UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM ERASMUS UNIVERSITY ROTTERDAM INSTITUTE OF SOCIAL STUDIES THE NETHERLANDS VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS OUTSOURCING AND TOTAL FACTOR PRODUCTIVITY: EVIDENCE FROM VIETNAMESE SMALL AND MEDIUM-SIZED ENTERPRISES BY PHAM THI HOA TIEN MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, December 2017 UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS OUTSOURCING AND TOTAL FACTOR PRODUCTIVITY: EVIDENCE FROM VIETNAMESE SMALL AND MEDIUM-SIZED ENTERPRISES A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By PHAM THI HOA TIEN Academic Supervisor: PHAM THI BICH NGOC HO CHI MINH CITY, December 2017 DECLARATION This is to certify that this thesis titled “Outsourcing and total factor productivity: evidence from Vietnamese Small and Medium-sized Enterprises”, which is submitted in fulfillment of the requirements for the degree of Master of Arts in Development Economics to the Vietnam Netherlands Program (VNP) The thesis constitutes only my original work and due supervision and acknowledgement have been made in the text to all material used Page i ACKNOWLEDGEMENT First, I would like to thank my supervisor - Dr Pham Thi Bich Ngoc for her support, advice, and valuable guidance during the thesis process Secondly, I would like to thank Dr Truong Dang Thuy who also gave me useful advice for my thesis I also would like to extend my thanks to the Vietnam – Netherlands program, professors, staffs, and classmates, for their help, encouragement and incredible knowledge Finally, I would like to thank my family and friends, who always unconditionally supported me in not only the thesis writing but also my whole life Pham Thi Hoa Tien Ho Chi Minh City, December 2017 Page ii ABBREVIATIONS SMEs : Small and Medium-sized Enterprises R&D : Research and Development GDP : Gross Domestic Product ROE : Return on equity OECD : Organization for Economic Co-operation and Development ILSSA : Labor Studies and Social Affairs MOLISA : Ministry of Labor, Invalids and Social Affairs SSE : Stockholm School of Economics GSO : General Statistic Office TFP : Total Factor Productivity TCT : Transaction Cost Theory RBV : Resource-Based View RDT : Resource Dependency Theory GMM : Generalized Method of Moment 2SLS : Two Stages Least Square CDM : Crépon, Duguet and Mairesse IV : Instrument Variables OP : Olley and Parker LP : Levinsohn Petrin OLS : Ordinary Least Square FE : Fixed Effects RE : Random Effects FEM : Fixed Effects Model REM : Random Effects Model Page iii ABSTRACT This study aims to examine the impacts of outsourcing activities on firms total factor productivity of 4,549 Vietnamese enterprises by using a panel dataset of Small and Mediumsized Enterprises during the period from 2005 to 2013 It is supposed to contribute to existing empirical, literature by employing the complementarity and substitutability test to investigate the effect of outsourcing on firms’ total factor productivity The total factor productivity in this study is calculated based on Levinsohn Petrin method Furthermore, the Fixed Effects with Driscoll Kraay standard error model, which has the advantage of correcting the problem of autocorrelation and heteroskedasticity is applying to get the better result of outsourcing and firms’ total factor productivity relationship estimation The finding proves a significant positive nexus between outsourcing and firms’ total factor productivity and confirms that firms spend more on outsourcing will get higher total factor productivity index These results are supported by a majority of empirical papers about relationship of outsourcing and total factor productivity and outsourcing’s theories From the findings, this study will give some discussion as well as some policy recommendations for firms to enhance their productivity Key words: Vietnamese SMEs, Total factor productivity, Driscoll Kraay Page iv TABLE OF CONTENT ACKNOWLEDGEMENT i ABSTRACT iv TABLE OF CONTENT v LIST OF TABLES viii LIST OF FIGURES ix CHAPTER INTRODUCTION 1.1 Research problems 1.2 Research objectives and questions 1.2.1 Research objectives 1.2.2 Research questions 1.3 Data and methodology 1.4 Thesis structure CHAPTER LITERATURE REVIEW 2.1 Outsourcing 2.1.1 Definition of outsourcing 2.1.2 Theoretical background for outsourcing 2.1.2.1 Transaction Cost theory 2.1.2.2 Resource dependency theory 2.1.2.3 Resource-based view theory 2.2 Total factor productivity 10 2.2.1 Definition 10 2.2.2 Measurement of total factor productivity 10 Page v 2.3 Empirical studies- outsourcing and TFP 13 2.4 Conceptual framework 14 CHAPTER DATA AND RESEARCH METHODOLOGY 16 3.1 Data source 16 3.2 Research model 16 3.2.1 Dependent variable 18 3.2.2 Independent variables 18 3.2.2.1 Explanatory variables 18 3.2.2.2 Control variables 19 3.3 Methodological approach 25 3.4 Econometric approach 26 3.4.1 Method for step 26 3.4.1.1 3.4.2 Levinsohn Petrin 26 Method for step and step 27 3.4.2.1 Ordinary least square 27 3.4.2.2 Fixed effects model 28 3.4.2.3 Fixed effects model with Driscoll Kraay standard error 28 CHAPTER EMPIRICAL RESULTS 30 4.1 Summary statistics and analysis 30 4.1.1 Data summary 30 4.1.2 Summary statistics 33 4.1.3 Model specification and diagnostic testing 35 4.2 Empirical results 36 Page vi 4.2.1 Step 1: Calculate total factor productivity at the firm level 36 4.2.2 Step 2: The difference between firms with and without outsourcing 37 4.2.3 Step 3: The relationship between outsourcing expenditure and firms’ TFP 39 CHAPTER CONCLUSION AND DISCUSSIONS 41 5.1 Main findings 41 5.2 Discussion and suggested policies 42 5.3 Limitation and potential future research 44 REFERENCE 46 APPENDIX 52 Page vii LIST OF TABLES Table 3.1 Number observations in dataset 2005-2013 16 Table 3.2 Variables description 23 Table 4.1 Observations by type of firms Error! Bookmark not defined Table 4.2 Observations by type of firms in the period 2005-2013 31 Table 4.3 Firms types with and without outsourcing 31 Table 4.4 Firms sizes in the period 2005-2013 32 Table 4.5 Descriptive statistics of TFP and other variables 33 Table 4.6: Firms sizes with and without outsourcing 34 Table 4.7 Correlation between variables 35 Table 4.8: Comparision of OLS, Fixed Effect and LP estimation 36 Table 4.9 : Regression results of different TFP between outsourcing firms and none outsourcing firms 38 Table 4.10: Regression results of TFP within outsourcing firms 39 v Page viii by SMEs Outsourcing services help SMEs overcome their constraint in some aspects Hence, employ more outsourcing activities (which is represented for spending more outsourcing expenditure) will open more opportunities for SMEs to be more efficient, as a consequent the more spending on outsourcing expenditure the higher TFP Besides, the results of regression for whole dataset or group of outsourcing firm show that control variables, which are presented for firm characteristics such as firm age and capital structure are positively correlated with firm total factor productivity In other words, results confirm that firms, which have more experiences might be performed more efficient Firms those have higher debt to total assets ratio are expected to well-perform than firms with less 5.2 Discussion and suggested policies Outsourcing or offshoring has become a modest trend in business in recent years (Palugod & Palugod, 2011) In recent year, the outsourcing activities are applied widely by MNC in the world It cannot be denied that the contribution of the advantages of outsourcing (lower cost, come over resources constrain, other) to the success of business The fact demonstrates that there is variety of companies, which successfully apply outsourcing such as Apple, Nike, Boeing and other (Gilley & Rasheed, 2000) Vietnam is not an exceptional case while outsourcing is increasing significantly in recently (Nahar & Kuivanen, 2010) However, the most of companies in Vietnam play the role as vendors or sub-contractors, not as outsourcing-users According to the survey of Neilson, there are some Vietnamese companies, which gain more revenue from being an offshore subcontractor such as FPT, LacViet, ERAS, LogiGear Vietnam and other Besides that, the number of managed server providers is also increasing For example of some famous company name offer inshore outsource services for SMEs in Vietnam such as GEMADEPT (warehouse and logistics outsourcing services), FPT software (information technology outsourcing), L&A (human resources service outsourcing), NMS (customer services outsourcing), and other Although, we not have the identical example or the noticeable number show the actual using outsourcing in Vietnam However, it is obvious to see that those outsourcing services help business actors to solve their constraint and offer the flexibility in some aspects Furthermore, it could help firms to concentrate on develop their core competencies These advantages of outsourcing contribute to SMEs also be Page 42 demonstrated though the increasing number of using outsourcing services in Vietnam In addition, the finding of this study confirm again that the effect of outsourcing is also important for Vietnamese SMEs in the integration process with international markets since it benefits can enhance firms’ performance and contribute to develop economy of Vietnam, especially increase the competitiveness of Vietnamese enterprises Based on the empirical findings, this study would prove some recommendations to improve outsourcing practices in Vietnam for both the Government and enterprises For the Government Adopt policies to encourage and support the implementation of outsourcing in business, educate the outsourcing advantage awareness for Small Medium sized enterprises The majority participants of Vietnamese economy are small and medium-sized enterprises and these SMEs play a vital role in nexus to employment, contributing to overall GDP Hence, it is necessary to have policies, which create the favorable conditions to enhance the productivity of Vietnamese SMEs Besides that, being aware of outsourcing advantages is necessary since may help enterprise improve their productivity However, the development of outsourcing activities in business actor has to be come from cooperation between the Government and enterprises Therefore, Government should adopt policies to enhance outsourcing knowledge for enterprises by organizing seminars to present benefits of outsourcing, open more economic forums across country to provide enterprise the chance to access opportunities for employ outsourcing activities In addition, Government should design special programs to support and encourage enterprises develop their outsourcing activities such as reduced interest rates with flexible terms and conditions since the capability of enterprises alone may be insufficient to employ outsourcing activities For the enterprises: Enhance the knowledge about benefits of outsourcing activities on productivity within enterprises: The increasing of outsourcing advantages knowledge should begin from the heads of companies, managers or those who have vital role in orienting the development of firm Their decisions have huge impacts on both business strategies and performance of Page 43 enterprises, especially for small and medium-sized enterprises (SMEs) In this sense, firm’s managers are expected to acknowledge and understand the important role outsourcing activities in improving their efficiency first, and after that they may lead firms to employ outsourcing activities This study proposes some evidences for positive relationship between outsourcing activities and firm total factor productivity in for specific case of Vietnamese SMEs Therefore, enterprises are encouraged to imply more outsourcing activities to be more productive Propose long-term strategies for implying outsourcing activities with appropriate steps in different periods: The implementation of outsourcing activities with immediately improving their productivity would be not a simple matter that firm can achieve in the short term This practice is due to the limitations of firm’s resources, especially the financial capability Furthermore, this research argues that when implying outsourcing activities, larger firms intend to have higher productivity since their financial resources are able to cover the initial cost of outsourcing implementation Hence, smaller enterprises should have carefully plans and strategies to imply outsourcing step-by-step in order to improve their productivity In addition, the result of this study reveals that older firms will get higher total factor productivity index than younger firms when applying outsourcing This is easy to understand since older firms with more experiences will get higher number of total factor productivity For firms, those have outsourcing activities already, results from this study suggest that firm should spend more expenditure on outsourcing activities by contracting out more low value added internal activities to enhance their total factor productivity 5.3 Limitation and potential future research Despite the fact that this study is carried out strictly with theoretical background, literature review and standard econometric method However, the study still faces some limitations that need to overcome in future researches to gain better results Firstly, this study only considers the effect of outsourcing to Vietnamese SMEs’ total factor productivity in two dimensions: dummy outsourcing variable, outsourcing expenditure intensity but unable to measure outsourcing in term of different types of Page 44 outsourcing such as onshore outsourcing versus offshore outsourcing, labor outsourcing versus services outsourcing and so on Therefore, we suggest that further research should compare the different outsourcing’s effect on TFP due to different type of outsourcing Secondly, the rationale of firm to making outsourcing decision is not studied in this research There are many reasons for employing outsourcing such as the problem of constraints capacity due to equipment, capacity constraints due to technology, constraints of labor, and so on Hence, understanding the motivation of enterprises for outsourcing, we can define which constrain matters that business actor can solve better by applying outsourcing The expansion of this topic for future research could be which rationale deciding the better practices of outsourcing Finally, this research utilizes innovation as dummy variable in control variable group to strengthen the result of regression; therefore, it is lack of many other effects of innovation on TFP under outsourcing’s effect circumstances As a result, investigating the interaction of innovation and outsourcing impact on TFP will be a new problem for further research In sum up, despite some 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Yuchtman, E., & Seashore, S E (1967) A system resource approach to organizational effectiveness American sociological review, 891-903 Page 51 APPENDIX APPENDIX 1: EMPERICAL STUDIES ON FIRM’S PRODUCTIVITY Authors Productivity measurement Period & Sample Methodology Cucculelli et al.(2014) Xth Capitali- Unicredit Italian firms database (2004 – 2006) Levinsohn and Petrin (2003) OLS De Kok et al (2006) Dutch manufacturing firms database (1994-1999) Huergo and Jaumandreu (2004) Spanish manufacturing firms database ( 1990 – 1998) Dhawan (2001) US COMPUSTAT data (19701989) Margaritis and Psillaki (2010) France firms database of Chemicals, Computers and Textiles industries ( 2002 -2005) OLS Ratio of debt and total asset Kim(2006) Korean manufacturing firms ( 1991 -1998) Pooled OLS TFP profitability (profit/total assets), asset structure (fixed tangible assets/total assets), growth opportunities (intangible assets/total assets), size firm age, capital stock, wages, international term, Keller and Yeaple (2009) COMPUSTAT data (1987 – 1996) Olley and Pakes OLS TFP FDI , international trade TFP Independent variable firm age, family-owned status and control variables (firm size, human capital, dummy firm in stock market, dummy sector, capital intensity and ownership status) firm age and control variable (firm size is log of total wage), dummy: organizational structure and dummy sectors in manufacturing industry) OLS Firm’s growth rate Semiparametric regression firm age , innovation, control variable (firm size , dummy sectors in manufacturing Productivity growth industry, dummy merge/acquisition , capacity utilization) OLS Ratio of output and labor capital and labor ratio, labor, capital Page 52 APPENDIX 2: EMPERICAL STUDIES ON RELATIONSHIP BETWEEN OUTSOURCING AND FIRM’S PRODUCTIVITY Authors Martin Falk (2012) Jan Mưhlmann Alberto López (2004) Peter et al (2003) Antonioli et al (2015) Lin, S., & Period and sample Methodol Outsourcing ogy measurement EUK-LEMS data OLS Imported material 1995-2000 and purchased services from abroad Eurostat data OLS Dummy for Statistics domestic Netherlands (CBS) outsourcing, international outsourcing Spanish manufacturing Firms ESEE (1990–1999) German dataset of the European Manufacturing Survey 2003 MSE and LSE database (1998–2001) OLS, GMM World Bank’s 2SLS Dummy subcontract, substop, substart Firm’s productivity measurement Result Quality adjust total factor productivity Outsourcing of material is not significant on TFP Positive relationship between purchased services on TFP Negative relationship between international core function outsourcing and TFP Positive relationship between domestic support function and TFP Labor productivity (output per unit labor) TFP This includes total output (Q), capital costs (K), Labor costs (L), energy costs (E), costs of materials (M) and costs of services (S) VAit  Ait K it  Lit Output: sale Outsourcing intensity has a positive effect on productivity Outsourcing is measured as the ratio of total input to total turnover Production inputs the firm’s outsourcing (OUT) Labor productivity : “value added (total turnover minus total inputs) per employee Outsourcing has a strong negative impact on a firm’s labor productivity Growth of (labor) productivity of firm i Material/ services Real output Outsourcing and productivity turns out positive only if considering the externalization of high valueadded activities It is negative in the case of low value-added activities Positive productivity gains from Page 53 Ma, A C (2012) Trade, Production and Protection database (1985– 2001) outsourcing material outsourcing Page 54 APPENDIX 3: TESTING RESULTS Model specification and diagnostic test: * Hausman testing hausman fe re hausman FEDout REDout Coefficients -| (b) (B) (b-B) sqrt(diag(V_b-V_B)) | FEDout REDout Difference S.E -+ D_outsourc~g | 016349 -.0066872 0230362 0059376 firm_age | 0015694 0003812 0011883 0002936 firm_size | 011458 0019834 0094746 0022002 capital_st~e | 0341882 0319271 0022611 0054208 D_inovation | 006221 0111153 -.0048943 0030827 b = consistent under Ho and Ha; obtained from xtreg B = inconsistent under Ha, efficient under Ho; obtained from xtreg Test: Ho: difference in coefficients not systematic chi2(5) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 59.84 Prob>chi2 = 0.0000 * Autocorrelation test xtserial TFP D_outsourcing outsourcing_exp_intensity firm_age firm_size capital_structure D_inovation Wooldridge test for autocorrelation in panel data H0: no first-order autocorrelation F( 1, 2337) = Prob > F = 9.820 0.0017 P< 0.05  Reject Ho * Heterokedasticity test xttest3 Modified Wald test for groupwise heteroskedasticity in fixed effect regression model H0: sigma(i)^2 = sigma^2 for all i chi2 (584) = Prob>chi2 = 1.3e+34 0.0000 Page 55 P< 0.05  Reject Ho * Test that multiple coefficients are zero test D_outsourcing firm_age firm_size capital_structure D_inovation ( ( ( ( ( 1) 2) 3) 4) 5) D_outsourcing = firm_age = firm_size = capital_structure = D_inovation = F( 5, 12933) = Prob > F = 2.15 0.0569 Page 56 ... HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS OUTSOURCING AND TOTAL FACTOR PRODUCTIVITY: EVIDENCE FROM VIETNAMESE SMALL AND MEDIUM- SIZED ENTERPRISES A thesis... This is to certify that this thesis titled “Outsourcing and total factor productivity: evidence from Vietnamese Small and Medium- sized Enterprises? ??, which is submitted in fulfillment of the requirements... Therefore, this study employs total factor productivity to measure firms’ productivity 2.2.2 Measurement of total factor productivity Multifactor productivity or total factor productivity was regularly