Not all companies can be major movers or innovators in the way that Microsoft, Boeing or Sony are. In fact, most companies cannot. So, how do small and medium-sized manufacturing companies deal with the need for new products or new processes that will keep them competitive? How do these firms incorporate research and development into their planning when they aren’t in a position to take on the financial risk and make the investment that larger firms can?
In most economies small and medium-sized enterprises (SMEs) — usually defined as business establishments with less than 500 employees — play a key role in economic activity. These firms are central to the US economy, accounting for the majority of new jobs created (Small Business Association Statistics 1998; Small Business Association Statistics 1999). In Japan they surprisingly account for greater than 70% of all firms. The largest percentage of these firms are in the service sector, and many others are new start-up companies built around a particular new technology. However, another very important segment of the small business sector is that of the existing small manufacturing firms (SMMs). These are the focus of concern here.
The question of how SMMs can succeed is even more critical in an economic environment with little or zero growth. What is the role of R&D in SMMs, especially in this type of situation?
Japan provides a particularly interesting study in this regard. Given its prolonged recession, we can look at the role of R&D for small and medium-sized companies in this type of environment to gain some understanding of how — or whether — they rely on research to help them survive in a difficult situation. Japan’s importance in the global economic system means that understanding the role of R&D in SMMs in Japan may also provide insight and direction for SMMs elsewhere. This may be particularly useful in light of the global economic slowdown. While not everything we learn from Japan’s SMMs may be applicable elsewhere, some of the fundamental approaches may point to critical transformations that could be useful in other economies.
The Japanese Experience
Recently the Management and Coordination Agency of Japan conducted broad surveys of 5,029 small and medium-sized manufacturers of that country. The following data and analyses are based on these data. Small and medium-sized manufacturing enterprises in this study were defined as those with 300 or fewer employees.
Japan’s SMMs are changing. During the period of high growth, Japanese manufacturers grew by taking advantage of the economies of scale yielded by mass production. Globalization, however, resulted in an influx into Japan of products from around the world. This brought greater competition and a need to distinguish products from those of rivals. At the same time, consumers’ needs and desires have grown more diverse as the economy has matured. Traditional systems of production geared to mass-produced uniform products are no longer appropriate. The importance of innovation and R&D activities has consequently increased.
Interestingly, we find that, faced with this situation, R&D spending in the SMM sector is increasing in Japan, assuming a greater proportion of the burden of differentiation. Using the data collected through the surveys by the Management and Coordination Agency of Japan, we can track the larger economic impact and identify success factors as well as challenges in the SMM research and development process. First, a review of the number of people directly involved in research and trends in research spending, broken down by size of firm in the manufacturing sector, reveal that, despite the recession, SMMs have been placing considerably more emphasis on R&D in the recent years.
Trends in R&D Spending by Size of Firm
Trends in the Number of Researchers
An analysis of the contribution of the different factors of production to the rate of growth in real value-added in manufacturing in Japan reveals that, regardless of the size of the business establishment, the importance of total factor productivity (TFP) has grown. Total Factor Productivity is an econometric tool for analyzing the factors of production and their relative contributions to the larger economy.1 This tool measures the impact of variables such as advances in technology and qualitative improvements in capital and labor on productivity by modeling an economic system. Particularly striking is the fact that without the contribution of TFP between 1991 and 1997, the rate of growth in real value- added, econometrically speaking, would have been negative. As TFP is an indication of advances in technology and qualitative improvements in capital and labor, it can be concluded that R&D is an important cause of growth in SMMs as well as the large enterprises.
Breakdown of the Contribution of Factors of the Production Rate of Growth
in Real Value-Added in Japanese SMEs
The innovation task for companies that are small or medium-sized is still imperative if these firms are to continue to exist. Without innovation, at some level, businesses ultimately decline and cease to operate. Arguably the type of innovation undertaken by these firms is no less difficult, though different, than that of large powerhouse firms. Even adaptation to local conditions is much more than a minor adaptation and often involves significant cost and risk. The technology frontier is constantly moving, so if an SMM does not progress technologically, it risks being completely irrelevant and will disappear at some point in time.
Types of Research and Innovation:
Having established the fact that R&D is important in the growth of value-added and innovation, even in SMMs, the question then becomes, what kind of innovation is key in SMMs? Given the resource constraints alone, incremental, rather than revolutionary, innovation fits the firms’ circumstances. Here again, looking at business innovation in Japanese SMMs is revealing. A survey of the 5,029 SMMs in Japan shows that in terms of business strategy, the majority are planning to develop new products and services, develop new sources of demand, continue business activities and improve efficiencies.
Strategies for Business Development for Japanese SMEs
These are incremental improvements. In particular, the 29.6% that expect to develop new products and services are looking at existing niche products rather than completely new product development. The data from the rest of this survey supports this. Only 4.1% are expecting to expand their business into new fields.
Supporting these empirical findings, interviews with business practitioners in 20 different firms, as well as site-visits, suggest that in the SMM environment R&D is fundamentally different in focus and objectives from the research pursued by either large companies or small start-up firms based on a particular new technology. This is essential if SMMs are to survive tough economic times. The focus is often more on process than on product because process innovation often matters more than product innovation in terms of reducing costs and cycle-time — and both resources and manufacturability are critical constraints. Furthermore, in order to be effective, the objective is often related more to design rather than a totally innovative new product, thus reducing risk. With respect to process innovations, shop-floor improvements based on day-to-day operations are the most likely form this innovation will take, and institutional mechanisms for capturing and encouraging it will go a long way.
Those interviewed all suggested that a common form of implementing this type of research and development is still to have a small R&D unit. This unit is generally a complement to shop-floor innovations and serves at the formal ‘learning’ unit of the firm by bringing together external knowledge gathered systematically through research with the internal knowledge gained on a more informal level. This unit can serve as a change-agent since it should be constantly benchmarking against competition. Ideally, this process is explicit and the information gathered is well documented so these knowledge assets are saved. The more explicit this is, the greater the opportunity for the firm to grow. The focus of this group is usually to build independent product design capability.
Furthermore, the role of design is very important because it is feasible to push out the design frontier while being a technology follower. By doing this, a follower may be able to capture the higher value-added market segments without being subject to the market uncertainties and the high cost of R&D on the frontier. In this context, the design would be more market-driven than technology driven and most likely the firm would be competing in the mature phase of a technology. Overall, these R&D units would be considering — within the constraints of production capabilities — the conceptualization of a product to achieve performance characteristics in aesthetics (packaging) and performance. Ultimately the followers would be trying to undergo significant organizational learning in order to move from “learning to produce” to “learning to produce efficiently,” and from there to product improvement, and ultimately to developing completely new products. Interviews reveal that the obstacles to building this R&D unit are significant. The most pressing barrier is usually financing. This is almost equaled by the difficulty in recruiting researchers and engineers and the fact that in SMMs all personnel generally assume multiple responsibilities. Ultimately, this means that everyone is stretched, particularly when it comes to time. The survey of Japanese SMMs reveals that these three factors were identified by the majority of the respondents as critical impediments.
Reasons for Not Undertaking R&D
While difficulty in recruiting and demanding too much of employees may be company issues, the issue of financing is one that policymakers could help address from a number of angles, including tax incentives. If small and medium-sized manufacturers don’t have R&D, they are likely to become irrelevant in the marketplace. In such a case they will either go out of business or be consolidated with a bigger company. This type of consolidation establishes more monopoly power for the bigger firms, with negative consequences for a competitive economy. Consequently governments need to also look at ways to keep R&D vibrant in small and medium-sized enterprises, particularly during recessionary periods.
In-house R&D, regardless of firm size, can have a significant impact on competitiveness, if not firm survival. However, in SMMs, there is a different type of R&D than that conducted in large enterprises. These research and development units can become the location for organized learning and a last-resort problem solver in production. Their role is to push-out the design frontier while following the technology frontier. The biggest challenge to SMMs is that design is still risky and expensive. It requires special expertise to manage both product development and process improvement.
1) Attribution analysis was peformed as follows: (back)
DP/P = a (DLH/LH) + (1- a)(DKS/KS) + (DT/T)
P: Real value-added
L: Total number of employees
K: Real value of tangible fixed assets
T: total factor productivity (TFP_ a: Labor share H: Total actual working hours
S: Operating ratio Figures indicate annual average rates of growth and contribution in each period t.