GLOBAL VALUE CHAIN

Amir Ridwan bin Idris

Department of Economic, Faculty of Economics and Management Sciences,
International Islamic University Malaysia, Kuala Lumpur, Malaysia

Muhammad Husain Momand

Department of Economic, Faculty of Economics and Management Sciences,
International Islamic University Malaysia, Kuala Lumpur, Malaysia

Syed Hadi bin Syed Othman

Department of Economic, Faculty of Economics and Management Sciences,
International Islamic University Malaysia, Kuala Lumpur, Malaysia

Syed Mohamad Bukhari bin Syed Bakeri

Department of Economic, Faculty of Economics and Management Sciences,
International Islamic University Malaysia, Kuala Lumpur, Malaysia

Introduction

Trading is a part of civilization regardless the methods used. Trading define as the

transfer of goods or services from one person or entity to another, often in exchange for money

although during ancient time barter system was used. As time passed, the method of trade

started to change as the globalization arise. Todays, trades become diplomatic as the import

and export emerges.

International trades give tons of benefits and the major is expanded the domestic

market. Trade allows any surplus of goods and services in the country exported into global

markets. Global markets help countries and firms interacted among them lead to industry

growth. Global markets also give the firms gaining more profit and the countries to increase

their income.
 Trade liberalization give a lot benefits including contribute to the revolution of

production process. Production process is one of the element firms or countries must excel to

cope with liberalization of trade. Production process can start from simplest to the most

complex which including various and sophisticated level of production can be labor or capital

extensive. Trade liberalization give the opportunity firms outsourcing for better production.

The new study of production introduces global value chain (GVC) as alternative to cope with

trade liberalization in order to success in business.

GVC is alternative in minimizing the cost and maximizing the efficiency also

productivity in production. GVC is a sophisticated process including various production stages

in different countries. This paper aims to analyze the GVC in term of the concept, thus examine

the pros and cons from its implementation.

Definition

GVC is recognized as Global Value Chain. GVC is a production process being

fragmented to multiple countries at different production’s stages. OECD define “GVC where

the different stages of the production process are located across different countries”. Each stage

of GVC has value added and a product can be fragmented up to hundred or thousand parts

separately and each can be produce in multiple countries. The process can also consist of

corporate services, R&D, input, assembly, distribution sales and services. This concept derived

from the concept of value chain by Michael Porter in 1985 that focusing on domestic

production only. Gereffi in his study is triggered to expand the areas of study from local

production to global due to liberalization of trade making outsourcing or perhaps more

sophisticated and complex process (GVC) appear. GVC also known in different terms

including the ‘global supply chain’, ‘international production networks’ and ‘offshoring’.

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History

As discuss before, GVC appear only in 1990s introduced by Gereffi. However, global

production has existed a few centuries before although it not as complex as GVC. If we look

at the meaning of GVS, it possible to relate that it exists before the term exist. During 17th and

18th century, British and Dutch were established international firm called British East Hindi

Company and Dutch East Company respectively. This firm travelled to various countries

finding resources as industrial ages begin to fulfil demand for domestic industry. They need

resources which only can be find in other countries like in Southern Asian making them

outsource their production process to other countries. Although during this period, it being

called as colonial, but the practices can be related with the meaning of GVC itself.

The development of production continued when in 1926 General Motor (US) build an

assembly factory in Indonesia. After that in 1960s few Multinational Companies(MNCs) build

assembly plants in Malaysia such Ford, Volvo, Mitsubishi, Mazda, Ford and more.

The first theory of the production came from Hopkins and Wallerstein in 1977 on

“Commodity chain” evolve to value chain by Michel Porter in 1985. After a few years, Garry

Gereffi introduce the Global Commodity Chain and early 2000s the theory of GVC emerges.

GVC can be done in few methods including selling, outsourcing, Foreign Direct Investment

(FDI), Joint Venture (JV), Merger & Acquisition (M&A) and etc.

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Types of Governance for Global Value Chain

Source: Gereffi (2013)

There are five major governances in GVC describe by Geriffi such Market, Modular,

Relational, Captive and Hierarchy. These governances describe the GVC operating method in

providing vast and complex production process. Todays, MNCs practices have changes by

outsourcing many activities also develop strategic alliance with competitor. So, governance

become less vertically integrated where the supply chain of a company is owned by that

company become more network-oriented.

1. Market

In this structure firms and individuals will act as buyer and seller in engaging to

exchange goods and services for money. Their interaction is only little and not extensively

making them independently operate. Price become the central mechanism for governance

as they negotiate based on their personal interest also not related each other except as buyer

and seller. This situation happens such trader buys product at the farm gate or in a wholesale

market and either sells it in the local market or exports it. The GVC in “market” can be

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define which producer in country A buy input in country B at open market. They can choose

any seller that can fulfil their objective without restricted to specific sellers.

2. Modular

This governance’s type describe that the key supplier will appointed by producer. In

this value chain, key supplier will make products based on customer/producer’s

specification and this key supplier will have another small supplier to support them. The

key supplier will take full responsibility on their machinery and technology. This type of

concept normally can be find in Original Equipment Manufacturing (OEM).

3. Relational

Relational will have mutual dependence between producer and supplier through

reputation, social and spatial proximity, family and ethnic ties, and others. The producer

and supplier have strong relationship, and this may influence the decision making.

Furthermore, this type of governance is difficult and time-consuming to be created because

need deep understanding between supplier and producer. This model can be seen in Chinese

companies where they are outsourcing in multiple and prioritize local Chinese company as

their supplier.

4. Captive

This model defines as some small suppliers has tendency to depend on larger dominant

buyers or producer. This usually happened in monopsony market where single buyer have

control over price of supplier where they have little or may not have other alternatives. This

model explain why supplier have small of tasks, significant switching costs, and

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 dependence on the processors’ provision of resources and market access. This happen in

least develop countries which MNCs push the local supplier to serve also influence those

firm in their decision.

5. Hierarchy

Hierarchy in this model mean a system in which production stages are ranked according

to relative status or authority. Normally, this model uses vertical integration (i.e.

“transactions" take place inside a single firm) where all the production stages manage by a

firm. The firm will show a dominant form of governance in it managerial control. This type

of administration portrays chains that are described by vertical joining and administrative

control inside an arrangement of lead firms that creates and produce items in-house.

Vertical hierarchy normally being practices by firm to secure their pattern or knowledge on

the product. They will have subsidiaries rather than appoint supplier in producing their

products.

A Case Study: The GVC for The Personal Computer Industry

The history of the personal computer industry can be tracked back to the 1980s where it is

very much based in the US with IBM as the leading company. However, the ensuing years saw the

emergence of Japanese computer makers as well in the 1990s followed by Taiwanese original design

manufacturers from the beginning of 2000s and from there we can already see a very much globalized

value chain in the personal computer (PC) industry. To get an idea of how big the industry is, revenue

in the PC industry worldwide amounted up to US$235 billion in 2005 alone. (Dedrick and Kraemer,

2006).

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 In this section, we would analyze the global value chain (GVC) for the personal computer

(PC) industry which make up as the largest segment in the computer industry (Roy, 2005).The global

value chain for the PC industry can be looked into based on categories such as the platform leaders

companies, the brand-carrying lead firms, the Original Design Manufacturers (ODM) and Contract

Manufacturers (CM), the components and parts makers, the distributors and also the retailers. Each of

these firms are located all over the world.

1) Platform leader

In the 1970s when IBM started creating their personal computers, they decided to outsource

two critical components of the PC to other companies in the US. Intel was tasked to build the computer

processer while Microsoft developed the operating systems. However, both Intel and Microsoft made

their designs modular and ended up starting to sell them to a number of different vendors (Roy, 2005).

This marked the beginning of a very unique relationship between firms in the PC value chain whereby

Intel and Microsoft control the position as the platform leader in the whole industry such that Dedrick

and Kraemer (2008) mentions them as the main controllers of the ‘Global architectural standards’ in

the PC industry. We can see that almost all PCs that there are there today uses Microsoft products as

their operating system and employs Intel’s microprocessor chips regardless of what their brand are.

Thus, Microsoft and Intel are both effectively controlling the direction of the growth in the

PC market as all the PC makers have to ensure that their products are compatible with the system

platforms designed by them. As such, access to information of their future technology roadmap are

very much critical for the PC firms (Kawakami, 2011). However, the strong position held by these

platform leaders allow them to also hold a very powerful market power. According to Dedrick and

Kraemer (2008), Microsoft and Intel account for an ever-greater share of the total cost of a PC as

efficiency in the industry improves. In another study done by them, it is indeed found that the highest

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profit margins in the production of notebooks are goes to these platform leaders with both Microsoft

and Intel earning supernormal operating margins which is 36% and 31% each. (Dedrick, Kraemer and

Linden, n.d.)

2) Brand-Carrying Lead Firms

The lead firms in this industry’s GVC would be the PC makers or also called PC vendors.

Examples of these are American firms such as Dell and HP and Japanese firms such as Toshiba.

Although these companies are based mostly in the US and in Japan, they have presence everywhere

all over the world.

These lead firms are the “System integrators” who puts together the overall design for the

PCs and places the orders for production over to the CMs or ODMs while outsourcing for the

component and also in terms of logistics and delivery (Dedrick and Kraemer, 2008). The PC makers

usually specialize in communicating and understanding the end users to identify new product markets

so that the newer and upcoming system designs are tapping into new technologies which is desired by

those target markets. For example, when the PC makers identified that there are a lot of end users who

want to have access to the internet without having to plug in some wires, then they would incorporate

this into their own product roadmaps as a signal to the component suppliers of “where the firm is

headed, the target markets and expected volumes, and the price/performance of components needed to

succeed” as mentioned by Dedrick and Kraemer (2008).

3) Original Design Manufacturers (ODM) and Contract Manufacturers (CM)

The rise of these ODMs originated in the 1990s when the lead firms started outsourcing PC

production assembly to Taiwanese companies such as Quanta and Compal. However, beginning from

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2001, the Taiwanese government allowed these companies to set up factories in China due to the rising

labor and land costs in Taiwan, and within seven years, it was already almost a total relocation to China

in 2008. These relocations together with consolidation between the Taiwanese ODMs themselves gave

them greater efficiencies and allowed them to increase their total production and also control share of

the world market as shown in the following graph. (Kawakami, 2011)

These Taiwanese companies are called Original Design Manufacturers because since the

1990s, they started to slowly help out the lead firms in term of designing and developing the PC itself

instead of just assembling it up together according to instructions. Dedrick and Kraemer (2008)

described them as specializing in ‘applied R&D’, ‘mature product development’ and also ‘sustaining

engineering’. However, despite their contribution to the development process of the PCs that they

manufacture, contract manufacturing is very competitive and lead firms can do change their suppliers

based on their projects. In a study, the average gross margin of four ODMs namely Compal, Inventec,

Quanta, and Wistron was 6.1 percent and the average operating margin only 2.4 percent in 2004 and

2005. (Dedrick, Kraemer and Linden, n.d.)

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4) Components and parts

The other key components of PCs are created all over the world. There are several thousand

suppliers of parts and components, most of which are small and medium-sized firms, but a few very

large firms also exist in each category. The key manufacturers for microprocessors, graphics, memory,

hard drives, networking, and software are mostly based in the US. For the LCDs, memory, hard drives,

batteries, the manufacturers are located in Japan while the manufacturers of LCDs, memory, optical

drives, power supply and various peripherals are in Taiwan. The table below shows an example of the

breakdown of value received by component manufacturers.

5) Logistic providers, distributors and retailers

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 Distribution and retail sector is mostly decentralized and local in each country, although

there are a few large distributors. For distribution, among the companies which operate internationally

are Ingram Micro, Tech Data and Arrow Electronics. However, the distributors do not actually own a

big part in the value of the whole GVC since it uses low-margin and high-turnover business models.

For retail, there are also big retailers such as Best Buy, Circuit City and Staples but even within the

sector there is a very fierce competition. The same picture as in the distribution sector applies and in

fact sometimes, the margins are retained by the lead firms themselves when they are able to sell directly

to end users as what is done by Apple with its Apple stores and website. (Dedrick, Kraemer and Linden,

n.d.)

Advantages of GVC

Some developing countries have fully embarked on the GVC revolution, but they still

face challenges in aligning GVCs with their national development strategies. The global value

chains (GVCs), the international fragmentation of production, have created jobs and economic

growth in devolving countries. GVCs are a powerful driver of productivity growth, job

creation, and increased living standards.

Developing countries have been increasing their participation in global trade of

intermediate goods, a widely used indication of GVC participation. If we look at trade in parts

and components (P&C), a subset of intermediate goods trade, we see that non-OECD countries

have experienced an increase in their share of this trade gradually over the last 20 years (Figure

1). The share of BRIICS countries in the exports of P&C have increased from 0.78% to 14%

in between 1990 and 2010.

Non-OECD, non-BRIICS, and Asia has more than doubled their share in the same 20

years period, from 4.6% to over 9%. However, OECD countries’ share decreased from over

92% of all exports of P&C to 70% by 2010. While the export story is well known, the import

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side is also important, it indicates participation GVC. For most of these economies, their share

of imported P&C trade has increased as well. Here the share of OECD economies fell to a

similar extent as exports (from 86% to 64%) while the share of BRIICS and rest of Asia

increased significantly.

Figure 1. (a) Share of Parts and Components Exports

Source: UN COMTRADE.

This increasing participation in GVC has activity benefited the domestic economy. This

trade and investment and knowledge flows to the developing countries that support GVCs can

provide mechanisms for innovation, rapid learning, and industrial upgrading, which created

better jobs in those countries’ (Lall, 2000).

(Polaski, 2004) argues that in order to capture more and greater gains from international trade,

countries are trying to enhance their value-added position as they expand their industrialization,

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but usually face difficulty in upgrading. The newly industrializing Asian countries have had

success in upgrading, however Latin America and Sub-Saharan Africa have had faced

difficulty (e.g., Mexico has been able to expand exports but only with a small amount of value-

added). The raise of China has threatened developing countries even outside of Asia that have

had trouble in upgrading. As China participates even more fully in the global economy,

developing countries will not be able to compete with China’s abundant supply of cheap labor

and developed infrastructure and will therefore be adversely affected.

More than 60% of world trade is trade in semi-finished goods and services used at

different stages of manufacturing process of goods and services for final use. This

Fragmentation of manufacturing processes and spread of their productions in different

countries have resulted in emergence of ‘limitless’ production systems. These may be

consecutive chains or complex networks, they may have either global or regional scope and

they are usually called global production systems (GPSs). Many of developing economies has

actively participated in GPSs. For example, the developing countries shares in global trade in

GPSs has increased to 30% in 2000 from 20% in 1990. This share increased to 40% in 2014,

but most of poor developing countries are still struggling to get access to GPSs in different

areas not only for exports of natural resources. Regional links between production systems

usually have been more significant than international, particularly in North America, Europe

and Eastern and South-Eastern Asia. This Regional production systems are very significant

especially for developing countries but relatively it is less developed in countries with transition

economy, Latin America and Africa (Khmara, Grinenko , & Koroied, 2017).

There is also a positive correlation between participation in GPSs and GDP per capita

dynamics. Recent study shows that developing countries are benefited from participating in

GPSs, since in the countries where participation in GPSs increases the most, GDP per capita

dynamics is approximately by 2 percentage points bigger than average. Besides that,

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participation in GPSs, has created more jobs in developing counties and increase the of

employment.

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Shortcomings of GVC

As we observe, GVC has been the key feature in current globalization strategy in favor

for developing countries to engage in global market offering a wide range of economic benefits

such as productivity enhancement and diversification of exports.

However, we must look into the effects of such engagement in GVC especially in term

of industrial development, technological transfer and employment generated from GVC

participation across developing countries like Asia, Africa, and Middle East. These are the

critical questions that need to be understood in order to know either developing countries or

developed countries that benefits the most and does it really ‘upgrading’ socio-economy. First,

we need to understand that public policy by the government play a significant role in promoting

a good outcome of such integration. Yet, policy can only effect GVC participation to a certain

extent due to the geographical aspect and lobby or even threats by multinational corporations

(MNCs) for their favor. If we look from another side, government policies are actually

promoting GVC as an international production process platform when MNCs who actually

controls the supply chains managements. Without MNCs, GVC might not be realistic as

government tend to favor protectionist strategies to protect domestic market. From this

perspective, we know that GVC gives certain countries and MNCs higher overall gains

obtained.

The first obvious disadvantage experience by developing countries is very low value

added obtain from the GVC participations. GVC has been criticized from the results of low

value creation and productivity experienced in many Asians countries rather than promoting

bigger share of domestic value added in exports. Many sites from the mainstream journal and

report has shown a devastating result regarding GVC which highlights the low share of value

added as for assembly production process, packaging and after sales service. For example, the

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iPad case by Kraemer et al., 2011) where only less than 5% of the sale values of iPad

contributed to the China and Taiwan (Table 1).

Table 1

China is still in good condition as their public policies has led them to better GVC

upgrading where they move from specializing assemblers to smartphone producers. However,

we may see that GVC are relatively complementary rather than competitive in nature for the

rest of developing countries. Most of developing countries are still in simple assembly

production process rather than handling sophisticated intermediates process and boosting

productivity through solid R&D. This phenomenon definitely does not give a significant

positive outcome to the domestic industrial development as only low-end process and inputs

were to be given to developing countries.

Moreover, as GVC typically involve the movement of intermediate goods within the

global network of MNCs, they try to strategies their business plan where they outsource their

low-cost production process to a labor incentive nation. In Table 2 by ESCAP, we may obverse

that MNCs tend to allocate their final products, distribution and end use to developing

countries. Yes, one may say that MNCs through GVC will promote higher employment and

curb unemployment problem in developing countries, but does it give greater benefit for the

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workers in term of salary? This kind of business plan will benefit the MNCs more as they

employ many cheap labors in order to cut cost and fully squeeze them till their last sweat while

proudly say that GVC boost employment in developing countries. Given very low level of

R&D and outdated technological process, we may acknowledge that low end supply chain may

not give a relatively adequate income level as MNCs employs many cheap and unskilled labor

in most of developing countries. While, MNCs allocates their high value production process in

their homeland like R&D, marketing and finance division in high income countries as it

provides redundant high skilled and professional workers. Hence this will ill further the growth

on wage inequality. Besides that, MNCs are smart, they allocate such low-end process in

developing countries in a way that they already have a platform to flood their products in

developing countries at the same time developed countries can import goods with relatively

cheaper price.

Table 2

This give another negative consequence with regard to GVC for developing countries

where there is no solid positive spillover on backward and forward linkages. Most of the GVC

cases across developing countries are either they source foreign inputs for export production

or provide inputs to foreign partners for their export production. Studies has shown that a

country that primarily assembles products into final goods and then exports them will tend to

have a high backward but a low forward linkage participation as they produce all inputs

domestically rather than outsourcing internationally. On the other hand, a country that

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primarily supplies intermediate goods to an assembler abroad will typically show a high

forward linkages participation, but a low backward participation measure. This difference

suggests that GVC participation across developing countries has fail to enhance backward

linkages as well as fail to boost domestic economic development as promised by MNCs.

Conclusion

In conclusion, GVC might not the as beautiful as MNCs has promised. There are a lot

more than just global value chain and moving goods and services across the globe. Many voices

need to be heard for the true realization of GVC and how does it impact the citizens of

developing countries. Do MNCs through GVC trying to promote such ideology where

developing countries work for developed countries. There is a need to analysis deeper on

externalities which may harm the economies while provide with preventive measure to solve

those issues.

However, we cannot deny its contribution in improving the development and welfare

of the nation. GVC contribute a lot especially in Foreign Direct Investment (FDI) as some

countries depend it as an engine of growth and many benefited from it. This is why

understanding GVC are very crucial so that we are aware current strategies used by developed

countries, so the developing countries can adjust their policies in order to gain from GVC in

areas of employment creation, technological transfer and industrial development.

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