The influence of labor market size and social capital to outsourcing decision empirical study for small and medium enterprises in vietnam

1.2 Research objectives & questions: The purpose of this research is to analyze the influence of local labor market size and social capital to the outsourcing decisions of Vietnamese sm

VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

The influence of labor market size and social capital to outsourcing decision: Empirical study for Small and

Medium enterprises in Vietnam

A thesis submitted in partial fulfillment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

LE DUY MINH

Academic Supervisor:

Dr PHAM KHANH NAM

HO CHI MINH CITY, DECEMBER 2016

LE DUY MINH

ACKNOWLEDGEMENTS

For the completion of this thesis, I would like to express my gratitude to the University of Economics Ho Chi Minh City in Vietnam and the Institute of Social Studies The Hague in The Netherlands for developing the Vietnam – Netherlands Programme for M.A in development economics

I would like to express my thanks to my teachers and family who have given me tremendous encouragement for completing this thesis

I wish to express a special gratitude to my supervisor, Dr Pham Khanh Nam, for all

of his supports and advices during the process of completing this thesis

Last but not least, I wish to say thanks to all of my friends during my time in the VNP for being a source of great encouragement

ABSTRACT

The purpose of this paper is to provide an insight to the impact of labor market size and social capital on the outsourcing decision in Vietnam Small and Medium enterprises, using the data collected in 2013 Logit binary model is employed to explore the effect of labor market size and social capital on firm’s probability to outsource The result indicates that there is connection between firm’s social capital and outsourcing decision While the link between labor market size and outsourcing in Vietnam is not proved to be significant in this research, the study does not reject the importance of market environment to outsourcing but suggest finding a more appropriate variable to quantify market condition

Keywords: outsourcing, social capital, labor market size, Vietnam SMEs

TABLE OF CONTENTS

CHAPTER 1 INTRODUCTION 7

1.1 Problem Statement 7

1.2 Research Objectives and Questions 9

1.3 Scope of Research 9

1.4 Thesis Structure 10

CHAPTER 2 LITERATURE REVIEW 11

2.1 Review of Theory 11

2.1.1 Concept of Outsourcing 11

2.1.2 Theoretical studies on outsourcing 12

2.1.3 Factors of Outsourcing Decision 13

2.1.4 Benefits and Risks of Outsourcing 16

2.1.5 Determinants of Outsourcing 18

2.2 Review of Empirical Studies 21

CHAPTER 3 RESEARCH METHODOLOGY 23

3.1 Analytical Framework 23

3.2 Econometric Model 24

3.2.1 Model Specification 24

3.2.2 Variables Measurement 25

3.2.3 Model Implementation 28

3.2.4 Data 30

CHAPTER 4 RESEARCH RESULT 34

4.1 Overview of SMEs in Vietnam 34

4.2 Descriptive Statistics 35

4.3 Regression Results 40

CHAPTER 5 CONCLUSION 45

5.1 Conclusion and Policy Implication 45

5.2 Study Limitation 46

REFERENCES 48

CHAPTER 1 INTRODUCTION

1.1 Problem statements

Outsourcing is defined as the practice of one firm to contract out their value-creation activities to a third-party vendor, ranging from design, research development and service provision (Hindle, 2005) While this concept is widely thought to be recently prominent, its root may have dated from the 1970s and 1980s in an effort by several firms to raise their efficiency and to look for outside assistance for their peripheral processes (Corbett, 2004) Among the earliest practices of this concept, the outsourcing deal between Kodak Eastman Company & IBM in 1989 received major global attention as Kodak decided to obtain services from the famous IT specialist This agreement, while initially receive criticism and doubt, gradually proved to be effective as Kodak could focus all their resources in their core competency and become a major player in the photography industry (Dickson, 2011)

More than 25 years after that business deal, more so with the emergence of information industry, outsourcing has become an integral part in the highly-competitive modern business due to its capability to capture scale economy that results in availability

of low resource cost and higher quality due to full attention in the core value-creation process Narayanan (2009) identify four strategic purpose of outsourcing: managing cash flow, managing control over payment, scaling resources and improve the end-product quality Magretta (2003) research in the car industry during 1990s show that firms that take most advantage of outsourcing, like Toyota, Honda & Chrysler earns a considerably higher profit compared to more traditional firm that relies more on their own capability, such as General Motors

On the other hand, firms are also exposed to the risk of outsourcing which is the difference between what the outsourcing employers require and what is actually produced

by the outsourcing contractors This difference is created due to different reasons, which

includes unrealistic expectation from the employers due to inflated information on the capability of the outsourcing subcontractors, misunderstanding between the employers and the contractors over the requirements of the products, generally poor performance by the subcontractors due to the lack of control, conflicting interests Some firms also avoid outsourcing to protect and boost their knowledge knowhow (Hamel & Prahalad, 1994) The benefits that outsource provide, thus, could be greatly restricted by the threats associated with it Outsourcing therefore is a difficult decision to make that requires clear analysis of different influencing factors (Antonietti, 2016)

Several studies have focused on the firm’s internal elements that determine an outsourcing decision, which is mostly linked to the transaction cost theory (Michael & Michael, 2011) On the other hand, very limited studies concentrate on the macroeconomics factors that favor or discourage outsourcing environment A positive business environment will foster collaboration based on fostering trust, softening the difference between the outsourcing parties and presenting the firm with wider choice for outsourcing options Social capital is considered as an integral element of the business condition to support outsourcing Bourdieu (1986) defined social capital as “the sum of the resources that the firm can access by virtue of having a durable network of relationship”

Another important factor that contributes to the outsourcing decision is labor market size Labor market size is related to the firm’s direct access to human skill and infrastructure thus affects its decision to outsource

Vietnamese economy has experienced a major amount of changes from its centrally planned economy until “Doi Moi” policy that replace the inefficient subsided economy with an open and market integrated model (Beresford, 2008) Economy greatly improved during 1990s with the country removing economics border with foreign business partner Growth continues to improve to the peak of 8.5% in 2007, in part due to the Government’s regulation to encourage private sector and improve export and high foreign investment During these years Vietnam emerged as an ideal destination for

outsourcing production for foreign companies because of cheap labor with high level of education Local social capital during this time immensely benefited from the knowledge shared by international companies and generally better access to the global resources, even more so after the membership of Vietnam into the WTO in 2007 (Hays, 2014) On the other hand, Vietnamese companies have started to outsource its operation In principle, when a company makes an outsourcing decision, its aim is to maximize profit

by comparing costs and benefits stemming from the decision However, there are many barriers and drivers to this decision Understanding these barriers and drivers could help companies to make better decision on outsourcing

The study will look into the year of 2013, five years after the economic slump in

2008 due to high inflation and global economy crisis that hampers the economy and sink the annually growth to the bottom in 2012 This paper aims to contribute to the existing literature about the determinants of outsourcing

1.2 Research objectives & questions:

The purpose of this research is to analyze the influence of local labor market size and social capital to the outsourcing decisions of Vietnamese small and medium enterprises The main questions that will be answered at the end of this study are:

 For Vietnam small and medium enterprises, does labor market size affect the outsourcing decision?

 For Vietnam small and medium enterprises, does social capital affect the outsourcing decision?

1.3 Scope of research

This research focuses solely on Vietnamese firms as outsourcing employers, not as outsourcing subcontractors It analyzes the impact of social capital and local labor market size to the decisions of Vietnamese firm to outsource or not by employing the logistic regression model Data is collected on Small and Medium Enterprises (SME) of Vietnam for the year of 2013

1.4 Thesis structure

The research is categorized into 5 separated chapters:

 Chapter 1: Introducing the research

This chapter offers a background for outsourcing as a global business practice and a review of Vietnam economy The research gap, question and scope are also identified

 Chapter 2: Literature review

This chapter examines the existing literature regarding the factors that surrounds the outsourcing decision as well as the role of local labor market size and social capital in outsourcing Theoretical and empirical evidences are analyzed

 Chapter 3: Research methodology

In this chapter, the econometrics model will be determined with the purpose of answering the research question The dataset and variables used in the model will be presented and explained in full detail

 Chapter 4: Research Results

This chapter presents the important information regarding each individual variables and their connection after conducting the research methodology

 Chapter 5: Conclusions and policy implementation

Key findings and areas of possible improvement for future research will be identified

CHAPTER 2 LITERATURE REVIEW

Gilley and Rasheed categorize outsourcing into two types: substitution and abstention outsourcing In substitution outsourcing, the firm replaces one of its former internal activities to seek for external supply This “vertical disintegration” withdraws the firm’s resources in the outsourced activity to focus in other area In abstaining outsourcing, the firm also relies on external party for goods/services purchase; however these products have not been internally produced by the firm before This method is still considered outsourcing, which differs from normal procurement in the way that the managerial and financial capacity of the firm allows them to internalize these goods/services should they wish to do so In general, we can differentiate outsourcing and normal transaction by the firm’s ability to conduct the outsourced activities on their own

This study employs the adequate and clearly-defined term of marketing from Sanders

et al (2007): Outsourcing is defined as the firms’ practice to contract out part of its activities to a third party firm; with the purpose of concentrating its own financial

capacity, personnel, facilities and resources into their main value-creation activities that

is considered essential

2.1.2 Theoretical studies on outsourcing

Among the in-depth studies of outsourcing, two theoretical perspectives that have the most association with outsourcing are transaction cost theory and resource-based view theory

Transaction cost theory

An outsourcing decision is dependent in 2 types of cost: production cost, which the direct cost of production from the third party and transaction cost, which is the cost to make sure that the subcontractors act in accordance to the expectation of the firm Williamson (2008) argues that transaction cost is the critical factor of outsourcing decision He applies the different categories of transaction cost, proposed first proposed by Dahlman (1981), as search cost – the cost to identify product providers that have the capacity for the outsourced activities, selection cost – cost of choosing a specific supplier, bargaining cost – cost of determining the outsourced price, enforcement & coordinating cost – the cost associated with monitoring the subcontractor to ensure that they do not act on opportunity and violate the contract

The link between outsourcing and transaction cost comes from the firm need to make sure the subcontracting acts exactly as what is specified in the contract, from the quality

of the end products/services, to the compliance to the standards if the production process,

to any legal fees if contract violation occurs Without these control however firm run the risk of lower output, lower quality and having to find the alternative options for their production

Resource-based view theory

In the resources based view theory, firms develop their competitive edge by the way they effectively deploy their resources pool – comprising of tangible and intangible

elements.(Wernerfeld, 19954) Competitive advantages are sustained only when the resourced are used in the most effective way, and the resources hold by the firm is distinctive compared to the competitors In relation with outsourcing, firms create an access to the resources outside their boundary either when they observe a more advanced resources pool in the external environment for a particular product, or when they want to reorganize their resources management and focus In both way, firms aim to a better product/service by outsourcing In the time when firms are more inclined to contract out products with high skill requirements, resource-based view complements transaction cost theory by adding the quality aspect of outsourcing

2.1.3 Factors that determine outsourcing decision

Cost

Saving cost is a prime purpose that the firm chooses to outsource for In general,

outsourcing has cost advantage when the cost of relying on the subcontractors - including

transaction cost and profit - is lower than the cost of in-house production (Harler, 2000) Since additional production cost for peripheral activities are associated with overhead cost and capital expenditure (Muscato, 1998), outsourcing is considered a viable option to take advantage of the economies of scale and the skill specialization of the outsourced firms (Adler, 2000) By transferring such fix cost of production into the variable contractual cost with the subcontractors, outsourcing could further reduce the financial risk for the outsourcing employers (Blumberg, 1998; Kakabadse & Kakabadse, 2000) Indirect cost is also significantly decreased by outsourcing: As the firm has less labor size and more concentration of resources, it could better control cost by having a leaner management system and more efficient organization (Fontes, 2000) Cost outsourcing has been successfully employed by a large number of firms One example is the effort of General Motor in 1998 to outsource all their accounting activities resulted in a reduction

of 20% of the cost in this area (Corbett, 2004)

However, with the goal of cost reduction in mind, the company needs to be sure that they

do not overestimate the cost saved by outsource Indirect transaction cost of outsourcing,

which is originated from the firm effort to control their subcontractors, is often hidden and could be higher than what the firm perceives (Michael & Michael, 2011) Transaction cost is related to the activity of searching and upholding reliable business partners, negotiation, contract formation that controls the parties’ responsibility (Vasiliauskiene & Snieska, 2009)

to their value-creation process (Prahalad & Hamel, 1990) Moreover, the firm could rely

on their subcontractors’ own core-competency – resources, infrastructure, and skill - to complement their whole product portfolio A well-known successful story from this strategy is ACER’s tactics of outsourcing most of its manufacturing activities and focus

on what it excels at: marketing, branding and sales The result is one of the most developed companies in term of sales and market shares growth, having the workforce of only one-tenth of its largest competitor’s (Heric & Singh, 2010) On the other hand, firm should carefully consider what should be outsourced without presenting the risk of losing their critical knowledge base and giving up their market potential (Dekkers, 2011)

On flexibility, outsourcing equips the firm with the ability to efficiently restructuring their resources and the firm organization, in scope and scale, to respond to technology development and the fluctuation of the market demand (Lankford & Parsa, 1999) In addition, the risk that may occur during macroeconomics change will be shared with their outsourced partners

Function

Outsourcing is also affected by the characteristics of the outsourced function, which is more unique and firm-specified Kremic (2006) separates this factor into 4 different categories: complexity, integration, asset specificity and structure

Complexity is the capability of the function to be well-defined and understood in details, with its interaction to the surrounding environment clearly identified Complexity is an important factor in outsourcing contract because it directly affects the subcontractors’ understanding of the purpose and the term of the outsourcing employers regarding the outsourced function The more complex the function is, the higher cost that is required to monitor and the lower motivation to outsource (Franceschini et al, 2003)

The second category is interaction In the value-creation process of the firm, interaction refers to the degree at which the particular function synergizes with other function in the system If the function reserves a central role inside the system, moving the function outside of the firm to outsource will be difficult due to the effort made to closely coordinate with the department that is affected (Prencipe, 1997)

Asset specificity relates to how the output generated by outsourcing is of any importance outside the firm boundary If the output could only be useful for that specific function, the outsourcing subcontractors will be less likely to commit their resource to improve the output, as their interest differs with the interest of the outsourcing employers

Structure specifies the degree to which the tasks in the function is pre-determined and follows a predictable order Function with simple structure is more likely to be outsourced since it can be easily implemented with great compliance,, and the functions are often the non-core activity of the firm (Kremic et al, 2006)

To summarize, some functions have more incentive to be outsourced than the other The difficult it is to outsourced, the more expensive it will be when switching the subcontractors (Franceschini et al, 2003) While function refers to different rings inside the firm’s value creation chain, it can be applied with firm level as well, as different companies possess different characteristics that are related to their viewpoint on outsourcing

socio-2.1.4 – Outsourcing benefits & risks

A summary of the advantages and disadvantages of outsourcing will be summarized in the table below:

Table 1 – Benefits and risks of outsourcing

Saving cost, reducing capital investments,

reducing financial risk

(Kadabadse & Kadabadse, 2000;

Improving quality, speed & flexibility

(Jennings, 1997; Razzaque & Chen, 1998)

Overdependence on the subcontractors (Dekkers, 2011)

Accessing to external skill & resources

(Gordon & Walsh, 1997)

Subcontractors do not meet skill/resources requirement

(Kremic et al, 2006) Accessing to knowledge & innovation

(Muscato, 1998)

Losing knowledge and competitive edge (Lei & Hitt, 1995)

Focusing on core competencies,

disintegrating “difficult” function

(Crone, 1992; Quinn & Hilmer, 1994)

Eroding internal knowledge base, losing market scope potential

(Kremic et al, 2006)

Building trust with business

partners/subcontractors

(Gilley & Raseed, 2000)

Conflict of interest & business environment uncertainty

(Wilcocks et al, 1995)

Avoiding legal constraints and restrictions

(Kadabase & Kadabadse, 2000)

Losing customer perception & reputation (Blumberg, 1998)

2.1.5 – Determinants of Outsourcing

Outsourcing is different in different business activities / production stages:

Compared to the researches about the impact of outsourcing to firm competitiveness, fewer studies have separated the value creation chain process of the company to research outsourcing in different stages of the process Hatonen & Erikson (2009) employed a firm-based perspective to identify the business stages that corporation choose to accomplish in-house production instead of contracting out, and vice versa Arnold (2000) segregated the outsourced activities into four types: core, core close, core-distinct and disposable Love and Roper (2001) focused on the stages in the innovation process, while Cusmano (2009) use the different area in value creation process that includes production, R&D, design and service activities The above researches however, have the similarity in the limitation of number of observations

The study does not take into account the difference outsourcing activities for different stages due to the lack of data for Vietnam SME which is considered a limitation

Outsourcing is affected by local labor market size

In this study, local labor market size is quantified by the labor size of the province where the firm is located at The local labor market thickness of the province represents the availability of local human capital, skill and infrastructure that reinforces firm’s direct access to different resources As the main reason for outsourcing for the firm is to taking advantages of resources that is hard to access from the firm’s location; by using such local resources in the province, firm is better off by internalizing their production and taking advantages of the economies of scope rather than risking an amount of transaction cost for outsourcing partners (Bresnahan & Levin, 2012) Thus, the relationship between local labor market size and outsourcing decision is expected to be negative In support of

this assumption, the empirical study of outsourcing in a global economy (Grossman & Helpman, 2001) suggests that firm has the incentive to outsource in an area where market thickness is higher compared to the local market where the firm is located at

Outsourcing is affected by social capital

Social capital is defined as the environmental or the organizational characteristics of networks, norm and trust (Putnam, 1995) Social capital is viewed as an intangible value that could be invested by the firm’s tangible resources to gain benefit through information and resources accessibility (Fukuyama, 1995) In business environment, it encourages knowledge transfer among different individuals and groups, which in turns develop a business tendency of reciprocity, openness and trust that encourage firms to outsource from each other (Masciarelli et al, 2011) For individual firms, social capital capability is the mean through which they generate a relation network that provide them with the access to the market knowledge This is even more essential for small and medium enterprises in making the outsourcing decision, as both do not have enough resources to control external factors but to rely on them

Outsourcing decision is affected by social capital through the decrease of transaction cost Under an outsourcing contract with the subcontractors, the firm are interested in making a rational decision Transaction cost occurs, however, because of information asymmetry leading to several difficulties to the firms: First, valuable and trusted information may not be available Second, the firm may not have enough knowledge base

to efficiently utilize the information y and finally the firm only has a definite amount of time to make the outsourcing decision (Hobbs, 1996)

Information asymmetry creates the condition for opportunistic behavior by the outsourcing subcontractors to gain benefit on their side in exchange of the outsourcing employers (the firms) interest Opportunistic behavior occurs in two ways: ex-ante opportunism and ex-post opportunism (Priyanath & Premaratne, 2015) Ex-ante opportunism happens before the contractual term is agreed in the effort of the subcontractors to misdirect their outsourcing employers Ex-post opportunism comes

after the contract is finalized to hide the subcontractors’ activities with respect to the mutual agreement Opportunistic behavior increases transaction cost, which the rational firms hope to minimize by having reliable source of information

Information asymmetry and transaction cost could be controlled by social capital in all of their dimensions: The structural, relational and the cognitive dimension (Nahapiet

& Gloshal, 1998) Structural form looks to the firm network relationship system and its attributes, which are expressed through the number of business contacts, the density of interaction and the complexity within the network Structural social capital assists the firms by increasing their knowledge of the network members, encouraging good-will through close contacts and improving the quality of information base Relational social capital is related to a more informal connection between the firms and their partners (including outsourcing subcontractors) after multiple encounters This dimension of social capital provides the firms with trust and personal identification, which discourages opportunistic behavior due to genuine goodwill and close relationship (Svensson, 2001) Cognitive form of social capital refers to the mutual understanding between the network members by the proximity of their vision, objectives, language and business practice, which enable mutual learning With cognitive social capital, firms could reduce asymmetrical information due to the enhanced communication between firms with the network members (Tsai & Gloshal, 1998)

The relationship amongst social capital, transaction cost and outsourcing decision is visualized by the figure below (Adapted from Priyanath & Premaratne, 2015)

Figure 1 – Relationship amongst social capital, transaction cost and outsourcing

decision

2.2 Review of empirical studies

Empirical studies on the determinants of outsourcing have been implemented, both

by qualitative and quantitative method For qualitative method, Niskanen (2013) analyzes the mining industry in Finland with qualitative case study research and confirms a high link between firm’s internal characteristics and environmental factors with the firm’s decision to outsource Akbari (2013) conducts an in depth research into the factors that affect outsourcing decision in Iranian industry, using an extensive questionnaires to assist both qualitative and quantitative research and confirms that outsourcing decision is impacted by the skill and knowledge inside the industry, the firm’s access to such skill and knowledge, the cost factor and customer pressure

For quantitative method, Girma and Gorg (2004) uses the firm level dataset in chemical, engineering and electronics manufacturing in the UK and concludes that average production cost is greatly correlated with outsourcing motive When faced by high production cost, mostly due to higher wage, firms tend to slash the cost by

Firm difference

Ex-ante TC Searching, Selecting, Bargaining

Ex-post TC Coordinating &

Contract Enforcement

contracting out their production Tomiura (2015) uses the sample of 118300 firms of Japanese and proves that there is significance connection between the firm’s financial performance, R&D and skill intensity with outsourcing probability Diaz-Mora & Triguero (2006) employs the probit model to quantitatively analyze the influence of firm characteristics, industry size and innovation investment into outsourcing and observes that firm size, wage and innovation level has a significant impact Antonietti (2016) employs a research on how local labor size and social capital affect outsourcing decision

in different stages of production for Italian manufacturing firms and concludes that local labor size and social capital have high impact on the full outsourcing decision of the firm For local labor size, the relationship is significant during the early processing and treatment stages of production process For social capital, the relationship is significant during the assembly, final processing and post production

For both type of empirical study, the firm’s internal characteristics are also important determinants of outsourcing, which is linked to the strategic and functional factors of outsourcing

CHAPTER 3 RESEARCH METHODOLOGY

3.1 Analytical framework:

The framework is built on the factors that influence the outsourcing possibility of a firm, which is identified as its own internal characteristics, the labor market size in which the firm operates and the social capital of the firm expressed through its network contacts The research will also determine the possibility of the interaction between labor market size and the firm social capital using specification test

Figure 2: Conceptual Framework

Labor market size

Firm social capital:

Number of business contacts in

the same sector

Number of business contact in

different sectors

Number of contacts with bank

Number of contacts with

politicians or other civil servants

Firm internal attributes: age,

average unit cost, skill intensity,

size, market scope,

subcontracting status

Firm’s decision for outsourcing production

3.2 Econometric models

3.2.1 Model specification

The regression is based on the model built by Antonietti (2016) in his study for the impact of local labor market size and social capital for Italian firms This model establishes the relationship between the dependent variable – whether firm outsources, and the independent variables; which includes the firm internal characteristics (age, average unit cost, skill intensity, size, share of revenue on subcontracting), local labor market size and firm social capital (business network size in same sector, different sector, with bank and with politicians) Since the dependent variable is a binary outcome, logistic regression is employed

The general function for this study is presented as:

log 𝒑 (𝒀𝒊𝒑=𝟏)

𝟏−𝒑(𝒀𝒊𝒑=𝟏)= 𝑎0+ 𝑎1 x 𝑎𝑔𝑒𝑖 + 𝑎2 x 𝑎𝑣𝑒𝑟𝑎𝑔𝑒_𝑢𝑛𝑖𝑡𝑐𝑜𝑠𝑡𝑖 + 𝑎3 x 𝑤ℎ𝑖𝑡𝑒_𝑐𝑜𝑙𝑙𝑎𝑟𝑖 + 𝑎4 x 𝑠𝑖𝑧𝑒𝑖+ 𝑎5 x 𝑠𝑢𝑏𝑐𝑜𝑛𝑡𝑟𝑎𝑐𝑡_𝑠ℎ𝑎𝑟𝑒𝑖 + 𝑎6 x 𝑙𝑜𝑐𝑎𝑙𝑖 + 𝑎7 x 𝑔𝑙𝑜𝑏𝑎𝑙𝑖 + 𝑏1 x 𝑚𝑎𝑟𝑘𝑒𝑡𝑠𝑖𝑧𝑒𝑝 +

c1 x 𝑣𝑛𝑤_𝑠𝑎𝑚𝑒𝑠𝑒𝑐𝑡𝑜𝑟𝑖 + c2 x 𝑣𝑛𝑤_𝑑𝑖𝑓𝑓𝑠𝑒𝑐𝑡𝑜𝑟𝑖 + c3 x 𝑣𝑛𝑤_𝑏𝑎𝑛𝑘𝑖 + c4 x 𝑣𝑛𝑤_𝑝𝑜𝑙𝑖𝑡𝑖𝑐𝑠𝑖 + ε

Where:

i is the firm and p is the province in which the firm is located

outsource: The dependent variable y that takes a value of 1 if the firms outsource production in 2012, and takes a value of 0 if not

agei: The age of the firm i

average_unitcosti: Average cost per unit of most important product for firm i

white_collari: Share of white collar employees at firm i

sizei: Number of full time employees at firm i

subcontract_sharei: Share of revenue of firm i that comes from production for a party

third-locali: Binary data that has the value of 1 if the firm’s market is only based in their local province, of 0 otherwise

globali: Binary data that has the value of 1 if the firm’s has a market share outside of Vietnam, of 0 otherwise

labormarketsizep: Labor market size of province p

vnw_samesectori: Firm i’s network contacts level with business in the same sector vnw_diffsectori: Firm i’s network contacts level with business in different sector

vnw_banki: Firm i’s network contacts level with banks

vnw_politicsi: Firm i’s network contacts level with politicians / civil servants

3.2.2 Variables Measurement

Dependent variables

Outsource: This is a categorical variable that takes a value of 1 if firm outsources

their production during the end year and a value of 0 if firm does not In the logistic regression, the probability that the firm outsources (outsource = 1) will be regressed with the independent variables

Independent variables

The definition of the independent variables used in this function, with their expected sign and explanation will be summarized in the below table

Table 2 – Description of independent variables

Sign

in 2013

average_unitcost Average cost of producing one

unit of the most important output

Million VND (+) or (-)

white_collar Share of managers, professionals,

office & sales personnel

from 0 to 1 (+) or (-)

labormarket_size The number of employed

workers from 15 years old in the province (Hanoi & Ha Tay is considered one province)

subcontract_share Share of the firm revenue that

comes from subcontracting to other firms

local Indicates whether the firm

operates/has their products sold

in their own province only

equal to 1 if the firm only operates inside their province, 0 otherwise

(-)

global indicates whether the firm

operates internationally / has

equal to 1 if the firm operates globally, 0

(+)

their products exported otherwise

vnw_samesector social network size of the firm

with business people in the same sector in the industry

categorical variable from 1

to 4 (**)

(+)

vnw_diffsector social network size of the firm

business people in different sector in the industry

categorical variable from 1

to 4 (**)

(+)

vnw_bank social network size of the firm

with bank officials

categorical variable from 1

to 4 (**)

(+)

vnw_politics social network size of the firm

with politicians/civil servants

categorical variable from 1

to 4 (**)

(+)

(**): Categorical variable – 1: from 0 to 4 contacts, 2: from 5 to 9, 3: from 10 to 19 contacts, 4: 20 or more contacts

Explanation of expected sign of the variable:

age: Longer-established firms has information for outsource decision

average unit cost: Firms with higher unit production cost are more likely to outsource to receive optimal scale On the other hand products with higher cost requires highly expertise and specific resources that firms do not want to rely on another party

size: Smaller firm with smaller production output tends to outsource less

white collar: Firms with more skill intensity have higher incentive to focus on skill and outsource production However these firms may want to protect the high-quality of their products, resulting in less outsourcing