business analysis

Chapter 3

Strategic Performing and Purposeful Organizational Value:

Selective Performing through Knowledge, Resources, and Global Value Chains

Limiting Core Competencies, Learning the Entropy Factor from the Performing of Alternative Stakeholders to Mitigate Entropy and Upgrading Strategies for Purposeful Organizational Value Linkages

In this chapter, we cover how organizations manage their purposeful organizational value, and sustain their competitiveness. One approach is the ‘internal view of strategy’, also referred to as the micro-foundations of strategic advantage. Extensive research on ‘micro-foundations of strategic advantage’ has led to several hypotheses, which are largely categorized into three groups:

1) The Knowledge-based view (KBV) hypothesis, originating in the inter-related theories of evolutionary economics (Nelson and Winter, 1982), organizational learning (Senge, 1990) and increasing returns (Arthur, 1994).

2) The Resource-based view (RBV) hypothesis, originating in the works of Penrose (1959) and Wernerfelt (1984).

3) The Global Value Chain view (GVC) hypothesis, originating in the works of Porter (1980) and Gereffi (2005)

The knowledge-based view (KBV) focuses on the process of development of knowledge resources. The KBV hypothesis contends that different firms follow a different path of experience to develop knowledge resources over their history. These different paths of experience generate varying bundles of resources and varied ways of combining and customizing these resources for specific deployments. Firms look to secure and sustain their competitive advantage in different ways by ‘codifying’ their experiences churning out knowledge.

The key ingredient to the Resource-based view (RBV) is the assumption of isolating mechanisms – that is, the knowledge-infused resources of a firm are difficult to substitute or imitate by other firms. RBV considers isolating mechanisms a key factor in the ability of a firm to outperform its competitors. Isolating mechanisms make the resources of a firm difficult to substitute or imitate by other firms; although by codifying their knowledge, the firms are able to replicate their unique resource base. Thus firms are able to generate above-average returns from its unique resources, and gain a dominant position in its chosen marketplace.

The Global value chain view (GVC) focuses on the governance of diverse value chains within which different types of resources are managed. Instead of owning all the resources by themselves, the firms can learn to govern the diverse value chains where various resources relevant to a firm’s purposeful advantage are managed. These diverse value chains may be spread across different nations and different cluster of firms, each with varying knowledge and knowledge infused resources. Members of each value chain have varying power to manage those resources, and may deploy those resources for alternative purposeful advantage The challenge for the firm is to coordinate diverse value chains for its purposeful advantage.

By integrating the above three views, the firms create a working model for organizational performing. Three additional steps help firms to transform learning into purposeful organizational value. These are core competence view, alternative stakeholder view and upgrading strategies view.

The core competence view (CCV) stresses on the core coordination, communication and integration abilities of a firm to be able to synthesize technologies and skills – traded from the diverse value chains where the firm is engaged -- into something insightful that may have a range of applications and customer benefits; it is through this aggregation, a firm is able to secure a higher market share and thereby growth. However, market dynamics may at times reduce the value of a specific aggregation, which would then call for significant changes in the core competencies.

Alternative stakeholder view emphasizes the role of the performing of excluded stakeholders as the entropy factor in firm’s performing.

Upgrading strategies view emphasizes the role of organizing complementary value linkages that serve both included as well as excluded stakeholders.

The Knowledge-based View Hypothesis

The Knowledge-based View (KBV) is an important formulation of competitive value in the context of the modern industrial economy where knowledge workers produce an estimated 55% of the world’s GDP (Cavalcanti, 2003; using 1998 data). The KBV hypothesis states that each firm has its own “unique” trajectory or path of knowledge development, which gives rise to divergent resources and ways of combining and customizing these resources for specific deployments. The KBV builds on three important organizational theories, as illustrated in Exhibit 3.x.

Exhibit 3.x: The KBV Hypothesis

Firm Performance

· Creates competitive advantage

· Sustains competitive advantage

The Evolutionary theory: according to KBV, the path is unique to each firm because the knowledge development is a local, evolutionary process (Nelson & Winter, 1982). In the evolutionary theory, knowledge is internal gained from various processes used by a firm during the course of its operations and from various experiences and interactions. The story of Patanjali Ayurveda, the fastest growing consumer goods firm in India during 2010s, is illustrative.

Evolutionary Theory and the Rise of Patanjali Ayurveda in India Since its founding in 2009, Patanjali has offered a rapidly evolving range of products under one umbrella brand “Patanjali Ayurveda”. The firm achieved total revenues of about $750 million in 2015, and projected doubling of that in 2016 (Arora, 2016). Firm’s evolution is based on the strong association of its founder, Baba Ramdev, with the indigenous knowledge of yoga, health and wellness. The firm has added several indigenous insights to this foundation – direct procurement from farmers gives it above-average margins despite unusually low prices, use of simple packaging gives it a natural look, use of endorsement by popular local politicians gives it a mass appeal and free publicity, and use of medical treatment centers, own non-medicinal stores and mega marts, and partnerships with major domestic retail chains gives it a broad reach.

The Organizational Leaning theory is another key ingredient to the KBV (Senge, 1990). This theory emphasizes both learning-by-doing (how knowledge is created and accumulated) as well as learning-by-using (how knowledge is used and deployed), and suggests that these processes generate differential competencies across firms.

Learning-by-doing has four types of knowledge processes (Håkanson, 2010): articulation, replication, integration and combination. Articulation and replication involve cooperative efforts within specific expert communities, while integration and combination involve coordination of specialized knowledge across such communities.

Articulation occurs in the form of codes, such as standard operating processes (SOPs). Replication is critical for achieving growth through knowledge; therefore, replication of articulated knowledge may occur simply by transmission of codes. To replicate less articulated knowledge, firms need to foster human interactions, like for example apprenticeship training.

Integration requires firms to promote empathy or ‘perspective taking’ among each expert community – i.e. taking the perspective of another community as part of its own way of knowledge development (Boland and Tenkasi, 1995, p. 356). For example: a consulting firm does not need to internalize hardware and software engineering skills in order to integrate the use of computer systems in its consulting services.

Combination calls for innovations involving closer cooperation and new perspectives. The goal of combination is to foster interaction among different expert communities with regard to their less articulated knowledge. To do so, firms need to offer enabling and motivational conditions. One way firms do so is through ‘organizational culture’, which facilitates dialog among members of otherwise different specialization frames. Another way is by investing in tools such as computer systems that offer dedicated support for interactions among members.

Organizational Learning and the Pharmaceutical Industry Before World War II, the pharmaceutical firms developed drugs using a community of chemists. After the World War II, biotechnology firms emerged that relied on a community of biologists to develop drugs using genetic engineering. Both sets of firms attained strategic advantage by articulating specialized knowledge within their focal disciplines, and replicating that knowledge for variety of applications. Over a period of time, leading pharmaceutical firms integrated the products of biotechnology firms within their marketing portfolio, by forming marketing alliances with them. More recently, they have acquired biotechnology firms, and strived to combine the efforts of biologists with those of the chemists, and use both sets of options and different combinations of these options.

In addition to learning-by-doing for creating and developing knowledge, KBV also emphasizes on ‘learning-by-using’ for securing competitive advantage. Firms need to appropriately deploy their knowledge in the form of value-generating strategies. Learning-by-using takes time, and it might be difficult for other firms to accelerate their learning and develop similar knowledge just by making investments (Zack, 1999). The firms may accelerate learning-by-using by designing knowledge maps as aids to prioritize and focus learning use, and systematically categorizing and benchmarking organizational knowledge for "critical learning mass" around particular strategic areas of knowledge (Zack, 1999). As also evidenced by the case of Patanjali Ayurveda, Randall (2013) found that in a transitional economy facing competition from foreign multinational enterprises (MNE), domestic firms that exploited their indigenous knowledge by using a ‘made in’ strategy and a ‘umbrella’ strategy to successfully position different products under an umbrella brand, reported significantly better performance, as compared to those who did not. The foreign MNEs often face long lead times in effectively using local knowledge, unless they have a possibility of acquiring local firms in emerging markets.

The Increasing Returns theory: As illustrated by the use of indigenous knowledge to generate rapid growth by Patanjali Ayurveda, the KBV puts an emphasis on managing knowledge transfers for achieving increasing returns from a given knowledge base (Grant, 2002). Unlike physical resources that are consumed as they are used, providing decreasing returns over time; knowledge offers the possibility of yielding increasing returns as it is used because the initial creation of the knowledge base is often costlier than its subsequent replication. Thus, the more knowledge is used (the scale of application), the more valuable it might become – thus yielding what is called “economies of scale”. Similarly, the more areas it is applied (the scope of application), the more valuable it becomes – thus yielding what is called “economies of scope”. Economies of scale and scope, together with the complementarity of knowledge processes (i.e. articulation, replication, integration and combination), imply increasing returns from knowledge-based initiatives, which are fundamental to the ‘new economy’ (Arthur, 1994).

KBV under dynamic environments

In dynamic environments, the assumptions of the three constituent theories of the KBV – evolutionary theory, organizational learning theory, and increasing returns theory – are often compromised, and require a different perspective.

The evolutionary theory: Though in stable environments different firms are likely to develop distinct heterogeneous evolutionary paths and heterogeneous portfolio of resources using their unique knowledge base, in dynamic environments, organizational survival depends on having a diversity of knowledge and resources (Nannen, van den Bergh & Eiben, 2013). Diversity of knowledge and innovative initiatives gives flexibility to a firm to adapt and influence the changing market needs. It is important to understand that just being local doesn’t guarantee survival and sustaining an advantage over competitors. For instance, when the Indian firm Mahindra and Mahindra was successfully able to compete against the larger MNEs in the tractor industry by focusing on low power tractors targeted at small and mid-sized farmers, Punjab Motors – the erstwhile market leader in India, failed to survive during the 1990s because its focus was on the higher power tractors targeted at more affluent and larger farmers. Thus, Punjab Motors being the local brand ‘lost out’ on competition and became the direct target of attack from many foreign MNEs, who used preferential credit terms and aggressive advertising tactics to cut out its market.

The organizational learning theory: In stable environments, knowledge creation and application processes are based largely on how knowledge as an object is acquired and used, but in dynamic environments, the subjective forms of knowledge become more important. Knowledge, as an object is essentially a commodity: as long as firms garner experiences, articulate their experiences into scalable knowledge, integrate and combine their knowledge into more complex sell-able objects, they are able to capture and sustain a competitive advantage. Whereas, in dynamic environments, the value of objective knowledge is subject to rapid erosion, as the complex objects based on that knowledge are commoditized. For instance, Nokia’s phones became a commodity that lacked any special value, once Apple launched its smartphones. Traditionally, research and development (R&D) is a key driver of organizational learning, but with brisk changes, firms often find it difficult to sustain large investments in R&D. Therefore, in many markets, firms specialized in R&D have emerged victorious as they excel in translating their knowledge objects into patents and other forms of intellectual property rights. They also use this knowledge base to offer training and other forms of more subjective knowledge transfers.

As markets for complex knowledge objects have developed, it is not sufficient for firms to focus just on learning how to acquire and apply these traded objects. Local influences on learning imply that knowledge is situated in specific contexts, making it difficult for the knowledge and the learning system to migrate from one context to another. Thus, context dependency in its essence signifies that knowledge which is meaningful and valuable in a social context may not necessarily have the same connotation in another context. For instance, Xerox invented Windows systems at its research center, but did not consider it valuable for its photocopier equipment. It was Apple who recognized the value of Windows for computers after its scientists visited the research center of Xerox. It was then Bill Gates who decided to adopt the same for Microsoft operating system, and the rest as they say is history.

Thus, in dynamic environments, organizational success is dependent on mechanisms for constructing shared meanings and cooperating within specialized communities, each with their own learning paradigms. For MNEs, cross-cultural factors and organizational inertia complicate such mechanisms, as diverse societal cultures differ dramatically in their meaning-making practices and inertia impedes the willingness to accept alternative practices. For instance, in the West, members may decide to use a new technology for high-end products targeted at affluent customers; but in emerging markets, members may seek to apply the same technology to offer mass luxuries in less affluent markets. While on the one hand, the Western members perceive mass luxury applications as devaluing their corporate identity, on the other, emerging market members tend to perceive premium luxury applications as irresponsible exuberance.

The increasing returns theory: In stable environments, investments are made to generate increasing returns through economies of scale and scope, aided by articulation and codification of knowledge into sharable and replicable information. For dynamic environments in contrast, the value of information tends to depreciate quickly. Therefore, in order to increase returns, firms must seek new intra and inter organizational sources that offer knowledge, using which they could augment their existing knowledge base, which otherwise was at risk of being irrelevant. In today’s network economy, innovations and returns are no more a linear model for creating knowledge within a firm. Rather firms prefer to collaborate with outside partners on building economies of scale and scope for new products, processes and services.

In dynamic environments, new technologies, ideas, and opportunities may emerge in many different and unconventional organizations, communities, and geographies. Firms may source knowledge through interactions and network connections with newly discovered geographies, customer segments, vendor groups, scientific laboratories, partners, competitors, and communities. This enables them to spread themselves and thus reduce overall costs, risks, and the time of knowledge creation. This process is therefore not linear, but interactive; it requires considerable communication and collaboration among different units within a firm and among different organizations.

The Resource-based View Hypothesis

The resource-based view (RBV) identifies resources and accounts for how they are created and maintained by integrating the unique knowledge base of the firm (Penrose, 1959; Wernerfelt, 1984).

Barney’s (1991) VRIN (Valuable, Rare, Inimitable and Non-substitutable) framework is the practical approach to RBV: it helps us recognize that valuable resources generate superior value, and are rare, because they are difficult to imitate and substitute (Priem and Butler, 2001; Hoopes, Madsen and Walker, 2003).

Given the inherent tautology in the above, the four factors in VRIN network are best operationalized as NIRV instead, wherein at the outset executives should identify key difficult-to-substitute resource portfolios and constituent resources that are also difficult-to-imitate or copy. Then validate the value by affirming that deployment of those resources does yield the firm a unique (rare) advantage in the market (i.e. it is profitable and able to secure desired market share and reputation). If not, then that might indicate that other firms have been able to substitute its resource portfolio, and/or imitate its constituent resources – i.e. the knowledge base constituting the firm’s resource base is no longer purposeful and is unlikely to yield purposeful advantage in competitive markets.

NIRV Framework for Applying RBV in Practice 1. Non-substitutability: How difficult it is to substitute the key resource-portfolios of a firm? 2. Inimitability: How difficult it is to imitate (copy) the constituent resources of a firm’s portfolio? 3. Rare: Does the firm have a unique (rare) advantage in the marketplace? 4. Valuable: Is the firm able to accrue sufficient value, in terms of profitability, market share and reputation?

Overall, RBV seeks to explain why some firms might continually have a stable, competitive edge in an extremely aggressive but stable environment Figure 3.x illustrates the RBV hypothesis stating that “isolating mechanisms” mitigate (almost to the point of eliminate) the threat of corporate erosions and thereby enable sustainable competitive advantage.

Figure 3.x: The RBV Hypothesis

-Social complexity

-Asset specificity

-Tacitness

Isolating Mechanisms

Isolating mechanisms are factors that allow firms to prevent attrition and disintegration of unique knowledge-based resources, and thereby remain competitive. Three major isolating mechanisms encompass RBV: causal ambiguity, path dependency, and competitive exclusivity.

Causal ambiguity –is not being able to find the specific reason of success of a practice or performance as there are multiple knowledge elements that affect the system holistically. The rationale for causal ambiguity may be further divided in the form of “social complexity”, “asset specificity”, and “tacitness”.

· Social complexity arises from informal and formal communications among social networks of a firm, which cannot be easily replicated in other firms even if the nature of business of the firm is the same. E.g. in a hospital, post handling a critical patient, the surgeon and the accompanying team discuss and analyze the case, which in turn creates an internal knowledge base, but is difficult to replicate in other hospitals as they may not have a similar team facing a similar situation. Thus the situation and the team are rare to be duplicated even in a similar social context and/or setting.

· Asset specificity focuses on a particular resource which is more valuable to the specific firm. Asset specificity may be of several types: human asset specificity (e.g. highly specialized human skills), material asset specificity (e.g. highly specialized materials), machinery asset specificity (e.g. highly specialized machinery), and method asset specificity (e.g. highly specialized software or procedure). For instance, diagnosis and treatment of a rare ailment requires specialized doctors, equipment and methods extremely specific to that ailment per se and therefore there may be a specialized hospital catering to only patients of that ailment or hospitals within a region may have specialized units among others catering to that particular ailment. Thus, the resources of the hospital are highly asset-specific, because their value outside of this hospital among those that lack similarly specialized doctors, equipment, and methods, is much less (Boseley & Duffy, 2012).

· Tacitness arises when resources within a firm per se are accumulated over time using processes and systems that are unique to that firm. Tacit resources could be cognitive or emotive or include relational skills, beliefs, and practices. For example, rare immunotherapy treatment requires careful monitoring of the patient condition on a range of factors and the understanding of which comes only with experience of handling such cases. Therefore, this knowledge gained is more than just theoretical knowledge gathered from written materials and therefore may not be easily copied.

Path dependency – A firm’s future path is dependent on its prior relationships, experience and reputation in relation to its resource portfolios, and is the source of its advantage over the others. The path of their future actions is dependent on and limited by the path they have taken to reach the present state (Teece, Pisano and Shuen, 1997). For instance, while Apple has developed a leading market position for its iphones in the Western markets, Samsung is the market leader in the emerging markets with its Galaxy smartphones. Samsung has built its success around a path of reputation in smart devices, including smart televisions and watches; and around relationships and experience that allow it to offer a diverse portfolio of smart phones, in different sizes, colors, and of different functionality, at low costs.

Competitive exclusivity – is marked by firms actively impeding sharing of resources with potential competitors, often by legally binding documents, such as nondisclosure agreements/exclusive supply agreements. The goal is to secure and enforce intellectual property rights, making it virtually impossible for other firms to duplicate or develop any alternative.

Limitations of the Isolating Mechanisms

Isolating mechanisms despite their importance under the RBV context have their limitations in dynamic environments, where the power of these mechanisms tends to be much weaker (Ferdinand et al, 2004). Thus, the three major mechanisms encompassing RBV, i.e. causal ambiguity, path dependency, and competitive exclusivity are often compromised.

The causal ambiguity assumption lies in the fact that while resources specific to a firm may have causal ambiguity, other firms may still construct functionally equivalent, yet different, set of resources focusing on alternative market niches. For example, large foreign banks usually lack local knowledge and experience. Therefore, they rely on their global relationships, knowledge, and reputation to target foreign and larger domestic clients, who have a stronger global awareness and need for global experiences. Local firms in Brazil, Russia, China, India and South Africa (BRICS) have been quite successful in leveraging their local relationships, knowledge and reputation to target individual and small and medium enterprise clients.

The path dependency assumption: Although a firm’s own future possibilities are dependent on its historical path of relationships, experiences and reputation, other firms may also accumulate a high possibility resource portfolio from different points and along different paths. For instance, China's early high speed trains were imported or built under technology transfer agreements with foreign train-makers including Siemens, Bombardier and Kawasaki Heavy Industries. Chinese engineers then redesigned key parts and improvised upon foreign designs to build indigenous trains that can reach operational speeds of up to 240 mph. The Chinese government supported these through several “speed up” campaigns during the late 1990s and 2000s for modernizing existing rail lines.

The lacuna with the competitive exclusivity assumption lies in the fact that although a firm’s resources may be exclusive in its own rights, that alone is not sufficient to achieve long-term exclusive competitive advantage for the firm within dynamic environments. Let us take the example of Finland-based Nokia, which was the second largest mobile phone maker during the 2000s. But it lost out on its competitive edge over time as it wasn’t able to successfully migrate to smartphones and android-based mobile devices, which by then had caught the imagination of people worldwide. By 2012, Nokia’s market share plummeted and the company was compelled to sell off its global mobile business division to Microsoft in 2013 for US$7.17 billion.

Supplementary Value and The Global Value Chain Hypothesis

The Global Value Chains or Value System hypothesis recognizes that the resources and their development are situated within value linkages of different stakeholders. Therefore, to supplement organizational value, beyond the firm’s own competitive value, the firms should understand and govern the entire system of value linkages. As shown in Exhibit 3.x below, a value system (Porter, 1985) is the larger interconnected system of value linkages, that includes the value linkages of a firm's supplier (and their suppliers all the way back), the firm itself, the firm’s distribution channels, and the firm's buyers (and presumably extends to the buyers of their products, and so on). It is the entire spectrum of linkages among the successive tiers of suppliers and the successive tiers of customers. The foundation of these linkages is situated in the values of various participants, and the influence exercised by these participants (Peppard & Rylander, 2006).

· Value dimensions of participants – i.e. what are they getting out of the value system? Different participants may desire and perceive different dimensions of value from the value system. Some of the value perceptions are positive (e.g. the entertainment pleasure a user perceives through Internet gaming), while others are negative (e.g. the inconveniences or detriments related to time, cost, and control of participating in an extended network). Value desires and perceptions of different participants help to identify the level and the limits of participant engagement behavior.

· Influences of various participants. Participants may influence the value dimensions and the behavior of other participants in the value system through exchange of (1) products and services, such as new content, (2) emotions, such as expression of likings by the consumers, (3) cognitions, such as information and ideas for new product and service design, and (4) power, such as regulatory prescriptions.

Exhibit 3.x: A Value System Connecting Successive Tiers of Suppliers and Customers

Org.’s Value Chain

Tier 1 suppliers Tier 1 customers Tier 2 customers

A value system analysis seeks to discover opportunities for restructuring network-wide exchanges, such as which processes should be emphasized and which firms should perform these processes. One advantage of this analysis is its scalability – it could be applied to a value chain of a firm, or to the interconnected value chains of a group of firms in an industry, or a cluster of firms in a region or the entire nation. An industry is defined as a group of firms that use similar processes, and therefore have similar primary activities. One may define an industry either narrowly, such as the organic coffee industry, or broadly, such as the beverages industry. A firm that is open to opportunities within a larger space, or that desires leadership of a larger space, may start with a broader definition of the industry and then narrow onto a relatively more attractive segment of the industry. Conversely, a firm that already has strong capabilities correlated to a focused target market may start with a narrow definition of the industry. The value system analysis may point this firm to the need for even greater focus, such as flavored organic coffee, or for broadening the focus to include organic coffee shops or farms, or organic tea.

Adam Smith (1776) was one of the first scholars to examine the design of network-wide exchanges. The benefits from the specialization of labor and knowledge offer the genesis for different firms performing different activities in a value system. However, network-wide exchanges are prone to high levels of transaction costs – which include the costs of negotiation, the risks of involuntary knowledge diffusion and imitation, and the costs of communicating the specialized needs and of assuring that these needs will be fulfilled by the other firms. When these transaction costs are high, value of network-wide exchanges will be low, resulting in low scale of production and growth.

In modern times, the analysis of value system has been motivated by a range of concerns discussed below.

1) Economic Impacts in the Industrial Markets:

In the 1960s, French agricultural scientists used the concept of value system (termed as filière). They were interested in increasing the scale of production and sourcing of agricultural products from the former French colonies in Africa, so that the French firms could maintain their competitiveness. They recommended regulatory interventions to offset market pressures for disaggregation of specialized activities, in the form of monopoly apex organizations for coordinating vertical exchange. The premise was that a French government owned sourcing organization will build captive relationships with various firms in the value system.

2) Cost-effectiveness of the Industries:

During the 1970s, the concept of value chain (termed as ‘business system) was used by business consultants to disaggregate the cost of goods sold into different functional activities. The objective was to identify the opportunities for reducing costs, using the learning and experience of the firm in various functional activities, and to maximize the margin of profitability (Bales et al., 1980). In reality, not many American firms were able to attain and sustain lower cost structures. Intense concern with cost structures resulted in only no-frills product commodities, that yielded little profits (Hayes & Abernathy, 1980). However, many Japanese firms defied this outcome. Japanese firms were able to achieve dramatic cost reductions by concentrating not on internal value chains, but on the value chains of external suppliers and channel partners. Their value system was based on a careful strategy of targeting the major suppliers of their leading global rivals, such as General Motors in the auto industry. These suppliers faced structural barriers and adverse terms of exchange with their primary customers, who were the leading global rivals of the Japanese firms. Japanese firms offered superior terms and closer cooperation in joint product development, and put out entire assemblies and sub-assemblies, as well as assembly systems. They deepened their engagement with extended supply networks and production operations of their suppliers, to achieve dramatically decreasing costs. They also focused on total quality management to add quality and innovative options that enhanced customer willingness to pay. Thus, they generated substantial cash flows and expanded their share of the global market (Womack & Jones, 1996).

In the 1980s, Porter (1980) contended that the costs ought to be analyzed in relation to the ‘value’, i.e. “the amount the buyers are willing to pay for what a firm provides them” (Porter, 1985: 38). He deployed the concept of network-wide value system to identify opportunities for offsetting the structural power and process inefficiencies in the supply chain, in order to both lower the costs and improve the value-added. The value system analysis was used to gain insights into both structural cost drivers and process cost drivers. Structural cost drivers are associated with the power effects of the industry context, technological field, and organizational design. Process cost drivers are associated with day-to-day management of activities and their linkages. The objective is to identify the incremental value the customer is willing to pay for the added costs, and to eliminate the costs for which the customer is unwilling to pay more (Porter, 1985). This included identifying the activities that a lead firm should disintermediate within its own value chain, by outsourcing them to others who may perform them more efficiently or with improved differentiation (Porter, 1985).

3) Impact on Corporate and Regional Competitiveness:

With information technology revolution, in the 1990s, Hammer (1990) underscored the need for firms to use the power of information technology to radically reengineer the entire business processes. The purpose was to achieve dramatic improvements in what the customer would be willing to pay, and how much will it cost to deliver that. In traditional value systems, both buyers and sellers had very long value chains, with many activities. As Gaulin & Marcolin (2001)[footnoteRef:1] noted, “The buyer’s set of functions starts with a felt need, then proceeds to product research and analysis, selection, order, payment, delivery, installation, operation and maintenance. The seller’s set begins with creating awareness of a product or service, the dissemination of product/service information, sale bid and closing, taking and tracking the customer’s order, invoicing, production, delivery and after-sales support and service.” All these activities required considerable time and resources. By deploying information technologies, such as using internet and mobile platforms, the same basic functions can be done faster, more accurately, and with significant cost savings. For instance, Lands’ End, the outdoor clothing retailer, was one of the first companies to use internet for marketing function. It added Internet catalogues and order taking to its existing catalogue and retail operations. This not only increased its client base, but also ensured ease of exchange and order tracking, and quicker response time at the buyer’s and seller’s end. [1: Gaulin, B. & Marcolin, B (2001). Changing the Value chain: A modular approach, Ivey Business Journal]

Research indicated that firms devote 25-40 percent of their resources on traditional transactional activities, which could be released through automation, and invested more productively in R&D and in customer service. For instance, Shell Chemical implemented a software package SIMON to assist with supplier-managed inventory, by tracking the usage pattern of its customers, to make more accurate production forecasts and reduce inventory. This helped Shell strengthen its relationships with both customers and suppliers, yielding a 10 to 1 return on investment in this software per the company estimates (Gaulin & Marcolin, 2001).

Emphasis on inter-firm collaborations brought to fore an added issue of bargaining power in different nodes of the value system, and the distribution of value amongst the various participants. If the balance of power is against the members at a node, then those members have limited incentive to differentiate, as a disproportionate share in the differentiation premium may be appropriated by other members in the system. Further, a disadvantageous balance of power may also impede the capability of those members to make sufficient investments into cost reduction. The firms had a better chance of appropriating a fair share of the cost reduction benefits if their own cost information remains private and is not shared with the dominating members. Cost reductions, if achieved, are likely to use common pool of public know-how, and be adopted by all the rivals of those members, and the benefits are likely to again accrue disproportionately to the dominating members.

In the 1990s, analysis of network-wide value system (termed “commodity chains”) was revived to understand how value linkages among groups of firms across regions are governed (Gereffi, 1994; Kaplinsky, 2000). Historically, the regional centers for value accrual were situated in the industrialized nations—raw materials were traded from around the world (peripheral regions), and then processed and branded in the industrialized regions (core) (Leslie & Reimer, 1999). However, with globalization, value linkages are distributed across multiple regions, and the firms in these regions increasingly specialize in a part of the value system, and are linked upstream and downstream with the firms in other regions.

Early research drew from the French filiere studies to analyze how a lead firm - usually a large multinational corporation (MNC) from an industrialized nation—takes charge of dispersing, coordinating, and assembling the global value system (Gereffi, 1994). Three modes of governance were identified: (1) hierarchical, where the MNC vertically integrated all processes in the value system into its own global value chain; (2) captive, where the MNC formed captive relationships with various participants in the global value system, offering them technological support in exchange for a promise that the participants will work only with the MNC; and (3) market, where the MNC engaged in open market exchange for various upstream and downstream activities situated in other nations and performed by other firms. There was a particular interest in improving the competitiveness of particular regions, and ensuring that the global competitive pressures do not negatively impact social standards such as the level of wages and investments in training and workforce development (Porter, 1990).

4) Social Impacts in the Emerging Markets:

In the 2000s, there was a new interest in analyzing the network-wide global value system from a developmental perspective of inclusion (Gereffi, Humphrey, & Sturgeon, 2005; Kaplinsky, 2000. There is a recognition that powerful firms set the ‘rules of the game’ in the global value system of many industrial sectors, while certain target groups lack economic power and face constrained choices for sustaining their participation and earning fair share of value. The monopolistic coordination of the global value system by the MNCs allowed them to appropriate rents – i.e. disproportionate share of value-added. But it also generated adverse pressures for the resource poor groups, such as the women and low-income rural people in the emerging markets. The MNCs tend to be quick to shift linkages of their global value chains from one region to another, depending on the short-term factors such as changes in exchange rates, wage rates, and inflation rates. Exhibit 3.x illustrates a buyer-driven export aloe value system for Kenya. The buildup of costs along the primary value system is also shown.

Exhibit 3.x: Buyer-driven Kenyan Aloe Export Value System

Business Environment Foreign regulations Kenyan Forest Act Corruption in Licensing Social prejudices Drought relief Conflict & insecurity Legal system Land tenure

Business Services

Source: Albu & Griffiths, 2006

Because of the pressures by the MNCs to reduce sourcing costs, in many regions, most of the labor-intensive work is often performed by women. As a result, exploitative practices can be common, increasing the vulnerability of the poorest of the resource poor members. Moreover, because of their bare subsistence incomes, local firms have limited capacity to invest in worker training or in following sustainable environmental practices. Such global value systems are unlikely to be economically viable and commercially sustainable over a period of time. Therefore, there is a clear business case for the resource rich to increase inclusiveness and fair share. Global value system development exercise is a powerful diagnostic tool to identify critical blockages for specific target groups, and provides a framework for how resource poor people can engage, or improve their terms of engagement with, domestic, regional or international trade.

5) Global Environmental Impacts:

In the 2010s, there has been an increased sensitivity about global warming and exhaustion of non-replenishable resources such as oil. Many studies of the network-wide global value system are examining not only the economic and social impacts in the industrial and the emerging markets, but also the environmental impact. These studies use a total sustainability lens to analyze the interaction of the global value system with profits (economic impact), people (social impacts) and planet (environmental impact). The emerging literature shows that the firms in many global value systems may ignore environmental impacts, divert resources away from environment protection, and exploit environment in unsustainable and harmful ways. For instance, Kaaria et al. (2008) found because of the pressures from the global buyers, low-income rural poor may invest additional incomes from participation in global value system into expenditure on assets and basic needs, rather than on natural resource management.

Two types of pressures are salient in the global value systems: market-specific certification standards, and the firm-specific expectations for alignment with their core competencies (Mitchell et al, 2009). Industrial markets have introduced certification standards, requiring the suppliers to be certified in certain standards of quality, labor conditions, and in some cases environmental impacts. In addition, leading firms are competing on proprietary technologies and ethical codes of conduct, anchored in their own distinct core competencies, and the suppliers are expected to make conforming investments to be able to work with the specific needs of these firms. With increasing competition and rapid communication, the societies are pressurizing the firms to “trade on values of authenticity, locality, history, culture, collective memories and tradition’ (Harvey, 2001: 109). The foundations for the competitive advantage of the firms are shifting from rapid continuous innovations using means of production, to delicate transformation in the meanings around the productive, consumption, and trading process.

Global Value Chain and Rents

Global value chain analysis helps firms generate learning in the form of rents. In economics, value or profits accrued by different participants in a value system is referred to as ‘rent’ (Kaplinsky, 2000). The rents accrue from both the differential productivity of resources, as well as the barriers to entry in specific nodes of the value system. The shifts in the productivity of resources, and in the barriers to inclusion, result in the change in these rents. Rents from linkages in a value system derive from four sources (Kaplinksy 2005).

· Monopolistic rents: These are associated with the ability of firms to shape the structure of market relations in their favor, using monopoly power and anticompetitive tactics. The result is exclusion of existing and potential competitors, and pressures on the vertical participants to give up a disproportionate share of value. For instance, rents generated by a large firm from forcing its resource poor suppliers to take an unfairly low share of value, using a threat of going to another supplier. A more complex example is rents generated by a firm who horizontally cooperates with its rivals in the nation to lobby with the government to institute unreasonable process standards, and to impose tariffs to unfairly discriminate against the firms from the emerging markets who are unable to meet these standards or who seek support from their governments to build capacity to meet these standards. These types of rents were of major concern to the neo-classical economists, and are therefore also referred as Neo-classical rents.

· Resource rents: These are associated with the ownership of scarce resources, such as an exclusive access to a diamond mine or to a supply source or to scientists of rare skills or to a proprietary technology. These types of rents were first identified by David Ricardio, and are therefore also referred to as Ricardian rents.

· Entrepreneurial rents: These are associated with the endogenous knowledge-based initiatives of the firms, through their in-house dynamic capabilities and their interactions with other participants in the value system, such as for joint research and marketing. These types of rents were first identified by Schumpeter, and are therefore also referred to as Schumpeterian rents.

· Institutional rents: These are associated with the institutional indicators, such as superior policy and regulatory framework, lower corruption and bureaucratic hurdles, superior law enforcement, ease of doing business, protection of property rights, political freedoms, civil liberties, transport and communication infrastructure, and financial and other institutional support systems. These types of rents arise because of the improved ability of the participants in a value system to generate and appropriate value for themselves and for other stakeholders engaged in a sector or a region. These types of rents were first identified by Douglas North.

As repositories of rents, value systems tend to motivate different members, as well as outsiders such as the new players and the government, to seek control of the governance, i.e. coordination of the participants and the terms of participation in the value system (Gereffi, 1994). For instance, the buyers might emerge as the lead managers in labor intensive sectors, such as footwear, by putting out the production process for achieving lower costs. Alternatively, the producers could emerge as the lead managers particularly in technology intensive sectors, and coordinate the activities of both suppliers and customers (Gereffi, 1994). In either case, the lead managers are able to generate superior rents by taking responsibility for the inter-firm division of labor (“systemic governance”), legislate standards for the capacities of those who might participate (“legislative governance”), adjudicate the process for monitoring the practice of these standards (‘judicial governance”), and execute the role of helping upgrade the capacities of particular participants (“executive governance”).

PART II. How to Enhance Purposeful Organizational Value Beyond Limits of Learning

Knowledge, resources, and global value chains allow firms to generate purposeful organizational value. In order to sustain this advantage, it is important for the firms to purposefully created value beyond limits of organizational learning. There are three major views on how to do so – the core competence view for understanding the limits of organizational learning, the alternative stakeholder view on alternative organizational performing, and upgrading strategies view for servicing both included stakeholders and excluded alternative stakeholders.

The Core Competence View

The Core competence view (CCV) – first articulated by Prahlad and Hamel (1990) -- makes a distinction between the knowledge processes of articulation and replication, referred to as competencies, and knowledge processes of integration and combination, referred to as core competencies. Core competencies are deemed as the root of a corporate’s distinctive qualities, and therefore sometimes also characterized as ‘distinctive competencies”. Prahalad and Hamel (1990) note:

“Core competencies are the collective learning in the organization, especially how to co-ordinate diverse production skills and integrate multiple streams of technologies...core competence is communication, involvement and a deep commitment to working across organizational boundaries...core competence does not diminish with use. Unlike physical assets, which do deteriorate over time, competencies are enhanced as they are applied and shared.”

Wang and Ahmed (2007) elaborate that core competencies are a bundle of a firm’s resources and capabilities that are strategically important to its competitive advantage. For example, the success of the European firm, Zara, in the fast changing fashion industry relies on its core competence in responsiveness to customers, which in turn is derived from a bundle of capabilities including swift copy of catwalk design, advanced information systems, just-in-time production and shop-floor led stock control that combine together for success. Therefore, the emphasis of core competencies is on creative ‘integration’ and innovative ‘combination’ of resources and capabilities in light of a firm’s strategic direction.

During the 1990s, CCV was very popular among strategy consultants to help guide diversification and outsourcing decisions of firms. In stable environments, a focus on the corporate-wide core competencies allows constituent firms to avoid dispersing their limited resources into too many diverse areas, and to be able to pursue an internally coherent strategy.. Prahalad and Hamel (1990) recommended three tests for identifying core competencies of any corporation:

a) A core competence is difficult for competitors to imitate or trade because it is a complex harmonization of individual technologies and production skills.

b) A core competence provides potential access to a wide variety of markets.

c) A core competence makes a significant contribution to the perceived customer benefits of the end product.

The first test is related to the concept of social complexity discussed under the isolating mechanisms for RBV. The second is connected to the concept of economies of scope discussed under the increasing returns theory for KBV. In addition, the CCV emphasizes the role of perceived customer benefits, connected to GCV. Prahalad and Hamel (1990) emphasized how Japanese firms widely used the CCV to offer the benefits that customers in the U.S. and other markets valued, and attributed their strategic advantage during the 1980s to this view. For instance, Honda’s core competence was using different technologies and skills to make powerful engines (a core product), which it then used in a variety of markets including trucks, cars, and motorcycles (end products) and the customers identified its innovative engines as a key factor in their preference for Honda.

Exhibit 3.x: The CCV Hypothesis

CCV under Dynamic Environments

The CCV has come under scanner, partly because the Japanese firms identified as exemplars by Prahalad and Hamel (1990) have fallen behind and seen dramatic falls in their global market shares since the 1990s. The shift in the fortunes of Japanese firms is related with a rapid appreciation in Japanese currency yen, particularly during the early 1990s. Yen appreciation made Japan-based knowledge combination and integration processes extremely costly from a global standpoint. On the other hand, processes of knowledge articulation and replication based in the overseas factories and investment networks of the Japanese firms became dramatically more cost-effective. Japanese firms have been reluctant to situate their complex knowledge combination and integration processes overseas, because of a fear that such offshoring will result in further, possible complete, hollowing out of the Japanese advantage. In the interim, more cost-effective combination and integration processes have allowed American firms to regain advantage in electronics, automotive, and other sectors, and to create new areas of advantage in biotechnology, energy and other areas.

In dynamic environments, it is not sufficient to compete solely on the basis of corporate-wide efforts to combine, integrate diverse skills and technologies into core products, and to find applications for them. Firms need to effectively plan for alternative emerging stakeholder values and program for upgrading their competencies. Otherwise, research shows that too much and too long focus on a specific set of core competencies, based on a specific set of skills and technologies, will actually make a firm’s core competencies a ‘core rigidity’ (Leonard-Barton, 1992). In other words, a firm’s insistence to stick to a previously successful combination and integration might put it in a ‘competency trap’ (Wang & Ahmed, 2007). This could block the firm’s capacity to adapt quickly to market dynamism reducing drastically its competitive advantage. For instance, Honda has traditionally focused on gasoline-run engines. In India, diesel is cheaper than gasoline because of government subsidies, and that is why it is widely used by the poor farmers. While Honda has adapted to diesel engines in the passenger car segment, it has gained a strategic advantage on fuel economy; however, Hyundai’s fleet is preferred by the public because of its superior engine performance. In comparison to Hyundai’s engine, the engine of Honda City has a lower displacement and is therefore less powerful. The peak power and torque ratings for Honda city are also lower than Hyundai. Additionally, Hyundai’s engine is more refined and quieter, while Honda’s is pretty audible inside the cabin (Singh, 2014).

Alternative Stakeholder View for Understanding Entropy

KBV, RBV and GCV held that if elitist firms developed increasingly higher-order resources, knowledge, and value chains through innovative combinations and creative integrations, they will be able to stay relevant with a competitive advantage on a sustainable basis. Central and common to all these three views is a strong belief in the isolating mechanism assumption – that complex knowledge, resources, value chains are difficult to substitute and imitate, therefore giving rise to firm heterogeneity, above-average returns and a competitive market share.

However, advantage built on KBV, RBV and GVC suffers entropy (i.e. erosion), if alternative stakeholders outside the value chains become salient. The ability of many emerging market firms to successfully compete with large elitist MNEs has precipitated a need for other alternative, and more inclusive, internal firm-based perspectives on strategic advantage. Entropy under dynamic environments arise from two broad category of factors: First, exclusion of relevant stakeholders and their interests, and second, inclusion of relevant stakeholders and their interests, but not upgrading the knowledge and technology infrastructure needed to serve these interests purposefully in competitive markets.

It is critical for the firms to continuously consider alternative stakeholder groups that are presently being excluded, and explore how it might serve their interests purposefully. In particular, the stakeholder groups that may have responsibility stake in the grand purpose of the firm should be included. For instance, a firm that seeks to be a world leader in smart phones may find low-income populations unable to afford its products. However, if these low income populations secure low cost smart phones or secure smart phone services at low cost, then they may become responsible stakeholders. The firm should decide whether it wishes to exclude certain group of stakeholders because it does not wish to serve them – for instance, a firm may be interested in relationships within its home region alone, or because it is not profitable for it to serve them. The profitability equation is variable and can change over time, based on the changes in the characteristics of the stakeholder group (e.g. income growth or preferences change) or in the technological inputs (e.g. design of low cost smartphones or availability of smartphone services at low cost, using a rental or shared use model to manage smartphone costs). Therefore, a stakeholder group that is not attractive presently may become attractive in future, and unless the firm continuously monitors the environment and find ways to bring greater inclusion, it may be subject to entropy forces.

Let’s identify three major factors contributing to entropy in dynamic environments, and label them as “eroding mechanisms”. As illustrated in Exhibit 3.x, eroding mechanisms counter the isolating mechanisms, and have powerful influence on the ability of the firms to sustain their strategic advantage.

Exhibit 3.x: Entropy Counters RBV, KBV and CCV in Dynamic Environments

Entropy in Competitive advantage

Non-consumer Mainstreaming: Research on innovation shows that new entrants often succeed using alternative sets of resources, knowledge and core competencies to address the needs of those presently not consuming a product, being underserved and/or overlooked. Christensen’s (1997) work Innovator’s dilemma finds most dramatic innovations occur when firms strive to design products addressing the needs of those who are not currently consuming a product. Christensen shows that in a number of industries, firms who introduced such innovations for non-consumers eventually gnawed into the advantage of firms who were focused on former consumers. Examples include the small off-road motorcycles introduced by Honda in the 1960s, Apple's first personal computer, and Intuit's QuickBooks accounting software. Though they seemed to be niche products initially, eventually they all created massive growth.

Entropy-effects of non-consumer mainstreaming have increased in the industrial markets, as firms have shifted their focus from empowering and sustaining innovations, to efficiency innovations (Christensen, 2013). The income inequity level has risen sharply worldwide, with nearly 80% of the world population – residing primarily in Africa and South and Southeast Asia – earning less than $2 / day. With increased globalization, there is an inter-firm rivalry jostling for capturing the left out 80% consumers.

Empowering innovations translates into transforming complex and costly products into simpler, cheaper, and redesigned products for a wider range of consumers. In the computer industry for example, there have been several waves of empowering innovations, which have expanded the consumer base from governments (mainframes, priced at $100,000+), to businesses (desktops), to urban consumers (laptops), and to even rural users (tablets – such as the $40 Akash tablet designed by the scientists in India and the US). Exhibit 3.x tells the story of Sony, once a pioneer in empowering innovations, who later became entrapped when even more empowering innovation became possible.

Exhibit 3.x: Sony – An Empowering Innovator Gets Entrapped

In the 1950s, Akio Morita, the founder of Sony, launched a series of miniature products, ranging from portable players, portable radio, portable television, and portable video recording. They had resounding success each time, as the established leaders failed to notice the disruptive effects until they lost the market totally. For Sony, each new wave of miniature products offered more attractive margins, and offered the motivation to invest in miniaturization core competence and its new application. In 2000s, with the rise of internet, downloadable music became a reality. Sony had a really big CD business, and had little motivation to invest in this business. That allowed Apple’s entry and rise in the music industry, using first the iPod and then the iTunes.

Source: Adapted from Christensen & Raynor (2003)

Sustaining innovations improve the performance of established products and services along the dimensions that customers in major markets are willing to pay a premium for. They contemporize products to be in sync with the needs, aspirations and lifestyle of today’s consumers for which they have much greater interest and willingness to pay. Examples include microprocessors enabling personal computers to operate faster; and battery enabling laptops operate longer. Overall with globalization, the number of firms pursuing sustaining innovations has increased; whereas, the ability of all firms to make meaningful sustained innovations, without undue cost increases, on a continuing basis has decreased drastically.

‘Efficiency’ innovations improve the cost-effectiveness of existing products, so that the consumers get greater value for their money with even superior quality. These are the types of innovations that many emerging market firms like Patanjali Ayurveda are following very successfully, to cater to the left out 80% market. Other examples of efficiency innovations include organizational innovations such as just-in-time manufacturing, online insurance underwriting by GEICO, and technological innovations such as the mini-steel. Exhibit 2x highlights the case of ministeel and dramatic efficiency innovations, that allowed greater mass access for cars and other steel-intensive products.

Exhibit 3.x: Ministeel as a disruptive efficiency as well as sustaining innovation

Minimills were a major efficiency innovation in the steel industry in the mid-1960s. Minimills, that used recycled steel for making steel, enjoyed a 20 percent cost advantage over integrated mills that instead used iron ore. Ministeels initially offered low quality steel and targeted a market underserved by the integrated mills. They offered rebar - small steel bars made from scrap – to create reinforced concrete. Rebar business accounted for only 4% of the integrated mills’ tonnage, and offered a gross margin of only 7%. The integrated mills were therefore happy to exit rebar business, and focus on higher-margin steel products. As the last integrated mill exited from the rebar business, and the growth opportunities in rebar business diminished, cut-throat competition among the minimills dropped the rebar price by 20%. To sustain their profitability and growth, the ministeels had to pursue sustaining innovations, to make better-quality steel in larger shapes, such as thicker bars and rods. For the integrated steels, this market tier was twice as large as the rebar market, and offered profit margins of 12%. The ministeels invested in equipment to make the larger shapes, and improved the quality and consistency of their steel. Again, the integrated steels had to exit this market, to focus on more profitable products. As the last integrated mill exited, the price of these thicker bars and rods also collapsed. This process of moving to the next upward tier continued, until the integrated mills ran out of markets to flee to. Source: Adapted from Christensen & Raynor (2003)

Political powerplay: Non-market factors, including governments and other social actors, play an important role in enabling competing firms to develop alternative sets of resources, knowledge, and core competencies. Let’s consider three types of political powerplays – predatory, regulatory, and reputation. At times firms experience predatory powerplay, i.e. regulators may be blindsighted by rivals who lower prices and assume losses for a temporary period in order to capture customers and vendors, away from existing firms. Conversely, regulators might impose very high taxes, liability and insurance costs, or audit and reporting requirements, thereby making an existing firm’s operations financially unviable. Finally, reputation erosion occurs as established firms become a target of reputation powerplay. Here, the consumers may choose to boycott large successful firms who are highly visible to various stakeholders and media, as they seek to push corporates to align more with their values of conscious capitalism, including green environment, human rights, and reasonable profits.

Globalization Games: We identify three types of globalization games that may erode the advantage of established firms:

Development Games – governments in emerging markets may support the development of their firms using a variety of means - e.g. they may compel foreign firms to transfer intellectual properties with limited compensation, and/or they may be lax on issues of human and environmental rights. They may also use public investments for acquiring raw materials from around the world and then offer them to their domestic firms at below market costs; and/or, they may manipulate their exchange rates if they are an export-driven economy. As a matter of fact, the Chinese government is known for aggressively pursuing all these means. Thus, when governments focus on these development efforts for specific sectors with large emerging markets, firms in other nations may suffer rapid erosion of their strategic advantage.

Trade Games –governments in industrial markets may promote industries that are capital and technology intensive as these require specialized skills, offer scope for improving productivity in their nations, and sustain well-paying jobs both in production and service offerings. They may use state-funded enterprises and defense initiatives for the initial development of the industry, offer fiscal incentives, R&D and training subsidies, and state partnership to their domestic firms. For instance, the Canadians supported aircraft development through state-run Canadair, supported Technology Partnerships Canada (a form of R&D assistance), Export Development Canada, and military contracts for maintenance and training. Similarly, many governments in Europe came together to promote and support Airbus in order to create a viable European aircraft alternative to Boeing of the USA. Boeing had to lobby hard with the US government in order to regulate and contain the European government support for airbus, and to sustain its strategic advantage.

Industry Games – in a global environment, every national region looks to offer different types of strategic advantages to the domestic firms, because of their industry base, education and skill base, innovation initiatives, and investments involving enhancement of productivity of the local workforce including places where an affordable cost of living allows labor costs to be dramatically low. Due to this, global production and service patterns are subject to rapid change; and these changing patterns in turn offer new opportunities for trade and exchange, enabling even new or less known firms to dramatically improve the cost-effectiveness, design, and value of their products over the established firms.

In the 1990s, the PC market was mostly a corporate market (roughly 75% of volume). Corporate buyers wanted a commodity. They were buying 500 or 5000 boxes, they wanted them all the same and they wanted to be able to order 500 or 5000 more roughly the same next year. They wanted to compare 4 vendors on price with the same spec sheet. They didn’t care what they looked like (and they were going under a desk anyway) and they didn’t care how easy it was for non-technical people to set them up because the users would never touch the configuration. Nor did they care much about the user interface, because most of the users were only going to be running 1 or 2 apps anyway. That resulted in what Christensen & Raynor (2003) referred to as low-end disruption of the personal computer market – the profits of desktop manufacturers fell dramatically, and they were forced to change their business model to essentially assembly. The industry changed from being integrated into disintegrated, and the products evolved into modular architecture, that offered users freedom to customize their computer using off-the-shelf parts and software. Source: Adapted from Evans, 2013

Upgrading Strategies View for Including Alternative Learning as Complementary Value

Investments in knowledge-based technological inputs and infrastructure are a major way to upgrade the value proposition delivered to existing stakeholders, while also becoming relevant to additional stakeholders. Upgrading means acquiring the technological, institutional, and market capabilities that allow firms (or communities) to improve their competitiveness and move into higher value accruing (i.e. rent-rich) activities (Mitchell, Keane & Cole, 2009). In the network-wide value linkages, upgrading is the key to realizing sustainable incomes and thus sustainable competitive advantage. Upgrading allows firms to improve their position in existing value system, or to access a more viable value system. There are seven types of strategies for a firm seeking to upgrade linkages in its value system:

1) Process upgrading: It involves improving efficiency of the processes in the value system through greater economies of scale or learning. Economies of scale help to reduce the fixed cost per unit through increased volumes, while economies of learning help to reduce the variable cost per unit through increased productivity. Improved technologies and techniques, improved materials, improved manpower, and improved marketing coordination, are different ways of achieving increased productivity.

2) Product upgrading: It involves improving the quality of the products in the value system, by improving the differentiation of the existing products, or by adding new lines of better differentiated products. Product upgrading is often critical to survive in the global value system and to access global markets, for instance, to meet the new hygiene standards, or to meet fair trade and organic demands, or to match the next-generation technology-based products offered by the rivals. The resource poor firms often lack sufficient knowledge of the market or competitive demands, or resources to upgrade their products to be aligned with these demands. Therefore, they may need alternative strategies.

3) Functional upgrading: It involves changing the mix of functions performed, such as adding a new value-added process, or eliminating a process that is adding little value, or moving to an entirely different set of functions in the same value system. For instance, a farmer may start processing its output to add value, or may become an apple retailer leaving aside apple farming. Or it may work with other farmers to exclude an intermediary and market directly as a group to the supermarket, with the functions of the intermediary being redistributed between the farmer group (e.g. grading and packaging) and the supermarket (e.g. credit and transport). In this case, farmers gain assured markets, higher stable prices, and favorable payment terms; while the supermarkets reduce their procurement costs and gain the reputation of selling high-quality, fresh produce (Singh, 2008).

4) Horizontal coordination: It involves developing relationships among firms engaged in specific processes, or functional nodes, such as cooperative or merger relationships among the design firms, or producer firms, or processing firms, or marketing firms, or distribution firms, or support firms. The resource poor firms can achieve economies of scale in their supply chain and reduce their transaction costs by coordinating with other similar firms. Pooling of resources and sharing of costs among members can help to invest in process and other forms of upgrading. Pooling of production can help to deliver feasible volumes that attract larger buyers and open up new market opportunities. Clustering can also help to attract suppliers and offer access to services such as credit and input purchases on favorable terms, and training and technical support. Collective action improves bargaining power as well as connectivity of the resource poor, and therefore their negotiation outcome of the terms of engagement in the global value system. Collective groups are also able to govern member behavior, by framing and enforcing appropriate codes of conduct desired for vertical qualification, and encouraging self-governance and monitoring.

5) Vertical coordination: It involves developing relationships among firms engaged in different processes, or functional nodes, such as cooperative or merger relationships among the producer firm(s) and the design firm(s), the producer firm(s) and the support firm(s) that offer credit to customers for purchasing. It implies replacing one-off spot transactions with longer-term relationships, such as subcontracting of design, intermediate inputs or support services function. It brings greater certainty about future cost structure or revenue flows, and encourages exchange of knowledge and support for improving capabilities of vertical partners. It requires building of trust relations between the buyer and the seller in a vertical, which may be slow and difficult to achieve if the terms of contractual exchange do not remain at least as good as the terms of open market exchange for all participants. For instance, if a firm offers training to its supplier in exchange for a captive purchase contract of parts for the new generation television it makes, then the supplier may have an incentive to build parts for rival firms – if the firm does not offer it its desired scale or value of purchase.

6) System upgrading: It involves a firm using the resources, capabilities and core competencies developed in one value system to productively diversify or shift into another – usually more profitable – value system in a different sector or region. For instance, a firm engaged in commodity-type low-grade rice for local rural market products may shift to export-quality high-grade rice or fruit. These are entirely different value systems with hugely distinct markets, channels, standards and dynamics (Mitchell, et al, 2009). However, it may be difficult for the resource-poor firms to engage in system upgrading on their own. Unless they have support, they may need to seek sectors or regions that have fewer barriers to their fair share, and where they could extend their limited resources without any additional dependency. For instance, they might move to another nation to perform the same activity, or take up another sector, such as fishing. Sometimes system upgrading may result in a shift in who participates in the value system. Dolan (2001[footnoteRef:2]) studied the case of East African horticulture. Traditionally, this industry was female dominated, with women selling produce on the local market and using the income for household needs such as food and education. When the MNCs and the government worked to upgrade the system through higher-value export contracting, the sector attracted men. Men traditionally owned the productive assets like land and took over the control of marketing and incomes, while women were relegated to just provision of labor in the farms. Other studies indicate that even when the gender relations in the value system act to exclude women from earnings, the improved nutritional outcomes and food security for the entire household may imply overall improvement in the life condition of women (Mitchell, et al, 2009). [2: Dolan, C.S. (2001) “The “Good Wife”: Struggles Over Resources in the Kenyan Horticulture Sector‟. Journal of Development Studies 37(3): 39-70.]

7) Context upgrading: It involves enabling changes in the policy, legal, governance and institutional environment to improve the functioning of, and cooperation and fair sharing in, a value system. It includes implementing codes of conduct governing relationships and operational standards at firm, industry or regional level.

In practice, it is difficult for the firms to implement any of the upgrading strategies in isolation. A firm’s business strategy must consider the sequential path, or upgrading trajectory involving a shifting priority on the different upgrading strategies. Business strategy may be based on three major upgrading sequences.

· Ascending upgrading strategy: Many resource poor industrial firms succeed using a bottoms-up upgrading sequence. They start with process upgrading, and then move into product upgrading, followed by functional upgrading and finally system upgrading. This is exemplified by the experiences of the firms from East Asia.

· Horizontal upgrading strategy: It is difficult for the poorest of the resource poor firms to upgrade using a bottoms-up sequence, because they face significant barriers for any meaningful process upgrading or for moving up the sequence. Often, they play only invisible or marginal roles in the global value system, and lack sufficient resources, capabilities and competencies to offset the barriers faced. In these cases, a successful strategy often begins with horizontal coordination – whereby association with others facing similar barriers pools available resources and brings power to overcome the barriers, and to connect with appropriate vertical links in the system, such as inputs or marketing services. It allows accruing incremental value, and generates new resources that can then be invested into functional, product, process or system upgrading. As an example, farmer groups are in a better position to invest in dedicated centers where they can take on new functions such as grading and packaging of fruits and vegetables to meet differentiated requirements of various buyer groups (Mitchell et al, 2009).

Horizontal upgrading strategy is particularly effective when it builds on the group structure and leadership linkages pre-existing among the individual firms. Otherwise there is a risk that the externally imposed collective structure may harm the poorest of the resource poor, such as women and low-income rural firms, if the traditional norms impose barriers on their inclusion and connectivity with the newly form collective group. As an example, beekeeping firms in South India worked with their federation to invite local honey traders to become their Professional Marketing Agents, and six traders agreed. This allowed beekeeping firms to access large buyers across India through these traders (Mitchell, et al, 2009). Exhibit 3.x illustrates another example of horizontal upgrading strategy by women-owned small firms in India.

Exhibit 3.x Horizontal Upgrading Strategy by Women-owned small firms In India, incense stick (agarbatti) industry comprises primarily of cottage-based firms. One of the stages in the incense stick value chain is production of raw bamboo sticks. In Tripura state, 15,000-20,000 women are engaged in this stage. They earned less than half a dollar a day, because this stage was previously seen as providing low, marginal value-added. These women entrepreneurs were unable to access raw materials owning to environmental policy constraints, efficiency produce in high volume, and make products of required standard and quality. As part of a horizontal upgrading project, these women were organized into smallholder groups, who participated in a larger rural marketing network and represented at Joint Forest Management Committees. These institutions enabled women to participate in new ways to add value through improved bargaining power in vertical relationships, dissemination of technical and market knowledge, and successful lobbying for changes in the input supply policies. Source: Adapted from Mitchell, Keane & Coles (2009)[footnoteRef:3] [3: Mitchell, J., Keane, J, & Coles, C. (2009). Trading Up: How a Value Chain Approach Can Benefit the Rural Poor, COPLA Global - Overseas Development Institute, London: UK.]

· Descending upgrading strategy: Government or MNCs may decide to invest in system upgrading, in response to the demands from the society or the customers, or to support their development priorities and agenda. These top-down initiatives may give an opportunity for the resource poor firms to join an upgraded value linkage, and to access dedicated support for functional, product, and/or process upgrading.

A special form of descending upgrading strategy involves a lead party – such as a major MNC buyer or a large local firm – taking on the role of governance, i.e. coordinating actions of the vertical participants in the value system. One supermarket chain in India aims to be the first choice buyer for all the small suppliers it deals with. It issues information on its specific requirements to its suppliers and, if it cannot buy the production at a certain time, introduces the suppliers to alternative buyers (Singh, 2008)[footnoteRef:4]. Vertical relationships reduce price volatility and vulnerability for the contractors, and helps them access services such as access to credit, technical support, capital equipment, and discounted bulk input supply (through the contracting firms). The stability of assured incomes creates incentives to invest in process, product and functional upgrading. One study found that more direct linkages with buyers facilitated transfer of skills in dairy processing to Egyptian women, and led to female empowerment as household resources were reallocated as a result of increased incomes of these women (ACDI/ VOCA, 2007)[footnoteRef:5]. The contracting firms (the lead party) benefit from assured quality and supply, reputation, and capacity for diversified sourcing channels without major investment. An example of the vertical descending support of horizontal upgrading effort by a major MNC buyer is illustrated in Exhibit 4.x, which shows how Starbucks worked with coffee farmer cooperative in Mexico. [4: Singh, S. (2008) “Leveraging Contract Farming for Improving Supply Chain Efficiency in India: Some Innovative and Successful Models”. Acta Horticultura 794: 317-323.] [5: Agricultural Cooperative Development International/Volunteers in Overseas Cooperative Assistance (2007) “Agricultural Export and Rural Income (AERI) Dairy and Livestock Program‟. Final Report. Washington, DC: ACDI/VOCA.]

Exhibit 3.x Descending Upgrading Strategy supports horizontal cooperation in Mexico In the past, Starbucks received coffee directly from coffee farmer cooperatives in Mexico. Farmer cooperatives were not competitive at providing their members with services such as negotiating with processors, so the American NGO Conservation international (CI) facilitated these roles. The cooperatives also found it difficult to manage export procedures. Therefore, Starbucks worked with CI to find a third-party for export services. The third party bought coffee directly from the cooperatives, and then exported that to Starbucks, at contractually specified prices. The improved chain efficiency helped to reduce the transaction costs for Starbucks, and allowed coops to earn greater incomes. Cooperatives also got paid earlier on delivery to the third party, and benefitted from the reduced risk of returned shipments, because the third party undertook quality control locally. Source: Adapted from Millard (2004)[footnoteRef:6] [6: Millard, E. (2004) „Increasing Profitability for Farmers Supplying to the International Coffee Market by Improving Supply Chain Management, Including Traceability‟. Research report. Washington, DC: Conservation International.]

Isolating mechanisms

Causal ambiguity

Path dependency

NIRV test for erosion and value

No substitution through trading or mobility?

Inimitable resources?

Performance

Basis for competitive advantage

Competive exclusivity

Rare advantage?

Value accrual sufficient?

Sustainability of competitive advantage

Buyers in Europe, Middle East, South Asia

P=$700/kg

Re-exporters South Africa

P=$200/kg

Exporrters

Mombasa

P=$120/kg

Traders in Eldoret and urban regions

P=$75/kg

SAP Processors in rural areas

P=$50/kg

Aloe Harvesters in rural areas

Brokerage agents in Nairobi

Packaging

Shipping

Road transport

Market information

Storage & Bulking up

Quality control

Fuel saving technology

Harvester coordination

Techical extension

Core competencies

Social Complexity

Knowledge combination

Core products

Economies of scope

End products

Perceived customer benefits

Firm performance

Creates competitive advantage

Sustains competitive advantage

Knowledge integration

Eroding mechanisms

- Nonconsumer mainstreaming

- Political powerplay

- Globalization games

Isolating mechanisms

- causal ambiguity

- path dependency

- competitive exclusivity

Hetergoneity or uniqueness of a firm's knowledge base, i.e. capabilities

The evolutionary theory -

local knowledge processes, i.e. organizational routines for articulation, replication, integration and combination

Organizational learning theory - local learning by doing & by using

Increasing returns theory -

economies of scale and scope from knowledge transfers