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

This paper studies how firms reorganize following diversification, proposing that firms use outsourcing, or vertical dis-integration, to manage diseconomies of scope. We also consider the origins of scope diseconomies, showing how 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 firms outsource, by shifting the composition of their fleets towards owner-operator drivers, when they diversify into the limousine business. The magnitude of the shift toward driver ownership is larger in less urban markets, where the tasks performed by taxicab and limousine drivers are more similar. These findings suggest: (1) firms use outsourcing to manage diseconomies of scope at a particular point in the value chain and (2) inter-agent conflicts can be an important source of scope diseconomies.