International businesses are increasingly choosing to move their R&D capacity to locations in Asia, with China emerging as the regions hotspot. The shift in R&D capacity to Asia comes at a cost to the US and Europe, research by Strategy& shows.
The study, titled '2015 Global Innovation 1000’ by Strategy& and PwC, looks at key trends of the 1000 global organisations that spend the most on R&D, and shows that R&D spending grew 5% last year to hit $680 billion (~ €632 billion). Taken as a percentage of revenue, total R&D spending is now at around 3.7%; a level in line with the ten-year average between 2004 and 2014, and the highest level since 2010. Just like last year, the computer & electronics sector accounts for the highest level of expenditure, followed by healthcare (including pharmaceuticals) and the automotive segment.
The report shows that Europe is gradually losing recent dominant position. In 2007 Europe could still call itself the leader when it came to the total domestic and imported R&D spend (35% of the total), since then the continent has, in just a few years, slipped to third place. Europe's decline is based on two main factors: low growth in domestic and imported R&D, and high growth in exported R&D. The growth of the domestic R&D expenditure in Europe increased 2% between 2007 and 2015, while it increased 40% in North America and 60% in Asia.
At the same time European countries, especially France and Germany, have expanded their R&D activities to distant lands, such as North America and Asia. Thus France, between 2007 and 2015, reduced its domestic R&D spend by 20% and the imported R&D fell by 21%; while exported R&D increased by 46%. In Germany, between 2007 and 2015, the domestic R&D spend dropped by 48% and the imported R&D fell by 7%; while exported R&D activity was up by 76%.
The UK, just like France and Germany, saw an increase in exported R&D activity between 2007 and 2015. Eight years ago UK-based corporates exported 67% of their R&D activities, in 2015 it was 80%, even more than the French and German corporates, the researchers conclude.
Asia and China
China has now emerged as the most desirable destination for R&D activities: 71% of surveyed innovation professionals indicated that the proximity of emerging markets is the main reason for the shift to China. Other frequently mentioned advantages are the proximity of the main production sites and suppliers, and lower development costs. "It is not surprising that Asia is taking the lead as the top destination for R&D," says Arno Pouw, head of PwC Advisory in the Netherlands. "To grow further, Western companies have focused on emerging economies. The growing middle class there requires them to be closer to those markets and their customers."
The US in particular has played a driving role in the growth of the Chinese R&D import market. In 2007, 31% of R&D imported into China come from the US, this has now increased to 41%, a significant increase, especially considering the fact that the total volume of imports nearly doubled to $44 billion (~€40billion). The results are in line with an earlier study by PA Consulting Group from a few months ago, which concluded that China now has the #1 market share for R&D, although this study focused in particular on the manufacturing industry.
Spending on R&D remains pivotal to company success, the report finding that companies that deployed 60% or more of corporate R&D spending abroad in 2015 earned a premium of 30% on operating margin and return on assets, and 20% on operating income over their less outward looking competitors.
The UK itself has continued to move its R&D activity abroad, increasing total low-cost country (LCC) R&D spending by 185% but decreased total high-cost country (HCC) R&D spend by 22%. The destination in terms of HCC has seen UK exports to the US drop from 40% in 2007 to 33% in 2015, while China and Japan have booked considerable benefits. At the same time, India has surpassed the UK as destination for R&D spending, now coming in at number four behind leaders China and the US.
The UK has considerable opportunities however, to keep its standing as a country of destination for R&D spending, Ashley Unwin, PwC UK’s head of consulting, notes that: “According to PwC’s 2015 Annual CEO survey almost 90% of UK CEOs saw digital technologies as vital to their success and a source of competitive advantage and 84% were worried about skills gaps. If the UK is to address these CEO concerns and thrive as a growing knowledge economy, the long-term decline in U.K. R&D investment identified in this survey must be reversed. UK corporates together with Government have the opportunity to drive more domestic R&D investment to build a UK economy that is recognized as a haven for talent, skills and knowledge.”