2.8.1. Types of Upgrading

Introduction

The pursuit of upgrading provides many opportunities to firms that range from increased efficiency and output to access to new market channels and industry knowledge. The types of upgrading firms undertake are characterized under the following categories:

  • process upgrading
  • product upgrading
  • functional upgrading
  • channel upgrading
  • intersectoral upgrading

Process Upgrading

Process upgrading increases the efficiency of production either through better organization of the production process or the use of improved technology. The need to cut costs and/or increase output in response to intra- or inter-chain competition drives process upgrading, reducing the per-unit cost of production.

An example comes from Guatemala, where handicrafts weavers found their products were competing with cheaper alternatives from Asia, spurring a drive toward greater efficiency.[1] While some producers switched from using the traditional back strap loom to the foot loom in order to weave more and larger pieces of cloth per hour, others reduced the complexity and density of their designs so they could produce more pieces in less time. [2]

Product Upgrading

Product upgrading—improving product quality and increasing value for consumers—may be stimulated by changes in end markets, usually stemming from changes in customer preferences, or the desire for higher value added, higher quality, and consequently more profitable products on the part of MSEs. To remain competitive in rapidly changing markets, MSE producers must be able to upgrade their products on an ongoing basis in order to adapt to new trends and achieve higher standards.

The coffee industry provides an example of demand-driven product upgrading. Customers are increasingly aware of the origins of coffee and of the social and environmental issues associated with its production, and they are demanding specialty coffees that meet specific health, safety, environmental and social standards. In response, many coffee growers are realizing new market opportunities by upgrading their products to meet specifications such as international organic and fair trade certifications or lead firm-developed standards such as the Starbucks CAFE practices.[3]

Functional Upgrading

Functional upgrading is the entry of a firm into a new, higher value-added function or level in the value chain. There are two ways functional upgrading can occur: 1) an entire level of firms may be effectively eliminated, thus changing the structure of the chain and often improving the quality of information flowing to MSEs; or 2) a single MSE producer or group of producers can acquire or develop productive capacity in higher-value stages to capture more of the product’s value.

Mexico’s blue jeans industry functionally upgraded from a traditional maquiladora model to a full-package production model. In the maquila model, manufacturers assembled pre-cut denim supplied by U.S. end markets into blue jeans that were shipped back to the U.S buyers. In full package production, the manufacturers became responsible for final assembly of the blue jeans as well as the upstream logistics function and procurement of the necessary material inputs. The original investments large U.S. end market buyers made in Mexico provided vertical linkages that enabled local producers to acquire the knowledge and skills necessary to gain additional access to U.S. end markets. Upgrading opportunities were further enabled through policy created by the business enabling environment--through the NAFTA free trade agreement, U.S. lead firms had an incentive to invest in the development of Mexico’s textile industry to take the burden of manufacturing off themselves in order to focus their attention on their core competencies in design and marketing. [4] [5]

Channel Upgrading

Channel upgrading is when firms enter one or more new end markets in the same basic product—domestic, regional or global. Participation in a range of markets provides MSEs with more effective risk management options and the capacity to enter new channels. Channel upgrading is also a response to changing market conditions —as new markets open up, old ones may shut down, consumer preferences change, and prices fluctuate in existing markets. In some cases, MSEs seek out new channels for lower quality by-products that are not currently being sold, such as when avocado or almond producers sell low quality product to oil processors at a lower cost to earn additional income and reduce wastage of product that cannot compete in higher-value channels. Whereas this “down market” form of channel upgrading does not result in higher prices, it does ensure benefits for MSEs by allowing them to sell a higher proportion of their total output and providing more effective risk management through market diversification.[6]

Channel upgrading may also involve entry into new geographical markets. For example, olive oil processors in Albania are beginning to sell their oil into regional markets, particularly Croatia. They plan to use Croatia as a “stepping stone” to acquire the production capabilities to eventually sell into the larger, more demanding EU market once production is sufficient. Similarly, cocoa producers in Indonesia use channel upgrading to reduce the price risks associated with the export market by selling to in-country processors.

Intersectoral Upgrading

Intersectoral upgrading is the entry of a firm into a completely new value chain or industry using knowledge acquired through production of another product or a specialized service. Intersectoral upgrading typically requires multiple upgrading strategies to occur simultaneously or in sequence in order to enter the new industry successfully. Intersectoral upgrading is especially notable as it facilitates a firm’s acquisition of more skill, knowledge, or technology specific to the new product.

Intersectoral upgrading occurred when shea nut producers in Sudan moved from selling nuts in local markets, to exporting cosmetic-grade butter to a formulating and packing facility in Kenya. In Taiwan, competence in producing televisions was used to make monitors and then to upgrade into the computer sector.[7] [8]

Footnotes

  1. ↑ Bloom, David; Dunn, Elizabeth; Clark, Cari Jo; Church, Phillip; Evans, Shand; Huang, Yi-an; Atcha, Shehnaz; Salyer, Patrick (2007). Integrating Micro and Small Enterprises into Value Chains: Evidence from Guatemalan Horticulture and Handicrafts. Washington, D.C.: The Louis Berger Group and ACDI/VOCA
  2. ↑ Dunn, Elizabeth; Sebstad, Jennefer; Batzdorff, Lisa; Parsons, Holly (2006). Lessons Learned on MSE Upgrading in Value Chains. Washington, D.C.: ACDI/VOCA
  3. ↑ Ponte, S. (2008). Developing a 'vertical' dimension to chronic poverty research: Some lessons from global value chain analysis (Working Paper No. 11) Chronic Poverty Research Center
  4. ↑ Gereffi, G. (1999). International trade and industrial upgrading in the apparel commodity chain. Journal of International Economics, 48(1), 37-70
  5. ↑ Bair, J., & Gereffi, G. (2001). Local clusters in global chains: The causes and consequences of export dynamism in Torreon's blue jeans industry. World Development, 29(11), 1885-1903
  6. ↑ Dunn, Elizabeth; Sebstad, Jennefer; Batzdorff, Lisa; Parsons, Holly (2006). Lessons Learned on MSE Upgrading in Value Chains. Washington, D.C.: ACDI/VOCA.
  7. ↑ Guerrieri, P., & Pietrobelli, C. (2004). Industrial districts' evolution and technological regimes: Italy and Taiwan. Technovation, 24(11), 899-914
  8. ↑ Humphrey, J., & Schmitz, H. (2002). Developing country firms in the world economy: Governance and upgrading in global value chains (INEF Report No. 61). Duisburg: University of Duisburg