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Interactive budgeting, product innovation, and firm performance: empirical evidence from Finnish firms

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Abstract

Innovation has generally been considered essential to the prosperity of firms. The existing innovation literature does not emphasize budgeting as an important contributor to product innovation, even though it recognizes that poor budgeting may weaken the capability to innovate. However, the budgeting literature suggests that budgets can be used in different ways to improve firm performance. The purpose of this study is to investigate how the frequency of budget preparation and the interactive use of budgets are associated with product innovation and firm performance. The empirical data were collected, through a web-based survey, from CFOs and CEOs in 132 Finnish firms. The results of our partial least squares analysis indicate that the frequency of budget preparation positively affects product innovation through interactive budget use, which supports our hypothesis. Furthermore, the frequency of budget preparation and interactive budget use do have a direct positive relationship with firm performance, but one mediated by product innovation. Therefore, this study contributes to the innovation and budgeting literature by showing the frequency of budget preparation and interactive use of budgets to be two separate and important factors in product innovation. The results also show that the relationship between budgets and product innovation and performance are different in defender and prospector firms.

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Notes

  1. According to Simons (1994), MCSs can be used either interactively or diagnostically. They are used diagnostically when applied to monitor organizational outcomes and correct deviations from present standards of performance. The purpose of diagnostic systems is to track variances from preset goals and manage by exception (Simons 1994). However, the separation between interactive and diagnostic use might be unclear such as found by Bisbe et al. (2007) who propose interactive control systems to be an ambiguous concept.

  2. There is a difference between firm capabilities/resources and outcomes. Henri (2006) measures innovation as a resource, while Bisbe and Otley (2004), as followed in this study, measures innovation as an outcome. However, Henri (2006) found the interactive use of MCSs to positively influence innovation capability.

  3. The linkage between firm innovation and performance can be justified also by the RBV of the firm (Barney et al. 2001; Porter Michael 1985; Henri 2006). The competitive advantage of a company is based on capabilities that are difficult to duplicate and substitute (Barney et al. 2001; Henri 2006). The capability to innovate products is an example of such capabilities, and there is evidence that it is positively correlated with overall performance (Bisbe and Otley 2004), and specifically with financial performance (Dunk 2011).

  4. We did not manage to contact 11 respondents, resulting in 489 firms in the final sample. There might be reasons that we did not manage to contact all respondents: we might have had wrong e-mail address, or the respondent may have been absent or not accepted e-mails from unknown senders, or the e-mail might have fallen foul of a junk mail filter.

  5. In addition, we compared the relationships of the model variables in different subsamples and found clear differences as a sign of nonexistence of common method bias. We also applied the unrotated factor analysis to all items of the model and found six separate factors with Eigenvalue over 1 (see Podsakoff et al. 2003).

  6. We used the orthogonal Varimax rotation throughout the component analyses because it results in linearly independent factors that are easily interpretable and useful in statistical analyses.

  7. The sample could be split in a way that values 1–2 represent defenders, 3–5 represent analyzers, and 6–7 represent prospectors. However, we did not use these types of subsamples because the responses were not equally represented in all strategy types. There was a small number of responses in two subsamples: nine responses for defenders, 94 responses for analyzers, and 29 responses for prospectors.

  8. We used a Varimax rotation of factor analysis in Panels A–D.

  9. We also estimated the PLS model without INTER1and INTER2 to assess their effect on the relationship between budget preparation frequency and the interactive use of budgets. The resulting path coefficient was 0.376 instead of the original coefficient 0.436, but this did not affect our conclusions.

Abbreviations

\(\bullet \) :

This study shows that the frequency of budget preparation and the interactive use of budgets affect both product innovation and firm performance.

\(\bullet \) :

Interactive budget use is positively associated with product innovation.

\(\bullet \) :

The frequency of budget preparation has a positive relationship with product innovation when budgets are used interactively.

\(\bullet \) :

The frequency of budget preparation and interactive budget use have a positive relationship with firm performance, but one mediated by product innovation.

\(\bullet \) :

Product innovation has a positive relationship with financial and non-financial performance.

\(\bullet \) :

Interactive budgeting has a positive relationship with product innovation in defender firms but not in prospector firms.

\(\bullet \) :

Budget preparation frequency has a negative relationship with non-financial performance in prospector firms.

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Acknowledgments

The contributions of the companies responding to the survey are gratefully acknowledged. We also appreciate the constructive comments of three reviewers and the editor.

Author information

Authors and Affiliations

  1. Faculty of Business Studies, University of Vaasa, P.O. Box 700, 65101, Vaasa, Finland

    Erkki K. Laitinen, Aapo Länsiluoto & Soila Salonen

  2. Seinäjoki University of Applied Sciences, P.O. Box 412, 60101, Seinäjoki, Finland

    Aapo Länsiluoto

Authors
  1. Erkki K. Laitinen
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  2. Aapo Länsiluoto
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Corresponding author

Correspondence to Aapo Länsiluoto.

Appendices

Appendices

1.1 Appendix 1: Description of the constructs

Panel A. Operative budgeting frequency of preparation

Which of the following budgets are prepared in your firm and how often? (7-point scale: 1 \(=\) not used ... 4 \(=\) used at times ... 7 \(=\) systematically)

  • OPER1. Operative budget, yearly.

  • OPER2. Operative budget, half-yearly.

  • OPER3. Operative budget, quarterly.

  • OPER4. Operative budget, monthly.

  • OPER5. Operative budget, weekly.

Panel B. Interactive budgeting

To what extent do you agree or disagree with the following statements? (On a 7-point scale: 1 \(=\) totally disagree ... 7 \(=\) totally agree)

  • INTER1. The budget process is continuous and demands regular and frequent attention from managers at all levels.

  • INTER2. There is a lot of interaction between top management and department/unit managers in the budget process.

  • INTER3. Managers use the budget process to discuss changes occurring in the firm with peers and subordinates.

  • INTER4. Managers use budgeting information as a means of questioning and debating the ongoing decisions and actions of lower-level managers.

  • INTER5. Budget tracking reports also play a central role in management discussions when there are no deviations from plans.

Panel C. Product innovation

To what is the extent do the following statements describe your company? (On a 7-point scale: 1 \(=\) not at all ... 7 \(=\) very well)

  • INNO1. During the last three years, we have launched more new products in the market than the industry average.

  • INNO2. Our firm is more often first-in-market with new products compared with the industry average.

  • INNO3. The percentage of new products launched in the product portfolio is much higher than the industry average.

  • INNO4. Our firm has probably more new products at the developmental phase to be launched next year than the industry average.

Panel D. Performance

In comparison with the industry average, how would you qualify the performance of your company over the last three years in terms of the following indicators? (On 7-point scale: 1 \(=\) well below the average ... 4 \(=\) about average ... 7 \(=\) well above the average)

  • PERF1. Rate of sales growth.

  • PERF2. Rate of profit growth.

  • PERF3. Return on investment.

  • PERF4. Profit/sales ratio.

  • PERF5. Increase in market share.

  • PERF6. Customer satisfaction.

  • PERF7. Customer retention.

  • PERF8. Acquisition of new customers.

Panel E. Perceived environmental uncertainty.

What is your perception of the relative predictability of the following eight items of the firm’s environment? (On 7-point scale: 1 \(=\) very predictable... 7 \(=\) very unpredictable)

  • PEU1. Suppliers’ actions

  • PEU2. Customer demands, tastes and preferences

  • PEU3. Deregulation and globalization

  • PEU4. Market activities of competitors

  • PEU5. Production and information technologies

  • PEU6. Government regulation and policies

  • PEU7. Economic environment

  • PEU8. Industrial relations

Panel F. Strategy

How the following descriptions most closely fit the strategy of your firm compared to other firms in the industry (on 7-point scale: 1 \(=\) defender, 4 \(=\) analyzer, 7 \(=\) prospector).

Defender (=1) This type of organization attempts to locate and maintain a secure niche in a relatively stable product or service area. The organization tends to offer a more limited range of products or services than its competitors, and it tries to protect its domain by offering higher quality, superior service, lower prices, and so forth. Often this type of organization is not at the forefront of developments in the industry—it tends to ignore industry changes that have no direct influence on current areas of operation and concentrates instead on doing the best job possible in a limited area.

Analyzer (=4) This type of organization attempts to maintain a stable, limited line of products or services, while at the same time moving out quickly to follow a carefully selected set of the more promising new developments in the industry. The organization is seldom “first in” with new products or services. However, by carefully monitoring the actions of major competitors in areas compatible with its stable product-market base, the organization can frequently be “second in” with a more cost-efficient product or service.

Prospector (=7) This type of organization typically operates within a broad product-market domain that undergoes periodic redefinition. The organization values being “first in” in new product and market areas even if not all of these efforts prove to be highly profitable. The organization responds rapidly to early signals concerning areas of opportunity, and these responses often lead to a new round of competitive actions. However, this type of organization may not maintain market strength in all of the areas it enters.

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Laitinen, E.K., Länsiluoto, A. & Salonen, S. Interactive budgeting, product innovation, and firm performance: empirical evidence from Finnish firms. J Manag Control 27, 293–322 (2016). https://doi.org/10.1007/s00187-016-0237-2

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