Part-I

Challenge to developing economies:

How to access global markets

How to do so in a way that provides for sustainable income growth (allowing for
increasing pricing power or value creation over time)

Labour intensive manufacturers 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.

Main Causes of Failure:

Growing competition and

Falling prices

Global standards:

Quality
Price
Timely delivery
Flexibility

Global value chains and international production networks are the product of two interrelated
processes transforming the international economydriven by

Increasing economic liberalization

Technological development

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 process 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.

Part-II
Purpose: Access international markets directly by selling final products with pricing power
and brand presence to international customers.
Requirements:

Information on

existing conditions in markets

available production technology
existing product-market competition

Capabilities to
Design
Produce
Market
Distribute
Service the product on global markets
Effective Response to
Changing Market Conditions
Evolving Tastes
New Competitors

Increasingly intense global competition in product-markets is forcing

prices down
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 product-market conditions change
GVCs and associated production networks may provide more manageable opportunities for
SMEs to

access global markets and

upgrade capabilities over time.

1. 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 subregional or regional grouping
of economies such as the GMS or ASEAN, and the global economy.

Simplified Value Chain:

Generic Value Chain & its Inputs:

2. Global Value Chain (GVC): Value chains become global, when their
component activities are geographically dispersed across borders to multiple country
locations.
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.
For example, in the apparel value chain, 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 also demonstrates
potential differences between industry and value chain perspectives. Apparel production
straddles more than one industry: it is closely linked to both agro-industry (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
activitiesincreasingly with high intellectual content, such as R&D, engineering, design,
sales, marketing, information systems, customer servicecontribute most of the value added
in many manufactured products. This is also reflected explicitly in the value chain
representation.

3. 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.
An international production network (IPN) involves the distribution and coordination of
geographically dispersed activities in multiple country locations.

What distinguishes lead firms from non-lead firms in a network: 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).

Intra-firm international production networks:

Production network primarily internal to a firm, involving ownership linkages among

subsidiaries and affiliates in different geographic location.
Classic transnational or multinational, vertically integrated corporation.
Coordination and control of production and related activities is internalized within a
particular firm, though it may stretch across borders.

Inter-firm (non-equity based) production network:

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 nonequity based production networks; usually coordinated by lead firms who set the
standards for participation.

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.

4. Increasing Importance of GVCs and IPNs:

i. Challenge of Coordination: Generally 2 approaches have been followed to overcome this
challenge.

Hierarchy:

Activities along the value chain within the control of a single firm, and
coordinate them through ownership and direct management.
Vertically integrated firmtogether with subsidiaries, affiliates, and
joint ventures
Ownership and control of inputs, components, and products as they are
transformed along the value chain

Example: Traditionally GM and Ford followed this but later on they

moved from it.

Coordinated by arms length transactions

Products change ownership as they move between activities along the
value chain, with no overall coordination of production among firms.
Example: In the apparel industry a clothing manufacturer purchasing yarn
on the open international market; or a supermarket purchasing fresh fruit
on the market from any available supplier.

Markets:

ii. Dismantling hierarchy: This challenge can be overcome by:

Focusing on their core competenciesactivities firms see themselves doing well and
that allow them to capture higher returns
Outsourcing non-core activities.
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).

iii. 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 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
Consumer demand for higher quality
Lower prices
Speed (e.g. rapid response in production and distribution, shorter
product life-cycles)
Flexibility (e.g. build-to-order, configure-to-order)
Increasingly stringent standards, including general standards
such as SA8000 on labour, industry-specific standards such as
phytosanitary standards in agro-industry, and firm-specific
standards such as the in-house brands of global retailers like
Carrefour.

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.

iv. Emergence of network orchestrators: Some firms have emerged 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.

Basis for their competitive advantage--involves coordinating and integrating activities

along a given value chain.
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:

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 Toyotas and Fords
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.
GVCs and IPNs provide for SMEs an increasingly effective mechanism for accessing
global and regional markets as suppliers within such chains and networks

ii. Types of GVCs:

Producer-driven chain or network:

Large multinational manufacturer plays a central role in exercising
relatively close control in coordinating a geographically distributed
network of subsidiaries, affiliates, and suppliers.
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.

Buyer-driven chain or network:

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.
Characteristic of labour-intensive, consumer goods industries such
as apparel, footwear, agro-industry, and consumer electronics
The participation requirementsalthough 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 buyers requirements.
May provide opportunities for upgrading over time
Hybrid chain or network:
Less Prevalent
More Horizontal in nature
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 Microsofts software strategy, Intels strategy in
semiconductors, and Dells customer-based branded assembly
and marketing strategy.

iii. Key Characteristics of GVCs/IPNs:

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:

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 standardsalthough 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.
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 innovationeven 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.

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, Toyotas
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 Fords, within the automobile industry.

Types of Innovation:
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:

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)
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, Carrefours 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 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.

6. How SMEs Fit Into GVCs/IPNs:

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 otherfor
example lower costsuppliers. 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 upgradeto move up the value chain and increase the value content of
activities. (Fig. 6)

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.

Part 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.
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.
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)
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 ICT-based
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)
sustainabilitythe 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) impactimproving the productivity and competitive performance of the SMEs
involved.

3. The Role of Enterprise Clusters

i. Clusters and 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.

ii. Development and Strengthening of Clusters

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.
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.