Author: Dr. Jean-Paul Rodrigue
A value chain is a functionally integrated network of production, trade, and service activities covering stages from the transformation of raw materials, manufacturing to the delivery of finished goods to a market.
1. Contemporary Production Systems
As the fourth industrial revolution unfolds, production and consumption are 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 must be produced, and what is being produced must be consumed. Any disequilibrium between supply and demand can be considered a market failure. On one side, insufficient production involves shortages and price increases, while on the other, overproduction and overcapacity involve waste, storage of excess inventory, and price volatility. Economic cycles are the outcome of the continuously shifting balance between supply and demand, with recessions usually taking place when supply exceeds demand for a period. It is mainly through corporations and their perception of market opportunities that decisions are made about allocating scarce resources and reconciling production (supply) and consumption (demand). While end markets are composed of individuals, production requires the organization and management of resources by hierarchical decision-making structures. The complexity and scale of contemporary manufacturing lean on an ecosystem of corporations of various sizes characterized by a small number of large corporations and a large number of small and medium-sized enterprises. This ecosystem generates freight flows within a complex distribution system that includes modes, and terminals, but also facilities consolidating, storing, and deconsolidating these flows.
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 and automation), chemical (reactions), and even biological (such as fermentation). It has a cost structure composed of direct costs, such as materials and wages, and indirect costs, such as distribution, which are often location-specific. Producing the same output at different locations can be associated with a different cost structure because input costs such as labor, land, and energy will vary. Contemporary manufacturing systems are constantly adapting to 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 (or majority) ownership of a manufacturing facility by foreign interests. Economic integration and trade agreements have gradually allowed various forms of foreign ownership, such as direct ownership and joint ventures. For instance, the European Union established a structure facilitating the mobility of production factors, which in turn enabled better use of the comparative productivity of the European territory. Similar processes are occurring in North America (NAFTA/USMCA), South America (Mercosur), and Pacific-Asia (ASEAN). Facing integration processes and massive movements of capital coordinated by global financial centers, factors of production have 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 goods 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 options. 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 regional and mainly built through regional agglomeration economies with industrial clusters 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, most 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. 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 concerning advanced economies. Competing and complementary transnational production networks are thus being established.
Products are getting increasingly sophisticated, requiring a vast array of components and skills for their fabrication. Such complex processes incite corporations to grow in scale and scope and make complex decisions to manage their operations and improve their competitive advantages. One key issue is the array of corporate expansion strategies available in a global economy, including horizontal and vertical integration, as well as outsourcing. The latter concerns transferring functions such as manufacturing, research, management, or distribution to be performed by a third party. This transfer can occur within the same country, but it often takes place in an external country, which is defined as offshoring. The term can be further nuanced with the concepts of nearshoring and farshoring involving a level of proximity. The expansion strategy of large corporations can be justified from the perspectives of seeking new resources and markets, looking for lower-cost locations, or getting access to new technologies.
In many cases, “platform companies” have become new paradigms where the function of manufacturing has been removed from the core of corporate activities. Corporations following this strategy, particularly mass retailers, have been active in taking advantage of the “China effect” in several manufacturing activities in the late 20th and early 21st centuries. This has been associated with massive offshoring of manufacturing. Yet, this advantage is being eroded with rising input costs and protectionist measures, inciting re-shoring where offshored activities are brought back from locations they were initially offshored to alternative locations. This underlines that locational decisions are continually being reassessed, considering changes in global input costs and regulations. Additionally, the attention of public policy is shifting from the promotion of competitiveness to the development of capabilities. The primary rationale is that competitiveness tends to focus on decreasing input costs, while capabilities focus on increasing the added value provided by the manufacturing sector.
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. The analysis of any supply chain reveals the actors and processes that contribute to the origination of a product consumed by a market, such as raw materials, food, or consumption goods. Thus, a supply chain includes a sequence of operations ranging from the extraction of raw materials, and the assembly of intermediate goods, to the distribution to consumption markets.
2. Defining Value Chains
Global production systems are highly integrated, interdependent, and linked through value chains.
Value 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 finished goods 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 value chain involves the acquisition or organization of inputs for added value.
Through a series of stages, value chains take commodities, transform them into higher-value products, and make them available on markets. A value chain is said to be global when several stages occur in different countries. This process can be backward or forward-looking:
- Backward participation. When a stage in a value chain produces outputs that were created by prior stages. This usually takes place in the later stages of a value chain, particularly in the assembly and distribution of a final good composed of parts manufactured by other suppliers.
- Forward participation. When a stage in a value chain produces outputs that will be used in further stages to create a final good. This usually takes place in the earlier stages of a value through the processing of resources and the creation of parts and components for further assembly.
Commodities are resources that can be consumed for a purpose and are usually part of the earlier stages of value chains. They can be accumulated for a period of time as some are perishable, while others can be stored for centuries. They can be exchanged as part of transactions or purchased on specific markets such as futures markets. Some commodities are locationally fixed, implying that they cannot be transferred, except for their title. This includes land, mining, logging, and fishing rights. In this context, the value of a locationally fixed commodity is derived from its utility, expected reserves, and potential extraction rate. Bulk commodities are commodities that can be transferred through a market transaction, with the most traded commodities including crude oil, steel, copper, coffee, natural gas, gold, sugar, corn, wheat, and cotton. Their value is derived from utility, supply, and demand, which is established through major commodity markets involving a constant price discovery mechanism that can fluctuate daily. A transaction (forward contract) on a commodity market is a promise to deliver a good at a stated time and location. It is the responsibility of the producer or trader to ensure that the delivery takes place, irrespective of its origin or if the price has changed after a forward contract was set.
Value chains are thus a sequential process used by corporations within a production system to gather resources, transform them into parts and products and, finally, distribute manufactured goods to markets. Each sequence is unique and depends on the type of product and where added value activities are performed along the supply chain. Value chains enable the sequencing of inputs and outputs between a range of suppliers and customers, mainly from a producer and buyer-driven standpoint. Producer-driven value chains tend to involve large manufacturers (e.g. automotive, mining, energy) that coordinate their mass-produced output with the demand and distribution capabilities of the market. Demand-driven value chains involve smaller manufacturers (e.g. garments, shoes, toys) that are responsive to the procurement orders of large traders and wholesalers, coordinating the orders of retailers and distributors.
Value chains must adapt to changing conditions, namely adjusting production to face changes in price, quantity, and even product specification. They are synchronized with product life cycles with phases of introduction, growth, maturity, and obsolescence that permeate value chains. Value chains in the early phases of a product life cycle tend to focus on innovation and gearing up production capabilities to face demand. As the product matures, can transform into value chains seeking mass production and low input costs. This means that value chains are continuously upgraded to fit technological, costs, and market changes. This upgrade can take place upstream to capture activities related to research and development or downstream to capture activities related to marketing and distribution.
The flexibility of production and distribution becomes particularly important, reducing production, transaction, and distribution costs as the logical outcome. As such, the value chain remains a paradoxical concept since technological and regulatory improvements could lessen transportation and transactional costs, implying that some actors would capture less value. This value would thus be transferred to other actors, mainly the end consumer, since they are receiving similar goods at a lower price.
Value chains have a distinct configuration reflecting the size, the level of concentration, and the market power of the suppliers and customers. From these configurations, three major types of value chains can be observed:
- Raw materials. The origin of these goods is linked with environmental (agricultural products) or geological (ores and fossil fuels) conditions. The configuration of the supply chains is often “one-to-one” since they involve large suppliers benefiting from economies of scale and large purchasers. The flows of raw materials (particularly ores and crude oil) used to be dominated by a pattern where less developed economies exported to more developed economies. Transport terminals in the former are specialized in loading, while those in the latter unload raw materials and often include transformation activities next to port sites. Industrialization in several developing economies has modified this standard pattern with new flows of energy and raw materials. The major shift involves China, which has become a dominant consumer and importer of raw materials.
- Semi-finished products. These goods already had some transformation performed, conferring 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 heavy parts, it is dominated by regional transport systems integrated into regional production systems. For lighter and high-value parts, a global system of suppliers tends to prevail with a reliance on air cargo operations. In all cases and configurations, there is a propensity to cluster as a tool to build economies of agglomeration and reduce transportation costs.
- Manufactured goods. These include goods that are shipped toward large consumption markets and require a high organizational level of flows to fulfill the demand. The configuration of the value chains is commonly around the “one-to-many” paradigm as large wholesalers, distributors, and retailers are using their distribution networks to access markets. Most flows concern developed economies, but a significant share is related to developing economies, 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. More recently, e-commerce has replicated the “one-to-many” paradigm with networks of distribution centers shipping online orders.
Based on the composition of the above configurations, each economy has a level of participation in global supply chains. The analysis of such a complex chain of agents and processes considers several perspectives:
- Transactional perspective: Identification of the flows and of the transactions that create them. This particularly concerns the decision-making process in the establishment and management of value chains.
- Comparative perspective: Assess the relative competitiveness of the elements of the value chains in terms of added value.
- Functional perspective: Identify the physical processes involved in the circulation of goods, including the capacity constraints in distribution, namely modal, intermodal, and terminal effectiveness.
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 more important. The integrated transport chain is itself being integrated into the production and distribution processes. Transport can no longer be considered a separate service required only as a response to supply and demand conditions. It is being built into the entire supply chain, 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 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, alternatively called global production networks, 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 across geographies where “just-in-time” and “door-to-door” strategies are relevant examples of interdependencies created by freight management strategies. Intermodal activities tend to create heavily used transshipment points and corridors between them, where logistical management is more efficient.
- Geographical integration. Underlines a reliance on supply sources that are often distant, because of necessity (e.g. raw materials) or convenience (e.g. lower costs). The need to overcome space is fundamental to economic development, and the development of modern transport systems has 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, where each market is serviced independently, to globally integrated production, where a transnational assembly sequence is established. The level of product customization can also indicate 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 associated with more efficient value chains. Among the most significant improvements:
- Improvements in transport efficiency incited an expanded territorial range to value chains, which has expanded the range of procurement and market options.
- The development of information technologies, enables corporations to establish a better level of control over their value chains. The coordination of flows within value chains has improved, particularly their reliability and timeliness.
- Technical improvements, notably for intermodal transportation, enabled more efficient connectivity between different transport modes, especially land and maritime connectivity, and thus within value chains.
The outcomes have been an improved velocity of freight, a decrease in 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. The production stages of a good occur at multiple locations in a complex web of relations and flow along supply chains. Consequently, the geography of value chains is integrated into the geography of transport systems. Among the main sectors of integration between transportation and value chains are:
- Agricultural. They include a sequence of fertilizers and equipment as inputs and grains, vegetables, and animals as outputs. Several specialized transportation modes are used for this production system, including grain railcars, trucks, and grain ships. Since many food products are perishable, modes often have to be adapted to these specific constraints with refrigerated transportation. Agricultural shipments tend to be highly seasonal with regional harvest periods. Ports play an essential role as points of warehousing and transshipment of agricultural commodities. A growing share of the international transportation of grain is getting containerized, in the range of 10 to 15%.
- Energy. 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 supported by railways, maritime shipping, and pipelines. Energy value chains tend to be massive, stable, and consistent since a constant supply of energy is required with some seasonal variations.
- Metals. Similar to energy commodity chains, these systems include in their initial sequence the transport of minerals from extraction sites to where they are transformed. In the second sequence, processed metals are transported toward the industrial sectors using them, such as shipbuilding, car making, machinery, and construction. There is no end market of significance for metal products, implying that metal goods are consumed in the intermediate stages of supply chains.
- Chemicals. Include several branches, such as petrochemicals and fertilizers. This value chain has linkages with the energy and agricultural sectors since it is at the same time a customer and a supplier.
- Wood and paper. Include the collection of wood products over vast forest zones, namely Canada, Northern Europe, South America, and Southeast Asia, towards production centers of pulp and paper and then to consumers. Wood remains a significant input for the construction sector.
- Construction. It implies movements of heavy materials such as cement, sand, rebars, bricks, and lumber, many of which are produced and consumed locally because of their high transport intensiveness.
- Manufacturing. Involves diversified flows of finished and semi-finished goods, which are sector-specific. 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 the needs of value chains, which incites a diversification of the services being offered. Within a value chain, freight transport services can be categorized by:
- Management of shipments. Cargo transported by the owner, the manufacturer, or by a third party. The tendency has been for corporations to subcontract their freight operations to specialized carriers who provide more efficient and cost-effective services.
- Geographical coverage. It 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 lead 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 truckload; LTL), as general cargo, container loads, or 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 is 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 is also concomitant to an environment where just-in-time (JIT) and synchronized flows has become the norm in production and distribution systems. International transportation is shifting to meet the increasing needs of organizing and managing its flows through logistics. Despite the diversity of transport services supporting various value chains, containerization is adaptable enough to cope with a variety of cargo and time constraints.
- 7.4 – Logistics and Freight Distribution
- 7.2 – Globalization and International Trade
- B.14 – The Logistics of Global Food Systems
- B.13 – The Containerization of Commodities
- B.9 – The Cold Chain and its Logistics
- 5.6 – Intermodal Transportation and Containerization
- B.9 – Petroleum: A Transportation Resource
- 1.5 – Transportation and Commercial Geography
- Cattaneo. O., G. Gereffi, S. Miroudot and D. Taglioni (2013) Joining, Upgrading and Being Competitive in Global Value Chains: A Strategic Framework, The World Bank, Policy Research Working Paper #6406.
- Suarez-Villa, L. (2003) “The E-economy and the Rise of Technocapitalism: Networks, Firms, and Transportation”, Growth and Change, Vol. 34, No. 4, pp. 390-414.
- World Bank (2020) World Development Report 2020: Trading for Development in the Age of Global Value Chains, Washington: World Bank.
- World Economic Forum (2012) The Shifting Geography of Global Value Chains: Implications for Developing Countries and Trade Policy, Global Agenda Council on the Global Trade System.
- World Economic Forum (2017) Impact of the Fourth Industrial Revolution on Supply Chains, Geneva.