When Suppliers Climb the Value Chain: A Theory of Value Distribution in Vertical Relationships

Although offshore outsourcing has become an important strategy to lower production costs among Western firms, it gives rise to the phenomenon of value chain climbing—suppliers in emerging markets can develop capabilities by supplying, with aspirations to compete with the buyers in the product market. We build an analytical model to study the impact of value chain climbing on value distribution in vertical relationships. The analysis identifies a set of dominant relationships, characterizes how the buyer’s optimal choice among these relationships depends on firms’ relative competitiveness in the product market and the supplier’s speed of capability development, and shows how the optimal choice evolves with the dynamics of the supplier’s capability development. The results provide new insights into our understanding of value distribution in vertical relationships across different contexts and over time. By endogenizing the supplier’s entry into the product market, our study enriches the literatures on vertical relationships, market entry, and the management of global value chains.

This paper was accepted by Bruno Cassiman, business strategy.