Keywords: vertical integration, quality upgrading, trade, Peru
JEL codes: D2, O1
This paper studies the relationship between a firm’s organizational structure and output quality. The setting is a large manufacturing sector in Peru where plants produce a vertically differentiated but otherwise homogeneous product for export: fishmeal. We link customs data to plant level data on each shipment’s quality grade, transaction level data on supplies, and GPS measures of supplier (fishing boat) be- havior. We start by documenting a robust association between the quality grade of a firm’s exports and the share of its inputs that comes from vertically integrated suppliers at the time of production. To understand the source of this relationship, we first show that classical theories of the firm predict that, in incomplete contracts settings, owning productive assets upstream may help a subset of downstream manufacturers attempting to produce high quality output to incentivize quality-effort from the assets’ operators. This explanation finds empirical support: in a given supplier-plant pair, the supplier delivers higher quality inputs (fresher fish) when integrated, and does so comparatively more during periods when (i) the plant aims to produce high quality output, and/or (ii) exogenous variation in upstream production (plankton) conditions makes quality-effort more costly. Finally, we show that firms source more of their inputs from integrated suppliers when faced with firm-specific shocks to demand for high quality exports. These results document an overlooked motivation for vertical integration and that strategic changes in organizational structure help manufacturers in developing countries achieve export success.