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Globalization of Production and Innovation: How Outsourcing is Reshaping an Advanced

Manufacturing Area

LUCIA CUSMANO�†, MARIA LUISA MANCUSI�‡ and ANDREA MORRISON‡§ �Centro di Ricerca sui Processi di Innovazione e Internationalizzazione (CESPRI) – Bocconi University, Via Sarfatti, 25,

I-20136 Milan, Italy †Department of Economics, Insubria University, Via Monte Generoso, 71, I-21100 Varese, Italy.

Email: [email protected] ‡Department of Economics – Bocconi University, Via Sarfatti, 25, I-20136 Milan, Italy.

Email: [email protected] §Urban and Regional Research Centre Utrecht (URU), Faculty of Geosciences, Utrecht University, Heidelberglaan 2,

NL-3508 TC Utrecht, the Netherlands. Email: [email protected]

(Received July 2007: in revised form April 2008)

CUSMANO L., MANCUSI M. L. and MORRISON A. Globalization of production and innovation: how outsourcing is reshaping an

advanced manufacturing area, Regional Studies. This paper investigates the determinants and the spatial and functional dimensions

of firms’ outsourcing. Based on a large survey of manufacturing firms in Lombardy, Italy, the analysis shows that outsourcing is

remarkably wide across sectors and has a clear regional dimension, concerning highly skilled firms at most. Offshoring is still a

minor fraction of the deverticalization process, largely related to wider strategies of internationalization by foreign group subsi-

diaries at intermediate stages of the value chain. The evidence suggests the regional system is inserting onto global knowledge

networks, but also points at the risk of ‘branch plant effects’ in high-technology segments.

Outsourcing Offshoring Regional production system Manufacturing industry Italy

CUSMANO L., MANCUSI M. L. et MORRISON A. La mondialisation de la production et de l’innovation: comment l’approvision-

nement à l’extérieur réorganise une zone industrielle avancée, Regional Studies. Cet article cherche à examiner les déterminants et

la portée géographique et fonctionnelle de l’approvisionnement à l’extérieur des entreprises. A partir d’une enquête détaillée des

entreprises industrielles situées en Lombardie en Italie, l’analyse laisse voir que l’approvisionnement à l’extérieur s’avère très gén-

éralisée à travers les secteurs et a une portée nettement régionale en ce qui concerne notamment les entreprises dont la main-

d’oeuvre est hautement qualifiée. Les activités offshore représentent toujours une proportion négligeable du processus de désinte-

gration verticale et se rapporte étroitement aux stratégies d’internationalisation des filiales des groupes étrangers aux étapes inter-

médiaires de la chaı̂ne des valeurs. Les preuves laissent supposer que le système regional s’insère dans des réseaux de connaissance

mondiaux, mais indique également la menace que pose des ‘effets établissement’ dans les secteurs à la pointe de la technologie.

Approvisionnement à l’extérieur Activités offshore Système de production régional Industrie Italie

CUSMANO L., MANCUSI M. L. und MORRISON A. Die Globalisierung von Produktion und Innovation: Wie sich eine fort ges-

chrittene Produktionsregion durch Outsourcing verändert, Regional Studies. In diesem Beitrag untersuchen wir die Determinan-

ten sowie die räumlichen und funktionellen Dimensionen des Outsourcing von Firmen. Ausgehend von einer umfangreichen

Erhebung unter produzierenden Firmen in der Lombardei, Italien, geht aus der Analyse hervor, dass das Outsourcing in den

verschiedenen Sektoren bemerkenswert weit verbreitet ist und eine eindeutig regionale Dimension aufweist, die vor allem

Firmen mit hohem Qualifikationsniveau betrifft. Die Verlagerung ins Ausland stellt weiterhin einen kleinen Bruchteil des Dever-

tikalisierungsprozesses dar und ist größtenteils mit den breiter angelegen Internationalisierungsstrategien von Filialen ausländischer

Regional Studies, Vol. 44.3, pp. 235–252, April 2010

0034-3404 print/1360-0591 online/10/030235-18 # 2010 Regional Studies Association DOI: 10.1080/00343400802360451 http://www.regional-studies-assoc.ac.uk

Konzerne auf den mittleren Stufen der Wertschöpfungskette verknüpft. Die Belege lassen darauf schließen, dass sich das regionale

System in die globalen Wissensnetzwerke einfügt, weisen aber auch auf das Risiko von ‘Zweigwerkseffekten’ in Hightech-

Segmenten hin.

Outsourcing Verlagerung ins Ausland Regionales Produktionssystem Produzierende Industrie Italien

CUSMANO L., MANCUSI M. L. y MORRISON A. Globalización de producción e innovación: cómo la contratación externa remo-

dela un área manufacturera avanzada, Regional Studies. En este artı́culo investigamos los determinantes y las dimensiones espacial y

funcional de la contratación externa de empresas. Basándonos en un importante estudio de empresas manufactureras de Lombar-

dı́a, Italia, en este análisis mostramos que la contratación externa está muy extendida en todos los sectores y tiene una clara dimen-

sión regional, sobre todo con respecto a las empresas altamente cualificadas. La externalización de servicios representa todavı́a una

fracción menor del proceso de desverticalización, y en gran medida relacionada con estrategias más extensas de la internacionaliza-

ción por parte de filiales de grupos extranjeros en fases intermedias de la cadena de valores. La evidencia indica que el sistema

regional se inserta en las redes de conocimiento globales pero también señala el riesgo de ‘efectos de las sucursales’ en segmentos

de alta tecnologı́a.

Contratación externa Externalización de servicios Sistema de producción regional Industria manufacturera Italia

JEL classifications: D21, F23, L23, O32

INTRODUCTION

Over the last few decades, industrial restructuring in the form of outsourcing has been emerging as a defining character of the capitalist dynamics, transforming business models and affecting the spatial structure of industrial systems. In particular, the international dimension of outsourcing (offshoring) has been lately drawing much attention at both the analytical and the policy levels, as a key driver of changes in the competi- tive position of advanced and emerging regions (UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT (UNCTAD), 2004; ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOP- MENT (OECD), 1998; AMITI and WEI, 2005).

The outsourcing phenomenon in advanced regions dates back to the mid-1970s and accelerated during the 1990s (GEREFFI and STURGEON, 2004), signalling the ‘deverticalization’ of the modern corporation (CHANDLER, 1977). Moreover, the structure of out- sourcing has been widening in functional terms, as out- sourcing strategies no longer concern only, or mostly, fairly specialized repetitive tasks in production and assembly. Rather, outsourcing increasingly involves ser- vices of various type and content, including sensitive functions and knowledge-intensive tasks, such as design and research and development (R&D) (HOWELLS, 2000; LEIBLEIN et al., 2002). As a conse- quence, the increasing ‘distributedness’ of production processes is followed (and affected) by a growing ‘distributedness’ of knowledge-intensive functions and innovation processes, so that value-creating resources and capabilities ever more frequently reside across the boundaries of the firm (COOMBS and METCALFE, 1998).

The functional breadth of the outsourcing phenom- enon is but one dimension of the complex emerging

trend, to which the spatial dimension should be added. On the one hand, the internationalization of value chains, or global ‘fragmentation’, has been attract- ing much media hype, but also increasing theoretical interest, because of its consequences on the positioning of countries in the international division of labour (for example, FEENSTRA and HANSON, 1996; ARNDT and KIERZKOWSKI, 2001; GROSSMAN and HELPMAN, 2002). On the other hand, agglomeration advantages and cluster-centred flexible specialization in core-regions are being reinterpreted (for example, SCOTT, 1988; GAROFOLI, 2002; BOSCHMA, 2004), as their relevance and geographical scale are affected themselves by post-Fordist dynamics (PHELPS, 2004; TORRE and RALLET, 2005).

Although lively, the theoretical and policy debate has

found still limited empirical application for two main

reasons. First, empirical investigations have been

mainly directed at specific sectors or local production

systems (for example, CORÒ and GRANDINETTI,

1999; AMIGHINI and RABELLOTTI, 2006), specific

functions, as in the case of the growing literature on

business service externalization (for example,

O’FARRELL et al., 1993; BEYERS and LINDAHL, 1996;

COE, 2000) or specific actors, such as multinational

branch plants or service-related headquarters (for

example, PHELPS, 1993; PERKMANN, 2006). Second,

quantitative studies based on large panel data sets have

been mostly based on very broad definitions of outsour-

cing, rarely differentiating the externalization of activi-

ties from more general purchasing strategies in a ‘make

or buy’ framework, and have often employed data at a

high (mostly industry) level of aggregation.1

The present paper contributes to fill this gap by

investigating the diversified patterns of externalization

across manufacturing industries and business actors

236 Lucia Cusmano et al.

in an advanced area, Lombardy (the Italian leading

economic region), which represents a mature and

highly heterogeneous industrial system, where large cor-

porations specialized in high-technology sectors coexist

with traditional industrial districts populated by small

firms. Drawing on original and representative firm-level

survey data, the paper explores the extent of the externa-

lization practices, detailing direction, breadth and depth

of outsourcing strategies, thus providing an original

empirical contribution to the outsourcing debate. In

particular, the international outsourcing of production,

services and R&D activities is confronted with region-

ally contained dynamics, and the characteristics of

business actors driving the process at different spatial

levels are explored. In doing so, the paper adds to the

sparse empirical literature on the determinants of out-

sourcing and offshoring at the firm level (GIRMA and

GÖRG, 2004; GÖRG et al., 2004; GROSSMAN and HELPMAN, 2002; SWENSON, 2004; TOMIURA, 2005), and provides original insights for discussing both the implications at the system level and the related arguments proposed by the relevant literature.

The paper is organized as follows. The second section summarizes the main issues emerging from the literature and policy debate about outsourcing and off- shoring, focusing on the motives for outsourcing and their relationship with its direction (local versus international outsourcing), depth (total versus partial outsourcing), and breadth (scope of functional outsour- cing). The third section presents the survey method- ology and the data set. The fourth section provides an extensive description of outsourcing patterns in Lom- bardy across industries and activities. The fifth section focuses on the characteristics of firms driving the process of deverticalization, presenting an econometric assessment which differentiates between regional and international outsourcing. The sixth section concludes, discussing implications of the observed trend for the regional system evolution and competitiveness.

OUTSOURCING: ECONOMIC DRIVERS,

SPATIAL DIMENSION AND FIRM

CHARACTERISTICS

Different strands of the literature, ranging from manage- ment approaches to transaction cost economics and more regional oriented studies, have investigated the factors underpinning firms’ decisions to outsource their internal activities, the spatial dimension of the externalization process, and the associated firms’ charac- teristics. However, while the motives for outsourcing and its geographical scope are often (and naturally) studied together in the literature, the interpretation of fragmentation trends and spatial restructuring in terms of firm-level characteristics is more recent and mostly discussed in empirical contributions.

Cost factors have featured prominently in the debate about vertical disintegration and its spatial dimension. The transaction cost analytical framework represents in this sense the main theoretical reference, suggesting that firms externalize activities when and where external provision is less expensive than internal procurement (WILLIAMSON, 1985). SCOTT (1988) argues that in capi- talist societies the organization of production, including its spatial distribution, is constantly scrutinized by firms with the purpose of reducing costs. This often implies seeking for factor price differences across locations, countries or regions, particularly, though not exclusively, when labour-intensive production and assembling are concerned. Accordingly, the spatial distribution of outsourcing reflects factor cost differentials, involving peripheral areas of advanced countries or developing regions, which attract routinized unskilled production, while core-regions dominate in unstandardized skilled labour or contact-intensive activities, characterized by high unit linkage costs (LEUNG, 1993). The recent integration of international markets and the increasing competitive pressure they have brought about help to explain the late upsurge in international subcontracting towards low-cost areas (FEENSTRA, 1998). Evidence of total outsourcing at the international level comes especially from traditional manufacturing sectors heavily hit by competition from emerging economies. Cost-cutting strategies have been favouring the emer- gence of ‘lean and mean’ global players, transforming producers into international buyers which coordinate global production networks of subcontractors in many different countries (GEREFFI, 1999).

The transaction cost perspective also emphasizes the additional cost burden associated with international outsourcing, as spatial dispersion can result in longer lead times, larger inventories, communication and coordination problems, difficulties in contractual speci- fication and monitoring, which tend to rule out distant subcontracting of non-standardized functions (GILLEY and RASHEED, 2000). The transaction cost approach therefore suggests that outsourcing to local suppliers is to be preferred when market relationships are less expensive at closer distance. In the case of advanced high-cost areas, proximity is an advantage in terms of contractual specification and monitoring, which are all the more relevant when non-standardized tasks or specific assets are concerned. As a consequence, advanced services tend to locate much closer to their primary source of demand since they entail significant customization, frequent contacts between users and providers, or even simultaneous production and consumption (HOWELLS, 2000).

However, as standardization and asset specificity evolve, international outsourcing concerns a wider range of functions and products, including apparently strategic activities, such as design and R&D. In this respect, FREEMAN and SOETE (1997) underline that not all R&D has high degrees of uncertainty and

Globalization of Production and Innovation 237

complexity attached to it. Indeed, several knowledge- intensive activities have been undergoing a process of ‘commoditization’, generally reflected in declining terms of trade and harsher price competition, even in segments of high-technology industries (MINIAN, 2006). As such, firms find it preferable to outsource these activities to suppliers who can offer standardized products or services at a lower cost. In addition, improved communication technologies make codifica- tion easier and increase the ability of firms to monitor and compare the quality of external suppliers, thus creating alternatives to direct or close control and mini- mizing the need for close user–producer interactions (TETHER et al., 2001; NARULA, 2001). ‘Organized proximity’ (TORRE and RALLET, 2005), that is, common behavioural rules and routines and the means for sharing information and knowledge, offers powerful mechanisms for long-distance coordination, thus widening the scope for outsourcing relational intensive activities at the international level.

Cost advantages related to standardized input pro- vision can also be found in relatively high-cost areas if providers serve a large market and enjoy economies of scale and specialization, as in the case of territorial agglomeration of clients. This might explain why off- shoring is still, in absolute terms, a limited phenomenon (AMITI and WEI, 2005) and also why, in core regions, outsourcing has been contributing to the expansion of service complexes or thickening of local business service markets (WOOD et al., 1993; ONO, 2007).

SCOTT (1988) relates the cost advantages of subcontracting at the local level to self-reinforcing marshallian externalities, as those which characterize urban agglomerations (ILLERIS, 2005) or manufacturing clusters. Marshallian externalities are a multidimen- sional concept, comprising both pecuniary externalities and knowledge externalities. These are characterized by different tendencies.

On the one hand, pecuniary externalities are con- sidered to be increasingly less important in driving the agglomeration of suppliers and, as a consequence, in explaining localized vertical disintegration (PHELPS, 2004; PHELPS and OZAWA, 2003). In fact, improve- ments in transport and communication technology and infrastructure have reduced the need for geographi- cal proximity. Location in one area does not preclude access to externalities generated in another area if the two are strongly connected. In this sense, pecuniary externalities are increasingly related to ‘accessibility’ rather than simply to ‘proximity’. Indeed, the wider availability of pecuniary externalities tends to act as a centrifugal force, deconstructing traditional industrial agglomerations and changing the scale at which agglomeration advantages are perceived (MARTIN, 1999; PHELPS, 2004).

On the other hand, knowledge externalities and benefits from labour market pooling continue to act as a significant centripetal force, favouring agglomeration

of specialized suppliers and flexible specialization models in core regions (GAROFOLI, 2002). In this context, the externalization of production and service activities is mainly driven by motivations other than costs, such as production smoothing, core-competence focus, or expertise- and knowledge-searching strategies.

Production smoothing and the search for flexibility are, according to BEYERS and LINDAHL (1996), ‘quasi- cost’ factors in the sense that they are indirectly related to cost-reduction strategies. In environments character- ized by unstable market conditions, subcontracting emerges as a mechanism for rapidly adjusting to changes in the market, without harmful effects on the level of efficiency (AJAYI, 2005). It stands as a defining character of flexible regimes of capital accumulation, in which internal economies of scale are largely replaced by external economies (SCOTT, 1988; STORPER and SCOTT, 1989). Production smoothing often takes place at the local level, as rapidity and monitoring of quality control are greatly important, unless bulky and highly standardized activities are involved. However, it is a strategy which typically involves ‘capacity’ or concur- rent subcontracting (IMRIE, 1986, p. 956), rather than downsizing through externalization.

Externalization is more likely to occur in rapidly evolving markets, which require innovative responsive- ness, fed by specialized providers and the integration of different mixes of information and expertise (COFFEY and BAILLY, 1992). As products become more sophisti- cated and production relies on an increasing range of specialized technological understanding, firms can hardly develop internally all the capabilities and compe- tences required to bring a product to the market. Especially in environments characterized by strong competition and short product life cycle, firms devote internal resources to strengthen their core business, while outsourcing non-core activities. This occurs, for instance, in the case of ancillary services, which are usually labour intensive (ABRAHAM and TAYLOR, 1996), but also for those complex activities in which firms would be unable to keep the pace with changes and challenges posed by specialized suppliers. In this case, subcontracting to external specialized providers responds to the related needs of strengthening core competences, diverting resources and attention from non-core activities, and accessing highly specialized expertise, which complement in-house capabilities.

The expanding need for specialized knowledge also explains the widening functional scope of outsourcing decisions, which increasingly involve non-manufactur- ing functions (WOOD, 1991). Indeed, outsourcing of service activities to specialized suppliers has been a hall- mark of recent industrial restructuring in advanced regions, concerning an ever-larger range of service func- tions.2 Business service functions are becoming increas- ingly sophisticated and manufacturing firms generally lack resources and strategic incentives to invest in their development (COE, 2000). Total outsourcing of services

238 Lucia Cusmano et al.

is commonplace for small and medium-sized enter- prises, which, by definition, have a limited amount of resources to invest and little scope for economies of scale in the intra-organizational provision. However, in advanced areas, where manufacturing competitiveness increasingly depends on knowledge contents, even large corporations might be unable to produce innova- tive services and normally refer to external knowl- edge-intensive providers for expertise and consultancy (WOOD et al., 1993), although the resulting relationship rarely takes the form of ‘pure’ service externalization (BEYERS and LINDAHL, 1996). More often, and especially when knowledge-intensive or strategic activi- ties are involved, complementary relationships between in-house departments and specialized suppliers are observed (MAHNKE, 2001). In such cases, outsourcing responds to the need for reaping specialization gains while exposing to a variety of learning experiences. The risk associated with this strategy is that, if it implies dismissal of strategic capabilities, it might also undermine firms’ absorptive capacity (MAHNKE, 2001). This is one of the firm-level characteristics that have attracted the attention of recent contributions interpreting the trends of fragmentation and spatial restructuring in terms of features of business players which are driving the outsourcing dynamics.

Firm-specific factors such as size (ABRAHAM and TAYLOR, 1996; MARTINEZ ARGÜELLES and RUBIERA MOROLLÓN, 2004; KIMURA, 2002; GIRMA and GÖRG, 2004; TAYMAZ and KILIÇASLAN, 2005; MAZZANTI et al., 2006), productivity (KIMURA, 2002; TOMIURA, 2005; OLSEN, 2006), R&D intensity (BARNEY, 1999; MAHNKE, 2001; MOL, 2005), human capital (TOMIURA, 2005; MAZZANTI et al., 2006), export or foreign direct investment (FDI) strategies (GEREFFI, 1999; GROSSMAN and HELPMAN, 2002; TOMIURA, 2005) are discussed and related to the cost arguments, specialization or knowledge-searching strategies commented above.3 Evidence on the matter is, however, mostly anecdotal or based on case studies. Investigation based on large firm-level data sets is in its early stages, often referring to specific industries or local production systems.

SAMPLE IDENTIFICATION AND SURVEY

METHOD

The empirical analysis draws on a representative and large data set concerning the main manufacturing sectors of Lombardy. The region represents a fully fledged and mature industrial system, recently affected by substantial tertiarization, although still exhibiting important remnants of a manufacturing core. The region accounts for about one-fifth of the Italian gross domestic product and is leading the country in most of the rankings related to innovation and internationa- lization, although such leadership has been gradually

eroding at the national level, and the region has been lately losing ground with respect to other advanced European areas (CUSMANO and MALERBA, 2005). Its openness makes it particularly exposed to international changes and pressures, which affect in different manners its highly heterogeneous sectors of specializ- ation and productive milieux, characterized by a signifi- cant presence of both high-technology multinationals and small firm-based traditional industrial districts.4

The target sample of 1200 firms is drawn from the national firm Census (ISTAT, 2001) and is stratified according to geographical location, manufacturing activity, and firm size.

Geographical stratification groups into four macro- areas neighbouring provinces that exhibit significant within-group similarities in terms of productive specialization:

. Milan.

. North-East: Varese, Como, Lecco, and Sondrio.

. North-West: Brescia and Bergamo.

. South: Pavia, Lodi, Cremona, and Mantua.

Stratification based on manufacturing activity is obtained with reference to eight macro-sectors:

. Energy and Chemistry: mining, extraction of crude petroleum and gas, coal and lignite, chemistry, rubber and plastic, electricity, gas and water supply.

. Food and Tobacco: food products, beverages and tobacco.

. Textile and Clothing: textile, wearing apparel, tanning and leather, footwear.

. Wood and Furniture: wood and product of wood, furniture.

. Paper and Publishing: publishing, printing and repro- duction of recorded media.

. Mechanics and Transport: basic metals, other non- metallic mineral products fabricated metal products, machinery and equipment, motor vehicles, jewellery.

. Electronics and Optics: electrical machinery, radio communication equipment and apparatus, precision and optical instruments, watches and clocks, account- ing and computing machinery.

. Construction: Construction and housing.

Size dimension stratification is based on the number of employees and is built around five cells:

. 6–9.

. 10–49.

. 50–249.

. 250–499.

. Equal to or more than 500.

These size classes are based on the European Union classification, but explicitly exclude micro-firms (i.e. firms with fewer than six employees).

The number of firms in each stratum of the target sample was obtained assuring proportionality to the

Globalization of Production and Innovation 239

total number of employees in the same stratum of the population. However, appropriate balancing criteria have been adopted in order to avoid strata with small or medium-sized firms to have an insufficient number of firms and ensure a satisfactory estimates’ precision.

Data were collected through an original firm-level survey conducted in 2005. Each firm in the target sample was contacted by a survey agency, which inter- viewed via telephone either the chief executive officer, or the managing director, or the chief adminis- trative officer. A second target sample was available to the survey agency to replace non-respondents. This allowed one to obtain a final sample of 1148 regionally based firms, which corresponds to a response rate equal to 96%. The sample industry and size composition is reported in Table 1, which shows that the Mechanics and Transport macro-sector accounts for the relative highest share of firms in the sample (34.8%), followed by Textile and Clothing (14.5%), Energy and Chemistry (14.5%), and Construction (12.5%). Table 1 also reports the response rate by sector, which shows that firms from Wood and Furniture and Construction were used by the survey agency to replace non-respondents in other sectors. As a consequence, appropriate survey esti- mation methods are employed in the empirical analysis to control for the potential bias originating from this non-response/over-response bias.

The sample is mostly composed of small and medium-sized firms (about 50% of the firms belong to the 10–49 employees class). The share of small and medium-sized enterprises is particularly dominant in the Wood and Furniture industry and in Construction, where about two-thirds of the firms have fewer than 50 employees. On the other hand, a non-negligible share of large firms characterizes a few sectors, such as Energy and Chemistry, Paper and Publishing, and Mechanics and Transport (Fig. 1).

OUTSOURCING PATTERNS IN LOMBARDY:

BREADTH, DEPTH, AND

INTERNATIONALIZATION

The survey conveys information on firms’ outsourcing decisions, where outsourcing is intended here as the

procuring of activities originally performed internally. More specifically, the respondent was first asked to indi- cate which functions the firm performs in-house, differ- entiating among the following functional categories:

. Production and assembling.

. R&D and design.

. Services (information technology, personnel adminis- tration, logistics and distribution, packaging, maintenance).

For each function, the respondent was then asked to specify if activities originally performed within firm boundaries had been contracted out. If so, the respon- dent was also asked to indicate whether the contractor is located in Lombardy, in another Italian region, or abroad. These sets of questions allow one to draw a picture of both the geographical dimension of outsour- cing and the depth of the phenomenon across functions.

The outsourcing phenomenon appears to have pervasively affected the manufacturing system in Lombardy. In fact, outsourcing involves nearly half of the firms in the sample, and is uniformly distributed across industries. The two significant exceptions are Paper and Publishing and Electronics and Optics, which represent the upper (60.7% of firms outsourcing) and the lower (42.5%) tails of the distribution, respect- ively (Table 2).

Direction

Outsourcing has a clear regional dimension: on average more than 40% of firms (83% of outsourcers, that is, firms outsourcing at least one function) refer to a regional supplier for some of the functions they have decided to contract out. This pattern prevails in sectors which are at the heart of regional industrial districts, such as Wood and Furniture, Textile and Clothing, and Mechanics and Transport, or which are mostly a locally based business, such as Construction. This evidence is consistent with contributions stating that local knowledge and supply chains, inter-firm and interpersonal networks substantially increase the scope of outsourcing (for example, MORGAN, 1997).

Furthermore, relying exclusively on regional con- tractors is effectively the most common option (Fig. 2). This strategy is indeed followed by a 30.8%

Table 1. Sample composition

Industry 6–9 10–49 50–249 250–499 �500 Total Response rate

Energy and Chemistry 19 63 62 9 10 163 0.91

Food and Tobacco 10 19 19 2 0 50 0.82

Textile and Clothing 26 78 54 4 5 167 0.92

Wood and Furniture 21 40 12 1 0 74 1.35

Paper and Publishing 6 30 15 4 1 56 0.79

Mechanics and Transport 59 193 113 21 14 400 0.89

Electronics and Optics 18 45 27 3 1 94 0.79

Construction 43 79 19 3 0 144 1.76

Total 202 547 321 47 31 1148 0.96

240 Lucia Cusmano et al.

share of firms in the sample (61.8% of all outsourcers). Again, it is the locally based Construction industry which is mostly involved in self-contained local net- works of contracting. Regional outsourcing is also an exclusive strategy for a significant share of firms in Mechanics and Transport. Thus, restructuring through externalization mainly generates localized lin- kages. As mentioned, this can be related to the

presence of large local clusters, which are a distinctive feature of the competitive system of Lombardy in this and other traditional sectors and which are likely to capture the outsourced functions. In this sense, the trend seems to be driven by highly localized advantages from division of labour and complementary specializ- ation, rather than by the search for cost differentials across space.

Table 2. Outsourcing, by industry (percentage of firms)

Industry

Percentage

of outsourcers

Of which (share)

Regional

outsourcersa National

outsourcersb Off-shorersc

Energy and Chemistry 51.53 0.82 0.33 0.18

Food and Tobacco 50.00 0.76 0.52 0.16

Textile and Clothing 47.90 0.83 0.29 0.25

Wood and Furniture 50.00 0.84 0.41 0.03

Paper and Publishing 60.71 0.71 0.53 0.09

Mechanics and Transport 48.25 0.84 0.30 0.16

Electronics and Optics 42.55 0.75 0.30 0.33

Construction 54.17 0.95 0.15 0.04

Total 49.74 0.83 0.31 0.16

Notes: aFirms outsourcing at least one activity within the region. bFirms outsourcing at least one activity in other Italian regions. cFirms outsourcing at least one activity abroad.

Fig. 1. Sample composition, by size class (%) across industries

Globalization of Production and Innovation 241

The share of firms that rely on outsourcing to other Italian regions stands at a significant distance, both in traditional sectors and in high-technology ones (Table 2). Indeed, in Electronics and Optics, international value chains attract outsourced activities to a larger degree than national producers. This high-technology industrial area is, however, quite an exception in the regional fragmentation dynamics. Off-shoring is, in fact, still a limited phenomenon, accounting for a minor part of the overall outsourcing trend. The participation to international fragmentation processes concerns fewer than 8% of the firms in the sample (and 16% of the actual outsourcers) and is unevenly distributed across industries. Two highly differ- ent sectors stand well above the average: Electronics and Optics, and Textile and Clothing. The share of outsour- cers that have been contracting activities abroad is equal to nearly one-third in the first and one-quarter in the latter. It is, therefore, in these two sectors that the exter- nalization process mostly reflects integration into the increasingly international division of labour.

Breadth and depth

It is to be expected that the regional or international dimension of the outsourcing process is related to the

content of the activities concerned, and that those activi- ties are (performed and) outsourced differently across industries, reflecting industry differences in terms of competitive factors, competitive strategies of the firms, and comparative advantages of the territories. Accord- ingly, the functions being outsourced are differentiated, and the relationship between outward orientation (or regional embeddedness) and type of activity is explored, always taking into account industry differences.

The breadth and depth of outsourcing is analysed in relation to the three functional categories of production and assembling, R&D and design, and services. First of all, it is important to underline that firms have been performing these functions to a different degree. Production/assembling activities are, as expected, the defining character of the manufacturing system in Lombardy, and even when firms decide to turn to external suppliers for activities they used to perform in-house, outsourcing rarely implies complete disinvest- ment. As shown in Table 3, only a very minor share of firms (3%) never carried out any production activities, whereas 94% exhibit dedicated functions. For nearly 74% of firms, production or assembling have not been affected by any type of outsourcing, while the remain- ing 20% of firms with dedicated functions have partially outsourced them. Only 3% of firms in the sample

Fig. 2. Regional outsourcing, by industry (percentage of firms)

242 Lucia Cusmano et al.

have been going through complete disinvestment in manufacturing activities. ‘Hollow companies’ (FREEDMAN, 2004), that is, firms turned into pure coordination structures, are therefore still rather infrequent.

Indeed, the strategy of full disinvestment (total out- sourcing) concerns a small share of firms across all the functions examined. The area in which turning to external suppliers most frequently implies that firms dismiss the related function is R&D and design. Among firms that have been performing some type of research activity (75% of the sample),5 very few out- sourced any of them, preferring to keep this strategic (and sensitive) function close to the in-house core. However, when outsourcing took place, it was more likely, compared with other functions, that it turned into total out-contracting. In other words, partial outsourcing is relatively less common for R&D than for other functions.

This evidence is at odds with the prediction of the resource-based view of the firm, which would suggest that complementary relationships between in-house departments and specialized suppliers are more likely to be observed in the case of knowledge-intensive activities (MAHNKE, 2001), as dismissing these functions undermines firms’ absorptive capacity. This is less the case if R&D-related activities present low degrees of uncertainty and complexity (FREEMAN and SOETE, 1997) or in environments characterized by ‘open inno- vation models’ (LAURSEN and SALTER, 2004), which would, however, require close ties and proximity (SORENSON et al., 2006).

This evidence can be further qualified by considering the direction of outsourcing, in both spatial and organ- izational terms. Table 4 presents the relevance of regional versus international suppliers, considering

‘potential outsourcers’ only (that is, firms that have/ had functions related to the area under investigation). For instance, nearly 40% of the firms with in-house services experienced deverticalization. Among them, 85% referred, at least for one of the externalized activi- ties, to regional suppliers. This suggests that the local markets for services are thick, although exclusively regional outsourcing is less common, that is, most firms resort to service providers located at various sites, across the regional and, to a lower degree, the national border.

This evidence is consistent with the observation in the literature that localized externalization is one of the driving forces of service markets growth in core regions (O’FARRELL et al.,1993, COE, 2000).

As far as R&D is concerned, over 82% of the firms performing some type of R&D activity have not experienced any (even partial) outsourcing. Regional markets are nevertheless relevant as not only the location of suppliers, but also the share of firms refer- ring to foreign contractors, is similar to that observed in production and assembling. This result, however, hides significant inter-industry differences (Fig. 3). Industries exhibiting a relatively higher percentage of firms outsourcing abroad include such different areas as Textile and Clothing, and Electronics and Optics. When uncovering the details about the nature of the outsourced activities, it is, however, evident that the similar trend is related to different strategies (and, supposedly, determinants). For Textile and Clothing, offshoring consists mainly in international outsourcing of production and assem- bling activities and, to a lesser extent, services. The Electronics and Optics industry is significantly more oriented towards international outsourcing of R&D and design, although the offshoring of production

Table 4. Direction of outsourcing, by localization (percentage of potential outsourcersa)

Function

Percentage of

outsourcers

Of which (share)

Percentage of regional

outsourcersb Percentage of

off-shorersc

Production/assembling 24.06 0.73 0.17 Research and development/design 17.71 0.72 0.18 Services 39.51 0.85 0.11

Notes: aFirms performing or having performed the function. bFirms outsourcing at least one activity within the region. cFirms outsourcing at least one activity abroad.

Table 3. Depth of outsourcing, by function (percentage of firms)

Function

Never

performed

Totally

outsourced

In-house and

outsourced In-house only

Production/assembling 2.96 3.05 20.30 73.69 Research and development/design 25.70 6.36 7.40 60.54 Services 15.33 4.36 29.09 51.22

Globalization of Production and Innovation 243

activities is also non-negligible. If nearly half of the R&D outsourcers in the industry outsourced abroad, about one-third of those outsourcing production turn to international suppliers. Energy and Chemistry is the other industry whose inter- national outcontracting is above the average in all functions and, particularly, in R&D. At the other extreme, the Construction and Wood and Furniture industries refer almost entirely to the domestic market.

The high share of international outsourcing in knowledge-intensive activities is partially to be related to strategies of multinational groups. In fact, the present data also show that, when offshored, the R&D function is indeed transferred to another group affiliate abroad (or the foreign headquarters) more frequently than in the case of production and services.6 This seems to suggest that regional high-technology indus- tries are affected by a sort of ‘branch plant effect’, which is generally associated with peripheral areas (PHELPS, 1993). Multinational branch plants are ‘out- sourced’ of their R&D functions by headquarters, which implies a lower degree of regional embeddedness in the forms of localized knowledge-intensive linkages.

FIRM-LEVEL CHARACTERISTICS AND THE

GEOGRAPHICAL DIMENSION OF

OUTSOURCING

Econometric model and description of the variables

Following recent empirical contributions to the deter- minants of outsourcing (GIRMA and GÖRG, 2004; MAZZANTI et al., 2006; MOL, 2005; TOMIURA,

2005), outsourcing decisions by firms are modelled as a function of a number of variables reflecting firm- specific characteristics, while accounting for sectoral specificities. Different probit models are estimated in order to assess the possible distinct relevance of these characteristics for the inward (regional) and the outward (foreign) orientation of the outsourcing strat- egy. In the first model, regional outsourcing is con- sidered exclusively: the dependent variable is a dummy equal to one when the firm has been undertak- ing regional outsourcing only. The second model describes the probability of a firm performing inter- national outsourcing: here the dependent variable is a dummy equal to one when the firm has outsourced some activity to another country. Finally, for the sake of comparison, a third model is also estimated where the dependent variable is a dummy equal to one when the firm performs any kind of outsourcing, that is, inde- pendently of the localization of the contractor. All models are estimated while accounting for the effects of sampling design and response on population estimates by using pseudo-maximum likelihood methods and allowing for probability sampling weights and stratification.

The explanatory power of a basic set of quantitative variables, also obtained from the survey, is first tested (Table 5). The first explanatory variable, PRO- DUCTIVITY (sales over employees), is intended to test the hypothesis that firms engaged in outsourcing have higher productivity than vertically integrated firms (OLSEN, 2006). The rationale is that firms out- source activities in which they are less efficient or for which they do not enjoy much competitive advantage, based, for instance, on unique knowledge or skills,

Fig. 3. Breadth of domestic outsourcing and offshoring, by industry (percentage of firms)

244 Lucia Cusmano et al.

while focusing on their core competencies or reallocat- ing resources towards activities with greater value added, and thus gaining in productivity. Only very few studies have analysed the reverse direction of causality, provid- ing, however, no clear-cut evidence (KIMURA, 2002; TOMIURA, 2005). For example, TOMIURA (2005) points to a greater marginal relevance of productivity for international outsourcing than for generic outsour- cing that would be explained by the high fixed costs for foreign contracting, which makes this alternative viable for rather productive firms. Notice that the present measure of labour productivity could be positively related to outsourcing also because firms contracting out their activities usually reduce the number of employees, while sales remain constant.

The second explanatory variable, RDI (R&D over sales), measures R&D intensity, whose impact on outsourcing cannot be straightforwardly signed (MAHNKE, 2001; MOL, 2005). The conventional view would argue that R&D-intensive industries tend to be vertically integrated in order to recover the high sunk costs generated by R&D investment. A further and complementary argument, based on the transaction cost approach, maintains that industries dealing with complex products face severe incentive and appropria- bility problems, which they tend to solve through vertical integration (MOL, 2005; TEECE, 1986). On the other hand, R&D intensity would be associated to extensive outcontracting in the literature conceiving the firm as an open platform, developing external networks, in particular international ones, to access relevant capabilities, rather than building them internally (BARNEY, 1999). The growing complexity of technol- ogies is one of the key reasons for firms to search for external sources of knowledge (BRUSONI et al., 2001) and relationships with suppliers represent important channels for accessing capabilities. Local outsourcing provides advantages of generally lower transaction costs and continuous interaction, favouring interactive learn- ing and incremental change. On the other hand, inter- national outsourcing can be aimed at entering global knowledge networks, and recent advances in communi- cation technologies have made this easier (MOL, 2005).

A further explanatory variable is a measure of firm size (SIZE ), here evaluated in terms of number of employees. There seems to be disagreement on the direction of the impact of size. The core competence literature, for instance, would indeed suggest that small firms are more likely to outsource, since they

have a strong incentive to devote their limited internal (physical, financial, and intangible) resources to core activities and bring out non-core ones (ABRAHAM and TAYLOR, 1996; CORÒ and GRANDINETTI, 1999). In the case of local systems, regionally confined outsourcing by small and medium-sized enterprises is to be interpreted in the framework of a strong division of labour, which allows local producers to enjoy increas- ing returns from specialization, and the local system to achieve a high degree of ‘flexible specialization’ (GAROFOLI, 2002). On the other hand, small firms are expected to outsource fewer activities, as they have a smaller scope to start with, and, especially as far as service activities are concerned, fewer and simpler needs than large firms (MARTINEZ ARGÜELLES and RUBIERA MOROLLÓN, 2004). The positive relation between firm size and outsourcing is supported by the idea that subcontracting is a strategy of ‘production smoothing’, which allows large firms to reduce costs and enhance flexibility (IMRIE, 1986; KIMURA, 2002; TAYMAZ and KILIÇASLAN, 2005). The effect of size has been tested by some recent empirical works (GIRMA and GÖRG, 2004; MAZZANTI et al., 2006), which, however, do not provide clear-cut evidence.

The explanatory variable HK (share of employees having secondary education) is meant to characterize the firm human capital endowment. Cost-saving strat- egies would suggest a positive relationship between human capital and outsourcing in general. The rationale is that firms employing highly skilled workers pay effi- ciency wages and are not able to pursue different wage strategies. However, in order to save costs, they would be keen to outsource peripheral activities for which they employ workers that are paid above the market rate efficiency wage. On the other hand, the competence perspective points to differentiated effects and to ambig- uous empirical outcome. MAZZANTI et al. (2006) under- line that a high level of skills can represent an important incentive to specialize in knowledge-intensive activities, while outsourcing more standard production. However, firms with high skills are less willing to outsource if this creates the risk of losing some distinctive capabilities, thus impoverishing the organizational competences which are built upon them. Finally, other authors have emphasized that human capital is particularly relevant for contracting internationally. Qualified human skills are in fact deemed essential for engaging in contracting abroad since this requires human capital intensive activi- ties such as negotiating with partners in foreign languages

Table 5. Explanatory variables (logs): descriptive statistics

Variable Measure Mean Standard deviation Minimum Maximum

SIZE Employees 3.42 1.25 1.79 8.52

PRODUCTIVITY Sales/employees 11.88 1.31 4.29 17.73 RDI Research and development/sales 0.69 1.02 0 4.62 HK Percentage of secondary-educated employees 3.11 1.21 0 4.62

EXPI Export/sales 2.015 1.74 0 4.62

Globalization of Production and Innovation 245

and concluding contracts under different legal systems (TOMIURA, 2005).

In all specifications industry specific effects are con- trolled and a dummy variable FINAL PRODUCT, which identifies firms engaged in the production of final goods, is introduced.7 This variable is included to account of the differentiated behaviour of firms oper- ating at different stages of the value chain and a positive relationship is expected between outsourcing and downstream production activities (for example, final transformation or assembling). This is because down- stream producers tend to exhibit a greater scope of activities or functions for which outsourcing can take place. In addition, it is especially in downstream pro- duction that outsourcing represents an effective strategy for smoothing production over different subcontractors, thus coping with seasonal or demand peaks (IMRIE, 1986). More broadly, this finding would be consistent with the evidence on cost-saving strategies, as pointed out in recent works on subcontracting relationships (TAYMAZ and KILIÇASLAN, 2005).

The present authors further control for the outward orientation of the firm and for organizational specific effects. The outward orientation of the firm seems to be an important control for offshoring behaviour and is captured by two indicators that should convey infor- mation on the firm business experience in foreign countries. EXPI (export/sales) represents export inten- sity, while FDI is an indicator variable, which takes the value of one if the firm has undertaken foreign direct investment.8 The paper first controls for the relevance of FDI per se, and then it further distinguishes between production and/or R&D FDI (FDI_PLANT), on the one hand, and the mere opening of a sales office abroad (FDI_SALES), on the other hand. The empiri- cal literature suggests a positive relationship between outward orientation and international outsourcing (TOMIURA, 2005), which is consistent with the likely reduction of fixed costs of foreign contracting when firms already have business experience in foreign countries. In addition, GÖRG et al. (2004) underline the potential advantage for exporters in accessing extensive knowledge on where to procure competi- tively priced inputs. This is in line with the model of GROSSMAN and HELPMAN (2002), which stresses the relevance of search costs for international outsourcing. In accordance, both kinds of internationalization strategies are expected to affect positively the prob- ability of foreign outsourcing, and the productive type of FDI to have a larger effect than the investment in sales units or offices.

As far as organizational-specific effects are con- cerned, a GROUP dummy is introduced that takes a value equal to one if the firm is part of an economic group, and zero otherwise. This variable is further split into the variable SUBSIDIARY, which identifies firms that are subsidiaries in a group, and GROUP_- HEAD, which identifies the headquarters.9 It is

expected that being part of a group positively affects outsourcing, as firms are, in principle, embedded in a larger network of providers and potential clients. In addition, subsidiary firms are expected to be more likely than headquarters to perform outsourcing, as the first are generally more involved in production activities, whereas the latter are likely to host adminis- trative and often strategic (for example, R&D) func- tions, enjoying economies of scale and scope in the provision of group-wide services. At the same time, because Lombardy is a core region characterized by a dynamic business environment and a major tertiary area (Milan), branch plants are expected to rely signifi- cantly on local service markets.

Results

Table 6 reports correlations among the main explana- tory variables; and Table 7 shows the results from differ- ent specifications of probit estimation for survey data for each of the three dependent variables specified in the previous section (any outsourcing, exclusively regional outsourcing, and international outsourcing).10

Interestingly, in all regressions human capital appears to be a good and highly significant predictor of outsour- cing behaviour. The result is consistent with both the cost-saving explanation (GIRMA and GÖRG, 2004) and the idea of specialization driven by skills. Human capital significance is observed when focusing both on regionally oriented outsourcers and on offshorers, even when outward orientation variables (EXPI, FDI) are taken into account. One can infer that human capital represents an important asset for operating in foreign markets, but also a relevant driver in the region- ally based flexible specialization.

By contrast, productivity does not appear to be sig- nificant in any of the specifications tested, which is not surprising since the reverse causality has been in fact rarely observed in the empirical literature.11 Fur- thermore, the result might be affected by the prevalence of small and medium-sized enterprises in the sample (and in the Lombardy, and more generally Italian, pro- duction system), as the effect on productivity induced by the possible employment reduction is likely to be marginal for small and medium-sized enterprises.

The R&D intensity variable (RDI) exhibits a similar pattern of significance. Differently from MOL (2005), no robust evidence is found that R&D-intensive firms

Table 6. Correlations among explanatory variables

SIZE PRODUCTIVITY RDI EXPI HK

SIZE 1.000

PRODUCTIVITY 0.145 1.000

RDI 0.251 0.043 1.000

EXPI 0.415 0.066 0.296 1.000

HK 0.263 0.181 0.190 0.187 1.000

246 Lucia Cusmano et al.

Table 7. Estimation results

Variable

(1) (2) (3) (4) (5) (6) (7)

All

outsourcing

Exclusively

regional

outsourcing

International

outsourcing

All

outsourcing

Exclusively

regional

outsourcing

International

outsourcing

International

outsourcing

SIZE 20.00 20.01 0.19�� 20.01 20.00 0.10 0.07 (0.05) (0.05) (0.05) (0.05) (0.06) (0.07) (0.07)

PRODUCTIVITY 0.03 20.00 0.03 0.03 0.00 0.02 0.02 (0.04) (0.04) (0.06) (0.04) (0.04) (0.06) (0.06)

RDI 0.08� 20.01 0.05 0.08 20.02 0.04 0.04 (0.05) (0.05) (0.06) (0.05) (0.05) (0.06) (0.06)

HK 0.14�� 0.10�� 0.21�� 0.14�� 0.10�� 0.19�� 0.19��

(0.04) (0.04) (0.08) (0.04) (0.04) (0.08) (0.08)

FINAL PRODUCT 0.16 0.25� 20.49�� 0.16 0.25� 20.52�� 20.52��

(0.12) (0.13) (0.18) (0.12) (0.13) (0.19) (0.19)

EXPI 0.03 0.03 0.11�� 0.12��

(0.03) (0.03) (0.05) (0.05)

FDI 20.09 20.32�� 0.31��

(0.13) (0.14) (0.16)

FDI_PLANT 0.65��

(0.30)

FDI_SALES 0.41

(0.34)

CONSTANT 20.82� 20.53 22.95�� 20.81� 20.59 22.54�� 22.48��

(0.46) (0.47) (0.73) (0.46) (0.48) (0.79) (0.78)

Industry dummies Yes Yes Yes Yes Yes Yes Yes

F-statistic 2.33 2.14 6.27 2.05 2.18 7.31 6.88

Prob . F 0.01 0.01 0.00 0.01 0.01 0.00 0.00 Observations 1099 1099 1099 1099 1099 1099 1099

(8) (9) (10) (11) (12) (13) (14)

SIZE 20.01 0.01 0.04 20.01 0.01 0.06 0.05

(0.06) (0.06) (0.07) (0.06) (0.06) (0.07) (0.07)

PRODUCTIVITY 0.03 0.00 0.01 0.04 0.01 0.00 0.00

(0.03) (0.04) (0.06) (0.04) (0.04) (0.06) (0.06)

RDI 0.07 20.02 0.04 0.07 20.02 0.04 0.04 (0.05) (0.05) (0.06) (0.05) (0.05) (0.06) (0.06)

HK 0.14�� 0.10�� 0.17�� 0.14�� 0.10�� 0.17�� 0.17��

(0.04) (0.04) (0.07) (0.04) (0.04) (0.07) (0.07)

FINAL PRODUCT 0.16 0.25� 20.51�� 0.16 0.25� 20.51�� 20.53��

(0.12) (0.13) (0.19) (0.12) (0.13) (0.19) (0.19)

EXPI 0.03 0.03 0.12�� 0.03 0.03 0.12�� 0.12��

(0.03) (0.03) (0.05) (0.03) (0.03) (0.05) (0.05)

FDI_PLANT 20.19 20.75�� 0.55� 20.20 20.78�� 0.58� 0.62��

(0.22) (0.22) (0.30) (0.22) (0.22) (0.30) (0.30)

FDI_SALES 20.17 20.37 0.32 20.16 20.37 0.34 0.39 (0.32) (0.30) (0.36) (0.32) (0.30) (0.36) (0.35)

GROUP 0.10 20.03 0.32�

(0.15) (0.15) (0.17)

GROUP HEAD 0.25 0.39 20.30 20.31 (0.25) (0.29) (0.27) (0.27)

SUBSIDIARY 0.07 20.13 0.40�� 0.26 (0.16) (0.16) (0.18) (0.20)

SUBSIDIARY �

FOREIGN

0.59�

(0.34)

CONSTANT 20.79� 20.63 –2.34�� 20.80� 20.68 –2.27�� –2.21��

(0.46) (0.48) (0.76) (0.46) (0.48) (0.78) (0.78)

Industry dummies Yes Yes Yes Yes Yes Yes Yes

F-statistic 1.83 2.41 6.83 1.76 2.34 6.59 6.56

Prob . F 0.02 0.00 0.00 0.03 0.00 0.00 0.00 Observations 1099 1099 1099 1099 1099 1099 1099

Notes: Standard errors are given in parentheses; �significant at 10%; ��significant at 5%; and ��significant at 1%.

Globalization of Production and Innovation 247

have a higher overall probability to outsource, thus the findings do not support the perspective of increasing specialization and reliance on external sources by R&D-oriented firms. If R&D-intensive firms outsource in order to search for competent external suppliers that provide complementary resources, as suggested by the ‘relational view’ (MAHNKE, 2001), the present findings might suggest that the regional scale is too small for creat- ing a market for competent suppliers (PHELPS and OZAWA, 2003), while in international markets, where competition is harsher, knowledge-intensive firms tend to be more sensitive to the appropriability problems entailed by outsourcing.

Size does not appear to be a good predictor for the general strategy of outsourcing. This is in line with the evidence provided by MOL (2005). When specifying the direction of outsourcing, the variable appears to exhibit a positive effect on international outsourcing, that is large firms appear to be significantly more likely to engage in offshoring. This result, which confirms findings by TOMIURA (2005), seems to point to an apparently trivial implication, that is, availability of a large pool of resources is relevant for sourcing at the international level. However, the effect of size disappears once one properly accounts for international orientation of firms through export intensity and FDI. It is found that a strong relationship exists between international outsourcing behaviour and foreign business experience, as represented by both export activity (EXPI ) and FDI. It is foreign investment in a production or R&D unit that really matters, while the mere opening of a sales office abroad does not show any effect on the probability to do any kind of outsourcing.

A striking difference emerges between firms out- sourcing at the regional level only and those going abroad when focusing on the final product dummy. This is significant in both cases (under all the specifica- tions tested), but takes a positive value, as expected, only when considering exclusively regional outsourcing. On the contrary, it exhibits a significant negative relation- ship with offshoring. It is maintained that this result is only apparently counterintuitive. In fact, it is consistent with findings in the trade literature showing that intra- industry trade currently dominates international trade flows (GROSSMAN and HELPMAN, 2002; MINIAN, 2006). In particular, multinationals develop large net- works among their affiliates that source factories all over the world (GEREFFI, 1999). In this respect, it is worth noticing that the final product variable is still significant and negative for the estimation on the off- shoring dependent variable when controlling for group dummies.

Related to the above, being part of a group matters for international outsourcing: support is found for the evidence that group subsidiaries rather than headquar- ters are the drivers of international outsourcing activi- ties. Furthermore, once one controls for foreign ownership by interacting the dummy SUBSIDIARY

with a dummy FOREIGN taking a value of one if the firm is controlled by foreign actors,12 it is found that it is foreign ownership of subsidiaries that posi- tively affects the probability of international outsour- cing. This suggests that foreign-controlled units located in Lombardy ‘have been outsourced’, that is, headquarters of foreign multinational enterprises have either appropriated the function or transferred it to another subsidiary/external firm. This adds to the evidence about R&D total offshoring by firms in high-technology industries in pointing to a sort of ‘branch plant effect’ in knowledge-intensive segments (PHELPS, 1993).

CONCLUSIONS

This paper has explored the extent of outsourcing from the perspective of individual firms located in an advanced manufacturing area. In doing so, it contrib- utes to the vast literature on firms outsourcing strategies and in particular to the understanding of the determi- nants of firms’ outsourcing decisions. Results shed light on a number of relevant dimensions of outsourcing (i.e., direction, breadth, depth) and thereby comp- lement and corroborate the prevalently qualitative and anecdotal evidence on this topic.

The first outcome of this investigation clearly indi- cates that, in the case of Lombardy, outsourcing is remarkably widespread and concerns to a similar extent all industrial sectors. The present findings support pre- vious evidence showing that subcontracting in core regions (for example, WOOD et al., 1991; COE, 2000; ILLERIS, 2005) is mainly local. Indeed, overall outsour- cing has a clear and predominant local dimension in those sectors which are highly rooted in regional clusters. In this sense, it appears that marshallian externalities are still relevant in driving deverticalization and feeding the local dense web of productive relationships, which constitutes the defining character of the flexible special- ization model (SCOTT, 1988; STORPER and SCOTT, 1989). The present evidence suggests that in this core region externalization is not leading to a loss of density of those traded relationships that represent the source of local competitive advantage (GAROFOLI, 2002).

Subcontracting in Lombardy (and in core regions) involves services to a large degree. The externalization of service functions contributes to thickening of the local service markets and feeds positive agglomeration effects in advanced areas. In this sense, core-competence focus, or ‘quasi-cost’ factors (BEYERS and LINDAHL, 1996), and the search for complementary expertise at the territorial level seem to be more relevant than cost rationales. The importance of human capital in explain- ing regionally based specialization further suggests that local fragmentation is driven by knowledge-oriented players. These actors, mostly downstream producers, maintain some related in-house capabilities which

248 Lucia Cusmano et al.

support the flexibility and governance of close ties with selected suppliers (O’FARRELL et al.,1993).

Interestingly, outsourcing in value-added services (i.e. R&D and design) is less common – suggesting that firms are still very much concerned with appropria- tion problems – but is relatively more likely to span across regional or even national boundaries.

The implications of the results for regional develop- ment – and the broad debate about the impact of glo- balization on regional clusters – are of particular interest. The risk of local networks impoverishment has been the focus of much recent debate about distant outsourcing. Regions are depositories of tangi- ble and intangible resources, which mostly reside in local firms and on which localized capabilities are built (BOSCHMA, 2004; MASKELL and MALMBERG, 1999). Distant outsourcing can seriously undermine these capabilities, reduce the local relational density, and the internal cohesion of the regional system.

In the case of Lombardy, it seems that externalization has been adding new ties or reinforcing existing ones in the local production system. Especially in the area of business services, opportunities have been created for focused niche players to enter regional markets. There- fore, it appears the adjustment to global trends has been taking place mostly within the model of flexible special- ization, driven by highly localized advantages from div- ision of labour and complementary specialization. Insertion into global production networks seems not to have been disruptive of industrial clusters, deepening, rather than weakening, local linkages.

However, the strong inward orientation of the process raises other questions, in relation to the long- term development trajectory. In fact, dismantling and relocating activities outside a region does not necessarily imply negative effects for the local economy, in terms of efficiency or development dynamics. Outward externa- lization can lead to a better allocation of resources, which shift from low-yielding activities, or declining sectors, to more productive ones. Furthermore, regions benefit from international outsourcing when firms sub- contract to high competent producers and/or markets, which become channels for accessing new knowledge and preventing lock-in effects (CAMAGNI, 1991).

Overall, the present analysis indicates that inter- national outsourcing is still a minor part of a wider frag- mentation trend, which concerns mainly traditional sectors, such as Textile and Clothing. In this case, inter- national outsourcing consists mainly of the externaliza- tion of production and assembling activities and seems to respond to efficiency-seeking strategies, which may positively affect regional dynamics.

However, international outsourcing also touches upon knowledge-intensive and large-scale sectors. On the one hand, this might favour or strengthen the insertion of the regional system into global knowledge networks. On the other hand, if it implies dismissal of high value- added functions or loss of strategic assets at the local

level, it might seriously hinder the growth potential of the regional system. The evidence suggests that the region might indeed suffer from a sort of ‘branch plant effect’ in knowledge-intensive segments, as R&D func- tions, when outsourced, are more likely to be entirely appropriated by foreign headquarters or research units.

In this late phase of world capitalism, which SCOTT (2005) describes as marked by intensified regionalization of production overlaid by a global division of labour, tra- ditional industrial core regions, such as Lombardy, face the challenge of preserving their internal cohesion, while governing their insertion into evolving global net- works, counteracting the centripetal forces which are redistributing knowledge-intensive functions and rede- fining the global geography of core and periphery.

Acknowledgements – The authors would like to thank the participants at the following: ProAct Conference

(Tampere, Finland), International Schumpeter Society

Conference (Nice, France), EARIE Conference (Amsterdam,

the Netherlands), EMAEE Conference (Manchester, UK),

and in seminars and workshops at the Università di

Roma Tre (Rome, Italy), CESPRI-Università Commerciale

‘L. Bocconi’ (Milan, Italy), Università del Salento (Lecce,

Italy), Università del Piemonte Orientale (Novara, Italy), and

Beta-Université Louis Pasteur (Strasbourg, France). Financial

support from IReR-Lombardia is gratefully acknowledged.

Andrea Morrison also acknowledges funding from the Italian

Ministry of Education, University and Research (PRIN 2005

on ‘Fragmentation and Local Development’).

NOTES

1. TOMIURA (2005) provides a concise review.

2. O’FARRELL et al. (1993) define this process of vertical

disintegration as ‘service unbundling’.

3. For the sake of clarity and to ease interpretation, these

relationships will be presented in detail in the fifth

section when discussing the structure of the empirical

analysis on firm-level characteristics and the geographical

scope of outsourcing.

4. Lombardy has been the focus of early investigations about

flexible production systems and industrial district models,

emerging in the late 1970s as a peculiar case of diffused

industrial development based on small and medium-

sized enterprises (GAROFOLI, 1983).

5. The survey adopted a broad definition of R&D, which is

intended as any activity oriented towards research and

experimentation.

6. A total of 69% of firms offshoring R&D activities do so,

at least partially, to a group affiliate. The corresponding

figures for production and services are 64% and 52%,

respectively. The difference is, however, more striking

when considering firms offshoring exclusively to group

affiliates: these are 35% of firms offshoring R&D, but

only 2% of firms offshoring production and 7% of

firms offshoring services.

7. The survey specifically asked whether the firm produces

a final good or an intermediate good.

Globalization of Production and Innovation 249

8. Here the survey first asked if the firm has pursued any

foreign direct investment, distinguishing between: (1)

production facilities, (2) an R&D laboratory, and (3) a

sales office.

9. In the survey, whenever the respondent declared the firm

belonged to a group, he/she was asked to specify the pos- ition of the firm within the group.

10. In the regressions, all continuous variables are measured

in logs: to treat observations with zero value in some of

the relevant variables, a ‘1’ was added before taking the

logarithm.

11. MOL (2005) finds a positive and significant effect of pro-

ductivity on outsourcing. However, in his regressions the

coefficient of productivity is effectively zero.

12. This is again obtained from a survey question asking for

the country of residence of the subjects retaining either

the ownership or the control of the firm.

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