The causes and consequences of technological innovation a study of small and medium enterprises in vietnam

HO CHIMINHCITY, DECEMBER 2016 UNIVERSITYOFECONOMICSHOCHIMINHCITYVIETNAM INSTITUTE OFSOCIALSTUDIESTHEHAGUE... Chapter1:INTRODUCTION...1 1.1 Problemstatement...1 1.2 Researchquestions...4

HO CHIMINHCITY, DECEMBER 2016 UNIVERSITYOFECONOMICSHO

CHIMINHCITYVIETNAM

INSTITUTE OFSOCIALSTUDIESTHEHAGUE

VIETNAM-NETHERLANDSPROGRAMME FORM.AINDEVELOPMENTECONOMICS

TranThi Nhu Y

ACKNOWLEDGEMENTS

Completingthis t h e s i s isa challengingandinterestingj o u r n e y aswell.I fo un d t h e researchfieldthatIwouldlovetodedicateinandamproudoftheoutcome.Inthisjourney,If i n d myselfluckyandhonor tohavethecompanionship ofrespectedandgenerouspeople

Foremost,I w o u l d l i k e t o expressmys i n c e r e t h a n k s andmyd e e p r e s p e c t t omysupervisor,Dr.LeVanC h o n H i s w i s d o m andcoachingalwayse n c o u r a g e m e t o embracechallengesanddorightthings.Heisalwaysaccessibleandgeneroustoanswerandexplaint h o r

o u g h l y allmyq u e s t i o n s despitemyp a r t l y weirdavailablet i m e d u e t o mybusinessschedule.IamgratefulforthevaluablecommentsonmythesisresearchdesignfromDr.PhamKhanhNamandDr.VuVietQuang.MygratitudetoDr.TruongDangThuyforhisstraightforwardsuggestiontotheveryfirstdraft ofmythesis Withit, Icouldgothisfar

Iamblessedw i t h t h e encouragemento f myc l a s s m a t e s , e s p e c i a l l y those t h a t VNPOfficecallt h e m “mygroup”.T h e y a r e smart,s t u d i o u s andgoodf r i e n d s w h o arealwaysavailablewhenIneed them TheyarePhuongLanto support mewiththeregressiontest,QueA n h t o p r o v i d e m e t h e sourcesf o r s e a r c h i n g d a t a , A n h T h u Truong,A n h T h uLe,ThaoNguyen,ThanhAnandTuongVytolistento meandencouragemecontinuously

Next,VNPOfficeareoneofthebestserviceteamIhave

everknown.Itskindnessandprofessionalismlet me reallyenjoythe timelearninghere

Myf a m i l y i s t h e precioussourceo f encouragementands u p p o r t Finally,i t ’ s myprofoundthankstoaspecialpersonwholetsmeseetheimportanceofthethesisandsharese v e r yofmyconcernsandjoy,hisnameisCuong

Thankyouforallthebestyougaveme.Iamcommittedtothisthesisenthusiasticallyandjoyfullywithyourcompanionship,andIhopethat this thesiscouldmakeyouproud

Innovationhasbeenlongconsidered

asaparadigmofachievingeconomicgrowthandsustainingnations’w e a l t h Inwhich,t echnologica

li n n o v a t i o n , i n c l u d i n g b o t h productandprocessinnovation,playsacrucialpart,especiallyintheknowledgeeconomy.Collectingdatafromt h e non-

statemanufacturingS M E s s u r v e y i n 2 0 1 1 and2 0 1 3 , t h i s s t u d y c o n d u c t anempiricalresearchtofindthe causesandconsequenceso f technologicalinnovation atfirmlevel.T h e analysiso f causest o technologicali n n o v a t i o n i s dividedi n t o threeareas:firmcharacteristics,internalinnovationfactorsandexternalinnovationfactors.Exceptforfirmagewhichisnegative ly associatedt o innovation occurrence,othersfactors arepositively correlated,i n c l u d i n g f i r m s i

z e , employeesw i t h degree,i n n o v a t i o n e x p e n d i t u r e , R&Dinvestment,spilloverpressurefromsuppliersandcustomers,industrynetworkandcompetitionlevel.Concerningtheinfluenceofinnovationonfirmperformance,theempiricalresultshowsevidenceforapositiveimpactwhilesuggestinganewapproachtoresolvethesimultaneouscausalitybetween thesetwoconcepts

Chapter1:INTRODUCTION 1

1.1 Problemstatement 1

1.2 Researchquestions 4

1.3 Thescopeofthestudy 4

1.4 Structureof thestudy 4

Chapter2:LITERATUREREVIEW 6

2.1 Definitionandclassificationofinnovation 6

2.1.1 Definitionofinnovation 6

2.1.2 Maintypesofinnovation 8

2.2 Thecausesoftechnologicalinnovations 10

2.2.1 Firmcharacteristicsandtechnologicalinnovation 10

2.2.2 Internalinnovationfactors 14

2.2.3 Externalinnovationfactors 16

2.3 Technologicalinnovation’simpacton firmperformance 20

2.4 Theconceptualframework 23

Chapter3:RESEARCHMETHODOLOGY 25

3.1 Estimatedmodels 25

3.2 Estimationapproach 28

3.2.1 Equation1: Thecausesoftechnologicalinnovation 28

3.2.2 Equation2: Theimpactofinnovationon firmperformance 29

Chapter4:EMPIRICAL RESULTS 31

4.1 Datadescription 31

4.2 Empiricalresults 37

4.2.1 Themeasurementofinnovation 37

4.2.2 Theimpactof innovation onfirmperformance 40

Chapter5:CONCLUSION 46

5.1 Mainfindings 46

5.2 Policyimplications 47

5.2.1 Implicationsfor SMEs 47

5.2.2 Implicationsforgovernment 48

5.3 Limitationsandfutureresearches 49

REFERENCES 51

LISTOFFIGURES Figure1.1 Number ofMSMEs inVietnam 1

Figure2.1 Thecausesoffirm-leveltechnologicalinnovation 23

Figure4.1Therecordedtimeofrevenueandinnovationvariablesfortheyearinquestionof2 0 1 3 33

LISTOFTABLES Table4.1Variabledescription 32

Table4.2Thecorrelationmatrix 34

Table4.3Paneldatastructure 35

Table4.4Percentageofinnovatorsbyfirmsize 35

Table4.5Percentageofinnovatorsbyfirmage 36

Table4.6ThepresenceofR&Dinvestment,Spilloverpressurefromsuppliersorcustomers,i n d u s t r y networkandcompetition 36

Table4.7Regressionresultsandmarginaleffectcontrollingfortherobustness forthesourceso f innovation 38

Table4.8Regressionresults withrandomeffectand fixedeffect 41

Table4.9Hausmantest forrandomeffectandfixedeffectmodel 42

Table4.10 Summaryof firmfacingcompetitionandfirmfacingno competition 43

Table4.11Regressionresults ofcompetitionandnon-competitiongroup 44

CHAPTER1:INTRODUCTION

1.1 Problemstatement

Thesignificantcontributionofmicro,smallandmediumenterprises(MSMEs)totheeconomicgrowthhasbeenhistoricallyrecorded,especiallyitsroleinprovidingemploymentopportunities.D u e t o t h e facto f l a c k i n g u p d a t e fromt h e nationals t a t i s t i c s o n M S M E s i n Vietna

MSMEsectoremployed5.1millionworkersin2012andaccountedfor46.8%oft h e totalworkforceinthecountry.Thesectorobservesanincreaseofnumberandemployeeso f 5 3 % and2 4 % respectivelyafterf i v e yearso f t w o -

d i g i t growth(from2 0 0 7 t o 2011).ThoughthepercentageoflaborintheMSMEsectorisnotadequatetothedominantnumbero f MSMEsinVietnam,itisundeniablethatMSMEstakeacrucialcontributiontothenationaleconomy

Intherecenttime,manufacturingcompaniesarefacedwithunstableeconomicenvironmentwithfrequent shocksandincreasingly fiercecompetition.Moreover,theknowledge-basedmechanism, whichhasbeeni g n i t e d since 1990s,hase v o l v e d themarketplaceto bemoredynamicandcompetitive

Tosomeextentinnovationcanbeacknowledgedasaninevitablemeansforfirmstoincreasetheircompetitivenessinadaptingtotherequirementsofthischallengingandunstableenvironment.Fromlongago,Schumpeter(1950)recommendsthatfirmsinnovateforrefreshingtheirassetvalue.Evenbeforethis,atthetimethatthe“innovation”termmaynothavebeenpopularlyused,researchersadmittheimportantroleofeconomicandtechnologicalchange(Lorenzietal.,1912;Veblen,1899;Schumpeter,1934).Firmshavebeenforcedtofocusontheir businessstrategies,especially theirdirectiontowardsinnovative activitiestocopewiththeprogressivelyfierceglobal

competitionafter1980s(Hodgettsetal.,1998).Also,d u e tothattenacioussituation,atpresent,bothindividualsandcompaniesstarttoassessand

adapttheparadigmofinnovationstrategiesaswellasentrepreneurshipcapabilityforgainingcompetitiveadvantages(Drucker,1985;Hultetal.,2003).Thereisanapparentescalationofinterestininnovation,itsprocessesaswellasitsimpacts.Innovationisinneedfororganizationf o r respondingto

shiftsincustomerdemandsandlifestylesoverdifferentperiodsandto

seizeopportunitiescreatedfromtechnologyanddynamicchanges.Alongwithstrategicdifferences,thein no va ti on s stronglycharacterizet h e c u r r e n t dynamiccompetition(Porter,2 00 0) Consistently,theresearchesofBettisandHitt,1995;HelfatandPeteraf,2003andVoss,1994s h o w t h a t firmperformanceandcompetitiveadvantagesc r i t i c a l l y r e l y oni t s c a p a b i l i t y ofgenerating,developingand exploitinginnovation

Thistrendofin no va ti on whichbenefits firmperformanceis,with highprobability,applicablef o r large-

sizeo r hight e c h n o l o g y enterprisesw h e r e t h e a v a i l a b l e c a p a b i l i t y f o r continuousimprovementsareresourceful.However,whetherinnovationtakesanintegralparti n thesuccessofsmallandmediummanufacturingenterpriseswhoseinvestmentcapabilityfori n n o v a t i o n s isextremelylimitedisstillinquestions.Theresearchonthismatterisevenscarcerf o r thedevelopingcountrieswherethetechnologycontentofcirculatedproducts andservicesarelowerthanhighlydevelopedcountries

With the spirit offillingtheabove-mentionedresearchgap,this studyutilizesthedatatakenfromt h e S u r v e y o f S m a l l andMediumS c a l e M a n u f a c t u r i n g Enterprises( S M

E s ) i n Vietnamt o delvei n t o t h e valuechaino f i n n o v a t i o n , fromt h e causesofi n n o v a t i o n

t o itsconsequencestofirmperformanceoftheenterprisesinquestions.Firstly,thestudyevaluatest

h e causesofinnovations,fromfirmcharacteristics,internalinnovationfactorsandexternali n

n o v a t i o n factors.Secondly,theimpactofinnovationonfirmperformanceisrevealedwitht

h e solutionsfortheinherentendogeneityproblemsbetweeninnovationandfirmperformance.Lastly,basedontheacknowledgementofthecausesandconsequencesofinnovation,

1.2 Researchquestions

Theprimarygoalofthisstudyistoestimatetheimpactextentofinnovationperformanceandto define thekeyfactorsforfirms indecidingthe deploymentofinnovation.U s i n g thepaneldataofMSMEs inVietnam,thestudyconcentratesonthreemainquestions:

First,whataret h e causeso f i n n o v a t i o n , d e l v i n g i n t o t h e firmcharacteristics,t h

examinetheeffectofi n n o v a t i o n onfirmperformanceaswellastoevaluatethedifferentfactorsdrivinginnovation.FollowingistheempiricalresultsofthestudyinChapter4presentedintotwoparts:thefirstpartdescribest h e datas o u r c e andvariableconstructions;t h e secondparti s t h e regressionresults.Finally,C h a p t e r 5 providest h e m a i n findingsalongwith p o l i c i e s implicationsandl

i m i t a t i o n s f o r future studies

a p t andrespondt o internalaswellasexternalc h a n g e s , profitabilitym e a s u r i n g t h e differenceofrevenuest o costs,andq u a l i t y m e a s u r i n g f i r m s ’ a b i l i t y t o ensuret h e q u a l i t y oft h

e w h o l e organizationtomeettherequirementsfromcustomers.Heemphasizesthatinnovationmustbec o n s i s t e n t l y alignedwithafirm'sprioritiesatanypointoftime,whiletheothercriteriamayt a k e thecrucialpartindifferentperiodoffirm’sgrowth

Galbraith(1982)showsanotherpointofview.Hedefinesinventionasthecreationofnewideasandinnovations astheprocessofimplementing theseideas.Describinginmoredetail

st o whate x t e n t thats o m e t h i n g newa r e consideredasi n n o v a t i o n s , A b e r n a t h y andUtterback(1982)maintainthatinnovationcanstartfromsmallscope,andthatmanysmalleri n n

o v a t i o n s m a y build alargeinnovation

Asacloserattentiontotheprocesswhereinnovationsoccur,Bessant(1982)’sideaisthata manufacturingi n n o v a t i o n canb e describedass o m e t h i n g t h a t "changesneithert h e productnorthebasicprocess,onlysomeelementsintheprocess."Meanwhile,anotherpoint

ofviewfromTushman(1982)shows innovationas"anyproduct orprocessnewtoabusinessu n i t (firm)."T h e y alsoe m p h a s i z e t h e dynamico f i n n o v a t i o n whichhasdifferentpattern,amountandtypethroughoutthedifferentproductlifecyclestages:introduction,growthandmaturity.

Consideringthed i v e r s e aspectso f t he pr ev io us d e f i n i t i o n s , Schroederetall(1989)deliveracomprehensivedefinitionbyinvolving65manufacturingmanagers.Mostoftheseparticipantsholdstheresponsibilityofmanagingtheatleastonemanufacturingplantstoatm o s t fivemanufacturingplantsofdifferentsizesinconsiderablelargecompaniesemployingvariouslevelsoftechnologicalapplication.Theinvolvementoftheseexpertsgiveanswertot w o questions.First,whatisthemeasurementofinnovationinmanufacturing.Second,howtoi m p r o v e innovationinmanufacturingsector.Theproposeddefinitioncompletestheideagiveni n thepreviousstudies,coveringthemagnitude,theobjectiveofandtheriskassociationwitht h e innovation:“Innovationinmanufacturingistheimplementationofnewideasorchanges,b i g orsmall,thathavethepotentialtocontributetoorganizational(business)objectives.”Thisdefinitionenablesbothlargeandsmallideas,incorporatesrisksoffailureandthepotentialtomeettheorganizationalobjectives

TheManualo fInnovationStatisticsofthe OECDin2005, alsoknownasthe OslomanualandusedfrequentlyasthebaseforinnovationsurveyforOECDcountriesaswellasm a n y non-OECD

countries,statesanotheraspectofinnovation:itsclassification.Inthelatestversionpublishedin2005,thedefinitionofinnovationismoredetailedwithdescriptionofthedifferenttypesofinnovation:“aneworsignificantlyimprovedproduct(goodorservice),orprocess,a n e w marketingm e t h o d , o r a

n e w organizationalm e t h o d i n businesspractices,workplaceorganizationorexternalrelations”.Inthepreviousversionin1995ofthismanual,t h e innovationdefinitionislimitedin

thetechnologicalproductandprocessinnovationsonly

Themarketingi n n o v a t i o n andorganizationali n n o v a t i o n aren e w l y a d d e d t o geta m

o r e comprehensiveevaluation ofcorporateinnovation

Inthescopeofthisstudy,thetechnologicalmethodsareputintohighconsiderationanddonotcovertheorganizationalormarketing methods.Thisisalsoamoreappropriateapproachofinnovationforsmallandmediummanufacturingenterpriseswherethebudgetformarketingislimited,theemployeenumberisusuallyoptimized,andtheownershipisquitestable

2.1.2 Maintypesofinnovation

AsstatedintheManualofInnovationoftheOECDpublishedin2005,innovationscanb e classifiedintofourmaintypesundertwobranches:technologicalandnon-

technologicali n n o v a t i o n s

Thetechnologicalinnovationsconsistofproductinnovationsandprocessinnovations

 “Aproductinnovationistheintroductionofagoodorservicethatisnewors i g n i f

i c a n t l y improvedwithrespecttoitscharacteristicsorintendeduses.Thisincludessignificantimprovementsintechnicalspecifications,components

andmaterials,incorporatedsoftware,userfriendlinessorotherfunctionalcharacteristics.”Aproductcanbeconsiderednewifithassignificantdifferencei n characteristicsorusescomparingtothepreviousproductsmanufacturedbyt h e samefirm.Anexistingproductmayhavesignificantimprovementswhenithaschangesinitscomponentsoritsmaterialsinordertoimprovetheproductperformance

 “Aprocessinnovationistheimplementationofaneworsignificantlyimprove

dproductionordeliverymethod.Thisincludessignificantchangesintechniques,equipmentand/orsoftware.”

Thedefinitionandclassificationofinnovationprovidesanoverviewaboutthei n n o v a

t i o n activitiesatfirmlevel.Afterthissection,thestudylimitstothescopetotechnologicalinnovation,includinginnovationforproductsandprocesses.Inthenextpart,thes t u d y looksdeeperintothecausesoftechnologicalinnovations,conducivetothefundamentalbasesfortheanalysisof

thecausesoftechnologicalinnovations

2.2 Thecausesoftechnologicalinnovations

Thedrivingforcesbehindinnovationarementionedinvariousprecedingresearches

T h o s e researchescoverbothmacroeconomicsandmicroeconomicsfactors.Inthescopeofthisstudy,ast h e enterprisesi n questionarei n t h e samec o u n t r y anda r e affectedbysimilarinstitutionalenvironmentoverconsiderablyshorttimespan,for

thesurveyin2011and2013,o n l y microeconomicsfactorsarereflectedtotheperformanceoftechnologicalinnovationatfirmlevel

Thisstudyinterestsinthedrivingforcesofinnovationthatgeneratefromtheoverallfirmcharacteristicswhichformthemostbasicdescriptionaboutafirm,suchasfirmsizeandfirmage,t h e internali n n o v a t i o n factorswhichi n c l u d e t h e resourcest h a t firmsp o s s e s s t o prepareforaneffectiveworkingprocessoranimprovement,totheexternalinnovationfactorst h a t t a k e effectswhe

nf i r m s interactw i t h t h e i r suppliers,customersandt h e i r peersi n t h e industry

2.2.1 Firmcharacteristicsand technologicalinnovation

Regardingt h e S M E sector,t h e t w o m a i n characteristicst h a t affectfirmi n n o v a t i o n performancearefirmsizeandfirmage.Looking

atprobabilityofintroducinginnovationspert h e sizeandageoffirmsmakessenseasSMEsectorobserveshighrateofentryandexitaswellasofgrowth.Revealingthecorrelationbetween firms i z

e orfirmageandi n n o v a t i o n occurrencewouldbenefitsfirmsinmakingdecisionsofimplementinginnovationtokeepfirmss u r v i v i n g andto buildfirmsstronger

Firmsize

Therelationshipbetweenfirmsize andfirmin no va ti on mightbe origined fromt h e workofSchumpeter(1942),namelytheSchumpeterianhypothesiswhichisconsistedbyaset

oft w o hypotheses:t h e firstaffirmsthati n n o v a t i o n andm o n o p o l y p o w e r havep o s i

dc o s t f o r i n v e s t i n g i n ani n n o v a t i o n project,h a r d t o

-c o n t r o l -costso f -currentproje-cts,diffi-cult-to-

currentprojects,difficult-to-findtechnicalinformationanddifficultiesinsearchingforqualifiedpersonnels(Kleinknecht,1989).Thisstudyalsorevealsthatfirmswithsmallersizearesignificantlylessinformedaboutthepublicpolicymeasurementsdesignedatthattimetoalleviatetheproblemsoffirminnovationthantheirlargercounterpartsare.Offeringameta-

analysisover20publishedstudies,Damanpour(1992)indicatesthatthepositiveassociationbetweenfirmsizeandinnovation,arguingthatthegreaterinputandoutputallowlargerfirmt o accumulat

em o r e resourcesf o r c a t c h i n g t h e forefronttechnologicaldevelopment.Considering300manufacturingplantsinScotland,LoveandAshcroft(1999)alsofindoutthatp l a n t

s i z e enhancesinnovation

Ontheoppositeside,thereareargumentsshowingt h a t smallerfirmsaremoret e c h n o l o

g i c a l l y i n n o v a t i v e A s M i n t z b e r g ( 1 9 7 9 ) statest h a t i n n o v a t i o n requirest h

e cooperationofdifferentpartsoftheorganization,thiscooperationcouldbemoreadvantageous

toreachinsmallerorganization.Damanpour(1992)setsforththatcomparingtothec o m p l e x

i t y oflargefirms,smallfirmspossessbetterflexibilityforadaptingandimproving,hencet r i

g g e r i n g t h e generationo f i n n o v a t i o n Anotherp o s s i b l e considerationi s t h a t t h eperformanceaswellascompensationofindividualsinsmallfirmsismorefirmlylinkedtothefirmperformancethaninlargefirms,henceindividuals,especiallytheengineersorscientistsworkinginthesmallerfirmsaremoremotivatedthantheonesworkinginthelargerfirms,resultingtomorefruitfulinnovation.Sizemayalsoberelatedtochangeresistance(Hannan&Freeman,1984).Asorganizationsgrowlargerinsize,theypaymoreattentiontocertainty,clearroles,andcontrollableandsystematicprocess(Downs,1967).Consequently,thep r o b a b i l i t y ofinnovationoccurrencedeclineswithsize

Sizealsoaffectstheinnovationcapabilityoffirmdifferentlyoverdifferentindustries.A s t u

d y conductedbyAcs andA u d r e t s h (1988),u s i n g data fromt h e U S S m a l l BusinessAdministration,presentstherelationbetweenfirmsizeandinnovationvariesoverdifferentindustries.Thegroupoflargefirmsismore

likelytobeinnovativethantheirsmallcohortsins o m e sectors,suchasf o o d , paperandr u b b e r Int h e o t h e r hands,s m a l l -

f i r m i n n o v a t i v e c a p a b i l i t y tendstobetterperformthantheirlargecohortsintheindustriesthatrequirehigherv o l u m e ofinnovativeness,usehighrateofskilledlaborandhavehighrateofthelargefirmsi n themarket,suchasintheindustriesofmanufacturinginstruments,electronicsorchemicalssector

Firmage

Theresearchontherelationshipbetweenfirminnovationandthetimefirmspresentint h e marketis much more limitedthanthe onebetweenfirminnovationandfirm size

Alongwithfirmsizeintermsoftotalemployeesintheworkplace,firmagedemonstratingt

h e yearsi n operationsi s a c l a s s i c controlvariablei n s t u d i e s o f i n n o v a t i o n

becausethelong-establishedorlargefirmshavegreaterresourcesforstrategicfreedomthant h e entrantorsmallfirms(HagedoornandDuysters,2002).Innovationsconductedbythenewentrants,survivingandincumb

growthandchangesofspecificindustry.A fewtheoreticalinsightshavebeendeveloped toexplainthese industry dynamicsmomentum(Audretsch(1995),Klepper(1996)),whilesomeotherpapersfindpieceso f evidenceontherelationshipbetweenfirms’innovativenessandtheirage.AcsandAudretsch(1988,1990)demonstratetheimportanceofinnovationintroducedbyentrantfirms.InasampleofAmericanfirms,Hansen(1992)findsthatfirmsizeisnegativelyrelatedtotheo u t p u t

o f innovation

Concerningtherelationship betweenfirmageandinnovation quality,SørensenandStuart(2000)are

amongstthepioneerswhoconductsuchkindofresearch.Basedonthedatafromthesemiconductorandbiotechindustries,theyinvestigateandanswerthequestionhowfirmageaffectspatentingandpatentquality.Theirresultprovidesstrongevidencethatfirmswhichislonger-

establishedcanachievehigherrateofpatenting,hence,aremoreinnovative.Interestingly,theyfindthatthetimeinoperationsoffirmsisnegativelyassociatedtotherateso f patentcitationi n semiconductorsindustry,ino t h e r hand,t h i s relationshipi s p o s i t i v e l y correlatedi n b i o t e c h n o l o g y industry.H o w e v e r , t h e apparentdifferencei n t h e relationshipbetweenfirmageandpatentqualitybetweenthetwosectorsisnotcoverinthescopeoftheirstudy.HuergoandJaumandreu(2004)alsoe

v a l u a t e t o whate x t e n t firmageinfluencesi n n o v a t i o n whichisproxiedbytheproductivitygrowth.Utilizingdataofplantlevelproductivity,theydiscoverthattheentrantfirmsaremorelikelytoexhibitahigherrateofp r o d u c t i v i t y growthwhichgraduallyconvergestoaveragegrowthrate.UsingtheNBERpatentdatasetandCOMPUSTATbyStandard&Poorsandlimitingthefirmsinvestigatedtothet i m e spanfrom1984to1994,BalasubramanianandLee(200

8)conducttheanalysisconsistingo f 494firmsand180,515patentsofthesefirmsandpredictthattheinnovationqualityand

firmagehasnon-linearnegativerelationshipintheconditionofsmalllearningrateandinertia;i n addition,intheareasofhightechnologicalconcentration,theabove-mentionednegativeage

–innovation qualityisgreater

Inconclusion,mostofthesestudiessuggestfirmsaccumulateknowledgeduringtheirexistenceandthemorethetimeofoperating,thelesstheinnovationqualityfirmscanperform

manufacturingorganization,Tsai(2001)concludesthatinaworkingenvironmentthatenablesdifferentunitstoaccesstonewcross-

unitknowledge,theorganizationalabsorptivecapacity,i n anotherwordtheabilitytosuccessfullyreplicatenewknowledge,haspositiveimpactont h e respectivebusinessunit’sinnovativeandoverallperformance.Freel(2000),Hoffmanetal.(1998)andRoperetal.(2008)statethat the

-areoftenconsideredasaprerequisitefacilitatingi n n o v a t i o n capabilityo f firms.Supportingt

he knowledgeands k i l l developmentf o r staff,R o m i j i n andAlbaledejo( 2 0 0 2 )

showthatformaleducationandtrainingprogramsislikelytoboosttheproductinnovationinsmall-However,thoughitdoesnotdirectlyindicatetheknowledgeassetwithinorganization,thereisastudyraisingtheinferiorroleofknowledgeintheinnovationprocess.Theempiricals t u d y ofLööfandHeshmati(2002)fromthedatacollectedinthesecondEuropeanCommunityInnovationSurveyshowsthatknowledge-

intensivefirmswhichrequireaccesstoandutilizationo f largek n o w l e d g e amounta r e i n t

Inconclusion,thehigherqualifiedstaffcandeliverhigherrateof innovation

Innovationexpenditure

Theexpenditureforinnovationcapturestheinterestofavarietyofresearches.Evangelistaetal

(1997)summarizet h e innovatione x p e n d i t u r e byfirmi n manufacturingsectori n t o s i x categories:expendituresf o r R&Dactivities,expendituresf o r patentsandlicenses,thecostfordesigning,tooling-

upandtrialproduction,expenditureformarketingandamountofinnovativeinvestment,undertheform ofacquisitionnewmachineryandplants.

Besidestakingthetotalinnovationexpenditure,thisstudywillfocusmoreonR&Dinvestmentasthistypeofinvestmentiscostlyandtakestimetogenerateeffects,leadingtohesitationininvestmentinthecasesofSMEs.Aimingatgeneratinginnovation,R&Dactivitiesconfrontvariousdoubtsonthesuitabilityofinvestment.Themainconcernisfromthecostlyinvestmentandinitialtimef o r

R & D t o g e n e r a t e technologicalprocessandt h e n , yieldingbusinessresults.C a n t w e l l andIammarino( 2 0 0 3 ) s u p p o s e sensitiveconsiderationo f R&Dinvestmentf o r p e r i p h e r a l region

sw h e r e l i m i t e d c u t t i n g

-e d g -e d s c i -e n t i f i c andt-echnologicals t r a t -e g y andfirmcapabilitytog-en-erat-et-echnologicallinkageswithotherlocations.Sorensen(1999)statest h a t “ R & D i s unprofitablef o r l o w levelso f

h u m a n c a p i t a l , andi t b e c o m e s profitableonlywhenhumancapitalreachesathresholdlevel

”

Intheotherhand,someresearchesstatethatR&DtakesacrucialpartindeliveringfirminnovationasinnovationisusuallytheprimarygoalofR&Dactivities.Firminnovationactivitiesmightbeaffectedbythelearningeffects.Inmoredetails,theinnovativecapabilityo f firmscouldenhancew i t h t i m e CohenandLevinthal(1989,1 9 9 0 ) statet h a t theR&Dactivitiesmightimprovethe“absorptivecapacity”offirms.Thesetworesearchersraisedtheterm“absorptivecapacity”asanewperspectiveoflearningandinnovationraised.Itisdefinedast h e a b i l i t y t o acquireknowledgef r

o m o u t s i d e o f t h e firmst h a t e n a b l e s firmst o m a k e s o m e t h i n g differently

2.2.3 Externalinnovationfactors

Firmcharacteristicsandinternalinnovationfactorsaretheresourcesthatenablefirmst o makethingsdifferent.However,thesefactorsarerarelythereasonstriggerthewillingtochangefromfirms.Firmsoperatesin anenvironment withvariouscontactswith itssuppliers,customersandcompetitorsthatrequiresfirmstochangeforsurvivingandgrowingbiginthe

fields.Hence,theimpactofexternalinnovationfactorsisincludedinthisstudyforamorecomprehensiveanalysisabout thecausesoffirminnovation.

Theexternalinnovationfactorsinthispartcoverthreetypes.First,theexternalnetworkw i t h otherfirmsi n t h e sameindustry,t h i s typeo f n e t w o r k i s a p a r t o f theh o r i z o n t a l cooperationoffirmswiththeirpeers.Second,thespillover

pressurefromsuppliersorcustomers,thispressurepartlyshowshowfirmsinteractwiththeverticalrelationshipwhenoperating.Third,thecompetition leveldemonstratesthemarketenvironmentthatfirmsarerunning

Spilloverpressurefromcustomersandsuppliers

Concerningthespillovereffectfromcustomersandsuppliersoninnovation,basedondataofthetwowavesin1996and1998oftheCommunityInnovationSurvey,Belderbosetal

(2004)indicatevariousrationalesbehindthecooperationinR&Dactivities.Theypointoutt h a t thecooperationwithsupplierscontributestotheincrementalinnovationswhichdelivert h e improvementinfirmproductivity.Meanwhile,customers,thoughfirmsdonotusuallyhaveformalR&Dcooperation,areaprecioussourceforfirmtoextractknowledgeinpursuingtheradicalchangestoboostthegrowthininnovativesale.Takingthesimilarpointofview,usingt h e sampleofGermanmanufacturingfirms,FritschandLukas(2001)discoverthatthesefirmst e n d togettheinvolvementoftheirsupplierstomaketheeffortincreatingprocessimprovement,inthemeantime,theyusuallyassociatewiththeircustomerstogenerateproducti n n o v a t i o n s

Intermsofspillover effectsfr om suppliersoninnovation, CheungandP i n g (2004)conductempiricalstudiesforChinaenterprisesandleadtotheconclusionthatforeigndirectinvestmentmakesapositiveimpactundertheformofspillovereffectsthroughthesupplier–

customerchannels.A studyofDutchinnovatingfirmsdemonstratesthatthecooperationwith

VonHippel(1988)recognizest h e importanceofcollaborationw i t h c u s t o m e r s i n reducingt h e r i s k arisingfromt h e marketintroductiono f newproducts.Particularly,t h e collaborationisextremelycrucialinensuringtheadaptationinusesforthenovelandcomplexproductinnovation(Tether,2002)

Industrynetwork

Variousstudiesstatethattheutilizationof externalnetworkextends theknowledgebaseoffirm,hencefacilitatethesuccessofinnovation(e.g.Freel,2000,2003;Hoffmanetal.,1 9 9 8 ; Romijn andAlbaladejo,2002; Rothwell,1977).Thenetworkcomprises the contactsw i t h o t

h e r partiesi n c l u d i n g university,k n o w l e d g e i n s t i t u t e s andsuppliers.Inw h i c h , t h econtactwithsuppliersisdiscussedinthepreviouspart.Inthecaseofdevelopingcountrieswherethetiebetweenenterprisesandacademicinstitutionsarenottightenoughforcontinuousi n n o v a t i

o n , t h e

inter-firmcooperationi n t h e s a m e i n d u s t r y b e c o m e s importantt o achievestrategics o l u t i o n sandadvantages,l i k e s o l v i n g a resources h o r t a g e , mitigatingr i s k s andattaininginter-firmknowledge(DeJong&Vermeulen,2006;seealsoHannaandWalsh,2002;Tether,2 0 0 2 ; BrouwerandKleinknecht,1996).Freel(2003)andO e r l e m a n s etal

(1998)p r o v i d e empiricalevidencesdemonstratethatusingsocialcapitalenablessmallfirmsperforms i g n i f i c a n t l y better.Inthemeantime,theutilizationofonlyexternalnetworkswithoutmakingadequatechangestotheinternaloperationswouldnotdelivertheexpectedimprovementini n n o v a t i o n performance.Belderbosetal

(2004)showthatthecompetitorcooperationintermso f innovationcanboosttheproductivityperformanceoffirms.AudretschandFeldman(1996)giveanotheranglet o t h e networkimpacto n i n n o v a t i o

n : t h e i n n o v a t i v e activitiesi s m o r e geographicallyconcentratedi n t h e industrieswherethep

r o d u c t i o n i s alsogeographically

concentrated.W e caninfert h a t comparingtoa firmlocatings e p a r a t e l y f r o m t h e manufacturingzone,firmslocateinaconcentratedmanufacturingareasuchasindustrialzone,t h e rateofinnovation would behigher.

i n e towardsthefactthatcompetitionpositivelyaffectsinnovation

(Galdon-SanchezandS c h m i t z , 2002;Nickell,1996;Blundelletal.,1995;andGeroski,1990),severaltheoreticalm o d e l s givebackgroundforthefactthatincreasingcompetitivepressuresleadstoareductioni n R&Deffort(Spence,1 9 8 4 ; andDasguptaandS t i g l i t z , 1980) Formorerecentresearch,Aghionetal

(2009)showthatthe competitionlevelindicatedbyentryrateintoaspecificindustry,hasopposingeffectsonfirmsofdifferentperformance.Whilecompetitionintensitycouldspeedupinnovationperformanceofthemore

heindirecteffectwhichislikelytobepositive,theotheriscalledthedirecteffectwhichmaynotb e positive.

Int h e m e a n t i m e , Geroski(1990)statest h a t actualm o n o p o l y couldd i r e c t l y affecti n n o v a t i v e activitiesast h e responset o a post-

innovationperiod.Possibleargumentss u p p o r t i n g b o t h directionsa r e plausible.A n expectedp o s i t i v e effectmayh a p p e n i n c a s e m o n o p o l i s t s p o s s e s s abundantresources.Particularly,t h e m o n o p o l y p o w e r provideshighcurrentprofitsthatenablemonopoliststohiremoreemployeeswithconsiderablehighcapability,andmaym a k e availableinternalfinancewhichstrengthensfirmcapacityi n responsetomarketeventsandreducesfirm'srelianceoncostlyexternalfinance.Meanwhile,thereareseveralreasonstoanexpectingnegativeeffect.Firstly,lowcompetitionlevelmayleadtotheindifferenceattitudetowardsimprovement.Secondly,thesparsenumberoffirmsi n searchofinnovationreducethelikelihoodthataninnovationcanbeoccurredwithinagivent i m e Lastly,monopolistsenjoyhighreturnfromtheinitialinnovationmayexperiencelowerreturnfromaninnovationt h a t replacespartofthesalesfromthecurrentlycirculatingi n n o v a t i

v e products.Inaddition,thereturnisprobablylowerthanthatanewentrantcanget(Arrow,1962).Thisopportunitycostlocksthecapitalstocktoincumbentinnovationandslowsd o w n t h e responseofmonopolytoinnovationeffort

2.3Technological innovation’simpactonfirmperformance

Motivatedbytheincreasingcompetitionoftheglobalmarket,organizationsarealwaysi n searchofthenewapproachesofdoingbusinessasthevalueaddedfromexistingproducts

andservicesi s erodedm o r e andm o r e r a p i d l y (Gunday,2 0 1 1 ) Innovationbecomesanindispensablecomponentforfirmstodealwithdifferentconstraintsthroughoutthevaluechaincreationandwiththecompetitivemarket.Asastrategicorientation,innovationisamethodf o r firmtoovercometheproblemsandtoaccomplishsustainablecompetitivenessinthemarket(Hittetal., 2001;Kuratko,2005).

Acknowledgingthei mp or ta nt r o l e of innovationto firmoperations,researchersarep

a r t i c u l a r l y payingmuchattentiontothisresearchfieldoverthelasttwodecades,thestudiesattempttodefineinnovation,categorizeitandinvestigateitsimpactsonthefirmscope,forpragmaticresults(Gunday,2011).Innovationhasbeendeterminedasoneoftheimportantfactorsofsuccessforsmallenterprises(Globeetal.,1973;Rothwell,1977)

Manyresearchesstudyingtherelationshipbetweeninnovationandfirmperformancereportedpositiveeffects:higherinnovationcapabilityleadingtobettercorporateperformance.Forinstance,Mansfield(1968)recordsthattheinnovatingfirmsinthesteelandpetroleumindustriesgrowatthehigherratethanother firmsinthoseindustriesduringthef i v e totenyearsfollowingtheinnovation.DamanpourandEvan(1984)reportedthatfirmswithhigh-

performancecouldexpectedhighercorrelationbetweentechnicalinnovationsandtheirperformancet h a n t h e l o w -

p e r f o r m a n c e fi rm s c o u l d Ina c o u n t r y wheret h e companiesa r e h i s t o r i c a l l y describedasbeinglongontechnologyadaptationbutshortontechnologyi n n o v a t i o n

innovativefirmstendtoperformbetterthanothers.AresearchusingdataoflargeU.S.firmsandconductedbyCalatoneetal.(2002) demonstratesthatinnovation is positivelyassociatedtofirmperformance

Technologicalinnovations,including productandprocessinnovations,take considerableattentionofresearchers

SMEsfacewithresource-constraints,consequently,theystrivetooptimizetheuseofresourcestogetmaximumproductivityandbenefitsfromtheavailableresources(WolffandBett,2006).Thisreasontogrowthcanbestimulatedbyprocessinnovation.BaerandFrese(2003)findthatclimateforinitiativesandsafetyinmindmediateshowtheprocessinnovationscanaffectfirmperformance.Ino t h e r words,a n environmentt h

a t leveragesclimatef o r initiatives–

whichistheculturethatencouragesnewinitiativesfromindividual(Freseetal.,1 9 9 7 ) andthatpromotespsychologicalsafety–

whichexpressesemployees’exposurewithoutfearofnegativeconsequencessuchascareerprospect(Kahn,1990)enablespositivecorrelationbetweenprocessinnovationandfirmperformance.Viceversus,alowappreciationo f climatesf o r initiativesandlacko f psychologicals a f e t y t r i g g e r s a negativecorrelationbetweenprocessinnovationandfirmperformance.Intheotherhand,withdataofsmallandmedium-

sizedmanufacturingfirmsintheUS,WolffandPett(2006)proposenosignificantrelationshipbetweenprocessinnovationandfirmgrowthaswellasfirmprofitability

Inthemeantime,firmperformancecanbeachievedbyenlargingtheexistingproductmarketorbydevelopinganewone.Romano(1990)analyzessmallentrepresesforfactorsaffectingtheproductinnovationandsetsforththatproductinnovationbringscompetitiveedgef o r high-

growthfirmstocopewiththecompetitionturbulence.Thecompetentresponsetothetechnologicalevolutionandmarketinformationthroughproductd e v e l o p m e n t i s affirmed(Iansiti,1995) AstudyofWolffandPett(2006)abouttheimportanceofproductandprocessi n n o v a t i o n s indicatesthatthereisapositive associationbetweenp ro du ct improvementandgrowth,andin

turnprofitability

Ingeneral,besidesseveralweaksignalsofsignificantimpactoftechnologicali n n o v a t

i o n o n differenti n d e x o f firmperformance,m o s t researchersc o n c l u d e a p o s i t i v e associationbetweenproduct andprocessinnovationsonfirmperformance

Internal innovation factors

•

•

•

•

Innovation in the previous period Employees with degree Innovation expenditures

External innovation factors

•Spillover pressure from customers and suppliersLevel of competition Industry network

firms’knowledge assets canb e expressedunder th e percentageof employeeswith degree.Besidei n n o v a t i o n expenditures,R&Di n v e s t m e n t i s reflectedaso n e oft h e keydrivers ofinvestmentforinnovation,hence,thisindicatorisaddedintotheconceptualframework.Asm e n t i

o n i n g intheliteraturereview,theexternalinnovationfactorsincludeverticalimpactofs p i l l

o v e r pressurefromcustomersandsuppliersorhorizontalimpactofcompetitionintensityandindustrynetworkwith otherpeers

Theframeworkalsodemonstratedtheimpactofinnovationonfirmperformance.Toavoidtheomittedvariablesproblems,besidestheimpactoftechnologicalinnovation,thestudycoversseveralkeycontrolvariableswhicharethefirmcharacteristics’proxiesth at willbec l e a r l y describeinthefollowingpartofestimatedmodel.Theresearchwillalsoinvestigatet h e impactofinnovationfactors,bothinternalandexternalon firmperformance

3.1 Estimatedmodels

Basedontheconceptualframeworkandliteraturereview,theproxiesofeachconceptaredefinedasfollows.Theindicationoftheseproxiesalsoselectedbasedontheavailabilityo f

t h e SMEsdataset

Innovationi s a d u m m y variable.Innovationi s equalt o 1 i f therei s technologicali n n o

v a t i o n intheperiodinquestions,otherwise,equalto0.Thequestionforthisinformationi n thesurveyis:“Hasthefirmintroducednewproducts,mademajorimprovementofexistingproductsorchangedspecification,orintroducednewprocess/newtechnologysincethelastsurvey?”

Firm Ageis thetotalyearsthatthefirmhavebeenoperatingasthecurrentfirm.

KnowledgeassetscanbeexpressedthroughEmployees withDegreeindicatingtheper

centageofemployeeswithuniversityorcollegedegreeoverthetotalemployees.DeCarolisandDeeds(1999)statethat t h e quantity ofemployeesp oss ess in g high-

technologicalknowledgeandskillsinacorporations,areasorregionisusuallyconsideredasameasureofh u m a n knowledgecapital

Revenuei s t h e p r o x y f o r firmperformance.T h e naturallogarithmo f revenuei s rec

ordedwiththeaimofcontrollingthemagnitudedistributionofrevenueandprovidingbetterinterpretation

of theregressionresults.

Thepreviousresearchesstatedi n t h e literaturereviewp r o v i d e f o u n d a t i o n f o r t h eempiricalmodel.The aboveparagraphsshow differentproxies fort he conceptsthat demonstratecausesofi n n o v a t i o n T o summarize,t h e p r o b a b i l i t y t h a t a firme n g a g e s i n technologicalinnovation,includingbothprocessandproductinnovation,isgivenby: