The Boom in Industry Research

Meetings on science and technology (S&T) policy or innovation in Washington, D.C., or elsewhere around the country usually find at least one speaker lamenting that industry has abandoned longer-term high-risk research. Nothing could be further from the truth. Industry is doing more long-range, high-risk, discovery-type research than ever before. Indeed, as Robert Buderi points out in Engines of Tomorrow, “the extended time horizon of central labs is why many [industrial research] directors insist that basic research is alive and well–if not thriving.” We can expect the recent strong growth in this type of research to continue as we move further into a new knowledge-driven economy.

Recent data from the National Science Foundation (NSF) show remarkable strength in total industrial research and development (R&D) investment during the past five years. This R&D investment by industry has risen from $97.1 billion (all spending is given in current dollars) in 1994 to a projected $166 billion in 1999, an increase of 71 percent and double-digit annual growth. The major change that few people are aware of is that directed basic research in industry (directed toward potential future products, processes, or services) has grown even faster than aggregate R&D investment over the past five years, rising from $6 billion in 1994 to a projected $10.9 billion in 1999, an increase of 79 percent, or nearly 15 percent a year. Applied research increased an equally amazing 91 percent in this period, whereas development grew only 65 percent. Thus, the trend is clearly toward an increased emphasis on research.

Industry support of university research has likewise been strong, growing from $1.45 billion in 1994 to $2.16 billion in 1999, an annual increase of nearly 10 percent. Industry’s support of research in universities as a fraction of the total academic effort grew from 6.7 percent to 7.6 percent over this period. The increase is not dramatic, but projections show continued growth of this funding by industry and increasingly close links between industry and universities. The recent proposal by President Clinton for significant increases in federally funded research in fiscal year 2001, particularly in the basic sciences supported by NSF, will complement industry’s growing support of academic research and lay the foundation for continued U.S. economic growth.

Inside the companies

The strong growth of industrial R&D is being driven by global competition and supported by healthy corporate profits and cash flows. As one should expect, a large fraction of industry spending on R&D is for the D. Of the estimated $166 billion that was invested in R&D in 1999 by industry, slightly more than 70 percent was for development activities such as engineering, prototypes, and testing to meet today’s immediate technological challenges. But nearly 30 percent of the total was for research–some 22 percent for applied research on tomorrow’s products, processes, or services, and nearly 7 percent for discovery-type research to provide viability for the day after tomorrow. “Tomorrow” in this context might be considered a few years, so the fundamental research being funded by industry in its own labs and at universities is actually quite long-range, on the order of 5 to 15 years–and risky.

Although it is true that some companies, such as W. R. Grace and Eastman Chemical, have closed the doors of their corporate labs, many companies without central labs are carrying on discovery research in their business-unit labs, and other companies such as Pfizer and Corning are expanding their corporate labs significantly. Bell Labs has increased its R&D investment from 8 or 9 percent of sales before divestiture to 12 percent of Lucent Technologies’ sales today. Nearly 10 percent of its R&D budget is allocated for discovery research. The goal at Bell Labs is to increase patent production to 6 or 7 each working day from the 3 or 4 they receive now. IBM already is granted more than 10 patents per day. These companies as well as companies such as Intel, Motorola, and Hewlett Packard do not acquire this kind of intellectual property without investment in discovery research. According to IBM, the difference today is that purely curiosity-driven studies have been virtually eliminated, and science is no longer considered an end in itself.

A significant change over the past 15 years is in how life science and information technology (IT) companies have dramatically increased their R&D investments. The Industrial Research Institute’s R&D Leaderboard of the top 100 R&D investors for 1998 shows that these companies clearly dominate the list. Eight of the top 10 investors were in these industries, as were 19 of the top 25 and 35 of the top 50. Investing 17 percent of its sales in R&D, Microsoft made the top 10 in 1998 and is expected to be close to the top 5 this year after a planned 28 percent increase in its R&D. The IT and life science industries are clearly being driven by R&D, including investment in discovery research. This trend has paid off handsomely for most investors in those industries, for the U.S. economy, for the economy’s competitiveness, and for the benefit of society.

Many industrial companies have a 1990s-style skunk works and/or make venture capital available for startups to stimulate potential breakthroughs in S&T. Intel, Hewlett-Packard, Lucent, IBM, Chevron, P&G, Texas Instruments, and Xerox are examples. These actions have prompted a renewed interest in stimulating creativity and idea generation among research scientists and engineers. Studies have shown that 3,000 or more ideas are needed for one commercial success, demonstrating that R&D is indeed a risky business. Good planning is an essential element of the process, especially at the “fuzzy front end” of innovation.

Economists point out that about half of U.S. gross domestic product (GDP) growth in the past 50 years was due to technological innovation. This percentage is likely to be considerably higher for the last half of the 1990s as a result of rapid changes in technological innovation. R&D investment by industry has helped total U.S. R&D investment as a proportion of GDP to rise sharply since 1994. Although still below the 1964 high of 2.87 percent of GDP, U.S. R&D was expected to reach 2.79 percent of GDP in 1999 and, if a forecast from the Battelle Memorial Institute is on target, will be even higher in 2000. Battelle’s forecast shows continued strong investment in industrial R&D. The projected total for industry in 2000 is $184 billion, up 10.5 percent over 1999, bringing industry’s funding to more than 70 percent of the total R&D effort in the United States.

R&D investment abroad by U.S.-based companies is also increasing at a healthy pace. This globalization of R&D has followed the globalization of markets and is essential for customizing products to meet local demands as well as for gaining new knowledge and effectively utilizing cultural differences. Thus, the question is not when or why but how best to organize and conduct R&D efforts in other countries in concert with domestic R&D efforts.

In an update of its study Globalizing Industrial Research and Development, the Office of Technology Policy at the U.S. Department of Commerce (DOC) reported in 1999 that R&D investments in other countries by foreign-owned and U.S. companies approximately tripled from 1987 to 1997. Foreign-owned companies spent $19.7 billion on R&D in the United States in 1997, up from $6.5 billion in 1987 and $14.6 billion in 1993. This work was conducted in 715 R&D laboratories owned by 375 foreign firms. Japanese companies had the highest number of these labs with 251, followed by German companies with 107, and French companies with 44.

More than 80 U.S.-based companies invested $14.1 billion on R&D in other countries during 1997, up from $5.2 billion in 1987 and $9.6 billion in 1993. These companies had more than 200 R&D labs, primarily in Europe (88), Japan (45), and Canada (26). The DOC report concluded that this acceleration of industry investment in global R&D shows that firms believe they need a presence in foreign markets if they are to grow. To be effective in these markets, they also need to benchmark themselves against the best performers in the world. Globalization of R&D is an excellent way for firms to utilize the world’s growing stock of resources and knowledge and to support business growth.

Policy impact

Forty years ago, the federal government funded 65 percent of U.S. R&D. Now industry funds 70 percent, about the same percentage that industry funds in Japan. The shift from government-funded dominance of U.S. R&D occurred in 1980. At that time, the globalization of markets, particularly in the chemicals, petroleum, and automotive sectors, was well under way. U.S. industry, viewing R&D investments as an excellent way to address the growing competition from abroad, doubled its R&D spending in just six years, from $30 billion in 1980 to $60 billion in 1986. The White House had completed its Domestic Policy Review of Industrial Innovation, which had been undertaken in response to a concern that the United States was losing its technological edge, that productivity improvements were lagging, that government regulations were stifling innovation, and that industry was not doing enough basic research. The venture capital market, at an estimated $750 million in 1978, was growing rapidly because of a 1978 cut in the maximum capital gains tax from 49 percent to 28 percent, which encouraged entrepreneurs inside and outside of large companies to begin new businesses.

These actions were followed by a series of other initiatives by Congress, the administration, and the private sector to promote much closer cooperation among industry, government, and universities and to address the growing concern over misdirected research in universities. Many of these initiatives built on previous studies. For example, the 1983 President’s Commission on Industrial Competitiveness, chaired by John Young of Hewlett-Packard, used much of the information developed in the 1978 Domestic Policy Review on Industrial Innovation. But attention had shifted from innovation to the larger issue of competitiveness and led to the creation of the private sector Council on Competitiveness, with John Young as its chairman, in 1986. The council was supposed to have a three-year life, but it still exists because of strong involvement by leaders of business and universities as well as the continuing importance of global economic competitiveness.

Creation of the Baldrige National Quality Award in 1986 was also a watershed for U.S. industry. The award has helped transform the way manufacturing and business processes are managed in the United States. A recent study of Baldrige Award winners found that total quality management (TQM) pays off handsomely, with TQM award winners averaging 44 percent higher stock-price return, 48 percent higher growth in income, and 37 percent higher sales growth than that of a comparable control group. Adoption of quality management programs is now a major driving force for employees at Motorola, Allied Signal, General Electric, and hundreds of other major firms. Japan has also created its own Baldrige Quality Award to complement its long-standing and highly visible Deming Prize.

A global perspective

Although ranked only number three in the Council on Competitiveness’ most recent Innovation Index, the United States has been the most competitive–and innovative–nation on Earth for the past seven years. This vitality is reflected by the recent dramatic growth in venture capital, which rose to $48.3 billion in 1999, up 150 percent over the $19.2 billion invested in 1998 and an order of magnitude higher than just four years earlier. Entrepreneurial activity stimulated by venture capital as well as R&D has helped the United States create five times as many fast-growing companies and generate four times as many initial public offerings as has Europe in recent years. The bottom line of innovation is job creation, productivity, and profitability. No other country comes close to the United States in these areas, nor in its current record-breaking economic expansion.

Other countries, especially Japan, are closely studying new U.S. management practices, including those for R&D and innovation. Japan has also carefully studied the U.S. government’s S&T policymaking infrastructure and has developed a plan to restructure its S&T decisionmaking agencies along similar lines. In fact, it is going one step further by bringing together technology policy formulation and economic policy under a reorganized Ministry of International Trade and Industry (MITI). (Better coordination of economic and technology policies is something that could be given more attention by our federal government.) Evidence of this interest by Japan was demonstrated when the Japanese chemical industry and MITI established a Japan Chemical Innovation Institute (JCII) in 1998. JCII will expand on the initiative of U.S. chemical companies and the U.S. Department of Energy’s “Industries of the Future” program to establish a chemical industry vision for the year 2025. The Japanese plan includes not only the roadmapping of chemical technologies but also the design of a new model for the management of technology (MOT) to support the creation of added economic value deemed critical to Japan’s future competitiveness. Reflecting the new Japanese interest in technology management, some Japanese chemical companies have established research-on-research departments to improve the effectiveness as well as efficiency of their R&D investments. Another Japanese organization, the Japan Productivity Center for Socio-Economic Development, which is responsible for administering the Japanese version of the Baldrige Award, has initiated a feasibility study with MITI for a new International Center for the Study of MOT. The message from Japan is clear: They intend to recover from their recent economic distress through effective management of technological innovation.

China has also recently placed heavy emphasis on innovation as a key to its transformation into a market economy. At a national conference on technological innovation in Beijing in 1999, President Jiang Zemin emphasized that technological innovation must play a much more important role than it has in the past as the driving force behind social and economic progress in the coming century. Premier Zhu Rongii at the same conference demanded that technological innovation be intensified in traditional industries and that a new innovation system be established in which state-owned technology-intensive enterprises play the leading role. The Communist Party of China (CPC) provided guidelines to encourage R&D innovation, covering infrastructure development, R&D investment levels, stimulation of venture capital, and other matters crucial to competitiveness. The CPC indicated that a long-term perspective in the development of technology was essential and that great importance should be attached to basic research and technology projects to meet strategic national needs.

Speaking at a Sino-U.S. Joint Science Policy Summit in October 1999, Zhang Cunhao, president of the National Natural Science Foundation of China, emphasized the importance of “applied” basic research in China’s national goals. He also argued that total R&D investment in China should be raised from the recent level of considerably less than 1.0 percent of its GDP to 1.5 percent in 2000. This goal is unlikely to be achieved, but China is using a variety of other techniques to advance S&T, such as recruiting foreign scientists for research at the China Academy of Sciences, creating a new top R&D award that is to be regarded as China’s Nobel Prize, and inducing foreign companies to establish R&D centers in China that will focus on fundamental as well as applied S&T.

Innovation and productivity

As previously noted, productivity is a key factor in competitiveness. For much of the past decade, economists seriously questioned the economic payoff in improved productivity from our growing investment in IT. Robert Solow, a Nobel laureate from MIT, has said, “You can see the computer age everywhere but in the productivity statistics.” Productivity growth had been advancing at a rate of around 1 percent a year until 1996, when inflation began to drop significantly. Since then, the percentage change in nonfarm productivity has more than doubled and has come close to 3 percent increases in the past two years. These strong increases in productivity, concurrent with rising wages and low inflation, now have some economic experts believing that our rising investment in IT is finally producing real returns. Leonard Nakamura of the Federal Reserve Bank of Philadelphia believes that the rising investment in intangible assets such as R&D and software helps explain the rising value of U.S. equities, because their earning power is understated by conventional accounting methods. If all of these assumptions prove to be true over the long run, the investment in IT has serious policy implications for the future.

The United States is investing much more in IT than are other nations. At an estimated 4.5 percent of GDP for 1999, the U.S. investment is more than double Japan’s 2 percent and well ahead of Europe’s 2.5 to 3 percent. The number of computers for each worker in U.S. companies is two to four times that of companies in Japan and Europe. An excellent example of the impact of IT is IBM’s recent announcement of “Blue Gene,” a $100 million research project to build the world’s fastest computer. This petaflop machine will initially be used to model the folding of human proteins, making this fundamental study of biology an important milestone in the future of health care.

With IBM’s recent entry into a biotech consortium and new alliances concerning patient care, we could be seeing a shift in their business strategy influenced by the great potential from directed basic research.

Moving forward

The strong investment in industrial R&D and the even stronger investment in IT and venture capital should enable the United States to maintain its momentum in technological innovation well into the new decade. One potential problem is the recent increase in real interest rates in the United States and Europe. Should they continue to rise, economies will lag along with investment.

The Clinton administration’s 21st Century Research Fund, with its growing support of basic research in the hard sciences and focus on IT, is especially timely in these respects. Some economists say that the United States is grossly underinvesting in R&D; that we should be spending three or four times as much. However, the amount that is spent on R&D is not as important as how well the spending is managed. The quality of R&D is particularly important. The United States is investing nearly as much as the rest of the world in basic S&T as well as development, and perhaps more than the rest of the world combined on IT and venture capital. All signs point to continued strong investment in these areas, but this investment needs to be leveraged by effective management of continuous adaptation to the rapid changes in technology and markets.

It is critical that Congress and the administration provide the appropriate economic climate for continued investment–and risk-taking–in the new millennium. The recent action by Congress to extend the R&E tax credit for five years is nothing short of a miracle. Congress is beginning to think longer term, which is especially important for the directed basic research in industry, for curiosity-driven basic research in universities, and for our nation’s future.