21. Local Production Networks of SMEs: The Future of Producing Locally?

Enterprises are usually categorized by their sizes into micro, small, medium-sized and large. The most commonly used categorization criteria are the number of employees and the annual turnover. The scale is less than 10 employees with up to 2 million Euro p.a. in turnover, between 10 and 49 employees with up to 10 million Euro p.a. in turnover, between 50 and 249 employees with up to 50 million Euro p.a. in turnover and more than 250 employees with more than 50 million Euro p.a. in turnover, respectively (Institut für Mittelstandsforschung Bonn, 2023). Literature often focuses either on large enterprises or on the combined subgroups of micro, small and medium-sized enterprises (SME). Micro enterprises, even though they do not appear in the acronym SME, are part of the SME definition of the EU Recommendation 2003/361 of the European Commission (Institut für Mittelstandsforschung Bonn, 2023).

The term Industry 4.0, often shortened to I 4.0, was first coined in Germany at the Hannover fair in 2011 (Drath & Horch, 2014, p. 56). It has since been widely used in reference to the fourth industrial revolution and is characterized by the rise of cyber-physical systems (CPS), the extended use of the internet, i.e., in the Internet of Things, and the interconnectedness as well as digitalization and automation, to mention some of the most prominent technologies (Gilchrist, 2016, p. 195 ff.; Pistorius, 2020, p. 6). In 2016, Gilchrist wrote the following about I 4.0:

In summary, Industry 4.0 will require the integration of CPS in manufacturing and logistics while introducing the Internet of Things and services in the manufacturing process. This will bring new ways to create value, business models, and downstream services for SME (small medium enterprises). (Gilchrist, 2016, p. 196)

However, as of today, the consensus is still that SMEs have disadvantages compared to large enterprises in terms of the implementation of Industry 4.0 technologies. Table 21.1 shows a selection of obstacles, risks, and difficulties of implementing Industry 4.0 in SMEs.

Overcoming these obstacles and adopting Industry 4.0, however, will provide SMEs with important tools for the future, as, e.g., Weissmann and Wegerer suggest that “dealing with an information-dominated value chain will be vital for the success of a company” (Weissman & Wegerer, 2019, p. 66, own translation). Industry 4.0 technologies are also expected to aid in connecting the actors involved in the production process, leading to an “optimized value stream” (Weissman & Wegerer, 2019, p. 67, own translation).

Defining the term network in this context is not a trivial matter since different authors often attribute slightly different meanings to the word “network”. Additionally, similar terms with closely related or even the same meaning are used as well, most often “cooperation”, but occasionally also “co-creation”. Schütze suggests using the term “network”, as it is the one used most commonly in literature (Schütze, 2009, pp. 9–10). The Observatory of European SMEs created a short but concise definition for a cooperation or a network of SMEs that was also favored by Schütze: “Interaction between independent SMEs for a specific purpose that goes beyond a single task” (KPMG Special Services et al., 2004, pp. 7, 17; Schütze, 2009, p. 10, translation). Such cooperations can be described with the dimensions “goal/objective”, “structure” and “dynamic” according to the Observatory of European SMEs (KPMG Special Services et al., 2004, p. 17).

It is not a new idea to have SMEs cooperate in a network. According to a report by the Observatory of European SMEs back in 2004, about 50% of SMEs in Europe – with this number varying depending on the country – were working with other SMEs (KPMG Special Services et al., 2004, p. 7). These networks of limited size are coordinated manually and tend to be rather set/inflexible (KPMG Special Services et al., 2004, p. 7). The focal enterprise coordinating the value chain would then typically be the one with direct customer contact. For instance, a carpenter might always ask the same metalworker and upholsterer for the manufacture of specific parts, or houses might be built with future homeowners often paying someone to coordinate and find all the suitable tradesmen. In fact, Eikebrokk et al. have found that “SMEs have very little understanding about how they would go about to initiate a co-creation network” (Eikebrokk et al., 2021, p. 361). Furthermore, the Observatory of European SMEs found that, while a lot of SMEs do cooperate, it is often with very few, rather permanent partners (usually one or two; two-thirds of SMEs have less than seven) that they always keep close contact with (KPMG Special Services et al., 2004, p. 7). This also means that every cooperation partner is tied to significant efforts in keeping up trust and communication. However, especially in smaller enterprises, “the capacity of the organization to coordinate the relationships” (KPMG Special Services et al., 2004, p. 29) plays a significant role in the number of manageable partners: large enterprises usually have specific personnel for the management of the supplier network, something SMEs often do not have the resources for. And while those findings by the Observatory of European SMEs are almost 20 years old, they still seem relevant today, though a slight shift in research interest towards cooperations between SMEs and start-ups should be mentioned.

Nevertheless, a few concepts exist with the goal of creating and governing such networks of autonomous SMEs. One such concept is the ‘Virtuelle Fabrik’ published in the late 1990s by Schuh, Millarg and Göransson (Schuh et al., 1998). As was done by Katzy and Crowston, the German term ‘Virtuelle Fabrik’ will be used in this paper (Katzy & Crowston, 2008). In contrast, the direct translation into English, ‘virtual factory’, is used for two scenarios, one being in the sense of Schuh et al., as described below, the other being “a concept of executing manufacturing processes in computers as well as in the real world” (Onosato & Iwata, 1993, p. 475). Camarinha-Matos and Afsarmanesh describe a similar concept to the ‘Virtuelle Fabrik’ with the English term ‘virtual enterprise’ (Camarinha-Matos & Afsarmanesh, 1999).

The basic idea behind the ‘Virtuelle Fabrik’ is to think of a network of smaller companies as one large factory with the purpose of dynamically processing orders and producing in small batches while maintaining the autonomy of each participating company (Schuh et al., 1998). This concept can be categorized as a “guided, focal network of enterprises” (Schuh, 2017, p. 266). To establish such a ‘Virtuelle Fabrik’, Schuh et al. defined four prerequisites, namely the “cooperation network, principles of cooperation (roles, rules and instruments), marketing of the Virtuelle Fabrik and production in the network” (Schuh et al., 1998, p. 67, own translation). This concept includes six intercorporate services or roles that organize and coordinate the network (Schuh et al., 1998, p. 67), “network coach, broker, performance manager, in- and outsourcing manager, auditor” (Schuh et al., 1998, p. 93, own translation). These roles are not necessarily tied to one person specifically but should be viewed as “tasks that need to be fulfilled depending on the situation” (Schuh et al., 1998, p. 94, own translation). The “broker”, for example, can be an actual person, but the role may be fulfilled by a company in the network as well (Schuh et al., 1998, p. 97 ff.). In the ‘Virtuelle Fabrik’ concept by Schuh et al., in order to create a cross-company value chain, two of the roles need to work together, namely the “broker”, as the one who acquires orders, and the “performance manager”, as the one who puts together the value chain (Schuh et al., 1998, pp. 100–101). Consequently, the knowledge of the performance manager, with regard to the capabilities represented in the network, is essential to the concept’s success. Once the value chain is determined, the companies chosen to produce an order are “activated” (Schuh et al., 1998, p. 31). In a later description of the concept, Schuh details how the cooperation network acts as a “stable platform” that the value creation network, or the actual ‘Virtuelle Fabrik’, is created from to temporarily work together for an order (Schuh, 2017, pp. 270–271).

While the organization of production in networks and local production each come with their own advantages, the following section will discuss these together to answer the first question: What is the potential of combining local production and production networks?

To provide a better structure, the various potential benefits will be grouped according to the commonly used three dimensions of sustainability: economic, ecological, and social sustainability (Fischer et al., 2020). Though, some aspects may be relevant to more than one dimension. For the sake of avoiding repetition, they will only be listed in one dimension with a reference to the other affected dimension(s). The goal of this chapter is to give an overview of the most relevant aspects. For further details, literature dealing with local manufacturing and production networks of SMEs should be consulted.

Considering the advantages and potential for SMEs of working together in local, highly connected, flexible networks, the question arises as to why such networks have not been widely implemented yet. Thus, the second question from Sect. 21.1 is addressed next: What are barriers for implementing local production networks? Two main reasons are the competitive advantage of large-scale production in global networks as well as the difficulties of implementing local production networks of SMEs.

Global value chains and mass production have some major competitive advantages which is highly likely to be one of the reasons why local production is hard to set up in some cases. Deqiang et al. state that “[t]he establishment of the global value chain (GVC) allows firms to minimize production costs across the entire production system” (Deqiang et al., 2021, p. 1). Other financial advantages result, for example, from being able to utilize economies of scale (Matt et al., 2015, p. 186) and outsourcing to countries with the availability of cheaper labor (The Government Office for Science, London, 2013, p. 24). All these monetary benefits allow companies to sell their products for prices that are often significantly lower than the prices of strictly local manufacturers. Despite these factors, recent developments have shown that some advantages may be getting smaller, as demonstrated, e.g., by the reshoring trend, meaning bringing production back from where it was outsourced to (Butollo, 2021, p. 264). There are several reasons for reshoring, one is the development of automation technology that to some degree diminishes the advantage of production in low-wage countries (Butollo, 2021, p. 264). Other reasons include, but are not limited to, the growing importance of co-location, the decreasing wage gap between high- and low-wage countries, and rising transport costs (Bryson et al., 2013, pp. 47–48). In addition, consumers are increasingly asking for more sustainable products (Matt et al., 2015, p. 185), which may also lessen the advantages of global value chains.

Besides the competitive disadvantages of local production, there are also some inherent difficulties when it comes to producing locally in networks. As was mentioned earlier, it seems that SMEs do cooperate with one another, but they often have few, though long-term partnerships (KPMG Special Services et al., 2004, p. 7). In this form of very small networks, the companies are in constant close contact with their partners, whom they have usually built trust with over time (KPMG Special Services et al., 2004, pp. 7, 14). And while these cooperations already provide various advantages, they are limited in size by the time and effort necessary to build and maintain the relationships and trust with the partnering companies (KPMG Special Services et al., 2004, p. 29).

Additionally, even though the concept of the ‘Virtuelle Fabrik’ provides rather detailed information on how a network could operate, it has not been widely adopted or implemented. In fact, there seems to not have been as much research interest in the concept of the ‘Virtuelle Fabrik’, specifically after the early 2000s. Also, Eikebrokk et al. (2021) recently found that SMEs do not really know how to even start such a network.

Schuh und Wegehaupt (2004) reflected upon the reasons for the lack of implementation. They interviewed several enterprises and found “opportunistic thinking of advantages, an insufficient shared infrastructure as well as a lack of a targeted management of the competencies of the partnering enterprises” (Schuh & Wegehaupt, 2004, p. 190, own translation) to be among the listed reasons for the concept not working as expected. Another issue was putting too much emphasis on trust as the basis for the network, as this led to the opposite: a “culture of mistrust” (Schuh & Wegehaupt, 2004, p. 190, own translation). From the customers’ perspective, the services and/or products appear to be too unclear or too broad, leading to mistrust in the network’s abilities (Schuh & Wegehaupt, 2004, p. 190).

One of the biggest issues, however, is the governance of the network. Schuh and Wegehaupt found that while “the centralized leadership by a dominant enterprise is rejected” (Schuh & Wegehaupt, 2004, p. 190, own translation), there is still a need for “clearly defined responsibilities and contact partners” (Schuh & Wegehaupt, 2004, p. 190, own translation). In short, the idea of complete decentralization and an absence of hierarchy did not work the way it was originally envisioned (Schuh & Wegehaupt, 2004). Instead, Schuh and Wegehaupt suggest a concept using a “focal management entity” (p. 191 ff.). They assign four tasks to this new entity: „Building the cooperation network”, “Active and passive marketing”, “Preparation and negotiation of contracts [and] Project management” (Schuh & Wegehaupt, 2004, p. 195, own translation). There is however no further elaboration on how this “focal management entity” would be established.

To the authors’ knowledge, the Observatory of European SMEs or as it is called now, Directorate-General for Internal Market, Industry, Entrepreneurship and SMEs (GROW), has also not published another report with updates on its findings since 2004.

In conclusion, it seems that not much has changed in the way SMEs cooperate since the first efforts to revolutionize production networks of SMEs in the 1990s, despite new opportunities opening up through technological advances and Industry 4.0.

After highlighting the potential of local production networks of SMEs and taking a closer look at the reasons for them not being a common occurrence yet, as well as discussing why local production might be gaining in relevance compared to global production, it appears important to conduct further research in this field. Therefore, the third question needs to be addressed: What are the conditions and prerequisites to facilitate the successful creation of local production networks?

From Sect. 21.3.2 several prerequisites for the facilitation of a viable, successful network of local SMEs can be derived, as shown in Fig. 21.1 and explained in more detail below.

The initiation of a network requires a significant amount of effort and investment without warranting success. Therefore, an initial “push” is necessary to initiate a network, and Eikebrokk et al. believe this to be “more realistically stimulated and facilitated by an external party, such as academia or an industry association” (Eikebrokk et al., 2021, p. 363).

There should not be a hierarchy, though some kind of “focal management entity” is still necessary (Schuh & Wegehaupt, 2004, p. 191 ff.). Schuh and Wegehaupt found in their reflection on the ‘Virtuelle Fabrik’ that enterprises did not want to be restricted by a hierarchy, but actors in the network that did take on coordination responsibilities were not necessarily the most suitable for the role in terms of competency either (Schuh & Wegehaupt, 2004, p. 192). Therefore, the network should also not simply rely on any single person or any enterprise to step up to do managerial tasks.

There should be no need for constant communication among the network partners. The large amount of effort necessary to cultivate cooperation through frequent and direct communication is the main reason why SMEs have only been able to maintain a limited number of partners so far (KPMG Special Services et al., 2004, p. 29 ff.). For the same reason, trust among the network enterprises cannot rely solely on close personal relationships as these take up too much effort to build in a larger network. On the flipside, trust also cannot be the sole basis for the partnerships, since Schuh und Wegehaupt (2004) found that this can lead to the opposite effect, i.e., mistrust.

There should be no need to share specialized knowledge between the network partners verbally or in writing, instead, knowledge should be transferred via the product itself (Krenz, 2020). This means that only the “interface between the components is to be configured” (Krenz, 2020, p. 289, own translation), i.e., only the point at which the product is handed over to the next network partner.

This list should be understood as a baseline for efforts towards the creation of local production networks of SMEs. It does not hold a claim to completeness. The better the reasons for the current lack of these types of networks are understood, the more stipulations can likely be added.

Furthermore, the points elaborated above can only provide a framework for the initiation of a successful local network of SMEs. In order to find concrete recommendations for action and solutions, more research – both conceptual and empirical – is necessary.