Santa Clara University

Large Firm, Small Firm

How Do Size and Experience Affect Innovation?

Conventional wisdom about the relationship between a company’s size, age, and technological innovation has been, to say the least, confused. Academic research papers demonstrate that radical innovation has been brought about by both young, small firms and by large, more established companies.

“The existing research results are all over the map on this issue and make drawing definitive conclusions difficult,” says Tammy L. Madsen, associate professor and chair of the Management Department at the Leavey School of Business. “The extant work leaves out some potentially important factors that influence innovation, especially the role of different forms of experience – such as that gained from co-development and sourcing partners.”

Professor of Management Tammy L. Madsen

In their paper published this year in the Strategic Management Journal, “Unbundling Competitive Heterogeneity: Incentive Structures and Capability Influences on Technological Innovation,” Madsen and her co-author, Michael J. Leiblein of Ohio State University, propose explanations for the inconsistencies in prior work: that small and large firms differ in their abilities to translate their own experiences and the experiences held by their partners into innovation.

Their 10-year study of 463 semiconductor firms operating worldwide finds that the innovation benefits of experience developed within a firm and accessed through co-development partners decline as a firm grows large. In contrast, large firms benefit more from a sourcing partners’ experience as compared to small firms. The findings have important practical implications for small, resource-constrained firms that often need to outsource critical activities.

“As these firms grow,” Madsen says,  “they may benefit by developing skills in crafting partnership agreements, and in managing alliances; capabilities in these areas may enhance their abilities to continually learn from co-development partners.”

The study emphasizes that large and small firms employ different employee selection, incentive, and monitoring systems that affect their abilities to translate different types of experience into meaningful innovation. Large and small companies benefit in different ways from these factors, and the ability to make the most of them can be critical for sustaining an innovation advantage.

For example, small firms are better able to lure top talent than large firms due to their comparative advantage in offering aggressive incentive packages. Such packages tend to reward individual contributions and thus, are more attractive to innovators as compared to traditional, merit-based systems. Rewarding individual contributions is critical and small firms are often characterized as more effective in protecting an innovator’s property rights. Also, at small firms, senior managers are more likely to be involved in employee recruitment and are better able to judge the quality of job applicants. Additionally, small size helps these firms avoid information overload while sustaining cooperation. As a result, small firms are better able to generate unique insights from their own experience to support innovation as compared to large firms.

At the same time, small firms tend to lack experience in evaluating and managing the external relationships. As a consequence, Madsen and Leiblein predicted that small firms’ innovation activities would benefit less from the experience of held by their co-development partners. Instead, the results showed that large firm size, as compared to small firm size, reduces the benefits associated with the experience held by co-development partners. However, as firms grow large, their innovation activity benefits more from the experience of their outsourcing partners.

In their next project, Madsen and Leiblein, expand on this work by quantifying how a firm’s patent stock and its different stocks of experience affect its ability to sustain a profit advantage.

In the end, both large and small firms are constrained in their innovative activity by the nature and variety of their experiences, incentives, and abilities. “One takeaway is that different types of experiences have different effects on firms, depending on their size. Ignoring these differences can lead managers to make inaccurate choices when it comes to resource investments in support of innovation,” Madsen says.

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