Absorptive Capacity and Regional Patterns of InnovationMaria Abreu, Vadim Grinevich,

Michael Kitson and Maria Savona

Presentation Structure• Regional Growth in the UK• The CBR Survey: A Meta-Regional Picture• The CBR Survey: The Innovation Picture• The Absorptive Capacity Concept• Innovation and Absorptive Capacity: Multivariate

Analysis• Innovation and Absorptive Capacity: ‘Open’ v

‘Closed’ innovation• The Case Study Evidence• Implications

Regional Productivity Disparities: The Scale of the Problem

• Since the mid-1980s, major productivity gap has opened up between London and South East on one hand, and rest of UK on the other

• Only three regions have productivity above UK average (London, South East and Eastern)

• Productivity growth in the Northern regions has been especially slower

• The productivity gap is such that output per employee in South East now more than 28 percent above that in Northern Ireland, and 20 percent above that in North East

GVA per capita, 2003

Source: Local Knowledge 0 550,000 1,100,000275,000 Meters

GVA per capita (£)

11,000 - 12,000

12,000 - 13,000

13,000 - 14,000

14,000 - 15,000

15,000 - 40,000

Change in GVA per capita, 1995-2003

Source: Local Knowledge 0 550,000 1,100,000275,000 Meters

Change in GVA per capita (%)

40 - 42

42 - 44

44 - 46

46 - 48

48 - 50

50 - 60

Regional Productivity Disparities: The Scale of the Problem

• Employment growth has also been unequal across the regions

• Highest in South East, Northern Ireland, South West and Eastern region

• Some regions have not fully recovered from massive job declines of early-1980s (North East, North West and West Midlands)

• South East only region to experience above average growth in productivity and employment

Drivers of Regional Competitiveness/Productivity According to HM Treasury/DTI

SKILLS ENTERPRISE

INNOVATION COMPETITION

INVESTMENT

Entry of newfirms raisescompetition

Skills raise firms’capacity to

develop and usenew technology

Management skills raiseentrepreneurship andbusiness excellence.New firms createdemand for skilled

labour

Increasingcompetitionencouragescompetition

Increasingcompetition creates

incentives forbusiness investment

Investment inphysical capitalincreases firms’

innovative capacity

Are innovative regions, prosperous regions?

Source: Martin (2005)

CBR Dataset

• Centre for Business Research (CBR) Survey 2004• 1-499 employees• Manufacturing and business services• 2137 respondents • More detailed information than in CIS although the

CIS survey is larger • CBR Survey also allows the opportunity to review

and research respondents in greater depth

Regional Competitiveness

• For the purpose of this initial analysis, a meta-regional classification is used: – Greater South East (South East, Eastern Region

and London)– Middle England (East Midlands, West Midlands

and the South West)– The Northern Way (North West, North East and

Yorkshire and Humberside) – Scotland/Wales

Markets and Competition

• The Greater South East engaged in the most international trade with over 20% of the businesses identifying overseas markets as being most important compared to only 12% of firms in Scotland/Wales

• There was a more intense competitive environment in the Greater South East with evidence of a core to periphery decline in the intensity of competition

• The Greater South East had the highest level of international competition – with 41% of firms facing some overseas competitors and with 10% of firms competing exclusively with overseas businesses

Geographical Distribution of Markets

0

10

20

30

40

50

60

Greater SouthEast

MiddleEngland

Northern Way Scotland/Wales

% D

istr

ibu

tio

n o

f F

irm

s

Local

Regional

National

International

Number of Serious Competitors(% distribution of firms)

Number Of firms

Greater South East

Middle England

Northern Way

Scotland & Wales

0 10.2 11.9 12.3 14.3 1 – 4 34.5 34.3 35.7 43.5 5 – 9 24.3 23.5 28.5 19 10 – 19 15.6 16 13.9 16.7 20 – 98 11.5 10.4 6.7 4.8 99 + 3.9 3.9 2.8 1.8 Total Responses 826 463 389 168

Extent of Overseas Competition(% distribution of firms)

% Greater

South East Middle

England Northern Way Scotland &

Wales 0 59.5 60.2 65.1 67.6 0 - 24 7 8.6 6.9 5.1 25 - 49 9.1 7.6 8.2 9.6 50 - 74 10.5 10.2 11.6 7.4 75 - 99 4.2 3.9 4.1 6.6 100 9.6 9.4 4.1 3.7 Total Responses 684 382 318 136

Networks and Cooperation

• The use of networks and effective collaboration has been identified as an important factor in improving business and regional competitiveness

• The highest level of collaboration took place in the Greater South East (48% of businesses) and the lowest took place in the Northern Way (37% of businesses)

Use of Collaboration and Networks

0

10

20

30

40

50

60

GreaterSouthEast

MiddleEngland

NorthernWay

Scotland/Wales

% o

f F

irm

s

% of Firms

The Geography of Networks and Cooperation

• There were significant regional variations in collaborative partners – illustrating that there are significant differences in the character

of, and scope of, regional networks • Firms in similar lines of businesses were the most important

collaborative partners– but this group was more important for Scotland/Wales and the

Greater South East compared to Middle England and the Northern Way

• Forward and backward linkages (collaboration with customers and suppliers) were more important for businesses in Middle England

• Collaboration with universities and research institutes was higher in the Northern Way compared to other regions

Policy Support

• The use of Business Link (and Business Gateway and Business Connect) was significantly greater in Middle England and the Northern Way than in the Greater South East and especially compared to the low use in Wales/Scotland

• The use of Local Learning and Skills Councils was higher in Middle England and the Northern Way compared to the other two regions

• The assistance from Development Agencies had a distinct core periphery incline – with the lowest use in the Greater South East and the highest (by far) in Scotland/Wales

• There was core periphery incline for export advice- with the highest level in Scotland/Wales

Policy Support

Regional Variations in use of Government sponsored business support agencies

(% distribution of firms)

Greater South East

Middle England

Northern Way

Scotland & Wales

Business Link/ Gateway/Connect*** 31.7 44.3 46.3 17.9 Local Enterprise Agency*** 5.5 7.6 12.5 28.3 Local Learning Skills Council *** 7.3 12.3 12.9 8.7 RDA/ WDA/ SE*** 4.4 8.0 11.8 37.5 Export Advice 9.6 13.3 12.0 14.7

Innovation Behaviour• Approximately 60% of firms introduced product

innovations • Approximately half of firms had introduced process

innovation• The CBR data indicates a higher level of innovation than

CIS– Different survey structures, CBR covers

manufacturing and business services– Issue of weighting– Issue of questionnaire design

Innovation Performance

• Product and Process innovation– Positively associated with firm size– Positively associated with firm growth– Higher in high-technology sectors

Product innovationIntroduction of product innovations during the previous 3 years

59.4

42.0

65.7

72.5

53.9

64.3

73.2

59.1

74.6

50.9

31.9

21.7

34.8

42.3

27.6

35.7

45.0

30.1

48.7

25.2

0

10

20

30

40

50

60

70

80

% o

f F

irms

Innovators Novel innovators

Source: Fu (2006)

Process innovationIntroduction of process innovations in previous 3 years

49.3

32.3

55.2

62.3

45.4

53.8

58.2

52.255.4

40.7

19.2

12.6

19.7

30.5

17.1

21.3

15.5

19.3

28.5

17.1

0

10

20

30

40

50

60

70

% o

f F

irms

Innovators Novel innovators

Source: Fu (2006)

Region Total Firms % Innovative Firms

% Goods Innovation

% Service Innovation

% Process Innovation

London 290 52.22 24.11 30.11 33.95

Eastern 257 52.87 27.87 32.52 43.32

South East 344 44.44 26.49 22.59 28.50

South West 181 56.88 31.08 30.35 42.40

West Midlands 185 50.72 28.92 19.86 35.40

East Midlands 139 53.09 26.40 18.82 41.45

Yorkshire 177 57.16 29.09 31.77 47.82

North West 203 46.17 25.94 23.90 26.56

North East 51 56.43 36.18 26.27 21.28

Wales 68 46.27 30.67 26.81 27.01

Scotland 111 56.92 35.11 38.87 34.01

Total 2006 52.11 29.31 27.44 34.67

Innovation Statistics by Region, CBR SME Survey 2004

Absorptive Capacity: “…the ability of a firm to recognize the value of new, external information, assimilate it, and apply it to commercial ends is critical to its innovative capabilities.” (Cohen and Levinthal, 1990)

• What are the main determinants of absorptive capacity? • Can regional variations in absorptive capacity explain regional

differences in innovation?• Can we draw implications for regional and national innovation

policies?

Research Questions

Absorptive Capacity

• Originally developed in the cognitive sciences (Bower and Hilgard, 1981; Lindsay and Norman, 1977)

• Extended by Cohen and Levinthal (1989, 1990) to the firm level:– Firm-level absorptive capacity is more that the

sum of the absorptive capacities of individual workers.

– Better internal communication processes improve the firm’s ability to absorb external knowledge.

– Networks are necessary to identify sources of relevant external knowledge.

• Used at the national level to denote the conditions necessary for a technological catch-up to begin (Nelson and Phelps, 1966; Verspagen, 1991; Keller, 1996; Criscuolo and Narula, 2002)

• Extension to the regional level:– Regional absorptive capacity is more than the sum of

the absorptive capacities of individual firms.– Role of local labour markets (Roper and Love, 2006)– Regional networks allow firms to identify potential

sources of knowledge.– Regional development policies promote firms’

investment in absorptive capacity.

Absorptive Capacity

Methodology• Empirical analysis of the effect of absorptive capacity on:

– The probability of introducing a product, service and process innovation.

– The probability of developing an innovation within the firm, in collaboration with other firms or institutions, or by adoption from other firms or institutions.

• Multivariate Probit model to improve efficiency and exploit all available information (Greene, 2003, pp. 174-175).

Data Issues

• Absorptive capacity variables:• Percentage of R&D employees• New management techniques• Employee training

• Connectivity variables• Collaborations with different spatial dimensions

Data Issues

• Control variables: • Exporter• Age, size and size squared• Ownership structure• Market• Number of competitors• Perceived obstacles to innovation• R&D tax credit• Sectoral and regional dummies

Variable Manufactured Product

Service Product

Manufacturing Process

Service Process

R&D Employees 0.449** 0.529* 0.009 0.687**

Managerial Training -0.010 0.520*** 0.091 0.322**

Scientist Training -0.056 -0.222 0.013 -0.289**

Other Employee Training 0.341** -0.078 0.000 -0.027

Total Quality Management

0.154 0.268** 0.322*** 0.145

Quality Circles 0.289* 0.102 0.316** 0.161

Job Rotation 0.282** 0.020 0.400*** 0.123

Performance-Related Pay

-0.033 0.080 -0.061 0.027

Collaborations: Local 0.044 0.123 0.341** 0.213

Collaborations: National 0.209* 0.340*** -0.052 0.287**

Collaborations: Overseas

0.482*** -0.033 0.269** 0.016

MV Probit Estimates, CBR SME Survey 2004

Variable Manufactured Product

Service Product

Manufacturing Process

Service Process

Obstacles: Finance 0.171 -0.022 0.123 0.053

Obstacles: Skills -0.031 0.160 -0.058 0.337**

Obstacles: Technology 0.269** 0.020 0.066 0.195*

Obstacles: Market 0.086 0.089 0.029 -0.195*

Obstacles: Other -0.283** -0.058 -0.252* 0.039

R&D Expenditure / Turn. 0.049 0.003 0.060 0.014

Claimed Tax Credit 0.571*** -0.028 0.199 -0.231*

Business Advice: Bus. Link

0.069 0.081 0.287** 0.141

Business Advice: RDA -0.088 -0.332** -0.072 -0.265*

MV Probit Estimates, CBR SME Survey 2004, cont.

Variable Manufactured Product

Service Product

Manufacturing Process

Service Process

Market: Local reference reference reference reference

Market: Regional 0.230 0.147 -0.141 0.082

Market: National 0.268 0.152 0.105 0.172

Market: International 0.497** 0.100 -0.003 -0.030

Age (Years) -0.004** -0.001 -0.001 0.001

Size: Employees (Ln) 0.032 0.117** 0.110** 0.075

Ownership: Proprietorship

reference reference reference reference

Ownership: Partnership -0.646** -0.604** -1.028*** -0.074

Ownership: Company -0.537* -0.165 -0.595** -0.091

Ownership: Other -4.368 -0.373 -5.166 -4.602

Observations: 805

Log Likelihood -1598.04

MV Provit Estimates, CBR SME Survey 2004, cont.

Absorptive Capacity: R&D

Manufactured Product

Service Product

Manufacturing Process

Service Process

R&D

Expenditure0 0 0 0

R&D

Employees+ + 0 +

Innovation Type

Absorptive Capacity: TrainingManufactured Product

Service Product

Manufacturing Process

Service Process

Managerial

Training0 + 0 +

Scientist

Training0 0 0 -

Absorptive Capacity: Management Practices

Manufactured Product

Service Product

Manufacturing Process

Service Process

Total

Quaity

Management

0 + + 0

Quality

Circles+ 0 + 0

Job

Rotation+ 0 + 0

Connectivity: the Role of CollaborationManufactured Product

Service Product

Manufacturing Process

Service Process

Local 0 0 + 0

National + + 0 +

Overseas + 0 + 0

The Role of MarketsManufactured Product

Service Product

Manufacturing Process

Service Process

Regional 0 0 0 0

National 0 0 0 0

Overseas + 0 0 0

The Impact of PolicyManufactured Product

Service Product

Manufacturing Process

Service Process

R&D Tax Credits

+ 0 + -

Business Advice: Business Link

0 0 + 0

Business Advice: RDA

0 - 0 -

Summary of the CBR results

• Absorptive capacity variables have a positive effect on innovation

• Management practices are particularly important for manufacturing product and process innovation.

• Local collaborations are only important for manufacturing process innovation

• National and overseas collaborations are generally more important than local collaborations

• Sectoral specificities are strong and significant.• Regional dummies are not significant.

Regional Effects

• Regional impacts captured through variations in:– Industrial composition– Local labour market– Extent and reach of networks– Spatial variations in constraints

Variable Innovation

(Product, Goods)

Innovation (Product, Services)

Innovation (Process, Goods

and Services)

S&E employees/Total 0.256*** 0.244*** 0.054

Other high skills empl/Total 0.077 0.253*** -0.006

Training 0.370*** 0.522*** 0.626***

New Management Technique

-0.097*** 0.093*** 0.191***

New Organisational Structure

0.124*** 0.200*** 0.146***

New Marketing Strategies 0.436*** 0.373*** 0.334***

Collaboration: Local 0.033 0.259*** 0.173***

Collaboration: National 0.396*** 0.271*** 0.393***

Collaboration: Overseas 0.356*** 0.004 0.109*

Obstacles: Finance 0.222*** 0.260*** 0.205***

Obstacles: Knowledge 0.076** 0.098*** 0.071**

Obstacles: Market 0.147*** 0.067*** 0.004

Obstacles: Other -0.085*** -0.008 -0.043

MV Probit Estimates, Fourth Community Innovation Survey, 2004

Variable Innovation

(Product, Goods)

Innovation (Product, Services)

Innovation (Process, Goods

and Services)

R&D expenditure/Turnover 0.004 -0.030 0.012

Regional Public Support 0.083 0.140** 0.079

Government Public Support

0.313*** 0.140* 0.396***

EU Public Support -0.235*** 0.130 -0.099

Claimed R&D Tax Credit 0.497*** -0.117 -0.035

Market: Local reference reference reference

Market: National 0.241*** 0.145*** 0.116***

Market: International 0.588*** 0.141*** 0.256***

Age 0.001 -0.111*** -0.008

Size: Employees (LN values)

0.025*** -0.017* 0.068***

Ownership Structure 0.065** 0.049 0.042

Constant -2.445*** -1.359*** -1.774***

Observations: 13,237

Log Likelihood: -15753.06

MV Probit Estimates, Fourth Community Innovation Survey, 2004, cont.

CIS and CBR

• Analysis of CIS confirms:– Importance of science and engineering employees– No effect of level of R&D expenditure– Importance of training (but CIS does not

disaggregate by type)– Importance of new management techniques (for

services and process innovation)– Importance of national and international

collaborations– Role of tax credits for manufacturing

CIS and CBR

• Additionally analysis of CIS suggests:– A stronger impact of supplying national and

international markets– Regional policy support positive for service

product innovation– Government support positive for manufactured

product innovation and process innovation– EU support negative for manufactured product

innovation

Innovation strategies and absorptive capacity

• Closed Innovation - firms rely on internal resources and the controlled environment of the corporate laboratory.

• Open Innovation - a process where firms use both internal and external sources of ideas and deploy multiple business models to improve corporate performance

• Adoptive Innovation - utilise innovations developed elsewhere

Variable Innovation developed internally

Innovation developed in

collaboration

Innovation adopted

externally

S&E employees/Total 0.488*** -0.222** -0.098

Other high skills empl/Total 0.050 0.163* -0.045

Training 0.473*** 0.419*** 0.319***

New Management Technique

-0.011 0.097** 0.023

New Organisational Structure

0.168*** 0.044 -0.130***

New Marketing Strategies 0.421*** 0.135*** 0.099**

Collaboration: Local 0.101** 0.200*** -0.052

Collaboration: National 0.125** 0.524*** 0.278***

Collaboration: Overseas 0.045 0.071 -0.147*

Obstacles: Finance 0.206*** 0.151*** 0.151***

Obstacles: Knowledge 0.102*** 0.001 0.086**

Obstacles: Market 0.061** 0.040 0.109**

Obstacles: Other -0.066 -0.041 -0.105**

MV Probit Estimates, Fourth Community Innovation Survey, 2004

Variable Innovation developed internally

Innovation developed in

collaboration

Innovation adopted

externally

R&D expenditure/Turnover 0.056* -0.019 -0.603

Local and Regional Public Support

0.122** 0.122** 0.127

Central Government Public Support

0.192*** 0.238*** -0.118

EU Public Support -0.202*** 0.087 -0.037

Claimed R&D Tax Credit 0.392*** -0.154 -0.050

Market: Local Reference Reference Reference

Market: National 0.144*** 0.067 0.099

Market: International 0.429*** 0.161*** 0.047

Age -0.050 -0.044 0.167***

Size: Employees (LN values)

0.036*** 0.032*** -0.015

Ownership Structure 0.052* 0.116*** -0.031

Constant -1.465*** -2.093*** -2.149***

Observations: 13,277

Log Likelihood: -12845.12

MV Probit Estimates, Fourth Community Innovation Survey, 2004, cont.

Open, Closed and Adoptive Innovation

• R&D employees only important for closed innovation• New Management Techniques significant for open

innovators• Local and national collaborations significant for both

open and closed innovators– but the effect is larger for national collaborations– and the effect is larger for open innovators

• Importance of serving international markets

Case Study: Rationale

• To understand the dynamics and interrelationships of absorptive capacity variables

• To provide greater understanding of causal processes

• To explore the role of place, institutions and policies

Case Studies: Innovation Matrix

M1 (100%)M2 (80%)

S1 (70%) M3 (70%) S3 (70%)

M4 (40%)

S2 (60%)

S4 (0%)

S6 (0%) S8 (0%)

S5 (0%) S9 (0%)

S7 (0%) M and S denote manufacturing and services companies respectively % in brackets is R&D employees fraction = (R&D employees/Total Employees)*100

Hig

h R

&D

em

p r

atio

Ze

ro R

&D

em

p r

atio

Collaboration No Collaboration

I II

III IV

Case Studies: Characteristics

I II III IV

Turnover (£mln) 2.1; 3.0 & 3.8 4.5; 9.0; 9.7 & 14 3.2; 7.9 & 16.6 2.2; 3.5 & 14.5

Number of employees

40; 43 & 68 60; 120; 124 & 99 20; 100 & 175 23; 130 & 260

Age (years) 6-17 14-23 21-30 16-22

Location EM & SW SE & SW EM, NW & SE EM, NW & SE

Sectors Semiconductors, Organic Chemicals & Software Supply

Semiconductors, Medical Instruments, Engineering and Architectural Activities

Management, Technical and Software Consultancy and Engineering Activities

Business Services, Software Supply and Computer Related activities

Case Studies: Innovation Behaviour

I II III IVmanufactured product 3 2 1service product 3 2manufacturing process 1service process 1 1manufactured product 1service product 1 1 1 3manufacturing process 2 1service process 1 1 2 2

new to the firm and industry

new to the firm only

Innovation reported

Case Studies: Quadrant I and Quadrant II

• Q1– Important role of external sources for innovation

such as market, customers and suppliers – Company ability to understand and exploit such

sources – Innovation is iterative and interactive

• Q2– Emphasise internal sources for innovation – Innovation seen as linear – interactions with

customers only at the final stages of delivery

Case Studies: Quadrant III and Quadrant IV

• Q3 – Important role for external sources and internal

capability– High innovation expenditure on non R&D activities

eg, training and innovation related ICT• Q4

– Passive reactive innovators – respond to external demands (customers, consultants and technical standards)

Case Studies: Quadrant dynamics Collaboration No Collaboration

M1 S3

M2 S2

S1 M3

M4

S4

S6 S8

S5 S9

S7

Hig

h R

&D

em

p ra

tioZero

R&D

em

p ra

tio

Case Studies Across-Quadrant Results: Absorptive Capacity

Indicators

• Related prior knowledge and staff skills– Founders knowledgeable about the core

technology– Employees have a high general level of education – Use of external and internal training but training

budgets tend to be small – Use of variety of recruitment channels tailored to

the company needs

Case Study Across-Quadrant Results: Absorptive Capacity

Indicators• Organisational structure and management

practices• Job and functional rotation• Quality management practices• Internal knowledge exchange mechanisms• Emphasis on corporate culture• Importance of workplace layout to maximise

learning and knowledge exchange

Case Studies Across-Quadrants Results: Barriers to Innovation

• Finance • Shortage of skilled labour• Location specific factors

– Local labour market– Attractiveness to labour– Infrastructure

• Choice of Location– Importance of residential preference and path

dependence

Case Studies Across-Quadrants Results: Role of Networks

• Local networks– Low rates of participation– Few real benefits other than general awareness

raising• National and international networks

– Provide innovation-related benefits mainly in the form of technical and professional inputs

Case Study Across-Quadrants Results: R&D Tax Credits

• Manufacturing:– General easy access– Benefit is through improving cash flow not

directly influencing the decision to innovate • Services:

– Found it difficult to qualify– Some have resorted to professional

accounting firms to negotiate acceptable settlement

Policy Implications• Different forms of absorptive capacity have different effects on

goods, service and process innovation.• Management practices are important for innovation• Training is important – but the evidence suggest that it is the

training of managers not scientists that is important • R&D tax credit has a positive and significant association with

manufacturing product innovation. • But case studies suggests that the transmission

mechanism is through the impact on cashflow• Networks are important, but their geographical impact varies

across types of innovation.• Policy focus in UK to develop local and regional networks

might be detrimental in some sectoral and regional contexts.

Collaboration and Clusters

• According to Porter (1998) clusters are ‘geographic concentrations of interconnected companies, specialised suppliers, service providers, firms in related industries, and associated institutions (for example universities, standards agencies, and trade associations) in particular fields that compete but also co-operate’

Collaboration and Clusters

• The stress on ‘geographic concentrations’ is misleading• The Porter analysis is based on where firms are, not

what firms do • Local collaborative behaviour is not an important

driver of innovation • National collaborators are consistently more important

than local collaborators• Important to distinguish between ‘bridging and’

bonding’ networks – bridging networks that are outward looking may be more important for knowledge based activity

Further Information

• Centre for Business Research

www.cbr.cam.ac.uk

• Programme on Regional Innovation

www.regionalinnovation.org.uk