S&E Indicators 2006 - Chapter 4: Research and Development: Funds and Technology Linkages

Business R&D

Largest R&D Industries

Businesses perform R&D with a variety of objectives in mind, but most business R&D is aimed at developing new and improved goods, services, and processes. For most firms, R&D is a discretionary expense similar to advertising. R&D does not directly generate revenue in the same way that production expenses do, so it can be trimmed with little impact on revenue in the short term. Firms attempt to invest in R&D at a level that maximizes future profits while maintaining current market share and increasing operating efficiency. R&D expenditures therefore indicate the level of effort dedicated to producing future products and process improvements in the business sector; by extension, they may reflect firms' perceptions of the market's demand for new and improved technology.

As previously mentioned, R&D performed by private industry is estimated to have reached $219.2 billion in 2004. The federal government funded 10.7% ($23.5 billion) of this total, and company funds and other private sources financed the remainder. These estimates are derived from the NSF and the U.S. Census Bureau's annual Survey of Industrial Research and Development, which collects financial data related to R&D activities from companies performing R&D in the United States. These data provide a basis for analyzing the technological dynamism of the business sector and are the official source for U.S. business R&D estimates (see sidebar "Industry Classification Complicates Analysis").

In addition to absolute levels of R&D expenditures, another key S&T indicator in the business sector is R&D intensity, a measure of R&D relative to production in a company, industry, or sector. Many ways exist to measure R&D intensity; the one used most frequently is the ratio of company-funded R&D to net sales.[14] This statistic provides a way to gauge the relative importance of R&D across industries and among firms in the same industry. The average R&D intensity of companies performing R&D in the United States peaked in 2001 at 3.8% as R&D budgets remained steady despite a decline in sales of R&D-performing companies. R&D intensity declined to 3.2% in 2003 as a result of the 2002 decline in company R&D and strong sales growth in 2003.

Largest R&D Industries

Although all industries benefit from advances in S&T, industries perform different amounts of R&D.[15] Some industries have relatively low R&D intensities (0.5% or less), such as the utilities industry and the finance, insurance, and real estate industries (appendix table 4-22 ). Six groups of industries account for three-quarters of company funded business R&D and 95% of federally funded business R&D (table 4-4 ).

Computer and Electronic Products

The computer and electronic products manufacturing sector accounts for the largest amount of business R&D performed in the United States (table 4-4 ). Industries in this sector include companies that manufacture computers, computer peripherals, communications equipment, and similar electronic products, and companies that manufacture components for such products. The design and use of integrated circuits and the application of highly specialized miniaturization technologies are common elements in the production processes of the computer and electronic products sector.

In 2003, these industries performed at least $42.5 billion of R&D, or 21% of all business R&D.[17] Companies and other nonfederal sources funded almost all of this R&D. The focus of the R&D in this sector is on development, with less than 16% of company-funded R&D devoted to basic and applied research. Two of the more R&D-intensive industries—communications equipment and semiconductor manufacturing—are included in this group. Both devoted more than 11% of sales to R&D in 2003.

Chemicals

The chemicals industry performed an estimated $32.5 billion of R&D in 2003. Like the computer and electronic products industries, very little of the R&D in the chemicals industry is federally funded. In terms of R&D performance, the largest industry within the chemicals subsector is pharmaceuticals and medicines. In 2003, pharmaceutical companies performed $25.4 billion of company-funded R&D, representing 79% of nonfederal R&D funding of the chemicals sector.

The Pharmaceutical Research and Manufacturers of America (PhRMA), an industry association that represents the government. In NSF's Survey of Industrial Research and Development, companies that predominantly license their the country's leading research-based pharmaceutical and biotechnology companies, annually surveys its members for information on their R&D investments. In 2003, PhRMA members reported investing $27.1 billion domestically in R&D, of which 38% was for basic and applied research (PhRMA 2005).[18] Most of PhRMA members' domestic R&D investment supports continuing R&D on projects that originated in their own laboratories (73% in 2003), but 20% supports R&D on products licensed from other companies (notably biotechnology companies), universities, or technology rather than manufacture finished products are often classified in the scientific R&D services industry. Therefore, a sizeable amount of biotechnology R&D that serves the pharmaceutical industry is reported in the R&D services sector (see section "R&D Services").

Computer-Related Services

Industries associated with software and computer-related services (such as data processing and systems design) performed approximately $26.1 billion of company-funded R&D in 2003.[19] The R&D of these industries combined with that of the computer and electronic products manufacturers discussed earlier account for over one-third of all company-funded R&D in 2003. As computing and information technology became more integrated with every sector of the economy, the demand for services associated with these technologies boomed. The R&D of companies providing these services also grew dramatically during this period. In 1987, when an upper bound estimate of software and other computer-related services R&D first became available, companies classified in the industry group "computer programming, data processing, other computer-related, engineering, architectural, and surveying services" performed $2.4 billion of company-funded R&D, or 3.8% of all company-funded industrial R&D. In 2003 the company-funded R&D of a comparable group of industries (excluding engineering and architectural services) accounted for 14.3% of all company-funded industrial R&D (table 4-5 ).[20] Although the R&D activities of computer-related services companies have grown dramatically, this group is not the sole performer of software development R&D in the United States. In fact, companies in almost every industry report expenditures for software development R&D.

Aerospace and Defense Manufacturing

Although it is common to refer to the "defense industry," there is no such category in the industry classification system used by the federal government. Companies performing the majority of DOD's extramural R&D are classified in the aerospace products and parts industry; other transportation equipment industries; and the navigational, measuring, electro-medical, and control instruments manufacturing industry. In 2003 these industries reported performing $14.3 billion of federal R&D, accounting for 69% of all federal R&D expenditures reported by companies (table 4-4 ). Almost half of the $15.7 billion of R&D performed by companies classified in the aerospace industry in 2003 came from federal sources. (See the section on federal R&D later in this chapter for further discussion of defense R&D.)

R&D Services

Companies in the business of selling scientific and engineering R&D services to other companies or licensing the results of their R&D are generally classified in the architectural, engineering, and related services industry or the scientific R&D services industry. Companies in this sector perform the majority of the federal R&D that is not performed by aerospace and defense manufacturing firms, $3.8 billion in 2003. Despite the significant amount of government-sponsored R&D performed by this sector, R&D services companies increasingly rely on nonfederal sources of R&D financing. The R&D performed by companies in the R&D services sector and funded by company and other nonfederal sources has grown from $5.8 billion in 1997 to $13.8 billion in 2003, an increase of 138%.[21] By comparison, the company-funded R&D of all other industries increased by 33% over the same period. Because much of the R&D reported by these companies also appears in their reported sales figures, the R&D intensity of the R&D services sector is particularly high (13% in 2003).

Although the companies in this sector and their R&D activities are classified as nonmanufacturing, many of the industries they serve are manufacturing industries. For example, many biotechnology companies in the R&D services sector license their technology to companies in the pharmaceutical manufacturing industry. If a research firm was a subsidiary of a manufacturing company rather than an independent contractor, its R&D would be classified as R&D in a manufacturing industry. Consequently, growth in R&D services may, in part, "reflect a more general pattern of industry's increasing reliance on outsourcing and contract R&D" (Jankowski 2001). (For more information, see the section entitled "Contract R&D Expenses.")

Automotive Manufacturing

The sixth largest business sector in terms of R&D is automotive manufacturing. Companies in this industry reported performing $16.9 billion of company-funded R&D in 2003, accounting for 9% of all such R&D performed by businesses in the United States. At one time, this industry played a larger role in U.S. business R&D, accounting for as much as 16.2% of all company-funded and -performed R&D in 1959.

In 2003, 13 companies in the automotive manufacturing industry reported R&D expenditures over $100 million, representing approximately 85% of the industry's R&D. In most industries large companies perform more R&D than small companies, but in the automotive manufacturing industry the distribution of R&D is even more skewed towards large companies, with the R&D activities of the "Big Three" auto manufacturers (General Motors, Ford, and DaimlerChrysler) dominating the sector. In their annual reports to shareholders, these companies reported combined total engineering, research, and development expenses of $15.8 billion in FY 2003 (see sidebars "R&D Expenses of Public Corporations" and "Trends in R&D for Industrial Research Institute Members").[22]

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Industry Classification Complicates Analysis

Each company sampled in the Survey of Industrial Research and Development is assigned to a single industry based on payroll data for the company, [16] and each is requested to report its R&D expenditures for the entire company. These expenditures are assigned to the previously established single industry. This classification scheme reasonably categorizes most companies into industries closely aligned with their primary business activities. However, for diversified companies that perform R&D in support of a variety of industries, any single assigned industry is only partly correct. And in some cases, the industry assigned based on payroll data is not directly related to a company's R&D activities.

Given this classification scheme, interpretation of industry-level R&D data is not always straightforward. It is important to assess the relationships between industries as well as the business structure within industries when analyzing R&D data. For example, most of the federally funded R&D reported in the navigational, measuring, electro-medical, and control instruments industry is performed by large defense contractors that also produce aerospace products. And investigations of survey microdata revealed that most of the R&D classified into the trade industry represents the activities of manufacturing firms that have integrated their supply chains and brought their warehousing, sales, and marketing efforts in house. For example, a large pharmaceutical firm could be classified in the trade industry if the payroll associated with its sales and marketing efforts outweighed that of its manufacturing activities. Therefore any analysis of the pharmaceutical industry's R&D should involve a concurrent analysis of the R&D reported in the drugs and druggists' sundries wholesalers industry. The same holds true for the computer and electronic products industries and their representative trade industry, professional and commercial equipment and supplies wholesalers. Wherever possible, this report aggregates industry-level data in a way that accounts for these classification issues.

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R&D Expenses of Public Corporations

Most firms that make significant investments in R&D track their R&D expenses separately in their accounting records and financial statements. The annual reports of public corporations often include data on these R&D expenses. In 2003 the 20 public corporations with the largest reported worldwide R&D expenses spent $103.8 billion on R&D. Microsoft topped the list with $7.8 billion in R&D expenses, followed by Ford Motor Company with $7.5 billion (table 4-6 ). Companies in the information and communications technologies (ICT) sector dominate this list, with nine representatives accounting for 44% of the total R&D expenses. The remaining 11 companies include 6 automobile manufacturers and 5 pharmaceutical manufacturers. The top 20 companies are headquartered in six different countries, with nine headquartered in the United States. However, the location of a company's headquarters is not necessarily the location of all its R&D activities. Most of the companies on this list have manufacturing and research facilities in multiple countries around the world. (For more information, see the section entitled "R&D Investments by Multinational Corporations.")

A recent change in accounting standards by the Financial Accounting Standards Board (FASB) will result in discontinuities in companies' reported R&D expenses, making it more difficult to evaluate R&D spending trends from publicly available financial data. By 2006 most large companies are expected to follow the guidelines of FASB's Statement of Financial Accounting Standards (SFAS) 123, Accounting for Stock-Based Compensation, which requires companies to expense the fair value of all stock-based compensation.[23] Many high-technology companies have historically compensated their R&D employees with stock options and stock awards. This stock-based compensation may not have been reported as company expenses prior to these new guidelines. The dramatic increase in Microsoft's R&D expenses from 2002 to 2003, resulting in its move from number 10 to number 1 on the list of global R&D companies, was the result of Microsoft's early implementation of SFAS 123 in July 2003.[24] Prior to that date, the value of stock options awarded to employees was not included in the reported expenses of the company. Accounting for the value of this compensation resulted in Microsoft restating its 2002 R&D expenses up by $1.9 billion. The company does not detail how much stock-based compensation contributes to its 2003 R&D expenses. Microsoft's R&D in table 4-6 is likely exaggerated relative to other companies because it was an early adopter of SFAS 123. (See sidebar "Trends in R&D for Industrial Research Institute Members" for information on how some U.S.-based corporations intended to adjust their R&D strategies in 2005.)

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Trends in R&D for Industrial Research Institute Members

For over 20 years the Industrial Research Institute (IRI), a nonprofit association of more than 200 leading R&D-performing industrial companies, has surveyed its U.S.-based members on their intentions for the coming year with respect to R&D expenditures, focus of R&D, R&D personnel, and other items. Because IRI member companies carry out a large amount of industrial R&D in the United States, the results from these surveys help identify broad trends in corporate R&D strategies. The most recent survey, administered in late 2004, suggests that many companies are shifting the focus of their R&D spending from directed basic research and support of existing business to new business projects (IRI 2005). This reported shift in R&D priorities also is reflected in how responding companies intend to spend their R&D budgets. IRI survey respondents reported the following plans for 2005:

Increase total company expenditures on R&D
Increase hiring of new graduates
Increase outsourcing of R&D to other companies
Increase outsourcing for university R&D and federal laboratories
Increase participation in alliances and joint R&D ventures

Overall, these strategic moves are consistent with responses suggesting increased R&D budgets following a period of relative austerity. Responding companies are increasing R&D spending to support existing lines of business as well as new business projects and are leveraging their R&D spending through joint R&D ventures and grants/contracts for university R&D. (For more information, see "Technology Linkages: Contract R&D, Public-Private Partnerships, and Industrial Alliances.")

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Footnotes

[14] A similar measure of R&D intensity is the ratio of R&D to value added (sales minus the cost of materials). Value added is often used in studies of productivity because it allows analysts to focus on the economic output attributable to the specific industrial sector in question by subtracting materials produced in other sectors. For a discussion of the connection between R&D intensity and technological progress, see, for example, R. Nelson, Modeling the connections in the cross section between technical progress and R&D intensity, RAND Journal of Economics 19(3) (Autumn 1988):478–85.

[15] Industry-level estimates are complicated by the fact that each company's R&D is reported in only one industry. (See sidebar, "Industry Classification Complicates Analysis.")

[16] Details on how companies are assigned industry codes in the NSF Survey of Industrial Research and Development can be found on the NSF website (http://www.nsf.gov/statistics/nsf02312/sectb.htm#frame). NSF, Division of Science Resources Statistics, Survey of Industrial Research and Development, 2003. Available at http://www.nsf.gov/ sbe/srs/indus/start.htm.

[17] Lower bound analyst estimates will be given in cases where disclosure of company-reported data or classification issues prevents the publication of total estimates from survey data.

[18] Methodological differences between the PhRMA Annual Membership Survey and the NSF Survey of Industrial Research and Development make it difficult to directly compare estimates from the two surveys. For example, the PhRMA survey definition of R&D includes Phase IV clinical trials whereas the NSF survey definition does not.

[19] Although disclosure of federal R&D funding prohibited the precise tabulation of total R&D performance for this industry, total R&D was at least $27.4 billion in 2003.

[20] The introduction of a more refined industry classification scheme in 1999 allowed more detailed reporting in nonmanufacturing industries. For the cited 2003 statistic, the R&D of companies in software, other information, and computer systems design and related services industries were combined. These three industries provided the closest approximation to the broader category cited for earlier years without exceeding the coverage of the broader category.

[21] NAICS-based R&D estimates are only available back to 1997. Estimates for 1997 and 1998 were bridged from a different industry classification scheme. Total R&D for this sector has grown from $9.2 billion in 1997 to $17.6 billion in 2003.

[22] Company annual reports accessed 25 March 2005 at http://www.sec.gov/edgar.shtml. Because R&D expenses reported on financial documents differ from the data reported on the NSF Survey of Industrial Research and Development, direct comparisons of these sources are not possible. See C. Shepherd and S. Payson, U.S. R&D Corporate R&D (Washington, DC: National Science Foundation, 2001) for an explanation of the differences between the two.

[23] FASB, SFAS 123 (Dec. 2004) (http://www.fasb.org/pdf/fas123r.pdf).

[24] Microsoft Corporation, 2004 Microsoft Annual Report, Note 13.