R&D 100

In 2000, when he and his colleagues at Celera Genomics, in Rockville, Md., finished sequencing the human genome, J. Craig Venter announced the advent of the “century of biology.” But IEEE Spectrum’s fourth annual R&D survey shows that the biotech century has had a slower than expected start among the world’s top 100 R&D spenders.

While the 100 companies, taken as a whole, increased their R&D spending by a healthy 7.6 percent in 2004, to US $254 billion, the pharmaceuticals and biotechnology sector actually cut back by 1.1 percent, to $51.7 billion [see box, "Sector Trends"], mirroring a sales drop of 1.6 percent. What’s more, in the five years since Venter’s grandiose prediction, the pharma-biotech sector’s share of the Top 100 has been stuck at 20 percent. Its only relative gain came in the top 25 spots, where the sector took seven places, up from four in 2000. That’s just behind the automobiles and components sector, which had eight in the top 25.

You would expect the life sciences sector to have a high R&D profile [PDF]. First, drugmakers and biomedical companies are busily creating products for a rapidly growing market spurred on by an aging population. Second, they spend billions to attract still more customers—you can’t watch TV for half an hour without seeing two or three drug commercials, with branding ads touting research prowess side by side with those aimed at erectile dysfunction. Third, the merger fever that has gripped Big Pharma over the last few years—Pfizer’s acquisitions of Pharmacia and Warner Lambert, Astra’s merger with Zeneca, and most recently Sanofi-Synthelabo’s hostile takeover of Aventis—has reduced overhead, presumably leaving more money for R&D.

On top of that, from 1998 to 2003, the U.S. government more than doubled the National Institutes of Health’s annual R&D budget, from $13.1 billion to $26.4 billion. Meanwhile, NASA’s R&D budget grew from $9.7 billion to just $10.7 billion, barely keeping pace with inflation. According to numbers compiled by the National Science Foundation, the U.S. government spent nearly 25 percent of its total R&D investment on health, compared with 18 percent by the United Kingdom; 16 percent by Canada; 12 percent by Italy; 7 percent each by Germany, France, and South Korea; and just 6 percent by Japan.

Why hasn’t all this government largesse motivated the private sector to spend more of its own money on life sciences R&D? After all, government spending on R&D isn’t supposed to replace that of the private sector but to complement it—by fostering an increase in general scientific understanding, honing the skills of graduate students, and correcting for market failures that would result in underinvestment.

It could come down to a question of timing. On average, it takes more than a decade to bring a drug to market from the discovery phase, and the NIH puts money into basic research, not commercialization. Given that the NIH funding increases began almost eight years ago, it stands to reason that pharmaceutical and biotechnology firms should be increasing R&D spending to exploit new discoveries and technologies generated by NIH-funded projects. And with the exception of 2004, these firms have increased spending, albeit at a more moderate pace than you might expect.

Over the past five years, R&D spending for the pharmaceuticals and biotechnology sector of the R&D 100 grew 24 percent, which was a bit higher than the overall growth on the list and more than twice the growth of its sales, which rose 11 percent. This trend increased the sector’s R&D intensity—R&D spending divided by sales—the ratio that analysts use to compare companies’ R&D investments.

Pharmaceuticals and biotechnology ranks as the second most research-intensive industry, just behind software and services. This should not be surprising given that R&D spending is the primary way firms differentiate themselves, the high degree to which the businesses depend on blockbuster drugs, and the fact that the market determines companies’ values according to the drugs that are in the research pipeline. High research risks have also led to greater consolidation in the industry, with pharmaceutical companies merging to diversify their portfolios of drugs in development and to reduce the risks inherent in research and development.

The five years of R&D Top 100 data from the fiscal years 2000 to 2004 show that the top 100 leaders increased their R&D spending by 21 percent—from $210 billion in 2000 to $254 billion in 2004. R&D intensity in 2004 decreased slightly for the group as a whole, from 6.4 percent to 6.1 percent, as sales jumped by 12.3 percent. But that rosy picture certainly doesn’t hold for every industry. Each sector has a different story to tell [see box, "Sector Trends"].

While R&D spending has increased steadily in the pharmaceutical and biotech sector, the trend has been much more volatile in the technology hardware and equipment sector, which includes computer, semiconductor, and telecommunications equipment firms. Its research funding hit bottom in 2003, then rose 8.1 percent in 2004, to nearly $65 billion. Yet that above-average gain couldn’t make up ground lost following the dot-com and telecom busts, which is why technology hardware and equipment is the only major sector to lose ground since 2000, with a 9 percent drop in R&D spending over the five-year span.

That drop is all the more remarkable for having come at a time of a recovery in sales, which are now back to 2000 levels. The technology sector, which boasted 11 firms in the top 25 in 2000, had only 6 in 2004. As a result, its share of the Top 100 spending fell from 34 percent in 2000 to 25 percent in 2004. Its R&D intensity dropped 9 percent from 2000 to 2004.

The composition of the R&D leaders within the sector has also changed markedly. The top four spenders in 2000 were all telecommunications companies: Ericsson, Lucent, Motorola, and Nortel together accounted for nearly $20 billion. By 2004, these four had chopped spending to just $9 billion. Canadian-based Nortel Networks Corp. and U.S.-based Lucent Technologies Inc. each spent more than $5 billion in 2000. Four years later, Nortel spent just below $2 billion, and Lucent was all the way down to $1.3 billion. Lucent, parent company of the once-venerable Bell Labs, continued its free fall from No. 6 in the overall 100 to No. 71, after cutting R&D spending five years in a row.

In 2004, Sweden’s Telefonaktiebolaget LM Ericsson slashed R&D by 23 percent, or $873 million, and the U.S. firm Motorola Inc. cut back by nearly 19 percent, or $711 million. Finnish rival Nokia Corp. nearly held R&D spending stable, slipping less than 1 percent. In fact, the only telecom firm to make it into the sector’s top four was Nokia, a company in the middle of the pack in 2000.

The sector’s semiconductor firms, led by South Korea’s Samsung Electronics Co. and Switzerland’s STMicroelectronics NV, increased spending. The single exception was Motorola spin-off Freescale Semiconductor Inc., which reduced spending by about 4 percent. Samsung went on a spree in 2004, increasing R&D spending by nearly 36 percent, or more than $1 billion, to leap to No. 16 on this year’s list. The company’s R&D spending has now topped $4.5 billion, just behind industry leader Intel, at $4.8 billion.

The automobiles and components sector captured the top three spots and four of the top five and took the second-largest share of the Top 100, at 24 percent. Its R&D spending for the past five years kept pace with sales, up 48 percent over the same period.

The rise of Toyota Motor Corp. has been the sector’s major story. The Japanese carmaker rose from No. 11 in 2000, when the company spent $4.3 billion, to No. 3 in 2004, when it spent $7 billion. In 2004, Toyota increased its spending by 10.7 percent and General Motors Corp. raised its spending by 14 percent, but the sector as a whole continues to have a below-average R&D intensity at 4.4 percent, virtually unchanged from 2000. Ford Motor Co., the 2004 R&D 100’s No. 1 spender, backed into the top spot by decreasing spending by 1.3 percent.

Automakers face an uncertain near-term outlook because of pressures from an increasing cost structure and the need to achieve shorter product life cycles to meet rapidly changing consumer preferences. Rising production costs are being driven by higher commodity prices and higher borrowing costs. For example, Ford and General Motors both had their bond ratings downgraded to below investment grade earlier this year. The pressure to cut costs could lower R&D spending, but the urge to radically slash R&D budgets may be tempered by the need to invest in new model designs to maintain market shares.

Like the auto industry, capital goods also had relatively low R&D intensity, just 4.5 percent, up from 4.3 percent in 2000. Its mix of companies—from aerospace giants European Aeronautic Defense and Space Co. (EADS) in the Netherlands and Boeing Co. in the United States to conglomerates like Siemens and 3M Co.—raised spending a robust 16.1 percent over 2003, almost twice as much as the increase in sales growth. Caterpillar, the earth-moving machinery and agricultural equipment maker, moved up to No. 90, after being out in some recent years. It increased R&D spending by nearly 39 percent. On the downside, Mitsubishi Electric Corp. cut spending by a whopping 24 percent, or $401 million, as sales dropped by more than $3 billion.

Capital goods sales leader General Electric Co. increased R&D spending by 16.2 percent, but it remains at the bottom of its sector for R&D intensity at just 1.6 percent. In fact, GE’s R&D intensity is at the bottom for the Top 100 overall along with Nestle SA and Deutsche Telekom. Such a low R&D intensity, though, isn’t as shocking as it first appears. R&D intensity can vary widely among a firm’s divisions, especially in conglomerates like GE. For example, GE is in business lines like entertainment and financing that have little or no R&D spending, but it also builds aircraft engines, a business in which it makes significant R&D investments.

R&D growth for capital goods over the past five years has been a better than average 41 percent, nine points higher than sales growth. As a result, the sector increased its share of the Top 100 from 9 percent to 10 percent.

Also increasing its share of the Top 100 is the consumer durables and apparel sector. Most of this sector’s firms in the Top 100 are consumer electronics or film companies; no apparel firms made the list. The sector as a whole increased its spending by 11.4 percent in the past year. Four firms increased R&D spending—Kodak, Matsushita, Sanyo, and Sharp—while three—Fuji, Philips, and Sony—decreased it. Over the five-year period, 2000 to 2004, the sector’s R&D spending grew by a better than average 33 percent, in line with sales growth.

But even robust sales growth does not necessarily translate into more R&D funding. The materials sector, which includes chemical companies like BASF, Bayer, and DuPont, decreased its year-over-year R&D spending in 2004 despite sales growth of 29 percent. In this sector, every single firm’s ranking in the Top 100 slipped at least one place in 2004. Some of this slippage was due to drops in spending, like Bayer Group’s 12.7 percent cut, but in other cases spending increases, including those for BASF AG, did not keep up with those of other firms. Over the five-year period, the sector’s R&D intensity dropped from 5.6 percent to just 4.4 percent.

On the other end of the spectrum, the software and services sector had the highest R&D intensity, 14.7 percent. The sector had only three firms in the Top 100—Microsoft, Oracle, and SAP—all packaged-software firms. Microsoft dominates the sector, accounting for 69 percent of its R&D, up from 59 percent five years ago. However, Microsoft dropped to No. 7 on the overall leaderboard after capturing the top spot for the first time in 2003.

Microsoft’s R&D spending decreased 20.5 percent in 2004 despite an increase in R&D employees. According to its U.S. Securities and Exchange Commission filings, the decrease was “due to lower stock-based compensation expense.” As we discussed in detail last year, in 2003 the company began offering its employees stock-based compensation in lieu of options. This affected its R&D accounting significantly, because almost half of Microsoft’s employees work on R&D.

Unlike software and services, telecom services’ R&D has not kept up with sales growth. The sector has just three firms in the Top 100—Deutsche Telekom, Nippon Telegraph & Telephone, and DoCoMo. R&D spending dropped year over year for the sector in 2004. Although spending fared better from 2000 to 2004, growing 16 percent, it didn’t keep up with sales growth of more than 50 percent. As a result, the sector has the lowest R&D intensity, at 2.1 percent. Also worth noting is that, with the exception of Deutsche Telekom, no U.S. or European local telephone service providers, long-distance carriers, or cellular firms rank in the Top 100.