SME innovation activity: Enterprises with research and development activities of their own dominate innovation activity

• Small and medium-sized enterprises contribute one third of the German economy’s innovation output
• The share of non-innovating businesses increased by ten percentage points in the past decade
• Barriers to innovation in the form of skilled labour shortages and high costs have grown significantly in the past 20 years

Small and medium-sized enterprises play a considerable role in Germany’s innovation system. Although the bulk of innovation activity in the German business community takes place in large-scale enterprises, SMEs nevertheless account for 32% of innovation expenditure and 35% of research and development. A study commissioned by KfW Research analysed the long-term development of structures, success factors and barriers for SMEs’ innovation activity.

It has found that innovation in the SME sector is dominated by companies that continuously undertake research and development (R&D). They make up 12% of SMEs, which is just a small group, and unlike the remaining five types of businesses defined in this study, they pursue particularly ambitious competition and innovative strategies of which developing new products and tapping into new markets are integral elements. These enterprises also invest the most in their innovation activities, achieve the bulk of innovation successes and have the highest business performance in terms of profit margin. Businesses with regular R&D thus account for more than two thirds of SMEs’ innovation expenditure, more than half of turnover with product innovations and 43% of cost savings achieved through process innovations.

By contrast, innovative small and medium-sized enterprises without own R&D currently represent 37%, a group nearly three times as large. Their innovation strategies are less ambitious and their innovation efforts accordingly less pronounced. Overall, their innovation achievements are also much less significant than those of enterprises with R&D activities. Nevertheless, their share in turnover from product innovations and cost reductions achieved with process innovations is important, at 34% and 42%, and even increased during the period under review.

The study confirms the observation that innovation in the German SME sector has been on the decline for years. It found that the share of enterprises that have not innovated grew substantially from 32% to 42% in the ten-year period of observation. Companies without own R&D, in particular, discontinued their innovation activities. SMEs faced with innovation barriers are another group of businesses that has grown significantly. Skilled labour shortages and high costs are the most frequent constraints mentioned. The share of impacted SMEs decreases from the group of enterprises that continuously undertake R&D to those that are not geared towards innovating at all. Enterprises also frequently point to laws and regulations as barriers to innovation.

These findings generally underscore that enterprises with a strong orientation towards innovation – especially those that undertake R&D – generate new-to-market product innovations and achieve cost reductions more often than other enterprises. This has a positive effect on key business performance metrics such as profit margin and success in foreign markets. Thus, businesses with continuous R&D on average achieve a profit margin of 5.4%, while those not geared towards innovating arrive at 4.2%.

The Chief Economist of KfW, Dr Fritzi Köhler-Geib, commented on the findings of the survey as follows: “The innovative potential of the German SME sector remains high overall but is concentrated on fewer and fewer businesses. However, a broad increase in innovation activity across the SME sector is precisely what is crucial for the economy to continue growing. Easing the skills shortage will play a particularly important role. Furthermore, extensive incentives for building or preserving research and development capacities in businesses in the long term will have to be provided. Innovation promotion must therefore support not just pioneer enterprises but innovation across the breadth of the SME sector. This includes, for example, promoting the acquisition of strategic skills and knowledge relating to innovation management in vocational training.”

The study “Types of SMEs in the innovation system: activities, constraints and successes” is available at Focus on Economics | KfW