University of Amsterdam / Amsterdam Centre For Service Innovation
Amsterdam Business School
Faculty of Economics and Business
MSc. Business Studies
Master Thesis by Bart Huijbregts
Student number 5838045
Sharing revenues to drive open innovation practices
Survey results from The Netherlands
Supervisor
Dr. W. (Wietze) van der Aa
Reviewer
Date
Dr. G.T. (Tsvi) Vinig
July 16, 2014
2 “If you have an apple and I have an apple and we exchange these apples then you and I will still each have one apple. But if you have an idea and I have an idea and we exchange these ideas, then each of us
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Abstract
How would giving away revenues contribute to both innovation and firm performance? This research is the first to link sharing revenues with innovation partners and open innovation practices to empirical explanations of innovation and firm performance. The goal of this paper therefore is to explore the role and performance implications of sharing revenues with innovation partners. The study was initially guided by a literature review. In literature, revenue sharing is a mechanism that coordinates the supply chain and arbitrarily divides resulting profits, but the impact on innovation and firm performance has not received any attention. The hypotheses were tested using quantitative data drawn from a survey and using the Tobit regression method. The paper transforms the supply chain into a revenue chain and shows that the impact of sharing revenues with innovation partners on innovation and firm are
mediated by open innovation practices. The results show that revenue sharing contributes to both innovation and firm performance and can be considered as a driver of open innovation practices and not only as a cost driver. The findings provide a richer understanding of the challenges and opportunities that firms experience when confronted with strategic decisions to improve innovation and firm performance. Future research may focus on how to obtain advantages from sharing revenues.
Keywords
Revenue sharing, Open innovation practices, Supply chain collaboration, Service innovation, Innovation performance, Firm performance
Acknowledgements
The author wishes to thank Dr. P. (Pim) den Hertog and Ir. M.J. (Matthijs) Janssen for their helpful comments and their insights on the research methodology and the implications. In addition, the author would like to thank Dr. A.S. (Alexander) Alexiev for providing the survey data and the insights on the dataset.
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Table of Contents
Abstract ... 3
1. Introduction ... 5
1.1. How Apple increased its innovation performance ... 5
1.2. Research question ... 9
2. Literature review ... 11
2.1. Open innovation ... 11
2.1.1. Innovation ... 11
2.1.2. Open innovation ... 13
2.1.3. Open innovation practices... 15
2.2. Revenue management ... 18
2.2.1. Supply chain coordination ... 18
2.2.2. Revenue sharing contracts ... 20
2.2.3. Revenue sharing models ... 23
2.3. Performance of service-oriented firms ... 25
2.3.1. Service innovation ... 25
2.3.2. Value innovation ... 26
2.3.3. Business model innovation ... 27
2.4. Theoretical framework ... 29 2.4.1. Hypotheses development ... 29 2.4.2. Conceptual model... 31 3. Methodology ... 33 3.1. Survey data ... 33 3.2. Descriptive statistics ... 34
3.3. Measures and procedures ... 40
4. Results ... 45
4.1. Test results related to innovation performance ... 45
4.2. Test results related to firm performance ... 48
5. Discussion ... 51
5.1. Conclusion ... 51
5.2. Limitations and future research ... 52
5.3. Managerial implications ... 55
References ... 57
5
1. Introduction
1.1. How Apple increased its innovation performance
Since the mid-1990s the Internet has evolved into a key enabler of today’s economy and society. It empowers people in ways previously unimagined. The Internet is bringing new levels of openness, accountability and participation, and is changing governance structures, effecting change around the globe. In 2009, the Internet topped Knowledge@Wharton’s list of the ‘Top 30 Innovations of the Last 30 Years’1. One of the judges noted not only the Internet’s role as a facilitator of information sharing, but also its role as a catalyst of innovation. The Internet is perhaps the greatest enabler of innovation linkages. PwC’s Global CEO Survey 2012 shows that respondents expect significant results from
innovations. CEO’s are nearly three times more confident in their company’s growth prospects than they are in the global economy’s growth. They expect that new products and services will drive growth for 28% of the companies. In order to meet these high expectations, companies need to expand their research & development activities and increase innovation performance. Apple is considered to be one of the world’s most innovative companies according to the innovation premium measure by Forbes.2 Apple is a hardware company and in 2001 CEO Steve Jobs announced the “digital hub” strategy. The strategy evolved from Steve Jobs´ idea on how Apple could solve a problem for the ultimate customer. The sale of an Apple device to a customer wasn’t the end of a relationship, but the beginning, and there were all kinds of elements designed to capitalize on that fact.
The revenue sharing model turns out to be the most important element. The first line of iPods was released in 2001 and Apple started to license third party accessories. In 2003, Apple launched the iTunes Store and started to distribute digital music. The main role of the iTunes Store is not only to sell music, but to enhance the company's sales of iPods, a portable digital music player. “The more content there is in their ecosystem, the better their devices sell,” said James McQuivey, an analyst with Forrester Research.3 In 2007 Apple introduced its most profitable product; the iPhone. Apple earned gross margins of 49 to 58 percent on its iPhone sales, which generated revenue of more than $33 billion
1
knowledge.wharton.upenn.edu/article.cfm?articleid=2163
2 forbes.com/special-features/innovative-companies.html 3
6 between April 2010 and the end of March 2012.4 It is the highest gross margin in the mobile phone industry. One might conclude, per Aristotle, that the devices are greater than the sum of its parts. In 2008 Apple launched the App Store and started to distribute third party software applications. In 2010 Apple released the first iPad and launched the iBooks Store. In 2011 Apple overtook Exxon Mobile to become the world's most valuable company in terms of market capitalization and in 2012 it overtook Microsoft to become the most valuable company in history. Apple’s net sales during 2012 increased $48.3 billion or 45% compared to 2011.5
Apple however, neither manufactures the components nor assembles them into a finished product. Manufacturing and assembly of hardware components is outsourced to contract manufacturers such as Foxconn or Pegatron who manufacture and assemble Apple branded products. Apple´s total investment in research and development back only 2.2% of total sales in 2012. Not much, in comparison with companies like Microsoft and Google investing approximately 15% of their turnover in R&D. In order to be successful, Apple relies extensively on other members of its supply chain to enable much of its innovation advantage. This allows Apple to act as a focal company and concentrate on its strengths: designing elegant, easy-to-use combinations of hardware, software and services. Apple searches for supply chain partners with distinctive complementary capabilities in all of these areas and creates unique collaborative relationships with them. As a result, Apple requires fewer internal dedicated resources and is able to distribute shared risks more easily.
However, the approach also holds certain constraints. Samsung, for example, is a particular important supplier as it provides some of the phone's most important hardware. Together these components account for 26% of the cost of an iPhone6. Since Samsung also manufactures smartphones and tablet computers of its own, this puts them in a somewhat unusual position of supplying a significant
proportion of one of its main rival's products. Samsung’s acting as a supplier of components for others, gives it the scale to produce its own products more cheaply. Samsung is one of Apple's biggest suppliers and Apple is one of Samsung's largest customers. Apple now says Samsung is copying designs and features that took years to develop. Samsung says it is about form following function as new
technologies enable new designs and about a marketplace in which rivals routinely seek inspiration from each other to develop better products. According to Apple the patent system makes innovation stronger
4
reuters.com/article/2012/07/26/us-apple-margins-idUSBRE86P1NI20120726
5 Apple Inc, Annual Report 2012, Filed Oct 31, 2012 6
7 and gives people the incentive to invent. The patent war between Apple and Samsung puts the future of innovation at risk7. Tesla is actually taking on the challenge to make all patents freely available for the advancement of electric vehicle technology. Tesla pioneered innovations that lowered the cost and increased the safety of battery packs. Its cars recharge much faster than others on the market, thanks to connector, software, and power-management advances. Now this public company will offer these for free and ask nothing but goodwill in return. It could aide Tesla’s rate of adoption and support Tesla’s growth. CEO Elon Musk says that the new open source policy’s goal is to help stem climate change8. Apple’s main competitor in the software industry, Google, says that patent wars are not helpful to consumers and in fact the patent system as it currently exists is not the right system to incent innovation9. Apple therefore took on a different approach to capture value from its digital content stores. In 2003, Apple launched the iTunes Store to support music labels to recover from illegal downloads. Consumers preferred the design and usability of Apple’s iPod over other MP3 players. Moreover, they were willing to pay a relatively small amount to download music from the convenient iTunes Store instead of downloading music for free. To capture value from the new service offering, Apple yields a cut of revenue from all sales in the iTunes Store, extending its revenue model. In 2008, Apple tapped into a whole new industry by introducing the App Store. Only applications in the App Store could leverage the hardware features built into Apple’s devices, such as the GPS module and gyroscope. The revenue model of the App Store was copied from the iTunes Store and contributed heavily to its success. By sharing revenues with application developers, Apple’s devices obtained new features in ways previously unimagined. Apple created products and services that people did not know they needed and moreover Apple was able to capitalize on it. It could be argued that the App Store is one of the most impressive experiments in open innovation since the Internet. Since launching the App store, 50 billion apps were downloaded and Apple paid out $10 billion to developers in its first five years10. When Apple launched the iBooks Store in 2010, obviously the revenue model was copied from the iTunes and App Store.
All Apple hardware and software are designed in-house. Apple is considered one of the most vertically integrated companies in the world as they control the processor, the hardware and the software and 7 forbes.com/sites/connieguglielmo/2012/08/23/apple-samsung-patent-war-puts-future-of-innovation-at-risk/ 8 forbes.com/sites/briansolomon/2014/06/12/tesla-goes-open-source-elon-musk-releases-patents-to-good-faith-use/ 9 news.cnet.com/8301-13578_3-57496747-38/google-time-to-ditch-our-current-software-patent-system/ 10 techcrunch.com/2013/06/10/apples-app-store-hits-50-billion-downloads-paid-out-10-billion-to-developers/
8 many elements of the ecosystem. Apple’s own retail stores sell Apple hardware, software and services directly to consumers and they are offered free workshops to learn to use their new buy. In 2011, Apple launches iCloud. The new service offering is designed to bridge the gap between iOS and Mac operating systems and make the experience more seamless. At the same time the iCloud service strengthens Apple’s lock-in strategy. Apple customers will be back every few years to buy new versions of products, because switching costs would come in a variety of forms when leaving an entire ecosystem. Other companies would be able to easily copy the revenue sharing model by simply giving away a higher revenue percentage if it wasn’t for the products and services that combine to satisfy a common need. Apple built its innovation performance around a network of developers, artists and authors. But it hasn’t been due to a master plan laid out years ago. It’s not like Steve Jobs rolled out a calculated roadmap ten years ago. Rather, he set a strategic target for Apple to be the digital hub for consumers. In hindsight, it’s easy to see that ten years ago, Apple had only a few ideas on how to do this. The rest came from a long series of experiments that created the ecosystem effects Apple desired and to which its revenue sharing model contributed heavily.
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1.2. Research question
Steve Jobs noticed in an early stage that the sale of an Apple device to a customer was only the beginning of a relationship and a shift to recurring customer relationships away from a product-based, “buy once” economy. The sharing economy leverages information technology to empower individuals, corporations, non-profits and governments with information that enables distribution, sharing and reuse of excess capacity in goods and services11. A common premise is that when information about goods and services is shared, the value of those products may increase, for the business, for individuals, and for the community12. People who write on the subject of the sharing economy talk of it being a socio-economic system built around the sharing of ‘human and capital assets’. Revenue sharing fits perfectly into the sharing economy.
In literature, revenue sharing is associated with the coordination of the supply chain and dealing primarily with post launch price-quantity decisions (Cachon & Lariviere, 2005). Current literature has not yet recognized revenue sharing as a driver of innovation performance. However, I strongly believe that by sharing revenues, not only Apple is committed to deliver new and easy to use features in lighter and better performing products, but at the same time artists, authors and developers are committed to bring new music, books and applications to Apple’s ecosystem. The revenue sharing mechanism creates a strong interdependence between suppliers and customers and creates a joint responsibility to aim for common goals and remain innovative in an effort to sustain competitive advantage.
The following research question will be discussed:
To what extent is performance of service oriented firms related to sharing revenues with innovation partners and is this relationship mediated by open innovation practices?
To examine the contribution of revenue sharing to open innovation practices, a literature review is conducted and the open innovation concept is explained in the context of collaboration and knowledge sharing. An overview is provided of some of the key perspectives on open innovation and subsequently revenue sharing is added to the concept. In fact, revenue sharing will evolve into an important
component of open innovation and might even show to be a prerequisite to practice open innovation. As the relationship between open innovation practices and revenue sharing is explored, they are put into the context of firm performance, more specifically the innovation and firm performance of
11 Sundararajan, Arun. "From Zipcar to the Sharing Economy". January 3, 2013. Harvard Business Review. 12
10 oriented firms. Both new product development and service innovation are essential for value creation. However, the contribution of the service sector is 63.4% to the total of approximately $71.62 trillion of Gross World Product in 2012 and exemplifies the potential of value propositions in the tertiary sector of the economy13. The service sector covers all economic activities that do not produce material goods. Agricultural and industrial sectors contribute 5.9% and 30.7%, respectively, to the Gross World Product in 2012. It is important to understand that services provided by agricultural and manufacturing
companies contribute to the service sector. Once the theoretical framework is explained, the research methodology and results are presented. Finally the limitations of the research are discussed, possibilities for future research are proposed and managerial implications are presented.
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2. Literature review
2.1. Open innovation
2.1.1. InnovationThe ongoing search to create new or more effective products, processes or services, can be referred to as the innovation process. In today’s competitive business environment, constant innovation is a
primary source of sustainable advantage. In order to better understand the concept of innovation in this chapter, the literature of innovation is reviewed and different innovation frameworks are discussed. Successful innovation is essentially about positive change and Bessant & Tidd (2007) put forward four categories where such change can take place:
Product or service innovations change the things that an organization offers; Process innovations change the ways in which these products and services are
created or delivered;
Position innovations change the context in which the products and services are framed and communicated;
Paradigm innovations change the underlying mental models that shape what the organization does.
In literature two types of innovation are widely accepted. Incremental innovation introduces relatively minor changes to the existing product or service and often reinforces the dominance of established firms. Incremental innovation is seen as necessary to build capabilities for the future and builds on core competencies. Radical innovation, in contrast, is based on a different set of capabilities and often creates great difficulties for established firms (Dewar & Dutton, 1986). To achieve radical innovation, companies need to overcome the barriers to disruption (Wessel & Christensen, 2012). Disruptive or radical innovation needs to create value, while simultaneously reducing or eliminating less valued features or services. An organization should create new demand in an uncontested market space, rather than compete head-to-head with other suppliers in an existing industry where industry boundaries are defined and accepted, and the competitive rules of the game are known (Kim & Mauborgne, 2005). Radical and incremental innovations have different competitive consequences because they require quite different organizational capabilities. Specifically, an innovation capability enables companies to sense opportunities and threats, make timely, customer-oriented decisions, and reconfigure network resources to meet evolving customer expectations better than the competition (Barreto, 2010).
12 Recognizing what is useful and what is not, and acquiring and applying new knowledge when necessary, may be quite difficult for an established firm. Organizational capabilities are difficult to create and costly to adjust, because of the way knowledge is organized and hierarchically managed. In the present day business environment a need for ‘the ability to sense and then to seize new opportunities, and to reconfigure and protect knowledge assets, competences, and complementary assets and technologies to achieve sustainable competitive advantage’ is strongly emphasized (Teece, 2000). These
organizational capabilities are important to comprehend, because of the dynamic characteristics of revenue sharing contracts that will be discussed later.
Besides incremental and radical innovation, Henderson & Clark (1990) also distinguish modular and architectural innovation. Modular innovations require new knowledge for one or more components, but the architecture remains unchanged. Architectural innovations have a great impact upon the linkage of components, but the single components will remain the same. The essence of architectural innovation is the reconfiguration of an established system to link together existing components in a new way.
Architectural innovation presents established firms with a more subtle challenge compared to radical innovation, because much of the firm’s knowledge is useful and can be applied. Since innovation remains a venture into the unknown, it can be quite costly and with no guarantees to return on the investment. Holding on to unique assets and resources may bring competitive advantage, but sharing these assets and resources may lead to multiple revenue streams. Not only will the company be better prepared for disruption when one of the revenue streams becomes obsolete, but also new sustainable revenue streams may arise from external sources.The concept of sharing assets and resources across a single firm’s boundaries is explained in the next paragraph.
13 2.1.2. Open innovation
Traditionally, large firms focus on internal R&D to create new products. In many industries, large R&D labs were a strategic asset and represented a considerable entry barrier for potential rivals. This process in which large firms discover, develop and commercialize technologies internally has been labeled the closed innovation model (Chesbrough, 2003a). Although this model worked well for quite some time, the current innovation landscape has changed. Due to labor mobility, abundant venture capital and widely dispersed knowledge across multiple public and private organizations, enterprises can no longer afford to innovate on their own. In management, Joy's Law is the principle that most of the smartest people work for someone else, attributed to Sun Microsystems co-founder Bill Joy. Consequently, in order to reveal its potential, knowledge underlying innovation processes need to transcend a single firm’s boundaries. The paradigm shift from creating innovations internally to accessing and integrating external knowledge has been labeled open innovation (Chesbrough, 2003a). Open innovation
fundamentally depends on the integration of resources and capabilities from a variety of internal and external sources.
Sawhney and Prandelli (2000) are generally credited with originating the term open innovation. Since then, Chesbrough’s (2003b) seminal work moved the concept on to include a variety of ways to capitalize on innovations both externally and internally. Over time, open innovation has become a way to invest in future markets, technologies, and competition, but with fewer internal dedicated resources and with shared risks (Chesbrough & Garman, 2009). Sometimes very different phenomena, such as joint research projects, industry-university collaborations, customer co-creation and crowdsourcing, tend to be labeled open innovation. It emphasizes that open innovation comes in many forms and tastes, which adds to the richness of the concept but hinders theory development (Groen & Linton, 2010). Open innovation enthusiasts claim the potentially revolutionary nature of the approach. Open innovation critics, instead, point out that neither the external sourcing of knowledge, nor the external commercialization of innovation are new ideas (Christensen, Olesen, & Kjær, 2005). In an extensive literature review, Dahlander and Gann (2010) found many references to concepts such as absorptive capacity and complementary assets. Altogether, open innovation is not a clear-cut concept and different sets of open innovation practices can be contrasted to develop matrices distinguishing various forms of open innovation (Huizingh, 2011).
14 One of the most often used definitions of open innovation is: ‘the use of purposive inflows and outflows of knowledge to accelerate internal innovation and to expand the markets for external use of
innovation, respectively’ (Chesbrough, Vanhaverbeke, & West, 2006). So-called inbound open innovation refers to the outside-in process and involves opening up the innovation process to knowledge exploration. In contrast, outbound open innovation refers to the external exploitation of internal knowledge. Both inbound and outbound open innovation includes multiple activities. Examples of inbound open innovation practices are supplier collaboration, customer collaboration, university collaboration, government collaboration, in-licensing and acquisitions. Examples of outbound open innovation practices are out-licensing and divestment of spin-offs. By definition every inbound effort by one organization generates a reciprocal outbound effort from another organization (Chesbrough & Crowther, 2006). However, empirical studies have consistently found that companies perform more inbound than outbound activities, suggesting that firms fail to capture potential benefits. Possible explanations include the fear of diffusing relevant knowledge and the limited possibility to leverage existing relationships (Huizingh, 2011).
The success of knowledge inflows and outflows is predetermined by how knowledge is shared in collaborative efforts. Therefore, firms may also choose to combine outside-in and inside-out processes, integrating inbound and outbound open innovation (Gassmann, Enkel, & Chesbrough, 2010). As a specific type of open innovation, collaborative innovation combines the inbound and outbound processes of open innovation by allowing firms to jointly develop and commercialize innovation. The coupled process links outside-in and inside-out open innovation practices. As such, open innovation reflects much more a continuum with varying degrees of openness than a dichotomy (Dahlander & Gann, 2010). Examples of coupled innovation practices are co-patenting, R&D alliances and
manufacturing alliances. In literature, sharing revenues with innovation partners is not recognized for enabling collaborative innovation. However, the characteristics of revenue sharing contracts typically enable companies to cooperatively develop and commercialize new products and services. Revenue sharing in the context of the coupled innovation process provides the incentive to improve products and services.
15 2.1.3. Open innovation practices
Open innovation practices impact both innovation and firm performance (Mazzola, Bruccoleri, & Perrone, 2012). The innovation performance of companies has been studied quite extensively and for a long period of time. However, the results of many studies have not yet led to a generally accepted indicator of innovation performance or a common set of indicators (Hagedoorn & Cloodt, 2003). These indicators range from R&D inputs, patent counts and new product announcements. However, the measurement of innovation performance in non-manufacturing sectors is in need of a rather different set of indicators that are more appropriate in the context of a wide range of service industries.
Indicators are also needed to measure the success rates of innovation processes and practices for developing new services. Moreover, there is currently a limited understanding of the costs of openness and the need to identify breakpoints between open innovation benefits and the costs associated with lost innovation skills (Reed, Storrud-Barnes, & Jessup, 2012). Innovation has to be measured, or else it cannot be managed. Although there is no common understanding on how to measure innovation performance, elements that impact upon the success of open innovation are known and these open innovation practices will be discussed in further detail.
An important problem with open innovation is the “disclosure dilemma” or “information paradox” (Arrow, 1962) as knowledge has to be revealed to show its value. Strong protection has an effect on innovation performance only through providing a basis for safe knowledge transfer (Hurmelinna-Laukkanen, 2011). The degree of openness is therefore a key strategic decision for managers in their effort to increase innovation and firm performance (Drechsler & Natter, 2012). Laursen & Salter (2006) show there is an optimal degree of openness in innovation. They describe the character of a firm's strategies for accessing knowledge from sources outside of the firm by external search depth and external search breadth. The former is more formal and implies a more accurate selection of the partners and the latter is characterized by the involvement of a large number of partners. Firms that involve higher numbers of partners are considered to be more 'open', with respect to external search breadth, than firms that do not. Accordingly, external search depth is defined as the extent to which firms draw intensively from different search channels or sources of innovative ideas. Firms external search strategy is curvilinear related to innovation performance, which suggests that too much
openness hurts innovation. Revenue sharing has not yet been attributed the potential to coordinate the openness degree, but in fact revenue sharing provides the opportunity to create value by sharing
16 knowledge and ideas with innovation partners. The level of openness might influence the amount of revenues and vice versa.
Although multi partner alliances may offer interesting benefits for partners, according to Jarvenpaa & Wernick (2011) a research gap exists in terms of how open innovation networks approach the
paradoxical tensions of boundaries, relationships, ownership and organizing of open innovation networks. Multi partner alliances have to manage the risk that members enjoy the benefits of the collective good without contributing anything. There is also an increased risk of potential conflicts as the number of dyadic relationships increases geometrically when the number of partners becomes larger and a greater number of partners also tend to introduce additional coordination and communication costs as a result of increased transaction costs (de Rochemont, 2010). The cohesiveness or diversity of the parties has seemingly opposing consequences regarding the convergence or divergence of ideas and decisions that emerge. Consequently, the ability to protect ideas and innovations is an important capability that enterprises need to develop when participating in open innovation. According to Bogers (2011), collaboration characteristics and environmental dimensions influence knowledge sharing and protection. In fact, the relationship between the partners mediates knowledge sharing and protection in open innovation networks (Bogers, 2011). To overcome the factors that hamper an open knowledge exchange, revenue sharing could provide a foundation to generate additional revenues by sharing knowledge and ideas with innovation partners.
Panayides & Venus Lun (2009) find that trust is also contributing to innovation performance. The presence of social mechanisms such as trust and social commitment reduce the level of resistance and brings harmony to a relationship (Das & Teng, 2001). High trust improves communication,
collaboration, execution, innovation, strategy, engagement, partnering, and relationships with all stakeholders (Covey, 2006). Organizations act as 'trust boundaries' where people inside will
automatically give a level of trust to the people inside their company that they will not give to outsiders. Companies have the opportunity to extend these boundaries into customers and suppliers. As such, trust is the catalyst to collaborative innovation. Without a foundation of trust, collaborative alliances can neither be built nor sustained (Fawcett, Jones, & Fawcett, 2012). Perceptions of value incongruence can quickly lead to distrust (Sitkin & Roth, 1993). However, trust does not come without costs. It takes time and effort to build and maintain trust. Trust and control are inextricably interlinked with opportunities and threats in strategic alliances (Das & Teng, 2001). Trust is developed through stable expectations that make outcome predictable and reliable by systematizing routine interactions into rules and
17 procedures (Jones & George, 1998). In this context a reliable competitor can be preferable to an
unpredictable supplier. However, excessive formalization of rules and procedures to ensure reliable processes can significantly impede creativity and the innovation process itself (Mintzberg, 1994). Apparently trust and distrust co-exist and reflect a continuum in the same way that open innovation is not a dichotomy either. This makes it rather complex to manage. Sharing revenues with innovation partners is a fairly simple and rational concept that is easily understood and could prevent the need for extensive rules and procedures and simultaneously increase perceptions of value congruence among innovation partners.
As such, open innovation practices may vary by category, type and level of innovation and the relationship with innovation partners. In particular, openness towards customers, suppliers and universities has a significant positive impact on innovation performance (Inauen & Schenker-Wicki, 2011). The success rate of innovation practices need to be measured as it involves the investment of capital and time. Getting returns on investments in innovation is necessary, however measuring innovation performance presents many problems as the purpose of innovation is to create business value and can take many different forms. Just as open innovation practices require partner involvement, also revenue sharing by default needs partnerships because otherwise no sharing would be possible at all. Furthermore, both open innovation practices and revenue sharing can be exercised with one or many partners. As such, sharing revenues is an important element of collaborative innovation. In the next part the concept of revenue sharing is introduced and explained in the context of supplier
collaboration. Subsequently, revenue sharing contracts and revenue sharing models will be discussed in more detail.
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2.2. Revenue management
2.2.1. Supply chain coordination
Innovative companies such as Apple, rely extensively on other members of their supply chains to enable much of their innovation advantage and discover technologies, services, and business lines that
organizations working alone would be challenged to find (Almirall & Casadeus-Masanell, 2010). The relationship adds value to supply chain collaboration by enhancing business synergy and reducing the transaction cost of the entire supply chain and thereby creates a highly competitive ecology.
Coordination, collaboration, cooperation, alliances, or integration are often used interchangeably to qualify inter-organizational partnerships. Malone and Crowston (1994) define coordination as the process of managing dependencies among activities. Coordinating the supply chain across organizational boundaries may be one of the most difficult aspects of supply chain management (Arshinder, Kanda, & Deshmukh, 2008). This approach requires cross-company coordination in order to create transparency and accurate information about material flows in the chain as basis for decisions. The focus shifts from value creation within a single company towards ensured supply for a given demand.
Coordination mechanisms are necessary to enable decision-makers to pursue channel coordination between manufacturers, suppliers and retailers (Giannoccaro & Pontrandolfo, 2004). In n-tier supply chains, adopting a decentralized or centralized decision-making approach can pursue channel
coordination by cross-company material flow and information management. The former occurs when several independent actors make decisions at the different supply chain stages. In a decentralized supply chain system members are separate economic entities acting opportunistically to optimize their individual performance. The latter option occurs when there is a unique decision maker in the supply chain. In a centralized supply chain a focal firm is the initiator of an international business transaction. They conceive, design and produce the goods or services intended for consumption (Cavusgil, Knight, & Riesenberger, 2008). A focal firm sets up a value constellation through acquisitions, licensing
agreements, non-equity alliances, joint ventures, contracting and other types of relations that go beyond arm's-length relations (Amit & Zott, 2001). The focal company often has a long term scope on the relationship with partners and considers them as an extension. However, in both supply chain approaches misaligned incentives are common, power-based negotiations are widespread, and the tendency to act opportunistically is prevalent. Coordination mechanisms could optimize both decentralized and centralize supply chain approaches.
19 Such supply chains give rise to interesting strategic inter-supplier considerations of individual production quantities and prices. Inventory challenges such as the bullwhip effect and inventory pooling problems, have traditionally been studied using the newsvendor model (Höhn, 2010). The newsvendor problem is the situation faced by a newspaper vendor who must decide how many copies of the day's paper to stock in the face of uncertain demand and knowing that unsold copies will be worthless at the end of the day (Tsay, Nahmias, & Agrawal, 1999). The concept has extensive applications, including inventory management, capacity planning, and pricing and revenue management. Traditionally, managers focus on the management of their internal operations to improve profitability. The risks in the newsvendor case can be mitigated through sharing assets and resources. In a strategic alliance, organizations combine or integrate their operations to a significant degree (Lambert, Emmelhainz, & Gardner, 1999). To assure strong relationship commitment, talented employees can be shared with suppliers, helping them improve. Partners can also integrate or combine assets and operations under sole ownership (Yin & Shanley, 2008).
A collaborative supply chain means that two or more independent companies work jointly to plan to execute supply chain operations with greater success than when acting in isolation (Simatupang & Sridharan, 2002). Wang (2002) shows that optimal supply chain coordination depends on the information structure. Interdependent relationships are characterized by sharing all relevant
information, including sensitive costing details, joint planning and problem solving and an emphasis on mutual success (Cao & Zhang, 2011). The increased relationship commitment is not based on altruism. It arises out of a philosophy that competitive success depends on the strength of the whole supply chain. Also here the degree of openness is a key strategic decision for managers in their effort to improve supply chain coordination. ASML is a company that operates a formal strategy with suppliers known as value sourcing, which is based on competitive performance in quality, logistics, technology and total cost. ASML’s value sourcing strategy is based on maintaining long-term relationships with suppliers, sharing risks and rewards with suppliers and single, dual or multiple sourcing of products, where possible or required. The agreements define a framework in all areas of the business relationship and are focused on continuous improvement. In the next paragraph the supply chain is turned into a revenue chain and it is explained how revenue sharing contracts increase the strength of the entire supply chain and consequently improve competitive success.
20 2.2.2. Revenue sharing contracts
Due to globalization and outsourcing, decentralized supply chains are prevalent today. In decentralized supply chains it is important achieving coordination through appropriate incentives. In particular, the incentives allow the risk and the revenue to be shared by all supply chain partners. As such outsourcing is a kind of open innovation. However there are clear differences. Traditional outsourcing is a means of providing regular, repeatable services, which are not the core skills of the organization and are therefore better and almost certainly more cheaply carried out by others who have specialist knowledge and equipment. The services provided are fully specified, agreed and predictable in both concept and in volume. The job of the outsourcer is to add reliability and consistency. Open Innovation, on the other hand, focuses on a particular one-off task, solving a problem, designing a new product, creating a new marketing strategy or looking for disruption. Open Innovation involves the exploitation of ideas and intellectual property from outside of the organization. The outcomes are not necessarily fixed. Arranging a formal contract among partners becomes more important as the coordination intensity increases. Supply chain contracts are a useful tool to make the several supply chain actors of a decentralized setting behave coherently among each other, as if the chain were operated in a centralized fashion (Giannoccaro & Pontrandolfo, 2004). Several contracts have been shown to
coordinate the supply chain. These models mainly include wholesale price contracts, buyback contracts, price-discount contracts, quantity-flexibility contracts, sales-rebate contracts, franchise contracts, and quantity discounts (Cachon, 2003). However, traditional outsourcing contracts are based on win-lose arrangements where one party benefits at the other’s expense. Many counterproductive decisions are made to obtain the lowest possible price. The channel performance of a wholesale-price-only scheme is shown to degrade with the number of suppliers, which is not the case with a revenue-share-only contract (Gerchak & Wang, 2004). Under a revenue sharing contract, a retailer pays a supplier a wholesale price for each unit purchased plus a percentage of the revenue that the retailer generated. Often the rent paid by retailers in shopping mall and high street locations is related to the generated revenue. Both the supplier and tenant will be willing to support the retailer, as their profits are
correlating with the retailer’s revenue. Revenue sharing in the context of open innovation provides the incentive to improve and transforms the supply chain into a revenue chain. Moreover, by sharing revenues with innovation partners, companies could gain access to assets and resources that normally require high capital investment.
21 Price-only contracts do not coordinate the supply chain. By sharing expertise and aligning goals, parties are able to drive innovation, adapt to changing needs and mitigate risk while working towards mutual success. Managing incentive conflicts can lead to ‘win-win’ situations and help to break the ‘zero sum game’ mentality. Own benefits and goals need to be secondary to common ones. A revenue sharing transaction, by default requires a win-win situation in the shorter or longer term, because otherwise no exchange would be possible at all. This requires full collaboration and trust rather than competition between companies. Specifically, the game theory attempts to model how an individual’s success in making a strategic decision depends on the choices of others. The Stackelberg model is an economic strategic game in which the leader firm moves first and then the follower firm moves sequentially to maximize their respective profits. Karmperis et al. (2011) apply the cooperative game theory approach and show that in situations where individual players examine to cooperate by forming a grand-coalition, coordination can be achieved with revenue-cost-sharing mechanisms. Moreover, the revenue sharing contract does not only improve the quantitative metrics such as supply chain profits, but also improves qualitative performance measures such as corporate social responsibility and ensure that each partner in the supply chain can benefit from the contract (Hsueh, 2013). As such revenue sharing intrinsically not only provides the incentive to improve financially, but also stimulates high quality standards.
There are several theoretical and empirical studies of revenue sharing contracts. A typical case is
Blockbuster, a movie rental firm. Mortimer (2008), estimates that the introduction of revenue sharing by Blockbuster increased total profit by 7% in the video rental industry. Revenue sharing is often applied for electronically distributing and viewing digital contents. Dana and Spier (2001) considered a supply chain with competitive retailers and derived optimal revenue sharing. Veen and Venugopal (2005) proposed that revenue sharing contract could optimize the chain and bring win-win situations. In fact, a revenue-sharing contract does improve supply chain performance (Yao, Leung, & Lai, 2008) and the revenue-sharing rule maximizes total profit under a variety of cost combinations (Chwolka & Simons, 2003). Under a consignment contract with revenue sharing, a decentralized supply chain can be
perfectly coordinated and both the manufacturer and the retailer are better off (Li, Zhu, & Huang, 2009; Y. Wang, Jiang, & Shen, 2004). The combination provides opportunities to the variety, depth, and service level aspects of assortment planning.
However, there are also some limitations. For the truly competitive, giving in or sharing does not come easy. Revenue sharing does not coordinate a supply chain with demand that depends on costly retail effort to influence revenue, e.g. advertising, service quality and store presentation (Cachon & Lariviere,
22 2005). Lal (1990) demonstrates that the supplier may offer revenue sharing when the supplier can engage in such costly effort. The retailer’s risk decreases as his share of revenue decreases, but so does his incentive to exert revenue-enhancing effort. Compensation arrangements with greater degrees of revenue sharing significantly reduce revenue-enhancing effort (Gaynor & Gertler, 1995). Early work on franchise contracts (e.g. Stiglitz, 1974) highlights the trade-off between risk avoidance and incentives. A franchise contract combines revenue sharing with a two-part tariff. That is, the supplier charges a fixed fee, a per-unit wholesale price, and a revenue share per transaction, which is usually called a royalty rate. While franchising can coordinate multiple noncompeting retailers, it cannot guarantee an arbitrary allocation of profit. Furthermore, under revenue sharing contracts, the supplier must monitor the retailer’s revenues to verify that they are split appropriately, which imposes a costly administrative burden on a firm’s financial reporting duties. Internet revenue streams introduce a greater degree of transparency than those offered by offline transaction models. Demand and stock information can be shared among all members in real time. Consequently, the Internet enables to eliminate much of the administrative burden and much of the costly retail effort, which were present in the supply chain prior to the information age.
As a result the Internet enables businesses to reconfigure supply chains and networks in ways that were not previously possible. In the new environment of e-business, the mechanisms by which firms
coordinate different stages in the supply chain are undergoing profound changes. Within the rate of adoption, there is a point at which an innovation reaches critical mass and increases the rate of the diffusion of innovation. Diffusion is the process by which an innovation is communicated through certain channels over time among the members of a social system (Rogers, 1962). With the introduction of the Internet, the speed of communication has increased tremendously. Consequently a majority of
businesses are changing the way they price and deliver their goods and services. Dell.com for example does not start to assemble a laptop only before it was ordered by a customer on it’s website.
Kickstarter.com enables innovators to sell early stage products to a community of early adopters, which enhances the chances of successful innovations. As such, not only much of the costly effort of revenue sharing contracts has disappeared, but the characteristics of revenue sharing contracts also provide companies with the ability to reconfigure supply chain resources and make timely, customer-oriented decisions, to meet the evolving customer expectations.
23 2.2.3. Revenue sharing models
Revenue sharing has multiple, related meanings depending on context. In literature, revenue sharing is mainly related to supply chain coordination. Revenue sharing is a mechanism that coordinates the supply chain and arbitrarily divides resulting profits (Cachon & Lariviere, 2005). However, revenue sharing comes in many forms. Any financial transaction in which companies or individuals receive payment based on the amount of money that was made rather than on the amount of work that was done is a form of revenue sharing. In this way, corporations that pay out the dividends to the
shareholders, utilize a particular form of revenue sharing. The sharing rule defines the split between the shareholders and the board of management. Employers who share revenues or cost savings with employees give bonuses based on the company's profit rather than on the amount of work that was performed. These plans are based on predetermined economic sharing rules that define the split between the company as a principal and the employee as an agent. In political science and economics, the principal–agent problem or agency dilemma concerns the difficulties in motivating one party (the "agent"), to act in the best interests of another (the "principal") rather than in his own interests
(Eisenhardt, 1989). Also taxes can also be considered a form of revenue sharing. Taxes ensure that a part of the generated revenue will be redistributed and return to the community.
Revenue sharing as a marketing strategy refers to an organization paying partners and associates a certain percentage for recommending customers to the company and helping to build business. By sharing revenue in this way, a company can build strategic partnerships with professionals related to, but not directly within, a company. On the Internet, revenue sharing is also known as cost per action (e.g. view, click, subscription, download, lead, sale, etc.). A journalist is being paid through a revenue-sharing model, when he creates an article for a website and is being paid based on the number of times the article is read or based on the number of clicks that advertisements associated with the article have received. YouTube also allows online video producers to keep 100% of advertising revenue above a certain threshold. Typically 45% of ad revenues are going to YouTube. That means content partners that are able to sell the ads for higher prices could end up keeping a larger share of the pie. Sometimes revenue sharing is more visible to the customer, such as when shipping costs or credit card payment fees are made visible on checkout. This shows that also on the Internet, revenue sharing comes in many forms and asks for creativity and ingenuity to define new revenue streams.
24 As discussed, the purpose of revenue sharing is not only to coordinate the supply chain but also to create business value and as such the concept shows more commonalities with open innovation then partnerships alone. With revenue sharing the knowledge flows are considered to be both upstream and downstream at the same time. Another interesting issue is what aspects of revenue sharing and open innovation practices make the concepts effective. It is unlikely that these concepts have positive effects in any situation, implying that the effectiveness of revenue sharing and open innovation are dependent on the environment in which they are viewed. In the next paragraph revenue sharing and innovation performance are perceived in the context of value creation. Otherwise common practice can be wasteful, even harmful, if applied to the wrong situations. The corresponding characteristics between collaborative innovation, revenue sharing and performance of service-oriented firms will be explored in more detail.
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2.3. Performance of service-oriented firms
2.3.1. Service innovation
As explained in the introduction, value propositions for services have enormous potential. Organizations face different obstacles to profit from new products or services. However, the literature on innovation and the management of innovation mainly focuses on the manufacturing industries. The concept of service innovation was first discussed in Miles (1993) and has been developed in the past decades. A service innovation is a new service experience or service solution for a customer in one or several dimensions: service concept, customer interaction, value system/business partners, revenue model, organization or technology (Hertog, 2010). Services are different from products because they are perishable and intangible and create benefits without the transfer of ownership. Business services are heterogeneous and the knowledge content of the services provided is often not easy to protect effectively with formal intellectual property protection methods such as patents (Blind et al., 2003). For many firms development of new services tends to be an ad hoc process. The ad hoc nature of the innovation process is due to the weak appropriability regime for most services (Sundbo, 1997). Intangibility is one of the attributes of service innovation that makes them easier to imitate (Amara, Landry, & Traoré, 2008). To serve as a basis for sustainable competitive advantage, resources must be valuable, rare, inimitable and non-substitutable (VRIN) (Barney, 1991). A formalized process will increase the chances of success for firms involved (Brentani, 2001). On the other hand service innovation is an iterative process that involves the customer and results in a customer experience (Chesbrough, 2011). Services are often highly customized due to the direct interaction between provider and customer. At the same time, information about a newly developed service and the customer’s preferences tends not to be widely and systematically shared (Nambisan, 2001). Customers demand highly customized
products and experiences, which requires active participation by the customer. Addressing the customer is the most important part when generating revenues.
26 2.3.2. Value innovation
The competitive goal is to redefine how business is conducted and value is created. Harvard marketing professor Theodore Levitt used to tell his students: “People don't want to buy a quarter-inch drill. They want a quarter-inch hole”. Value is the real service traded in any transaction. Successful companies increasingly do not just add value, they reinvent it. Revenues are generated when value is exchanged and in order to be able to apply the sharing rule, revenues need to be generated. Transactions are most commonly described as a linear process, a chain leading roughly from suppliers to a service provider then to the customer. The value chain model, developed by Porter (1985), shows the contribution to profit of the various activities in an organization. At every stage of the chain, value is added to the product. However, the process by which value passes from organization to customer is undergoing a massive transformation today. Value creation is not just adding value step after step but reinventing it by means of a reconfiguration of the roles and relationships among actors of the value creating system (Ramirez & Wallin, 2000). Value constellations create value for a target customer group by means of a business model translating technological developments into new, commercially viable products (Normann & Ramirez, 1993). To deal with business opportunities that are enabled by technological developments, economic actors with different assets and competencies have to be linked together to jointly create value for targeted customer groups (Vanhaverbeke & Cloodt, 2006).
A value constellation describes how value is captured from a network of multiple points and not necessarily along a sequenced or linear value chain. The flow of services can be effective without the linear aspects that limit the distribution of products. Setting up a value constellation can be difficult, because to create wealth, is to combine values that are not easily joined, therefore scarce and therefore profitable (Hampden-Turner & Trompenaars, 2000). Competitive advantage of a constellation is not only based upon the resources of its participants but also how they are assembled, structured and managed within the constellation. Applying value-based revenue models makes internal pricing decisions more complex and calls for precise courses of action (Bonnemeier, Burianek, & Reichwald, 2010). Even before a contract is initiated, a business needs to lay a foundation for value creation. In the next paragraph it is discussed why sharing revenues would improve both innovation performance and performance of service-oriented firms.
27 2.3.3. Business model innovation
With each innovation, there is a need for a viable structure of revenues and costs. As competition increases, innovation becomes part of the day-to-day activities. At the same time, it becomes more and more difficult to gain a competitive advantage through innovation and innovation management. The antecedents of successful innovation depend on a variety of contextual factors. Both the internal and external environments characterize the context to determine open innovation effectiveness (Gassmann, 2006). The business model can provide that context. Business models help to describe the rationale of how an organization creates, delivers, and captures value (Osterwalder, Clark, & Pigneur, 2010). However, also the business model lacks definitional consistency (Zott, Amit, & Massa, 2011). Most confusion related to the business model concept is that many people speak about business models when they really only mean parts of a business model. The business model is not just a value
proposition, a market positioning, a revenue stream, a pricing mechanism or a network of relationships by itself. In fact, it is all of these elements together.
The revenue model is the way a company gets compensated and consists of one or many revenue streams. A new revenue model basically is a new way of pricing or creating revenues (Hertog, 2010). The business model and the revenue model are connected through business patterns and revenue streams. Revenue sharing is not a business model in itself, but a way of exploiting partnerships to address the customer and distribute the resulting revenues (Osterwalder, Pigneur, & Tucci, 2005). With innovation happening in different parts of the supply chain, a company must decide which technologies and
features to incorporate into its products, and then make those elements work together in a product that is useful and attractive to customers. To create and extract economic value from new technological developments each firm needs a suitable business model, which operates as a mediator between technology development on the input side and economic value creation on the output side (Chesbrough & Rosenbloom, 2002). Business model design is therefore one of the most critical steps for determining the innovator’s profitability (Teece, 2010). Specifically the performance of service-oriented firms heavily depends on the business model, because services are often not easy to protect.
Unlike traditional financial models, which are built around one-time transactions, recurring revenue business models focus on a series of transactions. Several points of contact in the recurring revenue model increase the potential for collaboration compared to the potential offered by one-time
28 supply chain contracts. Due to the revenue incentive it allows companies to achieve sustained success over a longer period of time. Furthermore, a company can have the same revenue stream for different business processes. Leasing and Software as a Service (SaaS) contracts for example allow a customer to pay one subscription fee for different business patterns in one sum. So even while there are different business patterns the company gets compensated through a single revenue stream. Amazon, for example, will host a company’s IT functions and charge only for those services actually consumed. Businesses are only just starting to recognize the financial benefits of recurring revenue. Their customers are demanding the flexibility and personalization these models provide. Rolls Royce for example started to sell flight hours instead of selling jet engines, which allowed the company to focus on the reliability of its engines, which in its turn is of crucial value for its customers. A next step could be to include fuel consumption into the compensation for Rolls Royce. It changes the financing structure of Rolls Royce as the revenue streams are no longer related to the transaction of selling jet engines. However, recurring revenue streams are not revenue sharing contracts by default. In the case of Rolls Royce the revenue stream is not directly related to the airline. Therefore it is not necessarily a revenue sharing relationship, although the revenue stream is ultimately dependent on the success of the airline. Since the experience delivered by Rolls Royce and the airline is a joint effort, this also calls for a joint interest. Sharing revenues with customers offers opportunities for differential advantage and improve value creation and increase performance.
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2.4. Theoretical framework
2.4.1. Hypotheses development
Revenue sharing has proven to coordinate the supply chain as it enables information sharing among supply chain partners. With services there is limited possibility of either protection or secrecy to benefit from services innovation. Successful service-oriented companies will probably need to share revenues with innovation partners to benefit from innovations and sustain competitive advantage. Revenue sharing will align incentives and reduce the risk of subsidizing poor performance. Based on this idea the below hypothesis arises.
H1. Sharing revenues with innovation partners has a significant positive effect on performance of service-oriented firms.
Both innovation and firm performance of service-oriented firms will be tested. Innovation performance indicates to what extent a company is able to benefit from innovations and is measured by the
percentage of revenues contributed by improved and new products and services related to its total turnover. Revenue sharing is considered to contribute to a company’s innovation sales by addressing the customer and increasing the rate of diffusion. Firm performance indicates a company’s relative
performance in comparison to its peers. In today’s competitive business environment, constant innovation is a primary source of sustainable advantage. Sharing revenues with innovation partners is considered to create an open environment that allows companies to commercialize innovations and sustain competitive advantage. Both independent variables are explained in more detail in the methodology chapter.
Revenue sharing also creates a joint interest. Companies with revenue sharing contracts are challenged to continuously improve performance. When the supply chain is transformed into a revenue chain with revenue sharing, companies are not only willing to improve from a coordination or cost savings point of view, but also from a revenue point of view. Existing value constellations will meet market demands more efficiently and new value constellations will create new markets effectively. As such, applying revenue sharing and distributing revenues results into more inbound innovation practices because of joint interest of innovation partners. Participating in revenue sharing results into more outbound innovation practices as the company will benefit from more revenues by innovation partners. Consequently, revenue sharing is considered to be a main driver of open innovation practices.
30 H2. Sharing revenues with innovation partners has a significant positive effect on open innovation
practices.
Performance of service-oriented firms is also assumed to increase by carrying out multiple innovation activities. The joint effort results into improved and new products and services that organizations working alone would be challenged to find. Hence, in accordance with Mazzola et al. (2012), it is considered that open innovation practices increase innovation performance of service-oriented firms. As service innovation often involves the customer, open innovation practices allow companies to jointly develop and commercialize innovation. Consequently open innovation practices also increase firm performance of service-oriented firms.
H3. Open innovation practices have a significant positive effect on performance of service-oriented firms.
Based on the literature review, the effect of sharing revenues with innovation partners on innovation and firm performance of service-oriented firms is assumed to be mediated by open innovation practices. How else would giving away revenues contribute to both innovation and firm performance as stated in the first hypothesis? The most generic formulation of a mediation hypothesis is that the mediator intervenes between the independent and dependent variable. The final hypothesis will answer the research question if sharing revenues with innovation partners indeed does not only coordinate the supply chain, but also contributes to both innovation and firm performance because of its correlation with open innovation practices.
H4. The effect of sharing revenues with innovation partners on performance of service-oriented firms is mediated by open innovation practices.
31 2.4.2. Conceptual model
Based upon the literature review and the hypotheses development above, the conceptual model arises. The central idea in the mediation model is that the mediator intervenes between input and output. The most generic formulation of a mediation hypothesis is that the mediator intervenes between the independent and dependent variable (Baron & Kenny, 1986). In this case the independent variable is revenue sharing and the dependent variable is performance of service-oriented firms. The impact is tested with hypothesis 1.
Diagram 1. Direct effect of revenue sharing
The white boxes in the diagram consist of the items used to build the constructs and these variables will be further explained in the methodology chapter. Various transformation processes mediate the effects of the independent variable on the dependent variable. In this study open innovation practices
transform the supply chain in a revenue chain and is considered to mediate the relationship between revenue sharing and performance of service-oriented firms.
In general, a given variable may be said to function as a mediator to the extent that it accounts for the relation between the predictor and the outcome. Baron and Kenny (1986) discuss four steps in establishing mediation. First, show that the causal variable is correlated with the outcome (H1). This step establishes that there is an effect that may be mediated. Second, show that the causal variable is correlated with the mediator (H2). This step essentially involves treating the mediator as if it were an outcome variable. Next, show that the mediator affects the outcome variable (H3). It is not sufficient just to correlate the mediator with the outcome because the mediator and the outcome may be correlated because they are both caused by the causal variable. Thus, the causal variable must be controlled in establishing the effect of the mediator on the outcome. Finally, to establish that the
Business model (Revenue model, Financial structure) Innovation performance (Improved, New products and services) Revenue sharing Performance of service-oriented firms
Firm performance (ROE, Profit, Revenue, Market share)
H1 (Path c)
32 mediator completely mediates the causal variable with the outcome relationship, the effect of the causal variable on the outcome controlling for the mediator should be zero (H4). The effects in both steps three and four are estimated in the same equation.
To clarify the meaning of mediation, a path diagram is introduced as a model for depicting a causal chain. The basic causal chain involved in mediation is diagrammed in the conceptual model below. This model assumes a three variable model such that there are two causal paths feeding into the outcome variable. Hypothesis 1 is testing the direct impact of the independent variable (Path c) and hypothesis 3 is testing the impact of the mediator (Path b). There is also a path from the independent variable to the mediator (Path a). This path is tested in hypothesis 2. When Path c is reduced to zero, there is strong evidence for a single, dominant mediator. If the residual Path c is not reduced to zero, this indicates the operation of multiple mediating factors. The mediation effect in Path c’ is tested with hypothesis 4. The amount of mediation is called the indirect effect. The total effect equals the sum of the direct effect and the indirect effect or using symbols Path c = c' + ab. The indirect effect equals the reduction of the effect of the causal variable on the outcome or Path ab = c - c'.
Diagram 2. Diagram of conceptual model
H3 (Path b) H2
(Path a)
Business model (Revenue model, Financial structure)
Open innovation (Inbound, Outbound, Coupled)
Innovation performance (Improved, New products and services) Revenue sharing
Open innovation practices
Performance of service-oriented firms
Firm performance (ROE, Profit, Revenue, Market share)
H4 (Path c’)
33
3. Methodology
3.1. Survey data
Open innovation studies have been dominated by qualitative research approaches, drawing heavily on in-depth interviews and case studies. Van de Vrande et al. (2009) advocate quantitative research methods should be applied in order to compare results in innovation studies. As such, the hypotheses were tested using data drawn from a survey. The questionnaire was conducted in 2011 and asks companies for achievements in service innovations. The innovation survey was 4 pages long and there were a number of questions about the percentage of sales that can be attributed to existing, improved and new products or services, the relative firm performance regarding return on average invested capital, profits, revenues and market share, the innovation and collaboration process and the barriers experienced in participating in innovation activities. This study analyses the extent to which open innovation practices and sharing revenues is related to performance of service-oriented firms. The content of the survey consisted of a mix of existing and new measurement scales, meaning that, some questions in the scientific literature were already known and tested and other components were the very basis for new concepts or new theories. The survey was distributed to 8.503 companies in Amsterdam-Utrecht region in The Netherlands. Because all types of businesses, including the
manufacturing industry, provide services, almost all sectors were approached and asked to complete the service innovation questionnaire. Confidentiality was assured to all participants and upon request they were given the opportunity to benchmark individual results. Survey questionnaires were returned anonymously in pre-stamped envelopes or were submitted online.
Over half of the completed questionnaires were submitted online. Responses were received from 466 companies, representing a satisfactory effective response rate of 5.5 percent. The range of ages of the respondents is from 18 to 80 years, with an average age of 49 years (SD = 9.4); 82.9 percent were men; 77.9 percent of the respondents have a college or university background. The average tenure with the organization was 15.6 years (SD = 11.0) and 94.2 percent of the participants have been in their current position for more than one year (M = 11.6; SD = 9.2).
