More on literacy

There is a new study of literacy of college graduate, this one by the American Institutes for Research funded by The Pew Charitable Trusts. The report finds:

there is no difference between the quantitative literacy of today’s graduates compared with previous generations, and that current graduates generally are superior to previous graduates when it comes to other forms of literacy needed to comprehend documents and prose.

It also finds that college graduates are have higher literacy skills that the general population.
That is the good (or at least ok) news. The bad news:

Twenty percent of U.S. college students completing 4-year degrees — and 30 percent of students earning 2-year degrees — have only basic quantitative literacy skills, meaning they are unable to estimate if their car has enough gasoline to get to the next gas station or calculate the total cost of ordering office supplies.

Maybe OK for the Industrial Economy; a real problem for competing in the I-Cubed Economy.

Getting the metrics right – innovation and R&D

I was reading an article in Business 2.0 about how 3M has reconfigured its R&D process when one particular sentence touting their success hit me:

Product development cycles have shrunk from an average of four years down to two and a half, operating profits are up 23 percent, and R&D spending as a percentage of sales — a key bang-for-your-buck barometer — last year hit an all-time low of 5.7 percent.

Ok – shorter product development cycles; that’s good. Higher operating profits; that is really good. Lower R&D spending as percentage of sales; wait a second – lower? Yes, lower – this is a measure of efficiency (“bang for the buck”).
From a business point of view, this makes some sense. As the old saying goes, I know that half of my advertising [or R&D] budget is wasted, I just don’t know what half. So a company needs to worry about its R&D efficiency.
But from a national competitiveness point of view, this is exactly opposite of what we should be doing. All of the various reports decry our declining R&D budget as a percentage of GDP. In fact, the OECD Science, Technology and Industry (STI) Scoreboard 2005 leads with data on the investments in knowledge as a percent of GDP. So, lower spending is bad – either absolute or relative.
Returning to the business point of view, it is not clear that measuring R&D as a percentage of sale is a good metric for a company as well. It takes the view that R&D is a cost/expense rather than an investment and it is too easy to game the number by lowering R&D expenditures. Investopedia has the following advice on “Buying Into R&D”:

Measuring R&D
Financial expert/writer, Kenneth Fisher, touts the price-to-research ratio (PRR), which is the market value of the company divided by its research-and-development expenditure over the last twelve months. Fisher suggests buying companies with PRRs between five and 10 and avoiding companies with PRRs greater than 15. By looking for low PRRs, investors should be able to spot companies that are redirecting current profits into R&D, thereby better ensuring long-term future returns.
Technology investment guru Michael Murphy offers the price/growth flow model. Price/growth flow attempts to identify companies that are producing solid current earnings while simultaneously investing a lot of money into R&D. To calculate the growth flow, simply take the R&D of the last 12 months and divide it by the shares outstanding to get R&D per share. Add this to the company’s EPS and divide by the share price.
Measuring R&D Effectiveness Is Key
Unfortunately, while the Fisher and Murphy models both do a great job of helping investors identify companies that are committed to R&D, neither indicates whether R&D spending has the desired effect – the successful creation of profitable products. When evaluating R&D, investors should determine not only how much is invested but how well the R&D investment is working for the company.
Companies often cite patent output as a tangible R&D success measure. The argument goes that the more patents filed, the more productive the R&D department. But, in reality, the ratio of patents per R&D dollar tends to represent the activity of a company’s lawyers and administrators more than its engineers and product developers. Besides, there is no guarantee that a patent will ever turn into a marketable product.
One way, however, to perceive the proficiency of R&D is to calculate the percentage of sales that come from products introduced over a period of time, say the preceding three years. For the calculation, investors need annual sales information for specific new products. If lucky enough to get that kind of data from company reports, investors can do the calculation this way:
New product sales (previous three years) / Total sales (previous three years)
The resulting percentage gives investors a sense of R&D success as well as R&D output and offers a useful metric for comparing R&D performance with peer companies.
Investors should also pay attention to R&D expenditure/sales. According to Michael Murphy, good growth-flow companies spend at least 7% of their sales revenue on R&D. On the other hand, what is deemed a healthy R&D/sales ratio depends on the industry and the company’s stage of development.
Pharmaceuticals, software, and hardware companies, for instance, tend to spend a lot on R&D while consumer product companies typically spend proportionately less. In 2003, Johnson & Johnson, for example, reported spending about 10 cents per sales dollar on R&D, but drug company Pfizer spent 15% of expected sales on R&D; software giant Microsoft spent 16%; and network-equipment maker Cisco Systems spent 18%. For smaller, early-stage software and biotech companies the number can easily stretch as high as 80%.

Yet, the story gets even more complicated in that recent research shows that R&D spending does not deliver profits:

Companies which invest heavily in research and development may be wasting their money. According to a new study, there is no direct relationship between R&D investment and significant measures of corporate performance such as growth, profitability, and shareholder return.
But despite the absence of a clear return on investment, the pace of corporate R&D spending is accelerating, suggesting that many executives continue to believe that enhanced innovation is required to fuel their future growth.
According to consultants Booz Allen Hamilton, who analyzed the world’s top 1,000 corporate research and development spenders, innovation spending is still a growth business. This 2004 Global Innovation 1,000 spent $384 billion on R&D in 2004, representing 6.5 per cent annual growth since 1999.
And the pace is accelerating. Measured from 2002, the annual growth rate jumps to 11.0 per cent.
While the top 1,000 corporate R&D spenders invested $384 billion in 2004, the second 1,000 spent only $26 billion – only an additional 6.8 per cent beyond the top 1,000 spenders.
Yet as the study also points out, being large is an advantage when it comes to R&D. Larger organisations are able to spend a smaller proportion of revenue on R&D than smaller one with no discernable impact on performance.
But while spending more doesn’t necessarily help, spending too little will hurt. Companies in the bottom 10 per cent of R&D spending as a percentage of sales under-perform competitors on gross margins, gross profit, operating profit, and total shareholder returns.
However, companies in the top 10 per cent showed no consistent performance differences compared to companies that spend less on R&D.

And, as Ben McClure writes in the Motley Fool – Ruminations on R&D

Great companies invest in innovation. Those that roll the dice on research and development (R&D) programs tend to generate bigger profits than those that don’t. But take note, Fools: The world of R&D is full of questionable spending, unqualified results, and payoffs that can be hard to measure. Factoring R&D into stock evaluations and analysis is not a simple affair.

The dilemma for those of us looking for good metrics of the I-Cubed Economy is clear. Right now we have a black-box approach: money goes in and patents come out. We need better measures of the process, including a measure of efficiency – not all R&D spending is productive. Yet that productivity is hard to grasp and we don’t want to reward the view that cutting R&D is a good thing.
One of the measures propose in the Investopedia article — the ratio of new products sales to total — is an excellent measure. It is also a variation that is used in OECD surveys of innovation (as codified in the Oslo Manual: Guidelines for Collecting and Interpreting Innovation Data, 3rd Edition).
Unfortunately, the US does not conduct such an innovation study. We should (as I’ve said before). We need real metrics of innovation — not the ones left over from the industrial era.
PS – the Business 2.0 article has other interesting insight about how 3M moved its research away from “mini-alignments with old markets” and tied it basic nanotech research to marketable products. Interestingly, nothing in the article about the “lead user” theory that Eric von Hippel developed through his study of 3M. I wonder how that fits with the problem of aligning R&D with old markets?

Misleading indicators

The EU’s European Innovation Scoreboard was released last December, but there was small flurry of excitement last week when the European Commission sent out a press release “Innovation scoreboard: Mixed results that mentioned the “innovation” gap between the US and Europe. For example, the Financial Times and MSNBC ran this story: Europe’s record on innovation ’50 years behind US’:

The European Union’s record on innovation is so poor that it would take more than 50 years to catch up with the US, according to a survey presented by the European Commission on Thursday.
The Innovation Scoreboard compares the performance of the 25 EU countries with the US, Japan and several other nations, and ranks them according to factors such as the number of science and engineering graduates, patents, research and development spending and exports of high-tech products. The survey finds that only four EU countries — Sweden, Finland, Denmark and Germany — can compete with the US and Japan in terms of their innovative abilities.

However, this supposed comparison with the US is based on only partial data. As I have lamented before, the US does not have an innovation policy or a set of innovation indicators. We have a set of science and technology indicators. But that is not the same thing. Our S&T indicators measure R&D funding and the number of scientists and engineers as inputs and the number of patents as output. The US does not measure actual innovation, in the form of new products – nor do we measure non-technological innovation. European nations do, following the OECD Oslo Manual: Guidelines for Collecting and Interpreting Innovation Data.
The Scorecard measures five areas. The first three are input measures:
* Innovation drivers measure the structural conditions required for innovation potential,
* Knowledge creation measures the investments in R&D activities,
* Innovation & entrepreneurship measures the efforts towards innovation at the firm level,
The last two are output measures:
* Application measures the performance expressed in terms of labor and business activities and their value added in innovative sectors, and
* Intellectual property measures the achieved results in terms of successful know-how.
These areas are broken down into a total of 25 specific statistics, such as number of science and engineering graduates, amount of public R&D expenditures, amount of private R&D expenditures, high tech exports, etc. In a number of specific statistics, there is no data for the US. This includes the key statistics of sales of new-to-market products and sales of new-to-firm not new-to-market products — both of which are major indicators of innovation. Also missing from the US data are statistics on SMEs using non-technological change and employment in high-tech services — again, some key measures. In all the US is missing 10 out 26 data points.
How can anyone compare the EU and the US when over a third of the data points — and some of the most important data points are missing! To say that the EU is 50 years behind the US on innovation based on this study is absurd.
Yes based on R&D spending and the number of patents, Europe may very well be behind. But given that a large percentage of government R&D spending in the US is defense-oriented and given the problems with the US patent system turning out patents for anything and everything, I’m not even sure that statement holds up.
Apparently, politicians on both sides of the Atlantic (and even in Canada) are eager to raise the specter of falling behind the competition to press for more funds for S&T. I am all for increased funding. But let us not be blind to the fact that S&T is not innovation. And that increasing funding for S&T will solve our innovation problem. There are many other areas of innovation and many other innovative activities that need to be fostered and encouraged — such as design and creativity — if our nation is to succeed in the I-Cubed Economy.
But first, we need to get the damn statistics right. As they saying goes, that which is measured is managed. So, getting the measures wrong invariably means getting the policy wrong.
And so we stumble on in the darkness — looking for answers in the wrong places like the drunk looking for his keys under the lamp post.

What Innovation Advantage?

In our current don’t-worry-be-happy mode of economics, the tendency is to shrug off the growing competition from China, India and others. The story line goes like this – yes, they are low cost producers, but we’re the innovators and designers. Not so says Roger Martin, Dean of the Rotman Business School at the University of Toronto, in a provocative essay in the most recent issue of Business Week – “What Innovation Advantage?”:

There is a romantic notion in North American business that its future lies in design and innovation, while India and China will be the home of less skilled, lower-paying operations churning out the products and services the U.S. comes up with. It is a nifty twist on David Ricardo’s seminal 19th century theory of “comparative advantage,” which explained why cloudy and cool England exported woolen goods to sunny and hot Spain, which in turn exported wine to England.
The problem is that the theory didn’t ring true when I rode through the streets of Hyderabad, Bombay, and Bangalore on visits to major Indian companies. At Tata Consultancy Services’ 23-acre campus in Bombay, for instance, I learned about its central goal of providing customers with not just an acceptable-quality service but also a user experience that delights and surprises. To accomplish this, its tech professionals also are taught how to manage client change.
. . .<br
These globally oriented outfits are not entrusting all creativity, design, and innovation to "first world" opponents while they huddle over their workstations. True, they have staggering cost advantages over traditional competitors. But that doesn't mean they are incapable of design and innovation. (Their North American rivals just wish they were.) The Ricardian logic, based on so-called natural endowments, simply doesn't apply.
. . .
Assuming that capabilities are static and advantages are permanent is a mistake. Natural endowments of climate, location, and mineral resources may be enduring, but company-generated capabilities are quite fluid. It is as much an error to assume that competitors won’t attempt to develop a capability because it seemingly conflicts with an existing one — in this case low cost vs. innovation expertise. The general rule: If the opposite of a capability sounds stupid, competitors won’t try to acquire it — they’ll pursue the reasonable one. For example, the opposite of choosing to be “customer-oriented” is to elect to ignore your customers, a truly daft proposal.
Since lackluster design and staid conformity are obviously bad ideas, it is safe to assume that compelling design and potent innovation are going to be almost universally sought. So North American companies, many of which have pretty dreary design, are wrong if they assume their Asian rivals will pay no attention.

Professor Martin is right on target. While the future of competitiveness is in innovation and design, the US is not necessarily winning that fight. Nor is that high-end/low end division of labor turning out in our favor. Every month I publish in this blog an analysis of trade data in intangibles (which includes high-end professional services, royalties, fees, etc.). That data shows the US with a modest surplus of $6.9 billion – but one that has been essential flat. In other words, our small surplus in high-end services is not growing to cover our huge deficit in low-end goods. And the US has not had a surplus in advanced-technology goods since June 2002.
Policy makers need to wake up and understand that the future of the US economy is in serious jeopardy.

Changing economics of knowledge – a top 10 trend

The consulting firm McKinsey & Company has just released its Ten trends to watch in 2006. The trends are a thoughtful look at macro and micro changes occurring in the economic environment:

1. Centers of economic activity will shift profoundly, not just globally, but also regionally. The story is not simply the march to Asia. Shifts within regions are as significant as those occurring across regions.
2. Public-sector activities will balloon, making productivity gains essential.
3. The consumer landscape will change and expand significantly with almost a billion new consumers entering the global marketplace
4. Technological connectivity will transform the way people live and interact. More transformational than technology itself is the shift in behavior that it enables. We work not just globally but also instantaneously. We are forming communities and relationships in new ways.
5. The battlefield for talent will shift, with a focus toward importance and scarcity of well-trained talent.
6. The role and behavior of big business will come under increasingly sharp scrutiny.
7. Demand for natural resources will grow, as will the strain on the environment.
8. New global industry structures are emerging with nontraditional business models flourishing. In many industries, a barbell-like structure is appearing, with a few giants on top, a narrow middle, and then a flourish of smaller, fast-moving players on the bottom. Similarly, corporate borders are becoming blurrier as interlinked “ecosystems” of suppliers, producers, and customers emerge.
9. Management will go from art to science.
10. Ubiquitous access to information is changing the economics of knowledge.

While all of these are of significance, I found the last especially interesting:

Access to knowledge has become almost universal. Yet the transformation is much more profound than simply broad access. New models of knowledge production, access, distribution, and ownership are emerging. We are seeing the rise of open-source approaches to knowledge development as communities, not individuals, become responsible for innovations. Knowledge production itself is growing: worldwide patent applications, for example, rose from 1990 to 2004 at a rate of 20 percent annually. Companies will need to learn how to leverage this new knowledge universe — or risk drowning in a flood of too much information.

Many of these trends are part and parcel of our shift into the I-Cubed (Information, Innovation, Intangibles) Economy: technological connectivity, the role of talent and the new industry structures. However, learning how to manage information and knowledge is the underpinning of the entire transformation. It is not just the danger of drowning in information, it is also the problem of not being able to utilize the key information and intangibles. The easiest way to prevent drowning is to stay away from the water. Unfortunately, that may be the reaction of many — to shut out the flood and fall back on the old ways (and the old industrial age paradigms). That will be the road to disaster for some.
The other reaction to managing information will be to filter based on narrow criteria. However, narrowing the information flow is a sure-fire way of stifling innovation. A rich flow of diverse information is needed for the creative process. The old saying of separating the wheat from the chaff is only partly applicable. What is need are ways to think creatively about what to do with both the wheat and the chaff.
Key is the word “leveraging” — the ability to leverage knowledge will determine the success stories of the I-Cubed Economy. What that means, however, is yet to be completely revealed. We are still in the transformation — with most of us trying our best not to drown. As we learn to swim in — and then sail over — this sea of information, creativity, innovation and productive economic growth will flourish.

A positive indicator of New Orleans’ future – Tulane

After Katrina devastated New Orleans, I observed that how Tulane University responds will be a leading indicator of the city’s economic future:

For the Fall semester, Tulane students will be dispersed across the nation. How many return (either in January if that is possible or next Fall) will determine New Orleans’ future as a dynamic creative city.

Well, it’s January and the new term is starting — and the news is good! According to a story in this mornings Washington Post –
“Interrupted by Hurricane, Tulane’s Orientation Resumes for Freshmen”:

Nearly 90 percent of Tulane’s 6,700 undergraduates are returning, the university said, and more than 80 percent of freshmen — a significant accomplishment considering college officials initially wondered if they would break 60 percent. It is also a big boost for the city, where Tulane is the largest private employer and returning students will amount to a noticeable population increase.

The return of Tulane’s students, along with the earlier announcement of keeping their medical research programs while cutting back in other areas, keeps alive the hope that the University can spark an innovation and creativity-led economic revival of the city. Only time will tell, but the signs are good. As they say, stay tuned.

November trade in intangibles

This morning’s BEA trade data contained some good news as the overall trade deficit declined slightly. However, the surplus in our balance of trade in intangibles remained flat at $6.9 billion in November. The intangibles surplus is almost exactly what it was a year ago in November of 2004 and is still below the peak surplus of almost $7.5 billion in December 2004.
Even with the improvement in this month’s deficit, the total deficit for the first 11 months of 2005 ($661.8 billion) is already significantly above the total for all of 2004 (at a record setting $617.6 billion). At this rate, the deficit for 2005 could run as high as $720 billion.
The deficit in Advanced Technology Products declined slighly in November to $4.8 billion, as exports grew slightly while imports were basically unchanged. The last monthly surplus in Advanced Technology Products was in June 2002 and the last sustained series of monthly surpluses were in the first half of 2001.

Intangibles trade-Nov05.gif

Note: we define trade in intangibles as the sum of “royalties and license fees” and “other private services”. The BEA/Census Bureau definitions of those categories are as follows:

Royalties and License Fees – Transactions with foreign residents involving intangible assets and proprietary rights, such as the use of patents, techniques, processes, formulas, designs, know-how, trademarks, copyrights, franchises, and manufacturing rights. The term “royalties” generally refers to payments for the utilization of copyrights or trademarks, and the term “license fees” generally refers to payments for the use of patents or industrial processes.

Other Private Services – Transactions with affiliated foreigners, for which no identification by type is available, and of transactions with unaffiliated foreigners. (The term “affiliated” refers to a direct investment relationship, which exists when a U.S. person has ownership or control, directly or indirectly, of 10 percent or more of a foreign business enterprise’s voting securities or the equivalent, or when a foreign person has a similar interest in a U.S. enterprise.) Transactions with unaffiliated foreigners consist of education services; financial services (includes commissions and other transactions fees associated with the purchase and sale of securities and noninterest income of banks, and excludes investment income); insurance services; telecommunications services (includes transmission services and value-added services); and business, professional, and technical services. Included in the last group are advertising services; computer and data processing services; database and other information services; research, development, and testing services; management, consulting, and public relations services; legal services; construction, engineering, architectural, and mining services; industrial engineering services; installation, maintenance, and repair of equipment; and other services, including medical services and film and tape rentals.