challenges of industrial restructuring in a globalizing world: implications for small- and medium-...

8/3/2019 Challenges of Industrial Restructuring in a Globalizing World: Implications for Small- and Medium- scale Enterprises (

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ISEAS Working Paper: Visiting Researchers Series No. 3(2003)

Challenges of Industrial

Restructuring in a Globalizing World:

Implications for Small- and Medium-

scale Enterprises (SMEs) in Asia

George Abonyi

This paper was prepared with support from the United Nations Economic andSocial Commission for Asia and the Pacific (UNESCAP). An earlier draft was presented at a workshop organized in Singapore by the Asia Strategy Forum

(ASF) on REDUCING DISPARITIES. Rethinking Key Issues in Asian Development: Changing Policies, Institutions and Mind Sets, August 2002,

Singapore; supported by the Asian Development Bank, Japan Bank forInternational Cooperation (JBIC), and the United Nations Economic and SocialCommission for Asia (UNESCAP).

2003 Institute of Southeast Asian StudiesISSN 0219-3582


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CHALLENGES OF INDUSTRIAL RESTRUCTURING IN A GLOBALIZING

WORLD: IMPLICATIONS FOR SMALL- AND MEDIUM-SCALEENTERPRISES (SMES) IN ASIA

Abstract

Restructuring of global industries, for example, through the emergenceof international production networks (IPN), is posing new challengesto developing economies in Asia. Expectations and strategies based onthe historically unprecedented East Asian success with industrialdevelopment need to be adjusted in light of changing conditions. In

particular, the requirements for firms to effectively access globalmarkets and upgrade their position in global industries are becomingincreasingly complex and demanding. The capacity to master andupgrade production processes is necessary, but no longer sufficient foraccessing international markets for sustained income growth. This is

posing significant challenges for firms and economies in theregion, particularly for SMEs, which face special constraints. Task-oriented cooperation among groups of SMEs in the form of industrycluster and networks can provide an effective response to competitive

pressures in global markets. This poses challenges to both firms and governments: to implement effective collaborative strategies andprogrammes, and to strengthen supporting institutions, particularly atthe industry and local community level.

I. Introduction

This paper discusses emerging challenges for Asia related to industrial development in

the context of a globalizing world, with particular emphasis on SMEs. The context for

the discussion is provided by a brief overview in Section II of the East Asian model of

industrial development that, anchored in export-led industrialization, has led to

unprecedented growth for these economies in recent decades. The success of the East

Asian experience has set the benchmark for industrial development in Asia. However,

the organization of global production and markets is undergoing fundamental changes.

As a consequence, the means for accessing global markets for sustained income growth

are evolving: this is the focus of Section III.

The requirements for firms to access international markets and upgrade their

position within them are becoming increasingly complex and demanding. SMEs, the


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dominant form of enterprise in Asia, are generally not well positioned to respond to

these challenges. Yet, given the importance of SMEs in the regions economies as a

key source of employment and income, it is essential to find ways to improve their

performance. There is increasing evidence that SMEs may be able to compete more

effectively on global markets through cooperation among firms that addresses shared

constraints and opportunities. Section IV therefore discusses forms of cooperation, in

particular SME clusters and networks, and means for facilitating such cooperation.

Section V shifts the focus from cooperation among firms, to cooperation among

economies within the context of the changing organization of international production.

It is more exploratory in nature, taking a production based perspective on regional

cooperation and integration. Section VI presents concluding comments. The Annexes

provide cases and illustrations related to selected issues raised in the paper.

II. Context: The Rise of East Asia1

1. The Measure of Success

East Asia has achieved historically unprecedented sustained growth and development in

the past 3 decades. GDP per capita nearly quadrupled in real terms between 1975 and

2000 in East Asia, and tripled in Southeast Asia. Growth has been accompanied by

dramatic decline in the incidence of absolute poverty, and by clear improvements in key

social indicators for the region in areas such as health, education, and life expectancy.

Although the overall record of growth and development hides a diversity of conditions

of the countries of the region, it also reflects enormous strides in Asias overall

development.2

Industrial development, in particular the East Asian model of export-led

industrialization, was a critical part of this success story, driving growth rates and

development. To put this in context, between 1985 and 1997, total world trade grew

from $2.311 billion to $6.735 billion, with manufactures as the largest single

component by value (60% of the total in 1997). While total world manufactured

exports grew by 242% between 1985 and 1997, developing country manufactured

exports increased by 516%. As a result, the share of developing countries in total world

manufactured exports increased from 14.6% in 1985 to 26.2% in 1997. By far, the

largest share of developing country manufactured exports came from Asia, which grew


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from 78% in 1985 to 86% in 1997.3

For the interval 1985-1997, 8 of 10 highest-

ranking LDC manufacturing exporters were from Asia (7 from East and Southeast Asia,

with India 9th on the list).4

2. The East Asian Model of Industrial Development: An Overview

The East Asian experience with industrial development has been the subject of

extensive analysis and debate.5 At the risk of oversimplifying this complex process,

key characteristics may be summarized for the purposes of this paper as follows:

The process of East Asian industrial development is essentially a story ofupgrading: moving up the ladder of cascading comparative advantage, startingwith unskilled labour-intensive activities, progressing through more skilledlabour and technology intensive activities.6 This is often described as theflying geese model,7 with industries from different countries following eachother up the ladder in the production of final products; evolving into a kind offlying mini-geese model, as global and regional production of components andassociated intra-industry trade expanded in importance.

A critical factor in the export-oriented industrialization model (EOI) was themastery of productive efficiency that allowed upgrading of firms andeconomies, in terms of the increasing sophistication (and diversification) of

products and production processes.

Exports have to be sold. On the demand side, East Asian industrialization wasfuelled by the continuous expansion of global markets, in particular the US.

Multinational corporations (MNCs) and foreign direct investment (FDI) playeda critical role in the process of East Asian industrial development, both in thetransfer of technology and in providing access to global markets.

East Asian governments also played a critical role in providing an appropriatemacro environment for attracting FDI and for industrial development (thefundamentals), and through selective support, e.g. technology acquisition.

The East Asian model may therefore be summarized in simple terms as follows:MNC + FDI + expanding global markets export growth + upgradingindustrial developmentsustained income growth overall development

By the late 1980s, there were differences emerging among the East Asian

economies path to continued industrial development: between the independents,

including Korea, Taiwan, and China; and the integrationistssuch as Singapore, and

until recently to some extent Malaysia and Thailand.8 Although in the beginning, all

countries bought rather than made technology, the independents began to focus

increasingly on making technology. That is, while all East Asian countries continued

to buy foreign technology and invest in production capabilities, some countries (the


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independents) also began to invest heavily in domestic technology capability, e.g. to

create national innovation systems. By contrast, the integrationists continued to link

themselves closely to foreign investors, e.g. continuing dominance of the MNC + FDI

model.

3. Selected Issues in the East Asian Experience

A number of issues in the East Asian experience are particularly relevant to the focus of

this paper:

Industrial development as a historical process: Although both the speed andscope of industrial development of the East Asian economies were historicallyunprecedented, it took time. These countries did not suddenly leapfrog fromrelative backwardness to high technology. They moved slowly up the ladder ofindustrial development of increasing complexity over decades.

Role of globalization and technology transfer: Industrial development in EastAsia was closely linked to the forces that drove the globalization of production,as reflected in the extraordinary growth of world trade and investment. Initiallythis involved flows of final goods and the associated migration of the productionof such goods among economies. The movement of industry supply chains fromwithin the boundaries of a nation to supply chains of international scope,expanded the flows of intermediate products and components and associatedmigration of component production. This migration of production was possible

because of the transfer of technology and production capabilities inunprecedented volumes and by innovative means in a variety of industries.Firms were supported in developing technological capabilities through bothneoclassical economic policies (e.g. macro fundamentals), and through

selected government interventions fostering rapid technological development(e.g. access for exporters to tariff-free imports of intermediate and capitalgoods).

Relative openness and the role of exports: Relative openness with regard tothe export of goods, and imports of key inputs and technology was a criticalelement of the East Asian experience. But relative openness was not the sameas free trade, i.e. low and uniform tariffs on all imports as followed bySingapore and Hong Kong. There were selected protectionist measures in placefor example by Korea, Taiwan, Malaysia, Thailand, Indonesia, e.g. providingexporters access to tariff-free imports of intermediate and capital goods forexport production, but imposing variable (non-uniform) tariffs on generalimports. Exports played a key role in allowing East Asian economies to exploit

dynamic comparative advantage, e.g. by providing access to importedtechnology as a source of product and process upgrading to higher technologyand higher value added products and activities.9

Importance of scale: The export-oriented industrialization of East Asia wasprimarily a game for the big boys: in general, SMEs were not the agents ofindustrial development in East Asia. It was mass production rather than craft


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production that typically characterized the development of industries. Even inthe case of Taiwan, where SMEs played an important role, scale was a keyfactor and the government played an important role in financing the expansionof industrial capacity. For example, well into the 1990s the share of governmentin total fixed capital formation was the largest in the region, at around 50%;Taiwan ranked high in its share of large enterprises (in terms of assets and

sales), with 10 large manufacturing groups, exceeded only by Korea (21), ascompared for example with Malaysia (2) and Thailand (3).10

4. Limits of the East Asian Model: The Future is Different

i. Limits on Past Success

For all the successes of the East Asian model of industrial development, it had its

shortcomings in supporting development in the region. From the perspective of this

paper, a number of issues are of particular interest:

Participants and bystanders: The export-led model created participants, i.e.those who benefited significantly from development through manufacturedexport orientation both within and among the countries of the region; andbystanders, those who benefited much less often found in traditionalsectors such as agriculture. For example, in 1997 agriculture employed abouthalf of the Thai labour forces as compared with manufacturings 13.4% share ofemployment; however, manufacturing accounted for 31.6% of GDP and over82% of total merchandise exports, as compared with agricultures 10.8% ofGDP and 10.2% of merchandise exports.

Duality in industrial development: The resulting industrial structure of EastAsian economies generally reflected a duality in industrial development. Thisinvolved the emergence of modern, competitive export-oriented industries often

involving larger domestic firms linked to MNCs on one side; and on the otherside a large number of domestic firms, generally SMEs, relativelyunderdeveloped in terms of skills, technology, market access. The links

between the two parts of domestic industry were usually limited at best.

Neglect of domestic markets and production: Concentration and reliance onexport markets and selected industries led to a relative neglect of domesticmarkets. High savings rates and relatively low consumption rates were thecharacteristics of East Asian economies.

Vulnerability: Reliance of industrial development on a few key markets andselected industries created a vulnerability to volatility in these markets andindustries, e.g. as reflected in the recent downturns arising from slowdowns inthe US market and the global IT/electronics industry. In addition, expanding

market share of Asian manufactured exports in global markets often did not leadto associated pricing power for Asian producers in these markets.

ii. Selected Factors Shaping the Future


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There are important changes emerging in both the global and regional economic

environments that require rethinking key elements of the East Asian model of industrial

development. This has potentially important implications for both the continued

performance of the East Asian economies, and for the next generation of economies in

the region that seek to emulate the East Asian industrial development success story.

From the perspective of this paper, 3 issues are of particular importance:

Accessing global markets: The MNC + FDI model, that played a key role inEast Asian economies accessing global markets and technology, is changing. In

particular, the structure of global production is changing in important ways, e.g.emergence of production networks based on global standards instead oflocation.11 This changes the context and options for accessing global marketsand for upgrading, of firms and economies. In particular, possessing required

production capabilities (mastering production efficiency) is no longer asufficient basis for effective participation in the global economy for sustainedincome growth. It is therefore important to understand the various options fordomestic producers to access global markets, and their implications.

Evolution in minimum efficient scale of firms: As noted, SMEs played alimited role in the success of East Asian industrial development. However,reduction in the minimum efficient scale of firms in key industries throughthe development of flexible technologies; increasing importance of outsourcingand inter-firm collaboration; combined with the fragmentation of markets andthe associated importance of market niches is increasing options forefficient small producers to compete in global markets. This has importantimplications for the regions economies dominated by SMEs.

Changing relative importance of global markets: The role of externalmarkets, e.g. US and Europe, anchoring future Asian development is uncertain.

Their continued importance for Asia is not in question. However, it is not clearthat marginal growth in these markets will be sufficient or sufficiently reliableover the longer term as the basis for continuing industrial development andsustained income growth in Asia. While continuing to focus on global markets,Asia is likely to be looking increasingly closer to home for future growth.Within this context, the emergence of the Peoples Republic of China is acritical part of what is a wider transformation of the economic map of theregion.


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III. Accessing Global Markets

1. Limits to Productive Efficiency as the Means to Growth

In the rise of East Asia, accessing expanding global markets and industries was the

critical factor in industrial development both for technology acquisition, and as markets

for output. As noted, MNCs played a central role in this process both as a source of

technology and as channels to global markets. In this process, mastering productive

efficiency was the passport for the economies of East Asia to industrial and therefore

broader development. This involved, upgrading or moving up the ladder of cascading

comparative advantage through production the flying geese model noted earlier.

Looking to the future, the organization of global production and markets is

undergoing important changes. The means for accessing these markets and for

upgrading production are evolving, with important implications for firms and

economies. For example, production capabilities are diffusing increasingly widely

throughout the global economy, as more and more firms in a variety of locations are

mastering the capability to meet global standards of manufacturing. Therefore, a

fundamental change from the past to the emerging future is that the capacity to master

and upgrade production processes is necessary, but generally no longer sufficient for

successful industrial development and sustained income growth. Other factors, beyond

production efficiency, are shaping which producers will be successful in accessing and

competing effectively on global markets.

Furthermore, although the volume of exports from developing economies has

been expanding significantly in global markets, price pressure on exports of

manufactured products is becoming intense. As a consequence, the danger is that

producers may expand their presence in global markets, and yet be worse off. That is,

due to falling terms of trade, a country may generate more output and exports, but still

face falling returns. This is a problem well known to exporters of commodities and

agricultural products, but it is increasingly also to be found in manufactured exports,

especially labour intensive manufactures such as wooden furniture.12


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Example. Wood Furniture Industry: Output Growth but Declining Income13

The wood furniture industry is resource based, labour intensive, and plays animportant role in many developing economies. At the same time, leading

producers are from high wage developed economies, suggesting possibilities forlow-wage economies to move up the ladder of industry specialization andincome. However, growing competition and falling prices in the industry arecreating conditions for developing country producers where they expand output,

yet cannot achieve sustained income growth as they are unable to upgrade.

The challenge to developing economies, e.g. including the next generation in

Asia, is then two-fold: (i) how to access global markets; and (ii) how to do so in a

manner that provides for sustainable income growth. This is a particularly serious

challenge for producers from lagging economies, and at the firm level for SMEs, many

of whom have significant constraints on their capabilities to participate effectively in

global markets.

2. Alternative Paths to Global Markets

It is therefore important to understand the different ways producers from developing

economies may be linked to final markets, and their implications. This in turn allows

for a better appreciation of the challenges facing SMEs and how they may be met. In

general, there are 3 major ways for producers to access global markets:14

i. Arms-length producer-buyer trading relationship, through markets;ii. Vertically integrated firms, e.g. multinational corporations (MNC), together

with affiliates, e.g. subsidiaries, joint ventures; andiii. Network relationships involving non-equity based linkages among firms

which may take the form of collaboration among firms of similar market powerwith complementary assets, or with a dominant firm acting as a coordinator,setting network standards.


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i. Markets: arms length relationships

In principle, one way for independent producers to access markets, is to connect to

customers through the market mechanism. In practice, individual producers rarely sell

directly to the final customer, e.g. a Thai food producer generally does not sell directly

to a Canadian shopper.15 Producers generally reach their customers through

intermediaries. Intermediary buyers play a role in both the consuming and the

producing country. In the consuming country they include final retailers, independent

specialized buyers in final markets, and large international firms sourcing products from

many countries as independent buyers or through their own network of buyers. In the

producing country intermediaries generally include local buyers and export agents, and

large producing firms sourcing products from local suppliers.

In general, intermediary buyers can both facilitate and constrain the extent to

which individual producers can access markets and upgrade their operations. In this

context, in a growing number of industries, markets, especially in high-income

countries, are becoming more and more concentrated. An example of this is the

expansion of supermarkets and their impact on the structure of the fresh vegetable

industry, and in particular on the role of SME producers.16

ii. Vertically Integrated Hierarchies: Multinational Corporations (MNCs)

A second way for developing country producers to access global markets is through

MNCs, e.g. as subsidiaries or affiliates: the traditional MNC + FDI model. However,

the nature of both MNCs and FDI is undergoing changes, with potentially important

implications for producers from developing economies. In the past 20 years, trade

barriers have been reduced globally, and this has been a key factor for outward oriented

FDI that supported Asian industrial development related to the search for low labour

costs. In the 1990s, this was expanded to a search for production sites whose

characteristics went beyond low labour costs, and included additional factors such as

good infrastructure, supporting services, etc.

In the 21st century, factors influencing the location of FDI increasingly relate to

the organization of production, e.g. reducing time from product design to market.

Proximity of suppliers to final manufacturers has grown in importance and clusters of

FDI are co-locating to achieve systemic efficiency in production. At the same time,


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there has been a declining importance of commodities and cheap labour in

manufacturing, e.g. increasing importance of components as the building blocks of

production, and the increasing service intensity of products.

As a consequence, in some industries MNCs producing more labour-

intensive and consumer goods such as apparel, footwear, consumer electronics, toys

there is an increasing trend for large firms to retreat from production and to source

products made to close specifications. That is, there is an increasing transformation of

hierarchies into networks (discussed in the next section). This is increasing the scope

for domestically owned producers to link to global markets via such networks.

Example: Levi Strauss17

Levi Strauss, the most prominent brand name in jeans, has prided itself on its

own global production structure and on its profit sharing schemes with itsworkforce. This was maintained even in the 1990s, as competitors in theindustry increasingly outsourced production capacity. Toward the end of the1990s, however, significant declines in both profits and market share forced thecompany to close half its 22 plants in North America. Production capacity wasincreasingly outsourced to contractors throughout the world, and by the firsthalf of 2004 the US clothing giant will have shifted all of its company-owned

North American manufacturing to outside suppliers in Asia and other low-costareas of the world. In the process, Levi Strauss is retaining key value added

functions such as brand management, marketing, and product design, anddefining standards for suppliers to participate in and upgrade in its productionnetwork.

At the same time, in some capital- and technology-intensive industries such as

automobiles, there is a different tendency: firms such as GM, Ford, Nissan-Renault

continue to seek to control the production process itself, but in novel ways.

Competitive advantage in these industries lies increasingly in the design, branding, and

systems integration linking value chain activities.18 However, the design and

increasingly the manufacture of key component subsystems are being subcontracted to

global suppliers such as Delphi, Visteon, Magna, leading to a process of global

sourcing, requiring suppliers to follow the core firms, and involving a network of

subsidiaries and affiliates feeding components into these assembly plants on just-in-

time basis. This is leading to declining local ownership and local technology, and a


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shift to proprietary technology from global first tier suppliers, preferably directly

linked to the MNC, e.g. as a joint venture.

iii. Networks: Production linkages19

A third and increasingly important way of accessing global markets is through

networked, primarily non-equity based relationships among firms. There are generally

two forms of networks. One is the semi-hierarchical networks of large firms and their

(arms-length) suppliers, with a dominant firm acting as a coordinator and setting

network standards, e.g. for product design and quality. The second type of network

involves collaboration among firms with complementary assets and similar bargaining

power.20 In increasing number of cases, producers sell into final markets via non-equity

based production networks coordinated by lead firms who set the standards for

participation and upgrading in the network. It is estimated that more than one third of

global trade is now through such networks.21 Examples include Dell in computers;

Cisco in IT; Nike in footwear; JC Penny in apparel; IKEA in furniture; Tesco in food.

Examples22:

Cisco Systems is a leading global supplier of routers, switches and hubs forcorporate communication networks. U.S.-based Cisco does none of its ownvolume manufacturing. Its products are assembled by independent turnkeycontract manufacturers in California and Asia, with components and services

coming from a variety of independent international suppliers from Taiwan, Korea, Japan, Singapore, Thailand, Malaysia and the U.S. within theframework of a well-defined production network.

Nikes Air Max Penny basketball shoe is designed in the U.S., developed bytechnicians in the U.S., Taiwan and South Korea, and manufactured in South

Korea and Indonesia from 52 components supplied by companies in Japan,South Korea, Taiwan, Indonesia and the U.S. All of these suppliers are tiedtogether by an advanced information and logistics system.

In each case the lead firm plays the critical role in determining:

which producers are incorporated into the production network;

which market segments a producer will serve, including product mix;

which functions producers will undertake, e.g. production, design,marketing;

in which area a producer will be allowed to upgrade, e.g. move fromproduction to design.


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3. Implications for SMEs

Accessing global product markets may then involve SMEs direct participation as

independent producers; suppliers in MNC hierarchies; or as members in networks. In

each case, there are significant but differing challenges to SME producers.

For example, to participate effectively in global markets as independent

producers requires SMEs to have and maintain significant capabilities in a wide range

of areas ranging over the industry value chain, including design, production, marketing,

distribution, branding, etc. Furthermore, continued success is tied to responding

effectively and quickly to market dynamics, including to changing consumer tastes,

entry of new competitors, changes in industry structure. Participation as suppliers in

MNC hierarchies or members in networks, requires a capacity to meet specifications

and standards, e.g. on product quality and production process, in an increasingly

competitive global production environment.

Example. The Changing Fresh Vegetable Industry and Implications for SMEs23

The fresh vegetable industry is one of the most vibrant industries ininternational trade. It has also been characterized by increasing concentrationthrough the emergence of large supermarkets in key markets (e.g. Europe,

North America) that is potentially marginalizing SME producers in developingeconomies. As they have grown in size, supermarkets are exercising increasing

influence on the industry value chain. While generally not directly involved inproduction, they are exerting increasing control over product, production, and suppliers, e.g. through strictly enforced standards. In the process, they areincreasingly using a smaller number of large volume suppliers, confining SMEsto a narrow market segment of marginally profitable bulk produce to wholesalemarkets.

Experience from a wide range of countries and industries, indicates that SMEs

can participate effectively in global production and access global markets. However,

generally this requires that they cooperate to achieve collective efficiency and joint

action to address shared constraints and opportunities.

IV. Cooperation Among Firms: SME Clusters and Networks


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1. Focus on SMEs

In general, SMEs provide the backbone of the private sector in both developing and

developed economies. They comprise over 90% of all enterprises in the world, and

account for 50-60% of total employment. SMEs engaged in manufacturing often

account for an even larger share of manufacturing employment, which may rise to as

high as 80%. In the lagging economies of Asia, SMEs often offer the most likely

prospects for increasing employment and value-added.24

Given their prominence, it is important to find ways to allow SMEs to play an

effective role in economic growth and equitable development. They have a potentially

important role to play in terms of employment, income generation, poverty reduction,

and a wider distribution of wealth in developing economies. However, the potential of

SMEs is often not realized because of problems generally related to constraints of size.

This is especially the case with respect to SMEs competing effectively on international

markets.

2. Constraints on SMEs

Problems facing SMEs are many and varied. Because of their size, individual SMEs

are constrained from achieving economies of scale in the purchase of such inputs as

equipment, raw materials, finance, and consulting services; are often unable to identify

potential markets; and unable to take advantage of market opportunities that require

large volumes, homogenous standards, and regular supply. Small size is also a

constraint on accessing such functions as training, market intelligence, logistics and

technology. These constraints make it difficult for SMEs to access global markets; and

also limit their performance in increasingly open, competitive domestic markets.

Firms compete more and more not only on the basis of prices, but on the basis

of their abilities to innovate, or upgrade.25 Improvements in product, process,

technology, and organizational functions such as design, logistics, and marketing have

become the critical success factors in firm competitiveness in a globalizing economy.

SMEs are thus under pressure to innovate, to upgrade their operations in order to

participate in international markets. However, they often lack the resources to do so. In

general, small firms are constrained in their access to key services, which large firms

either have internally, or can purchase.


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3. Loosening Constraints through Cooperation: Clusters and Networks

On their own, small firms find it hard to overcome constraints relating to areas such as

finance, technology, market access and input sourcing. However, there is increasing

evidence that it is not so much the size of firms that is the critical constraint, rather it is

their isolation: the fact that they are small, with limited resources, andoperating alone

in a competitive environment.26 Focused or targeted cooperation among SMEs, as well

as between SMEs and institutions in their surrounding environment (e.g. industry) can

provide the basis for an effective response to competitive pressures, including accessing

global markets. Cooperation can help by creating opportunities for:

Collective efficiency based on scale: Achieving economies of scale beyondthe reach of individual firms in the purchase of inputs including technology,creating a pool of skilled workers, use of machinery, and pooling of

production capacity to meet large volume orders from global buyers;

Collective efficiency based on specialization: Cooperation can enable SMEsto specialize in their core businesses and evolve a division of labour amongfirms, achieving efficiency in production, and learning from each otherabout areas such as markets and product and process improvements; and

Joint action: Collaboration through producer associations that help open upaccess to international markets, and increase small firms access togovernment support services.

There is increasing evidence that cooperation among SMEs is more likely when

enterprises operate in proximity, and share business interests such as markets, productsand infrastructure needs; and respond jointly to common challenges such as external

competition. In this context, SME clusters are sectoral and geographic concentrations

of enterprises that produce and sell a wide range of related or complementary products,

with similar operations in the same industry, and face common constraints or

opportunities. Cooperation in clusters can lead to collective efficiency based on scale.

SME networks are groups of firms that complement each other, involved in different

parts of the same industry, and cooperate to achieve collective efficiency through

specialization, e.g. for gaining access to global markets beyond the reach of individual

SMEs.

4. From Informal Groupings to SME Clusters and Networks


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Concentration of enterprises in the same sector is not sufficient for the emergence of an

SME cluster or network. Informal groupings of firms are widespread in developing

economies, for example they can be found in the outskirts of many cities, often

producing similar goods for the domestic market in areas such as woodworking, textiles

and metalworking. They generally contain micro enterprises and SMEs whose

technology level is usually low relative to industry best practice; with workers that

generally have low formal skills. Cooperation among firms in these groupings is

limited at best. Instead they are usually characterized by low level of trust, and intense

competition; with limited perceptions of growth opportunities either for the firm or the

industry. Little learning tends to take place for sustained upgrading of skills, product or

production process. Poor infrastructure, weak inter-firm linkages, and lack of

information on technology and foreign markets tend to reinforce a dynamic of low

growth.

Although most firms in a cluster or network are also small, what distinguishes

an organized cluster or network is the cooperation and focused linkages that have

emerged among participating firms. SMEs in a cluster or network evolve together after

a realization that in a globally competitive economy they gain advantages if they

compete as a group, not as individual, isolated small enterprises. Examples of

organized clusters producing for global markets cover a wide range of industries, e.g.

surgical instruments cluster in Sialkot, Pakistan;27 electronics cluster in Penang,

Malaysia; knitwear in Tiruppur, India; software in Bangalore, India; leather shoes in

Sinos Valley, Brazil.

Example. Surgical instruments production in Sialkot, Pakistan28

The surgical instruments cluster in Sialkot, produces scissors, forceps, andother precision instruments using stainless steel. It involves around 350manufacturers, subcontracting work to over 1500 SMEs, and acquiring inputs

from 200 local suppliers and more than 800 service providers. The clusteremploys over 30,000 workers. Over 90% of the output is exported, and this

cluster accounts for more than 20% of global trade in the industry, makingPakistan the second largest producer after Germany. The firms in this clusterhave not only managed to successfully penetrate global markets, but they wereable to address effectively, partly through cooperation with central governmentand local institutions, the critical challenges of new quality assurance standardsimposed by the US and European markets in the mid 1990s.


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Example. Shoe cluster in Sinos Valley, Brazil29

In the early 1990s, Brazil was ranked as the worlds third largest exporter ofleather shoes. Within Brazil, the state of Rio Grande de Sol, in particular theSinos Valley in the state, although producing only 30% of Brazils total leather

shoe production, accounted for 80% of its leather shoe exports. In the 20 years1970-1990, a cluster of almost 2000 firms in Sinos Valley raised its share ofworld leather footwear exports from 3% to 12%, specializing in womens shoes.

By 1991, they had exported nearly 100 million pairs of shoes, worth almost$900 million. These firms covered a range of links in the footwear value-chain,and created more than 15,000 jobs. As in Sialkot, a number of key supportinstitutions geared to SMEs and the shoe industry played a key role both in theemergence of the cluster, and in its continued success.

The transition from an informal grouping or agglomeration to cooperative

clusters and networks such as in Sialkot or the Sinos Valley is difficult. General factors

necessary for successful transition include:

Proximity which is a key factor for inter-firm cooperation in promoting joint initiatives. It lowers transaction costs, and facilitates learning because of both physical closeness and shared background andexperiences.

Incentives which are generally necessary for inducing cooperationamong often intensely competitive firms. Perhaps the best incentives forthe establishment of clusters or networks from informal groupings arecrises, e.g. external imposition of standards such as food safety, and new

market opportunities. Crises provide visible shared challenges withclear potential payoffs that individual enterprises can recognize as veryimportant, yet cannot address on their own.

Trust which is the fundamental requirement for SME clusters andnetworks. The building and maintenance of trust over time is thefoundation for SME cooperation. Since clusters and networks involveindependent firms with no formal (e.g. equity-based) linkages,cooperation is fundamentally based on shared expectations andreciprocal obligations. Joint activities and mechanisms for clarifyingmutual roles and obligations, and testing firm reliability and performanceare part of the process of progressively building and nurturing trust.

The examples cited also reflect the key role of external support through effective

industry-specific measures such as training, supplier development, standards

development and diffusion. Evidence indicates that various interventions by public or

private institutions (e.g. industry associations) can play an important role in helping


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clusters and networks, once they emerge, to enhance and sustain competitive

performance. This has important policy implications for governments in the region.

5. Policy and Programme Implications

Policies to assist SMEs have generally targeted support to individual enterprises,

usually through a combination of initiatives such as credit schemes, grants, technical

assistance. The basic problem is that these initiatives are generally not effective in

responding to the challenges of global industries and markets. A key problem is that

these initiatives often tend to be supply-driven, focusing on inputs to production, and

not paying sufficient attention to the critical issue of who will buy the firms outputs,

i.e. the requirements of accessing international markets for sustained income growth. A

further constraint on this approach is that such programmes are rarely sustainable since

the cost of reaching a large number of small firms is very high, the likelihood of

significant cost recovery is very small, and the capacity of small firms to sustain

changes on their own is at best limited.

Focusing support on clusters and networks of SMEs provides more effective

basis for policy initiatives aimed at building up local competitive industrial capacity.

Three broad strategies for this are as follows:

Implementing programmes targeting inter-firm networks, industrysupply chains, and sectoral clusters, with particular focus on facilitating

knowledge transfer and inter-firm learning (e.g. on technology, skills,markets);

Enhancing the role for intermediary institutions at the local and industrylevel, with the private sector taking the lead (e.g. the Sialkot InstrumentsManufacturers Association; Penang Skills Development Centre); and

Stimulating the emergence of horizontal institutional networks throughregional alliances and partnerships both within and across countries (e.g.the purpose of the Greater Mekong Subregion Business Forumsupported by UNESCAP and ADB).

Based on experience with a wide range of cases, some best practice

conclusions emerge to guide programmes aimed at SME cluster and network

facilitation:30


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Principles to guide policies and programmes

Collective: Programmes should target not individual enterprises, but agroup of firms, particularly groups with perceived potential to evolveinto effective SME clusters and networks. Collective services lowertransaction costs, and allow for a wholesale as distinct from a retail

approach to SME support, which may be further leveraged throughindustry and local institutions as intermediaries. A collective approachto SME support helps generate linkages and mutual learning amongenterprises, and the emergence of clusters and networks.

Customer-oriented and responsive: Support should be demand driven,aimed at serving specific markets, e.g. assisting SMEs to access specificniche markets; strengthen collective operations within the framework of

particular production networks in specific industries, as a means toaccess global markets. The support should therefore be responsive to

particular cluster or network needs (e.g. addressing new industrystandards essential for market access), and not just focused on providinga set of generic services (e.g. credit, general training).

Promote inter-firm dialogue: Sharing activities, e.g. training/workshops,quality and certification processes, can stimulate the initial processes ofinter-firm dialogue, and begin the building of trust and reciprocityamong firms. This is especially important in the early stages of clusterand network development.

Clear payoffs: Priority should be given to the direct provision ofinnovative, value-adding services in a business like manner. Especiallyin the early stages of cluster and network development, small firms areunlikely to be interested in, let alone pay for shared services that addressneeds that are not clear and immediate, and where expected payoffs areuncertain or far off in the future.

Integrated approach: Isolated support measures (e.g. credit, training,technological assistance) are generally not sufficient or effective infostering SME development. Services should be integrated or bundledtogether (e.g. financing support and training for the acquisition andadaptation of particular technologies), and consistent with the absorptivecapacity of firms individually and collectively.

Participatory: Initiatives should not be primarily top-down or seen asoff the shelf. Cluster and network development activities should beunderstood as a process of organizational change aimed not simply attransferring general skills or information, but at fostering changes inindividual and collective attitudes and behaviours over time. Therefore,they need to be designed and implemented with bottom-up involvement

of client firms and related institutions. This requires an often long andcostly consensus building process on needs assessment, design andimplementation. But this is essential if a common strategic vision andstable alliances are to emerge as the basis for operational improvements.

Build on whats there: Clusters and networks are likely to endure and perform better if based on already existing agglomerations of firms.


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These are more likely to be faced with specific shared pressures that areunderstood by most firms as requiring changes in traditional ways ofdoing business if they are to survive (e.g. environmental constraints,technological obsolescence, infrastructure needs).

Key policy/programme support31

In developing and implementing initiatives to support particular clusters networks, it is

essential to be clear on how particular SME groupings actually access global markets.

As discussed earlier, this may be directly, i.e. producers selling to final consumers

(though generally through intermediaries); through MNC hierarchies by linking to the

supply chains of particular large firms; or through networks, e.g. production networks

dominated by large firms but with no ownership linkages to most suppliers as in the

case of surgical instruments from Sialkot, or fresh vegetables to UK supermarkets. In

each case the appropriate support to SME clusters and networks may differ. Forexample, market research aimed at accessing final consumers is not necessarily the

same as market research aimed at supplying lead firms in networks, e.g. UK

supermarkets.

Understanding markets: Understanding global markets, especially identifyingappropriate niches, is both complex and costly. Groups of SMEs with a shared

purpose, clusters and networks, can cooperate to undertake activities aimed atunderstanding markets better. The nature of global markets will differ,depending on whether SME clusters are accessing such markets directly,through hierarchies; or through networks. In the first case of accessing final

markets directly, it is essential to understand the needs of final consumers e.g.through market research including jointly hiring specialized consultants; hiringdesigners with knowledge of buyer tastes in particular market segments; and

buying key market-related information such as information on new fashioncolours in the clothing industry, on water-based paints and varnishes in thewood furniture industry. In the case of networks, it is important to understandand respond to the needs of leading network buyers (e.g. in the case of surgicalinstruments, buyers associated with leading US or German firms). Whereas inthe case of MNC hierarchies, the market is the proprietary supply chain of a

particular MNC, e.g. Toyota.

Joint selling: Reaching global markets is difficult and costly for SMEs. Jointmarketing efforts in various forms is an important means to access globalmarkets. As before, these need to be consistent with the particular way specificSME clusters/networks choose to access global markets, i.e. directly, throughhierarchies, or through networks. In each case, linking SME output to buyersmay mean something different, requiring differences in supporting initiatives.For example, in the case of the electronics cluster in Penang, the focus ofPSDCs Global Supplier Programme for Malaysian SMEs is to market


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partnerships for SMEs to supply MNC hierarchies through participation inparticular firm supply chains; whereas in the case of the surgical instrumentscluster in Sialkot (as in the case of selling fresh vegetables to UK supermarkets)selling is to global buyers in the context of international production networks.Selling directly to final customers is likely to mean identifying the mosteffective intermediaries in terms of both reaching final customers and retaining

pricing power. Joint buying: Cooperation in buying can provide both economies of scale, and a

sharing of costs. It can also provide an expanded set of options for SMEs. Thecost savings achieved through scale in joint purchasing, or the sharing of costs,as in the case of expensive technology, are clear. Less clear but perhaps evenmore important is the potential for expanding the range of available options toSMEs through joint buying efforts. For example, an important constraint on

productivity in poor countries is the inappropriate choice of technology,especially imported technology. Whereas it is difficult for individual smallfirms to gain information on available technology options, SME clusters andnetworks are in a far better position to access such information, e.g. interestsellers of technology to visit, demonstrate, sell, and train.

Product development: There may be strong constraints on cooperation inproduct development in SME clusters, since each firm may see its products asproprietary, and a source of competitive advantage. However, selling under acommon brand or standard such as Indonesian Batik or Thai silk, cangenerate significant benefits. This is especially the case when trying to reachglobal markets directly or sell into networks and hierarchies that buy in largevolumes that are far beyond the capacities of individual small firms. In the caseof networks based on a division of labour, where the output of one firm becomesthe input of another, joint product development is essential to ensure therequired product and process complementarity to maximize efficiency in thenetwork supply chain.

Standards and codes: As discussed, an increasingly critical entry requirementto global markets is meeting a variety of standards and codes that relate to

products and production processes. For example, ISO 9000 and ISO 14000require extensive documentation; and meeting health standards may requiresubstantial adjustments in product and process. Sharing costs, for example intraining and buying advice, is an important means to meet such standards andcodes, especially when they involve a shock to the existing production system,as in the case of the Sialkot surgical instruments cluster and its response tochanges in US quality assurance standards. This is especially important whenSMEs are trying to reach final consumers directly, and must identify and meetthe standards on their own.

Learning networks: There is increasing evidence that learning networks

provide an important mechanism for strengthening the capacity of SME clustersand networks to compete effectively in global markets. These providemechanisms for SMEs to come together, and share their experiences as the basisfor continuous cluster/network improvements. For example, forming abenchmarking or best practice club (e.g. Auto Components BenchmarkingClub in South Africa) can lead to significant improvements in performance.


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6. Institutional Implications

The provision of the types of programmes identified above for strengthening SME

clusters and networks, e.g. such as training and knowledge diffusion, is characterized

by market failures and high levels of complexity. They involve both inter-firm and

business-government cooperation, especially at the industry and local levels. Such

initiatives are institution intensive32 requiring the necessary capabilities on the part of

government institutions to develop and implement such initiatives. Consider initiatives

in areas such as training and supplier development. This requires government

institutions to:33

mobilize and draw on the specialized knowledge of firms both to understandspecific needs and to design effective programmes;

coordinate the activities of a variety of actors and institutions, e.g. differentministries and departments, different levels of government, business and labour;

ensure consistency over time with the changing needs of global industries toensure that programmes remain relevant as industries and markets evolve.

Such programmes are demand driven, and must be based on an up-to-date

understanding of industry needs and dynamics, and require some degree of industry

coordination, e.g. different firms; owners and workers. They require ways to induce

agreement among these different interests, and to coordinate the actions of diverse

groups necessary to implement effectively a programme.Facilitating the development of clusters and networks may also require the

establishment of new institutions, or the strengthening of existing institutions. Of

particular importance are business development service institutions. These include

non-profit membership organizations such as chambers of commerce and industry

associations; and service delivery organizations such as the example of the Penang

Skills Development Centre (PSDC) in Malaysia, and the Surgical Instrument

Manufacturers Association (SIMA) in Sialkot, Pakistan. Such institutions can help

strengthen SME clusters and networks on an on-going basis (example of PSDC), and

also help SMEs respond to sudden crises (example of SIMA).

Example. Penang Skills Development Centre (PSDC), Malaysia34


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is essential to ensure that the necessary institutional infrastructure is inplace, especially as (?) related to business development services.

Challenges to institutions: Effective demand-driven policies and programmes must be based on industry- and location-specificknowledge. This requires governments to develop on-going linkageswith groups of firms, e.g. through industry associations; as well as

effective internal linkages among government departments, in order toformulate and effectively implement industry-related policies and

programmes.

V. Cooperation Among Economies: Regional Production Integration?36

1. A Brief Note on Domestic Consumption and Markets

Although the emphasis to a large extent has been on accessing global markets,

expanding domestic markets in the region can provide an important basis for future

growth in Asia. In this context, past focus on export-lead industrialization in East Asia,

supported by sustained high savings and investment rates, and constrained

consumption, has led to underdeveloped domestic markets in the region. Therefore

these markets have significant scope for expansion. Widening emphasis beyond global

markets to also focus on domestic consumption in the regions economies could

therefore provide growing consumer markets close to home, to support the restructuring

and expansion of production, including SMEs.

There are indications that a shift in focus to expand domestic markets is now

underway (e.g. in Korea, Thailand, India) as a result of government policy; as a

consequence of increasing consumer confidence; and because of increased interest by

banks in consumer loans.37 However, with some notable exceptions (e.g. China, India,

Indonesia), the home markets of Asian economies tend to be too small to allow firms or

groups of firms to fully exploit scale economies in many industries. While the region

offers some opportunities for large-scale production, e.g. for large firms and/or clusters

and networks of SMEs, similarity of many products marketed by the regions countries

in a range of industries limits the market share any one of them can gain. This is why

access to large advanced markets, e.g. the US, is so important. It may be interesting to

consider, even if speculatively, the benefits of moving beyond discussions of trade

integration, to regional production integration.

2. The Issue: A Production Perspective on Regional Cooperation


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In the traditional approach to regional cooperation and integration, the focus in the early

stages is on the liberalization of trade in goods. Subsequent initiatives address issues

such as trade in services, movements of labour and capital, coordination of regulatory

and other policies, and monetary union, ending with the region as a single market.

Significant changes in industrial structure typically do not take place until economic

integration has reached the deeper stages. For example, the EUs Single Market (1992)

came decades after successive stages of cooperation.

An alternative approach to regional integration, taking a production

perspective, could focus on changing regional industrial structure early in the process.

In particular, the focus could be on the creation of regional production linkages (e.g.

production networks), and the distribution of production processes across borders.

3. The Region as a Production Base

The discussion in Asia of regional cooperation and integration has generally followed

traditional lines, e.g. as reflected in the case of AFTA. The initial focus has been on

liberalizing trade in goods, with the hope that increased trade will spur industrial

growth, diversification, and development with industrialization and growth typically

considered at the national level. However, the focus on trade liberalization may have

limited benefits, especially for groupings of smaller economies.

An alternative perspective on regional integration could begin with a focus on

regional production linkages. There are significant potential benefits for moving away

from strictly national models of industrialization, toward regional collaboration.

Regional specialization at the level of parts and components offers significant

opportunities, e.g. both static welfare gains and new opportunities to exploit scale

economies. The basic concept is to think of the region (or subregion) as the production

base, and distribute production around the region in accordance with dynamic

comparative advantage. The objective is to raise efficiency, reduce production costs,

and increase competitiveness of regional firms, e.g. by exploiting scale economies from

the huge number of consumers.

4. A Cautionary Note


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Regional production integration has potentially important benefits to offer to support

development in Asia. However, there are important issues to consider. The

concomitant requirements for mutual adjustment or deep integration among

economies may reach into areas previously regarded as domestic e.g. competition

policy, commercial legislation, tax codes, environmental regulations, labour standards,

product standards can pose significant challenges to national autonomy, potentially

reducing the flexibility of societies to chart their own development paths. Furthermore,

there are dangers of weaker economies being locked in to activities and industries

that provide limited benefits in a regional division of labour.

Given both the potential benefits and the risks of regional production

integration, perhaps this is a concept worth exploring, with due attention to protect the

interests of all participants. Subregional cooperations of the Greater Mekong Subregion

(GMS) type may provide mechanisms to proceed on an exploratory basis,38 with

particular emphasis on the role of and opportunities for SMEs, as discussed in this

paper.

5. Rationale for Production Integration

Traditionally, end products played the dominant role in international trade. This has

undergone important transformation, with the increasing importance and growth of

offshore sourcing of components and offshore production. This is a function of

technological and organizational innovations in transportation, communication, and

information technology facilitated by liberalization of trade and investment that

allow a slicing up of industry and firm value chains across borders to produce goods

in a number of stages in different locations, adding value at each stage. Advances in

management technology then permit firms to knit together multi-country sourcing,

production and distribution networks, simultaneously taking advantage of and shaping

shifts in comparative advantage in diverse locations. In this context, analysis indicates

that offshore sourcing or production of components can create jobs, expand output, and

frequently lead to higher wages.39

The rationale is as follows. If foreign sourcing of a component is cost saving,

then it improves the competitiveness of the end product. If the firm, which makes the

end product, is a price-taker, then the reduction in production costs increases


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profitability, creating an incentive to expand output. If the firm is a price-maker in end

product markets, the reduction in costs brought about by offshore sourcing enables it to

lower price and thus gain market share, leading to higher output. It follows that if

countries involved in the regional trading initiative specialize in component production

according to comparative advantage, i.e. using intensively factors of production and

technologies with which the country is relatively well endowed, it can make everyone

better off. In this context, outward investment can lead to increases in output and

employment.

In this approach, the focus shifts to comparative advantage at the level of the

production of parts, components, process/assembly, as distinct from the traditional

focus on end products. This can reduce production costs, allow for scale economies,

making the regions producers more competitive in world markets. For this approach to

regional integration to work requires the removal of barriers natural and man-made.

For governments, this implies the need to reduce or eliminate constraints on

cross-border linkages, such as policy constraints and physical and non-physical

obstacles that constrain firms from producing on a regional basis. For example, this

could involve the development of cross-border infrastructure, and trade facilitation

measures aimed not simply at freeing up the flow of goods and services, but at creating

an integrated production area. The implications for private sector include increased

investment in services and logistics networks that will permit them to coordinate

production activities across borders; and a shift in perspective that views the location of

activities from a regional rather than national perspective. As an example, the

establishment of the principle of national treatment of companies within the region

could open up possibilities for firms to integrate their businesses in the region.

Example. Implications for Subregional Cooperation in the GMS40

The GMS Programme is aimed at enhancing the economic development ofparticipating countries individually and as a group. The objective is to directly

change the economic structure of the GMS through cooperation in a wide rangeof specific initiatives (e.g. transport, energy, trade facilitation), in order toexpand access to resources and markets, and enhance the attractiveness of the

subregion to investors, e.g. as a production base. This can also help integratethe GMS more effectively into the global economy, further expandingdevelopment options. As progress is made in hardware, e.g. infrastructure,


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and software, e.g. trade facilitation, it may be useful to identify potential areasof production integration within the framework of the GMS Programme. Forexample, this could be done, on a modest scale, within the context of economiccorridor initiatives, such as the East-West Economic Corridor, in collaborationwith the private sector.

VI. Concluding Comments

The restructuring of global industries and markets is posing new challenges to

developing economies in Asia. Successful past models of industrial development in

East Asia need to be adjusted in light of new realities. In particular, the requirements

for firms to access global markets and upgrade their position in global industries are

becoming increasingly complex and demanding. This is posing significant challenges

for all firms in the region, but particularly for SMEs, which face special constraints due

to size.

Given the importance of SMEs in the economies of the region, e.g. as source of

employment, particular attention should be given to strengthening their capabilities. An

effective way to approach this is to focus on facilitating task-oriented cooperation

among small firms in the form of industry clusters and networks. This poses challenges

for both firms and governments: to implement collaborative strategies and

programmes, and to strengthen supporting institutions, particularly at the industry and

local community levels.

In this, although a continuing emphasis on global markets is essential,expanding domestic markets in the region can provide an important basis for future

growth. However, given the limits on the size of most domestic markets in Asia, it may

be useful to consider a regional perspective on industrial development.

The challenges of industrial development in Asia in the 21st century are then

likely to be the challenges of effective cooperation: among firms and among economies.


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Annexes

Annex 1. Wood Furniture Industry: Output Growth but Declining Income

Annex 2. Restructuring of the Fresh Vegetable Industry: Implications for SMEs

Annex 3. Clusters, Upgrading and Global Standards: The Case of the SurgicalInstruments Industry in Sialkot, Pakistan


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Annex 1. Wood Furniture Industry: Output Growth but Declining Income41

1. Introduction

The wood furniture industry reflects the key challenges of dynamic integration ofdeveloping economies into global markets. It raises issues about competing effectively

in industries where the organization of global production may allow the expansion ofeconomic activity and output, and yet not result in sustainable income growth.

The case of the wood furniture industry is especially relevant, since it is aresource based, labour intensive sector, that plays an important role in most developingeconomies. At the same time, leading producers are from high wage economies,indicating possibilities for upgrading, allowing low-wage economies to move up theladder of specialization, sophistication and income. Furthermore, it is an industrywhere the industry structure of leading producing countries, e.g. Italy, Denmark, ischaracterized by SMEs, the dominant form of enterprises in developing countries. Inthis context, the case of South Africa provides insights into challenges facingdeveloping economies.

2. Overview of the Global Furniture Sector

In 1998, the furniture industry was the 19th largest traded goods sector out of 261groupings,42 with a total value of global trade of $50 billion. It was the largesttraditional low-tech sector, exceeding the value of the apparel industry ($45.3 billion),and the footwear sector ($35.7 billion). It was the 17th largest import sector in Europein the period 1985-1997, with growth rate imports into Europe of 81% during the same

period.43Although it is a resource- and labour-intensive industry, the major furniture

exporting countries are industrially advanced economies, e.g. Italy, Canada, Denmark.Of the 15 major exporters (by value), only 6 are developing economies, of which 4 areAsian (China at no. 2; Malaysia no. 7; Thailand no. 9; and Indonesia no. 15).

The wooden furniture sector is becoming increasingly competitive, as more andmore producers enter global markets, including increasing penetration by developingcountries. As a consequence, global prices are declining. Detailed analysis by productsub-groups (4 subsectors) and countries of origin (using the World Bank distinctionamong low-income, lower middle income, upper middle income, and high income)shows for the period 1995-97 the following:

In all subsectors there is a tendency for unit prices of imports from the 4categories of countries to converge.

The unit price of EU imports decreased in 3 of 4 subsectors, remainingrelatively stable in the fourth.

The unit price of imports from high income countries was significantly higher

than from other exporting countries. The value of imports from the low-income group of countries was the 2

ndhighest, suggesting that they entered the low-volume craft market segments.

The above suggests an industry in the midst of intense global competition. Thetrend toward uniform and falling prices is due to either falling barriers to entry and new


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entrants; increasing efficiency and falling costs; or both. Given pricing pressures,producers need to develop the capacity to upgrade, e.g. products, processes, functions.

3. Role of Buyers in Accessing Final Markets

Buyers play a critical role in connecting producers to final global consumers. In almostall cases these buyers are in major importing countries. The relevant questions with

respect to the role of buyers include: to what extent do buyers assist in upgrading ofsuppliers/producers; and in this context, to what extent do developing economies suchas South Africa have the capacity to upgrade their operations as required by buyers.

There are 3 broad categories of buyers in the industry:

Large multinational retailers with both retail outlets and suppliers inmany countries e.g. IKEA sources from 2000 suppliers in 52 countries,and has more than 300 outlets on 3 continents;

Small-scale retailers purchasing directly from a limited number ofsuppliers in a limited number of countries; and

Specialized medium-sized buyers, sourcing from many countries, and re-selling to retail outlets, predominantly in a single country or region.Such a buyer may have more than 1500 suppliers located in manycountries, and even smaller specialized buyers will typically source frommore than 100 suppliers.

All 3 types of buyers are involved with the buying activity itself, e.g. purchasingfrom suppliers. Global retailers outsource the least; they have strong presence acrossmost activities in the industry value chain, e.g. product design, purchasing, logistics,marketing, retailing and distribution, after sales service, and in IKEAs case alsoincluding owning manufacturing facilities. Specialized buyers outsource the most,retaining buying and marketing functions, and generally also playing a role in design.One-store retailers vary in the range of their activities.

None of the buyers are fully integrated; all outsource some activities. Noactivities are exclusively outsourced to either high- or low-wage economies, a mix ofcountries are used. Multi-store retailers are least likely to use low-wage economy firmsas suppliers for outsourced activities other than production. In the case of the largest ofthese retailers, the overwhelming proportion of furniture (85%) comes from middle-and upper-income countries. However, some of these very large retailers such asIKEA, are in the process of significant change, with sourcing from developing Asianeconomies including China, Viet Nam and Indonesia expected to grow rapidly incoming years. Design is outsourced primarily in the case of smaller buyers, but it isonly the very small independent retailers who depend on their low-income countrysuppliers for design of their products, which tend to involve low-margin, price-sensitive

products such as garden furniture.

Increasingly, the large retailers expect to be able to offer low price, high quality,and variety. In general, there are similar demands made on suppliers by buyers. In this,the meeting the requirements of global standards, e.g. as demanded by large retailers,is becoming increasingly important. These relate primarily to the production processand include quality standards (e.g. ISO 9000, 14,000), labour standards (e.g. SA8000),and environmental standards (e.g. Forestry Stewardship Council) but with global


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retailers such as IKEA including standards in other areas such as child labour provisions. Meeting the variety of standards is a minimum requirement for suppliersbidding for contracts with global retailers such as IKEA.

4. Upgrading in the Industry and the Role of Buyers

Increasing competitive pressures are leading to significant upgrading efforts in the

industry in all dimensions, e.g. product, process, functions. Production processupgrading is widespread, including new machinery and equipment, logistics systems,and continuous quality improvements. Product innovation is of growing importance,

partly due to the growing role of flat-pack furniture in reducing transport costs; anddesign is playing an important role in determining market share. With growingmanufacturing capabilities in the global economy, most sustained barriers to entry andupgrading are intangible or service activities, including retail and distribution (e.g. largeretailers are squeezing mom and pop shops), global transport and logistics, marketingand advertising, branding, and design. These generally also happen to constitute thehigher value-added activities in the industry value chain.

Buyers expect suppliers to be able to undertake process and product upgrading,as required. In this context, buyers see a key role for themselves as providing clear

signals to their suppliers as to the type of upgrading required; with multi-store retailersand specialized buyers providing the greatest support to their suppliers for upgrading,e.g. training. In general, buyers increasingly outsource production, and actively support

producers to become more competitive.Functional upgrading is a more complex area. In general, some functions such

as logistics, transport and distribution do not seem particularly protected by buyers.However, others are seen as proprietary. For example, the buying function itself iscarefully protected, erecting a barrier for suppliers to deal directly with final customers.Similarly, global retailers such as IKEA invest significant resources in design, and

protect and control the design function as a key competitive advantage. Therefore thereare limits on producers abilities to upgrade within the context of industry structure.

5. The Case of South Africa

South Africa is the 14th largest exporting country (by value), just ahead of Indonesia.Domestic sales of wood furniture were essentially static during the period 1990-1999.However, exports grew (by value) tenfold during this period, with the share of exportsin total furniture sales increasing from less than 5% in 1992 to over 40% in 1999. Itwould appear that the South African wood furniture industry has become anincreasingly effective participant in global markets, with foreign demand drivingdomestic production.

However, as noted in the main text of this paper, participation in the globaleconomy does not itself guarantee income growth. This is partly a function of howcountries producers fit into the global industry structure. In this context, there is strong

evidence that South Africas wood furniture industry may be experiencing significantproblems. Unit price of exports as measured in $US, fell by 250% between 1992 and1999. This is much greater fall than experienced by all furniture imports into EUduring the same period (28%) and by all wooden imports into the EU (10%). There are3 possible reasons for this decline in the price of South African wood furniture exports:


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Tendency for new exports to be in lower value added segments, reducingthe value of average export price;

Growing efficiencies in production leading to lower costs and sustainedor increasing factor incomes, e.g. wages;

Fall in unit prices of existing products without a corresponding increasein productivity, so that factor incomes fall.

It is the third of the above reasons that presents a potentially major problem. Itwould suggest that the only way that South African producers can expand their exportsinto global markets is through a fall in factor incomes, e.g. wages. Looking at the firmlevel, there is strong evidence to suggest that this is indeed the case. That is, a surveyof buyers that source globally from a wide variety of firms, and who incidentally exertsignificant downward pressure on prices, indicates that South African suppliers are seenas significantly lagging suppliers from other countries in quality and delivery reliability.

It would seem that South African suppliers are hanging on to their market share by virtue of their price competitiveness which in this case seems to have beencreated largely by a continuously depreciating exchange rate. Attempts at functionalupgrading through design modifications have not been successful, due to a large extentto a lack of indigenous design capability, e.g. attempts generally involved minormodifications, as contrasted with Mexicos success in developing an indigenous styleof its own.

6. Conclusions

The global wood furniture industry is characterized by a combination of converging andfalling prices. Production capabilities are becoming increasingly widespread, and hence

buyers are increasingly outsourcing production. In this context, buyers supportproducers to become even more competitive, e.g. through process upgrading, but placelimits on possible functional upgrading by producers.

Evidence suggests that South Africa is experiencing difficulties in coping with

the increasingly competitive global wood furniture industry. This is an economy with avigorous private sector, and abundant relatively cheap labour, especially in skillsneeded for key functions in the industry, i.e. that could support functional upgrading.Yet, success in global markets in terms of growth in output and exports is sustained

primarily by currency depreciation, eroding the international purchasing power ofdomestic income growth. If this is the case for a relatively advanced developingeconomy like South Africa, what are the prospects for lagging economies?

The case of Mexico, the 6th largest exporting country, is instructive. It was ableto develop an indigenous style in wooden furniture that met market success. Givendesign and craft skills throughout Asia, the development of uniquely Asian brandswould therefore also seem to hold promise.


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Annex 2. Restructuring of Fresh Vegetable Industry: Implications for SMEs44

1. Introduction: Consolidation in Developed Markets

The fresh vegetable industry presents an interesting case study given its importance fordeveloping economies, and its growth as one of the most vibrant sectors in internationaltrade. For example, during the 1990s, imports of fruits and vegetables by EU countries

surpassed all other categories of agricultural products; with the sales of specialtyvegetables in EU countries increasing by 21% in volume between 1993-96. Much ofthis was sourced from developing economies. The increasing restructuring of global

production in this industry is leading to the integration of developing country producersinto global markets via production networks increasingly dominated by large retailers(supermarkets), posing potentially significant constraints for local SMEs.

A key development in global retailing has involved increasing concentration indeveloped markets. In the period 1980-1996, the number of retailers accounting for20% of US retail sales has decreased from 33 to 24; while those accounting for anoverwhelming 75% of Europes primary market sales have decreased from 132 to 43during the same period.45 In particular, in the UK, as a proxy for the global industry,the emergence of the large supermarket chains has been one of the most dramatic

examples of concentration in retailing. In 1999 the top 4 retailers Tesco, Sainsbury,Asda, and Safeway accounted for nearly 75% of all food sales. The share of the UKmarket of specialist greengrocers and fruiterers fell from 46% in 1980 to 24% by 1997.

As supermarkets have grown in size, they have exercised increasing influenceon the industry value chain across a wide range of products. They have developed theirown brands in competition with industry leaders such as Heinz, Kellogg, andSchweppes; developed sophisticated logistics systems; and have played increasinglydominant role in developing suppliers. Generally, supermarkets have focused onretailing and control of the supply chain, rather than direct involvement in production.Whereas imported horticultural products were primarily channelled through wholesalemarkets, the largest UK retailers now control 70-90% of fresh produce imports from

developing economies.Fresh fruit and vegetables are core competitive areas for retailers. Freshproduce represents a destination category for shoppers: it is one of the few productcategories, along

challenges of industrial restructuring in a globalizing world: implications for small- and medium-...

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