Can component manufacturers outgrow themselves?

Original equipment manufacturers that are dependent on lead firms for technological and branding assets are less likely to invest in innovation and upgrade themselves, but here is how to break the chain

By Putro Harnowo, Senior Content Manager, China Business Knowledge @ CUHK

The world has become so connected that cross-border collaboration is essential in today’s businesses. Take a look at the global chip shortage in the past few years, which has proven how the global value chain has become a dominant feature of the economy. This crisis highlights the need for multinational companies to enhance collaboration with original equipment manufacturers (OEMs) to secure their value chains.

Such a relationship is particularly prevalent in large-scale projects involving massive quantities of specific parts or goods. Using parts made by OEMs has been a traditional practice among world-leading carmakers. Nowadays, notable chipmakers such as Foxconn, TSMC, and Huawei are recognised for producing parts for smartphones and computers.

Although OEMs play a huge role in modern industries, only a few can stand out and successfully upgrade themselves. As international trade becomes more competitive, major brands or the lead firms strategically strive to maintain their dominance. The relationships often become imbalanced as OEMs find themselves vulnerable due to their reliance on their lead firms.

“Lead firms possess robust global coordination resources that can support OEMs with sales channels and financial resources,” says Ma Xufei, Professor at the Department of Management of The Chinese University of Hong Kong (CUHK) Business School.

“Lead firms prioritise cost competitiveness and assembly efficiency in selecting OEMs, thereby enabling the OEM to curtail investment in technological innovation to manage the cost structure and mitigate its potential threat to sustain cooperation.”

Shedding light on this disparity, Professor Ma, along with Deng Ziliang of the Renmin University of China and Zhu Ziyan of Sun Yat-sen University, explored the relationship between the two parties and found the root cause: the dependence on the lead firms weakens OEMs’ technological upgrading.

“The asymmetric ownership of technological and branding assets is the fundamental cause of lead firm and OEM power imbalance,” says Professor Ma. “To break the dependence on lead firms, OEMs can strengthen their bargaining leverage by enhancing their innovation capacities, finding alternative partners, cooperating with other OEMs to share resources and knowledge, and securing governmental support and protection to achieve more sustainable growth in the global value chain.”

How to rise above dependencies

In a study titled Transactional dependence and technological upgrading in global value chains, Professor Ma and the team collected data on a large longitudinal sample of Chinese OEMs from 2007 to 2014 from various government agencies in China, including the General Administration of Customs, the National Bureau of Statistics, and the Ministry of Science and Technology.

The researchers excluded foreign-invested and state-owned OEMs to ensure that firms in the sample were not manufacturing subsidiaries of multinationals and to rule out government interventions. The final data contains disaggregated information from 968 OEMs, including their research and development along with patent applications.

The analyses showed that the ability of OEMs to perform technological upgrading is reduced when they rely heavily on original equipment manufacturing for revenue. As a result, attempting to reduce this reliance and rebalance the power dynamics with lead firms may not be a practical option. This finding is consistent with power-dependence theory, which suggests that firms with less bargaining power are less likely to invest in innovation and upgrading.

“Without technical resources, OEMs find it difficult to find new partners, and are restricted to constantly relying on lead firms, ultimately forming a vicious cycle,” Professor Ma adds.

“Lead firms prioritise cost competitiveness and assembly efficiency in selecting OEMs, thereby enabling the OEM to curtail investment in technological innovation to manage the cost structure and mitigate its potential threat to sustain cooperation.”

Professor Ma Xufei

The researchers also found that several technology-related strategies can moderate this dependence. Specifically, OEMs that possess advanced technological capabilities, collaborate in technology-intensive industries, or operate in regions with robust intellectual property protection are more likely to engage in technological upgrading activities, even when they are highly dependent on lead firms.

“Possessing an abundance of technical resources can help OEMs be more flexible and autonomous in technological upgrades and reduce their reliance on lead firms,” says Professor Ma. “OEMs can also choose to collaborate in technology-intensive industries, so the lead firms would tend to be more active in cultivating and improving the technical capacity of OEMs. This can be achieved by redesigning management systems, improving plant layout, and training employees.”

The impact of transactional dependence was found to be stronger for OEMs that are located in places with weaker institutional environments. This suggests that institutional factors, such as the quality of governance and the strength of intellectual property protection, can play an important role in shaping the relationship between power-asymmetric transactional dependence and technological upgrading.

“OEMs can choose to upgrade their technology in regions with strong intellectual property protection,” he adds. “A stronger protection of intellectual property will reduce the risk of technology infringement, making OEMs’ local research and development activities more legitimate and without arousing suspicion and motivation for retaliation from leading companies. In this way, OEMs can upgrade technology more securely.”

Levelling the playing field

Given the varying degrees of power inequality between OEMs and lead firms, Professor Ma further explains five different types of governance in the global value chain. Market governance is a purely transaction-based relationship, and producers can make products with minimal input from buyers. At the other end of the spectrum, hierarchy governance is an equity-based relationship, where lead firms develop and manufacture products in-house. Modular, relational, and captive governance are mixed governance between both mentioned above, where OEMs lack technical capabilities and focus solely on ensuring cost-effectiveness.

“Different types of global value chain governance have different impacts on the relationship, where power imbalance is the core difference,” he says.

Most OEMs employ a combination of multiple governances in dynamic settings, migrating from one type to another. OEMs’ technological upgrading can be seen as an “avoidance” strategy to reduce their dependence on lead firms and alleviate power imbalances. Therefore, the ideal global value chain governance may depend on the specific context, as well as the power dynamics and technological capabilities of the firms involved.

“In the era of de-globalisation and post-pandemic, the global value chains must be restructured,” says Professor Ma. “Contract instability drives the lead firms to switch to new partners while putting enormous pressure on OEMs to maintain cost advantages.”

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Moreover, policymakers can play a role in promoting more balanced power relations by implementing policies that support the development of local technological capabilities and encourage collaboration between firms.

Although the study’s sample was mainly concentrated on OEMs in China’s electronic industry, Professor Ma is confident that the findings can be extrapolated to other industries and places. “Asymmetric dependencies and power relationships in global value chain exist across numerous industries,” he says. “Whether in manufacturing, services or digital platforms, suppliers often rely on lead firms for assembly, processing or other services.”

Therefore, it is reasonable to say that suppliers in industries that have a similar power imbalance and dependence relationship with lead firms may also face similar issues. However, Professor Ma notes that industry-specific factors and contexts need to be taken into account when applying the findings. Variances exist among diverse industries, and these differences may influence the outcomes.

“Further research can delve into the power relationships in other industries and consider industry-specific technical conditions and market environments,” he adds. “Moreover, the issue will be more pertinent in developing countries and emerging economies.”