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Innovation in Knowledge-Intensive Services

The Fourth Community Innovation Survey ( CIS4)

Mark Freel, University of Ottawa

Introduction

The Community Innovation Survey ( CIS) is conducted every 4 years by EU member states to capture comparable information on business innovation performance and monitor Europe's progress in this area. The latest survey ( CIS4) covers the three-year period 2002 to 2004, and is the largest survey conducted so far, covering 28,000 UK enterprises with 10 or more employees. In addition to measures of product and process innovation; the survey covers factors that hamper innovation, the sources of information used and the impact of innovation on the business. It also usefully covers what is classed as 'wider' innovation, such as the introduction of new management techniques. Further information on the survey can be found at the DTI innovation website ( DTI, 2007a).

The Scottish Executive recently commissioned an analysis of the innovation performance of Scottish firms that responded to the CIS survey - the full report can be found on the Scottish Executive business statistics website (Scottish Executive, 2007). This article draws from the section of the report that focuses on innovation in Knowledge-Intensive Services and the Finance Sector.

Importance of innovation in services

Business innovation is recognised as being key to raising the productivity, competitiveness and growth of Scottish firms and of the economy more generally. The Scottish Executive's Framework for Economic Development (Scottish Executive, 2004) identifies research & development (R&D) and innovation as a key priority for raising long-term sustainable growth by increasing productivity. High quality information on innovation activity is key to developing appropriate policy instruments to encourage innovation in Scottish firms. However, the standard metrics of science and innovation policy ( e.g. expenditures on R&D, patents granted, doctoral scientists) have been criticised as poorly reflecting the economic reality in the UK and, consequently, failing to capture most of the important creative and innovative activity ( NESTA, 2006). Failure to capture this 'hidden' innovation is particularly relevant for service industries. Innovation policy as 'science' policy reflects a view of innovation grounded in studies of manufacturing firms and industries, yet most developed economies are service economies.

Scotland has seen continued growth in the contribution of the service sector to the economy: increasing from 62% of GVA in 1989 to 73% in 2004. This is also evident in the change in the number of business and financial service firms as shown in Chart A2.1 below. This shows the changes in the stock of all VAT registered firms and of VAT registered business and financial services ¹. While the stock of all firms has remained relatively constant over the last decade, the number of finance firms has grown notably and the number of business service firms has grown substantially. It is clear that such Knowledge-intensive Services are an increasingly important component of the Scottish economy.

Despite this growth in the service sector, it remains somewhat neglected in the innovation studies literature. Services are often viewed as incapable of innovation and, at best, confined to the adoption of technological innovations generated by manufacturing. However, the service sector is tremendously diverse and firms within it will vary considerably in their innovation activity. For instance, recent statistics have shown sharply increasing innovation expenditures within a number of service sectors, even where one employs traditional manufacturing derived measures (Howells, 2000). In particular, small, Knowledge-Intensive Services ( KIS) are increasingly recognised as occupying a dynamic and central position in 'new' knowledge-based economies, as creative innovators in their own right, rather than as mere adopters and users of new technologies.

Chart A2.1: Changes in the stock of Scottish VAT registered firms, selected industries 1994 - 2006

Source: DTI, Small Business Service; 1994=100

By including certain service sectors, the Community Innovation Survey ( CIS) allows us to comment upon the innovativeness of such Knowledge-intensive Services in Scotland, and the usefulness of the CIS for capturing service innovation activity. The next section outlines the criteria used to define Knowledge-Intensive Services.

Defining Knowledge-Intensive Services

Miles et al. (1995) ² identified three essential characteristics of Knowledge-Intensive Business Services ( KIBS):

1. they rely heavily upon professional knowledge;
2a. they either are themselves primary sources of information and knowledge;
2b. or they use their knowledge to produce intermediary services for their clients' production processes;
3. they are of competitive importance and supplied primarily to business.

In addition, Miles et al. (1995) distinguish between 'traditional professional services' ( p-KIBS) and ' new technology based services' ( t-KIBS). The former, it is suggested, are liable to be intensive users of new technology, whilst the latter are more active in shaping new technologies. Within this framework, KIBS firms were identified using Standard Industrial Classification ( SIC (92)), at the 3-digit level, as outlined in Table A2.1.

Due to the importance of the finance sector within the Scottish economy, subsequent analysis also considers firms classified as 'financial intermediation' ( SIC 65-67). Not all such firms will satisfy criteria 3 above; however most would consider finance as a part of the Knowledge-Intensive Services.

Table A2.1: Knowledge-Intensive Business Services ( KIBS)

Patterns of innovation outcomes

Product/Service innovation

Chart A2.2 records the relative incidence of product/service innovation in key knowledge-intensive service sectors and manufacturing generally. The chart also incorporates an indication of the 'novelty' of innovations (novel innovations are defined as new products to market or new processes to industry). Though there are some variations across sectors, it is evident that the knowledge-intensive service sector is a source of product/service innovations. In the case of technology-based business services ( t-KIBS), some 45 per cent of firms introduced at least one new product/service during the period covered by the survey. This compares with around 39 per cent of manufacturing firms. The figures for traditional professional services ( p-KIBS) and financial services are 17 per cent and 37 per cent, respectively. Moreover, of those introducing product/service innovations, some 59.5 per cent of t-KIBS introduced at least one 'new to the market' ( i.e. novel) innovation ³. This is marginally less than the 63 per cent of manufacturing firms introducing novel innovations. Again, the figures for p-KIBS and financial services are 54.5 per cent and 37.5 per cent, respectively.

Chart A2.2: Relative incidence of product/service innovation in KIBS

Source: Scottish Executive, Community Innovation Survey

Process innovation

The pattern for process innovation is similar (Chart A2.3). Once more, it is clear that the knowledge-intensive service sectors may be the source of innovations and, again, there is evidence of significant sectoral variations. Specifically, whilst around 24 per cent of manufacturing firms introduced a process innovation during the period, over 41 per cent of t-KIBS and 29 per cent of financial service firms were process innovators. For p-KIBS, the figure is a little over 21 per cent.

In short, the incidence of process innovation in t-KIBS sectors was around 70 per cent higher than in manufacturing. In terms of relative novelty ( i.e. newness to the industry), the figures are generally lower than for product innovation. However, for both p-KIBS and t-KIBS around 35 per cent of process innovators introduced novel innovations. This compares with around 18 per cent of manufacturing firms and 16 per cent of financial service firms.

In summary, employing standard metrics of technological product and process innovation outputs, there appears to be limited evidence that knowledge-intensive services are systematically less innovative than manufacturing as a whole.

Chart A2.3: Relative incidence of process innovation in KIBS

Source: Scottish Executive, Community Innovation Survey

Patterns of innovation inputs and activities

Turning to innovation inputs: one might argue that the important differences between manufacturing and key service sectors are not in innovation outputs, but in the manner in which these outputs are achieved. Indeed, a common conjecture in the research literature posits services innovation as more reliant upon 'soft' sources of knowledge and technology (such as human resources or customer relationships), rather than 'hard' sources (such as R&D) (Tether, 2004). Accordingly, one might expect significant variations in patterns of expenditure and activity across sectors, with services firms placing relatively greater emphasis upon such activities as training and marketing, whilst in manufacturing a relatively greater emphasis is placed on R&D and the purchase of equipment and machinery.

The CIS data allows us to explore a number of these issues. For example, Chart A3.4, details the relative incidence of some expenditure in each of the categories identified by the survey. From this, there appears little evidence that manufacturing firms had a greater propensity to engage in R&D (either through internal expenditures or external contracting). Indeed, some 52.4 per cent of t-KIBS undertook some internal R&D, compared with 44.4 per cent of manufacturers. For p-KIBS and financial services, the figures are 27.7 per cent and 43.3 per cent respectively. Importantly, the manufacturing sub-sample recorded here is intended to provide a broad comparator only.

One would, of course, expect considerable variation across manufacturing sectors and, importantly, the current sample - like the manufacturing population - is likely to be dominated by low- and medium-technology sectors. Nevertheless, the data on R&D propensity are consistent with an emerging view which emphasises similarities between innovation processes in t-KIBS and (high-technology) manufacturing firms. Beyond R&D, t-KIBS record a relatively high propensity to engage in training (as do financial services), marketing and the acquisition of external know-how. For manufacturers, there is tentative evidence of a higher propensity to invest in design and embodied technologies. In general, p-KIBS record a lower propensity to engage in any of the listed activities - though the differences are smallest with respect to the acquisition of embodied technologies ⁴. Overall, the sectoral variations are sensible and, with respect to the utility of the CIS data, encouraging.

Chart A2.4: Relative incidence of innovation-related expenditure in KIBS

Source: Scottish Executive, Community Innovation Survey

Wider innovation

This final section considers what can be termed 'wider' innovation. The services innovation literature frequently bemoans the inappropriateness of narrow 'technicalist' views of innovation. The focus on technological innovation, it is suggested, is likely to underestimate the level of innovation activity in service sectors (and, correspondingly, overstate the comparative innovative performance of manufacturing sectors). Drejer (2004), amongst others, argues convincingly for a broader conceptualisation of innovation, more consistent with Schumpeter's original work (to include markets, organisation and supply).

Chart A2.5: Wider innovation in KIBS

Source: Scottish Executive, Community Innovation Survey

Table A2.2: Ratios of wider innovation to product and process innovation

A similar argument is made by Hipp and Grupp (2005) and, with specific regard to organisational innovation, by Tether and Hipp (2002). The general implication is that services have an orientation towards innovation that is more likely to be focussed upon organisational change and less likely to be manifest in products/services or production techniques. Acknowledgement of these concerns led the CIS to include questions on 'wider' innovations (encompassing corporate strategy, management techniques, organisation and marketing practices). Unfortunately, the questions were relegated to the end of the questionnaire and it is difficult to associate them with other measures of innovation activity. Regardless, if the concerns are legitimate, then one would anticipate a relatively higher incidence of wider innovation in services (compared to both wider innovation in manufacturing firms and technological innovation in services).

In the first instance, it is worth recalling the relatively strong performance of t-KIBS and, to a lesser extent, financial services in both product and process innovation (Charts A2.2 and A2.3). On the basis of these data, there is limited evidence that knowledge-intensive services are poorly served by traditional innovation output measures (at least not in comparison to our predominantly low and medium-technology manufacturing sectors).

With respect, specifically, to wider innovation (see Chart A3.5), this is again most common in t-KIBS - 61.2 per cent of t-KIBS introduced at least one wider innovation, compared with 51.7 per cent of financial service firms, 42.6 per cent of manufacturers and 33.8 per cent of p-KIBS. Moreover, in all sectors, the incidence of some form of wider innovation was considerably more common than either product or process innovation.

In terms of the greater emphasis on wider innovation than technical innovation in services, Table A2.2 gives the ratios of wider innovating firms to product and process innovating firms in each of our sectors. As noted, in all cases firms are more likely to have introduced a wider innovation. The differences are starkest for p-KIBS firms, which were more than twice as likely to be wider innovators than product innovators and 60 per cent more likely than process innovators.

However, even for manufacturers (and although the proportions of product and wider innovators are similar), firms were 77 per cent more likely to have introduced at least one wider innovation than a process innovation. On the whole, it is difficult to argue with the value of adopting a broader conceptualisation of innovation. However, it is less certain that its value would be peculiar or particular to studies of service innovation. It seems likely that our understanding of innovation activities within more mature and traditional manufacturing sectors has also been poorly served by narrow 'technicalist' definitions. And, to the extent that we seek to encourage higher levels of business experimentation, broader definitions would be welcome more generally. In this vein, the addition of measures of 'wider' innovation to the CIS is welcome. Though, one may be a little disappointed that they appear almost as an afterthought, with limited scope for association with responses to earlier questions on innovation outcomes, constraints, stimuli and so on.

Conclusion

Employing data from Scottish respondents to the recent Community Innovation Survey ( CIS), the foregoing sought to outline broad patterns of innovation in selected services sectors. The chosen sectors are of considerable and growing importance to the Scottish economy and facilitating innovation within these sectors is key to enhancing competitiveness. In outlining these patterns, the intentions were twofold: firstly to underline the extent of innovation activity in the highlighted sectors - these are not the innovation laggards of caricature; and, secondly, to comment on the utility of the CIS in capturing innovation beyond manufacturing industries. On the latter issue, the analysis has shown that wider definitions of innovation do capture additional activity that is not identified through the traditional measures - for both service and manufacturing firms. How much additional activity still remains hidden despite this wider definition is the question of most interest. New research is emerging on the nature of service innovation, which will add to our understanding of what may not be captured in the measures above ( DTI, 2007b).

This apart, the CIS continues to provide important information on a variety of innovation inputs and outputs, painting a sensible picture of underlying sectoral variations. Sensitivity to these variations is likely to be central to effective innovation policy.

References

Drejer, I. (2004) "Identifying innovation in surveys of services: a Schumpeterian perspective", Research Policy, 33, pp. 551-562.

DTI (2007a) The Community Innovation Survey webpage. Accessible at: http://www.dti.gov.uk/innovation/innovation-statistics/cis/page10957.html

DTI (2007b) "Innovation in Services" , DTI Occasional Paper No.9, DTI

Hipp, C. and Grupp, H. (2005) "Innovation in the service sector: the demand for service-specific innovation measurement concepts and typologies", Research Policy, 34, pp. 517-535.

Howells, J. (2000) "Innovation and Services: New Conceptual Frameworks", CRIC Discussion paper 38, University of Manchester.

Miles, I. (2001) "Services Innovation: A Reconfiguration of Innovation Studies", PREST Discussion Paper 01-05, University of Manchester.

Miles, I. et al (1995) "Knowledge Intensive Business Services: Their Role as Users, Carriers and Sources of Innovation", EIMS publication No. 15, Innovation Programme, DGXIII, Luxembourg.

Nesta (2006) The Innovation Gap: Why policy needs to reflect the reality of innovation in the UK, Nesta.

Scottish Executive (2007) The Community Innovation Survey 4: Profiling Scotland's Innovation Performance, Scottish Executive.

Scottish Executive (2004) Framework for Economic Development in Scotland, Scottish Executive.

Tether, B. (2004) "Do Services Innovate (Differently)?", CRIC Discussion Paper 66, University of Manchester.

Tether, B. and Hipp, C. (2002) "Knowledge intensive, technical and other services: patterns of competitiveness and innovation compared", Technology Analysis and Strategic Management, 14, pp. 163-182.

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