Diversification, Vertical Contracting and Diseconomies of Scope: Evidence from the Taxicab Industry

Abstract

This paper studies how firms reorganize following diversification. We propose that firms use outsourcing, or vertical dis-integration, to reduce scope-induced governance costs that arise following diversification. We also consider the source of scope diseconomies, and argue that different underlying mechanisms generate contrasting predictions about the link between within- firm task heterogeneity and the incentive to outsource following diversification. We test these propositions using micro-data on taxicab and limousine fleets from the Economic Census. The results show that taxicab fleets outsource, by shifting towards owner-operator drivers, when they diversify into the limousine business. Moreover, the magnitude of this shift toward driver ownership is larger in less urban markets, where the tasks of taxicab and limousine drivers are similar, but compensation systems differ. The findings suggest that: (1) firms use outsourcing to manage diseconomies of scope; and (2) that inter-divisional conflicts are an important source of scope diseconomies in related diversification.

Keywords: Diversification, diseconomies of scope, adaptation, outsourcing, asset ownership.

JEL Classification: D2, L22, L23, L9,