FINNISH BUSINESS SERVICES SECTOR IN EUROPEAN COMPARISON: TECHNOLOGICALLY BIASED AND INWARD ORIENTED IN INTERNATIONALIZATION

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1 Mika Kautonen & Marja Hyypiä Research Group for Science, Technology and Innovation Studies University of Tampere FINNISH BUSINESS SERVICES SECTOR IN EUROPEAN COMPARISON: TECHNOLOGICALLY BIASED AND INWARD ORIENTED IN INTERNATIONALIZATION First draft, please do not quote No proof reading INNOVATION PRESSURE International ProACT Conference th March 2006 Tampere, Finland To be presented under the Theme 1: Globalization and Innovation Pekka Ylä Anttila & Erkki Kaukonen 1

2 1. Introduction Among the fastest growing industries in the OECD countries, business services have increasingly gained attention among researchers as well as policy makers. Internationally many studies have indicated that especially the so called knowledge intensive business services may have a significant role to play in innovation systems as channels and agents of change. However, a deepening specialization in international division of labor and increased off shoring of also many service activities are constantly shaping the economic landscape of these businesses. This paper explores business services sector s relative significance and level of internationalization in a European comparative setting, including traditional service trade across the borders, foreign direct investment from and to Finland, and to a some extent also a more subtle question of variety of knowledge flows and networks. It also briefly discusses the role business services have in the national innovation system. Having such a wide coverage, the paper aims at positioning the Finnish business services sector in a wider European business services landscape and discussing some key issues explaining the sector s performance as well as its prospects. The paper is based on a study carried out within the Finnish ProACT Research Programme. The study draws both from secondary sources of data such as international and national industrial and trade statistics and their elaboration, and from primary data collected mainly by face to face interviews of 50 executives and experts, including most of the largest, leading firms and business units from the advertising and marketing and business consultancy sectors. In addition to these firms operating in the industries of principal interest, it was interviewed also a number of their client firms representatives as well as many other key informants. Concerning the statistical analysis, the paper is based on a lengthy report that is under a publication process and will be published in the series of the Finnish Ministry of Trade and Industry in March April 2006 (Hyypiä & Kautonen, forthcoming). The paper begins with a brief theoretical introduction on the multifaceted role of a business services sector in a national economy and with some notions concerning the process and significance of internationalization of the sector (Section 2). It then proceeds to present a statistical analysis and some of the outcomes on the European comparison of the business services sectors in which the main focus is on the Finnish business services sector (Section 3). The following Section (4) then presents some main outcomes from the interviews of the industry leaders and experts throwing more light into the issues that have come out in the statistical analysis before (the more thorough analysis will be provided in a research report under process that focuses on the qualitative data). The last Section (5) discusses and aims at providing some explanation on the main findings. It also briefly discusses the meaning of the findings in terms of the prospective development of the Finnish innovation system. 2

3 2. Multifaceted role of KIBS sector in an internationalizing innovation system It has recently become widely acknowledged that within the heterogeneous service sector, business services and especially the so called knowledge intensive business services have emerged as a bundle of industries that mostly shows high employment growth rates in the OECD countries. As in the other European and OECD countries, the business services sector nowadays is among the top in employment growth. In Finland, these industries have almost jobs an increase of 130 per cent have occurred in ten years. There are numerous drivers behind this dynamism including outsourcing from manufacturing and other sectors, changes in regulation and institutions, and a demand for many new types of services. Business services sector also increasingly attracts foreign direct investments globally: The whole services sector represents nowadays about 60 per cent share of the foreign direct investment stock (UNCTAD 2004). What is probably even more interesting and where our main interest lies is that the business services sector and especially the knowledge intensive business services is potentially emerging as a new strategic sector within the knowledge economy. The role of KIBS in innovation systems has become more understood in at least three different ways: First, successful launch of new technological innovations is crucially dependent on non technological innovations and service competencies; second, a possibility of service innovations and novel service processes as a source of competitiveness for firms, regions and nations has increasingly been acknowledged; and third, KIBS are now recognised as being able to perform important roles as intermediaries and nodes in [innovation] systems (Miles 2003, 27). In this third role, knowledge intensive business services intermediate between and across other organizations and business sectors innovation activities, they may act as pipelines to global business intelligence and can create local buzz, thus in many various ways contributing to economic growth. Less studied issues have been the internationalization of the KIBS firms and the whole sector although this definitely has impacts on innovation systems. So far, there has been only few studies also on the internationalization of innovation systems (see e.g. Carlsson 2006, 20), and in these few studies the technological viewpoint is strongly pronounced, i.e. the question of R&D function has been studied. Instead, vital non technological innovations, including novel design ideas, marketing strategies, organisational arrangements, and corporate, intercorporate and financial structures (Wood 2005, 435) have been almost exclusively overlooked. Thus, there appears to be a need for studies focusing on an international mediation of wider business intelligence competencies which shifts the focus from a supply oriented technological perspective towards a demand oriented one. Compared to manufacturing industries, business services often comprise of highly intangible and person embodied expertise that causes several differences in modes of internationalization. Also the producer client relationship may take more intensive form implying a continuous need for face toface interaction and thus a need for intense traveling or close geographical co location. Therefore, in business services some forms of interaction with customers located abroad are more usual than the others including people mediated exports e.g. personnel traveling abroad to advise foreign client where a service firm do not have to create foreign presence. In a case that a service firm intends to establish service production facility in foreign market this may take place by FDI, (organic growth/subsidiaries or mergers and acquisitions), by joint venture or by contractual arrangements (franchise or licensing, partnerships, associate firms etc.). 3

4 Based on a wide studies on research literature, both Glückler (2004) and Roberts (2001) state that foreign direct investments represent the most common form to generate international growth in business services instead of exports or different type of co operative networks. Yet partnerships are quite typical in many fields of business services. Exports are typical as interim measures, but on the long run firms tend to make investments and gain presence if they are to establish their foreign markets. In penetrating foreign markets, firms do no often make systematic selection of target markets but the selection process is strongly affected by a firm s existing relations and partnerships (O Farrel et al. 1996). Thus, when internationalizing, business services firms may be more reactively following their clients or more proactively seeking markets. According to Glückler (2004), the former is more usual as clients are increasingly expecting their service producers to be able to operate on an international level fulfilling international standards of service provision thus enabling or enforcing their service producers to internationalize. But whatever the forms and motives for business services sector internationalization, it is evident that these processes have several fundamental implications for innovation systems. On a more positive side, internationalization may increase a number and type of channels for knowledge and innovation and it may enable faster diffusion and convergence of managerial and technological know how. It also provides many national economies a source of employment growth and firms with expansion of markets and possibilities to widening base for outsourcing and deepened specialization. But the internationalization of the business services sector may bear also many social risks including the downside of heightened agglomerative tendencies where the strategic core of the sector concentrates geographically to a great extent only on few largest metropolitan areas (in Europe e.g. London, Frankfurt and Paris) and in the remaining countries and regions these strategic services are controlled from the outside thus narrowing their economic development potential (c.f. Wood 2005). In the following, the level of internationalization of the business services sector is measured in several ways. It has to be noted that internationalization as such is not the key but it is seen as a means to intermediate knowledge and innovations, in order to provide firms in a national innovation system with services representing high international quality and meeting the demands of the global firms or firms that intend to become global. 4

5 3. A country with one of the smallest and least internationalized KIBS sectors within the EU Design of the comparative tool In the following, the aim is to outline, compare and rank the European countries (EU15 excluding Greece) according to the relative size and significance, and the level of internationalization of the business services sector (especially Nace 72; Computer services, and 74; Other business services). Although the fourteen European countries involved, the main focus is on the Finnish business services sector. For this aim, we have developed an index based comparison comprising of 21 variables. Let us first describe briefly how the European index based comparative tool has been designed. These 21 variables are, first of all, proportioned in order to avoid the heterogeneity related to the differences in size of the countries and their economies. Another principle has been that the comparison is based on a number of variables to avoid distortion caused by a considerable deviation in any single variable. A third principle is to use index values to preserve the relative distances of the original values between the countries, instead, for example, of presenting only rankings. There are three main categories of variables in comparison: The first is the size and significance of the business services sector in a national economy (and innovation system), being reflected by the number of personnel in Computer services and Other business services (Nace 72 and 74), as well as the value added generated by these industries. As a variable indicating productivity in these industries, the value added is also proportioned per employee. The two other main categories of variables are related to the internationalization of the business services sector in each country. As the second main category of variables, the dimension of foreign trade of business services deals both with exports and imports of Computer services and Other business services. The third main category relates to the foreign direct investments in services (FDI) comprising both the inward and outward investments. In this third category, the scrutiny is on a more general level as the comparable data available consisted of statistics concerning services in general. Thus, they include a very heterogeneous bunch of industries. However, as it will be seen, the two other main categories of variables are quite consistent, and the overall picture created by the European comparison can be assessed as fairly reliable and coherent. In the following, we have to reduce the scrutiny of the knowledge intensive business services sector to analyzing two broad statistical categories due to practical reasons related to the supply and availability of the comparable data. These two statistical categories are Computer Services (Nace 72) and Other Business Services (Nace 74). Of the latter category, too, a majority of the industries belong to the knowledge intensive business services, but there are some industries that represent lower level of knowledge intensity. On the other hand, there are industries outside these two main categories that definitely belong to the knowledge intensive business services. However, we may state that these two represent the core of KIBS. Together these three main categories with 21variables in total indicate the role as well as the level of internationalization of business services sector in each economy (and its innovation system) thus reflecting also the sector s role in transferring knowledge and good practices from beyond the national borders. It is evident that different type of internationality that is difficult to measure such 5

6 as personnel s international experience and contacts, as well as international trade and knowledge transfer internal to the international chains remain mostly untouched in this kind of statistical analysis. It goes as a passing mention that not all of the international statistics are precise as there are differences in national compilation of statistics. Despite these reservations, the overall view can be arguably regarded as credible and consistent. During the time of compiling the comparative tool, there was not data available from each of the countries to construct time series and hence to get dynamism into the comparison. However, this will be done in the near future as for example Eurostat s statistics have progressed in this sense. The European comparison is meant to be repeated annually to monitor the developments between the business services sectors in each of the countries. Tables 1 3 consist of indexes that illustrate the country specific proportionate values in relation to the average level within the fourteen EU countries. The actual country specific values are presented in Appendix table 1. Empty rows and columns in Table 1 as well as in Appendix table 1 establish clearly some of the deficiencies and slow development in service related statistical data: there are, for example, some gaps in the data concerning especially foreign direct investment but also foreign trade in Computer and information services. As to foreign direct investments there are additionally a few exceptions in the years for witch the data is available. It has to be mentioned, however, that even recently there has been some crucial developments in the FDI data delivered by Eurostat Main outcomes of the European comparison To summarize the main outcome of the comparison from the Finnish viewpoint, it is to be seen from the tables in the following that among the fourteen European countries, the Finnish business services sector is placed among the last by the size, significance and internationalization of the sectors. By different main categories, the position varies between the ranks of eight and thirteen, and the overall rank is eleventh despite of strong positive growth occurred during the recent years. Table 1 displays the relational index values for every individual variable behind the main categories for each EU country included in the comparison (for actual proportionate values, see Appendix table 1). From the Finnish viewpoint, the following observations can be made: Size and significance of the business services sector (variables a e). In Finland, the observed business services sector is among the smallest in Europe measured by the share of personnel of the total number of employees in the market economy of each country. However, this difference is not remarkable compared to most of the countries, although in some countries such as the Netherlands this employment share is almost twice as big. If the share of the sectors personnel is proportioned with the country s employment in the whole service sector alone, the share is already somewhat higher. These reflect the fact that the share of employment in the manufacturing sector in Finland is still higher than in most of the Western European countries. Compared to the share of employment, the value added produced in the business services sector is lower indicating these industries relatively low productivity compared to many other industries of the country. Thus, when measured by the value added, the business services sector s significance for the national economy remains on a rather low level in European terms. However, when the value added of the sector is proportioned with the number of personnel of the sector, the resulting indicator demonstrates the 6

7 productivity of Finnish business services sector to be at least at the average level compared to the general European performance. Foreign trade in business services sector (variables f m). Compared to the above mentioned variables of the first main category, this category displays more drastic differences in the proportionate values indicating differences in the level of international integration of the countries business services sectors. Luxemburg as a small country of transit trade is somewhat a special case, but for example for Ireland the share of exports of especially computer services and the share of imports in other business services is exceptionally high. The variables of this main category can be argued to reflect the demand for such services and (at least to some extent) the level of self sufficiency in producing these services in each market economy often services are acquired from providers in close geographic proximity, that is, in the same country. Nevertheless, it may be the case that this provider in close proximity is in fact an affiliate of an international service chain. Hence, studying the level of the foreign direct investments in services is central in augmenting our understanding on the international integration of the respective national business services sectors. Foreign direct investments in services (variables n u). In this dimension, Finland can be characterized, contradictory to the manufacturing sector, as a country dominated by inward rather than outward foreign direct investments (see also Sinko & Vihriälä 2005) more than 50 per cent of the inward investment stock is in services. As such, both the inward and outward service investment stocks as proportioned with the gross national product are on the same level of 11 to 12 per cent (see Appendix table 1). Denmark and Sweden, for example, display manifold shares in outward foreign direct investments in services. 7

8 Table 1 (Business) services sector s relative size and significance by indexes based on variable specific EU15 averages (EU15=100, excluding Greece). Economy United Netherl Belgiu Luxembourg al n ny rk Portug Swede Germa Denma Spain Ireland Kingdo Italy Austria France Finland ands m Dimension/Variable m a Size and significance of b business c services d sector e Foreign trade of business services Foreign direct investment (FDI) in services f g h i j k l m n 92* 116* * o 105* 134* 40** * p * 77* q * ** 108* r 203* 70* * s * 17** * t * u The average index a Business services (Nace 72, Computer and related activities and Nace 74 Other business services) share of employees in the market economy in b Business services (Nace 72 and 74) share of employees in the services sector of the market economy in c Business services (Nace 72 and 74) share of the value added produced in the market economy in d Business services (Nace 72 and 74) share of the value added produced in the services sector of the market economy in e Value added per employee in business services (Nace 72 and 74) in f Computer and information services share of the total of merchandise and services exports in g Computer and information services share of the total of merchandise and services imports in

9 h Other business services share of the total of merchandise and services exports in i Other business services share of the total of merchandise and services imports in j The value of exports in Computer and information services / GDP in k The value of imports in Computer and information services / GDP in l The value of exports in Other business services / GDP in m The value of imports in Other business services / GDP in n The share of services in inward FDI (foreign direct investment) flows in (mean). *In o The share of services in outward FDI (foreign direct investment) flows in (mean). *In **In p The share of services in inward FDI (foreign direct investment) stock in *In q The share of services in outward FDI (foreign direct investment) stock in *In **In r The inward FDI (foreign direct investment) flow in services / gross fixed capital formation (GFCF) in (mean). *In s The outward FDI (foreign direct investment) flow in services / gross fixed capital formation (GFCF) in (mean). *In **In t The inward FDI (foreign direct investment) stock in services / GDP in *In u The outward FDI (foreign direct investment) stock in services / GDP in Table 2 The dimension specific averages of indexes on the size and significance of (business) services sector in EU15 countries (excluding Greece). Economy Dimension Size and significance of business services sector Netherla nds Belgium Spain Ireland United Kingdo m Italy Austria Luxembourg Portuga l France Sweden German y Finland Denmar k Foreign trade of business services Foreign direct investment (FDI) in services The average index

10 Table 3 The average indexes on foreign trade in business services and service FDI according to their direction (exports/outward FDI vs. imports / inward FDI). Dimension Economy Outward oiriented variables* Netherl ands Belgiu m Spain Ireland United Kingdo m Italy Austria Luxembourg Portuga l France Sweden German y Finland Denmar k Inward oriented variables** The average index *Outward oriented variables: f Computer and information services share of the total of merchandise and services exports in h Other business services share of the total of merchandise and services exports in j The value of exports in Computer and information services / GDP in l The value of exports in Other business services / GDP in o The share of services in outward FDI (foreign direct investment) flows in (mean). (Spain and Italy in , Ireland in ) q The share of services in outward FDI (foreign direct investment) stock in (Italy and Portugal in 2000, Luxembourg in 1995.) s The outward FDI (foreign direct investment) flow in services / gross fixed capital formation (GFCF) in (mean). (Spain and Italy in , Ireland in ) u The outward FDI (foreign direct investment) stock in services / GDP in **Inward oriented variables: g Computer and information services share of the total of merchandise and services imports in i Other business services share of the total of merchandise and services imports in k The value of imports in Computer and information services / GDP in m The value of imports in Other business services / GDP in n The share of services in inward FDI (foreign direct investment) flows in (mean). (Netherlands, Spain and Italy in ) p The share of services in inward FDI (foreign direct investment) stock in (Luxembourg and Portugal in 2000.) r The inward FDI (foreign direct investment) flow in services / gross fixed capital formation (GFCF) in (mean). (Netherlands, Spain and Italy in ) t The inward FDI (foreign direct investment) stock in services / GDP in (Luxembourg in 2000.) 10

11 Based on their index values and on the means of these values, EU countries can be ranked in relation to one another from various viewpoints. These rankings deserve a closer look and will be studied and discussed next. In Tables 2 and 3 (above) there are presented both the average index values concerning each of the main categories as well as separate average values for the outward and the inward oriented variables of foreign trade and foreign direct investments, that is to compare these orientations by confronting indexes describing exports and outward FDI with those describing imports and inward FDI. The total average index with all 21 variables included is presented in the lowest row of each table. In Table 4 we have listed the countries accordingly with one complementary dimension: foreign trade with computer services excluded. This is to see the impact of this relative strong business service branch on the foreign trade in Finland. Together these tables indicate, among other things, the following again from the perspective of the Finnish business services sector: The total average of the comparative indexes for Finland is 74 (EU14=100). This ranks the country as the eleventh. According to the total average of the comparative indexes, the ranking between the observed EU countries from the first to the last is the following: 1. Ireland (189) 2. Luxemburg (182) 3. The Netherlands (132) 4. Denmark (115) 5. Great Britain (104) 6. Belgium (103) 7. Sweden (100) 8. Germany (90) 9. France (85) 10. Spain (82) 11. Finland (74) 12. Austria (68) 13. Italy (61) 14. Portugal (53). The ranking above seem to follow a course where among the first are most of the Northern European countries whereas the Central and especially the Southern European countries are placed among the last, with the exceptions of Austria and Finland. This overall result is fairly consistent with, for example, Wood s (2003) findings based on a more qualitative analysis (that nevertheless do not include Finland). Measured by the relative size and significance of the business services sector, the leading countries in Europe are the Netherlands (1.), UK (2.), and Sweden (3.). Of the large countries, also Germany and France have quite high ranking in this main category especially when keeping in mind that these are relative values that often do not favour the largest countries in an international comparisons. The Finnish business services sector ranks as eleventh in this main category with an index value of 85. Measured by the foreign trade of the business services sector, the ranks between the countries are different: the first is Ireland, the second is Luxemburg and the third Sweden. Of the above mentioned, especially the Netherlands (4.) is again having a high rank, whereas Germany and France are among the five last

12 indicating a certain kind of self sufficiency of these countries, but relatively also a low level of integration into the international business services trade in European terms. In this main category, the Finnish business services sector ranks as ninth with an index value of 68. It is however noteworthy that when the index concerning international service trade is accounted without the computer services, Finland ranks only as the twelfth before Germany and Portugal (see Table 4). Measured by the foreign direct investments in services, the first countries are Luxemburg, the Netherlands and Denmark, followed by the large countries UK, France, Spain and Germany. It has to be acknowledged that this main category consists of a larger entity than only the business services sector, as mentioned earlier. The Finnish service sector ranks here as eleventh with an index value of 73. As mentioned before, Table 3 gathers together the average values of indexes that are related to either inward or outward variables in foreign trade and FDI. This serves in scrutinizing the countries orientation in integration of the international service trade; whether a country hosts an outward oriented business services sector or the country is more a target market for service imports and foreign investments. Ireland, Luxemburg, Denmark and the Netherlands, among the European leading business services countries in the above comparison, are strong in both groups of variables related to inward and outward dimensions. The Great Britain, being the most significant business services host country among the three largest EU countries, is positioned as the fifth in outward oriented variables, whereas Germany is the sixth in the inward oriented variables. This indicates that the former country hosts a highly expansive business services sector whereas the latter, although having several internationally known software and consultancy firms, has a higher demand on business services as is supplied domestically, probably partly due to the joining of the East Germany as well as specializing in many other sectors instead of business services. As was already indicated in relation to the inward FDI, Finnish business services sector is characterized by relatively high values in inward oriented variables, where the average of the indexes (91) is close to the average value of the fourteen countries and results in a position as the eight among the countries. In outward oriented variables, instead, the average of the indexes for Finland is only 49 leaving the country as the second last together with Portugal and before Italy. Tracking down the individual variables (of the total 21) in which Finland has its highest and lowest index values support the image of Finnish business services sector as fairly inward oriented branch in its integration to the global economy. Three variables with the highest index values are the following: 1. (g) The share of computer services by the total imports of goods and services in 2003 (actual share 0,9 %, index Finland=136, EU15=100) 2. (n) The share of services by the flow of inward foreign direct investments during the period of on the average (actual share 89,5 %, index Finland=121, EU15=100) 3. (r) The flow of inward foreign direct investments in services proportioned to the gross fixed capital formation during the period of on the average (actual share 24,8 %, index Finland=110, EU15=100). 12

13 Three variables with the lowest index values are the following: 1. (j) Value of exports in computer services proportioned by the total gross domestic product in 2003 (actual share 0,3 %, index Finland=23, EU15=100) 2. (t) The stock of inward foreign direct investments in services proportioned by the total gross domestic product in 2001 (actual share 11,2 %, index Finland=42, EU15=100) 3. (o) The share of services by the flow of outward foreign direct investments during the period of on the average (actual share 28,9 %, index Finland=44, EU15=100). These extremes can be used to identify some strengths and weaknesses in European comparison characteristic to Finnish business services sector. They indicate that, first, although the computer services are more significant in exports compared to the exports of other business services (see Appendix table 1), they remain relatively minor in the Finnish exports context not to mention the average European context (index values related to exports of Computer services in Finland are 52 and 23, EU15=100). Hence, it is not the index values related to exports of Computer services that improve Finland s ranking in European scale of comparison when excluding Computer services of the average index value concerning foreign trade of Business services for Finland the values for imports related indexes remain higher even in this particular branch of business services. In regard of Finland, this probably reflects a situation where there have been opportunities and demand for business services in the Finnish markets but at least in relative terms the Finnish business services firms have not been able to penetrate foreign markets as successfully as most of the European competitors in broad terms. This in mind, it has to be noted that with Ireland and Luxemburg excluded, Finland would be closer to the European average in foreign trade of business services: with their exceptionally high values (the index values for Irish exports of Computer services are 633 and 699, EU15=100) these two countries have a high impact on the average index. The second issue elicited by these strengths and weaknesses based on the extremes in the index values is that Finland is rather weakly positioned in outward foreign direct investments in services whereas it has a stronghold in these in regard of inward investments. Nevertheless, these inward foreign direct investments in services are not very significant if proportioned by the GDP. In both cases discussed here (exports of the computer services and these inward investments), the explanation for a low share if proportioned by the GDP may be that these services are characterized by low capital intensity. 13

14 Table 4 EU15 countries (excluding Greece) ranked according to selected dimensions characterizing the significance and rate of internationalization of the business services sectors (index values in brackets, EU15=100). Rank Rankings of the EU15 countries according to Size and Foreign trade significance of All dimensions of the business the business services sector services sector Foreign trade (excl. computer services) Services FDI All outward oriented variables All inward oriented variables 1. Ireland (189) Netherlands (138) Ireland (302) Ireland (244) Luxemburg (181) Ireland (272) Luxemburg (233) 2. Luxemburg (182) UK (129) Luxemburg (226) Luxemburg (185) Netherlands (153) Luxemburg (190) Ireland (181) 3. Netherlands (132) Sweden (112) Sweden (116) Sweden (130) Denmark (148) Denmark (127) Netherlands (135) 4. Denmark (115) Luxemburg (111) Netherlands (109) Netherlands (126) UK (115) Netherlands (126) Denmark (119) 5. UK (104) Germany (110) Belgium (102) Belgium (116) France (111) UK (114) Belgium (112) 6. Belgium (103) France (108) UK (77) UK (88) Spain (108) Sweden (99) Germany (97) 7. Sweden (100) Belgium (103) Denmark (72) Italy (76) Germany (101) Belgium (93) Sweden (93) 8. Germany (90) Ireland (101) Spain (70) Spain (74) Austria (81) France (87) Finland (91) 9. France (85) Denmark (96) Finland (68) Austria (73) Sweden (76) Spain (83) Spain (82) 10. Spain (82) Italy (94) Germany (65) Denmark (72) Ireland (75) Germany (70) UK (77) 11. Finland (74) Finland (85) Austria (48) France (65) Finland (73) Austria (69) France (69) 12. Austria (68) Austria (80) Italy (48) Finland (60) Portugal (69) Portugal (49) Austria (60) 13. Italy (61) Spain (79) France (45) Germany (58) Italy (53) Finland (49) Portugal (57) 14. Portugal (53) Portugal (54) Portugal (38) Portugal (32) Italy (47) Italy (54) (Belgium: no data) 14

15 4. In search for explanations Reasons for the rather weak position of the Finnish business services sector in the European comparison may be many (see also Sinko & Vihriälä 2005, Mankinen ym. 2003). In the following, building mainly on the 50 interviews carried out in our project of the ProACT Programme, we make an attempt to cover those we consider among the most important explanative factors discussing these briefly. Face to face interviews were themed with slightly provocative claims (29 in totals) concerning the level of and need for internationalization in the Finnish knowledge intensive business services (KIBS) sector. The focus was on the managerial (vs. technological) sub sectors of KIBS and specifically on business consulting and marketing services with a strategic perspective. The interviewees were chosen among the leading experts in Finnish management consultancy and marketing firms, medium sized client firms in high tech and design industries, branch organizations and public agencies 1. It goes as a passing mention that the following touches only some broad outlines of the extensive interview data and the more fine tuned analysis will be provided in a research report under process that focuses on the qualitative data. With the exceptions of the subgroups of interviewees in business consultancy and client firms, most of the interviewees agreed that in Finland the business services sector has developed and internationalized slower than in other European countries on an average. It was several times mentioned that the whole internationalization process only began after the EU accession. The rather general statement was, however, that during the last 3 5 years the internationalization has significantly intensified. According to the forthcoming report of statistical analysis (Hyypiä & Kautonen 2006), nevertheless, it seems that the acceleration of internationalization and the level of growth have not enabled the sector to catch up the European average level so far. There is, of course, considerable variation between industries in this sense: For example, in Technical and Computer services together with Advertising there are numerous good cases of progress in internationalization. In outward oriented internationalization (exports and outward FDI), it was several times claimed that the Finnish business services sector s cutting edge is sharp but very narrow. There are some clear cut conceptions of the underlying explanations that stand out almost throughout the interviews. First of all, there are factors related to the markets and other structural factors. When compared to the many other countries of the Western Europe, in Finland the industrial transformation from manufacturing to services started up rather late. Related to this, the domestic demand for many business services may have been relatively modest partly due to the fact that the consumption of these services can be considered as a sort of a learning process progressing rather slowly. At least according to the interviewees the Finnish business life consists typically of self made men relying on their own competences. The use of outside expertise is not expected to bring enough value for the money. That way the Finnish market for knowledge intensive business services is, even relatively speaking, smaller than could be expected. In Finland the trend to outsource service activities has not yet progressed that far, but the manufacturing and the public sectors, for example, still produce many such services in house that has been already outsourced in many other countries of the comparison. Here, the small size of the domestic markets reduce possibilities for different scale economies having an impact on specialization tendencies within the business services sector as well as for substantial growth to be gained in domestic markets. Whereas the former of these 1 The distribution of the interviewees defined by their organization is: eleven (11) interviewees from advertising and marketing firms, twelve (12) from management consultancy firms, fifteen (15) from client firms in high tech or design industries, two (2) from branch organizations, and ten (10) from public agencies. 15

16 aspects hamper the prospects for successful penetration of foreign markets for Finnish KIBS firms, the latter essentially requires it if a firm has an intention to significant growth. Almost consequentially, the average firm size in Finnish business services sector is relatively small in at least in Nordic terms. From the research literature we know that small firms generally tend to operate mainly on a local and regional basis with some exceptions of the so called born global firms that are typically very highly specialized and have narrow niche markets. In the smallest service firms the strategic choices to be made intertwine with those made by key personnel in their personal lives. A lot of traveling days seem less attractive for those with families with small children a fact that has occurred in several interviews. Knowledge intensive services are often location bound in their production and exporting possibilities are rather limited: according to the interviewees individual service projects can be delivered and single customers served from afar (aided by e. g. business travel and communication technologies) but extensive operations in a foreign market require local market presence. For a small firm with limited personnel resources, i.e. with just a few key persons available, alternatives can be scarce: heterogeneous clientele with a vast geographical span can be too challenging to manage. In addition to the small domestic markets and average firm size the interviews brought out yet another characteristic to the Finnish business services sector: here the margins in knowledgeintensive service production remain somewhat low. In our statistical analysis the same phenomenon can be seen in the level of productivity (see also Sinko & Vihriälä 2005). On the one hand this reflects general undervaluation of external expertise, and inadequate pricing practices on the other, and restricts the accumulation of capital. The lack of capital is conceived as an important factor hindering firms efforts to penetrate foreign markets. Rather remote location from large markets, excluding St. Petersburg and maybe the Baltic, is a significant factor especially with most of the knowledge intensive business services due to their constant need for intense interaction with clients. As mentioned above, even though there is a good supply of telecommunication and air connections, especially consultancy demands continuous faceto face contacts and causes thus more costs from the distance. Without highly recognizable and unique competences and image it is hard to attract customers from abroad willing to cover or share the costs of remote distance (see Hyypiä & Kautonen, 2005). Also distances within the country may have had adverse impact on the development of the service supply. Cultural factors such as language have had their role in international service trade. Business services firms in other Nordic countries, for example, have benefited from fairly homogeneous language area that has provided them with an expanded domestic markets. In the interviews it was also elicited that due to the cultural originality connected with the rather remote location, the Finnish business services markets are still perceived quite sheltered from external competition by some smaller businesses. Nevertheless, as earlier pointed out, the main direction of internationalization of the business services sector in Finland is inward. This means that a great deal of the largest firms of the sector is partly or entirely owned by internationally operating large service groups (e.g. auditing, advertising, see Toivonen 2004). Our interviews indicated that the local business units and daughter companies of these groups have mostly a task to serve nationally as there are other business units in other countries taking care of those markets. Therefore, some of those firms with the greatest resources to foreign expansion have not any strategic intent nor need for that. We may paradoxically term them as internationally bounded to be national. On the other hand, some of these units can be seen to serve as channels of international business intelligence, although belonging to an international 16

17 service chain cannot be considered to guarantee international level services. Partly due to the presence of international business chains, however, it was stated that the service supply is fairly sufficient in many areas even from the international point of view. Connected to mentality but also to competences, it was often brought out in the interviews that in Finnish business services sector there are competitive competences in terms of substance but shortage of a certain kind of spirit to excel in competition and gain competitive advantage. This kind of spirit was described to consist of enhanced marketing and management skills together with higher self esteem and service mentality. Mere substance is not enough in international competition; one has to know how to put it into practice, make it attractive, and benefit from it. Without these qualities, the current trend of inward oriented development in the Finnish business services sector s internationalization can be complicated to turn around, if necessary. 17

18 5. Discussion and conclusions In the European comparison the Finnish business services sector does not stand out in the matters of size and productivity, foreign trade and foreign direct investments. Even in Technical and Computer services, the two strongest branches of business services in the Finnish perspective with some leading and internationally competitive firms, the level of internationalization measured by foreign trade and direct investments is fairly ordinary. As far as the other branches of business services are concerned (those we may in generally label as managerial as opposed to technical services) the performance is, instead, rather weak in all terms of European comparison outlined in this paper. This is one of the outcomes delineated in our forthcoming report (Hyypiä & Kautonen, 2006) of more detailed statistical analysis. Nevertheless, the index based comparison presented here is created for the purposes of comparing the countries themselves, and not their individual branches of business services, in order to chart the role of business services sector in European national innovation systems. All in all, the Finnish national economy is not specialized into business services industries but actually lacks behind many of the other European countries. Therefore we can argue that the national innovation system has not backed up such industries. The reasons and explanations for this were discussed in the previous section. In the European comparison of fourteen EU countries Finland stands as eleventh with all the proportioned variables describing sector size and productivity, foreign trade and foreign direct investment included. This can be considered a major prospective threat as these industries are promising, as stated before, in terms of employment growth and especially due to their impacts on other industries. Question remains whether this also partly explains the phenomenon that is considered a problem in Finland, namely the commercialization of knowledge and innovations. In the Finnish business services sector s integration to the global economy, the main trend has been in inward oriented internationalization. Observed flows of inward foreign direct investments in services as well as service imports can be seen as reflecting deficiencies in supply and quality in some services or customer segments in the Finnish markets. At the same time, this may also reflect growth opportunities in domestic service markets. Inward FDI in services can be considered to advance development towards a service economy. In our forthcoming report (Hyypiä & Kautonen 2006), we analyzed some statistical data that indicate that the Finnish business services firms are able to generate exports equally to some other countries business services firms. We may hypothesize that this shows the problem does not lie on a level of a single firm and its capabilities, but simply on a fact that the whole bundle of knowledge intensive business services industries is both absolutely and relatively small in European terms. According to the interviews, the problem is not related to the level and supply of substance but in boldly putting it into practice and, furthermore, to aiming at foreign markets. Obviously, the outcomes of the statistical comparison should be dealt critically. For example, what is the significance of the outlined observations if the underlying phenomenon is obscured by the outdated definitions of relevant industrial classifications in statistics? Is it not the most essential to measure the whole private sector, for example, by its production, productivity and employment? Could this phenomenon measured in a better way using statistics on occupations that are crossing the industries and may reflect the knowledge intensity of production in a more reliable way? Partly we may answer the proposed questions affirmatively, but there are issues that go beyond those proposed that may be of considerable importance for example from the innovation system perspective. Let us discuss these in the following. 18

19 First, even if there are lots of business service functions and related jobs inside large manufacturing firms, these services are mostly not available for other firms unless these are outsourced to specialized business services firms or service spin offs occur. Therefore, channels for diffusion of innovations and good practices to other firms, especially to the SME sector, may be partly lacking (c.f. Kautonen, Hyypiä & Kuusisto 2005). Second, a great deal of business services trade is based on different kind of intangibles: i.e. trade of expertise is based on many rather immeasurable factors to decide upon in purchasing them (see e.g. Miles 2003, Kuusisto & Meyer 2003, Toivonen 2004). Competences to market and sell this type of services demand profound understanding of many underlying institutional and cultural norms and conventions and thus differ from, for example, marketing of investment goods. This may be seen in terms of path dependency and therefore demanding processes of learning. Regarding Finland, the strong role of public sector also as a provider of business services has certainly been one of the strengths of the national innovation system. At the same time, it may have had an impact also on the international expansion of the business services sector or a relative lack of it due to the fact that public providers do not aim to penetrate foreign markets. Therefore, the existence of public business services in certain sub sectors such as R&D and consultancy may have had a role for supply, use, pricing and expansion of these services (KTM 2005, Georghiou et al. 2003). Another matter is that so far, industrial policy rationale has leant to a great extent on favoring manufacturing industries. There have been some concerns whether the Finnish economy including the business services sector is on its way towards externally controlled branch plant economy. In the worst scenarios, this would result in adaptation and straightforward routine services without locally generated expertise and customization. Especially in the light of the statistical analysis, there are some indications of this kind of tendencies but according to many of the interviewees the prospects do not seem that drastic: not all local needs adapt to imported models and formulas. In addition, the spin off dynamics typical for many business services proves against these tendencies it was stated that top experts often tend to leave chain units to establish businesses of their own in order to increase their autonomy and possibilities to creativity. For that matter, business services sector has to a great extent a propensity to small firm size and entrepreneurial culture, and not all experts are willing to yield to external control. International trade, increase of networking and chains and mergers across the national borders in business services means a lot for a national innovation system: Here lies the opportunity to distribute knowledge and learn new business concepts, production methods and management techniques that can be applied in own production and for own clientele. As we see it, the outward oriented internationalization in forms of exports and FDI is not, after all, the main issue here. From the Finnish innovation system point of view, the most important is a prospering and internationally well connected KIBS sector: the greatest impacts of the sector can be achieved through its influence on the competitiveness of other sectors. 19

20 References Carlsson, B. (2006). Internationalization of innovation systems: A survey of the literature. Research Policy 35, pp Georghiou, L., Smith, K., Toivanen, O. & Ylä Anttila, P. (2003). Evaluation of the Finnish Innovation Support System. Ministry of Trade and Industry Finland, Publications 5/2003. Edita, Helsinki. Glückler, J. (2004). A Relational account of business service internationalization and market entry theory and some evidence. The University of Birmingham, School of Geography, Earth and Environmental Sciences, Working Papers on Services, Space, Society, No. 15. Hyypiä, M. & Kautonen, M. (2005). Expertise, Proximity and KIBS Client Relationships. Conference Proceedings of the International RESER Conference on Growth, Employment and Location of Services, September Granada, Spain. Pp Hyypiä, M. & Kautonen, M. (2006, forthcoming). Suomi liike elämän palvelujen kansainvälistymisessä ja keskittymisessä. KTM:n Rahoitetut tutkimukset julkaisusarja, Helsinki. Kautonen, M., Hyypiä, M. & Kuusisto, J. (2005). Asiantuntijapalvelujen kysynnän ja tarjonnan kohtaaminen Uudenmaan osaamiskeskusohjelman osaamisaloilla. In Lith, P. Kautonen, M., Hyypiä, M. & Kuusisto, J. (Eds.) Uusimaa osaamisintensiivisten liike elämän palvelujen keskittymänä. Culminatum Ltd. & Helsinki Region Centre of Expertise. Espoo. KTM (2005). Suomalaisten yrityspalvelujen kehityspolku maailman kärkijoukkoon. Kauppa ja teollisuusministeriö, KTM Julkaisuja 19/2005. Edita, Helsinki. Kuusisto, J. & Meyer, M. (2003). Insights into services and innovation in the knowledge intensive economy. Tekes, Technology Review 134/2003. Helsinki. Mankinen, R., Rouvinen, P. Väänänen, L. & Ylä Anttila, P. (2003). Yrityspalveluiden kasvu, kansainvälistyminen ja kilpailukyky. Elinkeinoelämän tutkimuslaitos ETLA. Keskusteluaiheita No Miles, I. (2003) Knowledge Intensive Services Suppliers and Clients. Ministry of Trade and Industry, Finland, Studies and Reports n 15/2003 O Farrel, P. N., Wood, P. A. & Zheng, J. (1996). Internationalisation of Business Services: An Interregional Analysis. Regional Studies, vol. 30.2, Roberts, J. (2001). Challenges Facing Service Enterprises In A Global Knowledge Based Economy: Lessons From The Business Services Sector. PREST Discussion Paper Series, Paper Sinko, P. & Vihriälä, V. (2005). Palvelusektorin koko, tuottavuus ja kilpailu: johdatus aiheeseen ja keskeiset päätelmät. In Palvelualojen kehitys, tuottavuus ja kilpailu. Valtioneuvoston kanslia, Valtioneuvoston kanslian julkaisusarja 11/2005. Helsinki. Toivonen, M. (2004) Expertise as Business. Long term development and future prospects of knowledge intensive business services. Helsinki University of Technology, Department of Industrial Engineering and Management, Doctoral Dissertation Series 2004/2. Espoo. UNCTAD (2004). World Investment Report The Shift Towards Services. United Nations Conference on Trade and Development. United Nations: New York and Geneva. Downloadable from <http://www.unctad.org/en/docs/wir2004_en.pdf> Wood, P. (Ed.) (2002) Consultancy and Innovation. The business service revolution in Europe. Routledge Studies in International Business and the World Economy, London & New York, Routledge. Wood, P. (2005). A service informed approach to regional innovation or adaptation? The Service Industries Journal, Vol. 25, No. 4, June 2005, pp

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