OLD TITLE:
STRATEGIC PERFORMANCE EFFECTS AND GROWTH: RESOURCE DEPENDENCE AND RELATIONAL ARCHITECTURE
NEW TITLE (please):
Innovation and Firm Growth:
How the Interplay of Trust and Dependence in Supply Chain Relationships Matters
ABSTRACT
We argue that firm growth is not simply an effect of a firm’s internal resources but also subject to strategically leveraging those within the supply chain. Drawing on data of 474 supplier firms, this study offers important insights into better understanding why some supplier firms that are embedded in vertical supply chain relationships are more effective in converting their innovation activities into growth than others are. First, we show that the supplier firm’s strategic innovation capacity can matter in enhancing growth. Second, we demonstrate that supplier firm growth ensuing from such an innovation capacity can be influenced by the customer firm’s requirements specification capability. Third, we outline how the extent to which the customer firm’s requirements specification capability affects the growth impact of the supplier firm’s innovation capacity is conditional on the levels of inter-firm dependence and trust.
Keywords: firm growth, innovation capacity, dependence, trust, dynamic capabilities
INTRODUCTION
In pursuing growth, firms exploit their resource base (Barney, 1991) or expand through innovations which they can do internally (Jonash and Sommerlatte, 1999; Roberts, 1999; Figg, 2000) or externally in collaboration with other firms (e.g., Tan and Tracey, 2007; Gudergan et al., 2012). In fact, many CEOs consider the use of collaborative ventures as a crucial pathway to generate or sustain business growth (PwC, 2011). According to PwC, close to 40% of those CEOs assume that the greater part of their innovations will be generated in collaboration with external partners. Often, it is certain supply chain relationships that foster innovations and ensuing growth (Desbarats, 1999; Roy et al., 2004; Zsidisin and Smith, 2005; Tan and Tracey, 2007). For example firms in the automotive and IT industries are known to emphasize innovation in their supply chain management (Christopher, 1998; Baker, 2007; Jüttner et al., 2007). Indeed, strategic supply chain relationships are seen as critical to enhancing performance and developing innovation capacity (Soosay et al., 2008; Wang and Peng, 2008). However, although supply chain collaborations are a means to enhance firm growth, failure rates in such collaborations range from 30–70%, suggesting that it is difficult to realize growth through collaborations with external firms (Kaplan and Rugelsjoen, 2010).
In this study we broadly seek to understand why some supplier firms that are embedded in vertical supply chain relationships are more effective in converting their innovation activities into growth than others are. Addressing this question is important for several reasons. First, notwithstanding that firms within a variety of industries have extended their innovation activities across firm boundaries and different supply chain stages (Azadegan, 2011), empirical insights concerning the effectiveness of innovation activities in supply chain alliances suggest that, although some suppliers improve their performance (Kotabe et al., 2003; Arend, 2006), others do not (Parkhe, 1993). And misaligned supply chain relationships can result in a slowing in overall sales growth (Blanchard, 2007). Hence, discerning differences in how supplier firms leverage their innovation capabilities can provide useful insights into better understanding how they generate growth through supply chain relationships.
Second, Roy et al. (2004) suggest that innovation is not entirely internal to the supplier firm but influenced by supply chain members. For example, Quesada and Syamil (2006) show that firms that are embedded in a supply chain can strengthen their innovativeness by involving suppliers in the innovation processes. And, upstream partner involvement in innovation activities is considered a source of performance improvement and growth for supplier firms (Dyer and Singh, 1998; Johnson, 1999; Wagner and Hoegl, 2006). The specific ways by which the supplier firm can better leverage their innovation efforts to improve firm growth through involvement of customer firms are less clear, however. We know that their marketing capabilities that support the development of products in ways that customer firm requirements can be met and loyalty can be produced (e.g., Srivastava et al., 1998; Hooley et al., 2005; Vorhies and Morgan, 2005) also foster better leverage of their innovation activities (Weerawardena and O'Cass, 2004). But we question whether the customer firm’s capabilities to specify and convey appropriate product requirements affect the supplier firm’s capacity to convert innovation activities into firm growth. Such customer firm requirements specification capabilities are commonly reflected in the extent to which these firms stipulate and direct product design details to their supplier firms in form of, for example, upstream directives (Bouncken, 2011b). Generally, business partners are considered a key source of innovations (von Hippel, 1998) and a firm’s ability to absorb knowledge gained externally is critical to successful innovation (Cohen and Levinthal, 1990). Indeed, business relationships enable firms to access complementary capabilities that are required to develop and commercialize new products (Rothaermel et al., 2006) and value creation is possible when business partners create unique configurations of capabilities (Hamel, 1991; Dyer, 1996; Murray and Kotabe, 2005). However, although we know that such capability configurations within business relationships affect innovations (Gudergan et al., 2012), there is no empirical insight about whether and, if so, how supplier firm growth ensuing from innovation activities is influenced by the customer firm’s requirements specification capability. This is in contrast to a well substantiated understanding that customer firms, themselves, benefit from linking their internal processes to external suppliers (Reck and Long, 1988; Cammish and Keough, 1991; Morris and Calantone, 1991; Frohlich and Westbrook, 2001).
Third, realizing the actual value of such external customer firm capabilities involves combination and exploitation activities (Penrose, 1959; Zahra and George, 2002; Denrell et al., 2003; Nielsen and Gudergan, 2012) and the capacity to effectively leverage such capabilities where they are required is critical to innovation success (Burgelman and Maidique, 1988). Such combinative capacity facilitates leveraging capabilities and resources (Koruna, 2003) and integrating knowledge (Kenney and Gudergan, 2006). Ultimately, it fosters creation of new value (Vainio, 2005) and innovation (e.g., Henderson and Clark, 1990; Kogut and Zander, 1992). In this sense it is akin to dynamic capabilities that are “dedicated to the modification of capabilities” (Cepeda and Vera, 2007) and imply the supplier firm’s “capacity ... to purposefully create, extend, and modify its resource base” (Helfat et al., 2007, p. 4). This combinative capacity facilitates the novel synthesis of external and internal resources into new innovations (Bowman and Ambrosini, 1997; Galunic and Rodan, 1998). The inter-firm dependencies surrounding this combinative capacity to leverage external customer firm capabilities so that the supplier firm’s innovation impact can be strengthened, however, reduce supplier firm autonomy and ascribe behavioural uncertainty to this capacity. Such dependence on and behavioural uncertainty concerning the customer firm capabilities render the effectiveness of the supplier firm’s combinative capacity uncertain (Pfeffer and Salancik, 1978) unless trust mitigates uncertainty about the customer firm (Krishnan et al., 2006). The extent to which the customer firm’s requirements specification capability affects the growth impact of the supplier firm’s innovation capacity subject to inter-firm dependence and trust is, however, not yet clarified.
This paper offers the following contributions. In drawing on Teece et al. (1997) and Teece (2007) we explain how, in vertical supply chain relationships, supplier firm growth can be subject to their strategic innovation capacity and that this impact can be contingent on the customer firm’s requirements specification capability. Then, drawing on Pfeffer and Salancik (1978; 2003) we clarify how the contingency effect concerning these customer firm’s capabilities is conditional on the level of supplier firm’s dependence and trust. In drawing on a sample of 474 supplier firms that are involved in supply chain relationships, we empirically substantiate these arguments. Combined, our theoretical arguments and empirical insights, offer a refined understanding concerning firm growth conditional on their strategic innovation capacity within the setting of supply chain relationships.
Next, we describe the theoretical background and resulting hypotheses. The presentation of the research approach details the sample selection and description, measures, and analysis procedure. We then present results of our survey from 474 senior managers, before concluding with a discussion of the findings and implications for theory and practice.
THEORY AND HYPOTHESES
We draw on the dynamic capabilities view (Teece et al., 1997) and resource dependence theory (Pfeffer and Salancik, 1978; 2003) to substantiate our arguments about supplier firm growth in vertical supply chain relationships. We do so by developing a set of hypotheses to elucidate the impact of the supplier firm’s innovation capacity on growth given differences in customer firm requirements specification capabilities conditional on the extent to which trust and dependence characterize the vertical supply chain relationship.
Firm Growth and Innovation Capacity
Penrose (1959) suggested that firm growth is, for the most part, shaped by the capacities of its management; the so-called Penrose effect. As management undertakes to leverage resources through the development of capabilities, a dynamic interacting process occurs that fosters a continuous rate of growth of the firm. This growth is subject to the creative and dynamic interaction between a firm’s productive resources and its market opportunities (Penrose, 1960). Mahoney (1995) underlines her argument that firms grow due to the effective and innovative management of resources. However, although Penrose (1959) implies that the sources of innovation lie predominantly, if not exclusively, within firms (Pitelis, 2002), we argue that the above logic also applies to firms that emphasize innovation in their supply chain management (Christopher, 1998; Baker, 2007; Jüttner et al., 2007).
In further refining the understanding of how resources affect firm performance, Teece, et al. (1997) suggest that differences in firm growth and survival are based on divergences of dynamic capabilities across firms. Resources are, for example, inputs to production that a firm controls or has access to (Amit and Schoemaker, 1993), while operational capabilities enable the deployment of these resources (Wang and Ahmed, 2007). Such resources and operational capabilities are, however, essentially static in nature and may become less effective in changing environments (Leonard-Barton, 1992). Dynamic capabilities facilitate the firm’s pursuit of the renewal of these resources and operational capabilities to adapt to volatile environments (Winter, 2003; Helfat et al., 2007). They are “dedicated to the modification of capabilities and lead, for example, to [innovative] changes in the firm's products or production processes” (Cepeda and Vera, 2007). In our context, we conceptualize them as the supplier firm’s “capacity ... to purposefully create, extend, and modify its resource base” (Helfat et al., 2007, p. 4). Thus, although resource abundance is assumed to enhance prospects for survival and growth (Penrose, 1959; Stinchcombe, 1965; Hannan, 1998), it is the way by which their leverage can be modified over time—based on the deployment of dynamic capabilities—that determines how firms can sustain growth over time. Hence, growth is governed by the creative and dynamic interaction between a firm’s productive resources and its market opportunities (Penrose, 1960).
Dynamic capabilities can serve a variety of purposes (Helfat and Winter, 2011) including the creation of innovation (Lorenzoni and Lipparini, 1999; Karim and Mitchell, 2000; Marsh and Stock, 2006; Pavlou and El Sawy, 2006) which is a key process of organizational renewal (Winter, 2003). Such an innovation capacity refers to a firm‘s ability to develop new products and markets, through aligning strategic innovative orientation with innovative behaviors and processes (Wang and Ahmed, 2004). This capacity encompasses the firm’s routines to formulate and implement an innovation strategy involving the creation, extension and modification of those resources and capabilities used for innovation (Dodgson et al., 2008). These notions are aligned with the positions of Nelson and Winter (1982), who considered innovations as involving changes in routines, and of Schumpeter (1934), who identified innovations with the “carrying out of new combinations” (pp. 65–66), that influenced Teece et al. (1997) in formulating the dynamic capabilities view.
According to this perspective, supplier firms in vertical supply chain relationships with a greater innovation capacity would outperform their competitors and accomplish a relatively greater rate of growth (Penrose, 1959; Teece et al., 1997; Helfat et al., 2007). Notwithstanding that some empirical studies have reported a positive relationship between dynamic capabilities and performance (e.g., Jantunen et al., 2005; Arthurs and Busenitz, 2006; Protogerou et al., 2011), our understanding concerning the relationship between dynamic capabilities and firm growth is, however, still underdeveloped (Di Stefano et al., 2010), in general, and within the context of inter-firm relationships, in particular.
General studies that have focused on empirically examining the link between innovation and sales growth vary in their findings and understanding the role of innovation in business relationships remains a challenge. For instance, Roper (1997) and Wolff and Pett (2006) found that a firm’s capacity to innovate influences its product improvements and, further, its growth performance. And Geroski and Machin (1992) observe that innovating firms are both more profitable and grow faster than non-innovators but also show that the influence of specific innovations on sales growth is short-lived. Then, Bottazzi et al. (2001) do not find any significant impact of a firm’s innovative position on sales growth. These inconsistent findings might be, to some extent, based on such studies having deployed different measures concerning innovation. Given our theoretical arguments and some empirical support for the impact of innovation on firm growth, we put forward:
H1: Greater growth of supplier firms that operate in vertical supply chain relationships is associated with a greater strategic innovation capacity.
Customer Firm Requirement Specification Capabilities
Although a firm’s internal capabilities are primary drivers of innovation (Dosi, 1982) innovation is also driven by a firm’s external partnerships (von Hippel, 1988). Valuable ideas can come from inside or outside the firm (Chesbrough, 2003; Laursen and Salter, 2006; Lyles and Gudergan, 2006; Lu et al., 2008; Bouncken and Kraus, 2013). Hence, it is insufficient to rely on resources and capabilities residing within the firm only to innovate and reconfigure operational capabilities that enable sustainable growth (Chesbrough, 2003; Fey and Birkinshaw, 2005; Foss et al., 2011). Resources and operational capabilities that were traditionally developed internally are now increasingly accessed outside the firm’s boundaries (von Hippel, 1988; Baum and Silverman, 2004; Laursen and Salter, 2006; Rothermael and Deeds, 2006); implying that inter-firm relationships play an important role in shaping innovation performance (Shan et al., 1994; Powell et al., 1996; Walker et al., 1997; Baum et al., 2000; Caloghirou et al., 2004; Owen-Smith and Powell, 2004; Pitsis and Gudergan, 2010).