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Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop (2022)

Chapter: 10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing

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Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
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10

Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing
1

Paper Authors: Valerie Smeets (Aarhus School of Business) and Frederic Warzynski (Aarhus School of Business)

Presenter: Frederic Warzynski (Aarhus School of Business)
Moderator: David Chor (Dartmouth College)

Frederic Warzynski, professor of economics at the Aarhus School of Business, discussed the measurement of globalization from the point of view of Denmark using data collected by Statistics Denmark and offshoring surveys coordinated with Eurostat. The workshop paper by Valerie Smeets and Frederic Warzynski, “Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing,” studies firm selection and organization choice in the production networks and outsourcings patterns of Danish firms. The presentation, however, drew from a mix of this and two other papers: “Measuring Globalization: A Danish Perspective” (with Peter Bøegh Nielsen, in progress) and “Offshoring, Workforce Composition and Innovation,” which is based on “Heterogeneous Globalization: Offshoring and Reorganization” (Bernard et al., 2020).

The work is motivated by the increasing fragmentation in global value chains (GVCs) since the 1990s, the fall of the Berlin Wall, and China’s entry into the World Trade Organization, along with the technological shift towards computing and information services. These changes have important implications for labor markets, creating a challenge for policy makers.

Warzynski argued that Denmark is an interesting country for study because it is an early adopter and mover in globalization, and is home to large, multinational enterprises (MNEs) with large market share in their respective industries. These MNEs are relatively open to foreign supply chains in the context of the European Union (Eurostat, 2017). Statistics Denmark creates very detailed

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1 The title of Warzynski’s presentation was “Measuring Globalization: A Danish Perspective.”

Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
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and rich datasets, thanks to the openness of Danish MNEs, allowing Danish researchers to answer interesting questions.

LITERATURE REVIEW

The three papers discussed in this presentation relate to an extensive body of literature containing six categories:

THEORETICAL BACKGROUND

Warzynski discussed the theoretical background for his presentation by describing a simplified theoretical framework based on Antràs and Helpman (2004), which applies the theory of firm and property rights in a global context. In this model, firms differ in two dimensions, which depend on the nature of the firm’s activity: productivity and headquarter (HQ) intensity of a needed input. When HQ intensity is low, adding little value at the HQ, control is not important and the efficient strategy for the firm is to outsource activity to countries with comparative advantage in the required factor of production. High-productivity firms will outsource to the global South and low-productivity firms will outsource to the global North. The least productive firms will then exit the market.

Conversely, Warzynski said, when HQ intensity is high, or there is a large amount of value added at the HQ, then control and location are important decisions. The most productive firms will produce in the global South, with foreign direct investment (FDI), and somewhat less productive firms will outsource to the global South. The firms below these somewhat less productive firms in the distribution will source components in the global North, either through integration (for the more productive firms) or outsourcing (for the less productive firms). Again, the least productive firms in the distribution will exit the market. Warzynski and his coauthors tested these theories using the Danish data described below.

Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×

DATA

Warzynski went on to explain that data were collected from three waves of mandatory offshoring surveys, each containing more than 4,000 firms, from 2001 to 2006 (reported in 2007), 2009 to 2011 (reported in 2012), and 2014 to 2016 (reported in 2016). All nonfinancial firms in Denmark that have more than 50 employees were required to take part, and the surveys had a compliance rate of more than 95 percent. In addition, there is a subsample of firms with between 20 and 49 employees.

Warzynski said that firms were asked about the type of business activity they outsourced. Firm activity was categorized into core activity and support activity. Core activity describes firm functions accounting for their main source of revenue. Support activity is divided into subfunctions: distribution and logistics; marketing, sales, and after-sales services (like support centers); information and computing technology services; administrative and management; engineering work and other technical services; research and development (R&D); facility management (only asked in the first round); and others. Firms were also asked about the organizational form of their outsourcing activity broken down by intra- and interfirm. The destination choice is broken down by “old European Union” (western Europe), “new European Union” (Central and Eastern Europe), China, India, other Asian countries and Oceania, and others, such as other European countries outside of the European Union, the United States, or Canada.

In the work presented, the focus was on the firm’s core activity only; Warzynski argued that this has the largest implications for the domestic labor market and represents the most important decision for the firm organizational structure. The findings can be extended to include firms’ support activities as well. The focus on business functions is discussed in depth in Olsen and Statistics Denmark (2008), Sturgeon (2013), Eurostat (2017), and Nielsen (2018), and is inspired by Porter (1985). The general idea is that firms separate and choose their activity in an efficient manner, and some activity is more likely to be offshored. Firms can also acquire a competitive advantage by choosing the correct level of activities of each form. Breaking down firm activity this way is a “new tool in the statistical toolbox” (see Nielsen, 2018) and can be validated by use of occupational groups in datasets linked by employer–employee relationships, as in Bernard et al. (2017) and Bernard et al. (2021).

SUMMARY STATISTICS

Warzynski first discussed the offshoring activity for both core and support activities. In the first wave (2001–2006), a large proportion of firms (more than 40 percent) purchased from domestic firms, driven by the category of facility management (e.g., cleaning, food). Facility management was not included in the other survey waves. Also in the first wave, approximately 6 percent of firms sourced only internationally and about 11.5 percent sourced both domestically

Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×

and internationally. About 41 percent of firms did not outsource any activity in the first wave. In the next two survey waves (2009–2011 and 2014–2016), domestic sourcing dropped significantly to about 19 percent in the second wave and 18 percent in the third. The number of firms that did not outsource increased in the second and third waves to 64 percent and 72 percent, respectively. International sourcing fell from 11.5 percent in the second wave to about 5.5 percent in the third. Firms that sourced from both domestic and international firms remained relatively flat between 2001 and 2016, although there was an increase in the second wave that disappeared by 2016.

Next, Warzynski looked at the core activities only, for which the patterns remained relatively similar. There was a decrease in international sourcing, particularly between the second and third waves (reported in 2012 and 2016), and an increase in domestic sourcing across all waves. There was a small increase, from 1 percent to 2 percent, in sourcing activity both internationally and domestically across the full sample. International sourcing occurred increasingly at the intrafirm level. Interfirm sourcing was relatively flat across the sample with a small dip reported in 2012. International sourcing both within and outside of the firm was flat in the first two waves before decreasing by half in the last wave. International sourcing to the global North was relatively flat with a drop reported in 2012, while international sourcing to the global South is increasing over the three surveys. Sourcing to both the global North and global South is decreasing across the three surveys. The most common destinations for outsourcing, in order of proportion as reported in 2016, were new European Union, China (a decreasing choice over the sample), other Asian countries and Oceania, other European countries, India, and the United States and Canada.

Warzynski summarized the trends as a clear slowing of outsourcing internationally and relatively flat domestic sourcing, which is complicated because of the dropping of the facility management activity. The international sourcing that remains is less concentrated in Asia and even less concentrated in the European Union. The global South remains the majority destination for international sourcing, and fewer firms outsource to both the South and North. International sourcing within a firm is more likely than outside of the firm, and fewer firms outsource to both areas.

ORGANIZATIONAL CHOICE

Warzynski went on to explain that, following the stylized facts of the data, firms are divided into several categories based on their organizational structure, focusing on their core activity only. Firms are split into five categories by whether they outsource within or outside of the MNE, or both: no outsourcing, domestic-only outsourcing, international sourcing outside group, international sourcing within group, and international sourcing both within and outside group. The second categorical variable adds the dimension of location of outsourcing, divided into eight subcategories: no outsourcing, domestic-only outsourcing, international sourcing outside group in the North, international sourcing outside

Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×

group in the South, international sourcing within group in the North, international sourcing within group in the South, international sourcing within and outside group in the North, and international sourcing with and outside group in the South.

ADDITIONAL SURVEY QUESTIONS

Warzynski stated that the second two waves of the survey asked firms to define their core activity, in order to determine whether the firm is primarily engaged in manufacturing, trade, or services. Firms primarily engaged in manufacturing were further subdivided into three categories: regular manufacturer, subcontractor, or a factory-less goods producer. Firms primarily engaged in trade define themselves as regular trade or a trade firm involved in manufacturing. Firms engaged primarily in service are divided by regular service and services involved in production. There is large heterogeneity within sectors, implying that firms engage in a mix of the three broad categories.

Moving to employment by business function, Warzynski said the second two surveys asked firms about the distribution of employees by function. This is useful for understanding the activity performed at the firm and how the firm allocates resources over time. This reporting was validated with occupation codes in a merged dataset (see Bernard et al., 2017, 2021).

Warzynski mentioned that the second two waves of the survey investigated the flow of activity back to Denmark. Firms were asked about their backsourcing activity, providing systematic evidence about the global sourcing decisions of Danish firms. Responding firms indicated that most of them were not involved, and the ones that were involved did not indicate that many jobs were created.

TESTABLE PREDICTIONS AND EMPIRICAL APPROACH

Warzynski explained that he and his coauthors used multinomial logit regressions with the two measures of organizational structure as the outcome variables of interest; the independent variable is the probability of a given firm choosing a particular form of organization, with explanatory variables of value added per worker, capital per worker, size of firm, a manufacturing indicator, and second-wave indicator.

Warzynski and his coauthors found that international sourcing outside of the group is negatively associated with capital intensity, a proxy for HQ intensity. Further, this sourcing is positively associated with value added per worker, a proxy for productivity. For international sourcing within group, and both within and outside group, value added per worker is positive and significant, while the proxy for HQ intensity is not statistically significant.

The results, Warzynski shared, show a link between decisions about organizational choice based on firm productivity and HQ intensity. HQ intensity is negatively related to outsourcing and positively related to FDI and complex

Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×

sourcing. Firms on the right tail of the productivity distribution are more likely to source in the global South and more likely to organize through FDI, conditional on HQ intensity. The results are robust when looking at core and support activities, not core alone, and using the stock of activities rather than the flow. These results validate the predictions of the work of Antràs and Helpman (2004) and the extension to bisourcing by Du and colleagues (2009).

Warzynski mentioned that labor market implications from these surveys can be found in Bernard et al. (2021), which reports that companies that outsource activity to the new European Union or China become more innovative and upgrade their workforce by hiring more high-tech, high-wage employees. That work merged the first wave of the study with R&D surveys, employer–employee data, a production survey, and international trade statistics from customs data. Nielsen (2018) studied large industrial firms in the second two waves of the survey, finding a large decrease in the number of unskilled workers at outsourcing firms and an increase in the number of skilled workers between 2009 and 2016.

FUTURE DATA COLLECTION

Warzynski indicated that the fourth wave of the survey would launch in August 2021 and contain similar questions, in addition to asking firms how the COVID-19 pandemic impacted GVCs. He and his colleagues will continue to integrate additional data sources.

SUMMARY

In conclusion, Warzynski stated that his and his coauthors’ work shows evidence of complex outsourcing patterns involving intra- and interfirm sourcing in the global North and South. Outsourcing decisions appear to be driven by two measures of firm heterogeneity: productivity and capital intensity. These results validate the theoretical predictions by Antràs and Helpman (2004). In future work, the authors will integrate more data sources and seek a better understanding of sourcing decisions in line with the make-or-buy literature.

DISCUSSION

Discussant: Catherine Thomas (London School of Economics)

Catherine Thomas, associate professor of managerial economics and strategy in the Department of Management at the London School of Economics, director of the Centre for Economics Performance International Trade Programme, and a fellow of the Centre for Economic Policy Research, discussed only the submitted paper, “Firm Selection and Organization Choice: Complex Patterns of Global Sourcing.”

Thomas began by stating that this paper is based on firm-level survey data from Danish firms. In the results reported in 2007, there were more than

Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×

4,000 firms divided in two non–mutually exclusive dimensions: intra- or interfirm boundaries, and domestic or international location. According to Thomas, understanding the variation in firm organization choices will reveal information on the firms’ relative efficiency, cost-reduction, or allocative efficiency, and eventually enable analysis of the welfare implications of the firms’ choices.

As Thomas reviewed, the authors connected the variation in the data to theory developed in the past literature, most notably the Antràs and Helpman (2004) model on how to mitigate the impact of incomplete contracts. The use of theory to understand the data limits the possible sources of variation that may exist outside of the formal framework. The model contains a production function with inputs from two parties with variable fixed costs and heterogeneous firms, as a result of variation in productivity and relative input factor intensity. In the formal model, productivity is measured firm-wide, which is difficult in the context of an MNE. This theory produces predictions about the sorting of firms into four mutually exclusive organization choices, depending on model parameters.

Thomas pointed out the benefit of this rich firm-level dataset as reducing required assumptions for analyzing the predictions of the model. The authors can explore what must be true for the predictions of Antràs and Helpman (2004) to be true. If these requirements are plausible, then one could begin to argue that the location decisions are due to incomplete contracts, as in the formal model.

Thomas then stated that the results indicate that firms select intrafirm sourcing when they have high value added per worker. This is consistent with the formal model with high HQ intensity and moderately high relative fixed costs of integration.

On the other hand, Thomas continued, the results indicate that this association only exists for firms sourcing in the global South, not in the North. She raised an additional concern that the productivity measure is not firm-wide as in the formal model, but rather is for the domestic HQ only. There may be alternative explanations for the observed correlations. More productive firms have more scale capacity to incur the fixed costs of fragmentation in their GVC. The firm then alters the tasks that they complete in-house, and firm activity that adds more value can be done at the firm HQ. Activities with less value added can be outsourced. Then efficiency gains arise from comparative advantage and not from the need to mitigate underinvestment.

In order to validate the results, Thomas stated that the theoretical model makes unique predictions that the authors can explore. One avenue may be to split the data by productivity and capital intensity, in order to understand how heterogeneity impacts their results. The model predicts different relationships under different model parameters. The results would be convincing if these relationships existed for firms that match those parameters. Further statistics on bargaining power and contracting between firms would be necessary to truly fit the proposed theoretical framework.

Thomas said the data indicate that some firms are entering extremely complex organizational structures with combinations of integration and

Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×

outsourcing at home and abroad. There are several possibilities for the complementarity between strategies. Du and colleagues (2009) suggest that using multiple sourcing of the same input is a strategic decision by a firm to improve its bargaining power relative to its suppliers.

Finally, Thomas concluded with these questions: Do economies of scope influence sourcing decisions of large, productive firms? Are there lower fixed costs to outsourcing an input if a firm already produces another input in-house in that location? Firms may “learn by doing,” thereby allowing them to easily operate an additional affiliate if they already have one. There may also be benefits to coordination among affiliates that are integrated. Characterizing “global value networks” may motivate new models of selection.

Warzynski began by addressing the question about the measure of firm productivity. A global measure of MNE productivity is not yet defined and will hopefully be developed. The authors have attempted to validate the model predictions, but the lack of complete validation may generate new theories on these mechanisms.

Warzynski also said that he and his coauthors are exploring whether scale and changing tariffs might provide comparative advantage related to the dynamic decisions of firms. The interaction between capital and productivity is an interesting angle, which is something the authors will continue to explore.

Additionally, Warzynski said that the authors want to further explore complementarities of strategies that may help extend the Antràs and Helpman (2004) model.

During the presentation, one audience member asked how the firm-level surveys may benefit input-output tables and if Statistics Denmark is taking any steps to make this improvement. Warzynski responded that he is mostly interested in the micro measurement picture, or the level of measurement of the presented work. Statistics Denmark is working with the Organisation for Economic Cooperation and Development and Eurostat, among others, to aid the development of the macro picture in input-output tables. Another asked a question about the decrease in outsourcing, particularly to China. Warzynski responded that there is less outsourcing to the South in general. He added a caveat that their data are in terms of flows and not levels. Another question arose about the bisourcing question Thomas raised regarding the Du et al. (2009) work, which the Warzynski and Smeets (submitted) paper attempts to explore. They extend the past literature to include location and not solely the make-or-buy distinction.

Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×
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Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×
Page 74
Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×
Page 75
Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×
Page 76
Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×
Page 77
Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×
Page 78
Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×
Page 79
Suggested Citation:"10 Firm Selection and Organizational Choice: Complex Patterns of Global Sourcing." National Academies of Sciences, Engineering, and Medicine. 2022. Innovation, Global Value Chains, and Globalization Measurement: Proceedings of a Workshop. Washington, DC: The National Academies Press. doi: 10.17226/26477.
×
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In recent decades, production processes of intermediate and final products have been increasingly fragmented across countries in what are called global value chains (GVCs). GVCs may involve companies in one country outsourcing stages of production to unrelated entities in other countries, multinational enterprises (MNEs) offshoring stages of production to units of the MNE overseas, or both. GVCs can also involve completely independent companies merely sourcing their parts from whichever upstream company may be the most competitive, with no control arrangement necessarily involved. The changing global trade environment and the changes in firms' behavior have raised new and more complicated issues for policy makers and have made it difficult for them to understand the extent and operations of GVCs and their spillover effects on national and local economies.

To improve the understanding, measurement, and valuation of GVCs, the Innovation Policy Forum at the National Academies of Sciences, Engineering, and Medicine convened a workshop, "Innovation, Global Value Chains, and Globalization Measurement" May 5-7, 2021. This proceedings has been prepared by the workshop rapporteurs as a factual summary of what occurred at the workshop.

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