The effect of import competition on product diversification revisited

Research summary Bowen and Wiersema, Strategic Management Journal, 2005, 26, 1153–1171, provide empirical evidence that U.S. firms decreased their degree of product diversification as a response to the increase in import competition in their 1985–1994 study. After replicating their study, we expand it with alternative econometric analyses and a larger data set. While we obtain nearly identical results using their Tobit regressions, the negative impact of imports on diversification disappears when we control for firm fixed‐effects. Furthermore, using tariffs as instrument for imports, we find that import competition may even lead domestic firms to increase their diversification. The negative relationship between import penetration and diversification seems to result from the endogeneity of imports, which grew more in industries dominated by firms with low diversification at the turn of the previous century. Managerial summary Previous research by Bowen and Wiersema, Strategic Management Journal, 2005, 26, 1153–1171 showed that when import penetration grew in the 1985–1994 period in the U.S., firms seemed to reduce their diversification across industries and refocus on their core business, presumably to increase their competitiveness against foreign imports. We replicate their study and reach the opposite conclusion regarding firms' response to greater pressure from imports, using enhanced statistical methods and also a larger database. We conclude that diversified firms are more likely to switch their focus to other industries when import competition increases in their main line of business, and this greater flexibility of switching industries seems to give them an advantage over specialized firms.