From Russia with Love: The Impact of Relocated Firms on Incumbent Survival
Executive Summary — The relocation of the machine tool industry from the Soviet-occupied zone of postwar Germany to western regions is a unique laboratory for studying the impact of industrial structures on incumbent survival. Typically, geographic agglomerations of similar firms offer benefits to each member firm by reducing the transportation costs for material goods, specialized workers, and industry knowledge among the firms. Of course, tight geographic concentration comes with countervailing costs as firms compete for local inputs. In this paper, HBS professor William R. Kerr and coauthors study the impact of increased local concentration on incumbent firms by considering postwar Germany, when the fear of expropriation (or worse) in the wake of World War II prompted many machine tool firm owners to flee to western Germany, where they reestablished their firms. Key concepts include:
- Relocations significantly increased the likelihood of incumbent failure, which suggests that the costs of increased competition for local inputs dominated the potential benefits from agglomeration economies.
- By contrast, during the same postwar period, new start-up entrants—whose location choices were more opportunistic—were not associated with increased incumbent failure rates.
- The increased failure rates of incumbents in western Germany due to relocating firms was concentrated in regions where labor forces were constrained due to low inflows of expellees from eastern Germany.
- In regions with a significant inflow of expellees and favorable input conditions, there was no effect of relocations on incumbent firms' risk of failure.
- The relocation of the machine tool industry from eastern to western Germany was substantial. In total, a fifth of the industry present in eastern Germany migrated during a narrow window of 1949-1956, representing an 8 percent increase in total industry size for the receiving zones.
- These location choices were made under extreme duress, with little regard to existing business conditions across regions in western Germany.
- Upon arrival, the relocating firms substantially impacted local industrial conditions as they quickly regained much of their former production capacity.
We identify the impact of local firm concentration on incumbent performance with a quasi natural experiment. When Germany was divided after World War II, many firms in the machine tool industry fled the Soviet occupied zone to prevent expropriation. We show that the regional location decisions of these firms upon moving to western Germany were driven by non-economic factors and heuristics rather than existing industrial conditions. Relocating firms increased the likelihood of incumbent failure in destination regions, a pattern that differs sharply from new entrants. We further provide evidence that these effects are due to increased competition for local resources.
Keywords: Agglomeration, competition, firm dynamics, labor, Germany. 36 pages