Podcast Transcript: Climb up the value chain
If you think a value chain is that gold necklace you just bough at that discount strip mall jewellery store, you may want to listen in for the next 18 minutes.
I am talking of course about global value chains, the ubiquitous business concept that can, according to my next guest, shape who makes it and who doesn’t in today’s increasingly competitive, and constantly changing, marketplace.
I’m Michael Mancini, Editor-in-Chief of CanadExport Magazine, the e-magazine of the Canadian Trade Commissioner Service. By the way, you can check us out online at canadexport.gc.ca.
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With me to break down global value chains—and to build them up for you too—is Professor George Yip, Dean of the Rotterdam School of Management at Erasmus University in the Netherlands. Thank you very much for taking the time to speak today.
Dr. George Yip: Hello, Michael. Pleased to be with you.
Michael Mancini: So as you know, we're here to talk about global value chains, what they are and why they matter. First of all, what exactly are global value chains?
Dr. George Yip: Well, before we get to the global part, let me just talk about what a value chain is. A value chain is the chain of activities that a business undertakes in order to produce and sell a product or a service. So typically a value chain would start at the very front end with research, which then leads to development of a product design, which then might lead to the purchasing of the materials you need to make it, the processing of the raw materials, sub-assembly, final assembly, then distribution, marketing and selling, and after-sales service. So that's a typical chain.
Now, with globalization, it simply means instead of doing everything in just one country, typically the home country, you move some of the activities overseas. So of course the big trend over the last 20 years has been the move of some parts of assembly or production to lower-cost countries such as China or India. But it's not just that activity. Some companies might move research so that they can access better scientists. So a lot of research now takes place in Singapore, or they might go to Russia, which has some very good scientists and not so expensive either. Or in another interesting example, a few years ago Sony moved the head office of its finance function, which is also part of the value chain in a sense, to New York because New York at that time was the capital of global finance—was the global capital of finance.
Michael Mancini: What is the difference between a global value chain and a global supply chain?
Dr. George Yip: Oh, a global supply chain is a subset of global value chain. So a supply chain is simply the procurement, and perhaps through the production. The value chain is everything, starting from research through development through to the distribution and after-sales service.
Michael Mancini: Now we're hearing a lot more about global value chains these days. Is the concept of global value chains new?
Dr. George Yip: It's been accelerating. And of course it goes with globalization. Globalization in the sense of what has happened, again, in the last 20 years with falling trade barriers, previously closed countries opening up to the world economy, including the Soviet bloc, including China and India, improving transportation, falling transportation costs, improving telecommunications, all of which has made globalization more possible, so that now, when companies think about their activities, instead of assuming everything should be done in the home country, they increasingly think what is the best other country or combination of countries to do each activity.
Michael Mancini: So why are global value chains important, then?
Dr. George Yip: Well, in the end, companies are looking for competitive advantage and higher profits. So for example, you can go somewhere to get lower costs—that's a very important source of competitive advantage—and higher profits as well. But you can also go abroad to get better quality. I mean, there are many activities now where you… for example, where you need very sort of dextrous manual labour, hard working, as in electronics, where you probably actually get better quality in China than you might get in Canada or the United States. So there's an opportunity to improve… to lower costs, opportunity to improve quality.
A good example's the company that most of us are familiar with, which is BMW. And BMW would have different activities… BMW has different activities in different countries. The… the final assembly is still done in Germany, but significant parts of various activities are in joint ventures in places like China, which will make parts of its components for it, and then it gets shipped back to Germany for final assembly.
Michael Mancini: Is a competitive advantage based on low labour costs sustainable?
Dr. George Yip: Well, of course most companies, particularly from Canada, are not just selling a low-cost product. It's… the low-cost labour then supports the proprietary product that has some technology, etcetera in it. So it's necessary but not sufficient is the way to think about it. And not having the low-cost labour can make you uncompetitive. So I think for a… for a Canadian company, obviously you cannot rely just on low-cost labour in some other country because then you have nothing to offer. But a Canadian company should be able to offer a superior business model, superior technology, superior design, superior management, supplemented by using lower labour costs through a global value chain.
Michael Mancini: What are the emerging regional blocs in global value chains? Who's going where for what?
Dr. George Yip: Well, in… in recent years of course western companies have… or… or… or companies from developed countries—the west and also Japan as a developed country—have been going primarily to Asia to get lower costs, particularly to China. At the same time, people are also doing it regionally. So within NAFTA, the North—and of course one of the purposes of NAFTA was to encourage regional value chains. So US companies went to Mexico to do a lot of their assembly work, so the maquiladoras. These factories just over the border, that's the name for them…the generic name for them. And many of them sprung up along the US-Mexico border. And because of the lower costs and the lower value of the Canadian dollar, many American companies such as General Motors moved a lot of their value chain activities over to Canada as well. So that's the regional effect.
In Europe, Germany is a prime example of shipping activities out east. So Poland is Germany's Mexico, for example, moving their activities to Poland or to other central and eastern European countries. And similarly, Japan within its region has moved a lot of activities to China or Vietnam or other lower-cost countries in that area.
Michael Mancini: Let’s talk a little about the different ways to approach global value chains. You can build your own global value chain, but you can also tap into one, sell into one. Can you give me an example of a company that has built its own value chain?
Dr. George Yip: Well, a lot of the bigger companies build their own… build their own value chains. So someone like a Phillips in the Netherlands, you know, has now sort of set up its own factories in China and in other places around the world. Volkswagen of course set up a factory… has a very extensive factory operation in Brazil. So in general, the big companies build their own value chains, and smaller ones then become suppliers into that value chain. Perhaps the most extreme example of that is an Indian company called Sundram Fasteners that narrowed down its product line to make radiator caps for General Motors and is now the global supplier of radiator caps to General Motors.
Or another example, Ràba, a Hungarian company that used to make trucks but, after the Iron Curtain came down, it found that its trucks could not compete with those made by Mercedes, Volvo and other western companies, so it focused down to making axles. So now it is part of the, you know, axle supply chain for companies like Mercedes.
Michael Mancini: But how do I figure out if I need to move a part of my operations abroad? And when I do figure that out, how do I know where to go?
Dr. George Yip: There are two ways to do this. The first one is benchmarking. So if your competitors are already doing it, you can benchmark what they're doing and see if they're getting an advantage from doing it. So if your other Canadian competitors or other global competitors—American, European and so on—are doing it somewhere else and getting lower cost or higher quality or both, then you'd better do it yourself. Alternatively, you could be a pioneer where you could think well, I… I… I'm conducting an activity already. Let's think about whether I could do it more cheaply somewhere else.
A third way to think about it often is… has to do with the scale of things. There are some activities where another provider in another country, by doing it for several other companies, can just do it at lower cost on a bigger scale. A simple example would be call centres. If you're a Canadian company operating a call centre, Canada has only… well, at least the main part of Canada has, what, three or four time zones. So a call centre might operate only ten to 12 hours a day. But if you go to a call centre that services the world, a call centre out of India, it might be able to operate 24/7 and therefore have lower fixed costs.
Michael Mancini: So what are some of the big challenges companies face as they seek to build their own global value chain?
Dr. George Yip: Well, probably the biggest problem is coordination. Once you send something a certain distance away, it's not right next door to you, you increase the coordination cost. So that's one problem. Another problem could be loss of proprietary knowledge, particularly if you're now outsourcing and offshoring at the same time. So those… those are the two… those are the two biggest challenges.
Michael Mancini: And so how do you deal with those challenges?
Dr. George Yip: Well, you actually have to put in processes to do the coordination. At a minimum, you have… you might send well trained, experienced managers out to the overseas site to supervise what's going on, send people going back and forth, have regular conference calls, shared in… you know, Intranet website to share information, regular e-mails, regular phone calls to do that. So that's the coordination issue.
In terms of protecting your proprietary knowledge, you try not to give away information to the outsource companies that's not completely… that's, you know, not totally necessary for what they have to do. So to some extent, that means modularizing what you're dong, and perhaps keeping the more secret parts back at… in the home country.
Michael Mancini: What do you do if you're a resource-constrained company looking to become more efficient by using and tapping into global value chains?
Dr. George Yip: Probably if you shrink your product line—going back to that example of the Indian company that shrank down to just making radiator caps. So devote your resources behind a smaller number of product lines, and then find the best place to produce that product.
Michael Mancini: Are the particular challenges of selling into a global value chain similar to those that you just mentioned when it comes to building your own value chain?
Dr. George Yip: There's some of that. But when you sell into a global value chain, you yourself tend not to be dispersed, so it's actually a different problem. So people are selling into a global value chain tend to be sitting in one country, and then they're shipping their products elsewhere. So they have the reverse coordination problem. They have to coordinate with their customer to make sure that they're really delivering what the customer wants at the right time.
Michael Mancini: Now, I’d like to read a quote of yours. You’ve said that global companies don't have to be everywhere, but that they must have the capability to go anywhere, deploy any assets, and access any resources, thereby maximizing profits on a global basis. Now, that sounds very difficult. How does a company become that nimble, especially SMEs?
Dr. George Yip: I wrote that down as an aspiration. And whenever I do workshops or consulting, I ask companies to score themselves out of ten on that capability. Nobody has ever scored themselves out of ten yet. But that's what they can think about doing. I think first an SME, the objective is really to be very good at one capability in one region. And particularly for an… an SME should really think of itself as being part of somebody else's value chain in most cases—well, or at least if it makes an intermediate product. So it doesn't have to be everywhere. If an SME is making a final product, then, you know, to some extent, it applies. The… being able to go anywhere, which is… they have defined the best place in the world to make the product or service that they're going to sell, because if they don't go to the best place in the world, somebody else who's a competitor is going to do that. So it's a tough standard, but that's the standard you have to meet if you want to be fully competitive.
Michael Mancini: George some might say that a company doesn't need to go global. They don't need to tap into global value chains. All you have to do, if you're a manufacturer for example, is adopt lean manufacturing standards in your home country to make the same profit gains, and that plugging into value chains really is not necessary. Is this true?
Dr. George Yip: Lean manufacturing is very good, of course. But if you're in a country with high labour costs, and labour is a high component of your costs—or there may be some other things: energy costs are a high component and you're a country with high energy costs—then you are going to have to globalize your… your value chain in any case. Or if you're in a part of the world with very poor logistics or access to distribution, then you're going to have to relocate to somewhere else that has better access. So lean manufacturing is not enough.
Michael Mancini: In the next five years, how do you see global value chains shifting?
Dr. George Yip: Well, actually, the most interesting development over the next five years has been this year's rapid rise in the price of oil. Global value chains depend on low transportation costs. But the high price of oil will make transportation costs higher. And already we're starting to see some companies bringing production back to high-cost countries like Canada, like the United States. So I… I think there will be some rethinking trend like that over the next five years.
At the same time, I think we'll still continue to see many other companies continue to develop global value chains. But I think the concept is now established, which is basically a sort of a zero-based thinking. Don't assume that you have to conduct activities in your home country, or in fact in any country. You know, just constantly rethink where an activity should be, while of course recognizing the cost of shifting something and the cost of disruption. But just sort of have this zero-based mind set.
Michael Mancini: Well what impact do you think this kind of volatility will have on global value chains and firms looking to take advantage of them? I mean, if the price of gas is… is… is high one day and not another, it makes taking advantage of global value chains that much more difficult, I think, especially for SMEs.
Dr. George Yip: It is more difficult. It means people will have to have more duplication, contingency plans, not… you know, put all their eggs in one basket or all their factories in a single country that's far away. So more flexibility and less commitment. Which leads to higher costs in the end. You get the lowest cost with the maximum commitment and the minimum flexibility. Flexibility costs money, in the short-term anyway. The more volatility there is, the more flexibility you have to build into your value chain system.
Michael Mancini: Professor George Yip, thank you very much for speaking with me today.
Dr. George Yip: Thanks very much. I enjoyed it.
Michael Mancini: I've been speaking with Professor George Yip, Dean of the Rotterdam School of Management at Erasmus University. He spoke to me from Rotterdam, in the Netherlands.
Well, that’s all for this podcast edition of CanadExport.
Now before you turn me off, I invite Canadian entrepreneurs to go to tradecommissioner.gc.ca. It’s where you can find the Canadian Trade Commissioner Service, Canada’s most comprehensive network of international business professionals.
You might also want to visit our resource section at tradecommissioner.gc.ca/eng/gvc that features useful links to global value chain websites.
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I’m Michael Mancini, signing off for now.
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