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

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

BY

TRAN THI NHU Y
MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, DECEMBER 2016


UNIVERSITY OF ECONOMICS

INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY

THE HAGUE

VIETNAM

THE NETHERLANDS

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

By

TRAN THI NHU Y
Academic Supervisor:
LE VAN CHON

HO CHI MINH CITY, DECEMBER 2016


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

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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.

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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

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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.

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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
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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

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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)

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The MSME sector employed 5.1 million workers in 2012 and accounted for 46.8% of
the total workforce in the country. The sector observes an increase of number and employees
of 5.3% and 2.4% respectively after five years of two-digit growth (from 2007 to 2011).
Though the percentage of labor in the MSME sector is not adequate to the dominant number
of MSMEs in Vietnam, it is undeniable that MSMEs take a crucial contribution to the national
economy.
Among MSMEs in Vietnam, though taking only 15.7% of total active MSMEs in 2012
– after the wholesale & retail trade and service sectors accounting for 39.8% and 20.5%
respectively, manufacturing is a labor-intensive industry, employing majority of employees in
the MSME sector, 31.8% of total MSME employees, 14.9% of total domestic workforce. This
figure partly shows the important role of manufacturing MSMEs in the economy.
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

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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,

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suggestions for promoting and for fruitful implementing innovations are proposed for attaining
higher firm performance.

1.2 Research questions
The primary goal of this study is to estimate the impact extent of innovation
performance and to define the key factors for firms in deciding the deployment of innovation.
Using the panel data of MSMEs in Vietnam, the study concentrates on three main questions:
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

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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.

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CHAPTER 2: LITERATURE REVIEW
2.1 Definition and classification of innovation
2.1.1 Definition of innovation
To estimate the innovation’s contribution to the firm performance, especially in the
manufacturing area, the definition of the term should be examined.

Taking into consideration the position of innovation on firm performance, Sink (1983)
defines innovation as one of the seven criteria constituting corporate performance:
effectiveness dealing with firms’ output, efficiency dealing with firms’ input, productivity
dealing with the cost and the deliverable output, quality of work life measuring the positive
evaluation of staff about the organization, innovation measuring capability to adapt and
respond to internal as well as external changes, profitability measuring the difference of
revenues to costs, and quality measuring firms’ ability to ensure the quality of the whole
organization to meet the requirements from customers. He emphasizes that innovation must be
consistently aligned with a firm's priorities at any point of time, while the other criteria may
take the crucial part in different period of firm’s growth.
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
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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.

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The marketing innovation and organizational innovation are newly added to get a more
comprehensive evaluation of corporate innovation.
In the scope of this study, the technological methods are put into high consideration
and do not cover the organizational or marketing methods. This is also a more appropriate
approach of innovation for small and medium manufacturing enterprises where the budget for
marketing is limited, the employee number is usually optimized, and the ownership is quite
stable.

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.

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

“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.

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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

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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 metaanalysis 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

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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.
Firm age
The research on the relationship between firm innovation and the time firms present in
the market is much more limited than the one between firm innovation and firm size.
Along with firm size in terms of total employees in the workplace, firm age
demonstrating the years in operations is a classic control variable in studies of innovation
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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
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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 foodmanufacturing 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)
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show that formal education and training programs is likely to boost the product innovation in
small-sized firms.
However, though it does not directly indicate the knowledge asset within organization,
there is a study raising the inferior role of knowledge in the innovation process. The empirical
study of Lööf and Heshmati (2002) from the data collected in the second European Community
Innovation Survey shows that knowledge-intensive firms which require access to and
utilization of large knowledge amount are interestingly not more innovative than laborintensive firms which use a large amount of labor and capital-intensive firms which requires a
large amount of finance resources for operating, controlling for discrepancy in innovation
investment and human capital.
Employee qualification is another form of firm knowledge. Investigating the smallsized 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
or higher.
In conclusion, the higher qualified staff can deliver higher rate of innovation.
Innovation expenditure
The expenditure for innovation captures the interest of a variety of researches.
Evangelista et al. (1997) summarize the innovation expenditure by firm in manufacturing
sector into six categories: expenditures for R&D activities, expenditures for patents and
licenses, the cost for designing, tooling-up and trial production, expenditure for marketing and
amount of innovative investment, under the form of acquisition new machinery and plants.

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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

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fields. Hence, the impact of external innovation factors is included in this study for a more
comprehensive analysis about the causes of firm innovation.
The external innovation factors in this part cover three types. First, the external network
with other firms in the same industry, this type of network is a part of the horizontal
cooperation of firms with their peers. Second, the spillover pressure from suppliers or
customers, this pressure partly shows how firms interact with the vertical relationship when
operating. Third, the competition level demonstrates the market environment that firms are
running.
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
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