2.7.1. Importance of Vertical and Horizontal Linkages to Foster Win-Win Relationships

Vertical Linkages to Foster Win-win Relationships

Effective vertical linkages between firms at different levels of the value chain play a key role in supporting the upgrading capacity of the chain. For example, firms in global value chains for fresh fruits and vegetables must be able to respond quickly to changing food safety and quality standards. Rapid response to changing market conditions requires on-going communication and cooperation both up and down the chain. When vertically linked firms are willing and able to share information on new products and technologies, then the value chain as a whole is more competitive because it can adapt more rapidly to changing market conditions.

Effective vertical relationships can contribute to value chain competitiveness in other ways, by creating conditions that support risk-taking and investment. Examples of this can be found in handicraft value chains, where it is common for lead firms to provide inputs to their artisan suppliers. This assures the lead firm of a quality product, even when quality inputs are not locally available. Such in-kind credit is an embedded service that helps artisans overcome cash flow constraints. Other examples of embedded services include training, technical assistance and credit for capital improvements. When agricultural producers have a secure, established relationship with their buyers, buyers may be willing to assist with long-term investments such as organic certification, irrigation equipment or post-harvest handling facilities. Such win-win interactions between firms benefit the entire value chain by improving productivity, product quality and reliability of supply.

On the other hand, if vertical relationships are characterized by mistrust, misinformation and opportunistic behavior, the entire value chain may struggle to remain competitive. Individual firms, by conducting their vertical relationships on the basis of an adversarial “win-lose” way of thinking, can create negative results for themselves as well as the rest of the firms in the value chain.

Armed with the advantage of knowing the market prices for cocoa, a middleman misinforms his smallholder suppliers as a negotiation tactic for gaining the greatest possible margins. Knowing from experience that the middleman is not always honest, smallholders add extra debris in the bag to compensate for likely misinformation. When the middleman goes to sell his cocoa to the lead exporter, he is identified as dishonest (for adding debris) and given the lowest grade price for his cocoa. The main exporter continues to be frustrated by the international market’s discounts on the low grade world price due to persistent quality problems.

While all the actors seek their own individual benefit, their collective actions drive down the competitiveness of the industry. The root of the problem is ineffective vertical relationships based on mistrust, misinformation and opportunistic behavior. The solution is for the exporter to provide the middleman with incentives to improve quality and for the middleman, in turn, to see the farmers as critical to his own success and to be willing to share market information that results in upgrading.

Horizontal Linkages to Foster Win-win Relationships

Through horizontal linkages, firms at the same level of the value chain interact to accomplish what a single firm working independently could not do so well. This interaction may come in the form of either cooperation or competition (or both). Effective horizontal relationships can promote efficiencies, reduce costs, open markets and spur beneficial competition. A producer association is a classic example of horizontal relationships designed to promote economies of scale, favorable market pricing, and other benefits for its members. Effective models of cooperation among micro- and small enterprises are needed in order for large numbers of these very small firms to be integrated into competitive value chains. Cooperation makes it possible for small-scale producers to reduce the costs of inputs and supporting services (e.g., training or transportation), while gaining access to new buyers and better prices through group marketing. By operating as a group, small-scale producers become more attractive commercial partners to larger firms, because the large firms’ transaction costs are lower than they would be in dealing with many small firms.

Farmers assist in selecting a representative from the community to act on their behalf with a large input firm. The farmers also agree to place cash orders with the selected representative. The representative waits until a sufficient quantity of orders have accumulated and then places a single order with the input firm. As a result of this cooperation, the farmers gain substantial cost savings on inputs and transaction cost savings by being able to place their orders and receive inputs in their village. Because the input firm benefits from this arrangement, it agrees to train the representative as an extension agent and provide him a small commission to cover his time and risk. This investment by the input firm increases farmers’ ongoing access to technical information and improves their upgrading opportunities.