Global Value Chains: The Rise of Global Factories

Introduction

As technology, communications and transport have developed, international trade has significantly expanded leading to the rise of globalisation  (Rodrigue et al, 2017). The escalation of globalisation has not only intensified the need for firms to develop and grow their competitive advantages but accelerated the development of international trade.  

Today, the biggest firms are not national but multinational corporations who lead  Global Value Chains (GVCs), involving subsidiaries, suppliers and customers across many countries. Intermediate goods now make up a larger proportion of cross border trade than final goods, as corporations look to offshore and outsource production to enhance profits, access new capabilities and expand markets and control (Gereffi, 2014). There has also been a consolidation of value chains in certain industries, through the rise of lead firms who control global production of goods and services, and generate substantial wealth and power.

The purpose of the literature review is to define the GVC concept, understand how GVCs are structured to capture value and look at GVC issues and opportunities for economic and social upgrading. The literature review will achieve this through examining various perspectives and activities of the lead firm, host nations, suppliers and employees. 

The Rise of GVCs

International trade is primarily based on the theory of comparative advantage, where nations specialise and export goods that they have an advantage in such as costs, technology or access to natural resources (Milberg & Winker, 2013). Firms are continuously evaluating their market position and looking to develop new areas of competitive advantage.

In 1985, Michael Porter first coined the term, value chain in his book ‘Competitive Advantage: Creating and Sustaining Superior Performance’, where he outlined the value chain approach used by firms to determine value could be added to raw materials at different points along the supply chain to realising customer value (Gereffi, 2014).

Though increasing international trade, the value chain concept has been applied at a global scale, whereby firms locate various stages of production in different countries to capture value. Globalisation has enabled firms to restructure their operations internationally to access new markets and lower-cost production through outsourcing and offshoring of activities (Gereffi, 2014, OECD, 2020).

Global Value Chain “the full range of activities that firms and workers perform to bring a product from its conception to end-use and beyond”, that are carried out on a global scale and that can be undertaken by one or more firms (Gereffi & Fernandez-Stark, 2011).

Outsourcing: “delegating (part of) activities to an outside contractor” (OECD, 2004).

Offshoring: “is used to describe a business’s (or a government’s) decision to replace domestically supplied service functions with imported services produced offshore… A company can source offshore services from either an unaffiliated foreign company (offshore outsourcing) or by investing in a foreign affiliate (offshore in-house sourcing)”. (OECD, 2004).

GVCs involve a complex system of authority, relationships and activities located across multiple nations and involving many intermediate products and services (Hernandez & Pedersen, 2017). GVCs include not only finished goods but also components and subassemblies, and operate in industries such as “manufacturing, energy, food production and all kinds of services, including call centres, accounting, medical procedures and research and development (R&D) activities” (Gereffi, 2014).

By 2009, the use of GVC’s was a well established corporate strategy and trade pattern, with the production with intermediate goods exceeding final exports at 51 per cent (OECD, 2011; WTO and IDE-JETRO, 2011). While it is estimated that the use of the GVC structure enables firms to increase profitability by 40 to 60 per cent (Milberg & Winker, 2013). In particular, benefits to firms outsourcing and offshoring include:

  • mass customization;
  • allows lead firms to focus on their core competence
  • retention of rents from branding, marketing and financialisation;
  • offloading risk and occasionally bypassing labour and environmental  risks;
  •  increased competition among suppliers and access to cheaper labour;
  • Increased production flexibility to change inventory lines and suppliers as the market shifts (Milberg & Winker, 2013).

Power, Governance and Structure

GVCs wield significant economic and political power as they transcend multiple national boundaries creating trade and workforce interdependencies. GVCs also have a major impact on national capabilities as they enable economic and social upgrading including technology and skills transfer, industry value-add, infrastructure development, product and service development, and employment (Gereffi, 2014). Therefore, GVC configuration and the relationships between parties is important not just to the lead firm but also suppliers and the nations that host them. 

Most GVCs have a lead firm who orchestrates and controls downstream decisions to make or buy based on opportunities to minimise their cost and extend their reach. Though there are some cases where suppliers can control the power at the firm level. Where lead firms do control the value chain, they hold massive power and “can actively shape the distribution of profits and risks in an industry (Gereffi, 2019).” 

Lead firms determine where international production takes place, will use foreign direct investment (FDI) to shore up markets and supply chains, undertake joint ventures and subcontracting, and support knowledge transfer and training in some cases (Hernandez & Pedersen, 2017). Lead firms have been found to exploit segmented labour markets to further increase their production flexibility and reduce costs. However, they may also work extensively with the supplier to improve the quality design and reliability of supply and logistics (Milberg & Winker, 2013). Either way, what matters most to a lead firm is that they are able to profit from focusing on their core competence and protect their brand identity. 

Lead firm:  the firm which shapes, controls, coordinates and distributes the value along the chain; and is responsible for the final sale (Azmeh and Nadvi, 2014)

Core competence: the key activities of a firm that its competitive advantage is derived from.

There are two major GVC structures depending on the power of different firms within the chain, these include:

  • Buyer-driven GVCs: are where the lead firm is the final buyer and will outsource (often at arm’s length) inputs for raw materials and manufacturing, instead focusing on their core competencies in higher value-add areas. Buyer driven chains tend to have low barriers to entry and buyers will often make decisions on producers based on cost reduction and production flexibility. Buyer driven chains typically occur in retail chains and branded non-durable final consumer products, including agriculture, clothing, and footwear. 
  • Producer-driven GVCs: are where the value chain is mostly coordinated by intermediary suppliers and distributors. Producer-driven chains are typical in industries where suppliers have their own core competencies such as those that require high technology and significant capital investment, and therefore have high entry barriers. Examples include the automobile and aeronautical industries (Rodrigue et al, 2017).

While the ultimate configuration of producer or buyer-driven GVCs will depend on various aspects, there are also a variety of GVC characteristics defined and depicted in image 1 by Gereffi et al. (2005), that need to be considered due to the impact on local communities. These include:

  • Hierarchical chains are established when the lead firm owns and operates the majority of the chain through subsidiaries or strategic business units to maximise control and profit capture;
  • Captive chains (Quasi-hierarchical) are used when intermediate suppliers require support and direction due to low capabilities, the supply chain is well established and often operated by oligopoly lead firms. Suppliers are less able to bargain but more able to receive support from lead firms;
  • Relational and modular chains are established when suppliers hold their own competitive advantages ( including technology and knowledge competencies, infrastructure, access to raw resources) and can operate independently of the lead firm. However suppliers make products according to the lead firms specifications; and
  • Market chains are an example of arms-length relationships that are often established when lead firms require a flexible relationship in order to respond to cost shifts or market changes (Hernandez & Pedersen, 2017).

Image 1:

(Gereffi et al., 2005)

Issues

With the rise of GVC, there has also been significant consolidation of power into a small number of large firms through mergers and acquisitions, increasing market control. As a result, lead firms often operate in oligopolistic markets with asymmetry in market information and capabilities (Gereffi, 2014). Large corporates no longer make their profits through product pricing but instead, through the use of GVC to enable mass customisation and cost-cutting.

Lead firms welcome the configuration of value chains that enable multiple suppliers to increase competition, drive down costs and enable greater production flexibility (Milberg & Winker, 2013). GVCs have also been linked with increasing income inequality between lead firms and their suppliers.  Where lead firms are able to earn substantial rents via their intangible assets including brand, copyrights and design; and barriers to entry stemming from existing capability and economies of scale (Gereffi, 2014).

Milberg and Winker (2013) advise that there are four main strategies used by lead firms to exert their control. These include:

  1. Inducing competition among suppliers – by working with multiple suppliers and holding short term contracts;
  2. Unloading risk onto suppliers – through arms-length relationships, risk can be deferred to suppliers who purchase raw material and manufacture goods. Some lead firms may purposefully look for suppliers in nations where there may be fewer social and environmental regulations;
  3. Establishing entry barriers – through branding and downstream purchasing power; and
  4. Minimising technology sharing – Brand power is often derived from considerable technology and design abilities. Lead firms will protect their source of competitive advantage to maintain customer loyalty and brand leadership. While outsourcing other areas of production that can be done at arms-length.

However, there are also issues for lead firms, not just the nations that host them. Lead firms need to contend with and adapt to the unique market situations in each place while also developing economies of scale and supporting knowledge transfers to local labour markets (Gupta & Govindarajan, 2001). Specific issues include managing local laws, regulations, customs, languages, and capabilities; and each location will require a different management style, a flexible approach and cultural awareness.  (Hernandez & Pedersen, 2017).

 While studies have also found a reduction in employment and labour share due to offshoring manufacturing and service sectors in the United States. Many Lead firms have also been found to now under-invest in future R&D becoming focused on raising through share prices, known as financialisation. Thereby reducing the domestic demand for long term investment and capabilities for technological change. Therefore, nations need to be aware of the issues and opportunities to design interventions and controls to maximise benefits and growth opportunities (Milberg & Winker, 2013).

Upgrading

In developing and economies in transitions, many small and medium enterprises (SMEs) often lack managerial and industrial capacities, including knowledge and technology capabilities, to develop their own competitive advantages or operate in global production networks (UNIDO, 2020).  GVCs can offer substantial benefits that support wider economic development for suppliers and host nations through a process known as upgrading. That is, where “economic actors – nations,   firms and workers” transition from low-value activities to higher value-add activities through participation in GVCs (Gereffi et al. 2005). Upgrading can lead to both economic and social outcomes and is considered a development strategy in its own right.

 For example, suppliers can ‘learn’ from lead firms the well-established processes, products and technologies used by global buyers. Benefits may include direct adoption as part of the contractual agreement and include training. More broadly economic upgrading includes “changes in business strategy, production structure and technology, policy and the organization of markets” and can demonstrate “supernormal returns on innovation” (Bernhardt & Milberg, 2011; Gereffi et al., 2005).  

Humphrey and Schmitz (2002) identify four types of upgrading, including:

  1. Product upgrading, or moving into more sophisticated/high-value product lines;
  2. Process upgrading, transforming production processes by reorganizing the production system and/or using advanced technology;
  3. Functional upgrading, which entails acquiring new areas of activity (or abandoning existing activities) to increase the overall skill; and
  4. Intersectoral or chain upgrading, in which firms move into new but often related industries.
Economic Upgrading move to a more profitable and/or technologically sophisticated capital- and skill-intensive economic niche (Gereffi, 1999)”

Social upgrading “the process of improvement in the rights and entitlements of workers as social actors by enhancing the quality of their employment” (Barrientos, Gereffi and Rossi, 2010).

Economic upgrading can also translate into social outcomes, known as social upgrading. By which the gains from economic upgrading (improvements in employment, wages and labour standards) are distributed more broadly though income multipliers and improvements to institutional frameworks to grow social welfare and living standards. Firms from developing countries may also achieve social upgrading whereby local firms and host nations adopt more progressive institutions as a condition or a by-product of working with the lead firm (Hernández & Pedersen,  2017).

However, both processes require a purposeful approach. Where host governments and other actors have not been conscious to capture the potential outcomes, benefits have not trickled down (Bernhardt & Milberg, 2011). Additionally, evidence shows, that global buyers do not necessarily facilitate functional upgrading and it requires host nations and suppliers to recognise the “connection between economic and social upgrading” to advance in the design of institutional, industrial and commerce policies, regulations and taxation to capture the benefits on offer (Bellhouse  & Salido, 2016).

What can policymakers do

The GVC framework changes the way that firms create value and operate in a global economy. While there are issues that stem from asymmetry in information, capabilities and power. If links in the chain are designed purposefully, it can support win-win outcomes for lead firms, host nations, suppliers and employees.

 The following offers a list of questions that policymakers can ask when undertaking GVC analysis:

1.       What is the structure of the GVC? Where are buyers and suppliers located geographically? Who are the key global players in terms of countries and firms? How concentrated is the market?

2.       Where does power and value come from in the chain? Does it stem from the design and aesthetics of the product (i.e., apparel) or does it depend on functionality, technological innovation and/or the flawless interplay of complex systems to operate (i.e., airplane)?

3.       What are the objectives of the host nation? To increase exports? Provide more (or better) employment opportunities? Transfer knowledge to domestic firms? Understanding GVCs is critical for knowing when to attract foreign investment or support the growth of domestic firms.

4.       Where does the host nation currently fit within this global and regional landscape? What are your options to improve positioning or create new opportunities in related industries (i.e., upgrading) (Frederick, 2017)?

5.       What opportunities and learnings can be gained from the lead firm. E.g. FDI, training, employment contracts, local procurement, joint ventures, R&D partnerships, tax reform, labour regulations etc.

6.       What local production and trade networks operate that can help to link large and small suppliers into local value chains. What can be done to create new or alternate links in the chain to promote diversified outcomes and improve access?

7.       What performance requirements and standards has the lead firm set as a condition entry and mobility within local contracts? What interventions and pressure points that allow for change in these contracts and within the local economy? What can be done to improve knowledge, technology and resources flows to make all firms in the chain more productive (Gereffi, 2014)?

Book references

Rodrigue, J-P et al. (2017) The Geography of Transport Systems, Hofstra University, Department of Global Studies & Geography

William Milberg; Deborah Winkler (2013) Outsourcing Economics: Global Value Chains in Capitalist Development. Cambridge University Press

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