UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS The influence of labor market size and social capital to outsourcing decision: Empirical study for Small and Medium enterprises in Vietnam A thesis submitted in partial fulfillment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By LE DUY MINH Academic Supervisor: Dr PHAM KHANH NAM HO CHI MINH CITY, DECEMBER 2016 DECLARATION “I certify that the substance of this thesis has not already been submitted for any degree and have not been currently submitted for any other degree I certify that to the best of my knowledge and help received in preparing this thesis and all sources used have been acknowledged in this thesis.” HCMC, December 2016 Signature LE DUY MINH ACKNOWLEDGEMENTS For the completion of this thesis, I would like to express my gratitude to the University of Economics Ho Chi Minh City in Vietnam and the Institute of Social Studies The Hague in The Netherlands for developing the Vietnam – Netherlands Programme for M.A in development economics I would like to express my thanks to my teachers and family who have given me tremendous encouragement for completing this thesis I wish to express a special gratitude to my supervisor, Dr Pham Khanh Nam, for all of his supports and advices during the process of completing this thesis Last but not least, I wish to say thanks to all of my friends during my time in the VNP for being a source of great encouragement ABSTRACT The purpose of this paper is to provide an insight to the impact of labor market size and social capital on the outsourcing decision in Vietnam Small and Medium enterprises, using the data collected in 2013 Logit binary model is employed to explore the effect of labor market size and social capital on firm’s probability to outsource The result indicates that there is connection between firm’s social capital and outsourcing decision While the link between labor market size and outsourcing in Vietnam is not proved to be significant in this research, the study does not reject the importance of market environment to outsourcing but suggest finding a more appropriate variable to quantify market condition Keywords: outsourcing, social capital, labor market size, Vietnam SMEs TABLE OF CONTENTS CHAPTER INTRODUCTION 1.1 Problem Statement 1.2 Research Objectives and Questions 1.3 Scope of Research 1.4 Thesis Structure 10 CHAPTER LITERATURE REVIEW 11 2.1 2.2 Review of Theory 11 2.1.1 Concept of Outsourcing 11 2.1.2 Theoretical studies on outsourcing 12 2.1.3 Factors of Outsourcing Decision 13 2.1.4 Benefits and Risks of Outsourcing 16 2.1.5 Determinants of Outsourcing 18 Review of Empirical Studies 21 CHAPTER RESEARCH METHODOLOGY 23 3.1 Analytical Framework 23 3.2 Econometric Model 24 3.2.1 Model Specification 24 3.2.2 Variables Measurement 25 3.2.3 Model Implementation 28 3.2.4 Data 30 CHAPTER RESEARCH RESULT 34 4.1 Overview of SMEs in Vietnam 34 4.2 Descriptive Statistics 35 4.3 Regression Results 40 CHAPTER CONCLUSION 45 5.1 Conclusion and Policy Implication 45 5.2 Study Limitation 46 REFERENCES 48 CHAPTER INTRODUCTION 1.1 Problem statements Outsourcing is defined as the practice of one firm to contract out their value-creation activities to a third-party vendor, ranging from design, research development and service provision (Hindle, 2005) While this concept is widely thought to be recently prominent, its root may have dated from the 1970s and 1980s in an effort by several firms to raise their efficiency and to look for outside assistance for their peripheral processes (Corbett, 2004) Among the earliest practices of this concept, the outsourcing deal between Kodak Eastman Company & IBM in 1989 received major global attention as Kodak decided to obtain services from the famous IT specialist This agreement, while initially receive criticism and doubt, gradually proved to be effective as Kodak could focus all their resources in their core competency and become a major player in the photography industry (Dickson, 2011) More than 25 years after that business deal, more so with the emergence of information industry, outsourcing has become an integral part in the highly-competitive modern business due to its capability to capture scale economy that results in availability of low resource cost and higher quality due to full attention in the core value-creation process Narayanan (2009) identify four strategic purpose of outsourcing: managing cash flow, managing control over payment, scaling resources and improve the end-product quality Magretta (2003) research in the car industry during 1990s show that firms that take most advantage of outsourcing, like Toyota, Honda & Chrysler earns a considerably higher profit compared to more traditional firm that relies more on their own capability, such as General Motors On the other hand, firms are also exposed to the risk of outsourcing which is the difference between what the outsourcing employers require and what is actually produced by the outsourcing contractors This difference is created due to different reasons, which includes unrealistic expectation from the employers due to inflated information on the capability of the outsourcing subcontractors, misunderstanding between the employers and the contractors over the requirements of the products, generally poor performance by the subcontractors due to the lack of control, conflicting interests Some firms also avoid outsourcing to protect and boost their knowledge knowhow (Hamel & Prahalad, 1994) The benefits that outsource provide, thus, could be greatly restricted by the threats associated with it Outsourcing therefore is a difficult decision to make that requires clear analysis of different influencing factors (Antonietti, 2016) Several studies have focused on the firm’s internal elements that determine an outsourcing decision, which is mostly linked to the transaction cost theory (Michael & Michael, 2011) On the other hand, very limited studies concentrate on the macroeconomics factors that favor or discourage outsourcing environment A positive business environment will foster collaboration based on fostering trust, softening the difference between the outsourcing parties and presenting the firm with wider choice for outsourcing options Social capital is considered as an integral element of the business condition to support outsourcing Bourdieu (1986) defined social capital as “the sum of the resources that the firm can access by virtue of having a durable network of relationship” Another important factor that contributes to the outsourcing decision is labor market size Labor market size is related to the firm’s direct access to human skill and infrastructure thus affects its decision to outsource Vietnamese economy has experienced a major amount of changes from its centrally planned economy until “Doi Moi” policy that replace the inefficient subsided economy with an open and market integrated model (Beresford, 2008) Economy greatly improved during 1990s with the country removing economics border with foreign business partner Growth continues to improve to the peak of 8.5% in 2007, in part due to the Government’s regulation to encourage private sector and improve export and high foreign investment During these years Vietnam emerged as an ideal destination for outsourcing production for foreign companies because of cheap labor with high level of education Local social capital during this time immensely benefited from the knowledge shared by international companies and generally better access to the global resources, even more so after the membership of Vietnam into the WTO in 2007 (Hays, 2014) On the other hand, Vietnamese companies have started to outsource its operation In principle, when a company makes an outsourcing decision, its aim is to maximize profit by comparing costs and benefits stemming from the decision However, there are many barriers and drivers to this decision Understanding these barriers and drivers could help companies to make better decision on outsourcing The study will look into the year of 2013, five years after the economic slump in 2008 due to high inflation and global economy crisis that hampers the economy and sink the annually growth to the bottom in 2012 This paper aims to contribute to the existing literature about the determinants of outsourcing 1.2 Research objectives & questions: The purpose of this research is to analyze the influence of local labor market size and social capital to the outsourcing decisions of Vietnamese small and medium enterprises The main questions that will be answered at the end of this study are:  For Vietnam small and medium enterprises, does labor market size affect the outsourcing decision?  For Vietnam small and medium enterprises, does social capital affect the outsourcing decision? 1.3 Scope of research This research focuses solely on Vietnamese firms as outsourcing employers, not as outsourcing subcontractors It analyzes the impact of social capital and local labor market size to the decisions of Vietnamese firm to outsource or not by employing the logistic regression model Data is collected on Small and Medium Enterprises (SME) of Vietnam for the year of 2013 1.4 Thesis structure The research is categorized into separated chapters:  Chapter 1: Introducing the research This chapter offers a background for outsourcing as a global business practice and a review of Vietnam economy The research gap, question and scope are also identified  Chapter 2: Literature review This chapter examines the existing literature regarding the factors that surrounds the outsourcing decision as well as the role of local labor market size and social capital in outsourcing Theoretical and empirical evidences are analyzed  Chapter 3: Research methodology In this chapter, the econometrics model will be determined with the purpose of answering the research question The dataset and variables used in the model will be presented and explained in full detail  Chapter 4: Research Results This chapter presents the important information regarding each individual variables and their connection after conducting the research methodology  Chapter 5: Conclusions and policy implementation Key findings and areas of possible improvement for future research will be identified 10 Data Description Independent variables will be summarized in table below Table 8: Explanatory Description Variable Obs Mean Std Dev Min Max Median Age 2382 15.512 9.943 76 13 Subcontract share 2382 0.01 0.053 0.87 Average unit cost 2382 4774.8 37334.8 0.02 960000 72 Firm size 2382 10.11 15.162 100 White collar 2382 0.394 0.22 0.33 Labor market size 2382 2490759 1385363 661200 3978000 Same sector contact 2382 1.784 0.964 Different sector contact 2382 3.092 0.969 Bank contact 2382 2.037 1.154 Politics contact 2382 2.237 1.097 4.3 Regression results Model analysis and results log 𝒑 (𝒀𝒊𝒑=𝟏) 𝟏−𝒑(𝒀𝒊𝒑=𝟏) = 𝑎0 + 𝑎1 x 𝑎𝑔𝑒𝑖 + 𝑎2 x 𝑎𝑣𝑒𝑟𝑎𝑔𝑒_𝑢𝑛𝑖𝑡𝑐𝑜𝑠𝑡𝑖 + 𝑎3 x 𝑤ℎ𝑖𝑡𝑒_𝑐𝑜𝑙𝑙𝑎𝑟𝑖 + 𝑎4 x 𝑠𝑖𝑧𝑒𝑖 + 𝑎5 x 𝑠𝑢𝑏𝑐𝑜𝑛𝑡𝑟𝑎𝑐𝑡_𝑠ℎ𝑎𝑟𝑒𝑖 + 𝑎6 x 𝑙𝑜𝑐𝑎𝑙𝑖 + 𝑎7 x 𝑔𝑙𝑜𝑏𝑎𝑙𝑖 + 𝑏1 x 𝑚𝑎𝑟𝑘𝑒𝑡𝑠𝑖𝑧𝑒𝑝 + c1 x 𝑣𝑛𝑤_𝑠𝑎𝑚𝑒𝑠𝑒𝑐𝑡𝑜𝑟𝑖 + c2 x 𝑣𝑛𝑤_𝑑𝑖𝑓𝑓𝑠𝑒𝑐𝑡𝑜𝑟𝑖 + c3 x 𝑣𝑛𝑤_𝑏𝑎𝑛𝑘𝑖 + c4 x 𝑣𝑛𝑤_𝑝𝑜𝑙𝑖𝑡𝑖𝑐𝑠𝑖 + ε Marginal effect While the coefficients and z in the regression results provide information for the direction of impact between the explanatory variables and the dependent variables, it does not estimate the change in the probability of outsourcing relating to the change in 40 each independent variable Marginal effects will be used to solve this issue We will take the marginal effect at the mean (MEM) and average marginal effect (AME) Different from the MEM that use the mean at each independent variable as a benchmark, AME takes into account the observed level covariates thus using the benchmark that better represent the sample AME also treats binary variable (that takes only value of and 1) in a better way rather than taking the value of 0.5 which is not particularly meaningful The regression results with marginal effect are described in table below: 41 Table – Regression results Outsource Social Capital Same sector contact Different sector contact Bank contact Politics contact Labor market size Coefficients MEM dy/dx AME Coefficients 0.043 0.001 0.001 (0.121) (0.003) (0.004) 0.284 ** 0.008 ** 0.01 ** (0.138) (0.004) (0.005) 0.21 ** 0.006 ** 0.007 ** (0.102) (0.003) (0.004) -0.118 -0.003 -0.004 (0.111) (0.003) (0.004) -1E-8 -3E-10 -4E-10 (8E-08) (0) (3E-9) -0.0007 -2E-5 -2E-05 (0.012) (0.0003) (0.0004) 2.886 ** 0.077 ** 0.1 ** (1.192) (0.032) (0.041) -4E-6 -1E-7 -1E-07 (6E-6) (0) (2E-07) 0.008 0.0002 0.0002 (0.006) (0.0002) (0.0002) -1.56 ** -0.041 ** -0.054 ** (0.686) (0.017) (0.024) -0.726 *** -0.022 *** -0.025 *** (0.253) (0.008) (0.006) 0.662 0.024 0.03 (0.444) (0.023) (0.026) Firm control variables Age Subcontract share Average unit cost Firm size White collar Local Market Global Market 42 _cons -3.659 (0.671) Num Ob 2382 Pseudo 𝑹𝟐 0.0783 % correctly specified 96.5% Notes: Standard errors are given in brackets *** Significant at 1%; ** significant at 5% * significant at 10% At 95% level of confidence, it could be observed that the percentage of share of revenue from subcontract activities, white collar worker, the market in which the firm operates, the network size with business persons in different sector and the network size with bank personnel have significant impact on the probability of outsourcing decision Under this result, the firm’s general social capacity could be considered important to its outsourcing tendency Connection with the different sectors in the same industry provides the firm with knowledge and trust that is useful for outsourcing decision Connection with the bank personnel represents the firm capability to have higher control for the financial performance of their subcontracting partner, raising the probability of outsource For the firm internal characteristics, firms that are subcontractors themselves may have more incentives to outsource to take advantage of scale as much as possible Firms are less probable to outsource if their operation market is only inside their province which is appropriate since local firms could themselves directly take advantage of the labor/resources inside their commune/district/province The share of white collar workers, which represents the skill intensity of the firm’s product, has a negative significant impact on outsourcing The reason could be that with the economics characteristics of Vietnam, the cost reduction effect of outsourcing is outweighed by the incentive of the firm to protect their knowledge base and keep their products under high quality 43 Another variable of interest in our study is labor market size Under the logit model the labor market size does not show significant effect to outsourcing decision (z= 0.16) Perhaps labor market size may not be sufficient to characterize the market factors that might have conditional relation with outsourcing Model testing This study uses Wald test to see the interaction possibility between labor market size and the network size, which may occurs since with a higher labor market size, firm may have more capability to expand on their contact network interaction variables are created between these independent variables (labormarket_size * labormarket_size, labormarket_size * vnw_samesector, labormarket_size * vnw_diffsector, labormarket_size * vnw_bank, labormarket_size * vnw_politics) The result is obtained in table below The null hypothesis is that the coefficients of five mentioned regressor are all zero and there are no interaction effects Table 10 – Wald test result chi2 ( 4) = 2.93 Prob > chi2 = 0.5704 The p value is 0.5704, so the null hypothesis is not rejected at 10% level It is then statistically safe to reject the interaction between labor market size and firm’s social capital 44 CHAPTER CONCLUSION 5.1 Conclusion and policy implications As there is a lack in the existing literature for Vietnamese outsourcing activities, this study attempts to close the research gap by providing an analysis of outsourcing decision for SME companies in Vietnam It also aims to complement the existing literature on the key determinants of outsourcing decision at firm-level, with the most focus on labor market size and social capital Data is collected by using SME Questionnaire – survey of small and medium scale manufacturing enterprises (SME) in Vietnam – for 2013 First of all, the description analysis shows that SMEs in Vietnam are not often the outsourcing employers In general, the weakness of Vietnamese firms as outsourcing subcontractors in turns leads to the low outsourcing decision from Vietnam SMEs outsourcing employers For low-skill and low-cost labor, Vietnam has an abundance of this labor market that SMEs in Vietnam could actually integrate directly into their organizational production without the need to outsource Vietnam also lacks the highskilled labor force with in-depth expertise that provides the outsourcing employers with strategic benefits In the regression results, social capital – which is quantified by the important contact network size that the firm possesses – is significantly and positively related to the probability at which the firm choose to outsource The entrepreneurship of the firm, reflected by their capability and tendency to build on their social capital and network contacts, provides firm with necessary information, personal goodwill and market knowledge that ultimately reduce transaction cost between outsourcing employers and outsourcing subcontractors This result also complements the study of Akbari of Iranian firms in different industry that firm’s access to market knowledge and resources increases their chance of outsourcing (Akbari, 2013) and the study of Antonietti for Italian firms that social capital positively affects outsourcing decision (Antonietti, 2016) 45 Local labor market size, which represents the concentrating of human capital and resources inside the area where the firm located in, is hypothesized to have a negative impact on outsourcing decision In this empirical result however, this variable does not have a significant relationship with outsourcing decision The study however does not reject the influence of market factors into outsourcing decision, but suggests other variables that better represent this relationship Other firm control variables, such as share of white-collar worker, the market scope where firm operates at and share of revenue from subcontracting activities also have a significant relationship with outsourcing decision This reflects that different functional characteristics of firms lead to different probability of the firm to outsource If the Vietnamese policy makers aims to encourage firm’s outsourcing to take full advantage of its benefit, they have to solve the issue of how to better connect firms with each other to expand on their social capital capacity, as well as how to build a business environment for trust and collaboration that encourage firms to share information and knowledge with each other in a honest and combined manner A focus into the in-depth skill in education also benefits outsourcing activities in Vietnam in a long-term, as it provides a competitive advantage to Vietnam current labor force 5.2 Study Limitation The limitation of this study will be listed to present further research into this topic in the future The first limitation is the lack of data on the more in-depth firms’ internal factors that influence outsourcing decision Previous empirical studies confirm the importance of R&D, firm level of innovation and production stages specific information to outsourcing There is thus an incentive to conduct a qualitative analysis to gain an insight of the importance of such factors and collect these factors’ information accordingly Since data is only collected in 10 provinces, the sample used does not fully represent the whole country thus further update on all provinces will be expected in the future 46 The second limitation is related to the use of labor market size to represent market related factors that influence outsourcing Firstly, it is perhaps a better way to calculate labor market size based on the area (not the province) the firm is operated with consider to the industry size in the same group As one firm often has connection outside their province boundary and normally with only the sector that is related to their industry group, industry-group size per area could be valuable information to gain insight on the true labor market size for outsourcing, or in general Secondly, a data collection in market-specific variables, such as development and trust, could be desirable to better reflect the relationship between market and outsourcing The final limitation is the use of the 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