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

Collecting data from the non-state manufacturing SMEs survey in 2011 and 2013, this study conduct an empirical research to find the causes and consequences of technological innovation at

UNIVERSITY OF ECONOMICS ERASMUS UNVERSITY ROTTERDAM

HO CHI MINH CITY INSTITUTE OF SOCIAL STUDIES

VIETNAM THE NETHERLANDS

VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE CAUSES AND CONSEQUENCES OF TECHNOLOGICAL INNOVATION:

A STUDY OF SMALL AND MEDIUM ENTERPRISES IN VIETNAM

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE CAUSES AND CONSEQUENCES OF TECHNOLOGICAL INNOVATION:

A STUDY OF SMALL AND MEDIUM ENTERPRISES IN VIETNAM

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

i

DECLARATION

“This declaration is to certify that this thesis entitled “The causes and consequences of technological innovation: a study of small and medium enterprises in Vietnam” which is conducted and submitted by me in partial fulfilment of the requirements for the degree of the Master of Arts in Development Economics to the Vietnam – The Netherlands Programme The thesis constitutes only my original works and due supervision and acknowledgement have been made in the text to all materials used.”

Tran Thi Nhu Y

ii

ACKNOWLEDGEMENTS

Completing this thesis is a challenging and interesting journey as well I found the research field that I would love to dedicate in and am proud of the outcome In this journey, I find myself lucky and honor to have the companionship of respected and generous people

Foremost, I would like to express my sincere thanks and my deep respect to my supervisor, Dr Le Van Chon His wisdom and coaching always encourage me to embrace challenges and do right things He is always accessible and generous to answer and explain thoroughly all my questions despite my partly weird available time due to my business schedule I am grateful for the valuable comments on my thesis research design from Dr Pham Khanh Nam and Dr Vu Viet Quang My gratitude to Dr Truong Dang Thuy for his straight forward suggestion to the very first draft of my thesis With it, I could go this far

I am blessed with the encouragement of my classmates, especially those that VNP Office call them “my group” They are smart, studious and good friends who are always available when I need them They are Phuong Lan to support me with the regression test, Que Anh to provide me the sources for searching data, Anh Thu Truong, Anh Thu Le, Thao Nguyen, Thanh An and Tuong Vy to listen to me and encourage me continuously

Next, VNP Office are one of the best service team I have ever known Its kindness and professionalism let me really enjoy the time learning here

My family is the precious source of encouragement and support Finally, it’s my profound thanks to a special person who lets me see the importance of the thesis and shares every of my concerns and joy, his name is Cuong

Thank you for all the best you gave me I am committed to this thesis enthusiastically and joyfully with your companionship, and I hope that this thesis could make you proud

iii

ABBREVIATIONS

MSME: Micro, Small and Medium Enterprise

OECD: The Organization for Economic Co-operation and Development

R&D: Research and Development

SME: Small and Medium Enterprise

iv

ABSTRACT

Innovation has been long considered as a paradigm of achieving economic growth and sustaining nations’ wealth In which, technological innovation, including both product and process innovation, plays a crucial part, especially in the knowledge economy Collecting data from the non-state manufacturing SMEs survey in 2011 and 2013, this study conduct an empirical research to find the causes and consequences of technological innovation at firm level The analysis of causes to technological innovation is divided into three areas: firm characteristics, internal innovation factors and external innovation factors Except for firm age which is negatively associated to innovation occurrence, others factors are positively correlated, including firm size, employees with degree, innovation expenditure, R&D investment, spillover pressure from suppliers and customers, industry network and competition level Concerning the influence of innovation on firm performance, the empirical result shows evidence for a positive impact while suggesting a new approach to resolve the simultaneous causality between these two concepts

v

TABLE OF CONTENTS

Chapter 1: INTRODUCTION 1

1.1 Problem statement 1

1.2 Research questions 4

1.3 The scope of the study 4

1.4 Structure of the study 4

Chapter 2: LITERATURE REVIEW 6

2.1 Definition and classification of innovation 6

2.1.1 Definition of innovation 6

2.1.2 Main types of innovation 8

2.2 The causes of technological innovations 10

2.2.1 Firm characteristics and technological innovation 10

2.2.2 Internal innovation factors 14

2.2.3 External innovation factors 16

2.3 Technological innovation’s impact on firm performance 20

2.4 The conceptual framework 23

Chapter 3: RESEARCH METHODOLOGY 25

3.1 Estimated models 25

3.2 Estimation approach 28

3.2.1 Equation 1: The causes of technological innovation 28

3.2.2 Equation 2: The impact of innovation on firm performance 29

Chapter 4: EMPIRICAL RESULTS 31

4.1 Data description 31

4.2 Empirical results 37

4.2.1 The measurement of innovation 37

4.2.2 The impact of innovation on firm performance 40

Chapter 5: CONCLUSION 46

5.1 Main findings 46

5.2 Policy implications 47

5.2.1 Implications for SMEs 47

5.2.2 Implications for government 48

vi

5.3 Limitations and future researches 49

REFERENCES 51

LIST OF FIGURES Figure 1.1 Number of MSMEs in Vietnam 1

Figure 2.1 The causes of firm-level technological innovation 23

Figure 4.1 The recorded time of revenue and innovation variables for the year in question of 2013 33

LIST OF TABLES Table 4.1 Variable description 32

Table 4.2 The correlation matrix 34

Table 4.3 Panel data structure 35

Table 4.4 Percentage of innovators by firm size 35

Table 4.5 Percentage of innovators by firm age 36

Table 4.6 The presence of R&D investment, Spillover pressure from suppliers or customers, industry network and competition 36

Table 4.7 Regression results and marginal effect controlling for the robustness for the sources of innovation 38

Table 4.8 Regression results with random effect and fixed effect 41

Table 4.9 Hausman test for random effect and fixed effect model 42

Table 4.10 Summary of firm facing competition and firm facing no competition 43

Table 4.11 Regression results of competition and non-competition group 44

1

CHAPTER 1: INTRODUCTION 1.1 Problem statement

The significant contribution of micro, small and medium enterprises (MSMEs) to the economic growth has been historically recorded, especially its role in providing employment opportunities Due to the fact of lacking update from the national statistics on MSMEs in Vietnam since January 2013, the most recent report of Asian Development Bank (2014) utilizes the figures of the year of 2012 and shows that in 2012, there were in total 333,835 MSMEs in operations, accounting for 97.7% of the total enterprises that paid corporate tax

Figure 1.1 Number of MSMEs in Vietnam

Source: Asian Development Bank (2014)

In the recent time, manufacturing companies are faced with unstable economic environment with frequent shocks and increasingly fierce competition Moreover, the knowledge-based mechanism, which has been ignited since 1990s, has evolved the market place to be more dynamic and competitive

To some extent innovation can be acknowledged as an inevitable means for firms to increase their competitiveness in adapting to the requirements of this challenging and unstable environment From long ago, Schumpeter (1950) recommends that firms innovate for refreshing their asset value Even before this, at the time that the “innovation” term may not have been popularly used, researchers admit the important role of economic and technological change (Lorenzi et al., 1912; Veblen, 1899; Schumpeter, 1934) Firms have been forced to focus on their business strategies, especially their direction towards innovative activities to cope with the progressively fierce global competition after 1980s (Hodgetts et al., 1998) Also, due to that tenacious situation, at present, both individuals and companies start to assess and

3

adapt the paradigm of innovation strategies as well as entrepreneurship capability for gaining competitive advantages (Drucker, 1985; Hult et al., 2003) There is an apparent escalation of interest in innovation, its processes as well as its impacts Innovation is in need for organization for responding to shifts in customer demands and lifestyles over different periods and to seize opportunities created from technology and dynamic changes Along with strategic differences, the innovations strongly characterize the current dynamic competition (Porter, 2000) Consistently, the researches of Bettis and Hitt, 1995; Helfat and Peteraf, 2003 and Voss, 1994 show that firm performance and competitive advantages critically rely on its capability of generating, developing and exploiting innovation

This trend of innovation which benefits firm performance is, with high probability, applicable for large-size or high technology enterprises where the available capability for continuous improvements are resourceful However, whether innovation takes an integral part

in the success of small and medium manufacturing enterprises whose investment capability for innovations is extremely limited is still in questions The research on this matter is even scarcer for the developing countries where the technology content of circulated products and services are lower than highly developed countries

With the spirit of filling the above-mentioned research gap, this study utilizes the data taken from the Survey of Small and Medium Scale Manufacturing Enterprises (SMEs) in Vietnam to delve into the value chain of innovation, from the causes of innovation to its consequences to firm performance of the enterprises in questions Firstly, the study evaluates the causes of innovations, from firm characteristics, internal innovation factors and external innovation factors Secondly, the impact of innovation on firm performance is revealed with the solutions for the inherent endogeneity problems between innovation and firm performance Lastly, based on the acknowledgement of the causes and consequences of innovation,

First, what are the causes of innovation, delving into the firm characteristics, the internal innovation factors and the external innovation requirement?

Second, what are the consequences of innovation on firm performance?

Last, what are the suggestions to promote innovations amongst MSMEs and to take full advantages of those innovations?

1.3 The scope of the study

The study uses the dataset taken from the Small and Medium Enterprises Survey conducted by the collaboration of the Development Economics Research Group (DERG) of the University of Copenhagen and several parties from Vietnam Gathering the separate data from the four SMEs surveys carried out in 2007, 2009, 2011 and 2013, the research forms a panel data consisting two years of 2011 and 2013 covering small and medium-sized non-state manufacturing enterprises of ten provinces Vietnam Named SMEs survey, however, this survey also consists the micro enterprises with less than and equal to ten employees

1.4 Structure of the study

This research about innovation consists of five chapters Following this first chapter of introduction for research motivation and overall information about the study, Chapter 2

5

represents the critical literature review on the definition and classification of innovation, the causes of innovation, its effect on firm performance, and the conceptual framework Next, the research methodology in Chapter 3 specifies the model and approach to examine the effect of innovation on firm performance as well as to evaluate the different factors driving innovation Following is the empirical results of the study in Chapter 4 presented into two parts: the first part describes the data source and variable constructions; the second part is the regression results Finally, Chapter 5 provides the main findings along with policies implications and limitations for future studies

Galbraith (1982) shows another point of view He defines invention as the creation of new ideas and innovations as the process of implementing these ideas Describing in more details to what extent that something new are considered as innovations, Abernathy and Utterback (1982) maintain that innovation can start from small scope, and that many smaller innovations may build a large innovation

As a closer attention to the process where innovations occur, Bessant (1982)’s idea is that a manufacturing innovation can be described as something that "changes neither the product nor the basic process, only some elements in the process." Meanwhile, another point

7

of view from Tushman (1982) shows innovation as "any product or process new to a business unit (firm)." They also emphasize the dynamic of innovation which has different pattern, amount and type throughout the different product life cycle stages: introduction, growth and maturity

Considering the diverse aspects of the previous definitions, Schroeder et all (1989) deliver a comprehensive definition by involving 65 manufacturing managers Most of these participants holds the responsibility of managing the at least one manufacturing plants to at most five manufacturing plants of different sizes in considerable large companies employing various levels of technological application The involvement of these experts give answer to two questions First, what is the measurement of innovation in manufacturing Second, how to improve innovation in manufacturing sector The proposed definition completes the idea given

in the previous studies, covering the magnitude, the objective of and the risk association with the innovation: “Innovation in manufacturing is the implementation of new ideas or changes, big or small, that have the potential to contribute to organizational (business) objectives.” This definition enables both large and small ideas, incorporates risks of failure and the potential to meet the organizational objectives

The Manual of Innovation Statistics of the OECD in 2005, also known as the Oslo manual and used frequently as the base for innovation survey for OECD countries as well as many non-OECD countries, states another aspect of innovation: its classification In the latest version published in 2005, the definition of innovation is more detailed with description of the different types of innovation: “a new or significantly improved product (good or service), or process, a new marketing method, or a new organizational method in business practices, workplace organization or external relations” In the previous version in 1995 of this manual, the innovation definition is limited in the technological product and process innovations only

2.1.2 Main types of innovation

As stated in the Manual of Innovation of the OECD published in 2005, innovations can

be classified into four main types under two branches: technological and non-technological innovations

The technological innovations consist of product innovations and process innovations

 “A product innovation is the introduction of a good or service that is new or

significantly improved with respect to its characteristics or intended uses This includes significant improvements in technical specifications, components and materials, incorporated software, user friendliness or other functional characteristics.” A product can be considered new if it has significant difference

in characteristics or uses comparing to the previous products manufactured by the same firm An existing product may have significant improvements when it has changes in its components or its materials in order to improve the product performance

9

 “A process innovation is the implementation of a new or significantly

improved production or delivery method This includes significant changes in techniques, equipment and/or software.”

The non-technological innovations consist of marketing innovations and organizational innovations

 “A marketing innovation is the implementation of a new marketing method

involving significant changes in product design or packaging, product

placement, product promotion or pricing.”

 “An organizational innovation is the implementation of a new organizational

method in the firm’s business practices, workplace organization or external relations.”

Only technological innovation is taken into consideration in this study Hence, the two types of innovation in question include product innovation and process innovation These types

of innovation are respectively known as technological product innovation and technological process innovation in the second edition of the second Manual of Innovation of the OECD published in 1997 In the scope of this study, the product innovation and process innovation are called technological innovation

The definition and classification of innovation provides an overview about the innovation activities at firm level After this section, the study limits to the scope to technological innovation, including innovation for products and processes In the next part, the study looks deeper into the causes of technological innovations, conducive to the fundamental bases for the analysis of the causes of technological innovations

10

2.2 The causes of technological innovations

The driving forces behind innovation are mentioned in various preceding researches Those researches cover both macroeconomics and microeconomics factors In the scope of this study, as the enterprises in question are in the same country and are affected by similar institutional environment over considerably short time span, for the survey in 2011 and 2013, only microeconomics factors are reflected to the performance of technological innovation at firm level

This study interests in the driving forces of innovation that generate from the overall firm characteristics which form the most basic description about a firm, such as firm size and firm age, the internal innovation factors which include the resources that firms possess to prepare for an effective working process or an improvement, to the external innovation factors that take effects when firms interact with their suppliers, customers and their peers in the industry

2.2.1 Firm characteristics and technological innovation

Regarding the SME sector, the two main characteristics that affect firm innovation performance are firm size and firm age Looking at probability of introducing innovations per the size and age of firms makes sense as SME sector observes high rate of entry and exit as well as of growth Revealing the correlation between firm size or firm age and innovation occurrence would benefits firms in making decisions of implementing innovation to keep firms surviving and to build firms stronger

Firm size

The relationship between firm size and firm innovation might be origined from the work of Schumpeter (1942), namely the Schumpeterian hypothesis which is consisted by a set

11

of two hypotheses: the first affirms that innovation and monopoly power have positive relationship; the second states a more highly innovative capability shown in large firms than small ones

There are several researches in the manufacturing support the Schumpeterian hypothesis The empirical result from the survey on industrial innovation in the Netherlands carried out in 1984 for 3,000 firms of ten and more employees of Kleinknecht (1989) demonstrates the higher the number of employees, the lower rates of the presence of R&D department which is used to be stated as the stimulus for innovating An empirical study conducted over 209 industrial firms in Israel in 1995 expresses the same result (Shefer & Frenkel, 2005) In addition, smaller firms tend to face with more barriers to innovation than larger firms do: shortage of capital, limited resources for forecasting market demand, unaffordable expected cost for investing in an innovation project, hard-to-control costs of current projects, difficult-to-find technical information and difficulties in searching for qualified personnels (Kleinknecht, 1989) This study also reveals that firms with smaller size are significantly less informed about the public policy measurements designed at that time to alleviate the problems of firm innovation than their larger counterparts are Offering a meta-analysis over 20 published studies, Damanpour (1992) indicates that the positive association between firm size and innovation, arguing that the greater input and output allow larger firm

to accumulate more resources for catching the forefront technological development Considering 300 manufacturing plants in Scotland, Love and Ashcroft (1999) also find out that plant size enhances innovation

On the opposite side, there are arguments showing that smaller firms are more technologically innovative As Mintzberg (1979) states that innovation requires the cooperation of different parts of the organization, this cooperation could be more advantageous

12

to reach in smaller organization Damanpour (1992) sets forth that comparing to the complexity of large firms, small firms possess better flexibility for adapting and improving, hence triggering the generation of innovation Another possible consideration is that the performance as well as compensation of individuals in small firms is more firmly linked to the firm performance than in large firms, hence individuals, especially the engineers or scientists working in the smaller firms are more motivated than the ones working in the larger firms, resulting to more fruitful innovation Size may also be related to change resistance (Hannan & Freeman, 1984) As organizations grow larger in size, they pay more attention to certainty, clear roles, and controllable and systematic process (Downs, 1967) Consequently, the probability of innovation occurrence declines with size

Size also affects the innovation capability of firm differently over different industries

A study conducted by Acs and Audretsh (1988), using data from the U.S Small Business Administration, presents the relation between firm size and innovation varies over different industries The group of large firms is more likely to be innovative than their small cohorts in some sectors, such as food, paper and rubber In the other hands, small-firm innovative capability tends to better perform than their large cohorts in the industries that require higher volume of innovativeness, use high rate of skilled labor and have high rate of the large firms

in the market, such as in the industries of manufacturing instruments, electronics or chemicals sector

13

because the long-established or large firms have greater resources for strategic freedom than the entrant or small firms (Hagedoorn and Duysters, 2002) Innovations conducted by the new entrants, surviving and incumbent firms play an importance part to the growth and changes of specific industry A few theoretical insights have been developed to explain these industry dynamics momentum (Audretsch (1995), Klepper (1996)), while some other papers find pieces

of evidence on the relationship between firms’ innovativeness and their age Acs and Audretsch (1988, 1990) demonstrate the importance of innovation introduced by entrant firms

In a sample of American firms, Hansen (1992) finds that firm size is negatively related to the output of innovation

Concerning the relationship between firm age and innovation quality, Sørensen and Stuart (2000) are amongst the pioneers who conduct such kind of research Based on the data from the semiconductor and biotech industries, they investigate and answer the question how firm age affects patenting and patent quality Their result provides strong evidence that firms which is longer-established can achieve higher rate of patenting, hence, are more innovative Interestingly, they find that the time in operations of firms is negatively associated to the rates

of patent citation in semiconductors industry, in other hand, this relationship is positively correlated in biotechnology industry However, the apparent difference in the relationship between firm age and patent quality between the two sectors is not cover in the scope of their study Huergo and Jaumandreu (2004) also evaluate to what extent firm age influences innovation which is proxied by the productivity growth Utilizing data of plant level productivity, they discover that the entrant firms are more likely to exhibit a higher rate of productivity growth which gradually converges to average growth rate Using the NBER patent data set and COMPUSTAT by Standard & Poors and limiting the firms investigated to the time span from 1984 to 1994, Balasubramanian and Lee (2008) conduct the analysis consisting

of 494 firms and 180,515 patents of these firms and predict that the innovation quality and

14

firm age has non-linear negative relationship in the condition of small learning rate and inertia;

in addition, in the areas of high technological concentration, the above-mentioned negative age – innovation quality is greater

In conclusion, most of these studies suggest firms accumulate knowledge during their existence and the more the time of operating, the less the innovation quality firms can perform

2.2.2 Internal innovation factors

Besides firm characteristics that are unintentional factors in generating innovation, firms also willfully adopt various practices that contribute directly to the development of their innovative capability, including the enhancement of the process and the improvement or introduction of new products The following part embraces different measures that firms employ to bolsters their workforce and resources that might cause innovation to happen

Knowledge assets

As both a tangible and intangible asset (Hall, 1993), knowledge plays a crucial role in the innovation process of a specific organization in the way what an organization knows determine what it can do (Thornhill, 2006) Hage and Aiken (1970) argue that equipped with the knowledge asset, firms get more chance in creating and implementing innovation From the empirical study of different business units in a petrochemical organization and a food-manufacturing organization, Tsai (2001) concludes that in a working environment that enables different units to access to new cross-unit knowledge, the organizational absorptive capacity,

in another word the ability to successfully replicate new knowledge, has positive impact on the respective business unit’s innovative and overall performance Freel (2000), Hoffman et

al (1998) and Roper et al (2008) state that the two key elements of staff - the knowledge and skill - are often considered as a prerequisite facilitating innovation capability of firms Supporting the knowledge and skill development for staff, Romijin and Albaledejo (2002)

Employee qualification is another form of firm knowledge Investigating the sized companies operating in developing countries, Ayyagari et al (2012) demonstrates firms can expect a higher rate of innovation if their top managers possess a higher education level and if they recruit a larger percentage of employees who have completed university education

16

Besides taking the total innovation expenditure, this study will focus more on R&D investment as this type of investment is costly and takes time to generate effects, leading to hesitation in investment in the cases of SMEs Aiming at generating innovation, R&D activities confront various doubts on the suitability of investment The main concern is from the costly investment and initial time for R&D to generate technological process and then, yielding business results Cantwell and Iammarino (2003) suppose sensitive consideration of R&D investment for peripheral regions where limited cutting-edged scientific and technological strategy and firm capability to generate technological linkages with other locations Sorensen (1999) states that “R&D is unprofitable for low levels of human capital, and it becomes profitable only when human capital reaches a threshold level.”

In the other hand, some researches state that R&D takes a crucial part in delivering firm innovation as innovation is usually the primary goal of R&D activities Firm innovation activities might be affected by the learning effects In more details, the innovative capability

of firms could enhance with time Cohen and Levinthal (1989, 1990) state that the R&D activities might improve the “absorptive capacity” of firms These two researchers raised the term “absorptive capacity” as a new perspective of learning and innovation raised It is defined

as the ability to acquire knowledge from outside of the firms that enables firms to make something differently

2.2.3 External innovation factors

Firm characteristics and internal innovation factors are the resources that enable firms

to make things different However, these factors are rarely the reasons trigger the willing to change from firms Firms operates in an environment with various contacts with its suppliers, customers and competitors that requires firms to change for surviving and growing big in the

Spillover pressure from customers and suppliers

Concerning the spillover effect from customers and suppliers on innovation, based on data of the two waves in 1996 and 1998 of the Community Innovation Survey, Belderbos et

al (2004) indicate various rationales behind the cooperation in R&D activities They point out that the cooperation with suppliers contributes to the incremental innovations which deliver the improvement in firm productivity Meanwhile, customers, though firms do not usually have formal R&D cooperation, are a precious source for firm to extract knowledge in pursuing the radical changes to boost the growth in innovative sale Taking the similar point of view, using the sample of German manufacturing firms, Fritsch and Lukas (2001) discover that these firms tend to get the involvement of their suppliers to make the effort in creating process improvement, in the meantime, they usually associate with their customers to generate product innovations

In terms of spillover effects from suppliers on innovation, Cheung and Ping (2004) conduct empirical studies for China enterprises and lead to the conclusion that foreign direct investment makes a positive impact under the form of spillover effects through the supplier – customer channels A study of Dutch innovating firms demonstrates that the cooperation with

Industry network

Various studies state that the utilization of external network extends the knowledge base of firm, hence facilitate the success of innovation (e.g Freel, 2000, 2003; Hoffman et al., 1998; Romijn and Albaladejo, 2002; Rothwell, 1977) The network comprises the contacts with other parties including university, knowledge institutes and suppliers In which, the contact with suppliers is discussed in the previous part In the case of developing countries where the tie between enterprises and academic institutions are not tight enough for continuous innovation, the inter-firm cooperation in the same industry becomes important to achieve strategic solutions and advantages, like solving a resource shortage, mitigating risks and attaining inter-firm knowledge (De Jong & Vermeulen, 2006; see also Hanna and Walsh, 2002; Tether, 2002; Brouwer and Kleinknecht, 1996) Freel (2003) and Oerlemans et al (1998) provide empirical evidences demonstrate that using social capital enables small firms perform significantly better In the meantime, the utilization of only external networks without making adequate changes to the internal operations would not deliver the expected improvement in innovation performance Belderbos et al (2004) show that the competitor cooperation in terms

of innovation can boost the productivity performance of firms Audretsch and Feldman (1996) give another angle to the network impact on innovation: the innovative activities is more geographically concentrated in the industries where the production is also geographically

19

concentrated We can infer that comparing to a firm locating separately from the manufacturing zone, firms locate in a concentrated manufacturing area such as industrial zone, the rate of innovation would be higher

Level of competition

Interested in 47 developing countries, Ayyagari et al (2012) investigate 19,000 firms and specify that exposure to foreign competition is associated with a higher level of firm innovation

The common points of view about the relationship between competitive environment and innovation performance is still unsettled While a large amount of empirical researches incline towards the fact that competition positively affects innovation (Galdon-Sanchez and Schmitz, 2002; Nickell, 1996; Blundell et al., 1995; and Geroski, 1990), several theoretical models give background for the fact that increasing competitive pressures leads to a reduction

in R&D effort (Spence, 1984; and Dasgupta and Stiglitz, 1980) For more recent research, Aghion et al (2009) show that the competition level indicated by entry rate into a specific industry, has opposing effects on firms of different performance While competition intensity could speed up innovation performance of the more technologically advanced firms, it could, however, slow down the innovation performance among the less efficient incumbents

Monopoly is rarely the case of SMEs But the monopoly in a niche market would closely describe the existence and development of many SMEs, hence the theoretical about monopoly can benefit the analysis of competition impact on innovation Geroski (1990) specifies the scheme that monopoly affects innovation through two effects: one is called the indirect effect which is likely to be positive, the other is called the direct effect which may not

be positive

20

He describes actual monopoly can make an indirect effect on innovative activities as follows: the current monopoly power can be a resourceful support for the corresponding monopolist in achieving a given level of monopoly power after implementing innovation The main reason to that positive effect is that a current monopolist erects the new entrant barrier that may be durable enough to protect monopolist in the future In addition, the huge customers base may also ensure success for the monopolist over its related rivals

In the meantime, Geroski (1990) states that actual monopoly could directly affect innovative activities as the response to a post-innovation period Possible arguments supporting both directions are plausible An expected positive effect may happen in case monopolists possess abundant resources Particularly, the monopoly power provides high current profits that enable monopolists to hire more employees with considerable high capability, and may make available internal finance which strengthens firm capacity in response to market events and reduces firm's reliance on costly external finance Meanwhile, there are several reasons to an expecting negative effect Firstly, low competition level may lead to the indifference attitude towards improvement Secondly, the sparse number of firms

in search of innovation reduce the likelihood that an innovation can be occurred within a given time Lastly, monopolists enjoy high return from the initial innovation may experience lower return from an innovation that replaces part of the sales from the currently circulating innovative products In addition, the return is probably lower than that a new entrant can get (Arrow, 1962) This opportunity cost locks the capital stock to incumbent innovation and slows down the response of monopoly to innovation effort

2.3 Technological innovation’s impact on firm performance

Motivated by the increasing competition of the global market, organizations are always

in search of the new approaches of doing business as the value added from existing products

21

and services is eroded more and more rapidly (Gunday, 2011) Innovation becomes an indispensable component for firms to deal with different constraints throughout the value chain creation and with the competitive market As a strategic orientation, innovation is a method for firm to overcome the problems and to accomplish sustainable competitiveness in the market (Hitt et al., 2001; Kuratko, 2005)

Acknowledging the important role of innovation to firm operations, researchers are particularly paying much attention to this research field over the last two decades, the studies attempt to define innovation, categorize it and investigate its impacts on the firm scope, for pragmatic results (Gunday, 2011) Innovation has been determined as one of the important factors of success for small enterprises (Globe et al., 1973; Rothwell, 1977)

Many researches studying the relationship between innovation and firm performance reported positive effects: higher innovation capability leading to better corporate performance For instance, Mansfield (1968) records that the innovating firms in the steel and petroleum industries grow at the higher rate than other firms in those industries during the five to ten years following the innovation Damanpour and Evan (1984) reported that firms with high-performance could expected higher correlation between technical innovations and their performance than the low-performance firms could In a country where the companies are historically described as being long on technology adaptation but short on technology innovation like Japan, Deshpande et al (1993) recorded that innovative firms tend to perform better than others A research using data of large U.S firms and conducted by Calatone et al (2002) demonstrates that innovation is positively associated to firm performance

Technological innovations, including product and process innovations, take considerable attention of researchers

22

SMEs face with resource-constraints, consequently, they strive to optimize the use of resources to get maximum productivity and benefits from the available resources (Wolff and Bett, 2006) This reason to growth can be stimulated by process innovation Baer and Frese (2003) find that climate for initiatives and safety in mind mediates how the process innovations can affect firm performance In other words, an environment that leverages climate for initiatives – which is the culture that encourages new initiatives from individual (Frese et al., 1997) and that promotes psychological safety – which expresses employees’ exposure without fear of negative consequences such as career prospect (Kahn, 1990) enables positive correlation between process innovation and firm performance Vice versus, a low appreciation

of climates for initiatives and lack of psychological safety triggers a negative correlation between process innovation and firm performance In the other hand, with data of small and medium-sized manufacturing firms in the US, Wolff and Pett (2006) propose no significant relationship between process innovation and firm growth as well as firm profitability

In the meantime, firm performance can be achieved by enlarging the existing product market or by developing a new one Romano (1990) analyzes small entrepreses for factors affecting the product innovation and sets forth that product innovation brings competitive edge for high-growth firms to cope with the competition turbulence The competent response to the technological evolution and market information through product development is affirmed (Iansiti, 1995) A study of Wolff and Pett (2006) about the importance of product and process innovations indicates that there is a positive association between product improvement and growth, and in turn profitability

In general, besides several weak signals of significant impact of technological innovation on different index of firm performance, most researchers conclude a positive association between product and process innovations on firm performance

23

2.4 The conceptual framework

Based on the integration of insights from various firm-based theories and empirical studies of innovations, the framework for the causes of technological innovation is illustrated

in Figure 2.1

Figure 2.1 The causes of firm-level technological innovation

Source: Author’s conceptual framework built from literature review

Regarding firm characteristics, total assets and firm size are used to measure the firm size Concerning internal innovation factors, innovation in the previous period is put into considerations as a part of the knowledge assets of firms Innovation performance in the past can be a great learning source for firm to execute further innovation activities Additionally,

Technological innovation

Firm characteristics

• Total assets

• Total employees

• Firm age

Internal innovation factors

• Innovation in the previous period

• Employees with degree

• Innovation expenditures

• R&D investment

External innovation factors

• Spillover pressure from customers

24

firms’ knowledge assets can be expressed under the percentage of employees with degree Beside innovation expenditures, R&D investment is reflected as one of the key drivers of investment for innovation, hence, this indicator is added into the conceptual framework As mentioning in the literature review, the external innovation factors include vertical impact of spillover pressure from customers and suppliers or horizontal impact of competition intensity and industry network with other peers

The framework also demonstrated the impact of innovation on firm performance To avoid the omitted variables problems, besides the impact of technological innovation, the study covers several key control variables which are the firm characteristics’ proxies that will be clearly describe in the following part of estimated model The research will also investigate the impact of innovation factors, both internal and external on firm performance

The relationship between current firm performance and technological innovation, however, gets the problem of simultaneous causality Facing with the limited literature resolving this matter, this study provides a new method to address the two-way causal relationship, hence, enables to conclude the impact that technological innovation makes on firm performance