Firm and Firm-product Competences

Regularity 7 Multi-product firms operate and compete on the basis of their overall and/or product-specific productivity or quality and especially the latter plays an important role for

22Lumpy investments are defined as investment spikes for which the investment rates exceed 20% of the capital stock.

23High(low)-variance industries are defined as industries with a coefficient of variation above (below) the global median.

this firm type. A product market characteristic, namely the market’s degree of product dif-ferentiation, decides about the relative contribution of the two dimensions: Product quality is more relevant in more differentiated markets.

The heterogeneity of firms and products within firms rests on either their productivity respectively cost of production or their quality of output and firms thus compete with their products on the basis of their superiority in either of the two dimensions, providing the sets of possible fundamentals for their activity and performance differentials.²⁴

Manova and Yu (2017) examine the role of product quality in the operations of Chi-nese multi-product firms during the period 2002-2006 and find that the differentiation of product quality across firms and across products within firms represent a key feature for understanding the differentials in the firms’ export performance and the effects of trade reforms.

Firms that export products at higher average prices and firms that vary prices more across their product range export more and exhibit a faster export growth. Similar patterns also hold when output quality²⁵ instead of the price of the output as its quality indicator is employed. Furthermore, superior firms, i.e. firms with a higher productivity, employment and intensity of skill, capital, advertising as well as research and development, sell their products at higher average prices and quality as well as reveal a greater price and quality dispersion across their products. Analyzing the variation within a product across firms, the study finds that the export price and the export revenue are positively correlated. A one-standard-deviation increase in the export revenues is accompanied by 20% higher export prices. The output quality used likewise positively correlates with the export revenue, overall providing an indication for a differentiation of quality across firms.²⁶ In addition, differentials are also in place across the products within firms: The export prices and revenues are systematically positively correlated across a firm’s product range: Products that are the firms’ top sellers tend to be their most expensive ones. In 45% and 19% of the time, the firm’s best-performing product in terms of the export revenues is also its most or second-most expensive product. Conversely, the firms’ most expensive products tend to be their top-selling ones. In 45% and 18% of the time, the firm’s most expensive product is its best- or second-best-performing one in terms of the export revenues. Due to the obtained finding that, across all the products in a firm’s portfolio, the price rank of a given product most likely coincides with its sales rank, indicating a differentiation of

24Eckel et al. (2015) develop a model of multi-product firms, in which the firms’ competence is based either on cost or quality, being identifiable by a negative or respectively positive correlation of the firms’

price and sales profiles across their products. They empirically test the model’s key prediction that firms in sectors with differentiated products exhibit a quality-based competence and find its confirmation in a Mexican data set. In addition, the empirical analysis yields the compatible as well as reinforcing result that the export sales of firms in non-differentiated-product sectors exhibit the opposite pattern.

25Output quality is inferred from data on export prices and quantities or proxied with the price or the inferred quality of imported inputs.

26As in Eckel et al. (2015), the theory on which Manova and Yu (2017)’s study is based states that a negative correlation between prices and revenues indicates an efficiency sorting, while a positive correlation a quality sorting.

quality across the products within firms, one can infer that the firms’ core products are the expensive and high-quality ones that generate the highest revenues, while the cheap and low-quality products that are sold at low volumes represent the firms’ peripheral ones.

Analyzing the variation across products within a firm, the study reveals that firms allocate their activities across products in accordance with their differentiation of quality and therefore both the quality differentiation and the resulting product hierarchies gov-ern the operations of multi-product firms. The export price and the export revenue are once again positive correlated. On the one hand, more expensive goods generate system-atically higher global sales. An increase by a one-standard-deviation in export revenues is associated with 10.6% higher export prices. As to bilateral sales on the other hand, exporters earn higher revenues from their more expensive products also within each des-tination. A one-standard-deviation increase in bilateral exports is related to 9.5% higher bilateral units values.²⁷ As before, in addition to the export price as the product’s quality indicator, the study more directly employs output quality. And for the two specifications, qualitatively similar results are obtained, even so quantitative differences exist: The global export revenue positively correlates with the output quality across the products within a firm and also a strong positive correlation between the bilateral export revenue and the output quality across the products within a firm-destination exists. By contrast, the point estimates in the latter specification are substantially higher. A one-standard-deviation increase in the bilateral export revenues is associated with a 280% higher product qual-ity. The firms’ core products reveal both high quality and high production efficiency as manifested in low quality-adjusted prices, thereby overall indicating a quality differentia-tion across a firm’s products. The positive correladifferentia-tions between prices and revenues, both within a product across firms and across products within a firm, are invariant to a firm’s market power across its products, possibly influencing its pricing strategy, and the asso-ciations are stronger for products with arguably greater scope for quality differentiation, such as differentiated goods and sectors intensive in research and development (R&D) as well as combined R&D and advertising.

Multi-product firms differentiate the output quality across their products by making use of inputs of varying quality levels. Input prices positively correlate with the output price across the products within a firm, with an elasticity ranging between 0.11 and 0.13, depending on the matching procedures between inputs and outputs. With input quality²⁸ instead of the price as its quality indicator, a strong positive correlation between input and output quality across the products within a firm is found. The relationship between the input prices and the output price is thereby invariant to the firms’ market power both in the output market and in the input market as well as invariant to processing imports and matching procedures. Moreover, the firms’ export prices rise substantially more quickly

27Investigating the correlation based not only on thelevels of the export price and revenue but on the within-firm ranks, a strong positive correlation between the products’ global and bilateral rank by price and by revenue across the products within exporters can be found and reinforces the study’s findings.

28Input quality is inferred from data on import quantities and prices.

with their input prices when the output product is differentiated.

For the variation across destinations within a firm, Manova and Yu (2017) detect that the export product scope and the export revenues are positively correlated. Exporters thus generate systematically higher revenues in destinations where they sell more products. The typical firm earns 85% higher bilateral revenues when it exports 50% more products to a given country. Thereby, the distribution of the sales across its products is not indepen-dent from its export scope. Instead of, firms concentrate more on their core competence products in markets being smaller for them, in the way that they skew their exports more towards their top-selling, most expensive and highest-quality products in markets with a smaller export scope. Reducing the product range by 50% comes along with a 21% (8.5%, 15.5%) rise in the revenues from the best-selling (most expensive, highest-quality) prod-uct relative to the second-best (second-most, second-highest). Qualitatively similar results are obtained when separately considering firms’ homogeneous and differentiated products.

Quantitatively however, the concentration of sales towards the expensive and towards the high-quality products falls faster with the export product scope for differentiated products than for homogeneous products, while the opposite is true for the concentration of sales towards the best-selling product.²⁹ Therefore, firms reallocate their activities towards their core, high-quality products in destinations with a smaller export scope both along their ex-tensive margin, by dropping lower-quality peripheral products, and their inex-tensive margin, by concentrating sales towards their high-quality products.³⁰

In addition, the export product scope is also related to the average price at which firms sell their products: Both are negatively correlated. The relationship is not driven by cross-country differences in a firm’s market power and existent in the sample of differ-entiated products with some potential for quality upgrading, while being absent among homogeneous products. The typical firm lowers its average bilateral price by 1% when it exports 50% more products to a given destination. For differentiated products, the corre-lation is 20% higher.³¹ As firms adjust their export scope, they operate at the lower end of their product hierarchies: Exporters expand (restrict) their product range across mar-kets by consistently exporting their core, expensive products of high quality and adding (dropping) their peripheral, cheaper products of lower quality. So, a negative correlation between the export product scope and the average output quality across a firm’s products exists. Even though, the weighted average quality is significantly positively correlated with the export product scope across destinations within a firm-year.

Aw and Lee (2017) investigate the relative importance of the two dimensions of firm heterogeneity, productivity and quality, for the export performance of Taiwanese multi-product firms in the period 2000-2004. Firms with high demand and multi-productivity measures

29Similar results are received in case of an alternative sales concentration measure: The Herfindahl index.

30According to the theory, the findings are inconsistent with constant markups, but variable markups importantly affect the sales decisions of multi-product firms.

31However, the relationship between export product scope and the revenue-weighted average price is markedly less negative and not statistically different from zero.

have a higher likelihood to export and to export a large number of products. As the firms decide about their export participation and export product scope, quality plays a larger role for export decisions of firms in more differentiated product markets and for export decisions of products with lower cost elasticities of quality improvements, while productivity has a larger influence on export decisions of firms in markets with lower degrees of product differentiation and on export decisions of products with higher cost elasticities of quality improvements. Regarding product-level characteristics, the lowest-selling products of large-scope exporters reveal firm-product demand and productivity measures that are progressively lower than that of the lowest-selling products of small-scope exporters, indicating that large-small-scope exporters face lower thresholds in productivity and demand for their products to be existent in the export market.