Organizational innovation in small European firms

430100ISB

0010.1177/0266242611430100Gallego et al.International Small Business Journal

is bj Small Firms

Article

Organizational innovation in small European firms: A multidimensional approach

International Small Business Journal 0(0) 1–17 © The Author(s) 2011 Reprints and permission: sagepub. co.uk/journalsPermissions.nav DOI: 10.1177/0266242611430100 isb.sagepub.com

Jorge Gallego and Luis Rubalcaba University of Alcalá, Spain

Christiane Hipp

Brandenburg University of Technology Cottbus, Germany

Abstract Organizational innovations are often neglected in innovation theory. However, organizational change does have an impact on firm output, first directly and second, through its interrelationship with technical innovation. This article focuses on the second aspect. By means of a multidimensional approach, the results show that organizational innovation is of particular relevance in the case of small firms. New empirical evidence is provided at the European level: the data is taken from 18 countries of the CIS4. The results suggest that, in contrast with large enterprises, small firms show an innovation pattern that complements organizational innovation with expenditure on in-house R&D activities and an intensive use of external knowledge. In contrast with earlier research, a broader analysis of countries and industries has been undertaken to show the transferability of previous country and industry-focused results. Keywords Europe, external knowledge search, organizational innovation, R&D, small firms, technical innovation

Introduction Traditionally, the innovation activities of firms are perceived to include only product and process innovations (Drejer, 2004). However, this view of innovation is limited and has been criticized for two key reasons. First, the view seems to be biased toward technical innovation1 in manufacturing and seems to be unable to fully capture the innovation activities in other industries, such as service

Corresponding author: Jorge Gallego, Department of Applied Economics, University of Alcalá, Plaza de la Victoria 2, Alcalá de Henares 28802, Madrid, Spain. Email: [email protected]

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International Small Business Journal 0(0)

innovations, that are less technically-oriented (Hipp and Grupp, 2005). Second, innovation in firms involves not only developing and applying new technologies, but also adopting and reorganizing business routines to remain competitive (Barañano, 2003). Organizational innovation is indeed actual observable innovation (Armbruster et al., 2006), as it may increase productivity and profits, thereby improving the competitiveness of the firm (Alegre and Chiva, 2008). Innovations in general aim at gaining some type of competitive advantage (Tang, 2006) by either shifting the demand curve of the firm’s products; for example, through increasing product quality, offering new products or opening new markets; or a firm’s cost curve, for example through reducing unit costs of production, purchasing, distribution or transactions (Bonanno and Haworth, 1998). Potentially, organizational changes can act in a similar way (Armbruster et al., 2008; Lemon and Sahota, 2004); for example, new methods of organizing a value chain may reduce unit costs or improve quality and exert the same effect on profits as cost-reducing process innovations or customer value-generating product innovations (Evangelista and Vezzani, 2010; Schmidt and Rammer, 2007). In addition to becoming an immediate source for competitive advantage, organizational innovation can serve as precondition for a firm’s knowledge development and management and act as an enabler and facilitator for technical innovation (Lundvall and Nielsen, 2002). In this respect, as Evangelista and Vezzani (2010) show in a recent work using Italian firm data, enterprises with a joint focus on technical and organizational innovations achieve competitive advantage. Further, Lee et al. (2008) show for the high-tech industry that organizational innovation is reflected in a flexible and creative learning culture that fosters a firm’s overall innovation and competitiveness. Therefore, it will prove more difficult for competitors to imitate more original and complex organizational issues, thus producing a competitive advantage for the organizational innovator (Rivkin, 2000). For these reasons and in order to obtain a complete picture of a firm’s innovation efforts, the concept of innovation should be extended to include organizational innovations rather than restricting it to technical development alone in a narrow, product- and process-focused sense (Schmidt and Rammer, 2007). Accordingly, this article seeks to conceptualize the organizational innovation notion (Wolfe, 1994) in a multidimensional way, following the suggestions of Subramanian and Nilakanta (1996). The main assumption proposes that organizational flexibility and change facilitate the introduction of improvements in products and processes (Van der Weerdt et al., 2006). In particular, small enterprises have the potential to undertake new organizational arrangements that support technical innovation processes (Hanna and Walsh, 2008). In addition, the present study pursues an illustration of how a firm’s technical innovation performance is not only influenced and encouraged by its organizational innovation capabilities, but also by internal innovation activities and learning capacities towards knowledge that are developed outside of its boundaries. In this respect, the investigation indicates the importance of organizational innovation in connection to a firm’s knowledge attainment, generation and management processes (Liao et al., 2008), highlighting the importance of firm size as well. The article is not restricted to any specific country or industry; instead, data is taken from 18 European Union (EU) countries of the Community Innovation Survey 4 (CIS4) and regards services as well as manufacturing companies. The article is structured as follows. The next section accounts for the innovation concept and presents an overview of the types of organizational innovation that may occur. The following section clarifies the theoretical approach and introduces the hypotheses of the research work. Next, the data used and methodology followed in the empirical analysis are described and the descriptive evidence and the results obtained after performing six Tobit regression models are presented. The

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final section draws conclusions, discusses managerial implications and limitations and poses future research questions.

Organizational innovation from a multidimensional perspective Research on innovation has its roots in the early twentieth century and was first shaped by Schumpeter who described innovation as the successful implementation of new combinations that also include reorganization (Schumpeter, 1911). This early conceptualization suggests that innovation is not restricted to any one aspect of an organization but includes all of a firm’s economic, technical, organizational, political, cultural and social elements. Later works concentrate on the connection between technical change and economic development and thereby, shift the focus to product and process innovations (see for example, Abernathy and Utterback, 1978; Barras, 1986). Accordingly, the first issue of the Oslo Manual (Organization for Economic Co-operation and Development (OECD), 1997), which forms the conceptual basis for empirical innovation research in Europe, defines innovation as technical change at the company level. For many years the focus of innovation research has been on physical goods innovation, usually defined as the development of significantly new or improved technical products, often supported by research and development (R&D) activities (Cooper and Kleinschmidt, 1987). Process innovations, in turn, are defined as new process technologies that make physical goods production more efficient or effective (Fritsch and Meschede, 2001; Añón Higón, 2011). The consequence of these narrow but easily measurable approaches is the risk of neglecting relevant influencing factors (von Hayek, 1996). Today, innovation research often highlights the importance of organizational change and other driving forces (Jiménez-Jiménez and Sanz-Valle, 2011; Pettigrew et al., 2001). Schumpeter’s (1911) early findings, in combination with recent demands for new perspectives and definitions in innovation research, reveal that the understanding of innovation must broaden and that it should include the non-technical aspects of organizations and their environment (Drejer, 2004; McAdam et al., 2010). Organizational structures and routines create order, transparency and reliability, all of which can help to reduce coordination efforts and transaction costs (Williamson, 1981). Organizational innovation involves the development and implementation of new intra-organizational or inter-organizational structures and proceedings to offer the consumer more efficient, effective and flexible solutions (Armbruster et al., 2006). Structural organizational innovation changes the responsibilities or information flow, as well as the number of hierarchical levels or the divisional structure of functions, while procedural organizational innovations affect the routines, processes and operations of a company. Alternatively, while intra-organizational innovations occur within an organization, inter-organizational innovations include cooperation activities with other institutions (Armbruster et al., 2006). Hence, organizational innovation refers to changes in the hierarchies, routines and leadership of an organization that result from implementing new structural, managerial and working concepts and practices in order to improve coordination of workstreams and employee motivation (Osterloh et al., 2001). However, there is no ideal or proven organizational structure for every kind of business and industry (Burns, 2005); the assessment of an adequate organization depends on, among others, existing strategies, the size of the organization and the environmental conditions under which the company operates (Wengel and Lay, 2000). A widely-accepted definition of organizational innovation in the social sciences, used throughout this work, is taken from the Oslo Manual, which defines organizational innovation as the implementation of a new organizational method in the firm’s business practices, workplace organization

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or external relations that has not been used before and is the result of strategic decisions made by management (OECD, 2005). Based on the above findings, organizational innovation is understood in multidimensional contexts, whereby different interrelationships emerge between different dimensions of innovations (Gago and Rubalcaba, 2007; Wolfe, 1994). The following proposed multidimensional concept places the role of organizational innovation in a wider context where it is regarded as a specific systemic dimension that is useful for, and important in the transformation of any kind of economic activity (Kanerva et al., 2006; Rubalcaba, 2006).

Concept specification and hypothesis building Technology changes and new forms of organizational designs are two key strands of change that drive modern organizations (Milgrom and Roberts, 1990; Roberts, 2004). The foundations of every innovative product or process are built on an organization that fosters innovation, existing competencies and the ability to learn and generate new knowledge (van Riel and Lievens, 2004). Knowledge generation, learning and organizational innovation are a company’s sources for sustainable competitive advantage (McAdam et al., 2010). Following the concept drawn by Evangelista and Vezzani (2010) and based on Leonard-Barton’s (1998) findings on the theory of the firm, Figure 1 illustrates how these internal and external knowledge-generation and organizational innovations are interlinked. In the following subsectors, these interlinkages are described in detail and hypotheses are derived.

Figure 1. Multidimensional conceptual framework of organizational innovation

Organizational innovation and technical change at the firm level The common perspective is that firms with highly-routinized and standardized processes and very hierarchical organizational structures sometimes, although rarely, introduce completely new product innovations (Tellis and Chandy, 2000). As a result, innovative products come more often from firms with more flexible organizational structures and processes, which allow for faster and more radical adaptations and changes (Dewar and Dutton, 1986). The Oslo Manual (OECD, 2005) indicates that organizational innovations are intended to increase a firm’s performance by reducing administrative or transaction costs, improving workplace satisfaction (and thus, labour

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productivity), gaining access to non-tradable assets (such as non-codified external knowledge) or reducing the cost of supplies. Accordingly, decentralized inter-organizational and intra-organizational structures empower the creative potential and responsibility for innovation among all employees and external stakeholders (Baum and Wally, 2003). In order to facilitate creativity at the product and process levels, companies require flatter organizational structures that encourage open communication, opportunities for open learning and organizational change (Williams and Yang, 1999). Firms with organic organizational structures (Miller, 1986) tend to follow a business strategy in which organizational innovation is a key success factor. Thus, organizational innovation supports a firm’s knowledge-generation and management processes and hence, adaptation to technical change at company level. This leads us to hypothesize: H1: Organizational innovations increase the propensity to introduce technical (product/process) innovations.

Particularly in small firms, information can flow quickly and decision-making can be straightforward (Jennings and Beaver, 1997). Bhidé (2000) argues that large firms should concentrate on innovation with low levels of uncertainty, while small organizations are better able to perform in more uncertain and dynamic environments. The ability to cope with unexpected change comes from flexible organizational structures and a culture of change. In this respect, we hypothesize: H2: Organizational innovations increase the propensity to introduce technical (product/process) innovations within small firms.

Intra-organizational and inter-organizational innovation activities Tirole (1988) sees R&D as important for economic development, as only a small component of the growth in income from public sources can be explained by an increase in capital intensity. Thus, Tirole assumes that R&D represents an economic activity that, as an endogenous variable, is an essential contributor to technical change. The latter is the result of innovation and learning within organizations and between organizations and their environments; thus, the firm as innovator is at the centre of attention. Learning at firm level is understood to be the ability to generate new knowledge based on internal or external (or both) tacit and explicit knowledge that is developed further or combined in a new way (Nonaka et al., 2003). Here, innovation capacity, in terms of organizational structures and resources, leads to the accomplishment and implementation of innovative activities (Amabile et al., 1996; Cummings and Oldham, 1997): the pursuit of learning is a route to achieving renewable competitive advantage (Morgan et al., 1998). Hurtley and Hult (1998) suggest that a firm’s learning orientation indicates a desire to assimilate new ideas. By pooling assets and using complementary specialized competencies, firms can increase their innovativeness (Sampson, 2007). Teece (1988) underscores the growing importance of internal R&D for innovation activities in particular, and for technical change in general. Cohen and Levinthal (1990) and Parisi et al. (2006) argue that a firm’s absorptive capacity depends heavily on its investment in internal R&D which, through learning processes, ultimately leads to innovative products and processes. Accordingly, we hypothesize: H3: A company’s own R&D activities increase the propensity to introduce technical (product/process) innovations.

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Nevertheless, successful innovation further depends on the development and integration of external ideas in the innovation process (Cassiman and Veugelers, 2002). Firms must use different types of external sources to acquire ideas from outside the company (Laursen and Salter, 2006) in order to compete effectively in a knowledge-intensive scenario. Therefore, innovation is becoming increasingly distributed and related to a firm’s ability to absorb information, knowledge and technologies (Segarra-Blasco and Aruzo-Carod, 2008) from external sources of innovation and via inter-organizational network relationships (Perkmann and Walsh, 2007). Further, universities and other public research bodies are valuable inter-organizational partners supporting innovation activities (Fritsch and Lukas, 2001; Veugelers, 1997). Recently, the open innovation model (Chesbrough, 2003) assumes that firms can and should use both internal and external ideas in a broad sense to advance innovation and competitiveness. Accordingly, the boundary between a firm and its surrounding environment is becoming increasingly more porous, enabling innovation from distributed inter-organizational networks rather than single firms (Coombs et al., 2003; Perkmann and Walsh, 2007). The requirement to be more flexible has focused attention on the potential of inter-firm collaboration and new organizational learning competences for innovation (Dacin et al., 2007; Reuer and Ragozzino, 2006). A valuable stream of literature from a variety of perspectives investigates and explains firms’ incentives to learn from each other (Lavie and Rosenkopf, 2006). In this respect, we define external search intensity as the use of external sources of information and knowledge to be introduced within a firm’s internal innovation process (Laursen and Salter, 2006). This leads us to hypothesize: H4: The above-average use of external knowledge sources for innovation increase the propensity to introduce technical (product/process) innovations.

Moreover, in their summary of the existing literature, De Jong and Vermeulen (2006) explain that the use of external information sources that extend a small firm’s knowledge and information base is related to its successful innovation. The inherent flexibility of small firms is related to their application of knowledge, improvisation and learning-by-doing (Szarka, 1990). Zhang et al. (2006) show clear differences in learning processes between innovative small enterprises and large companies by demonstrating that the former are more proactive in using external relationships and knowledge to innovate. These firms benefit from more effective environmental scanning and a greater willingness of owner-managers to transfer knowledge within the organization. Given the additional fact that small firms generally have more limited resources to undertake institutionalized, in-house R&D activities and, thus, to pursue flexible, fast-adopting knowledge strategies (Szarka, 1990), we propose the last hypothesis: H5: The above-average use of external knowledge sources for innovation increases the propensity to introduce technical (product/process) innovations within small companies.

Method Sample The analysis uses industry aggregated data from the CIS4 provided by Eurostat. CIS4 is based on the Oslo Manual (OECD, 1997), which rigorously defines what may be considered innovation and, anticipating the review of the Oslo Manual undertaken in 2005, for the first time contemplates other kinds of innovation activities and characteristics beyond technical innovation. The sample in the

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analysis consists of 170 units grouped into three categories based on firm size: small (250 employees); it includes the two principal aggregate industries – manufacturing and services – for which a wide and complete set of innovation-related data for the period 2002–2004 are available. Industry-aggregated CIS4 data are organized in such a way that potential problems regarding comparability and sample bias are avoided.

Data collection and analysis CIS4 reports evidence on innovation-related variables and the data is collected by national statistical offices in the 27 member-states of the EU. In the present research data are used from across 18 countries (in alphabetic order by acronym): Belgium (BE), Bulgaria (BG), Czech Republic (CZ), Germany (DE), Denmark (DK), Estonia (EE), Spain (ES), France (FR), Greece (GR), Hungary (HU), Ireland (IE), Italy (IT), Lithuania (LT), the Netherlands (NL), Poland (PL), Portugal (PT), Romania (RO) and Slovakia (SK). The rest of the EU countries have been excluded from the analysis due to a limited number of observations, or missing or unavailable data on key innovation variables used in the empirical analysis. The dependent variable reports information on enterprises in the private sector with technical innovation, regardless of other forms of innovation such as organizational or marketing developments. The term ‘technical innovation’ covers all types of undertakings, namely product innovation, process innovators and ongoing or abandoned product or process innovation activities. Therefore, technical innovators are enterprises that introduce new or significantly improved products to the market, or enterprises that implement new or significantly improved processes. These new products and processes are based on the results of new technical developments, new combinations of existing technology or the utilization of other external, inter-organizational knowledge acquired by the enterprise. In addition, enterprises with only ongoing or abandoned innovation activities to develop or introduce new or significantly improved products or implement new processes, including R&D activity, are referred to as technical innovators. The independent variables in the estimated models comprise indicators of internal and external knowledge-generation in order to introduce and implement new products and processes. •• Internal R&D intensity: the ratio of investment in intra-organizational R&D (including software development) to devise new and improved products and processes. This variable ranges from 0 to 1. •• External knowledge search intensity: following Laursen and Salter’s (2006) approach; this measure is calculated by using a CIS4 question which asks firms to indicate the significance of six categories of external sources of information to the enterprise’s innovation activities, based on a four-point Likert scale. The six categories are: (1) suppliers of equipment, materials, services or software; (2) clients or customers; (3) competitors or others enterprises in the same industry; (4) consultants, commercial labs or private R&D institutes; (5) universities or other higher education institutions; and (6) government or public research institutes. This variable addresses country-specific response bias by transforming the data into a binary indicator that indicates whether the proportion in each sector is above the average country response. Using this scoring formula, the external knowledge search variable takes, for example, a value of six if all six categories are used above the average of sector and country response. This procedure has been followed by other authors (i.e., Mohnen and Röller, 2005), and this variable can range from 0 to 6.

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•• Organizational innovation: following the definition of the Oslo Manual as described above, organizational innovation is a new or significantly improved knowledge management system intended to better use or exchange information, knowledge and skills within the enterprise, implement a major change to the organization of work, i.e. changes in management structure or integrating different departments or activities, or implement a new or significant change in relations with other firms or public institutions, i.e. through alliances, partnerships, outsourcing or subcontracting. This variable can be 0 = no introduction of an organizational innovation within the observed time period, or 1 = introduction of organizational innovation within the observed time period. In addition, three control variables and additional country dummy variables are integrated. First, the model accounts for the effect of international competitiveness on innovation activities. The variable asked if the company sold its products on any international market within the observed time period. This variable can be 0 (‘no’) or 1 (‘yes’). Second, firm size was controlled for: the variable takes the values of 1 = small, 2 = medium and 3 = large firms. Third, a dummy sector variable was included, which takes the value of 1 if the observation is a manufacturing sector or 0 if it is a service sector. Finally, 18 country dummies were included to control for different propensities to innovate in different countries.

Results Organizational innovation in European firms Beginning with the descriptive analysis, Figure 2 shows the share of innovative firms, whether large, medium or small, that introduce organizational and technical (product, process) innovations compared to all innovative firms in the corresponding size class. It also illustrates the relative difference between the two levels of change. As can be discerned from the data, the introduction of new products, processes and organizational arrangements increases progressively with firm size. Nearly seven out of 10 large firms in Europe bring in new or significantly improved products or processes, while this proportion diminishes to 48 percent and 32 percent of medium and small firms, respectively. This declining tendency is observed also with organizational innovation. Accordingly, 72 percent of large innovative firms in Europe introduce some sort of new organizational arrangement. In the case of medium and small enterprises, this share is correspondingly reduced to 61 percent and 53 percent, respectively. Nevertheless, Figure 2 also shows the relative difference of product/process (x1) and organizational innovation (x2), measured by dividing the absolute difference of the two values by the average value of the same two values: Percentage difference = [(x1-x2)/((x1+x2)/2)]

This variable (‘percentage difference’) shows that even if large firms more notably introduce both technical and organizational innovations, the relative importance of organizational changes in comparison to product/process improvements is superior in small enterprises. Thus, in relative terms, small firms seek organizational innovation more actively compared to large companies and relative to product and process innovation. An additional consideration is whether organizational innovations have a direct and positive impact on overall firm performance. The data in Table 1 show the percentage of innovative European enterprises within different size classes that report highly important effects of organizational innovation on process quality and productivity, quality of products and employee satisfaction and

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Figure 2. Percentage difference between the introduction of product/process and organizational innovations in small, medium and large firms Note: N = 170 Source: CIS4, Eurostat, own calculations.

motivation. The firms in the sample mostly benefit from organizational innovation by reducing the time required to respond to customer or supplier needs and improving the quality of goods or services. Most of the effects are recognized as the firm’s size level increases; however, small businesses recognize improvements in employee satisfaction more widely. This can be explained by the fact that firms with highly satisfied groups of employees often exhibit above-average levels of customer loyalty, productivity, employee retention, safety records and profitability (Harter et al., 2002). Alternatively, improvements in productivity ratios derived from organizational innovation are significantly more prominent in large than small enterprises; thus, large firms benefit further from the formation of economies of scale (Stigler, 1958).

Table 1. Highly-important effects of organizational innovation Highly important effects of organizational innovation

Small

Medium

Large

Significant difference between small and large firms?

Reduced time to respond to customer or supplier needs Improved quality of goods or services Reduced costs per unit output Improved employee satisfaction

20.08

22.81

26.71

No

23.96 10.48 10.20

26.51 13.01 9.53

29.51 18.40 10.36

No Yes (at 1%) No

Note: N= 170. Numbers indicate the percentage of organizational innovators within the respective size class. The significant difference is calculated by means of one-way ANOVAs. Reading example: 20.08% of the small organizational innovators valuate ‘Reduced time to respond to customer or supplier needs’ as a highly important effect of their organizational innovation. Source: CIS4, Eurostat, own calculations.

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Figure 3. Correlation between product/process and organizational innovations in 18 European countries Note: N = 170. Correlation factor: r = 0.699; p