Knowledge-intensive industries: when location matters.

 creative industry The rising share of intangibles in global economy highlights the crucial role of innovative, knowledge-intensive businesses. Creative industries, which produce software, games, movies and music, seem to disperse globally their value chains to leverage capabilities that appear to be specific to certain regions of the globe. These industries take advantage of very strong cluster effects, as exemplified by creative centers such as Hollywood, Hong Kong and Mumbai (film industry), New York and London (media business), the northern part of Italy (clothing, style and fashion segments) and Silicon Valley (internet, technology companies and venture capital). Cluster effects enhance competitive advantage of firms by dispersing their creative endeavors, tapping into multiple centers of excellence and coordinating knowledge across geographic space. Therefore, geographical dispersion of value creation has an important role in the analysis of creative industries, which need to understand the effects of this dispersion on the creation and the use of intellectual assets. However, along the location dimension there is the dispersion of firm´s activities: companies are increasingly implementing strategies to take advantage of the comparative advantages of locations. This results in a wider geographic dispersion of firms’ activities, with direct implications for the future of creative industries’ global value constellations.

Ram Mudambi, in an interesting article published in the Journal of Economic Geography covers the issue of value chains in industries which value creation is disproportionately based on creative, specialized, non-repetitive activities. The author admits that there are two distinct strategies with regard to the control of the value chain. The first, Vertical Integration Strategy, emphasizes taking advantage of ‘linkage economies’ whereby controlling multiple value chain activities enhances the efficiency and effectiveness of each one of them. The second, Specialization Strategy, focuses on identifying and controlling the creative heart of the value chain, while outsourcing all other activities.

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Value chain: 

Knowledge within the firm’s value chain can be broadly grouped into three categories: the upstream (input) end, the downstream (output or market) end and the middle. Activities at the upstream end generally comprise design, basic and applied research and the commercialization of creative endeavors. Functions at the downstream end typically comprise marketing, advertising and brand management and after-sales services. Tasks in the middle comprise manufacturing, standardized service delivery and other repetitious processes in which commercialized prototypes are implemented on a mass scale. At this point, an important question arises: Which activities or operations a firm should retain control over? Needless to say that firms should keep in-house the activities that create and appropriate the most value. Because of advances in IT&C (Information Technology & Communications), activities can disaggregate processes into progressively finer slices. As Mudambi affirms, firms are able to specialize in increasingly narrow niches, which need not even be contiguous in the value chain.

Location: value-added and the value chain

Processes supporting mass customization have become widely available and subject to rapid imitation, an issue that reduces the profitability of the productive function.  As a consequence, firms are finding that value-added is becoming increasingly concentrated at the upstream and downstream ends of the value chain.  Activities at both ends of the value chain are intensive in their application of knowledge and creativity. The pattern of value-added along the value chain may, therefore, be represented by the ‘smiling curve’.

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Figure 1. Smiling Curve of value creation (Mudambi, 2007)

Nike provides a good example of the smiling curve. The company outsources the tangible part of the business, the manufacturing activity, while manages in-house the highly creative design and marketing activities. Nike controls the two ends of the value chain. Auto manufacturers also show this same characteristic; major manufacturers develop design and marketing in advanced market economies and assembly in emerging market economies. In addition, auto firms buy parts from external, smaller providers.

Development of competencies

Mudambi notes that firms controlling various activities within the value chain have different incentives. Their responses to these incentives generate processes that change economy-wide patterns of economic activity. These processes can be broadly grouped into three categories labeled as ‘catch-up’, ‘spillover’ and ‘industry creation’, as can be seen in Figure 2.

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Figure 2. Dinamic analysis of value creation (Mudambi, 2007)

Catch-up: Firms controlling activities in the middle of the value chain have strong incentives to acquire the resources and competencies that will enable them to control higher value-added taks. These incentives explain why companies from emerging market economies like China, India, Brazil and Mexico are moving to develop their own brands and marketing expertise in advanced economies in order to increase their control over the downstream end of the value chain. Locating their R&D and marketing operations in advanced market economies also enables them to increase their absorptive capacity; in other words, they are attempting to develop capabilities to “catch-up” with rivals based in advanced market economies. Brazil´s Natura offers a good example: the firm opened a shop in Paris in order to learn first-hand the most advanced trends in cosmetics

Spillover: Because companies that control both ends of the smiling curve face increasing competition from new entrants from emerging market economies that intent to catch-up, firms from advanced economies modularize standard activities from both the upstream and R&D and downstream marketing activities. These activities can then be relocated to emerging market economies. The high value-added local activities of such multinational enterprises (MNEs) create knowledge ‘spillover’ into emerging market economies.

Industry creation: As Ram Mudambi points out, new industries emerge from basic and applied R&D at the upstream end (e.g. biotech, nanotech) and through marketing and distribution innovations at the downstream end (e.g. e-tailing, online auctions).. The process of ‘industry creation’ is the manifestation of Schumpeter’s gale of creative destruction. It accelerates obsolescence in advanced market economies and pressures some sunset industries to relocate to emerging market economies.

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Final question for the curious minds:

Do you know any multinational from emerging markets that dominates the high-value activities and outsources manufacturing activities to other countries?

REFERENCES:

Location, control and innovation in knowledge-intensive Industries. MUDAMBI, R. Journal of Economic Geography 8 (2008) pp. 699–725

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