Evidence from Estonia's ICT Sector Tarmo Kalvet * Marek Tiits

This paper was presented at The 5th ISPIM Innovation Symposium - Stimulating Innovation: Challenges for Management, Science & Technology, Seoul, Korea on 9-12 December 2012. The publication is available to ISPIM members at www.ispim.org.

Implementing Open Innovation in Catching-up Economies: Evidence from Estonia's ICT Sector Tarmo Kalvet * Department of Public Administration, Tallinn University of Technology, Akadeemia tee 3, Tallinn 12618, Estonia. E-mail: [email protected]

Marek Tiits Institute of Baltic Studies, Estonia. E-mail [email protected] * Corresponding author Abstract: Open innovation has become an important concept in innovation research. We analyse the implementation of open innovation by R&D and knowledge-intensive actors from the Estonian ICT sector based on interviews with the representatives of 30 companies and research teams. From the perspective of open innovation, three larger segments are distinguished in the knowledge and R&D intensive part of the Estonian ICT sector. There are already firms in the Estonian ICT sector that benefit from open innovation. However, open innovation assumes the existence of a strong public knowledge base as well as strong capabilities and capacities within the companies, and challenges were identified regarding both. The largest challenge is related to the limited supply of high quality ICT specialists and managers of international business and technology, creating a need for an improved public knowledge base and overall education. Keywords: open innovation; ICT; research and development; innovation policy; Estonia.

1 Introduction Since the 1990s, business models that were directed at creating stability in production and reaping economies of scale and scope (through large production units, mass employment, and in long-term planning) (Chandler and Hikino, 1990) are being replaced by highly specialized networks that operate and source production and knowledge, often supraregionally or even globally (Ernst and Kim, 2002; Berger, 2006; Dean et al., 2007; Gallagher and Zarsky, 2007; Ernst, 2008). Relatedly, open innovation—‘the use of purposive inflows and outflows of knowledge to accelerate internal innovation, and to expand the markets for external use of innovation, respectively’ (Chesbrough et al., 2006, 1)— has become an important concept in research on innovation and innovation management (Dodgson et al., 2008; Tidd and Bessant, 2009; Dahlander and Gann, 2010), especially for research and knowledge-intensive activities. Since 2007, these issues have also captured the attention of policy-makers, and open innovation is increasingly used as

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a guideline for revising policies (e.g., European Commission, 2007; OECD, 2008; Evaluation of the Finnish…, 2009; Mayer, 2010; Ebersberger et al., 2011). The studies generally show the positive impacts resulting from applying (more) open innovation practices. The research paper analyses if actors from the catching-up countries and regions possess the capabilities and capacities to take open innovation onboard. Based on empirical research, we use an example of a catching-up economy to pay more attention to the challenges associated with open innovation in an effort to bridge some of the gaps identified in the literature (Dahlander and Gann, 2010; van de Vrande et al., 2010). For analysis, we have chosen the case of Estonia, a small economy that in the last decades has experienced a remarkable transition from a planned economy to a free market economy. The focus is specifically on the ICT sector, which is one of the most R&D-intensive sectors globally (Moncada-Paternò-Castello et al., 2010). Comparatively, this sector has a higher potential to benefit from open innovation, which is thought to be more appropriate in contexts characterised by globalisation, technology intensity, technology fusion, new business models, and knowledge leveraging (Gassmann, 2006). In Estonia, the ICT sector is also R&D and knowledge intensive. As of 2009, employment in this sector accounted for 41% of the total R&D personnel (FTE) working in the business enterprise sector (Statistics Estonia, 2011), which included manufacture of computer, electronic, and optical products and electrical equipment as well as ICT activities such as computer programming, consultancy, and related activities and telecommunications services. When including related financial and insurance activities that are very ICT-intensive in Estonia (Kalvet, 2006), R&D personnel in ICT-related fields make up 52% of the overall R&D personnel. Estonian policy-makers have also shown considerable interest in open-innovation-based policy-making (De Jong et al., 2008; Kalvet et al., 2010). Although the focus of open innovation is on a firm, we are also interested in public sector actors because they have an important role to play, for example, as technology suppliers. The current study consists of a thorough literature analysis to identify major public- and private sector actors who carry out ICT R&D in Estonia. We pay special attention to their patenting activities and to their participation in the ICT theme of the European Union R&D Framework Programmes (FP6 and FP7) (see Cordis, 2010). These FPs are designed to strengthen EU centres of excellence and foster collaboration among them, thus facilitating open innovation (European Research Area Advisory Board, 2009). The major ICT R&D actors identified were interviewed to gather information on their R&D base and strategic interests, especially in relation to their participation (and limits to participation) in international R&D activities and open innovation. Representatives of 30 companies and research teams were interviewed over a period from August 2009 through August 2012. The paper is structured as follows. Section two discusses the potential of open innovation, based on a literature review. Section three describes and analyses the case of Estonia—the main ICT actors undertaking R&D, their open-innovation-related activities, their strengths and weaknesses relating to the internal environment for ICT R&D in Estonia, and the threats and opportunities. Section four discusses the findings and points

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out the main challenges to open-innovation discourse when applied in catching-up economies.

2 Literature review: Potential of open innovation The basic argument of open innovation is that useful knowledge is widely diffused, and the knowledge landscape is heterogeneous. This includes companies of all sizes, universities, non-profit organizations, user communities, etc. (Chesbrough, 2006; Chesbrough et al., 2006). Indeed, Reinert (2007) shows that innovation in enterprises carried out in co-operation with various players leads to positive externalities and generates economic development—an understanding that has a long-standing history. Hargadon (2003) maintains that external knowledge sources have been important to success in innovation. The open innovation approach attaches particular importance to external sources and alternative paths to market, processes that take place on global level. More concretely, open innovation is concerned with the opening of the innovation process. It flows in two directions: “the inbound open innovation, which is the practice of leveraging the discoveries of others” and outbound open innovation where firms “look for external organizations with business models that are better suited to commercialize a given technology than the firm’s own business model” (Chesbrough and Crowther, 2006, 229). Thus, benefits accrue from establishing relationships with external organisations for commercially exploiting innovation opportunities. These benefits can include additional financial revenues from selling or licensing-out ideas that might hitherto have been unused, outside partners better equipped to commercialise inventions to the mutual interests of both organisations, outside partners providing radical new solutions to problems, etc. (for summary, see Dahlander and Gann, 2010). While earlier research focused on the benefits of large, multinational enterprises (Chesbrough, 2006; Chesbrough and Appleyard, 2007), more recent contributions also analyse the positive impact of open innovation on small- and medium-sized companies (Lichtenthaler, 2008; Van de Vrande et al., 2009). The studies generally show the positive impacts resulting from applying (more) open innovation practices. More specific and under-researched questions remain: (1) how will benefits from a transition to open innovation be distributed; and (2) do actors from the catching-up countries and regions possess the capabilities and capacities to take open innovation onboard. De Jong et al. (2010, 893) conclude that more research is needed on how policymakers in developing countries should adopt guidelines for open innovation policies. Karo and Kattel (2010, 22), focusing on the context of catching-up economies, conclude that “… the open-innovation concept lacks proper attention to the underlying principle of the emerging consensus in innovation theory—contextual understanding of problems and aiming policies at influencing dynamic firm-level capabilities”, an argument also present in Karo and Kalvet (2009). Herstad and colleagues (2010) also argue that national policy mixes should respond to the challenges and opportunities of globally distributed knowledge networks, cross-sectoral technology flows, and open innovation processes. They point out that a balance should be sought in public policy concerning the formation of international linkages, providing incentives for building absorptive capacity and knowledge accumulation locally and sustaining domestic networking nationally.


3 Open innovation and the knowledge- and R&D intensive actors Estonian ICT sector and open innovation Estonia is a Baltic economy in Northeast Europe and has been considered by many as one of the successful, perhaps most successful, of the Eastern European catching-up economies (European Bank for Reconstruction and Development, 2000). Although concerns have been expressed by others (e.g., Tiits et al., 2008), it is still generally agreed that Estonia has had remarkable success in promoting a technology-based information society (Kalvet, 2012). For example, a United Nations survey (United Nations Department of Economic and Social Affairs, 2008, 81) describes Estonia as a country “reinventing itself from the confines of the previous Soviet era into a Baltic catalyst for digital adoption and innovation”. However, the Estonian ICT sector is still better described by the “doing, using, and interacting” mode of innovation than the “science, technology, and innovation” mode (on typology, see Jensen et al., 2007). First, this mode is evidenced by the low level of patenting. The analyses show that where Estonian inventors have been involved, patents and utility models issued internationally in the field of ICT for 2000–2009 amount to 285 records. So far, based on the interviews, we cannot link these patenting activities to outbound open innovation; instead, patents are used for protective reasons. Second, Estonian companies’ innovative activities are generally related to inward technology transfer, like acquisition of equipment and machines, and the level of cooperation with external partners is low. Most co-operation takes place within production value chains. Only a fraction of companies co-operate with research institutes in the public sector (Statistics Estonia, 2011). Overall, the level of inbound open innovation is rather limited.

Main ICT actors As of 2009, Estonian ICT companies’ R&D staff totals 1,041 (793 in FTE). Of these, 797 (636 in FTE) are focused on activities related to information and telecommunications, and 244 (157 in FTE) are focused on the manufacturing of electric and optical equipment. An additional 341 (202 in FTE) R&D workers are employed in financial and insurance activities. Still, according to the interviews, these figures are subject to possible overestimations as personnel engaged in more routine activities are likely to be reported in addition to R&D personnel (as defined by OECD and Eurostat, 2005). Based on a literature review of Estonian private sector ICT R&D (Kalvet et al., 2002; Tiits and Pihl, 2002; Högselius, 2005; Tiits and Kalvet, 2010), we conclude that a relatively small number of well-known high-profile ICT companies have been and continue to be key players in terms of R&D and/or product development efforts. For example, we estimate that Skype Technologies alone accounts for about half of the R&D investment of ICT enterprises, and the top 15 are responsible for approximately 80% of R&D investment in the ICT sector. Official sources provide us with no actual number of ICT researchers in the public sector, but the Estonian Research Portal (2010), claims 410 active researchers as of 2009 in the

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field of computer science. However, less than half of them (162) have at least one publication referenced in the ISI Web of Science, and even fewer (127) have a PhD degree. In a similar vein, another study has identified 131 Estonian computer scientists who have at least one citation of their research paper on Google Scholar (Lipmaa, 2009). Thus, we estimate that the Estonian public sector has no more than 150 reasonably active and productive ICT researchers. Figure 1 shows the main actors and their relationships with various funding bodies and research outputs. Target Funding is a major national funding scheme for research centres that have a critical mass of researchers. Enterprise Estonia mainly funds industrial ICT R&D, but many beneficiaries are relatively small start-up companies with limited R&D efforts. FP reflects successful projects funded both from the FP6 ICT Programme and the first three calls in the FP7 ICT Theme. In Estonia, four central nodes link many of the ICT R&D centres, which are the publicly funded Centres of Excellence and Competence Centres that unite and create synergies among top research units. Of these, two are research-oriented Centres of Excellence: Centre of Excellence in Computer Science (EXCS) and Centre for Integrated Electronic Systems and Biomedical Engineering (CEBE); and two are technology-developmentoriented Competence Centres: Competence Centre in Electronics-, Info- and Communication Technologies (ELIKO) and Software Technologies and Applications Competence Centre (STACC).

SWOT for participation in open innovation The most significant strengths characterising the internal environment for ICT R&D in Estonia derive from the prioritisation of the adoption of ICTs by the government and end users. In addition, several instruments are in place to support excellence in ICT R&D. These include both the national Centres of Excellence and Competence Centres programmes and the generally competitive R&D funding system, which prioritises high quality research. Estonia also has a good reputation within the international ICT landscape. There is a lot of enthusiasm in Estonia for developing and adopting ICTs. Estonia’s small size allows closer linkages among individual actors and, thereby, for greater dynamism. Interaction among higher education establishments is indeed quite close as is communication among major ICT enterprises. Still, the interaction between academia and industry remains weaker and more random. A limited number of local key players are very well integrated with global innovation networks.


Figure 1. Key actors in Estonian ICT R&D1

Source: Authors’ elaboration based on data from Estonian Research Portal (2010), Enterprise Estonia (2010) and Estonian Research Portal (2010). 1 CEBE – Centre for Integrated Electronic Systems and Biomedical Engineering; EXCS – Centre of Excellence in Computer Science; ELIKO – Competence Centre in Electronics-, Info- and Communication Technologies; FP - Framework Programme; STACC – Software Technologies and Applications Competence Centre; TLU – Tallinn University; TUT – Tallinn University of Technology; UT – University of Tartu.

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The global economic crisis is an important trigger for change and development as is continued globalisation (and participation in international value chains). The emergence of new fields of ICT R&D continues to exhibit major opportunities. The rapidly evolving globalisation of higher education (attracting new teaching and research staff as well as students) is another driver that will have a major impact in Estonia. The aspirations of the EU for establishing a well functioning European Research Area and the existence of various R&D support instruments also continue to present major opportunities for the catching-up economies. Estonia’s neighbourhood includes some of the most advanced ICT nations in the world and even closer ICT R&D and business co-operation with these neighbouring countries in the Baltic Sea Region would prove beneficial. In particular, linkages with Nordic countries could be more actively used by Estonian researchers and entrepreneurs as gateways for joint access to far-away markets, e.g., the Americas, Asia, etc. The most significant threats will likely derive from a lack of timely and sufficient action in meeting the challenges posed by the current economic crises, perhaps because the recently achieved economic stabilisation has made policy-makers overly complacent. The demographic challenges and projected decline of the Estonian labour force continue to require immediate action. While the emergence of global production and innovation networks presents good opportunities, international supply and R&D networks have already formed around bigger players in the more established fields of ICT. In order for new actors to be accepted into existing R&D and production networks, benefits must be very clear (and risks low). The limited specialised advantages of Estonian entities remain a considerable threat in this context.

4 Discussion From the perspective of open innovation, the following three larger segments can be distinguished in the knowledge and R&D intensive part of the Estonian ICT sector. Even though this division is necessarily a simplification (as one company could have different products and services in its portfolio that belong to different segments or could transfer from one segment to another), it is still revealing. Companies in the first segment—especially electronics manufacturing—can be described as supplier-driven. They need to climb on the knowledge ladder before open innovation becomes a concept relevant for them. Their technical change comes largely from suppliers of machinery (usually from outside Estonia) and other production inputs. The main objective of innovation strategies for these companies is to use technology from elsewhere to reinforce other competitive advantages. Their focus is mainly on process and non-technological innovation. Companies in the second segment practice mainly inbound innovation. Namely, for some economic sectors, software development provides a considerable competitive advantage, and the design and operating of complex systems for processing information is required. There are software development companies (including units within some financial companies) that are very knowledge-intensive. The main sources of technology are inhouse software and systems departments as well as suppliers of ICT hardware and of

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systems and applications software. Although the knowledge base of some would allow practicing outbound innovation more actively, this is practised seldom. Companies in the third segment comprise the small number of internationally active firms. They offer their own products and services on international markets and/or provide high-performance inputs into complex systems of production, of information processing, and of product development in the form of components, instruments, and software. These firms benefit from the operating experience of advanced users in the form of information, skills, and the identification of possible modifications and improvements. For them, R&D carried out anywhere in the world is important. The main tasks of innovation strategy are keeping up with users' needs, learning from advanced users, and matching new technologies to users' needs by leveraging the discoveries of others and co-operating with external organizations. These companies actively practice both inbound and outbound innovation. The best-known example is perhaps Skype, headquartered in Luxembourg and incorporated as a division of Microsoft since 2011. Most of the development team and overall employees are located in Estonia, and the company has very successfully managed to internationalise by combining technological and managerial competencies to reach customers as well as knowledge on global level (Barnard et al. 2013). For companies in this segment, the positive impact from applying open innovation practices is confirmed as suggested by the literature. However, further research is needed on the impact of possible long-run disconnectedness from the local innovation system. Thus, there are already firms in the Estonian ICT sector that benefit from the fact that value chains are fragmenting and globalising and that many multinational corporations (and countries) are opening themselves up to products and services from distributed knowledge networks. Participation in global innovation and production networks is, however, anything but equally accessible and profitable for all research labs and firms. Multinational firms continue to assume a co-ordinating role in modern business competition. In more established fields of ICT, international supply and R&D networks have already been formed around bigger players. With the increasing concentration of industry, the barriers to entry continue to mount. In order for new actors to be accepted into existing networks, benefits must be very clear and risks must be low. The limited specialised advantages of Estonian entities remain a considerable threat in this context. While several ICT actors confirmed interest in and plans to be more involved in open innovation, discussions with them revealed serious bottlenecks. As interviewees pointed out, open innovation assumes strong capabilities. Such dynamic capabilities (Teece, 2009) and overall framework conditions for open innovation (De Jong et al., 2010) were estimated to be low. Open innovation assumes the existence of a strong public knowledge base (as this potentially facilitates a more effective and efficient search for new innovations) in addition to a mobile, educated working population (as knowledge can flow through people moving among organizations, labour mobility enables or even forces firms to open up their innovation processes). Estonia and other catching-up economies have profound problems in both these areas (Innovation Union Scoreboard, 2011). These remain serious challenges that limit the potential open innovation on wider scale. Next to direct co-operation relationships among some key actors, the main mechanisms for facilitating co-operation are Centres of Excellence and Competence Centres (Figure 1). It is through these largely government funded mechanisms that local R&D academic units and industrial companies meet to build longer term strategic R&D synergies. Even

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though open innovation research seems to underemphasize the national dimension, cooperation within national boundaries through such schemes should be continuously encouraged due to its potential positive spillovers for all involved parties. Furthermore, while open innovation emphasises co-operation on the global level, it is regional collaboration within the Baltic Sea Region that is practiced and preferred by the Estonian ICT companies. In general we are seeing the emergence of cross-border supranational innovation co-operation in the Baltic Sea Region rather than truly global co-operation. Finally, it also appears that the ICT theme of the FP7, which could play a strong supportive role in the advancement of open innovation in Europe, is structured so that it is especially beneficial for countries with large absolute numbers of R&D personnel and a high volume of R&D investment. In other words, the FP7 ICT contributes to deepening rather than closing the gap between the old and new member states’ technological capabilities and participation in open innovation (Maier, 2009; Tiits and Kalvet, 2010). The improvement of the accessibility of European R&D Framework Programmes for smaller actors remains a challenge for European R&D policy. It is only through greater support that the technological potential of the Central and East European catching-up economies can be fully utilised and the aspirations for the advancement of the European Research Area and open innovation will materialise more globally. The following policy recommendations have been derived to improve the up-take of open innovation in Estonia: (1) Strengthen international business and technology management skills because a number of the ICT R&D units have insufficient skills to advance their positions in international R&D networks and, especially, to co-ordinate international R&D activities. (2) Strengthen the technological capacities of the Estonian ICT enterprises because the technology and product development capacities remain limited. This can be done by further promotion of the R&D and product development grants as well as more systematic use of public procurement to support R&D and innovation. (3) Internationalise and strengthen higher education in the field of ICTs. The needs of local industry should be better reflected through new course offerings with active industry involvement in planning, execution, and steering of ICT education programmes. (4) Strengthen the public research base, as it remains crucial to sustain and increase quality of higher education. More support should be provided for the emergence and development of new research groups (led by local and foreign talent) that ensures appropriate coverage of emerging new fields of ICT R&D.

5 Conclusions The paper focused on the sector that is the most knowledge and R&D intensive in Estonia and, as such, has the largest potential to boost innovation by applying the principles of open innovation. However, we conclude that given the structural nature of the challenges, there are no ‘quick fixes’ to increase the competitiveness of the ICT R&D and business in Estonia or to advance Estonia’s participation in open innovation. Our research findings suggest that internal competences need to be strengthened as a precondition for participating in open innovation. The largest challenge is related to the improvement of the framework conditions – improvement of the public knowledge base and overall education. More specifically, the


supply of high quality ICT specialists—scientists and engineers—and international business and technology managers has to be improved. Furthermore, the objective of public policies should not be to create international linkages per se but to improve knowledge bases upon which industrial development may continue to build. This exploratory work confirms the need for more research to learn how open innovation benefits are distributed and how public policies in catching-up economies should address the issue.

Acknowledgements We thank all interviewees. We are especially grateful to Heli Aru, Aavo Kaine, Madli Kaju, Kitty Kubo, Indrek Reimand and Epp Tohver-Bulavs for their comments on the research results. Research for this study was supported by the Estonian Science Foundation (grant ETF8423) and by European Social Foundation through the Estonian Research and Innovation Policy Monitoring Programme.

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