Theoretical Underpinnings of Value Chain Analysis

Abstract

Value chain related theories evolve over time in response to critique and their own conceptual development. In addition, they are ways of assessing the real world (theoretical frameworks); generating explanations about market development practice, and provide the opportunity for comparison over space and time. The purpose of this chapter is to provide an overview of the theoretical literature on theoretical underpinnings of value chain analysis. The approach used has been a sort of desktop review which involved collection of important secondary data to corroborate facts and to understand key issues pertinent to the theories was fundamental. After a search for literature, the review employed a method known as content analysis. The review result showed that the theories regarding value chain analysis intended, in time, by simplifying the reality or image to comprehend the phenomena with the purpose of their forecasting. In addition, the theories presented an increased concern, irrespective of the place where they were developed, but also, they stirred some critics. Moreover, it is the belief of this book chapter that it is intended to serve as both a summary of the state of the field and an overview reference for users.

1. Introduction

For a large part of the world’s growing population, the increasing integration of the global economy has provided the opportunity to achieve significant prosperity gains. For developing countries, the globalization of manufacturing has opened up new prospects of upgrading their industrial and service sectors. It also holds the promise of higher incomes, increasingly differentiated final products, and a greater availability of quality goods. Most notably, free trade agreements and other accords have created new export opportunities—mainly for food products—as the demand for variety continues to grow in developed countries. The expansion of agro-industrial operations and connections to export markets has been supported by these market shifts among governments, investors, and farmers in order to increase local food production, employment, company growth, and international trade. This has led to competition among producers to meet export market demands in terms of cost, quality, and delivery times. Consequently, a wide range of companies have evolved to provide goods and services to help agro-industries meet those demands. At the same time, policies, regulations, support services, tax and trade instruments and their associated actors and institutions have also developed to become intrinsic parts of the so-called “value chains.”

Such a move, globalization, is changing the environment in which poverty-reduction strategies are being implemented. In this new context, two things are clear: poverty alleviation cannot be sustained without economic growth; and economic growth cannot be sustained in non-competitive industries. Hence, a value chain approach which focuses on industries employing large numbers of the poor and with the potential to become and remain competitive in global markets should be in place. This approach therefore has relevance in a wide array of programs for which poverty reduction and/or wealth creation is either the ends or the means.

Market globalization generally links a firm's ability to remain viable to the competitiveness of the businesses in which it operates. Firms within an industry in a country or region must increasingly compete—even in local markets—with firms and industries from across the globe. To succeed in global markets, entire industries (or value chains) must be able to deliver a product to the consumer more efficiently, with a higher quality and/or in a more unique form than the value chains in competing countries. This tells us that competitiveness at the firm and industry levels is interdependent. In this chapter, readers will learn the theoretical underpinnings, theory of change and value chain analysis nexus, development and operation of agricultural value chains with practical cases from Ethiopia.

The “value chain” concept has evolved, within academics from a variety of “ideological” schools influencing it along the way [1]. The francophone concept of filière and the anglophone concept of commodity chain underpin value chain theory, analysis, and methodologies [2]. Beginning in the late 1990s, the term “commodity chain” was gradually replaced in the literature by “value chain” [3]. Many researchers appear to agree on the concept of value chains, but their explanations and abstractions of empirical results differ [4]. The two key concepts in the study of value chains are the words “value” and “chain.” In the analysis of the value chain, value is a synonym for “value-added,” [5] whereas “chain” refers to the processes and parties involved (from conception to disposal) in the lifespan of a product [6]. The term “value chain” has been defined in a variety of ways in the literature. Kaplinsky and Morris [7] defines it as “the entire set of activities necessary to take a product or service from conception to various stages of production, consumer delivery, and final disposal after use.” This definition recently was adapted to the specific field of agri-food products by [8], which provided the following explanation:

“The entire range of farms and firms, as well as their consecutive coordinated value-adding practices, that yield various raw agricultural items and convert them into specific food products sold to end-users and disposed of after usages in a way that is cost-effective all around, has wide societal benefits and does not perpetually deplete resources” [8].

This concept has been widely used to understand the effects of market relationships and upgrading processes on smallholders in developing economies. The fundamental feature of a value chain is market-focused collaboration: various business enterprises collaborate to produce and market products and services in an efficient and effective manner [9, 10]. The promotion of value chains in the agricultural sector aims to increase product competitiveness in international and domestic markets, as well as to generate more value-added within the region or country [11, 12]. The value chain approach has gained attention in development practice and policy, primarily as a lens for developing poverty-reduction initiatives with private sector participation. This has resulted in the development of a widely used analytical approach in development fields known as “value chain analysis” [13, 14].

Value chain analysis is a reformulation of the Orthodox theory of trade, which is based on Ricardo’s (1817) law of comparative advantage. In comparison to Orthodox trade theory, the value chain approach is more feasible and is now more commonly used to address poverty reduction and food security efforts, primarily by assisting the poor in gaining access to markets [15, 16]. In explaining why, the poor may face trade barriers and how to overcome them, value chain analysis is more useful than traditional theory. This is because Orthodox trade theory assumptions, such as the link between trade and poverty reduction on the one hand and economic growth on the other hand, have never been the main focus. It also fails to deliver feasible intervention strategies for policymakers and practitioners with more reasonable goals: how and when to assist a recognized target group in accessing (or, in better terms, accessing) specific effective value chains. Recognizing these flaws, trade theory is being amended and, in many important ways, is converging with value chain analysis [17, 18]. The sub-sections in 3.1 show the brief discussions on the development of the concept of value chain as a new paradigm.

2. Methods to be applied

In reviewing this book chapter, the approach used has been a sort of desktop review which involved collection of important secondary data to corroborate facts and to understand key issues pertinent to the theories was fundamental. After a search for literature, the review employed a method known as content analysis.

3. Theoretical underpinnings

The following sub-sections show the brief discussions on the development of the concept of value chain as a new paradigm.

3.1 The Filiére concept

The “Filiére” approach was developed in the 1960s to gain a more detailed understanding of the economic processes that underpin agricultural commodity production and supply chains [19]. In Francophone countries, the approach is used to analyze agri-food supply chains. It incorporates various schools of thought, including system analysis, Marxist economics, industrial organization, management science, and neoclassical welfare analysis [2]. It was soon utilized in the research of agriculture in developing countries, emphasizing growing exports of products such as cocoa, cotton, and coffee from French colonies. This theory is then used to shape French industrial policies. However, the “Filiére” idea failed in its analysis of the global world economy because it is a static model with non-changing participants. Rising or falling commodity or information flows, as well as stakeholder increases and decreases, are not taken into account [10]. Overall, the Filière can be used to describe the flow of physical inputs and services in the production of a finished product, and is conceptually similar to the modern value chain concept [20]. In more recent years, filiére research has been influenced by transaction cost economics (TCE), regulation theory, and convention theory [2].

3.2 Strategic business management perspective

Michael Porter's [21] concept of value chains is found in the literature of strategic business management, under the umbrella of supply chain management (SCM). The concept was created to assist managers in determining the value embedded within their company's various supply and support operations, as well as ways to improve that value in order to gain a competitive advantage. According to Porter, value chain analysis is the ultimate technique for evaluating the profits generated at each point of production. Porter distinguished various stages of the supply process (inbound logistics, operations, outbound logistics, marketing and sales, and after-sales service), the transformation of these inputs into outputs (production, logistics, quality, and continual improvement operations), and the support services the firm marshals to accomplish this task [22].

SCM first appeared in the early 1980s as an approach to managing flow of products and enhancing efficiency within a single company [23]. SCM's boundaries grew to include all actions and actors engaged in delivering a product from raw material to consumer over time, and it now encompasses all activities and actors involved in the delivery of a product from raw material to consumer [24]. Overall, the method strives to integrate and coordinate activities and stakeholders across the supply chain in a systemic and strategic manner in order to optimize the supply chain's performance in providing the product at the lowest possible cost [25].

SCM does not have a unifying theory that underpins it. Instead, a variety of current theories from diverse domains have been employed to describe certain elements, meaning that no single theory can adequately cover the scope of SCM [26, 27]. According to [28], the combination of TCS, the resource-based view, and network theory is most beneficial in explaining supply chain structure and management issues. These authors suggest that when the three theories are considered together, they can create a mid-level theory for SCM that they call the “new institutional economics approach.” Porter's concept of competitive advantage is also incorporated into SCM. According to Porter, enterprises or chains must offer consumers either cheaper pricing or unique product or service features in order to establish and retain competition [7].

Transaction Cost Theory: The transaction cost theory is classified as a branch of New Institutional Economics (NIE) [29, 30]. Transaction costs are expenses incurred when activities such as information gathering, negotiation, bargaining, enforcing, and monitoring are carried out [31]. The costs of identifying markets and trading partners, as well as the costs of obtaining price and product information, are referred to as information costs. The expenses of physically negotiating, bargaining, and formally drafting the terms of exchange are referred to as negotiation costs. Monitoring and enforcement costs are the expenses of making sure that the transaction's terms, like quality standards or payment methods, are followed by the trade agreements [32].

The business relationships between suppliers and purchasers produce “transaction costs” in addition to the costs of manufacturing and marketing at each phase of the value chain. Market inefficiencies, like low market consistency, lack of grades and specifications, or weaknesses in the business environment, often result from high transaction costs. TCE explores the basis for governance decisions about inter-company organizational relationships. Inter-organizational relationships are agreements that bring together organizations with the goal of producing joint added value [33]. In TCE, the fundamental unit of analysis is transactions among firms [34]. Under the conditions of stakeholders’ opportunistic actions, businesses choose a governance form that significantly reduces transaction costs. Through mutual investment, control mechanisms, and complex organizational structures such as contracts, value chain actors safeguard against the risk of opportunity. The majority of small and marginal farmers in underdeveloped nations live in remote areas with inadequate infrastructure, and they frequently miss out on market opportunities due to high transaction costs [35]. According to [36] transaction costs negatively impact market participation, while better market information triggers it. Barrett [37] argues that distance to market is a proxy for transaction costs and has a negative impact on market participation. Overall, the idea of transaction costs aims to clarify what kind of governance system is empirically defined [38].

Network theory: This is another relevant theoretical stream for developing value chain research. It relies on the interdependence of social and economic interactions in (production) networks consisting of multiple vertical and horizontal relationship issues among stakeholders in the supply chain [39, 40]. According to the network framework, businesses are integrated in a dynamic of vertical, horizontal, and business development relationship issues with several other institutions that provide inputs such as credit coordinators, advisory services, and transportation services [41]. The supply chain demonstrates vertical connections among market participants in order to co-produce for a market, whereas network theory combines vertical and horizontal interactions between actors [42]. Network linkages can boost a company's "social capital" by making it easier to obtain information, necessary knowledge, and financial assistance, as well as by empowering information sharing among key stakeholders lowering transaction costs and enhancing access to markets [43]. When the value chain is more described by a network than by a single vertical chain, network analysis is used. To summarize, networks are an important factor in the development of both intervening and upgrading value chains, and they serve as a basis for analyzing and mapping relations and flows among people and organizations [44].

3.3 Political economy perspective

The third important antecedent of value chain study is political economy research, which looks at the causes, nature, and effects of global industrial and technological integration. Wallerstein's world-systems analysis, which emphasizes on the world-system as the unit of social analysis and is focused on understanding the varied implications of the capitalist world economy, provides the foundation for this line of research, which is referred to as "global chains" research. As a result, one of the most important themes is the distribution of power and advantages among people from industrialized and developing countries. Despite the fact that the literature on global chains is broad and multidisciplinary, three important analytical frameworks may be distinguished: global commodity chains, the world economic triangle, and global value chains (GVCs) [45].

Gereffi developed the “Global Commodity Chain (GCC)” approach in the mid-1990s, which is based on Wallerstein's commodity chain [46]. This perspective is used to investigate the origins, nature, and consequences of global technological and industrial integration. The approach builds on the world systems perspective. Gereffi’s contribution has supported significant advances in the empirical and normative application of the value chain framework, especially for its emphasis on the power structures embedded in value chain analysis. The approach focuses on the power relations embedded in value chain analysis and connects the concept of value-added chain to global industry organization [47]. Moreover, in 2002, Messner developed the theory of the “world economic triangle” where actors, governance, and regulation systems are influential factors for regions (developing countries) scope of action in the global commodity chains. The six major characteristics in all economic triangles are: group of actors, their interests, trust, power relations, action-orientation, and mind sets [48]. World economic triangle approach focuses on the upgrading of whole regions or clusters through their integration in value chains, which might bring up grading perspectives for regions in developing countries. Therefore, this theory links horizontal (cluster development) and vertical approaches (value chain) [49].

In the mid-1990s, the growing fragmentation of supply chains in the global arena led to the development of the literature. This literature added an explicitly international perspective and centered on worldwide power dynamics and rule-setting processes (governance) across the chain [50]. Humphrey and Schmitz [51] introduced the “Global Value Chain” concept. In 2000, a team of researchers with considerable expertise met to establish a theory of “global value chains” [52] in a series of seminars. Its goal was to construct an exact theoretical model appropriate to real-world scenarios, robust, and applicable [19]. The advantages of Porters’ single firm orientation are recognized by this new school of thinking (GVC), while at the same time scrutinizing relations between the various stakeholders. A GVC approach enables social influences to be incorporated and provides a structure that connects constraints, governance structure, and upgrading strategies [2].

The governance structure is a crucial step to understand the nature of coordination and relationship mechanisms that exist between stakeholders in the chain [47]. Governance involves coordination and related positions in finding vibrant cost advantages and allocating key players’ roles [7]. Governance’s central premise is the realization that encounters between businesses in a value chain reveal organizational forms rather than merely random interactions [7], which implies that governance guarantees that the organization is represented by interactions among entities across a value chain [47]. It is noted that management and coordination often function in literature as interchangeable or synonymous terms [53]. The term governance was used by Williamson [54] in the 1980s to describe the collection of hierarchical frameworks in which a transaction is organized. Based on governance structures, value chains can be classified into producer-driven and buyer-driven value chains [47]. However, in developing countries, where food chains still have many stages, most transactions are carried out with the assistance of middlemen. They may be able to address information asymmetries that are prevalent in developing countries, but they may also take a greater share of the market share in the value chain, limiting upgrading possibilities for farm households [55, 56].

Most empirical findings [57, 58] in developing economies reveal that middlemen take the lion's share of the margin shares and are more influential in the chain. The hegemony of these middlemen in the value chain can be explained in part by the terrestrial dispersion of actors and the scarcity of price information. Because of the chain's extreme geographical dispersion, the actors require an assistant who can act on their behalf in other markets and provide price information [59]. Due to a lack of valuable market information and a lack of well-organized participants in developing countries, participants rely heavily on middlemen. Most of the time, middlemen purposefully create a communication chasm among both buyers and sellers and arbitrate them in their preferred manner. As a result, middlemen are viewed as market impediments by both buyers and sellers. The price is also set by the middlemen. In such cases, neither the producer nor the buyer has the power to determine exact product prices [60].

Middlemen's actions have an impact on customer prices since they often collect and manipulate selling prices. Ignoring middlemen and believing that producers/growers could be tied directly to purchasers without some sort of middle, value-added function is generally ill-informed and contributes toward further market imperfections and decreased competitive advantage. As a result, middle actors in value chains should be enticed with incentive schemes to drive better business operations based on effective competitive environment and compliance with laws and regulations. Munshi [61] argues that middlemen are not only an economic institution but also a social network structure that facilitates trade in developing countries. In addition to the two types of value chains described above, unlike developed countries value chains, this chapter proposes a third type of value chain for developing countries like Ethiopia known as the "middlemen-driven value chain." This means that three types of governance are distinguished based on the coordination role of “governance”: those where producers have dominance (“producers-driven value chain”), those where middlemen have hegemony (“middlemen-driven value chain”), and those where buyers have a key role (“buyers-driven value chain”).

Long marketing channels benefited middlemen while negatively impacting both producers and consumers. This meant that a long marketing channel was one of the main causes of increased transaction costs as well as crop marketing inefficiency. As a result, the government should devote sufficient attention to improving the imperfect market chain as well as long distribution channel by establishing institutions such as cooperative-unions. Brokers should be formalized into legal venture for the benefit of growers, wholesalers, retailers, and consumers by recognized financial institutions. This situation clearly necessitates fierce government interference. This is because unregulated middlemen are demolishing a considerable amount of value [59, 62]. In general, the governance structure provides information concerning farm households' positions in the value chain as well as the relationships among farmers and buyers.

Another key term in the GVC literature is upgrading, which is seen as a complement to governance. Upgrading is referred to as strategies for adding value, which is the intervention step of value chain analysis [63]. Upgrading is defined by Mitchell [15] as the “means of acquiring the technical, institutional, and market capabilities that enable poor communities to enhance their competitiveness and shift toward higher-value activities.” Value chain players are said to upgrade as they gain new skills by creating more value-added commodities or improving existing ones. Upgrading options could be specified by assessing profitability inside the chain and defining its constraints. Improving strategies that include interventions such as improving product quality and moving toward more creative market segments, redesigning the production line or investing in new process upgrade techniques, improving the chain’s performance, and introducing innovative features to increase the quality of activities to gain deeper importance throughout chain [64]. In various countries and businesses, empirical research [65] offers information about the benefits of upgrading agriculture enterprises.

Various scholars have identified four upgrading opportunities namely: process upgrading, product upgrading, functional upgrading, and inter-chain upgrading [64]. Process upgrading focuses on enhancing the efficiency of external and internal processes within the value chain. For instance, processes that ensure timely deliveries, collection of quality products, or improved marketing of a product, organizational restructuring, collaborations, and/or capability buildings are ways to achieve process upgrading [7]. Product upgrading refers to improving existing products and/or developing new ones. It is closely linked to process upgrading because changes in products often lead to changes in processes [15]. Functional upgrading is achieved when a firm changes one’s position within the chain to add value. An example of this can be farmers who start processing in addition to producing fruits. On the other hand, upgrading of the chain involves moving to a new chain. If participating in one chain is not profitable, farmers may look for other options, since they have a diversified livelihood strategy. But high barriers of entry into new value chains might limit their options [7].

3.4 Theory of change and value chain analysis nexus

Theory of change, which was developed in the 1990s, is a method for designing business strategies that brings together community development partners and addresses proposed way of achieving impact [66]. In the case of smallholder value chains, theory of change was used to develop business modeling techniques aimed specifically at integrating smallholder farmers into market-oriented value chains [67, 68]. It is a good place to start when it comes to understanding and clarifying smallholder commercialization transactions. It demonstrates how well the various interventions and tasks will interact to produce the desired market changes and, ultimately, the planned impacts on smallholder farmers for each value chain. It is based on the idea that by supplying farmers with the appropriate inputs, they will be able to expand their farming production, resulting in higher earnings and therefore more sustainable farmer practices [67]. The main goal of such assistance programs should be to enable smallholder farmers to make appropriate, well-informed decisions about how to manage their agriculture and which markets to pursue [69].

Consider an intervention designed to enhance household food security and welfare as an example (i.e., final impacts). Inputs could include fertilizer, pesticides, seeds, and pest management (Figure 1). However, inputs include not only production techniques, but also expertise, such that poor and disadvantaged farm households can use the accessible information for personal gain. Connecting smallholder farmers to well-functioning markets ranging from local markets to structured value chains is critical in long-term rural poverty-reduction strategies. Comprehending how to successfully connect disadvantaged growers to markets, as well as recognizing that markets can profit which types of participants, are important steps in community development [70, 71]. The theory of change depicted in Figure 1 illustrates a procedure that helps to identify critical steps and components when forming actor partnerships. Some of the strategies to increase profits for farm households include going to invest in upgrading the value chain to meet production and distribution requisites, making investments in wider sustainable livelihood strategies, as well as trying to adapt trade relations and value chain formation for smallholder sourcing.

Figure 1.

Value chain theory of change, objectives, outputs, and outcomes. Adopted from [69].

The intervention logic (theory of change) for a value chain method is depicted in Figure 1. These strategies include expanding input access, increasing productivity, enhancing value chain connections, expanding access to markets, and improving supportive framework (an enabling environment). Increased access to productive resources such as agricultural inputs, land, pest management, irrigation, as well as other extension services can help disadvantaged farmers increase their productivity. Similarly, it is critical that they cultivate their relationships with other actors in the chain. As a result, building strong value chain partnerships among farm owners as well as other actors in the chain through coordination, communication, and contracts is as significant as the other strategy elements. Finally, an enabling environment should be developed and enhanced through education and advisory services. These schemes would produce both tangible (higher profits, better access to capital, and lower costs) and intangible results (reduced income risks, trust, transparency, increased bargaining powers, and knowledge and skills). Smallholders would benefit from food security, as well as a reasonable income and environment. Despite efforts to incorporate value chain expansion into developing nations' poverty-reduction strategies, initiatives are frequently ineffective. One reason for this is a lack of coordination efforts throughout the entire value chain [69, 70].

3.5 Sustainable livelihood framework

Participation in the agri-food value chain knowledge, good health, and the ability to work that allows people to pursue various livelihood choices and achieve their goals. Human capital is a factor of the amount and quality of labor available in a household. These changes depending on the size of the household, skill levels depend on a number of factors at the producer level. There are several perspectives from development economics for understanding what determines smallholders' participation in agri-food value chains, including the sustainable livelihood framework (SLF), which includes five types of assets or capitals: natural, physical, human, financial, and social capitals [72]. Due to the quantities of assets envisaged by such individuals, the capitals explain why individuals in rural areas are able to participate in some activities while others are not. According to [73], varied value chain participation among smallholders could be explained by variable access to assets and services to decrease transaction costs.

The following are the explanations behind these capitals: Natural capital refers to the natural resource stocks (e.g., land, trees, water, air, genetic resources, etc.) from which resource flows and environmental services (e.g., nutrient cycling, hydrological cycle, erosion protection, pollutant sinks, and etc.) are produced that are important for livelihoods. Human capital includes things like literacy, skills, health, and the ability to work. Human capital is the combination of skills, leadership potential, and health situation, among other factors. Human capital occurs as a livelihood asset in the framework for sustainable livelihoods, that is, as a component or means of achieving livelihood outcomes [74]. Physical capital refers to the infrastructure and production goods that are required to support livelihoods and pave the way for livelihood strategies. Infrastructure includes accessible modes of transportation, proximity to towns and the capital city, a marketing location, suitable housing, water and sanitation, and information access. Infrastructure and producer goods are frequently thought to be required to sustain livelihoods [75]. Social capital: different social venues can establish formal and informal interactions from which people might get varied possibilities and rewards in their pursuit of a living. It encompasses vertical and horizontal networks and connectedness that strengthen people's trust and ability to collaborate, as well as their access to larger institutions such as political and civic bodies. Financial capital is the term used to describe the financial resources that people employ to fulfill their livelihood goals. Savings, credit, and production equipment are all part of it [74].

SLF provides a paradigm for examining how institutions affect smallholder income, asset holdings, consumption, and poverty in direct and indirect ways. Institutions, according to SLF, influence access to assets or resources, affecting livelihood strategies. For example, a household may choose to intensify or diversify its activities. If a household decides to intensify, like in this case of farmers investing in the production and selling of better fruits varieties, financial, social, and physical assets will all play a role. The livelihood strategy chosen has an impact on the outcomes, such as poverty alleviation [76]. The SLF, in general, explains the resources that smallholders require in order to participate in agri-food value chains.

4. Concluding remarks

In this chapter, we have explored the main theoretical concepts, ideas, and critiques arising from the literature on (agricultural) value chain theories. The value chain approach has gained attention in development practice and policy, primarily as a lens for developing poverty-reduction initiatives with private sector participation. This review paper revealed that there has been a revolution in thinking about value chain theories over the past several decades, since 1960s. Many of these value chain theories provide powerful explanations for growth and circumstances of the approach. In conclusion, theories are developed to provide us understand the value chain concepts and approaches over time. The theories presented an increased concern, irrespective of the place where they were developed, but also they stirred some critics. That is, new theories/approaches can develop on the basis of criticism and the rejection of existing frameworks of understanding and they are constantly evolving in parallel with the world they seek to explain.

Conflict of interest

The author declares no conflict of interest.

Additional information

The book chapter: “Theoretical underpinnings of value chain analysis” is part of my thesis work. It is made available online (link attached below). This can make the document more likely to increase the similarity index.

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