An Elementary Theoretical Approach to the Smiling Curvee with Implications for Outsourcing Industrialisationn

Abstract

This paper explores an economic model to interrogate the validity of the U-shaped curve (often called ‘smiling curve’) to describe sequential stages of a flow of a product from ‘upstream’ to ‘midstream’ and to ‘downstream, commonly used in the management and international business circle. These interdependent stages bear different costs and yield different returns. From the upstream enterprises’ viewpoint, to allow production to be undertaken by someone else in the less profitable midstream is a rational choice of ‘outsourcing’. Meanwhile, to join such a chain by firms in less developed economies seems to be an easy way to industrialise, hence the term of ‘outsourcing industrialisation’.Our findings indicate that the U shape is not as universal and fixed as one might think. For that end, we develop a theoretical model with empirical evidence from a range of industries. It becomes clear that a U-shaped smiling curve mainly exists in labour-intensive and technology-intensive industries where upstream and downstream firms are often more profitable. But in the capital-intensive sector, it is an inverted U shape that dominates the industry. An inverted U can also appear in the technology-intensive sector. In this context, the midstream, where developing economies are often located, is not necessarily disadvantageous in profit-making. This finding collides with common intuition regarding the capital-intensive sector. The implication is that firms in developing economies should engage outsourcing more in the capital-intensive sector despite their alleged lack of capital.Our findings enable us to have some new insight on industrial development strategies on both the firm and country levels in an increasingly globalising world.