Innovative Strategies in response to Financial Crisis
This chapter can be seen as an introductory part of this bachelor thesis, since this chapter introduces the topic of this thesis: innovation. Innovation is an important issue for firm’s growth and competitiveness, and the aim of this thesis is to relates innovation to financial crisis and to discuss how to manage innovation strategy during a downturn. This first chapter gives an introduction and the problem statement together with research questions which will be answered further in this thesis.
1.2 Problem Indication
The world is fast becoming a complicated place to life. Ages ago we were working on the field and exchanging goods for other goods to survive. Lords, kings and other high class people had the opportunity to get luxury goods due to their position. Industrial revolutions made an end to this way of life. Today we are living’ in the third revolution which is affected by fast economic changes and has competitive characteristics. To gain competitive advantage, a company should continuously invest in innovation (Hamel, 2000; Almeida et al. 2009), and therefore innovation has an important leading role in today’s economy.
Innovation can be defined as the commercial or industrial application of something new, such as a new product or process, a new type of organization, a new source of supply or product market (O’Sullivan, 2006 & Schumpeter, 1996; 66). Innovative companies are those that have the ability to see connections, to spot opportunities and to take advantage of them. (Tidd & Bessant, 2009).
Innovation is an expensive process whose outcomes are uncertain (O’Sullivan, 2006). It is expensive as the innovation process requires resources which companies may not have and need to gain, also because it takes a lot of time before the benefits can be measured. In the meanwhile a lot of internal and external changes can arise which may affect the outcome. As not all the companies have internal financial possibilities, innovation can be financed with external finance. Today’s financial crises make investors more careful in choosing the investments with higher returns. In the case of innovative projects however, investors must be willing to take great risk even if there is no guaranty the innovation will be a breakthrough innovation (Crawford & Di Benedetto, 2008).
Financial crisis, which have become more frequent since 1970’s, are creating an unorthodox set of challenges for companies all over the world. According to Nielsen (2009): “Instead of dealing with the challenges of managing growth and expansion many companies are now faced with the challenge of maneuvering in a highly volatile competitive landscape characterized by increased uncertainty, increased turbulence, and a general downward trend in many aspects of the economy.”
The distinguishing feature of innovation has become crucial in today’s fast changing economy which suffers of financial crisis now and then. According to Fischer (2004), it is scholars’ liability to protect innocent countries and their citizens by mitigating the impact of financial crisis. To do so, this thesis will attempt to discuss how companies should manage their innovation strategies to keep their competitive advantage in response to financial crisis.
1.3 Problem statement
“A crisis, such as the financial crisis that we have been experiencing over the last couple of years, can be either an opportunity for important new innovation, or a time of setback when innovation is delayed, or even reversed” (Shiller, 2010; 14). How companies can manage their innovation strategy in times of financial crisis is a result of this thesis formulated by the following problem statement:
‘How can a company manage its innovation strategy to keep its competitive advantage in response to financial crisis?’
1.4 Research Questions
The problem statement covers several terms: innovation strategy, competitive advantage, and financial crisis. Before answering the problem statement, following research question based on the three terms will be answered:
Innovation strategy and competitive advantage
What is innovation and which innovation strategies lead to competitive advantage?
Financial markets and innovation strategy
How financial markets affect innovation and innovation strategies?
Financial crisis affect innovation strategies
How financial crisis affect innovation strategies in the long and short term?
1.5 Research Design and data collection
This bachelor thesis is based on a literature study and thence it has an objective descriptive character. Books and academic papers are the most used source of information for this thesis. Scientific literature, like journals and books (secondary sources), are the bases of this study. They have been collected from the Library of Tilburg University and the Library of Radboud University Nijmegen. Specifically journals are gathered by JSTOR, Abi/inform, Wiley, ScienceDirect, Web of Sience, Elsevier and more. The non-probability sampling procedure, known as the snowball method, has been used to separate the usable information from the unusable information.
The topic of this bachelor thesis is innovation and the sub topic has been designed at the moment enough knowledge and data was gathered to be useful for research. A result of this process is this research proposal, and can be seen as a start of the ongoing project.
1.6 Structure
This thesis will be structured in line with the three research questions, which are formulated before. The first chapter will briefly introduce the topic of this thesis, followed by the problem statement and research questions. The second chapter contains de definition of innovation and strategies that are characteristic for innovation related to competitive advantage. The third chapter will discuss how financial markets affect innovation and innovation strategies. The last research question will be discussed in chapter four. In the fourth chapter not only financial crisis and innovation will be discussed, but also how firms have reacted on different financial crisis in the past. The purpose of the final chapter is to answer the problem statement by given an overall conclusion, discussion and recommendations. In order to that, this chapter describes the impact of innovation strategies on the competitive performance of an industrial company during a financial crisis.
Chapter 2 Innovation strategy and competitive advantage
2.1 Introduction
Innovation is a beautiful thing that inspires a lot of people all around the world. The journey of innovation will be undertaken each time a company create something new and unique. Especially the last decades innovation has become a trend like the beat of the heart (Schumpeter, 1939). This chapter aims to briefly introduce the concept of innovation. In particular, this chapter will discuss the definition of innovation, innovation strategies, and how it is related to competitive advantage.
2.2 Innovation
Joseph A. Schumpeter was the first to recognize the role of innovation for economic growth and established a definition for innovation. He suggest: “The way in which quantity of products varies if quantities of factors vary. If, instead of quantities of factors, we vary the form of the function, we have an innovation.” (Schumpeter, 1939: 87). More simply defined, innovation is the commercialization of invention that leads to new production function (Grant, 2010).
New technological knowledge
New market knowledge
New technological knowledge
New market knowledge
As Schumpeter passed away 8 January 1950 he missed revolutions that characterized today’s economy. In order of that scientist argue that Schumpeter’s view on innovation misses elements that are imported today. Although, they all contain the essence of Schumpeter’s definition. Therefore, Schumpeter’s definition of innovation is suitable for this thesis.
According to the definition of innovation, Afuah (2003) designed a static model. According to the model (figure 2.1) innovation has two kinds of impacts on the firm, namely: economic and organizational implications. Thereby are economic implications (low cost, improved attributes, new attributes) are old products transformed into superior products, that make the product competitive again. In contrast, organizational implications has impact on companies capabilities and mostly exist of complete new knowledge to the company (Afuah, 2003).
New product
Low cost
Improved attributes
New attributes
Competences
and
assets
New technological knowledge
New market knowledge
Figure 2.1 Innovation: organizational and economic implications (Afuah, 2003)
These impact on companies can be translated to the innovation process of figure 2.2. According to Grant (2010) and Fagerberg (2006), invention must be seen as the creation and first step of innovation and innovation will be the commercialization of the invention. To create an invention novel applications of existing knowledge is needed and is the first step in Grants process of innovation. The second and third step are invention and innovation, which will be followed by the fourth step diffusion. Diffusion is two-sided, the supply side follows by imitation by competitors and the demand side consist of adoption by customers. At the end, this process of innovation repeats, therefore it can be seen as the journey of innovation (Cheng & Van de Ven, 1996).
Figure 2.2 Process of innovation (Grant, 2010: 298)
2.3 Innovation approaches
Innovation has an important role in today’s economy, but the ability, willingness and capabilities of innovation differs among each company’s strategic window. Grant (2010) suggest that a company could be a leader or a follower in innovation. Leaders are the pioneers of the innovation and followers are the ‘fast-second’ entrant who puts niche market into a mass market. It is not always logical that the leader will be the winner, since they can succumb to the high risk and uncertain outcomes of innovation. The examples of the instant camera illustrates that the leader company Polaroid was the winner of the innovation ‘instant camera’ (Teece, 1987). The pocket calculator is an example of follower winning, the innovator Bowmar has lay off over Texas Instruments (Markides, 1997). In fact, the leader is always responsible for the cost of pioneering.
Since innovation is an expensive process whose outcomes are uncertain (O’Sullivan, 2006), innovation relays on optimal timing. Therefore Grant (2010: 306-307) suggest three factors whereof the advantage of innovation leader depend, namely:
‘The extent to which innovation can be protected by property rights or lead-time advantages’;
‘The importance of complementary resources’;
‘the potential to establish a standard’.
These factors indicate the importance of having heterogeneous and immobile resources to gain advantage which is difficult to imitate by competitors (Barney, 1991). Accordingly, a company must have valuable, rare, imperfectly imitable and substitutability resources (Barney, 1991 & Grant, 1991). Zahra (1996) argues that a company needs to implement a successful innovation strategy to create an enduring competitive advantage. Therefore, the next paragraph discuss innovation strategy.
2.4 Innovation strategy
Innovation is critical in today’s fast-changing economy and therefore companies need to have a clear understanding of: “Who is going to be the customer? What products or services should we offer the chosen customer? How should we offer these products or services cost efficiently?” (Markides, 1997: 11). These questions are the three basic issues where companies should deal of at strategic level. The understanding of company’s strategic level leads to a deliberate choice of the innovation strategy.
Innovation strategy can be defined as the plan that guide company’s decisions (Zahra, 1996) to offer new products or services (Afuah, 2003). The best fitting strategy differs among companies, there are in fact many typologies of innovation strategies (Hadjimanolis & Dickson, 2000). Freeman (1978) proposes a classification of innovation strategies. The six typologies of Freeman are defined in table 2.1.
Innovation strategy
Explanation
Offensive
Companies with an offensive strategy wants to stay on top of the market and are willing to take high risks by investing in the innovation and gain the capabilities needed.
Defensive
Companies with a defensive strategy are willing to take low risk and waits for a competitor with an offensive strategy launch their innovation, which they can re-use, re-contextualize, and re-combination.
Imitative
Companies with an imitative strategy are willing to take low risk and look for low-cost capabilities. They would like to produce an imitation of innovation from offensive strategies before the originator can succeed.
Dependent
Companies with a dependent strategy just innovate on customers request and are therefore not willing to take high risk.
Traditional
Companies with a traditional strategy are not willing to innovate or re-contextualize. They prefer to do less changes by existing innovation.
Opportunistic
Companies with an opportunistic strategy are looking for niche markets with unique needs ready for innovation.
Table 2.1 Freeman’s six typologies of innovation strategy adaptet from Freeman & Soete, 1997; Afuah, 2003 & Nielsen, 2009
A fundamental issue in each innovation strategy is the implementation of it and can even be seen as the most basic role of operations (Slack et al., 2010). Without effective implementation of the innovation strategy, the strategy will be ineffective and the innovation will be a failure. Preventing a company of this failure the five Ps of operations strategy can be leading by the implementation of the innovation strategy. According to Slack et al. (2010) the five Ps are: purpose, point of entry, process, project management, and participation. These Ps formulate that the complete company’s willingness, control, timing, and sharpness lead to successful implementation of the innovation strategy.
Beside these five Ps, Grant (2010) suggest alternative strategies of exploiting company’s innovation. These alternative strategies show that companies can exploit innovation on their one or by collaboration with other companies. Figure 2.3 layout these alternative strategies by risk and return, resource requirements and examples.
Figure 2.3 Alternative strategies for exploiting innovation (Grant, 2010: 305)
The choice of one of these alternative strategies depends on the characteristics of the innovation and the resources and capabilities. For example, companies are unfamiliar with the innovation and don’t have all resources needed. In that case, companies should look outside their company for help (Afuah, 2003). Strategic alliance, joint venture and internal commercialization are forms of looking outside company’s boundaries. Internal commercialization is about creating complete new enterprises or business units (Grant, 2010). Joint ventures and strategic alliances are willing to share their resources with others within the ventures or alliances. Gulati (1998: 293) defines ‘strategic alliances as voluntary arrangements between firms involving exchange, sharing, or codevelopment of products, technologies, or services’ and suggest that the creation of an alliance is a preferable strategic conduct. These collaboration need to be based on trust between employees and companies, it’s not about company’s own benefit but the joint benefit that comes first (Uzzi, 1997). Both, Gulati (1998) and Uzzi (1997), suggest that the willingness of sharing knowledge and learning from the social network, that will be created by joint ventures and strategic alliances, would be important for understanding company’s strategic level and their innovation success.
2.6 Innovation strategy related to competitive advantage
The advantage of innovation can be of great important to a company, especially according to Almeida et al. (2009) who suggest constant innovation is the key to survival in today’s fast-changing economy. In case of successful innovation a company creates value which can lead to competitive advantage. Competitive advantage is defined by Grant (2010: 211) as follow: “when two or more company’s compete within the same market, one company possesses a competitive advantage over its rivals when it earns (or has the potential to earn) a persistently higher rate of profit.” In order of that, company’s innovation strategy should create unique value that is difficult to implement by competitors (Barney, 1991). Therefore, competitive advantage causes the company a dominate position in their industry that need to be isolated till the time competitors imitate the innovation (Cantwell, 2006).
According to Grant (2010) the sources of competitive advantage are cost advantage and differentiation advantage. In terms of leader and follower, cost advantage will be chosen by the follower who offers lower prices and differentiation advantage is about offering unique products that is valuable to the customer. Grant (2010) refers to Porters generic strategies: cost leadership, differentiation and focus. Porter’s first two strategies are related to the two advantage of Grant. Porter’s focus strategy will be chosen by companies who are ‘stuck in the middle’, they don’t know if they want to become a leader or follower. According to Porter (1980), focus strategy leads guarantees low profitability and is not recommended to companies with ambition having competitive advantage. Dess & Davis’s (1984) field study confirms that competitive companies should focus only on porter’s differentiation and cost leadership strategies.
Leaders who choose the differentiation advantage and porter’s differentiation strategy often choose the innovation strategy offensive and opportunistic, since these innovation strategies are looking for value creation within existing and niche markets (Afuah, 2003). The leader will gain at first competitive advantage although the follower with cost leadership strategy will take advantage on the leader afterwards (Markides, 1997), since followers imitate and re-use leaders innovation. Therefore, the journey of innovation and companies strategic level is always changing especially in today’s fast-changing economy.
2.7 Conclusion
This chapter is designed to answer the following research question:
What is innovation and which strategies are characteristic for innovation when it is related to competitive advantage?
Innovation is the commercialization of invention that lead new production function. The first step of the innovation process prefers a clear understanding of the economic and organizational implication, which is the basic knowledge of a company. This knowledge can lead to an idea which can become an invention. Implementing the invention successfully could lead to an innovation. the company’s value created by the innovation gains competitive advantage.
The willingness, sharp and optimal timing of innovation will be effective by choosing the best fitting innovation strategy. Leaders of innovation are willing to take high risk to stay on top of the market and looking for niche markets. Offensive and opportunistic innovation strategies combined with Porter’s differentiation strategy guarantee leaders to be competitive and obtain competitive advantage. Although, followers could take advantage of leaders innovation before leaders pioneering cost are recovered. Followers are cost leaders with defensive and imitative innovation strategies. In case, followers take advantage on leaders, leaders will lose their competitive. Alternative strategies like joint venture and strategic alliances could isolate competitive advantage long-term, since the innovation process preformed faster. Also heterogeneous and immobile resources could obtain long-term competitive advantage.
Chapter 3 Financial markets and innovation
3.1 Introduction
The chapters before indicates innovation as a key aspect in today’s competitive economy. In other words, companies need to be unique, sharp, and willing to take risks to get along in their fast-developing markets (Tidd & Bessant, 2009). Developing an innovative idea is not necessarily the hardest part of innovation, as financing it may be an even greater challenge. This chapter discuss the role of financial markets affect innovation strategies.
3.2 Financial system
As mentioned in the previous chapters, innovation is a key of survival in today’s fast-changing economy. Willing to innovate, sharp invention and optimal timing are depending on heterogeneous and immobile resources that obtain long-term competitive advantage (Barney, 1991). Besides this, companies competitive advantage obtained by innovation make financial slack a strategic priority (O’Brien, 2003). “Failing to maintain sufficient financial slack can seriously inhibit a firm’s ability to successfully implement a strategy premised on innovation” (O’Brien, 2003: 416).
There are two ways of financing innovation, namely internal and external financing. Several scientist argue that internal financing has the priority in financing innovation (Schumpeter, 1939; O’Sullivan, 2006; Hall, 2005 and Himmelberg & Petersen, 1994). Especially since information asymmetries and moral hazard exist between companies who supply external finance (Himmelberg & Petersen, 1994). Unfortunately internal finance is not always possibly, because of financial instability or lack of liquidity. Explicitly when companies prefer large R&D intensity to be a leader in innovation (O’Brien, 2003), internal finance will not be capable enough to finance the innovation.. Large R&D intensity depends on the capability of resources, since innovation commonly rely on new knowledge companies should expand their resources.
External financing rely on financial markets. Financial markets include money markets, bond markets, and equity markets. Within this market people trade money to gain more out of their investment. Also financial intermediaries play an important role in funding innovative projects. Financial intermediaries are institutions that invest in short and long assets and are based on risk-sharing perspective (Allen & Gale, 2003). For both financial markets and financial intermediaries, financing innovation has important implications as innovation has high risk and uncertain outcomes.
3.3 High risk and uncertain outcomes
Uncertainty and risk lies within the process of knowledge (Tidd & Bessant, 2009 & Hall, 2005), especially since it is the first step of the innovation process (Grant, 2010). In this sense, knowledge is the knowhow of inventing new goods and services (Hall, 2005). Hall (2005) suggest that knowledge cannot be kept secret, mainly since financing innovation consist of external finance. Convincing investors and financiers of the innovative projects depends on outlining the concept, the more they know the chance of leaking knowledge to competitors rise (Thakor, 1996). Therefore, Tidd & Bessant (2009) prefer to make a series of stepwise decisions translated into the innovation funnel. The first step outlines the concept, the second step gives an detailed design, the third step will test the innovation, and the last step launches the innovation to the customer. Every step commits more resources and steps can only be taken at times the previous step has been completed. These steps must be seen as spreading risk and investing and turns uncertainty into well-calculated decisions taken by the innovative company, the investors and the financiers.
3.4 Innovation and capital structure
Inventing some new idea isn’t that difficult, but being an effective innovator requires getting innovative projects to the marketplace (O, Brien, 2003). Therefore, financial slack is an important element of effective implementing a strategy based on innovation.
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3.5 Venture capital, Angel investing & seed funding
Complete new companies are not interesting enough to get funding out of the financial system as they haven’t any security to relay on. In that case funds like venture capital, angel investing and seed funding could be contacted to obtain important external resource (Parhankangas & Landström, 2006). These funds have been setup by private investors to help new companies financially to start the business. These funds are a helping hand by reaching the state of funding itself or creating value to negotiate again with funders like financial intermediaries or financial markets. Because of these funds young ambitions companies with an innovative project could startup and reach the top of first movers. Despite of the benefit, the contract details are not that good for the inventor. Parhankangas & Landström (2006) suggest disagreement, incompetence, shrinking, and opportunism as four sources of disappointments that could affect the investor-inventor relationship importantly. Hall (2005) refers in his article to the research of Kaplan and Stromberg who examined 200 venture capital contract and compared them with the economic theory of financial contracting. “They find that the contracts often provide for separate allocation of cash flow rights, control rights, voting rights, board positions, and liquidation rights, and that the rights are frequently contingent on performance measures.” (Hall, 2005; 23). If the performance is poor and shows no willingness to improve, funders of the venture capital take over the firm.
3.6 Financial system effect on innovation
In today’s fast changing economy companies begin to realize that is needed to analyze their own past efforts and try to predict their future. According to Crawford & Di Benedetto (2008), companies should regularly study their most recent new products and services, by looking at the financial methods, forecast, and outcomes. Unfortunately, studies cannot order out risk and uncertain outcomes of innovative projects, but it can indicate and lower their effects. The findings by these studies can rise argues that could be important by obtaining finance.
Internal finance will be the best option to O’Sullivan (2006), as it is less expensive and would make a company more stable and independent. Another reason for internal financing is given by O’Brien (2003: 416): “Cost of financial distress are one pitfall to debt financing”. Although, obtaining internal finance is not possible for every innovative project, especially for small and young companies.
Thakor (1996) has identified reputations, willingness, and security options as thoughts of borrowers to decide which source of credit to use. The major concern of external financing lies In the first stage of innovative projects. In this stage it is important not to leak any information to competitors. Financing obtained by financial markets faces a greater probability of leaks.
Major changes in the financial system could affect innovation at the field of financing negatively. These financing outcome are not only related to the financial system, but also to the legal restrictions of a country or continent. Moreover, “the component of financial development explained by the legal rights of outside investors and the efficiency of the legal system in enforcing those rights is strongly and positively linked with long-run growth” (Levine, 2002; 23).
3.7 Conclusion
This chapter is designed to answer the following research question:
How financial markets affect innovation and innovation strategies?
The twentieth century is characterized by a lot of changes, which dramatically changed the financial markets and system. These changes caused positive and negative effects at economic development, growth and safety. Obtaining finance for innovative projects has become difficult, both from the side of lenders and borrowers since they are skeptic of the future. According to Mishkin (2001) financial markets should use financial systems to make accurate judgments about which innovation will be creditworthy. Analyzing innovative projects by the reason of efficiency, financial stability and financial structure are therefore recommended by Allen et al. (2006).
Finance for innovative projects can be obtained internal or external. Internal looks like the best option in times of instability, but not every company can fund the project internal. External finance can be obtained by financial intermediaries or financial markets. Both have important implications as innovation has high risk and uncertain outcomes. To prevent proprietary information of the project to leak to competitors, financial intermediaries should be chosen by obtaining external finance.
The innovative objectives of Nielsen (2009) identify first mover, consolidator, applicator, and imitator. All of these objectives are eligible to obtain external finance by financial intermediaries, in contrast of financial markets who only fund short-term investment. Therefore, applicators and imitators could obtain external finance of financial markets. New companies do not often obtain external finance of financial system, they could rely on funds like venture capital, angel investing, and seed funding. It’s important to understand that all types of external finance could end like a disaster in case of breach of contract.
Chapter 4 Financial crisis affect innovation strategies
4.1 Introduction
According to Nielsen (2009), the current financial crisis makes it necessary for companies to rethink their innovation strategies to survive in this instable economy. Therefore, this chapter will discuss how financial crisis affect innovation strategies both in long and in short run.
4.2 Financial crisis
The term ‘financial crisis’ is a definition with reference to different situations in time. To illustrate, a financial crisis can be a liquidity crisis, bank panics, and stock market crashes. Given the purpose of this thesis, we intend as financial crisis: (1) financial crisis in general and (2) banking crisis
