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The Impact of Supply Chains on Firm-Level Productivity

Juan Camilo Serpa, Harish Krishnan
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Juan Camilo Serpa, Harish Krishnan (2017) The Impact of Supply Chains on Firm-Level Productivity. Management Science
Published online in Articles in Advance 03 Mar 2017
. http://dx.doi.org/10.1287/mnsc.2016.2632
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MANAGEMENT SCIENCE
Articles in Advance, pp. 1–22
http://pubsonline.informs.org/journal/mnsc/ ISSN 0025-1909 (print), ISSN 1526-5501 (online)
The Impact of Supply Chains on Firm-Level Productivity

Juan Camilo Serpa,a Harish Krishnanb
a Desautels Faculty of Management, McGill University, Montreal, Quebec H3A 1G5, Canada; bSauder School of Business,
Downloaded from informs.org by [61.129.42.30] on 06 March 2017, at 03:52 . For personal use only, all rights reserved.
University of British Columbia, Vancouver, British Columbia V6T 1Z2, Canada

Contact: juan.serpa@mcgill.ca (JCS); harish.krishnan@sauder.ubc.ca (HK)
Received: August 21, 2015 Abstract. Firms in a vertical relationship are likely to affect each other’s productivity.
Accepted: July 8, 2016 Exactly how does productivity spill over across this type of relationship (i.e., through
Published Online in Articles in Advance: which mechanisms)? Additionally, how does the relative importance of these mechanisms
March 3, 2017 depend on the structure of the supply chain? To answer these questions, we decompose
https://doi.org/10.1287/mnsc.2016.2632 the channels of upstream productivity spillovers—from customers to suppliers—by devel-
oping a structural econometric model on a sample of approximately 22,500 supply chain
Copyright: © 2017 INFORMS dyads. We find that the “endogenous channel” (i.e., the effect of the customer’s own pro-
ductivity on the supplier’s productivity) is by far the most important source of spillovers.
This is especially true if (i) the supplier has a concentrated customer base, (ii) the sup-
plier and the customer have similar operational characteristics, and (iii) the relationship
has medium maturity. In the converse scenarios, we find, it is more important to have a
partner with a portfolio of favorable “contextual” characteristics (high inventory turnover,
financial liquidity, and asset turnover) than to have a productive partner.
History: Accepted by Serguei Netessine, operations management.

Supplemental Material: The online appendix is available at https://doi.org/10.1287/mnsc.2016.2632.
Keywords: supply chain management • econometrics • network analysis • spillover effects
1. Introduction Dell. In short, it teaches them how to think like Dell”

Syverson (2011) reviews an extensive literature that (Dyer and Hatch 2006, p. 59). Similarly, a manager of
shows large and persistent differences in firm-level one of Toyota’s suppliers argues that, as a result of
productivity, even within narrowly defined industries. the mentoring programs of the auto manufacturer, “we
Though researchers have made great strides in deter- reduced our process steps from 34 to 14, eliminating
mining the drivers of this productivity dispersion, the 20 non-value-added process steps from our produc-
role of supply chain relationships remains unclear. tion process. We reduced set-up times from 2 hours
Given the nature of supply chains, partners engaged to 15 minutes” (Dyer 2000, p. 8). Another supplier
in a vertical relationship are likely to affect each other’s says that, following Toyota’s mentoring programs, they
productivity, arguably at a fundamental level. Exactly have “made more than 70 changes to the manufactur-
how does productivity spill over along this type of ing cell” (Dyer and Hatch 2006, p. 60).
relationship (i.e., through which channels or mech- Second, the influence of vertical partners can appear
anisms)? Additionally, how does the importance of through other mechanisms that are independent of
these channels depend on the structure of the supply the partner’s productivity. As a case in point, con-
chain? These issues are not as well understood, and we sider the partner’s geographic location. When a part-
investigate them in this paper; in particular, we com- ner is located in a favorable region, it may be able to
pare the relative influence of two types of channels: source inputs more reliably; this may be due to the
endogenous and contextual. existence of good transportation infrastructure, com-
First, a firm can benefit by interacting with a partner, mercial regulations, or climatic conditions. A firm’s
solely on the basis of the partner’s productivity. When productivity can therefore be affected by the partner’s
a firm interacts with a more productive partner, the geographic location (irrespective of the partner’s pro-
firm can learn from and adopt the efficient practices of ductivity). In the literature this is known as a contextual
this partner; this may happen through collaboration, channel, i.e., a channel that describes the influence of
knowledge transfers, or mentoring. In the literature, a partner’s contextual characteristics (e.g., geographic
this is known as the endogenous channel. location, financial liquidity, or inventory turnover) on
The importance of the endogenous channel is well the firm’s productivity.
documented. For example, Dell requires its suppliers’ A firm’s productivity, therefore, depends on three
engineers to conduct risk management drills that teach types of effects: (i) the firm’s own characteristics, (ii) the
them “the language, processes and metrics used by productivity of its partners (the endogenous channel);
1
Serpa and Krishnan: The Impact of Supply Chains on Firm-Level Productivity
2 Management Science, Articles in Advance, pp. 1–22, © 2017 INFORMS
Figure 1. (Color online) Determinants of Productivity
c.
et
ics Partner’s
ter ’s
productivity
ac er
ist
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ar rtn
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Fi
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ov ry
Endogenous
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er
ve
spillover
In
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.
etc
cts
effe
e
Ag
Firm l
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Firm’s i n an age
productivity F ver
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ze
Si
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tua
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ca p
on Ag
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n
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eo
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y
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ac
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and (iii) the characteristics of its partners (the contex- have similar firm sizes, geographic locations, or opera-
tual channels) (see Figure 1). Our first goal in this paper tional features. This brings us to a third question.
is to answer the following two questions. • How does the structure of the supply chain (matu-
• Are productivity spillovers in a supply chain pri- rity, concentration, and homogeneity) affect the relative
marily due to (i) endogenous mechanisms, i.e., factors that size of the channels of productivity spillovers?
arise from interacting with more productive partners To answer the above questions, we collect a sample
(learning, knowledge transfers, etc.); or (ii) contextual of approximately 22,500 vertical relationships between
mechanisms, i.e., factors that arise from the partners’ 1983 and 2013. These data are collected from the 10-K
contextual characteristics? filings of publicly traded firms. We merge this data set
• Which of the contextual channels is more sig- with key idiosyncratic information about each firm to
nificant in causing productivity spillovers? Is it the estimate the impact of upstream spillovers, from large
financial traits of the partners? Is it the operational customers to (typically smaller) suppliers.
characteristics? Or, rather, is it the impact of the part- Our estimates find that the endogenous channel is
ner’s idiosyncratic characteristics (e.g., age, size, and highly significant; on average, a supplier’s productivity
geographic location)? increases by 0.26% as a result of having a customer base
However, the relative importance of these channels that is 1% more productive (holding all other factors
is likely to vary across different types of supply chains. constant). In contrast, we find that the impact of most
In particular, the impact of the channels may depend contextual characteristics is directly irrelevant but indi-
on whether (i) the relationship was formed recently or rectly relevant. This means that the contextual charac-
long ago (on the maturity of the relationship); (ii) the teristics of the customer are important, but not because
firm has one strong partner or multiple dispersed part- they directly affect the productivity of the supplier;
nerships (the degree of supply chain concentration); rather, because they affect the customer’s own produc-
and (iii) the partners are alike or different (the degree tivity (and indirectly spill over through the endoge-
of homogeneity), e.g., if the supplier and the customer nous channel).
Management Science, Articles in Advance, pp. 1–22, © 2017 INFORMS 3
The only contextual characteristics that have a mean- arises because the endogenous and the contextual
ingful direct impact are the customer’s financial liq- channels are inherently entangled (firms that have
uidity, its asset turnover, and firm size. The first two “good” characteristics also tend to be productive). The
characteristics tell us that a supplier’s ability to operate second problem is correlated network effects, which arises
efficiently depends on whether it can receive stable because firms that form links often share common
cash flows from its customers; this is because cus- environments—correlated productivity levels might
tomers are more likely to meet their short-term finan- thus reflect the impact of (unobserved) common shocks
affecting firms that are vertically linked, and not the
cial obligations if they have the ability to monetize their

capital goods and, also, if they can retain a proportion impact of spillover effects. The third problem is net-
of this revenue in the form of liquid assets. Similarly, work selection biases, which arises because a firm may
the impact of customer size indicates that the benefits be inclined to choose partners with specific contex-
of scale economies ripple upstream, along the supply tual characteristics (e.g., geographic location or size) or
chain. Note, however, that the impact of these con- even to choose partners that are highly productive.
textual characteristics, even if statistically significant, To mitigate the impact of these issues, we exploit the
would only cause a small effect when compared to the topology of the supply chain networks by using struc-
endogenous effect: a 1% change in any of the contextual tural techniques drawn from social networks econo-
characteristics would cause, at most, a direct impact of metrics. As such, our paper studies supply chain
0.05% on the supplier’s productivity. econometrics through the lens of the peer-effects liter-
The above results lead us to a stark conclusion: pro- ature, and by doing so, we bridge these two literatures.
ductivity drives productivity. However, is this condi- In doing so, we hope that our paper opens a research
tion true across all relationships? To obtain a nuanced agenda that refines the many identification issues that
picture about the productivity channels, we estimate remain to be explored within this context.
the relative impact of these channels across different
types of supply chain structures. We find that the 2. Research Background
endogenous channel is more pronounced (relative to This paper is related to three streams of research:
the contextual channels) when (i) the dyads are highly (i) firm-level productivity, (ii) supply chain linkages,
homogeneous; (ii) the supplier has a concentrated cus- and (iii) peer-effects econometrics.
tomer base; and (iii) the relationship is characterized by A survey of the literature on firm-level productiv-
medium maturity (i.e., the firms have been interacting ity is provided by Syverson (2011). We can divide this
for between three and six years). This result, we argue, literature into two groups. The first group uses data
is likely due to the impact of knowledge transfers: a from a single industry and, in this case, productiv-
supplier, after all, is more prone to learn from the pro- ity is often measured through inputs and outputs that
ductive practices of its customers, provided that these are specific to the industry. Examples of this literature
customers have similar characteristics to the supplier. include Kellogg (2011), who focuses on the oil-drilling
Similarly, knowledge transfers are more likely to hap- industry; Cachon et al. (2013), who study the automo-
pen when the relationship was not formed too recently bile industry; and Chandra et al. (2016), who study the
nor too long ago, or when the supplier only has a few Medicare industry.
strong downstream partners (as opposed to multiple The second group does not focus on the produc-
dispersed partnerships). In the converse scenarios, the tivity of a particular industry but, rather, on mak-
contextual channels of the customer gain prominence; ing conclusions that apply across the economy. The
in these cases, it is more relevant to have a customer problem is that inputs and outputs vary tremen-
with a portfolio of desirable characteristics than to have dously across industries and, to circumvent incon-
a productive customer. sistencies, researchers often gauge productivity by
From a practical standpoint, our results help us to using the “value-added” approach. Our paper uses
understand how productivity is channeled along a this approach (see Section 3); in particular, we use a
vertical relationship. We show that the “productivity methodology inspired by Brynjolfsson and Hitt (2003),
drives productivity” argument is the most compelling who also gather the Compustat data set to measure the
one in general. However, we also show that this con- relationship between firm-level productivity and IT.
dition is highly dependent on the structure of the sup- We contribute to the productivity literature by study-
ply chain. Our paper, as a result, helps managers to ing the relationship between this metric and supply
identify how productivity is transferred across vertical chain linkages. In this sense, our paper is related
relationships, not just in general but also across their to Kalwani and Narayandas (1995), who report that
own supply chains. suppliers observe higher returns on investment when
Methodologically speaking, our study faces three they are engaged in long-term relationships with
econometric problems. The first is the entanglement their customers. In the global sourcing literature, Jain
problem (also known as the reflection problem), which et al. (2014) show that a firm increases its inventory
investments when it sources from foreign suppliers; A simultaneity bias arises because the firm’s input
Lieberman and Demeester (1999) use data from the choices (capital and labor) and the TFP are simultane-
Japanese auto industry to show that just-in-time deliv- ously determined; the covariates, in other words, are
ery can improve supply chain productivity. The supply correlated with the error term. A selection bias arises
chain risk management literature has also become a fer- because a firm with larger capital stock is less likely
tile area in econometrics; examples include Carvalho to exit the market (despite low productivity draws).
et al. (2014), Hendricks and Singhal (2005), Osadchiy Given the negative correlation between capital stock
et al. (2015), and Wang et al. (2016). and the exit probability, productivity is also correlated
We contribute to this literature by decomposing the with the capital stock, and OLS underestimates β k .
different channels through which firms can affect each We jointly control for these biases by using an esti-
other in a vertical relationship. To our knowledge, this mation method proposed by Olley and Pakes (1996);
multichannel analysis has not been done previously: we explain this methodology in Online Appendix B.
this is, perhaps, because of the serious identification Although this approach has become a standard one
challenges associated with the task. To deal with these in the productivity literature, a drawback is that we
problems, we had to adapt techniques from the liter- must use positive capital investments as a proxy vari-
ature on peer-effects econometrics. Blume et al. (2010) able. In principle the Olley–Pakes approach can still
review the various econometric issues and some iden- be used when a proportion of firms have nonposi-
tification techniques proposed within this literature. In tive capital investments, although it requires that we
particular, we deal with the canonical reflection prob- ignore all such data points. Fortunately, less than 2.6%
lem by using results found by Bramoullé et al. (2009); to of the firms in our sample report nonpositive capital
mitigate the impact of network selection biases, we use investments.1
methods inspired by Goldsmith-Pinkham and Imbens There are other garden-variety problems associ-
(2013) and, especially, by Hsieh and Lee (2016). ated with the value-added approach. For example,
there is lack of information on the quality dimen-
sions and on the utilization of these variables, and
3. Measuring Productivity productivity is also sensitive to output prices.2 Pro-
3.1. Econometric Specification
ductivity estimates, however, are “quite robust to
We use total factor productivity (TFP) as our measure measurement peculiarities . . . The inherent variation in
of productivity; TFP is desirable because it is invari- establishment- or firm-level microdata is typically so
ant to the intensity of use of the observable input fac- large as to swamp any small measurement-induced
tors (Syverson 2011). To obtain our estimates, we begin differences in productivity metrics” (Syverson 2011,
by considering a log-linear Cobb–Douglas production p. 332). However, rather than simply assuming this,
function we test the robustness of our productivity estimates;
yirt α rt + β k, r k irt + β l, r l irt + TFPirt +ε irt , (1) for example, we reestimate our results by varying the
industry classification, the variable definitions, and the
where yirt represents the natural logarithm of output nature of the production function. We describe these
for firm i in industry r and year t, whereas k irt and robustness checks in Online Appendix C, where we find
l irt represent its capital and labor inputs. Parameter α rt that our estimates are highly robust to various econo-
captures fixed effects that are idiosyncratic to a given metric specifications with which we experimented.
industry and time period, whereas ε irt represents a
3.3. Data Description
firm-specific random shock. The term TFPirt represents
To estimate TFP, we use the Compustat database,
the relative productivity rank of the firm within its
which allows us to retrieve financial information about
industry; therefore, if we let α̂ rt , β̂ l, r , β̂ k, r denote the
publicly traded firms between 1983 and 2013 (e.g.,
industry-specific input elasticities, we have that
annual sales, levels of inventory, assets, and liabilities).
d irt yirt − β̂ l, r l irt − β̂ k, r k irt − α̂ rt
TFP We also use data from the NBER-CES Manufactur-
ing Database and the U.S. Bureau of Labor Statistics
is the estimated log-TFP of firm i at time t. to retrieve price deflators and labor-related informa-
tion. Our methodology to construct the variables can
3.2. Identification Strategy be found in Online Appendix A.
We use the value-added approach to measure log-TFP; Before arriving at our final sample, we discarded sev-
in this approach inputs consist of capital and labor, and eral problematic observations. Specifically, we dropped
output is measured as value added. Though this is one those firms with Standard Industrial Classification (SIC)
of the most popular approaches to measure productiv- code 99 (2,212 firms) as these are unclassified estab-
ity, two key issues arise when we estimate TFP through lishments; because TFP is an industry-specific measure,
ordinary least squares (OLS): simultaneity and selec- any such observation is useless. We also deleted obser-
tion biases. vations with missing data (or reporting nonpositive
Table 1. Average Estimates of β k, r and β l, r Across All impact of major customers on suppliers. The modeling
Industries presented below borrows terminology from Sacerdote
(2001) and Bramoullé et al. (2009).
Average elasticity Olley–Pakes OLS
Capital (β k, r ) 0.476 0.387

(0.0009) (0.0015)
4.1. Setup and Notation
Labor (β l, r ) 0.547 0.662
Consider a sample of N firm-year observations, N
(0.0008) (0.0018) {1, 2, . . . , N }; each i ∈ N is characterized by a K-vector
Scale elasticity 1.023 1.049 of characteristics, Xi [x1i , . . . , x Ki ], that can affect the
end-of-year productivity, TFPi . Each firm is also char-
Notes. This table shows the average Olley–Pakes estimates of the
production function. For comparison purposes, we present the OLS acterized by a customer base; let C be an N × N matrix
estimates of the production function. with typical element c i j , where c i j equals one if j is
a customer of i, and zero otherwise (we assume that
levels) about sales (3.4% of the observations), number
c ii 0). Similarly, let W be an N × N matrix character-
of employees (2.1%), capital investments (2.58%), gross
property (1.91%), or plant and equipment (1.54%). We izing the strength of the relationships; this matrix has
ended with an unbalanced panel containing 214,392 typical element
firm-year observations and 13,133 distinct firms across
70 industries.  c i j · (salesi j )
if c i j 1,


 PN

wi j n1 c in · (salesin )
3.4. Estimates 
We report, in Table 1, the average estimates of β k, r 0 otherwise,


and β l, r across all industries; we also report OLS esti-
mates for comparison purposes. Our results show that where salesi j is the revenue received by firm i from cus-
OLS underestimates the elasticity for capital stock and tomer j. Using graph theory, we can represent firms as
overestimates the labor elasticity; this is likely due to nodes, and their relationships through weighted edges
the above-mentioned impact of simultaneity and selec- (as such, W is the weighted adjacency matrix of the
tion biases. Our results also show that firms face (mild) graph). Two firms belong to the same subnetwork if
increasing returns to scale, given that the average scale they can be connected through an undirected path of
elasticity is greater than one (i.e., β k, r + β l, r > 1).
relationships, that is, if they are (weakly) connected in
To gauge the robustness of our results, we compared
the graph. We use ψ to index the subnetworks, each
them with those found in similar studies; in particular,
with size L ψ ; see Figure 2 for an illustration.3
we looked at the decile distribution of log - TFP and
at the interdecile productivity ratio (see Table 2). This
last ratio determines the degree to which a firm in the 4.2. Econometric Specification
90th percentile of the productivity distribution is more We specify the following linear-in-means model,
efficient than an nth percentile firm. Syverson (2004)
reports that the 90th − 10th percentile ratio is equal TFPi β + (γ1 x1i + · · · + γK x Ki ) + (θ1 x1iC + · · · + θK x Ki C
)
to 1.92, a ratio that is close to ours; in our case, this ratio |¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨{z¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨} |¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨{z¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨}
is equal to 1.99. Imrohoroglu and Tuzel (2014) report a firm effects contextual spillovers
90th − 20th dispersion of 1.8, whereas, in our case, the + ω TFPCi +u i , (2)
dispersion is equal to 1.69. |¨¨{z¨¨}
endogenous spillover
4. Productivity Spillovers
C
≡ N
P
We proceed to build an econometric model to estimate where x ki n1 w in x kn denotes the weighted aver-
vertical spillovers on productivity. Due to data limita- age characteristics of i’s customers and TFPCi ≡
PN
tions (which are explained in Section 4.3), our analysis n1 w in TFP n denotes their weighted average pro-
focuses on identifying upstream spillovers, that is, the ductivity. The vector γ ≡ [γ1 , . . . , γK ]0 represents the
Table 2. Decile Distribution of log - TFP
Percentile
10 20 30 40 50 60 70 80 90
log - TFP 0.227 0.391 0.477 0.542 0.600 0.658 0.721 0.800 0.917
90th − ith percentile ratio 1.99 1.69 1.55 1.45 1.37 1.29 1.21 1.12
Note. The 90th − ith productivity dispersion is equal to exp(log(TFP90th ) − log(TFPith )).
Figure 2. (Color online) Illustration of Notation
0 1 1 0 0 0 0
1 0 0 0 1 0 0 0
w1, 2 0 0 0 0 0 0 0
w1,3
C = 0 0 0 0 0 0 0
0 0 0 0 0 1 1
2 0 0 0 0 0 0 1
3 0 0 0 0 0 0 0
w2,4 = 1
0 w1, 2 w1,3 0 0 0 0
4 0 0 0 w2,4 0 0 0
0 0 0 0 0 0 0
W= 0 0 0 0 0 0 0
=1 0 0 0 0 0 w5, 6 w5,7
5 w5 0 0 0 0 0 0 w6,7
,6
0 0 0 0 0 0 0
w5,7 6
=1
7 w 6, 7
=2
Note. In this example, there are N 7 firms and two subnetworks with size L1 4 and L 2 3.
individual firm effects; θ ≡ [θ1 , . . . , θK ]0 represents the chain relationships between 1983 and 2013 (a span of
contextual spillover effects (the effect of the customers’ 31 years).
characteristics on i’s productivity); additionally, ω Although it would have been desirable to have data
represents the endogenous spillover effect (the effect on all customers, this is not a severe limitation. This is
of the customers’ productivity on i’s productivity). because small customers are unlikely to have a signifi-
The term u i represents an unobserved shock affecting cant influence on the firm’s productivity. That is, sup-
firm i’s productivity. If we let TFP ≡ [TFP1 . . . TFPN ]0 , ply chain relationships are important insofar as they
X ≡ [X1 . . . XN ]0 , u ≡ t[u1 . . . u N ]0 , and ι be an N-vector represent a significant portion of a firm’s annual rev-
of ones, the matrix representation of our model is enue (e.g., more than 10%).4 We could have explored
our results by using the Bloomberg Supply Chain
TFP ιβ + Xγ + (W)Xθ + (W)TFPω + u. (3)
Note that by jointly estimating the endogenous and Figure 3. (Color online) Direct and Indirect Effects
the contextual spillovers, not only can we estimate the TFPi
direct spillover effect of a contextual characteristic (θk ),
but also the indirect effect; the indirect effect allows us
to see how a given characteristic affects a customer’s Firm i
Indirect effect
own TFP (through γk ) and, in turn, how this change

Direct effect
indirectly affects i’s productivity through the endoge- size

nous effect, ω. Therefore, the indirect spillover effect is
size
γk ω; see Figure 3 for an example.
4.3. Data Description Firm j

TFPj
4.3.1. Supply Chain Linkages. Statement No. 14 of the (customer) Sizej
Financial Accounting Standards Board (FASB) requires
firms to disclose the revenue derived from sales to Notes. If customer j increases in size (by one unit), i’s TFP will receive
customers that exceeds 10% of their annual revenue. a direct spillover equal to θsize ; at the same time, a unit change in
the size of the customer will affect the productivity of this customer
The reports contain annual information about the firm by γsize . This change, in turn, will affect i’s TFP firm through the
and its customer’s name, and the dollar sales made to endogenous effect, ω. Therefore, the size of the indirect spillover
this customer. We use these reports to identify supply effect is γsize ω.
Table 3. Summary Statistics About the Customer Base of of the customer’s inability to compensate the supplier
Each Firm (i.e., because of unstable cash flows).
We use three key indicators of financial health:
Customers Observations Avg. revenue (%)
(i) financial liquidity (measured by the ratio of liq-
0 6,339 0 uid assets to liabilities), which allows us determine
1 10,614 21.74 whether the company is able to meet its short-term
2 3,480 32.32 financial obligations; (ii) financial leverage (ratio of
3 1,770 42.02
≥4 180 49.91
total debt to assets), which allows us to determine the
company’s debt status; and (iii) financial agility (total
Notes. The middle column shows the number of observations with asset turnover), which allows us to measure how effi-
M {0, 1, 2, 3, ≥ 4} reported customers. The right-most column
expresses the percentage of the firm’s total revenue that is attributed
cient is the company at deploying its assets to generate
to the major customers, i.e., Avg. revenue Nn1 salesin /Total Sales.
P revenue.
• Operational characteristics: The operational char-
acteristics allow us to measure how a customer’s
Table 4. Summary Statistics About the
Firm’s Subnetworks
operational profile spills over to the supplier’s produc-
tivity. A customer that has poor inventory management
Subnetwork size (L ψ ) skills will place orders that are less predictable, thereby
preventing the supplier from efficiently scheduling its
Mean 232.37 labor and capital inputs; this will lead the supplier to
SD 224.70
Median 243
end up with higher amounts of capital and labor slack
Minimum 2 (and, hence, lower productivity).
Maximum 605 We use three characteristics to capture a firm’s oper-
ational profile: (i) inventory turnover, which serves as
a proxy for the level of physical inventory that is held;
Relationships (SPLC) data set, which captures a much (ii) capital-to-labor ratio, which allows us to measure
larger number of links per firm. This data source, whether the firm is capital intensive or labor intensive;
however, only contains a cross section of relationships and (iii) diversification level (measured by the num-
(i.e., no panel data), which limits our ability to perform ber of business segments), which allows us to deter-
dynamic analysis (see Online Appendix C.4 for more mine whether a firm’s operations are specialized or
details). diversified.
In 939 cases the sales value was negative, zero, or • Idiosyncratic characteristics: We control for other
suspiciously high and the match was discarded. The idiosyncratic characteristics: (i) age, for which we
resulting data set contains 22,383 firm–customer rela- observe the year in which the firm first appeared in
tionships and 3,673 subnetworks across the panel, that Compustat as a proxy; (ii) size, which is measured
is, slightly more than 100 subnetworks per year. We use by the natural logarithm of total assets; and (iii) geo-
these firms to construct our interaction matrix W. graphic location. As a proxy proxy for geography,
Table 3 summarizes the customer bases for all firms we divide firms into five regions: Northeast, Mid-
and Table 4 summarizes the network characteristics. west, South, West, and Overseas. The first four cate-
From Table 3 we can observe that approximately gories represent the official Census Bureau designated
6,300 observations report no “major” customers; this regions, and the (excluded) dummy Overseas includes
includes, for example, firms in the consumer retail international firms, or those firms located outside of
industry or commercial airlines. Also, there is a good the mainland United States. Approximately, 5% of the
level of industry mix across the different echelons in firms are located overseas.
the network and, on average, we capture 26.88% of For a table of summary statistics, see Online Appen-
the annual revenue from firms that report at least one dix D. Note that we have normalized both the mean
customer. and standard deviation (SD) of these characteristics
4.3.2. Vector of Characteristics. We want to build a (across industries), which allows us to derive consis-
suitable vector of firm characteristics (Xi ) to properly tent comparisons of the coefficient estimates. Also, note
capture a firm’s profile. To this end, we use three types that the inclusion of the above variables was based on
of characteristics as proxies: financial, operational, and standard accounting definitions and those used by sim-
idiosyncratic. ilar studies (e.g., Keller and Yeaple 2009, Kalwani and
• Financial characteristics: By including financial co- Narayandas 1995, and Gaur et al. 2005). Unavoidably,
variates, we can measure how the “financial health” of however, there is some room to debate about how to
a customer spills over to the supplier’s productivity. As properly define these variables or even about which set
a case in point, a financially unhealthy customer could of contextual characteristics is best suited to serve as
prevent the supplier from operating effectively because proxy for a firm’s profile. To ensure that our results are
not biased by the inclusion (or the exclusion) of any 5.1.3. Network Selection Biases. A crucial assump-
particular covariate, or by the way in which we define tion of OLS is that the sample data (that is, the supply
these variables, we have reestimated our model by chain network) are formed as a result of an exogenous
using alternative definitions and co-variate groups. We process. In reality, however, firms choose whether to
discuss these robustness checks in Online Appendix C, partner with suppliers that are large or small, prox-
and show that our results are robust to various other imate or distant, or even to partner with firms that
model specifications. have historically high productivity draws. The under-
lying selection process will give rise to a nonrandomly
5. Identification selected sample; we thus need to consider the possi-

5.1. Identification Problems bility that our results are correlated with unobservable
The estimation of Equation (3) is complicated by factors arising from the selection process. For exam-
three identification problems: the entanglement prob- ple, two firms are more likely to form a link if they
lem, correlated network effects, and network selection share a common business philosophy, or if they expect
biases. We explain these issues below. to collaborate in a harmonious or agreeable way with
5.1.1. Entanglement Problem. The entanglement prob- each other. Consider Cooper Industries (2015) which,
lem (also known as the reflection problem) was first on its corporate website, argues that “[we] require our
highlighted by Manski (1993), who explains that the suppliers to share our vision. We do business with
endogenous effect, in general, cannot be disentan- suppliers that subscribe to our philosophy of contin-
gled from the contextual effects. To note this, assume ual delivery, quality and productivity improvements.”
(without loss of generality) that there is only one con- If we do not control for the effect of these synergies,
textual characteristic, that is, X is a scalar. Our linear- our results could be artificially driven by the effect of
in-means Equation (3) can thus be written as follows: endogeneity in the selection of supply chain partners.
TFP β(I − ωW)−1 ι + γ(I − ωW)−1 X 5.2. Identification Strategy
+ θ(I − ωW)−1 WX + (I − ωW)−1 u 5.2.1. Entanglement Problem. As we explain above,
b1 ι + b 2 X + b 3 WX + uo . (4) the endogenous and contextual channels cannot be
disentangled because there is no injective relationship
Equation (4) is the reduced-form version of Equa- between the reduced-form estimates and our linear-in-
tion (3); note that, although both equations are infor- means equation. Although this issue sometimes ham-
mationally equivalent, the reduced-form estimates (b 1 , pers our ability to obtain estimates, fortunately this is
b 2 , b3 ) cannot be uniquely mapped onto (β, γ, θ, ω) not always the case.
because we are missing information on one param- Bramoullé et al. (2009) show that there are instances
eter. In other words, there is no injective relation- where we can exploit the structure of our network to
ship between the two estimates, implying that there overcome the entanglement problem. The authors, in
could be infinitely many “valid” mappings between particular, prove the following proposition.
(b 1 , b 2 , b 3 ) and (β, γ, θ, ω). This issue arises because the
TFP and the contextual regressors are linearly depen- Proposition 1 (Bramoullé et al. 2009). Suppose there are
dent; i.e., as the contextual characteristics change so no correlated network effects or network selection biases. The
does TFP. This condition, in turn, prevents us from dis- contextual and endogenous spillover effects can be disentan-
tinguishing the contextual channels and the endoge- gled if and only if the identity matrix I and the matrices W
nous channel. and W2 are linearly independent.
5.1.2. Correlated Network Effects. Firms that form Proposition 1 shows that if the matrices I, W, and W2
linkages tend to interact under similar geographic, eco- are linearly independent, then the reduced-form esti-
nomic, and technological environments. Because of mates from Equation (4) can be mapped onto (β, γ,
this, it is difficult to determine if (i) the customer is θ, ω). This can be done by using the contextual “peer
affecting the supplier (via spillover effects) or (ii) the of peer” characteristics to instrument for the peer’s
partners are simultaneously being affected by their productivity. The intuition is as follows: matrix W2
common environments. Consider, for example, an agri- describes the weighted relationships between a firm
cultural supply chain, where the productivity of firms and the “customers of its customers.”5 If I, W, and W2
(across the various echelons of the supply chain) is are linearly independent, then any Wn X (for n 2, , . . .)
expected to be affected by an adverse weather event can serve as an identifying instrument. For example,
(a drought, for example). If we do not control for this the third or fourth echelon of customer characteristics
weather event, we might erroneously conclude that, can also be used to instrument the first echelon. Using
because firms have correlated productivity levels, these Figure 4, we illustrate this insight below.
levels reflect the impact of spillover effects, whereas, In the network from Figure 4(a), identification is not
in reality, this correlation is an artifact of the weather possible because there is a complete overlap in the net-
event. work (all firms derive one-third of their revenue from
Figure 4. (Color online) Illustration of Linear Independence Condition

(a) (b)
1/3
1 2 3
1
1/3
1/3 1/10 9/10
1/3
1
1/3
4 3 2 4
1/3
1
1 1 1 1 9
0 0 0
3 3 3 10 10
1 1 1
0 0 0 0 0
W = 3 3 3 W =
1 1 1 0 0 0 1
0
3 3 3
1 1 1 0 1 0 0
0
3 3 3
I = 3W 2 − 2W I, W, W 2, W 3, ... are linearly independent

2
Notes. In network (a) identification is not possible because I, W, and W are linearly dependent. Bipartite and “star” networks are other types
of structures characterized by this type of linear dependence. In network (b) identification is possible because the matrices exhibit linear
independence.
each customer). It is possible, however, to identify the Step 2. We use the estimates obtained in Step 1 to
model in the network from Figure 4(b) because the estimate the expectation of Equation (4), the reduced-
(partially overlapping) network structure of 4(b) allows form equation for the customers:
us to extract the unique impact of a customer on its
E[(W)TFP2SLS | X, W]
suppliers. For example, the “influence” (the weight) of
firm 2 is higher on firm 4 than on firm 1; the influence W(I − ω2SLS W)−1 (ιβ + Xγ2SLS + WXθ2SLS ).
of firm 4 is higher on firm 3 than on firm 1, etc. We
Step 3. We specify a second 2SLS model, but this
exploit these differences to tease out the exact impact time we use E[(W)TFP2SLS | X, W] as an identifying
of each characteristic on the supplier. instrument for (W)TFP. To this end, we define the
To check for linear independence of these matrices, instrument vector Z ≡ [E[(W)TFP2SLS | X, W] X (W)X]
we use Corollary 1 in Bramoullé et al. (2009), which to obtain (β∗ , γ∗ , θ∗ , ω∗ ) (Z0 X̂)−1 Z0 (TFP).
tells us that linear independence is guaranteed if the Bramoullé et al. (2009) show that the quality of the
(undirected) diameter of the network is greater than above estimates depends on two characteristics of the
three: we verify this condition by checking that the network: (i) the level of network density (the ratio of
diameter of our network is 16.6 After verifying linear existing links to possible links) and (ii) the level of net-
independence, we can identify Equation (3) by using work intransitivity (the ratio of intransitive triads to the
a methodology provided by Lee (2003) that consists of total number of triads). Bramoullé et al. (2009) find that
a series of generalized two-stage least squares (2SLS) the “structural parameters are better estimated when
estimators. the density of the graph is small” (p. 50) and, when
density is small, that “precision is an increasing func-
Estimation Procedure tion of intransitivity almost everywhere” (p. 51). In our
Step 1. We begin by estimating an overidentified 2SLS sample, the density of the graph is 0.0035 and the level
where the peer of peer characteristics, (W2 )X, instru- of intransitivity is 0.973; our network, as such, is char-
ment for the peer’s productivity (W)TFP. To perform acterized by properties that yield high-quality instru-
this 2SLS estimation, we first define the instrument vec- ments.
tor S ≡ [X (W)X (W2 )X]. Using this instrument vec- 5.2.2. Correlated Fixed Effects. In Section 5.2.1 we
tor, we recover estimates (β2SLS , γ 2SLS , θ 2SLS , ω2SLS ) showed how to solve the entanglement problem. How-
0 0
(X̂ PX̂)−1 (X̂ P)TFP, where X̂ ≡ [(W)TFP X (W)X] and ever, this strategy relies on the assumption that cor-
P ≡ S0 (S0 S)−1 S is the weight matrix (to account for the related effects are absent. Unfortunately, this is not a
fact that our model is overidentified). plausible assumption; as we explained above, firms
that establish relationships are likely to interact under process will give rise to a nonrandomly selected sam-
similar geographic, technological, and economic envi- ple. To solve this problem, we thus need to control
ronments which, in turn, leads to the presence of cor- the effect of dyad-specific shocks by accounting for
related unobserved effects across clusters of connected selection biases across the network. Unfortunately, the
firms. impact of selection biases is more acute in our context
The presence of correlated effects, unfortunately, than in traditional problems. This is because, in our
makes it harder to solve the entanglement problem; context, each firm has to select supply chain partners
this is due to the fact that degrees of freedom are lost from an entire network of potential collaborators. The
when we control for correlated effects. Bramoullé et al. number of biased decisions, as a result, grows expo-
(2009) outline the conditions required for identification nentially with the number of nodes (i.e., agents) in the
in this setting. network.
To mitigate the impact of selection biases, we build
Proposition 2 (Bramoullé et al. 2009). Consider a model
a structural model that jointly estimates two types of
where correlated effects are present. The contextual and processes: (1) the selection of supply chain partners
endogenous spillover effects can be disentangled only if the and (2) the determinants of productivity, conditional
identity matrix I and the matrices W, W2 , and W3 are lin- on the selection process; see Figure 5. This model is
early independent. inspired by Goldsmith-Pinkham and Imbens (2013)
After verifying linear independence, we proceed to and, especially, by Hsieh and Lee (2016).
estimate our results through a procedure that is sim- Process 1: Selection of supply chain partners. Con-
ilar to the one presented in the previous section; in sider the unweighted network matrix C, and recall that
this case, however, we first have to modify the linear- this matrix has element c i j , where c i j 1 if j is a cus-
in-means equation to absorb the source of correlated tomer of i, and c i j 0 otherwise. We assume that, at
effects. We apply a local within transformation that the beginning of period t, supplier i and customer j
allows us to subtract, from each firm’s equation, the evaluate the economic surplus of forming a link, Ui j .
average of those firms that are directly connected to it Assume that a link forms if and only if Ui j > 0, i.e.,
(the local network of the firm).7 To achieve this trans- that c i j 1Ui j >0 , and let
formation, we rewrite the equation as follows:
Ui j (α) α 0 + αi Xi + α j X j + α |i− j| X|i− j|
(I − W)TFP (I − W)Xγ + (I − W)WXθ |¨¨¨¨¨¨¨{z¨¨¨¨¨¨¨} |¨¨¨¨¨{z¨¨¨¨¨}
+ (I − W)(W)TFPω + (I − W)u. (5) firm characteristics dyad heterogeneity
+ αTFPi TFPi, t−1 +αTFP j TFP j, t−1
After transforming our linear-in-means equation, we |¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨{z¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨}
apply the following estimation procedure, which is past productivity
similar to the one in the previous section. + α h c h, i j

|¨{z¨}
Estimation Procedure historical connectivity
Step 1. We estimate an overidentified 2SLS by + α IND INDi j
using the instrument vector S ≡ [(I − W)X(I − W) · |¨¨¨¨¨¨{z¨¨¨¨¨¨}
WX(I − W)W2 X] to retrieve estimates (β 2SLS , γ2SLS , industry compatibility
0 0
θ 2SLS , ω2SLS ) (X̂ PX̂)−1 (X̂ P)TFP, where X̂ ≡ (I − W) · + α ξ |ξ i − ξ j | +ηi j . (6)
(W)TFP(I − W)X(I − W)WX] and P ≡ S0 (S0 S)−1 S. |¨¨¨¨¨¨{z¨¨¨¨¨¨}
Step 2. We use the estimates obtained in Step 1 to unobserved synergies
estimate
The above equation assumes that the likelihood of a
E[(I − W)(W)TFP 2SLS
| X, W] linkage, for which Ui j acts as proxy, depends on six
types of factors. First, it depends on the firm character-
W(I − ω 2SLS
W) [(I − W)(Xγ2SLS + WXθ 2SLS )].
−1
istics of both partners, Xi and X j . Second, it depends
on the degree of dyad heterogeneity, X|i−j| ≡ [|x1i − x 1j |,
Step 3. We specify a second 2SLS model, using the
|x2i − x2j |, . . . , |x Ki − x K j |]; the inclusion of this effect
instrument vector Z ≡ [E[(I − W)(W)TFP2SLS | X, W] ·
allows us to capture the idea that firms with simi-
(I − W)X(I − W)(W)X] to retrieve (β ∗ , γ∗ , θ∗ , ω∗ ) ≡
lar characteristics are more prone to forming a rela-
(Z0 X̂)−1 Z0 (TFP).
tionship. Geographic proximity, for example, is likely
5.2.3. Selection Biases. In the preceding sections we to be an important factor in the formation of a link.
assumed that the formation of supply chains is an Third, we assume that Ui j depends on past productiv-
exogenous process. However, in reality, firms choose ity draws, TFPt−1, i and TFPt−1, j . Fourth, it depends on
whether to select suppliers that are large or small, the historical connectivity of the dyad, which allows
proximate or distant, etc. The underlying selection us to capture the idea that firms may be more prone
Figure 5. (Color online) Illustration of Model Dynamics

Process 1 Process 2
Firm Firm
Firm 1 10
Firm
? 1
7
Firm
Firm
Firm i Firm Firm 9 Firm
2
2 3 11
?
Firm
8
?
Firm Firm Firm Firm Firm Firm
n 4 5 6 12 13
Network C
Formation of network C Spillover effects (conditional on network C)

Note. To deal with the presence of selection biases, we need to jointly capture the formation of supply chains (Process 1) and the determinants
of productivity, conditional on network C (Process 2).
to selecting partners with whom they have previously the likelihood of observing network matrix C is equal to
interacted. We create a proxy for historical connectiv-
ity by adding the dummy c h, i j , which is equal to 1 if j Lnetwork (α | X, C, Ch , TFPt−1 , ξ, η)
was a customer of supplier i in one of the previous five N Y
Y N
years, and zero otherwise; we also let Ch be the matrix (p i j (α | X, C, Ch , TFPt−1 , ξ, η))c i j
i1 j1
with characteristic component c h, i j . Fifth, it depends j ,i
on the degree of industry compatibility, INDi j . This
× (1 − p i j (α | X, C, Ch , TFPt−1 , ξ, η))1−c i j .
term represents the compatibility between the indus-
tries of the supplier and the customer; manufacturers
Process 2: Determinants of productivity. Once net-
of home furniture, for example, are likely to require
work C has been formed, firms interact and pro-
inputs from firms in the wood and lumber industry,
ductivity is realized. To estimate the determinants of
but less likely to source from, say, firms in food indus-
productivity, we consider equation
tries. To create a proxy for industry compatibility, we
use the input–output tables of the Bureau of Economic
TFP β1 + Xγ + (W)Xθ + (W)TFPω + u.
Analysis from previous periods, which allow us to
see the historical proportion of inputs that flow from
To capture for the effect of unobservable factors that
one industry to another (defined at the three-digit SIC
arise from the selection process, we allow u i to be cor-
code). Finally, we assume that there is the potential for
related with ξ i , which is an unobserved fixed shock
unobserved synergies affecting the likelihood of link
arising from Equation (6). In particular, we assume
formation. To represent these unobservable shocks, we
that ξ i and u i are independent and identically dis-
specify the term ξ i ∼ Norm(0, σξ2 ), which is an idiosyn-
tributed (IID) and satisfy the following distributional
cratic latent shock. In particular, firms with similar
assumptions:
values of ξ i may be more likely to form relationships
if α ξ < 0. Finally, ηi j represents an independent and
σu2 σuξ

0
logistically distributed error term. (u i , ξ i ) ∼ Norm , .
0 σuξ σξ2
If we let p i j (α | X, C, Ch , TFP, ξ, η) be the probability
that j selects i as a supplier, we have that
One can verify that the linear-in-means equation can
be rewritten as TFPi β + (γ1 x1, i + · · · + γK x K, i ) +
p i j (α | X, C, Ch , TFPt−1 , ξ, η) ≡ pr(Ui j (α) > 0)
(θ1 x1,C i + · · · + θK x K,
C
i ) + ω TFP i +(σ ξu ξ i )/σ ξ + v i , where
C
exp(Ui j (α)) v i ∼ Norm(0, σu2 − σuξ 2

/σξ2 ). Observe that σuξ is our
,
1 + exp(Ui j (α)) measure of selection endogeneity: if σuξ 0, then the
productivity of the firms is uncorrelated with the for-
where the last equality follows from the fact that the er- mation process; if σuξ , 0, then our model is affected
ror terms, ηi j , follow a logistic distribution. Therefore, by selection endogeneity.
We let LTFP (Υ | TFP; C, X, ξ) be the likelihood of ob- addition, attempt to control for the impact of selection
serving TFP, given coefficient vectors Υ ≡ (β, γ, θ, ω, biases. (To obtain the estimates in column (3), we first
ξ, σξ2 , σu2 , σξu ). Because the error terms, u i , are normally had to estimate the determinants of network formation;
distributed, we have that these estimates can be found in Table 6.)
Recall that the mean and variance of the variables
LTFP (Υ | TFP; C, X, ξ) have been normalized across industries; because of
exp((−(TFP − µTFP )Σ−1TFP (TFP − µ TFP ))/2) this, our estimates should be interpreted in terms of
,
(2π) (N/2) |ΣTFP | standard deviations. For example, in column (1), the
contextual effect θliquidity 0.124 should be interpreted
where µTFP ≡ E[TFP | C, X] and ΣTFP ≡ Var(TFP | C, X). as follows: “If a firm has a customer base that is 1 SD
Likelihood Function. We jointly estimate (i) the deter- more liquid than the industry average, the firm’s pro-
minants of the selection process (α) and (ii) the de- ductivity will improve by 0.124 of a SD.”
terminants of productivity (Υ), conditional on the
selection process. To this end, we seek to maximize 6.1. Endogenous Channel
All of our estimates show that the endogenous coeffi-
L(α, Υ | TFP, TFPt−1 , C, Ch , X, ξ) cient is positive and large. The actual size of the coeffi-
Lnetwork (α | X, C, Ch , TFPt−1 , ξ) × LTFP (Υ | TFP, C, X, ξ) . cient varies across the three models: if we only correct
|¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨{z¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨} |¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨{z¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨¨} for the entanglement problem, then the endogenous
selection process TFP determinants coefficient is equal to 0.677; if, additionally, we correct
for correlated fixed effects, then the size of the coeffi-
However, observe that the above equation cannot cient is 0.638; and, if, on top of this, we correct for the
be identified, given the presence of the unobserved impact of selection biases, then the endogenous coeffi-
component ξ. To factor out this parameter vector, we cient is 0.574. This implies that having a customer base
estimate that is one-standard-deviation above average produc-
tivity will increase a supplier’s productivity between
L(α, Υ | TFP, TFPt−1 , C, Ch , X)
∫ three-fifths and three-fourths of a standard deviation.
L(α, Υ | TFP, C, TFPt−1 , Ch , X, ξ) f (ξ) dξ, The results show that failing to account for the esti-
ξ mation biases would lead us to overstate the impact
where f (ξ) is the probability distribution function of of the endogenous channel. Table 6 (which shows the
the normal distribution. determinants of link formation) shows that firms with
a high degree of affinity (i.e., a low degree of unob-
Estimation Procedure. We choose to estimate L(α, served heterogeneity, |ξ i − ξ j |), are more likely to form
Υ | TFP, TFPt−1 , C, Ch , X) through Bayesian methods. a relationship: this is because α ξ < 0. As such, the sta-
In particular, we use Monte Carlo Markov chain tistical significance of this coefficient reflects the impor-
(MCMC) methods to draw samples from the prior dis- tance that firms assign to finding partners that have
tribution. After drawing these samples we calculate an aligned vision, or the potential to establish a har-
the posterior means as the estimates. This approach monious relationship. Moreover, Table 5 shows that
is detailed in Hsieh and Lee (2016). The above equa- ignoring this effect would bias our estimates upward.
tion could have been identified through maximum Despite a slight variation in the size of the coefficient,
likelihood estimators (MLE) instead of Bayesian meth- all of our models show that the endogenous effect is
ods. There are several reasons for choosing a Bayesian significantly higher than any of the contextual effects.8
approach, which are detailed in Goldsmith-Pinkham This implies that the customer’s productivity, and not
and Imbens (2013) and Hsieh and Lee (2016). To sum- the contextual characteristics, is the main driver of
marize, the Bayesian approach allows us to derive supplier productivity along the supply chain. (In Sec-
large-sample properties, something that is difficult tion 6.3, we compare the relative size of the endoge-
with the maximum likelihood estimates given the lack nous and contextual coefficients in detail.)
of appropriate theories regarding their distributional However, which mechanisms are driving the above
properties. result? Is the endogenous channel being driven by
knowledge transfers, collaboration, or mentoring?
6. Estimates Moreover, are these results representative of all types
We present three sets of results in Table 5: (i) the results of relationships? Alternatively, should we expect the
in column (1) only attempt to control for the entan- endogenous channel to be larger across certain rela-
glement problem; (ii) the results in column (2), on the tionships and smaller across other types of relation-
other hand, control for both the entanglement prob- ships? We explore these issues in Section 7, where we
lem and for correlated fixed effects; (iii) and finally, study how the endogenous channel varies as a function
the results in column (3) present estimates that, in of the supply chain structure.
Table 5. Model Estimates for the Linear-in-Means Equation
(1) (2) (3)
Effect Variable Coefficient t-stat. Coefficient t-stat. Coefficient t-stat.

∗∗∗ ∗∗∗ ∗∗∗
Endogenous Customer’s TFP 0.677 3.61 0.638 3.58 0.574 3.18
effect (ω)
Contextual Financial leverage 0.003 0.27 0.002 0.22 0.002 0.14
spillover Financial liquidity 0.124∗∗∗ 3.38 0.117∗∗∗ 3.36 0.115∗∗∗ 4.48

effects (θ) Financial agility 0.051∗∗∗ 3.52 0.051∗∗∗ 3.59 0.066∗∗∗ 6.32
Inventory turnover 0.023 1.02 0.024 1.1 0.028 1.31
Capital labor ratio −0.004 −0.22 −0.003 −0.21 −0.005 −0.31
Diversification 0.047 1.05 0.039 0.88 0.010 0.28
Age −0.015 −0.93 −0.013 −0.84 0.119 1.66
Size 0.080∗∗∗ 3.08 0.077∗∗∗ 3.02 0.040∗ 1.92
Region: West −0.180∗∗ −2.11 −0.166∗∗ −2.01 −0.017∗ −1.68
Region: Midwest 0.065 1.61 0.073∗ 1.78 0.102 1.01
Region: Northeast 0.102∗∗∗ 2.76 0.109∗∗∗ 2.97 0.141∗ 1.82
Region: South 0.041 1.1 0.046 1.28 0.097 0.68
Firm Financial leverage −0.004 −0.67 −0.004 −0.67 −0.012 −1.73
effects (γ) Financial liquidity −0.127∗∗∗ −9.39 −0.128∗∗∗ −9.42 −0.118∗∗∗ −7.94
Financial agility 0.116∗∗∗ 11.45 0.115∗∗∗ 11.44 0.109∗∗∗ 10.60
Inventory turnover −0.017∗ −1.73 −0.017∗ −1.72 −0.016∗ −1.73
Capital labor ratio 0.003 0.54 0.002 0.53 −0.002 −0.40
Diversification −0.376∗∗∗ −9.2 −0.381∗∗∗ −9.28 −0.176∗∗∗ −6.12
Age 0.121∗∗∗ 14.02 0.122∗∗∗ 14.24 0.119∗∗∗ 15.66
Size 0.116∗∗∗ 10.09 0.116∗∗∗ 10.11 0.143∗∗∗ 12.29
Region: West 0.122∗∗∗ 4.29 0.123∗∗∗ 4.33 0.192∗∗∗ 7.01
Region: Midwest 0.065∗∗ 2.24 0.066∗∗ 2.23 0.128∗∗∗ 3.68
Region: Northeast 0.112∗∗∗ 4.75 0.113∗∗∗ 4.75 0.142∗∗∗ 2.58
Region: South 0.018 1.05 0.020 1.17 0.061∗∗∗ 3.04
Intercept 2.538 1.14
Network fixed effects No Yes Yes
Selection covariance (σuξ ) N/A N/A 0.143
∗∗∗
p < 0.01; ∗∗ p < 0.05; ∗ p < 0.1.
6.2. Contextual Channels financial agility is positive and statistically significant,

Below we examine the impact of the contextual charac- both at the direct and indirect levels; firms thus bene-
teristics. For ease of interpretation, we list in Table 7 the fit by partnering with customers that have the ability
direct (θ), indirect (ωγ), and total (θ + ωγ) spillover to generate revenue efficiently. In addition, these cus-
effects. tomers are more productive themselves. The effect of
• Financial characteristics: We find that the direct financial leverage, on the other hand, is insignificant both
effect of liquidity is positive; this tells us that (hold- at the indirect level and at the direct level. Our results,
ing productivity constant) a firm benefits from hav- taken as a whole, imply that the suppliers are signifi-
ing customers with more liquid assets. Why could this cantly affected by the ability of the customers to deploy
be? A liquidity-constrained customer is more likely to their assets to generate and retain cash and, at the same
default on its short-term payments, which, in turn, time, less affected by the debt status of these customers.
could prevent the supplier from financing its own cap- • Operational characteristics: Both the direct and indi-
ital or labor, thereby impacting the supplier’s abil- rect effects of inventory turnover are statistically insignif-
ity to effectively use these inputs. The indirect effect, icant; having customers with high or low inventory,
on the other hand, shows that liquid customers are in other words, makes no difference for a firm’s pro-
less productive themselves (albeit by a small factor) ductivity. As we will show in Section 7, however, this
and, in turn, this indirectly hurts the supplier through result is highly dependent on the structure of the sup-
the endogenous channel. This result is likely because ply chain.9 We also find that the capital-to-labor ratio
high productivity is often associated with investments of the customer is insignificant, both at the direct and
in infrastructure modernization and capital improve- indirect levels. It is therefore irrelevant, for the sup-
ment, which leads the firm to having less in cash hold- plier, to have a customer that is more or less capi-
ings over the short term. The total effect is positive tal intensive than the industry average. Regarding the
and statistically significant, implying that having liq- level of diversification, we find that the direct effect is
uid customers is beneficial ultimately. The impact of insignificant; the indirect and total effects, on the other
Table 6. Estimates of the Determinants of Dyad Selection Table 7. Direct, Indirect, and Total Effects for the Model
Estimates of Table 5, Column (3)
Variable Coefficient t-stat.
Direct Indirect Total
Dyad-specific characteristic
Variable effect (θ) effect (γω) effect (θ + γω)
Industry compatibility (αIND ) 7.412∗∗∗ 23.9
Financial leverage 0.002 −0.007 −0.005
Historical connectivity (α h ) 5.293∗∗∗ 36.57
Financial liquidity 0.115∗∗∗ −0.068∗∗∗ 0.047
Dyad heterogeneity (|x ki − x k j |) Financial agility 0.0662∗∗∗ 0.063∗∗∗ 0.129∗∗∗
Productivity −0.047 −1.51 Inventory turnover 0.028 −0.009 0.019

Geographic location −0.136∗∗∗ −5.13 Capital labor ratio −0.0048 −0.001 −0.006
Financial leverage −0.019 −0.85
Diversification 0.010 −0.101∗∗∗ −0.091∗∗
Financial liquidity −0.140∗∗∗ −3.44
Age 0.119 0.068∗∗∗ 0.187∗∗∗
Financial agility −0.078∗∗ −2.25
Size 0.040∗ 0.082∗∗∗ 0.122∗∗∗
Inventory turnover 0.575∗∗∗ 4.10
Region: West −0.017∗ 0.110∗∗∗ 0.093∗∗∗
Input intensity 0.018 0.71
Specialization 2.835 0.01 Region: Midwest 0.1019 0.073∗∗∗ 0.175
Age −0.087∗∗ −2.35 Region: Northeast 0.141∗ 0.082∗∗ 0.223∗∗∗
Size −0.419∗∗∗ −4.26 Region: South 0.097 0.035∗∗∗ 0.132
Supplier characteristics (x i ) ∗∗∗
p < 0.01; ∗∗ p < 0.05; ∗ p < 0.1.
Productivity (TFPt−1, i ) 0.038∗ 1.87
Financial leverage −0.015 −0.58 only because larger firms are more productive them-
Financial liquidity 0.051 1.45
Financial agility 0.083∗∗∗ 2.65
selves, but also because size (per se) is a positive source
Inventory turnover −0.579∗∗∗ −4.19 of spillovers. This result hints toward the idea that
Input intensity 0.010 0.40 scale economies not only benefit the firm, but, also,
Specialization 2.059 0.01 that these benefits ripple along the supply chain: the
Age 0.036 1.11
expansion of a firm, in other words, induces a positive
Customer characteristics (x j )
Productivity (TFPt−1, i ) −0.145∗ −1.72 externality across the network. The direct effect of age
Financial leverage 0.136∗∗∗ 3.36 is insignificant, but the indirect effect is positive and
Financial liquidity 0.200∗∗∗ 4.21 significant; that is, age only has a role because it affects
Financial agility 0.388∗∗∗ 12.43 the productivity of the customer itself. The geographic
Inventory turnover −0.489∗∗∗ −3.50
location dummies show that partnering with customers
Input intensity −0.006 −0.13
Diversification 3.812 0.01 in the Northeastern region is significantly beneficial
Age −0.012 −0.34 for the suppliers, both at the direct and indirect lev-
Size 1.716∗∗∗ 18.69 els; this could be due to agglomeration economies
Constant (α0 ) −10.294∗∗∗ −9.20 that exist in this region, which lead to more efficient
Unobs. heterogeneity (α ξ ) −0.344∗ −1.89 interactions.
Notes. All variable definitions are provided in Online Appendix A.
The estimates above capture the coefficient estimates for Equa- 6.3. Managerial Insights
tion (6), the selection equation, in the model presented in Sec- Taken as a whole, how can managers interpret the
tion 5.2.3.
∗∗∗
p < 0.01; ∗∗ p < 0.05; ∗ p < 0.1.
above results? For example, what if the customers were
at the 90th percentile of the productivity distribution,
hand, are significant and negative. A supplier thus as opposed to the 10th percentile; similarly, what if
benefits by interacting with specialized customers, but they were at the 75th percentile of the size or liquidity
this is only because specialized firms are more produc- distribution, as opposed to the 25th percentile (mean-
tive themselves (not because the level of diversification ing that they are more liquid and larger than most
has a direct impact). Why could this be? Specialized peers)? How would these differences affect the sup-
customers are known to be more productive as they plier’s productivity?
are able to standardize production and have a more We perform a counterfactual analysis by estimat-
responsive partnership; in the literature, for example, ing the percentage average productivity improvement
there is a large debate about the “diversification dis- (PAPI). Roughly speaking, the PAPI (which is illus-
count,” which shows a negative correlation between trated in Figure 6) can be interpreted as a what-if cal-
market returns and the number of business lines in culation that describes the impact, on the supplier’s
which a firm operates.10 It would be interesting to productivity, that can be attributed to changes in the
examine, through the use of product-level data, how ranking of the customers’ characteristics.
spillover effects arise in separate lines of businesses. Consider a given characteristic, z {TFP; size,
• Idiosyncratic characteristics: The direct, indirect, liquidity, . . .}. The PAPI, for characteristic z, would tell
and total effects of size are significant, implying that us by how much would firm i’s TFP improve (for an
firms benefit from having large customers; this is not average firm in an average year), had the customers
Figure 6. (Color online) Percentage Average Productivity Improvement (PAPI) Depicting a “What-If” Scenario
30
(Supplier) percentage average TFP

productivity improvement (%)
20
10
Liquidity
Agility
Size
Age
Inventory.turnover
Diversification
0 Leverage
1 20 40 60 80 99
Percentile ranking of customers’ characteristics (%)
Notes. Consider, for example, the PAPI of liquidity. The figure depicts the percentage improvement on a supplier’s TFP, had its customers been
at a given percentile of the liquidity distribution (as opposed to the 1st percentile).
been at a given percentile of the distribution for char- customer’s own productivity, not because the charac-
acteristic z (as opposed to the 1st percentile). For exam- teristic itself can induce significant externalities across
ple, from Figure 6, we can observe that supplier i the network.
would have been 15% more productive had its cus-
tomers been at the 40th percentile of the TFP distribu- 7. Extension: The Impact of
tion (as opposed to the 1st percentile), and roughly 30%
Supply Chain Structure
more productive had these customers been at the 99th
The above results come with a caveat. Our estimation
percentile. This implies that having highly productive
depicts the average impact of the productivity chan-
customers, as opposed to unproductive ones, can trans-
nels. However, vertical interactions are highly hetero-
late into dramatic swings in the end-of-year produc-
geneous: a newly formed relationship between two
tivity for the suppliers. In contrast, the PAPI tells us
capital-intensive firms cannot be treated in the same
that supplier i would have only been 1.9% more pro- manner as a decade-long relationship between two
ductive had its customers been at the 40th percentile of labor-intensive firms.
the size distribution (as opposed to the 1st), and 3.3% We account for dyad heterogeneity by exploring
more productive had they been at the 99th percentile the impact of supply chain structure on the spillover
(while holding productivity constant). Interacting with effects. In Section 7.1, we begin by examining the
large customers, as opposed to smaller ones, can only impact of maturity (for how long have the firms inter-
explain minimal changes in productivity. Note how, acted?); then, in Section 7.2, we examine the impact
similarly, the PAPI of each contextual characteristic is of concentration (does the firm have a few key cus-
consistently below 5%, an amount that is much smaller tomers or multiple dispersed relationships?); and, last,
than the PAPI of TFP. in Section 7.3, we examine the impact of homogene-
The magnitudes involved are striking: a supplier’s ity (are the characteristics of the partners similar to
greatest productivity gain arises from partnering with each other?). For expositional purposes we exclusively
efficient customers, as opposed to partnering with present results for the model from Section 5.2.3 (which
firms that have specific characteristics. To put this sim- corrects for the three identification problems). All esti-
ply: productivity drives productivity. Managers should mates from this extension can be found in Table 8.
therefore be aware that any enhancement in the pro-
ductivity of a customer is likely, in the long term, to 7.1. Maturity
yield a significant positive externality to its upstream In this section we examine how the productivity chan-
partners (through endogenous mechanisms). Alterna- nels depend on the maturity of the relationship. We
tively, any swing in the profile of a customer’s char- define the maturity level as the number of consec-
acteristics (e.g., the level of specialization, liquidity, or utive years for which two firms have interacted in
the size of the firm) will matter for the future of the the past. We divide dyads into four levels: (i) low
upstream firms, but only if it has an impact on the maturity (one and two years maturity, 12,022 dyads);
Table 8. Endogenous and Contextual Effects as a Function of Maturity, Using the Full Sample
Years 1–2 Years 3–4 Years 5–6 Years ≥ 7
Effect Variable Coefficient t-stat. Coefficient t-stat. Coefficient t-stat. Coefficient t-stat.
∗∗∗ ∗∗∗ ∗
Endogenous Customer’s TFP 0.479 4.40 0.856 5.27 0.500 1.69 0.117 0.68
effect (ω)
Financial leverage 0.002 0.13 0.018 0.63 −0.031 −0.91 −0.012 −0.29
Financial liquidity 0.118∗∗∗ 3.39 0.130∗∗∗ 2.39 0.176∗ 1.77 0.093∗∗∗ 2.14
Contextual Financial agility 0.046∗∗∗ 3.05 0.016 0.67 0.088∗∗∗ 3.26 0.119∗∗∗ 3.52
spillover Inventory turnover 0.027 1.19 0.031 0.39 −0.119 −1.58 0.173∗∗∗ 2.77
effects (θ) Capital labor ratio 0.027 0.53 0.023 0.25 0.010 0.08 0.080 0.66
Diversification −0.016 −1.36 −0.075∗∗∗ −2.7 0.011 0.8 0.274∗∗∗ 3.14
Age −0.019 −0.92 −0.133 −1.1 0.073 0.57 −0.070∗ −1.73
Size 0.090∗∗∗ 3.07 0.151∗∗∗ 2.91 0.012 0.24 −0.095∗ −1.85
Region: West −0.181∗∗ −2.04 −0.291∗∗ −2.26 −0.046 −0.31 −0.124 −1.02
Region: Midwest 0.055 1.19 0.126 1.64 0.175∗ 1.86 −0.022 −0.19
Region: Northeast 0.059 1.45 0.171∗∗ 2.54 0.283∗∗∗ 3.36 0.157 1.42
Region: South 0.027 0.55 0.046 0.67 0.111 1.14 0.143 1.29
No. of dyads 12,022 4,724 3,324 2,312
Note. Firm effects are omitted from the table.

∗∗∗
p < 0.01; ∗∗ p < 0.05; ∗ p < 0.1.
(ii) medium-low maturity (three and four years, 4,724 extract the benefits of interacting with a more produc-
dyads); (iii) medium-high maturity (five and six years, tive customer; the supplier, after all, may have not yet
3,324 dyads); and (iv) high maturity (more than seven learned about the practices of this customer. However,
years, 2,312 dyads).11 This division gives us the most after the relationship has matured, the influence of
robust results because it is neither too coarse, but also knowledge transfers begins to kick in. This effect seems
not too granular to impede identification. to dissipate after some time, probably because, once
To estimate how spillover effects vary as a func- the supplier has adopted the efficient practices of its
tion of maturity, we use the following linear-in-means customer, there is a diminishing return to the knowl-
function, edge that can be extracted: the suppliers have already
X X “milked” the learning from the customer.
TFP ιβ + Xγ + Wm Xθm + Wm TFPωm + u, Let us now turn to the contextual channels. The size
m m and significance of these channels are stable across the
maturity levels; we find, for example, that the impact
where Wm denotes the weighted adjacency matrix of financial liquidity and agility remains significant
between those relationships that have maturity m ∈ throughout. There are some exceptions, however; in
{low, medium-low, medium-high, high}.12 As Dieye and particular, the effect of size becomes less significant
Fortin (2014) show, this type of linear-in-means func- as the relationship progresses, whereas the effect of
tion can be identified if and only if the matrices I, Wlow , inventory turnover becomes more significant. The level
. . . , Whigh , W2low , . . . , W2high are linearly independent. of diversification yields one interesting finding: in the
We find that the importance of the endogenous chan- early years it is beneficial to interact with customers
nel varies with the maturity of the relationship; in par- that are specialized; if the maturity is high, however,
ticular, the size of the endogenous effect follows an firms benefit from having a diversified customer base.
inverse U-shape that peaks at the medium-low matu- There are two identification issues in our sample.
rity level. In percentage terms, these results imply that A possible concern with our results is that our data
if a firm were to have a customer base that is at the 75th are truncated at the 10% revenue level, which could
percentile of the productivity distribution, as opposed generate gaps in the relationships that lead us to mis-
to the 1st, then the firm would have been (i) 15.95% estimate the true maturity of a dyad; if the weight of
more productive if the relationship had low maturity, this relationship is close to the 10% threshold level at
(ii) 32.6% if it had medium-low maturity, (iii) 14.22% if years t − 2 or t, for example, then it is likely that the
it had medium-high maturity, and (iv) 3.13% if it had missing year (t − 1) is an artifact of the data truncation.
high maturity. Fortunately, we found that only 4.3% of the relation-
What can explain this finding? We conjecture that ships have this type of gap, and approximately half
our estimates provide evidence of learning effects (in of these gaps could be attributed to “low” weights
particular, of the sigmoidal learning curve). As a new (below 15%) in the years surrounding the gap. How-
relationship forms, a supplier may not immediately ever, to ensure that our results are robust to this prob-
lem, we reestimate our model in Online Appendix C.3 of firms have extremely low degrees of concentration
by (i) filling for the gaps that are characterized by low (e.g., retail stores or commercial airlines). In Table 9,
weights and (ii) using alternative definitions of matu- we list the manufacturing sectors with the highest and
rity (i.e., instead of using the consecutive number of lowest concentration indices (but note that, in the esti-
years, we used the overall number of years that firms mation, we took industry fixed effects to control for this
have interacted). factor).
Additionally, firms with different characteristics To estimate the impact of concentration on the size of
(and in different industries) may be likely to engage the productivity channels, we use an interaction model
in more persistent relationships. If this is the case, between the CCi and the determinants of productiv-
how can we know if our results are indicative of the ity: (i) the firm effects, (ii) the contextual spillovers,
true effect of maturity or if they are an artifact of and (iii) the endogenous spillover. We also estimate the
self-selection across the maturity levels? We address stand-alone impact of CCi on TFP; we report the esti-
this issue in Online Appendix C.3 by reestimating mates of the spillover effects in Table 10.
our results through a restricted sample (which only Our results indicate that, as the level of concentration
includes those dyads that are found across the various increases, so does the size of the endogenous channel;
maturity levels). in particular, if a firm has a highly dispersed supply
chain (CCi ≈ 0), the size of the endogenous spillover
7.2. Concentration
is approximately 0.39; if, on the other hand, the firm
We now examine the impact of customer concentra-
is at the 99th percentile of the concentration distribu-
tion on the productivity channels. A firm that has a
tion (CCi 0.64) the size of the endogenous spillover is
dispersed customer base receives a small amount of
approximately 0.88.
revenue from multiple customers; the technology com-
This result makes sense. If the firm has one large
pany Mylex Corporation, for example, reported receiv-
customer, it will devote a large amount of effort to
ing revenues between 10% and 15% from multiple
establishing a deep relationship with this customer.
customers in a given year (including IBM, Hewlett-
This may give rise to more intense collaboration and
Packard, NEC Corporation, and Digital Equipment
open up the possibility of knowledge transfers. In these
Corporation). In contrast, a firm that has a concentrated
cases, the firm will derive large benefits from interact-
base receives a large portion of revenue from only a few
ing with a productive customer. If, rather, a firm inter-
customers; the technology company Three-Five Corp,
for example, received approximately 85% of its annual acts with dozens of small customers, the importance of
revenue from Motorola in 2001. endogenous mechanisms is expected to be small: after
Let CCi measure the degree of supply chain concen- all, a firm with a dispersed customer base is unlikely to
tration for firm i, where engage in supply chain collaboration at a deep level.
Let us now turn to the contextual channels. Some
2
N effects gain prominence across those firms with a con-

X salesin
CC i . centrated customer base. The effect of liquidity is rel-
n1 salesi
atively flat for those firms with dispersed bases, but
Here, CCi is a Herfindahl index similar to the one used highly negative for those firms with concentrated bases.
by Jain et al. (2014). In our sample, the firm at the 1st If the firm has multiple customers, the effect of delayed
percentile of the distribution has a CCi smaller than payments (caused by illiquid customers) can smoothen
0.001; the firm at the 99th percentile, on the other hand, out. This is not true for those firms with a few key
reports a CCi equal to 0.64; the average and median customers; in this case, the revenue stream of the sup-
CCi values are respectively equal to 0.08 and 0.03. Note plier is highly dependent on the liquidity status of
that this index is skewed because a large proportion these customers. The importance of age and geographic
Table 9. Manufacturing Industries (SIC Codes 20–39) with the Highest and Lowest Concentration Indices, CCi
Industries with average highest Industries with lowest

CC index (SIC code) CCi (%) average CC index CCi (%)
Electronics, Electrical Equip. and Components, Except 14.3 Petroleum Refining (29) 0.4
Computer Equipment (36)
Chemicals and Allied Products (28) 11.6 Tobacco Products (21) 0.7
Measuring, Analyzing, and Controlling Instruments (38) 10.8 Primary Metal Industries (33) 2.3
Apparel, Finished Products Made from Fabrics and 10.8 Paper and Allied Products. (26) 2.3
Similar Materials (23)
Fabricated Metal Products, Except Machinery (34) 10.5 Furniture and Fixtures (25) 2.6
Table 10. Estimates for an Interaction Model Between the Regressors and the Level of
Customer Concentration
(1) (2)
Effect Interaction term
Effect Variable Coefficient t-stat. Coefficient t-stat.
Endogenous effect (ω) Customer’s TFP 0.393∗∗∗ 3.30 0.763∗∗ 2.25

Financial leverage −0.006 −0.47 0.082 0.96

Financial liquidity 0.092∗∗∗ 3.53 0.116∗∗ 2.24
Contextual spillover Financial agility 0.054∗∗∗ 5.33 −0.237∗ −1.85
effects (θ)
Inventory turnover 0.006 0.28 0.446∗∗ 2.41
Capital to labor ratio 0.076∗∗∗ 2.67 −0.158 −0.85
Diversification 0.005 0.3 −1.109∗ −1.72
Age −0.021∗ −1.81 0.230∗∗∗ 3.34
Size 0.040∗ 1.79 0.033 0.28
Region: West 0.442∗ 1.73 0.260 1.04
Region: Midwest 0.231 1.24 0.091 0.50
Region: Northeast −0.026 −0.1 0.540∗∗ 2.49
Region: South 0.090 0.42 0.843∗∗∗ 4.38
Concentration term (CCi ) 0.053∗∗∗ 2.88
Notes. In column (1) we add the estimates for the coefficients of the spillover effects. In column (2) we
add the coefficients for the interacted term of the endogenous variable (CCi × TFPi ) and contextual
variables (CC i × x ki ). In the bottom row we include the impact of the concentration index in TFP (CC i ).
∗∗∗
p < 0.01; ∗∗ p < 0.05; ∗ p < 0.1.
location also seems to heighten as the level of concentra- Let Wm1 m2 denote the weighted adjacency matrix if the
tion increases, whereas the importance of other contex- firm and the customer are of type m1 ∈ [1, . . . , M] and
tual channels is invariant to the degree of concentration. m 2 ∈ [1, . . . , M]. Our linear-in-means equation is thus
Finally, in the bottom row we obtain estimates for given by
the standalone impact of CCi on TFP. We find that hav-
M X
M
ing a more concentrated customer base (per se) will X
TFP βι + Xγ + Wm1 m2 Xθm1 m2
increase TFP. This means that, all other things being m 1 1 m 2 1
equal, it is beneficial to have more concentrated rela- M X
X M
tionships; our results are in line with the results found + Wm1 m2 TFPωm1 m2 + u i .
by Patatoukas (2011), who argues that a concentrated m1 1 m2 1
base could translate into “efficiencies achieved through
enhanced production coordination, and inventory man- As before, we rely on Dieye and Fortin (2014), who
agement, cooperative advertising campaigns, and mar- show that identification in this setting is possible if and
keting alliances with major customers” (p. 364). only if the matrices I, W11 , . . . , WMM , W211 , . . . , W2MM are
A potential concern with the above results, again, is linearly independent.
that the truncation in our data might affect the degree We proceed to estimate these effects after verifying
of concentration. In Online Appendix C.3, however, we linear independence. We focus on the following dif-
have performed robustness checks to ensure that this ferences: (i) firm size (small versus large), (ii) input
truncation is not swaying our results. intensity (capital intensive versus labor intensive),
(iii) geographic location (West, Midwest, South, North-
7.3. Homogeneity east), and (iv) diversification (specialized versus con-
So far we have assumed that productivity spillovers glomerate). Because of space constraints, we limit this
are invariant to whether the partners are alike or not. extension to illustrating changes in the endogenous
Suppose, for example, that a supplier is a large con- effect.
glomerate; it is likely that this supplier is affected differ- • Input intensity: We divided firms according to
ently by customers that are also large conglomerates, their capital-to-labor ratio (CLR). We say that a firm
as opposed to small and specialized firms. is capital intensive (if its CRL is above the median)
To investigate these differences, we study how sup- or labor intensive (if its CRL is below the median).
pliers of given types are affected by customers of given Our results (in Table 11) show that homogeneity in
types. Consider a network comprising M types of the level of input intensity is a strong driver of the
firms, where “type” refers to some measurable char- endogenous channel. As we can see from Table 11,
acteristic, e.g., geographic location or capital intensity. the impact of endogenous mechanisms is larger when
Table 11. Endogenous Effect Arising from Interactions Table 13. Endogenous Effect Arising from Interactions
Between Firms with Different Levels of Input Intensity Between Firms of Different Sizes
Customer Customer
Capital intensive Labor intensive Small Large
Supplier Supplier
Capital intensive 0.713∗∗∗ 0.499∗∗ Small 0.273 0.792∗∗
Labor intensive 0.544∗∗ 0.662∗∗ Large −0.013 0.417∗∗

∗∗∗
p < 0.01; ∗∗ p < 0.05. ∗∗
p < 0.05.
firms interact with customers that have similar input a supplier of carpet and interior parts from Toyota
intensity. In capital-intensive relationships we would explains that they have “learned [from Toyota] about
expect that knowledge transfers are related to the effi- in-sequence shipping, kanban, one-piece production,
cient use of machinery; as a case in point, the engi- and standardized work” (Dyer 2000, p. 80). In contrast,
neers of Dell’s suppliers routinely visit Dell plants “to conglomerates may learn how to efficiently diversify
conduct failure analyses at Dell’s factories, after which by interacting with productive conglomerates.
they transfer the resulting knowledge to their own • Firm size: Homogeneity in size does not have a
facilities for corrective and preventive actions” (Dyer big influence on the endogenous effect. As our results
and Hatch 2006). In contrast, we would expect that show (in Table 13), it is more relevant for a firm of
knowledge transfers between two labor-intensive firms any size to interact with a large customer; in this case
are related to the efficient deployment of labor, best the endogenous effect is larger. Why is this so? We
hiring practices, or employee training; for example, speculate that economies of scale at the customer level
Adidas Footwear initiated the Manufacturing Excel- decrease the fixed cost of implementing collaboration
lence Department, which transfers knowledge to the platforms or information-sharing programs along the
suppliers on how to “deal effectively with increases supply chain. Another possibility is that large part-
in labor costs in a labor-intensive industry” (Anjoran ners have more leverage in influencing the practices
2014). In cases where capital-intensive firms interact of the supplier; this is evidenced by customer-initiated
with labor-intensive firms (e.g., a vertical link between campaigns among large customers to improve the
a vehicle manufacturer and an auto dealership), there efficiency of their upstream partners (e.g., Walmart,
is a limited ability for knowledge transfers, given Boeing, Dell, and Toyota).
that the operational structure is vastly different across • Geography: As shown in Table 14, the impact of
these firms. geographic proximity is greater when the dyad com-
• Diversification: We classified firms as specialized (if prises two northeastern firms. This may reflect the
the firm operates only in one business sector) or diver- impact of the connected transportation infrastructure
sified (if the firm operates in more than one business in this region (which may facilitate collaboration). Pre-
sector). Homogeneity in the level of specialization also vious findings have already found that connectivity
seems to be a strong factor in driving the endogenous matters at an intrafirm level (Giroud 2013). Geographic
effect (as shown in Table 12), but this is especially proximity is also a mildly relevant factor for firms
true if the supplier and the customer are both spe- located in the West and the South of the United States,
cialized firms. Again, this could reflect the idea that but not across firms in the Midwest.
endogenous mechanisms are stronger if the partners The above results show that homogeneity in input
have similar production structures. Specialized firms intensity and specialization is a strong driver of en-
can learn how to streamline their production more effi- dogenous spillovers. In other words, the productivity
ciently by interacting with productive customers that drives productivity story is more relevant among firms
have, as well, specialized operations; as a case in point,
Table 14. Endogenous Effect Arising from Interactions
Table 12. Endogenous Effect Arising from Interactions Between Firms with Different Geographic Locations
Between Firms with Different Levels of Specialization
Customer
Customer West Midwest Northeast South
Specialized Diversified
Firm
Supplier West 0.542∗∗ 0.169∗∗ 0.187∗ 0.182∗
Specialized 0.695 ∗
0.592 ∗ Midwest 0.130∗ 0.329 0.28 0.367
Diversified 0.566∗ 0.648∗∗∗ Northeast 0.130∗ 0.118 0.951∗∗ 0.452∗
South 0.494∗ 0.175 0.188 0.630∗∗
∗∗∗
p < 0.01; ∗ p < 0.1. ∗∗
p < 0.5; ∗ p < 0.1.
with similar operational structures. One might expect by its customers and, at the same time, show that this
that suppliers are better able to learn from the pro- condition is contingent on the structure of the sup-
ductivity of customers, provided that these customers ply chain. Our paper, as a result, can help managers
operate in similar ways to them. In contrast, homogene- to identify how productivity is transferred across their
ity in size and geography seems to be less important. own supply chains, not just in general.
Although not reported, the impact of several contex- Obtaining the above results was a difficult task that
tual channels also varies with the degree of homogene- forced us to face several identification challenges; we
ity. There are some noteworthy results. First, the impact
attempted to mitigate these challenges by adapting

of inventory turnover is higher across dyads character- econometric techniques from the literature on social
ized by (i) two capital-intensive firms, (ii) two firms of networks. Our paper, in this sense, makes a method-
large size, and (iii) two firms with high levels of diversi- ological contribution to the supply chain literature. So
fication. The effect of financial liquidity is higher when far, the econometrics literature has made great strides
a supplier is small, regardless of the customer’s size. in advancing the methodologies on social networks
This is likely due to the fact that smaller firms have and peer effects. But most of these efforts focus on net-
more stringent budgets, and, because of this, the nor- works that comprise human beings, not firms. Firms,
mal functioning of their operations is highly contingent however, choose their partners (and affect each other)
on the payments received from their customers. The in ways that are inherently different from humans. Our
spillover effects of age, inventory turnover, and lever- approach is a first attempt to transpose the techniques
age are largely invariant to the degree of homogeneity. of the social networks literature to supply chain net-
works and, though we have adapted a robust econo-
8. Discussion of Robustness and metric framework (to the best of our capabilities), we
Conclusions also hope that future papers can improve on these
8.1. Summary of Robustness Checks techniques.
At various stages in the paper we had to make discre- Our methodological approach comes with some
tionary decisions as to how to model spillover effects; limitations. First, future research could improve our
we made some decisions on the basis of tractability, methodology to correct for selection biases by provid-
or for expositional convenience. Unavoidably, however, ing alternative research designs to isolate the effect
some of our modeling assumptions open the door to of unobserved factors. In supply chain networks, the
debate: do our results truly depict the presence of selection problem is particularly acute because firms
spillover effects or, rather, are they an artifact of our select their partners based on latent factors that are
modeling choices? To answer this question, we perform related to the outcome (decision) variable. For exam-
a series of robustness checks, most of which are pre- ple, a manager’s decision (to form a vertical link)
sented in Online Appendix C. depends on a plethora of unobserved factors that end
We begin in Online Appendix C.1 by varying the up affecting the prospective productivity of the firm.
way in which we measure productivity; we do so One way to improve this approach would be to specify
by using alternative industry classifications and also a decision process that controls for the presence of het-
by changing the specification of the production func- erogeneous unobservable factors (such as the model
tion. In Online Appendix C.2, we vary the way in proposed by Hsieh and Lee 2016). These efforts, in
which we measure spillover effects, either by look- turn, would improve our understanding about how
ing at other weighting mechanisms for the adjacency supply chains form.
matrix, W, or by using alternative covariate groups for Second, one could think of alternatives to measure
the vector of contextual characteristics, X. In Online the strength of the relationship, for example, by look-
Appendix C.3, we test the robustness of the results ing at the number of units that are sourced, or at the
from Section 7 (the impact of supply chain structure) relative importance of an input. In this sense, the use of
by using alternative measures of maturity and concen- product-level data may help us to create more precise
tration. In Online Appendix C.4, we perform a series of research designs. Third, we only explore the impact of
checks to determine the impact of the data truncation; upstream spillovers (i.e., from customers to suppliers).
finally, in Online Appendix C.5, we estimate the effect By exploiting more detailed data sets, future research
of dynamic spillovers by using a lagged model. could measure the impact of downstream spillovers.
Despite minor changes in the estimates, the main Fourth, given the nature of our data, we were unable
results of our model are robust to these alternative to make definitive statements about the mechanisms
specifications; see the online appendix for more details. that drive the endogenous effect; it would be interest-
ing to see whether the endogenous channel is driven
8.2. Concluding Remarks by active actions from the customers (e.g., mentoring
By decomposing the channels of productivity spill- programs, supply chain infrastructure) or by passive
overs, we show how a firm’s productivity is affected actions (e.g., adaptive learning from the suppliers).
10
Future research could also explore how spillover effects Maksimovic and Phillips (2002) is a well-known example within
diffuse across the echelons of the supply chain, a this literature; in their paper, the authors examine productivity dif-
task that Wang et al. (2016) are currently undertaking. ferentials across conglomerates and specialized firms.
11
Another interesting extension is to study the dynamic For a table of summary statistics across the maturity levels, see
Online Appendix D.
nature of spillover effects, which we briefly explain in 12
For example, if a supplier and a customer are interacting for the
Online Appendix C.5.
second consecutive year, Wlow would capture this weight. Observe
Thanks to the recent infusion of data about verti- that W m Wm .
P
cal relationships, it is now possible to conduct an in-
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30] On: 06 March 2017, At: 03:52

The Impact of Supply Chains on Firm-Level Productivity

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The Impact of Supply Chains on Firm-Level Productivity

University of British Columbia, Vancouver, British Columbia V6T 1Z2, Canada

History: Accepted by Serguei Netessine, operations management.

Keywords: supply chain management • econometrics • network analysis • spillover effects

1. Introduction Dell. In short, it teaches them how to think like Dell”

Figure 1. (Color online) Determinants of Productivity

cial obligations if they have the ability to monetize their

Capital (β k, r ) 0.476 0.387

Figure 2. (Color online) Illustration of Notation

own TFP (through γk ) and, in turn, how this change

indirectly affects i’s productivity through the endoge- size

4.3. Data Description Firm j

5. Identification selected sample; we thus need to consider the possi-

Figure 4. (Color online) Illustration of Linear Independence Condition

I = 3W 2 − 2W I, W, W 2, W 3, ... are linearly independent

similar to the one in the previous section. + α h c h, i j

Figure 5. (Color online) Illustration of Model Dynamics

Formation of network C Spillover effects (conditional on network C)

exp(Ui j (α)) v i ∼ Norm(0, σu2 − σuξ 2

Table 5. Model Estimates for the Linear-in-Means Equation

(1) (2) (3)

Effect Variable Coefficient t-stat. Coefficient t-stat. Coefficient t-stat.

spillover Financial liquidity 0.124∗∗∗ 3.38 0.117∗∗∗ 3.36 0.115∗∗∗ 4.48

6.2. Contextual Channels financial agility is positive and statistically significant,

Productivity −0.047 −1.51 Inventory turnover 0.028 −0.009 0.019

(Supplier) percentage average TFP

Years 1–2 Years 3–4 Years 5–6 Years ≥ 7

Note. Firm effects are omitted from the table.

Industries with average highest Industries with lowest

Effect Variable Coefficient t-stat. Coefficient t-stat.

Endogenous effect (ω) Customer’s TFP 0.393∗∗∗ 3.30 0.763∗∗ 2.25

Financial leverage −0.006 −0.47 0.082 0.96

Capital intensive Labor intensive Small Large

Labor intensive 0.544∗∗ 0.662∗∗ Large −0.013 0.417∗∗

attempted to mitigate these challenges by adapting

depth exploration of spillover effects across interfirm References

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