Don’t blame the foreigners
Foreign companies in the UK spend five times the amount of UK owned companies and spend a larger percentage of their sales – 10 percent versus only 2 percent for UK owned companies. Foreign-owned UK operations are big spenders on R&D. Many large foreign R&D investors choose the UK for its R&D gene pool.

The 17 foreign owned UK companies with R&D over £50m invest 10.8 percent of sales in R&D, five times the average for UK owned companies with similar R&D profile. Twelve of these 17 have a much larger R&D intensity in the UK than their parent companies, i.e. they have chosen to place a high proportion of their global R&D effort in the UK.

Global perspective
Not surprisingly, the United States continues to be the strongest R&D nation, with six of the top 15 biggest R&D investing companies; Europe collectively has five. The USA also has 11 of the top 15 larger companies by R&D intensity (R&D as percentage of sales); Europe has the remaining four.

The scoreboard identifies significant growth in R&D from South Korea and Taiwan, which now contribute 33 companies to the global 1000 – with firms like Hyundai (R&D of £976m, double the previous year’s) and Samsung (R&D of £2.5bn, up 37 percent). South Korea is the eighth largest country in the scoreboard and is growing its R&D faster than any other significant R&D country.

Interestingly, the cut off point at 1000 companies precludes some of the high growth companies from China and India, which are probably a bigger threat than the ones listed in the global 1000 list.

Concentration at the top and large companies
Global R&D is heavily concentrated by sectors and companies with 82 percent of R&D expenditure being in the top seven sectors out of 31, and 64 percent of R&D is done in the top 100 companies of the global 1000 list. This concentration is a double-edged sword, in that if a particular sector changes or a large company has a bad cyclic period, it dramatically impacts the overall R&D picture and the health of the local economy.

As an example, Samsung represents 47 percent of South Korea’s R&D expenditure, Ericsson represents 44 percent of Swedish R&D expenditure, and Nokia represents a colossal 87 percent of Finland’s expenditure.

In terms of numbers of companies, the UK had 54 companies in the global 1000 list, which is around 5 percent of the total, compared to US companies representing 38 percent, Japanese 22 percent, German 12 percent, and French 6 percent. The stark reality is that there are no UK owned companies present in the global top 10 – the nearest being Glaxo SmithKline which came in at number 11.

Global sector dynamics
Amongst the top five sectors, pharmaceuticals had the largest increase over the previous year with 10 percent R&D growth, followed by automotive with 7 percent. In automotive, 70 percent of the increase was contributed by five companies out of 68, Hyundai having the largest change.

Different R&D nations have different R&D sector specialisations, with the USA strong in IT hardware, software and pharmaceuticals, Japan in automotive and electronics, Switzerland in pharmaceuticals and the UK in both pharmaceuticals and aerospace. Japan and Germany are R&D specialists in automotive and electronics: Japan has a lead in four sectors, while Germany occupies the number two position in six sectors.

Pharmaceuticals also leads in R&D intensity with 15 percent of its sales spend on R&D, versus 8.6 percent for IT/hardware and 10.7 percent for software.

Patent intensity
The number of US patents granted per £10m of R&D varies dramatically between sectors: nine times as many patents are granted for electronics or IT hardware as for pharmaceuticals. The number of patents – often used as an indicator of innovation – may not be a good reflection of a country’s innovation performance. A few companies have consistently higher patent-to-R&D ratios than their sector averages. Examples are Canon and Seiko Epson in electronics, Honda in automotive and Pfizer in pharmaceuticals.

Most companies in the chemistry-based sectors (pharmaceuticals, chemicals, health) reduced their number of 2004 patents over 2003 whereas most in the physics-based sectors (aerospace, automotive, electronics, IT hardware, software) increased their patent count.

UK R&D scene
Overall R&D decreased by 0.5 percent over the previous year for the 750 UK companies in the scoreboard. This average reflects a balance between foreign-owned UK companies which reduced R&D by 3 percent and UK listed companies which increased it by 1 percent. In addition, six companies (two foreign-owned) reduced R&D substantially; without these six, UK R&D would have increased almost 2 percent.

There was continued strength of R&D in key sectors such as pharmaceuticals (4 percent increase) and aerospace & defence, which together contribute over half of the UK 750’s R&D (52 percent).

There was a significant growth in middle-sized companies, with R&D intensity of over 10 percent; substantial R&D of over £6.4m; and sales of over £26m increased by 77 percent between the 2001 and 2005 scoreboards.

In the UK, the top 25 companies accounted for two thirds of the total R&D. There are 100 more smaller companies with R&D of at least £300k. The UK has a strong mix of highest and lowest R&D intensity sectors. The UK has much higher proportions of pharmaceuticals, aerospace, food producers and oil & gas R&D than the global average, and much lower proportions of automotive, IT hardware and electronics R&D.

Software is a major industry in the UK, with a group turnover of £32 billion in 2001 and growing at a healthy rate of 17 percent per annum. However one has to differentiate between software operations that carry out R&D locally as opposed to software companies which import software and add little value by duplicating CDs and packing them in a box with locally written manuals.

A vast majority of software is consumed by the government sector (around 50 percent) and thus a proactive supplementary procurement programme aimed at SMEs will reinforce and strengthen this sector.

The illusive percentage target
Israel invests 7 percent of its GDP in R&D, versus 1.5 percent for Ireland and 1.9 percent for the UK. Most EU members has signed up to the Lisbon Accord, which has set up a target of 2.5 percent of GDP to be spent on R&D budgets.

Like a spreadsheet junkie, the policy makers feel that the best and the quickest way of achieving this target is to focus the big guys, which naturally spend most in absolute dollars. The idea is that if the big guys spend even more, the race towards a 2.5 percent target will be achieved well ahead of its target date of 2015.

This has no resemblance to real life, as the R&D scoreboard figures have clearly demonstrated. It only takes one or two big companies to falter or go under and the whole programme is set back by years.

Reduce concentration
Large companies’ R&D expenditures are dictated by internal cash flows, shareholder returns and immediate market needs that can be converted into revenues, i.e. short term goals. Dependency on large companies for R & D expenditure growth can also create disproportionate instability, when things don’t go according to plans. Marconi was a recent example of this.

Large companies only spend the bare minimum that they can get away with without compromising their future product pipeline. Unfortunately, some of those companies will not be around and will either get subsumed into bigger companies, or simply go out of business. You are more likely to achieve a growth in R&D expenditure if literally tens of thousands of new and existing start-ups and SMEs are encouraged, supported and incentivised correctly.

What matters is R&D effectiveness
Instead of an illusory and somewhat isolated percentage target concocted by policy makers to fit in with a nice sound bite, it would be better to look at the effectiveness of R&D spend. Growth in R&D will only come from successful commercial exploitation which will motivate the necessary cash flow to fund further R&D and exploitation of skills. Ireland and Israel are good examples of this.

The UK, and for that matter the EU, has never been short of ideas and inventions. What it lacks is a sufficient gene pool of experienced managers, entrepreneurs and risk takers, who can take the R&D and make a commercial success from it by selling into global markets.

Although you can teach and mentor the R&D gene pool, the basics of sales, marketing, business development, P&L, funding & exit strategies, nothing beats ’on the job training’ and experience of a real time, live environment in a high-tech start-up (HTSU).

The totality of this experience can only be gained from home grown start-ups, as multinational and large companies tend to separate their commercial operations from the R&D operation in different locations, regions and even countries, thus making it difficult to produce sufficient numbers of suitably qualified, well conversed, experienced entrepreneurs with the requisite skills.

The danger is that a large portion of the massive injection of government lead R&D projects will end up on shelves, collecting dust in federal and corporate laboratories, unless a balancing investment is made in the infrastructure that will produce the commercial and financial gene pool necessary to sustain that R&D expenditure.

Otherwise, it will produce a massive set of R&D body shops that will never be able to compete effectively with newly emerging BRIC countries (Brazil, Russia, India and China).

R&D tax credit: much to do about nothing?
The popularity of R&D tax credits amongst policy makers and advisors, consultants, accountants, is understandable, as invariably there are substantial fees to be earned by clarifying the complex rules and regulations surrounding R&D tax credits.

We believe that R&D tax credits are used by start-ups and SMEs as a source and a substitute for proper funding. This is not because they prefer this route, but because of limited access to risk capital and early stage funding problems that have been highlighted in previous reports in The Chilli.

Although R&D tax credits are a godsend for a start-up struggling to get proper funding, they tend to distract management from the core task of growing the business, since they have to deal with issues like miscounting, inspections enquires and endless permutations exercises, to allow maximum credits.

Many start-ups do not claim tax credits because of the associated bureaucracy and ensuing paper or (e-mail) trail. Every attempt must be made to simplify the process and reduce the cost and effort required in obtaining R&D credits. Besides, a vast majority of R&D tax credits end up being used up by large companies, which can not only afford to fund their own R&D, but have all the necessary resources to milk the tax credit machine dry.

Remember Marconi, Plessey and Ferranti: they weren’t short of government funded/assisted R&D projects. These companies didn’t invest in the commercial exploitation of those projects.

In other words, R&D tax credits would be better focused on HTSUs, which are more likely to exploit the results – it is their survival key. It may even be worth considering diverting some of the £550 million given out in R&D tax credits towards more seed and ECF type funds, so that the high growth companies have a better bet than 4,500 companies currently claiming to be doing R&D and getting a disproportionate amount of tax credits.