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CLUSTERS AND GLOBAL VALUE CHAINS: A COMPARATIVE STUDY OF LEATHER FOOTWEAR CLUSTERS IN ADDIS ABABA, ETHIOPIA Asfaw Wassie (PhD), College of Business and Economics, Hawassa University, ABSTRACT Nowadays, industrial clusters are becoming common in developing countries, found in a range of sectors and regions. There are some case materials that suggest that few of these clusters have already turned themselves in to dynamic clusters by meeting the challenge of both local and international competition. However, footwear clusters from Ethiopia which are largely constituted by micro, small, and medium enterprises (MSMEs) have not yet duplicated their local competitiveness to the international market. This and other cluster cases have attracted considerable interest from both academics and practitioners for many years. Despite the growing interest, detailed information on MSME clusters in Ethiopia remains limited. Moreover, majority of the studies ignored the external relationships that clusters have with their external/foreign buyers. This study, therefore, applied an integrated framework of firm performance, consisting of cluster, global value chain and internal firm factors, to the leather footwear clusters in Ethiopia. Using the same framework, a comparative investigation was also conducted between Natural and Artificial With a Concurrent Mixed Method design, a total sample size of 250, comprising 150 and 100 from natural and artificial leather footwear clusters, respectively, based on a stratified random sampling technique, was taken for the study. Thematic content analysis was employed for the qualitative investigation while a range of statistical analyses techniques including structural equation modeling were applied for the quantitative part of the study. The results showed that the integrated model makes a strong case of firm performance. Larger number of path relationships between the factors and the performance of firms in the integrated model were found to be generalizable across cluster models. The comparative investigation also revealed that although there were some positive outcomes with regards to bilateral, multilateral and institutional linkages, in general, it was challenging to create the envisaged advantages of clustering from the government s intervention. The main challenge of transforming the static part of the natural cluster remains to be seen in the artificial cluster. Creating appropriate linkage with external/foreign buyers that could lead to better source of learning and upgrading also adds to the challenge. These findings, hence, provides both theoretical and practical implications. Key words: industrial clusters, global value chains, firm performance, natural cluster, artificial cluster 1 INTRODUCTION Competitiveness is defined as the ability to compete. It is the ability to design, produce and market products superior to others offered by competitors, by considering price and non-price quality (Ambastha and Momaya, 2004). The search to maintain, and improve, competitiveness in this slippery world has increased in importance and receives much attention from political leaders, business people, and scholars (Markusen, 1996). Many methods to improve competitiveness have been proposed and one that receives particular attention is the concept of a clustering companies. Clusters are geographic agglomerations of interconnected companies, specialized suppliers and business service providers, firms in related industries and associated institutions in a particular field where they compete but also cooperate, and enjoy local externalities (Schmitz, 1992). A leading business scholar, Michael Porter (1998), indicates that a key advantage for an individual member of clustering is that they gain as if they were larger companies. Industrial cluster scholars argue that clustering may help local firms overcome their growth constraints in order to compete in distant markets (Giuliani, Pietrobelli & Rabellotti, 2005). A cluster improves small firms competitive advantages so that they are able to compete with fully integrated firms in the international market. Clustering results in an improved performance, as firms attain benefits from agglomeration economies, including opportunities to utilize innovations in their products and processes (Porter, 1998). In a cluster, firms also have opportunities to cooperate that may compel them to confront the fast pace of market demand (Schmitz, 1999). Clustering may also reduce the production and marketing costs for individual enterprises (Schmitz, 1992; Weijland, 1994) to the extent that they can be able to compete in world markets. In other words, clustering helps small firms improve their competitive advantages, since it helps in overcoming the constraints from diseconomies of scale. However, recent changes in production dispersion, distribution channels and financial markets, accelerated by the globalization of product markets and the explosion of information technologies, suggest that due attention needs to be paid to external linkages. Gereffi s global 2 value chain (GVC) approach (Gereffi, 1999) takes into account activities taking place outside the cluster to, particularly, to understand the strategic role of the relationships with key external actors. According to Gereffi (1999), the global value chain describes the full range of activities, which are required to bring a product or service from conception, through the various phases of production, delivery to final buyers and final disposal after use. Studies on global value chains (Gereffi, 1999; Bair and Gereffi, 2001) provide evidence showing that many small firms from developing countries have become successful exporters not only because they are supported by strong subcontracting relationships to suppliers, but they also have good relationships with foreign investors or buyers (Berry, Rodriguez & Sandee, 2002). Working in a cluster facilitates small firms to respond positively to changes in global competition. However, having a link to global buyers is necessary to access global markets, particularly to developed world markets where most global buyers operate. By linking to external or global buyers, firms from developing countries gain access to upgrading thus allowing small firms to improve their own production processes and products and thus overcome the barriers that hinder their entry into foreign markets. The ability of firms in a cluster to respond to changes in the international market also depends on the dynamics, such as an ability to transform itself, cooperate to deal with changes, and solve common problems. All of these dynamic factors will affect the advantages offered by cluster that determine firm performance. In particular, firm internal factors such as the characteristics of entrepreneurs and managers (Contractor, Kundu & Hsu, 2003) influence how producers perceive the changes and how they respond to them. With this view, the study attempted to assess an integrated impact of cluster, global value chain and internal firm factors on the performance of firms in the selected footwear clusters taking a country of incipient industrialization as a case. It also assessed the role of government intervention in a cluster development process by exploring the changes between natural and government created clusters with respect to an integrated model of firm performance. Ethiopian Footwear Industry 3 Leather footwear production plays a significant role in the development process of both developed and developing countries. Since the 1980s, industry has experienced shifts in production both nationally and globally. Ethiopia has a major comparative advantage in the raw materials sector needed for the leather sector, which makes it in principle very appropriate for leather product exporting, because it has the largest livestock production in Africa (van der Loop, 2003). The livestock population of Ethiopia is believed to be one of the largest in Africa comprising a little more than 100 million, according to a sample survey conducted by the Central Statistics Agency (CSA) in This comparative advantage is further underlined by the fact that the costs of raw hides and skins constitute on average between 55 to 60% of the production of semi-processed leather (Kiruthu and Samuel, 2002). The leather and shoe industry in Ethiopia was among the first players in the industrialisation process with the establishment of two tanneries in the 1920s. Leather shoes, however, were first produced in the late 1930 s by two shoe factories in Addis Ababa which were owned by Armenian merchants (Sonobe, Akoten & Otsuka, 2002). These factories were nationalized by the military government in 1974 and remained in the list of the largest shoemakers of the country. These pioneers nurtured a number of shoemakers, who subsequently opened their own factories in Addis Ababa and trained their workers. Today the government of Ethiopia considered the footwear industry as the most important part of the leather and leather products value chain. The importance of the leather footwear sector as a part of the leather industry has been emphasized by the government at various levels. In the PASDEP (Plan for Accelerated and Sustained Development to End Poverty), which was the strategic plan from 2005/06 to 2009/10, the leather industry was mentioned as an important sector for trade and industry development (Tebarek, 2011). In the current Growth and Transformation Plan (GTP) from 2010/ /15, the sector is also among eight that the government has emphasized, including sugar, cement, metal, textile, and garment industries, for the period (Ethiopia. MoFED, 2010). Furthermore, as part of promoting export of finished leather and leather products including footwear, the government imposed 150% tax in December 2011 on the export of crust leather, semi processed leather, which accounted for 67.3% of the total leather exports in 2011 (Fortune, 2012). Despite such nationwide support for the footwear industry, the export of footwear accounted only 11.7% of the total leather and leather products exports in 2012/13. 4 PASDEP s target of collecting close to 200 million USD in revenue from leather and leather product exports at the end of the previous five-year economic plan (2009/10) was not achieved. The collection was only 75.5 million USD, far less than its plan. Despite this lackluster performance, the government set an ambitious revenue target ( USD) in the current fiveyear economic plan (GTP), out of which the footwear sector is expected to generate USD. However, as indicated in table 1 below, the actual export value of leather footwear is considerably lower than what has been targeted. For instance, the export target for 2013/14 was 260 million USD but the actual export reached 30 million USD. The export target seems even more unrealistic as the remaining period for the completion of the GTP is less than a year. Table 1: Export target and actual export of leather footwear (in million USD) Footwear Year 2010/ / / / /15 Export target Actual export Source: LIDI (2014) and GTP (2010/ /15) The Ethiopian footwear industry is composed of two groups: the larger mechanized footwear producers and the remaining production units that can be considered as micro, small, and medium (MSMEs) which are mainly concentrated in the capital city of Addis Ababa. There are currently 15 mechanized factories of leather shoes in Ethiopia out of which 12 of them have an estimated annual installed production capacity of 3,726,250 pairs of shoes but with actual output of 1,787,500 pairs. There are a considerable number of MSMEs which are mostly found in natural clusters in different parts of the capital city, such as, Merkato, Messalemia, Asco, Kuwas Meda etc. The largest cluster is found in Merkato, locally known as 'Shera Tera' where producers, input suppliers and component retailers are concentrated. The footwear producers are observed more concentrated and localized in the areas of Sebategna and Mesalemia, the shoe production shops in the areas of Asco and Kwas-Meda are quite few in number and scattered (UNIDO, 2006). Furthermore, many leather footwear MSMEs are to be found in the Yeka sub city, which is 20 km away from Merkato, in the government created cluster called Ethio-International Footwear 5 Cluster Cooperative Association (EIFCCOS). The following section focuses on the two selected case clusters: Merkato and EIFCCOS. Leather Footwear clusters in Ethiopia Like other countries in the world, industrial clusters for micro- and small-scale enterprises are also present in Ethiopia. The most common types of clusters in Ethiopia are natural clusters. Although the exact number of clusters in is not known, they are commonly found among labor intensive manufacturing sectors and are mostly located in urban centers, rural towns and tourist areas (Ali, 2012). One example of such clusters in Ethiopia is the footwear cluster in Merkato, Addis Ababa. The Merkato Footwear Cluster The Merkato footwear cluster is a spontaneously grown agglomeration MSMEs. Its name reflects its location. Merkato is the largest open air market in Africa located in the city centre of Addis Ababa. The natural cluster is believed to comprise above 1500 shoe makers. It also consists of other related businesses and activities that include buyers, suppliers (soles, leather, shoe accessories), and specialized service providers (repair, machinery rent etc.). Nearly all raw materials and services such as design, machinery and equipment maintenance and labor supply required for shoe manufacturing are found in the natural cluster. The majority of enterprises also supply their products through wholesalers that are mainly located in and around the cluster (Sonobe et al., 2006). The cluster s installed daily production capacity is estimated as 12,750 pairs of shoes (UNIDO, 2006). Table 2 shows the installed production capacity of informal footwear producers categorized by size: Table 2: Estimated Yearly Production Capacity of the Footwear Informal Sector Installed Capacity Category (pairs per day) Medium scale producers ,620 Small scale producers ,250 Micro scale producers ,700 Total installed daily capacity ,570 PAIRS (ca Dozens) AT 50 WEEKS X 5.5 = 275 WORKING DAYS PER ANNUM ,456,750 PAIRS Source: UNIDO (2006) The Merkato cluster has been functioning for decades and went through difficult times. The socialist ideology of the military government that persisted for about two decades ( ) in the country was hostile for entrepreneurship or private investment. The cluster and the sector at large were stifled as a result. In 1991, the military government was overthrown and the new government undertook economic policy reforms to transfer the economy into a free market one. It also adopted a structural adjustment program that includes domestic market deregulation and trade opening. Some of these reforms helped for the revival of the cluster and the private sector at large. However, the domestic market was flooded with imports particularly Chinese-made shoes following the trade reform. Although the Chinese shoes were less durable, they were more fashionable with better designs and relatively cheaper than those produced in the cluster and elsewhere in the country. Throughout the 1990s, the domestic footwear industry was hit hard. As a result many firms could not compete and were forced to close/change or downsize their business (Sonobe et al., 2006). The export promotion strategy in 1990 s and the subsequent industrial and micro and small enterprises (MSEs) development strategies consider the leather industry as a priority sector. The strategy emphasizes the need to upgrade exports from unprocessed hides and skins toward fully processed leather and final products such as footwear, bags, jackets etc. The main focus of the support, however, has been to the large footwear firms. The small firms cluster did not benefit from the government MSE promotion initiatives mainly because it operates out of the radar of regulatory bodies. Despite the absence of support from the government, the Merkato small shoe cluster has made a remarkable recovery in the early 2000s at a time when the large firms continue to struggle for survival and lobby for government support. Although there is no official record on the number of firms in the cluster, recent studies have shown an increasing expansion of this cluster. Prior to 2000 the number of firms in the cluster was estimated to be around 500 (van der Loop, 2003). 7 Following the recovery from severe Chinese competition, this number increased substantially and reached about 1000 by 2005 (Sonobe, et al., 2006) and is currently estimated to be above The Ethio-International Footwear Cluster Cooperative Society (EIFCCOS) In line with the current MSEs Development Strategy of Ethiopia, however, the government has formulated a cluster development strategy in January The main objective of the cluster development strategy is to alleviate problems of working and selling premises often faced by MSEs in various clusters through the construction of standard working and selling premises where MSEs can operate together as a cluster. The concentration of enterprises in a cluster is believed not only to resolve their space constraints but also help create market linkages, induce network and collaboration among the enterprises, and facilitate technology transfer. Moreover, having MSEs that work on similar and closely related goods in a cluster provides an opportunity for subcontracting linkages with medium and large scale factories. Accordingly, government provided shoe making MSEs with working and selling premises in 2003 at a place named Yeka which is 20 km away from the natural cluster and established the cooperative cluster named as EIFCCOS (artificial cluster). The premises are made out of 6 G+4 buildings that were constructed with a total cost of more than 3 million USD. 174 producing enterprises and 26 input suppliers are currently operating in these premises majority of which used to operate at the natural cluster. The aim of the cooperative cluster is to establish a vertically integrated manufacturing unit with the capacity of 12,500 pairs of shoes per day to be sold largely to the export market (Ali, 2012). However the cluster is not currently operating at full capacity and despite the recent developments in terms of reaching some African and European markets, the export progress has so far been slow. PROBLEM STATEMENT Firms in developing countries and particularly in Sub-Saharan Africa (SSA) are under pressure to improve their competitiveness as they must overcome significant financial, organizational, technological, and infrastructural limitations in order to meet the demands of the global markets (Gibbon and Ponte, 2005). Ethiopia s manufacturing sector, which is dominated by small firms, 8 face similar limitations like its counterparts in SSA. MSMEs in Ethiopia face a number of constraints including, lack of access to markets, finance, business information; lack of business premises; low ability to acquire skills and managerial expertise; low access to appropriate technology and poor access to quality business infrastructure (Stevenson and Annette, 2006). Moreover, their potential contribution to economic growth and poverty reduction often remains unfulfilled because of constrains associated with isolation and informality. Many of these obstacles can be overcome when small-scale firms are able to share resources, access external economies that lower their operating costs, and undertake joint actions that improve their competitiveness. Spatial proximity facilitates the achievement of such gains, as it is the case for firms operating within industrial clusters (UNIDO, 2009). This observation appears to have great relevance to Ethiopia. While much evidence still needs to be gathered, it is now clear that industrial c
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