What's the Big Idea? Multi-Function Products, Firm Scope and Firm Boundaries

50 Pages Posted: 30 Sep 2019 Last revised: 2 Jun 2023

See all articles by Mengxiao Liu

Mengxiao Liu

Department of Economics, Lehigh University

Daniel Trefler

University of Toronto - Rotman School of Management; National Bureau of Economic Research (NBER)

Date Written: September 2019

Abstract

Products often bundle together many functions e.g., smartphones. The firm develops the big idea (which functions to bundle) and then chooses one supplier per function. We develop a model featuring holdup in which the firm's bargaining power declines in the number of suppliers. Greater scope as measured by the number of suppliers exacerbates holdup, but this is partially offset by the appropriate choice of vertical integration or outsourcing. Our main result flows from the empirical observation that the number of functions varies across products within an industry (firm heterogeneity). We introduce the notion of an 'ideas-oriented' industry in which more productive firms have higher marginal returns to introducing a new function. We show that more productive firms will (1) have more suppliers and (2) be more likely to integrate those suppliers. We take this to the data using a neural network to predict whether or not each of 29 million PATSTAT patent applications involves new/improved functions. We merge these patents with Capital IQ data on 55,000 companies and their supplier networks. We show that in industries where patents are skewed towards new or improved functions, more productive firms have more suppliers and are more likely to integrate these suppliers.

Suggested Citation

Liu, Mengxiao and Trefler, Daniel, What's the Big Idea? Multi-Function Products, Firm Scope and Firm Boundaries (September 2019). NBER Working Paper No. w26320, Available at SSRN: https://ssrn.com/abstract=3461488

Mengxiao Liu (Contact Author)

Department of Economics, Lehigh University ( email )

620 Taylor Street
Bethlehem, PA 18015
United States

Daniel Trefler

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416-978-4190 (Phone)
416-978-6713 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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