Business Groups, Innovation And Srtructural Transformations In Developing Economies

Abstract

New industrial revolution and related issues of structural transformations have been the focus of considerable attention in recent years. Developing economies experience dynamic change as the pace of technological innovation is accelerating. There are signs that countries are revaluating their approach toward industrial policies and face a challenge to find the right balance between the responsibilities of government, public entities and business for innovation-driven development. This study aims a) to identify business group’s characteristics that make it an institute capable of coordinating innovation-driven development during the shift to a new technological paradigm, b) to analyse innovation-driven development within business groups in situation of instability caused by the structural transformations. The study uses business group-level reports and strategies to explore the role of administrative power, planning and structural factors in determining innovation outcomes of business groups in terms of technological and economic changes. We exploit a two-sector model imply that there is sector with surplus resources (basic sector financing innovation) and sector with scarce resources (pioneer sector providing innovation) in business group. While modelling the processes of innovation-driven development in the situation of economic instability, we reached the conclusion that institutions determine the direction and the level of business groups’ impact on innovations growth in a time of structural transformations.

Keywords: Business groupsinstitutionsstructural transformationsinnovation

Introduction

The world is undergoing another industrial revolution as economic growth continues at a staggering pace in some developing countries. At the same time, these growing economies are dealing with new challenges related to the need of structural transformation of the economy to conform to the new technological order. In particular, there are challenges related to innovation-driven growth coordination and financing.

Governments should be the main coordinator in this case, but, nevertheless, the private and public sectors share responsibilities during the process of structural transformation (Golichenko, 2017). The question is which private economic entities can perform this role in developing countries.

For developed countries this question is resolved in favour of corporations as they can effectively manage internal and external environments through the system of long-term contracts. The system allows planning of business development when there is a substantial time gap between initial investment and releasing innovative product to the market (Galbraith, 1973).

In developing countries, the system of contracts is not as effective as in developed countries, due to the high possibility of the contract not being fulfilled by one of the parties and low level of contract security. In this case, contracts are replaced with companies integrating to form business groups (Manikandan & Ramachandran, 2015; Gordeeva & Antipina, 2013; Khanna & Yafen, 2015).

Developing countries face another problem: investing in innovation. The process of structural transformation makes this issue even more complicated as there is a need to synchronize innovation-driven development of related industries. Financial markets cannot solve this problem, which pushes business groups to fill the gap in financial market capabilities.

Problem Statement

Questions associated with business groups’ development and management have been the focus of considerable attention of academic research (Khanna & Yafen, 2015; Zhang, Sjogren, & Kishida, 2016). The problems of industrial organization and monopoly power of groups (Singh, Pattnaik, Gaur, & Ketencioglu, 2018), groups’ involvement in the financial sector (Buchuk, Larrain, Muñoz, & Urzúa, 2014; Chittoor, Kale, & Puranam, 2015), the relations between business groups and governments (Dieleman & Boddewyn, 2012) are widely discussed by different economists.

There are papers focused on such research problems as business group opportunities in innovation development (Culpan, 2014; Lee, Lee, & Gaur, 2017; Gubbi, Aulakh, & Ray, 2015), modernization management (Bessonova & Gonchar, 2017; Chepurenko, 2017), and business groups’ role in catching up economic development (Morck & Nakamura, 2018; Nakamura, 2015).

There is no proper research done on the question of including business groups in a mechanism of innovation-driven development at the state level. Therefore, there is a need to explore questions of business group role as an economic entity participating in the process of structural transformation to a new technological paradigm.

Organizational structure and economic specifics of business groups make it so that they can perform institutional functions toward the innovation sector, especially taking into account governmental regulations being in place. First of all, groups have a centralized hierarchical structure which allows synchronization with affiliated companies (Yang, Schwarz, & Multilevel, 2016). Secondly, business groups are highly diversified but at the same time interested in synergy effect from affiliated industry growth (Purkayastha, Kumar, & Lu, 2017; Lee, Lee, & Gaur, 2017; Oh, Chang, Lee, & Seo, 2018). Last, business groups have resource availability and/or have mechanisms to find resources. Despite these prerequisites, the results of business groups’ support for the innovation sector differ. In Japan, South Korea, and India, groups contribute to innovation, and at the same time this trend is not as noticeable in other countries (Joint Research Centre, 2018). Therefore, the question about specific business group management and factors influencing innovation-driven growth of business groups is very important to explore.

Research Questions

Considering the need to fill in this research gap, here are questions explored in the current study:

Purpose of the Study

The objectives of the study are:

Research Methods

The graphic model

The process of innovation development in business groups is described with the two-sector model (Gordeeva, 2016). The model considers business group as a process of production and consumption of a product. In figure 1 below, the X axis contains all the firms affiliated in a business group (S), and the Y axis contains all the marginal products created by the companies on X (MP.) The first firm has the highest production, and the last firm the smallest.

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At figure 2 , X axis contains the same firms as at figure 1 . Y axis contains marginal product of consumption (MP), which is the same for all the firms.

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Because business group in a two-sector model is the result of production and consumption, we can combine figure 1 and figure 2 (see the result on figure 3 ).

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In figure 3 , OAF is a produced product (result of production process), and OMDF is a consumed product (consumption or expenses). As all the companies within one business group have the same consumption or expenses, by dividing expenses by the production we arrive at a standard or conditional unit of expenses. Therefore, a business group is divided in two sectors – OABC and CBDF.

The first sector (OABC) has a surplus of resources and it is the basis of a business group. Here the value of produced goods (OABC) is higher than the value of consumed goods (OMBC.) As a result, there is a surplus of resources equal to MAB. High productivity creates an effective correlation between results and expenses while producing a basis product.

The second sector (CBDF) has scarce resources. In this sector, expenses are higher (CBDF) than the value of the produced goods (CBF) on BDF. The main product here is a pioneer, which has a more complicated definition that innovation. Besides innovative products, pioneer products include goods that are already being launched by other companies, but not by the business group that starts producing it. A pioneer product is not a necessity product, and in the production process it uses more resources than the resulted value of the product. As a result, the pioneer sector can only exist in terms of the basis product redistribution between sectors of one business group.

The proportion between basic and pioneer sectors can be identified based on the consolidated financial report. Basic activities would include operational activity of the business group, excluding pioneer product output. It would be part of the pioneer sector, together with uncompleted construction, social responsibility of the company, investment, research, and development.

Different financial mechanisms, transfer prices, and other instruments allow redistribution of part of the basic product to the pioneer sector. Transfer prices are usually set lower than the value of the product. Meanwhile at the external market, the situation can be the opposite. Pioneer product prices are set higher than its value.

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Figure 4 shows the result of redistributing a basic product between the basic and pioneer sectors of a business group. Part of the basic product AEK is transferred to the pioneer sector. Accordingly, the pioneer sector shows revenue equal to ELDB. The basic sector also shows revenue (MKEB). As the business group is an open system, product prices may not match the value of the product, which causes AEK to not be equal to ELDB. In addition, the redistribution mechanism is based on expenses. Both sectors’ revenue is equal to MKLD. All the business group companies show an average return on capital employed.

Findings

Innovation-driven development within business groups in situation of instability caused by the structural transformation

It is also worth exploring what opportunities and limitations a business group may have in the time of structural economic transformation. The nature of the new technological paradigm together with the monetary policies implemented by developed countries allows identification of several factors of economic instability in developing countries:

The graph in figure 5 below shows that the factors listed above can lead business groups investing in innovations to grapple with escalation of costs and drop in production at the affiliated companies. It is represented by the shift from М₁D₁ to М₂D₂ (please see figure 5 “a”). The revenue level decreases to a size of КLD₂М₂, production declines as well (shift from A₁G₁ to A₂G₂.)

The shift from КLD₁М₁ to КLD₂М₂ shows that the basis sector revenue does not cover expenses that the business group needs to take on to support the pioneer sector and innovation. It causes a surplus of the pioneer product.

A negative environment and unpredictable demand on produced goods lead to a decrease in production and investment. As a result, the production in pioneer and basis sectors declines to О'А₂'G₂' (please see figure 5 “b”), which blocks investment demand in the private sector.

It is possible to overcome this issue if government creates demand on investment to innovation product development (see figure 6 .) The government should invest in the pioneer sector to support it. The first step is investment in R&D to stimulate innovations. The main criteria of government-financed R&D should be the basic sector demand on technological products created as result of the innovations. At the same time the government should support business groups to put in production these technologies. These measures will lead to the effectiveness improvement and the expansion of the pioneer sector in business group from G₂’ to G₃.

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The group costs decrease from M₁’D₁’ to М₃D₃ which rises the profit of affiliates to КLD₃М₃. The profit increase stimulates investment to a business group and allows to expand a production in basis and pioneer sectors, including production of the innovative product (see the shift of the marginal product of production to А₄G₄ at figure 6 ).

Conclusion

In developing countries business groups should have an array of functions and responsibilities in the process of structural transformation of the economy to support innovation due to management system based on administrative power and planning as well as a high asset concentration under the governance. Special characteristics of business groups have guaranteed the market for innovative products, control over costs, investment, resources, technologies, and personnel. In addition, internal investment between a business groups’ affiliates and the targeted investment based on the multi-level planning create prerequisites for the affiliated industries synchronized development needed during a shift to a new technological paradigm.

The two-sector model described in 5.4 above confirms that proportion between the basis and pioneer sectors do not create any limitations on innovation development within the business group. While modelling the processes of innovation development in the situation of economic instability, we reached the conclusion that external shocks and structural shifts in the economy, incorrect risk evaluation, and governmental regulations can change the trajectory of pioneer sector development. However, world leading innovative corporations show that the short-run decline of the pioneer sector can go together with an expansion of its innovation component, as evidenced by capital expenditures reduction of €77bn compared with the R&D increase of €64bn in 2017 (Joint Research Centre, 2018). All the listed factors confirm that institutions determine innovation-driven development direction and the level of the business groups’ impact on innovations support in a time of instability.

Structural transformation of the developing economies outlines general directions for further research in view of business groups’ institutional environment. This includes paying attention to evaluation metrics and methods of increasing the institutions’ efficiency as well as to new institutional instruments of business group management that would allow a shift to a new technological paradigm.

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