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CENTRE FOR INTERNATIONAL BUSINESS STUDIES
The impact of internal and external networks on innovation performance. Evidence from the UK Community Innovation Survey
Marion Frenz and Grazia Ietto-Gillies[1]
Paper Number 1-06
Research Papers in International Business
The impact of internal and external networks on innovation performance. Evidence from the UK Community Innovation Survey
Marion Frenz and Grazia Ietto-Gillies
Abstract
The paper is developed at the interface between innovation studies, the organization of the firm and internationalization. Specifically the paper explores the impact of internal and external networks on the innovation performance of enterprises operating in the UK. It uses information from the UK Community Innovation Surveys 3 and 2. The national and international dimensions of the networks are explored and tested for their impact on innovation performance. We find that both internal and external networks are positively associated with innovation performance and that the effects are greatest when an enterprise belongs to an international internal network.
JEL classification: F23; O12, 19, 33, D85
Keywords: Networks: internal and external; Cooperative agreements; Innovation; Internationalization; Community Innovation Survey UK.
1. Introduction
Economic developments of the past two and a half decades such as the globalisation and liberalisation of markets combined with the diffusion of new information and communication technologies have made it increasingly important and easy to transfer knowledge and information within and across national borders. This, in turn, has led to changes in the way companies generate and diffuse their innovations as well as in their strategies for knowledge acquisition. Indeed, the main role in acquisition, transfer and spread of knowledge is played by the transnational companies (TNCs).
Learning, knowledge-absorption and diffusion are key elements in the generation and development of innovation. An important source of learning is the environment in which the firm operates. Those firms that operate within a network structure which spreads over several locations have opportunities for learning from a variety of different locations. A company’s internal network then acts as a facilitator for the spread of knowledge from subsidiary to subsidiary and from location to location. The extent to which the various locations act as learning opportunities partly depends on how varied they are, how knowledge intensive they are and whether the knowledge they embody is specific and relevant to the firm’s activities.
A firm’s potential for learning from a given environment also depends on its knowledge absorption capacity and on its relationship with the company’s headquarters. If the subsidiary has considerable freedom to interact with the local environment, it may be in a better position to exploit and absorb local knowledge. In this respect the internal organizational structure of the company’s network becomes relevant for the acquisition and spread of knowledge[2] (Bartlett and Goshal, 1989; Gupta and Govindarajan, 1991 and 2000; Hedlund, 1986; Hedlund and Rolander, 1990; Zanfei, 2000; Castellani and Zanfei, 2004 and 2006; Frenz et al., 2005; Frenz and Ietto-Gillies, 2007). We might expect headquarters to be more prone to acquisition of knowledge from the environment since they are less hampered by control decision mechanisms (Castellani and Zanfei, 2006).
A company’s internal network may spread within a single country; however, in the case of transnational companies, it will extend into a number of countries. A company with an international internal network has scope for tapping into the knowledge of more diverse environments, on the assumption that different countries offer indeed more diverse knowledge environments than different locations within the same country. This has two consequences for the generation and spread of knowledge. First, the company as a whole has a greater learning opportunity via the operations of its subsidiaries in various countries. For example, in Cantwell’s theory of international activities the TNC is viewed as a strategic decision-maker actively seeking to invest in locations which are conducive to innovation (Cantwell, 1989, 1997, 1999a, 1999b). Second, as knowledge is spread and absorbed within the company via its internal network, each subsidiary has the potential to benefit. Furthermore, the spillover effects from the subsidiaries into the various different environments in which they operate also lead to increased knowledge and innovation opportunities for the various localities in which the company operates (Cantwell, 1989; Castellani and Zanfei, 2004 and 2006). This view of TNCs and their location strategies suggests that strong local economies are likely to attract investment from TNCs (Cantwell and Iammarino, 2000, Cantwell and Piscitello, 2005, Phelps, Mackinnon, Stone and Braidford, 2003) and inward FDI may indeed be motivated by the desire to reap benefits from the innovation environment in the host country (Driffield and Love, 2003).
Internal networks are not the only way in which firms may use their networking power to access knowledge and innovate. Enterprises may also source knowledge through engaging in cooperative agreements with other firms as well as with a variety of institutions such as universities and public research institutes. There is, in fact, evidence of a rapid growth in R&D alliances over the last two decades (Hagedoorn, 1996). These agreements, too, may be at the national or international level. Indeed, the growth in the number and importance of TNCs over the last few decades took place in tandem with a growth in cross-border cooperation agreements, with much of the latter taking the form of R&D alliances (Hagedoorn, 2002, Hegert and Morris, 1988, Narula, 2000 and 2003).
This paper aims to assess the relevance for innovation performance of internal and external networks as well as the relevance of the international dimension in both internal and external networks. The paper proceeds as follows. The next section is devoted to a discussion of different types of networks their inter-relationship as well as their relationship to innovation. Section three sets out the hypotheses. Section four discusses data and methods. Section five presents the results and the final section concludes.
2. Networks and innovation
Knowledge acquisition and diffusion, whatever the mechanisms by which they take place, are likely to lead to innovation and to manifest in increased innovation performance. This is where the present paper is positioned; we want to test whether the existence of networks, in their various connotations, impacts on the innovation performance of UK enterprises. To this effect we use data from the Community Innovation Survey (CIS). It should be noted at the outset that the CIS gathers information on elements of innovation activities in relation to the single enterprise[3] and not in relation to the company as a whole. The two coincide only in the case of single-enterprise firms, which usually are small firms.
Prior to stating the hypotheses, the following gives an overview of the various types of networks and their relationship to each other. Specifically we concentrate on whether: (i) the networks are internal to the firm; this is the case whenever the surveyed enterprise is a subsidiary of a wider company or indeed a HQ of a company with subsidiary in the UK or abroad; and (ii) the network derives from external collaborations with other institutions of the private or public sector. The internal or external network can geographically extend to the UK only or to other countries outside the UK. If the internal network is international, than the company of which the enterprise is part is a transnational corporation which may be UK or foreign owned.
Table 1 gives an overview of the possible types of networks considered in this paper according to the organizational structure and geographical dimensions. The number of enterprises that are part of such networks in our sample is also given. The total number of enterprises in our dataset is 679 as will be further discussed in section four.
Table 1 Number of enterprises by organizational and geographical dimensions of networks
Geographical dimension / Internal network / External network
Network within the UK / 141 enterprises are part of an internal network all located in the UK / 83 enterprises cooperated with another institution in the UK
Network extends abroad / 221 enterprises are part of an internal network which stretches outside the UK / 49 enterprises cooperated with another institution outside the UK
Total / 362 enterprises have an internal network / 102 enterprises have an external network
Total number of observations is 679. Database: UK CIS 3
It must first be noted that the role and position of internal and external linkages is not symmetrical in terms of ex-ante strategies and ex-post expectations. Strategically the internal networks are developed by the company with a variety of objectives in mind ranging from location of the whole or parts of the production process, to the development of markets, to the search for assets or resources. Knowledge acquisition and innovation may play a role in the ex-ante reasons for establishing specific subsidiaries but not in all cases, and, even where it does, it is unlikely to be the main one. Again, it may be an area in which sector-specificity plays a role.
In the case of external linkages the reverse is true, particularly, because in the case of the CIS database, the specific external linkages are cooperation agreements with the aim of developing and sharing innovations. We can therefore say that regarding external networks their ex-ante and ex-post aims are knowledge related. We would expect a positive innovation performance from them.
What about the relationship between internal and external networks? Are these two types of networks likely to be substituted or complementary? In other words and ceteris paribus, is an enterprise which is part of an internal network more or less likely to seek external innovation cooperation? Similarly, is an enterprise with access to an international internal network, because it is part of a TNC, more or less likely to seek external innovation linkages internationally or within the UK?
These questions cannot be answered a priori. It may be argued that the existence of internal networks gives the enterprise an opportunity to engage in external networks and, therefore, that the two types of linkages – internal and external – develop as complements within either the national or international dimension. On the other hand, it may be argued that an enterprise that has access to knowledge in other locations via the internal network of which it is part – be they within the national territory or international – has less need to seek costly and risky external cooperative agreements; therefore, in this perspective, the relationship will be seen as one of substitution. Both cases are plausible and it may be that in reality the relationship is, partly, sector-specific. For example, in sectors where innovation-specific cooperative agreements are very risky and/or firms aim at appropriating their knowledge internally, e.g. research-intensive sectors, the trend might be more towards the establishment of internal channels of knowledge development and spread rather than external ones.
There is another aspect of the complementarity v substitution relationship between internal and external networks which we should highlight. According to the organizational structure of – and the control mechanisms within – the company, the surveyed enterprise may or may not have a large degree of autonomy in forging external networks. The degree of autonomy is likely to be higher with regard to external networks within the country in which the enterprise operates – in our case the UK – than for external linkages abroad.
In fact, the probability of our enterprise engaging in external innovative linkages abroad may depend on a variety of elements and specifically. First, whether the headquarters of the company – let’s call it company X – favour such a strategy and give autonomy for its development. Second, whether the foreign country – say France – does or does not have subsidiaries of company X located within it. If it does, it seems likely that the external firms and institutions in France will forge collaborative agreements directly with the French subsidiary rather than the British one. We would therefore expect enterprises belonging to TNCs with internal networks in many countries to be less likely to engage directly in external linkages abroad: the company’s headquarters of other foreign subsidiaries may do it instead.
This discussion on the relationship between internal and external networks leads us to the following conclusions.
- The extent to which enterprises that are part of an internal network engage in external networks may partly depend on the autonomy they have from the HQ.
- An enterprise that is part of a wide internal international network may be less likely to be involved in international external networks because the subsidiary(ies) in the foreign country or the HQs will take over the task of forging those external linkages. This may point to a relationship of substitution between international internal networks and international external ones.
- In spite of the conclusion in 2 regarding international linkages, our conclusion regarding linkages in general is that there is no a priori reason why internal and external networks as a whole should be complementary or substitute: enterprises that belong to internal networks are not necessarily – a priori – likely to engage in external networks; the outcome may be sector-specific.
Table A1 in Appendix A gives correlation coefficients between internal and external networks by industries. They seem to indicate a relationship of complementarity between internal and external networks. It should be noted that whatever the relationships between internal and external networks and whatever the ex ante reasons for the establishment of internal and external networks, ex post we expect a positive impact on innovation performance.
3. The hypotheses
It is to this ex-post relationship between networks and innovation that we devote the rest of this study. On the basis of the processes of knowledge acquisition and spread sketched in the previous two sections we would expect, ceteris paribus, the following relationship between various types of networks and innovation.
Enterprises that are part of companies that operate within internal networks are more likely – ceteris paribus – to be innovative than enterprises that are part of an independent, single-unit firm. This is due to the fact that the internal network allows each enterprise within the company to access the knowledge that others have developed or acquired through the locality in which they operate. This is reflected in our first hypothesis 1a that states: