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.
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.
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.
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.
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.
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:
- Increase Federal Government spending on targeted R & D projects, such as infrastructure, health care, energy efficiency/independence, broadband Internet, etc
- 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.
- 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)
- 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.”
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.