1.Characteristics and Classification of Investment Projects.

Investments can be considered from different points of view. The basic task for investment decision-
making then will be to ascertain whether the future benefits from the investment will make the initial
outlay worthwhile.

Key Concept: An investment project is a series of cash inflows and outflows, typically starting with a cash
outflow followed by cash inflows and/or cash outflows in later periods.

This approach on the one hand leads to relatively easy solutions through the use of calculations that
allow the stream of cash flows to be converted into measures of the investment project's profitability.
On the other hand, it limits the analysis of benefits and returns to the effects of cash flows.

Connecting investments to the company's balance sheet emphasises the tying-up of capital. The benefit
of an investment project is then seen as the monetary value gained by the company through acquiring a
long-term asset in the form of increased future profits and cash flows attributable to that long-term
asset.

Investment projects can take many forms. Financial investments can be either speculative or non-
speculative. Investments in assets can be subdivided into those concerning physical assets and those
concerning 'intangible' assets.

The following figure shows a differentiation of physical investment projects, classifying them according
to possible causes for investments:

1. Foundational investment

2. Current investment a) Replacement investment b) Major repair or general overhaul investment

3. Supplementary investment a) Expansion investment b) Change investment c) Certainty investment

Foundational investments are linked with a start-up and they can be either investments in a new
company, or in an existing company's new branch at a new location. Current investments are
replacement, major repair or general overhaul investments. Supplementary investments refer to
investments in equipment in existing locations and investments.

Key Concept:

Investment projects can be categorised in many different ways. As they have substantially different
characteristics, investment projects may require different investment appraisal methods to
appropriately assess their impact, value and profitability.

2.Investment Planning and Investment Decisions

The life cycle of an investment can be regarded as consisting of specific phases. The main phases of this
life cycle are: planning, implementation and utilisation.
3.Investment Planning as Part of the Management Process

The planning phase involves preparing to make decisions about one or more investments, including
identifying the types of investment projects necessary to achieve the company’s objectives. During the
implementation phase, detailed project planning is followed by the construction or acquisition of the
asset. As soon as this is finalised, utilisation can start and the investment project can begin to earn
returns for the company.

Planning requires many pieces of information and has multiple aims, including:

• Identifying risks and uncertainties

• Incorporating options and increasing flexibility

• Reducing complexity

• Identifying and exploiting synergistic effects

• Formulating targets

• Achieving early warning of problems

• Co-ordinating functional plans and sub-plans

• Enabling control processes

• Securing information

• Motivating employees and collaborators

Goal setting will both influence awareness of the problems and provide a framework for the assessment
of possible solutions. Different forms of goals exist.

Formal goals provide the high-level criteria for assessing the consequences of investments.

Substantive goals are derived from these formal goals and relate to the steps required to fulfil the
formal goals. After the operationalisation of the goals, uncertainty and risk, and especially risk attitudes,
must be considered.

Problem identification and analysis forms the next part of the investment planning process. The aim
here is to assess the present situation, anticipate the forecasted future development and identify the
deviation between the two, so that the benefits of a potential investment can be anticipated. The third
phase, the search for alternatives, identifies possible investment alternatives that might be suitable
options to address current problems and future needs.

Forecasting and assessment and decision-making form the final phases of the planning process. They
require that information is gathered to forecast the future impact of alternative investment projects and
that suitable analyses are carried out to select the best investment options.

4.Investment Planning as Part of the Capital Investment Decision-Making Process

There is more to planning capital investment projects than financial analysis alone.

The capital investment choices that companies make are shaped by current strategy, but they also play
a part in allocating
substantial resources that will influence future strategy.

1. Develop capital investment strategy

2. Generate investment ideas

3. Define & present possible projects

4. Screen projects (preliminary)

5. Analyse projects to decide rankings and selections

6. Implement selected projects

7. Monitor and post audit projects

7.Developing the capital investment strategy.

Capital investments should not be made on an ad hoc basis, but should link into the organisation’s
existing and planned investment programme. Whatever the organisation’s strategy, it should be
translated into guidelines and limitations as to what sorts of investment projects are likely to be
acceptable from a strategic standpoint. These guidelines should be clearly communicated to
organisational personnel when capital investment policies

are developed and disseminated. The capital investment decision-making process:

1. Develop capital investment strategy

2. Generate investment ideas

3. Define & present possible projects

4. Screen projects (preliminary)

5. Analyse projects to decide rankings and selections

6. Implement selected projects

7. Monitor and post audit projects

Feedback & learning

8.Defining and presenting potential investment projects

An investment idea cannot be evaluated until it has been properly defined and presented. At the project
definition and presentation stage, more than one option should beconsidered where possible. In the
case of a project to reduce production defects, for instance, options might include:

• Modifying the existing production plant.

• Replacing the plant with similar technology.

• Completely overhauling the production technology.

Once the definition and proposal-presentation phase of the decision-making process is complete, the
company should have a good sense of what investment options exist, their scope and impact, and what
likely costs and benefits they involve. However, they won’t all be good investment prospects. So, the
next stage is important to ensure that only promising projects, which fit with the company’s strategy,
proceed further to full financial appraisal.

5.Strategic Analysis Tools Supporting the Capital Investment DecisionMaking Process

While important in themselves, even the most rigorous financial analysis tools cannot capture all of the
strategic dimensions of capital investment projects, since many of them are not amenable to
quantification. Consequently, researchers have looked for other analysis tools that do help decision-
makers to incorporate these important aspects. Broadly, two avenues have emerged for developing
alternative strategic investment appraisal techniques. The first involves modifying established
approaches to incorporate neglected ‘strategic’ project benefits. The second avenue involves drawing
on analytical frameworks that are significant departures from conventional financial and risk analyses.
Three such approaches that have been linked with strategic investment decision-making will be
described now.

The balanced scorecard

Strategic cost management analysis

Technology roadmapping

Fuzzy set theory and the analytic hierarchy process

Summary: strategic analysis tools

6.Investment Appraisal Methods as Tools for Investment Planning

Understanding the different investment appraisal methods, their assumptions, limitations and possible
usages will lead to an increased understanding of investment decision-making and an informed choice
of methods. This should greatly enhance decision-making in regard to both single investment projects
and investment programmes. The key questions to be answered using investment appraisal methods
can differ depending on problems identified during the analysis and search for alternatives.

They are the following:

Key Decisions:

x Should an investment be undertaken or rejected? ( Absolute profitability of an investment project)

x In the case of mutually exclusive investment projects, which one should be preferred? (B Relative
profitability of an investment project)

x For how long should an investment project be utilised? ( Optimum economic life of an investment
project)

x When should the investment project be started? (Optimum investment point in time)

x Which of the investment projects should be preferred and carried out when a limited financial budget
restricts the number that can be undertaken at the same time? ( Optimum investment programme)
x Which investment and financial projects should be undertaken, in what numbers and amounts and at
what time? ( Optimum investment and financial programme)

x Which investment projects and product types should be pursued and manufactured, in what number
and at what time? (Optimum investment and production programme)

bu hisse key oldugu ucun deyisiklik elemek istemedim. Sual ve cavabıardi mence cavablari yazsaq kafidir

Ugurlar

9) Cost Comparison Method.

Key Concept: Absolute profitability is achieved if the total cost of making an investment is lower than
the total cost of rejecting it. Relative profitability is achieved if making an investment results in a total
cost that is lower than that of the alternative investment project under consideration.

Assessing absolute profitability on the basis of total costs is not meaningful if the revenues generated by
an investment differ from those that would be generated without the investment

Assessing absolute profitability on the basis of total costs is not meaningful if the revenues generated by
an investment differ from those that would be generated without the investment

Assessment of the method The cost comparison method requires relatively simple calculations. Making
predictions from the data can be difficult and time consuming and, despite the assumption of certainty,
many elements of the data will be unreliably estimated.

The actual decrease in the capital tie-up, which can be interpreted as amortisation or pay back, will
normally depend on the revenues (here assumed to be identical for all alternatives and, therefore,
neglected) as well as on the resulting costs and the average profit (P). If these measures are equal to
cash flows, apart from depreciation (D), and if no additional cash flow that is not affecting the operating
result is gained, then the sum of depreciation and profit represents the total amount amortised or paid
back (PB). P + D = PB

10) Profit Comparison Method.

Key Concept: Absolute profitability is achieved if an investment project leads to a profit greater than
zero. Relative profitability is achieved if an investment project leads to a higher profit than the
alternative investment project.

As the name suggests, the profit comparison method (PCM) differs from the cost comparison method
because it considers both the cost and revenues of investment projects. The target measure is the
average profit, which is determined as the difference between revenues and costs.

Assessment of the method; The PCM acknowledges the fact that different investment opportunities
(projects) lead to different revenues. Thus, the method has a wider range of use than the CCM.

in these cases the CCM has to be used. Apart from this difference, both methods have broadly the same
strengths and weaknesses. Therefore the corresponding earlier assessment of the CCM applies equally
to the PCM.
11) Average Rate of Return Method.
Key Concept: Absolute profitability is achieved if an investment project leads to an average rate of
return higher than a given percentage. Relative profitability is achieved if an investment project leads to
a higher average rate of return than the alternative investment project.

The average rate of return method differs from the PCM in regard to its target measure. The ARR
method combines a profit measure with a capital measure to focus on the return earned on the capital
invested.

In most respects, the ARR method resembles the CCM and the PCM. Therefore, the previous
assessments of these models apply also to the ARR method. The PCM in particular has the same range
of application and thus is competing.

If the project with the highest capital tie-up also yields the highest rate of return, then the
compensation assumption made for the ARR method is not problematic because the hypothetical
investment project has no influence on the profitability. However, this is if not, then it can affect
profitability.

If several investment opportunities exist with comparable rates of return, which are similar to that of
the investment project with the lower capital tie-up and if the projects are competing for limited
resources, the use of the ARR method may be appropriate.

12) Static Payback Period Method.

1)Key Concept: The payback period of an investment project is the period after which the capital
invested is regained from the average cash flow surpluses generated by the project.

2)Key Concept: Absolute profitability is achieved if an investment project’s payback period is shorter
than a target length of time (usually expressed in years). Relative profitability is achieved if an
investment project has a shorter payback period than the alternative investment project.

The target measure used for the static payback period (SPP) method is the time it takes to recover the
capital invested in the project. It can be calculated based on average figures or on total figures.

The SPP method offers a measure of the risk connected with an investment. Judging the absolute and
the relative profitability of investment projects based only on the SPP method is not a suitable analysis,
because any costs and revenues occurring after the payback period will be completely ignored.

The SPP can be determined by dividing the capital tie-up by the average cash flow surpluses.

The capital tie-up corresponds with the initial investment outlay. If the project has an expected
liquidation value that can be estimated with some certainty, it may be useful to subtract it from the
initial investment outlay, since the SPP is often viewed as a measure of project risk.
The first case is assumed here. So, interest represents a cost (in the calculation of profit) as well as a
cash outflow and, unlike for depreciation, there is no adjustment required to convert profit to net cash
flow. To sum up, a project’s average net cash flow can be expressed as follows:

Assessment of the method; It must be emphasised that the SPP should not be used as an exclusive
decision criterion because it fails to incorporate any profits or cash flows occurring after the payback
period. However, it is a useful supplementary investment appraisal tool since it provides some indication
of the risk connected with an investment project.

13) Discounted Cash Flow Methods.

An assumption made here is that all relevant effects of the alternative investment projects are depicted
by these cash inflows and outflows, and that no other effects need to be considered. Therefore, the
target criterion used to evaluate investments takes only (discounted) cash flows into account.
Additionally, it is assumed that all cash flows can be forecasted and allocated to defined periods of
identical lengths more precisely to the beginning or the end of these periods as the representative
points in time.

The time value of money; Comparing cash flows from different periods can be achieved only by
incorporating the time value of money. The values of the cash flows depend on the time at which they
take place. Therefore transformations need to be carried out either by discounting or compounding cash
flows to compare them at specific points in time.

Using compounding, the cash flows are converted to their equivalent value as at the end of the
investment project.

Where t represents the number of time periods for which the cash flows are discounted or
compounded. The interest or ‘discount rate’ (i) plays a major role in dynamic investment appraisal
methods and will be further examined later on.

Sometimes, the monetary value of an investment results from a stream of identical cash flows over
several years. In order to calculate the present value of a stream of identical cash flows (annuity) the
capital recovery factor (or annuity factor) can be used:

In a comparable way, a single cash flow received in time period 0 can be transformed into an annuity.
This can be calculated by the use of the annuity factor, which is the inverse value of the above capital
recovery factor:
14) Net Present Value Method.
1)Key Concept: Net present value is the net monetary gain (or loss) from a project, computed by
discounting all present and future cash inflows and outflows related to the project.

2) Key Concept: Absolute profitability is achieved if an investment project’s NPV is greater than zero.
Relative profitability: An investment project is preferred if it has a higher NPV than the alternative
investment project.

Using the NPV method, all future cash flows related to an investment project are discounted back to
time 0, taken to represent the start of the investment project. The NPV represents a specific kind of PV.

Using the NPV method, the profitability of investment projects is assessed as follows:

The difference between cash inflows and cash outflows (CIFt - COFt ) is the net cash flow (NCFt ). As
shown in the following figure, all net cash flows after t = 0 are discounted back to this point in time.
net present value model does make some assumptions, the potential effects of which should be
evaluated against the real situation. The model’s assumptions include the following:

a) A single target measure (the NPV) is considered adequate.

b) The economic life is pre-determined and appropriate.

c) Other associated decisions (such as financing and production decisions) are made before the
investment decision in order to be able to forecast cash flows for separate investment projects.

d) The data is certain.

e) The cash flows can be allocated to specified time periods and points in time.

f) All current and future investments not explicitly considered (financial investments due to cash inflow
surpluses and investments to balance up the different capital tie-up and/or economic life of
investments) will yield at the relevant uniform discount rate.

g) A perfect capital market exists.

The profitability of investment projects often depends on several performance targets. In such cases a
single target measure may be insufficient for decision-making and other methods should be used.

15) Annuity Method.

1)Key Concept: An annuity is a series of cash flows of equal amounts in each period of the total planning
period.

2) Key Concept: Absolute profitability is achieved if an investment project’s annuity is greater than zero.
Relative profitability: An investment project is preferred if it has a higher annuity than the alternative
investment project.

The annuity method (AM) uses the same discounted cash flow model as the NPV method. The only
change is a different target measure, the annuityThe annuity can be regarded as an amount that an
investor can withdraw in every period when undertaking the investment project. When calculating an
annuity, the cash flows are normally allocated to the end of each period and this is assumed in the
following notes. Initially, the time span used is the economic life of the project.
As can be deduced from the formula, the annuity method leads to the same assessment of absolute
profitability as the NPV method.

Using the annuity method, the NPV of an unlimited chain of identical projects can be calculated as
follows:

The assessment of the annuity method is similar to that of the NPV method, since identical model
assumptions and data requirements exist. The calculation of the annuity is only slightly more difficult
than that of the NPV.

However, use of the annuity method is unnecessary in many situations. In the analysis of absolute
profitability, the NPV method leads to identical results.

16) Internal Rate of Return Method.

1)Key Concept: The internal rate of return is the rate that leads to a NPV of zero when applied as the
uniform discount rate

2)Key Concept: Absolute profitability is achieved if an investment project’s internal rate of return is
higher than the uniform discount rate. Relative profitability: An investment project is preferred if it has a
higher internal rate of return than the alternative investment project

The internal rate of return (IRR) method, considered next, is largely analogous to the NPV method. Only
two assumptions are modified – concerning the reinvestment of free cash flow surpluses and the
balancing of capital tie-up and economic life differences.

An isolated investment project has a project-specific cash flow balance that is negative for every period
of its economic life if it is determined on the basis of the internal rate of return. This condition is fulfilled
if:

The sum of all net cash flows in the economic life is higher than or equal to zero:

For all periods t = 0,...,t*, with t* signifying the period in which the last cash outflow surplus appears, the
cumulative net cash flows are smaller than or equal to zero:

The internal rate of return (r) was defined above as the interest rate at which the NPV becomes zero.
Therefore:
3)Key Concept: An investment project A is relatively profitable compared to a project B if the IRR of the
differential investment is higher than the uniform discount rate.

Key Concept: An investment project A is relatively profitable compared to a project B if the IRR of the
differential investment is higher than the uniform discount rate.

As with the annuity method, the IRR method shows some advantages over the NPV method when it
comes to interpreting the results. A project’s IRR can be seen as representing the interest earned on the
capital employed – an intuitive approach that makes the IRR method popular in company practice.

If the NPV method is used and the ‘certainty of data’ assumption is discarded, the IRR can be interpreted
as a critical rate of return which must not be surpassed by the real cost of capital if the investment
project is to remain favourable.

17. Dynamic Payback Period Method

The dynamic payback period method combines the basic approach of the static
payback period method with the discounting cash flow used in the NPV model.
The dynamic payback period is the period after which the capital invested has been
recovered by the discounted net cash inflows from the project. Absolute
profitability is achieved, if the payback period of an investment project is shorter
than a designated time limit. Relative profitability: An investment project is
preferred if it has a shorter payback time than the alternative investment project.
The DPP method does not necessarily lead to the same results for absolute or
relative profitability as the NPV method. Whether results differ for absolute
profitability depends on the designated time limit as well as on the cash flows for
the last period. Identical results are obtained if the designated time limit is assumed
to be the project’s economic life. Differences in comparing relative profitability,
however, can result from cash flows that occur after the payback period has been
achieved, as the DPP method does not systematically account for these subsequent
cash flows.

18. Data Collection

Data collection is the process of gathering and measuring information on targeted
variables in an established system, which then enables one to answer relevant
questions and evaluate outcomes. While methods vary by discipline, the emphasis
on ensuring accurate and honest collection remains the same. The goal for all data
collection is to capture quality evidence that allows analysis to lead to the
formulation of convincing and credible answers to the questions that have been
posed. Data collection and validation consists of four steps when it involves taking
a census and seven steps when it involves sampling. Initial investment outlay The
initial investment outlay for an investment project is a cash outflow resulting from
the acquisition of the project, and/or the company-wide activities necessary for its
provision and establishment. The purchase price should reflect any discounts
received, but must also include any costs associated with procurement, for example
freight and customs/import duties. Cash flows resulting from the in-company
production of an investment project can be derived from the cost accounting
system, as a calculation of production costs. However, any discrepancy between
recorded costs and cash outflows should be scrutinised, as it might require
adjustments to the data. It is often difficult to work out the cash flows caused by
additional in-company activities associated with the acquisition or production of an
investment project, particularly where there are ‘indirect cash flows’ caused by the
joint use of indivisible assets by several projects. This is comparable to the
problem of indirect costs and revenues in cost accounting systems.

19. Compounded Cash Flow Methods

The compound value method is a dynamic investment appraisal method that uses
the compound value as its target measure – i.e. all cash flows are compounded to
the end of the investment project. The compound value is the overall net monetary
gain or loss resulting from the investment project and is related to the end of its
economic life. The method is characterised by three assumptions about the capital
market. First, it is assumed that different interest rates exist: a debt interest rate for
borrowings and a credit interest rate for financial investments. Second, it is
assumed that unlimited amounts can be borrowed or invested at these rates. Third,
interest rates are assumed to be independent of the amount borrowed or invested.
Apart from these assumptions and the use of compound values as target measures,
the model parallels the net present value model. Absolute profitability: is achieved
if an investment project’s compound value is greater than zero. Relative
profitability: is achieved if an investment project has a higher compound value
than the alternative investment project.

20. Compound Value Method

The compound value method is a dynamic investment appraisal method that uses
the compound value as its target measure – i.e. all cash flows are compounded to
the end of the investment project. The compound value is the overall net monetary
gain or loss resulting from the investment project and is related to the end of its
economic life. The method is characterised by three assumptions about the capital
market. First, it is assumed that different interest rates exist: a debt interest rate for
borrowings and a credit interest rate for financial investments. Second, it is
assumed that unlimited amounts can be borrowed or invested at these rates. Third,
interest rates are assumed to be independent of the amount borrowed or invested.
Apart from these assumptions and the use of compound values as target measures,
the model parallels the net present value model. Absolute profitability: is achieved
if an investment project’s compound value is greater than zero. Relative
profitability: is achieved if an investment project has a higher compound value
than the alternative investment project.

21. Critical Debt Interest Rate Method

The critical debt interest rate method, like the compound value method, assumes
separate debt and credit interest rates. The critical debt interest rate serves as the
target measure for this method. The critical debt interest rate is the rate that results
in a compound value of zero. This approach indicates the interest earned on capital
tied-up over each period of the investment project, given a specified credit interest
rate.The CDIR method and the CV method have a relationship similar to that of
the internal rate of return method and the net present value method. Assuming the
likely case that the debt interest rate exceeds the credit interest rate, the absolute
profitability of investment projects can be defined as follows.An investment
project is absolutely profitable if its critical debt interest rate exceeds the market’s
debt interest rate. An approximation of the critical debt interest rate can be made as
described for the IRR. First, the compound value CV1is calculated for a debt
interest rate d1
. If CV1 is positive (negative), a higher (lower) debt interest rate d2 is
selected and used to calculate a lower (higher) compound value CV2
. Using these two results, an interpolation or extrapolation can be executed using a
formula similar to the one used to calculate with the IRR method:

22. Visualisation of Financial Implications (VoFI)

Method
The visualisation of financial implications method is based on the ideas of
HEISTER that were later developed by GROB. Its defining feature is a
comprehensive financial plan that considers all cash flows connected with an
investment project. The VoFI comprehensive financial plan considers the
economic consequences of an investment project, specifically in regard to:
• The amounts and proportions of internal funds and debt capital used.
• The amounts and timing of debt redemption from cash inflows.
• The alternate yield on the long-term financial investment of the initial internal
funds (the opportunity interest rate that generates the so-called opportunity income
value) – not necessarily identical to the yield on shortterm financial investments
during the project’s economic life.
• The existence of different forms of loans, with differing payback and interest
conditions. Target measures for the VoFI method can be compound values, initial
values, intermediate values, withdrawals, or specific rates of return. Compound
values are considered here, primarily because of their clarity. They represent the
value of the accounts at the end of the economic life of an investment project, and
are discernable directly from comprehensive financial plans. An investment project
is absolutely profitable if its compound value exceeds the opportunity income
value at the end of its economic life.
An investment project is relatively profitable if its compound value exceeds the
compound values of alternative projects.

23. Assessment of the method -NPV

It should be noted that only profit-dependent taxes are considered. Although this
might be sufficient in most cases, a conclusive and thorough investment appraisal
could also need to include other kinds of taxes and their resultant effects which can
be incorporated by adjustments of the cash flows. More problematic is the
assumption that only one type of profit-dependent tax is levied, and that it is a
proportional tax. In reality, differential taxation of profit occurs using several kinds
of taxes whose inter-connecting effects can be complicated to recognise.
Moreover, the rate of taxation is not always constant, given the high incidence of
tax-free allowances and/or progressive taxation schemes. The linear tax rate
assumption might often be unrealistic, therefore. Where a single profit assessment
basis and only one rate of taxation (a proportional tax) are not justifiable
assumptions, extended models involving further analyis should be employed.

24. Assessment of the method-İRR

It should be noted that only profit-dependent taxes are considered. Although this
might be sufficient in most cases, a conclusive and thorough investment appraisal
could also need to include other kinds of taxes and their resultant effects which can
be incorporated by adjustments of the cash flows. More problematic is the
assumption that only one type of profit-dependent tax is levied, and that it is a
proportional tax. In reality, differential taxation of profit occurs using several kinds
of taxes whose inter-connecting effects can be complicated to recognise.
Moreover, the rate of taxation is not always constant, given the high incidence of
tax-free allowances and/or progressive taxation schemes. The linear tax rate
assumption might often be unrealistic, therefore. Where a single profit assessment
basis and only one rate of taxation (a proportional tax) are not justifiable
assumptions, extended models involving further analyis should be employed.

25. Income Taxes and Investment Decisions

Taxes should be included in the analysis of investment projects since they may
affect project profitability. Their consideration in the assessment of investment
projects is illustrated here using both the net present value (NPV) and visualisation
of financial implications (VoFI) methods. The influence of taxes on the
profitability of investment projects is affected by several factors, including: the
form of the tax laws; the legal form of the company and the perspective from
which the appraisal is made. Some simplifying assumptions usually have to be
made in regard to these factors.

26. Taxes and the Net Present Value Method

In modifying the NPV method to include tax considerations, a simplified model
variant is chosen that considers only profit-dependent taxes. The relevant profit
measure can be derived from the original cash flow profile modified by
depreciation and the difference between the liquidation value and the remaining
book value of assets sold at the end of a project’s economic life. In addition to the
premises of the NPV model, the following assumptions are made:
• The company pays profit-dependent tax at the same time as the profit is reported:
at the end of each period.
• Tax payments are proportional to the profit made.
• The company makes a profit in each period, independent of the project under
consideration. Therefore, immediate loss compensation is possible in each period
for which the proposed investment results in a loss, so a loss carryforward is
neither necessary nor possible.
• The original cash flow profile of an investment project remains unaffected by
taxes.
• Interest paid to creditors reduces profit and therefore reduces taxes; interest
received from debtors raises profit and taxes.
• All cash inflows or outflows resulting from a project – with the exception of the
initial investment outlay and possibly the liquidation value – are counted in that
same period as yields or expenses for the purposes of calculating profit. The initial
investment outlay is initially capitalised in the balance sheet. Its subsequent
depreciation annually reduces the profit, and the sale of the project generates a
cash flow, that simultaneously may influence the profit. The NPV calculation
requires two additional steps to account for taxes:
• The original cash flow profile must be modified by payments directly resulting
from taxation.
• The uniform discount rate must be adjusted to recognise the effects of tax paid on
the yields of alternative investments, as well as tax deducted from the interest paid
on debt capital.

27. Taxes and the Visualisation of Financial

Implications (VoFI) Method
The VoFI method explicitly records changes in tax payments that result from an
investment project in an exhaustive financial plan. The determination of these
changes is made in a separate calculation linked to the VoFI tables. Adjusted
interest rates for loans or for short-term investments are not required. Instead, taxes
are included when determining the compound value. Additionally, either a simple,
after-tax opportunity interest rate may be used to determine the compound value of
the internal funds, or tax payments may be included in a VoFI plan for the
alternative opportunity investment. The VoFI method, with its separate
calculations, allows an investment appraisal to incorporate a specific tax system’s
known characteristics, such as the relevant kinds of tax, the tax bases, and the tax
rates. However, no such specific tax system is included here, since no one system
could adequately represent the wide variability in international tax systems.
28. Special Characteristics of Foreign Direct
Investments
A foreign direct investment (FDI) includes the establishment, expansion or
acquisition of sales outlets, storage or production plants abroad, and the direct
influencing of the decisions made by a foreign company unit. The investing
‘home’ company sustains cash outflows in its domestic currency to finance assets
in the ‘investment country’, so that future cash flow surpluses may be achieved in
the currency of that country. In view of the relatively high investment amounts and
the complexity of these decisions, model-supported assessment of foreign direct
investments seems particularly advisable. Additionally, foreign direct investments
have special characteristics that make it useful to present a separate discussion of
models and methods for their appraisal. For foreign direct investments, at least two
company units are involved: the unit that views the investment as an FDI and the
existing or newly-formed unit abroad. For these two company units, the cash flows
resulting from the FDI may differ in their amounts and timing for
several reasons (such as exchange rate differences, subsidies, tax payments and
transfer payments). Then, factors influencing these cash flows have to be analysed
in order to forecast their amounts and timing. The necessary analysis and
forecasting activities can be summarised in sequential steps:
1. Identify the cash flow changes at the daughter company in the investment
currency initial investment outlay, cash flows, liquidation value, payments
resulting from the financing of the investment project and financial investments
connected with it, cash flows from and to the mother company, and tax payments.
2. Identify the cash flow exchanges between mother company from the point of
view of the mother company and in the home currency cash flows for financing,
interest and amortisation, for mutual supplies of semi- or fullyfinished products,
for claims on patents or licences, for management services and from the transfer of
surpluses from the investment including the liquidation value or residual value,
etc..
3. Identify other cash flow changes within the mother company, in the home
currency resulting particularly from the financing of the investment project,
associated financial investments, risk management, changes to production and
sales processes as well as tax payments in the home country.
29) Net Present Value Model and the Assessment of Foreign
Direct Investments
In a perfect international capital market, the International FISHER Condition stipulates that interest rates
in different national capital markets are equivalent after accounting for exchange rate changes. So, if the
uniform discount rate is based on capital market interest rates for investments or loans, it is
independent of the investment country.

This section will outline how NPV calculations can be used to assess foreign investments. Some special
characteristics of such investments are taken into account, primarily concerning the consideration of
different currencies and the inclusion of an international capital market.

the procedure described for the NPV model is based on the assumption of a perfect international capital
market, but can be also applied in modified form for an imperfect market.

he usual assumptions of the NPV model apply should be taken into account when assessing both model
variants. It should be noted that, even in the case of an imperfect international capital market, perfect
national capital markets are assumed.

30) The Visualisation of Financial Implications (VoFI) Method

and the Assessment of Foreign Investments.
When determining the compound value of an investment, inflation may be taken into account using a
combination of nominal cash flow values and nominal interest rates (including inflation effects). This
allows differences in price trends for various product types in the relevant countries to be considered.

this section demonstrates how foreign investments can be assessed in detail using the visualisation of
financial implications (VoFI) method. For this purpose, the standard version of the VoFI method must be
modified slightly.

The VoFI method illustrates changes in tax payments in a transparent and realistic way.

The VoFI method is well suited to considering both national and international imperfect capital markets
and offers a realistic view of foreign direct investments profitability across the spectrum of country-
specific financing and investment opportunities.
The high transparency of the VoFI method is another one of its advantages. Currency changes for
mother and daughter companies can be illustrated clearly, as well as cash flow streams between both
and the tax effects of investments.

31) Models for Economic Life and Replacement Time Decisions.

The ‘lifetime’ of an investment project the period for which it operates – is crucial to its financial results
and its profitability.

Often, technical life should not be completely exhausted in order to maximise financial success. Product
market changes may make it uneconomic to continue with a project because it becomes dysfunctional,
obsolete or in need of economic overhaul.

Economic factors also influence the optimum economic life the period of project utilisation that best
fulfils company aims. Economic life is, by necessity, always shorter than or equal to the project’s
technical life.

economic life of an investment project. It is assumed from here that:

Economic life and replacement time decisions are made in different situations, yet the decision-support
models are in many ways the same. For both types of decision, the number and type of subsequent
project are crucial. Subsequent projects are projects whose inception depends on the cessation of the
considered investment and, if started at the end of the economic life of the preceding investment, may
be said to constitute a chain of investments.

In addition, optimum economic life and replacement time analyses require the following assumptions:

32) Optimum Economic Life without Subsequent Projects.

Key Concept: Using the NPV model, the optimum economic life of a single investment is achieved at that
point in time when the maximum NPV is reached.

NPV can be determined in two ways:

1)By determining the NPV for every economic life alternative n, using the formula:

2)By determining the marginal profits. This requires the calculation of two components that result from
continuing the project for an additional period t:

Key Concept: The economic life ends at the close of period t – 1 if the following period t is the first,
whose marginal profit is negative

The validity of assuming that the NPV function achieves only one maximum may be verified by
determining marginal profits for all following periods t + 1, t + 2, ... until the end of the technical life of
the investment project.

Assuming a given maintenance policy, or considering the economic life of each investment project in
isolation, might be problematic in many situations. Also, it should be noted that the suitability and
precision of the described model depend largely on whether it is realistic to assume there will be no
subsequent investment project.
33. Optimum Economic Life with a Limited Number of
Identical Subsequent Projects

This section considers the determination of optimum economic life when a limited
number of identical subsequent investment projects are available. These projects
should be undertaken sequentially, so that a limited chain of identical projects is
considered. The identical feature of the investment projects – as mentioned above –
is their cash flow profile; other characteristics can differ.

First, it is assumed that the investment chain consists of a basic project and a single
subsequent investment project, i.e. a two-project chain is planned. For both the
basicand second investment projects, the optimum economic life is achieved at the
maximum NPV of the investment chain.
The NPV approach can be applied to appraising a chain of two investment projects
by calculating, for all the basic investment project economic life alternatives (n 1),
the NPV of the investment chain (NPVC). That chain comprises (i) the discounted
NPV of the second investment project (used for its optimum economic life) and (ii)
the NPV of the basic investment (NPV1), with both related to the beginning of the
planning period:

In the alternative approach, if period t is the first period for which the basic
investment’s marginal profit is lower than the interest on the maximum NPV of the
second investment project for that period, then the optimum economic life of the
basic investment ends at the close of period t – 1

The following statement generally applies with regard to the economic life of
separate projects in a limited chain of identical projects:
In a limited investment chain of identical projects, the optimum economic life of
the separate projects tends to decrease as the number of subsequent projects
increases.
This phenomenon is known as the chain effect. Accordingly, the optimum
economic
life of a basic investment tends to be shorter than that of an investment without
subsequent projects.
34. Optimum Economic Life with an Unlimited Number of
Identical Subsequent Projects
For all investment projects in an unlimited chain of identical projects, economic
life reaches an optimum when the NPV of the unlimited chain is at its maximum.
In contrast to the previous examples, it is now assumed that a basic investment is
followed by an infinite number of identical, sequential investment projects.
Therefore, the interest that is part of the calculated marginal profit is identical for
each successive project in the investment chain. From this, it follows that all the
projects in an unlimited chain of identical investments have identical optimum
lives. This concept is expressed in the following:

For all investment projects in an unlimited chain of identical projects, economic

life reaches a common optimum when the NPV of the unlimited chain is at its
maximum.

For a marginal profit analysis, marginal profit is compared with the interest on the
NPV of subsequent projects as a function of their economic lives (i · NPV􀂒t).
These interest payments make up its annuity. In order for the extension of a project
by one period (t) to be profitable, the marginal profit from this period should be
higher than the corresponding annuity. Again assuming NPV as a function of
economic life reaches only one maximum, the criterion for optimality is as
follows:

The end of the optimum economic life of a project in an unlimited chain of

identical projects occurs at the close of period t – 1, if the following period t is the
first one whose marginal profit is lower than its annuity.
Formally, the criterion is:

The end of the optimum economic life of a project in an unlimited chain of

identical projects occurs at the close of period t – 1 if the following period t is the
first one whose marginal profit is lower than the annuity achieved up to the period
t–1
Formally, the criterion is:

35. Innovation policy – definition and delineation

Innovation policy is public intervention to support the generation and diffusion of
innovation, whereby an innovation is a new product, service, process or business
model that is to be put to use, commercially or non-commercially.
Innovation policy, as we delineate it, is intervention that is designed and
administered by government, including multiple agencies at various spatial levels.
We do not include private, corporate policies or strategies for innovation within
this definition, although organisations that originate these are often the targets of
innovation policies.
Definition includes innovation generation, market introduction and diffusion.
The generation of innovation involves the production of underlying
knowledge, artefacts and practices that are needed to produce something
novel. Thus innovation policy overlaps with and is linked to science, research
and technology policy. We also include the introduction and diffusion of
innovation in our definition, since the bottleneck for innovations is often not their
design and development, but their absorption by users. Therefore, what qualifies
a ‘policy intervention’ as an ‘innovation policy intervention’ is its purpose
to provide support to the process of the generation, introduction, diffusion,
adoption and use of novelties.
The target groups of innovation policies are in principle
all those actors who generate innovations from the supply side and also
those who ask for, absorb and use innovations from the demand side

36. The nature of policy instruments and their impact

The political science literature has defined – broadly speaking – three
dominant understandings of instruments over time.
In the 1970s, the classical approach conceived of instruments as policy
mechanisms for goal-attainment. This included traditional functionalist
perspectives which defined instruments as the set of techniques by which
government authorities wield their power in attempting to ensure support and
effect or prevent social change. Governmental actors are in charge at every step of
the process, instruments are selected on the basis of their specific characteristics to
tackle the gap and their implementation is largely a technical and mechanistic
matter and largely context insensitive once the specific gap is identified.

This school of thought was subsequently modified, based on the realisation

that it is not the characteristics of the instrument alone that determine
the effectiveness of the instrument, but the context and process of its
implementation.

Sociological school of thought. According to this approach, an instrument

is, by definition, only one of a whole range of variables that intervene in the
system and affect target groups. Here, the implementation structure and
process of the instrument are seen as major factors, with implementation
agents creating their own specific understanding of the problem, the target
group and the mechanisms of the instruments. In this sociological view,
instruments are not technical, neutral devices that can be selected and implemented
to solve a ‘given’ problem.

37. Entrepreneurialism: Characteristics

The literature sees entrepreneurship as comprising a range of personal
characteristics, which we suggest can be considered to form two general
categories:
a) a value or attitude system of cultural values; and
b) a set of skills which we suggest are instrumental in the realisation of a value
system. The value system is broadly a set of beliefs about ends, namely that the
results of entrepreneurship, wealth creation, personal interest, self-realisation
through business and capital accumulation are the personal priority of an
individual.
The entrepreneurial skill set comprises those aptitudes that give the entrepreneur
the means of realising the ends of the entrepreneur. The relation between ends and
means is evidently problematic, given the circularity in both directions in
determining the meaning of the terms, namely that entrepreneurs are people who
have entrepreneurial skills on the one hand while entrepreneurial skills are those
possessed by entrepreneurs on the other.

38. Systematic Approaches

Entrepreneurship policy, while having its own specific rationales, can also
be considered within the context of broader policies to promote economic
growth, development and sustainability. The European Union, for example,
has sought to develop its framework for entrepreneurship policy across a
multi-country context and within a single programme, the Entrepreneurship
and Innovation Programme , consisting of six streams of activity
This requires systematic policy coordination at all levels and
between all levels. The EIP is an umbrella project in effect – to promote
entrepreneurship that covers financial assistance to firms, promoting the
Enterprise Europe network and supporting eco-innovation.
The programme is important as a form of support to entrepreneurship because of
the scale of funding, although the amount of money is to be spent across the whole
of Europe.
An evaluation of the programme examined its relevance, efficiency and
effectiveness. The review, largely based on a survey and
interviews about what the participants and beneficiaries believed was useful,
came to a number of conclusions on operational performance and early and
intermediate inputs, including the following:
● that the programme was particularly effective at the European level in
addressing the needs, problems and issues set out;
● that the overall objectives were coherent and the implementation
processes
were integrated measures by member states;
● that it was on track to achieve the anticipated impacts expected of it; and
● that stakeholders believed the budget and the dedicated resources were
at the appropriate level.

39. Schemes to Promote Cultural and Behavioral

Change

Policy makers the world over have recognised the importance of entrepreneurship
in the quest for economic development and support instruments
like entrepreneurship education to increase levels of entrepreneurial activity.
Entrepreneurship education is considered integral to creating a culture
for entrepreneurship, and there has been a significant increase in the use of
entrepreneurship education in schools, colleges and universities in Europe
and elsewhere.
Studies of the impact of entrepreneurial education adopt various proxies
for entrepreneurship including intentions to become an entrepreneur, the
feasibility of entrepreneurial ventures and competencies associated with
entrepreneurship. However, the results of such studies are mixed. Some studies
find entrepreneurship education impacts positively on perceived attractiveness and
feasibility of starting new business activities, while others find evidence that such
effects are negative. Such inconsistent results, as noted by a number of authors,
stem from various methodological shortcomings.
OLS estimations are used to analyse the relationship between the
strength of students’ intentions to become entrepreneurs or avoid entrepreneurship
and several variables, including pre-course beliefs, sex, religion and whether
parents or friends are self-employed. The results show that the strength of students’
intentions is positively related to the strength of pre-course beliefs, consistent
beliefs and the interaction between the two, all of which are significant at either the
1 per cent or the 5 per cent level. While not employing a control group, von
Graevenitz argue that it was unlikely that students updated their beliefs on
information outside the course, since the contents of the course were very specific
and not duplicated in other courses. However, in line with Oosterbeek, these
results suggest that entrepreneurial education strengthens the intentions
to become entrepreneurs and further that the consistency of signals received
affects changes in students’ intentions to become entrepreneurs.
40. Schemes to provide advice of a standardised form
Schemes providing information and advice include general support to
entrepreneurship across a whole range of challenges, but there are some which are
directed at specific types of business, usually SMEs, and firms with particular
aspirations. Our first example is of a programme in Canada in the province
of Quebec, the OPREX initiative, that aims to improve export performance of
firms, particularly SMEs, through: a) training and preparedness activities and
services; b) awareness activities and services; and c) support and guidance
activities and services.
There has been several analysis by Wren and Storey, Roper and Hart, Rotger etc.
Overall, the analysis shows that the treatment effects (difference between
the treated and control groups) are relatively low and in most cases statistically
insignificant. This suggests that (on average) additional support does not
contribute to an increase in the duration of self-employment.
In the case of training, statistically significant effects are found for ‘exits into
unemployment’ so that additional support is associated with an increase in exiting
self-employment into unemployment. By contrast, coaching significantly reduces
exits into dependent employment; business founders who receive coaching
support are less likely to enter dependent employment when quitting
self-employment.

41. Schemes to provide more specific and situational advice.

Coaching In recent years, governments have begun to support advice to SMEs
through subsidy of business coaching. Coaching can be a diverse form of advice-
giving, including specific information on issues such as marketing but also more
generalised advice to new business owners whose background and experience in
their new roles may be limited. While policy initiatives that support advice-giving
have been justified on the basis of market failures, other justifications that
emphasise the subjectivity of the SME and entrepreneur have also been
proposed.
These subjective, entrepreneur-based assessments of need are based on Austrian
conceptions of economic action. The neo-Austrian approach focuses on the need
to develop help that is specific, and answers the often unique needs of the
entrepreneur.
The methods used in the analysis by Lambrecht and Pirnay did not employ a true
counterfactual analysis and only compared firms that had been helped with
typical firms . The study reports three main reasons for the hiring of a consultant:
a) quality enhancement of goods and/or services; b) diagnosis of the enterprise;
and c) organisational improvement. While this study is focused on a scheme that
provided direct and ‘operational services in a solution oriented way, the
assistance given is likely to have been broad enough to constitute
entrepreneurship support.
Within the support measures provided by the European Regional Development
Fund (ERDF)-funded Northwest ERDF Operational Programme (2007–13), a
coaching scheme was introduced to promote entrepreneurship. The Northwest
Regional Development Agency area introduced a coaching scheme in parallel with
other RDAs across England and Wales.
There are differences between coaching and other approaches to supporting
rapid improvements in business performance. Contrasts three different
approaches to coaching and mentoring, counselling and consultancy.
Evaluations of coaching schemes are difficult because engagement with firms
varies significantly. Needs are different across firms and the action provided by
coaches varies also. Such schemes also support entrepreneurs but do not
encourage entrepreneurship, as those receiving assistance are already running
their ownbusinesses.
The Nesta study on mentoring, which covers a number of coaching programmes,
not only those directed at the creative industries, reaches the following
conclusions, which concern operational issues, and does not set expectations
about the impact of such schemes:
● Coaching helps entrepreneurs tackle a range of problems within a firm, but
particularly people-related issues. ● There may be greater suitability for coaching
with the creative industries. ● In terms of relationships, the coaching period
should be within a period of between six months and two years, and meetings
should take place on a monthly basis. ● Personal matching between mentors and
mentees is vital for the success of the mentoring; invariably mismatches arise
between personalities, so arrangements must be made to allow coaches or
mentors and those they assist to break off their relationship if tension and
disagreement occur; expectations on both sides need to be carefully managed.
Other reviews of coaching as an activity have highlighted the following issues: the
variety of approaches ; the specific characteristics of the coach and how they
impact upon the coach’s effectiveness; the difficulties of establishing a coaching
profession to maintain standards and to ensure a coherent vision ; the role of
leaders in the coaching process ; and coaching as a means of promoting
organisational change.
The early review of expert help including coaching for entrepreneurs in Scotland
by Turok and Raco identified this scheme as the first of its type in this area.
Evaluation of the characteristics of firms showed that these varied significantly
and that a simple offering of support would not meet the needs of firms. In the
evaluation, it was proposed that a more strategic relationship should be
developed between the support agency and those firms most requiring help.
A review of the evaluation of coaching performance by their clients carried out by
Gale et al16 and cited in Feldman and Lankau suggests that, in regard to the
operation of private coaching schemes, it is difficult to make assessments of the
impact and quality of the service offered: ‘Evaluations that coaches receive from
their clients are mainly subjective in nature and are not empirically valid
measures of coaches’ actual effectiveness. Feldman and Lankau note that the
academic research on the outcomes and impacts of coaching are very limited; far
more common are practitioner publications on coaching, but these lack any
empirical and robust methods of impact assessment.

42. Multi-instrument Schemes.

The concept of clusters can be related to various conceptual and theoretical
developments around locally embedded groups of firms and other organisations,
such as ‘industrial districts’, ‘new industrial spaces’, ‘flexible specialisation’ and
‘regional innovation systems’. However, most scholars link the popularity of
clusters to Porter’s analysis of the competitive advantage of nations and the
associated four facets of competitiveness, namely firm rivalry, factor inputs,
related industries and demand conditions. In this context clusters are defined as:
‘geographical concentrations of interconnected companies and institutions in a
particular field’. This definition includes economic actors such as specialised input
suppliers, customers, manufacturers of complementary products and related
firms, as well as governments and other institutions such as universities,
standards agencies and trade associations. Most definitions of clusters (see, for
example, Enright, 1996; Spencer et al., 2010) include a degree of specialisation in
a particular industry (measured by employment), co-location of the specialised
industry and other related industries, and scale or critical mass in the cluster.
There are however many deep-seated conceptual and empirical controversies
about what clusters are and how they can be identified, how they emerge and
evolve, why they matter and how they can be used by policy . Clusters ‘vary in
size, breadth and state of development’ and as a result a number of typologies
have been proposed to characterise them.
44. The Economic Importance of Clusters.
Since Marshall’s (1890) analysis, the advantages arising from geographical
proximity have been associated with external economies in the form of
specialised labour markets, input suppliers and knowledge spillovers, giving rise
to innovation and productivity benefits. Co-location is associated with better
access to specialised, high-productivity employees with lower search and training
costs. At the supply input level, intermediate industries provide downstream
firms with local access to specialised materials and components, finance,
marketing and business services, as they themselves exploit greater internal
economies of scale and benefit from reduced transport costs. Some studies focus
on the relationship between clusters and innovation. Scholars have analysed
whether firms in clusters are more or less innovative than non-clustered firms and
the relative importance on innovation of localisation and urbanisation economies,
namely whether benefits occur within industry or across related industries in a
particular location. Baptista and Swann (1998) analysed the innovations
introduced by 248 UK manufacturing firms during 1975 and 1982 and compared
clustered (defined on the basis of absolute regional employment in a firm’s own
industry) with nonclustered firms. They found that strong employment in the own
industry in the home region raises a firm’s likeliness to innovate. While there are
many potential benefits associated with clusters, there are also some possible
downsides. As Swann (2006, p.259) notes, ‘clusters may be a “good thing” but
they are not unambiguously a “good thing”’. Overspecialisation has been
associated with long-term lock-in, inability to adapt and therefore greater
vulnerability vis-à-vis external shocks (Grabher, 1993). OECD (2009) and Swann
(2006) note how the economic benefits from clusters in certain locations may be
offset by economic costs or activity losses in other locations. Clustering can also
be associated with certain disadvantages such as congestion and competition
effects in both input and output markets (Swann et al., 1998) and could also lead
to raising the cost of real estate, as well as the cost of specialised labour (Martin
and Sunley, 2003). At the aggregate level, whether the advantages outweigh the
negative aspects is not easy to determine (OECD, 2009).
45. The Rise of Cluster Policies.
Global Cluster Initiative Survey identified about 500 cluster initiatives, mostly in
Europe, North America, Australia and New Zealand (Sölvell et al., 2003). Danish,
Dutch and Finnish governments were among the pioneers in setting up
programmes with strong SME components (Andersson et al., 2004). Human
capital and innovation issues have been strongly supported in the cluster policies
of countries such as Australia, Austria, Canada, Finland, France, Germany, New
Zealand, Norway, Portugal, Spain and the United Kingdom (Isaksen and Hauge,
2002). In the 1990s, the Department of Trade and Industry in the UK endorsed the
idea of clusters, which were promoted as a key element in the regional economic
strategies of the newly created regional development agencies. Andersson et al.
(2004) note additional differences in the adoption of cluster policies. While China
has mainly pursued broker policies related to science parks and incubators,
Thailand, for instance, explicitly promotes SME cooperation. In Japan, early R&D-
support programmes for SMEs have been replaced with initiatives to support
innovation within clusters (Andersson et al., 2004). The cluster concept has been
particularly adopted in the context of multilateral policy cooperation. The
promotion of the concept under the auspices of international organisations such
as the Organisation for Economic Co-operation and Development (OECD) has
greatly contributed to its diffusion. The OECD’s Committee for Scientific and
Technological Policy and its Working Party for Technology and Innovation Policy
embraced the concept from the early 1990s. Later, organisations such as the
World Bank and UN institutions such as UNIDO and UNCTAD incorporated the
clusters idea in the context of development for developing countries (Andersson
et al., 2004). The European Commission has also enthusiastically embraced the
cluster concept, particularly in relation to the implementation of regional policy
and the development of the Lisbon Agenda, and more recently in the context of
the smart specialisation agenda currently dominating EU’s regional policy
discourse (OECD, 2012). In particular, it has been active in supporting mapping
exercises such as the European Cluster Observatory and promotes knowledge
exchange and networking between cluster initiatives (e.g. through the Europe
INNOVA initiative or the European Cluster Alliance funded under the PRO INNO
Europe initiative).
46. Cluster Policy Interventions: Design, Implementation and Instruments.
Traditional policy measures are also sometimes relabelled as clusters (Sölvell et
al., 2003), and sometimes network policies and cluster policies are used
interchangeably (see Cunningham and Ramlogan, this volume, Chapter 9). Cluster
policies may be designed to pursue objectives of industrial and SME policy or
research and innovation policy. Programmes may also differ according to the
national institutional configuration, the level of government involved and the
nature of government intervention (Enright, 2003). They can also vary in terms of
the types of sectors, firms and territories targeted, the identification and selection
of the targeted clusters, the policy instruments used and the institutional context
and actors’ constellation of cluster programmes. These aspects are further
elaborated below. Borrás and Tsagdis (2008) note that a relatively neglected
aspect in the literature relates to the institutional and governance configurations
underpinning cluster policies. For instance, in the US the government generally
has a hands-off attitude and maintains an arm’s-length relationship with industry
while trying to provide a conducive business environment, while in a coordinated
market economy like Germany collective action takes place through tripartite
relationships between the state and associations representing the business
sectors, and trade unions. They note that, while the US system provides a more
flexible framework, it lacks strategic coherence and concrete action to promote
clusters. In Germany, by contrast, cluster promotion presents a stronger top-
down impetus and more strategic coherence, although, unlike the US, it often
fails to mobilise the
private sector to join in. In relation to the level of government responsible,
particularly in countries with a decentralised or federal system, cluster
programmes are fundamentally regional policy initiatives. In other cases,
responsibility is sharedbetween the national and the regional levels in relation to
the selection of funding of the programmes, for instance in the case of the French
Pôles de compétitivité. In Canada, even though sub-national governments have
implemented strategies to support clusters, the main cluster support programme
is delivered at the national level by the Canadian National Research Council (NRC).
The BioRegio and InnoRegio programmes in Germany are also examples of joint
work between the federal and the regional level, with the former playing the role
of facilitator and the latter actively managing the programmes. In the US, the
policy instruments and resources to promote clusters and economic development
are generally the realm of state policy (OECD, 2007). Authorities at the regional
and local level tend to be more aware of the problems of the locality and are
allegedly better placed to adapt policies to specific regional circumstances
(Boekholt and Thuriaux, 1999). They may however lack the holistic view, the
competences, or the capacity to act on the right policy levers that cluster
development requires (Enright, 2003; Duranton, 2011). Last but not least,
sometimes clusters may be supported in cross-border regions, for instance the
Medicon Valley cluster in the Öresund region spanning the Copenhagen
metropolitan area in Denmark and southern Sweden. Policies also differ in the
way clusters are identified and selected for support. Identification may be done
using quantitative and qualitative methods, and in a top-down and bottom-up
manner (OECD, 2007, p.78). Top-down identification may involve different
methods to assess the concentration of activities; quantitative methods include
the use of detailed industry, location and economic statistics to map
concentration, input–output data and firm-level information from surveys (Nesta
et al., 2003), while qualitative approaches to cluster identification tend to be
based on expert knowledge (for methodological bottlenecks in cluster analysis
also see Roelandt and den Hertog, 1999). The task of identifying clusters can also
be delegated to a lower level of governance in a bottom-up manner. Sub-national
governments and agencies can identify the more prominent clusters to support,
and embed them in their regional innovation or economic development strategies
(OECD, 2007). Alternatively, it may involve bottom-up self-identification of
clusters in response to specific eligibility criteria. There are advantages and
disadvantages associated with bottom-up and top-down selection; while the
former may translate into small and loosely connected collections of similar or
related firms being selected, often reflecting policy aspirations rather than reality
(Martin and Sunley, 2003), engineered or top-down approaches may face greater
difficulties in building social capital and developing linkages and a shared vision
(Andersson et al., 2004).
47. Cluster polıcy evaluatıon.
Thorough evaluations of cluster programmes are rare, as highlighted by meta-studies on cluster
policies (Andersson et al., 2004; OECD, 2007; Sölvell, 2008; European Cluster Observatory3 ).
The challenges associated with evaluating cluster policies have been a source of recent interest
in the academic and policy communities (Díez, 2002; Raines, 2003; Fromhold-Eisebith and
Eisebith, 2008), and some main challenges are reported below. Given the diversity of cluster
objectives and the often hybrid nature of the intervention, a key challenge facing cluster policy
evaluation is establishing what the evaluation should focus on (Schmiedeberg, 2010). Gallié et
al. (2010) identify several possible levels of cluster policy evaluations, namely: the effectiveness
and suitability of the intervention (i.e. actions and results in relation to objectives, organisation
of the programme, participation, governance, number of projects, etc.); the results or
outcomes of specific projects; and the impact of cluster intervention on the economic
performance of targeted firms, clusters and regions (profitability, productivity, R&D
expenditure, innovation). Impact evaluations of cluster policies on regional or firm-level
outcomes face the challenge of trying to disentangle the effects of the policy from the natural
evolution of clusters. This is why cluster policy evaluations rarely assess economic impact or
consider interactions and synergies in the performance of different actors (Andersson et al.,
2004). An additional difficulty relates to the object of the evaluation, namely the definition and
boundaries of clusters. Drawing the boundaries of clusters to assess impacts is
methodologically and conceptually challenging. Too narrow definitions based on geographical
or sectoral boundaries may not capture cross-sectoral linkages and spillover effects on firms
outside the cluster. Conversely, broadly defined clusters can lose ‘conceptual precision,
especially when they incorporate politically driven policy agendas’ (Henry and Pinch, 2006, p.
117). Data availability associated with the definition of the cluster is a key challenge for
evaluation and conditions the choice of methodologies used (Schmiedeberg, 2010). Frequently
used measures such as science, technology and innovation statistics are limited in their ability
to capture systemic relations within the cluster (forward and backward linkages, knowledge
sharing, etc.). They rely on traditional industrial classifications, which tend to underrepresent
service industries and emerging sectors (which are precisely the ones policy makers are more
interested in). In addition, indicators are often not available at the required level of geographical
disaggregation (Arthurs et al., 2009). The problem of attribution is also significant when evaluating
cluster policies. The nature of the policy makes the identification of causal relations that can be
interpreted as impacts of the intervention a difficult task (Schmiedeberg, 2010). As a ‘soft’ policy, the
emphasis of cluster policy is to foster a general atmosphere conducive to cooperative relationships
between agents (Aranguren et al., 2014). The challenge of attribution is aggravated by the fact that,
more often than not, cluster programmes do not identify the specific market failures they seek to
address. And while the effects of cluster policy are likely to materialise only in the long term, often not
sufficient time is allowed to lapse between the implementation of cluster policies and their evaluation.
Finally, the political or corporate interests that often dominate cluster schemes can act as institutional
impediments to evaluation (FromholdEisebith and Eisebith, 2008). Evaluations may be used merely for
‘internal’ purposes and not made public. Thus, as Sternberg et al. (2010, p.1078) note, ‘while the infant
nature of cluster promotion has served as an excuse for non-evaluation for a while, some initiatives
have meanwhile matured and are subject to commissioned evaluations . . . However, this is guided by
politics and administration, and hence no substitute for a more critical academic appraisal.’ Needless to
say, the policy evaluation culture is very different in different countries.

48. Specıfıc analysıs of selected cluster ınıtıatıves.

For the purposes of this review, only those initiatives for which evidence (in either the grey or the
academic literature) exists on the impact of the intervention in question were selected. In other words,
the review was concerned only with evidence related to the impact of deliberate policy efforts for
cluster promotion. While there is considerable literature on clusters and the impact of clusters,
relatively less literature dedicated to the impact of cluster policy intervention is available, and the
quality and accessibility of this material are uneven. In a number of cases, evaluations were identified
but were either not available (perhaps because of confidentiality restrictions) or not readily usable as a
result of language barriers. Where possible, however, some were translated into English. Evidence
related to 17 cluster programmes was selected for closer scrutiny. The policies under consideration
differ considerably in rationales, objectives and operationalisation (see Table 7A.1 in the Appendix).
Most programmes are a combination of several policy streams, and generally combine science and
technology policy with the promotion of strategic industries. A number of programmes explicitly draw
from Porter´s cluster model as the rationale for intervention, with Porter himself being involved in the
identification of clusters in a number of cases (e.g. the UK, Finland and the Basque Country). But there
are very few examples of clusters addressing a single policy goal, and the programmes that are purely
science and technology or industrial policy are the exception. The programmes also differ according to
when they were launched, with some (such as the Basque Cluster Programme) starting as early as 1991
and the most recent being the French Pôles de compétitivité, launched in 2005. Some of the
programmes were promoted by national governments, while others such as the West Midlands clusters
in the UK or the Bavarian State Government Cluster Initiative were designed and implemented at the
regional level. A number of cluster programmes do not have a clear sectoral or regional focus, while
others target ‘leading’ or high-tech clusters. This is important when comparing findings, as some
programmes tend to attract firms that would naturally be more innovative, while in other cases, such as
the French Local Production Systems, the selected clusters may instead belong to sectors in relative
decline. In other cases, however, only one sector is targeted (BioRegio). The way in which clusters are
selected is not always explicit. A solely top-down selection is rarely used; rather targeted areas tend to
be chosen on the basis of dialogue or self-selection. A number of initiatives use a competitive approach
to attract potential clusters, although sometimes the criteria for selection are not clear-cut. The number
of clusters supported also differs. The large number and consequent diversity in some of the clusters
make it difficult to draw conclusions or establish general findings applicable to all the supported
clusters. For this reason some of the evaluations only focus on a reduced number of clusters (Basque,
Finnish, Swedish). All evaluations addressed the relevance and efficiency of the programmes, including
some management aspects and details on investment. A number of evaluations considered the
programme’s relevance in relation to the broader innovation support environment (policy mix) of the
country or region, although generally they have focused only on the programme or on a particular
instrument within the programme. Most evaluations centred on analysing the performance of the
programme in terms of intermediate effects such as increased collaboration and networking, as well as
other types of ‘soft’ outcomes. It is worth noting that most of the evaluations have been commissioned
by the public authorities managing the programmes, in some cases to justify follow-on funding. Many
evaluations, particularly some covering the interim stages, concentrated on the management and
relevance of the programmes rather than the impact. Finally, all evaluations adopted quite different
methodological approaches. In many evaluations, the methodology of choice was qualitative, supported
by a simple statistical analysis of survey data targeting cluster participants. The presentation of the
evidence is in many cases descriptive in nature (particularly in formally commissioned evaluations) and
lacking a clear description of the methodology followed. Other studies are methodologically more
robust, using for instance regression analysis with a control group to measure the effects of the
intervention. We highlight in the following paragraphs some key points emerging from individual studies
with respect to issues of collaboration, management and governance, entrepreneurship and innovation
and levered private sector funding, before moving on to look at longer-term impacts

49. The polıcy mıx for ınnovatıon: conceptual emergence and development.
An interest in possible complementarities or tensions between innovation policy ‘instruments’ is nothing
new (see for example Smith, 1994; Branscomb and Florida, 1998). The shift in emphasis towards more
‘systemic’ views of innovation in the late 1980s and early 1990s implies – though has rarely delivered – a
greater focus on the range of policies that might affect the relationships and processes that underpin
innovation. The term ‘policy mix’ has a long history in economic policy debates, being coined by Nobel
Economics Prize-winner Robert Mundell (1962). During the 1990s and early 2000s the phrase came to
prominence in policy studies literature (see e.g. Howlett, 2005) in the work on environmental policy and
regulation (e.g. ETAN Expert Working Group, 1998; Sorrel and Sijm, 2003). Thus the policy mix concept
seems to have found its way into the European innovation policy discourse via these two routes.
Analysts and policy makers alike have grasped at the concept, not only to help deal with the growing
complexity of the innovation policy agenda in a systemic world, but also to help rationalise the relative
failure of two decades of active R&D and innovation policy efforts to transform the innovation
performance of the European economy. Most recently this thinking can be seen in the Organisation for
Economic Co-operation and Development (OECD) Science, Technology and Industry Outlook (2010a),
which devotes an entire chapter to ‘The Innovation Policy Mix’ (OECD, 2010a), and in the OECD
Innovation Strategy document of the same year (OECD, 2010b).

50. Scope and method of the revıew of evıdence.

Having briefly reviewed the emergence and conceptualisation of the ‘policy mix’ concept in innovation
policy analysis, we now turn to a review of the evidence as regards interaction between instruments and
designed portfolios. The review is based on a range of sources and material. We began by defining a
range of key words that are related to mix, interplay and complementarity of instruments. With those
key words, we first searched the ISI Web of Knowledge and Google Scholar for academic literature in the
area of STI policy. Second, we scanned an existing database of innovation policy evaluations
(InnoAppraisal) to find reports that explicitly discussed and analysed the interplay between
policies/instruments (Manchester Institute of Innovation Research et al., 2010). Both searches
unearthed remarkably few examples. Third, we reviewed all the chapters in this Handbook for
systematic discussion and analysis of dedicated policy mixes and portfolios as well as policy interplay.
Fourth, we systematically reviewed existing country reports provided by the OECD and EU reviews
(CREST/ERAC2 ), which are not evaluations but rather are based on expert assessment and secondary
data, but which sometimes reach conclusions about the ‘appropriateness’ of mixes. Fifth, we re-visited a
research project (the ‘R&D Policy Mix Project’ – see Guy et al., 2009) that conceptualised and described
the R&D (rather than innovation) policy mixes of different countries. Again, this project is more a
description and an expert assessment about the mix than a rigorous empirical evaluation of impact.
Sixth, we have analysed a number of recent system evaluations mentioning policy mix issues to
understand whether (and if so how) the mix of policies and instruments at system level has been
analysed. As already noted, evidence for the impact of policy mixes and interplay is remarkably thin. As
discussed in section 17.2, policy ‘mix’ and ‘interplay’ are concepts most often used in a normative sense,
as part of a demand for improved policy making and improved evaluation. As a matter of fact, however,
we find only a very few instances both of deliberate designs of mixes and of systematic evaluations of
the interplay of policies and instruments. For example, our key word search in the InnoAppraisal
database (Manchester Institute of Innovation Research et al., 2010) showed 14 instances of ‘policy mix’,
all of them referring normatively to a need to see the bigger picture, the ‘mix’, and none of them related
to any actual systematic investigation of a policy mix.

51. Evıdence on the ınterplay of ındıvıdual ınstruments.

Policy makers and analysts understand that the way an instrument impacts on behaviour,
innovation input and innovation output is connected to the ways in which other framework
conditions and instruments influence the same target groups and technologies or pursue the
same policy goals. Nevertheless, one important finding of the InnoAppraisal study is that
evaluations of policy instruments are largely done in isolation. On the basis of evaluating
individual business support measures, outline the need and rationale for complementary
instruments for those evaluated measures to be fully effective . We then outline findings on
three main forms of de facto interplays highlighted by evaluations: interplay between financial
and non-financial instruments supporting firm innovation capabilities ; interplay between direct
and indirect funding schemes ; and interplay between supply-based and demand-based
approaches.

52. Revıews of the ınnovatıon polıcy mıx at country and system levels
There is a long tradition of country evaluations or reviews initiated by the OECD. The ‘national
system of innovation’ conceptual framework also pushed by the OECD gained momentum,
offering an enriched framework to analyse systems, not only ‘pillars’ and stocks, but also
‘flows’, interactions and collaborations between actors as well as learning processes. This built
the basis for the return of system-level ‘evaluations’. The OECD has reinstated its ‘reviews of
innovation policies’, covering not only OECD members but more widely . The EU has developed
an internal process managed by its member states advisory board for research and innovation.
Quite recently four countries have asked professionals to conduct similar reviews (Finland
2009, Austria 2009, the Czech Republic 2011 and Norway 2012).
All three types of approaches have different functions: the OECD reviews are broader analyses
of OECD member states structures and performances with substantive reports serving as the
basis for future policy development in the reviewed countries. the EU reviews have a focus on
governance and policy learning within and between EU member states; and the commissioned
system’s evaluations all have ad hoc foci serving concrete political purposes in a given political
constellation. However, most studies do not differ much in their overall approach; they share a
number of attributes: they are a mix of primary data analysis, peer review and discourse, and as
systems evaluation they are based on a portfolio of individual studies of certain aspects of the
system. While none of those exercises apply a systematic empirical research programme to
assess the conditions for and effects of interplay of policies and instruments, taken together
they provide a set of important insights into national policy mixes.
There were 34 case studies compiled, covering various aspects of policy mixes in 14 country
settings, ten regional settings and ten sectoral settings. This study did not analyse mixes that
were deliberately designed, but de facto emerging mixes. Further, while labelled ‘policy’ mixes,
it looked at the interplay of policy instruments rather than policies. It reviewed existing
literature and evaluation on the cases and on that basis attempted to draw general lessons on
patterns and trends in the context of a simple conceptualisation of policy mixes.
As highlighted in the synthesis report of this policy mix project , policy rationales in the EU
countries investigated were not concerned with policy mix in the design of policies, with very
few noticeable exceptions in specific countries , for specific technologies or in countries that are
required to adhere to certain mix considerations by outside forces, for example when receiving
structural fund support. The review does not find either common or converging patterns for
typical combinations of policies, as the ‘emergence of policy mixes appears to be highly path
dependent and results in quite diverging trends’ .
The authors note some interesting convergences, or trends, that are worth noting. The first
trend deals with governance and coordination and the reinforcement in many countries of
intermediary agencies that conduct part of the research and innovation policy. There is a long-
standing argument of professionalisation, and the report underlines their role in order to
minimise tensions and to maximise synergies and complementarities.
This second trend is more and more associated with a greater focus on overall framework
conditions to create a supportive environment for firm innovation. These concern in particular
intellectual property rights and standards and a rebalancing toward demand-based policies and
the utilisation of innovations in the production and delivery of public services .

53. Evıdence on delıberate mıxes and agency portfolıos.

The increased prominence of policy mix concerns in the innovation policy literature and
debates as outlined has not thus far translated into the increased use of deliberate portfolios or
mixes of innovation policy measures. A scan of the existing evaluation literature revealed very
few examples of the deliberate design of a policy mix.
The examples we draw on are: the German High Tech Strategy (HTS) and the Lead Market
Initiative (LMI) , at the macro-level; the development of policy portfolios over time in energy
research introduces the two cases of funding agencies with a large enough remit to proactively
build and transform their portfolios over time. They both operate in the field of energy policy.

54. Portfolio development over time

In the area of energy policy and energy-efficiency measures we found two analyses that
examined how different measures impact upon the absorption and diffusion of energy-efficient
technologies over time. The first example is an analysis of the Danish and Norwegian wind
industry . Buen’s starting claim is that the ‘cumulative impact’ on ‘permanent technical change
at company and sector level’ increases if individual instruments are designed for specific needs,
the ‘totality’ of instruments covers all needs in the target arena and stimulates both technology
push and pull and the employment of different policy instruments is coordinated.
This definition of important criteria does not include the interplay of instruments over time,
even if the analysis is about the effects over time. When analysing the impact, Buen shows how
the succession of different instruments has influenced the development of total installation and
efficiency gains in Denmark and Norway over the last 30 years. The Danish case is one of long-
term success in mobilising dynamic technical change. A first wave of installations was pushed
by investment subsidies, rigorous approval processes and awareness campaigns. A second wave
was influenced by sending long-term signals,guaranteed grid connections and feed-in
guarantees from large suppliers as well as an increase in energy surcharges. An abrupt change
of policy in the late 1980s , in conjunction with a slowdown in foreign demand, subsequently
led to a crisis in the industry. After 1994, installed capacity grew, owing to the clarification of
framework conditions and long-term expectations as well as an increase in foreign demand. In
anticipation of a stricter price regime planned for 2001, installation peaked towards the year
2000. After that, the policy turned towards an upgrade of efficiency, driven by a new feed-in
tariff to replace old turbines with newer ones. Factors that were argued to be conducive to this
overall policy success of the Danish innovation story in wind turbines included the build-up of a
general consensus on the overall importance of this area, the long-term focus, predictability
and commitment, the linking of growth and sustainability goals, the combination of supply and
demand measures, and the specific tradition of Danish cooperation, ensuring long-term support
through subsidies targeted at cooperatives.
In contrast, Buen’s analysis of the Norwegian wind sector concludes that a conscious sequence
of instruments was missing. Enormous R&D subsidies in the late 1970s and early 1980s were
not followed up by further tailored supply or demand measures. When demand measures were
finally set up, they favoured foreign designs. Overall, Buen concludes that the Norwegian mix
was designed to secure energy supply rather than to support domestic innovation in the sector,
it lacked demand-side measures altogether, and thus framework conditions and instruments
were too unpredictable to provide domestic industry with consistent incentives.
From these examples, the first important lesson for policy making is the need to re-visit the
instrument mix being offered over time, to remove instruments that have served their purpose
and which may start to become detrimental and to maintain long-term expectations in the
market. Second, the overall objective of the mix of instruments and the relationship between
partly competing objectives needs to be clear rather than oscillating between them. Finally,
local framework conditions and traditions make a difference, and policy instruments need to be
tailored towards these specificities.

55. Observatıons on evaluatıon practıce and challenges.

Our review suggests that two levels of evaluation should be distinguished. One group looks at
how different instruments in combination affect a target group, a technology or a sector ; the
other focuses on understanding the interplay of different policies for different or overlapping
target groups in a more systemic sense. For the former, we have identified a small number of
quantitative and qualitative evaluations. For the latter, there are a limited number of peer and
expert reviews and ‘system’ evaluations, which examine in detail the components of the system
and subsequently develop an overall picture, but which do not explicitly look at the effects of
the various mixes found. An initial, yet simple, conclusion from this observation is that
evaluation practice does not undertake sufficient systematic efforts to tackle the challenge of
the interplay of instruments and policies, at either level.
Equally, innovation policy makers and evaluators pay too little attention to the impacts of the
joint or sequential use of innovation policy instruments and their interplay with other
instruments . This suggests a need for greater consideration of portfolio evaluations, which can
consider policy intervention more broadly, or the establishment of evaluation approaches
which consider the impacts of multiple programmes on particular target groups over time.
Evaluating the combined effect of interventions is important for two reasons. First, as Guerzoni
and Raiteri point out, ‘evaluating the impact of a policy tool in a quasi-experimental setting
without controlling for simultaneous public programmes aiming at the same objective, can lead
to procedural confounding due to hidden treatments’. Second, the variety of innovation policy
tools that is implemented in any given system can be employed more effectively if one knows if
the combined net effects of a treatment exceed those of the combined costs of the treatment.
We have seen that evaluations can empirically and quantitatively analyse the effects of
combinations of instruments. They may be used to compare changes of input or output as a
consequence of one or a few isolated instruments against the effects of a combination of
instruments. The examples we found centred around the combination of direct and indirect
R&D support and took advantage of a dedicated large-scale survey that allowed the collection
of appropriate indicators for the use and effect of both direct and indirect measures.
The most problematic issues for quantitative analysis of interplay concern interactions over
time and system complexity. The data required to establish and sequentiality over time, in the
face of random external events, can be excessively challenging.
These challenges and shortcomings have led us to conclude that qualitative reviews of
interplays over time must have a place amongst more traditional quantitative analyses. The
example of the French agency ADEME demonstrated a more holistic analysis of overall
instrument portfolio development and was able to establish, based on expert knowledge and
monitoring data, the relative contribution made by the set of policies in stimulating research
and innovation activities and in their diffusion.
The latter point raises the issue of the complexity of evaluating mixes, particularly in terms of
their strategic complementarity. The two agencies covered both address a range of different
stakeholders with a variety of measures to achieve their goals: the transformation of energy
systems towards greater sustainability. In both cases it is not possible to meaningfully
determine, in quantitative terms, the strategic complementarities over time and across diverse
actor groups. Thus, assessment of the overall effects of mixes must rely on qualitative
judgements, which will be more robust if the construction of the mix and its individual
instruments are based on broad stakeholder involvement.
Finally, the design and practice of evaluations into policy interplay and policy mix are limited
owing to the fragmented responsibilities that agencies have; very rarely do agencies have an
interest in the effects of interplay and the interrelationship of policies beyond their own remit.
For this reason, evaluations also suffer from the same coordination issues faced by the
governance of the mix itself. This is compounded by the fact that evaluation is increasingly
commoditised and applied to clearly specified instruments and situations.

56. The innovation policy mix, key concepts.

57. İnterplay of direct and ındirect r&d measures.
The academic literature dealing with both direct and indirect measures is quite limited. We review
below the main results we can derive from the few studies concerned with the comparison or the
interplay of the two types of measures. In line with most work done on tax credits, most studies are
econometric and look for input additionality (more R&D performed). There are even fewer studies
dealing with output additionality (more innovations). A first result is rather general and deals with the
role of public support at large. Carboni (2011) on Italy, Zhu et al. (2006) on China, Bérubé and Mohnen
(2009) on Canada, Falk (2009) on Austria and Mulkay and Mairesse (2013) as well as Lhuillery et al.
(2013) all conclude that reducing the R&D costs of companies (through tax credits or subsidies) has
positive effects. The effect is however limited: Westmore (2013) comparing 19 countries over 20 years
considers that a 5 per cent reduction in R&D costs drives to an increase of 6 per cent of the R&D stock.
For France Mulkay and Mairesse (2013) find lower levels: a 10 per cent reduction in the cost of R&D
drives to an increase of 4 per cent of the R&D capital. A third discussion concerns the respective
performance of the two types of instruments on firm R&D performance. Here the views widely differ.
Some analyses consider that direct targeted supports outperform tax incentives. This is the case of a
study of government support instruments in Shanghai by Zhu et al. (2006), who found that ‘(stable)
direct funding by government has a positive effect on industrial R&D investment whereas tax incentives
led enterprises in the observed industrial sectors to switch to more general and less costly science and
technology (i.e. low-tech) activities, which was seen as a less desirable outcome’. This is also the
conclusion of Grilli and Murtinu (2012) in their study of Italian new technology-based firms (NTBFs):
‘selective R&D subsidies outperform other types of scheme in fostering NTBF performance’. Carboni
(2011) for Italian firms finds an opposite result: tax incentives appeared to be more effective in
increasing R&D activity in the firm than direct grants, although grants encourage the use of funding
sources internal to the firm. This is confirmed by Lhuillery et al. (2013) on the French case (see Box 17.2).
An econometric method enables comparison of the effect of an additional euro of support at different
levels of pre-existing support: it shows significant differences in favour of tax credits (except for one
level of support that corresponds to the median of support received). However, a major question to
address is whether there are greater effects from the combination of both supports, as is often
advocated by policy makers. Again the evaluation literature shows very different results. Lhuillery et al.
(2013) find no additional effects on R&D expenditures by French firms that benefit from both R&D
subsidies and tax credits compared to those firms receiving tax credits alone. Similarly Falk (2009) finds
no output additionality effect for tax incentives at all, and for direct or indirect measures only for those
firms that already show a high growth in R&D expenses. Bérubé and Mohnen (2009)3 examined the
effectiveness of R&D grants for Canadian firms that were already benefiting from R&D tax credits. They
found that firms that benefited from both types of policy measures introduced more new products,
made more world-first product innovations and were more successful in commercialising their
innovations when compared to their counterparts who only benefited from R&D tax incentives. In a way
these results may not be contradictory: using more than one source of funding may lead not only to
greater consumption of public resources but to a more effective application of such resources, according
to the specific needs of the firms involved. Tax credits and R&D programmes can be complementary and
thus drive to a more balanced R&D portfolio, as tax credits tend to focus more on the short term, while
R&D programmes allow mid- to long-term planning of research activities. This is the conclusion of the
French ministry, which mentions two indirect effects: accompanying the increase in R&D intensity of
firms, as well as the shifting structure of industry (in particular toward software and internet-based
services, which now represent 18 per cent of total R&D expenditure in France; MENESR, 2014). What is
striking in those studies that analyse the interplay of measures is that they do not analyse the concrete
mechanisms, specific sectoral or administrative context conditions and implementation processes that
influence the effectiveness of the measures and their interplay. Therefore, while they give some
indication about the overall effects, they do not give the full picture of policy design and implementation
that is needed to draw concrete policy conclusions.

58. R&D Support and Need for Complementary Measures.

Some attention has been addressed to the lack of complementary measures with regard to the supply of
direct subsidies for R&D in firms. Remarkably, however, the evaluations that address the issue all do so
by identifying ‘gaps’ in the portfolio and by recommending the addition of complementary measures,
rather than by evaluating the complementarity of existing instruments. For example, a review of the
French agency ANVAR’s ‘Procédure d’aide au projet d’innovation’ (de Laat et al., 2001) proposed that
young companies utilising the scheme could ‘benefit from complementary services other than financial
aid, especially concerning their connection to external partners’, which could include specific services
for young companies and coaching to starting entrepreneurs. Likewise, a review of the UK Small Firms
Loan Guarantee (SFLG) (Cowling, 2010) found that, ‘as a significant minority of SFLG supported
businesses are seeking to innovate and/or expand into new geographical, particularly international,
markets, there may be a case for SFLG supported businesses to be offered advisory support programmes
in parallel with their financial support’. Lastly, an evaluation of a large Japanese medical technologies
programme (PREST, 2003) noted that ‘the programme should offer complementary measures to assist
small firms with preliminary (international) market studies before they commit to a full project’. The
need for complementary measures to accompany schemes that foster R&D collaboration is also
expressed in the evaluation reports reviewed. However, evidence as to interplay is rare. In the late
1980s, when collaborative R&D programmes were on the rise, the landmark evaluation of the UKALVEY
scheme (Guy et al., 1991) recommended that ‘R&D support should at the very least be accompanied by
complementary action to address skills shortages’. This point was reinforced by many evaluations and
reviews analysed by Cunningham and Gök (this volume, Chapter 8), leading the authors (in line with
Lambert, 2003) to conclude that collaboration in R&D is one stage in the overall innovation process and
that the tangible outputs and intangible outcomes of that stage may lead to further demands for policy
support and lead to the alignment of collaborative support programmes within a broader set of
supporting and complementary policies which can capitalise on both their tangible and their intangible
outcomes (Cunningham and Gök, this volume, Chapter 8).

59. Interplay of Demand and Supply Measures.

Few studies have looked at the interplay of various kinds of direct support measures. A synthesis study
of a variety of UK business support schemes – based on existing evaluations – conducted in 2009 (SQW
Consulting, 2009) did include, inter alia, the assessment of the relative impact of different types of
interventions, to ‘examine the degree to which the interventions were competing or complementary in
terms of this contribution’. In itself, this is one of the very rare examples of attempting to understand a
policy portfolio across a policy area. However, as it was based on reviewing existing evaluations, the
available data and analysis of the interplay of measures were somewhat patchy. The report mainly
looked at policies to support small and medium enterprises (SMEs), regional policy schemes, business
support measures and energy policies. It found evidence that there were issues both of
complementarity and of competition in the same policy domain. The authors define two levels of
complementarity: operational complementarity describes the ‘degree to which programmes and
projects reinforce each other in their delivery on the ground’, whereas strategic complementarity refers
to the extent to which ‘policies and programmes are designed and introduced in a coherent and
harmonised way to contribute to the same higher level objectives’. The study notes that evaluations
that take complementarity into account tend to focus on operational rather than strategic
complementarity. The broad findings of the review were that (SQW Consulting, 2009, p.iv): ● For
business support interventions the main issue was operational duplication (rather than
complementarity) between services and the interaction with other sources of advice and support
(especially from the private sector). ● The interaction most evident in the small firm policy interventions
was the strategic and operational one between Business Link, other public sector interventions such as
the Manufacturing Advisory Service and private sector provision of advisory services. ● The energy
policy interventions present a strategic issue of complementarity or competition which was not
addressed in the evaluations, namely the potential tension of supporting different energy forms at
roughly the same time. The authors recommended that ‘assessment of the degree and nature of
interactions between interventions and their effects should be a matter of course in the design of
interventions and their evaluation’ – in other words, that the potential interrelationships between
existing and planned policy interventions should be considered in the formulation and design stage of
any new policy instrument (SQW Consulting, 2009, p.vi).

60. Composition and Interaction.

The idea of potential interaction between policies is fundamental to the policy mix concept. At a basic
level, it is possible to hypothesise that policy mix interactions might take the form of complementarities
between instruments (i.e. the presence of one instrument in the mix increases the effectiveness of
another) or trade-offs (where one instrument attenuates the effectiveness of another). It might also be
that one instrument has no effect on another when both are present in a mix. Gunningham and Sinclair
(1999), discussing environmental policy mixes, go further, hypothesising four classes of interaction in an
instrument mix: instruments that are inherently incompatible; instruments that are inherently
complementary; instruments that are complementary if sequenced in a particular way; and instruments
whose complementarity or otherwise is essentially context-specific. Writing in the general political
science literature, Bressers and O’Toole (2005) identify five classes of interaction between instruments
in a policy mix, depending on the actors or groups and processes targeted by policy, on the one hand,
and the interdependence between different domains of policy action, on the other (see Table 17.1).
OECD (2010a) offers a framework for thinking about composition and interaction which emphasises four
interrelated considerations, namely: the policy domains in question; the rationales offered in support of
policy intervention; the strategic tasks pursued; and the policy instruments deployed (OECD, 2010a, p.
254). Similarly Flanagan et al. (2010, 2011) emphasise policy sub-systems (the network of state and non-
state actors and institutions that shape policies focused on a particular problem area in a particular
jurisdiction at a particular time), rationales, policy goals, policy targets (actors or processes in society or
economy targeted for behaviour change by policy action) and interacting instruments. Most recently
Borrás and Edquist (2013) offer a framework that emphasises policy objectives (derived from identified
systemic problems), activities in the innovation system (to be targeted by policy intervention) and
instrument selection (in the context of national policy styles). Clearly, despite the different objectives of
these three sets of authors, there is some commonality in the basic conceptualisation (summarised in
Table 17.2).