Background: Innovation is recognised as one of the most important determinant of organisational performance. Yet, the results of studies that investigate the relationship between innovation and organisational performance are inconclusive. The inconsistency has been attributed to a number of factors, which include, among others, the measures used to evaluate organisational performance.

Aim: This study was set out to identify, categorise and critically analyse the instruments used to assess organisational performance when investigating the relationship between innovation and organisational performance.

Setting: The study focuses on all scientific publications reporting on organisational performance, inclusive of both financial and non-financial indicators of performance, and are not limited to any specific country or industry.

Methods: The systematic literature review methodology was used to identify studies which investigated the relationship between innovation and organisational performance. Once identified, articles were analysed on the way organisational performance was measured. Classification was done with reference to financial and non-financial indicators, accounting and market-based, as well as objective and subjective measures.

Results: The findings show that profitability, sales growth and return on assets (ROA) are the most preferred accounting-based financial measures of organisation performance. In addition, Tobin’s Q was found to be the most favoured market-based financial measure of organisational performance. The study further reveals that market share, customer satisfaction and productivity are the most popular non-financial-based measures of organisational performance.

Conclusion: The use of measures of organisational performance is often left to the discussion of the researcher, which is not implicitly wrong, but does little to contribute to the body of knowledge on this important topic. Researchers are firstly urged to clearly define which aspects of organisational performance they intend to study, secondly to use established instruments or often used indicators of organisational performance, and thirdly to combine both objective and subjective measures of organisational performance. This would allow for researchers to build on the work of other and strengthen the body of knowledge in this area.

Introduction

Organisational performance is an important indicator of organisational success (Stegerean & Gavrea 2010). Apart from organisational performance, organisational success also relates to employee skills levels, personnel development, quality of strategic planning and the ability to understand and adapt to the nature and dynamics of the business environment (Carvalho et al. 2016). However, organisational performance is arguably the most important indicator of organisational success and one of the most important variables in management research (Stegerean & Gavrea 2010).

Research indicates that organisational performance is influenced by innovation (Durán-Vázquez, Lorenzo-Valdés & Moreno-Quezada 2012; Likar, Kopa & Fatur 2014; Nybakk & Jenssen 2012; Oke, Walumbwa & Myers 2012; Yen 2013). Undertaking research on these constructs is important to organisations as managers should be aware of the impact of different variables on organisational performance in order to manage them in an effective manner (Bigliardi 2013; Ndregjoni & Elmazi 2012). Yen (2013), for example, states that the facilitation of innovation is an important management function that can be directly linked to organisational performance.

An important aspect to consider when evaluating innovation efforts and organisational performance is the time factor, given that there is a time lag between innovation initiatives and the outcome that follows (Likar et al. 2014). In fact, O’Connor et al. (2008) state that the time lag between innovation and its impact on organisational performance ranges from 3 to 6 years. It is important to note this, as a focus on short term indicators (e.g. return on investment [ROI], sales growth and operating income) may be inappropriate and may indicate that innovation strategies are not working, while the effect may only be visible in the longer term (Ndregjoni & Elmazi 2012).

Although the study of organisational performance has been at the core of management research, very little has been done with regard to appropriate measures to assess the effectiveness of innovation initiatives. In addition, a cursory review of the literature shows that researchers focus on the discussion around typologies of organisational performance on financial and non-financial aspects, with very little attention to other dimensions, such as objective and subjective measures. The present study, therefore, aims primarily to investigate the most frequently used instruments. The results of this investigation will then be used as a lens through which to investigate which typologies (financial vs. non-financial; objective vs. subjective) of organisational performance were adopted and further to investigate whether the instruments selected played a role in the outcome of the study. This will result in the compilation of a more comprehensive and updated literature review that can form the basis for future research when selecting measures of organisational performance.

Problem statement and objective

The results of studies that investigate the relationship between innovation and organisational performance are inconclusive, with some studies (Carvalho et al. 2016; Cortez et al. 2015; Mafini 2015) showing a positive relationship, while others showed mixed results or no relationship with no definite conclusion (Hervas-Oliver, Sempere-Ripoll & Boronat-Moll 2014; Simachev, Kuzyk & Feygina 2015). This inconsistency has been attributed to a number of factors, including, among others, the measures used to evaluate organisational performance.

In an attempt to understand these inconsistences, Rubera and Kirca (2012) conducted a meta-analysis in a quest to better understand a firm-innovativeness-performance relationship, drawing on the chain-of-effects model as a unifying framework. The study revealed that the size of the firm, the sector in which the firm operates and the nature of innovation (radical innovation, for example) adopted can influence the relationship between innovation and organisational performance. However, although Rubera and Kirca’s study is significant in many ways, the study did not investigate whether the type of instruments used to measure organisational performance can also influence the relationship between these constructs. This reveals a gap in the literature and shows the need for a critical review of the influence of the type of instruments used to measure organisational performance on the reported relationship between innovation and organisational performance.

Therefore, the objective of this study is twofold: firstly, the study seeks to investigate the most frequently used instruments and, secondly, the study will investigate whether the type of instruments used does influence the nature of the relationship between these constructs.

Measures of organisational performance

The construct of organisational performance is central to the understanding of organisational success and the factors responsible for that variation (Hoopes, Hadsen & Walker 2003). In order to get an accurate and comparative gauge of the variation mentioned, valid and reliable measures are necessary (Saunders 2012). Although several methods for measuring organisational performance exist, these methods can be classified into two main categories, namely financial and non-financial performance measurement (Maltz, Shenhar & Reilly 2003; Shin et al. 2015).

Financial performance measurement

Despite the general consensus among scholars that a firm’s performance is a multidimensional construct, one of the most extensively used measures is the financial component – the fulfilment of the economic goal of the organisation (Gentry & Shen 2010). This is in line with Davidson’s (2003) argument that the primary goal (aim) of management is to generate profit and to maximise shareholder value. Important to note is that scholars who embark on empirical studies employ a number of different measures to evaluate financial performance (Berger & Bonaccorsi di Patti 2003; Davidson 2003).

The literature research reveals that to assess the financial aspects of organisational performance, researchers generally use either accounting-based measures, such as profitability, sales growth, return on assets (ROA), return on sales (ROS), return on equity (ROE) and/or ROI, or stock market measures, such as Tobin’s Q and price earning (P/E) ratio (Hult et al. 2008; Likar et al. 2014; Nawaz, Hassan & Shaukat 2014; Tsao & Lien 2013).

In the 1980s, researchers primarily used accounting-based measures of financial performance (Hoskisson et al. 1999). However, with the rise of shareholder activism in the late 1980s and early 1990s, organisations started adopting shareholder value maximisation as a measure of financial performance (Useem 1993). This paradigm shift promoted the adoption of market-based performance measures in management research (Hoskisson et al. 1999).

Despite its limitations, profit maximisation remains one of the key measures of organisational performance (Garg, Joubert & Pellissier 2004). Various researchers use growth as a sole measure of performance, while others choose to combine growth and profitability (Likar et al. 2014). However, most researchers prefer to combine ROS, ROA, ROE and ROI because they complement one another. The use of a single ratio generally does not provide sufficient information to allow investors to judge the overall performance of the firm (Marx 2004). For instance, ROA allows analysts to evaluate the effectiveness and efficiency of the firm’s management and employees in generating profit by productively using assets (Firer et al. 2008). On the contrary, ROS allows analysts to evaluate the effectiveness and efficiency of the firm’s management and employees in generating profit by means of sales (Karanja 2011; Marx 2004).

For the sake of clarity, a short explanation of the aforementioned measures has been provided in Table 1.

According to Campbell and Mínguez-Vera (2008), accounting-based measures are useful because they provide useful objective measures of organisational performance. However, various authors (Fernandez 2001; Frigo 2003; Smith 2007) argue that accounting measures only reflect the history, both in terms of income statements, which explain what happened in a certain year, and those of the balance sheet, which reflects the state of the firm’s assets and liabilities at a certain point in time. As such, it is impossible for accounting-based measures to measure value creation.

The challenge of uncovering the true financial value of innovation is a result of practices such as international financial reporting standards (IFRS) not adequately reflecting innovation expenditure (Frigo 2003; Smith 2007). IFRS forces the recording of the immediate expense of investment and thus creates a challenge owing to the time lag between innovation expenditure and the effect it has on financial performance. This leads to a situation in which researchers will need to correlate initial expenditure with a product that will only emerge a few years later (Selby 2010).

Despite the need to measure the effects of innovation, Morris (2008) convincingly argues that measuring innovation presents a problem in itself, because innovation involves venturing into the unknown. Therefore, if one tries to pin down these unknowns too quickly, they may become harder to recognise. In addition, when measuring the impact of innovation, the innovation lifespan should also be put into perspective (Eggink 2011). For instance, sustaining innovation is continuous in nature and as such there is no beginning and no end to the innovation process (OECD/Eurostat 2005). Moreover, different types of innovation will have different lifespans. For example, some innovations will last for a very long time while others may have a short lifespan.

Several market-related measures are proposed in order to account for the long-tern benefits of innovation in an organisation. These include Tobin’s Q and price earning (P/E):

Despite the intuitive appeal of the above-mentioned measures of the stock market (Lubatkin & Shrieves 1986), the assumption of market-efficiency has been questioned by prominent scholars in finance (Tobin 1969). Bettis (1983) argues that, even if the market-efficiency theory holds, stock price does not necessarily reflect its fundamental value because it is influenced by what management chooses to disclose to the investors. Acknowledging that neither accounting nor market-based measures are perfect, management researchers have accepted measures based on both accounting and stock market as valid for assessing organisational performance (Hoskisson et al. 1999). In support of this view, Shook et al. (2004) agree and argue that in order to improve the quality of construct measurement, a stream of management researchers prefer using multiple indicators to measure key constructs and then use the structural equation modelling technique (SEM) to do the analysis. For instance, Tsao and Lien (2013) used both ROA and Tobin’s Q whereas Talke, Salomo and Kock (2011) and Padgett and Moura-Leite (2012) decided to use Tobin’s Q exclusively, mainly because of its ability to capture the value of long-term investment such as innovation.

Non-financial performance measurement

According to Ndregjoni and Elmazi (2012), non-financial measures must also be assessed in order to evaluate overall performance, for two main reasons. Firstly, several interest groups are involved in the business and they all have particular goals and expectations related to the organisation. Secondly, the strategic business areas are not necessarily financial in nature. As a result, several approaches to non-financial indicators exist, such as customer satisfaction and retention, market share, productivity, operational effectiveness and efficiency, reputation, branding and quality (Battor & Battor 2010; Tsai & Tsai 2010; Oke et al. 2012; Ul Hassan et al. 2013).

Alam (2003), after examining the literature on new product performance measures, proposes three performance dimensions for determining the success of new products, namely financial criteria, customer criteria and opportunity criteria. As indicated by other scholars, financial criteria include financial indicators of new products such as profitability, sales, cost, ROI and market share. The second dimension (customer criteria) refers to customer satisfaction and how new products attract new customers and create new market opportunities. The third dimension (opportunity criteria) is much broader in scope as it relates to overall opportunity that can be created by new products. These include, among others, unlocking opportunities for existing products, providing a platform for developing other new products and acquiring skills and experience, as a result of new product development projects.

More recently, Gentry and Shen (2010) conducted an extensive literature review on organisational performance with the aim of contributing to the debate concerning appropriate measures of organisational performance. They concluded that the use of both financial and non-financial measures is the most appropriate and sound approach to measure organisational performance. However, the authors further argue that the use of financial aspects of performance as a sole measure is not necessarily wrong, but they emphasise that researchers should always clearly define which aspects of organisational performance they intend to study, and then develop and test the hypotheses around that. All of the above should be viewed against the background research against which organisational performance is measured, namely objectively and subjectively.

Objective versus subjective measures

Objective measures are the absolute values of a firm’s actual performance (Battor & Battor 2010) and subjective measures generally ask respondents to assess their company’s performance relative to that of their competitors (Greenley 1995). For instance, objective financial measures are audited financial data such as sales, profit or asset values (Rajan & Reichelstein 2009). By contrast, the term ‘subjective measure’ is used to mean that the company’s performance is derived from direct observations by management, financial analysts or employee perceptions about organisational performance (Dawes 1999). By virtue of its nature, objective measures are verifiable whereas subjective measures cannot be verified (Rajan & Reichelstein 2009).

Method

This study adopted two generic steps central to the systematic review methodology (Nightingale 2009), namely defining the search strategy, and then selecting relevant studies by applying the inclusion and exclusion criteria. Originating in medical science, a systematic review differs from conversional reviews in that it aims at synthesising research in a systematic, transparent and reproducible manner (Tranfield, Denyer & Smart 2003). A systematic literature review uses explicit, thorough methods to identify, select, appraise and synthesise a set of research studies on a well-defined topic (Robson et al. 2007). The primary aim of this review was to identify and report on the instruments used in prior studies that investigated the relationship between innovation and organisational performance, and to identify the most frequently used instruments as well as the rationale behind choosing those instruments.

The keywords ‘innovation’ (innov*) and ‘performance’ (perform*) were used in the search. The options (criteria) selected for the search were full text, peer-reviewed and scholarly journals. Target articles needed to match both keywords in a title. Fifty-eight databases on the major database (presented in Box 1-A1), EBSCOhost, were searched for articles and 120 articles were retrieved. Articles whose abstract indicated that either financial or non-financial performance was used as a measure of organisational performance, which were published in English in the last 5 years and where the full text was available were included in the study. Only 71 articles (Table 1-A1) met these criteria.

Findings and discussion

In the sample of 71 studies, five studies (Articles 10; 17; 19; 40 and 46) focused exclusively on non-financial measures, 29 studies (Articles 2; 6; 7; 9; 11; 12; 15; 20; 25; 26; 27; 30; 32; 34; 36; 39; 43; 45; 47; 51; 52; 55; 56; 60; 61; 65; 69; 70 and 71) focused exclusively on the financial component and 37 studies (Articles 1; 3; 4; 5; 8; 13; 14; 16; 18; 21; 22; 23; 24; 28; 29; 31; 33; 35; 37; 38; 41; 42; 44; 48; 49; 50; 53; 54; 57; 58; 59; 62; 63; 64; 66; 67 and 68) combined both the financial and non-financial instruments to measure organisational performance. The financial (accounting and market) measures are discussed first, followed immediately by the non-financial measures.

Financial measures

The different instruments used to measure financial performance in the sample of 71 studies are presented in Table 2. From the sample of 71, a total of 16 financial instruments (profit, sales growth, ROA, ROI, turnover, ROE, ROS, Tobin’s Q, operating costs, market to book, income, cash flow, basic earning power, long-term debt, inventory turnover and EPS) were used to measure financial performance.

In support of the argument by Cho and Pucik (2005), Table 2 shows that profitability, despite its weaknesses in measuring long-term investment, is by far the most preferred financial indicator used to measure financial performance, with a staggering 29 studies opting to use this measure, followed by sales growth with 28 studies. The most cited reason for using profitability and sales growth to measure organisational performance is twofold. Firstly, authors argue that innovative behaviour leads to improved operational performance such as cost efficiency, quality improvement and speed to market, which ultimately results in higher profitability and sales growth (Cambra-Fierro et al. 2011; Ul Hassan et al. 2013). Secondly, authors (Basterretxea & Martinez 2012; Cortez & Cudia 2010; Forsman & Temel 2011) argue that both profitability and sales growth are the most common indicators used in prior studies to measure organisational performance and, as such, enable a comparison between the output of prior studies and the study in question.

In agreement with literature, ROA completes the top three most commonly used instruments to measure financial performance. Consistent with the rationale for using profitability and sales growth instruments, ROA, ROS, ROI and ROE are generally selected for their popularity in prior studies that investigated innovation and organisational performance (Postruznik & Moretti 2012; Rubera & Kirca 2012). Similarly, revenue is preferred because it can be directly linked to innovation activities and it is also a commonly used indicator in prior studies (Eris & Ozmen 2012; Likar et al. 2014).

Tobin’s Q is the most preferred market-based measure of financial performance, with five studies opting to use this measure. In contrast to the reasons provided for using accounting-based measures, Tobin’s Q is used mainly because of its ability to capture the value of long-term investment, such as innovation investment (Padgett & Moura-Leite 2012; Sivakumar et al. 2011; Talke et al. 2011). Furthermore, Table 2 illustrates that financial instruments, such as operating cost, market to book, income, cash flow, basic earning power, inventory turnover and EPS are not so popular among innovation scholars, despite Selby (2010) presenting a good argument for the use of EPS as a measure of organisational performance, owing to its strength in capturing future expected earnings.

Non-financial measures

Table 3 presents the instruments used to measure non-financial aspects of organisational performance when investigating the relationship between innovation and organisational performance. From the sample of 71 studies, a total of 10 instruments (market share, customer satisfaction, productivity, operational efficiency, employment growth, quality, competitiveness, reputation or branding, product attractiveness and quick to market) were used to measure non-financial aspects of organisational performance. Table 3 reveals that market share (14 studies), customer satisfaction and retention (12 studies) and productivity (10 studies) are the most popular instruments used to measure non-financial components of organisational performance. Interesting to note is that there are no reasons provided for why the measures were selected. However, one can infer that market dominance, customer satisfaction and productivity were chosen because they are easy to measure and they provide useful information to gauge whether a company is doing well or not.

Other studies used competitiveness, branding, product attractiveness and quick to market as instruments to measure organisational performance. Studies that focused exclusively on non-financial aspects of organisational performance prefer to use the top three frequently used measures, namely customer satisfaction (Modi 2012; Oke et al. 2012; Walker, Damanpour & Devece 2011), market share (Adner & Kapoor 2010) and productivity (Ito & Lechevalier 2010).

Subjective versus objective

Only three studies (Articles 50, 53 and 54) used both objective and subjective measures. In two studies (Articles 50 and 53), the results of the study revealed mixed results and in one study (Article 54), the results showed that innovation leads to superior organisational performance. Despite the importance of using both objective and subjective measures, a considerable number of studies adopted either subjective or objective measures of organisational performance.

Subjective measures

Table 4 presents the article reference number of studies (see Table 1-A1) that used the subjective measures of organisational performance and the findings of the studies that investigated the relationship between innovation and organisational performance.

As stated in the literature, subjective measures are perceived organisational performance, where respondents are requested to assess their company’s performance relative to that of their competitors. Of the 71 studies that investigated the relationship between innovation and organisational performance, 43 studies used the subjective measures of organisational performance. The findings provide overwhelming evidence (41 studies) indicating innovation is positively and significantly related to organisational performance. In contrast, two studies found mixed results.

Objective measures

Table 5 depicts authors and hypothesis results of studies that used objective measures of organisational performance on the relationship between innovation and organisational performance. Objective measures, the absolute values of a firm’s actual performance, are generally sourced from an independent body such as a stock exchange.

Table 5 shows that when objective measures of organisational performance are used, the higher number of studies reveals mixed results. This suggests that the type of instrument used might also influence the results in studies that investigate the relationship between innovation and organisational performance. For example, the study conducted by Likar et al. (2014) showed innovation is significantly and positively related to performance when measured using ROE, whereas the same study revealed no relationship when ROS and ROA were used. Table 5 shows that, of the 25 studies that investigated the relationship between innovation and organisational performance, 13 found a positive relationship and 12 found mixed results.

Managerial implication

The primary purpose of this study is to report on the instruments used to measure organisational performance and investigate whether the type of instrument used influences the results of those studies that investigated the relationship between innovation and organisational performance. Using the systematic review methodology, this study finds that combining both financial and non-financial measures is touted as the most effective measure of organisational performance. In total, 37 studies use both financial and non-financial measures, which constitute 50.7% of the overall sample of articles. However, a substantial number of authors still prefer to use financial measures as the sole measure of organisational performance, with 29 studies focusing exclusively on the financial measures, which constitute 40.8% of the overall sample. The sole use of financial indicators as a proxy for organisational performance may be informed by the popular notion that ultimately the goal of the organisation is to maximise profit in the short term and to maximise shareholder value in the long-term.

In addition, the study provides evidence that profitability, sales growth, ROA, ROS, ROI, ROE and turnover are the most preferred accounting measures for financial performance. Similarly, the study further reveals that Tobin’s Q is the most favoured market-related measure used by innovation scholars to measure financial aspects of organisational performance.

On the contrary, market share, customer satisfaction and productivity measures are reported as the most preferred non-financial measures of organisational performance. This study provides clear evidence that the use of non-financial measures as a sole measure is not a common trend, with only 5 (7%) of 71 studies opting to exclusively use non-financial measures to measure organisational performance.

The use of any specific measure of organisational performance is not implicitly wrong, but Gentry and Shen (2010) urge that researchers should always be cautious in their approach and clearly define which aspects of organisational performance they intend to study, and then develop and test hypotheses around that defined area.

When findings were studied, this study showed that organisations that practise innovative behaviour generally exhibit superior organisational performance relative to organisations with less innovative behaviour. The study showed that 54 studies, which constitute 76% of the overall sample, supported the hypothesis that innovation leads to superior organisational performance. In addition, the findings also showed that 60.6% of the overall sample used the subjective measures of organisational performance, relative to only 35.2% which used objective measures of organisational performance. When objective measures were used, the findings reveal that a higher number of studies (48%) showed mixed results, no relationship or negative relationship, relative to 0.05% which showed mixed results, no relationship or negative relationship when subjective measures are used. This finding suggests that the selection of the instruments to measure organisational performance does influence the outcome of the results, as shown in studies that investigate the relationship between innovation and organisational performance.

Thus, the implications of the research for both researchers and practitioners can be divided into two main areas:

Conclusion

In conclusion, this finding supports the argument put forward by Gentry and Shen (2010), which states that a thorough literature study should be central to decision-making when selecting measures of organisational performance, as the types of measures seemingly influence the outcome of the enquiry.

Recommendation for future research

This study should serve as stimulus for future studies to explore all the possible factors that influence findings related to the relationship between innovation and organisational performance. Future studies that investigate the relationship between innovation and organisational performance should try to isolate the role of innovation on organisations, and eliminate the cloud created by factors such as measurement tools, by selecting the instrument(s) based on the objective of the study.

Acknowledgements

The authors declare that they have no financial or personal relationships which may have inappropriately influenced them in writing this article.

T.S. was responsible for all aspects of the research, including matters such as identifying the research problem, formulating the research objective, the research design, execution of the research and drafting the article. R.S. played a mentoring role and assisted with the critical comments and provided guidance in drafting the article.

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Original Research

Innovation and organisational performance: A critical review of the instruments used to measure organisational performance

Tebogo Sethibe, Renier Steyn

Abstract

Introduction

Problem statement and objective

Measures of organisational performance

Financial performance measurement

Non-financial performance measurement

Objective versus subjective measures

Method

Findings and discussion

Financial measures

Non-financial measures

Subjective versus objective

Subjective measures

Objective measures

Managerial implication

Conclusion

Recommendation for future research

Acknowledgements

Competing interests

Authors’ contributions

References

APPENDIX 1