Industrial Research Institute's R&d trends forecast for 2004: more IRI member companies than...

The R&D Trends Forecast for 2004 indicates that more companies are reducing rather than increasing their R&D spending. More companies than last year plan spending increases, but those cutting spending outnumber them. Consequently, the changes and reductions that we characterized last

year as "leveraging" now appear to be "lessening." Reductions outnumber increases in capital spending, basic research, support of existing businesses, staffing, new-grad hiring, research intensity (R&D spending target as a share of sales), and even outsourcing and licensing. The major indicators of reductions (with survey question numbers in parentheses) are:

* Total company expenditures on R&D (1)

* Capital spending for R&D operations (2)

* R&D professional personnel level (4)

* Hiring new graduates (5)

* Targeted R&D/Sales Ratio (9a)

In the prior-year comparison charts on page 20, some lines are increasing, implying improvement. The charts show increases in categories: share of sales, total dollars, total hires, and others. It is important to be aware that these increases are occurring, because they may represent behavior observed by Richard Foster, as reported in the November December 2003 RTM (pp. 36-43).

Foster wrote that in a study of 1,200 firms, McKinsey & Company found that many of today's industry leaders spent 22 percent more on R&D than their unsuccessful peers during the 1990 91 recession. In contrast, the leaders spent just 9 percent more outside of the recession. Therefore, this year we have a situation among the companies surveyed that has happened before but does not happen often. We are in a recession, and a significant fraction of companies decided to increase R&D spending in response. The charts show that in each of several categories, such as R&D spending (1), more companies than last year indicated increases of at least 5 percent. The Sea--Change Index (Table 1) tells the rest of the story, indicating that more firms actually plan decreasing industrial R&D spending and activity in several important categories. If Foster is right, the ones increasing spending will likely be future successful leaders.

Here is another way to look at the data. Imagine that you are a grade-school teacher with 20 children in your classroom, and you track the health of your students. One day you note that 4 students seem perfectly healthy, 14 have the sniffles but are well enough to attend school, and 2 are absent due to illness. The next day, you note that 6 students seem healthy, 6 have the sniffles and are present, and 8 are absent due to illness. If you kept a graph of that health data in the same way as the IRI graph of the category increases, your graph would show a significant increase in "well" students--a jump from 10 to 30 percent. Problem is, the students are sicker--the group so ill as to be absent increased from 10 to 40 percent, a larger jump. As the teacher, you find both points are useful: more students are well, and more students are ill. With the IRI data, we show both the graphs and the Sea Change Index because both the increases and the decreases are important.

The rest of this article describes highlights and implications of 2003's responses for R&D conduct and spending in 2004. For continuity with prior reports (RTM, Jan.-Feb. 2003, pp. 17-20), we continue calculating the "Sea-Change Index" (Table 1). For each question, such as "Total company expenditures on R&D," the index is calculated by subtracting the percentage of respondents predicting any decrease from the percentage predicting an increase of 5 percent or more. This assessment tells us whether respondents, taken together, intend to increase or decrease the factor measured by each question. Table 1 shows the results for the surveys conducted from 1999 through 2003, labeled "2000" through "2004" respectively. The Sea-Change Index helps to outline the dilemma in this year's results, correctly showing that on balance, more companies are cutting R&D spending and intensity. Figure 1 summarizes the index results, which are tabulated in Table 2 and compared with prior years on page 20.

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Changes in the Nature of R&D

The major difference between last year's forecast and this: last year's appeared to be a "flight to value" and this year's forecasts reduction in spending brought on by decreased industrial activity. Many companies transitioned from "doing more with less" to "doing less with less." Signals of the transition are quite clear, as both "Total company expenditures on R&D" and "Targeted R&D/sales ratio" are clearly decreasing in the Sea-Change Index.

Last year, those indices were both down but the number of companies cutting expenditures was twice the number cutting the R&D/sales ratio--indicating that in many cases spending was down because sales were down. This year, the number cutting the ratio is about the same as the number cutting expenditures, implying that not only are companies predominately planning on spending less, but also that for many companies that spending is a shrinking share of shrinking industrial revenue.

Compared to last year, companies report that they intend to increase activity in precompetitive university research consortia, and contracts with government labs. They also intend to participate more in joint ventures and alliances for R&D. More companies report that R&D outsourcing to other companies will again decrease, as will licensing technology from others.

This combination of strategic activity confirms last year's observation that companies will put more emphasis on working with others and less emphasis on outsourcing in which they pay others to do research under contract. Companies will likely focus collaborations on current and new relationships in which contract terms are most reasonable--the observed decrease in intent to partner with universities implies that significant factors such as contract terms, technical performance or strategic preferences do not support increases.

International Perspective

In last year's report, we saw a large increase in the number of companies with declining spending on existing business and directed basic research. Continued declines, not as deep as last year but still net reductions, mark this year's survey responses. The survey results forecast decreases in total company R&D expenditures, R&D professional personnel, hiring new graduates, licensing technology from others, and the R&D-to-sales ratio. All of those indices are at their lowest levels since the year 2000.

International Perspective

Data from Standard & Poor's Compustat in Table 3 show that as measured by research intensity, foreign companies are out-spending U.S. companies. For instance, the Japanese companies trading on the U.S. stock exchanges have about 1/10 the net sales as their U.S.-domiciled counterparts. However, they spend over 4 percent of each sales dollar on R&D, compared with the 1.7 percent spent by the U.S. companies. This might have strategic implications for U.S. companies on global markets, because even though U.S. companies lead the world in innovation, if present trends continue, this soon will not be true. They are out-spent and as non-U.S. economies develop and mature, the U.S. companies will likely be out-sold.

Increasingly, capital and consumer goods are developed, manufactured and sold outside of the U.S. for global consumption by a growing global market. At the same time, the U.S. is importing more goods than ever. One could argue that this results in U.S. consumers voluntarily--through trade--funding foreign economic development. Moreover, many services (e.g., telephone-based marketing, software development, customer support) are now provided increasingly by foreign-based employees. Consequently, much of the revenue from trade--revenue on which the U.S.'s wealth was developed--is no longer flowing to primary manufacturers or service providers domiciled in the United States. As that revenue declines, so does the cash flow that enables spending on exploratory research, gifts to academia, and other investment that industry provided in the past.

Impact and Consequences

Over the past several years, a number of industrial economists have pointed out the impact of global monetary policy on competitiveness. They make compelling arguments and counterarguments concerning the effect of monetary policy on trade and economic development. The IRI survey's trend implies that industries that compete in the U.S. economy have taken steps resulting in reduction of research and development resources. How might these be linked? We will point out indicators and highlight ideas that may help to describe the linkage:

First, in light of the retrenching environment, the data show that companies are engaging in more collaborative R&D. Interestingly enough, the IRI data show this collaboration taking place increasingly with other companies instead of with universities or government labs. This collaborative preference might have several motivating factors. One might be as a response to more intense investment by the foreign firms that are competing, on the U.S. stock market, for shareholder capital. One indicator of that competition: as described earlier in this article, among firms publicly traded in the U.S., on a percentage of sales basis, the companies domiciled outside the U.S. heavily outspend those domiciled within.

The U.S. government has many policies and initiatives that directly and indirectly support industrial research, and private industry has its usual motivation to compete. Even so, the survey results show continuing, declining trends, indicating that some government and private industrial policy questions remain unexplored and others should be re-visited.

One question for future exploration might be whether the decline in real income to U.S. households (according to U.S. government census data on household income, adjusted for CPI) is associated with the relative intensity, or relative changes in intensity, of R&D spending by U.S.-domiciled as compared to foreign-domiciled firms that are publicly traded in the United States. An answer to that question might help government policy-makers decide on future initiatives that would encourage U.S. firms to spend more intensely on research. Further inquiry might explore whether private-sector job creation and wealth creation in the U.S. would be a consequence of a marginal increase in the intensity of R&D spending across U.S. firms.

Additional consideration should be given to the long-range impact of private and government policy decisions on various outcomes. For example, Intel co-founder and chairman Andy Grove, speaking during a recent technology summit in Washington, D.C., predicted that the domestic software and services industry is about to lose U.S. market share in the way that steel and semiconductors have in the past. Over the past few decades, the semiconductor industry's U.S. market share fell from 90 percent to 50 percent today; steel has fallen from 50 percent to 10 percent today. Grove's point: there are fewer people earning advanced degrees in the U.S. in science and engineering; cost of U.S. labor is higher than that in some foreign countries; and high-bandwidth Internet connections are prevalent and cheaper on a global scale.

The combination of these factors encourages--or at least eases the way for--software developers in India and other countries to do business with U.S. firms. In the case of software and services, corporate leaders seeking to maximize shareholder value are increasingly deciding to buy from overseas vendors, with the result being that the domestic software and services industry market share will fall. The IRI data seem to echo this trend: plans to hire new graduates are down, and plans to collaborate with other companies are up.

It might be that U.S. industry can save itself from its decline by increasing research spending toward a set of complementary objectives. One such set of objectives that might make sense for a firm--or a group of firms--would be an increase in their global competitiveness linked with an increase in the size and wealth of the markets into which they sell. It could be that those ends are achievable through the increasing employment and demand that might flow from an intensity of R&D spending that was nearer the average level--instead of trailing--their foreign competitors, hopefully in ways that encourage domestic economic development.

Consider the examples cited in this article: Foster claimed that many of today's industry leaders progressed past their competition by increasing R&D spending during the 1990-91 recession. Grove reminded us that the U.S. semiconductor industry's market share has fallen from 90 to 50 percent. Interestingly enough, Intel emerged from the 1990-91 recession as an industry leader, possibly by increasing the intensity of its R&D spending. In the previously cited RTM article, Foster wrote that Grove's Intel dramatically increased R&D spending to $780 million (114 percent above the 1989 level), and consequently outperformed its peers through increasing sales by 87 percent.

So one observation outlined at the beginning of this article--while overall spending and effort are decreasing, relatively more firms are increasing spending and effort than last year--indicates that, as in past recessions, some firms have determined that increasing R&D is a key part of their competitive response. Foster would probably tell us that the new crop of leaders will come from those companies, which is good news. On balance, the data show that overall R&D spending and effort are declining for a second year, which is bad news. Foster would probably tell us that those who are cutting R&D spending are unlikely to compete successfully.

R&D Trends Forecasts for 1999-2004 As % of respondents expecting increases of 5% or more

Increase in Company R&D Spending

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Increase in R&D Capital Spending

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Increase in Hiring of New Graduates

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Increase in R&D Professional Staff

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Increase in Grants for University R&D

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Increase in Directed Basic Research

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Increase in Alliances and Joint Ventures

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Increase in Outsourcing R&D to Other Companies

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Increase in Support of Existing Business

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Increase in New Business Projects

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Increase Licensing From Others

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Increase Licensing To Others

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Table 1.--"Sea Change Index"

                                         2000   2001   2002

1. Total company expenditures on R&D        0      5     -4
2. Capital spending for R&D operations      4      3    -17
3. Relative distribution of R&D costs:
   a) Support of existing business        -20    -10     -6
   b) Directed basic research              -9    -21    -11
   c) New-business projects                34     44     30
4. R&D professional personnel level        -3     -2     -4
5. Hiring new graduates                    -5      2    -16
6. Outsourcing R&D to other companies      11     11     -6
7. Licensing technology from others
     ($ volume)                            10      4      0
8. Licensing technology to others
     ($ volume)                            20     10     17
9. How will 2004 compare to 2003?
   9a. Targeted R&D/sales ratio           N/A     -1     -5
   9b. Grants, contracts, etc., for
         university R&D                     8      3     -1
   9c. Participation in consortia for
         precompetitive university
         research                         -14    -12    -19
   9d. Contracts with Federal
         laboratories                      -9    -13     -8
   9e. Participation in alliances and
         joint R&D ventures                40     40     33
   9f. Acquisition of technological
         capabilities through M&A         N/A     33     35
   9g. Your spin-offs based on
         developed technology             N/A     19     19
   9h. Outside-customer technical-
         service efforts relative to
         total R&D (time or $)            -19     -6     -3

                                         2003   2004

1. Total company expenditures on R&D      -15    -16
2. Capital spending for R&D operations    -18    -18
3. Relative distribution of R&D costs:
   a) Support of existing business        -24    -20
   b) Directed basic research             -21    -17
   c) New-business projects                 7      1
4. R&D professional personnel level       -22    -24
5. Hiring new graduates                   -14    -22
6. Outsourcing R&D to other companies      -8     -8
7. Licensing technology from others
     ($ volume)                            -2     -5
8. Licensing technology to others
     ($ volume)                             8      1
9. How will 2004 compare to 2003?
   9a. Targeted R&D/sales ratio            -8    -15
   9b. Grants, contracts, etc., for
         university R&D                    12     10
   9c. Participation in consortia for
         precompetitive university
         research                           0     20
   9d. Contracts with Federal
         laboratories                      28     38
   9e. Participation in alliances and
         joint R&D ventures                49     44
   9f. Acquisition of technological
         capabilities through M&A          18     15
   9g. Your spin-offs based on
         developed technology              20     11
   9h. Outside-customer technical-
         service efforts relative to
         total R&D (time or $)             18     20

Table 2.--Results of 2004 R&D Trends Forecast

                                                 Relative Change
                                                (% of Respondents
                                                    Reporting)

  Expected Changes in 2004 Compared              Less
      with 2003 Experience                     than -5%   -5% to 0

 1. Total company expenditures on R&D              6         25
 2. Capital spending for R&D operations           14         20
 3. Relative distribution of R&D costs:
    a) Support of existing business                8         22
    b) Directed basic research                    10         22
    c) New-business projects                       7         14
 4. R&D professional personnel level               5         29
 5. Hiring new graduates                           7         24
 6. Outsourcing R&D to other companies             5         12
 7. Licensing technology from others
      ($ volume)                                   1         13
 8. Licensing technology to others
      ($ volume)                                   0         16
 9. How will 2004 compare with 2003 for the
    following:
    a. Your targeted R&D/Sales Ratio           Decrease 28%
    b. Grant, contracts, etc. for university
         R&D                                   Decrease 13%
    c. Participation in consortia for pre-
         competitive university research       Decrease 5%
    d. Contracts with Federal laboratories     Decrease 4%
    e. Participation in alliances and joint
         R&D Ventures                          Decrease 3%
    f. Acquisition of technological
         capabilites through M/A               Decrease 6%
    g. Your new spin-offs based on
         developed technology                  Decrease 7%
    h. Outside-customer technical-service
         efforts relative to total R&D (time
         or $)                                 Decrease 11%
10. Do you have a growth center?               Yes 36%
11. Have you ever used E-business as a
      value-creation channel for new
      technology?                              Yes 28%

                                                 Relative Change
                                                (% of Respondents
                                                   Reporting)

  Expected Changes in 2004 Compared                         >2.5%
      with 2003 Experience                     >0 to 2.5%   to <5%

 1. Total company expenditures on R&D              39         15
 2. Capital spending for R&D operations            44          6
 3. Relative distribution of R&D costs:
    a) Support of existing business                47         13
    b) Directed basic research                     43         10
    c) New-business projects                       34         23
 4. R&D professional personnel level               41         15
 5. Hiring new graduates                           47         13
 6. Outsourcing R&D to other companies             49         25
 7. Licensing technology from others
      ($ volume)                                   56         21
 8. Licensing technology to others
      ($ volume)                                   52         15
 9. How will 2004 compare with 2003 for the
    following:
    a. Your targeted R&D/Sales Ratio           Remain-same 59%
    b. Grant, contracts, etc. for university
         R&D                                   Remain-same 64%
    c. Participation in consortia for pre-
         competitive university research       Remain-same 70%
    d. Contracts with Federal laboratories     Remain-same 54%
    e. Participation in alliances and joint
         R&D Ventures                          Remain-same 50%
    f. Acquisition of technological
         capabilites through M/A               Remain-same 73%
    g. Your new spin-offs based on
         developed technology                  Remain-same 75%
    h. Outside-customer technical-service
         efforts relative to total R&D (time
         or $)                                 Remain-same 58%
10. Do you have a growth center?               No 58%
11. Have you ever used E-business as a
      value-creation channel for new
      technology?                              No 54%

                                                 Relative Change
                                                (% of Respondents
                                                     Reporting)

  Expected Changes in 2004 Compared                         More
      with 2003 Experience                     5 to 10%   than 10%

 1. Total company expenditures on R&D             10          5
 2. Capital spending for R&D operations           10          6
 3. Relative distribution of R&D costs:
    a) Support of existing business                4          6
    b) Directed basic research                     9          6
    c) New-business projects                       9         13
 4. R&D professional personnel level               5          5
 5. Hiring new graduates                           3          6
 6. Outsourcing R&D to other companies             5          4
 7. Licensing technology from others
      ($ volume)                                   5          4
 8. Licensing technology to others
      ($ volume)                                  10          7
 9. How will 2004 compare with 2003 for the
    following:
    a. Your targeted R&D/Sales Ratio           Increase 13%
    b. Grant, contracts, etc. for university
         R&D                                   Increase 23%
    c. Participation in consortia for pre-
         competitive university research       Increase 25%
    d. Contracts with Federal laboratories     Increase 42%
    e. Participation in alliances and joint
         R&D Ventures                          Increase 47%
    f. Acquisition of technological
         capabilites through M/A               Increase 21%
    g. Your new spin-offs based on
         developed technology                  Increase 18%
    h. Outside-customer technical-service
         efforts relative to total R&D (time
         or $)                                 Increase 31%
10. Do you have a growth center?               Under consideration 6%
11. Have you ever used E-business as a
      value-creation channel for new
      technology?                              Under consideration 18%

A scale of 1 to 6 was used, with 1 representing "significantly less"
(less than -5%,), 2 "slightly less" (-5 percent to 0), 3
"approximately the same" (even with inflation) (greater than 0
to 2.5 percent), 4 "slightly more" (>2.5 to <5 percent), 5 "somewhat
more" (5 to 10 percent), and 6 "significantly more" (more than 10
percent).

Table 3.--United States-domiciled companies are
out-spent in R&D (Source: S&P Compustat, 10/2003)

  Country of                                 R&D/
Incorporation                      GAAP      Sales
   (Total)        Net Sales        R&D        (%)

United States    10,362,072.5   $172,318.2    1.7
Japan             1,040,623.3    $43,380.5    4.2
Germany             764,710.8    $24,487.3    3.2
United Kingdom      966,357.5    $16,371.4    1.7
France              624,786.9    $12,076.6    1.9
Switzerland         284,636.5     $9,369.6    3.3
Netherlands         664,262.5     $7,008.5    1.1
Canada              306,018.9     $6,121.5    2.0
Sweden               94,927.4     $4,831.1    5.1
Finland              64,509.0     $3,660.0    5.7

This report was written by Albert L. Johnson. senior analyst for science and technology at Corning, Inc., and chair of IRI's Research-on-Research Committee. It is based on the forecast conducted annually by the RoR committee, with the assistance of Madora Bianco and Margaret Grucza of the IRI staff: johnsonAL@corning.com