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2.6.2. Types of Value Chain Governance

Types of Value Chain Governance

The connections between industry activities within a chain can be described along a continuum extending from the market, characterized by "arm’s-length" relationships, to hierarchical value chains illustrated through direct ownership of production processes. Between these two extremes are three network-style modes of governance: modular, relational, and captive. Network-style governance represents a situation in which the lead firm exercises power through coordination of production vis-à-vis suppliers (to varying degrees), without any direct ownership of the firms.[1]

Five global value chain governance types ranked according to the degree of power asymmetry and explicit coordination.

Market

Market governance involves transactions that are relatively simple, information on product specifications is easily transmitted, and producers can make products with minimal input from buyers. These arms-length transactions require little or no formal cooperation between participants and the cost of switching to new partners is low for both producers and buyers. In this case, the buyer has no controlling interest in the production, sets few if any standards, and provides producers with little to no information on what the market wants and how to produce it. Here, the parameters are defined solely by each firm at its point in the chain, and the central governance mechanism is price rather than a powerful lead firm. An example is when a trader buys produce at the farm gate or in a wholesale market and either sells it in the local market or exports it.[2]

Modular

This is the most market-like of the chain network governance patterns. Typically, suppliers in modular value chains make products or provide services to a customer's specifications. Suppliers in modular value chains tend to take full responsibility for process technology and often use generic machinery that spreads investments across a wide customer base. This keeps switching costs low and limits transaction-specific investments, even though buyer-supplier interactions can be very complex. Linkages (or relationships) are more substantial than in simple markets because of the high volume of information flowing across the inter-firm link, but at the same time, codification schemes can keep interactions between value chain partners from becoming highly complicated and difficult to manage.

The African-European cut flower value chain entails two distinctive strands. Cut flowers sold via auctions to wholesalers and retailers have historically been the most important channel to market. However in recent years, selling directly to retailers, such as large UK supermarket chains, has gained popularity. These powerful lead firm buyers have been shifting unwanted activities upstream towards exporters, and producers in Kenya have reacted by vertically integrating, and functionally upgrading to acquire the downstream logistics functions. The auction system is characterized by loose, market-based trading relationships, whereas supermarket buyers require their producers to be accountable for complying with environmental and social requirements specified by the UK supermarkets. The supermarket retailers in the direct strand demonstrate a much higher degree of leverage than any other type of intermediary or buyer (i.e., auction strand) in the value chain. Due to their market power, they have the ability to impose higher, more stringent standards while pushing risk towards their suppliers rather than taking it on themselves. [3]

Relational

In this network-style governance pattern, interactions between buyers and sellers are characterized by the transfer of information and embedded services based on mutual reliance regulated through reputation, social and spatial proximity, family and ethnic ties, and the like. Despite mutual dependence, the lead firm still specifies what it needs, and controls the highest valued activity in the chain, thus having the ability to exert more control over the supplier. Producers in relational chains are more likely to supply products differentiated in the marketplace as a result of their complexity, quality, origin or other desirable characteristics. As a result, dense interactions and knowledge sharing occurs, but unlike modular networks, this knowledge cannot be codified, easily transmitted or learned. Furthermore, relational linkages take time to build, so the costs and difficulties involved in switching to new partners tend to be high.

The desire to establish relational versus more controlled linkages with suppliers can also be attributed to cultural preferences. For example, in the automotive industry, Japanese firms prefer to maintain relational business ties with their suppliers in contrast to U.S. carmakers who either feel the need to exert more control through captive relationships or prefer to maintain distant, “hands-off” market relationships. [4]

Captive

In these chains, small suppliers are dependent on a few buyers that often wield a great deal of power and control. Such networks are frequently characterized by a high degree of monitoring and control by the lead firm. The asymmetric power relationships in captive networks force suppliers to link to their buyer under conditions that are set by, and often specific to, that particular buyer. This leads to thick linkages and high switching costs all round. Yet, these lead firms are also the most likely to invest in the product and process upgrading of their suppliers. Since the core competence of these lead firms tends to be in areas outside of production, helping their suppliers upgrade their production capabilities does not encroach on their core competency, but it will benefit the lead firm by increasing the efficiency of their supply chain. Competent, ethical leadership is important in such cases to ensure that suppliers receive fair treatment and an equitable share of the market price.

In the U.S. chicken value chains, small farmers raise chickens for a handful of larger processors based on outgrowing contracts. These farmers are generally in a captive position vis-à-vis the vertically integrated processors. The processors frequently take advantage of the high level of competition among captive farmers by exerting pressure to lower mortality, advance facilities and introduce more efficient growing practices, causing the farmers to constantly face pressure to improve their practices. Despite the economic benefits the farmers receive from raising chickens, many resent the concentrated power held by large integrators, leaving the farmers with a narrow range of tasks, significant switching costs, and dependence on the processors’ provision of resources and market access.[5]

Hierarchial

Hierarchical governance describes chains that are characterized by vertical integration and managerial control within a set of lead firms that develops and manufactures products in-house. This usually occurs when product specifications cannot be codified, products are complex, or highly competent suppliers cannot be found.

Hierarchical structures provide regular employment, guarantee quality and build producer capacity. Less tangible social benefits may also be associated with hierarchical relationships: influential business people may offer a measure of protection to local communities, for example, or provide schools, health facilities or consumer credit. These benefits can be important to the livelihood strategies of the vulnerable, but the prioritization of social considerations over industry competitiveness represents a potential trade off between economic upgrading and social upgrading.

Footnotes

  1. Gereffi, G. (2005). Export-oriented growth and industrial upgrading: lessons from the Mexican apparel case. World Bank case study for Uma Subramanian. January 31.
  2. 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.
  3. Ponte, S. (2008). Developing a 'vertical' dimension to chronic poverty research: Some lessons from global value chain analysis. Working Paper, #111, Chronic Poverty Research Center.
  4. Sturgeon, T., Van Biesebroeck, J., & Gereffi, G. (2008) Value chains, networks and clusters: Reframing the global automotive industry. Journal of Economic Geography 8(3), 297-321.
  5. 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.