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Asian Development Outlook 2003 : III. Competitiveness in Developing Asia
Global Value Chains
For firms in less developed countries of Asia, being part of a GVC can be an important catalyst in learning and adapting advanced technologies. It can also enhance the development process in general. Estimates show that the benefits of trade liberalization that are accompanied by the establishment of international supplier chain arrangements between firms in the industrial and less developed countries can be 10 to 20 times larger than those accruing from trade liberalization alone (Moran 2002). International production chains are likely to benefit firms in countries where they can go into GVCs in sectors including furniture, footwear, textiles and garments, and electronics, in three main ways. First, by increasing the set of internationally traded goods, GVCs increase opportunities to benefit from the gains from trade by allowing the participants greater room for specialization in the labor-intensive stages of manufacturing processes (which overall might be technology or capital intensive). Second, by broadening the scope for gains from trade, it renders protectionist, import-substitution, or anti-foreign investment policies even less effective. Third, given that this kind of production and trade tends to occur in tightly knit "just in time" global networks, it gives added impetus to the need for improving the efficiency of transport and communications infrastructure and for a stable business environment (Yeats 1998, p.2). GVCs can enable firms to enter global production networks more easily, allowing them to benefit from globalization, climb the technology ladder, and gain wider access to international markets. GVCs provide firms with a wide spectrum of options to operate in global markets with a view to staying competitive. In theory, GVCs offer a way for local enterprises in developing countries to engage in international markets at their own level of capability. In practice, however, it is often extremely difficult for a firm to secure an initial order, and only if a firm has a proven track record with a buyer is it likely to win a major contract. Entry into GVCs is easiest when an agglomeration of local buyers and manufacturers already exists, so that newcomers can learn from the established players. Sometimes, new entrants emerge as spin-offs from existing local firms or from MNC subsidiaries with whom they establish a new GVC linkage. For countries and groups of firms outside successful clusters, accessing GVCs can be difficult. For very poor countries with little engagement of or prior experience in GVCs (especially high-technology GVCs), entry can pose major developmental challenges to policy makers and business leaders alike. Exploiting Global Value Chains for Economic Development: Ten NIE Entry StrategiesFirms in the NIEs have been participating in GVCs for several decades and their experience can be very useful for firms in other Asia-Pacific countries. GVCs encouraged local firms to learn technology and overcome the barriers to entry into export markets. Ten common GVC entry strategies for firms in the NIEs have been the following:1. foreign direct investment (FDI) 2. joint ventures 3. foreign and local buyers 4. licensing 5. subcontracting 6. informal means (e.g., overseas training, hiring, returnees) 7. original equipment manufacture (OEM) 8. own design and manufacture (ODM) 9. strategic partnerships for technology 10. overseas acquisition of equity. Each of the 10 strategies enabled latecomer firms to enter GVCs at progressively more advanced stages of development, though they had to expand both technological and market opportunities. Indeed, GVCs are not always easy to enter and it can be decades before the latecomer gains a strong position. These entry strategies are not new, although some have expanded greatly due to globalization of production. Numbers 1 to 7 represent early-stage strategies; 8 to 10 are highly advanced methods for latecomers to initiate their own GVCs. Each strategy has evolved through time as latecomers acquired greater technological capabilities and marketing skills. Foreign Direct Investment. Table 3.7 shows the significant expansion of FDI in the Asia-Pacific region, and that it is highly concentrated in the more advanced economies of East Asia as well as the PRC. This concentration worries the Southeast Asian countries, which have traditionally depended on FDI for their exports and for technology transfer. In less developed countries of the region, FDI has stagnated, except in India, where it is picking up.  Historically, FDI was an important export starting point for many firms in East and Southeast Asia, and sometimes led to joint ventures and OEM. As Schive (1990) and Fok (1991) show, foreign subsidiaries acted as "demonstrators" for local firms. Some foreign firms (e.g., the American Singer Company, which produced sewing machines in Taipei,China) directly assisted local firms to develop by training local subcontractors. Most MNCs trained local technicians, engineers, and managers in their subsidiaries, upgrading the capabilities and experience of the workforce. While the overall contribution of FDI to capital formation in economies such as Korea and Taipei,China was very small, it accounted for a large share of exports and employment (James 1990, Dahlman and Sananikone 1990). For example, in Taipei,China, FDI contributed about 2.2% of total domestic capital formation between 1965 and 1968, rising to 4.3% between 1969 and 1972. This fell to 1.4% between 1977 and 1980, and again rose to 2.5% between 1984 and 1986. Foreign firms accounted for around 20% of the economy's total exports between 1974 and 1982, falling to 16% in 1985 as local firms assumed greater significance. MNCs accounted for around 16% of manufacturing employment in 1975, increasing to 17% in 1979, and declining to 9% in 1985 (Hobday 1995a, pp.108-109). In Taipei,China, individual MNC investments gave rise to a Schumpeterian process of "swarming" as local firms rushed to supply basic services and simple components. Joint Ventures. In the early stages of Korean export development, the Government permitted firms such as Hyundai, Daewoo, Lucky Goldstar, and Samsung to form joint ventures with Japanese and US firms (Amsden 1989). Samsung Electronics began by assembling simple transistor radios and black-and-white televisions under a joint venture with Sanyo Electric in 1969. According to Bloom (1991), the Government later encouraged Japanese firms to leave, once local companies had acquired the necessary know-how. In electronics, now the largest GVC, of the 691 firms registered in Korea as producers back in 1977, 480 were Korean owned (mostly small companies), 167 were joint ventures, and 44 were wholly foreign-owned ventures. Table 3.8 shows how leading Japanese firms formed joint ventures in the late-1960s and early-1970s with Korean partners. Samsung and the others diversified into electronics from other industrial areas. They offered low-cost finance and labor in exchange for know-how and export outlets. By 1976, around 50% of electronics employment was accounted for by foreign-owned or joint venture firms (Bloom 1991, p.9). Joint ventures first applied to consumer goods and later to telecommunications. Samsung Electronics, as indicated above, began as a joint venture with Sanyo. Its first step was to acquire overseas training, machinery, components, raw materials and foreign management techniques from Sanyo. As wages rose in Japan, Samsung offered Japanese companies capacity for producing large scale, low cost, standardized goods. Korean overhead costs were pared to an absolute minimum to meet Japanese demands. In Taipei,China, Japanese firms tended to supply the local market through joint ventures. By 1963, at least seven major joint ventures had been agreed between firms there and Japanese electrical appliance manufacturers (Wade 1990), mostly producing transistor radios, black-and-white televisions, and simple components. In 1963, Sanyo formed a joint venture with the Taipei,China importer of its goods to supply the local market and by 1970 the company began exporting. This venture initiated production of "white goods," air conditioners, audio products, television sets and, later, videocassette recorders (Chaponnière and Fouquin 1989).  Foreign and Local Buyers. Foreign and local buyers were a key entry point into GVCs for NIE firms and an essential source of marketing and technological knowledge. Hone (1974) shows that many Asian firms initially sold their goods to the large buying houses from Japan and the US. Foreign buyers would typically place orders of between 60% to 100% of the annual capacity of local firms in sectors such as clothing, electronics, and plastics. The Japanese buyers (e.g., Mitsubishi, Mitsui, Marubeni-Ida, and Nichimen) located themselves in the NIEs to purchase cheap goods as wages started rising in Japan in the early-1960s. In the late-1960s, these buyers purchased more than US$1.4 billion a year of low-cost East Asian manufactured goods, 75% of which were then sold to the US. This led to a host of Japanese manufacturers moving directly to Korea; Singapore; and Taipei,China; many American retail companies (e.g., J.C. Penney, Macy's, Bloomingdales, Marcor, and Sears Roebuck) also set up offices there (Hone 1974). The buyers enabled local firms to obtain the credit needed to expand. Without these guaranteed forward export orders, many firms would not have been able to gain the necessary credit facilities. Foreign buyers supplied technology in various forms. They provided information on product design and advice on both quality and cost accounting procedures. The larger buyers visited factories and supervised the start-up of new operations, assisting with the purchase of essential materials and capital equipment. Rhee et al. (1984) show that around 50% of a sample of 113 firms in Korea benefited directly from buyers through plant visits by foreign engineers. Buyers supplied latecomers with blueprints, specifications, information on competing goods, production techniques, and guidance on design and quality. About 75% of firms received assistance with product design, style, and detailed specifications. In electronics, American retail chains and importers were the most important buyers during the 1970s in Korea. As Moran points out:
Licensing. Under licensing contracts, local firms paid for the right to manufacture goods usually for the local market and the MNC would transfer the necessary technology for this to be undertaken. Usually, licensing required a higher level of technological capability on the part of the latecomer than say a joint venture, in which a "senior partner" would normally provide the necessary expertise for the local firm to undertake the production. In Taipei,China, between 1952 and 1988 the authorities approved more than 3,000 licensing agreements, many including formal technology transfer clauses (Dahlman and Sananikone 1990). Companies often secured licenses in the early stages to gain access to technology and markets, leading on to OEM. This continued into the 1970s and 1980s. Subcontracting. Sometimes, MNCs trained local firms under long-term subcontracting relationships. Under these, the latecomer firm would be granted access to training and engineering support and, in return, would produce a component or subsystem, which would then be incorporated into the final equipment by the purchaser. Subcontracting usually took place in lower-value products and systems and was mostly oriented toward the export market, via the MNC buyer. Informal Means. Complementing the formal means for entering GVCs, firms often deployed informal or unofficial strategies, including the copying of products and reverse engineering. It was common to hire foreign engineers on short-term contracts, who were sometimes retired, and recruited local staff already trained by foreign MNCs located in the home economy. Also, many East Asian engineers were educated in foreign universities or worked abroad in foreign companies and some were employed by well known R&D institutes, such as Bell Laboratories in the US. The flow of technically trained Taipei,China nationals returning home rose from just 250 in 1985, to 750 in 1989 to more than 1,000 in 1991. In Taipei,China, former Bell Laboratories employees began the Taipei,China Bell Systems Alumni Association. By 1992 this had 120 members, exceeding its rival Bell Alumni equivalent in Korea, which had around 80 members. Hundreds of others returned from Caltech, Massachusetts Institute of Technology, and other leading US technology centers (Hobday 1995a). Original Equipment Manufacture. OEM is a specific form of subcontracting that developed out of the joint operations of MNCs and local suppliers, becoming the most important channel for export marketing during the 1980s. This was especially true in electronics, which was the leading export sector in the NIEs. OEM, which began in semiconductors and computer products, is similar to subcontracting in other sectors such as bicycles and footwear. The term OEM originated in the 1950s among people in the computer industry who used subcontractors to assemble equipment for them. In the 1960s, it was adopted by American semiconductor companies that used local firms to assemble and test semiconductors. Under OEM, the latecomer would produce a completed product according to an exact specification provided by the foreign MNC. The MNC would then market the product under its own brand name, through its own distribution channels. This enabled the latecomer to avoid investing in export marketing and distribution channels. OEM often involved the foreign partner in the selection of capital equipment and the training of managers and engineers as well as advice on production and management. Sometimes (e.g. Korea; Hong Kong, China; and Taipei,China) OEM grew out of licensing deals, as the partners got to know each other. Initial success in OEM often led to long-term technological relationships between partner companies because the MNC depended on the quality, delivery, and price of the final output from reliable and trusted suppliers. Own Design and Manufacture. ODM was first reported by Johnstone (1989) and applies mainly to the electronics sector. As the OEM system evolved during the early 1980s, Taipei,China companies such as Acer and RJP began to specify and design the electronic products purchased under OEM, usually beginning with simple products. In 1988 and 1989 this began to be called ODM in Taipei,China but the term was not used in Korea until a decade or so later. However, Korean firms also made equivalent progress in carrying out some or all of the product design, usually according to a general design layout supplied by the foreign buyer, which was often a MNC. In some cases the buyer cooperated with the latecomer on the design. In other cases the buyer was presented with a range of finished products to choose from. These were defined and designed by the latecomer firm based on its growing knowledge of the international market. As with OEM, the goods were then sold under the MNC's or buyer's brand name. ODM offered a means for latecomer firms to capture more of the value added while avoiding the risk associated with the launching of its own-brand products. In the early stages, ODM applied mainly to incremental changes to existing products rather than to new products that were developed by the leading firms based on R&D. Strategic Partnerships for Technology. Strategic partnerships for technology are non-equity joint ventures carried out by Asian firms on an equal basis with foreign MNCs. In recent years, this strategy has enabled the largest latecomer firms to enhance their position in GVCs by developing highly advanced new products and processes jointly with foreign companies. Samsung, for example, entered into an 8-year agreement with Toshiba of Japan in 1992 to develop flash memory chips and with Texas Instruments of the US to make semiconductors in Portugal in 1993. More recently, Lucky Goldstar (LG) of Korea formed a joint venture with Philips of the Netherlands (LG-Philips) in 1999. In this venture, LG provided Philips with advanced manufacturing process know-how for liquid crystal display monitors for desktop and notebook computers, while Philips provided financial capital and access to its basic research facilities in Eindhoven. The combination of LG and Philips enabled LG to recover quickly from the financial crisis in Korea in 1997, and then to forge ahead to become the world leader in the manufacture of thin-film transistor/liquid crystal display screens. Overseas Acquisition of Equity. At their most advanced stage, former latecomer firms operate as "leaders" on the international stage, initiating their own GVCs. Companies such as Samsung and Hyundai have bought several high-technology firms in industrial countries to gain distribution channels, technology, and production facilities. For example, in 1986 Samsung acquired Micron Technology to enter the semiconductor market. In 1988, the same firm took an equity stake in Micro Five Corp to acquire computer technology and invested in Comport in the US to gain hard disk drive technology. Similarly, in 1986 Daewoo acquired a majority holding in Zymos to gain wafer fabrication capabilities. In 1986, Daewoo took over Cordata Tech to gain know-how in IBM-compatible personal computers, as well as manufacturing and marketing facilities. In 1986, Lucky Goldstar acquired Fonetek, a radio communication company, to gain technology. These types of acquisitions enabled the most advanced latecomer firms to dominate their own GVCs and compete with GVCs dominated by US, Japanese, and European firms (Bloom 1989). Marketing and Technology Upgrading StrategiesGVCs enabled firms to move beyond labor-intensive assembly into the production and export of advanced goods in areas such as computer products and electronics. However, these firms were not solely concerned with technology. To move up the GVCs, they also needed to acquire marketing knowledge and distribution skills to meet increasingly sophisticated customer demands in the industrial countries. This would also enable them to capture a greater proportion of the post-production value added denied to them under GVC arrangements such as subcontracting, OEM, and licensing. Table 3.9 presents a simplified "stages" representation of both marketing and technological progress under typical GVC arrangements, such as subcontracting and OEM. In reality, the process is far more complex and many firms do not follow this path. However, as a first-order approximation, the model is a useful starting point for assessing actual patterns of progress. According to the five-stage marketing model of Wortzel and Wortzel (1981), the local NIE firm progressively internalizes the marketing functions initially carried out by the foreign buyer or manufacturer. In stage 1, the latecomer is entirely dependent on local or foreign buyers for marketing, distribution, and quality control. The local firm simply delivers low-cost production capacity. As the model indicates, during stages 2 to 5, the latecomer firm assimilates more and more sophisticated marketing functions. Spurred on by the prospect of additional growth and profit and by competition from other local firms, the latecomer learns how to conduct its own sales and marketing. In doing so, it broadens its range of customers and improves the packaging and, eventually, the quality of its products. Eventually, by stage 5 the latecomer firm develops its own brand and organizes its own sales either directly to overseas customers or through distributors. It no longer depends on the distribution channels of foreign buyers or manufacturers. In marketing terms, the latecomer is indistinguishable from leaders and followers in the industry. During the 1980s, most advanced Asian exporters had reached stages 3 and 4 in areas such as electronics, clothing, and footwear. However, although many firms had taken control of local marketing, product design, and quality, they had yet to establish their own brand names in the markets of industrial countries. Wortzel and Wortzel (1981), writing when they did, believed that stage 5 was largely theoretical in the NIEs. By the early 1990s, however, some latecomer firms such as Samsung and LG of Korea and Acer and Tatung of Taipei,China had established well-known global brand names. Nevertheless, most latecomers remained dependent on foreign buyers and MNCs for their marketing outlets. For example, although Cal-Comp of Taipei,China was the world's largest producer of calculators and fax machines in 1991, it was virtually unknown in western industrial economies. Cal-Comp produced roughly 80% of Japanese Casio calculators under OEM. Similarly, Inventec of Taipei,China produced a significant share of the world's telephone handsets, including 60% of British Telecom's handset sales, but remained virtually unknown. The marketing strategies deployed within GVCs involved investment and learning; they also involved considerable risk. In computers, Acer for example, experienced major problems in sustaining its own-brand sales (accounting for 60% of sales in 1988). The sheer scale of investment forced the company to retreat to OEM/ODM after sustaining heavy financial losses. Similarly, Hyundai was forced to cease marketing its own brand of computers in the US, after consumers were puzzled as to why Hyundai, a car brand, should be selling computers. The right-hand column of Table 3.9 adds a technology dimension to the marketing model, suggesting how latecomer firms gradually learn the techniques of production. This sequence for the firm is broadly consistent with what has been found to occur empirically at the industry level (e.g., Dahlman et al. 1985, Westphal et al. 1985). By upgrading their capabilities, firms learn production skills, then investment know-how and, ultimately, innovation capabilities (as initially argued by Lall [1982]).  Successful early entrants to GVCs tend to begin with simple assembly skills and, later, incrementally assimilate process capabilities. At these early stages, firms are highly dependent on outside sources of technology from, most notably, the firms that bought their products. As their capacity expands and the number of customers increases, they need to control the quality and speed of production, so they invest in the technical skills required to internalize key production methods. Spurred on by export market opportunities and competition, firms invest in product and process engineering, and some establish an engineering department to coordinate these activities. This enables the firm to sell higher quality products to a larger base of customers and, most importantly, allows the firm to move up the value chain by bringing the advantages of low-cost engineering to the GVC. Typically, the latecomer entrepreneur recognizes that, unless the firm acquires technology at least as rapidly as its competitors, it will remain trapped in the capacity export stage and low value-added production. By stage 4, the firm's strategy is to strengthen the engineering capabilities needed to develop new processes and products. In these areas, the firm has overcome its technological dependency. By this stage, it is likely to have forged independent links with capital goods suppliers and may conduct some limited R&D into new products, enhancing its prospects and position within the GVC. A firm that reaches the final phase, stage 5, is no longer a latecomer. It has reached the stage of being able to initiate its own GVC by acting as a leader in the chain, through its advanced marketing and R&D capabilities. At stage 5, firms are indistinguishable from world market leaders and compete at the technological frontier. However, the most advanced Korean and Taipei,China firms have only recently reached this stage, in a few product areas. The purpose of matching technology with marketing in Table 3.9 is to indicate how export marketing can pull forward the technology of latecomer firms. For example, through subcontracting and OEM relations, export demand acts as a focusing device for technological investments and forces the pace of learning. Local competition stimulates the process, as followers imitate the export leaders. There may not always be a systematic interdependence between the technology and marketing dimensions. In principle, it is possible for a firm to acquire advanced technology but still remain at the early stages of marketing. However, if the firm does not focus closely on the type of products that the market demands, it runs the risk of investing in inappropriate technology. To avoid this problem, most Asian latecomers have developed strategies to improve both technology and marketing skills simultaneously. Marketing and distribution capabilities are needed for firms to capture the value added in packaging, distribution, and after-sales service, and eventually increase brand recognition. Improved marketing helps firms expand their customer base and provide better control of the direction they take. Similarly, technological know-how is needed to improve quality, punctuality, and flexibility in production. In some of the five stages, marketing and technology have direct links. For instance, when shifting from stages 1 to 2, firms have to internalize process skills to expand production capacity, shorten delivery times, and improve product quality. Later, to achieve stage 4, firms will need sufficient R&D to convert market signals into innovative products. Often, the channels for technology transfer and marketing in GVCs are one and the same, as in the case of subcontracting, OEM, and ODM. Within GVC arrangements, latecomer firms are presented with a technology transfer mechanism—and a requirement for strategy upgrading. In subcontracting, the local firm is often supplied with technical specifications that require training and advice on production engineering by the MNC. The strategy of the MNC is to ensure high quality and to control the delivery and price of the final output. Consistent with this, the strategy of the latecomer is to meet these demands via technological learning. Difficulties, Risks, and Threats Within Global Value ChainsUp to this point, this section has stressed the potential benefits for enterprises engaging in GVCs. These include the ability of local enterprises to (i) begin production with its existing level of capability, (ii) access technological knowledge, (iii) access large export markets, (iv) exploit economies of scale, (v) progressively upgrade capabilities in manufacturing with the help of foreign enterprises, (vi) learn process and product innovation skills, and (vii) eventually catch up with advanced firms.16 Within the GVC, there is pressure to adapt to market demand in industrial countries, resulting in more flexible and competitive enterprises. The willingness and ability of latecomers to learn rapidly from leading GVC players are essential. However, firms also face many challenges and risks in taking part in GVCs. Under many GVC arrangements, the latecomer partner is often subordinated to the decisions of the buyer in the initial stages of the relationship, and often depends on the MNC for technology and components as well as market access. The MNC sometimes imposes restrictions on the activities of the latecomer firm by, for instance, preventing it from selling in other markets or to other customers. Profits tend to be severely squeezed and, without its own distribution outlets, the latecomer is limited in its post-manufacturing valued added. The heavy dependence on assembly can prevent firms from spreading the risks of production to other parts of the GVC. Also, the arrangement makes it difficult for latecomers to build up the international brand image needed to sell high-quality goods directly. This situation is often overcome, though, when the latecomer firm grows, finds new customers, and builds its capacity. SummaryGVCs have clearly facilitated rapid industrial growth and permitted the assimilation of technology by developing countries. In some cases, latecomer firms have overcome or renegotiated restrictive clauses; for example, Korean firms managed to have some marketing restrictions set aside so that they could sell directly to third countries. GVCs have allowed many firms to achieve economies of scale in production and have justified investments in automation technology. Nonregional MNCs continue to benefit from the expansion of low-cost capacity in the region. GVCs therefore endure as arrangements valued by both MNCs and latecomer firms. This section has outlined some of the key business strategies for exploiting GVCs, showing how latecomer firms can secure upgrading paths via technological learning and innovation. The latter not only increases the efficiency and profit of local firms, but also makes them even more attractive within the chain to buyers. Upgrading helps protect firms against lower-wage competition, allowing companies to move on to higher value-added, and more complex, products. Investment strategies have enabled many firms to move from process innovation (i.e., making something more efficiently) to product innovation (i.e., creating a new product), as learning about processes also requires more knowledge about product design. Working closely with leading MNC product designers provides firms with the opportunity, eventually, to take over the design of the product. Within long-term relationships with MNC buyers, local firms have broadened their product ranges, moved beyond heavy reliance on single clients and, in some cases, developed their own-brand products. Each firm and country must learn its own lessons from the successes of the NIEs in GVCs. These differ according to the firm's or country's particular level of development, resources, entrepreneurial capabilities, and existing and potential areas of dynamic comparative advantage. Firms in less developed Asian economies can draw no simple or mechanistic lessons, partly because the GVCs themselves changed when the NIEs joined them. However, it is clear that firms wishing to enter GVCs need to be operating in an environment in which the right institutional "fundamentals" are in place, including a stable macroeconomic environment for business investment, a reliable business infrastructure, and widely available basic and technical education. Policies are required to reward entrepreneurial risk taking, otherwise firms will not enter GVCs and clusters of suppliers will be unable to form. To provide a conducive environment for firms to join a GVC, policy makers may wish to consider the barriers facing firms that wish to enter one. Sometimes, it is overregulation of companies or high taxation; sometimes, bureaucratic rules concerning FDI, joint ventures, and company start-ups. Skilled workers and technicians may be lacking in some areas.
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