Determinants of product innovation activity the case of vietnamese SME firms

UNIVERSITY OF ECONOMICS

INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY

THE HAGUE

VIETNAM

THE NETHERLAND

VIETNAM - NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

Determinants of Product Innovation Activity:
The case of Vietnamese SME Firms
BY

DANG THUY TRANG

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, May 2015

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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

Determinants of Product Innovation Activity: The
case of Vietnamese SME Firms

A thesis submitted in partial fulfillment of the requirements for the degree of
MASTER OF ARTS IN DEVELOPMENT ECONOMICS
By
DANG THUY TRANG

Academic Supervisor:
LE CONG TRU PhD.

HO CHI MINH CITY, May 2015

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ABSTRACT
This study examine two manors of product innovation including improving

existing product and making new product with the scope of Vietnamese SME's firms.
The aim of this study is to figure out what determinants have significant impact on each
type of product innovation and whether correlation between these two manors exists.
Determinants are categorized into internal and external factors. The first group includes
age, experience of entrepreneur, firm size, training cost, and R&D cost. The second group
includes competition level, outsourcing cost, external consultant, networking, knowledge
of market/marketing cost, and export orientation. Bivariate-probit model is used for
attaining research's purposes above. The model is applied on 1418 SME's firms which are
separated into five sections: textile & shoes, food manufacturing and processing,
mechanics and electricity, wood processing and all other sections. Five factors are figured
out to have significant influence on product innovation activity of firms including firm
size, age of entrepreneur, export, competition level and network. Marginal effect
calculated from bivariate-probit regression are helpful evidence for firms to adjust
significant determinant to improve their innovation performance.

ABBREVIATION
R&D

Research and Development

SMEs

Small and Medium Enterprises

CIEM

Central Institute for Economics Management

OECD

Organization for Economic Co-operation and Development

MIT

Ministry of Industry and Trade

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CONTENTS
I. INTRODUCTION.................................................................................................................................................... 7

I.1 Problem statement ............................................................................................................................... 7
I.2 Research objectives: ............................................................................................................................ 8
I.3 Research questions .............................................................................................................................. 8
I.4 Scope of the study................................................................................................................................ 8
I.5 Structure of the study ........................................................................................................................... 8
CHAPTER II: LITERATURE REVIEW ............................................................................................................... 10

II.1 Innovation........................................................................................................................................ 10
II.1.1Definition of innovation ............................................................................................................. 10
II.1.2 Popular indicators of innovation activity in SMEs: .................................................................. 10
II.1.3 Classification of innovation: ..................................................................................................... 12
II.1.4 Characteristics of innovation activities in developing country ................................................. 12
II.1.5 Comparison between large enterprises and SMEs based on indicator of product innovation ... 13
II.2 Product innovation ........................................................................................................................... 14
II.2.1 Definition of product innovation ............................................................................................... 14
II.2.2 Classification of product innovation ......................................................................................... 14
II.3 Reviews of Related Theories ............................................................................................................ 15
II.4 Reviews of Empirical Studies ......................................................................................................... 17

II.4.1 Determinants of product innovation .......................................................................................... 17
II.4.2 Empirical review of methodology ............................................................................................. 30
CHAPTER III: RESEARCH METHODOLOGY AND DATA ............................................................................ 36

III.1. Data and sample ............................................................................................................................. 36
III.2 Variables and Measurement ............................................................................................................ 36
III.2.1 Dependent variable .................................................................................................................. 36
III.2.2 Independent variables .............................................................................................................. 37
III.3 Analytical approach ........................................................................................................................ 41
III.3.1 Empirical model, estimation method ....................................................................................... 41
CHAPTER IV. EMPIRICAL RESULT .................................................................................................................. 45

IV.1 Innovation activity of SMEs in Vietnam ........................................................................................ 45
IV.2 Data description .............................................................................................................................. 46
IV. 3 Descriptive statistics ...................................................................................................................... 47
IV.4 Regression Results .......................................................................................................................... 50
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IV.5 Marginal effects: ............................................................................................................................. 55
CHAPTER V: CONCLUSION AND RECOMMENDATION ............................................................................. 58

V.3 Recommendation ............................................................................................................................. 59
V.4. Limitation and Future Research ...................................................................................................... 60
REFERENCE ............................................................................................................................................................ 61

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LIST OF TABLES

Table 1: The innovativeness indicators for SMEs in different dimentions ....................... 11
Table 2: Comparison between large enterprises and SMEs based on indicator of product
innovation .......................................................................................................................... 13
Table 3: Dependent variables ............................................................................................ 37
Table 4: Determinants of Product Innovation ................................................................... 40
Table 5 : Innovation Rates in Manufacturing SMEs ......................................................... 45
Table 6: Number of observations with improved and new product .................................. 46
Table 7: Four cases of combination between improving existing product and creating new
product ............................................................................................................................... 46
Table 8 : Descriptive statistics ........................................................................................... 47
Table 9 : Correlation between some independent variables .............................................. 49
Table 10 : Summary of results from bivariate - probit regression .................................... 50
Table 11: Marginal effect .................................................................................................. 55

LIST OF FIGURES
Figure 1: Conceptual Framework ...................................................................................... 35
Figure 2: Methodology model ........................................................................................... 44

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I. INTRODUCTION
I.1 Problem statement
International economic integration allows more firms to be established and more
foreign firms to enter domestics market. Under such intensive competition pressure,
firms need to continuously innovate their products to attain comparative advantage from
other opponents. This is due to limited life cycle of individual product and more arising
demand of customers. M. Banbury and Mitchell (1995) proved that the more often firms
create new products, the better they perform and the higher their probability of surviving
in long term is. This is applicable for both small and large firms (Vermeulena, De Jong,

& O'shaughnessyc, 2005). Chris Freeman and Soete (1997) - even asserted that ‘not to
innovate is to die’. Due to such important role of innovation, a large amount of studies
have been done to identify factors having influence on product innovation of small firms
(Martinez-Ros,1999; Jong, 2006; Fritz,1989; Vega-Jurado, Gutierrez-Gracia, Fernandezde-Lucio & es-Henriquez, 2008; Hadjimanolis,2000; Freel, 2000).
It requires more than expenditure on R&D for attaining improved or new products.
Factors with considerable influence on innovation activity that should be taken into
account include firm size, production technology ( ratio of sales over fix assets), origin of
ownership, spending on market insight... (Avermaetea, et al., 2004). How much these
factors may affect innovation activity is not equal and depends on economic section of
firms. Thus, a model simulating impacts of aforementioned elements is necessary to be
established .
While there are a range of international researches addressing this topic, number
of papers on such matter at Vietnamese scale is quite limited. As Vietnam is a developing
country, a moderate technical progress may result in huge increase of firm' sale or market
share... (Hadjimanolis, 2000). Thus, a model applying this matter for Vietnamese
scenario is essential to be devised. This paper is expected to achieve that target.

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Both Vietnamese enterprises and policy makers can utilize results of this paper.
First of all, enterprises can refer to this model when they are in need of promoting
innovation for their product. As the model points out specific elements and the level such
elements need controlled. This is also a useful guidance for policy makers. In detail,
being aware of influential elements of each industry allow policy makers to make proper
decision to assist innovation of that specific section.
I.2 Research objectives:
The study is expected to figure out determinants with significant impact on
product innovation activity of Vietnamese SMEs and influential level of each factors.
By understanding the interaction between the internal and externals factors having impact

on product innovation, enterprise’s leaders may adjust firm’s strategy to adapt to
characteristics of environment to gain the highest performance in product innovation
activity.
I.3 Research questions
There are two main questions addressed in this study. The first one is what
indicators have considerable impact on product innovation behavior of firms. The second
one is to which extent product innovation is influenced by these factors.
I.4 Scope of the study
The study examines Small and Medium enterprises across Vietnam with data
extracted from SMEs survey 2011.
I.5 Structure of the study
This paper includes five chapters. The first chapter - Introduction presents the
issue and background of the issue addressed in this paper, then discussing research
objective. Chapter II–Literature review presents the theoretical and empirical foundation
of the topic which aims at creating a conceptual framework for the research. This part
explains the definition of innovation, product innovation, theoretical and empirical theory
about determinants of product innovation activity of firms, the methods applied to
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measure product innovation. Chapter III – Research Methodology focuses on the method,
data description and the analytical model applied in this paper. Chapter IV– Findings and
Discussions discuss the regression results and marginal effect of each factor on product
innovation probability. The final part Chapter V–Conclusion and Recommendations
suggest policies for policy makers and for top management of firms when they want to
increase the rate of innovating product.

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CHAPTER II: LITERATURE REVIEW
II.1 Innovation
II.1.1Definition of innovation
According to Hyvarinen (1990), innovation activities involve both internal and
external activities of firms with the target of creating new products, enhancing existing
products, process, governance or marketing.... Most of innovation activities originate
from research and development (R&D). Some may be acquired by firms via other sources
such as licensing, seminars, consultants, customers, providers... Technologies can be
applied in various ways in each firms. When technology is aware at a broader sense
rather than relating to products only, innovation activities will play a key role in
development of SMEs (OECD, 1982)
II.1.2 Popular indicators of innovation activity in SMEs:
There are three popular proxies usually used to indicate levels of innovation:
input, output and impact. These indicators could be analyzed in general or particular
meaning and measured by quantity or quality. The measurement units used most
frequently are number and rate. Among various inputs of producing, time, capital and
labor are the common factors used to measure effectiveness of innovation. Because these
factors can be collected more easily and exactly than others belong to output or impact,
the input method is preferred than the other two methods. The second indicator- output
involves in analyzing straight outcome of innovation, creation, expertise, proficiency and
absorption of technique. The typical proxy of output is patent as its data can be found in
most country’s statistic system. However, patent is not the most significant in all
companies and all industries. Some innovations may not be registered for patents.
Besides, patent refers to invention rather than innovation. Output method sometimes
utilized number of license as indicator. The last and the latest among three methods is
impact indicators. This method relates to innovation in larger aspect and refer to
qualitative outcomes rather than quantity. Impact is comparison between cause and effect
of innovation and the variation of sales, capital, productivity, development, etc.... of firm
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( Harrison& Hart, 1987;Kamien & Schwartz, 1975; Meyer-Krahmer,1984; Walsh, 1984
and Scholz ,1988)
The table below describe three indicators of innovation when they are examined
based on four dimensions including technology, individual, enterprise, market/ environment.
Table 1: The innovativeness indicators for SMEs in different dimentions
Dimension

Input

Output

Impact

Technology

* Personnel participating R&D
* Inventions
* Science
* Different technologies information
* Information
* Know-how from outside
* Timetables
* Degree of newness
* Life cycle

* Innovations types and ideas
* Inventions
* Patents
* Licenses

* Delays in reaction to
- information in results of
- innovation process

* Change in enterprise ‘s
technology
* Improved technologies
* Other innovations
* New ideas
* Renewals
* Development possibilities
* Diffusion of innovation

Individual

* Know-how
* Ideas
* Financial input
* Motivation
* Attitude
* Working hours
* Education

* Job satisfaction
* Profit
* Dividends
* Know-how
* Skill
* Adoption and/or development
of ideas

* Development of individual
* Better living standard
* Employments
* Status
* Motivation

Enterprise

Personnel
Funds
Strategy
Information
Know-how
Competition
Cooperation between-departments

Growth
Profit
Better strategies
Innovations
Improved know-how
Skills
Publications
Exports

Success
Improved value added
Equity increases
Enlarged-market

Better image
Rewards
Development of enterprise
Internationalization

Market and
environment

Education
Infrastructure
Political inputs
Branch
Market
Competition
Hostility
Location
Interest group

Payback of loans
Taxes
Products
Innovations
Markets

Development of branches
New enterprises
Employment
Regional development
Facts
Know-how

Economic growths
Diffusion of innovation

Source: Hyvarinen (1990)
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II.1.3 Classification of innovation:
There are four criteria which are usually used to classify innovation: time,
influencer (firm/entrepreneur), market, and technology. Firstly, innovation can be ranked
based on its newness. The order from the oldest to the latest is basic, applied and
incremental innovation. The time within the concept of innovativeness of small- and
medium sized industrial enterprises gives the opportunity to notify the following: degree
of newness of innovation, delay in the reactions of SME to changes in environment and
in the information about them, time-related development of a SME , time dependent
innovation process, the delay between the output and impact and input of innovation
activities. When influencer or causer of innovation is analyzed, the typical classification
is innovation caused by entrepreneur or caused by firm. When it comes to innovation in
different departments of firms, there are five types of innovation: product, process,
marketing, organizational and social innovations (Hyvarinen, 1990). The final criterion is
market. This means that an amendment is innovation when it is new to the market.
II.1.4 Characteristics of innovation activities in developing country
Typical features of developing countries related to innovation activities are listed as
below:
 There’s a shortage of policies facilitating innovation and organizations which
should be in charge of managing and supporting technology and innovation. Some
of them maybe exist, however their performance may not be mature yet. These
institutions include high tech industrial zone, investing firms, suppliers of
technological material. The insufficient innovation system at national level reduce
technological chances of the whole economy (Fontes and Coombs, 1997).

 Quality of innovative products which are produced by domestic manufacturers are not
trusted by consumers. Beside, due to small size, the demand of local market is limited
and the demand for innovative product is unimportant (Fontes and Coombs, 1997).
 The economy is dominated by small firms. While the number of medium and large
firms is quite modest. According to the theory of relation between size and
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innovation activity, such an industrial structure doesn’t encourage innovation.
There is no complementing relation between small and large firms as found in
developed country (Fontes and Coombs, 1997).
 The cooperation between firms and research institutions, universities is not very
tight. There’s not much new techniques transferred from these organizations to
manufacturing firms (Jones & D., 1996)
 Most of innovation activities result from adapting techniques which are initially
created or invented in developed countries. Thus, an open economy which allows
connections with foreign countries is necessary for stimulating innovation.
II.1.5 Comparison between large enterprises and SMEs based on indicator of
product innovation
Innovation activity of firms is differed due to scale which is presented in Table 2 below.
Table 2: Comparison between large enterprises and SMEs based on indicator of
product innovation
Indicators

Large enterprises

SMEs

Resource: Staff,
capital, market

awareness, experience

Complex structure, application Simple structure, easy to
of innovation require
apply innovation like new
complicated assessment
invention or improved process

Planning

Well –prepared and inflexible

Easy to adapt to market
fluctuation

Flexibility

Require formal project to
apply innovation

Flexible and can react rapidly
toward market fluctuation

Governance

Final decision is not decided
by one person

Difference in authorization
between levels of staff is not

much

Source of information

Well aware of government‘s
documents

Unofficial information plays a
key role in some case.

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Adaptation

Disapprove of new idea, just
create basic innovation

Easy to approve to use small,
new unique idea

Level of innovation

Moderate, not radical
innovation

Radical innovation

Source: Hyvarinen (1990)
II.2 Product innovation

II.2.1 Definition of product innovation
There are different ways to define product innovation. It is widely interpreted as
the activities of developing and launching to market a product which is new, enhanced or
significantly improved. In specific, product innovation may range from inventing a new
product, improving a product's quality, enhancing product's technical features or adding
new parts, input and expecting functions to an established product (Acs & Audretsch,
1988). From another point of view, as long as the product is new to market, it will be
considered as an innovation, even when alike products are already exist.
II.2.2 Classification of product innovation
Different forms of product innovation could be separated into two categories:
radical innovation and incremental innovation. The first means creating a totally new
product while the second refers to improving existing product. Radical innovation
involves in introducing new product to market. This process includes two simultaneous
stages with the first stage relates to developing idea, designing product, technical
preparation, and the second stage relates to analyzing market. Incremental innovation
involves in enhancing established functions, technical value and user friendliness. This
method of innovation is usually utilized at the declining phase of outcome to lengthen
expectancy of product (White, Braczyk, Ghobadian, & Niebuhr, 1988).
Although some people prefer to explain this term by the first meaning, only a
certain number of firms attain such level of innovation. A paper of Wong (2014) even
finds out that over 80 percent of new product become failure and not every successful
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launches can maintain a steady growth. This is however, not a problem as it has been
proved that a regular and steady innovation on existing products is more important than a
sudden substantial change in products. In fact, many industries across the world tend to
favor product improvement than inventing a whole new one since the seventy.
II.3 Reviews of Related Theories
Neoclassical Economics is the initial method used by economists and business

managers to determine innovation activity. In this theory, innovation or technology is
defined in basic description and simply measured by production function. No relation
between firm's characteristics and innovation was figured out so all firms shared the same
features in term of technology. Schumpeter (1934) is the first author carry out deep
analysis in the significant impact of technology on economic growth. He is also a pioneer
considering relationship between firm's characteristics and innovation. His study received
a lot of interest from public and more studies were conducted in term on technological
improvement after then. In the research, Schumpeter takes two elements (firm's size and
market competition) into account and assumes they have direct impact on innovation.
The finding of this study encourages later research on influence of external factors
regardless of industry or public level. This study, however, does not discuss in detail
about other firm's characteristics or the procedure of creating innovation in firms. Thus,
more references need to be considered for a comprehensive understanding.
Various opinions have been suggested to make clear this idea. Some typical theory
are namely transaction cost economics (Williamson, 1989), the positive theory of agency
(Jensen & Meckling, 1976) the evolutionary theory (Nelson & Winter, 1982) and theory
resource-based view the firm (Wernerfelt, 1984).
Transaction cost economics analyses costs incurred from transferring of product
from seller to buyer. Potential costs can arise at three phrases: contact, contract and
control (Noote Boom,1999). Contact costs includes cost of searching for appropriate
product of buyer and cost of promoting products to potential customers of seller. Contract
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is the cost of negotiating the specific terms to fulfill transaction. The final phrase control
is the cost of ensuring both parties comply to terms and conditions specified in contract.
In general, all these costs originate from three reasons. The first is uncertainty which
includes fluctuation in both parties' behavior and uncertainty of the environment. The
second is specific investment which mean capital required to use or operate a product
after transferring. The last reason is information asymmetries. Due to such transaction

costs which constrain flow of technology between firms, between researchers and firms,
it is recommended that innovation should be internalized rather than transact through
third party organization.
The second theory mentioning impact of firm's relationship on innovation activity
is agency theory. This theory analyses conflicts between principal/agent or
manager/shareholder... and accused information asymmetry for such conflict which may
lead to inefficiency (Jensen & Meckling, 1979). To minimize information asymmetry,
agency theory suggest to constrain open corporation and knowledge/ technology transfer
as these relations may create deviation in interest of manager and shareholder and reduce
firm's effectiveness. While network is necessary for firms in adapting new technology
(Tidd & Bessant, 2009), it is not easy to avoid information asymmetry when adapting
external knowledge. Finally, under assumptions of agency theory, firms may restrain
investment of technology to avoid information problems.
The procedure of developing innovation process of firm is studied by evolutionary
method. This method assumes that technology always changes and such change/evolution
is regular and constant. Due to the assumption that every adjustment of technology is
accumulative, its development relies on its past Pavitt(1987). The most important
contribution of this theory is it emphasizes the difference between firms when it comes to
technical capability. As this is necessary to classify procedure of innovation (Dosi,
Freeman, Nelson, Silverberg, & Soete, 1988)

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Another theory analyzing innovation of firms is resource based view which aims
at figuring out firm's key resource to develop comparative advantage. According to this
theory, innovation is a valuable asset of firm as it is based on information which can be
accumulated and enlarged continuously (Wernerfelt, 1984). Innovation is considered as a
significant source of advantage for firms as it allows firms to outperform competitors or
improve weakness. Besides, innovation is valuable and scarce, it does not depreciate with

use (Itami & Roehl, 1991) and it takes effort to make transfer of innovation. It's not easy
to imitate or substitute an innovation due to limit of time and economy of scale.
Innovation is a key feature creating comparative advantage for firms. However, level of
innovation in each firms will be determined by specific characteristics of firms such as
capital, human or governance structure. Thus, comprehensive analysis of firms' features
is necessary in determining innovation activity of firms.
The last model is industrial organization. This model assumes that technology has
a linear relationship with information and technology is the connector of science and
innovation. From such a viewpoint, it is understood that innovation is considerably
depend on external determinants and firms are shaped by its actions in the past.
II.4 Reviews of Empirical Studies
II.4.1 Determinants of product innovation
Regardless of varied methods applied to examine product innovation, all determinants
addressed in those papers can be divided into two main types: internal and external
factors (Schumpeter,1942; Martinez-Ros, 1999; Avermaetea, et al., 2004; Fritz, 1989).
The first group refers to elements related to enterprise's character such as : size, technical
staff, professional staff, investment on R&D, spending on marketing.... and factors
involved in features of entrepreneurs, i.e. : age, experience with product before... The
second group comprises of factors affecting firms from outside such as intensity of
competition, comprehensive relationships, outsourced consultants...

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In another study of Damapour (1991), different factors having influence on
innovation activities are divided into three groups as follows:
 Enterprises’ human resource which include owner, manager, technical staff…
 The enterprise’s characteristics
 External factors having interaction or impact on enterprise, such as competition
level, network…

In 1990, King extended such theory with two antecedences of innovation which
are: national innovation policies and Inter-firm Linkages. Yoshihara also mention
national economy in his study in 1976. He explains that environmental changes provide
opportunity for innovation which include both threats and encouragement for firms'
business. In specific, enterprise' environment can be separated into two categories: the
first one is direct environment including market demand and supply, customer taste, antibusiness attitudes as well, the second one is macro factors such as national and
international economy, political situation, education, technology, population and so on.
In sum up, determinants of innovation activities consisting the argument and
measurement in relevant references are summarized as below:
II.4.1.1 Internal factor
a. Characteristics of owner/ manager
The roles of owner/manager's characteristics are approved by many studies to
have impact on innovative ratio of firms. Schumpeter (1934, 1942) is one of the first
authors figure out the influence of entrepreneurs on innovation. There is more researchers
agree about the role of this factor recently (Mascitelli, 2000). Indeed, the owner/manager
is supposed to analyze market and determine appropriate moment of investing to enjoy
new advance technique (Fontes & Coombs, 1996). Besides, as entrepreneurs directly

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keep in touch with major relations of firms, they will decide whether or not to apply
innovative idea from these potential sources (Lipparini, 1994). In small business, the
manager/owner is mainly responsible for strategic decision then his role is more
significant as compared to large business where the decision is made through various
levels of assessment Drucker (1985) and Urban & Hauser (1980) stated that small firms'
innovative behavior tend to be influenced by individual features while large firms
innovation is determined by characteristics of firms such as product, capital, investment...
The innovation activities of individuals form an important part of the innovation
resources and organizational behavior.

The age of the entrepreneur is expected to be negatively related to innovation. The
reason is younger manager/owner has more incentive to perform innovation as they have
more time bonding with firms (Diederen, van Meijl, & Wolters, 2000). Avermaetea, et
al., (2014), proposed a contrast argument which states that "a degree in science or
technology and long-time experience in the firm are thought of as indicators for
innovative capabilities".
The accumulation of knowledge and experience is approved by many studies.
However, whether an experienced manager/owner is more innovative than a younger one
or not hasn’t been empirically certified clearly (Romijn and Albaladejo, 2002).
Background and skill of entrepreneur are important factors to be analyzed as well. Some
authors proposed that a manager/owner who is post graduate will be more eager to
innovate than a graduate one. This is due to a range of skills such as communication,
social connection, technical fluency created during the studying time (Cohen &
Levinthal, 1999). However, there are not many papers recently approving such a
suggestion (Romijn & Albaladejo, 2002). Finally, attitude of entrepreneurs should be
considered as a determinants of innovation because firms will enjoy more innovative
opportunity when entrepreneurs have interest in advanced technique.

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b. Firm size
There are two completely opposite arguments about influential sign of firm size on
innovation. Schumpeter (1942) and Frits (1989) agreed with the positive relationship.
They explained that only large firms with prosperous budget can sponsor innovative
activities which usually require remarkable expenditure. Large firms which have larger
budget to hire/purchase new technique tend to produce more innovative products. The
negative relation is approved by Fritz (1989) and Martinez-Ros (1999). They stated that
small firms with less hierarchy can quickly response to any change of market. Besides,
while large firms can proceed some options such as take over, merging and acquire to

increase comparative advantage, small firms have less options so innovating product is
usually resort to. Moreover, large firms is often associated with high market share. Large
control power may lead firms to under evaluate innovation activity .
Symeonidis (1996) provide detail arguments for the impact of size on innovation
of firms. Firstly, R&D requires huge initial investment, thus firms must have large sales
to make up for investment costs. Secondly, economy of scale exists in producing
innovative products. Thirdly, large corporation with diverse business area tend to better
exploit advantage from sudden innovation. Fourthly, large firms can distribute risks from
an investment of innovative product via other projects of different industry. Fifth, it is
easier for large firms to mobilize capital from outside. Sixth, market power allows big
firms to make use of innovation better, thus these firms are more eager in proceeding
innovation.
Regarding this factor, Acs and Audretsch (1988) proved the strong influence of
size on innovation activity, via both input and output. It is even found out that the
relationship between size and innovation activity is not linear. When size increases, there
will be more opportunity innovation will happen. Until a certain level, when size
continue to increase, innovation rate will reduce (Kamien& Schwats, 1982).

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Actual relation between firm size and innovation tested by empirical study is
rather diverse. In 1982, Kamien and Schwartz checked this relation among different
industries. Only chemical section presented a significant relationship. In another paper of
Mansfield in 1981, fundamental studies are mainly carried out by large firms, but small
firms invest more for innovating product.
Most empirical studies analyze firm size factors by relating innovation activity to
size measurement across firms in different industries. Firm size is proved or assumed in
those studies to be exogenous. Innovation has direct influence on firm growth, then on
firm size. Thus size of enterprise in year t is assumed to be related to innovation activity

in year t-1. (Scherer, 1992).
In case innovation activity has relation with undetermined elements which are
serially correlated, firm size is expected to be correlated with those elements in year t.
Thus, when regress innovation on size, the result will be bias. However, some others
propose that innovation influences firms through a couple of year . In another way,
influence of innovation on firm size is lagged across some years. Thus, endogeneity is not
a big issue anymore.
Besides, there is another issue when comprising firm size into the analysis of
innovation. That is the potential correlation between firms size and industry - level
factors such as technological opportunity which may positively affect innovation. This
may cause bias result to regression with sample including different industries. The
solution is adding control variable for such industry effect (Cohen and Levin ,1989).
However, adding control variable may not help solve the problem completely as many
large firms work on various industries. To prevent this problem, it is suggested to
categorize industry to deeper level of 2 digit, but this then encounter another problem that
each sectors within one industry may have difference in some features.

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In sum up, firm size is proved by many research to be influential to innovative
activity of firms. The sign, nature, and the method to analyzed this relation, however is
varied across each study.
c. Human capital and investment in training &marketing
Beside capital, labor force is another factor that makes up production function of
firms. This mentions important role of human capital on firms' performance. In 2004,
Avermaetea, et al. pointed out that “the skills of the workforce and the firm’s investment
in such skills contribute substantially to product and process innovation in small food
firms”. Spending on regular training and coaching for staff is a wise investment for firms
to gain more innovation in future ( Freel, 2000).

It's used to be believed that innovation is determined by specialists, professors, or
engineer (Tidd, 1997). Recently, innovation has been proved by many studies to be
resulted from effort of total workforce of each company (Clark & Fujimoto, 1991) . In
spite of humble contribution of each person, the accumulated influence of the whole staff
is considerable. Employees may involve in innovation via one among below steps:
discovering opportunity, generating idea, developing, trying and putting innovation in
market (Kleysen & Street, 2001). In general, the role of the whole staff in developing
new product is undeniable.
Employee involvement is agreed to influence innovation. However, how much
such contribution is depends on staff's actual knowledge and skill (Warner 1994).
Experienced and skillful staff usually require high salary which is equivalent to their
efficiency. They prefer to work for large firms where financial resource and working
condition is better than at small firm (Freel, 2000). This is one direct cause leading to
variation in innovation activity between large and small firms. Workforce skill even
contribute 60% to innovation of service firms. Due to above arguments, it is suggested
that firms should spend more on staff training to enhance workforce capacity to attain
higher innovation rate.
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e. Origin of ownership
Origin of firm ownership is divided into two types: foreign owner and domestic
owner. For firms situated at developing countries, multi-national companies with
professional working style, tremendous physical resources is believed to be more active
in innovating. Besides, multi- national companies may receive transfer of technology
from foreign subsidiaries. Thus, these firms have higher rate of innovating compared with
purely domestic firms (Cave,1982 ).
In a study of Baldwin & Sabourin (2000), origin of ownership is figured out to be
positively correlated with process innovation activity. About half of foreign firms apply
process innovation while relevant number for domestic firms is only a third. The

probability of carrying out process innovation of foreign firms are 50% higher than
domestics firms. Regarding product innovation, the result presents no different between
two types of company.
f. Intensity of physical capital
The production technology's features may have influence on whether the
innovations will be introduced or not. Production technology can be verified via intensity
of physical capital. "Firms with more capital intensive technologies will tend to innovate
more if, as expected, the rents of innovation are less threatened as, to exploit the
innovation, high investment in physical capital is required" (Martinez-Ros, 1999). More
capital intensive processes may have negative effect on innovation as they are more
automated and rigid. Thus, total influence of capital intensity is uncertain.
g. R&D activities
Enhance and improvement in technique are considered to be highly related with
innovation in both product and process. As research and development activities play a
key role in creating technological advance, they usually receive attention from many
companies (Grunert, Hartvig Larsen, Madsen, & Baadsgaard, 1996). In food processing
sector, R&D activities are disapproved by some authors to have influence on innovation.
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However, many others agree of a positive relationship between these two elements
(Huiban & Bouhsina, 1998).
To measure innovation, many authors utilize the number of patents and spending
on R&D of firms. In a study of Crepon, Duguet, & Mairesse (1998), it has been proved
that the sale of an innovative product increase 5% when R&D spending rises up 10%.
Another study of Baldwin & Diverty (1995) which applies the data from a survey of 500
Canadian firms figures that the chance to invent a new product or enhance an existing
one will increase 24% for firms which have spending on R &D. This study also asserts
that R&D and firm size have the biggest influence on innovation. Firms not performing
R&D have only an 11% opportunity of innovating, while the rate for firms with R&D

expenditure is 41%.
h. Export orientation:
International trade allows countries to focus on their own competitive advantage.
International trade also requires firms to provide the best product they can produce.
Especially for developing country, trading with foreign customers allows firms to gain
higher margin than domestically trade. However, the higher customers pay, the higher
quality they require. Thus, export tends to encourage firms to perform more innovation.
In a research of Higon and Driffield (2007), data shows that about 45% of SMEs
business exporting their products carry out innovation while this number for SMEs
trading domestically only is 26%. In another study of Matinez Ross (1999), export
orientation is included into the model as control variable. This study expect that firms
trading in foreign market resort to innovation to gain more competitiveness. The vice versa relation is also anticipated which is explained that firms with high innovation rate
may be more keen on export activity as they have sufficient intangible resources to
maintain development. Data collected from study of Becker and Egger (2013) also
supports positive relation of innovation and export. In detail, about 62% of export firms
carry out either product or process innovation, while only 30% of firms surveyed having
no innovation.
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i. Sector/ Industry characteristics:
A range of conceptual and empirical tests are addressed to clarify the variation of
product innovation among different industries. In general, there are three main
approaches for this issue. Firstly, research is proceeded with data including a variety of
sectors without making comparison (Bougrain& Haudeville, 2002; Brouwer, 1997;
Hadjimanolis, 2000). The first two authors agree the existence of difference among
industries but the specific innovative manors are not examined. The second author group
states that not enough evidence for variation of innovation among sectors is available and
they also ignore patterns of innovation. Hadjimanolis (2000) separates the data into five
sectors, but no comparison are mentioned. In sum up, results of these papers maybe bias

as total effect may overwhelm significant factors.
The second type of study restricts their sample within one sector. Romijn and
Albaladejo (2002) includes a lot of elements in their model. However, data is constrained
at electronics and software firms only. As a result, consequence of this approach is
insufficient generalizability.
In the third type, differences across sector are analyzed for example,
manufacturing versus non-manufacturing, manufacturing versus services and high-tech
versus low-tech. Acs & Audretsch (1988) include a lot of industries in their study. No
comparison among sectors are made, but the difference between large and small firms is
examined and the variation due to innovative intensity is addressed. The analyzing
method is the same for researches of Kim et al. (1993), Rogers (1971) and Bhattacharya
and Bloch (2004). Only a few studies clarify differences in detail. Oerlemans et al. (1998)
figured out several differences in the way firms utilize their resources. Freel (2003)
proved that variation of innovation behavior across sectors is remarkable while Roger
(2004) explains clearly the different of sign and intensity of every factors among
manufacturing and non-manufacturing sectors.
II.4.1.2 External factors
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