Exploring the contribution of micro firms to innovation: does competition matter?

Plain English Summary Are micro firms marginal players in innovation? It seems not. Exploring a large sample of small European businesses, we find a non-negligible share of innovative firms with fewer than 10 employees. How does competition affect their innovative behavior? We find that as competition increases, innovation also increases if the initial level of competition is low, but innovation declines if the initial level of competition is high. The results hold for all firms regardless of size. Our findings have two important implications for research and policy. First, micro firms must be considered as significant players in innovation and more comprehensive innovation data should be collected from them. Second, competition fosters small businesses' innovation, but excessive competition can hamper it. Thus, policies aimed at promoting well-balanced competitive markets are crucial if micro firms are to exploit their full innovation potential. With a special focus on firms with fewer than 10 employees, we examine how small businesses participate in innovation and how perceived competition affects their innovative behavior. Statistics from a large sample of European micro-, small-, and medium-sized enterprises document a relevant share of innovative firms, including micro ones. We empirically explore the relationship between competition and the likelihood of being innovative, the degree of complexity of the innovation strategy, and its frequency. Estimates provide evidence of an inverted-U-shaped relationship, whereby innovation initially increases with competition and then it slightly declines. The results hold for all firms, regardless of their size, but the negative effect seems to be more marked for smaller firms. Competition shows a stronger relationship with technical and external innovation. By including micro firms, this paper contributes to the understanding of innovative patterns and activities in firms of all size.