Effects of Referring Business Partners on Firm Networks and Performance

We study the effect of search frictions in firm-to-firm trade on business performance. We hypothesize that frictions in searching for suppliers and clients—driven by lack of information or lack of trust—may lead to firms having too few business partners and may generate inefficient matches. Both effects limit industry performance. Too few partners constrain firm growth, and limit firms' resilience to shocks such as Covid. And inefficient matches mean that high quality firms may be stuck with low-quality partners, creating misallocation. These effects are potentially important, but presently there is limited evidence on their magnitudes, mechanisms, and implications for industry performance.

To make progress on these issues, we conduct a field experiment with 800 firms in Jiangxi province, China, in which we evaluate the impact of referring business partners on firm networks and performance. We work with firms in the industry producing the Chinese writing brush, the supply chain of which has two layers: input suppliers and final good producers. We used our baseline survey data to identify (supplier, client) pairs that the data suggest would make good partners. Then in 2021 we conducted a randomized controlled trial in which we referred firms in such pairs to each other. To distinguish between mechanisms, in one treatment arm we only provided firms with information about the potential partner, while in another we gave them a sizeable subsidy for the first transaction.  We then conducted a follow-up survey in 2022, and plan to conduct another follow-up in 2023. We intend to measure impacts on the network of firm transactions, as well as on firm performance.

Our study investigates the growth barrier resulting from search frictions in firm-to-firm trade. This topic is plausibly important for low-income countries. Specifically, firm-to-firm trade is essential even at low-income levels, including in the agri-food value chains of low-income countries as well as in manufacturing. And search frictions, due to weak infrastructure and contract enforcement, seem particularly high in low-income countries. Consistent with this view, case studies suggest that supply chain failures were common in the wake of the Covid pandemic in low-income countries such as Nigeria. Thus, the mechanism that search frictions limit partnering, which in turn constrains growth and increases exposure to shocks, is plausibly important for low-income countries.