Can U.S. Reverse the Decline in R&D Spending: Global Competitiveness at Risk!

Introduction

A R&D crisis is brewing in the U.S. It’s not only the demise of Bell Labs and the huge cutbacks in pure research at companies like IBM, GE, AT&T, Verizon and others. But also the decline in U.S. federal government R &D spending, especially as a percentage of GDP (see 1. amd 6. below). Compounding this problem, a recent report from Ernst & Young (see 7. below), states that companies in developed nations increasingly plan to turn to emerging markets for core research and development. That means even less R & D will be done in the U.S. in coming years.

These and other reports/ statistics overwhelmingly confirm that both industrial and government R & D spending has substantially decreased in the U.S. Yet that spending is the engine of innovation, purveyor of productivity enhancements and technology competitiveness. R&D for a technology company is its seed corn, the source of its future growth and revenues in the form of products, intellectual property or services that are often years away from being monetized. It seems many CEOs have forgotten that the key to American prosperity and competitiveness over the past century has been its ability to lead the world in science, technology, and innovation. But that certainly isn’t happening now!

R&D Spending Report is not pleasant reading

Let’s look at where we are and what can possibly be done to arrest and then reverse the steady decline in R&D spending.

1)  Total US tech R&D spending as a percentage of GDP is below where it was for much of the 1960s, according to Kleiner Perkins partner Mary Meeker’s analysis of USA Inc. That’s mostly because federal government spending on tech research is way down. Remember, it was U.S. government sponsored research and investment that gave us the Internet and GPS. Ms. Meeker makes a strong case that more government investment in tech, education, and infrastructure should be a key part of U.S. government policy. She says that more government investment in tech, education, and infrastructure will be a key part of turning the USA around.  CHART OF THE DAY: The Government Money That Built The Internet Is Going Away

2) Total R&D spending among the world’s top spenders on innovation dropped in 2009 for the first time in 13 years, according to Booz & Company’s 2010 Global Innovation 1000 study released November 3, 2010. The 1,000 companies that spent the most on research and development decreased their total R&D spending by 3.5% to $503 billion in 2009. This followed a relatively strong 2008 during which R&D spending continued to grow despite the recession. R&D as a percentage of revenues was up slightly from a year earlier (3.8% of 2009 sales, up from 3.5% in 2008.), because revenues dropped at a faster rate than R&D spending.

Booz & Company’s annual study tracks the 1,000 publicly traded global companies that spend the most on R&D, based on their public disclosures. The consulting firm, which has studied data going back to 1997, said 2009 was the first year to show a decline in total R&D spending among these companies. The cuts last year were concentrated in auto, computing, electronics and industrial companies, some of the biggest spenders. “The world-wide recession finally caught up with the world’s top innovation spenders in 2009,” the Booz report says, adding that “the most forward-looking companies will likely move quickly to restore the R&D cuts they made in 2009.”

Apple last year spent about 3.1% of its sales on R&D, or about half the typical level for computer and electronic companies, said Barry Jaruzelski, a partner at Booz, and yet Apple’s R&D appears to be far more effective than that of many rivals.

R&D Spending Drops at Major Firms

Also see: Corporate R&D spending declined during 2009 downturn says Booz & Company

3)  The last decade had brought a steady decline in HP’s spending on research and development. While HP’s sales have surged in the last decade, spending on R&D (as a percentage of sales) has fallen steeply. HP’s R&D spending in the last decade is presented below (Source: SEC filings):

2010: $2.96 billion, or 2.3 percent of sales

2009: $2.82 billion, or 2.4 percent of sales

2008: $3.54 billion, or 2.7 percent of sales

2007: $3.61 billion, or 3.4 percent of sales

2006: $3.59 billion, or 3.9 percent of sales

2005: $3.49 billion, or 4 percent of sales (Mark Hurd became CEO March 29, 2005).

2004: $3.56 billion, or 4.5 percent of sales

2003: $3.68 billion, or 5 percent of sales

2002: $3.31 billion, or 5.9 percent of sales

2001: $2.72 billion, or 6 percent of sales

2000: $2.63 billion, or 5.4 percent of sales

HP’s new CEO Leo Apotheker has said he is committed to turning that around. But, he didn’t say how or when. For comparison, IBM spends about 6 percent of revenue on R&D each year. Oracle spent 12 percent of revenue on R&D for the 12 months ended May 31, 2010. If HP is going to compete with its two largest rivals it has to step up its innovation game and invest accordingly. Dell has spent about 1 percent of revenue on R&D for the last three fiscal years.

A look at HP’s decade-long R&D slide: Can Apotheker reverse it?

4)  Kodak has been taking a scalpel to R&D. The photo and imaging company spent $322 million in 2010, less than half the total of five years earlier. Though Kodak’s R&D outlays in relation to revenues had remained between 5.2 percent and 5.5 percent, they fell the last two years, to 4.7 percent in 2009 and 4.5 percent last year.

Xerox’s research, development and engineering spending in 2010 was $781 million, a 7 percent decline from 2009. And, the $840 million in 2009 had been a 5 percent drop from the previous year. Xerox’s R&D spending in relation to total revenues also has been on the wane in recent years. Such spending last year represented 3.6 percent of revenue — a sizable decline from the general level of 5 percent to 5.5 percent in recent years.

Firms spend smarter on research and development

5) Microsoft research and development spending declined by 3 percent in its recently completed fiscal year. It is the first time in five years that the company has reduced its R&D spending.

The trend appears to reflect Microsoft’s efforts to continue keeping a close eye on expenses even as it exits the recession.

Microsoft’s annual R&D spending dips for first time in five years

6)  The United States has fallen behind seven other countries — Israel, Sweden, Finland, Japan, South Korea, Switzerland, and Iceland — in terms of research and development spending as a percent of GDP. The Economic Policy Institute found that the United States ranked 15th out of 30 nations in broadband penetration in 2007.

In his 2011 State of the Union address, President Obama stated, “In America, innovation doesn’t just change our lives. It is how we make our living.” Yet, the United States is falling behind in its investments in research and development. We need more investments in R&D to ensure that America continues its innovation leadership.

Huffington Post on U.S. Research and Development

7)  According to a recent report from Ernst & Young, companies in developed nations increasingly plan to turn to emerging markets for core research and development. Ernst & Young found that about 11% of companies based in North America now spend more than a quarter of their research and development budget in emerging markets. But, within five years, more than 23% expect to have surpassed that mark. Of companies based in Western Europe, only 7% said they conduct more than a quarter of their R&D spending in emerging markets, but about 19% plan to within five years.

Overall, 16% of respondents said they currently conduct more than a quarter of R&D spending in emerging markets and 28% plan to invest to do so in five years. In the past decade, American companies have turned from using overseas R&D centers simply to localize products, to tapping them as a source of R&D for products globally, said Anil Gupta, a strategy professor for the University of Maryland and author of “Getting China and India Right.”

“China, India, and Brazil are becoming true centers of innovation and research,” he said. Companies are still able to hire researchers for about a quarter of the salary it would take in the U.S., he said. The skills of the work forces in emerging markets also have improved, as the countries’ university systems mature, he said.

More Companies Plan to Put R&D Overseas

The U.S. is Aware of the looming R & D Investment Crisis

The Wall Street Journal reports that President Obama talked R &D with Silicon Valley big wigs during a February 17th dinner at the Silicon Valley home of well respected venture capitalist John Doerr. Mr. Obama met with Apple’s Steve Jobs, Facebook’s Mark Zuckerberg and Google’s Eric Schmidt, among other high tech CEOs. “The president specifically discussed his proposals to invest in research and development and expand incentives for companies to grow and hire,” said White House Press Secretary Jay Carney to reporters traveling with the president. Obama’s budget, released this week, included billions of dollars for new R&D spending.

President Obama’s 2012 fiscal year budget matches his important State of the Union observation last month that “maintaining our leadership in research and technology is crucial to America’s success” with new investment targets for an array of key science and innovation programs. Republicans have mapped out a different strategy, arguing that we need to cut almost all of these science R&D programs in a bid to reduce the federal budget deficit. The $3.7 trillion budget proposal allocates $147.9 billion to research and development in the coming fiscal year, which begins on October 1. That amounts to a small decrease (in real spending terms) from the 2011 fiscal year, after accounting for a projected 1.3 percent rate of inflation.

Included is funding for basic research at the National Science Foundation, the Department of Energy’s Office of Science and the National Institute of Standards and Technology labs. Those agencies conduct research into clean energy technologies, advanced manufacturing processes and cyber security, among other things. The budget also calls for making the research and experimentation tax credit for companies permanent, and increasing it by 20%.

We think this is the first step to a turn-around, but are worried that the Republican controlled House of Representatives could block the administrations R & D spending plans citing the need to cut the budget deficit, which has exploded since the 2008 financial collapse.

What can the U.S. government and major corporations do to bolster R &D?

Here are a few of my ideas:

  1. Increase Federal Government spending on targeted R & D projects, such as infrastructure, health care, energy efficiency/independence, broadband Internet, etc
  2. Provide R & D tax credits of at least 25% of spending; permit overseas corporate profits to be repatriated tax free if they’re earmarked for research spending.
  3. Encourage Industry-University co-operation on research projects, e.g. multi-corporate client funded academic research. This topic will be discussed at the March 3 IEEE-TiE Silicon Valley meeting (information and discounted registration details at www.comsocscv.org)
  4. VC and Angel investor funding of innovative start-up companies with potential breakthrough or “game changing” technologies

Silicon Valley entrepreneur Basant Khaitan would like to see creation of a simple, non-bureaucratic process, which provides incentives for all stakeholders. He suggests a simple model: “Government should create a modest $10-$20B annual fund with a 5-10 year sunset timeframe. It will match VC funds (1:1) on terms which are ~20% discounted (equity, loan, whatever) to those of VCs. Maximum funding of $10M per entity. Government will not have any management role but will be entitled in audit at its cost.” Basant cautions that these and other details need to be carefully defined and/or refined. He says he’s confident such a program “would create a much better ROI on government funds than all the known unemployment compensation schemes.”

Recommended Reading

A great report on the importance of U.S. R & D spending is U.S. Scientific Research and Development 101 published by Science Progress in Washington DC.

0 thoughts on “Can U.S. Reverse the Decline in R&D Spending: Global Competitiveness at Risk!

  1. Alan, thanks for the extensive research that went into this article and the many links. Very helpful on a provocative topic.

    I do wonder if the premise that a decline in R&D spending equals lower competitiveness is true?

    1) Although the Federal R&D investment is double what it was in the 1960s, I suspect that much of the R&D investment was spent on programs we no longer support in the same manner, such as the space program and defense programs (e.g. nuclear testing). Granted, there were positive spillover effects from these programs. It would be interesting to see what the ROI would have been for those positive spillovers. It may not have been that great, if one takes all of the money that has been invested in those programs and apply it only to the positive spillover effects and not the actual programs as well.

    2) This is implied in one of the articles referenced (I think the one about Kodak), but R&D productivity has had to increase since the 1960s. Computers are so much more powerful today and the advent of the Internet allows the decentralization of intelligence. Researchers can collaborate in real-time, whether they are in New York or New Guinea, and they can easily search and learn. Crowdsourcing, whether through the use of networked PCs to create virtual supercomputers or just to come up with new products (www.quirky.com), may revolutionize the way new products are developed.

    3) Like everything else, there is good and bad to decentralization. As mentioned in that article, researchers in lower-cost countries can be 25% the cost of those in America. Plus, there is the advantage of being able to extend the work day to 24 hours by sourcing R&D worldwide.

    4) How are R&D dollars measured? Would a secretary’s salary at Bellcore have been included in R&D? 30 years later, with that position no longer necessary, a given amount of R&D could still be done, but for less money because the salary for the secretary would no longer be needed.

    5) Similarly, Google engineers are reported to have something like 20% of their time for “research”. Some cool Google products have been developed with this free time. Does 20% of their salaries show up in R&D? Again, this model may be more productive than the ivory tower model in the sense that these researchers are not isolated from the demands of getting products out the door.

    Thanks for starting the conversation.

  2. Under Obama’s 2011 fiscal year budget proposal, many R&D programs would see expanded or new funding to meet a number of administration goals, said presidential science adviser John Holdren, including:

    •doubling the budgets for the National Science Foundation, the Energy Department’s Office of Science and the National Institute of Standards and Technology
    •spurring development of clean energy technologies and providing national high-speed internet access
    •improving science, technology, engineering and math education
    •and promoting private R&D investment by expanding the R&D tax credit and making it permanent.
    To pay for those priorities, Holdren says, agencies were asked to make the painful determination of which programs were underperforming or of lower priority to the president’s national objective “to out-innovate, out-educate and out-build the rest of the world.”

    “I think it is especially encouraging to have a president who really supports R&D and education,” says Albert Teich, who directs science and policy programs at the American Association for the Advancement of Science in Washington, D.C. “You wish every president saw things this way. What’s discouraging, of course, is that we face this huge deficit. And not everybody in Congress is going to agree with the president’s priorities. So there’s bound to be fights over it.”

    This “zero-sum game” for federal R&D budgeting is novel, Teich notes. It is also virtually impossible to achieve, he adds, since a host of different congressional committees are responsible for eventually drafting the spending bills that will determine how money will be apportioned for individual agencies. And they don’t coordinate their spending plans to allow such a finely balanced ledger.

    http://www.wired.com/wiredscience/2011/02/science-obama-budget/

  3. Terrific, fact filled article. Would like to see more on possible remedies to promote corporate R&D which seems to be in a sharp downward spiral with possible exception of Google.

    Another point is that VCs are unwilling to fund embryonic companies that are pursuing R&D for new markets. Those start up companies used to be a big driver of innovation in the US. But many are folding after not being able to get funding. Can Angel investors fill that gap?

  4. Echo earlier comment about “the extensive research that went into this article and the many links. Very helpful on a provocative topic.”

    I don’t think the U.S. government can do much to stimulate R&D, especially with Republican opposition to spending in the name of controlling the budget deficit.

    Would like to know what TiE Silicon Valley is doing or at least advocating in this area? I attended the jointly sponsored IEEE-TiE Professors Panel yesterday which was very informative and enlightening! Great job of organizing and moderating that excellent session!

  5. Canadian Companies also cut R&D spending: 4 consecutive years of decline!

    It’s not just a U.S. phenomenon. Canada’s 100 biggest corporate research and development spenders cut back R&D investment by almost two per cent in fiscal 2009 from the year earlier, according to data compiled by Research Infosource Inc.

    The companies collectively cut spending by $180 million, or 1.8 per cent, to $10.22 billion, for the fourth decline in as many years.

    http://www.cbc.ca/news/business/story/2010/10/27/canadian-corporate-reasearch-spending.html

    It seems this trend is irreversible and will lead to major stagnation down the road.

  6. Thanks for this post – very informative. Startup activity is at an all time high in America in the last 15 years and more so in the Silicon Valley.

    The various estimates suggest that over $160B was invested in over 6 million businesses mainly from family, friends and other sources. Angels alone put up nearly $30B in 50,000 companies and VCs put almost equal amount, funding less than 4,000 companies. SBA has $2B in funding available, but it is inefficient.

    The sad thing is that the popular press does not talk about all of these investments. Politicians and others are too busy talking about the demise of American innovation and how other countries are doing a better job. Yes, while other countries are becoming active, it will be a long time before they come up and match America’s enterprising ability and ecosystem.

    Yes, our public policies need to shift, R&D tax credits must be made permanent and politicians need to understand that. The current budget has elements about technology investments,which is positive. Also politicians need to stop bickering and understand that this country needs more and more help in the R&D areas to stay competitive.

    R.Paul Singh
    TiE (www.tiesv.org), Marketing Chair

  7. Startup activity is at an all time high in America in the last 15 years and especially more so in the Silicon Valley.

    According to various estimates, over $160B was invested in over 6 million businesses, from family,friends and other sources. Angels alone put up nearly $30B in 50,000 companies and VCs put almost equal amount, funding less than 4,000 companies. SBA has $2B in funding available, but it is inefficient.

    The sad thing is that the popular press does not talk about these ways of funding R&D. Politicians and others are too busy talking about the demise of American innovation and how other countries are doing a better job. Yes, while other countries are becoming active, it will be a long time before they come up and match America’s enterprising ability and ecosystem of innovation and entrepreneurship.

    Yes, our public policies need to shift, R&D tax credits must be made permanent and politicians need to understand that. The current budget has elements about technology investments , which is positive. Needless to say we need more and more investment in R&D in this country to stay competitive and thrive. I just hope politicians whether Republicans or Democrats get this message and start making it a reality.

    R Paul Singh
    Tie (www.tivesv.org) Marketing Chair

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