Companies that spend a part of their R&D budget in low-cost countries such as China and India do better on sales growth and market cap growth.
As business becomes increasingly global, corporate innovation strategies are becoming more global as well: Multinational companies are spending a significant - and growing - share of their research and development money outside the countries in which they are headquartered.
Booz & Company's latest annual Global Innovation 1000 study found that in 2007, the top 80 US corporate R&D spenders deployed an estimated $80.1 billion of their $146 billion R&D funds overseas. The top 50 European companies spent $51.4 billion of their $117 billion total outside the continent. In Japan, the top 43 Japanese firms exported $40.4 billion of their total $71.6 billion to other countries.
Moreover, companies that invest wisely in a multinational innovation footprint are gaining far better returns on their R&D investment than companies that exclusively keep their laboratories at home - or that fragment them across a wide variety of locations.
The study found that the Global Innovation 1000 companies are spending an average of 55 per cent of their innovation dollars outside their home country, demonstrating how international the practice of innovation has become. All the biggest companies are now multinational, and their R&D footprints reflect the need to succeed in the global economy. Fully 91 per cent of this year's Global Innovation 1000 already conduct innovation activities outside the countries in which they are headquartered.
Those 1,000 companies spent a total of $492 billion in 2007 on R&D, a 10 per cent increase over the prior year. Geographically, global R&D would seem at first to be centered in the US, Europe, and Japan; companies headquartered there made up 94 per cent of the total in 2007, down just one percentage point from the prior year.
The share of R&D facilities located outside the home markets of multinational corporations, has been rising steadily- from 45 per cent in 1975 to 66 per cent in 2005, according to a 2006 study conducted jointly by Booz & Company and INSEAD. That share continues to increase: Between 2004 and 2007, MNCs increased their total R&D sites by 6 per cent, and of those new sites, 83 per cent were in China and India. They also increased R&D staff by 22 percent; 91 per cent of that increase was in China and India.
To gain further insight, Booz closely examined the global innovation footprints of the top 100 R&D spenders, along with the top 50 companies in each of the three highest-spending industries: auto, health care, and computing and electronics. The 184 companies in this group support more than 3,400 facilities in 47 countries around the world. Together, they spent more than $350 billion on R&D in 2007. That amounts to 71 per cent of the total spend of the Global Innovation 1000 and 57 per cent of all private-sector R&D spending. On average, just 45 per cent of these companies' total R&D spending occurred inside their home countries.
Companies in the US spent the largest amount on R&D in other countries, making the US the top 'net exporter' of R&D spending in 2007, followed by Japan and Switzerland. The top 'net importer' is China, where $24.7 billion in R&D spending was accounted for by foreign companies, with product development activities now following the numerous manufacturing sites established there.
India was the second-largest, with $12.9 billion in net imports; its large, English-speaking talent pool and fast-growing auto, computing and electronics, and pharmaceutical markets will stimulate further growth, Booz notes. Other top net importers included Canada, Israel, and the United Kingdom.
There are at least reasons why multinationals are moving their R&D facilities abroad: Lower costs, access to talent and market proximity and insight.
The initial impetus for conducting R&D overseas was often to save money, but Booz's analysis shows that lower engineering labour rates explain only one-third of the move to site R&D facilities overseas. Labor costs are rising in LCCs as demand for skilled engineering and other talent grows.
The second reason is access to talent. Many companies are heading overseas in search of access to the burgeoning numbers of talented engineers and scientists around the world, and to the ideas that they are generating. Global companies are also learning quickly that specific countries are gaining specific skills (automotive engineering in India, electronics in China), and they are chasing that talent accordingly.
The third reason is market insights. Locating R&D facilities closer to growing global markets yields valuable insights into markets and customer preferences. The automotive industry is a case in point: Selling successfully in these new markets requires the engineering talent to rethink the design of cars for these markets.
Overall, Booz's analysis suggests that companies that take a more aggressive posture in globalizing their R&D footprint enjoy stronger sustained financial performance. Of the 184 top spenders that Booz studied closely, those that deployed more than 60 per cent of their R&D outside their home countries tended to perform better, over the past three years, on several performance indicators, including operating margin, total shareholder return, market cap growth, and return on assets.
Somewhat unsurprisingly, companies that invest more than 10 per cent of their total R&D spend in LCCs such as China and India do better- 25 percent better on three-year sales growth, and as much as 67 percent better on three-year market cap growth. Clearly, there is still some money to be saved by arbitraging labor costs, even among the highly skilled engineers needed for complex corporate R&D projects. Yet just as important is the knowledge gained about how to better serve those fast-growing local markets.
