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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
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)
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
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
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.
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.
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
vi
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
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
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
ix
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
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
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
xli
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
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.
2
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
3
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
4
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
5
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
6
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
7
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
8
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
9
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
10
(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).