The Impact of Regulation-driven Environmental Innovation on Innovation Success and Firm Performance

It is widely agreed in the literature that environmental innovation is not only determined by market pull and technology push factors but also depends on regulatory incentives. There is an ongoing debate on how regulation-driven environmental innovations influence innovation and firm success. Can firms succeed in the market with innovations stimulated by environmental regulation, i.e. can they achieve a similar market success compared to innovations triggered by market demand or by new technological developments? The positive answer is known as the Porter hypothesis which calls for a certain strictness of environmental policy. In general, the Porter hypothesis suggests that strict environmental policy spurs "innovation offsets". Increases in resource efficiency lead to higher economic efficiency, at least in the long run. These arguments are however still based on case studies. We want to validate the hypothesis by analysing regulation-driven environmental innovations. The impact of environmental innovations on firm performance is ambiguous. On the one hand, regulatory-driven environmental innovation may impose additional costs to firms and lower their profits. On the other hand, eco-innovators could profit from lower uncertainty in innovation due to regulatory standards and demand-generating effects. We analyse (a) whether regulation-driven environmental innovation generate similar innovation success compared to other types of product and process innovation, and (b) whether regulation-driven environmental innovation increase or decrease firm success (as measured by return on sales). Using firm data from the German innovation survey (the “Mannheim Innovation Panel”), we find that both product and process innovations driven by environmental regulation generate similar success in terms of sales with new products and cost savings as other innovations do. However, we find different effects when looking on the field of regulation that triggered innovations. Regulations in favour of sustainable mobility contribute to higher sales with market novelties while regulations in the field of water management lower this type of innovation success. With regard to a firm's price-cost margin, new processes implemented in order to comply with environmental regulation requirements lower profitability, indicating higher costs for this type of innovation which cannot be passed on prices. Higher profit margins can be observed for firms with innovations triggered by regulations on recycling and waste management as well as on resource efficiency. Summing up, environmental innovators on average do not perform worse compared to other innovations. This means that Porter is right when saying that environmental innovations do not harm the competitiveness of firms in general. However, if we look at specific environmental policy fields, we find winners and losers of environmental policy. For example, the innovators in the vehicle sector - e.g. suppliers of the automobile industry - have achieved above average sales shares, whereas the adopters of these innovations in the transport industry had to pay the costs, and may have in fact experienced a loss of competitiveness.

Rennings, Klaus and Christian Rammer (2010), The Impact of Regulation-driven Environmental Innovation on Innovation Success and Firm Performance, ZEW Discussion Paper No. 10-065, Mannheim, published in: Industry and Innovation.