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Understanding Service Sector Innovation UNDERSTANDING SERVICE SECTOR INNOVATION BY Jerry• Sheehan UNDERSTANDING SERVICE SECTOR INNOVATION The future of the service economy depends on worldwide appreciation, dedication, and encouragement of innovation as a key component. ervices play a key role in developed economies. Industries that deliver help, utility, experience, information, or other intellectual content have expanded rapidly in recent decades and now account for more than 70% of total value added in the Organisation for Economic Co- operation and Development (OECD) countries.1 Market-based ser- vices (that is, excluding those typically provided by the public sector, such as education, health care, and government) account for 50% of the total and have become the main driver of productivity and eco- nomic growth in OECD countries, especially as use of IT services has grown (see Figure 1).2 Services have also emerged as the main source of job cre- ation in OECD countries, often compensating for job losses in manufacturing. Business services, such as computing, information services, and R&D services, generated more than half of all employment growth in many countries in recent years. Moreover, they help improve the competitive performance of firms in vir- tually all sectors of modern economies. 1The OECD has 30 member countries: Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Spain, Sweden, Switzerland, Turkey, U.K., and U.S. (See www.oecd.org.) 2Business services include the renting of machinery and equipment, computer and related activities, R+D, and other business services. Market services include wholesale and retail trade; hotels and restaurants; transport and communications; financial intermediation; and real estate, rentals and business services. Total services include market ser- vices plus public administration, health, education, and other community, social, and personal services. ILLUSTRATION BY LISA HANEY COMMUNICATIONS OF THE ACM July 2006/Vol. 49, No. 7 43 Several factors contribute to the expansion of the telecommunications, finance, and business services service economy. At the macroeconomic level, have among the largest investments in R&D in the increasing manufacturing productivity and growing service sector and a strong reliance on highly skilled competition from developing countries limit employ- workers. Policymakers will need to determine how ment growth in manufacturing and motivate efforts best to stimulate the growth of these sectors and to to focus on higher value-added activities. At the firm enhance the development and exploitation of knowl- level, rising investment in intangibles, growing edge in other service-sector industries. In other words, emphasis on knowledge management, a renewed they will need to determine how best to promote focus on core competencies, and outsourcing play innovation in services. major roles. Within the manufacturing sector, ser- vices previously produced in-house are now obtained SERVICES FIRMS INNOVATE, BUT DIFFERENTLY via outsourcing. By the mid-1990s, services Innovation has long been recognized as a key to eco- accounted for nearly 25% of the value added embod- nomic growth [67], but its role in the service sector has been underappreciated, in 60% part because of data limitations. 1980 2001 In recent years, a number of sur- 55% veys have made it increasingly 50% clear that service-sector firms are innovative, but with patterns of 45% innovation that differ from 40% those in the manufacturing sec- tor. In the third Community 35% Innovation Survey (CIS3) 30% administered in 15 European United United Australia Italy Belgium Germany Austria Canada Sweden Poland Finland Czech Norway countries, the share of service- States Kingdom Republic sector firms reporting they had Greece Mexico New France Netherlands Spain Japan Denmark Slovak Hungary Portugal Korea Zealand Republic introduced a new product or Source: OECD, STI Scoreboard 2003. process between 1998 and 2000 ranged from about 25% in Spain to more than 55% in Ger- Figure 1. Share of ied in final demand for manufactured goods, com- market services in total many. Comparable figures for pared to 15% or less in the early 1970s. In most value added, 1980 manufacturing firms were 40% countries, manufacturing relies more heavily on and 2001. in Spain and 65% in Germany. telecommunications, business,Sheehan and computer fig 1 (7/06)services Recent innovation surveys in with a view to stimulating greater productivity. Man- Australia, Japan, Korea, and New Zealand show ufacturing firms have also moved to more closely link similar results, with between 18% and 40% of ser- products to services by providing their clients with vices firms reporting innovation, compared to integrated product-service packages and integrated between 25% and 50% of manufacturing firms. solutions rather than traditional products [69]. Rates of innovation vary considerably across differ- The growing importance of services in the econ- ent parts of the service sector. In the CIS3 survey, omy implies that efforts to improve standards of liv- more than 60% of business services firms and 50% of ing, boost productivity, and create jobs must focus financial services firms reported they were innovative, increasingly on the service sector. Whereas the service compared with only 40% and 30% of firms in whole- sector has often been characterized as a locus of low sale & retail trade and transport & communication, wage, unproductive, and un-innovative jobs, recent respectively. For comparison, just under 50% of all evidence gained through innovation surveys and bet- manufacturing firms reported they were innovative. ter statistical data discredits this view, confirming that Similar patterns were found in Japan, where business services are indeed innovative and, in some areas, services, communications, and financial intermedia- more innovative than manufacturing [102]. In fact, tion firms were more likely than manufacturing firms knowledge-intensive services, whose value added is to indicate they had been innovative. In Australia, too, intangible rather than incorporated in physical prod- the share of innovative firms in communication ser- ucts, play an increasingly dynamic and pivotal role in vices exceeds that of the manufacturing sector. Uni- today’s knowledge-based economy, contributing to formly, large service-sector firms are considerably more innovation in all economic sectors [69]. Firms in the likely to be innovative than small firms. 44 July 2006/Vol. 49, No. 7 COMMUNICATIONS OF THE ACM Average BERD as a % of value added in industry and innovative density as a % of all firms and Norway are below the Euro- pean average despite high relative Manufacturing Services levels of spending on services 70 70 R&D. ) ) Germany y y e e 0 v 0 v r These statistics do not mean 0 r 0 u u 0 s 0 s 60 60 2 2 Belgium 3 Germany 3 – S – S I that R&D is not important to ser- 8 I Netherlands Iceland 8 Iceland C 9 C 9 Austria t 9 t 9 a Portugal a 1 Denmark t 1 t , s 50 50 vice-sector firms, but that other , s y o y Finland t o Sweden r t i r i Sweden u Portugal France s u s Austria E n E n ( ( factors also play a significant role e e Belgium s s d d Italy m 40 40 m r Finland n r Norway i Denmark n i f Netherlands f o in service-sector innovation. o l Spain i l i t France a t a t a t Norway a o v o Greece v t t o Indeed, in innovation surveys, o 30 30 % n % n n a n a I I Greece Italy s s a a Spain both manufacturing and service 20 20 firms rank acquisition of machin- 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 0.0 0.2 0.4 0.6 0.8 ery and equipment as the primary Average BERD intensity, 1995–2000 Average BERD intensity, 1995–2000 as a % of GDP (OECD data) as a % of GDP (OECD data) activity underlying innovation. Source: OECD [68], based on data from Eurostat, CIS3 Survey and OECD ANBERD Database, 2004. Manufacturing firms rank inter- nal R&D a close second, whereas Figure 2. Link between Innovation processes differ somewhat between ser- R&D and innovation in service firms rank worker training vice and manufacturing firms. In general, innovation manufacturing and higher (see Figure 3), reflecting the in the service sector relies less on in-house R&D than services. fact that market services employ a in the manufacturing sector. Whereas countries with larger share of workers with higher Sheehan fig 2 (7/06) high levels of R&D in their manufacturing sectors education than manufacturing—by a factor of two in (measured as a share of value added) also have high many countries. Service firms also tend to report shares of innovative manufacturing firms, this rela- higher reliance on the acquisition of knowledge from external sources (for example, through patent licensing), As a % of all innovative firms, country average from CIS countries reviewed although they are about as likely 70% Services Manufacturing as manufacturing firms to finance 60% external R&D. 50% Of course, innovation processes differ from one service- 40% sector industry to another. Busi- 30% ness services and financial 20% intermediation firms use virtually 10% all mechanisms of innovation more than firms in other service 0% Acquisition of Training Intramural Market Design, Acquisition of External industries. The largest differences machinery and R&D introduction of production, knowledge R&D equipment innovations deliveries arise with intramural R&D and training. In the CIS3 survey, Source: OECD [68] based on data from Eurostat, CIS3 Survey. approximately three-quarters of Figure 3. Activities that business services firms reported tionship does not hold for the service sector (see Fig- contribute to innovation.
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