By Barry Jaruzelski
Nearly all large companies are now conducting elements of research and development work outside their home country. To compete in global markets, companies need to choose the innovation model that best suits their business strategy, build their innovation capabilities, and deploy their R&D assets and personnel in regions that will best support world-class innovation and design. Asia has become the world’s number-one region for corporate R&D activity, surpassing both Europe and North America.
Establishing a global research and development model has become a basic requirement for large corporations that want to be competitive in today’s marketplace. An overwhelming 94% of the world’s top R&D spenders currently conduct elements of their R&D programs abroad, according to Strategy&’s 2015 Global Innovation 1000 study.1
Multinational companies are shifting their innovation investment to countries in which their sales and manufacturing are growing fastest, and where they can access the right talent. Companies based in fast-growing emerging markets are building their innovation capabilities to preserve their market shares and to compete with multinationals – both in their home markets and, increasingly, as they expand their businesses in other countries.
To compete effectively worldwide, companies must first determine the innovation model that is best aligned to their overall business strategy, build their innovation capabilities, and then implement their model around a global network. Competing with multinationals is particularly important for Asian companies, which are based in the largest and fastest growing region for innovation activity. Over the last seven years, Asia has become the number one location for corporate R&D, surpassing both Europe and North America, chiefly because of European and US firms setting up R&D centers in Asia to better serve local needs.
Building a world-class innovation model and strategy, and implementing it globally, comes with a unique set of complexities. Survey respondents to our study cited a variety of challenges in conducting R&D outside their home countries, with “finding and retaining top talent” and “protecting intellectual property” most often cited. Other challenges included quality and customer focus, risk and project management, and cultural differences. The good news is that leading innovators are creating specific innovation models that work, and are finding ways to manage these and other complexities on a global scale.
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The Three Innovation Models
Company leaders must first clearly articulate, as part of their overall business strategy, the role that innovation plays in the company’s mission. How central is innovation to the company’s competitive advantage? Strategy& has identified three fundamental innovation models, each with its own distinct way of managing the R&D process and its relationship to customers and markets:
- Need Seekers, whose strategy is to identify the needs and desires of end users by engaging them directly, strive to be the first to market with breakthrough products meeting previously unarticulated needs
- Market Readers, who tend to watch their customers and competitors closely, create value by incremental change and capitalising on market trends, using a second-mover strategy to minimise risk
- Technology Drivers, who leverage their R&D to propel both breakthrough innovation and incremental change, develop original solutions by applying new technology.
The percentage of companies following the Need Seeker model is much higher among Chinese companies than the global average – a characteristic they share with Silicon Valley firms.2
The centrality of innovation in the company’s competitive advantage should inform the organisation’s global footprint. In the absence of a holistic vision, R&D sites can proliferate as a result of one-off decisions and acquisitions, and lead to a loss of focus. Companies also need to consider the specific requirements of each phase of the innovation life cycle. For example, in the idea-generation phase, companies may benefit from setting up smaller, more agile teams where the top talent is located. For product development, larger centres can take advantage of scale and lean principles.
In building out their core R&D strategy, emerging markets companies (EMCs) face a special challenge.3 They are typically first movers in their home markets, and in many cases have won impressive market share and achieved phenomenal growth rates. But globally they are actually latecomers, and most will find themselves playing catch-up with more experienced and better-resourced multinationals in global industries that are often already mature. In a recent survey, however, two-thirds of multinational executives said there was already a Chinese firm in their industry that was as innovative as their own firm.
The most successful EMCs – companies like Mexico’s CEMEX, China International Marine Container (CIMC), Haier, Samsung, and Wanxiang Group – have followed a deliberate, stepwise, cumulative plan for building their innovation programs. They move from basic capabilities that enable production to more sophisticated ones that can support world-class innovation and design. Innovation and globalisation are tightly linked at Chinese firms.4 As EMCs transition from one phase of the capabilities-building process to the next, they must choose among the alternative means of acquiring the capabilities they need: external contracting, internal development, acquisitions, or partnerships
Managing a Dispersed Network
Companies need to define the geographic markets and the customers within those markets that are central to the company’s growth strategy, and then determine where R&D resources need to reside so the company can best understand and serve those markets. Companies following each of the three basic innovation models will need distinct approaches. For Need Seekers, for example, the key consideration may be locating R&D facilities as close to end customers as possible, whereas Market Readers, as second movers, may have more flexibility to base location decisions on cost. Technology Drivers may want to create R&D centres of excellence in global locations where expertise in a specific field is concentrated, or near large potential markets with different demand characteristics.
To ensure operational excellence, leaders must create clear missions, roles, and lines of authority to align the dispersed R&D sites with the company’s innovation strategy. Here, leadership needs to invest in the digital tools and related processes that have enabled the best companies to manage such areas as resource deployment, project collaboration, portfolio management, and operating transparency across a global network.
Companies have to create a global talent management strategy. Increasingly, the people with the skills that companies need are going to be found outside the Western countries where management may have typically relied on in the past. Companies need common standards for talent development and retention that can be applied at each of their global centres, and they must foster a corporate culture aligned with the company’s innovation strategy and that encourages collaboration among centres worldwide.
The Global Footprint Premium
Wherever companies are headquartered, one truth remains constant across all geographies and industries: companies that overweight their R&D spending outside their headquarters country continue to outperform their less globalised competitors. Companies that deployed 60% or more of R&D spending abroad in 2015 earned a premium of 30% on operating margin and return on assets, and 20% on growth in operating income, over their more domestically focused competitors. This finding was similar to the results of our 2008 study, suggesting that there continues to be a payoff from the deployment of capabilities on a global scale, and greater success from understanding and meeting local market needs.
Additionally, over the past decade companies have become more proficient at managing global innovation networks. In our 2008 study, for example, we found that companies with highly focused footprints (those with the smallest number of global R&D sites, relative to sales) tended to outperform companies with more fragmented global R&D operations consisting of numerous smaller sites. Evidently they found it easier to manage teams in person than via conference or video calls and collaboration tools. In this year’s study, companies with dispersed global R&D operations were performing as well as or better than companies with focused footprints. This suggests that multinationals have become more experienced at coordinating projects across global sites, and that the digital collaboration tools have improved markedly and companies have become more adept at employing them. These changes afford multinationals the best of both worlds: the ability to locate their R&D facilities close to their markets and the ability to access the best talent at optimal cost levels, all without compromising efficiency.
Asia Becomes the R&D Leader
The most dramatic change in global flows of innovation spending in the 21st century has been Asia’s rise as the number one location for conducting corporate R&D. In 2015, our study found that Asia accounted for 35% of the global total for the 207 largest spenders in the subset we used for regional comparisons, surpassing both North America (33%) and Europe (28%).5 This is the total of “in-region” R&D spending, including both spending by local companies and “imported” R&D spending – done by firms headquartered outside the region. In 2007, in contrast, Europe had been the leader, followed closely by North America.
In 2007, the majority of R&D spending in Asia, North America, and Europe all came from domestic firms (in each region). In 2015, Asia became the only one of the three to see the balance shift. 52% of its R&D spending was imported. Between 2007 and 2015, R&D spending in China increased by 120%, to $55 billion, making it the second-largest location for corporate R&D, passing Japan and Germany ($50 billion and $32 billion, respectively). Although the US retains its top position with $145 billion, its lead is narrowing: In 2007, R&D in China was 23% of the US total. In 2015, it amounted to 38% of the US total.
In 2015, there were 123 Chinese companies among the Global Innovation 1000, up from 114 in 2014. Total global spending by these companies in 2015 was $39.4 billion, up 31.6% from 2014 – compared to growth of 3.6% growth by other Asian companies, and 5.1% by the Global innovation 1000. The largest industry by the number of companies among Chinese innovators was industrials (41%), followed by computing and electronics (16%) and software and Internet (15%). PetroChina Co. maintained its position as the top Chinese R&D spender. However, a new entrant, Alibaba Group Holding Ltd., made its appearance in the number 2 spot.
Our survey respondents cited proximity to a high-growth market as the top reason for moving R&D to China (71%), followed by proximity to key manufacturing sites (59%), proximity to key suppliers (54%), and lower development costs (53%). Siemens, based in Germany, has referred to China as “the workbench of the world”, and stated that the company had made a conscious decision that it needs to be close to this promising market with its product definition, product design, and engineering.
Chinese firms are now also exporting R&D spending. Although China’s total R&D exports in 2015 were a modest $2.0 billion, several leading Chinese companies have become global brands – and are extending their global R&D operations. Consumer electronics and home appliance company Haier, for example, established an R&D centre in Japan after its acquisition of Sanyo’s appliance business from Panasonic in 2011. It has since opened R&D hubs in Germany and the US, as its business has grown in Europe and North America.
As companies further develop and optimise their global innovation networks, they will continue to tap into more diverse global talent pools, a wider knowledge base, and deeper insights into growing markets. With the right implementation, the globalisation of R&D will benefit the search for breakthrough innovations, and enable companies to make bigger-bet portfolio choices than they have in the past.
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About the Author
Barry Jaruzelski is a thought leader on innovation for Strategy&, PwC’s strategy consulting business. Based in Florham Park, N.J., he is a principal with PwC US. He works with high-tech and industrial clients on corporate and product strategy and the transformation of core innovation processes. He created the Global Innovation 1000 study in 2005, and in 2013 was named one of the “Top 25 Consultants” by Consulting magazine.
References
1. “2015 Global Innovation 1000 study: Innovation’s New World Order,” (strategy+business, Winter, 2015) http://www.strategy-business.com/feature/00370
2. “2014 China Innovation Survey: China’s Innovation Is Going Global,” (Strategy&, 2014) http://www.strategyand.pwc.com/media/file/Strategyand_2014-China-Innovation-Survey.pdf
3. “How Emerging Markets Companies Can Avoid Growth Traps,” strategy+business December, 2015) http://www.strategy-business.com/blog/How-Emerging-Markets-Companies-Can-Avoid-Growth-Traps
4. “Emerging Best Practices of Chinese Globalizers: Develop the Innovation Models,” (World Economic Forum, in collaboration with Strategy&, March, 2015) http://www3.weforum.org/docs/WEF_Chinese%20Globalizers_2015_EN.pdf
5. “2015 Global Innovation study: China Press Release,” (Strategy, 2015) http://www.strategyand.pwc.com/cn/home/press/press-releases/displays/
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