J. Serv. Sci. & Management, 2008, 1: 111-122
Published Online August 2008 in SciRes (www.SRPublishing.org/journal/jssm)
BBStrategic Capabilities, Innovation Intensity, and
Performance of Service Firms
Lu-Jui Chen1, Chun-Chung Chen2 & Wen-Ruey Lee3
M
1MingChuan University
2National Taiwan University
3National Taipei College of Business
P
ABSTRACT
This study developed and empirically tested a model examining the relationships among strategic capabilities, innova-
tion intensity, and firm performance. Strategic capabilities include internal venturing capability and social relationship
capability. Analyzing a sample of service firms from Taiwan, the study indicates that social relationships with other
firms are important to facilitate innovative activities of service firms. Innovation intensity further helps service firms to
improve a firm’s expected performance. However, internal resources capability does not show the expected effect on
innovation intensity. And innovation intensity is also not related to a firm’s growth.
Keywords: resource-based view, social relationship, innovation intensity, firm performance, service firms
1. Introduction
This study explores the relationships between strategic
capabilities, firm’s innovation and the performance of the
service firms. Innovations of firm create new jobs, gener-
ate new wealth for firm. However, we do not know much
about value of the extent to firm’s strategic capabilities on
innovation, since previous studies have explored innova-
tion without exposing its strategic capabilities. In this
paper, we try to reveal the role of strategic capabili-
ties—especially strategic in internal capabilities and in
external networks—in the innovation creation process.
And we also deal with the performance implication of
strategy of with innovation. Two guiding theo-
ries—resource-based view and social network—were
invoked to account for the value of innovation and per-
formance.
Resource-based view (RBV) emphasizes firm with
idiosyncratic resources [9] that are owned or controlled
by the firm [49]. These capabilities of deploying re-
sources made firms heterogeneous in nature. RBV regards
the firm as a bundle of resources and suggests that their
characteristics make a positive effect to the potential of
innovation, and by implication of its performance. There
are an increasing number of studies focusing on the com-
petitive factors of firms. The studies show that intangible
and tangible resources [24] and human resource man-
agement [30], among others, are elements that clearly
contribute to firm’s internal capabilities.
Social networks advance that external connections are
the sources of competitive advantages [6]. External net-
works with suppliers, customers and others would facili-
tate the product/service mobilized and concrete. Firm
transacts with outside entities in order to acquire external
resources and opportunities, adjusted for the firm’s poten-
tial value. Social network theory implies that its relational
characteristics are embedded with creative opportunities
and potentials for the process of value in firm.
Services have been increasingly providing intelligent
inputs, adding products with a wide range of value and
using other technological processes in this new economic
time [68]. Firms create value by offering the types of ser-
vices that customers need, at an acceptable price. In re-
turn, firms receive value from their internal property and
their stakeholders. Unlike manufacturing firms, which
rely on patented technologies or unique products, service
firms gain their competitive advantage primarily through
their ability of combination to make use of their proprie-
tary knowledge. The activity of service firms is an “inter-
action between human and human” (or organization and
organization). It is contrary to Daniel Bell’s characteriza-
tion, which considers pre-industrial society as a “game
against nature,” and industrial society as a “game against
fabricated nature” [10]. Thus, the service industry needs
not only technical skill, but also social skill.
Services can be the initial element in producing an in-
novative packaging material through R & D, or the “me-
diating” element in developing a major mining project. In
other instances, services firms add product value by pro-
viding convenience, health and knowledge. For decades,
services make up the bulk of nowadays’ economy and
also account for most of the growth. In fact, services now

112 Lu-Jui Chen, Chun-Chung Chen & Wen-Ruey Lee
dominate, making up about 70% of the aggregate produc-
tion and employment in the Organization for Economic
Cooperation and Development (OECD) nations and con-
tributing about 75% of the GDP in the United States.
Most western countries have also increased service prod-
ucts, and the export of these products is between 10% and
20%. The service output in Taiwan took over 70% of its
GDP in 2005. This means that Taiwan is moving in a di-
rection characterized by service-oriented output. There is
considerable potential for increase in value of services.
It is well recognized that the service business plays an
important role in a nation’s economic development. The
determinants of business components for service firms
should be different from manufacturing firms. Most re-
search in the performance literature, for example, has
focused on the determinants of performance in manufac-
turing industries [60]. Yet the services firm literature has
long argued that the nature of goods and services are not
the same and that services face a unique set of challenges
[18, 19]. Accordingly, it is reasonable to expect that char-
acteristics in service settings are likely to be different and
specific. Our prediction is the extent to which those de-
terminants of strategic capabilities can be generalized to
service firms.
This study pushes the envelope of research on the stra-
tegic capabilities by service firms in Taiwan by integrat-
ing RBV and social network theory. This study attempts
to contribute to the knowledge and research in the service
firms’ management in the following ways. First, most
research studies have focused exclusively on manufac-
turing firms but not on service firms [2, 35]. While ser-
vices have become the fastest-growing component of in-
ternational trade, it is important to know the extent to
which competitive perspectives, theories and practices,
developed for manufacturing firms, are also applicable to
service firms. Second, few studies have examined the
behavior of service firms by using competing theoretical
perspectives [17, 19]. Although server studies attempted
to integrate these two theoretical domains to explain or-
ganization development, we believe that none have done
so in the context of service firms. Third, we design this
study to test the theoretical relationship by combining
subjective and objective data. The results inform our
knowledge of the management of the service industry
with a complementary view.
This study is organized as follows. In the next section,
we present a brief review of relevant theoretic literature.
The conceptual framework and the research hypotheses
will be provided. The following section describes the
methodology, samples, variables, and hypotheses testing.
Finally, we will present concluding remarks and manage-
rial implications.
2. Theory and Hypotheses
The strategic capabilities is indicated by the degree to
which they can contribute the development of core com-
petences, competitive advantage, and, ultimately, firm
performance. Hence, strategic capabilities defined here
are the firm’s capacity to deploy internal resources and
integrate external resources that have been coordinated
purposely to achieve a firm’s creation and a desired end
state [9].
Innovation is the process of creating a commercial
product and service from an invention. The innovation
can be created through internal entrepreneurial mind-set
[59, 71] and cooperative strategies [6]. Hence, we argue
that two types of strategic capabilities will influence the
process of innovative activity of a firm, and that the
process is a key mediator that affects the firm’s perform-
ance. We draw on theoretical perspectives from several
sources: internal resource advantage from the re-
source-based view (RBV) of a firm [9, 49, 72], external
advantage of social relationship from the social capital
perspective [6, 11, 22], innovative intensity [33, 59, 71],
and exploration and exploitation from organizational
learning [37, 41].
The following section introduces the above theories
sequentially and also introduces the research hypotheses
simultaneously.
Internal venturing capability and inno vation intensity
Most innovation is developed through internal R&D, ex-
ercised by corporate staffs. Thus, the most competitively
successful firms reinvent their industry or develop a com-
pletely new one across time as they engage in competition
with current and future rivals. In this sense, strategic en-
trepreneurship is about producing the innovation and en-
couraging innovative intensity activities that create to-
morrow’s business [59, 71]. Internal venturing is the set
of resources and activities firms use to develop innova-
tions.
The resource-based view [9, 49] complementing the
traditional model of Porter’s [52] competitive advantage,
stressed the importance of the internal resources and ca-
pabilities of a firm in the context of the competitive envi-
ronment. The RBV suggests that researchers devote their
attention to analyzing the performance of firms in terms
of their resources, rather than their product market activi-
ties [72], since distinctive organizational resources, capa-
bilities, and competencies generate a sustainable competi-
tive advantage and lead a firm to above-normal perform-
ance [53].
Gaining superiority in a competitive market depends on
a firm’s ability to identify, develop, deploy, and preserve
particular resources that distinguish it from its rivals [4]
[14]. Resources and capabilities contribute to improving
the firm’s competitive position and thus have the potential
to create competitive advantage [8]. In order to produce a
sustainable competitive advantage, resources and capa-
bilities should be characterized as highly valuable, rare,
inimitable (i.e., they are costly to copy by rivals), nonsub-
stitutable (i.e., no substitute to fulfill the same function is
immediately available to competitors) [8] and nontrans-
ferable (i.e., resource cannot easily be purchased) [14].

BBStrategic Capabilities, Innovation Intensity, and Performance of Service Firms 113
More recent studies emphasize the important of
knowledge-based resources [36, 63], which is character-
ized by firm employment [49]. Therefore, competitive
advantage resides in the resources available to the firm [8,
63]. Recent extensions of RBV suggest that sustainable
competitive advantages are not achieved through the stra-
tegic utilization of any one kind of resource, but rather
through the bundling and revitalizing of multiple, distinc-
tive firm resources and competencies in order to create
valued outputs capable of becoming sustainable competi-
tive advantages [63].
The essence of human capital is the sheer intelligence of
the organizational member [9]. According to RBV, firm
employment enhances the potential of internal advantage,
which is most difficult to imitate and can provide a firm
with sustained competitive advantage [33]. The greater
the employment potential, the more they can give a spe-
cific advantage through cost savings from increased utili-
zation, combination of resources, lower turnover and
higher productivity from boosting the productivity of in-
dividual workers. According to Jackson et al. [33] and
Ulrich and Lake [67], employment can be further analyzed
into the following three dimensions: capability and potential,
motivation and commitment, and innovation and learning.
Capability and potential includes concepts such as
educational level, professional skills, experience, attitudes,
personal networks, values, and the ability of current
employees to evolve within the organization. Finally,
innovation shows the degree to which employments are
open to create. Innovation is increased by the quality of
the human capital and an enhancement of the labor
productivity [70].
Hence, this study proposes that ability of employment
in the service firms can represent an internal resources
advantage. For example, a service firm’s market orienta-
tion and strategic decision-making are bundled together
with internal complementary resources, such as innova-
tion [42, 46]. And internal resources usually mean human
resources, financial property, and management know-how,
etc. However, the resource-based view of the firm [49, 72]
stresses the resources that are bundled by the firm, which
is understood as an organization characterized by admin-
istrative routines. It is the services based on the firm's
resources, rather than the resources per se, that constitute
the firm's knowledge. Hence, the knowledge base of firms
is intrinsically linked to the knowledge of their employees
[38] and those that highlight the greater share of service
activities and the tendency of high-skills services [50].
The production of services is almost entirely dependent
on the ability of the firm to make use of the knowledge of
the employees in the case of services.
Innovative capabilities can be considered as a subset of
dynamic organizational capabilities. The company sur-
vived in difficult times and improved its market position-
ing, establishing a reputation for innovation. Personnel
competencies are improved in a number of ways (e.g.
multi-skilled development) that are evident when a firm’s
employees are engaged with customer or supplier peers.
The sales per employee capture efficiency and effective-
ness improvements for the firm [58, 74], which are often
the central goal of restructuring a firm’s process and
product.
Organizational innovation is viewed as the functional
systems and processes organizations utilize to upgrade a
firm’s existing products, services, and processes, along
with the creation and introduction of new products, ser-
vices, and processes [66]. Innovation represents the
commercialization of new technologies or technological
change [71]. Hence this study infers innovation as “a
complex activity which proceeds from the conceptualiza-
tion of a new idea to a solution of the problem and then to
the actual utilization of economic or social value.” As
March [41] suggests, exploration and exploitation are
essential for organization, but they compete for scarce
resources. Thus, a firm’s capability to allocate scarce re-
sources that can maximize the returns from either explo-
ration or exploitation comprizes its intangible competen-
cies. According to Penrose [49], Cohen and Levinthal
[13], and Teece et al. [63], a firm innovates through
learning processes that enable the firm to re-bundle and
revitalize existing and newly acquired resources into core
competencies and competitive advantages, and by apply-
ing internally and externally created knowledge and
technology to develop new products, services, and proc-
esses.
Most improvements to service activities are incre-
mental. In effect, a firm’s innovative view may create a
new market. For example, FedEx Corp. redefined the
package delivery market. The internal resources of firms
bring about competitive advantage, innovations and effi-
ciency [40]. Because innovative activity is characterized
by the continuous improvement of products and produc-
tivity, the sudden and unpredictable changes in the threats
and opportunities that a firm faces are called Schumpete-
rian revolutions. Schumpeterian revolutions have the ef-
fect of drastically changing the value of a firm’s resources
by changing the threats and opportunities that face a firm.
The RBV provides a unified approach in the conceptuali-
zation of the foundation of innovation. Several research-
ers have extended the RBV concepts linking to innovation
[14, 51, 63]. We suggest that a firm’s level of overall in-
novation is manifested in its capability to explore new
possibilities. Likewise, a firm’s level of product or service
quality is manifested in its capability to exploit currently
established certainties. Hence,
Hypothesis 1: A firm’s internal venturing capability has a
positive relationship with the firm’s innovation intensity.
Social relationship capab ility and innovation intensity
Social capital could be understood roughly as the good-
will that is engendered by the fabric of social relations
and that can be mobilized to facilitate action [1]. The core
of social capital is the idea that goodwill drawn from
family, friends, workmates and acquaintances provides a

114 Lu-Jui Chen, Chun-Chung Chen & Wen-Ruey Lee
range of valuable resources, including information, influ-
ence and solidarity [1, 23]. Recent research has applied
social relationships as external advantage to a broader
range of social phenomena, including relationships within
and beyond the firm [11]. They control business benefits
with outside entities [5, 6].
A firm’s network will consist of relationships as well
as the firm’s position within the whole network of rela-
tionships. There are two types of relationships for the
business network. One is referred to the closeness of a
firm’s set of direct and dyadic relationships, which has
been labeled relational embeddedness. The other is the
aspect of centrality of the firm in multiple-level relation-
ships, which has been called structural embeddedness [22,
25]. For the clarity of analysis, the study focuses on dy-
adic relationships.
Firms create competitive advantage and economic
value through effective interfirm collaboration [16]. So-
cial relationships build on the general idea that economic
actions are influenced by the social context in which they
are embedded, and that actions can be influenced by oth-
ers in social interaction [25]. Relational capital, which is
so important at the dyadic level, rests upon close ties at
the dyadic level and can also play an important role in
creating business value and learning [34]. Tsai and Gho-
shal [65] identify the social capital as the essential ante-
cedent to facilitate the activity of value creation of firms.
Absorptive capability is a critical feature that makes
firms learn and assimilate outside knowledge [13]. Con-
sidering collaboration as a learning opportunity [26], a
firm may initiate collaboration relationships and create
new know-how [32]. Lane and Lubatkin [37] have sug-
gested that inter-organization relationships facilitate the
difficulties of assimilation of knowledge. The breadth and
the depth of the relationships between firms are associ-
ated with mutual adaptation of activities and the trust ex-
isting in the relationships. Mutual trust eliminates trans-
action costs and also increases the opportunities to create
new opportunities [16]. Firms are embedded in
socio-economic networks rather than being isolated is-
lands in the market [22] — no matter whether they are
engaged in innovative activity or not. Thus collective
learning, or cooperative learning, is the situation in which
partners learn to work together [15], which often contrib-
utes to the increase in the stock of knowledge.
Innovation is equally important for large and small
firms in the contemporary competitive and changing
market. No firms—even the largest firms such as multi-
nationals—can always undertake major innovations alone
and overcome any resource barriers for innovative activi-
ties. Hence, there is an increasing trend in strategic col-
laborations [21, 25] and this trend is seen as an external
advantage to the firm. Close contact and intense interac-
tion between individual firms act as an effective mecha-
nism to transfer or learn “sticky” and beneficial knowl-
edge-how across the organizational interface. The com-
bination of knowledge and the creation of innovation are
complex social processes; much of the value of innova-
tive concepts is fundamentally socially embedded [45].
Social relationships have become an important asset to
multinational firms because of the need for appropriate
resources (e.g., information, technology, knowledge, ac-
cess to distribution networks, etc.) to compete effectively
in the markets. For example, exchanges based on these
linkages can facilitate product innovation, expedite re-
source exchange and create intellectual capital [45, 65].
Service-centered logic implies that value is defined by
and co-created with the consumer and determined by the
customer on the basis of value-in-use, rather than being
embedded in predefined output [68]. Thus, from a new
service development perspective, the customers become
not only a necessity, but also an opportunity.
Service firms make their living by accessing, creating,
and using information in ways that add value to an enter-
prise and its stakeholders [28]. Thus, a firm that is located
in a cooperative relationship of social interaction likely
has greater potential to innovate and exchange know-how
with other firms, because of its specific external advan-
tages in the network. Firms gain advantages through close
cooperation, and they obtain specific information about
new products. Also, they can assess their value with re-
spect to their needs, while producers gain insight into the
user or customer needs and can adjust their innovation
activity accordingly. Hence,
Hypothesis 2: A firm’s social relationship capability has
a positive relationship with the firm’s innovation inten-
sity.
Innovation intensity and firm performance
The definition of firm performance, explored here, is
based on the notion that a firm is an association of pro-
ductive assets (including individuals) who voluntarily
come together to obtain economic advantages [49] Own-
ers of productive assets of a firm will make those assets
available to a firm only if they are satisfied that the in-
come they are receiving is at least as large as the income
they could expect from any reasonable alternatives [9].
Depending on these insights, it is possible for us to out-
line a firm’s performance by comparing the value that a
firm creates using its productive assets with the value that
managers of the firm expect to obtain.
New sources of value are generated through novel de-
ployments of resources [59]. New ways of exchanging
and combining resources are important to create a firm’s
value. A firm’s innovation is related with organizational
learning [13, 65]. The more emphatically knowledge is
learned and absorbed, the higher the performance a firm
can achieve through the capability of innovation [37].
Innovation is considered vital for its contribution to
business performance, and the literature consistently as-
sociates it positively with performance. Empirically, this
linkage for innovation and its impact on performance was

BBStrategic Capabilities, Innovation Intensity, and Performance of Service Firms 115
validated by Han et al. [27]. Higher innovation possessed
by a firm causes higher organizational performance in the
market competition [62]. Considering the operational
complexity of a service firm, the intensity of innovation is
generally manifested in the form of product modification
[69]. The firm requires diverse resources inputs and com-
binative capabilities [36]. In the light of the growth of a
firm, its ability of innovation will generate a competitive
edge and business growth in the market [57]. Thus, a
firm’s innovation has become important for it to increase
growth of development and value creation [73].
According to Leiponen’s research about the Finnish
Community Innovation Survey, more than 20% of service
firms reported having launched new services in the pre-
vious years [39]. In other words, recent survey data indi-
cates that innovation does occur in the service industry.
Because service firms face dynamic demand and market
uncertainty, they are likely to pursue more proactive and
more aggressive strategies, as uncertainty increases,
through innovation activities [48]. The literature states a
number of strongly allied concepts of innovation and ser-
vice firms [3, 54, 71]. The new products or new processes
introduced in help incumbent firms to safeguard their
market position and sustain growth. In essence, the more
dynamic or complex the environment, the greater the
compulsion to innovate and the more innovative firms are
likely to be. Customer tastes or expectations fluctuate;
competitors, for example, introduce new products. The
pressure on firms to innovate will be great and, hence,
one may anticipate that the intensity of innovation is the
decisive factor for service firms.
This study intends to analyze the relationship between
the intensity of organizational innovation and a firm’s
performance. We opted to consider, first of all, the rela-
tionship between organizational innovation and financial
results, which have been the main focus of research on
business strategy. Measure such as sales volumes, change
in sales and market share expansion seem appropriate as
measures of the firm’s performance.
From a broader economic point of view, understanding
innovation within service firms becomes vital as the share
of the service sector in terms of GDP and employment
keeps rising. But service activities’ value creation and
outcomes have been slow or even negative [39]. The ef-
fect of innovation does not always immediately affect
economic and financial results. In other words, financial
results are seen as a ‘lagging indicator’ for the measure of
a firm [64]. Moreover, certain external factors may favor
one firm over another, such as changes of government
regulations or production or distribution costs [64]. For
this reason, we also consider it appropriate to use per-
ceived measures as considered in the literature. One way
in which we posit performance is by examining the out-
come of the firm’s innovation. Innovative outcomes will
materialize over time rather than instantly, so the ex-
pected performance—rather than the present perform-
ance—should constitute another dependent variable. Fur-
thermore, if goal attainment is at the heart of a firm’s
performance, then we should also maintain that it is the
market performance, rather than the present market per-
formance, that should be assessed. Perceived measures
are likely to reflect both enacted and potential outcome
[55]. Therefore, we use expected performance as another
measure of performance. Consequently, we use two per-
formance indicators to predict a firm’s performance.
Hence,
Hypothesis 3a: A firm’s innovation intensity has a posi-
tive relationship with its future performance.
Hypothesis 3b: A firm’s innovation intensity has a posi-
tive relationship with its growth.
Hypotheses 1 to 3 are summarized in Figure 1.
3. Methods
Sample and date collection
This model is tested on samples of firms in the Taiwanese
service industry. Data for this study come from two major
sources. Data for social relationship capability, innovation
intensity, and expected firm performance are perceptual
measures; data for internal venturing capability and firm
growth are from industrial secondary archives. A survey
questionnaire was developed based on previous literature.
We sent it to business managers familiar with the devel-
opment of the service industry to verify questionnaire
items and terms. Some minor changes in wording were
made and the questionnaire was then adjusted.
Our sample was drawn from the Top 5000-The Largest
Corporations in Taiwan, 2006, compiled by China Credit
of Information Service, Ltd (CCIS), Taiwan. This data
source not only lists the sample companies that we need
but also provides data about the firms. Because of missing
data for some firms, this study collected data for 1,600
firms as a sample. These questionnaires were sent to sen-
ior manager of these service firms. A t-test on the number
of employees showed no significant differences in our
sample and those that were not included in the sample.
After several follow-ups, there were 237 responses. We
exclude several incomplete questionnaires. There are 226
complete responses. The samples are comprised of 226
observations, meaning that we provide a valid sample size
for the subsequent statistical analysis to be carried out. In
order to ascertain that the response is effective, we sent
another set of questionnaires to other managers in the
responding firms. Nineteen of the second questionnaires
were returned. We found a high degree of correlation
between the two sets of responses. Hence, we argue that
the first collection is sufficient for subsequent hypotheses
testing. After the process of collecting questionnaires, we
use archival data to provide information for the rest of the
constructs as another source of analytic data.
Variable measurement
This study uses the LISREL (Linear Structural Relations)
model as the analytical tool. Jöreskog introduced the
LISREL model in 1973. The LISREL model consists of

116 Lu-Jui Chen, Chun-Chung Chen & Wen-Ruey Lee
Figure 1. The Hypothesized Model
two parts: the measurem ent model and the structural
equation model. The measurement model specifies how
latent variables or constructs depend upon or are indicated
by the observed variables.
The hypothesized model includes four constructs: in-
ternal venturing capability, social relationship capability,
the intensity of innovative activity and firm performance.
The operational nature of the constructs has been widely
discussed in the literature. Eleven variables were devel-
oped in this research. It must be noted that two of the
eleven variables are objective measures: internal re-
sources advantage and firm growth. The study uses ar-
chival data to measure internal resources advantage as
one of the measures of a firm’s growth in order to avoid
common method bias. We explained each measure of the
variables as follows:
Internal venturing capability: The employee produc-
tivity shows a positive impact on the innovation intensity
of a firm, and is the basis of sustainable competitive ad-
vantage [56]. The natural logarithm of sales per employee
(X1) is a widely used measure of employee productivity [31]
and was adopted here in analyses.
Social relationship capability: We measure social re-
lationship capability by the following three areas: (1) co-
operation in deciding strategic objectives and goals (X2);
(2) cooperation in functional areas such as service prod-
ucts, R&D, purchasing, marketing, human resources, and
budgeting (X3); (3) cooperation in implementing new
plans for the service design, R&D, or new market entry
(X4) [25][34]. We ask respondents to indicate one coop-
erative partner who is the most important or critical.
Innovation intensity: This study uses the following
items to ask respondents how the firm is involved in in-
novative activities: (1) How many service product inno-
vations per year were produced in your firm? (Y1); (2)
What was the extent of formulating new service proposals,
including service design and specifications? (Y2); (3)
Within the firm, do managers consistently care about the
innovative issues? (Y3) [39][42]
Firm performance: Firm performance includes two
types of measures. First, we use perceived measures. To
assess the perception of expected firm performance, we
ask respondent to estimate the expected increase in sales
growth (Y4), profitability (Y5) and market share (Y6)
with 5-point Likert type scale (1 = very small to 5 = very
high). Second, we adopt firm growth, measured as change
in sales (Y7) [5][6], as the other proxy for firm perform-
ance.
Table 1 shows the descriptive statistics of the inde-
pendent and dependent variables analyzed in the hypothe-
sized model.
4. Results
Measuring model evolution
We use composite reliability, which is analogous to coef-
ficient α [20], and average variance extracted to measure
internal consistency.
Estimates of composite reliability and average variance
extracted are sufficient to support internal consistency.
All information is shown in Table 2. In addition, we also
evaluate the discriminant validity of the model. We com-
pared chi-square value for a measurement model, and
constrained the correlation to equal one to a baseline
model without this constraint. All the measures of con-
structs in the measurement model are significant in dif-
ference and achieve discriminant validity.
Structural model estimation
With respect to the fitness of statistics for the full model
(χ2
(41)=112.18, p=0.00, GFI=0.92, AGFI=0.87, CFI=0.95,
NNFI=0.94), the chi-square is significant, which is usu-
ally influenced by sample sizes. All the other statistics are
within the acceptable ranges. All the other statistics are
within the acceptable ranges, which indicate a good
model fit.
In order to empirically test theoretic hypotheses, the
hypothesized model is examined by using LISREL, in
which the four paths between different latent variables are
estimated. Our empirical results show that the internal
resources construct has a non-significantly negative effect
H2:+
Social relationship
capability
Internal venturing
capability
Sources of strategic capabilities
of a fir
m
H3a:+, H3b:+Firm performance
Expected performance
Firm growth
Innovation intensity
H1:+
Process of innovative activi-
ties
Results of strategic capabili-
ties for a firm

BBStrategic Capabilities, Innovation Intensity, and Performance of Service Firms 117
Table 1. Descriptive Statistics and Pearson Correlation Analysis (N=226, * p<0.01; ** p<0.05)
Mean SD X1 X2 X3 X4 Y1 Y2 Y3 Y4 Y5 Y6 Y7
X1 2.46 1.38 1
X2 4.19 0.77 –0.040 1
X3 4.06 0.96 0.027 0.716** 1
X4 3.99 1.07 0.047 0.598** 0.791**1
Y1 3.73 0.65 –0.040 0.764** 0.551**0.445**1
Y2 3.65 0.98 0.018 0.404** 0.314** 0.251** 0.592**1
Y3 2.46 0.98 –0.017 0.382** 0.324** 0.259** 0.584**0.357**1
Y4 3.69 0.93 –0.002 0.447** 0.274** 0.173** 0.564**0.314**0.305**1
Y5 3.65 1.05 0.032 0.311** 0.259** 0.244**0.422**0.270**0.312**0.700** 1
Y6 3.52 1.11 –0.041 0.382** 0.261** 0.166* 0.459**0.256**0.234** 0.732** 0.510** 1
Y7 0.07 0.27 0.212 0.075 0.026 0.131 0.038 0.100 –0.042 0.043 0.061 0.0501
Table 2. matrix of latent constructs for full sample (IV: internal venturing capability , SR: social relationship advan-
tage; II: innovation intensity; EP: expected performance, FG: firm growth; ** p<0.05)
Figure 2. The results of Hypothesized modela
a: The figure depicts a structural model with maximum likelihood estimates. We set the error variances for single indicator at 0, with loadings
(lambdas) fixed at 1 (that is, X1 and Y7 with each corresponding latent variable)
Table3. Analysis of competing structural model (IV: internal venturing capability, SR: social relationship advantage ;
II: innovation intensity; EP: expected performance, FG: firm growth; ** p<0.01)
Hypothesized model Rival model
Path Estimate Path Estimate
IVÆII –0.02 IVÆEP 0.01
SRÆII 0.71** IVÆFG 0.04**
IIÆEP 0.78** SRÆEP –0.02
IIÆFG 0.02 SRÆFG 0.04
IIÆEP 0.79**
IIÆFG –0.01
χ2
(41)=112.18, p=0.00,
GFI=0.92, AGFI=0.87, CFI=0.95
NNFI=0.94, PNFI=0.69
χ2
(37)=102.37, p=0.00,
GFI=0.92, AGFI=0.86, CFI=0.96
NNFI=0.94, PNFI=0.63
IV SR II EP FGComposite reliability AVE
IV 1 – –
SR 0.019 1 0.85 0.66
II –0.012 0.517** 1 0.76 0.53
EP 0.005 0.343** 0.464** 1 0.83 0.63
FG 0.212** 0.089 0.038 0.059 1 – –
Social relationship
capability
ζ
2
0.71**
Internal venturing
capability ζ
1
Firm performance:
Firm growth
η3
Firm performance:
Expected performance
η2
Innovation intensityη1
-0.02 0.78**
0.02

118 Lu-Jui Chen, Chun-Chung Chen & Wen-Ruey Lee
Figure 3. The Rival Model and the results (all predicted directions are positive as literatures suggested)
on the intensity of innovative activity (γ11=-0.02,
t-value=-0.86). Hypothesis 1 is thus not supported. With
regard to Hypothesis 2, it is found that the external re-
sources have a significantly positive effect on the inten-
sity of innovative activity (γ12=0.71, t-value=10.23). Thus
Hypothesis 2 is supported. So is Hypothesis 3a, that the
intensity of innovative activity is significant positively
with the expected firm performance (β21=0.78,
t-value=8.37). Hypothesis 3b, that the effect of the inten-
sity of innovative activity on the financial performance
does not have a significant positively prediction, is not
supported by this test (β31=0.02, t-value=0.55). Results of
the parameter estimate are summarized in Table 3 and
showed in Figure 2.
Compariso n with a rival model
We don’t use the full model because this study argues that
the intensity of innovative activities is a key mediate
variable for firm performance1. Comparison with a rival
model is an important way to assess the power of a speci-
fied model [7]. The rival model is showed in Figure 3.
Our hypothesized model is based in an elaborate theory
that hypothesizes a specific nomological inference of
constructs. We thus compared our hypothesized model
with the rival model using the following criteria: (1)
overall fit, as measured by CFI; (2) percentage of the
model’s statistically significant parameters; (3) ability to
explain the variance in the outcomes of interest, as meas-
ures by square multiple correla tions (SMC) of the focal
and outcome variables; and (4) parsimony, as measured
by the PNFI [44]. The direct paths of the rival model are
supported in much of the literature [9] [16] [49] [63].
However, this study argues that the strategic operational
process, which is the intensity of innovative activity, is
the critical factor in a firm’s performance. Thus, we do
1 We still tested the fit of the full model. According to the result, estima-
tion of full model is no better than the hypothesized model. Hence, we
argue that our hypothesized model is an effective model.
the comparison to ascertain the effectiveness of the hy-
pothesized model.
The CFI for the rival model is a little higher than for
the hypothesized model (CFI= 0.96 v.s 0.95). In our hy-
pothesized model, 50% (or 2 of 4) aspects of the path are
significant, whereas only 33% (or 2 of 6) aspects of the
path are significant in the rival model. Moreover, little
additional explanatory power is gained from the addi-
tional two paths in which the increment to SMC is 0.05
(for financial performance). In comparing the models, we
see there is a difference in parsimony between the hy-
pothesized and rival models (4 versus 6 paths). CFI is not
an indicator that accounts for the parsimony difference, so
we compare the two models using PNFI. The PNFI of the
hypothesized model is 0.69, exceeding the rival’s 0.63.
Although there is no guideline to determine what the sig-
nificant difference in PNFI values is, we note that a sacri-
fice of PNFI value is 91% (from 0.69 to 0.63). We ac-
complish a great improvement in parsimony without sac-
rificing too much CFI. Hence, a sacrifice is worthy for
parsimony.
Based on these findings, we acknowledge that this
comparison provided added confidence in the constructs
of our hypothesized model. The intensity of innovative
activity also represents a critical process of advantageous
creation as a sufficient predictor for the firm.
5. Discussions
Overall, the results of this study provide support for the
argument that social relationships (that is, external re-
sources of a firm) facilitate the innovative activity of ser-
vice firms, and that the innovative activity has a positive
effect on the expected firm performance. This finding is
robust at the dyadic level. The first finding is consistent
with previous studies showing that interorganizational
relationships are positively related to innovation intensity.
The result also supports theorists who emphasized the
Internal venturing
ca
p
abilit
y
ζ
1
Social relationship
capability ζ
2
Innovation intensity ζ3
Firm performance:
Expected performance η1
0.01
0.04**
–0.02
0.04
0.79** Firm performance:
Firm growth η2
-0.01

BBStrategic Capabilities, Innovation Intensity, and Performance of Service Firms 119
importance of acquiring external knowledge for product
development [71].
It is clear that cooperation and innovation among ser-
vice firms are important as operational measures. Here we
have the implication that focus on the cooperation be-
tween firms will create innovation as well as market op-
portunity development. Cooperation creates interfirm
benefits that are consistent with the literature on organ-
izational advantage. The more interaction they have, the
more business possibilities there will be; the more coop-
eration they have, the more their market opportunities are
likely to be productive. The concept of social relation-
ships, therefore, is central to the understanding of innova-
tion and value creation [45]. An important point to note is
that these productive possibilities need to be fully ex-
ploited through a firm’s exchanges and cooperation [43].
On the basis of this argument, it seem reasonable to argue
that innovation is better facilitated by interfirm coopera-
tion, because the interaction will help a firm to consoli-
date existing markets and create new market share and
market value.
However, our analysis found that the intensity of inno-
vation is not influenced by internal resources and may
even cause a negative effect, although it is non-significant.
This is contrary to our argument and it is interesting to
discuss. In theory, human resources will be positively
related to firm innovation [63] [71]. But the relationship
between the firm’s human resources and innovation is
diametrically opposed to what we predicted in Hypothesis
1.
We infer the reasons for this result as follows: (1) We
didn’t measure the organizational climate. Some people
would be frustrated by a chaotic environment and seek
some sort of stability to improve efficiency of the status
quo. Others would be frustrated by the long list of unreal-
ized opportunities for improvement. Service firms are
located in a competitive market, which affects a firm’s
business orientation. (2) The codifiability of the knowl-
edge assets is the other reason. Knowledge is embedded
on the employee [49]. Service innovations sometimes are
easier to create by codifiable knowledge than relatively
tacit. All knowledge assets are codifiable to varying de-
grees [36]. All else being equal, the knowledge assets on
the employee are codifiable mostly that make the insig-
nificant effect. (3) RBV focuses on the firm-level analysis
and our measures of the latent variables are also likely to
represent firm-level information (archival data consists of
firms’ information).
Furthermore, innovation is needed to narrow down to
the refined or specific level. A firm is composed of dif-
ferent kind of divisions, and innovation often rests with
specific divisions or individuals [49]. Therefore, for ex-
ample, we asked managers to respond regarding the in-
novative activity and that may cause bias between the two
kinds of measures. (4) The type of innovation should be
considered further. Innovation can be subdivided into
radical and incremental. A large number of radical inno-
vations spring from autonomous strategic behavior, while
the greatest percentage of incremental innovations come
from induced strategic behavior [59]. Therefore, em-
ployee is the reasons for why cause an unwilling result
according to the different types of innovation [62]. Cer-
tainly, all these reasons may help explain the negative
result of Hypothesis 1. The path from internal resources
to the intensity of innovative activity should be addressed
specifically in future study.
We also examined the relationship among the three la-
tent variables regarding the intensity of innovative activ-
ity and the two kinds of firm performance. We showed
how the mediate variable contributed to the firm’s per-
formance. While the intensity of innovative activity is
related positively to the expected firm performance, con-
tradicting to the prediction, there is a non-significant ef-
fect between innovation and financial performance. In-
ternally developed innovations result from deliberate ef-
forts. Most successful firms develop both radical and in-
cremental innovations over time. Although critical to
long-term competitiveness and performance, the out-
comes of investments in innovative activities are uncer-
tain and often not achieved in the short term, meaning
that patience is required as firms evaluate the outcomes of
their innovation efforts [6][48]. Therefore, we infer that
innovation is an activity for future business and future
growth but not on the instant. Thus Hypothesis 3a is sup-
ported. Financial performance shows that the last year’s
business outcome was not positively influenced by inno-
vation, so Hypothesis 3b is not supported.
6. Conclusions and Future Research Direc-
tion
The view of strategic capabilities presented here includes
proprietary resources that exist within a firm and social
capital located among firms. To enhance efficiency and
effectiveness of the intensity of innovative activities, co-
operation between firms is the most important factor. The
study results suggest that innovative activity should be
integrated into managerial considerations, and that it is a
critical process for firm performance. This study finds
that the roots of innovation of a service firm are deeply
embedded in social relationships. Second, this study also
identifies that innovation is a business activity for the
future. Service firms intend to innovate new products and
processes, and create new market opportunities so as to
sustain competitive advantage. Therefore, a firm’s strat-
egy underlies its theory of how to compete in the market
successfully. Whether it is deliberate or emergent strategy,
a firm generally needs to address in the best operational
way what the critical economic processes in an industry
or market are and how it can take advantage of these to
generate competitive advantage for itself [9]. In conclu-
sion, service firms experience a competitive advantage
when their actions create economic value and when other
competitors cannot pursue the same activity. This study

120 Lu-Jui Chen, Chun-Chung Chen & Wen-Ruey Lee
also found evidence for the suggestion that firms that in-
vest more in cooperative relationships share value and
common benefits. Moreover, they also need to encourage
the development of strong personal and team relation-
ships, a high level of trust and strong connections across
porous boundaries [16][45][65]. The hypothesized
framework this study develops could offer a useful
ground for advanced tests of different phenomena.
There are several limitations in this study. First, the
service firms’ context of this study limits its potential
generalizability for respective industries. Service firms
include diverse businesses such as advertising, network
information supply services, and so on. More studies fo-
cusing on different categories of service firms may shed
light on the generalizability of the theoretical position
developed here. Second, it is possible that the causality
may flow in opposition to that proposed here. For exam-
ple, perhaps the concern about the intensity of innovative
activity promotes social interaction. Although we have
built our hypotheses upon existing theories and past ar-
guments, future research may show that reserve or inter-
active relationships exist. Third, the model was tested
empirically in a Taiwanese sample. Therefore, future
study in this area could replicate this study and extend it
to other economic systems to see if the findings would be
similar to those reported here. Finally, the interaction
between internal resource advantage and social relation-
ship advantage may constitute another direction for future
study. This study offers interesting findings and contrib-
utes to the understanding of the strategic capabilities and
innovation intensity of service firms.
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