1.1 Research Background
Over the past decade, new approaches to innovation management have become prime drivers of various industries. As product life cycles condense and substitutive product offerings expand, product innovation becomes increasingly outstanding for establishing sustainable competitive advantage. In the manufacturing industries, product quality is regarded as a strong basis of innovation conducts the implementation of new product development. Therefore, the causal relatio nship between product quality and product innovation must be clarified before innovation can be adequately assessed in all industries.
Besides manufacturing industries, the service sector is an important role to the economy of every advanced society and accounts for over two-thirds of the jobs in most advanced countries. This situation results from historical developments from extraction through manufacturing to services. To remain competitive in the global market, manufacturing firms have innovated to meet customer demand, to raise their market share, and to increase profitability. Service firms have acted similarly and innovation theory has been extended to the service industries (Evangelista & Sirilli, 1998; Aa & Elfring, 2002). Recently, researchers have examined the meaning and characteristics of product innovation. However, little information is available on the understanding and valuation of service innovations. For example, only technological and process innovations have been examined in studies of the manufacturing industries (Afuah, 1997; Takeishi, 2001; Laosirihongthong, Paul, & Speece, 2003;
Marchau & Van der Heijden, 2003), while service innovation in the service sector has not been widely studied. The lack of such information constitutes a gap in our knowledge of innovation management.
Markets for durable products have attracted increasing interest from firms that provide innovative services for their new products. In the automotive industry, for instance, nearly all motor companies sell new cars with financial, marketing, maint enance, repairing, warranty and repossession services. Unsurprisingly, most consumers prefer products with pre-sold and post-sold services, which increase motivation to purchase. Firms accordingly provide more extended services to satisfy the tastes of consumers and establish the reputation of their products. Focusing on automotive industry, this study tries to explore the nature and characteristics of service innovation, and also wishes to discuss product quality’s impacts on the adoption and development of innovative services.
In some recent studies, Dubey and Wu (2002) and Romijn and Albaladejo (2002) showed that product innovation will occurs only when the industry size is intermediate. In addition, oligopolistic firms will engage in innovation to advance their product quality. This research wishes to challenge this viewpoint and argues that firms will not undertake innovation activities unless they produce high-quality products. The determinant of innovation contains product quality but not industry size.
Innovation involving high risk in the initiation stage is not necessary to improve product quality (Damanpour & Gopalakrishnan, 2001). This study will demonstrate that high quality products will induce both product and service innovations.
As important providers for both product and service innovations, automakers around the world have undertaken many famous innovative activities since automobiles had been invented in the late nineteen century. To be universally known, safety belt, ABS (anti- lock braking system), and air bags are three most important innovative products in the history of passenger cars; in addition, process innovation, such as JIT (just in time) technique of Toyota motors also provides competitive advantage for the motor firms. Extending to the sales of automobiles, firms also offer
various service innovations because consumers prefer products that come with pre-sold and post-sold services, which generally promote their purchase motivation.
Meanwhile, service innovations cover all financial and marketing innovations before products are sold, as well as all maintenance, repairing, warranty and repossessing activities after products are sold. In fact, every purchase activity combines the consumption of products and services at different rates (Fitzsimmons & Fitzsimmons, 1994). Automotive industry represents an important example of the combination of products and services.
1.2 Research Objectives
In the marketplace where innovators and followers compete fiercely, who will benefit from the competition? To clarify the causal relationship between product quality and innovation, this study divides innovation into product innovation and service innovation, and then, discusses quality’s impacts on product and service innovations separately. With a quality-based approach, this study wishes to establish models to demonstrate that both product and service innovations will be strongly influenced by product quality itself. Focus on the automotive industry, which is one of the most important durable products, this study also contributes to quality management by empirically analyzing how some firms manage to be more innovative than their competitors. This study argues that firms producing high-quality products will actively engage in both product and service innovations. Moreover, this research discusses product and service innovations for durable products because most service innovations are provided concerning a long time of usage. Thus, the objectives of this research are as below:
(1) To construct a game theory model to explore the causal relationship between product quality and product innovation.
(2) To construct a game theory model to explicate the quality’s impacts on service innovation in the automotive industry.
(3) To apply real option theory to test and verify the quality’s impacts on service innovation in the automotive industry.
(4) With further discussion and suggestion, this study also wises to contribute to more understanding of product innovation, service innovation and quality management by analyzing their interrelationships and managerial implications.
(5) This study also suggests systematic methods to evaluate and analyze different forms of innovation activities from perspectives of game theory and option pricing models.
1.3 Research Boundaries
To discuss the relationship between product quality and innovation, product innovations in this study involve new products, processes, procedures and technologies introduced; service innovations cover all marketing innovations before products are sold and all associated financial, maint enance, repairing, warranty and repossessing activities. And for simplicity, the definition of product quality will adopt a simpler form when building game theory models, that is, quality is defined as the probability of a randomly selected consumer being satisfied with a product. On the other hand, the empirical analyses of this research introduce the general error (problems) in products sold and used by customers to represent product quality in the automotive ind ustry. All details of the definitions and recent literature on quality and innovation will be further discussed in Chapter 2. Concerning the target industry to be analyzed in this research, automotive industry will be proposed in the stages of models building and empirical investigation.
1.4 Overview of the Research Methodology
To achieve the research objectives described above, this study uses two main research methods including game theory and real option theory. Since all detailed research methods will be presented on Chapter 3 to 5, only the reasons why this dissertation adopt these research methods will be briefly introduced below.
1.4.1 Game Theory
Regarding durable products and their product quality, high-quality firms, low-quality firms and consumers form dynamic games of complete or incomplete information. First, the firms must decide whether to offer innovative products or services, and then set their price based on this decision. Second, customers read the price and innovation decisions of the firm and make their purchase decisions accordingly. The firm is the first to decide and act, so the games are dynamic.
1.4.2 Real Option Theory
This study applies an options-based model for valuing and verifying the service innovations introduced by game theory models. In fact, option pricing is more appropriate than traditional discounted cash flow (DCF) for evaluating innovative investments (Afuah, 1998). DCF uses a high discount rate to represent uncertainty in the marketplace, which is characterized by change and uncertainty. An investor will reduce his investment when facing risk, under a DCF assessment. In contrast, options-based valuation considers uncertainty as an opportunity to increase profit. As new information arrives and uncertainty decreases, investors and managers have the right, without associated symmetric obligations, to make profitable decisions. Most innovative activities are highly risky, and are undertaken only if the managers evaluate the innovative investment using options-based thinking (Faulkner, 1996).
1.5 Outline of the Dissertation
Figure 1.1 describes the outline of the dissertation. The contents of this dissertation are organized as follows. Chapter 2 reviews the relevant literature on product quality, product innovation and service innovation. Chapter 3 constructs a game theory model to explore the causal relationship between product quality and product innovation. Chapter 4 constructs a game theory model to explicate the quality’s impacts on service innovation for the automotive ind ustry. To test and verify the results introduced from Chapters 3 and 4, Chapter 5 applies real option theory to value and analyze the quality’s impacts on service innovation in the automotive industry. Chapter 6 finally derives some main conclusions and suggests the possible directions of future research.
Chapters 1 & 2
Chapters 3, 4
Chapter 6 Research Objectives
Literature Review
Product Quality and Innovation
Empirical Analysis: Product quality and Innovation
(Real Option Theory)
Model Building:
Product quality and Service Innovation
(Game Theory) Model Building:
Product quality and Product Innovation
(Game Theory)
Managerial Implication and Conclusion
Figure 1.1 The Flow of this Thesis
Chapter 5