The effect of innovation orientation on firm performance: evidence from micro and small manufacturing firms in selected towns of Awi Zone, Ethiopia

Innovation (in business) means novelty, new things being done, or old things being done in new ways to increase the performance in terms of sales, profitability and market shares in an organization (Zwingina & Opusunju, 2017). According to the Oslo Manual (OECD, 2005), an innovation comprises the elements of creativity and is defined as the implementation of a new or significantly improved product (good or service), or process, a new marketing method, or a new organizational method in business practices, workplace organization or external relations. To Hodgetts and Kuratko (2004), innovation is the creation of new wealth or the alteration and enhancement of existing resources to create new wealth. Innovation is also seen as a process of idea creation, developing an invention and ultimately introducing a new product, process or service to the market (Thornhill, 2006).

The first variable that can determine the performance of micro and small manufacturing firms is product innovation. According to the OECD’s Oslo Manual (OECD, 2005), product innovation can broadly have defined as the introduction of new or significantly improved or modified existing product concerning its characteristics, capabilities, user-friendliness, and components which include improvements in technical specification and materials or other functional characteristics by a firm. Product innovation remains one of the firms’ major roots of competitive advantage (Rosli & Sidek, 2013). This is because quality can be enhanced through product innovation, thereby contributing to firms’ performance and competitive advantage, respectively. Different studies confirmed the existence of a positive relationship between product innovation and the performance of firms (Atalay et al., 2013; Oduro, 2019; Rosli & Sidek, 2013). According to Corsino and Gabriele (2011), the introduction of new products has a positive influence on sales growth and corporate revenue. To this end, when MSEs adopt product innovation, it will have a significant influence on their performance. Hence, the first hypothesis of the study is that:

Product innovation has a significant positive effect on the performance of manufacturing firms in Ethiopia.

The second variable that was considered in this study was process innovation. Process innovation refers to the improvement in the production process, delivery method or supporting activities which includes significant changes in techniques and equipment including bringing significant improvement in the equipment, technology and software of the production or delivery method business (OECD, 2005). Many researchers such as Ar and Baki (2011), Atalay et. al. (2013), Morone and Testa (2008) have found a positive influence of process innovation on firm performance. In their study, Cherrafi et. al. (2018) concluded that implementing process innovation could increase a firm’s operational output, customer satisfaction and financial performance. Furthermore, Muharam et. al. (2020) investigated the effect of process innovation on the financial performance of Indonesian firms and concluded that process innovation significantly and positively predicted the firm’s financial performance. Supporting this result, Ukpabio et. al. (2019) asserted that process innovation significantly impacts firm performance and it remains an essential element in small and medium-sized firms. Therefore, the following hypothesis is put forward:

Process innovation has a significant positive effect on the performance of manufacturing firms in Ethiopia.

The third variable, marketing innovation, refers to the implementation of a new marketing method involving significant changes in product design or packaging, product placement, product promotion or pricing. In other ways, it is the implementation of a new marketing concept or method that differs significantly from the enterprise’s existing marketing methods and which has not been used before (OECD, 2005). Previous studies by Issau et. al. (2021), Ukpabio et. al. (2019), and Karabulut (2015) reported that market innovation significantly predicted SMEs’ performance. This means that if manufacturing SMEs use market innovation through the exploitation of new markets or segments would result in higher performance. According to Muharam et. al. (2020), in a study conducted in Indonesian firms, marketing innovation was found to have a positive and significant effect on firm performance. As such, the hypothesis is developed as follows:

Marketing innovation has a significant positive effect on the performance of manufacturing firms in Ethiopia.

The last variable that influences MSEs performance is organizational innovation. It refers to the application of the new organizational method in the firm’s business practices such as knowledge management, new management approach, business reengineering, workplace organization or external relations that has not been previously used by the firm (OECD, 2005). Ndesaulwa and Kikula (2016) argued that organizational innovation, rather than process and product innovation, is the most vital factor for total sales. Sharing the same view, Makó et. al. (2015) disclosed that organizational innovation could encourage and promote robust organizational learning and skills processes. In addition, Abdilahi et. al. (2017) identified organizational innovation positively and significantly influences achieving SMEs performance in terms of sales volume. Yavarzadeh et. al. (2015) also revealed that organizational innovation has a positive and significant effect on organizational performance in terms of financial, growth, customer, and internal process. However, Atalay et. al. (2013) contrasted this finding, affirming that no significant and positive link exists between organizational innovation and firm performance. Despite the inconsistent findings, the present study hypothesized that:

Organizational innovation has a significant positive effect on the performance of manufacturing firms in Ethiopia.

Several studies from the recent period of research on innovation have typically reported a positive relationship between innovation and different measures of firm performance (Gebreeyesus, 2011; Gunday et al., 2011; Issau et al., 2021; Mwangi & Namusonge, 2014). These findings consistently point to the critical need for a firm to innovate to sustain and build revenues, thereby leading to improved performance. According to Zhu et. al. (2019), MSEs need innovation to improve their performances. The assertion made by the authors was because of the conclusions reached by scholars on the innovation-performance linkage. For instance, using cross-sectional data from a sample of 378 SMEs, Abdilahi et. al. (2017) confirmed that innovation significantly affects the performance of SMEs in Hargeisa. In line with this, Otero‐Neira et. al. (2009) examined the relative importance of innovation and found that different performance levels are directly and positively linked to innovation. Furthermore, Rosli and Sidek (2013) investigated the effect of innovation on the performance of Malaysian manufacturing SMEs and revealed that process innovation and product innovation positively influence firm performance.

This section reviews empirical studies of the effect of innovation on firms’ performance. The relationship between innovation and firms’ performance has been studied in different countries in various sectors and their empirical findings are discussed below.

Using panel data collected from 3599 manufacturing and services firms in France over 7 years, Mairesse and Robin (2009) examined the link between innovation and firm performance. The empirical finding indicates that product innovation has a significant positive effect on firm performance; however, process innovation was found to have an insignificant effect on firm performance.

Tuan et. al. (2016) examined the effects of innovation on firm performance. The study indicates that innovation is positively and significantly related to firm performance and revealed that marketing, organizational, and process innovations are more important factors affecting firm performance than product innovation. Similarly, a study on the effect of innovation elements on the performance firms in the banking sector indicated that product innovation has a positive and significant effect on profitability, while process innovation has a positive and significant effect on both the profitability and efficiency of the banking sector (Mabrouk & Mamoghli, 2010).

The empirical evidence regarding the relationship between innovation and the performance of manufacturing firms in Rwanda found that innovation explained by R&D positively boosts manufacturing firms’ financial performance (Ndemezo et al., 2018). In addition, Yavarzadeh et. al. (2015) also examined the effect of organizational innovation on the performance of the tax affairs general administration of Iran. The empirical finding of the study revealed that product, process, and organizational innovation have a positive and significant effect on organizational performance in terms of financial, growth, customer and internal process.

According to Atalay et. al. (2013), Masso and Vahter (2012), and Cassiman et. al. (2008) who studied the relationship between innovation and performance and productivity of firms in Turkey, Estonia, and Brazil, respectively, at different sectors. The result shows that product and process innovation has a significant and positive impact on firm performance. However, regarding the effect of marketing and organizational innovation, there is no significant evidence which shows its significant and positive effect on firms’ performance.

Other empirical studies done on the effect of innovation elements on firm performance of profitability in Sri Lanka, and therefore, innovation capability shows a rise in the profitability of financial performance, implying a positive relationship between innovation and firm performance (Rajapathirana & Hui, 2018). Mwangi and Namusonge (2014), Rosli and Sidek (2013), Alam et. al. (2013), and Camisón and Villar-López (2014) investigated the effects of innovation types on manufacturing firms in different countries and in different aspects of firm performance have also found that there is a positive effect on firms’ performance. However, Karabulut (2015) found a negative relationship between marketing innovation and firm performance.

In summary, empirical studies regarding the effect of innovation on firm performance provide mixed evidence; some studies confirmed that there exists a positive relationship between innovation and firm performance, while some studies indicated that there is no significant evidence that shows a positive relationship, and also others show that a negative relationship between some dimensions of innovation and firm performance.

From the theoretical and empirical literature reviews, it is hypothesized that innovation positively impacts firms’ performance. In that, firms with a higher level of innovation activities would have better performance improvement. The conceptual framework of the current study is presented in Fig. 1.

Conceptual framework of the study