A multi-dimensional analysis on how different types of innovations impact SMEs business performance

WPAE-2019-02 A multi-dimensional analysis on how different types of innovations impact SMEs business performance by Juan A. Sanchis Llopis and Alfonso Expósito García February 2019 Departamento de Estructura Económica (Economía Aplicada II), Facultad de Economía, Universitat de València Avda dels Tarongers, s/n, 46022 – Valencia, Spain Phone +34 96 382 83 49 / Fax +34 96 382 83 54 http://www.estructuraeconomica.es e-mail: [email protected] Working Papers in Applied Economics Economics ISSN 2172-3036 1 A multi-dimensional analysis on how different types of innovations impact SMEs business performance. Alfonso Expósito García University of Sevilla and Juan A. Sanchis Llopis University of Valencia and ERICES Abstract. This paper examines the impact of innovation decisions on business performance for small and medium-sized enterprises based on a multi-dimensional analytical approach. With this aim, the impact of the firm’s innovation decisions (in terms of the introduction of product, process, and/or organisational innovation) on four alternative performance indicators (two financial indicators: sales increase and cost reduction; and two operational indicators: increase of productive capacity and improvement in quality) is analysed. Additionally, an array of potential moderating determinants (such as firm and entrepreneur characteristics) are controlled for. Our findings highlight the existence of positive impacts of innovation decisions on both dimensions of business performance (financial and operational), but these impacts significantly differ depending on the type of innovation and the performance indicator considered. Thus, in order to study the multifaceted effects of innovation decisions made by the firm, results point out that the relationship between innovation (product, process, or organisational) and business performance should be analysed from a multi-dimensional approach. These findings imply significant implications for the design and implementation of innovation strategies in SMEs, since these should be tailored according to the business performance sought by the firm. Keywords: innovation, business performance, SMEs, Spain. JEL Classifications: M21, L25, O30. 2 1. Introduction. SMEs are commonly defined as reactive, flexible and risky organisations (Terzioski 2010), as well as more innovative than their larger counterparts (Tonge et al. 2000), which reflects the widespread assumption that in order to be successful, entrepreneurs or small business managers need to possess an innovative edge to compete successfully against bigger, well-established incumbents (Rosenbusch et al. 2011). Further, SMEs are able to obtain profits from a quicker and more flexible adjustment to environmental changes due to their simplified hierarchies and quick decision-making (Nootebomm 1994; Vossen 1998). In this sense, the introduction of innovative products, processes, and/or new organisational business models may represent an additional opportunity for SMEs to stand out from the competition and improve their performance to remain competitive, both in the short- and medium-term (Porter 1980; Keizer et al. 2002; Máñez et al. 2010 and 2015). In contrast to the extensive literature asserting the positive aspects of innovation on business performance (see Añón Higón et al. 2015; Freel 2000; Freel and Robson 2004; Hervas-Oliver et al. 2014; Máñez et al. 2015; Van Auken et al. 2008; Zahra and George 2002; among others), other studies have reported mixed and inconclusive findings for SMEs (Vermeulen et al. 2005; Terzioski 2010). A number of explanations to these results come from the fact that innovation requires a large amount of resources (e.g. financial, technological, and human capital), which might constitute a significant constraint for SMEs (Acs and Audretsch 1988; Vossen 1998). Moreover, success in introducing innovation may require special organisational capabilities in order to better appropriate its performance benefits (Howell et al. 2005; Thornhill 2006) and/or may imply an increase in uncertainty and risks (Nieto and Santamaría 2010). Therefore, further research in this topic might be essential since there still remains a lack of empirical evidence on the relationship between innovation and the performance of SMEs (OECD 2010; Rosenbusch et al. 2011). This paper aims to fill this gap by providing new empirical evidence on the relationship between innovation and SMEs business performance using a multidimensional analytical approach. This approach is based on the postulation that different types of innovations introduced by the firm exert a distinctive impact on the various dimensions of business performance. Specifically, we check whether the strength of the innovation-performance relationship depends on the type of innovation and on the 3 performance dimension considered. Following the definition of innovation by OCDE (2010), three different types of innovations are analysed: product, process, and organisational (or managerial) innovations. Regarding performance dimensions, each one is measured by two alternative indicators: sales increase and cost reduction, on the financial dimension, and increase of productive capacity and quality improvement, on the operational dimension. Therefore, this study aims to extend previous research studies, such as Rosenbusch et al. (2011), Van Auken et al. (2008), and Freel and Robson (2004), among others, with the objective to answer following general questions: Does empirical evidence support the positive relationship between innovation and SME business performance in both, financial and operational dimensions? Is innovation indeed always a positive strategy for the improvement of business performance regardless of the performance measure and the type of innovation considered? A sizeable sample of Spanish SMEs is employed from industrial, construction, commercial and services sectors, all collected in 2012, but with retrospective information on the three previous years for innovation activities. Our results indicate that while product innovation impacts positively on sales increase, and organisational innovation reveals a positive effect on cost reduction, all innovation types (product, process and organisational) show significantly positive effects on both operational performance indicators (productive capacity increase and quality improvement). In this regard, our results provide a better understanding of the importance and the role of innovation in improving certain performance dimensions/indicators of SMEs, in that they are relevant for those decision-makers related to innovation, entrepreneurship and business performance. The rest of the paper is organised as follows. The second section reviews the main literature on the relationship between the innovation decisions and business performance of SMEs and presents our research hypotheses. The subsequent section presents information on the sample and on the methodology applied in the analysis of the data. The last two sections discuss the analytical results and present the conclusions of the study. 2. Literature review and hypotheses. Regarding the relationship between innovation and the business performance of SMEs, an array of studies have shown positive effects of innovation activities on business 4 performance. Nevertheless, these studies have focused on specific dimensions of business performance of SMEs, avoiding a multidimensional analytical approach. Moreover, most of the existing studies have principally analysed the effects of technological innovations (such as product innovation and, to a lesser extent, process innovation) on SME business performance (Foreman-Peck 2013; Hervas-Oliver et al. 2014). Thus, there remains a significant knowledge gap regarding the impacts of non-technological innovation (such as organisational innovation) (Aragón-Sánchez and Sánchez-Marín 2005; Lin and Chen 2007). On focusing on the financial dimension of business performance, studies such as Calvo (2006) and Pérez et al. (2004), show that innovation increases the financial performance of a firm and the survival rates among SMEs. In this respect, Geroski and Machin (1992), Zahra et al. (2000) and Máñez et al. (2015) find robust evidence concerning the larger margins obtained by innovative firms, which indicates that innovation may foster sales growth and internal efficiency, thereby significantly reducing production costs due to the gains obtained from the increase in labour productivity. Hall et al. (2009), among others, highlight this aspect and, using a sample of European countries, including Spain, argue that product and process innovations exert a positive impact on SME productivity. In addition to the positive effects on the financial performance of SMEs, further benefits of innovation include learning economies, economies of scale and scope, and the ability to set quality standards (Shepherd and Shanley 1998). These benefits usually arise from a better capability to identify, assimilate, and apply knowledge more easily throughout the company due to innovation (Cohen and Levinthal 1990). In this regard, evidence shows that the spread of innovation to processes and managerial aspects in multiple business areas of the company increases its productive potential and leads to a continuous improvement in quality, which together represent a medium-term competitive advantage that guarantees a positive operational performance (Zahra and George 2002). In very competitive markets, the survival of SMEs is related to their ability to offer differentiate high-quality products and services (Edquist 2001). Specifically, process and organisational innovations may play a significant role in the improvement of product (and service) quality as a result of the introduction of new forms of management that enhance quality in certain areas or in the company as a whole (i.e. total quality management as evidenced by Prajogo and Sohal 2003). Moreover, the spread of the innovation process 5 to all areas of the firm may exert a positive impact on its medium-term performance through an increase of its productive potential and the achievement of continuous improvement in quality (Zahra and George 2002). The increase of productive capacity as an operational performance measure might be understood as a pure indicator of business growth, though growth can be measured in various ways (Westhead and Birley 1995; Dobbs and Hamilton 2007). In this respect, existing literature shows that innovation tends to foster business growth in small firms (Storey 1994; Heunks 1998; Freel and Robson 2004). Further, growth in terms of employment generation has received special attention over alternative measures (Curran 2000; Gibb 2000), especially in countries, such as Spain, that suffer from persistent unemployment problems (Triguero et al. 2014). This latter work states that process innovation shows a positive effect on employment for Spanish SMEs, while that of product innovation remains insignificant. Nevertheless, this study considers the augmentation of productive capacity as a global operational outcome, given that more production necessarily implies an increase of productive capacity through a greater use of physical and human factors (Freel 2000). In the light of the literature review, this paper aims to highlight the impacts of different types of innovation (i.e. product, process and organisational) from a multidimensional approach, thus considering different dimensions of the SMEs’ business performance. Thus, our first general hypothesis is: Hypothesis 1: The introduction of innovation (product, process and organisational) by the firm may impact on both dimensions of SME performance (financial and operational). Nevertheless, these impacts may differ depending on the performance dimension (and indicator) considered. It should be borne in mind that although both dimensions of business performance may be positively influenced by innovation, these impacts may vary significantly between the two business-performance dimensions (financial and operational) and/or the type of innovation introduced by the firm (product, process and/or organisational). Despite confirmation of this fact by the existing literature, most attention has been given to the study of the effects of innovations of a technological nature (such as product innovation 6 and, to a lesser extent, process innovation) on the business performance of SMEs (Hervas- Oliver et al. 2014). Hence, there is still a significant lack of knowledge regarding the impacts of non-technological innovation types (such as organisational innovation) on business performance (Aragón-Sánchez and Sánchez-Marín 2005). In this sense, Damanpour et al. (1989) state that innovation is a multi-faceted phenomenon with different types of benefits for SME performance that depend on the type of innovation introduced by the firm. In this study, we aim to identify how these impacts on business performance of SMEs may differ from one type of innovation to another. Consequently, our second and complementary research hypothesis is: Hypothesis 2: The type of innovation implemented by the firm will determine which of the business performance indicators is influenced and to what extent. Therefore, any type of innovation might not always be suitable for influencing all dimensions and/or indicators of SME business performance. The relationship between innovation and business performance may also be moderated by other determinants, both internal and external to the firm. In this sense, Rosenbush et al. (2011) argue that the global impact of innovation on SME performance should be described by an aggregation of positive and negative mediating effects, which are moderated by contextual factors, both internal and external. Among these moderating factors, characteristics of the firm, such as size and age (Henderson 1999; Hall et al. 2009), characteristics of the entrepreneur, such as educational level acquired and managerial experience (Entrialgo 2002; Dobbs and Hamilton 2007), and entrepreneurial and strategy determinants (Veugelers 1997) have been revealed as relevant. R&D cooperation strategies (both with market partners and with public agents) among SMEs have also played a significant role in developing new products and processes (Spithoven et al. 2013). Additionally, governance environmental (national or regional) and sectoral characteristics have attracted scholars’ attention as moderating factors in the innovationperformance relationship (Yang 2016). On the basis of these arguments, our analysis controls for a wide group of these internal and external. A more detailed description of the variables used in our analysis is given in the following section, as well as in the Appendix. 7 3. Data. The research analysis proposed is constructed on the general hypothesis that innovations (i.e. product/service, process, and organisational innovations) introduced by the firm in previous years might have a significant effect on the various dimensions of business performance for SMEs in subsequent years. The business performance and innovation variables used in this study are described below. Moreover, a full description of all variables employed is also provided in the Appendix. Data comes from a survey carried out in 2012 on the competitiveness of Spanish SMEs. This data forms part of the project “Analysing the qualitative aspects shaping the quality of entrepreneurs and SMEs: implications for the economic development of the Spanish Regions”, promoted by the Regional Government of Andalusia (P09-SEJ-4857). The firms included in the sample have fewer than 250 employees and annual sales below 50 million Euros. The survey was conducted across six Spanish regions: Andalusia, Extremadura, Madrid, Murcia, Navarre, and the Basque Country, representing southern, central and northern regions of the country. The questionnaire was designed to include questions on the innovative activities of each business and on the subjective perceptions of the entrepreneur regarding the impact of innovations, introduced by the firm during the three years previous to the year of the survey (period 2009-2011), on different dimensions of its current business performance. Data on the characteristics of the firm and entrepreneur and on business strategies was also gathered. All types of SMEs were included in the study with the exception of self-employed entrepreneurs without employees. The survey was addressed to the person with the role of entrepreneur in the firm, which is defined as the person who performs principal managerial functions within the business. In this regard, several studies have provided empirical evidence that SME managers are the most important decision-makers within their organisations (Van Gills 2005; Hall et al., 2009) and their managerial perceptions shape the firm’s strategic behaviour to a significant degree (O’Regan and Sims 2008). Additionally, several recent studies have confirmed that selfreported information by managers constitute an adequate approach to measure business performance and other strategy variables, such as innovation (Foreman-Peck 2013; Madrid-Guijarro et al. 2013). 8 The sampling procedure for this dataset was designed to represent the structure of the regions following the stratified sampling principles in finite populations. The population of firms was segmented by size, sector and location in order to ensure wide coverage. The number of firms in each stratum was calculated with reference to information contained in the Central Directory of Firms that had been collated by the Spanish National Statistical Institute. The stratified sample, with quotas for business-size groups and sectors, was representative of the business population of every region included in the study, with an error of ±6.0% at a confidence level of 95.5 per cent. A response rate of 20.8 per cent was obtained in the fieldwork. The final dataset, after correcting for missing data, was made up of 1,424 observations. No bias was detected between respondents and non-respondents. The questionnaire asked managers the following question: “Is your firm perceiving a significant beneficial impact on its business performance due to innovations introduced in the last three years?”, for which the possible answer is either “yes” or “no”. Additionally, the questionnaire distinguished between four alternative indicators regarding business performance gains: two indicators on a financial dimension (increase in sales and cost reduction) and another two on the operational dimension (increase in productive capacity and improvement in the quality of products/services provided by the firm). As regards innovation variables, the survey provides information on three types: product (or service) innovation, process innovation, and organisational innovation. Product innovation and process innovation, are related to technological innovation, since technological changes generate new (or transformed) products/services and processes (Freeman 1974). However, managerial or organisational innovation is based on changes introduced into the organisational and administrative structure of the company and are more closely related to management than to the company’s main activities. In relation to the questions on innovation, which constitute our main determinants for business performance, the questionnaire asked managers the following question: “Has your firm introduced any new or significantly improved innovation during the last three years?”, where innovation is classified as product/service innovation, process innovation, or organisational innovation. If the firm had introduced any type of the innovations mentioned, then the answer to the question was yes, and no otherwise. 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Employment Growth in New Independent Ownermanaged Firms in GB, International Small Business Journal, 13, 11-34. Yang, J. S. (2016). The governance environment and innovative SMEs. Small Business Economics, 48(3), 525-541. Zahra, S., & Covin, J. (1993). Business Strategy, Technology Policy and Firm Performance. Strategic Management Journal, 14(6), 451-478. Zahra, S., & George, G. (2002). Absorptive capacity: a review, reconceptualization, and extension. Academy of Management Review, 27(2), 185-203. Zahra, S., Ireland, R., & Hitt, M. (2000). International Expansion by New Venture Firms: International Diversity, Mode of Market Entry, Technology Learning, and Performance. Academic of Management Journal, 43(5), 952-950. 19 Table 1. Number of observations and frequency by innovation type. N % Innovators 892 62.60 Innovators by type Product innovation 790 55.44 Process innovation 404 28.35 Organisational innovation 464 32.56 Table 2. Frequency distribution of certain categorical variables. Sector Industry 10.81% Real Estate & Construction 14.88% Commercial 25.61% Services 48.70% Size Micro (1-9 employees) 87.93% Small (10-49 employees) 10.46% Medium (more than 49 employees) 1.61% Firm Strategy Exporting 19.30% Importing 25.26% Attending fairs 73.12% Market cooperation 23.79% Institutional cooperation 15.09% 20 Table 3. Financial performance. Sales increase Cost reduction β Margins β Margins Innovation Product 0.3530 (0.0728) 0.1280*** (0.0257) 0.0693 (0.0730) 0.0261 (0.0274) Process 0.1146 (0.0851) 0.0415 (0.0308) 0.1174 (0.0834) 0.0442 (0.0313) Organisational 0.1144 (0.0780) 0.0415 (0.0282) 0.2185 (0.0758) 0.0822*** (0.0282) Firm characteristics Size 2 0.1575 (0.1200) 0.0568 (0.0428) 0.1877 (0.1178) 0.0715 (0.0451) Size 3 0.1484 (0.2992) 0.0535 (0.1066) 0.4173 (0.2960) 0.1584 (0.1102) Age 0.0047 (0.0071) 0.0017 (0.0025) 0.0032 (0.0071) 0.0012 (0.0026) Business strategy Export 0.1728 (0.0950) 0.0627* (0.0343) 0.1960 (0.0919) 0.0737** (0.0344) Import 0.0418 (0.0906) 0.0151 (0.0329) -0.1690 (0.0878) -0.0636* (0.0329) Fair 0.1425 (0.0804) 0.0517* (0.0290) -0.0655 (0.0796) -0.0246 (0.0299) Market Cooperation -0.0704 (0.0922) -0.0255 (0.0334) 0.2222 (0.0909) 0.0836** (0.0340) Institutional cooperation 0.1291 (0.1110) 0.0468 (0.0402) -0.0695 (0.1066) -0.0261 (0.0400) Venturing orientation 0.0995 (0.0191) 0.0361*** (0.0067) 0.0542 (0.0187) 0.0204** (0.0069) Entrepreneur characteristics Gender 0.0988 (0.0776) 0.0358 (0.0281) 0.1652 (0.0769) 0.0621** (0.0288) Age -0.0063 (0.0047) -0.0023 (0.0027) -0.0076 (0.0047) -0.0028 (0.0017) Managerial experience -0.0194 (0.0112) -0.0070* (0.0040) -0.0039 (0.0113) -0.0014 (0.0042) Level of studies =2 -0.3093 (0.3688) -0.1098 (0.1262) -0.5309 (0.3709) -0.2001 (0.1369) =3 -0.3171 (0.3660) -0.1126 (0.1251) -0.4641 (0.3680) -0.1753 (0.1359) 21 =4 -0.2620 (0.3670) -0.0925 (0.1254) -0.4405 (0.3699) -0.1664 (0.1366) =5 -0.2545 (0.3642) -0.0898 (0.1242) -0.3601 (0.3663) -0.1360 (0.1352) Observations 1424 1424 Wald Chi2 145.66***. 83.09*** Pseudo R2 0.077 0.045 Correctly classified 63.13% 61.24% ***, **, * indicate statistical significance at the 1%, 5%, and 10% levels, respectively. Robust standard errors given in parentheses. Table 4. Operational performance. Productive capacity Quality improvement β Margins β Margins Innovation Product 0.2433 (0.0742) 0.0857*** (0.0258) 0.3540 (0.0802) 0.0934*** (0.0208) Process 0.3040 (0.0867) 0.1071*** (0.0301) 0.2663 (0.1003) 0.0703*** (0.0262) Organisational 0.2093 (0.0791) 0.0737*** (0.0277) 0.1817 (0.0899) 0.0479** (0.0236) Firm characteristics Size 2 0.0204 (0.1214) 0.0072 (0.0429) -0.1051 (0.1387) -0.0287 (0.0390) Size 3 0.9379 (0.3966) 0.2724*** (0.0819) 0.6799 (0.4431) 0.1333** (0.0591) Age -0.0056 (0.0071) -0.0019 (0.0025) 0.0021 (0.0081) 0.0005 (0.0021) Business strategy Export 0.1973 (0.0976) 0.0695** (0.0342) 0.1579 (0.1109) 0.0416 (0.0292) Import -0.0626 (0.0912) -0.0220 (0.0321) -0.0702 (0.1018) -0.0185 (0.0269) Fair 0.0857 (0.0815) 0.0302 (0.0286) 0.1396 (0.0874) 0.0368 (0.0230) Market Cooperation 0.1471 (0.0943) 0.0518 (0.0331) 0.1626 (0.1106) 0.0429 (0.0291) Institutional cooperation -0.0574 (0.1118) -0.0202 (0.0393) 0.1582 (0.1366) 0.0417 (0.0359) Venturing orientation 0.0972 (0.0195) 0.0342*** (0.0066) 0.0770 (0.0225) 0.0203*** (0.0058) Entrepreneur characteristics Gender 0.1041 (0.0782) 0.0366 (0.0275) 0.1436 (0.0865) 0.0379* (0.0228) Age -0.0173 (0.0048) -0.0061*** (0.0016) -0.0111 (0.0053) -0.0029** (0.0013) Managerial experience 0.0025 (0.0115) 0.0009 (0.0040) 0.0086 (0.0128) 0.0022 (0.0033) Level of studies =2 -0.0305 (0.3655) -0.0103 (0.1233) 0.2167 (0.3861) 0.0565 (0.1074) =3 -0.2096 (0.3615) -0.0727 (0.1221) 0.1808 (0.3807) 0.0478 (0.1065) 22 =4 -0.1139 (0.3630) -0.0390 (0.1225) 0.0677 (0.3818) 0.0186 (0.1071) =5 -0.1987 (0.3596) -0.0689 (0.1213) 0.0381 (0.3774) 0.0105 (0.1061) Observations 1424 1424 Wald Chi2 154.72***. 108.51*** Pseudo R2 0.086 0.085 Correctly classified 66.15% 79.21% ***, **, * indicate statistical significance at the 1%, 5%, and 10% levels, respectively. Robust standard errors given in parentheses. APPENDIX. Definitions of the Variables. Variable Definition Business Performance Sales increase Whether the business has increased sales due to innovation introduced within the last three years (coded 1). Cost reduction Whether the business has reduced costs due to innovation introduced within the last three years (coded 1). Productive capacity Whether the business has increased productive capacity due to innovation introduced within the last three years (coded 1). Quality improvement Whether the business has increased quality due to innovation introduced within the last three years (coded 1). Innovation Product innovation Whether the business had introduced any new or significantly improved product/service innovation within the last three years (coded 1). Process innovation Whether the business had introduced any new or significantly improved process innovation within the last three years (coded 1). Managerial innovation Whether the business had introduced any new or significantly improved managerial innovation within the last three years (coded 1). Firm Characteristics Size Dummy variable is coded 1 if the business belongs to size-bands: Micro (1 to 10 workers), Small (11 to 50 workers), or Mediumsized (50 to 249 workers). Age Years since the business was founded. Business Strategy Export Dummy coded 1 if the business exports abroad. Import Dummy coded 1 if the business imports from abroad. Fair Dummy coded 1 if the business participates in business fairs. Market Coop. Dummy coded 1 if the business cooperates actively with business partners in R&D. Institutional Coop. Dummy coded 1 if the business cooperates actively with public institutions in R&D. Venturing orientation Variable measuring the venturing orientation of the firm (=1 for highest risk aversion to enrolling in risky business projects, and =7 for lowest risk aversion). Entrepreneur Characteristics Gender Dummy coded 1 if the entrepreneur is male (=0 if female). Age Age of the entrepreneur. 23 Experience Years of managerial experience of the entrepreneur in the business. Qualification Dummy coded 1 if the entrepreneur attained a certain level of studies (=1 unqualified, =2 primary schooling; =3 secondary school qualifications; =4 vocational training; =5 university degree or higher). Business Environment Region Dummy coded 1 if the business is located in a particular region. Sector Dummy coded 1 if the business operates in a particular sector.