Eurasian Bus Rev

DOI 10.1007/s40821-015-0033-1
ORIGINAL PAPER

Network alliances and firms performance: a panel data

analysis of Pakistani SMEs
Naqeeb Ur Rehman1

Received: 23 March 2015 / Revised: 2 October 2015 / Accepted: 6 October 2015

Eurasia Business and Economics Society 2015

Abstract Empirical studies shows that SMEs are characterized by budget constraints and are reluctant to invest in innovation activities such as undertaking R&D,
taking out patents, and hiring highly qualified research staff. This paper suggests
that SMEs can adopt network alliances to minimize their resource constraints.
SMEs network alliances such as joint ventures, R&D cooperation and firms colocated in the industrial zones positively influence the firms labour productivity and
innovation performance. In addition, SMEs are engaged in product and process
innovation, quality standards and management experience have a positive impact on
the firms labour productivity and innovation performance. To the best of my
knowledge, hardly any empirical study is carried out to analyze the Pakistani SMEs
using unbalance panel data. This research paper has used 2 year unbalanced panel
data (2002 and 2007) on 391 Pakistani manufacturing SMEs. Overall, two models
have been used with generalized least square estimation and probit analysis using
the random effects.
Keywords

Innovation  Networks  R&D  SMEs  Pakistan

1 Introduction
Innovation is an important driver of firms sustained competitive advantage (Katila
and Shane 2005; Mohsin et al. 2015). Innovativeness reflects a firms tendency to
engage in and support new ideas, novelty, experimentation and creative processes
that may result in new products, services or technological processes (Hoffman et al.
1998). In other words, innovation increases the firm knowledge learning abilities.
& Naqeeb Ur Rehman
naqirehman@gmail.com
1

Hazara University, Mansehra, Pakistan

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However, there are more barriers to innovation in small and medium-sized

enterprises (SMEs) than in large firms; for instance, lack of funds, lack of technical
expertise, low research & development (R&D) expenditure and stringent government regulations (Hadjimanolis 1999; Freel 2000). In other words, the barriers to
innovation in SMEs are greater in developing countries with low infrastructure
facilities. In developing countries, low human capital, lack of information
concerning technology and insufficient government support, and lack of formal
credit (bank loans) are the major obstacles to SMEs performance (Radas and Bozic
2009; Hung 2007; Reddy 2007; Aw 2002). However, it is not only in developing
countries, that SMEs meet with obstacles as, in the literature several studies (e.g.,
Freel 2000; Koch and Strotman 2008; Bjerk et al. 2014) suggest that in developed
countries (technologically advanced economies) SMEs encounter even more
obstacles than large firms. For instance, lack of external finance (formal credit),
low management and marketing abilities, lack of formal R&D departments and a
low skilled labour force reduce SMEs productivity performance (Beck et al. 2005;
Bezic et al. 2010). In contrast, SMEs can improve their innovative performance
through networks by increasing their organizational capabilities (marketing and
management). That is the resource constraints of SMEs can be overcome through
strategic alliances (joint ventures), subcontracting R&D, and clustering i.e., one
geographical location (Rammer et al. 2009; Hussain 2000; van Staveren and
Knorringa 2007; Wiklund et al. 2007; Koch and Strotman 2008).
This leads the researcher to formulate a key research question. How can SMEs
improve their performance using network alliances (e.g., joint venture, R&D
alliances and geographical proximity/industrial zones) to overcome SMEs resource
constraints? This research question is answered in this empirical study. Previously,
there were very few studies (e.g., Dasanayaka 2008; Malik et al. 2010; Jamali 2010)
available on Pakistani manufacturing SMEs. None of these studies investigated the
SMEs network alliances using panel data. This paper fills that research gap and
makes a contribution to the existing knowledge specifically related to the Pakistani
SMEs. Interestingly, SMEs are the backbone of the Pakistani economy. The number
of SMEs in Pakistan is estimated nearly 3.2 million and make a contribution to the
national income almost 40 % of Gross Domestic Product (GDP) and a share of
30 % of exports (Thaver 2014). Further, SMEs are a focal point for government
policy for economic revival, poverty alleviation and employment generation
(Khokhar 2010). However, domestic SMEs are facing many challenges such as the
rising cost of energy prices, infrastructure facilities (e.g., premises, internet) and
investment in knowledge based assets (e.g., R&D, patent rights). This has motivated
the researcher to analyze the Pakistani SMEs and suggest rigorous policy
instruments for the development of SMEs in Pakistan.
This empirical study is based on an unbalanced panel data analysis of 391
Pakistani manufacturing SMEs. A random effect model with generalized least
squares and maximum likelihood (i.e., probit) methods suggest that firms engaged in
network alliances such as subcontracted R&D, joint ventures, and co-location in
industrial zone, have a positive impact on the firms performance. In addition, SMEs
with process innovation, production technology and quality standards (ISO-quality
standards) significantly improve the firms performance. Two indicators of firms

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performance has been used i.e., labour productivity and product innovation. This
paper is structured as follows: Sect. 2 provides a review of the literature. In Sect. 3,
the methodology of the paper is discussed, while Sect. 4 presents empirical analysis.
In Sect. 4, random effect models (GLS and probit) were used for estimation. Lastly
Sect. 5 draws conclusions from the findings.

2 Literature review
In a knowledge-based economy with strong competition on local and international
scale; firms are required consistently to engage in innovation activities. One of the
important factors for firms becoming involved in the innovation activities is the
desire to improve their performance. Studies on SMEs suggests that small firms are
less innovative than large firms due to their skills gaps such as managerial,
marketing and technological competencies (Freel 1999; Narula 2004). In comparison, SMEs have certain advantages over large firms such as their organizational
flexibility, rapid response to market changes and their innovative potential (Hall
et al. 2009; Terziovski 2010). In fact without innovation, it is difficult for a firm to
grow and compete with rivals. However, specifically the resource limitation of
SMEs with reference to developing countries has motivated this research to
emphasize the role of network alliances to increase their firms performance (see
Lin 2009; Mahmood 2008). Networks stimulate innovation and allow firms to cope
with the rising demand for technological dependence on others (Minarelli et al.
2013). Networks provide SMEs greater access to external sources such as
complementary skills and knowledge, sharing technical expertise and organizational
capabilities (financial and scientific resources) which are important factors in
enhancing firms performance (Gronum et al. 2012; Shaw 2006; Wiklund and
Shepherd 2003). More specifically, networks improve the firms learning abilities
(absorptive capacity) and form an essential determinant of firms performance
(Nadine 2015). This study has identified that a firms engagement in network
alliances (e.g., joint ventures, R&D collaborations, firms co-located in industrial
zone) significantly improve the firms productivity and innovation performance.
2.1 Joint ventures
Innovation activity is expensive in terms of both costs and risks and these two
factors can be reduced though networks. A number of researchers have argued that
collaboration is the key factor for overcoming SMEs resource constraint capabilities
(Lopez-Navarro and Callarisa-Fiol 2013; Fukugama 2006; Narula 2004; Bjerk et al.
2014). Firms engaged in cooperation activities and establishing networks with
external sources (universities, research organizations) are more likely to experience
a higher performance (Fukugama 2006). Strong network may benefit the firm in the
utilization and exploitation of existing knowledge (Fukugama 2006; Allen and
Andrew 2007). Alternatively, firms with networks can reduce time spans, costs,
risks and can gain higher flexibility in their operations (Narula 2004).

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In particular, SMEs resource limitations (lack of access to credit, low skilled

labour force etc.) lower the firms ability to undertake R&D; alternatively, SMEs
can collaborate with large firms for technological innovations (Sikka 1999).
Similarly, Estrada and Fuente (2010) argued that technological joint venture (JV) is
important to develop inter-organizational relations. For instance, the benefits of
inter-organizational relationships (e.g., joint venture) are based on the adequate
integration of resources and SMEs can achieve their development and growth
objectives (Lopez-Navarro and Callarisa-Fiol 2013). Likewise, Anderson et al.
(2011) discussed that joint venture provide a good source for inter-organizational
learning and for transformation of tacit knowledge (non-codified). In addition, high
commitment and trust between partners in JV is very essential because these two
proxies significantly improve the firms innovation performance (Anderson et al.
2011). Regarding JV purpose, joint ventures are formed by two or more firms for a
specific long term objective in order to increase their market share, profitability
(Anderson et al. 2011). Further, Lopez-Navarro and Callarisa-Fiol (2013) argued
that strategic alliances (JV) between firms provide them with greater access to
resources, technological knowledge, while sharing costs and risk with each other
may improve their performance. This suggests that SMEs can form joint ventures
and may overcome the barriers to innovation performance.
H1: Joint venture has a positive impact on the firms performance
2.2 R&D alliances
Firms reliance on internal R&D activities and other internal capabilities (e.g.,
skills) is no longer enough to cope with the higher cost of innovation, shorter
product lifecycles and higher technological complexities (Berchicci 2013). This
recent shift from closed to open innovation models has emphasized the role of R&D
alliances. Through such network activities (i.e., R&D alliances with universities,
suppliers and other research organizations) firms may increase their competitiveness and superior performance (Ahuja 2000; Cantner et al. 2010; Harris and Trainor
2005). The common goal of external R&D is to develop new products and processes
by saving costs. SMEs suffer the drawback of conducting R&D because failure in
this risky investment might be financially disastrous (Karlsson and Olsson 1998;
Teirlinck and Spithoven 2013). Studies (e.g., Bjerk et al. 2014) have found that
SMEs have insufficient resources to conduct R&D activities. In comparison, some
researchers (e.g., Kim 2000) have found R&D intensity higher in SMEs than large
firms. For instance, Kim (2000) has conducted a study on Korean small software
firms and identified that the ratio of R&D employee to total employees is much
higher for SMEs compared to large firms. However, SMEs in developing countries
have a very low level of investment in R&D due to financial constraint (Reddy
2007). It is argued that SMEs can rely on R&D alliances for innovation output
(Hoffman et al. 1998). The reasons for SMEs to collaborate in R&D are to share
costs/risks, reduce innovation time span and gain access to the additional market
knowledge through joint ventures and licensing (Karlsson and Olsson 1998; Narula
2004).

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Furthermore, empirical studies (e.g., Teirlinck and Spithoven 2013) suggest that
SMEs R&D outsourcing and research cooperation have a significant impact on the
firms performance. SMEs cannot undertake R&D internally because they do not
have formal R&D departments nor can they afford huge R&D budgets and highly
skilled researchers (Teirlinck and Spithoven 2013). R&D alliances provide several
benefits such as complementary capabilities, technological capabilities, contribute
to a firms knowledge base, economies of scale in R&D, spreading the risk and costs
(Sampson 2007). Lane and Lubatkin (1998) argued that R&D alliances will increase
the firms innovation performance and absorptive capacity, if these small firms are
reluctant to invest alone in R&D. To sum up, SMEs R&D alliances with other firms
may boost their innovation activities with less costs and risks. The next hypothesis
is as follow;
H2: R&D collaboration has a positive impact on the firms performance
2.3 Industrial zone
One way to form networks with other firms is when firms are co-located in industrial
zones. In industrial zone knowledge transfer takes place more rapidly between firms
than it does among firms who are not co-located (Dimitriadis et al. 2005). This
physical proximity leads to exchanges of employees between firms in the supply
chain and they often share innovation (Harris 2009). This clearly indicates that
when firms that is geographically close, knowledge transfer through employees
meetings/turnover has a significant impact on the firms performance. In addition,
SMEs operating in industrial zone are better performers compared to those SMEs
operating independently because firms share production activities and can improve
their quality of products or services (Grando and Belvedere 2006). Nevertheless,
Bezic et al. (2010) found a negative impact of co-location of firms on export
performance. Their finding suggests that higher geographical proximity may exert
upward pressure on costs of input (externality of agglomeration). This externality of
agglomeration refers to firm competitive disadvantage specifically for low
technological firms. For instance, sharing knowledge with other firms or linkages
to universities and research institutes would increase the input costs for low-tech
firms which are focused on price competitiveness. On the other hand, a number of
researchers (e.g., van Staveren and Knorringa 2007) argued that the economic
impact of clusters (industrial zone) are reducing the transaction cost between firms,
enabling collective action and improve learning through knowledge spillovers.
Overall, the evidences apparently suggest that firms are located in industrial zones
have higher firms performance. The next hypotheses are as follows;
H3: Firms located in industrial zone has a positive impact on the firms
performance
In summary, there is evidence in the literature suggest that firms with network
alliances such as, joint ventures, R&D collaborations and geographical proximity
(industrial zones) have a significant impact on the firms performance. However,
previous studies (e.g., Malik et al. 2010; Dasanayaka2008) have not provided any

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empirical evidence related to the network alliances i.e., joint venture, R&D alliances
and geographical proximity of Pakistani SMEs. This study contributes to the
existing literature by extending empirical analysis to Pakistani SMEs using two
estimation models.

3 Source of data and descriptive

Source of data: The two-year unbalanced panel data (2002 and 2007) on Pakistani
manufacturing SMEs were obtained from the World Bank Enterprise Surveys. The
Pakistani governments statistical department (Pakistani Bureau of Statistics) does
not have panel data on SMEs at micro level. The researcher was therefore left with
the option of using World Bank Enterprise Survey data. In unbalanced panel data
(longitudinal study) some firms were not observed in 2007 and hence there is
missing information on certain variables in the sample. However, longitudinal data
provide a more accurate inference of model estimators and have a greater degree of
freedom and sample variability than do cross sectional data (Hsiao 2007). The
survey interviewed owner-managers of 780 manufacturing firms from the 13 major
cities of the country. However, for empirical analysis only 391 firms were finally
used because of missing information on sales variable. The survey data provide
information about the countrys overall business environment for 2 years (2002 and
2007). Data provided information on variables such as employment, sales,
innovation indicators, finance, business-government relations, internationalization
and so forth. The researcher analysed the data using his research questions on
innovation and networks and explored the new dimension of the study with
reference to Pakistani SMEs.
To date, very few empirical studies are available on Pakistani SMEs use of
network alliances and innovation variables. The average number of employees is
148 and this suggests that in the sample most of the firms are SMEs. However, size
dummy variables were not created for SMEs because the SMEs definition varies
country to country in terms of sales and employees. The average age of these
manufacturing firms is 18 years. Further, in the survey firms were asked about their
product and process innovations introduced in the previous 3 years; whether they
are located in an industrial zone, subcontracted R&D (R&D alliances). Similarly,
information was gathered on whether the firms have an international quality
certification (ISO 9000) and what proportion of the firms production is directly
controlled by computer (used as technology for production). The reason to include
this variable because one of the methods is to achieve SMEs competitive advantage
is through using the computer integrated manufacturing: SMEs may improve its
competitiveness and efficiency through the implementation of production technology (Marri et al. 1998).
The strength of the data is the availability of longitudinal micro level data which
is very rare to obtain on Pakistani SMEs. However, the dataset has certain
limitations. First, no data is gathered on firms R&D undertaking or spending. This
could suggest that Pakistani SMEs are reluctant to invest directly in R&D activities
because of the high costs and risks involved. Second, there is insufficient

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information provided on the type of networks (e.g., university-industry linkages,

association with research institutions or consultants). Similarly, no information is
provided related to business improvement methods (quality controls) apart from a
question on ISO quality standard certification. Neither is data gathered on patent
granted/counts for measuring innovation performance, which is a better indicator to
measure the quality of innovation. The data are analyzed with Stata 14.
(a)

(b)

(c)

Dependent variables
This empirical paper has used two indicators of measuring SMEs performance i.e., labour productivity (see Mahmood 2008) and product innovation
(see Lin 2009). In the literature firms performance is refers to labour
productivity and innovation performance (product innovation).
Independent variables
The research paper has used three variables such as joint ventures, R&D
alliances and industrial zones to measuring the SMEs strategic alliances. In
addition, a number of researchers (Jong 2006; Wong et al. 2008; Sharma
2003; Musolesi and Huiban 2010) argued that SMEs engaged in product and
process innovation positively influence the firms performance. Product
innovation is defined as new or significantly improved goods/services and
process innovation defined as new or significantly improved method of
production etc. Specifically, process innovation reduces the average cost of
production and significantly boosts the firms performance (see Wolff and
Pett 2006). In addition, quality programs in intra-and-inter firms relations
significantly improve the firms performance. This study has suggested that
quality programs should positively influence the firms performance.
Numerous empirical studies (Chapman and Al-Khawaldeh 2002; Koberg
and Watson 2012; Hoang et al. 2010; Malik et al. 2010) showed the positive
association between quality programs and firms performance. Regarding
quality programs, the International Standard Organization (ISO) is based on
several quality control principles such as customer focus, the motivation of
leadership, process approaches and the involvement of people in the firms
continuous improvement programs. For example, Malik et al. (2010) showed
that ISO-certified SMEs are higher performer than non ISO certified SMEs.
This paper has used firms with ISO certification as dummy variable to
measure the quality programs. Further, managers are highly educated and
experienced. Their knowledge and skills make social contacts with other
firms and such managerial experience positively influence the firms
performance (see Audretsch 2004; Esteve-Escribe and Peinado 2009).
Control variables
Previous studies indicate that there are certain factors that influence the
innovation performance of a firm which needs to be controlled. For instance,
firms size and age are important variables which affect the firms innovation
output. Firms size and age are included as continuous variables in
logarithmic forms.

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3.1 Descriptive statistics

Table 1 shows the number of manufacturing firms distributed according to region
and sector. Most of these SMEs are from the metropolitan cities such Karachi
(n = 155), Sialkot (n = 138), Faisalabad (n = 131) and Lahore (n = 115). Most of
these cities have industrial zones and make significant contribution to the national
income. Similarly, the majority of the firms are in the textiles (27.145), food
(16.52 %), and garments (15.75 %) sector. Textiles are the major export product of
Pakistan. The sector column labelled others represents firms from the marble,
plastic, and furniture industries.
Table 2 provides information on the firms characteristics. Only a relatively
proportion of firms (approximately 21 %) are engaged in product and process
innovation. This implies that Pakistani SMEs have a low innovation output.
Approximately 30 % of the firms have ISO certification of quality improvement. This indicates that majority of the firms use quality control programs
informally without having quality standard certification. As in the dataset, the lack
of information on undertaking R&D and only 12 % of these SMEs to rely
subcontracting their R&D projects to other businesses suggests that overall R&D
culture is very low in Pakistani SMEs. Most of these SMEs (approximately 50 %)
are located in industrial zones (see Table 2). This indicates that these SMEs may
have linkages with other firms in the same industry. For instance, the study of
Nadvi (1992) stated that industrial zones in Pakistan are the major source of
innovation for small enterprises. In these industrial zones, firms collaborate
through vertical and horizontal production interrelations, sharing skills and interfirm division of labour (Nadvi 1992). Only 10 % of the firms were in a joint
venture. This indicates that these SMEs have weak linkages overall with other
firms in the same industry.

Table 1 Number of
manufacturing firms according
to sector and region

City

Sector

Karachi

155

Textiles

212

Sialkot

138

Food

129

Faisalabad

131

Garments

123

Lahore

115

Chemicals

66

90

Electronics

65
42

Gujranwala
Peshawar

66

Leather

Wazirabad

22

Machinery and equipment

Hyderabad

20

Others

Sukkar

16

Sheikhapura

11

Quetta

10

Islamabad

Hub

Total

123

780

18
125

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Table 2 Firm innovation
characteristics (figures are in
percentages)

Yes

No

Total

Product innovation

402

21.39

78.61

100

Process innovation

402

20.65

79.35

100

Quality methods (ISO)

774

30.23

69.77

100

Subcontracted R&D

400

11.75

88.25

100

Industrial zone

402

49.75

50.25

100

Joint venture (with foreign partner)

400

10.00

90.00

100

Table 3 Variable definitions and summary statistics

Variables

Definition

Mean

SD

Labour
productivity

391

Log (sales/number of employees)

13.287

1.4323

Product
innovation

402

Dummy coded 1 if firm is engaged in product innovation

0.2139

0.4105

Process
innovation

402

Dummy coded 1 if firm is engaged in process innovation

0.2064

0.4052

Subcontracted
R&D

400

Dummy coded 1 if firm is engaged in R&D alliances

0.0375

0.1902

Quality (ISO)

776

Dummy coded 1 if firms is ISO certified

0.3023

0.4595

Log size

780

Log (number of employees)

3.5740

1.3534

Log age

780

Log (2007-age)

3.2205

1.2569

Production
tech.

401

Percent of production machine is computer controlled

1.4563

0.9427

Industrial zone

402

Dummy coded 1 if firm is located in industrial zone

0.4246

0.0121

Joint venture

400

Dummy coded 1 if firm is engaged in joint venture with

foreign firms otherwise 0

0.0312

0.1708

Log manager
exp

703

Number of years top manager experience

2.5752

0.8195

Table 3 shows the definition and summary statistics of key variables used in the
regression model. Each variables mean and standard deviation is presented and
shows the overall average values of two year unbalance sample (see Table 3).

4 Econometric models
In this paper two econometric models are used to estimate the relationship between
network alliances, together with innovation inputs and firms performance. First,
generalized least square (GLS) estimates is used by using a random effects (RE)
model for empirical analysis. In order to correct the serially correlated errors, the
feasible generalized least square method is used which is better than ordinary least
square (OLS) because it corrects the zero correlation (for example see model).

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yit b0 b1 xit    bk xitk ai uit

yit is dependent variable with ith firm and in time t, b0 is intercept with explanatory
variables xit in time t, whereas, ai is fixed unobserved heterogeneity (do not vary
over time), and uit is the time varying error affect y (Wooldridge 2007). However, it
is assumed that there is no correlation between ai and xit or in other words, a very
small correlation (see assumption).
Covai ; xi 0

The random effect (RE) model for estimation is,

log LPit b0 b1 Prod:Innovit b2 Proc:Innovit b3 RDsub;it b4 Qualityit
b5 Indzone;it b6 Techit b7 Mgtexp;it b8 JVit b9 Sizeit b10 Ageit
b11 Sectord;it vit
2
where vit = ai ? uit
LP is the log labour productivity [log(sales/employees)] in time t, ith represents
the firm, then product/process innovation. RD shows the subcontracted R&D in time
t, quality is the quality certification (ISO) obtained by a firm in time t. Then states
that whether firms are located in an industrial zone, the use of technology in
production (computer controlled), and joint venture (JI). The last variables are the
sector dummies used in the equation. An additional variable management
experience (Mgt-exp) is included in the model. The error term vit is the combination
of fixed error term (ait) and time varying error term (uit). However, some correlation
was expected between these two errors, so in order to overcome this problem,
pooled OLS coefficients which may result in biased estimates. Feasible generalized
least square (GLS) method is used to reduce their correlation. In addition, random
effects model is used. Moreover, RE assumes that unobserved effect is uncorrelated
with all independent variables, whether independent variables are time invariant or
not. For the random effect model, Breusch Pagan Lagrange multiplier test has been
utilized (See Table 4). This test rejected the null hypothesis of no random effect; in
other words, the test suggests that the model has random effects.
In addition, probit model (using the maximum likelihood method) has been used.
Since the dependent variable is discrete choice (product innovation), which
investigates the relationship between network alliances and innovation performance
(see Table 4). In the probit model it is assumed that error terms are independent and
normally distributed. The model is the following;
y xi b ei

1 yi [ 0
yi
0 yi  0

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Equation 3 shows the example of the probit model. The coefficients are obtained
in Eq. 3 by maximization of the likelihood function.
  However, the coefficients are

obtained through calculating marginal effects

oy
ox

4.1 Empirical results

Table 4 reports the results of generalized least square and maximum likelihood
methods using random effect model.1 The coefficients of process innovation showed
positive relationship with the firms performance. This suggests that firms
introducing significant improvements in their process innovation (e.g., production
or management techniques) would be likely to achieve higher firms performance.
Process innovation reduces the firms average cost of production which results in
higher labour productivity. This outcome confirms the previous finding of Musolesi
and Huiban (2010) and Wolff and Pett (2006) and hence, the initial hypothesis is
accepted. Firms engagement in subcontracted R&D has a positive impact on the
firms performance (labour productivity and product innovation). This apparently
indicates that R&D alliances increase the firms performance. Such collaborative
research alliances (R&D networks) reduce the costs and risks associated with firms
performance (Teirlinck and Spithoven 2013). However, overall low level of R&D
collaboration (12 %) and process innovation (nearly 21 %) suggest that these
manufacturing firms have low innovation input and output. In other words, Pakistani
SMEs are reluctant to undertake innovative projects due to higher innovation cost
and associated risks. Further, it is evident that data is not gathered on their R&D
undertaking.
Similarly, firms with ISO-certification (quality standards) achieved higher firms
performance (labour productivity and product innovation). This finding suggest that
a focus on customer satisfaction, management commitment and using scientific and
statistical tools for decision making (Koberg and Watson 2012) significantly
increased firms performance. However, Pakistani SMEs has the low tendency
(30 %) towards implementing ISO quality programs. Perhaps this indicates that
these manufacturing firms have lower capabilities (e.g., skills employees) to carry
out such quality programs. Further, co-location in industrial zone has a positive
impact on firms performance. This implies that firms can easily share their
production activities; the exchange of employees between firms leads to transfer of
knowledge in such inter-firm relationships (Harris 2009). In other words, this
geographical proximity between firms may result in more innovation activities than
take place in firms which are not co-located. This outcome confirms the prior
expectation. Nevertheless, low R&D collaboration and product/process innovation
suggest that even this geographical proximity of Pakistani SMEs provide fewer
opportunities in terms of innovative collaborations. This may indicates that the
overall lack of innovative culture between domestic SMEs. Production technology
and management experience have a positive impact on the firms performance.
1
The sample size slight increased (n = 400) for probit model because of labour productivity has been
removed as dependent variable. Product innovation (dummy variable) is used as dependent variable in the
second model.

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Table 4 Regression analysis using random effects
Generalised least square (GLS)
model-1

Probit-maximum likelihood
Model 2

Coefficients

t
value

Marginal
Effects

z value

Labour productivity (log)

Product innovation

-0.2565 (0.2640)

-0.97

As dependent

Process innovation

0.5780*** (0.0424)

13.63

0.7802***
(0.2134)

3.65

R&D alliances

0.1547* (0.0841)

1.84

0.7693*
(0.4638)

1.65

Quality methods (ISO)

0.0678** (0.0841)

1.98

0.3987*
(0.2101)

1.90

Industrial zone

0.0674** (0.0325)

2.07

0.4649**
(0.21115)

2.20

Production technology

0.0346** (0.0174)

1.99

0.1642*
(0.0958)

1.71

Management experience

0.0035*** (0.0011)

3.10

0.0142**
(0.0066)

2.13

Joint venture

0.1893** (0.0916)

2.06

0.1022*
(0.0613)

1.66

Size (log)

-0.0003 (0.0004)

-0.70

-0.2120*
(0.1198)

-1.76

Age (log)

0.00195 (0.0110)

0.17

0.2100
(0.1987)

1.05

Food

-0.0294 (0.0421)

-0.70

0.1101
(0.1201)

0.91

Textiles

0.1366*** (0.0359)

3.79

0.2260
(0.3139)

0.72

Garments

-0.0319 (0.0658)

-0.81

0.0898
(0.3509)

0.26

Chemicals

0.0273 (0.0658)

0.42

0.2425
(0.4480)

0.54

Electronics

0.0026 (0.0863)

0.03

0.8894*
(0.6097)

1.45

Leather and Leather products

-0.0121 (0.0659)

0.19

0.1297
(0.4752)

0.27

Machinery and equipment

0.4243 (0.3193)

1.32

0.2506
(0.2134)

1.17

Other

0.04108 (0.0361)

1.14

0.3158
(0.3239)

0.98

Constant

-3.9812*** (1.1448)

-10.5718*
(5.5634)

1.90

Sector dummies

-3.47

Overall R2

0.3120

Sigma

0.0019
(0.0128)

Breusch and Pagan LM test for

random effects

325.25 (v2) 0.0017

(P value)

Rho

0.9531*
(0.6131)

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Table 4 continued
Generalised least square (GLS)
model-1

Probit-maximum likelihood
Model 2

Coefficients

Marginal
Effects

n = 391

t
value

z value

n = 400

Robust standard errors are in parentheses

***/**/* Indicates 1/5/10 % significance levels

Evidence from the literature (e.g., Esteve-Escribe and Peinado 2009) suggest that
firms with production technology; and, qualified; and, experienced management
provide more ideas to innovation, and strategies for higher firms performance.
Furthermore, firms engagements in joint ventures with foreign partners have a
positive relationship with their labour productivity. This indicates that a joint
venture is a good source for inter-firm relationships, specifically with foreign
partners which are superior in technology. This results in greater integration of
resources between local and foreign firms (Lopez-Navarro and Callarisa-Fiol 2013).
This finding supported the initial hypothesis.
Our first empirical model failed to determine the relationship between firm size
and labour productivity. Interestingly, the negative relationship between firms size
and innovation performance suggests that small firms are more innovative than large
firms. This further suggests that small firms with strategic alliances and flexibility
(greater responsiveness to market needs) increase their innovation performance.
Lastly, estimation examined the positive relationship between sector dummies
(textile and electronics) and firms performance. It is indicated that innovative
practices are higher in these two sectors compared to other sectors. Overall, it is
observed that the findings from two econometric models are almost similar and this
confirms the validity of results.

5 Conclusion
This empirical paper has made a significant contribution to the knowledge on Pakistani
SMEs. Two empirical models (GLS and probit) have been used to analyse the
relationship between network alliances (joint venture, R&D alliance and geographical
proximity), innovation activities (product/process innovation, quality methods) and
firms performance. In both models the results were consistent with the prior expectation
from the literature. Engagements in subcontracted R&D, and, joint ventures, as well as
firms co-located in industrial zones had a positive impact on firms performance. Process
innovation, quality methods, production technology and management experience
increased the likelihood of product innovation in a firm. Interestingly, the negative
relationship between firms size and innovation performance implied that small firms
had more flexibility and innovation output than large firms.
This empirical study offers some important policy implications. First, SMEs with
resource constraints can rely on network alliances such as R&D collaboration, and

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inter-firms relations through joint ventures. These alliances provide SMEs with
more access to resources by cutting the cost and risks of innovation. However,
Pakistani SMEs have still weak linkages to universities, research institutions and
other firms. Only a small portion of firms are engaged in strategic alliances. This
implies that robust business-friendly policies are required to encourage their
strategic alliances. This can only be possible when public and private sector
provides them with a platform (e.g., exhibitions, fairs, consultancy, innovative
grants and subsidies for R&D collaboration) to maximize their social networks and
to reduce their costs and risks of innovation. Regarding the managerial implications
of this study, network alliances provide more opportunities to the entrepreneurs/
senior managers in small firms to improve their managerial capabilities from
management teams of other highly innovative firms. However, these network
alliances must be focused in order to boost the firms performance.
The main limitation of this study is first, the lack of available data on the type of
relationships (intra-inter firm, university-industry linkages), patent counts, and R&D
spending. In future research, data on these variables may provide much better
analysis of SMEs networks. Second, two-year panel data is not sufficient to capture
the long-term effects of productivity and innovation and a study over a longer period
of time could provide a better outcome. Third, total factor productivity is a far better
indicator than labour productivity. Lastly, the results of this paper cannot be
generalized to other countries in the world because each country has different
demographic and economic factors.

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