Investigating the technology-based innovation gap for the United Kingdom Finbarr Livesey Dr Tim Minshall Dr James Moultrie

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Investigating the technology-based innovation gap for the United Kingdom Finbarr Livesey Dr Tim Minshall Dr James Moultrie Report to the Design Council June 2006

Investigating the technology-based innovation gap for the United KIngdom Copyright Institute for Manufacturing June 2006. All rights reserved. First published in Great Britain by the University of Cambridge Institute for Manufacturing, Mill Lane, Cambridge CB2 1RX. ISBN: 1-902546-49-0 No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means without the prior permission in writing of the publisher, nor be otherwise circulated in any form of binding or cover other than that in which it is published and without a similar condition including this condition being imposed on the subsequent purchaser.

Executive summary This report investigates the gap in technology-based innovation performance and policy between the UK and other leading nations. Assuming the importance of innovation for improvements in productivity and hence economic growth, the report gathers the available evidence on innovation performance in the UK and asks where improvements could be made in the UK s policy framework to improve innovation outcomes. Increasing challenges from developed and emerging economies The UK s position as a leading nation, in terms of innovation and overall economic performance, is under threat. The United States is taking a strongly pro-active approach to renewing their policy framework to support innovation, with numerous bills recently introduced in the US Congress. At the same time, China has doubled its national investment in R&D between 1997 and 2002. Strong science, weak commercialisation The common perception of the UK as a country with a strong science base but lacking in translation of that strength into innovative products and companies appears to be borne out. The UK leads in publications and citations per capita and has very high overall numbers of science graduates. However, it has had one of the lowest levels of turnover from new product introduction, scoring 29 against a European average of 100 according to the 2001 Third Community Innovation Survey (CIS). Comparing the 2001 and 2005 versions of the CIS survey, the number of companies introducing new goods or services has risen from 18% to 29%. However, for these product innovators the percentage of their turnover from new to market products has dropped from 8% to 6.8%. Imbalance in the translation of science into products A novel ratio, of the number of US patents granted to worldwide science and engineering academic papers, highlights the problem for the UK. This ratio provides an estimate of the balance between academic output and patenting. It appears that the US and Japan have approximately one patent granted for every two papers published, compared to one patent for every ten papers for the UK. Current policy is focused on R&D investment and the environment for innovation As the UK lags in investment in R&D there is a strong focus on raising the levels of public and private spending on R&D. Over the past twenty years the UK has fallen behind the US and Japan, having spent a similar amount on R&D in the early 1980s. Currently the UK spends 1.9% of GDP on R&D which is approximately the EU average. However, the United States is investing just over 2.6% of its GDP in R&D, with Japan even higher at 3.2%. 1

At the same time, the government is attempting to provide the best environment for innovation and technology development. The UK government has recently made a number of significant and positive changes to its innovation policy and R&D investment. The DTI s Innovation Review developed an action plan across government to improve the innovation performance of the country. The Science and Innovation Investment Framework 2004 2014 outlines plans to increase science spending in real terms by over 5% a year. These programmes and changes need to be given time to have an impact. A broader vision of innovation in government As there is a weakness in commercialisation for UK companies, the government may need to extend its vision so that it spans from R&D through to product commercialisation. Traditional approaches to policy, where government acts further from the market, may not be appropriate given the current performance of UK companies. Government action can provide the leadership required to improve commercialisation outcomes. The need for systemic monitoring and review Other countries, such as the US, are attempting to take a systemic and periodic approach to innovation policy development. The UK may need to have a more established process for monitoring innovation outcomes in a systemic manner and for updating the policy framework in place to enable companies to improve their innovation performance. This would imply improving the available statistics on innovation and the coordination between the numerous government programmes in place to improve the innovation performance of companies and the country. 2

Table of contents Executive summary 1 Introduction 4 Is there an innovation gap for the UK? 7 Funding technology development 25 Where could we improve performance? 35 What support is already in place? 37 Opportunities for change 46 Conclusions 49 Appendix - Examples of international policies 50 Appendix - Note on other forms of intellectual property 55 Acknowledgements 58 References 59

Introduction It is time that we in Britain, so good at fundamental science, also came fully to appreciate the intellectual challenge behind product development. We seem culturally unable to realise that this can be more challenging than fundamental science and requires the very best minds. Lord Broers, Reith Lectures 2005 Innovation, through its impact on productivity is an important component of economic growth. 1 As the Chancellor indicated in his Pre-Budget report in December 2005 the UK s economic success will depend on its ability to create new knowledge and translate it into innovative goods and services. 2 However, there is growing concern that the UK is underperforming in terms of innovation and more specifically is not taking advantage of its strong science base. The traditional view is that the UK invents but does not innovate well. If this is true the UK is at risk of providing the skills and knowledge for other countries to grow while not taking advantage of its own investments. This report reviews the available evidence on innovation performance for the UK and provides evidence on the existence of a growing innovation gap between the UK and other nations. It also reviews policies in the UK to see if there is a need for modifications and new policies targeted at improving outcomes in science and technology exploitation to improve the long term growth potential of the UK. A history of invention The UK has long been viewed as an inventive nation and has been a source of new technologies since the beginning of the industrial revolution. 3 The image of the lone inventor is strong in the history of the UK, with men such as Brunel, Telford and Stephenson held up as examples. However, current examples of leading technology innovators are hard to find. James Dyson is probably the most visible and that in itself points to a problem we appear to have so few recognisable innovators that the same role models are overused in the public eye. The challenge for the UK In 2000, the Council for Science and Technology commented that: The UK s under performance in creating wealth from its world class science base has been the subject of concern, inquiry and study since the country lost its industrial and technological leadership towards the end of the 19 th century. 4 The advantages that we had in the past are being challenged by rapid global economic changes. Emerging economies such as China have significant production capability, as well as emerging capabilities in research and development, and design. The potential impact of these changes is highlighted in recent economic projections from Goldman Sachs for the so In this report we use the term innovation to mean the successful exploitation of an idea in the marketplace, and more specifically a technology based product. This provides a distinction to invention, which is a promising idea which has not yet been introduced to the market. These distinctions are taken from Branscomb, L. and Auerswald, P., (2002) Between Invention and Innovation, National Institute of Standards and Technology.

called BRICs economies Brazil, Russia, India and China. 5 In these projections to 2050 the UK drops to seventh in the world in terms of the size of the economy. This is not just a concern of the United Kingdom. The United States is currently having what some refer to as a Sputnik moment, as evidenced by the recent report from the National Academies of Sciences titled Rising Above the Gathering Storm. The report contends that leaders have expressed concern that pressures on the science and technology enterprise could seriously erode past success and jeopardise future US prosperity. 6 A further signal that the United States is concerned about its leadership in innovation and technology is the introduction of a bill in the Senate that proposes a complete overhaul of innovation policy and a significant increase in funding. 7 As lower cost economies become more capable of carrying out high quality research and development, the UK will have to aggressively pursue its strategy of moving up the value chain to compete on unique products and services. 8 We will need to compete at all stages of development and exploitation if we wish to retain our position as a leading economy at the forefront of technology developments. Innovation, productivity and growth The UK government s understanding of the importance of innovation is based on its impact on productivity. A policy framework based on five drivers of productivity (investment in physical capital, skills, innovation, competition, enterprise) was developed by the Treasury in 2000, which states that: Innovation and technological progress are important factors in determining economic growth. Productivity growth relies on a continual stream of inventions and innovations of both new technologies and improved working practices. 9 This focus on innovation was clearly expressed in the Department of Trade and Industry s review of innovation in 2003 which noted that: In the past, many UK-based businesses have prospered even when selling in low value markets, but today British industry faces a new challenge: how to raise its rate of innovation? 10 The UK response increased investment in the science base These concerns over the long term competitiveness of the UK have emerged at a time when there is significant governmental focus on science and innovation. The government published three white papers leading up to the 2003 Innovation Review which laid out the government s understanding of the innovation challenge, current policies across government and an action plan for the UK. The vision is for the UK to become a key knowledge hub with a reputation not only for outstanding scientific and technological discovery, but also to be a world leader in turning that knowledge into new and exciting products and services. 11 The government s Science and Innovation Framework 2004 2014 sees our science base as the bedrock of our economic future. 12 The core goal of the Framework is to raise the percentage of GDP spent on R&D to 2.5% by 2014. This would be a significant rise in spending from both government and UK based firms. This target avoids the question of whether we are achieving sufficient returns from the current investment in the science base. If we have the best science in the world but we cannot translate that science into commercial goods and services our potential for growth may be severely limited.

Focus of this report In this paper we are not investigating the link between innovation and overall economic performance. We are taking as a given the importance of innovation, and specifically technology commercialisation, to the national economy and asking whether the UK is performing well compared to other countries in terms of innovation. The core questions that this report addresses are: Does the UK have an invention-innovation gap with comparable nations such as the United States and Japan, specifically for technology development? What policy gaps exist in the UK with regard to innovation and in particular technology commercialisation? What changes can we recommend to improve innovation outcomes for the UK? The flow of the report is shown in figure 1. Is there an innovation gap for the UK? Funding technology development Where could we improve performance? What support is already in place? Opportunities for change Figure 1 Flow of the report 6

Is there an innovation gap for the UK? Innovation is a highly dynamic process that depends on many factors, ranging from the skills of scientists through to the quality of public institutions and the networks that exist between companies. However, measuring innovation is difficult. No single innovation indicator gives a comprehensive picture of performance so it is important to look across a range of indicators. 13 Our approach is based on the concept of a national innovation system. We have simplified and broken the system into the enabling environment, inputs, outputs and outcomes. Then, instead of having to depend on one innovation indicator, we have multiple indicators grouped according to whether they are inputs to the system, outputs from the system or outcomes of the system, as illustrated in figure 2. Enabling conditions Economic Stability Legal & regulatory framework Infrastructure (road, rail etc) Vision & leadership INPUTS Investment in R&D Finance Graduates in SET OUTPUTS Papers published Patents granted Patent/Paper ratio OUTCOMES Growth of the technology sector New products to market Spin outs from universities Start-ups created Figure 2 Simplified national innovation system The enabling environment includes the legal structures, institutions and natural endowments of the country. Inputs are factors such as investment in research and development (R&D) and the skills of those involved in technology development. Outputs are the results of the investment of financial and human capital and range from scientific papers published through patents to trademarks granted. Finally, outcomes include growth of the technology sector, new products introduced in the market and new companies started. 14

When looking for an innovation gap we should consider three levels: The overall performance of the innovation system. Differences in isolated indicators (e.g. investment in R&D). The level of transfer from inputs to outputs, and outputs to outcomes. Different stakeholders will view different parts of the system as being more or less important. Academic researchers will be concerned with publication rates, whereas companies will focus on whether they are getting viable products to market. The question for the country is whether we are achieving strong economic growth with viable companies being started and valuable technologies being exploited by UK companies. In this way, we see that the discussion of the innovation gap leads immediately to a discussion on technology commercialisation are we achieving sufficient returns from our investments in technology, from research and development through to technology commercialisation? In the analysis that follows we have used the United States, Japan, France and Germany as the comparison group of nations. These countries were chosen as they are key competitors to the UK and they are also the countries for which data is most readily available. Where there are other countries with significant activity for an indicator, they are included in the analysis. International comparisons of overall innovation performance A number of reports have attempted to provide aggregate scores for national innovation performance. These reports tend to collect indicators into an average or weighted score for innovation, in an effort to provide a sense of overall performance. The Council on Competitiveness in the United States released a report in 1999 which developed a national index for innovative capacity. 15 The approach taken was to measure the ability of a country to produce a stream of commercially relevant innovations. The index included measures such as the number of people engaged in R&D, investment in R&D, and the strength of intellectual property protection. To make country comparisons, the index was scaled for population and calculated for 17 OECD countries from 1973 to 1995. 180 160 140 120 100 80 60 40 20 0 1980 1985 1990 1995 France Germany Japan United Kingdom United States Figure 3 Innovative capacity index (selected years)

According to this index, over the past twenty years the UK has consistently under performed against all other large economies, other than Italy. Also, while some high performing nations have converged, the UK remains well below the level of the US and Japan up to 1995. The graph in figure 3 shows the results for the UK and the main comparator nations and we can see that the gap in innovative capacity has remained essentially stable or widened to all of these countries between 1980 and 1995. The European Commission s TrendChart series released a 2005 survey of innovation performance in the UK along with a summary innovation index for all EU members, Japan and the US. 16 The UK review comments that the UK innovation system is broadly performing well. However, it goes on to note that the two important indicators are lagging business investment in R&D and the share of employment in manufacturing in high-tech sectors. The weakness in these indicators possibly indicates a difficulty in generating a high value adding manufacturing sector based on new technology within the UK. The overall measure of innovation performance in the TrendChart series is the Summary Innovation Index (SII). 17 This is an average of 26 scaled indicators of innovation performance ranging from the number of science and engineering graduates to the number of new patents per capita. As this is a relative measure, the year to year numbers are difficult to compare, but it appears that in the past three years France has caught up, and Germany, the US and Japan remain ahead of the UK, as shown in figure 4. 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 2003 2004 2005 France Germany Japan United Kingdom United States Figure 4 Comparison of the rescaled Summary Innovation Index with UK=1 The OECD s Economic Survey of the UK 2005 states that innovation performance [for the UK] is mediocre in comparison to the best performing OECD countries. 18 This is based on the level of R&D spending across the economy, the number of researchers in employment and triadic patents held in the country. It also contends that the [UK] science base is among the strongest in the world based on percentage of scientific publications and citations. In a separate cross-country comparative report released by the OECD earlier in 2005 this contrast was emphasised again. 19 It highlights a long term decline in [the UK s] relative innovation performance contrasted to a relatively successful science base.

The broad agreement across these sources on the weakness of the innovation performance of the UK is striking. The above aggregate data indicates a persistent problem with the UK s innovative capacity in the past twenty plus years. This supports and strengthens the DTI s analysis, produced in support of the Innovation Review in 2003, which states that UK innovation performance is around average or below average of other advanced economies. 20 Comparisons of inputs The key inputs into the innovation system are finance and skills. The following section provides a summary of the available statistics on public and private funding of innovation, as well as discussing the development of skills in the UK. A more detailed discussion of funding for technology development is given in a later section. Investment in R&D in the UK is low compared to other countries A common indicator used to compare countries and their commitment to innovation is spending on R&D expressed as a percentage of gross domestic product (GDP). This allows us to have meaningful comparisons between countries of different sizes in terms of their basic commitment to research and development. The UK is currently far behind its key comparators and competitors with current R&D as a percentage of GDP at approximately 1.9%. 21 This is in comparison to Sweden (~4%), the US (~2.6%) and Japan (~3.2%). Figure 5 shows the percentage of GDP spent on R&D in total for the UK compared to key nations (with the UK rescaled to one). 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 1999 2000 2001 2002 2003 France Germany Japan United Kingdom United States Figure 5 Comparison of R&D investment as a percentage of GDP (UK=1) The level of R&D spending in a country is a combination of public and private spending. The figures below show the percentage of GDP spent in both categories for the UK and the main comparator nations. 10

0.95 0.9 0.85 0.8 0.75 0.7 0.65 0.6 0.55 0.5 1999 2000 2001 2002 France Germany Japan United Kingdom United States Figure 6 Public spending on R&D as a percentage of GDP 3 2.5 2 1.5 1 0.5 1999 2000 2001 2002 2003 France Germany Japan United Kingdom United States Figure 7 Private spending on R&D as a percentage of GDP 11

In both the public and private sectors the UK has a lower level of investment in R&D. In fact, the UK has had a consistently lower level of spending on R&D than many of its competitors over the past ten years. This is a relative decline as the UK was similarly situated to Japan and the US in percentage terms at the beginning of the 1980s. In 1981, the UK s total spending on R&D as a proportion of its gross domestic product was higher than that of any other member of the G7, with the exception of Germany. 22 The gap in R&D intensity between the UK and other countries could arise because of differences in industrial structure, for example if the UK has more industries that on average do less R&D. Recent work by the Institute of Fiscal Studies suggests that the majority of the gap to Germany and France is due to lower intensity in particular sectors. 23 The UK has a higher R&D intensity in pharmaceuticals and services, but a lower intensity in motor vehicles. Private investment in R&D is very concentrated in the UK As well as having a lower level of R&D investment there is concern that the UK has a narrow R&D base. Figures from the 2005 R&D Scoreboard indicate that pharmaceuticals and aerospace and defence account for over half of the R&D spend of the top 750 UK companies, and the top 25 companies account for two-thirds of R&D investment. 24 Direct comparisons to other countries are difficult, but the latest Science and Engineering Indicators from the United States indicates that in 2003 just under half (48%) of business R&D is concentrated in three sectors computers and electronic products (21%), computer related services (14%) and chemicals, which includes pharmaceuticals (13%). 25 The Lisbon target for R&D investment will be challenging The UK government has set a target for national R&D spending to be 2.5% of GDP by 2014. 26 This is a response to the Lisbon agenda, which has set a target for the European area to spend 3% of GDP on R&D by 2010. 27 These targets will be difficult to achieve, especially in the case of the UK as the increase in R&D spending will have to come mainly from the private sector. The UK leads Europe in private equity but the US has a significant lead in venture capital The availability of money to support technology development is a key issue for all companies. A more detailed picture of funding for technology development is given later in this report, but some key indicators are included at this stage to complete the picture on innovation performance. According to the PricewaterhouseCoopers European Technology Investment Report for 2005, the UK had the largest amount of private equity, largest number of deals and the largest amount of venture capital in Europe for 2004. 28 Just under 2.7 billion was invested in private equity, through 1,124 deals, with a little over a billion pounds invested as venture capital. However, technology investment accounted for 16% of private equity investment, compared to 88% in Ireland, 30% in Germany, and 26% in France. For the purposes of this report, we use the definition of private equity as provided by the British Venture Capital Association (BVCA). Private equity is medium to long-term finance provided in return for an equity stake in potentially high growth unquoted companies. From BVCA report A guide to private equity, October 2004. We use the term venture capital to describe that component of private equity that is targeted at early stage and expanding companies. 12

While the UK leads Europe in terms of venture capital the bulk of this money, more than 60%, is targeted at later stage investment activities and this move away from early stage has been a noticeable trend in recent years. 29 This contrasts strongly with the US venture capital industry, where not only is the total available capital (unsurprisingly) much greater, but the proportion of this targeted at early stage / market entry is much higher. For comparison, venture capital investments in all industry sectors totalled US$20.9 billion in 2004 [ ]. 30 The US and European numbers are not directly comparable, as the different surveys include slightly different elements, but a rough comparison of the US and UK venture capital investment level indicates an order of magnitude difference. A key UK strength is the number of science and engineering graduates The UK has a very strong education system, with a large number of science and engineering (S&E) graduates produced each year. In terms of the number of new graduates in S&E per 1000 people aged 20-29, the UK is comparable to France and well ahead of other countries (figure 8). 31 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 1999 2000 2001 2002 2003 France Germany Japan United Kingdom United States Figure 8 S&E graduates comparison (UK=1) However, there is a lingering concern that there is an imbalance in the disciplines that students are studying. The Roberts Review in 2002 investigated the supply of science and engineering graduates in the UK, driven by a concern that a lack of supply would constrain future innovation. 32 The report found that while the UK had a relatively large, and growing, number of students studying for scientific and technical qualifications this growth [was] primarily due to increases in the numbers studying IT and the biological sciences. 13

Technology based degrees are increasing at first degree level According to a recent DTI report: The annual number of first degrees obtained in SET subjects grew by 43% between 1994/95 and 2003/04, compared to just 11% for no-set degrees. 33 Broadly, the number of first degree holders with a science, engineering and technology (SET) qualification has increased from 1.3 million in 1997 to 2.1 million in 2004. Figure 9 shows the change in the number of students graduating with first degrees in selected subjects, including the biological sciences, physical sciences and engineering, between 1998 and 2005. 34 In this period, numbers of first and higher degrees has increased in all areas except first degrees in physical sciences and engineering and technology. 250 225 200 175 1998 = 100 150 125 100 75 50 25 0 Medicine & dentistry Subjects allied to medicine Biological sciences Physical sciences Mathematical sciences Computer science Engineering & technology Change in first degrees Change in higher degrees Figure 9 Change in selected subject degrees granted in the UK 1998-2005 According to the DTI report between 1994 and 2004 while there is a strong increase in first degrees in computer science, subjects allied to medicine and biological sciences, there has been approximately a 10% drop in engineering and technology, physical sciences and architecture. Taking a narrower set of science and technology based degrees into consideration (for example excluding medicine) the percentage of all degrees that are awarded which are technology based appears to be increasing at the first degree level while it is decreasing at the postgraduate level. Here we have taken degrees in biological, physical, mathematical and computer sciences, and engineering and technology as those with a technology basis. This excludes medical degrees, subjects allied to medicine, veterinary science and agriculture, as well as architecture. 14

28% 26% 24% 22% 20% 18% 16% 14% 12% 10% 2001 2002 2003 2004 Techology based first degrees as percentage of total Technology based postgraduate degrees as percentage of total Figure 10 Percentage of all degrees with a technology base Whether these graduates then go on to careers in technology based industries is another question. Taking data from the Higher Education Statistics Agency (HESA) on first destinations for students and aggregating those that go into explicit technology related areas, we can see approximately one-fifth of technology based students go into technology based industries. 25% 20% 2004 2003 15% 10% 5% 0% Percentage technology postgraduate degrees transitioning to technology based job Percentage of technology postgraduate degrees transitioning to education Percentage technology first degrees transitioning to technology based job Percentage of technology first degrees transitioning to education Figure 11 Degree leavers transition into technology related industries and education 2003 2004 Whether this level of skills provision and transition into technology-based employment is sufficient to support the innovation targets of the UK is unclear. The DTI report models employment levels in SET occupational groups. This indicates that supply is on course to meet demand but the ambition to raise R&D expenditure is likely to generate an even larger requirement for SET graduates Here we have taken the Standard Industrial Classifications (SIC) for the job of the leaver and included Manufacturing, computer activities and research and development activities. This means we have excluded construction, mining, and agriculture amongst others. 15

Output performance of the UK Moving on from the inputs to the innovation system, we can look at the immediate outputs of the system. Scientific output in the UK is very high The case for a strong science base in the UK is predicated on our strong publication record. The volume of scientific articles produced in the UK is second only to the United States, and the same is true for citations of those papers (figure 12). 35 6 5 4 3 2 1 0 Publications 1993-1997 Publications 1997-2001 Citations 1993-1997 Citations 1997-2001 France Germany Japan United Kingdom United States Figure 12 Comparison of volume of papers and citations (UK=1) 1.2 1 0.8 0.6 0.4 0.2 0 Publications 1993-1997 Publications 1997-2001 Citations 1993-1997 Citations 1997-2001 France Germany Japan United Kingdom United States Figure 13 Comparison of papers and citations per capita (UK=1) 16

When population (for 2005) is taken into account and we look at papers per capita the order of countries changes, with the UK moving ahead of the United States (figure 13). The UK s apparent strength is not shared by the rest of Europe. An expert report for the TrendChart series noted that when adjusted for population the lead in total papers that the EU has over the US disappears, with the US having 4.64 publications per capita while the EU has 3.60. 36 A significant gap exists in terms of patenting for the UK Providing commentary on patenting across countries is very complex, as companies can file within their own country, at the European level, or in multiple other countries. Data for patenting in the United States is seen as a good proxy, as most companies looking for a large market will file in the US. Taking the latest data available (2004) from the US Patent Office for patents granted the UK is ranked fourth behind the United States, Japan, and Germany. 37 It should be noted that there were 3,450 UK originated patents compared to 84,271 of US origin, and 10,779 for Germany. Looking at patents granted per million population the gap lessens, but the US and Japan still have almost six times as many patents as the UK. 38 350 300 250 200 150 100 50 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 France Germany Japan United Kingdom United States Figure 14 US patents granted per million population 17

A relatively new measure of patenting activity around the world is triadic patents. These are patents which have been applied for at the Japanese and European patent offices and granted by the US Patent Office to protect the same invention. The high cost of filing for patents from three separate patent offices makes triadic patent families a more accurate measure of important inventions than simple patent counts, because generally only highly valuable inventions justify the costs. 39 Figure 15 shows the number of triadic patents per million of population in 2001, the most recently available data. 40 In that year it appears that Germany and Japan have over twice the number of triadic patents per capita of the United Kingdom. 160 140 120 100 80 60 40 20 0 United Kingdom France United States Germany Japan Figure 15 Number of triadic patents per million population, 2001 Again there is a distinct gap between the UK and the leading nations although compared to US patents granted the US and Germany have swapped places. The ratio of patents to papers in the UK is very low Even though innovation is not a linear process, the ratio of patents to scientific publications may give an indication of how well scientific output is being translated into marketable technologies. However, it is a rough indicator as it cannot show whether those patents have resulted in products. We have not seen this indicator in publication before, and so we believe that this is a novel way to look at the linkage between different parts of the innovation system. Using data on worldwide papers published and US patents granted from the National Science Foundation s Science and Engineering Indicators, it appears that the UK has a very low level of patents to papers. 41 Interpreting such an indicator is difficult, as some countries will produce more patents than papers. Does this mean that these countries are exploiting the science base of other countries in order to grow? 18

In simple terms, it appears that the US and Japan have approximately one patent granted for every two papers published, while the UK has only one patent granted for every ten papers published. 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 France Germany Japan United Kingdom United States Figure 16 Ratio of US patents granted to worldwide S&E papers 1 Taiwan 0.665 11 Austria 0.130 2 Japan 0.579 12 France 0.129 3 United States 0.436 13 Belgium 0.120 4 South Korea 0.321 14 Singapore 0.114 5 Germany 0.258 15 Netherlands 0.106 6 Switzerland 0.175 16 Denmark 0.096 7 Sweden 0.169 17 Ireland 0.086 8 Canada 0.159 18 United Kingdom 0.083 9 Israel 0.150 19 Norway 0.081 10 Finland 0.144 20 Italy 0.077 Figure 17 Top 20 countries patent to paper ratio for 2001 These ratio figures need to be interpreted with care, as the UK has a large volume of papers compared to most other countries. However, if we are publishing many papers and not taking advantage of them we are missing an opportunity to exploit the outputs of the high quality UK science base. 19

Outcomes for companies and countries Our core concern is whether companies and countries are achieving strong outcomes for innovation, and more specifically in terms of technology commercialisation. We will see those outcomes in how much of the economy is based on high-technology, whether investors are seeing a strong return in investing in technology, and if companies are managing to bring new products to market. High-technology is less and less of the UK economy Defining and measuring the contribution of high-technology based companies to the economy is difficult as what counts as high-technology is constantly changing. The OECD defines specific sectors, for example pharmaceuticals, to be high-technology and in that way we can calculate how much of the economy is based on high-technology. 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1995 1996 1997 1998 1999 2000 2001 2002 2003 France Germany Japan United Kingdom United States Figure 18 Percentage of gross value added attributed to high-technology sectors 1995-2003 42 Japan is an obvious leader on this measure, with the US second and the UK, Germany and France relatively close together. What is more concerning is the decline in the UK for the share of GVA based on high-technology, dropping from just over 3% to approximately 2.2% in nine years. The OECD definitions of high, medium and low technology sectors are based on an analysis of standard industrial classification codes for R&D expenditure and output across 12 OECD countries. Under ISIC Rev. 3 high technology includes aircraft and spacecraft (353), pharmaceuticals (2423), office, accounting and computing machinery (30), radio, TV and communications equipment (32), and medical, precision and optical instruments (33). See Annex A of (2005) OECD Science, Technology and Industry Scoreboard 2005, OECD. 20

Technology and early stage investments do not look attractive Earlier we noted that the UK leads Europe in terms of the availability of private equity, and more specifically venture capital. However, much of that investment is not directed towards technology, with only 16% of private equity financing technology in 2004. If attention is focused upon the performance of early-stage and technology sectors, the returns of investments in these sectors illustrate why UK investors are moving up market (figure 19) 20 15 10 5 0-5 Early Stage Development Mid-MBO Large MBO Generalist Total UK Non-UK Pan-European Technology Non-Technology Figure 19 UK all-funds performance (percentage terms) since inception to December 2004 43 It should be noted that this data is only given up to 2004, and the inclusion of new data may present a slightly less negative picture. However, data comparing returns from UK and US early stage investments over a 3, 5 and 10 year period do show the that UK funds have performed worse than their US counterparts. 44 Spin-offs are relatively cheap, patents and licence income are not How well are universities managing to start companies from their research? While this is not the only route for new technology-based companies to be founded, there has been much focus on university spin-outs in the past two to three years. Comparisons with other countries are difficult, as reliable data is not available beyond the United States and the United Kingdom. According to the HEFCE Higher Education Business and Community Interaction Survey 2005 there were 197 new spin-outs in the UK in 2002-2003 compared to a total number of start-ups in the UK of 325,900. 45 Looking at the value of these spin-outs in 2005: In the past two years alone, 20 spin-outs from UK universities have floated with a value of over 1 billion. 46 By contrast, at the end of December 2005 the FTSE 100 market cap was 1,414 billion, the FTSE 250 cap was 234 billion, and the FTSE small cap was 55 billion. The most recent comparison of the United States and UK spin-out performance also comes from the HEFCE survey. The survey contrasts the responses of 156 US universities to 165 UK universities. 21

Number of institutions Research expenditure industrial ( 000s) Research expenditure public ( 000s) Total research expenditure ( 000s) New patents granted Licences IP income from licensing, other and spin-off sales ( 000s) Spin-off companies formed Research expenditure ( million) per patent Research expenditure per of licence income Research expenditure ( million) per spin-off US universities AUTM survey 156 1,599,540 13,436,675 21,081,281 3,109 3,739 643,166 364 6.78 32.78 57.92 UK HEIs HE-BCI 165 201,770 2,220,742 3,418,501 371 758 37,079 197 9.21 92.20 17.35 Figure 20 Comparison of UK and US university exploitation costs from the HEFCE Interaction Survey 2005 In this sample, there were 364 spin-offs in the US and 197 in the UK. However, from this data it appears that the US spin-outs have a higher cost of initial research funding. By contrast, approximately 1.5 times as much research expenditure per patent and three times more research expenditure for each pound of licence income is required in the UK. Direct comparison of spin-out performance (in particular, survival) is difficult as the data gathered by the main UK (HEFCE) and North American (AUTM) surveys are not directly comparable. AUTM has aggregate data on spin-out formation and survival rate going back to 1980. HEFCE is partially provided only back to 1995 but without overall survival rates As noted by the first HEFCE survey, attempts to compare UK and US [..] should however be treated with some caution, as there may be differences in the way in which the definitions have been applied, and we do not know the relative success of these companies in the market. 47 UK companies turnover from new products is very low Possibly the most worrying indicator for the UK is the turnover generated by the introduction of new products by companies that are new to themselves and new to the market true innovations. Data from the 2001 version of the Community Innovation Survey (CIS) indicates that while the UK scores average to above average on most indicators, on sales of new to market products (as a percentage of all turnover) the UK scores 29 against a European normalised average of 100. 48 If this is an accurate measure of the success of new product introduction for UK firms, this is a significantly worrying indicator for long term growth. Comparing results from the previous version of the survey (CIS2), we see that UK companies report a lower level of new product introduction than four years previously. 49 The rate of novel product innovation has fallen from 13% to 8% of firms. At the same time the level of unsuccessful innovation has risen from 27% to 37%. 22

The results of the fourth Community Innovation Survey are to be released in mid 2006 and it is hoped that the UK s lacklustre performance in this area will have improved. The first findings have been published and they point to a general improvement in innovation activity. 50 Between 2001 and 2005 the level of product innovators (introducing new or significantly improved goods or services) rose from 18% to 29%. The level of process innovation is relatively unchanged (rising from 15% to 19%). However, for product innovators the percentage of their turnover from new to market products has fallen from 8% to 6.8%.** Again this points to an overall weakness in new product introduction and exploitation. Summary of innovation performance Figure 21 brings together the indicators from the previous sections and shows the most recent data available for France, Germany, Japan, and the US compared to the UK. Indicator France Germany Japan USA Overall measures SII (Trend Chart 2005) 0.96 1.21 1.35 1.25 Innovative Capacity (CoC 1995) 1.93 2.90 3.31 4.02 Inputs Gross Domestic R&D as a % of GDP (2003) 1.16 1.34 1.68 1.38 Investment in venture capital as % GDP (2000-2003) 0.54 0.46 0.12 1.74 Number of new S&E graduates per 1000 people (2003) 1.06 0.40 0.63 0.52 Outputs Volume of science and engineering papers (1997 2001) 0.68 0.93 0.98 3.70 Science and engineering papers per capita (1997 2001) 0.67 0.68 0.47 0.75 US utility patents granted per million population (2004) 0.97 2.26 4.80 4.97 Triadic patents per million population (2001) 1.13 2.41 2.42 1.36 Ratio of US patents to science and engineering papers (2001) 1.31 2.71 6.54 5.35 Outcomes Sales of new to market products as % of turnover (2000) 3.41 3.65 High-tech industry as a % of GVA (2001) 0.92 0.83 1.21 0.95 Figure 21 Comparing the UK s innovation performance to other countries Data for Japan is for 1998-2001 ** It should be noted that the 2005 survey sectoral coverage was wider than that used in 2001. Additions included sale, maintenance and repair of motor vehicles, retail trade, hotels and restaurants. 23

Each indicator has been scaled so that the UK equals one. In each case this means a score of greater than one means the UK is lagging that country in that indicator, and a score of less than one means the UK is ahead. To have a qualitative sense of the UK s performance, the scores are colour coded. If a country scores less than 0.9 we have highlighted that green as a strong lead for the UK and if a country scores more than 1.1 we have highlighted that red as a gap for the UK. 24

Funding technology development As stated at the start of this report, one key factor underpinning the ability of firms to successfully commercialise new inventions is the availability of funding. For start-up firms, who may have no retained profits to draw upon for development work, the availability of funding from external sources is essential. In this section we review the main sources of funding available to firms at various stages of technology development and discuss some of the challenges presented by the current situation. Who provides the funding? Funding for technology development is available from a range of sources and is targeted at different stages of the route to market as shown schematically in figure 22. 51 This chart shows the sources of funding at each of the stages of commercial development of an idea, the later discussion will show how there are weaknesses in some of these areas. Concept Prototyping Initial commercialisation Growth Grants Equity Grants/competitions Personal, family, friends Business angels Venture capital IPO Debt Bank loan Revenue Consultancy income Advance Sales Figure 22 Simplified mapping of sources of funding for stages of growth of a technology-based start-up Grants The DTI is the major public provider of direct grants to innovation-based businesses. Figure 23 summarises the main grant schemes currently available in the UK, and gives an indication of the total budget allocated to these schemes. A major recent organisational change has been shifting of responsibility for Grants for R&D from central to regional administration in April 2005. 25

Main title Managed Broad purpose Target Amount per by companies company Grants for R&D DTI/RDAs Aim to investigate the technical Businesses with < 75k (Research) and commercial feasibility of fewer than 50 innovative technology. employees Grants for R&D Projects than involve a Any business < 500k (Exceptional) significant technological advance and are strategically important for a particular technology or industry sector. Grants for R&D Aim to develop a pre-production Businesses with < 200k (Development) prototype of new product or fewer than 200 process that involves a employees significant technological advance. Grants for R&D Simple, low cost development Businesses with < 20k (Micro) projects lasting no longer than fewer than 10 12 months. employees. Knowledge DTI A grant to cover part of the cost All businesses Not specified Transfer of using a person to transfer and needing expert Partnerships embed knowledge into a help to business from the UK innovate. knowledge base via a strategic project. Knowledge A grant to an intermediary to All businesses Not specified Transfer set up a network in a priority wanting to Networks technology area, bringing grow by together businesses, exploiting universities and others with technology an interest in technology applications. Collaborative Funding for collaborative All UK-based Not specified R&D research and development business wishing projects between businesses, to exploit universities and other potential technology collaborators. The level of grant support will vary from between 25% and 75% of R&D costs. Figure 23 Direct funding for innovation in the UK 52 While many commentators regard this provision as being well targeted and appropriate, and the small number of reviews of these schemes (discussed later) do show positive impacts, three issues can be highlighted: There is a concern that this money is being allocated in amounts too small and fragmented to really move inventions close to commercial take-off, or even getting them to a point where follow-on funding from other sources would be obtainable. 53 26

Grant for R&D (micro) 50% <10 20K % costs covered Maximum grant Grant for R&D (research) 60% <50 Max no. employees 75K Grant for R&D (development) 35% <200 200K Grant for R&D (exceptional) 35% Any 500K Figure 24 Grants, their limits and eligibility criteria The move to regional administration of some of these programmes may lead to a proportional lack of grant funding for innovation-rich regions. These grants may not be targeted at the right activities to support the improvement in UK firms abilities to get products to market. Concern has been noted that many of these are focused too much on technical, rather than product and market development (though State Aid rules clearly pay a part in this). Equity Provision of equity funding can be split into private (business angel and venture capital) and public sources. Each of these will be described in the following sections. Business angels It is recognised that business angels can play a key role in the early stage funding of technology start-up. 54 Having experienced entrepreneurs investing not only their money but also leveraging their experience for the benefit of new firms is highly desirable. Due to the nature of the way they operate, accurate data on business angels is hard to access. However, research indicates that between 500 million and 1 billion is invested by angels each year in the UK and it is estimated that 75% of these investments is below 100k. 55 Successive Governments have sought to promote business angel investment. Since the 1980s, promotion activities have included tax breaks for individual investments in growth businesses (through the Enterprise Investment Scheme (EIS)) and, more recently, relief for investment in collective venture capital schemes through Venture Capital Trusts (VCTs). 56 27