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Innovation and Training in New Firms

January 2001

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RePEc

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Statistics Canada

Recent studies have demonstrated the quantitative importance of entry, exit, growth and decline in the industrial population. It is this turnover that rewards innovative activity and contributes to productivity growth.While the size of the entry population is impressive - especially when cumulated over time - the importance of entry is ultimately due to its impact on innovation in the economy. Experimentation is important in a dynamic, market-based economy. A key part of the experimentation comes from entrants. New entrepreneurs constantly offer consumers new products both in terms of the basic good and the level of service that accompanies it. This experimentation is associated with significant costs since many entrants fail. Young firms are most at risk of failure; data drawn from a longitudinal file of Canadian entrants in both the goods and service sectors show that over half the new firms that fail do so in the first two years of life. Life is short for the majority of entrants. Only 1 in 5 new firms survive to their tenth birthday. Since so many entrants fall by the wayside, it is of inherent interest to understand the conditions that are associated with success, the conditions that allow the potential in new entrepreneurs to come to fruition. The success of an entrant is due to its choosing the correct combination of strategies and activities. To understand how these capabilities contribute to growth, it is necessary to study how the performance of entrants relates to differences in strategies and pursued activities.This paper describes the environment and the characteristics of entrants that manage to survive and grow. In doing so, it focuses on two issues. The first is the innovativeness of entrants and the extent to which their growth depends on their innovativeness. The second is to outline how the stress on worker skills, which is partially related to training, complements innovation and contributes to growth.

Entrants' Perceptions About Their Industry Environment

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. Correlation between Skill Characteristics and Innovation/Technology Variables

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Percentage of Entrants Reporting Intense Industry Competition

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. Correlation between Skill Characteristics and Innovation/Technology Variables

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Innovators' and Noninnovators' Perceptions of Industry Risk

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Figures - uploaded by John R. Baldwin

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Content uploaded by John R. Baldwin

Content may be subject to copyright.

Innovation and Training in New Firms

John Baldwin

No. 123

11F0019MPE No. 123

ISSN: 1200-5223

ISBN: 0-660-18314-5

Micro-Economic Analysis Division

Statistics Canada

24th floor, R.H. Coats Bldg.

Ottawa, K1A 0T6

(613) 951-8588

baldjoh@statcan.ca

October, 2000

This paper was presented to a conference devoted to “Assessing the Impact of Training on the

Performance of Small and Medium Sized Enterprises” held jointly by the Centre for Business

Research, University of Cambridge and the Centre for Small and Medium Sized Enterprises,

University of Warwick, March 1998.

This paper represents the views of the author and does not necessarily reflect the opinions of

Statistics Canada.

Aussi disponible en français

Analytical Studies Branch – Research Paper Series - iii - Statistics Canada No. 11F0019MPE No. 123

Table of Contents

ABSTRACT................................................................................................................................................................ V

ACKNOWLEDGEMENTS.................................................................................................................................... VII

1. INTRODUCTION.................................................................................................................................................. 1

2. THE SURVEY OF ENTRANTS........................................................................................................................... 3

3. A PROFILE OF ENTRANTS............................................................................................................................... 5

3.1 THE COMPETITIVE ENVIRONMENT ...................................................................................................................... 5

3.2 THE FOCUS OF ENTRANTS................................................................................................................................... 8

4. ENTRANTS AND HUMAN RESOURCE STRATEGIES...............................................................................11

5. INNOVATION AND ENTRANTS..................................................................................................................... 13

5.1 INNOVATIVE COMPETENCIES.............................................................................................................................14

5.2 TECHNOLOGICAL COMPETENCIES .....................................................................................................................16

5.3 COMPREHENSIVENESS OF INNOVATION IN THE ENTRANT POPULATION............................................................. 16

6. INNOVATION AND HUMAN CAPITAL ........................................................................................................19

6.1 INDUSTRY DIFFERENCES IN INNOVATION, TECHNOLOGY AND FIRMS’ EMPHASES ON SKILLED LABOUR .......... 19

7. GROWTH OF ENTRANTS AND THE IMPORTANCE OF INNOVATION...............................................23

7.1 GROWTH DIFFERENCES ACROSS ALL MARKETS ............................................................................................... 23

7.2 GROWTH DIFFERENCES IN NEW AND MATURE MARKETS ................................................................................. 27

8. THE JOINT EFFECT OF INNOVATION, TECHNOLOGICAL AND SKILL COMPETENCIES ON

GROWTH.................................................................................................................................................................. 32

9. CONCLUSION......................................................................................................................................................36

REFERENCES.......................................................................................................................................................... 37

Analytical Studies Branch – Research Paper Series - v - Statistics Canada No. 11F0019MPE No. 123

Abstract

Recent studies have demonstrated the quantitative importance of entry, exit, growth and decline

in the industrial population. It is this turnover that rewards innovative activity and contributes to

productivity growth.

While the size of the entry population is impressive—especially when cumulated over time—the

importance of entry is ultimately due to its impact on innovation in the economy.

Experimentation is important in a dynamic, market-based economy. A key part of the

experimentation comes from entrants. New entrepreneurs constantly offer consumers new

products—both in terms of the basic good and the level of service that accompanies it.

This experimentation is associated with significant costs since many entrants fail. Young firms

are most at risk of failure; data drawn from a longitudinal file of Canadian entrants in both the

goods and service sectors show that over half the new firms that fail do so in the first two years

of life. Life is short for the majority of entrants. Only 1 in 5 new firms survive to their tenth

birthday.

Since so many entrants fall by the wayside, it is of inherent interest to understand the conditions

that are associated with success, the conditions that allow the potential in new entrepreneurs to

come to fruition. The success of an entrant is due to its choosing the correct combination of

strategies and activities. To understand how these capabilities contribute to growth, it is

necessary to study how the performance of entrants relates to differences in strategies and

pursued activities.

This paper describes the environment and the characteristics of entrants that manage to survive

and grow. In doing so, it focuses on two issues. The first is the innovativeness of entrants and the

extent to which their growth depends on their innovativeness. The second is to outline how the

stress on worker skills, which is partially related to training, complements innovation and

contributes to growth.

Keywords: innovation, training

Analytical Studies Branch – Research Paper Series - vii - Statistics Canada No. 11F0019MPE No. 123

Acknowledgements

I am indebted to Joanne Johnson who assisted me with the entry survey that formed the basis of

the data used in this paper and to Daniel Stripinis and Bob Gibson who assisted with the

tabulations used herein.

Analytical Studies Branch – Research Paper Series - 1 - Statistics Canada No. 11F0019MPE No. 123

1. Introduction

Recent studies have demonstrated the quantitative importance of entry, exit, growth and decline

in the industrial population.1 It is this turnover that rewards innovative activity and contributes to

productivity growth.

The importance of entry can be gauged in the first instance by its size. The annual entry rates for

the manufacturing sector (defined as the employment in entrants divided by total employment)

from 1972 to 1986 averaged about 1.9% for the United States and 2.4% for Canada (Baldwin,

Dunne, and Haltiwanger, 1995, p. 127). When calculated over five-year periods (1972-77, and

1977-82), the US average across two-digit industries was 11.3%, while the Canadian was 10.9%

(Baldwin, Dunne, and Haltiwanger, 1995, p. 137).

These rates need to be set in context. Entry is not the only process that causes turnover in the firm

population. Growth and decline also occur in the incumbent population. The amount of market

share transferred from all declining to all growing firms (including both exits and entry) in a

typical Canadian manufacturing industry over a decade ranges between 30% and 40% (Baldwin,

1995).

A significant part of this turnover comes from the entry and exit of firms. At any point in time,

the population can be divided into those that grow and those that decline. Job turnover is the sum

of all employment increases in those growing (job growth) and the sum of the change in

employment in those declining (job loss). The importance of entry and exit can be calculated as

the share of job growth that is accounted for by entry, or the share of job decline that is accounted

for by exit. When this is done using comparable manufacturing databases for Canada and the

United States, the results are quite similar. For year to year changes from 1970 to 1985, job

creation due to entry in the United States averaged 21% of the total job increase; in Canada, it

averaged 27%; (Baldwin, Dunne and Haltiwanger, 1995, p. 126). Calculated over two

comparable five-year periods (1972-77, 1977-82), entry accounted for 44% in the United States

and 45% in Canada. As the length of period over which the importance of entry is calculated,

entry becomes relatively more important.

While the size of the entry population is impressive—especially when cumulated over time—the

importance of entry is ultimately due to its impact on innovation in the economy.

Experimentation is important in a dynamic, market-based economy. A key part of the

experimentation comes from entrants. New entrepreneurs constantly offer consumers new

products—both in terms of the basic good and the level of service that accompanies it.

By doing so, new firms provide an important stimulus to the industrial population. A few small

entrants grow to become the new dynamos of the industrial system. Others remain relatively

small but provide an important source of innovation in the small-firm sector—especially when it

comes to quality differentiation. Smaller firms excel in their ability to provide quality and

1 See Baldwin (1995).

Analytical Studies Branch – Research Paper Series - 2 - Statistics Canada No. 11F0019MPE No. 123

flexibility of service (Baldwin et al., 1994). Small firms are constantly changing their product

offerings—with respect to both types of products and services offered. Small firms are adept at

ascertaining changing consumer tastes with regards to the amount of services that are bundled

with a product, or being flexible with regards to other aspects of the product offering. New small

firms that are better able to sense consumer requirements are constantly replacing other small

firms that are less able to do so (Baldwin, 1995). One manifestation of the success of small

entrants is their tendency to pay higher wages and to be more productive than those firms that

they force out of the market (Baldwin, 1995; 1996). It is the process of entry and exit that

generates information on which combinations of products and services best satisfy consumer

tastes.

This experimentation is associated with significant costs since many entrants fail. Young firms

are most at risk of failure; data drawn from a longitudinal file of Canadian entrants in both the

goods and service sectors show that over half the new firms that fail do so in the first two years

of life.2 Life is short for the majority of entrants. Only 1 in 5 new firms survive to their tenth

birthday.3

These failures involve a cost—both in human and financial terms. Failure is accompanied by the

expenditure of both dollars and time on the part of new entrepreneurs. This is the investment that

the market economy makes while experimenting in finding the new and improved goods and

services that consumers want. It can also be regarded as an investment in managerial experience,

because some entrepreneurs who fail will learn from their experiences and go on to found other

new businesses that eventually succeed. These resources should not be regarded as wasted—

anymore than the resources that are expended on obtaining information in a world of imperfect

information are wasted. Failures are an investment that society makes in the dynamic competitive

process.

Since so many entrants fall by the wayside, it is of inherent interest to understand the conditions

that are associated with success, the conditions that allow the potential in new entrepreneurs to

come to fruition. The success of an entrant is due to its choosing the correct combination of

strategies and activities. To understand how these capabilities contribute to growth, it is

necessary to study how the performance of entrants relates to differences in strategies and

pursued activities.

The objective of this paper is to describe the environment and the characteristics of entrants that

manage to survive and grow.4 In doing so, it focuses on two issues. The first is the

innovativeness of entrants and the extent to which their growth depends on their innovativeness.

The second is to outline how the stress on worker skills, which is partially related to training,

complements innovation and contributes to growth.

2 See Baldwin and Johnson (1999).

3 See Baldwin, Bian, Dupuy and Gellatly (2000).

4 See Baldwin, T. Gray et al. (1997) for a study of the characteristics of new firms that are associated with exit.

Analytical Studies Branch – Research Paper Series - 3 - Statistics Canada No. 11F0019MPE No. 123

2. The Survey of Entrants

The development of longitudinal databases on exit and entry have allowed us to better estimate

the amount of entry taking place and to determine that this aspect of turnover shifts significant

amounts of market share and changes the identity of market participants. But the longitudinal

databases derived from administrative records do not contain very rich descriptions of the

participants. Survey data has to be developed if we are to better understand the underlying

characteristics of entrants—their competencies not only with regard to innovation but also in

such areas as human resource development, marketing, and management; their financial

structure, their training activities and how this relates to innovation. When survey data are

developed and linked to longitudinal data on firm performance, such as sales or profitability,

differences in competencies that are related to performance differences can be outlined. Here we

use a survey of entrants to outline the type of environment that entrants face and the connection

between growth, innovation and associated competencies that innovative firms develop.

We make use of firm-level data on entrants to examine the nature of their innovative capabilities.

The firm-level data are taken from The Survey of Operating and Financing Practices of entrants

performed by Statistics Canada. The focus on new firms permits us to examine the innovative

capabilities of entrants as opposed to small firms in general. The richness of the survey database

allows both output and input-based measures of innovation, technological and skill-based

competencies of smaller firms to be developed.

The survey focused on new entrants that emerged from their early childhood and survived to their

early teen years. In light of the high death rate of new firms, these are the more successful

entrants. The frame consisted of all entrants to the commercial sector (both goods and services)

in the period 1983-86 that survived to 1993; the survey was conducted in 1996. The sample

included 3,991 firms from both the goods and services sector. The response rate to the survey

was 80%.

The survey provides a broad overview of the financing and operating practices of entrants. The

questionnaire contains information on 1) management—the extent of managerial and industry

experience and the degree of ownership in the firm 2) the nature of the competitive

environment—whether products quickly become obsolete, whether production technology

changes rapidly, whether the threat of new entry is high 3) the firm’s competencies in the area of

management, technology, human resources, financing, marketing and production, with special

attention paid to various facets of competencies in each area 4) the extent of financial planning 5)

the importance of investment in R&D, technology, and training 6) whether the firm engaged in

formal training and 7) the manner by which various activities were financed.

While the entrant survey offers a wide and varied set of questions that can be used to gauge the

technological prowess of entrants, there are potential problems that should be addressed. First,

many of the questions are subjective. The potential problems with subjective questions are well

known. The most important is that subjective questions dealing with subjects that are inherently

difficult to evaluate or out of the range of a respondent’s experience provide information that is

Analytical Studies Branch – Research Paper Series - 4 - Statistics Canada No. 11F0019MPE No. 123

unreliable. The classic example is a question that asks subjects to rank various shades of blue by

their ‘blueness’ or asks someone to rank their abilities to perform a task with which they are

unfamiliar.

Although many of the questions of this survey are subjective, they fall within the range of

experience of the managers of new firms. The questions that deal with the magnitude of

competitive forces and importance of competencies in various areas are all questions that

business managers ask themselves on an ongoing basis. Competitive forces require firms to

compare themselves against their competitors. The practice of benchmarking, for instance, has

led many firms to assess themselves against industry leaders on a continuous basis.

In order to minimize ambiguity, the questions in the survey were all tested extensively with

survey managers. Some questions were taken from previous surveys. The survey also addressed

the subjectivity problem by including objective measures of activity in areas where it was

feasible. The inclusion of parallel questions on activity provides an independent check on the

validity of the answers to the subjective questions. Answers to the question about the emphasis

given to R&D can be compared to answers regarding the percentage of investment devoted to

R&D. Answers to the question about the emphasis given to training can be compared to answers

regarding whether training is done. When these comparisons are made, the subjective valuation

given by a firm to an activity and the probability that an action is undertaken are found to be

closely related.

Another potential problem arises in business surveys when respondents taken from different

areas in a company have different views of the importance being given to different strategies.

This is a particular problem when the views being solicited deal with prescriptive issues—what

should be done (as opposed to a recollection of actual events), or what emphasis has been given

in the past to these issues. Since The Survey of Operating and Financial Practices of Entrants

focuses on the latter set of questions, the potential for this problem with the data is lessened.

There is a second reason for arguing that this is a relatively unimportant problem with the survey.

Although information loss in a large company may result in some senior personnel not fully

appreciating the directions that the firm is taking, the survey being used here focuses on smaller

firms, where all senior personnel are close to ongoing events. Since the survey was usually filled

in by senior management, variability of responses across individuals is likely to be less of a

problem.

Finally, there are other issues related to the nature of measurement that derives from an ordinal

Likert scale. The measurement issue is handled here by using the extreme score measure (the

percentage of firms scoring 4 and 5 on the five-point scale) to capture all firms that assessed

themselves as higher than the median category. This gives a robust measure of the percentage of

firms that felt they were above the midpoint of the distribution of scores that was given to

them—but does not worry about distinctions above this point.

The survey data, by itself, provides a profile of the broad strategies of entrants—the marketing

and production strategies that they pursue, the innovations that they introduce and the training

activities of the firm. It is linked to administrative data on sales, assets, and the wage bill of each

Analytical Studies Branch – Research Paper Series - 5 - Statistics Canada No. 11F0019MPE No. 123

firm since birth. In doing so, we develop objective measures of performance by which the sample

can be divided so as to investigate the strategies that are associated with success. For the purpose

of this paper, performance is measured in terms of growth of output. The growth rate is measured

as the compound rate of growth in sales from the first year after birth to 1993.

3. A Profile of Entrants

This section of the paper begins the process of describing the strategies that the select group of

entrants who survive to their early teen years pursue. It will outline the product, marketing, and

production strategies that are given the most emphasis. In later sections, we turn to the emphasis

that is placed on worker skills, the importance of innovation and technology and finally how both

affect the growth prospects of entrants. But first we describe the competitive environment that

conditions the activities that entrants pursue.

3.1 The Competitive Environment

The competitive environment that new entrants face affects the skills required for survival and

growth. Competition has many dimensions: it depends on the type of rivals an entrant faces, the

pressures placed upon it by buyers and suppliers, and the rapidity of changes in products and

technology.

The type of competition in an industry is partially determined by the maturity of the market.

Industries vary by the stage of development of the market for their primary product. The

introductory stage consists of those markets where the product demand is just starting to grow,

but the product is unknown to many potential users; the growth stage occurs when product

demand is growing and the product is becoming familiar to many potential users; the maturity

stage is when product demand growth is slowing and the product is familiar to most potential

users; finally post-maturity occurs when no growth in product demand occurs and there are few

potential new users. The stage of the product is expected to influence the firm because previous

work (Gort and Klepper, 1982) suggests that early stages in the product lifecycle involve a high

degree of uncertainty. Product and technological innovations follow one another in quick

succession. In later phases, the types of problems that a firm faces change. Reducing production

costs via technological change becomes more important.

Despite the fact that successful entrants are new, they generally serve mature markets. While

29% of successful entrants are in a growing product market, 50% are in mature markets.

Moreover, a greater percentage is in the post-maturity phase (18%) than the introductory phase

(3%). As the lifecycle model would have predicted, successful entrants as a whole reported more

rapid technological than product obsolescence. When asked to indicate if they felt that products

quickly become obsolete and production technology changes rapidly in their industry, only 24%

Analytical Studies Branch – Research Paper Series - 6 - Statistics Canada No. 11F0019MPE No. 123

of entrants felt that product obsolescence was rapid in their industry5 (Figure 1). Yet, 45% said

production technology changed rapidly.

The number of competitors also serves as a measure of the amount of competition that entrants

face. About 40% face between 5 and 19 competitors. Another 38% compete with over 20 firms.

However, the number of competitors is only a rough proxy for competitiveness; firms face

competition from potential as well as existing competitors. Even when the number of

competitors is small, rivalry can be intense.6 In order to gauge the intensity of competition,

entrants were asked if they disagreed or agreed with two propositions 1) that the threat of entry

was high, and 2) that their competitors’ actions were predictable. Most entrants (41%) felt their

competitors’ actions were easy to predict. However, some 61% of entrants felt that threats from

entry were high (Figure 1).

Customer relations also affect the nature of the competitive environment. Firms with only one

customer face uncertainty due to bilateral bargaining and the loss of the customer. Firms with

few repeat customers cannot build customer loyalty. Neither factor is very important for

successful entrants. Over half obtain less than 10% of their revenue from one customer and over

two-thirds of their customers are repeat customers.

Uncertainty also arises when consumer demand is difficult to predict and/or consumers can easily

substitute among competing products. The ease of substitutability represents the largest source of

uncertainty for entrants, as almost 60% of these firms felt consumers could easily substitute

competing products (Figure 1)7. Unpredictability of consumer demand was less of a problem;

just 40% of successful entrants rated this hard to predict.8

The competitive environment that successful entrants face is also affected by the nature of

product competition. Entrants ranked competition in their industry on a scale of 1 (low) to 5

(high) in seven areas—price, customer service, quality, and flexibility in responding to

customers, product range, product customization, and the frequency of introducing

new/improved products. The percentage of successful entrants that ranked each area as highly

competitive (4 or 5) is plotted in Figure 2. In keeping with their occupying mainly mature

markets, successful entrants report that competition in their industry is greatest with respect to

price, customer service and quality. In contrast, factors that mark growth industries—

customization or introducing new products—are less important.

5 That is, they scored 3, 4 or 5 on a scale of 1 to 5.

6 See Baldwin (1995) for data that show that the intensity of competition, as measured by market share turnover, is

not closely related to concentration.

7 That is, they ranked this possibility with a 3, 4 or 5.

8 Ibid.

Analytical Studies Branch – Research Paper Series - 7 - Statistics Canada No. 11F0019MPE No. 123

Figure 1. Entrants’ Perceptions About Their Industry Environment

Competitors are predictable

010203040506070

percent of firms

Threat of entry high

Product changes rapidly

Technology changes rapidly

Demand is unpredictable

Consumer s can easily subst itute

Agree

Disagree

Figure 2. Percentage of Entrants Reporting Intense Industry Competition

01020304050607080

ercent of firms

Price

Customer Service

Quality

Flexibi lity in r esponding to

customers

Product range

Product customizatio

Introducing new/improved

products

Figure 3. Innovators' and Noninnovators' Perceptions of Industry Risk

ew entrants are a constant threat

Liquidation value below purchase

Technology changes rapidly

Demand is unpredictable

Competitors can easily substitute

among suppliers

Competitors are unpredictable

Products quickly become obsolete

Consumers cannot easily substitute

0 10203040506070

% of firms that agree

Innovators

on-innovators

Analytical Studies Branch – Research Paper Series - 8 - Statistics Canada No. 11F0019MPE No. 123

Do innovators face a quieter environment than non-innovators? Is innovation in the small-firm

segment encouraged by concentrated market structures? The lifecycle model of entry offered by

Abernathy and Utterbach (1978) or by Gort and Klepper (1982) would suggest that innovative

entrants generally should be found in highly fluid, highly competitive situations.

In order to examine this issue, entrants are defined to be innovative if they are introducing new

products or processes; then differences between entrants that are introducing new products and

processes and those that are not doing so are examined.

How does the competitive environment of innovators differ from non-innovators? First,

innovating successful entrants face more competitors; only three-quarters of non-innovative

entrants face more than four competitors, compared to 87% of innovators.

Second, innovators are generally found in segments of industries where certain key aspects of

competition focus on innovation. When the perceptions of innovators and non-innovators about

the nature of competition that they face are compared (Figure 3), it is clear that changes that are

related to innovation are far more intense in the innovators’ industries. Technology is more likely

to be changing rapidly. Products are more likely to face rapid obsolescence. Demand is

unpredictable, probably because competitor actions are also more difficult to forecast.

It should be pointed out that, in other environmental areas, competition is just as intense for both

innovators and non-innovators alike. The threat of entry is high everywhere. Firms are just as

capable of switching suppliers. Both groups face the same threat that consumers can easily

substitute products if they should so choose.

While small firms may have to find a niche strategy in order to survive, the innovators among

them do not lead a protected existence. In general, all entrants continuously face the threat of

entry. Innovators are also faced with continuous changes as a result of new product introduction

and technological change that are related to the innovative nature of their industry.

3.2 The Focus of Entrants

What are the product and production strategies adopted by new firms in the face of the

environment that they face? A firm’s product-based strategies are directed at making their

existing products as attractive as possible to consumers. There are several ways in which firms

can do this: they can offer an attractive price, focus on quality, and strive to provide superior

customer service, or offer flexibility in meeting their customers’ needs. Alternatively, firms can

try to alter their product line. In doing so, they might choose to customize their products, develop

a product line that carries a wide range of related products, or continually expand and update

their product line by frequently introducing new/improved products.

Of these strategies, successful entrants give the highest priority (scored on a scale of 1 to 5) to

strategies related to quality and service. Each of the strategies here—quality, customer service,

and flexibility in responding to customers and price—are deemed to be important (Figure 4).

Analytical Studies Branch – Research Paper Series - 9 - Statistics Canada No. 11F0019MPE No. 123

Figure 4. Importance of Product-Based Strategies

012345

average score

Introducing new/improved

products

Customization of products

Offering a wide range of

Related Products

Flexibility in Responding to

Customer Needs

Quality

Customer Service

Price

Analytical Studies Branch – Research Paper Series - 29 - Statistics Canada No. 11F0019MPE No. 123

However, it is noteworthy that the training differences between faster and slower growing firms

are greater in new than in mature markets. Mature markets are more likely to require skills that

can be obtained by hiring workers with existing skill sets. In new markets, new products are

being introduced so rapidly that new skills are constantly required. The very novelty of the

products often requires skills that are so new or firm-specific that companies have to train

workers to match the desired skill level. Therefore, training becomes more critical to the growth

process in markets where the product is in the earlier stages of the product lifecycle.

R&D also serves to distinguish faster from slower-growing firms in both stages of product

development (Figure 21). However, the difference is greater for mature markets. At first glance,

this is counterintuitive since R&D is associated with new product development, which in turn is

linked with new markets. But, as we have seen, product development is equally important in both

market stages, while process innovation is more important in mature markets. If R&D is a critical

component required for both types of innovation, then R&D differences should be greater for

mature markets—as they are.

While the connection between growth and the intensity of product innovation does not serve to

distinguish new from mature markets, other aspects of the customer product strategy do so

(Figure 22). There are positive differences between faster and slower growing firms with regards

to both customization of new products and the frequency of introducing new/improved products

for both mature and new markets. This is what one would expect since the emphasis on product

innovation is greater for faster growing than for slower growing firms in both markets. However,

the difference between faster and slower growing firms is greater in new markets where products

are changing more rapidly. By way of contrast, differences in mature markets are greater for the

strategy of responding to customer needs in a flexible manner. There are smaller differences

between faster and slower growing firms for the two conventional aspects of competition—

quality and customer service—but the differences are nonetheless positive. The difference is

statistically significant in new markets for a quality strategy; in mature markets, it is significant

for a customer-service strategy.

Associated with a greater stress by growing firms on product innovation and other new product

strategies comes a greater emphasis on a number of different marketing strategies (Figure 23).

Faster growing firms in both markets are significantly more likely to stress product reputation.

They are both more likely to stress market expansion—but the source of that expansion differs

because the markets are not at the same point in the lifecycle. Faster growing firms in mature

markets are more likely to target new foreign markets and new domestic markets than are faster

growing firms in new markets (Figure 23). Despite the fact that mature markets offer less growth

on average, faster growing firms in the mature stage of a product lifecycle expand by targeting

both new domestic and foreign markets.

Analytical Studies Branch – Research Paper Series - 30 - Statistics Canada No. 11F0019MPE No. 123

Figure 23. Differences in the Perceived Importance of Marketing Strategies Between

Faster and Slower Growing Entrants

Figure 24. Differences in the Perceived Importance of Production Strategies Between

Faster and Slower Growing Entrants

-5

Using third-

party

distributors

Targeti ng new

foreign

markets

Improving

position in

existing

markets

Targeting new

domestic

markets

Promoting

company or

product

reputations

Satisfying

existing

customers

% difference

New Mar kets

Mat ur e Ma rk et s

-0.05

0.15

0.35

0.55

0.75

0.95

1.15

Using

computer

controlled

processes

Reducing

production

times

Using high-

quality

suppliers

Improving the

efficiency of

input use

% difference

New Markets

Mature Markets

Analytical Studies Branch – Research Paper Series - 31 - Statistics Canada No. 11F0019MPE No. 123

All firms in the initial stage of the product lifecycle are producing new products for new markets.

Therefore, it is not surprising that the stress on new markets does not distinguish between faster

and slower growers here. However, it is true that the percentage difference in the stress that is

placed on improving existing market position, which for firms in new markets means expanding

market share in their new product markets, is greater between faster and slower growers in new

markets than in mature markets. Therefore, growing firms in this phase of the product lifecycle

do place a greater emphasis on the aspect of market expansion that was relevant to them.

More importantly, what serves to distinguish faster growers from slower growers in new markets

is the extent to which third-party distributors are used. The demands being made on new firms in

the early stages of the lifecycle are sufficiently large that relying on outside parties for

distribution, where they are available, husbands scarce resources.

This section demonstrates the universal importance of product innovation in markets that differ

in terms of their position in their lifecycle. While differences in emphasis exist, they involve

detail only—with more new products and more customization in the early stages of the lifecycle.

The degree of process innovation shows more market differences. Mature markets are those

where growth is more closely related to process innovation.

This finding should not be interpreted to mean that an emphasis on production strategies is

unimportant in new markets. While faster growing firms in new markets place relatively less

stress on process innovations (Figure 24), they are more likely to stress new computer-based

production strategies. On the other hand, faster growers in mature markets are more likely to

focus on reducing production times or using high-quality suppliers.

In summary, similarities in the importance of product innovation can be found across markets

that are both young and old. The generalizations that originated in comparing faster and slower

growing firms in the entire population are qualified but are not overturned when the analysis is

extended to markets that differ by degree of maturity. Adding detail by examining different

markets provides insights that bolster the original conclusion that innovation is critical for

growth. In particular, product innovation is important in both young and old product markets

alike.

Successful entrants are those that reach beyond the bounds of their established product markets.

They introduce new and/or improved products and seek out new customers. They look inside the

firm. They give greater emphasis to training. They continually strive to improve, update and

modify their operations—but in different ways. Despite the primary focus of entrants on

established markets that has been drawn in a previous section, innovation in new firms in most

markets is rewarded with growth. These results corroborate those found in the GSME survey

(Baldwin et al., 1994) where more successful19 firms outperform less-successful firms in almost

every area, but where innovation is the key factor that discriminates between more- and less-

successful firms.

19 In the 1994 study, success is defined by an index consisting of growth in market share, productivity and

profitability.

Analytical Studies Branch – Research Paper Series - 32 - Statistics Canada No. 11F0019MPE No. 123

8. The Joint Effect of Innovation, Technological and Skill

Competencies on Growth

Innovation has different dimensions. Previous sections have examined the extent to which each

of these dimensions is pursued by new firms and how some of these dimensions, such as training

and technology use, are related. However, the connection between an entrant’s emphasis on skills

and innovation was conducted primarily at a high level of aggregation. The various dimensions

of innovativeness or technological competence were combined into one index and compared to

the dimensions of a skill-based human resource strategy, either separately or together.

In order to pursue the distinctions that might exist across types of innovators in terms of their

emphasis on training, the emphasis that is given to skill development in four different groups is

investigated here. Entrants are divided into those that produced just a product innovation, just a

process innovation, both product and process innovations, and those that did not report an

innovation.

There are two reasons for choosing this classification scheme for analyzing differences in human-

resource strategies. First, a cluster analysis of all the innovation and technology characteristics in

entrants that were described earlier produced these four distinct clusters. Secondly, Baldwin and

Johnson (1998) used an associated survey on small and medium-sized firms and found that these

four types differ substantially in terms of their success and strategic emphasizes. Confirming that

these differences can also be found in the entrant population corroborates the differences that

were previously observed.

In order to assess the success of each category, the survey respondents were divided into two

groups—the faster and the slower growers.20 Then the proportion of each innovator group that

fell in the highest growth category was calculated. The combined product/process innovators are

most likely to be in the highest growth category. Some 70% of this group fall in the faster

growing group (Figure 25). Product innovators are second (59%) and process innovators are third

(49%). Less than 43% of noninnovators are found in the top half of growers.

These differences accord with previous research that also found the highest growth rates

belonged to comprehensive innovators and the lowest to non-innovators (Baldwin and Johnson,

1998). This suggests that comprehensive innovation is the key to success, or that this type of

innovator is located in the fastest stage of the lifecycle of a product market. That product

innovators grow slightly more quickly than process innovators could also be connected to

differences in the position of each innovator type in the product lifecycle. If process innovators

are more likely to be in the later mature phase of the product cycle, their lower growth rates

simple reflect the more mature stages of the market. The results of the previous section that show

a larger percentage of firms in mature markets to be process innovators suggest that this

explanation accounts for part of the difference. The innovative group with the highest growth

rates also places the greatest stress on training.

20 The sorting was done separately for each birth year in the sample.

Analytical Studies Branch – Research Paper Series - 33 - Statistics Canada No. 11F0019MPE No. 123

The average score on each of the human resource strategy variables is highest for the combined

product/process innovators and generally lowest for the noninnovators (Figure 25). This too

accords with the previous findings (Baldwin and Johnson, 1998). Comprehensive innovators tend

to emphasize a number of strategic areas more intensely than do noninnovators (Baldwin and

Johnson, 1996b) and human resource strategies is one of these areas. For three of the four

variables, product innovators place greater stress on the importance of the strategy than do

process innovators. In the previous study, differences between these two groups were not found

to be large. Our results here suggest that product innovators may indeed need to worry more

about training because the skills required of the workforce at the early growth stage have to be

developed internally rather than acquired externally.

In the previous two sections, growth was shown to be associated with a number of separate

strategies. Faster growing entrants were more likely to be innovative and more likely to pursue a

human resource strategy that focused on recruiting skilled employees, training them and retaining

them. The connection between these different strategies was not investigated at great length. Was

it innovation itself that led to growth or skill emphasis? Or was the difference in skill emphasis

and its relation to growth simply caused by the fact that innovators generally are in the faster

growth class and innovation requires a special type of human-resource strategy?

We investigate this issue in two ways. In the first instance, we divide each of our innovative

types into those that emphasize a particular human-resource strategy—for example, into those

that have or do not have a formal training program (LABFOR). This is also done for LABTRAIN,

LABSKL, and LABSCORE. Then we calculate the percentage of those firms emphasizing the skill

strategy that are fast growers and those that are slow growers within an innovation class. These

percentages are plotted for each innovator type in Figure 26 for the two variables that capture

whether a training program is in place (LABFOR, LABTRAIN). In each case, there are a higher

percentage of fast growers in the category where training is being done. These differences do not

exist for the two variables that just rank the importance of training (LABSCORE) or the importance

of recruiting skilled labour (LABSKL) except for the noninnovator category. In conclusion,

irrespective of the category, if training plans are implemented, growth is superior. Training is an

important complementary strategy for innovators but training matters, irrespective of the

innovation environment.

The second approach to test the separate effect of training on success involved the use of

multivariate analysis. The rate of growth of the successful entrants was regressed on the three

indices—INAV, TEAV, and LABAV. This regression was run separately by three groups that were

used for stratification purposes in the original sample. This was done first for the entire sample.

Second, it was done for goods versus service industries. Third, it was done for high knowledge

and low knowledge industries. High and low knowledge industries were defined using

R&D/sales ratios, average wage and multifactor productivity growth.21

21 See Baldwin (1998) for a discussion of the creation of this industry taxonomy.

Analytical Studies Branch – Research Paper Series - 34 - Statistics Canada No. 11F0019MPE No. 123

Figure 25. Differences in Growth and Skill Emphasis Across Innovator Types

Figure 26. Differences in the Percentage of Firms that are Fast-Growers by Skill Group

10%

20%

30%

40%

50%

60%

70%

80%

PROCESS

PRODUCT

COMBINED

NOT

INNOV

Labtrain=0

Labtrain=1

Labfor=0

Labfor=1

% of firms that are fast growers

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Growth Rate

Labscore

Labtrain

Labfor

Labskl

PROCESS

PRODUCT

COMBINED

NOT INNOV

Average Scor

Analytical Studies Branch – Research Paper Series - 35 - Statistics Canada No. 11F0019MPE No. 123

For the entire sample, the results show that innovation and labour skills are each significantly

related to the growth of entrants. The skills variable has about the same coefficient as the

innovation variable. When the sample is broken down into goods and services industries, the

innovation variable has a larger and more significant coefficient in goods than services.

Moreover, the innovation variable is significant in the former but not the latter. The reverse is

true of the skills variable. This confirms earlier results (Baldwin and Johnson, 1996a) that stress

the human-resource emphasis in services is a key factor behind growth. When the sample is

broken into ‘high’ and ‘low’ knowledge industries, innovation is seen to be more important in the

former, while labour skills are equally important in both. In conclusion, the effect of an emphasis

on skills is generally felt independently of the effect of innovation on growth, and this is

pervasive across the subsectors examined here.

Table 3. Coefficients from a regression of growth on innovation, labour and technology indices

Innovation

(INAV)Skills

(LABAV)Technology

(TEAV)

All .072 .077 -.011 F(3,2794)=9.0

(.031) (.030) (.029)

[.021] [.009] [.707]

Goods .156 .066 -.009 F(3,2794)=10.7

(.065) (.069) (.053)

[.016] [.344]4 [.858]

Services .043 .087 -.015 F(3,2794)=6.3

(.032) (.031) (.035)

[.176] [.005] [.664]

High Knowledge .084 .070 .041 F(3,2794)=8.0

(.032) (.035) (.45)

[.009] [.045] [.369]

Low Knowledge .068 .077 -.045 F(3,2794)=3.7

(.045) (.043) (.038)

[.134] [.082] [.247]

Note: Bracket figures are probability values for a two-tailed t test for the null hypothesis that the

coefficient is zero.

Analytical Studies Branch – Research Paper Series - 36 - Statistics Canada No. 11F0019MPE No. 123

9. Conclusion

Entry is important. At any point in time, a substantial amount of market share or employment is

accounted for firms that entered in the recent past.

Entry is an inherent part of the dynamic competitive process that leads some firms to grow and

others to decline. And it is within this context that it needs to be appreciated. It is not the only

process at work—but it is an important part of it.

The entry process involves trial and error. Firms have to develop basic skills before they can

survive—and large numbers appear not to have these skills at birth. Firms that fall by the

wayside generally start off smaller, pay lower wages and have lower labour productivity.

Moreover, their management lacks knowledge of basic management skills in many cases

(Baldwin et al., 1997). Nevertheless, there is a subset of new entrants that survive and grow—and

the growth of this group is substantial.

It is in the area of innovation that entrants make a widespread contribution. The contribution of

entrants to some industries is well understood. New technology-based firms play an important

role in the early stages of the lifecycle of many industries. They are the means by which the ideas

of new entrepreneurs are initially commercialized. Whether it be in electronics, instruments,

medical equipment, steel, or biotechnology, new firms have played an important role in the

innovation process.

While the profile of entrants in industries such as electronics and biotechnology is highly visible,

the role of small firms is important in many other industries. Innovation is widespread and is

generally associated with growth. Firms in many industries have developed the capacities that are

needed for innovation in their particular industries. These capabilities often involve development

of new technology or devising new products or processes that are highly novel. The range and

diversity of the innovation skills of new firms across all industries is remarkable.

The importance of the innovation process is attested to by the connection between growth and

innovation. The successful entrants that grow the most are those that develop one or other type of

innovative activity—either with respect to the introduction of new products, an emphasis on

technology, or human resources.

This innovation process, to be successful, requires complementary skills. In particular, firms that

develop new products and processes have to focus more intensely on human resource

capabilities. Key among these capabilities is the training activities of entrants. New firms develop

competencies in a number of different areas. An innovative firm may focus more intensely on a

broad range of competencies, but training is a key complementary capability. More importantly,

while training complements the innovation strategy, it has an effect on growth that is quite

separate from the innovation/technology strategy that a firm pursues. Entrants that train are more

likely to grow—irrespective of the emphasis that a firm places elsewhere on innovation and

technological capabilities.

Analytical Studies Branch – Research Paper Series - 37 - Statistics Canada No. 11F0019MPE No. 123

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It once took two decades to replace one-third of the Fortune 500; now a subset of new firms are challenging and displacing this elite group at a breathtaking rate, while armies of startups come and go within just a few years. Most new jobs are, in fact, coming from small firms, reversing the trend of a century. David Audretsch takes a close look at the U.S. economy in motion, providing a detailed and systematic investigation of the dynamic process by which industries and firms enter into markets, either grow and survive, or disappear. He shapes a clear understanding of the role that small, entrepreneurial firms play in this evolutionary process and in the asymmetric size distribution of firms in the typical industry. Audretsch introduces the large longitudinal database maintained by the U.S. Small Business Administration that is used to identify the startup of new firms and track their performance over time. He then provides different snapshots of the process of industries in motion: why new-firm startup activity varies so greatly across industries; what happens to these firms after they enter the market; the extent to which entrepreneurial firms account for an industry's economic activity and why that measure varies across industries; how small firms compensate for size-related disadvantages; and who exits and why. Audretsch concludes that the structure of industries is characterized by a high degree of fluidity and turbulence, even as the patterns of evolution vary considerably from industry to industry. The dynamic process by which firms and industries evolve over time is shaped by three fundamental factors: technology, scale economies, and demand. Most important, the evidence suggests that it is the differences in the knowledge conditions and technology underlying each specific industry -- key elements in innovation -- that are responsible for the pattern particular to that industry.

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Mar 1995

John R. Baldwin

The Dynamics of Industrial Competition describes the internal dynamics of industries using new and unique longitudinal data that make it possible to track firms over time. It provides a comprehensive picture of a number of different aspects of firm turnover in North America that arise from the competitive process - the entry and the exit of firms, the growth and decline of incumbent firms, and the merger process. Instantaneous and cumulative measures of market dynamics are provided by examining change in both the short and the long run. Using various measures of firm turnover to proxy the amount of competition, the study examines and contextualizes the relationship between industry performance and the intensity of the competitive process.

Business strategies in more- and less-innovative firms in Canada

Article

Aug 1996
RES POLICY

This study investigates differences in the policies being pursued by more-innovative and less-innovative firms. It focuses on a broad group of strategies — in marketing, finance, production, management, and human resources and asks whether there are key areas in which the strategies being followed by more- and less-innovative firms differ. It also investigates how the activities of firms in each of these areas differ. Finally, it compares the performance of more- and less-innovative firms. The study finds that more-innovative firms place a greater emphasis on management, human resources, marketing, financing, government programs and services, and production efficiencies - each of these areas is important. Finally, more-innovative firms are more successful than less-innovative firms.

Innovation and Training in New Firms

Abstract and Figures

Recommended publications

Digital Discovery & e-Evidence, Bureau of National Affairs

Opsonins

Analysis of middle school students' views and impressions about a science center

Gender Differences in CEO Compensation: Evidence from the USA