BUSINESS ENVIRONMENT, INNOVATION CAPABILITY AND BUSINESS PERFORMANCE: EMPIRICAL STUDY OF JAKARTA’S FLOUR BASED FOOD SMEs

This study is concerned on the relationship between innovation capability and business performance in small and medium enterprises context. The existing studies generally have analyzed the issues pertaining of innovation capability in large business or knowledge intensive firm context. By researching of the innovation capability of small and medium enterprises (SME's) , it wil l review innovation capability in a broader and novel context. The S M E ' s operate in a competi t ive environment and are not very advanced technologically. This research proposes statistical hypotheses to study these based on data samples. By employing path analysis, This research test the relationship between innovation categories and business performance. The result of our study show that government regulation directly affects to innovation capability, product and process innovation capability directly affect business performance in SME's . Finally, managerial implication will be discussed.


Introduction
Economic development has long been an area of interest to people, communities, and the governments that serve them. Through economic development and economic growth, jobs are created, income is generated, and the quality of life is improved in both relative and absolute terms. Practice in the developed country like Indonesia has demonstrated that economic development is a prerequisite for the prosperity of the nation.
There are three significant economic trends have altered our nation's competitive position, leading to today's "new economy". First, increased globalization of the economy has hampered state efforts to at track and retains industry. The competition among nations increased, so the state effort focused to increase the competitiveness of the industry. Because small business enterprises (SME's), have a big portion in the economy, so the in:q)rovement in the small business management will be improve the economic condition as whole (Caniels and Romijn, 2005). How to make SME's survive in the global competition is the main agenda of the economic policy in many countries. Second, the rapid growth of the service sector has reduced the dependence on manufacturing. The mature economy will be dominated by the service sector, so the development of SME's have to focused to the inprovement of small service business sector. The SME's has to give more attention to the service management and service sector, which was neglected in the past. Finally, technological advances have decreased the time and cost associated with communication, processing information and simultaneously led to the growth of technology industries and technology based business. Technology not exclusively privileged to the big companies anymore. The SME's activities can also use and develop the technology to improve their business process as well as increase their performance. Technologies enable the spread of innovation more widely and quickly. Technological advances during the latter part of the 20* century have been key contributors to the trends of globalization and dominance of service sector in the recent economy. In short, the most significant contribution to the change of the global economy has been innovation. For example, the increasing information technology use has led to more efficient and higher volume production of good and service around the world. The productivity increases resulting from information technology investments have played an important role in overall transition to the new economy.
In the other side, SME's face the government regulations as factors that influence their business. Several result highlight the importance of the government support for the growth and development of the SME's businesses. Barriers to develop a business are significantly and negatively correlated with business innovation. The fewer the procedures required to develop a business, the greater the number of business advancement. If government reduce to starting business and ease access to credit, rates of business innovation might grow.
As a result of these combined changes (the dynamism of business environment and government regulations), today we find ourselves in a so called new economy in which knowledge and innovation are the dominant economic forces. Knowledge intensive worker had a great contribution to the new economy era. Globalization, service sector growth, and technological innovation are the principal components of this new economic regime.

Literature Review and Hypotheses Development 2.1. SME's Innovation
SME's play a major role in countries at all levels of economic development. They generate much employment and are widely considered to be vital for competitiveness and economic growth. In developing countries, like Indonesia, very substantial numbers of poor working people rely for their livelihood on employment in SME's. SME's become the critical backbone for the economic development. Unfortunately globalization and technology tend to give much more opportunity for the big business. Frequently the role of SME's neglected by the national economic decision maker. In fact the hyper competition in the global economy, pose the same treat to the existence of SME's, competitive pressures are increasing at the same time. SME's was in the weak position in the global competition envkonment. Their economics of scale and the resource is less than the large companies. Although, some scholar argues that SME's are often more fertile then larger furns in term of innovation (Afiiah, 1998). Their comparative advantages over large firms in innovation are their flexibility and speed of response. SME's may enjoy greater flexibility because of the simplicity of their internal process and have the great adaptability to response with the business environmental changes. This flexibility allowing dispersed bits of knowledge are combined, new knowledge that no one had previously anticipated may be created (Tolstoy, 2009). But in reahty, only a small segment of the SME's sector is capable of making full use of new business and coping effectively with threats without assistance. This situation reveals in the need to suggest or find more efficient management processes that allow SME's to achieve a better performance.
In the era of hyper competition, restructuring, lowering costs and enhancing product or service quality are no longer sufficient. Porter (1998) argued that companies must be able to create and commercialize a stream of new product and processes that extend the technology frontier, while at the same time keeping a step or two ahead of their rivals.
Innovation has been a dominant factor in maintaining worldwide competitiveness (Martin et al., 2009). One of the key sources of competitive advantage is the ability of the company to iimovate. Some people argue that we are living in the age of innovation. The ability to innovate considered a vital factor to the success in the global conpetition economy. From a micro point of view, innovation is management discipline: it focuses on the organization's mission, searches for unique opportunities, determines whether they fit the organization's strategic direction, defines the measures for success, and continually reassesses opportunities (Gaynor, 2002). But, in fact innovation has a multi facet, a multidimensional form of innovation, including technological, marketing, administrative and strategic irmovation. The type and phase of innovation, especially in the SME's should be on the research agenda, because each other have different characteristics. There are an increasing number of studies on the main competitive forces of SME's, one of them is innovation.
(Brown and Eisenhardt in Lin and Chen, 2007) found that the majority research in the innovation domain focuses on product innovation in a manufacturing context. It is not weird because the innovation in product is more tangible and easy to measure than in the other form of innovation. But along with the complexity of business process, this uni-dimensional approach is not appropriate anymore (Wright et al., 2005). From an organizational perspective, real innovation success resides in the marketplace. Not in the end product, but in the process to increase customer value that use the product. And also, in process to transform a good idea and good product into sales revenue and profit. In addition, a company must also strive to institutionalize innovation in the long term. They have to establishing an appropriate culture, structure, incentives, systems and processes that facilitate innovation to occur as part of daily business (Lin and Chen 2007). This is the strategic side of innovation in the company. To make irmovation as a corporate culture in the company that guarantees the conpetitive advantage in the long term. To obtain a corporate culture innovation firm have to invest more in intangible resources, but it is quite problematic because usually SME's didn't have enough economic of scale and resources to support their activities. To solve this problem, with the great flexibility and adaptability, SME's form an alliances and cooperation with the othei-s SME's to obtain the advantages of being large and, at the same time, keep the advantages of SME's in term of speciaUzations, reduction in costs and flexibUity (Pil and Holweg, 2003).
According to resource based view theory, the internal resources and capabiUties of the firm are the main element to reach a competitive advantage in the context of the competitive environment. In this way, the firms that devote their internal forces (in this context is the ability to innovate) has the ability to exploit the opportunities of the environment and to neutralize threats, while avoiding weak points, are more liable to obtain competitive advantages than those that do not the same. The resource based view approach based of competitive advantages on two concept: resources and capabilities. Resources are those intangible and tangible assets linked to the fu-m in a semi permanent way, whereas capabilities are related to the way of accomplishing different activities, depending on the availability of resources (Grant. 1996).
This research constructs one hypothesis and two sub-hypotheses regarding the SME's innovation. Those hypotheses are: Hi : Business environment directly affects irmovation capability. Hia : Dynamism directly affects innovation capability. Hib : Government regulation directly affects mnovation capability.

Innovation and Performance
There is no doubt that the 21^ century will be credited as the century of innovation. But, the empirical studies, declare that the relationship between irmovation and performance is still complicated. Some scholar argues that innovation had a positive impact on firm's performance (Wolff andPett, 2006, Sanchez andMarin, 2005)) but the other does not agree with that matter. Some author (Mick and Foumier, 1998) note that increasing levels of irmovation may create hesitancy in a consumer, in terms of irmovation adaptation, due to fear of buying products that may quickly be supersede by lower cost, higher performing versions, or for fear of adopting unproven technology. The higher irmovation increases the rejection by the consumer of the product, because they are not familiar with the product. (Damanpour in Lin and Chen, 2007) argued that the association between irmovation and fmn performance depends on the performance measurement and the characteristics of a given organization.
The blurring relation between irmovation and performance make confusion. To clearing the confusion, innovation activities are generally categorized as either incremental or radical. The distinction between these two different types illustrates how organizations approach innovation in different ways. A cumulative series of minor changes or introducing something similar to previous organizational practices is called an incremental or routine innovation, whereas an abrupt major change or doing something markedly different from what the organization had done before is called a radical innovation. Although there has been debate over which type of irmovating activity is more important and effective, the more astute managers understand the necessity for both. But in the long term radical irmovation is positively related to organizational performance of SME's, while in the short term incremental innovation is positively related to organizational performance of SME's. Lin and Chen (2007) provides another piece of evidence that irmovation does not necessarily result in better company sales (company performance). This empirical result based on the bottom line criterion of sales clearly indicated that innovation is not a panacea. Conqjanies that have fantasies about irmovation need to face the reality that when all is said and done, the key may be a system wide dedication to hard, focused, and purposeful work achieved through processes and strategic irmovation, not only focuses in the product irmovation.
Conq)eting in an international area challenges the company to become more irmovative, because it is the key to stay competitive nowadays. Going global is a daunting task for some SME's that generally lack sufficient manpower, financial resources, language ability and international perspective. Besides, a majority of the SME's are family enterprises which generally choose to stay small and staffed by family members only. SME's must find another ways to increase the capability to irmovate in the environment that has limited resources. With alliances, SME's should be able to reach an economic scale as a group and maintain internally autonomous as well. The advance of technology, especially information technology, make easier to find the alliances partner around the world.
The sanpling frame for research were flour based SME's. This kind of business is dominated the SME's sector in Indonesia. The food small industry in Indonesia usually involves the food based flour. Although this kind of industry had big segment in the food market in Indonesia, the raw material of this industry still imported. As a tropical countries Indonesia couldn't produce the wheat agriculture. The regulations about the import of this kind of products have been great impact to the SME's in this industry. So to anticipate of this kind of regulation the SME's must make an innovation in their process and the Manajemen & Bisnis, Volume X, Nomor 1, Maret 2009 product based floor.
This research develops one main hypothesis and three sub-hypotheses for irmovation and performance issues. Those hypotheses are: H2 : Irmovation capability directly affects business performance. Hia : Product irmovation directly affects business performance. Hib : Process irmovation directly affects business performance. Hic • Management innovation directly affects business performance.

Research Method 3.1. Data Collection
The sampling frame for the research were flour based SME's listed in Atma Jaya SME's Directory. The data sources were reviewed and screened to develop a sampling selection. Firms that provide relevant information were identified as sample members. Because of the diversity of the production capacity, the selected firms were categorized into three groups. The first group is named the big group. They consume wheat flour more than 750 bags/ month. The second group is the medium one. The firms in this group need the flour in the range 250-750 bags/month. The last is the small group. They consume the flour less than 250 bags/month. The small one is the dominant player in the business. In order to achieve the representativeness of the sampling frame, this research employed the proportional stratified random sanqjling. The formula of the equation is:

n= (NZNhSh^)/{N^(d^/Z^) + (2;NhSh^)}
whereas the sample size for each category is : nh = {(NhSh)/(lNhSh2)}x n N = the number of sampling frame Nh = the number of SME's per category • 1 = the small group 2 = the medium group 3 = the big group Sh = varians of each category <. D = level of significance Z = the normal distribution score (Zscore) For the level of significant (a) = 5%, then Z = 1,96 The numbers of the firms in the san5)ling frame were 346 firms. They consisted of 137 firms in the small group, 113 firms in the medium one, 96 firms in the big one. By employing the proportional stratified random sanq)ling, this research had 146 firms. After we subtracted with the 19 non response firms, this research had 118 firms that consisted of 55 firms in the small group, 42 firms in the medium one, and 21 in the big one.
The data collection proceeded in Oct 2005. It consisted of two phases. The first phase was a pre test, which randomly selected one fums from each of the three groups. The second phase was the questionnaire distribution. The questiormaire was pre tested by conducting in depth interview with the entrepreneurs as key informants. The modification of the wording and the V. Rachmadi Paraiono dan Y. Eko Widodo structm-e of the question were introduced. The questiormaire was again pretested to 3 business subject lecturers from Atma Jaya University. Based on the findings, adaptations were applied and then questiormaire was finalized.

Research Variables
This research developed a three part self reporting questiormaire. The furst part of the questiormaire was developed to ask for the business envirormient. This research adapted business envirormient construct developed by Li (2000). Business envirorunent was measured with a five-point Likerl scale (l=very slow to 5=very fast). In the second part of the questiormaire, this research adapted irmovation capability construct. It developed by Tsai et al.,(2001).
According to Tsai et al.,(2001), innovation capability consists of product irmovation, process irmovation and management irmovation. Respondents were asked to elaborate on the changes were introduce and specify the three types of irmovation capability that the fnm had applied in the last 3 years. This research used a five-point Likert scale (l=totally disagree to 5=totally agree) to measure the constructs. The third part of the questiormaire asked for the respondents to assess their business performance. The measurement of business performance used a five point Likert scale (l=declining to 5=growth). Business performance can be measured in any number of ways, ranging from objective measures to subjective assessment (Delmar in Freel and Robson, 2004). Since the lack of the SMEs business performance data, this research used subjective assessment to measure in this research.

Result and Discussions
The aim of this research is to confirm the relationship among business envirormient, irmovation capability and business performance. A path analysis is used to test theoretical model that specify causal relationships between a numbers of observed variables. Path analysis is an appropriate tool for measuring the relationships between the business envirormient and irmovation capability, and the relationship between irmovation capability and business performance. This research proposed model for the business envirormient, innovation capability and business performance.  According to Tabic 1, this research know that regulation directly affected the product irmovation. Meanwhile, the product irmovation and process irmovation directly affected the business performance. In the model refining process, the path link: dynamism-process irmovation; regulation-process irmovation; dynamism-management irmovation; regulation-management innovation; and management irmovation-business performance were excluded due to statistically insignificant relationship.

Business Environment and Innovation Capability
The result from the path model, this research exclude the path link: dynamism-product irmovation, dynamism-process irmovation, dynamismmanagement irmovation, government regulation-process irmovation and government regulation-management irmovation. They were excluded due to statistically insignificant.
The effect of the business environment on irmovation capability is mattered Innovation have recently seen as a way in which fums can survive and benefit from the changes in their environment. Irmovation capability is affected by identifiable environmental factors. According to our research, government regulations had a significant inq)act to stimulate and foster irmovation capability. Regulatory features of products affect a fum's capacity to innovate. Some evidences suggested that some government regulations have lead to the changing of operation management of SME's and stimulating new product developments. For instance, the increasing of oil price as a part of dynamism of environment has spurred the SME's to launch a more efficient and market friendly new product. The restriction of additive substances to food product application as a part of government regulation had the firms find a new way to preserve the product. New product is developed based on the dynamic of government regulations. These evidences indicate that SME's still think that the government role is more dominant driver for their business, including in influencing irmovation capability building.

Innovation Capability and Business Environment
The results of the study indicate significant relationship between innovation capability and business performance. The major contribution to business performance comes from product and process irmovation capability. Product irmovation recorded higher contribution than process innovation.
It is true that firms need to develop new products to gain competitive advantage. Product innovation has been identified as a strategic tool crucial to survival of firms. The absence of the management irmovation capability lead to business performance is only confirming the pervasiveness of poor management V. Rachmadi Pamiono dan Y. Eko Widodo skills. Imiovation needs an eclectic base of managerial competency. Poor planning, lack of financial evaluation, lack of fimctional expertise and discontinuity of management staffs are exan^les of the management deficiency faced by the fums.

Conclusion
The findings of this research have shown that in response to the uncertainty business environment, the SME's have anticipated with the innovation capability development. The government regulations have been a dominant driver to stimulate innovation capability development. Then, it is suggested that the changing business environment should not be avoided, but remains necessary to innovation capability development. While it could have negative effects on the efficiency of innovation activity, it remains the critical input in the process of knowledge creation. The effectiveness of the outcome of innovation does not necessary imply to the business performance. That means that product, process, and management innovation may not always lead to enhance business performance. This is a dilemma for SME's in which developed innovation capability. The results of the study should lead for further research into a number of areas. It is important to know whether or not the results of this study can be generalized and whether theories on innovation capability in SME's can be developed.