Presentation at the International Symposion on “R&D Outsourcing and Smartsourcing”

1. Presentation at the International Symposion on “R&D Outsourcing and Smartsourcing” Bucharest, Romania 20 February 2008 R&D Offshoring and Outsourcing: Nurturing Sustainable R&D Capabilities in a Globalized World Prof. Dr. Alexander Gerybadze Center for International Management and Innovation Center for Research on Innovation and Services (FZID) University of Hohenheim

2. R&D Offshoring and R&D Outsourcing: Nurturing Sustainable R&D Capabilities in a Globalized World The Agenda / Key Issues Global Innovation / Trends in R&D Offshoring R&D Outsourcing / New Partnership Models in Innovation Strategic Implications for R&D and Innovation Policy

3. Major Trends in the Global Innovation Arena • R&D and Innovation is Key for International Competitiveness • Multinational Corporations are the Drivers of Technical Change • Trend to Globalize R&D: Persistent R&D Offshoring • Trend to Externalize R&D: R&D Outsourcing / Open Innovation • Trend to Commercialize R&D • Trend towards Downstream Innovation

4. Type of Value-adding Activities Do In-house at the Home-base of a Multinational Firm Do sth. at a Foreign location (Foreign direct Investment) Contract out to suppliers and / or External partners OFFSHORING Increasing trend of globali- zation of all value-adding acti- vities including R&D OUTSOURCING Increasing tendency to „harvest-out“ / Focus on few core activities in-house First of all, Offshoring and Outsourcing need to be differenciated

5. Canada Mexico* China Rest EU 25 Korea Taiwan France UK Austria Nether-lands** USA Switzerland* Japan** Germany Singapore North America 339 Mrd. $ Western Europe 224 Mrd. $ Asia 283 Mrd. $ World R&D Expenditures strongly concentrated on a few Countries Within the Triad regions / Gross Expenditures for R&D (GERD) 2005 • World R&D Expenditures / GERD 2005 Total 845 Billion $ PPP • By Comparison: 27 Billion $ PPP in Eastern Europe (of which 64% in Russia) * Data for 2003; ** Data for 2004. Source: OECD, Main Science and Technology Indicators 2006.

6. Increasing Global Dispersion of Innovation Activities / R&D Globalization and R&D Offshoring outside of Home Region Share of R&D Outside of Home Region (in %) 40% Europe 30% North Amerika 20% 10% Japan 1992 1995 1998 2001 Source: Gerybadze 2004, p.246; Roberts 2001 / Global Benchmark Survey on the Strategic Management of Technology

7. Intensity of R&D Offshoring * * * * * * * * * * * * * * * * * * * * * * * * * * Business Expenditures on R&D also concentrated on few Industries which increasingly go Global R&D In- tensity 2006 (%) R&D Expen- ditures 2006 (in Mio €) Industry 1. Pharmaceuticals & Biotech 2. IT-Hardware & Equipment 3. Automobiles & Parts 4. Electronics & Electrical 5. Software & Computer Services 6. Chemicals 7. Aerospace & Defence 8. Consumer / Leisure goods 9. Industrial Engineering 10.General Industrials 70 523 64 532 60 807 27 139 26 523 17 186 15 991 14 209 9 319 8 868 15.9 8.6 4.1 4.4 9.8 3.1 4.8 6.5 2.7 2.1 Very strong R&D Offshoring Strong R&D Offshoring * * * * * Source: EU Industrial R&D Investment Scoreboard 2007, INTERIS Database University of Hohenheim 2007

8. R&D Offshoring and R&D Outsourcing: Nurturing Sustainable R&D Capabilities in a Globalized World Presentation Part 2 Increasing Globalization of R&D: What does this mean for Building R&D Capabilities in Host Countries? R&D Outsourcing / New Partnership Models in Innovation Strategic Implications for R&D and Innovation Policy

9. Lead Market Innovation / Advanced Services Changing Pattern of Knowledge Flow in the Innovation Process Increasing Trend towards Downstream Innovation in many dynamic Industries • Many Host Countries build up Universites and Science base … • … but R&D Location not just driven by need to access Research Research- based Innovation Engineering- Innovation / Advanced Manufacturing Traditional Interpretation / Linear-sequential Innovation Process • Most important „new drivers“ for R&D Offshoring - Access to Advanced Market / Lead Market - Manufacturing Excellence / Engineering Innovation - Strong Innovative Competitors - Standard setting / Innovation enhancing Regulation

10. Most European and Asian MNC set-up Lead-R&D in the U.S. Home-base-Augmenting R&D Lead R&D Center in the U.S. Reverse Knowledge Transfer • R&D Offshoring of MNC in Europe: few selected research areas • R&D Outsourcing: Mainly clinical studies / but often dominated by U.S. based CRO´s • Some R&D in Eastern Europe: Labour-intensive screening and Multi-center Clinical studies Case Example Pharmaceuticals & Biotech: still Research-based, but strongly dominated by the U.S. Home-base-Exploiting R&D FOREIGN BASE (e.g. USA) Transfer of Knowledge to Foreign R&D Labs Where is the most critical concen- tration of talent? Location with most advanced Scientific base? HOME BASE (e.g. Germany) Leading R&D Center in Germany

11. Close Interaction between Product- & Process Development / Embeddedness advanced Supplier-Networks critical Research may generate New Products and Industries / Embeddedness in Research Community critical Interaction with Lead Users / Strong Ties with Demand side Partners & Regulatory agencies • Examples: • Automotive engineering • Mechatronics • Chemical processing • Examples: • Genetic engineering • High-energy physics • Superconductivity • Examples: • Telecommunication • Automotive electronics • Medical products & • services • Very few successes in Research-based Innovation in Europe • Many success stories in Engineering Innovation / Often Medium-tech European Countries often with Strong Capabilities in Downstream Innovation „Rear-Drive“ „Front-Drive“ Where is the Engine in the Innovation Process? RESEARCH-BASED INNOVATIONS / Scientific Excellence ENGINEERING INNOVATION / Advanced Manu- facturing LEAD MARKET INNOVATION / Close Access to Lead Customers

12. Outsourcing Partners Private Companies in Germany Public Research & Universities Foreign Outsour- cing (%) 70.4 43.7 61.0 66.5 58.1 63.0 12.8 7.4 33.4 20.6 23.3 14.4 16.8 48.9 5.6 12.9 18.6 22.6 • Share of Foreign R&D Outsourcing Increasing • Mostly private Companies as Outsourcing Partners • Role of Public Research & Universities often overestimated R&D Outsourcing in Germany / Increasing Global Outsourcing in a few selected Industries • R&D Outsourcing concentrated on a few Industries with very specific requirements External R&D Expenditures ( 2003 in Mio €) R&D Out- sourcing (% of BERD) Industry 1. Automobiles 2. Chemical Industry 3. Electronics / Data Processing 4. Machinery 5. Metall Processing Total / Manufacturing Industries 4 767 1 698 886 300 128 7 940 25.0 21.1 10.4 7.3 13.5 18.6

13. R&D Offshoring and R&D Outsourcing: Nurturing Sustainable R&D Capabilities in a Globalized World Presentation Part 3 Global Innovation / Trends in R&D Offshoring R&D Outsourcing growing in Importance / but contracts go to professional partners / mostly private firms Strategic Implications for R&D and Innovation Policy

14. Learn from Success Stories / Sustainable Strategies in other Countries • Coherent Development Strategies that build on Human Capital, Science and Industrial Innovation • The New „Eastern European Tigers“: Estonia, Slowenia, Czech Republic, Saxony • The „Baltic Tigers“: Finland, Sweden, Denmark • The „Celtic Tigers“: Ireland, Scotland, Wales • The „Alpine Tigers“: Baden-Württemberg, Bavaria, Austria, Switzerland

15. R&D units typically linked to Manufacturing plants • Foreign affiliates still play limited role in stand-alone R&D labs (only 6% of R%D employmant) • R&D services industry received only 0.1% of FDI inflow (80% of this investment from Germany) • CzechInvest actively targets companies with R&D and technologi- cally advanced projects • Encouraging and fostering an Innovation and Technology culture has moved to center stage of Economic development strategy Case Example of a „Eastern European Tiger“ / Innovation and Foreign Direct Investment in the Czech Republic • R&D Expenditures 3.5 Billion $ 2005 (up from 1.3 Billion in 1995) • R&D 1.54 % of GDP (up from 0.95% in 1995) • Strong role of R&D of Foreign affiliates (52% in 2005 / up from 27% in 1995)

16. Build / Nurture Local Firms / Spin-offs • Build Technology Centers • Build Business Support Services • Attract Foreign Firms in areas where the Country offers appropriate Capabilities • Participate in European R&D Support Programmes What can a Country do to build and Leverage Sustainable R&D Capabilities? • Active, long-term and stable investment in Education at all levels • Focus on Academic Excellence in Targeted fields • Increase of R&D as % of GDP (to levels of >2%)

17. Develop Strategic Partnerships with Corporations and Government Agencies in Continental Europe • Even in a Globalized World, Proximity and Cultural Heritage still matters • Build alliances with Firms and Research centers especially in „Alpine Tiger“ states • Baden-Württemberg - Machinery / Manufuture BW - Mechatronics - Automobiles / Automobile components - Materials • Bavaria - Specialty Electronics - Food / Beverages - Data processing / Software • Austria • Switzerland

18. Build on Industries with Downstream Potential / High Value-added in Country plus Innovation - Specialty Machinery - Food Chain / Wine - Supplier Industries • Build Strong Innovation Clusters for particular Industries • Develop growing Business Services / Knowledge-intensive Business Services (KIBS) • Design and Administer EU Structural Fund projects aimed at enhancing Innovation • Strong Investment Promotion Agency as Promoter and Implementor of National Development Programme Setting the Agenda for a dedicated Programme aimed at Fostering Innovation and Economic Growth • Don´t just follow the „High-tech Bandwagon“ / Every government in the World targets IT and Biotech! • Emphasize Country-specific Capabilities / Country-USP

19. OFFSHORING OUTSOURCING Manufacturing „Made in Germany" „Made by BMW" Marketing Sales R&D Administration Offshoring and Outsourcing Strategien for different elements of the Value Chain in Multinational Corporations Differenzierte Formen der Wertschöpfung Etwas In-house durchführen und am Stammsitz des Unternehmens Etwas im Ausland durchführen, aber innerhalb eines MNU Etwas durch ein anderes Unterneh- men durchführen lassen

20. The Innovation Performance of Research-based Innovation and High-tech Industries is rather limited in Germany German Innovation Performance is much higher in areas where the core of value added is in Engineering Innovation / which build on a strong Home-base of Manufacturing and Engineering excellence Research-based Innovation Engineering Innovation Lead Market Innovation FOREIGN BASE Foreign Direct In- vestment in Manufacturing & Advanced Foreign Plants of German Firms Home-base Exploiting R&D Export Strategies Strong Home-base in World-class Manufacturing and Engineering / Functioning Supplierand Engineering Infrastructure HOME BASE First Commercial use often in Germany Advanced R&D In Germany Examples:Automobiles, Process engineering, Special purpose machinery

21. Increasing Trend towards Downstream Innovation Innovation Strategies within Multinational Corporations addressing two Key Issues • Key Issue 1: Where is the Geographical Center / Locus of Innovation • Where can we best learn about the Winning Combination? Research- based Innovation Engineering- Innovation / Advanced Manufacturing Lead Market Innovation / Advanced Services Traditional Interpretation / Linear-sequential Innovation Process Changing Pattern of Knowledge Flow in the Innovation Process • Key Issue 2: Where is the Core of Value Added in the Innovation Process / The Functional Source of most advanced Knowledge? • Where is the Engine in the Innovation Process?

22. Competitive Position Germany Weak Weak Leading Weak Weak Leading Weak Weak Leading Strong Business Expenditures on R&D also concentrated on few Industries which increasingly go Global Competitive Position Japan R&D Ex- penditures 2006 (Mio €) R&D In- tensity 2006 (%) Extent of R&D Globa- lization Industrie * * * * * * * * * * * * * * * * * * * * * * * * * * 1. Pharmaceuticals & Biotech 2. IT-Hardware & Equipment 3. Automobiles & Parts 4. Electronics & Electrical 5. Software & Computer Services 6. Chemicals 7. Aerospace & Defence 8. Consumer / Leisure goods 9. Industrial Engineering 10. General Industrials 70 523 64 532 60 807 27 139 26 523 17 186 15 991 14 209 9 319 8 868 15.9 8.6 4.1 4.4 9.8 3.1 4.8 6.5 2.7 2.1 Weak Strong Leading Strong Weak Average Weak Leading Strong Strong Very strong R&D Offshoring Strong R&D Offshoring * * * * * Source: EU Industrial R&D Investment Scoreboard 2007, INTERIS Database University of Hohenheim 2007

23. Global Innovation: New Modes of Knowledge Production International R&D and Innovation Study (INTERIS) - Sample Firms Europa ABB Bosch Siemens Philips Alcatel Ericsson Nokia Akzo Bayer BASF Aventis Glaxo Wellcome Merck KGaA Novartis Roche St.Gobain ThyssenKrupp Sulzer DaimlerChrysler Renault Volkswagen/Audi EADS USA General Electric Honeywell Agilent Technologies Hewlett-Packard IBM Lucent Technologies Motorola Dow Chemical DuPont Ely Lilly Pfizer Johnson&Johnson Merck Co. Alcoa United Technologies Ford General Motors TRW Boeing Japan Hitachi Mitsubishi Electric Toshiba Matsushita Sharp Sony NEC Kao Toray Eisaj Kyocera Toyota Electronics / Electrical Engineering Consumer Electronics IT / Telekommunication Chemical Industry Pharmaceuticals Materials / Engineering & Maschinery Automotive & Automotive Suppliers Aerospace & Defense

24. Does Excellence in Academic Research attract foreign R&D Units? • Academic Excellence can be key for attracting foreign R&D, but … • … often a necessary / not a sufficient condition • Many countries / regions build up strong research base, but do not attract foreign MNCs • Hypothesis: Foreign MNCs locate where strong local presence of Benchmark Co´s signals academic excellence Academic Excellence in Host country Home-based MNCs in related technical area Foreign MNCs with R&D unit in Host country

25. Global Innovation / R&D Offshoring Major Trends of Innovation: Increasing Global Disperion of Innovation Activities and New Forms of Open Innovation • Globalization of R&D / R&D Offshoring • Increasing Complexity of Innovation processes • Open Innovation / Partnering and Networking • Innovation moving Downstream / Strong role of Lead customers • New types of Standard-setting Competition • New transnational projects combining joint R&D and joint standard-setting Success in Innovation increasingly dependent on Global Presence and on strong Participation in most advanced innovation networks abroad

26. Competitive Position Germany Weak Weak Leading Weak Weak Leading Weak Weak Leading Strong Managing Global Innovation Top 10 Leading Industries / World Industrial R&D Spending Competitive Position Japan R&D Ex- penditures 2006 (Mio €) R&D In- tensity 2006 (%) Extent of R&D Globa- lization Industrie * * * * * * * * * * * * * * * * * * * * * * * * * * 1. Pharmaceuticals & Biotech 2. IT-Hardware & Equipment 3. Automobiles & Parts 4. Electronics & Electrical 5. Software & Computer Services 6. Chemicals 7. Aerospace & Defence 8. Consumer / Leisure goods 9. Industrial Engineering 10. General Industrials 70 523 64 532 60 807 27 139 26 523 17 186 15 991 14 209 9 319 8 868 15.9 8.6 4.1 4.4 9.8 3.1 4.8 6.5 2.7 2.1 Weak Strong Leading Strong Weak Average Weak Leading Strong Strong Very strong R&D Offshoring Strong R&D Offshoring * * * * * Source: EU Industrial R&D Investment Scoreboard 2007, INTERIS Database University of Hohenheim 2007

27. Research based Innovation Engineering- Innovation / Integrated Process Development & Manufacturing Lead Market Innovation / Customer and Service Inte- gration Corporate / Home-based R&D Capabilities Advanced Manufacturing concentrated in Home-base Home-based Lead Markets Japanese Firms German Firms Multipolar / Globally- Distributed R&D Multipolar / Globally distributed Manufacturing & Engineering Multipolar / Foreign Lead Markets Key issue: Embeddedness in Research System / Talent base abroad Key issue: Embeddedness in most Advanced Engineering locations abroad Key issue Strong network relation- ships with Lead customers in „Avantgarde markets“ Managing Global Innovation New Forms of Managing Innovation and the Role of Network Embeddedness in Foreign Countries

28. Managing Global Innovation Networks: The Case of Automotive Electronics Presentation Part 2 Managing Global Innovation Innovation Networks and Standard-setting in Automobile Electronics Managerial Issues for three selected Projects: Jaspar, Autosar and FlexRay

29. Managing Global Innovation Networks: The Case of Automotive Electronics Presentation Part 3 Managing Global Innovation Innovation Networks and Standard-setting in Automobile Electronics Managerial Issues for three selected Projects: Jaspar, Autosar and FlexRay

30. Managerial issues Organizational Issues in Managing Transnational Innovation Networks Corporate R&D / Product Devt. at German HQ Corporate R&D / Product Devt. at Japanese HQ Coordination Problems between HQ and European Subsidiary Coordination Problems between HQ and Japanese Subsidiary Project team in Japanese R&D subsidiary Project team in European R&D subsidiary Weak represen- tation of HQ agenda in German nese coopera- tion projects Weak represen- tation of HQ agenda in Japa- nese coopera- tion projects Cooperative R&D Project in Japan Cooperative R&D Project in Germany

32. The Global Innovation Value Chain and the Battle for Standards Sucessful Global Innovation requires to manage the Full Range of the Innovation Value Chain The Global Value Chain University Education Basic Research Industrial R&D New Pro- duct Per- formance Intellectual Property Position Standard setting Strength Manufactu- ring Ex- cellence Lead Market Capability World Market Rollout High Performance Innovating Country • Downstream Innovation increasingly important • Standard-setting and IP-Position most critical ! Competitive (Keeping pace with Top 10 Countries) Developing (Catching-up Countries) World Class (Top 3 Countries)

33. The Global Innovation Chain and the Battle for Standards Who defines the Standard in Automobile Electronics: the European OEM or U.S.based High-tech Firms? Software (15% R&D intensity) High-tech 8-10% R&D intensity Semiconductors (12% R&D intensity) Automobile Electronics & Vehicle IT 5-7% R&D intensity Automobile Suppliers (Sub-systems & Components) 3-4% R&D intensity Low-tech Automobile-OEM (Final assembly & System integration) European strengths U.S. dominated

34. The Global Innovation Value Chain and the Battle for Standards Case Studies of the Battle for Standards are well documented in the Literature • IBM 360 • IBM Personal Computer • VHS vs. Betamax • Microsoft Windows • ETHERNET • Mobile Telephony • Internet standards & protocol In many cases, innovators with the best technology lost out because they were incapable of influencing the standard and / or unable to secure a strong IP-Position

35. The Global Innovation Value Chain and the Battle for Standards More recently, European firms have taken a more active role in Standard-setting Competition • CAN • MOST • FlexRay • PROFIBUS • PROFINET • Industrial Ethernet • AUTOSAR • . . . In most of these Cases, European firms have become quite successful in pushing the frontier and in coordinating the Innovation race and the Standard-setting race

36. The Global Innovation Value Chain and the Battle for Standards Success in the Standard-setting race requires to follow a stringent Procedure Core members of a Standard-setting Cluster pursue a consistent strategy emphasizing the following elements: A. Explore basic concepts that are likely to result in an accepted standard B. Convince customers and downstream complementors to invest in widespread application thereby strengthening the standard C. Enable suppliers and upstream complementors to invest in necessary equipment, tools and supplies D. Manage intellectual property (patents, brands, trademarks) for the major knowledge domains E. Organize a Club that clearly defines the roles, responsibilities and access rules for its members

37. The Global Innovation Value Chain and the Battle for Standards Specialization along the Global Innovation Value Chain is feasible . . . University Education Basic Research Industrial R&D New Pro- duct Per- formance Intellectual Property Position Standard setting Strength Manufactu- ring Ex- cellence Lead Market Capability World Market Rollout Science-driven Upstream Innovator Strategy / Downstream Activities Abroad Downstream Innovator Strategy / Exploiting Foreign R&D Capabilities . . . as long as the Standard-setting process and IP-Management is well under Control

38. Innovation strategies of should focus on areas for which Full Range of Global Innovation Value Chain can be controlled • Downstream Innovation Competence and Standard-setting Competence as Important as Research Competence • Innovation Policy should be concentrated on areas for which stan- dard-setting competence and downstream elements of the value chain can be secured • Less emphasis on high-tech programs for which global standards and Business models are determined in other Countries • Better linkage between Research community and Innovation- oriented Business community within a region (country) • The New Geography of Innovation: Clusters of Leading Firms, Suppliers, Standard-setting Clubs and Research Centers The Global Innovation Value Chain and the Battle for Standards Strategic Implications

39. Ranking der technologieintensiven Sektoren und die Bedeutung der F&E-Internationalisierung in den Sektoren R&D-Expen- ditures in million $ 2005 R&D as %- of Revenues 2005 Extent of R&D Globa- lization Industry / Sector Information-Technology / IT-Hardware Pharmaceutical, Biotechnology Automobiles & Parts Electronics & Electrical Software & IT-Services Chemicals Leisure Goods / Electr. Consumer Goods Aerospace & Defense Industrial Engineering General Industrials Telecommunication Services Health Care Equipment & Services Packaged Consumer Goods Other Industries (Sum of 23 Sectors) All Companies / Total of Z Co. 82,368 80,382 75,479 31,551 28,158 19,597 18,356 17,424 10,457 10,693 8,605 7,754 6,825 24,219 421,868 8.2 14.9 4,2 4.8 10.4 3.2 7.0 4.6 2.7 2.4 N.A. 6.4 ca. 2.0 N.A. 3.8 ****** ** *** *** *** *** *** ** ** ** *** ** *** High Degree of R&D Globalization ** Medium Degree of R&D Globalization * Low Degree of R&D Globalization Sources: INTERIS-Database / University of Hohenheim; The 2006 R&D Scoreboard