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Governance and Upgrading in Global Value Chains

Paper for the Bellagio Value Chain Workshop

John Humphrey and Hubert Schmitz*

Institute of Development StudiesUniversity of Sussex

Brighton BN1 9RE, UK

August 2000

* This paper draws on a paper written by the authors for a research project entitled “The interaction oflocal and global governance: implications for industrial upgrading”. That paper will be publishedas “Governance and Upgrading: Linking Industrial Cluster and Global Value Chain Research” inthe IDS Working Paper series. We are grateful to Martin Bell and Khalid Nadvi for valuablecomments on an earlier draft of the working paper.

1. Introduction

This paper is written as an introduction to some of the issues to be discussed at the workshopon value chains to be held at the Rockefeller conference centre in Bellagio in September2000. Specifically, it addresses two of the questions set out in the conference outline:

“C. When is governance required in international trade?One of the most important insights of value chain analysis has been its emphasis ongovernance, and the recognition that the key governors of the chain (or the focalorganisations, to use the terminology of network theory) may be located at differentpoints in the chain....This raises three important questions. Firstly, under whatcircumstances is governance required in inter-firm relationships?...Secondly, whatdetermines whether this governance involves tight control by the lead organisationover other parts of the chain, relatively loose control, or co-operation among“equals”? Thirdly, how and why do these patterns of governance arrangementschange in particular chains over time?

D. The role of the local in the globalValue chain analysis naturally focuses on the chain and relationships within it. Thistends to mean that the role of national and local factors in access and upgrading areplayed down....However, research appears to show that local organisation is oftencritical for participation in value chains. The “local” appears to matter in at least fourways. Firstly, national trade policies have had a big impact on the formation of valuechains….Secondly, what Gereffi (1999) terms “organisational innovations” in valuechains have transformed global chains….Thirdly, access to markets may depend oncollective and/or public organisation at the local and regional level....Fourthly, therole of local knowledge systems and innovation on upgrading is an issue littlediscussed in the value chain literature. ...This last point leads on to a broader question.Where do the resources for upgrading come from? Do they derive from the leadorganisations in the chain? Or from resources in-country? Or from the experience ofsupplying foreign markets? Or from other agents in the chain?”

This paper suggests answers to some of these questions and points to issues that requireattention during the workshop. It assumes a good knowledge of the value chain literature.1

Its main focus is the developing countries and their relationships with the global economy,although some of the examples used are taken from advanced countries. This focus reflectsthe expertise of the authors and the priorities of the globalisation network formed followingthe “Spreading of the Gains from Globalisation” workshop at IDS in September 1999 [papersfrom this workshop can be found on the IDS Website -www.ids.ac.uk/ids/global/conf/globwks.html]. In this paper, we argue that developingcountries face particular challenges in regard to their insertion into global value chains.However, many of the issues raised in this paper also apply to advanced countries.

1 Gereffi’s work on global commodity chains is the undisputed reference point in this literature.However, the term ‘commodity’ is commonly used to denote standardised products made in largevolumes, while the global commodity chain analysis is particularly relevant to trade indifferentiated products, as will be shown below. Following Kaplinsky (1998), therefore, we use theterm ‘global value chain’, which also has the advantage of drawing attention to the critical questionof who adds value where along the chain. However, there are many competing terms used by avariety of authors - including value networks (Industrial Performance Centre, MIT), productionsystems (Wilkinson) etc. - and we will need to agree on terminology.

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Clearly, many of the points made in this paper are open to discussion and refutation. Atvarious points, comments questions and points for debate are highlighted using italics. Wehave drawn extensively on material written by workshop participants. However, there is a lotof material to digest. Apologies to those whose contributions have been neglected ormisinterpreted.

The paper is structured as follows. The following section focuses on governance: what wemean by the term, what is governed within global value chains, when governance arises andhow it changes. Section 3 focuses on upgrading: what do we mean by it, what determines thepotential for local upgrading in global chains, what is the role of local factors in upgrading. Ituses both the distinction between production systems and knowledge systems and the conceptof competence acquisition by firms (see Lee and Chen forthcoming) to define a series ofissues around upgrading in value chains.

2. Governance

Governance has become a widely used term in the development literature, but it is frequentlyleft undefined. It is also a key feature of Gereffi’s global commodity chain concept. Butwhen does governance arise? Why is it necessary?

2.1 What do we mean by governance?

It is common to distinguish between three forms of co-ordination of economic activity:market, network and hierarchy. The distinctions used by transactions costs economics and byJessop’s work on governance are presented in Table 1. We propose to distinguish two distinctforms of network organisation. Relationships in networks can be asymmetrical, and thedegree of symmetry is critical for the dynamics of value chain relationships. Therefore, wedistinguish between ‘network’ as relationships between more or less equal partners and‘quasi-hierarchy’ as a relationships between firms in which one is clearly subordinated to theother, as in the case of subcontracting networks.

Table 1: Types of co-ordination of economic activities

Williamson Jessop Humphrey andSchmitz

market anarchy of exchange 1. arm’s-lengthmarket relations

2. networknetwork self-organisingheterarchy

3. quasi-hierarchyvertical integration organisational

hierarchy 4. hierarchy

Sources: Jessop (1998: 29); Williamson (1979); Humphrey and Schmitz (2000).

Which of these four forms of co-ordination do we call ‘governance’? Jessop (1998: 29) arguesthat in the literature on governance, there are two approaches. One uses the term to refer to“any mode of co-ordination of inter-dependent activities. Among these modes, three arerelevant: the anarchy of exchange, organisational hierarchy, and self-organising ‘hierarchy’”.In other words, all four categories in the right-hand column of Table 1 would be ‘governance’.The second approach is to restrict governance to ‘heterarchy’, by which Jessop meansco-ordination through networks. Clearly, many interesting examples of governance withinGCCs have been found in inter-firm networks, and this is at the heart of work on buyer-drivenchains. However, it seems perverse not to include organisation hierarchy (or vertical

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integration) within the governance concept as this involves even more explicit direction andcontrol of activities. Therefore, we adopt a third meaning of governance, which we believe tobe implicit in much of the value chain literature. Governance refers to any co-ordination ofeconomic activities through non-market relationships.

In such definitional issues, there is no right or wrong. If we accept the usefulness of thedistinction between network and quasi-hierarchy, there are still three options available to usat Bellagio:

1. To use governance in its widest meaning, referring to any form of co-ordination,including the market.

2. To use governance just to refer to network and quasi-hierarchy.3. To use governance to refer to any form of non-market co-ordination of economic

activity - therefore, including hierarchy.

Two further points need to be clarified:

• Along the length of a particular global value chain, different types of co-ordination mayco-exist. Chains may have network relationships at one point and market relations atanother, for example. Similarly, relationships may be very different at different tiers insupply chains. Does this create problems when we try to categorise chains?

• In addition to these forms of private governance, public governance through a range ofgovernmental agencies, and hybrid public-private governance also has an importantimpact on value chains. Esser et al. (1995) and Messner (1997) have shown how and whynetworks of public and private agencies are required for industrial upgrading andcompetitiveness. Such ‘policy networks’ (Messner 1997) include business associations,technology centres and groups of business leaders, in addition to governmental agencies.We will consider the role of such governance in value chains later in this paper, but whenwe discuss definitions we need to clarify whether our concept of chain governance isrestricted to the private actors only or includes these other agencies.

2.2 What is governed in value chains?

Gereffi’s defines the governance structures of GCCs as the “authority and power relationshipsthat determine how financial, material, and human resources are allocated and flow within achain” (1994: 97). Similarly, Palpacuer (forthcoming) draws on the strategic networkapproach to highlight the role of the focal organisation in strategic networks:

“The focal organisation leading the network...is permanently engaged in attractingand selection new members,...in sustaining network relationships by managingconflicts and learning, in positioning and repositioning the network in the market, andin building the structure and the culture of the network” (Sydow 1992: 114, emphasisin original, quoted in Palpacuer, forthcoming).

In practice, what is controlled/influenced in a chain by governance? Dolan and Humphrey’s(2000) analysis of global value chains in horticulture identifies three different aspects ofgovernance:

§ Positioning of the chain within the market. Supermarkets play a decisive role indetermining what is offered to customers. They determine what products are availableand when, and their characteristics (quality, appearance, packaging, etc.). This involvesinterpreting market trends and specifying what products should be produced to meet thesetrends. It may also involve specifying the processes used to make the products.

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However, supermarkets may merely dictate the ‘what’ and leave the ‘how’ to thesupplier.2

§ The structure of the chain. UK supermarkets shifted from sourcing through wholesalemarkets towards quasi-hierarchical supply chains. Their decisions influenced the overallstructure of the chain - the type and number of firms involved and the distribution offunctions between them.

§ Monitoring and control systems. The UK supermarkets specified the quality systems ofsuppliers and the procedures for monitoring performance. They also influenced specificdecisions about which producers and exporters are included in or excluded from thechain.

These three aspects of governance within chains would appear to be fairly common acrossdifferent types of value chain. Gereffi’s work on the garment chain (1994) highlighted theimportance of retailers and brand-name companies in structuring global trade and the role ofbranding, marketing and the co-ordination of inter-firm relations in establishing competitiveadvantage. Similarly, in the global auto industry (which is very different in its organisation) itis clear that the assemblers (i) play a decisive role in the overall positioning of the chainthrough the way they develop and market products, (ii) have restructured the chain in the pastdecade through practices such as industrial condominiums, modular supply and followsourcing (these are discussed in Humphrey and Salerno 2000), and (iii) have increased theirmonitoring and control of the supply chain through the specification of quality systems,supply audit and open book pricing. 3

Kaplinsky presents an overlapping but different analysis of what is governed in value chains(2000: 12-13). This is summarised in the following table. It places greater emphasis uponassisting suppliers to meet chain requirements, but it does not include the overall strategicpositioning of the chain, which seems to be a core element of the idea of strategic networks.Kaplinsky’s approach does, however, have the merit of focusing on the complementarity ofgovernance elements that are internal and external to the chain.

2 In producer-driven value chains, this same variation is captured by the distinction between subcontracting and ‘black box’ design. In the former case, the buyer supplies the design and drawings.In the latter case, the buyer defines a design challenge (performance characteristics, durability,interface with the remainder of the product, etc) which is then solved by the supplier’s design.

3 While this discussion has focused on suppliers in the auto industry, a similar analysis might beundertaken for vehicle distribution and financing, in which the assemblers have also played acrucial, though contested, role.

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Table 2: Examples of legislative, judicial and executive value chain governanceExercise by parties internal to

chainExercise by parties external to

chainLegislativegovernance

• Setting standards forsuppliers in relation to on-time deliveries, frequency ofdeliveries and quality

• Environmental standards• Child labour standards

Judicialgovernance

• Monitoring the performanceof suppliers in meeting thestandards

• Monitoring of labour standardsby NGOs

• Specialised firms monitoringconformance to ISO standards

Executivegovernance

• Supply chain managementassisting suppliers to meetthese standards

• Producer associationsassisting members to meetthese standards

• Specialised service providers• Government industrial policy

support

Source: Kaplinsky(2000: 13).

At Bellagio, we need to try to arrive at common view of the essential elements of governanceand then see if we can provide a taxonomy and a set of methodological procedures for quicklycategorising chains (or parts of chains) by their governance types.

2.3 What determines the emergence of network and quasi-hierarchy in value chains?

Under what circumstances do focal organisations seek to develop network or quasi-hierarchical relations with distant suppliers? What advantages does this offer, and what are itscosts? Why would firms in advanced countries go to the trouble and expense of monitoringand supervising international supply chains? In what circumstances is reliance on arm’slength market co-ordination a better solution for the buyer?

Rather than see governance in value chains as the “normal” situation, we believe that firmsneed to have good reasons to incur the expense and the inflexibility of developing inter-firmgovernance arrangements. In other words, it is necessary to explain three things:

• why products are not supplied through “simple” market co-ordination;

• why processes are spread across independent firms, rather than contained within a singleenterprise;

• why, when governance exists, it takes the network or quasi-hierarchical form?

There are some well-established explanations for the development of network or quasi-hierarchical relationships between firms. The literature on transactions costs argues thatnetwork governance arises for recurrent transactions when asset specificity is too great toallow market governance but not sufficient to justify vertical integration. 4 In this case,governance is related to asset specificity and opportunism. Palpacuer (forthcoming: 18),drawing on the work of Richardson (1972) , takes a different route, arguing that networkrelations (including quasi-hierarchical relations) emerge in value chains when co-ordination isrequired. Market linkages are insufficient to develop “both a quantitative co-ordination of

4 The paper by Sturgeon (2000 - available on the IDS Bellagio website) uses transactions costsarguments to analyse the value chain producing personal computers in the USA.

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output volume and a qualitative co-ordination of product characteristics”. This is seen clearlywhen the buyer is involved in product definition, so that designs have to be transferred to thebuyer, or when supply scheduling is critical (as is the case with fresh produce insupermarkets). In these cases, the need for co-ordination (and the consequences of poor co-ordination) justifies the expense of investing in governance. The existence of differentcompetences between firms is the reason for not overcoming these problems through verticalintegration.

When do network relations take a quasi-hierarchical form? We suggest that quasi- hierarchyemerges in value chains when the buyer is exposed to considerable risk if the supplier fails toperform. The increasing importance of non-price competition based on such factors asquality, response time and reliability of delivery, together with increasing concerns aboutsafety and standards, means that buyers (both retailers and manufacturers) in developedcountries have become more vulnerable to shortcomings in the performance of their suppliers.

The elements of co-ordination and risk together determine governance relations along thelines suggested in the following table:

Table 3: Determinants of governance in value chains

ChainGovernance

Determinants

None (i.e.arm’s lengthmarketrelations)

Buyer and supplier do not need to collaborate in product definition. Eitherthe product is standard, or the supplier defines it without reference toparticular customers. Risks to buyer are low, either because requirementsare easy to meet, or because supplier has a clear capability to meet them.

Network Co-operation between more or less ‘equals’. Supplier and buyer jointlydefine the product, and combine complementary competences.5 This ismore common when both buyer and supplier are innovators, close to thetechnology or market frontiers. The risk to the buyer is minimised by thesupplier’s high level of competence.

Quasi-hierarchy

High degree of control of buyer over supplier; buyer defines the product.The buyer would incur losses from the suppliers’ performance failures, andthere are some doubts about the competence of the supplier. Where highsupplier competence is not generalised, buyers invest in specific suppliersand seek to tie them to their chain.

Hierarchy Buyer takes direct ownership of developing country operations. The buyercarries out in product definition, which may involve proprietary technology.The risks of poor performance by independent suppliers increase if the buyeruses quality as a brand attribute. These factors favours direct control overthe production process.

Table 3 implies that quasi-hierarchy is likely where global value chains frequently linktogether producers in developing countries and retailers in developed countries. Globalbuyers6 are constantly scouting for lower-cost production sites, which means integrating newproducers into value chains and exposing these producers to the demands of moresophisticated markets. Hobday has argued that the ‘latecomer’ firm to the global economy

5 For a discussion of the role of complementary competences in the creation of network relationshipsbetween firms, see Richardson (1972).

6 Global buyers exist in both producer- and buyer-driven chains. For example, vehicle andcomponents production is producer-driven, but leading assemblers still buy products globally.

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faces two disadvantages: “[It is] dislocated from the main international sources of technologyand R&D” and “dislocated from the mainstream international markets it wishes to supply”(1995: 34). These dislocations create the need for quasi-hierarchy.

Similarly, Keesing and Lall (1992) argue that producers in developing countries are expectedto meet requirements that frequently do not (yet) apply to their domestic markets. Thiscreates a gap between the capabilities required for the domestic market and those required forthe export market. This gap is widened when the buyer requires consistent quality andsupply, creating two reasons for quasi-hierarchical governance. Firstly, close monitoring andcontrol may be required to ensure that products and processes meet the required standards.Secondly, if the gap has to be closed quickly, buyers will need to invest in a few selectedsuppliers and help them to upgrade. In order to reap the benefits of this investment the buyershave an interest in locking suppliers into stable relationships. These factors make the costs ofthis form of governance worthwhile. But the need for global chain governance decrease asthe delivery capabilities of local suppliers improve and diffuse.

It is important to note that the key determinant of the quasi-hierarchical governance is not theintrinsic characteristics of the product itself, such as its complexity or its closeness to thetechnology frontier, but rather the risks faced by the buyer. These arise from the level ofprobability of poor performance and the consequences of that poor performance. Complexproducts may be supplied through market or network relations.

While various value chain studies have focused on sectors where quasi-hierarchypredominates, there are various instances of suppliers and buyers co-ordinating their activitiesthrough market and network, even when products are sophisticated and fast-changing. At thesame time, changes in competence distribution means that chains also change theircharacteristics. Four examples illustrate these points.

Winter vegetable exports from MexicoA paper by Calvin and Barrios (1998) on the evolving trade in winter vegetables between theMexican State of Sinaloa and the U.S. market illustrates the dynamism of value chains.7 Thistrade is driven by many of the same factors that characterise European vegetable imports fromAfrica (Dolan et al. 1999) : buyer concentration, product differentiation and specialistpackaging increased emphasis on quality and consistency and the demand for year-roundsupply. In addition, Mexican produce has to satisfy U.S. requirements with regard to grading,size, quality and maturity (controlled by the Agricultural Marketing Service and applied toU.S. produce as well), and regulation of pesticide chemical residues, and pests.

The trade in vegetables began with US buyers going to Mexico and purchasing on the spotmarket. This type of arm's-length market relationship requires minimal investment by thebuyer. The trade then developed and became more structured. An infrastructure grew on theMexican side of the border to facilitate the trade. The Mexican growers’ organisation,CAADES, provided an inspection depot for trucks, created a location for AgriculturalMarketing Services inspections and provided information on quality and quantityrequirements for the U.S. market. At the same time, “U.S. distributors searched for growersand provided them infrastructure, credit, technology and marketing knowledge” (Calvin andBarrios 1998). Once the products were shipped into the USA, the distributors then the sold itonto wholesalers or direct to retailers.

7 All the information in this subsection is taken from the article by Calvin and Barrios. This isavailable on the web, but in an unfriendly format and with the tables in separate Excel files. Acleaned up copy has been placed on the IDS Bellagio webpage. The authors are grateful to RaquelGomes at MIT for drawing their attention to this article.

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The chain has since evolved further. Firstly, private companies have taken over some of theservices provided by CAADES: “Some centres provide additional services such as unloadingproduct would exceed the U.S. weight limits, providing a new cab or truck repairs to ensuresafety compliance, repacking facilities for products that don’t meet the grade, and packing orpalletising services” (Calvin and Barrios 1998). Secondly, production in Mexico is nowlargely in the hands of large growers, sourcing predominantly from their own farms andcontracted growers. Thirdly, the Mexican growers have been integrating forwards, takingover the distribution role and setting up dedicated distribution channels. As can be seen inTable 4, the trade is now dominated by a small number of growers, and Mexican grower-distributors account for a large share of the trade. The right-hand column shows thatdistributors source predominantly from one grower.

Table 4: Structural distribution for fresh vegetables in Nogales, selected products(a)

Product(b) Percent of memberimports per commodity

by the top 10 distributors

Percent of productdistributed by Nogales-based Mexican grower-

owned distributors

Average percent ofa distributor'simports from

largest growerTomatoes 68 63 83Cucumbers 75 72 83Squash 71 43 59Peppers 70 71 76

Note: (a) No date is provided for this information. Other data supplied in the paper refer tothe periods 1995, 1996 and 1997.

(b) These are four the five products with the largest export volumes. Information isnot available for on the fifth product, water melons.

Source: Calvin and Barrios (1998), Tables B-6 and B-7.

This case shows clearly how spot markets developed into a trade involving the local businessassociation and distributors that provided support for local growers. At this point in theprocess, intervention by both buyers and the business association was required to support theentry of Mexican produce into the U.S. market. Later, these networks were replaced by acombination of market provision and increasing vertical integration as border services havebeen taken over by private firms and large growers have moved into distribution. 8

This tendency towards vertical integration is also seen in the African fresh vegetablesindustry. In this case, UK importers and African exporters have moved backwards intogrowing. The reasons for this difference are fairly clear. In the Mexico-U.S. case, thedistributors merely brokered the product, not even taking formal ownership of it. In Africa,the exporters added value through processing, and this gave them a much larger role in thechain.

Of course many chains evolve over time. Our challenge is to systematise these insights andgeneralise them. Can we identify which trajectories of chain governance emerge in whichcircumstances?

Knitwear in ItalyIt seems logical to think that as product complexity increases, buyers will be more likely todevelop network or quasi-hierarchical relationships. In fact, buyers may use marketrelationships even when products are sophisticated or design-intensive. As long as suppliershave the information necessary to meet buyers’ demands and the buyer has some degree of

8 It may still be the case that relationships between distributors and retailers have network or quasi-hierarchical characteristics, but the analysis of Calvin and Barrios does not focus on this part of thechain.

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confidence that these requirements can be met, market relations are viable. Wilkinson’saccount (1995) of the Italian knitwear industry shows how buyers source their productsthrough wholesalers. There are no direct links between the retailer and the producer. Theretailer relies on the producer or the wholesaler to interpret market requirements correctly. Iforders are placed for products not yet produced, then the retailer also depends upon theproducer’s ability to supply similar products on schedule. The implication of this is counter-intuitive. Production for more sophisticated market niches may be arranged through arm’s-length market relations, while less sophisticated products may involve quasi-hierarchy. Thekey determinant is not the absolute level competence required from the supplier, but rather thebuyer’s degree of confidence in the supplier's ability to meet the requirements of the chain.

The implication of this case is that as producers become more sophisticated, quasi-hierarchymight evolve into network or market. It also implies that while inter-firm networks areimportant in industrial districts, relations with buyers may not take the network form.

Turnkey networks in the computer industryThe personal computer industry shows how complex products can be produced through acombination of market and network relationships. Part of the sector is organised aroundarm’s-length market relationships. Companies make new products by taking rapid advantageof new technologies and products that become available through market relations to a largenumber of firms. For companies making personal computers, close relationships with thedesigners of chips, disk drives, etc. are only important insofar as they provide early access tonew product specifications. Most companies do not influence the design of key components.At other parts of the chain, network relations appear to operate. Sturgeon’s (2000) account oflinkages between the companies that design and market computers (Dell, Apple, etc.) and thespecialist firms that assemble and test circuit boards shows how firms work together whileretaining their independence. Clearly, information flows between firms defining products andfirms assembling them are important, but the relationship is clearly not one of quasi-hierarchy. There is limited dependence on both sides and no ‘tutelage’ of supplier by buyer.While Sturgeon attributes the development of this chain structure to factors such asdifferences in scale economies between automated assembly and marketing, market instabilityand the dominance of modular architecture9 for personal computers, similar relationshipswithin chains can be seen in very different circumstances. For example, relationshipsbetween large firms in Germany and small suppliers of specialist goods and services seem tohave similar ‘network’ characteristics. Small firms co-operate with large customers, butretain their autonomy and a broad customer base.10 It might also be argued that relationshipsbetween assemblers in the auto industry and their ‘black box’, first-tier suppliers have thesecharacteristics. Firms co-operate closely on product development, but the supplier has abroad range of customers, and customers have various suppliers who are expected to competewith each other for new contracts.

This implies that the “Japanese” model of high dependence and reciprocal obligation is notthe only way to sustain asset specific investments and information flows between suppliersand customers. In the “Western” model, suppliers are less dependent and also morevulnerable to the vicissitudes of markets and changing inter-firm relationships. What doesthis imply for levels of transactional dependence, market structures and spillovers ofinformation through sectors?

9 For the discussion of the distinction between modular and integral product architectures and theirimpact on the computer industry, see Fine (1998).

10 See Lane (1996: 292) for an account of how small firms in Germany co-operate with largecustomers while retaining their autonomy. Lane contrasts this case with the situation of smallsuppliers in Japan, who are tightly linked to large firms by transactional dependence, equity tie-ups,etc.

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Half-channel distribution systemsHorticulture provides an examples of quasi-hierarchical chains. Gibbon (2000) is correct todraw our attention to the fact that many agricultural products are traded in very differentways. Some are characterised by vertical integration and control by transnational companies,while others are dominated by international traders. In particular, certain products are soldthrough agents or auctions so that there is no direct contact between the user of the product (aretailer or a processor) and the producer. Van der Laan (1993) refers to this as a half-channelmarketing system. Such systems are found most frequently in the trade of standardisedcommodities, but these need not be absolutely undifferentiated. Half-channel systemsfrequently develop grades and standards to classify products. They may also provide somemeans by which the buyer can be confident about the quality of the product - either throughdirect inspection or from the reputation of the seller. In other words, market relations maypredominate, but the market is organised. Gibbon’s work emphasises the co-ordinating roleof international traders and of quality conventions in making markets work. This isimportant. It shows that the opposition between governed networks and the anarchy of themarket is a false one. Markets can be co-ordinated.

This takes us back to the scope of the chain governance concept. Governance is not solelyprivate. In half-channel distribution, governance certainly exists, but not between firms in thechain. Public or private institutions have to define the rules of the game. In the USA, forexample, it is the government that defines grades and standards for agricultural produce. Inthe case of the Dutch flower auction, flower classifications have been developed by thetraders. Governments also define and verify phytosanitary standards. These requirements aredefined by the receiving country, either unilaterally (as in the case of many U.S. Departmentof Agriculture regulations on agricultural imports) or through international agreements.

It seems likely that where half-channel distribution systems are used to supply markets withcomplex or exacting standards, some form of local-level governance will be required tosupport producers. This point will be developed further in section 3. At this point, it is worthnoticing that a recent study of production systems for Brazilian fruit exports (Damiani 1999)has emphasised that local-level governance facilitated the acquisition of knowledge aboutmarket entrance requirements, the development and maintenance of a reputation for qualitywhich applied to producers in the region as a whole and the introduction of pest controlprocedures to satisfy USDA requirements on fruit fly control. This was achieved by acombination of federal institutions, economic development agencies, business associationsand leading private firms. In other cases these functions can be taken over by large, leadfirms. An analysis by Gomes (1999) of fruit exports from a different region of Brazil showshow large firms took responsibility for organising the local production system. In both cases,however, local governance (public, private and public-private) seemed to act as a substitutefor some of the governance processes seen in inter-firm networks characterised by network orquasi-hierarchy.

Clearly we need to consider the extent to which governance within tightly-managed chainscan be substituted by combinations of local-level governance and what might be called“supra-national governance” through international certification schemes, labelling schemes,codes of practice, and agreements on grades and standards.

2.4 Is governance increasing in global chains?

Finally, there is an important question about the extent to which global trade is beingincreasingly co-ordinated by network and quasi-hierarchical relationships. In other words, isour interest in governance in value chains merely the discovery of something which hasexisted for a long time or a reflection of a new trend in the global economy?

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It does seem to be the case that there has been an increase in retailer governance ofdeveloping country production systems. This, surely, is the critical insight of the notion ofbuyer-driven global commodity chains (Gereffi 1994). One factor in this process is clearlyretail concentration, which is one of the critical explanatory variables offered by Gereffi toexplain the increasing prevalence of buyer-driven chains (Gereffi 1999b). To this factor, onemight add the prevalence of product differentiation strategies in increasingly competitiveglobal markets (which requires greater co-ordination between buyer and supplier), and theintegration of less competent producers into global supply chains by wholesalers and retailerslooking for low-cost production sites. These factors explain why network and quasi-hierarchyreplace arm's-length market relations. At the same time, business trends towards focusing oncore competence and the increasing complexity of technological and product innovation mayexplain why vertical integration is less attractive than previously.

Nevertheless, it is important to recognise that there is no reason to suppose that value chainsnecessarily evolve in the direction of increasing governance. It was argued above thatgovernance is expensive. If alternative (and cheaper) ways of co-ordinating activitiescontaining risk can be devised, then firms will use them. This does not mean, necessarily,substituting the market for governance, or one form of inter-firm governance for another. Itmight mean substituting (private) chain governance by public-private or public governance.In this respect, grades, standards, certification, etc may be developed as means of reducing thecosts of governance. Therefore, there may be oscillation between different forms of co-ordination rather than a uni-directional movement towards increasing governance.

In our discussion it may be particularly useful to consider the following three questions:

§ does the increasing concentration in retailing translate into increasing governance in thesourcing operations? In what circumstances?

§ does the increasing competence of developing country producers lead to decreasing chaingovernance? In what circumstances?

§ Can public-private governance through grades, standards, certification, etc reduce theneed for private governance in the value chain?,

3. Upgrading

For researchers concerned with developing countries, upgrading is a central question. Micro-level upgrading within value chains should contribute to the overall process of development.Conversely, if upgrading opportunities for developing country producers are extremelylimited, then developing countries may face declining incomes as new sources of labour enterglobal markets. Kaplinsky’s discussions of rent and the global distribution of income (1998;2000) suggests that value chain analysis helps to identify ways of avoiding immiserisinggrowth and emphasises the need for upgrading. The purpose of this section is to develop theupgrading concept and ways of analysing upgrading processes. It introduces a distinctionbetween material flows within value chains and knowledge flows, placing the latter within thebroader concept of knowledge systems. It also attempts to use the competence-basedapproach to understand the potential and limitations of relationships within value chains forupgrading of developing country firms.

3.1 What does upgrading involve?

The concept of upgrading appears to have been introduced relatively recently into value chaindiscussions (Dolan, Humphrey et al. 1999; Gereffi 1999b; Kaplinsky 1998; Schmitz andKnorringa 1999). While all authors stress the importance of upgrading, it remains an elusive

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concept that has been difficult to pin down. There are various possible taxonomies, and therange of upgrading possibilities across different sectors and differently structured value chainsappears to be huge. Therefore, some tidying up and conceptual rigour is required.

In two papers made available in 1999, Gereffi provides two distinct categorisations ofupgrading. Each is referred to as “levels of analysis” for industrial upgrading:

Table 5: Upgrading schemes from GereffiUpgrading Scheme 1 Upgrading Scheme 2

Within factories: process upgrading, productupgrading and order size

“At a product level, one can talk about themovement from simple to more complexgoods of the same type (e.g., cotton shirts tomen’s suits)”

Within inter-firm enterprise networks: “frommass production of standardised goods to theflexible production of differentiatedmerchandise”

“At the level of economic activities, there arevarious roles that involve increasinglysophisticated production, marketing, anddesign tasks” - including assembly, OEM,OBM and ODM”

Within local or national economies: fromsimple assembly to OEM or OBM, withgreater forward and backward linkages

“an intrasectoral progression, typically fromthe manufacture of finished items to theproduction of higher value goods andservices involving forward and backwardlinkages along the supply chain”

Within regions: greater regional integrationof production, distribution and consumption

“the intersectoral shift from low-value,labour-intensive industries to capital- andtechnology intensive ones (e.g., clothes tocars to computers)”

Sources: Scheme 1, Gereffi (1999b: 52); Scheme 2, Gereffi, (1999a: 6-7).

Humphrey and Schmitz (2000) provide a more specifically firm-centred typology forupgrading, which overlaps with the second of Gereffi’s typologies. It distinguishes between:

• process upgrading - transforming inputs into outputs more efficiently by re-organising theproduction system

• product upgrading - a movement into more sophisticated lines of products (which can bedefined in terms of increased unit values)

• functional upgrading - the acquisition of new functions, such as design or marketing.

Clearly, we have some tidying up to do here. Definitions are overlapping and confusing. Itmay be necessary to create different upgrading typologies to address different questions, butmore consistency and more logic seems essential.

3.2 What determines the potential for upgrading in value chains?

There is little agreement on how global value chain governance influences the upgrading oflocal producers. Based on his research on the garment chain, Gereffi concludes that thoseproducers that gain access to the chain have good prospects for upgrading within production

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and then subsequently move into design, marketing and branding as a consequence of acombination of ‘learning by exporting’ and ‘organisational succession’ (see below). Theopportunities for upgrading are driven, in part, by the needs of the buyer:

“In order to deal with the influx of new competition, branded marketers like LizClaiborne are adopting several strategic responses that will alter the content and scopeof their global sourcing networks: they are discontinuing certain support functions(such as pattern grading, marker making and sample making), and reassigning themto contractors; they are instructing the contractors where to obtain neededcomponents...” (Gereffi 1999b: 47).

At the same time as buyers are driving functions back along the chain, the supplier arelearning: “Learning-by-doing is the key mechanism in the pattern of organisation successionthat drives the upgrading process in global commodity chains” (Tam and Gereffi 1999: 1).‘Organisation succession’ 11 refers to a process by which manufacturers start producing forbuyers catering for the low end of the market and then move up to buyers targeting moresophisticated market segments: “This succession of foreign buyers thus permittedmanufacturers to upgrade their facilities as they met buyer demands for more sophisticatedproducts” (Gereffi 1999b: 53).

At first sight, this scenario seems plausible but three aspects require closer examination.

1. Firstly, to what extent is this upward movement a simple consequence of ‘learning byexporting’, or does it rely on more active upgrading efforts by producers? Upgradinginvolves changing the basis of knowledge within the enterprise. This requires investmentin people, organisational arrangements and equipment. Bell has for a long time insistedthat the need for such investment needs to be more explicitly recognised (Bell 1984).Similarly, Lee and Chen (forthcoming) emphasise the importance of firm-levelinvestment in upgrading:

“Upon engaging in OEM businesses for high-and products, the contract manufacturermay be able to create a learning platform to acquire product design and developmentknowledge from the outsourcing firm based on its possession of competitive processcompetence. However, since the transfer of knowledge from the outsourcing firmonly occurs selectively, it is highly dependent upon the contract manufacturer’sinvestment in enhancing its own design and development capabilities” (Lee and Chenforthcoming: 14-15).

2. Functional upgrading strategies may well conflict with the interest of established buyers.Sourcing from new suppliers is rarely possible without the buyer investing in thosesuppliers capabilities. The greater such sunk costs, the more likely it is that buyers willattempt to prevent their producers simply switching to new buyers. This conflict needs tobe recognised. Martin Bell at SPRU, University of Sussex (in personal communication)has referred to the scenario of a relatively conflict-free progression from assembly ofimported inputs to OEM, ODM and then branded manufacturing as the ‘benign escalator’.While the shift from assembly to OEM is not controversial, moving to ODM and OBMcannot be taken for granted. Research on the footwear chain suggests that in some chainsglobal buyers discourage, if not obstruct, design, marketing and branding by localproducers. As stressed by Schmitz and Knorringa (1999) , local producers face obstaclesbecause such upgrading encroaches on their buyers’ core competence. This linksupgrading opportunties to governance forms. How neat is this fit?

11 Gereffi uses “organisational succession” in the JIE paper. Tam and Gereffi use “organisationsuccession”. This paper uses the former.

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3. Does product upgrading necessarily require switching buyers. Organisational successionimplies that it does. Gereffi’s quote on Liz Claiborne et al. above, and the work of Dolanet al. (1999) both suggest that the buyer’s repositioning of the chain as a whole providesupgrading opportunities for existing suppliers. This is also the implication of research onstrategic networks, in which the lead firm “is permanently engaged in attracting andselecting members, in spinning off activities, in entering new alliances, in sustainingnetwork relationships by managing conflicts and learning, in positioning or repositioningthe network in the market…” (Sydow 1992: 114). Nevertheless, this analysis isinadequate as it stands. UK supermarkets not only repositioned the chain, but also shiftednon-strategic activities from the UK to Africa. More work needs to be done on the factorsdetermining such shifts. Distinguishing between strategic and non-strategic functions inthe chain seems an important step. But it also begs the question of what exactly makes acertain function strategic.

These considerations lead to a more cautious assessment of local upgrading opportunities.They also pose questions about the circumstances in which involvement in global valuechains promotes or impedes upgrading. What are the characteristics of chains that influenceupgrading? Is the form of governance the crucial factor? What drives the distribution offunctions within chains? Our challenge is to systematise our knowledge of value chains sothat we can go beyond specific cases and begin to generalise about upgrading.

In order to open up this discussion, it is necessary to have a clearer idea about the processesinvolved in upgrading. This paper draws on the work of Bell and Albu on production andknowledge systems and on the work of Lee and Chen on competence acquisition.

3.3 Upgrading processes

In a paper which discusses how the issue of technological capabilities (in effect, upgrading) istaken up in the literature on industrial clusters in developing countries, Bell and Albu make adistinction between production systems and knowledge systems:

The production system can be understood to encompass the product designs, materials,machines, labour inputs, and transaction linkages involved in the production of goods to agiven specification.... The knowledge system concept on the other hand, encompassesthose flows of knowledge, stocks of knowledge and organisational systems involved ingenerating and managing changes in the products, processes or organisation ofproduction” (Bell and Albu 1999: 1723).

The upgrading question can then be approached in terms of the knowledge system. Whattypes of knowledge in needed for upgrading? Through what channels is this knowledgeacquired? How do different insertions of developing countries firms into global marketsinfluence the acquisition of different types of knowledge?

The technological capability literature draws attention to the fact that buyers in the valuechain are only one possible source of the knowledge required for upgrading. Within thisliterature, a greater emphasis has been placed upon intra-firm research and developmentactivities, and upon inter-firm learning between technology supplier and user. Within theliterature on industrial districts, emphasis has been placed on inter-firm learning within thelocality and the role of technical and marketing institutions. Finally, it is recognised thatknowledge can be acquired through active and strategic searching by firms.

Bell and Albu (1999) categorise types of knowledge systems in terms of two variables.Firstly, knowledge systems may be undirected/closed or purposeful/open with regard to theways in which they seek knowledge. Secondly, the bases for inter-firm transfers ofknowledge within clusters may be unstructured/passive or co-operative/active. They further

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suggest that the characteristics of knowledge systems will vary according to the complexity ofthe technology and the extent to which the cluster is close to or distant from the technologyfrontier (1999: 1730-1731). Some of these distinctions may be transferable to the discussionof value chains.

The work of Lee and Chen on firm-level competence and upgrading in contractmanufacturing in the electronics industry provides a different set of insights into upgradingprocesses. They argue that competence acquisition arises from, on the one hand, consciouseffort and investment by the upgrading firm, and on the other, management of linkages withinthe value chain. Their analysis provides the following insights into the upgrading processesinvolved in the shift from OEM operations to design and development:

1. They provide a finer distinction between different types of linkages, even within thegeneral category of ODM manufacturing. The critical variables they use are “the degreeof supplier’s design and development competence and the exclusiveness of contractualsupply” (Lee and Chen forthcoming: 10). These are important determinants ofknowledge flows within the chain. For example, they suggest that competence flows areweaker in non-captive relationships. This link between forms of governance andknowledge flows would appear to be crucial. It needs to be theorised and generalised.

2. The issue of conflicts of interest between contract manufacturer and buyer is explicitlyaddressed. Upgrading from OEM to ODM may mean that the supplier becomes acompetitor to the buyer (Lee and Chen forthcoming: 8). Lee and Chen suggest ways inwhich this conflict of interest can be managed - for example, by suppliers selling intodifferent markets.

3. Certain characteristics of the sector that influence the distribution of activities betweenbuyer and contract manufacturer are discussed. It is argued that two “externalcontingencies” have influenced upgrading opportunities for contract manufacturers. Thefirst is shortened product life cycles, which increases the importance of knowledge flowsbetween design, development and manufacturing (and hence favours acquisition of designand development skills by contract manufacturers). The second is standardisation, whichreduces transaction-specific investment and encourages inter-firm collaboration(Lee andChen forthcoming: 8-9). This type of argument is echoed by Sturgeon’s (2000)discussion of the factors that have led to the acquisition of new functions by contractmanufacturers.

Upgrading dynamics are clearly complex. They are influenced not only by governancerelationships within the chain, but also by the upgrading firm’s strategic intent andcapabilities and by the external contingencies that favour particular value chainconfigurations. In addition to these three factors, one might also stress the role of local andnational systems of innovation and human resource development that facilitate firm-levelefforts to upgrade and take advantage of value chain opportunities. While these may be takenfor granted in East Asia, it remains the case that the types of upgrading widely seen in EastAsia are the exception rather than the rule in developing countries.

Providing a generalised account of knowledge requirements and forms of knowledgeacquisition, together with their links to different forms of value chain governance is wellbeyond the scope of this paper. In fact, it may be an impossible task. Value chains varyconsiderably, as do the characteristics of different sectors. Therefore, we will merely outlinesome of issues involved and provide some illustrations of knowledge flows and knowledgeacquisition.

In the face of such complexity, there are at least two possible strategies. One way ofproceeding would be to reduce complexity by constructing simplified models of value chain.

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The second, inductive, approach involves analysing various empirical studies of value chainsin order to establish some general principles about the circumstances in which upgradingtakes place. Both could be tried in Bellagio. In this paper, the latter strategy is used. Anumber of preliminary propositions are put forward and then cases which illustrate how theyhave been derived are presented.

Propositions1. Firms confined to production tasks in quasi-hierarchical value chains upgrade processes

rapidly. Radical product and functional upgrading may be restricted by the interests ofthe lead firm (or focal organisation) in maintaining the chain structure.

2. Product and process upgrading depend significantly upon intra-firm innovation resourcesand/or support from technical and marketing bodies. Therefore, they are more likely tobe led by large firms or to take place where national and local systems of innovation arewell-developed. Buyers do not drive functional upgrading. Suppliers generally have todemonstrate their competence and the advantages for the buyer of transferring functionsbefore such functions are transferred.

3. Within quasi-hierarchical value chains, the potential for functional upgrading arises intwo circumstances. Firstly, the focal organisation may broker the transfer of non-strategic competences within the chain, or re-define its own competences and abandoncertain activities (for example, the shift of US brand-name manufacturers out ofmanufacturing). Secondly, strategic alliances between firms other than the focalorganisation may lead to the creation of new chains focused on new customers.12

4. Where chains are co-ordinated through market relations, the role of large firms and/orlocal technical and marketing institutions are critical for establishing initial access toexport markets and promoting process, product and functional upgrading. While thisrequires greater local effort and co-ordination, in the longer-term it may provide greaterpotential for upgrading, because the local knowledge system has more access to externalknowledge. This is the case for half-channel systems.

5. Firms are frequently inserted into more than one chain - for example, producing for bothdomestic and export markets, which might have significantly different characteristics.Learning in one chain may facilitate upgrading in another. This is the case described byTewari (see below).

6. As developing country firms engage in functional upgrading based on competenceacquisition, their relationships with buyers shift from quasi-hierarchy to network.

These propositions can be supported by the following illustrative cases of value chains andupgrading.

Half-channel networks for fruit exports from Brazil and Cote d’IvoireFresh fruit can be exported through half–channel or entire–channel marketing systems. Whenexporters deal with large customers, market requirements will be transmitted through thechains. They will receive information about what types of products can be sold and theperiods in which produce is required. In Northern Europe, in particular, supermarkets andhypermarkets are increasing share of fresh fruit sales, and they tend to establish entire–channel marketing systems, making direct contacts with growers (Profound 1997: 28).

12 In other words (i) chains are not static, and (ii) firms manoeuvre for long-term competitiveadvantage. In some cases, non-focal organisations co-operative together to create new opportunitiesfor upgrading.

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When exporters work through half-channel systems, such as wholesale markets andinternational auctions, knowledge about markets has to be obtained in different ways. Thecases of fruit export from the Northeast of Brazil analysed by Damiani (1999) and Gomes(1999) show how knowledge can be acquired in different ways. Export markets aredemanding, and as markets for fresh fruit develop and become more sophisticated, entryrequirements increase. Exporters have to reach minimum standards of sophistication beforethey can enter export markets and benefit from the information flows generated by this entry.Therefore, some form of early transmission of market requirements is necessary.

In the case analysed by Damiani, the search for knowledge about export market requirementswas led in part by the agencies which were responsible for promoting agricultural productionin areas that were being transformed by irrigation schemes. They sought knowledge fromexisting agricultural exporters in Brazil and from European technical experts.13 This is not theonly option. In the case analysed by Gomes, the development of the local fruit exportindustry was led by a small number of large private firms. They found out about exportmarkets, developed production processes suitable for the local environment and pioneeredmarketing efforts.

A similar story can be found in Côte d'Ivoire, one of the fastest–growing African exporters ofmangoes. Côte d'Ivoire produces a range of five different types of mangoes, of which onetype, “Kent” has been the most popular among European consumers because of widespreadrecognition of its appearance, colour and taste. The OACB, the fruit producers/exporters'association in the country began a campaign to promote the second most popular type,“Amélie”. Rather than wait for the market to discover this product, the OACB, in alliancewith European importers, launched an information campaign in the European market, withhints concerning the ripeness of the Amélie variety, how to prepare the fruit, its nutritionalbenefits and storage conditions. Thus, the producing country was directly involved in productdiversification and in the promotional campaign. The OACB's quality strategy has introducedprogressive training programmes for its associates for packaging and harvesting in thecountry. It also introduced an internal quality system so that quality and reliability on qualityproducts was guaranteed. These factors combined gave the Côte d'Ivoire an opportunity tocontinue to increase its share of global markets, and exporters were seeking out newimporters, particularly in Northern European countries, and diversifying their markets byestablishing networks with Saudi Arabia and the UAE (Eurofruit 1998).

Shoe exports from BrazilThe case of the Sinos Valley shoe cluster14 provides an extreme contrast to the fruit exporters.It is an example of a cluster of firms into a global value chain dominated by a relatively smallnumber of large buyers and characterised by quasi-hierarchical relationships. In this case, thevalue chain link provided clear transfers of knowledge, but these reinforced a focus onproduction, and eventually undermined attempts within the cluster to upgrade in response tonew competitive threats.

The arrival of buyers from the United States (stimulated by the cluster itself and Braziliangovernment export incentives) in the late 1960s transformed the cluster from anagglomeration of predominantly small firms producing for the domestic market to a clusterdominated by large exporting firms, some of which integrated vertically. At one level, thistransformation facilitated upgrading. Process standards rose, as did product quality. Theconsiderable challenges and risks of entering export markets were eased by the buyers:

13 Damiani also notes the importance of local institutions in developing and protecting the region’sreputation in export markets and the importance of both local and national governments in meetingthe pest control requirements of the USDA.

14 The account which follows is based on Schmitz (1995).

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“These export agents were not just buyers.... they studied the market whichnecessitated visiting shoe shops in the United States in Europe as well as internationalshoe fairs. They developed models which required setting up model shops in theValley to produce samples. They inspected product quality and production scheduleson site; they provide technical assistance; they organised transport and paymentarrangements” (Schmitz 1995: 14).

In other words, firms in the Sinos Valley concentrated on the production process and theorganisation of their own local supply chains, while product definition (and hence, marketknowledge), logistics, technical support and contract settlement were arranged by the buyers.The firms in the Valley were confined to a narrow range of functions.

The danger of this situation became evident when Chinese producers undercut Brazilianproducts and the U.S. market in the early 1990s. While this event can be seen as the result ofa more general entry of Chinese producers into the manufacture of labour-intensive productsfor global markets,15 it should be noted that it is a danger inherent in quasi-hierarchical valuechains. Global buyers actively scout for new sources of supply, and substitution by newsources is always a potential threat to existing suppliers. Schmitz (1999) suggests thatprocess and product upgrading was not sufficient to maintain returns to capital and labour inthe cluster because Brazilian producers were faced with sharply declining prices for theirproducts in North America. However, the largest firms in the cluster actively opposedproduct and functional upgrading, because it would take them into direct conflict with thelarge US buyers. Some firms, however, operating in different value chains, achievedfunctional upgrading. Notably firms catering for the high end of the domestic market andexporting to other South American countries accumulated considerable design and marketingexperience. Buyer-producer relationships in these chains tend to be market or network-based.

African fresh vegetables for UK supermarketsSuch tight value chain linkages, based on quasi-hierarchical relationships, do not bythemselves rule out product and functional upgrading. The study of the value chain linkingAfrican vegetable producers to UK supermarkets by Dolan et al. (1999) began with anassumption that knowledge flows back along the chain would be limited. Like the SinosValley case just described, upgrading would be confined to process improvements,particularly relating to quality.

In fact, a very different situation was found. In part, this is attributable to the supermarkets’strategy of product upgrading and repositioning of the whole chain. Over time, thesupermarkets have presented customers with increasingly processed products. There iscontinuing product and process innovation at the suppliers. The supermarkets’ competitivestrategies have also encouraged the development of new products - new vegetables, newvarieties of existing products and products with extended shelf life or growing season - aswell as the development of new packaging and presentations.

However, this upgrading is not due solely to the overall repositioning of the chain by thesupermarkets. A critical factor seems to be the structure of the chain itself. The chain doesnot consist simply of, on the one hand, buyers who interpret consumer requirements, designproducts, market them and arrange the logistics, and on the other hand, producers whoproduce exactly what they are told and hand it over to the buyers. Between the producers andthe supermarkets lie African-based processor/exporters and UK importers. Between them,they have responsibility not only for logistics but also for important aspects of productdevelopment and marketing, and importantly they have the size to take a strategic view of the

15 See Kaplinsky (1998: 7) for a discussion of Chinese penetration of U.S. and Japanese markets forlabour-intensive products.

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industry. Increasingly, there are signs of vertical integration between the exporters andimporters. These factors are an important element in the upgrading process. In this case, thesupermarkets’ narrow focus on retailing and supply chain management as their corecompetences provides ample scope for upgrading along the chain. Importers and exportersactively develop new products and are involved in market research and product promotion.

Traders in the garments industryThe fourth example has some parallels with the horticulture case. Gereffi’s work on garmentshas emphasised the upgrading of the East Asian NICs in the garments industry. Countriessuch as Korea and Taiwan have shifted from assembly of garments through to full packagesupply, production of textiles and the organisation of chains that link US buyers withproducers in various Asian countries.

This development has been analysed by Smith (1996). He places considerable emphasis onthe role of the large trading companies in Korea in restructuring the industry when risingwages and low unemployment made Korean garment exports less competitive. He suggeststhat these trading companies (linked to the chaebols), through their control of MFA quotas,acted as intermediaries between U.S. buyers and local garment producers. It was theseintermediaries that had the strategic vision and resources (financial and managerial) to leadthe relocation to offshore plants and to shift production in Korea towards textiles. Thisinterpretation has two important consequences for our understanding of upgrading in valuechains. Firstly, it suggests that the “learning by exporting” effect was largely the result of aninsertion into the value chain which gave the traders an important role in organising the chainwhen garments were being produced in Korea:

“Historically, the trading companies played a pivotal brokerage role, linking thedesigners and buyers from the developed core nations to the small Korean businessesthat are the direct producers of clothing. These chaebols provide administration,financing and quotas to the subcontracting firms. They also often have extensivelinks and investments in the production of textiles and other inputs at the ‘upstream’end of the commodity chain” (Smith 1996: 222-23).

Secondly, it follows that the development of the “triangle” trade between the USA, the EastAsia NICs and the less developed producers in East and Southeast Asia (China, Indonesia,Vietnam, etc.) involves a transfer of production from the first-tier East Asian NICs, but notnecessarily functional upgrading. The trading companies already had responsibility fororganising the production part of the chain.

The knitwear firms of LudhianaAnother route to upgrading is opened up when firms learn lessons from one value chain thatcan be applied to another. Tewari’s (1999) analysis of how the woollen knitwear cluster inLudhiana was able to shift rapidly to Western export markets following the collapse ofRussian markets in the early 1990s illustrates how capabilities in logistics and designdeveloped through supplying the high end of the domestic market can be used to open up newglobal export markets.

By the late 1980s, a considerable portion of Ludhiana’s output of woollen knitwear consistedof low-quality, mass produced products directed to the Russian market: “Design, colour andyarn variations did not fetch much the premium in the Soviet export market” (1999: 1658).Following the collapse of this market, existing and new exporters were able to find customersin Europe, East Asia and the United States. Although the emphasis in these markets was ondesign, quality, speed of response, etc., Tewari argues that firms had developed capabilities inthese areas through supplying the domestic market for high-quality knitwear:

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“Many exporters to did well, or were able to adjust quickly had a strong presence andstake in the domestic market. The simultaneous presence of many exporters [toRussia] in dynamic segments of the domestic market, forced them to make keyorganisational changes and build managerial capacities early on” (Tewari 1999: 1654,stress in original).

According to Tewari, these firms then responded to the challenges posed by new exportmarkets by “hiring designers, skilled workers upgrading definition, packaging and distributionsystems” (1999: 1654). These responses, combined with the arrival of new foreign buyers inLudhiana enabled previously some firms to switch to new export markets and allowed manysmall firms to begin exporting for the first time.

4. Using our arguments to analyse value chains

It does not seem appropriate to provide conclusions to this background paper. It is meant toopen up discussion, not conclude it. Instead, we will just present some of the types ofhypotheses that we have been developing in our work on global chain governance, localupgrading and the connection between the two. By developing ideas about governance,upgrading, knowledge systems, etc., we have defined a series of propositions that our currentresearch work on local-global interactions is trying to address. For example:

§ Quasi-hierarchical governance is costly. One key driver for it is the buyer’s perception ofa high risk of supplier failure. Risks are high when the competence differential (betweenwhat the supplier is used to doing and what is demanded by the buyer) is high. This iswhy quasi-hierarchy is most common in sourcing from new developing countryproducers. As the latter’s competence increases, the need for quasi-hierarchicalgovernance decreases.

§ Integration into quasi-hierarchical chain is very beneficial for developing countryproducers in the early stage. Global buyers facilitate rapid process and productupgrading.

§ In later stages, however, local producers may find themselves in a situation of “lock-in”because global buyers do not facilitate or actively prevent functional upgrading (takingover strategic chain functions).

§ The possibility of avoiding the “lock-in” depends on three factors: the power of the globallead firm, the strategic intent of the local producers, and the quality of local supportsystems (private, collective and State). If producers do achieve functional upgrading,governance relations tend to be redefined.

Clearly, we are still some way from translating these propositions into researchablehypotheses. To do this (and to make other hypotheses we develop at Bellagio feasible forresearch) we will have to (i) define more clearly key concepts such as the different types ofupgrading and different types of governance, (ii) operationalise the concepts so that we can,for example, identify the type of governance seen at particular points in value chains(preferable in ways that are cost effective), and (iii) consider the types of comparative valuechain analysis that would enable us to test the hypotheses. There is plenty to do at Bellagio!

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