Author: Dr. Jean-Paul Rodrigue
1. Contemporary Production Systems
As the fourth industrial revolution is unfolding, production and consumption are the two core components of economic systems and are both interrelated through the conventional supply / demand relationship. Basic economic theory underlines that what is being consumed has to be produced and what is being produced has to be consumed. Any disequilibrium between the quantity being produced and the quantity being consumed can be considered as a market failure. On one side, insufficient production involves shortages and price increases, while on the other, overproduction and overcapacity involves waste, storage and price volatility. It is mainly through the corporation and its perception of market potential that a set of decisions are made about how to allocate scarce resources, reconciling production (supply) and consumption (demand). This cannot occur without freight flows within a complex system of distribution that includes, modes, terminals, but also facilities consolidating, storing and deconsolidating these flows, namely distribution centers.
Manufacturing is a core economic function as it produces tangible goods fulfilling various needs using processes that can be manual (using tools), mechanical (using machines), chemical (reactions) and even biological. It has a cost structure composed of direct (such as materials and wages) and indirect costs (such as distribution), which is often location specific. Contemporary manufacturing systems are the outcome of significant changes in production factors, distribution and production networks:
- Production factors. In the past, the three dominant factors of production, land, labor and capital, could not be effectively used at the global level. For instance, a corporation located in one country had difficulties taking advantage of cheaper inputs (e.g. labor and land) in another country, notably because regulations would not permit full (and often dominant) ownership of a manufacturing facility by foreign interests. This process has also been strengthened by economic integration and trade agreements. The European Union established a structure that facilitates the mobility of production factors, which in turn enabled a better use of the comparative productivity of the European territory. Similar processes are occurring in North America (NAFTA), South America (Mercosur) and in Pacific-Asia (ASEAN) with various degrees of success. Facing integration processes and massive movements of capital coordinated by global financial centers, factors of production have an extended mobility, which can be global in some instances. To reduce their production costs, especially labor costs, many firms have relocated segments (sometimes the entire process) of their manufacturing activities to new locations.
- Distribution. In the past, the difficulties of overcoming distances were related to constraints in physical distribution as well as to telecommunications. Distribution systems had limited capabilities to transport merchandises between different parts of the world and it was difficult to manage fragmented production systems due to inefficient communication systems. In such a situation, freight alone could cross borders, while capital flows, especially investment capital, had more limited ranges. The tendency was to trade finished goods, since it was more complex to trade intermediate goods. Trade could be international, but production systems were dominantly regionally focused and mainly built through regional agglomeration economies with industrial complexes as an outcome. With improvements in transportation and logistics, the efficiency of distribution has reached a point where it is possible to manage large scale networks of production and distribution.
- Production networks. In the past, the majority of relationships between elements of the production system took place between autonomous entities, which tended to be smaller in size. As such, those production networks tended to be rather uncoordinated. The emergence of multinational corporations underlines a higher level of linkages within production systems, as many activities that previously took place over several entities are now occurring within the same corporate entity. While in the 1950s, the share of the global economic output attributable to multinational corporations was in the 2% to 4% range, by the early 21st century this share has surged to a range between 25% and 50%. About 30% of all global trade occurs within elements of the same corporation, with this share climbing to 50% for trade between advanced economies.
The development of global transportation and telecommunication networks, ubiquitous information technologies, the liberalization of trade and multinational corporations are all factors that have substantially impacted production systems. Products are getting increasingly sophisticated requiring a vast array of components and skills for their fabrication. One key issue is the array of corporate expansion strategies available in a global economy, including horizontal and vertical integration, as well as outsourcing. In many cases, so called “platform companies” have become new paradigms where the function of manufacturing has been removed from the core of corporate activities. Corporations following this strategy in the 2000s, particularly mass retailers, have been active in taking advantage of the “China effect” in a number of manufacturing activities. Yet, this advantage is being eroded with rising input costs, inciting re-shoring where activities that were offshored are brought back to locations they were initially offshored from. This underlines that locational decisions are constantly being reassessed in light of changes in global input costs. Additionally, the attention of public policy is shifting from the promotion of competitiveness to the development of capabilities. The main rationale is that competitiveness tends to focus on decreasing different input costs, while capabilities is focusing on increasing added value provided by the manufacturing sector.
2. Commodity and Value Chains
Commodities are resources that can be consumed. They can be accumulated for a period of time (some are perishable while others can be virtually stored for centuries), exchanged as part of transactions or purchased on specific markets (such as futures market). Some commodities are fixed, implying that they cannot be transferred, except for the title. This includes land, mining, logging and fishing rights. In this context, the value of a fixed commodity is derived from the utility, the expected reserves and the potential rate of extraction. Bulk commodities are commodities that can be transferred through a market transaction, which includes for instance grains, metals, livestock, oil, cotton, coffee, sugar and cocoa. Their value is derived from utility, supply and demand, which is established through major commodity markets involving a constant price discovery mechanism.
The global economy and its production systems are highly integrated, interdependent and linked through value chains.
Value Chain (also known as commodity chain). A functionally integrated network of production, trade and service activities that covers all the stages in a supply chain, from the transformation of raw materials, through intermediate manufacturing stages, to the delivery of a finished good to a market. The chain is conceptualized as a series of nodes, linked by various types of transactions, such as sales and intra firm transfers. Each successive node within a commodity chain involves the acquisition or organization of inputs for the purpose of added value.
Value chains are thus a sequential process used by corporations within a production system to gather resources, transform them in parts and products and, finally, distribute manufactured goods to markets. Each sequence is unique and dependent on product types, the nature of production systems, where added value activities are performed, markets requirements as well as the current stage of the product life cycle. Value chains enable a sequencing of inputs and outputs between a range of suppliers and customers, mainly from a producer and buyer-driven standpoint. They also offer adaptability to changing conditions, namely an adjustment of production to adapt to changes in price, quantity and even product specification. This means that value chains are constantly upgraded to fit technological, costs and market changes. The flexibility of production and distribution becomes particularly important, with a reduction of production, transaction and distribution costs as the logical outcome. The three major types of value chains involve:
- Raw materials. The origin of these goods is linked with environmental (agricultural products) or geological (ores and fossil fuels) conditions. The flows of raw materials (particularly ores and crude oil) used to be dominated by a pattern where less developed economies exported towards more developed economies. Transport terminals in the former are specialized in loading while those in the later unload raw materials and often include transformation activities next to port sites. Industrialization in several developing countries has modified this standard pattern with new flows of energy and raw materials. The major shift involve China, which has become a major consumer and importer of raw materials.
- Semi-finished products. These goods already had some transformation performed conferring them an added value. They involve metals, textiles, construction materials and parts used to make other goods. Depending on the labor intensiveness and comparative advantages segments of the manufacturing process have been offshored. The pattern of exchanges is varied in this domain. For ponderous parts, it is dominated by regional transport systems integrated to regional production systems. For lighter and high value parts, a global system of suppliers tends to prevail.
- Manufactured goods. These include goods that are shipped towards large consumption markets and require a high level of organization of flows to fulfill the demand. The majority of these flows concerns developed countries, but a significant share is related to developing countries, especially those specializing in export-oriented manufacturing. Containerization has been the dominant transport paradigm for manufactured goods with production systems organized around terminals and their distribution centers.
3. Integration in Value Chains
Transport chains are being integrated into production systems. As manufacturers are spreading their production facilities and assembly plants around the globe to take advantage of local factors of production, transportation becomes an ever more important issue. The integrated transport chain is itself being integrated into the production and distribution processes. Transport can no longer be considered as a separate service that is required only as a response to supply and demand conditions. It has to be built into the entire supply chain system, from multi-source procurement, to processing, assembly and final distribution. Supply Chain Management (SCM) has become an important facet of international transportation with the container becoming a transport, production and distribution unit.
A significant trend has thus been a growing level of embeddedness between production, distribution and market demand. Since interdependencies have replaced relative autonomy and self-sufficiency as the foundation of the economic life of regions and firms, high levels of freight mobility have become a necessity. The presence of an efficient distribution system supporting global value chains (the term global production networks is often used as well) is sustained by:
- Functional integration. Its purpose is to link the elements of the supply chain in a cohesive system of suppliers and customers. A functional complementarity is then achieved through a set of supply/demand relationships, implying flows of freight, capital and information. Functional integration relies on distribution over vast territories where “just-in-time” and “door-to-door” strategies are relevant examples of interdependencies created by new freight management strategies. Intermodal activities tend to create heavily used transshipment points and corridors between them, where logistical management is more efficient.
- Geographical integration. Large resource consumption by the global economy underlines a reliance on supply sources that are often distant, as for example crude oil and mineral products. The need to overcome space is fundamental to economic development and the development of modern transport systems have increased the level of integration of geographically separated regions with a better geographical complementarity. With improvements in transportation, geographical separation has become less relevant, as comparative advantages are exploited in terms of the distribution capacity of networks and production costs. Production and consumption can be more spatially separated without diminishing economies of scale, even if agglomeration economies are less evident.
Depending on the complexity of the product a range of location strategies within global production networks take shape, ranging from multidomestic production (each market serviced independently) to globally integrated production. The level of customization of a product can also be indicative about how value chains are integrated. For products requiring a high level of customization (or differentiation) the preference is usually to locate added value components relatively close to the final market. For products that can be mass produced and that require limited customization, the preference leans on locating where input costs (e.g. labor) are the lowest.
4. Freight Transport and Value Chains
As the range of production expanded, transport systems adapted to the new operational realities of local, regional and international freight distribution. Freight transportation offers a whole spectrum of services catering to cost, time and reliability priorities and has consequently taken an increasingly important role within value chains. Improvements in freight transportation are therefore associated with more efficient value chains. Among the most important improvements:
- Improvements in transport efficiency incited an expanded territorial range to value chains. This has expanded the range of procurement and market options.
- The development of information technologies, enabling corporations to establish a better level of control over their value chains. This enabled to improve the coordination of flows within value chains, particularly their reliability and timeliness.
- Technical improvements, notably for intermodal transportation, enabled a more efficient connectivity between different transport modes (especially land / maritime) and thus within value chains.
The results have been an improved velocity of freight, a decrease of the friction of distance and a spatial division of production. This process is strongly embedded with the capacity and efficiency of international and regional transportation systems, especially maritime and land routes. It is uncommon for the production stages of a good to occur at the same location. Consequently, the geography of value chains is integrated to the geography of transport systems. Among the main sectors of integration between transportation and commodity chains are:
- Agricultural commodity chains. They include a sequence of fertilizers and equipment as inputs and cereal, vegetable and animal production as outputs. Several transportation modes are used for this production system, including railcars, trucks and grain ships. Since many food products are perishable, modes often have to be adapted to these specific constraints. Agricultural shipments tend to be highly seasonal with the ebb and flows of harvest periods. Ports are playing an important role as points of warehousing and transshipment of agricultural commodities such as grain. A growing share of the international transportation of grain is getting containerized. In 2007, 100 million tons of grain were carried on bulk ships while an additional 10 million tons was carried by container.
- Energy commodity chains. Include the transport of fuels (oil, coal, natural gas, etc.) from where they are extracted to where they are transformed and finally consumed (see for instance International oil transportation). They are linked to massive flows of bulk raw materials, notably by railway and maritime modes, but also by pipeline when possible. They tend to be very stable and consistent commodity chains since a constant energy supply is required with some seasonal variations.
- Metal commodity chains. Similar to energy commodity chains, these systems include the transport of minerals from extraction sites, but also of metals towards the industrial sectors using them such as shipbuilding, car making, construction materials, etc.
- Chemical commodity chains. Include several branches such as petrochemicals and fertilizers. This commodity chain has linkages with the energy and agricultural sectors, since it is at the same time a customer and a supplier.
- Wood and paper commodity chains. Include collection over vast forest zones, namely Canada, Northern Europe, South America and Southeast Asia, towards production centers of pulp and paper and then to consumers.
- Construction industry. Implies movements of materials such as cement, sand, bricks and lumber, many of which are local in scale.
- Manufacturing industry. Involves a much diversified set of movements of finished and semi-finished goods between several origins and destinations. These movements will be related to the level of functional and geographical specialization of each manufacturing sector. Such flows are increasingly containerized.
Most value chains are linked to regional transport systems, but with globalization, international transportation accounts for a growing share of flows within production systems. The usage of resources, parts and semi-finished goods by value chains is an indication of the type of freight being transported. Consequently, transport systems must adapt to answer the needs of value chains, which incites diversification. Within a value chain, freight transport services can be categorized by:
- Management of shipments. Refers to cargo transported by the owner, the manufacturer or by a third party. The tendency has been for corporations to sub-contract their freight operations to specialized providers who provide more efficient and cost effective services.
- Geographical coverage. Implies a wide variety of scales ranging from intercontinental, within economic blocs, national, regional or local. Each of these scales often involves specific modes of transport services and the use of specific terminals.
- Time constraint. Freight services can have a time element ranging from express, where time is essential, to the lowest cost possible, where time is secondary. There is also a direct relationship between transport time and the level of inventory that has to be maintained in the supply chain. The shorter the time, the lower the inventory level, which can result in significant savings.
- Consignment size. Depending on the nature of production, consignments can be carried in full loads, partial loads (less than truck load; LTL), as general cargo, as container loads or as parcels.
- Cargo type. Unitized cargo (containers, boxes or pallets) or bulk cargo requires dedicated vehicles, vessels and transshipment and storage infrastructures.
- Mode. Cargo can be carried on a single mode (sea, rail, road or air) or in a combination of modes through intermodal transportation.
- Cold chain. A temperature controlled supply chain linked to the material, equipment and procedures used to maintain specific cargo shipments within an appropriate temperature range. Commonly relates to the distribution of food and pharmaceutical products.
Globalization also concomitant, a by-product, to a post-fordist environment where just-in-time (JIT) and synchronized flows are becoming the norm in production and distribution systems. International transportation is shifting to meet the increasing needs of organizing and managing its flows through logistics. In spite of the diversity of transport services supported various value chains, containerization is adaptable enough to cope with a variety of cargo and time constraints.