Working Paper No. 08-10

Trade, Industrial Structure, and Brand

Henry Yen-Heng Chen

November 2008

ABSTRACT

In the past few decades, many Taiwanese firms have served as subcontractors to US and Japanese branding firms. This leads to two questions: 1) Why do most subcontractors not establish their own brands in the final goods market? 2) Would they be more likely to become branding firms under certain conditions? This seems to be a common dilemma for many firms in other newly industrialized or developing countries. This paper builds a simple duopoly model that considers both the vertical and horizontal differentiation in brands. Two players, the US branding firm and the Taiwanese subcontractor, play a two-stage game that decides whether they should cooperate. Under this cooperation scenario, the US branding firm decides to outsource production to the Taiwanese subcontractor and the latter also agrees to take this job. The result shows that without horizontal differentiation, the subcontractor will become a branding firm only if it is subsidized to do so. However, if 1) the brands are horizontally differentiated; 2) the sunk cost to brand is low; and 3) the brand value for the potential branding firm is high enough, the subcontractor might choose to brand and enter the final goods market even without subsidies. This paper also provides empirical evidence that confirms this argument.

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