Balancing Internal and External R&D Strategies to Improve Innovation and Financial Performance.

Autorde Oliveira Paula, Fabio
CargoResearch and development - Report


"Solve unsolved problems innovatively--previous 3M mission statement" (Collins & Porras, 1996, p. 69) It is commonly accepted that innovation is important for firms to help them reach their goals, but it is not exactly a goal itself. It is also a popular belief that innovative companies are better than ones that are not innovative. 3M seems to have noticed this fact and smartly used this belief as a marketing tool in a former mission statement. However, innovation development, besides having a strong marketing appeal, may help firms achieve better performance in many other ways.

Innovation helps in the acquisition of sustainable competitive advantages through the introduction of new successful products and services or innovative processes that improve a cost-leadership position by lowering costs and increasing profits (Ceccagnoli, 2009; Christensen & Raynor, 2013). Extensive literature about the effects of innovation on a firm's financial performance exists. Many authors (e.g., Cheng & Huizingh, 2014; Faems, Van Looy, & Debackere, 2005) empirically studied the influence of the level of firm innovation on financial performance and concluded that a positive relationship exists between them. Besides the impact on financial performance, innovation is essential for firm survival in today's uncertain environment (Teece, 2007) and it is even more important in technology-based industries (Belderbos, Faems, Leten, & Van Looy, 2010). Concurrently, with the approach of the relationship between innovation and financial performance, research has emerged examining different innovation sources, which can be internal and external (Frenz & Ietto-Gillies, 2009).

Internal sources come mainly from R&D developed inside the boundaries of the company. On the other hand, external sources can be innovations acquired from other firms, mergers, acquisitions and collaboration with other players in the industry (Chesbrough, 2003; Faems et al., 2005). Many studies examined the relationship among all these sources and innovation performance. The relationship between internal R&D and innovation is positive in many of them (Belussi, Sammarra, & Sedita, 2010; Faems et al., 2005), although it is dependent on firm structure (Arora, Belezon, & Rios, 2014) and on the knowledge type developed (Perez-Luno, Medina, Lavado, & Rodriguez, 2011). Another branch is formed by studies that look for the relationship between external sources of R&D and innovation. This relationship depends on the type of partner (Chatterji & Fabrizio, 2014; Soh & Subramanian, 2014), the type of knowledge sought (Perez-Luno et al., 2011) and firm absorptive capacity (Cohen & Levinthal, 1990). Absorptive capacity affects the relationship between external R&D and innovation performance positively. As absorptive capacity rises, with higher levels of internal R&D (Tsai, 2009), internal and external R&D would be complementary. In contrast, some papers found that they may be substitutes for each other (Hagedoorn & Wang, 2012).

The study of the relationship between innovation and financial performance is not as extensive as the studies associating R&D sources and innovation performance. Most studies of this type investigate only a specific country and focus more on developed economies (e.g., Faems, De Visser, Andries, & Van Looy, 2010). However, according to some authors, the process of accumulating innovation capabilities and their application by firms from less developed economies might be different from the process in developed countries. While firms in the latter countries usually have resources and capabilities to develop radical product innovation from the beginning (Utterback & Abernathy, 1975), firms in the former countries start their process of accumulating capabilities by copying or licensing products from foreign firms and gradually adapt their production process while accumulating innovation capabilities. This process can allow them to catch-up to be able to implement more sophisticated innovations in the future (Kim, 1998).

These differences in the innovation process of firms from different countries must affect the relationship among the different sources of innovation, innovation performance and financial performance. So, the dearth of studies focusing on less developed countries justifies more investigation. European countries dominated the top positions of the 2016 ranking of the most innovative countries according to the Global Innovation Index (Dutta, Lanvin, & Wunsch-Vincent, 2016), with four of the top five countries in the ranking, and 15 countries among the 25 most innovative. However, they are not homogeneous in their innovative stage. While some of the world's most innovative countries are from Europe, the continent also has countries in moderate and low innovative development stages (European Union, 2015), which are less investigated by empirical studies than the top innovators.

Building on the literature mentioned above, this paper aims to answer the following research questions: Do either internal or external sources of innovation impact on innovation performance? Are they complementary? And does innovation performance impact financial performance? Although several studies have investigated these relationships, most of them focused only on the relationships among R&D sources and innovation performance or on the relationship between innovation and financial performance. This study proposed a model to investigate these relationships conjointly. Besides, different aspects are known to influence these relationships, such as the country and the industrial sector. Most studies investigate only limited scenarios, however, we believe that different outcomes may emerge from a study considering different dimensions. Using a sample of manufacturing firms from 14 European countries (Bulgaria, Cyprus, Czech Republic, Spain, Croatia, Portugal, Hungary, Slovenia, Norway, Lithuania, Romania, Italy, Slovakia and Estonia), this paper tested the proposed model to investigate the relationships among the constructs mentioned above controlling for industry technology intensity (high-tech manufacturing and low-tech manufacturing) and for groups of similar countries (which have different innovation development levels).

The proposed model, with some adaptations, is also being tested in other research projects considering other regions and industries, using different databases. The present study partially supported that internal and external R&D are complementary in firms from high-technology industries, whereas they are not in firms from low-technology industries. For the two groups of firms, both internal and external R&D separately had a positive effect on innovation performance. The relationship between innovation performance and financial performance could only be verified for Portugal, Spain, Estonia and Lithuania, countries that present some specificities provoked by how they are recovering from the 2008 global crisis.

The remainder of the article contains the literature review, presenting the hypotheses and the proposed model, followed by the methods section, which includes the description of the data, an explanation of the sample selection, a description of the variables and the statistical method. Then, we present the results, followed by a discussion and conclusions, which includes theoretical and managerial implications, limitations and suggestions for future studies.

Literature Review

Complementarity of internal and external R&D

Internal R&D is most often mentioned in innovation management literature as causing a positive impact on innovation performance (Belussi et al., 2010; Frenz & Ietto-Gillies, 2009; Hagedoorn & Wang, 2012; Oerlemans, Knoben, & Pretorius, 2013). As internal R&D is mainly represented by proxies such as R&D expenditures and R&D intensity (Hagedoorn & Wang, 2012), this positive relationship indicates that the effort to produce internal knowledge is highly related to its effective generation. However, the level of impact internal R&D has on innovation performance depends on the type of innovation. Hall and Bagchi-Sen (2007) found that a high level of internal R&D is associated with high levels of research-based innovation, which is more associated with the patenting of new technologies, but not with high levels of product-based innovation, which is related to the introduction of or changes in products and services. Some studies found that internal R&D is more important for process innovation than external R&D (Tomlinson, 2010), although a positive relationship between internal R&D and new product development was found in some empirical studies (e.g., Stam & Wennberg, 2009).

External knowledge sources and R&D also have a central role in innovation development. Several empirical studies confirmed that the relationship between external R&D and innovation performance is positive (Belussi et al., 2010; Faems et al., 2005; Faems et al., 2010; Ritala, Olander, Michailova, & Husted, 2015). This positive relationship may be caused by the easier transference of tacit and codified knowledge, the access to new complementary assets or the sharing of R&D costs (Faems et al., 2005). However, these results are not unanimous and some studies suggested that the relationship might be an inverted U-shape, with lower levels when the firm has few or many types of partners and higher levels for a moderate amount of partner types (Duysters & Lokshin, 2011). Other empirical studies did not find a significant relationship (Belussi et al., 2010; Mowery, Oxley, & Silverman, 1996). These contrasting results may have been caused by the coordination and monitoring costs to avoid misappropriation, which increases with a greater number of partnerships and depends on the partner type (Hallen, Katila, & Rosenberger, 2014).

Based on the previous discussion, one may conclude that balancing internal and external R&D is necessary in order to have successful...

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