1.3.7. Inter-firm Relationships - Overview
A distinguishing feature of the value chain approach is the attention that it gives to relationships between firms. Effective inter-firm relationships are considered an essential component in creating and maintaining value chain competitiveness. Even when other conditions are favorable—end market demand is strong, quality inputs are affordable, technologies are efficient, supporting markets function well, and so on—ineffective relationships can jeopardize the competitiveness of a value chain and its ability to generate economic growth, employment and incomes.
For larger firms at higher levels of the value chain, both cooperation and competition contribute to upgrading and competitiveness. For example, cooperation among exporters can help them to identify common needs and address those needs, through lobbying, branding or other joint activities. At the same time, healthy competition among exporters can foster innovation and promote upgrading. With each firm vying to offer the best quality, design, reliability or other competitive characteristic, the result will be increased efficiency and competitiveness at the industry level.
The value chain approach pays close attention to inter-firm relationships because they can make or break the success of a competitiveness strategy. Effective vertical and horizontal relationships promote upgrading, reduce costs and support greater responsiveness to changing markets. Weak inter-firm relationships, on the other hand, can hinder value chain competitiveness by strangling investment, creating technical and cost inefficiencies and limiting the breadth and depth of commercial relationships. Transformation of inter-firm relationships is a common objective in value chain projects designed to achieve the development goals of economic growth and income generation.
Click the image below to launch an interactive module on analyzing inter-firm relationships.
The criterion for evaluating inter-firm relationships is effectiveness. Effective relationships are defined as those that promote economic growth with poverty reduction through the integration of large numbers of micro- and small enterprises (MSEs) into increasingly competitive value chains. Effective relationships can be recognized as relationships that
- Move the value chain in the direction of greater competitiveness;
- Increase the number of MSEs that contribute to and benefit from the chain’s competitiveness; and/or
- Promote firm-level and chain-level upgrading.
Effective inter-firm relationships shift the value chain closer to competitiveness, greater integration of MSEs and/or upgrading. Ineffective relationships shift the value chain away from these goals or block project interventions that would contribute to the attainment of these goals. For more on types of relationships, click here.
Inter-firm relationships can be examined from an individual or systems perspective. An individual perspective focuses on the one-to-one relationship between two firms. This might be useful when analyzing the relationships of a pivotal firm, such as a country’s leading exporter or sole processing plant. The individual perspective is also useful for identifying leverage points in very visible relationships in order to create demonstration effects that influence other firms in the value chain to change their own practices.
A systems perspective on inter-firm relationships is concerned with an entire class of relationships in the value chain. For example, an analysis of the characteristics and conditions of relationships between supermarkets and small-scale farmers might reveal a pervasive lack of trust on both sides, with negative consequences for upgrading and the integration of small-scale farmers into these value chains. A systems perspective is necessary in order to create significant and sustainable changes in the effectiveness of an entire category of inter-firm relationships. This might require changing systemic conditions to create greater incentives for (or remove disincentives to) forming effective relationships. For example, helping agricultural input suppliers to establish networks of local agents can facilitate proactive marketing, information dissemination and education at the community level, leading to changed attitudes towards the purchase of inputs and related commercial services such as crop spraying.
The foundation of effective inter-firm relationships is the understanding that all firms can benefit at the same time—that “win-win” relationships are possible and desirable. This is in sharp contrast to the belief that firms are operating in a zero-sum game, in which one firm in the relationship can only win if the other firm loses. Such “win-lose” attitudes can be very common and are based on longstanding beliefs that certain groups are natural adversaries. An almost universal example is provided by traditional adversarial relationships between “middlemen” and small-scale producers, which can have negative effects on value chain competitiveness. However, recent experience has shown that even these relationships can be based on a shared interest in product upgrading, such as between Guatemalan weavers and local artisan-brokers, or between Pakistani embroiderers and mobile women sales agents.
If most firms in the value chain instinctively take an adversarial stance in their relationships with other firms, then this must be acknowledged and addressed. The identification of win-win situations in which all firms can benefit is a necessary first step in building effective inter-firm relationships. When firms lack shared objectives, or when they fail to recognize their shared objectives, then the foundation for effective inter-firm relationships is weak.
There are a number of distinctive frameworks that can be used to analyze and evaluate inter-firm relationships. These frameworks emphasize different characteristics of the relationships, although some characteristics are common across more than one framework. Three types of frameworks to analyze relationships are:
2) transaction cost framework; and
Each provides a useful perspective for analyzing the effectiveness of inter-firm relationships.
All interventions to foster supportive relationships must be designed and implemented with sustainability in mind. Generally this means facilitating the establishment or strengthening of relationships rather than becoming an intermediary or guarantor.
Look for small, riskable steps with rapid and visible benefits. Quick, easily-implemented activities that demonstrate value can provide a platform on which to further build relationships. For example, a lead firm may provide half-day trainings to supplier communities to address quality concerns, leading to less rejected produce and therefore reduced costs and increased income. Such activities can help to build trust and a common sense of purpose, and can contribute to the shift from adversarial to more supportive relationships.
Buy down risk to create transactions that lead to win-win relationships. Often new ways of relating between actors in a value chain carry substantial perceived risks. Concerns over commitment failure, free riding, theft, rent seeking or a loss of profits may limit the willingness of a value chain actor to engage with other actors. These risks are often more intense when developing commercial relationships with and between MSEs and smallholder farmers. The process of "buying down risk" (i.e., reducing risk through strategic use of subsidies) has to be based on an understanding of how win-win or supportive commercial relationships evolve. When facilitating the establishment of commercial relationship, the project cannot be seen as the primary contact for either party to the transaction. The project has to be the matchmaker or bridge--and this may require masking its supporting role from one party or the other as a means of maintaining the focus on the core relationship between the parties engaging in the transaction. Click here to read more on buying down risk.
Strengthen multiple types of inter-firm relationships. Strengthening supportive relationships 1) among MSEs and 2) between MSEs and input suppliers or service providers can serve to counter-balance adversarial relationships with buyers. Strengthened horizontal relationships may enable MSEs to bypass intermediaries, create economies of scale and/or increase market power. Supportive relationships between MSEs and input suppliers can incorporate the delivery of embedded services and can provide MSEs with access to other market actors, including new buyers. In addition, relationships between MSEs and multiple buyers can reduce risk.
Convince stakeholders that “win-lose” strategies will ultimately lead to “lose-lose” outcomes. This involves analyzing incentives, showing actors where they fit into the value chain as a whole and appealing to rational self-interest, recognizing that some actors may be deliberately pursuing win-lose strategies, looking for a quick profit and exit. There are, however, likely to be others with longer-term perspectives, whose rational self-interest can be used as a basis to challenge behavior. For example, in India, vegetable wholesalers are pursuing a price-based strategy, squeezing farmers’ margins. Both producers and buyers regularly renege on contracts: Wholesalers buy at the local market when produce is available; farmers sell to the local market when the price there is higher. USAID is helping wholesalers and retailers to see that by differentiating themselves in the market through other means (higher quality, more variety, etc.), they can offer fairer prices to farmers, thereby creating a greater incentive to honor contracts.
Make benefits explicit and transparent. The benefits of entering into relationships must be clear to—and contribute to their business objectives of—the firms involved to ensure their commitment. Transparent pricing and clearly stated fees, explicit contracts and codes of conduct are just some of the ways to foster the transparency of benefit flows. In societies that have a strong tradition of using socially based relationships to conduct business, it may be equally important to ensure that the limits of new commercial relationships are clear. In such relationships, social benefits—such as consumer credit, lobbying of government representatives or assistance with health or education needs—can not be assumed.
Establish common standards. Predetermined quality standards that are measurable help engender trust. This is aided by tools such as weights and measures, reputable testing facilities and third-party certification services. Chili pepper growers in Malawi believed that they were being constantly cheated by traders who discounted previously negotiated prices at the point of sale for reasons of quality. Advice concerning chili grades received by end market buyers, combined with the introduction of moisture meters and the practice of testing product at a local laboratory enabled growers to understand the value of their product and to negotiate with buyers from a position of strength.
Build on existing trust. Trust related to ethnic or kinship grouping may already exist, facilitating sales into regional rather than national markets. For example, Somali migrant and refugee communities, particularly in Nairobi, maintain strong market linkages with Somalia, serving both as a source of goods unavailable in Somalia and as a market for traditional Somali food products, such as camel milk. Trust may also be built around existing market mechanisms. A project in the Philippines working in the sweet palm fruit value chain found that rural semi-processors were unwilling to deal directly with urban-based processors because of cultural differences and a feeling of intimidation. Rather than trying to eliminate the community-based market intermediaries, as had originally been intended, the project instead strengthened their capacity.
Introduce trusted intermediaries into a value chain. Sometimes potential intermediaries are not already active in a value chain but can be brought in to strengthen weak linkages. Women garment embroiderers in rural Pakistan were unable to interact with male input providers or buyers because of cultural rules regarding gender segregation. Building the capacity of female sales agents to better understand market demand (materials and designs) and to manage and train home-bound embroiderers has proved an effective strategy to increasing the competitiveness of this industry.
Facilitate changes that make MSEs more attractive to buyers, input suppliers and service providers. By lowering transaction costs or increasing the quality and consistent delivery of products, MSEs can make themselves more attractive to buyers and suppliers and encourage investment in longer-term relationships. This in turn can increase MSEs’ confidence and help them to move beyond thinking in adversarial terms. Initiatives that increase MSEs’ value to buyers and suppliers include the development of associations, product improvement or branding, and facilitating alternative financing.
Introduce guarantees and risk-sharing mechanisms. A project in Zambia has assisted input providers to establish a contingency fund to cover defaults. The fund is financed through an application fee paid when inputs are provided on credit. Similarly, the Development Credit Authority guarantee in Ethiopia has enabled coffee unions to access credit. The unions proved their creditworthiness and the bank increased its lending to the unions even without increases in the guarantee. Donor-funded interventions can also provide a “safe” neutral space for actors to meet to resolve issues and exchange information—which can be an effective means of building trust.