Martin M.

Rosner

Economic Determinants of
Organizational Innovation

A study was made of how the economic orientation of an organi-

zation can influence its innovativeness. The effects of two factors,
organizational slack and economic orientation, were studied in an
empirical setting. Measures of these two variables were m.ade in a
group of hospitals and correlated with the frequency and promptness
with which new drugs were tried in the hospitals. Trial of new drugs
tended to vary directly with organizational slack and inversely with
economic orientation. This is a special case, however, since the
primary goal of hospitals is not economic, and the costs of trying of new
drugs are minimal. It is suggested that the factors studied may be more
important in more typical situations.
Martin M. Rosner is associate professor in the College of Commerce
at De Paul University.

ALTHOUGH many consider innovation a desirable organiza-

tional objective, some regard it as a necessary evil. Much of this
objection is based upon the economic costs of innovation. Organi-
zations adopt innovations in order to become better adapted to
their environment or to improve their chances of achieving their
goals; but adoption of innovation is generally considered to be
costly, to be temporarily detrimental to efficiency in the organiza-
tion, and to contribute to unreliability in its operation.^ Before

following authors have commented on this phenomenon: Peter M. Blau,

Initiative and Bureaucracy, Public Administration Review, 20 (Winter 1960), 41-44;
Theodore Levitt, Creativity is Not Enough, Harvard Business Review, 14 (May-June
 ORGANIZATIONAL INNOVATION 615

innovation can occur, the organization must be willing and able

to accept the costs and the temporary dislocations associated with
the change.
To investigate how economic factors affect organizational inno-
vation, a study was made of two factors—organizational slack and
economic orientation. Measures of the two variables in a group of
hospitals were correlated with measures of organizational innova-
tion—the frequency and promptness of trial of new drugs.^
INTRODUCTION
Organizational slack determines whether the organization can
afford innovation. It is the difference between the payments
required to maintain the organization and the revenue obtained
from the environment,^ and is the source of resources for the
organization.* The existence of slack means that the organization
can afford (i) to purchase costly innovations, (2) to absorb fail-
ures, (5) to bear the costs of instituting the innovation and {4) to
explore new ideas in advance of an actual need.^

1963), 72-83; Victor A. Thompson, Modem Organizations (New York: Alfred A.

Knopf, 1961), p. 19; James G. March and Herbert A. Simon, Organizations (New
York: John Wiley, 1958), p. 279; and Victor A Thompson, Bureaucracy and In-
novation, Administrative Science Quarterly, 10 (June 1965), 1.
2 This article is drawn from my unpublished Ph.D. dissertation, "Organizational
Influences on Hospital Adoption of New Drugs" (Graduate School of Business,
University of Chicago; September, 1965). I am grateful to Selwyn W. Becker and
Gerald Gordon for providing the inspiration for the work and for their guidance
in its execution and completion. I would also like to thank Thomas L. Whisler,
Gordon R. Antleman, and George Bugbee for their help and counsel in the study.
3 Richard M. Cyert and James G. March, A Behavioral Theory of the Firm
(Englewood Cliffs, N. J.: Prentice-Hall, 1963), p. 279. In economic organizations,
slack is equivalent to economic rent or profit, depending on whether it is dis-
tributed. In George J. Stigler, The Theory of Price (New York: Macmillan, 1952), p.
180, the following definitions are given: "Rents are the returns to productive
services in excess of what they can earn in alternative employments. When these
returns accrue to owners of resources hired or purchased by the firm they are called
rents, but when they accrue to the entrepreneurs they may be called profits."
•* Cyert and March, op. cit., p. 280.
5 Gary A. Steiner, The Creative Organization (Selected Papers, No. 10; Chicago:
Graduate School of Business, 1964), p. 23; Everett M. Rogers, Diffusion of Innovation
(New York: Free Press of Glencoe, 1962), p. 176; Gyert and March, op. cit., p. 280;
and Selwyn W. Becker, The Innovative Organization (Selected Papers, No. 15; Chi-
cago: Graduate School of Business, 1965, p. 9.
 6i6 ADMINISTRATIVE SCIENCE QUARTERLY

Although slack may exist in an organization, its executives may

prefer not to use excess resources to finance innovations. Instead,
they may seek to maximize efficiency by reducing costs, and in
the extreme case, may even prefer to sacrifice output in order to
achieve cost reduction. Economic orientation is defined, in this
study, as the degree of preference that an organization has for low
costs.
Since innovations tend to raise costs and cause temporary
inefficiency, they are likely to be discouraged, delayed, or avoided
in economically oriented organizations." A cost-cutting innovation
might be an exception; but even this involves additional costs
while it is being tried and evaluated and economically oriented
executives might even delay adoption of such an innovation in
the hope of reducing costs.
Empirical evidence on the relationships between innovation
and organizational slack and economic orientation is scarce. Al-
though organizational slack has not been directly measured,
innovativeness has been correlated, for example, with such mea-
sures of slack as profitability and rate of increase in assets.
Findings from these studies sometimes have been contradictory;''
but Mansfield's finding that promptness of adoption of innovation
is inversely related to firm liquidity supports the view that eco-
nomic orientation inhibits innovation,® as does Ross' finding that
lack of adaptability of school systems is positively correlated with
a desire for efficiency.^

EMPIRICAL SETTING AND METHOD

Setting
The present study correlated the promptness and frequency
8 March and Simon, op. cit., p. 173; and Steiner, op. cit., p. 23.
^C. F. Carter and B. R. Williams, The Characteristics o£ Technically Progres-
sive Firms, Journal of Industrial Economics, 7 (March 1959), 87-104, concluded
that technically progressive firms were characterized by high rates of increase in
assets. Edwin Mansfield in The Speed of Response of Firms to New Techniques,
The Quarterly Journal of Economics, 77 (May 1963), 290-331, found that prompt-
ness of adoption was not directly related to profitability.
* Mansfield, op. cit.
8 Donald H. Ross, Administration for Adaptability (New York: Metropolitan
Schools Study Council, 1951), Vol. II, p. 142.
 ORGANIZATIONAL INNOVATION

with which a group of hospitals tried new drugs with measures

of economic orientation and organizational slack. In this empirical
setting, the possibility of such an innovation recurs frequently
among similar hospitals. All hospitals are exposed to the same
new drugs, and the frequency and promptness of trial of the drugs
are measurable and can be correlated with measures of the inde-
pendent variables.
This type of innovation and the organizational power structure
make this a special case of organizational innovation. First the use
of new drugs can be instituted with a minimum of effort and dis-
location, since they are externally created, and the users of new
drugs need not institute elaborate search programs to find them,
since drug manufacturers actively promote their use. Furthermore,
drugs can be tried on a small scale prior to full scale adoption.
These factors tend to reduce the costs of innovation. Second,
organizational control over the adoption of new drugs is some-
what limited. Use of drugs is a professional decision and hospital
administrators are reluctant to interfere in therapeutic decisions.
Nevertheless, hospital acceptance of new drugs still involves a coor-
dination of organizational and individual actions. Hospital trial
and subsequent use is dependent upon a physician's decision to
write a prescription and an organizational decision to follow his
order.
Although the financial risks involved in the acceptance of new
drugs are minimal, they still exist, and consequently, the release of
a new drug may result in a stress situation in the hospital. The
risks take the form of inventory losses resulting either from non-use
of drugs made obsolete by the new drug or from lack of acceptance
of the new drug by the medical staff. If these losses occur fre-
quently, the hospital's inventory of drugs may contain a significant
amount of "dead" stock. But since new drugs can lead to improve-
ment in medical care, hospitals may be willing to assume such
financial risks.
Hospitals with a great deal of organizational slack are able to
afford the financial risks of innovation and can be expected to
adopt a permissive attitude toward trial of new drugs. In contrast,
economically oriented hospital administrations prefer to avoid
such financial risks. A policy of delayed or curtailed trial shifts
 6i8 ADMINISTRATIVE SCIENCE QUARTERLY

much of the cost of adopting innovations to other hospitals and

pharmacies. A physician interested in trying a new drug, but un-
able to do so in the hospital, will try it in his office practice or in
another hospital. If the new drug is superior to its predecessors,
many staff doctors will have adopted it by the time it is stocked and
dispensed in the economically oriented hospital. By that time, the
drug is likely to have achieved large-scale acceptance in the hospital,
and efficiency is further enhanced because the hospital pharmacist
can effect economies by purchasing large quantities of the new
drug at favorable prices.
Trial of new drugs can also be influenced by individual charac-
teristics of the medical staff, such as (i) the innovativeness of the
physician, (2) the interaction among staff members, (3) the type
of information about new drugs available to the physician, (4)
the risk perceptions of physicians, (5) brand preferences of physi-
cians, and (6) perceived need for the drug. Organizational factors
likely to affect the process included (1) hospital size, (2) univer-
sity affiliation, (3) therapeutic emphasis, and (4) the pattern of
administrative control processes in hospitals. Furthermore, ex-
ternal influences, such as the promotional efforts of drug manu-
facturers can be expected to affect trial. In this study, controls
were established over the organizational factors and over medical
staff innovativeness.
Dependent Variables
The hospital sample consisted of twenty-four, nonteaching,
short-term, voluntary hospitals located in the Chicago area with
capacities of 216 to 393 beds. Frequency of trial of new drugs was
measured by responses to a questionnaire on drug use. The new
drugs released by national drug manufacturers between January
1962 and May 1964 were listed in the questionnaire, and chief
pharmacists of the hospitals were asked to indicate which of these
drugs had ever been ordered in their hospitals.
Promptness of trial was traced by means of audits of purchase
invoices for a sample of six drugs. The drug sample was designed
to facilitate the auditing task while including recently released
drugs. In order to increase the probability that the hospitals in
the sample would use the audited drugs, it was originally planned
 ORGANIZATIONAL INNOVATION 619

that the sample would include only drugs ranked among the five
leading products in their therapeutic class.^" Unfortunately, no
product released since 1962 ranked among the leading five; there-
fore, the sample of drugs used to trace promptness of trial included
three drugs released in late 1959 and early 1960 that were among
the five leading products in their therapeutic classes, and three
drugs released since 1962 that had achieved extensive use in three
out of four hospitals polled in a pilot study.^^ The raw score for
promptness of trial was the elapsed time in days between the date
of market release of a drug and the date of first purchase. For each
drug, the raw score was normalized in relation to scores for all
hospitals for that drug.^^ This procedure was followed in order
to control for time differences related to characteristics of the drug
being traced. It was assumed that time differences in the raw
scores could be affected by such factors as relative safety and need.
For example, a comparatively safe antibiotic would secure quicker
acceptance among all hospitals than a relatively toxic, although
effective, anti-leukemia preparation.
Independent Variables
Organizational slack was measured by the hospital occupancy
rate, i.e., the proportion of the total annual hospital bed-days which
were in use during the year. The use of this measure assumes
that the costs necessary to maintain hospitals of similar size and
function are relatively constant, and that differences in organiza-
1" Data on therapeutic categories and leading drugs in each category were obtained
from National Hospital Survey (Dedham, Mass.: R. A. Gosselin, 1963).
11 The drug sample consisted of declomycin, librium, aldactone, aldomet, prosta-
phyllin, and valium.
12 Normalization of raw scores allows comparison between two different measures
of the same characteristic. Thus, two normalized scores could be added and
averaged to arrive at a composite measure for the characteristic. The normalization
procedure used for promptness of trial was used throughout the study, where a
direct relationship existed between the raw score and the characteristic being
measured. All hospital raw scores for a particular dimension for a particular drug,
e.g., raw promptness of trial scores for librium, were totalled. This total was
divided into a hospital's raw score for promptness of trial for librium to derive
the hospital's normalized score. Normalized scores for promptness of trial of
librium could then be compared with normalized scores for promptness of trial of
any of the other drugs of the sample. The raw scores were not directly comparable.
 62O ADMINISTRATIVE SCIENCE QUARTERLY

tional slack will result from differences in income. Economic

profitability is the ideal measure of organizational slack, but since
data on economic profitability were not available, it was necessary
to use the measure that was available though imperfect.
The prevailing hospital attitude toward the achievement of
minimum costs was determined by performance measures of cost
and resource use in the pharmacy. The following measures were
used:
1. Drug cost per in-patient day. The cost of drugs dispensed
to in-patients for the latest fiscal year was divided by the total in-
patient days for that period. Where the pharmacy dispensed drugs
to out-patients, these costs were deducted. Economic orientation
was assumed to increase as this ratio decreased, the assumption
being that the less the hospital spent on drugs, the more concerned
it was with cost reduction.
2. Drug inventory turnover rate. The cost of drugs for the
latest fiscal year was divided by the average value of the inventory
of drugs for that period. As this ratio increased, economic orienta-
tion was assumed to increase, since it was likely that the econom-
ically oriented hospital would also be concerned with using its
inventory investment efficiently so as to secure the highest possible
retum on this investment.
The use of these factors as measures of economic orientation is
not without difficulties. The achievement of both low drug cost
and rapid drug turnover contributes to greater profits from the
dispensing of drugs. In practice, however, the administrator must
strike a balance between them, because if the lowest cost per unit
of drug can only be obtained by ordering an excessively large
quantity of the product, the inventory would be increased. Fur-
thermore, the achievement of these goals may reduce efficiency
in other ways. Low inventory levels can be maintained by pur-
chasing drugs as needed, but the cost of processing many small
orders is much greater than the cost of processing one large one.
These measures were used, however, because they are related to
the level of drug use in the hospital and because they are highly
visible to the administration. An economically oriented adminis-
trator would probably stress these goals in preference to less visible
cost measures. The normalized scores for drug cost and drug
 ORGANIZATIONAL INNOVATION 621

turnover were averaged to arrive at the hospital's economic orien-

tation ^^
Method of Analysis
Multiple regression analysis was used to determine the relation-
ships between a particular dependent variable and the independent
variables. Standard partial regression coefficients were used to
evaluate the influence of the independent variables.^* Functional
transformation of variables were made, so that the data would
conform more closely to the assumptions of the regression model,
i.e., additiveness of effects together with normal and indef>endent
distribution of residuals with homogeneous variance. In this case
normalized scores of the independent variables are proportions,
and proportions are known to exhibit heterogeneity of variance.
This can be corrected by making an arc-sine transformation of the
proportions.^^
Controls were established in the study in order to isolate the
effects of the independent variables. This was done by controlling
the sample of hospitals and by including other factors in the re-
gression. The use of a relatively homogeneous sample of hospitals
was designed to control for the effects of differences in hospital
ownership, therapeutic emphasis, and research orientation of the
staff, factors deemed relevant to innovation. For instance, govern-
ment-owned hospitals usually institute stringent purchasing pro-
cedures that could stifle the introduction of new drugs; long-term
hospitals devoted to the care of patients with tuberculosis or mental
illness could differ markedly from general short-term hospitals in

13 Where an inverse relationship existed between the operational measure and

the characteristic to be measured, the following normalization procedure was
used: If x, was the hospital's raw score, its normalized score was 2 x , - x , , normal-
ized to sum to one. Thus, normalized scores for inversely related measures could
be compared with and added to normalized scores for directly related measures to
derive a composite score for a characteristic.
"See George W. Snedecor, Statistical Methods (5th ed.; Ames: Iowa State
College, 1956), p. 416, for methods of calculation and applicability of standard partial
regression coefficients.
^^ Ibid., pp. 314 and ff. Snedecor recommends the use of funtcional transforma-
tions, where the data do not conform to the assumptions of the regression model;
i.e., additiveness of effects together with normal and independent distributions of
residuals with constant variance.
 622 ADMINISTRATIVE SCIENCE QUARTERLY

their use of drugs; and the level of knowledge of new drugs in re-
search and education hospitals is likely to he higher than in non-
teaching hospitals, so that both the frequency and promptness of
introduction of new drugs may differ.
The following factors were included in the regression to control
for their effects:
1. Hospital size. Measured by bed capacity. Differences in
size can be associated with differences in the diversity of medical
specialties and disease mix in the hospital; both factors affect the
need for new drugs.
2. Control of medical staff activity. Measured by a composite
index of medical staff procedures related to administrative re-
quirements, medical treatment, and drug therapy. This was sup-
plemented by physicians' ratings of the degree of control exercised
over their activities by the hospital. Control limits the physicians'
freedom of action, including his freedom to prescribe new drugs.
3. Visibility of medical care. A measure of procedures used in
the hospital to evaluate the quality of medical care dispensed by the
medical staff. An index was constructed of (1) hospital autopsy
rate and (2) number of conditions subject to clinical audit in the
latest fiscal year. Hospitals with high visibility are aware of unsat-
isfactory therapy and should be in a position to evaluate and try
new drugs.
4. Medical staff innovativeness. The innovative norms of the
medical staff were determined by means of physician self-ratings.
At least two chiefs of clinical departments in each hospital were
asked to rate themselves for venturesomeness in trying new drugs.
The average of the self-ratings was the hospital's score for this
factor. It was assumed that hospital innovativeness would vary
directly with the innovative norms of the staff.
Hypotheses
The following operational hypotheses were advanced:
Hypothesis 1. As the occupancy rate of the hospital increases,
the frequency of trial of new drugs will increase.
Hypothesis 2. As the occupancy rate of the hospital increases,
the promptness of trial of new drugs will increase.
 ORGANIZATIONAL INNOVATION 623

Table 1. Economic influences on the trial of new drugs.

Standard partial Level of
Independent variable regression coefficient significance*

Frequency of trial
Arc sine: economic orientation -0.441 0.03*
Arc sine: occupancy rate 0.168 0.22*
f =1.86, i{2 = 0.40t
Release-trial periodX
Occupancy rate -0.134 0.09S
Economic orientation 0.100 0.18§
f =1.24, iJ2 = 0.0511

• One-tailed level of significance of the partial regression coefficient based upon

a Student's t with 17 degrees of freedom.
t f value at 0.10 significance level equals 2.15; F value at 0.30 significance value
equals 1.32.
t Dependent variable: arc sine-release-trial period
§ One-tailed significance level of the partial regression coefficient based upon a
Student's t with infinite degrees of freedom.
II F value at 0.10 significance level equals 1.83; F value at 0.50 significance level
equals 1.22.

Hypothesis 3. As the economic-orientation score of the hos-

pital increases, the frequency of trial of new drugs will decrease.
Hypothesis 4. As the economic-orientation score of the hos-
pital increases, the promptness of trial of new drugs will decrease.
FINDINGS
The data pertinent to tests of the hypotheses are summarized
in Table 1. The directions of the regression coefficients follow
the predicted patterns. Frequency of trial has a strong inverse
relationship with economic orientation, but a weak positive rela-
tionship with occupancy rate.
In contrast, for the period between the release and trial of a
drug, occupancy rate shows a stronger influence than economic
orientation. The normalized scores for the six drugs in the sample
were pooled, so that the relationships are based upon 136 obser-
vations. The pooling of observations may be the cause of the
high proportion of unexplained variance, and the low signifi-
cance of the F value, since there miay have been as many as six
values of the dependent variable for every value of the independent
variable.
 624 ADMINISTRATIVE SCIENCE QUARTERLY

Although both regressions show a fairly high degree of un-

explained variance, analyses of residuals of the regressions show
normal distributions with no systematic relationship to the re-
gression estimates. Therefore, although there may be other factors
that affect the process, the unknown or unmeasured variables exert
only random influences on the dependent variables. The variables
studied were not expected to provide a complete explanation of
hospital adoption of new drugs, but were only expected to influ-
ence adoption in a predictable manner.
CONCLUSIONS
The directions of the regression coefficients support the theo-
retical analysis, but the magnitudes and levels of significance
fail to indicate consistently strong influences on the dependent
variables. Economic orientation exerted a strong influence on
frequency of trial, but only a moderate influence on promptness of
trial; while occupancy rate exerted a weak influence on frequency
of trial and a much stronger influence on promptness of trial.
These results must be considered within the empirical context.
Hospital trial of new drugs is a somewhat extreme example of
organizational innovation because of characteristics of the innova-
tion and of the organization. The cost of adopting a new drug is
relatively low; the economic impact is reflected in increased in-
ventory and higher costs of operation in the pharmacy. These
risks are not as great as those involved in the purchase of new
capital goods or a manufacturer's commitment to an untried pro-
duction process. Furthermore, administrative control over the
medical staff is minimal, whereas both economic orientation and
occupancy rate are factors that influence and are influenced by
actions of the hierarchical bureaucracy. The lack of consistent
strength of influence may reflect the fact that the hierarchical
bureaucracy is only indirectly concerned with use of new drugs;
primary responsibility for their use rests with the medical staff.
Indeed, the fact that the hospital hierarchical bureaucracy can
exert even a minimum of influence over frequency and promptness
of trial of new drugs—decisions that many consider to be within
the exclusive sphere of the medical staff—is notable. This result
 ORGANIZATIONAL INNOVATION 625

suggests that economic factors should exert a more marked influ-

ence in organizations that are more concerned with costs and for
innovations which have a more significant economic impact than
new drugs have on hospitals.