The Experience of Canadian Firms and Industries

1. The Experience of Canadian Firms and Industries Jo Van Biesebroeck Economics Department, University of Toronto Industry Canada & Rotman Offshore Outsourcing: Capitalizing on Lessons Learned

2. Outsourcing Multiple Parts: An Application to the Automotive Industry(with Lijun Zhang) Global Value Chains in the Automotive Industry: Prospects for Canada (with Gary Gereffi and Tim Sturgeon)

3. Overview • Why does it matter to look at many parts? • It accelerates outsourcing • for a variety of reasons • Preliminary findings for the automotive industry • Importance for Canadian firms

4. Looking at many parts • The whole is more than the sum of its parts: cars are the prototype of integral design • Organize activities along a supply chain • Relational contracts become feasible • As costs fall and quantity rises, high FC/ low MC strategies become more attractive • There might be complementarities • Institutions can develop

5. 1. Integral design • Clark-Fujimoto (1991) “Product Development Performance: Strategy, Organization, and Management in the World Auto Industry” • Most components interact in myriad ways • Difficult to separate design from manufacturing • Car components trade in Asia lags other sectors (relative to the West) • When production jobs disappear, engineering jobs might go with them Looking at many parts

6. 1. Integral design • Question: Why are so few finished cars traded? • Industry developed in high-wage countries (skill involved in design!) • Poor countries served by exports of second hand cars and second hand designs (for local mfg) • Once low-wage countries acquire design capabilities, why wouldn’t we see exports to NA? (p – MC margins are huge >50%) Looking at many parts

7. 2. Supply Chains – Value Chains • A structured organization helps to • exploit comparative advantage across countries • exchange information efficiently • conduct innovation • Relational Contracts expand feasible set • Long tradition in economics  in a repeated game more equilibria can be supported • E.g. Toyota outsourcing: suppliers recover FC in unit price (‘they have infinite memory’) Looking at many parts

8. 2. Supply Chains – Value Chains • Note: Division of sales (in trade data) will differ from division of value added • Electronics: intermediate parts often embody most of the technology • Question: who initiates offshoring? • Automobiles: OEMs • Apparel: further upstream low-tech intermediates • Electronics (modular): contract manufacturing Looking at many parts

9. 3. high FC / low MC strategy • Antrás (2005) – life cycle model • Cut-offs between organizational forms are a function of quantity, which is linked to cost/price through final good demand we augment the model for multiple parts • Melitz (2004) – heterogeneous firms • Activities follow productivity ranking: FDI > exporting > only domestic sales Looking at many parts

10. 3. high FC / low MC strategy • Questions: What to make of opposite predictions on relation between productivity & offshoring? • Serving domestic market (Antras): low productivity firms go first • Serving foreign market (Melitz): high productivity firms go first Looking at many parts

11. 4. Complementarities • Novak-Stern (2003): when you outsource one part, you might as well outsource more • IP protection • Compete on cost or time to market • Coordination efforts are interdependent • Van Biesebroeck (2007): • Outsourcing is complementary to other production decision (e.g. greater product variety) Looking at many parts

12. 4. Complementarities – institutions • Nunn (2007) ↔ Acemoglu, et al. (2005) • Does contracting environment provides comparative advantage for goods requiring specific investments or vice versa?  we allow production to affect institutions δ = f(# of components outsourced) • Empirical finding: past outsourcing predicts price (↑) time to off-shore (↓) Looking at many parts

13. Findings for the automotive industry • Within-component price heterogeneity is important (quality?) • Very distinct trade patterns • Sourcing pattern generates a (somewhat) intuitive ordering of parts and countries • Some evidence of contracting complementarities / institutions developing

14. 1. Price heterogeneity – chassis

15. 1. Price heterogeneity – tires

16. 2. Trade patterns • Very large regional trade flows • NAFTA • EU • South-East Asia (Japan, Korea, Thailand, China) • MNEs supply their overseas assembly locations from their home base • Customized components follow the product-cycle • Domestic content requirements abound • Oursourcing to low-wage countries is rising Findings for the automotive industry

17. 3. Ordering of parts and countries Average year (post 1989) that exports to the U.S. start for a list of 34 parts/modules * North is Japan and Western Europe Findings for the automotive industry

18. 3. Ordering of parts and countries Average year (post 1989) exports to the U.S. start Findings for the automotive industry

19. 4. Complementarities - institutions? Findings for the automotive industry

20. Importance for Canadian firms Revisit the four findings • Price • Trade • Sourcing • Complementarities

21. 1. Price • For many parts, Canadian prices are at the low end, i.e. very competitive • Within each part, there is demand for high quality – high price varieties Importance for Canadian firms

22. 2. Trade • Regional: given that production volumes in NA won’t increase, the almost total reliance on U.S. is precarious • Low cost: Especially since NAFTA, this is not going to be Canada’s comparative advantage • Supply overseas plants: • customized inputs – Head-Reis-Spencer (2004) • Through exports or FDI – APMA survey (2005) Importance for Canadian firms

23. 3. Sourcing • In a world of incomplete contracting, attractiveness is a combination of “production cost” and “quality of institutions” • Off-shoring is not all or nothing, new parts and technologies are introduced continuously Importance for Canadian firms

24. 4. Complementarities • Generates feedback effects • Changes that strengthen Canada’s position for one part, will increase marginal productivity of investments in other parts • Also works in reverse: “failure to …” • Coordination helps • One of the strengths of the industry in Canada Importance for Canadian firms

25. Thanks For a copy of the slides: jovb@chass.utoronto.ca