Systems of innovation: The case of small food firms in the EU

Tessa Avermaete University of Ghent, Department of Agro-Marketing, E-mail: [email protected]

Abstract

The food industry makes up a key theme in the European political debate and represents one of the most important industries in the European Union. Over the past decades the entire food chain including the manufacturing industry - is subjected to major structural changes. Both the public opinion and the political world exert pressure on the food industry to attain product safety, quality and sustainable production methods. In this regard, food firms are forced to innovate continuously. The article deals with the case of small food firms. Based on both literature and preliminary results of a survey among small European food firms, an argument is developed to illustrate the meaning of scientific research on innovation in an industry where patent data are rare, R&D expenditures low and statistical data highly limited.

Key words: innovation, small food firms, environment

The author would like to thank the promoter of this thesis, Professor Jacques Viaene and the members of the European INNOVALOC project, in the framework of which this research is carried out.

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1 Introduction

Over the past decade, the European food industry has faced dramatic changes in both methods of production and structure. The evolution towards a transparent and free European market, internationalisation of the world food market as well as recent food crises lay on the bases of rapid and continuous changes in the entire food chain.

The phasing out of European borders, inclusive the introduction of the euro, results in a more intensive competition between European firms. This holds not at least true for the food industry. As competition between food firms increases, supermarkets gain power. The increased power of retailers is, among others, due to the large supply of both raw and manufactured food and the fusing of important supermarkets. The current situation in the European food market is especially hard for small enterprises that do not profit from economies of scale. In consequence, many small food firms are taken over by their larger competitors or by giant multinationals as Unilever and Nestlé (Traill 1997). This phenomenon is enforced by internationalisation and globalisation.

Indeed, conformable with the GATT and WTO agreements, protection of the European market and the subsidising of European exports are reduced. Import taxes are cut on, export subsidies are decreased and the quota system for milk is possibly abolished (Pitts and Paul 2000). Although scientific research is still needed to identify the effect of internationalisation on the prices of food manufactured products (Pitts and Riordan 1999), it is generally agreed that the European food industry faces the longer the more competition on the internal and external consumers’ market.

Finally, the European food sector has suffered severely from food crises like BSE, foot and mouth disease, the Coca-Cola hysteria and the dioxin crises. Although the media mainly focused on the consequences for the agricultural sector, the effects of the food crises on the manufacturing industry should not be underestimated. In all EU member states, safety and quality standards for the processing of food are strengthened (Christensen et al. 1996; Caswell and Henson 1997; Taylor 2001). Moreover, increasing pressure has been concentrated on environmental friendly production processes.

From the previous, it is clear that small food firms need to innovate if they are to remain competitive. This paper deals with the system of innovation in small food firms. The paper is structured as follows. Section two provides the overall framework of the research. Section three outlines the literature on which the framework builds. Based on theory and facts, the framework is applied to small food manufacturing enterprises (section four). The final section contains the conclusion and outlines future research in the domain of innovation systems for small food processing firms.

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2 Overall framework

Politicians and scientists show an increasing interest in the dynamics of innovation. Scientific research on innovation dynamics has lead to the belief that innovation takes place within a specific environment. Moreover, innovation is considered as an essential component for economic growth. Both ideas are reflected in the overall framework of this research, which is visualised in figure one. The framework integrates research done in the domain of economy, regional sciences and sociology. Two hypotheses can be derived from the framework:

Hypothesis one: The environment influences the innovative behaviour of firms.

Hypothesis two: Innovation has an impact on the environment in which the firm operates.

The aim of this paper is to provide the theoretical background of the overall framework and to illustrate the evidence of the framework for small food manufacturing enterprises. Therefor, four building blocks of the framework are distinguished: (1) knowledge creation takes place within a specific environment, (2) codified and tacit knowledge as components of knowledge creation, (3) necessity of inter-firm linkages and (4) innovation as a key to enhance regional performance and sustainable development.

ENVIRONMENT Political, economical, technological, socio-economical structure Historical and cultural background

KNOWLEDGE CREATION INTERNAL KNOWLEDGE Codified knowledge Know-what Know-why

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INTERESTED PARTIES -

R&D institutions and universities Suppliers of equipment Suppliers of raw material Clients Competitors and similar enterprises

Tacit knowledge Know-how Know-who

INNOVATION

Figure 1: Dynamics of innovation

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3 Theoretical approach

The importance attributed to innovation is reflected in an abundant literature on the process that underlies technological and non-technological changes. Based on R&D expenditures and patent data, the greater part of innovation studies focuses on large enterprises and high tech industries. Nevertheless, many arguments in current literature can easily be applied to small and low tech industries.

(1) knowledge creation takes place within a specific environment

There is a growing awareness that knowledge creation takes place within a specific institutional, organisational, local, regional or national environment. This holds true for knowledge creation of an individual as well as for the creation of knowledge within a firm and between a firm and other persons or organisations. The importance of the environment for the learning process is illustrated in a large number of innovation studies (for example: Cooke et al. 1997; Breschi 1999; Gertler 2001; Lundvall et al. 2001; Morgan 2001; Ritsila 1999).

The idea of environmental anchored knowledge might only recently be the subject of intensive research, the concept is not entirely new in economic sciences. The identification of industrial districts as introduced by Marshall already suggests the vision on knowledge as a regional competence (Maillat 1998; Lundvall 2001). However, the research of Marshall - and in his footsteps many others – does not provide insight why firms cluster (Maskell 2000) neither does it explain localised knowledge.

An important aspect of the firms’ environment is the availability of external sources of technological knowledge (Breschi 1999; Wolfe 2000) such as public research centres, universities and suppliers of equipment. Proximity to external sources of technological knowledge plays a very important role for firms that are not able to carry out routine controls and lack the means to practice research and development.

Besides the technological environment, firms also operate in a specific institutional environment. This concept is outlined by Oinas, who states that:

Institutional competencies refer to the understanding of and relative compliance with prevailing social practices, values, and perceptions concerning resource utilisation in specific institutional environments. Institutional environments, through their cultural (practice based on values, norms and beliefs) and political (laws, rules and regulations) aspects, condition economic action (Oinas 2001).

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Further, firms serve clients with a specific cultural and historical background. Moreover, firms have to understand the socio-demographic structure and follow up the evolution in needs and wants of the consumer. One can think of the increasing concern for animal welfare forcing the European meat industry to re-organise the production chain. The same holds true for the political environment. Globalisation and internationalisation influence regional and national policy, which leads for example to the reduction of protection regulations and the strengthening of environmental norms.

Finally, the recognition of tacitness in social, economical and regional sciences also contributes to a better understanding of why the environment matters for knowledge creation. Tacit knowledge is embedded in social networks (Nightingale 1998) and depends on the history and background of an individual. Moreover, the transfer of tacit knowledge is best achieved through face to face interaction (Morgan 2001) and hence requires geographic proximity. The next paragraph goes more into detail on the characteristics of tacit knowledge and illustrates its importance in the innovation process.

(2) the components of knowledge

Knowledge represents the main source of competitive advantage and innovativeness of a firm. Although this thesis is generally agreed on, the debate on the weight of the different components of knowledge for innovation lasts. Basically, distinction is made between explicit knowledge and tacit knowledge. Both concepts are subject to extensive discussion, for instance by Cowan et al. (1999), Johnson and Lundvall (2001) and Nonaka et al. (2000).

Explicit or codified knowledge, on the one hand, is linked to scientific and technological skills. In general, scientific knowledge is produced to understand how technologies work. This understanding reduces technical uncertainty and helps reduce the number of experimental dead ends that are explored (Nightingale, 1998). Explicit knowledge can be generated through R&D activities, within the firm or by external parties. It can be expressed in formal and systematic language and shared in the form of data, scientific formulae, specifications, manuals and such like (Nonaka et al. 2000). The rapid diffusion of ICT has eased the world-wide transfer of explicit knowledge. However, explicit knowledge can also be patented in order to prevent its transfer.

Tacit knowledge, on the other hand, refers to uncodified knowledge. The concept of tacit knowledge was introduced by Polanyi (1966) who defines it as a form or component of human knowledge distinct from but complementary to the knowledge explicit in conscious cognitive processes. Polanyi illustrates this conceptualisation by referring to facts of common perception: we all are aware of certain objects without being focused on them. Tacit knowledge enables us to interpret information and comprehend things that cannot be codified, like riding a bicycle. In contrast with explicit

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knowledge, tacit knowledge is difficult to transfer (Nightingale 1998; Lawson and Lorenz 1999; Gertler 2001). Moreover, tacit knowledge is deeply embedded in individuals, organisations and localities (Lundvall et al. 2001). Therefor, its transition is best shared through face-to-face interaction between partners that share some basic similarities: the same language, common ‘codes’ of communication, shared conventions and norms; personal knowledge of each other based on a past history of successful collaboration or informal interaction (Gertler 2001).

Another approach of knowledge is found in Lundvall (1996) and Malecki (1997). They distinguish four kinds of knowledge: (1) Know-what, (2) Know-why, (3) Know-how and (4) Know-who. In summary, know-what refers to knowledge about facts. Know-why is about principles and laws in nature, in the human brain and in society. Know-how is related to skills. It reflects the capability to do something and therefor depends highly on experience and background. The last component, knowwho, reflects the relational capacities of an individual or organisation. Know-what and know-why can rather easily be codified and transferred; know-how and know-who on the contrary are more difficult to codify and transfer. In this context, the former components are classified under the denominator of explicit knowledge, while know-how and know-who are regarded as components of tacit knowledge.

Recent literature in the domain of learning processes suggests that knowledge is created through the interaction between explicit and tacit knowledge. This interaction between explicit and tacit knowledge is called knowledge conversion. The conversion process expands tacit and explicit knowledge in both quality and quantity (Nonaka et al. 2000). This argument also holds true for the innovation process (Lawson and Lorenz 1999). Moreover, Nightingale argues that both explicit and tacit knowledge are essential for innovation:

Scientific knowledge as such cannot be directly applied to produce technology because it answers the wrong question. Innovation progresses from a known, desired end result to find the starting conditions that will produce it, while scientific knowledge, in contrast, can only be used to move in the opposite direction, from known starting conditions to an unknown end result (Nightingale 1998).

(3) necessity of inter-firm linkages

The conversion of knowledge within a firm might compose the direct forces that drive innovation. However, a firm almost never innovates in isolation but interacts closely with other organisations and individuals through complex relations that are often characterised by reciprocity and feedback mechanisms in several loops (Murdoch 2000). People and firms need outside sources of cognition and

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competence to complement their own. That is the fundamental reason why inter-firm linkages are important, especially for innovation (Nooteboom 1999).

Inter-firm linkages are also a key issue in the analyses of innovative clusters. Although there is no standard definition, an innovative cluster can be regarded as collections of firms within one specialised industry or technology, concentrated within the same local geographical area (Feldman 2001). The underlying idea for the existence of regional clusters of innovation relies on the importance of tacit knowledge and is twofold. On the one hand, tacit knowledge is best shared among individuals and organisation that share a common language, culture and background. On the other hand, the transfer of tacit knowledge is less difficult through face-to-face contacts. The latter requires of course geographical proximity.

The overall framework of figure one shows that many organisations and industries can be noted as interested parties. When discussing the case of small food firms, we will go into detail on the importance of the different groups.

(4) innovation as a key to enhance regional performance and sustainable development

Regional economic performance depends upon the progressive introduction over time of innovations in products and processes to enhance the competitiveness of the regional economic base in an increasing competitive world (CEC 1991).

As can be derived from the above quote, the European Commission recognises innovation as a tool to enhance regional performance. In line with this thesis, the European Commission has carried out an increasing number of programmes to promote innovation and has financed numerous scientific projects on innovation.

The vision of the European Commission on innovation is also shared by scientists (for example: Alderman and Wood 1994; Fanfani and Lagnevik 1995; Mascitelli 2000; Oinas 2001)). Identifying regional innovation capabilities makes up an important phase to achieve economic and social cohesion within the European Union. Indeed, although the borders between EU member states seem to disappear, disparities between European regions tend to grow. In this regard, some scholars have dealt with the impact of innovation on regions lagging behind (Gladwin et al. 1989; Humphrey and Wilkinson 1993). At last, studies are undertaken to understand the relation between innovation and the performance of developing countries (López 2000; Van Dijk 2001).

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4 Implications for small food firms

This section is based on literature in the domain of innovation in the food industry and preliminary results of a survey among small food firms1 in two Belgian provinces: West Flanders and Hainaut. Analogous with the previous section, four main questions arise. First, what is the impact of the environment on knowledge creation in small food firms? Second, what kind of knowledge determines the innovativeness of these firms? Third, in how far is co-operation with other firms and institution relevant for small food firms? And finally, does innovation in small food firms have an impact on the environment?

4.1 Impact of the environment on entrepreneurship in small food firms

Innovation in small food firms is driven by several aspect of the environment. In the literature on food marketing, a long list of driving forces for innovation in the food industry can be found. We distinguish four factors that shape the nature and the intensity of innovation in small food firms: (1) internationalisation, (2) the structure and power of food retailers, (3) the political environment and (4) changes at the consumer level.

Internationalisation

Internationalisation of the world market has, like for almost any industry, consequences for small food firms. Borders between European member states fade and the protection of the European market is reduced. Although the price effects of the internationalisation of the food markets are still under research (Field and Pagoulatos 1996; Pitts and Paul 2000), it is quite clear that the entire European food industry faces increased competition. The increased competition has serious effects for small food firms. While many of these firms used to have fixed regional outlet, they are the longer the more confronted with competition from both European and non-European enterprises. In this regard, small food firms are to innovate drastically, leave the business or become subsidiary of larger manufacturers.

Power of retailers

The power shift in the food chain in favour of retailers is indisputable. Within the European Union retailers become more concentrated and continuously gain power towards the food manufacturing industries. Since the 70’ s, the European food retail structure shows great changes: the number of food

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The survey is carried out among 60 enterprises, equally spread over the two provinces, of the food and beverage industry. All enterprises count less than 50 employees.

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stores decreases but the size of the stores increases (Gracia and Albisu 1997). One of the main instruments of the modern retailers consists of private label products (Hughes 1996; Traill 1997). Private label products rely on the store’ s image and hence, they require little advertising support. The use of private brand products can be seen as an opportunity to small and medium sized food firms in the sense that these brands allow firms to sell their products without the need for developing a recognised brand (Traill 1997). However, prices of private label products are on the average very low, which also explains the increasing consumer loyalty towards private labels. Therefor, private labels compose an enormous competition for firms that have an own brand or those firms that have too high production costs to make profitable use of private labels.

Political environment

Besides the internationalisation and the growing power of retailers, one can not ignore the role of the government for recent technological and non-technological changes in the food industry. Government regulation of the food industry may occur for a number of reasons: protection of the home market, protecting public health, protecting the environment and the insurance of a social security system. Therefor, the government’ s role is not limited to the regulation of domestic food markets (Sonka 1997) but also includes food quality and safety standards, environmental regulations and national company legislation.

In the framework of the World Trade Organisation negotiations, the EU is forced to reduce the level of protection of the internal market, reduce subsidies for exports from the European Union and build off – and in the longer term eliminate – the quota system (Pitts and Riordan 1999). As mentioned previously, this de-regulation of the food sector causes an increased competition on both the European market and non-European outlets.

With the development of a global food market, it became apparent that a common basis for quality systems was needed (Varzakas and Jukes 1997). Moreover, recent events in the food sector have forced national and regional governments to strengthen food quality and safety regulation in order to guarantee public health. One of the main instruments used to guarantee for food quality and safety, is the introduction of ISO 9000 standards and the HACCP (Hazard Analysis and Critical Control Points) system. In most EU member states, HACCP became part of the national business legislation. While even large food companies may face difficulties to adopt HACCP, for most small food companies the adoption of HACCP often requires the establishment of an entirely new system of managing food safety (Taylor 2001). Not only does the HACCP system demand an integral and integrated control over the entire food processing, it also implies the use of specific materials for the manufacturing. In this regard, many small food firms were obliged to replace old machines and tools. The survey among

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small food firms in Belgium showed that the introduction of HACCP was for a couple of firms the main reason to rebuild the entire production site. Finally, it is important to note that some member states have introduced a stricter interpretation of the HACCP system than others. In Ireland and Great Britain, for example, food firms are encouraged to apply HACCP while in Belgium and France, food firms are obliged to produce in line with the HACCP system.

Apart from quality and safety standards, national and regional governments in the EU have shown concern for environmental friendly production processes. This concern is reflected in environmental taxes, higher environmental norms and certification of environmentally friendly produced foods (Mahé 1997) like ISO 14.000 and eco-labelling. Similar to the quality and safety standards, environmental regulation may differ considerably from country to country or even from region to region.

The discussion on the impact of the political environment on small food firms would be incomplete without mentioning national company legislation such as the social legislation and business taxes. Although all member states need a minimum social security, social legislation and taxes often explain the differences in price-levels for identical products between countries.

Consumers’ choice

Innovation and the success of innovation depends to a large extend on the consumers’ behaviour. Changes in food consumption patterns and food-related behaviour very often determine the nature of innovation that take place in an industry (Traill 1997). Main question the entrepreneur is faced with reads: What is the consumer willing to pay for a specific product? In the case of the food industry, the role of economic factors is formulated in Engel’ s Law. Engel’ s Law states that when income rises, the proportion of expenditures allocated to food declines. However, globalisation and the crises in the food sector, are reflected in an increasing importance paid to non-economic aspects of food consumption. Apart from the price, consumers are concerned with the foods’ quality and safety, the environmental harm caused by the production, animal welfare and – with regard to the North-South gap – ethical and moral values. Last but not least, the demographic characteristics influence European food consumption patterns (Traill 1997; Meulenberg and Viaene 1998; Pitts and Riordan 1999). Examples are numerous: the increased participation of women in the paid labour force, ageing population, increased cultural diversity within the society, etc. A summary of the impact of consumers’ behaviour on innovation in the food industry is provided by Gracia and Albisu:

There are other factors related to consumers’ behaviour such as: income levels, sociodemographic characteristics, culture, attitudes and lifestyles, diet and health concerns which are

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also affecting common food patterns. Apart from these homogenisation processes, some food consumption differences exist and will exist because of cultural differences, established preferences, cultural backgrounds and other peculiarities. Everywhere consumers are demanding a larger number of food products with more attributes, including inconvenience, quality, diversity (frozen, ready to eat, natural, light products) and health. Besides, consumers face a wider range of food products, offered in different new ways as a result of the increasing competitiveness in the food retail sector (Gracia and Albisu 1997).

4.2 Learning processes at the level of small food firms

Research on learning processes in small low tech enterprises is in short supply. One can reason that small low tech industries lack time and means to undertake research and hence do not have a real learning culture. However, arguments can be raised against this view. For example, small firms have a less bureaucratic structure, commitment and motivation of the managers is higher and their R&D is more efficient because they do not produce know-how that they will not use in the short term (Grunert et al. 1997).

The food industry in general is characterised by a low R&D intensity (Christensen et al. 1996; Galizzi and Venturini 1996). This holds especially true for small food manufacturing enterprises which often lack the capacity and the resources necessary to carry out their own R&D activities (Baardseth et al. 1999). However, the low rate of R&D expenditures does not imply that innovation in the food industry is low or unimportant. As an example, we mention the survey held among 2783 small food manufacturing enterprises in France. Although research expenditures in the firms represent less than 1.7 percent of the value added, 70 percent of the firms declared to have achieved at least one innovation (Le Bars et al. 1998). How can this phenomenon be explained?

In the first place, knowledge creation in small food firms is not based on research and development. Alternatively, decision-makers in small food firms mainly rely on tacit knowledge. Understanding the knowledge process in small food firms requires an insight in the history and structure of the European food industry. The greater part of small food firms in Europe are familial enterprises, originally created to process food from regional agricultural activities. Many of the firms were created more than a century ago and over this period of time, knowledge is transferred and translated from generation to generation. Therefor background and experience rather than theory make up the knowledge base of small food firms and, at least until recently, the majority of managers entered the business without higher degree of education.

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However, the fact that small food firms are the longer the more run by people with higher education is the result of increased competition, higher quality and safety standards and the strengthening of environmental norms. To remain competitive on the international food market, the need for research and development can no longer be ignored. While some small food firms have built out their own labs, other firms chose to co-operate with universities and research institutions (Baardseth et al. 1999), suppliers of equipment and other enterprises within the food chain. In reality, small food firms in Europe rely on own equipment and knowledge as well as on co-operation with research organisations to carry out the necessary R&D.

4.3 Inter-firm linkages of small food firms

There is growing evidence that small food firms need external sources of knowledge to complement the internal knowledge. Quality control is one of the areas for which the greater part of small food firms co-operates with research organisations. A considerable amount of small food firms work together with universities and other research institutions for the control of food safety and quality. Food controls need to take place on a routine base and therefor, geographical proximity is preferred. However, research institutes can also fulfil a role in the development of new products and optimisation of existing processes. The survey among small food enterprises in Belgium learns that entrepreneurs maintain good communication with the responsible scientists. In some cases, students in engineer studies made a thesis on food production processes or doing a training period in the firm: an experience profitable for both parties.

When a firm decides to introduce a major change in the production process, suppliers of equipment become an important source of information. In contrast with the case of research institutes, geographical proximity to the supplier of equipment is not essential. As the application of a new production process is rather exceptional for small food firms, entrepreneurs prefer guarantee of the new process above the speed of introduction. The Belgian survey confirms this reasoning: entrepreneurs were often willing to cross the national border before introducing a new production process.

Nevertheless, major process innovations in small food firms are rare. The greater part of innovation in these firms consists of improvements of existing products or processes. In this regard, co-operation, communication and observation of competitors should be taken into account as an entrepreneurial strategy. In the more rural areas with a concentration of speciality foods, we found better communication between the firms. In general, small food firms are well aware of changes realised by similar enterprises in the region.

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The links in the food chain compose the last group of interested parties for innovation in small food firms. Innovation at one level of the food chain almost automatically requires changes at other levels of the food chain. As an example, one can think of a food retailer that wants to increase its biological food supply. This requires biological production methods along the entire chain, from the field to the consumer. The same holds true for fair trade food. Moreover, co-operation between the different links of the food chain is no longer a choice but also a necessity to guarantee food safety and food quality. Although politicians, scientists and industries generally acknowledged this view, vertical integration and co-operation in the food chain has still a long way to go.

4.4 Effects of innovation on development

In both developing and developed countries small food firms play an important role in the production, manufacturing and retail of food. It is therefor argued that small food firms are everywhere essential to economic development as an integral part of all market economies (Taylor 2001).

First and most obvious argument to illustrate the role of small food firms builds on their role in employment. Within the European Union, the food industry is the second most important sector in terms of employment. Knowing that about 99.7 percent of all food manufacturing enterprises in the EU are small or medium sized, it is evident that the latter have a considerable role in the European economy. Second, there is evidence that small food firms are particularly situated in rural areas where they have developed to process products from local agriculture (Traill 1995; de Noronha Vaz and Nicolas 2000). Although this tendency is changing as manufacturers increasingly import raw material, small food firms still rely heavily on local services for accountancy, advertising, consultancy, etc. In this regard, small food firms are thought of by means of achieving sustainable economic growth in local economies (McDonagh and Commins 1999). Finally, it is suggested that small and rurally located firms produce specialised regional products of a different kind than those produced by large firms. Large firms generally have a national or European market approach and consequently focus on products with more of a mass appeal. In this sense, an important component of Europe’ s highly valued cultural identity is invested in such small companies (Traill 1995).

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5 Conclusion and future research

In this paper, an overall framework to study innovation dynamics in small food firms is developed. Two main ideas are raised. On the one hand, innovation takes place within a specific environment. In this regard, an insight in the characteristics of the environment is required in order to understand the innovative behaviour of a firm. On the other hand, innovation has an impact on the environment in which the firm operates. Current studies stress in particular the effects of innovation on employment and competitiveness. Most of the literature used to develop the framework builds on evidence from large and high tech industries but, as illustrated in this paper, can also be applied to small and low tech industries.

The lack of literature on small food firms reflects the denial of the role of these firms in economic growth. It is indeed hardly possible to study innovation in the European food industry based on patent data and R&D expenditures. However, this thus not implies that food manufacturing enterprises are not innovative and insignificant for economic growth. On the contrary, we argue that small food firms are important for sustainable development: economic growth, job creation and maintenance of the cultural diversity in the EU.

To empirically verify the hypotheses further research will be carried out in the framework of the European INNOVALOC programme. As statistical data on small food firms are limited, the research is based on a unique questionnaire held among firms in 13 European regions. It is thereby the aim to identify the driving forces for innovation in small food firms at the micro level, the meso level and the macro level.

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