Sourcing By Design: Product Complexity and the Supply Chain

TLDR

The auto‑industry literature has examined internal versus external sourcing and identified product architecture as a key contributor to product complexity. This study investigates the joint relationship between product complexity and vertical integration in the luxury‑performance auto sector. Employing a property‑rights framework, the authors argue that high product complexity favors in‑house production and test this with a simultaneous‑equations model on luxury‑performance auto data. The analysis reveals a significant positive relationship between product complexity and vertical integration, suggesting implications for incentive structures and firm performance interpretation.

Abstract

This paper focuses on the connection between product complexity and vertical integration using original empirical evidence from the auto industry. A rich literature has addressed the choice between internal production and external sourcing of components in the auto industry. More recent literature has developed the concept of product architecture as another choice variable that may be one of the important contributors to product complexity. In this paper, we connect these two important decisions and study them jointly. We use the property rights approach to argue that complexity in product design and vertical integration of production are complements: that in-house production is more attractive when product complexity is high, as firms seek to capture the benefits of their investment in the skills needed to coordinate development of complex designs. We test this hypothesis with a simultaneous equations model applied to data from the luxury-performance segment of the auto industry. We find a significant and positive relationship between product complexity and vertical integration. This has implications for optimal incentive structures within firms, as well as for interpreting firm performance.