Organization of Knowledge and Innovation: The Case of Finnish Business Services

Industry and Innovation, Jun 2005 by Leiponen, Aija

ABSTRACT This empirical study examines knowledge creation activities in business service firms. Using survey data of 167 Finnish knowledge-intensive business service firms, I explore hypotheses about the organization of learning and innovation. Results from an exploratory factor analysis combined with regression analyses suggest that, first, collective application of knowledge is more likely to lead to significant improvements in services than individual application of knowledge. Second, external sourcing of knowledge, particularly from customers and competitors, is more conducive to new service introductions than local and incremental learning on the job. Broad information sourcing and internal cooperation to mobilize knowledge thus support the renewal of knowledge-intensive business services. More significant service innovations are also supported by highly educated employees, but the role of R&D investments is not significant.

KEY WORDS: Knowledge, innovation, business service firms, Finland

1. Introduction

Despite the growing role of services in industrialized economies, innovation has mainly been studied in the context of manufacturing. In the manufacturing sector, new goods are tangible and research and development (R&D) investments are well documented. In contrast, services are characterized by intangibility and user-participation (Miles, 1994; Boden and Miles, 2000), whereby each service process is different. Some creativity is thus required of every service delivery. However, service innovation can be distinguished from customization. Service innovation involves changes in the process of delivering existing services or the development of completely new kinds of services.

Qualitative studies of service innovation have argued that the innovation process is more informal and ad hoc than innovation activities in the manufacturing sector (e.g. Sundbo, 1997). For instance, investments in R&D play a less prominent role in the development of new services. Moreover, the process of service innovation has been suggested to be qualitatively different from manufacturing innovation. In particular, Barras (1986) has proposed that in financial services the innovation cycle is reversed: technology adoption ignites service process innovation, which eventually leads to service product innovation. This is in stark contrast to the cycle of innovation described by Abernathy and Utterback (1978).

Independent of the process of innovation, recent survey data indicate that innovation does occur in the service sector. According to the Finnish Community Innovation Survey of 1997, approximately 20 percent of firms in a sample of 550 service firms1 reported having launched new services in the previous 3 years (1994-96) (SF, 1998), a level of innovation activity comparable to product innovation in Finnish manufacturing industries. From a broader economic point of view, understanding innovation in service industries is becoming acute as the share of the service sector in terms of gross domestic product and employment keeps rising,2 but service industries' productivity growth has been slow or even negative. It is acknowledged, however, that conventional measures of productivity do not account well for the intangible nature of services. On this basis, more research on the characteristics and implications of service evolution and renewal is needed.

This study focuses on innovation in a subset of the service sector, knowledge-intensive business service industries (KIBS), which has experienced rapid growth over the past 10-20 years in the industrialized countries. For example, according to Tomlinson (2000), the share of KIBS inputs in the economy has increased from 5 percent in 1970 to 25 percent in 1990 in the UK. Origins of this growth can be traced, on the one hand, to the genuinely increasing demand for knowledge services, and, on the other hand, to structural changes in the division of labor, particularly in the manufacturing sector. Firms have begun to outsource service functions from specialized service providers (e.g. O'Farrell, 1995). As a result, productivity and competitiveness of manufacturing firms depend to an increasing extent on the innovativeness of service suppliers. Nevertheless, the factors behind the creation of these services are not well understood. These are the topic of this study.

The next section discusses extant literature and derives empirical hypotheses concerning the nature and process of innovation in knowledgeintensive business services. Section 3 introduces and describes the Finnish business service data-set, while the main empirical analysis is carried out in section 4. Section 5 discusses the results and draws conclusions.

2. Innovation and Knowledge in Business Services: Literature Review and Empirical Hypotheses

Previous research on the organization and innovation of professional service firms remains relatively scarce (but see Tordoir, 1995; Hauknes, 1998). Löwendahl (1997) proposes a conceptual framework to analyze their knowledge bases and associated strategies. Building on the resourcebased view of the firm, Lowendahl argues that a professional service firm's resources shape its potential to generate competitive advantage. In particular, a key dimension is whether knowledge resources are organizationally or individually controlled. Resources are organizationally controlled when the performance of the service process depends primarily on organizational procedures, firm-specific assets such as intellectual property and team-based skills. Individual control of resources implies that individual professionals, experts, are the critical source of competence, not teams with sophisticated shared routines.