The Governance of Global Value Chains; Implications for Industrial Upgrading Timothy J. Sturgeon, Ph.D. Industrial Performance Center Massachusetts Institute of Technology SEMINAR ON GLOBALIZATION, KNOWLEDGE, AND DEVELOPMENT Universidad Nacional Autonoma de Mexico (UNAM) March 13-17, 2006 Mexico City

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Frame of Reference — Key Trends for Firm-level Analysis of Globalization Increased outsourcing Computerization of product design Computerization of process technology Formalization and segmentation of work tasks (services offshoring) Increasing market volatility and industry clock-speed (Fine) Increasing geographic scope of production systems Better integration of geographically dispersed production systems The rise of a new, global-scale supply-base The global value chains framework is an overarching rubric that can help to tie these trends together New features are global suppliers, global buyers, and value chain modularity, which eases coordination between the two.

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Market Channel End User Product R&D Process R&D Product strategy Functional design Form design Dist. Sales Reps. System Int. Retail Market Channel MarketingAdmin. Traditional Manufacturing Firm A) Vertical Integration B) Value Chain Modularity Lead Firms (Brands and Retailers) End User Dist. Sales Reps. System Int. Retail Codifiable transfer of specifications (CAE, CAD, CAM, MRP, ERP) at inter-firm link. What Baldwin and Clark (2000) call a“pinch point” in the chain of activities. Full Package Supplier Prototype fab. Parts purchasing Manufacturing Testing Packaging Admin. Product strategy Product R&D Functional design Form design Prototype fab. Marketing Admin. Firm boundary Parts purchasing Process R&D Design for mfg. Manufacturing Testing Packaging Marketing From Vertical Integration to Value Chain Modularity

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Elements of Modularity Modular product designs (e.g., the PC) Modular value chain linkages (the hand-off) Modular value chains (internal) Modular value chains (external) Only modularity in external value chains leads to capacity pooling and external economies of scale Modular product designs make value chain modularity easier, but only one break point is needed — full product design modularity is not required

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Elements of Value Chain Modularity Codification of complex information eases the hand-off at the inter-firm link—information technology and widely recognized standards are key. Highly competent suppliers with multiple locations and customers An adequate number of suppliers to allow lead firms to switch Generic capacity –Allows lead firms to add and subtract capacity on short notice –Allows large suppliers to substitute locations Benefits for lead firms: lower costs and risk Risks for lead firms: IP leakage, creation of competitors, attenuated learning by manufacturing, forecasting and inventory distortions, de-codification with technological change, ceding of value to suppliers

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Performance Benefits of Modular Production Networks Information Technology Open Character of Network Lower Barriers to Network Entry and Exit Standards Codified Network Linkages Greater Geographic Flexibility Product/Customer Flexibility Lower Factor Costs Network Characteristics Network Performance Greater Organizational Flexibility Higher Capacity Utilization Suppliers Provide Base Processes Generic Capacity Capacity Attenuated Interdependence Lower Total Cost and Risk Preconditions

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Lead firms with captive supply bases Lead firm A Supply base A Lead firm B Supply base B Co-evolution Competition Supply Chain End users Value Chain First tier Second tier Materials

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Lead firms with shared, modular suppliers Lead firm ALead firm” n” Shared supply base Co-evolution (including competition) Co-evolution (including competition) Codifiable transfer of specifications (CAE, CAD, CAM, MRP, ERP) at inter-firm link. What Baldwin and Clark (2000) call a“pinch point” in the chain of activities.

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Value chain modularity with supplier consolidation Lead firm ALead firm” n” Co-evolution (including competition) Co-evolution (including competition) Global suppliers Global Supplier Examples: Electronics contract manufacturing: Flextronics, Solectron, Sanmina-SCI, Celestica, Jabil, Hon Hai, Quanta, Compal Auto parts: Magna, Delphi, Visteon, Bosch, Denso, Yazaki, Lear, Johnson Controls, TRW, Continental Call Center Servvices: Accenture, SNT Group, Atento, Convergys, SR Teleperformance, Wipro BPO, Bertelsmann Clinical Trials and Contract Medical Research: Quintiles, Covance, IMS Health, Parexel IT Services and Enterprise Computing: IBM, Accenture, PriceWaterhouseCoopers, McKinsey, Cognizant

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Revenue Growth at the Top Five Electronics Contract Manufacturers, 1994 through 2001, $M Note: All Celestica revenues in 1994 were from IBM. Sources: Company annual and quarterly reports; Electronic Business Top 100 Contract Manufacturers, 2003.

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Top Five EMS Contract Manufacturers Revenues, Employment, and Facilities, and Location, 1999 and 2002; Compound Annual Growth Rate ; and Top Five Share of Top 100, 2002 Source: Electronic Business Top 100 Contract Manufacturers, 2000 and Notes: Flextronics facility figures are for 2000; growth rates have been adjusted accordingly. Solectron facility figures are for 2001; growth rates have been adjusted accordingly.

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Product Mix for the Largest Five EMS Contract Manufacturers, 2001

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 The new global supply-base; Celestica’s global footprint

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Global suppliers offer “total geographic flexibility” in a shared global supply-base; coordination is internalized Regional production systems are nested within global production systems

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Upgrading at an Electronics Contract Manufacturing Plant in Guadalajara, Mexico, February, 2001 – July, 2004 (Jabil Circuit) Source: Luhnow, David. “As Jobs Move East, Plants in Mexico Retool to Compete.” Wall Street Journal.com. March 5, 2004.

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 The Role of “Proximate Production Platforms” (Mexico, East Europe) in GVCs Rapid order fulfillment for “lean retailing” Last minute customization for pull-through ordering Medium technology products and processes that require moderate degree of design/prodcution co-location Product categories that require in-region production (autos, medical, military and security-related) Pass through production location as newer products shift from US to China Competition is with developed country plants, not with China Regional integration needs to move beyond trade, to the integration of production, innovation, and security regimes

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 The governance of global value chains: an analytic framework Based on a paper by: Gary Gereffi, Duke University John Humphrey, IDS Timothy Sturgeon, MIT Published in: Review of International Political Economy, 12(1) 2005 Summary of approach with related literature can be found at the Global Value Chains Initiative website:

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Theoretical Underpinnings (starting point: industrial organization) 1. Transaction Costs Economics Key concept: Asset specificity Academic field: Institutional economics 2.Production Network Theory Key concepts: Trust, reputation, repeat transactions, social networks, geographic proximity, power Academic fields: Economic sociology, economic geography 3.Complementary Competencies Key concepts: Resource view of the firm, learning, core competence, co-evolution (buyer-supplier and industry) Academic fields: Strategic management, operations management, evolutionary economics

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Five GVC Governance Types Low High Network org. forms

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Some Dynamics in Global Value Chain Governance  increasing complexity of transactions (harder to codify transactions; effective decrease in supplier competence)  decreasing complexity of transactions (easier to codify transactions; effective increase in supplier competence)  better codification of transactions (open or de facto standards, computerization)  de-codification of transactions (technological change, new products, new processes)  increasing supplier competence (decreased complexity, better codification, learning)  decreasing supplier competence.(increased complexity, new technologies, new entrants)

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 Supplier Upgrading (and Downgrading) in Global Value Chains More customers Product upgrading Inter-sectoral upgrading Base process focus More capabilities Process upgrading Functional upgrading Functional bundling Many customers Many capabilities Few customers Few capabilities CAPTIVE FULL PACKAGE SUPPLIER RELATIONAL MODULAR De-codification and reduced competence through technological change, new requirements, and new competitors

Copyright Timothy J. Sturgeon, Industrial Performance Center, MIT, 2006 GVC Governance Types Links to Policy