About the determinants of the degree of novelty in smallbusinesses’product innovations

Depósito de investigación de la Universidad de Sevilla https://idus.us.es/ “This version of the article has been accepted for publication, after peer review (when applicable) and is subject to Springer Nature’s AM terms of use, but is not the Version of Record and does not reflect post-acceptance improvements, or any corrections. The Version of Record is available online at: https://doi.org/10.1007/s11365-013-0269-0” 1 ABOUT THE DETERMINANTS OF THE DEGREE OF NOVELTY IN SMALL BUSINESSES’ PRODUCT INNOVATIONS Juan A. Martínez-Román Isidoro Romero Abstract This paper explores the nature and determinants of product innovation in small businesses from a survey of more than 1,500 small firms in Spain. Two levels of factors affecting innovation are considered: (1) The personal characteristics of the entrepreneurs -their age, motivations, educational background and degree of interpersonal trust. (2) The characteristics of the organizations’ management –cooperation, risk taking, proactivity and specific innovation and growth policies. The paper shows that the factors explaining the firms’ decisions to introduce small incremental innovations -and the strength of these influencesare different, to a large extent, from those favoring substantial product innovations. Keywords Product innovation, Level of innovation, Entrepreneurship, Small business. Introduction In recent decades, the high innovative capacity of small and medium-sized enterprises (SMEs) in specific contexts has often been highlighted by academics and policy makers (Acs and Audretsch, 1990; Link and Bozeman, 1991). As a result of this perception, different measures have been implemented at local, regional and national levels to support the innovation activities of SMEs. However, the discussion about the specific factors which influence the innovative activity of small businesses is far from being closed (Hotho and Chanpion, 2011). Though small businesses represent the majority of firms in any economy, the importance of their innovation activities has been generally underestimated in comparison with those of the medium and large-sized enterprises. The scarce studies particularly focusing on innovation in small businesses suggest that the determinants of innovation in this type of firms present significant particularities. In this respect, the personal characteristics of the entrepreneur exert a strong influence on the organization and performance of this type of firms. Furthermore, the specificities of the organization of small businesses condition their strengths and weaknesses in their attempts at innovation. However, since research in this field has been generally conceived from the perspective of large companies, academics have mainly focused on topics such as technological innovation, 2 R&D activities and patents. In contrast, though a great diversity exists among small businesses (Nooteboom, 1994), the great majority of them are not engaged in this type of innovation activities, but in ‘softer’ forms of innovation. Thus, innovation in small businesses frequently has an incremental nature rather than a technological character. These firms very often undertake just small improvements in their products or processes which in some cases only can be considered innovations from the perspective of the firm itself. Nevertheless, these forms of innovation help them to survive in the market, to be more competitive and eventually grow and access to new geographical markets. In addition, small businesses are also capable of introducing radical or substantial innovations in their products -in some cases of a technological nature. In this respect, this paper raises the following questions: What are the factors explaining product innovation in small firms? Do these factors influence product innovation in small business in the same manner for different levels of novelty in their product developments? Are the factors influencing small incremental improvements in small businesses’ products the same as those favoring more substantial innovations? From this perspective, the current paper explores the determinants of product innovation in small businesses distinguishing between different levels of innovativeness in their product developments. The empirical analysis is based on a survey among more than 1,500 small firms (with less than 50 employees) in Spain. The paper is organized as follows: the following section discusses the nature and significance of innovation in small businesses and puts forward some possible influential factors on product innovation in this type of firms according to the literature. The third section presents the dataset, the research methodology and the results of the empirical analysis carried out. The final section discusses the research results and some policy implications. Nature and determinants of innovation in small businesses About the degree of novelty of innovations Innovation is a complex phenomenon whose economic impact is directly associated with the degree of novelty of its innovative outcomes (Freeman et al., 1982; Schumpeter, 1934). When assessing the firm's innovative behavior, it is not only necessary to observe whether the firm introduces innovations, but also the degree of ‘radicalism’ or novelty of these innovations (Galende and De la Fuente, 2003; Chang et al., 2011; Göktan and Miles, 2011). Despite the efforts made in this regard, there is an important gap in the literature concerning the measurement of the degree of novelty associated with innovations (García and Calantone, 2002). This might be due to the difficulty of quantifying and evaluating the results of innovation (Romijn and Albaladejo, 2002). In this respect, for research purposes, different classification criteria have been developed considering the impact of innovations on market developments, competition and demand. Miles and Snow (1978) classified the innovations based on the strategic value for the company. Freeman and Perez (1988) differentiated between four categories of technological innovations, 3 ranging from incremental innovations, which represent non-structural changes driven by demand, to profound changes in the techno-economic paradigm of a great influence on the whole economy. Furthermore, some authors have elaborated statistical constructs to capture the degree of novelty in the market (Martínez–Román et al., 2011), while others associate the degree of novelty with the stage of product life cycle in which the innovation is introduced (Deshpandé et al., 1993). Besides, more sophisticated elements of measurement have also been introduced, such as the product innovation index of Romijn and Albaladejo (2002). This index combines two aspects -the degree of novelty incorporated in the innovations and the scientific level of the technological knowledge required for introducing themin a one-dimensional scale. Furthermore, the Oslo Manual (OECD, 2005) has proposed a classification based on the product’s degree of novelty. In this sense, ‘worldwide’ product innovation occurs “the very first time a new or improved product is introduced”. Nevertheless, even when the products are not new worldwide, they could be new in the specific market where a firm operates. These ‘new to the market’ innovations lead to a temporary monopoly since the new (or improved) products do not face competition. Finally, ‘firm-only’ product innovation “occurs when a firm implements a new or improved product or process which is technologically novel for the unit concerned but is already implemented in other firms”. They usually represent incremental innovations which apply widely available knowledge frequently coming from the imitation of competitors. Firmonly innovations might be more prevalent in small businesses, given their resource constraints, especially in mature industries and traditional service activities. This type of innovations, which has often been disregarded in the literature, might have an important economic significance since it allows firms to improve their competitive position within their own markets (Kaufmann and Tödtling, 2001). Nevertheless, despite the efforts of formalization and classification developed, the practical difficulties for studying innovation remain. In this respect, differences of opinion between reviewers, academics and policy makers can be also observed when they are asked to separately assess the novelty degree of the innovations implemented by the SMEs (Massa and Testa, 2008). In the current paper, we will focus only on product innovations, including goods as well as services. Both ‘new to the firm’ and ‘new to the market’ innovations will be considered and the assessment of the novelty of the product developments will be based on the subjective perspective of the entrepreneurs. About the determinants of innovation in small businesses When considering the factors favoring innovation in small firms, it is convenient to differentiate between the entrepreneurs’ personal characteristics and the organizational characteristics of the small businesses that they run. Though an extensive literature has addressed both types of determinants, the conclusions are not completely consistent and some aspects are still a matter of controversy (Rizoni, 1991; Mousa and Wales, 2012). In addition, the literature has not frequently differentiated among different degrees of novelty when considering the factors explaining 4 innovation. Moreover, in the few cases this distinction was made, the relative importance of the explanatory factors for each type of innovation was not addressed. In this respect, this paper is built around the following core hypothesis: H0: The personal characteristics of the entrepreneurs and the organization characteristics of the small businesses which determine small incremental innovations are not the same -or do not present the same strengthas those favoring substantial innovations. Personal characteristics of the entrepreneur. The entrepreneur's role in strategic decision making and in the risk taking is crucial in small businesses due to the functional characteristics of this type of organizations. Even the subjective perception of the firm owner has proven to be a determining factor in the detection of business opportunities (Renko et al., 2012). In this respect, the entrepreneurs’ age can be pointed out among the personal characteristics influencing their attempts at innovation. Age is frequently associated with the entrepreneurs’ experience as business managers and owners (Marvel and Lumpkin, 2007; Cegarra-Navarro et al., 2011). Experience enables better risk management in the firm (Gimeno et al., 1997) and can increase the entrepreneur’s capacity to identify and exploit business opportunities (Shane, 2003). Thus, the number of years of experience of the entrepreneur has been associated positively with radical innovation, while the variety of professional and previous business experience primarily might support incremental innovations (Marvel and Lumpkin, 2007). Nevertheless, other researchers have observed a negative relationship between the entrepreneur’s age and the rate of business profitability (Gimeno et al., 1997). Thus, older entrepreneurs might accept lower rates of profitability due to the fear of being forced to face a job search process in the case of their business failing. This conformist attitude associated with age might also be a major impediment to innovation, since older entrepreneurs might prefer to assure the survival of their businesses -even when they only provide marginal benefits- to facing a higher risk. This might be particularly a limitation for the innovation initiatives implying higher levels of novelty that, generally, are associated with greater risks. However, other studies have not observed a relationship between the age of the entrepreneurs and innovation in general -either positive, or negative (Romero and Martínez–Román, 2012). In this respect, in this paper we propose the following hypothesis: H1: The age of the entrepreneur has a negative influence on the introduction of substantial product innovations, while it has no influence on the introduction of small incremental innovations. Since knowledge is a fundamental factor in the innovation and assimilation of new technologies (Von Hippel, 1988; Hoffman at al., 1998; Curado et al., 2011), individual training plays an important role in contributing to the internal learning and the generation of new ideas 5 within the business (Damanpour, 1991; Galende and De la Fuente, 2003). The educational background of the entrepreneurs has been found to be an important factor explaining innovation in small businesses (Koellinger, 2008; Romero and Martínez–Román, 2012) and has particularly appeared as a determinant characteristic influencing the firms’ level of innovativeness (Marvel and Lumpkin, 2007). Tertiary education favors the learning processes, autonomy in the decisionmaking and the creativity of the managers and businesses owners. However, not all the studies have observed this positive influence of education -see, for instance, Keizer at al., 2002). In this respect, we propose the following hypothesis: H2: Entrepreneurs with tertiary education are more likely to introduce both substantial and small incremental product innovations. Furthermore, the entrepreneurs’ motivation in carrying out their business activity might be an influential factor on innovation in SMEs. In order to foster innovation, the individual must be motivated and open to commitment and professional challenges. People decide to become entrepreneurs for a variety of reasons, so that different taxonomies of entrepreneurial motivations have been proposed in the literature (BarNir, 2012). One of the most usual ones differentiates between intrinsic and extrinsic motivations. An intrinsic entrepreneurial motivation implies that entrepreneurs undertake their activity for the mere pleasure of carrying it out, that is, for vocational reasons or for the need of personal development. On the contrary, extrinsic entrepreneurial motivation indicates that the entrepreneurs´ activity is driven by the desire of gaining an economic reward or a material achievement. In this respect, Guzmán and Santos (2001) defended that those entrepreneurs with an extrinsic motivation might be less prone to the introduction of innovations, among other energizing business behaviors. Another relevant typology differentiates between ‘necessity’ and ‘opportunity’ motivation. Opportunity entrepreneurs start a business in order to pursue an opportunity in the market, whilst necessity entrepreneurs are pushed by unemployment situations or the dissatisfaction with their previous jobs (Reynolds et al., 2002). The continuity of a family business can also be pointed out as the primary motivation of some business owners. Some authors include this motivation within the category of opportunity, pointing to a positive incentive for potential entrepreneurs (Vivarelli, 2004). However, in some cases, it could be also associated with necessity motivations and lead to survival entrepreneurs with a poor motivation for innovation. In this respect, we proposed the following hypothesis: H3: Entrepreneurs with an intrinsic and opportunity motivation are more likely to introduce substantial product innovations, while these motivations do not influence the introduction of small incremental product innovations. In addition, other psychological traits and personal values of the entrepreneurs can also favor innovation. In this sense, the degree of interpersonal trust conditions the ease and fluidity of contact needed to share and transmit knowledge (Tsai and Ghoshal, 1998). Therefore, in those 6 spatial contexts where a culture of trust among individuals exists, it is more probable for cooperative relationships among businesses to be successfully developed, particularly those of an informal nature. Some studies of SME networks have confirmed that the trust between the participants plays a very important role in the innovation performance of these networks (Ojasalo, 2008), facilitating the access and flow of information and knowledge among SMEs (MacKinnon et al., 2004). This might be especially important for the cooperative development of highly-ambitious innovation projects. In this way, Partanen, Chetty, and Rajala (2011) have found that the successful commercialization of radical innovations is more likely to require strong ties with customer partnerships compared to incremental innovations. Furthermore, Kauffmann and Tödtling (2001) observed that partnerships with suppliers and consultants have a positive influence on ‘new to the market’ product innovations compared to ‘new to the firm’ innovations. In this respect, we propose the following hypothesis: H4: Trust in the suppliers and clients has a positive influence on the introduction of substantial and small incremental product innovations, this effect being more important for substantial innovations. INSERT FIGURE 1 ABOUT HERE Organizational characteristics of small businesses Business size has received special attention by those studying the innovative activity of SMEs (Acs and Audretsch, 1990; Vaona and Pianta, 2008). Size conditions the firm capabilities and the availability of internal resources –human, financial and organizationalthat are important for innovation (Wernerfelt, 1984; Barney, 1991). Size can affect both the process of internal generation and the transfer of scientific and technical knowledge from outside the organization. However, this supposed direct positive effect of firm size on innovation has been subject to continuing debate (Scherer, 1965; Soete, 1979). In this respect, another hypothesis proposes a non-linear relation between both variables (Martínez–Román et al., 2011; Romero and Martínez– Román, 2012). When considering the degree of innovativeness, firm size has been shown in some works to facilitate the availability of resources to carry out more innovative product developments (Amara et al., 2008). However, the bureaucracy associated with a larger size might also reduce the degree of innovation, according to other studies (Chandy and Tellis, 2000). In this sense, Schumpeter (1934) stressed the role of small businesses as agile and flexible organizations, pioneering the introduction of major technological innovations. This idea has been confirmed in contemporary studies highlighting the value of radical innovation as a source of competitive advantage in SMEs (Amara et al., 2008), especially in dynamic environments (Simon et al., 2002). Nevertheless, the orientation of small businesses toward radical innovation depends on, among other factors, their competitive strategy (Laforet, 2008) and it is wrong to always associate smaller business with radical innovation (Chandy and Tellis, 2000). Thus, a 7 study in the UK among high-growth SMEs in high technology sectors concluded that small business ‘gazelles’ focused on incremental product innovations (Oke et al., 2007). In this respect, we propose the following hypothesis: H5: Firm size has the same positive effect on the introduction of substantial and small incremental product innovations. Innovative effort is often measured by spending on R&D when the object of study is technological innovation (Furman et al., 2002; Hull and Covin, 2010; Quintana and Benavides, 2008). In this case, the effort in R&D appears as an indicator of explicit organizational knowledge, of a technological nature, which is accumulated within the companies (Von Krogh et al., 1994; Davenport and Prusak, 1998). In other circumstances, this measure should be necessarily complemented with other relevant information on the firms' innovative effort. The emphasis on technological innovation has led to focus empirical research on high-tech industrial activities, designing research methodologies hardly applicable in other sectors and smaller firms (Asheim et al., 2003; Bhaskaran, 2006.) This limitation clearly come out when innovation is studied in regions characterized by the predominance of SMEs and mature industries and nontechnological sectors (Tödtling and Trippl, 2005, Martínez–Román et al., 2011). In any case, specific financial efforts on innovation-oriented activities (input) should be associated with greater results in terms of innovation (output). Innovation expenditures might be particularly important for the development of substantial innovations, while incremental innovations might be frequently the result of learning by doing processes or more informal and spontaneous initiatives. In this respect, we propose the following hypothesis: H6: Expenditure in innovation-oriented activities has a positive effect on the introduction of both substantial and small incremental product innovations, this effect being more important for substantial innovations. Schumpeter (1934) highlighted the role of firm growth, pointing out firm size and market concentration as determinants of technological innovation. In small businesses, firm growth is closely linked, among other factors, to the capabilities, ambitions and skills of the entrepreneur (Morrison et al., 2003). In this respect, firm growth seems to be related to a strong leadership, an increased commitment and willingness to sacrifice, to business planning and a strategy and organization geared to growth and technological change, among other factors (Gundry and Welsch, 2001). In this sense, product innovation might be driven in many cases by the firm’s ambition to grow. Furthermore, firms operating in industries with high-growth rates also may be stimulated to introduce new products in order to reach new segments or establish their market lead (Zahra, 1993). In this respect, we propose the following hypothesis: 8 H7: Positive expectations for business growth have the same favorable effect on the introduction of substantial and small incremental product innovations. Survival and growth of firms appear in the literature associated with the entrepreneurial orientation (EO) of the company (Mousa and Wales, 2012). In this respect, Miller (1983) characterized an entrepreneurial firm as that which “engages in product-market innovation, undertakes somewhat risky ventures, and is first to come up with ‘proactive’ innovations”. Later research extended this concept of EO (Covin and Slevin, 1991; Lumpkin and Dess, 1996; among others), consolidating, in any case, these three main dimensions of EO: innovativeness, proactivity and taking risks. In this manner, business culture is a determining factor in the innovative orientation of firms (Naranjo-Valencia, 2011). Regarding this, risk taking seems to be one of the factors favoring innovation at the enterprise level (Marcati et al., 2008; Baron and Tang, 2011). The capacity to take risks has been associated with the ability of the managers to deal with the uncertainty related to new investments and strategic decisions in general (Covin and Slevin, 1991; Dinur, 2011; Van Riel et al., 2011). Thus, risk taking goes beyond the psychological profile of the entrepreneurs and managers to become a characteristic trait of the business culture in innovative companies (Calantone et al., 2002; Forsman, 2011). The capacity to take risks might be particularly important for those small businesses carrying out highly-innovative product developments. In this respect, we propose the following hypothesis: H8: An enterprise culture implying a favorable attitude towards risky projects has a positive effect on the introduction of substantial product innovations, while it has no effect on the introduction of small incremental innovations. Miller (1983) pointed out proactivity as a dimension of business strategy that allows entrepreneurs to act in advance by adopting an aggressive behavior compared to their rivals. Other research has empirically demonstrated the positive influence of proactivity on the innovative capacity of the firm (Gómez-Haro et al., 2011). ‘Proactive’ entrepreneurs differ from ‘reactive’ entrepreneurs who only respond to previous changes in the market or their business environment (such as new technologies and innovation, changes in competition or customer tastes). Formal business planning is a characteristic trait of proactive firms. A formalized business planning implies an attitude of reflection and control though which firms can face the uncertainty of business development and make decisions in situations of great risk, as at the beginning of a business or in the process of introducing an innovation. The existence of a business plan has been observed to have a positive influence on firm innovation (Romero and Martínez–Román, 2012). The importance of planning might be greater in the case of the ambitious and complex innovation projects associated with substantial innovations. However, its role in the introduction of incremental innovations might be minor, since these innovations can be the result of spontaneous and informal processes. Furthermore, Miller and Friesen (1978) considered proactivity as the ability to find and exploit new products and market opportunities 15 INSERT TABLE 3 ABOUT HERE Let us next consider the influence of the small businesses’ characteristics. In this respect, firm size, employment growth prospects and alertness regarding new business opportunities are statistically-significant factors influencing the introduction of both types of product innovations. However, these variables do not contribute significantly to explaining why some small businesses introduced only small incremental improvements in their products whereas other developed substantial innovations. In this respect, H5, H7 and H10 are supported by these results. Among those variables the largest effect is associated with the alertness regarding new business opportunities according to the odd ratios in Table 4. The same consideration is applicable to the dummies for the services and construction sectors. These variables have a large impact on the probabilities of introducing product innovation as shown by the odd ratios (see Table 4). Specifically, these probabilities considerably diminish for those small businesses operating in the construction and services sectors (in comparison with those operating in industry). On the contrary, risk taking and formal planning are relevant factors for the introduction of substantial innovations, but do not seem to influence in any way the introduction of small incremental product innovations. These results confirm H8 and H9. Clearly, this is due to the higher risk of failure associated with the development of substantial innovations when comparing them to incremental innovations. However, the small businesses that try to avoid risks are rarely involved in substantial innovations. Besides, the results for planning seem to be due to the higher complexity of the projects oriented at developing substantial innovations, while small incremental innovations can be originated just by small ‘learning by doing’ improvements (which do not require being planned). Furthermore, the R&D cooperation with universities and technological centers appears as a statistically-significant factor only when comparing the small businesses introducing substantial innovations to those not innovating at all. This is in line with H12. Moreover, the odd ratio indicates that the impact of R&D cooperation on the probability of introducing substantial product innovations is very strong in this case. Finally, innovation expenditure and formal cooperation play a positive role favoring product innovation, the first one being particularly strong, as shown by the odd ratios in Table 4. These effects remain significant across the different levels of novelty, also making a difference between substantial innovations and small incremental product innovations. Consequently, the analysis supports H6 and H11. INSERT TABLE 4 ABOUT HERE Conclusion Innovation has too often been treated in the literature as a uniform phenomenon without considering the very different degrees of innovativeness in the firms’ product developments. In 16 addition, the notion of innovation and the possible explanatory variables have been generally established from the perspective of large companies, without adapting them to the particular circumstances of small businesses. This research, specifically designed to study innovation in small businesses, tries to fill this gap in the literature regarding some aspects. The paper defends the hypothesis that the factors influencing innovation activity in small businesses vary for different levels of novelty regarding their product developments. Particularly, the analysis carried out indicates that the factors that influence the firms’ decisions to introduce small incremental innovations significantly differ from those favoring substantial product innovations. Moreover, for some of the factors that are important both for substantial and small incremental innovations, the strength of the effects is also different in each case. The analysis carried out leads to the following conclusions. Firstly, the small businesses which introduced substantial product innovations are generally led by entrepreneurs with an intrinsic motivation that consider this career option to be the best for their personal and professional development. Besides, an enterprise culture implying a high propensity to take risks, formal planning and cooperation with universities and research centers seem to be crucial for the introduction of substantial innovations in small businesses, whereas they do not seem to be relevant regarding the introduction of mere incremental innovations. In addition, the development of cooperation agreements and the allocation of financial resources for innovation favor both substantial and small incremental innovations, but they are more crucial for the former. On the contrary, firm size, alertness and the existence of growth policies -though in general terms favor product innovationdo not make a difference between those small firms introducing substantial innovations and those introducing mere small incremental innovations. Furthermore, the results obtained for the level of trust in clients and suppliers deserves particular attention. This factor was introduced in the analysis in order to capture the positive effect of informal cooperation activities within the value chain leading to product innovation or the possible positive role of the clients and suppliers as a source of knowledge applicable to product development in small businesses. The results presented in this paper seem to confirm this intuition in the case of substantial product innovations. Thus, the small firms which present high levels of trust in their suppliers and clients have greater probabilities of introducing substantial innovations. However, this positive influence vanishes in the case of small incremental innovations and, paradoxically, becomes significantly negative. Hence, the small firms introducing small incremental innovations present lower levels of trust in their clients and suppliers than those which did not innovate at all. This result contradicts our first intuition and previous literature. According to this finding, strong ties with clients and suppliers can hinder incremental product innovations under certain circumstances, as has been further discussed in the previous section. The conclusions of this work have direct implications for the design of policies aiming at stimulating innovation in small businesses. Policy makers have to be aware that the factors contributing to innovation in small firms are different depending on the level of the novelty in the product developments and can differ across sectors. In this respect, they should establish clear objectives for their actions and implement specific programs according to their targets. On the 17 one hand, a possible objective could be stimulating small incremental innovations among small businesses in order to increase their productivity and competitive position. In this case, administrations might collaborate to develop the capacity of small businesses to be alert to new market opportunities and to exploit them through the undertaking of specific innovation efforts and stimulating the cooperation between firms. On the other hand, administrations could be especially interested in fostering substantial (and radical) innovations in fast-growing small businesses. In this case, they should focus on young entrepreneurs with a strong intrinsic motivation and a high propensity to take risks. Furthermore, the highly-innovative small firms face greater financial requirements for their ambitious innovation projects and, therefore, certain support measures might be effective in order to facilitate –directly or indirectlytheir access to finance. Public institutions could also catalyze R&D inter-firm cooperation, especially with other agents within the same value chain, and R&D cooperation with universities and research centers. 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