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"Five Lacks": Root Cause for Inadequate Innovation Capability of Large SOEs


By Shi Yaodong, Research Department of Industrial Economy of DRC

Research Report No 180, 2012 (Total 4182)

Inadequate innovation capability of large state-owned enterprises (SOEs) can be mainly attributed to "five lacks", namely, lack of stimulation, capabilities, experiences, brands and appropriate environment.

I. Lack of Stimulation

The lack of stimulation refers to inadequate innovation stimulation in most large SOEs. Due to enterprises' reluctance to made investment in difficult innovation activities which involve large investment, high risks and long investment recovery period, they are often found to "be well capable but poorly stimulated".

First, as the major player in innovation activities, enterprises are stimulated by three reasons. First, for survival. Enterprises can by no means survive from fierce market competitions without constant innovation. The more pressure for survival, the more stimulated the enterprises are to conduct innovative activities. Second, for development. If enterprises are not involved in constant innovation activities, they can hardly grow and develop. Third, for capital gains. Innovation activities, once succeed, can bring profits much higher than the industrial average and high investment returns to shareholders.

For large SOEs, especially leading players in the market, due to inadequate competition pressure, most of them do not feel much pressure for survival and development, and their leading status in the market secure handsome capital gains. Therefore, compared with other enterprise, SOEs are more likely to invest in low-risk and sophisticated technologies and products, and are particularly inclined to organize massive production by introducing foreign proven technologies, rather than conducting original innovation acidities involving large investment, high risks and long business cycle.

Secondly, entrepreneurs are personalized representatives of enterprise's innovation activities and they initiate and promote such activities. Their innovations are stimulated by three factors. The first is the potential threat that they might be replaced by others. Entrepreneurs might be fired by shareholders if innovation activities turn to fruitless and bring no constant economic returns. The second is personal economic benefits. As personal remuneration is based on the performance of innovation activities, entrepreneurs are keen on innovation. Such innovation-performance-based arrangement should be stable and last long such as stock incentives mechanism; otherwise, entrepreneurs may choose innovation activities involving lowest risks, for fear of failure of expensive innovation activities, or they may put shareholders' money at risk in the short term. The third is personal fulfillment and sense of honor. Entrepreneurs can by no means feel the sense of success or enjoy the widely recognized social status, if they fail in innovation activities. Leaders of large SOEs are generally both entrepreneurs and government officials, which is known as the "revolving door" phenomenon, who are appointed by the State Assets Administration Committee. Their promotion and transfer, social status and sense of honor and fulfillment largely depend on the enterprise size, growth rate and stability, but are poorly related to the achievements of technological innovation.

Second, the R&D employees are those who conduct innovation activities, and the stimulation for these persons directly influences the practical effects of corporate innovation. Like entrepreneurs, the R&D staff has the same demand for remuneration and promotion as well as desire to realize their personal value. Compared with counterparts in private and foreign-invested enterprise, SOE's R&D staff receive lower remuneration limited by the ceiling on total wages (the total wages may grow annually according to the performance of the year, but the increment is usually smaller than in foreign-funded and private enterprises)1. Rare opportunities to get promoted or become one of decision makers have severely impaired their enthusiasm in innovation, and they are inclined to work in private and foreign-funded enterprises for high remuneration. SOEs are jokingly called the talent training base for foreign-funded and private enterprises, as their R&D staff often make job-hopping and turn to work in foreign-funded and private enterprises.

SOEs are hardly enthusiastic in cooperating with other SOEs, private enterprises and research institutions for three reasons. First, SOEs have never been in the situation that only by joint innovation can they survive and develop, and they are inclined to share benefits exclusively among their own people. Second, the considerable disparity in strength confines the desire for joint innovation, while large SOEs are reluctant to throw off their airs and cooperate with small and middle-sized enterprises. The third is the absence of effective institutional arrangement for benefits sharing and enterprises' worry that their know-how may be easily revealed to their rivals. All these have impaired the enthusiasm of SOEs for cooperation with their counterparts for innovation.

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1 The National Mid- and Long-term Talent Development Planning Outline (2010-2020) issued in June 2010 proposed to "improve state-owned enterprises' talent incentive mechanisms, implement mid- and long-term incentives such as stock equity and option, and be inclined to innovation talents and entrepreneurs." Approved as national independent innovation demonstration area, Zhangjiang New and Hi-tech Zone in Shanghai issued in July 2011 Stock Equity and Labor Division Incentives and Provisional Methods of Enterprises in Zhangjiang National Independent Innovation Demonstration Area, which stipulated incentives such as right offering, options and bonuses for technical staff of SOEs, colleges and universities, research institutions in the new and hi-tech zone. The document specified that enterprises taking stock equity and bonus incentives must have key techniques for enterprise development, independent intellectual property and constant innovation capability; their R&D expense over recent three years must be no less than 2% of the sales income and the proportion of R&D staff shall be no less than 10% of the total; the total sum of right offering and stock equity as incentives shall be no more than 35% of the increase in net assets attributable to after-tax profits over recent three years, and the total sum of incentives for right offering shall be no more than 50%, and for large enterprises, the total sum of stock equity as incentives shall be no more than 10% of the paid-in capital (stock equity). The document marks a significant breakthrough as it was the first time for Shanghai to adopt equity incentives in SOEs to attract high-end technological talents. Please refer to Scientific and Technological Achievements Are Allowed to Participate in Equity in SOEs, published in Xinmin Evening News on July 19, 2011.