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

While offshore outsourcing has become an important strategy to lower production costs among western firms, it gives rise to a 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, and shows how the buyer’s choice among these relationships depends on firms’ relative competitiveness in the product market and the supplier’s speed of capability development. The results provide new insights into our understanding of value distribution in vertical relationships across different contexts. We further extend the model to a dynamic setting, showing how vertical relationships and, consequently, value distribution evolve 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.