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UNIVERSITY OF ECONOMICS ERASMUS UNVERSITY ROTTERDAM HO CHI MINH CITY INSTITUTE OF SOCIAL STUDIES VIETNAM THE NETHERLANDS VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE CAUSES AND CONSEQUENCES OF TECHNOLOGICAL INNOVATION: A STUDY OF SMALL AND MEDIUM ENTERPRISES IN VIETNAM BY TRAN THI NHU Y MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, DECEMBER 2016 UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE CAUSES AND CONSEQUENCES OF TECHNOLOGICAL INNOVATION: A STUDY OF SMALL AND MEDIUM ENTERPRISES IN VIETNAM A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By TRAN THI NHU Y Academic Supervisor: LE VAN CHON HO CHI MINH CITY, DECEMBER 2016 DECLARATION “This declaration is to certify that this thesis entitled “The causes and consequences of technological innovation: a study of small and medium enterprises in Vietnam” which is conducted and submitted by me in partial fulfilment of the requirements for the degree of the Master of Arts in Development Economics to the Vietnam – The Netherlands Programme. The thesis constitutes only my original works and due supervision and acknowledgement have been made in the text to all materials used.” Tran Thi Nhu Y i ACKNOWLEDGEMENTS Completing this thesis is a challenging and interesting journey as well. I found the research field that I would love to dedicate in and am proud of the outcome. In this journey, I find myself lucky and honor to have the companionship of respected and generous people. Foremost, I would like to express my sincere thanks and my deep respect to my supervisor, Dr. Le Van Chon. His wisdom and coaching always encourage me to embrace challenges and do right things. He is always accessible and generous to answer and explain thoroughly all my questions despite my partly weird available time due to my business schedule. I am grateful for the valuable comments on my thesis research design from Dr. Pham Khanh Nam and Dr. Vu Viet Quang. My gratitude to Dr. Truong Dang Thuy for his straight forward suggestion to the very first draft of my thesis. With it, I could go this far. I am blessed with the encouragement of my classmates, especially those that VNP Office call them “my group”. They are smart, studious and good friends who are always available when I need them. They are Phuong Lan to support me with the regression test, Que Anh to provide me the sources for searching data, Anh Thu Truong, Anh Thu Le, Thao Nguyen, Thanh An and Tuong Vy to listen to me and encourage me continuously. Next, VNP Office are one of the best service team I have ever known. Its kindness and professionalism let me really enjoy the time learning here. My family is the precious source of encouragement and support. Finally, it’s my profound thanks to a special person who lets me see the importance of the thesis and shares every of my concerns and joy, his name is Cuong. Thank you for all the best you gave me. I am committed to this thesis enthusiastically and joyfully with your companionship, and I hope that this thesis could make you proud. ii ABBREVIATIONS MSME: Micro, Small and Medium Enterprise OECD: The Organization for Economic Co-operation and Development R&D: Research and Development SME: Small and Medium Enterprise iii ABSTRACT Innovation has been long considered as a paradigm of achieving economic growth and sustaining nations’ wealth. In which, technological innovation, including both product and process innovation, plays a crucial part, especially in the knowledge economy. Collecting data from the non-state manufacturing SMEs survey in 2011 and 2013, this study conduct an empirical research to find the causes and consequences of technological innovation at firm level. The analysis of causes to technological innovation is divided into three areas: firm characteristics, internal innovation factors and external innovation factors. Except for firm age which is negatively associated to innovation occurrence, others factors are positively correlated, including firm size, employees with degree, innovation expenditure, R&D investment, spillover pressure from suppliers and customers, industry network and competition level. Concerning the influence of innovation on firm performance, the empirical result shows evidence for a positive impact while suggesting a new approach to resolve the simultaneous causality between these two concepts. iv TABLE OF CONTENTS Chapter 1: INTRODUCTION................................................................................................... 1 1.1 Problem statement........................................................................................................ 1 1.2 Research questions ....................................................................................................... 4 1.3 The scope of the study ................................................................................................. 4 1.4 Structure of the study ................................................................................................... 4 Chapter 2: LITERATURE REVIEW........................................................................................ 6 2.1 Definition and classification of innovation .................................................................. 6 2.1.1 Definition of innovation .................................................................................... 6 2.1.2 Main types of innovation ................................................................................... 8 2.2 The causes of technological innovations ................................................................... 10 2.2.1 Firm characteristics and technological innovation .......................................... 10 2.2.2 Internal innovation factors ............................................................................... 14 2.2.3 External innovation factors .............................................................................. 16 2.3 Technological innovation’s impact on firm performance.......................................... 20 2.4. The conceptual framework ....................................................................................... 23 Chapter 3: RESEARCH METHODOLOGY .......................................................................... 25 3.1 Estimated models ....................................................................................................... 25 3.2 Estimation approach .................................................................................................. 28 3.2.1 Equation 1: The causes of technological innovation ....................................... 28 3.2.2 Equation 2: The impact of innovation on firm performance ........................... 29 Chapter 4: EMPIRICAL RESULTS ....................................................................................... 31 4.1 Data description ......................................................................................................... 31 4.2 Empirical results ........................................................................................................ 37 4.2.1 The measurement of innovation ...................................................................... 37 4.2.2 The impact of innovation on firm performance ............................................... 40 Chapter 5: CONCLUSION ..................................................................................................... 46 5.1 Main findings ............................................................................................................. 46 5.2 Policy implications .................................................................................................... 47 5.2.1 Implications for SMEs ..................................................................................... 47 5.2.2 Implications for government............................................................................ 48 v 5.3 Limitations and future researches .............................................................................. 49 REFERENCES ....................................................................................................................... 51 LIST OF FIGURES Figure 1.1 Number of MSMEs in Vietnam .............................................................................. 1 Figure 2.1 The causes of firm-level technological innovation ............................................... 23 Figure 4.1 The recorded time of revenue and innovation variables for the year in question of 2013......................................................................................................................................... 33 LIST OF TABLES Table 4.1 Variable description ................................................................................................ 32 Table 4.2 The correlation matrix ............................................................................................ 34 Table 4.3 Panel data structure ................................................................................................. 35 Table 4.4 Percentage of innovators by firm size..................................................................... 35 Table 4.5 Percentage of innovators by firm age ..................................................................... 36 Table 4.6 The presence of R&D investment, Spillover pressure from suppliers or customers, industry network and competition .......................................................................................... 36 Table 4.7 Regression results and marginal effect controlling for the robustness for the sources of innovation ........................................................................................................................... 38 Table 4.8 Regression results with random effect and fixed effect .......................................... 41 Table 4.9 Hausman test for random effect and fixed effect model ......................................... 42 Table 4.10 Summary of firm facing competition and firm facing no competition ................. 43 Table 4.11 Regression results of competition and non-competition group ............................ 44 vi CHAPTER 1: INTRODUCTION 1.1 Problem statement The significant contribution of micro, small and medium enterprises (MSMEs) to the economic growth has been historically recorded, especially its role in providing employment opportunities. Due to the fact of lacking update from the national statistics on MSMEs in Vietnam since January 2013, the most recent report of Asian Development Bank (2014) utilizes the figures of the year of 2012 and shows that in 2012, there were in total 333,835 MSMEs in operations, accounting for 97.7% of the total enterprises that paid corporate tax. Figure 1.1 Number of MSMEs in Vietnam Source: Asian Development Bank (2014) 1 The MSME sector employed 5.1 million workers in 2012 and accounted for 46.8% of the total workforce in the country. The sector observes an increase of number and employees of 5.3% and 2.4% respectively after five years of two-digit growth (from 2007 to 2011). Though the percentage of labor in the MSME sector is not adequate to the dominant number of MSMEs in Vietnam, it is undeniable that MSMEs take a crucial contribution to the national economy. Among MSMEs in Vietnam, though taking only 15.7% of total active MSMEs in 2012 – after the wholesale & retail trade and service sectors accounting for 39.8% and 20.5% respectively, manufacturing is a labor-intensive industry, employing majority of employees in the MSME sector, 31.8% of total MSME employees, 14.9% of total domestic workforce. This figure partly shows the important role of manufacturing MSMEs in the economy. In the recent time, manufacturing companies are faced with unstable economic environment with frequent shocks and increasingly fierce competition. Moreover, the knowledge-based mechanism, which has been ignited since 1990s, has evolved the market place to be more dynamic and competitive. To some extent innovation can be acknowledged as an inevitable means for firms to increase their competitiveness in adapting to the requirements of this challenging and unstable environment. From long ago, Schumpeter (1950) recommends that firms innovate for refreshing their asset value. Even before this, at the time that the “innovation” term may not have been popularly used, researchers admit the important role of economic and technological change (Lorenzi et al., 1912; Veblen, 1899; Schumpeter, 1934). Firms have been forced to focus on their business strategies, especially their direction towards innovative activities to cope with the progressively fierce global competition after 1980s (Hodgetts et al., 1998). Also, due to that tenacious situation, at present, both individuals and companies start to assess and 2 adapt the paradigm of innovation strategies as well as entrepreneurship capability for gaining competitive advantages (Drucker, 1985; Hult et al., 2003). There is an apparent escalation of interest in innovation, its processes as well as its impacts. Innovation is in need for organization for responding to shifts in customer demands and lifestyles over different periods and to seize opportunities created from technology and dynamic changes. Along with strategic differences, the innovations strongly characterize the current dynamic competition (Porter, 2000). Consistently, the researches of Bettis and Hitt, 1995; Helfat and Peteraf, 2003 and Voss, 1994 show that firm performance and competitive advantages critically rely on its capability of generating, developing and exploiting innovation. This trend of innovation which benefits firm performance is, with high probability, applicable for large-size or high technology enterprises where the available capability for continuous improvements are resourceful. However, whether innovation takes an integral part in the success of small and medium manufacturing enterprises whose investment capability for innovations is extremely limited is still in questions. The research on this matter is even scarcer for the developing countries where the technology content of circulated products and services are lower than highly developed countries. With the spirit of filling the above-mentioned research gap, this study utilizes the data taken from the Survey of Small and Medium Scale Manufacturing Enterprises (SMEs) in Vietnam to delve into the value chain of innovation, from the causes of innovation to its consequences to firm performance of the enterprises in questions. Firstly, the study evaluates the causes of innovations, from firm characteristics, internal innovation factors and external innovation factors. Secondly, the impact of innovation on firm performance is revealed with the solutions for the inherent endogeneity problems between innovation and firm performance. Lastly, based on the acknowledgement of the causes and consequences of innovation, 3 suggestions for promoting and for fruitful implementing innovations are proposed for attaining higher firm performance. 1.2 Research questions The primary goal of this study is to estimate the impact extent of innovation performance and to define the key factors for firms in deciding the deployment of innovation. Using the panel data of MSMEs in Vietnam, the study concentrates on three main questions: First, what are the causes of innovation, delving into the firm characteristics, the internal innovation factors and the external innovation requirement? Second, what are the consequences of innovation on firm performance? Last, what are the suggestions to promote innovations amongst MSMEs and to take full advantages of those innovations? 1.3 The scope of the study The study uses the dataset taken from the Small and Medium Enterprises Survey conducted by the collaboration of the Development Economics Research Group (DERG) of the University of Copenhagen and several parties from Vietnam. Gathering the separate data from the four SMEs surveys carried out in 2007, 2009, 2011 and 2013, the research forms a panel data consisting two years of 2011 and 2013 covering small and medium-sized non-state manufacturing enterprises of ten provinces Vietnam. Named SMEs survey, however, this survey also consists the micro enterprises with less than and equal to ten employees. 1.4 Structure of the study This research about innovation consists of five chapters. Following this first chapter of introduction for research motivation and overall information about the study, Chapter 2 4 represents the critical literature review on the definition and classification of innovation, the causes of innovation, its effect on firm performance, and the conceptual framework. Next, the research methodology in Chapter 3 specifies the model and approach to examine the effect of innovation on firm performance as well as to evaluate the different factors driving innovation. Following is the empirical results of the study in Chapter 4 presented into two parts: the first part describes the data source and variable constructions; the second part is the regression results. Finally, Chapter 5 provides the main findings along with policies implications and limitations for future studies. 5 CHAPTER 2: LITERATURE REVIEW 2.1 Definition and classification of innovation 2.1.1 Definition of innovation To estimate the innovation’s contribution to the firm performance, especially in the manufacturing area, the definition of the term should be examined. Taking into consideration the position of innovation on firm performance, Sink (1983) defines innovation as one of the seven criteria constituting corporate performance: effectiveness dealing with firms’ output, efficiency dealing with firms’ input, productivity dealing with the cost and the deliverable output, quality of work life measuring the positive evaluation of staff about the organization, innovation measuring capability to adapt and respond to internal as well as external changes, profitability measuring the difference of revenues to costs, and quality measuring firms’ ability to ensure the quality of the whole organization to meet the requirements from customers. He emphasizes that innovation must be consistently aligned with a firm's priorities at any point of time, while the other criteria may take the crucial part in different period of firm’s growth. Galbraith (1982) shows another point of view. He defines invention as the creation of new ideas and innovations as the process of implementing these ideas. Describing in more details to what extent that something new are considered as innovations, Abernathy and Utterback (1982) maintain that innovation can start from small scope, and that many smaller innovations may build a large innovation. As a closer attention to the process where innovations occur, Bessant (1982)’s idea is that a manufacturing innovation can be described as something that "changes neither the product nor the basic process, only some elements in the process." Meanwhile, another point 6 of view from Tushman (1982) shows innovation as "any product or process new to a business unit (firm)." They also emphasize the dynamic of innovation which has different pattern, amount and type throughout the different product life cycle stages: introduction, growth and maturity. Considering the diverse aspects of the previous definitions, Schroeder et all (1989) deliver a comprehensive definition by involving 65 manufacturing managers. Most of these participants holds the responsibility of managing the at least one manufacturing plants to at most five manufacturing plants of different sizes in considerable large companies employing various levels of technological application. The involvement of these experts give answer to two questions. First, what is the measurement of innovation in manufacturing. Second, how to improve innovation in manufacturing sector. The proposed definition completes the idea given in the previous studies, covering the magnitude, the objective of and the risk association with the innovation: “Innovation in manufacturing is the implementation of new ideas or changes, big or small, that have the potential to contribute to organizational (business) objectives.” This definition enables both large and small ideas, incorporates risks of failure and the potential to meet the organizational objectives. The Manual of Innovation Statistics of the OECD in 2005, also known as the Oslo manual and used frequently as the base for innovation survey for OECD countries as well as many non-OECD countries, states another aspect of innovation: its classification. In the latest version published in 2005, the definition of innovation is more detailed with description of the different types of innovation: “a new or significantly improved product (good or service), or process, a new marketing method, or a new organizational method in business practices, workplace organization or external relations”. In the previous version in 1995 of this manual, the innovation definition is limited in the technological product and process innovations only. 7 The marketing innovation and organizational innovation are newly added to get a more comprehensive evaluation of corporate innovation. In the scope of this study, the technological methods are put into high consideration and do not cover the organizational or marketing methods. This is also a more appropriate approach of innovation for small and medium manufacturing enterprises where the budget for marketing is limited, the employee number is usually optimized, and the ownership is quite stable. 2.1.2 Main types of innovation As stated in the Manual of Innovation of the OECD published in 2005, innovations can be classified into four main types under two branches: technological and non-technological innovations. The technological innovations consist of product innovations and process innovations.  “A product innovation is the introduction of a good or service that is new or significantly improved with respect to its characteristics or intended uses. This includes significant improvements in technical specifications, components and materials, incorporated software, user friendliness or other functional characteristics.” A product can be considered new if it has significant difference in characteristics or uses comparing to the previous products manufactured by the same firm. An existing product may have significant improvements when it has changes in its components or its materials in order to improve the product performance. 8  “A process innovation is the implementation of a new or significantly improved production or delivery method. This includes significant changes in techniques, equipment and/or software.” The non-technological innovations consist of marketing innovations and organizational innovations.  “A marketing innovation is the implementation of a new marketing method involving significant changes in product design or packaging, product placement, product promotion or pricing.”  “An organizational innovation is the implementation of a new organizational method in the firm’s business practices, workplace organization or external relations.” Only technological innovation is taken into consideration in this study. Hence, the two types of innovation in question include product innovation and process innovation. These types of innovation are respectively known as technological product innovation and technological process innovation in the second edition of the second Manual of Innovation of the OECD published in 1997. In the scope of this study, the product innovation and process innovation are called technological innovation. The definition and classification of innovation provides an overview about the innovation activities at firm level. After this section, the study limits to the scope to technological innovation, including innovation for products and processes. In the next part, the study looks deeper into the causes of technological innovations, conducive to the fundamental bases for the analysis of the causes of technological innovations. 9 2.2 The causes of technological innovations The driving forces behind innovation are mentioned in various preceding researches. Those researches cover both macroeconomics and microeconomics factors. In the scope of this study, as the enterprises in question are in the same country and are affected by similar institutional environment over considerably short time span, for the survey in 2011 and 2013, only microeconomics factors are reflected to the performance of technological innovation at firm level. This study interests in the driving forces of innovation that generate from the overall firm characteristics which form the most basic description about a firm, such as firm size and firm age, the internal innovation factors which include the resources that firms possess to prepare for an effective working process or an improvement, to the external innovation factors that take effects when firms interact with their suppliers, customers and their peers in the industry. 2.2.1 Firm characteristics and technological innovation Regarding the SME sector, the two main characteristics that affect firm innovation performance are firm size and firm age. Looking at probability of introducing innovations per the size and age of firms makes sense as SME sector observes high rate of entry and exit as well as of growth. Revealing the correlation between firm size or firm age and innovation occurrence would benefits firms in making decisions of implementing innovation to keep firms surviving and to build firms stronger. Firm size The relationship between firm size and firm innovation might be origined from the work of Schumpeter (1942), namely the Schumpeterian hypothesis which is consisted by a set 10 of two hypotheses: the first affirms that innovation and monopoly power have positive relationship; the second states a more highly innovative capability shown in large firms than small ones. There are several researches in the manufacturing support the Schumpeterian hypothesis. The empirical result from the survey on industrial innovation in the Netherlands carried out in 1984 for 3,000 firms of ten and more employees of Kleinknecht (1989) demonstrates the higher the number of employees, the lower rates of the presence of R&D department which is used to be stated as the stimulus for innovating. An empirical study conducted over 209 industrial firms in Israel in 1995 expresses the same result (Shefer & Frenkel, 2005). In addition, smaller firms tend to face with more barriers to innovation than larger firms do: shortage of capital, limited resources for forecasting market demand, unaffordable expected cost for investing in an innovation project, hard-to-control costs of current projects, difficult-to-find technical information and difficulties in searching for qualified personnels (Kleinknecht, 1989). This study also reveals that firms with smaller size are significantly less informed about the public policy measurements designed at that time to alleviate the problems of firm innovation than their larger counterparts are. Offering a metaanalysis over 20 published studies, Damanpour (1992) indicates that the positive association between firm size and innovation, arguing that the greater input and output allow larger firm to accumulate more resources for catching the forefront technological development. Considering 300 manufacturing plants in Scotland, Love and Ashcroft (1999) also find out that plant size enhances innovation. On the opposite side, there are arguments showing that smaller firms are more technologically innovative. As Mintzberg (1979) states that innovation requires the cooperation of different parts of the organization, this cooperation could be more advantageous 11 to reach in smaller organization. Damanpour (1992) sets forth that comparing to the complexity of large firms, small firms possess better flexibility for adapting and improving, hence triggering the generation of innovation. Another possible consideration is that the performance as well as compensation of individuals in small firms is more firmly linked to the firm performance than in large firms, hence individuals, especially the engineers or scientists working in the smaller firms are more motivated than the ones working in the larger firms, resulting to more fruitful innovation. Size may also be related to change resistance (Hannan & Freeman, 1984). As organizations grow larger in size, they pay more attention to certainty, clear roles, and controllable and systematic process (Downs, 1967). Consequently, the probability of innovation occurrence declines with size. Size also affects the innovation capability of firm differently over different industries. A study conducted by Acs and Audretsh (1988), using data from the U.S. Small Business Administration, presents the relation between firm size and innovation varies over different industries. The group of large firms is more likely to be innovative than their small cohorts in some sectors, such as food, paper and rubber. In the other hands, small-firm innovative capability tends to better perform than their large cohorts in the industries that require higher volume of innovativeness, use high rate of skilled labor and have high rate of the large firms in the market, such as in the industries of manufacturing instruments, electronics or chemicals sector. Firm age The research on the relationship between firm innovation and the time firms present in the market is much more limited than the one between firm innovation and firm size. Along with firm size in terms of total employees in the workplace, firm age demonstrating the years in operations is a classic control variable in studies of innovation 12
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