The Value Chain Approach - Linking National Producers to International Buyers and Markets

Transcription

1 The Value Chain Approach - Linking National Producers to International Buyers and Markets Professor John Humphrey Institute of Development Studies University of Sussex Brighton, UK 1 Value chains, co-ordination and adding value The basic idea of a value chain is very simple. Products have to go through a sequence of activities in their journey from raw materials to the market. The key question is how these different activities taking place along the value chain are co-ordinated, particularly when the value chain crosses national boundaries. The economic literature tends to emphasise two forms of co-ordination - the firm and the market. One simple way of co-ordinating a whole range of activities is to bring them within the control of a single firm and to co-ordinate them through management. Multinational corporations, for example, increasingly co-ordinate of factories based in many different countries around the world. Flows of goods between subsidiaries of multinational companies are responsible for a significant share of world trade. Alternatively, markets can co-ordinate activities along the chain. When this happens, products change ownership as they move from between activities. For example, the firm may produce iron ore, which is sold to a steel company, which sells steel to a steel stockist, who sells it on to a manufacturer of nails, who sells nails to a wholesaler, who sells them to the furniture company, who sells furniture to an exporter, who finds a buyer in another country, etc. Each company at each stage in the value chain will know the company immediately preceding and following it, but may not have any idea of the rest of the chain. These types of market linkages are often referred to as "arm's length market relationships". For standard products, these arm's length market relationships can be very efficient. Traders and wholesalers, in particular, often make such arrangements more effective - by holding inventory to help match supply and demand, setting prices and passing information between producers and users. This can be very convenient for both buyers and sellers. For example, a furniture company might need to buy wood, glue, nails, etc. These are likely to be available from the local wholesaler or stockist as and when the furniture company requires them. The furniture company does not need to know who produced them or where they came from, and this makes business straightforward. Similarly, the manufacturers sell to a few intermediaries, who pool together the demand of lots of small customers. However, global markets are becoming more complex. Global buyers increasingly to want to know how products are made and how they are sourced. They want to have a lot more information about both their immediate suppliers and about what is happening further back along the supply chain. There are four reasons for this: 1. Product differentiation and innovation have become increasingly important sources of competitive advantage. Therefore, buyers require non-standard products, and these involve customised, complex exchanges between buyers and suppliers. One important driver of this process is increasing concentration in the retail sector. Large retailing firms whether sourcing directly or through intermediaries - have become powerful global

2 buyers. Frequently, these buyers focus on retailing but play an important role in product development and branding. However, their power and their use of product differentiation and innovation in the pursuit of competitive advantage means that they actively manage the supply chain. 2. The elimination of stocks and the pressure to reduce time to market favours greater integration of supply chains. This is reinforced by the prevalence of non-standard products. The more customised product, the less likely it is to be available from stock and the more the buyer depends upon one or a small number of suppliers. 3. Final product markets in developing countries are characterised by an increasing emphasis on safety, labour and environmental standards. Buyers need to know how products are produced and to monitor and audit suppliers. In many cases, conformance with these requirements can only be achieved through monitoring of processes in the supply chain, rather than testing of the product. In some cases, product testing is expensive and time-consuming. In other cases, such as conformance to labour standards, the product itself does not provide information about supply chain processes. 4. In the pursuit of low-cost inputs in labour-intensive sector such as garments, global buyers are frequently looking to develop new sources of supply. New suppliers are expected to meet requirements that frequently do not (yet) apply to their domestic markets. This creates a gap between the capabilities required for the domestic market and those required for the export market. Therefore, buyers (retailers, traders, etc.) have to ensure that products and processes meet the required standards. If the gap has to be closed quickly, buyers will need to invest in a few selected suppliers and help them to upgrade. Greater value chain co-ordination in the fresh vegetables sector A clear example of greater value chain co-ordination is provided by the transformation of the fresh vegetables sector in the UK. Twenty years ago, there was a developing trade in offseason temperate vegetables exported from some African countries, particularly Kenya, to the UK. In Kenya, small exporters would buy green beans in local wholesale markets or directly from smallholders, pack them in boxes or sacks and send them to the UK importers, who would then sell them through UK wholesale markets. They would be bought by a variety of retailers (large and small), caterers, etc. Twenty years later, the business has been completely transformed. The key changes are:? Fresh vegetables are now largely sold through large supermarkets. Five supermarket chains account for over 70% of all fresh food retail sales in the UK.? The supermarkets have completed on the basis of product differentiation, increasing the variety and also the level of processing. Cash-rich but time-poor consumers buy products that are easy-to-use - ready-trimmed, washed, mixed with other ingredients, etc. There are much more likely to the wrapped in trays or cellophane packs than presented loose.? Product freshness and shelf life have been enhanced by speedier passage through the supply chain. Levels of quality, continuity of supply and consistency of quality across the whole year have been objectives of the retailers.? Food safety requirements and standards are much stricter, particularly with regard to pesticides and minimum residue levels fixed by the EU.? Various European food retailers and importers have signed up to the Eurep Good Agricultural Practice code, which is particularly concerned with environmental issues (land use, pesticides, control of chemicals, integrated crop and pest management, etc.), and also with labour standards.? In order to deliver product differentiation, quality, consistency of supply, safety and environmental and labour standards, the value chain has been transformed in two important ways.

3 Firstly, the level of co-ordination of activities in the chain has increased enormously. Traceability now goes from the supermarket shelf to a grower's field (literally). Suppliers are regularly audited and monitor. Specialised logistics systems are used to transport fresh vegetables from the field in Kenya to the supermarket shelf within 48 hours (including all processing and packaging, which takes place almost entirely in Kenya and with mostly imported materials). Seed companies, exporters, importers and retailers work together to develop new varieties, increased growing seasons, new product promotions, etc. Secondly, the structure of the chain has changed. None of the new requirements for the chain could have been obtained through continued reliance on independent small growers and wholesale markets market relationships. Now the industry is dominated by a small number of large exporters, who are growing increasing quantity of vegetables on their own land. These exporters are linked in exclusive relationships to UK importers, and the import business is consolidating rapidly. The supermarkets are dealing with fewer and fewer importers who are expected to arrange round-the-year delivery of a range of fresh fruit and vegetables, sourcing from different countries as required. Understanding this transformation of the value chain is important for strategy-makers in a number of ways:? Any firm wanting to enter the supermarket value chain has to be able to provide the necessary scale, control (traceability), quality, reliability of delivery and innovation capability before being considered as a potential supplier. The barriers to entry have increased enormously.? The overall benefits of involvement in the sector have probably increased as the level of post-harvest processing has increased, generating a lot more employment.? Logistics, particularly airfreight infrastructure, is critical for a country's success. This, in turn, depends in part on related activities, such as tourism, which generate the level of air traffic required to increase competition between airlines and reduce freight costs.? Auditing and monitoring of the chain is helped by working with a small number of large growers or by the exporters growing on their own farms. This has led to a steady reduction in this number of smallholders integrated into this value chain. Policies aimed at promoting smallholders may require the targeting of different markets.? The key agents in the chain, who make the key decisions, are probably the supermarkets. Therefore, new strategy initiatives around issues such as labour standards and environmental impact meet the involvement of these key agents 2 A value chain mindset This case of fresh vegetable exports from Kenya to the UK is a good illustration of what we mean by "adopting a value chain mindset". It forces us to think in different way about how export markets are organised. What image comes to mind when we think about exporting? Probably an enterprise that makes a product for the domestic market and then finds a foreign buyer for it. Perhaps the firm displays the product at a trade fair, or maybe it contacts an international trader or broker. Increasingly, the real world is not like this. Take a simple product like a T-shirt. These are often sold by large retailers and brand-name companies. The product is increasingly differentiated, if not by quality, then by branding. A Nike T-shirt is not a Walmart T-shirt, even if there are few real differences in their intrinsic characteristics. Neither Walmart nor Nike just buy ready-made T-shirts from any supplier. They contract with approved international marketing agents or selected large producers, who may have factories in a variety of countries. Some large buyers will be concerned about labour exploitation or environmental issues (often as a result of NGO pressure and consumer campaigns), and only

4 source from approved factories. Even small buyers are increasingly concerned about this. One Ethiopian producer of leather garments we met recently told us that to expand exports he would probably have to integrate backwards into leather tanning to upgrade his tanning capabilities. At the moment he could only win "spot" or top-up orders from international buyers and occasionally some European fashion garment retailers. As a marginal supplier, his products escaped too much scrutiny. However, to became a regular supplier, he would have to ensure that the leather used for his garments was processed in an environmentallyacceptable manner, as defined by the EU and the retailers he was supplying. As such environmentally-acceptable leather is not available locally, one strategy would be to invest in a local tannery and bring it up to the required standard. In this case, the strategic implications of supporting such an entry into European markets would include providing information about European requirements, inspection services to verify standards were being met, finance for investment and facilitating importation of necessary equipment. Facilitating entry to the value chain: organic cocoa Finding (or being found by) the right buyer can be a shortcut to exporting. Take the case of organic cocoa. If a group of small farmers somewhere in Latin America wanted to export organic cocoa to Europe, the challenges might be formidable. What organic certification is recognised in Europe? What varieties of cocoa are preferred? What times of year are market conditions most favourable? What are the tariff levels and documentation requirements? Is there shipping available? The answers to these questions can be found. In some cases, export promotion or import facilitating agencies will be able to provide the answers. Perhaps an agent can be found who knows about the market. Local rural development agencies may see it is part of their role to provide this type of support. However, answering these many different questions will require the mobilisation of a lot of expertise. For one group of cocoa producers in the Caribbean, these problems are being solved by a major European chocolate maker. Organic chocolate is in big demand. There is a shortage of supply, and so big buyers are prepared to invest their own money in developing new sources of supply. For some buyers, investing in co-operatives and developing a Fairtrade image is an additional attraction. The European buyer is investing in organic production with a group of cocoa farmers. Its experience in importing cocoa means that it knows the answers to many of the questions listed above. The cocoa producers can concentrate on producing cocoa, and the buyer organises everything else. An additional benefit is that they have supply contracts lasting a whole year, with a stable price. This can be seen as a shortcut into the export market in the short-term. In the longer term, it may become a trap. The exporters might remain ignorant of European market requirements and become dependent on one buyer. Over time, organic cocoa may become more plentiful in the market, and the buyer will find other sources. Will the cocoa co-operative above be prepared to find other buyers, markets and distribution channels? In the past few years, these are precisely the challenges that the small-scale leather tanning industry in the south of India has had to face in order to secure its survival in the face of concerned with India about environmental pollution arising from the tanning industry and much stricter requirements with regard to the presence of PCPs in leather and the use of azo dyes for products imported into the EU. Ensuring compliance with these increasingly complex (and yet very desirable) environmental requirements has involved considerable support for the industry from national government, regional government, business associations and specialised technical services for the leather industry.

5 Large companies will also specify the design of the garments that they source. The retailers and brand-name manufacturers are closest to the final market. They interpret changing fashions and customer needs, although they may contract out some of the design work to other companies. The changing nature of the international garments industry is one of the reasons why the Africa Growth and Opportunity Act (AGOA) has had such unexpected impacts in Africa. Firstly, a lot of the business is being co-ordinated by East Asian firms, who have been acting as producers and intermediaries in the garments industry, particularly for the North American market, for a considerable time. Firms in African countries that want to get into this business often have to deal with these East Asian firms, or with regional buyers for the US retailers, rather than with the retailers themselves. Secondly, these East Asian firms, both producers and traders, have began to invest in both garments manufacture and also textile production - the latter in order to meet local content requirements. The speed with which garment manufacturing capacity has grown in response to the opportunities provided by AGOA is explained partly by the role of these international producers and buyers in co-ordinating the value chain. This development of global value chains is by no means confined to garments, although the growth of brand-name companies that design and market products but do not actually produce any products at all is particularly marked in this sector. The same effect can be seen in footwear, leather products in general, toys, electronics, white goods, and the automotive parts industries. In electronics, it is taking a specific form. The firms whose names appear on products such as computers and mobile phones rarely make them. They do not manufacture the circuit boards or the components, and they do not assemble the product. This is increasingly done by very large contract manufacturers, such as Flextronics and Selectron - largely invisible to the buying public, but now global companies with tens of thousands of employees and plants in many countries. Often, these plants have been spun-off by the brand-name companies to the contract manufacturers. What all this means is that supplying the global market often doesn't involve making a finished product that can be sold to the end-user. Increasingly, it seems to involve making parts of a product, often to specifications given by an international buyer, or defined in partnership with a buyer. In extreme cases, buyers or traders will provide the raw materials, specify what is to be produced and how, and arrange the logistics. In other cases, the buyer will specify what is required in terms of performance, assess the capabilities of the supplier and then contract with a supplier to provide a product that meets the desired specifications. The impact on trade promotion strategies, import regulations and trade support requirements is enormous. 3 Adding Value and avoiding the production of commodities Strategy-makers promoting agricultural exports, in particularly, would broadly welcome these developments. They offer value production, avoiding those basic commodities whose prices have plummeted so badly in recent years. Moving out of commodities means adding value and producing non-standard products. But, doing this has consequences for the organisation of the value chain and for producers. These are not always understood. The advantage of a standard product is that it can be produced in any quantity, large or small. Because it is standard, it can be sold in wholesale markets and mixed with the output of other producers. A small amount of coffee grown by a single producer can be mixed with the output of other producers and sold in the quantities required by coffee traders or processors. In this process of mixing the output of various producers, any special characteristics of the

6 coffee grown by one producer are lost. Because the requirements of the market are wellknown, little direct communication is required between buyer and seller. If, on the other hand, producers want to make added-value, non-standard products - perhaps asserting particular claims about how it is produced - they face three challenges: 1. They have to make sure that they are adding value in the eyes of the buyer. Adding value only leads to higher prices from buyers if consumers place value on the new product attributes. So, the producer has to know what particular characteristics the buyers wants for the consumer. 2. The source of added value in the product has to remain identifiable as the product moves along the value chain. There are three basic ways of doing this:? The added value is immediately visible on inspection, as with graded products. Wherever the product is transported, its value is apparent. However, it should not be mixed with low-quality produce. Unmixing these products again might be impossible or at the very least expensive.? The product is certified and the certification is attached to the product. An example of this would be the Forestry Stewardship Council (FSC) scheme for sustainable managed forests. Timber from such forests receives certificates which then "travel" with the wood as it moves along the chain. Once again, certified and uncertified produce must not be mixed.? There is direct monitoring and traceability of the product is it moves along the chain, as would be the case of fresh vegetables imported into Europe, described in the Kenyan example above. The third type of control appears to be increasingly prevalent, partly as a response to increasing regulation, partly because the value chain linkages that are required for it also enable collaboration between suppliers and retailers on issues such as quality, reducing time to market and product innovation. Note, however, that this form of control usually requires large scale production. Traceability and monitoring are expensive, but there are economies of scale. If added-value products are developed, they have to be supplied on the scale required by the customer. In other words, non-standard products have to be produced by large producers or by groups of small producers (outgrowers, co-operatives, etc.). Not being able to keep the identity of the product intact as it moves along the value chain can prevent value being added to the product. An example of this is described in a recent article on the wool industry in New Zealand (Champion, S., and Fearne, A., 2001, 'Alternative Marketing Systems for the Apparel Wool Textile Supply Chain: Filling the Communication Vacuum', International Food and Agribusiness Management Review, Vol 4: ). Some wool producers might wish to produce higher-quality wool and gain a higher price. However, because of its nature, wool production is dispersed and fragmented among many farmers. While there may be benefits from better co-ordination of the supply chain, each early stage wool processing mill uses the output of one thousand farms or more. No single farm, or even group of farms, can reap the rewards of improved quality by keeping its product separate from the product many other farms. Auctions and traders still dominate the business: "For wool growers, this dominance of the auction system means that diversity is lost..." (p. 242). Some producers try to circumvent this problem of commoditisation by resorting to large-scale country of origin quality promotion campaigns identifying products as "made in...". In this case, the whole country's output is identified as being of higher value, even if each producers is small.

7 Without an understanding of value change linkages, the obstacles to adding value and capturing value in a chain would not be seen, strategies and potential solutions to problems voiced by exporters could be dysfunctional or distortional. 4 The value chain as a strategy tool Value chain analysis can be used as a strategy-making tool in a number of different ways. Most simply, it can be used as a diagnostic tool to understand the competitive challenges and market dynamics facing particular firms or sectors as they try to enhance their position in export markets. Value chain mapping can identify the different types of markets and buyers, key relationships within the value chain, sources of inefficiency, etc. The steps to making such a diagnosis can be found in ITC's Trade Strategy Template. More ambitiously, the value chain approach can help to develop broader, sectoral strategies aimed at enhancing competitiveness in the medium term and achieving socio-economic objectives. Recent work by Professor Afonso Fleury at the University of São Paulo has highlighted important value chain issues in the textile industry in Brazil. The competitiveness of the textile industry needs strengthening. In particular, the production of synthetic textiles and comments from this textiles has been the focus of some strategy studies by government and by the BNDES (The National Bank for Economic and Social Development). The value chain analysis highlights certain issues that a purely sectoral analysis might miss. In particular, Fleury notes that inputs into the production of synthetic fibres depend upon the upstream chemical industry. The way that feedstocks are developed is not optimal for synthetic fibre production in Brazil. In part, this is because most of the output of second generation petro-chemical products goes to the plastics industry, which has different requirements. Fleury also notes that the output of the synthetic fibre industry goes not only to the garments sector, but also to the automotive industry (for seats and vehicle interiors). In the auto industry, large firms (such as the transnational firms that make seating systems) are willing to order in larger volumes and pay better prices than the small firms in the garments industry, that are subject to intense competition in final markets. Furthermore, some of the transnational firms in the auto industry may be dealing with the same synthetic fibre producers in a number of countries final, and therefore they are in a strong position to have their needs attended to. In other words, the issues of communication and knowledge flows along the value chain are not solely concerned with effective communication, but also with the ability of firms to make themselves heard. This relates to their relative importance as customers to their suppliers and who they are competing against when they seek the attention of their suppliers. Similar problems can be found in other sectors. For example, in the case of fresh vegetables, exporters are dependent on airline companies for air freighting produce to Europe. If the exporters are small, they cannot always obtain direct services, or regular services, and therefore are not able to meet demands for speed and reliability of delivery from their customers. A value chain approach can isolate the key problems faced by exporters by mapping the chain and the various inputs into it and then identifying the key areas where market requirements are most difficult to meet or where synergies might be achieved with exporters from other sectors.

8 5 Poverty reduction through trade The ultimate aim of development strategy is to provide sustainable increases in incomes, particularly for poor people. If trade is to provide one means of doing this, then developing country producers and exporters have to find ways of accessing markets, improving their efficiency and improving the returns to their participation in these markets. This issue is particularly important for workers in the informal economy. Although informal work (casual work, child labour, very small-scale own account working, working with irregular contracts, etc.) is usually associated with production for the local domestic market, many informal workers do actually work directly or indirectly for global markets. If trade is to benefit the poor, then that the very least improving the intense and economic security of these globalised informal economy workers should be an object of strategy. Such considerations are not fanciful. They already provide the basis for important strategy initiatives. For example, Fairtrade initiatives for products such as coffee focus on the articulation of local-level organisation of small producers own account with international marketing bodies, often sponsored by NGOs. The Ethical Trade Initiative promoted by the Department for International Development in the UK is premised on the assumption that buyers in developed countries (retailers, importers, etc.) can influence what happens in their suppliers and can in be made subject to pressures over this in the countries where they sell their products. This is one way of using value chain linkages as a means of improving wages and working conditions for workers employed on casual or contemporary contracts, and might be extended to homeworkers and subcontractors along the supply chain. Another DFID initiative, the Business Linkages Challenge Fund, supports the development of business linkages involving poor people in developing countries and businesses that will help them link to national what global markets. The following table provides a summary of the ways in which the incomes and economic security of producers and workers in the globalised informal sector might be improved: Means of raising incomes 1. Gaining access to global markets when none was available previously 2. Raising the productivity/efficiency of the informal economy (same product, lower costs) 3. Levelling the playing field: providing the same level of support for own account workers as for SMEs, both formal and informal. 4. Increasing the value of the product sold/produced. How to achieve them? Developing new value chain linkages (marketing channels).? Creating new capabilities among producers so that they can produce new products.? Co-operation - co-operatives, producer groups, etc. to provide economies of scale, particularly in processing and marketing.? Training, etc.? Capital investment (this could go in the box below).? Finance/credit, from the state, or from co-operative schemes.? Infrastructure - particularly important for rural producers.? Same access to business development services as SMEs.? Protection from harassment - basic legal rights.? Greater output. Either by more efficient use of same imports (point 2), or by use of credit, better access to labour/land, etc. to increase volume.? Greater intrinsic unit value. Better quality through training, investment, improved value chain linkages, etc.

9 5. Redistributing returns along the chain. 6. Making value chain linkages more efficient so that less value is lost along the chain.? Greater extrinsic unit value. Extrinsic value does not relate to the properties of the product itself. Extrinsic unit value can be increased by mean such as Fairtrade schemes or labelling, which allow a higher-priced be charged for the product.? Creating new market structures to bypass monopolies or points of exploitation, or making markets more transparent.? Developing legal rights for own account workers, particularly with respect to contract law, payment, etc.? Forcing a better deal for labour through legislation and labour standards/codes for wage workers and homeworkers.? Global regulation of value chains.? Improving the links between producers and intermediary/buyers, particularly with regard to communication of buyer requirements and coordination of schedules.? Improving physical movement of goods along the chain.