Beyond Borders

10/21/08

Beyond Borders

The world’s top corporate spenders continue to invest aggressively in research and development—and over 90% of these companies are conducting R&D in countries other than those in which they’re headquartered.

Booz & Company’s fourth annual Global Innovation 1000 study finds that the world’s top 1,000 corporate R&D spenders committed US$492 billion in 2007—10% more than the previous year.
Reflecting the increasingly dispersed world of R&D, the average company studied invests more than half (55%) its budget outside its home country. In a surprise, the U.S. is one of the leading recipients of R&D investment from abroad, along with rapidly growing economies such as China and India. Increasingly, companies are looking to establish capabilities overseas not only to take advantage of lower labor costs but also to take advantage of specialized skills, proximity to markets, and local insights. Lower engineering labor rates explain only a third of moves to site R&D facilities overseas, the study finds.

Despite the high level of spending, however, the question remains how to get the most return for investment. The report reveals that high spending doesn’t in itself improve performance relative to a peer group. However, companies that committed more than 60% of their spending overseas over the last three years enjoyed superior shareholder returns, operating margins, market cap growth, and return on assets. And those firms that invested a greater percentage of their R&D resources overseas than their overseas sales had a three-year market capitalization fully 50% higher than those investing at more modest levels.

Improved performance isn’t a matter of spreading cash over a large geographical footprint, the study finds. Those companies that have created fewer and larger overseas facilities perform 30% better in terms of three-year operating income growth, and 40% better on three-year market cap growth. Companies deploying a far-flung network of smaller research sites can experience execution problems. The study finds, in fact, that nearly half of companies that deployed R&D resources globally did not reap the benefit they anticipated.

Booz & Company took an in-depth look at R&D flows from country to country based on data from a prominent subset of 184 of the Innovation 1000’s top spenders. Interestingly, a number of countries have significant two-way flows of inward and outward investment. The U.S. is the greatest example of this; among the 184 company subset, U.S. companies invested $80.1 billion in overseas R&D, while $42.6 billion was invested in the U.S. by overseas firms. In fact, about 40% of the R&D in the U.S. comes from firms headquartered outside the country.

The U.S. remains the R&D capital of the world, accounting for the highest overall spending. However, China and India are gaining in importance both as locations for research and as sources of R&D spending. Though they account for only 1% of spending today, Chinese and Indian companies increased their R&D investments by 22% in 2007, far outpacing growth elsewhere. Europe, for instance, increased its spending 12% last year, increasing its global share to 31%. The U.S. maintained its share of worldwide spending at 42%.

As locations for R&D facilities, low-cost countries such as India and China remain highly attractive, despite losing some of their pull as labor costs rise. The study finds that those firms investing more than 10% overall in low-cost countries performed 25% better than average in terms of three-year sales growth, and 67% above average for three-year market cap growth.

Despite the changing map of R&D activity, R&D spending remains concentrated among three sectors: computing and electronics (29%), healthcare (22%), and automotive (16%) make up two-thirds of the overall spending. The software and Internet industry has the highest level of spending relative to sales (13.6%), followed by health (13.3%), and computers and electronics (7%). By contrast, the chemicals and energy sector committed only 1% of sales to R&D 2007.

The three highest-spend sectors are each seeing significant changes in the ratio of home-to-overseas investments. In the case of computing and electronics, 70% of industry spending originates in the U.S. or Japan, though only 40% actually stays in those countries. Healthcare companies have less diverse global networks, as the research side of the industry has been slow to establish a presence in emerging markets; almost 95% of drug discovery spending was committed to facilities in the U.S., Europe, or Japan last year. As for the automotive sector, 83% of spending derives from the U.S., Germany, and Japan, but only 60% stayed at home, as companies increasingly seek to be nearer emerging markets such as China and East Europe.

The top 10 global R&D spenders in 2007 were, in order of magnitude, Toyota, General Motors, Pfizer, Nokia, Johnson & Johnson, Ford, Microsoft, Roche Holding AG, Samsung Electronics, and GlaxoSmithKline.

Download the full report, "Beyond Borders: The Global Innovation 1000."