Technovation 29 (2009) 438 n e L F. K 1. Introduction product innovations as a means to becoming competitive to a higher extent than their large counterparts. In this paper by innovation, we mean a new or signiï cantly Because of the importance of the SME sector in creating economic growth, both developed and developing coun -tries are interested very in ï nding ways to stimulate SMES ARTICLE IN PRESS in realizing innovations. But in which ways can SMES be helped to innovate? What is the best way for policy makers to encourage innovation? Many efforts have been made in 0166-4972/$-see front matter r 2008 Elsevier Ltd. All rights reserved doi: 10.1016/j. technovation. 2008.12.002 ï¿Corresponding author. Tel.:++385 1 236 2238; fax:++385 1 2335 165 E-mail addresses: sradas@eizg. hr (S. Radas ljbozic@eizg. hr (L. Bozë icâ 'Small and medium enterprises (SMES in further text) are considered to be the engine of economic growth and employment. One of the primary means through which SMES are expected to accomplish this task is by developing and commercializing innovations. Innovation may be even more important for SMES than for large ï rms: some authors (Fritz, 1989; Sweeney, 1983) deem that SMES use improved product (good or service) introduced to the market as well as new or signiï cantly improved process introduced within the enterprise. We investigate both incremental and radical product innovations. Incremental innovation refers to product line extensions or modiï ca -tions of existing platforms and products, while by radical innovations we mean products that are new to the market as well as for the company Understanding forces that contribute to the success of small and medium enterprises (SMES) is very important, as these enterprises are vital for both developed and developing economies. Since innovativeness is among the most important means through which such businesses contribute to economic growth, numerous research studies were conducted to determine which factors positively impact SME€ s innovative efforts. This is an even more important issue for developing economies, where SMES are faced often with inadequate infrastructure. Since there is a lack of studies on SME innovation in developing economies, often policy in such countries is based on ï ndings from developed countries In this paper, we explore factors that drive innovation activities in SMES in a small emerging transition economy (Croatia), and compare it with ï ndings from developed economies. In addition to factors used in most previous studies, we consider market scope ï rm†s market orientation and presence of strategic, managerial and marketing changes. We ï nd that most factors that were found to be important in developed economies are important in developing economies as well. In addition to that, market scope was discovered to be a very important factor in both product and process innovation. Implementing corporate changes has positive impact on radical product innovation while implementing new organizational structures has positive effect on incremental innovation. When investigating determinants of product innovation, we distinguish new products of low novelty from new products of high novelty, and show that they need to be supported by different policies. To gain additional insight in innovation efforts, we examine obstacles to innovation We ï nd that ï rms that report facing obstacles are not less likely to innovate less, which suggests that innovators are able to work around obstacles without damaging effects to innovation. This study is based on a postal survey of 448 SMES in Croatia, which was performed in 2004 r 2008 Elsevier Ltd. All rights reserved Keywords: SME; Innovation; Developing country Abstract The antecedents of SME in transition Sonja Radasï Institute of Economics, Trg J †450 ovativeness in an emerging conomy jiljana Bozë icâ 'ennedy 7, 10000 Zagreb, Croatia www. elsevier. com/locate/technovation ARTICLE IN PRESS nov that direction during the last few decades (Keizer et al 2002). ) If we could understand how SMES innovate and what propels them to innovate, answering these questions would be much easier. Interestingly, despite the strong commitment to supporting SMES, the actual process by which such ï rms undertake innovative activity remains unclear (Hoffman et al. 1998). ) Therefore, the ï rst step in devising the right incentives to support innovation in SMES is an investigation into which factors impact the innovation efforts of SMES and in which way (Keizer et al. 2002 Since SMES are integrated in the region in which they exist to much larger extent than large ï rms, the determi -nants of innovation for SMES depend on speciï cities of that region (Kaufmann and Todtling, 2002. For example Keizer et al. 2002) show that using innovation subsidies having links with knowledge centers, and the percentage of turnover invested in R&d are the most important factors for innovation in SMES in Netherlands (more precisely, in the Brabant region), which has direct impact on their policy recommendations. However, basing policy measures on these results may be ineffective for other countries because the same factors may not be as crucial for another region and another economy. For example Kaufmann and Todtling (2002) in their investigation of SMES in Upper Austria show that support measures that are not in tune with real situation ††on the ground††can be rather ineffective Most published research studies, which deal with determining factors signiï cant for SME innovation, come from developed economies. As noted in Hadjimanolis 1999) ††The study of innovation, including the obstacles to its successful implementation, while relatively well re -searched in the industrialized countries is neglected rather in less-developed countries. ††It is known not to which extent the ï ndings from developed countries can be generalized to developing economies. For example, in the context of technology management, Cetindamar et al 2009) show the importance of questioning the appropri -ateness of US-based management theories with regard to their use in developing countries. Yet policy makers in developing countries, faced with the task of crafting regulations to support SME innovation, often draw upon the stock of knowledge from investigation of SMES in developed economies. So an important issue for policy makers would be to ï nd out to which extent they can rely on these ï ndings. In this paper, we shed some light on this question by investigating factors that signiï cantly impact innovation in SMES in Croatia, a small developing economy. In investigating these factors, we build upon the existing ï eld of research about innovation determinants in SMES. Our data come from the Community Inno -vation Study performed in 2004 and covers period from 2001 to 2003 Following Keizer et al. 2002), we deï ne a list of variables and then proceed to examine their signiï cance for S. Radas, L. Bozë icâ'/Tech innovation in Croatian SMES. We take relevant ï rm characteristics (as is usual in the literature), but in addition we include some new variables. We include (1) market scope,(2) presence of organizational and strategic changes in the ï rm and (3) market orientation of the ï rm. To the authors†knowledge, except for market orientation in Salavou and Lioukas (2003) study of Greek SMES, the three mentioned variables were considered not in this context before. We include market orientation because it was shown to have strong link with innovation (Kohli and Jaworski, 1990; Deshpandeâ'et al. 1993; Slater and Narver 1994; Atuahene-Gima, 1996; Langerak et al. 2004). ) We consider organizational and strategic changes because willingness and ability to transform is important for ï rms in developing economies which need to improve in order to compete and survive. As Hadjimanolis (1999) points out ††While ï rms in less-developed countries, in the recent past were operating within a relatively protected environment they must now face the global forces of competition. The globalization of the markets requires the adaptation of ï rms in order to survive. ††We also investigate the effect of market scope, i e. ï rm†s dominant market on innovation dominant market can be local, national or international as this is an important issue for a small economy. Since innovating with incremental innovations is different than innovating with radical innovations in terms of factors Balachandra and Friar, 1997) and skills (Freel, 2005 required, in this paper we distinguish new products of low novelty (incremental innovations) from new products of high novelty (radical innovations. In this respect, our approach is similar to Amara et al. 2008) who considered both the innovation and novelty of innovation in their study of learning and innovation in SMES By exploring determinants of innovation, we gain knowledge about what propels an enterprise to innovate This picture is not complete without the investigation of hampering factors that prevent ï rms from innovating This is why in this paper, we also examine obstacles to innovation 2. Theoretical background and literature review Stimulating innovation in SMES is a very important matter for an economy; a number of studies were conducted recently with the goal to discover which factors contribute to innovation efforts by SMES (Keizer et al 2002). ) Following Keizer et al. 2002), the factors that have effect on innovation can be divided into internal and external, where internal variables refer to characteristics and policies of SMES while external variables refer to opportunities that SME can seize from its environment 2. 1. Internal factors bearing impact on innovation Among the internal factors shown to be the most important determinants of innovative activity are high incidence of qualiï ed scientists and engineers, and strong ation 29 (2009) 438†450 439 leadership provided by a highly educated director or founder Hoffman et al. 1998; Le Blanc et al. 1997), although some consider a list of both internal and external variables Although for most of the described variables, the sugges -tion is that they have a direct and a positive effect on innovative efforts (Keizer et al. 2002), there is no absolute consensus on that. For example, while Hoffman et al 1998) report that internal factors have more bearing on innovation than external factors, Keizer et al. 2002) ï nd a limited number of both external and internal variables that have a signiï cant inï uence on innovation efforts where ARTICLE IN PRESS novation 29 (2009) 438†450 studies do not ï nd that effect (Keizer et al. 2002). ) Among other internal factors, Docter and Stokman (1988) and Oerlemans et al. 1998) report that existence of technology policy instruments in the ï rm and planning for the future are internal factors linked to innovation efforts. Larson et al 1991) and Meer et al. 1996) claim that application of project management structures has bearing on the innova -tion activities. Strategy is another internal factor that is shown to have impact on innovation in SMES. In particular Birchall et al. 1996) and Carrier (1994) mention explicit strategies to increase and stimulate internal creativity and risk taking behavior. Yet another internal variable is investments in R&d (Birchall et al. 1996; Oerlemans et al 1998). ) Among other internal factors that were found to be important determinants of success of innovative efforts are the nature of the commercialization and marketing effort the degree of marketing involvement in product planning and ï rm competence in the area of technology strategy and technology management (Hoffman et al. 1998 2. 2. External factors bearing impact on innovation Regarding external factors, Keizer et al. 2002) group them into three sets: collaboration with other ï rms linkages with knowledge centers and utilizing ï nancial resources or support regulations. Entrepreneurs consider collaboration with other ï rms as a very important part of their innovation efforts (Massa and Testa, 2008. In particular, Kaminski et al. 2008) show that collaboration with suppliers can contribute to innovativeness of SMES Collaboration with suppliers may also have the goal to overcome size constraints as reported in Lipparini and Sobrero (1994), while collaboration with both suppliers and customers may be performed for the purpose of co -design (Birchall et al. 1996; Meer et al. 1996; Docter and Stokman, 1988; Davenport and Bibby, 1999. Collabora -tion with customers can be a source of improved technology (Le Blanc et al. 1997). ) Strategic alliances are also shown to be important inï uencers of innovative efforts when they are integral part of ï rm†s development plan (Forrest, 1990; Cooke and Willis, 1999 Linkages with knowledge centers include contributions by professional consultants, university researchers and technology centers (Le Blanc et al. 1997; Hoffman et al 1998; Oerlemans et al. 1998), as well as contribution by innovation centers and Chambers of Commerce Oerlemans et al. 1998 Regarding variables which relate to utilizing ï nancial resources or support regulations, availability of R&d funding was shown to be an important inï uencer of innovative efforts in SMES (Le Blanc et al. 1997; Birchall et al. 1996; Hoffman et al. 1998 2. 3. Internal and external factors in extant studies S. Radas, L. Bozë icâ'/Tech440 Most of these studies explore just one or a few of the mentioned variables, except for Keizer et al. 2002) who external factors prevail. Even for a particular factor different studies may yield different results. For example regarding the education level of employees and managers Keizer et al. 2002) ï nd in their study of mechanical and engineering sector SMES that neither the education of the manager nor the percentage of employees with high education is signiï cant in explaining innovative efforts which is contrary to prior research (Hoffman et al. 1998 Le Blanc et al. 1997). ) Contradictory results were also found regarding linkages with sources of knowledge, as reported by Hoffman et al. 1998). ) Similarly, different views exist on the role of ï nancial funding (Hoffman et al 1998) and the proportion of turnover spent on R&d Oerlemans et al. 1998; Birchall et al. 1996 All these ï ndings point to the fact that it is still unresolved which variables inï uence innovation efforts in SMES and in which way. Generalizations are difï cult due to the complexity of the system we are observing; namely as the behavior of SMES differs by industry sectors and geographically, it is hard to infer general rules that would hold across the board. One way to learn more about determinants of innovative efforts in SMES is to conduct a variety of studies under diverse economic conditions and in different geographical areas 3. Research model In this section, we propose the research model which contains determinants of innovation together with the obstacles. Fig. 1 outlines our conceptual model 3. 1. Modeling factors that propel innovation As the indicator of innovation effort, we use the fact that the ï rm developed and launched any product innovation or process innovation in 3-year period Determinants of innovation •External factors •Internal factors Obstacles to innovation Innovation •Whether innovated or not •Type of innovation Fig. 1. Conceptual model 2001†2003. Three types of product innovation are studied: line extensions, ††me-too††products, and radical product innovation. The ï rst two types of innovations are usually referred to as incremental innovations. Line extension refers to minor modiï cation of an existing product, while ††me-too††products are imitations of competitors†products that already exist on the market Both incremental and radical innovations have an im -portant role. Managers design incremental innovations to satisfy a perceived market need with products that can be 3. 1. 1. External factors A new external factor that we add to this analysis, one which has not been investigated in this setting before, is market scope (Table 1). By market scope, we mean the most important market for the company (local, national or international). ) For small countries in particular, the market where the ï rm operates is important for the way business is conducted. For example, ï rms that are present only in small local markets can be more complacent and less motivated to innovate than the ï rms that are active on wider (international) markets. Firms that go international ARTICLE IN PRESS deï e ï r e ï r e ï r rises ï rm sear S. Radas, L. Bozë icâ'/Technovation 29 (2009) 438†450 441 Following Keizer et al. 2002), Birchall et al. 1996) and Meer et al. 1996), as external factors we consider innovation subsidies by municipality, innovation subsidies by the government and collaboration with other ï rms or institutions (Table 1). Within collaboration, we single out cooperation with universities or research institutes. Re -garding the industry†science collaboration, it is not clear what we can expect to ï nd. Some studies show that industry†university links in transition countries are quite weak (Koschatzky, 2002; Radas, 2004; Radas and Veho -vec, 2006; it is even more worrisome that although ï rms may be satisï ed with the quality of the collaboration, they may not rate its commercial results highly (Radas, 2004 This situation, which is caused in all likelihood by weaknesses of both parties, can potentially have negative effects on innovation Table 1 External factors: deï nition of variables External factors Factor Innovation subsidies from a municipality 1 if th Innovation subsidies from the government 1 if th Collaboration with other ï rms or organizations 1 if th enterp Links with universities or research institutes 1 if the and re developed in a relatively short period of time (Ali, 1994 The introduction of incremental innovation is critical for the long time survival of ï rms (Banbury and Mitchell 1995). ) On the other hand, radical innovation is a major innovation, the product totally new to the market as well as to the company. It could be based on new technology or on satisfying a latent market need by disrupting incumbent markets (Iyer et al. 2006). ) In this paper, each of the ï ve types of innovation (product, process, line extension, ††me -too††and radical) is represented by a dummy variable where 1 denotes that such innovation was introduced in the time period 2001†2003, and 0 denotes otherwise Next we focus on deï ning factors that impact innova -tion. Following the work of Keizer et al. 2002), we classify our independent variables as external and internal. All variables refer to the period from 2001 to 2003 National market 1 if the do International market 1 if the do encounter stronger competitors and therefore have to innovate in order to gain and keep their position. Actually survival on a more competitive market requires a steady stream of innovations. Additional push to innovate comes from the fact that more competitive markets often offer higher incentives for innovation (Sorescu et al. 2003). ) For a small developing country, the further from the head -quarters the company goes, the harder it becomes to compete because among other things the ï rm has to solve increasingly complex supply chain, logistic and marketing issues while contending with incumbent companies. In the model, we introduce two dummy variables; one indicates ï rm†s presence on national market and the other indicates its presence on international markets (Table 1 3. 1. 2. Internal factors We investigate two types of internal factors. The ï rst group of factors is related to ï rm characteristics like ï rm age, share of highly educated employees, and share of full -time equivalent employees engaged in intramural R&d Table 2). We did not consider ï rm ownership because almost all the ï rms in our sample are owned privately. The second group of factors speaks about implementation of changes in strategy, marketing, management and organiza -tional structure (Table 3) and about market orientation Table 4). In the remainder of this section, we explain our choice of factors and discuss their possible effect on innovation efforts 3. 1. 2. 1. Firm characteristics. Firm age: Although there is no result concerning age of SMES and innovation, there is some evidence (Hausman, 2005) that younger small ï rms up to 10 employees) are more innovative than older small ï rms. Namely, small businesses become less innovative nition m received innovation subsidies from a municipality, 0 otherwise m received innovation subsidies from the government, 0 otherwise m had any cooperation agreement on innovation activities with other 0 otherwise had any cooperation agreement on innovation activities with universities ch institutes, 0 otherwise minant market is national, 0 otherwise minant market is international, 0 otherwise ARTICLE IN PRESS eï n rms of e this of F s†nov over time as they become less aware of environmental changes or innovative solutions (Hausman and Fotentot 1999). ) This question is even more interesting in our context, because transition countries have changed from centrally planned to market economy. In our study, the dividing point for old and new ï rms is 1990, which is accepted as the beginning of transition period. Old ï rms Table 3 Internal factors: strategy, management and marketing changes Internal factors Factors related to strategic and managerial changes Implementation of new or signiï cantly changed corporate strategies Implementation of new, advanced management strategies Implementation of new or signiï cantly changed organizational structures Factors related to changes in marketing Signiï cant changes in ï rm†s marketing concepts or strategies Signiï cant changes in esthetic appearance or design Table 2 Internal factors: ï rm characteristics Internal factors Factor d Firm age 1 if the ï Proportion of highly educated employees in the ï rm Number compute Proportion of full time equivalent employees engaged in intramural R&d Number employee S. Radas, L. Bozë icâ'/Tech442 are entrenched more and experienced, but they also may be organized in an old fashioned way, lacking in entrepre -neurial spirit and necessary skills. Thus, we may expect that they will be less innovative. However, since the period covered in our study was 2001†2003, which comes 11 years after beginning of transition, it is possible that all the differences between the old and new ï rms had disappeared Proportion of highly educated employees: As we discussed in the previous section, one of the internal factors shown to be among the most important determinants of innovative activity for SMES is a high incidence of highly qualiï ed employees (Hoffman et al. 1998). ) These highly qualiï ed employees represent the knowledge base of the company which is a source of ideas for new product and process development. In support of that claim, Mohnen and Roâ ller 2005) show that human capital is one of the crucial factors in innovative activities, and that absence of necessary skills is a serious impediment to innovation. Modern literature emphasizes importance of knowledgeable employees in all business functions, not just in R&d (Leiponen, 2005), as innovation in modern ï rms requires technical, marketing and integrative competencies (Iansiti, 1995; Kogut and Zander, 1992. This is in particular case in smaller ï rms where functional boundaries are blurred sometimes. Keizer et al. 2002) also consider the proportion of all highly educated employees. Literature shows that highly educated employees positively affect ï rm†s innovative capability, so we also expect to ï nd that for a transition economy the proportion of highly qualiï ed employees in SMES has positive inï uence on innovative capability Proportion of full-time equivalent employees engaged in intramural R&d: Although for innovation in SMES, it is important to have educated highly employees across all Factor deï nition 1 if such a change was implemented in 2001†2003,0 otherwise 1 if such a strategy was implemented in 2001†2003,0 otherwise 1 if such a structure was implemented in 2001†2003,0 otherwise 1 if such a change was implemented in 2001†2003,0 otherwise 1 if such a change was implemented in 2001†2003,0 otherwise ition was founded after 1990,0 otherwise mployees with university degree divided by total number of employees†we ratio for 2001 and 2003 and then take the average number TE employees employed in the R&d divided by total number of we compute this ratio for 2001 and 2003 and then take the average number ation 29 (2009) 438†450 business functions (Leiponen, 2005), it is possible that R&d is the strongest driver of innovation. To investigate that issue, we consider proportion of FTE employees in R&d. We expect that indeed the stronger the R&d function is, the more innovative the ï rm would be 3. 1. 2. 2. Strategy, management and market orientation. In order to understand innovation at a yet deeper level, we need to get into issues of strategy, management and marketing Strategic and managerial changes: Well-deï ned corpo -rate strategy, sound management practices and organiza -tional structures are shown to be important enablers of innovation in developed countries (Birchall et al. 1996 while their absence can seriously undermine innovation Kaufmann and Todtling, 2002; Freel, 2000. SMES in developing countries, in particular transition ones, started with very low levels of corporate, managerial and organizational expertise. In order to remain competitive they needed to adopt signiï cant changes in all three areas We posit that these changes, which involve adoption of new skills and practices, are certain to have signiï cant positive effect on innovation We deï ne three variables, one for each area Since corporate strategy is recognized as an internal factor that is shown to have impact on innovation in SMES ARTICLE IN PRESS nov Table 4 Internal factors: marketing orientation Market orientation index: componentsa Customer orientation index 1. We constantly monitor the level of orientation to serving customers†needs 2. Our business objectives are driven primarily by customer satisfaction 3. Our strategy for competitive advantage is based on understanding of customer needs 4. Our business strategies are driven by our beliefs about how we can create greater value for customers 5. We measure customer satisfaction systematically and frequently 6. We give close attention to after sales service Competitor orientation index 1. We rapidly respond to competitive actions that threaten us 2. Our salespeople regularly share information within our organization concerning competitors†strategies S. Radas, L. Bozë icâ'/Tech Hadjimanolis, 1999), we include variable implementation of new or significantly changed corporate strategy (Table 3 We consider management†s strategies because as pointed out in Freel (2000) innovation, being a complex and inclusive process, requires an eclectic base of managerial competency, and managerial deï ciencies can present a serious obstacle for innovation. This is why we deï ne variable implementation of new advanced management strategies (Table 3). Finally, in order to optimally make use of human capital and other resources available to the ï rm, the ï rm has to have a suitable organizational structure. In extant research, it was shown that continuous adapting of the organizational structure is one of the basic functions of innovation management (Tomala and Seâ'ne -chal, 2004. Leonard-Barton (1988) also found that innovation is connected closely with organizational change To assess the impact of organizational change, we deï ne the variable implementation of new or significantly changed organizational structures (Table 3 3. Top management regularly discusses competitors†strengths and strategies 4. We target customers where we have an opportunity for competitive advantage Inter-functional coordination index 1. All of our business functions (marketing/sales, manufacturing, R&d etc.)) are integrated in serving the needs of our target markets 2. All of our business functions ad departments are responsive to each other†s needs and requests 3. Or top managers from every function regularly visit our current and prospective customers 4. We freely communicate information about our successful and unsuccessful customer experiences across all business functions 5. Our managers understand how everyone in the business can contribute to creating customer value afor each of the items, ï rms indicated their agreement with the following statements on the scale from 1 (completely disagree) to 5 completely agree Changes in marketing: To investigate the dynamic aspect of marketing function, we use two indicator variables Table 3). First we measure whether significant changes in marketing concepts or strategy were implemented. Second we investigate possible significant changes in esthetic appearance or design of products. As with strategic and managerial change, in transition countries these changes signal adoption of new knowledge and skills, which is expected to positively impact innovation Market orientation: Among internal factors that are shown to have impact on the success of SMES innovative efforts are marketing effort and the degree of marketing involvement in product planning (Hoffman et al. 1998 We broaden the scope to include several dimensions of market orientation. Simply deï ned, market orientation is implementation of marketing concept, or the process of generating and disseminating market intelligence for the purpose of creating superior value for the customer Narver and Slater 1990; Kohli and Jaworski, 1990 Numerous studies have found that the market orientation is positively related to business performance (Narver and Slater, 1990; Slater and Narver, 2000; Cano et al. 2004 Tse et al. 2003; Hooley et al. 2000). ) Market orientation represents business culture (Narver and Slater, 1990) or business behavior (Kohli and Jaworski, 1990) that leads to superior performance partially because it encourages innovation activities (Langerak et al. 2004). ) Innovation is important contributor to the business performance Therefore, positive market orientation†innovativeness re -lationship is hypothesized frequently and empirically supported in many studies in marketing literature (Kohli and Jaworski, 1990; Deshpandeâ'et al. 1993; Slater and Narver, 1994; Atuahene-Gima, 1996; Langerak et al 2004). ) However, evidence about link between market orientation and innovation comes mostly from study of large ï rms, and this connection is researched under in SMES (Salavou and Lioukas, 2003. Therefore in this paper, we include market orientation among possible drivers of innovation in SMES Market orientation is measured by widely accepted Narver and Slater (1990) market orientation scale that covers three behavioral components of market orientation These are Customer orientation, Competitor orientation and Interfunctional coordination and they are equally important components of market orientation. Each of these compo -nents is measured an index by a set of questions (Table 4 The value of each index is computed as the average value of the items comprising the index. Reliability analysis was performed for each of the indices, and Cronbach a†s are 0. 84,0. 83 and 0. 83, respectively. Average inter-item correlations are 0. 48,0. 54 and 0. 51, respectively. These numbers indicate a very high level of reliability of these indices. Market orientation index is average of respon -dents†scores on customer and competitor orientation as well as interfunctional coordination. All three components ation 29 (2009) 438†450 443 of market orientation are correlated strongly and therefore converge on a common construct (Narver and Slater 1990), the market orientation index. Reliability analysis for this index yields Cronbach a of 0. 91 and inter-item correlations of 0. 45, which indicates very high degree of reliability 3. 2. Obstacles to innovation To gain more complete understanding of innovation in SMES, we inquire about obstacles and hampering factors SMES are expected to have more problems with barriers to innovation than large ï rms due to inadequate resources and expertise. Obstacles to innovation can be classiï ed as external and internal (Piater, 1984. External obstacles include those that are related supply, demand related or environment related. Internal obstacles have to do with difï culties that are related to resources within the ï rm or human capital. In this study, we look at the mixture of internal and external obstacles, seeking to identify the most important ones (Table 5). In particular, we consider demand for ï rm†s products, ï nancing issues, state support business environment, organizational issues, and availabil -ity of information about markets and technology. We ask ï rms (1) if they encountered obstacles in their innovation activities, and then (2) we ask them to rate each obstacle. In this paper, we seek to examine if obstacles have any bearing on whether ï rms innovate. In his study of SMES in Cyprus ARTICLE IN PRESS statements on the scale from 0 (no importance) to 3 S. Radas, L. Bozë icâ'/Technov444 high importance ï¿Lack of qualiï ed staff ï¿Lack of information concerning technology ï¿Lack of information concerning market Table 5 Variables related to obstacles to innovation Variable Deï nition Encountered obstacles 1 if any of the statements below is true about any innovation activity, 0 otherwise ï¿It was delayed seriously ï¿It was prevented from being started ï¿It was burdened with serious problems Hampering factors Financing and expenses Firms indicated their agreement with the following statements on the scale from 0 (no importance) to 3 high importance ï¿Innovation costs are too high ï¿Lack of appropriate source of ï nance ï¿Insufï cient support from the state for innovation activities The three above statements are used to form the index Internal factors Firms indicated their agreement with the following The three above statements are used to form the index Hadjimanolis (1999) found that obstacles are not corre -lated to innovation. The explanation he offers for this interesting result is that innovative ï rms are somehow able to get around obstacles, so that although they recognize barriers to innovation those barriers do not cripple them To investigate that issue in Croatia, we analyze the relationship between barriers to innovation and the fact that the ï rm innovated We measure hampering factors by two indexes that are formed each from three statements that require answers on the scale from 0 (indicating no importance) to 3 (high importance). ) Indexes are named financing and expenses and internal factors (Table 5). We performed reliability analysis for each of these indexes. The Cronbach a for the indexes is 0. 72 for financing and expenses (average inter -item correlation is 0. 47), 0. 82 for internal factors (average inter-item correlation is 0. 6). The two a†s together with high inter-item correlations indicate high index reliability for ï nancing and expenses and internal factors. The value of the index is computed as the average value of the items that comprise the index 4. Research methodology The data presented in this study were collected as part of Community Innovation Survey conducted on Croatian companies from manufacturing and service sectors during year 2004. The companies were chosen depending on two characteristics: main activity and number of employees The data were collected by mail survey followed up by two telephone prompts. This particular survey was the ï rst CIS performed in Croatia and it refers to innovation activities over the period from the beginning of 2001 to the end of 2003. We deï ne SME as a ï rm employing between 10 and 250 people (microï rms are excluded. Both service and manufacturing ï rms are included. The response rate for the SMES was 16%.%More precisely, the response rate for the service sector was 17.5 %while the response rate for the manufacturing sector was 15%(in comparing our sample with the population we ï nd no statistically signiï cant difference in proï ts and exports; however, since our ï rms are on average somewhat larger in number of employees care should be taken when generalizing the results of this papers to very small ï rms..After examining and cleaning the data, 448 ï rms were used in this analysis In this study, we deï ne a list of possible factors that have bearing on innovation (Tables 1†4). Our goal is to ï nd those factors that have signiï cant impact on innovation in SMES in a small developing country. The dependent variables in our study are binary (indicating the presence of innovation or not), which calls for logit modeling Following the approach in Keizer et al. 2002), we start by examining bivariate relationships between these factors and the dependent variables that describe product and process innovation, and only those factors that are ation 29 (2009) 438†450 signiï cantly related to dependent variables are retained The signiï cance is determined on the bases of w2 statistics this statistics indicates whether the model obtained by addition of that one variable signiï cantly differs from the intercept-only model Those retained factors are used then in ï ve new multivariable logit models. Two models have product and process innovation, respectively, as dependent variable while the other three models consider three types of new products, namely line extensions, ††me-too††products and radical new products. w2 statistics and Mcfadden†s R2 are computed for every model In the analysis of obstacles to innovation, we use ANOVA analysis and the Pearson w2 test 5. Results 5. 1. Factors that impact innovation Examining bivariate relationships between independent factors and dependent variables shows that the factors not signiï cantly related to innovation are innovation subsidies ï rm age and proportion of full-time equivalent employees engaged in intramural R&d. Although other authors Keizer et al. 2002) have shown subsidies to be signiï cant drivers of innovation, our data interestingly show no evidence that having received municipality or government subsidy increases the probability that the ï rm innovates the proportion of innovators that received subsidies is not signiï cantly different from the proportion of innovators in the other group as evidenced by the Pearson w2 of 0. 87 There is a possibility that we do not observe the connection because there is a time lag between subsidy and its result However, this absence of impact on innovation may be caused by the fact that subsidies in Croatia are not sufï ciently large to enable a ï rm to make signiï cant investment in innovation activities Subsidies, ï rm age and proportion of full-time equiva -lent employees engaged in intramural R&d are omitted from further analysis. The remaining factors are used as independent variables in a logit model with innovation variables as dependent. We ï t a logit model for each innovation variable. Table 6 shows the results All the models in Table 6 are signiï cantly different from null model. Mcfadden†s R2 in every model is acceptable for a cross-sectional data model obtained from large-scale surveys of this type Out of the external factors, collaboration with other ï rms or organizations has positive signiï cant impact on process innovation and incremental product innovation but it has weak negative effect on radical product ARTICLE IN PRESS Table 6 Relationship between factors and innovation Factor Product tion Process Line Me too Radical strategies 5 S. Radas, L. Bozë icâ'/Technovation 29 (2009) 438†450 445 0. 46 Implementation of new, advanced management strategies 0. 05 0. 42 Implementation of new or signiï cantly changed organizational structures 0. 36 0. 4 Signiï cant changes in ï rm†s marketing concepts or strategies ï¿0. 09 0. 44 Signiï cant changes in esthetic appearance or design 1. 32 ***0. 38 Marketing orientation ï¿1. 74 0. 28 LR w2 (11) 82.62 Log-likelhood ï¿109.0 Mcfadden†s R2 0. 27 innova Collaboration with other ï rms or organizations 0. 84 0. 59 Links with universities or research institutes 1. 72 1. 19 National market 0. 73 ***0. 19 International market 0. 66 ***0. 17 Proportion of highly educated employees in the ï rm 1. 42 0. 89 Implementation of new or signiï cantly changed corporate 0. 59 Coefï cients marked by*are signiï cant to 0. 1 level, those marked by**are s Standard errors are shown in parentheses under coefï cient value. Due to delet innovation extension product innovation product innovation 1. 55***1. 27**1. 22**ï¿0. 79 0. 55)( 0. 53)( 0. 55)( 0. 6 ï¿0. 61 0. 81 ï¿0. 63 2. 01 ***0. 73)( 0. 71)( 0. 71)( 0. 74 0. 39**0. 63**0. 89***0. 28 0. 19)( 0. 26)( 0. 22)( 0. 21 0. 48***0. 68***0. 54***0. 16 0. 16)( 0. 21)( 0. 18)( 0. 18 0. 62 1. 26 0, 49 2. 5 ***0. 79)( 0. 87)( 0. 8)( 0. 82 0. 57 0. 06 0. 22 0. 85 *0. 42)( 0. 50)( 0. 45)( 0. 47 0. 40 0. 87*0. 27 ï¿0. 07 0. 40)( 0. 5)( 0. 44)( 0. 47 0. 48 0. 24 1. 01**ï¿0. 32 0. 37)( 0. 44)( 0. 39)( 0. 42 ï¿0. 19 ï¿0. 1 ï¿0. 36 0. 36 0. 39)( 0. 47)( 0. 43)( 0. 43 0. 55 0. 61 0. 72*0. 67 *0. 35)( 0. 42)( 0. 37)( 0. 38 ï¿0. 12 ï¿0. 14 0. 09 0. 14 0. 27)( 0. 34)( 0. 29)( 0. 3 52.18 65.65 61.44 39.49 ï¿121.32 ï¿90.31 ï¿109.6 ï¿105.52 0. 18 0. 27 0. 22 0. 16 igniï cant to 0. 05, and those marked by***are signiï cant to 0. 01 ion of missing cases, number of observations N  218 ARTICLE IN PRESS nov innovation. This conï rms some of the ï ndings from the literature (Birchall et al. 1996). ) However, having links with academic and research institutions has very strong positive effect on radical product innovation, while the effect on other types of innovation is lacking. Kaufmann and Todtling (2000) report similar effect, which is consequence of the fact that radical innovations need creative ideas and advanced knowledge that usually resides in academia and research community. This is congruent with Massa and Testa (2008) ï nding that for academics only the radical innovation is considered as innovation, while entrepreneurs tend to deï ne the term more broadly. In general, our results conï rm those in the literature concerning external collaboration, in particular the ï nding from Keizer et al 2002) about positive effect that links with knowledge centers have on innovation. This ï nding is especially interesting in transition setting, because it suggest that although the cooperation between industry and academia may be burdened infrequent and with problems, it bears some fruit and therefore should be encouraged by policy Another signiï cant external factor is market scope which has positive signiï cant effect on every kind of innovation except on radical innovations. Presence on national and international market has a strong positive effect on probability to innovate. This ï nding is in line with the fact that wider markets are more competitive, and survival on more competitive markets requires innovation The result that market scope is highly signiï cant for all types of innovations except for radically new products makes sense because of a large difference between radical innovations and innovations of lower novelty. Radical innovation, being something completely new to the market is a much less controllable event than incremental innovation due to much higher level of risk and unpredict -ability, which is offset by the product†s possibility to open up new markets and generate very high proï ts (Ali, 1994 It is not just the consequences of innovation but also the antecedents that differ. In the study of small ï rms by Subrahmanya (2005), it is reported that radical innovation depends on internal factors, while incremental innovation depends more on external factors. This is why market competitiveness (reï ected in market scope) as an external factor does not have impact on radical innovation while it is a very signiï cant factor in incremental innovation Additional explanation is that ï rms that operate on competitive markets need a steady stream of innovations to sustain their position and thus cannot afford to take time and resources away from incremental innovations to invest it in risky radical innovations Regarding internal factors, data show that the propor -tion of highly educated staff has a positive effect on radical product innovation, while it has no effect on other types of innovation. This is understandable since radical innova -tions require substantive creative effort, while introducing products that are similar to those already existing on the S. Radas, L. Bozë icâ'/Tech446 market does not require as much original input from ï rm†s own staff (i e. the work can be completed by less-skilled employees). ) It is more surprising that proportion of highly educated staff is not a signiï cant predictor in process innovation. This ï nding can be explained by considering characteristics of the ï rms in the sample. Namely, a large majority of the sampled ï rms are in medium and low technology sectors (this is a consequence of the structure of Croatian economy), where process innovation is of relatively low novelty. Being of low novelty, it does not require high employee skills Interestingly, proportion of full-time equivalent employ -ees engaged in intramural R&d was not found to have any relationship with innovation. This ï nding is a reï ection of the fact that in modern ï rms innovation is not conï ned only to R&d (Leiponen, 2005), in particular in small and medium ï rms ††where R&d activity is being distributed across a number of operational areas, rather than concentrated within a single and discrete R&d function††Freel, 2005 Among factors that address strategic and managerial changes, implementation of advanced management strate -gies is not signiï cantly related to probability of innovation except for line extensions), which is most likely because SMES are small enough that informal and more horizontal management styles are still quite effective. Implementation of signiï cantly changed corporate strategies has a positive effect on radical innovation. This is the reï ection of the fact that the top management (including CEO) has a very inï uential position in SMES; in particular, top echelon is playing an important role in determining strategic orienta -tion of the ï rm. Salavou and Lioukas (2003) show that strategic choices by top management (for example adopt -ing entrepreneurial orientation) have signiï cant positive impact on radical innovation in SMES. One way to explain this is that entrepreneurial orientation supports proactive new product development that favors novelty, in contrast to defensive strategies that favor imitation. Being risky and expensive, radical product innovation requires time and involvement of the best and the brightest people in the company. To devote all those resources to radical innovation is a deliberate decision that only top manage -ment can make Those ï rms that have implemented new or signiï cantly changed organizational structures have higher probability of me-too innovation, but the positive effect does not extend to other types of innovation. Because me-too innovations are copies of competitors†products, creativity and proactive stance are not all that important in their development. The challenge here is to produce the product at the lowest cost and deliver it to customers in the shortest time, and this is where good organizational structures become essential to ensure that these activities be performed efï ciently and on time Interestingly, having implemented changes in ï rm†s marketing concepts or strategies has no effect on the probability to innovate. However, ï rms that had imple -ation 29 (2009) 438†450 mented signiï cant changes in esthetic appearance and product design are more likely to product†innovate ARTICLE IN PRESS nov It seems that innovators pay serious attention to all aspects of their product portfolio, not neglecting the ††superï cial††changes in products like appearance and design Although literature has documented a link between market orientation and innovation, our study does not support that. Previous studies (performed mostly on large ï rms) showed that market orientation has impact on both radical (Christensen and Bower, 1996) and incremental innovation (Sandvik et al. 2000), but it is possible that SMES are different in that respect. Our result conï rms Salavou and Lioukas (2003) who in their study on Greek SMES did not ï nd connection between market orientation and innovation. We offer the same explanation as Salavou and Lioukas (2003: namely in the presence of other variables market orientation appears to play a lesser role or no role at all 5. 2. Obstacles to innovation Regarding obstacles, our ï rst goal is to investigate if ï rms that report obstacles tend to innovate less. Although 40%of ï rms in our sample report having faced serious problems in innovation activities, interestingly, we do not ï nd that having obstacles prevents ï rms from innovating Data show that there is no difference in process innovation between ï rms that report obstacles and those that do not (N  172, w2  1. 9, p  0. 17. Regarding product innovation, there is a weak relationship showing that far from being less innovative, ï rms that reported obstacles are compared more innovative with other ï rms that did not report obstacles (81.16%of those that reported obstacles innovated compared with 68.93%of those that did not report obstacles†N  172, w2  3. 2 and p  0. 07 It is possible that although obstacles do not prevent ï rm from innovating, there might be other damaging effects Namely, obstacles may cause decrease in the number of new introductions and/or their share in income. In order to investigate that issue, we looked into the number of new products and their share in the income. We performed ANOVA and found no signiï cant relationships on either the number of new products or on their share in income although on average those ï rms reporting obstacles have introduced smaller number of line extensions and radical new products. All these ï ndings suggest that ï rms that report obstacles are somehow able to deal with problems and prevent the potential serious negative impact on innovation. This conï rms the result from Hadjimanolis 1999), who in the study of SMES in Cyprus shows that barriers to innovation are correlated not to innovativeness nor economic performance. To quote Hadjimanolis (1999 ††The reason may be that innovative ï rms although facing important barriers tend to ï nd ways to overcome them while non-innovative ï rms which do not make serious S. Radas, L. Bozë icâ'/Tech efforts to innovate tend to underestimate (or not be aware of) the pitfalls/problems associated with innovationy††Next we focus on hampering factors. Firms that report obstacles quote both financing and expense and internal factors as signiï cantly more important (ANOVA results are N  95, F  4. 46, p  0. 04 for financing and expense and N  98, F  6. 7, p  0. 01 for internal factors Although extant research shows both factors to be challenging for SMES (Freel, 2000), in our sample financing and expense is the factor that presents the most problems The fact that ï nancing and innovation cost is rated as the most important hampering factor by all ï rms conï rms ï ndings from other studies that indicate ï nancing as one of the most important issues for SMES (Hadjimanolis, 1999 Kaufmann and Todtling, 2002; Bertlett and Bukvicë, 2006 More detailed investigation of data shows that sources of ï nancing are indeed lacking: most Croatian SMES ï nanced their innovation activities internally (145 ï rms), followed by bank credits (48 ï rms) and supplier credits (31 ï rms Other ï nancing instruments are very rare. This ï nding is in line with other studies that ï nd that SMES generally show lack of awareness of alternative sources of ï nance (Freel 2000). ) Regardless of problems with ï nancing, data reveal that 85.5%of the ï rms that reported obstacles managed to secure sources of funding (mostly internal followed by credits from banks and suppliers), which suggests that SMES in Croatia somehow ï nd a way to work around that problem Internal factors encompassing lack of qualiï ed staff and lack of information about technology and markets are also rated as signiï cantly more important by the ï rms that report obstacles, although in general these issues are not as important as ï nancing and innovation expenses. This conï rms ï ndings from extant research, because problems with attracting qualiï ed employees, as well as with having skills and knowledge are documented well in other studies Freel, 2005; Kaufmann and Todtling, 2002 6. Conclusion and policy implications Both developed and developing countries are very interested in ï nding ways to stimulate SMES in realizing innovations, due to importance of SME sector in creating growth and employment. Most studies on determinants of innovation are performed in developed countries, and consequently policy makers from developing countries mostly look at those ï ndings when crafting policy measures. However, as few studies in developing economies were performed on this topic, it is known not to which extent it is possible to generalize those ï ndings. It is also known that drivers of SME innovativeness depend on geographic area, which adds another layer of complexity that policy makers have to consider Summarizing the main ï ndings of our study, we can say that most factors that are found to be important in studies of SMES in developed economies are also conï rmed to be important in this study, such as having external links ation 29 (2009) 438†450 447 with other companies and having links with academic and research institutions. We conï rmed ï ndings from ARTICLE IN PRESS nov developed economies about the positive impact that proportion of highly educated staff has on product innovation (Freel, 2000; Hoffman et al. 1998), but we did not ï nd that innovation is related to the number of people employed in R&d Unlikely developed economies (Keizer et al. 2002), we found that innovation subsides are linked not to innova -tiveness, which may be the consequence of poor design of those incentives. This together with the fact that a very small number of ï rms received a subsidy suggests that the existing subsidy schemes are not effective, and that policy makers need to devise better incentives In developing countries, in particular in transition countries, SMES started with very low level of skills and expertise including corporate, management and organiza -tional. We found that implementation of signiï cantly changed corporate strategies raises probability of radical innovation, while implementation of new or signiï -cantly changed organizational structures raises probability of me-too innovation. Interestingly, the ï rms that had implemented signiï cant changes in esthetic appearance and product design are also more likely to introduce product innovations We also ï nd market scope to be very important in fostering innovativeness; namely ï rms operating on wider markets are more likely to innovate. This result is very important for a small open developing economy like Croatia, because it suggests that by encouraging exporting it may be possible to encourage innovation as well Regarding factors that hamper innovation, ï nancing and innovation cost is the most important problem which corresponds to ï ndings from developed economies Hadjimanolis, 1999; Bertlett and Bukvicë, 2006. This factor is followed by lack of qualiï ed employees and information about technology and markets, which is also recognized as a problem in developed economies. Interest -ingly, we ï nd that ï rms that report facing obstacles are not less likely to innovate less, which suggests that innovators are able to work around obstacles without damaging effects to innovation. Similar effect is found in Cyprus another developing economy All in all, our ï ndings show that there may be many similarities between developed and developing economies In other words, if Croatian case is indicative of other developing countries, ï ndings from developed economies may travel across geographic and economic boundaries better than could be expected. However, there may be some particularities that policy makers in developing countries should address. In Croatia, we found that policy should be encouraging SMES to implement changes involving corpo -rate strategy and organizational structure. This can be done through offering training for SMES, so that ï rms can become informed about possible organizational and corporate structures, trends and strategies. Another way S. Radas, L. Bozë icâ'/Tech448 to enable changes could be sponsored through consulting programs run with the purpose to help enterprises assess what is right for them and assists them in making necessary changes. Another policy measure (in particular in small economies) should be encouraging SMES to become exporters. First step would be to determine what possible obstacles to exporting there are and then address those with a set of targeted measures. Incentives that would help ï rms to access wider markets could also encourage innovation Policy should encourage employment of highly qualiï ed people by SMES. Employing educated people has potential to strengthen ties with academic community, so that would most likely also improve external networks. Policy could encourage inter-company cooperation by aiding in cluster formation†this strategy has shown good results in Slovenia (Bertlett and Bukvicë, 2006. That later strategy should be easier to implement than forging ties with academics, as Massa and Testa (2008) ï nd that entrepre -neurs prefer collaborating with their peers, other entrepre -neurs and/or their social networks One thing to consider when devising innovation incen -tives is that SMES traditionally face high transaction costs in accessing government programs. This may be particu -larly difï cult for SMES in transition countries where system is undergoing constant changes. For example, we ï nd that very small percentage of Croatian SMES received existing subsidies which seem to be non-efï cient Apart from designing effective incentives, policy makers need to think about making the application process easy and enterprise-friendly. In addition, we have shown that radical and incremental innovation have different ante -cedents, so policy makers can devise different incentive schemes depending on which type of innovation they wish to encourage We also ï nd that some of our ï ndings conï rm those from Cyprus (Hadjimanolis, 1999) and Greece (Salavou and Lioukas, 2003. Although we have to be careful in drawing conclusions in the absence of other studies on SME innovation drivers from the geographic region of South Eastern europe, this suggests that SMES in the same geographic region may share many similarities in their innovation practices Future research should involve simultaneous investiga -tion of several developing countries as well as several developed countries using the same survey instrument to address the same set of factors Acknowledgments This paper was presented at the 2005 Technology Transfer Society Conference (special session on R&d and Regional Economic Performance. 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Bozë icâ'/Technovation 29 (2009) 438†450450 The antecedents of SME innovativeness in an emerging transition economy Introduction Theoretical background and literature review Internal factors bearing impact on innovation External factors bearing impact on innovation Internal and external factors in extant studies Research model Modeling factors that propel innovation External factors Internal factors Firm characteristics 3. 1. 2. 2. Strategy, management and market orientation Obstacles to innovation Research methodology Results Factors that impact innovation Obstacles to innovation Conclusion and policy implications Acknowledgments References

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