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Multi-Product Firms , Industry Mix , and Product Switching

This paper examines firms and the products they manufacture — and abandon — over time. We find strong relationships between product switching and a number of microand macroeconomic variables, including firm performance, aggregate manufacturing growth and product diversification. Most importantly, product switching is a very important — and active — margin of firm adjustment that is positively correlated with firm outcomes. Two-thirds of U.S. manufacturing firms alter their product mix every five years, and the products added and dropped account for approximately 50 percent of total firm output. Firms that switch products also exhibit significantly higher contemporaneous output, employment and productivity growth than firms that leave their product mix unchanged. Product switching also plays a prominent role in the overall growth of U.S. manufacturing. The contribution of product switching to aggregate output growth is an order of magnitude larger than that of plant entry and exit. Observation of product-level production by firms yields insight into demand and supply complementarities across products and sectors. We find that there are significant asymmetries in the routes firms take in assembling a particular bundle of products and that product diversification is not synonymous with mergers and acquisitions. The vast majority of product and industry additions by continuing firms are done within existing facilities already owned by the firm. The prevalence and importance of product switching highlight the need for a dynamic theory of the firm that emphasizes product choice. We develop a framework that models a firm’s incentives to alter its product mix as a function of evolving firm, product and industry characteristics, as well as the interactions of these characteristics, over time.