Market Structure and Productivity: A Concrete Example

This paper shows that imperfect output substitutability explains part of the observed persistent plant-level productivity dispersion. Specifically, as substitutability in a market increases, the market’s productivity distribution exhibits falling dispersion and higher central tendency. The proposed mechanism behind this result is truncation of the distribution from below as increased substitutability shifts demand to lower-cost plants and drives inefficient plants out of business. In a case study of the ready-mixed concrete industry, I examine the impact of one manifestation of this effect, driven by geographic market segmentation resulting from transport costs. A theoretical foundation is presented characterizing how differences in the density of local demand impact the number of producers and the ability of customers to choose between suppliers, and through this, the equilibrium productivity and output levels across regions. I also introduce a new method of obtaining plant-level productivity estimates that is well suited to this application and avoids potential shortfalls of commonly used procedures. I use these estimates to empirically test the presented theory, and the results support the predictions of the model. Local demand density has a significant influence on the shape of plantlevel productivity distributions, and accounts for part of the observed intra-industry variation in productivity, both between and within given market areas. Recent empirical explorations have left little doubt about the magnitude of plant-level total factor productivity variation: it is enormous. This heterogeneity is also persistent. Perhaps surprisingly, much of the variation cannot be explained by differences between (even narrowly defined) industries. For example, studies reviewed in Bartelsman and Doms (2000) have found 85-to-15 TFP percentile ratios of between 2:1 and 4:1 within various four-digit SIC industries. Productivity growth also exhibits huge within-industry dispersion: Haltiwanger (1997) finds that only 8.5% of productivity growth variation is explained by four-digit industry. An assortment of theoretical work has arisen attempting to explain the sources of such diversity. The great majority of this research focuses on supply-side (production) causes, such as idiosyncratic technology shocks, management influences, R & D efforts, or investment patterns. In this paper I turn my attention to the demand (i.e., output market) side, and look at how market structure can cause such within-industry heterogeneity to persist. I argue that acrossplant differences in output market conditions are partially responsible for observed persistent productivity dispersion—and in fact, the dispersion of that dispersion. The specific channel through which this posited influence flows is variable output substitutability in a world of product differentiation. The more difficult it is for consumers to switch between competing suppliers, the greater the amount of dispersion that can be sustained. I will focus here on a particular component of substitutability, geographic market segmentation created by transport costs, and examine its impact on productivity dispersion within a single industry. The purpose of this paper, however, is not to give the final word on transport costs and productivity in a particular industry. Instead, I hope to show through a detailed case study—where many potentially confounding factors are held constant—how transport costs as well as other substitutability factors might impact productivity variation and levels throughout the economy. The rationale for using output market effects, and substitutability specifically, to explain the degree of within-industry productivity heterogeneity is more readily apparent when one considers how such wide efficiency variation can exist in equilibrium. After all, output should tend to be reallocated to more productive plants over time. High-productivity plants are able to produce output at lower cost than industry rivals, allowing them to grab additional market share 1 Just a sampling includes Jovanovic (1982) and Ericson and Pakes (1995). See Bartelsman and Doms (2000) for a review of this literature. 1 2 There are supply-side stories that can explain persistent dispersion as well. I simply want to highlight another piece of the puzzle, to my knowledge not previously formalized, from the demand side. by undercutting their opponents’ prices without sacrificing profit rates. One might expect this process to redistribute most or all of an industry’s production to a select few high-productivity plants. Output and productivity patterns like this are not usually observed in the data, however; the overwhelming weight of empirical evidence indicates widely varying producer productivity levels within nearly every industry. What prevents this output reallocation process from occurring? Some possible explanations, such as demand booms (which allow nearly anybody to operate profitably temporarily), are short-run stories and cannot explain why large productivity dispersion is observed throughout the business cycle. Persistent technological disparity driven by supply-side factors may play an important role. However, there is almost certainly more to the story. Imperfect output substitutability is a long-run explanation that is likely to account at least in part for the observed productivity dispersion. For example, microbrewers may not produce their output at nearly as low a unit cost as Miller or Anheuser-Busch, but they can survive (and even thrive) in the long-run marketplace because segments of the population prefer microbrews to mass-produced beer and are willing to pay the higher unit prices necessary to support the microbrewers, rather than buy from their competitors. This paper examines how imperfect substitutability creates persistent across-plant productivity dispersion within a four-digit SIC industry. The testable premise of the above discussion is that markets having less output market segmentation (i.e., greater substitutability) should have plant-level productivity distributions with lower dispersion and higher central tendency than distributions in more segmented markets. The intuition behind this notion is simple. Greater substitutability makes it easier for customers to shift purchases to more efficient producers, driving low-productivity plants out of business and raising the bar for successful