Measuring Firm-Level Innovation Capability of Small and Medium Sized Enterprises with Composite Indicators (2013)

INTRODUCTION The series of discussions and empirical findings about the relation between innovative activities and firm performances recognize that innovative activities at the firm-level may contribute to productivity heterogeneity across firm sizes and industries to the extent that those are properly captured and measured (Crepon, Duguet and Mairesse, 1998; Hall, 2011). These results imply that the development of firm-level innovation capability may be of crucial importance when a firm intends to enlarge its competitive advantages or core competencies, thus long-term growth potential. Based on the results of numerous studies regarding the relation between innovation and firm performance, if innovation inputs and outputs or their combinations were to be represented by one (single or complex) indicator, one could have a useful way to measure a firm's potential to perform in the future given the revealed relation of innovation to firm performance. Then, the remaining task to measure the future growth potential of firm might boil down to how to measure whether a firm is more likely to be innovative (how much a firm invested in innovations or how much a firm would accomplish innovation in the future within a given period of time). To do this, a variety of indicators related to R&D have been established from the context of both government policy and a firm's own performance over a long period of time. These indicators, the most widely used measures of formal and creative activities to develop in-house innovation in the manufacturing sector, have some limitations for the following two reasons (Arundel, 2007): a firm has a diversity of characteristics of innovation, formal or informal, in modern knowledge-based economies that are not appropriately covered by only using R&D related indicators--the diffusion of developed knowledge, the feedback role of distributed knowledge to innovation etc., and the R&D effort measure is of limited use as an innovation indicator because it measures only innovation input and represents nothing about outputs (Kleinknecht, Van Monfort and Brouwer, 2002). In recent years, beyond R&D related indicators, a lot of single (partial) innovation measures such as the share of sales from products new to the firms or market, innovative sales per employee, etc. are being suggested to assess firm-level innovative activity and to rank firms or industries from the perspective of innovation. They are chosen to adequately capture various firm-level innovative activities and to represent how a firm is innovative based on the results of Community Innovation Survey (CIS)-typed innovation surveys (see Table 1). As Arundel and Hollanders (2005) also argued, however, those single (partial) indicators do not seem to fully account for the wider variation in innovative firms. In addition, they do not present complete picture of how innovative SMEs are in one industry and country, which may be misleading in international or inter-industry comparisons. The innovation process within a firm contains several characteristic features from the inputs such as R&D, learning by doing and organizational changes to development of new products followed by market exploitation. It is a so-called complex 'black box' which cannot be characterized or represented by any single indicator. The complexity of innovation within the domain of a firm makes it necessary to consider as much information as numerous innovation-related variables may represent so as to measure firm innovativeness. In this sense, the purpose of this study is to suggest adequate solutions to the following questions. Is there a simple and proper way to represent a variety of innovative activities and the corresponding innovation outputs with a 'composite' indicator from the perspective of ranking firms or industries? Why is the 'composite indicator' of interest and important? If a new indicator were to be suggested, can it be a substitute for the criterion used to evaluate the innovation capability of a firm, or at least, for the self-diagnosis tool for so-called 'innovative firms' adopted within OECD regions ? …