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Cover Story

Does R&D Really Pay?

Issue Date - 03/02/2011
A certain inexorable logic of capitalism provides an initial answer to these questions. The economist Joseph Schumpeter suggested in the early 1940s that economic progress follows a cycle of “creative destruction,” by which the conversion of a creative insight into a new consumer good leads to new methods of production and transportation, new markets, and new forms of industrial organisation. At the same time, this process eliminates older approaches and the companies that employ them. Since Schumpeter’s time, economists, business analysts, sociologists, and historians have brought their perspectives to bear on innovation. The consensus from their writings is simple: innovation benefits consumers and creates new economic value. Firms looking for advantages over their peers must invest in research and product development. Only then can they introduce new products, offer new services, reduce production costs, and meet environmental and safety regulations in a more efficient manner. At the same time, innovation is hard. While creativity manifests itself through “eureka” moments (albeit with an underpinning in extensive research and experimentation), innovation requires organised information-sharing amongst staff, planning on an organisational scale, and systems for scaling-up manufacturing from the laboratory to mass production.

Innovation also requires significant and consistent financial support over a long period of time. A recent study of the development and diffusion of synthetic dyes in the late 19th century, polymers in the mid-twentieth century and biotechnology in the last two decades, found that products in each area took 20 to 25 years from initial concept to market, even though a century had elapsed between dyes and biotechnology. Despite many efforts, research management can show only modest success in speeding products to market.

To bring a technology from invention to market requires time, effort and increasing R&D investment. Yet in recent years, funding for R&D in the chemical industry has entered a precarious position, as companies underwent significant internal changes or merged with former competitors. Reports on industrial R&D from the past three decades track a decline in expenditures: in 1980, the top fifteen chemical firms expanded their R&D spending by 13%; in 1990, R&D spending grew by 6%; in 2003, forecasters predicted a 1% decline!
This reduction in spending carries an imminent risk of shifting the chemical industry from a virtuous to a vicious innovation cycle. In a virtuous cycle, R&D spending leads to new marketable products or processes, and income from innovations justify additional R&D investment. Additional funds flow into the companies, providing yet greater resources for R&D. The vicious cycle works in reverse: as R&D spending declines, outputs slow, and companies shift into cost-cutting modes.

A vivid illustration of this point can be found in a contrast of chemical and pharmaceutical industry R&D expenditures. R&D investments in these two industries ran in parallel between 1980 and 1990. In the early 1990s, the pharmaceutical industry was able to deflect concerns about steep regulatory requirements and a low success rate in drug development by continuing to invest in research. Companies attracted investors, public confidence, and additional cash for R&D. The pharmaceutical industry then boomed in the later half of the 1990s. Measured as a percentage of sales, pharmaceutical firms now spend double that of chemical companies on R&D.

Many factors are involved in the crossing of R&D investment by the pharmaceutical and chemical industries. In addition, spending does not guarantee product success. The key point, however, is that virtuous cycles of consumer confidence and investor support that once belonged to the chemical industry are slipping just as R&D spending declines. Historically, the belief that investment in R&D would produce radical innovations meant that funding was available to make the innovations happen. The converse is true today: the belief that chemical companies are in trouble is making it hard for firms to support R&D.

Across the industry and within every company, technology managers must make the case for continued R&D support, despite tight budgets and low investor confidence. Only the research division can identify new products, lower production costs, help meet government regulations, and reduce the environmental burden of future products. As perspectives on science and technology evolve, including how best to manage and run a science-based corporation, R&D groups have the opportunity to show leadership within their firms.

While this is a very serious challenge, the alternative – which a historical perspective on “creative destruction” shows to be a real possibility – is for chemical companies to become low-value commodity producers, while other sectors (electronics, pharmaceuticals and biotechnology) expand with new products and manufacturing technologies.

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