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Supply Chain Perspectives and Issues: A Literature Review

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A literature reviw on various topics related to supply chains in the economics literature such as Supply chains in the business literature, offshoring, risk in supply chains, SMEs, services, value-added and sustainability. It also gives an overview on recent business models, trade policy and finance.

0389377892879


ISBN 9789287038937




Supply Chain Perspectives
and Issues
A Literature Review


Albert Park
Gaurav Nayyar
Patrick Low




Disclaimer


Opinions expressed in this publication and any errors or omissions therein
are the responsibility of the authors concerned. Opinions expressed by
the authors are their own personal opinions and should not in any way be
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(FGI) and the World Trade Organization (WTO) to verify the information
contained in this publication. However this published material is distributed
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© 2013 by Fung Global Institute and World Trade Organization.


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with the written permission of the Fung Global Institute and the WTO Publications Manager.


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3Supply Chain Perspectives and Issues


Foreward ................................................................................................... 10


Introduction .............................................................................................. 12


Part I. Supply Chain Perspectives ............................................................ 26


1. Supply chains in the economics literature ........................................ 27


Abstract................................................................................................................. 27


1.1 The evolution of global supply chains ................................................. 28


1.1.1 A brief history and some useful definitions ........................... 28


1.1.2 Conceptual underpinnings .......................................................... 29


1.1.3 Some salient features .................................................................... 31


1.2 The distribution of income across countries ...................................... 32


1.2.1 Value-added along a supply chain: manufacturing


and services activities .................................................................. 32


1.2.2 Upgrading ........................................................................................ 32


1.2.3 New entrants ................................................................................... 33


1.3 The distribution of income, jobs and welfare within countries ...... 34


1.3.1 Advanced economies .................................................................... 34


1.3.2 Developing economies .................................................................. 36


1.4 The role of trade policy ............................................................................ 37


1.5 Future directions ........................................................................................ 37


1.6 Endnotes ...................................................................................................... 38


1.7 References ................................................................................................... 38


2. Supply chains in the business literature ........................................... 41


Abstract................................................................................................................. 41


2.1 Defining supply chains ............................................................................. 41


2.1.1 The blind men and the elephant ................................................. 41


2.1.2 The firm perspective ..................................................................... 45


2.1.3 Conceptualising supply chains ................................................... 45


2.2 Supply chain management ...................................................................... 47


2.2.1 A brief history ................................................................................. 47


2.2.2 The supply chain management framework .............................. 49


2.3 Future directions ........................................................................................ 51


2.4 References .................................................................................................. 52


Contents




4 Supply Chain Perspectives and Issues


Part II. Supply Chain Issues..................................................................... 54


3. Supply chains and offshoring ............................................................ 55


Abstract................................................................................................................. 55


3.1 A brief history of offshoring and outsourcing .................................... 55


3.1.1 Definitions ........................................................................................ 55


3.1.2 Historical development ................................................................. 57


3.2 For the business practitioner .................................................................. 58


3.2.1 Disappointment ............................................................................... 58


3.2.2 Offshoring and outsourcing reconsidered .............................. 59


3.3 For the policy maker ................................................................................. 62


3.3.1 Economic implications of offshoring ......................................... 62


3.3.2 Empirical evidence for developed countries .......................... 65


3.3.3 Empirical evidence for developing countries ........................ 69


3.4 Future directions ........................................................................................ 70


3.5 Endnotes ...................................................................................................... 72


3.6 References ................................................................................................... 72


4. Supply chains, upgrading and development ............................................ 79


Abstract................................................................................................................. 79


4.1 Defining upgrading and development .................................................. 79


4.1.1 Development contexts ................................................................... 79


4.1.2 Defining upgrading ........................................................................ 80


4.1.3 Typology of upgrading ................................................................. 81


4.2 Global value chains ................................................................................... 82


4.2.1 Definition and history ................................................................... 82


4.2.2 Value chain governance ............................................................... 82


4.2.3 Typology of governance ............................................................... 83


4.2.4 Governance and upgrading trajectories .................................. 84


4.2.5 The global value chain framework............................................. 86


4.3 Global production networks .................................................................... 87


4.3.1 Definition and history ................................................................... 87


4.3.2 The global production network framework ............................. 88




5Supply Chain Perspectives and Issues


4.4 Supply chains and rural development ................................................. 90


4.4.1 Rural development ......................................................................... 90


4.4.2 Alternative food networks ............................................................ 90


4.4.3 Short food supply chains ............................................................. 91


4.5 Empirical studies ....................................................................................... 91


4.6 Future directions ........................................................................................ 93


4.7 References ................................................................................................... 93


5. Supply chains and risk ....................................................................... 97


Abstract................................................................................................................. 97


5.1 Defining risk ................................................................................................ 97


5.2 The supply chain risk management framework ................................. 98


5.2.1 Risk identification .......................................................................... 99


5.2.2 Risk assessment ...........................................................................102


5.2.3 Risk mitigation ..............................................................................103


5.3 Empirical studies .....................................................................................108


5.4 Future directions ......................................................................................109


5.5 References .................................................................................................110


6. Supply chains and SMEs .................................................................. 113


Abstract...............................................................................................................113


6.1 Defining SMEs ...........................................................................................113


6.2 The significance of SMEs .......................................................................114


6.2.1 SMEs as the backbone of the economy ..................................115


6.2.2 SMEs as development actors ....................................................115


6.2.3 SMEs as supply chain actors ....................................................115


6.3 The competitive environment for SMEs ..............................................116


6.3.1 Challenges .....................................................................................116


6.3.2 Advantages ....................................................................................116


6.4 SMEs and supply chain management .................................................117


6.4.1 SCM as the solution .....................................................................117


6.4.2 SCM as the problem .....................................................................118


6.4.3 Reconciliation: developing SCM for SMEs .............................119


6.5 Empirical studies .....................................................................................121


6.6 Future directions ......................................................................................122


6.7 References .................................................................................................122




6 Supply Chain Perspectives and Issues


7. Supply chains and services ............................................................. 125


Abstract...............................................................................................................125


7.1 The nature and role of services in production and trade ..............125


7.2 The role of services along global supply chains .............................127


7.2.1 The consequences of complementary markets ....................127


7.2.2 Identifying services along the supply chain .........................128


7.2.3 The notion of “servicification” ....................................................129


7.2.4 Services, networks and value analysis ...................................131


7.2.5 The OECD new sources of growth projection .......................131


7.3 Data challenges ........................................................................................132


7.3.1 The implications of the “smile curve” for services in global


value chains ....................................................................................132


7.3.2 The imperfect statistical identification of services on


supply chains ................................................................................133


7.3.3 Definitional redundancy further complicates analysis ........134


7.4 Future directions ......................................................................................134


7.5 Endnotes ....................................................................................................135


7.6 References .................................................................................................135


8. Supply chains and trade in value-added ......................................... 139


Abstract...............................................................................................................139


8.1 Gross trade flows and the problem of double counting .................139


8.2 Measuring trade in global supply chains ..........................................140


8.3 The import content of exports ..............................................................141


8.3.1 Conceptual underpinnings ........................................................141


8.3.2 Empirical evidence ......................................................................142


8.3.3 Limitations .....................................................................................142


8.4 Beyond the import content of exports ................................................143


8.4.1 Conceptual underpinnings ........................................................143


8.4.2 Empirical evidence ......................................................................144


8.5 Future research ........................................................................................146


8.6 Endnote ......................................................................................................147


8.7 References .................................................................................................147




7Supply Chain Perspectives and Issues


9. Supply chains and business models ................................................ 149


Abstract...............................................................................................................149


9.1 Historical development ..........................................................................149


9.2 Definitions and conceptualisations .....................................................151


9.3 Supply chain business models .............................................................155


9.3.1 The business and engineering approach ...............................155


9.3.2 Design tools ...................................................................................156


9.3.3 The agile supply chain ................................................................160


9.3.4 Other best practices ....................................................................162


9.4 Empirical studies .....................................................................................162


9.5 Future directions ......................................................................................163


9.6 References .................................................................................................164


10. Supply chains and sustainability ..................................................... 167


Abstract .............................................................................................................167


10.1 The rapid rise of sustainability ............................................................167


10.2 Key definitions and concepts ...............................................................168


10.2.1 Defining sustainability ...............................................................168


10.2.2 Corporate social responsibility ...............................................169


10.2.3 The triple bottom line .................................................................169


10.3 The sustainable supply chain management framework .................170


10.4 Other frameworks ....................................................................................172


10.4.1 Reverse logistics .........................................................................173


10.4.2 Reverse/closed-loop supply chains .......................................173


10.4.3 Product stewardship ..................................................................173


10.4.4 Green/environmental supply chain management ...............173


10.4.5 Industrial ecology .......................................................................175


10.4.6 Lifecycle management ...............................................................176


10.4.7 Integrated chain management .................................................177


10.5 Empirical studies .....................................................................................178


10.6 Future directions ......................................................................................179


10.7 References .................................................................................................180




8 Supply Chain Perspectives and Issues


11. Supply chains and trade policy ....................................................... 183


Abstract...............................................................................................................183


11.1 The evolution of supply chains and trade policy .............................183


11.2 Trade policy barriers and trade flows in GSCs:


a magnification effect ..............................................................................185


11.3 GSCs and the demand for deep integration ......................................186


11.4 The role of preferential trade agreements .........................................187


11.4.1 GSCs have facilitated the proliferation of deep PTAs ........187


11.4.2 Can deep PTAs facilitate the further growth of GSCs? ......188


11.5 Going forward: GSCs and the multilateral trading system .............190


11.6 Endnotes ....................................................................................................191


11.7 References .................................................................................................192


12. Supply chains and trade finance ..................................................... 195


Abstract...............................................................................................................195


12.1 Definitions and concepts .......................................................................195


12.1.1 Trade finance ...............................................................................195


12.1.2 Trade credit ..................................................................................196


12.1.3 Credit chains ................................................................................197


12.2 Research areas .........................................................................................198


12.2.1 Trade finance and the financial crisis ...................................199


12.2.2 Trade finance and operations research ................................201


12.2.3 Trade finance and development..............................................203


12.3 Future directions ......................................................................................203


12.4 References .................................................................................................204


Consolidated Bibliography .................................................................... 207




9Supply Chain Perspectives and Issues


Acknowledgements


Thanks are owed to the many people who have enabled the production of this publication.
Comments and suggestions on the manuscript were kindly provided by Masato Abe,
Richard Baldwin, Hubert Escaith, Andrew Sheng, Timothy Sturgeon, Julia Tijaja, and
Adrian Wood.


Production was coordinated by Lyn Ng, Esther Tsui and Rocky Tung of the Fung Global
Institute. Further thanks are owed to Xiao Geng, Louis Kuijs, Hau Lee, and Xiaoru Wang
for guidance during the planning stages of this volume. We would also like to thank Martin
Evan-Jones for his excellent editing work.


This publication was made possible under the institutional support of the Fung Global
Institute (FGI) and the World Trade Organization (WTO).


About the Authors


Albert Park is a Research Analyst, Global Supply Chains at FGI. Gaurav Nayyar is an
Economist, Economic Research and Statistics Division at the WTO. Patrick Low is both
Chief Economist at the WTO and Senior Fellow at FGI.




10 Supply Chain Perspectives and Issues


Foreward


Global value chains (GVCs) have been a feature of the international economic
architecture for many years, but scholarly interest in the phenomenon is more recent.
Today that interest is intense, emanating from an array of academic disciplines as well
as from the policy world. This volume, jointly produced by the Fung Global Institute and
the World Trade Organization, is an attempt to capture the core features and themes of
the exploding literature on GVCs. Our review of the literature demonstrates the eclectic
nature of existing work on GVCs, which in turn is a reflection of the complex character
of these international production arrangements. Apart from seeking to capture the
different strands of the literature, it is our hope that the volume may contribute to
a deeper mutual understanding among different disciplinary perspectives, including
economic, political economy, business and management, development, social, and
public policy analyses.


At its simplest, the GVC story is about the symbiotic relationship between imports and
exports, and the key role of foreign investment in internationalised production. The political
economy of trade policy is very important in a world of GVCs, since the preponderance
of intermediate products in total trade is testimony to the invalidity of the old mercantilist
notion that exports are virtuous and imports much less so. The interdependency between
imports and exports along supply chains leads to the conclusion that if we really want
to understand trade and production linkages among nations, we need to look at how
much value is added in different production locations instead of merely measuring trade
in gross terms. Governments and international agencies are only just beginning to get to
grips with the challenges of measuring trade in value-added terms.


Beyond the basic trade and investment relationships, however, there exists a rich, multi-
faceted reality that calls for deeper study. International supply chains only became a
viable means of organising production when advances in information and transport
technology, backed by supportive policies, made it possible to extend production
processes across countries and around the globe. Producers and buyers were able
to pursue low-cost and other market-related advantages through optimal locational
decisions. The resulting structures have led to complex inter-linkages among numerous
goods and services markets and the creation of networks that can only be understood
in their entirety. This is why a multi-disciplinary approach to the study of GVCs is
indispensable. It is also why both endogenous and exogenous change can be sudden
and have far-reaching effects, and why the interface of GVCs with policy needs to be
analysed holistically.




11Supply Chain Perspectives and Issues


We would argue that the difference between GVCs and the traditional international
trade and investment linkages of four or five decades ago are more than a matter of
degree. They reflect a fundamental shift in economic, political and social relationships
among nations. GVCs are networks that link intricately with other networks, such as
finance, logistics, government services and knowledge and people that form a complex
adaptive global system which transcends geography and legal jurisdictions. They raise
unprecedented challenges for policymakers, academics and businessmen alike.


If we fail to appreciate the complexities of this constantly changing world, or choose to
ignore them, it will be to our cost. It is our hope that this volume will lessen the likelihood
of neglect by raising awareness and deepening understanding.


Andrew Sheng


President
Fung Global Institute
Hong Kong




12 Supply Chain Perspectives and Issues


Preliminaries


A comprehensive review of the literature on global value chains (GVCs) is an ambitious
undertaking for at least three reasons. First, the literature is voluminous and the risk
of omitting key references is high. Second, the proper study of GVCs requires a multi-
disciplinary approach, with literature originating from a wide variety of disciplines. This
requires an understanding of different intellectual and conceptual approaches. Third,
with such a high level of interest in GVCs, the field is a moving target, and new work in the
next months and years will warrant an update.


We have done our best to address the first two of these challenges. Readers are welcome
to inform us of any work they feel is missing from the review and this will be rectified, as
appropriate, in subsequent revisions.


Internationally dispersed production networks have grown in prominence over recent
decades. In some measure, they could be said to reflect an intensification of long-
established trade and investment links among nations. However, we would argue that they
are qualitatively different from traditional exchange relationships because they represent
much more than the old model of trade, where countries typically exchanged finished
products that were mostly produced within their own territories.


Production sharing entails a different kind of linkage, where successive stages of the
production process are located in different countries. These international production
chains are complex. They combine capital, labour, goods, and services through logistics,
finance, technology, management structures and government policy in a continuum that
produces output for consumers.


But the story does not always end there. Even after the sale of a product to the consumer,
the production chain may continue in different forms. For some products, it may be a
matter of after-sales service and upgrading. For others, it could be the addition of new
applications on an electronic device. The characteristics of a production chain also vary
depending on how far back we go in tracing inputs, how far forward we go in tracing
consumption, and how far sideways we go in tracing inputs into the selected supply chain.


These production arrangements are referred to by different names. Relevant terminology
includes production sharing, fragmented production, vertical specialisation, trade in tasks,
(global) supply chains, (global) value chains, global production networks, offshoring, and
outsourcing. At a general level, some of these terms might be used inter-changeably, but
many authors have distinguished among them to focus on particular features of joined
up production structures. In this review we have not taken a strong position in adopting
a specific designation because a prevailing consensus on meanings has not emerged in
the literature.


Our literature review has been organised into two main parts. The first part (Chapters
1 and 2) is of a general nature and seeks to identify the defining features of GVCs
through two prisms – those of economics and of business. The economics perspective


Introduction




13Supply Chain Perspectives and Issues


attempts to understand GVCs through trade theory, along with the motivations for
specialisation and production location decisions. Economic analysis is also concerned
with measurement issues, the distributional implications of GVCs and the role of policy.
The focus in the business literature is more concerned with a firm-level perspective.
The body of literature that has emerged under the rubric of supply chain management
looks at varied, operationally relevant subject matter, such as logistics, management
practices and marketing. The two putatively different disciplinary focuses may
emphasise different aspects of GVCs and the world in which they operate, but they
also have a good deal in common.


Although we have not addressed the point explicitly in our review, we have found that
often the economics and business literatures refer to similar concepts or ideas using a
different idiom. When the business literature refers to commoditisation and customisation,
for example, economists are thinking of market segmentation and barriers to entry and
exit. When business management refers to modularisation, economists are thinking about
bundling, complementarity among markets and joint production. Seeking out synergies
between these two strands of literature will enrich the analysis of supply chains.


The second part of our literature review (Chapters 3 to 12) takes up specific issues that
have received particular attention in writings on GVCs. Our treatment of these issues is
eclectic from a disciplinary perspective. The topics covered individually in each of our
chapters include offshoring and outsourcing, upgrading and development, risk, small- and
medium-sized enterprises, services, trade in value-added, business models, sustainability,
trade policy, and trade finance.


We had to exercise our own judgment in how best to slice up the literature for our review
and other choices could have been made. Our selection reflects not only the flow of
the literature, but also in some measure the priority research areas for the Fung Global
Institute in this field.


The review cites almost 400 sources. This is obviously not exhaustive, but we would claim
that our search covers most of the important contributions to the GVC literature in the
areas of most interest to us. We organised the citations by the year of publication, and an
interesting pattern emerged. The GVC literature did not take off until the year 2000. Only
around 15 per cent of our citations appeared before 2000, with over half that number
appearing between 1995 and 2000 (nine per cent). The bulk of the citations used for our
review – 85 per cent – were published between 2000 and the present. We can confidently
say that based on our research, interest in the GVC phenomenon did not take off until
1995, and has picked up pace ever since.


The weight of written contributions from the authors is not equal and this is reflected in
the order in which our names appear. Albert Park was responsible for a large share of
the product. He wrote Chapters 2, 4, 5, 6, 9, 10 and 12. Gaurav Nayyar wrote Chapters 1,
8 and 11. Albert Park and Gaurav Nayyar jointly wrote Chapter 3, and Patrick Low wrote
Chapter 7 and this Introduction.


Economic perspectives on supply chains (Chapter 1)


The economics literature on GVCs emphasises the contribution made by advances in
transport and information technology to the process of globalisation. Business model
innovation and generally supportive government policies towards trade and investment
have also played an important part in enabling and shaping the internationalisation




14 Supply Chain Perspectives and Issues


of production. Economic analysis typically looks at the sources of gains from trade in
explaining the configuration of production across the globe.


Comparative advantage – whether driven by technological differences or by different
factor endowments – remains as relevant today in explaining the gains from trade as
it was before GVCs became a dominant feature of the trade landscape. The same can
be said of intra-industry trade and economies of scale. Economic geography and the
agglomeration effects associated with external economies of scale are clearly relevant to
the configuration of GVCs. Some also point to the more recent heterogeneous firm trade
theory as an additional explanation of the benefits from trade. The fact that economists
reach back to existing theory as the basic explanation for GVCs suggests that they see no
need for a new theoretical framework.


Established trade theory only takes us so far, however, in understanding the multi-
dimensional aspects of contemporary GVCs. While increasing international fragmentation
of production, larger shares of intermediate goods in total trade, and intensified reliance
on services in production and trade – all prominent features of GVC-based production
– may be explained in a general sense by traditional theory, we need to go beyond this
to tease out a complete picture and adequate appreciation of the relevance of policy.
Moreover, it is impossible to ignore the close nexus between trade and investment in
supply chain production, or the fact that products are frequently bundled into single
offerings (sometimes referred to as “tasks”), or that markets are typically complementary
and highly interdependent.


A full appreciation of the GVC phenomenon clearly calls for a multi-disciplinary framework,
which this literature review argues is still very much in the making. It is impossible to avoid
the conclusion that GVCs display network characteristics that weave a web of complex
interactions around production, consumption, multi-tiered input structures, business
processes, support functions, finance, management and policy. This raises many challenges.
Perhaps the most important is to recall that when analysis needs to focus on particular
aspects of GVCs, as it inevitably does, we should not forget the broader causal relationships
that also weigh on outcomes and their consequences.


Some of the economics literature on GVCs is also concerned with distributional questions
– both within and across countries – regarding the attribution of value-added along
value chains. Certain activities are more skill-intensive and technology-dependent,
implying higher returns per unit of production. This is reflected in wage levels. The
issue is important in a geographical as well as an occupational sense, and has spawned
considerable literature on upgrading and ways of acquiring larger shares of value-added,
as will be seen in later chapters of this review. Many factors are in play here, including the
nature of the supply chain in question, and where it begins and ends. Policy choices are a
crucial element in this discussion.


Insights from the business literature (Chapter 2)


The firm-level orientation of the business literature pushes the focus of analysis in
a more operationally relevant direction, where definitional issues that capture the
contrasting characteristics of supply chains are important. In thinking about the
organisational and functional characteristics of joined-up production structures,
distinctions are made between supply chains, value chains, filière, commodity chains
and global production networks.




15Supply Chain Perspectives and Issues


As this genre of literature has progressed, a field of study called supply chain management
(SCM) has emerged. The origins of SCM are eclectic and it is therefore difficult to pin
down precisely an intellectual parentage for this body of analysis. The SCM framework
builds on the distinction between function-orientated and organisation-orientated
directions. The functional orientation is concerned with such matters as purchases and
supply, logistics, transport, marketing and business management. The organisational
orientation is about industrial organisation, supply chain configuration, transactions costs
and system dynamics. This focus emphasises the networked nature of supply chains and
the processes that shape them.


As with much of the analytical work on GVCs in both economics and business analysis,
conceptualisation and theorising has tended to follow business developments and
practices. Theories are more likely to be formed to explain rather than guide business
practice. On the other hand, the formalised nature of conceptual structures can discipline
thinking and offer insights that are not intuitively obvious at first glance. A survey of
articles on supply chains published in 2000 suggests that more than four-fifths of them
were empirical, and that one-third of these were prescriptive in nature. The SCM literature
is still in a formative phase and is continually subject to refinement and consolidation.


Offshoring and outsourcing (Chapter 3)


The fragmentation at the heart of GVC production is a source of contentious debate, as
well as economic gain. Offshoring is an intra-firm process. It refers to the relocation
of part of the production process by the lead firm to a foreign country that does not
involve external contracting or purchasing, although the establishment of a joint venture
might also qualify as offshoring. Outsourcing, on the other hand, occurs when parts of
the production process are no longer undertaken by the lead firm. While offshoring, by
definition, means relocating an activity to a foreign country, outsourcing may occur either
in the country of the lead firm or abroad.


The essential motivation for both offshoring and outsourcing is cost reduction. Cost
structures and other factors affecting the balance of benefits and disadvantages from
offshoring and outsourcing arrangements change over time. Offshored activities may be
on-shored again if the cost calculus goes against foreign-based production. The same can
occur in the case of outsourcing.


On the cost front, a number of factors could change the productivity/wage ratio and
provoke a reassessment of a location decision. Wages may rise as result of a tightening
labour market or from social pressures on wage levels. If productivity improvements
occur and maintain the previously prevailing productivity/wage ratio, the original location
decision may not be affected.


Other issues that could affect an offshoring or outsourcing decision include a reassessment
of the risks associated with a particular location or contractual arrangement, a
reconsideration of what constitutes a critical process for a lead firm, and a specification
of requirements for adequate managerial control. Performance shortcomings, sensitivities
over the protection of intellectual property, or risks to the lead firm’s reputation in the
context of social or environmental issues could also affect offshoring or outsourcing
decisions. From a policy perspective, many things could change the calculus. Competing
locations could become more or less attractive as a consequence of changes in laws and
regulations that affect operating conditions.




16 Supply Chain Perspectives and Issues


The trade-jobs-wages issues linked to offshoring and outsourcing in foreign locations
is a source of considerable contention and political debate. Much empirical work has
been undertaken to assess the impact of internationally fragmented production on jobs
and wages in both the home and receiving countries. The results have gone in different
directions, influenced by differences in scenario design, data sets and methodologies.
Firm conclusions are therefore difficult to draw with great confidence. It might be argued,
however, that some studies have exaggerated job losses in the home country, although
offshoring and outsourcing can lead to rapid job turnover. The skill composition of the
work force may also be affected, rewarding relatively high-skilled workers in industrial
countries and aggravating income inequality. This is an argument for government support
through the provision of safety nets and adequate training and education systems.


A point to note, however, is that some firms are repatriating parts of the supply chain to
home countries or undertaking new investments domestically that might previously have
been offshored or outsourced. Apart from the possibility that political pressure could
have played some part, changes in relative costs (including wages and transport) among
locations are important, as well as concerns about the impact of separating production
processes from R&D on the longer-term ability of firms to innovate.


Supply chains, upgrading and development (Chapter 4)


The developmental aspect of participation in GVCs goes back to fundamental and long-
standing questions about the processes through which developing countries progress in
terms of economic diversification, growth and development. Industrialisation has long
been given pride of place in this debate. Policymakers, in particular, are interested in
finding ways for their countries to participate in GVCs that will provide well-paid jobs,
ensure effective skills acquisition and transfer, and greater involvement in higher value-
added activities – in short, a process of upgrading that contributes to an economic
transformation. Simply being the source of extraction at the start of a commodity supply
chain or providing a modest participation in low-skilled tasks somewhere along a supply
chain does not build a road to longer-term development.


The literature on upgrading focuses on a range of potential opportunities, such as
increasing skill levels in the workforce in association with higher value-added activities,
increasing efficiency levels, and finding ways of modularising or packaging offers so as
to differentiate products.


The key to success identified in much of this literature is enhanced competitiveness. A
well-known categorisation applied in the literature distinguishes between four categories
of upgrading, involving change in processes, change in products, functional (intra-chain)
upgrading and inter-sectoral upgrading. Process upgrading is about achieving greater
efficiency in existing activities. Product upgrading implies qualitative improvements in
output. Functional upgrading refers to assuming new tasks along a given supply chain.
Inter-sectoral upgrading means moving across chains, usually applying an established
capacity or skill set to a related supply chain. A progressive upgrading path is implied by
the order in which these four categories are presented.


The political economy of supply chain participation is also a strong theme in the upgrading
and development literature on GVCs, and is often referred to as governance. The word
“governance” used in this context has much to do with control and power asymmetries




17Supply Chain Perspectives and Issues


which can be exercised through different channels, including political influence, market
power, ownership relationships, informational advantages, and skill sets.


A hierarchy of relationships has been developed in the literature that is built, essentially,
on the degree to which a lead firm controls and owns a GVC. In each of these categories
(market, modular, relational, captive, hierarchical), relationships between a lead firm
and its suppliers will depend, among other things, on the specificities in information
requirements, the capacity for product differentiation, the intrinsic complexity of the
activity or product, the degree of longevity required in a relationship, and market power.


We have already made reference to less than fully developed definitional distinctions
between supply chains and value chains, with the former being more narrowly drawn
for analysis from a business or firm perspective and the latter encompassing a broader
context, including developmental considerations and the role of policy. The even more
broadly drawn notion of global production networks has emerged relatively recently.
As with the upgrading literature, emphasis is placed on the socioeconomic and political
environment in which production relationships operate. Three dimensions underlie the
conceptual framework – value, power and embeddedness.


Value derives from processes of creation, enhancement and capture. Power resides in
corporations, national governments, international institutions and (collectively) in non-
governmental organisations and trade unions. Embeddedness defines relationships
driven by spatial and sectoral factors.


Each of these three dimensions is then considered at the organisational level of firms,
sectors, networks and institutions. While this framework is appealing as a comprehensive
means of trying to understand and explain international production relationships, the
reach and multi-faceted character of its present formulation makes it hard to apply to
policy analysis from which normative conclusions might be derived.


While we have not covered the material in this review, a growing body of literature
deserving attention is on the role of industrial policy. As governments seek to develop and
diversify their economies, various approaches have been adopted to create incentives
for local production. Many of these policies are predicated on the notion that firms need
breathing space in order to establish themselves and gain competitiveness. Governments
should therefore provide protection and support to such firms for a certain period of time.


The debate on industrial policy is an old one and both competing and complementary
policies have been tried with varying degrees of success, ranging from import substitution
to export-led growth models, with a number of variants in between. Domestic market size
is a key determinant of options available to individual countries. Supply chain production
offers some interesting options not available in a simple import substitution framework.


A key distinction in this literature is between narrow- and broad-based policies. Narrowly-
drawn policies target particular industries and seek to change the incentive structures they
face. Broad-based policies are generally enabling in nature and focus on the key ingredients
of competitive success, such as establishing adequate infrastructure, improving training
and education, establishing sound macro-economic fundamentals, facilitating trade and
removing unnecessary and costly regulatory impediments to business. While these two
options are not necessarily mutually exclusive, and both need good underlying governance
structures to succeed, narrowly-directed policy incentives are more demanding, in terms of
design and the quality of government.




18 Supply Chain Perspectives and Issues


Another branch of literature in this area has focused on rural development, with particular
reference to food production. The focus is both upon the production and the consumption
side. Work in this area has led to the idea of alternative food networks (AFNs) that seek
to replace mass production driven by economies of scale, with realigned food production,
distribution and consumption frameworks that focus on an integrated approach to
economic, social and environmental objectives. A derivative of AFN analysis is manifested
as short food supply chains (SFSCs) that are concerned with connecting producers and
consumers through adequate information flows along the entire supply chain.


These approaches to rural development and food production are contrasted and, in some
senses, are set against industrialised food production, which is often highly mechanised
and geared to capturing economies of scale. While the AFN-type models may well
contribute to rural development and better income for farmers in many regions of the
world, it is less clear whether this is a viable, across-the-board substitute for large-scale,
high-technology farming in a world with an ever-growing number of mouths to feed and
a growing middle class.


Supply chains and risk (Chapter 5)


Significant episodes of severe disruption arising both from natural disasters and conflict
since the turn of the century have shone new light on risk, and have focused analysis
on how it can be avoided, mitigated and managed. The issue is particularly pronounced
where vulnerabilities emanate from multiple sources, as they do in the case of complex
international production structures, and where options exist for managing exposure.
Supply chain risk management (SCRM) is a burgeoning field that offers new insights.
While not offering the only analytical approach in the literature, it appears to have gained
certain traction.


The SCRM framework is basically a taxonomy, or an aid to systematic thought and analysis.
The sources of risk and the circumstances in which they exert an impact on supply chain
operations are so numerous as to preclude the preparation of an instruction manual that
prescribes ex ante preventive and remedial actions. The framework is useful, however,
in that it covers multiple contingencies and defines likely sets of appropriate actions. It
can also be an aid to learning through experience. The SCRM framework distinguishes
between the identification, assessment and mitigation phases of risk analysis.


At the identification stage, a further distinction is made between risks arising directly from
a focal firm, supply risks emerging upstream and demand risks occurring downstream.
These distinctions may not always be helpful in terms of identifying the numerous possible
sources of risk. This arises in part because of the challenge of defining the boundaries of
a supply chain. A common problem, for example, is to decide how many tiers supplying
a lead or focal firm should be included in the analysis. Moreover, some unforeseen
events may be of a magnitude that affects the whole supply chain, as well as aspects of its
external operating environment.


A further distinction that may sometimes help to narrow down the exercise of defining
the source of risk is between what the literature refers to as “environmental risks”
and “enterprise risks”. The former emanate from factors outside the purview of the
supply chain. Enterprise risks emerge from within the supply chain itself. Economists
would probably refer to these as exogenous and endogenous risk. Environmental
and enterprise risks may cut across the earlier distinction among risks sourced at




19Supply Chain Perspectives and Issues


the lead/focal firm level and those of upstream or downstream provenance. While the
taxonomical distinctions made so far have all been spatial in the sense of identifying
where risks originate, other approaches have focused both on the source of risk and
its effects, and on the extent of the impact of risks. Effects and impacts may be more or
less severe, and more or less enduring. Risk assessment is the second step in the SCRM
Framework. The objective is to assign a degree of significance to identified risks. The
assignment value, which may be implicit rather than quantified as a probability in this
kind of analysis, depends both on the likelihood of an event and on an assessment of
its impact. Once again, reliable assessment is often made difficult by a combination of
complexity and uncertainty. This is true even where firms have actually gone through an
analytical exercise of the kind proposed by the SCRM framework. Adequate information
may not be available, and even if it is, such information will tend to be treated with
a degree of subjectivity. Although risk assessment involves stochastic uncertainty,
methods exist for assigning a probability distribution to an outcome, but we are still left
with an approximation that some may argue is only little better than a random guess.


Once risk has been identified and assessed, the operational part of the SCRM framework
involves risk mitigation. Risk mitigation strategies have been widely studied and surveyed.
One classification focuses on avoidance, mitigation and acceptance strategies for risk
management. Another distinguishes between product management, supply management,
demand management and information management. These two approaches to categorising
risk management strategies can be combined to produce answers to questions of both
where action can be taken and what the action should be. Numerous approaches may
be relevant, including disinvestment, auditing, vertical integration, multiple sourcing,
stockpiling, joint inventory management with vendors, and many others.


Small- and medium-sized enterprises and supply chain participation
(Chapter 6)


Small- and medium-sized enterprises (SMEs) play a significant role in many economies
through their contribution to employment, development, diversification of output, and
acquisition of knowledge. Some authors refer to SMEs as the backbone of many national
economies. Data does not always reveal the true role of SMEs. In the case of gross trade
data, for example, the input of SMEs into the production of large exporting firms will not
be identified as SME exports, but rather as exports of the final producer. The only way
this result can be remedied is through measuring trade in value-added terms through
an input-output matrix, or by going straight to firm-level data (which are often simply
not available).


The existence of GVCs offers both challenges and opportunities for SMEs. On the side
of challenge, an economy that embraces GVC participation will generally be more open
and impose fewer trade barriers. This can reduce domestic market opportunities for
SMEs. Secondly, GVC participation may shift the technological frontier domestically and
put a premium on innovation. Thirdly, numerous constraints on GVC participation may
include a lack of skilled resources (manpower, accumulated knowledge), poor and costly
access to finance, and relatively elevated costs in dealing with government policy both
in terms of how it is designed and how it is implemented. SMEs seeking to participate in
supply chains generally have to deal with a more powerful lead firm capable of extracting
concessions. This can raise costs to the SME and preclude participation.




20 Supply Chain Perspectives and Issues


But on the positive side, GVCs present an entry point for participation. An SME does not
have to wait until it can produce every part of a product before it enters the market. It
can specialise in components and build specialisation, capacity and competitiveness as a
basis for its expansion and growth. Much will depend on the type of GVC involved and how
far it is vertically integrated, with tight limitations on outsourcing and contracting. SMEs
also possess advantages less available to large firms. These include flexibility, an ability to
make and act upon quick decisions, seize opportunities for innovation (particularly of the
organisational variety), and adapt.


The literature on SMEs and their participation in GVCs is relatively sparse, but what there
is suggests that the picture is mixed, with some SMEs prospering and others atrophying.
More research is undoubtedly required, but successful SMEs clearly see the presence of
GVCs as an opportunity rather than an imposition.


Supply chains and services (Chapter 7)


The emergence of GVC production has almost certainly made production more services-
intensive, although it is difficult to disentangle the different sources of services growth,
as this trend was already apparent in many national economies. Perceptions are further
clouded by the fact that we have consistently underestimated services output. This is
particularly true in trade where, with a shift from measuring trade as a gross flow to
a value-added flow, the estimated share of services in total world trade has doubled to
almost half of the total flow. Even this share remains understated at the aggregate level
because many services supplied within manufacturing firms without any change in
ownership are also counted as part of manufactured output.


The only real distinction between goods and services turns on tangibility. Other differences,
such as the greater heterogeneity intrinsic to services output, challenges of measurability,
differences in the means of delivering standards as well as in storability, and approaches
to regulation, are essentially a matter of degree. Because of the growing prominence of
services and their role in economies, the question arises whether we should continue
to preserve distinctions as strong as those we have now between goods and services,
especially at the level of international rule making.


As far as GVCs are concerned, services are ubiquitous. Not only do most aspects of
GVC operations rely critically on producer services such as finance, transport, electronic
communications, distribution and business services, but dozens of other services are
implicated in different ways along supply chains. Moreover, supply chain production
involves the interaction of multiple markets at any point in the supply chain, and these
markets are often composite, multi-product offerings that include both goods and services.
They are part of complex networks that cooperate in the production of final output. From a
developmental perspective, these multi-product clusters can offer entry into supply chain
production through modularisation and product differentiation.


The implications of such structures of complementary, interdependent markets are
profound for policy. A policy aimed at one market will inevitably affect many others,
and policies will have a multiplicative impact, as the output of one market becomes
input incorporated into subsequent markets along the chain. This certainly argues for
coordinated approaches to policy making.


There is clearly much more we need to know about services and their contribution to
individual supply chains, even at the disaggregated level. This, however, will require




21Supply Chain Perspectives and Issues


a much stronger data-gathering effort as well as a willingness among governments to
think differently about the true nature of services in national economies, as well as the
global economy.


Supply chains and trade in value-added (Chapter 8)


As economies have become more integrated through international exchange, trade
dependency has also intensified. This is easily detectable from measuring the trade to
GDP ratios of countries over time. But such a ratio is not a useful measure because GDP is
measured in terms of returns to factors, and therefore in net or value-added terms, while
trade is typically measured in gross terms. This sometimes results in countries having
trade/GDP ratios greater than unity, which of course is nonsense in conceptual terms.
The correct approach is to measure trade in value-added, in other words to establish what
each country actually contributes to the value of products in international trade.


When we do this, bilateral trade balances change (although not the aggregate trade
balance), the technology content of the trade of individual countries looks different, the
nature of interdependency among nations via trade is more faithfully reflected, and the
double-counting intrinsic to gross trade estimates is eliminated. The data requirements
for estimating trade flows are far more demanding, but the resulting picture is a lot more
reflective of reality. The emergence of GVCs, reflected in the growth of the share of
intermediate products in total merchandise trade, has made it more important to use a
value-added measure.


The respective contributions of countries along supply chains can be measured in four
different ways – using firm surveys, special customs regimes that allow restitution or
exemption of duties on imports used in exports, gross trade statistics divided between
intermediate and final goods, and value-added estimates built up from input-output tables
of the entire economy. All of these methods have their difficulties, but the last of them is
by far the best. Not only are the data more complete, but they also allow services to be
taken into account. Recent efforts such as the EU-funded World Input-Output Database
(WIOD) and the OECD-WTO Trade in Value-Added (TiVA) database, have compiled world
input-output databases, from which many revealing statistics will be derived. A good deal
of work remains to be done in this area.


Supply chains and business models (Chapter 9)


Modern usage of the term “business model” began in the 1990s with the ICT revolution. The
link is explained by what the ICT made possible: Reduced transaction and coordination
costs, new products and services, new channels for reaching consumers and new pricing
and revenue mechanisms.


Markets and organisations were seen more as information processors than as vehicles to
drive profits, and innovations became more promising in an organisational as well as a
technical, product-oriented sense. A challenge for business models is in moving from their
typically descriptive constructs that attempt to order thinking about business processes
towards more prescriptive approaches for the business practitioner.


Business models sometimes lack a conceptual foundation that would permit a sufficient
degree of abstraction to derive a framework that offers systematic insights. Where
theories do develop, competing analytical frameworks will emerge. These are usually
fewer in number and claim (or aspire to) predictive, prescriptive or explanatory power.




22 Supply Chain Perspectives and Issues


In the business context, it would only be a moderate exaggeration to suggest that there
are almost as many business models as there are writers who have made an effort to
construct them. This plethora of models needs to be consolidated even if there never
will (or should) be a unique model structure. But at the other end of the scale, the word
“model” is over-used to characterise a descriptive structure or a sui generis strategy.
Indeed, the range of definitions encountered in the literature of business models is
extraordinarily wide.


Lest one were to get the impression that these observations are motivated by inter-
disciplinary rivalry, let it be observed that the over-formalisation and excessive
abstractions of many economic models also limit their utility. We should be looking
for something in the middle, and we should not gainsay the challenges of contributing
to systematic thinking in respect of a formidably complex set of interactions in the
global economy.


Building conceptual frameworks is a process and the business models are becoming more
sophisticated as explanatory tools and useful as guides to practitioners. Seven of these
models are presented in Chapter 8, in part to demonstrate how different approaches are
from one another, but also to point to the emergence of conceptualisations and structures
that respond more directly to organisational and process choices facing business.


If the ICT revolution gave rise to modern business models it was also significantly
responsible for the development of GVCs. Business models and GVCs are therefore
inseparable. Early efforts to build business model design tools for supply chains tended
to be largely quantitative, building on operations research. But, as with over-formalised
models in economics, too much was left out, and the literature has increasingly strived to
incorporate qualitative elements of analysis. Once again, our review has taken specific
examples to illustrate the kinds of components put forward for system design, and to
capture the essence of interdependent processes along supply chains. For example, one
of these cross-references design principles, resources and capabilities with the market,
the offering, operations and management in order to identify the key components of the
business model. Another tabulates a series of questions that derives decisions along
different organisational and temporal axes.


Finally, another more dynamic and objective-driven framework is the agile supply chain.
Agile supply chains build the capacity to respond rapidly and at low cost to change.
Rapid information flows both within and outside GVCs are essential to this model, which
is also linked to the notion of lean manufacturing. These approaches place an efficiency
imperative front and centre. Real-time response is the focus of attention rather than
forecasts. The four essential requirements for this model are world-class IT infrastructure,
trust relationship, product/process redesign capacity, and risk management.


Future research in the business model field faces a strong challenge in terms of
consolidation. Fewer dominant frameworks will render the genre more relevant and useful
to practitioners.


Supply chains and sustainability (Chapter 10)


Considerable progress has been made in recent years in thinking about sustainability as an
embedded objective within production and consumption systems. A widely cited starting
point for this work is the Bruntland Commission’s 1987 report entitled “Our Common
Future”. Sustainability was defined as meeting today’s needs without compromising




23Supply Chain Perspectives and Issues


the needs of future generations. The economics literature contains various asset-based
definitions of the capital stock of the planet, usually defined broadly. This stock must not
be depleted, and should preferably be enhanced, in every generation. The manner in
which the stock must be measured varies in rigour among formulations. No generally
accepted technical definition of sustainability has been developed at the global level.


Other metrics of sustainability have sprung up alongside environmental concerns. These
relate in particular to child labour, corporate social responsibility (CSR), the triple bottom
line, sustainable supply chain management (SSCM) and a range of other measures/
policies associated with GVCs that are linked to SSCM.


CSR is a somewhat amorphous appeal to business to maintain an ethical stance in its
operations and to support sound environmental and social objectives. This framework
has been criticised on a number of grounds, including the absence of systematic pre-
commitment on the part of business, and the suggestion that corporations contribute to
social and other objectives through their fiscal contributions and their respect for the
regulatory environment in which they operate. The argument has also been made that the
job of corporations is to make profits for their shareholders, not to fill in for states that fail
to meet their public policy obligations. A good number of corporations have nevertheless
pursued CSR objectives.


The triple bottom line construct has been more successful, with its emphasis on economic
performance (profits) alongside appropriate environmental and social performance. The
triple bottom line approach has been built upon the SSCM framework. Four elements were
attached to the triple bottom line, comprising a strategy for sustainability, an appropriate
organisational culture, transparency and risk management. These were intended to
provide a guide to business as they shape overall corporate policy.


A further contribution of SSCM has been to bring together the disparate initiatives
that used to inform sustainability commitments, such as diversity, environment, safety
and human rights. SSCM has also spawned a number of more specific frameworks for
approaching sustainability along GVCs, which are spelled out in chapter 10. While much
progress has been made in teasing out the meaning of sustainability in the world of
GVCs, most of this is focused on the environment and not on other social or public policy
objectives. More work is also needed in operationalising the sustainability constructs that
have been developed.


Supply chains and trade policy (Chapter 11)


Trade opening and the emergence of GVCs were to some extent parallel processes in Asia,
and elsewhere. This is unsurprising, given the role that open markets played in facilitating
the development of GVCs. Opening to foreign direct investment (FDI) was also a crucial
element in preparing the way for GVCs. Despite progress, some problems still remain
in terms of market access, including in relation to non-tariff-measures (NTMS). While
NTMs are putatively designed to serve public policy objectives, they can become non-
tariff barriers (NTBs) when they are deployed for protectionist ends, either in design or
in execution.


Under supply chain production, upstream barriers and other unnecessary additional
trade costs have a magnification effect on all subsequent transactions. This is particularly
the case when components change hands several times, including across borders, before
they reach the final product of which they are part. Since GVC production processes




24 Supply Chain Perspectives and Issues


involve not just goods, but services and FDI as well, magnification effects spill over into
these other markets, even if the measures concerned were imposed on a good in the
first place. These arguments speak strongly in favour of continued efforts in the WTO to
facilitate trade further.


Because of the continued existence of impediments to trade and their magnified impact
in joined up production structures, GVCs create demand for deeper integration and
the complete removal of remaining trade barriers. For a variety of reasons, the WTO
has not been effective in supplying new trade opening to a significant degree for more
than a decade. This is one factor that has encouraged the establishment of so many
preferential trade agreements (PTAs) – a process to which Asia came relatively late in
relation to other regions across the globe. While PTAs may achieve a degree of deep
integration beyond what has been attainable in the WTO, they still carry potential risks
and costs. PTAs can exclude non-signatories in discriminatory ways. They may lead to
regulatory divergence that erects barriers to trade among regions. They can raise costs
through rules of origin regimes.


For these reasons, PTAs carry risks that the WTO is better at guarding against, but
only if it can deliver on its agenda more effectively than it has for over a decade. A
challenge for the WTO is to pursue deeper integration without sacrificing the non-
discrimination principle.


Supply chains and trade finance (Chapter 12)


The financial aspects of GVCs have received considerably less attention than even the
services components of international production arrangements. Most of the focus in the
literature has been on supply chains for goods. Trade finance became a central policy
issue, however, following the Great Recession in 2008-9. Trade finance is used in the vast
bulk of international trade transactions either as trade credit, insurance or guarantees.
Trade finance may be used to secure transactions or to provide collateral for other credit.


Trade credit is a subset of trade finance, and it is an alternative source of credit for
suppliers who face difficulties in acquiring bank finance. In the aftermath of the 2008-9
financial crisis, many businesses found access to bank credit difficult. While the problem
eased in the more advanced economies as banking liquidity returned, problems in
securing trade finance or of meeting the elevated cost of funds have persisted for some
developing country traders. International agencies such as the World Bank have helped
to ease the problem. Available evidence suggests that trade credit extended to SMEs has
been a crucial source of liquidity for SMEs, who have also used trade credit for collateral
to secure bank credits.


A particularly interesting feature of GVCs on the financial side has been the development
of credit chains. They arise where suppliers feel obliged for a variety of reasons to
extend credit to buyers. Since these suppliers are unlikely to have ready access to other
sources of finance for working capital, they also seek credit from their own suppliers.
This behaviour provokes an upstream chain reaction, thus giving rise to credit chains
that operate in parallel with GVCs – that create the commercial relationships in the first
place. Chapter 12 discusses a range of reasons why credit chains may come about and
the purposes they serve. These financial links potentially constitute an additional source
of risk along supply chains and the phenomenon deserves deeper study.




25Supply Chain Perspectives and Issues


In addition to research on the role of trade finance in the post-crisis period, which is
reviewed in Chapter 12, reference is made to work emanating from operations research
relevant to trade finance, as well as the development aspects of trade finance. As
mentioned above, securing trade finance and paying an affordable price for it have both
proved to be challenges for some traders in developing countries over recent years.


An overall impression from the review of literature presented in Chapter 12 is that
considerable scope exists for deeper analysis of the financial aspects of supply chain
operations. The integration into mainstream supply chain analysis of work from the
financial side would contribute to completeness. Incorporating trade finance in risk
management along supply chains, for example, would fill a gap.


Concluding comments


As this introduction shows, the literature review ranges over a wide array of key issues
facing GVCs. This introduction is no substitute, however, for the detailed reviews contained
in the volume. Three overarching observations are in order here.


First, by looking briefly at the range of content in the review, it is clear that even though
issues are treated separately, synergies abound. One of the most obvious areas where
this is apparent is in relation to risk analysis and management. But there are many others,
such as the supply chain for trade finance.


Second, theory and conceptualisation have lagged behind practice in many instances.
This seems to be an increasingly common feature in areas that are too complex for easy
conceptual abstraction. It means that those seeking to develop generally applicable
propositions in the literature need to be particularly attentive to what is actually happening
on the ground.


Finally, it is useful to be reminded how young this field of study is and therefore how
much more work needs to be done in order to understand the true nature of the GVC
phenomenon, and also to stay abreast of how rapidly it is changing in many dimensions.





Part I


Supply Chain Perspectives




27Supply Chain Perspectives and Issues


Abstract


Many unskilled labour-intensive production tasks began to be offshored by advanced
country firms to developing countries, where low-cost but relatively unskilled labour
imparted a comparative advantage, essentially in final assembly operations, combined
with institutions that could absorb firm-specific technological know-how. This profitable
international production fragmentation became feasible with the onset of the information
and communications technology (ICT) revolution, which enabled the coordination of
spatially dispersed complex tasks at a relatively low cost. The growth of global supply
chains has changed the distribution of incomes across countries. Participation in these
supply chains, initiated by the successful completion of low value-added manufacturing
tasks, contributed to industrialisation and high rates of economic growth in several Asian
developing economies. The process of catch-up with developed economies is likely to get
stronger as many of these countries seek to move up the value chain through their exposure
to advanced technologies (made available by the offshoring process) and build up human
capital. At the same time, the continued exclusion of several developing economies from
global supply chains, such as those in Africa, means that the gap among countries in
the developing world could widen. The international fragmentation of production has
also affected the distribution of incomes within countries. In advanced economies, the
direct, negative effect of production fragmentation on employment and wages for low-
and semi-skilled workers is the primary concern. In developing economies, production
fragmentation is likely to create jobs for a large pool of unskilled labour. However, because
a relatively unskilled activity in a developed economy may be a relatively skilled one in
a developing economy, offshoring may increase the demand for (and returns on) skilled
labour among developing economies. These distribution effects, both across and within
countries, are likely to affect trade policy, and consequently, the evolution of supply chains.


Chapter 1
Supply chains in the economics
literature




Supply chains in the economics literature


28 Supply Chain Perspectives and Issues


1.1 The evolution of global supply chains


1.1.1 A brief history and some useful definitions


In the pre-globalised world, poor transportation technology meant that each community
produced most of what it consumed. The steam revolution, which powered railways and
steamships, reduced trade costs dramatically, thereby making it feasible to spatially
separate production and consumption (Bairoch 1990).


Comparative advantage and economies of scale made the separation profitable. The
“Industrial Revolution” began in Britain around the same time, providing it with a significant
cost advantage in manufacturing production. This made it an importer of agricultural
and industrial raw materials from developing countries, and an exporter of finished
manufactured goods.


Countries in Continental Europe and the United States industrialised soon after,
around the middle of the 19th century, and adopted similar international trade patterns
(Baldwin 2012).


The result was a self-sustaining cycle of specialisation, large-scale production, and
innovation and income gains that made further innovation profitable in Europe, North
America and Japan.


At the same time, the displacement of manufacturing activity from developing countries
in Asia, Africa and Latin America destroyed incentives for innovation. Industrialisation
in the “North” and de-industrialisation in the “South”, especially in India and China, led
to massive income divergence across country groups (Pritchett 1997).


The separation of production and consumption, described as “globalisation’s first
unbundling” by Baldwin (2006), increased the importance of proximity in the production
process. By enabling international trade, the transport revolution provided an incentive
for large-scale production, which involved bringing together goods, technology, people,
training, investment, and information.


Proximity lowers the costs and risks of coordinating such complexity, and hence trade resulted
in the bundling of all stages in individual factories, often clustered locally in industrial sectors.


Historically, international trade involved the exchange of finished products between
countries based on comparative advantage, as determined by differences in technology
(Ricardo) or differences in factor endowments (Heckscher-Ohlin).


Extensive intra-industry trade among industrialised countries was explained by the fact
that participation in international markets provided firms with an opportunity to achieve
economies of scale (Krugman 1980). Intra-industry trade often included the sale and
purchase of parts and components by firms located in different countries. It is therefore
argued that in this context, global supply chains have long existed among advanced
economies. Trade between the United States and Canada in the auto industry and intra-
EU trade in machinery are two prominent examples (Baldwin 2012).


Most of such international sourcing was driven by firm-level specialisation and excellence.
For instance, in the case of air conditioning systems for automobiles, the French firm
Valeo dominated its product market through excellence. In principle, Swedish, Italian
and German automobile firms could each manufacture their own air conditioners. But




29Supply Chain Perspectives and Issues


economies of scale and the “learning-by-doing” effect meant that it was cheaper for them
to import this auto part from France (Baldwin 2012).


The emergence of firms as regional champions in the production of different parts and
components was central to this “horizontal” internationalisation of supply chains among
high-wage, advanced economies. More recently, the international exchange of final goods
between developed and developing economies, especially in Asia, (Ozawa 1995; Ando and
Kimura 2003), as envisaged by the traditional trade models of Ricardo and Heckscher-
Ohlin, has become less important.


International production fragmentation, in which manufacturing or services activities
done at home are combined with those performed abroad, has now taken centre stage.
This represents a major point of departure from the so-called “Fordist” production system
– exemplified by the American automobile industry – where all economic activity was
organised within a single firm located on one site or in close proximity (Feenstra 1998).


Increasingly, firms across advanced and developing countries add value along these
global supply chains by completing a specific task associated with the production of
a finished product and then exporting it. This may be an important part or component
required in the production of a good. It may even be a service that is a vital intermediate
input in further production.


Grossman and Rossi-Hansberg (2008) introduced the term “task trade” to describe this finer
international division of labour. Others refer to it as “vertical specialisation”, ”offshoring”,
“outsourcing”, “production sharing”, “slicing the value chain’” and “delocalisation”.


Trade in tasks can be carried out through arm’s length contracts between firms in different
countries, through foreign direct investment (FDI) or through a range of intermediate
arrangements that combine the two.


In the case of FDI, investors such as multinational firms, with their headquarters based
in one country, will establish operations under their ownership and managerial control
in another country. A large part of such “vertical” FDI represents investment by advanced
economies’ firms in developing countries.


A multinational firm is likely to internalise its activities in a foreign country through FDI
in a subsidiary if the internalisation cost is lower than the cost associated with an arm’s
length contract1 (Helpman 1984).


1.1.2 Conceptual underpinnings


So why did firms in advanced economies find it profitable to increasingly offshore tasks
or parts of the production process to developing economies? And does international trade
theory need a new framework to study this phenomenon of global supply chains?


The gain from dispersion is associated with differences in the factor intensity of
different production stages and differences in relative factor prices across countries.
Vast absolute differences in unskilled labour wages between developed and developing
economies, driven by differences in factor endowments, made cross-border production
sharing profitable.


This stays true to the concept of comparative advantage, as defined by the Heckscher-Ohlin
model of trade – countries specialise in the production and exports of “tasks” which use




Supply chains in the economics literature


30 Supply Chain Perspectives and Issues


its relatively abundant factor of production relatively intensively. For example, a relatively
unskilled, labour abundant developing economy would complete and export the relatively
unskilled labour intensive tasks involved in the production of goods, say final assembly.
Similarly, a relatively capital or skilled labour intensive country would export intermediate
products, such as capital goods and design and research and development services.


However, while the Heckscher Ohlin model of trade is highly relevant to understanding
the evolution and shape of supply chains, it does not provide the whole story. Unskilled
labour costs in developing countries might not be nearly so low as the differences in
wages suggest because differences in aggregate total factor productivity (TFP), resulting
from differences in technology and institutions also play a part.


For instance, a key issue in the context of offshoring is whether developed country firms
can take their “Northern” technology with them. If they cannot because the institutions
in a developing country are so weak or disruptive that efficient production is simply not
possible, then offshoring is unlikely. If the technology is portable, then wage differences
do translate into labour cost differences and off-shoring is profitable. This outcome is as
representative of the Ricardian model of trade as it is of the Heckscher-Ohlin model.


Traditional trade theories make extreme and contradictory assumptions about
international diffusion of technical knowledge. The Heckscher-Ohlin model of trade
argues that technology is freely available across countries and hence comparative
advantage is determined by relative factor endowments.


In contrast, the Ricardian model of trade stresses differences in technology as the
basis of international trade – countries tend to specialise in activities about which their
inhabitants are especially knowledgeable. An intermediate position which seems more
relevant to global supply chains is that knowledge can move from one country to another,
but only at a price, such as with payments of royalties – explicit or implicit in transfer
prices – or the salaries of foreign experts (Markusen 1997; Anderson et al. 2006).


The Heckscher-Ohlin model is highly relevant when explaining supply chains for developing
countries whose aggregate TFP is closer to that of advanced economies, in other words,
emerging markets. In developing countries where aggregate TFP is significantly lower
than in advanced countries, the sector-specific transfer of “Northern” technology creates
a Ricardian comparative advantage in the goods or sectors concerned.


Comparative advantage, whether defined in a Heckscher-Ohlin or Ricardian sense, is
naturally relevant in the formation of global supply chains because location decisions for
firms revolve around efficiency, specifically, placing each stage of production in the lowest
cost location. This cost calculation trades off direct factor costs with “separation” costs.
The former include wages, technology, capital costs, subsidies and other policy-related
incentives. The latter comprise transmission costs, transportation costs and increased risk.
Hence, a firm in Japan, Germany or the United States is likely to offshore the unskilled labour
intensive stages of producing a manufactured good to its low-wage neighbors so long as the
cost advantage it receives outweighs the costs associated with the process of offshoring.


The location decision may also be influenced by local spillovers or potential patterns of
complementarity between tasks (Grossman and Rossi-Hansberg 2008). In some sectors,
proximity between designers and consumers may be critical. In others, certain production
stages may be made cheaper, faster and more effective when co-located with certain
other stages. For example, the tasks performed by a nurse during surgery are most




31Supply Chain Perspectives and Issues


valuable when the surgeon is nearby. It is also possible that stages and sectors could be
characterised by strong technological complementarities that make production clustering
or agglomeration beneficial (Healey and Ilbery 1990).


Importantly, exploiting the potential benefit of international production fragmentation
became feasible with the information and communications technology (ICT) revolution
around the mid-1980s, which enabled the coordination of complex tasks at distance,
at a relatively low cost (Batra and Casas 1973; Dixit and Grossman 1982; Jones and
Kierzkowski 1990, 2001). Another key enabling factor of production fragmentation was
the proliferation of standards, which enable the modularisation of production processes
through mechanisms for verifying complex information on quality.


FDI directed at developing countries began to grow substantially during the 1990s. For
example, non-OECD economies accounted for about 38 per cent of outward FDI from the
US in 2004 and about 46 per cent of outward FDI from Japan in 2005 (Forte 2004).


Baldwin (2006) termed this as “globalisation’s second unbundling” – production stages
previously performed in close proximity began to be dispersed geographically. Most of the
unskilled labour-intensive production tasks began to be offshored by advanced country
firms to developing countries with a comparative advantage in completing these tasks,
being those with low unskilled labour wages as well as institutions that could absorb their
technological know-how.


1.1.3 Some salient features


It is worth noting that 21st century global supply chains are different from those that
existed among advanced economies in the 20th century. Today, they are much more than
extra trade in parts and components. FDI is an integral part of these networks and hence
investment in production capacity assumes greater importance. The same holds true for
infrastructure services, including telecommunications, transport and logistics.


Long-term business relationships also lead to cross-border flows of know-how such as
formal intellectual property (technology) and more tacit forms, such as managerial and
marketing expertise.


The export orientation of the host country, usually a developing economy, is greatly
enhanced by FDI and long-term business relationships of other kinds. By providing
access to capital, skills, technology and market knowledge, it enables firms to manufacture
products that meet world-market specifications with regard to technological content,
quality and design (Helpman 1984). It is also important to highlight the fact that most
global supply chains, including already significant “North-North” ones, are largely regional.


Baldwin (2012) identifies “Factory Asia”, “Factory North America”, and “Factory Europe” as
blocs with a strong supply-chain relationship. Within these blocs, there is a hub-and-spoke
asymmetry in the dependence of factory economies on intermediate imports from the
region’s “headquarter” economy.


For example, Baldwin (2012) finds that the US shows little dependency on imports from
Canada and Mexico, but that these countries show considerable dependence on the US and
very little on each other. The same is true for Factory Asia where Japan is the “headquarter”
economy, although the asymmetries are far less defined than they are for NAFTA. Germany is
the hub in Factory Europe.




Supply chains in the economics literature


32 Supply Chain Perspectives and Issues


1.2 The distribution of income across countries


1.2.1 Value-added along a supply chain: manufacturing
and services activities


In their research on global supply chains, economists have focused on the manufacturing
sector. This is attributable to the fact that traditionally, any item that could not be put in
a box (such as services) or was too heavy to ship (such as houses) was thought of as
non-tradable in international markets. But with rapid advances in ICT, packets of digitised
information play the role that boxes used to play, thereby implying that many more services,
such as software, call centres and business process outsourcing, are now tradable.


Of late, economists have been paying increasing attention to upstream service activities,
such as R&D and design. The same cannot be said for downstream services, such as
distribution and marketing, involved in the supply of goods to consumers (Wood 2001).2


The role of services in supply chains needs to be studied in more detail, given that their
costs often account for a larger share of the final price of a good than the costs of their
manufactured components.


The economics literature, in fact, alludes to a non-linear relationship between the stage of
production in a global supply chain and its contribution to total value-added. In particular,
there is a U-shaped relationship, referred to as the “smile curve” by Stan Shih – Acer’s CEO
in the early 1990s; it suggests that upstream activities such as R&D and product design
together with downstream activities such as branding and advertising services constitute
a large share of value-added, but the intermediate production stages as component
manufacturing and final assembly do not.


This suggests that value-added is less for the tasks along the supply chain that are usually
offshored. The obvious explanation relates to cost accounting. When a stage’s cost is
reduced by offshoring, its share in value-added falls, since a stage’s value-added is based
on cost. This basic cost-accounting effect can be amplified by two factors: technology
transfer and relative market power (Baldwin 2012).


As explained earlier, if a firm moves its advanced technology to the offshore location, it is
likely to reduce the cost of the offshored task even further. Consequently, this increases
the relative value of non-offshored tasks. Moreover, offshored tasks tend to be activities
where entry barriers – and hence economic rents – are low. They can be carried out in
many developing economies and thereby become homogeneous. Non-offshored stages,
however, are likely to comprise tasks, which represent the core competency of lead firms,
where they have market power due to product differentiation and where rents are high.


1.2.2 Upgrading


A country’s position in a global supply chain, in terms of stages of production, is generally
correlated with its comparative advantage. Developing countries complete low value-
added unskilled labour intensive tasks because they have a relatively abundant supply of
unskilled labour. It is advanced economies, where the skill- and capital-intensive tasks are
completed, which capture most of the value-added.


Some advantages are “natural”. Several countries sit atop massive deposits of oil, while
others do not. In modern economies, however, comparative advantage is often man-made. So




33Supply Chain Perspectives and Issues


it is possible for a country which has a comparative advantage in unskilled labour intensive
tasks today to have a comparative advantage in high technology-intensive tasks tomorrow.


For example, the United Kingdom had a comparative advantage in textile manufacturing
following the Industrial Revolution. Then that advantage shifted to the United States. It
shifted once again – this time to the south in the United States (Blinder 2005). At present,
the comparative advantage in textile manufacturing resides in China and other low-
wage developing economies. Hence, the concept of “dynamic comparative advantage”
or “kaleidoscopic comparative advantage” (as defined by Bhagwati and Dehejia 1994) is
critical to understanding global supply chains. It is worth noting that shifts in comparative
advantage are not always the default position and are often shaped by government policies
and business decisions.


In Asia, several firms in Japan offshored unskilled labour intensive manufacturing tasks
to South Korea, Chinese Taipei, Hong Kong and Singapore, starting in the 1970s (Baldwin
2012). Hence, these countries entered global supply chains by specialising in component
manufacturing and product assembly. As they industrialised, they began to manufacture
sophisticated intermediate inputs, which they earlier imported from advanced economies.
These newly industrialised countries also expanded into the design and distribution of
goods, and hence captured more of total value-added.


The availability of technology played a crucial role in upgrading (Wood 2001) and global
supply chains have made technology internationally more mobile by offshoring firms’
specific technical know-how, especially via investment in the establishment of subsidiaries
overseas. At the same time, it is important to highlight the fact that investment in human
capital and the resulting capability of firms to absorb technology is also crucial to supply
chain upgrading (Lall, 1992).


The transfer of technology and knowledge facilitated through trade in intermediates and
FDI made it possible for developing countries, such as Hong Kong, South Korea, Singapore,
and Chinese Taipei to move up the product ladder in terms of capital intensity and quality.
At the same time, industrialisation in these countries or territories produced rising wages,
which, in turn, triggered offshoring of unskilled labour intensive tasks to China, Thailand,
the Philippines, Indonesia and Malaysia after 1990.


Similarly, Mexico and Poland were favoured offshore locations for unskilled labour
intensive manufacturing tasks in North America and Europe respectively (Baldwin 2012).
For China, there is already some evidence of deepening productive capacity and a move
up the ladder – it has begun to produce sophisticated intermediate goods that previously
would have been imported.


The potential transition of developing countries to completing high value-added tasks
can affect the distribution of income between advanced and developing economies. The
global sourcing of services, which account for a large share of global value-added, may
have similar effects.


1.2.3 New entrants


Along with the supply chain changes mentioned in the previous,section the distribution of
income between developing countries has also been widening. Development at different
speeds in Asia relative to Africa is attributable, in part, to the exclusion of African countries
from global supply chains for manufactured goods and services.




Supply chains in the economics literature


34 Supply Chain Perspectives and Issues


Why did this happen? For one, African countries traditionally had a comparative advantage
in commodity exports. For another, their industrialisation strategies were based on trade
policy instruments, such as tariffs and quotas, for import-substitution. After countries in
Asia seized the initiative, breaking into global supply chains became difficult for several
African countries despite their departure from import substitution, because of externalities
and economies of clustering.


The more chains a country is already involved in, the easier is it to become involved in
additional chains, because there are economies of scale in the supply of infrastructure,
skilled labour, support services, and information (Wood 2001).


So how can African countries enter the network of global supply chains to diversify into
manufacturing production? It is likely that as surplus labour gets absorbed in developing
countries, such as China, Mexico and Poland, wages will rise there (and that is already
happening in China). This is likely to widen the supply chain base for completing unskilled
labour intensive manufacturing tasks. African countries would thus have an opportunity
to diversify into industrial production. But so too would other low-wage nations, including
India, Vietnam and Bangladesh, hitherto less involved in supply chain activity (Baldwin 2012;
UNESCAP 2011).


In order to compete for inclusion in global supply chains, African countries and others
have to remove institutional barriers to trade, such as red tape, customs procedures,
laws, finance and personal security, and improve basic infrastructure. They will also need
to invest in innovation systems and skills development as well as maximise linkages to
commodity exports.


1.3 The distribution of income, jobs and welfare within countries


International production fragmentation is conducted based on firms’ decisions to enhance
their competitiveness. Increased offshoring directly enhances the productivity of the
factor whose tasks are moved offshore. This results in a more efficient resource allocation
of resources, which is likely to push up the overall efficiency and productivity in the
headquarter economy.


At the same time, the offshoring of tasks based on comparative advantage implies that
certain jobs are likely to be transferred from developed to developing countries. Hence,
just as in the Heckscher-Ohlin model of trade, there could be distributional implications of
offshore outsourcing via changes in the demand for skilled and unskilled labour. The owners
of a country’s scarce factor are likely to lose, either by seeing a decline in their return or
being rendered redundant, when the costs of offshoring their task falls. In fact, according
to Feenstra (1998), in a world where trade in intermediate inputs accompanies trade in final
goods, the impact of globalisation on employment and factor returns is relatively large.


1.3.1 Advanced economies


Grossman and Rossi-Hansberg (2008) provide a basic framework to study the effects of this
new international organisation of supply on resource allocation, factor prices and welfare.
Skilled labour is relatively abundant and thus relative cheap in advanced economies.
Unskilled labour, in contrast, is relatively scarce and thus relative expensive. The result is
a spatial sorting of skill intensive stages to developed economies and unskilled labour-




35Supply Chain Perspectives and Issues


intensive stages to developing economies, thereby resulting in an increase in the returns
to skilled relative to unskilled labour in developed economies.


Wood (2002) and Anderton et al. (2006) show that the development of supply chains may
have affected not just the wage gap between the majority of skilled workers and unskilled
workers in developed countries, but also the wage gap between a tiny minority at the top of
the income distribution and everyone else. They provide the following explanation. In the
“North”, the initial effect of a decline in transport costs and co-operation costs is to widen
the gap in wages (or with rigid wages, in unemployment rates) between unskilled and all
skilled workers, a la Grossman and Rossi-Hansberg (2008). By retaining the more skill-
intensive activities, both highly-skilled and medium-skilled workers benefit. Subsequent
falls in co-operation costs shift more production to developing countries, but the activities
which leave developed economies become increasingly skill-intensive, and that transfer
eventually lowers the demand for more medium-skilled workers. However, as the relative
wages of highly skilled workers continue to rise, wage inequality among skilled workers
increases. Anderton et al. (2006) argue that it is therefore also possible that beyond a
certain point, the wage gap between moderately skilled and unskilled workers shrinks
rather than widens in developed countries.


Of principal interest in policy circles is the direct, negative effect of production
fragmentation on employment and wages for low-skilled manufacturing workers in the
“headquarter” economies.


Evidence suggests that increased outsourcing to developing countries of manufacturing
activities, such as clothing production and electronic assembly within global supply
chains, has eliminated jobs in advanced economies (Spence 2011). In the case of the
Japanese manufacturing sector, for example, Fukao and Amano (2004) find a negative
effect of outward FDI on domestic employment.


As a result, much of the unskilled labour in advanced economies is now being absorbed
in the non-tradable services sector, such as in road transport and personal services. Jobs
in these sectors are relatively low-paid.


As the domain of tradable services expands with constant improvements in ICT and the
increasing standardisation of services trade through mutual recognition agreements,
for instance, it is possible that many service sector workers in advanced economies will
also have to compete for jobs with emerging economies. This could involve semi-skilled
activities, such as call centres and book-keeping, as well as highly skilled tasks, such
as design and R&D, so long as these services can be delivered electronically over long
distances with little or no degradation in quality (Blinder 2006). It is worth noting that by
eliminating jobs or reducing wages for skilled workers, offshoring of skill intensive tasks
may potentially reduce income inequality in advanced economies.


Offshoring brings about overall improvements in productivity. For instance, Kimura and
Kiyota (2004) show that Japanese firms globalising their activities perform better than
those staying in Japan.


If the resulting impact on factor prices is not too large, all domestic parties can share in the
gains from improved opportunities for offshoring. In fact, if the positive productivity effect
outweighs the negative relative factor demand or factor price effect, it is possible to prevent
an inevitable conflict of interests through redistribution, albeit difficult in the short run.




Supply chains in the economics literature


36 Supply Chain Perspectives and Issues


Hence, governments in advanced economies must adapt to new realities. Social safety nets
are likely to be important in the short-run. Education systems would be crucial for making
the necessary economic and social adjustments in the medium to long run. But this does
not mean that simply providing more education is all that is needed. According to Blinder
(2006), the critical divide in the future may be between work that is easily deliverable
remotely with little or no diminution in quality, and work that is not. And this divide does
not correspond well to traditional distinctions between high-skilled and low-skilled work.


For example, it is unlikely that the services of either taxi drivers or airline pilots will ever
be delivered electronically over long distances. The second has significant educational
requirements, while the first does not. Hence, the real challenge would be to develop an
education system, which imparts skills (including vocational training) that would make
people employable in a range of different occupations.


1.3.2 Developing economies


From the standpoint of developing economies, international production fragmentation has
a positive effect on employment because it creates jobs for unskilled labour in offshore
locations (Grossman and Rossi-Hansberg 2008). By increasing the demand for unskilled
labour, it may even increase their wages, thereby reducing income inequality.


Using a more general framework, Wood (2002) explains that integration into value
chains could push wage inequality between moderately skilled and unskilled workers
in developing countries either way. According to him, the outcome depends on whether
or not the fall in “cooperation or coordination costs” (that depend on ICT, travel costs
and institutions) is accompanied by a fall in transport costs and on the initial conditions
prevailing in those countries.


For example, if a poorly educated developing country started with little production of
world-quality goods, a fall in co-operation costs would raise wage inequality, because
the activities transferred from the developed “North” would be more skill-intensive than
those in which workers were currently employed. It is for this reason that the services
offshoring, in the case of business process operations, may have contributed to the
worsening distribution of income in developing countries. A fall in co-operation costs
would have a different effect if the country had a better educated workforce. Activities
shifted from the “North” would initially be less skill-intensive than other production in
the country, resulting in a decline in wage inequality. Eventually, however, offshored
activities would be likely to become more skill-intensive, which would cause wage
inequality to rise (Wood 2002).


Trade in intermediates, facilitated by FDI, are also likely to be associated with capital inflows
and technology transfers, thereby having strong positive effects on the productivity growth
of domestic firms.


Kimura (2005), for instance, shows that international production networks in East Asia have
positively worked for fostering local firms, at least in some sectors. In a study on Indonesia, Amiti
and Konings (2007) find a positive impact of intermediate goods trade on a firm’s productivity.


At the same time, other research expresses concern about the possible negative effects
of inward FDI on the development of local firms and hence on employment, especially in
the context of special economic zones or enclaves with minimal linkages to the rest of the




37Supply Chain Perspectives and Issues


domestic economy. It is also argued that the transfer of labour saving-technologies associated
with trade and FDI has resulted in insufficient job creation for a large pool of unskilled labour
in developing economies.


1.4 The role of trade policy


Historically, countries used infant industry protection policies to build a strong industrial
base before becoming competitive in international markets. Present day advanced
economies such as the Unites States, Germany and Japan followed this path. So did several
developing economies such as China, India and Brazil. Certain aspects of industrial policy,
such as import substitution, FDI restrictions and local-content restrictions, made it difficult
for countries to participate in global supply chains.


After the ICT revolution, however, many developing economies dropped the policy of infant
industry protection to attract offshored manufacturing jobs and investment. In fact, given that
cross-border relocation of different stages of production can happen through international trade
in intermediate inputs, trade liberalisation greatly enhanced production sharing (Damuri 2012).


Industrialisation through joining global supply chains became a new development
paradigm (Baldwin 2012). This new “industrial policy” changed the political economy of
trade liberalisation. Emerging economies unilaterally liberalised tariffs and embraced pro-
business policies to attract factories and jobs.


This change in policy stance can also be seen in countries’ willingness to embrace
disciplines on (behind-the-border) non-tariff measures in “deep” regional trade agreements
with their key supply chain partners. Starting in the mid-1980s and accelerating sharply
in the 1990s, countries signed agreements with new disciplines in the areas of investment,
services and intellectual property. As multilateral progress on these issues stalled during
the Doha Round, the number of 21st century disciplines in regional trade agreements
(RTAs) exploded in the 2000s.


The major trade policy issue looking forward is how the international “harmonisation” of
regulations can enhance trade within global supply chains (Feenstra 1998; Bhagwati and
Hudec 1997; WTO, 2011). Another issue is a growing trend for governments to adopt trade
regulatory measures, such as export restrictions on raw materials, in order to maximise
domestic value-added.


1.5 Future directions


Much of the recent boom in supply-chain trade was attributable to the ICT revolution that
reduced the costs and risks of combining developed economy technology with developing
country labour. A remarkable reduction in policy barriers to trade in goods, especially
tariffs, also played a crucial role, as did efficiency improvements in transportation and
logistics (such as containerisation) and increased standardisation. Further improvements
in ICT will facilitate more and longer-distance trade in parts and components.


Tariffs cannot fall below a bound rate of zero and hence further tariff liberalisation is
unlikely to provide a boost to future supply chain unbundling. But, given the political
economy that accompanied the recent growth of global supply chains, further reductions in
non-tariff barriers to trade, especially in the context of “deep” regional integration agreements,
are likely to bring down the costs of moving goods, back and forth, across borders.




Supply chains in the economics literature


38 Supply Chain Perspectives and Issues


Trade costs, however, could still rise with policy changes, geopolitical uncertainties and
oil prices. If oil prices, for example, do rise substantially, the geography of supply chains
will be affected. It would favour “near-shoring” and supply chains would become even
more regional than they are today. Growing uncertainty and shorter production cycles
may also contribute to the increased regionalisation of supply chains.


What about the distribution of income across countries? The offshoring of unskilled
labour-intensive stages of manufacturing, greater international mobility of technology and
economic reforms produced rapid growth and industrialisation in developing economies,
starting in the early 1970s, with a significant pick up in the 1990s.


This, often described as globalisation’s “second unbundling” led to, at least in part, the
reversal of the big income divergence of the late 19th and early 20th century. Going forward,
it is possible that new technologies, such as 3D printing and robotics, will eliminate routine,
low-skilled tasks that are easier to computerise and robotise.


At the same time, the more intensive use of sophisticated production machines will
make the remaining tasks more skill-, capital- and technology-intensive. This will favour
production in high-wage advanced economies.


Hence, for this reason as well for upgrading their position in global supply chains to
capture more of the value-added, developing economies would need to move up the
ladder of skills, capital and technology.


Of course, their ability to upgrade is likely to be a function of the availability of skilled labour,
their own “learning-by-doing”, and knowledge transfer from advanced country firms with
their interaction being facilitated by offshore outsourcing. Growth in offshore outsourcing
itself, however, may be curtailed by growing concerns of job losses in advanced economies.


There is also the question of global supply chains leading to development at different
speeds within the developing world. The rapid industrialisation of the “South” in recent
times has been driven by excellent performances of just a dozen nations – all of them
heavily involved in international supply chains, and most of them in Asia.


The performance of Chinese manufacturing alone accounts for much of the reversal. The
ability of countries, especially those in Africa, to diversify into manufacturing and services
production, would be significantly influenced by the possibility of their firms entering
global supply chains and, based on this increased participation, to maximise linkages with
the rest of the domestic economy.


1.6 Endnotes


1. This is indicative of high transaction costs.


2. Studies analysing the role of global supermarkets in retail trade are an exception.


1.7 References


Amiti, Mary and Jozef Konings. 2007. “Trade Liberalization, Intermediate Inputs, and
Productivity: Evidence from Indonesia.”, American Economic Review, 97(5): 1611-1638.


Anderson, Edward, Paul Tang and Adrian Wood. 2006. “Globalisation, Co-operation Costs
and Wage Inequalities”, Oxford Economic Papers, 58 (4): 569-95.




39Supply Chain Perspectives and Issues


Ando, Mitsuyo and Fukinari Kimura. 2003. “The Formation of International Production
and Distribution Networks in East Asia”, NBER Working Papers 10167, National Bureau of
Economic Research.


Bairoch, Paul. 1990. “The Impact of Crop Yields, Agricultural Productivity and Transport
Costs on Urban Growth between 1820 and 1910”, In A.D. Van der Woude, A. Hayami, and
Jan de Vries (eds), Urbanization in History, Oxford: Clarendon Books.


Baldwin, Richard. 2006. “Globalisation: The Great Unbundling(s)”, Chapter 1, in
Globalisation Challenges for Europe, Secretariat of the Economic Council, Finnish Prime
Minister’s Office, Helsinki.


Baldwin, Richard. 2012. “Global Supply Chains: Why they Emerged? Why they Matter?
And Where they are Going?”, CTEI Working Papers, Working Paper Number 2012-13, The
Graduate Institute, Geneva.


Batra, Raveendra N. and Francisco R. Casas. 1973. “Intermediate Products and the Pure
Theory of International Trade: A Neo-Heckscher-Ohlin Framework.”, American Economic
Review, 63(3): 297-311.


Bhagwati, Jagdish and Vivek H. Dehejia. 1994. “Freer Trade and Wages of the Unskilled - Is
Marx Striking Again?”, in J. Bhagwati and M. H. Kosters, eds., Trade and Wages: Levelling
Wages Down?, Washington, DC: AEI Press, pp. 36-75.


Bhagwati, Jagdish and Robert H. Hudec. 1997. Fair Trade and Harmonization, Volume 1,
Cambridge, MA: MIT Press.


Blinder, Alan S. 2006. “Offshoring: The Next Industrial Revolution?”, Foreign Affairs, 85(2):
113-128.


Damuri, Yose Rizal. 2012. “International Production Sharing: Insights from Exploratory
Network Analysis.”, CTEI Working Papers, No. 2012-03, The Graduate Institute, Geneva.


Dixit, Avinash K. and Grossman, Gene M. 1982. “Trade and Protection with Multistage
Production”, Review of Economic Studies, 49(4): 583-594.


Feenstra, Robert C. 1998. “Integration of Trade and Disintegration of Production in the
Global Economy”, The Journal of Economic Perspectives, 12(4): 31-50.


Fukao, K. and Amano, T. 2004. “Foreign Direct Investment in Japan”, Mimeo, American
Chamber of Commerce in Japan, Tokyo.


Grossman, Gene M. and Esteban A. Rossi-Hansberg, 2006. “Trading Tasks: A Simple Theory
of Offshoring”, American Economic Review, 98(5): 1978-1997.


Healey, Michael and Brian W. Ilbery. 1990. “Location and Change: Perspectives on
Economic Geography”, Oxford, New York: Oxford University Press.


Helpman, Elhanan. 1984. “A Simple Theory of Trade with Multinational Corporation” ,
Journal of Political Economy, 92(3): 451-471.


Jones, Ronald and Kierzkowski, Henryk. 1990. “The Role of Services in Production and
International Trade: A Theoretical Framework”, Chapter 3 in Jones and Anne Krueger
(eds.): The Political Economy of International Trade, Oxford: Blackwells.


Jones, Ronald and Kierzkowski, Henryk. 2001. “Horizontal Aspects of Vertical
Fragmentation”, in L. Cheng and H. Kierzkowski (eds.), Global Production and Trade in
East Asia, Kluwer.




Supply chains in the economics literature


40 Supply Chain Perspectives and Issues


Kimura, Fukunari and Kozo Kiyota. 2004. “Exports, FDI, and Productivity of Firm Cause and
Effect”, Mimeo.


Kimura, Fukunari and Mitsuyo Ando. 2005. “The Formation of International Production and
Distribution Networks in East Asia”, NBER Chapters in: International Trade in East Asia,
NBER-East Asia Seminar on Economics, Volume 14, pages 177-216.


Krugman, Paul. 1980. “Scale Economies, Product Differentiation, and the Pattern of Trade”,
American Economic Review, 70(5): 950-59.


Markusen, J. 1997. “Trade versus investment liberalisation”, Nota di Lavoro 75.97, Milan:
Fondazione Eni Enrico Mattei.


Ozawa, T. 1995.“The Flying Geese Paradigm of Tandem Growth”, Mimeo.


Pritchett, Lant. 1997. “Divergence, Big Time”, Journal of Economic Perspectives, 11(3): 3-17.


Spence, Michael. 2011. “ The Impact of Globalization on Income and Employment: The
Downside of Integrating Markets”, Foreign Affairs, 90(4): 28-41.


United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP). 2011.
“India: A New Player in Asian Production Networks?”, Studies in Trade and Investment
Number 75 (ST/ESCAP/2624), Bangkok.


Wood, Adrian. 2001. “Value Chains: An Economist’s Perspective”, IDS Bulletin, 32(3): 41-45.


Wood, Adrian. 2002. “Globalisation and Wage Inequalities: A Synthesis of Three Theories”,
Weltwirtschaftliches Archiv, 138 (2002) 54-82.


World Trade Organization (WTO). 2011. “The WTO and Preferential Trade Agreements:
From Co-existence to Coherence”, World Trade Report, Geneva.




41Supply Chain Perspectives and Issues


Chapter 2
Supply chains in the business
literature


Abstract


Changes in the structure of 20th century international industrial organisation that have
incited research interest among economists have also driven a significant body of work
in the business literature. Indeed, many of the factors driving the changing industrial
structure are derived from business. Examples include the innovation and implementation
of assembly lines, scientific management, modularisation, lean manufacturing, and just-in-
time production. While the economics literature has produced terminology such as “task
trade”, “vertical specialisation”, and “production sharing”, the business literature tends to
emphasise “supply chains”. This is in conjunction with terms from political economists
and development theorists that include “value chains”, “global commodity chains”, and
“global production networks”. Of these, the supply chain provides the most relevant per-
spective for the business practitioner. Networks of firms are viewed from a focal firm per-
spective, and the supply chain ontology adopts various dimensions to orient a firm with
its network surroundings (for example, direct-extended-ultimate supply chains, horizontal
tiers or degrees of separation, and vertical structures within each tier). Further functional-
ising the supply chain concept is the field of supply chain management (SCM). Born from
multidisciplinary roots that include logistics, marketing, management, and sociology, SCM
has developed into a distinct field of study over the past fifty years. SCM theory has only
recently reached a state of maturation where it produces operationalisable concepts and
tools, but progress is being made in advancing both the overarching field of SCM and the
specific issues that fall under the SCM umbrella. This chapter will review the overarching
field, while Part II and its chapters will address the specific issues.


2.1 Defining supply chains


2.1.1 The blind men and the elephant


The realities addressed by supply chains reflect phenomena arising from the changing
nature of the international economy during the latter half of the 20th century. As such,
the same phenomenon is documented and researched from multiple fields, resulting in a




Supply chains in the business literature


42 Supply Chain Perspectives and Issues


plethora of terms fundamentally pointing to the same reality. However, these terms embody
perspectives from their respective fields to characterise this new reality.


We review a sample of the most common terms encountered when discussing this
phenomenon. The list is by no means exhaustive, but should provide cursory overviews
for the majority of terms encountered in the literature. They include supply chains, value
chains, filière, global commodity chains, and global production networks.


Supply chains


Supply chains emerged when issues related to materials flow were first introduced. Since
the 1990s, however, the term showed an exponential rise in popularity, along with its
corresponding concept of supply chain management, introduced by consultants in the
1980s (Arshinder and Deshmukh 2008; Chen and Paulraj 2004). Among its many origins,
Chen and Paulraj (2004) point to five, in particular, when explaining this trend:


(1) the quality revolution;
(2) notions of materials management and integrated logistics;
(3) a growing interest in industrial markets and networks;
(4) the notion of increased focus; and
(5) influential industry-specific studies.


The term “supply chain”, in contrast to “value chain”, has remained a relatively unified term
in use with few nomenclatural variations.


However, it has been confusingly associated with multiple definitions in its usage. Common
among these definitions is the existence of an input-output structure covering a range
of value-adding activities (Gereffi et al. 2001). The use of the term “supply” also carries
a more specific denotation than “value”, and Sturgeon (2001) thus suggests that supply
chains be confined to the set of activities that are driven by a lead firm (or firms), while
value chain refers to a greater set of activities.


Value chains


The concept of the value chain provides a key starting point in understanding the
dynamics of industrial organisation, international trade, and regional development. Use
of the term “value chains” has been documented as far back as the 1960s in the context of
development paths for mineral-exporting economies.


In the 1980s, however, the term rose to popularity, particularly in the business literature,
due to the works of Michael Porter (1980, 1985, 1990). Porter proposed two elements
now found in modern value chain analysis: the value chain and the value stream. The
value chain referred to the intra-firm activities involved in transforming inputs into
outputs, and included not only the physical transformation processes, but also the
support functions involved. These include research and development, procurement,
human resources management, and many of the tasks that may now be regarded as
higher value adding activities. His value system resembles the modern value chain in
extending the framework of activities to inter-firm linkages (Kaplinsky and Morris 2002;
Gereffi et al. 2001; Hess and Yeung 2006).




43Supply Chain Perspectives and Issues


While these conceptualisations provide limited utility in the analysis of socioeconomic
dynamics and development, they provided many of the theoretical foundations for the
value chain today (Henderson et al. 2002).


The concept also translated into economic geography, beginning with the works of Peter
Dicken (1986), who integrated value chains into a territorial context, and was followed by
a large body of works on transnational corporations and regional development (Hess and
Yeung 2006).


Furthering the concept was popular work by Womack and Jones (1996) on the value
streams in the context of lean production. The proposed value streams were equivalent
to the modern value chain, and added yet another term to the increasingly confusing
nomenclature on value chains. Global commodity chains add yet another contributing
“chain” based concept, which in turn was built from the legacy of world-systems theory.


Many of these multiple concepts, terms, and their respective practitioners came together
at a conference in 2000 in Bellagio, Italy to communicate and unify their research under
the value chain umbrella (Bair 2005). Since then, the value chain field has seen significant
advancement from the works of Gary Gereffi, Timothy Sturgeon, Raphael Kaplinsky, John
Humphrey, and Hubert Schmitz in the areas of industrial organisation and economic
sociology (Kaplinsky 2000, 2004).


With the consolidation of value chain efforts, the definition of value chains found in the
literature has been very consistent over the past decade. A value chain is defined as the
full range of activities which are required to bring a product or service from conception,
through the different phases of production (involving a combination of physical
transformation and the input of various producer services), delivery to final consumers,
and final disposal after use (Kaplinsky and Morris 2002; Gereffi et al. 2001; Kaplinsky
2000, 2004). Furthermore, when these value chains span enterprises in more than one
country, they are termed “global value chains” (Kaplinsky 2000).


Global production networks


Henderson et al. (2002) define global production networks as “the globally organized
nexus of interconnected functions and operations by firms and non-firm institutions
through which goods and services are produced and distributed”. The concept has
many predecessors, ranging from value chains, supply chains, global commodity chains,
clusters, and actor-network theory.


The most recent and relevant of these is Gereffi’s concept of the global commodity
chain. The “Manchester School” of researchers, including Neil Coe, Peter Dicken, Jeffrey
Henderson, Martin Hess, Khalid Nadvi, and Henry Wai-chung Yeung, among others,
have done much work to advance the concept. Together, they have expanded upon
the global commodity chain framework by moving beyond a governance focus and by
altering the nomenclature of the “commodity chain” to the “production network”, to be
more inclusive. Also significant is the work by Dieter Ernst done on global production
networks, developed simultaneously but independently. Ernst conceptualised GPNs as
an organisational innovation that “combine(s) concentrated dispersion of the value chain
across firm and national boundaries, with a parallel process of integration of hierarchical
layers of network participants” (Ernst and Kim 2001: 1).




Supply chains in the business literature


44 Supply Chain Perspectives and Issues


Global commodity chains


Global commodity chains (GCCs) are defined as “sets of inter-organizational networks
clustered around one commodity or product, linking households, enterprises, and states to
one another within the world-economy. These networks are situationally specific, socially
constructed and locally integrated, underscoring the social embeddedness of economic
organization” (Henderson et al. 2002; Gereffi 1994). GCCs are distinct from the early value
chain concept in their explicit international dimension and focus on governance structure
within the chain. Governance in GCCs is characterised as either producer-driven or buyer-
driven, and acknowledges the significant influence that lead firms exert on the structure and
operations of the rest of the chain (Gereffi et al. 2001; Kaplinsky and Morris 2002).


The GCC concept was developed in the mid-1990s by Gary Gereffi and Miguel Korzeniewicz,
along with Dieter Ernst, John Humphrey, and Hubert Schmitz, among others. The concept
was heavily influenced by Wallerstein’s world-system framework and the structuralist and
dependency paradigms of the 1970s and 1980s.


GCCs are an attempt to render these paradigms operational in order to understand
modern forms of industrial organisation. In taking a global network approach, GCCs
include a comprehensive range of organisations and elements significant to economic
and social development. By rising above state-centric analysis to recognise the
significance of inter firm networks and corporate power, GCCs have enabled analysis that
reveals previously unrecognised restrictions on firm development and, by correlation,
economic and social development.


The studies have provided insights into a wide range of issues, including upgrading,
market expansion, and trade patterns, as well as industries, such as footwear, garments,
electronics, horticulture, and tourism. Furthermore, the analysis produces prescriptive
results that hold value for policy formulation (Henderson et al. 2002; Hess and Yeung 2006;
Gereffi, Humphrey, and Sturgeon 2005).


The GCC concept does encounter some criticism, particularly from global production
network research, which attempts to build on the GCC concept. First is the high level of
aggregation found in GCCs, both in geography, which is split between core and periphery,
and governance, which is split into buyer-driven and producer-driven chains. In addition,
the latter split is acknowledged to be representative of some empirical realities, but is
not necessarily universally applicable. Secondly, the emphasis on the role of inter-firm
governance is seen to come at the expense of overlooking the significance of institutions
and other external governance factors in GCCs. Thirdly, GCCs do not take into account
path dependencies and firm ownership in their analysis. Finally, the perspective carried
forth in GCCs attribute firm trajectories largely as a result of the exogenous network
environment, and gives little credit to independent, endogenous firm efforts (Hess and
Yeung 2006; Henderson et al. 2002).


Filière


Filière, meaning “thread” in French, is a concept very similar to value chains that originates
from the French literature. The concept analyses production as the flow of goods and
services across a system of agents (Kaplinsky and Morris 2002; Henderson et al. 2002).




45Supply Chain Perspectives and Issues


The concept was first developed by French scholars in the 1960s and 1970s to understand
the economic processes within production and distribution, and to map commodity flows
across agents and activities. Early studies focused on the structure of French agriculture,
and were applied to agricultural policy and then industrial policy in the 1980s. More recent
work integrates an element of political economy in its considerations of public institutions.
(Kaplinsky and Morris 2002; Gereffi et al. 2001).


Kaplinsky and Morris (2002) and Henderson et al. (2002) identify some differences in the
filière concept, in that the time and international dimensions are lacking, being focused on
static domestic scenarios, with its emphasis on the role of large firms and state institutions
(if this infers a critique based on the lack of SME coverage, much the same could be said
about SCM, too).


2.1.2 The firm perspective


Among the many descriptions referring to the interconnected nature of firms today, we
choose to proceed with “supply chains” for two reasons: (1) it best represents the firm’s
perspective in the complex system dynamics of the international economy, and (2) it is
the term of choice for the majority of business-relevant research, such as management
science and operations research.


In their seminal paper, Mentzer et al. (2001) merges preceding definitions of a supply
chain to produce the following: “a supply chain is defined as a set of three or more entities
(organisations or individuals) directly involved in the upstream and downstream flows
of products, services, finances, and/or information from a source to a customer.” For the
purposes of this chapter, this is also the definition we adopt moving forward.


2.1.3 Conceptualising supply chains


In studying the supply chain, one constantly encounters the methodological challenge of
defining boundaries among the many interconnections of a network. Mentzer’s definition
is purposefully open-ended in allowing as many actors as may exist in between the focal
firm and the ultimate source/consumer.


Whereas early conceptions of the supply chain focused on the flow of goods from supplier
to manufacturer, distributor, and end user, supply chains are now recognised as covering the
dirt to dirt source of earliest supply to end consumption (Cooper, Lambert, and Pagh 1997).
Furthermore, Mentzer et al. (2001) point out that “any one organization can be part of numerous
supply chains. Wal-Mart, for example, can be part of the supply chain for candy, for clothing,
for hardware, and for many other products. This multiple supply chain phenomenon begins
to explain the network nature that many supply chains possess. For example, AT&T might find
Motorola to be a customer in one supply chain, a partner in another, a supplier in a third, and
a competitor in still a fourth supply chain.” In order to handle such complexities, some basic
typologies of supply chains have been proposed. These typologies classify supply chains
according to either organisational or functional scope.


The organisational scope of supply chains begins by classifying according to degrees of
separation from the focal firm (Figure 2.1). A “direct supply chain” encapsulates the focal
firm and its immediate suppliers and customers. An “ultimate supply chain” includes all
the organisations involved upstream and downstream relative to the focal firm until the




Supply chains in the business literature


46 Supply Chain Perspectives and Issues


ultimate supplier(s) and ultimate consumer(s) is reached. Anything in between the direct
supply chain and ultimate supply chain in scope can be referred to as an “extended supply
chain” (Mentzer et al. 2001).


Figure 2.1: Classification of the organisational scope of supply chains


Source: Mentzer et al. (2001)


The nature of the organisation is also classified as either primary or supporting. Primary
organisations directly add value to the specific output to be consumed. Supporting
organisations add value indirectly by supporting the primary organisations. In addition,
organisations can be grouped according to the number of degrees of separation from the
focal firm, such as the “Tier 1” and “Tier 2” groupings in Figure 2.2.


Figure 2.2: Organisational tiers based on degrees of separation in the supply chain


Source: Lambert and Cooper (2000)


Figure 2.1 Classication of the organisational scope of supply chains. (Mentzer et al. 2001)


FIGURE 1a - DIRECT SUPPLY CHAIN


FINANCIAL
PROVIDER


THIRD PARTY
LOGISTICS SUPPLIER


FIGURE 1b - EXTENDED SUPPLY CHAIN


FIGURE 1c - ULTIMATE SUPPLY CHAIN


MARKET
RESEARCH FIRM


SUPPLIER ORGANIZATION CUSTOMER
CUSTOMER’S
CUSTOMER


SUPPLIER’S
SUPPLIER


. . .


SUPPLIER ORGANIZATION CUSTOMER


. . .


SUPPLIER ORGANIZATION CUSTOMER . . .. . .ULTIMATESUPPLIER
ULTIMATE


CUSTOMER


Figure 2.2 Organisational tiers based on degrees of separation in the supply chain. (Lambert and Cooper 2000)


Tier 3 to
Initial


suppliers
Tier 2


Suppliers
Tier 1


Suppliers
Tier 1


Customers
Tier 2


Customers


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Focal Company Members of the Focal Company’s Supply Chain




47Supply Chain Perspectives and Issues


The number of tiers describes the horizontal structure of the supply chain, which may
be long or short. The vertical structure of the supply chain refers to the number of
organisations within each tier. These allow some orientation of the organisation within
the supply chain, such as in describing the horizontal position of the focal firm relative to
the ultimate supplier or customer (Lambert and Cooper 2000).


The supply chain also has a functional scope. This covers the business processes that span
the supply chain, and can cover functions as varied as marketing, product development,
customer service and operations (Arshinder and Deshmukh 2008; Cooper, Lambert, and
Pagh 1997).


Whereas no standard template of business functions is found, the processes undertaken
can be classified as one of four types: a managed process link, a monitored process link,
a not-managed process link, or a non-member process link.


A managed link is critical to the focal firm, whereas a monitored link may only require
auditing or little intervention. Not-managed links are not critical enough to require
attention and/or are trusted by the focal firm to independently deliver. Finally, non-
member process links are with organisations in other supply chains that still influence
the performance of the supply in question, such as when a supplier works with the focal
firm’s competitor (Lambert and Cooper 2000).


2.2 Supply chain management


2.2.1 A brief history


Birth of the idea


The origins of supply chain management are not exactly known, but there is general
reference to its introduction by consultants in the early 1980s. In the decades since, it
has received considerable attention, initially starting within the business community. From
the early 1990s, academic research started following supply chains and tried to establish
some theoretical structure (Cooper, Lambert, and Pagh 1997; Lambert and Cooper 2000;
Croom, Romano, and Giannakis 2000).


SCM’s antecedents


Part of the reason the start of supply chain management is difficult to pin down is because
of its many antecedents. These include channels research in the 1960s on managing inter-
organisational operations, systems integration research in the 1960s, and information
sharing in the 1980s.


Forrester is commonly cited for introducing key ideas on industrial dynamics, physical
distribution, and transportation in the late 1950s and early 1960s (Mentzer et al. 2001;
Croom, Romano, and Giannakis 2000; Cooper, Lambert, and Pagh 1997). In fact, Mentzer et
al. (2001) start their paper with the following citation from 1958 that very much foreshadows
supply chain management today: “Management is on the verge of a major breakthrough in
understanding how industrial company success depends on the interactions between the
flows of information, materials, money, manpower, and capital equipment. The way these
five flow systems interlock to amplify one another and to cause change and fluctuation




Supply chains in the business literature


48 Supply Chain Perspectives and Issues


will form the basis for anticipating the effects of decisions, policies, organizational forms,
and investment choices.” (Forrester 1958, p. 37).


Drivers


This variety of antecedents and approaches is not surprising, however, as the 1960s
and onwards witnessed significant shifts in industrial organisation in the international
economy. Many fields were documenting the phenomenon that we now refer to as supply
chains. Before examining the variety of fields, however, we look at the drivers of this
structural shift.


The introduction of Manufacturing Resource Planning in the 1970s drove a transition
from the economies of scale and mass production philosophy to the superior just-in-time
(JIT) and flexible specialisation production philosophy. JIT is a demanding philosophy
to implement, however, with rigorous requirements on speed, minimal inventory, and
consistency. Furthermore, international labour arbitrage through global sourcing enabled
lower costs but introduced firms to a new world of operational challenges. Faced with the
challenge of coordinating an increasingly complex influx and outflow of materials, firms
began to realise the importance of buyer-supplier relationships.


Concurrently, intense global competition in the 1980s expanded the new competitive
requirements in cost to time and quality, as well. This necessitated improved downstream
coordination with suppliers and distributors, and spurred research efforts in integrated
transportation and logistics management. Combined, these factors gave rise to the
popularity of supply chain management and its establishment as an academic discipline
(Mentzer et al. 2001; Tan 2001).


Plurality of disciplines and terms


Efforts to research the rising supply chain phenomenon came from a plethora of firm-
oriented disciplines. In an effort to categorise these, we distinguish between function-
oriented and organisation-oriented disciplines. Amongst the function-oriented disciplines
are purchasing and supply literature, logistics and transportation, and marketing. In
the organisation-oriented disciplines, we find industrial organisation, transaction cost
economics, institutional sociology, and systems dynamics, among others (Croom, Romano,
and Giannakis 2000; Tan 2001; Melo, Nickel, and Saldanha-da-Gama 2009).


As a result, a wide variety of terms relating to the supply chain concept have also arisen
over the past few decades. These include network sourcing, supply pipeline management,
demand chain management, value chain management, and value stream management.
They can be found in discussions amongst academics, consultants, or business
management. (Croom, Romano, and Giannakis 2000). Of these, the purchasing/supply and
logistics/transportation literature were the most prevalent with business, and out of the
many terms, supply chain management rose in recognition.


Consolidation


The rise of supply chain management by the late 1980s and its embodiment of so many
concepts resulted in a problem of definitions in the 1990s. Literature from this period laments




49Supply Chain Perspectives and Issues


that the term is used so often that the meaning is lost (Tan et al. 1998a; New 1997; La Londe
and Masters 1994; Tan 2001; Davis 1993; Ross 1998; Mentzer et al. 2001).


Moreover, SCM was only increasing as a concept of real relevance and as a popular topic
(Cooper, Lambert, and Pagh 1997; La Londe 1997; Mentzer et al. 2001). The late 1990s
gave rise to the recognition that clear definitions and conceptual frameworks on SCM
were needed (Saunders 1995, 1998; New 1995; Cooper, Lambert, and Pagh 1997; Babbar
and Prasad 1998; Croom, Romano, and Giannakis 2000).


This period saw much consolidation and maturation of SCM as a theoretical construct.
For example, whereas the Council of Logistics Management viewed SCM as a type of inter-
firm logistics in 1986, they revised their definition in 1998 to declare logistics management
as a subset of SCM.


Other fields, such as operations research, may have started their investigations of the
supply chain phenomenon independently, but then merged their efforts into SCM
afterwards (Lambert and Cooper 2000; Melo, Nickel, and Saldanha-da-Gama 2009). This
consolidation culminated by the late 1990s and early 2000s with the seminal works of
Cooper, Lambert, Mentzer, and their associates (Cooper, Lambert, and Pagh 1997; Lambert,
Cooper, and Pagh 1998; Lambert and Cooper 2000; Mentzer et al. 2001).


2.2.2 The supply chain management framework


SCM as a management framework is now at a stage where the definitions, subject,
purpose, and perspective are largely unified. These common grounds emerged from the
multidisciplinary sources of SCM, and researchers have leveraged these commonalities
to consolidate the plurality of frameworks on SCM. However, there is still variance when it
comes to the operational concepts and, correspondingly, the operational implementation
of SCM. We review some of the most widely cited unifying frameworks of SCM.


Stadtler (2005) and Mentzer et al. (2001) both present definitions of SCM that integrate the
many found in their respective literature reviews:


“Supply chain management (SCM) is the task of integrating organizational units along a
SC and coordinating materials, information and financial flows in order to fulfil (ultimate)
customer demands with the aim of improving competitiveness of the SC as a whole.”
(Stadtler 2005).


“…supply chain management is defined as the systemic, strategic coordination of the
traditional business functions and the tactics across these business functions within a
particular company and across businesses within the supply chain, for the purposes of
improving the long-term performance of the individual companies and the supply chain
as a whole.” (Mentzer et al. 2001).


These definitions and their predecessors view the target subject of SCM as the supply
chain, consisting of two subcomponents: (1) the organisations that make up the structure
of the supply chain, and (2) the processes that make up the flows across the supply chain.
The purpose of SCM is to increase competitiveness of the supply chain through improved
customer service. The perspective is unequivocally network-based, attaching significance
not only to the firm’s “nodes” that compose sectors of the international economy, but also
to the relationships between those nodes.




Supply chains in the business literature


50 Supply Chain Perspectives and Issues


As Burgess, Singh and Koroglu (2006) note, the operational concepts in SCM tend to
be classified into general categories or constructs. We present our selection of these
classifications in reverse chronological order in order to start with a recent example and
then show the patterns of inheritance across predecessors (Table 2.1).


Table 2.1: Classification of operational constructs for supply chain management


SCM operational constructs
Burgess, Singh, and Koroglu (2006) soft constructs leadership


intra-organisational relationships
inter-organisational relationships


hard constructs logistics
process improvement orientation
information systems
business results and outcomes


Stadtler (2005) integration of organizational units choice of partners
network of organisations
leadership


coordination of flows information and communication technology
process orientation
advanced planning


Chen and Paulraj (2004) environmental uncertainty
customer focus
top management support
supply strategy competitive priorities


strategic purchasing
information technology
supply network structure
managing buyer-supplier relationships supplier base reduction


long-term relationships
communication
cross-functional teams
supplier involvement


logistics integration
supply chain performance measurement supplier performance


buyer performance
Mentzer et al. (2001) integrated behavior


mutually sharing information
mutually sharing risks and rewards
cooperation
the same goal focus on serving customers
integration of processes
long-term relationships with partners


Lambert and Cooper (2000) physical and technical components planning and control
organizational structure
product flow facility structure
information flow facility structure


managerial and behavioral components management methods
power and leadership structure
risks and rewards
culture and attitude




51Supply Chain Perspectives and Issues


Underlying the various classifications is a fundamental body of operational issues that is
closely shared across the classifications. Variance is found, however, in the terminology
and framing of the issues. The true test, then, of the validity of the varying classifications
will be in their explanatory ability in the academic setting or their prescriptive utility in
the operational setting. For this, further empirical studies are needed to test and refine the
various operational constructs proposed.


2.3 Future directions


While supply chains and supply chain management have made significant progress in
maturing as its own field or paradigm of thought, the state of the literature is in need of
empirical research to test and refine the new theories born in the past decade. As Lambert
and Cooper (2000) note, supply chain management theory tends to follow, rather than
inform, business practice. Empirical research would enable progress on the prescriptive
works that will ultimately define the literature’s utility to the business practitioner and
narrow the divide between theory and application.


Figure 2.3: Articles concerning the supply chain


Source: Croom, Romano, and Giannakis (2000)


In terms of the specific paths of theoretical development, two approaches have been
observed and are expected to continue.


The first is to fragment the breadth of supply chain management issues into more
manageable portions, and then to develop theory in relation to that specific issue.
Examples of this can be seen in the emergence of sustainable supply chain management
(SSCM) and supply chain risk management (SCRM).


The second approach is to retain a broad conceptual stance and to integrate the theories
being developed from many different perspectives. This is the approach taken in Mentzer


PRESCRIPTIVE DESCRIPTIVE


THEORETICAL 6% 11%


EMPIRICAL 27% 56%




Supply chains in the business literature


52 Supply Chain Perspectives and Issues


et al. (2001) and Lambert and Cooper’s (2000) foundational works. Both will be required to
recursively drive the theoretical development of supply chain management.


2.4 References


Arshinder, Arun Kanda and S.G. Deshmukh. 2008. “Supply chain coordination: perspectives,
empirical studies and research directions”,, International Journal of Production Economics,
115(2): 316-335.


Burgess, Kevin, Prakash J. Singh, and Rana Koroglu. 2006. “Supply chain management: a
structured literature review and implications for future research”,, International Journal of
Operations & Production Management, 26(7): 703-729.


Chen, Injazz J. and Antony Paulraj. 2004. “Towards a theory of supply chain management: the
constructs and measurements”,, Journal of Operations Management, 22(2): 119–150.


Cooper, Martha C., Douglas M. Lambert, and Janus D. Pagh. 1997. “Supply chain management:
more than a new name for logistics”, The International Journal of Logistics Management,
8(1): 1-14.


Croom, Simon, Pietro Romano, and Mihalis Giannakis. 2000. “Supply chain management:
an analytical framework for critical literature review”, European Journal of Purchasing &
Supply Management, 6(1): 67-83.


Dicken, Peter. 1986. “Global Shift: Industrial Change in a Turbulent World”, Harper and
Row: London.


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53Supply Chain Perspectives and Issues


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D. Smith, and Zach G. Zacharia. 2001. “Defining supply chain management”,, Journal of
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Part II


Supply Chain Issues




55Supply Chain Perspectives and Issues


Abstract


The shuffle of jobs offshore (or back onshore) has caught the attention and concerns of
policy makers. The structural shifts in industrial structures are creating new winners and
losers. Unskilled labour-intensive parts of the manufacturing production process have
been increasingly offshored by advanced country firms to relatively unskilled labour-
abundant developing economies. This “offshoring” phenomenon is expected to reduce
jobs for low- and semi-skilled workers in advanced economies while increasing them in
developing economies. At the same time, resulting productivity increases in advanced
economies can raise the demand for native workers – at least in complementary tasks.
The empirical literature suggests that fears of job-losses due to offshoring in advanced
economies are often exaggerated – restricted largely to the short-run. Policy makers
can address these concerns through strengthening social safety nets in the short run
and instituting skills-upgrading programmes to create a more flexible labour force in
the long run. Greater challenges lie ahead for these policy makers, with an increasing
number of services jobs being offshored from developed to developing economies.
Even in developing economies, services offshoring can worsen inequality by raising
skill premiums, thereby making investment in education equally crucial there. Looking
ahead, given increasing wages in certain developing economies, increasing transport
costs, new technologies and concerns about separating R&D from manufacturing
activities, there is a possibility of a large number of manufacturing and services tasks
returning to advanced economies.


3.1 A brief history of offshoring and outsourcing


3.1.1 Definitions


Before beginning our discussion on offshoring and outsourcing, we must first lay down
the conceptual boundaries of the two terms. Figure 3.1 illustrates a basic framework
describing the changes that define the two terms.


Chapter 3
Supply chains and offshoring




Supply chains and offshoring


56 Supply Chain Perspectives and Issues


Figure 3.1: Movement of activities in offshoring and outsourcing


Source: Miroudot (2009)


Outsourcing describes when firms decide to buy products or services from external
vendors, as opposed to making them in house. This is referred to as the firm’s “make or
buy” decision (Sako 2006; Contractor et al. 2010). While movement towards making more
in house can be described as vertical integration, movement towards the “buy” decision
is described as outsourcing. Outsourcing is used both with and without geographical
constraints in the literature. In some cases, outsourcing describes the sourcing of
products and/or services from external firms within the same country, while in others,
outsourcing can also involve external firms in foreign countries (sometimes referred
to as “international outsourcing”). Regardless of the geographical boundaries, the key
component of outsourcing is that a previously internal activity is now being sourced from
an external firm.


Offshoring is defined by firm activities being geographically relocated from the firm’s
domestic country to a lower-cost foreign country (Sako 2006; Farrell 2004; Levy 2005;
Conductor et al. 2010). In contrast to outsourcing’s relocation of value chain activities
across organisational boundaries, offshoring entails the relocation of value chain
activities across geographical boundaries. However, there is variation as to whether
offshoring activities are, by definition, kept in-house (see Marin 2006; Miroudot, Lanz,
and Ragoussis 2009), or whether they may also be outsourced to another firm (see Sako
2006; Contractor et al. 2010). A compelling distinction is offered by the WTO and the
Institute of Developing Economies, Japan External Trade Organization (IDE, JETRO) (2011),
wherein offshoring is used to refer to intra-firm trade and foreign direct investments (FDI),
while international outsourcing is used to refer to arm’s length sub-contracting. Thus,


Geographical
location


Organisational
location


domestic abroad


within
the rm


outside
the rm


outsourcing oshoring
or international


outsourcing


oshoring


Figure 3.1 The movement of activities entailed in oshoring and outsourcing, adapted from Miroudot (2009)




57Supply Chain Perspectives and Issues


the movement of activities to the bottom right-hand quadrant in Figure 3.1 is labelled as
offshoring when the recipient firm of the activities received FDI (such as mergers and
acquisitions or “greenfield” investment) from the source firm of the activities, while non-
FDI-related relationships (i.e. arm’s length relationships) are referred to as international
outsourcing. The two different types of relationships hold consequences for the level of
technology transfer, investment, trade, and development of involved firms and countries.


Recently, questions as to the real benefits of offshoring, plus the political controversy
surrounding the practice, have led to alternate modes of activity relocation. These
have been assigned a new body of terms, and include the return of activities back to
their original country (referred to as re-shoring, in-shoring, or on-shoring) and the
reincorporation of activities into the focal firm (in-sourcing).The faster turnaround times
and strategic benefits of geographically shorter supply chains have also produced the
term “near-shoring”. Appearing in recent literature from the last five years, it is yet to be
seen how these terms will develop (or disappear) in the future.


3.1.2 Historical development


The basic driver of offshoring and outsourcing is lower cost. The economic divergence
between the global “North” and “South” through the first part of the 20th century set
the stage for the cost savings reaped by firms, starting in the second half of the
20th century. With wages in developing countries at a fraction of the cost of wages in
developed countries, the potential savings to be reaped from labour arbitrage grew with
economic divergence. What triggered the realisation of these savings, however, were the
technological innovations and regulatory environment that drastically lowered the costs
of doing business across firm and country boundaries. Organisational innovation then
arose to capture the possibilities created through these economic enablers, driving the
growth of supply chains. This, in turn, increased the importance for firms to specialise in
order to compete, driving the increasing outsourcing of non-essential activities.


This rise of offshoring and international outsourcing, by enabling the more optimal
utilisation of country’s comparative advantage results in a win-win situation. Developing
countries – particularly the East Asian economies – took this opportunity to industrialise,
while developed countries saw the replacement of industry jobs with higher value-added
service jobs. However, continued advances in technological and firm capabilities, in
conjunction with general changes in the international economy, have created significant
issues for 21st century offshoring.


The rapid expansion of supply chains across country and firm boundaries give rise to
increased risks associated with offshoring and outsourcing activities.


In addition, the 21st century has seen continued information and communication
technology advances that have created a problem for developed countries. While in the
20th century, fears of unemployment were assuaged by the creation of service sector jobs,
service jobs are no longer immune to offshoring. Policy makers are therefore facing an
increasingly contentious political issue, where the current geography of global supply
chains has created fears of increasing unemployment and disappearing industrial
capabilities (Blinder 2006).


Geographical
location


Organisational
location


domestic abroad


within
the rm


outside
the rm


outsourcing oshoring
or international


outsourcing


oshoring


Figure 3.1 The movement of activities entailed in oshoring and outsourcing, adapted from Miroudot (2009)




Supply chains and offshoring


58 Supply Chain Perspectives and Issues


3.2 For the business practitioner


3.2.1 Disappointment


Beginning this section with a subheading on “disappointment” may seem strange in
contrast to the touted benefits of offshoring, but many business practitioners may be able
to associate with this sentiment. At the turn of the new millennium, offshoring was viewed
as a necessity for manufacturers and those dependent on manufacturing to compete
(Ferreira and Prokopets 2009).


The economic rationale was straightforward – why pay US$20 per hour for a worker in the
US when you could pay US$2 per hour for a worker in India? By moving activities abroad,
businesses could expect to cut costs by up to 70 percent (Farrell 2004). However, the real
cost savings often fell short of expectations, with 50 percent of firms failing to generate the
expected financial benefits of offshoring (Aron and Singh 2005).


As a result, a central research theme emerged in the literature in trying to understand
why offshoring was not working. While initial studies such as Farrell (2004) and Aron and
Singh (2005) point to shortcomings in implementation, later studies point to a changing
economic equation (Ferreira and Prokopets 2009; Goel, Moussavi, and Srivatsan 2008;
Roztocki and Fjermestad 2005). We start by reviewing the arguments behind each.


Arguments based on shortcomings in implementation point to the need for a more careful
consideration of what activities to offshore and an expanded conception of what offshoring
entails. First is the reality that the potential benefits of offshoring vary according to
the extent of globalisation across industries (Farrell 2004). The offshoring success
stories associated with electronics and apparel, for example, may lead practitioners to
overestimate the potential benefits that they may see in lesser globalised industries (say,
those with higher regulatory barriers or prohibitive transportation costs, for example).


Secondly, overly simplistic considerations of offshoring may be to blame. Offshoring
requires a granular and systematic approach when considering which activities to
offshore and how to redesign processes to capture the potential benefits. Simply offshoring
sections of current business activities is not sufficient, nor sustainable; practitioners must
disaggregate and redesign their processes in order to capture the benefits (Aron and
Singh 2005; Farrell 2004; Roztocki and Fjermestad 2005).


Furthermore, offshoring entails more than just labour arbitrage. In addition to the benefits
to be seen in process reengineering, practitioners should also consider opportunities
for revenue growth associated with offshoring – and how to capture those opportunities
(Aron and Singh 2005; Farrell 2004).


Another set of arguments arose with the shifting economic climate during the latter
part of the 2000s. By this point, the literature seems to concede that the real benefits
of offshoring were never as high as they were thought to be; in part, this has been due
to the overlooked costs and risks associated with globally dispersed firm activities.
Expectations of cost savings, estimated at around 25 to 40 percent, were in reality around
5 to 15 percent (Ferreira and Prokopets 2009). These costs and risks came to the forefront
when practitioners found themselves facing a falling dollar, combined with rising costs of
oil, commodities, and wages.




59Supply Chain Perspectives and Issues


From 2000 to 2008, costs for shipping a container tripled due to the price of oil. From
2003 to 2008, wages in China rose by 19 percent on average, year on year; and from
2005 to 2008, global commodity prices increased by 27 percent while the value of the US
dollar fell 18 percent relative to the Chinese Renminbi (Ferreira and Prokopets 2009; Goel,
Moussavi, and Srivatsan 2008). These drastically shifted the cost savings equations for
offshoring, inciting doubts of its viability and a plethora of new terms such as in-sourcing,
in-shoring, on-shoring, re-shoring and near-shoring.


The positive outcome of this reset in expectations, however, is the advancement of
concepts and tools to help business practitioners more accurately estimate and capture
the benefits of offshoring.


3.2.2 Offshoring and outsourcing reconsidered


When overlaying the advised approaches to offshoring in the literature, we emerge with
three distinct phases of analysis for the business practitioner: (1) analysis of industry
globalisation; (2) analysis of value chain reconfiguration; and (3) analysis of complementary
growth opportunities.


Farrell (2004) stresses that the potential gains of offshoring are first determined by
the extent of globalisation found in the relevant industry. Industries that are still in the
early stages of globalisation may not have the technological infrastructure and global
resources to make offshoring feasible and profitable. The extent of globalisation is affected
by technical limits in the ability to disaggregate value-added activities, the regulatory
environment, and organisational attitudes to change. To guide practitioners on the
opportunities and limitations to be found in adding different levels of globalisation, Farrell
presents five stages for global industrial restructuring (Figure 3.2).


Figure 3.2: Stages of global restructuring and consequences of offshoring


Source: Farrell (2004)


If the industry sector presents attractive terms for offshoring, the next phase of analysis is
to consider the optimal value chain configuration to capture gains.


The first step is to take a more disaggregated view of firm activities. Aron and Singh (2005)
and Contractor et al. (2010) both propose the classification of activities as core, critical (or
essential), and commodity (or non-core) activities.


Core activities are to be kept in-house and represent the strategic core competencies for
a business. Critical activities are areas of the value chain that a business does not wish


Enter New
Markets


Move Production
Abroad


Disaggregate
the Value Chain


Reengineer
the Value Chain


Create New
Markets1 2 3 4 5


Companies use
production models
similar to the ones
they deplay at home
to enter new countries
and expand their
customer bases.


Companies relocate
their entire production
processes to take
advantage of cost
dierentials; they
export nished goods
globally.


Companies’ individual
product components
are manufactured
in dierent locations
or regions; countries may
specialize in component
manufacturing, assembly,
or both.


Companies redesign
their production
processes, taking local
factors into account
to maximize eciencies
and cost savings.


Given lower costs
due to globalization
companies can
oer new products
at lower prices and
can penetrate new
market segments or
geographics, or both.


LESS GLOBAL HIGHLY GLOBAL


Figure 3.2 Five stages of global industrial restructuring and their consequences of oshoring, from Farrell 2004




Supply chains and offshoring


60 Supply Chain Perspectives and Issues


to specialise in but is highly dependent on. Critical activities can be outsourced and/
or offshored, but require trusted or highly reputable partners. Commodity activities are
standardised tasks that can be easily sourced from a market of vendors. These are highly
attractive for outsourcing and offshoring. To aid in the assignment of classifications, Aron
and Singh (2005) suggest ranking activities by value creation and value capture before
categorisation (Figure 3.3).


Figure 3.3: Ranking activities by value-creation and value-capture


Source: Aron and Singh (2005)


As business managers have come to realise, outsourcing and offshoring are associated
with hidden risks and costs that need to be included in the net cost equation. Risks
include exchange rate and factor cost fluctuation, reduced transparency, slower response
times, and intellectual property theft. Costs include one-time sunk costs from offshoring
implementation and local import and tax implications (Farrell 2004; Ferreira and Prokopets
2009; Goel, Moussavi, Srivatsan 2008). Ferreira and Prokopets (2009) provide a framework
for considering costs in Figure 3.4, and a more thorough consideration of the supply chain
risks incurred from offshoring and outsourcing can be found in Chapter 5.


Figure 3.4 Cost elements to consider when oshoring/outsourcing, from Ferreira and Prokopets 2009


Best Practice Elements of a Total Cost Model


Source: Archstone Consulting


Supplier Price
and Terms


Supplier Unit Price


• Direct Material
• Direct Labor
• Indirect Labor
• Management
• Overhead
• Capital Amortization
• Local Taxes
• Manufacturing


Expenses
• Local Regulatory


Compliance Costs


Terms


• Net Payment Terms
• Volume Discounts
• Free Goods


Delivery Costs


Logistics Costs


• In-Country
Transportation


• Ocean/Air Freight
• Destination Transport
• Packaging


Region/Country
Specif ic Costs


• Customer Duties
• Value-Added Taxes


Operations
Quality & Costs


In-Plant Material
Inventory


• Intra-Plant Demand
• Safety Stock


+ + +
In-Plant Material


Inventory
• In-Plant Handling
• Plant Warehouse


Operations and
Overhead


Other Costs


Standard


• Risk
• Qualification
• Local Tax Incentives


Customer Specif ic


• Unique Services
• Unique Capabilities


Situational


• Procurement Staff
• Broker Fees
• Infrastructure


(IT, Facillities)
• Exchange Rate Trend
• Skills Training
• Tooling/Molds


Supply Chain


• Inventory Maintained
in the Supply Chain


• Satellite Warehouse
Operations/Overhead


Cost of Quality


• Quality Validation
• Quality Communications
• Performance Impact
• Incremental Remedies


Process Value-creation
ranking*


Value-capture
ranking*


Total
ranking


Float management
for suppliers and dealers 1 1 2 Processes


the company
shouldn’t
offshore


Working capital
management 2 3 5


Cash-flow forecasting 4 2 6


Revenue and
expense reporting 3 4 7


Processes
the company
might offshore


Payment authorization 5 5 10


Invoice verification 6 6 12


* Determined by executive consensus


}


}




61Supply Chain Perspectives and Issues


Figure 3.4: Best practice elements of a total cost model


Source: Ferreira and Prokopets (2009)


With a better understanding of the real costs and risks associated with offshoring and
outsourcing, the business manager must now make a decision on their optimal disaggregation
and dispersion of tasks in conjunction with potential organisational forms (see Figure 3.5).


With offshoring in multiple countries, managers must also tailor the mix of capital investment
and labour costs to each market (Contractor et al. 2010; Farrell 2004). Aron and Singh (2005)
provide a decision framework based on risks in considering operational options (Figure 3.6).


Figure 3.5: Concept of optimising disaggregation and dispersion of tasks


Source: Contractor et al. (2010)


Figure 3.4 Cost elements to consider when oshoring/outsourcing, from Ferreira and Prokopets 2009


Best Practice Elements of a Total Cost Model


Source Archstone Consulting


Supplier Price
and Terms


Supplier Unit Price


• Direct Material
• Direct Labor
• Indirect Labor
• Management
• Overhead
• Capital Amortization
• Local Taxes
• Manufacturing


Expenses
• Local Regulatory


Compliance Costs


Terms


• Net Payment Terms
• Volume Discounts
• Free Goods


Delivery Costs


Logistics Costs


• In-Country
Transportation


• Ocean/Air Freight
• Destination Transport
• Packaging


Region/Country
Specif ic Costs


• Customer Duties
• Value-Added Taxes


Operations
Quality & Costs


In-Plant Material
Inventory


• Intra-Plant Demand
• Safety Stock


+ + +
In-Plant Material


Inventory
• In-Plant Handling
• Plant Warehouse


Operations and
Overhead


Other Costs


Standard


• Risk
• Qualification
• Local Tax Incentives


Customer Specif ic


• Unique Services
• Unique Capabilities


Situational


• Procurement Staff
• Broker Fees
• Infrastructure


(IT, Facillities)
• Exchange Rate Trend
• Skills Training
• Tooling/Molds


Supply Chain


• Inventory Maintained
in the Supply Chain


• Satellite Warehouse
Operations/Overhead


Cost of Quality


• Quality Validation
• Quality Communications
• Performance Impact
• Incremental Remedies


Figure 3.5 Concept of optimizing disaggregation and dispersion of tasks, from Contractor et al. 2010


High


Global firm value


Low


Little


Little


Much


Much
Disaggregation


Dispersion




Supply chains and offshoring


62 Supply Chain Perspectives and Issues


Figure 3.6: Choosing the right organisational arrangement


Source: Aron and Singh (2005)


Finally, gains from offshoring should not be narrowly considered as attempts to attain
the lowest possible costs. While basic offshoring of activities can cut costs by up to 50
percent, Farrell points to another 20 percent that can be cut, in conjunction with activity
offshoring. These are attributed to gains from process reengineering (15 percent) and
better training (5 percent). They require less incremental thinking and more architecture-
level reconfiguration, along with gains from productivity of low-cost, low-skilled workers.


As against the cost consideration, practitioners should also realise new revenue
generation opportunities made available by lower costs and the ability to reach more
customers across economic tiers and country borders. In doing so, practitioners may find
that their awareness of increased costs to offshoring can be countered by new revenue
generation opportunities (Farrell 2004; Goel, Moussavi, and Srivatsan 2008).


3.3 For the policy maker


3.3.1 Economic implications of offshoring


In recent years, the focus of analysis of the trade-jobs-wages nexus has shifted towards
offshoring. This includes both arm’s length transactions with independent suppliers
abroad (often referred to as international or offshore outsourcing) and the transfer of
certain tasks within a firm to a foreign location via the establishment of subsidiaries or
affiliates (foreign direct investment). Here, labour market adjustments in response to trade


Outsource to service
provider located nearby


(nearshore)


Litigation support


Set up captive center
nearby or onshore


R&D, design


Execute process in-house
and onshore


Pricing,
corporate planning


Offshore and outsource to
service provider over time


Insurance claims
processing,


customer support


Use extended organization
offshore, but monitor closely


in real time


Supply chain coordination,
bioinformatics


Set up captive
center offshore


Equity research


Offshore and outsource
to service provider


Data entry,
transaction processing


Use extended organization
offshore


Telecollection,
technical support


Use extended organization
offshore, but conduct


frequent process audits


Customer data analysis,
market research analysis


LOW


LO
W


MODERATE


M
O


D
ER


AT
E


O
pe


ra
tio


na
l r


is
k


Structural risk


HIGH


H
IG


H




63Supply Chain Perspectives and Issues


opening occur within industries and even within firms, unlike standard models of
trade that can only explain adjustments between industries or sectors (Feenstra and
Hanson, 2001).


In industrialised countries, where unskilled labour is scarce relative to skilled labour
and capital, unskilled labour-intensive parts of the manufacturing production process
are likely to be offshored or outsourced to relatively unskilled labour-abundant
developing economies.


By substituting unskilled workers with foreign labour, offshoring or international
outsourcing enables production in advanced economies to focus on their comparative
advantage (more capital) or skilled labour-intensive tasks (Glass and Saggi, 2001). This
efficient pattern of task specialisation has a negative effect on unskilled or low-skilled
workers (Feenstra and Hanson, 2001). Some lose their jobs (Grossman and Rossi-
Hansberg, 2008) while others see their wages fall relative to those of skilled workers
(Krugman,1995; Feenstra and Hanson, 1996).


In a simple theoretical model of trade in production tasks, Grossman and Rossi-Hansberg
(2008) refer to the adverse impact of offshoring on employment in advanced economies as
the “labour supply effect” and the “relative price effect” respectively.1 Whether offshoring
affects wages or employment levels depends on a country’s labour market (Anderton et
al., 2002). Wood (2002) and Anderton et al. (2006) show that offshoring and international
outsourcing may have also affected the wage gap between moderately and highly skilled
workers. As the costs of supply chain coordination continue to fall over time, more
production shifts to developing countries, but the offshored or outsourced activities
become increasingly skill-intensive. This means that the demand for medium-skilled
workers in developed countries declines over time.


However, as the relative demand for highly skilled workers continues to rise, wage
inequality among skilled workers increases. It is therefore also possible that eventually, the
wage gap between moderately skilled and unskilled workers shrinks rather than widens
in developed countries. The recent increase in services offshoring, made possible by new
technologies and improved communications, is perhaps indicative of the theory because
it has been linked to the displacement of medium-skilled workers in advanced economies.
In addition to business process outsourcing and call-centres, financial services, higher
education services and certain health services are now being increasingly offshored,
either through arm’s length contracts or FDI, owing to improvements in technology and
rising educational levels in developing countries (Blinder, 2006).


Given these are skill-intensive activities, it is likely that such offshoring would restrain
the widening of wage inequality between skilled and unskilled labour in developed
economies. Greater competition, brought about by offshoring, could also reduce this wage
inequality by inducing firm restructuring of skill-intensive headquarters’ activity such as
management, marketing and accounting services (Ekholm and Ulltveit-Moe, 2007).


New jobs are also created in developed economies as a result of offshoring or
international outsourcing. First, the fragmentation of the production process creates the
need for coordination and supervision and thus has a direct job creating effect (Burda
and Dluhosch, 2001). Second, the cost savings associated with offshoring unskilled
labour-intensive tasks increases productivity in advanced economies, thereby raising the
demand for native workers – if not in the same tasks that are offshored, then certainly in
complementary tasks (Ottaviano, Peri and Wright, 2012; Jensen and Turrini, 2004).2




Supply chains and offshoring


64 Supply Chain Perspectives and Issues


Several recent papers have argued that this indirect productivity effect of offshoring
or international outsourcing could offset or even outweigh the displacement effect and
thereby generate an overall positive effect on the wages or employment of native workers
(Grossman and Rossi-Hansberg, 2008; Costinot and Vogel, 2010; Harrison and McMillan,
2011; Wright 2012).


The balance of these opposing effects, and hence the net impact, will depend on a number
of country-specific characteristics, such as labour market institutions (Anderton et al.,
2002). In addition, there is the possibility of indirect employment effects in two forms. If, for
example, as a consequence of the efficiency gains associated with offshoring, the firm in
question provides its services to other businesses (in the same or in another sector) at a
lower cost, they may be able to expand activities and employment.


Moreover, if offshoring or international outsourcing results in lower prices to final
consumers, some proportion of their higher real income increases will be spent on
domestically produced goods and services, thereby raising overall employment. In other
words, when offshoring occurs, there will be second-order intra- and inter-sector spillover
effects (Egger and Egger 2005). Given these factors, it becomes an empirical question as to
whether job gains will be sufficient to offset job losses in developed countries.


In developing countries, which are generally relatively abundant in unskilled labour and
hence mainly destinations of production relocation, offshoring – via arm’s length contracts
or FDI – should create jobs for unskilled labour (Arndt, 1997).


Moreover, it is possible that a job created in the ‘“South” is not just a job re-located from the
“North” – offshoring to countries with a relative abundance of labour should change the
factor mix used for production or service provision towards higher employment intensity
(Bottoni et al., 2007; Agrawal et al., 2003; Bhagwati et al., 2004).


Greater demand for unskilled workers should also result in an increase in their relative
wages, leading to decline in wage inequality. Here, it is important to distinguish between
arm’s length transactions and “greenfield” FDI on the one hand, and “mergers and
acquisitions (M&A)” FDI on the other.


While the former are likely to be associated with an increase in the quantity of labour
employed and in the level of wages, M&A FDI is only expected to affect wages. However,
it is possible that the skill content of offshored labour-intensive tasks is generally higher
than the domestic average of developing countries – activities that are considered to
involve low skills from the perspective of a developed country might well be high skilled
from the perspective of a developing country (Wood 2002; Feenstra and Hanson, 1997).


Consider the case of call centres in India, for example. Offshoring or international
outsourcing can actually increase the demand for skilled labour and thus widen the
skilled-unskilled wage differential in developing economies. It therefore has effects similar
to those of skill-biased technological change. In addition, knowledge and technological
externalities associated with offshoring may lead local firms to increase their demand for
relatively skilled labour, which, in turn, would result in an increase in the relative wage of
skilled labour and hence wage inequality (Feenstra and Hanson, 1997; Pissarides, 1997).
In this context, the distinction between offshoring via FDI and offshoring via arm’s length
contracts becomes important because the transfer of technology is likely to be associated
more strongly with the former. What is more, if foreign investment crowds out domestic
investment, this could be mainly at the expense of SMEs, the backbone of employment




65Supply Chain Perspectives and Issues


in most developing countries (Ghose, 2004). Developing countries may also begin to
compete with each other in attempting to become offshore locations for unskilled labour-
intensive manufacturing tasks. Such competition may entail greater public expenditure
in infrastructure, simplification of business regulations and procedures, and investment
incentives in the form of tax concessions.


With a trend towards maximising domestic value-added, the completion of higher value-
added activities is also likely to be characterised by competition between countries. In
principle, it is therefore possible that certain countries lose industrial production, and
therefore employment, as a consequence of fragmentation (Jones and Kierzkowski, 2001).
Capacity constraints could play a role in this regard.


Furthermore, if the quality of new jobs created is low, the positive effect of offshoring in
terms of job creation is somewhat undermined. It is argued that jobs created in local
affiliates of offshoring firms offer better working conditions than domestic firms (Olsen,
2006), perhaps owing to higher productivity levels, as well as private norms and the
obligation to sign codes of conduct.


However, the offshoring of labour-intensive tasks could reduce job quality by expanding
employment in the informal sector, which is characterised by lower wages and non-wage
employment benefits. This would happen if formal sector firms that get an offshoring
contract further subcontract the task to enterprises in the informal sector (Jansen and Lee,
2007). A downward pressure on prices and profitability, induced by increased competition
among suppliers, as more firms enter the market, may prompt firms to reduce labour costs
by subcontracting some tasks to the informal sector (Görg and Hanley, 2004).


Labour standards are another concern. There is the risk that competition for offshoring
contracts is mainly done on the basis of price, and hence countries attempt to gain a cost
advantage by lowering labour standards.


Finally, if offshoring induces local firms to specialise in the production of component parts
and final assembly, it could undermine the future development of higher value-added
production stages, and thus skill and wage upgrading (Bottoni et al., 2007). It may therefore
be insufficient for developing countries to rely on lead firms’ offshoring strategies alone in
pursuing industrial upgrading.


3.3.2 Empirical evidence for developed countries


When assessing employment effects of offshoring, either via international outsourcing
or via foreign direct investment, it worth noting several other factors, such as changes in
technology, consumers’ preferences, and business cycles affect job destruction and job
creation. Moreover, the scale of turnover in modern labour markets is quite large.


Given these factors, it is important that the job losses attributed to offshoring are
appropriately contextualised. Much of the empirical work shows that while offshoring
plays an important role in explaining changes in job status and wages, other explanations
like technological change and country specific characteristics cannot be ignored (Regev
and Wilson 2007; Ekholm and Hakkala 2006; Geishecker and Görg 2004; Morrison and
Siegel 2001) and at times are even more important (Feenstra and Hanson, 1999).


Recent empirical estimates have stirred up a great deal of public debate about the
employment impact of offshoring. For example, Timmer et al. (2012) show that the benefits




Supply chains and offshoring


66 Supply Chain Perspectives and Issues


of deepening production networks have been limited for advanced economies, as activities
intensive in the use of capital and highly skilled labour have increased, while the use of
low- and medium-skilled workers has declined.


Forrester (2004) predicts that by 2015, Europe and the United States will lose in the
order of one and three million jobs, respectively, as a result of “offshoring” to overseas
service providers. Others argue that this projection is “conservative” and estimate
that as a result of offshoring, 14 million jobs are “at risk” in the United States alone
(Bardhan and Kroll, 2003).


In contrast, some studies argue that fears about job losses in advanced economies tend to
overestimate “the likely impact of offshoring” (McKinsey Global Institute, 2003).


One crucial shortcoming of the majority of such estimates is that they only consider direct
job losses due to offshoring, and neglect both the indirect effects of employment creation
and offshoring flows in the opposite direction.


Much of the literature on the subject paints a more nuanced picture. Most studies show
that while low-skilled workers are more likely to lose, and high-skilled workers more
likely to benefit, the impact of offshoring on the domestic labour market is limited, in
quantitative terms.


The effect on jobs: industry-level studies


In a comprehensive analysis of data spanning 12 OECD countries, 26 industries, and two
years (1995 and 2000), the OECD (2007) identifies a “job destruction” effect of foreign
outsourcing, albeit a small one. It finds that a one per cent increase in offshoring results
in a 0.15 per cent decrease in employment in the manufacturing sector. These estimates
represent direct effects only.


Extending the coverage to 17 countries, Hijzen and Swaim (2007) refine the methodology
used by OECD (2007) to disentangle relocation and productivity effects. They find that in
the case of material offshoring, the productivity effect is sufficiently robust, so that new
jobs created by increased sales offset job losses due to production relocation.


In a more recent study, using the World Input-Output Database for a sample of 18 European
countries between 1995 and 2008, Foster et al. (2012) show that while offshoring has
a limited effect on cost shares in services industries, the effects on the manufacturing
industries have been relatively large, and that they impact medium-skilled workers to a
greater extent than low- and high-skilled workers.


Many industry-level studies for particular advanced economies find that material
offshoring to developing economies, measured by imports, is associated with a relative
decline in demand for low-skilled labour in advanced economies. This is reflected in
falling employment for low-skilled labour, but the magnitude of this negative effect is
quantitatively small (Anderton et al. 2002; Kucera and Milberg 2003; Falk and Wolfmayr
2005). Egger et al. (2003) show that the adverse employment effect of offshoring is
accentuated for industries with a comparative disadvantage. Others argue that when both
the displacement and scale effects are taken into account, offshoring does not have a
negative effect on manufacturing employment at the sectoral level. Amiti and Wei (2005),
for example, find that this is the case for a sample of 69 manufacturing industries in the
United Kingdom between 1995 and 2001.




67Supply Chain Perspectives and Issues


In a subsequent study on the United States, Amiti and Wei (2006) show that when a sector
is narrowly defined (to 450 sectors) and when a short time period is investigated, there
is evidence of a minor impact of offshoring on job losses. However, when a sector is
more broadly defined (to 96 sectors), and a longer time period is considered, there is
no observable link between offshoring and job loss, as both the relocation and indirect
productivity effects are picked up.


In the case of services offshoring, certain studies find that this has had little impact on
overall domestic employment in advanced economies (Amiti and Wei 2006; Van Welsum
and Reif 2006). It may be attributed to the fact that services offshoring has destroyed jobs
for low-skilled workers and created jobs for the highly skilled in about equal measures
(Crino 2006; Amiti and Wei 2006).


The effect on jobs: firm-level data


Hanson, Mataloni, and Slaughter (2003) show that offshoring to other advanced economies
increased the demand for highly-skilled workers in U.S. parent firms. In contrast, the
authors also show that offshoring to developing economies reduced labour demand for
unskilled or low-skilled workers.


This result is reinforced by the results of Harrison and McMillan (2011) who find that
“horizontal” offshoring (aimed at serving foreign markets, often other advanced economies)
stimulates domestic employment while “vertical” offshoring (setting up offshore affiliates
for trade in intermediates) aimed at producing intermediates, hurts domestic employment.


Several empirical studies using firm level data also find that material offshoring to affiliates
in low-income countries leads to significant reductions in employment levels in parent firms.
These include Görg and Hanley (2005) for the Republic of Ireland, Harrison and McMillan
(2006) for the United States and Biscourp and Kramarz (2007) for France. A potential source
of error in many of these studies, however, is that they only consider the direct, short-run
effects of offshoring and assume inter-sectoral independence (Egger and Egger, 2005).


Analysing firm-level data for Germany between 2000 and 2006, Wagner (2011) finds
that while there are no statistically, discernible effects of offshoring on employment, it
does have a strong positive effect on firm-level productivity. This suggests that possible
job losses due to offshoring (or, the relocation effect) are more than outweighed by
the increased productivity and competitiveness in the firm, which allows it to expand
employment (the scale effect).


These results relate to the medium run, being estimated for one to three years after the
event. Other studies for European countries also find no evidence for employment loss
due to offshoring of manufacturing activity (Marin 2004; Castellani et al. 2007).
For U.S. multinationals, evidence suggests that overseas expansion during the 1990s did
not displace hiring in the U.S. by these firms (Desai, Foley, and Hines, 2005; Landefeld and
Mataloni, 2004).


Similarly, using Japanese firm level data, Ando and Kimura (2007) show that manufacturing
firms expanding offshoring operations in East Asia had higher domestic employment
growth rates than other manufacturing firms.




Supply chains and offshoring


68 Supply Chain Perspectives and Issues


In the case of services offshoring, some studies find that increased imports of intermediate
services by parent firms in advanced economies did not have a significant impact on job
losses (Hijzen et al. 2007; Borga 200; Schultze 2004).


For computer and data processing services, accounting and auditing services as well
as engineering and architecture services, however, Landefeld and Mataloni (2004) find
that overseas job growth was much stronger in foreign affiliates of U.S. firms than in their
home locations. In these three sectors, domestic employment growth of multinationals
also lagged behind overall U.S. employment growth (including the non-multinationals),
thereby implying that this is not simply a reflection of cyclical factors.


In a study of services offshoring from the United States to India, Baily and Lawrence
(2004) find that while relatively low-skilled programming jobs were lost to the latter,
higher-skilled jobs of software engineers and analysts were gained in the former.


The effect on jobs: worker-level data


Using worker-level data to assess the impact of offshoring on an individual’s job security
has a number of advantages. First, it allows researchers to account for individual
characteristics, such as the age, tenure, marital status and skills of a worker, which
may play a role in job turnover. Second, relating the employment status of a worker to
outsourcing activity in the industry allows one to capture indirect effects – not what
happens to workers in the offshoring firm but what happens to all workers in an industry
that offshores intensively.


Using this approach, a number of studies find that offshoring to low-income countries
reduced domestic employment in different advanced economies, although the effects
were economically small (Ebenstein et al., 2009 and Liu and Trefler, 2008 for the United
States; Egger et al., 2007 for Austria; Munch, 2010 for Denmark and Geishecker, 2008 for
Germany). Geishecker (2008) finds that tenure seems to matter.


In the first six months of employment, offshoring raises the hazard of job loss by more than
one percentage point. With higher employment duration, however, the absolute changes in
the hazard rate due to offshoring are much smaller. In a study on Germany, Bachmann and
Braun (2011) find that offshoring actually increases job stability in the services sector,
especially for high-skilled workers.


The effect on wages


A majority of studies report a skill-biased effect of offshoring, either in favour of high-
skilled workers or to the detriment of low-skilled workers. For example, on the basis of
data for the United States, Japan, Hong Kong and Mexico, Feenstra and Hanson (2001)
show that offshoring is associated with a rising wage share for skilled workers.


Similarly, Anderton et al. (2002) demonstrate that offshoring to low-income countries leads
to falling wage-bill shares of low-skilled workers in the United Kingdom, the United States,
Italy and Sweden. Country studies on Germany (Geishecker and Görg, 2004), France
(Strauss-Kahn, 2003), the United States (Slaughter, 2000), Sweden (Ekholm and Hakkala,
2006) and Italy (Helg and Tajoli, 2005) also find that offshoring reduces the demand for




69Supply Chain Perspectives and Issues


low-skilled workers relative to high-skilled workers. Geishecker and Görg (2005) show
that only low-skilled workers in low-skill intensive industries experience reductions in
their real wages owing to production relocation. The same holds for high-skilled workers:
gains are only made if they are in high skill intensive sectors. Moreover, Head and Ries
(2002) show that the inverse relationship between offshoring and relative wages of
unskilled labour disappears as production stages are relocated in high-income countries.


Many studies only find a small impact of offshoring on the skilled-unskilled wage
differential. For instance, Hijzen (2007) suggests that while offshoring played a part,
technological change was the main factor behind the increase in wage inequality in the
United Kingdom during the 1990s.


The same conclusion is reached by Morrison and Siegel (2001), when considering the
United States. Other studies document an uncertain effect that depends on the country
features. Egger and Egger (2003), for instance, find that manufacturing offshoring from
Austria to Eastern Europe had little effect on wage rates, and attribute this to union
bargaining power and the centralised wage-setting process.


Similarly, in evaluating data from Germany (with rigid labour markets), the United Kingdom
(with flexible labour markets) and Denmark (with flexible employment adjustments but
relatively rigid wage setting), Geishecker et al. (2010) find that there are small negative
wage effects of offshoring on unskilled workers in all three countries, but these effects are
the lowest in Denmark.


A small set of studies also show that offshoring will not necessarily widen the inequalities
between workers in developed countries. Lorentowicz et al. (2005), for example, find that
Austrian offshoring decreased the relative wages for Austrian skilled workers by two per
cent in the period between 1995 and 2002. They suggest that this happened because
Austria’s human capital levels are poor relative to its trading partners in Eastern Europe.


Returns on labour (regardless of skill levels) relative to those on capital may also
change as a result of offshoring. It is argued that an expansion of the global workforce
due to increased participation from countries with relatively low capital stocks has
led to a substantial decline in the global capital-labour ratio (Freeman, 2005). This is
likely to depress wages. Offshoring therefore enables companies to cut labour costs by
a substantial margin. In theory, these cost savings could be passed on to consumers,
distributed to the firm’s remaining workforce through increased wages, or kept as profits.
Evidence suggests that offshoring has had a negative impact on labour’s share of total
income in advanced economies (IMF, 2007).


3.3.3 Empirical evidence for developing countries


The effect on jobs


The evidence regarding how much employment is generated in host countries as a
result of offshoring is rather patchy. A recent joint study by WTO-IDE JETRO (2011)
provides strong evidence of the numerous job opportunities that have been generated
through countries’ engagement in regional supply chains. It finds that unlike many
advanced economies which are far more domestically oriented, foreign final demand
is very important for job creation in many East Asian countries, including Malaysia,
Singapore, Chinese Taipei and Thailand.




Supply chains and offshoring


70 Supply Chain Perspectives and Issues


A survey by UNCTAD indicates that, in terms of new jobs created, India is the greatest net
beneficiary of services offshoring in the developing world, with IT-enabled services and
business process offshoring being the largest employers (UNCTAD, 2004). The Philippines
has also seen a rapid growth in employment due to services offshoring. In Africa, service
investment has mainly been in call centres. While South Africa has become the prime location,
Ghana, Mauritius, Morocco, Senegal and Tunisia have also attracted some offshoring contracts.


While the number of jobs created as a result of offshoring service provision is likely to
grow in the future, there are supply-side constraints that restrict future growth. Only a
small fraction of the labour force has college education in disciplines relevant to the skilled
segments of service offshoring – such as engineering, accounting and financial services.
What is more, an even smaller fraction of young professionals with such degrees are
suitable for employment, given obstacles such as insufficient language proficiency, cultural
barriers and low educational quality (Farrell et al., 2005; Coe, 2007). Competition for talent
from domestic companies and low regional mobility is likely to further reduce the pool.


The effect on wages


Egger and Stehrer (2003) find that material offshoring from firms in the European Union
(EU) helped contain the rise of the skill premium in the Czech Republic, Hungary and
Poland during the 1990s. In contrast, Feenstra and Hanson (1997) show that the offshoring
of production from the United States to Mexico accounted for a large portion of the
increase in the skilled labour share of total wages and an associated shift in relative
wages. Similarly, Fajnzylber and Fernandes (2004) find that the use of imported inputs and
FDI is linked to greater demand for skilled workers in Brazil, while Görg and Strobl (2002)
identify the import of technology-intensive capital through offshoring as the main factor
behind the increases in relative wages of skilled workers in Ghana. A possible explanation
for these diverging results is that skill levels in Central and Eastern Europe are similar to
those in the old EU countries, while there is a gap in terms of skill endowments between
advanced economies on the one hand, and Mexico, Brazil and Ghana on the other.


There is also some evidence to suggest that increased supply chain activity has not
generated relatively low quality of employment in developing economies. For instance, a
study by the World Bank (2008) shows that special economic zones (SEZs) – often used
to facilitate a country’s participation in GSCs – were characterised by higher wages for
unskilled labour relative to the rest of the economy. Even working conditions were found
to be more favourable, with many SEZs making progress towards meeting international
norms for labour standards.


One weakness of most of the aforementioned studies is that they may only capture the
wage and employment effects of offshoring in the formal sector, while a possible impact of
offshoring is the increased sub-contracting to the informal sector as firms in developing
countries seek to minimise costs and externalise risks.


3.4 Future directions


The business literature has done much to uncover the realities of the offshoring equation,
but in the process it has reached into the areas of business model design and supply
chain risk management. A future area of potential development is to integrate the findings




71Supply Chain Perspectives and Issues


from these two areas (reviewed in Chapters 5 and 9) in order to develop more robust
decision support tools for business practitioners.


In the economics literature, it is difficult, if not impossible, to compare studies due to
the tremendous differences in terms of countries, databases, and empirical estimations.
Moreover, a majority of studies alluded to above consider the short run effects of
offshoring (via arm’s length transactions or via foreign direct investment) on employment,
mainly due to data availability and methodological limitations. Hence, there is a need for
further research to investigate differences across countries using a common methodology.
In doing so, it must also attempt to calculate the long-run employment effects of offshoring.
Despite the limitations outlined above, it is important to contextualise what the available
empirical evidence means for policy. First, it suggests that fears of job-losses due to
offshoring in advanced economies are often exaggerated. While offshoring may lead to
higher job turnover in the short run, there is no indication that trade or offshoring leads
to higher unemployment overall.


Looking at the employment impact of offshoring exclusively in terms of the total number
of jobs lost or gained, however, would present an incomplete picture. In developed
countries, low-skilled jobs will be lost, while higher-skilled jobs will be gained. This
shift in the demand towards highly-skilled workers in advanced economies would
increase income inequality.


Evidence also suggests that offshoring can weaken the position of workers versus the
owners of capital. Given the distributional consequences and the danger that unskilled or
low-skilled workers may be excluded from the labour market, policy makers need to find
ways to mitigate the associated social and economic costs. This skill-bias implies that the
transition from one job to another can entail substantial adjustment costs for individual
workers. In the short run, therefore, losers could be compensated through strengthening
social safety nets.


In the long run, however, relying on assistance is not sustainable and therefore incentive
mechanisms to look for re-employment after job loss need to be put in place (Davidson
and Matusz, 2006). Skill upgrading is very important, as a more educated labour force is
a more flexible labour force (Auer et al., 2005).


At the same time, advanced economies may retain many jobs that require little education
because they are not suitable for electronic delivery. According to Blinder (2006), these
include services where personal presence is either imperative or highly beneficial – it
could be a waiter taking an order in a restaurant or a nurse performing a physical exam.
Training programmes for these jobs are therefore equally important. In general, flexible
labour markets are also likely to help, as adjustment costs would be reduced if workers
can move freely and flexibly from one job to another.


In developing countries, the evidence suggests that offshoring has had an employment-
generating effect. In the case of material offshoring, this has primarily been in the area
of unskilled, labour-intensive manufacturing tasks. More research is needed in terms
of the impact on the quality of jobs, as well as employment in the informal sector.
Services offshoring can, potentially, have negative effects on inequality by raising skill
premiums. Hence, skill upgrading to investment in education is equally important in
developing economies.




Supply chains and offshoring


72 Supply Chain Perspectives and Issues


In a recent special report on offshoring, the Economist (2013) outlines a move towards
firms in advanced economies bringing back to their home countries a large number
of manufacturing tasks that have been offshored for decades. This is being driven, in
part, by rising wages in China and India, the lack of scale and efficiency in low-income
destinations, such as Vietnam and Indonesia, as well as stagnant wages in the United
States and Europe.


Increasing transport costs and increasing risks in extended supply chains (due to the
multiplication of policy risks across countries and natural disasters for example) are
also playing a part. So too is the concern that separating production from research and
development is harming a firm’s long-term ability to innovate.


The Economist (2013) also argues that developed countries are increasingly beginning
to take back service industry jobs too. While the scale of this re-shoring is still modest,
a large number of companies want complex and strategic IT and business process tasks
to be done locally. In the long run, education and labour market reforms are likely to
be important factors determining the extent of re-shoring in advanced economies.
Developments in recent innovations, such as 3D printing, may also reduce the need to
offshore unskilled labour tasks to low-wage countries.


3.5 Endnotes


1. This theory draws on previous work by Jones and Kierzkowski (1990) and Feenstra and
Hanson (1996, 1999).


2. In the short-run, however, offshoring could exert downward pressure on wages
or induce firms to downsize their work force since the same amount of goods can be
produced with fewer workers (Arndt, 1997). This would result in a rising share of profits in
national income (McKinsey Global Institute, 2003).


3.6 References


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Ekholm, K. and K-H. Ullveit-Moe. 2007. “A new look at Offshoring and Inequality:
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75Supply Chain Perspectives and Issues


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78 Supply Chain Perspectives and Issues


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University of Essex, manuscript.




79Supply Chain Perspectives and Issues


Chapter 4
Supply chains, upgrading and
development


Abstract


“Development” is a far-reaching term, and the subjects of the reviewed literature vary
by geographical and organisational coverage, stage of socioeconomic development
under study, and perspective adopted. More specifically and substantively addressed is
increased participation in global value chains, including upgrading, as applied to firms,
industries, and regions. This is driven by both the business practitioner’s and policy maker’s
perspectives, and is addressed through the global value chain framework. In contrast to
supply chains, value chains provide a better macro-scale perspective on matters such as
distribution of income and power across firm networks, and the interlinkages between
firms and their socioeconomic environments. Operationalisable typologies of upgrading
and value chain governance reviewed here will be of interest to the business practitioner
and policy maker. Our literature search also yields a niche body of literature on the subject
of rural development and agriculture, which is reviewed near the end of the chapter.


4.1 Defining upgrading and development


4.1.1 Development contexts


With a broad term like “development”, many uses and definitions can be found in the
literature. Within the literature applicable to supply chains, four dimensions can be
identified when researchers speak of development: geographical, organisational, societal,
and subject-specific. In the geographical dimension, one finds development used in
reference to local, national, and international development. Regional development is
also used, but can refer, confusingly, to either regional development within a country, or
regional development of multiple bordering countries. As such, if listed from the smallest
geographical scale to the largest, one can find discussions of development at the local,
regional (domestic), national, regional (international), and international scales.


The organisational dimension of development discussions is not as neatly arranged
in linear fashion as the geographical dimension. The most frequent subjects of




Supply chains, upgrading and development


80 Supply Chain Perspectives and Issues


study in this dimension, however, are firms, clusters, sectors, and industries. Clusters
originate from the industrial organisation and economic geography literature, and
contain an embedded geographical dimension, referring to firms that are located in close
geographical proximity to each other. The terms “sector” and “industry” are often used
interchangeably in the literature.


The societal dimension refers to the pre-industrial, industrial, and post-industrial
socioeconomic stages based on modernisation theory. Each of these stages carries
unique challenges for growth. The pre-industrial relevant literature largely focuses on
development in a rural and/or agricultural context. The literature on the industrial context
is the most populous within the development and supply chains literature, and addresses
the challenges associated with industrialisation. The post-industrial literature deals with
economic development and growth in the “developed” countries. However, given the
popular conception of developed countries as existing outside the realm of discussions
on development, we will address these problems in separate sections; namely in Chapter
3 on offshoring, Chapter 7 on services, and Chapter 10 on sustainability.


The subject-specific dimension is rather straightforward, and refers to whether the literature
addresses the business person’s perspective and/or the policy maker’s perspective (or
neither). This largely applies to the prescriptive studies in development that aim to produce
results for implementation.


4.1.2 Defining upgrading


Upgrading is another oft-used term that suffers some definitional vagueness. Morrison,
Pietrobelli, and Rabellotti (2008) point to its “fuzzy” conception in relation to innovation, and
the term is used in parallel with skills, technology, and learning. While the concept can be
found in business and economics literature on clusters, value chains, core competences
and dynamic capabilities, Morrison, Pietrobelli, and Rabellotti (2008) point to its origins
in international trade theory. The term was originally used to indicate countries that are
specialising towards higher value-added goods within the same sector. Amongst recent
literature, it is considered to be a critical means to face market competition (Humphrey
and Schmitz 2002; Giuliani, Pietrobelli, and Rabellotti 2005; Kaplinsky and Readman 2001;
Morrison, Pietrobelli, and Rabellotti 2008). The following is a sample of the definitions
of upgrading that have been found in the literature:


● “innovation producing an increase in the value-added” (Morrison, Pietrobelli, and
Rabellotti 2008)


● shifts in activities that “increase the skill content of their activities and/or move into
market niches which have entry barriers and are therefore insulated to some extent
from these pressures” (Humphrey and Schmitz 2002)


● “insertion into local and global value chains in such a way as to maximise value creation
and learning” (Gereffi et al. 2001)


● “the capacity of a firm to innovate to increase the value-added of its products and
processes” (Giuliani, Pietrobelli, and Rabellotti 2005)


All the definitions share a common goal of enhancing and retaining value. The subject
to be upgraded varies, depending on whether the literature utilises the management
perspective or the governance perspective, and ranges from upgrading firms to value
chains, clusters, regions, and industries.




81Supply Chain Perspectives and Issues


Upgrading from the business perspective tends to endorse the importance of
specialisation to sustain and increase net returns, while the economic perspective tends
to suggest the importance of diversification; perhaps beneficial on country or industry
dimensions, as opposed to a firm dimension. The means are varied as well, and include
upgrading skills, technology, knowledge, products, processes, functions and value
chains. The following section elaborates on a widely used typology of upgrading used
in the context of value chains.


4.1.3 Typology of upgrading


Giuliani, Pietrobelli, and Rabellotti (2005) present a typology that begins by splitting up
endogenous and exogenous factors in firm upgrading. While endogenous factors are
simply described as internal firm efforts to upgrade, exogenous factors are further broken
into three influences: (1) the collective efficiency of the cluster in which the firm is located,
(2) the governance of the value chain in which the firm is linked, and (3) the learning and
innovation patterns of the industry sector that the firm participates in sectoral innovation
systems. Humphrey and Schmitz (2000, 2002) present a typology that could be used to
guide endogenous efforts to upgrade. In this typology, four categories of upgrading are
presented: process, product, function/intrachain, and intersectoral/chain.


Process upgrading aims to increase value capture through production efficiency. This
is done through process re-engineering and/or the introduction of superior technology
(Gereffi et al. 2001; Giuliani, Pietrobelli, and Rabellotti 2005; Schmitz 2004). Kaplinsky and
Readman (2001) go on to further divide process upgrading along intra-firm efforts, as can
be evidenced by increased inventory turns or reduced waste, or inter-firm efforts, such as
through increased and more on-time deliveries.


Product upgrading increases value capture by moving into product lines with high
unit values (Gereffi et al. 2001; Giuliani, Pietrobelli, and Rabellotti 2005; Schmitz 2004).
Compared to process upgrading, product upgrading presents the “quality versus quantity”
approach. An example can be seen in Gereffi’s (1999) study of upgrading in the Asian
apparel commodity chain from supplying discount chains to supplying department stores.


Functional or intrachain upgrading increases value capture through two means that focus
on: (1) the firm’s functions that embody higher value-added, and/or (2) shifting coverage
of activities in the value chain to acquire higher value-added functions. An example of the
former would be increased focus on the firm’s outsourcing, accounting and quality functions.
An example of the latter would be a shift from manufacturing to design (Gereffi et al. 2001;
Giuliani, Kaplinsky, and Readman 2001; Pietrobelli and Rabellotti 2005; Schmitz 2004).


Intersectoral or chain upgrading is a strategy whereby the firm utilises functional
knowledge in one chain to expand to a similar function found in another chain in a different
industry sector. An example would be a radio manufacturer expanding to TVs, computer
monitors, and then laptops. Another would be a graphite material specialist in the golf
club market expanding to racing bikes and then aircraft components (Gereffi et al. 2001;
Giuliani, Kaplinsky, and Readman 2001; Pietrobelli and Rabellotti 2005; Schmitz 2004).




Supply chains, upgrading and development


82 Supply Chain Perspectives and Issues


4.2 Global value chains


4.2.1 Definition and history


The concept of the value chain provides a key starting point in understanding the
dynamics of industrial organisation, international trade, and regional development. Use
of the term “value chains” has been documented as far back as the 1960s in the context of
development paths for mineral-exporting economies (Girvan 1987). In the 1980s, however,
the term rose to popularity, particularly in the business literature, due to the works of
Michael Porter (1980, 1985, 1990). Porter proposed two elements now found in modern
value chain analysis: The value chain and the value stream. The value chain referred to the
intra-firm activities involved in transforming inputs into outputs, and included not only the
physical transformation processes, but also the support functions involved. These include
research and development, procurement, human resources management, and many of
the tasks that may now be regarded as higher value adding activities. His value system
resembles the modern value chain in extending the framework of activities to inter-firm
linkages (Kaplinsky and Morris 2002; Gereffi et al. 2001; Hess and Yeung 2006).


While these conceptualisations provide limited utility in the analysis of socioeconomic
dynamics and development, they provided many of the theoretical foundations for the value
chain today (Henderson et al. 2002). The concept also translated to economic geography,
beginning with the works of Peter Dicken (1986), and was followed by a large body of
works on transnational corporations and regional development (Hess and Yeung 2006).


Furthering the concept was popular work by Womack and Jones (1996) on value
streams in the context of lean production. The proposed value streams were equivalent
to the modern value chain, and added yet another term to the increasingly confusing
nomenclature on value chains. Most recently, the works of Gary Gereffi, Timothy Sturgeon,
Raphael Kaplinsky and John Hubert Schmitz have established the concept in areas of
industrial organisation and economic sociology (Kaplinsky 2000, 2004).


While these definitions have varied across authors and across time, the modern definition
found in the literature over the past decade is remarkably consistent. In it, a chain is
defined as the full range of activities which are required to bring a product or service
from conception, through the different phases of production (involving a combination
of physical transformation and the input of various producer services), delivery to final
consumers, and final disposal after use (Kaplinsky and Morris 2002; Gereffi et al. 2001;
Kaplinsky 2000, 2004; Sturgeon 2001; Chang, Bayhaqi, and Zhang 2012). Furthermore,
when these value chains span enterprises in more than one economy, they are termed
“global value chains” (Sturgeon 2001; Chang, Bayhaqi, and Zhang 2012; Kaplinsky 2000).


4.2.2 Value chain governance


Value chain governance is defined by Gereffi (1994) as “the authority and power relationships
that determine how financial, material, and human resources are allocated and flow within
the commodity chain.” The concept recognises the existence of power asymmetries and
lead firms that exert political influence or control over other firms and the very structure of
the value chain. As such, an understanding of value chain governance is critical in enabling
value chain analysis and the investigation of matters such as the ability of developing country
firms to access international markets (Kaplinsky and Morris 2002; Gereffi et al. 2001). Figure 4.1 Typology of value chain governance (Gere i, Humphrey, and Sturgeon 2005)


Market


Customers


Suppliers


Modular Relational Captive Hierarchy


Lead
Firm


Lead
Firm


Relational
Supplier


Turn-key
Supplier


Component and
Material


Suppliers


Component and
Material


Suppliers


Captive
Suppliers


Lead
Firm


Integrated
Firm


End Use


Va
lu


e


Ch
ai


ns
Materials


Degree of Explicit Coordination


Degree of Power Asymmetry
Low High


Price




83Supply Chain Perspectives and Issues


Gereffi, Humphrey, and Sturgeon (2005) attribute the existence of governance patterns in
value chain relationships to three drivers: (1) the complexity of the information that needs to
be transferred, (2) the extent to which this information can be codified, and (3) the capabilities
of available suppliers in fulfilling the transaction. Gereffi et al. (2001) point to risk exposure to
supplier failure as another reason for governance patterns and lead firms to emerge.


Lead firms are also judged to emerge due to unbalanced distributions of market power or
market share amongst firms and the position of firms in high value segments of the value
chain. Power is exercised by these lead firms in the value chain through monitoring of
suppliers and control over key resources, chain entry/exit, and information distribution
(Gereffi et al. 2001; Gereffi, Humphrey, and Sturgeon 2005).


4.2.3 Typology of governance


Early typologies of value chain governance have been proposed by Gereffi (1999) in his
buyer-driven versus supplier-driven global commodity chains and by Kaplinsky and
Morris (2002) in their legislative-judicial-executive value chain governance analogy.
However, Gereffi, Humphrey, and Sturgeon (2005) produced a typology in their seminal
work on the governance of value chains that has become widely adopted in the value
chain literature. This typology consists of five types of value chain relationships: Market,
modular, relational, captive, and hierarchy (Figure 4.1). These types are determined by the
complexity of information flowing through the chain, the extent to which this information
can be codified, and the available supplier capabilities in fulfilling the transaction.


Figure 4.1: Typology of value chain governance


Source: Gereffi, Humphrey, and Sturgeon (2005)


Figure 4.1 Typology of value chain governance (Gere i, Humphrey, and Sturgeon 2005)


Market


Customers


Suppliers


Modular Relational Captive Hierarchy


Lead
Firm


Lead
Firm


Relational
Supplier


Turn-key
Supplier


Component and
Material


Suppliers


Component and
Material


Suppliers


Captive
Suppliers


Lead
Firm


Integrated
Firm


End Use


Va
lu


e


Ch
ai


ns


Materials


Degree of Explicit Coordination


Degree of Power Asymmetry
Low High


Price




Supply chains, upgrading and development


84 Supply Chain Perspectives and Issues


Market governance is characterised by low switching costs between alternative partners
for both parties. These relationships exist when the complexity of information exchanged
between buyer and seller is relatively low, allowing transactions to proceed with minimal
intervention or governance. Generally, this is found in situations where product specifications
are relatively simple and transactions are easily codified. Transactions are then determined
by suppliers’ offered product specifications and prices. While the cost of switching parties
is low, however, this does not mean that linkages cannot persist over time.


Modular value chain linkages arise in situations with relatively low switching costs,
similar to market linkages, but with more complex information exchange. These situations
tend to come about when specifications for complex products can be modularised.
Buyers provide specifications in this case, but the supplier is responsible for possessing
the skills and technologies, as well as for making capital purchases on behalf of the
buyer for materials and components. In such a relationship, the buyer has minimal
need to direct or control supplier activities, but the initial information exchange is more
complex than that of a market linkage.


Relational value chain linkages are characterised by mutual dependence and high levels
of asset specificity between buyers and sellers. These arise in situations where complex
product specifications result in the requirement of intensive information transactions
and advanced supplier capabilities. These relationships entail frequent interaction
and close coordination, making the costs of switching partners high. Transactions
along these linkages can be facilitated by close proximity, familial or ethnic ties, trust/
reputation, and contractual terms. Outsourcing can be described as a type of relational
value chain linkage.


Captive value chain relationships refer to the supplier being held captive through
dependence on the buyer. In these situations, product specifications are complex but
supplier capabilities are low, resulting in significant intervention and control by the buyer.
Given the investment of effort required in these transactions, buyers seek to lock in their
suppliers through financial or operational dependence. For example, captive suppliers are
frequently confined to a narrow range of tasks and depend on the buyer to carry out the
more complex complementary tasks. Suppliers are able to gain market entry and some
resources in return.


Hierarchy linkages arise when satisfactory suppliers cannot be found by the buyer, often
due to product complexity or concerns about intellectual property. In this situation, buyers
adopt the vertical integration approach to develop and manufacture products in house. As
such, the suppliers in hierarchy relationships are actually governed directly by the buyer
through managerial control.


There are some shortcomings to this typology, however. The concept of the lead firm here
is restricted to a much narrower context of lead firm and first-tier suppliers. Additionally,
it removes the notion of agency from governance by focusing on governance type as
determined by transaction type instead of by rent-maximising motivations.


4.2.4 Governance and upgrading trajectories


Gereffi (1999) and Lee and Chen (2000) suggest a trajectory for upgrading, in which firms
begin with process upgrading and then proceed to product, functional and finally chain
upgrading. This is based on their observations of East Asian firms transitioning through


Figure 4.2 Example trajectories of upgrading (Kaplinsky and Morris 2002)


Process


Original
equipment
assembly


(OEA)
Original
design


manufacture


Disembodied content of value added increases progressively


Original
brand


manufacture


Moving chains
- e.g. from
black and


white TV tubes
to computer


monitorsOriginal
equipment


manufacture
(OEM)


Trajectory


Examples


Degree of
disembodied
activities


Product Functional Chain




85Supply Chain Perspectives and Issues


their roles as original equipment assemblers (OEAs) to original equipment manufacturers
(OEMs), own design manufacturers (ODMs), and finally own brand manufacturers (OBMs)
(Kaplinsky and Readman 2001; Kaplinsky and Morris 2002) (Figure 4.2).


Figure 4.2: Example trajectories of upgrading


Source: Kaplinsky and Morris (2002)


This trajectory of upgrading has encountered criticism as rather optimistic in portraying
an automatic conveyor process up the value ladder (Schmitz 2004; Morrison, Pietrobelli,
and Rabellotti 2008; Giuliani, Pietrobelli, and Rabellotti 2005).


Humphrey and Schmitz (Humphrey and Schmitz 2000, 2002; Schmitz 2004) address this
by investigating how chain governance can affect the prospects for the posited trajectory
of upgrading. They utilised a predecessor to Gereffi’s 2005 typology of value chain
governance, which consisted of four types instead of five. Modular and relational types
were grouped into a “balanced” category at that time, but the other types remain the same.
Their studies focused on the captive and balanced types of governance.


For captive, their results show clear indications that captive chain linkages fostered rapid
process and product upgrading, but hinder functional upgrading. In these situations,
buyers are extremely demanding of low capability suppliers, but invest a significant
amount of time monitoring and instructing suppliers as a result. This allows the supplier
to progress rapidly through process and product improvements. However, barriers
seem to appear when the firm approaches functional upgrading efforts. The first barrier
posited is due to the buyer’s self-interest in preserving their core competencies in the
non-manufacturing segments of the value chain, which tend to impart higher value and
more governance power. These non-manufacturing segments include design, branding,
and marketing. Simply put, the buyers have no interest in helping their suppliers become


Figure 4.2 Example trajectories of upgrading (Kaplinsky and Morris 2002)


Process


Original
equipment
assembly


(OEA)
Original
design


manufacture


Disembodied content of value added increases progressively


Original
brand


manufacture


Moving chains
- e.g. from
black and


white TV tubes
to computer


monitorsOriginal
equipment


manufacture
(OEM)


Trajectory


Examples


Degree of
disembodied
activities


Product Functional Chain




Supply chains, upgrading and development


86 Supply Chain Perspectives and Issues


competitors. The second barrier is the immense investment of capital, time, and effort
required for a supplier to independently develop their own brands or set up marketing
channels in the same value chain.


The rapid upgrading through production and slow upgrading in non-production segments
of captive global value chains is offset by the example of substantial functional upgrading
but slow process and product upgrading found in domestic value chains. Cases in
India and Brazil show that domestic-focused firms are more likely to acquire functional
capabilities and then expand into neighbouring markets, and reveal potential limits to
export-driven economic growth.


Balanced linkages offer the ideal upgrading conditions, as power and commitment is
shared between firms. This is conducive to focusing on value creation through new
product and process development, and is commonly documented in the literature on
innovation networks in developed countries. A prerequisite for this type of buyer-supplier
relationship, however, is a high level of competencies already held by the supplier
– something that is difficult to find in developing country firms. However, research on
modular production networks (Sturgeon 2002) point to the ability of developing country
firms to form highly complementary clusters that are together able to form balanced type
relationships with their respective buyers. Examples include the computer cluster in
Chinese Taipei and the Brazilian shoe cluster.


More recently, Morrison, Pietrobelli, and Rabellotti (2008) point out an alternative and
largely disregarded source of growth: Deepening firm capabilities at any segment of the
value chain instead of rigidly looking at expansion along the value chain as the only source
of growth. For example, climbing up the value chain ladder in the horticulture industry
might imply upgrading from growing flowers to packaging, distributing, branding, and
retailing them. However, there is significant growth to be found in each one of those stages,
such as in the development of new flower varieties or in developing new packaging that
embeds highly valued characteristics.


These efforts present both clear and immediate utility to both the business person and
the policy maker in understanding the various sources of growth and the feasibility of
capturing them.


4.2.5 The global value chain framework


Value chain analysis focuses on the dynamics of the interlinkages within the productive
sector and their implications for socioeconomic development. In considering the way
in which countries and firms are globally integrated, the framework provides insights
on the distribution of income and power along the GVC that traditional modes of social
and economic analysis are not able to provide (Kaplinsky 2000; Morrison, Pietrobelli, and
Rabellotti 2008; Kaplinsky and Morris 2002).




87Supply Chain Perspectives and Issues


The methodology of value chain analysis contains a rather loose or modular set of
analyses to be adapted to the purposes of each study. Kaplinsky and Morris (2002) break
the value chain analysis methodology into eight primary components:


(1) setting the perspective,
(2) mapping,
(3) market segmentation,
(4) market access,
(5) value chain performance,
(6) value chain governance,
(7) upgrading, and
(8) distributional issues.


Given the descriptive breadth of value chains, the GVC approach can be utilised for a
similarly broad range of issues. As such, the first challenge in GVC analysis is in defining
the perspective with which to approach the value chain. This perspective will determine
the variables to be examined, and sets the stages for the downstream analytical steps. For
example, a study of the national distribution of value add in automobiles and a study on
women’s involvement in the labour market will incur different variables of investigation.


Once the perspective for the analysis is determined, a decision must be made on the
network scope of the study. Given the network structure of GVCs, one could trace
suppliers and buyers both horizontally and vertically from immediate linkages through
to the ultimate supplier and consumer. Methodological boundaries must be defined, most
likely through a consideration of resource limitations in conducting the study.


The third component is an examination of the final markets in the GVC, and is particularly
relevant due to the prevalence of buyer-driven chains. The type of market study is
determined by relevance to the chosen perspective and variables, and typically entails
market segmentation and basic quantitative characterisation.


The fourth analysis examines the linkages between the perspective’s focal firm/segment
in the GVC and the final market. Again, this is done in recognition of the significance of
buyer-driven chains. The fifth component examines operational performance of firms in
the GVC and/or of the chain, itself. Sixth is a consideration of governance in the GVC, and
utilises the typology of chain governance. Similarly, the seventh component utilises the
typology of firm upgrading to examine upgrading dynamics in the chain. Finally, the eighth
component considers the critical distribution of power and income along the GVC.


4.3 Global production networks


4.3.1 Definition and history


Henderson et al. (2002) defines global production networks as the “the globally organized
nexus of interconnected functions and operations by firms and non-firm institutions
through which goods and services are produced and distributed”. The concept has many
predecessors, ranging from value chains, supply chains, global commodity chains, and
actor-network theory – to name a few.




Supply chains, upgrading and development


88 Supply Chain Perspectives and Issues


The most recent and relevant of these, however, is Gereffi’s concept of the global
commodity chain. The “Manchester School” of researchers are including Neil Coe, Peter
Dicken, Jeffrey Henderson, Martin Hess, Khalid Nadvi, and Henry Wai-chung Yeung, among
others, have done much work to advance the concept. (To avoid confusion, however, it
should be noted that while most of the listed researchers are located at the University of
Manchester, Henry Wai-chung Yeung is located at the National University of Singapore).
They have expanded upon the global commodity chain framework by moving beyond
a governance focus and by altering the nomenclature of the “commodity chain” to the
“production network” to be more inclusive.


Also significant is the work by Dieter Ernst on global production networks, developed
simultaneously but independently. Ernst conceptualised GPNs as an organisational
innovation that “combine(s) concentrated dispersion of the value chain across firm and
national boundaries, with a parallel process of integration of hierarchical layers of network
participants” (Ernst and Kim 2001). However, Henderson et al. (2002) point out here, too,
that the concept was derived from a narrow range of sectors – namely the electronics and
information technology industries – and does not adequately qualify for general relevance.


4.3.2 The global production network framework


The GPN analytical framework, as proposed by Henderson et al. (2002), provides a way
to understand the “global, region and local economic and social dimensions” embodied
in globalisation. Three principal variables are examined in the global production network:
value, power, and embeddedness (Figure 4.3).


Figure 4.3: The global production network framework


Source: Henderson et al. 2002
Figure 4.3 The global production network framework (Henderson et al. 2002)


Categories


Dimensions


Firms
- Ownership
- “Architecture”


Institutions
- Governmental
- Quasi-governmental
- Non-governmental


Networks (Business/Political)
- “Architecture”
- Power conguration
- Governance


Sectors
- Technologies
- Products/Markets


Conguration
Coordination


Value
- Creations
- Enhancement
- Capture


Value


Power
- Corporate
- Collective
- Institutional


Embeddedness
- Territorial
- Network


Structures


Development




89Supply Chain Perspectives and Issues


Value, here, is defined by economic rent and Marxian surplus value. Considerations
of value are segmented into the processes of value creation, value enhancement, and
value capture. The examination of conditions for each process reveals a wide array of
socioeconomic dynamics, such as the role of technology, relationship with labour, and
effects of governance.


Power refers to the ability to influence others in the global production network, much
like the governance dynamics discussed in GVCs, but is categorised into three types:
corporate power, institutional power, and collective power. Corporate power is held by
the firm and places emphasis on analysing the existence and impact of lead firms in the
GPN. Institutional power is held by governments and international organisations. These
international organisations are classified as international inter-state agencies, such as
ASEAN and the EU, the Bretton Woods organisations plus the World Trade Organisation,
the UN agencies, international credit rating agencies, and other standard setting bodies.
These organisations do not exert their power through direct market competition with
corporate power, but rather influence the conditions under which market competition is
held. Collective power is held by civil organisations such as labour unions and NGOs that
seek to influence both the corporate and institutional powers.


Embeddedness refers the socioeconomic relationships or ties that bind firms and other
actors to each other. Two types of embeddedness are considered: territorial and network.
Territorial embeddedness takes into account the interconnections that result due to the
geographical location of a firm, and takes a similar perspective to industrial clusters
research. Network embeddedness takes into account the interconnections that result due
to the membership of firms and entities actors in certain economically-motivated networks,
and directly relates to the value chain and production network perspectives.


These three variables of value, power, and embeddedness are then considered across four
dimensions of analysis: firms, sectors, networks, and institutions. The firm dimension is
relatively straightforward, and examines the dynamics of value, power, and embeddedness
from the firm perspective. The sector dimension encompasses a range of companies and
various institutional and civil organisations involved in an industry sector. This dimension
begins to consider more policy-related influences on industry dynamics. The network
dimension is still conceptually open, and has yet to be defined. However, its interests are
in examining the governance dynamics that arise in networks of firms and other actors.
Finally, the institutions dimension considers the local and global institutions that are key
to enabling the economically and socially sustainable performance of firms and networks
in specific locations.


The GPN framework possesses considerable potential in its explanatory powers. However,
its ambitiousness, as evidenced by its consideration of a wide range of factors, require
intensive effort to move the framework forward. As such, it still remains largely a framework
of analysis with which to orient one’s considerations, and lacks a clear methodology or
tools for generating prescriptive results. Thus far, GPN studies have primarily relied on
qualitative interviews to generate data, and have tended to disregard quantitative data
such as trade or production statistics. However, this is something GPN researchers in the
field are already looking to address (Hess and Yeung 2006).




Supply chains, upgrading and development


90 Supply Chain Perspectives and Issues


4.4 Supply chains and rural development


4.4.1 Rural development


Rural development deals critically with the effort to “create additional value for rural regions”
(Marsden, Banks and Bristow 2000). Modern rural development research and practice
seeks to adapt the rural economy and its actors to the forces of globalisation (Jarosz 2008).


Two main challenges are addressed; one sourced from the producer’s perspective and
one sourced from the consumer. From the producer’s side, the previous rural development
model of industrial agriculture is no longer seen as economically or environmentally
sustainable. This industrial agriculture model is characterised by intensive, large-scale,
and commoditised food production geared to maximise economies of scale. The literature
addresses a perceived crisis of confidence in this model, with food producers expecting a
continuous and steady loss of capital from the farm and rural areas (Marsden, Banks, and
Bristow 2000). From the consumer’s side, the literature notes a new pressure for quality
food products that meet socially-constructed criteria. This is evidenced in the emergence
of new food markets that are differentiated from existing “anonymous mass food markets”
(Renting, Marsden, and Banks 2003).


While rural development is a broad concept and difficult to define, van der Ploeg et
al. (2000) present an attempt to characterise rural development according to six key
aspects. The first refers to rural development as a realignment between agriculture and
society at the international and domestic level. The second defines the search for new
rural development models as a critical component. The third specifies individual farm
households as the subject for operationalising rural development strategies. The fourth
defines the countryside and its actors as the realm of applicability. The fifth component of
rural development is policies and institutions. The sixth and final component encapsulates
the wide array of approaches that result from the attempt to achieve rural development.


Rural development overlaps with supply chains in the area of alternative food networks
(AFNs) and short food supply chains (SFSCs). These are viewed as important mechanisms
for testing and implementing new modes of rural development. The literature reviewed in
this area was largely produced in the late 1990s and early 2000s by European researchers
addressing European markets. This is somewhat unexpected, given the relevance of rural
development and supply chains to developing economies that are still dominated by the
agricultural sector. However, given the fundamental problem addressed – of creating and
capturing additional value for rural regions – there is potential for translating findings
from rural European markets to developing market contexts elsewhere.


4.4.2 Alternative food networks


Alternative food networks (AFNs) are efforts to realign food production, distribution,
and consumption with economic, social, and environmental objectives. These networks
counter the standard industrial modes of agriculture and are seen as potential solutions
to the challenges of rural development (Renting, Marsden, and Banks 2003).


AFNs can be characterised as having one or more of the following characteristics: (1)
shorter distances between producers and consumers, (2) smaller farm size with the
use of organic or holistic means of food production, (3) the use of alternative food
distribution and retail means, such as food cooperatives and farmer’s markets, and




91Supply Chain Perspectives and Issues


(4) alignment to social, economic, and environmental goals (Jarosz 2008). Amongst
the variety of AFNs, a particular type known as short food supply chains (SFSCs) has
gained significant exposure.


4.4.3 Short food supply chains


Short food supply chains (SFSCs) can be classified as a type of alternative food network,
and focus on the inter-relations between producers, distributors, and consumers of
food products (Renting, Marsden, and Banks 2003). SFSCs emerged out of attempts by
the farming population to recapture value in the supply chain by short-circuiting the
anonymous, commoditised industrial food supply chains to meet new consumer demands
for information and transparency.


Accordingly, the defining characteristic of a SFSC is the ability to connect the food
producer and the food consumer through the preservation of information through the
supply chain. This information critically allows the consumer to make a value judgement
about the desirability of a food product. As explained by Marsden, Banks, and Bristow
(2000), “it is not the number of times a product is handled or the distance over which it is
ultimately transported which is necessarily critical, but the fact that the product reaches
the consumer embedded with information.”


A typology of SFSCs is presented in Renting, Marsden, and Banks (2003) and Marsden,
Banks, and Bristow (2000), consisting of three categories of SFSCs graded along the spatial
dimension. The first is face-to-face chains where the producer and consumer conduct
transactions directly through personal interactions. These include farm stands and online
suppliers. The second is spatially proximate chains, which provide consumers with food
produced in the immediate region or locality. An example would be the retail of locally
grown produce at specialty food markets or the offering of locally sourced ingredients
at a restaurant. The third category is spatially extended chains, where information on the
place and means of production is translated to consumers who are outside the region of
production. This can be seen in the products distinguished by their terroir, such as the
sale of French champagne or Italian gorgonzola in foreign markets.


The result of SFSCs is a “re-socialisation” and “re-spatialisation” of food through
communication on the location, method of production, and other food properties to the
consumer. As such, SFSCs are viewed as a potential source of new rural development
models that break from current industrial food chains to enable more socially and
environmentally sustainable methods of agricultural production (Marsden, Banks, and
Bristow 2000; Renting, Marsden, and Banks 2003).


4.5 Empirical studies


The contrasts in development perspectives can be seen in the empirical studies (Table
4.1 below). Studies have clearly adopted both firm and policy maker perspectives, while
the coverage of industries is heavily skewed towards globalised and lower value-added
industries. However, analysis is fairly consistent in adopting the value chain or production
network framework, and coverage of all major regions is seen.




Supply chains, upgrading and development


92 Supply Chain Perspectives and Issues


Table 4.1: Empirical studies sourced from the literature


While we are aware of the existence of empirical studies on the service sector, we are
surprised to see the lack of works in our sourced literature. Given that the offshoring
of services is a recent phenomenon in the 21st century and that services have been
successfully offshored to developing country settings, such as India, this is a clear area
of need for future studies.


Citation Year Type Industry Geography Subject


Coe et al. 2004 case
study


BMW Eastern Bavaria,
Germany; Rayong
Province, Thailand


Global production
networks and regional
development


Cooke and Morgan 1993 case
study


multiple Baden-
Wurttemberg,
Germany; Emilia-
Romagna, Italy;
Basque,
Spain; Wales,
United Kingdom


Regional SME bolstered
development


Fitter and Kaplinsky 2001 case
study


coffee International Distribution of rent
across the global value
chain


Gereffi 1999 case
study


apparel Asia Industry upgrading for
countries in the apparel
supply chain


Gereffi, Humphrey, and
Sturgeon


2005 case
study


bicycles, apparel, fresh
vegetables,
electronics


International Typology of value chain
governance


Giuliani, Pietrobelli, and
Rabellotti


2005 case
study


manufacturing,
natural
resources, complex
products, software


Latin America Firm upgrading in
clusters and global value
chains


Jaffee, Kloppenburg, and
Monroy


2004 case
study


agriculture, food
processing,
distribution


United States,
Mexico


Fair trade practices
in the
geopolitical “North” and
“South”


Jarosz 2008 case
study


agriculture,
distribution


Washington,
United States


Agriculture and
alternative food
networks in
metropolitan areas


Kaplinsky 2004 case
study


fresh fruit and
vegetables, canned
deciduous fruit,
footwear, automotive


International Distribution of rent
across the global value
chain


Macpherson and Wilson 2003 survey manufacturing Northwest England Development
opportunities for
SMEs in the supply chain


Ndou, Vecchio,
and Schina


2011 survey food processing Tunisia E-business models for
SMEs in developing
countries


Sturgeon, Biesebroeck,
and Gereffi


2008 case
study


automotive International Value chain analysis of
the global automotive
industry


UNESCAP 2011 case
study


plastics, ginger and
coffee, rubber and
electronics


Bangladesh,
Nepal, Sri
Lanka


Integration of
developing country
SMEs into global value
chains


Walker and Preuss 2008 case
study


public sector,
health sector


United Kingdom Sustainable
development through
public sector sourcing
from SMEs


Wang and Cheng 2010 case
study


logistics Hong Kong Upgrading of Hong
Kong from a port
city to a supply chain
management center




93Supply Chain Perspectives and Issues


4.6 Future directions


The past decade has seen significant advances in theory relating to supply chains in
conjunction with development and upgrading. This is, in large part, due to a very active
body of researchers, including the likes of the global value chain school of thought
(including Gary Gereffi, Raphael Kaplinsky, John Humphrey, Hubert Schmitz, and Timothy
Sturgeon) and the Manchester school on global production networks (including Neil Coe,
Peter Dicken, Jeffrey Henderson, Khalid Nadvi, and Henry Wai-chung Yeung).
With the establishment of theoretical foundations, such as the typologies on upgrading
and governance, as well as the analytical frameworks on supply chains in their various
forms, we foresee the development of a variety of derivative tools to support the business
practitioner looking to manoeuvre in the supply chain and for policy makers looking for
paths towards industrial and economic development. The connection between theory and
application will require a clearer segmentation, however, of perspectives and scenarios
for use other than exists right now in the literature.


After the consolidation and rise of concepts such as global commodity chains and global
value chains, we also look to global production networks as a possible next step in the
evolution of the network-of-organisations concept. We see the merits in its integration of
prior best concepts into a more comprehensive and balanced framework for analysis, and
can foresee the GPN concept rising with buy-in from the current research body and more
theoretical development to create a portfolio of analytical tools.


In light of the heavy emphasis of empirical studies on a few select industries, such as
electronics, automotive and apparel, we also see the need for expanding empirical studies
across less understood industries. In particular, we note recent studies on services and
their role in development, and hope to see an expansion in studies on the role that services
can play in development.


4.7 References


Chang, Philip, Akhmad Bayhaqi, and Bernadine Zhang Yuhua. 2012. “Concepts and trends
in global supply, global value and global production chains”, APEC Policy Support Unit,
Issues Paper No. 1.


Coe, Neil, Martin Hess, Henry Wai-chung Yeung, Peter Dicken, and Jeffrey Henderson.
2004. “’Globalising’ regional development: a global production networks perspective”,
Transactions of the Institute of British Geographers, 29(4): 468-484.


Dicken, Peter. 1986. “Global Shift: Industrial Change in a Turbulent World”, Harper and
Row: London.


Ernst, D. and Kim, L. 2001. “Global production networks, knowledge diffusion and local
capability formation: a conceptual framework”, Paper presented at the Nelson & Winter
Conference, Aalborg, 12-15 June.


Gereffi, Gary. 1994. “The organization of buyer-driven global commodity chains: How U.S.
retailers shape overseas production networks”, in: G. Gereffi and M. Korzeniewicz (eds.),
Commodity Chains and Global Capitalism. Westport: Greenwood Press. pp. 95-122.


Gereffi, Gary. 1999. “International trade and industrial upgrading in the apparel commodity
chain”, Journal of International Economics, 48(1): 37-70.




Supply chains, upgrading and development


94 Supply Chain Perspectives and Issues


Gereffi, Gary, John Humphrey, and Timothy Sturgeon. 2005. “The governance of global
value chains”, Review of International Political Economy, 12(1): 78-104.


Gereffi, Gary, John Humphrey, Raphael Kaplinsky, and Timothy J. Sturgeon. 2001.
“Introduction: globalisation, value chains and development”, IDS Bulletin, 32(3): 1-8.
Giuliani, Elisa, Carlo Pietrobelli, and Roberto Rabellotti. 2005. “Upgrading in global value
chains: lessons from Latin American clusters”, World Development, 33(4): 549-573.


Henderson, Jeffrey, Peter Dicken, Martin Hess, Neil Coe, and Henry Wai-chung Yeung.
2002. “Global production networks and the analysis of economic development”, Review of
International Political Economy, 9(3): 436-464.


Hess, Martin and Henry Wai-chung Yeung. 2006. “Whither global production networks
in economic geography? Past, present and future”, Environment and Planning A, 38(7):
1193-1204.


Humphrey, John and Hubert Schmitz. 2000. “Governance and upgrading: linking
industrial cluster and global value chain research”, Institute of Development Studies,
Working Paper 120.


Humphrey, John and Hubert Schmitz. 2002. “How does insertion in global value chains
affect upgrading in industrial clusters?” Regional Studies, 36(9): 1017-1027.


Jaffee, Daniel, Jack R. Kloppenburg, and Mario B. Monroy. 2009. “Bringing the “Moral Charge”
Home: Fair Trade within the North and within the South”, Rural Sociology, 69(2): 169-196.


Jarosz, Lucy. 2008. “The city in the country: growing alternative food networks in metropolitan
areas”, Journal of Rural Studies, 24(3): 231-244.


Kaplinsky, Raphael. 2000. “Globalisation and unequalisation: What can be learned from
value chain analysis?” Journal of development studies, 37(2): 117-146.


Kaplinsky, Raphael. 2004. “Spreading the gains from globalization: what can be learned
form value-chain analysis?” Problems of Economic Transition, 47(2): 74-115.


Kaplinsky, Raphael and Jeff Readman. 2001. “Integrating SMEs in global value chains:
towards partnership for development”, United Nations Industrial Development
Organization.


Kaplinsky, Raphael and Mike Morris. 2002. “A handbook for value chain research”, Institute
of Development Studies.


Macpherson, Allan and Alison Wilson. 2003. “Enhancing SMEs’ capability: opportunities
in supply chain relationships?” Journal of Small Business and Enterprise Development,
10(2): 167-179.


Marsden, Terry, Jo Banks, and Gillian Bristow. 2000. “Food supply chain approaches:
exploring their role in rural development”, Sociologia Ruralis, 40(4): 424-438.


Morrison, Andrea, Carlo Pietrobelli, and Roberta Rabellotti. 2008. “Global value chains and
technological capabilities: a framework to study learning and innovation in developing
countries”,Oxford Development Studies, 36(1): 39-58.


Ndou, Valentina, Pasquale Vecchio, and Laura Schina. 2011. “Designing Digital Marketplaces
for Competitiveness of SMEs in Developing Countries”, e-Business and Telecommunications,
pages 82-93.




95Supply Chain Perspectives and Issues


Porter, Michael E. 1980. “Competitive Strategy: Techniques for Analyzing Industries and
Competitors”, The Free Press: New York.


Porter, Michael E. 1985. “Competitive Advantage: Creating and Sustaining Superior
Performance”, The Free Press: New York.


Porter, Michael E. 1990. “The Competitive Advantage of Nations”, The Free Press: New York.


Renting, Henry, Terry Marsden, and Jo Banks. 2003. “Understanding alternative food
networks: exploring the role of short food supply chains in rural development”, Environment
and Planning, 35(3): 393-411.


Schmitz, Hubert. 2004. “Local upgrading in global chains: recent findings”, DRUID
Summer Conference.


Sturgeon, Timothy J. 2001. “How do we define value chains and production networks?” IDS
Bulletin, 32(3): 9-18.


Sturgeon, Timothy J. 2002. “Modular Production Networks, a New American Model of
Industrial Organization.” Industrial and Corporate Change, 11(3): 451-496.


Sturgeon, Timothy, Johannes Van Biesebroeck, and Gary Gereffi. 2008. “Value chains,
networks and clusters: reframing the global automotive industry”, Journal of Economic
Geography 8(3): 297-321.


UNESCAP. 2011. “Enabling environment for the successful integration of small and
medium-sized enterprises in global value chains: country studies of Bangladesh, Nepal
and Sri Lanka”, United Nations ESCAP Studies in Trade and Investment 70.


Van der Ploeg, Jan Douwe, Henk Renting, Gianiuca Brunori, Karlheinz Knickel, Joe Mannion,
Terry Marsden, Kees de Roest, Eduardo Sevilla-Guzmán, and Flaminia Ventura. 2000.
“Rural development: from practices and policies towards theory”, Sociologia Ruralis,
40(4): 391-408.


Womack, J. P. and D. T. Jones. 1996. “Lean Thinking: Banish Waste and Create Wealth in Your
Corporation”, Simon & Schuster: New York.


Walker, Helen and Lutz Preuss. 2008. “Fostering sustainability through sourcing from small
businesses: public sector perspectives”, Journal of Cleaner Production 16(15): 1600-1609.


Wang, James J., and Michael C. Cheng. 2010. “From a hub port city to a global
supply chain management center: a case study of Hong Kong”, Journal of Transport
Geography 18(1): 104-115.






97Supply Chain Perspectives and Issues


Abstract


One area in which both business practitioners and policy makers are immediately
able to perceive the significance of the supply chain concept is in the new risks that
have materialised in an increasingly interconnected world . Isolated events such as the
September 11 attack in the United States in 2001, the Eyjafjallajökull volcano in Iceland,
the Fukushima disaster resulting from the Tohoku earthquake and tsunami in 2011, and
flooding in Thailand in the same year now precipitate waves of uncertainty that travel
faster and further than ever before. Perhaps unsurprisingly, the literature on risk and
supply chains is one of the most advanced in theoretical development and operational
applicability among the supply chain issues reviewed in the literature. In this chapter, we
review the central concept of supply chain risk management (SCRM) and provide a more
in-depth analysis of the SCRM framework’s underlying concepts of risk identification,
assessment, and mitigation.


5.1 Defining risk


Firms today have access to a new world of resources as a result of globalisation. However,
firms have had to expand their capabilities beyond their traditional boundaries to rely
on extended networks in order to capture these new gains. As a result, today’s market
place is defined much more by competition between teams rather than individual firms.
Correspondingly, the fate of the firm is now communally shared, to some extent, and risks
that were considered ignorable before have come to take on a new significance due to
expanded network exposure (Faisal, Banwet, and Shankar 2006).


Sodhi and Tang (2012) point to three emerging characteristics underlying the new
changes that are driving the growth in risk. First is the increasing number of firms found
in supply chains and, thus, an increasing number of points for possible disruption. Second
is the decreasing visibility and transparency that results from the increasing length of
the supply chain, which in turn impedes detection and response efforts. Third is the


Chapter 5
Supply chains and risk




Supply chains and risk


98 Supply Chain Perspectives and Issues


increasing global consequences of local actions in a supply chain, which increases the
risk of globally suboptimal results from locally optimal decisions.


The nature of these risks is derived from the systemic interactions characteristic of supply
chains and their significance was realised through a string of events around the turn of
the millennium. The first was the Y2K bug and the rapid realisation of the extent of global
interconnectedness by the end of the 1990s. Soon after came the 2000 fuel protests and
the 2001 outbreak of foot-and-mouth disease in the UK, which led the UK government to
mandate a study on supply chain vulnerability.


This was well under way by the time the September 11 attacks suddenly gave rise to
the issue of supply chain risk on the US research agenda (Jüttner, Peck and Christopher
2003; Christopher and Peck 2004). This recognition was not limited to the Western world,
given the 2003 outbreak of SARS on the Chinese mainland and in Hong Kong that shut
down major economic hubs and raised fears of a global epidemic (Faisal, Banwet, and
Shankar 2006). More recently, food security issues such as melamine contamination in
infant formula and powdered milk in China have added to the awareness of supply chain
risk (Narasimhan and Talluri 2009). Altogether, these events have raised awareness of the
importance of supply chain risk and have cemented efforts to establish a research agenda
on supply chain risk management.


Supply chain risk is expected to continue being a major issue for both firms and
governments. Technology and business model innovation will only further the gains
made through trade. Toyota, as of 2012, runs 50 overseas manufacturing operations
spread across 26 countries. The produced vehicles and components are then supplied to
more than 170 countries and regions. The realisation of risk events can thus travel further
and faster than before (UNESCAP 2013).


Firms that are not prepared have much to lose, as a popular study by Hendricks and
Singhal (2005) has shown. Their survey of over 800 supply chain disruption-related
company announcements over a 10-year period found that negatively affected companies
suffered between 33 per cent and 40 per cent lower stock returns against industry
benchmarks. Even in the case that the growing global interconnectedness is halted by a
rise in protectionism or isolationism, the connections already in existence are at risk of
being severed, composing a distinct class of supply chain risks of their own (Narasimhan
and Talluri 2009; Manuj and Mentzer 2008b).


5.2 The supply chain risk management framework


Attempts to address risks in the supply chain context have been unusually unified in
approach when compared to theory building efforts found in the other supply-chain
related issues covered in this volume. Research largely falls under the framework of
supply chain risk management (SCRM), with some minor variance in nomenclature and
the subcategorisation of issues.


SCRM encapsulates the process of identifying supply chain risks, assessing them and
choosing among a range of approaches to mitigate them (Nieger, Rotaru, and Churilov
2009; Manuj and Mentzer 2008a, 2008b; Khan and Burnes 2007; Gaonkar and Viswanadham
2007; Jüttner, Peck, and Christopher 2003). An example of this basic SCRM framework
can be seen in the work of Manuj and Mentzer (2008a) in Figure 5.1. In the following


1. Risk Identif ication
Using multiple sources and classifying risks into
supply, operations, demand, and security risks


2. Risk Assessment and Evaluation
Decision Analysis, Case Study(s), and
Perception-based


3. Selection of Appropriate Risk Management
Proposed strategies: avoidance, postponement,
speculation, hedging, control,
sharing/transferring, and security


5. Mitigation of Supply Chain Risks
Preparing for unforeseen risk events


4. Implementation of Supply Chain Risk
Management Strategy(s)


Enablers of risk strategy implementation:
complexity management, organizational learning,
information technology, and performance metrics


Figure 5.1 An example of the supply chain risk management (SCRM) framework. (Manuj and Mentzer 2008a)




99Supply Chain Perspectives and Issues


sections, we review the concepts contained in the successive steps of risk identification,
risk assessment, and risk mitigation.


Figure 5.1: An example of the supply chain risk management (SCRM) framework


Source: Manuj and Mentzer (2008a)


5.2.1 Risk identification


Approaches to risk identification invariably centre around a typology of risks. The utility
of this typology is in aiding the practitioner to make sense of the variety of risks he or
she faces and to organise the information needed for risk assessment and mitigation.
The most widely used typology of those reviewed is based on a spatial categorisation of
risks from the perspective of a focal firm. These categories include the operational risks
sourced from within the focal firm, supply risks from upstream firms, demand risks from
downstream firms, and environmental risks.


1. Risk Identif ication
Using multiple sources and classifying risks into
supply, operations, demand, and security risks


2. Risk Assessment and Evaluation
Decision Analysis, Case Study(s), and
Perception-based


3. Selection of Appropriate Risk Management
Proposed strategies: avoidance, postponement,
speculation, hedging, control,
sharing/transferring, and security


5. Mitigation of Supply Chain Risks
Preparing for unforeseen risk events


4. Implementation of Supply Chain Risk
Management Strategy(s)


Enablers of risk strategy implementation:
complexity management, organizational learning,
information technology, and performance metrics


Figure 5.1 An example of the supply chain risk management (SCRM) framework. (Manuj and Mentzer 2008a)




Supply chains and risk


100 Supply Chain Perspectives and Issues


There is general consensus on the definition of the first three, but some variability on the
conception of environmental risks. We start with the definitions for operational, supply,
and demand risks as compiled from Bogataj and Bogataj (2007), Christopher and Peck
(2004), Harland, Brenchley, and Walker (2003), Jüttner (2005), Sodhi and Tang (2012), and
Manuj and Mentzer (2008a, 2008b).


Operational risks are derived from the operations of the focal firm, and are commonly
subdivided into process risks and control risks. Process risks relate to disruptions in the focal
firm’s set of value-added processes, such as design, manufacturing, and distribution. Control
risks, on the other hand, refer to the controls used to govern processes. An example would
be established operational policies or procedures, which can both amplify or mitigate risks.


Supply risks negatively affect the timing, cost, and/or specifications of all inputs required
by the focal firm, whether the inputs are goods, services, or even information. These are
sourced from firms upstream from the focal firm. An example of a supply chain risk would
be the bankruptcy of a key component supplier.


Demand risks are based on the failure to match production with consumer demand,
whether it is due to changing consumer preferences or imperfect communication between
the focal firm and downstream firms. An example would be the risks incurred when
expanding into a foreign market with little knowledge of local preferences.


Risks sourced outside of these three categories include risks at the network level that
cannot be defined as upstream or downstream and risks that originate outside the network.
These risks have been categorised as environmental risks, security risks, and corporate
risks, among others.


The difficulty in categorising these risks arises from the need to define the network
boundaries of the supply chain. An additional conceptual difficulty is the transforming
nature of risk as it is propagated through a supply chain. For example, an environmental
risk such as an earthquake may turn into an operational risk for the affected firm,
which in turn creates supply risks that travel downstream and demand risks that travel
upstream. Table 5.1 presents a sample of the variety of these risks that do not fall within
the operational, supply, and demand risk categories.


Table 5.1: Examples of environmental or non-operational/supply/demand risks
reviewed in the literature


Reference Environmental or non-operational/supply/demand risks


Bogataj and Bogataj (2007) risks derived from the physical, social, political, legal, operational, economic, or cognitive environments


Christopher and Peck (2004) risks derived from socio-political, economic, or technological events


Jüttner (2005) risks derived from political, natural, or social uncertainties


Sodhi and Tang (2012)
financial risks, supply chain visibility risks, political/social risks, IT system
risks, intellectual property risks, exchangerate risks, environmental risks,
regulatory risks


Manuj and Mentzer (2008a) security risks, macroeconomic risks, policy risks, competitiverisks, and resource-constraint risks




101Supply Chain Perspectives and Issues


In reviewing the various attempts, a synthesis of the environmental risk concept and an
enterprise risk concept presents a possible solution to creating a clear and coherent
segmentation of these risks.


In such a synthesis, environmental risks are most simply described as risks sourced from
beyond supply chain borders, which in this conception, are an aggregate of firm borders
that belong to the supply chain; the criteria for which firms to include in the supply chain
are determined by the risk management scenario. Examples of environmental risks vary
from tsunamis to labour strikes, to the nationalisation of business assets or even the
invention and implementation of the internet.


Enterprise risks are distinguished from environmental risks by their origin from within
the supply chain. However, unlike operational, supply, and demand risks, enterprise risks
originate from systems and infrastructure that span portions or the entirety of the supply
chain. Examples of enterprise risk include the failure of central IT systems that manage
information flow across the supply chain, leakage of intellectual property distributed across
supply chain partners, and legal exposure resulting from inadequate supplier compliance
policies. An adaptation of these typology categories is presented in Figure 5.2.


Figure 5.2: An adaptation of the reviewed risk identification typologies


Two other typologies to note, aside from this focal firm-centric spatial approach, are a
spatial cause-and-effect typology of risks and a magnitude of impact-based typology
of risks. Sodhi and Tang (2012) present a spatial cause-and-effect typology, where risk
sources are distinguished as locally-derived or globally-derived and their consequences
considered at, again, the local and global levels. This typology is more easily demonstrated
visually, and a typology adapted from their work is presented in Figure 5.3.


Environmental risks
(including political, social, economic, and so forth)


Enterprise risks


Supply
risk


Demand
riskOperational


risks


Figure 5.2 An adaptation of the reviewed risk identication typologies




Supply chains and risk


102 Supply Chain Perspectives and Issues


Figure 5.3: Adaptation of a typology of supply chain risk drivers and consequences


Source: Sodhi and Tang (2012)


The magnitude of impact-based typology, also presented by Sodhi and Tang (2012),
distinguishes between “normal” risks, classified as “delays”, and “abnormal” risks, classified
as “disruptions”. Gaonkar and Viswanadham (2007) present a similar categorisation
that divides Sodhi and Tang’s “disruptions” category into “disruptions” and more severe
“disasters”. These alternate typologies also hold value for the management practitioner,
and a potential area for future work includes integration of these three typologies to
provide a comprehensive system for the categorisation of risks. In light of the fact that
the perception of risk directly affects the response to risk, the utility of a comprehensive
typology should not be underestimated.


5.2.2 Risk assessment


Risk assessment is the next step in the SCRM progression, taking the identified risks
and assigning them with the significance that will, in turn, guide the development of a
risk mitigation strategy. At the most fundamental level, risk assessment centres around
two questions: (1) what is the likelihood of a risk event occurring, and (2) what is the
significance or impact of that risk event? (Harland, Brenchley, and Walker 2003; Khan and
Burners 2007; Zsidisin et al. 2004). While relatively straightforward in theory, answering
these two question proves difficult in practice due to three challenges.


First is a design problem. In the literature reviewed, there was no universal risk assessment
tool being developed by a body of authors. Instead, a myriad of approaches and associated
tools have been presented. Perhaps this is fitting, given that risk assessment is highly
situation-specific; the same risk will have very different repercussions depending on time
and place in the value chain. However, the question of how to design a risk assessment
process around a practitioner’s given situation has yet to be fully addressed; and as Manuj
and Mentzer (2008) point out, “the heart of risk assessment is asking the right questions.”


Second is a coordination problem. Risk assessment requires the gathering of information
and the assessment of that information horizontally across firm boundaries and vertically
across levels of company hierarchy. Given that visibility and knowledge vary across these
organisational boundaries, risk assessment entails a significant coordination challenge
in execution.


Consequences


Risk
Sources


Local


Operational risks
local risks stemming from supply
and demand


Localisation risks
risks from corporate level decisions
on specic markets or regions


Network risks
risks stemming from a rm or
region that spreads to impact the
whole supply chain


Enterprise risks
risks from corporate level decisions
that impact the entire supply chain


Local


Global


Global


Figure 5.3 Adaptation of a typology of supply chain risk drivers and consequences from Sodhi and Tang (2012)




103Supply Chain Perspectives and Issues


Third is a subjectivity problem. This can be illustrated through a simple example: how
does one assess the impact of the discovery of child labour on a consumer good’s brand
name? Firms hold both tangible and intangible assets. In the case of intangible assets,
such as brand value, intellectual property and goodwill, arriving at a dollar valuation is
a very subjective process. This is further compounded by the fact that the assessment
of risk is significantly affected by the culture, confidence, and knowledge held by the
assessor. As mentioned in the previous section, the perception of risk directly affects the
behavioural response to risk (Juttner 2005; Juttner, Peck, and Christopher 2003).


Unfortunately, we are not able to present any answers to the above problems. What we
are able to do, however, is review the assessment tool classifications that are presented in
the literature so that the practitioner may know what options are available. We begin with
a broad classification by Manuj and Mentzer (2008) of tools as either decision analysis,
case study, or perception based. Decision analysis entails the input of data into a risk
assessment formula that produces some solution set of outcomes. In the case that the
formula is based on qualitative inputs (such as low-medium-high or yes-no inputs), the tool
is referred to as perception based. The remaining type, case studies, allows firms to assess
their risks through the process of investigating some aspect(s) of their organisation.


These tools can also be categorised by the types of analysis, inputs, and implementation.
Analysis can be based on probabilistic choice (PC) or risk analysis (RA). PC assesses
risks as an average expected impact of a risk event. An example of this logic would
be multiplying the impact of a risk event by its probability of occurrence to provide an
average expected outcome. However, there are situations where the realisation of a risk
event is extremely rare but catastrophic. In these situations, the very low probability of
occurrence may make the expected outcome appear misleadingly insignificant. For such
situations, an RA approach based on minimising regret would be more appropriate (Manuj
and Mentzer 2008).


The types of inputs to be used for analysis can be classified as qualitative or quantitative
and objective or subjective. It should be pointed out that quantitative inputs are not
exclusively objective (for example, considering the question of “what would be the financial
damage if someone leaked our trade secret”), and qualitative inputs are not exclusively
subjective. Finally, implementation of risk assessment processes or tools can be formal or
informal. Formal implementation entails a structured approach with designated assessors,
a predetermined time frame, and other protocols. Informal implementation, on the other
hand, could be done whenever, wherever, and by whomever.


Further research is needed in understanding how to tailor the various types of risk
assessment concepts to the situation. While practitioners have acknowledged the
importance of risk assessment, there is a chasm between the generation and the
utilisation of risk assessment results (Juttner 2005; Tang 2006). Whether this is due to
a lack of credibility or relevance of current assessment tools or whether it is due to the
lack of a methodology bridging assessment results with mitigation strategy design is, as
yet, unknown.


5.2.3 Risk mitigation


Following risk assessment is risk mitigation. This step contains, in actuality, two parts: (1)
the selection, and (2) the implementation of various risk management strategies. Several




Supply chains and risk


104 Supply Chain Perspectives and Issues


excellent reviews have been done on the risk mitigation strategies available to supply
chain practitioners, including the works of Jüttner, Peck, and Christopher (2003), Manuj and
Mentzer (2008a, 2008b), Sodhi and Tang (2012), and Tang (2006). What will be set forth here
is an integration of research findings from such works. These frequently display superficial
differences across studies, but most of these conflicts have been found to be rooted in
nomenclature and not in logic. The findings are synthesised and presented here as a
sequence on the classification, selection and implementation of risk management strategies.


There are a number of risk management strategies both documented and developed in the
literature. These can be organised along two lines of classification. The first categorises
strategies according to whether they entail risk avoidance, mitigation, or acceptance.
Recalling probability and impact as the two key characteristics of risk assessment,
avoidance emphasises a minimisation of probability, while mitigation focuses on impact.
An example of avoidance would be withdrawing from a risky market or adopting a zero
tolerance policy on supplier compliance. Mitigation, or reduction of risk, is often done by
maintaining an agile, adaptable, and aligned supply chain (Lee 2004) or an aligned, flexible,
and buffered supply chain (Sodhi and Tang 2012). The third category, risk acceptance, is
the simplest of the three, and entails no action being taken in preventing or otherwise
addressing the risk event. An example of a framework for mitigation responses can be
seen in the framework presented by Lessard and Miller (2001) in Figure 5.4.


Figure 5.4: A framework of risk mitigation strategies


Source: Lessard and Miller (2001)


The second classification of risk management strategies, presented by Tang (2006), is
based on the supply chain context; specifically, on whether the strategy addresses supply,
demand, products, or information. (Figure 5.5) Supply management encompasses all


Diversify
portfolio of projects


Br
oa


d
/ s


ys
te


m
ic


High control Low control


Ty
pe


s
of


ri
sk


s


Extent of control over risks


Sp
ec


f ic
to


p
ro


je
ct


Direct allocation
and mitigation


Shifting of
indeterminate risks


Embrace
residual risks of


Inuence and transform


Indirect


Direct shaping


Figure 5.4 A framework of risk mitigation strategies, from Lessard and Miller (2001)




105Supply Chain Perspectives and Issues


upstream-sourced risks, such as commodity constraints and supplier failures. Demand
management addresses all downstream risks, such as inventory shortages or changing
consumer preferences. Product management can address any part of the supply chain,
but focuses on addressing risk through product and process re-engineering. Similarly,
information management can also address any part of the supply chain, but targets
information management between firms to reduce risk.


Figure 5.5: A classification of risk management strategies


Source: Tang (2006)


These two classifications can be combined in the form of the following statement:
“Firms can respond to [avoid/mitigate/accept] risks through [supply/demand/product/
information] risk management.” This has been displayed in Table 5.2 which organises
various strategies sourced from the literature. The most commonly cited of these will be
summarised for the practitioner’s reference, below.


Table 5.2: Matrix of risk management strategies,
categorised by risk response and management approach


Divestment is a means of risk avoidance by withdrawing from supplier, customer, or
product markets to entirely avoid exposure to risks. An example is divestment from


Risk Response


Avoidance Mitigation Acceptance


Risk
Management


Approach


Supply
management


Divestment,
auditing, vertical
integration


Contract strategy,
multiple/local
sourcing


No strategy


Demand
management


Divestment,
vertical integration


Stockpiling, pricing,
marketing


No strategy


Product
management


Divestment Postponement No strategy


Information
management


Joint business
planning, vendor
managed inventory


No strategy


Figure 5.5 A classication of risk management strategies presented by Tang (2006)


Supply
Chain Risks


Demand
Management


Information
Management


Supply
Management


Product
Management




Supply chains and risk


106 Supply Chain Perspectives and Issues


a supplier found guilty of ethical violations in order to protect reputation and cut off
communicable ethical risks. The downsides of a divestment approach are the high
opportunity costs and loss of investment incurred by withdrawing from a market.


Auditing is a pre-emptive approach to risk avoidance by implementing controls and
safeguards that prevent the development and realisation of risk scenarios. An example
would be implementing ethical audits of suppliers to prevent the selection of at-risk
suppliers and to maintain the soundness of selected suppliers. As has been seen in real-
life case examples, however, auditing is far from a 100 per cent guarantee against risks.


Vertical integration avoids risks of supplier or customer misbehaviour, misunderstanding
or mistrust by taking control of them. Continuing with the example of supplier ethics, a
firm could implement a vertical integration strategy and take control of a key supplier
in order to have direct access and control over supplier behaviour. The cost of such
control, however, is an increased management burden, reduced supply chain flexibility,
and the adoption of a host of other operational risks associated with the expanded
organisational exposure.


Contract strategy improves coordination and risk sharing along a supply chain by
formalising agreements between supply chain partners. These agreements share risks
while increasing aggregate value across the parties involved. For example, a flexible
supplier contract allows a retailer to reduce stockpiles and better tailor inventory to
demand, while the supplier shares in increased profits through an increased margin for
such arrangements. Such contracts allow parties to capture gains that require multi-party
agreement and coordination. The cost of contract strategies lie in creating, enforcing, and
revising (or not revising) them.


Multiple/local sourcing is an approach to mitigating high impact but highly localised risk
events through diversification. Multiple sourcing applies when such risks affect upstream
suppliers, while local sourcing applies when such risks affect downstream suppliers. An
added benefit of local sourcing is the increase in responsiveness to local demand. The
repercussions of this strategy are reduced abilities to leverage economies of scale and
increased network management burdens.


Stockpiling is a redundancy-based inventory strategy to mitigate unexpected fluctuations
in demand. Strategic stockpiling stores buffer inventory at key locations that can be
accessed by multiple downstream partners and/or enable rapid response to demand. This
concept of building in buffers or redundancies can be applied not only to inventory, but
also to warehouses, distributors, suppliers, and other elements in the supply chain. Two
drawbacks to such an approach, however, are extra costs and reduced transparency in
the supply chain.


Pricing is a demand management strategy that influences customer behaviour through
price manipulation. Also known as revenue management and yield management, such
strategies allow supply chain members to adapt to supply disruptions in products, such
as perishable goods, that are particularly vulnerable to demand fluctuations.


Marketing is another demand management strategy that enables firms to influence
demand. We include here concepts of product substitution, product bundling, assortment
planning and visual merchandising. These allow firms to shift customer preferences
across products in order to counter demand uncertainty and diffuse supply variability.




107Supply Chain Perspectives and Issues


Postponement is a product management strategy that increases the ability to respond to
demand variation by redesigning products and/or processes so that resource costs are
incurred as late as possible. The benefits can be considered in the example of a restaurant,
where food components are standardised and cooking instructions optimised, such that
a limited variety of ingredients can be quickly adapted into a large variety of dishes. The
costs associated with postponement are the design and restructuring costs associated
with new standardised component assemblies and operations.


Joint business planning leverages information sharing across supply chain partners to
identify areas of strategic alignment and fosters the trust and coordination required to
capture the potential gains. This can be done through passive infrastructure, such as
enterprise resource planning (ERP) systems, and active management, such as annual
partner meetings. The trade-off risks include the hazards of creating opportunities for
collaborators to turn into market competitors and creating security risks by sharing
sensitive information, such as intellectual property.


Vendor managed inventory enables risk sharing through information sharing, and entails
a retailer passing on valuable market data to the supplier in return for the supplier taking
responsibility for inventory risk. This is quite appealing to suppliers looking to upgrade
their capabilities and capture higher value-added activities.


As the above descriptions make clear, every strategy incurs costs. Often, reducing
exposure to one risk increases exposure to another, and it is this trade off that presents
the real challenge for the practitioner.


Initial work has been presented by the likes of Manuj and Mentzer (2008a) and Sodhi and
Tang (2012) on building decision support tools for practitioners choosing appropriate risk
management strategies, but further research and development is needed. Additionally,
it should be made clear that the list of aforementioned risk management strategies is
far from exhaustive, and intentionally so. These strategies are merely intended to provide
a starting point for considerations made by the risk management supplier. Appropriate
strategies, being situation dependant, are only limited by the practitioner’s knowledge and
imagination. The strategies mentioned can be utilised beyond their compartmentalised
descriptions and in combination.


Beyond the selection of an appropriate risk management strategy is the actual
implementation of that strategy. This area is even less developed than the strategy selection
literature, and an empirical study of factors affecting implementation of strategy and of the
efficacy of various strategies is much needed.


To summarise the preceding discussion, we close with an example of an SCRM
framework in Figure 5.6 from Manuj and Mentzer (2008a) that comprehensively
visualises the steps reviewed.




Supply chains and risk


108 Supply Chain Perspectives and Issues


Figure 5.6: The SCRM framework
Global supply chain risk management and mitigation framework


Source: Manuj and Mentzer (2008a)


5.3 Empirical studies


With the emergence of a SCRM framework, empirical studies have already begun to test
and revise concepts through real-life use. Studies on SCRM implementation and efficiency
have also started to emerge, such as with the works of Ritchie and Brindley (2007) and
Sodhi and Tang (2012). (See Table 5.3)


There is wide coverage across industry sectors, but the empirical studies reviewed tend
to centre on the developed country perspective and on the UK perspective, in particular.
While the developed country perspective can be rationalised, given the presence of the
lead firms that are headquartered there, the works seen from the UK were found to be
driven by the UK government’s proactive stance in understanding supply chain risk.


GLOBAL SUPPLY CHAIN RISK MANAGEMENT AND MITIGATION FRAMEWORK


Step 1: Risk
Identif ication


Step 2: Risk Assessment and Evaluation


Initial
Supplier


Ultimate
CustomerSupplier


Avoidance Postponement Speculation Hedging Control Share/Transfer Security


Customer


Supply
Risks


Operational
Risks


Demand
Risks


Security


... ...Focal Firm


Risk within
the rm


DOMESTIC ENVIRONMENT


GLOBAL ENVIRONMENT


Step 3: Risk Management Strategies


Step 4: Implementation of Supply Chain Risk Management Strategy(s):
The enablers: Complexity Management, Information Systems, Organizational Learning, and


Performance Metrics


Step 5: Mitigation of Supply Chain Risks


Figure 5.6 The SCRM framework (Manuj and Mentzer 2008a)




109Supply Chain Perspectives and Issues


Table 5.3: Empirical studies sourced from the literature


The United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP)
also sponsored a number of studies on the impact of natural disasters on global supply
chains (UNESCAP 2013; UNESCAP and UNISDR 2012; Ye and Abe 2012). These empirical
studies document the impact on global supply chains of the 2011 Great East Japan
earthquake, the 2011-2012 Thailand floods, and the 2010-2011 Australian floods.


Ye and Abe (2012) point to the fundamental need for both business and government action
when faced with natural disaster risks. Their study of the impact and response to the Great
East Japan earthquake and flooding in Thailand in 2011 highlights the crucial importance
of public-private partnerships in managing natural disaster risk to GSCs.


UNESCAP (2013), UNESCAP and UNISDR (2012) further add policy recommendations and
observe the challenges businesses face between streamlining/agglomerating their supply
chain activities versus maintaining time and inventory buffers that negatively impact
returns and supply chain strategies (such as “lean” and “just-in-time”).


5.4 Future directions


What will be immediately apparent for those coming from foreign perspectives is the
bias of the literature towards management of supplier (as opposed to customer) risk and
towards adopting a perspective that lies in the “centre” of the supply chain. For example,
discussions may be relevant for manufacturing and distribution firms, but not as much for
the farmer or miner on one end and the retailer or post-purchase servicing company on
the other. This is a conceptual limitation that will require empirical and theoretical input
from a broader range of supply chain participants to overcome.


GLOBAL SUPPLY CHAIN RISK MANAGEMENT AND MITIGATION FRAMEWORK


Step 1: Risk
Identif ication


Step 2: Risk Assessment and Evaluation


Initial
Supplier


Ultimate
CustomerSupplier


Avoidance Postponement Speculation Hedging Control Share/Transfer Security


Customer


Supply
Risks


Operational
Risks


Demand
Risks


Security


... ...Focal Firm


Risk within
the rm


DOMESTIC ENVIRONMENT


GLOBAL ENVIRONMENT


Step 3: Risk Management Strategies


Step 4: Implementation of Supply Chain Risk Management Strategy(s):
The enablers: Complexity Management, Information Systems, Organizational Learning, and


Performance Metrics


Step 5: Mitigation of Supply Chain Risks


Figure 5.6 The SCRM framework (Manuj and Mentzer 2008a)


Citation Year Type Industry Geography Subject


Harland,
Brenchley, and
Walker


2003 case study hi-tech, computers,
consumables


United
Kingdom,
Netherlands,
American


Theory building for
SCRM


Jüttner 2005 survey consumer goods, logistics,
distribution, retail, public
sector, pharmaceuticals,
brewing, automotive,
finance


United
Kingdom and
International


Theory building for
SCRM


Juttner, Peck, and
Christopher


2003 survey manufacturing, retail,
logistics


United Kingdom Theory building for
SCRM


Manuj and
Mentzer


2008 survey appliances, electronics,
pharmaceuticals, heavy
equipment


N/A Risk management
strategies for global
manufacturing


Ritchie and
Brindley


2007 case study agricultural equipment,
construction


United Kingdom 6 year longitudinal
study of SCRM impact
on firm performance


Sodhi and Tang 2012 case study Boeing, Mattel, plastics
manufacturer


International Application of SCRM
theory


Ye and Abe 2012 case study electronics, chemicals, steel,
automotive, others


Japan, Thailand Impact of natural
disasters on global
supply chains


Zsidisin et al. 2004 case study computers, aerospace, semi-
conductors, mobile phones


N/A Risk assessment
practice of purchasing
departments




Supply chains and risk


110 Supply Chain Perspectives and Issues


Within the SCRM framework, we also see the need for further empirical studies and
communication between practitioners and academics in the area of risk assessment.
While SCRM theory still tends to lag behind practice, assessment is an area of particular
need. Given that the advance of risk assessment is mired in difficulties stemming from
organisational psychology and the on-the-ground perspective of practitioners, we
recognise the merit of taking a more theoretical approach to the problem.


5.5 References


Bogataj, David and Marija Bogataj. 2007. “Measuring the supply chain risk and vulnerability
in frequency space”, International Journal of Production Economics, 108(1-2): 291-301


Christopher, Martin and Helen Peck. 2004. “Building the resilient supply chain”, International
Journal of Logistics Management, 15(2): 1-13.


Faisal, Mohd Nishat, D.K. Banwet, and Ravi Shankar. 2006. “Supply chain risk mitigation:
modelling the enablers”, Business Process Management Journal, 12(4): 535-552.


Gaonkar, Roshan S., and N. Viswanadham. 2007. “Analytical framework for the management
of risk in supply chains”, IEEE Transaction on Automation Science and Engineering, 4(2):
265-273.


Ghoshal, Sumantra. 1987. “Global strategy: an organizing framework”, Strategic
Management Journal, 8(5): 425-440.


Harland, Christine, Richard Brenchley, and Helen Walker. 2003. “Risk in supply networks”,
Journal of Purchasing and Supply Management, 9(1): 51–62.


Hendricks, Kevin B. and Vinod R. Singhal. 2005. “An empirical analysis of the effect of
supply chain disruptions on long-run stock price performance and equity risk of the firm”,
Production and Operations Management, 14(1): 35-52.


Jüttner, Uta. 2005 “Supply chain risk management: understanding the business
requirements from a practitioner perspective”, The International Journal of Logistics
Management, 16(1): 120-141.


Jüttner, Uta, Helen Peck, and Martin Christopher. 2003. “Supply chain risk management:
outlining an agenda for future research”, International Journal of Logistics: Research &
Applications, 6(4): 197-210.


Khan, Omera and Bernard Burnes. 2007. “Risk and supply chain management: creating
a research agenda”, The International Journal of Logistics Management, 18(2): 197-216.


Lee, Hau L. 2004. “The triple-A supply chain”, Harvard Business Review, 82(10): 102-113.


Lessard, Donald, and Roger Miller. 2001. “Understanding and managing risks in large
engineering projects”, MIT Sloan School of Management, Sloan Working Paper 4214-01.


Manuj, Ila and John T. Mentzer. 2008a. “Global supply chain risk management”, Journal of
Business Logistics, 29(1): 133-155.


Manuj, Ila and John T. Mentzer. 2008b. “Global supply chain risk management strategies”,
International Journal of Physical Distribution & Logistics Management, 38(3): 192-223.


Mason-Jones, Rachel, and Denis R. Towill. 1998. “Shrinking the supply chain uncertainty
circle”, IOM Control, 24(7): 17-22.




111Supply Chain Perspectives and Issues


Nieger, Dina, Kristian Rotaru, and Leonid Churilov. 2009. “Supply chain risk identification
with value-focused process engineering”, Journal of Operations Management, 27(1):
154-168.


Narasimhan, Ram and Srinivas Talluri. 2009. “Perspectives on risk management in supply
chains”, Journal of Operations Management, 27(1): 114-118.


Ritchie, Bob and Clare Brindley. 2000. “Disintermediation, disintegration and risk in the
SME global supply chain”, Management Decision, 38(8): 575-583.


Sodhi, ManMohan S. and Christopher S. Tang. 2012. “Managing Supply Chain Risk”,
Springer: New York.


UNESCAP. 2013. “Building resilience to natural disasters and major economic crises”,
UNESCAP Theme Study, 69th Comission Session.


UNESCAP and UNISDR. 2012. “Reducing vulnerability and exposure to disasters: the Asia-
Pacific disaster”, report 2012.


Ye, Linghe and Masato Abe. 2012. “The impacts of natural disasters on global supply
chains”, ARTNeT Working Paper No. 115, June, Bangkok, ESCAP. Available from www.
artnetontrade.org.


Zsidisin, George A., Lisa M. Ellram, Joseph R. Carter, and Joseph L. Cavinato. 2004. “An
analysis of supply risk assessment techniques”, International Journal of Physical
Distribution & Logistics Management, 34(5): 397-413.






113Supply Chain Perspectives and Issues


Abstract


Small- and medium-sized enterprises (SMEs) present an issue of significant political
and economic interest as they create jobs and drive development in developing and
advanced countries. However, there is a perception that SMEs face a conundrum in the
new realities brought about by globalisation. While supply chains present a portal for
SMEs into international markets, they also open up SME market niches to encroaching
large-sized enterprises (LEs). The competitive capabilities imparted by supply chain
management (SCM) literature is suggested here for SMEs to compete against LEs; a
slingshot in the battle between David and Goliath. The literature, however, reveals a
controversy over whether SCM, in reality, helps or hurts SMEs. Some of the reasoning
points to the presence of an LE perspective bias, and SMEs sometimes consider SCM
as a threat, not a solution. The recent literature is addressing this issue by taking up
the SME perspective, but the question of an SCM for SMEs is still in a very early stage of
development. More effort will be required to gather data and build theory for SMEs in
both developed and developing markets.


6.1 Defining SMEs


As a point of methodological concern, it should be noted that the definition of an SME
varies by country and researcher. Classification is universally divided between SMEs
and larger enterprises (LEs), with occasional sub-segmentation of SMEs into smaller
groupings. Classification is determined by the number of firm employees, and the range of
employee cut-offs found in the literature is presented in Table 6.1. Table 6.2 shows further
example definitions from South-East Asia (UNESCAP 2009).


Chapter 6
Supply chains and SMEs




Supply chains and SMEs


114 Supply Chain Perspectives and Issues


Table 6.1: A sampling of the SME firm size criteria surveyed in the literature


US-orientated studies tend to adopt the cut-off at 500 employees or fewer adopted by the
US Small Business Administration (US SBA 2008). European studies tend to utilise smaller
cut-offs of either less than 200 or 250 employees to qualify as an SME. Any firm above the
size threshold is automatically classified as an LE.


Table 6.2: A sampling of SME definitions in South-East Asia


Source: UNESCAP (2009)


It should also be noted that SMEs entail very different notions depending on whether
the term is used in a developed or developing country context. In the former, SMEs are
perceived to be innovative and agile firms that employ high skill labour. In the latter, SMEs
are perceived as labour intensive but low skill firms that seek capabilities upgrading.


6.2 The significance of SMEs


SMEs are considered key participants in any economy due to a number of unique traits
not held by LE counterparts. As a whole, they compose the dominant majority of most
economies’ firms and jobs, leading Kaplinksy and Readman (2001) to refer to them as the
backbone of the private sector in countries both developed and developing. Secondly,
SMEs play a critical role in the development process. Finally, SMEs also populate a number


# Employees Geography Source(s)


<200 Norway, Wales, Scotland Quayle (2003), Wagner, Fillis, and Johnsson (2003), Vaaland
and Heide (2007)


<250 United Kingdom Wynarcyzk and Watson (2005)


<500 United States Hong and Jeong (2006), UNCTAD (1993)


≤500 United States, Mexico, Europe Arend and Wisner (2005), Fawcett et al. (2009),
US SBA (2008)


Country Definition


Cambodia Firms that employ between 11 and 50 employees and have fixed assets of $50,000 to $250,000 are
categorized as small. Firms with 51-200 employees and fixed assets of $250,000 to $500,000 are
medium sized.


Indonesia Fewer than 100 employees.


Lao People’s
Democratic
Republic


“Small enterprises are those having an annual average number of employees not exceeding 19
persons or total assets not exceeding two hundred and fifty million kip or an annual turnover not
exceeding four hundred million kip”.


“Medium sized enterprises are those having an annual average number of employees not
exceeding 99 persons or total assets not exceeding one billion two hundred million kip or an annual
turnover not exceeding one 1 billion kip”.


Malaysia Depends on the business sector. Different criteria, based on the number of employees and annual
sales turnover. For details, see www.smeinfo.com.my/pdf/sme_definitions_ENGLISH.pdf.


Philippines Fewer than 200 employees, and less than P 40 million in assets.


Thailand Depends on the business sector. Different criteria, based on number of employees and fixed capital
size. For details see http://cms.sme.go.th/cms/web/homeeng.


Vietnam SMEs are independent production and business establishments that are duly registered according
to the current law provisions, each with registered capital not exceeding VND 10 billion or annual
labour not exceeding 300 people.




115Supply Chain Perspectives and Issues


of key roles in the supply chain. As such, a healthy SME sector is considered necessary
for a healthy economy.


6.2.1 SMEs as the backbone of the economy


SMEs compose the dominant majority of firms and jobs worldwide. In most economies,
SMEs account for more than 90 per cent of total firms and more than 50 per cent of
jobs, sales, and value-added (UNCTAD 1993). Worldwide, SMEs represent 90 per cent of
all firms and 50 to 60 per cent of all employment on average. The proportion of global
employment represented by SMEs rises to 80 per cent when narrowed down to the global
manufacturing sector (Kaplinsky and Readman 2001). In the US manufacturing sector,
SMEs represent 98 per cent of all firms and two-thirds of all jobs (Fawcett et al. 2009). In
the UK, SMEs account for approximately 50 per cent of total GDP and nearly 70 per cent
of all jobs. Within Wales, this number rises to 90 per cent of all Welsh jobs, with SMEs
representing 80 per cent of all Welsh firms (Quayle 2003). SMEs also play a particularly
dominant rule in Turkey, where SMEs account for 99.5 per cent of all firms and 61.1 per
cent of all jobs (Koh et al. 2007).


The demographic evidence on the significance of SMEs is clear, but SMEs play key roles
as job generators, innovators and exporters as well. Not only do they act as a source
of future LEs, but they also infuse economies with agility/adaptability. The hypothesis,
as reviewed by UNCTAD (1993), is that SMEs have smaller management teams that
enable responsiveness, take roles as market price-takers that temper inflation, and drive
job creation and innovation. SMEs even expand consumer choice by catering to niche
consumer demands that would normally be neglected by LEs seeking economies of scale.


6.2.2 SMEs as development actors


SMEs are considered key participants in a country’s development for two commonly
cited reasons. First is their ability to create jobs for low-skilled labour that is commonly
found in the human resource pool of developing economies. This employment presents
opportunities not only for poverty reduction and human resource development, but also
for balanced development that is inclusive of poor households and women. Second, SMEs
help build the early economic foundations needed for development. SMEs transform
endowments of labour and natural resources into capital and industrial infrastructure.
In doing so, they establish the economic relationships that enmesh SMEs and LEs across
both urban and rural areas. SMEs are also the fount from which LEs are often born, and
many national champions in the newly industrialised economies have emerged in such
a manner (Kaplinsky and Readman 2001; UNCTAD 1993; UNESCAP 2009). Thus, a strong
SME sector is considered a powerful engine for driving country development.


6.2.3 SMEs as supply chain actors


SMEs are playing increasingly significant roles as actors in global supply chains.
International organisations consider them as important drivers of development, and are
supporting their entry into international markets through global supply chains (UNESCAP
2009). They are already integrated as suppliers of commodities and low cost labour
in developing countries and as innovators and technology specialists in developed
countries. The former has been documented through extensive empirical studies of the




Supply chains and SMEs


116 Supply Chain Perspectives and Issues


global agricultural, apparel, and electronics industries. The latter has also been seen in
the advanced skills contributed by machinery suppliers in Germany and Switzerland. In
addition to being suppliers, they also act as distributors, producers, and customers in
the supply chain. Thus, an SME presence is extensive in supply chains and is expected
to grow (Thakkar, Kanda, and Deshmukh 2008). The literature on risk and sustainability
reflects an increasing awareness and concern from lead firms and large enterprises on
understanding and managing the SMEs in their networks (Koh et al. 2007).


6.3 The competitive environment for SMEs


6.3.1 Challenges


The most commonly cited challenge for SMEs in today’s market is globalisation. More
specifically, two drivers are documented in the literature: liberalising trade policy and
technological/organisational innovation. Liberalising trade policy has reduced barriers to
entry into foreign markets for the firms that have the resources to do so; namely, LEs. At
the same time, government policies that have protected SMEs and SME niche markets are
slowly disappearing. The second driver, technological and organisational innovation, has
expanded the capabilities of firms, endowing greater power and reach over geographical
and organizational boundaries (Fawcett et al. 2009; Koh et al. 2007; Thakkar, Kanda, and
Deshmukh 2008).


The result is an increasingly competitive environment that exacerbates SMEs’ characteristic
internal resource constraints. These include perennial constraints in accessing finance,
technology, human resources, and market information (UNESCAP 2009). Specialised or
niche markets that were previously under the domain of SMEs are increasingly being
encroached upon by LEs, and SMEs in the value chain often find themselves under the
control of more powerful firms. All the while, SMEs continue to be faced with resource
constraints in terms of finances, knowledge, manpower and time. This boils down to the
simple reality that SMEs must find ways to increase productivity (Fawcett et al. 2009;
Thakkar, Kanda, and Deshmukh 2008; Quayle 2003).


6.3.2 Advantages


SMEs are not entirely powerless in today’s global market; they have been able to counter
the economies of scale of LEs with superior differentiation. By providing products and
services that better cater to their customer’s needs, SMEs are able to compete against the
low cost but commoditised offers of LEs. That being said, this differentiation advantage
is fading with the increased capabilities of today’s LEs (Elmuti 2002).


SMEs, however, also have inherent organisational advantages. They tend to be more flexible,
faster decision-makers with better communication and utilisation of internal knowledge
among employees (Thakkar, Kanda, and Deshmukh 2008). The result is an organisational
unit that is better positioned to adapt to change; perhaps it is no surprise, then, that LEs
view the outsourcing of tasks to SMEs as a path towards increased adaptability and
agility. Finally, as Fawcett et al. (2009) point out, globalisation is conversely providing new
opportunities for SMEs’ access to the global consumer and resource markets.




117Supply Chain Perspectives and Issues


6.4 SMEs and supply chain management


Theoretically, supply chain management should provide SMEs with guidance on operating
successfully within their supply chain. However, to succeed in the new chain versus chain
competition of global markets empirical evidence shows that the very value of the SCM literature
to the SME manager is in question. We first review the theoretical benefits SCM should provide
the SME, and then examine explanations and empirical evidence as to why reality differs.


6.4.1 SCM as the solution


Because of globalisation, SMEs effectively find themselves facing more advanced
challengers in a vastly expanded competitive arena. Thus, the fundamental challenge
posited for SMEs is to increase productivity; simply put, to produce more while using less.


In response, the literature proposes that the network-competitiveness concepts of supply
chain management should also be applied to SMEs. SCM should theoretically strengthen
SMEs through operational excellence, enhanced learning, and new market opportunities.
In Thakkar, Kanda, and Deshmukh’s (2008) own literature review, supply chain inefficiency
is found to be one of the most prevalent issues facing SMEs. Supply and process costs
account for 30 per cent of the average manufacturing SME’s budget, with 40 per cent of
the supply costs derived from logistics costs.


To this end, SCM offers a laundry list of benefits, including shorter lead times, fewer
operational disruptions, reduced inventory, better quality and customer service, faster
innovation, and reduced risk (Arend and Wisner 2005; Fawcett et al. 2009; Vaaland and
Heide 2007). An empirical study by Koh et al. (2007) further investigates the efficacy
of SCM for more than 200 Turkish SMEs, and finds evidence supporting a positive and
significant effect of SCM for SMEs.


The second benefit offered by SCM is in the enhanced learning opportunities gained by
SMEs in the supply chain. By integrating into a supply chain, SMEs gain access to stores
of information, knowledge, and even training (Quayle 2003; Macpherson and Wilson 2003;
Vaalande and Heide 2007).


The final benefit of SCM posited is market entry. Particularly prevalent in the SMEs and
development literature, SCM can be utilised by SMEs to manoeuvre across and within
supply chains in order to gain access to new value-added activities and markets (Fawcett
et al. 2009; Humphrey 2001; UNIDO 2001). With these potential benefits of SCM, weak
SMEs can reach potential benefits through learning and operational efficiency. Strong
SMEs can use SCM to manoeuvre to positions in the supply chain that increase its value-
added and/or relative influence over partners (Hong and Jeong 2006; Thakkar, Kanda,
and Deshmukh 2008).


This body of issues, grouped under firm “upgrading”, was addressed in more depth in
Chapter 4, which offered a typology of the learning/upgrading paths available and their
feasibility according to the type of relationship the SME has with its supply chain partners.


Given that many technological and operational innovations are embedded in the concepts
and practice of SCM, researchers are eyeing SCM as a potential and possibly necessary
tool for SMEs to survive competition against LEs and other SMEs. In a market that values




Supply chains and SMEs


118 Supply Chain Perspectives and Issues


responsiveness and innovation, SCM may be the tool SMEs need to enhance their current
advantages and sustainably compete in the global market.


6.4.2 SCM as the problem


A central research question in the literature on supply chains and SMEs, however, is on
whether SCM and SMEs are compatible. The theorised benefits have not been fully realised
in actual results. This is widely cited to be due to SMEs not implementing SCM properly, if
at all (Arend and Wisner 2005; Fawcett et al. 2009; Thakkar, Kanda, and Deshmukh 2008;
Vaaland and Heide 2007).


However, we would like to posit an alternative interpretation that shifts the locus of the
problem from the SME to SCM. We propose that SCM was not developed with SMEs in
mind, and that this is the cause for the lack of managerial interest and the inability to
“properly” implement SCM. We derive this claim from the disconnect between SCM and
SMEs reviewed in the literature, which we split into disconnects in managerial perspective
and disconnects in implementation requirements.


The SCM literature reviewed not just for this chapter, but for this literature review in its
entirety, exhibits a consistent bias in managerial perspective. SCM is viewed as a network
management tool for firms (typically large multinational enterprises) to manage their
suppliers (typically low value-added SMEs in developing countries). Case studies and
SCM success stories tend to showcase LEs (Fawcett et al. 2009). The innovative and
specialised SME, typically associated with a developed country setting, is found not in
the business-centric SCM literature but in the more policy-relevant value chain literature.


The absence of the SME perspective in the SCM literature is often raised in the SME-SCM
literature (Koh et al. 2007; Quayle 2003; Thakkar, Kanda, and Deshmukh 2008). This is
a significant issue given the near 180-degree difference in the managerial perspective
of the SME versus LE perspectives. In contrast to a large organisation concerned with
upstream supplier management, the starting point of considerations need to switch to a
small organisation concerned with downstream customer/demand management.


For example, SCM currently addresses issues related to supplier compliance, long-term
sustainability, and agility at the large organisational scale. However, SMEs face more
demanding challenges in managing their customers and understanding how to leverage
supply chain resources to enter new markets. Additionally, their resource constraints
result in a short-term time horizon that makes long-term considerations of sustainability
infeasible. Thus, the LE perspective embodied in SCM concepts is incompatible with the
SME setting. This is in line with empirical results from surveys of SMEs, showing that they
have little interest in paying attention to SCM concepts – even going as far as to view SCM
as a threatening tool used by LEs to control SMEs (Arend and Wisner 2005; Fawcett et al.
2009; Macpherson and Wilson 2003; Quayle 2003; Thakkar, Kanda, and Deshmukh 2008;
Vaaland and Heide 2007). To sum up, we quote Vaaland and Heide (2007), who observe
that “studies… indicate a considerable gap between what is normally considered as
important SCM tools and ideas and the reality that SMEs operate in.”


The implementation requirements of SCM and the resource constraints characteristic
of SMEs are another cause of failure in SME-SCM implementation. SCM emphasises
information and communication technologies to enable new network-oriented business
models. However, SMEs often lack the finances and technical expertise to build such




119Supply Chain Perspectives and Issues


infrastructure, as well as the human resources to run it (Fawcett et al. 2009; Vaaland and
Heide 2007; Wagner, Fillis, and Johansson 2003).


Furthermore, the merits for such infrastructure also include redundant features for the
SME, such as enabling more agility. SCM implementation also requires control over one’s
organisation, and sometimes partnering organisations. However, SMEs in supply chains
often find their decision-making power curtailed by the influences of other lead firms in the
chain. As such, SMEs that implement SCM are often strong firms that do so by their own will
or weak firms that are forced to do so by lead firms (Arend and Wisner 2005; Fawcett et al.
2009; Hong and Jeong 2006; Vaaland and Heide 2007). Interestingly and perhaps alarmingly,
Arend and Wisner (2005) find that the former category of strong firms is weakened by SCM
implementation, while the latter category of weak firms is strengthened by it.


6.4.3 Reconciliation: developing SCM for SMEs


As the literature makes clear, practitioners and researchers are questioning the very value
that SCM can deliver to SMEs. The flagship paper for this concern is Arend and Wisner’s 2005
study of more than 400 senior managers, which found that “SMEs more likely to perform well
chose to engage in SCM, which was a choice that hurt SME performance.”


While the idea of SCM as a tool for tackling the challenges of network competition is as
relevant to SMEs as LEs, the design of SCM has clearly shown that current SCM solutions
do not align well with SME problems. If progress is to be made on understanding how to
implement SCM for SMEs, we argue that a shift in rhetoric is necessary from “SMEs as the
fault” to “SCM as the fault”.


For example, even Arend and Wisner (2005) state that “SMEs are not suited to implementing
SCM effectively” – phrasing that is propagated in the literature, as studies seek to
understand why SMEs are failing to implement SCM. Instead of asking why SMEs are not
suited for SCM, however, it may be more fruitful to ask why SCM is not suitable for SMEs.
First steps have already been taken in investigating the differences between SMEs and
LEs and in understanding their repercussion in SCM implementation. The next step is to
transform these differences into design constraints that can then be used to develop an
SCM that is suitable for SMEs.


A future distinction may need to be made between LE-SCM and SME-SCM. Within SME-
SCM, further distinctions may also be necessary between what has already been referred
to as weak SMEs versus strong SMEs. As Macpherson and Wilson (2003) note, the SME
sector is not homogenous, and a distinction beyond the number of employees is needed.
For example, a low-cost manufacturer in Bangladesh, an R&D specialist in Germany, and
an e-commerce start-up in the US may all be SMEs but each holds a very different position
with consequences in the supply chain.


Fawcett et al.(2009) present one typology according to SME business goals. Three paths
are proposed: the niche player, the grow-and-sell player, and the long-term growth player.
The niche, or status quo, player is satisfied with maintaining its current market niche.
The grow-and-sell player is looking to be acquired, and is concerned with establishing a
strong track record to indicate the potential for future growth that will raise its valuation.
The long-term growth player is to become an LE and industry leader. Hong and Jeong
(2006) present a fairly advanced functional typology, assigning two measures to SMEs
based on a strategic focus on supply chain position (Figure 6.1).




Supply chains and SMEs


120 Supply Chain Perspectives and Issues


Figure 6.1: A typology of SMEs


Source: Hong and Jeong (2006)


Hong and Jeong’s framework further expands the weak versus strong firm distinction,
classifying SMEs by their current position of political power (high or low) in the supply
chain and by their strategic focus (low cost or value-added) to produce four strategic roles
in the supply chain (coordination, innovation, efficiency, or collaboration). This is further
developed by indicating five growth paths that converge upon the innovative firm as the
ultimate goal for SMEs (Figure 6.2).


Figure 6.2: Five paths for SME growth


Source: Hong and Jeong (2006)


High


Low


Low
Cost


Value
Added


Chain
Relationship


Position


Strategic Focus


Coordination


Innovation


Collaboration


Eciency


1


5


4


32


Figure 6.2 Five paths for SME growth, from Hong and Jeong (2006)


Figure 6.1 A typology of SMEs, from Hong and Jeong (2006)


Coordination Innovation


Eciency Collaboration


High


Low


Value AddedLow Cost


Strategic Focus


Chain
Relationship


Position




121Supply Chain Perspectives and Issues


In reconsidering the question proposed by Arend and Wisner (2005) of: “Is there a fit?”, the
answer seems to be that there is a fit, in theory, but now the question is “how?”


6.5 Empirical studies


The empirical literature shows broad geographical and industrial coverage. However,
a closer look at studies of developed country SMEs versus developing country SMEs
shows an understandable bias of developing country studies towards the commodities
and manufacturing industries while developed country studies remain fairly diversified.


In addition to investigating the question of SME-SCM relevance, studies have also shown
an emphasis on understanding technology integration and e-business models for SMEs.
Little, however, is seen in terms of SME-SCM in the context of services; a potential area for
future investigation.


Table 6.3: Empirical studies sourced from the literature


Citation Year Type Industry Geography Subject


Arend and Wisner 2005 survey manufacturing and services United States, Mexico,
Europe


Compatibility between
SCM and SMEs


Cooke and Morgan 1993 case study multiple Baden-Wurttemberg,
Germany; Emilia-Romagna,
Italy; Basque, Spain; Wales,
United Kingdom


Regional SME bolstered
development


Koh et al. 2007 survey metal product and general
purpose machinery
manufacturing


Turkey Compatibility between
SCM and SMEs


Macpherson and Wilson 2003 survey manufacturing Northwest England Development
opportunities for SMEs in
the supply chain


Ndou, Vecchio, and Schina 2011 survey food processing Tunisia E-business models for
SMEs in developing
countries


Quayle 2003 survey manufacturing, high tech,
electrical, packaging and
distribution, finance, services,
construction, agriculture


Wales The SCM practices of
SMEs


UNESCAP 2007 case study fresh fruit and vegetable,
wood furniture, apparel,
automobile components


Vietnam (Greater Mekong
Subregion)


Integration of developing
country SMEs into global
value chains


UNESCAP 2011 case study plastics, ginger and coffee,
rubber and electronics


Bangladesh, Nepal, Sri
Lanka


Integration of developing
country SMEs into global
value chains


Vaaland and Heide 2007 survey retail, electronics, telecom, oil
and gas, food and beverage,
construction, transportation,
machinery, paper and
pulp, pharmaceuticals, ship
building, electricity and
water, fisheries, agriculture
and forestry, defense


Norway Compatibility between
SCM and SMEs


Wagner, Fillis, and Johansson 2003 survey engineering, IT,
manufacturing, service


Scotland Adoption of e-business
by SMEs


Walker and Preuss 2008 case study public sector, health sector United Kingdom Sustainable development
through public sector
sourcing from SMEs


Wynarcyzk and Watson 2005 survey manufacturing United Kingdom Correlation between SCM
and SME growth




Supply chains and SMEs


122 Supply Chain Perspectives and Issues


6.6 Future directions


Research in the area of SCM and SMEs is still in its infancy. However, given the widespread
recognition on the part of policy makers of the importance of SMEs to their respective
economies, the subject of SMEs is gaining greater ground in the literature. In light of
the relative unavailability of information on SME practices and performance, there is a
significant need for empirical studies to build foundational data required to build theory.
From this, the SME typologies that have been developed can be further advanced to guide
the design and implementation of SCM practices.


Theory building need not begin from scratch, however. One potentially fruitful area of
development is a reconsideration of current SCM concepts and tools in relation to
their implicit adoption of an LE or non-LE perspective. Such efforts will enable a better
understanding of the extent of an LE perspective in current SCM theory and evaluate the
potential for application or re-adaptation of current theory to address the SME perspective.


6.7 References


Arend, Richard J. and Joel D. Wisner. 2005. “Small business and supply chain management:
is there a fit?” Journal of Business Venturing, 20(3): 403-436.


Cooke, Philip, and Kevin Morgan. 1993. “The network paradigm: new departures in
corporate and regional development”, Environment and Planning D, 11(5): 543-564.


Elmuti, Dean. 2002. “The perceived impact of supply chain management on organizational
effectiveness”, Journal of Supply Chain Management, 38(3): 49-57.


Fawcett, Stanley E., Chad Allred, Gregory M. Magnan, and Jeffrey Ogden. 2009.
“Benchmarking the viability of SCM for entrepreneurial business model design”,
Benchmarking: An International Journal, 16(1): 5-29.


Hong, Paul and Jungsik Jeong. 2006. “Supply chain management practices of SMEs: from a
business growth perspective”, Journal of Enterprise Information Management, 19(3): 292-302.


Humphrey, John. 2001. “Opportunities for SMEs in developing countries to upgrade in a
global economy”, International Labour Office.


Kaplinsky, Raphael and Jeff Readman. 2001. “Integrating SMEs in global value chains:
towards partnership for development”, UNIDO.


Koh, S.C. Lenny, Mehmet Demirbag, Erkan Bayraktar, Ekrem Tatoglu, and Selim Zaim. 2007.
“The impact of supply chain management practices on performance of SMEs”, Industrial
Management & Data Systems, 107(1): 103-124.


Macpherson, Allan and Alison Wilson. 2003. “Enhancing SMEs’ capability: opportunities in supply
chain relationships?” Journal of Small Business and Enterprise Development, 10(2): 167-179.


Morrissey, Bill, and Luke Pittaway. 2004. “A study of procurement behaviour in small firms”,
Journal of small business and enterprise development, 11(2): 254-262.


Ndou, Valentina, Pasquale Vecchio, and Laura Schina. 2011. “Designing Digital
Marketplaces for Competitiveness of SMEs in Developing Countries”, e-Business and
Telecommunications, pages 82-93.




123Supply Chain Perspectives and Issues


Quayle, Michael. 2003. “A study of supply chain management practice in UK industrial
SMEs”, Supply Chain Management, 8(1): 79-86.


Ritchie, Bob and Clare Brindley. 2000. “Disintermediation, disintegration and risk in the
SME global supply chain”, Management Decision, 38(8): 575-583.


Thakkar, Jitesh, Arun Kanda, and S.G. Deshmukh. 2008. “Supply chain management in
SMEs: development of constructs and propositions”, Asia Pacific Journal of Marketing and
Logistics, 20(1): 97-131.


UNCTAD. 1993. “Small and medium-sized transnational corporations: role, impact and
policy implications”, United Nations Publication ST/CTC/160.


UNESCAP. 2007. “Linking Greater Mekong Subregion enterprises to international markets:
the role of global value chains, international production networks and enterprise clusters”,
UNESCAP Studies in Trade and Investment No. 59.


UNESCAP. 2009. “Globalization of production and the competitiveness of small and
medium-sized enterprises in Asia and the Pacific: trends and prospects”, UNESCAP
Studies in Trade and Investment No. 65.


UNESCAP. 2011. “Enabling environment for the successful integration of small and
medium-sized enterprises in global value chains: country studies of Bangladesh, Nepal
and Sri Lanka”, United Nations ESCAP Studies in Trade and Investment 70.


US Small Business Administration. 2008. “Table of Small Business Size Standards
Matched to North American Industry Classification System Codes”, Viewed February
18 2009, available at: www.sba.gov/idc/groups/public/documents/sba_homepage/
serv_sstd_tablepdf.pdf.


Vaaland, Terje I. and Morten Heide. 2007. “Can the SME survive the supply chain
challenges?” Supply Chain Management: An International Journal, 12(1): 20-31.


Wagner, B.A., Ian Fillis, and U. Johansson. 2003. “E-business and e-supply strategy in
small and medium sized businesses (SMEs)”, Supply Chain Management: An International
Journal, 8(4): 343-354.


Walker, Helen and Lutz Preuss. 2008. “Fostering sustainability through sourcing from small
businesses: public sector perspectives”, Journal of Cleaner Production 16(15): 1600-1609.


Wynarczyk, Pooran and Robert Watson. 2005. “Firm growth and supply chain
partnerships: an empirical analysis of U.K. SME subcontractors”, Small Business
Economics, 24(1): 39-51.






125Supply Chain Perspectives and Issues


Abstract


Supply chain production has likely made production more services-intensive. Only recently
has the extent of reliance on services in supply chains become evident, particularly since
global trade statistics measured in value-added terms were developed. However, a full
understanding of the role of services in supply chains remains elusive. Recent work
reported here attempts to capture the multiplicity of distinct services implicated in supply
chain production; the interdependent nature of markets; the tendency towards reliance on
networks and the resultant bundling or modularising of product offerings that combine
different goods and services; the role of services as a driver of innovation; services as a
potentially untapped source of value-added capture, and a range of data challenges that
will take time to resolve.


7.1 The nature and role of services in production and trade


The intangibility of services raises analytical and statistical challenges. Systematic efforts
to deepen our understanding of the economic role played by services – particularly at the
international level – have only occurred in the last 30 years. These efforts have intensified
recently with the increased presence of global value chains, where services fulfil a vital
and complex role.


Services have occupied a dominant place in most economies for a long time. According
to the World Bank’s World Development Indicators (2012), the share of services value-
added in world GDP was 70 per cent in 2010, rising fairly steadily from 53 per cent in
1970, 57 per cent in 1990 and 68 per cent in 2000. Besides reflecting the shift towards
service economies in advance countries, the growth in these shares over time will almost
certainly have been influenced by improvements in statistical methods and techniques.


The services share has also risen as a result of structural changes in economies that
have led to greater segmentation and more arm’s-length transactions, allowing the
separate identification of services transactions. Notwithstanding national variations in the
respective shares of GDP attributable to services, manufacturing, agriculture and mining,


Chapter 7
Supply chains and services




Supply chains and services


126 Supply Chain Perspectives and Issues


in most economies the services share is greater than that of the other three components
of economic activity combined.


The story of the share of services in international trade is even more interesting, reflecting
data limitations that the international community has only just begun to address. For many
years we have estimated the share of cross-border services transactions in international
trade at just over one-fifth of total trade (WTO International Trade Statistics, 2012).


However, the recent OECD/WTO work on measuring trade in terms of the value-added
to products by different countries along supply chains, rather than in gross terms, has
yielded a dramatically different picture. In 2008, for example, the share of commercial
services in world trade was estimated at 23 per cent in gross terms and 45 per cent in
value-added terms (Figure 7.1).1


Figure 7.1: Sectoral contribution to total trade, gross and value-added measures (2008)


Source: WTO Secretariat estimates based on OECD-WTO data


Chart 1 Sectoral contribution to total trade, gross and value-added measures (2008)


Structure of world exports in
value-added terms, 2008


Primary products


Manufacturing


Services


Structure of world exports in
gross terms, 2008


Primary products


Manufacturing


Services


Source: WTO Secretariat estimates based on OECD-WTO data


45%


23%
12%


37%


65%


18%




127Supply Chain Perspectives and Issues


7.2 The role of services along global supply chains


Services are part of almost every activity in an economy. This is particularly true of
what are often referred to as producer services – transport, communications, finance,
distribution and business services. This pervasiveness makes services key determinants
of competitiveness and the productivity of capital and labour. But this is only part of the
picture, since numerous other services are involved in the production and sale of products,
whether the final product is a good or a service.


Services have sometimes been referred to as the “glue” that holds supply chains together
and ensures that they function in a fluid manner. This is only one aspect of what services
do. They are also part of many production and sales processes, as we will see later.


Modern communication and transportation technologies have enhanced the tradability
of services. This has facilitated their incorporation in supply chain production as traded
inputs. In addition, what the business literature calls “modularisation”2 has led to the
incorporation or bundling of services to composite products. This phenomenon is similar
to what the economics literature refers to as “trade in tasks”3 , where inputs do not break
down readily into the product classification and nomenclature systems with which we are
more familiar. A typical example of this would be “business functions”.


While, in the past, productivity growth has been greater in manufacturing than in services,
emerging literature on the extent of unidentified service activities in production raises
questions about the accuracy of relative productivity measures.


Even if the data reflect reality, services may be a growing source of competitiveness. This
conclusion follows from a new appreciation of how the service economy works and in
producing and delivering services as elements of aggregated value propositions.


As we discuss below, much of the analysis does not necessarily refer directly to services,
but rather to “invisibles.” However, since invisibles are intangible, and the one defining
feature distinguishing services from goods is intangibility, there is no doubt that invisibles
include services.


7.2.1 The consequences of complementary markets


In terms of their operation, supply chains can be thought of as a series of linked markets
for goods and services. These markets are interdependent, in the sense that something
happening in one market affects many other markets. This complementarity, sometimes
referred to as joint demand or derived demand, is associated with negative cross-
elasticities of demand.


It means that if the price of product A increases in one market, then the demand for
product B in another will fall. The result is that demand for both A and B falls. This
complementarity links goods and services markets with no distinction in terms of
economic effects as to whether the products in question are tangible or intangible.4 Under
these multiple-market relationships, changes in conditions in one market – including as
a result of policy intervention – provoke ripple effects in others along the whole supply
chain, both upstream and downstream. The same logic holds in situations where there
is modularisation or bundling, and inputs are composites of at least two products that in
principle could be supplied separately.




Supply chains and services


128 Supply Chain Perspectives and Issues


While the complementary nature of markets is intuitively obvious and doubtless taken
into account in many decisions of market agents, this reality does not always seem to be
fully factored into the expectations of policy makers in terms of the consequences of their
actions. Policy interventions will affect relative prices across different interdependent
markets, possibly with unintended consequences.5 This suggests that policy-making
should be an integrated process.


There are two aspects: At the level of measures and policies. When governments adopt
measures pursuant upon a policy, they should take into account market complementarities
and knock-on effects in the particular market situation at hand. The impact of such
reverberations can be particularly pronounced where policies affecting components
(goods or services inputs) have a multiplicative or magnification effect as they cross more
than one frontier along the supply chain.


At the policy level, this is about the design of different policies with varying objectives and
contexts which, in the end, come together to affect outcomes beyond the initial focus of
attention and the objectives of individual policies. Outcome linkages and spillovers call for
a holistic approach to policy formulation.


Policies formulated internationally that also aim to shape outcomes in areas like trade
in goods, trade in services, investment, intellectual property protection and competition
will affect many activities in many markets. Getting policy right in each of these areas is
therefore essential to the effective overall operation of supply chains.


The current approach that relies on “silo” agreements in these different areas is short on
appreciation of the consequences of complementarity. The pattern observed internationally
is a reflection of how policy is made domestically, suggesting that any new approach must
begin at home.


7.2.2 Identifying services along the supply chain


In practice, it is no easy matter to identify, separately, all the individual service components
that make up the full value of a product, not least because of the bundling phenomenon.
The detailed product breakdown in Figure 7.2, depicting the value chain for a coat, is
a useful illustration of the difficulties encountered in trying to disaggregate a range of
different services. Of the US$425 price tag for the jacket, only 9 per cent of this initial retail
price is associated with making the jacket, with the remainder attributable to “invisible”
assets.6 This is the identification problem: what is contained in the invisible assets?


There will be elements both on the pre-manufacturing upstream part of the process, as
well as on the post-manufacturing downstream. Upstream sources of value are likely to
include design, intellectual property, branding, and so on. Downstream elements include
advertising, marketing and retailing. Disentangling the sources of value, the individual
services involved, and the implication of policy for these segments of the supply chain,
are formidable tasks.


One of the most thorough efforts at achieving this is the case study of the Nokia95
phone undertaken by Ali-Yrkkö et al. (2011). Through meticulous sleuthing, the authors
managed to produce a detailed breakdown of the value chain for the product. The parts
(including processors, memories, integrated circuits, displays and cameras) accounted
for 33 per cent of the product. Assembly only accounted for 2 per cent. The remaining




129Supply Chain Perspectives and Issues


two-thirds of the product was accounted for by Nokia’s internal support services (31 per
cent), licenses (4 per cent), distribution (4 per cent), retailing (11 per cent) and operating
profit (16 per cent).


Despite the relatively fine detail of the breakdown of invisibles in this case study, a good
deal is still missing in terms of the different services that went into production. The missing
services problem also applies in the case of the manufacturing part of the operation,
notwithstanding its small share.


Figure 7.2: A suit made in China and sold in the United States


Source: Fung Global Institute research


7.2.3 The notion of “servicification”


The Swedish National Board of Trade has undertaken some useful work in a number of
studies in recent years on the servicification of the Swedish economy and of Swedish
firms operating internationally (Kommerskollegium, 2010a, 2010b, 2012). Related work
based on the same idea of servicification makes reference to servicising (Reisken et al.,
2000) and the “manuservice” economy (Bryson and Daniels, 2010). As discussed in Ryu
et al. (2012), the term “servitisation” was first used by Vandermerwe and Rada (1988). The
definition of servification and similar derivatives of the word used to denote the same
phenomenon is not very precise but this captures important ideas about how the role of
services has evolved in recent years.


Essentially, servicification refers to the increased use of services in manufacturing, both
in terms of production processes and sales. This phenomenon may in part reflect the
separation of services functions in manufacturing from core production functions.


In Sweden’s case (and no doubt elsewhere) this is linked to the development of
enterprise groups, where manufacturing enterprises comprise different firms, some of
which are dedicated to service production. Higher productivity growth in manufacturing
than in services, and shifting demand and production patterns, underlie the decline in
the share of manufacturing and the rise of services in economies like that of Sweden
(Kommerskollegium, 2010a).


Figure 1: A suit made in China and sold in the United States


Cost Breakdown by Country Manufacturing Costs and Invisible Assets


Source: Fung Global Institute research


86%


5%


4%


4%


1%


Manufacturing
Labor


Shell fabric


Lining


Interlining


Buttons


Sleeve heads


Shoulder pads


Labels


Hangtag


91%


9%


Invisible Assets
• Services (retail, logistic, banking, etc.)
• Intellectual Property
• Prots
• Other Unknowns


$425




Supply chains and services


130 Supply Chain Perspectives and Issues


A significant feature of servicification is the opportunity it offers for strategic firm behaviour
designed to move up the value chain. While some of the bundling or modularisation
occurring along supply chains as a result of servicification may be occasioned by the
exigencies of locational dispersion in production and consumption, or by regulatory
requirements, these tendencies are also likely to be fed by strategic motivations internal to
firms (Sundin et al., 2009; Kommerskollegium, 2012). Firms may seek to customise their
offerings so as to differentiate them in the market place and earn higher returns or to
spread risk by diversifying the output mix.


A case study of the Sweden-based multinational Sandvik Tooling (Kommerskollegium,
2010b) revealed that in order to manage the supply chain and deliver goods, the firm had
recourse to 40 discrete services. A further 12 services were required to handle customer
delivery (Table 7.1). The study does not specify whether these services were separately
supplied even if they could be separately identified, or whether they were packaged
(modularised) into composite offerings.


Table 7.1: Services necessary to the Sandvik Tools supply chain


This wide array of services includes both high value-added and low value-added activities.
Some of the services are trade-able, others are not. Some may be produced in-house,
others at arm’s length. Arm’s-length services can be outsourced or offshored.


Among this large set of services associated with the production of machine tools, there
would doubtless be opportunities for product differentiation and higher average value-
added packages – in other words, for repositioning on the supply chain. Some of these
services could even be provided to customers of rival manufacturing firms in the same
market, or to rival firms themselves.


Finally, depending on the product in question, significant scope may exist for the provision
of after-sales services as an additional source of product differentiation and profit. These
services can take many forms, including technical assistance and training, maintenance,
provision of spare parts and repair services and a range of other customer care services
(Saccani et. al, 2007). The means of delivery of after-sales services by a lead firm will vary
from direct supply, sub-contracting arrangements, agency relationships and franchising.


Services for operating the supply chain


Legal services; Accounting, book-keeping etc.; Taxation services; Medical services; Computer services; Research
and development; Rental/Leasing; Advertising; Market research; Services incidental to manufacturing; Placement
of personnel; Maintenance and repair; Security services; Packaging; Printing; Publishing; Design; Building-cleaning
services; Photographic services; Courier services; Logistic services; Postal services; Telecommunications; Audio-Visual
services; Educational services; Environmental services; Banking services; Insurances; Health related services; Hotels
and restaurants; Travel agency services; Maritime transport – freight; Inland waterways – freight; Inland waterways –
freight; Air transport - freight/passenger; Road transport – freight/passenger; Cargo-handling services; Storage and
warehouse services; Freight transport agency services; Feeder services; Energy services.


Services for customer delivery


Computer services; Research and development; Rental/leasing; Maintenance and repair; Management consulting;
Technical testing and analysis services; Services incidental to manufacturing; Design; Environmental services;
Financial services; Logistics; Warehouse services.




131Supply Chain Perspectives and Issues


7.2.4 Services, networks and value analysis


In a similar vein to the analysis of complementary markets, joint production and trade in
tasks discussed earlier, a new literature is emerging that goes under the broad rubric of
“service science”. The literature has yet to become mainstream but it strives to explain how
networks, technology, entrepreneurship and consumers interact to generate innovation
and create value. Recently published volumes by Maglio et al. (2010) and Demirkan et al
(2011) are examples of a burgeoning literature around service science.


A “service-dominant” logic of value creation and exchange (Vargo and Lusch 2004)
underpins much of the analysis, which focuses on service systems. Production is seen more
as a dynamic and collaborative, interactive process among people than as the combination
of readily definable fixed and variable inputs of capital, labour and components into units
of output. The analysis that goes under the name of “service science” bears a resemblance
to the notion of innovation systems.


Service science aspires to a high degree of inter-disciplinary or even trans-disciplinary
thinking. Spohrer (2009) argues for “an integrated approach that spans not only existing
discipline-based silos within academic organisations (i.e. marketing, operations, and
human resource management within a business school) but also across academic
organisations (i.e. business, engineering, and liberal arts).”7 Ng et al. (2011) suggest that
service science should combine what they describe as a prevailing reductionist analytical
perspective with a systems perspective as a means of establishing a disciplinary base for
service science.


A useful bridge between services science and more conventional analytical approaches
is provided by Allee (2008), examining the relationship between value and tangible and
intangible assets. Intangible assets may be unpriced in the market and non-contractual,
but nevertheless embody value.


Such “intangibles” could include human knowledge, internal structures, working methods,
reputation, business relationships, trust, social citizenship, environmental responsibility,
and business values. These intangibles can sometimes command explicit value in the
market, such as through consultancy contracts or explicit price premia.


Allee (2008) argues, however, that trying to price these assets in terms of units of input
is a fool’s errand. An idea of the worth of the assets can be gleaned from the difference
between the value of a firm’s assets and its sale value. An imperfect and approximate
indicator of this value could be captured by the goodwill recorded on a firm’s balance
sheet. Some of the value emerges as barter relationships among parties to transactions.


For the rest, the argument seems to be that value analysis requires an understanding
of how roles and relationships create value. Even unpriced assets can be rendered in
negotiable value and a systematic analysis of roles; transactions and deliverables must be
undertaken in value creation analysis.


7.2.5 The OECD new sources of growth projection


If the Allee (2008) analysis assists in bridging the gap between service science and more
traditional analytical approaches to understanding markets, the OECD’s work (OECD,
2011, 2012) on intangible assets as new sources of growth is a further contribution in this
direction. The OECD refers to a threefold definitional distinction among the components of




Supply chains and services


132 Supply Chain Perspectives and Issues


invisible assets. These include computerised information (software and data), innovation
property (research and development, intellectual property), and economic competencies
(brand equity, human capital specific to firms, networks joining people and institutions,
organisational know-how and advertising and marketing strategies).


The “economic competencies” category is strikingly similar to the essential focus of
service science. The OECD’s use of terminology has varied over time. Earlier references
were to intellectual assets, knowledge assets and intellectual capital, while in later work
the term used has been knowledge-based capital (KBC).


All these terms refer to “invisibles”, which are to be contrasted with tangible assets
such as plant, machinery and buildings. The OECD argues that countries investing
proportionately more in KBC are doing better via enhanced productivity than those
investing proportionately less.


A further useful addition to the OECD’s work in this field is an analysis of the implications of
policy on investment in, and production of, KBC. Relevant policies include tax and regulatory
regimes, intellectual property, competition policy, investment policy, protection of data,
data privacy and policies affecting corporate governance. This discussion reinforces the
growing conviction that the segregation of policies into separately constructed regimes is
inimical to coherence at the interface of policy and supply chain operations. An integrated
approach to policy appears increasingly necessary.


7.3 Data challenges


7.3.1 The implications of the “smile curve” for services in global
value chains


One of the most commonly reproduced diagrammes in discussions on supply chains is “the
smile curve” articulated by the founder of the Chinese Taipei-based hardware and electronics
corporation Acer, Stan Shih. The smile curve illustrates the opportunities that exist on a
value chain to produce higher value-added components upstream and downstream of
manufacturing and assembly (Figure 7.3). This was the strategy from which Acer was born,
upgrading from assembly to high value-added invisibles on the supply chain for computers.


Figure 7.3: Stan Shih’s smile curve


Source: Adapted from Business Week Online Extra, May 16, 2005


Higher


Value
Added


Concept, R&D Sales / after service


Distribution


Marketing


Manufacture


Design


Branding


Lower


Time




133Supply Chain Perspectives and Issues


Unless interpreted with care, the smile curve can be misleading in terms of understanding
the role of services on the supply chain. The problem arises from the interpretation of
what exactly the smile curve depicts.


The vertical axis does not show what share of value-added each identified activity represents
of the total price of the product – in other words, the identified sources of value are not
additive. Even the implied relative share of value-added among activities is not established
because the position of each activity on the curve is determined by the production sequence
depicted on the horizontal axis. We do not know, for example, whether “value-added per unit
of output on branding” is less than the same measure for design.


Another interpretative pitfall relates to whether we think of the smile curve as a product, a
sector, or an entire economy. This can become particularly troublesome if the assumption
that manufacturing is where the jobs are, in contrast to the high-return, capital intensive
segments of the production process. If taken to represent the whole economy, it is easy
to assume there is an inevitable trade-off between jobs and higher value-added – in
other words, “reliance on services destroys jobs”. In fact, some parts of the upstream or
downstream value chain may be labour-intensive (such as retailing).


Be that as it may, assuming greater capital-intensity in higher value-added activities
does not necessarily mean a job shortage for the economy because the composition of
available jobs for the production of a single good is not the same as the job requirements
for the economy as a whole.


Indeed, the job consequences of upgrading depend on the structure of the entire economy.
It may well be that moving to higher value-added segments on a supply chain implies
fewer employment opportunities on that chain. But many other factors, such as skill levels
in the workforce and the functioning of the labour market, will determine the employment
consequences of upgrading to the economy as a whole.


7.3.2 The imperfect statistical identification of services on supply chains


The only truly distinguishing difference between services and goods is tangibility. The
intangibility of services makes them harder to identify and measure. The difficulty is
compounded by the heterogeneous (customised) nature of many services transactions
and the lack of a properly developed and generally accepted nomenclature for services.


Other challenges arise for the reasons discussed before – services may not be supplied
separately from one another, or from goods, and they may not even be contracted for and priced.


From a statistical point of view, it also matters whether transactions are arm’s-length. On a
supply chain producing goods, any services produced “in-house” – without any recorded
arm’s-length transaction – may well appear as goods in both output and trade data.8 While
this creates no discrepancy between output and trade data, it still misrepresents services
as goods.9 The degree to which this occurs depends on the structure of the economy. As
firms grow, and agglomeration effects create external economies of scale, the outsourcing
or offshoring of services previously produced internally are likely to increase. This will
lessen the degree of statistical confusion between goods and services.




Supply chains and services


134 Supply Chain Perspectives and Issues


Another classification issue, however, further militates against precision and predictability
in distinguishing between goods and services in production. This results from reliance
on ownership as a criterion for determining whether output counts as goods or services.


Contract manufacturing arrangements result in manufactured output being classified
as services output. This is the treatment prescribed by the sixth revision of balance of
payments statistics and the 2008 revision of the system of national accounts. As Adlung
and Zhang (2012) point out, this is not just an accounting matter. In a world where policies
applying to goods and services are not uniform, different policy treatment can affect
investment and ownership decisions in the real economy. This means that policy can
inadvertently distort economic structures.


7.3.3 Definitional redundancy further complicates analysis


The concepts of “embodied” and “embedded” services have been widely used to describe
the role of services in production.10 An embodied service is generally defined as a service
whose product constitutes an input into the manufacture of a good. Examples of embodied
services include transport, telecommunications, financial services and business services.
An embedded service is one that constitutes an input into the sale of a good, such as retail,
after-sales support, and inventory management.


One problem with the distinction is that it creates a discrete definitional break in
processes along a supply chain that does not seem to serve any useful analytical
purpose. From a policy perspective, the distinction is not precise enough – the relevant
policy mix is likely to be very different among services categorised within each group.
Moreover, the distinction cuts across key service sectors and does not match fully
with certain kinds of services such as management, administration and back-office
functions or information technology systems, which might be embodied or embedded.
The categories therefore overlap.


Perhaps the most serious drawback is that these categories do not distinguish clearly
between arm’s-length and non-arm’s-length transactions. It is this distinction that
determines whether services are incorporated in goods (and vice-versa) for statistical
purposes. The two categories do not, therefore, help us distinguish between statistical
(informational) shortcomings and structural/organisational factors, both of which are
associated with identification challenges relating to the contribution of services to
supply chain production and trade. In short, the key issue for statistical recording is the
contractual nature of the supply relationship, not embodiment or embedment.


7.4 Future directions


Services matter more than one might judge from the paucity of analytical attention they
have received. Much of this summary has emphasised what we do not know and need to
understand better. Significant identification problems render difficult the task of making
detailed analyses from which policy conclusions and recommendations can be drawn.


Data challenges and the absence of a generally accepted nomenclature for services make
an already complicated reality worse. While this is a matter for government action rather
than future research, it is certainly something that influences what is feasible, other than




135Supply Chain Perspectives and Issues


at a highly granulated level through case studies, where data are directly generated and
product descriptions are largely sui generis.


Methodological challenges will of course arise in any attempt to move from the specific to
more generalised conclusions.


The unbundling and separate identification of the services components comprising
value addition along supply chains is one useful, if painstaking area of investigation. An
understanding of what drives the multiple-product composite offerings of suppliers along
supply chains is another for potentially interesting research. An understanding of how
services generate value and innovation along supply chains, including where invisibles
embody value, but are not priced, remains to be more fully developed.


7.5 Endnotes


1. See also Francois and Manchin (2011) for calculations of the services value-added
content of trade.


2. Modularisation arises from arrangements whereby the offering of a value chain
supplier is a packaged combination of products, be they goods and/or services. Such
offerings may reflect cost minimisation considerations or they may be strategically put
together as a means of market segmentation (customisation) that provides higher returns
for the supplier.


3. For the seminal economics paper on this that brings together previous literature on
offshoring and the workings of supply chains, see Grossman and Rossi-Hansberg (2008).


4. In practice, however, the fact that goods, unlike services, are storable and can be held as
inventory may influence the complementarity relationships between goods and services.


5. The possibly apocryphal tale of Victorian rat catchers who raised more rats than
they killed in order to increase their incomes as rat exterminators is a simple example
of how policies taken in isolation of any thought of knock-on effects can have unintended
consequences.


6. Since this is a product from the fashion industry, it is likely that the initial retail price
would be discounted, in order to avoid the problem of managing inventories in an industry
where fashions change quickly. Nevertheless, the invisible assets still represent a major
part of the product’s value.


7. Cited in Ng et al. (2011). P.15


8. Modern national accounting survey techniques attempt to adjust for this.


9. The same can happen with respect to goods on a services supply chain, but probably
occurs less frequently.


10. See, for example, Drake-Brockman and Stephenson (2012).


7.6 References


Adlung, R.; Zhang, W. 2012. “Trade disciplines with a trapdoor: contract manufacturing”,
WTO Working Paper, ERSD-2012-11. Electronic access: http://www.wto.org/english/
res_e/reser_e/ersd201211_e.pdf




Supply chains and services


136 Supply Chain Perspectives and Issues


Ali-Yrkkö, J., Rouvinen, P., Seppälä, T.; Ylä-Anttila, P. 2011. “Who Captures Value in Global
Supply Chains? Case Nokia N95 Smartphone”, in Journal of Industry, Competition and
Trade, September, Volume 11:3, 263-278.


Allee, V. 2008 “Value Network Analysis and value conversion of tangible and intangible
assets”, Journal of Intellectual Capital, 9(1): 5-24.


Bryson, J.R.,; Daniels, P. W. 2010. “Service Worlds: The ‘Services Duality’ and the Rise of the
‘Manuservice’ Economy” in Maglio, P.P., Kieliszewski, C. A. and Spohrer, J.C. (eds.) Handbook
of Service Science, Springer, New York.


Demirkan, H.; Spohrer, J.C.; Krishna, V. (eds). 2011. The Science of Service Systems,
Springer, New York.


Drake-Brockman, J.; Stephenson, S. 2012. “Implications for 21st Century Trade and
Development of the Emergence of Services Value Chains”, Electronic access: http://ictsd.
org/downloads/2012/11/implications-for-21st-century-trade-and-development-of-the-
emergence-of-services-value-chains.pdf


Ferrantino, M. J. 2102. “Using Supply Chain Analysis to Examine the Costs of Non-Tariff
Measures (NTMs) and the Benefits of Trade Facilitation”, WTO Working Paper, ERSD-2012-
02. Electronic access: http://www.wto.org/english/res_e/reser_e/ersd201202_e.pdf


Grossman, G. M. and Rossi-Hansburg, E. (2008) “Trading Tasks: A Simple Theory of
Offshoring”, in American Economic Review, 98(5): 1978-1997.


Kommerskollegium 2010a. Servicification of Swedish Manufacturing, Stockholm.


Kommerskollegium. 2010b. At Your Service: The Importance of Services for Manufacturing
Companies and Possible Trade Policy Implications, Stockholm.


Kommerskollegium. 2012. Everybody is in Services – The Impact of Servicification in
Manufacturing on Trade and Trade Policy, Stockholm.


Maglio, P.P.; Kieliszewski, C. A.; Spohrer, J.C. (eds): 2010. Handbook of Service Science,
Springer, New York.


Ng, I.; Maull, R.; Smith, L. 2011. “Embedding the New Discipline of Service Science” in
Demirkan, H., Spohrer, J.C. and Krishna, V. (eds.) The Science of Service Systems, Springer,
New York.


OECD. 2011. “New sources of growth: intangible assets”. Electronic access: http://www.
oecd.org/sti/inno/46349020.pdf


OECD. 2012. “New Sources of Growth: Knowledge-Based Capital Driving Investment and
Productivity in the 21st Century”, Interim Project Findings. Electronic access: http://www.
oecd.org/sti/50498841.pdf


Reisken, E.D.; Johnson, J.K.; Votta, T. J. 2000. “Servicizing the Chemical Supply Chain”,
Journal of Industrial Ecology, 3(2) & 3(3): 19-3.


Francois, J.;Manchin, M. 2011. “Services Linkages and the Value Added Content of Trade”.
Electronic access: http://siteresources.worldbank.org/INTRANETTRADE/Resources/Inte
rnal-Training/287823-1256848879189/6526508-1283456658475/7370147-13080702997
28/7997263-1308070314933/PAPER_7_Francois_Manchin.pdf




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Ryu, J,; Hosun, R,; Park, K,; Kim, H. 2012. “A Framework for Servitization of Manufacturing
Companies” in Mangal, V; Karmakar, U. (eds.) 2012. The UCLA Anderson Business and
Information Technologies (BIT) Project: A Global Study of Business Practice, Singapore:
World Scientific Publishing Company.


Saccani, N.; Johansson, P.; Perona, M. (2007) “Configuring the after-sales service supply
chain: A multiple case study”, International Journal of Production Economics, 110: 52-69.


Spohrer, J. C. 2009. “Welcome to our declaration of interdependence”, Service Science, IBM.


Sundin, E., Lindahl, M., Comstock, M., Sakao., T, Shimomura, Y. 2009. “Achieving mass
customization through servicification”, Journal of Internet Manufacturing and Services,
2: 56-75.


Vandermerwe, S.; Rada, J. 1988. “Servitization of Business: Adding Value by Adding
Services”, in European Management Journal 6(4): 314-324.


Vargo, S. L.; Lusch, R. L. 2004. “Evolving to a new dominant logic for marketing”, Journal of
Marketing, 68: 1-17.


World Bank. 2012. World Development Indicators, (Washington DC, World Bank).


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Negotiations, (Geneva, World Trade Organization).


WTO. 2012. International Trade Statistics, (Geneva, World Trade Organization).






139Supply Chain Perspectives and Issues


Abstract


The increasing importance of global supply chains challenges the way statistics on trade
are collected. Statistics on international trade flows are measured in gross terms and,
hence, record the value of intermediate inputs traded along the value chain multiple times.
Trade in global supply chains can be measured using firm surveys, customs statistics that
record trade flows under special schemes of tariff reduction or exemption, or the Standard
International Trade Classification (SITC) classifying goods as being intermediate or final.
Because of several limitations associated with these methods, however, using input-output
tables has become the preferred method for measuring trade in global supply chains. They
are used to compute the value of imported inputs embodied in goods that are exported.
A more complete measure of a country’s participation in global value chains combines
foreign value-added in exports (upstream links) with exports that are incorporated
in other products and re-exported (downstream links). Estimates of the ratio of value-
added exports to gross exports suggests that the double counting in gross trade flows,
and hence international production sharing, has intensified in recent years, especially for
fast growing countries undergoing structural transformation. Relying on national input-
output tables, however, has its limitations. Combining it with bilateral trade data is difficult
because there is no standard international classification, the level of sectoral aggregation
is often different and their publication is infrequent. On-going efforts from the international
statistics community to estimate trade in value-added go beyond the limitations of the
input-output approach.


8.1 Gross trade flows and the problem of double counting


Over the past several decades, one of the most important changes in the nature of
international trade has been the growing interconnectedness of production processes
in a vertical chain that stretches across many countries, with each country specialising
in particular stages of a good’s production. In the literature, this phenomenon – studied
quite extensively by trade economists – is referred to as “global supply chains”, “global
value chains”, “international production networks”, “vertical specialisation”, “offshoring”,


Chapter 8
Supply chains and trade in
value-added




Supply chains and trade in value-added


140 Supply Chain Perspectives and Issues


“production fragmentation” and “multi-stage production”. Evidence suggests that, on
average, more than half of the value of world exports is made up of products traded in the
context of global supply chains (OECD 2012).


The increasing importance of global supply chains challenges the way statistics on
trade are collected (Maurer and Degain 2010). Statistics on international trade flows are
collected in gross terms and hence, record the value of intermediate inputs traded along
the value chain multiple times.


For instance, an auto part produced in Country A and exported to Country B for final
assembly would be counted again as Country B’s exports, although there is no production
transformation on that product. Similarly, when a particular intermediate input is imported,
it is not clear whether it would be used directly by consumers, or used by a producer
for further production and export. As a result of this double recording in trade statistics,
countries engaged primarily in product assembly or completing tasks downstream appear
to capture most of the value of goods and services traded, while the role of countries
providing inputs upstream is underestimated in relative terms.


There appears to be an association between a nation’s level of development – as measured
by per capita income – and its position in global supply-chain trade. As nations get
richer up to a point, they use imported intermediates more intensively in their exports.
For example, as China moved up from textiles and apparel to assembling electronics and
machinery, the import content of its exports rose.


Beyond a threshold, however, the intensity diminishes. Advanced technology nations,
such as the United States, Japan and Germany, focus on sophisticated components that
are exported for assembly elsewhere (Gonzales 2012).


This asymmetry between advanced economies and developing economies in global
supply chains can affect the measurement of their participation in international trade.
The much-talked-about US-China bilateral trade relationship is a case in point. Evidence
suggests that the United States’ trade deficit vis-à-vis China is reduced by about 20 to 30
per cent when measured in value-added terms rather than in gross terms (Stehrer 2012;
Johnson and Noguera 2010).


8.2 Measuring trade in global supply chains


There is little systematic evidence quantifying the nature and growth of global supply chains.
This is attributable to the lack of relevant data for measuring vertical trade relationships.


In principle, trade in global supply chains can be measured in four ways (Daudin et al.
2011). One possibility is to use firm surveys. But these are only available for a limited
number of countries and for a limited number of multinational firms. Another possibility
is to rely on customs statistics which record trade flows under special schemes of
tariff reduction or exemption. In order to provide incentives for domestic industrial
development, many developing countries provide tariff exemptions for imported inputs
that are used in exports while developed economies do so for the domestic input content
of imported final products.


Special schemes result in customs officials recording the concerned trade under a special
heading. This allows researchers to obtain a narrow measure of global supply chains.
For example, in examining the US offshore assembly programme (OAP) that records the




141Supply Chain Perspectives and Issues


domestic input content of imports into the US, Swenson (2005) finds that offshoring
activities grew significantly during the period between 1980 and 2000.


Egger and Egger (2005) present a similar result for the outward processing trade (OPT)
programme of the EU, especially with Central and Eastern European countries.


China’s integration into global supply chains has also been studied by analysing such
statistics (Lemoine and Ünal-Kesenci 2004). The major difficulty of this method is
that it can be used only for a handful of countries, which make these data available.
Another shortcoming relates to the general trend of tariff reduction. As the tariff rate on
parts and components becomes lower, firms’ incentives to use such special schemes
decrease. This results in poor coverage of the international intermediate goods trade
under these special headings.


A third methodology to capture the role of global supply chains in international trade is
to use the Standard International Trade Classification (SITC) to categorise goods as being
intermediate or final. This type of analysis was initiated by Yeats (1998), who found that
trade in parts of components of machinery accounts for more than 30 per cent of total
OECD countries exports.


In a more recent study, Athukorala and Yamashita (2006) measure vertical trade for
most countries in the world in the context of the five-digit SITC (Rev 3) classification, by
treating some goods belonging to categories 7 (machinery and transport equipment) and
8 (miscellaneous manufactured articles) as parts and components or intermediate inputs.
In doing so, they find that trade in intermediate goods increased from 18.5 per cent to 22
per cent of world manufacturing exports between 1992 and 2003.


In another recent study, Miroudot et al. (2009) show that the share of intermediates in
world merchandise trade increased from just over 50 per cent in 1999 to almost 60
per cent in 2007. They also show that in 2007, over 70 per cent of services trade was
in intermediates.


Other studies which used this method focus on specific regions. Its extensive use is
understandable, because the data can be easily collected and have a wide coverage
in terms of regions, time period and products. This method, however, suffers from the
important limitation that a classification of goods into intermediate and final may be
somewhat arbitrary.


The fourth – and increasingly the most used method of measuring trade in global supply
chains – is to use input-output tables. In principle, with such tables for all countries in the
world, a value chain can be calculated for each final good sold in each country. This would
be a decomposition of its price into the value-added (being the sum of wages, profits
and natural resource rents) in each of the sectors and countries which has contributed,
directly or indirectly, to its supply (Wood 2001). Its conceptual underpinnings and related
empirical evidence are described below.


8.3 The import content of exports


8.3.1 Conceptual underpinnings


The seminal work of Hummels et al. (2001) developed a measure that computes the value
of imported inputs (or foreign value-added) embodied in goods that are exported. It is
referred to as the “vertical specialisation index”. In an ideal world, the estimation of such




Supply chains and trade in value-added


142 Supply Chain Perspectives and Issues


a measure would be done using data on the production process and on the direction
of trade flow for every stage of each good that is traded. These data are impossible to
obtain except on a case-by-case basis. Hence, this measure of vertical trade is estimated
empirically by using input-output tables, which include sector-level data on inputs
(distinguishing foreign and domestic sources), gross output, and exports.


The use of input-output tables avoids the arbitrariness of methods that classify goods
into “intermediate” and other categories. It also enables the calculation of the value of
imported inputs used indirectly in production of an exported good; imported inputs
may be used in one sector, whose output is employed in a second, then a third, and
eventually embodied in an export good.


It is worth noting that the use of relatively aggregate (sector) data from the input-output
tables can lead to biases in calculating the true level of the imported input content of
exports. Consider, for example, that a sector produces two goods. One good uses no
imported inputs but is exported, while the other uses imported intermediate inputs but is
not exported. For both these goods individually, the import content of exports would be
zero, yet calculation at the sector level would yield a positive value.


It is worth noting that the use of intermediate goods imports for domestic consumption
is becoming increasingly important because several global supply chains now end in
emerging economies with large markets.


8.3.2 Empirical evidence


Using input-output tables for 14 countries (10 OECD countries and Ireland, South Korea,
Chinese Taipei and Mexico), Hummels et al. (2001) show that the growth in vertical
specialisation accounted for about one-third of the growth in overall exports between
1970 and 1990. The authors also find that variations in the vertical intensity of all sectors,
rather than changes in the sectoral composition of overall exports, accounted for most of
the growth in vertical specialisation over time and across countries.


In addition, Hummels et al. (2001) show that the most common geographical pattern
of vertical specialisation involved inputs imported from developed economies being
transformed into export goods in developing economies destined for other developed
economies. This result is reinforced by the findings of Gonzales (2012) who finds that
while 37 per cent of the gross value of Mexican exports consists of US intermediate
inputs, only 2 per cent of US exports consist of Mexican intermediate inputs. “South-South”
vertical links appear to be the weakest.


More recent studies by Daudin et al. (2011) and Koopman et al. (2010) find that small open
economies such as the Czech Republic, Luxembourg, Singapore and Estonia source more
inputs from abroad than large countries, such as the US and Japan. China is the exception,
being a large country with a high import content of exports.


8.3.3 Limitations


In their estimation of the import content of exports, Hummels et al. (2001) assume that the
intensity in the use of imported inputs is the same between production for exports and
production for domestic sales. This assumption is violated in the presence of processing
exports. Parts and other intermediate materials used in the production of processing
exports often receive tariff exemptions and other tax preferences from governments.




143Supply Chain Perspectives and Issues


To compute the share of foreign value-added in a country’s exports when processing
exports are pervasive, Koopman, Wang, and Wei (2012) develop a formula (for which
Hummels et al. 2001 is a special case) which accounts for the possible difference
between the intensity of imported intermediate inputs in the production of processing
exports and in other production. Using data from China for 1997, 2002 and 2007, they
find that the share of foreign value-added in China‘s manufactured exports was about
50 per cent, almost twice as high as that implied by the methodology employed by
Hummels et al. (2001).


In the model developed by Hummels et al. (2001), the only way in which a country can
participate in global supply chains is by using imported inputs to produce a good that it
exports (directly or even indirectly when imported inputs are used in the production of
domestic inputs, which are then used in the production of exports).


It may also be the case that a country imports intermediate inputs, adds value, and then
exports semi-finished goods to another country, which adds further value and then
exports final goods. For example, Japan produces electronic components, most of which
are exported to South East Asian countries, where they are used as inputs to produce TVs,
most of which are then exported to other countries.


The literature strikes a note of caution on the terminology used to describe these two
concepts of measuring value-added flows between countries (Stehrer 2012). “Value-added
in trade” calculates the amount of foreign value-added embodied in the gross exports of a
country, while “trade in value-added” accounts for the value-added of one country directly
and indirectly contained in final consumption in another country.


The methodology developed by Hummels et al. (2001) also assumes that all imports are
100 per cent foreign-sourced. This implies that a country cannot receive intermediate
imports that embody its own value-added, returned home after being processed abroad.


This assumption is unlikely to hold in a world where more than one country exports
intermediates. Therefore, given the multi-country, back-and-forth nature of present day
global supply chains, the measure of the import content of exports developed by Hummels
et al. (2001) is unlikely to provide an accurate reading of value-added trade.


8.4 Beyond the import content of exports


8.4.1 Conceptual underpinnings


Estimating the value of a country’s exports that are embodied in a second country’s export
goods is not straightforward because it requires matching bilateral trade flow data to
inter-country input-output tables. A number of recent studies in the literature do reconcile
input-output tables with bilateral trade statistics to get a set of domestic and import use
tables broken down by partner countries. The resulting world input-output table measures,
more accurately, the domestic value that countries are adding to goods and services along
the global supply chain (Timmer 2012).


For instance, Koopman et al. (2010) calculate the share of exports made of domestic value-
added used in third countries to produce other exports, and combine this indicator with
the import content of exports to derive a “participation index”. This gives a more complete
picture of the involvement of countries in GSCs. Simply relying on the import content




Supply chains and trade in value-added


144 Supply Chain Perspectives and Issues


of exports would undermine the participation of commodity producers or upstream
suppliers of intermediate inputs in GSCs.


On the flipside, only considering the share of exports – comprising domestic value-
added – used by other countries to produce other exports would penalise downstream
producers and countries that often consume products instead of re-exporting them to
third countries. Given the above, a recent report by UNCTAD (2013) constructs a measure
of country participation in global value chains by combining foreign value-added in
exports (upstream links) with exports that are incorporated in other products and re-
exported (downstream links).


According to Daudin et al. (2011), it is also possible to identify that part of a country’s
exports which, further down the production chain, are re-imported as embedded inputs
for final consumption, i.e. the domestic content of invested or consumed imports. In fact,
Koopman et al. (2010) demonstrate mathematically how this double counted portion of
value-added in intermediate goods trade could be measured and adjusted so that gross
exports can be fully decomposed into its various value-added components.


Johnson and Noguera (2012) define “value-added exports” as the amount of value-added
from a given source country that is embodied in the final consumption in each destination.
A note of caution is the need to differentiate between countries simply participating in
global value chains and actually adding value. For example, resource rich or commodity
producing countries will have a higher share of domestic value-added in final foreign
demand, and hence record a higher rate of GVC participation, even if they add little value
to the extracted commodity or raw material.


In the aggregate, the ratio of value-added exports to gross exports measures the extent
of double-counting in trade statistics, an important metric of international production
fragmentation. At the bilateral level, this ratio is a marker for both bilateral production
chains, as well as multi-country production chains, in which value-added transits through
third countries en route from source to destination.


8.4.2 Empirical evidence


Estimating the aforementioned “participation index” for OECD economies and selected
non-OECD countries, Koopman et al. (2010) show that a large percentage of the (domestic)
value of exports is used in downstream industries in other countries.


For example, based on import content of exports measure, the GSC participation of the
United States is less than 10 per cent of the value of US exports and is made up of foreign
inputs. However, taking into account the use of US intermediates in other countries’
exports, the country’s participation in GSCs rises to more than 40 per cent.
According to Daudin et al. (2011), the same holds true for other producers of industrial
inputs, as well as countries that have an abundance of primary product exports. The above
highlights the fact that factoring in the use of exports as inputs into exports by another
country is important for improving our understanding of global supply chains.


In terms of geographical concentration, global value chains are not limited to Asia. OECD
economies, especially those in Europe, show a comparable level of participation (OECD
2012). Large non-OECD economies, such as China and Brazil, have a lower share of
exports used as inputs in further production for export, as opposed to the small ones,




145Supply Chain Perspectives and Issues


such as Singapore or Chinese Taipei (Koopman et al. 2010). This is because the former
are often located in the downstream part of GSCs – as a base for final assembly – whose
export products are destined for final consumption instead of further processing. It is
worth noting that the data used in this study only include emerging economies. The
participation of non-OECD economies in GSCs is likely to have been lower if data for LDCs
were included in the global input-output model.


Using the GTAP database to analyse 66 regions and 55 sectors in 1997, 2001 and 2004,
Daudin et al. (2011) highlight the fact that standard trade statistics paint an inaccurate
picture of the relative dependence of different sectors on international demand. In addition
to estimating the import content of exports, they reallocate value-added trade to its initial
producer industry. As a result, some sectors have more value-added trade than they have
export trade, i.e. they are mainly traded as inputs in other goods.


Services are much more dependent on external demand. So too are agricultural raw
materials. For instance, 11 per cent of value-added in services worldwide is consumed by
foreign consumers compared to service exports, constituting only 7 per cent. In contrast,
despite the fact that industrial exports are equal to 67 per cent of industrial value-added,
a large part of these exports embody service or commodities production. Hence, only
32 per cent of world industrial value-added is actually consumed by foreign consumers.


Koopman et al. (2012) even show that a country’s revealed comparative advantage
in a sector may change with the use of a domestic content in exports measure, rather
than traditional trade statistics. For example, with gross trade data, the machinery and
equipment sector is a comparative advantage sector for China. With domestic value-added
in exports data, however, they find that China has a revealed comparative disadvantage
in the same sector.


Daudin et al. (2011) also show that value-added trade reduces the incidence of
regionalisation in world trade. For example, Asia relies more heavily on extra-regional
final markets than standard trade statistics suggest. This is also the case for America
and Africa.


Much of the literature discussed here focuses on measuring trade in value-added over
short time spans, often even in a single recent year. A recent study by Johnson and
Noguera (2012) computes and analyses the value-added content of trade during the
period between 1970 and 2009. They construct an annual sequence of global input-output
tables covering 42 countries to show that for the world as a whole, the ratio of value-added
to gross exports has been declining over time, falling by between 10 and 15 percentage
points over the last four decades. The decline in this ratio was especially steep after 1990.


This suggests that the double counting in gross trade flows and hence international
production sharing has intensified in recent years. Beneath these global results, Johnson
and Noguera (2012) find that both the magnitude and timing of declines in the ratio of
value-added to gross exports differs across countries. Declines appear to be largest for
fast-growing countries undergoing structural transformation.


There is ample variation across bilateral trading partners as well. For example, the ratio
falls by 0:29 for US exports to Mexico, but is nearly unchanged for US exports to Japan.
This bilateral variation reflects both changes in the extent to which exports to a given
destination are used in production of exports, as well as changes in how a given source
country serves the destination via third markets.




Supply chains and trade in value-added


146 Supply Chain Perspectives and Issues


8.5 Future research


The most important limitation of the method based on input-output tables is that these
tables are constructed at a national level, and have little information about the international
aspects. Some recent studies have attempted to combine information from input-output
tables with bilateral trade data.


The accuracy of this method also depends on the level of sectoral aggregation in an
input-output table. The importance of global supply chains is best captured with a more
detail breakdown of production activity in an economy. Moreover, there is no standard
international classification, which often inhibits international comparison. Another
problem is related to the frequency of publication of such data. It is usually produced
every five years, thereby making it difficult for it to be combined with international trade
statistics (Damuri 2012).


The OECD, in co-operation with the WTO, has launched an ambitious project on the
measurement of trade in value-added terms. Its objective is to look for a synthesis of
the existing approaches, in order to define best practices. A world input-output table
comprising 56 countries (and 37 industries) that account for more than 95 per cent of
world output is envisaged. Such a model would be vital for gaining better estimates of
bilateral trade flows in value-added terms, and of the contribution of each economy
to global production. While the margin of error would be low at a reasonable level of
aggregation, this is not likely to be the case when interpreting more specific results in
terms of countries and industries.


Based on stochastic principles developed in exploratory network analysis, a recent study
by Damuri (2012) explores a new way to use information in input-output tables to estimate
the pattern of international production fragmentation. It takes into account not only
bilateral relations, but also captures the whole network of production.


The author constructs a matrix of international production linkages by combining input-
output tables of 45 countries and trade statistics. It takes a form of an input-output table,
but instead of showing production sectors as rows and columns, it has countries as the
sources of production in its rows and countries as destinations in its columns.


On-going efforts from the international statistics community to address issues
related to estimation of trade in value-added also go beyond the limitations of the
input-output approach. For instance, the 2008 revision of the System of National
Accounts (SNA 2008) looked into the estimation of trade values in the specific case
of manufacturing services.


Escaith (2008) proposes to expand the concept of value-added trade to other types of
business relationships within international value chains and develop “satellite accounts”
of the external sector. The objective is to organise all related economic statistics, including
business and employment data, and integrate these in line with the SNA directives.1


Sturgeon (2013) reviews the various initiatives undertaken by the statistical community
and recommends a framework for integrating trade and business statistics into a network
of micro-databases within the EUROSTAT context. Tang, Wang and Wang (2013) present
an example of combining input-output analysis with business surveys in order to measure
trade in value-added by firm characteristics in the case of China.




147Supply Chain Perspectives and Issues


8.6 Endnote


1. The Global Forum on Trade Statistics, organised by several international agencies
in Geneva in February 2011, provides a synthesised view of the new requirements
on international trade and its relationship with global value chains, employment, the
environment and the interdependence of economies. http://unstats.un.org/unsd/trade/s_
geneva2011/outcome.htm


8.7 References


Athukorala, Prema-Chandra, and Nobuaki Yamashita. 2006. “Production Fragmentation and
Trade Integration: East Asia in a Global Context”, North American Journal of Economics
and Finance, 17(3): 233–256.


Daudin, Guillaume, Christine Rifflart, and Danielle Schweisguth. 2011. “Who Produces for
Whom in the World Economy?” Canadian Journal of Economics, 44(4): 1403-1437.


Escaith, Hubert. 2008. “Measuring Trade in Value-added in the New Industrial Economy:
Statistical Implications”, Paper presented at the 12th French National Accounts Association
Symposium, Paris, 4-6 June.


Hummels, David, Jun Ishii, and Kei-Mu Yi. 2001. “The Nature and Growth of Vertical
Specialization in World Trade”, Journal of International Economics, 54(1): 75-96.


Johnson, Robert C. and Guillermo Noguera. 2012. “Fragmentation and Trade in Value-
added over Four Decades”, National Bureau of Economic Research Working Paper
Number 18186.


Koopman, Robert, William Powers, Zhi Wang, and Shang-Jin Wei. 2010. “Give Credit Where
Credit Is Due: Tracing Value-added in Global Production Chains”, National Bureau of
Economic Research Working Paper Number 16426.


Koopman, Robert, Zhi Wang, and Shang-jin Wei. 2012. “Estimating Domestic Content in Exports
when Processing Trade is Pervasive”, Journal of Development Economics, 99(1): 178-189.


Koopman, Robert, Zhi Wang, and Shang-jin Wei. 2012. “The Value-added Structure of Gross
Exports: Measuring Revealed Comparative Advantage by Domestic Content in Exports”,
Paper presented at the 2012 AEA Annual Meeting, Chicago, 7 January.


Maurer, Andreas and Christophe Degain. 2010. “Globalization and trade flows: what you
see is not what you get!” World Trade Organization Working Paper Number ERSD-2010-12.


Miroudot, S., R. Lanz and A. Ragoussis. 2009. “Trade in Intermediate Goods and Services”,
OECD Trade Policy Working Paper Number 93.


Organization of Economic Cooperation and Development. 2012. “Mapping Global Value
Chains: Preliminary Results”, Working Party on Globalization of Industry. Paris. 26-27 April.


Stehrer, Robert. 2012. “Trade in Value-added and Value-added in Trade”, World Input-
Output Database Working Paper Number 8.


Sturgeon, Tim. 2013. “Global Value Chains and Economic Globalization: Towards a New
Measurement Framework”, EUROSTAT.




Supply chains and trade in value-added


148 Supply Chain Perspectives and Issues


Tang, Hei Wai , Fei Wang, and Zhi Wang. 2013. “The Domestic Segment of Global Supply
Chain in China under State Capitalism”, Paper presented at the International Conference
on Global Value Chains and Structural Adjustment, Beijing.


Timmer, Marcel. 2012. “The World Input-Output Database: Contents, Sources and Methods”,
World Input-Output Database Working Paper Number 10.


United Nations Conference on Trade and Development (UNCTAD). 2013. “Global Value
Chains and Development: Investment and Value-added Trade in the Global Economy”,
United Nations, Geneva.


Yeats, A. 2008. “Just How Big is Global Production Sharing?” World Bank Policy
Research Working Paper Series, Working Paper Number 1871, Washington DC,
World Bank.




149Supply Chain Perspectives and Issues


Chapter 9
Supply chains and business models


Abstract


While the term “business model” might seem ubiquitous today, its use only arose in the
1990s with the information and communications technology (ICT) revolution. Since then,
the business model literature has advanced definitions and conceptualisations that
describe, and prescribe, a range of supply chain architectures. In the age of network
competition, the business model concept now rests upon the focal unit of the supply chain
and no longer upon the individual firm. Theory has emerged to aid the practitioner in
designing supply chains and in understanding the latest business models. While not as
directly relevant, policy makers also stand to gain from this literature in understanding
the considerations that businesses take into account for their business design decisions.


9.1 Historical development


The term “business model” is well established in the modern lexicon, but this belies its
relatively young age. Business models came to prominence recently in the 1990s during
the information and communications technology (ICT) revolution and the dot-com boom.
The capabilities introduced by ICT could be implemented in the business environment to
create previously infeasible ways of doing business (Brynjolfsson and Hitt 2000).


To grasp the significance of these new ICT technologies, Brynjolfsson and Hitt (2000)
conceptualised markets and organisations as information processors. With the new
information computation capabilities and dramatically reduced costs, the institutions
and thinking from the pre-ICT economy suddenly became outdated; and as with previous
general purpose technologies, the implementation of technical innovations also gave way
to significant organisational innovations.


It is these new organisations that are the focus of the “business model” term, and
Osterwalder (2004) highlights four key drivers: (1) reduced transaction and coordination
costs enable isolated firms to shift towards more collaborative and integrated forms of
network organisation; (2) brand new products and services, often with an information




Supply chains and business models


150 Supply Chain Perspectives and Issues


component, can now be offered; (3) brand new channels for reaching the customer; and
(4) brand new pricing and revenue mechanisms.


The new frontier of business opportunities created by these drivers and the resulting
business models being built to capture them drove the rise of business model-related
topics in media, management and academia (Morris, Schindehutte, and Allen 2005;
Osterwalder 2004). This, however, is not to say the “business model” was invented in the
1990s. Osterwalder (2004) reports that the earliest documentation in the literature goes
as far back as 1960. While far from scientific, a search on Google Scholar for academic
literature using the exact key phrase “business model” shows a four-order magnitude of
difference increase in the number of results between 2000 and 2009 compared to those
between 1960 and 1969 (Table 9.1).


Table 9.1: Results, by decade, from a Google Scholar search
of the exact key phrase, “business model”


Source: Search conducted on 24 January 2013


Much of the literature from the 1990s attempts to document, categorise, and rationalise the
plethora of new business models – in particular, e-commerce business models – that were
appearing. Much of the theory building during this time focused on developing typologies
of business models (see Timmers 1998; Mahadevan 2000). However, the collapse of the
dot-com bubble proved many of these business models irrelevant, and the literature
shifted its focus to the theoretical underpinnings of business models to understand why
(Tikkanen et al. 2005).


Since then, the term “business model” has emerged as a more clearly defined and operationally
useful area of research. Indicative of the continual maturation of the field, the most recent
literature has now begun to shift from the theoretical underpinnings of business models to
the development of managerial tools for business model design and implementation.


Decade # of Google Scholar search results


2010s (until 24 January 2013) 25,200


2000s 105,000


1990s 5,840


1980s 466


1970s 195


1960s 96


1950s 27


1940s 25


1930s 14


1920s 13


1910s 15


1900s 17




151Supply Chain Perspectives and Issues


9.2 Definitions and conceptualisations


A consequence of the rapid proliferation of the business model term during the 1990s was
the deterioration of its definitional clarity. Like “globalisation”, business models came to be
used by everyone but known by no one (Morris, Schindehutte, and Allen 2005; Osterwalder
2004; Tikkanen et al. 2005; Timmers 1998). As Magretta (2000) notes, “the terms ‘business
model’ and ‘strategy’ are among the most sloppily used in business. People use them
interchangeably to refer to everything [sic] - so they mean nothing.”


In other chapters, we try to separate the definitions from the conceptualisations of issues
for the reader, but this proves difficult with the business model literature. Quite often,
proposed definitions of a business model take the form of a conceptualisation. Further
complicating the deconstruction and analysis of the literature is the fact that many of the
conceptual definitions are also presented as conceptual tools for the business practitioner.


In light of the fact that there are more than enough definitions to review, we set aside
those dual conceptual definition-tools and address these functional definitions in section
9.3. For this current section, we begin by introducing the variety of textual definitions of
“business model” found in the literature (Table 9.2).


Table 9.2: A sample of definitions of “business model” reviewed in the literature


In Table 9.2, we can see the ambition embodied in the business model concept. Described
as an “architecture”, a system, flows and streams, the business model is a metaphysical
abstraction of a firm’s most essential features. What these essential features are, however,
and where the business model concept stands, relative to strategy, marketing, and other
complementary ideas, varies significantly across authors. To gain a better view of how
the literature orients the business model concept, we present several visualisations
of the definitions found in the literature, starting with the simplest (Mahadevan 2000)
(Figure 9.1 - Figure 9.7).


Mahadevan (2000) utilised a basic concept of flows that exist across the supply chain.
This is shared as a characteristic with many other definitions found in the literature
(Figure 9.1).


Author Definition of “business model”


Amit and Zott (2001) a depiction of the content, structure and governance of transactions that have
been designed to create value


Magretta (2002) a story explaining who the customers are and how to make money by providing
them with value


Mahadevan (2000) a blend of three critical business streams: the value stream for business partners
and buyers, the revenue stream, and the logistical stream


Morris, Schindehutte, and Allen (2005) a concise representation of how decision variables relating to venture strategy,
architecture, and economics are addressed to create sustainable competitive
advantage in defined markets


Osterwalder (2004) an abstract model of the business and money earning logic of a company and a
business layer binding business strategy with business processes


Tikkanen et al. (2005) a system of components and related material and cognitive aspects of the firm


Timmers (1998) an architecture for the flow of products, service, and information that includes
descriptions of the business actors plus their roles, the incentives for each actor,
and the sources of revenue




Supply chains and business models


152 Supply Chain Perspectives and Issues


Figure 9.1: Business model definition


Source: Adapted from Mahadevan (2000)


Timmers (1998) introduces the context of marketing with the business model in his landmark
work on e-commerce business models. In Timmers’ conception, the business model is a
subset of an overarching marketing model, and exists at the multi-firm level. In order to derive
firm-specific insights on value creation and capture, however, the context of the business
model needs to be complemented with a firm-specific marketing strategy (see Figure 9.2).


Figure 9.2: Business model conceptualisation




Source: Adapted from Timmers (1998)


Magretta (2002) takes a very different approach compared to the typical analytical
deconstruction approach of other authors. In her conception, the business model is, very
simply, related to a story; this is appropriate given the significant qualitative considerations
involved in business model design. Magretta also makes a distinction between business
models, which describe the money-learning logic (as Osterwalder (2004) puts it) of a firm
or system of firms, and strategy, which describes how to sustainably beat the competition.
(See Figure 9.3)


Figure 9.3: Business model conceptualisation and validation test


Source: Adapted from Magretta (2002)


Figure 9.1 Business model denition adapted from Mahadevan (2000)


Business model


A unique blend of three streams that are critical to the business


Value
Revenue
Logistical


Figure 9.2 Business model conceptualisation adapted from Timmers (1998)


Marketing model


an architecture of ows + descriptions of
Business actors/roles


Actor incentives
Sources of revenue


Products
Services


Information


Marketing strategy


an assessment of commercial viability for a rm


Competitive advantage
Marketing mix


Product-market strategy
Other....


+


Business model


Strategy


∞ a story explaining who the customers are and how to make money by
providing them with value
∞ a description of how the pieces of a business t together as a system


∞ how to beat the competition by being dierent


not to be confused with


Figure 9.3 Business model conceptualisation and validation test adapted from Magretta (2002)




153Supply Chain Perspectives and Issues


Amit and Zott present a conceptualisation in their 2001 work wherein the business model
contains the more structural and static components of a business, while a complementary
concept of the revenue model describes the dynamic modes in which the business model
operates to create and capture value (Figure 9.4).


Figure 9.4: Business model conceptualisation and design framework


Source: Adapted from Amit and Zott (2001)


Progressing forward in complexity, Morris, Schindehutte, and Allen (2005) present a
definition of business models derived from the entrepreneur’s perspective (Figure 9.5).
Here, they distinguish business models from business plans, strategy, and activity sets. In
contrast to Magretta’s (2002) conception the issue of sustainable competitive advantage is
directly addressed by the business model.


Figure 9.5: Business model conceptualisation and design framework


Source: Adapted from Morris, Schindehutte, and Allen (2005)


Osterwalder (2004) presents a landmark work in the review, consolidation, and
advancement of the business model in his doctoral thesis. In his efforts to build a “business
model ontology”, he proposes the segmentation of the business model into nine key
elements that address the products/services, structure, finances and customer interfaces
of the firm (Figure 9.6). Osterwalder also distinguishes a strategy from a business model,
locating strategy at the highest macro perspective. Offered below are business models in
terms of scope of consideration and a business modelling or process layer to represent a
more operational/on-the-ground perspective.


Business model


Revenue model


complementary but distinct concepts


a depiction of the transaction


specic modes in which a business model enables value generation/appropriation


that are designed to create value


Content
Structure


Governance


Figure 9.4 Business model conceptualisation and design framework adapted from Amit and Zott (2001)


a concise representation of
how variables in


are addressed to create
sustainable competitive &
advantage in markets


Venture strategy
Architecture
Economics


Business plan Activity setStrategy


Business model


Figure 9.5 Business model conceptualisation and design framework adapted from Morris, Schindehutte, and Allen (2005)


related but distinct from




Supply chains and business models


154 Supply Chain Perspectives and Issues


Figure 9.6: Business model conceptualisation


Source: Adapted from Osterwalder (2004)


Finally, Hedman and Kalling (2003) present a conception that segments the business mode
into seven interrelated components. This conceptualisation directly adopts the up-stream/
down-stream process perspective of the supply chain, as shown in Figure 9.7.


Figure 9.7: Business model conceptualisation


Source: Adapted from Hedman and Kalling (2003)


Overall, the variance in perspectives makes it impossible to present a clear and universal
definition of the business model. That said, we consider the very existence of the concept
to be valuable for one critical reason. The concept of the business model draws the
attention of the practitioner to the logic underlying the existence of their business, and
encourages the practitioner to ask why information goes into this database, why we
outsource these activities, why we serve these customers with these products, and so on.
In a global market characterised by rapid change and increasing intangible components
(information and services), these questions enable the practitioner to evaluate and adapt
their business at a more fundamental level.


For a more in-depth review and discussion of the variance in business model concepts, we
highly suggest Osterwalder’s (2004) work on business model ontologies.


Business model
composed of 7 causally related components


Suppliers Operationalresources Oering


Customers


Competition


Activities and
organizations


Scope of
management


Figure 9.7 Business model conceptualisation adapted from Hedman and Kalling (2003)


Business model
a conceptual tool that expresses a company's logic of earning money through 9 elements


Strategy layer


Business modelling/process layer


Product
∞ Value proposition


Financial aspects


Infrastructure management
∞ Value conguration
∞ Partnership
∞ Capability


Customer interface
∞ Relationship
∞ Target customer
∞ Distribution channel


∞ Revenue model
∞ Cost structure


Figure 9.6 Business model conceptualisation adapted from Osterwalder (2004)




155Supply Chain Perspectives and Issues


9.3 Supply chain business models


As can be seen from the definitions and conceptualisations of business models, one can
not escape the inclusion of a supply chain – or otherwise, network-centric component – in
the business model. The ICT revolution that gave rise to the business model concept also
gave rise to the proliferation of supply chains, and the two concepts can be considered
as being related through this common source. The business literature makes it clear that
businesses can no longer afford to disregard one another if they are to survive in an
increasingly integrated world economy. To address this new reality, the literature presents
a variety of approaches and best practices in supply chain business models.


9.3.1 The business and engineering approach


Typically, the design of a supply chain involves generating several alternatives and
evaluating them on the basis of benchmark performance measures. These often
incorporate considerations of long term strategic planning in a general time frame of three
to twelve years (Goetschlalcks and Fleischmann 2008). Benchmarking considerations,
often centred on optimising revenues, are constrained by a series of business risks, be
they strategic (“make or buy decision”, long term strategic alliance with key suppliers or
customers) or operational (such as those linked to demand considerations, lead-time and
inventories).


Geoffrion and Powers (1995) provide a comprehensive review of the early literature and
how the corporate status of logistics has changed dramatically since the late 1970s. Their
review addresses the formal research of a minimal-cost configuration for a company’s
production and distribution network that satisfies product demand at specific customer
service levels. They show, inter alia, how progress in IT and software improved the
information and decision-support systems used to assist business management.


International decision-support models have the same characteristics, variables and
constraints as single country frameworks, but need to also model exchange rates, tax
and duty rates, and border and beyond-the--border regulations. In addition, geo-political
considerations may complicate the analysis, especially in the case of long-term strategic
planning. Risk analysis is particularly complex in these international designs, including
many third parties, as “every company pays for the inefficiencies up-chain and down-
chain” (Geoffrion and Powers 1995).


In addition to the more advanced algorithmic models to support decision making and
supply chain operations, management schools have also developed strategic approaches,
based on game-theory.


A key differentiating factor in the supply chain decision making scenario is the importance
of cooperation. Unlike the “win-lose” business propositions derived from more traditional
import substitution industrialisation (ISI) and defensive trade policies, a key merit of
the supply chain approach is the possibilities of enabling “win-win” scenarios. However,
doing so requires the balancing of focal firm objectives and constraints (such as profit
maximisation and long-term growth) and cooperative supply chain objectives (such
as process optimisation and market competitiveness). Cooperative game theory helps
design a supply chain by selecting an optimal coalition of partners. But non-cooperative
(also called strategic) outcomes should not be ruled out and are often identified in order




Supply chains and business models


156 Supply Chain Perspectives and Issues


to determine the set of equilibrium points that can be reached in trade conditions (Cachon
and Netessine 2004; Hennet and Ardax 2008).


While these tools remain largely conceptual, their practical implications in terms of private
and public decision making should not be ignored. These strategic aspects of outsourcing
for lead firms or large first-tier suppliers often determine the set of feasible strategies
for the insertion of new players into a global value-chain, and further upgrading. The
following section addresses specific design tools in the literature.


9.3.2 Design tools


A number of supply chain business model design tools emerged from the literature, and
can be broadly classified as either quantitative or qualitative in approach. Our review
sourced a limited number of articles on quantitative design tools, and our discussion
will be limited, as a result. However, one excellent review on the evolution of quantitative
models from operations research is presented by Meixell and Gargeya (2005).


The quantitative tools are predominantly based on mathematically modelling supply chain
components to optimise around the goals of either maximised profit or minimised cost. An
example can be seen in the IBM supply chain simulator, which takes the form of a fully-
fledged software programme that allows managers to simulate location, replenishment,
and inventory decisions, among others (Bagchi et al. 1998). The appeal of such tools is
clear for the business practitioner: One can quickly, conveniently and cheaply evaluate
outcomes of decisions without the real-world consequences. However, while such models
have been seen in more specific applications, such as inventory management or sales
forecasting, current models do not yet account for the breadth of considerations that must
be taken into account at the business model design level. In particular, models need to be
expanded to cover more activities and organisations across the supply chain, in addition
to considering performance measures that move beyond simple profit/cost calculations
(e.g., reliability, responsiveness, or flexibility) (Meixell and Gargeya 2005).


Qualitative tools were much more prevalent in our surveyed literature. These take the
form of frameworks built around key design questions or considerations for the business
practitioner to answer. We present four such frameworks from the literature, which have
been sufficiently developed to hold utility for the business practitioner.


Zott and Amit (2010) interpret the process of value creation as a system of activities in the
supply chain, and prescribe two groups of design parameters: one group of three design
elements, and one group of four design themes.The design elements consist of content,
structure, and governance of the activity system. These elements embody the activities,
interconnections, and actors in the supply chain. To guide the business practitioner are
the infinite configurations possible with these elements.


Zott and Amit point to four design themes which represent the strategic source of
value creation that guides the structuring process of design elements. The themes, or
rather, value-creating strategies presented are pursuing novelty through investment in
organisational innovation, lock-in of control over supply chain participants (e.g. customer
bases, key suppliers), complementarities or synergies between activities, or efficiency
with the aim of lowering costs. A summary of components can be found in Figure 9.8.




157Supply Chain Perspectives and Issues


Figure 9.8: Components of the activity system design framework


Source: Zott and Amit (2010)


Nenonen and Storbacks (2010) present another business model framework based on
interaction with multinational firms as well as previous literature. Also focused on value-
creation components and processes, their framework considers three types of business
model components (design principles, resources, capabilities) in four settings (market,
offering, operations, management).


Design principles guide the structure and execution of operations, and echo the
concepts of the design themes of Zott and Amit. Resources refer to tangible, static
(operand) resources and intangible, dynamic (operant) resources that combine to create
value. Capabilities refer to the skills and knowledge used as instructions for value-
adding activities.


The four settings focus on relevant dimensions of firm and supply chain
activities. The market dimension relates to consideration of the three business model
components in the context of customers and the marketing activities in reaching
them. Offering refers to offering design and earnings logic, and also to the product and
process designs underlying a firm’s products and/or services. The latter two dimensions
are relatively straightforward, with operations referring to the context of operational
design and infrastructure and management referring to support and development of
human resources.


Figure 9.9 presents a visual framework from Nenonen and Storbacks (2010). Overall, the
logic of this framework is not as easy to grasp relative to Zott and Amit’s (2010) framework,
but the four specific settings addressed may hold more utility for relevant practitioners.


Framework provides insight by:
Giving Business Model Design a language, concepts, and tools
Highlighting Business Model Design as a key managerial/entrepreneurial task
Emphasising system-level design over partial optimisation


Design Elements
Content What activities should be performed?
Structure How should they be linked and sequenced?
Governance Who should perform them, and Where?


Design Themes
Novelty Adopt innovative content, structure or governance
Lock-In Build in elements to retain business model stakeholders, e.g., customers
Complementarities Bundle activities to generate more value
Eciency Reorganise activities to reduce transaction costs


Figure 9.8 Components of the activity system design framework, from Zott and Amit (2010)




Supply chains and business models


158 Supply Chain Perspectives and Issues


Figure 9.9: Framework of business model design considerations


Source: Nenonen and Storbacka (2010)


Morris, Schindehutte, and Allen (2005) also utilise a multi-component, multi-level approach
in building their business model framework. In this case, the components are actually
six key questions that must be answered in developing the value-creating logic of the
firm. These questions are: (1) “how do we create value?”; (2) “who do we create value for?”;
(3) “what is our source of competence?”; (4) “how do we competitively position ourselves?”,
(5) “how do we make money?”, and,(6) “what are our time, scale, and scope ambitions?”


These questions are asked at three levels of operational specificity: foundation, proprietary,
and rules. The foundation level refers to the answer of questions by entrepreneurs at the
most fundamental level when formulating a non-operationally specific business model.
The proprietary level then advances from the foundation level to consider how questions
can be answered in a unique manner that will be proprietary and characteristic to the
firm. Finally, the rules level asks for specific operational actions to realise the answers
produced at the proprietary level. The resulting framework is presented in Figure 9.10.


This framework holds value in identifying the right questions and the difference in
answers according to operational scenarios, but the guidance provided to practitioners
gets weaker with increasing operational specificity. Nonetheless, the questions provide a
high-level reality check for the practitioner’s consideration.


Figure 9.10: Decisions-based business model framework


Source: Adapted from Morris, Schindehutte, and Allen (2005)


Level of decision making


Foundational Proprietary Rules


Factors related to the offering
How do we create value?


Market factors
Who do we create value for?


Internal capability factors
What is our source of competence?


Competitive strategy factors
How do we competitively position ourselves?


Economic factors
How do we make money?


Personal / investor factors
What are our time, scope and size ambitions?


Design principles Resources Capabilities


Market Market & customer definition Customers & brand
Market & customer


management


Offering Offering design & earnings logic Technology
Offering management


& R&D


Operations Operations design Infrastructure, suppliers & partners
Sourcing, production &


delivery


Management Management system Human & financial resources Management & leadership




159Supply Chain Perspectives and Issues


Tikkanen et al.’s (2005) business model framework is unique in recognising the
significance of managerial perceptions (belief systems) in business model design.
The logic behind such an approach is that managerial perception of the firm and the
environment determines resulting actions and outcomes.


The framework proposed by Tikkanen et al. examines the relationship between managerial
perception and material, or rather objective, components of the firm. The perceptions are
organised into a belief system with four components: industry recipes, boundary beliefs,
product ontologies, and reputational rankings.


Industry recipes refer to perceptions of the economic, competitive, and institutional
environments and their influence on firm performance. Boundary beliefs refer to the
firm’s boundaries, and are socially shared beliefs on the delineation and relationships
of a firm within a greater environment or community of organizations. Product
ontologies refer to the characteristics that are used to define a firm’s products and/or
services. Finally, reputational rankings refer to the perception of competitors relative to
the perception of personal performance. The framework can be seen below in Figure 9.11.


Figure 9.11: Materials and beliefs-based business model framework


Source: Tikkanen et al. (2005)


Reputational rankings Industry recipe Boundary beliefs Product ontologies


Strategy and
Structure


The longer the
industry life-cycle and


the more stable the
related industry recipe
the more narrow the


alternatives for
structural change


The less ambiguous
the link between
firm strategy and


the totality of firm’s
belief system, the


more crystallized the
strategic intent of a
company and the
more consistent


its actions


Network


The higher the
cognition of a firm’s


own reputational
ranking, the higher


reputational rankings
the firm seeks and


expects from its
customers


and suppliers


The targets of a firm’s
marketing efforts are


constrained by the
firm’s boundary beliefs


about who it can
pursue as a customer


or serve as
a supplier


The more focused the
product ontology,


the more structured
and goal-oriented the


management of the
product development


project portfolio


Operations


The stronger the
industry recipe, the


more uniform process
architectures will be


across competing
firms


The narrower the
firm’s beliefs in
its operational


boundaries, the
fewer are its unique


resources
and competencies


Managerial cognitions
of current and future
product ontologies


is a major constraint
and reinforcer in the


evolution of product /
service offerings


Finance &
Accounting


The stronger
the cognition of


reputational rankings,
the more uniform the


capital budgeting and
financial reporting


practices of
competing firms.


The firm’s cognition
of its boundaries
constrains its use
of management


accounting practices
and financial
instruments




Supply chains and business models


160 Supply Chain Perspectives and Issues


While the reviewed frameworks each present their own merits, a universal framework
is yet to emerge from the literature. This is a consequence of the drastically different
perspectives and approaches associated with business model design. Given the early
state of the literature, we expect that much more empirical testing and iterative design will
be required before a unified supply chain business model framework emerges.


9.3.3 The agile supply chain


In contrast to the “bottom-up” approach that practitioners can adopt from the various
business model frameworks, best practices in current business models can also be used
as references in a “top-down” approach towards designing the business model. To this
end, agile supply chains have emerged as a key reference model in the literature.


Definitions


Agile supply chains are defined through their ability to rapidly, and cost-effectively,
respond to change as enabled through the seamless flow of information from the market
and across the supply chain (Barnes and Lea-Greenwood 2006; Lee 2004). The concept
originates from flexible or agile manufacturing systems from the 1990s, and requires
appropriate organisational structures, information systems, logistics processes and
mindsets (Christopher and Towill 2000; Gunasekaran, Lai, and Cheng 2008).


Given that the agile concept is often discussed in conjunction with “lean” chains, we
cannot avoid addressing this as well. Lean supply chains focus on the elimination of waste
(Christopher and Towill 2001).


Naylor et al. (1999) further establishes the following definition: “Leanness means
developing a value stream to eliminate all waste, including time, and to enable a level
schedule.” The concept was popularised with the Toyota Production System, although
UK production of the Spitfire aircraft during World War II and US production of
automobiles in 1915 are also cited as origins (Christopher and Towill 2001). When
comparing the two concepts, “lean” wins when the criterion is low cost under conditions
of stable demand and low product variety. However, “agile” proves superior when the
criteria are service and customer value and when the scenario entails volatile demand
and high product variety (Christopher and Towill 2000, 2001),


Significance


The agile supply chain concept has been showcased as best practice in the literature
due to a number of environment factors. First, is the fact that new standards of
competitive advantage require firms to leverage the combined capabilities of their supply
chains, competing as networks instead of as individuals (Christopher and Towill 2000,
2001). Secondly, the growing geographical and organisational reach of supply chains are
increasing operational strains to maintain transparency and responsiveness across the
supply chain (Barnes and Lea-Greenwood 2006); finally, there is agreement in the literature
that supply chain risks and disruptions are increasing for today’s firms (Christopher and
Towill 2001, Lee 2004).




161Supply Chain Perspectives and Issues


In light of the increasingly challenging environments, agile supply chains have offered
a solution for business practitioners. Case studies have highlighted firms that have
benefited from implementation, such as Nokia, Dell, and fast fashion companies (e.g. H&M,
Mango, Zara), while showcasing firms that have missed out on opportunities because of
the lack of agility (e.g. Ericsson, Compaq).


Implementation


Agile supply chains require the development of a strong virtual dimension, as enabled
through ICT infrastructure (Barnes and Lea-Greenwood 2006). It is essential that
information is able to drive decisions in real time across the supply chain. In that sense,
a defining characteristic of agile supply chains is that they are real time demand-driven
instead of forecast-driven (Christopher and Towill 2000). Four categories of requirements
are identified: IT infrastructure, trust-based relationships, product/process redesign, and
risk management.


IT infrastructure is needed to build the virtual supply chain, which refers to the dimensions
of the supply chain that manage information, as opposed to inventory. Investment in
IT infrastructure is required to create real-time nerve networks that integrate supply
chain firms with each other and each of their respective markets. Proposed methods
include the implementation of point-of-sales (POS) systems to draw market data, use of
electronic data interchanges (EDI) for integration of IT systems across firm boundaries,
and electronic systems such as computer aided design (CAD) to improve the efficiency
of information flow across partners (Barnes and Lea-Greenwood 2006; Christopher and
Towill 2000; Lee 2004).


Strong relationships based on trust are also required across the supply chain to enable both
rapid and unified response. This needs information sharing and strong communications
between firms. To this end, Christopher and Towill (2000) suggest adopting practices
such as joint strategy determination, buyer-supplier teams, information transparency and
open-book accounting.


Another key component of the agile concept is the redesign of products and processes
to be integrated and optimised at the supply chain level. The required operational
capabilities include postponement of product/service offering until the “last possible
moment” combined with the use of strategic inventory buffers. Additionally, an emphasis
is placed on the required for reliable logistics to support the redesigned process (Barnes
and Lea-Greenwood 2006; Christopher and Towill 2000; Lee 2004).


Finally, Lee (2004) also calls for the implementation of risk management practices as
part of agile concept. These include the establishment of contingency plans and crisis
risk management teams. The result of successful implementation is that firms are able
to effectively compete in the market as a confederation of partners linked together as a
network (Christopher and Towill 2000).


Somewhat tangential to the agile supply chain concept is “strategic agility”, which can
be possibly considered as an enabler. Strategic agility is an organisation’s soft skill or
meta-capability to transform their business model and remain open minded to change.
This concept is in response to the paradox wherein successful firms and supply chains
become inflexible over time, and aims to maintain the ability to transform and adapt as
a business against the complacency engendered by success (Doz and Kosonen 2010).




Supply chains and business models


162 Supply Chain Perspectives and Issues


9.3.4 Other best practices


In addition to agile supply chains, there are a few other “business model best practices”
that are identified in the literature. These entail sustainability, post-purchase servicing, and
dynamic pricing.


Sustainability, in all its popularity, has also found its way into the business model literature.
Nidumolu, Prahalad, and Rangaswami (2009) position sustainability as a source of
business model innovation. Pirkin, Pokesie, and Lewis (2009) add empirical studies of
this, studying Nordic companies for evidence of a new business model incorporating the
concepts of sustainability. Also falling under the umbrella of sustainability is the concept
of closed-loop and reverse supply chains, which extend considerations of the product
lifecycle to post-purchase activities. Closed-loop supply chains contain a standard
forward supply chain and the oft-neglected reverse supply chain that handles return/
exchange and refurbishment activities (Guide, Harrison, and Wassenhove 2003). These
activities add significant operational complexity for business managers, but present
opportunities for increased profitability and consumer value by efficiently reusing or
reselling products and supporting the customer beyond the point of sale. More in-depth
coverage on the subject matter of both sustainability and closed-loop supply chains can
be found in Chapter 10.


“Rocket science retailing” is a term taken from the work of Fisher, Raman, and McClelland
(2000). The concept describes dynamic pricing using big data methods for consumer
information gathering and analysis. Dynamic pricing is highly compatible with the agile
supply chain concept, given their requirements for intensive ICT infrastructure and
emphasis on rapid and seamless communication across the chain. In addition to Fisher,
Raman, and McClelland (2000), Kung, Lin, and Dyck (2013) delve into dynamic pricing in
the supply chain context.


9.4 Empirical studies


Much of the empirical literature has focused on case studies of best practices, either in
context of an industry leader or a gold standard supply chain design. Given that industry
leaders and supply chains these days tend to be international by default, little focus is
seen on any one country or region.




163Supply Chain Perspectives and Issues


Table 9.2: Empirical studies sourced from the literature


Interestingly, case studies on supply chain business models have also adopted the “policy
maker” perspective, focusing on specific countries or regions. These include studies on
the cocoa industry in Costa Rica, the food services industry in Russia, and supply chain-
related services industry in Hong Kong.


9.5 Future directions


Conceptions of the business model still remain scattered and they are in need of some
unification; possibly under a business model framework. Several such candidates have
been seen in the literature, but no one prevailing framework has yet emerged.


In light of the daunting breadth of the ideas underlying business models, however,
the creation of a universal design framework may be infeasible in the short term. As a
sort of “holy grail” in terms of management tools, it may be infeasible in the long term
as well. Instead, continued empirical studies on the latest supply chain business model
innovations, such as the sustainable and agile concepts, can provide more immediate
utility for business practitioners, while also producing the data that will be required to
inform future attempts towards design theory.


Citation Year Type Industry Geography Subjct


Appelqvist, Lehtonen,
and Kokkonen


2004 case study Patria (A380 supplier, aerospace) Finland Product and supply
chain design


Barnes and Lea-
Greenwood


2006 survey Fashion industry United Kingdom The fast fashion business
model


Boyson, Corsi, and
Verbraeck


2003 case study US Air Force United States An e-supply chain portal
business model


Chung, Yam, and Chan 2004 case study Hashro International The information hub
business model in global
sourcing


Haynes et al. 2012 case study Cocoa Costa Rica Value analysis of organic
and fair trade cocoa


Kraemer, Dedrick, and
Yamashiro


2000 case study Dell International IT as a business model
enabler


Montgomerie and
Roscoe


2012 case study Apple International The “own the consumer”
business model


Morris, Shirokova, and
Shatalov


2012 case study Food service industry Russia Effects of business model
design and performance
in Russia


Ndou, Vecchio, and
Schina


2011 survey Food processing Tunisia E-business model for
SMEs in developing
countries


Nenonen and
Storbacka


2010 survey Power and automation tech,
chemicals, electronics, utility,
printing, ICT, real estate, machinery,
metals, telecom, forestry


International Business model
framework development


Reiskin et al. 2008 case study Chemical Strategies Partnership
(service organisation)


United States The servicification
business model


Vonderembse et al. 2006 case study Black and Decker, IBM+Hitachi and
DaimlerChrysler


International Lean, agile, and hybrid
supply chains




Supply chains and business models


164 Supply Chain Perspectives and Issues


9.6 References


Amit, Raphael and Christoph Zott. 2001. “Value creation in e-business”, Strategic
Management Journal, 22(6-7): 493-520.


Appelqvist, Patrik, Juha-Matti Lehtonen, and Jukka Kokkonen. 2004. “Modelling in product
and supply chain design: literature survey and case study”, Journal of Manufacturing
Technology Management, 15(7): 675-686.


Barnes, Liz, and Gaynor Lea-Greenwood. 2006. “Fast fashioning the supply chain: shaping
the research agenda”, Journal of Fashion Marketing and Management, 10(3): 259-271.


Birkin, Frank, Thomas Polesie, and Linda Lewis. 2009. “A new business model for
sustainable development: an exploratory study using the theory of constraints in Nordic
organizations”, Business Strategy and the Environment, 18(5): 277-290.


Boyson, Sandor, Thomas Corsi, and Alexander Verbraeck. 2003. “The e-supply chain portal:
a core business model”, Transportation Research Part E: Logistics and Transportation
Review, 39(2): 175-192.


Brynjolfsson, Erik and Lorin M. Hitt. 2000. “Beyond computation: information technology,
organizational transformation and business performance”, Journal of Economic
Perspectives, 14(4): 23-48.


Cachon G.P. and S. Netessine. 2004. “Game theory in supply chain analysis”, in Handbook
of Quantitative Supply Chain Analysis: Modeling in the eBusiness Era, D. Smichi-Levi, S.D.
Wu and Z. Shen, Ed., Boston: Kluwer, pp 13-66.


Chesbrough, Henry. 2007. “Business model innovation: it’s not just about technology
anymore”, Strategy & Leadership, 35(6): 12-17.


Christopher, Martin and Denis Towill. 2000. “Supply chain migration from lean and
functional to agile and customised”, Supply Chain Management, 5(4): 206-213.


Christopher, Martin and Denis Towill. 2001. “An integrated model for the design of agile
supply chains”, International Journal of Physical Distribution and Logistics Management,
31(4): 235-246.


Chung, Walter W.C., Anthony Y.K. Yam, and Michael F.S. Chan. 2004. “Networked enterprise:
A new business model for global sourcing”, International Journal of Production Economics,
87(4): 267-280.


Doz, Yves L., and Mikko Kosonen. 2010. “Embedding strategic agility: A leadership agenda
for accelerating business model renewal”, Long Range Planning, 43(2): 370-382.


Fisher, Marshall L., Ananth Raman, and Anna Sheen McClelland. 2000. “Rocket science
retailing is almost here-Are you ready?” Harvard Business Review, 78(4): 115-124.


Geoffrion A. and R. Powers. 1995. “20 years of strategic distribution system design: an
evolutionary perspective”, Interfaces, 25(5): 105-127.


Goetschlalcks, M and B. Fleischmann, 2008. “Strategic Network Design” in H. Stadtler and Ch.
Kilger (Ed.) “Supply Chain Management and Advanced Planning”, Fourth Edition; Springer.


Guide, V., R. Daniel, Terry P. Harrison, and Luk N. Van Wassenhove. 2003. “The challenge of
closed-loop supply chains”, Interfaces, 33(6): 3-6.




165Supply Chain Perspectives and Issues


Gunasekaran, Angappa, Kee-hung Lai, and T. C. Edwin Cheng. 2008. “Responsive supply
chain: a competitive strategy in a networked economy”. Omega, 36(4): 549-564.


Haynes, Jessica, Frederick Cubbage, Evan Mercer, and Erin Sills. 2012. “The Search
for Value and Meaning in the Cocoa Supply Chain in Costa Rica”, Sustainability, 4(7):
1466-1487.


Hedman, Jonas and Thomas Kalling. 2003. “The business model concept: theoretical
underpinnings and empirical illustrations”, European Journal of Information Systems,
12(1): 49–59.


Hennet, J-C and Y. Ardax. 2008. “Supply chain coordination; a game theory approach”,
Journal of Engineering Applications of Artificial Intelligence, 21(3): 399-405.


Kung, David S., Frank Lin, and Harold Dyck. 2013. “Information Technology Strategy
Incorporating Dynamic Pricing in the Business Model of the Future”, Ubiquitous
Information Technologies and Applications. Springer: Netherlands. 897-903.


Kothandaraman, Prabakar and David T. Wilson. 2001. “The future of competition: value-
creating networks”, Industrial Marketing Management, 30(4): 379–389.


Kraemer, Kenneth L., Jason Dedrick, and Sandra Yamashiro. 2000. “Refining and extending
the business model with information technology: Dell Computer Corporation”, The
Information Society, 16(1): 5-21.


Lee, Hau L. 2004. “The triple-A supply chain”, Harvard Business Review, 82(10): 102-113.


Lee, Hau L. 2010. “Don’t tweak your supply chain- rethink it end to end”, Harvard Business
Review, 88(10): 62-69.


Magretta, Joan. 2002. “Why business models matter”, Harvard Business Review, 80(5):
86-93.


Mahadevan, B. 2000. “Business models for internet-based e-commerce: an anatomy”,
California Management Review, 42(4): 55-69.


Meixell, Mary J. and Vidyaranya B. Gargeya. 2005. “Global supply chain design: A literature
review and critique”, Transportation Research Part E: Logistics and Transportation
Review, 41(6): 531-550.


Montgomerie, Johnna, and Samuel Roscoe. 2012. “Owning the consumer: getting to the
core of the Apple Business Model”, CRESC Working Paper Series.


Morris, Michael, Minet Schindehutte, and Jeffrey Allen. 2005. “The entrepreneur’s business
model: toward a unified perspective”, Journal of Business Research, 58(6): 726-735.


Ndou, Valentina, Pasquale Vecchio, and Laura Schina. 2011. “Designing Digital
Marketplaces for Competitiveness of SMEs in Developing Countries’” the e-Business and
Telecommunications, pages 82-93.


Nenonen, Suvi and Kaj Storbacka. 2010. “Business model design: conceptualizing
networked value co-creation”, International Journal of Quality and Service Sciences, 2(1):
43-59.


Nidumolu, Ram , C.K. Prahalad, and M.R. Rangaswami. 2005. “Why sustainability is now the
key driver of innovation”, Harvard Business Review, 87(9): 56-64.




Supply chains and business models


166 Supply Chain Perspectives and Issues


Osterwalder, Alexander. 2004. “The business model ontology: a proposition in a design
science approach”, Dissertation, Universite de Lausanne. Lausanne, Switzerland.
(HEC 173)


Osterwalder, Alexander and Yves Pigneur. 2002. “An e-business model ontology for
modelling e-business.” 15th Bled Electronic Commerce Conference. Bled, Slovenia.


Reiskin, Edward D., Allen L. White, Jill Kauffman Johnson, and Thomas J. Votta. 2008.
“Servicising the chemical supply chain”, Journal of Industrial Ecology, 3(2-3): 19-31.


Tikkanen, Henrikki, Juha-Antti Lamberg, Petri Parvinen, and Juha-Pekka Kallunki. 2005.
“Managerial cognition, action and the business model of the firm”, Management Decision,
43(6): 789-809.


Timmers, Paul. 1998. “Business models for electronic markets.” Electronic Markets,
8(2): 3-8.


Vonderembse, Mark A., Mohit Uppal, Samuel H. Huang, and John P. Dismukes. 2006.
“Designing supply chains: Towards theory development”; International Journal of
Production Economics, 100(2): 223-238.


Zott, Christoph and Raphael Amit. 2010. “Business model design: an activity system
perspective”, Long Range Planning, 43(2): 216-226.




167Supply Chain Perspectives and Issues


Chapter 10
Supply chains and sustainability


Abstract


The concepts of “supply chains” and “sustainability” are highly compatible in their
shared recognition of a network-centric reality and the resulting interpretations of
system dynamics. Furthermore, the aggregate flows across global supply chains are
significant – and increasingly so – for considerations on social, environmental, and
economic sustainability. A plethora of theories have developed in this overlap between
supply chains and sustainability, including sustainable supply chain management
(SSCM), green supply chain management (GrSCM), and close-loop supply chains. These
theories and their basic definitions and history will be reviewed in this chapter. While
theoretical development has been distinguished in its intensity and productivity over
a short period of time, progress is still needed in translating theory into application for
the business practitioner. To this end, empirical case studies are needed to showcase
best practices and guide the development of prescriptive tools.


10.1 The rapid rise of sustainability


The topic of sustainability has expanded rapidly within the public arena since 1987,
when the UN-initiated Brundtland Commission published its landmark report entitled
“Our Common Future”. The 1990s saw many environmental and socially sustainability
issues rise to the forefront in cases such as global warming, child labour, and corporate
social responsibility.


The 2000s brought more corporate awareness and acceptance, with the adoption of an
economic sustainability dimension; that of profiting sustainably (Elkington 1998; Linton,
Klassen, and Kayaraman 2007; Nidumolu, Prahalad, and Rangaswami 2009). This public
awareness and recognition of the significance of sustainability has resulted in substantial
political momentum demanding the implementation of sustainability policies. For example,
Linton, Klassen, and Jayaraman (2007) point to legislation that was adopted worldwide
over a relatively short timeframe to phase out chemicals with ozone depleting potential.
Research, then, has a significant opportunity to contribute to the policy making process,




Supply chains and sustainability


168 Supply Chain Perspectives and Issues


and to business strategies on sustainability (Srivastava 2007; Halldorsson, Kotzab, and
Skjott-Larsen 2009).


As embodiments of global flows of goods, labour, capital, and information, supply chains
provide a powerful context for understanding sustainability. Both share an emphasis on
system dynamics, and the concept of an ultimate supply chain extending from raw inputs
to final outputs provides fertile grounds in which to test concepts of sustainability.


From a business perspective, the advancement of sustainable supply chain management
(SSCM) is particularly pressing, in light of the fact that current legal and political trends
will force many changes, regardless of whether academics or practitioners are prepared.
The Stern Review on the Economics of Climate Change (2006) attributed 40 per cent of
global greenhouse gas emissions to agriculture, industrial production and transport, and
Elkington (1998) anticipates that individual companies will be pushed to take increasing
responsibility over an extending network of partners (Halldorsson, Kotzab, and Skjott-
Larsen 2009).


The following section will review the field by first defining sustainability and its closely
associated concepts of corporate social responsibility (CSR) and the triple bottom
line. Following that, is a discussion of the theoretical frameworks that have been built
on top of these definitions, with a particular emphasis on SSCM. Finally, the empirical
work is reviewed by research methodology and industrial/geographical coverage before
concluding with opportunities for future research.


10.2 Key definitions and concepts


10.2.1 Defining sustainability


The most widely cited definition of “sustainability” in the literature comes from the
Brundtland Report, which states that: “Sustainable Development is development that meets
the needs of the present without compromising the ability of future generations to meet
their needs.” (WCED 1987; Carter and Rogers 2008). While this definition set the backdrop
for further discussions on sustainability and added a critical time dimension, its breadth
produced multiple interpretations. As a result, Halldorsson, Kotzab, and Skjott-Larsen
(2009) showed that there is no single understanding of sustainability, with interpretations
ranging from reverse logistics to strategic sustainability on a corporate level.


In addition, the plurality of interpretations and the broad starting definition make it difficult
to create operational tools and to clarify the practitioner’s role in the greater macro context
(Shrivastava 1995; Stead and Stead 1996; Linton, Klassen, and Jayaraman 2007; Carter and
Rogers 2008).


That said, a tremendous amount of attention has been directed towards the issue
of sustainability and supply chains in the quarter of a century since the Brundtland
Report, and there has been rapid progress in establishing an operationalisable theory of
sustainable supply chain management, particularly within this past decade.


The starting interpretation of sustainability in the research field until the 1990s was
effectively interchangeable with “environmentalism”. It was not until the popularisation of
corporate social responsibility (CSR) that the concept of social sustainability was widely
adopted (Carter and Easton 2011).




169Supply Chain Perspectives and Issues


The economic dimension of sustainability then became popularised with Elkington’s
triple bottom line (1998), and has since established sustainability as a three-dimensional
concept of environmental, social, and economic sustainability.


This has provided the foundation for the sustainable supply chain management (SSCM)
framework that was introduced in 2008 (Carter and Jennings 2008).


The following sections provide a more detailed review of the concepts of CSR and
the triple bottom line, before moving on to the review of theoretical works and the
SSCM framework.


10.2.2 Corporate social responsibility


Corporate social responsibility (CSR) broadly refers to the notion that companies must
uphold a social and ethical role in maintaining the well being of human beings and the
environment (Andersen and Skjoett-Larsen 2009; Halldorsson, Kotzab, and Skjott-Larsen
2009). Like sustainability, CSR also suffers from a broad definition that makes it difficult to
present a unified and operationally significant theory.


One possible reason is that CSR comments on the ideal relationship between business
and society – a philosophically contentious issue for which there is still debate today (Hill
et al. 2003; Andersen and Skjoett-Larsen 2009).


However, there is general consensus that CSR is increasingly relevant to the domain of
supply chains. Recognition of supply chain governance structures in the literature and
in the real world, such as the Nike “sweatshop” and Conoco Burmese oil production
scandals, have extended social and ethical obligations across a network of stakeholders.
Furthermore, firms that have power or control over partner firms may be held responsible
for their partners’ behaviour (Carter and Jennings 2002; Gereffi, Humphrey, and Sturgeon
2005; Andersen and Skjoett-Larsen 2009).


In order to create a more actionable theory of CSR for the supply chain practitioner, Carter
and Jennings proposed the concept of Logistics Social Responsibility (LSR) (later refined
to Purchasing Social Responsibility, or PSR). LSR and PSR specifically acknowledge these
new responsibilities of lead firms within the supply chain, and propose a framework for
practitioners to manage their partners (Carter and Jennings 2002, 2004). These would
serve, in conjunction with the triple bottom line, as precursors to the development of the
sustainable supply chain framework (SSCM), (Carter and Rogers 2008).


In light of the progress made in defining CSR theory and application, it is worth noting that
there is still a gap between the standards endorsed by firms and the standards actually
delivered by firms, a so called failure to “walk the talk” (Cramer 1996; Roberts 2003). This
would be an inherent weakness of CSR’s reliance on the supply chain practitioner’s sense
of obligation or responsibility, and would find a compelling response in the triple bottom
line which addresses the firm’s need to deliver profit.


10.2.3 The triple bottom line


The triple bottom line was popularised by Elkington (1998), and represents the most
popular conceptualisation of sustainability to date (Figure 10.1). The triple bottom
line expands upon earlier definitions of sustainability as environmental and/or social
sustainability by adding the economic criteria.




Supply chains and sustainability


170 Supply Chain Perspectives and Issues


Figure 10.1: The triple bottom line


Source: Carter and Rogers (2008)


Referring to the business concept of profit as the bottom line in determining success,
Elkington expands the definition of success for business to account for not only profits,
but also people and the planet. This forms the basis for Carter and Roger’s evolution of
the LSR and PSR concepts into a complete framework of SSCM (Carter and Jennings 2002,
2004; Carter and Rogers 2008).


10.3 The sustainable supply chain management framework


Much of the early work on sustainability and supply chains was pursued in a standalone
fashion, with issues such as diversity, the environment, safety and human rights being
pursued independently without considering potential interrelationships (Carter and
Easton 2011). The works of Murphy and Poist (2002), Carter and Jennings (2002, 2004)
and Carter and Rogers (2008) were significant in their attempts to build theory integrating
many of the dimensions explored within sustainability and supply chains.


Out of these efforts arose the concept of sustainable supply chain management (SSCM),
which will be reviewed with many of its parallel approaches in this section.


In their landmark paper, Carter and Rogers (2008) define SSCM as, “the strategic,
transparent integration and achievement of an organisation’s social, environmental,
and economic goals in the systemic coordination of key inter-organisational business
processes for improving the long-term economic performance of the individual company
and its supply chains.” The latter half of this statement is particularly salient, as it addresses
the supply chain manager’s question: “What is it that we need to do, not just to survive,
but to thrive, and not just for one year, three years, or five years from now, but for 10


Environmental
Performance


Sustainability


Economic
Performance


Social
Performance


Figure 10.1 The triple bottom line, as presented by Carter and Rogers (2008)




171Supply Chain Perspectives and Issues


years, 20 years, and beyond?” (Carter and Easton 2011). The SSCM framework (Figure
10.2) provides managers with a structured approach towards answering that question.


Figure 10.2: SSCM framework


Source: Carter and Rogers (2008)


In the SSCM framework, sustainability is evaluated by the dimensions of the triple bottom
line and achieved through four enablers:


● Strategy: sustainability considerations play a key role in formulating business strategy;
● Risk management: adoption of supply chain risk management considerations such as
contingency planning, supply disruptions and demand disruptions;
● Organisational culture: maintenance of high ethical standards and expectations
of sustainable behaviour towards the firm, society and the natural environment;
● Transparency: managing trust and communication with stakeholders through traceability
and visibility both upstream and downstream.


These four enablers and the triple bottom line provide a clear set of criteria that unify
many of the achievements from disparate fields, to provide managers with an operationally
relevant theory.


Among the approaches represented here are resource dependence theory, transaction
cost economics, population ecology, and the resource-based view of the firm. These
perspectives bring together cross-paradigm insights from the disciplines of sociology,
political science, economics, biology, and management (Carter and Jennings 2008).


In this overall literature review, there are already key achievements identified in the
sections on “business models and supply chains” (Chapter 9) and “risk management and
supply chains” (Chapter 5) that are ripe for integration into the SSCM framework.


Environmental
Performance


Strategy
• Sustainability as part
of an integrated
strategy


Organizational Culture
• Deeply Ingrained
• Organizational Citizenship
• Values and Ethics


Risk Management
• Contingency Planning
• Supply Disruptions
• Outbound Supply Chains


Transparency
• Stakeholder Engagement
• Supplier Operations


Sustainability


Economic
Performance


Social
Performance


Figure 10.2 The sustainable supply chain management (SSCM) framework (Carter and Rogers 2008)


Better Better


Good


Best




Supply chains and sustainability


172 Supply Chain Perspectives and Issues


10.4 Other frameworks


As discussed in the previous section, the conception of SSCM did not occur in isolation
within any one field, but rather integrated the advances of several approaches studying
sustainability from a systems perspective.


In this section, we will review some of these parallel research efforts, bearing in mind that
while these efforts may not be complete in themselves, they may contribute to theorising
and SSCM (Seuring 2004). The concepts to be reviewed are as follows: Reverse logistics,
reverse/closed-loop supply chains, product stewardship, green/environmental SCM,
industrial ecology, lifecycle management, integrated chain management.


Table 10.1 and 10.2 below list a few of these concepts by coverage of the supply chain.


Table 10.1: The coverage of sustainability concepts


Source: Halldorsson, Kotzab, and Skjott-Larsen (2009)


Table 10.2: Supply chain activities


Source: Seuring (2004)


Stage in supply chain: streams of SCM research Design Sourcing Production Distribution Consumption/Use Disposal


Reverse logistics


Triple bottom line


Product stewardship


Green SCM


Corporate social responsibility


Carbon footprint in supply chains


: Very limited if any consideration


: Comprehensively addressed


: Partially or only more recently considered


Concept Distinctive
feature


Actor network Material flows/
system boundaries


Time frame


Integrated chain
management


Stakeholder
integration


Companies involved
in and stakeholders
affected by material
flows


Material flows within
their societal and
legal boundaries


Societal and legal
systems (decades)


Industrial symbiosis Geographical
approach / regional
application


Companies involved
in an industrial
symbiosis


Material flows in a
regional network


Factory life cycle
(years to decades)


Life-cycle
management


Product design as
most important
decision phase


All production stages
involved in designing
and producing
products and services


Material flows that are
related to a product
life cycle


Product life cycle
(months to years)


Supply chain
management


Managerial activities
needed within the
actor network


All production stages
directly involved in
fulfilling customer
demands


Operational material
and information flows
to satisfy customer
needs


Supply chain
development (months
to years); delivery
cycle (hours to weeks)




173Supply Chain Perspectives and Issues


10.4.1 Reverse logistics


Reverse logistics can be thought of as studying processes which involve “reversing”
production – that is, in the study of processes such as recycling, repair and returns. The
following definitions are offered in the literature:


“The role of logistics in product returns, source reduction, recycling, materials
substitution, reuse of materials, waste disposal and refurbishing, repair, and
remanufacturing” (Stock 1998)


“The process of planning, implementing, and controlling the efficient, cost effective flow
of raw materials, in process inventory, finished goods, and related information from the
point of consumption to the point of origin for the purpose of recapturing value or proper
disposal” (Rogers and Tibben-Lembke 2001).


Most of the processes fall under post-consumption activities, aside from source reduction.
For a more in-depth review, please refer to Andersen and Skjoett-Larsen (2009), Rogers
and Tibben-Lembke (2001), and Carter and Ellram (1998).


10.4.2 Reverse/closed-loop supply chains


The concept of reverse supply chains/closed-loop supply chains is closely related to
reverse logistics. To start with the broader concept, close-loop supply chains refer to two
supply chains: a forward supply chain of production and a reverse supply chain of return
(Halldorsson, Kotzab, and Skjott-Larsen 2009). Emphasis is placed on the concept that
return management is a shared activity across the supply chain, and cannot be limited
to a single party. More in-depth coverage can be found in special issues of the California
Management Review (2004) and Interfaces (2003), (Andersen and Skjoett-Larsen 2009).


10.4.3 Product stewardship


Product stewardship scrutinizes the product development and production process for
opportunities to reduce a product’s ecological footprint. In doing so, “some manufacturers
can reduce costs, promote product and market innovation, and reduce the environmental
impact of their products.” (Halldorsson, Kotzab, and Skjott-Larsen 2009).


10.4.4 Green/environmental supply chain management


Green SCM and environmental SCM are terms referring to environmental and economic
concerns and are effectively interchangeable. For the sake of choosing one, we will use
green SCM (GrSCM).


Srivastava (2007) identifies GrSCM’s roots in the environment management and supply
chain management literature and defines the approach as “integrating environmental
thinking into supply-chain management, including product design, material sourcing and
selection, manufacturing processes, delivery of the final product to the consumers as well
as end-of-life management of the product after its useful life”. Seuring (2004) identifies
further definitions in Table 10.3.




Supply chains and sustainability


174 Supply Chain Perspectives and Issues


Table 10.3: Definitions of green or environment SCM surveyed in the literature


Source: Seuring (2004)


The literature on GrSCM is fairly extensive, and can be classified as reactive, proactive,
or value seeking, in a progression that goes from least committed to most committed.
“Reactive” literature covers green activities that require minimal commitment, such
as labelling recyclables. “Proactive” takes environmental considerations into account
throughout business operations, such as in undertaking green design or reducing
waste. “Value seeking” adopts not only GrSCM practices, but considers GrSCM
philosophy to be an integral part of the business strategy (Kopicki et al. 1993; van
Hoek 1999; Srivastava 2007).


In the classification by problem context, Srivastava (2007) segments the literature into the
categories exhibited in Figure 10.3.


Author(s) Green or environmental supply chain management (ESCM)
Beamon, 1999, p.337 ‘The fully integrated, extended supply chain contains all of the


elements of the traditional supply chain (Figure 1), but extends the
one-way chain to construct a semi-closed loop that includes product
and packaging recycling, re-use, and / or remanufacturing operations.’


Bowen et al., 2001, p.175 ‘The term ”green supply” indicates supply [chain] management
activities that are attempts to improve the environmental performance
of purchased inputs, or of the suppliers that provide them. Two main
types of green supply can be identified. The first is termed greening the
supply process, while the second is product-based green supply.’


Zsidisin and Siferd, 2001, p. 69 ‘Environmental supply chain management (ESCM) for an individual
firm is the set of supply chain management policies held, actions
taken, and relationships formed in response to concerns related
to the natural environment with regard to the design, acquisition,
production, distribution, use, reuse, and disposal of the firm’s goods
and services.’


Rao, 2002, p. 632 ‘The concepts pertaining to greening the supply chain or supply chain
environmental management (SCEM) are usually understood by industry
as screening suppliers for their environmental performance and
then doing business with only those that meet regulatory standards.
The driving forces for implementing the concept into the company
operations are many and comprise a range of “reactive regulatory
reasons to proactive strategic and competitive advantage reasons. ‘




175Supply Chain Perspectives and Issues


Figure 10.3: A framework of green supply chain management


Source: Srivastava (2007)


For a definitive review on GrSCM, refer to Srivastava (2009). Seuring (2004) also provides
a useful comparison of GrSCM to other sustainable supply chain approaches.


10.4.5 Industrial ecology


Industrial ecology studies industrial systems and processes from a biology-derived
ecological perspective. Industrial activities are considered as a part of a larger ecosystem,
and by-products at each step are considered for reuse as inputs elsewhere.


This systems perspective also provides a unique geographical/spatial dimension, and can
be applied to understanding sustainable development of local industrial parks or regional
industrial clusters. Given the natural sciences roots of the systems perspective, industrial
ecology has sometimes been referred to as the “science of sustainability” (Seuring 2004;
Linton, Klassen, and Jayaraman 2007).


Seuring (2004) finds the following definitions of industrial ecology, and notes that the
Frosch and Gallopoulos (1989) work is seen as the initial trigger for development of
the field.


Reverse Logistics
& Network Design


Green Supply Chain Management


Importance of GrSCM Green Design Green Operations


LCA ECD


Green Manufacturing
& Remanufacturing


Waste
Management


Repair / Refurbish Disassembly


Disassembly Process PlanningDisassembly Leveling


Product/
Material


Recovery R
eu


se C
ol


le
ct


in
g


Pr
e-


pr
oc


es
si


ng


Lo
ca


tio
n


&
D


is
tr


ib
ut


io
n


(N
et


w
or


k
D


es
ig


n)


Remanufacturing


In
ve


nt
or


y
M


an
ag


em
en


t


Re
du


ci
ng


Pr
od


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ur


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is


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Figure 10.3 A framework of green supply chain management by Srivastava (2007)




Supply chains and sustainability


176 Supply Chain Perspectives and Issues


Table 10.4: Definitions of industrial ecology surveyed in the literature


Source: Seuring (2004)


10.4.6 Lifecycle management


Life cycle management (LCM) and its methodology of life cycle analysis (LCA) provide
business practitioners with a decision-making approach that demands achievement of
both environmental and economic criteria. Seuring (2004) identifies four main definitions
of LCM in the Table 10.5 below.


Author(s) Industrial ecology (IE)
Frosch and Gallopoulos, 1989, p. 95 ‘The traditional model of industrial activity - in which


individual manufacturing processes take in raw materials
and generate products to be sold, plus waste to be
disposed of - should be transformed into a more integrated
model: an industrial ecosystem. The industrial ecosystem
would function as an analogue of biological ecosystems.’


Graedel, 1994, p. 23 ‘Industrial Ecology (IE) is a new ensemble concept in which the
interactions between human activities and the environment
are systematically analysed. As applied to industry, IE seeks
to optimize the total industrial material cycle from virgin
material, to finished product, to ultimate disposal of waste.’


Ayres and Ayres, 1996, pp. 278-279 ‘Industrial Ecology is a neologism intended to call attention
to a biological analogy: The fact that an ecosystem tends to
recycle most essential nutrients, using only energy from the
sun to “drive” the system. [...] In a ‘perfect’ ecosystem the only
input is energy from the sun. All other materials are recycled
biologically, in the sense that each species’ waste products
are the “food” of another species. [...] The industrial analogy
of an ecosystem is an industrial park (or some larger region)
which captures and recycles all physical materials internally,
consuming only energy from outside the system, and
producing only non-material services for sale to consumers.’


Korhonen, 2000, p.19 ‘Industrial ecology has been understood as material flow
management concept for industrial companies. It will focus
on the physical material and energy flows that a company
uses from its natural environment as well as from its co-
operation partners. It will focus on the flows that a company
will produce as its waste and on emission outputs dumped
back to nature.’




177Supply Chain Perspectives and Issues


Table 10.5: Definitions of lifecycle management surveyed in the literature


Source: Seuring (2004)


LCA is largely based on an environmental analysis of the product life cycle, and targets the
product design phase for implementation of improvements, as 80 per cent of a product’s
environmental burden and cost are determined during this phase (Seuring 2004).


10.4.7 Integrated chain management


Integrated chain management builds off of LCA, but is distinct in its consideration of the
public policy perspective. This may not be surprising, given ICM’s origination from Dutch
and German government initiatives (Seuring 2004).


Author(s) Life-cycle management (LCM)
Linnamen et al., 1995, p. 121 ‘Life cycle management consists of three views: (1)


the management view - integrating environmental
issues into the decision making of the company; (2) the
engineering view - optimising the environmental impact
caused by the product during its life cycle; and (3) the
leadership view - creating a new organisational culture.’


Fava, 1997, p. 8 ‘Life cycle management is the linkage between life cycle
environmental criteria and an organisation’s strategies
and plans to achieve business benefits.’


Heiskanen, 2002, pp. 428, 429 ‘LCA-based ideas and tools can be viewed as emerging
institutional logics of their own. While LCA makes use of
many scientific models and principles, it is more a form
of accounting than an empirical, observational science.
Thus, the life cycle approach implies a kind of ‘social
planner’s view’ on environmental issues, rather than
the minimisation of a company’s direct environmental
liabilities.’


Hunkeler et al., 2003, p.19 ‘Life cycle management (LCM) is an integrated framework
of concepts and techniques to address environmental,
economic, technological and social aspects of products,
services and organizations. LCM, as any other management
pattern, is applied on a voluntary basis and can be adapted
to the specific needs and characteristics of individual
organisations.’




Supply chains and sustainability


178 Supply Chain Perspectives and Issues


Seuring (2004) lists some of the definitions of ICM produced by government and academia
in Table 10.6 below.


Table 10.6: Definitions of integrated chain management
surveyed in the literature


Source: Seuring (2004)


10.5 Empirical studies


While possibly due to a bias in search terms, much of the empirical literature identified
integrates with the theory building process for sustainable supply chain management.
Both case studies and surveys are found, with a geographical emphasis on the United
States and Europe. A wide range of industries are covered, with agribusiness and
manufacturing appearing most commonly. Table 10.7, below, provides a brief survey of
the identified articles.


Author(s) Integrated chain management (ICM)
Enquete Kommission, 1994, p. 549 ‘Integrated Chain Management (Stoffstrommanagement) is


the management of material flows by stakeholders [to be]
the goal-orientated, responsible, integrated, and efficient
manipulation of material flows. Set targets derive from the
ecological and economic realm. under consideration of
social aspects. Goals are set on the level of the single firm,
within the supply chain of actors, or on public policy level.’


Cramer, 1996, p. 36 ‘Integrated Chain Management (ICM) is the integrated
management of a supply chain in terms of the
environmentally, socially and economically responsible
management of the production, consumption, distribution
and ultimate disposal of a product.’


Wolters et al., 1997, pp. 121, 122 ‘Integrated Chain Management (ICM) is the incorporation
of sustainability considerations into supply chains and
related networks. Integrated Chain Management has two
main features. The first is the flows of materials which result
from economic activities. The second is the institutional
framework which shape the production and consumption
processes driving the material flows.
ICM considers the entire material cycle from cradle to grave
- in one sense it is the organisational implementation of
life cycle analysis (LCA). [Such life cycles or] product chains
involve institutional networks of companies, consumers,
professinals and other entities as well as material flows. ICM
has to address both dimensions to be successful.’


Boons, 1998, p.22, 2002, p. 496 ‘The framework for [integrated] product chain management,
and the improvement of the ecological performance of a
product, consists of three building blocks: (a) the product
chain as a network of actors; (b) the options available to reduce
the ecological impact of a product; and (c) assumptions about
the behaviour of actors in the product chain.’




179Supply Chain Perspectives and Issues


Table 10.7: Empirical studies sourced from the literature


10.6 Future directions


The development of sustainable supply chain concepts is impressive for both its variety
and theoretical utility . However, these still fall short of presenting prescriptive and easily
tangible value for the business practitioner.


SSCM provides a theoretical framework for practitioners to orient their thoughts and goes
as far as offering general guidelines or criteria for success. However, usefulness as a
heuristic engine to generate management tools is not yet there.
To that end, we see the need to focus next on the development of prescriptive tools to


Citation Year Type Industry Geography Subject


Andersen and
Skjoett-Larsen


2009 case study IKEA International CSR practices in global
supply chains


Carter and
Jennings


2002 survey food, textile and apparel,
print publishing,
chemicals, petroleum
and coal, rubber and
plastics, primary metals,
fabricated metal
products, industrial
machinery, electronics,
transportation
equipment, instruments
and related products


United States Theory building
for logistics social
responsibility


Carter and
Jennings


2004 survey consumer products
manufacturing


United States Theory building for
purchasing social
responsibility


Closs, Speier,
Meacham


2011 case study food, pharmaceuticals,
electronics, retail


International End-on-end value chains
and SSCM


Haynes et al. 2012 case study cocoa Costa Rica Value analysis of organic
and fair trade cocoa


Marsden, Banks,
and Bristow


2000 case study beef production Wales Food supply chains and
rural development


Murphy and
Poist


2002 survey manufacturing,
merchandising


United States Theory building for
socially responsible
logistics


Pagell and Wu 2009 case study cleaning products, forest
and wood products,
electronics, food service,
IT equipment, paper and
pulp, construction


United
States and
International


Theory building for SSCM


Seuring and
Müller


2008 survey n/a Germany Identification of core
issues facing SSCM


Walker and
Preuss


2008 case study public sector, health
sector


United Kingdom Sustainable development
through public sector
sourcing from SMEs


Zhu and Sarkis 2004 survey manufacturing China Correlation between
green SCM and firm
performance




Supply chains and sustainability


180 Supply Chain Perspectives and Issues


guide implementation of sustainability concepts for supply chain managers. Moreover,
empirical case studies on best practices would help create awareness of the real
outcomes in relation to the many theoretically posited benefits of sustainable supply
chain management.


10.7 References


Andersen, Mette and Tage Skjoett-Larsen. 2009. “Corporate social responsibility in global
supply chains”, Supply Chain Management: An International Journal, 14(2): 75-86.


Carter, Craig R. and Dale S. Rogers. 2008. “A framework of sustainable supply chain
management: moving toward new theory”, International Journal of Physical Distribution
and Logistics Management, 38(5): 360-387.


Carter, Craig R. and Lisa M. Ellram. 1998. “Reverse logistics: a review of the literature and
framework for future investigation”, Journal of Business Logistics, 19(1): 85-102.


Carter, Craig R. and Marianne M. Jennings. 2002. “Logistics social responsibility: an
integrative framework”, Journal of Business Logistics, 23(1): 145-180.


Carter, Craig R. and Marianne M. Jennings. 2004. “The role of purchasing in corporate
social responsibility: a structural equation analysis”, Journal of Business Logistics, 25(1):
145-186.


Carter, Craig R. and P. Liane Easton. 2011. “Sustainable supply chain management:
evolution and future directions”, International Journal of Physical Distribution and Logistics
Management, 41(1): 46-62.


Closs, David J., Cheri Speier, and Nathan Meacham. 2011. “Sustainability to support end-
to-end value chains: the role of supply chain management”, Journal of the Academy of
Marketing Science, 39(1): 101-116.


Elkington, John. 1998. Cannibals with Forks: The Triple Bottom Line of 21st-Century
Business. Stoney Creek, CT: New Society Publishers.


Frosch, Robert A. and Nicholas E. Gallopoulos. 1989. “Strategies for manufacturing”,
Scientific American, 261(3): 144-152.


Gereffi, Gary, John Humphrey, and Timothy Sturgeon. 2005. “The governance of global
value chains”, Review of International Political Economy, 12(1): 78-104.


Halldorssen, Arni, Herbert Kotzab, and Tage Skjott-Larsen. 2009. “Supply chain management
on the crossroad to sustainability: a blessing or a curse?” Logistics Research, 1(2): 83-94.


Haynes, Jessica, Frederick Cubbage, Evan Mercer, and Erin Sills. 2012. “The Search
for Value and Meaning in the Cocoa Supply Chain in Costa Rica”, Sustainability, 4(7):
1466-1487.


Hill, Ronald Paul, Debra Stephens, and Iain Smith. 2003. “Corporate social responsibility: an
examination of individual firm behavior”, Business and Society Review, 108(3): 339-364.


Kopicki, Ronald J., Leslie L. Legg, and Kenneth E. Novak. 1993. Reuse and Recycling:
Reverse Logistics Opportunities. Oak Brook, IL: Council of Logistics Management.


Linton, Jonathan D., Robert Klassen, and Vaidyanathan Jayaraman. 2007. “Sustainable
supply chains: an introduction”, Journal of Operations Management, 25(6): 1075-1082.




181Supply Chain Perspectives and Issues


Marsden, Terry, Jo Banks, and Gillian Bristow. 2000. “Food supply chain approaches:
exploring their role in rural development”, Sociologia Ruralis, 40(4): 424-438.


Murphy, Paul R. and Richard F. Poist. 2002. “Socially responsible logistics: an exploratory
study”, Transportation Journal, 41(4): 23-35.


Nidumolu, Ram, C.K. Prahalad, and M.R. Rangaswami. 2009. “Why sustainability is now the
key driver of innovation”, Harvard Business Review, 87(9): 56-64.


Pagell, Mark, and Zhaohui Wu. 2009. “Building a more complete theory of sustainable
supply chain management using case studies of 10 exemplars”, Journal of Supply Chain
Management, 45(2): 37-56.


Rogers, Dale S. and Ronald Tibben-Lembke. 2001. “An examination of reverse logistics
practices”, Journal of Business Logistics, 22(2): 129-148.


Seuring, Stefan. 2004. “Industrial ecology, life cycles, supply chains: differences and
interrelations”, Business Strategy and the Environment, 13(5): 306-319.


Seuring, Stefan, and Martin Müller. 2008. “From a literature review to a conceptual
framework for sustainable supply chain management”, Journal of cleaner production,
16(15): 1699-1710.


Shrivastava, Paul. 1995. “The role of corporations in achieving ecological
sustainability”, Academy of Management Review, 20(4): 936-960.


Srivastava, Samir K. 2007. “Green supply-chain management: a state-of-the-art literature
review”, International Journal of Management Reviews, 9(1): 53-80.


Stead, W. and J. Stead. 1996. Management for a Small Planet: Strategic Decision Making and
the Environment, 2nd edition. Sage Publication: Thousand Oaks, CA.


Stock, James R. 1998. Development and Implementation of Reverse Logistics Programs.
Oak Brook, IL: Council of Logistics Management.


Van Hoek, Remko I. 1999. “From reversed logistics to green supply chains”, Supply Chain
Management: An International Journal, 4(3): 129-135.


Walker, Helen and Lutz Preuss. 2008. “Fostering sustainability through sourcing from small
businesses: public sector perspectives”, Journal of Cleaner Production 16(15): 1600-1609.


World Commission on Environment and Development. 1987. Our Common Future. Oxford
and New York: Oxford University Press.


Zhu, Qinghua, and Joseph Sarkis. 2004. “Relationships between operational practices
and performance among early adopters of green supply chain management practices in
Chinese manufacturing enterprises”, Journal of Operations Management, 22(3): 265-289.






183Supply Chain Perspectives and Issues


Abstract


Supply chains and trade policy are tightly linked to each other. Trade distorting effects
of tariff and non-tariff barriers (which are levied on the gross value of imported goods,
rather than value-added) are magnified in global supply chains; it takes many more
cross-border transactions to provide a single unit of a final good than before. Global
supply chains create new forms of cross-border spillover effects and have therefore
generated a demand for deep forms of integration, which could make production-
sharing activities less vulnerable to disruptions or restrictions. For instance, it is not
possible to disentangle merchandise trade from services trade, and standards may
need to be stipulated to make each stage of production compatible with the other.
At present, “deep” provisions in international trade agreements – covering the areas
of services, investment, competition policy and intellectual property, among others –
are largely found at the regional level. “Deep” RTAs, in turn, may stimulate the further
proliferation of global supply chains if they cover a sufficient number of economies and
do not introduce distortions with third countries. However, the wild and tangled growth
of RTAs and stringent rules of origin have created problems (“spaghetti bowl” trade). To
the extent that RTAs are consolidated and gradually multilateralised, they might prove
a useful step to achieving the first-best solution of multilateral trade liberalisation that
goes beyond tariff reduction. Examples can be found in the field of technical barriers to
trade, trade facilitation, the opening of markets for trade in services and the presence of
contingency measures within trade commitments. The multilateral trading system faces
the challenge of addressing the need for trade integration between countries while
preserving non-discrimination between regulatory regimes..


11.1 The evolution of supply chains and trade policy


Global supply chains have made the trade policies of different countries more interdependent,
thereby reducing the incentive for purely “domestic” control of competitiveness through
import-substitution. The efficiency of exporters is increasingly dependent on obtaining
imports of high-quality intermediate inputs from the lowest-cost source.


Chapter 11
Supply chains and trade policy




Supply chains and trade policy


184 Supply Chain Perspectives and Issues


Amiti and Konings (2005) argue that tariff liberalisation on intermediate products has been
shown to double the improvement in productivity of domestic plants compared to tariff
liberalisation on final goods. Hence, raising import costs by applying tariffs or non-tariff
barriers on intermediate goods can adversely affect a country’s competitive edge. This is
especially true for developing countries, which are generally located downstream in the
value chain, and hence have a relatively larger share of foreign value-added embedded
in their exports (Koopman et al. 2012). Debaere and Mostashari (2010), for instance, show
that the expansion of developing countries’ exports to the US in recent times is largely
explained by their own trade liberalisation – more so than by cuts in US import duties.


The building blocks of East Asia’s involvement in global supply chains were laid by an
export-promotion industrialisation strategy at a time when the industry relocation process
from Japan gained momentum. Many countries, particularly those in the Association of
Southeast Asian Nations (ASEAN), unilaterally cut their effective tariff rates in the form
of duty-drawback schemes and duty-free treatment for unskilled labour-intensive
enterprises in export processing zones (Baldwin 2006). Exempting exporting firms from
paying import duties on their inputs enhanced their cost advantage in the world market
(Engman et al. 2007).


During the 1980s and early 1990s, many of these countries switched from such special
treatments to lowering applied most favoured nation (MFN) tariff rates unilaterally
(Baldwin 2007). Tariff policies were seen as a critical component of competition between
economies in the region to induce foreign firms to locate production stages there. Through
this period, policy changes to attract FDI flows also took centre stage (Kimura 2006).


Exports of parts and components became increasingly important, rising from about 2 per
cent of ASEAN’s total exports in 1967 (the year of the association’s founding) to 17 per
cent in 1992 (the time when the free trade agreement was signed). The share of parts and
components in total intra-regional trade increased from 2 per cent to 18 per cent during
the same period (Ando and Kimura 2005; Kimura et al. 2007).


The post-World War II period has seen a progressive reduction in tariffs on
manufactured goods through successive rounds of multilateral negotiations, regional
agreements and unilateral liberalisation. This has certainly played a part in shaping
global supply chain trade.


For instance, consider the WTO’s Information Technology Agreement, which has removed
tariffs on key technology and telecommunications products, initially for 29 signatories
and now for 75 countries, covering 97 per cent of world trade in information technology
products (Baldwin 2006; Kimura and Obashi 2011). Global value chains, especially in Asia,
are found to be particularly strong in the industries covered by the agreement and their
expansion coincides with the agreement’s entry into force after the conclusion of the
Uruguay Round (Anderson and Mohs 2011).


Even a seemingly “small” tariff, however, can have a sizeable impact on costs when
production is globally fragmented. At the same time, non-tariff measures (NTMs),1 that
have become increasingly important trade policy instruments in recent years, also pose a
threat to the smooth functioning of global supply chains.


For instance, the effects of differentiating the use of tariff policy on intermediate and final
goods as well as implementing NTMs – such as non-automatic licensing – should not
be overlooked; they are important policy instruments for countries seeking to maximise




185Supply Chain Perspectives and Issues


domestic value-added. The consolidation of production networks in the future is therefore
likely to create demands for deeper integration between economies, which, at present,
appears to have acquired a largely regional (rather than multilateral) dimension.


11.2 Trade policy barriers and trade flows in GSCs:
a magnification effect


Global production fragmentation means that it takes many more cross-border transactions
to provide a single unit of a final good than before. And given that tariffs are levied on the
gross value of imported goods, rather than value-added, the cumulative cost of tariffs adds
up (Hanson et al. 2005; Yi 2010; Yi 2003).


Consider the global supply chain for producing a computer disk drive, as discussed in
Hiratsuka (2005) and Baldwin (2008). The disk drive is assembled in Thailand, which
acts as the hub of the supply network, using 43 components from 10 other countries in
addition to 11 components produced in Thailand. Hence, there are at least 10 moves across
international borders, and perhaps more, depending on the extent to which shipments
can be bundled. Furthermore, since the disk drive will be shipped to the location of final
computer assembly (such as China) where the other major computer components are
gathered, the number of cross-border moves multiplies even further.


In a global supply chain such as that which requires semi-finished goods to move back
and forth across international borders multiple times, the adverse effects of tariffs are
magnified. Koopman et al. (2012) show that taking into account the foreign value-added
content of exports significantly raises the extent of measured protection, especially in
emerging economies. For instance, they find that the effective tariff rate is 17 per cent
higher than the nominal rate in the United States, 71 per cent higher in Hong Kong and as
much as 116 per cent and 171 per cent higher in China and Mexico, respectively, due to
trade in intermediates.


The same holds true for non-tariff measures (NTMs). Consider transport and administrative
procedures, for instance. Moïsé et al. (2011) show that the simplification of customs and
port procedures results in a reduction of trade costs of up to 10 per cent. These costs are
magnified in global supply chains, where intermediate inputs cross borders multiple times.
In sum, the effect of a marginal increase in trade costs, owing to trade policy instruments,
such as tariffs and NTMs, is much larger than would be the case if there were a single-
stage production framework. Yi (2003) refers to this as the “magnification effect”.


In the case of non-tariff barriers, the cumulative price increase at each step would include
not only the monetary costs of moving along the supply chain, but the costs associated
with time barriers as well (Ferrantino 2012). Trade in parts and components is very time-
sensitive – the cost of an extra day is estimated to be 60 per cent higher for importers
of intermediate goods than for importers of final goods – because upstream firms may
have limited foresight of how much time will be needed for goods to cross the border
and comply with required procedures; “just-in-time” production is not feasible when
components travel through multiple countries.


Hence, uncertainty introduced by delays at border checkpoints, for example, force firms
to maintain larger inventories and incur an opportunity cost of delayed sales. Exporters
may also be subject to depreciation costs on immobilised goods. Hummels and Schaur
(2012) estimate that, per day of delay, these costs are equivalent to an ad-valorem tariff of




Supply chains and trade policy


186 Supply Chain Perspectives and Issues


between 0.6 per cent and 2.1 per cent. In fact, given that the effects of trade barriers are
compounded along GSCs, they can have a discontinuous effect on trade flows. Increased
levels of trade costs can lead to a “tipping point”, beyond which the operation of a modern
supply chain becomes infeasible (Yi 2003).


11.3 GSCs and the demand for deep integration


With the advent of global supply chains, it is not possible to disentangle merchandise trade
from services trade because the efficient provision of services plays an important role in
facilitating the international production of goods. This implies that domestic regulations
and foreign investment limitations, which act as a barrier to services trade, are also likely
to have a negative impact on merchandise trade (Deardorff 2001).


Logistics and related services are particularly important for the operation of global
supply chains. Most often, these services are facilitated by third-party logistics firms,
which provide coordinated services in supply-chain consulting, transport management,
freight transport services, trade finance, express delivery, wholesale trade and customs
brokerage (USITC 2005).


Hence, measures to liberalise market access in logistics services can substantially lower
the costs of operating supply chains. Global supply chains are associated with several
additional trade costs. These range from managerial costs associated with monitoring
and coordinating international production to learning about the laws and regulations that
are required to do business in another country. Such costs are likely to be especially high
for developing economies that may lack the kind of sophisticated business laws and the
product and labour regulations which rich countries use to consolidate their trade in
intermediate goods (Baldwin 2010).


Furthermore, when production networks are global, firms may set standards for their
input suppliers to ensure a level of quality, to make the input compatible with other stages
of the production process in order to produce a differentiated product, or to externalise
the management of risk. This is especially relevant for food supply chains where ensuring
the quality and safety of products is often paramount (Henson and Reardon, 2005). It has
led firms in the field to adopt product and production standards that have implications for
market access (Ponte and Gibbon 2005; Gereffi et al. 2005).


However, as supply chains span different regulatory environments, harmonisation or
mutual recognition of these standards assumes importance; greater uniformity will enable
producers of intermediate goods to participate in the supply chain in more locations
(Henson and Reardon 2005; Marucheck et al. 2011).


The above suggests that for supply chains to operate smoothly, particularly in the context
of “North-South” production sharing, certain national policies need to be harmonised
across jurisdictions (Lawrence 1996). Hence, the expansion of global supply chains has
generated a demand for deep forms of integration aimed at covering all dimensions
of market access and filling a governance gap between countries. International trade
agreements that include provisions related to trade in services, investment, competition
policy, intellectual property, the institutional framework and product market regulations
could make production sharing activities more secure and less vulnerable to disruptions
or restrictions (Yeats 2001).




187Supply Chain Perspectives and Issues


In a recent study, Antràs and Staiger (2008) show that the rise of global supply chains
creates new forms of cross-border spill over effects that go beyond the standard trade
policy externality (the terms-of-trade effect) and hence affect the demand for deep
integration. Specifically, when prices are set by bilateral bargaining because international
production involves exclusive contracts with input suppliers, input producers experience
rent-shifting (i.e. shifting profits from the input supplier to the domestic producer), while
downstream products experience the traditional terms-of-trade effects.


In this context, governments of input-exporting countries must therefore negotiate not only
lower tariffs on the imports of the input, but also tariff and other policies which affect the
final product. For example, suppose country A is seeking to export auto parts to country B.
Country A’s interest is no longer only to seek reductions in tariffs on auto parts, but also the
domestic regulations and standards in country B for the sale of completed automobiles.
Without such a commitment, country B may inefficiently tax or protect the final goods
market, knowing that part of the pain is suffered by auto parts manufacturers in country A.


Hence, with increased offshore outsourcing, deeper commitments that can address these
new cross-border effects are likely to become more important.


The foregoing discussion suggests that externalities associated with production offshoring
are different from those associated with traditional market access. In a global supply chain,
barriers between third-party countries upstream or downstream matter as much as the
barriers put in place by direct trade partners because the cost impact of any trade policy
measure is transmitted along the supply chain. Therefore, the more international the value
chain, the broader should be the number of partner countries in agreements, thereby
underscoring the importance of multilateral trade liberalisation.


Unfortunately, these concerns cannot be easily addressed with existing GATT/WTO rules,
such as non-discrimination and reciprocity, because they were designed for a world
in which international trade predominantly consisted of trade in final goods (Bagwell
and Staiger 2002). Moreover, “deep” economic integration covering issues beyond tariff
reduction might be easier to achieve within the context of RTAs with a more limited
number of partners than in a multilateral setting. Countries might therefore turn to available
instruments, such as PTAs, to solve their coordination problems.


11.4 The role of preferential trade agreements


11.4.1 GSCs have facilitated the proliferation of deep PTAs


Since global supply chains seek to minimise transactions costs, they often operate on a
regional basis, such as in East Asia for electronics or in North America for motor vehicles.
This had made preferential trade agreements (PTAs) an increasingly important component
of trade policy. The recent wave of such agreements with their deep integration provisions
in the area of services, investment and competition may, at least in part, be an institutional
response to the new problems associated with the growth in global supply chains.


PTAs, such as the North American Free Trade Agreement (NAFTA), not only increase
market access, through tariff reductions, but also include disciplines that reduce the risks
and increase the profitability of investment in Mexico. The recent accession of eastern
European economies to the European Union, as well as some of the euro-Mediterranean




Supply chains and trade policy


188 Supply Chain Perspectives and Issues


agreements, could be partly explained as a response to the demand for deep integration
agreements associated with expanding international production sharing.


The evolving nature of trade agreements in East Asia, where a significant and growing
share of international production sharing takes place, also highlights the link between
global supply chains and deep integration.


The increased regionalisation of trade in parts and components in the ASEAN countries
began before the negotiation of PTAs, with a market-led integration process, which saw a
reduction of tariff barriers and openness to foreign investment (UNESCAP 2011). But to
keep the momentum of supply chains going, countries in the region, starting in the late
1990s, began to expand their integration agenda by turning their attention to differences
in economic institutions and regulations – in areas such as product standards, intellectual
property rights, infrastructural services and investment protection – which could have
become a potential hindrance to production sharing.


In the ASEAN region, more recent North-South agreements, such as Japan’s economic
partnerships with Malaysia, Indonesia, Thailand and Vietnam, and ASEAN’s push for
deeper disciplines, clearly show that the region is moving towards deeper integration.
Pomfret and Sourdin (2009, 2010) find that ASEAN countries used their PTAs as vehicles
for concerted trade facilitation and that the driving force behind these policies was the
desire to increase the efficiency of global supply chains.


Cross-country empirical evidence also suggests that higher levels of trade in parts and
components, relative to total trade, increase the likelihood of signing deeper regional
trade agreements (World Trade Organization 2011). Orefice and Rocha (2011) show
that (after taking into account other PTAs determinants) a 10 per cent increase in the
share of production network trade over total trade increases the depth of an agreement
by approximately 6 percentage points. It is possible that the presence of international
fragmentation of production can alter political economy forces in favour of trade policy
measures that are less discriminatory.


11.4.2 Can deep PTAs facilitate the further growth of GSCs?


PTAs can stimulate the creation of global supply chains or facilitate the insertion of firms
into existing production networks by enabling trade among potential members. This
may be because “deep” provisions in PTAs ensure the predictability of the trade policy
environment, which could be crucial for trade in global supply chains (GSCs) that involve
long-term contractual relationships. It may also be attributable to the fact that “deep”
arrangements, such as the harmonisation of certain regulations, are a prerequisite for
trade in services.


The simultaneous reduction of trade costs in several neighbouring countries, through
regional reform initiatives that improve the efficiency of customs procedures, reduce
corruption and develop port infrastructure, can help bring supply chains to new parts
of the world, such as sub-Saharan Africa. Just as many regions are on the wrong side of
the “tipping point” and do not attract global supply chains at present; “deep” integration in
the area of trade facilitation is likely to have combined benefits that exceed those to each
individual country.




189Supply Chain Perspectives and Issues


The literature emphasises the role of EU enlargement in the increased fragmentation of
production across Europe (Altomonte and Rungi 2008). NAFTA is also described as an
agreement at the origin of some GSCs in North America. Using data for 200 countries
between 1980 and 2007 and defining the depth of an agreement in terms of coverage of
areas, Orefice and Rocha (2011) find that deep preferential trade agreements increase
bilateral trade in parts and components by 35 per cent among country members.2


A limitation of this index of “deep” integration is that it is gives the same weight to
each of the areas covered in a PTA, thereby assuming that the potential impact of each
provision on supply chains is of the same magnitude. The WTO (2011) uses an alternative
method – principal component analysis – that addresses this problem by generating
an index capturing the depth of an agreement. It shows that, on average, signing deep
agreements increases trade in production networks between member countries by almost
8 percentage points.


In another study, Johnson and Noguera (2012) show that regional trade agreements have
large effects on bilateral ratios of value-added exports to gross exports (VAX). For a typical
agreement, gross trade rises by about 30 per cent while value-added trade rises by 23
per cent, resulting in a drop in the VAX ratio of about 7 per cent. This is indicative of
greater interdependency between economies through trade in parts and components.
Furthermore, the authors find deep trade agreements are associated with larger declines
in VAX ratios than shallow agreements, i.e., they strengthen trade in global supply chains.


WTO (2011) also considers two other indices capturing the depth of an agreement in
the areas of competition policy and technical barriers to trade (TBTs). The choice of
provisions is determined by their importance in production sharing. The integration of TBT
measures, involving mutual recognition, harmonisation of standards and transparency,
makes international fragmentation of production easier by lowering the costs of testing
and product certification.


Competition policy allows multinational enterprises to take full advantage of cost
differences among countries when production is fragmented. The authors find that
including an additional provision in competition policy and TBTs will increase trade in
global supply chains by one and three percentage points, respectively. At the same time,
RTAs can inhibit the growth of global supply chains through strict rules of origin (RoO),
creating trade diversion that undermines the benefits from preferential market access
(Baldwin 2006). Krishna (2005) outlines three broad approaches for determining whether
products are eligible for preferential treatment. The “change in tariff” approach requires
the final product to have a different tariff heading than the input used3; the “value-added”
approach consists of a minimum domestic content requirement, while the third approach
requires that some specific production processes be undertaken in the local economy.


Such rules can be used as instruments of trade protection if they force firms to switch to
more costly suppliers of intermediate goods within the RTA, in preference to other lower
cost sources outside. While this distortion in the production structure may stimulate the
formation of regional supply chains, it separates firms from the broader global supply
chain and raises costs (Krueger 1999).


Higher production costs may also arise from the costs incurred to document, administer
and verify compliance (to the relevant authorities) for multiple rules of origin (RoO) and
agreements (Brenton and Manchin 2003; Brenton and Imagawa 2005).




Supply chains and trade policy


190 Supply Chain Perspectives and Issues


East Asia’s multiple RoO approach, embedded in the overlapping RTAs, for example,
created the “spaghetti bowl” effect (Kawai and Wignaraja 2011). Similarly, when firms
from EU countries started to relocate labour intensive stages of production in low-wage
neighbouring nations from the 1990s (in Central and Eastern Europe and in the Southern
Mediterranean), the European Union engaged in bilateral agreements with a number
of them. These agreements contained non- harmonised rules of origin, giving rise to a
spaghetti bowl effect that restricted firms’ ability to source intermediate goods from the
cheapest source (Gasiorek et al. 2009).


Global production fragmentation challenges the design of effective rules, as it becomes
difficult to clearly identify the origin of products that incorporate inputs from many
different countries within and outside the RTA. This highlights the need for designing less
restrictive, GSC-friendly RoO to limit their trade-distortive impact.


“Diagonal cumulation”, which means that inputs from anywhere in the region can be
used without undermining the origin status, is one way forward (Manchin and Pelkmans-
Balaoing 2007). “Full cumulation”, by implying that the processing activities carried out
in RTA participant countries are deemed to satisfy the content requirements regardless
of whether the activities are sufficient to confer originating status on the input materials
themselves, is likely to further facilitate increased product fragmentation (Estevadeordal
and Suominen 2004). Furthermore, overlapping RoO across multiple trade agreements
should also be harmonised. In East Asia, there has been some movement towards
establishing substantially simpler RoO. For instance, RoO provisions in the ASEAN FTA
with China and the Republic of Korea allows producers of a large range of products to
choose the change in tariff heading rather than the value-added content as the method
for determining origin status. The latter method is harder to comply with given the high
degree of production fragmentation in major manufacturing products traded within the
ASEAN region.


Similarly, the signing of the Pan-European Cumulation System (PECS) on rules of
origin in 1997 permitted diagonal cumulation, i.e., allowing EU final good producers
to source inputs from a wider set of countries without fear of losing origin status
(Baldwin et al. 2009).


11.5 Going forward: GSCs and the multilateral trading system


Global supply chains have created the demand for “deep” integration across economies.
“Deep” integration, in turn, can play a positive role in the reduction of trade costs and thus
enable firms to vertically specialise. At present, “deep” provisions in international trade
agreements are largely found at the regional level.


Regional trade agreements (RTAs) can certainly help in the proliferation of global supply
chains if they cover a sufficient number of economies and do not introduce distortions
with third countries. Guiding principles or even binding disciplines to harmonise and
simplify RoO in PTAs might be helpful in this context.


Furthermore, to the extent that RTAs are consolidated and gradually multilateralised,
they might prove a useful step to achieve the first-best solution of multilateral trade
liberalisation that goes beyond tariff reduction.




191Supply Chain Perspectives and Issues


The multilateral extension of certain “deep” provisions is already under way. Examples can
be found in the field of technical barriers to trade (TBTs), trade facilitation, the opening
of markets for trade in services and the presence of contingency measures within trade
commitments (Baldwin et al. 2009). In TBTs, global supply chains may help explain the
adoption of international standards, at least in parts and components, in industries
characterised by global sourcing.


The growing relevance of trade facilitation measures is reflected in the WTO’s “Aid-for-
Trade” initiative, which focuses on alleviating international supply chain bottlenecks,
such as infrastructure. Given a broad consensus, there is also the possibility of a WTO
agreement on trade facilitation being carved out of the Doha Development Agenda.


Concerning the opening of markets for trade in services, offshore outsourcing led firms to
require more access to efficient services inputs, which, in turn, encouraged governments
to put services trade opening on the multilateral trading system agenda (Hoekman and
Kostecki 2001). Given the importance of ensuring the affordability of key services, the
incentive for nations to apply international standards to improve the competitiveness of
their own exporters and to make their own services markets more attractive to foreign
investors is only likely to get stronger. Appropriate domestic regulatory reform is also
likely to be crucial in this regard.


Finally, global production fragmentation may create greater support for new multilateral
rules on contingency measures, such as safeguards, anti-dumping and countervailing
measures, in trade commitments. When firms engage in global supply chains, they prefer
measures discouraging the imposition of contingency measures in as many bilateral
trading relationships as possible, rather than in any single bilateral trade relationship.
This highlights the producer support for the spread of a common or similar set of rules
on the application of contingency measures (Baldwin et al. 2009). In sum, the institutional
challenge for the WTO is to find an approach that can facilitate the deeper integration that
countries are seeking, while upholding the core principle of non-discrimination at the
same time.


PTAs are promoting deep integration at the moment. But the multilateral trading system
needs to ensure coherence among divergent regulatory regimes, which, in practice, may
segment markets and raise trade costs. In order to achieve this, member countries need
to revisit current rules of the multilateral trading system, some of which may be outdated,
in light of the proliferation of GSCs. This may involve overcoming differences in national
interests, as some counties seek to preserve their domestic value addition, while others
attempt to move up the value chain.


Disciplining the use of tariff escalation policies, on the one hand, and export restrictions,
on the other, might represent one such area where the legitimate concerns of all WTO
members would need to be taken into account.


11.6 Endnotes


1. NTMs encompass a variety of trade impediments and regulations, including
administrative customs procedures, technical regulations, health or safety standards,
quantitative restrictions and subsidies.


2. The authors follow Yeats (1998) and Hummels et al. (2001) in using trade in parts and
components to proxy for global production sharing.




Supply chains and trade policy


192 Supply Chain Perspectives and Issues


3. This could be done at different levels of disaggregation, the most common being at the
Harmonized System 4-digit level.


11.7 References


Altomonte, C. and A. Rungi. 2008. “Changing Patterns of Economic Integration: Germany
and Italy in the Countries of EU Enlargement”, DYNREG Working Paper No. 24, Economic
and Social Research Institute.


Anderson, M. and J. Mohs. 2011. “The Information Technology Agreement: An Assessment
of World Trade in Information Technology Products”, Journal of International Commerce
and Economics, 3(1): 109-56.


Ando, M. and F. Kimura. 2005. “The Formation of International Production and Distribution
Networks in East Asia”, in Ito, T. and Rose, A. (eds), International Trade in East Asia, NBER-
East Asia Seminar on Economics, Volume 14, Chicago: University of Chicago Press.


Antràs, P. and R.W. Staiger. 2008. “Offshoring and the role of trade agreements”,
National Bureau of Economic Research (NBER) Working Paper Series, Working Paper
Number 14285.


Bagwell, K. and R.W. Staiger. 2002. The Economics of the World Trading System, Cambridge,
MA: MIT Press.


Baldwin, Richard. 2006. “Multilateralising Regionalism: Spaghetti Bowls as Building Blocs
on the Path to Global Free Trade”, The World Economy, 29(11): 1451-1518.


Baldwin, R., Simon Evenett and Patrick Low. 2009. “Beyond tariffs: Multilateralizing Non-
Tariff RTA commitments”, in Baldwin, Richard and Patrick Low (eds.), Multilateralizing
Regionalism: Challenges for the Global Trading System, Cambridge: Cambridge
University Press.


Baldwin, Richard. 2010. “21st Century Regionalism: Filling the Gap Between 21st Century
Trade and 20th Century Trade Rules”, CEPR Policy Insight No.56, Centre for Economic
Policy Research, London.


Baldwin, Richard. 2008. “Managing the Noodle Bowl: The Fragility of East Asian
Regionalism”, Singapore Economic Review, 53(3): 449-478.


Baldwin, Richard. 2007. “Managing the Noodle Bowl: The Fragility of East Asian
Regionalism”, Working Paper Series on Regional Economic Integration, No. 7, Manila:
Asian Development Bank.


Brenton, P. and H. Imagawa. 2005. “Rules of Origin, Trade and Customs”, in Customs
Modernization Handbook, L. de Wulf and J. Sokol (eds.), The World Bank, Washington D.C.


Brenton, P. and M. Manchin. 2003. “Making EU Trade Agreements Work: The Role of Rules
of Origin”, World Economy 26(5): 755-69.


Deardorff A. 2001. “International Provision of Trade Services, Trade, and Fragmentation”,
Review of International Economics, 9(2): 233–48.


Debaere, P. and S. Mostashari. 2010. “Do Tariffs For the Extensive Margin of International
Trade? An Empirical Analysis”, Journal of International Economics, 81(2): 163–169.


Engman, M., O. Onodera and E. Pinali. 2007. “Export Processing Zones: Past and Future
Role in Trade and Development”, OECD Trade Policy Working Papers 53, OECD Publishing.




193Supply Chain Perspectives and Issues


Estevadeordal, A. and K. Suominen. 2004. “Rules of Origin: A World Map and Trade Effects”,
in Cadot, O., Estevadeordal, A., Suwa-Eisenmann, A., and Verdier, T. (eds.), The Origin of
Goods: A Conceptual and Empirical Assessment of Rules of Origin in PTAs, Washington
DC: IADB and CEPR.


Ferrantino, M. J. 2012. “Using Supply Chain Analysis to Analyze the Costs of NTMs and the
Benefits of Trade Facilitation”, Geneva, World Trade Organization, Working Paper ERSD
2012-02.


Gasiorek, M., P. Augier, and C. Lai-Tong. 2009. “Multilateralising Regionalism: Lessons from
the EU Experience in Relaxing Rules of Origin”, in Baldwin, Richard and Patrick Low (eds.),
Multilateralizing Regionalism: Challenges for the Global Trading System, Cambridge:
Cambridge University Press.


Gereffi, Gary, John Humphrey, and Timothy Sturgeon. 2005. “The governance of global
value chains”, Review of International Political Economy, 12(1): 78-104.


Hanson, G. H., R. J. J. Mataloni and M.J. Slaughter. 2005. “Vertical Production Networks in
Multinational Firms”, Review of Economics and Statistics, 87(4): 664-678.


Henson, S. and T. Reardon. 2005. “Private Agri-Food Standards: Implications for Food
Policy and the Agri-Food System”, Food Policy, 30(3): 241-253.


Hiratsuka, D. 2005. “Vertical Intra-Regional Production Networks in East Asia: A Case Study
of Hard Disk Drive Industry”, Chiba City, Japan External Trade Organization, Institute of
Developing Economies Working Paper.


Hoekman, B. and M.M. Kostecki. 2001. The Political Economy of the World Trading System,
Oxford: Oxford University Press.


Hummels, D. and G. Schaur. 2012. “Time as a Trade Barrier”, NBER Working Paper No.
17758.


Johnson, Robert C. and Guillermo Noguera. 2012. “Fragmentation and Trade in Value-
added over Four Decades”, National Bureau of Economic Research Working Paper
Number 18186.


Kawai, M. and G. Wignaraja. 2011. Asia’s Free Trade Agreements: How is Business
Responding? Cheltenham (UK): Edward Elgar.


Kimura, F., Y. Takahashi and K. Hayakawa. 2007. “Fragmentation and Parts and Components
Trade: Comparison between East Asia and Europe”, The North American Journal of
Economics and Finance, 18(1): 23-40.


Kimura, F. 2006. “International Production and Distribution Networks in East Asia: 18 Facts,
Mechanics, and Policy Implication”, Asian Economic Policy Review, 1(2): 326-344.


Kimura, F. and A. Obashi. 2011. “Production Networks in East Asia: What We Know So Far”,
ADBI Working Paper Series, No. 320, Asian Development Bank Institute.


Koopman, R., W. Powers, Z. Wang and S.-J. Wei. 2012. “Give Credit Where Credit Is Due:
Tracing Value-added in Global Production Chains”, The American Economic Review,
forthcoming.


Krishna, K. 2005. “Understanding Rules of Origin”, NBER Working Paper No. 11150,
Cambridge, MA: NBER.




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Krueger, A. 1999. “Are Preferential Trade Arrangements Trade-Liberalizing or Protectionist?”
Journal of Economic Perspectives, 13(4): 105-124.


Lawrence, R. Z. 1996. Regionalism, Multilateralism and Deeper Integration, Washington DC:
Brookings Institution


Manchin, M. and A.O. Pelkmans-Balaoing. 2007. “Clothes without an Emperor: Analysis of
the Preferential Tariffs in ASEAN”, Development Working Papers Milan, Centro Studi Luca
d’Agliano, University of Milano Development Working Paper No. 3688.


Marucheck, A., N. Greis, C. Mena and L. Cai. 2011. “Product Safety and Security in the Global
Supply Chain: Issues, Challenges and Research Opportunities”, Journal of Operations
Management, 29(7-8): 707-720.


Moïsé E., T. Orliac and P. Minor. 2011. “Trade Facilitation Indicators: The Impact on Trade
Costs”, OECD Trade Policy Working Papers, No. 118, OECD Publishing.


Orefice, Gianluca and Nadia Rocha. 2011. “Deep Integration and Production Networks:
An Empirical Analysis”, Geneva, World Trade Organization, Working Paper ERSD 2011-11.


Pomfret, R. and P. Sourdin. 2009. “Have Asian Trade Agreements reduced Trade Costs?”,
Journal of Asian Economics, 20(3): 255-268.


Pomfret, R. and P. Sourdin. 2010. “Trade Facilitation and the Measurement of Trade Costs”,
Journal of International Commerce, Economics and Policy, 1(1): 145-163.


Ponte, S. and P. Gibbon. 2005. “Quality Standards, Conventions and the Governance of
Global Value Chains”, Economy and Society, 34(1): 1-31.


United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP).
2011. Fighting Irrelevance: The Role of Regional Trade Agreements in International
Production Networks in Asia. United Nations Economic and Social Commission for Asia
and the Pacific.


United States International Trade Commission. 2011. “The Economic Effects of Significant
U.S. Import Restraints. Seventh Update 2011. Special Topic: Global Supply Chains”,
Investigation No. 332-25, August.


World Trade Organization (WTO). 2011. World Trade Report 2011: The WTO and preferential
trade agreements: From co-existence to coherence, Geneva, WTO.


Yeats, A. 2001. “Just how Big is Global Production Sharing”, in Kierzkowski, H. and Arndt,
S. (eds.), Fragmentation: New production Patterns in the World Economy, Oxford: Oxford
University Press.


Yi, K.M. 2010. “Can Multistage Production Explain the Home Bias in Trade?”, The American
Economic Review, 100(1): 364-93.


Yi, K.M. 2003. “Can Vertical Specialization Explain the Growth of World Trade?”, Journal of
Political Economy, 111(1): 52-102.




195Supply Chain Perspectives and Issues


Chapter 12
Supply chains and trade finance


Abstract


The issue of finance is an integral one in the supply chain context, given that supply chains
embody flows of information, capital, goods, and labour. The concept of credit chains,
reviewed here, directly addresses this. The supply chain concept has traditionally tended
to emphasise the tangible/material dimensions of the chain. As a result, the financial di-
mension had been relatively neglected in the literature. This changed with the 2008-2009
global financial crisis. As both a potential aggravator and victim of the crisis, trade finance
and supply chains became the subject of a new and rapidly growing body of literature.
Previously, the subject had been largely addressed in the context of operations research
and economic development. We review findings from all research areas in the literature,
and observe significant merit in the credit chain concept of supply chain financial flows.
Migration of the concept to other areas of supply chain research could potentially ad-
dress financial dimensions of supply chains that are otherwise underemphasised in the
literature.


12.1 Definitions and concepts


12.1.1 Trade finance


Broadly defined, trade finance refers to “any financial arrangement connected to inter-firm
commercial transactions”. It is often used in the context of international trade, in which it
refers more specifically to “the funding of individual international commercial transactions
by financial intermediaries” (Ellingsen and Vlachose 2009; Bénassy-Quéré et al. 2009).
Trade finance is considered critical to lowering trade frictions, and 80 to 90 per cent of
trade transactions involve some form of trade finance, whether as trade credit, insurance,
or guarantees (Auboin 2009). The wide array of financial arrangements and instruments
can be divided according to purpose in either securing a trade transaction or in using a
transaction as collateral to access credit.




Supply chains and trade finance


196 Supply Chain Perspectives and Issues


Securing a trade transaction


When formalising a purchase order, the buyer and seller utilise a bank or another trade
finance entity as a third party in either serving as a basic financial intermediary or as a
guarantor of payment. The former refers to an “open account” setup, while the latter refers
to an arrangement involving “letters of credit” (L/Cs). In an open account arrangement,
the buyer is responsible for payment upon an agreed time after receipt of deliverables.
The time for payment typically ranges from zero to 180 days after arrival. In an L/C ar-
rangement, a bank or trade finance organisation will act as guarantor of payment, and
effectively serves to reduce the risk of non-payment from the buyer. The supplier receives
payment earlier, typically upon the presentation of shipping and insurance documents.
Insurance is also offered in securing the transaction. Letters of Guarantee serve to cap
potential losses in the case of non-performance from either party. Furthermore, credit
insurance can be purchased to protect against a variety of transportation, exchange rate,
and political risks (Hurtrez and Salvadori 2010; Auboin 2009).


Accessing credit using the transaction as collateral


In addition to serving as intermediaries, guarantors, and insurers of trade transactions,
trade finance companies also offer suppliers credit using a secured sales transaction as
collateral. Pre-shipment financing options issue credit based upon purchase orders or L/
Cs, and is used by the supplier to purchase production inputs or provide general liquidity.
Post-shipment financing uses the accounts receivables or the produced assets as collateral.


The purchase of a supplier’s accounts receivable by a bank or trade finance company
is known as factoring or forfeiting. Factoring tends to be used for short-term contracts
(less than 180 days), while forfeiting offers similar access to liquidity on a transaction-
specific basis for longer, medium-term contracts (180 days up to seven years). The pro-
duced asset, itself, can be used as collateral in a variety of financing strategies. One
example is trade-receivables-backed finance, where assets are securitised and rated on
the credit-worthiness of the buyer. This offers smaller, non-investment grade suppliers
a source of liquidity during the waiting period before payment (Hurtrez and Salvadori
2010; Auboin 2009).


These forms of trade financing are largely dominated by private banks, which make up 80
per cent of the trade finance market. However, other actors, such as export credit agen-
cies, regional development banks, multilateral financial institutions, suppliers, and buyers
also offer credit or insurance (Auboin 2007, 2009).


12.1.2 Trade credit


Trade credit is a subset of trade finance, and is offered by suppliers to their buyers in
the form of an option to delay payment after the receipt of goods. Trade credit is usually
extended through open account contracts that define the number of days during which
the supplier will wait for payment and/or extend trade credit. As such, trade credit is found
in the accounts receivable for suppliers and accounts payable for buyers.


Suppliers may still use the trade credit/account receivables as collateral for bank-issued
credit– albeit at a discount. This arrangement of using open account contracts and factor-
ing is often referred to as “supply chain” finance. (Hurtrez and Salvadori 2010)




197Supply Chain Perspectives and Issues


How common is trade credit?


Trade credit is well documented as an important source of short-term financing for firms
around the world. Surveys by the World Bank have revealed that firms typically finance
about 20 per cent of their working capital through trade credit, and Worldscope has found
that trade credit is more important than bank credit for short-term financing in 60 per cent
of its covered countries (Escaith and Gonguet 2009; Raddatz 2010).


In the United States, trade credit represented half of all corporate short-term liabilities in
2004 (Boissay 2006). SMEs frequently use trade credit as collateral for bank credit. In the
United States, approximately 25 per cent of all bank loans in 1998 were secured by ac-
counts receivable. In Italy, such credit lines represented 22 per cent of all bank loans and
54 per cent of all short-term loans in 2002 (Omiccioli 2005).


12.1.3 Credit chains


Supply chains embody flows of information, capital, goods and labour through firms
(Mentzer 2001). Kiyotaki and Moore (1997) presented landmark work modelling the credit
linkages found between firms in a supply chain, what they termed the credit chain. In their
work, they postulate that suppliers are forced to extend trade credit to buyers in order
to remain competitive, allowing the buyers to receive goods without payment for some
agreed amount of time. The supplier, already limited in funds, then seeks trade credit from
his or her suppliers.


Thus, in conceptual terms, firms in a supply chain can be seen as having a dual nature
as a lender to buyers and borrower from suppliers. The initial buyer’s demand for trade
credit triggers successive demands for trade credit upstream, resulting in the formation
of a “credit chain”(Kiyotaki and Moore 1997; Battiston et al. 2007). This phenomenon will
be explored in detail below.


How do credit chains come about?


There are a number of motivations for the use of trade credit; eight of which are sum-
marised here. First and foremost is the competitive pressure for a firm to offer attractive
purchasing terms to the buyer. This is particularly prevalent if the firm is in a position of
weak market power and the buyer is in a position of strong market power (Kiyotaki and
Moore 1997; Fabbri and Klapper 2008).


Second is to signal a supplier’s confidence in its product quality. By extending the pay-
ment period, suppliers are effectively letting buyers “try before they buy” the received as-
sets (Klapper, Laeven, and Rajan 2011; Lee and Stowe 1993; Long et al. 1993; Antras and
Foley 2011). A third possible reason is the establishment of trade credit as an industry
culture/norm between buyers and suppliers (Lee and Stowe 1993). Fourth is the use of
trade credit as a form of price discrimination that can signal favouritism to an important
buyer (Klapper, Laeven, and Rajan 2011; Wilner 2000; Fisman and Raturi 2004; Van Horen
2005; Giannetti, Burkart, and Ellingsen 2011).


Fifth, while offering credit inevitably involves risk, a supplier may actually be in a better
position to offer credit to a buyer due to leverage. In the case that the buyer does not pay,
the supplier may withhold the remaining delivery of supply. The supplier may also have
better knowledge of the buyer than a bank or other third party financier. Additionally,




Supply chains and trade finance


198 Supply Chain Perspectives and Issues


suppliers often offer riskier buyers discounts for early payment to limit the non-payment
risk (Kiyotaki and Moore 1997; Klapper, Laeven, and Rajan 2011; Smith 1987; Brennan et
al. 1988; Petersen and Rajan 1997; Biais and Gollier 1997; Burkart and Ellingsen 2004).
Sixth, even while a supplier may offer a buyer trade credit, that supplier may access bank
credit – albeit at a discount – using the accounts receivable trade credit as collateral
(Klapper, Laeven, and Rajan 2011; Battiston et al. 2007; Burkart and Ellingsen 2004).


Seventh, trade credit may be cheaper and/or more available than bank credit for buyers.
During periods of monetary tightening or financial crisis, trade credit has been shown to
act as a substitute for bank credit (Himmelberg et al. 1995; Choi and Kim; 2005; Love et al.
2007). In developing economies that have weak formal financing channels, trade credit
can serve as an informal source of financing (McMillan and Woodruff 1999; Johnson
McMillan and Woodruff 2004; Allen, Qian, and Qian 2005; Cull, Xu, and Zhu 2007). Indeed,
in the sample analysed by Fabbri and Klapper (2008), 20 per cent of firms surveyed
found trade credit to be cheaper than bank credit. Large, high quality suppliers may
have an advantage in obtaining outside finance, and could pass on this advantage to
smaller, credit constrained buyers (Klapper, Laeven, and Rajan 2011; Boissay and Gropp
2007). Or, large suppliers can act as liquidity providers, insuring buyers against liquidity
shocks (Cunat 2006).


Finally – and possibly most importantly for the formation of credit chains – firms that ex-
tend credit to buyers might demand it from suppliers. Also valid is the opposite situation;
when suppliers extend credit, buyers may extend credit as well to improve their competi-
tiveness. Fabbri and Kalpper (2008) found that access to bank financing and profitabil-
ity are not significantly correlated to trade credit supply. Rather, firms are more likely to
extend trade credit if they have received trade credit, with the aim of “matching maturity”
between payables and receivables. This suggests a correlation between the decision to
supply trade credit to buyers and demand trade credit from suppliers.


12.2 Research areas


The prevalence of trade finance and trade credit, and the ramifications of the concept of
credit chains, presents opportunities for research on their role in the international econo-
my. Among the literature surveyed, a number of primary areas of research emerged. The
most cited and most recent is the body of literature on trade finance, trade credit and
credit chains in the context of the 2008-2009 global financial crisis. While there was prior
research on the role of trade finance in financial crises – particularly after the 1997 Asian
financial crisis – this latest global crisis has produced an unprecedented level of interest.


The next area falls under operations research, and focuses on the modelling and optimisa-
tion of operations under varying trade credit conditions. This literature dates back to the
1960s, but has been rising in prevalence, in correlation to the rise of supply chains and
supply chain management.


Finally, a third body of literature is identified in the role of trade finance in developing
countries. Due to the unique benefits of credit chains and supply chains, trade finance
is perceived as an enabler of economic development by providing sources of informal
financing in a weak infrastructural setting.




199Supply Chain Perspectives and Issues


12.2.1 Trade finance and the financial crisis


The global trade collapse during the Great Recession of 2008-2009 caused significant
alarm in the international community for its magnitude, suddenness, and globally syn-
chronised nature. Global trade fell 30 per cent relative to GDP and at a faster pace than
seen during the Great Depression in the 1930s.


Trade fell in almost every OECD country, with half experiencing declines of greater than
20 per cent. The fourth quarter of 2008 saw a drop in exports of 18 per cent for Germany,
20 per cent for the United States, 25 per cent for France, and 32 per cent for China. Al-
together, the collapse in trade was unprecedented in post-World War II history (Eaton et
al. 2011; Cheung and Guichard 2009; Bénassy-Quéré et al. 2009; Haddad, Harrison, and
Hausman 2010; Gregory et al. 2010).


In response, the international research community hastened to understand the drivers of
the trade collapse, of which four have risen as probable causes: (1) a contraction in global
demand; (2) restricted access to trade finance; (3) amplification through supply chains/
credit chains; and (4) rising protectionism.


The role of demand contraction


There is general agreement that the contraction in global demand during the Great Reces-
sion caused the majority of the trade collapse (Cheung and Guichard 2009; Eaton et al.
2011; Escaith 2011; Haddad, Harrison, and Hausman). Eaton et al. (2011) finds that 80 per
cent of the drop in trade to GDP ratio can be explained by a drop in spending on manufac-
turers, particularly in durable goods.


However, there is a portion of the trade collapse, estimated to be between 10 to 20 per
cent, that is not attributable to demand-side contractions (Eaton et al. 2011; Cheung and
Guichard 2009). One of the most commonly cited causes for this is trade friction from the
restricted availability of trade finance.


The role of restricted trade finance


Trade finance plays a critical role in enabling trade and providing short-term financing
for firms. The importance of trade credit is even greater in developing countries, where
weaker financial infrastructure makes firms more reliant on trade credit of imports and
exports (Menichini 2009).


The Great Recession and its ensuing liquidity squeeze are estimated to have created a gap
in the availability of trade finance in the range of 25 to 500 billion US dollars (Chaffour and
Farole 2009). In light of this shortage and trade finance’s significance in enabling trade,
serious concerns were voiced that further restrictions could deepen and prolong the re-
cession (Chaffour and Farole 2009; Auboin 2009; Ellingsen and Vlachose 2009).


Chaffour and Farole (2009) discuss two types of trade finance market failures that can be
brought about by a financial crisis: supply shortages and overpricing. Supply shortages
are brought about by the deleveraging and risk-adjustment process that accompany a
financial crisis. The demand for liquidity means that trade credit lines, which typically
have terms of less than 180 days, are amongst the first credit lines cut. In addition,
collapse in inter-bank trust and hoarding of cash result in an increase in strategic




Supply chains and trade finance


200 Supply Chain Perspectives and Issues


defaults. Furthermore, those who typically offer trade finance may be temporarily unable
to calculate risk due to the international and opaque nature of the trade finance market.
Finally, the international nature of trade finance becomes a lower priority relative to
domestic financing, given the domestic political pressure and general national interests
that rise during times of crisis.


Overpricing of trade finance is also prone to occur during financial crises. First, the up-
ward price adjustment of credit products occurs faster than the relatively “sticky” price of
products in the real sector. This means firms depending on trade finance have little room
for passing on these higher costs. Secondly, Basel II regulations overprice trade finance,
due to their calculation of risk along geographic instead of performance measures. Lastly,
the process of market recalibration can result in trade finance overshooting equilibrium
prices temporarily.


There is abundant empirical evidence on the scarcity of affordable trade finance during
the crisis. World Bank surveys of banks, global buyers, and firms documented constrained
operations due to the lack of trade finance and the substantially higher costs of trade
finance compared to costs before the crisis.


Of the firms surveyed, SMEs and exporters in emerging markets were affected the most
(Malouche 2009). A joint survey by the Banker’s Association for Trade and Finance and
the IMF in 2009 similarly documented an increase in the price of trade finance and a drop
in trade finance flows to developed countries (IMF and BAFT 2009).


In addition, the historical performance of markets during crises show that trade finance
tends to be vulnerable, such as seen during the 1997 Asian financial crisis. However,
Chaffour and Farole (2009) found that trade volumes declined about four times faster
than trade finance volumes between October 2008 and January 2009. While the condition
of the trade finance market likely amplified the short-term trade response and certainly
poses barriers towards recovery, its contribution to the immediate trade collapse, itself,
should not be overemphasised.


The role of supply chains and credit chains


In addition to demand contraction and restricted trade finance, the trade collapse is
hypothesised to be driven by propagation of the crisis through the supply chain/credit
chain (Chaffour and Farole 2009; Cheung and Guichard 2009; Escaith and Gonguet 2009;
Bénassy-Quéré et al. 2009; Raddatz 2010; Escaith 2011; Menichini 2009). The rationale
for this mechanism is fairly straightforward. Firms tend to both extend and receive trade
credit, creating credit linkages that are often found in supply chains. In a credit chain with
little “slack” in liquidity, the failure of credit linkage can set off a cascade of failures across
the chain, resulting in a multiplier effect, one that might explain the scale and synchronic-
ity of the trade collapse.


Anecdotal evidence points to the relevance of this mechanism. Raddatz (2010) cites sev-
eral studies revealing non-payment by customers as a major cause of financial distress
and bankruptcy in US firms, and the tendency of firms to delay payment to their trade
creditors when faced with late payment from their own customers.


However, the ability to investigate this mechanism has been hampered by lack of data on
inter- and intra-firm trade credit activities (Cheung and Guichard 2009; Raddatz 2010). In-




201Supply Chain Perspectives and Issues


stead, attempts have been made using more aggregate level input-output data and general
equilibrium modelling.


Escaith and Gonguet (2009) combined concepts from international input-output analysis
and the monetary circuit to model interactions between the real and financial sectors in
a global value chain. When banks operate at the limits of their capital adequacy ratio and
when assets are priced to market, they find a statistically significant resonance effect that
amplifies signals between the real and monetary circuits.


Raddatz (2010) approached the challenge by examining if an increase in trade credit
linkages between two industries also increases their output correlation. Raddatz’s re-
gression analysis across 378 manufacturing industry pairs in 43 countries finds that
an increase in trade credit linkages between two industries significantly increases their
output correlation.


While these studies have done much to examine and test the existence of this hypoth-
esised trade credit multiplier transmission channel, its impact on the trade collapse has
been found to be relatively minor.


Bénassy-Quéré et al. (2009) directly assessed the significance of the chain multiplier effect
in the trade collapse through a multi-region, multi-sector CGE model, and found that the
double-digit drop in global trade during the fourth quarter of 2008 and the first quarter of
2009 was not significantly explained due to the disruptions of supply/credit chains. While
the multiplier effect’s insignificance in driving the magnitude of the trade collapse is now
general consensus, its role in the speed and global synchronicity is still subject to specu-
lation (Escaith 2011; Cheung and Guichard 2009).


The role of protectionism


The trade collapse also stoked fears of protectionism and its potential rise during the
crisis. The spread of trade liberalisation resulted in a situation where many countries were
well within the tariff boundaries set by the WTO, and had ample room to increase tariffs
if they so wished – particularly true for those who joined the WTO early on. The political
situation introduced significant worry that a demand for protectionism in order to protect
domestic markets could increase trade barriers with the onset of the 2008-2009 global
financial crisis (Gregory et al. 2010),


These fears, however, never became reality, as the trade restrictions that did arise covered
a very small share of global trade, and further restrictions did not arise. As Escaith (2011)
summarised, “seen from the mid-2011, the 2008-2009 trade collapse looks like a standard
– yet outsized – effect of a fall in the demand for durable goods and postponed purchases
of intermediates drawing down inventories. Eventually, supply-side disruptions –caused
by a shortage of trade finance, the interruption and breaking-down of international supply
chains, and the increase in tariff and non-tariff trade barriers– played a minor role.”


12.2.2 Trade finance and operations research


A second area where supply chains and trade finance overlap is within the field of opera-
tions research; more specifically, on the subject of inventory management. Harris (1913)
presented foundational work on his economic order quantity (EOQ) formulae. These EOQ




Supply chains and trade finance


202 Supply Chain Perspectives and Issues


models provided business managers with a means for determining optimal inventory
practices, such as optimal pricing and inventory cycle times.


In the century since, Harris’ basic EOQ model has been expanded to cover a plethora
of new scenarios. These efforts have factored in multiple suppliers/buyers, multiple
warehouses, product depreciation, economic inflation, shortages, and varying demand
patterns, amongst many others (Huang and Hsu 2008). There have also been attempts
to modify traditional EOQ methodology to simplify the mathematics involved and ease
operational implementation (Cárdenas-Barrón 2007) or to swap out cost minimisation
motives for discounted cash flow (Chen and Chuang 1999).


The first of these efforts to adapt the EOQ model to factor in supply chains and trade
finance was the seminal work of Goyal (1985). Goyal’s model consisted of a single supplier
and a single buyer, and accounted for trade credit in the form of a permissible delay in
payments. This model has been used as a foundation to expand into accounting for various
other factors, including a trade credit strategy that also incorporates discounting for early
payment, batch shipping strategies, multiple warehouses, and product deterioration.


As successive research efforts have sought to build on previous results, these models
have advanced in both context specificity and complexity. At the same time, complexity
has been, on occasion, reduced through efforts to simplify the mathematics involved for
potential end-users managing firm operations. A selection of the advances made in these
models is presented in Table 12.1. This is by no means comprehensive, but serves to
indicate the general expansion seen in EOQ modelling over recent decades.


Table 12.1: A sample of the extension of EOQ models over time


This particular body of literature is notable for its immediate prescriptive use by the
business manager. The research findings here tend to translate directly into business
practice, and can inform optimal pricing, ordering, and shipment policies. The results do
indicate trade credit as enabling cost savings and thus an increase in profits for both
buyers and suppliers, although post-earnings redistribution of profits may be required
(Ho, Ouyang, and Su 2008; Sarmah, Acharya, and Goyal 2008; Sarmah, Acharya, and
Goyal 2007). In addition, trade credit can potentially act as a mechanism for demand


Study Scenario


Goyal (1976) establishes single supplier, single buyer, single item inventory model for
optimal ordering quantity


Goyal (1985) incorporates trade credit as a permissible delay in payment


Banerjee (1986) incorporates batch shipping strategy


Aggarwal and Jaggi (1995) incorporates product deterioration and permissible delay


Jamal, Sarker, and Wang (1997) incorporates inventory shortages with product deterioration


Hwang and Shinn (1997) incorporates permissible delay in payment to find optimal pricing and
lot size for buyer


Sarker, Jamal, and Wang (2000) incorporates inflation with shortages, deterioration, and permissible
delay in payments


Ouyang et al. (2002) incorporates 2 component trade credit: (1) a permissible delay in
payment, (2) discount for early payment


Abad and Jaggi (2003) incorporates both trade credit and batch shipping strategy




203Supply Chain Perspectives and Issues


management, given the positive correlation between the trade credit period offered by the
supplier and order size from the buyer (Huang and Hsu 2008; Huang 2007).


12.2.3 Trade finance and development


Trade finance is perceived to play a key role in helping developing countries integrate
into the global economy. However, two barriers increase the cost of trade finance for
developing country firms relative to their developed country competitors. The first is the
underdeveloped financial infrastructure in developing countries. A World Bank (2005)
study found that banks surveyed in Africa lacked expertise and resources for managing
trade finance instruments. In addition, surveys across multiple African countries have
found that risk averse behaviour by banks and a lack of public trust in the effectiveness
of the banking sector further restricts trade finance. Instead, firms rely on trade credit,
international financing, or informal financing such as by friends and family (Malouche
2009; Auboin 2007; Bénassy-Quéré et al. 2009).


Auboin (2007) posits a second source of barriers in the growing technology gap that
contrasts the ease of access to trade finance between developed and developing
countries. E-banking capabilities have reduced transaction costs and increased access
to information associated with trade finance. Firms in developing countries that lack the
information infrastructure required to effectively integrate into global e-banking systems
find themselves at a competitive disadvantage. In other words, the gap in trade finance
capabilities not only exists, but is also growing due to technological advances. Banking
sectors face increasing minimum expectations in providing trade finance for entry into
the global economy.


Two solutions are found in the literature. The first is through multilateral financial
institutions, regional development banks, and export credit agencies. These parties
not only supplement the supply for trade finance to developing country firms, but also
provide technical assistance to improve banking sector capabilities. Malouche (2009)
finds that export credit agencies and development banks effectively buffered the effects
of the global financial crisis in developing countries. The second solution lies in the trade
credit extended by buyers in the supply chain. Bénassy-Quéré et al. (2009) find that sub-
Saharan textile subsidiaries relied more on trade credit from the parent company than on
financing from domestic banks. Trade credit has also been found to be more effective than
government financing, as was found in the ability of dairy processors to provide access
for small farmers across Central and Eastern Europe (Escaith and Gonguet 2009).


12.3 Future directions


Credit chains offer a compelling concept that has proved valuable in investigating the
financial crisis, modelling operations, and understanding development. However, little
concerted work has been seen in further developing a theory of credit chains since
Kiyotaki and Moore’s landmark work in 1997.


Significant utility is foreseen in integrating the concept with other aspects of supply chain
theory, such as those areas reviewed in previous chapters, in order to add the financial
dimension of supply chain realities to theoretical considerations. For example, we can
point to a specific opportunity for investigation in applying the EOQ models of trade credit




Supply chains and trade finance


204 Supply Chain Perspectives and Issues


conditions to scenarios representative of a financial crisis. In this manner, the operational
research work on trade credit can be utilised for stress testing and can contribute tools for
financial/credit chain risk management in the greater body of literature on supply chain
risk management.


12.4 References


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