Have Large Corporations Given Up on Innovating?

Make versus buy is one of the most fundamental choices an enterprise has to decide. Is it more profitable to invent something internally or buy it from an external vendor?

Increasingly, when it comes to research and development, large corporations are concluding they should buy rather than make. But the history of innovation reveals that many transformative inventions were discovered serendipitously and even inadvertently. It may be in choosing to become deployers of capital rather than creators of value, institutions are not calculating the cost of lost intelligence - and opportunities. JL

Eduardo Porter reports in the New York Times:

The stock market places a lower valuation on original research than it did three decades ago. Corporate executives, their compensation tied overwhelmingly to short-term gains in the market value of their companies, may be responding accordingly. Rather than invest in their own science, big companies more easily buy innovative start-ups.

The iPhone in your pocket has more computing power than the Voyager spacecraft that left the solar system two years ago. High-tech cancer drugs are being approved every month. A few years into the future, Google’s Calico project promises to extend our life span.

It’s easy, indeed, to be excited about the scientific and technological prowess of American companies.

Apple, Procter & Gamble, 3M — American businesses dominate the list of the most innovative companies in the world. And new companies trumpeting new products, financed by dynamic venture capital operations, continue to emerge from Silicon Valley, the Boston region, New York, Northern Virginia and elsewhere.

But talk to a scientist in a research lab almost anywhere and you are likely to hear that the edifice of American innovation rests on an increasingly rickety foundation.

Investment in research and development has flatlined over the last several years as a share of the economy, stabilizing at about 2.9 percent of the nation’s gross domestic product in 2012, according to the National Science Foundation.

That may not be far from the overall peak. But other countries are now leaving the United States behind. And even more critically, investment in basic research — the fundamental building block for innovation and economic advancement — steadily shrank as a share of the economy in the decade to 2012, the last year for which there are comprehensive statistics.

The trend poses two big challenges. The first concerns government budgets for basic research, the biggest source of financing for scientific inquiry. It fell in 2013 to substantially below its level 10 years earlier and, as one of the most politically vulnerable elements in an increasingly straitened federal budget, looks likely to shrink further.

The second, equally important, challenge regards the future of corporate research. Evidence suggests that American corporations, constantly pressured to increase the next quarter’s profits in the face of powerful foreign competition, are walking away from basic science, too.

“Companies’ R&D,” Ashish Arora of Duke University’s Fuqua School of Business told me, “is moving away from the R toward the D.”

This bodes ill for American progress.

The number of American patent applications keeps rising. Yet increasingly divorced from the scientific advances on which technological progress ultimately rests, the patenting rush looks less and less like fundamental innovation.

A research paper by Professor Arora and Sharon Belenzon from Fuqua, and Andrea Patacconi of the Norwich Business School at the University of East Anglia, tracks American corporations’ loss of interest in scientific research.

 

Research Laggard

Investment in research and development leveled off in the last few years as a share of gross domestic product in the United States, even as it continued to grow in other countries.

Investment in research and development

as a share of G.D.P.

4.5

%

South Korea

4.0

3.5

Japan

Taiwan

3.0

Germany

United States

2.5

China

2.0

E.U. AVERAGE

1.5

1.0

0.5

0

’95

’00

’05

’10

’13

Source: Organization for Economic Cooperation and Development

MAY 19, 2015

By The New York Times

The R&D of publicly held companies increased to 2 percent of sales in 2007 from 1 percent of sales in 1980. The share of businesses holding patents increased to just less than 30 percent from 20 percent during the period. Yet the share of companies whose researchers published in scientific journals shrank. Publishing original research took a much-diminished role in corporations’ overall R&D efforts.

American corporate labs are the stuff of legend. Researchers dream of the halcyon days of Bell Labs and its eight Nobel Prize winners, who brought us the transistor and Unix. Others reminisce about Xerox PARC, which came up with the graphical user interface that propelled the personal computer into just about every home and office.

Those days are long gone. Today, laments Mark Muro of the Brookings Institution, investment in innovation has been balkanized, split between government financed basic research, squeezed by skimpy budgets, and a corporate R&D effort constrained by its focus on the very short term.

What happened? The researchers at Duke and East Anglia reject the argument that tightening regulations have pushed companies to cut their research budgets. Corporate investment in basic research, they note, is waning in Europe, too. This is not exclusively an American dynamic.

They also doubt that science has somehow become less valuable, an argument proposed by prominent economists like Robert Gordon of Northwestern University. Citations of recent scientific research are as common in corporate patents today as they were in the 1980s, suggesting science remains critical to companies’ innovation.

Still, something has clearly changed: Investors may value corporate patents as much as ever, but the stock market places a lower valuation on original research than it did three decades ago. Corporate executives, their compensation tied overwhelmingly to short-term gains in the market value of their companies, may be responding accordingly.

Science has always been risky. Xerox was not the main beneficiary of the graphical user interface. Apple and Microsoft were. Bell Labs might not have poured much money into discovering cosmic microwave background radiation without the backing of a deep-pocketed telephone monopoly.

Harassed by international competition in our more cutthroat era, companies have less incentive to create knowledge that may or may not be profitable. Instead, they are encouraged to patent more intensely, to protect what profitable knowledge they already have.

Can innovation survive this realignment?

Ultimately a dearth of research threatens productivity growth, which slowed sharply over the last decade to less than half the average of the previous 10 years. It leaves young scientists in the lurch, without projects on which to apply their knowledge. It discourages young Americans from pursuing scientific careers.

Congressional efforts to bolster corporate research by making the R&D tax credit permanent are unlikely to help much. Already extended umpteen times since it came into being in 1981, the credit “delivered, at most, a modest stimulus to domestic business R&D investment from 2000 to 2010,” according to the Congressional Research Service.

Congress might do better by getting out of the way. Efforts by congressional Republicans to reshape federal research policy through the reauthorization of the America Competes Act, reducing funding in crucial areas like climate change and geoscience, among other provisions, could do real damage to the nation’s research effort.

As large companies have cut their research budgets, small, science-driven businesses have stepped in to pick up some of the slack, spawned by the Bayh-Dole Act of 1980 that encouraged scientists and universities to commercialize the discoveries they made on the federal dime.

They have opened a path for corporate innovation. Rather than invest in their own science, big companies may now more easily buy innovative start-ups and develop their most promising discoveries into profitable technology.

And yet this ecosystem is vulnerable, reliant on a dwindling pot of public money that underwrites most university-based research.

“The buy-up strategy would be fine if we had confidence that the university system and start-ups were picking up the slack,” Professor Arora told me. “But we still don’t understand how this division of innovative labor would work.”

It might work. But it looks risky to put all our trust in that approach. It’s time for a different paradigm — more on that in a future column — to finance the innovation that will power America’s future.