Characteristics of Foreign R&D Strategies of Swiss Firms

1. Characteristics of Foreign R&D Strategies of Swiss Firms Implications for Policy

2. Background and research questions Background • Outward-investments increasingly pertain to R&D • We notice from casual observation and empirical research that the motives for performing R&D at foreign locations are changing (what also is reflected in theoretical thinking) • Technology/knowledge sourcing is gaining ground as a motive of foreign R&D as compared to more traditional motives • Concern in the public that foreign R&D may “erode” the domestic knowledge base (“relocation”, substitution) • On the other hand: Based on the belief that technology sourcing primarily is a means for augmenting strategic assets of (domestic) headquarters, it is hypothesised that foreign and domestic R&D are complements

3. Background and research questions Research questions • Which of the two competing hypotheses, on balance, is supported by the data in case of the Swiss economy? • As the answer depends on the relative importance of alternative foreign R&D strategies: • What strategies firms pursue in performing R&D at foreign locations? • Which strategies are most prevalent? • Based on this analysis: what are the direct home-country effects of foreign R&D strategies of Swiss firms? • What do we know about indirect home-country effects? • What are the determinants of (the extent of) knowledge spillovers? • Is the Swiss economy in a good position to capitalise on spillovers? • What are the policy implications in the Swiss case?

4. Outline Outline • Background and research questions • Data • Identifying foreign R&D strategies • Method • Empirical results • Prevalence of alternative strategies • Home-country effects of foreign R&D • Direct effects • Indirect effects (knowledge spillovers) • Policy recommendations

5. Data Data • Firm-level data stemming from the Swiss Innovation Survey 2002 • Sample • Stratified by 28 industries and 3 industry-specific firm size classes • Coverage: manufacturing, construction, commercial services (firms with 5 or more employees) • Response rate: 40% = 2583 firms, of which: • 1078 firms performing R&D • 156 firms performing R&D at foreign locations • These 156 firms are the sample we use in our cross-section analysis • In future research, we intend to analyse the topic based on four waves of the Swiss Innovation Survey

6. Identifying foreign R&D strategies: method Starting point • We assume that firms may (but must not) be driven to invest in foreign R&D by more than one motive • Therefore, a firm’s foreign R&D strategy can be described by a specific combination of such motives (“mixed” strategy) • In order to identify different (mixed) R&D strategies we draw on information on the importance of seven motives of performing foreign R&D • Assessments of the firms themselves • 5-point Likert scale

7. Identifying foreign R&D strategies: method Motives of performing foreign R&D % (highly) important * • Supporting local production and sales 40 • Proximity to leading edge universities 26 • Proximity to highly innovative firms 35 • Transfer of knowledge to the headquarter 26 • Lower R&D costs 26 • Higher public support for R&D activities 12 • Ample supply of R&D personnel 38 *Value 4 or 5 on a five-point Likert scale

8. Identifying foreign R&D strategies: method A two-step procedure to identify R&D strategies Step I • Cluster analysis of 7 motives of foreign R&D • We find four clusters each containing firms that are similar in terms of the combination of the underlying motives • One may conclude that the clusters represent four specific foreign R&D strategies • However, as cluster analysis is a purely statistical procedure (classification method), this interpretation only is preliminary Step II • In order to check whether the clusters identified in the first step effectively may be interpreted as specific R&D strategies, we characterise them by a number of (mostly) theory-based sets of variables

9. Identifying foreign R&D strategies: method Variables used in step II to characterise R&D strategies • The motives used in the first step, i.e. the cluster analysis • A large number of variables representing the most important ingredients of the OLI paradigm of explaining FDI • O-advantages: innovation input/output, use of external knowledge, appropriability, technological opportunity, firm size, labour productivity • L-disadvantages: innovation barriers in Switzerland • I-advantages: R&D co-operation, firm size • Market environment: demand prospects, intensity of price and non-price competition, number of principal competitors • Structural characteristics of the firm: industry affiliation, firm size and firm age, export orientation, company status

10. Empirical results: 4 strategies Four strategies of foreign R&D pursued by Swiss firms • Firms pursuing a broad-based strategy in terms of motives, with tapping into knowledge from universities and embodied in specialists as the most important elements (25% of firms, 11% of employment) • Firms strongly embedded in foreign networks of highly innovative firms, complemented by an intensive knowledge transfer to the domestic headquarter (24% of firms, 24% of employment) • Firms pursuing a strongly focused strategy, with foreign R&D almost exclusively used as a means to extend local markets (36% of firms, 57% of employment) • Firms pursuing, in terms of motives, a quite narrow-based strategy that aims at reducing R&D costs and gaining access to highly skilledpersonnel(15% of firms, 8% of employment)

11. The strategies in detail Characteristics of strategy I (broad-based strategy in terms of motives, with particular importance of knowledge sourcing (universities, specialists) • Strong O-advantages • High internal research, development and other innovation expenditures as well as very intensive use of external knowledge • Intensive patenting activities and generation of many world novelties • Favourable supply-side conditions (technological opportunities, appropriability) • Several kinds of L-disadvantages • In the first place: insufficient supply of highly/specifically qualified personnel • In second instance: excessive regulation and insufficient financial incentives for performing R&D in Switzerland • Structural characteristics • Highly export-oriented medium-sized firms • Younger than average • Slightly over-represented in mechanical engineering and in services

12. The strategies in detail Characteristics of strategy II (high relevance of knowledge sourcing within networks of very innovative firms; intensive reverse knowledge transfer) Strong O- and I-advantages – excellent market perspectives • Strongly research-oriented internal innovation activities based on an excellent staff and intensive use of science-oriented external knowledge (journals, patent documents) • Tight network of R&D co-operation • Surprisingly, supply-side conditions for generating innovations are only average, whereas demand/market conditions are excellent • Hardly any L-disadvantages • These firms actively search worldwide for complementary knowledge at the most attractive locations rather than being pushed to perform R&D abroad • Structural characteristics • Large share of very small, in many instances young companies; however, some large MNE’s also pursue this strategy • Pharmaceuticals, chemicals and services are over-represented • Export-orientation is low (reflecting the high share of small firms)

13. The strategies in detail Characteristics of strategy III (strongly focused strategy: foreign R&D almost exclusively is market-oriented) • Only moderate O-advantages – strong market growth • Moderate internal innovation outlays (development-oriented), not matched by tapping into external knowledge sources • Quite extensive network of R&D co-operation • Weak supply-side conditions for generating innovations, but strongly growing markets characterised by fierce price competition with few competitors • Only few L-disadvantages • Insufficient availability of highly-skilled personnel • Structural characteristics • Very high share of large, well-established (old) companies • Extremely high export-orientation • Over-representation of manufacturing (with the exception of pharmaceuticals/chemicals)

14. The strategies in detail Characteristics of strategy IV (quite narrow-based strategy that aims at reducing R&D costs and gaining access to highly skilled personnel) • Weak O- and I-advantages – market perspectives not promising • High application-oriented internal innovation expenditures (engineering, follow-up investments), • Quite substantial use of knowledge generated by other firms along the same value chain • Given this pattern, firms pursuing this strategy are “incremental innovators” • Slowly growing markets characterised by fierce price competition • Almost no L-disadvantages • Structural characteristics • Very high share of small, in many instances, old companies • Some over-representation of electrical engineering

15. Assessment of the results Assessment of the empirical results • The two-step procedure yields four clusters which safely may be interpreted as specific “types of foreign R&D strategies”, as the results are • satisfactory by statistical criteria (cluster analysis) • well-founded in theory (OLI paradigm of FDI) • As hypothesised, it is sensible to conceptualise investments in R&D at foreign locations as “mixed” strategies” in terms of the underlying motives (although not all firms pursue broad-based strategies)

16. Prevalence of alternative R&D strategies Prevalence of alternative strategies in the Swiss case • The two “traditional”, (strongly) focused strategies 3 and 4 (market and cost orientation) are still more prevalent than those for which knowledge/technology sourcing is either at the core (strategy 2) or, at least, is an important element (strategy 1) • Number of firms 51% • Employment 65% • Nevertheless, the two strategies that aim, among other things, at augmenting a firm’s strategic assets through knowledge sourcing have become highly relevant, in particular in terms of the number of firms (49%;employment: 35%) • Strategy 3 (exclusively focusing on extending foreign markets) and strategy 2 (combining technology sourcing and reverse knowledge transfer) dominate the pattern of foreign R&D of Swiss firms • Number of firms 60% • Employment 81%

17. Home-country effects of foreign R&D Impact of foreign R&D on the Swiss economy • In order • to assess whether foreign and domestic R&D, on balance, are substitutes or complements, and • to identify policy needs and recommend policy measures we have to assess, in a first step, the impact of foreign R&D of Swiss firms on the domestic economy • The literature distinguishes to types of effects • directhome-country effects: impact of FDI in R&D on the domestic headquarter company (reflecting the prevalence of alternative strategies) • Indirect home-country effects (resulting from knowledge spillovers to other domestic firms)

18. Substitution vs. complementarity • Direct effects In view of the relative importance of the four strategies, we conclude that, in the Swiss case, foreign and domestic R&D, on balance, are complements: • Dominant role of the strongly market-oriented strategy 3, giving rise to firm-specific economies of scale in R&D at the headquarter • Low importance of cost-oriented strategy 4 (relocation of FDI is hardly relevant) • Reverse technology transfer is a core feature of strategy 2, thus enhancing the knowledge base at the (domestic) headquarter • Knowledge transfer does not play such an outstanding role in case of strategy 1, but is an important feature also in this case

19. Knowledge spillovers • Indirect effects • Positive indirect effects(knowledge spillovers to other domestic firms) would tilt the balance even further towards complementarity • The extent of knowledge spillovers depends on several factors, such as • The ability of firms to prevent know-how from leaking to (domestic) competitors • The willingness to share knowledge with other (domestic) firms (suppliers, users) • Most importantly: spillovers are the larger, the higher the capacity of domestic firms to absorb external knowledge • Spillovers are more likely if the R&D performing headquarter is strongly embedded in the domestic economy

20. Knowledge spillovers What about spillovers in the Swiss case? • We argue that the Swiss economy is likely to benefit a lot from knowledge spillovers • Absorptive capacity of domestic firms is high • The knowledge base is more widely distributed than elsewhere in Europe as Swiss SME’s are more innovative than those of all EU Member States • Employment of highly qualified personnel is very high, what is partly due to immigration (the number of graduates per age-group is only average)

21. Knowledge spillovers • Firms performing R&D abroad are well embedded in the Swiss economy • R&D co-operation is more widespread than in most EU countries and strongly science-based • Technology transfer between science (which is of very high standard) and (high-tech) industry works well • Promoting R&D co-operation between universities and industry is the core element of Swiss technology policy • There are some important clustersof knowledge-intensive industries such as pharmaceuticals/biotechnology, instruments/electronics, financial services  Notwithstanding the positive assessment of both types of home-country effects, policy may support the Swiss economy to capitalise even more on Swiss firms’ foreign R&D

22. Policy recommendations We propose five lines of policy action • Enhancing the domestic supply of highly qualified labour (education policy, etc.) • Increasing the number of graduates (in particular scientists and engineers) • Promoting labour market participation of highly qualifiedwomen • Mobilising the intellectual potential of foreign children growing up in Switzerland • Securing the high standard of university research and fostering new frontier research (science policy)

23. Policy recommendations • Promoting the application of the results of science in the business sector (technology policy) • Promoting technology transfer and co-operation between science and industry • Avoiding a too restrictive regulatory framework for the application of frontier technologies • Providing an environment conducive to start-ups • etc. • Promoting clusters of vertical and horizontal partners of the firms that invest abroad in R&D (embeddedness)

24. Policy recommendation • General measures to make Switzerland an even more attractive location for doing business (location policy) • Low and incentive-oriented taxation • Deregulation of (product) markets • etc. To conclude  We recommend, as can be seen from our proposals, a framework-oriented policy design rather than a more interventionist concept