2.6.1. Why Governance Matters

Why Governance Matters

Understanding how and when lead firms set, monitor and enforce rules and standards can help micro and small enterprises (MSEs) and other firms in the chain better integrate and coordinate their activities. Governance is particularly important for the generation, transfer, and diffusion of knowledge leading to innovation, which enables firms to improve their performance and sustain competitive advantage. Awareness of the governance structure of a value chain can provide governments, donors and development practitioners with information about how best to provide MSEs with the training and technical assistance needed to upgrade their position in the chain.

Governance helps to determine the following:

Acquisition of production capability

Lead firms can be very demanding about reducing costs, raising quality and increasing on-time performance. Yet, along with high standards, lead firms can also provide knowledge and support. MSEs learn by observing what their buyers are doing or in other cases, the lead firm will transmit best practices through embedded services or provide hands-on advice on how to improve production processes and producers’ skills. Knowing how a chain is governed helps donors and development practitioners understand how much assistance lead firms are likely to provide their suppliers and which upgrading activities they are most likely to support.

Brazil’s Sinos Valley leather shoe cluster illustrates how the various types of chain governance are characterized by different expectations and requirements of suppliers that in turn, affect suppliers’ potential to acquire production or knowledge-intensive skills. The U.S. and European buyers tightly coordinated their chain linkages through captive relationships with Brazilian suppliers, placing more emphasis on price, quality improvements and flexibility. However, in order to meet these demands, the buyers also facilitated product and process upgrading of the Brazilian suppliers' operations. In contrast, domestic and Latin American buyers maintained market-based governance with the suppliers. These less restrictive relationships enabled the shoemakers to acquire new functions in the chain such as design and marketing (functions that were not encouraged by the U.S. and European buyers), yet these buyers did not provide any support in developing the necessary skills to perform these new functions. [1] This case illustrates the power lead firms have in determining and/or facilitating suppliers’ acquisition of new capabilities.

Market access

Even as developed countries dismantle trade barriers, developing country producers do not necessarily gain access because chains are often governed by a limited number of powerful buyers. In order to participate in export manufacturing to developed countries, MSEs need to be on the radar of the lead firms of their chains because the lead firm frequently makes the decisions on where products will be produced and who will produce them. Producers need access to lead firms and can gain it only by learning how to communicate with the firms and produce to specification.

Distribution of Gains

The activities that reap the highest returns are usually found in intangible competences (R&D, design, branding) characterized by high barriers to entry that are frequently synonymous with holding the lead firm status in the chain. In contrast, developing country firms tend to engage in the tangible, production-related activities under terms set by the lead firm that have low entry barriers and thus low returns. It is important to know which activities in the chain bring in the most profitable returns and who engages in these value-adding segments. Understanding how a chain is governed provides MSEs and practitioners with valuable information on how to develop skills and with whom to develop relationships that would give them the flexibility and freedom to undertake additional functions in the chain, thus altering the current distribution of gains.

In the global tuna value chain, harvesting for the cannery business became extremely competitive in the late 1980s and early 1990s, when U.S. and Japanese lead firms decided to vertically disintegrate their operations due to the falling price of tuna. Rather than engage in the less profitable harvesting activities, the U.S. and Japanese multinationals and trading companies firmly held onto the highest value-adding segments—distribution and retailing—and formed tightly weaved, inter-firm production networks with their suppliers, rather than direct ownership. Consequently, when the Pacific Island countries (PICs) entered the value chain in harvesting activities, they ended up with much lower gains than they originally anticipated. Even though the United Nations Law of Sea allowed the PICs to exclusively claim their rights to the marine resources within their economic zones, their ensuing efforts to develop an export-oriented tuna industry faced serious obstacles when these countries found it difficult to enter the most profitable activities in the value chain, held by a handful of U.S. and Japanese lead firms. The PICs did not have access to the lead firms or their networks, which inhibited them from accessing final markets and from acquiring the know-how necessary to survive the rapidly changing, risky industry. This left them stuck in the most competitive, risky and least profitable part of the value chain. [2]

Leverage for policy initiatives

Given the power lead firms have to impose product and process parameters on their suppliers, they are also excellent leverage points for the business environment to use to exert influence on what happens in their supplier firms. Understanding chain governance and the power of lead firms can assist local and global, public and private, government and nongovernmental agencies and practitioners to advocate for better labor and environmental standards or a more equitable distribution of gains. Leverage is highest where the lead firms’ reputation is enhanced/damaged by the actions of their suppliers. For example, the UK government’s Ethical Trade Initiative (ETI) to promote and improve implementation of corporate codes of practice covering working conditions for temporary agricultural workers, who are often exploited and subject to abusive health and safety practices, stems from global chain governance research.

The wage struggles of the tomato farm workers in Florida exemplify the significance of lead firms’ leverage for change in the value chain. In order to enable the tomato pickers to earn an extra penny per pound, the Coalition of Immokalee Workers negotiated directly with the major recognizable consumer brands in the fast-food industry that are supplied by Florida’s fresh tomato farms, instead of confronting individual grower-shippers. Following years of negotiations, the agreement was signed in 2007 by McDonalds and by Yum! brands (including KFC, Pizza Hut and Taco Bell). This example shows how lead firms are important drivers for instigating change affecting all parties in the value chain. [3]

Footnotes

  1. ↑ Bazan, L. & Navas-Aleman, L. (2004). The underground revolution in the Sinos Valley: A comparison of upgrading in global and national value chains. In H. Schmitz (Ed.), Local enterprises in the global economy: Issues of governance and upgrading (pp. 110-139). UK: Edward Elgar Publishing Limited.
  2. ↑ Schurman, R. (1998). Tuna dreams: Resource nationalism and the Pacific Islands' tuna industry. Development and Change, 29, 107-136.
  3. ↑ Gereffi, G., Lee, J. & Christian, M. (2008). The Governance Structures of U.S.-Based Food and Agriculture Value Chains and their Relevance to Healthy Diets. Paper prepared for the Healthy Eating Research Program, Robert Wood Johnson Foundation.