What’s the Big Idea? Multi-Function Products, Firm Scope and Firm Boundaries (with Daniel Trefler). NBER Working Paper #26320. Journal of Economic Behavior & Organization, Volume 180: 381-406, 2020.
Previous title: "Contracts, Product Design, and Firm Boundary Decisions"
Abstract Products often bundle together many functions, e.g., smartphones. The firm develops the big idea (which functions to bundle) and then chooses one supplier per function. We assume there is a holdup problem and prove that the firm’s bargaining power (Shapley value) is declining in the number of suppliers. Greater scope as measured by the number of suppliers exacerbates holdup, but this can be partially offset by the appropriate choice of vertical integration or outsourcing. Our main result flows from the empirical observation that the number of functions varies across products within an industry (firm heterogeneity). We introduce the notion of an ‘ideas-oriented’ industry as one in which more productive firms have higher marginal returns to introducing a new function. This leads to two testable hypotheses. More productive firms will (1) have more suppliers and (2) be more likely to integrate those suppliers. We take this to the data by training a multilayer perceptron to predict whether or not each of 29 million PATSTAT patent applications involves new/improved functions. We merge these patents with S&P Capital IQ data on 55,000 companies and their supplier networks. We show that in industries where patents are skewed towards new or improved functions, more productive firms have more suppliers and are more likely to integrate these suppliers.
The Missing Option in Firm Boundary Decisions. The European Economic Review, Volume 132 (2021) 103602.
Previous title: "Global Supply Chains without Principals"
Abstract Integration involves two firms, the integrating firm and the integrated firm. This paper argues that both firms matter in the integration decision. To explain how, I construct two property-rights models by introducing the two-directional integration setup in Grossman and Hart (1986) into Antràs (2003) and Antràs and Helpman (2004). One model features homogeneous firms; the other model features heterogeneous firms. In these models, a buyer firm and a seller firm choose one of three ownership structures: buyer integration of the seller, seller integration of the buyer, and outsourcing. Both firms’ idiosyncratic characteristics influence the choice of ownership structure. Predictions of the models are examined in a novel dataset of 209,062 buyer-seller relationships in 154 countries/territories. Both models receive strong and robust support. By allowing either firm to become the owner in an integrated relationship, this paper explains the coexistence of backward and forward integration, which occurs in 758 of the 2282 industry pairs that contain integrated relationships and is assumed away by the existing literature.
