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How and why is global production organized in chains or networks and what are the implications of this?
Today multinational firms try to intergrade global production within their operations to gain competitive advantage and more profits. Global production networks theory is a relatively new theory that derived from earlier attempts, such as global value chains and global commodity chains, to explain how global production works and to consider all the possible actors that shape it. Corporations that want to follow the new trend in manufacturing and business conduct must take into consideration a welter of factors that shape and indicate the optimal process of global operations for maximizing profits. Global production strategies can offer multinational corporations many advantages if designed the right way as well as unavoidable disadvantages. Competitive dynamics and capitalist dynamics are the main forces for global production and the mobility of capital nowadays only adds to the ease that these networks are established and formed. Regional advantages and peculiarity must be taken into consideration before a firm decides the exact form of global production that wants to follow. Communication across the network and purchasing policies within the organization consist an important area for the smooth operation of the network, and corporations are aware of that, forming special divisions solely for those purposes. Ramifications of global production networks can be traced all around the globe, in developed or developing economies, and affect a bigger portion of everyday life and business conduct than what it is believed to be.
Yeung explains global production networks as “an organizational arrangement comprising interconnected economic and noneconomic actors coordinated by a global lead firm and producing goods or services across multiple geographic locations for worldwide markets. These actors include different types of firms as well as non-firm actors, such as the state, international organizations, labor groups, consumers, and civil society organizations, in diverse localities”.(Yeung.2015)Global production network analysis derived from the literature of global value chains and global commodity chains. Global value chains are defined as “the value added of all activities that are directly and indirectly needed to produce a product”. (Timmer, Los, et.al, 2014)Global commodity chains refer to “the full range of activities, including coordination, that are required to bring a specific product from its conception to its end use and beyond. This includes activities such as production, design, marketing, distribution, support to the final consumer, and governance of the entire process”. (Startosa,2010)Global production network analysis broadens beyond the interaction of suppliers and manufacturers and brings into the frame several actors that influence and shape global production, such as national governments, worker’s unions and non-governmental organizations. Also, global production network analysis accentuates the social and institutional embeddedness of production and examines power relations amongst actors, which differ as production is spread in multiple global sites. (Gereffi et.al ,2011)
The advantages and disadvantages of a global integrated strategy were set out by Dickens. Adopting this type of strategy increases the corporation’s oligopoly power past the size of specific national markets via the exploitation of scale and experience. The TNC is in a better position to exploit the rising inconsistency between yielding markets for good and inefficient markets for manufacturing factors. Also, the firm is more likely to engage in transfer pricing and the specialized and embedded functions of operations within a country, makes the government less likely to adopt a hostile stance towards the firm. But a global integrated strategy includes risks and costs. This strategy leaves the TNC susceptible to disturbance of their operations or a part of it, due to labor unrest or government policies. Fluctuations in currency exchange rates might interrupt integration strategies, radically changing the economies of interfirm transactions of in-between and end products. Performance requirements or different limitation might be forced into the firm by governments that obstruct the optimum operations of a corporation’s integrated production chain. Last but not least, managing global integrated operations is more multifaceted and challenging than that of managing individual national subsidiaries. (Dickens, 1998)
A value chain analysis is important when constructing global strategy. The purpose of this analysis is to locate in which functions and procedures of production and organizational services provide the firm with competitive advantage and which of them can be sliced and integrated into a global network. Global strategy formulation depends on the interaction of comparative advantages of locations and competitive advantages of the firm. While comparative advantage helps to decide on the location that provides more value, competitive advantage helps the firm to recognize which activities can be outsourced and which activities the firm should focus its resources. The value chain is a set of activities taken by the firm to perform business, such as the production of a product, sales or after sales support. For those activities, there are two types of competitive advantage firms can create. First is low cost; the ability of the firm to engage in business actions within the value chain in relative low cost from its competitors. Second is differentiation; a unique way of conducting activities and creating products that differentiate the firm from its competitors. (Gereffi, 2015).
There are three competitive dynamics that drive lead firms to become more global. These are cost, flexibility and speed. Due to these competitive pressures, capital implements a spatial fix involving divestment and investment in variant regions. High cost regions go through a process of deindustrialization, while low cost regions are targets for new investment assisted by the rise of a new international division of labor. This spatial fix temporarily reliefs global corporation from their cost problems but does not pose a long-term solution for overcoming competition, the other two dynamics -flexibility and speed- might be more important. Lead firms have begun to understand that competitive advantage can be gained by a more elastic and effective way of organizing global production. This notion is termed as organizational fix and must differentiate from the idea of spatial fix. if a firm was to reorganize its production network it would not necessarily mean spatial relocation. Rather that, an organizational fix derives mainly from choosing different business strategies. For example, outsourcing is an organizational fix in which international lead corporations are capable to augment their production suppleness without the responsibility of owing production or service facilities. These organizational fixes tend to make production networks more globally oriented and integrated, and sophisticated networks led by lead firms emerge. Depending on low cost production areas though does not fully addresses the problem of competitive dynamics in today’s global economy. Capitalist dynamics have driven firms to find new competitive advantages throughout improvements on their transportation and communication systems and technologies, a phenomenon labeled as time-space compression. (Yeung, 2007).
Capitalist dynamics are the reason of existence of global production networks, encouraging actor-specific strategies in various economies. Three essential dynamic forces are being identified in the form of honing cost-capability ratios, maintaining market development and operating with the financial disciple. Used in various compounds, these dynamic forces are the essential etiological conditions to clarify actor-specific strategies that shape these networks, which in turn create various experiential outcomes. These are the autonomous variables that help to understand why global production networks are arranged and ruled in specific ways, with various aftereffects in industrial alteration and territorial growth. Due to continuous antagonistic pressures in advanced economies for cheaper goods and services in final markets, many frontrunner vertical integrated firms had to reassess their cost structures. The reconfiguration of cost structures was considered in both indirect and direct cost. Indirect costs are associated with finance, such as transaction costs with suppliers or customers or investing in know-how while direct costs are associated with production, such as wages or material inputs. Wages in particular, became the most common area of optimization. The shift of production to global location with lower labor costs, with the use of subsidiaries or subcontracting, was an innovating method of locational opportunity for vertical integrated corporations in developed industrial economies. Though, this emphasis on cost as the main force of global production, circumvents an important aspect, the firm’s capabilities. Therefore, focusing on cost alone does not produce enough analysis to define the corporation as the key actor within a network. Capabilities must get consideration alongside cost for a complete and actor-oriented notion of the firm to take shape. (Yeung, 2015)
The meaning of capital can take various forms. In everyday use, money and assets that can be turned into money are considered as capital. But in global economy, capital contains physical inputs into the process of production, like buildings, machines and human resources. Physical capital is reflected through monetary terms most of the times, because value is measured via money. Individuals can exchange real assets for money but societies cannot apply the same process. Money capital is thought to be extremely mobile. Firms and individuals can transfer funds to various financial institutions and different regions in less than an hour. However, real capital -constituting the main factor of production- is not even as close as mobile as money; some equipment is place-bound. An individual can liquidize such real assets, making immobile assets into mobile capital, though real capital is measured in money, meaning that real assets may lose their value along the way, making such a move injurious. Capital mobility can be identified in three types. Firstly, money capital is able to barter for either goods or services. Secondly, real capital -machinery, human capital, etc. – can be transferred through regions, though some real assets have limited mobility. Lastly, the value of real assets may fluctuate due to shifts in global economy. (Blair,1995).
Cost reduction is a crucial factor prompting leading firms to adopt practices such as outsourcing and subcontracting, though cost as a concept is relative. To achieve better understanding of how cost influences the production network, the actor specific capabilities that a firm or a supplier possesses must be taken into consideration. A cost-capability ratio helps to understand the impact of cost and why leading firms choose to outsource specific value adding processes to specific suppliers. This ratio differs from corporation to corporation. Firms may optimize this ratio through reducing cost or by cultivating new capabilities or by both ways. Firms that optimize their cost/capability ratio using global production networks have a better chance to keep or upgrade their position in global end markets. Suppliers who embed into a leading firms’ production network and upgrade their own capabilities, might optimize their own ratios over time. These suppliers might become strategic partners of the firm, if transaction relations are amplified and interfirm learning takes place. Market creation in global production networks theory involves both producers and customers. Producers seek more profits by expanding in different markets and customers demand better products or services at lower prices. The continuing configuration of a production network and the creation of new markets is the outcome of this repeated process. Firms are getting pressured to develop and sustain their market reach, regardless their cost/capability ratios. Firms with high ratios are more prone to reconfigure their production networks in order for them to maintain their position in the market. Low ratio leading firms carry on trying to gain access to market and hope to benefit from first mover advantages in markets. In the meantime, suppliers are subject to the same pressures, as market access via leading firms eventually leads to more value capture. Customers are crucial as well for market creation. Except from quality and price, customers are now more informed than ever about the products they use and take into consideration more factors such as environmental impingement or ethical and social responsibility. These preferences have a growing impact in constructing and organizing a production network. The opportunities that arise from financialization necessitate leading firms to expand their production networks. Firms that succeed in globalizing their production networks have a tendency to perform better in financial markets, which changes their lens on how the firm should grow and govern. Corporations do not rely completely on financial institutions or banks to fund their projects and investments, as they can now turn to capital markets for private funding. However, firms have to meet the terms of their investors, which in most cases is raising the stock price and create more value for the shareholders. Subcontracting high maintenance production operations to capable suppliers allow firms to maintain their position in the market while gaining more value for their shareholders. (Yeung, 2015).
When a firm designs its global production strategy, has to take decisions about some important areas. First, they must decide on the number of the plants they want to scatter across the globe and their exact locations, which is determined by a number of factors such as cost, government policies or returns. Second, is the role of these plants and the relationship between them. Third, are the purchasing policies that the organization will adopt. Studies have shown that the decision of a plant location is of great importance and the time that firms invest for that decision to be taken exceeds the overall time consumed to organize the production network and the logistic chain. Five factors related with the location decision and derive from FDI considerations are; the market , its size and growth, what type of products or services are demanded and the level of competition; the resources available to the location, raw materials or workforce; the production costs, cost of labor or raw materials, transportation and energy; the political conditions of the location, tax rates or incentives, position of the government toward foreign investment; and lastly cultural and linguistic conditions, such as similar way of conducting business, different languages spoken or the attractiveness of a product in that market. (Stonehouse, Campell et.al, 2004)
Transnational corporations, according to Dickens, can follow four strategies of global production which can vary from firm to firm and industry to industry. The simplest strategy is the globally concentrated production. All production activities are gathered in a single location and then products are exported to global end markets through the firms’ sales network. Host market production, is a type of production, that production and final goods are targeted directly towards the host market. In cases where the host market is similar with that of the firm’s, the end product will have less differentiations. Criteria for host market plant creation are the size of the host market, advantages related to cost reduction for setting up in the host market and restrictions at market entry. This type of production acts as a substitute to imports and thought host market production becomes obsolete in the global production framework; there are reasons to adopt it such as the need to differentiate the product based on the markets preferences or after sales support and the existence of tariff barriers to trade. Product specialization for a regional market, takes place when production is geographically placed to serve a particular region (EU, NAFTA, etc.). The topographical assessment of the plants involves an exchange between large scale production economies and the movement cost of production inputs within the network and final products to end markets. Transnational vertical-integrated production, is the most common strategy deployed by transnational corporations and involves production processes, intermediate products and raw materials dispersed around the globe. With this strategy, an intermediate product can be manufactured in one part of the globe and sent to a different location in another country to continue the production process. Also, the final product may be exported to a third market. Despite the evolution of communication and transportation, the distance between head offices and production, accounts for a big portion on the decision where production should set up, with firms choosing locations closer to their home country due to geographical convenience. Transnational corporations outsource same parts of their production process to two or more contractors. With this strategy, firms avoid relying solely on one supplier, whose operations might get halted for different reasons, creating disturbances in the production network. (Dickens, 2007).
Communication across production network is possible through the lateral organization. The lateral organization is a process in which information is exchanged and decisions are being taken making coordination across the network feasible. Each unit within the network with information and quota in an activity, assign a person as a representative for the coordination of the activity. Thus, the lateral organization helps the firm decentralize their decision process and increases the firm’s ability to take more decision on more issues. Communication across networks can take two forms, formal and informal. However, for premier cross border communication, formal ways must be adopted. Central management appoints groups of managers to coordinate the functions of production, the units involved and come up with new products for global markets. To avoid conflict, gain clarity about their purpose and not overlap with other activities, these groups establish a charter of their scope and authority. For the staffing of the group, representatives are needed from every involved unit. The representatives should have adequate information about the issues concerned and the authority to decide on collective action and commit their unit. However, due to the human aspect of the group, conflicts are inevitable. For that purpose, the team must establish processes to resolve those conflicts. Also, if the group is not rewarded accordingly, might have less motivation to resolve these conflicts. Their performance and outcomes within the group must be tied to the reward system. Experienced coordination groups do not require an appointed leader. The leader may change for every issue at hand, appointed by the group based on who is more capable on the particular issue. Though for most groups, a leader is appointed from central management to dictate the agenda, lead discussion and communicate with external to the group agents about their work. Most of the time, the designated leader comes from the firm’s home country. (Galbraith, 2000).
for the smoother operation of the production network firms establish purchasing policies for their subsidiaries. Two types of purchasing policies exist. Central purchasing and autonomous purchasing. When implementing central purchasing, a single division is responsible for all corporate purchases of components with the goal being the exploitation of economies of scales and the level of quality. (Stonehouse, Campell et.al, 2004). Firms invest in specialized divisions that are responsible not only for quality control of the components but also with management specifications, the transportation to each subsidiary, communication across the network and insurance. (Gereffi, 2015). Subsidiaries are then necessitated to buy from the central division. With autonomous purchasing, subsidiaries are responsible for component acquisition. This might be the result of a government policy tackling global sourcing or a firm policy centered around a specific country. With this type of purchasing policy, subsidiaries must guarantee that the quality standards are met and cost of components and delivery don’t exceed the projected costs. In most cases a mix of these policies is implemented, central purchasing used for standard components and autonomous for specialized parts based on the market of the subsidiary. (Stonehouse, Campell et.al, 2004).
Global production networks consist of doubt and cooperation amongst different actors, ranging from the firm to government institutions and non-governmental actors. Therefore, these networks are not only an arena for firms to compete for market share or value adding activities. They constitute a complicated political economic system, in which firms and markets are built based on the sociopolitical environment. (Levy, 2008). The ramifications of global production networks exist in both developing and developed economies. For developing economies, one issue is the growth of jobs. Most developing countries are agricultural and global production networks shift the balance of jobs to manufacturing or service. These countries cannot fill these positions with indigenous population due to lack of training or education leading global firms to expatriate executives. Some developing countries-such as East Asian countries-who have achieved development in integrating these global production networks and practices, face difficulties in sustaining this development. However, the crux of the problem lies in poverty. Low incomes entail to low level of living which derives from the low productivity average of a country’s entire labor force. This low productivity is a result of different factors. From the supply side, some factors are poor health, different working attitudes or the high population growth combined with unemployment. From the demand side, deficient skills, uneducated workforce or techniques that help the automation of production leaving human capital unneeded. Also, low incomes prevent savings and investments, leading to less working positions. Lastly, low incomes are associated with high family member numbers, because children are the reason states provide social and economic security in these families. (Dickens, 1998)In developed economies a contradictory trend exists. Firms focus more and more on social corporate responsibility, adopting codes of conduct yet inequalities arise within the workforce due to weakening of their unions, loss of state provision and raising antagonism from offshore subcontractors. One more implication is that markets are not these abstract structures based on economic theory, meaning that the concept of “free” market does not exist. Markets are being shaped daily by the power struggle of economic and non-economic actors, and the struggle to regulate the markets at their will. The market does not become more “free” under new ways of governance rather that it is controlled by different forces and constraints. (Levy, 2008)
Global production networks tend to be the main process of production and value creation for multinational corporations. In the era of globalization, global production networks are the main forces behind it, integrating different cultures and ways of conducting business into a common system for profit for every actor within the organization. A thorough global strategy is needed though, for a network to be successful, practical and salutary, and take into consideration as many factors as possible that can affect the performance of the network in positive or negative ways. The increasing competition and the need for profits, are the main drivers for constructing a global production network and the constant evolving technologies in transportation and communication and the flexibility of capital are the means to do it. Multinational corporations occupy the role of the coordinator within the network, putting in use their superior knowledge of conducting global business to ensure the success of the network, the goals set by the shareholders and the prosperity of every actor within network. Suppliers and subcontractors align with the goals of the multinationals, parallel to their own, recognizing the opportunities and benefits that come with being a part of the network, either by gaining more profits or by evolving their own capabilities with the knowledge they acquire within it. Non-firm actors, such as governments and non-profit organizations, try to impose regulations and codes of ethics within these networks, either to serve their own personal agenda or -like in many cases- to restore justice and fair share for every actor of the network that might not obtain a fair amount of benefits. Global production networks account for an enormous share of global economic activity, affecting every person’s life in a bigger scale, such as interaction of corporations with governments for favorable policies in either way, or a smaller scale, such as the everyday activities of a normal consumer.
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