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Thursday, April 14, 2016

Global Value Chains: The quest for integrative capabilities

Hassan Wafai
Introduction

The emerging reality of the global economy has directed attention to the connectivity issues of the increasingly fragmented and geographically dispersed global supply chains (World Trade Report, 2014).  While the fragmentation of production across different countries is not a new phenomenon, the dynamics of such fragmentation in terms of scope and scale have posed immense conceptual and empirical challenges (OECD, 2014; Coe at al., 2008).

The Global Value Chain (GVC) approach provides an analytical framework that captures the movements of goods, services, capitals, ideas, knowledge (know-how) within global networks.  The GVC approach has gained importance as a means to engage in the discussion of international trade, global-local dynamics, understanding value creation processes and the formation of geographical specialization, and reflecting on regional and national policies (OCED, 2013; OECD, WTO-OMC, & World Bank, 2014).

While GVC’s participation is a relevant concept to economies, sectors, and clusters, it actually occurs at the organizational level.  If local organizations are not able to plug into GVCs, there would be no sustainable economic competitive advantages, no matter how open the economy is, or whether it is engaged in regional free trade agreements.  For policymakers, the fundamental question therefore would be “how to facilitate value chain’s participation of firms and workers to improve their countries’ economies and (social) performance” (Kowalsk et al., 2015).

Since not all organizations are equally able to plug into GVCs, even though they operate in a relatively connected and open economy, we argue in this paper that attention should focus on analyzing the process through which firms build the required capabilities, named hereunder as integrative capabilities, to integrate in GVCs. 

Integration into GVCs

For an organization to integrate into a GVC, it should possess sufficient integrative capabilities.   In that sense, the term integrative capabilities would refer to two distinct types of organizational capabilities: participative and upgrading capabilities.  Only when a firm has sufficient participative capabilities can plug into a GVC.  Participative capabilities therefore indicate that the firm has sufficient technical and managerial knowledge and skills to produce products and/or services that are valued by GVCs’ actors.  This echoes the definition proposed by Grant (1996) of organization capabilities that are the “ability to perform repeatedly a productive task which relates either directly or indirectly to a firm's capacity for creating value through effecting the transformation of inputs into outputs” (Grant, 1996). 

The second type of capabilities is the upgrading capabilities, which refers to a firm’s ability, once successfully plugged in, to learn, acquire, and develop the knowledge and expertise needed to climb up the value chain to a higher value adding position.  In fact, the upgrading capabilities have long been considered as synonymous with firm level innovative capabilities (Pietrobielli and Rabellotti, 2011; Morrison, et al., 2008), which result from continuous learning and interaction between GVCs’ actors (Bessant et al., 2012; Marra et al., 2012).  In that sense, upgrading capabilities are associated with firm level absorptive capabilities, which are about acquiring and using new knowledge from outside the firm (Cohen and Levinthal, 1990). The process in which firms builds upgrading or innovation capabilities is also strongly influenced by power asymmetry within GVCs; network flagship organizations have instrumental role to help local firms develop upgrading capabilities (Ernst & Kim, 2002; Bessant al et., 2012). There is also sufficient empirical evidence to support the proposition that foreign direct investments and the intermediate goods and service, imported from industrialized economies, expedite the learning and knowledge transfer, hence the process of building upgrading capabilities (WTO, 2014). 

The interactions between GVC’s actors and their wider community, whether defined geographically or professionally, have an important impact on accelerating the learning and knowledge transfer in GVC, hence building integrative capabilities (Humphrey and Schmitz, 2002).    While the GVC literature tends to emphasize the relationship within GVCs, it did not capture the complex and the multifaceted relationships between GVCs and their wider environments (Parrilli et al. 2012; Coe et al., 2012).  

The concept of innovation system (IS) covers these complex and multifaceted relationships.  While it is somewhat broad, the innovation system concept has evolved around the intricate and dynamic networks of actors, organizations and institutions that systemically contribute to innovation processes at different levels and in various capacities. 

The relationship between IS and integrative capabilities

 

The relationship between IS and integrative capabilities is complex and mutually affecting.  To a large extent, these relationships determine a firm’s ability to integrate into GVCs (i.e. to participate, and then to upgrade).  IS and integrative capabilities could offer a useful two by two matrix, as shown in Figure 1, which helps to conceptualize some of the dynamics surrounding GVCs integration, the formation of clusters, and learning processes.  




Quadrant 1

Quadrant 2

Quadrant 3

             Quadrant 4



 

 

 

In Quadrant 2, a strong innovation system is characterised by well established, locally, and internationally recognized institutions; effective and efficient infrastructure and procedures; and coordinated policies, among others.  Under such systems, firms that have strong integrative capabilities would be able to plug into GVCs and upgrade in both directions, upstream and downstream, investing in knowledge based capital (KBC) (OECD, 2013).  The relational type of governance (Gereffe et al., 2005) would most likely evolve promoting learning networks and clusters (Tsekouras & Papaioannou, 2002). 

Quadrant 3 represents situations where IS is characterized by weak institutions and infrastructures, an absence of policies, bureaucratic procedures, and pervasive corruption.   Firms operating under such systems with weak integrative capabilities would less likely be able to participate or upgrade in GVCs.  Captive and hierarchical types of governance would evolve, reflecting high level of power asymmetry in GVCs and the tendency of lead firms to adopt vertical integration strategy.  Accordingly, clusters are less likely to emerge in such situations.

In Quadrant 1, under a relatively weak IS, firms with strong integrative capabilities can still engage with GVCs.  While such firms would have the capabilities to plug into GVCs, upgrading might be challenging.  Accordingly, modular chains (Gereffe et al., 2005) would most likely prevail.  The competitive advantages of firms operating in modular chains stem from their ability to invest in production capacity and confine to the specifications set by lead firms. 

Finally, quadrant 4 reflects situations found in emerging economies where firms have weak integrative capabilities and operate under a relatively strong IS.  In the short term, captive and hierarchical governances (Gereffe et al., 2005) are most likely to emerge where lead firms would have a considerable power over local firms, that would struggle to plug into GVCs.  However, the strong IS could help reduce the cost of technology and learning related transactions, hence firms would be able to gradually build capabilities which would push GVC away from hierarchical and captive structure toward more modular and relationship structures (Pietrobellie and Rabellottie, 2011).   It is important to note also that the role of lead firms is very important to help local firms improve their capabilities (Ernst & Kim, 2002; Bessant al et., 2012)

Conclusions

Successful integration into GVCs results in considerable gains in productivity and competitiveness.  While the GVC literature has focused on the integration into GVCs from a national and macro level perspective, few studies have examined how a firm could build sufficient capabilities to integrate in GVCs.

We argued that there are two sets of factors that influence a firm’s ability to integrate into GVCs:  firstly, the extent to which the firm has built integrative capabilities to integrate into GVCs, and secondly, the information system (IS) in which the firm operates. 

To a large extent, the relationship between IS and integrative capabilities is complex and mutually affecting.  To a large extent, this relationship determines a firm’s ability to integrate into GVCs

References

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