Psychic distance, innovation, and firm performance.

VerfasserAzar, Goudarz

Abstract Previous research suggests that internationalization improves a firm's ability to innovate, but the effect of internationalizing into specific target markets or destinations on the innovation ability of firms has not been fully investigated. This study examined whether the psychic distance between target market and home market affects firms' propensity to innovate. The starting assumption was that perception of a high degree of differences and subsequent environmental uncertainty when expanding into psychically distant markets triggers strategies for interacting and integrating with the market environment. These include producing and adopting innovations to processes and products and to organizational strategy, structure, and administrative procedures to cope with the new environment and overcome uncertainties. These innovations and the associated competitive advantages can improve firm performance. Hypotheses regarding the relationships between psychic distance, innovation, and firm performance were tested here by structural equation modeling using data from 186 export ventures into 23 international markets by Swedish companies. The results indicate that the link between psychic distance and firm performance is mediated by innovation.

Keywords Psychic distance * Innovation ? Internationalization * Firm performance * Uncertainty

1 Introduction

Innovation is generally viewed as an important determinant of a firm's competitiveness and as enhancing its organizational performance (Fagerberg et al. 2005; Damanpour and Evan 1984; Han et al. 1998; Damanpour and Aravind 2011). Previous research has shown that innovation has a particularly strong effect on the performance of highly internationalized firms (Kafouros et al. 2008). Operating in foreign markets enriches a firm's sources of knowledge and other strategically relevant resources and increases its learning capacity, all of which have key roles in innovation. Through internationalization, firms may access ideas and expertise from new and different markets that improve their abilities to innovate. Internationalization enables the firm to acquire materials and inputs from the most economical sources around the globe (Kafouros et al. 2008; Kotabe et al, 2002; Hitt et al. 1997). Kafouros et al. (2008) therefore argue that greater internationalization can lead to greater returns from innovation.

Despite much research into the relationship between firm internationalization and innovation (Hitt et al. 1997; Kafouros et al. 2008; Kotabe et al. 2002), little attention has been paid to the effect of the "destination" of internationalization on innovation (Alvarez and Robertson 2004). The destination refers to the foreign market(s) in which firms operate (e.g., through exporting). Alvarez and Robertson (2004) categorized export destinations in developing and developed markets and found that the destination of exports influences firms' innovation activities. They revealed that firms which export to developing countries are more likely to have R&D units and to invest in product design, whereas firms which export to developed countries are more likely to invest in new products and production processes. It has been claimed that exporting to developed markets requires upgrading of production processes (technology) to meet the market's specifications, while exporting to developing markets demands leadership in product design and research (Gereffi 1999).

Firms can internationalize to markets at varying psychic distance from the home market. Psychic distance is a perceptual distance between the firm's home market and a foreign market, and it results from the perception of both cultural and business differences between the home market and the foreign market (Evans and Mavondo 2002; Evans et al. 2008). Entering psychically distant markets leads to high perceived levels of uncertainty (O'Grady and Lane 1996; Evans and Mavondo 2002) since the firm sees itself as lacking sufficient market information to accurately predict the challenges facing it in the new foreign market (Yamin and Sinkovics 2006; Penrose 1959). The perception of uncertainty has been shown to stimulate a firm's propensity to innovate (Ettlie 1983; Freel 2005; Hrebiniak and Snow 1980; Huber et al. 1993; Ozsomer et al. 1997; Pierce and Delbecq 1977; MacCormack and Verganti 2003). This process of innovation is a crucial component of a firm's strategy (Gunday et al. 2011), by acting as a means to facilitate its adaptive changes to the environment and cope with environmental uncertainties (Damanpour and Evan 1984; Damanpour et al. 2009). Innovation is thus a source of competitive advantage in international markets (Pla-Barber and Alegre 2007). According to Silva et al. (2010), the high competitive pressure of international markets pushes firms to adopt innovations in order to cope with environmental changes, meet market conditions, and eliminate a performance gap caused by uncertainties in the environment (Damanpour and Evan 1984). However, no previous study has investigated uncertainty as a result of the psychic distance between home and foreign markets in prompting innovation.

Furthermore, much research has been devoted to the effect of innovation on firm performance but such research has mainly focused on one type of innovation, i.e., technological innovation, while the influence of organizational innovation on firm performance has been basically ignored (Damanpour and Evan 1984; Damanpour and Aravind 2011; Birkinshaw et al. 2008; Armbruster et al. 2008). A possible explanation for this omission is that relative to organizational innovation, technological innovation is generally perceived to have a more clear association with performance (Damanpour and Evan 1984). Adopting technological innovations results in the introduction of new technologies, more efficient production techniques, and new products and processes that create competitive advantages and hence enhance organizational performance (Hall and Mairesse 1995; Kafouros et al. 2008; Zahra and Covin 1995). However, according to Hamel (2006), organizational innovation can also provide sustained competitive advantages for the firm. Adopting organizational innovations results in changes in strategy, structure, and administrative procedures that improve, inter alia, the organization's climate, communication, personnel policies, teamwork, information sharing, and coordination and cooperation mechanisms (Gunday et al. 2011; Damanpour and Aravind 2011; OECD 2005a), all of which can enhance a firm's performance. Moreover, the structural improvements brought about by organizational innovations can create an appropriate environment for the initiation and adoption of other types of innovation (Gunday et al. 2011; Damanpour and Evan 1984).

Damanpour and Aravind (2011) argue that the adoption of a single type of innovation or even a set of only one type of innovation might not enable firms to fully realize the positive consequences of innovation on performance. Coping with changes and uncertainties in the environment and obtaining superior performance requires the balanced introduction of a portfolio of different types of innovations, i.e., both technological and organizational (Damanpour and Aravind 2011; Damanpour and Evan 1984). This argument builds on the resource-based view (RBV) according to which the synergistic use of technological and managerial knowledge resources is said to lead to the generation of technological and organizational innovations that enhance firm performance (Damanpour and Aravind 2011; Damanpour et al. 2009; Barney 1991; Camison and Villar-Lopez 2014; Amit and Schoemaker 1993).

The present study seeks to extend previous research on innovation and psychic distance by developing and testing empirically a framework that links these ideas. The main aim is to examine whether perception of a high level of uncertainty in psychically distant markets stimulates the adoption of innovations, leading to enhanced firm performance. Thus, the contribution of this study is as follows: first, we examined the importance of uncertainty as a result of psychic distance between home and foreign markets in explaining firm innovation strategies. Although much research has examined the effect of uncertainty on innovation, to the best of our knowledge no previous study has investigated the impact of uncertainty resulting from the perception of cultural and business difficulties in foreign markets on firm innovation strategies. Knowledge of this is important, since implementing appropriate innovation strategies enables firms to overcome uncertainties and reap the benefits of business opportunities in psychically distant markets. We then tested the influence of cumulative adoption of innovation types (technological and organizational) on firm performance, building on the RBV, in order to determine the effect of organizational innovation on performance and synergistic use of different types of innovation. Lastly, we investigated the mediating role of adopting innovations in the relationship between psychic distance and firm performance. The study therefore also contributes to research on the link between psychic distance and firm performance. Although some previous studies have examined the effect of psychic distance on firm performance, the results have been extremely inconclusive (Prime et al. 2009).

The empirical part of this study was based on export ventures by a sample of Swedish companies classified as "low-technology" (OECD 2005b), henceforth "low-tech". According to Mendonca (2009), despite their high economic importance and ability to innovate, low-tech industries still remain an "unprivileged research topic" as regards the effects of innovation.

The remainder of this paper opens with defining the concepts psychic distance and innovation, followed by a discussion of the proposed relationships between psychic distance, innovation, and firm...

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