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How Does Outsourcing Affect Performance Dynamics? Evidence from the Automobile Industry

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  • Sharon Novak
  • Scott Stern

Abstract

This paper examines the impact of vertical integration on the dynamics of performance over the automobile product development lifecycle. Building on recent work in organizational economics and strategy, we evaluate the relationship between vertical integration and different performance margins. Outsourcing facilitates access to cutting-edge technology and the use of high-powered performance contracts. Vertical integration allows firms to adapt to unforeseen contingencies and customer feedback, maintain more balanced incentives over the lifecycle, and develop firm-specific capabilities over time. Together, these effects highlight a crucial tradeoff: while outsourcing is associated with higher levels of initial performance, vertical integration will be associated with performance improvement over the product lifecycle. We test these ideas using detailed data from the luxury automobile segment, establishing three key results. First, initial performance is declining in the level of vertical integration. Second, the level of performance improvement is significantly increasing in the level of vertical integration. Finally, the impact of vertical integration on alternative performance margins is mediated by the level of pre-existing capabilities, by the salience of opportunities to access external technology leaders, and by the scope for learning over the product lifecycle. Together, the findings highlight a strategic governance tradeoff between short-term performance and the evolution of firm capabilities.

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  • Sharon Novak & Scott Stern, 2007. "How Does Outsourcing Affect Performance Dynamics? Evidence from the Automobile Industry," NBER Working Papers 13235, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:13235
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    Cited by:

    1. Jeremy T. Fox, 2018. "Estimating matching games with transfers," Quantitative Economics, Econometric Society, vol. 9(1), pages 1-38, March.
    2. Jean Tirole, 2009. "Cognition and Incomplete Contracts," American Economic Review, American Economic Association, vol. 99(1), pages 265-294, March.
    3. Elisabetta Magnani, 2012. "Vertical disintegration and training: evidence from a matched employer–employee survey," Journal of Productivity Analysis, Springer, vol. 38(2), pages 199-217, October.
    4. Sharon Novak & Scott Stern, 2007. "Complementarity Among Vertical Integration Decisions: Evidence from Automobile Product Development," NBER Working Papers 13232, National Bureau of Economic Research, Inc.

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    More about this item

    JEL classification:

    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
    • L62 - Industrial Organization - - Industry Studies: Manufacturing - - - Automobiles; Other Transportation Equipment; Related Parts and Equipment
    • O32 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Management of Technological Innovation and R&D

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