THE EFFECTS OF CONTINUOUS IMPROVEMENT AND INNOVATION MANAGEMENT PRACTICE ON SMALL TO MEDIUM ENTERPRISE (SME) PERFORMANCE Dr Milé Terziovski, PhD Director and Deputy Chair, European Australian Cooperation Centre, Faculty of Economics and Commerce, The University of Melbourne, Parkville, Victoria, Australia Tel: 61 3 93447868, Fax: 61 3 8344 3714, Email:
[email protected]
ABSTRACT This paper presents the results of a mail survey used to investigate the relationship between continuous improvement/innovation management practices and SME performance in Australia. Multi-item scales were developed and used to measure key components of continuous improvement and innovation management. Nine dimensions of SME performance were measured, for example, speed to market, success rate of new products, improved product innovation, reduction in waste, etc., Hypotheses, relating practice with performance outcomes, were developed and tested within a Continuous Improvement and Innovation Management (CIAIM) framework, using response data from 115 Australian SMEs from the manufacturing sector. A survey response rate of 21 per cent was obtained. The following results were obtained using multivariate analysis techniques: The CIAIM model was found to be a valid and reliable framework for measuring and predicting the relationship between continuous improvement/innovation management practice and SME performance. The most significant predictors of high SME performance were found to be: •
The adoption of a continuous improvement and innovation management strategy. This was found to be a critical factor for high performing SMEs to achieve their strategic goals and objectives.
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The use of core technologies and organizational objectives as a guide for evaluating new ideas and information as part of the continuous improvement and innovation management system.
The paper concludes that a continuous improvement and innovation management strategy and system are significant predictors of SME performance. The implication for managers is that these practices are imperative in order to avoid SME failure. The findings are consistent with the literature. Key Words: continuous improvement, innovation, performance
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INTRODUCTION According to the Australian Bureau of Statistics (ABS, 1999) there are approximately 900,000 businesses currently operating in Australia of which 94-96 per cent are considered SMEs. These enterprises have generated more than half of Australia’s employment growth and are seedbed for innovation and the formation of large corporations (Australian Bureau of Statistics, 1999). Despite the overall contribution of SMEs, however, every year thousands of SMEs fail. According to the US Small Business Administration 24 per cent of all new businesses fail within two years and 63 per cent fail within six years (Wheelen and Hunger, 1999, p.284). Similar failure rates occur in Australia, UK, The Netherlands, Japan, Taiwan, and Hong Kong. This was confirmed by a longitudinal study conducted by Dun & Bradstreet (in Wheelen & Hunger ,1999) of 800,000 small US firms from 1985 to 1994. Seventy per cent of these firms were still in business in March 1994. Contrary to other studies, this study only counted firms as failures if they owed money at the time of their demise. The main reasons for SME failure range from inadequate accounting systems to inability to cope with growth. Two underlying predictors of SME failure emerge from the literature: •
An overall lack of strategic management, with an inability to plan a strategy to reach the customer.
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Failure to develop a system of controls to keep track of SME performance.
Purpose of the Study and Research Questions The purpose of this paper is to present the results of a mail survey used to investigate the relationship between continuous improvement/innovation management practices and SME performance. A continuous improvement and innovation management framework is developed within which hypotheses are tested using Multiple Regression Analysis. Hence, the following research questions are addressed: • Is a continuous improvement and innovation management (CIAIM) model a reliable and valid tool for predicting the relationship between SME practice and performance? •
Which management practices are significant and positive predictors of high SME Performance?
LITERATURE REVIEW For the purpose of this study the term SME incorporates two primary classifications, namely small business and medium business. Behrendorff et al (1996) defines a small business as “being independently owned and managed, being closely controlled by owners/managers who also contribute most, if not all, of the operating capital: having the principle decision-making functions resting with the owner/managers. Three size categories defined by the Australian Bureau of Statistics (1999) are adopted in this paper: ‘small’ (20-49 employees), medium (5099 employees) and large (100 or more employees). Continuous Improvement and Innovation Management Innovation is widely accepted as a crucial competitive weapon in today's global market place. Innovation is defined as “the adoption of an idea or behaviour, whether a system, policy,
3 program, device, process, product or service, that is new to the adopting organisation” (Damanpour, 1992). The Innovation Study Commission’s (1993) defines innovation as “something new or improved, which is done by the enterprise to significantly add value either directly or indirectly for the enterprise or its customers.” This definition has been adopted on the survey instrument, instructions to respondents. Jha et al., (1996) define continuous improvement (CI) as a collection of activities that constitute a process intended to achieve performance improvement. In manufacturing, these activities primarily involve simplification of production processes, chiefly through the elimination of waste. In service industries and the public sector, the focus is on simplification and improved customer service through greater empowerment of individual employees and correspondingly less bureaucracy (McLaughlin,1990). Acquisition and use of skills for process analysis and problem solving are seen as fundamental to CI in the private and public sectors. CI, innovation management and quality management are closely connected in the literature. For example, Imai(1986) defines Total Quality Control (TQC) as "organized kaizen improvement activities involving everyone in a company - managers and workers - in a totally integrated effort toward improving performance at every level". The underpinning principle of KAIZEN (Japanese word for continuous improvement) is the use of various problem-solving tools for the identification and solution of work-based problems. The aim is for improvement to reach new ‘benchmarks’ with every problem that is solved. To consolidate the new benchmark, the improvement must be standardised. In many Australian SMEs this standardisation has been attempted via the ISO 9000 quality systems certification process (Terziovski et al., 1997). KAIZEN generates process-oriented thinking (P criteria) since processes must be improved before improved results (R criteria) can be obtained. Improvement can be broken down between continuous improvement and innovation. KAIZEN signifies small improvements made in the status quo as a result of ongoing efforts. On the other hand Innovation involves a step-change improvement in the status quo as a result of a large investment in new technology and/or equipment or a radical change in process design using the Business Process Reengineering concept (Hammer et al., 1993). There is one significant difference between KAIZEN and Innovation according to Imai (1986). KAIZEN does not necessarily call for a large investment in capital or a radical redesign of processes to implement the strategy. However, the KAIZEN strategy does call for continuous effort and commitment from all levels of management. Thus KAIZEN calls for a substantial management commitment of time and effort. Investing in KAIZEN means investing in people. According to Harrington (1995) “..all organisations need both continuous and breakthrough improvement.When breakthrough improvement and continuous process improvement are combined, the result is a 60 per cent improvement per year over continuous improvement alone.” However, Harrington concludes, based on empirical evidence, that continuous improvement is the major driving force behind any improvement effort. Breakthrough improvement serves to ‘jump-start’ a few of the critical processes. Several other research studies have pointed out to the need for continuous improvement and innovation as a key source of competitive advantage for organizations. In today's competitive environment, the challenges for all businesses (including SMES) is not only to innovate in
4 existing markets to survive and remain profitable, but also to innovate in new markets in order to stay in front of competitors. A major study commissioned by the Australian Manufacturing Council, Leading the Way (1995) identified “size and complexity” as the main issue for SME survival; the point at witch SMEs switch from informal to more formal and structured planning systems in order to survive. The study confirmed on the basis of a 1300 response data base, that continuous improvement and innovation management has a positive impact on the business performance of individual firms. A more specific study by Soderquist et al. (1997) investigated continuous improvement and innovation practices in French SMEs. The study was an extension of Birchall et al.'s (1996) study in which a macro-level comparison of factors affecting managing of innovation in SMEs in the UK, France, and Portugal was presented. In their study, Soderquist et al. (1997) examine the drivers for change and the short-and long-term goals, the sources of innovation and the nature of innovation management in French SMEs. Respondents were asked to consider a recent and successful innovation in product or service and then to indicate just how important a number of items were as a source of particular innovation. The top nine sources of innovation were found to be: • The introduction of new products and/or services. • Continuous improvement of work processes. • Radical change, e.g. through Business Process Reengineering. • Increased focus in marketing/sales efforts. • Reduction in indirect staff numbers. • Improvement on staff competence. • Improved quality of products and services. • Improving the quality of management. • Efforts to improve supplier performance. The study identified two groups of SMEs. The first group reported satisfaction with their organization's performance in product and service innovation and also reported that their organizations had a strategic approach to innovation. The downside for these companies is that innovation might come at the cost of short-term profitability and innovation in working processes and procedures. The second group comprised SMEs who were satisfied with current actions for improving short-term performances. Further analysis showed that this group is more likely to report a stronger emphasis on effective performance management approach. The downside for these companies is that such a focus is less likely to result in satisfactory product and service innovation. The following conclusions can be drawn from the Soderquist et al. (1997) study: •
Continuous improvement of work processes was ranked the most important action for improving the short-term profitability, while increasing customer focus was ranked the most important action for improving long-term well-being of the company.
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The demands placed on business by customers/clients, close working relationship with key customer, and input from their own R&D department were considered as the most relevant sources for successful innovation in product/service.
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Suggestions from internal quality improvement groups was ranked as the most important source of innovation for work processes and procedures. The respondents placed the highest emphasis on pressures for cost cutting and technology management.
Whilst the findings of this study are relevant and useful to managers and practitioners, the analysis is based on simple statistics, and it does not rigorously test the strength of the relationship between SME practice and performance. More rigorous studies have been conducted by (Gibb and Davies, 1990; Rizzoni, 1991; Sebora et al., 1994). These studies have identified and highlighted the critical success factors for continuous improvement and innovative strategy in SMEs and the importance of a marketing orientation and effective strategic formulation in successful SMEs. The critical success factors highlighted in these studies include: •
Promoting a corporate culture.
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Creating an effective structure.
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Analysing competitors.
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Developing co-operations and partnerships.
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Developing flexibility and speed of response.
In a recent study by (Boer, et al, 2000) describe and explain how companies can gain a competitive advantage by extending their innovation efforts to the various phases of the product life cycle and by facilitating knowledge transfer and learning both within the company and with other partner organizations. The authors develop a methodology based on collaborative research by the authors and their involvement in the Euro-Australian cooperation project CIMA (Euro-Australian Co-operation Centre for Continuous Improvement and Innovation Management). This project was established as a joint venture between the European Commission and the Australian Government in 1997. The methodology provides a structured, step-by-step approach to mapping the user company’s current level of learning within product innovation, identifying strengths and weaknesses and then suggesting enabling mechanisms which can be implemented by the company to stimulate continuous improvement and learning, depending on specific contingencies. This process is supported by a behavioural model, explaining relationships between learning behaviours and outcomes, capacities enabling these behaviours, levers that managers can use to change existing or promote new behaviours, and contingencies affecting this whole set of relationship. Literature Synthesis Despite the large size of the literature on CI and innovation management, there is little empirical research with the desired focus or rigour according to Jha et al., (1996). Less than 2 per cent of the 1,002 bibliographic references on CI analysed by Michela et al.(1996), were explicitly identified in the subject fields of the references as "studies" by the database developers compared with the 24 per cent identified as "case studies". Although one could criticize the practitioner literature for being, at times, repetitive, some of the repetition is justified when the same principles, tools and success factors are described to
6 different audiences (e.g. accountants, executives, human resource specialists, manufacturers) as reached by publishing in targeted journals. The Soderquist et al. (1997) study has shed some new light on the critical success factors in managing continuous improvement and innovation management in French SMEs. However, there are some limitations with the study which need to be taken into account. As this is a single region study, generalizations are limited. Furthermore, the study does not comply with generally-accepted standards of methodological rigour. The analysis is based on simple statistics, and it does not rigorously test the strength of the relationship between SME practice and performance. Therefore, our study aims to address the above issue by intergrating CI and innovation management under five key areas: strategy, structure, culture, systems, and performance in a similar fashion as the CIMA methodology (Boer, 2000). Multivariate analysis is used in order to test the validity and relaibility of the CIAIM model and the strength of the relationship between SME practice and performance. The following hypotheses were formulated for testing: Hypotheses to be Tested H1: “The CIAIM model is a reliable and valid instrument for measuring and predicting the relationship between continuous improvement/innovation management practice and firm performance.” H2: “Continuous improvement and innovation management strategy and systems have a positive and significant effect on SME performance” RESEARCH DESIGN In order to test the formulated hypotheses, quantitative data was gathered from a large random sample in a mail survey of SME manufacturing firms. Twelve industry codes based on the Australian Standards Industry Classification (ASIC) system were. A total of approximately 550 SME manufacturing sites were sent a questionnaire. Responses were received from 115 sites yielding a response rate of 21 percent. Variables /Survey Instrument A total of 19 questions were included in the questionnaire. A variety of sources were used in developing the questions, including the Continuous Improvement and Innovation Management (CIMA) Methodology (Boer, et al, 2000) developed by the Euro-Australian Cooperation Centre for Continuous Improvement and Global Innovation Management. The questionnaire for our study was pilot tested on 12 sites in Australia, and subsequently revised. SME Performance is used throughout this paper to represent innovation performance (eg. higher success rate of new products launched, faster speed to market) and operational performance (eg.reduction in waste, increased quality, delivery-in-full-on-time). (Venkatraman & Ramanujam ,1986, p.801). Data Preparation A total of 57 independent variables and 12 dependent variables were used in the analysis. Confirmatory Factor Analysis was conducted where 5 usable independent factors were extracted and one dependent factor. Factor Analysis and Multiple Regression Analysis require all cells in the data set to be complete. The variable mean was substituted for missing cells.
7 Profile of respondent firms Section 1 of the survey instrument asked 5 demographic questions. Two of these questions addressed the characteristics of the respondent firms. With reference to Tables 1and 2, more than 50 per cent of the total respondents were Managing Director or CEO with the balance of respondents were Manager level or higher. The size of the companies that responded range from less than 5 employees to 1 firm being greater than 500 employees, with 90 per cent of firms falling between 21 and 500 employees. These figures correspond with the Australian Bureau of Statistics (1999) classification of firms discussed in the introduction section of the paper. Position
Frequency Secretary 1 Manager 19 Operations Manager 8 Financial Controller/Accountant 8 Managing Director or CEO 60 Director 12 Chairman 1 Other 3 TABLE 1 - Position in Company
Percent 0.9 16.8 7.1 7.1 53.1 10.6 0.9 2.7
Number of Employees Frequency
