The effect of import competition on product diversification revisited

• Published date: 01 November 2020
• Date: 01 November 2020
• Author: Juan Santalo,Manuel Becerra,Garen Markarian
• DOI: http://doi.org/10.1002/smj.3194

RESEARCH ARTICLE

The effect of import competition on product

diversification revisited

Manuel Becerra

1

| Garen Markarian

2

| Juan Santalo

3

1

Strategy and Entrepreneurship

Discipline, University of Queensland

Business School, Brisbane, Australia

2

Finance and Accounting Group, WHU –

Otto Beisheim School of Management,

Vallendar, Germany

3

Strategy Department, IE Business

School, Madrid, Spain

Correspondence

Manuel Becerra, Strategy and

Entrepreneurship Discipline, University

of Queensland Business School, Brisbane,

Australia.

Email: m.becerra@business.uq.edu.au

Abstract

Research summary: Bowen and Wiersema, Strategic

Management Journal, 2005, 26, 1153–1171, provide

empirical evidence that U.S. firms decreased their

degree of product diversification as a response to the

increase in import competition in their 1985–1994

study. After replicating their study, we expand it with

alternative econometric analyses and a larger data set.

While we obtain nearly identical results using their

Tobit regressions, the negative impact of imports on

diversification disappears when we control for firm

fixed-effects. Furthermore, using tariffs as instrument

for imports, we find that import competition may even

lead domestic firms to increase their diversification.

The negative relationship between import penetration

and diversification seems to result from the endo-

geneity of imports, which grew more in industries dom-

inated by firms with low diversification at the turn of

the previous century.

Managerial summary: Previous research by Bowen

and Wiersema, Strategic Management Journal, 2005,

26, 1153–1171 showed that when import penetration

grew in the 1985–1994 period in the U.S., firms seemed

to reduce their diversification across industries and

refocus on their core business, presumably to increase

their competitiveness against foreign imports. We repli-

cate their study and reach the opposite conclusion

regarding firms' response to greater pressure from

imports, using enhanced statistical methods and also a

larger database. We conclude that diversified firms are

Received: 26 September 2017 Revised: 23 April 2020 Accepted: 24 April 2020 Published on: 26 July 2020

DOI: 10.1002/smj.3194

2126 © 2020 John Wiley & Sons, Ltd. Strat Mgmt J. 2020;41:2126–2152.wileyonlinelibrary.com/journal/smj

more likely to switch their focus to other industries

when import competition increases in their main line

of business, and this greater flexibility of switching

industries seems to give them an advantage over spe-

cialized firms.

KEYWORDS

competition, diversification, imports, replication

The reasons why firms diversify into new businesses and its implications for competitive advan-

tage have been at the core of research on corporate strategy since the seminal work of Rumelt

(1974). Some scholars argue that diversification dilutes managerial attention among different

businesses and it may be driven by empire-building motivation and managerial risk reduction,

which may reduce firm performance (Berger & Ofek, 1995). In contrast, other scholars highlight

the economies of scope and potential to transfer core competences between related industries

as the basis for the advantages of diversified corporations, which can redeploy their resources

among their businesses in ways that are not possible for specialized firms (Sakhartov &

Folta, 2014). Though Palich, Cardinal, and Miller's (2000) meta-analysis suggests that an

inverted curvilinear relationship between diversification and performance may help reconcile

both perspectives, the accumulated empirical evidence regarding the implications of diversifica-

tion for competitive advantage does not seem to be sufficiently robust to settle the question. For

instance, abundant research in finance obtained before 2000 found evidence in favor of a diver-

sification discount (Berger & Ofek, 1995; Lang & Stulz, 1994), but the negative performance

consequences of diversification seem to disappear after the endogeneity of the diversification

decision is taken into account (Campa & Kedia, 2002; Villalonga, 2004). Ultimately, it is not

clear whether firms increase or decrease their competitiveness by changing their degree of

diversification.

In a key paper that investigates foreign competition and firm diversification strategy, Bowen

and Wiersema (2005), thereafter BW, analyze a Compustat sample of 1,127 U.S. firms from

1985 to 1994, and conclude that these firms reduced their product diversification as a response

to the increase in foreign imports. They further argue that this was done in order to refocus

their attention on their core businesses, which presumably increases their efficiency and poten-

tial to become “world-class”(Bowen & Wiersema, 2005, p. 1154). Indeed, U.S. imports rose

from $22 billion to $2.7 trillion over the period 1960–2015 according to theU.S. Census Bureau,

while it seems that firms have become somewhat less diversified, as least in the last two decades

of the 20th century (D'Aveni and Thomas, 2009). However, correlation does not necessarily

indicate a causal relationship, which is particularly critical in the analysis of diversification and

performance, as finance research in this topic has shown since 2000.

Given the importance of conducting replications to enhance knowledge accumulation and

its robustness across methods, time, and data sources (Bettis, Helfat, and Shaver, 2016; Hub-

bard, Vetter, and Little, 1998; Mezias and Regnier, 2007), we first replicate BW's analysis of

diversification and import competition obtaining very similar results. We also conduct several

additional analyses, also including a bigger and comprehensive database. Our empirical ana-

lyses with firm fixed effects and using tariffs as instrument for import competition suggest that

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