation: improving existing products, or developing new products. Functional innovation: changing the mix of value chain activities undertaken by a supplier; for example, moving ‘upstream’ from manufacturing to product design. Chain innovation involves using existing capabilities to upgrade to a new and more attractive value chain, from example, the shift of some Taiwanese firms from producing microwaves to higher value personal computers.
Standards: Product and process standards are increasingly shaping production, especially within the framework of global value chains. There is growing pressure in key markets, such as the US and EU, for global producers to adjust their operations to reflect not only profitability, but also social and environmental objectives (e.g. corporate social responsibility or CSP requirements). In addition, within the framework of GVCs, standards play the key role in ensuring product and process consistency and reliability along the chain. Therefore producers wishing to participate within GVCs, increasingly have to meet stringent requirements of a growing multiplicity of standards in a wide range of industries (e.g. wood furniture, automobiles, electronics). Examples of the diversity of standards include internationally agreed standards, such as ISO 900 (quality), ISO 14,000 (environment), SA 8000 (labour), G3 for cellular phones; industry-specific standards, such as phytosanitory standards and Hazard Analysis and Critical Point (HACCP) in the food industry; region-specific standards, such as QS 9000 (quality in autos originating in the US); and firm-specific standards, supporting brand name (e.g. VDA6.1, Volkswagen quality standard, Carrefour’s in-house brand standards). Emergence of global suppliers: Leading firms in an increasing number of industries are reconfiguring their strategies and reorganizing their production networks; and in the process placing global suppliers in a key role within such networks. This is particularly evident in two important industries: electronics and automobiles. Lead firms in these industries are becoming increasingly reliant on ‘global suppliers’, often based
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close to home, but supported by global sub-contractors. This spreads the risks and lowers the costs of doing business to lead firms. Global suppliers, in turn, are reorganizing networks within value chains, redefining the role and relationships of lower-level suppliers/producers, further back in the chain. In this context, lead firms and their supporting global suppliers are increasingly looking for firms that already have the requisite production capabilities, not firms that need to be brought up to required standards. This reorganization of networks, although most pronounced in electronics (e.g. Solectron, Box 6) and automotives (e.g. Lear, Box 7), is also becoming a factor in an increasingly wider range of industries, for example garments (e.g. Li & Fung as ‘full package providers’, Box 8) and fresh vegetables (Section III). As a consequence, global suppliers are emerging as key global investors, with significant influence on the export competitiveness of host countries, and on the fortunes of SMEs. (see Figure 6).
Box 7. Global Contract Manufactures in the Electronics GV Beginning in the second half of the 1990s, lead firms in the electronics GVC, for example in the computer and networking sectors, (e.g. IBM, Hewlett Packard, Maxtor from US; Ericsson, Nokia, Alcatel from Europe) have been consolidating their contract manufacturing relationships, giving larger share of production to a smaller group of large, technologically sophisticated contract manufacturers, requiring global presence. This trend is expected to accelerate. A Bear Stearns survey of brand name electronics firms (in 2002) found that these firms expected to outsource 73% of total production on average; 40% stating their intention to ultimately outsource 90-100% of final product manufacturing. The following examples are instructive: Solectron, the largest electronics contract manufacturer, (as of 2001 with around US$18.7 billion in revenues) was concentrated until 1991 in a single location in Silicon Valley. In the early 1990s its key customers, including Sun Microsystems, Hewlett Packard, and IBM, began to demand global manufacturing and process engineering support. By 2001 the company’s network consisted of nearly 50 production facilities worldwide, global and regional headquarters, materials purchasing and management centers, new product innovation centers, after-sales repair service centers, and technology centers to develop advanced process and component packaging technologies. Box 8. Global suppliers in the Automotive GVC Lear is the fifth largest vehicle parts supplier (in 2002), focusing on automotive interior modules and systems. It is a supplier to a wide variety of brands—member of a number of production networks--including GM, Suzuki, Hyundai, Isuzu, Jaguar, Mazda, Opel, Ford, VW, Porsche, Mercedes, Chrysler, Saab, Subaru, Fiat, Daewoo, Renault, Toyota, Mitubishi, Honda, Audi, BMW, Peugeot, Nissan, Volvo, and Rover, among others. Headquartered in the US, it had (in 2001) 120,000 employees in more than 200 locations in 33 countries, with sales in 2000 of $14 billion.
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Box 9. Li & Fung: a ‘full-package’ provider in the Garment GVC Li & Fung does not own any production facilities. Instead, it manages or ‘orchestrates’ the process of production of garments by a global network of specialized suppliers for private-label manufacturing on behalf of mostly US and European retailers. In this, the firm manages the “full package” of product development, product sourcing, and product delivery, including quality control and on-time delivery. Li & Fung headquartered in Hong Kong, employed in 2001 about 5000 people worldwide, operating through a network of 68 offices in 40 countries; annual turnover of over US$4.2 billion. In 2000 the firm had about 700 customers, mainly retailers in the US (75%) and Europe (21%). From its original role as a regional sourcing agent in the 1970s, the firm began in the late 1980s to provide complete garments programmes for specific buyers. As the manufacturing of garments became more highly complex and geographically dispersed in the 1990s, the firm expanded its activities and network extensively. In 2001 it was involved in managing 10 of the 15 steps in the garment manufacturing value chain; through manufacturing contracts with 7,500 suppliers of whom 2,000 are reportedly active at any given time; giving it employment links with an estimated 1.5 million workers. Its network of suppliers is located primarily in Asia, including China, Bangladesh, India, Pakistan and Sri Lanka; as well as in Egypt, Madagascar, Morocco and South Africa. The firm generally takes between 30% and 70% of a given supplier’s output, providing a balance between the clout to secure needed capacity, but not making it over-dependent on a given supplier. For a specific product or client such as Limited Brands (US), Li & Fung assembles a set of specialized suppliers to handle everything from product development to the sourcing of raw materials, production planning and management, and shipping. It then ‘orchestrates’ the process according to well-defined milestones and standards. For example, Li & Fung gives a Taiwanese dyer specifications for the end product to be delivered—such as exact colour, quality standards it must meet, and the date when the fabric must be shipped to the cutter in Bangladesh. But it does not try to influence the way each supplier accomplishes its part of the process. The company monitors quality by verifying that product specifications have been met at every milestone in the process. Given its network’s wide span, Li & Fung leverage global economies of scope to deliver high-quality, low cost products, reliably and quickly to customers. 18
6.
How SMEs Fit Into GVCs/IPNs
18
Sources: UNCTAD, Part Two, World Investment Report 2002, United Nations, Geneva 2002; and Brown, J.S., S. Durschlag, and J. Hagel III, “Loosening up: How process networks unlock the power of specialization”, The McKinsey Quarterly, 2002 Number 2
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Global value chains and associated production networks are evolving a tiered structure. The key role in the network is played by the lead firm, e.g. Levi in apparel, Ford in autos, Carrefour in fresh fruit and vegetables. These lead firms are supported by an increasingly smaller number of preferred 1st tier or global suppliers; who are, in turn, surrounded by lower-tier suppliers of parts, components, and other inputs. These lower tier suppliers, further back in the network, are often SMEs doing low-skill, low-value added activities, producing relatively simple outputs, and competing on the basis of low cost, with limited capacity and/or options for upgrading. In general, it is easier to enter into a chain/network as a lower-tier supplier. But this is likely to be an unstable position for a firm, since it is easier to be replaced by other—for example lower cost—suppliers. The challenge therefore for an SME is to enter the chain/network as a higher-tier supplier; or alternatively as a lower-tier supplier but with the opportunity to upgrade—to move up the value chain and increase the value content of activities. (Fig. 6) Figure 6. How SMEs Fit into GVCs/IPNs 19
From the perspective of SMEs, the organization of production networks may be seen as an implicit agreement or ‘bargain’ between the lead or higher tier firms and SME suppliers. The lead firm, such as IKEA in wood furniture, provides market and technical information (e.g. directly or through higher tier suppliers), with the expectation that lower 19
UNIDO, Integrating SMEs in Global Value Chains, United Nations Industrial Development Organization, Vienna, 2001, p. 6
22
tier suppliers will perform to meet global standards set by the lead firm. Supplier SMEs on the other hand, such as suppliers to IKEA in Viet Nam producing bamboo furniture, invest in equipment and specialization, with the expectation that lead firms (or their higher tier suppliers) will continue to use their outputs, and ideally over time, provide opportunities for the firms to upgrade within the chain/network. The key issues for the SMEs in this context include: (1) what does it take to become a supplier with the opportunity to upgrade in a particular GVC; and (2) how stable is this implicit bargain likely to be for a specific SME in a given GVC/network. These questions can best be addressed within the context of particular GVCs—the focus of the next section (III). III.
Accessing Selected GVCs: Constraints and Opportunities 1. Introduction
The GMS countries vary greatly in the characteristics of their economies and of their firms. They are at different stages in their development and in their global competitive position. Keeping these differences in mind, four GVCs, of general interest to the GMS countries were selected for review as illustrations of the key challenges with respect to integrating SMEs into such value chains. These are: (i) fresh fruit and vegetables; (ii) wood furniture, including bamboo and rattan; (iii) garments/apparel; and (iv) automobile components. The selected GVCs reflect consultations with GMS governments, private sector enterprises inside and outside the subregion, and other donors; as well as an assessment of possible areas of cooperation through cross border linkages and/or jointly addressing shared or concerns. 2.
Agribusiness: Fresh Fruit and Vegetable GVC 20 i.
Introduction: Consolidation in Developed Markets
The fresh vegetable industry has been one of the most vibrant growth sectors in international trade. For example, during the 1990s imports of fruits and vegetables by EU countries surpassed all other categories of agricultural products, much of it sourced from developing economies. However, the increasing restructuring of global production is leading to the integration of developing country producers into global markets via GVCs and IPNs more and more dominated by large retailers/supermarkets such as Carrefour and Tesco, posing potentially significant constraints as well as opportunities for local SMEs, such as those in the GMS. There has been significant growth of global food retailers/supermarkets driven by trade liberalization and increasing demand for both processed food and “all season” variety in fresh fruit and vegetables. This has been accompanied by increasing 20
Particularly useful sources for this section included Humphrey, J., Shaping Value Chains for Development: Global Value Chains in Agribusines, GTZ, Eschborn, 2005; and Dolan, C., J. Humphrey, and C. Harris-Pascal, Horticulture Commodity Chains: The Impact of the UK Market on the African Fresh Vegetable Industry, IDS Working Paper 96, Sussex 2000.
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concentration in developed markets, reinforcing the growing power of such retailers. In the period 1980-1996 the number of retailers accounting for 20% of US retail sales has decreased from 33 to 24; while those accounting for an overwhelming 75% of Europe’s primary market sales have decreased from 132 to 43 during the same period. 21 The top 5 food retailers increased their share of the US market from 23% in 1992 to 43% in 2000; while in Europe the 5 largest food chains increased their share of total retail food turnover from 13% in 1990 to 26% in 2000, with the 30 top grocery/retail businesses accounting for 69% of total sales in 2001. In particular, in the UK, as a proxy for the global industry, the emergence of the large supermarket chains has been one of the most dramatic examples of concentration in retailing. In 1999 the top 4 retailers—Tesco, Sainsbury, Asda, and Safeway—accounted for nearly 75% of all food sales. 22 As retailers/supermarkets have grown in size, they have exercised increasing influence on the GVC. They have in effect become “gatekeepers”, controlling access to global markets. For example, in the UK the largest retailers now control 70-90% of fresh produce imports from developing economies. Retailers have developed their own brands in competition with global producers such as Heinz, Kellogg, and Nestle; developed sophisticated logistics systems; and have played increasingly dominant role in developing and managing suppliers. Generally, large supermarkets have focused on retailing and control of the supply chain, rather than direct involvement in production. Fresh fruit and vegetables are core competitive areas for large retailers. Fresh produce represents a ‘destination category’ for shoppers: it is one of the few product categories, along with fresh meat and wine, for which shoppers will switch stores. It is also one of only two remaining categories (along with meat), which is primarily ‘own label’, and thus over which they can exercise control. Although price continues to be important—margins of suppliers are under constant pressure—competition has moved well beyond price. Supermarkets now compete on attributes such as quality, year-round availability, presentation, product range, packaging, and product innovation. As a consequence, retail buyers emphasize the following in sourcing products:
21 22
•
Quality and consistency: This requires sophisticated quality control and logistics systems to ensure that products are grown and preserved in the best possible state.
•
Reliability of supply: This places emphasis on efficient producers, logistics systems, and security of supply.
•
Cost: Price continues to matter, and a key element in cost reduction is scale. Retailers feel that they can reduce transaction costs by dealing with fewer, larger suppliers; and that such suppliers can more easily reduce their own costs, increasing the price competitiveness of final products.
From “Retailers to the World”, The McKinsey Quarterly, No. 3, 1999 From Humphrey (2005), op cit; and Reardon et al (2001), op cit.
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•
Variety, value-added, innovation: Processing, packaging, and development of new varieties of products create significant premiums. For example, prices increase significantly with progression from loose carrots, to carrots packed in plastic bags, to peeled and sliced carrots; and mini carrots can sell for up to 15 times the prices of loose, full-sized carrots.
•
Food safety: Global markets are characterized by increasingly strict food safety and pesticide requirements, and supermarkets have developed systems that allow products to be traced from the field to the supermarket.
•
Corporate Social Responsibility (CSR): Social issues, such as labour and environment standards, are emerging in importance as key industry standards that must be met as a minimum requirement by suppliers.
Concentration in retailing is one part of a larger process of on-going consolidation at various stages in the agribusiness GVC, with important implication for lower-tier suppliers. As with large retailers, so with fast food chains, food processors and manufacturers, and input suppliers--increasing the importance of large-scale procurement throughout the agri-business GVC. As a consequence, the requirements of large buyers (retailers, processors, fast food chains) have raised the competence required of suppliers, as well as the level of coordination in the GVC. ii.
Restructuring the GVC
The increasing importance of large supermarkets in retailing fresh and processed food has reorganized the agribusiness GVC. It has shifted power in the governance of GVCs from producers such as Nestle, to retailers such as Carrefour. In effect, global retailers have transformed themselves from resellers of global producers’ products, to sourcing themselves—leading to an increasingly important role all along the GVC, including product development, branding, supplier selection, distribution. An example of this ‘power shift’ in the GVC is the increasing importance of private labels in retailing, e.g. Carrefour’s ‘Filiere de Qualite’, Loblaws’ “President Choice--with such private labels accounting, for example, for over 43% of UK total food sales. As a consequence, global retailers/supermarkets are increasingly bypassing wholesale distributors and markets and going directly to producers; and using a smaller number of preferred 1st tier suppliers who meet their specified standards. In the process, they are exerting increasing control over the product (e.g. quality), and information (e.g. ‘traceability’), in effect extending ‘just-in-time’ and ‘total quality’ systems to the agriculture sector. There is growing direct and indirect control exercised by a small number of global retailers over a much more fragmented (global) producer group. The key governance decisions by retailers in the GVC include the following:
25
• •
•
•
Product mix: Products required are determined by the retailers, e.g. in terms of both product mix and presentation. Access to market: Global supermarkets are increasingly in a position to determine which producers are to be included in the GVC. Before particular suppliers are included, they are subject to an audit of their facilities, and must satisfy supermarkets that they can meet the range of product and process requirements. Distribution of activities among enterprises in the supply-chain: Key activities in the GVC include growing, post-harvest processing, transport and logistics, marketing, and innovation (product, process, function). Global retailers such as Carrefour are in a position to define which activities are carried out by which enterprises in the chain, including possibilities for upgrading. Along the way, a key development has involved increasing transfer of processing activities from developed country importers to developing country exporters, including technically more complex tasks such as bar-coding and labeling. Monitoring the supply-chain: Supermarkets require exporters/1st tier suppliers to ensure that producers are continually meeting an increasing range of standards, e.g. in health, human right, environment. In effect, they monitor the monitors. An example of the priority given to this task is Tesco’s ‘hit squad’, which is prepared to inspect any supplier without prior notice to ensure compliance. Similarly, there is an increasing use of third party monitors of supplier performance. iii.
Critical Role of Global Standards
A growing number of global standards, both public and private, are playing an increasingly critical role in regulating access to and upgrading in the GVC. Public mandatory standards tend to be more extensive and stringent, and relate primarily to safety and health. An example of a complex public product standard is the “maximum residue limits” (MRL) introduced in 2001 as part of the EU pesticide regulation harmonization program; while examples of public process standards include traceability requirements, and risk assessment at various stages of the GVC. Private standards may be introduced by retailers as part of their competitive strategy, for example product and process standards defined by Carrefour for their private label, Filiere de Qualite; or by coalitions of interests, for example the EurepGAP standard on the production and processing of fresh produce by EUREP, an association of European fresh produce importers and retailers. While public debate is focused mostly on public standards (e.g. WTO/SPS), the rapidly growing private standards (e.g. of Carrefour, Tesco) are perhaps becoming more important in controlling access of suppliers to GVC.
26
Fig 7. The Role of Standards 23
iv.
Implications for Small Suppliers (SMEs)
The evolution of the fresh fruit and vegetables GVC threatens the exclusion of suppliers unable to meet requirements. However, it also provides significant opportunities for those who can. For example, the trend to product differentiation such as organic produce, driven by both the tastes of global consumers and by the strategies of retailers for higher revenues, is producing significant opportunities for qualified producers to serve niche markets that are regional or even global in nature. Furthermore, the outsourcing by global retailers of technically sophisticated activities such as bar-coding, labelling, and the preparation of ready-to-eat food provide important opportunities for upgrading within the GVC. Fundamentally, participation and upgrading in GVCs led by global retailers such as Carrefour, or global producers such as Nestle, require that SMEs change their way of doing business all along the value chain, e.g. storage on the farm and in transit; monitoring composition of content, etc. This requires significant investment by small producers in machinery, facilities, and organization, often beyond their individual technical capacity and financial capabilities. Box 10. Supplying Tomatoes Supplying tomatoes to global retailers such as Carrefour, global producers such as Nestle, or global fast food chains such as McDonald’s imposes on suppliers a multiplicity of demanding private standards related to size, form, colour, safety, consistency, volume, cost. These, in turn, are likely to require suppliers to undertake significant investments, e.g. in drip irrigation, greenhouses, hygienic services. 23
Humphrey (2005), op cit, p. 14
27
Those producers who are able to upgrade production and management systems and meet requirements--e.g. standards, quality, quantity, logistics—can access expanding international markets through GVCs, realizing growth in scale and revenues, and potential opportunities for upgrading. However, those suppliers unable to meet such requirements increasingly find themselves in stagnant or declining, uncertain, and unprofitable and informal segments of the business. Box 11. An SME Success Story In 2001 in Brazil’s poor Northeast region, 2 small melon exporters joined the preferred provider list for the French supermarket chain, Carrefour. Over the next 3 years they advanced from providing melons to a few supermarkets in their region to 67 hypermarkets throughout the country, and then stores in the 21 countries where Carrefour operates. 24 In practice, global retailers/buyers interested in sourcing part of their output from SMEs face a number of well-known problems, e.g. logistical constraints, side-selling, financing needs. However, these constraints on utilizing SME suppliers are made even more complex by global retailer requirements noted earlier, such as the need for: • • • •
Consistency across producers and through the season; Maintaining post-harvest quality and preventing product deterioration, e.g. need for cold storage facilities; Ensuring compliance with a wide range of standards, e.g. health, safety, ethical trade such as child labour; Communicating changes in requirements to a large number of dispersed small producers, e.g. on product and process standards and innovations.
In this context, it may be noted that in general, there are differences among the approach of global retailers and global producers/buyers with respect to providing BDS to suppliers. Generally global retailers, such as Carrefour and Tesco, are less likely to provide such services, as compared with global producers/processors, such as Nestle or Dole, who are ‘technical/production specialists. iv. Conclusions Success in the fresh fruit and vegetables GVC increasingly depends on meeting the exacting and varied requirements of large retailers in major markets. These are nonnegotiable conditions for market entry. The restructuring of the GVC through the rise of the large retailers is leading to concentration of the supply base in favour of ‘dedicated’ suppliers that can deliver consistently high-quality reliable products, and is restricting market access to the largest exporters. This increasingly excludes producers and exporters 24
USAID (2005), op cit
28
who lack the scale and capacity to meet key supermarket requirements such as quality control, volume, logistics, etc. Furthermore, difficulties of entering key markets such as the US and EU have been increased by a growing variety of stringent standards. In general, many small producers have big problems adapting to the changes in doing business demanded by GVCs, including their technological, management, organizational and financial requirements. Wood Furniture GVC 25 i. Overview of the Wood Furniture GVC Furniture is a big and expanding global business. Between 1995 and 2000 global trade in furniture grew by 36%, as compared for example with world merchandise trade as a whole 26.5%) or apparel (32%). By 2000, with global furniture trade at US57.4 billion, it was the largest low-tech sector exceeding apparel (US$51 billion).26 Two of the GMS countries, China and Thailand, are among the top 10 global exporters. It should be noted that the discussion that follows will primarily be in the context of traditional wood furniture (e.g. hardwood, softwood). However, the key issues in the discussion of the GVC are intended also to generally apply to non-timber wood-related products such as bamboo and rattan. 27 It is assumed, based on the structure and dynamics of the industry, that furniture manufactured from these materials are also part of the overall wood furniture GVC, and present significant opportunities particularly for GMS producers. Relatively inexpensive, compared with hardwood items, bamboo exports for example, are estimated at $2.7 billion a year, with strong growth in major developed markets, with the US importing over $400 million of bamboo and rattan furniture in 2003.28 3.
Furniture is a resource based, labour intensive sector, where leading producers are from high wage economies such as Italy, Canada, and Denmark; with their production structures characterized by SMEs. This indicates significant possibilities for upgrading, allowing smaller firms in low-wage economies to move up within the GVC in terms of specialization, sophistication and income. The furniture industry is divided into different sub-sectors, with the Harmonized System of product classification distinguishing four wood product groups: office furniture, kitchen furniture, bedroom furniture, and dining/living and shop furniture. The wood furniture sector is becoming increasingly competitive, as more and more producers enter global markets, including from lower- and middle-income countries. As a consequence, global prices are declining. Detailed analysis by product sub-groups (4 subsectors) and countries of origin (using the World Bank distinction among low-income,
25
Particularly useful sources for this section included Kaplinsky, R. and O. Memedovic, The Global Furniture Value Chain: What prospects for upgrading by developing countries, UNIDO, Vienna, 2003; Kaplinsky, R., M. Morris, and J. Readman, The Globalisation of Product Markets and Immiserising Growth: Lessons From the South African Furniture Industry, Institute of Development Studies, Sussex, 2001; and International Wooden Furniture Markets: A review, International Tropical Timber Organization and International Trade Centre UNCTAD/WTO, Geneva, 2005. 26 Kaplinsky et al (2003), op cit 27 It should be noted that bamboo is technically defined as a grass, rather than a tree. 28 The International Network for Bamboo and Rattan (INBAR), various estimates.
29
lower middle income, upper middle income, and high income) shows for the period 1995-2000 the following: • • •
• •
In all subsectors there is a tendency for unit prices of imports from the 4 categories of countries to converge, indicating the emergence of a ‘world price’. The unit price of EU imports decreased in 3 of 4 subsectors, remaining relatively stable in the bedroom category. While unit price of imports from high-income countries fell, those from middleincome countries rose, indicating that some middle income producers particularly from Central/Eastern Europe (e.g. Chech Republic, Poland, Romania) were upgrading into product groups formerly dominated by high income countries. The unit price of imports from high income countries was significantly higher than from other exporting country producers in all 4 sub-sectors. The value of imports from the low-income group of countries was next highest, suggesting that firms from low income countries concentrated on high-value, low volume craft segments.
The above suggests an industry in the midst of intense global competition. The trend toward uniform and falling prices is due to either falling barriers to entry and new entrants; increasing efficiency and falling costs; or both. Given pricing pressures, producers need to develop the capacity to upgrade, e.g. products, processes, functions. ii. Role of Buyers in Accessing Global Markets Buyers play a critical role in connecting producers to final global consumers. In almost all cases these buyers are based in major importing countries, e.g. US, EU. The relevant questions with respect to the role of buyers include: to what extent do buyers assist in upgrading of suppliers/producers; and in this context, to what extent do enterprises, particularly smaller producers, in developing countries have the capacity to upgrade their operations as required by buyers. There are 3 broad categories of buyers in the industry: • • •
Large multinational retailers with both retail outlets and suppliers in many countries e.g. IKEA sources from around 2000 suppliers in 52 countries, and have more than 300 outlets on 3 continents; Small-scale (e.g. “one-store”) retailers purchasing directly from a limited number of suppliers in a limited number of countries; and Specialized medium-sized buyers, sourcing from many countries, and re-selling to retail outlets, predominantly in a single country or region. Such a buyer may have more than 1500 suppliers located in many countries, and even smaller specialized buyers will typically source from more than 100 suppliers.
All three types of buyers are involved with the buying activity itself, e.g. purchasing from suppliers. Global retailers outsource the least; they have strong presence across most activities in the GVC, e.g. product design, purchasing, logistics, marketing, retailing and distribution, after sales service, and in IKEA’s case also including owning
30
manufacturing facilities. Specialized buyers outsource the most, retaining buying and marketing functions, and generally also playing a role in design. One-store retailers vary in the range of their activities. Figure 8. VC Activities of Different Types of Buyers 29
None of the buyers are fully integrated; all outsource some activities to a mix of both high- and low-was countries. Multi-store retailers are least likely to use low-wage economy firms as suppliers for outsourced activities other than production. In the case of the largest of these retailers, the overwhelming proportion of furniture (85%) comes from middle- and upper-income countries. However, some of these very large retailers such as IKEA are sourcing increasingly from developing Asian economies including China, Viet Nam and Indonesia. Design is outsourced primarily in the case of smaller buyers, but it is only the very small independent retailers who depend on their low-income country suppliers for design of their products, which tend to involve low-margin, price-sensitive products such as garden furniture. Increasingly, the large retailers expect to be able to offer low price, high quality, and variety. In general, there are similar demands made on suppliers by buyers. In this, meeting the requirements of ‘global standards’, e.g. as demanded by large retailers, is becoming increasingly important. These relate primarily to the production process and include quality standards, labour standards, and environmental standards—but with global retailers such as IKEA including standards in other areas such as child labour
29
Kaplinsky et al (2003), op cit, p. 8
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provisions. Meeting the variety of standards is a minimum requirement for suppliers bidding for contracts with global retailers such as IKEA. iii. Upgrading in the Industry and the Role of Buyers Increasing competitive pressures are leading to significant upgrading efforts in the industry in all dimensions, e.g. product, process, functions. Production process upgrading is widespread, including new machinery and equipment, logistics systems, and continuous quality improvements. Product innovation is of growing importance, partly due to the growing role of flat-pack furniture in reducing transport costs; and design is plays an important role in determining market share. With growing manufacturing capabilities in the global economy, most sustained barriers to entry and upgrading are intangible or service activities, including retail and distribution (e.g. large retailers are squeezing ‘mom and pop’ shops), global transport and logistics, marketing and advertising, branding, and design. These generally also happen to constitute the higher value-added activities in the GVC. Buyers expect suppliers to be able to undertake process and product upgrading, as required. In this context, a key issue relates to the role of buyer in assisting their suppliers to upgrade, where such assistance can include providing product and process specifications, and monitoring performance; training; financing; technical assistance, i.e. working directly with suppliers to help upgrade their performance; and helping their suppliers with their supply chains (e.g. logistics). Large-scale buyers see a key role for themselves as providing clear signals to their suppliers as to the type of upgrading required; with multi-store retailers and specialized buyers providing the greatest support to their suppliers for upgrading, e.g. training. In general, buyers increasingly outsource production, and actively support preferred suppliers to become more competitive. Functional upgrading is a more complex area. In general, some functions such as logistics, transport and distribution do not seem particularly ‘protected’ by large buyers. However, others are seen as ‘proprietary’. For example, the buying or market access function itself is carefully protected, erecting a barrier for suppliers to deal directly with final customers. With respect to design, small retailers generally have no design capabilities, and often sell into standard markets, such as garden furniture. Medium-size and selected small buyers act as intermediaries, finding new designs and passing them on to their suppliers. Global retailers such as IKEA, however, invest significant resources in product design. These global buyers see control of the overall design function as a critical success factor in their competitive strategy. iv.
The Case of South Africa: Lessons
The experience of the South African wood furniture industry is a clear illustration why the challenge to SMEs in the GMS is two-fold, as noted at the beginning of the paper: (i) how to access global markets; and (ii) how to do so in a way that provides for sustainable income growth (allowing for increasing pricing power or “value creation”
32
over time). In the case of South Africa producers were able to expand output, yet could not achieve sustained income growth because they were unable to upgrade with the GVC. South Africa has been a relatively significant exporting country (by value)—in the late 1990s it was just ahead of Indonesia. Domestic sales of wood furniture were essentially static during the period 1990-1999. However, exports grew (by value) tenfold during this period, with the share of exports in total furniture sales increasing from less than 5% in 1992 to over 40% in 1999. It would appear that the South African wood furniture industry had become an increasingly effective participant in global markets, with foreign demand driving domestic production. However, as noted, participation in the global economy does not itself guarantee income growth. This is partly a function of how countries’ producers fit into the GVC for particular product markets. In this context, South Africa’s wood furniture industry experienced significant problems. Unit price of exports as measured in $US, fell by 250% between 1992 and 1999. This is much greater fall than experienced by all furniture imports, for example, into EU during the same period (28%) and by all wooden imports into the EU (10%). There are 3 possible reasons for this decline in the price of South African wood furniture exports: • • •
Tendency for new exports to be in lower value added segments, reducing the value of average export price; Growing efficiencies in production leading to lower costs and sustained or increasing factor incomes, e.g. wages; Fall in unit prices of existing products without a corresponding increase in productivity, so that factor incomes fall.
It is the third reason above that presents a potentially major problem in development. It would suggest that the only way for South African producers to expand their exports into global markets is through a fall in factor incomes, e.g. wages. Looking at the firm level, there is strong evidence to suggest that this has indeed been the case. That is, a survey of buyers that source globally from a wide variety of firms, and who incidentally exert significant downward pressure on prices, indicates that South African suppliers had been seen as significantly lagging suppliers from other countries in quality and delivery reliability. It would seem that South African suppliers had been hanging on to their market share by virtue of their price competitiveness—which seems to have been created largely by a continuously depreciating exchange rate. Attempts at functional upgrading through design modifications have not been successful, due to a large extent to a lack of indigenous design capability, where attempts generally involved minor modifications. v.
Conclusions
The global wood furniture industry is characterized by a combination of converging and falling prices. Production capabilities are becoming increasingly
33
widespread, and hence buyers are increasingly outsourcing production. In this context, buyers support producers to become even more competitive, e.g. through process upgrading, but place limits on possible functional upgrading by producers. The experience of South Africa suggests some of the challenges faced by developing country producers in the wood furniture GVC. This is an economy with a vigorous private sector and abundant relatively cheap labour, especially in skills needed for key functions in the industry, e.g. for process, product, and functional upgrading. Yet, producers were not able to achieve the necessary upgrading and success in global markets in terms of growth in output and exports had been sustained primarily by currency depreciation, eroding the international purchasing power of domestic income growth. The experience of this relatively advanced developing economy for GMS producers is instructive. At the same time, the contrasting path of another major developing country exporter, Mexico, is suggestive of possible options. Mexico was able to develop an ‘indigenous’ style in wood furniture that has met market success. Apparel GVC 30 i. Overview The apparel industry is one of the oldest and largest export industries, a classic ‘starter’ industry for export-oriented industrialization, and one that played a key role in Asia’s industrialization and development. It represents a typical buyer-driven value chain/network, with highly competitive and dispersed global industry structure, including regional and local competitors. The apparel GVC is organized around five main components (Fig. 9): raw material supply, including natural and synthetic fibers; provision of components, such as the yarns and fabrics manufactured by textile companies; production networks made up of garment factories, including their domestic and overseas subcontractors; export channels established by trade intermediaries; and marketing networks at the retail level. Entry barriers are low for most ‘assembly’ garment factories, and they increase with movement up the GVC from textiles to fibers. 4.
The lead firms in the network represent diverse global ‘buyer channels’, including cost-driven discount chains (e.g. Wal Mart, K-mart); upscale brand marketers (e.g. Liz Claiborne, Tony Hilfinger); apparel specialty stores (e.g. the Gap); and private labels of mass merchandisers (e.g. JC Penny, Sears). The key activities of the lead firms at this stage involve design, branding and marketing; and they derive their main leverage through their ability to shape mass consumer markets via strong brand names and local sourcing strategies, e.g. Nike, Reebok, and Levi.
30
Particularly useful sources for this section included Gerefi, G. and O. Memedovic, The Global Apparel Value Chain: What Prospects for Upgrading by Developing Countries, UNIDO, Vienna, 2003; Source-it: Global material sourcing for the clothing industry, International Trade Centre UNCTAD/WTO, Geneva, 2005; and Nadvi, K. and J. Thoburn, Challenges to Vietnamese firms in the world garment and textile value chain, and the implications for alleviating poverty, EADI Workshop on Clusters and Global Value Chains in the North and the Third World, Novara, Italy, October 2003.
34
Fig. 9 Apparel Global Value Chain 31
31
Source: Fig. 1, Gereffi, G. and O. Memedovic, The Global Apparel Value Chain, UNIDO, Vienna 2003
35
The general restructuring of global retailing, noted earlier in the context of the fresh food and vegetable GVC, is also reshaping the apparel industry, with important implications for the nature and scope of participation by local producers from the GMS. Global retailing is increasingly dominated by large enterprises 32 that are developing greater specialization by product (e.g. specialized stores selling mostly toys, office supplies, clothes, shoes), and price (e.g. high-volume, low-cost discount chains). Within this context, the apparel industry is experiencing increasing concentration in key markets (i.e. US, Europe), generally through mergers and acquisitions (M&A). This involves a shift in market power from producers to retailers, and increasing reliance on offshore production. For example, by the late 1990s the five largest retailers in the US (WalMart, Sears, Kmart, Dayton Hudson Corporation, and JC Penney) accounted for almost 70% of all apparel sales; and by 2000 the two top discount retailers, Wal-Mart and Kmart controlled by 2000 approximately 25% (by volume) of all apparel sold in the US. The EU is following a similar pattern of restructuring; while in Japan high fashion department stores such as Seibu and Isetan have declined in the face of increasing competition from new specialty apparel retailers offering lower prices. iii.
Industry Transformation: Big Buyers and Global Sourcing
The apparel GVC is dominated by three types of buyers: retailers, branded marketers, and branded manufacturers—all of whom source globally. A diverse group of large apparel retailers have shifted from being primarily buyers from garment manufacturers, to developing strong linkages with global suppliers. They include national department stores such as JC Penney and Sears, discount chains such as Wal-Mart and Kmart, and specialty retailers such as the Gap and Benneton. These retailers have shifted from being passive buyers to producing private-label or store-brand lines through active engagement at different points in the GVC, e.g. product design, fabric selection and procurement, overseeing production of manufacturers dispersed around the globe. Global retailers are, in turn, supported by increasingly powerful first-tier global suppliers who organize production-related activities on their behalf. These are independent companies that match domestic manufacturers, for example in developing countries, and foreign/global buyers. The critical success factors for these global suppliers, for example Li & Fung, are their logistics capabilities and management coordination. It is these global suppliers that are playing a critical role in governing the production networks within the apparel GVC. The apparel GVC is also characterized by the presence of prominent marketers with well-known brands, e.g. Liz Claiborne and the Gap in fashion-oriented apparel; Nike, Reebok, Adidas in athletic footwear. These brand marketers are manufacturers without factories—they have never done any production—focusing on design, branding, and marketing. They play a key role in providing information/knowledge and market access to allow suppliers to upgrade, as they increasingly devolve functions and key parts of the value chain to their suppliers. For example, they increasingly outsource support 32
Wal-Mart Stores, the largest retailer, is also the largest corporation in the world, number 1 on the Fortune 500 as measured in revenues.
36
functions (e.g. pattern grading, sample making); and are ‘devolving’ external sourcing of many activities and inputs to selected 1st tier global suppliers. Furthermore, to compete in the new global environment, they are shrinking their supply chains, using fewer preferred manufacturers, and are adopting increasingly stringent standards. Branded manufacturers are the third key group of buyers dominating the apparel GVC. Leading apparel manufacturers in developed countries, such as Levi, have been under increasing pressure from lower priced off-shore producers providing products of similar quality, quantity and service. As a consequence, they have been shifting from production to marketing, building on their retail outlets and brand names. In addition to Levi, other leading US apparel producers who are examples of this trend include L’eggs hosiery, Playtex, Wonderbra, and Phillips-Van Heusen. v.
Liberalization and the Transformation of the Apparel Industry
There are four key factors shaping the structure and dynamics of the apparel GVC: (i) the phasing out of the Multi-Fibre Arrangement (MFA) on 1 January 2005; (ii) the corresponding increasing competitive dominance of China; (iii) pressures to meet stringent international standards, e.g. labour, environmental; and (iv) demands from global buyers for cheaper products, higher quality, and shorter lead times. The most constrained producer under the MFA was China (followed by India). Therefore the greatest impact of liberalization is on China’s role in the GVC. With the phasing out of the MFA tariffs, a consolidation of apparel export production is expected, with China (including the key role of Hong Kong) widely seen as becoming even more dominant as the global apparel export leader, given its capability to be a ‘full package provider’. China’s main involvement so far has been in the labour-intensive parts of the GVC. However, with increasing outsourcing going to China, it is moving up the value chain, putting competitive pressure on other producers. Yet, the nature and extent of China’s overall dominance is perhaps less clear than expected, and with it, the competitive evolution of the apparel GVC. At this time, China is inserting itself into different points in the GVC, as distinct from taking over most activities in the chain. This is reflected in the rising trade deficits with a number of Asian countries, primarily because of importing many inputs for export production. Within the framework of the apparel GVC, this could provide opportunities for other Asian producers—if they restructure in the context of China’s changing role. For example, there is rising demand for imports of textiles and other intermediary inputs for the growing Chinese apparel industry; and those producing higher fashion and higher quality apparel are also likely to continue to be in a strong competitive position. Furthermore, Chinese labour costs are rising; some global buyers are becoming concerned about relying solely on Chinese producers; and earlier this year the US and the EU re-introduced trade restrictions on surging Chinese garment exports. Nonetheless, Chinese competition requires upgrading by other apparel and textile manufacturer. This puts pressure on smaller enterprises relying on traditional labour-intensive methods for low quality textile
37
production whose abilities to move to the higher value added activities in the apparel GVC are generally constrained. The elimination of the MFA and increasing concentration of production, particularly in those countries with the capabilities in ‘full package production’ particularly China and India, is expected to have a significant ‘demand side’ effect as well. As one industry expert put it rather dramatically: “The quota phase out will bring the greatest buyers’ market in the history of the garment industry…”. 33 It is estimated that large retailers such as Wal-Mart, JC Penny, the Gap, and Liz Claiborne will demand price cuts and reduce the number of their suppliers (e.g. from an average of about 30-40 in 2004, to 10-15 post MFA). 34 This will add significant pressure on those countries without primary textile industries, such as Cambodia, and on smaller producers whose present capabilities to upgrade within the GVC are limited.
5.
Automobile Components GVC 35
i. Introduction/Overview The automobile components industry consists of a complex mixture of firms of very different sizes, types, and geographic scope; producing an enormous variety of products from the very simple parts, to the technologically very complex systems. In terms of value, the purchasing of components accounts for between 50-70% of the price of an average car.36 Therefore for enterprises able to participate even at the lowest tiers of production, the automotive components industry, in principle, can offer significant potential for accessing regional and global markets, and for upgrading. The supplier-oriented model of economic development has generally assumed that lead firms such as GM and Ford, will continue to seek out or develop distinct supply bases in multiple locations, and along with this, support the upgrading efforts of local producers. The strategies of lead firms are evolving, however, in quite different directions. They are offloading increasing responsibilities to their top tier suppliers, expecting considerably more in return in terms of activities along the value chain and geographic scope. The new demands on suppliers go well beyond excellence in manufacturing performance and low costs—which are becoming widely available. Higher tier suppliers must increasingly provide process technology development capabilities, and an ability to perform a wide range of activities in the value chain, including help with product and component design, component sourcing from lower tier 33
ITC (2005), op cit. Gereffi and Memedovic (2003), op cit 35 Particularly useful sources for this section included Global Production Networks in Europe and East Asia: The Automobile Components Industries, GPN Working Paper 7, May 2003; Veloso, F. and R. Kumar, The Automotive Supply Chain: Global Trends and Asian Perspectives, ERD Working Paper No. 3, Asian Development Bank, Manila, January 2002; and Sturgeon, T. J., and R. K. Lester, The New Global SupplyBase: New Challenges for Local Suppliers in East Asia, Paper prepared for the World Bank’s Project on East Asia’s Economic Future, World Bank, Washington, 2001. 36 ABN-AMRO, European Auto Components: Driven by Technology, ABN-AMRO, London, 2000 34
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suppliers, inventory management, testing, packaging, and outbound logistics. The key challenge the strategies of lead firms are posing to suppliers in their production networks, and cascading down to the lowest tiers is: getting the right part or process, in the right numbers, to the right place, at the right time, at the right cost, with minimum of inventories in process or in transit. These new requirements are raising the barriers for entry and upgrading for smaller and newer suppliers who seek to participate in the automobile GVC. ii. Rise of the Mega-Suppliers The manufacturing of automobiles hardly changed between 1913 when Henry Ford introduced the moving assembly line, to the early 1970s. Organizationally, it was characterized by a high degree of vertical integration within major producers, especially the US ‘Big 3’ that dominated the industry. Geographically, it had a global reach, but producing for globally dispersed distinct, and generally protected national or in some cases regional markets, with relatively low level of geographic integration. The situation changed dramatically in the 1970s with the emergence as global players of highly efficient, cost-competitive Japanese automakers. The key change that revolutionized the competitive structure and dynamics of the industry was the displacement of the ‘Ford’s’ mass production by the Toyota’s lean production innovation. This was later accompanied by a variety of further changes in the industry, one of the most important of which has been the wide ranging use of increasingly sophisticated electronics as components and building blocks in autos. Partly as a consequence, the automobile GVC has evolved toward a complex, multi-tiered global supplier structure that along the way transformed the key participants and relationships within the GVC. Japanese automakers such as Toyota have long been known for their extensive reliance on multi-tiered supplier networks and high outsourcing levels. Japanese networks tend to be dominated by their largest customer. For example, Denso, a Toyota-linked company, has tended to generate half its revenues from Toyota, and none from rival Nissan. However, a variation of this network structure ‘went global’. In the 1980s US and European automakers under increasing competitive pressure primarily from their Japanese competitors, began to import finished vehicles from lowercost locations, e.g. Mexico, Canada, Spain, within the context of regional agreements such as NAFTA and EU. This was followed in the 1990s by a new wave of assembly and supplier plant construction in emerging markets such as Thailand, India, Mexico, Brazil, China, Viet Nam, and Eastern and Central Europe. In addition to supplier-driven factors, a key reason for this relocation was changes in demand patterns: an increasingly maturing market in developed countries, and a projected growth market in emerging economies, particularly in Asia. Although the Asian Crisis slowed the demand and production of the auto industry, reaching pre-crisis levels only in 2000/2001, Asia is expected to be the driver of global industry growth in coming years (Fig. 10). This has led to substantial increase in investment in Asia in recent years. For example, US and EU automakers have targeted the region not only to establish a greater presence in Asian markets, but also to expand production capacity in Asian countries for regional and global markets.
39
Fig. 10 New Vehicles Sales in the ‘Triad’ vs. Rest of the World 37 (millions of vehicles)
As the number of locations multiplied, automakers streamlined their operations on a global scale, focusing on vehicle design and component sourcing. As noted earlier, even GM and Ford, historically the most vertically integrated automakers, have increasingly spun off internal parts subsidiaries, shifting to outside suppliers. As lead automakers do less with their production facilities, suppliers (e.g. 1st and 2nd tier) do more, including offering a wider range of components and systems, e.g. vehicle doors can be delivered with glass, fabric, interior panels, handles, and mirrors pre-assembled; dashboards can be delivered complete with polymers, wood, displays, lights, and switches. This involves a more centralized global sourcing, tighter coordination of global design efforts, and consolidation of project management in core regional locations. At the same time, the need to respond to unique market demands creates pressure to localize design to cater to local consumer tastes. The trend that automakers are performing far fewer functions with their assembly facilities than in the past changes the nature of the relationship between lead firms and their 1st (and to some extent 2nd ) tier suppliers. Higher-tier suppliers are moving into module design, lower tier component sourcing, and the provision of local content in newer markets. The growing need to provide automakers with modules on a global basis
37
From McKinsey, Automotive News, where “Triad” refers to the US, Western Europe, and Japan
40
is driving the consolidation and geographic expansion of 1st tier suppliers who are the now increasingly the ‘gatekeeper’s to GVCs for lower tier smaller suppliers.
iii.
Impact of “Modularity” on the GVC and Small Suppliers
It may be useful to put the concept and impact of modularity on the GVC in the broader context of automobile production. The three major processes prior to assembly of a finished vehicle are the manufacture of bodies, of components, and of engines and transmissions. Fig. 11 The Basic Automobile Production Chain 38
In this general context, two related developments are transforming the automobile production system and the GVC, and along the way the role of suppliers, including at lower tiers in the chain. The first is a trend toward the reduction in the number of individual vehicle platforms. Although the variety of vehicle models has increased substantially, this diversity is being constructed on a much smaller number of different platforms. The focus is now on creating a greater number of car models on fewer underbody platforms, allowing for greater commonality across the model ranges of individual producers. This allows a greater degree of sharing of components across model ranges, providing much larger markets (global niches) for even smallest auto parts. A related second key trend involves the modularization of certain key components and the development of component systems. A module is a group of components that constitute a coherent unit for production, such as a car seat. A component system is a group of components such as the breaking system, steering system, or electrical system. 38
Dicken, P., Global Shift: Reshaping the Global Economic Map in the 21st Century, (4th ed.), Sage Publications, London, 2003.
41
Fig. 12 Modularity in the Auto Industry 39 The preference by automakers to work increasingly with a smaller number of larger suppliers, at least for key components, and to transfer greater degree of responsibility for aspects of design and engineering to preferred suppliers. A select group of 1st tier suppliers (e.g. Bosch, Johnson Controls, Lear, Magna, Yazaki) have become the preferred global suppliers of automakers. In this context, consolidation within supplier networks has involved 1st tier suppliers embarking on a wave of vertical integration (e.g. mergers, acquisitions, joint ventures) and building stable links with their preferred lower (e.g. 2nd ) tier suppliers; along with geographic expansion to be able to deliver modules on a global basis. For example, in 1990 there were around 30,000 suppliers in North America, falling to 10,000 by 2000; and expected to fall to around 3,000 by 2010. 40 This has important implications for lower tier suppliers whose participation and upgrading in the GVC increasingly depends on a fewer number of larger and more demanding higher level suppliers.
39 40
Sturgeon, T. J. and R. K. Lester, (2001) op cit, p. 21 Financial Times, 4 March 2003
42
Fig. 13 Transformation of structure of Automobile GVC 41
iv.
A Note on the ‘China Factor’
The market- and cost-driven consolidation by global suppliers could indicate over time such consolidation of production in China, where until recently production focus was on the domestic market. The recent opening of the Honda plant aimed at exports signal such a possibility. China’s automobile industry continues to grow rapidly, and it is projected that by 2010 it will become the world’s largest automobile market, with domestic production reaching 5 million units. However, despite China’s growing auto industry, productivity lags behind other Asian competitors. Furthermore, China at this time lacks the ability to conduct research and development, relying on foreign partners to develop new vehicles. Therefore at this stage, China's automotive industry still remains relatively underdeveloped both technically and managerially. It is expected to take a considerable amount of time before China becomes a global competitor in the automotive export market. v. Implications for Local SME Suppliers in Asia Global suppliers generally establish production facilities in countries where their customers have final assembly plants, and/or where lower operating costs raise the possibility of large-scale exporting. In this context, as noted, Asian markets are expected to be the key source of global industry growth. Given expected growth in sales, and 41
ABN-AMRO, op cit, p. 10
43
corresponding expansion of lead firms in the region, suppliers are also expanding their Asian operations. However, having similar plants in a variety of Southeast/East Asian countries makes no economic sense and further consolidation is expected. Given increasing liberalization, fragmented national production systems are being replaced by regional systems that allow increases in scale economies in plants serving regional markets. This regional strategy is nested within a global strategy for suppliers and automakers that seek to generalize and reuse as many design elements—platforms, modules, components—as possible among regions. Yet the potential for local sourcing is high, because of the large number, size, and weight of components and materials. Within the GVC then local content will come from affiliates of global suppliers. These higher tier suppliers are being forced by cost pressures to search for low-cost but high-quality and reliable parts that can be delivered on time—making logistics capabilities a critical requirement. In this context, limited technical competence has generally confined smaller local suppliers to simple, standardized, and slow changing components such as bearings—but for a regional or even global market that can support scale economies. This may provide an entry point to the auto components GVC for smaller and newer producers as suppliers of such simpler parts to 1st and 2nd tier suppliers with a regional and global reach, and/or for local content where the market is sufficiently large. But under this global suppliers system there are likely to be less support provided (e.g. BDS) for small new firms, as higher tier suppliers are looking for suppliers who are already able to make the desired products; and not for firms that need to be brought up to the needed level of performance. For example, the capability to use of advanced information and technology (ICT) systems is increasingly a requirement for being part of a GVC held together by sophisticated logistics systems. The majority of the suppliers that participate in the autoparts GVC are not 1st tier suppliers or core module producers/systems integrators; most of the firms are smaller enterprises, working at the 3rd, 4th tier level--as component specialists/component manufacturers, process specialists such as metal stamper, die caster, injection molder, or forging shop--manufacturing particular relatively simple components such as hubcaps, for the next level supplier in the GVC; or subassembly manufacturers, process specialists with additional assembly, integration and perhaps even design capabilities producing more complex components such as a steering column, pedal system, or product-type subassembly such as battery or radiator. A large number of domestic firms are small process-focused companies, producing a broad array of lower value products, characterized by small facilities, limited technological capabilities, but generally efficient manufacturing operations and lean business structures.
44
Fig. 14 Upgrading Path of Local Suppliers in the Automotive GVC 42
To move from a commodity-like small component supplier to a simple assembly manufacturer requires acquiring capabilities in several manufacturing processes to produce the components; the logistical capabilities to manage the enterprise supply chain (e.g. outbound logistics) within the production network; and stronger technical and engineering capabilities. In addition, capabilities in design, test, validation and prototyping (product development) are also needed in this upgrading process. Therefore firms need to be able to reach a certain minimum size (for productions scale and investment in machinery), technical capabilities, and financing. Within ASEAN, Thailand has emerged as the major focus of automobile and component production for both Japanese and Western auto companies, a regional export hub for components--the third largest exporter of auto products in Southeast and East Asia after Japan and Korea. The Royal Thai Government has invested heavily in cluster development and strengthening for the industry, particularly in Rayong and Samutprakan, south of Bangkok.
42
From Veloso F. and R. Kumar, (2002), op cit, p. 20.
45
Fig. 15 Location of Key Automobile Assemblers and Component Manufacturers in Thailand 43
However, given the rising labour and land costs in Thailand, this could provide over time, opportunities for neighbouring countries for entry into the GVC, through a subregionally coordinated strategy of production re-location and integration. This would be consistent with the increasing ‘complementation’ of production in Southeast Asia/ASEAN being organized by global suppliers such as Denso. For example, Cambodia has rubber and relative good quality processing, which could provide the foundations for the production of selected components.
43
Thailand Automotive Institute
46
Fig. 16 Denso’s regional complementation scheme 44
44
Global Production Networks In Europe and East Asia: The Automobile Components Industries, (2003), op cit, p. 52.
47
IV.
Preparing SMEs for Competing on International Markets 1.
Accessing Global Markets: Constraints on SMEs
Enterprise performance in global product-markets is no longer a function of price alone. Within the context of GVCs and associated networks it is now primarily a function of reliability, which involves getting the right products in the right quantity, of the specified quality, at a competitive price, to the right place, at the right time. Along the way, firms must be able to meet an increasing number of stringent standards, conformity requirements, and certifications.
The challenges facing SMEs in competing on global markets are many and varied. Because of their size and isolation individual SMEs are constrained from achieving economies of scale in the purchase of such inputs as equipment, raw materials, finance, and consulting services; are often unable to identify potential markets; and unable to take advantage of market opportunities that require large volumes, consistent quality and homogenous standards, and regular supply. Small size is also a constraint on accessing such functions as training, market intelligence, logistics and technology. These constraints make it difficult for SMEs to access global markets; and also limit their performance in increasingly open, competitive domestic markets. 45 Entering into a supplier relationship with larger enterprises in GVCs can mean a larger and more stable market for SME outputs, allowing such firms to better organize their production and improve their technologies. However, GVCs also define a more demanding environment, requiring SMEs to work in a more formal manner, and upgrade not only their production methods, but their management practices as well. Improvements in product, process, technology, and organizational functions such as design, logistics, and marketing have become key success factors in firm competitiveness in a globalizing economy. SMEs are thus under additional pressure to innovate, to upgrade their operations in order to participate in international markets. However, they often lack the resources to do so. In this, small firms are constrained in their access to key business development services which large firms either have internally, or can purchase. 2.
Loosening Constraints through Business Development Services (BDS)
Given the constraints on SMEs, they require a wide variety of assistance to meet the challenges of an increasingly competitive and complex international business environment in general, and for participating in GVCs in particular. This is the traditional role of business development services (BDS), whose scope has included, for example, the following types of general activities 46 :
45
See for example Szabo, A., Internationalization of SMEs: The UNECE Approach, Enterpreneurship and SME Development, UNECE., undated. 46 Business Development Services for Small Enterprise Development: Guiding Principles for Donor Interventions, Committee of Donor Agencies for Small Enterprise Development, February, 2001.
48
• • • • • •
Training in general business management, entrepreneurship, and particular business skills such as marketing, accounting, finance; Counseling and advice, often on a ‘firm by firm’ basis, and where particularly effective, as follow-up to training; Technology development and transfer, involving the adaptation, design and development of technologies and their dissemination to SMEs; Information on markets, buyers, technology, increasingly available through ICTbased facilities, as well through traditional mechanisms such as trade fairs, exhibitions, visits/tours; Business linkages involving the development and strengthening of commercial linkages between SMEs and large firms (e.g. subcontracting) and among SMEs (e.g. development of ‘enterprise clusters’); and Financing aimed at channeling funds to SMEs either directly (e.g. special purpose financial institutions such as ‘SME Banks’) or indirectly (e.g. through special ‘windows’ of commercial banks), perhaps at preferential rates.
The following general criteria or objectives may be useful in assessing the effectiveness of BDS: (i) outreach--ensuring scope of coverage to as large a number of the target SMEs as possible; (ii) sustainability—the continuity of BDS over time consistent with enterprise needs, for example, beyond any initial support from donors and government; (iii) cost-effectiveness in the delivery of services; and (iv) impact— improving the productivity and competitive performance of the SMEs involved. 47 From this perspective, the experience with BDS has been decidedly mixed, particularly as related to export/trade development. Traditionally, donors and governments have participated in “BDS markets” at the level of BDS transactions: directly providing services to SMEs via public BDS providers, e.g. producing trade promotion materials and organizing trade fairs; or permanently subsidizing services delivered by other BDS providers. These approaches generally failed to achieve high outreach since the numbers of SMEs served was usually limited by the amount of the subsidies available, and programs often stop when public funds are gone. Furthermore, services tend to be best developed around large population centres as distinct from rural/provincial areas, where many SMEs are located. There emerged a growing consensus that publicly-provided and publicly-funded programs have had at best limited success in providing high quality, affordable and sustained BDS to a large number of targeted SMEs that increased enterprise productivity, competitiveness, and job creation. 48 As a consequence, in the 1990s there was a shift to work with private industry associations to support participation of firms in privately managed trade fairs and encourage the development of perhaps subsidized but marketdriven institutions or business centres to deliver BDS to firms. Some of these activities were cross-sectoral (“generic” services), others sector specific, e.g. agribusiness. 47
Workshop 2: Establishing Local Support Structures and Linkages, Regional Aspects of Entrepreneurship and Employment in South Eastern Europe, Skopje, November 2004. 48 Based on review of research carried out by UNIDO, ILO, WB, IFC, USAID, ADB, IADB, etc.
49
By the late 1990s lessons from key donors active in this area such as IFC, UNIDO, GTZ were creating a trend toward a ‘market development paradigm’ that led away from public-service provision or direct, project-level support to enterprises. For example, the Committee for Small Enterprise Development, an interagency group made of bilateral and multilateral donors produced guidelines and key principles on private sector and trade development stressing the following: • • • •
importance of clearly identifying the particular market failures a BDS-related intervention is attempting to address; reduced role for governments and donors, who should act more as ‘market facilitators’ than players, with an expanding role for private enterprises; avoidance of highly subsidized or entirely free services; and a focus on local capacity building to ensure sustainability--defined as continuing ‘market driven delivery of BDS, with exit strategy for governments and donors;
The market development paradigm posits as an ideal in the provision of BDS the creation of a market with a diverse array of high-quality services that meet affordably the needs of a large proportion of target SMEs. The basic assumption is that the objectives of outreach and sustainability of BDS can be best achieved not by continuing direct intervention by governments and donors, but by well-developed markets for BDS, which are seen as for the most part ‘private goods’ similar in nature to any services where market rules should apply. Consistent with this is the expectation that with appropriate product design, delivery, and payment mechanisms, BDS can ultimately be provided on a commercial basis even for the lowest income segment of the SME sector. This shifts the focus of public intervention (including by donors), away from the direct provision and subsidies at the level of BDS transactions toward the facilitation of a sustained increase in the demand and supply of such services. The key actors, their role and relationships with respect to BDS are summarized in Figure 17. These include: SMEs that are the ‘demand side’, the potential clients of services; BDS providers are the sources of services provided directly to SMEs—and may include enterprises (profit, not-for-profit), government agencies, individuals, and as well as larger enterprises (e.g. lead firms, 1st tier suppliers) that provide such services as part of broader business-to-business relations (e.g. to SME subcontractors); BDS facilitators that on the ‘supply side’ can support BDS providers, e.g. by developing new services, promoting good practice, building provider capacity; and on the ‘demand side’ can educate SMEs about potential benefits of services, stimulating the ‘market’ for needed BDS; and Governments and donors, who provide funding for BDS projects and programs, and may intervene on supply or demand side, and funds may be used to provide or subsidize BDS directly or through BDS facilitators.
50
Fig. 17 Actors and Roles in BDS 49
The effective implementation of the market development paradigm for BDS is dependent on the key role of non-government and non-donor actors to provide the diverse array of BDS needed by SMEs. From a government and donor perspective, relying on the private sector requires a clearer understanding how BDS providers can become financially self-sufficient; and refocusing the role of government (and donors) to that of effective facilitators for privately provided BDS. This, in turn, is likely to involve the development of effective public/private partnerships in the provision of BDS. 50 From the perspective of linking SMEs to GVCs, a useful distinction may be made between “operational” and “strategic” BDS. 51 Operational services are those providing support for on-going enterprise operations, for example training and advisory services in areas such as general management, entrepreneurship, basic marketing, accounting, finance. As noted, SMEs require support in terms of such general core services which are the foundations for enterprise viability. BDS focused on operational services are generally available, with an articulated demand and willingness to pay for such services. Strategic services are intended to address medium and longer-term issues/constraints in order to improve the performance of SMEs in terms their ability to access and compete effectively on particular product-markets. These could include, for example, services that help SMEs identify particular market niches; design products for international markets and buyers; identify, acquire or adapt technology to upgrade production facilities; meet exacting international product and process standards; provide proof of conformity 49
from Workshop 2: Establishing Local Support Structures and Linkages, Regional Aspects of Entrepreneurship and Employment in South Eastern Europe, Skopje, November 2004, p. 3. 50 In this context, there may be a tradeoff between outreach and sustainability for the lowest income segment of SME market; and the related potential sustainability of BDS facilitators is unclear. (Workshop 2, 2004) 51 See for example Workshop 2 (2004),
51
through testing required for certification requested by global international markets/buyers. Such services are of particular and direct relevance to the challenges of developing SME-GVC linkages. However, the markets for such strategic services for SMEs are often not clearly developed, and increasingly the focus of donor interventions. In this context, it is important to stress, as noted earlier in passing, that strategic BDS may be embedded within the organization of GVCs. For example such services may often be provided by buyers serving international markets, and global or higher tier (e.g. 1st/2nd tier) suppliers to their SME subcontractors. The earlier identified differences between buyer-driven GVCs and producer-driven GVCs may be relevant in this context. 52 For example, there is increasing evidence that in buyer-driven GVCs such as garments, footwear, agricultural produce, strategic BDS—for example related to new product ideas, designs, quality standards--may be embedded in the supplier relations of SMEs with international buyers or higher tier producers. Therefore in these types of GVCs key strategic BDS may be privately provided through subcontracting linkages. The primary public (or donor) role with respect to strategic BDS in this context may be to trigger the emergence of such privately provided BDS within the framework of particular GVCs by exposing potentially qualified SME producers to international buyers and global suppliers through initiatives such as exhibitions, trade fairs for SMEs, study tours for buyers to visit SME producers, workshops involving lead firms or buyers serving international markets. This can help initiate emergence of supplier networks, supplemented by common service facilities (e.g. IT/internet centres) when technology is too expensive or complex for individual SMEs. Producer-driven GVCs such as auto-parts, electronics, and IT, provide a somewhat different environment for provision of strategic BDS. Here local SME suppliers are generally required to attain exacting process and product standards and certifications in order to be part of the more technology- and investment-intensive GVC subcontracting network. However, the lead firms and higher tier global suppliers (e.g. 1st/2nd tier) may have little incentive in the technology acquisition and upgrading concerns of individual local SMEs interested in becoming suppliers or upgrading in such GVCs. In this case SMEs may have to solve their own more complex and more costly information problems in terms of getting insights into alternative production processes and products. At the same time, once SMEs are part of supplier networks in such GVCs, support for upgrading may also be, in part, privately provided by lead firms and/or higher tier suppliers. Public BDS, perhaps in partnership with lead firms and higher tier suppliers, is likely to have a more important role here in supporting the more complex upgrading efforts of SME suppliers wishing to access and upgrade in GVCs. The Penang electronics industry provides an interesting example later in the paper.
52
See for example Pietrobelli, C. and R. Rabellotti, Competitiveness and Upgrading and Clusters and Value Chains: The Case of Latin America, The DTI/UNIDO Competitiveness Conference, South Africa, June 2004; and Sandee, H. and S.C. van Hulsen, Business Development Services for Small and Cottage Industry Clusters in Indonesia: A Review of Case Studies from Central Java, prepared for the International Conference on Business Services for Small Enterprises in Asia: Developing Markets and Measuring Performance, Hanoi, April 2000.
52
The presence of strong local producers and/or cooperation among local enterprises through business and producers’ associations can play important role in initiating and sustaining linkages between local SMEs and global buyers or higher tier suppliers. Such local producers’ and business associations can also play an important role in providing the necessary BDS support to local firms, particularly within the framework of enterprise clusters. 3.
The Role of Enterprise Clusters i.
Clusters and GVCs
Cooperation through clusters can help SMEs improve their capabilities and bargaining power for accessing and upgrading within GVCs. Small firms generally find it hard on their own to overcome constraints for competing on global markets, and individually may be of limited interest to globally buyers and suppliers given the transactions costs involved. However, targeted cooperation among SMEs, as well as between SMEs and institutions in their surrounding environment (e.g. industry associations, government agencies, training institutions) can provide the basis for an effective response to competitive pressures, including the demands of membership in GVCs. Cooperation can help SMEs by creating opportunities for achieving collective efficiency and joint action to address shared constraints and opportunities including: •
•
•
Collective efficiency based on scale: Achieving economies of scale beyond the reach of individual small firms in the purchase of inputs including technology, creating a pool of skilled workers, use of machinery, and pooling of production capacity to meet large volume orders from global buyers; Collective efficiency based on specialization: Cooperation can enable SMEs to specialize in their core businesses and evolve a division of labour among firms, achieving efficiency in production, and learning from each other about areas such as markets and product and process improvements; and Joint action: Collaboration, for example through producer associations that help open up access to both international markets and related BDSs.
In this context, SME clusters are sectoral and geographic concentrations of enterprises that produce and sell a wide range of related or complementary products, with similar operations in the same industry, and face common constraints or opportunities. Cooperation in clusters can lead to collective efficiency based on scale. SME networks are groups of firms that complement each other, involved in different parts of the same value chain, and cooperate to achieve collective efficiency through specialization, e.g. for gaining access to global markets and GVCs, beyond the reach of individual SMEs. Effective clusters (and networks) support the participation of SMEs in GVCs. For global suppliers such as Li & Fung in garments or for global retailers such as Carrefour in fresh produce, SME clusters lower the transaction costs of input collection and marketing output. In technologically more complex and dynamic GVCs (e.g. auto parts, electronics, IT), clustering allows the collective sharing of investments needed by sub-contractors in
53
process and product upgrading that would be beyond the technical and/or financial capabilities of individual SMEs. e.g. acquiring and adopting new equipment. Ways of linking clusters of local producers to GVCs are represented in Fig. 8. Fig. 8 Linking Clusters of Local Producers to GVCs 53
What distinguishes an organized cluster or network from simply a collection of firms is the cooperation and focused linkages that have emerged among participating enterprises. SMEs in a cluster or network evolve together after a realization that in a globally competitive economy they gain advantages if they compete as a group, not as individual, isolated small enterprises. Examples of different types of organized clusters producing for global markets include the surgical instruments cluster in Sialkot, Pakistan; knitwear cluster in Tirupur India; and the electronics cluster in Penang, Malaysia.
53
Kaplinsky, R. and J. Readman, Globalization and Upgrading: what can (and cannot) be learnt form international trade statistics in the wood furniture sector?, IDS, Sussex, UK, 2000
54
Box 12. Surgical instruments cluster in Sialkot, Pakistan 54 The surgical instruments ‘cluster’ in Sialkot, produces scissors, forceps, and other precision instruments using stainless steel. It involves around 350 manufacturers, subcontracting work to over 1500 SMEs, and acquiring input from 200 local suppliers and more than 800 service providers. The cluster employs over 30,000 workers. Over 90% of the output is exported, and this cluster accounts for more than 20% of global trade in the industry, making Pakistan the second largest producer after Germany. The firms in this cluster have not only managed to successfully penetrate global markets, but they were able to address effectively, partly through cooperation with central government and local institutions, the critical challenges of new quality assurance standards imposed by the US and European markets in the mid and late 1990s. Box 13. Knitwear cluster in Tirrupur, India 55 Tirupur has traditionally manufactured knitwear and established its name in India in the manufacture of cotton undergarments. In the 1970’s, as a result of collaboration with an Italian cluster, Tirupur began to exploit opportunities in the export market. In 1985 after successful introduction of new dyeing techniques a group of textile entrepreneurs exported $8 million worth of T-shirts. By 1990 exports had grown to about $100 million, supported by a strong informal network created among the entrepreneurs, combined with competitive costs. Cooperating enterprises formed the Tirupur Export Association (TEA), and focused on upgrading sector capabilities, including supporting institutions and shared infrastructure projects. Over the last two decades, Tirupur has emerged as a leading export cluster in knitwear and has established a global presence. Individual units are highly specialized at the manufacturing of fabric, dyeing, processing, knitting and export marketing. By 2000 over 5000 enterprises in Tirupur worked in the cluster and exports reached over $1 billion. An interesting recent example of cluster-based cooperation relates to infrastructure development. The Tirupur cluster was constrained in upgrading and in expanding the scale of operations because of the poor availability of infrastructure services. The TEA with the Tamil Nadu Area Development Corporation, an agency of the state government, cooperated to launch, with external support, the Tirupur Area Development Program, comprised of a range of infrastructure services to enhance and support the competitiveness of the Tirupur cluster and sustain its export drive. Enterprises in the cluster agreed to undertake this exercise on a commercial format where investment costs would be recovered through the user charges. The Government of Tamil Nadu and the Tirupur Municipality also indicated their readiness to support such an initiative 54
From Abonyi, G., The Relationship Between International Production Networks and Local Clusters: The Changing “Model” of Development in Asia, prepared for the first meeting of the Asia Strategy Forum, Bangkok, July 2001, based on Nadvi, K., and S. Kazmi, “Global Standards and Local Responses”, Paper for Workshop on “The Impact of Global and Local Governance on Industrial Upgrading”, Brighton, February, 2001, Draft. 55 See for example Sakhtivel, A., Tirupur Knitwear Export Cluster, Presented at the 2004 ITC Executive Forum, Montreux.
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Box 14. Electronics cluster in Penang, Malaysia 56 The Penang electronics cluster, employing close to 100,000 people, has built since the early 1970s high volume production capability in electronic components, which spread to consumer electronics, machine tool support, hard disk drives, and more recently to a wide range of components in the PC value chain. The Penang State Government and Penang Development Corporation have successfully helped develop clusters and networks that encourage horizontal information sharing, considerable inter-firm interactions, and public-private partnerships in skill formation. Forging deliberate links with the world’s leading electronics firms such as Intel, Motorola and Hewlet Packard (HP) was an explicit strategy of the Penang State Government from the early 70s. The Penang electronics cluster then advanced with the evolution of these lead firms. For example, Intel’s transformation from assembly to incremental innovation capabilities made it possible to transfer technology; and for the local plant to move to more complex higher value-added activities such as testing and redesigning mature products. These lead companies attracted world-class firsttier suppliers including contract manufacturers such as Solectron, and hard disk makers such as Seagate. This has diversified and expanded the PC supplier base, making the region attractive to innovative PC assemblers such as Dell. However, the limits of upgrading--e.g. technological, labour skills--are also emerging in the Penang cluster. Lead firms and 1st tier suppliers have indicated they would like to increase their local sourcing, but are unable to find suitable local suppliers that meet their needs. This has triggered a renewed emphasis on GVC-specific BDS, through both private enterprise (e.g. Intel) and public-private collaboration (e.g. Penang Skills Development Centre).
ii.
Development and Strengthening of Clusters 57
The transition from an informal grouping or agglomeration to cooperative clusters and networks such as in Sialkot or Tirrupur is challenging. Based on a review of experience, the general factors necessary for successful transition include the following: •
Proximity is a key factor for inter-firm cooperation in promoting joint initiatives. It lowers transaction costs, and facilitates learning because of both physical closeness and shared background and experiences.
56
See Abonyi (2001), op cit Particularly useful sources for this section include Andersson, T., S. S. Serger, J. Sorvik, and E. W. Hansson, The Cluster Policies Whitebook, International Organization for Knowledge Economy and Enterprise Development (IKED), Sweden, 2004; Ecotec Research and Consulting, A Practical Guide to Cluster Development, prepared for the Department of Trade and Industry, London, England, 2004; and Ceglie, G. and M. Dini, SME Cluster and Network Development in Developing Countries: The Experience of UNIDO, UNIDO, 1999
57
56
•
•
Incentives are generally necessary for inducing cooperation among often intensely competitive firms. Perhaps the best incentives for the establishment of clusters or networks from informal groupings are crises and collective opportunities with clear payoffs for participants, e.g. changes in market standards such as food safety, and specific new market opportunities with ready buyers. These provide visible shared challenges with clear potential payoffs that individual enterprises can recognize as very important, yet cannot address on their own. Trust is the fundamental requirement for SME clusters and networks. The building and maintenance of trust over time is the foundation for SME cooperation. Since clusters and networks involve independent firms with no formal (e.g. equity-based) linkages, cooperation is fundamentally based on shared expectations and reciprocal obligations. Joint activities and mechanisms for clarifying mutual roles and obligations, and testing firm reliability and performance are part of the process of progressively building and nurturing trust.
Clusters and networks can also facilitate the cost-effective outreach and sustainable delivery of both operational and strategic BDS to a potentially large number of participating enterprises. In this context, producers’ and business associations, and public-private partnerships can play a key role. Again, the Sialkot surgical instruments cluster and the Penang electronics cluster provide illustrations. Box 15. Surgical Instrument Manufacturers Association (SIMA), Sialkot 58 The local trade association, SIMA, played a critical role in helping to develop the Sialkot surgical instrument cluster’s effective response to the crisis brought on by the introduction of new stringent quality assurance standards in the US and Europe in the mid 1990s. For example, SIMA mobilized its members quickly to formulate a collective response within 1 month of the announcement of US intention; and organized a delegation of local producers to represent the cluster in negotiations in Washington. It also lobbied the Pakistani Government for financial and technical support to allow cluster members to implement the necessary changes, including bringing in a quality consultant to advise SMEs. Box 16.. Penang Skills Development Centre (PSDC) and Intel 59 To ensure that the necessary skills are in place in the Penang electronics cluster that allow local firms to upgrade their skills consistent with the evolution of the global industry, government-business collaboration led to the establishment of PSDC in 1989. It is a non-profit institution whose mission is to promote shared learning among SMEs in the electronics cluster. Its services are demand driven, responsive to the needs of TNCs operating in Penang, and local firms. The PSDC involves a partnership of the central and local governments, and industry. By the end of September 2000 over 60,000 people have taken part in over 3,000 courses. In March 2000 PSDC launched the Global Supplier Programme for Malaysian SMEs, together with a number of TNCs such as Intel, and the Government, in order to better prepare local firms for partnerships with TNCs . 58 59
based on UNIDO (1999), op cit Based on Abonyi (2001), op cit
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In this context, the approach of Intel to BDS is instructive. Intel’s Malaysian subsidiary was established in 1972, initially assembling components and from 1978 testing them. By 2000 it had a network of 300 suppliers, of which around two-thirds were locally owned, and Intel was involved in an extensive program of supplier upgrading in close collaboration with PSDC and the Government. However, it is important to note that the focus of Intel’s program has been process upgrading. Intel regards its product and functional skills as its core competence, and has not supported strengthening design skills of its suppliers. 60 Focusing support on clusters and networks of SMEs also provides more effective basis for public policy and program initiatives aimed at building up local competitive industrial capacity. Three broad strategies for this are as follows: • Implementing programs targeting inter-firm networks and value chains, and sectoral clusters, with particular focus on facilitating knowledge transfer and inter-firm learning (e.g. on technology, skills, markets); • Enhancing the role for intermediary institutions at the local and industry level, with the private sector taking the lead (e.g. the Sialkot Instruments Manufacturers Association; Penang Skills Development Centre); and • Stimulating the emergence of horizontal institutional networks through regional alliances and partnerships both within and across countries (e.g. the purpose of the Greater Mekong Subregion Business Forum). Based on experience with a wide range of cases, some ‘best practice’ conclusions emerge to guide programs aimed at SME cluster and network facilitation: • Build on what’s there: Clusters and networks are likely to endure and perform better if based on already existing agglomerations of firms. These are more likely to be faced with specific shared pressures that are understood by most firms as requiring changes in traditional ways of doing business if they are to survive (e.g. environmental constraints, technological obsolescence, infrastructure needs). • Collective: Programs should target not individual enterprises, but a group of firms, particularly groups with perceived potential to evolve into effective SME clusters and networks. Providing collective services has lower transaction costs, and allow for a ‘wholesale’ as distinct from a ‘retail’ approach to SME support, which may be further ‘leveraged’ through industry and local institutions as intermediaries. A collective approach to SME support helps generate linkages and mutual learning among enterprises, and the emergence of clusters and networks. • Customer-oriented and responsive: Support should be demand driven, aimed at serving specific markets, e.g. assisting SMEs to access specific niche markets; strengthen collective operations within the framework of particular GVCs, as a means to access global markets. The support should therefore be responsive to particular cluster or network needs (e.g. addressing new industry standards essential for market access), and not just focused on providing a set of generic services (e.g. credit, general training).
60
From a presentation by S.Y. Fong, Intel (Malaysia).
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•
•
•
•
•
Promote inter-firm dialogue: Sharing activities, e.g. training/workshops, quality and certification processes, can stimulate the initial processes of inter-firm dialogue, and begin the building of trust and reciprocity among firms. This is especially important in the early stages of cluster and network development. Clear payoffs: Priority should be given to the direct provision of innovative, value-adding services in a business like manner. Especially in the early stages of cluster and network development small firms are unlikely to be interested in, let alone pay for shared services that address needs that are not clear and immediate, and where expected payoffs are uncertain or far off in the future. Integrated approach: Isolated support measures (e.g. credit, training, technological assistance) are generally not sufficient or effective in fostering SME development. Services should be integrated or bundled together (e.g. financing and training for the acquisition and adaptation of particular technologies), and consistent with the absorptive capacity of firms individually and collectively. Participatory: Initiatives should not be primarily top-down or seen as ‘off the shelf’. Cluster and network development activities should be understood as a process of ‘organizational change’ aimed not simply at transferring general skills or information, but at fostering changes in individual and collective attitudes and behaviours over time. Therefore they need to be designed and implemented with bottom-up involvement of client firms and related institutions. This requires an often long and costly consensus building process on needs assessment, design and implementation. But this is essential if a common strategic vision and stable alliances are to emerge as the basis for operational improvements. Strengthen Local Institutions: A common and consistently critical success factor in cluster development is the presence of effective institutions, particularly at the GVC or industry and local level that facilitate for example horizontal and vertical SME linkages, business-government cooperation, learning, etc. The earlier examples provide illustrations, including the Surgical Instruments Manufacturers Association and the Sialkot Chamber of Commerce in Sialkot, Tirapur Exporters Association, Penang Skills Development Centre.
Examples of the kinds of strategic services that may be of particular relevance to SME clusters and networks for accessing and upgrading in GVCs include the following. 61 •
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Understanding markets: Understanding global markets, especially identifying appropriate niches in GVCs, is both complex and costly. Clusters of SMEs with a shared purpose can cooperate to undertake activities aimed at understanding markets better, e.g. through jointly sponsored market research including hiring specialized consultants; hiring designers with knowledge of buyer tastes in particular market segments; buying key market-related information such as information on new fashion colours in the clothing industry, on water-based paints and varnishes in the wood furniture industry.
see UNIDO (2001)
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• •
•
•
•
Joint selling: Reaching global markets, or global suppliers and international buyers in GVCs, is difficult and costly for SMEs. Joint marketing efforts are important means to access global markets. Joint buying: Cooperation in buying can provide both economies of scale, and a sharing of costs. It can also provide an expanded set of options for SMEs. An important constraint on productivity in poor countries is the inappropriate choice of technology, especially imported technology. Whereas it is difficult for individual small firms to gain information on available technology options, SME clusters and networks are in a better position to access such information, e.g. interest sellers of technology to visit, demonstrate, sell, and train. Product development: There may be strong constraints on cooperation in product development in SME clusters, since each firm may see its products as proprietary, and a source of competitive advantage. However, selling under a common brand or standard such as ‘Indonesian Batik’ or ‘Thai silk’ can generate significant benefits when selling into GVCs that buy in large volumes that are far beyond the capacities of individual small firms. In the case of networks based on a division of labour, where the output of one firm becomes the input of another, joint product development is essential to ensure the required product and process complementarity to maximize efficiency in the network supply chain. Standards, codes, and certification: As discussed, an increasingly critical entry requirement to global markets is meeting a variety of standards, codes and certification requirements that relate to products and production processes. Sharing costs, for example in training and buying advice, is an important means to meet such standards and codes, especially when they involve a ‘shock to the existing production system’, as in the case of the Sialkot surgical instruments cluster and its response to changes in US quality assurance standards. Learning networks: There is increasing evidence that ‘learning networks’ provide an important mechanism for strengthening the capacity of SME clusters and networks to compete effectively in global markets, including accessing and upgrading in GVCs. These provide mechanisms for SMEs to come together, and share their experiences as the basis for continuous cluster/network improvements. For example, forming a ‘benchmarking’ or ‘best practice club’ (e.g. Auto Components Benchmarking Club in South Africa) can lead to significant improvements in firm performance.
In reviewing these types of services, it is useful to keep in mind the earlier discussion on BDS, in particular the ‘market development paradigm’ and a preference for a private sector driven approach, but constrained by the generally limited availability of markets for strategic BDS for SMEs and hence a potential role for governments and donors. That is, the availability of the types of strategic services identified above for strengthening SME clusters and networks is often characterized by market failures and high levels of complexity. As a consequence, the provision of such services is ‘institution intensive’, likely to require both inter-firm and business-government cooperation; and they may also require the establishment of new institutions, or the strengthening of existing institutions especially at the industry and local levels, as reflected in the earlier
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examples (e.g. Tirupur Export Association; Penang Skills Development Centre; Surgical Instruments Manufacturers Association in Sialkot).
V.
Recommendations for GMS Subregional Initiatives to Support SME Participation in Global Value Chains 62 1.
Overview
Facilitating the participation of domestic SMEs in GVCs requires a wide range of different types and levels of initiatives, involving government, private sector, and donor support, as required. These include: •
•
• •
Strengthening the enabling environment for export-related SMEs: This is primarily the role of government, though it is likely to require public-private partnerships in various forms to address selected issues. It includes improving: o software: For example, policies, rules, regulations with respect to exports and the importing of inputs for export-related production; strengthening the capacity of the financial sector in channeling funds to SMEs, particularly export-related SMEs; streamlining the FDI system; o hardware: For example, improving basic infrastructure and logistics systems, particularly as related to SMEs. Strengthening vertical linkages of domestic producers to GVCs: At the ‘top of the chain’ this involves strengthening linkages between relatively large national exporters and international buyers/global suppliers. At the ‘bottom of the chain’ this involves strengthening linkages between higher tier suppliers/buyers (foreign, and domestic linked to GVCs) and lower tier suppliers (SMEs). Strengthening horizontal linkages among domestic producers in GVCs: This involves the development of enterprise clusters and networks to increase collective efficiency and joint action of domestic producers in particular GVCs. Upgrading: This involves strengthening the capacity of enterprises to improve their position in the GVC, e.g. by moving to higher value-added activities, for example by improving information flows and learning, promoting product and process innovation, development of functional capabilities (e.g. design, marketing, logistics), benchmarking and ‘best practice’ initiatives. This also involves strengthening the domestic value chain as a whole, within the GVC, by addressing systemic value chain constraints, e.g. logistics linkages between domestic producers.
Related BDS may include the following types of activities, either embedded in existing GVC linkages (e.g. provided by global buyers or 1st/2nd tier suppliers to their subcontractors), or provided on a ‘fee-for-service’ (including subsidized) basis.
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The focus here is on subregional or multi-country as distinct from purely domestic initiatives. These may include strengthening linkages across borders in the GMS, or common constraints that may be addressed on a subregional/multi-country basis.
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•
•
• •
Generic operational services: This involves addressing general constraints related to business performance, e.g. general management skills, entrepreneurship, strengthening general business functions such as finance, accounting, production and operations management, marketing. General GVC-related: This involves strengthening the general understanding by enterprises (SMEs) and related government agencies of the transformation of international production, trade and investment; in particular of the role, organization and operations of GVCs and their general implications for lower-tier suppliers. o As a pre-requisite to effective participation by domestic producers, particularly SMEs in particular GVCs, it is essential to develop a ‘GVC mindset’. That is, it is important to have an appreciation of the systemic nature of GVCs, and therefore of focusing on systemic efficiency requirements of the domestic value chain as whole, as distinct from a focus on individual enterprise performance. This means that enterprises, business associations, and government agencies must have the capacity to understand and analyze domestic value chains for key product groups within the context of GVCs, and see where improvements in the value chain as a whole can strengthen the collective efficiency of domestic producers to participate effectively in particular GVCs. Particular GVC-generic: This involves addressing general constraints and requirements for participating in particular GVCs, e.g. requirements of becoming a lower-tier supplier and upgrading in the fresh fruit and vegetable GVC. Particular GVC issue-specific: This involves focusing on specific issues/activities related to particular GVCs, e.g. design capabilities in the bamboo furniture GVC; packaging and labeling requirements in fresh fruit and vegetables GVC. 2.
Proposed Work Program for UNESCAP
The proposed work program for UNESCAP ideally is best implemented as an integrated program, with the logical sequencing to some extent reflected in the order in which the proposed initiatives are presented. Strategically, taken as a set, the proposed initiatives follow from the analysis in this paper, identifying key constraints and requirements for SMEs to participate effectively in GVCs of interest. Operationally, the proposed work program is intended to be ‘modular’ in nature, in that any of the initiatives may be implemented independently of of the others. In this context, the first initiative proposed, establishing a ‘GMS GVC Working Group’ is intended to provide the overall institutional foundations for more specific, focused GVC-related cooperation in the GMS. i.
Institutional framework for guiding GMS GVC cooperation
Issue: There exist significant opportunities for cooperation on a subregional basis among the GMS countries with respect to specific GVCs. However, in each GVC there are a wide range of constraints that need to be addressed by the participating countries. These include both ‘soft’ constraints, for example relating to rules and regulations, both domestic and cross-border, and ‘hard’ constraints, such as strengthening cross-border
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logistics systems. Therefore drawing on the lessons of 13 years of operations of the ADB-facilitated GMS Program, it is essential to have in place a multi-country or subregional mechanism that allows the GMS countries to jointly identify and address on an on-going basis key constraints with respect to selected GVCs. This mechanism would provide the overall framework for more specific GVC-related initiatives. It requires the clear commitment of the GMS governments, and close links with the private sector. Initiative: Establish a GMS institutional framework for facilitating subregional linkages within selected GVCs: in effect providing a framework and mechanism for implementing a coherent ‘GMS value chain programme’ aimed at specific product/markets. In particular, set up a “GVC Working Group” of the GMS countries, building on the experience of the GMS Program, e.g. at the level of the Senior Officials/GMS Coordinators, with UNESCAP providing Secretariat support, and in collaboration with the GMS Business Forum (GMS BF). This Working Group could build directly or indirectly on the existing commitments, structure and activities of the GMS Programme, e.g. infrastructure, trade facilitation, investment, as well as other GMS-related initiatives, but focus on selected GVCs. There are two options for the establishment such a GMS GVC Working Group. It may be established as a working group directly within the framework of the on-going GMS Programme; or it may be established as an independent working group that builds on the existing activities and structures of the GMS Program and other subregional initiatives. The GVC Working Group would have a 2-level agenda: • Strategic: Select particular GVC(s) for focusing subregional cooperation activities. o This requires assessment of a number of GVCs for consideration, for example those where existing GMS cross-border value chain linkages may be strengthened and extended; and/or potential new value chain-related linkages that have significant promise over the medium-term for subregional cooperation. (Note: This is a process similar to the sector analyses at the beginning of the GMS Programme that identified priority projects.) Selected individual GVCs need not involve all GMS countries simultaneously, along the lines of the GMS Economic Corridors model. Agreement on GVC work programme would follow, with the commitment of the GMS governments. Examples could include garment production integration on a subregional basis; developing a ‘GMS’ marketing (and working toward GMS branding) of organic fruit and vegetables, given a growing market and problems of ‘small lot supply’ in some countries; with Thailand as regional auto parts hub, outsourcing of lower tier production of components (e.g. Cambodia has rubber and processing); wood/bamboo/rattan furniture production/marketing. • Operational: Prepare and implement a work programme addressing specific key constraints on subregional/cross-border linkages in the given value chain(s). o This requires identifying and addressing specific cross-border and domestic constraints relevant to the specific GVC(s) selected. Examples: Specific GVC-related trade facilitation activities such as simplification/harmonization of processes, rules, regulations related to imports (e.g. inputs, components) and of exports (e.g. components, final products) in the selected GVCs. This can build on the on-going
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trade facilitation initiatives in the GMS Program. Similarly, strengthening specific logistics requirements for the selected GVC can build on existing GMS infrastructure cooperation. ii.
Subregional Training Workshops on specific GVCs (e.g. organic fruit and vegetables; wood/bamboo/rattan furniture)
Overall Issue: SMEs in the GMS have limited understanding of structure, dynamics and requirements of GVCs, as well as of the potential opportunities they provide. A ‘generic GVC familiarization workshop’ is not likely to be effective; workshops need to be directly relevant to participating SMEs, offering clear potential payoffs. General initiative: Given the above, training workshops should focus on particular GVCs and on specific needs within such GVCs. To ensure credibility, they should be conducted jointly with global buyers in the selected GVCs (e.g. Carrefour or Tesco in fresh fruit and vegetables GVC); in partnership with industry associations/chambers of commerce in the GMS countries; as well as with other donors active in the selected GVCs. The workshops need to be ‘subregional’ in nature, that is, relevant to a number of the GMS countries. In this context, the GMS BF has a potentially important coordinating role to play. A 2-level approach should be taken, composed of a ‘GVC Familiarization Workshop’ for SMEs, followed up by specific workshops involving ‘training of trainers’, targeted at key constraints in the selected GVCs. (a)
GVC ‘Familiarization’ Workshop
Issue: SMEs have limited understanding of the demands of being suppliers in GVCs, e.g. scale, quality, standards. However, general ‘training workshops’ on this are not likely to be effective for SMEs that have limited resources and look for usable information. Therefore workshops should be directly relevant to participating SMEs and focus on producer groups (enterprises) that may, over time, have the potential to be suppliers to particular GVCs; and that have a multi-country relevance (i.e. the workshops can be repeated in GMS countries). It would set the stage for more specific operationally focused topics within the selected GVCs. These workshops should be delivered directly to groups of SMEs, also serving as a ‘cluster strengthening exercise’; and as noted, implemented with the participation of relevant global buyers/producers, build on work of existing donors, in partnership with GMS BF and domestic business associations. Initiative: This workshop would explain in operationally-relevant terms what it takes to become and stay a supplier in the given GVC; and the practical implications for the SMEs individually and as a group. Given the scale needs of buyers, this type of workshop can help reinforce the need for cooperation and task-related trust among SMEs (e.g. similar to UNIDO’s ‘cluster building’ workshops). In order to be effective and credible, this workshop should be conducted jointly with global buyers/producers as the primary ‘resource people’, e.g. Carrefour on fresh fruit and vegetables GVC; IKEA on wood furniture; and with credible local industry association. GMS Business Forum can be a
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general partner, given its subregion-wide role and coordination requirements. The workshop should also involve other donors with experience in the specific GVC. (ii)
Workshops on Specific Issues in the selected GVC(s)
Issue: These training workshops follow from and should be clearly coordinated with the ‘Familiarization’ workshop, addressing specific topics of particular operational relevance in the selected GVC, where upgrading of SME knowledge and skills are essential. Given the number of SMEs involved, these should be structured as ‘training of trainers’. Initiative: The topics of each workshop would be determined by the particular critical ‘bottlenecks’ in the specific GVC, in consultation with global buyers/producers in the GVC. For example, workshops could address issues such as: design, standards and certification, technology acquisition and sharing, packaging, shipping and logistics, branding and labeling, channel and distribution. The intent is to repeat these workshops in the GMS countries, by focusing on GVCs with multi-country/subregional relevance; involve global buyers/producers as appropriate; and implement with credible local industry associations in each country; and in general partnership with the GMS BF. These workshops should also be implemented in partnership with other donors addressing similar issues and/or that can contribute, e.g. MPDF, GTZ. • If possible, workshops should be complemented by capacity building for institutions working with SMEs in these specific areas. (iii)
Establishment of ICT training and resource Centres
Issue: Familiarity with ICT is essential for SME participation in GVCs which are generally coordinated by such information and management systems (e.g. in agribusiness networks led by global retailers such as Carrefour; wood furniture networks led by global buyers such as IKEA). They are also important for linking SMEs to each other in sharing key information and task-related communication (clusters). In general, SMEs in the GMS have limited appreciation of the role of ICT; and often face significant constraints on accessing information. However, SMEs do not need just to access general information; they need information that addresses specific needs they have, e.g. potential buyers for their products; working with e-business systems of global buyers in their GVC. Initiative: Establish a GVC-specific information and training program, e.g. relating to GVC market information and business e-communication training. That is, it should relate to needed information support for SMEs in particular GVCs, e.g. e-business requirements of organic fruit and vegetable GVC. Instead of traditional ad hoc IT training courses, it may be most effective to establish/utilize an enterprise/institution as an ‘information intermediary’ that offers integrated IT services for SMEs in particular GVCs in specified locations, including outside capital cities. Such an institution’s products would include: hosting ICT-related training facilities and programmes focused on the selected GVC; information and related advisory services with respect to the given GVC. The host agencies could include provincial Chambers of Commerce; and the GMS BF could play an overall supporting/coordinating role on a subregional basis.
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•
This initiative could build on the experience of UNIDO’s BISnet and “One-StopShop” (OSS) which have been implemented in a number of countries, including Sri Lanka, Pakistan, and in progress in China, though these focus on general SME information and related training needs, as distinct from the GVC focus here. (iv)
Building SME Supplier Clusters Across Borders
Issue: It is too costly, time consuming, and risky for global buyers to deal individually with many small suppliers. They prefer to deal with a small number of core suppliers. Therefore an important challenge for SMEs is cooperation—the formation of alliances, groups or clusters—to reduce the transaction costs of global buyers/producers, and for collective efficiency. Cluster development is primarily a domestic issue, involving the cooperation of groups of local SMEs. However, the preparation of a number of ‘economic/industrial estates’ in border areas provides potential opportunities for ‘cross border cluster development, and experience already exists with this general approach. Initiative: There are a number of ‘joint economic zones/industrial estates’ in preparation or in discussion involving key border points in the GMS, e.g. Thailand/Myanmar, Thailand/Lao PDR, Viet Nam/Cambodia. These may be approached, from the outset, as supporting a cross-border cluster of suppliers for particular GVCs, e.g. auto parts, garments. This can help enhance the attractiveness of the GMS to foreign investors in terms of a ‘single subregional production base’. This initiative would require close cooperation among the relevant GMS governments in creating ‘cross-border economic zones’ or linkages—in terms of coordinating/harmonizing rules, procedures, regulations in the context of specific GVCs . (v)
Building Vertical Linkages in Selected GVCs
Issue: Building vertical linkages is the basic objective of GVC-related initiatives aimed at linking domestic SME producers to global buyers/suppliers. Furthermore, in many GVCs these vertical relationships are the key mechanisms through with SMEs learn about changing product-market requirements, i.e. through which GVC-related strategic BDS are delivered. However, given their constraints, it is challenging for SMEs to build such linkages on their own. Initiative: Build on existing experience with GMS ‘business matchmaking’ and ‘trade fairs’ to implement such ‘GVC business matching/fairs’ for specific GVCs of subregional interest. This may build on and be linked to ‘GMS familiarization tours’ by global buyers, that have been organized by the GMS Programme in the past, though not focused on particular GVCs or industry. It can also be linked to the building SME supplier clusters, both domestic and cross border. These activities should be implemented as joint public-private initiatives, co-sponsored by key multilateral and bilateral donors, and in cooperation with the GMS BF given it subregion-wide reach.
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(vi)
Subregional Cooperation in Certification
Issue: Access to global markets through GVCs depends increasingly on credible certification. Global buyers generally look to work only with certified companies, e.g. as an indication that minimum required capabilities are present. Where testing and inspection are not by the GVC buyer, suppliers must be able to prove the reliability of their inspection procedures, test data, and conformity with international standards. Concept: Focusing on specific GVCs: (a) strengthen selected GVC-related certification bodies; and/or (b) establish or support a process of GVC-related certification by an independent body (e.g. ILO certification of Cambodian garment manufacturers). Given resource and technical constraints on some GMS countries, such certification bodies or initiatives could be established in selected countries but with a subregional mandate. In general, support for certification for SMEs can form part of GMS industrial promotion strategy at both the country and subregional level. 3.
Concluding Comments
In general, global value chains and associated networks offer significant opportunities for qualified GMS SME suppliers, if they meet a multiplicity of demanding requirements. Furthermore, the basic objective of such linkages is not only market access through GVCs, but upgrading over time. The challenge then is to address the specific needs of GMS SMEs in particular GVCs, on a subregional basis, in an effective way.
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