The Challenges of Late Industrialization: The Global Economy and the Japanese Commercial Aircraft Industry

The Challenges of Late Industrialization The Global Economy and the Japanese Commercial Aircraft Industry Seishi Kimura...

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The Challenges of Late Industrialization The Global Economy and the Japanese Commercial Aircraft Industry

Seishi Kimura

The Challenges of Late Industrialization

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The Challenges of Late Industrialization The Global Economy and the Japanese Commercial Aircraft Industry Seishi Kimura

© Seishi Kimura 2007 All rights reserved. No reproduction, copy or transmission of this pulication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2007 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN-13: 9781403998798 hardback ISBN-10: 1403998795 hardback This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Kimura, Seishi, 1969 The challenges of late industrialization:the global economy and the Japanese commercial aircraft industry/Seishi Kimura. p. cm. Includes bibliographical references and index. ISBN 1403998795 1. Competition, International. 2. Barriers to entry (Industrial organization) 3. Aircraft supplies industry“Japan“Case studies. 4. Aircraft industry“Japan“Case studies. I. Title. HF1414.K515 2007 338.4 7629133340952“dc22 2006042276 10 9 8 7 6 5 4 3 2 1 15 14 13 12 11 10 09 08 07 06 Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham and Eastbourne

For my parents, and my wife, Naoko

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Contents

List of Tables

ix

List of Figures

x

Acknowledgements

xi

Preface

xiii

1 Introduction 1.1 1.2 1.3 1.4

1

Purpose of the study Definition of the key concepts Research approach and focus Structure of the study

2 Late Industrialization and Globalization: Literature Review

2 3 5 11

13

2.1 Theoretical approaches to the late industrialization 2.2 Globalization literature 2.3 Concluding remarks

14 22 31

3 Changing Context of Firm-based Late Industrialization in the Global Business Transformation

33

3.1 Firm-based late industrialization in global value chain perspective 3.2 Global business transformation and its consequences for FLI in the commercial aircraft industry 3.3 An overview of the post-war development of the Japanese aircraft industry 3.4 Concluding remarks

4 Upgrading in Global Value Chains: Analytical Framework 4.1 The upgrading process: the ‘controlled’ growth of the dependent firm in a GVC vii

34 56 72 77

79 81

viii Contents

4.2 Determinants of upgrading 4.3 The dynamics of upgrading

5 The Post-war Development of the Japanese Commercial Aircraft Production: Case Study 5.1 Historical background 5.2 Rebuilding the industry (1952 to early 1960s) 5.3 Failure to catch up by the national project (late 1950s to 1970s) 5.4 Upgrading to ‘significant’ supplier status in the Boeing’s GVC (1970s to mid-1990s) 5.5 Diversifying into different GVCs (late 1990s to present) 5.6 Concluding remarks

90 108

111 112 116 121 134 162 171

6 Conclusion

174

Appendix

183

Notes

193

Bibliography

206

Index

220

Tables 1.1 3.1 3.2

Field interviews, 2000–2001 Various actors in global value chains Two stylized strategies of firm-based late industrialization 3.3 Market shares in the commercial aircraft industry 3.4 Development costs of new aircraft 3.5 R&D investment by the leading system integrators and module system makers in the aerospace industry in 2004/05 fiscal year 3.6 Aerospace parts imports by the major aircraft manufacturing countries 3.7 Various partners of an international collaboration project 3.8 The number of ‘significant’ suppliers in selected commercial aircraft 3.9 International comparisons of the aerospace industry (2000) 3.10 Top ranking of the aerospace companies (2001) 3.11 Aircraft parts exports from selected latecomers 4.1 Learning dimensions in the upgrading process 4.2 Alternative types of global sourcing 5.1 Relative importance of Japanese aircraft and aero-engine producers 1941–1945 5.2 Licensed aircraft manufacturing in post-war Japan 5.3 Indigenous aircraft production in post-war Japan 5.4 Excerpt from the B767 Operations Requirements and Resources Plan – CTDC Manpower and Equipment Survey 5.5 Japan’s development costs of the B777 project 5.6 Selected financial results of the major Japanese aircraft manufacturers in 1990 A1 The list of the interviewees of the fieldwork A2 Japanese manufacturers’ participation to international collaboration projects

ix

7 44 55 58 59

59 65 67 68 73 74 77 82 95 116 119 129

155 157 158 183 185

Figures 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8

A value chain of the commercial aircraft industry The power–dependence model Chain hierarchy of the commercial aircraft industry Functions and competences underpinning a GVC Mechanism of firm-based late industrialization The alternative strategic routes towards FLI Recent restructuring of the aircraft industry The virtuous circle of entry barriers of the finished product market of the commercial aircraft industry 3.9 Total production, exports and military dependency of the Japanese aircraft industry 3.10 Productivity of aerospace divisions of the major Japanese aerospace companies 4.1 Dynamic strategic fit of a dependent firm 4.2 Two-way interactions between strategies and local institutional settings 4.3 Interactions among the determinants 5.1 Japanese aircraft production 1930–1945 5.2 Local institutional setting of the YS-11 Project 5.3 Japanese workshare in the B767 production 5.4 Japanese workshare in the B777 production 5.5 Local institutional setting in the B777 project 5.6 The area of Japan’s competences in the commercial aircraft GVCs 5.7 Japanese manufacturers’ participation in the various GVCs (as of December 2005) 5.8 Japan’s upgrading process through international collaboration projects

x

37 41 43 48 51 53 57 62 75 76 97 107 109 113 126 140 145 146 163 170 172

Acknowledgements

In writing this book, most of all, I would like to thank Professor Peter Nolan, my supervisor at the Judge Business School (originally named as the Judge Institute of Management Studies), University of Cambridge. No amount of words can express my gratitude to him for intellectual guidance and moral support. I owe my debt to Professor Ajit Singh and Professor Christopher Howe for their valuable comments. I owe a tremendous debt of gratitude to those individuals – executive managers and engineers of both Japanese and foreign aircraft manufacturers and airline companies, senior bureaucrats at the related Japanese government ministries, and executives of industrial associations – who kindly allowed me to interview them and helped me to gather primary data during my fieldworks on the Japanese commercial aircraft industries. I also owe a debt of gratitude to the funding agencies – Cambridge Political Economy Trust and Suzy Paine Fund – for financially enabling me to carry out my research. I would like to express my gratitude to Professor Yoshihiko Motoyama, Professor Tatsushi Matsunaga, Dr Takanori Ida, Dr Norio Sawabe, Dr Susumu Egashira, Dr Yasuo Sugiyama, Dr Ha-Joon Chang, and Dr Hugh Whittaker for providing me with invaluable academic advice. In particular, I deeply thank Professor Radha Sinha and Professor Yoshitaka Okada for supporting me throughout my academic career. I wish to thank my dear friends: Dr Jocelyn Probert, Dr Jin Zhang, Dr Armen Papazian, Dr Hiroshi Oikawa, Hiroshi Masuda, Hiroyuki Kuribayashi and Dr Satoshi Mizutani. I especially thank Professor Miles Dodd for reading through the manuscript with me. They all provided me with deep friendship and moral support both in my academic and private life. I would also like to thank my colleagues and students at Fukushima University for providing me with an ideal academic environment. Finally, I would like to acknowledge my parents Sadatoshi and Chiyoko Kimura. They have always provided me with unconditional support. Above all, I want to thank my wife, Naoko. She made a direct xi

xii Acknowledgements

contribution by helping me with my data gathering and input. But most importantly, she put up with my long working hours and encouraged me throughout this study. SEISHI KIMURA Fukushima, Japan

Preface Economic globalization has created a new set of challenges and opportunities for the late industrialization. This book examines the bottom-up process of late industrialization, in which latecomer firms grow in terms of scale and scope, and in turn contribute to the overall industrial development of their home countries. The analysis focuses on the growth of latecomer firms in globalizing industries, with a particular reference to the post-war growth of the Japanese manufacturers in the commercial aircraft industry. After reviewing the literature on economic globalization and late industrialization, we examine how recent trends of economic globalization have transformed the context of late industrialization in the commercial aircraft industry. By adopting and elaborating the global value chain (GVC) perspective, we underline that vigorous market consolidation has, on the one hand, remorselessly raised the barriers to entry for the latecomer firms, which attempt to catch up as system integrators. On the other hand, incumbent system integrators have been increasing and deepening their outsourcing practices on a global scale. This rise of global sourcing has opened a ‘window of opportunities’ for the latecomer firms to upgrade as a supplier in GVCs. We then propose an analytical framework for the upgrading process of latecomer firms in GVCs, deriving theoretical insights from the interdisciplinary literature – including supplier system research, competence-based strategic management, systems of innovation, and new institutional economics. The analytical framework delineates what kinds of competences the latecomer firms must learn in order to upgrade in the GVCs. It also explains how the upgrading process can be controlled by the lead firms, which possess the dominant power over GVCs. Moreover, basing on our fieldwork on the Japanese aircraft industry, we inductively identify three significant factors underlying the upgrading process: (1) lead firm’s sourcing strategies, (2) latecomer firm’s dynamic strategic fit, and (3) local institutional setting. Our analytical framework expounds the logics behind those factors – how and why they are significant factors as well as how they interrelate with each other in the upgrading process. The empirical part of this study carries out an in-depth case study analysis of the post-war growth of the Japanese aircraft manufacturers, xiii

xiv Preface

which are latecomers in the fast-globalizing commercial aircraft industry. Unlike the well-publicized successful catch-up of Japan’s steel, shipbuilding, and automotive industries, the Japanese aircraft manufactures have failed to become the leading competitors in the world market. Nevertheless, they have successfully upgraded their production activities since the 1970s – particularly as the global suppliers in the Boeing’s GVC. By employing our analytical framework, we comprehensively examine how and why they have failed to catch up, but have succeeded to upgrade in their efforts towards the firm-based late industrialization.

1 Introduction

Japan’s rapid industrial growth has demonstrated that late industrialization was actually possible during the 20th century. She was a latecomer in the world economy when it ‘opened the country’ (kaikoku) to modern international trade in the late 19th century. By the end of 20th century, nevertheless, she has become the first major nation outside the Western mainstream, to succeed in ‘catching up’ with the economic and technological leaders. Japan’s success served as a beacon for the latecomers who followed, and provided some guidelines for the pursuit of late industrialization to those who mainly began industrializing after the Second World War. These latecomers have actually achieved late industrialization to a significant degree although they have not fully ‘caught up’ with the forerunning economies yet. They came to be categorized as the ‘newly industrializing economies’ (NIEs), and include Korea, Taiwan, Hong Kong and Singapore, as well as some ASEAN countries. However, the world economy has undergone far-reaching structural changes since the end of the 20th century. The main features of this structural change are globalization, for which the transnational corporations (TNCs) have been often designated the primary driving force. Having expanded the scale of their operations through endogenous growth and M&A, the TNCs have intensified their oligopolistic competition on a global scale and have raised the barriers to entry to the finished product market. In addition, the TNCs have increased their cross-border outsourcing both in scale and scope, and have in turn expanded, deepened and intensified the global dimensions of the intermediate goods markets. These trends towards economic globalization have fundamentally changed the context of late industrialization. 1

2 The Challenges of Late Industrialization

Consequently, it has been often argued that the lessons from Japan’s successful late industrialization in the past century are no longer valid for today’s latecomers in the globalizing economy. For instance, Japan did not follow the textbook version of laissez-faire. She instead implemented various industrial policies, focusing on nurturing large indigenous industrial firms, enabling them to compete in the oligopolistic international market. Some globalists (that is, those who emphasize the globalization trends) have asserted that such industrial policies would not be effective any more. The concept of late industrialization has been studied extensively, in terms of the structural opportunities (or obstacles) inherent in the world economy as well as in terms of the latecomers’ potential to seize the opportunities (or to overcome the obstacles). However, the existing literature on late industrialization largely fails to take into full account the effects of economic globalization. On the other hand, the concept of globalization is one of the most controversial issues in social science today. Nevertheless, partly due to its high level of aggregation, the globalization debate tends to result in elusive conclusions and implications – specifically in relation to late industrialization. Therefore, there is urgent need for focused and in-depth research to gain a clearer and more comprehensive understanding of late industrialization in relation to the recent trends of globalization. The new and ambitious aim of the present study is to fill this gap in the existing literature both theoretically and empirically.

1.1

Purpose of the study

The purpose of this study is to understand the firm-level dynamics of late industrialization in the epoch of globalization. The study analyses the process of ‘firm-based late industrialization’ (FLI), in which the latecomer firms grow – in terms of increasing value-added productivity – in global industries. More specifically, it examines the nature of the obstacles or opportunities, which latecomer firms might encounter in pursuit of growth, and further, how they may (or may not) be able to overcome the obstacles or exploit the opportunities. The analysis focuses on the process of latecomer firm growth in relation to the globalization of industrial structures as well as in relation to firms’ strategies and learning processes, inter-firm relations, and local institutional settings – with particular reference to the post-war growth of the Japanese commercial

Introduction 3

aircraft industry. Thus, the research questions addressed in the study are: • How may latecomers pursue firm-based late industrialization (FLI)? • What are the trends and driving forces of the recent global business transformation? • How have these globalization trends changed the context of FLI? • What are the underlying factors of the FLI process? • How can we describe the FLI of the post-war Japanese commercial aircraft production? • What are the lessons to be learnt by current latecomers from the Japanese post-war FLI? By answering these questions, the study intends to create a comprehensive fund of knowledge about FLI, which may ultimately assist developing countries in designing government policy and corporate strategies for FLI.

1.2

Definition of the key concepts

To address these research questions, one first needs to clarify the precise meaning of the key concepts as well as the theoretical concerns of the study. What do the key concepts – late industrialization and globalization – specifically mean in this study?

1.2.1

Firm-based late industrialization

The concept of ‘firm-based’ late industrialization (FLI) used in this study has a different meaning from the more general term ‘late industrialization’. The concept of late industrialization usually refers to a macro process, in which developing countries transform their economies from an agricultural to an industrial base. Meanwhile, FLI refers in this study to a micro-rooted/bottoms-up process, in which the growth of latecomer firms in a concerned industry will contribute to national-level industrial development, and will ultimately produce a high and rising standard of living for the citizens of their home countries. Radosevic (1999: 122) points out that the firm-level analysis has not been taken into consideration for a long time in political economy (Hall 1997), growth theory (Chandler and Hikino 1997), or development economics (Teece and Zelner 1997). However, the series of poineering studies by Peter Nolan reveal that the in-depth analyses at the firm-level are critical for comprehensive understanding about the late industrialization


in the age of globalization. He emphasizes the pivotal role played by the firms in economic development and its significance in policy making, with special reference to China (Nolan 2001a, 2001b; Nolan and Zhang 2002, 2003). The firm is a basic organization of national economic significance acting as a locomotive to create new value in a national economy by transforming the fixed cost inherent in investment into revenuegenerating goods and services (Lazonick 1991; von Tunzelmann 1995). Since productivity is the root driver in the long run of national per capita income (Porter 1990: 6), the ultimate goal of FLI – that is, the rising standard of living of latecomer countries – is principally brought about by the growth of firms, which increase productivity and wage levels by augmenting the value-added element of their productive activities. In short, it should be a special concern for students of late industrialization to scrutinize the growth of the latecomer firms in a certain industry that ultimately contribute to the overall industrial development at national level. In this study, therefore, we especially focus our analysis on the growth of the latecomer firms in the fast-globalizing commercial aircraft industry.

1.2.2

Globalization

The term ‘globalization’ has become widely accepted jargon in various disciplines, such as economics, management studies, political science, sociology and anthropology. According to Held and McGrew (2000), the general concept of globalization can be defined as follows: [G]lobalization denotes the expanding scale, growing magnitude, speeding up and deepening impact of interregional flows and patterns of social interaction. It refers to a shift or transformation in the scale of human social organization that links distant communities and expands the reach of power relations across the world’s major regions and continents. (Held and McGrew 2000: 4) In general, the concept of globalization thus refers to the multifaceted social phenomenon that has a significant impact on politics, economics, societies and cultures over the world. One significant problem with the term ‘globalization’ is that it is a multi-faceted/catchall concept. For political scientists, for instance, the term globalization often refers to the emergence of a post-Westphalian world order – growing extensity and intensity of military relations and political activity between the political units of the world system

Introduction 5

(Held and McGrew 1998: 222–32). Meanwhile, in the field of economics and management studies, the main issues include the globalization of finance, competition, the firm structure and technology. Consequently, the discussion (especially interdisciplinary) about the globalization phenomenon has resulted in heated but often elusive conclusions and implications, as we shall see in detail later. To avoid such conceptual imprecision, this study focuses on the globalization of production systems rather than that of short-term financial flows.1 Hence, paraphrasing the above general definition in terms of production systems, the concept of globalization in this study refers to the expanding magnitude, speeding up and deepening impact of interregional flows and interactions among the geographically dispersed production activities – such as design, manufacturing, marketing and after-sales service. More specifically, the study will examine the major driving forces for the globalization of production systems – that is, the recent behaviours of transnational corporations (TNCs), such as focusing on core business, outsourcing and strategic alliances.

1.3

Research approach and focus

This study is in essence exploratory research because it primarily aims to understand a concept and phenomenon which has not yet been theorized in a rigorous manner (Creswell 2003: 21–2). As we will see in the literature review in the next chapter, the key concepts of the study (that is, late industrialization and globalization) have been thus far discussed separately. Besides the important pioneering studies by Nolan and his colleagues (Nolan 2001a, 2001b; Nolan, Sutherland and Zhang 2003), little attempt has been made to scrutinize firm-based late industrialization in the context of the recent global business transformation. There is no rigorous model or theory – to the extent of my knowledge – elucidating the process of latecomer firm growth in the epoch of globalization. Hence, this study’s research approach is designed to contribute to theory building rather than theory testing.

1.3.1

Analytical framework

The study will attempt to develop an analytical framework to identify the major determinants of firm-based late industrialization, and to describe how they interact with each other in the context of the global business transformation. In general, the analytical edge embodied in the framework is contained in the choice of variables included, the way


the variables are organized, the interactions between the variables, and the way in which alternative patterns of variables and their contextual environment affect outcomes (Nelson and Winter 1982: 25–7; Porter 1991: 96–9). The analytical framework of this study includes those variables such as the latecomer firm’s strategy and learning, the lead firm’s outsourcing strategy, the nature of the institutional setting as well as the lead firm’s control over the latecomer firms’ growth. The analytical framework is constructed not only deductively deriving from the theoretical insights of the inter-disciplinary literature (such as economics, management studies, and political economy), but also inductively based on the in-depth case study of the post-war growth of the Japanese aircraft manufacturers. In other words, this study incorporates a two-directional interaction between the development of the analytical framework and the implementation of the fieldwork in the case study. I turned to the in-depth case study to identify significant variables and explore the relationships between them. At the same time, I constantly checked the significance and consistency of these identified variables and their relationships by referring to the theoretical insights of the inter-disciplinary literature. In turn, the analytical framework organized the implementation and presentation of the case study by guiding the relevant variables and events to be examined.

1.3.2

Case study method

The study employs the case study method for its empirical inquiry. Given the dynamic and contextual nature of the research questions listed above, the case study method has many advantages over other research methods, such as survey or computer-based analysis of archival records (Texier 2000: 54–5; Yin 2003: 11–14). The case study method makes it possible to follow all the steps of the process of FLI, from its beginning to its recent advancement. It also makes it possible to take into consideration the complex interactions between the phenomena concerned – that is, the FLI of the post-war Japanese commercial aircraft industry – and the contextual elements, such as the local institutional settings and the global businesses transformation. The basic unit of analysis is the role of the Japanese aircraft manufacturers in the global production system. In addition, there are embedded units of analysis – the vertical and horizontal inter-firm relations and the institutional setting, such as industrial associations and government agencies. The case study was carried out partly by reviewing existing written material, such as academic research, industrial analyses of private and government agents and annual reports. These documental sources are

Introduction 7

the basis for the early historical period of the case study. To analyse more recent history and the current situation, I conducted fieldwork in Japan in 2000 and 2001. I conducted 32 semi-structured interviews with 57 persons at 21 organizations. These interviews were carried out with persons involved in Japanese commercial aircraft production – that is, executive managers and engineers of both Japanese and foreign aircraft manufacturers; senior bureaucrats at related Japanese government ministries; and executives of industrial associations. Interviews were also carried out at the Japanese airline companies and at research organizations. Table A1 (see Appendix) lists the organizations, interviewees, titles and dates, and Table 1.1 summarizes this schedule, with the organizations grouped into six categories. The validity of information obtained in the interviews was achieved through data triangulation, involving the double-checking all information in at least two interviews and when possible checking with documental sources. Data triangulation reduces the risks of the biased perspectives of individual interviewees (Texier 2000: 61). In addition, the documental sources have been used to fill information gaps but also as a pointer towards new interview questions.

1.3.2.1

Choice of industry

The commercial aircraft industry2 is chosen for the industry focus because it is one of the fastest globalizing industries in terms of both market structure and production system. On the one hand, the commercial aircraft market has undergone an intense consolidation process over the last two decades. The enormous cost of product development drives the system integrators in the commercial aircraft industry to amortize those costs across the markets around the globe. At the same time, as Table 1.1 Field interviews, 2000–2001 Category

Government agencies Trade associations Japanese aircraft manufacturers Foreign aircraft markers Airline companies Research organizations Total

Number of organizations

Number of interviewees

2 3 7 5 2 2 21

4 9 32 6 4 2 57


the technology advances rapidly and the size of aircraft increases, so has the cost of product development for new aircraft risen relentlessly. The large product development expense together with the severe cost pressure from the customers (that is, airline operators) has driven the industry towards ever larger firm size and higher concentration. Indeed, as the result of vigorous consolidation process throughout the 1990s, marking its peak when Boeing acquired McDonnell-Douglas in 1997, the industry has become a duopoly in the major market segments: Boeing and Airbus Industrie in the large jet aircraft (over 120 seats) market; and Bombardier and Embraer in the regional jet market. Such extreme global market concentration poses formidable barriers to entry for latecomers. Furthermore, such a powerful trend in the extent of firm-level concentration of global market share has not been peculiar to the commercial aircraft industry. It could be observed in industries as diverse as soft drinks, pharmaceuticals, automobiles, trucks, power equipment, farm equipment, oil and petrochemicals, mining, pulp, brewing, banking, insurance, advertising and mass media (Nolan 2001: 102). Meanwhile, the commercial aircraft industry is a good example of the typical globalization trend of production systems described earlier. In addition to the enormous product development cost, an aircraft’s long product life cycle (over 20 years) and the uncertain nature of advanced technologies exacerbate the business risk of the commercial aircraft industry. In order to share those high risks with other firms, the prime contractors in the industry have increasingly resorted to strategic alliances and outsourcing, which are often termed ‘international collaborative aircraft development’. Facing ever fiercer global competition and technological complexity, the system integrators have concentrated on strategic activities while globally outsourcing less-strategic activities. Such global sourcing even includes medium-skill activities – such as the component design and assembly, which are more likely to be profitable than low-skill, labour-intensive piece part manufacturing. The rise of global sourcing has thus provided the opportunities for the latecomers to upgrade by becoming competitive global suppliers. Therefore, by focusing on the recent restructuring of the commercial aircraft industry, we may highlight the new set of obstacles and opportunities for late industrialization in a fast globalizing industry.

1.3.2.2

Choice of country and firms

Japan has been chosen for the country focus of the study because the post-war growth of the Japanese aircraft industry well illustrates both the

Introduction 9

difficulties and possibilities of late industrialization in a global industry. Aircraft production in Japan is mainly carried out by one division of the multi-product heavy industry companies: Mitsubishi Heavy Industries (MHI), Kawasaki Heavy Industries (KHI), Fuji Heavy Industries (FHI) and Ishikawajima-Harima Heavy Industries (IHI). There are also two smaller manufactures, Shin-Meiwa Industries and the Japan Aircraft Manufacturing Corporation (JAMCO), which have a close relationship with FHI and KHI respectively. The post-war profile of the Japanese aircraft industry illustrates a unique aspect of Japan’s experience in late industrialization. Unlike the well-documented stories of the country’s steel, shipbuilding, automotive and electronic manufacturers, the Japanese aircraft manufacturers have failed to become leading competitors in the international market. In 2001, the sum of total aerospace sales of the four major Japanese aircraft manufacturers is just 14 per cent of that of Boeing alone (see Table 3.10). In other words, the Japanese aircraft manufacturers could not gain a competitive position in the world market, as have Toyota or Sony. Consequently, the post-war Japanese aircraft industry has often been stigmatized as a ‘failure’ of catch-up. On the other hand, the Japanese aircraft firms have gradually but successfully upgraded their activities as global suppliers. The Japanese aircraft industry as a whole increased its total production twenty-fold from 55 billion yen to over 1 trillion yen between 1965 and 2001 (see Figure 3.9) During the same period, the aerospace export value rose from practically nil to over 350 billion yen. Meanwhile, the Japanese aircraft manufacturers have upgraded their supplier status incrementally. In the airframe sub-industry, for instance, the Japanese manufacturers started their supplier activities as piece-part subcontractors for the Boeing B747 in the late 1960s. They then expanded the scale and upgraded the level of their activities throughout the 1970s and 1980s. In particular, the Japanese aircraft firms have become the single source sub-system suppliers for both the B767 and B777 carrying out the detailed design and production of most of the fuselage and a part of wing. They upgraded their supplier status from ‘programme participant’ undertaking 15% work share in the B767 programme to ‘programme partner’ undertaking 21% work share in the B777. Furthermore, Boeing officially announced on 26 April 2004 the go-ahead for the B787, which will the most important new aircraft programme to be launched by Boeing since the late 1980s as a replacement for the rapidly ageing B757 and the B767 (Financial Times, 26 April 2004).3 What to be noted is that the Japanese manufacturers, namely MHI, KHI and FHI, will become


‘revenue-sharing partners’ undertaking 35% work share (see Figure 5.8). Such upgrading of the Japanese manufacturers’ supplier status can be also represented with the steady increase in capital intensity and valueadded per labour unit in the major Japanese aircraft manufacturers (see Figure 3.10). Thus, while Japanese manufacturers failed to catch up to the global leading competitors, their success in upgrading as global suppliers may present an apt case study for illustrating the difficulties and the possibilities of firm-based late industrialization in the globalizing commercial aircraft industry.

1.3.3

Limitations

The traditional problem posed by the case study method is whether a study’s findings can be generalized beyond the immediate case study. ‘How can you generalize from a single case?’ is a frequently heard question (Yin 2003: 10). Indeed, both the nature of the commercial aircraft industry and the post-war growth of the Japanese aircraft industry are peculiar in terms of ‘general’ images of manufacturing industries or ‘general’ histories of late industrialization. As Texier (2000: 62) rightly points out, the commercial aircraft industry is regulated very strictly by the state because of its strategic value in technological, economic and military terms. Moreover, the firms studied are large corporate entities making up the extreme concentration of global market share.4 They produce a very limited number of massive and extremely complex products for only very few customers. The conclusions that this study draws from the case study might not be valid for firms producing mass-market types of products. Also, Japan was the first non-Western country to catch up with global economic and technological leaders. In particular, as we will see later, Japan established a military aircraft industry ‘advanced’ for its time during the early stage of the Second World War. The lessons to be learnt from this study’s case study might not be applicable for the current latecomers, which have far fewer resources and less experience in aircraft production than Japan had at the outset of its late industrialization. Despite these limitations, this study provides significant groundwork for analytical generalization and theory building. Essentially, the object of the case study method is not to represent a ‘sample’ for enumerating frequencies, that is, statistical generalization. The goal of case study is, instead, to generalize a particular set of results to some broader theory, that is, analytical generalization (Yin 2003: 37). This is exactly what this

Introduction 11

study aims to achieve by creating the analytical framework and delineating the global business transformation of the commercial aircraft industry, which is one of the fastest globalizing industries in terms of both market and production. In addition, this study highlights the new imperatives in pursuit of late industrialization in the epoch of globalization by illustrating in detail how even Japan painfully struggled to overcome the obstacles and to seize the new opportunities in the global commercial aircraft industry.

1.4

Structure of the study

This study is organized into four main chapters. Chapter 2 reviews the literature, without claiming to be exhaustive, on economic globalization and late industrialization. Chapter 3 examines how recent trends in economic globalization have transformed the context of late industrialization in the commercial aircraft industry. By adopting and elaborating the global value chain (GVC) perspective, we underline that vigorous market consolidation has, on the one hand, remorselessly raised the barriers to entry for latecomer firms, which attempt to catch up as system integrators. On the other hand, incumbent system integrators have been increasing and deepening their outsourcing practices on a global scale. This rise of global sourcing has opened a ‘window of opportunity’ for latecomer firms to upgrade as suppliers within GVCs. In Chapter 4, we develop the analytical framework for the upgrading process of latecomer firms in GVCs, deriving theoretical insights from the interdisciplinary literature – including supplier system research; competence-based strategic management; systems of innovation; and new institutional economics. The analytical framework outlines the kinds of competence the latecomer firms must learn in order to upgrade in the GVCs. It also explains how the upgrading process can be controlled by the lead firms, which possess the dominant power over GVCs. Moreover, based on our fieldwork on the Japanese aircraft industry, we inductively identify four significant factors underlying the upgrading process: (1) lead firms’ sourcing strategies, (2) latecomer firms’ dynamic strategic fit, and (3) local institutional setting, as well as (4) lead firms’ control over the latecomer firm growth in GVCs. Our analytical framework expounds the logics behind those factors – how and why they are significant factors as well as how they interrelate with each other in the upgrading process. Chapter 5 carries out an in-depth case study analysis of the postwar growth of the Japanese aircraft industry, which was a latecomer in


the fast-globalizing commercial aircraft industry. On the basis of our analytical framework, we comprehensively examine how and why it has failed to catch up, yet has succeeded in upgrading. Finally, Chapter 6 concludes the study, emphasizing the correlation between the analytical framework and the case study in analysing the firm-based late industrialization of the Japanese commercial aircraft industry.

2 Late Industrialization and Globalization: Literature Review

Ever since the world economy started taking shape a couple of centuries ago, there have been extensive discussions on how the backward economies could industrialize belatedly and ‘catch up’ with the leading industrialized economies. More recently, since the end of the 20th century, there have been heated debates over whether or not the structure of the world economy has been shifting fundamentally towards a so-called ‘global’ economy. Almost everyone agrees that the structure of the world economy has been transforming in some way and to a certain extent. However, there is little understanding how the structural transformation of the world economy might affect the latecomer economies in pursing late industrialization. In this chapter, we first review the various theoretical approaches to late industrialization. We organize our discussion into three parts according to the different analytical focuses. In the first section, we examine the analysis of external factors affecting the latecomers – that is the structure of the world economy. This approach is mainly concerned with the structural obstacles and opportunities that the latecomers face in pursing late industrialization. Then we turn to the internal factors influencing the latecomers. We review what kinds of capabilities have been identified to help the latecomers to overcome the structural obstacles and to seize such opportunities that may arise. Thirdly, we consider the major agents of late industrialization – namely, large industrial firms and the latecomer governments, whose roles have been frequently discussed in the literature. In the second half of this chapter, we review the literature on economic globalization. After presenting an overview of the globalization debate, we examine the globalization literature that is concerned with causes and effects of economic globalization. We particularly focus 13


on the debate on whether or not ‘global firms’ are arising and wresting power from national governments. Most importantly, we examine the arguments put forward in the globalization literature concerning the extent to which economic globalization affects the prospects for late industrialization.

2.1

Theoretical approaches to the late industrialization

2.1.1 Obstacles and opportunities in the world economy: the external factors Friedrich List (1841) was a pioneer in raising the issue of late industrialization in the middle of the 19th century. As a German political economist, he was against England promoting liberalism around the world and forcing Germany to liberalize her trade policies (List 1841/1922). He argued that there would be a ‘fixed’ division of labour in the world economy as long as England kept exporting industrial goods and Germany exporting agricultural goods by following their comparative advantages. Such ‘fixed’ division of labour, List asserted, would restrain Germany from industrializing and would condemn it to a dependent position in the world economy. In order to outgrow their dependent position, List argued, Germany and the other latecomers would be forced to protect and nurture their indigenous industries in order to develop their own ‘national economies’ (Suehiro 2000: 36). List’s arguments have been overtaken and elaborated by the dependency theory, which was influential during the 1960s and 70s. The dependency theorists assert that somehow there is concrete division of labour between the ‘centre’ developed countries and the ‘periphery’ developing (or underdeveloped) countries in the world economy. The former take the initiative in organizing and running worldwide capitalist activity, into which the latter are integrated in ‘concrete situations of dependency’ (Frank 1971; Palma 1978; Cardoso and Faletto 1979). In other words, the developing countries are structurally stuck in an unfavourable economic situation, in which they are exploited by the advanced countries for the benefit of capitalist reproduction. The dependency theory mainly focuses on surplus transfer or unequal exchange, and hence the obstacle to indigenous capital accumulation by the developing countries (Lo 1995: 445). More recently, the New International Division of Labour (NIDL) analysis focuses on the increasingly fragmented global production system,1 in which developing countries tend to be trapped in a vicious circle specializing in low skill/technology production activities, coupled

Late Industrialization and Globalization 15

with a low-income level (Fröbel, Heinrichs et al. 1980; Lo 1995: 445). Both dependency theory and NIDL show a strong inclination towards the structuralist / stagnationist view of late industrialization, emphasizing the disadvantages of backwardness in the world economy. They suggest implicitly and explicitly that it is very difficult, if not impossible, for the latecomers to advance their level of industrialization from the periphery of the world economy. However, their theoretical validity has come to be seriously questioned by the rise of Japan and the East Asian newly industrialized economies (NIEs), which have marked a high economic growth rate and achieved the late industrialization to a significant degree since the 1980s. On the other hand, Gerschenkron (1962) sheds light on the advantages of backwardness for late industrialization. Based on his historical research comparing the patterns in economic growth of the United States and various European countries, Gerschenkron proposes the following hypothesis: Industrialization always seemed the more promising the greater the backlog of technological innovations, which the backward country could take over from the more advanced country. (Gerschenkron 1962: 9, emphasis added) Gerschenkron thus contends that latecomers may learn and use the technologies which are already in use in the advanced countries much more easily than innovating them from scratch. Abramovitz (1986) also examines the so-called ‘catch-up hypothesis’, which asserts that being backward in level of productivity carries a potential for rapid advance by bringing into production a large backlog of unexploited technology (Abramovitz 1986). This catch-up hypothesis is derived from the so-called ‘convergence proposition’ that some students of modern economic growth theory contend (Dowrick and Gemmell 1991; Baumol, Nelson et al. 1994; Maddison 1995). This argues that productivity levels across countries tend to converge in the long run; hence in comparison across countries the growth rates of productivity over any long period tend to be inversely related to the initial levels of productivity (Abramovitz 1986: 221–2).2 Furthermore, according to the product cycle model (Vernon 1966), latecomers would have opportunities to industrialize as technologies of products become standardized as they mature, and accordingly comparative advantage shifts in favour of the less-developed countries. However, Perez and Soete (1988) assert that the production of matured


products would not provide much opportunity to catch up because the matured products have exhausted their technological dynamism. Hence, by following the product cycle model, the latecomers might face a clear risk of becoming ‘fixed’ in a low wage, low growth pattern (Perez and Soete 1988: 459). Then, Perez and Soete continue: A real catching-up process can only be achieved through acquiring the capacity for participating in the generation and improvement of technologies [that is, innovation] as opposed to the simple ‘use’ of them. This means being able to enter either as early imitators or as innovators of new products or processes. (Ibid: 459–60) According to Perez and Soete, the real ‘window of opportunity’ for latecomers opens during changes in techno-economic paradigm – the concept considers that technology embodies institutional specificity. The forerunner loses the competitiveness in the old paradigm, and must swiftly adjust their institutions to the new paradigm in this transition period. Latecomers may have an advantageous position in this institutional adjustment over the forerunners because the latecomers – unlike the forerunners – do not carry the burden of capital stocks and institutions inherited from the past (Perez and Soete 1988: 477; Lo 1995: 458; Shin 1996: 18).

2.1.2 Latecomers’ capabilities and national innovation systems: the internal factors Another stream of literature focuses on the latecomers’ internal ability to actually utilize the technological backlog. In order to seize the opportunity to catch up, latecomers must exert great efforts to absorb and improve imported technologies because technology transfer is not an automatic or cost-free process. Inward technology transfer requires new investment in learning because technologies embody the tacit knowledge, which resides – for example, for the manufacturing process technology – in operations, process control, problem solving, etc. (Dosi 1988; Radosevic 1999) Moreover, the lower the skill and capabilities of the latecomers, the poorer the technological transfer (Amsden 2001: 51). Hence, latecomers must invest in learning to understand the tacit underlying principles of imported technologies. The latecomers must also carry out innovation in moulding the imported technologies to fit their particular conditions


(Lall 1992). In short, to succeed in catching up by making use of technological backlog, the latecomers must be financially and functionally capable of learning and innovation. Various researchers have identified a wide variety of underlying factors for the latecomers to succeed in learning and innovation. Especially, some authors have termed these factors ‘social capabilities’ (Ohkawa and Rosovsky 1973; Abramovitz 1986; Suehiro 2000) and ‘technological capabilities’ (Lall 1992; Bell 1997; Archibugi and Coco 2004). These factors can be broadly categorized into three different levels of analysis. The micro-level analyses focuses on the factors that reside in the firm and between firms, while the macro-level analyses concern the country’s endowments as well as its economic and political institutions. Moreover, the meso-level analyses shed light on the interactions between the microlevel and the macro-level factors.

Micro-level factors. Lall (1992) elaborates a concept of ‘technological capabilities’ to explain the determinants of technological learning in developing countries. The firm-level technological capabilities mainly comprise: (1) project execution capability that refers to the skills required to establish or expand operations of the firm, including undertaking preinvestment feasibility studies, construction (design, equipment, staff) of the new facility, project management, project engineering and procurement; (2) production capability that refers to the skills required to produce industrial goods at a given level of efficiency and given input combinations; and (3) innovation capability that refers to the skills required to generate and manage technical change (Lall 1992: 166; Amsden and Hikino 1994: 129; Bell 1997: 89). Meanwhile, Suehiro (2000) identifies the micro-level ‘social capabilities’ as entrepreneurship, which may bring about the ‘innovative combination’ of limited managerial resources that the latecomers possess at hand. Suehiro also focuses on the capabilities in the workplace. They reside in the skills and routines of workers, who can demonstrate technical proficiency and improvements through the learning-by-doing process (Nelson and Winter 1982; Suehiro 2000: 60–7). Macro-level factors. Lall (1992) sheds light on the national-specific factors by which countries differ in their ability to utilize or innovate technologies. He calls those macro-level factors in late industrialization ‘national technological capabilities’ (NTC). One element of NTC is human capital that Lall defines broadly to include not just the skills generated by formal education and training, but also those created by


on-the-job training and experience of technological activities, as well as the stock of inherited skills (Lall 1992: 170). Similarly, Abramovitz correlates macro-level social capabilities with the years and quality of education (Abramovitz 1986). Abramovitz also emphasizes the importance of institutional capabilities, by which he means the experience of organization and management of large-scale enterprises and of financial institutions and markets capable of mobilizing capital for individual firms on a similarly large scale (Abramovitz 1986: 222–3). Gerschenkron (1962) also emphasizes the importance of an organized banking system capable of providing long-term capital for industrial investment. Lall (1992) asserts that institutional functioning, together with market forces and government policies, creates the structure of incentives. Incentives affect the pace of accumulation of capital and skills; the types of capital purchased and the kinds of skills learned; and the extent to which existing endowments are exploited in production (Lall 1992: 171). Suehiro (2000), furthermore, underlines the government capabilities as a competent and independent economic technocracy. It is capable of planning and executing effective policies based on an efficient system of intelligence sharing as well as on its autonomy from the rentseeking (Krueger 1974) of vested interests. Likely, Gerschenkron underlines the government’s leading role in supporting industrial investment (Gerschenkron 1962: 11–21).

Meso-level factors. The organizing concept of ‘National Innovation Systems (NIS)’ is another analytical approach to nation-specific factors for technological learning and innovation (Freeman 1987; Lundvall 1992; Nelson and Rosenberg 1993). Rather than focusing on the individual factors at the micro- and macro-level, the NIS approach tries to delineate a system of interacting private and public firms (either large or small), universities and government agencies, aiming at the creation of learning and innovating processes within national borders.3 Interaction among those units may be technical, commercial, legal, social or financial, inasmuch as the goal of interaction is the development, protection, financing or regulation of technological learning and innovation (Niosi and Bellon 1996: 139). Freeman (1996) asserts that differences in the efficiency and effectiveness of NIS have mainly accounted for the contrasting experiences in late industrialization between East Asia and Latin America (Freeman 1996). For example, Freeman points out that the NIS in East Asia, in contrast to the NIS in Latin America, have brought about the development of strong


science and technology infrastructures, heavy investment in advanced telecommunications, and growing participation in international technology networks and agreements (ibid: 178). These effective NIS in East Asia have provided the embedded firms with information, standards, basic scientific knowledge and various facilities too large to be owned by private firms (Lall 1992: 170). They have also created the virtuous ‘structure of incentives’ in the East Asian economies, which have affected the pace of accumulation of capital and skills; the types of capital purchased and the kinds of skills learned; and the extent to which existing endowments are exploited (ibid: 171). Furthermore, Porter (1990) outlines the four multi-level factors that affect innovative activity in specific firms of specific industries in a specific country (Porter 1990: 71–124): • Factor conditions include not only the existing resource endowment but also the factors of production that the nation can help to create, such as specialized skills and the developed science base. • Demand conditions include both the composition and character of national demand. They can be an important stimulus to innovation if domestic buyers are sophisticated in their assessment of the cost and quality of home products. • Related and supporting industries, which are internationally competitive. They may provide access to cutting-edged components and machinery as well as a flow of updated information. • Firm strategy, structure, and rivalry set a national context, in which companies are created and managed. The nature of domestic rivalry determines the multitude of pressures on firms to invest and innovate. Porter stresses that these four factors work together as a system in interacting each other (Porter 1990: 132–48). What is particularly interesting about Porter’s so-called ‘diamond model’ of national advantage is that Porter does not include the role of government in the core factors. He rather considers the government’s real role in innovative activities of a nation lies in influencing the four factors listed above (Porter 1990: 126–8).

2.1.3 The role of large industrial firms and governments: the agents In the preceding sections, we reviewed the literature by focusing on the latecomers’ external opportunities and internal capabilities for realizing


late industrialization. We now turn to review the respective roles of the latecomers’ large industrial firms and governments – they have been most extensively discussed in the literature as critical agents of late industrialization.

Large industrial firms. Based on Alfred Chandler’s (Chandler 1977; 1990; Chandler, Amatori et al. 1997) historical analyses on the dynamics of big business during the past century, Chandler and his colleagues assert that large industrial firms have played a critical role in late industrialization (Amsden and Hikino 1994; Hikino and Amsden 1994; Chandler and Hikino 1997). By committing to the extensive long-term investment in human and organizational resources as well as physical assets, according to the Chandlerian approach, the large industrial firms became a locus of learning technological, managerial, and organizational knowledge for an entire economy. This is because the large industrial firms could exploit high complementarity between the investments in tangible capital such as manufacturing facilities and in intangible assets such as human capabilities and organizational innovations: Extensive investments in large-scale plant and equipment created a fertile ground for managers and other personnel to educate themselves about both the technical skills and the organizational process of a new technology. Reciprocally the potential of the new technology could only be realized through the trained skills acquired in the production and distribution of past products. (Chandler and Hikino 1997: 27) Furthermore, the Chandlerian approach underlines the role of large industrial firms in exploiting scale economies, employing lower-cost labour, introducing incremental improvements in production processes, and improving customer services, most of which resulted from learned and accumulated capabilities through the complementary investments described above (ibid). Amsden and Hikino (Amsden and Hikino 1994; Hikino and Amsden 1994) argue that these functions of large industrial firms have been critical in gaining international competitiveness because the latecomers do not have the proprietary technology to exploit firstmover advantage. They also point out that latecomers’ large firms tend to have a conglomerate type of organizational structure as a result of diversifying their limited and concentrated technological capabilities into various capital-intensive industries.


On the contrary, Piore and Sable (1984) assert that the transition from a techno-economic paradigm based on mass production, which is mainly carried out by the large industrial firms – that is, Fordism – to one based on networks of small artisan firms – that is, flexible specialization – has taken place in the advanced capitalist world since the 1970s (Lo 1995: 455). These flexible networks were able to produce smaller production batches of sophisticated quality products for rapidly changing consumer preferences. However, besides the test of its feasibility in advanced countries, Amsden (2001) disregards the significance of flexible specialization in the late industrialization; saying: Nor did small-scale firms circumvent the need for such investments by modernizing artisan production systems and substituting them for mass production Small-scale firms before World War II, and for most of the postwar period, did not act as an agent of late industrial development. (Amsden 2001: 98)

Government intervention. The role of government in late industrialization has been one of the most extensively discussed topics in the economic development literature.4 More specifically, the social scientists and policy makers at national and international institutions have examined the important agents of rapid economic growth and late industrialization in the East Asian countries (that is, Japan and the Asian NIEs) during the second half of the past century. From the late 1970s, the neo-classical economists started asking why the East Asian countries could sustain fairly stable growth during and after the two oil shocks during the 1970s (Suehiro 2000: 24). They came to a neo-liberal conclusion and disregarded the effectiveness of government interventions. They contended that the stable growth of East Asia was mainly brought about by the healthy market mechanism (Balassa 1982; Little 1982; Lal 1983). The main contribution of the government, according to the neo-classical economists, was to ‘get the “price mechanism” right’ by liberalizing or abolishing various pricedistorting policies and institutions, such as multiple exchange rates and quantitative import restraints. Moreover, the influential Bretton Woods institutions espoused this neo-liberalism idea towards government intervention (World Bank 1992; World Bank 1993). Hence, the neo-liberal economists only admit the ‘minimalist’ (Streeten 1993) and ‘market-friendly’ (World Bank 1992) roles of government in rectifying market failure and creating stable macroeconomic environments. They are basically opposed to government intervention


that would likely cause government failure by allocating scarce resources to the wrong industries or firms (that is, failing to ‘pick the winners’) or by inviting rent-seeking activities (Krueger 1990; World Bank 1993). On the other hand, the ‘statist’ political economists argue that the extent to which the developing countries suffered market failure was sufficiently severe to make government intervention essential for economic growth. They insisted that, without governmental industrial policies, the East Asian countries could not achieve the rapid production expansion and upgrading in those industries that they intended to nurture (for example, steel, electronics and automobiles) (Johnson 1982; Amsden 1989; Okimoto 1989; Wade 1990). Industrial policy could play a critical role in inducing long-term investment in these targeted industries by purposely distorting the price mechanism (Amsden 1989), nurturing the indigenous large industrial firms by controlling and guiding domestic competition (Singh 1994; Amsden 2001), and coordinating complementary investments in the absence of efficient markets (Chang 1994; Aoki, Murdock et al. 1996). Thus, these political economists assert that by distorting the market signals (‘getting the relative prices wrong’ (Amsden 1989), government intervention in the East Asian latecomers created the ‘structure of incentives’ (Lall 1992) to pursue the ‘Schumpeterian efficiency’, as defined in terms of learning potential (Dosi 1997: 478), rather than ‘static efficiency’ of resource allocation according to their current comparative advantages (Amsden 1989; Chang 1995). They also argue that the government failure could be remedied through the disciplinary mechanism for the firms’ activities (Amsden 1989: 145–7) and through various measures to improve the decision-making capacity and autonomy of the government (Chang 1994: 34–45).

2.2

Globalization literature

The modality of globalization is probably one of the most hotly debated issues today, reaching almost every discipline of social science. However, there is disagreement about the extent to which economic globalization has actually advanced. The advocates of a notion of globalization (hereafter, the globalists), on the one hand, assert that we are witnessing a historical socioeconomic transformation: a new world economic order called the ‘global’ economy is gradually replacing the more traditional order called the ‘inter-national’ economy5 (Drucker 1986; Ohmae 1990; Reich 1991). In general, the logical stream of the globalists (Ohmae 1995; Dunning


1997b) first inducts a hypothetical image of the ‘globalized economy’ (or deepest form of globalization) from the recent trends in the world economy – especially the aggregated statistics that show rapid increase in foreign direct investment (FDI) and financial capital mobility. Then, they assume that a historical transformation towards a global economy would involve most major economic entities on the earth. Hence, the globalists share a deterministic connotation with the modernization theory of economic evolution (Parsons 1956; Rostow 1990). Such futurological, hypothetical, deterministic connotation of the globalists has invited fierce critiques from the sceptics. They counterargue that what we are actually observing in the recent trends of world economy is not a sign of an emerging new order, but rather an extension of interconnection between national economies (that is, internationalization) (Ruigrok and van Tulder 1995; Hirst and Thompson 1996; Wade 1996). By calling attention to the more disaggregated data of FDI – such as its location and its relative importance to ‘home’ activities of transnational corporations (TNCs), the sceptics contend that TNCs still heavily rely upon their ‘home base’ for production, R&D and managerial control. The hard-liners among the sceptics even insist that the historical movement that the advocates call globalization had begun several centuries ago (Kozul-Wright 1995; Hirst and Thompson 1996). Nevertheless, other commentators point out that there are fundamental and qualitative differences between the world economy today and the world economy before 1914. For instance, the world economy now is not solely controlled by the Western colonizing countries (Gray 1998: 65). One of the most remarkable phenomena in the economic history of the twentieth century is the rise of the East and South East Asian economies. Also, internationally dispersed economic activities are now functionally integrated, not merely the exchange of raw materials and processed products between the colonizing and colonized countries (Dicken 1998: 5). In the following subsections, we will closely review the globalization literature by focusing on what globalization generally means to the firm and the state, and more specifically to those of latecomers.

2.2.1

The rise of global firms?

The globalists assert that the rise of ‘global firms’ has been a main driver for economic globalization. According to Dunning (1997a: 34), global firms (1) own or control subsidiaries, and engage in value-added business alliances and networks in each continent and in each major country; (2) source their inputs of labour, capital, raw materials and intermediate


goods from wherever it is best to do so; (3) engage in financial transactions independent of time and space; and (4) sell their goods and services in each of the main markets in the world. Although Dunning admits that this typical type of global corporation has not exited yet, he deems that the rise of global corporation is an historical trend. Ohmae (1990; 1995) and Reich (1995a; 1995b) believe that the emergence of global firms has made the nationality of companies less important for the economic prosperity of both the countries in which they operate and those of which they are nationals. What is most important for the country’s economic prosperity, Reich argues, is not the nationality of the company’s ownership, but whether it provides good employment (of high wages) to the people of the country in which they are located (Reich 1995a; 1995b). The sceptics, on the other hand, dismiss the emergence of global firms as simply myth or rhetoric. Hirst and Thompson (1996), for instance, point out that between 70 and 75 per cent of TNCs’ value-added was produced on home territory in 1992. They assert that the TNCs from major developed countries still rely upon their ‘home base’ as the centre of their economic activities. It implies that the nationality of a TNC’s ownership does matter for the nature of its economic activities and in turn for the economic prosperity of its home country (Hirst and Thompson 1996: 96–7). Ruigrok and van Tulder also show that of the largest one hundred firms in the world, not one is truly ‘global’, ‘footloose’ or ‘borderless’ (Ruigrok and van Tulder 1995: 159). Hence, by calling attention to the disaggregate data of TNCs activities, the sceptics pose important caveats to the globalists, who inductively assert the rise of global firms by relying mainly on the aggregate balance of payments flow data of TNCs. The sceptics insist that TNCs are not ‘globalizing’ their nature, but simply extending their economic activities abroad while retaining their bases in home countries. However, the sceptics seem to refute the whole notion of economic globalization without considering the recent diversification of TNC activities. Along with the rapid expansion of FDI and cross-border mergers and acquisitions (M&As), we have also observed an explosive growth in inter-firm / cross-border strategic alliances since the early 1990s (UNCTAD 2002). TNCs have also rapidly increased cross-border outsourcing of components and services, as we will see in the next chapter. Thus, the TNCs have been driving economic globalization not only through transnational activities within the boundary of the firm (that is, international production through FDI and cross-border M&A), but also by those beyond the boundary of the firm (that is, cross-border


strategic alliances and outsourcing). Together with FDI, such crossborder inter-firm alliances – both horizontally (that is, strategic alliances) and vertically (outsourcing) – are causes as well as consequences of globalization. Dunning particularly calls these phenomena the advent of ‘alliance capitalism’ (Dunning 1997b).

2.2.1.1

Latecomers in the global economy

In the globalization literature, some globalists hold an optimistic view of latecomers in a globalization process (Ohmae 1995; Dunning 2002). They accept the criticism of the sceptics who argue that the globalization of trade and production has not taken place evenly across the globe, but are highly concentrated within the Triad regions (that is, Western Europe, North America and Japan). However, the globalists contend that a larger numbers of countries, including the latecomers, will eventually join this so-called ‘Interlinked Economy of the Triad’ if they are willing to learn from aggressive economies such as Taiwan, Hong Kong and Singapore. Dunning (2002: 94–9), for instance, believes that the world structural transformation led by globalization (that is, the advent of alliance capitalism) holds out great promise for the latecomers’ future because the world now has the necessary resources, knowledge and experience, as well as the technical means, by which these assets can be transmitted between countries. Regarding developing countries, Dunning asserts: I believe the opportunities and challenges of globalization cut across the traditional North/South divide [that is, international division of labour between a ‘centre’ and a ‘periphery’], and over the next 25 years, it is likely that many millions of the descendants of yesterday’s impoverished generation will come to enjoy at least the basic comforts which we, in the richer countries, so easily take for granted. (Dunning 2002: 94) For the main factors underlying this optimistic view, Dunning points out that the recent development of flexible production systems and the advent of the ‘alliance capitalism’ have promoted the ‘putting-out’ of some value activities to latecomers. In these transformations in the world economy, latecomers will ‘benefit from a “trickle-down” effect of some kinds of subcontracting’. This ‘trickle-down’ effect in turn will enhance the linking of latecomers with the flagship nations in the global economy (Dunning 2002: 90–7).


Dunning’s argument here seems to challenge the structuralist / stagnationist view of dependency theory and NIDL. However, Dunning stops short of considering the question of how actually such a ‘trickle-down’ effect will occur or what kinds of subcontracting will be available for latecomers. It is highly questionable to expect that the large numbers of latecomers would benefit from the ‘putting-out’ of high value-added activities by TNCs. Should only small numbers of latecomers benefit from this ‘putting-out’, then the fruits of the globalization process would not trickle-down to many countries, but rather would exacerbate the ‘marginalization’ in the world economy (Martin and Schumann 1997; Bhalla 1998; De Swardt-Kraus 2000).6 Such an account actually seems to support the presence of NIDL. In addition, important questions remain concerning how the globalization has (or has not) transformed the backlog of technology – its nature and availability for latecomers. Nor does it suggest what kinds of social capabilities and government policies are necessary for the latecomers to benefit from the backlog of technology in the epoch of globalization.

2.2.2

The demise of the nation states?

The fate of nation states and the role of national governments in the epoch of globalization are another hotly debated issue. The most extreme argument has been advanced by the so-called ‘hyper-globalists’ (Held and McGrew 1998), who contend that the nation state has lost its legitimacy in the emerging global market, where financial institutions and global firms allocate and move capitals in a ‘footloose’ and ‘borderless’ manner (Ohmae 1990). This polemic talk of the ‘demise of the nation state’ has promptly invited various critiques and counter-arguments from the sceptics who consider that the nation state is still a primarily significant economic entity in the world economy. They often point out that the distribution, origins, and destinations of FDI are highly uneven among the different countries and regions (Ruigrok and van Tulder 1995; Chang 1998; Dicken 1998). By emphasizing the geographically concentrated FDI – particularly within Western Europe, the United States and Japan, they assert that what is often referred to as ‘globalization’ is better described as ‘Triadization’. The uneven distribution of FDI origins and destinations, the sceptics maintain, emanates from the national-specific ways in which business and production are organized and developed (Wade 1996). Those national-specific factors cannot be easily swept away by the globalizing capital movements because


they are institutionally embedded, and their evolutions are path-dependent (Kozul-Wright 1995). Moreover, Gray (1998) is cynical of the sceptics saying that they are attacking a straw man. He insists that nobody except a few in the business community expects the world to become one unified entity, in which nation states have withered away to be replaced by homeless TNCs (Gray 1998: 64). However, the view seems to be largely shared in the globalization literature that, to a certain extent, the states’ capacity to control the national economies has been reduced or eroded by the rapid expansion of TNCs and of international capital flows (Chang 1998: 107). Strange (1996), for instance, argues that: [T]he progressive integration of world economy, through international production, has shifted the balance of power away from states and towards world markets. This shift has led to the transfer of some powers in relation to civil society from territorial states to nonterritorial TNCs. (Strange 1996: 46) By the word ‘power’, Strange points to influence over outcomes rather than mere possession of the capability to exercise control over institutions (Strange 1996: 53). She, therefore, contends that TNCs have encroached on the power of the nation state to influence what goods and services are produced, how, where and by whom within its borders (Stopford and Strange 1991). Petrella (1996: 76) also contends that the TNC ‘privatizes (and internationalizes for its own purposes) the role of the state’. On the other hand, some commentators contend that the role of state has become more important in the age of globalization. Porter (1990: 19) argues that the role of the home nation of firms seems to be stronger than ever as competition globalizes, because it is the source of the skills and technology that underpin competitive advantage. Gray (1998: 76) and Hirst and Thompson (1996: 190–1) assert that nation states remain a decisive mediating structure over which TNCs compete to control. The role of national government remains important in the epoch of globalization not simply because nation states are not withering, but because governments retain decisive power over the economic prosperity of their own population. Referring to Strange’s definition of ‘power’, national government may have abated its influence (that is, power) over what goods and services are produced, how, where and by whom within its borders; but it still and will retain its influence and


obligation over the economic prosperity of people within its borders. This is partly because people are much less mobile than capitals and goods, ‘in the sense they remain “nationalized” ’ (Hirst and Thompson 1996: 171). We may synthesize the debate on the role of national government in the global economy in the following terms. The globalization literature stresses that national governments have been losing their capacity or power to independently control their national economies, but their policies themselves are still and will remain significant for their national economic prosperity. Then, the outstanding crucial question would be: Given their reduced power to control the outcomes of national economies, what are the new functions for states striving to attain national wealth in the epoch of globalization?

2.2.2.1

Industrial policies in the global economy

Finally we review the policy measures that the globalists often recommend to the latecomers. The globalists largely share the views of neoliberalism concerning government intervention in the economy. We identify three main threads of neo-liberal policy argument, which the globalists would recommend to the latecomers. Firstly, it is argued that the latecomers cannot execute industrial policies in the epoch of globalization. This argument is an extension of the idea of the ‘demise of the nation state’, which we have touched upon earlier. The globalists assert that any policy which conflicts with the interests of TNCs, is not a viable option in the pursuit of economic growth. This is because TNCs can relocate their investment to any location, which offers them a better investment climate; they are therefore ‘footloose’. The contention is that strategic industrial policies are nullified by TNCs’ ‘voting with their feet’ (Stopford and Strange 1991; Dunning 1997a; Chang 1998). Consequently, the globalists recommend latecomers to liberalize their policies towards TNCs and inward FDI, and to concentrate on increasing their attractiveness for FDI by providing tax incentives, developing their infrastructure and human capital, ensuring political stabilization and so on. However, it is questionable how much TNCs are truly ‘footloose’, and whether the latecomers cannot execute industrial policies which conflict with the TNCs’ interests. Chang (1998: 108) argues that the relative bargaining strengths of TNCs and national governments are different for given countries and industries, depending on the degree of freedom in investment relocation. For certain industries, Chang


contends, the feasible investment sites are limited for a number of reasons: [M]any mineral-related industries require investments near the depositories; some industries require particular types of skilled labor at reasonable prices some countries have locational advantages, say, as an entry point into a big market; some countries have exceptionally large and/or fast-growing markets; and so on. (ibid.) Hence, if the variable sites for a certain industry are limited to certain countries, those countries may possess bargaining power over the TNCs in that industry. Nevertheless, latecomers should have a clear understanding of their bargaining strengths when they formulate their strategies to integrate into the globalizing economy – for example, deciding which industry they enter, what kinds of strategic industrial policies are available, how they can establish and strengthen their bargaining power, and so on. Secondly, it is argued that latecomers do not need to execute the industrial policies, particularly toward TNCs and inward FDI, in the age of globalization. The globalist view largely expresses a strong belief that ‘what is good for TNCs is good for the host country, and that the recent trend in globalization is eliminating whatever minor conflicts of interest may have once existed between the two’ (Chang 1998: 103). For instance, one commentator regards the recent liberalization of policies toward TNCs among latecomers as a ‘fortunate’ sign, showing that latecomers now recognize FDI for what it really is: a source of extra capital, a contribution to a healthy external balance, a basis for increased productivity, additional employment, effective competition, rational production, technology transfer and a source of managerial know-how (Brittan 1995).7 It is, nevertheless, still unclear how much the interests of TNCs and those of latecomers have in fact become merged (Singh and Zammit 1998). To understand how well inward FDI could support late industrialization, we should scrutinize what kinds of employment, competition, technology and managerial know-how the TNCs will bring to the latecomers via FDI. In other words, we should carefully examine whether the TNCs’ presence does actually support the long-term late industrialization of the latecomers. Finally, it is argued that latecomers should not execute the strategic industrial policies towards TNCs and inward FDI. As we have seen, the


globalists assert that latecomers should establish linkages with the fastgrowing Triad economies in order to achieve their late industrialization. Furthermore, the globalists seem to consider that the only way for latecomers to establish those linkages is to liberalize their policies toward TNCs and to invite inward FDI aggressively by accommodating the needs of TNCs (Stopford and Strange 1991; Dunning 1997a). In addition, the globalists also seem to believe that the industrial policies of individual nations would distort the emerging global market and obstruct the diffusion of the fruits of globalization across the world. This argument often bears a strong normative connotation when it is underpinned by the theory of convergence. The theory of convergence predicts that ‘competition, imitation, diffusion of best practice, trade, and capital mobility naturally operate to produce convergence across nations in the structure of production and in relations among economy, society, and state’ (Berger and Dore 1996: 1).8 According to the globalists, such convergence process has been enhanced by increasing interdependence of globalization, and that all nations would benefit from this diffusion of best practice. Thus, they condemn industrial policies as ‘beggar my neighbour’ actions, which only obstruct this process by distorting the ‘level playing field’ of the open global market (Ohmae 1990; Dunning 1997a). This ethical connotation leads some commentators to condemn the globalization thesis as a rhetorical device (Ruigrok and van Tulder 1995; Hirst and Thompson 1996; Gray 1998). However, it is highly questionable whether the latecomers can attract FDI or subcontracting by simply liberalizing their policies towards TNCs. As Dunning (1997a: 45–6) himself points out, ‘the orientation of the motivation for TNC activity has [recently] changed from that of seeking markets and natural resources to exploit better existing competitive advantages of the investing companies, to that of acquiring created assets perceived necessary to sustain and augment existing competitive advantages’. In addition, the resource-based view of the firm (Penrose 1959/1995; Wernerfelt 1984; Peteraf 1993) and the strategic trade theory (Krugman and Smith 1994) emphasize that the competitive advantages of a firm are internally developed, and they often require a long period and government protection to develop. Then, regarding the TNCs’ asset-seeking motives, it is hard to assume that latecomers would acquire more FDI and subcontracting by simply liberalizing their policies towards TNCs. Another important critique against the anti-interventionist argument based on the convergence theory is that there has never been a ‘level


playing field’ in the world market. Ruigrok and van Tulder (1995: 221) carefully examine the history of how Fortune 100 companies have come to attain a competitive position in world markets and find that ‘virtually all of the world’s largest firms have experienced a decisive influence from government policies and/or trade barriers on their strategy and competitive position’. Furthermore, based on the longer historical perspective, Chang (2002) reveals that almost every country that succeeded in late industrialization – such as the United Kingdom, Germany and the United States – exerted the state intervention to a significant degree for protecting and nurturing their infant industries when they were backward economies. Therefore, there is neither ‘ethical’ nor ‘historical’ obligation for the current latecomers to follow the logic of convergence theory or neoliberalism. Instead, if the fruit of economic globalization is not automatically or evenly diffused across the world, the national government is an ultimate agency that could and should help its population to claim its share of the fruit. National governments have a duty to employ every means at their disposal, including industrial policy, to promote industrialization and enhance the economic prosperity of their population.9

2.3

Concluding remarks

In relation to late industrialization, we have examined three theoretical approaches that focus on (1) the obstacles and opportunities emanating from the structure of the world economy, (2) the latecomers’ internal factors pertinent to the removal of the obstacles and/or taking advantage of the opportunities, and (3) the major agents for advancing the process of late industrialization. On the other hand, the globalization literature, in general, implies that the structure of the world economy has been undergoing a major transformation as a result of the expanding scale, magnitude of growth, acceleration, and deepening impact of interregional flows and patterns of economic interactions. Although there is disagreement about the extent to which economic globalization has actually advanced, there seems little doubt that we need to take into consideration its possible effects when we discuss any socio-economic phenomenon. The issue of late industrialization is not an exception to this. However, the debate on economic globalization tends to be futurological, hypothetical, deterministic or abstract. The globalization literature does not offer focused in-depth analysis as to how economic globalization has actually affected the context of late industrialization.


Consequently, the debate has resulted in heated discussion but often elusive conclusions. It has largely failed to provide clear implications for the current latecomers’ policy makers and business leader in pursuit of FLI. Meanwhile, the existing literature on late industrialization has largely failed to take comprehensive account of the effects of globalization. The significant exception is Nolan’s studies on China’s late industrialization (Nolan 2001a, 2001b). He conducted meticulous analyses on how the Chinese firms attempt to survive and grow under the global business revolution in various industries such as aerospace, pharmaceuticals, steel, oil among others. Drawing on this analytical approach, we will further scrutinize the effects of globalization on late industrialization by answering the following questions. What are the new obstacles and opportunities for late industrialization in the global economy? How has the economic globalization changed the nature of latecomers’ internal factors required to achieve the late industrialization? What are the roles of indigenous firms and the national governments of latecomers in striving to bring about late industrialization in the advent of alliance capitalism? What are the implications for current latecomers pursuing FLI in the era of globalization? We will attempt to answer those questions in the rest of this study.

3 Changing Context of Firm-based Late Industrialization in the Global Business Transformation

This chapter explores how the global business transformation of the commercial aircraft industry, which accelerated in the 1990s, has changed the context of firm-based late industrialization (FLI). More specifically, we will try to identify what kinds of strategic route towards FLI (hereafter called the FLI strategy) would have a better (or worse) prospect of success under the rapid global shifts in competition and production systems. Global shift in the commercial aircraft industry mainly comprises two trends. One is consolidation of the finished product market and the accompanying fierce oligopolistic competition. The second is the globalization of the intermediate goods market, which is characterized by the stretching and deepening of outsourcing. Putting forward the main argument of this chapter already at this juncture, the global industrial shift has made the catch-up strategy more difficult and riskier than ever, while it has opened ‘windows of opportunities’ for the upgrading strategy. The post-war development of the Japanese aircraft manufacturers illustrates a successful case where advantage has been taken of the changing context of FLI under globalization. The Japanese aircraft industry has long been stigmatized as one of the failures in Japan’s impressive postwar history of late industrialization. Indeed, it failed to catch up in the finished product market in contrast to the well-known success stories of the automobile and electronic industries. However, we will attempt a reassessment of that historical view by shedding light on the different aspects of FLI – upgrading. We will focus on the fact that the Japanese aircraft manufacturers have successfully upgraded their positions in the intermediate goods market and have progressed through FLI gradually and steadily since the 1970s. As mentioned in Chapter 1, Japan is very 33


special case through the history of late industrialization. But it may delineate the two different aspects of FLI by having clearly failed to catch up, but having succeeded in upgrading. In the following discussion, we will first highlight the differences between ‘catch-up’ and ‘upgrading’ FLI strategies by adapting the conceptual framework from the global value chain (GVC) perspective. Then, we will examine how global industrial shifts have affected the prospects of the two FLI strategies differently with special reference to the commercial aircraft industry. Finally, we will briefly examine how successful the post-war Japanese aircraft industry has progressed in FLI both in terms of catch-up and upgrading FLI strategies.

3.1 Firm-based late industrialization in the global value chain perspective To analyse the impact of such a global industrial shift on the prospects of firm-based late industrialization (FLI), it is first necessary to be clear about how FLI can be pursued by a latecomer firm. Hence, in this section, we will stylize the two strategies by which a latecomer firm pursues FLI; namely, the ‘catch-up’ and ‘upgrading’ strategies of FLI. Clearly separating those two FLI strategies is an important first step in analysing the changing context of FLI because the recent global industry shifts would affect the two FLI strategies differently. However, such a clear distinction between the FLI strategies cannot be simply drawn. In this section, we attempt to develop explanatory definitions of the catch-up and the upgrading FLI strategies by elaborating the significant conceptual issues of FLI, particularly examining the categories of various productive actors and the asymmetric power relations among them.

3.1.1 Catch-up strategy and upgrading strategy of FLI: a first definition Reviewing the various latecomers’ experiences of late industrialization, particularly in Japan and the Asian Newly Industrialized Economies (NIES) (Johnson 1982; Amsden 1989; Wade 1990; Hobday 1995), it is possible to identify two distinct strategies for pursuing FLI: namely ‘catch-up’ and ‘upgrading’. The catch-up strategy of the FLI by definition refers to a strategy in which a latecomer firm in a certain industry aims to narrow the gap in the competitive advantages of a precursor firm, which is usually a system integrator and has a significant market share. Hence, catch-up

Changing Context of Late Industrialization 35

is a radical approach towards FLI in the sense that the latecomer firm attempts to gain and sustain a competitive advantage in the finished product market1 within the targeted (often short) period of time. In this case, the latecomer firm would directly challenge the market shares of the incumbent system integrator by launching its own-brand products. The success or failure of the catch-up FLI strategy is assessed in relative terms, i.e., in comparison with the precursor’s economic and business performance, such as total production, revenue and market share. Upgrading strategy of FLI, on the other hand, refers to a strategy in which a latecomer firm focuses on achieving a higher value-added operation over a period of time. Instead of directly challenging to enter the finished product market, the latecomer firm working with an upgrading FLI strategy primarily aims to upgrade its supplier status step-by-step in the intermediate goods market.2 It is thus an incremental approach towards FLI. The strategic goal of the upgrading FLI strategy is to generate and capture the higher value-added by enlarging the scale and/or scope of supplier activities. The success or failure of the upgrading strategy of a particular latecomer firm is to be assessed in absolute terms taking into account the scale and nature of its supplier activities. In particular, since upgrading is accomplished by changes in the nature of supplier activities, it should be appraised not only quantitatively, for example by total production or labour productivity; but also qualitatively taking into account the technological level and the scope and depth of competences inherent in the supplier activities. However, it might be pointed out that those two FLI strategies are not necessarily mutually exclusive. Taking a broad view, catch-up might be construed as the ultimate stage of the upgrading process. It follows that a supplier in the intermediate market might eventually be able to upgrade its competences sufficiently to gain competitive advantage as a system integrator in the finished product market. In order to do so, nevertheless, the latecomer firm must overcome high entry barriers to the finished product market. What must be emphasized here is that transforming from a supplier into a system integrator is far from linear and is strongly influenced by power relationship. Firstly, a system integrator and a supplier undertake a different scope of activities: a supplier usually confines its activity to component production, while a system integrator undertakes both production and post-production activities, such as marketing and aftersales service. Secondly, there is an asymmetric power relation between them: the system integrator, being the prime contractor, usually has dominant power over the supplier. In addition, those two aspects of


inter-firm relations between a supplier and a system integrator are deeply interrelated. That is to say, their different scopes of activity might cause the asymmetric power relation between a supplier and a system integrator, as well as vice versa. Furthermore, as we will see later, the logic of such mutual interaction would ultimately demonstrate the underlying mechanism of FLI.

3.1.2 The mechanism of FLI: elaborating the global value chain perspective Returning to the difference between the two types of FLI strategy outlined above, the catch-up FLI strategy primarily aims to become a competitive system integrator while the upgrading FLI strategy primarily aims to become a supplier undertaking high value-added sourcing activities. Hence, in order to form a comprehensive picture of both FLI strategies, we should first scrutinize the inter-firm relations between a system integrator and a supplier. Furthermore, in order to understand those inter-firm relations, we need to explore the underlying mechanism of the FLI. For the purpose of this study, we adopt and enhance the global value-chain (GVC) perspective (Gereffi and Korzeniexicz 1994; Kaplinsky and Morris 2000; Gereffi, Humphrey et al. 2001) in order to examine inter-firm relations between the suppliers and the system integrators in the commercial aircraft industry, and in turn to clearly define the two FLI strategies in that industry.

3.1.2.1

The global value chain perspective

The GVC perspective represents a growing stream of research that focuses on the emergence of a new global production system, in which economic integration goes beyond international trade in raw materials and final products, to encompass centrally coordinated but internationally dispersed production of many activities along the chains of given commodities or manufactured products (Raikes, Jensen et al. 2000: 393).3 It is highly worthwhile to introduce the GVC perspective in some detail at this point because it offers an effective organizing framework to understand the functional division among the different productive actors. The GVC perspective is based on a simple but useful concept of ‘valuechain’, which Kaplinsky and Morris (2000) succinctly define as: The value chain describes the full range of activities, which are required to bring a product or service from conception, through the


different phases of production (involving a combination of physical transformation and the input of various producer services), delivery to final consumers, and final disposal after use. (Kaplinsky and Morris 2000: 4) Due to that the concept of value chain covers the ‘full range of activities’, the GVC perspective broadens our focus from solely the manufacturing activities towards the pre- and after-manufacturing activities from product definition, design and marketing to after-sale services.4 For instance, the sequence of productive activities of a commercial aircraft value-chain can be illustrated as in Figure 3.1. The product development begins with conducting the market and operational researches to conceptualize a newly developing airplane. Having set the specifications for configuration and performance, the aircraft companies move to the design stage, which consists of two phases: the basic design of the whole plane and the detailed design of each component. What is peculiar about the manufacturing stage of a commercial aircraft is that the prototype must prove the absolute product reliability by passing the severe testing and certification procedures conducted by the aviation authorities, such as the Federal Aviation Administration (FAA) of the United States. For post-production activities, the value-chain extends through sale or leasing, delivery and after-sale maintenance services. Various researchers have adapted this simple idea of value-chain, often using different terminology such as the value stream (Womack and

FUNCTIONS

Market research

Design

Manufacturing

Marketing

After-sale service

Leasing

Testing /Certification

Sales

Total system integration

Module system integration

Sub-system assembly

Component manufacturing

Detailed design

Project planning

Basic design

Product conceptualization

Market risk evaluation

Customer needs appreciation

ACTIVITIES

Figure 3.1 A value chain of the commercial aircraft industry

Service


Jones 1998) and the filiere (Raikes, Jensen et al. 2000). In his well-known conceptual framework for the firm competitiveness, Porter, for instance, regards a value-chain to be completely contained within the individual firm, and poses a different term, value system, for a set of interlinked firms (Porter 1980; Porter 1985). What should be emphasized here is that the GVC perspective emphasizes instead that a firm does not accommodate ‘complete’ value-chain on its own, but specializes in certain value-chain functions, such as design or marketing (Gereffi, Humphrey et al. 2001: 2). In other words, the sequence of productive (that is, value-added) activities leading to and supporting end use are divided between different firms often located in different places (Humphrey and Schmitz 2000; Sturgeon 2001). Furthermore, what makes the GVC perspective distinct from the other industrial analyses is that its emphasis is on the fact that the various firms constituting a value-chain are coordinated and controlled by the powerful firm (or firms). The powerful firm plays a dominant role in organizing and restructuring a GVC. The GVC perspective therefore offers an effective organizing framework to classify the various productive actors, which specialize in the different areas of activities in a value-chain, in regard to the asymmetric power relations in a global value-chain. The issue of power relations is particularly relevant for the FLI because the superior power presumably increases the firm’s capacity to appropriate or retain the value created throughout the GVC. The power relations concern the balance of leverage within GVCs, that is, bargaining power that each firm has in determining who undertakes the most value-added and profitable activities and functions (Kaplinsky and Morris 2000: 2; Palpacuer 2000). Nevertheless, as Gereffi, et al. point out, the issue of power relations within chains has not been given enough prominence in previous discussion of chain dynamics (Gereffi, Humphrey et al. 2001: 4). Existing GVC research has largely failed to provide insights into how the powerful firm might control subordinate firms in a GVC. They have also failed to explain the sources of the asymmetric power relation in a GVC. These shortcomings are the very reason why we regard the GVC perspective as a heuristic device rather than an analytic tool (Kaplinsky and Morris 2000: 25). While a heuristic device offers an effective organizing framework for the systematic presentation of phenomena, an analytical tool must also provide logical insights into the contents and relationships between the variables constituting the organizing framework.


We will now attempt to elaborate the GVC perspective towards an analytical tool by remedying its weakness through insights from the literature on networks, inter-organizational relations, and strategic management. On the one hand, strategic network research (for example, (Jarillo 1988; Sydow 1992) together with the ‘powerdependence model’ of Emerson (Emerson 1962) shed light on how a GVC is controlled by a powerful firm on the basis of the asymmetric power relations. The sources of asymmetric power relation in a GVC, on the other hand, can be explained by synthesizing the ‘resourcebased view’ of the strategic management literature (for example, Penrose 1959/1995; Wernerfelt 1984) and the ‘resource-dependency perspective’ of the inter-organizational literature (for example, Pfeffer and Salancik 1978).

3.1.2.2

Classifying the various productive actors within a GVC

We begin our elaboration of the GVC perspective by classifying the different productive actors constituting a value-chain. More specifically, we try to define the powerful firm, which dominates and controls a value-chain, and other subordinate firms by focusing on their activities as well as on their power asymmetry in a GVC. For the purpose of the study, we call the former the ‘lead firm’ and the latter the ‘dependent firm’. Lead firms are the principal actors in the GVC. They place themselves at the head of the supply chain as prime contractors and the largest customers for suppliers. Lead firms provide the initiative and enjoy a high degree of independence from the other actors. The main characteristics of a lead firm in GVC can be enumerated as follows: (Ruigrok and van Tulder 1995: 65–6):5 • A lead firm has sheer size and enjoys a high degree of independence from other firms. A lead firm is the principal actor as well as the director of the play; • A lead firm has direct access to domestic and foreign finished product markets and/or customers, either through subsidiary sales and service offices, or through third parties importing/distributing the lead firm’s product and offering service. A lead firm will at all times be able to license and control the use of its own trademark (except for criminal abuse); • A lead firm owes its relative independence [i.e., dominant power] (1) to its control over a series of core technologies and other strategic


functions, specific to an industry or industrial activity; and/or (2) to its financial muscle. • A lead firm imposes an explicit vision of the organization and management of the GVC. Its vision serves as the focal objective that all members of the GVC strive to accomplish. In short, a lead firm occupies a dominant position in the GVC through its control of strategic competencies, such as proprietary technologies, brand management, marketing network and product definition, and on the basis of its sheer size and financial muscle. According to the strategic network perspective (Jarillo 1988; Sydow 1992), lead firms strategically coordinate and control inter-firm relations within the GVC in such a way that it can gain and sustain the systemic advantages throughout the value-chain vis-à-vis the other competing GVCs. Lead firms control their GVC by taking decisive roles in the management of the chain as follows (Sydow 1992; Humphrey and Schmitz 2000; Humphrey and Schmitz 2001): • Setting the key parameters of production: what, how, when, and how much to be produced; • Integrating the many different components, which are produced by itself or suppliers, into a complete system resulting in the final product (i.e., a system integrator); • Selecting and monitoring the members of the chain; • Sustaining inter-firm relationships by managing conflict; • Positioning and repositioning the chain in the market; and • Building the structure and the culture of the chain. In certain types of GVC, lead firms may have to surrender their role as sole director, yet they will always remain the leading actor, and if given the opportunity will try to regain control (Ruigrok and van Tulder 1995: 65). The competitive advantage of lead firms, therefore, depends not only on efficient corporate management inside the boundary of the firm, but also on its effective systemic management over the entire value-chain as a system integrator. Dependent firms, on the other hand, merely participate in the GVCs as suppliers, not as directors of the play. They are thus under the control of lead firms to a certain degree. They must comply with the lead firms’ decisions regarding the management of the chain listed above; for example, the key parameters of production. Since the supplier’s scope of activities is usually limited to the intermediate goods market, dependent


firms do not have access to the final purchasers of the product. It means that the fate of dependent firms is largely or totally dependent on how successful lead firms are in gaining the systemic advantage in the finished product market through effective GVC management. Thus, for the purpose of this study: Dependent firms are defined as legally independent manufacturing suppliers in a global value chain, whose activity and fate are dependent on the lead firms’ systemic management of the value-chain. According to Emerson’s ‘power–dependence relations model’, dependency of organization A (e.g., a latecomer firm) on organization B (e.g., a lead firm) means that B possesses the power to make A do what B wants A to do (Emerson 1962). In other words, Dahl (1957) describes power as follows: ‘A has power over B to the extent that he can get B to do something that B would not otherwise do’ (Dahl 1957: 202–03). The relationship between dependency and power in inter-organization relationships can be simply depicted as in Figure 3.2. Thus, although dependent firms are legally independent, their dependency on lead firms for their fate means that their autonomy is limited de facto by the power of lead firms. I have developed this concept of dependent firms by building on what Hobday (1995) calls ‘latecomer firms’ in his study of technological developments in East-Asian locally owned firms in the electronics industry. He describes as latecomer firms manufacturing companies, which face two sets of competitive disadvantage in attempting to compete in export markets. First, located in developing countries, latecomer firms are dislocated from the main international sources of technology and R&D. Second, they are dislocated from the mainstream international markets they wish to supply and from demanding buyers (Hobday 1995: 33–4). While Hobday develops his definition solely with reference to firms located in developing countries, I contend that its concept can be

DEPENDENCY A

B POWER

Figure 3.2 The power–dependence model Source: Developed based on Emerson (1962)


generalized to apply to any manufacturing firms, which does not possess sufficient power to take the initiative in a GVC – irrespective of whether it is located in a developing or a developed country. I here therefore coin the generalized concept of the ‘dependent firm’. For instance, although the Japanese aircraft manufactures are located in an advanced country, they must also be categorized as dependent firms so long as their activities and successes depend on the lead firm of GVC, in which they participate, that is, the Boeing Company. Furthermore, the number of people who are employed by dependent firms and whose activities and fate are dependent on lead firms could be very large even in the advanced countries. In the value-chain of Coca-Cola within the EU, for instance, Nolan (1999) estimates that at least 180,000 employees of dependent firms work full-time to meet the needs of the Coca-Cola system,6 which itself employs around 27,000 people (Nolan 1999: 75). Latecomer firm, in this study, simply refers to any firm that enters the industry in which it is involved belatedly. The latecomer firm might be either a dependent firm or a lead firm, depending on its power status in a GVC. At the same time, those firms that entered the industry in early days could be also either dependent firms or lead firms in the GVC perspective. For instance, both SAAB Aerospace and Fokker entered the commercial aerospace industry at the early stage of the industry’s development, but have fallen to become dependent firms in the recent global business transformation. Hence, in the rest of this study, the term ‘latecomer firm’ will be used without the consideration of power status; while the term ‘dependent firm’ or ‘lead firm’ will be used to denote its power status from the GVC perspective.

3.1.2.3

The Chain Hierarchy

Dependent firms can be further stratified into different levels in the hierarchy of the value-chain. They can be placed in one of the three tiers of the chain hierarchy according the unit scale of their products as well as to the scope and the technological complexity of their activities. Figure 3.3 summarizes the chain hierarchy. Explaining from the bottom of the hierarchy, (1) a piece-part subcontractor solely provides the manufacturing service to the prime contractor. Asanuma (1985: 49–50) calls this lowest status supplier a ‘drawing-supplied (DS)’ supplier, as the entire design for supplying parts is carried about by the buyers. The second tier supplier is (2) a sub-system supplier, which undertakes the detailed design and assembly of the supplying sub-system. In aircraft production, for instance, those sub-systems include wing skins and major fuselage panels. Compared to DS suppliers, Asanuma calls them ‘design-approval (DA)’ suppliers, as they draw the detailed design themselves and then submit it to buyers

Changing Context of Late Industrialization 43 The Hierarchy of producers in supply chain

Actors in the GVC of a complete aircraft

Actors in the module valuechain of an Aero-Engine

(Modularization) Top: System integrator Medium/Large Jet : Boeing, Airbus Regional Jet: Bombardier, Embraer

Lead firm

1st Tier: Module system maker Aero-Engine: GE, Rolls-Royce, United Technologies, Honeywell, etc. Avionics: Honeywell, Rockwell Collins, etc.

Modular lead firm

2nd Tier: Sub-system supplier Cockpit System: Smiths, Thales, etc. Structures: JADC, Vought, Grumman, Airbus members Aero-engine: JAEC, Fiat, MTU, etc.

Dependent firms Dependent firms

3rd Tier: Piece part subcontractor MHI, KHI, FHI, IHI, GKN, Daewoo, etc.

Figure 3.3 Chain hierarchy of the commercial aircraft industry

for approval (Asanuma 1985).7 Nevertheless, the prime contractor still decides the basic design, such as the shape and specification of the supplying components. The first tier supplier is (3) a module system maker, which builds a complete module system. Sturgeon (2002) named this type of supplier ‘turn-key suppliers’, as they provide the full-rage of product-related services (Sturgeon 2002). What is to be noted here is that a module system maker is not only in the highest higher status of dependent firm, but also often behaves like a lead firm in the industry whose product architecture is of modular rather than integral nature. A product unit in an integral architecture situation is in close proximity to or has a close spatial relationship with elements in other units, and together they are tightly synchronized (Fine 1998: 134–5). In contrast, a module is a unit whose structural elements are powerfully intraconnected but are relatively weakly connected to elements in other units (Baldwin and Clark 2000: 63). Component interfaces with a module are standardized. The important point is that the product architecture shapes the relationship between a system integrator and a first-tier supplier. In the case when the product architecture is integral, a lead firm needs to control the first-tier suppliers strongly in order to achieve tight synchronization of the system integration. On the other hand, the module product architecture makes the first-tier supplier independent from the system integrator, particularly when a module maker has direct


access to the customer. For instance, the personal computer industry has highly modularized product architecture. First-tier suppliers and module makers, such as Intel for semiconductors and Microsoft for software, have direct access to customers and enjoy high independence from the system integrators, such as IBM or Dell. The aircraft industry has also been visibly modularized within aeroengines. The module makers, such as Rolls Royce, General Electronics and Pratt & Whitney for an aero-engine, often have direct access to customers when the airline operators have the option to select the brand of aero-engine or avionics to be installed on their aircraft. In such cases, the value-chains of the modular systems can be seen as quasi-independent branches, which are sub-sets forming part of the integral GVC of aircraft production. The modular system makers may act as lead firms in these module value-chains. For the purpose of this study, lead firms in module value-chains are called module lead firms. Nevertheless, they are only ‘quasi’-independent because module makers are still dependent upon the main GVCs of the complete aircraft. Table 3.1 summarizes the various productive actors constituting a GVC.8 The lead firm of a GVC, as mentioned earlier, coincides with a system integrator, carrying out the final assembly as well as market-

Table 3.1 Various actors in global value chains Productive actors

Piece-part subcontractor

Manufacturing Component parts manufacturing

Scope of activity Design

Market-related

Position in GVCs

Dependent firm

Sub-system suppliers

Module system maker

System integrator

Sub-system manufacturing

Module system integration

Total system integration Production of strategic components

Detailed design

Module basic design

Product conceptualization Basic design

Marketing and after-sales service of module system

Operational research Marketing After-sales service

Module lead firm

Lead firm

Source: Developed based on Asanuma (1985); Sturgeon (2002); Ingersoll Engineers (1994)


related activities, such as operational research, marketing, sales and after-sales service. For the product unit of modular architecture (an aero-engine in this case), the module system makers, such as Rolls Royce and GE, act as the module lead firms within the module value-chain of the aero-engine.

3.1.2.4

Sources of the asymmetric power relations in a GVC

In the preceding section, we have emphasized that an asymmetric power relationship exists in a GVC between a lead firm and a dependent firm. On the basis of Emerson’s ‘power-dependency model’, the logic put forward was that a lead firm has superior power over a dependent firm because the latter is dependent on the former for its activity and fate. However, the above discussion begs a more fundamental question: how does a lead firm have superior power over a dependent firm and not vice versa? All firms are interdependent on each other because no firm can survive and gain competitive advantage without depending on others for the resources and capabilities they lack (Pfeffer and Salancik 1978; Sanchez and Heene 1997). In general, according to Pfeffer and Salancik (1978), interdependence exists in social systems and social interactions: whenever one actor does not entirely control all the conditions necessary for the achievement of an action or for obtaining the outcome desired from the action. (Pfeffer and Salancik 1978: 40) Firms are neither self-contained nor self-sufficient organizations in any economic activities but are like ‘islands of planned co-ordination in a sea of market relations’ (Richardson 1972: 883). The resources and capabilities for which a firm depends on others are important and sometimes critical for its survival. Inevitable interdependency among firms further implies that all firms have power over other firms to a certain degree. The essence of the GVC analysis underlines the fact that the asymmetric power relationship exists within such interdependency.9 Then, what makes a dependent firm more dependent on the lead firm, and why not vice-versa in a global value-chain? The answer lies in the relative importance of resources and capabilities which the firms offer each other, and which determines superiority or inferiority in inter-firm power relationships. The importance of the firm’s resources and capabilities in turn depends on how essential they are for the competitive advantage of the GVC. If firm A can offer more important resources and capabilities to gain and sustain competitive advantage than another participant firm B within the GVC, A would


have superior power over B. Then, what makes the particular resources and capabilities of a firm more important than others? To answer this question, it is first necessary to clarify what ‘resource’ and ‘capability’ of a firm mean here because various definitions are proposed and often used interchangeably. The concepts of resource and capabilities of a firm have been elaborated by emerging streams of research called ‘resource-based view of the firm’ (Penrose 1959/1995; Wernerfelt 1984; Peteraf 1993). It is interested in linking the explanation of the existence, structure and boundaries of a firm as well as its competitive advantage to the characteristic of internal resources and capabilities of that firm (Foss 1997; Hodgson 1998).

3.1.2.5

Resource-based View of the Inter-firm Dependency

The term resources is here defined as inputs into the firm’s production and marketing activities, which are principally tradable at ‘strategic factor markets’ (Barney 1986). Usually, three general types of firm resources are identified: physical resources, financial resources and intangible resources. Intangible resources are much more difficult to delimit and value than physical resources (plant and its physical technology, raw materials, etc.) and financial resources. Intangible resources are restricted here to those which are tradable, such as patents, trademarks, individual skills (accountancy and legal skills, etc.) and formal organizational procedures (but not informal relations). Thus the term ‘resources’ does not include the team-based and experience-based human and organizational ‘capital’, which are rather included in the concept of ‘capabilities’. The term capabilities is here defined as intangible and experiencebased knowledge capital, which structures and directs the firm’s bundle of resources at hand to carry out the production and marketing activities in the intended ways, and typically to do so more efficiently than others (Foss 1996; Dosi, Richard et al. 2000). In terms used by Penrose – one of the founders of the resource-based view of the firm – capabilities bring forth ‘the services that the resources can render’ (original emphasis, Penrose 1959/1995: 25). Capabilities are not tradable like resources because of their tacit components, which are elaborated by Christensen in the following way: First, it [capabilities] involves the internally accumulated ‘stock’ of experience in mobilizing (and possibly acquiring) and orienting these or similar resources for productive [and marketing] purposes Second, this experience-based capacity is embedded in social teams


(or networks of people) and not in discrete individual skills (Christensen 1996: 114) Capabilities involve organized activity and the exercise of capability is typically repetitious, that is they are embodied in the routine of a firm (Nelson and Winter 1982; Teece, Rumelt et al. 1994; Dosi, Richard et al. 2000). In the following, the term ‘competence’ is used as a common denominator for resources and capabilities. We now return to the question posed above – ‘what makes the particular competences of the firm more important than others?’ The hierarchy of the firm’s competence is a function of the following three attributes of competence: • Criticality for product performance, • Difficulty to reproduce, and • Scarcity.

Criticality. Firstly, a firm can exercise superior power by possessing the competences which are critical for the performance and market value of products. To put it differently, the closer to the core source of production definition and development, the more critical the firm’s competence will be within a value-chain of the product. If the product concerned is developed based on a technology-push process, the competences necessary for technological innovation are more essential for developing new products than other competences. On the other hand, if the product is developed based on a demand-pull process, the competences necessary for identifying demand preference and market condition are more crucial than others for successful product definition and development. Furthermore, among product-related competences, the competences that support the production of critical components would generate superior power than those supporting non-critical components. Critical components vary from industry to industry. In the case of the commercial aircraft industry, wings, avionics or engines can be considered of high strategic importance because they largely condition the performance of the aircraft. A commercial aircraft is a typical product developed in the demand-pull process. Aircraft makers in the commercial market must concentrate on their customers’ (that is, airline companies) demands for the low unit price of the aircraft and low direct operation cost (DOC) with reliable safety features rather than solely on technological superiority (see Section 3.2.2). Moreover, since new aircraft development projects can be launched only after having secured


FUNCTIONS

Market research

COMPETENCE

Marketrelated

Design

Manufacturing

Marketing

Product-related

Service

Market-related

Figure 3.4 Functions and competences underpinning a GVC Note: See also Figure 3.1

a certain minimum number of orders, aircraft makers must attract as many launch customers as possible by reflecting their demands in the product conceptualization. Among different competences, marketrelated competences, which support market research, marketing and after-sale service, are fundamental in arriving at the specification for product design and manufacturing (Figure 3.4).

Difficulty to reproduce. Secondly, a firm can exercise superior power by possessing unique competences, which are difficult to reproduce. If a latecomer firm could easily obtain the similar competences of a lead firm by imitating or replicating, the latter’s superior power dissipates quickly. However, reproducing the competences require a firm the intra-firm investments both in strengthening the resource base and in nurturing the capabilities over a period of time. Especially, it is hard to reproduce those competences, which consist of a large stock of experience – and organization-based capabilities, due to the following three factors (Dierickx and Cool 1989; Teece, Pisano et al. 1997): • Causal ambiguity: Due to its intangible nature, it is difficult to understand and copy the mechanism of experience- and organizational capabilities; • Time compression diseconomies: Experienced-based capability by definition can be acquired only after spending a certain amount of time and resources to master the activity; • Asset mass efficiency: Experienced-based and organization-based capabilities can be more effectively and efficiently developed after gaining a certain level of knowledge about the activity and sharing it among the member of organization.


In short, attempting to reproduce such unique competences requires a long period of time and considerable sunk costs. It further exacerbates uncertainty and increases the risk of intra-firm investment in reproducing such competences. The competences underlying marketing and after-sales service are typical examples of unique competences. They require establishing long-term customer relations by bearing significant sunk costs for customer information gathering, advertising, customer service facilities and so on (Lall 1991; Keesing and Lall 1992; Roberts and Tybout 1995). Returning to the case of a commercial aircraft, market-related competences are harder to replicate or imitate than product-related ones because they are more difficult to codify or standardize, leading to causal ambiguity.10 Moreover, such competences underlying the functions of marketing and customer needs appreciation could be consolidated only after a firm establishes close and trusting customer relations through long experience and reputation. It is hard for latecomer firms to catch up with the market-related competence of lead firms because the same quality of ‘experience-based’ customer relations is hard to acquire in a short period of time (that is, time compression diseconomies). Neither can latecomer firms build up those competences effectively without having a ‘critical mass’ of experiences to start with (that is, asset mass efficiencies). In addition to these qualitative difficulties, the significant amount of investment – such as in establishing marketing channels, training sales persons and preparing equipment and facilities for after-sale service – make it difficult and risky for latecomer firms to attempt acquiring those competences. The larger the sunk cost and the longer the period required to reproduce the competences, the more difficult and risky it will be for a firm to do so. Furthermore, the more difficult and risky it is to reproduce them, the more important those competences must be, which in turn gives stronger power to the firm that possesses them.

Scarcity. Finally, the importance of a firm’s competences also depends on their scarcity within the industry. If firm A can find alternative sources for the competences on which it depends from firm B, the degree of A’s dependency on B can be limited. In other words, if the competences are highly concentrated in a few firms, their significance as a source of power increases (Thompson 1967: 31; Pfeffer and Salancik 1978: 50). In the case of the commercial aircraft industry again, marketrelated competences are now highly concentrated in a few oligopolistic final assemblers as a result of frequent M&A activities starting in the


1930s and accelerating in the 1990s, as described in the final section. All suppliers have no choice but to depend on the few final assemblers for market-related competences: Boeing and Airbus in the medium and large aircraft market, and Bombardier and Embraer in the regional jet market. This concentration of market-related competences in turn gives those final assemblers superior power over suppliers in their global value chains. In short, the asymmetric power relationships between the various productive actors in the GVC arise from the difference in hierarchical level of competences, for which one depends on the others. More specifically, a lead firm has superior power over a dependent firm in a GVC because the latter depends on the former for the more important competences in terms of quality and/or quantity. The lead firm utilizes those high-ranking competences to implement the core technologies and strategic activities, by which they gain and sustain their competitive advantage.

3.1.2.6

Dual-faceted competences: the underpinning of the FLI

It is essential to point out that the power-generating competences, discussed above, also enable a firm to earn high and sustainable profit. This linkage between power and profit can be encapsulated by the concept of rent. Rent refers to the supranormal profit, which arises from the possession of scarce productive factors. To put it differently, productive factors create rent if they are scarce in supply due to the difficulty in reproducing them or to imperfect mobility (Peteraf 1993; Kaplinsky 1998). Rent-generating productive factors are either fixed factors which cannot be expanded (for instance, high-yielding mineral deposits and land), or quasi-fixed in the sense that their supply cannot be expanded rapidly (for instance, technology, human resource and organizational capabilities, and brand-name). Such rigidity of rent-generating factors also acts as a barrier to entry. To the extent that the barriers to entry protect a firm from being challenged by potential competitors, the rent can avoid dissipation by competitive pressures, and a firm is in turn able to earn a high and sustainable profit.11 At the same time, to the extent that the barriers to entry block a firm from being challenged by potential competitors, the rent-generating competences may become exclusive to the firms already possessing them. Those firms could in turn be in a position to exert superior power over the others who have to depend on them for those competences.


It is clear by now that the aforementioned attributes of powergenerating competences coincide with those of rent-generating productive factors – that is, scarcity and difficulty of reproduction. To put it differently, the scarce and unique competences play a dual-faceted role in the FLI: (1) making the firm’s activities rent generating, that is, lucrative, on the one hand; and (2) giving the firm the bargaining power to reserve for itself the lucrative activities within the GVC as well as appropriating the generated rents, on the other. Therefore, the core logic of the FLI may be described as follows: Firm-based late industrialization is the process by which a latecomer firm acquires the dual-faceted competences that would generate rent as well as bargaining power. Rent, to the extent that entry barriers protect it, makes the firm’s activities profitable over a period of time. Bargaining power, on the other hand, gives the firm the leverage to gain access to those profitable activities within the global value-chain as well as to appropriate the generated rent. The mechanism of the FLI may be illustrated as in Figure 3.5. First of all, a latecomer firm must acquire new competences by overcoming the barriers to entry.12 The barriers to entry emanate from such elements of the competences that are scarce, difficult to reproduce or critical for product performance. Once having acquired those competences, the latecomer firm would be now able to overcome the barriers to entry. To the extent that it is protected by those barriers to entry, the latecomer

Latecomer firm Rent Learning Source of supernormal profit Competence

High value-added activity

Scarce

High/Sustainable profit

Difficult to reproduce

Critical Barriers to entry

Leverage to undertake the lucrative activities in GVCs

Power to appropriate the rents

Bargaining power

Figure 3.5 Mechanism of firm-based late industrialization

FLI


firm could generate rent, which in turn makes the firm’s activities higher value-added. At the same time, again protected by the barriers to entry, the latecomer firm could gain bargaining power, which in turn would give the firm access to the lucrative activities as well as the leverage to appropriate the rent generated throughout a GVC. As a result, the latecomer firm could enjoy profit and achieve growth over a period of time, and could ultimately contribute to overall industrial development at the national level – that is, firm-based late industrialization.

3.1.3 Defining the two FLI strategies: the alternative set of strategic route and essentials to succeed In the preceding sub-sections, by elaborating the GVC perspective, we classified the various types of productive actors playing different parts in a value-chain, into lead firms and dependent firms. Also, by synthesizing the resource-based view of the firm and the resource-dependency perspective of inter-organization theory, we explained the nature and sources of the asymmetric power relationships in a GVC. Furthermore, on the basis of those analyses, we identified the nature of competences underpinning the mechanism of the FLI. Returning to the problem put forward at the beginning of this chapter – the difference between the catch-up FLI strategy and the upgrading FLI strategy – we are now in a position to comprehensively illustrate the distinct strategic routes by which a latecomer firm pursues FLI. That is to say, aiming to become a different type of productive actor in a GVC (namely, a lead firm or a high-ranking dependent firm), a latecomer firm employing catch-up FLI strategy would take a different strategic route towards the FLI from the one employing upgrading FLI strategy. On the one hand, a latecomer firm pursing catch-up FLI strategy directly aims to become a lead firm in a GVC. The latecomer tries to become a lead firm either by seizing the dominant power from the incumbent lead firm in an already existing GVC or by establishing a new GVC from scratch. In order to do so, it must acquire the superior dual-faceted competences that would generate the high rent and strong bargaining power in a GVC. In other words, the catch-up FLI strategy primarily tries to undertake the strategic functions in a value chain. The strategic functions are those employing the competences critical for product performance, or difficult to reproduce, and scarce. Hence, the strategic route of the catch-up FLI strategy can be conceptualized as in the upper half of Figure 3.6. In the case of a commercial aircraft valuechain, as seen earlier, the strategic functions include the production of


critical components (such as the wing or the cockpit) as well as market research, the early stages of design (such as product conceptualization, basic design and project planning), the late stages of manufacturing (such as total system integration), marketing and after-sales services. On the other hand, a latecomer firm employing upgrading FLI strategy would begin its endeavours toward FLI by entering the existing GVC at the point of the lowest entry barriers (see the lower half of Figure 3.6). Such entry point for upgrading is usually the low-skilled manufacturing of non-strategic components. Hence, the latecomer firm attempts, in the first place, to become a dependent firm of the lowest status in a GVC, that is, a piece-part subcontractor. Then, it aims to incrementally increase the value-added of its activities through upgrading its status as a dependent firm towards a sub-system supplier and even higher status. The dependent firm has two ways to increase the value-added of its supplier activities. One is to widen the scope of its activities towards both upstream and downstream by complementing manufacturing with design and sub-system assembly (Figure 3.6). The other way is to move into the product lines of larger unit value either by producing more strategic components or by combining multiple interfacing parts together into larger sub-systems, which might eventually lead to module system integration.13 Such a movement towards upgrading can be also seen as the rightward shift in Table 3.1.

Catching-up strategy High entry barriers

Strategic functions Market research

Strategic functions

Design

Manufacturing

The lowest point of the entry barriers

Upgrading strategy Figure 3.6 The alternative strategic routes towards FLI

Marketing

Service


Moreover, what must be underlined here is that the strategic route of catch-up entails much higher risk than that of upgrading. The catch-up FLI strategy entails high risk because latecomer firms face two kinds of barriers to entry. Firstly, they have to overcome from the outset the high barrier to entry emanating from the nature of the dual-faceted competences necessary to become a lead firm in a GVC. Secondly, since the lead firm, as a system integrator, has to gain and sustain the systemic advantage against the other GVCs in the finished product market, the catch-up FLI strategy also has to overcome the high barriers to entry arising from the competitive environment of the finished product market. Hence, the feasibility of catch-up FLI strategy depends on the degree of difficulty necessary to overcome the barriers to entry. It is highly uncertain whether a latecomer firm would be able to overcome those high entry barriers with the limited intra-firm resources and limited time available. It requires significant amounts of intra-firm investment over a significant period of time, and moreover strong support from the state might be essential. If a firm should end up failing to overcome the entry barriers after making significant intra-firm investments, or if the state supported such a latecomer firm and failed (that is, ‘picking a loser’), either or both the firm and the state could be left with massive debts without achieving a significant position in a GVC. Nevertheless, it is also true that once a latecomer firm could safely secure its position as a lead firm, it would be able to enjoy great self-esteem as an independent leader in the industry concerned. By taking the upgrading strategy, a latecomer firm faces a much lower risk. It initially focuses on overcoming the entry barriers at the lowest level in the GVC; then moves on to challenge the higher entry barriers one step at a time always taking into consideration the available resources at hand. Thus, the upgrading FLI strategy does not oblige the latecomer firm to overextend its investments and commitment to learning efforts as much as in the case of catch-up. Since the latecomer firm remains a supplier in the intermediate goods market, it can also avoid the fierce competition and volatility of the finished product market. Nevertheless, as long as it is pursuing an upgrading FLI strategy, the latecomer firm remains a dependent firm, whose activities and fates are still largely controlled by the lead firm. Being a supplier, it is subject to being told by the lead firm what, how and when and how much to produce. Thus, there is not much scope for dependent firms to upgrade unless the lead firm makes available to it an increasing amount of higher value-added sourcing work in the intermediate goods market. In other words, the feasibility of implementing the upgrading FLI strategy still


largely depends on the lead firm’s sourcing strategies – more specifically, their willingness to outsource the larger amount of higher valueadded activities. Furthermore, even if the dependent firm is successful in upgrading in a certain GVC, it might still end up failing overall FLI if its lead firm mismanages the GVC and fails to gain the systemic advantages in the finished product market. Therefore, the basic characteristics of the two stylized FLI strategies are summarized in Table 3.2. The catch-up FLI strategy and upgrading FLI strategy are distinct in their strategic routes and in their essentials for success. The former pursues a radical and high-risk strategic route. In this case, a latecomer firm directly attempts to seize the dominant power of the lead firm. To be successful, it must not only learn the competence that would enable it to generate the dominant power in the GVC, but must also gain a systemic advantage in the fiercely competitive finished product market. On the other hand, the upgrading FLI strategy entails a much lower risk due to its limitations in being a dependent supplier firm in the intermediate goods market. Nevertheless, its success depends on the nature of the intermediate goods market, which is in turn partly affected by the lead firm’s sourcing strategies. It also must incrementally learn the competences to carry out higher value-added sourcing activities.

Table 3.2 Two stylized strategies of firm-based late industrialization Catch-up

Upgrading

Type of approach Assessment methods Type of market in action Type of productive actor targeted

radical in relative terms

incremental in absolute terms

finished product market

intermediate goods market higher-status of depended firm

Essentials for success

• learning the competences that would generate the dominant power in a GVC • gaining the systemic advantage in the finished product market

lead firm

• learning the competences to carry out higher value-added sourcing activities • availability of high value-added sourcing activities in the intermediate goods market


3.2 Global business transformation and its consequences for FLI in the commercial aircraft industry In the previous section, as the first step in analysing the changing context of FLI in the global economy, we stylized the two FLI strategies – namely catch-up and upgrading – and highlighted their different strategic routes and the essentials for their success. We now turn to focus on the extent to which recent global shifts in GVC patterns have changed the context of those FLI strategies in different ways, with special reference to the commercial aircraft industry. The recent global shifts in the commercial aircraft industry have transformed not only the entry barriers of the finished product market but also the nature of the intermediate goods market. On the one hand, the finished product market in the commercial aircraft industry has become highly concentrated. Indeed, there is currently an effective global duopoly in each of the two major market segments – the medium/large jet market (110 seats and above) and the regional jet market (30–110 seats).14 On the other hand, the scale and scope of the intermediate goods market has expanded. This is mainly because the strategic sourcing of the lead firms has become dominant, particularly in the form of the international collaboration project (ICP) for developing a new aircraft. As we have seen in the previous section, one essential for the success of the catch-up FLI strategy is to overcome the entry barriers in the finished product market emanating from fierce competition. The chances for the upgrading strategy, on the other hand, are strongly affected by the nature of the intermediate goods market, which is in turn strongly affected by the lead firms’ sourcing strategies. In the following section, we try to illustrate that the global business transformation in the commercial aircraft industry has not only raised the entry barriers in the finished product market, but has also transformed the nature of sourcing in the intermediate goods market.

3.2.1

Consolidation of the finished product market

Ever since the very early stage of its history, the aircraft industry has experienced a process of consolidations, in which the small workshops originally established by adventurous entrepreneurs developed into massive global giants during the 20th century (Bilstein 1996). The consolidation process accelerated during the 1990s and has resulted in the finished product market in the aircraft industry being more concentrated than in any other industry (Figure 3.7).


As the result of the vigorous consolidation process which occurred throughout the 1990s, reaching its peak with the acquisition of McDonnell-Douglas by Boeing in 1997, the industry has become a duopoly in the major market segments: Boeing and Airbus Industrie in the large (over 120 seats) jet aircraft market; and Bombardier and Embraer in the regional jet market.15 (Fairchild Dornier, previously standing third in the regional jet market, filed for bankruptcy in April 2002.) In particular, the oligopolistic competition in the regional jet market became so severe that the even some established forerunners, such as Fokker, British Aerospace and Fairchild Dornier, were forced to exit from the market (Table 3.3). As for the commercial large-scale aeroengine market, the top three manufacturers – General Electric, United U.S.A. 1994

1995

1996

1997

1998

Acquired Rockwell's aerospace and defense department in Dec., 1996

1999

2000

2001

2002

SBS Int'l

Boeing Rockwell McDonnell Douglas

Boeing Completed merging with MDC on Aug. 1, 1997

Sold arms dept. to GD

Sold commercial helicopter dept. in Jan.,1999 Acquired Hughes' satellite manufacturing dept. in Oct., 2000 Acquired Jeppesen of flight info services in Oct., 2000

Hughes Space & Communications Jeppesen Galaxy Aircraft

Acquired Galaxy Aircraft in May, 2001 Acquired Gulfstream in Jul., 1999

Gulfstream General Dynamics

Sold IMP Corp to software company in Jul., 2001

Sold combat planes dept. in Aug., 1994

Lockheed

Lockheed Martin

Merges in March, 1995

Acquired Loral in April., 1996 Sold aero-electronics systems dept. to BAE Systems in Jul., 2000

Martin Marietta Loral TRW

Agreement for Northrop to buy TRW was made on Jul., 2002

Merged in May, 1994 Northrop Grumman

General Dynamics

Acquired on Aug., 1994

Vought Aircraft

Acquired defense and electronics dept. in Mar., 1996

Westinghouse Electric

Sold commercial aero structure dept. to Carlyle Group in Aug., 2000. Went back to its original name Vought.

Northrop Grumman

Vought Aircraft

Acquired Litton in April, 2001 Litton Industries Acquired Newport News of the U.S. in Nov., 2001

Newport News Shipbuilding

Fairchild Dornier

Fairchild Aerospace Dornier Acquired Dornier from Daimler-Bentz

Acquired by CD&R (inverstment group) in April 2000

Figure 3.7 Recent restructuring of the aircraft industry Source: JADC (2003): VIII–15–16

Filed the bankruptcy in April 2002

58 The Challenges of Late Industrialization Europe 1994

1995

1996

1997

1998

1999

2000

2001

2002

Withdrew from regional jet in 1999

Saab (Sweden)

Saab (Sweden) Nov. 2001: Announced the end of regional jet production

Acquired 35% shares from Saab AB in June, 1998 BAe (U.K.)

BAE Systems (U.K.)

GEC's defense electronics dept and Marconi Electric Systems completed merging in Dec., 1999, and became BAE Systems

Marconi Electric Systems (U.K.)

Acquired Lockheed Martin's aeroelectronics systems dept in Jul., 2000

Airbus Industrie (France, Germany, U.K., Spain) Matra Hautes Technologies (France)

20%

Airbus Industrie was founded in Jul., 2001

Airbus SAS (France) 80%

Merged with Lagardere Group's Matra Hautes Technologies and was privatised in June, 1999, and became Aerospaciale Matra

Aerospatiale (France)

EADS was founded on Jul 10, 2001

EADS NV (Netherlands)

DASA (Germany)

CASA (Spain)

Figure 3.7 (Continued)

Table 3.3 Market shares in the commercial aircraft industry (% of total ordered unit) 1990

2004

Medium-Large Jet

Boeing Airbus McDonnell

60 25 15

Boeing Airbus

40 60

Regional Jet

Fokker British Aerospace Bombardie

48 31 21

Bombardie Embraer Fairchild

53 45 2

Source: JADC (2005: II-3–4; II-19–20)

Technologies and Rolls Royce – account for more than 60% of the total market (Society of Japanese Aerospace Companies 2002b: 76).

3.2.1.1

Driving Forces for Market Consolidation

There are a number of forces driving the industry towards larger firm size and higher levels of market concentration. First of all, the cost of developing new aircraft is higher than for any other industrial goods because of its large scale and high technological complexity. As the technology becomes more advanced, and the scale of aircraft grows even larger, the development cost has risen exponentially. The development cost of the Douglas DC-8 (173 seats),


which was developed in the late 1950s, was estimated to be US$440 million (US$2.6 million per seat) in current price. But that of the Boeing B777 (375 seats), which was developed in the early 1990s, jumped to about US$4,800 million (US$12.7 million per seat) (Table 3.4). That of the Airbus A380 (550–650 seats), a super-jumbo expected to enter service in 2006, is estimated to be around US$10.7 billion. At the same time, to keep abreast of rapid technological progress, the system integrators in the aerospace industry must maintain a high level of intra-firm R&D investment. As Table 3.5 shows, the top system integrators spent more than US$1 billion (in current price) on R&D in 2004. Such large development costs of new aircraft and the R&D investment involved

Table 3.4 Development costs of new aircraft (in current price) Aircraft

DC-8 (−50) A300 (B2/B4) B767 (−200) B777 (−200) A380(−800)

Number of seats1

Year entering service

Development cost2 (US$ million)

173 267 216 375 555

1959 1974 1982 1995 (2006)

440 263 1,700 [6.5] 2,100 [9.8] 4,800 [12.7] 10,700 [19.3]

Notes: 1 This number of seats applies to two-class configuration 2 Current value 3 Development cost per seat Source: JADC (2003: VII-15); JADC (2005:VII-22); SJAC (2000b: 2)

Table 3.5 R&D investment by the leading system integrators and module system makers in the aerospace industry in 2004/05 fiscal year (in current price) Company EADS BAE Systems Finmeccanica Boeing Snecma (now part of SAFRAN) Lockheed Martin Honeywell Rolls-Royce

R&D spend ($ million) 3,119 2,131 1,976 1,879 1,025 962 917 541

Source: Financial Times (24 October 2005) ‘R&D Scoreboard 2005’

% of sales 72 122 193 36 111 27 36 47


make economies of scale in production a critical competitive advantage in the aircraft industry. This high cost and investment can only be recovered by achieving a large number of aircraft sold. Consequently, the market concentration inevitably narrows because the total aircraft market is only large enough to be shared among a few large firms. If the large volume of delivery by one aircraft manufacturer comprises a series of aircraft of different sizes and flight ranges, the economies of scale in production would coincide with the economies of scope in marketing, sales and after-sale service. Once the system integrators have established their marketing and after-sales service networks, they can diversify their product line-up with lower additional costs by using the same network. From the point of view of customers, economies of scope also emerge when there is compatibility among the product series offered by a certain manufacturer. The airline companies can save direct operational cost (DOC) if the spare parts or pilot and engineer training are compatible across the series of aircraft of different sizes and flight ranges. From the point of view of manufacturers; offering such diversified product series – a so-called ‘full product line’ – produces strong competitive advantages. Furthermore, the high development cost and large intra-firm investments have a long gestation period, as the product life cycle of an aircraft is much longer than that of other industrial goods. For example, compared to the aircraft’s product life cycle of over 20 years,16 that of the automobile is 3–4 years. Moreover, the aircraft market is extremely volatile because the demands for air travel (Revenue Passenger Miles: RPM), and in turn the demand for aircraft, are closely linked to the world economic trends (for example, GDP trends and exchange rates) and to the political environment (for example, war and terrorist threats). Only large firms with a strong financial base can withstand the long gestation period of large investments as well as the severe market volatility, and survive as lead firms in the aircraft industry. Finally, market consolidation has been led and strongly supported by the governments of major aerospace countries. In particular, the change in the US government’s attitudes towards anti-trust regulation accelerated the consolidation process in the aircraft industry during the 1990s. In 1993, Les Aspin, the then USA Defence Secretary, invited the executives of the biggest US defence and aerospace companies to dinner. He told his guests that there were too many players in the industry to enable full benefits to be gained from economies of scale and to undertake the necessary R&D to keep the industry advancing at the desired pace (Nolan 2001: 152). The event was known as the ‘Last Supper’.


Although the Pentagon blocked Lockheed Martin’s attempt to acquire Northrop Grumman in 1998, and the European Committee blocked GE’s attempted acquisition of Honeywell in 2001, the basic attitude of the anti-trust regulators seems to remain favourable to consolidation within their own domestic and regional markets. This is because the governments of both the USA and Europe have fully understood that the battlefield in the aircraft market exists at the global level, and that further consolidation at the domestic and regional levels might be necessary for their companies to survive.

3.2.1.2

Virtuous circle of competitive advantages

As the aircraft industry has become more concentrated, oligopolistic competition in the finished product market has become much greater. There are mainly three sources of competitive advantage in the finished product market for commercial aircraft: project launch competence product-related competence and market-related competence. Project launch competence enables a firm to take the initiative in launching the development project for a new aircraft. Taking the initiative at the project launch stage is the first step for a system integrator to establish itself as a lead firm in a GVC. Project launch competences include: 1) a strong financial base to tolerate the large burden of project costs; 2) skills to evaluate correctly the potential risk and expected return; and 3) a sufficiently good reputation and strong brand image to secure a sufficient number of the launch customers. The ‘launch customer’ is idiosyncratic to the aircraft industry, and refers to those airline companies which place orders for the new aircraft even before the project has been formally launched. For the manufacturers, it is necessary to secure sufficient launch customers to reduce the initial risk of the new project to a tolerable level.17 What this means is that a lead firm has to be already trusted by the airline companies for its reputation and brand from the very beginning of the new project. Secondly, to be competitive lead firms also need to have productrelated competences, consisting of 1) control over the key technologies, 2) economies of scale and of scope, and 3) project management skills, such as production planning and supplier (GVC) management. Finally, the market-related competences are represented by effective and efficient marketing, sales, and after-sales service networks. These three categories of competence together constitute the entry barriers against any latecomers attempting to catch up in the finished product market. Moreover, each type of competence interrelates systematically and creates a virtuous circle of competitive advantages (Figure 3.8). Project


Project launch competences • Strong financial base • Project evaluation skills • Reputation/branding

• Experience • Revenue

• Large and focused investments The ever-higher barriers to entry

Product-related competences

Market-related competences • Marketing and sales networks • After-sales service networks

• Low cost • Full product line-up

• Control over key technologies • Economies of scale and scope • Project management

Figure 3.8 The virtuous circle of entry barriers of the finished product market of the commercial aircraft industry

launch competences enable lead firms to invest in core competences and strategic activities on a large scale and in a clearly defined manner. The focused investments strengthen the lead firms’ control over key technologies and project management. The large-scale investments enable the lead firms to achieve economies of scale and scope. Such product-related competences reduce the production cost and expand the product lineup, which in turn strengthens the lead firms’ positions when it comes to market-related competences. Finally, a successful aircraft development project equips the lead firm with more experiences and greater financial revenue, which in turn strengthens their project launch competences.

3.2.1.3

The ever-higher barriers to entry for catch-up

Extreme market concentration on the global scale has left only a few large firms in the finished product market. As the firm size has enlarged, lead firms have employed ever-larger amounts of resources and capabilities throughout the virtuous circle of competitive advantages. In addition, due to the prevalence of strategic sourcing based on the concept of ‘core competence’, the lead firms have concentrated their investments on strengthening their control over core technologies and strategic activities. As a result, the fiercely oligopolistic competition in the finished product market has presented latecomers with ever-higher entry barriers for catch-up. Such a virtuous circle of competitive advantage also results in a Catch-22 dilemma for the latecomer firms. When trying to gain competitive advantage in the finished product market,


the latecomer firms need to have project launch competences in the first place. However, it is extremely difficult, if not impossible, for latecomer firms to evaluate the project risk accurately, or to gain the trust of airline companies, while lacking established experience and reputation as system integrators. Furthermore, governments play a critical role in enhancing their lead firms’ competitiveness, and in turn further raise the barriers to entry (Nolan 2001a: 174–6). There are mainly four sources of government support. First of all, the vast military procurement, particularly in the USA and Europe, has nurtured product-related competences in military aircraft manufacturing. Many important commercial aircraft products, including airframes, aero-engines and avionics, had their origins in military production. Also, since the aircraft companies usually undertake both commercial and military production, the military procurement contribution provides stability and solid financial foundation (that is, the product launch competence). Secondly, governmental export credit guarantees have played a vital role in promoting aircraft exports by European and USA manufacturers (that is, enhancing the market-related competence). Also, the national government might put the pressure on domestic airline companies to buy the indigenously produced aircraft instead of importing foreignmade ones. This could be a very effective industrial policy for a country with a large potential domestic flight market – such as Japan or China – to nurture the indigenous aircraft industry. Thirdly, some governments in advanced economies, notably Britain, have provided launch aid for a new development project (that is, enhancing the project launch competence). Launch aid constitutes a risksharing, success-conditional, long-term loan, to be repaid at an agreed rate when sales pass a certain point, but non-repayable if the project fails. Finally, governments of all advanced economies carry out the large spending to support the R&D activities, much of it emanating from military expenditure. The aircraft industry has consistently been one of the main recipients of government support for R&D (that is, enhancing the product-related competences). In short, such government support for the aircraft industry creates formidable barriers to entry for latecomer firms if their governments cannot meet such expenditure. It seems that the catch-up FLI strategy has become harder than ever, if not impossible, as a result of global shifts in the aircraft industry. It is not illogical that a latecomer firm might be able to overcome the barriers to entry at some time if its government were to provide effective, large-scale and long-term support to develop and nurture the three types


of competences. However, the scale of resource needed and the risk of failure entailed in such massive government support have been inflating remorselessly. One industry report estimates that even an aggressive and well-financed competitor would need 23 years to attain a business position alongside the incumbents in the finished product market; they conclude that the aircraft industry is the most difficult in which to succeed with catch-up among all the major global industries (Morgan Stanley Dean Witter 1998: 6).

3.2.2

Globalization of the intermediate goods market

While the aircraft’s finished product market has consolidated, the intermediate goods market has also transformed in nature. The recent transformation of the intermediate goods market of the aircraft industry has shown the typical trends of globalization. According to the often-quoted definition by McGrew (1992), the globalization process can be identified by two following general phenomena: Globalisation has two distinct phenomena: scope (or stretching) and intensity (or deepening). On the one hand, it defines a set of processes which embrace most of the globe or which operate worldwide On the other hand it also implies an intensification of the levels of interaction, interconnectedness or interdependence between the states and societies which constitute the world community. (McGrew 1992: 23) Although ‘globalization’ is an elusive term due to its multi-disciplinary concept, which encompasses politics, sociology, economics, business and anthropology, as discussed earlier, McGrew’s definition of the globalization process quoted above is still useful as a focusing tool to understand the dynamics of the intermediate goods market in the aircraft industry. Applying the above general definition, the globalization process of the intermediate goods market could be illustrated by the following three phenomena. Firstly, the scope and scale of aircraft value-chains have expanded, as they have come to involve more suppliers located away from the major aircraft manufacturing countries. Secondly, the intermediate goods market has deepened, as some suppliers have come to play a more significant role in the value-chain both technically and financially. Thirdly, the level of interaction, interconnectedness or interdependence between actors of value-chains has intensified, as the system integrators adopt ‘lean’ production principles in value-chain management by making best use of fast-advancing IT systems.


Stretching. First of all, in regard to the geographical scope, the aircraft’s value-chains stretch out into a truly global-wide dimension. Airbus Industrie, for instance, has more than 1,500 suppliers in 27 countries, including over 500 US companies, and suppliers in Singapore, India, Australia, Indonesia, Korea, Japan and China among others (Nolan 2001a: 145). Boeing’s supply chain is even more massive and global. It comprised more than 13,000 suppliers (7,650 production suppliers and 5,441 non-production suppliers) in 2001 located on every continent (Morris 2002). From the latecomers’ point of view, as the aircraft valuechain extends globally, they would have greater opportunities to be involved in the value-chains and to become supplier of intermediate goods even though they are located away from the major system integrators’ bases. The scale of the intermediate goods market has also enlarged internationally. Table 3.6 indicates that the major aircraft manufacturing countries, in which most system integrators are located, have rapidly increased their imports of aerospace parts in total and particularly from latecomers: for 66% and 116% respectively between 1995 and 2000. Also, the latecomers’ share has risen from 25% to 32% during the same period.

Table 3.6 Aerospace parts1 imports by the major aircraft manufacturing countries ($ million) Origins

USA France UK Germany Spain Total

1995

2000

World

Latecomers2

2,592 3,052 2,756 1,183 296 9,879

1,766 484 n/a 186 42 2,4783

World 5,354 4,925 3,609 2,189 358 16,435

Latecomers2 3,617 1,313 n/a 371 54 5,3553

Notes: 1 The data of aircraft parts are based on the Standard International Trade Classification system, Revision 3 (SITC, Rev.3). Aerospace parts are categorized in STIC 792.9, which includes parts of aircraft and associated equipment; spacecraft (including satellites) and spacecraft launch vehicles; parts thereof. It does not include tyres, engines and electrical parts. 2 Latecomers refer to all countries other than the five major aircraft countries listed here 3 This value does not include the imports by the United Kingdom due to lack of data Source: Computed from United Nations COMTRADE database


It is noteworthy here that the aircraft industry historically has not been characterized by high levels of foreign direct investment of transnational corporate organization. This is because the industry’s high level for a minimum critical scale is large relative to the size of the world market. Additionally the need for strong plant-specific learning and cost reduction factors, may incur prohibitive cost penalties in establishing multiple facilities for offshore production (Mowery 1987: 11). Thus, the large proportion of aircraft part imports shown in Table 3.6 can be considered not to result from ‘international production’, that is intra-firm trade within transnational corporations, but rather as a result of ‘global sourcing’, that is transactions between independent firms located in different countries (Levy and Dunning 1993: 14). This seems to further imply that the indigenous aircraft firms of latecomer countries have been entering the expanding market as global suppliers.

Deepening. Secondly, the intermediate goods market has deepened, as the system integrators have begun to outsource larger components and higher value-added functions to selected suppliers. It is extremely difficult to elucidate such a deepening process quantitatively due to its qualitative nature. One way to follow the process can be to focus on the increase in ‘significant suppliers’. For the purpose of this study, a significant supplier is here defined as a dependent firm with high status in a GVC. It undertakes not only manufacturing, but also design and sometimes even marketing and co-financing in the development/production project of new aircraft. In particular, such significant suppliers are apparent in the so-called international collaboration project (ICP), which has become a popular organizational framework to develop and manufacture new aircraft and aero-engines. It is now common for the system integrators to select project partners, with whom they create significant levels of inter-firm cooperation in research, design, production and marketing. They also expect significant contribution by all partners in the form of development funds or risk capital (Mowery 1987: 3). There are two types of partners in the ICP: a ‘programme participant’ and a ‘programme partner’. They differ in their scope of activities, the scale of risk burden,18 the payment method, and the contractual period. The ICP partners are also termed ‘risk-sharing partners’ or ‘risk and revenue sharing partners’, depending on whether the payment method is linked to the overall project revenue. The different types of ICP partner are summarized in Table 3.7, which is also related to the generic category of productive actors developed in Table 3.1.

Changing Context of Late Industrialization 67 Table 3.7 Various partners of an international collaboration project Generic Piece-part Terms Subcontractor Dependent Terms Firms in the ICPs

Sub-contractor

Sub-System Suppliers or Module System Makers

Participant

Partner

Programme Partner

Risk Sharing

Revenue Sharing

Risk Burdens

Tooling costs

Component development costs

Project level costs

Payment Methods

Fixed price

Fixed price linked to incurred tooling costs

Fixed price linked to incurred development costs

Flexible price linked to sales price

Contractual Period

Short-term

Long-term

Project life

Revenue sharing based on assessed value-added shares

Source: Field interviews; see Table 3.1

All major system integrators of airframe production have pursued international collaboration since the 1980s. Airbus Industrie is itself an international collaboration of the ‘national champions’ in Europe: the United Kingdom, Germany, France and Spain. Boeing also pursued international collaboration for their large aircraft (over 200 seats) projects. Boeing’s international collaboration emerged out of international subcontracting relationships that began with the fabrication of components for the B747. A consortium of the Japanese aircraft firms has developed into the most important partner of Boeing’s international collaboration in the B767 and B777 projects, as will be discussed in detail for a case study in Chapter 5. Conversely, McDonnell-Douglas largely failed to establish effective international collaboration as the result of a series of unsuccessful attempts at collaboration with European aerospace firms.19 Also in the regional jet market, both Bombardier and Embraer are active in establishing effective international collaboration. The number of significant suppliers has also risen outside the organizational framework of international collaboration. They mainly include the sub-system suppliers, who carry out not only manufacturing but also the detailed design of supplying components. In the case of Boeing, the number of such sub-system suppliers increased from five for the B747 project in the 1960s to 15 for the B717 in the late 1990s (Table 3.8). Airbus is recently even more proactive in raising the number

68 The Challenges of Late Industrialization Table 3.8 The number of ‘significant’ suppliers in selected commercial aircraft

Boeing

Airbus Bombardier Embraer

B747 B767 B777 B717 A330/340 A380 CRJ-700 ERJ-170

Year of first flight

International collaboration partners

1969 1981 1994 1998 1992 (2005) 1999 2002

0 3 4 0 4 21 13 13

Sub-system suppliers* 5 11 14 15 4 35

Note: * It does not include the aero-engine makers Source: JADC (2005): VIII-20–23

of significant suppliers, both international collaboration partners and sub-system suppliers. There were only four international collaboration partners and four sub-system suppliers for the A330/340 project in the early 1990s, but Airbus have already contracted 21 international collaboration partners and 35 sub-system suppliers (as of September 2002) for the new A380 project. What should be emphasized here is that the expanding scale and scope of the intermediate goods market as well as the increasing number of significant suppliers indicates that more opportunities are now available for latecomer firms to upgrade themselves towards the higher level of suppliers in the aircraft industry.

3.2.2.1 Driving Forces for Globalization of the Intermediate Goods Market One of the driving forces behind the expanding scope/scale and the deepening of the intermediate goods market is the system integrators’ motives for sourcing. There are mainly three motives for system integrators to source an increasing number of components and higher valueadded functions from latecomer firms: (1) access to market, (2) access to technology, and (3) access to capital (Mowery 1999; Radosevic 1999). For instance, Boeing effectively combines all these motives in sourcing from Japanese firms. Boeing has succeeded in dominating the Japanese finished product market, in all probability due to the close relationships with they have established with Japanese manufacturers, bureaucrats and politicians, through long sourcing experience. Boeing has also been successful in transferring a significant amount of risk to the Japanese ‘risk-sharing partners’, who are subsidised with cheap capital from the government. Finally, Boeing learned efficient manufacturing process technologies from the Japanese suppliers, as will be further discussed below.


The second major driving force is the development of strategic management thinking about ‘core competence’. The logic of this is that the lead firms should concentrate on those resources which they possess which are relatively unique, provide a valuable service to customers and which are difficult to replicate, and that they should outsource the remaining competences to other firms in the value chain (Prahalad and Hamel 1990; Kaplinsky and Morris 2000: 10). Facing ever-fiercer global competition and technological complexities, Boeing, again, is deliberately focusing on the strategic functions, such as product definition and marketing, while being willing to outsource the manufacturing functions. The rapid advancement of information technologies is another important driver of globalization in the intermediate goods market. System integrators can now integrate very closely with their first-tier suppliers in globally diverse locations, working on their basic design and project planning through EDI (electronic data interchange), which brings about an increasingly detailed, instantaneous exchange of information.20 In addition to the driving forces mentioned above, the system integrators also face increasing cost pressures from customers. In particular, deregulation of the airline industry was initiated by US with the Airline Deregulation Acts of 1978, and was spread to Europe in 1988 with ‘Package 1’ as well as to Australia, Korea and China among others in the 1990s. Such deregulation has led to severe airline competition, and in turn compelled airlines to put great cost pressure on the aircraft producers. Consequently, the definitions of ‘good’ aircraft by airline companies have changed from solely technological superiority towards the low unit price of aircraft and low direct operation cost (DOC) with reliable safety.21 In such a market environment, pursuing a ‘good’ aircraft, the makers have little choice but to aggressively reorient the production approach from the technology-oriented towards the customer-oriented. More specifically, to achieve cost reduction and a shorter production cycle, they have come to seek out systemic efficiencies in the value-chain as a whole by adopting the ‘lean’ production principles pioneered by Toyota. Thus, it finally brings us to the third phenomenon of globalization of the intermediate goods market: that is the intensification of the level of interaction, interconnectedness or interdependence between the different actors throughout the value-chains.

3.2.2.2

Intensification: the rise of the ‘lean’ global value-chain

The aircraft makers have tried assiduously to adopt the lean production principles from the automobile industry since low cost became


the crucial source of competitive advantage in the aircraft industry in the early 1990s. Lean production principles involve eliminating unnecessary steps, aligning all the steps in an activity in a continuous flow, recombining labour into cross-functional teams dedicated to that activity, and continually striving for improvement. Applying these principles, companies can develop, produce and distribute products with less human effort, space and time, and fewer tools and overall expense inputs (Womack and Jones 1994: 93). For example, as will be discussed in Chapter 5, Boeing has been extremely enthusiastic in creating a lean value-chain on the global scale under slogans, such as ‘working together’ and ‘global lean enterprise’, where engineering, production and supplier management are to be aligned and globalized (Morris 2002). Originally developed to further in-plant efficiency in the automobile industry, it soon became apparent that the benefits of adopting the lean principles would be limited unless the various tiers of component suppliers also adopted similar practices throughout the value-chain. Thus, the system integrators of a lean value-chain decided to promote systemic (or collective) competitiveness throughout the value-chain, on the one hand, by intensifying the level of interaction with its first-tier suppliers through making the best use of the advancing information technologies; on the other hand, they also synchronized the activities at the various links in the value chain by ensuring that the firsttier suppliers adopted similar processes throughout the supply chain (Kaplinsky and Morris 2000: 10; UNCTAD 2002: 121). Consequently, adopting the lean value-chain has intensified the level of inter-firm linkages throughout the supplier system. The rise of the lean value-chain has further involved the overall restructuring of the supplier system and particularly the inter-firm relations between the system integrators and the first-tier suppliers (Watkins 1999; Society of Japanese Aerospace Companies 2000b). First of all, the system integrators tend to align closely with a smaller number of ‘significant’ suppliers, with whom they develop partnership-style relationships through intensive, collaborative and long-term interactions.22 The system integrators are trying to identify such significant suppliers – so-called the ‘centers of excellence’ – who, they believe, are capable of taking on greater responsibilities in production and risk sharing. Secondly, the system integrators tend to delegate to a smaller number of significant suppliers larger bundles of goods and services. They expect those suppliers to undertake R&D, design, assembly and input procurements at the sub-system or the modular system levels, as long as the sourcing components are confined to non-strategic technologies or


functions. Finally, the stratification of the supply chain increases as the system integrators gradually delegate to suppliers the responsibility for managing lower-tier suppliers of components and raw materials. Boeing, for instance, reduced the number of suppliers from over 30,000 in 1998 to around 13,000 in 2001, and expects to further reduce to around 10,000 in 2004 (Morris 2002). There are around 3,500 suppliers for Boeing’s commercial sector. Among them, only 250 suppliers account for 80% of the total value of Boeing’s sourcing (Society of Japanese Aerospace Companies 2000b: 15). Boeing benefits from working closely with a smaller number of significant suppliers by optimizing planning and spreading risk. It also gains economies through large volume purchase and through obtaining better quality inputs and faster R&D. This trend to a lean form of GVC can be observed in many globalizing industries. It has been initiated and most advanced in the automobile industry, and adopted by many other industries – for example, the soft drink industry – in the last couple of decades (Nolan 1999: 45).

3.2.2.3

New opportunities and challenges for upgrading

Returning to the context of firm-based late industrialization, the globalization of the intermediate goods market presents new opportunities as well as new challenges for those pursuing an upgrading strategy. The expanding scale and scope of the intermediate goods market have opened routes for latecomer firms to enter the global value-chain as international suppliers even though they may be located far from the system integrators. The deepening of intermediate goods market implies that the latecomer firms would have more scope to upgrade their supplying activities and functions within the global value-chain by becoming ‘significant’ suppliers. Therefore, the globalization of the intermediate goods market has opened ‘windows of opportunities’ for those relying on the upgrading strategies for FLI. However, the globalization of the intermediate goods market has also created some new hurdles, which the latecomer firms now have to overcome in order to upgrade themselves to become significant suppliers. Although the aggregate size of the intermediate goods market has increased, competition among suppliers to upgrade or even simply to retain their positions and status within the value-chain has been exacerbated as the result of the system integrators reduction of their supplier bases. More specifically, to be selected as significant suppliers in the ‘lean’ global value-chain, the suppliers are obliged to strengthen their financial base to be able to share the development risk with the system


integrators. They also have to build the competencies in electronic data interchange links, lower-tier supplier management, and module/subsystem integration in addition to the wider scope of competence, such as component design and testing (Ingersoll Engineers 1994). In order to meet these financial and competence requirements, subsystem suppliers have recently tried to expand their businesses mainly relying on mergers and acquisitions (Nolan 2001a: 103). They are striving to attain sufficient scale and scope to produce and integrate ever-larger bundles of goods and services. In other words, the intensifying competition in the intermediate goods market has created a similar environment to the finished product market in experiencing greater consolidation. Medium-scale M&A (50–150 million dollars) in the global aircraft industry, which largely influences the intermediate goods market, jumped from 15 transactions in 1995 to 53 in 1998 (Society of Japanese Aerospace Companies 2000b 27). Such a trend is most apparent in the avionics, landing gear and auxiliary power unit (APU)/electrical systems.23 In sum, the globalization of the intermediate goods market has had a mixed impact for the prospects of the upgrading strategy. The expansion and deepening of the market has created more opportunities for latecomer firms to upgrade within the global value chain. However, to take advantage of those opportunities, the latecomers should already have the large scale of capital resource and a high level of technological, marketing, and manufacturing capability.

3.3 An overview of the post-war development of the Japanese aircraft industry We have thus far expatiated the two strategies for firm-based late industrialization in addition to examining how the global shifts in the commercial aircraft industry have affected the respective contexts of catch-up and upgrading. We now turn to a brief review of how successful the Japanese aircraft industry has been in achieving FLI in the post-war era. Various commentators have repeatedly called down its post-war experience as one of a few failing cases of Japan’s attempt in late industrialization.24 Indeed, Japan has largely failed to implement catch-up FLI strategy. As mentioned earlier, the success or failure of the catch-up strategy can be assessed in relative terms, that is, in comparison to the forerunners’ performance. As Table 3.9 shows, the scale of the Japanese aircraft industry is much smaller than that of the leading countries in the industry. For instance, Japan’s total aircraft sales and

Changing Context of Late Industrialization 73 Table 3.9 International comparisons of the aerospace industry (2000)

USA (Aircraft only) UK France Japan (Aircraft only) Germany Canada Brazil (Embraer)

Sales (billion US$)

Contribution to GDP (%)

Employees (thousand)

1462 821 276 226 127 92 125 125 29

148 082 193 174 027 019 067 176 na

800 (465) 151 99 32 (25) 62 83 na

Military demand (% of total sales) na (41) 46 24 na (63) 22 19∗ na

Note: * Data in 1998 Source: SJAC (2002b: 6); Flight International, 21 August 2001: 46

workforce are about one-seventh and one-eighteenth respectively of that of the United States in 2001. Also at the firm level, unlike the wellpublicized stories of its steel, shipbuilding, automotive and electronic manufactures, Japanese aircraft manufacturers25 have failed to become leading competitors in the international market. In 2001, the sum total of aerospace sales of the four major Japanese aircraft manufacturers, that is, Mitsubishi Heavy Industries (MHI), Kawasaki Heavy Industries (KHI), Fuji Heavy Industries (FHI), and Ishikawajima Harima Heavy Industries (IHI) reached only 14 per cent of that of Boeing (Table 3.10). Japanese aircraft manufacturers have not been able to gain a competitive position in the world aircraft market, as have Toyota or Sony in their respective sectors. However, the Japanese aircraft firms have successfully upgraded their status as global suppliers. As mentioned earlier, the success or failure of the upgrading strategy can be assessed in absolute terms both quantitatively – for example, by total production or labour productivity – and qualitatively – for example, by the technological level and the scope/depth of competences implanted in the supplier activities. As for the Japanese aircraft industry as a whole, its total production has increased twenty fold from 55 billion yen to over 1 trillion yen (in current price) between 1965 and 2001 (Figure 3.9). The industry’s dependency ratio on military procurement has also been gradually decreased from it peak of near 80 per cent in the late 1970s to less than 60 per cent in 2001.

74

Table 3.10 Top ranking of the aerospace companies (2001) Company (country) division [% of total sales] 1

2 3 4

5 6 7 8 9 10

Aero sales (mil$)

Total sales (mil$)

Employees (1000)

R&D (mil$)

57,871

58,194 35,056

1869

1,936 858

28,599

27,572 18,397 23,990 18,922 4,351

1030 455 1250 7277

1,832 1,459 607 1,432

16,867 27,897 7,679 13,558

872 1520

475 1254

968

342

125,913 11,389 23,652 9,653 13,966 7,774

219

2,349

1150

832

324

151

639 76 11,048 243 51 292 54 265 26

831∗

Boeing (USA) Commercial Airplanes [60.2%] EADS (Netherlands) Airbus [66.7%] Lockheed Martin (USA) BAE Systems (UK) Commercial Aerospace [23.0%] Raytheon (USA) United Technologies (USA) Engines [27.5%] Northrop Grumman (USA) General Electric (USA) Engines [9.0%] Honeywell Int’l (USA) Aerospace Solutions [40.8%] Bombardier (Canada) Aerospace [55.7%]

23,968 20,264

15,462 12,971 11,458 11,389 9,653 7,774

··· 19 22 31 34 61 89

Mitsubishi Heavy Ind. (Japan) Aerospace Systems [16.5%] Embraer (Brazil) Ishikawajima-Harima (Japan) Aero-Engines [21.5%] Kawasaki Heavy Ind. (Japan) Aerospace [20.4%] Fuji Heavy Ind. (Japan) Aerospace [4.8%] Nippon Aircraft Manufact. (Japan)

3,883 2,897 1,916 1,779 546 252

23,560 3,883 2,897 8,905 1,916 8,724 1,779 11,209 546 227

127 209 162 434

Notes: ‘Aero Sales’ refers to aerospace division’s sales for 2001 fiscal year, including aircraft, aero-engine, avionics, missiles, space and aero structures. The top line of financial figures refers to consolidated results for the overall group, including non-aerospace business. The divisional figures are for those businesses that are fully or largely concerned with commercial aerospace. ∗ The figure for 2000. Sources: Flight International, ‘Aerospace Top 100’, 13 August 2002, 36–53; Nihon Keizai Shinbunsha (2001) 2002 Nendo Kaisha Nenkan (Japanese Company Yearbook 2002)

Changing Context of Late Industrialization 75 1,100 100

1,000 900

Total production (bil yen)

700 Military demand ratio

600

60

500 Total production (left)

400

40

Military demand ratio (%)

80

800

300 20

200 100 Export 0 1965

0 1970

1975

1980

1985

1990

1995

2000

Figure 3.9 Total production, exports and military dependency of the Japanese aircraft industry Source: SJAC (various years) K¯ok¯ u Uch¯u K¯ogy¯o Nenkan (The Aerospace Industry Yearbook) Original Source: Research Institute of Economy, Trade and Industry, Kikai T¯okei Nenp¯o (Manufacturing Statistics Yearbook)

At the same time, the Japanese aircraft manufacturers have upgraded their supplier status incrementally. In the airframe sub-industry, for instance, the Japanese manufacturers started their supplier activities as piece-part subcontractors for Boeing’s B747 in the late 1960s. They have expanded the scale and upgraded their activities throughout the 1970s and 1980s. In particular, Japanese aircraft firms have become single source sub-system suppliers for the B767 and B777 undertaking the detailed design and manufacturing for most of the fuselage and a part of wing. Such upgrading of supplier activities can also be illustrated by the steady increase of total production as well as the rise of capital intensity and the value-added per labour scale in major Japanese aircraft manufacturers (Figure 3.10). It seems safe to conclude that the Japanese aircraft firms and industry as a whole have succeeded in upgrading their scale and quality throughout the post-war era. Moreover, a larger picture of Japanese post-war FLI can be attained when it is compared with those of other latecomers, such as Brazil, China, Indonesia, Korea and Taiwan.26 Those latecomers have aggressively tried to nurture the indigenous aircraft industry as a ‘strategic industry’ both for national security reasons and for advancing to

76 The Challenges of Late Industrialization 20 Value-added per employee (left) Capital intensity of labour (left)

Value-adding per employee (mil yen)

18 16 14 12 10 8 6 4 2 0 1965

1970

1975

1980

1985

1990

1995

2000

Figure 3.10 Productivity of aerospace divisions of the major Japanese aerospace companies∗ Notes: Includes the eight major Japanese aerospace companies MHI, IHI, KHI, FHI, Nippi, JAMCO, ShinMeiwa, and Showa Aircraft (Value-adding per employee) = (Capital intensity of labour) × (capital productivity) Sources: SJAC (various years) K¯ok¯ u Uch¯u K¯ogy¯o Nenkan (The Aerospace Industry Yearbook)

the higher level of industrialization. In particular, China has aggressively tried to nurture an indigenous aircraft industry, whose scale is much larger than Japan.27 However, apart from the impressive success of Embraer of Brazil within the niche regional jet airliner market, no aircraft company from the latecomer countries has succeeded in catching up in any significant way. Meanwhile, China’s, Korea’s and Indonesia’s records in upgrading to become global suppliers has been extremely limited compared to that of Japan (Table 3.11). Their supplier status has mainly stagnated at the level of piece-part subcontractor or sub-system supplier with no design or finance function. One might draw two inferences in relation to the changing context of firm-based late industrialization. One is that catch-up FLI strategy seems next to impossible in the aircraft industry of the twenty-first century, while it is extremely difficult, if not possible, to create a niche market. It is also clear that Japan has taken the greatest advantage of the globalization of the intermediate goods market. Japanese aircraft manufacturers have long been stigmatized for demonstrating a case of regrettable failure

Changing Context of Late Industrialization 77 Table 3.11 Aircraft parts exports from selected latecomers∗∗∗ ($ million)

Japan China Korea Indonesia

1988

1990

1995

2754

4176 949∗ 1634 144

5730 1,484.5 619 3700 2083 1977 300∗∗ 170

504

2000

2001 1,702.9 3452 2299 184

Notes: ∗ The value of year 1992 ∗∗ This is the value of 1996 as the data for 1995 is not available ∗∗∗ Taiwan, Province of China, is not included here because it is not an official member state of the United Nations. For political reasons this UN database is not allowed to show Taiwan as a reporting entity. Source: United Nations COMTRADE database

in Japan’s impressive post-war industrialization. However, instead the post-war upgrading of the Japanese aircraft manufacturers should be admitted as a successful case of FLI in the global business transformation. It therefore presents an ideal example of how latecomer firms may seize emerging opportunities to upgrade in the fast globalizing commercial aircraft industry. In the empirical part of this study, we will carry out in-depth case studies of Japan’s post-war FLI in commercial aircraft production.

3.4

Concluding remarks

The commercial aircraft industry has been undergoing a drastic business transformation on a global scale. Facing ever-fiercer global competition and technological complexity in the commercial aircraft market, the lead firms have strengthened their competences in strategic activities through organic growth as well as M&A. This has given rise to extreme market consolidation and intensified the oligopolistic competition. Meanwhile, the lead firms have increased their outsourcing of non-strategic activities on a global scale. The globalization of the intermediate goods market has expanded, deepened and intensified the scope of global sourcing. These global business transformations have also changed the context of firm-based late industrialization. On the one hand, the extreme market consolidation has raised the barriers of entry to the finished product market in a self-perpetuating manner. The ever-fiercer oligopolistic competition has made it remorselessly more difficult, if not impossible, for a latecomer firm to succeed through catch-up FLI


strategy – that is, endeavouring to gain a systemic advantage in the finished product market. On the other hand, globalization of the intermediate goods market has increased opportunities for high valueadded sourcing activities. The rise of global sourcing has thus opened windows of opportunity for latecomer firms to achieve the upgrading FLI strategy – that is, incrementally upgrading their supplier status as a dependent firm in a GVC. However, a latecomer firm would be able to take advantage of such windows of opportunity only if it has a sufficient level of competence for responding quickly and flexibly to the lead firm’s needs within the ‘lean’ global value chain. Therefore, the global business transformations in the commercial aircraft industry have shifted the context of FLI towards one in which an upgrading FLI strategy would have a greater prospect of success than a catch-up FLI strategy. Given those contextual changes in FLI, the impressive post-war development of the Japanese commercial aircraft industry may be judged a successful case of seizing emerging opportunities for upgrading FLI in a GVC. All these phenomena seem to indicate that any latecomer firms that are eager to achieve FLI in the commercial aircraft industry should acquire a comprehensive understanding of the process of and examine the determinants for upgrading FLI.

4 Upgrading in Global Value Chains: Analytical Framework

This chapter develops the analytical framework for understanding how and why a latecomer firm in a global industry – particularly, the commercial aircraft industry – could upgrade its status as a dependent firm in a GVC. In the preceding chapter, we tried to show that the recent global business transformations have opened the ‘window of opportunity’ for the upgrading firm-based late industrialization (FLI) strategy. More specifically, by taking advantage of the globalization of the intermediate goods market, a latecomer firm might be able to incrementally enlarge the scale and scope of its supplier activities. In so doing, the latecomer firm could in turn generate and capture a higher value-added role and consequentially stronger bargaining power within the GVC, and ultimately to contribute to the overall industrial development at national level – that is, achieving FLI. However, as we can see from the literature review in Chapter 2, the traditional literature on late industrialization largely confines its analysis to ‘catch-up’ rather than the ‘upgrading’ process of FLI. The process of upgrading FLI has only been presented anecdotally, but the detailed analysis of the process is almost non-existent either theoretically or empirically. Only the global value chain (GVC) perspective sheds light on the upgrading process. However, the GVC perspective largely fails to provide analytical insights into the underlying factors of the upgrading process. In particular, the GVC perspective is not sufficiently profound to deal with critical issues, such as how and why a latecomer firm may (or may not) upgrade within a GVC. Filling this critical void in the literature on late industrialization is the main purpose of this chapter on analytical framework and the following chapter that incorporates a case study of post-war Japanese commercial aircraft production. 79


In order to obtain an analytical understanding of the upgrading process, we should first reaffirm the significance of the fact that a dependent firm, which is a main actor in the process, has an inferior power relation to the lead firm of a GVC. We have already explained the causes of such asymmetric power relations in a GVC in the preceding chapter. Then, how does the lead firm exert its superior power in order to control the dependent firm? Indeed, the answer to this question leads to the core issue in the GVC perspective, which underlines the lead firm’s control over the dependent firms in such a way as to align them closely with its own business needs. What should be noted here is that the lead firm’s control largely extends beyond the legal boundaries of the firm in the GVC. The rise of strategic sourcing and of the ‘lean’ global value chain has raised deep issues concerning the nature of the firm as well as of industrial organization. It has created a ‘stark social division of labour’ among the legally independent firms between the ‘activities related to product definition’ (that is, design and marketing), and ‘activities related to production’ (that is, process development and manufacturing) (Sturgeon 2000). These legally independent firms are dispersed globally while their activities are functionally integrated and coordinated by the lead firms in the non-arm’s length hierarchical relationship. In other words, all production activities in a GVC are coordinated and controlled by lead firms in a network form of industrial organization.1 Hence, the command structure in a GVC differs from that of traditional international production, which is usually organized by the common ownership and control structure of transnational corporations.2 In this chapter, therefore, we propose an analytical framework for understanding the underlying factors of the upgrading process. Our analytical framework takes into account the various forces inside, outside and across the boundaries of the firms, which would affect the upgrading of the dependent firm in the GVC. The first section elaborates the upgrading process as the ‘controlled’ growth of the dependent firm, whose domains of activities and learning are controlled by the lead firms. The second section narrows its analytical focus to concentrate on the individual upgrading process of a particular dependent firm. Drawing on the multi-disciplinary literature as well as the in-depth case studies on the post-war development of the Japanese aircraft manufacturers that will be put forward in Chapter 5, our analytical framework identifies the three important determinants for a particular dependent firm to upgrade its position in a GVC. The final section looks into the interactions between those determinants, which systemically create the

Upgrading in Global Value Chains: Analytical Framework 81

forces that shape the prospects for successful upgrading by a particular dependent firm in a GVC.

4.1 The upgrading process: the ‘controlled’ growth of the dependent firm in a GVC According to the mechanism of the FLI illustrated in Figure 3.5, we can identify the very origin of the upgrading process as the learning by a dependent firm,3 in which it acquires and adapts its competences over a period of time in order to carry out higher value-added sourcing activities within a GVC (Dosi, Richard et al. 2000: 16). Having acquired the higher level of competences, the dependent firm may upgrade from the lowest-tier of supplier, that is, a piece-part subcontractor, towards the higher tiers; that is, a sub-system supplier, and further towards a module maker (See Figure 3.3). Then, what kinds of competences do the dependent firms have to learn for upgrading? What is the context in which the dependent firms may learn in a GVC? What must be emphasized in the analysis of the upgrading process in a GVC is that the lead firms try to control the growth of dependent firms such a way as to make it closely aligned with their sourcing strategies. Lead firms may do so by exerting what Susan Strange (1988) calls ‘structural power’ throughout the GVC – the power to decide how things shall be done in the GVC, or the power to determine the surrounding structure of the sourcing relationships in the GVC (Strange 1988: 25).4 More precisely in regard to the upgrading process, the lead firms exert the ‘structural power’ over the dependent firms by deciding ‘what’ and ‘what not’ the latter will do within the GVC, and thereby moulding and controlling the latter’s learning dimensions.

4.1.1

Learning dimensions in the upgrading process

Lead firms must make sure that the suppliers are sufficiently competent to meet their business needs effectively and efficiently. They thus decide what kinds of competence are required for selection for each supplier level. From the point of the view of the dependent firm, to achieve upgrading by being selected for the higher levels of supplier, they must advance through distinct learning phases, each with specific learning dimensions (Radosevic 1999: 217). In short, the lead firms set the specific learning dimensions for each level of supplier; while the dependent firms must achieve those learning dimensions in order to be selected as suppliers. Consequently, the lead firms control the rate and trajectory of

82 The Challenges of Late Industrialization Table 4.1 Learning dimensions in the upgrading process Targeted level of suppliers

Learning dimensions

(1) Piece-part Subcontractor

QCD for ‘drawing-supplied’ manufacturing Value engineering (VE) / Value Analysis (VA) QCD for detailed component design, manufacturing and assembly Relation-specific skill with lead firms All product-related competences at module level Supplier management in a module value chain

(2) Sub-system Supplier

(3) Module Maker

growth of dependent firms by setting learning dimensions for each stage of the upgrading process. Table 4.1 summarizes the learning dimensions of the three major stages in the upgrading process (also refer to section 3.1.2.2 and Table 3.1). (1) To begin with the lowest status of supplier, the learning dimensions for becoming a piece-part subcontractor consist of the basic productrelated competences to achieve ‘drawing-supplied’ manufacturing at the required level of quality-cost-delivery (QCD). Furthermore, those under severe competitive pressure might also be expected to bring about the value engineering (VE) and the value analysis (VA), that is, cost cutting prior to and during the mass production process by improving component design (Asanuma 1989: 20). (2) The learning dimensions for upgrading towards sub-system supplier status include technical and process competences sufficient to carry out detailed component design and medium-scale assembly according to the product specifications laid down by the prime contractors. For a sub-system supplier to be successful, it must at least achieve competitive QCD. It must also be able to thoroughly understand the prime contractors’ specific needs and to efficiently accommodate them. Asanuma (1989) calls such competences relationspecific skills, which enable a supplier to respond flexibly to the prime contractor’s specific needs (Asanuma 1989: 21). Suppliers can acquire relation-specific competences5 only after repeated interaction with the particular prime contractors through a close and collaborative inter-firm relationship. To upgrade to sub-system supplier status, therefore, a dependent firm needs to attain relation-specific competences with the particular prime contractor, in addition to the general product-related competences required for competitive QCD. Moreover, those relation-specific competences could constitute significant barriers to entry for suppliers because


it is time-consuming and expensive to develop them through repeated interaction. The prime contractors would also incur the cost of switching suppliers, from those which have already acquired the relation-specific competences attuned to their specific needs (Monteverde and Teece 1982a; 1982b). (3) The learning dimensions required to upgrade to the status of module maker consist of all the product-related competences at the module system level, such as module basic design and module system integration, and sometimes contributing to product conceptualization. The module system is normally interchangeable because its interface with other components is highly standardized. Hence, module makers might not be required to acquire a high level of relationship-specific competences. Instead, they need to impose effective supplier management throughout a module value chain. They may also have to acquire market-related competences – such as market risk evaluation and aftersales service – in the case where the end-users choose among the various makers which module system is to be provided in the final product. This is the case for aero-engines for medium and large commercial aircraft. Aero-engine makers – such as General Electronics, Pratt and Whitney and Rolls Royce – carry out the full range of product- and market-related competences. Indeed, they act as the module lead firms in an aeroengine GVC (see section 3.1.2.2).

4.1.2

The lead firm’s control over sourcing activities

Secondly, a lead firm must also make sure that the dependent firm’s sourcing activities are closely aligned with its sourcing strategies. Any misalignment in the vertical sourcing relations could not only degrade the systemic competitiveness of the whole GVC, but also weaken the legitimacy of the lead firm as a director of the GVC. To avoid those negative outcomes, lead firms try to keep the sourcing activities of dependent firms under control in three ways: (1) control over quality, cost and delivery (QCD), (2) control against opportunistic behaviour, and (3) control over the domains of activity and learning.

4.1.2.1

Control over quality, cost and delivery

Lead firms try to buy components from suppliers at the lowest possible price while ensuring a satisfactory level of quality and on-time delivery. To prevent their suppliers from failing to achieve the required levels of QCD, the lead firms give them the detailed directions with a set of parameters that define the sourced product and its production processes. Such directions include, in addition to the price setting: 1) what is to


be produced; 2) how it is to be produced; 3) when it is to be produced and delivered; and 4) how much is to be produced (Humphrey and Schmitz 2001: 21–2).6 Moreover, they ensure that the suppliers actually follow their directions in the best possible way through (i) selection, (ii) inspection and evaluation, and (iii) training. In the first instance, the lead firms try to select as their suppliers, dependent firms, which can offer the highest level of QCD in the intermediate goods market. The lead firms often instigate competition between suppliers through multiple sourcing. By implying the threat to switch suppliers with short-term inter-firm relations, lead firms have strong leverage to squeeze the better offered prices out of the suppliers. More stringently, lead firms may directly control the suppliers’ profit margin through open-book or open cost measures (Ruigrok and van Tulder 1995: 83). In long-term inter-firm relationships, lead firms often control the suppliers’ profit margin in such a way as to encourage continuous cost reduction through ‘value-engineering (VE)’ and ‘valueanalysis (VA)’ (Asanuma 1997: 181–4). Lead firms with a long-term perspective also employ various measures for quality control over sourcing activities. Those measures include ‘quality audits’ in the supplier selection process. For instance, to be selected, dependent firms are required to adopt quality control techniques and facilities, such as ‘statistical process control’ and ‘numerically controlled (NC) machines’, and will be required to maintain control charts always available for examination by the lead firms (Ruigrok and van Tulder 1995: 82). Another powerful quality control measurement is that of ‘vendor rating’, in which the lead firms regularly evaluate suppliers, and an overall rating tells both parties how suppliers measure up against each other (Ruigrok and van Tulder 1995: 83). Such evaluations cover all aspects of QCD and reward those with high score. The system is also designed to promote competition among the suppliers with long-term inter-firm relations. If a lead firm is unable to find the suppliers already proven to be capable at the required level in the intermediate goods market, or in a case where a lead firm has to select an unqualified supplier for other business reasons, it often selects the most favourable supplier available and assists its learning through knowledge and capability transfer. Lead firms may transfer such knowledge and capability through sales, granting of licenses or patents, transfer of know-how, sale or transfer of second hand machinery, technical assistance, quality control, occupational training, or access to technical information, etc. (Radosevic 1999: 153). In such cases, becoming a supplier could in itself become a


significant learning opportunity for dependent firms. However, the lead firms carefully restrict such knowledge and capability transfer to the minimum level, only sufficing to make the suppliers capable of meeting their needs. In other words, they are not interested in supporting the learning of dependent firms per se.

4.1.2.2 Control against opportunistic behaviour and double-crossing diversification As we saw in the preceding chapter, aircraft GVCs have been adopting ‘lean’ production principles. Consequently, lead firms have become closely aligned with a smaller number of ‘significant’ suppliers (section 3.2.2). These aligned suppliers share the information intensively with the lead firm through the fast-advancing electronic data interchange (EDI) in order to work in a collaborative fashion and to promptly respond to the needs of the lead firm. Nevertheless, such closely aligned sourcing relationships may well be a double-edged sword for lead firms. On the one hand, it enables lead firms not only to optimize planning and spread the risk, but also to gain economies through large volume purchase and through obtaining better quality inputs through faster R&D. On the other hand, lead firms become vulnerable to opportunistic behaviour or double-crossing behaviour by such closely aligned suppliers. It is because, as transaction cost economics assert, in order for the lead firms to benefit from the close alignment with their suppliers, they need to bring about a synergic inter-firm combination of complementary competences as well as idiosyncratic investment in relationspecific assets (Williamson 1985). Opportunistic behaviours includes ‘shirking’ under situations where the indivisibilities of inter-firm joint efforts make it difficult to detect such behaviour (Alchian and Demsetz 1972; Barzel 1982); and the post-contractual ‘hold up’ of the relational rents by taking advantage of asset-specificity (Klein, Crawford et al. 1978; Monteverde and Teece 1982b). Then, according to transaction cost economics, safeguarding against the hazards of such opportunistic behaviour would incur increasing transaction costs (that is, the costs of searching, contracting, monitoring and enforcing), which often reach a sufficiently high level to prevent inter-firm collaboration altogether. If the lead firms maintain a long-term perspective, there are nevertheless a few effective ways for them to control suppliers’ opportunistic behaviour while incurring only a manageable level of transaction cost. One way is to create a situation of a repeated-game in long-term sourcing relations. Under such a situation, any untrustworthy behaviour by the


suppliers would result in costly sanctions that exceed any potential benefits that opportunistic behaviour may provide (Axelrod 1984; Gulati 1995). Such sanctions might be termination of the sourcing contract, which entails banishment from the GVC, or acquiring a reputation as an untrustworthy supplier throughout the whole industry. Lead firms may also control the supplier’s opportunism by nurturing inter-firm trust founded upon mutual expectations of learning more about each other through repeated interaction (Bachmann 2001: 350). Sako (1992) particularly calls such inter-firm trust ‘goodwill trust’, being based on mutual expectation of unrestricted commitment between the sourcing partners (Sako 1992). In recurring sourcing relationships, to the extent that the lead firms meet the suppliers’ expectations, suppliers will develop a sense of obligation to conform with the lead firm’s expectations in return, refraining from opportunistic behaviour (Macaulay 1963; Gulati 1995).7 Such safeguards against supplier opportunism work in a ‘self-enforcing’ manner in the long-term. They presumably have high initial ‘set-up’ costs, but once in place they have relatively low maintenance costs (Dyer 1997: 547). The underlying mechanism of these safeguards implies that the transaction costs are bound to diminish over a period of time as the sourcing partners learn more about each other through repeated interaction (Langlois and Robertson 1995: 29). It can also be understood that the lead firms exercise power over the suppliers by influencing, shaping, or determining their very wants through repeated interaction (Lukes 1974: 23). This is the most ‘subtle’ way of controlling the suppliers’ activities, and is what Ruigrok and van Tulder (1995) call ‘structural control’ (Ruigrok and van Tulder 1995: 75). It tries to secure the suppliers’ compliance by influencing their thoughts and desires even when no obvious power attempt has been made (Lukes 1974: 75; Hart and Saunders 1997: 27). In any event, if the lead firms effectively exercise structural control taking a long-term view, they could establish an ‘informal command structure’ to prevent suppliers’ opportunistic behaviour in closely aligned sourcing relations.8 Structural control is conducive to goal homogeneity in sourcing relations, while subduing open conflict and leaving room to forms of latent conflict at worst (Ruigrok and van Tulder 1995: 75). It will therefore result in what Nishiguchi (1994) calls ‘problem solving’ sourcing, which is characterized by a stable, long-term, and collaborative inter-firm relationship. Indeed, it has been repeatedly pointed out that effective structural control over suppliers is an important source of competitive advantage in the Japanese


automobile industry (Sako 1992; Nishiguchi 1994; Dyer 1997). From a supplier’s point of view, such ‘problem solving’ sourcing is beneficial because it brings about long-term and stable sourcing contracts. However, those closely aligned suppliers may find themselves ‘locked in’ to the structural control exerted by certain lead firms. In such cases, suppliers are obliged to refrain not only from opportunistic behaviour, but also from any strategic options that would be likely to conflict with their current lead firm. For instance, they may be pressured or sometimes forced to give up supplying other lead firms, which are direct competitors of their current lead firms. The lead firms may try to prevent their suppliers – particularly those competent and/or those with whom they share the information intensively – from taking part in the rival lead firms’ GVC – here, we call it ‘double-crossing’ diversification. In so doing, the lead firms attempt to block any possibility that their own suppliers might enhance the systemic advantage of rival firms by becoming their competitive suppliers, and/or by leaking the company’s confidential information to rival firms.

4.1.2.3

Control over the learning dimensions

Finally, a lead firm tries to control the learning dimensions of a dependent firm by restricting the latter’s sourcing activities to nonstrategic ones. In doing so, the former tries to prevent the latter from becoming a potential challenger by replicating its own competitiveness. As discussed above, the lead firm demands that its supplier should be capable of meeting its business needs effectively. More precisely, the lead firm requires its suppliers to possess the general competences to achieve a satisfactory level of QCD. The former also requires the latter to have relational competence in order to respond promptly and flexibly to its business needs. If necessary, the lead firm will support the suppliers’ learning through knowledge and capability transfer. However, a lead firm must guard against its suppliers becoming so competent and powerful that they may encroach upon the lead firms’ competitive edge as the system integrator in the GVC. So the lead firm must ensure that the learning dimensions of the dependent firm do not impinge upon the core technologies, neither upon those competences underlying the strategic functions – such as system integration, marketing, and after-sales service. A firm’s learning can be exercised in various ways.9 Most obviously, learning can take the form of formal education and R&D. Such formal learning may equip a firm with the codified (or tangible) knowledge; for instance, the operational manuals of new equipment that is to be


introduced into sourcing activities. In many cases, more significantly, learning is largely experience-based rooted in ordinary economic and social activities, as summarized by Lundvall (1992: 9): Such activities involve learning-by-doing, increasing the efficiency of production operations (Arrow 1962), learning-by-using, increasing the efficiency of the use of complex systems (Rosenberg 1982), and learning-by-interacting, involving users and producers in an interaction resulting in product innovations. (Lundvall 1988) Such experience-based learning enables a firm to acquire tacit (or intangible) knowledge and to perform given activities better and more quickly through repeated trial-and-error. In a dynamic sense, moreover, both formal and experience-based learning may also equip the firm with the so-called ‘absorptive capacity’ (Cohen and Levinthal 1990) that enables it to assimilate related, but new knowledge effectively, and apply it innovatively to the firm’s activities.10 This implies that firm learning is a reinforcing process: the more the firm has learned, the more efficiently the firm is able to absorb related knowledge. Especially, experience-based learning also underlines the pathdependency and domain-specificity of the firm’s competence and of the path of its upgrading. To paraphrase the words of Teece, Pisano et al. (1997): the notion of path dependencies imply that where a dependent firm can go in the upgrading process is a function of its current position and the paths ahead. Its current position is often shaped by the path it has travelled (Teece, Pisano et al. 1997: 522). This follows because the firm’s learning is cumulative – a set of competences and the absorptive capacity that a dependent firm currently possesses are a product of what they have thus far learned within the previous domain of activity. As a result, the learning opportunities of the firm might be ‘closed in’ (Teece, Pisano et al. 1997: 523) to previous activities. To put it differently, the firm learning dimension could be ‘locked out’ (Cohen and Levinthal 1990: 136) from unrelated activities. Hence, the firm learning is domainspecific; and such nature of firm learning gives rise to the so-called ‘learning trap’ – that is, the firm is confined to a certain domain of activities (Aoshima and Kato 2003: 172–7). In turn, the lead firms could exploit such learning traps in order to control the growth of dependent firms. By strictly restricting the domain of current sourcing activities and keeping them tightly aligned with actual business needs, lead firms can affect the learning path of dependent firms concentrating on making them into more useful


and reliable suppliers for them. Those dependent firms will only be competent to effectively meet the lead firms’ sourcing requests, and they will not possess the competences for directly challenging the lead firms’ competitive position. From the dependent firm’s point of view, the closer they align their sourcing activities to those of the lead firms, the more they will link their growth and future to performance of the lead firms. By exploiting the social attributes and path-dependency of the learning process, therefore, the lead firms can control the growth of dependent firms at the deepest level – moulding the latter’s learning trajectory. To summarize the lead firm’s control over the growth of dependent firms, the lead firms exert the ‘structural power’ throughout the GVC, by determining ‘what to do’ and ‘what not to do’, and more fundamentally ‘what to learn’ and ‘what not to learn’ in the sourcing activities. On the other hand, to achieve upgrading, the dependent firms must pursue a discontinuous learning process by mastering the specific learning dimensions, which the lead firms require for each tier of suppliers. If necessary, they often support their suppliers’ learning through the limited knowledge and capability transfer. Nevertheless, they most carefully try to prevent the dependent firms from upgrading to a higher level – through acquiring the critical, difficult to reproduce, or scarce competences – enabling them to encroach into their dominance in a GVC or to challenge their competitiveness as a system integrator. Fine (1998) puts it in a metaphoric way: every time that lead firms make sourcing decisions, ‘it is planting a “capability seed” that has the potential to grow into a valuable and powerful organizational competency’ (Fine 1998: 159). Thus, lead firms must be careful neither to plant those ‘capability seeds’ to their suppliers beyond what is absolutely necessary, nor to allow them to sprout and grow so powerfully that the suppliers come to pose a potential threat to their own competitiveness. In other words, by carefully confining the sourcing activities into the non-strategic activities, the lead firms must block the chance for dependent firms to gain experience-based learning in the core technologies and strategic functions. The lead firms often exercise the power to be deaf to the suppliers’ demands to take part in strategic activities in the contract negotiation (Kaplinsky and Morris 2000: 66).11 Moreover, such lead firms’ control over the growth of dependent firms in a GVC seems to highlight the structural limitations of the upgrading strategy of FLI. It seems to imply that there is a ‘glass ceiling’ inherent in the upgrading process. Dependent firms will inevitably hit the glass ceiling as a result of the ‘controlled’ growth of the firm in a GVC. In


the empirical part of this study, we will examine the possibilities and limitations of upgrading in the case studies on the Japanese aircraft industry.

4.2

Determinants of upgrading

We have thus far discussed the upgrading process in general terms. In this section, we turn to further focusing our analysis on the individual prospects for upgrading. What determines the prospects of upgrading for a particular dependent firm? Why can (or cannot) a particular dependent firm achieve upgrading as a supplier within a GVC? To answer these questions, we identify three critical factors, which will promote and/or impede a dependent firm in upgrading its activities towards a higher value-added level; these are: • Lead firms’ sourcing strategies: Lead firms’ strategic goals for outsourcing that in turn determine a mode of sourcing relationships. They determine whether the sourcing activities will create a learning platform that may bring about knowledge transfer and experiencebased learning. • Dependent firms’ dynamic strategic fit: The fitness of dependent firms’ strategies over time in relation to the ever-changing external factors – primarily, the nature of available global sourcing – and the internal factors, including a current portfolio of competences and learning potential. It determines the likelihood of a dependent firm’s potential to upgrade its sourcing activities in the long run. • Local institutional setting: The nature of industrial networks and policy networks, in which dependent firms are locally embedded. By influencing the way the embedded firms operate, it either supports or hinders the dependent firms in their efforts to attain a dynamic strategic fit. We derive these three determinants for upgrading from the in-depth case studies conducted on the post-war development of the Japanese aircraft manufactures (see Chapter 5). On the basis of the multi-disciplinary literature that concerns the global sourcing, the supplier system, the firm strategies, and the institutional aspects of the firm among others, we also examine the logic behind those determinants, how and why they are important factors underlying the upgrading process as well as how they interrelate with each other.


We try to argue in this section that the upgrading prospects of dependent firms are largely shaped by the three determinants listed above both individually and jointly. More specifically, they create opportunities for and/or the barriers against a dependent firm’s attempts to acquire those dual-faceted competences that generate higher rent as well as stronger bargaining power within a GVC. In the following sections, we will delineate those determinants’ individual and systemic influences on the dependent firms’ prospects for success in upgrading within a GVC.

4.2.1

Lead firm’s sourcing strategies

Due to their dominant role in a GVC, the lead firms’ sourcing strategies should be considered the first determinant for the upgrading of dependent firms. The prospect of upgrading by dependent firms in general depends on the nature of the intermediate goods market. The larger and deeper the intermediate goods market, the wider the ‘windows of opportunities’ for upgrading become. As we saw in the preceding chapter, such ‘windows of opportunities’ for upgrading have been opening even wider in the commercial aircraft industry. Facing ever-fiercer competition and increasing technological complexities with the limited resources and capabilities at hand, lead firms have been compelled to outsource more value-added activities in the GVC to their suppliers. Hence, as a result of the recent (on-going) global business transformation, which we discussed in Chapter 3, the lead firms have enlarged the scale and scope of global sourcing, raising the quality of sourcing activities, and intensifyed sourcing relationships (see section 3.2.2). The above account of better prospects for upgrading should be seen as a general trend in the whole industry. Nevertheless, the individual prospect of upgrading is different for each dependent firm engaged in the discrete types of global sourcing. Thus, whether a particular dependent firm will be able to upgrade through undertaking sourcing activities is not a given a priori. In order to upgrade, the dependent firm must undertake such global sourcing that will create learning opportunities. Those sourcing activities will give the dependent firm the opportunity to carry out experience-based learning – such as learning-bydoing, using, searching and interacting – to acquire new dual-faceted competences for upgrading. On the other hand, the lead firms, as we discussed in the preceding section, try to keep the learning potentials of the dependent firms under control by carefully selecting what categories of sourcing activities they will make available to their suppliers.


Referring once more to Fine’s metaphor; every time lead firms make sourcing decisions, ‘it is planting a “capability seed” [that is, learning opportunities through experience-based learning] that has the potential to grow into a valuable and powerful organizational competency’ (Fine 1998: 159). At the same time, however, lead firms try to limit the extent to which each ‘capability seed’ may sprout and grow in each dependent firm in order to keep them aligned with their own sourcing strategies. The lead firms’ sourcing strategies can be broadly categorized into three groups on the basis of their different strategic goals. Although it is difficult to clearly separate those strategic goals since they usually work in combination and are complementary, we can heuristically identify the following strategic goals; they are (i) short-term cost reduction, (ii) long-term value-creation, and (iii) various business issues.

4.2.1.1 Short-term cost reduction versus long-term value creation Cost reduction sourcing (CRS). Lead firms may primarily pursue reduction in production cost by outsourcing non-strategic and low-skill activities to dependent firms from which they can buy those services more cheaply than it would cost them to carry it out themselves. Also, following the logical stream of transaction cost economics, externalizing certain activities can be seen as a means of minimizing the transaction cost in the make-or-buy choice over intermediate goods – when the administrative costs for internalizing those activities surpass the transaction cost for sourcing from suppliers. Clearly, the primary strategic goal for such ‘cost reduction sourcing (CRS)’ is to purchase non-strategic and low-skill products and services from suppliers at the lowest price given a satisfactory level of quality, cost and delivery (QCD). The CRS usually leads to a short-term sourcing contract, which is characterized by arm’s-length and ‘bargaining oriented’ inter-firm relationships (Nishiguchi 1994: 174). In such situations, the lead firms try to bargain with suppliers for a cheap price by always making clear their option to switch suppliers in the short term. This sourcing strategy can be well illustrated by following Helper (1993) to adopt Hirschman’s (1970) ‘exit/voice’ dichotomy of strategic behaviour. A lead firm using the ‘exit’ option – which is the case of CRS – will look for a new supplier, whereas the ‘voice’ option – which is the case in the ‘value creation sourcing (VCS)’, as we will see below – implies that the lead firm will work together with the supplier in order to fix the problem (Hirschman 1970; Helper 1993; Ruigrok and van Tulder 1995). To make the ‘exit’ option available all the time, the lead firms in CRS maintains an armlength distance from suppliers.


The lead firms in CRS are interested in the suppliers learning no more than what is absolutely necessary for them to carry out non-strategic and low-skill sourcing activities at the required level of QCD. In other words, dependent firms cannot expect that much learning will derive from CRS, in which the experienced-based learning is strictly low-level and shortterm. Nor do they have much room for learning through trial-and-error because the lead firms give them detailed directions with a clear set of parameters that define the sourced product and the production process, as seen above. Furthermore, the knowledge and capability transfers are minimal since the sourcing relationship is essentially arm’s length. Therefore, the CRS may simply reaffirm the advantages that lead firms have in a GVC and their ability to internalize strategic and high value-added activities and externalize cost cumbersome and low skill activities (Radosevic 1999: 185). It may be also seen – in the Marxist term – as a mechanism for lead firms to appropriate a part of the value produced by dependent firms. It may take shape in offshore sourcing or in sourcing to exploit temporary advantages in labour cost and tax advantages (Radosevic 1999: 184–5).

Value creation sourcing (VCS). As for the strategic goals of global sourcing, lead firms may primarily emphasize the creation of new values through sourcing relationships, rather than solely focusing on the reduction of procurement costs of intermediate goods and services (Zajac and Olsen 1993; Chesnais 1996). Such ‘value creation sourcing (VCS)’ pursues what Zajic and Olsen (1993) call ‘transaction value’, which is contrasted with the more traditional notion of transaction cost. Transaction value emanating from global sourcing implies synergic inter-firm collaboration between the sourcing partners, giving rise to the so-called relational rents in addition to what could have been achieved by either firm in isolation (Dyer and Singh 1998: 662; Madhok and Tallman 1998: 328). Various scholars have traced the sources of those relational rents, which are in turn the source of transaction value in global sourcing; these are: • Investments in relation-specific assets (Klein, Crawford et al. 1978; Dyer and Singh 1998); • Synergic combination of complementary resources and capabilities (Chesnais 1996; Dyer and Singh 1998); • Unique informational efficiency and substantial knowledge exchange brought about by repeated interactions and joint learning (Aoki 1988; Dyer and Singh 1998).


In short, the above factors give rise to relational rents through intimated alignment and intensified information sharing between the sourcing partners. However, as discussed in the previous section, such close sourcing relationships may also induce opportunism, particularly by the suppliers, and result in high transaction costs, which may negate the relational rents (Madhok and Tallman 1998). ‘Transaction value’ and ‘transaction cost’ should be seen as two sides of a coin. Thus, the lead firms must be sure to exert effective control to prevent suppliers’ opportunistic behaviour when they aim to create new transaction value through VCS (see section 4.1.2.2). VCS leads to a long-term sourcing contract, which is characterized by a closely aligned and ‘problem-solving oriented’ inter-firm relationship. In such situations, the lead firms exercise the ‘voice’ option, in which they work together with the supplier in order to achieve continuous quality improvement and cost reduction for sourced products and activities over a period of time. When the suppliers face problems and fail to achieve their objective, as Nishiguchi (1994: 172–3) elaborates, the lead firm would usually resort to exhaustive data collection from the suppliers, data analysis and recommendations in order to find a solution. If the problems were found to be more serious than expected, on-site inspections and rigorous retraining of the supplier would follow. It is unusual for the lead firm to fire or switch their suppliers in the shortterm without attempting such collaborative attempts to solve the problems. As documented in many studies on sourcing relations, such VCS policies have been well developed in Japan, and constitute important sources of competitive advantage for some Japanese industries, particularly the automobile industry (Nishiguchi 1994; Dyer and Singh 1998). VCS may provide dependent firms with dynamic learning opportunities. Lead firms tend to be more interested in nurturing the suppliers’ capabilities than they are in the case of CRS. This is because the lead firms usually try to employ VCS as a mechanism to make use of their suppliers as so-called ‘external capabilities’ (Langlois and Robertson 1995: 68) or ‘external firms’ (Nolan 1999: 75) according to their own needs. Rather than simply benefiting from the suppliers’ cheap labour or tax advantages, which is often the case with CRS, lead firms engaging in VCS pursue joint learning through intensive information sharing with the suppliers in order to achieve the systemic competitiveness throughout the GVC. However, it should be reiterated that the lead firms are not interested in the suppliers’ learning per se. Instead, they always try to control the suppliers’ learning to be closely aligned with their needs as


well as to prevent the suppliers from becoming sufficiently competent enough to be a potential competitive threat (see section 4.1.2.3).

4.2.1.2

Business issues

There are mainly two types of business goal for global sourcing. One is to pass on an element of risk to suppliers throughout a GVC. Another is to enter the local market of the suppliers. Such business issues, for instance, play a significant role in global sourcing in the commercial aircraft industry. The industry bears very high risk due to its high development costs with long gestation period. On the other hand, marketing competition is extremely severe in the commercial aircraft industry due to the small unit number of total demand in the global market. It is common conduct that lead firms in the industry strategically use global sourcing as a political tool to gain favourable access to the suppliers’ local market. Such sourcing is specifically called ‘offsets’, which Mowery (1999) defines as: An offset is a provision in an international export transaction that commits the seller firm [that is, lead firm] to provide technology, to procure locally produced components, or to provide other forms of technical and other assistance to firms in the purchaser nation that go beyond those deemed economically necessary to support the sale. Offsets typically are undertaken by the selling firm in response to formal or informal demands made by the government of the purchasing nation. (Mowery 1999: 85) [emphasis added.] Global sourcing driven by such business issues may share the nature of either CRS or of VCS, as a result of a complex contractual negotiation between sourcing partners (Table 4.2). Therefore, a particular dependent firm would have more learning opportunities and in turn a better prospect for upgrading in the GVC Table 4.2 Alternative types of global sourcing Lead firm’s primary strategic goal

Cost reduction

Value creation

Lead firm’s strategic behaviour Sourcing relationship Sourcing period Dependent firm’s learning potential

Exit Bargaining Short-term Small

Voice Problem solving Long-term Large


when it engages itself in ‘value creation sourcing’ rather than in ‘cost reduction sourcing’. In practice, the lead firms would make strategic decisions on the nature of global sourcing through a contractual negotiation with suppliers by taking into account various factors, including economic (cost), business (risk dispersion and market access), political (favourable treatments from the local governments of latecomer firms), and technological (learning potential of dependent firms).

4.2.2

Dependent firms’ dynamic strategic fit

The firm-level approach employed in this study places the factors directly concerning dependent firms at the centre of our analytical framework for the upgrading process in a GVC. As is the case with any other firms, successful formulation and implementation of corporate and business strategies are key factors for dependent firms wishing to grow and upgrade. However, the active role for managerial strategy has been largely neglected in the discipline of development economics (Chesnais 1996: 27). It tends to see the firm as a passive reactor to factor endorsements, in the case of the neoclassical school, or to transactional circumstances in the case of the transaction cost school. It is surely unacceptable in the context of globalization, where a small part of a firm’s success as well as a nation’s industrial development can be explained by the efficient allocation of endorsed factors of production or by the economization of transaction costs. Our analytical framework thus takes fully into account the dynamic roles of dependent firms in the upgrading process, namely the strategic intent and learning effort. To gain and sustain competitive advantage either as a system integrator in the finished product market, or as a supplier in the intermediate goods market, a firm needs to formulate its strategy in an effective way to cope with, and if possible influence the changing environment. As for the first step towards successful corporate strategies, a firm needs to grasp clearly the opportunities and threats existing in its environment, which is in turn a product of competition, customer’s preference and technology. At the same time, a firm also needs to identify correctly its strengths and weaknesses on the basis of its internal factors – the nature of its competences and organization. Then, a firm has to formulate and implement its strategies so as to be consistent with both its external and internal environments (Grant 1998: 13). The consistency of corporate strategies in regard to both a firm’s external and internal environments can be encapsulated by the notion of ‘dynamic strategic fit’ (Itami and Roehl 1987). The concept of strategic


fit postulates that a successful strategy enables a firm to make the match between its internal competences and organization, on the one hand; and the opportunities and risks created by its external environment, on the other (Hofer and Schendel 1978: 12). Moreover, to achieve upgrading over time – adapting what Itami and Roehl (1987) contends – a dependent firm must attain the strategic fit dynamically in relation to the ever-changing environment in the intermediate product market as well as in relation to the ever-increasing level of competences required for upgrading. Figure 4.1 illustrates the dynamic strategic fit of a dependent firm.

4.2.2.1

External fit

In general, a successful corporate strategy, on the one hand, has to achieve dynamic external fit by setting its domain of activities in line with the characteristics and trends of the firm’s external environment, such as customer preference, competitor behaviour and technological progress. A firm sets its domain of activities through articulating its own product/market portfolio and operational sphere. The product/market portfolio in turn includes decisions such as in which product areas and

External Factor Lead firms’ sourcing strategies Learning opportunities Lead firm’s competitiveness

Setting the domain of activities in line with the dynamic trends of external factors

External fit Domain of activities Dependent firm’s strategy

Dynamic strategic fit

Internal fit Internal factor Competence backing Relation-specific competence

Learning to fulfil the competence gap

Figure 4.1 Dynamic strategic fit of a dependent firm Source: Developed based on Itami (1987: 1–11)

Targeted higher value-added sourcing activities


market segments to operate by answering the question ‘what to sell, and to whom’; and the operational sphere includes decisions on what activities in the value chain to undertake internally by answering the question ‘what operations to do in-house’ (Itami and Roehl 1987: 3–5). In particular, being a supplier in a GVC, a dependent firm can attain the dynamic external fit for its strategy by setting its domain of activities in line with the characteristics and trends of the lead firms’ sourcing strategies. At the same time, the dependent firm should try to focus its domain of activities to provide it with opportunities to learn and grow over time. There are mainly three building blocks for the dynamic external fit of a dependent firm. First of all, aiming to achieve upgrading, dependent firms must be selected as suppliers by lead firms and be involved in a GVC. In order to do so, dependent firms must swiftly identify which intermediate goods and activities the lead firms are likely to outsource by carefully observing changes in the lead firms’ sourcing strategies. Then, dependent firms must dynamically adjust their domains of activities and be ready to undertake the sourcing activities emerging in the intermediate goods market. Secondly, the dependent firm should focus on the domains of activities, which will provide it with a dynamic platform for learning and upgrading. We shall examine in the following section what kinds of sourcing activities may induce the dynamic learning of the dependent firm. Thirdly, a dependent firm must make a correct decision about which lead firm’s GVC it attempts to enter and upgrade. As explained in the preceding chapter, a dependent firm by nature depends for its fate on the lead firms’ competitiveness in the finished product market. Even though a dependent firm might be successful in upgrading within a certain GVC, if the lead firm of the concerned GVC fails to gain competitive advantage in the finished product market, then the dependent firm won’t be able to achieve firm-based late industrialization. It is very difficult to identify the correct lead firm a priori, but the dependent firm must carefully investigate which lead firm is likely to have the better chance to gain sustainable competitive advantage, by examining its core competences, financial strength and GVC management.

4.2.2.2 Internal fit: (static) competence backing and (dynamic) learning potential On the other hand, successful strategies must also obtain internal fit by being sufficiently supported by the firm’s internal competences – that is, competence backing. It is costly and time-consuming for firms to


acquire new competences, especially those relating to high value-added products and activities due to their technological complexity, tacitness and high barriers to entry. Since a firm cannot expand its competence base in a short period of time, it needs to have sufficient competence resources to carry out its intended strategy. Nevertheless, competence backing is only one element of the internal fit of a dependent firm’s strategy. It is a static element, but upgrading is a dynamic process by nature. The dependent firm cannot achieve upgrading in a GVC as long as it contents itself with a static strategic fit – undertaking sourcing activities to the extent that the firm’s static competence backing allows. Pursuing upgrading FLI strategy, a dependent firm must aim to become a higher level supplier in the GVC. It further must learn the new competences necessary to accomplish the specific learning dimensions to reach the upper hieratical levels of suppliers, which were delineated earlier (see Table 4.1). For example, to upgrade from a piece-part subcontractor to a sub-system supplier, a dependent firm needs to learn how to carry out effectively detailed design and manufacturing of components, together with the relation-specific skills in the sourcing relationship. In other words, whether a dependent firm succeeds in upgrading itself to the targeted higher level of supplier largely depends on its (dynamic) learning potential – how efficiently it can accumulate the newly required competences to upgrade itself to the targeted supplier level in the GVC.12 Such learning potential is manifested in both formal and experiencedbased learning processes (see section 4.1.2.3).

Dependent firm learning. Particularly, in the case of a dependent firm, its learning process is dominantly incremental and cumulative in nature rather than radical and path-breaking because they are usually lagging in the technology and market frontiers (Hobday 1995: 46–7). Hence, the core learning process of a dependent firm is to absorb external knowledge that already exists in other firms as well as in the market. The learning potential of a dependent firm is largely a function of (1) the scale and scope of the new external knowledge to which the dependent firm is exposed; (2) the ability to absorb the new knowledge and apply it to sourcing activities in an innovative way, and (3) sufficient financial resource to invest in learning. First of all, the extent of external knowledge to which a dependent firm is exposed in turn depends on (i) the intensity of information sharing with lead firms in sourcing relations; and (ii) the knowledge inflow from the institutional setting, in which the firm is embedded. Since the latter factor will be discussed in the following section, we


here only give a supplementary explanation for the first factor. In the preceding section, we explained that the intensity of information sharing in sourcing relationships was largely affected by the lead firm’s sourcing strategy, that is, either ‘short-term cost reduction’ or ‘long-term value creation’ (see section 4.2.1.1). Furthermore, it is also determined by the nature of the parts that the dependent firm supplies. For example, piece-part subcontractors have very limited information sharing with lead firms because they simply manufacture exactly according to the designs handed over from the latter – that is, ‘drawing-supplied’ manufacturing. In this case, knowledge inflow to dependent firms is largely limited to what is necessary to put the pieces together at the required level of QCD and no more. On the other hand, by playing a part in product development, subsystem suppliers can expect a much larger scale and scope of knowledge inflow from lead firms. This is because to design and manufacture the sub-systems that fit smoothly into the whole system, the dependent firm has to learn beyond ‘component knowledge’ particular to its own work package. To a certain degree, sub-system suppliers need to acquire ‘architectural knowledge’ of the whole system.13 In product development of multi-component/multi-technology products, firms are required to ‘know more than they make’ (Brusoni, Prencipe et al. 2001) to achieve coherence in a GVC (Takeishi 2002). It would lead to considerable information sharing with lead firms. Such information sharing would be particularly intensive for ‘significant’ suppliers – such as a risk-sharing/a programme partner – in the international collaboration project. Thus, those high-level supplier positions in the GVC are likely to provide a dependent firm with the platform for learning. Secondly, to make the knowledge inflow actually productive, dependent firms should be able to efficiently assimilate the external knowledge, and to put it to use in carrying out sourcing activities effectively and innovatively. As briefly described earlier, Cohen and Levinthal (1990) term such firm’s ability ‘absorptive capacity’ (see sections 4.1.2.3 and 4.2.2.2). Drawing on the classical work of cognitive psychology, they assert that a firm’s absorptive capacity is largely a function of the level of prior related knowledge. Cohen and Levinthal refer to studies in the area of cognitive and behavioural sciences at the individual level, which suggest that prior knowledge enhances learning in a cumulative and self-enforcing way (Lindsay and Norman 1972; Bower and Hilgard 1981). Those studies imply that, according to Cohen and Levinthal, the learning is self-enforcing – ‘learning performance is greatest when


the object of learning is related to what is already known’ (Cohen and Levinthal 1990: 131). Although Cohen and Levinthal (1990) only consider the assimilation of external knowledge, the notion of absorptive capacity also has relevance for experience-based endogenous learning, such as learningby-doing and learning-by-using. The firm can bring about endogenous learning by reflecting on its own experience – finding lessons to be learnt from its own experience and implementing them in their future activities. A firm’s capacity to reflect its own experience is also largely a function of the level of prior related knowledge. In this case, therefore, the object of learning is internal to the firm rather than external to the firm. Furthermore, applying the notion of absorptive capacity to the upgrading process, a dependent firm with long experience of manufacturing, for example, is likely able to learn product-related competences (such as component design and assembly) more efficiently than the market-related competences (such as marketing and after-sale service) (see Figure 4.1). More generally, this suggests that the learning process required to upgrade from a piece-part subcontractor to a sub-system supplier is usually easier than that from a sub-system supplier to a module maker or to a system integrator. In the former case, the learning dimension is largely contained within the product-related knowledge (that is, acquiring the related knowledge to enhance what is already known). Whereas in the latter case, the dependent firm needs to acquire the market-related competences, which may be unrelated to what the firm already knows. We have thus far discussed absorptive capacity in general terms. Nevertheless, a dependent firm must also attain the so-called ‘relationspecific’ competence in relation to the particular lead firm. As discussed earlier in section 4.1.1, relation-specific competence enables a dependent firm to be sufficiently responsive to understand and accommodate the lead firm’s specific needs (Asanuma 1989). Hence, relationspecific competence can be regarded as that special absorptive capacity, by which a dependent firm may effectively assimilate and utilize the knowledge inflow from a particular prime contractor. It can be attained only after repeated interactions with the particular lead firm. Relationspecific competence is particularly critical for a sub-system supplier that needs to have intensive information sharing with its lead firm. In turn, such intensive information sharing will bring about a larger knowledge inflow into the dependent firm.


Thirdly, for a dependent firm learning is not free nor is it an automatic process, such as what traditional neoclassical economics assume to be the international technological ‘diffusion’ (Baumol 1986; Dowrick and Gemmell 1991). Successful learning actually incurs significant costs in carrying out continuing innovation to further the original knowledge – such as (i) moulding to fit particular conditions of use in a widening range of specific situations, and (ii) further improvement to attain higher performance standards beyond those originally achieved (Lall 1992; Bell 1997: 86). More essentially, to take advantage of an effective learning opportunity that would bring about a large knowledge inflow, a dependent firm must, in the first place, be able to mobilize sufficient finance to take part in the GVC as a significant supplier, such as a subsystem supplier. The amount of finance necessary to be a significant supplier, as seen in section 3.2.2.3, has increased since the system integrators began to adopt lean production principles and to rely upon fewer significant suppliers to provide an ever-larger bundle of goods and services. Especially, securing sufficient finance to bear component development cost is a precondition for a dependent firm wishing to enjoy large knowledge inflow by becoming a sub-system supplier in a GVC. Component development cost includes, for instance, purchasing and/or creating new tooling, building new facilities, carrying out the trial-and error in designing, manufacturing and testing new components. Hence, the dependent firm must carefully examine the required extent of financial resource for undertaking supplier activities that bring about learning opportunities. It must also discover access to sufficient financial resources. If the firm should not be able to raise sufficient money for the investment internally, it must look for other possible sources of financing externally – such as co-financing with collaborative firms, or loan and subsidy provided by government agencies and/or the business association. Such external financial support for the dependent firm learning will be further discussed in the following section.

4.2.3

Local institutional setting

The last, but not the least determinant of upgrading is the institutional setting in which dependent firms are locally embedded. By directly and/or indirectly influencing the way the dependent firms operate, the local institutional setting can either support or hinder them in their efforts to attain a dynamic strategic fit and in turn to achieve upgrading.


The local institutional setting of dependent firms consists of an industrial network and a policy network.

Industrial network. An industrial network is a collection of various relationships that dependent firms maintain with other organizations, of which a firm is one kind (Håkansson 1990). Such inter-firm relationships consist of vertical ones (for example, with suppliers, prime contractors, sales dealers and so on) and horizontal ones (for example, with partnering firms in collaborative projects, other organizations such as research organizations, government agencies, trade associations and so on). There are two basic functions of industrial networks; deriving from the literature of network14 and institutionalist15 approaches in economics, sociology and management studies: (1) To create ‘the dense network of co-operation and affiliation by which firms are inter-related’ (Richardson 1972: 883). It facilitates consolidation and/or coordination of the resources and capabilities of the different firms’ with the intention of jointly carrying out complementary activities.16 No firm is in itself a self-sufficient organization; firms are interdependent on each other to a certain degree (Pfeffer and Salancik 1978; Sanchez and Heene 1997). To the extent that the individual firms specialize in a certain domain of activities, they need to supplement their own resources and capabilities with those of others in order to form an efficient value chain (Håkansson 1990; Edquist and Johnson 1997). This coordinating function of industrial networks is particularly important for dependent firms, whose resources and capabilities are individually limited. (2) To bring about interactive learning among the embedded firms. It combines different trenches of knowledge in new ways, and/or simply shares it through interaction within and between the various firms (Lundvall 1988). The former may result in knowledge creation (Håkansson and Johansson 2001) and the latter in knowledge diffusion, and both may be considered a form of innovation (Nelson and Rosenberg 1993; Hobday 1995). Such interactive learning may occur within firms (between different individuals or departments) (Nonaka and Takeuchi 1995), between firms and consumers (Lundvall 1988), between different firms, or between firms and other organizations like public agencies (Håkansson 1990; Edquist and Johnson 1997). Such multi-faceted interactive learning jointly creates a so-called ‘knowledge system’ (Bell and Albu 1999). It highlights the knowledgecentred process taking place within an industrial network, in which knowledge stocks within firms and acquired knowledge flow throughout


the network. Thus, the efficiency of the knowledge stock and flow support the learning potential of the embedded dependent firms. Furthermore, the knowledge system cannot sustain its dynamism in the long run unless it is an open system into which new knowledge constantly flows from outside. This openness of the knowledge system within local industrial networks can be secured if the embedded firms simultaneously participate in a GVC, which consists of firms belonging to the different local knowledge systems (Bell and Albu 1999: 1726; Humphrey and Schmitz 2000).

Policy network. A policy network is a hybrid of public–private governance consisting of business associations, technology centres, as well as government agencies (Esser, Hillebrand et al. 1996; Messner 1997). It regulates the behaviour of individual firms as well as inter-firm relations in the industrial network. In other words, the policy network structures the institutional framework in which industrial networks evolve and are maintained.17 It influences both directly and indirectly the embedded firm’s strategy and operations in relation to other organizations through their three basic functions: (i) to reduce uncertainty by providing information; (ii) to manage conflict and cooperation; (iii) to provide incentives and/or constraints (Edquist and Johnson 1997: 51). For example, it might support the learning of embedded firms by facilitating knowledge inflows and providing additional resources for intrafirm investments for knowledge absorption. More specifically, business associations can facilitate the knowledge flows throughout the industrial network. Technology centres can increase the flow of new knowledge into a latecomer firm. The industrial policies executed by government agencies, such as subsidies, can increase the resources available to the firm for intra-firm investments. Especially, pursuing late industrialization, the governments of latecomers may actively mould institutional frameworks through industrial policy.18 Industrial policy can be an effective device to coordinate investments in complementary projects and promote the industrial changes in a certain direction (Chang 1994: 74–6). However, the change in direction promoted through industrial policy does not necessarily enhance, but often hinders the upgrading of embedded dependent firms, as will be seen below. Moreover, the positive influences of a local policy network on the upgrading process are most effective when the supporting activities are systemically coordinated between the various actors.


4.2.3.1

Influences on the dependent firm’s dynamic strategic fit

We have thus far expounded the possible influences of the local institutional setting on the embedded firms in general. We will now point to their specific influences in relation to the external and internal strategic fit and learning of embedded dependent firms.

External strategic fit. Providing the firm with a certain bundle of information and incentives, the institutional setting may help or hinder dependent firms to understand and position themselves in line with the characteristics and trends of external factors, that is, customer demands and competition. While the dependent firm tries to align its domain of activities with the opportunities existing in its external environment, its decisions on product/market portfolio and the operational sphere would be moulded and guided in a specific direction by the information and incentives the institutional setting presents. More specifically, government agencies and trade associations can provide the firm with up-to-date information about customer demands and competitors by conducting market and operational research. The results of that research can be disseminated through various interorganizational relationships within the industrial network, such as government–industry joint councils and an industrial association’s PR activities on behalf of its member firms. The firm often makes the decision on its domain of activities (that is, product/market portfolio and operation sphere referring) having reference to the information available in its institutional setting. The government, in particular, can be more active or commanding in guiding the firm into a certain domain of activities by using industrial policy as a device to create artificial incentives and constraints in industrial activities. Japan’s MITI (Ministry of Industrial Trade and Industry), for instance, is well known for its active involvement in firm’s strategic decisions through administrative guidance as well as through provision of various financial incentives such as export credits, tax break, subsidies and so on for producing and exporting certain products. The aforementioned influences of an institutional setting can be either positive or negative for the firm’s efforts to achieve external fit. The firm’s strategy would be helped in achieving an external fit if the provided information were accurate and updated, and if the guided direction were to match the volatile characteristics and trends of the firm’s external factors. On the contrary, such information and guidance would become a handicap if they were inaccurate and/or not flexible


enough to keep up with the changes in characteristics and trends of volatile competition and customer demands.

Internal strategic fit and learning. The institutional setting influences the firm’s efforts to attain the preferred balance between internal competence (i.e., resources and capabilities) and strategy, that is, internal fit, in three ways. Firstly, the institutional setting may induce the firm to choose an overextension strategy that is too ambitious or too passive. The strategy has to set its upgrading goals within the scope of learning potential. In other words, the strategy needs sufficient ‘competence backing’ (Itami and Roehl 1987: 111). It is closely related to the role of the institutional setting in respect of external fit discussed above. The firm may be encouraged or sometimes forced to target a domain of activities, where the tasks are overwhelming and/or the competition forces too severe for the firm, having regard to competence it currently possesses and its realistic prospects of learning. In such a case, the corporate strategy becomes a mere slogan. On the other hand, if the firm was encouraged or forced to employ a strategy that was not sufficiently challenging, it would lack the incentive to improve and would become slack. Secondly, the institutional setting may help the firm to utilize its competences effectively by facilitating consolidation and coordination with other firm’s competences. Any activity, whatever its position in the value chain requires that a certain set of resources and capabilities be brought together, as no firm can possess all the resources and capabilities by itself. By coordinating its own competences with others’ to carry out the complementary activities, the firm can minimize waste in competence utilization. Moreover, by consolidating its competences with others’, the firm may be able to challenge a particular domain of activities, which would be too difficult or too competitive on its own. By regulating and controlling conflicts and corporations within the interorganizational relationships, as seen above, the industrial network and institutions would thus facilitate the firm’s competence coordination and consolidation with others. Thirdly, institutional setting influences the firm’s efforts to acquire new competences, that is, learning. Institutional setting could directly increase the available resources for the firm to invest in learning. The government, for instance, may provide firms with financial support – such as subsidies and tax breaks – to purchase new equipment, to conduct in-house R&D, and so on. At the same time, the institutional setting could support the firm’s learning and innovation processes by providing technical support – such as public-funded research projects,


External factors

• Providing market information • Pressing the administrative guidance • Creating artificial incentives and constraints

External fit

Firm strategy

• Selecting only the information and incentives that match its own strategy • Initiate and create the changes it desires

Internal fit

Internal factors

LOCAL INSTITUTIONAL SETTING

public research facilities and so on – as well as by facilitating interactive learning with other organizations, as discussed above. Such influences of the institutional setting on a firm’s learning are also important in terms of reducing the degree of uncertainty in the learning process. Learning usually requires a long gestation period and has an unforeseen outcome. Financial and content support provided by the institutional setting could reduce the uncertainty in the learning process. Moreover, the institutional setting could indirectly affect the firm’s trajectory of learning by influencing the firm’s decisions on product/market portfolio and its operational sphere. This is because, as discussed above, the firm’s current activities become the platform on which the firm could develop its competences through the learning-bydoing and learning-by using processes. Therefore, the local institutional setting may further influence the path dependencies of the dependent firms’ learning. In sum, the local institutional setting may enhance or hinder the dynamic strategic fit and learning of its embedded firms by directing their domain of activities as well as by competence backing, competence utilization and learning. Figure 4.2 summarizes the possible influences of the local institutional setting on embedded dependent firms.

• Affecting competence backing • Coordinating/consolidating the individual competences • Providing financial and learning supports

Figure 4.2 Two-way interactions between strategies and local institutional settings


4.2.3.2 Two-way interactions between the firm’s strategy and its institutional setting We have thus far focused on the influences of local institutional settings on the embedded dependent firms. However, the firm is not always passive towards the influences of its institutional setting, but can also be active in taking advantage of the institutional setting to create its own system in a material way (Texier 2000: 33). In a passive manner, the firm reacts to the institutional setting by adapting its own activity. As the institutional setting changes, the firm tries to adapt its strategy to the newly provided incentives or constraints. Taking an active approach however, the firm may select which institutional incentives and/or constraints to take into account on the basis of its strategic intent. The firm thus tries to avoid such institutional influences that might obstruct its strategic goals. Furthermore, in a proactive manner, the firm is able to influence the institutional setting. The firm can initiate and even create the changes it desires in the institutional setting in a strategic way through formal and informal interorganizational channels, such as industrial associations, policy councils and study groups among others. The initiative in these dynamic relations between the firm’s strategy and its institutional setting can change over time depending on the level of the firm’s competence and on the authoritarian nature of the institutional constraints. Therefore, for dependent firms to upgrade successfully, their strategies need to achieve optimal strategic fit and learning effect by taking advantage of the positive influences of their institutional setting, and at least minimizing its negative impact (Figure 4.2).

4.3

The dynamics of upgrading

The preceding sections discussed how each of the determinants affects the prospects for the upgrading of dependent firms in a GVC. Dependent firms are likely to upgrade when lead firms increase the global sourcing, which may provide them with learning opportunities. Dependent firms are likely to upgrade when they not only achieve a static strategic fit, but also formulate viable ‘overextension’ strategies and demonstrate effective learning to remedy their competence gap. Dependent firms are likely to upgrade when the local institutional setting in which they are embedded enhances their dynamic strategic fit and learning. Furthermore, as briefly stated above, these determinants also interact amongst each other and create a dynamic system underlying the upgrading process in a GVC. As these two-way interactions proceed,


the causes and effects of the individual determinants become blurred. This section shows how the individual determinants combine into a dynamic system by summarizing the interactions among the determinants. Nevertheless, some interactions are stronger and more important than others. The interactions among the determinants can be conceptually depicted as in Figure 4.3. (1) As we discussed in section 4.2.3.2, there is a two-way interaction between the dependent firm’s strategies and its surrounding local institutional setting. The outcomes of such two-way interactions often delineate a ground roadmap towards the firm-based late industrialization (FLI); for instance, determining which FLI strategic routes between catch-up and upgrading are to be pursued. (2) The learning potential of a dependent firm is influenced by the lead firm’s sourcing strategies. To learn through global sourcing in the

Global value chain

Lead firm’s sourcing strategies

(4)

(2)

(3)

Dependent firm’s dynamic strategic fit (Embedded) (1)

Local institutional environments

Global value chain Figure 4.3 Interactions among the determinants Note: Refer to the content for the numbers in the figure

(5)


first place, a dependent firm should be selected as a supplier to undertake sourcing activities in a GVC. Once taking part in the GVC, a dependent firm may gain the experience-based learning as well as knowledge and capability transfers from a lead firm. Moreover, as seen above, the nature of global sourcing – cost-reduction or value-creation – also shapes the learning potential of the dependent firm. (3) On the other hand, the lead firm’s decisions about which intermediate goods and/or activities to outsource are influenced by the availability of competent latecomer firms as potential suppliers. A lead firm may outsource a larger amount of work if competent suppliers are easily available. A lead firm may also favour a value-creating sourcing over a cost-cutting one if it anticipates effective learning potential in a dependent firm. (4) The lead firm’s sourcing strategies may be influenced by the local institutional setting in which the potential suppliers are embedded. A latecomer firm subsided by its government, would be more attractive as a supplier than others. More importantly, a lead firm may be attracted to establish a sourcing relation with latecomer firms, which are part of an efficient local industrial network. In so doing, the lead firm can improve and enlarge the knowledge system of its GVC. (5) On the other hand, the local institutional setting may transform itself to better accommodate the lead firm’s sourcing strategies, so that its embedded latecomer firms will have a better chance to be selected as global suppliers. Consequently, these interactions between determinants together create a dynamic system and form a context in which a dependent firm endeavours to upgrade in a GVC (Figure 4.3). Most fundamentally, they systemically create the forces that shape the possibility for a dependent firm to acquire those dual-faceted competences, which would generate higher rent and stronger bargaining power within a GVC. Nevertheless, these systemic interactions among the determinants do not capture the evolutional or the power-related aspect of the upgrading process. As we discussed in section 4.1, the upgrading process in a GVC can be seen as the incremental / path-dependent growth of the dependent firm, whose activity and learning trajectory are controlled by the lead firm. In the empirical part of this study, therefore, we will aim to explore how and why a dynamic system of upgrading has been created, implemented, developed and transformed in the context of Japanese aircraft manufacturers in the post-war era.

5 The Post-war Development of the Japanese Commercial Aircraft Production: Case Study

This chapter carries out an in-depth case study analysis of the postwar development of the Japanese aircraft industry on the basis of the analytical framework developed in the preceding chapter. As we briefly reviewed in Chapter 3, Japan has largely failed with catch-up strategy pursuing firm-based late industrialization (FLI); that is, the Japanese aircraft manufacturers have not been able to gain competitive advantage as system integrators in the finished product market. From the perspective of upgrading FLI strategy, however, they may be said to have been successful in gradually increasing total aerospace production and productivity as well as export of component parts. The Japanese post-war experience offers an apt case to examine both the difficulties and the possibilities of these two FLI strategies in the fast-globalizing commercial aircraft industry. How and why did Japan pursue the FLI catch-up strategy? What are the factors for Japan’s failure to catch up? How and why did Japan shift its FLI strategy towards upgrading? How and why has Japan achieved upgrading of FLI? How have the determinants of upgrading, which we identified in the analytical framework of Chapter 4, influenced the process of Japan’s upgrading both individually and systematically? How has the growth of Japanese aircraft manufacturers been controlled within the GVC? In this chapter, we try to answer these empirical questions by scrutinizing the transformation of the Japanese aircraft manufacturers’ competences and strategies, in relation to the evolution of the historical and institutional contexts. After briefly reviewing the pre-war and wartime period to set out the historical background, we will divide the post-war development of the Japanese aircraft production into four periods: (1) 1952–early 1960s: Japan tried to rebuild the industry through the licensed production of US 111


military aircraft; (2) Late 1950s–early 1970s: Japan pursued a catch-up FLI strategy by the YS-11 national project; (3) Late 1970s–mid 1990s: Japan shifted to an upgrading FLI strategy and achieved a successful outcome within Boeing’s GVC; (4) Late 1990s–present: Japan has become aware of the limitations of an upgrading FLI strategy and has attempted to diversify into different GVCs. Especially, we try to illustrate how and why Japan has been able to seize new opportunities for an upgrading FLI strategy having emanated from the global business transformation in the commercial aircraft industry, which we discussed in Chapter 3. On the basis of our analytical framework, we try to delineate the underlying factors contributing to the failure to catch up in the second period as well as for the success in upgrading achieved in the third period. We also shed light on how Boeing has prevented Japan from growing into a system integrator and therefore potential competitor.

5.1 5.1.1

Historical background Rise and fall of the Imperial aircraft industry

An aircraft was first introduced to Japan in 1910. Only five years later, some military research institutes started licensed production of both airframes and aero-engines by inviting aircraft engineers from France and Britain. Having observed that aircraft were deployed in combat operations in the First World War the Japanese military recognized the strategic importance of aircraft as a crucial factor in the next generation of warfare. Several private aircraft manufactures were established around 1921 – including Nakajima, Mitsubishi, Kawasaki and Kawanishi among others, and they started to take orders from both the Army and Navy. Each manufacturer signed licensing agreements with leading French, German and British firms to assemble modern aircraft and engines in Japan. Before and during the Second World War, the Japanese aircraft industry rapidly modernized and expanded under the aggressive promotion of the imperial military. The Japanese imperial military tried to accelerate the development of an independent aircraft industry after its naval force was limited by the Washington Naval Limitation Treaty of 1922 and the London Naval Arms Limitation Agreement of 1930. The military adopted the ‘Independent Aircraft Technology Plan’ in 1932, in which it declared that it would henceforth procure only aircraft and engines designed by Japanese engineers. In particular, the Imperial Navy – principal target of the arms reduction treaties – created the ¯ Naval Air Arsenal (Kugish¯ o) in 1932, to coordinate the development of

Japanese Commercial Aircraft Production: Case Study 113

independent aircraft technology. To nurture the design and production capabilities of aircraft manufactures, both the Imperial Army and Navy ordered various types of military aircraft and engines. Due to jurisdictional disputes, the Army and Navy refused to share technology or even manufacturers1 until Japan entered the Second World War. Nevertheless, they both made their manufacturers compete for orders through prototype production. To be successful, the manufacturers had to satisfy the high performance requirements set by the military. As the result of determined promotion by the Military together with the manufacturers’ diligence in improving their technological capabilities, the Imperial aircraft industry had produced several outstanding attack planes and engines by the time the Pacific War broke out. Mitsubishi’s legendary ‘Zero’ fighter equipped with Nakajima’s ‘Sakae’ engine was introduced in 1935 and dominated the skies in battle in the early years of the Pacific War. It demonstrated the superior Japanese technology – at least of a small fighter aircraft and engine – around 1940. In terms of production scale, annual aircraft production jumped more than 60 times from merely 445 planes in 1930 to 28,180 planes in 1944, and the total production during those years amounted to 88,920 planes (The United States Strategic Bombing Survey 1947: 155) (Figure 5.1). It should be noted that this stunning success of independent aircraft technology and the rapid expansion of production scale during this period 30,000

Number of aircraft

25,000 20,000 15,000 10,000 5,000 0 1930

1935

1940 Year

Figure 5.1 Japanese aircraft production 1930–1945 Source: The United States Strategic Bombing Survey (1947: 155)

1945


would become a source of post-war nostalgia of many Japanese for the Imperial aircraft industry, as we shall see later. However, Japanese superiority in the air battle began to decline in 1942 as the USA introduced cutting-edge fighters – such as the P51 ‘Mustang’ and the F6F ‘Hellcat’ – as well as large bombers such as the B29. This was partly because the Japanese manufacturers had to place precedence on increasing the number of aircraft produced rather than improving their aircraft technology, in response to the three ‘production expansion orders’ from the military. Indeed, a total of 62,400 military aircraft were produced during the Pacific War (1941–1945), accounting for three-quarters of the total number produced since 1932 (Adachi 1981: 9). Towards the end of the Second World War, the Japanese aircraft production became chaotic and its technological limits became apparent. Reviewing the problems of the Imperial aircraft industry in ¯ the post-war, the leading Kugish¯ o engineers succinctly pointed out the following weaknesses among others:2 • Although the Japanese aircraft engineers achieved Western technological levels in one after another functional area, their knowledge often remained shallow and disjointed. • They had not yet mastered mass production when production expansion orders were issued, and so the designers and production workers were in unfamiliar territory. • Military conscription deprived the factories of skilled workers and quality materials. • Inefficiencies resulted from jurisdictional disputes between the Army and Navy. • Basic technological expertise required further support and development. When Japan was defeated in 1945, its Imperial Aircraft Industry was the fifth largest in the world; comprising 12 airframe makers and seven engine makers, together with one million employees (Society of Japanese Aerospace Companies 1985: 4). However, it turned out to be impossible for an industrially backward Japan to keep up with the top levels of the world aircraft industry, which demanded high technological levels in a wide range of related industries.

5.1.2

The seven-year prohibition of aircraft activity

One of the first tasks the US Occupation executed was to dismantle the Japanese aircraft industry, which symbolized Imperial military power.


In November 1945, the Occupation banned all aircraft and aerospace component manufacture, repair, instructing, research and testing. All aircraft production and research facilities were seized for reparations or destroyed. The large aircraft manufactures were broken up into several small firms and forced to produce non-military products, such as bicycles, agricultural tools and motorcycles amongst others. This prohibition of all aircraft activity lasted for seven years which later became ¯ known as the ‘seven-year blank’ (Nana Nen no Kuhaku) in the history of Japanese aircraft industry. This ‘seven-year blank’ was a critical period of dramatic advancement in world aircraft technology. It was the dawn of the jet age. Military jet aircraft became prevalent from around 1946. Also, the first commercial jet airplane, the Comet of the British De Havilland, was introduced into the market in 1952. The appearance of a jet airplane brought about a technological revolution not only in aero-engines, but also in airframe design, wing structure, materials and production process among others. This was because a jet aircraft flies much faster than a propeller aircraft. High flight speed poses the new technological challenges in aerodynamics; such as how to avoid the shock wave around the wings, or how to control high temperatures in engines and on airframe surfaces (Adachi 1981: 11). Having missed such a critical period of technological advancement, Japan suffered a critical handicap when it was allowed to resume aircraft activity in 1952. The ‘seven-year blank’ irrevocably handicapped post-war development of the Japanese aircraft industry. Nevertheless, the industrial base, which had expanded rapidly during wartime, was not completely destroyed. Each of the dismantled aircraft manufacturers would be reunited soon after the prohibition on aircraft activities was lifted. The successors of the three largest manufactures during wartime – Nakajima, Mitsubishi and Kawasaki – eventually reemerged as Fuji Heavy Industries (FHI), Mitsubishi Heavy Industries (MHI) and Kawasaki Heavy Industries (KHI) respectively (Table 5.1). As we shall see later, these three so-called ‘heavies (Juko)’ would continue to be the central force spearheading the post-war development of the Japanese aircraft industry. There is therefore some degree of continuity from the pre-war to the post-war era, in terms of industrial structure – such as collaborative research institutions and close state-industry relations – as well as the manufacturers’ resources and capabilities – such as capital, production facilities and engineers.3

116 The Challenges of Late Industrialization Table 5.1 Relative importance of Japanese aircraft and aero-engine producers 1941–1945 Firm

Airframes

Nakajima Mitsubishi Kawasaki Tachikawa Aichi Nippon Kyushu Manchuria Nippon International Kawanishi Hitachi Tachiarai Fuji Showa Tokyo Mitsui Mining Matsushita Ishikawajima Nissan Auto Toyota Auto

19,561 12,513 8,243 6,645 3,627 2,882 2,620 2,196 2,134 1,994 1,783 1,220 871 616 258 17 4

Subtotal Navy air depots Army air arsenal

67,184 1,700 1,004

Total

69,888

(%)

Aero-engines

280 179 118 95 52 41 37 31 31 29 26 17 12 09 04

24 14

(%)

36,440 41,534 10,274

31.3 35.6 8.8

1,783

1.5

2,169 837

1.9 0.7

13,571

2,286 1,633 160

2.0 1.4 0.7

110,686 4,452 1,439

3.8 1.2

116,577

Source: The United States Strategic Bombing Survey (1947: 156–7)

5.2

Rebuilding the industry (1952 to early 1960s)

On 9 April 1952, the US Occupation (SCAP) lifted the ban on aircraft and component production in Japan. This was mainly due to changes in post-war Asian geopolitics and the rise of the US containment policy against communism. Facing the naissance of communist China and the military aggression of communist expansion during the Korean War, the US decided to rebuild Japan militarily and economically in order to make it ‘a bulwark against communist expansion in Asia’. After seven years of frustration, the Japanese government and aircraft manufactures were yearning nostalgically for the aircraft engineering and industry which was part of their wartime legacy, and they quickly moved to re-establish the institutions and production facilities to rebuild the aircraft industry.


5.2.1

Origins of the local institutional setting

Even before formal resumption of the aircraft industry, the bureaucracies were struggling for control over jurisdiction over the industry. The Ministry of Transportation (MOT) was in charge of civil aircraft production during the war, and had also been given jurisdiction for aircraft operations by SCAP4 during the 7-year prohibition period. Consolidating its jurisdiction over the aircraft industry, MOT drafted an Aircraft Law, which would direct not only operational matters, such as type certification, but also production matters, such as a manufacturer’s technological and production facilities’ certification. However, this Aircraft Law was opposed by the Ministry of International Trade and Industry (MITI), which tried to monopolize jurisdiction over all post-war industrial production. As soon they discovered the MOT’s intention, MITI quickly moved to set up a special task force for aircraft production administration and drafted the Aircraft Manufacturing Law countering the MOT’s Aircraft Law. In July 1952, the Diet5 passed both the MOT’s Aircraft Law and MITI’s Aircraft Manufacturing Law, but it divided aircraft administration, recognizing MOT jurisdiction for the airline’s operational activities and MITI jurisdiction for the manufacturers’ production activities. Such bureaucratic rivalry and jurisdictional divisions have lasted throughout the post-war period and decisively influenced the institutional setting. More specifically, they put the Japanese aircraft manufacturers under the strong control of MITI and its industrial policies. The Aircraft Manufacturing Law enabled MITI to use fiscal measures, including depreciation benefits and subsidies, and administrative guidance to coordinate entrepreneurial activity and manage distribution of work and technological diffusion in the industry (Samuels 1994: 204). Nevertheless, MITI’s jurisdictional monopoly over aircraft production prevented manufacturers from collecting up-to-date information about the end-users, that is, airline operators, who were under the jurisdiction of the MOT. As will be seen later, this caused some fundamental problems in the design and production of the first and only Japanese indigenous civil aircraft, the YS-11 (Yamamura 1995). Meanwhile, the relationships among the firms themselves as well as between the firms and the government gradually became closer. Responding to the formal resumption of aircraft activities, nine companies which had engaged in aircraft production in the prewar period created a discussion group in July 1952. This private group provided the basis for intra-industrial collaboration, which later developed into a formal industrial association, the Aircraft Industry


Association in 1954. Keidanren (the largest cross-industrial business association in Japan) also established a Defence Production Committee (DOC) in 1952. On the public side, MITI established an aircraft division – ¯ Bukika) – within later called the Aircraft and Ordinance Division (K¯okuki its Heavy Industries Bureau. MITI furthermore modified the Aircraft Manufacturing Law in 1954 to gain a tighter grip over the industry, aiming to avoid over-investment in the industry by facilitating collaboration between the firms. A communication channel between the firms and the government was also established with the creation of the Aircraft Production Council (Shingikai) in September 1952. The Aircraft Production Council has developed into an important forum, where MITI and the aircraft manufacturers sit together and discuss crucial issues concerning the industry’s development. Thus, the seeds of the local institutional setting quickly sprouted to affect aircraft manufacturers in the first couple of years after the post-war resumption of aircraft activities in Japan.

5.2.2

Learning through licensed production

The aircraft manufacturers started rebuilding their production capabilities through repair and maintenance contracts from the US Force stationed in Japan. The first such contract went to Showa Aircraft in July 1952 for the overhaul of US Navy liaison planes, trainers and transports. Kawasaki started entering into similar contracts with the US Air Force in December 1952, followed by Mitsubishi in 1953 and Shin-Meiwa in 1955. At the same time, Japanese component vendors (including Nihon Musen, Kabaya and Fuji Precision) started repairing US equipment. These activities enabled the Japanese aircraft manufacturers to advance their aircraft engineering skills rapidly, but also confronted them with the harsh reality that their aircraft technologies were far behind those of Europe and North America following the seven-year prohibition period. Studying technological papers sent from the United States and by visiting aircraft factories in the United States, the Japanese manufacturers learned the new methods of process engineering, such as tooling, inventory and quality management.6 These US military orders were also crucial in re-establishing the financial bases of the aircraft business in Japan.7 For the next step in improving their modern aircraft manufacturing capabilities, the Japanese aircraft manufacturers engaged in the licensed production of the US military aircraft. The first licensed production took place when FHI started to produce the Beech Aircraft’s T-34 trainer (a single propeller plane) in 1954 (Table 5.2). The T-34 was later upgraded

Japanese Commercial Aircraft Production: Case Study 119 Table 5.2 Licensed aircraft manufacturing in post-war Japan Year

Model

Type

Licensor

Licensee

Units Produced

1954 1955

B-45 (T-34) F-86F

Single propeller Jet

FHI MHI

162 300

1955 1957 1959 1961

T-33A L-19 P2V-7 F-104J

Jet Single propeller Large piston aircraft Jet

KHI FHI KHI MHI

210 22 48 230

1969

F-4EJ

Jet

MHI

140

1981 1981

F-15J/DJ P-3C

Jet Large turbo-prop

Beech Aircraft North American Lockheed Cessna Lockheed Lockheed McDonnell Douglas McDonnell Douglas Lockheed

MHI KHI

199 105

Source: SJAC (2002b: 36)

by the T-1, which was the first jet plane indigenously produced in postwar Japan. Licensed production became the core activity for the Japanese manufacturers after they were offered licenses for the North American F-86 and the Lockheed T-33 trainer. MHI and KHI were appointed prime contractors for the F-86 and T-33 respectively in June 1955, but their production processes were largely shared with other manufacturers under the administrative guidance of MITI. The total costs (in current price) for licensed production of F-86 and T-33 together amounted to 56.6 billion yen; and they had produced 300 F-86 by February 1961, and 210 T-33 by March 1959. These license contracts opened significant opportunities for Japan both in terms of financial benefit and technological development. Licensed production was enthusiastically supported by the United States, which wanted Japan to bear more of the military burden in postKorean War Asia. Furthermore the United States offered subsidies to assist Japanese production of the T-33 trainer (70 million yen (in current price) each plane) and the F-86 fighter (150 million yen (in current price) each plane) (Society of Japanese Aerospace Companies 1985: 23). The subsidies were offered under the terms of the Mutual Defence Assistance Agreement (MDA). The MDA created a scheme to appropriate $50 million earned from selling maize to Japan for ‘strengthening the Japanese defence production and industry in general’ (Adachi 1981: 12). The United States would finance more than half the production cost of Japan’s first post-war jet fighter.


5.2.2.1

Indigenization process

The Japanese manufacturers were aggressively sought to absorb modern technologies through licensed production by increasing the rate of indigenization in the ‘phase-in procedure’ (Hall and Johnson 1970: 320). The first stage of both the F-86 and T-33 programmes began with licensees simply assembling knockdown kits supplied by the licensors. Knockdowns were replaced by shipments of component parts in the second stage when the licensees’ own assembly tools had become completely operable. As production tooling was completed, Japanese manufactured parts were used in assembly in the third stage. The US licensors generously transferred production technologies to the Japanese manufacturers especially during the early stages of the programmes.8 Japanese licensees received all product and process designs and specifications, a great deal of planning information as well as the statistical quality control technique, which was first introduced to Japan at that time. Technical assistance included not only the formal data on tooling and tool design, but also the informal data written in the notes and black books of foremen and other production line personnel. Mitsubishi modernized its production facility with F-86 tools directly supplied from North America’s factory in Columbus, Ohio. Kawasaki also received approximately 2,000 separate tooling designs from Lockheed (Hall and Johnson 1970: 316–17; Samuels 1994: 209). In this way, Adachi (1981: 12) asserts that Mitsubishi and Kawasaki’s production operation and management techniques came to surpass their pre-war capabilities.9 The rate of indigenization rose as the Japanese manufacturers assumed full manufacturing responsibilities with US material support primarily limited to ‘hardcore’ items, which were defined as those items ‘beyond the capability of the Japanese industry to produce or economically unfeasible for production in Japan’ (Hall and Johnson 1970: 322). The indigenization rate eventually reached about 60% for F-86 and 65% for T-33 by the end of their production (Society of Japanese Aerospace Companies 1985: 13). Indigenization was the Japanese manufacturer’s core strategy for mastering the licensed technologies. According to Jirô Horikoshi, the legendary chief designer of the Mitsubishi Zero fighter, components would be indigenized under three general conditions: (1) when production, operations, and maintenance would be hindered if a domestic source were not available; (2) when components could be produced economically by Japanese facilities and technologies, and (3) when these components and technologies could ‘be frequently utilized in later aircraft, missile, and other industr[ies]’ (quoted in


Samuels (1994)). Through their indigenizing efforts Japanese aircraft manufacturers built the foundation for manufacturing capabilities and facilities. Indigenizing strategy was more aggressively pursued in the subsequent two licensing projects. In September 1957, Kawasaki received approval to produce the Lockheed P2V-7 anti-submarine/search aircraft under license.10 A total of forty-eight P2V-7 were manufactured, and its domestic content had reached 95% when it was replaced by its successor, the P2-J in 1969 (Society of Japanese Aerospace Companies 1985). Another project was license production for Japan’s next-generation FX jet fighter, the successor of the F-86. The Lockheed F-104 design was selected for the FX from several candidates in 1958 for commercial, political and technical reasons.11 The prime contract went to Shin Mitsubishi Heavy Industries, which would first assemble seventeen knockdown kits and then proceed to licensed production of 160 F-104Js.12 Indigenization of the F-104 was firmly pursued from the beginning of the project, even when it was more expensive than importing. Accordingly, 60% of the original F-104 budget (excluding engines) was appropriated for indigenization. Overall, the domestic content of the final F-104 production was 70% (ibid). The Japanese aircraft manufacturers succeeded in dramatically raising their competence through the indigenization efforts of the P2V-7 and the F-104, which were respectively the first aircraft with on-board electronic computers and the first supersonic jet fighter manufactured in Japan. One estimate, for example, showed that the ratio of technology purchased abroad to total aircraft R&D spending in Japan fell from 70 to 45% between 1961 and 1962 alone.13 Overall, the licensed production of US military aircraft during the first ten post-war years played a decisive role in rebuilding and modernizing the Japanese aircraft industry.

5.3 Failure to catch up by the national project (late 1950s to 1970s) Although Japanese aircraft manufacturers benefited enormously from the licensed production explained above, they also began to realize the limitations of licensed production as a strategy for the industry’s further development. From around 1956, both MITI and the manufacturers started raising their voices, asserting that passive dependence on licensed production of military aircraft handicapped the long-term development


of the Japanese aircraft industry. Such criticisms could be summarized as follows: (Mowery 1987: 7–9; Maema 1999: 119–120): 1. Aircraft produced under license would be out of date because they had been developed long before Japan started producing them. It is sometimes not worth paying an expensive license fee for obsolete technologies, particularly in the fast advancing field of electronics. 2. However licensing more up-to-date aircraft also incurs economic and technological problems. The more up-to-date the aircraft, the more expensive the license fee would be. Further, those components based on cutting-edge technologies are usually designated ‘hard core’ items and remain ‘black-boxed’ – inaccessible to licensees. 3. Licensed production would not contribute to improving the R&D and design capabilities of Japanese engineers. Even though the technical R&D data are made available by a licensor, the licensee engineers would not acquire sufficient knowledge to sustain innovation, which is largely experience-based knowledge – only attainable through a trial-and-error process. Searching for a way to overcome the constraints of licensed production, policy makers decided to pursue the catch-up strategic route towards FLI. During the 1960s, the catch-up FLI strategy resulted in a national project of the YS-11. It mobilized all the participants in the Japanese aircraft industry in order to promote the indigenous development and production of a medium-sized commercial aircraft. The present section examines the rise and the fall of the YS-11 project, which resulted in the failure to catch up in the finished product market for commercial aircraft. The YS-11 project brought home to both policy makers and manufacturers the acute difficulty of overcoming the entry barriers to the finished product markets. Nevertheless, the precious experience of the YS-11 project had provided a solid foundation on which the Japanese aerospace industry participants later upgraded their capabilities as significant suppliers in the international collaboration projects, which will be covered in the forthcoming sections.

5.3.1

Rise of the catch-up FLI strategy

¯ Akazawa Shoichi, the MITI Aircraft and Ordnance Division director, was the original promoter of the idea to develop and build an indigenous commercial aircraft. He enthusiastically promoted his idea to influential


politicians and the Ministry of Finance by arguing the following three points (Adachi 1981: 18–19; Samuels 1994: 210–11): 1. The aircraft industry is a high value-added and high precision industry. It also has a broad base of different industries, so the diffusion of the technology developed will be very great. 2. Depending solely on military demands makes the industry vulnerable to unstable military budgets. Production of a commercial aircraft would help to secure a stable scale of production in the long run. 3. Production of a commercial aircraft would help to improve the balance of payments. Since Japan was banned from exporting military aircraft, it needed to promote the commercial sector of the industry. Meanwhile, the export market was expected to develop a medium local aircraft to succeed the DC-3, of which more than 13,000 units had been produced. Domestic air travel was also expected to increase rapidly; so domestically built aircraft would curtail the commercial aircraft imports. Akazawa therefore tried to embrace the ‘catch-up’ strategy of FLI – directing the Japanese aircraft manufacturers to challenge the finished product market directly. He urged strong government support for them so as to make them independent in commercial aircraft production. Nevertheless, as discussed in section 3.1.3 the catch-up strategy entails high risk because the latecomer firms – in this case the Japanese aircraft manufacturers – must create and control their own value-chain with sufficient effectiveness to overcome the barriers to entry. Indeed, both MITI and aircraft manufactures were sceptical of Akazawa’s grand idea. When senior managers and engineers saw the Lockheed and the North American factories, they became acutely aware of the wide technological gap between American and Japanese manufactures. However, as Maema (2002) points out, Akazawa did not fully understand the significance of this technological gap because he lacked an engineering background. He also felt strong nostalgia for the wartime glory of the Imperial air force, particularly the Zero fighter (Maema 2002: 165). He therefore bluntly refused licensing offers from foreign manufactures, such as Fokker, who had already introduced the Friendship F27 into the medium-size transport aircraft market.14 Akazawa’s grand idea began to take shape through the typical ‘Japanese style of negotiation’. Akazawa first held an informal meeting in a Tokyo restaurant with senior managers from each of Japan’s heavy industrial and aircraft-related companies. Informal meetings involving


government agencies, firms, parts suppliers, users and research institutions continued throughout the year of 1956. Akazawa’s persistence gradually gained sufficient support both within MITI and from the private sector. After cabinet ministers had been lobbied persistently, the government eventually decided to appropriate 35 million yen in direct subsidies (hojokin) for design research of a medium-size commercial transport plane in fiscal year 1957 (Samuels 1994: 211; Maema 1999: 82–3).

5.3.2 The YS-11 project: formation of the local institutional setting15 The catch-up strategy of FLI started to acquire institutional substance ¯ oki when the Commercial Transport Design Research Association (Yus¯ Sekkei Kenkyu¯ Ky¯okai, hereafter Yuken) was established in 1957 by the Aircraft Industry Association under the auspices of MITI.16 Yuken was a prototype for the local institutional setting which developed later, in which the public and private sectors of the industry collaborated closely. The chairman of Yuken, Soda Taizo, was chief of MHI’s aircraft division. He was joined by managers from eighteen airframe, component, materials and precision equipment manufacturers. Senior Liberal Democrat Party politicians were appointed as ‘advisers’. By early 1958, a technology committee had been established; study teams conducted operational research to decide the fundamental design of the planned aircraft. The committee’s senior members included the ‘all-star’ team of legendary aircraft designers from wartime, who were dubbed the ‘Five Samurai’.17 They played a strong leadership role in decisions regarding fundamental design; but, as will be seen later, this would become a factor which delayed the project. Participating firms undertook joint research with Yuken in planning, propulsion, airframe, components, design, wind-tunnel testing and real-size model building. On the basis of the operational research and the accumulated data on foreign practices, Yuken set the basic specification of the planned aircraft as a medium-sized turbo-prop, capable of carrying around 60 passengers. The planned aircraft was named the YS-11 after the code numbers of its basic specifications. The YS-11 project was formally covered by the national budget after MITI drafted and the Diet passed the Aircraft Industry Promotion Law ¯ K¯ogy¯o Shink¯o H¯o) in May 1958. The Promotion Law designated (K¯okuki the YS-11 a national project and authorized funding for its design, development and manufacture. Furthermore, the government-industry consortium, which had been developed around Yuken, metamorphosed


into a national policy company (kokusaku gaisha), the Nihon Airplane Manufacturing Company (Nihon Kokuki Seizo Kabushiki Kaisha, hereafter NAMCO) in June 1959. The government held half the equity, with the remainder held by six ‘manufacturing partners’18 (20%) and a larger number of nominally unrelated firms, such as electric utilities, trading companies, banks and so on. Of the NAMCO equity allotted to manufacturers, MHI held 51%, KHI 26%, and FHI 13%. NAMCO, as a national policy company, guaranteed returns to the participating manufacturers. MOF was initially against the establishment of the national policy company, which would rely on the government for the total cost of prototype manufacture – expected to be more than 3 billion yen. Instead MOF preferred a single private national champion. MITI and the aircraft manufacturers overruled MOF’s reservation on the basis of the following three arguments: 1. In terms of technology, facilities or financial resources, no single aircraft manufacturer could independently carry out prototype manufacturing and mass production of a medium-sized aircraft. 2. In order to achieve an internationally competitive cost, instead of making a new investment the existing facilities of each manufacturer would have to be coordinated and effectively used under the framework of a national policy company. 3. The manufacturers’ commitment to the project would not be possible without a guarantee of strong government support. While NAMCO was responsible for testing and sales, the six manufacturers undertook research, design and manufacturing as subcontractors: MHI, forward fuselage and final assembly; KHI, main wings; FHI, tail section; Shin-Meiwa,19 rear Fuselage; Showa, honeycomb structures; and JAMCO, ailerons and flaps. Aero-engines were purchased from Rolls Royce, and 150 aircraft were planned to be manufactured between 1963 and 1970. In the process of preparation for the YS-11 national project, therefore, the local institutional setting came to be embodied and consolidated in a way suitable for pursuing the catch-up FLI strategy. Figure 5.2 illustrates the relationships between the main actors in the Japanese aircraft industry during the years of the YS-11 project. Participating manufacturers maintained close and collaborative inter-firm relationships under the auspices of NAMCO. MITI and the aircraft manufacturers maintained formal lines of communication through joint-membership of the advisory council (shingikai) and the equity sharing of NAMCO. The


MITI Influence

Membership Equity share

Aircraft Industry Association

Influence NAMCO

Aircraft Advisory Council

Equity share Loan of employees

Coordination Membership

Membership Manufacturing partners MHI, KHI, FHI, Nippi, Shin-Meiwa, Showa

National aeronautic laboratory Technical support

Figure 5.2 Local institutional setting of the YS-11 Project

Aircraft Industry Association collected the views and acted as the voice of the private sector in the Japanese aircraft industry. Public sector players in the industry, particularly MITI, often took such voices of the private sector into consideration in policymaking. Such close public–private relationships and the collaborative inter-firm network are often known as the ‘All-Japan Consortium’. Nevertheless, what must be emphasized is that MITI exerted the dominant influencing power over the aircraft manufacturers both in the sphere of formal legislation and in administering informal ‘administrative guidance’. In other words, MITI ‘directed’ the aircraft manufacturers in the YS-11 national project.

5.3.3

Why did the YS-11 national project fail to catch up?

Despite the enthusiasm of the supporters of the national project both in MITI and the industry, the YS-11 project was suddenly terminated in 1974 after 182 aircraft had been built and sold. The outcome of the project was mixed. It was very poor in strict business terms since its loss exceeded 36 billion yen (in current price of 1974). In technological terms however, many assert that the project was a great success, advancing the Japanese aircraft industry’s production and assembly skills tremendously. What is clear, however, is that the YS-11 national project did not achieve catch-up in the commercial aircraft finished product market. In this and the following sections, we will try to argue, on the basis of our analytical framework developed in Chapter 4, that the YS-11 project failed to catch up because the Japanese aircraft manufacturers largely lacked the strategic fit for overcoming the high barriers to entry of the


finished product market. Furthermore, the dominant role of the local industrial setting in the YS-11 project distorted the strategic management of participating manufacturers.

5.3.3.1

Lacking the strategic fit for catch-up

As to their domains of activities (see section 4.2.2.1), in the YS-11 project the Japanese manufacturers set their product/market portfolio on a medium-sized turboprop transport, which would operate on short distance local routes and required only short take-off and landing facilities. This strategic decision followed assessment of the market and operational research conducted by Yuken as explained earlier. It targeted the market vacated by the aging DC-3, especially in Japan and South East-Asian countries, since air travel in those countries was expected to expand rapidly with the growth of their economies. Yuken emphasized the importance of the short landing capability for serving most airports on the targeted routes. Turboprop propulsion was chosen over the newly developed pure jet engine because, in addition to their lack of experience with jet aircraft production, they considered the turboprop more economical for short distance flights. Such product/market targeting of the YS-11 project might have been reasonable at the beginning of the project. However, it was undermined by the delay in the YS-11’s market introduction due to many design changes and technological problems. For instance development progress was delayed when the NAMCO designers changed the aircraft’s fundamental design drawn by the ‘Five Samurai’ of Yuken. Yuken’s fundamental design was deemed too light and too small to achieve the expected performance targets. It was rather a ‘rose-coloured’ design developed to convince the politicians and the MOF of the costperformance of the YS-11 in order to secure the government subsidies.20 Such development delays reduced the YS-11’s market value while its direct rival product – the Fokker Friendship 27 – increased its market share;21 and the short-ranged pure jet planes – such as the BAC111 and the Fellowship 28 – started appearing on the market from 1960. When the YS-11 finally appeared on the market in 1965, many critics called it an obsolete turboprop model (Maema 2000). When it came to the operational sphere (see section 4.2.2.2), the YS11 project attempted to cover all activities throughout the value chain of a commercial aircraft because it intended to be as independent as possible. There was a division of labour between NAMCO and the participating manufacturers: the Yuken/NAMCO consortiums undertook the


design stage of the product-related activities and all stages of marketrelated activities, while the participating manufacturers were responsible for actual manufacturing (Figure 5.2). However, this broad operational sphere was far beyond the Japanese manufacturers’ cumulative levels of competence. They faced a large competence gap and a steep learning curve in order to achieve catch-up in the finished product market. As for productrelated competences, the Japanese manufacturers could not control the key technologies because they were largely ‘black-boxed’ in the licensed production of the US F-86 fighter, the T-33 trainer and the succeeding F-104 fighter and P2V-7 antisubmarine/search aircraft. Their skills were especially weak for cockpit and electrical systems, which had advanced globally much faster than structural technology. In fact, the YS-11 cockpit was a copy of the DC-7, but with Japanese components substituted to some degree. Despite the national project emphasis on indigenous development and production, licensed products accounted for 14% of the YS-11 while imported components accounted for fully 42% (Samuels 1994: 385–6). Moreover, the YS-11 project was the first commercial aircraft production venture for Japanese manufacturers who only had experience of military procurement. The knowledge spin-off from military aircraft production was far less than the policy makers, MITI in particular, had originally expected. In the 1960s and 70s, Japan indigenously produced four military aircraft – the PS-1 marine patrol/ rescue flying boat, the C-1 transport, the T-2 trainer and the F-1 fighter. Two US military aircraft – the F-104 fighter and F-4 fighter22 (Table 5.2 and Table 5.3) were also produced under licensing. There are two main bottlenecks restricting technological spin-off between military and commercial production. One is a general difference in the concepts of military and commercial aircraft. While military aircraft production emphasizes high offensive performance above all, commercial aircraft production has to achieve not only a high level of safety and reliability, but must also provide for passenger comfort and ease of operational maintenance. Another is that the most crucial and cutting-edge technologies remained ‘black-boxed’ in the licensed production, as mentioned above. The military production significantly advanced the manufacturers’ competences in system integration and component manufacturing. However they were often irrelevant or insufficient for the development and production of a modern commercial airplane. Japanese manufacturers were especially weak in process technologies and management techniques for the mass production stage because the total production

Japanese Commercial Aircraft Production: Case Study 129 Table 5.3 Indigenous aircraft production in post-war Japan Starting year

Model

Type

Development & manufacture

Volume

KHI KHI FHI FHI FHI NAMCO MHI KHI FHI ShinMaywa Develop: NAMCO Manufacture: KHI MHI ShinMaywa MHI FHI FHI MHI Develop: JADC Manufacture: CTDC

4 2 27 66 66 182 757 83 299 23 31

(Joint development with Boeing) 1980 T-4 Jet plane 1987 T-5 Turbo prop plane 1992 B777 Jet plane

KHI FHI JADC

175 36 275

(Joint development with Boeing) 1995 XF-2 Jet plane

MHI

1953 1953 1954 1958 1960 1964 1965 1965 1966 1968 1971

KAL KAT L

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