Corporate Innovation along the Supply Chain

The importance of customer demand on motivating supplier innovation has long been recognized, and feedback from customers plays a key role in this “demand-pull innovation” process. Timely reception of feedback, accurate interpretation of requests, and prompt adjustment in intermediate stages are critical to the ultimate success of innovation, and they all require frequent and intensive interactions between suppliers and customers. With the rapid development of transportation and communication tools, does locating closer to major customers remains an important determinant to suppliers’ innovation success nowadays? In “Corporate Innovation along the Supply Chain (June, 2019)”, Yongqiang Chu, Xuan Tian, and Wenyu Wang empirically investigate this question.

Finding a correlation between supplier-customer proximity and supplier innovation tells us little about the causality, because location choices of suppliers and customers are likely endogenous and are affected by unobservable firm characteristics and economic conditions, which in turn can affect supplier innovation. The authors overcome this identification challenge by exploiting plausibly exogenous shocks caused by customer relocations. Specifically, in the Compustat segment customer database they employ, customers are much larger than their suppliers (often more than 100 times larger). Hence, it is reasonable to assume that large customers are unlikely to change their locations in response to factors related to their suppliers that are much smaller. This feature makes it possible to use customer firm relocations as plausibly exogenous shocks to the geographic proximity between suppliers and customers.

Using a generalized difference-in-differences method, the authors find that the geographic proximity between the supplier and its major customer has a positive effect on the quantity, quality, and efficiency of supplier innovation, measured by patent counts, the number of citations per patent, and the ratio of patent counts to the R&D investment, respectively. To explore the underlying economic channels of these findings, the authors further document that geographic proximity has a more pronounced effect on supplier innovation when the customer itself is more innovative and when the customer and its supplier are closer in technological space, where customer feedback is more relevant and informative. The authors also find that when a customer relocates closer to (away from) a supplier, the supplier's citations to this customer's patents increase (drop) while its citations to other patents remain unaffected, indicating a weakened information flow between the supplier and customer.   

Read full article at https://doi.org/10.1287/mnsc.2017.2924.

REFERENCE

Yongqiang C, Tian X, and Wang W (2019). Corporate Innovation along the Supply Chain. Management Science 65(6):2445-2466.

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