Summary:
Innovation plays an essential role in economic growth and corporate development. However, the literature focuses mainly on corporate innovation from the perspective of innovation quantity and efficiency, while rarely investigating the different types of innovation and their determinants, such as incremental versus radical innovation (Dewar and Dutton, 1986; Cardinal, 2001). According to the People's Daily, the number of patent applications in China has multiplied by 10 times over the past 10 years, and China has received the highest number of patent applications worldwide in the past 5 years. Nevertheless, the overall quality of innovation in China remains low. Thus, investigating the heterogeneity of innovation using radical and incremental innovation contributes not only to the innovation literature, but also to government policy design for a transition economy and sustainable development. This paper investigates the effects of customer concentration on radical and incremental innovation by firms. Prior studies show that major customers can contribute to corporate innovation by providing information on consumer demand and new product development (Fang, 2008; Coviello and Joseph, 2012). However, few differentiate between radical versus incremental innovation. Theoretically, collaboration between major customers and firms can increase radical innovation, as information from major customers can mitigate the technological and financial risks. Christensen (2014) argues that closely collaborating with and learning from major customers can benefit firm research and thus provide short-term profits. However, in the long term, radical innovation is vital to firm development, yet the lack of radical innovation increases a firm's fiasco risk. Therefore, the effect of customer concentration on radical and incremental innovation by firms is uncertain and requires empirical evidence. Our initial sample consists of all firms listed on China's Shenzhen and Shanghai Stock Exchanges from 2009 to 2016. We manually collect customer data from voluntary disclosures in the annual reports of A-share listed firms. All financial data are from China Stock Market & Accounting Research (CSMAR), ownership data are from the China Center for Economic Research (CCER), and patent data are from the China Research Data Services Platform (CNRDS). We exclude firms in the financial industry, firm-year observations with incomplete or incorrect financial and ownership information, and firm-year observations with zero invention and utility patents. Finally, we winsorize the continuous variables by 1% at the top and bottom of the sample and end up with 9,046 firm-year observations. Our results show that firm customer concentration is significantly positively associated with radical innovation. However, this relation only appears among state-owned enterprises (SOEs) and firms with high geographic proximity to their major customers. In addition, we find that among firms with such a relation, higher customer concentration increases firm invention patents rather than utility patents. This paper contributes to the literature in two ways. First, its contributes to the corporate innovation literature by exploring the heterogeneity of innovation types, namely radical and incremental innovation, whereas prior studies focus on innovation quantity and efficiency. In addition, we provide new measures of radical innovation against the Chinese institutional background. Second, we contribute to the literature on how customer concentration affects corporate investment. Prior studies have documented evidence on conservatism, cost of capital, performance, auditor choice, and auditing fees. Whereas Chu et al. (2018) investigate how geographic location between firms and customers affects innovation, we investigate the effect of customer concentration on a firm's radical innovation. This paper has two limitations that could be addressed in future studies. First, although we present new measures for radical innovation, our measures for both radical and incremental innovation could be more accurate using broader data on patents, such as citations for patents. Second, future studies could explore more aspects of the customer perspective in addition to customer concentration, such as customer operational and financial status.
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