Working Paper: NBER ID: w26320
Authors: Mengxiao Liu; Daniel Trefler
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 develop a model featuring holdup in which the firm's bargaining power declines in the number of suppliers. Greater scope as measured by the number of suppliers exacerbates holdup, but this is 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 in which more productive firms have higher marginal returns to introducing a new function. We show that more productive firms will (1) have more suppliers and (2) be more likely to integrate those suppliers. We take this to the data using a neural network to predict whether or not each of 29 million PATSTAT patent applications involves new/improved functions. We merge these patents with 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.
Keywords: multifunction products; firm scope; firm boundaries; vertical integration; outsourcing
JEL Codes: F1; F12; F14; L14; L15; L23; L24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| More productive firms in ideas-oriented industries (O31) | More suppliers (L81) |
| More productive firms in cost-oriented industries (D21) | Fewer suppliers (L14) |
| More productive firms in ideas-oriented industries (O31) | More likely to integrate suppliers (L14) |
| More productive firms in cost-oriented industries (D21) | Less likely to integrate suppliers (L14) |