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Benefiting from FDI through TNC-SME Linkages

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1 Benefiting from FDI through TNC-SME Linkages
TNC: parent enterprise with foreign affiliates (i.e. in countries other than its home country). Equity capital stake of 10% is normally considered as the threshold for control of assets. SMEs: non-subsidiary, independent firms which employ less than a given number of employees (250 in Europe, 500 in the US). Small firms are those with fewer than 50 employees, micro-enterprise those with fewer than 10 or 5. Financial assets are also used to define SMEs (see Glossary). FDI: investment involving a long-term relationship and reflecting a lasting interest and control by a resident entity in one economy in an enterprise resident in an economy other than that of the foreign direct investor. Lorenzo Tosini UNCTAD

2 Outline Overview of TNC-SME linkages and potential benefits
Case studies: Uganda, Mozambique and Brazil Linkages determinants and policies Video “Business Linkages in Uganda” The programme of this morning session 6 TNC-SME linkages are potentially one of the fastest and most effective ways of upgrading domestic enterprises, facilitating the transfer of technology, knowledge and skills, improving business and management practices, and facilitating access to finance and markets.

3 Business Linkages Purchasers Suppliers Four types:
Backward linkages with suppliers Linkages with technology partners Forward linkages with customers Other spillover effects Broadly speaking the definition refers to any programme aimed at linking purchasers with potential suppliers. For our purposes purchasers are usually identified with TNCs interested in investing or already operating in a host economy, perhaps a developing one whereas suppliers are local businesses trying to enhance their competitiveness and to capture opportunities for increased trade. We can identify four many types of linkages: 1. Backward linkages occur when TNCs buy parts, components, materials and services from local suppliers; 2. The second kind of linkages form when TNCs engage in joint ventures, licensing agreements, or strategic alliances with local partners, offering them access to technological and managerial know-how and offering foreign companies access to local authorities, institutions and markets (example to follow on the Egyptian case in the IT industry); 3. Forward linkages with customers occur when TNCs outsource the distribution of their brand name products through marketing outlets, or when TNCs produce machinery, equipment or other inputs, offer after-sales services beyond the usual advice on usage and maintenance of the purchased good with industrial buyers; 4. The last type include demonstration effects and human capital spillovers. This term refers to uncontrolled, not channelled ways of transferring technology or know-how as opposed to the second type of linkages which happen through formal and contractual channels.

4 Importance of TNC-SME linkages to host economies
TNCs as a source of demand for the outputs of local suppliers Quality and capacity upgrade to international levels Technology transfer, market information, skills, and easier access to finance. TNC-SME linkages are potentially one of the fastest and most effective ways of: upgrading domestic enterprises, facilitating the transfer of technology, knowledge and skills, improving business and management practices, and facilitating access to finance and markets By embedding foreign direct investments (FDI) through linkages common criticism on the footloose nature of foreign investment may be overcome: Poor subsidiary role Financial leakage Technology not available Few supply linkages

5 Linkages and linkages Many initiatives to promote linkages
No two linkage programmes are the same Different forms of financing: purely donor-driven government-driven public-private sector partnerships totally independent supplier development programmes run by TNCs There exists a number of “linkages” initiatives run and financed by different actors: on one end we may have entirely donor-driven programmes (a large number of international organizations or donors’ development agencies have their own linkage programme) and at the other end we may come across a totally independent programme developed by TNCs themselves (just to name a few: Toyota, Unilever, Intel, IBM). Even in the same country, or under similar circumstances, the approach should be tailor made: no two linkage programmes are the same. Then there is “no one-size fits all”. Are you aware of any such initiatives in your country? What are their features? Who are the actors involved?

6 Internal benefits Help develop domestic industry
Deepen the involvement of FDI in host country Maximize purchasing of FDI and other companies to the benefit of the host country Through multiplier effect assist general economic growth of the host country Facilitate import substitution Promote Corporate Social Responsibility What are the main benefits that the host economy may derive from FDI embedded through well-designed and well-implemented linkages programmes? The list is certainly non-exhaustive but it is important to mention that these benefits do not occur automatically and should not be taken for granted. The development impact of FDI depends on a number of factors. TNCs can contribute significantly to economic development in host countries – if the host country can induce them to transfer their advantages in appropriate forms and has the capacity to make good use of them.

7 External benefits Useful selling tool for attracting FDI
Allow domestic companies to grow and move into export markets Improve the general profile of the country’s industrial capacity Looking beyond the host economy’s borders, there are some more benefits that can improve the overall appeal of a country’s economy to foreign investors. Investors tend to favour countries with strong investment protection laws or practice, but they also attach importance to a sound track record. Their decisions are often based on the existence of a sound policy framework and ease of business practices within the host country. Such a conducive investment climate creates opportunities and incentives for private enterprises, both foreign and domestic.

8 Success stories Egypt, South Africa, Viet Nam, Mexico, Colombia, Nigeria, Brazil, India, Malaysia, Uganda Case studies and successful policies aimed at promoting linkages have been published on two UNCTAD publications: Creating Business Linkages: A policy perspective (top right corner with direct link to download it from UNCTAD website) – It includes a comprehensive overview on good practices in the promotion of business linkages and concrete guidelines on how to design and implement such a programme. Integrating Developing Countries’ SMEs into Global Value Chains (bottom left corner again with direct link for download) – It highlights the role of governments in facilitating the entry of SMEs into Global Value Chains and ensuring they benefit from such participation. GVC: interlinked value-added activities that convert inputs into outputs which, in turn, add to the bottom line and help create competitive advantage. Global means that it spans multiple locations at a global scale. A typical value chain consists of: inbound distribution/logistics, manufacturing operations, outbound distribution/logistics, marketing & selling, and after-sales service. These activities are supported by purchasing/procurement, R&D, HR development, and corporate infrastructure. Before we move on and have a look at a couple of examples of successful linkages, do you have any questions?

9 Uganda 6 firms (National Housing, MTN, Celtel, Kinyara Sugar, Toyota, Nile Breweries) with 26 local businesses to streamline their supply chains. Impact on employment: from 2006 to 2008, employment in SMEs assisted grew nearly 100% Programme run in cooperation with: Uganda Investment Authority and Enterprise Uganda. As a result of the programme in Uganda, the SMEs increased their sales, they have created job, and they have improved their business efficiency. For example, Toyota Uganda has improved relationship with the suppliers as the SMEs got to know the TNC’s corporate culture and could follow the strategic direction of Toyota. Super Clean Ltd., the largest of the SMEs, was able to increase sales by almost 100% and it expanded its staff from 85 to 210 within the 2 years of the programme.. 4W Car Care, another SME increased its sales by more than 500% within 2 years and it raised numbers of employees from 2 to 32. The largest of the SMEs increased its sales by 100% and expanded its staff from 85 to 210 in 2 years Another SME increased its sales by 500% and expanded from 2 to 32 employees Toyota Uganda case

10 Mozambique 43 farmers linked with CDM Breweries (a subsidiary of SAB Miller of South Africa) for the 2010 barley campaign production The farmers diversified their sources of income and learned how to run their farms as a business Annual income increased from an average 300USD to 700USD Some small farmers increased their productivity by 150%, bought cattle for agricultural activities and upgraded their production techniques CDM financially supported technical testing and is willing to buy more than 5 times the amount of barley currently produced CDM Breweries case Programme run in cooperation with: Investment Promotion Center (CPI) and Enterprise Mozambique. The pilot project in Mozambique was very successful. Farmers could diversify their sources of income, learned how to become small entrepreneurs and run their farms as a business. Their annual income increased on average from $USD300 to $USD700. Additionally some small farmers could upgrade their production techniques, acquire more sophisticated tools and buy cattle for agricultural activities, thereby increasing their productivity by 150%. CDM financially supported the technical testing, and part of the costs of the pilot project aimed at barley production in the Province of Manica. The project can practically count on an unlimited potential for further expansion, since CDM is willing to buy more than fifteen times the amount that is currently produced. 10

11 Success factors in linkages
Viable business ideas Highly reputed intermediary institutions Remove obstacles and barriers to linkages creation From the analysis of the case studies presented in the two UNCTAD publications, the following factors have been found to be fostering the creation of successful linkages: Identifying a viable business idea that can be realized by SMEs and TNCs is fundamental. It is the starting point for a lasting linkage programme. Relying on highly reputed intermediary institutions that can broker business linkages agreements by, amongst other things, mitigating the risks and negative perceptions of TNCs dealing with SMEs. Removing obstacles and perceived barriers to linkages creation. Mutual concerns and suggestions voiced from private sector representatives (both international and domestic) can push Governments to implement practicable and effective measures aimed at removing bottlenecks.

12 UNCTAD‘s technical assistance projects
Brazil Zambia Uganda Tanzania Vietnam Dominican Republic Argentina Mozambique Peru UNCTAD has been developing or participating to specific business linkages projects in the following nine countries, in several sectors spanning from automotive industry, agribusiness, mining, telecommunications, and tourism. Figures for Tanzania: 4 TNCs (National Housing Corp., Vodacom, Tanzania Breweries Ltd., and Shoprite) – 36 SMEs

13 Brazil: Projeto Vínculos
Fill competitiveness gap between TNCs and SMEs 300 SMEs – employees 20 TNCs As a concrete example of how UNCTAD delivers its linkages related work, in addition to producing research papers and publications, we will get an insight on the Brazilian linkages programme, named Projeto Vínculos, which has been implemented between June 2005 and August 2010 by UNCTAD in partnership with several stakeholders (the German technical cooperation agency, SEBRAE, a Brazilian business school, and a Brazilian NGO). The TNC-SME business linkages programme targeted companies in the North-East of Brazil (States of Pernambuco, Ceará, Bahia) to move then westward to Manaus (in the Amazon area) and southward to the State of São Paulo (five Brazilian states overall)- The large majority of Small and Medium sized Enterprises (SMEs) in the area of intervention did not have the capacity needed to benefit effectively from the rise of foreign direct investment and outsourcing of production activities by transnational corporations (TNCs) and large domestic companies. The main logic of the project was: to fill the competitiveness gap between the SMEs capacity and the TNCs’ demands. Amongst the participating TNCs there were Philips, Alcoa, BASF, Bosch.

14 Forging partnerships 3-level approach Macro-level Meso-level
Micro-level The project approach tackled the whole linkages issue at three levels (Policies, Institutions and Companies), an approach which was kept in the overall organizational structure by involving representatives from the government - both at the national and local level, supporting institutions, TNCs and SMEs involved. Such an approach helped creating a high-level platform for public-private dialogue. As an example, technical training to selected SMEs has been provided by SME support institutions at the State-level, SEBRAE (the Brazilian Support Service for Micro and Small Enterprises) and the National Industrial Training Service. In most cases, TNCs have contributed about 30 per cent of the total cost for suppliers’ upgrading. Policies Institutions Companies

15 Results suppliers upgrading
This is an example of the progress achieved by 27 participating SMEs in the State of Pernambuco. On the first column of the left you see the areas that had been identified by the three TNCs (Philips, Gerdau and Alcoa) as the main suppliers’ weaknesses, directly affecting their competitiveness. The overall progress made by the SMEs in all the five areas shows an outstanding 212%. For SMEs, the concrete results are shown by the increased sales and/or exports, the expansion of client base, access to information, technology and management processes, coaching and technical advice, improved competitiveness, product standards and managerial skills.

16 Determinants of linkages
Critical mass of purchasing companies Pool of qualified domestic enterprises Effective selection mechanism Supportive policies and measures What are the underlying determinants (i.e. the elements that identify or determine the nature of something) of linkages formation? Constituting a critical mass of purchasing companies which can create real opportunities for domestic supply (DEMAND-SIDE of the linkage equation), TNCs with corporate strategies conducive to local SME development. The existence of SMEs which are able to meet TNC standards (normally high standards), that are capable of supplying goods and services that meet TNCs’ (purchasing companies) requirements for quality, performance, delivery and standards compliance. (SUPPLY-SIDE of the equation). Participation to a linkage programme can only happen on voluntary basis. It is a private-sector led process: TNCs and SMEs make commercial deals (it’s normal business) so TNCs need to be involved in the selection process but both sides need to have common goals (win/win situation). Local companies must commit fully to their development plans (no-hopers are dropped): that is why a constant monitoring and evaluation mechanism is needed at every step of the development process. The existence and efficiency of a set of supporting public policies in attracting FDI, facilitating technology transfer and improving SME performance. A set of measures to assist potential domestic enterprises overcome supply-side constraints to achieve the standards required to become suppliers to TNCs.

17 The policy role Improving the investment climate
Specific linkage policies The framework pictured in this slide provides a systemic, yet adoptable approach for policy analysis and design conducive to linkage attraction, building and sustainability. The four key policy areas included in the oval complement one another in a coherent framework which fulfils the mutual interest of TNCs and local enterprises, and reinforces domestic development goals. Improving the investment climate involves the adoption of changes in the legal, regulatory and institutional environment, including the development of hard and soft infrastructure. It aims to increase opportunities and incentives for private enterprises to invest, create jobs and expand, in order to strengthen the local industrial base and the competitiveness of domestic enterprises. Strategic FDI attraction includes devising policies for attracting and retaining quality FDIs which have linkage potential, create positive spillovers that benefit the local economy and strengthen strategic sectors that are vital to the development objectives of the country. Strengthening absorptive capacity means creating and facilitating opportunities for local enterprises to learn, internalize and utilize the management skills, knowledge and technology made available by direct TNC linkages. This also includes stimulation of entrepreneurship for creating a group of vibrant and innovative local entrepreneurs that have both the will and ability to become international players. Specific linkage policies create programmes that foster and provide incentives for TNC-local SME cooperation. They aim to remove the information gap, negotiate costs of technology upgrading and facilitate the process involved in linkage building between TNCs and local enterprises. Strategic FDI attraction Strengthening absorptive capacity

18 Overall policy implications
FDI promotion integrated in the overall development strategy Incentives to encourage TNCs to invest in strategic activities TNCs involved in the upgrading of human resources Investment in infrastructure development (e.g. EPZs, industrial and science parks) Financial support to strategic investments involving domestic and foreign companies Support the development of domestic suppliers and clusters The role of policy in building linkages is, in itself, important but more attention needs to be given to policies that are in line with market forces and that build, in particular, on the mutual interests of both foreign affiliates and domestic firms to create and deepen linkages and foster competitiveness and economic growth. Well-targeted government intervention can tilt the balance in favour of more linkages and thereby contribute to knowledge transfers from TNCs that can feed into the development of a vibrant domestic enterprise sector. The linkage-building practices and experiences just presented indicate that no two linkage programmes are the same but rather are country/context-specific. Local conditions vary and it is therefore necessary to undertake a detailed review of the needs and demands of both domestic enterprises and TNCs, as well as the support systems available through the government, development agencies, existing industry and private institutions. Source: UNCTAD

19 Key lessons Sustainable linkages require the participation and collaboration of all interested stakeholders A conducive policy environment is needed if linkages promotion has to be turned into an inclusive mechanism to build local productive capacity. The establishment of sustainable linkages does not happen automatically, as a direct consequence of the presence of TNCs (remember the two fish bowls?), but requires the participation and collaboration of all interested stakeholders (i.e. TNCs, local companies, the government). Only if a conducive policy environment is set up, specific linkages promotion programmes have a chance to be transformed from isolated cases into sustainable and inclusive mechanisms to build the local productive capacity.

20 Business Linkages in Uganda

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