Related Diversification and Outsourcing in the Taxicab Industry

This paper studies how firms reorganize after diversifying into related businesses. Specifically, we propose that outsourcing is one way to reduce the coordination costs that arise in multi-divisional firms. We, also, examine the mechanisms underlying coordination costs, and show how alternative theories lead to contrasting predictions about the link between diversification and outsourcing. We test these propositions using novel micro-data on taxicab and limousine firms from the Economic Census. The results show that taxicab fleets outsource, by shifting ownership of taxicabs to drivers, when they diversify into the limousine business. Moreover, the magnitude of the shift toward driver ownership is larger for firms in less urban markets, where the tasks of taxicab and limousine drivers are similar, but compensation systems differ. These findings suggest that firms use outsourcing to mitigate coordination costs associated with related diversification, particularly when employees in different divisions have heterogeneous incentives or ability but perform similar tasks