Innovation Management Processes in SMEs: The New Zealand. Experience

Innovation Management Processes in SMEs: The New Zealand Experience Professor Delwyn N. Clark Waikato Management School, University of Waikato, Hamilton, New Zealand Email: dnclark@mngt.waikato.ac.nz Stream: Technology, Innovation and Supply Chain Management, or Entrepreneurship, Small Business and Family Enterprises 1

Innovation Management Processes in SMEs: The New Zealand Experience ABSTRACT Professor Delwyn N. Clark* Waikato Management School, University of Waikato, Hamilton, New Zealand Email: dnclark@mngt.waikato.ac.nz The management of innovation processes in New Zealand is important to policy makers, business advisors, managers and entrepreneurs. As the government s Economic Transformation Agenda depends on growth and innovation of New Zealand businesses (which are predominantly SMEs), research to understand how to evaluate and implement new innovations is needed. This paper reports key findings from an empirical study of 95 New Zealand companies which are active innovators. The companies are profiled and their perceptions of the New Zealand innovation context presented. Potential returns for different innovation types are assessed and their innovation management processes evaluated using indices for Strategy, Market, Resource, and Innovation factors. While these companies are well organised to commercialise their innovations, significant inhibitors to growth were identified. Keywords: Innovation, new product development, process development, organisational performance, strategic management, SMEs Introduction The New Zealand economy has performed well in terms of income per capita growth since 1994 (averaging 2%), and has the 4 th lowest unemployment rates in the OECD at 3.7% (Ministry of Economic Development (2007a). However, the level of income per capita of $US25,950 in New Zealand is much lower than peer economies rating 22 nd in the OECD and at 76% of the income level in Australia. The Ministry of Economic Development (2007a) reports that catching up with other international countries will require high and sustained growth in productivity, significant changes in the products and services produced as well as how they are produced, and increasing numbers of innovative and globally competitive firms. Accordingly, the government s Economic Transformation Agenda depends upon the growth and innovation of New Zealand businesses (Smith, 2006). Adding to this challenge, New Zealand is a nation of small and medium enterprises (SMEs) with 99.4% of companies having less than 100 employees (Ministry of Economic Development, 2007b). Hence, the processes for creating, evaluating and commercialising innovations is very important to policy makers, business advisors, managers and entrepreneurs in New Zealand. To assist 1

with the national agenda, this study focuses on innovation management processes in SMEs in New Zealand. Innovation Innovation for small firms involves changes to maintain or improve competitiveness. The scope of these changes includes new and better ways of doing things which span all aspects of the business - from products and processes, to new markets and organisational innovations (Schumpeter, 1934). For this study, the five types of innovation outlined by North & Smallbone (2000) in their SME research in the UK were adopted: 1. Product or service innovations e.g. new products or services developed from research or introduced to the market. 2. Market development innovations e.g. entering new markets with existing products. 3. Marketing innovations e.g. development of new brand or use of databases for marketing. 4. Process technology innovations e.g. applications of new tools or methods such as computer controlled manufacture. 5. Administrative innovations e.g. application of computer systems to office management. In New Zealand, the Business Operations Survey (BOS) was introduced in 2005 to collect data on business practices and performance (Ministry of Economic Development, 2007b). In terms of funded R&D, only 7% of the NZ businesses surveyed had undertaken or funded R&D in the previous financial year. Larger firms tended to engage more as 15% of businesses with 100 or more employees reported R&D activity, compared with 6% of businesses with 6-19 employees. The manufacturing industry had the highest proportion of businesses engaged in R& D activity (14%). Using a broader definition of innovation, the BOS found 52% of NZ firms engaged in innovative practices including: innovation in goods and services - 30%; innovation in operational processes 29%; innovation in organisational or managerial processes 31%; and innovation in marketing methods 29%. Overall, larger businesses were more likely to engage in innovation than smaller businesses 68% of businesses with 100 or more employees, compared with 50% of businesses with 6-19 employees. The highest rate of innovation was found in the finance and insurance industry (68%), followed by the manufacturing industry (65%) (Ministry of Economic Development, 2007b). 2

Return from New Innovations Entrepreneurs and managers are frequently faced with decisions about which new innovation to adopt. For these decisions, it is important to understand the likely impact of the potential innovations on their firm s future revenue streams. Santi et al (2003) have developed a model which assesses the potential rent-return (RENT) from an innovation based upon three components: volume of sales, the rate of margin, and length or duration of the innovation s life cycle. Volume of sales is estimated from potential geographic and sector diffusion, size of markets and limits due to prior patents. Rate of margin (or profits) is based upon the process of generating the innovation, the type of innovation, and the kind of prior protection. Length of lifetime is assessed by the technological basis of the innovation, innovation intensity of the sector and ability to imitate the innovation. Based upon high or low component levels, Santi et al (2003) proposed a typology of six different potential RENT configurations. The CEREN/CEMI RENT diagnostic utilises these potential RENT configurations as a basis for evaluating new innovations and understanding their implications for investment and returns (Mazzarol & Reboud, 2006). Table 1 shows all of the potential RENT configurations, including two variations of the Flash in the Pan and Oasis options. Insert Table 1 about here Clearly the potential RENT varies for each of these configurations and the scale of the variables. Entrepreneurs, managers and investors would be much more enthusiastic about a new innovation which is a Champion with potentially high sales, high profits and a long life-cycle, than a Shrimp offering much lower potential RENT. In addition to evaluating the potential RENT from a new innovation, these configurations provide a useful diagnostic tool to explore the implications of each innovation. For example, does the firm have the resources to implement the Champion innovation and extract all the potential RENT from it? Can the volume of sales be increased to improve the potential RENT from an Oasis-True innovation? Can the rate of margin be increased for a Joker innovation? Can the life cycle be extended for Flash in the Pan High Profits innovation? 3

Innovation Management Processes The process of managing the development and implementation of new innovations is also important for firms to successfully commercialise their new ideas. Mazzarol & Reboud (2006) have designed an Innovation Diagnostic Diamond (IDD) which can be used to evaluate an entrepreneur s current approach to innovation management. This tool calculates indices for activities in four key areas market, innovation, resources and strategy: 1. Market Index a measure of the firm s focus on customer needs and how the new innovation offers value for money; 2. Innovation Index a measure of the firm s formal process of new product development and its management of intellectual property; 3. Resources Index a measure of the firm s technological, human, financial and managerial resources; and 4. Strategy Index a measure of the firm s strategic planning activities as related to the commercialisation process. These indices are calculated on a 1-10 scale and plotted on a diamond-shaped radar graph to provide a visual representation of the firm s performance. This diagnostic enables entrepreneurs, managers and investors to see at a glance how well the firm s activities are organised. With this tool, areas of weakness in innovation management can also be identified and then addressed. METHODOLOGY An international study of innovation and strategic decision making in SMEs has been conducted in 16 countries led by Mazzarol and Reboud using the CEREN/CEMI diagnostics. As part of this research, data was collected on innovation practices in 95 New Zealand companies during 2006-2007. A purposeful sample of companies was selected based on criteria for size, trading history and innovation activity. Size limits were based upon OECD definitions for SMEs from 10-250 employees and annual turnover up to NZ$100 million. As evidence of trading history was required, start ups and very early stage ventures (under three years of operations) were excluded. As evaluation of one new innovation 4

was a key part of the study, evidence of innovation activity was a primary selection criterion. Industry/sectors with well-defined products and high levels of innovation and commercialisation were targeted. Companies were invited to participate by phone and email, after background research on their profiles had been reviewed. Face-to-face interviews were conducted with owner-managers or senior executives using the diagnostic questionnaire. After each interview, the participants were sent a copy of their report with an accompanying letter highlighting the key assessment of their innovations. For this paper, the New Zealand results will be analysed to consider three specific research questions on innovation activities and innovation management processes: 1. How does the innovation context in New Zealand influence innovation activities of larger, innovative New Zealand SMEs? 2. What types of innovations are larger, innovative New Zealand SMEs developing? 3. What is the status of the innovation management processes in larger, innovative New Zealand SMEs? RESULTS and DISCUSSION Key results from this sample of New Zealand companies will be reported and discussed in this section. First, a brief profile of the companies and their innovation activities will be provided, and then findings on the innovation context, innovation types and innovation management processes will be presented. Profile of New Zealand Companies Characteristics of the New Zealand companies studied are summarised in Table 2. The age profile shows that most of these companies are well established with an average age of 20.8 years; the age range spanned from 4 to 143 years, with only 18% of the companies with less than 10 years in business. In terms of size, the average number of full time employees (FTE) currently was 56, which was a 17% increase from 48 FTE three years prior. Growth in FTE was significant during this period as is shown further in the FTE profiles. The annual turnover distribution also shows significant growth over the previous three year period; average gross annual turnover for these companies increased 65% 5

from NZ$8.4 million three years prior and to NZ$13.8 million. These companies are much larger than the average New Zealand small firm which is partially attributable to the use of the OECD size definitions for comparability in this international research project and it also reflects their track records. In terms of industry, this sample includes 56% manufacturers, 15% IT and software, 7% communication and other services, 11% tourism, cultural and recreational services, 6% wholesale/retail trade, and 5% other (including energy and publishing). Note, as this is a specialist sample of large innovative SMEs, it does not include companies from all industries or sectors. Insert Table 2 about here Propensity to Innovate Given the focus of this research on innovation returns and innovation processes, as well as evaluating the CEREN/CEMI diagnostics, it was important for the companies participating to have some experience with innovation. Pre-screening looked for evidence of new products, new markets or introduction of new technologies, as well as asking if the company was planning to introduce a new innovation within the next three years. To assess the propensity to innovate, interviewees were asked about their focus on new innovations 1 and to estimate the numbers of new innovations introduced over the previous three year period. Innovation is perceived to be a major focus in these New Zealand companies as 92% reported always or mostly responses to this question [within the innovation index]. The scale of innovation activity over the previous three years is high as most of these companies (59%) reported introducing more than 10 innovations, 23% introduced 6-10 innovations, and only 18% introduced less than 5 innovations during this period. Further, the average annual investment in new innovations was 19% of turnover for these companies. These New Zealand companies have a high propensity to innovate based upon their innovation focus and extent of innovation activity. Most of this sample can be considered as active innovators. 1 Do you feel that the generation of new innovations is a major focus of your firm? 6

Innovation Context New Zealand The external environment provides the context for innovation which can potentially be enabling, neutral or inhibiting. To examine the influence of the New Zealand context on innovation activities, the perception of these New Zealand innovators to a series of key environmental factors were assessed using a Likert-type scale. Table 3 shows the results for this sample, highlighting the mode and providing the mean score (out of 5). Insert Table 3 about here The three factors with the highest mean sores were the New Zealand lifestyle, access to high quality research centres and access to external financing to fund future growth. Lifestyle impacts on companies in many different ways which may mean increased business for tourism companies, or perceptions of New Zealand s clean and green image may influence brand values and identity for exporters. Perceived access to high quality research centres was scored highly by many of these companies. This finding is very interesting given the broad geographic spread of the companies and the relatively small number of specific research centres in the country. However, this shows that physical proximity is not a constraint to access to research centres in New Zealand. The perception of relatively easy access to external financing of future growth is surprising given the small scale of the venture capital market in New Zealand. However, these companies were well established and primarily financing their own new projects from retained profits (94% of sample) and loans (78%). The factors with the lowest mean scores were the regulatory environment, ease of access managerial staff, and ease of access to skilled workforce. These findings suggest that growth of innovative companies will be inhibited in New Zealand as managerial staff, skilled employees and the regulatory framework are fundamental for increasing business activities. There was a high level of agreement from these innovative companies that the New Zealand context does not provide strong government support for local innovators. Furthermore, over half of the innovators perceived that the cost of doing business was not low in comparison with other countries and geographic distance to markets was a problem for many of these New Zealand companies. 7

There are a number of implications for policy arising from this study of successful New Zealand companies that are active innovators. In particular, it seems timely to review the government support schemes for local innovators as they were not perceived to be strong. Policy initiatives designed to address the other inhibiting contextual factors will be necessary for the New Zealand government to improve the context for innovation and achieve its economic transformation agenda. Innovation Types Interestingly, all of these New Zealand companies had a portfolio of innovations which included different types of innovations e.g. product/service and market development, process technology and marketing innovations. Table 4 shows the distribution of innovation types for the New Zealand companies. While product/service innovations were the dominant type of innovation, many companies were also actively innovating in market development, and to a lesser extent in process technology. Insert Table 4 about here To examine the influence of the type of innovation on the potential return of the innovation, the potential return of one new innovation was evaluated for each company using the CEREN/CEMI RENT diagnostic. The types of innovation chosen by these companies for this evaluation included 73 product/service innovations, 6 market development innovations, 4 marketing innovations, 10 process technology innovations, one administration innovation and one integrated combination innovation. As shown in Table 5, these innovations also incorporate all eight of the potential RENT configurations. Insert Table 5 about here Over half of the new innovations examined scored in the Champion category which potentially provides the greatest return based on high sales, rate of return and lifetime. This relatively high level of high potential innovations reflects the nature of the sample as experienced innovators. A similar level of Champion innovations was found in Australia, while in France the average category 8

was the Shrimp (Mazzarol & Reboud, 2007). The Oasis-True category was the second highest innovation reported by 13.7% of these New Zealand companies. These innovations have relatively high returns and durable life cycles, but relatively low potential sales. While they are likely to be more suitable for a small business to manage, this category also reflects the limitation to growth that a relatively small market size (as in New Zealand) poses for some products and sectors. The third most frequent innovation category was the Flash in the Pan - High Profits which represents high sales and high potential returns during a shorter life cycle. This category is very important for many companies which operate in sectors with relatively short product life cycles and also where IP cannot be protected. Companies dependent on these types of innovations need to produce a continuous stream of innovations in order to maintain and improve their performance. Innovation Management Processes The processes associated with their new innovation were evaluated for each company to address the third research question on the status of innovation management processes in New Zealand SMEs. For this analysis, four key indices were calculated and reported using the Innovation Diagnostic Diamond (Mazzarol & Reboud, 2006) in Figure 1. The average scores are very high with three of the indices (Market, Innovation and Resource) scoring over 7.8, and the Strategy score just below on 7.5. These results suggest that these New Zealand companies are very well organised to commercialise their innovations. The ability to manage the implementation processes for new innovations is important to realise their potential. Hence these findings are consistent with the growth and performance data for these New Zealand companies. Insert Figure 1 about here The mean scores for the Market, Innovation, Resource and Strategy indices for each of the RENT configurations are presented in Table 6. While the Champion innovations have high mean scores, it is interesting to see that other RENT configurations also have high mean scores. Some companies may have high scoring innovation management processes, and the ability to realise the 9

potential from their innovations, even though specific innovations may have variable or lower potential RENT. It is relevant to note here that innovation management processes contribute to both the creation of new innovations and their implementation. Insert Table 6 about here CONCLUSIONS and FURTHER RESEARCH This paper has provided a brief overview of an original research investigation of innovation processes in 95 New Zealand SMEs. The companies profiled in this study were well-established with high levels of growth in both FTE and revenue over the previous three years; they were active innovators in terms of focus, numbers of new innovations, and levels of investment in innovation. While these New Zealand companies had a portfolio of different types of new innovations, the product/service innovation was the dominant type found. In terms of the context for innovation, there are policy implications from the findings as these active and successfully innovative companies perceive that New Zealand does not provide strong support for local innovators. Further the inhibitors to growth by SMEs, which include access to skilled employees, access to managerial staff, the regulatory framework for business, relative costs of doing business and geographic distance to markets, will need to be addressed for the New Zealand government to improve the context for innovation and achieve its Economic Transformation Agenda. The new innovations evaluated from this sample of New Zealand SMEs illustrated all five innovation types and all eight of the potential RENT configurations studied. Finding that the majority of the innovations were in the high potential RENT categories augurs well for New Zealand SMEs. However, market size in New Zealand was a limiting factor for some products and sectors, and the lack of IP protection reduces the life cycle for many other SMEs. Further investigation of these factors is recommended. The innovation management processes for these New Zealand companies were assessed using indices for Market, Innovation, Resource, and Strategy factors. The average results were very high 10

across all of these processes, which signals that they are well organised to commercialise their innovations. The ability to manage the processes for developing and implementing new innovations is clearly fundamental for growth of SMEs, and these New Zealand companies are very well positioned for such growth. Further analysis of the data collected from this study will be carried out to examine and test more specific hypotheses in future. For example, the relationships between innovation type and innovation potential, and between innovation management processes and innovation potential. International comparisons will be made to see how New Zealand SMEs innovation processes compare with those in other countries, such as Australia, France, Italy, Belgium, USA, and China. Further research will probe the effectiveness of the innovation management processes in developing new innovations, to supplement the work on innovation implementation processes. Further work will also be done to refine and test the diagnostics used in this study to measure RENT potential and innovation management processes. For example, customising the diagnostics for different innovation types particularly process technology and administration innovations, and adapting the indices to assess the company s processes for multiple innovations rather than a single innovation. In addition to providing diagnostic tools for SME owners, this project also provides valuable information for policy makers in New Zealand and beyond. REFERENCES CEMI/CEREN Case Study Protocol: Strategic Innovation in Small Firms An International Analysis of Innovation and Strategic Decision Making in Small to Medium Enterprises, CEMI Report 0602, (2006), pp.39. Mazzarol, T. & Reboud, S. (2006). The Strategic Decision Making of Entrepreneurs within Small High Innovator Firms. International Entrepreneurship and Management Journal 2(2):261-280. Mazzarol, T. & Reboud, S. (2007). Innovation Management in Small Firms: A Comparison of French and Australian Companies. EFMF 37 th Annual Entrepreneurship, Innovation and Small Business Conference, 13-14 September 2007, Ljubljana, Slovenia. 11

Ministry of Economic Development. (2007a). Statement of Strategic Intent 2007/2010. Wellington: Ministry of Economic Development. Ministry of Economic Development. (2007b). SMEs in New Zealand: Structure and Dynamics. Wellington: Ministry of Economic Development. North, D. & Smallbone, D. (2000). The Innovativeness and Growth of Rural SMEs During the 1990s. Regional Studies 34(2):145-157. Santi, M., Reboud, S. Gasiglia, H. and Sabouret, A. (2003). Modèle de valorisation et de protection intellectuelle des innovations des PEI. July, HEC/INPI: 63 p. Schumpeter, J. (1934). The Theory of Economic Development. Cambridge:Harvard University Press. Smith, K. (2006). Public Policy Framework for the New Zealand Innovation System. Ministry of Economic Development, Occasional Paper 06/06. Wellington, 59p. 12

Table 1: Potential RENT Configurations Volume of Rate of Length of Configuration Name Sales Margin (Profit) Life Cycle High High Long Champion High High Short Flash in the Pan- High Profits High Low Long Joker Low High Long Oasis - True High Low Short Flash in the Pan- Low Profits Low Low Long Oasis Mirage Low High Short Gadget Low Low Short Shrimp 13

Table 2: Profile of New Zealand Organisations Characteristics Number Percentage Age of Firm 0-9 years 10-19 years 20-29 years 30-39 years 40 + years Organisation Size -Current 0-19 full time employees 20-49 full time employees 50-99 full time employees 100-249 full time employees Organisation Size Three Years Ago 0-19 full time employees 20-49 full time employees 50-99 full time employees 100-249 full time employees Gross Annual Revenue Current NZ$ 0-9 million NZ$ 10-19 million NZ$ 20 29 million NZ$ 30-39 million NZ$ 40-49 million NZ$ 50 + million Annual Revenue Three Years Ago NZ$ 0-9 million NZ$ 10-19 million NZ$ 20 29 million NZ$ 30-39 million NZ$ 40-49 million NZ$ 50 + million 17 37 23 12 6 24 28 22 21 36 33 17 9 52 17 16 4 2 4 64 24 1 4 2 0 17.9 38.9 24.2 12.6 6.3 25.3 29.5 23.2 22.1 37.9 34.7 17.9 9.5 54.7 17.9 16.8 4.2 2.1 4.2 67.4 25.3 1.1 4.2 2.1 0 14

Table 3: Perceptions of the New Zealand Environment External Environment Factors 1. Not At All It is easy for our business to access a workforce with the necessary skills and education? The cost of doing business is low in comparison to other countries? Geographic distance to key markets is not a problem for our business? It is easy for a business such as ours to access external financing (e.g. banking or venture capital) to fund future growth? It is easy for a business such as ours to find and recruit high quality managerial staff to assist with future growth? The lifestyle in this country enhances our business? It is easy for a business such as ours to access high quality research centres (e.g. universities) locally? Government support for local innovators is strong? The regulations governing business operations in this country (e.g. patent laws, taxation, corporate governance rules) are excellent for our business? The communications infrastructure in this country (e.g. roads, telecommunications, internet services) are excellent for our business? 2. Not Really 3. More or Less 4. Yes. Agree 5. Totally Agree Mean Score 8 46 26 13 2 2.53 14 28 24 25 4 2.76 20 23 15 31 6 2.79 13 21 13 40 8 3.09 20 30 27 18 0 2.45 8 20 15 39 13 3.31 8 11 33 40 3 3.20 14 27 25 24 5 2.78 18 33 29 13 2 2.45 8 33 29 23 2 2.99 15

Table 4: Distribution of Innovation Types Types of Innovations Proportion of Total Innovations 0-20% 21-40% 41-60% 61-80% 81-100% 1. Product/Service Innovations 9 31 26 23 6 2. Market Development Innovations 38 35 15 7 0 3. Marketing Innovations 59 21 10 5 0 4. Process Technology Innovations 52 26 10 6 1 5. Administrative Innovations 73 13 6 3 0 6. Other Innovations 87 4 3 1 0 Table 5: New Innovation Type and RENT Potential New Innovation Number Percentage Volume of Sales Average Score Rate of Return Average Score Length of Lifetime Average Score Champion 52 54.7% 10.7 10.2 10.0 Flash in the Pan High 8 8.4% 10.6 10.1 6.0 Profits Joker 3 3.2% 9.7 6.7 8.3 Oasis True 13 13.7% 6.2 9.6 9.4 Flash in the Pan Low 7 7.4% 10.6 5.6 5.7 Profits Oasis Mirage 5 5.3% 6.4 6.2 9.2 Gadget 3 3.2% 6.0 8.7 5.7 Shrimp 4 4.2% 5.5 5.3 6.0 16

Figure 1: New Zealand - Innovation Diagnostic Diamond Strategic Innovation Index Strategy Index Market Index 10 8 6 4 2 0 Innovation Index Resource Index Maximum Score NZ Average Score Table 6: Innovation Management Process Scores by RENT Configuration Number Market Innovation Resource Strategy Index mean Index mean Index mean Index mean Champion 52 8.3 8.2 8.1 7.6 Flash in the Pan High 8 7.5 7.4 8.0 7.3 Profits Joker 3 8.7 7.9 8.2 7.1 Oasis True 13 8.5 8.0 8.0 7.4 Flash in the Pan Low 7 8.4 7.7 7.1 7.5 Profits Oasis Mirage 5 7.3 7.1 6.9 7.6 Gadget 3 7.9 7.3 7.9 6.8 Shrimp 4 7.3 7.2 7.2 7.1 95 8.15 7.91 7.86 7.49 17