The profitability implications of supplier concentration during economic recession and restoration: the moderating role of supply localization

Economic recessions and subsequent restorations significantly impact supply chain dynamics, altering demand and supply resource availability. Firms' profitability hinges on effectively managing supplier relationships during these fluctuating economic periods. This study examines the complex relationship between supplier concentration and firm profitability, specifically focusing on how this relationship changes across recessionary and restorative economic phases. The research employs Resource Dependence Theory (RDT) as its theoretical foundation, positing that changes in demand and supply resources shift the power balance between firms and their suppliers. This shift in power, influenced by supplier concentration, dictates the impact on firm profitability. Furthermore, the study explores the moderating role of supply localization, the proportion of suppliers located within the same province. The argument is that supply localization can enhance cooperation during recessions due to shared regional resources and policy environments, while potentially exacerbating dependence and negative effects during restorations when diverse supply sources become crucial. Understanding these dynamics is essential for firms to develop effective supply chain management strategies to navigate economic volatility and ensure sustained profitability. The impact of economic fluctuations on supply chain dynamics is significant, changing supply and demand along the chain. This creates changes in resource dependencies and power dynamics among counterparties. During recessions, reduced demand can shift power to downstream firms, mitigating the negative effects of supplier concentration. However, during restorations, supply shortages can reverse this dynamic, potentially harming firms with high supplier concentration. This study examines this hypothesis using a sample of Chinese listed firms.

Existing literature on supplier relationships presents mixed results on the impact of supplier concentration on firm performance. Some studies highlight benefits from consolidated relationships, improved cooperation, and resource optimization. Others emphasize the risks associated with high dependence on a few suppliers, particularly in the context of economic downturns, potentially leading to power imbalances and exploitation. The Resource Dependence Theory (RDT) provides a framework for understanding these contrasting perspectives, suggesting that power imbalances stem from unequal dependencies between firms and suppliers. Prior research has explored strategies like long-term contracts and geographic diversification to mitigate risks but largely neglects the dynamic interplay of these strategies during economic fluctuations. Contingency theory complements RDT, proposing that optimal strategies depend on the specific context, especially during economic shifts. The moderating influence of supply localization is largely unexplored in this context. Studies have shown that geographic proximity can facilitate information exchange, reduce costs, and foster stronger collaboration. Conversely, reverse localization may offer benefits of diversification and access to broader resources.

The empirical analysis utilizes data from the financial statements and accompanying notes of 3319 listed companies in China (excluding financial firms and those with incomplete data) from 2020 and 2021. 2020 is considered the recession stage, and 2021 the restoration stage based on macroeconomic indicators such as GDP growth, per capita GDP growth, and unemployment rates from the National Bureau of Statistics of China and the International Labor Organization. Supplier information, including geographic location, was manually collected and supplemented with data from multiple databases (CSMAR, Wind, Tianyancha) to establish the supplier network. Python was used to crawl latitude and longitude data for suppliers. Geographic networks were visualized using ArcGIS, showing intra-provincial (black lines) and inter-provincial (blue lines) supplier transactions. The dependent variable is the change in return on assets (ROA) between 2020 and 2021 for each firm, reflecting profitability change during the economic fluctuations. Supplier concentration (SC) is measured using the Herfindahl-Hirschman Index (HHI) calculated from the purchasing amounts of the top five suppliers. Supply localization (SL) is the proportion of purchases from intra-provincial suppliers. Control variables include firm size, age, financial leverage, asset intensity, fixed asset ratio, sales growth, firm ownership (state-owned or not), and whether the firm operates in multiple industries. An OLS regression model with industry and province fixed effects is employed to analyze the relationship between the change in ROA, SC, SL, and their interaction term, SC × SL. To address endogeneity concerns, a two-stage least squares (2SLS) method is applied using peer SC (average SC of industry peers) and local SC (average SC of firms in the same province but different industry) as instrumental variables. Robustness checks are conducted by using alternative measures for the dependent variable (ROA, ROE, change in ROE), alternative measures for SC and SL, and different model specifications (removing controls, industry and province fixed effects).

The main OLS regression results reveal a significant positive relationship between SC and change in ROA during the recession (β = 2.612, t = 2.16), supporting the hypothesis that supplier concentration is beneficial during economic downturns. This positive relationship is further amplified by a higher proportion of intra-provincial supplier transactions (β = 5.301, t = 2.30), confirming the moderating role of supply localization in the recessionary context. During the restoration stage, a significant negative relationship emerges between SC and change in ROA (β = -1.963, t = -1.79). The interaction term between SC and SL is also significantly negative (β = -14.368, t = -3.09), meaning that supply localization exacerbates the negative impact of supplier concentration during the restoration. Conditional effect diagrams visually confirm these interaction effects, showing steeper positive slopes for higher SL during recession and steeper negative slopes during restoration. The 2SLS regression, employing instrumental variables to address endogeneity, reinforces the main findings, showing consistent significant positive and negative coefficients for the instrumental SC variable during recession and restoration, respectively. Robustness tests using alternative dependent variable measures (ROA, ROE, change in ROE), SC and SL calculations, model specifications (removing control variables, fixed effects), and industry-specific analyses consistently support the main findings.

The findings support the hypothesis that the impact of supplier concentration on firm profitability is context-dependent and significantly moderated by supply localization. During recessions, the concentrated supplier relationships help firms mitigate risks due to reduced demand and potential for greater cooperation facilitated by geographic proximity. This suggests that focusing on a smaller number of reliable, locally based suppliers during economic downturns could be advantageous. Conversely, during restorations, a concentrated supply base can become detrimental as demand surges and limited supply from concentrated suppliers creates a power imbalance favoring suppliers. This highlights the importance of geographic diversification and broader supplier networks to mitigate risk and leverage opportunities during economic recoveries. The results contribute to the literature on supply chain management and economic cycles by revealing the asymmetric effects of supplier concentration and the amplifying role of supply localization across different economic phases. These insights offer valuable guidance for supply chain managers in formulating context-specific strategies.

This study provides strong evidence for the dynamic and context-dependent impact of supplier concentration on firm profitability across economic cycles. The findings highlight the importance of strategically managing supplier relationships based on the prevailing economic conditions. During recessions, focusing on a smaller number of reliable, locally-based suppliers can be advantageous, while during restorations, diversification is key. Future research could explore other contingent factors, such as firm-specific capabilities and market dynamics, to refine the understanding of these complex relationships. Further investigations across different industries and geographical settings could also enhance the generalizability of these findings.

This study focuses on listed companies in China, which may limit the generalizability of the findings to other contexts. While Resource Dependence Theory provides a plausible explanation for the observed effects, the study did not directly measure power dynamics, which would strengthen the causal interpretation. The data rely on voluntarily disclosed information from companies, potentially introducing bias. The analysis considers only the top five suppliers, ignoring the impact of other suppliers on firm profitability. Future studies might address these limitations by incorporating more detailed supplier data, directly measuring power dynamics, and expanding the scope to encompass a wider range of firms and geographical regions.