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INNOVATION INTENSITY: ITS ANTECEDENTS AND EFFECTS ON BUSINESS PERFORMANCE OF SMALL AND MEDIUM ENTERPRISES (SMEs) IN THE MALAYSIAN MANUFACTURING SECTOR IFFI FITRIAH UNIVEASITI MALA SlA SABA H THESIS SUBMITTED IN FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PHILOSOPHY SCHOOL OF BUSINESS AND ECONOMICS UNIVERSITI MALAYSIA SABAH 2007

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INNOVATION INTENSITY: ITS ANTECEDENTS AND EFFECTS ON BUSINESS PERFORMANCE OF SMALL

AND MEDIUM ENTERPRISES (SMEs) IN THE MALAYSIAN MANUFACTURING

SECTOR

IFFI FITRIAH

PEBFL~TJ 1,~t.hlJ

UNIVEASITI MALA SlA SABAH

THESIS SUBMITTED IN FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE

OF DOCTOR OF PHILOSOPHY

SCHOOL OF BUSINESS AND ECONOMICS UNIVERSITI MALAYSIA SABAH

2007

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UNIVERSITI MALAYSIA SABAH

BORANG PENGESAHAN STATUS TESIS@

JUDUL : INNOVATION: ITS ANTECEDENTS AND EFFECTS ON BUSINESS PERFORMANCE OF SMEs IN THE MALAYSIAN MANUFACTURING SECTOR

IJAZAH : DOKTOR FALSAFAH (ENTREPRENEURSHIP)

SESI PENGAJIAN : 2004-2007

Saya, IFFI FITRIAH mengaku membenarkan tesis Doktor Falsafah ini disimpan di Perpustakaan Universiti Malaysia Sabah dengan syarat-syarat kegunaan seperti berikut :

1. Tesis adalah hakmilik Universiti Malaysia Sabah 2. Perpustakaan Universiti Malaysia Sabah dibenarkan membuat salinan untuk tujuan

pengajian saya 3. Perpustakaan dibenarkan membuat salinan tesis ini sebagai bahan pertukaran antara

institusi pengajian tinggi 4. TIDAK TERHAD

(Penuli : IFFI FITRIAH)

Alamat: Jalan Pasir Salamet no.16 Perumnas Bumi Pasir Rahayu Sukabumi 43145 Jawa Barat Indonesia

Tarikh : 30 Mac 2007

Disahkan oleh

-(Penyelia : Prof. Dr. SyEd 1l.zizi Wafa)

Tarikh: 5' /"1 /0 r I I

CATATAN :@ Tesis dimaksudkan sebagai tesis Ijazah Doktor Falsafah dan Sarjana secara penyelidikan atau dissertasi bagi pengajian secara kursus dan penyelidikan, atau Laporan Projek Sarjana Muda (LPSM)

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DECLARATION

The materials in this thesis are original except for quotations, excerpts, summaries and references, which have been duly acknowledged

. , I~-

PS 4-002-090(A) July 7, 2007

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ACKNOWLEDGMENTS

Praise and thanks to the Almighty Allah for giving me the strength and patience to cope with the problems and difficulties that I faced in completing this thesis.

I am deeply indebted to my supervisor, Prof. Dr. Syed Azizi Wafa who has guided me all throughout the project. The valuable suggestions he has offered had helped me com pleted my study.

I also wish to record my sincere appreciation and thanks to the dean and staff of the School of Business and Economics, Universiti Malaysia Sabah as well as the dean and staff of the Centre for Postgraduate Studies for their assistance during my period of study.

I must also express my gratitude to the involved manufacturing sector SMEs for their participation as the samples of this study and to so many individuals which is impossible to mention their names here for their help during the data collection stage of this study.

Finally, lowe a personal debt to all my family members. Their love and prayers gave me the determination to complete my study.

IFFI FITRIAH PS04-002-090(A) UNIVERSITI MALAYSIA SABAH July 7,2007

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iii

ABSTRACT

This was a survey research which investigated five important issues concerning innovation intensity and business performance in Malaysian manufacturing Small and Medium Enterprises (SMEs). The first issue was concerned with levels of business orientations, innovative capability, and innovation intenSity. The second was concerned with effects of innovation antecedents (market orientation, learning orientation, entrepreneurial orientation and innovative capability) on innovation intenSity. The third was concerned with effects of innovation intenSity on business performance (subjective business performance, return on assets, sales, sales growth, and return on sales) . The fourth was concerned with moderating effects of environmental uncertainty on relationship between innovation intensity and business performance. The fifth was concerned with mediating effects of innovation intensity on relationship between innovation antecedents and business performance. A set of questionnaire was used as the research instrument and stratified systematic sampling was used to determine the research sample. The sample consisted of 182 SMEs in the Malaysian manufacturing sector but only 161 were used for further analyses. Data were analyzed using descriptive statistics and inferential statistics (factor analysis and regression analysis). Research hypotheses were tested at significance level of 0.=.05. Results of the first issue showed that levels of business orientations and innovative capability were slightly high, while level of innovation intenSity measured as a single scale was moderate. Concerning the second issue, only innovative capability had significant effects on innovation intensity. On the third issue, innovation intenSity had significant effect on subjective business performance and sales. Concerning the fourth issue, environmental uncertainty did not have any significant moderating effect on relationship between innovation intensity and business performance. Concerning the fifth issue, significant mediating effects of innovation intenSity were found on relationship between innovative capability and subjective business performance and on relationship between innovative capability and sales. In general, these findings provide wider implications for theory development, industrial practices, and industrial policymaking.

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iv

ABSTRAK

INTENSITI INOVASI : ANTESEDEN DAN KESAN TERHADAP PRESTASI PERNIAGAAN ENTERPRIS KECIl DAN SEDERHANA

(EKS) DALAM SEKTOR PEMBUATAN DI MALA YSIA

Kajian ini merupakan suatu kajian survei yang mene/iti lima isu penting berka/tan inovasi dan prestasi pemiagaan da/am enterpris keCl! dan sederhana (EKS) da/am sektor pembuatan di Ma/aysia. Pertama, berkaitan tahap orientasi pemiagaan kemampuan berinovasi dan intensiti inovasi. Kedua, berka/tan kesan anteseden inovasi (orientasi pasaran orientasi pembe/ajaran, orientasi keusahawanan dan kemampuan berino vas!) terhadap intensiti inovas/: Ketiga, berkaltan kesan intenslti inovasi terhadap prestasi pemiagaan (prestasi pemiagaan subjekti" pu/angan ase0 j ua/an, pertumbuhan jua/an, dan pu/angan jua/an). Keempa0 berkaitan kesan penyederhanaan ketidakpastian persekitaran terhadap hubungan antara intensiti inovasi dan prestasi pemiagaan. Ke/ima, berkaitan kesan perantara intensiti inovasi terhadap hubungan antara anteseden inovasi dan prestasi pemiagaan. 500/ se/idik digunakan sebagai a/at penye/idikan dan kaedah pensampe/an sistematik ber/apis digunakan untuk menentukan sampe/ kajian. Sampe/ ka)iim terdiri daripada 182 EKS da/am sektor pembuatan di Ma/aysia tetapi hanya 161 digunakan untuk analisis se/anjutnya. Data diana/isis menggunakan kaedah statistik deskriptlf dan statistik taabiran (ana/isis faktor dan ana/isis regresi). Hipotesis kajian diu)! pada aras keertian a=. OS. Dapatan ka)!an berkaitan isu pertama mununjukkan tahap orientasi pemiagaan dan kemampuan berinovasi ada/ah agak tinggi, manaka/a tahap intenslti inovasi yang diukur secara bersepadu ada/ah sederhana. Bagi isu kedua, hanya kemampuan berinovasi mempunyai kesan signifikan terhadap intensiti inovas/~ manaka/a isu ketiga, intensiti inovasi mempunyai kesan signifikan terhadap prestasi pemiagaan subjektif dan jua/an. Bagi isu keempa0 kesan ketidakpastian persekitaran sebagai penyederhana ada/ah tidak signifikan terhadap hubungan antara intensiti inovasi dan prestasi pemiagaan. Bagi isu ke/ima, kesan intensiti inovasi sebagai pengantara ada/ah signifikan pada hubungan antara kemampuan berinovasi dan prestasi pemiagaan subjektlf dan pada hubungan antara kemampuan berinovasi dan jua/an. Secara umumnya, dapatan ka)!an ini memberikan imp/ikasi yang besar terhadap perkembangan teori, pengama/ industri, dan pembentukan dasar industri.

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TABLE OF CONTENTS

DECLARATION

ACKNOWLEDGEM ENTS

ABSTRACT

ABSTRAK

TABLE OF CONTENTS

LIST OF TABLES

LIST OF FIGURES

LIST OF APPENDICES

CHAPTER 1: INTRODUCTION

1.1. Background of the Study

1.2. Statement of the Problem

1.3. Objectives of the Study

1.4. Research Questions of the Study

1.5. Hypotheses of the Study

1.6. Scope of the Study

1.7. Significance of the Study

1.8. Definition of Terms

CHAPTER 2: SMALL AND MEDIUM ENTERPRISES IN MALAYSIA

2.1. Introduction

2.2. Definition of Enterprises versus Industries

2.3. Definition of Small and Medium Enterprises

2.4. Historical Development of SMEs in Malaysia

2.5. Policy Towards SMEs in Malaysia

2.6. Profile of SMEs in Manufacturing Sector in Malaysia

2.7. The Contribution of SMEs to Malaysian Economy

2.8. Characteristics of SMEs in Manufacturing Sector in Malaysia

2.9. Previous Research on Malaysian SMEs

v

Page

ii

iii

iv

v

ix

xii

xiii

1

9

12

13

14

14

15

18

24

24

25

34

40

43

47

52

54

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CHAPTER 3: REVIEW OF LITERATURE

3.1. Introduction 60

3.2. Issues on Innovation 60

3.2.1. Definitions and Dimensions of Innovation 61

3.2.2. Innovation in Small and Medium Enterprises 64

3.2.3. Innovation Intensity 72

3.3. The Resource-Based View (RBV) Theory and Innovation 73

3.4. Relationship between Innovation Antecedents and Innovation 78

3.4.1. Market Orientation and Innovation 78

3.4.1.1. The Market Orientation Concept 78 3.4.1.2. Studies on Market Orientation and 84

Innovation

3.4.2. Learning Orientation and Innovation 86

3.4.2.1. The Learning Orientation Concept 86 3.4.2.2. Studies on Learning Orientation and

Innovation 92

3.4.3. Entrepreneurial Orientation and Innovation 94

3.4.3.1. The Entrepreneurial Orientation Concept 94

3.4.3.2. Studies on Entrepreneurial Orientation and 100 Innovation

3.4.4. Innovative capability and Innovation 104

3.4.4.1. The Innovative capability concept 104 3.4.4.2. Studies on Innovative capability and

Innovation 107

3.5. Innovation and Business Performance 108

3.5.1. Business Performance Measurement Concept 108

3.5.2. Studies on Innovation and Business Performance 111

3.6. Environmental Uncertainty in Moderating Relationship between Innovation and Business Performance 114

3.7. The Mediating Effect of Innovation on the Relationship between Innovation Antecedents and Business Performance 116

3.7.1. Market Orientation and Business Performance 119

3.7.2. Learning Orientation and Business Performance 122

3.7.3. Entrepreneurial Orientation and Business Performance 123

3.7.4. Innovative Capability and Business Performance 124

3.8. Theoretical Framework of the Study 125

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CHAPTER 4: RESEARCH METHODOLOGY

4.1. Introduction

4.2. Design of the study

4.3. Sampling Design of the Study

4.3.1. Population and Sampling Frame of the Study

4.3.2. Sample of the study

4.4. Instrument of the Study

4.4.1. The Questionnaire

4.4.2. Pretesting The Questionnaire

4.5. Methods of Data Collection

4.6. Test of Nonresponse Bias

4.7. Statistical Analysis of the Study

4.7.1 Descriptive statistics.

4.7.2. Inferential Statistics

4.7.3. Validity and Reliability Assessment

CHAPTER 5 : RESULTS OF THE STUDY

5.1. Introduction

5.2. Sample Profile of the Study

5.3. Validity and Reliability of the Research Instrument

5.4. Levels of Innovation Intensity/Business Orientations and

vii

128

128

129

129

133

137

138

147

149

150

152

152

153

159

162

162

164

Innovative capability 179

5.5. Hypotheses Testing 182

5.5.1. The Effects of Innovation Antecedents (Market Orientation, Learning Orientation, Entrepreneurial Orientation, Innovative Capability) on Innovation Intensity. 182

5.5.2. The Effect of Innovation Intensity on Business Performance and The Moderating Effect of Environmental Uncertainty on the Relationship between Innovation Intensity and Business Performance. 184

5.5.3. The Mediating Effects of Innovation Intensity on the Relationship between Innovation Antecedents (Market Orientation Entrepreneurial Orientation, Learning Orientation, Innovative Capability) and Business Performance 190

5.5.4. Summary of the Hypotheses Testing Result 196

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CHAPTER 6: DISCUSSION, IMPLICATIONS, AND CONCLUSION

6.1. Introduction

viii

197

6.2. Discussions of the Findings 197

6.2.1. Levels of Business Orientations, Innovative capability, and Types of Innovation 197

6.2.2. Effects of Innovation Intensity Antecedents on Innovation 201

6.2.3. Effects of Innovation Intensity on Business Performance 204

6.2.4. Moderating Effects of Environmental Uncertainty on the Relationship between Innovation Intensity and Business Performance 206

6.2.5. Mediating Effects of Innovation Intensity on the Relationship between Innovation Antecedents and Business Performance 206

6.3. Implications of The Finding

6.3.1. Theoretical Implications

6.3.2. Practical Implications

6.3.3. Policy Implications

6.4. Conclusion

6.5. Limitations and Directions for Further Research

REFERENCES

APPENDICES

208

208

209

212

213

215

218

235

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LIST OF TABLES

No Title of Table Page

2.l. The EU Legal Definition of Enterprises 26 2.2. Definitions of Malaysian SMEs 34 2.3. Number of SMEs as Reported by Different the Government and

Different Agencies 44 2.4. Distribution of SMEs in the Manufacturing Sector (by Type) Census 45

2000 2.5. Distribution of SMEs in the Manufacturing Sector (by Sector) 45

Census 2000 2.6. Distribution of SMEs in the Manufacturing Sector (by Sector)

Census of Establishments and Enterprises, 2005 47 2.7. Contribution by SMEs to The Manufacturing Sector 48 2.8. Comparative Productivity Growth Rates 1996 and 2005 49 2.9. Distribution of SMEs by Key Indicators and Sectors, 2005 and 1996 51 2.10. Types of Certification Received by SMEs 53 2.1l. SMEs' Internal Sources of Financing 54 2.12. Summary of the Previous Studies on Malaysian SMEs 56 3.1. Dimensions of Innovation 66 3.2. Relative Advantages of Small and Large Firm in Innovation 70 3.3. Relative Disadvantages of Small and Large Firm in Innovation 71 3.4. Definitions of Organisational Learning 88 3.S. Dimensions and Definitions of Entrepreneurial Orientation 99 3.6. Summary of Studies on the Relationship between Market, Learning,

and Entrepreneurial Orientations and Innovation 102 3.7. Summary of Studies on the Relationship between Innovative

capability and Innovation 107 3.8. Summary of Previous Study on Correlation between Objective and

Subjective Measures 110 3.9. Summary of Studies on Effects of Innovation on Performance 113 3.10. Summary of Studies on Environmental Uncertainty as Moderator

Variables 116 3.1l. Previous Studies on the Effect of Market Orientation on Business

Performance 120 3.12. Previous Studies on the Effect of Entrepreneurial Orientation on

Business Performance 124 4.1. Division of Sampling Frame Number according to Industry Group and

State. 132 4.2. Total Number of Sample Selected from the Sampling Frame according

to Strata of Industry Group and State. 136 4.3. Summary of the Questionnaire. 139 4.4. Reliability Analysis in Pretest (n=45) 149 4.5. Test of Nonresponse Bias 151 4.6. Hypotheses and Their Corresponding Variables 157 5.l. Summary of the Sample Profile of the Study 163

5.2 (a) Pattern Matrix of Market Orientation Scale 167 5.2 (b) Component Matrix of Market Orientation Scale 168 5.3 (a) Pattern Matrix of Learning Orientation Scale 169

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5.3 (b) 5.4 (a) 5.4 (b) 5.5 (a) 5.5 (b) 5.6 (a) 5.6 (b) 5.7 (a) 5.7 (b) 5.8 5.9

5.10 5.11 5.12

5.13 (a)

5.13 (b)

5.13 (c)

5.13 (d)

5.13 (e)

5.14 (a) 5.14 (b)

5.14 (c)

5.15.

Component Matrix of Learning Orientation Scale Pattern Matrix of Entrepreneurial Orientation Scale Component Matrix of Entrepreneurial Orientation Scale Pattern Matrix of Innovative Capability Scale Component Matrix of Innovative Capability Scale Pattern Matrix of Innovation Intensity Scale Component Matrix of Innovation Intensity Scale Pattern Matrix of Environmental Uncertainty Scale Component Matrix of Environmental Uncertainty Scale Component Matrix of Subjective Business Performance Descriptive Statistics of Business Orientations and Innovative Capability (n= 161) Descriptive Statistics of Innovation (n= 161) Descriptive Statistics of Business Performance (n= 161) Regression Analysis of Market Orientation, Learning Orientation, Entrepreneurial Orientation and Innovative Capability on Innovation. Hierarchical Regression of Innovation Intensity on Subjective Business Performance with Environmental Uncertainty Hierarchical Regression of Innovation IntenSity on Return on Assets with Environmental Uncertainty Hierarchical Regression of Innovation IntenSity on Sales with Environmental Uncertainty Hierarchical Regression of Innovation Intensity on Sales Growth with Environmental Uncertainty Hierarchical Regression of Innovation IntenSity on Return on Sales with Environmental Uncertainty Correlation among Variables Multiple Regression of Market Orientation, Learning Orientation, Entrepreneurial Orientation, Innovative Capability, Innovation on Subjective Business Performance Multiple RegreSSion of Market Orientation, Learning Orientation, Entrepreneurial Orientation, Innovative Capability, Innovation on Sales Summary of the Hypotheses Testing Results

x

170 171 172 174 175 176 176 177 178 179

180 181 182

183

185

186

187

188

189 191

194

195 196

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LIST OF FIGURES

No Title of Figure

3.1. Domains of Innovation (Avermaete et ai, 2003) 3.2. Model of the Study 4.1. Sampling Design of the Study. 4.2. Difference between Moderator and Mediator Model (Adapted from

Chevalier, 1999) 4.3. Steps in Factor Analysis (Kerlinger and Lee, 2000) 5.1. Operationalisation of Mediator Variable 5.2. Operationalisation of Mediator Variable after Examination of

Correlation

Page

64 126 137

154 159 190

192

xi

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LIST OF APPENDICES

No Title of Appendix Page

A Assistance Programmes Provided by Malaysian Government 265 Ministries and Agencies for Small and Medium Enterprises.

B The Steps Performed to Obtain the Information about the Sampling 241 Frame from the SMIDEC Website

C Research Questionnaire 247

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CHAPTER 1

INTRODUCTION

1.1. Background of the Study

Innovation plays a significant role on the success of organizations. According to

Hult, Hurley and Knight (2004), innovation is a key component in the success of

organizations. It is through innovation that organizational managers devise

solutions to business problems and challenges, which provide the basis for the

survival and success of firm well into the future. Schumann, Prestwood, Tong and

Venston (1994) claimed that innovation is the basis of all competitive advantages.

Innovation is the means used by organizations to anticipate and fill customer

needs and it is the method used by organizations to utilize technology. In

addition, Mohd Khairuddin, Abdul Jumaat and Sa'ari (2003) stated that innovat ion

presents opportunities for organizations in terms of growth and expansion into

new areas as well as allows them to gain competitive advantages.

The capacity to innovate is among the important factors that affect an

organizations' performance (Hurley and Hult, 1998). According to Mohd

Khairuddin et al. (2003), an innovative organization is characterized by its

entrepreneurial ability to change, experiment, transform and revolutionize creative

ideas into useful product, services or work methods. It is important that

organizations must constantly innovate in every aspect of their business

operations in order to compete and survive in the competitive market place.

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It is evident that most economists, management theorists and even policy

makers have agreed that SMEs play an important role in the economy of many

countries (Khan and Manopichetwattana, 1989). The roles of SMEs can be seen

from their contribution to the goods and services provided, job creation, income

generate, and supporting industries to large manufacturers (Mohd Khairuddin,

1999). The contribution of SMEs to innovation-led growth has been also of

renewed interest in recent years. A large body of evidence shows that SMEs,

especially young firms, contribute greatly and increasingly to the innovation

system by introducing new products and adapting existing products to the needs

of customers (DECO, 2000).

Innovation in SMEs has a number of peculiarities, which can be seen as

their advantages or disadvantages in comparison to larger firms. Some

researchers have viewed that greater motivation in management and labor are

some innovative advantages in SMEs (Hadjimanolis, 2000; Nooteboom, 1994;

Rothwell & Dodgson, 1994). These are due to intertwined ownership and

management, more variation and improvisation in the tasks of workers, tacit

knowledge in unique skills, more efficient communication, closeness to customer

and flexibility. In an SME, the decision to be innovative is made by a small

number of people. A number of SMEs have in fact benefited from the exodus of

researchers thwarted by the managerial restraints of larger firms. While SMEs can

place innovative activity at the center of their competitive strategy, larger firms

also tend to promote successful researchers to management positions, (Scherer,

1991). Khan and Manopichetwattana (1989) pointed out that innovation in SMEs

is determined by its proactiveness and risk taking, well-endowed with

management and quality, remain updated information about environment,

market, and techniques. However, as claimed by Hadjimanolis (2000) some

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disadvantages of innovation in SMEs as compared to larger firms are weakly

structured innovation, low market power and scarcity of resources in order to

appropriate the benefit of their innovation.

In investigating the issues of innovation in SMEs, many studies have

adopted Resource-Based View (RBV) theory as their theoretical foundation (e.g .

Kostopaulus, Spanos and Prastacos, 2002; Barney, 1991; Hadjimanolis, 2000;

Lawson & Samson, 2001) Theoretically, the central premise of RBV addresses the

fundamental questions of why firms are different and how firms achieve and

sustain competitive advantages by deploying their resources. The firms' resources

are heterogeneous and not all resources are of equal importance or possess the

potential to be source of sustainable competitive advantages. The discussion of

RBV in connection to innovation is based on a fundamental premise that

organizational resources (both tangible and intangible) and capabilities are those

that underlie and determine a firm's capacity to innovate (Kostopaulus et a/.,

2002). The requirements of resources for producing sustainable competitive

advantages are valuable, rare, difficult to imitate and replaced by competitors

(Barney, 1991). Lawson and Samson (2001) argue that despite strong application

to innovation, RBV has a number of weaknesses. According to Lawson and

Samson (2001), the weaknesses of RBV include the difficulty in identifying

valuable resources and capabilities, the difficulty in integrating complementary

resources and capabilities, and the value of resources may change over time

becoming a core rigidity of organization. At this juncture, the present study

attempted to provide a support for the argument that resources and capabilities

are important in relation to innovation and business performance of SMEs.

Resources are variously defined in the literature as the inputs or factors

available to a firm through which it performs its operations or carries out its

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activities (Ordaz, Alcazar, Valle-Cabrere, 2003). Many researchers have claimed

that business orientations can be considered as resources for some reasons (e.g.

Peterson, 1989; Miles and Arnold, 1991, Narver and Slater, 1990). First, business

orientations consist of underlying philosophies that determine the nature and

scope of their activities and plans. Second, they tend to flavor the overall

decision-making framework of their management. Third, they reflect the strategic

direction implemented by an organization to create the proper behaviors for the

continuous superior performance of the business. The types of business

orientations that are relevant to innovation and have been emphasized by many

researchers include market orientation (Atuahene-Gima, 1996; Jaworski & Kohli,

1993; Narver & Slater, 1990; Salavou, Baltas & Lioukas, 2003), learning

orientation (Baker & Sinkula, 1999; Sinkula, 1994; Slater & Narver,1995) and

entrepreneurial orientation (Lumpkin & Dess,1996 ; Salavou & Lioukas, 2003

Verhees & Meulenberg, 2004).

According to Hunt and Morgan (1995: 11), "market orientation is an

intangible entity that would be a resource if it provides information that enables a

firm to produce, for example, an offering well tailored to a market segment's

specific tastes and preferences". Other researches also believe that market

orientation can lead a firm to competitive advantages since it is unique and rare

among competitors (Jaworski & Kohli 1993; Narver & Slater, 1990).

In terms of learning orientation, the researchers also believe that it has

capability to create competitive advantages. According to Hunt and Morgan

(1995), learning is an important complex resource of the firm that can create

competitive advantages. Their claim is supported by Dickson (1996) who indicates

that learning is preeminent over other resources. This is because learning

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enables firm to maintain long-term competitive advantages by continuously

improving market information processing faster than rivals do.

Meanwhile, in relation to entrepreneurial orientation, Stopford and Baden-

Fuller (1994) pOinted out that corporate entrepreneurship is the intangible assets

of a firm. These assets include proactiveness, striving aspirations, a teamwork

approach, dilemma resolution and a learning capability. In addition, Hadjimanolis

(2000) has reported that closeness and awareness of markets, learning and

decision process of the firm can be viewed as examples of knowledge-based

resources.

Research on the relationship between market orientation and innovation

has been increasing since Drucker (1954: 37) mentioned:

There is only one valid defimtion of business purpose: to create a customer ... It is the customer who determines what the business is... because It is its purpose to create a customer, any business enterprise has two-and only these two-basic functions: marketing and innovation.

Many research have tried to identify the relationship between market orientation,

innovation and business performance (e.g Atuahene-Gima, 1996; Deshpande,

Farley & Webster, 1993; Han, Kim & Srivastava, 1998; Hurley & Hult, 1998;

Jaworski and Kohli, 1993; Noble, Sinha, & Kumar 2002; Verhees & Meulenberg,

2004). According to Jaworski and Kohli (1993), market orientation essentially

involves doing something new or different in response to a market condition . It

may be viewed as a form of innovative behavior. However, these researchers do

not deal with innovation explicitly in their model. In their further research,

Jaworski and Kohli (1996) stated that innovation has been inappropriately absent

in models of market orientation, whereas it should be regarded as an outcome of

market orientation. Deshpande, et al. (1993) found that customer orientation and

innovativeness are key determinants of business performance. They suggest that

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the most important manifestation of customer orientation may be the success of

innovation en route to the success of organization. Hurley and Hult (1998) also

identify innovation as a part of a broader framework that links market orientation

and learning orientation as cultural aspects of the firm to its capacity to innovate

and ultimately to its performance. Slater and Narver (1994) suggested that the

market-driven business is well positioned to anticipate the developing needs of

customers and respond to the needs through the addition of innovative products.

Although these views show some evidence of the direct relationship between

market orientation and innovation, some other findings show only the partial

relationship or no relationship between market orientation and innovation. Han et

a/. (1998) have identified that only the customer orientation (a dimension of

market orientation) - performance relationship is mediated by innovativeness.

However, the mediating effects are not supported when they examine other

dimension of market orientation: competitive orientation and interfunctional

coordination. Noble et a/. (2002) also found little evidence for the mediat ing

effects of innovativeness on the relationship between strategic orientation

(including market orientation) and performance. Atuahene-Gima (1996) found

that market orientation had a significant effect on innovation characteristics such

as innovation-marketing fit, product advantage and interfunctional teamwork.

Whereas market orientation had no significance effect on product newness and

innovation-technology fit. All of those findings support the argument made by

Han et a/. (1998) that the market orientation literature has only recently begun to

acknowledge the effects on innovation.

However, some literature suggest that firms require a new set of

imperatives such as an alignment of market orientation and entrepreneurial

orientation, if they are to be successful in product innovation in these turbulent

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times (Hamel & Prahalad, 1994; Slater and Narver, 1995). Other studies support

these views by combining market orientation, entrepreneurial orientation and

innovation (Atuahene-Gima & Ko, 2001; Verhees & Meulenberg 2004) . Atuahene

and Ko (2001) found that the interaction between market orientation and

entrepreneurial orientation plays an important role in fostering product innovation

and its outcomes. Verhees and Meulenberg (2004) have identified that market

orientation may stimulate or inhibit innovation depending on innovativeness of the

company in the product domain. Innovativeness is identified as an element of

entrepreneurial orientation.

Other studies (e.g. Hurley and Hult, 1998; Baker & Sinkula, 1999)

emphasized relationships between market and learning orientations and

innovation. Hurley and Hult (1998) found that the more the group's culture

emphasizes learning and development, the higher the cultural innovativeness, and

thus the capacity to innovate. Being oriented toward learning indicates an

appreciation for and desire to assimilate new ideas and innovation. Baker and

Sinkula (1999) found that the effects of market orientation on new product

success would be weakened as learning orientation increased. This finding proves

that product innovation occur in many ways not just those grounded in customer­

voiced needs and wants. Another study by Hult et a/. (2004) found that learning

orientation has no significant direct effect on performance. However, learning

orientation has a significant antecedent effect on innovativeness as well as market

orientation and entrepreneurial orientation. While market orientation and learning

orientation may help a manager to devise superior products, processes and ideas,

it is likely that entrepreneurial orientation provides the stimulus for driving such

activities. Furthermore, the empirical findings from Hult et a/. (2004) confirm

innovativeness as an important determinant of business performance. The study

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by Hult et a/. (2004) seems to fill a significant gap in understanding

innovativeness, the nature of relationship between innovativeness and strategic

orientation that drive it, and the effect of innovativeness on business

performance.

Interestingly, some other studies (e.g. Salavou & Lioukas, 2003; Salavou

et al., 2003) have investigated the combination among market orientation,

learning orientation, entrepreneurial orientation and technological orientation as

antecedents of innovation. Salavou and Lioukas (2003) found that entrepreneurial

orientation had positive impacts on radical product innovation. But when

controlling for entrepreneurial orientation, market orientation appeared to playa

lesser role or no role at all on radical product innovation. However, technological

orientation had inSignificant effect on product radicalness. Salavou et al. (2003)

demonstrated that market and learning orientations were important contributors

to SMEs' organizational innovation. They stated that new products seem to be

introduced as a response to closeness to customers and greater knowledge

intensity. When members of an organization acquire knowledge via the learning

process, that organization acquires the ability to be innovative. However, they

also found that technological orientation had an insignificant effect on

organizational innovation.

As stated earlier, besides organizational resources, capabilities are

premises that underlie and determine a firm's capacity to innovate (Kostopaulus

et aI., 2002). Capabilities in RBV literature are the most likely source of

sustainable competitive advantage since they are valuable and difficult to

duplicate (Collis, 1994). Day (1994) defines capabilities as complex bundles of

skills and accumulated knowledge, exercised through organizational processes

that ensure superior coordination of functional activities. Capabilities are closely

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related to organizational processes because they enable the activities in a

business process to be carried out. If resources provide the inputs, capabilities

represent the firm's capacity to coordinate, put it in productive use, and shape

inputs into innovative outputs (Collis, 1994). Most studies have identified that

some capabilities that are important for innovation include research and

development capabilities, manufacturing capabilities and marketing capabilities

(Guan & Ma, 2003; Hadjimanolis 2000; Weerawardana, 2003).

1.2. Statement of the Problem

As described in Small and Medium Enterprise (SME) Annual Report 2005 (Sank

Negara Malaysia, 2006), Malaysian government believes that strong and dynamic

SMEs will stimulate the economy and contribute to a wide range of economic

development. In recognition of SMEs' substantial contribution to the country's

economy, the government has introduced strategies and initiatives to promote

SME development. Moreover, since the First Malaysia Plan, various assistance

programmes which cover a wide spectrum of SMEs' needs have been

implemented by the government mainly to boost performance of SMEs. However,

despite the availabi lity of those strategies and initiatives as well as those

assistance programmes, SMEs in Malaysia are still facing problems in improving

their performance.

The statistics also revealed that SMEs in Malaysia have relatively low

contribution to the total manufacturing sector output, added value and

employment as compared to other countries (e.g. Germany and Taiwan) . In 2003,

SMEs accounted for 89.3 percent of active establishment in the manufacturing

sector and contributed only 29.1 per cent to the total manufacturing sector

output, 26.1 per cent to the added value and 32.5 per cent to the employment

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(SMIDEC, 2004). Meanwhile, in 2005, of 96.6 percent of total manufacturing

establishment, only 29.6 per cent was contributed to the manufacturing sector

output, 25.6 per cent to the added value and 31.3 per cent to the employment

(SMIDEC, 2006). In Germany, SMEs contributed 57 percent to the total output

and 70.2 percent to the employment. While in Taiwan, SMEs contributed 31.4

percent to the total output and 77.6 percent to the employment. It is believed

that the low contribution of SMEs to the manufacturing sector in Malaysia may

hamper the process in achieving the rapid industrialization of the nation.

Encouraging more innovation in Malaysian manufacturing sector SMEs can

be one of the alternatives to boosting performance and competitiveness. This is

consistent with the statement issued by the member countries of APEC as

described in the "Daegu Initiative on SME Innovation Action Plan". In the 1-2

September 2005 APEC SMEs Ministerial Meeting in Daegu, Korea, the ministers

recognized that innovation is the main driving force that can create dynamic SMEs

and sustain growth in the current globalized marketplace (Bank Negara Malaysia,

2006). In fact, in Malaysia, manufacturing sector SMEs have not fully embraced

on innovation. Findings of studies on SMEs in Malaysia show that:

• Innovation tend to occur in large firms as compared to small and medium

firms (EPU, 2004)

• SMEs in manufacturing sectors are characterised by low levels of technological

capabilities, arising from inadequate capital investment, thereby resulting in

an inability to ensure product quality and hence meet market requirements. In

addition, typically, SMEs that hardly invest in R&D are oriented towards the

domestic market and depend mainly on internal sources of funds to finance

their business operations (SMIDEC, 2004).