Services innovation and the knowledge economy (Manchester, 1999)

Services innovation and the knowledge economy
Manchester, 22-23 April 1999

This workshop was an exploration of the services sector, setting the scene for the two meetings of the Six Countries Programme in the year 2000. AD 2000 is the first century of a new millenium, a century, which may be the first of a new kind of economy. Whatever the uncertainties, the major capital input will be knowledge. In other words, knowledge will be the component of the end product or final service, which will determine competitiveness and quality. But what is the services sector and how will knowledge, the main capital input, be delivered?

The heterogeneity

The services sector is confusing. It is clear what to define as belonging to the primary sector, the extracting of raw materials from the environment, and to the secondary sector, the transforming of raw materials into artefacts, but the tertiary sector has been the dustbin for all other kinds of human economic activity. Technological and organisational change resulted in a shift in employment from the primary sector to the secondary, now services are the dominant employment sector. This latter shift is, however, not clear-cut. There is a blurring of boundaries, a blurring of where one starts and who benefits. Some manufacturing firms talk of themselves as delivering services, highlighting a distinguishing characteristic of services - their focus on the supplier-client interaction. Many have more employees in service functions than in production functions, and many are out-sourcing service functions. On the other hand, the service sector includes the delivery of all public goods and much of it lies within the public sector. Some services are standardised and some highly customised. There are some very large suppliers of services but countless small firms, to the extent that SMEs in services may be the majority, 80% of all SMEs in Ireland for example. Miles proposed that this very heterogeneous sector could be rationalised by classifying services as activities directed to effecting changes in the state of:

  • the environment: e.g. waste, cleaning, park keeping;
  • artefacts: e.g. transport, wholesale and retail trades, repair and maintenance;
  • people: e.g. health, education, hospitality;
  • symbols: e.g. entertainment, consultancy.


Innovation in services is another area of confusion. Many new service companies are being founded, a clear indicator of vitality and an increasing proportion of exports are in services. Services are the principal consumer of technology, utilising about 80% of Information Technology in most advanced economies and some areas such as financial services are heavily dependent on IT for competitiveness. 25% of all R&D is in service organisations. IT appears to be pushing the sector into new modes of innovative development and undoubtedly services are generating new kinds of things as in telecommunications. Some services are new types never before provided. Yet, the sector is regarded as a passive and indeed late adopter of technology and there is a perceived lack of productivity and innovation in crucial parts of the sector (Kuhlmann)

The perception of lack of innovation may be due to a traditionally narrow focus on innovation as a phenomenon of the manufacturing sector and to use of methodologies and definitions designed for the manufacturing sector. Techniques for developing policy such as tax incentives for R&D are still based on the characteristics of R&D in manufacturing. Innovations in many service areas are being missed. Furthermore, the blurring of boundaries makes it difficult to assign an innovation to a service or a manufacturing firm and standard surveys do not capture service inputs to the innovation process to avoid duplication with its implications for national accounts. Surveys of innovation in services can capture the richness and diversity of the sector and what is happening, and inter alia provide a more informed base for policy formulation. In Canada for example, government has moved from subsidies to knowledge inputs and a more informed base is needed for this shift. Surveys there have revealed the impact of IT, the threat to the banking system posed by software firms acting as intermediaries and the manner in which technical service costs include a substantial element of the costs of inputs from other technical services. OECD manuals are no longer relevant but as with national statistical series it is difficult to change these. There is undoubtedly need for better measurement and data.

A clearer understanding might be obtained by considering innovation in services from three aspects:

  • innovation in services themselves, largely organisational change,
  • innovation in service functions, and
  • services as agents of innovation.


Utilities supply basic human needs in power, heat and, through water supply and effluent treatment, in health, but their operating context restricts innovative development. There is little opportunity to differentiate products and gain a premium other than in 'green energy'. The massive and continuing investments in the supply of water and treatment of sewage continues to be in what is essentially Victorian technology, because public health concerns enforce the security of what is known. Introduction of new technology would have to be essentially an overnight shift to a new system, possible only in the context of failure in the existing system. The social obligation to meet environmental requirements can lead to increased energy use, for example in waste management, resulting in an increase of CO2 emissions. The massive investment in infrastructure is faced by the Regulator's demand for a 10% reduction in charges by a privatised utility organised to make a profit. The integration of water, power, gas and a diversification into telecommunications in one utilities company has not led to the expected integration of services since the regulator prevents single billing. Innovative effort in the power utility and to a lesser extent the water utility focuses on new ways of being a good neighbour, in introducing new IT and GIS technologies into its call centre in order to respond quickly and fully to customer enquiries and in developing a 'no dig' policy in order to avoid disturbance in the urban setting (Ford).

Change to environmental sustainability is dependent not only on technology and behaviour but also on new ways of arranging the doing of things. That new technology is not sufficient is illustrated by washing and drying machines, which reduced the consumption of power and water but their efficiency in use led to increase in the number of washes. The net result was that after an immediate decline there was a plateauing in power consumption. One has to look to new kinds of services to gain positive environmental effects and these involve on the one hand best use of technology and behavioural change supported by enabling financial, consultancy and information services. Renting and sharing; recycling and reuse of products and materials; repair, maintenance and upgrading rather than new purchase; use of material efficient professional workers rather than do-it-yourself; purchase of better quality rather than quantity, these are some activities which achieve positive environmental effectrs by selling functions rather than products. Services will have a major role in sustainability but need both policy and behavioural change to become effective (Slob and Nijhuis).

In contrast to utilities, retailing has witnessed an explosion in innovation. The producer-retailer-market interfaces have been reshaped and the large multiple retailers, who now dominate the market, determine much product innovation and are leading users of new technologies. Through superstores and shopping malls, multiple retail chains have reconfigured shopping by display of mass-produced goods, eliminating seasonality, introduction of new types of fresh and convenience foods and entering into new functionalities such as in banking, cr and pharmaceuticals. New regimes of governance have been introduced in the supply chain, ultimately probably the most significant change. Products are mass-produced to the specification of the retailer and for retailing under own brand labels. Each stage from production to final consumption is controlled through application of new technologies from genetic engineering to satellite and information technology - the properties of a food product, production under controlled conditions, transport, warehousing and packaging, chill chains and servicing loyalty cards. For example, the tomato as it reaches the consumer is the outcome of a hi-tech and organisational innovation chain in which the traditional concepts of manufacture and service have been subsumed to meet the needs of the retailer. It has involved a complex network of collaborators and many knowledge intensive inputs (Harvey).

A new innovation chain

The domination of large retailers in so many areas is now such that one can develop a new view of the innovation system. What is emerging is that the innovation system is being led by the large retailing superstores and specialised chains, increasingly grouped together to provide central facilities to meet the many needs of customers. They are the interface with the final consumer, measuring and assessing demand and converting this into demand on their own suppliers. The large retailers define and specify the products in quality and quantity, which producers in the primary and secondary sectors are to deliver and the production processes by which these are to be produced. They are demanding customers. They require their suppliers to achieve conformity to their specification and to innovate to meet the specification, but they also stimulate further innovation by forcing competition between their suppliers. They are themselves innovative and require innovative inputs into each stage of their own logistic chain from suppliers of systems and knowledge. Knowledge Intensive Businesses (KIBs) are a major source of such inputs. Manufacturers also need knowledge intensive inputs in order to innovate in order to improve the quality of the product, to create new products which meet the requirements of the demanding retailers and to integrate new technology in their production processes and their service functions. This new innovation system or chain highlights not only the significance of innovative development in adding value at each stage of the retailers' logistic chain but also in each stage of the suppliers' design, development and production chain. The two chains have in effect become intermeshed. This new chain also highlights the role of KIBs as the agents of innovation, creating, co-creating and transferring as an interactive intermediary between knowledge and need (Coombs).

Knowledge Intensive Businesses

KIBs have become crucial elements of national and regional innovation systems, but they are neither supported by, nor well linked to, national innovation systems nor recognised as a critical intermediary. The need for knowledge intensive inputs, however, is such that one has to consider the innovation system as encompassing many services so that the final innovative product is the output of manufacturer and services. Furthermore, much growth in services is driven by other service industries. One has to move towards the concept of a product system, an interaction between manufacturer, manufacturers of components and a range of services, which are also interacting amongst themselves. The innovation system has become more distributed and much more complex.

The functions of KIBs are of a very wide range and they form a new second order knowledge infrastructure (Hertog and Bilderbeek). The first knowledge infrastructure is composed largely of public sector national and university laboratories and research. Undoubtedly, much fundamental knowledge will continue to be generated from within these and their orientation will continue to be long term. KIBs act in a variety of roles and some of these roles are undertaken within one firm, other firms have a special and distinctive role. Some generate knowledge, some fuse generic knowledge with local knowledge to produce new knowledge and some in doing so act as co-producers of knowledge. They are important intermediaries acting as bridges and distributors of knowledge learned in one industry and carrying it across to other industries. The high degree of human mobility between KIBs ensures a constant diffusion of information within the sector.

Government and policy

The implications for government and for government policy are multiple and complex. The sheer size allied with a vertical structure in an economy of horizontal interaction, points to the need for significant organisational change in governments. In a vertical structure, there is an inevitable focus on the present and on the set of services provided from within each particular segment of the vertical rather than on engagement in the horizontal chains within which services and manufacturers engage.

They contain huge technical systems, which can be inhibited by issues such as privacy. Innovation is undoubtedly happening but in specific places. The vertical structure and the silo mentality leave innovative developments undetected and prevent diffusion from one part to another. Nevertheless, public services are probably more innovative than recognised (Steeples).

The futile manufacturing versus services debate creates a barrier to government entering into active support of the new forms of services emerging as agents of change. Not only are these services weakly integrated in national innovation systems, they are actively discriminated against as compared to manufacturing, in Ireland for example, suffering a significantly higher rate of corporation tax. The services industry itself has a role to play, by organising itself to have a representative voice with government, as have the agricultural and manufacturing sectors. In Ireland, the Irish Coalition of Service Industries represents its members to government in matters common to the sector, as do the other sectors and special interests are dealt with by the member federations (Martin). The major responsibility for change, however, is with government but the inertia of a well-established system is considerable. Inertia in the face of change lies in current structures, functions and roles and in an installed capacity devoted to the paradigms of the past. It is evident in policy, R&D support, measurement and data and therefore the information base on which policy and its implementation are based. The focus is still on services as transactions, the movement of goods, people and money rather than on recognising that the crucial role of services lies in taking care of each part of a complex logistic and interactive chain and in adding value to each part.

The implications for government of the emerging new innovation order are multiple and complex. As a provider of services, government must itself become a role model by acting as a demanding customer and stimulating even riskily radical innovations in the range of services for which it is responsible such as the environment and safety. To act as a demanding customer entails that public services behave as retailers, opening to the feedback from their clients and bringing users into the innovation process. Thus, a more demanding environment would be created for all sectors and a clear vision of how society will look in the future would be interactively created. Recognition of the role of KIBs in particular as agents in innovation, wealth creation, employment and competitiveness would lead to an integration of KIBs in the innovation chain of public services and in the modernisation of public administrations. Such recognition is also a necessary precursor to integration of knowledge intensive services in innovation policy. This requires that a balance is achieved between the first mode of knowledge creation, the traditional focus of policy, and the second mode, represented by KIBs, a balance between two different cultures. The implication is that KIBs, just as the institutions of the first order, are drawn into the process of policy formulation, and both integrated in clusters of economic actitivity in which the characteristic cooperation and competition are stimulated. KIBs, whilst generally small firms, are distinctively different from manufacturing SMEs but it is a sector equally dependent on entrepreneurial vitality. Policies to stimulate the vitality and the competence of a sector on which innovative development in other services, in government and in manufacturing is increasingly dependent must match the distinctiveness (Smits).

The dual role of government as providers of services and as policy makers for the innovation chain poses many challenges as the new order of innovation emerges.

Speakers at the workshop

  • Stefan Kuhlmann, Fraunhofer ISI, Karlsruhe
  • Ian Miles, Centre for Research on Innovation and Competition, University of Manchester
  • Daood Hamdani, Statistics Canada
  • Pim den Hartog and Rob Bilderbeek, Dialogic, The Netherlands
  • Roger Ford, North West Water Ltd., Manchester
  • Mark Harvey, Centre for Research on Innovation and Competition, University of Manchester
  • Rod Coombs, Centre for Research on Innovation and Competition, University of Manchester
  • Adriaan Slob and Lissy Nijhuis, TNO, The Netherlands
  • Ole Guldberg, DG3, European Commission, Brussels
  • Tom Martin, Coalition of Service Industries, Dublin
  • Paul Steeples, Dept. of Trade and industry, London
  • Ruud Smits, University of Utrecht and Chairman of the Six Countries Programme

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