Linking Local Suppliers to Multinationals: How Can Governments Play a Useful Role?
by Xiaofang Shen

Countries that have attracted significant foreign direct investment (FDI) inflows in recent decades are more eager than ever to see that this investment is linked to domestic companies supplying parts, components, and services. Success will mean more employment and profits for the companies, more and higher-quality FDI for the host countries, faster technological progress, a stronger balance of payments, and in general a more successful entry into and participation in the world economy.

In recent years multinational companies have been moving away from internalizing much of their production or procuring mainly from a large number of arms-length supplier companies, which are left to sink or swim as the buyer shifts supply sources. Instead, these companies are concentrating their own activities on their core skills and subcontracting out for parts, components, and services to an ever smaller number of carefully chosen key suppliers with whom they develop strategic collaborative arrangements. In a developing or transitional economy, multinational companies may bring in the first-tier multinational suppliers, who in turn look for second- and even third-tier suppliers in the host country.

While this evolving trend provides enormous potential benefits to aspiring supplier companies in host countries, it also represents a big challenge to them. Multinational companies work with their suppliers and help them in many ways, but they are tough customers. They demand top-quality service, which means close to zero tolerance of product defects, just-in-time delivery, quick responsiveness to market demand changes, and competitive prices.

In today’s globalized economy, strengthening suppliers is the only way to improve buyer-supplier relations between multinationals and local suppliers. Exhortations and informal pressures will accomplish little. Formal requirements on foreign investors violate international treaties and would be counterproductive in any case: multinationals themselves work in a highly competitive environment and cannot afford less than first-class suppliers.

Creating successful suppliers first requires the strong commitment of potential supplier companies, who must understand the needs and requirements of multinational clients, recognize the improvements that are required of them, and make the necessary efforts to achieve the improvements. Their success will also need the support of a wide range of service providers, particularly those providing technological services (testing centers, research and development centers, standardization institutions, and so forth); managerial and labor training services; and financing. Although these services are often provided by the public sector in developing countries, they are increasingly being provided by the private sector around the world.

The market does not work perfectly in all these interactions, especially in developing and transitional economies, and there are important roles for well-designed government policies and programs. Such policies and programs must be designed to achieve two objectives. First, they must ensure that competition thrives, so that both buyers and suppliers strive for business performance that meets the highest international standards. Second, they must help all key actors in the drama—multinational buyers, domestic suppliers, and the various providers of technological, educational and training, and financial services—play their roles more effectively.

Many governments have adopted special policies and programs to promote buyer-supplier relations between multinational and domestic companies, often with mixed results. A few governments have enjoyed success with such policies, however. Successful programs include the National Linkage Program, run by the Industrial Development Authority of Ireland from 1983 to the late 1990s; the Local Industry Upgrading Program, run by the Economic Development Board of Singapore since 1986; and the Center Satellite System Development Program, run by the Industrial Development Bureau of Taiwan, China since 1984.

Despite the different country contexts, which affected the structural and operational style of these linkage programs, all three programs shared similar basic approaches and some key features. Lessons drawn from these programs’ experiences may benefit other countries. All three programs:

• Were market and demand driven and aimed at upgrading domestic suppliers to meet multinationals’ high standards of quality and delivery requirements. They did so by targeting the most aspiring suppliers as their clients and, through self-selection and other mechanisms, selecting the winners on the basis of their proven abilities and commitment to future improvements.

• Worked closely with multinationals or large domestic buyers in running their activities, tapping those companies’ interests and resources to help domestic suppliers. They provided a channel through which buyers and local suppliers could better communicate with each other. Buyers were invited to help potential suppliers understand their supply needs and requirements, help them identify areas in which they have good opportunities, and draw their attention to weaknesses they must overcome in order to succeed. This assistance helped enhance the mutual understanding and trust between multinational buyers and local suppliers, and it prepared the ground for further business contact between the two parties based on their specific business interests.

• Acted as active intermediaries between supplier companies and industrial service providers. The programs themselves rarely provided credit, training, or technology assistance. Instead, they identified available services and helped supplier companies access the services they needed. These linkage programs fed back information to the various service providers on the priority needs of supplier companies, so that the providers could tailor and improve their services more effectively. The programs thus helped supplier companies succeed in what is basically a costly, risky, and difficult business by tapping the broad resource base available.

• Provided some monetary incentives, but they were applied through performance-based and cost-sharing mechanisms. In Singapore the program shared salary costs of experienced engineers and managers of multinational companies, who agreed to devote time to the supplier upgrading activities under the program. In Ireland the program provided cash grants to promising suppliers to help cover the initial costs and risks of capital investments. in Taiwan, China the program subsidized training, technology consultation, and other needs essential to supplier capability enhancement.

• Were staffed with a few but highly professional and motivated people who worked for clients and drove for results. Government commitment—demonstrated in the consistent provision of sufficient, though modest, budget support to these programs—was essential to their success. Neither large staffs nor large budgets were necessary to achieve results: in Ireland and Singapore the programs operated initially with no more than a dozen staff.

• Suggest that government intervention needs to evolve in response to the changing market needs. Ireland, Singapore and Taiwan, China all started the linkage promotion programs at a time when the level of foreign direct investment suggested significant local procurement potential, but the actual level of local procurement was low. The low level of procurement reflected the large business and cultural gaps between foreign and local companies and the lack of adequate industrial services needed by supplier companies. Over time, as domestic companies improve their capability, as more service providers become available on a commercial basis, and as the gaps between foreign and local companies narrow, government programs can shift focus or be cut back. In Ireland, for example, the National Linkage Program was terminated recently. After 15 years of fostering domestic supplier industries and service providers, local companies were finally up and running on their own.

Xiaofang Shen is senior investment policy officer and program manager for East and Southern Africa, Foreign Investment Advisory Service. Special thanks to Joseph Battat, Joel Bergsman, and Donald Kelly for their contributions to this article.