How firm innovativeness and unexpected product reliability failures affect profitability
| Author | Alan W. Mackelprang,Marco Habermann,Morgan Swink |
| Published date | 01 September 2015 |
| Date | 01 September 2015 |
| DOI | http://doi.org/10.1016/j.jom.2015.06.001 |
Journal
of
Operations
Management
38
(2015)
71–86
Contents
lists
available
at
ScienceDirect
Journal
of
Operations
Management
j
o
ur
na
l
ho
mepage:
www.elsevier.com/locate
/jom
How
firm
innovativeness
and
unexpected
product
reliability
failures
affect
profitability
Alan
W.
Mackelpranga,∗,
Marco
Habermannb,
Morgan
Swinkc
aDepartment
of
Logistics
and
Supply
Chain
Management,
College
of
Business
Administration,
Georgia
Southern
University,
PO
Box
8036,
Statesboro,
GA
30460,
USA
bDepartment
of
Management,
College
of
Business,
Ohio
University,
Copeland
Hall,
Athens,
OH
45701,
USA
cDepartment
of
Information
Systems
and
Supply
Chain
Management,
Neeley
School
of
Business,
TCU
Box
298530,
Fort
Worth,
TX
76129,
USA
a
r
t
i
c
l
e
i
n
f
o
Article
history:
Received
5
December
2013
Received
in
revised
form
5
April
2015
Accepted
8
June
2015
Available
online
25
June
2015
Accepted
by
Daniel
R.
Guide
Keywords:
Innovation
strategy
Product
quality
Firm
performance
Empirical
Warranty
claims
Longitudinal
a
b
s
t
r
a
c
t
This
study
examines
relationships
among
a
firm’s
innovativeness,
its
unexpected
product
failure
costs,
and
financial
performance.
When
a
firm
chooses
to
develop
more
innovative
products
and
processes,
product
reliability
outcomes
become
more
uncertain.
These
uncertainties
in
turn
may
lead
to
unexpected
warranty
claims
costs,
as
well
as
other
costs
that
can
erode
the
advantages
of
an
innovation
leadership
position.
This
study
empirically
tests
these
propositions
using
publically
reported
warranty
and
financial
data
from
2003
to
2013,
representing
482
unique
firms.
Consistent
with
prior
studies,
our
estimation
of
the
direct
effects
of
firm
innovativeness
on
financial
performance
shows
an
inverted–u–shaped
rela-
tionship.
Importantly,
we
find
that
more
innovative
firms
also
experience
more
unexpected
product
failure
costs,
and,
consistent
with
organizational
information
processing
theory,
the
negative
impacts
of
these
costs
on
financial
performance
extend
well
beyond
the
direct
costs
associated
with
remediating
warranty
claims.
Further,
we
find
that
this
relationship
is
robust
to
differing
levels
of
industry
innova-
tiveness.
Hence,
our
study
suggests
that
product
failure
risks
associated
with
firm
innovativeness
are
significant,
and
act
to
at
least
partially
offset
the
financial
benefits
of
innovation
leadership.
In
addition,
standard
accounting
for
product
warranty
claims
may
substantially
understate
the
true
costs
associated
with
product
failures,
which
appear
to
generate
significant
SG&A,
fixed
asset,
and
inventory
costs
above
and
beyond
direct
warranty
processing
costs.
Our
study
also
demonstrates
a
novel
usage
of
warranty
claims
data.
We
discuss
the
implications
of
these
findings
for
both
managers
and
researchers.
©
2015
Elsevier
B.V.
All
rights
reserved.
1.
Introduction
In
order
to
grow
profits
and
to
gain
competitive
advantages,
firms
often
invest
in
R&D
efforts
to
develop
innovative
new
prod-
ucts
and
processes
(McDermott,
1999).
Many
researchers
and
business
writers
extol
the
benefits
of
such
efforts.
However,
inno-
vation
also
has
risks,
particularly
in
areas
of
product
quality.
The
complex,
multidimensional
nature
of
product
quality
offers
numerous
management
challenges,
as
well
as
opportunities
for
dif-
ferentiation
and
competitive
advantage
(Powell,
1995;
Flynn
et
al.,
1995;
Kim
et
al.,
2012).
In
this
study,
we
focus
on
product
reliabil-
ity,
as
a
dimension
of
product
quality
that
is
impacted
by
design
choices
made
in
the
development
of
new
products
and
produc-
tion
processes.
Product
reliability
indicates
how
well
a
product’s
∗Corresponding
author.
E-mail
addresses:
amackelprang@georgiasouthern.edu
(A.W.
Mackelprang),
haberman@ohio.edu
(M.
Habermann),
M.Swink@tcu.edu
(M.
Swink).
performance
in
the
field
matches
its
specified
functionality;
it
is
the
ability
of
a
system
or
component
to
function
under
stated
conditions
for
a
specified
period
of
time
(IEEE,
1990).
Reliability
failures
may
occur
because
of
product
design
limitations
and/or
production
limitations
(Ramdas
and
Randall,
2008).
Because
prod-
uct
reliability
potentially
affects
both
revenues
and
costs,
its
effects
on
a
firm’s
profits
are
not
easy
to
predict.
Moreover,
these
effects
are
seemingly
dependent
on
strategic
positioning
and
market
factors,
further
clouding
the
issue
(Garvin,
1988).
When
innovative
firms
seek
to
develop
new
products
and
processes,
they
must
balance
sales
benefits
of
enhanced
product
performance
and
novelty
against
the
cost
detriments
that
poten-
tially
arise
from
unpredictable
product
reliability.
As
an
example,
consider
innovations
offered
by
BMW
in
recent
years.
BMW
designers
have
often
been
the
first
to
market
automobiles
with
enhanced
functionality
and
new,
technology-based
features.
Often,
these
design
choices
involve
greater
risks
of
product
reliability
failures
that
stem
from
increased
complexity
(e.g.,
more
electron-
ics
and
degrees
of
motion
in
drivers’
seats),
unproven
product
http://dx.doi.org/10.1016/j.jom.2015.06.001
0272-6963/©
2015
Elsevier
B.V.
All
rights
reserved.
72
A.W.
Mackelprang
et
al.
/
Journal
of
Operations
Management
38
(2015)
71–86
technologies,
and
inexperience
with
production
technologies.
As
a
result,
BMW’s
most
innovative
automobiles
have
often
had
among
the
poorest
of
reliability
records
(O’Donnell,
2003).
Such
exam-
ples
abound.
For
example,
Thirumalai
and
Sinha
(2011)
state
that
“while
healthcare
providers
constantly
attempt
to
adopt
innovative
devices
in
the
best
interests
of
the
patients,
they
are
often
stymied
in
their
attempts
by
the
high
incidence
of
defects
in
medical
devices.”
Such
reliability
failures
increase
both
the
number
of
prod-
uct
warranty
claims
and
the
costs
of
processing
them.
Importantly,
uncertainties
associated
with
innovation
make
it
more
difficult
for
firms
to
accurately
predict,
and
adequately
preplan
for,
these
product
failures
and
associated
claims
(Galbraith,
1974).
The
BMW
example
above
illustrates
a
trade-off
between
inno-
vation
and
uncertain
reliability.
Firms
that
develop
many
new
and
more
radical
product
and
process
designs
might
extend
prod-
uct
functionality
and
desirability,
yet
because
of
uncertainty,
they
also
increase
the
possibility
of
unexpected
failures,
which
in
turn
increase
warranty
claims
costs,
and
possibly
other
associated
costs.
At
the
same
time,
innovators
such
as
BMW
often
enjoy
first-mover
advantages
that
allow
them
to
gain
market
share
and
to
charge
higher
prices.
While
BMW
has
indeed
experienced
numerous
reli-
ability
problems,
its
profits
have
been
consistently
healthy.
Such
trade-offs
engender
strategic
positioning
with
respect
to
design
choices;
where
one
firm
in
an
industry
might
choose
to
be
a
lead
innovator,
as
defined
by
relative
R&D
intensity
within
its
industry,
while
another
might
choose
to
be
a
fast
follower.
Lead
innovators
incur
greater
risks
of
unexpected
failures,
largely
due
to
a
lack
of
necessary
information.
Fast
followers
might
avoid
these
risks,
yet
they
forfeit
first-mover
advantages
(Lieberman
and
Montgomery,
1988).
The
foregoing
discussion
raises
the
following
questions,
which
motivate
our
research
study.
First,
do
firms
that
position
them-
selves
within
their
industry
as
leading
innovators
suffer
greater
costs
from
unexpected
warranty
claims
that
arise
from
product
reli-
ability
failures?
If
so,
do
these
unexpected
claims
have
any
effect
on
firm
financial
performance
beyond
direct
additions
to
warranty
claims
costs?
Further,
are
these
costs
significant
enough
to
offset
the
other
profit
benefits
of
being
a
lead
innovator?
And
finally,
how
does
industry
context
(industry
innovativeness)
affect
these
relationships?
While
the
innovation
and
product
reliability
literatures
are
both
quite
large,
they
have
not
addressed
these
questions
empirically.
Recent
meta-analyses
of
empirical
research
on
firm
innovative-
ness
confirm
that
innovativeness
generally
has
positive
effects
on
financial
performance
(Rosenbusch
et
al.,
2011;
Rubera
and
Kirca,
2012),
though
econometric
analyses
suggest
that
the
rela-
tionship
is
curvilinear
(inverted-u-shaped)
(Yeh
et
al.,
2010).
In
addition,
these
reviews
identify
many
moderators
of
the
innovativeness–performance
link,
along
with
antecedents
and
other
consequences
of
innovation,
yet
none
have
addressed
the
potential
product
reliability
risks
associated
with
more
innova-
tive
products.
Research
of
product
reliability
issues
tends
to
focus
on
engineering
design
considerations,
on
design
of
related
war-
ranty
policies
(e.g.,
duration,
breadth
of
coverage,
limitations:
see
Murthy,
2006;
Huang
et
al.,
2007),
or
on
customer
responses
to
product
failures
and
product
recalls
(e.g.,
Archer
and
Wesolowsky,
1996;
Rhee
and
Haunschild,
2006).
In
addition,
a
large
operations
management
literature
on
the
management
of
product
quality
neglects
the
relationship
of
innovativeness
to
product
reliability,
instead
mostly
focusing
on
design
and
manufacturing
practices
(e.g.,
Ahire
and
Dreyfus,
2000;
Nair,
2006).
We
consider
it
important
to
address
this
gap
in
the
litera-
ture,
for
several
reasons.
Firms
appear
to
be
increasingly
pursuing
innovativeness
as
a
point
of
differentiation
within
their
indus-
tries
in
competing
for
market
demand
(Adner
and
Levinthal,
2001),
and
they
may
be
more
likely
to
neglect
the
consideration
of
unknown
effects
of
novel
product
and
process
design
choices
on
product
reliability
outcomes
and
related
costs.
As
designers
push
the
boundaries
of
complexity
and
novelty
in
product
and
process
designs,
they
are
often
unable
to
specify
product
and
pro-
cess
parameters
that
guarantee
perfect
functionality.
Further,
as
Ramdas
and
Randall
(2008)
demonstrate
product
design
choices
(e.g.,
regarding
component
commonality)
can
affect
the
propensity
for
production
flaws.
These
effects
combine
to
contribute
to
the
innovativeness–reliability
trade-off
in
product
design.
Offerings
of
more
novel
and
radically
new
products
and
supporting
processes
may
increase
product
appeal
for
customers,
but
they
also
likely
introduce
greater
levels
of
uncertainty
and
opportunity
for
prod-
uct
failures.
We
believe
it
is
important
to
investigate
and
quantify
these
effects,
so
that
managers
can
include
these
issues
into
the
cal-
culus
that
they
use
to
justify
and
develop
new
product
and
process
proposals.
From
a
perspective
of
theory,
proposed
explanations
of
the
effects
of
firm
innovativeness
on
performance
tend
to
build
upon
Schumpeter’s
(1942)
theory
of
profit
extraction,
that
is,
innova-
tion
gives
a
firm
at
least
a
short
term,
quasi-monopoly
position,
until
imitations
or
replacement
products
emerge
in
the
market-
place.
However,
this
perspective
ignores
the
possible
damage
to
the
firm’s
position
that
occurs
when
novel
products
and
processes
fail
to
perform
as
promised.
Additionally,
Organizational
Informa-
tion
Processing
Theory
(OIPT)
(Galbraith,
1973;
Galbraith,
1974;
Daft
and
Lengel,
1986)
suggests
that
organizations
are
limited
in
their
abilities
to
preplan
and
optimize
the
execution
of
activities
that
involve
uncertainty.
In
such
situations,
organizations
often
choose
to
increase
their
ability
to
respond/adapt
by
employing
slack
or
buffer
resources
such
as
inventories
and
excess
capacities
(Galbraith,
1974).
Given
the
high
degree
of
uncertainty
surrounding
the
reliability
performance
of
novel
products
and
processes,
costs
are
likely
to
be
raised
as
firms
seek
to
minimize
uncertainty
effects
through
increased
inventory
and
production
buffers.
If
product
reli-
ability
was
perfectly
known,
the
organization
would
be
fully
able
to
preplan
responses
for
chosen
levels
of
product
reliability,
without
requiring
significant
slack
resources.
Thus,
as
a
first
step,
it
is
important
to
examine
the
magnitude
of
the
effect
of
unexpected
reliability
failure
costs
on
a
firm’s
profits,
along
with
investigating
industry
innovativeness
as
a
condition
by
which
the
costs
might
be
amplified,
and
a
firm’s
monopoly
position
weakened.
Innovative
industries
exhibit
rapidly
changing
techno-
logical
conditions
and
short
product
life
cycles
(Davidow,
1986).
Associated
time
pressures
incentivize
firms
to
accelerate
the
pro-
cess
of
assessing
product
reliability
in
order
to
shorten
new
product
time-to-market,
but
doing
so
may
also
produce
more
uncertain
product
reliability
levels.
In
sum,
our
study
is
important
because
it
is
an
initial
effort
at
assessing
a
previously
neglected
factor
in
linking
innovativeness
to
performance,
and
because
it
provides
a
fuller
picture
of
trade-
offs
related
to
product
and
process
design,
warranty,
and
quality
related
planning.
Our
study
also
makes
a
methodological
contribu-
tion
in
that
it
extends
the
literature
on
the
usefulness
of
warranty
claims
as
a
proxy
measure
of
external
product
quality;
we
are
the
first
to
use
newly
available
claims
data,
while
controlling
for
differ-
ences
in
warranty
policy.
Using
accounts
that
state
a
firm’s
warranty
reserves
and
accruals
(which
are
indicators
of
warranty
policy
cov-
erage),
we
construct
a
new
variable,
“unexpected
product
failure
costs,”
which
gives
a
measure
of
uncertainty
in
product
reliabil-
ity
outcomes.
Overall,
our
study
extends
the
literature
on
quality
management
as
a
strategic
choice
that
involves
design
factors
that
affect
both
production
and
market
risks.
The
next
section
describes
the
relevant
extant
research
on
strategic
choices
and
the
role
of
product
quality
in
firm
compet-
itiveness.
Following
this,
we
outline
our
hypotheses,
which
are
followed
by
a
description
of
our
data,
methodology
and
results.
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