AN INTERFACE BETWEEN ENTREPRENEURSHIP & INNOVATION - NEW ZEALAND SMEs PERSPECTIVE Prepared for DRUID Nelson & Winter Conference 2001 Aalborg University, Denmark 12 - 15 June 2001
Dr Amir Pirich Stephen Knuckey John Campbell Sustainable Development and Innovation Branch Ministry of Economic Development Ph: + 64 4 472 0030 Fax: + 64 4 474 2659 www.med.govt.nz 33 Bowen Street, PO Box 1473, Wellington NEW ZEALAND
Economists, with varying success, have often addressed the issue of interface between entrepreneurship and innovation. Recently, there has been an increased interest in this field, due to the realisation that entrepreneurs and entrepreneurship can contribute to society in various ways, including for example, economic growth (Hayek, 1948), business creation (Gartner, 1985), national identity (Bolton, 1971), and the innovation process (Schumpeter, 1934). The last point, on the contribution of entrepreneurs to the innovation process, is particularly critical to public policy making in small and open economies such as New Zealand. New Zealand is predominantly a nation of small and medium size enterprises (SMEs) - we often tend to describe ourselves as a nation of entrepreneurs and refer to "Kiwi ingenuity" as a typical feature of our country. In New Zealand, SMEs constitute the majority of all non-agricultural enterprises, for example, 84% of enterprises employ 5 or less full time equivalent staff and 96% of enterprises employ 19 or less staff, and as such are more predominant than in many other countries. In the New Zealand context, SMEs are viewed as the most critical source of flexibility and innovation, and make a significant contribution to economy, both in terms of their number and the proportion of the labour force they employed. The significance of the SME sector in New Zealand is increasing as large firms downsize to compete in the international market, workers face less job security, and more people turn their hand to small business either at retirement or as a lifestyle choice. With further opportunities presented by globalisation and technological development, the role of SMEs seems likely to continue to increase rather than diminish in the coming years. In the context of public policy making, it is critical to develop an understanding of the interface between entrepreneurship and innovation, and in particular, of how to stimulate innovative activities and a culture of entrepreneurship within the larger context of national innovation systems. We explore the basic notions and theory underlying entrepreneurship, innovation and public policy initiatives in turn.
The views expressed in this paper are those of the authors, not necessarily the Ministry of Economic Development.
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1. INTRODUCTION
New Zealand is a nation of 3.7 million people, located in the South Pacific at least 1,200 miles from the nearest other significant nation. Historically, New Zealand's economy has been agriculturally based - established by the colonising settlers of the middle and late nineteenth century to serve as England's farm (Reeve & Pirich, 1998). As Auckland based history professor James Belich (1998) has argued, New Zealand was seen as a form of East Anglia in the South Pacific, a society and economy modelled on the UK. It was assumed that New Zealand would grow to mirror and then even surpass the UK in its institutions and social and economic structures. The basic model lasted until the early 1970s. Change eventually occurred as the result of the inevitable processes of postcolonial development and other economic factors. Key issues in this were the entry of the UK into the European Economic Community, oil price shocks, the growing importance of Asian economies and the New Zealand links to Asian markets. Within the space of a generation, New Zealand ceased to be European and, in particular, UK focused. New Zealand began building a new identity; a combination of both traditional factors and those that related to the increased social and economic ties to Asia. By 1996, trade with the UK represented only around 6% of the total for New Zealand, contrasting with a combined figure of around 40% for Australia and Japan (Reeve & Pirich, 1998). Despite many far-reaching changes and much national soul searching over recent years, New Zealand's economy still reflects many of its historical features. Employment in the agricultural sector represents 10% of the workforce while exports from the primary sector represent around 50% of the total. Apart from forestry, primary sector industries are seeing decreases in their share of exports whereas the services sector has experienced significant growth in this regard (Reeve & Pirich, 1998). Currently, around 250
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companies (out of a registered total of well over 290,000) account for 90% of exports. In New Zealand, small and medium enterprises (SMEs) constitute the majority of all non-agricultural enterprises, for example, 84% of such enterprises employ 5 or less full time equivalent staff and 96% employ 19 or less staff. Therefore, SMEs are more predominant than in many other countries. Therefore, in the New Zealand context, SMEs are viewed as the most critical source of flexibility and innovation, and make a significant contribution to economy, both in terms of their number and the proportion of the labour force they employed. The significance of the SME sector in New Zealand is increasing as large firms downsize to compete in the international market, workers face less job security, and more people turn their hand to small business at retirement or as a lifestyle choice. With further challenges presented by globalisation and technological development, the role of SMEs seems likely to continue to increase rather than diminish in the coming years, as illustrated in the graph below (OECD, 2001). B usine ss owne rs as p e rce ntage of lab our force
L u xe m b o u rg * D e n m a rk
1986
1998
N o rw a y Au s tria Sw eden Fin la n d G e rm a n y(W e s t) Fra n c e S w itze rla n d Ja p a n U n ite d S ta te s Th e N e th e rla n d s U n ite d K in g d o m O E C D -2 3 Ire la n d B e lg iu m S p a in Ic e la n d Canada N e w Ze a la n d P o rtu g a l* Au s tra lia Ita ly G re e c e * 0 .0
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1 0 .0
1 5 .0
2 0 .0
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2. THEORETICAL BACKGROUND
A review of the theories surrounding entrepreneurship and innovation reveals an immense amount of material. Therefore, we begin by attempting to become familiar with each of the concepts of innovation and entrepreneurship independently. The organisation of these ideas into our theoretical framework will be context dependent. However, our purpose is to use the framework for thinking about possible government policy mechanisms for facilitating and stimulating entrepreneurship and innovation in New Zealand SMEs. 2.1 Entrepreneurship The theories of entrepreneurship and knowledge generation have been consistently approached from either one or another perspective. Firstly, an economics perspective: •
Cantillon (1755) described the entrepreneur as one “who assumes the risk of buying goods, or parts of goods, at one price and attempts to sell them for profit, either in their original states or as new products.”
•
Say (1852) saw the “entrepreneur as a person who judges, combines factors of production and survives crises.”
•
Knight (1921) views the entrepreneur as an “economic pioneer who initiates change or innovation by managing uncertainty and risk.”
•
Hayek (1948) noted that the entrepreneur never has the benefit of perfect knowledge and therefore must have the ability to adapt quickly. This concept is elaborated upon later.
•
Schumpeter (1934) describes the leadership role of the entrepreneur in an economy in his belief that entrepreneurs are “continually reorganising the economic system” via development of new products, new processes and new markets etc. He is best known for describing entrepreneurship as a process of ‘creative destruction’.
•
Liebenstein (1968) suggests that “successful entrepreneurs are those that are able to overcome market inefficiencies.”
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Casson’s (1982) entrepreneur is one who can co-ordinate resources without perfect knowledge.
•
Bolton (1971) gives several economic functions of entrepreneurs in society including market innovation, product and service variety and providing seedbeds from which large companies will grow.
•
Kirzner (1973) believes that the relationship between entrepreneurship and economic growth is a function of alertness to identification and exploitation of market opportunities.
•
Baumol
(1993)
concludes
this
body
of
work
by
arguing
that
entrepreneurship is a vital component of productivity and growth. Sautet (2000) argues that the Hayekian understanding of information or Hayekian Knowledge Problem (HKP) is often absent from mainstream economic theory. HKP refers to the existence of uncertainty and ignorance in the marketplace. Given that entrepreneurs thrive on uncertainty and ignorance, economic theory that does not assume a HKP has insufficient regard for the role of the entrepreneur in the market system. In other words, the entrepreneur takes advantage of disequilibrium prices caused by knowledge gaps in the market. Neo-classical theory, resting on the assumption of perfect knowledge, therefore implicitly denies the entrepreneur a role in resource allocation. Sautet (2000) notes that Austrian economics sees entrepreneurial activity as a process of "discovering the goods to be produced and the methods used to produce them". In Coase (1960) theory, "the goods to be produced and the methods of production are given". This argument suggests that for Coase, the entrepreneur is simply a manager. However, other interpretations of Coase theory exist. For example, Coase theory may reflect an open-ended universe, which would require the entrepreneur-manager to continue at an optimal level of make or buy decisions (Foss, 1993). These two vastly different interpretations are partly a function of some ambiguity in Coase's work. Coase has never discussed the role of uncertainty in depth, which suggests that he does not conceive of a HKP and therefore, whether prices are in disequilibrium is left unclear (Sautet, 2000).
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Williamson (1975) contends, like Coase, that transaction costs can explain the emergence, the existence and the evolution of organisations by showing that they result from a constant search for economising on transaction costs on the behalf of individuals. However, this economic organisation takes place in a market in which there is no HKP and this analysis therefore allows no room for the entrepreneur. While a focus on the nature of transaction costs distinguishes both Coase and Williamson from more pure neo-classical approaches, the absence of disequilibrium within their analyses retains a neoclassical view of the market (Sautet, 2000). Several conclusions can be made regarding the absence of an HKP in transaction cost economics: The implication is that if transaction costs are reduced to zero, entrepreneurial activity is no longer necessary. However, as Kirzner (1973) notes, "zero transactions costs do not of themselves guarantee that transaction opportunities will be discovered." The transaction costs view naturally leads to a cost-benefit analysis. However, Thomsen (1992) explains that transaction costs analysis does not assume that "individuals know what it is they don't know".
Therefore, "the choice
between carrying out an activity within an organisation or leaving it in the market cannot be made in terms of costs and benefits: knowing the latter would require individuals to know and evaluate what could or could not be discovered if scope were left for entrepreneurship, a logical impossibility." Consequently, an entrepreneurship approach towards the importance of transaction costs is required in order to emphasise the discovery aspect involved in the emergence of a firm. In this way, Sautet aims to build on the work of modern Austrian School theorists such as Kirzner, who consider the entrepreneur as the 'prime-mover' in the firm. Therefore, the idea that the entrepreneur is simply a profitmaximising decision-maker within the firm is regarded as defunct.
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So how is entrepreneurial behaviour distinct from maximising behaviour? In Kirzner's (1973) theory, it is the notion of 'alertness', a tendency for an individual to discover what would be profitable to him/her if he/she were to discover it. This view suggests that entrepreneurship is not a resource that can be planned. That is, alertness cannot be traded on the market. Throughout this Kirznerian interpretation of entrepreneurship is the implication that entrepreneurial activity serves an equilibrating function. This is the essence of what is known as the Lachmannian problem (Lachmann, 1976). As the market is a continuous process, the market must be subject to equilibrating and disequilibrating forces at the same time. Therefore, we simply cannot know whether the individual's activities are equilibrating or not. In response, Sautet (2000) develops a new explanation for the emergence of the firm - entitled the exploitability thesis. The theory develops along the following lines: •
In order to exploit various opportunities, the entrepreneur must purchase the necessary inputs or the services of the input owners.
•
No production takes place if the entrepreneur cannot secure the necessary inputs for the exploitation of his/her opportunity.
•
Most entrepreneurial opportunities are only fully realised in the long term.
•
Consequently, the entrepreneur will often be required to secure the use of his/her inputs, presumably via a series of long-term contracts.
Sautet (2000) labels this specific entrepreneur the entrepreneur-promoter. The entrepreneur-promoter knows at the point of discovery which inputs (and their prices) are required to exploit his/her opportunity over time. Over time, the general inputs to be used in the exploitation of a particular opportunity may actually become specific to each other and, consequently, difficult to replace.
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Therefore, "the only way that the entrepreneur-promoter can exploit his/her discovered opportunity is by the implementation of a firm" (Sautet, 2000).
Because this thesis takes place in a world of disequilibrium and in which information is costless, the firm is not only a solution to cost, but also a solution to a problem of true ignorance and co-ordination. As the entrepreneur-promoter needs to rely on the entrepreneurial insights of others,
the
exploitability
thesis
contains
a
social
dimension
to
entrepreneurship. Overall, this view of entrepreneurship tells us that "the economic problem is not how to make or buy, but how to discover and exploit” (Sautet, 2000). However, Sautet agrees that, while the thesis described so far can explain the start-up of a firm, in a living and vibrant economy a more pertinent concern is the continued existence of many firms that is observable. Up to this point, a relatively simple interpretation of the firm has been used. Consequently, he begins to explain a role for the more complex firm and what is known as the double HKP where: •
Not only does there exist an HKP in the marketplace, the entrepreneurpromoter may also be ignorant of his/her own ignorance regarding what his/her employees know.
•
Therefore, co-ordination of his/her employees is only the beginning for the entrepreneur; he/she must encourage his/her employees to impart their knowledge within the context of firm activities.
In summary, there are three key points regarding entrepreneurship that Sautet (2000) makes: •
Neo-classical theory cannot adequately explain the emergence of the firm.
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In the context of entrepreneurial activity the essence of the firm is coordination rather than ownership.
•
The firm must induce entrepreneurial activity because of the nature of the HKP and double HKP. The firm is the locus of exploitation of a profit opportunity.
Secondly, a psychological perspective: •
Pickel (1964) and Hornaday & Bunker (1970) suggest that there are certain personality characteristics that are typical of entrepreneurs.
•
McClelland (1976) suggests that the motivation of the entrepreneur is crucial. Regardless of variations in economic development, social structure and opportunity, “entrepreneurs with high achievement needs will almost always find ways to maximise economic achievement.”
•
According to Rotter’s (1966) work on locus of control, individuals who are ‘internal’ or believe that they control their own destiny are more likely to be entrepreneurs.
•
Brockhaus (1982) notes that psychological characteristics, past experience and
personal
characteristics
are
all
important
influences
on
entrepreneurship.
Thirdly, a sociological perspective: •
Weber (1976) looked at how symbolic interactions (as a function of religion, gender, ethnicity etc.) in a society may or may not encourage the entrepreneur via, for example, a strong work ethic.
•
Parsons & Smelser (1956) argue that because societies and economies are dynamic and entrepreneurs integrate, arbitrate and regulate sub-systems within a society and an economy, entrepreneurs are effective at managing changes and conflicts between individuals and systems.
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Storey (1982) argues that as creators of both competition and employment, entrepreneurs can provide alternatives to bureaucratic relationships such as that between employers and employees.
•
Finally, Vesper (1980) sees class distinctions, warfare, migration patterns, attitudes
towards
innovation,
social
deviance
etc.
as
influencing
entrepreneurship. As mentioned earlier, the HKP refers to the uncertainty in the marketplace, which leaves knowledge gaps that entrepreneurs feed off. Moreover, as Coleman (2000) notes: “the ambiguity inherent in the innovation process prevents creating such a hard and fast rule” regarding corporate entrepreneurship [corporate entrepreneurship is defined by Coleman (2000) to be the “permeation of the entrepreneurial spirit throughout the organisation”]. In other words, if we accept that the existence of an HKP is what entrepreneurs thrive on, an HKP must also prevent us from developing a universal theory of entrepreneurship. However, there are elements that appear consistently in the creation of corporate entrepreneurship. Coleman (2000) has reviewed Russell’s (1999) categorisation of these elements, namely, individual, environmental, and organisational. Firstly, the individuals in the firm are crucial because, without entrepreneurial insight which is possessed by people, innovation will not take place (Coleman, 2000). Therefore, people are important to the creation of corporate entrepreneurship, not money spent specifically on innovation (Drucker, 1986). Secondly, while there is no test to determine entrepreneurs and innovators, they do appear to share some of the same qualities. These include vision, high energy level, need to achieve, self-confidence and optimism, tolerance for failure, creativity, tolerance for ambiguity and internal locus of control (Coleman, 2000). There is also a role for the environment (primarily economic) in fostering entrepreneurial firms. For example, a dynamic environment (Russell, 1999)
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means that the incentives for firms to pursue corporate entrepreneurship are high because their competitive advantages are constantly outdated. Also, heterogeneity (Zahra, 1999), that is, the presence of diversified markets encourages entrepreneurial innovation by enlarging the potential scope of the firm. Moreover, Russell (1999) also argues that a hostile or competitive market provides a strong incentive for firms to innovate because their advantages are not protected. Corporate entrepreneurship is also affected by the organisation itself. Within this category, we can examine corporate entrepreneurship in terms of the firm’s strategy, culture, structure and resources (Coleman, 2000). Therefore, according to Coleman (2000), the three main aspects of a firm’s entrepreneurial strategy are: •
an ambiguous entrepreneurial vision;
•
cost-leader versus differentiation decisions; and
•
the entrepreneurial posture of the firm.
Therefore, firstly, it is important that firms’ strategies are flexible so that the outcomes of business activity are not fixed. Secondly, Dess, Lumpkin & McGee (1999) note that the ability to combine differentiation and cost leadership is crucial for firms that are pursuing corporate entrepreneurship. Thirdly, the extent to which a firm’s management supports risky ventures and seeks to actively compete with its rivals also determines a firm’s level of corporate entrepreneurship (Covin & Miles, 1999). Given that the definition of corporate entrepreneurship is the “permeation of an entrepreneurial spirit throughout the firm”, culture is clearly important. Russell (1999) suggests that culture is a powerful governing force regarding corporate entrepreneurship because norms can encourage innovation, creativity and searches for new opportunities; ensure resource support and information
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sharing; and promote open-mindedness and tolerance for failure. Therefore, not only is management’s ‘entrepreneurial posture’ important to the creation of corporate entrepreneurship, but so too are various bottom-up, societal processes. Organisational structure is also a factor in creating corporate entrepreneurship. Like Sautet (2000), Coleman (2000) casts doubt upon the transaction cost model as a means of encouraging corporate entrepreneurship. The argument here is that the actions or, in this case, organisational structures that are most profitable for the firm in the long-run may not necessarily have the lowest transaction costs (Coleman, 2000). Likewise, there is the risk of incurring massive short-term costs if the firm maintains an overly long-term competitive outlook (Coleman, 2000). The strength of Coleman’s (2000) discussion vis-à-vis Sautet’s (2000) thesis is that it creates a clearer picture of the emergence and maintenance of the entrepreneurial firm. By suggesting three areas of study (individual, environmental and organisational), Coleman (2000) implicitly tells us that entrepreneurial firms do not simply exist due to gaps of knowledge in the marketplace.
Instead,
entrepreneurial
firms
are
made
via
complex
combinations of internal and external forces. The focus on interdependence in Coleman’s (2000) discussion is also relevant to our theoretical framework. For our purposes, though, Coleman’s (2000) weakness is that the discussion is based on the behaviour of large firms. Whereas entrepreneurship in large firms can be interpreted in terms of, for example, their organisational structure, culture,
market
environment
and
people,
an
interface
between
entrepreneurship and innovation in the SME is unlikely to be so readily observable. Essentially, Coleman (2000) seems to be arguing that if large firms can develop ways of imitating the behaviour of SMEs, then large firms will become more entrepreneurial. For example, Coleman (2000) states that “small
entrepreneurial firms (our Italics), due to their very nature have the ability to innovate and adapt at a higher rate than large firms.”
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However, Brown & Huang (1998) argue that the claim that small firms are naturally entrepreneurial is due to the fact that the majority of innovation research has focused on large firms. While innovation may be the driving force behind the growth and competitive positions of small firms, this does not mean that innovation in SMEs is a natural occurrence. Brown & Huang (1998) looked specifically at technological innovation (i.e.: actual new products and processes), as opposed to activities such as discovery, product and process development, organisational change and invention. Regarding work on innovation theory and economics, which is a major component of this paper, they found that innovation effort decreases with firm size because more effort is allocated towards maintaining extensive product lines in large firms. In contrast to Sautet (2000), for example, this seems to suggest that transaction costs do have a role in determining entrepreneurial behaviour. Brown & Huang (1998) also described chaos theory as being useful regarding technological innovation because the appearance of a new technological innovation appears to drive small firms into a flurried search for innovation. Economic geography has produced mixed findings regarding innovation in small firms (Brown & Huang, 1998). They found that the regional environment was less important than internal firm factors concerning innovation in SMEs. However, in a study of the less developed Aragon region in Spain, Brown & Huang (1998) found that technology firms were concentrated on city areas and their developed proximity to nearby developed regions was crucial to their success. Also, the presence of regional innovation networks and innovation centres have been identified as major motives for SMEs’ location choices in Germany (Brown & Huang, 1998). Because this paper is interested in innovation and entrepreneurship in SMEs it is easy to dismiss any findings regarding large firms as irrelevant. However, it may be that, as Nooteboom (1994) has argued, SMEs and large firms are good at different stages of the innovation process. Therefore, in a dynamic
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economy, SMEs and large firms may be complementary. Overall, it is risky to assume that the task of facilitating and stimulating the entrepreneurial behaviour of SMEs is independent of large firms and vice versa. Organisational research has found that an environment’s culture matters regarding innovation and entrepreneurship in SMEs (Shane, 1993). In this regard, in seems important to point out that whereas large firms often have the resources to create their own culture, SMEs may be more dependent on external sources of culture. Brown & Huang (1998) offer the following conclusions: •
Small business research has focused on investigating innovation from different perspectives.
•
Most studies have been quantitative and based in the US or Europe.
•
The economics discipline has demonstrated that the SMEs are an important driver of innovation.
Organisational research shows that a number of factors such as networking, regional innovation centres and careful planning and strategy development can enhance SMEs’ innovation performance. It must also be noted that customers are also important sources of innovation for SMEs. The OECD says that “entrepreneurship” is the result of three dimensions working together: conducive framework conditions, well-designed government programmes and supportive cultural attitudes” (OECD, 1998). This view is entirely consistent with the implications of this discussion so far. Across these three perspectives of entrepreneurship, two major conclusions are apparent. Firstly, the economic, psychological and sociological academic fields accept that entrepreneurship is a process. Secondly, despite the separate fields of analysis, entrepreneurship is clearly more than just an
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economic function. In addition, Morrison (1998) makes two points, which act as a useful summary and are worth considering later: •
As entrepreneurship is concerned with change, it is not clear that this change will always be positive, even if (in the words of Schumpeter) the ‘destruction is creative’.
•
Entrepreneurship is also commonly associated with choice. However, it is possible to be pushed into entrepreneurship too.
2.2 Innovation Innovation has been traditionally defined as the successful implementation of creative ideas (Stein, 1974; Woodman, Sawyer & Griffith, 1993). Contemporary economic theorists have tried to address the concept and related issues with varying success.
This is despite widespread recognition of the fact that
innovation is crucial to the success of an economy at both the micro and macro levels (Leavy & Jacobson, 1997). Over the last decade a great deal of attention has been directed at the study of the actors, the institutions, and the relevant linkages that together are deemed to constitute different models of innovation. An understanding of models of innovation, including their diffusion and dissemination throughout the economy and society, is very important. In addition an understanding of what shapes these developments is critical. "Innovation has become the industrial religion of the late 20th century. Business sees it as the key to increase profits and market shares. Governments automatically reach for it when trying to fix the economy. Around the world, the rhetoric of innovation has replaced the post-war language of welfare economics...yet there is still much confusion over what it is and how to make it happen." (Economist, 1999).
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Damanpour (1991) has viewed innovation as a continuous and cyclical process involving the stages of awareness, appraisal, adoption, diffusion and implementation. However, it is also possible to view innovation as an outcome, where an innovation is the tangible product. For conceptual reasons, it is possible to divide this outcome view of innovation into radical and incremental innovations. Pavitt (1991) describes radical innovations as revolutionary or discontinuous changes. On the other hand, incremental innovations are conventional or simple extensions of a line of historical improvements. Moreover, Drucker (1986) has attempted to clarify such discussion by suggesting that innovation is not explicitly the improvement or technical modification of a product. Instead, innovation is the “creation of new value and new satisfaction for the customer." Leavy and Jacobson (1997) note that theories of innovation (much like those concerning entrepreneurship) have tended to focus on a single level of analysis. They note the aforementioned work of Drucker (1986) as an example of this at the firm level. The three paradigms that were described above also compete against one other for prominence in research on innovation. Moreover, they even criticise themselves in this regard: Leavy (1997) has previously concerned himself with factors governing innovation at the firm level too, while Jacobson (1994) established an interest in innovation at the regional or national level. Innovation at the sectoral level (Nelson, 1992) and at the global level (Niosi & Bellon, 1996) has also been completed. It is worth considering some basic models of innovation and related innovation paradigms.
In this context, the subject of analysis is to establish an
understanding on how innovations occur in general. For this purpose, analysis can start with three competing basic explanations of the innovation phenomenon, which are (Sundbo, 1995):
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•
the entrepreneurship paradigm;
•
the technology - economic paradigm; and
•
the strategic innovation paradigm.
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The entrepreneurship paradigm (Sundbo, 1995) is frequently used to describe innovation activities that occur at the level of individual firms that have gained favourable market position due to the development of a particular innovation. This happens without any systematic previous approach to the innovation process. Rather, there is a "market forced" effort to introduce a new product, process or service into various markets in order to retain, and possibly enlarge, the volume of activities, or to facilitate new business opportunities. The focal point of this paradigm is the entrepreneur - inventor whose individual and independent actions drive the innovation process. Here innovation per se is seen as a key to obtaining a better position in the market and generation of extra profits, and is often generated in a relatively unstructured manner. However, in recent years, quite a few innovators – entrepreneurs have adopted a more formal and systematic view towards innovation activity and long-term business strategy The technology - economic paradigm (Sundbo, 1995) is usually associated with innovation policies of large companies, which are users of so-called "mass-technologies".
The key feature of this paradigm is the significant
involvement of engineers and technicians in the development of new technologies under a company umbrella. Engineers and technicians were not involved directly in defining the company’s business development strategies, apart from technical input, but rather were given the task to solve particular technical issues.
There are several ways these individuals approach a
problem, e.g. in-house R&D, co-operation with other companies who are facing the same issue, buy-in of a solution from someone else, etc. It is important to note that these options require varying levels of internal R&D competencies for utilising, developing, exploring and absorbing new technologies. The strategic innovation paradigm (Sundbo, 1995) is relatively new. Its emphasis is on firm strategy, market conditions and broad firm competencies
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as factors that impact on the innovation process and as such significantly determine the market performance of a firm. This approach to innovation is multifunctional and represents a combination of internal competencies, longterm marketing strategies, market developments, the identification of new market opportunities or new market approaches, the creation of technological alliances and partnerships, and the fostering of networks, etc. Innovation is viewed as both technological and non-technological, i.e. it can be an entirely new artefact, process, production activity, or a marketing innovation. The key feature of this paradigm is a strategic manager or management team who are able to recognise new possibilities in the market and exploit them by using internal resources together with other available elements. In this context, the strategic behaviour of enterprises contributes to the economic growth of a country. In addition, innovation activity is often modelled in several different ways for either analysis or policy purposes, and for many years the so-called "linear model" of innovation was widely used to describe the innovation process. Because of the dynamics in the last few decades, the traditional linear model of innovation has become less relevant (Klein & Resenberg, 1986) and, increasingly, the chain-link model of innovation is becoming a more common tool of analysis. This chain-link model suggests that the national innovation system should be examined as an integrated whole and policy developed accordingly. These new insights have important implications for the firm. Innovation is not simply driven from formalised research and development but depends on access to information, to technologies and to the skills needed to implement them effectively. Increasing the capabilities of firms to learn and to be aware of superior technological opportunities is as important as making sure firms have the resources to innovate (Metcalfe, 1998). In this regard, a significant amount of innovation originates through design improvements, "learning by doing" and "learning by using". This process, along with R&D, results in the accumulation of knowledge and experience, i.e. the development of competencies and human capital.
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3. NEW ZEALAND’S SITUATION
The level of innovation of New Zealand's firms is a reflection of the present structure and maturity of economy.
The New Zealand economy is still
dominated by the primary sectors, although there are a number of emerging clusters of innovation in the economy. For New Zealand to develop a truly innovation-driven economy we need to shift the focus away from these traditional commodity-based products to the development of a diverse, knowledge-intensive, new and value-added products, processes and services driven long-term R&D strategy that builds on our existing knowledge base. The major barrier for innovation-intensive development of the New Zealand economy at the generic level is a combination of several interrelated factors. For example, previous policies (dependence on government funded R&D programmes), lack of larger regional economic co-operation initiatives (Close Economic Relations with Australia is very important, while APEC has the potential to become important). Also, distance from major markets, lack of scale, relatively high transaction costs, remains of a colonial philosophy, conservative financial and investment sector, general perception of science and technology are other crucial factors. Consequently, the major barrier for knowledge-intensive development of the New Zealand economy at the economy level is also a combination of several interrelated factors. For example, domination of primary sector, very small enterprises, focus on few markets, weak processing component, lack of product-process-service variety, lack of capital, lack of S&T competencies, etc. Having acknowledged these barriers and issues, the real challenge for New Zealand is how to overcome these difficulties and build a powerful and competitive knowledge base.
At present New Zealand’s underpinning
knowledge base is extensive, but highly specialised by international standards in a small number of areas. In particular, these include the agricultural, biological and earth sciences, especially in relation to pasture and animal production, indigenous species and pests. We have significant downstream specialisation of knowledge in food sciences and biotechnology and are
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increasingly recognised as a leader in experimenting with new management approaches, for example in public sector management and organisation, and in resource law. However, New Zealand's small population and limited economic wealth explain much of the current fragmentation in our research and knowledge base. These issues remain real constraints on our ability to develop a wider spread of research and commercial specialisation.
Major gaps in our
knowledge base are most evident in relation to manufacturing technologies (products and processes), as illustrated in the table below. Revealed Comparative Advantage (RCA) by Type of Industry, (Porter, 1998). High technology
Medium-high technology
Medium-low technology
Low technology
New Zealand
9.0
23.0
43.0
300.8
Australia
41.5
41.8
58.0
245.2
Denmark
63.5
62.7
138.4
167.2
Finland
58.8
57.7
105.1
191.0
Norway
36.9
54.9
154.6
189.5
Sweden
86.6
91.3
100.6
121.9
* The average value for RCA across all countries for any particular industry sector is 100. For individual countries, a value greater than 100 indicates that the country’s exports are relatively specialised, or it has a revealed comparative advantage, in that industry sector. An RCA value less than 100 indicates the some other country(s) shows a revealed comparative advantage in that industry sector.
An "innovation-driven economy" requires extensive development of areas with high value-added potential through significant R&D effort. Key characteristics of a modern economy are therefore growth in high-technology investment and production, highly skilled labour and rapid productivity improvement.
This
implies major investment in research and development, particularly in the private sector, and in education, training, new managerial and work structures. It also requires highly effective interaction between education and research establishments, the private sector and government. For New Zealand, the shortage of domestic human and financial resources inevitably means that expanding high value added economic activities would require us to constantly expand and refresh our knowledge base. This will
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mean an increased capacity to import, adapt, transform and apply globallysourced knowledge (especially embodied knowledge) and expertise. Assessment of the knowledge base in New Zealand and appropriate strategies to expand it need also to take account of "networked knowledge". These flows of technology and information between people and institutions are essential to the innovative process. However, several studies point to an asymmetry of competencies. That is, there is a mismatch between the supply and demand for knowledge. These studies suggest that our problem may not so much be an inferior "stock" of knowledge, but an inability, particularly in the private sector, to absorb and apply successfully all of the commerciallyrelevant and valuable knowledge currently available or accessible. New Zealanders are generally regarded as technically competent and, by international standards, quick to pick-up and use new technologies such as electronic banking, cell-phones, etc.
Nonetheless, our economic structure
reflects a predominance of low technology industries.
This may be
attributable in large part to a historical bias in the New Zealand finance market and in public policy towards primary sector production based on resources and on a (presumed) comparative reliability of income associated with these industries. Many New Zealand industries are relatively efficient and compare well with other developed countries on the basis of current competitiveness. However, most international studies and indicator comparisons suggest that our knowledge accumulation, technological capability and innovative capacity are lagging significantly behind most other western countries. In other words, while we have several small "pockets of excellence", our comparatively low (overall)
levels
of
innovation
and
technology
threaten
our
future
competitiveness in both global and domestic markets. Some specific factors that might explain the comparatively slow development of knowledge-based and technology-intensive industries are difficult to ascertain. However, they appear to include:
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•
constraining
public
Pirich, Knuckey & Campbell
attitudes
to,
and
perceptions
of,
innovation,
entrepreneurship and profitability; •
low levels of private sector R&D expenditure - due in part to small firm size, limited domestic market opportunities, inadequate venture capital, tax treatment of R&D expenditure, etc;
•
negative perceptions of science and technological education/careers;
•
loss (through emigration and career change) of qualified/skilled S&T personnel;
•
the limited end-user impact, e.g. commercial impact, of much public investment in RS&T; and
•
obstacles to more effective networking and interaction within the innovation system.
Evidence of New Zealand’s poor R&D performance can be presented in tables, such as that reprinted below: GERD (% GDP) OECD
2.17
% of GERD financed by business 61.2
Reference Countries
2.16
55.7
1.43
98
New Zealand
1.12
31.0
0.32
75
BERD as % of GDP
No. of S&T publications per 100,000 population
1.48
52
All figures for 1997/98 – Source: New Zealand Research & Development Statistics 1997/98 (MORST 1999) Definitions: GERD – Gross Domestic Expenditure on R&D; BERD – Business Enterprise Sector Expenditure; G7 – Canada, France, Germany, Italy, Japan, UK and US; Reference Countries – Australia, Denmark, Finland, Ireland, Norway, Sweden
On the face of it, New Zealand’s R&D statistics look poor. Comparing New Zealand to international counterparts in terms of total national expenditure on R&D, New Zealand ranks about 13th in the OECD. Similarly, New Zealand achieved one of the lowest levels of business funded R&D (31.0%) and business performed R&D as a percentage of GDP (0.32%) in 1997/98. R&D intensity (R&D expenditure divided by turnover) was 0.37% in 1997/98 in the manufacturing sector, compared with an average of 6.6% in OECD countries. These are all regarded as indicators of the domestic potential to produce knowledge. However, all statistical comparisons of New Zealand with other OECD countries, particularly in the case of R&D data, must recognise that New
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Zealand never had, nor will we ever have, extremely large defence expenditure and defence related research activities. This is important because defence is the largest source of commercial “spillovers”, for example, electronics, telecommunications and information technologies. However, there are positive
trends emerging, which are often overlooked.
R&D expenditure in New
Zealand reached a record high in 1997/98, at an estimated $1,107.4 million, compared to $889.5 million in 1995/96. This was the biggest increase since the surveys started. Business expenditure on R&D in New Zealand increased from 0.27% of GDP in 1995/96 to 0.32% in 1997/98. Total R&D expenditure in New Zealand increased on average at 6.2% per year from 1990/91 to 1997/98.
Over this period New Zealand’s GERD as a
percentage of GDP has been growing at about 12% on average, compared to the OECD, where GERD as a percentage of GDP has shrunk by about 1% on average.
Similarly, between 1991 and 1997, New Zealand’s business
expenditure on R&D (BERD) increased on average at 8.5% (as a percentage of GDP, New Zealand BERD has increased on average at about 2.8% between 1991 and 1997). In comparison, BERD for the OECD as a whole has been increasing at around only 2.4% (as a percentage of GDP, BERD in OECD countries has been shrinking at about 1% per annum, although picked up over 1995-97). The trends of R&D spending growth in New Zealand are positive and strongly contrast with the period 1981-1989 when it is estimated that there was a real decline of around 27% in R&D spending in New Zealand. New Zealand’s level of scientific publications and growth rate of patent applications are also relatively high (the growth rate of information and communication technology patents is phenomenal). Moreover, we perform strongly in terms of inflows of international knowledge inputs, as evidenced by a high proportion of high and medium technology imports.
However, any
interpretation of the level of indicators needs to be treated with care because they do not reflect the quality or efficiency of investment. For example, a high R&D intensity does not necessarily imply that R&D inputs are efficiently used. Furthermore, relative country results should be treated with caution, especially when absolute differences are small, as many indicators lack precision.
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3.1 Structural Characteristics As indicated in the previous section, a large number of factors impact on R&D and innovation including industry structure, skills and networks. This section considers these factors and the evolution of innovation in New Zealand. As noted previously, the level and effectiveness of New Zealand firms’ R&D and innovation activities is a reflection of the present structure and maturity of the economy. Specifically, certain structural characteristics of the New Zealand economy create conditions that may make the development and uptake of new technologies more difficult relative to other developed economies. New Zealand’s small economy (some basic statistics on demographics of New Zealand’s SMEs are attached in Annex 1) limits the scale achievable by firms focusing on the domestic market, as well as their ability to use domestic production as a springboard for exports.
In addition, because the largest
economic sectors are in primary products and processing with commodities being the dominant exports, the opportunities to use R&D and advanced technology for competitive advantage are seen as relatively limited compared to other sectors. However, we can certainly develop and sell technologically advanced capital equipment that can be used to process commodities. Changes in industry structure can influence levels of private expenditure on R&D. Since 1990 there has been a shift in the emphasis of R&D in the manufacturing sector, with increasing amounts being performed in producing machinery equipment, instruments and transport equipment, and in the service sector. The most significant increases in R&D expenditure between 1995/96 and 1997/98 occurred in the service sector (an increase from $62.5m to $112.2m), including communications, computer software, and insurance and technical consultation services. Also, while New Zealand manufacturing firms have a lower R&D intensity than the OECD average (ignoring imported R&D), our services sector carries out more R&D than the OECD average.
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This structural reality is compounded by the very small size of New Zealand firms compared to small firms in other developed countries. Small firms are increasing in terms of both enterprise numbers and employment levels in the New Zealand economy, leading to a decline in the average number of workers employed per enterprise from seven in 1994 to just over six in 1998. There are also a large number of ‘life style’ companies in New Zealand, i.e. where the owner is satisfied with a comfortable standard of sales and profits and is not interested in growth or competing in international markets. The predominance of these types of small firms may limit the ability to take advantage of scale economies and to generate the resources needed to upgrade technological competence. Although small firms are thought to have advantages in terms of flexibility, responsiveness to market changes, filling niche opportunities, sharing information internally, and making small scale technological investments, there is often a critical mass of capital, employees, and sales necessary to capitalise on these advantages. In general, New Zealand’s very small firms do not have this critical mass. Other industrial countries tend to have more large multinational companies that both carry out a large proportion of BERD and provide contracting opportunities for small hitech firms. Small New Zealand firms are also typically characterised by personal ownership and management, have little or no specialist managerial staff, and are not part of larger business enterprises. Consequently, factors such as transaction costs - in terms of time and financial resources - become more significant to New Zealand firms. These costs as a percentage of sales are high for small firms for activities such as gathering relevant information, securing capital, and buying and implementing new technology. Therefore, the risk of failure tends to be high when investing in new technologies and, unless competitive pressures are great, will typically far exceed the risks of doing nothing.
Given these risks, small firms must have a very high
confidence level that new technologies will be successful, and successful with a minimum of disruption to operations.
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Empirical evidence shows that networking has become a key factor in innovation. That is to say, innovation no longer depends only on how firms, universities, research institutes, and regulators perform, but, increasingly, on how they work together.
The growing reliance on firm collaboration and
networks, at both the national and international level, is driven partly by the fact that many firms can no longer bear all the costs and risks of innovation alone. Another aspect to consider here is that the required knowledge is often multi-disciplinary and emerges from a wider range of firms and institutions. In the case of R&D activities, it appears that many New Zealand businesses are reluctant or unable to enter into partnerships with other firms. Research on R&D networks in New Zealand show that networks are being formed on an internal basis between parent companies and subsidiaries, and on an informal, ad hoc, personal basis, as opposed to formal, structured linkages. The limited R&D capacity of New Zealand’s businesses may be a key reason. In other economies, large customer firms serve as a source of technological solutions and, often, a facilitator of R&D partnerships. In contrast, New Zealand firms often supply final market products or supply customer firms that are not large enough to play this facilitator role. Even the larger New Zealand firms, unless foreign owned, are small by global standards. Therefore, our large firms do not always have the resources to work with local suppliers to upgrade the capabilities of the total sector.
Therefore, the inter-firm
relationships that operate elsewhere, in which firms benchmark their capabilities, discuss operations, and share technological information, are relatively weak here. Dependency on suppliers for new production technology is a condition that deserves special mention. Because New Zealand does not have a domestic machine tool or process technology industry of any significance, firms are dependent on foreign suppliers, for whom New Zealand is a small market. The majority of New Zealand firms may have limited leverage on the cost of the equipment, and may even have limited choice among suppliers willing to provide the desired level of service. These factors can make technology upgrades and significant process changes even more daunting when
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combined with the usual cost, time, and disruption factors. Other information on relevant scientific and technological developments relevant to small firms may also be difficult to access.
A number of surveys have found that
research funded by PGSF and the work of the CRIs is not well matched to firm needs.
4. STRATEGY AND CAPABILITY
The process of innovation and technology diffusion is undergoing substantial change. The main driving forces are increasing market pressures (stemming from globalisation, deregulation, changing patterns of demand and new societal needs), as well as scientific and technological developments (e.g. increasing multi-disciplinary practices in the production of new knowledge, diminishing cost of information access and processing). This requires firms to change their management approaches and competitive strategies to succeed in a more open environment. However, change is a gradual process in New Zealand, due in part to the legacy of a protected market and the continued patterns of competition that remain. 4.1 Evolution of Innovative Capability In the 1980s, behind protective barriers, firms had built up broad product lines, irrespective of efficiency or comparative advantage. Their isolation from international competition meant that in many cases these portfolios lacked consumer appeal as well as economic sustainability. When protection was removed, the first result was a wholesale rationalisation of these product lines and related processes. After this period of cost cutting and rationalisation in response to deregulation and liberalisation, New Zealand firms turned their attention to quality, which became the predominant emphasis of firms’ competitive strategies.
This
focus was supported by adjustments to production and operation systems in
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the early 1990s. Here the main focus of priorities or outcomes was quality and timeliness.
Firms moved to develop sources of advantage based on
differentiated products and services that did not have to compete wholly on price. A second distinctive phase took place during the mid 1990s, characterised by expanding markets, export growth, renewal of product lines, a wider range of competitive strategies, and more dynamic human capital. While efforts on quality and operations continued, attention was given to improving customer focus and supplier relations by moving operations and focus up and down the value chain. enterprises
At the same time, a very large number of New Zealand began
exporting
and
took
the
first
steps
towards
internationalisation. For example, it has been estimated that some 70% of medium to large firms and 40% of small firms began exporting in this period (Infometrics, 1999). Although this momentum slowed during the ‘Asia Crisis’, the tough conditions provided a real incentive for further redesign of operations and practices. The focus of priorities or outcomes has now expanded to include flexibility and, in a few cases, innovation. For most firms, exporting is still a minor part of the business (estimated at less than 20% of sales). But at the very forefront of New Zealand’s business community is a very small number of firms estimated at about 50 - which have built up elaborate networks of offshore distribution and operations in many countries, and are now competing with distinctive products and innovation. Despite the great improvements in competitive capability that have been made over the last decade, there is still much to be learned. Few firms have yet to match leading international benchmarks (Knuckey et al, 1999); no more than 10% of firms are approaching international standards of performance on practices such as human resources, innovation and offshore investments. Overall, the culture in many New Zealand firms continues to be insular. Firms still have short rather than long term outlook, most view R&D as an expense and not as an investment, few have technology/innovation strategies, few
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make an effective use of performance measurement or comparison systems, and firms tend to be risk averse in adopting new technologies. Although New Zealand firms have moved from a cost-quality focus to a market (timelinessflexibility) focus, few are yet to take an innovation focus. This means: •
knowledge of global technological developments is often not viewed as important;
•
benchmarking capabilities against foreign firms is not widespread and when it is done, typically only includes Australian firms;
•
the need to upgrade management skills and improve technical competence has not been widely recognised, probably because the competitive environment still does not demand such upgrades; and
•
dependence on the domestic market remains high despite the growth in exports in recent years.
Much of this is a function of managing the transition to an economy that has become more open as trade barriers have been reduced and markets deregulated.
This is an evolutionary process. The key point from this
evolutionary picture is that as the vast majority of firms are not yet including innovation as part of their competitive armoury, it is not surprising that they do not have well-developed innovation and technology practices, including investing in R&D. This movement towards globalisation and liberalisation has provided firms with mixed incentives to perform R&D. On the one hand it is easier to access foreign technology, reducing incentives for private investment in R&D. But on the other hand, the returns available to innovative firms are increasing with the size of the global market, increasing the incentive to do R&D. It can be expected that as New Zealand firms move down this adjustment path, greater numbers will recognise that enhanced technical capabilities, including investments in R&D and new product and process technologies, will become increasingly important to profitability.
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When that happens, the strategy of innovation will become the prime vehicle for pursuing advantage. We would also expect an improved awareness of technological developments abroad, which increasingly become critical to export sales as foreign customers expect a higher and higher level of technical competence. The positive trends in (as opposed to levels of) New Zealand’s R&D statistics may reflect this story.
These findings indicate a
continued need for firms to make the transition to a more competitive environment, both as the domestic economy becomes increasingly open to foreign competition and as the desire to increase exports forces participation in competitive markets abroad.
4.2 Skills for Innovation and R&D
It is important that New Zealand is developing people with the right skills in the right fields to support greater capacity for R&D in both research institutions and businesses. Small New Zealand firms often do not have the physical and human resources to undertake R&D in-house. Even for those progressive firms who have developed internal R&D capabilities, the availability of required skills continues to be a major issue. In terms of available skills, New Zealand does have relatively good figures in terms of the number of scientists and engineers in the labour force. Scientists and engineers accounted for 4.3% of the labour force in 1996, which is higher than most other European countries. The number of employed scientists and engineers grew at an annual rate of 5.4% over 1991-96 compared to an average overall annual labour force rate of 3.4%. However, New Zealand does not compare well on total R&D research staff, although the numbers have been rising steadily in recent years. There were 4.4 R&D researchers per 1,000 labour force in New Zealand in 1997/98, compared to 5.5 in OECD countries and 6.7 in reference countries. Of more interest is the potential future supply of human resources in science and technology, which can be projected on the basis of student enrolments in these areas.
In 1996, over 4,480 students graduated in science and
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engineering fields, accounting for about 20% of all graduates. This reveals a large increase over the 1990 graduate figure of 2,560.
However, as a
proportion of total graduates, there was a slight decrease over this period (from 24% to 20%). The popularity of a science and engineering degree is much higher in other OECD countries. Science and engineering graduates comprise over 40% of all graduates in Germany, Finland, Belgium, Italy, Norway and Switzerland. Indeed, studies have shown that there are negative perceptions of science and technology education/careers in New Zealand. However, analysing such skills data is a complex process. There are many definitional problems with the OECD subject categories as different countries have different classifications for their degree programmes. For example, in New Zealand, students graduating with majors in information technology could be classified as either commerce or science. Notwithstanding the problems noted above, analysis suggests that New Zealand’s level of ‘hard’ natural science graduates is very good when compared with other OECD countries.
However, as we shift from hard
sciences to applied technology subjects, like mathematics, computer science and engineering, New Zealand’s output of graduates declines. However, what is probably more important is that the rate of technological change is likely to continually change the demand for skills in the labour market. The pace of change makes it more likely that today’s workers will need to up-skill more often, change jobs and probably careers several times during their working lives. Rather than technological and science skills per se, the most crucial “skills set” for innovation is likely to consist of: •
soft skills such as teamwork and communication, a willingness to learn new skills, and motivation to seek new educational opportunities;
•
enterprise skills;
•
the flexibility to adapt to new technologies; and
•
basic skills such as literacy and numeracy.
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A key issue then, is whether the education system as a whole is well placed to help deliver individuals with good combinations of specialist and generalist skills.
Indeed, firm level research undertaken in the last 2-3 years does
suggest that this is the real “skills shortage” reported by firms. In a number of these studies, most firms’ concerns were with attitude and basic aptitude, and many firms were dissatisfied with levels of literacy, numeracy, motivation and discipline. This applies equally to scientists and technologists as it does to other specialist skill areas. Maintaining expertise in New Zealand is also a key issue. Although immigration has in the past primarily served to offset losses from outward migration, in the year to May 1999 there was a net loss from migration of 10,696 persons. The main concern is not the numbers, but the nature of the people leaving.
While more than 50% of emigrants are low-skilled, the
greatest growth in emigration is coming from physical, mathematical, engineering and science professionals (including IT). Although net migration in many high-skilled fields is still positive, levels have declined since 1995. This raises a question about the equivalency of human capital between emigrating New Zealanders and immigrants. It is important that New Zealand businesses are not inhibited in expanding R&D efforts due to lack of required skills.
4.3 Finance for Innovation and R&D
Access to investment capital for R&D is another problem typically faced by small firms and entrepreneurs. Three themes stand out. First, small enterprises lack investment readiness skills: innovators tend to lack understanding of the implications of different forms of funding, do not know how to present proposals, and are unwilling or reluctant to share control or provide information on their ideas/companies in return for capital. This is a problem for small firms in all countries but the high proportion of very small firms in New Zealand means that the problems are likely to be more acute here. Instead, small firms primarily rely on cash flow and borrowed funds. For those firms that are investment ready and willing to relinquish control for
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equity financing, the venture capital market is still immature compared to overseas markets, but developing rapidly. Second, although most firms find borrowed funds to be readily available, financial institutions tend to be more willing to loan to existing firms than to new ventures (not surprisingly given the higher transaction costs involved), and access to funds for R&D can be problematic. Third, it is generally accepted that New Zealand does not have well-developed finance markets for companies built on intangible assets (again, not surprising given the immaturity of the market and the relatively high transaction costs). Increasingly, though, it is these types of firms that will be driving investment in R&D.
However, it is clear that venture capital investors are increasingly
focusing on Internet and e-commerce related companies, albeit at the expansion stage and higher value deals. The picture that emerges is that New Zealand firms tend not to be near the technological frontier (and performing R&D). As above, this can be attributed to the present structure and maturity of the economy and also due to time lags in adjusting to the opening of the economy and building capabilities. Part of this may also be due to the relative isolation of firms from hi-tech competition or simply that they choose to be followers. This is not unusual. Economies that are technologically behind tend to catch-up by imitating rather than by pushing the technological frontier. This accepts that economies benefit from foreign R&D as well as from domestic R&D. It should be noted in this context that an economy’s own technologicalgeneration activities only represent one source of technological advances, and others will be imported from overseas. For example, a recent OECD study noted that acquired technology (embodied R&D) typically accounts for 40% to 60% of the total technology embodied in output of OECD countries examined. New Zealand reached 70%. Indeed, there is evidence supporting the notion that foreign R&D contributes significantly to productivity in a small open economy, like New Zealand. At the firm level, embodied R&D is a substitute for BERD. That is, producers have the choice between developing
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technology internally, or purchasing technology from specialist firms. Producers are likely to purchase technology if the specialist firms can produce better and cheaper technology because of benefits from scale and specialisation. In any case, firms can grow by using imported rather than domestic R&D. The value of this strategy should not be under-estimated, as it may be the most efficient solution for the size of firms and industries in New Zealand. The relative shortage of domestic human and financial resources in our small economy inevitably means that expanding high value-added economic activities would require us to constantly expand and refresh our knowledge base. This will mean an increased capacity to import, adapt, transform and apply globally-sourced knowledge (especially embodied knowledge) and expertise.
5. USE OF GOVERNMENT FUNDED R&D
In situations where market incentives for research are weak, where spillover benefits are likely to be pervasive, or governments seek to ensure dissemination of the results, governments have tended to provide direct support for research in government-funded institutions. In the New Zealand context, the government has several key interests in supporting publicly funded R&D, namely: •
to underpin own policy development, in particular in social and environmental areas;
•
to address country’s unique characteristics, such as natural environment and flora & fauna;
•
to foster well-functioning education system which can fruitfully interface with R&D activities; and
•
to support areas where there are significant externalities and risk of underdelivery.
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The government plays a major role in funding of research and development through the Public Good Science Fund (PGSF), Marsden Fund, and Technology NZ (run by Foundation for Research, Science, and Technology and the Royal Society of New Zealand) and indirectly invests in R&D through its funding of universities. The government also has an ownership interest in a substantial knowledge base through the Crown Research Institutes (CRIs).
Broadly, the New
Zealand government purchases over NZ$600 million per year of science, research and development mainly from public institutions such as CRIs and universities. It is worth mentioning that the New Zealand innovation system traditionally has been dominated by the role of government, both in funding and performance. Since 1988 the New Zealand science system, in parallel to many other changes affecting the public sector as a whole, has undergone a major restructuring (Reeve & Pirich, 1998). The effect has been to create a separation between the purchase and provision of research, and the development of appropriate policy (Reeve & Pirich, 1998). New institutions have emerged as have new instruments for the funding – or purchase – of research, including the PGSF in particular.
A rigorous process has been
developed for the identification of priorities for the PGSF. Before the major changes of the late 1980s and early 1990s, the relationship between the various components in New Zealand’s science research system was heavily influenced by the position of the state in economic and social life. New Zealand followed a highly regulated and interventionist style of economic management which had the effect of bringing within one very large system the government-funded and owned research laboratories, universities and many forms of state owned industries also performing research (Reeve & Pirich, 1998). Today, mostly as a consequence of the radical change to the public sector, the New Zealand system is characterised by separately organised and
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accountable research by government, the universities and industry, although with areas of overlap in operations and strategic direction. This is defined through the convergence of research agendas, and the strengthening of organisational and financial links for the co-ordination of research performed by the different parties (Reeve & Pirich, 1998). Full collaboration involving major programmes of joint work and the sharing of research equipment and resources is less of a feature. A major aspect of the restructuring of the New Zealand science system and government policy for research science and technology has been the focus on the roles of government funded (or purchased) and performed research. This includes the relationship of such restructuring and policy to a broad set of needs regarding the economy, society and the environment. The consequence has also been to shape the space between government and industry both in the performance and exploitation of research (Reeve & Pirich, 1998). This has been an issue of key concern, as evidenced by the establishment of the CRIs as quasi-
independent organisations run on commercial lines. The initial impact of the public sector changes was to emphasise the separate nature and territories of research for government and industry.
Government funded research as
supported by the PGSF was regarded as providing the underpinning knowledge base for other activities, although clear and direct exploitation by industry of the government activity was seen as possibly undermining the distinct roles which each party was expected to fulfil. Linked to this were concerns about avoiding potential government subsidy of industry and the crowding-out of activities that ‘should’ be performed and funded by industry. One effect of this approach was to emphasise a rather linear model of the innovation process in which government activity provides the initial stimulus or base of knowledge. This is then subsequently applied and exploited by industry – although given the concerns over research appropriateness, the mechanism through which such exploitation would occur appeared somewhat unclear. It is important to point out, that significant S&T competencies in New Zealand are with CRIs, and not with universities and the private sector. In addition,
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New Zealand has significant S&T competencies sitting within a number of government departments, which is yet another paradox of New Zealand innovation system. This makes further analysis on the innovation system, even more complex. The S&T competencies that exist within CRIs need to be better utilised than they are at present, in particular the role of CRIs in tertiary education needs to be fostered, for example in providing post-graduate courses for students and facilities to educational establishments. In short, the rationale for public sector research at the broadest level is that it should: •
enable research to be undertaken and disseminated in a way that advances social welfare by more than alternative uses of the public’s funds; and
•
achieve results that would not otherwise occur.
The role for government is not clear-cut, and can change over time.
It
depends on: •
the private incentives and arrangements for doing research (whether “crowding out” is likely);
•
the ability of government to identify the appropriate areas of research;
•
the scope for, and benefits from, wider dissemination of results from public compared to private research; and
•
the cost of undertaking the research within the public sector relative to contracting it to the private sector (taking into account issues of specification and control).
Compared with other OECD and reference countries, New Zealand’s share of R&D financed by government is higher (50% vs 30%), while the share of R&D financed by business is lower (30% vs 60%). Similarly, compared with other OECD countries, New Zealand's structure of R&D performance is quite different. The majority of R&D activities (67%) are carried out by the business sector in other OECD countries while in New Zealand over 70% of R&D is carried out by the government sector and university sectors. New Zealand also has the highest proportion of total research carried out by government
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entities (42% compared with the OECD average of 11%). Given the previous discussion on limits on the capability of New Zealand firms to undertake and use R&D, the substantial level of government investment in R&D raises an important question. Namely, is there a barrier between the institutions doing the R&D and the institutions (i.e. firms) that can add value using R&D? Broadly speaking, evaluations of government investment in R&D in terms of the PGSF and Technology New Zealand have provided positive results on scientific and technological outputs, increased competencies, and improved collaboration - although the evaluations have so far been limited. However, a number of studies have identified concerns: •
A study (Pirich & Reeve, 1998) by the Ministry of Research, Science and Technology in 1998 of the PGSF highlighted:
presence of asymmetry of competencies in some sub-sectors and inadequate absorptive capacity among users in some sectors;
inconsistency of user support across different areas and during the research programme, and insignificant support from private sector in funding follow-up R&D projects; and
lack of stronger links with other funding instruments, such as research funded through Vote: Education and through other Votes. •
A study by Infometrics (1999) of 30 of New Zealand’s leading exporters found that there is a high degree of disillusionment with the process of public funding of R&D, particularly with CRIs. Common issues included:
the process of applying for funding is cumbersome and time consuming; two companies indicated that the process was so slow that the projects they intended to fund were redundant before the process was completed;
firms were critical of the lack of commercialisation displayed by Industrial Research Ltd, its ability or willingness to establish close
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working relationships, and were concerned they were spread too thinly across many areas; and
retaining control over, or integrity of intellectual property rights was a contentious issue for some companies using outside research organisations.
•
A Decision Research Ltd survey of 30 manufacturers in 1998 found that some considered that CRI charges make them an uneconomic option for R&D.
•
A study by BERL in 1995 showed that few firms used external sources of product innovation, due primarily to the small size of NZ firms, diversity of interests and high fixed transaction costs which make directing research activities more difficult.
This survey showed that external sources of
innovation used by firms included CRIs (6%), research associations (9%) and offshore license arrangements (15%).
•
The best manufacturing practice survey (Knuckey et al, 1999) found that the least valuable sources of assistance were public sector agencies including universities and business schools (9%) and CRIs/research associations (11%).
This research points to potential barriers for private sector R&D investment in terms of: •
Applied research undertaken by the government should generate opportunities for follow-on investment by the private sector because the project should have been progressed far enough for a commercial return to be a reality. However, there is relatively little follow-on investment undertaken in New Zealand.
•
This could be due to the projects being irrelevant, or the fact that the intellectual property for the research is held by government institutions.
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•
Pirich, Knuckey & Campbell
The CRIs, in particular, may not have the right incentives to more aggressively market their intellectual property (although all are presently establishing such approaches). This is particularly the case with CRIs whose income is derived primarily from government resources.
•
There is a lack of awareness or understanding in the private sector of available government initiatives and a need for more focused promotion.
Furthermore, there is concern that the human capital developed as a result of public investments in science too often remains in public laboratories and universities rather than being applied to commercial needs.
The need to
integrate more effectively New Zealand’s human capital with the private industry, and build strategic linkages and relationships between the private sector, technology agencies and intermediaries is a critical issue requiring initiatives at multiple levels of the national innovation system (Pirich & Campbell, 1999). The Foresight project is one process that has aimed to link the government’s investment in science and technology closer to the needs of the private sector. Innovation strategies, and hence use of innovation services, are of low relevance until firms reach the technology frontier. Indeed these services will also tend to be used by those firms with prior experience of R&D. The results pointing to a lack of use of universities and CRIs probably reflect the underdeveloped innovation and technology practices in New Zealand firms. However, leading firms are increasingly using outside expertise from either independent firms or CRIs to undertake well-defined R&D. The Infometrics report indicated that the availability of public funds does motivate these firms to use outside R&D resources. There is also a capability issue for public sector agencies involved in the R&D process.
Many of the issues that
government institutions such as universities or CRIs face when looking to promote and facilitate the application of their research are the same faced by other businesses. CRIs and universities do not always have the mix of skills required to do this. The picture of innovation that emerges is a complex process that involves multiple networks, capabilities and resources.
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The creation of an environment that facilitates the innovative process will need to take into account all of these issues, including: ¾ the structure and scale of New Zealand industry; ¾ the adjustment path of the New Zealand economy; ¾ the skills and finance available to undertake R&D and innovation; and ¾ the scale of mechanisms available to foster human capital mobility and transfer, and the effectiveness of government’s current investment in science and technology.
5. CONCLUSIONS
This analysis has identified a number of important potential barriers to New Zealand’s development into a knowledge-intensive, value-added economy. In particular, it highlights that, in many ways, New Zealand’s innovation system is in a catch-up phase and our entrepreneurship culture in a process of rapid development. This reinforces the importance of increasing New Zealand’s capacity to import, adapt, transform, and apply globally-sourced (especially embodied) knowledge and expertise along with fostering entrepreneurship. In addition, macroeconomic, regulatory, taxation, trade, and education policies, among others, have a strong and even dominant influence on economic performance. In this context, there is no single lever available to government to stimulate innovation and entrepreneurship. Instead, an integrated approach across a range of policy measures will offer the most significant means to encourage innovation and entrepreneurship. In this context, a strategic approach to innovation and entrepreneurship has at its core three key interrelated elements: •
the economic conditions and the incentives supportive of innovative and entrepreneurial behaviours;
•
the sophistication and efficiency of knowledge generation and diffusion; and
•
the capability of firms, the workforce and individuals.
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Firms will only invest in innovation if they can expect sufficient private returns. In this context, innovation policy needs to act to enhance returns to investment in R&D, and innovation generally, while keeping costs to a minimum. Here, incentives to innovate may derive from measures that drive firm compliance costs down, and fiscal incentives that act to reduce expenditures on innovation-related investment. Just as important is the effect of competition in spurring innovative activity. This is accentuated in the face of rapid technological change and increasingly sophisticated consumer needs. Therefore, the policy objectives should: •
minimise the risks associated with innovation (e.g. a stable and supportive macroeconomic policy);
•
where possible, build on the private incentives of individuals and firms (thereby reflecting better targeting of firm-initiated research to real needs and opportunities); and
•
aim to encourage entrepreneurship in general (e.g. ease of starting and registering businesses), and risky innovative activity in particular (e.g. bankruptcy laws that may excessively penalise failure).
The impact of R&D (and innovation generally) strongly hinges on its diffusion across the public and private sectors and between and within firms. Greater importance is now placed on measures which utilise and expand the knowledge base through more effective interaction and networking within the innovation system (e.g. between the enterprise sector and the science system, and collaboration between firms). Therefore, the policy objectives should: •
include measures which support and encourage more effective use amongst
SMEs
of
relevant,
globally-accessible,
innovations
and
technologies; •
strengthen links between firms and public research infrastructure, e.g. greater use of public/private partnerships and enhancing the role of intermediary institutions; and
•
build up the internal absorptive and innovative capacities of firms, e.g. for example, encouraging personnel movements between industry-public
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sector, especially SMEs, and benchmarking (transmitting best-practices from elsewhere). New Zealand’s innovation capability spans a number of critical policy domains: economic, regional and industry development policy, labour market and industrial relations policy, education policy, science and technology policy, and immigration policy. Combined, these policies determine the quality and size of the available skill and knowledge base and how effectively that knowledge is creatively applied. Therefore, the policy objectives should: •
foster human capital mobility between CRIs, Universities and private sector in order to transfer knowledge and ideas;
•
facilitate the entry of new participants with innovative ideas, innovative concepts and technological solutions; and
•
promote measures to improve public understanding of the essential contribution that continuous learning, technological innovation, and entrepreneurship make to an economy, and to society in general.
Promotion of entrepreneurship culture is one of the key policy objectives and it represents an integral part of wider activities that contribute to economic development. Therefore, the following broad areas need to be considered in policy development: •
developing a culture in which links between business, schools, and education more generally, are seen as a natural partnership;
•
providing opportunities for individuals and communities to build specific and practical knowledge and skills for enterprise;
•
developing confident individuals that have the skills to deal with constant change and that look at their environment with “eyes of opportunity” where the glass is half-full rather than half-empty;
•
promoting
the
success
of
enterprising
and
entrepreneurial
New
Zealanders in both business and social development activities; and •
fostering a culture that encourages risk-taking and accepts failure as permissible social and individual norms.
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Annex 1: Basic Structure of Small and Medium Enterprises in NZ FIGURE 1.1 ENTERPRISE NUMBERS BY EMPLOYEE NUMBERS •
F igure 1.1 Number of Enterpris es by F T Es (1998)
1%
2%
1%
5%
7%
Definitions of Small and Medium Enterprises (SMEs) differ across industry sectors and countries, and can be based upon a number of criteria. Most important for policy consideration are the characteristics of these businesses which typically include: personal ownership and management, few, if any, specialised managerial staff and not being part of a larger business enterprise. In New Zealand most firms sharing these characteristics fall in the 0-19 Full-time Equivalents (FTEs) bracket. SMEs constitute the majority of all enterprises in New Zealand.
0-5 6-9 10-19 20-49 50-99 100+ 84%
•
•
84% of all enterprises employ 5 or fewer FTEs. 96% of New Zealand enterprises employ 19 or fewer FTEs.
FIGURE 1.2 FTES BY INDUSTRY AND ENTERPRISE SIZE •
F igure 1.2 Enterprise Structure by Employee Numbers (1998)
The average number of FTEs has fallen in recent years from 7 in 1994, to just over 6 in 1998. SMEs employ over 50% of FTEs in the following industries: Agricultural services, Hunting, Forestry & Fishing (66.6%); Construction (72.7%); Retail trade (60.3%); Accommodation, Cafes & Restaurants (60.4%) and Property & Business Services (57.3%). > The Construction industry is particularly significant with almost three-quarters of the FTEs employed in that industry employed in small and medium enterprises.
•
100% 80% 20+
60%
6-19 40%
0-5
20%
•
0% A
B
C
D
E
F
G
H
I
J
K
L
M
N
O
P
Q
•
ANZ SIC Classification
In Government and Utility provider sectors, SMEs make up only a small proportion of total FTEs, which is to be expected, considering the size of these operations.
2
ANZSIC Industry Classifications: A- Agriculture, B- Mining, C- Manufacturing, D- Electricity, Gas & Water supply, E- Construction, F- Wholesale Trade, G- Retail Trade, H- Accommodation, Cafes & Restaurants, I- Transport & Storage, J- Communication Services, K- Finance & Insurance, LProperty & Business Services, M- Government Administration and Defence, N- Education, O-Health & Community Services, P- Cultural & Recreational Services, Q- Personal & Other Services.
FIGURE 1.3 INTERNATIONAL COMPARISON •
F ig u r e 1 .3 S u r v iv a l R a te s o f 1 9 9 5 E n te r p ris e B ir th s
Overall, enterprises with 19 or fewer FTEs have higher mortality rates than enterprises employing 20 or more FTEs, suggesting a more vulnerable economic position for SMEs compared to larger enterprises. With respect to Industry classification, industries with the highest survival rate into 1998 were Electricity, Gas & Water supply, Finance & Insurance, and Government Administration & Defence. Both the utility and government-based industries have a significantly lower proportion of SMEs. The Accommodation, Cafes & Restaurants industry had the lowest survival rate, and also had a relatively high proportion of FTEs employed by small and medium enterprises.
100 90
•
80 70 60 1996 1997
50
•
1998 40
•
30 20 10 0
0 -5
6 -9
1 0 -1 9 2 0 -4 9 S iz e o f E n te rp ris e
5 0 -9 9
100+
•
Figure 1.4 Percentage of total FTEs Employed Country
Year
1-19
20-99
100+
New Zealand
1999
42
18.9
39.1
United States
1993
18.4
18.8
62.7 53.7
Canada
1992
25.5
20.8
France
1992
25.3
21.7
53
Germany
1992
31.3
18.2
50.5
Italy
1991
55.6
15.9
28.5
United Kingdom
1991
31.2
15
53.8
•
SMEs form a significant component of modern economies, both in terms of the number of firms in an economy and their contribution to a country’s employment. Both Italy (55.6%) and New Zealand (42%) exhibit high levels of SME employment compared with other OECD nations, indicating that in these two countries, SMEs form a highly significant component of the economy.
Source: OECD (1997) “Small Business, Job Creation and Growth: Facts, Obstacles and Best Practice.”
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Annex 2: GDP, Regulatory Barriers and Entrepreneurship
GDP per Capita & Entrepreneurship 40000
Luxembourg
1999 GDP per Capita
35000
U.S
30000 Norway
25000
Japan U.K
Iceland S witzerland Denmark Canada Aus tralia Aus tria Ireland B elgium Germany S wedenNL F inland F rance Italy
20000 S pain
P ortugal
NewZ ealand
Korea
15000
Greece
Czech Republic Hungary
10000
Mexico P oland T urkey
5000 4
5
6
7
8
Entrepreneurship Notes. Entr epr eneur shi pbased on per cept ions of busi ness ex ecutives. S our ce: IMD (2000) OECD, in OECD Entr epr eneur ship, Gr owth and P ol icy DS T I/IND (2001)1
Regulatory barriers to entrepreneurship (1998) 3 2.5
B arriers to competition R egulatory and adminis trative opacity
2
Adminis trative burdens on s tartups
1.5 1 0.5
U
ni te d
Ki ng d C om an Au ad st a ra li a N I r ew el a Z n U ea d ni l te an d d St a D te en s m N a rk o N et rwa he y rla Po nds r tu g Au a l st G ria re ec e Sp Sw a in ed e Fi n nl a G e nd Sw rm i tz any er la nd Ja pa Be n lg iu Fr m an ce Ita ly
0
S ource: B as ed on OE CD E conmoics Department, International R egulation Databas e, in OE CD, E ntrepreneurs hip, Growth and P olicy DS T I/IND(2001)1.
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