Subregional Workshop on Integration of SMEs of the Greater

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					                                                                                 Background Paper

    Subregional Workshop on Integration of SMEs of the Greater Mekong Subregion
                   (GMS) into Global and Regional Value Chains

                                          George Abonyi


The purpose of this paper is to provide background and highlight issues for consideration at the
UNESCAP-hosted workshop in Bangkok. Questions have been posed in the agenda. In this
context, this brief background paper seeks to support review and dialogue on the main themes,
and is a summary of a longer paper being prepared on this topic.1

I.        Introduction

Two complementary and interdependent processes are at work in the international economy, with
important implications for the competitiveness of companies, and the prosperity of nations. The
first is the process of integration of product markets and related relocation of economic activities:
the internationalization of production. This is leading to the emergence of global value chains
(GVC) in key industries. The second involves reorganization of firms’ activities around core
competencies, involving ‘breaking up’ of production, marketing and distribution systems and
moving them outside the firm, often to new locations. This is creating international production
networks (IPN) involving the coordination and integration of production among geographically
dispersed locations. These GVCs and associated IPNs are emerging as the organizing framework
for production, trade and investment in an increasingly broad spectrum of product groups.

Global value chains and networks provide opportunities for firms, including SMEs in developing
economies, to enter into large-scale export activities, and build new capabilities. Within the
context of GVCs, regional and global markets increasingly involve exports of components instead
of ‘complete final products’. As production systems become decentralized and more specialized,
new market opportunities emerge for all types of firms, including for SMEs, to enter into global
markets, and upgrade into increasingly technology-intensive export activities through
specialization. Even small components can be produced for large regional or even global market
niches if they are part of the sourcing structure of global value chains and networks; that is, if
 Abonyi, G., Integrating SMEs Into Global and Regional Value Chains: Implications for Subregional
Cooperation in the Greater Mekong Subregion (GMS), UNESCAP, Bangkok, November 2005.

small firms, individually or in groups, are able to deliver a specified product in the right quantity,
with required quality, at the right time. However, in order to participate in such value chains and
networks, firms must be able to meet an expanding range of increasingly stringent global
standards. The payoffs from participating in GVCs and IPNs can be potentially high for SMEs,
but increasingly, so are the requirements for entry.

Subregional cooperation can assist individual GMS countries address more effectively the
challenges and opportunities provided by global value chains and associated production networks
to access international markets. The types of cooperation can include: (1) taking a multi-country
approach to value chain supplier development by jointly identifying and addressing specific
cross-border constraints in selected value chains within the existing framework of GMS
cooperation; (2) jointly implementing, with the participation of key global enterprises, training
workshops to help SMEs in the GMS understand and respond to the needs of particular global
value chains and networks; (3) facilitate the establishment of ICT training and resource centres
focusing on the e-business requirements of particular value chains; (4) facilitate the emergence of
cross-border SME supplier clusters; (5) support the development of linkages between SMEs in
the GMS and global buyers and producers in particular value chains; and (6) strengthen the joint
capability for internationally recognized certification in selected value chains.

In this process, UNESCAP, together with other donors in the region, can support the efforts of
GMS governments and private sectors in meeting the emerging challenges and opportunities of
global value chains and networks.

II.     Global Value Chains and International Production Networks: A Primer

A value chain refers to the full range of value-added activities required to bring a product from its
conception, through design, sourcing raw materials and intermediate inputs, production,
marketing, distribution and service support to final consumers. A value chain can span enterprises
in a local economy, a national economy, a subregional grouping of economies such as the GMS,
and the international economy. Such value chains become ‘global’ (GVC), when their component
activities are geographically dispersed across borders to multiple country locations.

                                Fig. 1 Apparel Global Value Chain2

A production network represents the full set of linkages within or among a group of firms in
particular value chains for producing specific products such as computers, mobile phones, shoes,
jeans, or cars. It represents how lead firms such as Toyota, Carrefour, or Nike organize their
particular networks of subsidiaries, affiliates, or suppliers to deliver a product or service. An
international production network (IPN) involves the distribution and coordination of
geographically dispersed activities in multiple country locations.

          Example: A Production Network within the Global Apparel Value Chain
          To produce a line of garments, a global retailer such as Levi might (directly or
          indirectly) purchase South Korean yarn that would be woven and dyed in Taiwan
          by a subsidiary; send the fabric to be cut in Bangladesh by a subcontractor; ship
          the pieces for final assembly to an affiliate in Thailand, where the garments
          would be matched with Japanese zippers, and deliver the finished product to
          geographically dispersed affiliated retailers in North America and Europe. This
          set of firm-specific linkages, within the framework of the global apparel value
          chain constitutes a particular international production network.

    Source: Fig. 1, Gereffi, G. and O. Memedovic, The Global Apparel Value Chain, UNIDO, Vienna 2003

In general, two basic types of value chains and associated production networks are: producer-
driven and buyer-driven. They have differing implications for participating SMEs.

    •   In a producer-driven chain or network the lead firm, often a large multinational
        manufacturer, such as Ford or Toyota, plays a central role in exercising relatively close
        control in coordinating a geographically distributed network of subsidiaries, affiliates,
        and suppliers. This type of chain/network tends to be characteristic of capital- and
        technology-intensive industries such as automobiles, telecommunications, IT, and
        semiconductors. As a consequence, to be a supplier to this type of chain/network requires
        a certain level of technical capabilities and sophistication, and associated investments As
        an example, Sony, sourcing worldwide, imposes very high standards on suppliers,
        requiring strong technological capabilities, flexibility in response, strong customer
        service orientation, and the capacity to work with its IT-based e-procurement system.

    •   In a buyer-driven chain or network large retailers, marketers and brand manufacturers,
        for example Levi in apparel or Carrefour in food, play the pivotal role in working with
        and sourcing from decentralized networks of independent suppliers, defining product and
        process specifications and standards. This tends to be characteristic of labour-intensive,
        consumer goods industries such as apparel, footwear, agro-industry, and consumer
        electronics. The participation requirements, although can be quite stringent as in the case
        of IKEA in furniture, are comparatively low, offering many opportunities for developing
        country producers.

It is useful to be aware of the following basic characteristics of global value chains and networks:

    •   Governance: strategies of lead firms, including deciding who can be a supplier, what will
        they produce, how it is to be produced, how much is to be produced by each supplier and
        when, which function will a supplier be allowed to undertake within the network (e.g.
        production, design, marketing) and in which of these areas will a supplier be allowed to
        upgrade (e.g. moving from production also into design, adding higher value).
    •   Upgrading and innovation: the basis for strengthening competitive performance,
        increasing pricing power, and achieving sustainable returns by increasing efficiencies in
        the production process, improving existing products or developing new products, moving
        ‘upstream’ from manufacturing to product design, or using existing capabilities to move
        to a new more attractive value chain (e.g. from microwaves to personal computers).

       •   Standards: product and process standards both as market-driven requirements driven by
           consumer concerns with the social and environmental impacts of business, e.g. labour
           standards; and as set by lead firms to strengthen their competitive performance, e.g. for
           ensuring consistency, reliability and differentiation in their products.
       •   Emerging key role of global suppliers: emergence of ‘global suppliers’ as key players in
           organizing participation by lower level suppliers in value chains and networks, with lead
           firms such as Ericsson (telecommunications), Ford (automobiles) and Limited Brand
           (apparel) becoming increasingly reliant on a small number of global suppliers such as
           Flextronics (for Ericsson), Visteon (for Ford) Li & Fung (for Limited Brand) who are, in
           turn, determining the participation and role of lower level suppliers in the network.

III.       Challenges and Opportunities of Accessing Global Value Chains: Examples

GMS countries vary greatly in the characteristics of their economies and firms. They are at
different stages of development and global competitive position. Keeping these differences in
mind, two GVCs illustrate the challenges and opportunities in integrating SMEs into such value
chains: (i) fresh fruit and vegetables (buyer-driven); and (iv) auto parts (producer-driven).

           1.      Fresh Fruit and Vegetable GVC

The fresh fruit and vegetables industry is one of the most vibrant industries in international trade.
It has also been characterized by increasing concentration through the emergence of global
retailers/supermarkets such as Carrefour and Tesco. As they have grown in size, global retailers
are exercising growing influence on the industry value chain. While generally not directly
involved in production, they are exerting increasing control over product, production process, and
suppliers through strictly enforced market and firm-specific standards. Along the way, they are
increasingly using a smaller number of large volume suppliers, who in turn are consolidating and
rearranging lower tier suppliers within their production network. Any firm wishing to enter the
global value chain and networks has to be able to provide the necessary scale, control
(traceability), quality, reliability of delivery, and innovation capability before being considered a
potential supplier. Both the potential payoffs and the barriers to entry have increased significantly
in the context of global value chains and associated networks.

Those producers able to upgrade production and management systems and meet requirements--
standards, quality, quantity, logistics—can access expanding international markets through
GVCs, realizing growth in scale and revenues, and potential opportunities for upgrading. For
example, the trend to product differentiation such as organic produce, driven by both the tastes of
global consumers and by the strategies of retailers for higher revenues, is producing significant
opportunities for qualified producers to serve niche markets that are regional or even global in
nature. However, those suppliers unable to meet such requirements increasingly find themselves
in stagnant or declining, uncertain, and unprofitable and informal segments of the business.

        2.      Auto Parts GVC

The automobile components industry consists of a mixture of firms of very different sizes, types,
and geographic scope; producing an enormous variety of products from very simple parts, to
technologically complex systems. Purchasing of components accounts for between 50-70% of the
price of an average car. Therefore for enterprises able to participate even at the very lowest tiers
of production, the automotive components industry can offer significant potential for accessing
regional and global markets, and for upgrading.

Lead firms such as GM and Ford are increasingly performing far fewer functions, shifting more
responsibilities to their top tier suppliers. These global suppliers are moving into module design
and lower tier component sourcing, and taking increasing responsibility for management of the
supply chain. The key challenge down to the lowest tier suppliers is: getting the right part or
process, in the right numbers, to the right place, at the right time, at the right cost, with minimum
of inventories in process/in transit. These requirements are raising the barriers for entry and
upgrading for smaller and newer suppliers who seek to participate in the automobile GVC.

At the same time, global suppliers are being forced by cost pressures to search for low-cost but
high-quality and reliable parts that can be delivered on time. This can provide an entry point to
the auto components GVC for smaller and newer producers as suppliers of such simpler parts
hubcaps to higher tier suppliers with a regional and global reach. But higher tier suppliers are
looking for firms who are already able to make the desired products; and not for firms that need
to be brought up to the needed level of performance; and who have the capacity to use
sophisticated logistics systems tying together the production network.

To move from a commodity-like small component supplier to a simple assembly manufacturer
requires acquiring capabilities in several manufacturing processes to produce the components; the
logistical capabilities to manage the enterprise supply chain (e.g. outbound logistics) within the
production network; and stronger technical and engineering capabilities. In addition, capabilities
in design, test, validation and prototyping (product development) are also needed in this
upgrading process. Therefore firms need to be able to reach a certain minimum scale (for
production, and investment in machinery), technical capabilities, and financing. In sum, the auto
parts GVC provides potential opportunity for SMEs to access regional and global markets and
upgrade over time, but only if they meet an increasingly demanding supplier environment.

IV.     Challenges Facing SMEs in Participating in GVCs and the Role of Clusters

The challenges facing SMEs in competing on global markets in general, and becoming suppliers
to GVCs such as fresh fruit and vegetables or auto parts in particular, are many and varied.
Because of their size and isolation individual SMEs are often unable to identify potential markets
or to take advantage of market opportunities that require large volumes, consistent quality and
stringent standards, and regular supply; and are constrained from achieving economies of scale in
the purchase of such inputs as equipment, raw materials, finance, and consulting services. Small
size is also a constraint on accessing training, market intelligence, logistics and technology.

Entering into a supplier relationship in global value chains and networks can mean a larger and
more stable market for SME outputs, allowing such firms to better organize their production,
improve their technologies and realize higher revenues. At the same time, such chains and
networks also define a more demanding environment, requiring SMEs to work in a more formal
manner, and upgrade not only their production methods, but their management practices as well.
In this context, the basic challenge for SMEs is to meet the stringent requirements of becoming
and remaining suppliers to global value chains and networks.

Given these constraints, preparing SMEs to meet the challenges of participating in GVCs requires
a wide range of supporting factors. This includes a conducive enabling business environment, for
example in terms of policies, rules and regulations with respect to imports of needed of inputs and
exports of outputs in the global value chain and network; efficient logistics systems, including
both the necessary infrastructure and related institutional environment; and available business
development services (BDS) that meet the specific needs of small enterprises.

In this context, cooperation through enterprise clusters can help SMEs improve their capabilities
and bargaining power for accessing and upgrading within GVCs. Small firms generally find it
hard on their own to overcome constraints for competing on global markets, and individually may
be of limited interest to global buyers and suppliers given the transactions costs involved.
However, targeted cooperation among SMEs, as well as between SMEs and institutions in their
surrounding environment (e.g. industry associations, government agencies, training institutions)
can provide the basis for an effective response to competitive pressures, including the demands of
membership in GVCs. Cooperation can help SMEs by creating opportunities for achieving
collective efficiency and joint action to address shared constraints and opportunities including:

•   Collective efficiency based on scale: Achieving economies of scale beyond the reach of
    individual small firms in the purchase of inputs including technology, creating a pool of
    skilled workers, use of machinery, and pooling of production capacity to meet large volume
    orders from global buyers.
•   Collective efficiency based on specialization: Cooperation can enable SMEs to specialize in
    their core businesses and evolve a division of labour among firms, achieving efficiency in
    production, and learning from each other about markets, product and process improvements.
•   Joint action: Collaboration, for example through producer associations that help provide
    access to both international markets and related business development services.

SME clusters are then sectoral and geographic concentrations of enterprises that produce and sell
a wide range of related or complementary products, with similar operations in the same industry,
and face common constraints or opportunities. The development and strengthening of clusters can
therefore provide an important means to help SMEs participate in global value chains and
networks by reducing the transaction costs for global buyers in dealing with small suppliers, and
by increasing the collective efficiency of participating SMEs

        Example: Knitwear cluster in Tirrupur, India
        Tirupur has traditionally manufactured knitwear and established its name in India in
        the manufacture of cotton undergarments. In the 1970’s, as a result of collaboration
        with an Italian cluster, Tirupur began to exploit opportunities in the export market. In
        1985 after successful introduction of new dyeing techniques a group of textile
        entrepreneurs exported $8 million worth of T-shirts. By 1990 exports had grown to about
        $100 million, supported by a strong informal network created among the entrepreneurs,
        combined with competitive costs. Cooperating enterprises formed the Tirupur Export
        Association (TEA), and focused on upgrading sector capabilities, including supporting
        institutions and shared infrastructure projects. Over the last two decades, Tirupur has

         emerged as a leading export cluster in knitwear and has established a global presence.
         Individual firms are highly specialized in the manufacturing of fabric, dyeing,
         processing, knitting and export marketing. By 2000 over 5000 enterprises in Tirupur
         worked in the cluster and exports reached over $1 billion.

V.       Recommendations for Areas of Subregional Cooperation in the GMS to Support
         SME Participation in Global Value Chains3

         1.      Pilot GVC Cooperation Program Within the Framework of GMS:
                 Government-led, Private Sector Partner, Donor Support

Issue: There exist opportunities for cooperation among the GMS countries in specific GVCs.
However, with respect to each area, there are a wide range of GVC-related constraints that need
to be addressed by the participating countries. It would therefore be useful to have a mechanism
that allows the GMS countries to jointly identify and address on an on-going basis key constraints
with respect to selected GVCs.

Initiative: Establish a GMS institutional framework for facilitating subregional linkages within
selected GVCs, i.e. in effect initiating a ‘GMS value chain programme’ aimed at specific
product/markets. In particular, set up a “GVC Working Group” within the framework of the on-
going GMS Programme, with UNESCAP providing Secretariat support, and involving the GMS
Business Forum. This Working Group would build on the existing structure and activities of the
GMS Programme, e.g. infrastructure, trade facilitation, investment, but focus incremental
activities on selected GVCs. The GVC Working Group would have a 2-level agenda:
•    Strategic: Select particular GVC(s) for focusing subregional cooperation activities.
         o    This requires analysis of a number of GVCs for consideration, for example those
              where existing cross-border value chain linkages may be strengthened and extended;
              and those that have potential for subregional cooperation (a process similar to the
              sector analyses at the beginning of the GMS Programme that identified priority
              projects). Selected GVCs need not involve all GMS countries simultaneously, along
              the lines of the GMS Economic Corridors model. Agreement on GVC work program
              would then follow, with the commitment of the GMS governments.

  The focus here is on subregional or multi-country as distinct from purely domestic initiatives. These may
include strengthening linkages across borders in the GMS, or common constraints that may be addressed on
a subregional/multi-country basis.

                       Examples could include garment production integration on a subregional
                       basis; developing a ‘GMS’ marketing (and branding) of organic fruit and
                       vegetables, given a growing market and problems of ‘small lot supply’ in
                       some countries; with Thailand as regional auto parts hub, outsourcing of
                       lower tier production of components (e.g. Cambodia has rubber and
                       processing); wood/bamboo/rattan furniture production/marketing.
•   Operational: Prepare and implement a work programme addressing key constraints on
    cooperation in the given value chain(s).
        o    This requires identifying and addressing specific cross-border and domestic
             constraints on cooperation relevant to the specific GVC(s) selected.
                       Examples: Specific GVC-related trade facilitation activities such as
                       simplification/harmonization of processes, rules, regulations related to
                       imports (e.g. inputs, components) and of exports (e.g. components, final
                       products) in specific GVCs. This can build on the on-going trade facilitation
                       initiatives in the GMS Program. Similarly, strengthening logistics systems
                       for the selected GVC can build on existing GMS infrastructure cooperation.

        2.       Coordinated Subregional Training Workshops on specific GVCs (e.g.
                 organic fruit and vegetables; wood/bamboo/rattan furniture)

                 (i)       GVC ‘Familiarization’ Workshop

Issue: SMEs have limited understanding of the demands of being suppliers in GVCs, e.g. scale,
quality, standards. However, a general ‘training workshop’ on this is not likely to be effective for
SMEs that have limited resources and look for usable information. Therefore such workshops
should be directly relevant to the participating SMEs and should focus on those producer groups
that may, over time, have the potential to be suppliers to particular GVCs and that have a multi-
country relevance (i.e. the workshops can be repeated in GMS countries). It would set the stage
for more specific operationally focused topics within the selected GVCs. These workshops have
to be implemented with the participation of relevant global buyers/producers, build on work of
existing donors, in partnership with GMS BF and domestic business associations.

Initiative: This workshop would explain in operationally relevant terms what it takes to become
and stay a supplier in the given GVC; implications for the SMEs individually and as a group.

Given the scale needs of buyers, this type of workshop can help reinforce the need for
cooperation among SMEs (e.g. similar to UNIDO’s ‘cluster building’ workshops). In order to be
effective and credible, this workshop should be conducted jointly with global buyers/producers as
the primary ‘resource people’, e.g. Carrefour on fresh fruit and vegetables GVC; IKEA on wood
furniture; and with credible local industry association. GMS Business Forum can be a general
partner, given its subregion-wide role. The workshop should also involve other donors with
experience in the specific GVC.

                (ii)    Workshops on Specific Issues in the selected GVC(s)

Issue: These training workshops follow from and are coordinated with the ‘introductory’
workshop, and address specific topics of particular operational relevance in the selected GVC,
where upgrading of SME knowledge and skills are essential.

Initiative: The topics of each workshop would be determined by the particular critical
‘bottlenecks’ in the specific GVC, in consultation with global buyers/producers in the GVC. For
example, workshops could address issues such as: design, standards and certification, packaging,
shipping and logistics, branding and labeling, channel and distribution. The intent is to repeat
these workshops in the GMS countries, by focusing on GVCs with multi-country/ subregional
relevance; involve global buyers/producers as appropriate; and implement with credible local
industry associations in each country; and in general partnership with the GMS BF. These
workshops should also be implemented in partnership with other donors addressing similar issues
and/or that can contribute, e.g. MPDF, GTZ.
    •   If possible, workshops should be complemented by capacity building for institutions
        working with SMEs in these specific areas.

                (iii)   Establishment of ICT training and resource Centres, with
                        emphasis on Market Information and Communication

Issue: Familiarity with ICT is essential for SME participation in GVCs which are generally
coordinated by such systems (e.g. in agribusiness networks led by global retailers such as
Carrefour; wood furniture networks led by global buyers such as IKEA). They are also important
for linking SMEs to each other (clusters). In general, SMEs in the GMS have limited appreciation
of the role of ICT; and often face significant constraints on accessing information. However,

SMEs do not need just to access general information; they need information that addresses
specific needs they have, e.g. potential buyers for their products.

Initiative: Establish a market information and communication training program, and related
information support system for SMEs on particular GVCs, e.g. e-business requirements of
organic fruit and vegetable GVC. Instead of traditional IT training courses, it may be most
effective to establish/utilize an enterprise/institution as an ‘information intermediary’ that offers
integrated IT services for SMEs in particular GVCs in specified locations, including outside
capital cities. Such an institution’s products would include: hosting ICT-related training facilities
and programmes focused on the selected GVC; information and related advisory services with
respect to the given GVC. The host agencies could include provincial Chambers of Commerce;
and the GMS BF could play an overall supporting/coordinating role.
    •   This initiative could build on the experience of UNIDO’s BISnet and “One-Stop-Shop”
        (OSS) which have been implemented in a number of countries, including Sri Lanka,
        Pakistan, and in progress in China.

                 (iv)    Building SME Supplier Clusters Across Borders

Issue: It is too costly, time consuming, and risky for global buyers to deal individually with many
small suppliers. They prefer to deal with a small number of core suppliers. Therefore an
important challenge for SMEs is cooperation—the formation of alliances, groups or clusters—to
reduce the transaction costs of global buyers/producers, and for collective efficiency. Cluster
development is primarily a domestic issues, involving the cooperation of groups of domestic
SMEs. However, the preparation of a number of ‘economic/industrial estates’ in border areas
provides potential opportunities for ‘cross border cluster development.

Initiative: There are a number of ‘joint economic zones/industrial estates’ in preparation or
discussion involving key border points in the GMS, e.g. Thailand/Myanmar, Thailand/Lao PDR,
Viet Nam/Cambodia. These may be approached, from the outset, as supporting a cross-border
cluster of suppliers for particular GVCs, e.g. auto parts, garments. This can help enhance the
attractiveness of the GMS to foreign investors in terms of a ‘single subregional production base’.
This initiative would require close cooperation among the relevant GMS governments in creating
‘cross-border economic zones’ or linkages—in terms of coordinating/harmonizing rules,
procedures, regulations in the context of specific GVCs .

                (v)     Building Vertical Linkages in Selected GVCs

Issue: Building vertical linkages are the basic objective of GVC-related initiatives aimed at
linking domestic SME producers to global buyers/suppliers. In many GVCs these vertical
relationships are the key mechanisms through with SMEs learn about changing market
requirements, i.e. through which GVC-related strategic BDS are delivered.

Initiative: Build on existing experience with GMS ‘business matchmaking’ and ‘trade fairs’ to
implement such ‘matching/fairs’ for specific GVCs of subregional interest. This may be linked to
‘GMS familiarization tours’ by global buyers and the ‘building SME supplier clusters’. These
should be implemented as joint public-private initiatives, co-sponsored by key multilateral and
bilateral donors, and possibly jointly with the GMS BF given it subregion-wide reach.

                (vi)    Subregional Cooperation in Certification/Standards

Issue: Access to global markets through GVCs depends increasingly on credible certification.
Global buyers increasingly look to work only with certified companies, e.g. as an indication that
minimum required capabilities are present. Where testing and inspection are not by the GVC
buyer, suppliers must be able to prove the reliability of their inspection procedures and test data,
and conformity with international standards.

Concept: For particular GVCs, this may take the form of GMS Government-sponsored
strengthening or creation of certification bodies in selected GMS countries; or support for the
process of certification by an independent body (e.g. ILO certification of Cambodian garment
manufacturers). Given resource and technical constraints on some GMS countries, such
certification bodies could be established in selected countries but with a subregional mandate.
Support for certification for SMEs can form part of an industrial promotion strategy.