The value of international outsourcing:a study on Veneto clothing industry

Carlo Gianelle, University of Siena, Doctoral School

Giuseppe Tattara, University of Venice, Dept. of Economics

October 2007

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Globalization: real and financial integration

Outsourcing abroad of production has become a focal policy followedby firms in order to face competition on international markets

To ‘measure’ the degree of internationalization of a firm is not easy:

• Direct overseas investments• Forms of ‘light’ integration: i.e. trade agreements and

subcontracting, particularly important in the case of Italian SMEs: involve reduced capital flows and temporary commodity flows

In the 90s SMEs in traditional sectors create a dense network of linksand subcontracting relations with overseas companies:

• Gradual elimination of trade barriers• New countries: East Europe, China and India• New technology and phase economies (fragmentation of cycles)• Low transport costs

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Italy: apparel and footwear

Italy:In the 80s many production phases have been delegated to Italianoutworkers (cutting, dyeing, sewing, stitching and pressing – apparel,stitching – footwear)

Phases at the beginning or end of the production chain require human capital (creation, modelling etc.) and sophisticated machinery (cutting,washing, dyeing and printing → apparel, moulded soles → footwear)

Veneto:The number of employees working in SMEs textile-clothing-footwearin Veneto sharply increased in the 70s and declined subsequently inthe 90s because a vast majority of subcontractors are foreign(foreign outsourcing → Benetton is an earlier example: from 80%domestic to 20% domestic in 5 years)

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Veneto: apparel and footwear

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Artisan firms Big firms not-artisan TOT

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Empirical strategy

We consider outsourcing abroad as a new policy adopted by the finalfirms and try to evaluate its effect at the firm level

Does the decision of outsourcing abroad lead to:

• Expansion of the activity in terms of Turnover?

Necessary to defend or increase the market share

• Realization of more profits in terms of Gross earnings (Ebitda)?

‘Lean and mean’: anecdotal evidence → final firms (brands) slice the production process iff they are able to embeda larger share of profits

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The effects of outsourcing Did delocalization increase Turnover and Gross profits? Is the effect higher, the higher the quota of products realized abroad? Was this a lasting improvement or a once for all bonus?

Fixed-effect impact equation using panel data referring to final producers

• logY is alternately the Turnover and the Gross earning (EBITDA)both expressed in logarithms

• Impact of outsourcing is estimated by means of the dummy Dc that splits the time series in 2 periods: before and after the relocation event

• Linear trend T also included. Dummy Dc interacts with T, resulting in the variable TDc that captures the growth effect of relocation

• Controls: sector orders at the international level Ord; year dummies γt

ititititititit uOrdTDcDcTlogY 43210

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The dataset

Self-selected group of 70 limited and joint stock companies based in Veneto (1/4 of the total employment of companies with more than 50 employees), final producers in the clothing and footwear sector, which have delocalized some important production phases

Mostly medium-size firms, with average workforce of 110, average turnover of 36 millions of Euros

Budget data from the Veneto Provincial Chamber of Commerce collection; employment data from the VWH database; data on outsourcing from a questionnaire delivered to each firm and supplemented by several telephone interviews

Time: 1982 – 2003, unbalanced panel; 16 obs. per firm on average

Countries of delocalization: Romania, China, Tunisia, Hungary, Bulgaria, Croatia, Turkey, Slovakia, India, Indonesia, etc.

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Average and growth effect of relocation

Average effect: drift of the continuous line Growth effect: difference in the dotted line slope

td=0 time

EBITDA, Turnover

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Effects of relocation: visual representation

Resid. of regress. of logTurn (left) and logEBITDA (right) over controls

In the case of EBITDA there’s a DIP: some firms delocalize after adrop in gross (net) profits → reasonable result but caution is requiredin interpreting the coefficient estimates: firms self-select into treatment

Problem: the average effect of relocation tend to be overestimated ifreported to the entire population

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The estimates (1)logTurn logEBITDA

1 2 3 4

Average impact 0.1629***(0.0447)

0.1765**(0.0775)

Growth impact -0.0272***(0.0102)

0.0007(0.0164)

Average imp. quota 0.3499***(0.0799)

0.2111(0.1289)

Growth imp. quota -0.0351**(0.0143)

0.0044(0.0261)

Sector orders 0.0190***(0.0024)

0.0193***(0.0024)

0.0194***(0.0038)

0.0191***(0.0039)

Time trend Yes Yes Yes Yes

Year dummies Yes Yes Yes Yes

Firm’s effects Yes Yes Yes Yes

n. of observations 1136 1136 1094 1094

R-sq within 0.5036 0.5052 0.2644 0.2632

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Effects of delocalization and fragmentationThe decision to delocalize can imply:

1) moving abroad phases which were once carried out within the firm2) moving abroad those phases which were delocalized domestically

Case (1): slicing production and allocating abroad superimpose oneanother and the estimate blurs the effect attributed to outsourcing withthe effect of fragmentation. To evaluate the net impact of the offshorealternative we split the sample in treated and untreated firms:

• treated firms delocalize abroad and at the same time fragment production

• non treated firms delocalize phases previously outsourced in the domestic market

For treated firms the parameter estimate reflects both delocalizationabroad and fragmentation

The estimates (2) logTurn logEBITDA

1 2 3 4

Average impact + fragm. -0.0515(0.0639)

-0.1792(0.1319)

Growth impact + fragm. -0.0214*(0.0109)

0.0417**(0.0179)

Average impact - fragm. 0.2227***(0.0514)

0.2934***(0.0872)

Growth impact - fragm. 0.0250**(0.0114)

-0.0188(0.0193)

Average imp. quota + fragm.

0.0419(0.1038)

-0.4242**(0.2106)

Growth imp. quota + fragm. -0.0232(0.0164)

0.0753***(0.0292)

Average imp. quota - fragm. 0.4521***(0.0994)

0.4750***(0.1515)

Growth imp. quota - fragm. -0.0274*(0.0162)

-0.0291(0.0320)

R-sq within 0.5097 0.5096 0.2644 0.2632

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Conclusions

• This work considers both subcontracting and direct investments

• EBITDA and Turnover positively feel the ‘one-for-all’ impact of relocation abroad

• For firms that have already fragmented production when going abroad, profits increase more than proportionally to the increase in the level of activity

Delocalization has an immediate strong negative impact on blue-collaremployment and on the connected skills, particularly in a region wherethe number of people employed in manufacturing is high, as in Veneto

In an area where the destiny of the firm has often been considered insymbiosis with that of the workers, profit realization is now farther andfarther away from places where firms that lead the productive chainsare located: a profit increase by the final producers only partiallyreflects positive variations in local employment and revenues.