THE PROFITABILITY OF INNOVATING FIRMS

This article seeks to evaluate the effects on corporate profitability of producing a major innovation. We examine two types of effect: innov ations can have a direct but transitory effect on profitability associ ated with the production of a new product or the use of a new process, and innovations can have an indirect effect on how firms generate pro fits because they signal the transformation of a firm's internal capab ilities associated with the process of innovating. Positive direct eff ects on the order of 2.1 million pounds spread over seven years are ob served for a sample of 721 large, quoted U.K. firms. More fundamentall y, large indirect effects are also observed, not least because innovat ing firms seem to be more able to benefit from spillovers and are rela tively insensitive to adverse macroeconomic shocks. These indirect eff ects associated with the transformation of a firm's internal capabilit ies may be as much as three times larger than the direct effects of in novation.