What factors determine the outsourcing intensity? A dynamic panel data approach for manufacturing industries

Abstract

The present article investigates the determinants of outsourcing production using a panel of 93 Spanish manufacturing industries for the period 1993 to 2002. Outsourcing is measured as production tasks which are contracting out to external suppliers, a more direct and suitable indicator. After controlling for unobserved heterogeneity and simultaneity, our results show a high persistence of the outsourcing intensity. Moreover, outsourcing of production is positively related to unit labour costs, skills requirements, national ownership and orientation to international markets. We also find evidence for a negative link between the outsourcing intensity and the share of small firms.

Acknowledgements

I am indebted to Rosario Gandoy, Juan Ignacio Palacio and Oscar Bajo for constructive comments on a previous version of this article. I also thank participants at the 7th European Trade Study Group Conference (Dublin, Ireland, September 2005) as well as an anonymous referee for helpful suggestions. Financial support by the Consejería de Educación y Ciencia of the Junta de Comunidades de Castilla-La Mancha under the project PBI-05-021, cofinanced by FEDER funds, is gratefully acknowledged.

Notes

¹ See Piore and Sabel (1984). The higher flexibility can be obtained through flexible production which allows firms to adapt standardized inputs to a variety of specifications (Eckel, 2004). Through flexible production, firms can alter the final goods they provide according to the specific needs or desires of their customers.

² Nevertheless, fragmentation of production and outsourcing are often treated as synonymous. The term outsourcing comes from the compound expression ‘outside resource using’. Along this article, the terms outside and external refer to outside or external to the firm.

³ The Economist has recently published a survey of outsourcing, in which is pointed that ‘manufacturing has already gone a long way down the road of outsourcing’ (The Economist, November 13th 2004).

⁴ Tomiura (2005) employs a similar indicator but, as pointed out above, he uses cross-section data. Holl (2004) opt for a narrower indicator, the subcontracting of products, parts and components, to study the probability of outsourcing. At last, Girma and Görg (2004) use a bit wider measure, the industrial services receive, which comprises activities such as processing of inputs but also certain services as maintenance of production machinery or engineering services.

⁵ Various types of outsourcing exist in the manufacturing industries depending on the relationship between the principal and the third-party company. Subcontracting is a particular case where a ‘dominant/dominated’ relationship is created. Specifically, subcontracts correspond to the relationship between two companies (the subcontractor and the main contractor), where the subcontractor company participates in the production process of a particular product, which belongs to the contractor company. The subcontract conditions require the main contractor to provide a diagram and precise technical specifications for the manufacture of the product, as well as the supply of its main raw materials.

⁶ In the context of transaction costs and contractual incompleteness, Grossman and Helpman (2002) examine theoretically the decision between outsourcing or vertical integration of intermediate inputs (make or buy decision) taking into account the costs that arise from search frictions and imperfect contracting and the costs of running a larger and less specialized organization. To consider the international dimension as well as the ownership dimension, Antras and Helpman (2004) develop a theoretical framework in which, based on productivity and sectoral characteristics, firms decide whether to integrate into the production of intermediate inputs or outsource them and firms also choose the location of inputs production (at home or abroad).

⁷ A strategic motive can be added to these usual motives for outsourcing when a firm's outsourcing decision affects the rivals’ outsourcing decisions and the firm takes into account it in the decision process. Shy and Stenbacka (2003) and Buehler and Haucap (2006) study how firms may strategically outsource the productions of inputs analysing the trade-off between the fixed cost of investing into in-house production facilities for an input or the higher marginal cost for sourcing the input over the market (which is caused by changes in input demand and inputs prices).

⁸ This hypothesis is in accordance to Antras (2003) who using a model of outsourcing based on the property rights approach shows that final goods in the capital-intensive sector are produced under vertical integration whereas those in the labour-intensive sector are outsourced.

⁹ This increase is higher than the average scored by German manufacturing enterprises, which has placed in 27% for the period 1992 to 2000 according to Görzig and Stephan (2002). However, it should be noted that the fragmentation processes in German industry had most probably taken place before the 1990s.

¹⁰ The sector ‘Manufacture of office machiney and computers’ has been removed from the econometric analysis. The data in 2002 show a sharp decrease of output which is not present in employment or number of enterprises suggesting a measure error for that year. Since the indicador of outsourcing used is calculated related to output, the level of fragmentation will be overestimated.

¹¹ Although some American and British firms have already begun to outsource some of their business services abroad (so far mostly to India), the outsourcing of white-collar work is still only emerging (The Economist, November 13th 2004).

¹² Following Piga and Vivarelli (2003) those firms which face tougher foreign competition may exhibit a stronger tendency to cooperate. For this reason, we also could expect that firms competing in international markets were more prone to engage in outsourcing agreements.

¹³ The author is grateful to the anonymous referee for this suggestion.