The dynamics of inter-firm networks and firm growth

Daisuke Fujii, Yukiko Saito, Tatsuro Senga 10 February 2018

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Japan stands out among developed countries for its fast-declining business dynamism. For example, the number of small and medium-sized enterprises (SMEs) dropped by 23% between 1999 and 2014, reflecting the increase in retirement of ageing business owners and weak entrepreneurial activities (Small and Medium Enterprise Agency 2017). This has created concern among policymakers as existing inter-firm networks, which are vital to productivity and sustained economic growth, are being lost.

Firms form production networks through selling and buying goods and services to and from each other. Such buyer-supplier relationships are important for both short-run sales and profits, but also for long-run growth for firms. For example, Toyota Motor Corporation would share its business knowledge with suppliers, which would allow them to learn how to improve efficiency and performance. This, in turn, would help reduce costs and improve the quality of products made by Toyota. Firms can benefit from these intangible assets by building long-term relationships with buyers and sellers. Recent literature has highlighted the importance of such intangible capital accumulation over the lifecycle dynamics of firms and establishments (Atkeson and Kehoe 2005, Hsieh and Klenow 2014).         

Development of buyer-supplier networks

In recent work, we constructed panel data of Japanese firms with supplier-customer information (Fujii et al. 2017). The sample includes about one million firms over 10 years, provided by Tokyo Shoko Research Ltd. Using these panel data, we studied creation and destruction of buyer-supplier relationships at the firm level, focusing on firm age.

Firms accumulate trading partners as they age, and the number of buyers and suppliers becomes large. In the development of their relationships, younger firms tend to add and drop trading partners more frequently. Examination of the survival rate of links between buyers and sellers reveals that links of younger firms survive less on both sides (buyers and suppliers) and that a link survival rate increases with the duration of active relationships. A trading relationship which has existed for a long time is likely to continue in the next period. These results may support the ‘noisy selection’ mechanism of inter-firm links. As Jovanovic (1982) noted in the context of firm-employee match survival patterns, the learning process of link-specific match quality between buyers and sellers may drive this age-dependence of link creation and deletion patterns across different firm stages.

Buyer-supplier networks and firm growth

We next examined how such development of buyer-supplier relationships affects firm growth at different stages of the firm lifecycle. To this end, firms are divided into five age groups: 0-4, 5-9, 10-19, 20-39, and 40+ years old. We looked at how the relationship between inter-firm networks and firm growth varies across different firm age groups (Figure 1). We find that the benefits from adding new relationships decrease and that from maintaining exiting relationships increase as firms age. More precisely, younger firms that successfully find new trading partners exhibit a greater rate of sales growth, and, for older firms, the stability of inter-firm relationships and intangible capital accumulation with existing trading partners becomes more important.

Figure 1 Effect on firm growth

Policy implications

To grow, firms need to find and build good customer-supplier relationships. It is vital to have a set of good customers to increase sales and profit. It is also important to have a set of good suppliers, since the access to low-cost intermediate materials and services reduces marginal costs, leading to enhanced productivity. This productivity improvement is amplified when a firm operates on a large scale or faces a high demand elasticity. For both customers and suppliers, stable relationships reduce uncertainty regarding match-specific productivity and help firms to invest in improving firm performance. The relative importance of supplier and customer relationships changes over the firm lifecycle.

Our research suggests the importance of searching for potential trading partners and learning match-specific productivity for younger firms. In contrast, older firms, conditional on surviving, seem to enjoy a stable set of customers and suppliers to keep their operations. These findings suggest that obtaining new trading partners is important for younger companies, and that there may be room for policy intervention in this area.

Editors’ note: The main research on which this column is based first appeared as a Discussion Paper of the Research Institute of Economy, Trade and Industry (RIETI) of Japan.

References

Atkeson, A, and P J Kehoe (2005), “Modeling and measuring organization capital”, Journal of Political Economy, 113 (5), 1026-1053.

Fujii, D, Y U Saito, and T Senga (2017), “The Dynamics of Inter-Firm Networks and Firm Growth”, RIETI Discussion Paper 17-E-110.

Hsieh, C T, and P J Klenow (2014), “The life cycle of plants in India and Mexico”, The Quarterly Journal of Economics, 129 (3), 1035-1084.

Jovanovic, B (1982), “Selection and the Evolution of Industry”, Econometrica, 50 (3), 649-670.

Small and Medium Enterprise Agency of Japan (2017), "White paper on small and medium enterprises in Japan".

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Topics:  Industrial organisation Productivity and Innovation

Tags:  firms, growth, networks

Lecturer in Economics, University of California, Los Angeles; Fellow, RIETI

Senior Fellow at the Research Institute of Economy, Trade and Industry, Japan

Assistant Professor, Queen Mary University of London

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