What makes export manufacturers pursue functional upgrading in an emerging market? A study of Chinese technology new ventures

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What makes export manufacturers pursue functional upgrading in an emerging market? A study of Chinese technology new ventures§ Ruey Jer ‘‘Bryan’’ Jean * National Chengchi University, Taiwan

A R T I C L E I N F O

A B S T R A C T

Article history: Available online xxx

This study examines unique factors causing emerging market firms to pursue functional upgrading. Our analysis draws on the resource-based view and learning theory, and our study sample consisted of Chinese new technology ventures. We test the effect of governance mechanisms and internal resources on the functional upgrading of firms. The results indicate that trade shows and quality advantage facilitated the functional upgrading of firms. However, contrary to our expectations, electronic markets and technological advancement do not emerge as significant variables. The implications of the results are discussed in consideration of the existing literature, and future research opportunities are described. ß 2014 Elsevier Ltd. All rights reserved.

Keywords: China Functional upgrading Global value chain (GVC) Original equipment manufacturing (OEM)

1. Introduction Globalization has prompted firms to enter the global value chain (GVC) by serving as contracting suppliers for multinational enterprise (MNE) buyers. The majority of suppliers are operating in emerging markets such as China, Vietnam, and India. Profit margins of contract manufacturers conducting original equipment manufacturing, (OEM) services for global buyers have recently been decreasing. For example, Foxconn gained a profit margin of only approximately 2–3% by manufacturing iPhones for Apple Inc. Accordingly, export manufactures have strived to upgrade and provide high value-added services, such as design and branding, in the GVC (Alcacer & Oxley, 2014). However, industrial upgrading is not an easy task for emerging-market firms, which tend to lack international experience and relevant resources. Furthermore, MNEs may leverage their strong bargaining power to inhibit the upgrading of emerging-market firms, thereby appropriating higher rent in the GVC. The manner in which an emerging-market firm achieves industrial upgrading and develops its innovative capability to capture value in the GVC is thus critical for that firm’s success. This is particularly salient for Chinese firms because of their traditional ‘‘world factory’’ position in the global supply

§ The authors are grateful for the financial support from National Science Council Taiwan (100-2628-H-004-002-MY3). * Correspondence to: Department of International Business, National Chengchi University, Taiwan. Tel.: +886 2 29393091x81224; fax: +886 2 2938 7699. E-mail address: [email protected]

chain. Because labor and production costs in China have recently increased, determining how Chinese firms can become more innovative and upgrade their capabilities to appropriate more value in the GVC has become a critical subject. International business studies have investigated the internationalization of emerging-market firms, particularly Chinese firms (e.g., Deng, 2012). A recent review indicates that most previous studies have focused on patterns and process of Chinese firms’ internationalization such as location and entry modes choice (Deng, 2012). However, few studies have addressed factors influencing the upgrading of Chinese firms such as the transformation of value-added activities through integration with the GVC. Previous studies (Deng, 2012; Yamakawa, Peng, & Deeds, 2008) have revealed that Chinese firms have unique characteristics for participation in the global market. Extending this perspective, we assert that the upgrading and catch-up strategies that Chinese firms use to gain value in the GVC also have unique characteristics and warrant further examination. The GVC literature contains reports on topics related to the GVC and industrial upgrading (Gereffi, 1999; Gereffi, Humphrey, Kaplinsky, & Sturgeon, 2001). Governance has been a central topic for GVC scholars. According to transaction cost theory, governance mechanisms are particular mechanisms that support economic transactions in exchange relationships (Heide, 1994; Williamson, 1975). The GVC literature extends this notion and defines GVC governance as comprising elements for establishing and structuring exchange relationships between global buyers (lead firms) and local supplying firms. Various forms of governance mechanism, such as the arm’s-length market, quasi-integration,

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Please cite this article in press as: Jean, R. J. B. What makes export manufacturers pursue functional upgrading in an emerging market? A study of Chinese technology new ventures. International Business Review (2014), http://dx.doi.org/10.1016/j.ibusrev.2014.03.009

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and hierarchical governance mechanisms employed by lead firms in the GVC, have been discussed in previous studies (Humphrey & Schmitz, 2000). Gereffi, Humphrey, and Sturgeon (2005) analyze the factors driving various governance mechanisms, including transaction complexity, information complexity, and supplier capabilities. In addition, research has addressed various types of upgrading, such as product, process, functional, and intersectoral upgrading (Giuliani, Pietrobelli, & Rabellotti, 2005). Despite this interest in governance in the GVC and upgrading, empirical work is limited on this issue. Although the relationship between governance mechanisms and upgrading in the GVC has been discussed, the exact effects of various governance mechanisms on upgrading continue to be debated. Humphrey and Schmitz (2002) argued that a quasi-hierarchical chain offers favorable conditions for process and product upgrading, but hinders functional upgrading. By contrast, chains characterized by arm’s-length market relationships tend to be associated with slow upgrading of processes and products, whereas functional upgrading is more feasible. However, the various arguments presented in the literature are not supported by sufficient empirical evidence. Another substantial gap in the GVC literature is the negligence of the firm capabilities perspective to upgrading in the GVC. Morrison, Pietrobelli, and Rabellotti (2008, p. 52) stated that ‘‘future studies should explore vertical dimensions of technological capabilities (i.e., different levels of complexity of capabilities) in the GVC and upgrading’’. Again, the limited empirical evidence provides inconsistent support for the relationship between technological capability and the competitiveness of a firm. In a study of the Indian automobile industry, Kumaraswamy, Mudambi, Saranga, and Tripathy (2012) observe that research and development (R&D) is not associated with the tendency to upgrade. The institutional environment and national innovation systems may influence the development of technological capability (Lall, 1992; Pietrobelli & Rabellotti, 2011). In China, dysfunctional modes of competition have resulted in a situation in which the legal infrastructure (such as laws protecting intellectual property) does not provide a sound environment for innovation. In such circumstances, firms encounter difficulty in transforming their R&D input into innovative upgrading processes. This tendency is reflected in the national innovation data. For example, despite China’s considerable investment in R&D, the innovation output measured according to patents granted by the U.S. Patent and Trademark Office has shown little progress (Altenburg, Schmitz, & Stamm, 2008). Hence, the literature contains much debate on ‘‘whether and how China [is] progressing from production to innovation’’ (Altenburg et al., 2008). Considering the gaps in the literature on upgrading in the GVC, this study examines the key factors driving firms’ pursuit of functional upgrades. Our research question is, ‘‘How can firms enhance their functional upgrading by participating in the GVC?’’ Specifically, we query, ‘‘How do governance mechanisms and internal capabilities for development jointly contribute to a firm upgrading in the GVC?’’ We focus on a particular form of functional upgrading, namely the transformation and shifting of emergingmarket firms from OEM firms to original design manufacturing (ODM) firms. The OEM model is typically used by technological firms participating in the GVC. In the OEM model, a contracting supplier produces finished products according to the precise specifications of foreign lead firms. By contrast, the ODM model involves designing products and their specifications, and manufacturing these products for lead firms. In the ODM model, suppliers add value through product engineering, designing for manufacture, and product design. Hence, ODM provides a model for functional upgrading in which suppliers play a more innovative role in completing tasks for their lead firms than they do in the OEM model. Compared with OEM, ODM has been considered a

more profitable value-adding business service for contracting suppliers who can capture additional rent in value chains. For example, in the personal computer industry, Taiwanese suppliers have upgraded their statuses as contract manufacturers and currently engage in numerous innovative valued-added activities in value chains, such as product design and component design. Considering firms’ internal capabilities that contribute to the functional upgrading of emerging market firms, we focus on technology advancement and quality advantages. Emerging markets have strived to improve their product quality and invest substantially in R&D to upgrade and catch up with their global rivals. Hence, we focused on these two dimensions of internal capabilities as antecedents of functional upgrading. This study provides several contributions. First, drawing on the resource-based view (RBV) (Barney, 1991) and organizational learning literature (Salomon & Jin, 2008, 2010), we integrate the internal and external factors that influence whether emergingmarket firms become ODMs. We focus on the governance mechanism as an external factor and on firms’ technological and quality capabilities as internal factors. Specifically, we investigate relational and market governance mechanisms, namely export trade shows and electronic markets, as external factors that cause firms to help new Chinese ventures upgrade to ODM firms. Previous studies have generally discussed the relationship between quasi-hierarchical governance and upgrading, and have provided limited empirical evidence on relational (network) governance and arm’s-length market governance, or on the use of trade shows and electronic markets as knowledge spillover channels that contribute to upgrading. This study examines unique characteristics of Chinese firms’ leverage of electronic markets and trade shows as governance mechanisms which impact on functional upgrading. This study also examines firms’ quality advantage and technological advancement as two dimensions of technological capacity (TC; Lall, 1992) related to functional upgrades. Our study integrated the external GVC and the internal TC perspectives, thus responding to the call for greater theoretical integration between the GVC and studies on upgrading (Morrison et al., 2008). Recent studies have emphasized that a comprehensive framework integrating governance perspectives and the TC of firms must be established to facilitate the analysis of upgrading in the GVC (Morrison et al., 2008). Furthermore, empirical evidence on the manner in which emerging-market firms develop their international competitiveness and achieve industrial upgrading is scarce, but is beginning to accumulate (Kumaraswamy et al., 2012). This study use new technology ventures in China as the subjects of data collection; thus, our results offer empirical evidence on the internationalization of new ventures in emerging markets. The study context enabled us to enrich the literature by examining the influence of external and internal factors on firms’ upgrading in an emerging market context. Emerging-market firms, as latecomers, typically encounter obstacles that limit innovation. This article is organized as follows. The literature on the GVC and the upgrading of firms is reviewed to provide theoretical support for the links between constructs. In a subsequent section, we discuss our predictions for the relationships amongst external factors, internal capabilities, and firms’ functional upgrading. These hypotheses are tested empirically, and we present our research results. The paper concludes with a discussion of the findings and recommendations for future research. 2. Literature review and hypotheses 2.1. GVC upgrading The term ‘‘GVC’’ refers to the sequence of functional activities required in the process of value creation involving more than one

Please cite this article in press as: Jean, R. J. B. What makes export manufacturers pursue functional upgrading in an emerging market? A study of Chinese technology new ventures. International Business Review (2014), http://dx.doi.org/10.1016/j.ibusrev.2014.03.009

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country (Giuliani et al., 2005). The GVC literature has indicated the importance of functional integration and governance (Gereffi et al., 2001; Sunny Li, Hao, & Erin, 2010). As mentioned previously, GVC literature has discussed various forms of governance mechanism in the exchange relationship ranging from arm’s-length marketbased relationships, network relationships, and quasi-integration to hierarchy-based relationships. In market-based relationships, global buyers coordinate with supplying firms by using a transactional approach and purchase standardized products. By contrast, firms incur high transaction costs when trading customized products, thus requiring hierarchical or network relationships to govern the transactions. In addition, the GVC literature has indicated the role of industrial upgrading in appropriating value from value chains. The term ‘‘upgrading process’’ has been used often to describe the paths by which suppliers in developing countries ‘‘move up the value chain’’ (Ponte & Ewert, 2009). Based on the definition provided by Giuliani et al. (2005), we define upgrading in this study as the capacity of a supplying firm to learn from global buyers to innovate and, thus, acquire new functions (from pure manufacturing to design). GVC studies have often classified upgrading into four categories (Humphrey & Schmitz, 2002), namely (a) product upgrading: supplying more sophisticated products with increased unit value; (b) process upgrading: achieving a more efficient transformation of inputs into outputs through the reorganization of productive activities; (c) functional upgrading: acquiring new functions (or abandoning old ones) that increase the skill content of activities; (d) intersectoral (or interchain) upgrading: applying competences acquired in one function and using them in a different sector or chain. We specifically focus on the functional upgrading of exporting firms shifting from OEM to ODM. 2.2. GVC governance (and LLL) Previous studies have extensively discussed governance and industrial upgrading in the GVC, but the literature lacks consensus and empirical evidence on the relationship between governance and upgrading. According to Pietrobelli and Saliola (2008, p. 951), ‘‘the link between enterprise upgrading and GVC governance has been made explicit only recently’’. Furthermore, most discussions on governance and upgrading have focused on the relationship between a quasi-hierarchy and upgrading. Humphrey and Schmitz (2002) assert that a quasi-hierarchical chain offers favorable conditions for process and product upgrading but hinders functional upgrading, because functional upgrading affects the core competence of the lead firm. An earlier study by Humphrey and Schmitz (2000) suggested that arm’s-length market-based relationships tend to be associated with relatively slow process and product upgrading, whereas functional upgrading is feasible. However, prior to this study, the links amongst arm’s-length market relationships, relational governance, and functional upgrading have not been empirically examined. Considering governance mechanisms as antecedents of emerging firms’ functional upgrading, we specifically focus on electronic markets and trade shows as market and relational (network) governance mechanisms Electronic markets are electronic intermediates which provide matching, aggregation, and market research functions for suppliers seeking foreign buyers (Anderson & Anderson, 2002). An electronic market can be considered a virtual form of trade show which facilitates the accumulation of a group of suppliers and customers online. Because of institutional constraints, such as the lack of efficient trade associations in China, electronic markets provide unique and unconventional virtual intermediary approaches that enable Chinese export manufacturers to enter the GVC. Accordingly, our study examined electronic markets as market-based governance mechanisms. In

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the GVC literature, one study (Humphrey & Schmitz, 2001) indicated that IT and e-commerce can potentially be used by firms to upgrade in the GVC, but the role of electronic markets in market-based governance and their relationship with upgrading has not been empirically examined. Hence, in this study, electronic markets are treated as unconventional market governance mechanisms which enable Chinese firms to become integrated into the GVC and upgrade. Trade shows, defined as ‘‘events that bring together, in a single location, a group of suppliers who set up physical exhibition of their products and services from a given industry or discipline’’ (Natasha & John, 2008). Trade shows can be considered a marketplace in which numerous suppliers and potential customers accumulate in one location in a short span of time. Some researchers have suggested that trade shows can be regarded as relationship- and network-building events (e.g. Li, 2006). In the context of China, Chinese exporters consider trade shows to be a major form of promotion and an opportunity to connect with foreign lead firms and customers (Li, 2006). Although a previous GVC study suggests that trade shows are market-based governance mechanisms (Humphrey & Schmitz, 2000), we view trade shows as relational governance mechanisms which help Chinese firms build and develop business relationships with their foreign buyers. This is because relationships (guanxi) and long-term orientation are unique social elements in Chinese society (Park & Luo, 2001). Hence, Chinese firms may prefer to use trade shows as a relationship-building mechanism instead of as a market-based transaction mechanism. Recent studies have applied organizational learning theory to the exporting context (Alcacer & Oxley, 2014; Salomon & Jin, 2008, 2010). Most studies have emphasized, generally, ‘‘learning by doing’’ and, specifically, ‘‘learning by exporting’’ (Salomon & Jin, 2008, 2010) effects in which exporters can gain access to markets and technological knowledge by interacting with global buyers in foreign markets. According to this perspective (Salomon & Jin, 2010), the mechanism through which learning by exporting is considered to occur is a mechanism in which exporting firms access information to which they are not privy. An international business study indicates that Chinese firms can effectively apply processes of linkage, leverage, and learning (LLL) to accelerate their internationalization (Mathews, 2006). Drawing on this perspective, we argue that trade show and electronic markets participation are two governance mechanisms which provide external linkages for Chinese new ventures with global buyers. This external linkage can help Chinese new ventures to leverage intangible resources, such as knowledge on foreign markets and technological knowledge. These resources are leveraged through interactions and linkages with intermediaries or foreign customers. In turn, repeated linkage and leverage may result in learning by exporting for Chinese new ventures. Drawing on the learning-by-exporting theory, the LLL model, and governance mechanisms, and upgrading literature, our study integrates international business and the GVC perspective on upgrading. Furthermore, we examine the moderating effect of export dependence on the effect of export trade show and electronic market participation on functional upgrading. We assert that the effect of export activity on a firm’s learning capacity diminishes as the firm becomes increasingly dependent on exports. As a firm gains experience in exporting, its capacity to acquire useful new information related to the marketing or technical aspects of upgrading a product or process declines. In addition, GVC literature has focused primarily on the relationships amongst actors involved in the chain, including lead firms and suppliers. However, the endogenous process of technological development at the level of the firm has largely

Please cite this article in press as: Jean, R. J. B. What makes export manufacturers pursue functional upgrading in an emerging market? A study of Chinese technology new ventures. International Business Review (2014), http://dx.doi.org/10.1016/j.ibusrev.2014.03.009

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been ignored. Morrison et al. (2008) report that the TC perspective complements the GVC perspective. Technological capabilities are defined as the technical, managerial, and organizational skills that firms require to use hardware and software effectively and to accomplish technological change (Bell & Pavitt, 1995; Lall, 1992). The extant literature has presented various categories of TC. We followed the approach of Lall (1992) and categorized TC according to the complexity level of technology. According to Lall (1992), TC can be classified in a horizontal dimension of functional capability and in a vertical dimension of the complexity of capability. Morrison et al. (2008) indicated that the level of complexity (vertical dimension) in TC must be examined to understand how a firm’s development of capability is associated with the GVC. Hence, this study focuses on the factors in the vertical dimension of TC complexity, including quality advantage and technological advancement. The RBV proposes that an organization is a unique bundle of accumulated tangible and intangible resource stocks, including specific internal capabilities, processes and procedures, and routines that are linked to or controlled by the organization. The RBV suggests that a firm’s unique internal resources and capabilities can be sources of the firm’s competitive advantage. A previous study adopts the RBV to discuss various sources of TC (Zahra & Nielsen, 2002). According to this perspective, we assert that quality advantage constitutes a routine-based lower-level production capability, whereas technological advancement is an innovation-based higher-order technological capability which can be a source of firms’ innovation generation. We consider functional upgrading to be an innovative process in which firms develop their organizational capability in response to environmental dynamics. We assert that TC (including quality advantage and technological advancement) is a key determinant of a firm’s ability to functionally upgrade. Our conceptual model is shown in Fig. 1. We discuss the relationships amongst the key constructs of this conceptual model in the following section.

2.3. The role of governance mechanisms in functional upgrading 2.3.1. Trade shows Trade shows are events that bring together, at a single location, a group of suppliers from a given industry or discipline who set up physical exhibits of their products and services. Trade shows have been identified as a valuable opportunity for firms to promote themselves, to gain information or publicize, to sell their goods or services, and to network (Li, 2006). Trade shows are particularly valuable for new ventures, which typically possess limited resources with which to conduct international business (Wilkinson & Brouthers, 2006). A surprisingly limited amount of research has been conducted on the role of trade shows in facilitating or enhancing product or process innovation. One exception is an early study conducted by Bello and Gloria (1993). However, their work was conceptual rather than empirical and examined cases from the United States alone. We assert that trade shows can help new Chinese ventures enhance their innovation capabilities and pursue functional upgrading for several reasons. First, trade shows help new ventures collect market-related information on foreign customers and competitors. Trade shows facilitate interaction with numerous firms and organizations, thus enabling people to gather information on products offered by their competitors and the resources and capabilities of those firms, as well as the problems they face in product and service innovation. This is particularly relevant for new ventures that have limited resources for searches related to innovation (Li, Chen, & Shapiro, 2010). Second, trade shows can help firms gain technological knowledge on operating processes, methods, and techniques. Foreign buyers can provide feedback to improve existing products and can even use trade shows to offer technical, operational, or product development assistance to new ventures. Third, a previous empirical study indicates that trade shows can generate relationship learning amongst Chinese exporters and facilitate upgrading and innovation processes

Fig. 1. Conceptual model and hypotheses.

Please cite this article in press as: Jean, R. J. B. What makes export manufacturers pursue functional upgrading in an emerging market? A study of Chinese technology new ventures. International Business Review (2014), http://dx.doi.org/10.1016/j.ibusrev.2014.03.009

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(Li, 2006). In summary, trade shows facilitate the relationshipbuilding and learning processes of Chinese exporters and can be regarded as relational governance. Hence, we proposed the following hypothesis: H1. Trade shows exert a positive effect on the probability that a new venture will pursue functional upgrading. 2.3.2. Electronic markets Recent advances in communication and information technologies have generated new markets for a diverse range of goods and services (Jean, Sinkovics, & Kim, 2008; Jean, Sinkovics, & Cavusgil, 2010). In this study, electronic markets refer to Internet-based business-to-business (B2B) transactions, which represent interorganizational systems. In these systems, multiple buyers and sellers use electronic interactions to conduct their business. Furthermore, electronic markets have key functions such as cataloging, matching, aggregation, and reducing the logistical or communication costs between buyers and sellers (Grieger, 2003; Kaplan & Sawhney, 2000). The importance of electronic markets has prompted researchers to develop typologies of electronic markets and to understand the motivations of participants in single markets (Grewal, Comer, & Mehta, 2001). However, extant literature offers little insight into whether and how electronic markets contribute to participants’ strategic outcomes, such as innovation and performance. We suggest that electronic markets enable exporters to access information on foreign markets through interaction with foreign customers and agents. In addition, electronic markets provide catalogs that list competitors’ products and prices, enabling firms to track the latest developments in their competitors’ products easily. Thus, exporters can exploit market knowledge gained from electronic markets to develop innovative ideas. In addition, certain electronic markets provide to their participants market research data, such as information on potential customers, competitors, and products. This information helps exporters identify industry and market trends and, in turn, facilitates the development of innovative products and processes for foreign markets. Thus, electronic markets play a salient role in facilitating the collection of information and identification of new opportunities in emerging markets. Typically, the institutional environment in an emerging market fails to support the development of intermediaries such as trade associations. For example, Alibaba has become the world’s largest B2B electronic market and has facilitated the successful internationalization of several new Chinese ventures. However, relying solely on electronic markets for information on foreign markets may result in poor decision making and strategy formulation because of the lack of real interactions with the host environment. Yamin and Sinkovics (2006) suggested that online internationalization causes exporters to fall into a ‘‘virtuality trap,’’ which impedes effective foreign market knowledge acquisition. However, we assert that the benefits of electronic markets outweigh their possible negative effect. Hence, we propose the following hypothesis: H2. Electronic market participation exerts a positive effect on the probability that a new venture will pursue functional upgrading. Despite the benefits provided by trade shows and electronic markets through learning effects and the acquisition of knowledge on foreign markets, the positive effect on functional upgrading is likely to decrease as a firm’s dependence on exports increases. The positive effect of experience-based learning is limited by unintentional and unsystematic learning. In addition, experience tends to be ambiguous, with multiple and conflicting interpretations, causing deciphering the ‘‘complex words’’ to be difficult.

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According to the GVC literature (Gereffi et al., 2001, 2005), arm’s-length market-based governance is characterized by an exchange of simple, standardized, and explicit knowledge. Hence, firms that learn by exporting through trade shows and electronic markets mainly acquire explicit market and technological knowledge from their lead customers in the GVC. Tacit knowledge is difficult to gain through market-based governance. Li, Poppo, and Zhou (2010) asserted that relational governance mechanisms, such as trust and shared goals, are likely to foster the exchange of tacit market and technical knowledge. Therefore, as a firm begins to rely more on exports, the role of market governance in facilitating innovation may decline because of a lack of implicit knowledge. Implicit market knowledge, such as knowing the preferences of a foreign end user, plays a crucial role in designing innovative products. Previous research has indicated that market governance involves not only repeated simple transactions but also relatively low switching costs for transaction parties, thus exerting a lowlevel-of-learning effect on both parties. As chains evolve, suppliers may be willing to develop closer relationships with their lead firms and may use forms of relationship governance, such as trust, to facilitate the exchange of tacit knowledge with customers in the GVC. Accordingly, we expect that the learning by exporting effects of trade shows and electronic markets diminish as firms’ dependence on exports strengthens. Thus, we propose the following hypotheses: H3a. The positive effect of trade shows on the functional upgrading of new ventures is weaker when a firm’s dependence on exports is stronger. H3b. The positive effect of electronic markets on the functional upgrading of new ventures is weaker when a firm’s dependence on exports is stronger.

2.4. The role of internal resources in functional upgrading 2.4.1. Quality advantage ‘‘Quality advantage’’ refers to quality control capabilities that enable a firm to ensure the quality of its products. According to the RBV, quality control capability is an intangible resource that affords a firm a competitive advantage. The TC perspective considers quality control capability to be a routine aspect of TC that facilitates accumulating technological knowledge and enhancing innovation (Bell & Pavitt, 1995; Lall, 1992). One study shows that quality capabilities are particularly crucial for new ventures because such firms are typically hindered by the liability of newness and a lack of reputation (Knight & Cavusgil, 2004). Quality control capabilities indicate the ability of a new venture to provide a sound product or service to its customers. An emphasis on quality entails using innovative processes and providing a method of differentiating the goods of a firm from those of its competitors. Various dimensions of product control capabilities, such as customer focus, employee training, and teamwork, have been linked with product and process innovation (Perdomo-Ortiz, Gonza´lez-Benito, & Galende, 2006). PerdomoOrtiz et al. (2006) report that overall quality management enhances business process innovation, and Pekovic and Galia (2009) indicate that overall quality control enhances various dimensions of innovation. The RBV suggests that a firm’s resources can be leveraged to develop specific capabilities. Quality control capabilities serve as resource stocks that can be accumulated and leveraged to develop the firm’s innovative capabilities in functional upgrading. Hence, we propose the following hypothesis:

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H4. Quality advantage exerts a positive effect on the probability that a new venture will pursue functional upgrading.

2.4.2. Technological advancement ‘‘Technological advancement’’ refers to a firm’s technological capability relative to comparable firms in the same industry (Knight & Cavusgil, 2004). Technological advancement facilitates the creation of superior products and the improvement of existing products, and increases effectiveness and efficiency in production. Technological advancement is particularly crucial in high-technology firms, especially new technology ventures (Lee, Lee, & Pennings, 2001). Previous studies have shown that technological advancement is linked to a firm’s ability to innovate. The TC perspective suggests that R&D reflecting a high level of technological capability facilitates technological learning and innovation (Lall, 1992). The RBV suggests that technological advancement enables firms to establish a competitive advantage in dynamic environments (Knight & Kim, 2009). Technological capability in R&D enhances a firm’s absorptive capability, which is ‘‘the ability of a firm to recognize the value of new, external information, assimilate it, and apply it to commercial ends’’ (Cohen & Levinthal, 1990). Absorptive capability plays a crucial role in enhancing a firm’s innovative activities, such as functional upgrading from OEM to ODM. This is particularly critical for new ventures because such companies typically possess limited knowledge stocks and resources with which to acquire and leverage external knowledge gained from the GVC. Thus, we propose the following hypothesis: H5. Technical capability exerts a positive effect on the probability that a new venture will pursue functional upgrading.

3. Method This study examines the effects of internal resources and governance mechanisms on the functional upgrading of Chinese firms. Emergence of a market economy in China has altered the opportunities and incentive structures shaped by a centrally planned economy, and has stimulated the growth of new ventures, particularly in technological industries (Li & Atuahene-Gima, 2001; Yan & Haiyang, 2010). The Chinese government has played a central role in facilitating entrepreneurship in technological sectors. In recent decades, the government has initiated more than 52 national technology development zones throughout China. The emergence of Chinese new technology ventures has attracted a considerable amount of attention amongst academic researchers (e.g., Li & Atuahene-Gima, 2001; Yan & Haiyang, 2010). Previous studies have indicated that the internationalization of Chinese firms is unique and warrants further attention (Cardoza & Fornes, 2011; Yamakawa et al., 2008). Hence, we assert that Chinese firms’ upgrading and catch-up strategies for becoming integrated in the GVC have unique characteristics. Despite the enormous potential of new technology ventures to contribute to the economy, these ventures face great uncertainty and a high failure rate. They are hindered by ‘‘liabilities of newness’’ more than other entrepreneurial ventures are. The success of a new technology venture’s growth and innovation may depend largely on the firm’s ability to establish external relationships and develop its internal capabilities (Li & Atuahene-Gima, 2001). These requirements are particularly salient in China because China’s emerging economy is characterized by a volatile environment lacking in institutions and strategic market factors for supporting business and innovation. Thus, China’s emerging economy provides a rich context in which to explore our research

questions. In addition, numerous Chinese new technology ventures have been linked to global lead firms by serving as contract manufacturers. However, Chinese manufacturing has faced increasing challenges in the form of rising production costs, including wages. Accordingly, the manner in which Chinese export manufacturers upgrade themselves functionally and advance in the GVC becomes critical to their competitiveness. The setting of this study provides an excellent context in which understand this crucial topic. We adopt the definition of new technology ventures provided by Li and Atuahene-Gima (2001). Such ventures are no more than 8 years old, and fulfill the following criteria: (a) at least 30% of the firm’s employees are technically skilled, and (b) the firm spends at least 3% of its total capital on R&D. Our study sample comprises 633 Chinese new technology ventures featured in a single Chinese B2B electronic market list. All ventures in the list participate in export business and have provided information on their OEM and ODM activities, as well as export information such as sales percentages. Furthermore, the list provides information on the status of a firm’s engagement in the B2B electronic market. Hence, the list is an ideal directory from which to extract data for this study, which examines functional upgrading and the factors driving it. We defines new technology ventures according to the following criteria: (a) the firm’s founding team consists of engineers or scientists; (b) at least 30% of the firm’s employees were technical staff; and (c) the firm spent at least 3% of its total revenue from sales on R&D. None of the firms included in our study is older than 8 years. The criteria we adopt have been widely used in empirical studies on technology ventures in China (Li & Atuahene-Gima, 2001; Yan & Haiyang, 2010). Various technological industries, including electronic components (30%), consumer electronics (25%), security (15%), electrical equipment (5%), computer hardware and software (10%), energy (5%), and lighting (10%), are represented in our sample. The average firm size is 187 employees, and the average firm age is 6.147 years. In our sample, 54% (n = 342) of firms provide both OEM and ODM services, whereas 46% (n = 291) provide only OEM services. 3.1. Measurement 3.1.1. Dependent variables The dependent variable in our analysis was whether a firm adhered to the ODM model. Firms in the source directory provide information on their service model design. We dichotomize the firms by coding those that provide only OEM service as 0, and those that additionally provide ODM service as 1. In the sample, 54% (n = 342) of firms provide both OEM and ODM services, whereas 46% (291) provide only OEM services. 3.1.2. Explanatory variables The key explanatory variables are the firm’s governance mechanisms, namely trade shows and electronic market participation, and internal resources, namely technological capability and quality advantage. To measure the trade show variable, we record the number of trade shows in which a firm had participated. The directory provides a list of this information, with the names of specific trade shows attend. An earlier study similarly assesses the number of trade shows attend to measure the extent to which a firm participates in trade shows (Wilkinson & Brouthers, 2006). In addition, the directory provides information on the number of years in which a firm has participated in the electronic market. We use this information to assess the firm’s electronic market participation. Furthermore, the moderating variable of ‘‘export dependence’’ was measured using the percentage of export sales reported by firms in the directory. Previous studies have similarly used the export percentage as a measure of export dependence.

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Table 1 Descriptive statistics and correlation matrix for characteristics of the study cohort (n = 633).

1. 2. 3. 4. 5. 6. 7.

Size Age Trade show Electronic market participation Quality advantage Technological advancement Export dependence

Mean

Std. Dev.

187 6.147 0.95 4 36 25 70.75

0.129 4.25 0.21 2.089 10.75 10.75 24.62

1

2 0.20 0.72 0.17 0.32 0.31 0.22

0.14 0.369 0.146 0.277 0.219

3

4

0.05 0.10 0.01 0.26

0.13 0.16 0.05

5

6

0.54 0.10

7

8

0.17

N = 633, p < 0.05 for correlation coefficients greater than 0.10.

Additional explanatory variables in our study are a firm’s quality advantage and technological capability, which are measured according to the number of quality control personnel and the number of R&D personnel, respectively, reported in the directory. 3.1.3. Control variables We control for the size and age of firms. Firm size is recognized as a factor affecting a firm’s strategic motivation and performance. We measure size according to the number of employees at a firm. Similarly, firm age has been shown to be a crucial variable related to firms’ strategic behavior and is particularly relevant in studying new ventures (Table 1). 4. Analysis and results We use logistic regression to estimate the influence of trade shows, electronic market participation, export dependence, quality advantage, technological advancement, and their respective interaction effects on the dependent variable. Logistic regression is frequently used in analysis if a dependent variable is binary coded (0 or 1 in this study). The probability that a firm elects to follow the ODM model to functionally upgrade is estimated as follows (in reference to OEM-only mode). Probability(ODM = 1) = 1/{+exp[ b0 + b1(trade show) + b2(electronic market participation) + b3(export dependence) + b4(export dependence  trade show) + b5(export dependence  electronic market participation) + b6(quality advantage) + b7(technological advancement) + b8(firm size) + b9(firm age)], where b0 is the intercept, and b1, b2,. . ., b9 are the regression coefficients. Of the 633 firms we study, 342 pursue ODM (functional upgrading), whereas 291 firms provide only OEM. We adopt a cutoff value of 0.22, which is suggested by the area under the receiver operating characteristic curve. As shown in Table 2, the results indicate that our model exhibits a satisfactory fit. The Hosmer and Lemeshow test yielded a p value of .612, which was within the acceptable range, and

the Nagelerke R square was 0.113. Furthermore, the results indicate that our model’s prediction that 50.2% of firms are engaged in OEM (i.e., not attempting functional upgrading) and that 74.9% of firms are pursuing ODM (i.e., functional upgrading) is correct and the overall prediction rate is 63.5%. The model fit indices and prediction rate indicated that the current logit model explained the phenomenon of functional upgrading reasonably well. Table 2 shows the empirical results of each hypothesis test. H1 predicts that trade shows exert a positive effect on the probability of new ventures to pursue functional upgrading. Our results support H1 (b = 0.19; p < .05). In H2, we propose that, as a new venture’s participation in the electronic market increases, the firm becomes increasingly likely to pursue functional upgrading. Contrary to this expectation, the results (b = 0.136; p < .05) indicate that firms that participate in electronic markets to a greater degree are less likely to pursue functional upgrading. This might be related to the difficulties encountered in virtual communication through electronic markets, which may cause innovation to be challenging. This possibility is examined in greater detail in Section 5. H3 focuses on the possible moderating effect of a firm’s dependence on exports. H3a and H3b propose that the probability that firms with higher export dependence pursue functional upgrading is less affected by trade shows and the electronic market. The results supports these hypotheses (b = 0.06, p < .05; b = 0.04, p < .05, respectively). The effect of a firm’s internal resources is considered in H4, which states that firms exhibiting a strong quality advantage are likely to pursue functional upgrading. The results support this hypothesis (b = 0.019; p < .05). In H5, we suggest that firms exhibiting greater technological advancement are likely to pursue functional upgrading. The results does not support this hypothesis (b = 0.013, p > .05). We discuss the implications of our findings in the following section. 5. Discussion

Table 2 Logistical regression results (n = 291 for no functional upgrading; n = 342 for functional upgrading). B Trade shows Electronic markets Export dependence Export dependence  Trade shows Export dependence  Electronic markets Quality advantage Technological advancement Firm size Firm age Constant Nagelkerke’s R-square = 0.113. Hosmer and Lemeshow test, p = .612. **p < .05.

Wald test

Exp(B)

0.19** 0.136** 0.008** 0.006**

13.971 8.848 4.654 6.063

1.209 0.973 1.008 0.994

0.004**

5.619

0.996

0.019** 0.013 0.001 0.029 0.213

3.834 1.596 0.06 1.45 0.324

1.019 0.987 1 0.972 0.808

Several studies have discussed the GVC and the upgrading of firms from various theoretical perspectives. However, extant research on the factors driving the decision to functionally upgrade a firm in the GVC remains sparse. The purpose of this study is to attain a greater understanding of the factors that cause firms to pursue functional upgrading and enhance their competitive advantage. We apply different theories, the RBV, organizational learning theory, and the LLL framework, and integrate the external governance and international TC perspectives to construct a conceptual framework. We use data on new technology ventures in China to assess the effect of governance mechanisms and internal resources on the probability of a firm to pursue functional upgrading from OEM to ODM. Specifically, we examine the effect of trade shows, electronic markets, export dependence, quality advantage, technological advancement, and the interaction effects of these variables on the likelihood of functional upgrading. This study broadens the current understanding of the factors that drive

Please cite this article in press as: Jean, R. J. B. What makes export manufacturers pursue functional upgrading in an emerging market? A study of Chinese technology new ventures. International Business Review (2014), http://dx.doi.org/10.1016/j.ibusrev.2014.03.009

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export manufacturers to engage in innovative development to enhance their competitiveness in emerging markets. Our results reveal that firms participating in more trade shows are more likely to pursue functional upgrading. Firms may use trade shows as an export learning channel to gain market and technical knowledge from their customers, agents, and competitors in foreign markets. In addition, through the process of learning, Chinese new ventures develop strong linkages and relationships with their foreign buyers. The results support the LLL model and indicated the roles of learning and linkage in accelerating the internationalization of emerging-market firms, particularly small- and medium-sized firms (Mathews, 2006). Relationships and long-term orientation are unique cultural characteristics in China. Thus, trade shows play a vital role in the relationship building and learning processes that drive functional upgrading amongst Chinese new ventures. Although studies have discussed the importance of trade shows, empirical evidence of the effect of trade shows on increasing the innovative capacity of emerging-market firms remained extremely limited before this study was conducted. Our findings are consistent with those of Bello and Gloria (1993), who emphasized the key role of trade shows in enhancing product development and innovation. Contrary to our expectations, the results of this study indicate that, although electronic markets are prevalent and provide unique services to Chinese exporters, participation in electronic markets reduces the probability of firms to engage in functional upgrading. This is possibly because the virtual nature of online B2B markets inhibits learning and renders the generation of innovative ideas challenging. Innovation tends to require in-depth or face-to-face communication. Our findings are consistent with recent reports emphasizing the vulnerability of firms of which the internationalization strategies rely on the Internet as a channel to access foreign knowledge. Virtual or Internet learning may impede the effectiveness of foreign-market knowledge acquisition and accumulation (Yamin & Sinkovics, 2006). Another plausible reason for the negative effect of B2B electronic participation on functional upgrading is dysfunctional competition. During our field interviews, several company representatives note that online markets can trigger dysfunctional competition between firms, such as the illegal copying of new products or counterfeiting products by obtaining market information online. This problem may discourage firms from pursuing innovative functional upgrading. Dysfunctional competition might be particularly pervasive in emerging markets such as that of China, where legal infrastructures (e.g., trade markets and patent production) are inadequate (Li & Atuahene-Gima, 2001). Although electronic markets provide unique opportunities through which Chinese new ventures can become integrated into the GVC, the results indicated that the effect of electronic markets on functional upgrading is insignificant. Another research for negative effect of electronic markets on upgrading may be because of sample selection issue. Most Chinese new ventures we select are at the exploration and early stage of participation at electronic markets. Firms may engage in different degree of upgrading at different level of electronic markets participation. Our finding on electronic market participation was intriguing and deserves further investigation. In addition, we analyze the moderating effect of a firm’s dependence on exports. The results reveal that export-related learning effects gained through external channels such as trade shows and electronic market participation decrease as a firm’s dependence on exports increased. These findings are consistent with the literature on ‘‘learning myopia’’ and experiential learning. Studies on learning myopia have suggested that firms ignore new ways of thinking when they depend too much on the current experience of learning (Almeida, Dokko, & Rosenkopf, 2003; Levinthal & March, 1993). When a firm relies excessively on

knowledge from exporting experience, they may ignore new knowledge that is incompatible with current systems and, consequently, opportunities to innovate and upgrade. Furthermore, this study examines the effects of firms’ internal resources, including two vertical dimensions of the complexity of TC (i.e., quality advantage and technological advancement), on their probability to engage in functional upgrading. The results indicate that quality advantage exerts a significant and positive effect on a firm’s propensity to upgrade functionally. This finding supports the conceptual link between quality and innovation reported in the literature. The results indicate that advantage in quality control plays a crucial role in helping a firm succeed in innovative tasks, including the pursuit of ODM standards. The results indicate that quality advantage is a crucial source of a competitive advantage for Chinese new technology ventures and can enable them to become integrated into the GVC and functionally upgrade. Moreover, the results imply that Chinese firms have shifted their focus from cost and price advantage to quality advantage in their strategies for catching up with competitors and upgrading. However, our results do not indicate a significant relationship between technological advancement and functional upgrading, possibly because the inadequate institutional environment and dysfunctional competition amongst competitors causes transforming R&D into innovative products and processes to be difficult. The findings of this study can provide managers with novel insight into innovation strategies applicable in emerging markets. Our results reveal that governance mechanisms, including trade shows and electronic market participation, are crucial in firms’ innovative strategies for functionally upgrading from OEM to ODM in emerging markets. However, managers should be aware of the limitations of various types of governance mechanisms. Trade shows provide an effective export learning channel for new ventures, whereas electronic markets might not provide a suitable channel for external learning and relationship building and, thus, do not facilitate innovation. Furthermore, internal resource development and quality advantage play a crucial role in driving a firm to engage in functional upgrading. 6. Contributions of the study The study provides unique contributions. First, this study examined unique and unconventional trajectories of the integration of Chinese new ventures into the GVC and the functional upgrading of these ventures. The results provided a clear understanding of Chinese firms’ catch-up and upgrading strategies in the global market. Second, few studies have integrated internal and external factors and discussed their effects on the upgrading strategies of Chinese firms. We make a sound contribution to this stream of research by empirically examining the effects of governance mechanisms and internal technological and quality capabilities on the functional upgrading of Chinese firms. Third, few studies have integrated GVC literature with international business research to examine upgrading. Our study provides empirical evidence pertaining to this emerging stream of research. 7. Limitations and recommendations The findings of this study should be interpreted in consideration of several limitations inherent to the study design. First, we focus on an extremely limited number of variables for internal resources and governance mechanisms. Future studies should investigate additional resources and linkages, including managerial capability, supplier networks, and personal networks. Second, we focus only on the interaction effect of export dependence on governance mechanisms. Future studies should investigate additional variables,

Please cite this article in press as: Jean, R. J. B. What makes export manufacturers pursue functional upgrading in an emerging market? A study of Chinese technology new ventures. International Business Review (2014), http://dx.doi.org/10.1016/j.ibusrev.2014.03.009

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such as institutional characteristics or the competitive nature of the environment, as possible moderating variables. In addition, electronic markets in China provide firms with valuable opportunities to internationalize. Future studies should examine the effect of electronic markets on other processes and outcomes of the internationalization of Chinese firms. Furthermore, the methodology used in this study was limited to a cross-sectional and correlational design because we relied on secondary data on Chinese new technology ventures that had been collected in a business context. Future studies should conduct survey research to explore additional topics in greater depth. In addition, future studies should analyze data from countries other than Taiwan and compare the resulting findings with our findings to assess the consistency of results across countries. Specifically, a comparison of the rising power issue among emerging-market countries should be conducted in future studies. Finally, the cross-sectional design prevented us from determining the causality of phenomena. Future studies should collect longitudinal data and employ a longitudinal design to explore the possible causal relationships proposed in this study. 8. Conclusion As global competition in business intensifies, emerging-market firms face great challenges related to increasing production costs. To remain ahead of the competition, such firms must adopt innovative value-added activities and move up the value chain. This study provides a theoretical explanation and empirical results that deepen the current knowledge on methods Chinese export manufacturers can use to develop innovative strategies and engage in functional upgrading, which in turn, enhance their competitiveness. However, researchers in this field are only beginning to develop an understanding of the factors that influence the innovation strategies of firms participating in emerging markets. Further research is recommended in this promising area of international business. References Alcacer, J., & Oxley, J. (2014). Learning by supplying. Strategic Management Journal, 35(2), 204–223. Almeida, P., Dokko, G., & Rosenkopf, L. (2003). Startup size and the mechanisms of external learning: Increasing opportunity and decreasing ability? Research Policy, 32(2), 301–315. Altenburg, T., Schmitz, H., & Stamm, A. (2008). Breakthrough? China’s and India’s transition from production to innovation. World Development, 36(2), 325–344. Anderson, P., & Anderson, E. (2002). The new e-commerce intermediaries. MIT Sloan Management Review, 43(4), 53–62. Barney, J. (1991). Firm resources and sustained competitive advantage. Journal of Management, 17(1), 99–120. Bell, M., & Pavitt, K. (1995). The development of technological capabilities. Trade, Technology and International Competitiveness, 69–101. Bello, D. C., & Gloria, J. B. (1993). Using industrial trade shows to improve new product development. Journal of Business & Industrial Marketing, 5(2), 43–56. Cardoza, G., & Fornes, G. (2011). The internationalisation of SMEs from China: The case of Ningxia Hui autonomous region. Asia Pacific Journal of Management, 28(4), 737–759. Cohen, W. M., & Levinthal, D. A. (1990). Absorptive capacity: A new perspective on learning and innovation. Administrative Science Quarterly, 35(1), 128–152. Deng, P. (2012). The internationalization of Chinese firms: A critical review and future research. International Journal of Management Reviews, 14(4), 408–427. Gereffi, G. (1999). International trade and industrial upgrading in the apparel commodity chain. Journal of International Economics, 48(1), 37–70. Gereffi, G., Humphrey, J., Kaplinsky, R., & Sturgeon, T. J. (2001). Introduction: Globalisation, value chains and development. IDS Bulletin, 32(3), 1–8. Gereffi, G., Humphrey, J., & Sturgeon, T. (2005). The governance of global value chains. Review of International Political Economy, 12(1), 78–104. Giuliani, E., Pietrobelli, C., & Rabellotti, R. (2005). Upgrading in global value chains: Lessons from Latin American clusters. World Development, 33(4), 549–573. Grewal, R., Comer, J. M., & Mehta, R. (2001). An investigation into the antecedents of organizational participation in business-to-business electronic markets. Journal of Marketing, 65(3), 17–33. Grieger, M. (2003). Electronic marketplaces: A literature review and a call for supply chain management research. European Journal of Operational Research, 144(2), 280–294. Heide, J. B. (1994). Interorganizational governance in marketing channels. Journal of Marketing, 58(1), 71–85.

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Please cite this article in press as: Jean, R. J. B. What makes export manufacturers pursue functional upgrading in an emerging market? A study of Chinese technology new ventures. International Business Review (2014), http://dx.doi.org/10.1016/j.ibusrev.2014.03.009