Encouraging Firms to Move up the ‘Value Added Chain’:

What Policies are Likely to be Effective?

Geoff MasonNational Institute of Economic and Social

Research, London

February 2006

Research questions• What are the main factors that encourage UK-based

companies to adopt high value added product strategies –or discourage them from doing so?

• What are the key prerequisites for UK-based companies to succeed in adopting high value added product strategies?

• What steps can companies themselves take to help reduce or surmount any barriers to adopting higher value added product strategies which are identified?

• What policy reforms (if any) might help encourage companies to adopt higher value added product strategies or reduce the main barriers to companies doing so?

Dispersion of average labour productivity levels (Source: FAME)

[Value added = Operating profit + Employee costs + Depreciation + Amortisation]

Manuf-acturing

Printing Plastics Marketservices

Logis-tics

Generalinsuranceservices

Year 2000-02 2000-02 2000-02 2000-02 2000-02 2000-02

Number of enterprises 12871 806 575 13706 1039 336

Average VA per employee (£) 30519 35761 29354 35796 30259 50465

Number of enterprises reporting consolidated accounts data

2501 122 87 3825 178 100

Average VA per employee - -consolidated accounts only (£)

Index numbers (Median = 100):

32470 35421 30381 38870 32602 44352

10th Percentile 57 69 67 23 71 57

25th Percentile 76 81 80 62 85 69

50th Percentile 100 100 100 100 100 100

75th Percentile 133 123 130 155 120 170

90th Percentile 179 146 171 247 165 217

Above average value added per employee at enterprise level could be due to….

• High share of sales devoted to high-specification products which command higher market prices than more ordinary products

• More efficient use of materials and bought-in services with little or no change in product specifications

• High levels of spending on advertising campaigns which help raise the market prices commanded by low-specification branded products

Research design• Comparisons of matched samples of high value added

(HVA) and medium value added (MVA) companies in four very different industries: – plastics processing, commercial printing, logistics and

general insurance services • Case study companies selected from FAME company

accounts dataset [2 groups of 5 firms in each industry]: – HVA group -- located in upper quartile on measure of

average value added per employee– MVA group -- in inter-quartile range on same measure

• Semi-structured face-to-face interviews with senior managers, plus detailed follow-up enquiries

Plastics processing • Facing cheaper imports from Far East, Turkey and

elsewhere in less complex product areas• Majority of firms seek to specialise in product areas

where specifications are complex and/or transport costs are high

• HVA firms more capital-intensive• HVA firms: strongly depend on continuous product

innovation, eg, for medical applications or high-spec end of food packaging market

• MVA firms: majority of sales still derive from low-margin products that are shielded against imports by transport costs

Commercial printing• Facing continued overcapacity and downward pressure

on prices; some product areas almost entirely covered by imports

• Majority of firms seek to specialise in niches where geographical proximity to customers is important

• HVA firms more capital-intensive, more likely to be securing economies of scale through long production runs (with long-term contracts) or to have identified specialist niche markets

• MVA firms more often caught up in short production runs at short notice, facing downward pressure on profit margins

Logistics - road transport, cargo handling, storage and warehousing, freight forwarding

• Facing price competition, pressure on costs from driver shortages and congestion, high costs of new IT systems

• HVA firms typically smaller and focussed on high value specialist niches, eg, controlled temperature storage and distribution; international movement of specialised equipment

• MVA firms more likely to span wide range of transport and storage activities, with minority share of sales in ‘value added services’, eg, supply chain management (skill-intensive); additional product handling, packing and preparation (often not skill-intensive at all)

General (non-life) insurance services• Cyclical industry, periodic downward pressure on

prices, profits and employment• Sample firms all independent insurance brokers• HVA firms more capital-intensive -- all operating on

international scale, providing services in the main to business customers; all involved in reinsurance

• MVA firms primarily serve national or regional markets, more likely to serve small business and personal customers as well as large business customers -- face growing competition from large insurers selling direct to customers -- only 1/5 involved in reinsurance

Plastics processing - responses to competitive pressures

• HVA firms: – Plans for continued innovation in high value product areas– Work closely with customers and suppliers on new product

development – 3/5 UK-based R&D, 2/5 depend heavily on foreign-based R&D

• MVA firms:– Main emphasis on retaining position in low value product areas

which are costly to transport – 2/5 aspiring to diversify into higher value products, 1/5 relying

on greater automation, 2/5 pursuing other options such as off-shore relocation of production or importing plastic goods from Far East for re-sale

– 3/5 R&D mainly foreign-based, 2/5 work to blueprints supplied by customers

Plastics processing -- barriers to high value added production

• Main barriers are capital constraints and skill deficiencies

Both groups of firms:• High-level technical jobs often hard to fill -- frequently

depend on foreign-based R&D• Shopfloor recruitment often difficult (shift-working,

tight labour markets)• Diverse internal skill gaps (eg, project development;

maintenance; first-line management; shopfloor skill deficiencies due to high labour turnover)

Plastics processing -- skills issuesHVA firms: • Higher proportion of graduates• Heavier recent investments in off-the-job training • Production workers needed additional training to meet

more demanding customer requirementsMVA firms: • Widespread reports of management skill deficiencies at

different levels• HR managers often distant from strategic decision-

makingBoth groups:• Not much apprenticeship training; mixed feelings about

value of NVQs

Commercial printing - responses to competitive pressures

• HVA firms: Changes in product strategy usually complemented by increased spending on new equipment and changes in work organisation (eg, more flexibility in work practices) -- in 3/5 cases recent increases in automation made possible by securing long-term contracts involving long production runs

• MVA firms: Typically slower to respond to market competition and take stock of established product strategies -- strategic plans under consideration more speculative in nature -- uncertain about unfamiliar markets and associated skill requirements -- struggling with smaller volumes and downward pressures on prices

Commercial printing -- barriers to high value added production

• Main barriers described as capital constraints and market uncertainty

Skill deficiencies also reported:• Both groups of firms: Few recruitment difficulties in

print and design areas; external skill shortages more likely to occur in finishing and sales/ marketing

• Internal skill gaps: both groups emphasise shortfalls in management skills -- at senior level and at supervisory/ first-line management level (eg, lack of experience of organisational change, lack of motivation skills)

• MVA firms also report skill gaps among production workers

Commercial printing -- skills issues• HVA firms typically have higher proportions of graduates

and people with intermediate-level qualifications• HVA firms more likely to have developed structured

approach to training needs analysis and training provision in recent years; more involved in technical training

• MVA firms: training often focussed on health and safety -- few signs of catching up with skills accumulated over long period by HVA firms

• Only 1/10 firms involved in apprenticeship training; limited amount of NVQ training

• Design and IT skill needs well met by FE college and university courses

Logistics - responses to competitive pressures

• Both groups: heavy investments in IT, establishment of driver training schools, mergers and acquisitions

• HVA firms consolidating existing niche market strategies (hard-to-replicate skills and networks)

• 4/5 MVA firms diversifying more and more into wide range of activities that clients wish to outsource --> new management and skills resourcing challenges

Logistics -- barriers to high value added production

• Skill gaps predominate over capital constraints• MVA firms need more managers who combine technical

and people skills, and who can be pro-active in identifying business opportunities

• Freight forwarders need to understand clients’ wider business needs

• Drivers and warehouse staff need higher levels of IT and customer-facing skills

• Diverse external recruitment difficulties in both groups: drivers, warehouse [applicants with weak literacy and numeracy], sales, experienced freight forwarders, experienced mid-career managers

Logistics -- skills issues• HVA firms typically have higher proportions of

graduates and people with intermediate-level qualifications (partly reflects higher % of drivers and warehouse employees in MVA firms)

• Internal skill gaps in MVA firms: basic IT skills, customer-facing skills (drivers and warehouse employees), people-management skills in need of improvement

• Considerable amount of training in both groups --firms tend to rely heavily on own resources and systems -- very little apprentice training, limited use of Employer Training Pilots

General insurance - responses to competitive pressures

• HVA firms: incremental changes in product strategy

• Some MVA firms seeking to move into new markets (eg, bespoke services for corporate clients)

• Fierce competition on external recruitment (individuals and teams)

• Mergers and acquisitions• Compliance with new statutory regulation of

general insurance by FSA

General insurance -- barriers to high value added production

• Biggest barrier is market uncertainty, followed by skill gaps (capital constraints hardly mentioned)

• External recruitment difficulties: experienced brokers and support staff (technicians and account handlers)

• Internal skill gaps: IT skill weaknesses among older staff; gaps in account management, sales and team leadership skills

General insurance -- skills issues

• HVA firms had larger shares of graduates and people with professional insurance qualifications

• Substantial recent training in both groups (partly in response to FSA requirements)

• No involvement with apprenticeships and very little NVQ-related training

Assessment (1)• Sectoral variation in opportunities for UK-based

producers to identify markets which are not vulnerable to low-cost import competition

• Different ways of attaining high value added per employee:– Successful product innovation in plastics processing– Large scale production in printing, supported by capital

investment and improvements in work organisation– Focussing on specialist niche market opportunities in logistics

(high % of sales in high-margin product areas)– Catering to business customers in international market for

general insurance services

• Majority of HVA firms doing something qualitatively different from MVA firms in same industry

Assessment (2)

• In three out of four industries HVA firms typically had higher levels of physical capital-intensity than MVA firms

• In all four industries HVA firms were on average better equipped in terms of stocks of skills (as measured by formal qualifications)

• Product/service innovation (working closely with main customers) critical for HVA success in plastics, logistics and insurance

• Process innovation key success factor in printing (partly developed through HVA firms’ relationships with machinery suppliers)

Assessment (3)• Success in high value added production takes time to achieve --

dependent on accumulation over time of strategic judgement and expertise, capital equipment and management and workforce skills, and development of relationships with customers and suppliers

• Some MVA companies are under no pressure to move up-market because profitability is adequate in their current product areas

• Other MVA firms are under pressure to move up-market due to intense competition and low profit margins in existing product areas

• Main barriers to moving up-market vary between sectors: capital constraints, market uncertainty, gaps in skills

Assessment (4)• Moves to ‘add value’ not always more skill-intensive

(eg, assembly of plastics products; personalisation of direct mail; preparation and packing of goods in warehouses)

• However: bulk of HVA activities clearly skill-intensive:– continuous product innovation in plastics– successful automation / process innovations in printing– problem-solving in niche areas of logistics– negotiating appropriate terms and cover for business clients

facing multiple insurance risks

Implications for Skills Policy• High levels of skill necessary but not sufficient condition

for successful HVA production• Hard for government to directly influence product strategy

formation and demand for skills within companies• But government policies can provide ammunition for

supporters of training and high value added production to use in internal debates within companies, for example:– More incentives to invest in long-duration training,

eg, apprenticeships– Subsidies for short courses of updating training for adult

employees, not necessarily leading to formal qualifications which attract LSC funding

– More consistent quality of education outputs, from school-leavers to graduates (more school-leavers qualified to study engineering and science)

Implications for Business Support Policy• Cost-effective encouragement needed for all kinds of

investment spending by firms -- on capital equipment, training and R&D / innovation

• Support programmes need to focus in particular on:– Companies seeking to move upmarket and constrained in

various ways from doing so– Companies that need to move up-market (no future in current

product strategy) but too immersed in day-to-day problems to think about change in product strategy

• Key role for RDAs and SSCs in identifying types of company that fit these descriptions?

• Improvements to efficiency of institutional environment within which firms make investment decisions, eg transport and communications infrastructure; financial system; basic/strategic research and knowledge transfer