The Profitability of Innovating Firms

This article seeks to evaluate the effects on corporate profitability of producing a major innovation. We examine two types of effect: innovations can have a direct but transitory effect on profitability associated with the production of a new product or the use of a new process, and innovations can have an indirect effect on how firms generate profits because they signal the transformation of a firm's internal capabilities associated with the process of innovating. Positive direct effects on the order of [sterling]2.1 million spread over seven years are observed for a sample of 721 large, quoted U.K. firms. More fundamentally, large indirect effects are also observed, not least because innovating firms seem to be more able to benefit from spillovers and are relatively insensitive to adverse macroeconomic shocks. These indirect effects associated with the transformation of a firm's internal capabilities may be as much as three times larger than the direct effects of innovation.