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IE 463 Lecture 7

GLOBAL PRODUCTION NETWORKS,

STRATEGIC ALLIANCES

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PRODUCTION NETWORK

• Production network is a group of agents who establish “continuous” business relationships among them along time (the necessary but not sufficient condition),

• network relationships, in turn, result in the self- coordination of autonomous agents,

• there are “price” relationships of the input-output type (purchase and sale relationships between the agents),

• there are “no-price” relationships, since the agents do not act in isolation but exert influence on each other’s decisions (flows of design or quality, development of a common language, organizational learning, sharing of information, knowledge or capabilities etc.),

• production network is a coordination tool that builds or transforms the market structure

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1. Virtous network:• linkages among the agents tend to be long-termed • there are joint developments of processes and products

among the firms• the relationship regulatory mechanisms are subject to

negotiation by all the agents and not only by the organizers

• the innovative capacity is high and not exclusive of a reduced number of firms

• there is a certain homogeneity in the labor and technical skills, which facilitates the generation of a common language

• there is strong relationship between the development of the network’s innovative capacity and,

- the form adopted by the work organization - the mechanisms for the generation of consensus-based agreement

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Virtuous networks are innovative because of;• quality assurance, • training processes (human capital),• implementation of incremental developments of products and processes,• a strong interdependence among the agents (social capital). The development of mutual trust and/or informal relationships is achieved by;• the importance of no- price exchanges, • the development of joint activities that generate lower collective uncertainty levels,• the development of informal discussions,• a common language that creates a permanent tacit knowledge and new competitive advantages.

They are “open systems” that strongly interact with other “networks” and technological and educational institutions!

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2. Weak network:

• low linkage level among the firms,

• significant predominance of hierarchical relationships, centered on the organizer/s, contractual or agreed upon conditions within frameworks of strong dependence,

• poor dissemination of cooperation and information and knowledge exchange mechanisms, by the lack of a common language or by the exclusive ownership of such language by some members,

• “intangible” assets flows are limited and, if any, they are unidirectional,

• almost no joint developments exist,

• the design of products is virtually centered on the coordinating agent on an exclusive basis,

• there are strong heterogeneities in the development of innovative capabilities of individual firms and in the manner social relationships are managed.

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relationships

virtuous network weak network

relationships, in addition to certain conditions, are also supported by;

• strong linkages

• trust

• collaboration• intangible flows (no-price

exchanges)

• informal contacts

• horizontal links

relationships are exclusively

supported by the requirement to

fulfill certain conditions, • with no counterpart of no-price

exchange flows• poor knowledge dissemination

due to the verticality of links

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VALUE CREATION IN A NETWORK

“The creation of value is fundamental in all business activities” Value in a networks is created and realised during the exchange of a resource between its firms. It proceeds via the management of the imbedded,• network resource layer and• network exchange layer1. Resource layer: resources are used in combinations. In a production network, resources of different firms are “tied” to each other; they are deployed and combined over firms’ boundaries. Resource combinations that are tied but not exchanged constitute the resource layer. In this layer, resources are combined and activated by those actors who share some knowledge and experience.

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All the resource combinations that are connected but not exchanged in the network constitute the resource layer.

Resource layer durability depends on,•the complementarity of the resource combinations (partners provide different knowledge, equipment, skills etc. to the activity, complementing resources are devoted to a specific relationship)•the transferability of the resource combinations (defined by the extent resources can be used in other combinations and transferred to external agents, and by the cost for finding and using replacement)

A resource that is highly substitutable often has low

complementarity in the network. A production network

resource layer should exhibit high complementarity and

low transferability so that there is high multilateral

dependence of actors’ resources.

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Firms recombine, not only the internal resources within the firm but also the resources within the network over firm boundaries. These combinations, in turn, are tied to each other within the network.

2. Exchange layer: Resources (goods and services) are used, processed, developed and exchanged between firms in order to create value. Since the business relationships are connected to eachother and constitute a network structure, the dyadic relations between two actors are embedded and thereby affected by a larger exchange network.

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focal supplier

focal resource exchange focal

customer

supplier’s supplier

supplier’s supplier

supplier’s customer

supplier’s customer

customer’s supplier

customer’s supplier

customer’s customer

customer’s customer

parallel supplier

: resource exchange

EXCHANGE LAYER

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RESOURCE AND EXCHANGE LAYERS

actor actor actorresource exchange

resource exchange

resources activated

resources activated

resources activated

multilateral dependence

The ability to realise a product’s value in an exchange, depends on how well the resource collection is utilized in value creation.

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GOVERNANCE STYLE

An important dimension of production network is itsgovernance style since governance styles play important roles in the reorganization and relocation of industries;

1. Authority production networks:

• intra-firm networks rely on the authority of

administrative control for governance, and thus relate to

the internal workings of the firm

• in captive production networks, dominant lead firms

exert power akin to the managerial control in the

vertically integrated firm to coordinate tiers of largely

captive suppliers (eg. Japanese supply networks).

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The advantages of such close buyer-supplier linkages are high efficiency, stimulated by technological upgrading in the supply base, close coordination of “just-in-time” deliveries, and flexibility in the face of market volatility, as workers and suppliers are redeployed on short notice.

2. Relational production networksRelational production networks tend to be built through social and spatial proximity and especially through long term contracting relationships between firms, • those networks built largely through spatial proximity are

referred to as “agglomeration networks” • those that rely on social proximity alone are referred to as

“social networks”

Often, social and spatial proximity are closely related.

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Relational production networks tend to be embedded in larger “socio-economic systems”, in some cases allowing the temporary redeployment of workers to agriculture or the “informal” sector when the demand requirements of buyers change suddenly. Relational production networks can adapt to volatile markets quite rapidly. The trust, personal, and familial relationships of the community enable individuals and small firms to take on new roles as conditions change

3. Virtual production networksAmerican companies have responded to the pressures of international competition by developing their ownnetworked production-the virtual production network. It is based on linking highly innovative but deverticalized lead firms with sets of highly functional suppliers.

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Turn-key suppliers provide a wide range of production-related services, including logistics, process engineering, component purchasing, manufacturing, assembly, packaging, distribution, and even after-sales service, while lead firms provide the innovative muscle and marketing clout to drive and define the market for new products. In some industries, such as motor vehicles, suppliers perform module and component design tasks as well.

The principal difference between American-centered virtual production networks and Japanese-centered captive production networks is the merchant character of turn-key suppliers, which is achieved through the development of a large and diverse pool of customers,

and the relatively arms-length relationship lead firms maintain with their suppliers, which is achieved by maintaining a small but interchangeable pool of suppliers.

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Production networks that rely on turn-key suppliers allow buyers to easily to connect to and disconnect from a set of merchant service providers. The result is a highly flexible system characterized by fluid relationships (low barriers to entry and exit), geographic flexibility, low costs, rapid technological diffusion, and powerful external economies of scale and scope.

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GLOBAL PRODUCTION NETWORKS

On the broadest level, the term globalization refers to the

growing global-scale inter-connection and integration of

human activity. These inter-connections are expressed in

many areas of society and economy. In the arena of

economic integration, the term globalization also

encompasses a wide range of phenomena, including,

1. cross-border integration of financial markets

2. increased global-scale market competition

3. wholesale and retail trade

4. increased foreign direct investment

5. increased cross-border contracting and global-scale production networks

6. formation of international joint ventures and strategic alliances for R&D

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Firms internationalize when they invest in new “offshore” production capacity that is operationally discrete from domestic capacity. GM’s investments in Europe are a good example. These operations were begun, in the 1920s, with acquisition of local European firms (Opel and Vauxhall) that continued to develop, manufacture, and sell a set of products that were almost completely distinct from those developed and produced by the parent company’s home operations.

Firms globalize when they attempt to integrate key day-to-day functions on a global scale, such as component sourcing, vehicle development, new model introduction (the US “Big Three” automakers’ investments in Mexico are a good example).

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As such, globalization does not necessarily include the establishment of new offshore capacity, since efforts can be made to upgrade and integrate existing offshore operations with domestic operations (GM’s currenteffort to coordinate vehicle development at its Opel, Lansing, and Saturn divisions is a good example, as is the move to current models at older plants in Brazil).

• Internationalization processes involve the simple extension of economic activities across national boundaries. It is, essentially, a quantitative process which leads to a more extensive geographic pattern of economic activity.

• Globalization processes are qualitatively different from internationalization processes. They involve not merely the geographical extension of economic activity across national boundaries but also—and more importantly—the functional integration of such internationally dispersed activities.

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GLOBAL COMPETITION - LOCAL KNOWLEDGE

In response to the increasingly demanding requirements of global competition, three interrelated transformations have occurred in the organization of international economic transactions:

1. Global production networks (GPN) have proliferated as a major organizational innovation in global operations

2. GPNs have acted as a catalyst for international knowledge diffusion, providing new opportunities for local capability formation in lower- cost locations outside the industrial heartlands of North America, Western Europe and Japan.

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3. “digital convergence” of communications media, enabling the same infrastructure to accommodate manipulation and transmission of voice, video, and

data, has created new opportunities for organizational learning and knowledge exchange across organizational and national boundaries, hence magnifying the first two Transformations.

The combination of these three transformations has

changed dramatically the international geography of

production and innovation,

• there is a transition from Multinational Companies (MNC) to Global Network Flagships, that integrate their dispersed supply, knowledge and customer bases into global (and regional) production networks

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• GPN operations disseminate important knowledge to local suppliers in low-cost locations, which could catalyze local capability formation

Knowledge transfer is not automatic! It requires a

significant level of absorptive capacity on the part

of local suppliers and a complex process to internalize

disseminated knowledge.

Driving forces of GPN

1. liberalization,• trade liberalization• liberalization of capital flows• liberalization of Foreign Direct Investment (FDI) policies• privatization

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Global corporations are the primary beneficiaries of liberalization,• a greater range of choices for market entry between

trade, licensing, subcontracting, franchising, etc. (locational specialization)

• better access to external resources and capabilities that a flagship needs to complement its core competencies (outsourcing)

• reduced the constraints for a geographic dispersion of the value chain (spatial mobility)

2. rapid development and diffusion of information and communication technology (IT),• they increase the need and create new opportunities

for globalization - lower cost and risk of communication,

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- dispersion of firm-specific resources and capabilities across national boundaries; greater scope for cross-border linkages, i.e. the integration of dispersed specialized industrial clusters

A firm can now serve distant markets equally well as local producers; it can also now disperse its value chain across national borders in order to select the most cost-effective location. IT and related organizational innovations provide effective mechanisms for constructing flexible infrastructures that can link together and co-ordinate economic transactions at distant locations,• IT fosters the development of leaner, meaner (skillful)

and more agile production systems that cut across firm boundaries and national borders

• a network of firms enable a global network flagship to respond quickly to changing circumstances, even if much of its value chain has been dispersed

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3. competition,There is a broader geographic scope of competition and a growing complexity of competitive requirements. Competition now cuts across national borders, a firm’s position in one country is no longer independent from its position in other countries• the firm must be present in all major growth markets

(dispersion)• it must integrate its activities on a worldwide scale, in

order to exploit and coordinate linkages between these different locations (integration)

26The nodes of a global production network.

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TYPES OF GLOBAL FLAGSHIPS

1. Brand Leaders (Cisco, GE, IBM, Compaq, Dell)

Ex: Cisco’s GPN connects the flagship to 32 manufacturing plants worldwide. These suppliers are formally independent, but they go through a lengthy process of certification to ensure that they meet Cisco’s demanding requirements. Outsourcing volume manufacturing and related support services enable “brand leaders” to combine cost reduction, product differentiation and time-to-market.

2. Contract Manufacturers (Solectron, Flextronics)They establish their own GPN to provide integrated global supply chain services to the global brand leaders

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KNOWLEDGE DIFFUSION IN GPN

The flagships can exert considerable pressure on local suppliers, especially in small developing countries; • Flagship can discipline/control suppliers by

threatening to drop them from the networks whenever they fail to provide the required services at low price and world class quality

• GPNs are powerful carriers of knowledge; - transfer of technical and managerial knowledge to the

local suppliers, to upgrade supplier capabilities - once a network supplier successfully upgrades its capabilities, this creates an incentive for flagships to transfer more sophisticated knowledge, including engineering, product and process development Diffusion is completed when transferred knowledge is internalized and translated into the capability of the local suppliers.

29Knowledge transfer mechanisms

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STRATEGIC ALLIANCE

Cooperative strategy is a strategy in which firms work together to achieve a shared objective.Cooperating with other firms is a strategy that creates value for a customer,

• exceeds the cost of constructing customer value in other ways

• establishes a favorable position relative to competition

A strategic alliance is a cooperative strategy in which, firms combine some of their resources and capabilities to create a competitive advantage.Strategic alliance involves,

• exchange and sharing of resources and capabilities• co-development or distribution of goods or services

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Strategic alliance is constructed in such a way as to serve

the strategic intent of all parties, whose goals are in

general different but can be made complementary.

A taxonomy of motivations to form alliances;• mandated formation: to conform to legal or regulatory

requirements, like international joint ventures to comply with host country regulations

• cost arguments: make-or-buy questions for entering the alliance which is a buy option

- accounting - based arguments like cost savings in research

- transaction cost arguments• access to resources• learning• strategic positioning like gaining info about markets

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CombinedResources

CapabilitiesCore Competencies

ResourcesCapabilities

Core Competencies

ResourcesCapabilities

Core Competencies

STRATEGIC ALLIANCE

Firm A Firm B

Mutual interests in designing, manufacturing,or distributing goods or services

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TYPES OF AGREEMENTS

1. Licensing agreementsOutsource functions to other companies,

2. Marketing agreementsOutsource to expert with access to distribution network,

3. Manufacturing agreements

Outsource production to manufacturer with required capacity,

4. R&D agreements

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FORMATION PROCESS : ARCHETYPES

1. Ad hoc pool : led by a large established entity, resources are assigned to the alliance are sparse, and resources generated are expected to flow back to parents (eg. ad hoc cooperation for new business development or R&D)

2. Consortium : richer resource inputs allowing flexibility for adapting to new opportunities, resources generated are expected to flow back to parents (eg. research consortium of lesser players like that of Volvo, Renault, Mitsubishi)

3. Project-based ventures : few resources are put in by the parties but resources gained are retained in the particular joint venture (eg. when parties attempt to enter a new market together like EU companies entering Japanese market)

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4. Full-blown ventures: input resources are provided more freely so as to adapt to new eventualities, generated resources are kept in the alliance so as to build it up for future strategic moves, issue is to combine forces to catch up, to create better value through joint utilization of efforts and possibly, to provide a way to exit after the restructuring of one’s business activities

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TYPES OF COOPERATIVE STRATEGIES

Joint venture: two or more firms create an independent company by combining parts of their assets

Equity strategic alliance: partners who own different percentages of equity in a new venture

Nonequity strategic alliances: contractual agreementsgiven to a company to supply, produce, or distribute a firm’s goods or services without equity sharing

Equity: the ownership interest of shareholders in a corporation

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mergers and acquisitions

joint ownership

formal cooperative venture

joint venture

informal cooperative venture

degree of vertical integration MARKET none

HIERARCHYlarge

mergers and acquisitions

joint ownership

formal cooperative venture

joint venture

informal cooperative venture

degree of interdependence lowhigh

i. Strategic alliance options in terms of vertical integration :

ii. Strategic alliance options in terms of interdependence :

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BUSINESS-LEVEL COOPERATIVE STRATEGIES

1. Complementary strategic alliances

Complementary strategic alliances are designed to take advantage of market opportunities by combining partner firms’ assets in complementary ways to create new value.These include distribution, supplier or outsourcing alliances where firms rely on upstream or downstream partners to build competitive advantage

Supplier

Buyer

vertical alliance

i. Vertical complementary strategic alliance It is formed between firms that agree to use their skills and capabilities in different stages of the value chain to create value for both firms (eg. outsourcing)

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ii. Horizontal complementary strategic alliance

It is formed between partners who agree to combine their resources and skills to create value in the same stage of the value chain,• focus on long-term product development and

distribution opportunities• the partners may become competitors• requires a great deal of trust between the partners

horizontal alliance

Buyer Buyer

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2. Competition response strategic alliances

They occur when firms join forces to respond to a strategic action of another competitor.They can be difficult to reverse and expensive to operate, so competition response strategic alliances are primarily formed to respond to strategic rather than tactical actions

3. Uncertainty reducing strategic alliances

They are used to hedge against risk and uncertainty.These alliances are most noticed in fast-cycle markets,they may be formed to reduce the uncertainty associatedwith developing new product or technology standards

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4. Competition reducing strategic alliances

They may be created to avoid destructive or excessive competition,• explicit collusion exists when firms directly negotiate production output and pricing agreements in order to

reduce competition (illegal)• tacit collusion exists when several firms in an industry

indirectly coordinate their production and pricing decisions by observing each other’s competitive actions and responses

• mutual forbearance is a form of tacit collusion in which firms avoid competitive attacks against those rivals they meet in multiple markets competition reducing strategic alliances may require governments to find ways to permit collaboration among rivals without violating antitrust laws

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CORPORATE-LEVEL COOPERATIVE STRATEGIES

Corporate-level cooperative strategies are designed to facilitate product and/or market diversification.

1. Diversifying strategic alliance

This alliance allows a firm to expand into new product or market areas without completing a merger or an acquisition,• provides some of the potential synergistic benefits of a

merger or acquisition, but with less risk and greater levels of flexibility

• permits a “test” of whether a future merger between the partners would benefit both parties

2. Synergistic strategic alliances They create joint economies of scope between two or more firms, and the synergy across multiple functions or multiple businesses between partner firms.

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3. Franchising

Franchising spreads risks and uses resources, capabilities, and competencies without merging or acquiring another company,• contractual relationship concerning the franchise that is

developed between two parties, the franchisee and the franchisor

• an alternative to pursuing growth through mergers and acquisitions

Franchising: franchiser grants franchisee rights & license to produce & sell product/service, and/or use the business system developed by franchiser

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INTERNATIONAL COOPERATIVE STRATEGIES

Cross-border strategic alliance is an international cooperative strategy in which firms with headquarters in different nations combine some of their resources and capabilities to create a competitive advantage. A firm may form cross-border strategic alliances to leverage core competencies that are the foundation of its domestic success to expand into international markets.

• Allows risk sharing by reducing financial investment

• Host partner knows local market and customs

• International alliances can be difficult to manage due to differences in management styles, cultures or regulatory constraints

• Must gauge partner’s strategic intent so they do not gain access to important technology and become a competitor

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PARTNER SELECTION IN GLOBAL STRATEGIC ALLIANCES (GSA)