Effectiveness of smes’ innovation and entrepreneurship the role of leading enterprises

Economic Management Journal August 2014, Volume 3, Issue 3, PP.41-50

Effectiveness of SMEs’ Innovation and Entrepreneurship: the Role of Leading Enterprises Dongchu Cui School of Economics and Management, Yanshan University, Qinhuangdao, 066004, China Email: cuidongchu@ysu.edu.cn

Abstract The purpose of this paper is to capture the behaviors in small micro-firms’ innovation and entrepreneurship sufficiently in China.

Because the results of previous study on this (more venture capital, new markets, new products, new technology, new governance structure and national policy) have not effectively reflect the essence of the problem. This paper uses an extensive firm-level data (a sample of 1232 Chinese small micro-firms) and applies Analytic Hierarchy Process analysis. We visit the firms and interview the managers and government leaders, then we issued questionnaires to the firms. By using AHP, to analyses the data. We find the leading firms can effectively drive the small micro-firms’ transformation and upgrading. Our findings contribute to the empirical literature concerning the role of leading enterprises and will also help the government to formulate policy.

Keywords: Micro and Small Enterprises; Innovation and Entrepreneurship; Leading Enterprises

1 INTRODUCTION The aim of this paper is to find out which method is the most effective in small micro-enterprises’ (SMEs) innovation and entrepreneurship in China. Typically, long-term survival requires SMEs to revitalise their business and stay competitive (Lavy and Merry 1998; Shaheen 1994; Chen 1992). This need is even greater in China. After implementation of economic reform and the Open-door Policy, China has emerged gradually as a global economic power. But the economic growth is inefficient: the irrational industrial structure, resource and environmental constraints are becoming increasingly acute, the economic growth rate dropped and the price is still high intertwined.

These difficulties faced by the real economy are significantly increased. For SMEs engaged in the real economy, transformation and upgrading is imminent.

On recognising this need, an increasing number of studies have begun to find the path for the firms’ development (Jiang 2007; Zhou 2010). Some researchers discovered endogenous innovation (Krugman 1999; Rainer A, Franco N 2005), integrated innovation (Rothwell and Dodgson 1992; Naushad Forbes and David Wield 2000; Kin and Lee 2001; Pavitt Freeman and Patel 2002) and self-determined innovation (Chen 1994; Shi 1996; Xu and Chen 2006; Wang 2007) help firms transfer, some acknowledge Foreign Direct Investment (Damijan 2003; Bwalya and Samuel Mulenga 2006; Yokota et al.2010; Sinani et al.2004;Khaled Elmawazini 2010; Sun 2005; Wei 2007;Guo 2008) influence the transfer and some explore the effect of organizational learning (Shaker A. Zahra 2012) and entrepreneurial orientation ( Ranch et al.2009; Thomas Zellweger and Philipp Sieger 2012) on firms’ renew operations.

This paper aims to explore the key success factors of the SMEs’ transformation and upgrading. We apply the theory AHP as our method, analyse the data gathered from questionnaires and interview. All the samples are chosen from Hebei province in China. After the first stage of interview, we extract 6 key success factors for the SMEs’ innovation and entrepreneurship, such as financial support, introduction of technology or R&D, broaden the market, policy support, entrepreneurial learning and leading effect of the leading firms. We make questionnaires by using the above - 41 www.emj-journal.org

factors and use AHP to analyse on data drawn from 1232 SMEs to test which factor helps the firms to transfer its operation type effectively.

The study contributes to SMEs’ innovation and entrepreneurship literatures in that it helps to explain the main driving force of SMEs in China, which has been ignored in general. Within the Chinese context, our chief purpose is to highlight and explain the SMEs’ effective transformation path. Our study also exploits how Chinese culture affect the entrepreneur’ behaviour and allows readers to better understand the development of SMEs in China.

The remainder of the paper is structured as follows. First, we review the literature on innovation and entrepreneurship in extant research. Second, we illustrate our case research methodology and describe the firms we examined. Third, we present and discuss the results of our analyses. Finally, we discuss our insights, examine limitation, and indicate avenues for future research.

2 LITERATURE REVIEW 2.1 Micro and Small- Firms In both developing and developed countries, the vast majority of firms are SMEs. Approximately 97% of firms in Mexico and Thailand are SMEs (Kantis, Angelli, and Koenig 2004; Simmons 2004). In the United States, the number is over 98% (US Small Business Administration and Census Bureau, 2010). In China, over 99% of businesses similarly have fewer than 100 employees (National Bureau of Statistics of China, 2012). Some researchers figure the number may be twice as high as what is reported (Mead and Liedholm, 1998). In this paper, we state: H1 The firms we studied are all registered in the business sector, belong to the state statistical range. The leading firms refer to the ones have a deep impact, appeal and demonstration on other firms in the same industry in the region.

We define SMEs in china as those with less than 300 employees and the main business income below CNY 20 million1. The SMEs sector generates substantial employment and economic output in many countries. Their share of overall employment tends to be higher in developing countries, which are typically more focused on small-scale production (Tybout, 2000). There are 10.23 million SMEs in China, which is 99% of the total number of Chinese firms, and their final goods and services accounted for about 60% of the gross domestic product (GDP), their tax paid accounted for 54.3% of the country's corporates and they provide 85% of the urban and rural jobs. The firms covers the major sectors of the national economy, including 84 industry categories and 362 industry classes and 859 industry subclasses. These firms are closely related with the employment, economic growth and social stability (Ijiri and Simon 1964; Brich 1979; Picot et al. 1994; Urata and Kawai 1999; Li et al. 2003; Fang 2008; Xu 2007). The intensity of them determines the income level of urban and rural residents, the more developed regions of the small and micro firms, the wage income of urban and rural residents and property income is higher (Qian et al. 2011; Yang 1995; Zhang 2007).

Some researchers (Simon and Lara 2009) explore factors associated with small firm growth: (1) individual entrepreneur characteristics; (2) firm characteristics; (3) relational factors (such as social networks or value chains); and (4) contextual factors (such as the business environment). However, these factors can’t explain why do some MSEs expand rapidly while others stagnate in China, even if policy-makers and practitioners target customized export programmes to the specific situational demands of established micro and small firms (Paul, Mike and Deniz 2002).China represents a new model of development in several important respects: industrial upgrading efforts are often domestically driven (Loren and Erick 2010). To encourage wealth creation and to secure greater international competitiveness, the Chinese government in the 12th Five-Year (2011-2015) Plan outlines the important instructions 1

The standard is in accordance with National Bureau of Statistics of China. The samples we use in this paper are all from the mechanical industry, so we choose the industry division standard of large/medium/small/micro sized enterprises which is slightly different from the other industries.

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of the transformation and upgrading for all enterprises.

2.2 The Role of Innovativeness Innovativeness is considered a key factor for the transformation and upgrading in China, especially in SMEs. Since most SMEs always imitate the innovation or integrate innovation in China, which are different from innovate. In this paper, we consider the process of innovate is the process of transformation and upgrading for SMEs. Transformation and upgrading are two different words but related. Most researchers define transformation as the process of changes in business strategy and organizational. Which is also called Second Oder Change (Lavy and Merry 1998). The purpose of transformation in firms is to improve the operating performance, ongoing competitiveness (Shaheen, 1994) and form a new model for future operations (Chen 1992). The concept of upgrading—making better products, making them more efficiently, or moving into more skilled activities—has often been used in studies on competitiveness (Kaplinsky, 2001; Porter, 1990). The concept of upgrading may be effectively described for enterprises working within a value chain, where four types of upgrading are singled out: process upgrading, product upgrading, functional upgrading, and intersectional upgrading ( Humphrey and Schmitz 2000 ). In this paper, we use the concept of transformation and upgrading as follows2: transformation refers to change the mode of industrial development; upgrading refers to promote the overall industrial structure optimization and upgrading through a comprehensive optimization of the technical architecture, organizational structure, layout structure and industry structure. From this concept, we formulate the following hypothesis: H2 The firms will face difficulties in the long run if they do not carry out transformation and upgrading. They have the wishes of transformation and upgrading, at least not excluded.

H3 The government provides policies support to the transformation and upgrading firms, such as preferential tax policies, financial support, land concessions and so on.

Previous research on firms’ methods of transformation and upgrading has stressed on three parts: internal capacity, technological innovation and international distribution.

The starting point for firms’ internal capacity system research is that the division of labour can increase the firm’s production efficiency (Adam Smith 1776). Then the entrepreneur's role is strengthened, entrepreneur is considered to be the main operation to promote the market structure (Marshall 1890, 1925). More detailed study found that the heterogeneity of enterprises makes the enterprises in an imperfect competition condition (Chanberlin E 1933, Robinson 1934).Enterprises expand the operating capacity by the internal accumulation of knowledge,thus promoting the growth evolution (Edith Penrose 1959). This accumulation of knowledge is the result of internal, promoted by production resources and will lead to the growth of management strength. Around this topic, the researchers have different points of views: one faction proposes the resource-based view of the firms (Birger 1984; Richard 1984; Sideny 1987; Peter 1993), they focus on the factor markets rather than the product markets and they believe core resources are the key to business success; another faction proposes the capacity-based view of the firms (C.Prahalad and G. Hamel 1990; George and Philip 1992; David, G.Pisano and A.Shuen 1997), they emphasis to the unique ability of firms’ production, business activities and processes as a starting point to enterprises’ development.

Technological innovation has been the hot spots of firms’ transformation and upgrading. Schumpeter’s innovation theory (Schumpeter 1934, 1939) inspired the follow-up study. He finds innovation is the endogenous production process, must be able to create new value and at the same time means destruction. Other researchers show the quantitative analysis by technological innovation, such as Solow growth model (Solow 1956), interaction model (R.Rothwell 1994) and so on. Solow growth model introduces technological progress into the economic development, and interaction model shows business innovation is an integration progress from the inside to outside.

Moreover, other empirical research based on international distribution by John Cantwel et al. (John Cantwel et 2

The concept is according to the notice of industrial transformation and upgrading plan (2011-2015), which is promulgated by the State Council of China.

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al.1999, 2002, 2004, 2007) showing the factor that affect the enterprises to upgrade is foreign direct investment (FDI). They suggest that that multinational corporations MNCs. emanating from the most important locations in their industry are more likely to evolve towards technological strategies of geographically differentiating their innovative activities abroad, MNCs originating from weaker centres in the same industry tend rather to evolve towards a strategy of replicating in the profile of their technological development abroad the pattern of their home country specialisation and increasing FDI is also a factor causing the emergence of newer countries with the more sophisticated technology generation associated with patenting.

2.3 Influencing Factors of Innovation and Entrepreneurship in Smes We divide the study of factors of innovation and entrepreneurship in SMEs into two types: internal factors and external factors.

Resource of economic rent is considered to be the driving force of business growth. Firm is a management framework of the collection of heterogeneous resources. Its growth in real terms performs the expansion of the collection of resources. To gather the external resources, two basic conditions are required: (1) the economic rent pay to gather the external resources must be not less than the existing income; (2) The enterprise must maintain paid to the existing internal resources not less than the existing benefit of the economic rent. So the growth process of the firm is the pursuit of a higher level of economic rent. The economic rent is divided into three types: the Ricardian rents, the Chamberlinian rents and the Schumpeterian rents. The Ricardian- rents is based on the scarcity of resources, and it is the primary form of rent. It entirely from the heterogeneity of the resource (including tangible and intangible resources) owned by the enterprises itself. The intangible resource including organizational practices, corporate reputation is difficult to imitate. The Chamberlinian-rents is based on the high entry costs, scale advantages, as well as the strong market share, it is temporary and not sustainable. The Schumpeterian-rents is based on the innovative behaviour of entrepreneurs’ insight and risk appetite.

The external growth factor is the prevalence of uncertainty. Exogenous uncertainty is the uncertainty arising from external causes, also known as environmental uncertainty, it has nothing to do with the economic entity's own nature and capacity. There are two kinds of uncertainty, exogenous uncertainty and endogenous uncertainty, while exogenous uncertainty can be divided into transaction uncertainty and behaviour of two kinds of uncertainty. The goal of Business growth is to reduce uncertainty. Milliken (1987) proposed a general definition of environmental uncertainty: due to lack of information or no ability to distinguish between relevant and irrelevant data, the individual was not accurately predicting the environment of the organization. Environmental uncertainty is the sources of uncertainty and cannot be avoided. Knight thought the basic approach of SMEs to cope with uncertainty is centralized. Kerzner (1973) thought that entrepreneurs could perceive and capture opportunities for excess economic rents, this ability of entrepreneur is known as the Entrepreneurial Orientation. The general uncertainty in the economic system led to the scattered and asymmetric of information, the innovation is essentially an opportunistic behaviour based on the information asymmetry, which can make each market participant have the opportunity to break the existing the competitive position of the dominant enterprises to access and create new economic rent. Its root is that through the enterprise its own behaviour, to create uncertainty, to obtain a reduced advantage relative to competitors’ endogenous uncertainty.

3 METHOD 3.1 Sample and Data Collection Table 1 shows the sampling frame consisted of the eleven types of enterprises, with the total number one thousand and two hundred thirty-two from four majors cities of Hebei Province. To ensure the accuracy of the survey data, we conducted face-to-face interview with the governments, the firms and the researchers. With the help of government authorities, the research was progressing well, the entrepreneurs participated in the discussion on time, filled in questionnaires carefully and returned them back on time. Without the help of the governments’ help, the study may be difficult.

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TABLE 1 SAMPLES USED IN THE ANALYSIS Company type

number

region

1.machinery manufacturing 2.high-tech companies 3.travel agency 4. winery 5.cake shop 6. clothing store 7.hotel 8. foreign trade company 9. organic food company 10.cultural centures 11. real estate companies

409 234 189 127 52 41 40 46 35 31 28

Xingtai Qinhuangdao, Tangshan, Shijiazhuang Qinhuangdao Qinhuangdao Shijiazhuang , Qinhuangdao Shijiazhuang , Qinhuangdao Qinhuangdao , Tangshan, Shijiazhuang Tangshan , Qinhuangdao Qinhuangdao Qinhuangdao Tangshan , Qinhuangdao

Note: the governments recommended the selected aeras, the companies we selected are the representatives of the same type.

3.2 Measures The research took the forms of informal discussion survey, on-the-spot investigation and questionnaire survey. The respondents are all from SMEs in Shijiazhuang City, Tangshan City, Xingtai City and Qinhuangdao City in Hebei Province, in China.

A total of twenty informal discussions were organized in these four cities from 2010 to the present, four of them are discussions with local government officials, and the rest are discussions with the entrepreneurs. Discussions with the government are to understand the support policies about enterprises’ innovation promulgated by local government.

Learned through the discussions, the Government's policy is very comprehensive, including financial support, inspire technological innovation, the introduction of personnel incentives, taxation and land preferential policy, and even some government also took the initiative to come forward for companies looking for venture capital to invest. But the strange thing is that under these preferential policies the development of SMEs doesn’t change, nor the change in innovation. So the other seminars were organized with the entrepreneurs or the representatives. Each discussion invited 20 representatives from different companies, and a total of 320 representatives of small micro-enterprises take part in the discussion. Most of the representatives (nearly 80% of the total) said, although the government provides a lot of good policies, but these policies have a large range of additional conditions, they can’t promote the development of SMEs effectively, and there are also serious lag, many implementation policy cannot effectively solve the existing problems of small and micro enterprises facing. They also They also said they would rather maintain the status quo, and do not like easily to incline to innovation or entrepreneurship, even if their market share is getting smaller and smaller, as long as there is a market they will not easily change, unless they see some other enterprise get more profits from innovation and entrepreneurship, they will consider innovation. This phenomenon is very strange, because the Chinese government's policy has played a significant role in the development of enterprises, once the government policy support, the enterprise will have much room for development. In order to verify this phenomenon is prevalent in SMEs, we select other firms for on-the-spot investigation.

The on-the-spot investigation costs us nearly four months, nine hundred and twelve SMEs were surveyed. Finally we found that the factors on innovation and entrepreneurship in SMEs did not show significant correlation with entrepreneurs’ individual differences, such as the education level, personal experience and different personality characteristics and so on. This result is contrary to our expectations, because we have been considered that entrepreneur-oriented have a great impact on innovation of enterprises. In order to investigate the results of quantitative analysis, we designed a questionnaire.

One thousand and two hundred thirty-two questionnaires were distributed to SMEs, after the seminars and the onthe-spot investigations. The main part of the questionnaire is very simple, in order to avoid the respondents be confused by the options, there is no option, only the score. By the help of the government departments, the questionnaire issued out eventually fully recovered.

3.3 Methods We used the analytic hierarchy process (AHP) to indicate which factor or factors are the most effective in SMEs’ - 45 www.emj-journal.org

innovation and entrepreneurship. This method was proposed by Thomas Ossetia (1980). This method is very practical and effective in dealing with complex decision problems.

Firstly, we established a hierarchical model (shown in fig.1), including the target layer, rule layer and scheme layer.

Then we constructed in pairs comparison matrix. From the second layer of the hierarchy model to the lowest level, each factor in the subordinate (or influence) on the same floor should be compared, we used the 1-9 comparison scale to construct pair-wise comparison matrix. Thirdly, we calculated the weight vector and did the consistency test.

Finally we calculated of portfolio weight vector and did a combination of consistency test. In this paper, we use the software yaahp v 0.5.3 to calculate the matrix.

FIGURE 1 A HIERARCHICAL MODEL OF SMES’ INNOVATION AND ENTREPRENEURSHIP

Influencing factors of SMEs’ innovation A

market environment B1

comprehensive strength of the enterprise itself B2

policy support B3

innovation policy C9

fund-raising policy C8

government policy C7

the entrepreneur-oriented C6

corporate finance situation C5

R & D capabilities C4

threats from competitors C3

C1

leading firm’s behavior C2

market demand

Note: the factors shown in fig.1 are the main factors summed up through the informal discussions. The questionnaire is is also designed based on these factors.

4 RESULTS Table 2 is the calculated result based on one of the questionnaires, according to this questionnaire, the consistency test is 0. That means this questionnaire is pretty standard idealized. In fact most of the questionnaires cannot meet this ideal state, as long as the consistency of test results is between 0 and 0.1 that will be in line with our requirement.

TABLE 2 OVERALL WEIGHT CALCULATION

C1 C2 C3 C4 C5 C6 C7 C8 C9

B1 0.4545 0.1429 0.7143 0.1429

B2 0.0909

B3 0.4545

0.0909 0.4545 0.4545 0.6 0.2 0.2

results

ranking

0.0649 0.3247 0.0649 0.0083 0.0413 0.0413 0.2727 0.0909 0.0909

3 1 3 9 5 5 2 7 7

Table 3 shows the results through statistics calculated on all valid questionnaires. Among them, the firms engaged in winery, hotel and real estate choose C7-government policy as the main factors, that is due to the restrictions of policy of Hebei Province on related industries, foreign trade companies develop poor in general in the context of the existing world economic environment. The initial investment in the organic food companies is very important, so - 46 www.emj-journal.org

they need financial support badly. Even so, C2 is still in top three in the factor ranking in these firms.

TABLE 3 THE MAIN INFLUENCING FACTORS OF THE SAMPLES Company type

number

number of valid questionnaires

main factors

1.machinery manufacturing 2.high-tech companies 3.travel agency 4. winery 5.cake shop 6. clothing store 7.hotel 8. foreign trade company 9. organic food company 10.cultural centures 11. real estate companies

409 234 189 127 52 41 40 46 35 31 28

389 228 170 116 45 34 29 38 27 26 20

C2 C2 C2 *C7 C2 C2 *C7 *C1 *C8 C2 *C7

FIGURE 2. THE PROPORTION OF EACH INFLUENCING FACTOR

5 DISCUSSION Through investigation, we found not only the main factors affecting the business innovation, but also understand the main problems in SMEs’ development in China. Currently, SMEs in China are facing the main problems of capital, employment, technology and innovation. These problems are so difficult to solve, so the firms are more willing to choose the way of other companies through development, rather than another way.

Take financing for example, the SMEs need a lot of funds to develop, although the government departments enacted many support policies for SMEs’ financing, but the funds used by the firms are very little from banks or other financial institutions, most funds are from the firms’ own funds or borrowed from friends and family. Why this happen? The entrepreneurs answered this question, the first reason is the relatively high threshold for the bank, even if there is policy support, but most policies have certain conditions attached, you need to have enough plants or others as collateral mortgage, because of the limited strength of SEMs, it is difficult for SMEs to conform the lending standards. In addition, even some of the SMEs meet the requirements of the loans, banks are usually unwilling to lend funds to the so risky small micro-enterprises, a lot of the companies surveyed have signed a loan contract with the banks, but they are all dragged by banks with the grounds of insufficient capital supply. This phenomenon is more common in small micro-enterprises. The private lending is more popular among SMEs, but there is no legal protection for it in China right now, so there are some problems which we will conduct in-depth study in the future. That’s why the role of financial flows to no avail in SMEs’ Innovation in China.

Another problem the SMEs faced is the employment difficulties, not to mention the employees to engage in innovation, the most basic labour workers or skilled workers are difficult to hire in these firms. At the same time, a large number of graduates are faced with tremendous pressure on employment. But neither of them wants to - 47 www.emj-journal.org

establish an employment relationship with each other. Why? One side is the shortage, one side is the surplus. The representatives of SMEs said that the actual operating capacity of these graduates is weak and they also have jobhopping tendencies, when they became trained they will quit, that will cause losses. The graduates said that these enterprises are not guaranteed, may collapse at any time, they will face a higher risk. Most of the SMEs are using high-paying employment, which to ensure the normal operation of the enterprise but increase the cost of doing business, so how to survive is the first issues to consider. Graduates are to obtain more civil servants or to secure state-owned enterprises, therefore, more and more are eliminated and they are still unemployed. What is the root of the problem? Education system? Business growth environment? Or the laggard Social Security System?

Science and technology should be the driving force of the business innovation, but the surveys rarely have their own proprietary technology or patents, most of the enterprises have no R & D institutions. When we asked them whether they were worried about being eliminated in the future. They said they can survive for at least five years relying on the current market share. When we asked how to do after five years? They said, there are many similar enterprises, how they do, how we would do. Of course, there are a part of SMEs who do well in R & D, they have a special R & D team and have their own patented products, but the development of these enterprises are based on providing products for large enterprises, from a certain perspective. Their innovation is driven from large enterprises, rather than their own drivers. The technological progress of the remaining companies are from imitation, take machinery manufacturing enterprises for example, the technological progress of the research enterprise are all through buying technology products from other technology leadership, and then imitate. Why do they all refused to technology research and development or evade the R & D? Because there is no one will share the risk of the failure in technological innovation.

For these above reasons, how SMEs to innovate? China does not have the soil of innovation for the SMEs, may be the word creativity will be more appropriate.

6 CONCLUSIONS Our study shows that the effective factor in SMEs’ innovation is the leading enterprises. The leading role of leading enterprises is not always effective, but at least at present in Hebei Province in China, the development of SMEs need the leading enterprises, there are strong demand for China's state-owned enterprises or other Fortune 500 companies to invest and set up here, the capital and technology support cannot effectively drive the development of the industry.

Although we does not endorse such a driven behaviour for development, but the driven behaviour is most able to stimulate the enterprises vitality. Although the behaviour of Chinese enterprises affected most by the government policy, but right now so many policies are ineffective and some government departments do exist the omission phenomenon, these are all resistance to the development of enterprises.

Our study focused on small and micro enterprises in Hebei Province, and not all of the small micro-enterprise research, , therefore whether the conclusion is overall representative is open to question, in addition, the economic development of Hebei Province ranks 19 in China's 31 provinces, autonomous regions and municipalities in, whether the business innovation model in the rapid economic development regional the same with Hebei Province, or whether Hebei mode have guiding significance to backward provinces are worthy of further study and explore.

7 ACKNOWLEDGMENT This paper was supported by Qinhuangdao science and Technology Bureau (201101A545), Hebei Provincial Department of Commerce (HBSW2013002), the Education Department of Hebei Province (QN20131140, G2014203230)

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AUTHORS Dongchu Cui was born in Nong’an, Jilin province of China in 1981. She received the Master Degree in International Trade and Doctoral Degree in World Economy from Jilin University in 2006 and 2010 respectively.

After that she continued her post-doctoral study of Management science and engineering in Yanshan University in 2011, she worked in Yanshan University as a lecturer since 2011, and her present interest is decision analysis.

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