INTRODUCTION

An increasingly large number of industries are characterized by market fragmentation, compressed product life cycles, rapid innovation, and rising new product development costs (Clark & Wheelwright, 1993). In such industries, the competitive position of a firm is often predicated upon its ability to develop new product offerings ahead of rivals (Pisano, 1990). Firms that are able to bring new products to market before competitiors stand a better chance of gaining market share, recouping product development costs, and generally capitalizing upon first mover advantages. Firms that are slow in the product development race risk losing market share to their quicker rivals. This ability is nowhere more critical than in entrpreneurial firms competing in "first to market" races where winners will prosper and grow and losers may not be able to survive.

The challenge of developing new porducts is not without difficulties. Product development has been characterized as a highly uncertain process, often entailing large resource expenditures with no guarantee of success. The more an organization reduces this uncertainty, the greater the likelihood of successful product development (Tushman, 1978). Most prior research in the strategy literature views a firsm’s internal research and development capabilities as the prime determinant of its ability to develop vaulable new products (Clark, & Wheelwright, 1993; Mowery, 1983). However, internal R&D is not the only possible source of innovation solutions. Firms that are located close to similar enterprises can tap the R&D knowledge of those enterprises and use that knowledge to improve the effectiveness of thier own product development efforts. As a consequence of such knowledge spillovers, other things being equal, firms located close to similar enterprises should develop more new products than firms that are not located close to similar enterprises. The benefits of knowledge spillovers are potentially greatest in small entrepreneurial firms. With limited resources, such firms are unlikely to have the internal capabilities to solve all product development challenges quickly and can benefit from externally generated solutions.

The effect of knowledge spillovers will be moderated by the ability of a firm to understand and evaluate external knowledge. This ability, referred to as absorptive capacity by Cohen and Levinthal (1989), is largely a function of a firm’s level of prior related knowledge, which is liable to be lowest in small entrepreneurial firms. This viewpoint suggests that small firms will have a limited ability benefit from knowledge spillovers. In this paper we lay out the theoretical arguments underlying these relationships and present specific hypotheses. We test these hypotheses on a sample of firms in the biomedical device industry. Our results provide no support for the hypothesis that knowledge spillovers affect the success of product development at the regional level. We did find, however, that individual firm differences moderate the relationship between knowledge spillovers and product development at the firm level. Firm absorptive capacity was found to have a negative effect on the relationship between industry concentration in a region and the number of new products developed in 1993.

The concept of knowledge spillovers between firms is not new. A century ago, Marshall (1890) noted that knowledge spillovers are one of the external benefits realized by firms concentrated in a geographic region. More cently, several authors have emphasized that knowledge spillovers in specialized and geographically concentrated industries are a spur to innovation, competitiveness, and economic growth (Porter, 1990; Romer, 1986). The basic thesis is that the geographical proximity of firms based in the same industry facilitates the transmission of knowledge. Spying, imitation, and rapid interfirm movement of highly skilled labor quickly disseminates knowledge among neighboring firms (Glaeser, et al., 1992).

From a firm level perspective, the implication is clear; firms located close to other firms in their industry can tap into the knowledge pool developed by those enterprises and utilize it to improve their own product development efforts. Thus, a firm can be viewed as having two primary sources of research knowledge: its own internal R&D efforts and the R&D efforts of enterprises in the same industry that are located in the same geographic region. These sources of knowledge are not independent of each other; knowledge that spills over from other enterprises should have a positive impact upon the efficacy of the firm’s own internal R&D efforts. This gives rise to the following hypothesis:

Hypothesis 1: The success of a firm’s product development efforts will be positively correlated with the concentration of firms in the same industry in the geographical region where the firm is located.

This hypothesis focuses upon knowledge spillovers between firms within the same industry. While this has been the dominant theme stressed in the literature on knowledge spillovers, it is not the only theme Jacobs (1969) contends that an important externality arises from the cross-fertilization of knowledge across different industries. This contention is supported by Scherer (1982) who found that 70 percent of inventories in a given industry are used outside of that industry. This view is reinforced by the argument that many technological advances are based upon the fusion of previously independent lines of research (Kodama, 1992). For example, the original development of liquid crystal displays for pocket calculators was not possible until electronics, optic, and crystal technology reached a certain level of development, and then it required the fusion of these once separate research streams into a new technology.

The cross-fertilization and fusion arguments suggest that knowledge spillovers arise not only within an industry, but also across industries. More precisely, just as the geographical proximity of enterprises within the same industry can result in knowledge spillovers, so can the geographical proximity of firms in different industries. For example, a software firm may benefit from knowledge spillovers, both because there are many other software firms located nearby (the effect predicted by hypothesis 1), and because a diverse array of enterprises based in other industries are also located nearby. One can postulate that the more diverse the local representation of firms from other industries, the greater the potential for knowledge spillovers leading to technological fusion is. This gives rise to a second hypothesis:

Hypothesis 2: The success of a firm’s product development efforts will be positively correlated with the diversity of the industrial base in the geographical region where the firm is located.

It is important to realize that hypotheses 1 and 2 are in no way contradictory. It is quite possible for there to be both a high concentration of firms within the same industry in a given geographical region, and a wide array of firms representing other industries.

An additional regional factor that has to be considered is the impact of the overall economic activity in the region. It seems reasonable to assume that there are differences in the abilities of firms to access the external knowledge pools of similar sizes in geographic regions with different levels of economic activity. For example, lets assume that the concentration of economic activity in an industry is the same in Boise, Idaho, as it is in Los Angeles, California. Because the total economic activity is much greater in Los Angeles, one would expect a firm located in Los Angeles to have a reduced ability to access the external knowledge, compared to a firm in Boise. This leads to the next two hypotheses:

Hypothesis 3a: The relationship between the success of a firm’s product development efforts and the concentration of firms in the same industry in the geographical region where the firm is located will be negatively correlated with the total economic activity in the geographical region.

Hypothesis 3b: The relationship between the success of a firm’s product development efforts and the diversity of the industrial base in the geographical region where the firm is located will be negatively correlated with the total economic activity in the geographical region.

The previous hypotheses focus upon the factors that determine the size and diversity of the external knowledge pool arising from spillovers available to a firm within a particular geographical region. Logically, the ability of a firm to understand, evaluate, and utilize this knowledge should also be an important predictor of the efficacy of a firm’s product development efforts. This ability has been referred to as the absorptive capacity of the firm (Cohen & Levinthal, 1989). Cohen and Levinthal argue that a firm’s absorptive capacity is largely a function of the level of prior related knowledge within the firm and will depend on the absorptive capacity of its individual members. However, firm absorptive capacity is not just the sum of its employees absorptive capacity but will also depend on a variety of organizational factors such as firm R&D investments. Firms that have invested in R&D are more likely to have a greater understanding of how to utilize externally available knowledge. Cohen and Levinthal (1990) present empirical evidence consistent with this argument.

If Cohen and Levinthal’s arguments are correct, we would expect the interaction between the size of the external knowledge pool arising from spillovers and a firm’s absorptive capacity to have a positive impact upon the efficacy of the firm’s product development efforts. We expect a similar interaction effect between the diversity of the external knowledge pool and firm absorptive capacity. While we cannot measure the amount external knowledge directly, we have already argued that the external knowledge pool available to a firm in its geographical region is a positive function of the local concentration of firms in the same industry, and the diversity of the remaining industrial base in that locale. This leads to the following hypotheses:

Hypothesis 4a: A firm’s absorptive capacity will have a positive effect on the relationship between the concentration of firms in the same industry in the geographical region where the firm is located and the success of a firm’s product development efforts.

Hypothesis 4b: A firm’s absorptive capacity will have a positive effect on the relationship between the diversity of the industrial base in the geographical region where the firm is located and the success of a firm’s product development efforts.

While there are no universally accepted way of modeling a firm’s absorptive capacity, the measures that have been used, (i.e. R&D expenditures (Cohen, & Levinthal, 1990), and participation in research communities (Deeds, et al., 1995)) are all strongly correlated with firm size. This suggest that smaller firms will have a lower level of absorptive capacity and therefore a reduced ability to exploit external knowledge stocks. These arguments give rise to the following hypotheses:

Hypothesis 5a: The effect of firm absorptive capacity on the relationship between the concentration of firms in the geographical region and the success of a firm’s product development efforts will be moderated by firm size.

Hypothesis 5b: The effect of firm absorptive capacity on the relationship between the diversity of the industrial base in the geographical region and the success of a firm’s product development efforts will be moderated by firm size.

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Last Updated 1/15/97 by Geoff Goldman & Dennis Valencia

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