1.1. Overview of the Value Chain Approach

Introduction

USAID/E3 applies the value chain approach to drive economic growth with poverty reduction through the integration of large numbers of micro- and small enterprises (MSEs) into increasingly competitive value chains. By influencing the structures, systems and relationships that define the value chain, USAID helps MSEs to improve (or upgrade) their products and processes, and thereby contribute to and benefit from the chain’s competitiveness. Through this approach USAID enables MSEs—including small-scale farmers—to create wealth and escape poverty.

The value chain approach has distinctive features in terms of both i) the scope used in analyzing an industry and ii) the tangible and non-tangible considerations used in designing and implementing interventions. The features discussed here are not necessarily unique to the value chain approach; but few, if any, other economic development approaches simultaneously emphasize all of these features:

• A market system perspective
• A focus on end markets
• Understanding the role of value chain governance
• Recognition of the importance of relationships
• Facilitating changes in firm behavior
• Transforming relationships
• Targeting leverage points
• Empowering the private sector

Value chains are situated within broader economic systems. For a model that expresses the context for value chains, see the inclusive market systems framework here.

Why Use the Value Chain Approach?

Globalization of markets ties the sustainability of firms to the competitiveness of the industries in which they participate. Firms within an industry in a country or region must increasingly compete—even in local markets—with firms and industries from across the globe. To succeed in global markets, entire industries (or value chains) must be able to deliver a product to the consumer more efficiently, with a higher quality and/or in a more unique form than the value chains in competing countries. In this way, competitiveness at the firm and industry levels are interdependent. Increasing the competitiveness of the firm is only effective at sustainably creating wealth and alleviating poverty when the competitiveness of the industry is similarly raised by interventions at all levels of the value chain.

What is the Value Chain Approach?

The value chain approach is one of several market systems approaches to development. In recent years this type of methodology has seen a surge in popularity among a variety of donors in a diversity of contexts. While they differ in their terminology, frameworks, principles and even definitions of a system, what these types of approaches have in common is the foundational belief that the poor and their economic opportunities are profoundly influenced by the dynamic systems in which they participate. By influencing how those systems perform, we can improve opportunities and outcomes for the poor. The value chain approach seeks to understand the firms that operate within an industry—from input suppliers to end market buyers; the support markets that provide technical, business and financial services to the industry; and the business environment in which the industry operates. Such a broad scope for industry analysis is needed because the principal constraints to competitiveness may lie within any part of this market system or the environment in which it operates. While it may be beyond the capacity or mandate of a donor or implementing agency to address certain constraints, the failure to recognize and incorporate the implications of the full range of constraints will generally lead to limited, short-term impact or even counter-productive results.

The end markets into which a product or service is sold—whether local, regional or international—provide the opportunities and set the parameters for economic growth. Generally there are multiple actual and potential end markets, each with different demand characteristics and returns. It is therefore important to segment the market: outline each of the potential end markets, what is required to compete in them, and what benefits and risks can be expected by selling into them. Since end markets are dynamic, the identification of trends should complement information about the current situation.

Understanding the role of value chain governance is fundamental to the value chain approach. Governance describes which firms within a value chain set and enforce the parameters under which others in the chain operate. Embedded in governance are inter-firm relationships, power dynamics—both symmetrical and asymmetrical—and the distribution of benefits. While the form of value chain governance is influenced by the characteristics of the product and the degree of specification in the end market, governance patterns evolve over time with changes in markets, products and inter-firm relationships.

The quality of relationships between different stakeholders is a key factor affecting the functioning of a value chain. Strong, mutually beneficial relationships between firms facilitate the transfer of information, skills and services—all of which are essential to upgrading. Value chain opportunities and constraints generally require a coordinated response by multiple firms in the chain—which necessitates trust and a willingness to collaborate. The value chain approach therefore emphasizes a dynamic that has long been recognized: Social capital (networks of relationships and social institutions) are critical to business and competitiveness. In contrast to much enterprise development work in the past, the value chain approach seeks to do more than solve specific identified production and marketing problems. Directly solving problems may create some initial momentum, but building internal capacity to address value chain constraints will empower stakeholders, reduce dependency and ensure sustainability of investment impacts. The focus of the value chain approach is therefore on transforming relationships—particularly between firms linked vertically in the value chain to: i)facilitate upgrading to become more competitive, and ii)adapt to changes in end markets, in the enabling environment or within the chain to remain competitive. Value chain actors make upgrading decisions based on a variety of financial and non-financial incentives. In order to be able to influence the uptake of new market behaviors, the value chain approach seeks to understand the business and cultural norms, risk tolerance levels, environmental factors and other such non-financial determinants.

For more on key features of the value chain approach, please click here.

How is the Value Chain Approach Implemented?

In addition to the features of the approach described above, the following implementation principles can be used to design and implement successful value chain development programs:

• Facilitating changes in firm behavior.The value chain approach seeks to facilitate changes in firm behavior that increase the competitiveness of the chain and generate wealth for all participating firms, thereby contributing to inclusive economic growth. Changing firm behavior requires an understanding of the financial and non-financial incentives of the various stakeholders—why they behave in the way they do, and what is needed to motivate them to change their behavior. Implementers of the value chain approach identify firms within the industry with the incentives, ability and willingness to address constraints and facilitate upgrading throughout the chain.

• Transforming relationships. By making the benefits of win-win relationships explicit to stakeholders, some firms can be encouraged to change the way they relate to others. However, sometimes conflicting incentives and high levels of mistrust diminish the effectiveness of such simple appeals to self-interest.

• Targeting leverage points. Value chain project implementers target points of leverage that have a multiplier effect on interventions in order to maximize impact and outreach. Points of leverage include economic and social structures, commercial incentives and social norms and incentives.

• Empowering the private sector. The goal of the value chain approach is to enable private-sector stakeholders to act on their own behalf: to upgrade their firms and collectively create a competitive value chain that contributes to economic growth with poverty reduction. The value chain analysis and strategy development process is therefore participatory to the extent possible. The role of the donor and implementing partner is to facilitate and support implementation of the competitiveness strategy by the private sector in such a way that ensures that development objectives—economic growth, poverty reduction and other concerns such as sustainable natural resource management—are also met.

• Learning and Adaptive Management . Inherent in this approach is the challenge of working in markets that are dynamic and trying influence behavior that is unpredictable. Achieving successful outcomes in such a context requires continual learning and adaptation to know what is working and under what conditions.

For information on implementing the value chain approach, please click here.

For information on projects using a value chain or market systems development approach, please click here for a report.

How Applicable are the Principles of the Value Chain Approach?

The value chain approach is comprehensive, with an extensive set of tools and best practices. This approach is not appropriate for every development project or in all country contexts. Prerequisites for taking a value chain approach include a minimum level of good governance and stability in the enabling environment, the existence of at least some market activity (even with low-value products or exclusively local markets), and a project goal of economic recovery, growth or poverty reduction.

Nevertheless, there are important aspects of the value chain approach that can be applied to any private sector development project, as well as to other kinds of projects, including those focusing on post-conflict livelihoods and private sector-driven environment or health projects. In particular, these aspects include the need for a thorough understanding of end-market dynamics and consideration of the business enabling environment. Without analysis of these two aspects of the value chain framework, project impact is likely to be limited and unsustainable.