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157

Innovation and
business
performance
Small entrepreneurial firms
in the UK and the EU

ALAN HUGHES
Judge Institute of
Management Studies and
Centre for Business
Research, University of
Cambridge

ntrepreneurship and innovation are


businesses. Generalisation across the sector
high on the policy agenda. The EU and
as a whole is therefore dangerous, even
the OECD have each produced major
though the data sources may at times perpolicy oriented studies of these frequently
mit little else.
twinned phenomena, and the DTI White
Between 1979 and 1991 the share in UK
Paper Opportunity for All (2001) devoted a
employment of businesses employing less
separate chapter to each.
than 200 employees rose
This article provides an
from 49.1 per cent to 58.1
It is not the case
overview of the innovative
per cent. This increase was
that the typical
performance of smaller rms
mainly accounted for by
small rm generates
in the UK in a comparative
increases in the share of
more employment
European perspective. It then
businesses with less than 50
than larger rms do.
seeks to examine the conemployees and especially
Rather it is the case
straints smaller enterpreneurthose with less than ten
that a few small
ial firms face in their
employees. Since 1991 the
rms produce
innovative activities and
growth in the business popspectacular growth,
explores the impact of innoulation and the share of
which pulls the
vation in smaller rms on their
activity of businesses
average up
growth and protability.
employing less than 200 has
fallen then recovered, but
Heterogeneity in the SME sector
has not advanced beyond the high point
It is important to emphasise the broad range
reached at the turn of the decade. Since
of business characteristics encompassed by
1991 the shares of activity in businesses
most definitions of small and medium sized
with less than 10, and less than 50, employenterprises (SMEs). This term can cover sole
ees appears to have stabilised. The growth
proprietorships to small quoted businesses.
of the entrepreneurial economy based on
Moreover the sector will include hi-techSMEs has therefore been highly concentratnology knowledge based firms and corner
ed amongst micro-firms at the tail end of the
shops, as well as firms with high growth
size distribution.
aspiration and other so-called life style

1070-3535/01/030157 + 05

2001 IPPR

158

NEW ECONOMY

Figure 1 Employment in the private sector by size of enterprise

1993

2000

With
no employees
2.996m

With
no employees
3.017m

250+ employees
8.661m

1-9 employees
2.788m

10-250 employees
6.143m

250+ employees
9.946m

1-9 employees
3.697m

10-250 employees
5.492m

Source: DTI Small Firms Statistics Unit/Small Business Service


Note: Since 1993 a new data source from the DTI shows a significant fall in employment in SMEs employing between 10 and 250 workers.
Micro-enterprises employing between 1-9 employees have significantly increased their share of employment, but so have large firms employing
over 250 and especially over 500 employees. The trends of the 1980s have not persisted into the 1990s.

SME growth: the stylised facts


The extensive international data, which has
emerged on patterns of business growth,
reveal that smaller, younger businesses, which
inhabit the tail of the size distribution, experience wider variations in growth rates than
do larger, maturer ones. It also reveals that
younger rms grow faster than other rms do
and the very smallest grow faster than the rest.
However, only a handful of businesses will
account for the bulk of employment, output
or sales generated by a given cohort of surviving rms. It is not the case that the typical small rm generates more employment
than larger rms do. Rather it is the case that
a few small rms produce spectacular growth,
which pulls the average up.
It is important in discussing the contribution of SMEs to innovation and growth to note
that economic activity remains heavily concentrated in a few giant rms. In the European
Union it has recently been estimated that the
mean share in activity of the largest four

enterprises across a large sample of industries


and countries was 20 per cent with a maximum of 87 per cent. These ratios appear to
have been rising rather than falling in recent
decades.

Measuring innovation
Any attempt to assess innovative activity
and performance must begin with the denition of suitable metrics. These usually fall into
the two categories of input and output measures. Inputs usually include expenditure on
R&D and measures of the staff employed in
R&D. Output measures include patents and
measures of the incidence of product, process
and logistic innovations. Distinctions can also
be drawn between innovation new to the
rm that may be diffusing from innovation
activity in another rm, and more novel innovation that is new to the rm and to industry.
Each of these may lead to measures of innovation intensity in terms of innovation counts,
as well as measures based on the distribution

INNOVATION AND BUSINESS PERFORMANCE

of sales by novelty of product or service innovation.


Broadly speaking there are two approaches to obtaining data on innovation outputs.
The object approach focuses on patents or
more directly on the analysis of specic innovative products or processes. This approach
frequently uses the trade and technical press,
and expert engineering/technologist evaluations of signicance, novelty, or importance.
In contrast the subject approach is based on
an analysis of rms own perceptions of their
innovative activity. This approach underpins
the Harmonised European Community Innovation Surveys that have been associated
with the development of extensively piloted
survey instruments designed to measure
innovation at the level of the rm.
There is evidence to suggest that the object
approach underestimates the innovative

159

activity of smaller rms, in particular diffusion or incremental activity which the object
approach may overlook. The Centre for Business Research (CBR) has pioneered the subject approach in relation to UK data for SMEs
and the article draws on data based on the
subject approach.

Innovation in the EU
In reporting innovation activity in the EU this
article relies on the results of the second Community Innovation Survey (CIS2) of 1997/1998
involving twelve European States. The survey
was intended to cover all enterprises in manufacturing with 20 or more employees and all
service enterprises with ten or more employees. These can be split into three size bands,
small (10 to 49 employees), medium (50 to 249
employees) and larger (250 or more employees). This allows a comparison of innovation

160

activity by broad sector and size over the


three-year period, 1995-7.
The results of CIS2 reveal that innovation
activity rises with enterprise size in the EU
as a whole, a result that holds for both manufacturing and services. In the specific sense
that the proportion of enterprises reporting
one or more product or process innovations
rises with size, it seems that bigger is better.
Figures 2 and 3 rank countries in terms of
the innovation performance of small rms,
revealing that UK small rms are ranked in
the top ve in Europe in both manufacturing and in services. Moreover, an inspection
of the pattern for medium and larger rms
also reveals that UK small rms do better relatively than UK large rms and especially
better than medium rms. In that comparative sense smaller is better.

NEW ECONOMY

Innovation constraints and the


innovation/performance link
In order to probe behind these results and in
particular to examine patterns of innovation
constraints and the innovation/performance
link we can use the results of the regular CBR
biennial survey of SMEs in the UK. These
cover 2500 enterprise in Manufacturing and
Business Services employing between one
and 500 employees. The latest results are
based on the 4th survey of 1999. The surveys
generate subject-based data on innovation
inputs and outputs and over 200 company
specic variables on enterprise structure and
performance.
Innovation constraints
Figure 4 compares the main constraints experienced by innovators and non-innovators in
the CBR sample in meeting their business

INNOVATION AND BUSINESS PERFORMANCE

161

Mean scores based on a range of 1-5

objectives. Innovation is measured by the


presence or absence of a process or product
innovation in the three-year period 1997-99.
Each constraint was scored on a scale of 1 to
5. The length of the horizontal bars represents
the mean scores recorded for each constraint
by the sample rms in the two groups.
Innovators in the UK SME sector feel
more constrained in all dimensions than
non-innovators. However, what is perhaps
more interesting in view of the heavy emphasis placed upon financial constraints in recent
policy debates is that they receive much less
emphasis than demand and labour skill constraints. The biggest relative difference
between innovators and non-innovators is
that innovators feel much more constrained
by lack of management, marketing and sales
skills.

Innovation and performance


The impact of innovation on corporate performance has been the subject of an intensive
and, especially amongst smaller rms where
there are severe data problems, often-inconclusive literature. For smaller businesses this
literature, often based on small or data restricted samples, suggests positive relationships
between innovation and employment or
turnover growth but weak or absent relationships with protability
To examine the link between innovation
and performance in the CBR sample it is
helpful to first look at the variations in innovation intensity measured by the proportion
of sales accounted for by novel products or
services. For all sample firms around 7.4
per cent of sales in 1999 were accounted for
by recently introduced new products. This
proportion was lower in stable/declining

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NEW ECONOMY

Table 1 The proportion of new products as a % of sales in 1997 and growth 1997-9
New products as a % of sales (1997)

Number of firms

Median employment
growth 1997-99

Median turnover
growth 1997-99

All firms
Low (<10%)
High (10%)

560
358

1.0**
10.2

7.8**
14.1

Manufacturing
Low (<10%)
High (10%)

331
234

0.0**
9.1

4.0**
11.4

Services
Low (<10%)
High (10%)

229
124

5.0
14.3

13.2
22.5

** A significant difference from the number in the row below at the 5% level
Source: Cosh and Hughes (2000b)

firms compared to medium growers, in


micro firms compared to small and medium
SMEs, and in services compared to manufacturing.
Table 1 draws on the panel nature of the
CBR dataset (which tracks the same rms over
time) to explore the link between innovation
and performance. It reveals that past innovation intensity (measured as the percentage
of sales accounted for by new products in
1997) is positively related to 1997-99 growth
in our sample. Thus low innovation intensive
rms with new products accounting for less
than ten per cent of sales in 1997 had significantly lower employment and turnover
growth rates in the subsequent three years.
This result is largely driven by the manufacturing sub-sample. The differences in services, although in the same direction, are not
statistically signicant because of the wide
variation in growth rates within the innovation groups.
The link between innovation and profitability is less clear cut. Data on median
prot to sales margins shows that median
prot margins gradually fell between 1997
and 1999 for both high and low innovation
intensive groups. The median rate of fall of
profit margins was significantly different

between the low- and high-innovation intensity rms only in the medium size group. In
that group high-innovation intensity in 1997
had a positive relative impact on the change
in prot margins 1997-99. In all other subgroups innovation intensity appeared to have
no signicant impact on subsequent changes
in prot margins. These results are broadly in
line with the wider literature referred to earlier. This raises important questions about
why the bottom line outcomes are on average not more positive.
International benchmarking comparison
One of the most interesting developments in
the theoretical and empirical analysis of business behaviour and innovative performance
has been the increasing emphasis placed upon
skill shortages, management competence and
strategic response in relation to both innovation intensity and its links with nancial performance. It is therefore interesting to consider
further the skill and management constraints
experienced by innovative rms in meeting
their business objectives, drawing upon a
recent study of product development performance in UK, Japan and US (Oliver et al (2000)).
The results relate to 38 medium-sized
consumer audio electronic firms in Japan,

INNOVATION AND BUSINESS PERFORMANCE

Table 2 The good news and the bad on product development

163

Conclusions

This paper has


argued that, despite
The good news....
Japan
UK
the importance
Product lead times to market in weeks
84
48
of small entrepreEngineering hours per new part
106
19
neurial firms in
economic activity,
And the bad news
the UK (and all
major industrial
Weeks to normal quality standards
2
8
economies) still
Warranty claims per million parts
716
15,419
remains dominated
by large rms. On
Source: Based on data in Oliver et al (2000)
average these larger
firms are more
North America and the UK and are based on
innovation intensive than smaller rms. Howcomprehensive data on 31 new product
ever, UK SMEs appear to be relatively more
development projects in these companies.
innovative in a comparative European context
The conventional uncommercial UK boffin
than are our larger firms. The paper also
wisdom would suggest that UK firms would
argued that in the UK and elsewhere only a
be to be slow to market compared with
handful of SMEs grow rapidly into large rms.
Japan. Table 2 confounds this view. The
It is therefore important to identify the central
good news is that product lead times in this
factors that lie behind that phenomenon and
sample measured in terms of weeks to marthe particular links that may be made between
ket, and engineering hours per new part
innovation, and business growth and nancial
were significantly lower in the UK than
performance. Innovative SMEs in the UK are
Japan. The bad news is that this haste
relatively more constrained by management
brought much repentance. The number of
skills than they are by nancial market failures.
weeks to achieve normal quality standards,
Management competence and skill issues may
and the number of warranty claims were far
be a key factor in preventing innovation from
higher in UK firms.
producing systematically positive bottom line
In assessing the comparative weaknesses
protability effects.
and strengths in the UK sample the authors
It follows from this argument that an
stress the lack of management competence
important emphasis in policy should be placed
and of a professional marketing function with
on building management competence in UK
international outlook. This has strong echoes
SMEs. In a related vein it is also important that
in the wider survey-based results reported
policy should place greater emphasis on develearlier and obvious implications for convertoping competence in the stock of businesses
ing innovation into bottom line performance
with growth aspirations, compared with an
effects.
emphasis on the promotion of start-ups