Linking Market Orientation and Ambidexterity to Financial Returns with the Mediation of Innovative Performance

Journal of Economic and Social Research Vol 15(1) 2013, 31-54 Linking Market Orientation and Ambidexterity to Financial Returns with the Mediation of Innovative Performance Mehmet Şanal *, Lütfihak Alpkan **, Selim Aren ***, Bülent Sezen **** and Yüksel Ayden ***** Abstract. This study aims to empirically test the relations among responsive and proactive market orientations, explorative and exploitative innovation strategies, and firm performance, and to compare the performance impact size of the combined strategy i.e. ambidexterity to that of individual impacts of explorative and exploitative innovation strategies. Data from 558 Turkish firms collected by a questionnaire study has been analyzed via path models. The findings indicate that proactive market orientation is more closely related to explorative innovation strategy which increases innovative performance more compared to responsive market orientation which has a closer relation to exploitative innovation strategy that increases financial performance more. Innovative performance is a mediator in the strategy-performance relations. Ambidexterity has a greater performance impact than both exploration and exploitation. JEL Classification Codes: M00, C12 Keywords: Market Orientation, Exploitative Innovation Strategies, Explorative Innovation Strategies, Ambidexterity, Financial Performance Acknowledgement This work is supported by the Scientific Research Fund of Fatih University under the project number P51021101_B * Fatih University, Vocational School, Istanbul. E-mail:msanal@fatih.edu.tr ** Gebze Institute of Technology, Kocaeli. E-mail:alpkan@gyte.edu.tr *** Gebze Institute of Technology, Kocaeli. E-mail:aren@gyte.edu.tr **** Gebze Institute of Technology, Kocaeli. E-mail:bsezen@gyte.edu.tr ***** Fatih University, Istanbul. E-mail: yayden@fatih.edu.tr

1. Introduction Mehmet Şanal, Lütfihak Alpkan, Selim Aren, Bülent Sezen and Yüksel Ayden Innovation has become an important competitive source of advantage and selecting the appropriate innovation strategy has been a very critical issue for both practitioners and researchers in the current globalization era. Empirical research has begun to be done for about a decade now to facilitate making strategic choice between seemingly opposite or alternative innovation efforts. Similarly a duality in planning and implementing innovation efforts persist at organizations in both developed and developing nations. Some firms concentrate more on understanding and responding to the tactical moves of existing competitors and to the expressed needs of existing customers. Some others try to discover and adapt to emerging markets, competitors and customers and to their latent and changing needs. In order to keep up with the competition they specialize on either one way. Indeed there exists two different types of learning activities i.e. exploitation and exploration which require different types of structures, processes, capabilities and contribute to the different aspects of business performance among which firms divide attention and resources (He and Wong, 2004; Raisch and Birkinshaw, 2008). Exploitation includes such things as refinement, choice, production, efficiency and implementation; whereas exploration includes things such as search, variation, risk taking, flexibility and discovery (March, 1991). However, there should be a third way, a combined way to survive this competition. Li et al., (2008) suggest not only exploiting current products and competences, but also exploring new ideas and products at the same time. Earlier studies on this matter indicate that there is a tradeoff between exploiting the existing competences and exploring new ones. According to March (1991:71) both exploitation and exploration are essential for the organizations, but they compete for scarce resources. Still, Levinthal and March (1993) argue that an organization engaging solely in exploration never gains most of the possible returns of its present knowledge base whereas an organization engaging solely in exploitation experiences obsolescence and both will suffer. They propose that to ensure its current and future viability, an organization should engage in both in a combined manner. Thus, on one hand, many scholars suggest that successful organizations must be ambidextrous trying to explore and exploit at the same time (Alpkan and Aren, 2009; Gibson and Birkinshaw, 2004); on the other hand, practitioners should keep in mind that to develop and manage this idealized combination is still difficult and risky (e.g. Porter, 1980) 32

Linking Market Orientation and Ambidexterity to Financial Returns with the Mediation of Innovative Performance leading to an unintended but possible result: inability to be both at the same time i.e. to be stuck in the middle. Many researchers try to uncover the antecedents and/or consequences of ambidexterity i.e. an ability to pursue simultaneously two seemingly contradictory goals (e.g. Jansen et al., 2006). Scanning empirical studies in general, reveals that among other possible antecedents, market orientation as a type of organizational culture to grasp and disseminate market knowledge seems to be an outstanding driver of ambidexterity (e.g. Menguc and Auh, 2008); and among other types of ambidexterity, ambidextrous innovation strategy is the commonly used strategic choice that contributes to some aspects of organizational performance (e.g. He and Wong, 2004). Another common finding in the literature is that innovative performance is in general very critical in linking culture and or strategy to financial returns (e.g. Han et al., 1998). A general consensus seems to be established in the literature to conceptualize exploration and exploitation as orthogonal rather than incompatible variables and to accept their interaction term (the ambidexterity hypothesis) as a positive driver of firm performance. However some studies show that separate performance impacts of exploitation and/or exploration are higher than their interaction s (ambidexterity) performance impact (e.g. Morgan and Berthon, 2008). Yet, despite a growing number of such research, studies on ambidexterity that try to develop and test comprehensive paths of relations beginning with market needs and ending with financial performance are surprisingly rare. Therefore, to develop and test comprehensive models of relations where ambidexterity is located at the heart is still a necessity to compare the innovative and financial performance impacts of alternative paths of relations comprising the antecedents and consequences of both explorative and exploitative innovation strategies. In this study we aim to develop alternative paths of relations to compare the performance impacts of exploration, exploitation and ambidexterity in order to answer the following research questions: (1) which one is the most influential on innovative and financial performance, exploration, exploitation or ambidexterity; (2) whether the innovative performance plays a mediating role in these relationships or not; and (3) do theories explaining strategic choices in developed countries also apply to the business life of developing nations? Specifically, we propose that market orientation -with responsive and proactive dimensions- plays the role of cultural milieu for the explorative and exploitative innovative strategies to 33

34 Mehmet Şanal, Lütfihak Alpkan, Selim Aren, Bülent Sezen and Yüksel Ayden flourish and innovative performance plays the mediator role that links these strategies to financial performance. The article proceeds in the following manner. We review in the second section the related literature and discuss the possible relations among our study variables, responsive and proactive market orientation, explorative and exploitative innovation strategies, ambidextrous innovation strategy, and innovative and financial performances; after which we develop a theoretical model of hypothesized relations beginning with the market knowledge going through ambidexterity ending up with firm performance. In the third section we explain our methodology of data collection and analysis, and we report on our findings. In the fourth section, the findings are interpreted, managerial and further research implications are forwarded. 2. Theoretical Foundations and Hypotheses 2.1. Market Orientation Market orientation is a set of beliefs and abilities that puts the customer s needs first and focuses on generating, disseminating and using the information about customers and competitors to create superior customer value (Deshpande et al., 1993; Kohli and Jaworski, 1990; Narver and Slater, 1990). Market oriented firms are more systematic and anticipatory about gathering, interpreting and using the market information than other firms (Day, 1994). Many empirical investigations show that being market oriented is associated with high performance (Baker and Sinkula, 2005; Kirca et al., 2005; Qu, 2007). For instance, Yılmaz et al. (2005) suggests that an organization focusing on understanding and satisfying customers should try to acquire, improve, and utilize market knowledge which leads to higher performance. However, market orientation is criticized for limiting organizations from expanding beyond their served markets (Hamel and Prahalad, 1994) and it restricts innovativeness since market oriented firms might extremely overemphasize their existing customers needs (Berthon et al., 1999; Christensen and Bower, 1996). Thus, Narver et. al. (2004) suggest a more comprehensive market orientation concept that consists of two sets of behavior. The first is responsive market orientation which means customerled business (Slater and Narver, 1998) that attempts to discover, to understand, and to satisfy the expressed needs of customers (Narver et al., 2004:335). The second is proactive market orientation in which a business attempts to discover, to understand, and to satisfy the latent needs of customers (Narver et al., 2004:335). A responsive market oriented firm focuses on the market information regarding the current product and market

Linking Market Orientation and Ambidexterity to Financial Returns with the Mediation of Innovative Performance domain to understand and satisfy customers expressed needs whereas a proactive market oriented firm discovers future needs or new market opportunities through market experiments to understand and satisfy customers latent or emerging needs (i.e. the needs the customer is unaware of ) (Atuahene-Gima, 2005; Li et al., 2008). These two types of market orientations may lead to different learning and innovative outcomes. Scholars associate responsive market orientation to adaptive learning (tactical adjustments) on one hand, and relate proactive market orientation to generative learning (fundamental strategic shift) on the other (e.g. Baker and Sinkula, 2005; Morgan and Berthon, 2008). Thus, one can assume that a firm adopting both types of market orientation may pursue at the same time explorative and exploitative strategies. 2.2. Market Orientation and Innovation Strategies Following He and Wong (2004) and Morgan and Berthon (2008), we approach ambidexterity from a strategic choice perspective and operationalize exploitation as exploitative innovation strategy and exploration as explorative innovation strategy. The first aims at improving existing product-market positions, while the latter aims at entering new product-market domains (He and Wong, 2004). Obviously, ambidexterity is the interaction of both. Examining the relations between market orientation and ambidexterity, we should focus separately on their dimensions and discuss the possible associations. Responsive market orientation culture having the potential to produce adaptive learning about the existing market conditions seem to prepare a convenient knowledge basis for the strategists to exploit what is at hand rather than to explore what is new and uncertain. However, proactive market orientation culture seems to force and convince the strategists to run after what is risky but possibly more fruitful, i.e. exploration. Accordingly, a culture of reactive response and a knowledge basis with special emphasis on the expressed needs of existing customers may produce a conservative position restricting the organizational ability and/or intention to pursue breakthrough innovations (Atuahene-Gima and Ko, 2001; Morgan and Berthon, 2008). Similarly, Narver et. al. (2004) argue that although responsiveness may still lead to innovativeness, a firm that aims to be first to market new products and services with cutting edge technological innovation i.e. an innovation leader should be more proactively rather than reactively market oriented. Thus, a responsive market orientation is more suited with the efficiency orientation and exploitation, 35

Mehmet Şanal, Lütfihak Alpkan, Selim Aren, Bülent Sezen and Yüksel Ayden while proactive market orientation is more suited with the change orientation and exploration. Therefore we hypothesize that: H1: The effect of responsive market orientation on exploitative innovation strategy is greater than the effect of proactive market orientation on exploitative innovation strategy. H2: The effect of proactive market orientation on explorative innovation strategy is greater than the effect of responsive market orientation on explorative innovation strategy. 2.3. Innovation Strategies, Innovation Performance and Financial Performance Linking innovation strategies to firm performance may also produce a duality. Either strategy may contribute to different aspects of innovativeness. For instance, an exploitative innovation strategy can increase innovation performance by prioritizing refinement and efficiency; while an explorative innovation strategy can do the same by searching and risk taking. A climate of tolerance for risk taking exerts positive effects on innovativeness (Alpkan et al., 2010). However it is important to clarify which innovation strategy, exploitative or explorative, exerts more positive effects on which type of innovation performance, incremental or radical. We may expect in this matter that if an organization concentrates more on refinement and efficiency, it is more likely to increase its incremental innovation performance. For instance continuous improvement efforts may increase the quality of the product design process (Kitapçi and Sezen, 2007). However, if an organization concentrates more on searching and risk taking then their ability to satisfy existing customers overt needs will not be so high. On the other hand, searching and risk taking if successfully implemented may result in discovery and satisfaction of the customers latent needs through radical innovations. Contrarily, the contribution of exploitation to innovation radicality may be limited since it hinders productivity and causes variety reduction (Atuahene-Gima, 2005; Danneels, 2004). Still, this does not mean that adopting one strategy that is more related to any of the innovation performances will automatically negate the other innovation performance. For instance, exploitation as in the form of refinement and efficiency may still contribute to the selection of better alternatives among radical ideas developed by an explorative approach. 36

Linking Market Orientation and Ambidexterity to Financial Returns with the Mediation of Innovative Performance Similarly exploration efforts may sometimes end up with rather less radical innovations. Thus, we hypothesize that; H3: The effect of exploitative innovation strategy on incremental innovation performance is greater than the effect of explorative innovation strategy on incremental innovation performance. H4: The effect of explorative innovation strategy on radical innovation performance is greater than the effect of exploitative innovation strategy on radical innovation performance. Han, Kim and Srivastava (1998) test and substantiate the mediating role of innovations in the market orientation - performance relation. A similar assertion can be developed from an exploration - exploitation perspective. Firms seek both strategies just in the pursuit of higher financial returns. However, adopting these strategies cannot automatically produce this. Instead, they can indirectly -with the mediation of incremental and radical innovations- produce profitability and sales growth. In other words, since innovation performances are the expected fruits of innovation strategies as discussed above, unless they are increased, the financial performance will not be increased. Given this, a path of positive relations comes into being: incremental innovations primarily based on exploitation may lead to current customer satisfaction that will bring financial success at the end. Another path can also be proposed: radical innovations produced mainly by exploration may create a first come first served advantage that will in return bring higher financial returns. Thus, we hypothesize that; H5: Incremental innovation performance mediates the relation between exploitative innovation strategy and financial performance. H6: Radical innovation performance mediates the relation between explorative innovation strategy and financial performance. 2.4. The Effects of Ambidexterity Li et. al. (2008) propose that explorative and exploitative innovations are the key indicators to organizational ambidexterity. The joint pursuit of both innovation strategies is expected to produce better results than concentrating on either one alone. Following the studies that conceptualize exploitation and exploration as orthogonal simultaneously achievable, orthogonal variables (Baum et al., 2000; Beckman et al., 2004; Gupta et al., 2006; Rothaermel, 2001), we argue that their interaction affects innovation 37

Mehmet Şanal, Lütfihak Alpkan, Selim Aren, Bülent Sezen and Yüksel Ayden performances much more positively. We assume that, since they are not at the expense of one another, they may exert synergetic positive effects. Thus the gains are not the results of only one or the other, but of both. The same logic may apply to the financial results. In this concern, Jansen (2005) implies that compared to organizations that focus on either exploitative or exploratory innovations, ambidextrous organizations obtain higher levels of financial performance. Thus when implemented together, some possible adverse effects of one may be cured by the other. For instance, high experimentation costs and lagged returns of exploration may be neutralized by short term and less risky returns of exploitation. Similarly, exploration can defy imitation by competitors and decrease the captivity towards tough price competition. Thus, asserting that combination of both is more fruitful than separate individual effects, we hypothesize that; H7: The effect of ambidexterity on incremental innovation performance is greater than the individual effects of exploitative and explorative innovation strategies on incremental innovation performance. H8: The effect of ambidexterity on radical innovation performance is greater than individual effects of exploitative and explorative innovation strategies on radical innovation performance. H9: The effect of ambidexterity on financial performance is greater than the individual effects of exploitative and explorative innovation strategies on financial performance. The hypothesized relationships between the study s constructs are delineated in Figure 1. Figure 1. Research framework 38

Linking Market Orientation and Ambidexterity to Financial Returns with the Mediation of Innovative Performance 3. Methodology 3.1. Sample and Data Collection The data used to test the hypothesized relations among the study variables depicted on Figure 1 were collected from a sample of 558 Turkish firms. The member list of the Confederation of Businessmen and Industrialists of Turkey (TUSKON) and Turkey s Top 1000 industrial enterprises list of Istanbul Chamber of Industry (ISO) were used to randomly select responding firms. We sent the questionnaire to the senior executives of 1500 firms in Turkey. In total 589 responses were collected at the end of the survey, representing a response rate of %39.2. We removed missing, inconsistent and doubtful responses from the sample and the usable responses were reduced to 558 firms. 432 of them operate in manufacturing sector and 126 in service industry. 344 of them are small and medium sized firms and 214 are large firms. 3.2. Operationalization and Validation of Scales A questionnaire was developed by using well-established scales from the relevant literature and adding some self-developed questions. The constructs were measured by using multiple-item, five point scales. The scales developed by Deshpande and Farley (1998) and Narver, Slater, and McLachlan (2004) were adopted to measure responsive and proactive market orientation, respectively. Items of exploitative and explorative innovation strategies were adapted and combined from several past studies (Bhoovaraghavan et al., 1996; He and Wong, 2004; Jansen et al., 2006; Markides, 1997; Morgan and Berthon, 2008; Spanos and Lioukas, 2001; Subramaniam and Youndt, 2005; Tushman and Anderson, 1986). Incremental and radical innovation performance items were adapted from Gunday et. al. (2011). Financial performance questions were taken from Auh and Menguc (2005). Ambidexterity construct was measured as a multiplication of exploitation and exploration which were also calculated by taking the average of construct items in their respective factors. For a pilot test of questionnaire items, 40 senior executives from both large firms and SMEs were contacted and through face to face interviews they were asked to evaluate the content and the meanings of the items. Some items were excluded and modified based on the feedback received from these interviews. 39

Mehmet Şanal, Lütfihak Alpkan, Selim Aren, Bülent Sezen and Yüksel Ayden Measure validation procedure included scale reliability, unidimensionality, and convergent and discriminant validity. Both confirmatory and exploratory factor analysis methods were utilized to validate the measures of the study. Some of the constructs were self-developed in this study. In addition, we also used well-established constructs whose validity had been confirmed in general in the western context, but not yet tested in the relatively different culture of Turkish companies. Accordingly, we conducted exploratory factor analysis to reduce the items into resulting variables. Then we conducted confirmatory factor analysis to test for discriminant validity of these variables. The reliability scores and factor loadings are given in Table 1. The coefficient alphas and factor loadings are well beyond the threshold levels suggested by Nunnally (1978) and Fornell and Larcker (1981). SPSS-AMOS has been used for confirmatory factor analysis. The fit indices for the full model including all variables are beyond the acceptable levels. For example, Goodness of Fit Index (GFI) is 0.901; Comparative Fit Index (CFI) is 0.922; Root Mean Square Approximation of Error (RMSEA) is 0.047; and Tucker-Lewis Index (TLI) is 0.914. These statistics prove unidimensionality and convergent validity for the study variables (e.g. Li et al., 2005; Paulraj et al., 2008). Average Variance Extracted (AVE) values for each variable have also been calculated. All AVE values are found above 0.50 proving discriminant validity (Paulraj et al., 2008). As another support for discriminant validity, the correlation values between the variables are lower than the square root of AVE values (e.g. Camisón and López, 2010). Table 1: Factor loadings and reliabilities Factor loadings and reliabilities for Market Orientations Factors Responsive Market Orientation (Cronbach Alpha = 0.725) 1 2 I believe this business exists primarily to serve its customers expressed needs..693 We are more customers focused than our competitors..659 Our strategy for competitive advantage is based on our understanding of customers expressed needs..642 We measure the quality of our services to our customers regularly and systematically.603 Our business objectives are driven primarily by the satisfaction of our existing customers.623 Data on customer satisfaction are disseminated at all levels in this business unit on a regular basis..527 40

Linking Market Orientation and Ambidexterity to Financial Returns with the Mediation of Innovative Performance Proactive Market Orientation (Cronbach Alpha = 0.802) 1 2 We work closely with lead users who try to recognize customer needs months or even years before the majority of the market may recognize them..729 We incorporate solutions to unarticulated customer needs in our new products and services..671 We brainstorm on how customers use our products and services..663 We continuously try to discover additional needs of our customers of which they are unaware..628 We innovate even at the risk of making our own products obsolete..693 We search for opportunities in areas where customers have a difficult time expressing their needs..645 We help our customers anticipate developments in their markets..530 Factor loadings and reliabilities for Innovation Strategies Factors Exploitative Innovation Strategy (Cronbach Alpha = 0.799) 1 2 Capacity utilization of existing production process..784 Efficiency increasing in existing production process.812 Cost decreasing in existing production process.711 Innovations that reinforce and maintain how you currently compete.598 Increasing the existing customers satisfaction from the existing products and services.686 Explorative Innovation Strategy (Cronbach Alpha = 0.673) We develop completely new ideas instead of following our competitors.736 Developing and/or using new technologies.724 Inventing new customer needs and new markets.746 Changing your position in existing markets.559 Factor loadings and reliabilities for Innovation Performances Factors Incremental Innovation Performance (Cronbach Alpha = 0.809) 1 2 Introducing innovations in current products and services to decrease product costs.808 Introducing innovations in components and materials of current products and services to increase product quality.834 Introducing innovations in current products leading to improved ease of use and improved customer satisfaction.801 Radical Innovation Performance (Cronbach Alpha = 0.877) Developing new products with components and materials totally different from the current ones.886 Developing new products with technical specifications and functionalities totally different from the current ones.877 Developing totally new products that are not an extension or a new version of current ones.840 41

Mehmet Şanal, Lütfihak Alpkan, Selim Aren, Bülent Sezen and Yüksel Ayden Factor loadings and reliabilities for Financial Performance Factors Financial Performance (Cronbach Alpha = 0.906) 1 Return on sales (profit/total sales).886 Return on assets (profit/total assets).853 General profitability of the firm.873 Return-on-investment (profit/total investments).847 3.3. Analyses and Hypothesis Testing Items of the scales were transformed into composite scores to perform hypothesis testing. Table 2 reports construct correlations, means, and standard deviations. Table 2: Construct correlations, means, and standard deviations Pearson Correlations Mean Std. Dev. 1 2 3 4 5 6 7 1 2 3 4 5 6 Responsive Market Orientation Proactive Market Orientation Exploitative Innovation Strategy Explorative Innovation Strategy Incremental Innovation Performance Radical Innovation Performance 7 Financial Performance ** p<0.01 * p<0.05 4.2091.55730 3.8524.69181 4.3404.60585 4.1816.62776 4.0609.79613 3.7694.94924 3.8069.90667 1.507 ** 1.355 **.305 ** 1.318 **.426 **.464 ** 1.281 **.367 **.283 **.319 ** 1.220 **.295 **.130 **.269 **.435 ** 1.212 **.257 **.179 **.198 **.379 **.292 ** 1 42

Linking Market Orientation and Ambidexterity to Financial Returns with the Mediation of Innovative Performance Hypotheses were tested by using path analyses in the structural equation modeling software, AMOS. The results of first four regression analyses are summarized in Table 3. In the first regression model, dependent variable is exploitative innovation strategy and the predictor variables are responsive market orientation and proactive market orientation. As can be seen from Table 3, the impact of responsive market orientation on exploitative innovation strategy (EXPLOIT) is greater than that of proactive market orientation on exploitative innovation strategy, thus H1 is supported. In the second model, dependent variable is explorative innovation strategy (EXPLORE) and the predictor variables are again responsive and proactive market orientations. The impact of proactive market orientation on explorative innovation strategy is found greater than the impact of responsive market orientation on explorative innovation strategy, thus H2 is supported. In the third model, the effects of exploitative innovation strategy and explorative innovation strategy on incremental innovation performance have been evaluated. As opposed to our assertion, the effect of exploitative innovation strategy on incremental innovation performance is less than that of explorative innovation strategy on incremental innovation performance, therefore H3 is not supported. In the fourth model, radical innovation performance has been taken as the dependent variable and exploitative and explorative innovation strategies are the predictors. The effect of explorative innovation strategy on radical innovation performance is found greater than the effect of exploitative innovation strategy on radical innovation performance, thus H4 is supported. Table 3: The standardized path estimates and fit statistics for the first four regression models Model 1: Dependent variable: Exploitative Innovation Strategy (EXPLOIT) Path Std. Estimate Significance Hypothesis Proactive market orientation EXPLOIT.193 < 0.01 H1 Supported Responsive market orientation EXPLOIT.406 < 0.01 Chi-square /Degrees of freedom = 3.061, Goodness of fit index (GFI) =.934, Comparative fit index (CFI) =.91, Root mean square error of approximation (RMSEA) =.061 43

Mehmet Şanal, Lütfihak Alpkan, Selim Aren, Bülent Sezen and Yüksel Ayden Model 2: Dependent variable: Explorative Innovation Strategy (EXPLORE) Path Std. Estimate Significance Hypothesis Proactive market orientation EXPLORE.541 < 0.01 H2 Supported Responsive market orientation EXPLORE.168 < 0.01 Chi-square /Degrees of freedom = 3.325, Goodness of fit index (GFI) =.934, Comparative fit index (CFI) =.899, Root mean square error of approximation (RMSEA) =.065 Model 3: Dependent variable: Incremental Innovation Performance (INCINNPER) Path Std. Estimate Significance Hypothesis Exploitative innovation strategy INCINNPER.205 < 0.01 H3 Not Supported Explorative innovation strategy INCINNPER.481 < 0.01 Chi-square /Degrees of freedom = 3.746, Goodness of fit index (GFI) =.953, Comparative fit index (CFI) =.925, Root mean square error of approximation (RMSEA) =.07 Model 4: Dependent variable: Radical Innovation Performance (RADINNPER) Path Std. Estimate Significance Hypothesis Exploitative innovation strategy RADINNPER.005.922 H4 Supported Explorative innovation strategy RADINNPER.443 < 0.01 Chi-square /Degrees of freedom = 3.832, Goodness of fit index (GFI) =.951, Comparative fit index (CFI) =.935, Root mean square error of approximation (RMSEA) =.071 Table 4: The standardized path estimates and fit statistics for the path model testing hypothesis 5 Dependent variable: Financial Performance (FINPER) Path (First Model) Std. Estimate Significance Hypothesis EXPLOIT INCINNPER.377 < 0.01 EXPLOIT FINPER.044.383 H5 Supported INCINNPER FINPER.491 < 0.01 Chi-square /Degrees of freedom = 1.488, Goodness of fit index (GFI) =.979, Comparative fit index (CFI) =.992, Root mean square error of approximation (RMSEA) =.030 44

Linking Market Orientation and Ambidexterity to Financial Returns with the Mediation of Innovative Performance Path (Second Model) Std. Estimate Significance Hypothesis EXPLOIT INCINNPER.382 < 0.01 H5 Supported INCINNPER FINPER.511 < 0.01 Chi-square /Degrees of freedom = 1.473, Goodness of fit index (GFI) =.978, Comparative fit index (CFI) =.992, Root mean square error of approximation (RMSEA) =.029 Table 5: The standardized path estimates and fit statistics for the path model testing hypothesis 6 Dependent variable: Financial Performance (FINPER) Path (First Model) Std. Estimate Significance Hypothesis EXPLORE RADINNPER.349 < 0.01 EXPLORE FINPER.091.103 H6 Supported RADINNPER FINPER.357 < 0.01 Chi-square /Degrees of freedom = 1.414, Goodness of fit index (GFI) =.982, Comparative fit index (CFI) =.994, Root mean square error of approximation (RMSEA) =.027 Path (Second Model) Std. Estimate Significance Hypothesis EXPLORE RADINNPER.353 < 0.01 H6 Supported RADINNPER FINPER.391 < 0.01 Chi-square /Degrees of freedom = 1.446, Goodness of fit index (GFI) =.981, Comparative fit index (CFI) =.994, Root mean square error of approximation (RMSEA) =.028 The mediation effect of incremental innovation performance on the relation between exploitative innovation strategy and financial performance was tested first by using a partially mediated path model including both direct and indirect paths from exploitative innovation strategy to financial performance. As can be seen from Table 4, the resulting fit indices show a good fit. In this model, the direct effect of exploitative innovation strategy on financial performance is not significant. We further analyze the second model in which the direct effect of exploitative innovation strategy on financial performance is deleted. This second model also shows a good fit and the chi-square differences between these models are not significant. Therefore, we conclude that incremental innovation performance fully 45

Mehmet Şanal, Lütfihak Alpkan, Selim Aren, Bülent Sezen and Yüksel Ayden mediates the relation between exploitative innovation strategy and financial performance, thus H5 is supported. The other hypothesized mediating effect was the mediation of radical innovation performance on the relation between explorative innovation strategy and financial performance. This hypothesis was tested in a similar manner; first by using a partially mediated path model including both direct and indirect paths from explorative innovation strategy to financial performance, and then removing the direct path from the model. Table 5 shows the resulting fit indices for the first model, which indicate an acceptable fit. The direct effect of explorative innovation strategy on financial performance is not significant. Again, in the second model the direct effect of explorative innovation strategy on financial performance is excluded. The second model also shows a good fit and the chi-square differences between these models are not significant. Therefore, we conclude that radical innovation performance fully mediates the relation between explorative innovation strategy and financial performance, thus H6 is supported. Table 6: The standardized path estimates and fit statistics for the path model testing hypotheses 7and 8 Path Std. Estimate Significance Hypothesis AMBIDEXTERITY INCINNPER.440 < 0.01 H7 Supported AMBIDEXTERITY RADINNPER.286 < 0.01 H8 Supported EXPLOIT INCINNPER -.124.01 EXPLOIT RADINNPER -.204 < 0.01 EXPLORE INCINNPER.065.011 EXPLORE RADINNPER.119 < 0.01 Chi-square /Degrees of freedom = 4.129, Goodness of fit index (GFI) =.919, Comparative fit index (CFI) =.946, Root mean square error of approximation (RMSEA) =.075 46

Linking Market Orientation and Ambidexterity to Financial Returns with the Mediation of Innovative Performance Table 7: The standardized path estimates and fit statistics for the path model testing hypothesis 9 Dependent variable: Financial Performance (FINPER) Path (First Model) Std. Estimate Significance Hypothesis AMBIDEXTERITY FINPER.245 < 0.01 H9 Supported EXPLOIT FINPER.209 < 0.01 EXPLORE FINPER.171 < 0.01 Chi-square /Degrees of freedom = 4.126, Goodness of fit index (GFI) =.932, Comparative fit index (CFI) =.912, Root mean square error of approximation (RMSEA) =.075 In order to test for hypotheses 7 and 8, a path model including ambidexterity, incremental and radical innovation performance, and exploitative and explorative innovation strategy variables have been developed. The standardized regression weights for this particular model can be seen in Table 6. The effect of ambidexterity on incremental innovation performance has been found to be greater than (a) the effect of exploitative innovation strategy on incremental innovation performance, and (b) the effect of explorative innovation strategies on incremental innovation performance. The effect of ambidexterity on radical innovation performance is also greater than (a) the effect of exploitative innovation strategy on radical innovation performance, and (b) the effect of explorative innovation strategies on radical innovation performance. Thus H7 and H8 are supported. Finally, hypothesis 9 was tested by using a path model including exploitative and explorative innovation strategies and ambidexterity as the independent variables and the financial performance as the dependent variable. Table 7 reports the standardized path estimates and fit statistics for this path model. The effect of ambidexterity on financial performance is found greater than (a) the effect of exploitative innovation strategy on financial performance, and (b) the effect of explorative innovation strategies on financial performance, thus H9 is supported. 4. Discussion Our findings indicate that both market orientations impact positively on innovation strategies. Specifically, responsive market orientation impacts more on exploitative innovation strategy, while proactive market orientation impacts more on explorative innovation strategy. These findings confirm 47

Mehmet Şanal, Lütfihak Alpkan, Selim Aren, Bülent Sezen and Yüksel Ayden recent studies (e.g. Morgan and Berthon, 2008; Narver et al., 2004) which imply that while a proactive culture is more compatible with exploration, a reactive culture is more suited with exploitation. Another set of findings is about innovation strategies and innovation performances. The effect of explorative innovation strategy on both incremental and radical innovation performances is greater than that of exploitative innovation strategy; while the latter is not even influential on radical innovations. A plausible explanation for the stronger effect of explorative innovation strategy on incremental innovation performance may be related to the potential of explorative efforts for the creation of novel ideas about not only radical but also incremental changes. Moreover in some circumstances some explorative efforts with the expectation of radical innovations might end up with only incremental ones. Thus efforts for search, variation, risk taking, and flexibility are necessary even for incremental innovations, but efforts for refinement and efficiency are not contributing to radical innovations. As for the effects of innovation strategies on financial performance, it is found that incremental innovation performance mediates the relation between exploitative innovation strategy and financial performance, and also that radical innovation performance mediates the relation between explorative innovation strategy and financial performance. In other words in order to increase financial returns, first of all innovation strategies should produce the innovations that they aim. Thus innovation is the link between strategy and financial results. Han, Kim and Srivastava (1998) have already found that innovation plays a mediating role in the market orientation - performance relation. Our findings confirm and enlarge this path of relations by adding innovation strategies into it. In other words a market oriented culture provides a suitable milieu for innovative efforts, especially explorative efforts that bring higher financial performance only through incremental and radical innovations. Another interesting finding is that exploitation is more effective on financial performance compared to exploration which in turn is more effective on innovation performances. This means that solely focusing on exploration or innovation is not enough for higher financial returns. Thus ambidexterity is a must. According to past research, although not confirmed in many of the empirical studies, ambidexterity has a synergetic power that increases firm performance more than its orthogonal constituents. In our study, this is also confirmed. The effects of ambidexterity on incremental and radical innovation performances 48

Linking Market Orientation and Ambidexterity to Financial Returns with the Mediation of Innovative Performance and financial performance are found higher than the effects of exploitative and explorative innovation strategies. Considering above findings, practitioners should keep in mind that exploration alone may produce both radical and incremental innovations that will bring long run financial returns, but may also produce inefficiency in the short run and that exploitation alone might not produce radical innovations but may guarantee short term financial efficiency. Not only organizations but also individual managers should keep in mind in their planning, implementation and control activities a combined attention to both innovativeness and efficiency. An ambidextrous approach can be built on relevant market information. In order to establish such a convenient milieu for both exploration and exploitation to flourish, market orientation i.e. generation and dissemination of both overt and latent market knowledge is a must. A market oriented culture should not only be proactive to support explorative strategies and innovativeness, but also be responsive to support exploitative efforts and efficiency. Over-specialization on either one is not suggested both at organizational and individual level. This study has a number of limitations and further research implications. Financial performance has been measured subjectively from the same respondent in every firm and at the same time with the independent variables. In future studies, longitudinal research on multiple respondents and objectively measured multiple aspects of firm performance may be utilized. Moderators and other dependent variables such as market dynamism and learning and entrepreneurial orientations may be added to the model. To conclude, our study in a developing nation context confirms the generally accepted ambidexterity hypothesis by adding market orientation to the big picture. As expected, a combined prioritization between innovation strategies rather than a dedicated concentration on any isolated strategy seems to be more fruitful in terms of innovativeness and financial efficiency. 49

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