The Implications of R&D Off-Shoring On The Innovation Capacity of EU Firms

The implications of R&D off-shoring on
the innovation capacity of EU firms
January 2007
The innovation policy initiative PRO INNO Europe combines analysis and benchmarking of
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stakeholders to implement joint actions. The initiative aspires to become the main European
reference for innovation policy analysis and development throughout Europe and brings together
over 200 innovation policy makers and stakeholders from 33 countries. Additional
information on PRO INNO Europe is available on the Internet (www.proinno-europe.eu).
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LTT Research Ltd / 2006 2

Table of Contents
ACRONYMS AND ABBREVIATIONS ..................................................................................6
SUMMARY .......................................................................................................................7
PART I: REVIEW OF ECONOMIC LITERATURE AND ANALYSIS OF THE EIS 2005

INDICATORS ................................................................................................................11
1 INTRODUCTION .....................................................................................................11
2 R&D, INNOVATION AND ECONOMIC GROWTH........................................................13
2.1 Growth models in economics ................................................................................13

2.2 The role of spillovers ...........................................................................................14
2.2.1 General findings in the research ...................................................................14
2.2.2 The role of international spillovers ................................................................16
2.3 Empirical research on innovation, R&D and growth ..................................................19
3 ECONOMIC THEORIES OF OUTSOURCING AND OFF-SHORING ................................23
3.1 The boundaries of firm –why outsource? ................................................................23

3.2 The theory of international trade –why off-shore? ...................................................26
4 BENEFITS AND CHALLENGES OF R&D OFF-SHORING..............................................28
4.1 General reasons for R&D off-shoring .....................................................................28

4.2 Firm level decisions to off-shore ...........................................................................29
4.3 The challenges in R&D off-shoring.........................................................................31
4.4 Concluding remarks from the literature..................................................................34
5 ANALYSIS OF THE EIS INDICATORS AND EIS 2005 SURVEY ..................................36
5.1 EIS 2005 –indicators and general findings of the survey...........................................36

5.1.1 Indicators and country groups ......................................................................36
5.1.2 Relative performance of the EU compared to the US and Japan .........................39
5.1.3 Differences between EU countries .................................................................40
5.1.4 Concluding comments of the EIS 2005 survey ................................................41
5.2 Qualitative analysis of the effects of R&D off-shoring on EIS indicators .......................42
5.2.1 Background ...............................................................................................42

Table of Contents
5.2.2 Analysis of the indicators.............................................................................44

5.2.3 Summary ..................................................................................................57
PART II: EMPIRICAL EXAMINATION OF R&D OFF-SHORING IN EUROPE ......................59
6 REVIEW OF AGGREGATE LEVEL DATA ON R&D OFF-SHORING ................................59
6.1 Trends in R&D expenditure in EU ..........................................................................60

6.1.1 Aggregate R&D expenditure in EU .................................................................61
6.1.2 Business sector R&D expenditure in the EU ....................................................62
6.1.3 Funding of business R&D in the EU................................................................65
6.1.4 Evidence from firm-level data.......................................................................66
6.2 Internationalisation of R&D in the EU.....................................................................69
6.2.1 Evidence from aggregate level R&D flows.......................................................69
6.2.2 Evidence from R&D foreign direct investments (FDI)........................................70
6.2.3 Evidence from patents ................................................................................76
6.3 Empirical analysis of aggregate level data ..............................................................83
6.4 Conclusions .......................................................................................................86
7 SIMULATION OF FUTURE DEVELOPMENT................................................................88
7.1 The simulation approach......................................................................................88

7.2 Results of simulations .........................................................................................89
8 FINDINGS FROM THE SURVEY ................................................................................93
8.1 The Survey and responding companies in short.......................................................93

8.2 Trends in R&D and R&D off-shoring.......................................................................93
8.3 Reasons behind off-shoring decisions ....................................................................98
8.4 Effects of R&D off-shoring....................................................................................99
8.5 Key findings from the survey.............................................................................. 105
9 ECONOMETRIC ANALYSIS OF EPO AND SURVEY DATA ......................................... 106
9.1 Determinants of the level of R&D off-shoring spending........................................... 106

9.2 Determinants of R&D off-shoring replacing domestic R&D....................................... 108
9.3 Determinants of the off-shored R&D location ........................................................ 110
9.4 The effects of R&D off-shoring on R&D performance .............................................. 112
9.5 Summary ........................................................................................................ 114

Table of Contents
10 CASE STUDIES: THE CORPORATE PERSPECTIVE................................................... 116
10.1 Case study method and description of interviewed firms....................................... 116

10.2 Reasons for R&D off-shoring............................................................................. 117
10.3 Modern R&D and its requirements ..................................................................... 121
10.4 The effects of R&D off-shoring .......................................................................... 123
10.5 What does the future look like?......................................................................... 125
10.6 Conclusions ................................................................................................... 127
11 CONCLUSIONS FROM THE STUDY......................................................................... 131
11.1 Conclusions from the literature study................................................................. 131

11.2 Conclusions from the empirical studies............................................................... 132
11.3 Drivers behind the innovation capacity of EU firms .............................................. 136
11.3.1 Dynamic firms need dynamic markets................................................... 137
11.3.2 New ways of R&D financing ................................................................. 139
11.3.3 IPRs and open technology ................................................................... 140
PART III: R&D OFF-SHORING IN A POLICY FRAMEWORK ........................................... 142
12 EU INNOVATION POLICIES AND R&D OFF-SHORING ........................................... 142
12.1 Introduction ................................................................................................... 142

12.2 Internationalisation of R&D – US experience ....................................................... 142
12.3 Liberalisation vs. protectionist measures ............................................................ 144
12.4 Innovation policy and R&D off-shoring ............................................................... 145
12.5 Innovation policies in Europe ............................................................................ 147
12.6 Innovation policy measures .............................................................................. 148
12.6.1 Tax incentives ................................................................................... 148
12.6.2 R&D subsidies ................................................................................... 149
12.6.3 R&D Collaboration.............................................................................. 149
12.6.4 Technology Programmes ..................................................................... 150
12.6.5 SME financing and venture capital ........................................................ 150
12.6.6 Policies towards international cooperation.............................................. 150
12.7 Discussion ..................................................................................................... 151
12.8 Summary ...................................................................................................... 152
13 POLICY RECOMMENDATIONS ............................................................................... 154

Table of Contents
13.1 Pros and cons of R&D off-shoring for EU............................................................. 154

13.2 Possible political measures ............................................................................... 156
13.2.1 Focus on enhancing the business environment and educational system...... 156
13.2.2 Increase public and private R&D investment .......................................... 158
13.2.3 Concentrate on a well-functioning R&D environment ............................... 158
LITERATURE REFERENCES .......................................................................................... 160
APPENDICES............................................................................................................... 169
1 Case outline ....................................................................................................... 169

2 The cases........................................................................................................... 173
Case A ............................................................................................................ 173
Case B ............................................................................................................ 176
Case C ............................................................................................................ 179
Case D............................................................................................................ 182
Case E ............................................................................................................ 185
Case F ............................................................................................................ 189
Case G............................................................................................................ 191
Case H............................................................................................................ 193
Case I............................................................................................................. 195
Case J............................................................................................................. 197
Case K ............................................................................................................ 199
Case L ............................................................................................................ 201
Case M............................................................................................................ 203
Case N............................................................................................................ 206
3 Case summary table ............................................................................................ 209

Acronyms and Abbreviations
BERD – R&D conducted by business enterprise
EU – European Union
EIS – European Innovation Scoreboard
FDI – foreign direct investment
GERD – total gross domestic R&D (a sum of BERD, GOVERD and HERD)
GOVERD – R&D conducted by government
HERD – R&D conducted by higher education
ICT – information and communications technology
IIA - international investment agreement
IPR – intellectual property right
IT – information technology
M&A – Merger and acquisition
MNE – Multinational enterprise
Innovation - the implementation of a new or significantly improved product (good
or service), or process, a new marketing method, or a new organisational method in
business practices, workplace organisation or external relations (Oslo manual).
R&D – Research and development is defined as the commitment of resources to
research and the refinement of ideas aimed at the development of commercially
viable products and processes.
R&D off-shoring - a firm’s relocation of domestic R&D to another country either by
obtaining services from an unaffiliated foreign company or by investing in a foreign
affiliate or joint venture.
SME – Small and medium-sized enterprise
TFP – total factor productivity

Summary
This study focuses on identifying the implications of R&D off-shoring on the
innovation capacity of EU firms. Research and development (R&D) is defined as the
commitment of resources to research and the refinement of ideas aimed at the
development of commercially viable products and processes. R&D off-shoring is
defined as a firm’s relocation of domestic R&D to another country either by obtaining
services from an unaffiliated foreign company or by investing in a foreign affiliate or
joint venture. European firms have off-shored their manufacturing functions for
decades but currently the fraction of more strategic business functions, e.g. R&D, has
been viewed to increase its share of the total off-shore investments. There is an
uncertainty about the effects of this phenomenon to the innovation capacity of
European companies.
The study is divided in three parts: Part I reviews the economic literature, Part II
focuses on the empirical methods in discovering the drivers and implications of firms’
R&D off-shoring decisions, and Part III discusses R&D off-shoring in a policy
framework. Conclusions from the study can be found in chapter 11 and the policy
recommendations in chapter 13. The following summarises the study.
Part I
The information used in Part I consists of economic literature, recent academic
research and European Innovation Scoreboard (EIS) 2005 survey. Part I reviews the
literature concerning R&D off-shoring: presents the links between R&D, innovation
and economic growth, discusses the economic theories behind outsourcing and off-
shoring and presents the benefits and challenges of R&D off-shoring as indicated by
recent studies. The last chapter of Part I analyses the findings of the EIS 2005 study
and the effects of R&D off-shoring on EIS indicators.
Part I discovers that the possible negative effects of R&D off-shoring consist of lost
spillover effects, lost skilled labor following the off-shored R&D, lost jobs in R&D
leading to decreasing innovations, decreasing productivity and slow economic
growth. The positive effects of R&D off-shoring include spillover of new innovations
leaking back to the EU area, increasing innovation capacity (depending on the home
country’s adaptability) and the benefits of EU firms from locating their R&D
operations where they are relatively most efficiently performed. So far only a small
share of the R&D conducted by EU firms takes place off-shore. EU policymakers can
significantly affect firm level decisions by increasing the attractiveness of the EU area

as an innovation base. In addition, the current developing countries like China and
India will eventually lose their position as low cost locations.
EIS 2005 survey reveals a gap between the EU25 and US and between EU25 and
Japan in terms of innovation, explained largely by the number of patents, population
with tertiary education and ICT expenditures. Also the differences between different
EU countries are large. The possibility for the EU firms to off-shore a part of their
R&D into the relatively more innovative areas or into low cost locations may actually
result in higher innovation capacity and growth in the long run.
Part II
Part II presents the findings from the empirical research conducted as the main part
of this study. We have analysed the aggregate data on R&D off-shoring, simulated
future development, conducted a survey for over 150 EU firms and performed
econometric analysis on patent and survey data, and conducted 14 in-depth case
studies.
The aggregate data about R&D investments used in this study is from Eurostat,
LOCOmonitorTM and European Commission’s 2005 survey on the EU industrial R&D
investment. The analysed patent data is from OECD’s Patent Database. As a
methodological contribution of this study the use of the LOCOmonitorTM data proved
to be an important source of statistical data. We used statistical and econometric
tools to find that the general trend has been towards increasing R&D intensity
although for some countries the opposite trend can be observed. R&D foreign direct
investments (FDI) to and from the EU25 have been increasing sharply over the past
four years the major countries being Germany, UK and France. R&D inflows are
received from developed countries such as the US whereas the outflows from EU
have been increasingly directed to China and India. However, the main destination
for outward R&D is still another EU country, the US being the second choice.
We conducted a simulation exercise on the future development of R&D off-shoring

and its impact on EU countries based on the differences in these countries in the
recent years. The results are very sensitive to different variables (e.g. the choice of
scenario) especially for the country-specific estimations. We can conclude that in
future domestically invented and owned patents will increase in all EU countries.
A firm-level survey was conducted by TNS Gallup as a way to discover the business
view on R&F off-shoring. In analysing the results it became evident that R&D off-
shoring is seen as a positive phenomenon that has affected positively the firms’

abilities to conduct R&D. The fraction of off-shored R&D relative to total R&D
spending per firm is relatively low, but expected to increase. A majority of the
surveyed firms expect off-shoring to contribute positively to the general innovation
capability of EU firms. Developing Asia as a destination location for off-shore R&D is
not as popular among the surveyed firms as could perhaps be expected from public
discussion. Over 60 % of the responding companies have located their off-shored
R&D in another EU country. Access to skilled labour and strategic benefits like
alliances with other firms encourage firms to off-shore, and the location choice for
off-shore R&D depends on IPR protection, links between the educational system and
the private sector, market proximity and possible cost savings.
We matched the data from the survey to the data from the European Patent Office
and performed a micro-econometric analysis. Among the most interesting findings is
a conclusion that having located off-shore R&D into developing Asia is associated
with a higher degree of domestic R&D replacement than off-shoring to other
locations. On the other hand, the more important the local attitude to innovation the
less likely it is that a firm has off-shored to developing Asia. The more important the
infrastructure is the more likely it is that a firm has off-shored to non-EU Europe.
Also, the more important the IPRs are the less likely it is that a firm has off-shored to
Latin America.
In developing a more in-depth understanding about the reasons and effects of R&D
off-shoring we interviewed 14 company representatives, half of them on-site. We
found that for multinational enterprises (MNEs) R&D off-shoring is a part of global
R&D operations, which in turn constitutes an essential part of the firm’s globalisation
and growth strategy. The most important and longest-term R&D work is kept close to
home. For many case companies a part of the off-shored R&D is incremental,
market-oriented development work, i.e. tailoring the products and services to new
markets. Firms are also partnering with a range of R&D intensive small and medium
sizes enterprises (SMEs) as well as with local universities in order to more efficiently
leverage the innovations of the off-shore locations. Rapid dispersion of innovation
and formation of powerful virtual networks have improved SMEs’ position in global
R&D. All of the case firms have benefited from access to growth markets, talented
work force, increased international innovativeness and cost efficiencies. This has led
to e.g. increased competitiveness, improved internal processes and cross-cultural
project management skills. The case firms suggest that EU would benefit from
increasing its innovation capacity by forming clusters of innovation and thereby
increasing the cooperation and partnerships between businesses, universities and
financiers.

Part III
In the last part of this study we look at R&D off-shoring in the policy framework.
Based on our findings about the issues affecting EU firms’ off-shoring decisions, there
are some important business environment measures that EU governments can focus
on in order to maintain and increase the level of R&D investments in Europe. We see
no reason to use any protectionist measures and try to prevent the globalisation of
business R&D functions. Instead, EU countries would be able to reap the benefits of
R&D off-shoring by continuing to liberalise the markets and thereby rendering
possible the inflows of FDI R&D from non-EU countries. The results of R&D off-
shoring on a national level are dependent on policy environment, general
infrastructure, political institutions and attitude towards innovation and creativity. We
recommend EU and its national governments to focus on the business environment
and educational system by aiming to increase both private and indirect public R&D
investment and in that way develop a well-functioning R&D environment. Direct
public support, either tax benefits or subsidies, are rarely an efficient long-term
answer to future innovation capacity and growth.
The study has been funded by the European Commission under the "Coherent
Development of Research and Innovation Policies" action line of the 6th Community
Programme for R&D.

PART I: REVIEW OF ECONOMIC LITERATURE AND
ANALYSIS OF THE EIS 2005 INDICATORS
1 Introduction
Off-shoring, both in-house, and off-shore outsourcing, is not a new phenomenon.
Companies have off-shored their supporting and manufacturing functions to foreign
countries for decades, mainly due to cost-saving reasons. Recently, however, the
tasks being off-shored have become more complicated, and the reasons for off-
shoring now include more elaborate drivers than simply cost-saving. Today even
R&D, one of the most strategic functions, is increasingly being off-shored. This has
raised concerns in the off-shoring countries (mainly EU and the US), as R&D is
considered to be one of the key variables in determining the innovation capacity and
significantly contributing to competitiveness and economic growth.
The common fear is that developed countries are losing ground in R&D and
innovation, while the developing countries gain. For example, Bardhan and Jaffee
(2005) note that the number of Science and Engineering Ph.D.s is falling and the
academic positions in the United States as measured by salaries are becoming less
attractive. Similarly, Freeman (2005) argues that the US share of the world’s Science
and Engineering work force is declining rapidly, and the job market for S&E
specialties is too weak to attract more students to these opportunities in the United
States. Identical concerns have been presented for the EU area. Moreover, the latest
European Innovation Scoreboard (EIS) clearly shows an innovation gap between the
EU and the US, and between the EU and Japan. The latter gap seems, in fact, to be
widening. Thus, while there are concerns that the EU is losing ground in R&D with
regard to developing countries, also other developed countries continue to be ahead
or even increase the gap.
One reason for the supposed declining innovation prospects for the developed
countries is suggested to be off-shoring, as increasing number of companies are
moving their R&D operations off-shore. However, this relation has not been
confirmed in the literature yet. It is also important to see that the presumed decline
in the innovation capacity of the US and EU can be caused by other factors. Thus,
off-shoring can rather be the consequence than the cause, which means that the
causality is reversed.

In order to better analyse the effects of off-shoring on the innovation capacity of the
off-shoring countries it is important to understand the economic rationale behind the
off-shoring phenomenon. First, it is crucial to understand the reasons why firms
engage in off-shoring and how is this process normally coordinated. Second, it is
important to understand how innovation capacity develops and what determinants
should be included. Finally, off-shoring can affect countries is various ways, i.e. it is
not at all a simple matter whether it will be harmful or beneficial for the off-shoring
countries and what kind of long run consequences will emerge.
This literature review will focus on the related economic literature regarding off-
shoring and outsourcing in general, and R&D off-shoring in particular. We begin the
review by discussing the impact of R&D on economic growth in chapter 2. Third
chapter examines theories explaining outsourcing and off-shoring in economics. In
the chapter 4 the focus shifts to the firm level decisions to off-shore. Different
reasons for off-shoring and challenges related to it will be examined. The last chapter
presents a qualitative analysis of the EIS indicators assessing the potential impact of
R&D off-shoring.

2 R&D, innovation and economic growth
In modern economic theory R&D is an important element explaining long run growth.
Thus, let us begin the review with an overview on economic growth literature and
especially the role of R&D in the growth process.
2.1 Growth models in economics
Early neo-classical growth models emphasized the role of capital accumulation. In

the Solow–Swan model1, output is produced by capital and labor with constant
returns to scale, diminishing returns to each input, and some elasticity of substitution
between the inputs. The model also assumes constant saving-rate. The classical
models predicted an eventual cease of per capita growth, which seemed to contradict
with empirical evidence. This was clearly a deficiency and thus, growth theorists
included an exogenous element representing technological progress. This
modification could solve the problem by allowing for positive constant growth, but
the problem was that in the long run, output per capita and labor productivity growth
were fundamentally determined by an exogenously given rate of technological
progress, which still remained unexplained. In other words, neoclassical models did
not explicitly model issues such as R&D. Although some improvements to the
neoclassical growth model have been introduced later, it still is not sufficient to
explain the impact of technological progress on economic growth in the long run.
A renewed interest in growth research emerged when a group of new growth models
were introduced in the 1980s2. These new theories focused especially on explaining
long-term economic growth. The assumption of diminishing returns to capital was
relaxed and technological progress was introduced as endogenous to the model. As
opposed to earlier models, in these new “endogenous growth models” growth could
go on indefinitely. Contributions by Romer (1987, 1990), Aghion and Howitt (1992)
and Grossman and Helpman (1991) have led to significant development of growth
theory thereafter. These models explicitly include R&D by assuming that it leads to
technological advance, which is later rewarded by some form of monopoly power
(ability to make profits). According to these theories, provided that there is a
constant stream of new ideas, economic growth can remain at a positive level also in
the long run. In short, R&D based endogenous growth models propose that the
1
For Solow-Swan model see for example Barro and Sala-i-Martin (1995)
2
See for example Romer (1986) and Lucas (1988)

accumulation and diffusion of technological knowledge is the driving force of long-
term economic growth3.
When assessing the contribution of innovation to economic performance it is clearly

important to take into account the direct account of innovation, for which in most of
the studies R&D is used as a proxy. In addition, one must acknowledge that there
are externalities, spillovers, which may also have a significant effect on growth and
economic performance. Endogenous growth models recognize also this point and
many models include the possibility of spillovers. Let us next discuss the literature on
spillovers in more detail.
2.2 The role of spillovers
2.2.1 General findings in the research
The role of technological diffusion is, indeed, important both at economy and firm
level4. While R&D efforts may lead to fast technological progress in some leading
economies, also follower economies can partly share these advances. Similarly, at a
micro-level, R&D conducted by one company can affect the productivity of other
firms. Specifically, knowledge created by R&D activities of one firm stimulates the
development of new knowledge by other firms and/or enhances their technological
and innovative capabilities. The same can also occur inside a firm, as new
innovations by one unit may have positive effects on the operations of another unit.
Finally, spillovers do not only occur within an industry, but significant spillover effects
can also take place within industries.
Spillovers are of importance also in the assessment of the implications of R&D off-
shoring; it is crucial for the future innovation capacity of the EU area that new
findings and innovations though in some cases developed abroad, spill over back to
the EU markets.
Because of the existence of spillover effects, the empirical assessment of the effect of
R&D on productivity and economic growth needs more than simply the inclusion of
direct links. The most important spillover, knowledge spillover, can be significant. A
firm typically benefits, not only from its own R&D, but also on R&D conducted by
other firms, the domestic science base as well as research conducted by foreign firms
3
It is important to bear in mind that although endogenous growth theory is referred to here as a coherent framework, it
actually includes many different models that have distinguishable characteristics. See the discussion in Barro and Sala-I-
Martin for endogenous growth models.
4
Audretsch and Feldman (2003) present a comprehensive literature review of the history and scope of economic theory
related to knowledge spillovers and the geography of innovation.

and research institutes. Moreover, knowledge is spreading through patents, scientific
literature and other scientific communication, licenses, and intermediary products.
International diffusion of technology seems to very important factor in global

innovation process; in fact, the empirical research suggests that more than 50 per
cent of productivity growth in the individual OECD countries can be attributed to
innovations from three countries only (the US, Germany and Japan). Also local
spillovers are important for off-shoring decisions, as many industries form clusters5.
Proximity to clusters may also act as one reason for off-shoring decisions as will be
discussed in chapter 4.
Spillovers can affect the economy and firms in many possible ways. Cameron (1998)
distinguishes between the following four effects. First, technological spillovers reduce
the cost of firm’s rivals because of knowledge leakages, imperfect patenting and
movement of skilled labor between firms. These leakages can be quite fast and
efficient in knowledge distribution. For example, Mansfield (1985) has examined the
speed of technological leakages and finds that on average information on
development decisions ends up in the hands of rivals within 12-18 months6. It is
important to understand, though, that obtaining information is not equivalent as to
being able to use it productively. In other words, imitation does not occur
immediately, and in many cases it takes some time before rivals are able to utilize
the new knowledge7.
Second, there is a so called “surplus appropriability problem”, which means that even
in the absence of technological spillovers the actual innovator cannot appropriate all
the social gains from innovation, except when there is a possibility of perfect price
discrimination to rival firms (through licensing) and/or to end users8. Third, the
classic Schumpeterian “creative destruction” effect relates to innovation processes.
As new innovations appear, they cause the obsolescence of old products or
5
The importance of clustering was recognized already by Marshall, who provides three reasons for clustering. First, an
industrial center creates a pooled market for skilled workers. Second, a cluster creates opportunities for the development
of an intermediate goods industry. Third, knowledge flows locally more easily. Thus, technological spillovers can emerge.
In addition, several other advantages can be related to clustering, for example lower transportation costs, market size
effects and scale economies. The empirical evidence on clusters from the US suggests that the distribution of patents is
localized. Interestingly, it has been found that a significant proportion of spillovers come from firms in different
technological area than that of the receiving firm’s. It also seems that the distribution of innovations is more localized
than the distribution of production. (Cameron (1998). See also Feldman and Francis (2006))
6
The detailed nature of a new product or process reaches at least some of the competitors within about one year after the
completion. Development decisions as well as detailed information concerning processes tend to leak out somewhat more
slowly, as processes are mostly developed involving less communication and interaction with other firms. However, the
time difference between product and process leakages was not large.
7
Indeed, it is important to recognize the difference between incoming spillovers, which increase the innovation rate of
the firm, and appropriability, which affects the ability of firms to appropriate the returns from innovation.
8
See Griliches (1992) for a study on this effect

processes. Lastly, depending on whether new innovations are substitutes or
complements, either positive network effects or congestion may appear.
The central finding in the studies of spillover effects is that, in general, spillovers are
large and significant9. It turns out that returns to process R&D are usually higher
than returns to product R&D, and that basic R&D typically yields higher returns than
applied R&D. Returns to R&D vary considerably between industries so that in
research-intensive sectors R&D yields higher returns. In addition, inter-industry
differences are more significant than inter-country differences. Griliches (1992)
summarizes that despite some difficulties, a significant number of reasonably well-
done studies indicate that R&D spillovers are present, their magnitude may be quite
large, and social rates of return remain significantly above private rates.
Although inter-firm spillovers are important, R&D spillovers occur also inside firms.
For example, Battisti and Stoneman (2003) argue that in the overall diffusion of new
technology intra-firm diffusion is as important as inter-firm diffusion, although the
former has been to a large extent neglected in the literature. The reason for this is
probably the difficulty of obtaining intra-firm data10. Battisti and Stoneman (2003)
show empirically that the inter-firm effect is more important in the early stages, and
the intra-firm effect prevails in the later stages of the diffusion process.
2.2.2 The role of international spillovers
The international diffusion of technology is perhaps the most important form of

spillovers, as it can affect global innovation capacity and growth. International
spillovers can affect productivity through three channels. First, country’s openness to
information flows and its ability to absorb information from abroad is clearly
important. This requires strong domestic R&D sector through which international
spillovers are transmitted. Second, international trade is an important means to
acquire inputs more advanced than those produced home and thus provides access
to higher productivity production. Third, foreign direct investment and international
trade are both ways to learn new product technologies and processes.
9
See Cameron (1998) for summary of the central findings in studies of spillover effects.
10
So far the intra-firm literature has relied heavily on the so called epidemic models. The Mansfield type epidemic learning
model predicts in particular that the extent of use of a new technology within the firm will increase with the number of
years since first adoption, as learning reduces the risk of further adoption.

The literature typically distinguishes between two types of international spillovers;
embodied and disembodied international spillovers11. Embodied (rent) spillovers
refer to international spillovers through the trade of intermediate goods. Coe and
Helpman (1995) made an important contribution by pointing out that most
international trade takes place in intermediate goods when firms use inputs
manufactured and developed by their trading partners. Coe and Helpman estimate
that foreign R&D affects domestic productivity beneficially and that the link is
stronger the more open the economy is to foreign trade. In addition, their estimates
of the rates of return of R&D are high, both internationally and domestically. Here
the spillovers results from the fact that the original developer cannot extract all the
rents associated with the product, and some of the rents go to the buyer of this
intermediate good. This, again, adds value to the production of the buyer firm.
The results of Coe and Helpman induced an active debate of the importance and
measurability of international spillovers12. Most of the later research accepts their
main results, but some problems have been pointed out in the literature. For
example, Keller (1998) finds that also randomly created trade patterns result in
positive international R&D spillover estimates, and that these are often larger, and
explain the variation in productivity across countries better than real bilateral trade
patterns. This finding clearly leads to doubt the claim that patterns of international
trade drive R&D spillovers13.
Another approach to look at international spillovers is to focus on disembodied

knowledge spillovers, i.e. those forms of knowledge transfer that are not embodied in
tradable goods. Patents are used as a proxy for international spillovers in many
studies, such as Eaton and Kortum (1999), who argue that patenting is a good
indicator of where ideas are flowing. Technological distance is another common way
to model international disembodied spillovers; it is assumed that countries having
technological proximity are more likely to utilize these spillovers. The results by Kim
and Lee (2004) indicate that domestic R&D and international disembodied R&D
spillovers measured by the technological distance have positive and large effects on
TFP growth and technical change. In high-R&D-intensive countries only domestic
R&D has a large significant influence on TFP and technical changes, but for the low-
R&D-intensive countries, spillover variables are the main contributing factors to
productivity growth.
11
See for example Kim and Lee (2004)
12
See, for example, Engelbrecht (1997) and Lichtenberg and van Pottelsberghe de la Potterie (1998)
13
Moreover, Kao, Chiang and Chen (1999) reject the influence of foreign R&D expenditure weighed by bilateral trade
shares altogether.

Other relevant studies include for example Kiyota (2005), who studies firm-level
longitudinal data from 1994 to 2000 in Japan and finds that firm-level FDI had
positive impacts on productivity growth in both manufacturing and non-
manufacturing industries. In manufacturing, import-related R&D spillovers also had
significant positive effects on productivity growth, while intranational R&D spillovers
were not significant in general. Accordingly, the results thus suggest that
international R&D spillovers through trade and FDI can have significant effects on
productivity growth. Kiyota also finds that the positive effects of FDI-related R&D
spillovers last longer than import-related R&D spillovers, though both accelerate
productivity growth.
Nadiri and Kim (1996) have analyzed the international technology spillovers on the
production structure, output and productivity growth in the G-7 countries. They find
that the relative importance of own R&D effort compared to foreign R&D spillovers
differs considerably by countries. While it is high to the US (6), it is only 0.3 for
Canada and Italy, implying that the latter countries rely heavily on international
spillovers. For Germany, Japan, France and the UK it was about 1.2-1.6. Thus, it
seems that large EU countries are already relying rather strongly on international
spillovers.
Bernstein and Mohnen (1994) study international spillovers in R&D intensive sectors
and find that spillovers affect the cost, intensity of traditional factors, and the R&D
capital intensity as well as total factor productivity (TFP). Spillovers are transmitted
through the exports of goods and services, international alliances between firms such
as licensing agreements and joint ventures, FDI, international labour markets for
science and engineering, and international communications. They also find that
production processes become less labour intensive as international R&D spillovers
grow. In the short-run, R&D intensity is complementary to the international spillover.
For the US this relationship persists in the long-run as well, but for Japan the own
R&D intensity decreases. US R&D capital accounts for 60% of Japanese total factor
productivity growth, while Japanese R&D capital contributes 20% to US productivity
gains. In nutshell, the study finds that international spillovers cause social rates of
return to be about four times the private returns, meaning that the externalities are
significant.
International partnerships and alliances are another important channel for

international spillovers. For example, Gomes-Casseres et al. (2006) explore
knowledge flows in inter-firm alliances and argue that knowledge flows between

alliance partners are larger than those between pairs of non-allied firms. However,
knowledge flows are smaller than flows between units within single firms.
2.3 Empirical research on innovation, R&D and growth
Let us next assess the empirical evidence on the link between innovation and growth.
In economic literature the impact of innovation is typically estimated by using R&D
spending as a proxy, although the formal definition of innovation is usually broader14.
In theory, R&D significantly enhances growth and increases productivity, and the
ongoing stream of new innovations is a critical element in the positive growth in the
long run. On the empirical side there is a vast literature assessing the link between
R&D and growth by using the new growth theory. In majority of studies a strong
positive link between R&D capital and output is found15. Typically, a 1 per cent
increase in the R&D capital stock leads to an increase in output of 0.05-0.1 per cent.
The studies also find a strong positive link between R&D and productivity growth. In
addition, there seems to be a social gross (excess) rate of return to R&D, which is
estimated to be between 20-50 per cent.
Although many researchers find that R&D is a major contribution to economic

growth, there are some ambiguities. In reality, countries with high innovative activity
do not necessarily present higher growth figures. At the firm level there is lot of
research on the relationship between innovation and profitability16. Overall the
evidence is not unambiguous, as it has been difficult to establish a link between
innovation and profits, and innovation and productivity. For example, it has been
claimed that, contrary to some expectations, R&D is only a small contributor to
productivity at the firm level and not necessarily cost-ineffective. Thus, firms may
not invest as much as would be optimal in the economy level. For example, Jones
and Williams (2000) find that a free market economy often under invests in R&D,
and that the socially optimal level is significantly higher than what the free market
sets it at. For example, they argue that in the US the optimal level of R&D would be
about four times its current level17.
The problem to establish a link between firm profits and R&D partly results from the
fact that the number of factors potentially affecting profits is higher than the number
of factors affecting productivity. However, it seems that innovative firms in general
14
For example, the Oslo manual defines innovation comprising product, process, marketing and organizational
innovations.
15
See Cameron (1998) for a broad survey
16
See Cameron (1998)
17
Note that this study is conducted in year 2000.

are doing better. For example, Stoneman and Kwon (1996) find that firms not
adopting new technologies present smaller profits compared to those firms that do.
On the other hand, Duguet (2002) finds is that only radical innovation would
significantly contribute to total factor productivity (TFP) growth18. As for output
levels, Griliches (1992) finds that the estimated elasticity of output with respect to
R&D is around 0.07, meaning that for a 10% increase in R&D expenditure there will
be a 0.7% increase in output. This implies a rate of return of around 27% for R&D.
At a country level, several studies argue that R&D positively affects TFP. For
example, Coe and Helpman (1995) find that for larger countries the effects of own
R&D investment on productivity is significant, similarly as are spillovers from foreign
R&D investment. Studies by Griliches (1988) and Nadiri (1993) suggest that a
country’s production process and productivity growth depend on current and past
investments in R&D activities. Aiginger and Falk (2005) examine the determinants of
growth of GDP per capita using panel data for OECD countries for the period 1970–
1999 and find a large and statistically significant impact of business R&D (BERD)
intensity on GDP per capita with an elasticity of 0.22. In addition, the share of high-
technology exports is significantly positively related to GDP per capita. However, it
seems that BERD is more important than technological specialization in explaining
the level of GDP per capita.
Also studies Bassanini et al. (2001), and Guellec and Van Pottelsberghe de la Potterie
(2004) suggest that innovation activity measured as the change in R&D intensity is
one of the most significant factors affecting differences in GDP and productivity
growth. Using panel data for 16 OECD countries, Guellec and Van Pottelsberghe de la
Potterie find that the long-run elasticity of TFP with respect to public sector R&D
(GERD) and business sector R&D (BERD) capital are 0.17 and 0.13 on average.
Nevertheless, as already mentioned the results on the role of R&D in economic

growth contain some amount of ambiguity. For example Comin (2004) argues that
the actual contribution of R&D to TFP is extremely small. The study argues that R&D
is an industry with free entry, meaning that in equilibrium R&D firms, like ordinary
firms, will break even. This clearly contradicts the findings of Jones and Williams
(2000), who claim that all TFP factor growth is attributable to R&D investments. For
Comin (2004), the value of the resources used for R&D equals the value of the
technologies. Comin calculates from National Science Foundation estimates the
18
The result is robust to the definition of incremental innovation, differences in estimation methods and to the
introduction of variable returns to scale.

amounts spent on the development of new knowledge, products, and processes by
workers with training in the physical sciences. By determining the growth rate of
technology for a given level of R&D investment he finds that R&D contributes only
about 3 to 5 tenths of one percentage point to the 2.2% annual total factor
productivity growth in the post-war United States. Thus, while R&D investments can
have large externalities if the “next big thing” is discovered, the value of R&D is still
surprisingly small. It is important to note, however, that this study views R&D as
embodied, i.e. firms can mostly benefit from R&D only by using the goods that result
from the R&D itself19. This, in turn, implies that R&D investments are not necessarily
very profitable from a single firm’s point of view. Instead of R&D, Comin emphasizes
the role of other forms of innovation leading to increased productivity. These may
include, for example, managerial and organizational innovations and learning by
doing. Other scholars, such as Bardhan and Jaffee (2005), also question the cost-
effectiveness of R&D for firms, stressing the difficulty of appropriating returns to
innovation20.
Most researchers tend to support the claim that the socially optimal level of R&D
investment would be higher than the current about of R&D. This, clearly leads to the
question of whether governments should subsidize R&D investments by firms and/or
increase funding for public R&D conducted by universities and research institutes. A
strong education system seems to be one of the key factors affecting the innovative
capacity of a country, thus university research is widely supported by governments
throughout the world. Moreover, there is some evidence on spillovers between
academic research and certain types of government R&D and the private sector,
even though these spillovers are normally smaller than those between firms.
In contrast, government-financed business R&D is a somewhat controversial issue.

Advocates of government financed R&D argue that public support is imperative, as
otherwise firms under invest in R&D. On the other hand, critics question whether
such subsidies can be made without simultaneously resulting in significant distortions
to other aspects of economic activity21. For instance, it is possible that government
R&D results in crowding-out of private R&D spending. Also the selection of
government financed R&D projects has been a matter of debate; it can be asked
whether government can optimally select the R&D projects and firms worth
supporting.
19
According to this view innovations alter production only through new goods being produced from such investment
20
Bardhan and Jaffee (2005) suggest that this might actually be one reason for firms to go off-shore.
21
On discussion of this issue see for example Griffith (2000)

In empirical economic research on innovation the main emphasis has been on the
effect of R&D on productivity and growth. However, some studies have also
examined other determinants of innovation capacity. For example, Driouchi et al.
(2006) analyze the effects of knowledge on aggregate economic performance using
data from the United Nations Development Program (UNDP) and the World Bank for
four groups of countries during 1995-2001. Their findings suggest that knowledge is
a key driver of economic growth for each of the country groups. Variation in
economic performance among these groups may be related to the timing of
investment in education, R&D, and information technology22. In general, the
literature points to the direction that human capital significantly impacts economic
growth in OECD countries. For example, a recent study on OECD countries by
Bassanini and Scarpetta (2002) uses annual data for 21 OECD countries from 1971
to 1998 and argues that the social return on one additional year of schooling is a six
percent increase in steady-state output.
Geroski (1989) studies the effect of entry and innovation on TFP growth with a
sample of UK firms where innovation is measured by the SPRU significant innovations
database23. The study finds that between 1976-1979 innovative activity accounted
for 50 per cent of total factor productivity growth24. Budd and Hobbis (1989)
estimated UK manufacturing productivity between 1968-1998 by UK firms’ patenting
in the US and imports of machinery as measures of innovation. They found that
these parameters had a significant and positive effect of productivity.
To conclude, although in theory R&D should significantly enhance growth at the

economy level and profits at the firm level, this does not always occur. Clearly, there
are many issues that can contribute to the failure of R&D to create high economic
growth. For example, the time lag between innovation and actual production is
sometimes very long and therefore we do not see quick improvements in growth
figures. On the other hand, many things in addition to R&D and other innovative
activities affect economic growth, and growth can stagnate despite high R&D
spending. The same applies at the firm level.
22
Also, economic policies that affect trade and FDI may have a role.
23
See webpage http://www.sussex.ac.uk/Units/spru/foresight/ for details of the database.
24
However, in some later studies by Geroski (1995) the observed direct effects of innovations on corporate performance
were relatively small. In this study it seems that the benefits from innovation tend to be indirect, namely for user
industries. However, innovative firms seem to be less susceptible to cyclical pressures than non-innovative firms and firms
in a competitive environment also seem more likely to engage in innovative activities than other firms.

3 Economic theories of outsourcing and off-shoring
3.1 The boundaries of firm –why outsource?
When assessing R&D off-shoring it is important to understand the firm decision to

engage in outsourcing in general. Of course, some firms conduct R&D off-shoring in-
house, e.g. via FDI, but others outsource R&D to foreign subcontractors. In addition,
there are numerous types of partnerships and joint ventures with other firms,
institutions and universities. Thus, when a firm decides to go off-shore, it faces a
choice between in-house operations and outsourcing.
The firm choice “make or buy” has been a topic of active research for decades. The
discussion of the boundaries of firm dates back to Coase (1937), whose classical
argument was that in the presence of transaction costs, it can be less costly to
coordinate production through a formal organization than through markets.
According to this view the determination of the boundaries of a firm is fundamentally
based on efficiency reasons. In other words, firms exist only if they perform better
than markets in reducing transaction costs. The ideas of Coase have been studied
quite a lot by for example Williamson (1975, 1985) who developed the so-called
“transaction cost economics” approach (TCE). Williamson contributed by identifying
some potential sources of transaction costs and argued that firms can be more
efficient in dealing with these costs than the markets, as firms can use relational
contracts. Williamson suggested a three-factor paradigm in explaining the internal
governance. His three factors were frequency in transactions, uncertainty and asset
specificity25. According to this view, high level of uncertainty and asset specificity
may need a hierarchical relationship where one party has a control over another.
Similarly, if the transaction is frequent a formal governance system can be profitable.
Accordingly, the particular nature of each transaction defines the most efficient
structure, i.e. market, hierarchy or alliance.
Grossman and Hart (1986) contributed to the theory of firm by presenting a theory
of costly contracts, which emphasizes the existence of two types of contractual
rights: specific rights, and residual rights. Sometimes it may be too costly, or even
practically impossible, to design a contract including all specific rights over another
party's assets. For example in terms of R&D contracts it may be difficult to know ex
ante all the possible findings and outcomes of the R&D process. Thus, it may be
25
Asset specificity means that an input used by a firm or individual consumer is highly asset specific if it cannot readily be
used by other firms because of the site specificity, physical asset specificity, or human asset specificity

optimal for the first party to purchase all residual rights, in other words, to acquire
ownership. However, some harmful effects associated to the purchase of a firm’s
supplier may emerge, since this removes residual rights of control from the manager
of the supplying firm, which can distort manager's incentives26.
From a firms’ point of view the decision of whether to make or buy is essentially a
question of costs, with the term costs defined broadly. Firms have to evaluate the
costs of outsourcing on one hand and the cost of conducting the operation in-house
on the other. This can be simplified to evaluating the costs of production and costs of
governance. Costs of production clearly refer to the costs accruing when an output is
produced in-house or to the costs of purchasing the similar output from the supplier.
Asset specificity is an important consideration here; if the firm possesses the
resources specific for the task in question it is less likely that it will outsource, since it
probably can produce the product with lower costs than the potential supplier27.
In addition to production costs different kind of governance or agency costs will arise.
In case of outsourcing, contracting and negotiating costs at the beginning can be
significant, similarly as the monitoring costs during the process. Sometimes the
search for a partner or subcontractor may incur costs even before the contractual
relationship has been set. It is also possible that valuable information from firm’s
actions might leak during the process, which is especially important when discussing
about R&D outsourcing, since it is probably more difficult to protect intellectual
property rights in outsourcing relations than with in-house processes. The possible
disputes in case of break of contract and the agreement over residual rights have to
take into account too. Finally, different kind of agency problems (of moral hazard or
adverse selection type) can emerge. Nevertheless, it is important to note that also
in-house operations are not free from governance and agency costs either. For
example, managers and workers may have poor incentives for conducting the work,
and there may be information leakages. Typically, the same agency problems should
be considered here as in organization theory in general28.
Spencer (2005) summarizes the four basic approaches explaining firm’s decision to
outsource instead of integrating vertically (either at home or abroad): 1) A property
rights model, according to which outsourcing is more favorable the less important the
final-good providers are in creating surpluses; 2) An incentives model, where high
26
See also Holmström and Roberts (1998)
27
It is important to note that sunk costs should be excluded from the decision making process, although firms sometimes
fail to do this in reality. See for example the discussion in Roodhooft ja Warlop (1999).
28
See for example Holmstrom and Milgrom (1994) for incentives in a firm

incentives to off-shoring offset vertical integration advantages; 3) A delegation of
authority model, where an agent’s effort increases under off-shoring while total
control over the project by the principal is lost; and 4) A transaction-costs approach,
where the trade-off is between the costs of finding an off-shoring partner and the
high fixed costs of vertical integration.
Another approach is provided by Antras (2005), who relates this decision to the
maturity of the technological product. For a relatively new and non-standardized
good the safest method for off-shoring is through foreign affiliates to keep the
potential negative effects of incomplete contracts at a minimum. On the other hand,
for a higher level of product maturity, the transfer of production can successfully
occur at arms length with no subsequent involvement of the parent firm. Antras
refers also to other studies29 that, in accordance to his findings, suggest that the
transfer of younger technology should usually be conducted internally, while that of
technology between five and ten years old can be completed through licensing. In
addition, Davidson and McFetridge (1984, 1985) find that the probability of
internalization is higher the more radical the technology and the larger the R&D
section of a firm.
Other studies30 indicate that, in general, internalizing is more infrequent the more
codifiable and less complex the technology is with complexity being measured
through the amount of R&D necessary to produce the good. Similarly, Trefler (2005)
argues that for a sufficiently routine project that can be fully scoped or described
outsourcing is the appropriate choice, while projects difficult to describe from the
outset should be conducted in-house. The findings of Grossman and Helpman (2002)
add further to the understanding of the decision to outsource. They find that in case
the markets are highly competitive, outsourcing requires a large per-unit cost
advantage for specialized input producers compared to integrated firms. In contrast,
when markets are less competitive, it is central to compare the fixed costs that must
be borne by an integrated firm and those that are paid by specialized producers.
In conclusion, it is easy to see why traditionally only highly standardized tasks have
been outsourced. When the task outsourced is specific there are fewer risks involved,
since contract design, enforcement and monitoring are relatively easy. If the product
is already mature also the risk of knowledge leaking is negligible. Clearly,
outsourcing such a crucial and strategic activity as R&D is a challenging process. On
29
See Mansfield and Romeo (1980), and Mansfield (1979).
30
See, for example, Wilson (1977), Kogut and Zander (1993).

the other hand, in many cases the required resources to conduct successful R&D are
huge, and it may turn out not to be cost efficient from a single firms point. Equally,
sometimes a firm may lack the specific assets to conduct for example a certain ICT
intensive project. Thus, outsourcing the whole process or part of it may become a
profitable decision.
3.2 The theory of international trade –why off-shore?
In economic theory off-shoring relates to the theory of international trade and

division of labour. First of all, off-shoring can be examined in view of Ricardian theory
of trade, according to which one country can have either absolute or relative
advantage over another country. Absolute advantage means that a country can
produce a product more efficiently than another country assuming equal outputs. The
theory of comparative advantage, on the other hand, states that it can be beneficial
for two countries to trade, even if one of them is able to produce every item cheaper
than the other. What matters in that case is not the absolute cost of production, but
the ratio between production costs of different products in different countries.
Off-shoring phenomenon also relates to the Hechsher-Ohlin theory. According to this

paradigm, one condition for trade between two countries is that the countries differ
with respect to the availability of the factors of production (in the traditional
Heckscher-Ohlin theory these include labour and capital). For example, one country
may have high amount of capital but only few workers, while another country has a
mass of workers but is lacking capital. Heckscher-Ohlin theory states that countries
where capital is abundant and workers are few should specialise in the production of
goods that are capital intensive. Similarly, countries with abundant labour resources
should specialise in labour intensive production. Specialisation and trade between
countries generates higher standard-of-living for both of the countries involved. In
terms of off-shoring this means that some countries may have relative abundance in,
say, skilled labour, which explains that also some foreign firms might want to
conduct their research and development there. In addition to the classical Ricardian
and Hecksher-Ohlin theories there are several other theories of international trade
that also relate to the firm choice of location31. These are not, however, discussed in
the current context.
When examining the off-shoring phenomenon it is vital to understand the economics

of foreign direct investment as well, since FDI is a common way to conduct R&D off-
shoring. The economic literature on this subject is vast and research of R&D is
31
See for example the discussion in Hill (2002)

conducted in several different fields of study. The traditional approach has been to
explain FDI with comparative advantage and some key macroeconomic variables. FDI
thus depends on factors such as GDP, exchange rates, labour education levels, and
political and institutional environment in the host country. Other popular approaches
to examine FDI are the general equilibrium approach and industrial organization
approach (the so called new theory of firm)32.
32
See for example Markusen and Maskus (2001), Markusen (2005), and Blomström and Kokko (2003)

4 Benefits and challenges of R&D off-shoring
4.1 General reasons for R&D off-shoring
In general, globalization has significantly contributed to the change of R&D from a

homegrown process to one that can be safely and profitably conducted off-shore.
Countries farther away from each other steadily improve communication and engage
in mutual trade, and the developing world evolves closer to developed nations in
terms of education, legislation, and infrastructure. This clearly contributes to the
increase of off-shoring in general, and R&D off-shoring in particular. For example
Walsh (2003) suggests that the globalization of R&D stems especially from the
advent of information communications technology (ICT) and sustained growth in this
industry. Walsh also notes that the global scientist dispersion at the end of the Cold
War contributed to the establishment of international research consortia, broadening
the possibilities of the internationalization of R&D. Furthermore, many developing
countries have participated in international trade through WTO membership, which
probably has encouraged management decisions to opt for those regions (for
example China).
Other researchers emphasize the role of ICT as well. For example, Trefler (2005)
argues that two major factors in the spread of global R&D are the technological
improvements in ICT and the openness consensus of developing country political
coalitions. Jaffee (2004) points out that earlier the trend was to off-shore entire
companies, since the costs of disassembling a production process were extremely
high. However, as the costs of using services overseas started falling with the
development of communications technology, certain segments could be off-shored
with little distance-related cost. Therefore, the major change has been the separation
of the production process due to advances in technology: nowadays the comparative
advantage determines the location of occupations rather than the location of
industries. This distinction means that, on one hand, jobs with high specificity can be
maintained in the home country, while on the other hand a greater number of jobs
can also be off-shored with less effect on the efficiency of the firm. A study by Bartel
et al. (2005) further reinforces this point. According to them, the startling advances
in technology, especially in computer and information sectors, have allowed for the
rapid increase in IT outsourcing. This study finds that technological change increases
the odds of off-shoring, because firms can use better technology to improve their
services while not having to bear the heavy costs of implementation.

Other general factors contributing to the off-shoring of more complex tasks are
summarized by Spencer (2005). First, the reduction in tariffs and other trade
barriers, and the reduced costs of international search and matching33 are factors
increasing the attractiveness of off-shoring option. Equally, today’s world of
combined economies is leading to thicker markets34. It also important to note that
countries and locations possess different factor endowments, such as differing capital
intensities (Antras 2003), skill intensities (Marin and Verdier 2003), and labor
endowment (Grossman and Helpman 2002). All of these may contribute to the
increase of off-shoring as today’s increasingly global business environment provides
relatively easy access to the resources of other countries.
Although the general factors may encourage firms for off-shoring it is fundamentally
a firm level decision. Thus, let us next consider in more detail the firm decisions to
off-shore.
4.2 Firm level decisions to off-shore
The traditional motivation for off-shoring has been cost-savings. Firms off-shored
their (usually less strategic) operations to regions of lower costs, especially to
countries with low costs of labor. Conversely, nowadays the trend is increasingly to
off-shore some of the key operations too, and the reasons go beyond cost efficiency.
In fact, the research indicates that in many cases cost-savings are no longer the
most important motivation for off-shoring, and this is especially true when
considering R&D off-shoring. Moreover, while cost savings still undeniable play a role
in R&D off-shoring as well it is also important to acknowledge the potential problems
when off-shoring to countries with cheap labor force. For example, Clissold (2004)
presents evidence that the weakness of the legal system in China has frightened
many foreign investors. Thus, the low cost is clearly not the only decisive factor.
Bardhan and Jaffee (2005) point out the following motives for R&D off-shoring:
experience accumulated through off-shoring of manufacturing and service activity,
the need for a shorter R&D cycle, the increased efficiency and effectiveness of R&D
activity, and the growing R&D talent in certain regions (especially in Russia, China,
and India). Trefler (2005) questions pure cost-cutting reasons as ultimate driver
behind off-shoring, as 85% of all off-shoring by US companies is done within other
OECD countries -not particularly inexpensive destinations. Instead he emphasizes the
other motives, such as proximity to consumer bases. The recent Economist
33
See also Grossman and Helpman, 2005
34
See McLaren, 2000

Intelligence Unit survey (2004) conducted among corporate executives finds that the
three most critically important factors for the selection of R&D locations were: local
R&D expertise in the firm’s industry, availability of R&D scientists with appropriate
skills, and cost of labor for R&D. Country stances towards investment in R&D (such
as intellectual property rights) were also critically important, which broadly reflects
the importance of institutions and societal stability in the destination country.
It is an interesting question whether R&D off-shoring affects the profitability of R&D,

i.e. is obtaining increased efficiency one reason for R&D off-shoring? Bardhan and
Jaffee (2005) assess the problem with a firm survey of 48 firms headquartered in
California. They find that smaller effectiveness of R&D can lead to greater off-shoring
of marginal attributes that are not likely leading to big increases in profits. Even
though US R&D expenditures, patent generation, and productivity growth have
matched investments, data at national and firm levels raise concerns about the cost-
effectiveness of R&D, especially given the difficulty of appropriating innovation profits
on a consistent basis due to increased global competition. This suggests that instead
of off-shoring leading to smaller effectiveness of R&D, it may be that the low
effectiveness makes R&D off-shoring more likely. Assuming that off-shoring would
provide means to enhance the efficiency, it would clearly have a positive effect on
the off-shoring firms and economies.
In addition to pro-off-shoring factors it is important to assess the reasons that may

induce firms not to off-shore to a particular place. Of central importance here is the
imperfect contract enforcement in some countries, which is likely to act as
discouraging R&D off-shoring35. By definition, incomplete off-shoring contracts are
contracts that cannot be written conditional on the level of investment. Potential
problems with incomplete contracts include, for example, unforeseen contingencies
and their higher-than-expected costs and the inability of courts to enforce contracts.
In general, Antras (2005) finds that the decision for firms to off-shore production
boils down to a trade-off between the lower costs of manufacturing found in
developing countries and the distortions that arise from the imperfect contract
system found in such countries. In particular, when the good is new and cutting-
edge, let alone still in R&D process, contract incompleteness is very unattractive,
since both the product development and the manufacturing stages of production are
adversely affected.
35
Spencer (2005) provides a summary of the literature on the relationship of incomplete contracts and international off-
shoring.

Similarly, a survey of firms in Bardhon and Jaffee (2005) suggests that the main
reasons against off-shoring include concerns and sensitivity about intellectual
property rights, lack of knowledge and exposure to the potential targeted host
countries, and, somewhat startlingly, high costs, especially for relatively smaller
firms. Thus, the uncertain costs associated with imperfect contracts can dissuade
firms from off-shoring.
4.3 The challenges in R&D off-shoring
While R&D off-shoring can bring along significant benefits, it can also present firms
and economies with major challenges. On an economy level off-shoring is a highly
sensitive area evoking debate. The major concern of the protectionist group has been
the potential loss of local jobs. In addition, it has been suggested that those workers
who manage to maintain their work would have substantially lower wage. Therefore,
the protectionist side usually feels that that home labor markets should be
defended36. In contrast, economists are mostly pro-globalization and argue that the
gains from international trade more than compensate the possible losses.
It is true that we often read about massive layoffs at home, while the same firm
might open a new factory in a third country. On the other hand, the theory of
international trade clearly states that production should take place in a location that
has the comparative advantage for conducting it and this should lead to higher
welfare of both countries. It is also useful to realize that while job layoffs get a lot of
public attention, if remains often unclear to the general public how long the laid off
workers actually remain unemployed37. Moreover, as regards R&D off-shoring it
seems that one of the most important reasons for firms to go off-shore in the first
place is the access to skilled labor that may not be sufficient at home. Thus, off-
shoring R&D does not necessarily move away jobs at home at all.
Another consideration relating specifically to R&D off-shoring is the fear that it could
lead to deterioration of domestic innovation capacity and loss of comparative
advantage should new innovations be increasingly developed outside home area. Let
36
See for example Jaffee (2004) on more discussion of this issue.
37
A recent report on displaced workers in the U.S37 presents a number of interesting aggregate results. The study is
conducted by the United States Bureau of Labor Statistics, and covers years from 2001 to 2003. From January 2001
through December 2003, 5.3 million American workers lost their long-term (three years or more) job, up from four million
in the period from January 1999 to December 2001. By the time of the survey in January 2004, 65% of those who had
lost their jobs in the three year period were reemployed, and another 15% were no longer considered in the workforce (so
20% were unemployed). Of those that lost their jobs, 43 percent were lost due to plant closures or moves. Nearly one-
third of those who were displaced from their long-term jobs were involved in manufacturing, many of which came from
the manufacturing of durable goods such as computers and electronic products sectors. Among those reemployed
workers, 43 percent were earning as much or more in their new job as they were in the job the lost, a smaller number
than from the 2002 survey, and 34% reported earnings drop of 20% or more.

us next discuss whether local job protection of R&D workers is reasonable and
whether we should worry about the effects on innovation capacity.
Van Welsun and Reif (2005) analyze the accounts of jobs thought to be at risk of
being off-shored. Somewhat surprisingly, they find no evidence of linkage between
off-shoring and long-term worker displacement in the home country, including
workers in R&D sector. Jaffee (2004) presents a detailed analysis of the two
important potential negative effects assumed to arise from off-shoring, i.e. job losses
and wage cuts38 in the US. He finds that those people that are in “at-risk professions”
actually have a more favorable re-employment situation than dislocated workers in
other occupations. Though more improvement is needed on the individual level for
fairer job loss policies, in aggregate there does not seem to be any serious effects on
job levels due to outsourcing.39 As for income levels, according to Jaffee (2004) the
relative wage was higher (with some individual exceptions) for “at-risk occupations”
in absolute terms and relative to wages of other U.S. workers in all but one case.
Jaffee (2004) also argues that the job losses or income decline as a result of R&D
off-shoring are not occurring presently, and are not likely to appear within the next
ten years. However, within the next fifty years there could be either a shifting of
comparative advantage or increased off-shoring of initially non-tradable goods and
services, which could create adverse effects. This concern is shared by Freeman
(2005), who questions the ability of developed countries to cope with radical changes
in knowledge leadership.
As for Europe, Kirkegaard (2005) argues that off-shoring and outsourcing are more
an opportunity than a threat. While these will generate both winners and losers, it is
fundamentally up to individual governments to ensure that countries realize a net
gain. Clearly, the problem with assessing the implications of R&D off-shoring on EU
and US job markets is that there is not much research yet, as the phenomenon is
relatively new and the consequences appear with a significant time lag.
Let us next turn to the threatening scenario that developed countries are losing their
comparative advantage in knowledge-based industries to developing countries. This
common concern is summarized by Trefler (2005), who writes that China and India,
“in the most alarming scenario […] have an infinite capacity to absorb OECD
38
He uses the structure created in Bardhan and Kroll (2003) to isolate those jobs that are especially at risk of off-shoring
(no required face-to-face contact with customers, information and data-based services that are adaptable to foreign
workplace cultures, and communication requirements that are readily adaptable to high speed broadband links). Then, he
examines how people in these professions in the United States have managed over recent years with the increase in off-
shoring.
39
See also Autor (2000) for more on the growth of temporary help in the United States, and the role of outsourcing in
displacing those positions with the least firm-specific importance.

technologies and management strategies, to improve on them, and ultimately
compete head-to-head with the OECD.” This situation would, of course, be
exacerbated by the low wages in developing countries, which further enhances their
competitive advantage with respect to developed countries. Can the off-shoring of
knowledge-based industries really make developing countries able to overtake
developed countries economically? Fundamentally this question remains unanswered,
as is it practically impossible to forecast what is going to happen within, say, the next
50 years. However, some scenarios have been presented in the literature.
It is a fact that the growing number of research installations outside the EU and the
US may contribute to human resource leapfrogging, provided that population
continues to grow in developing countries, enough workers are directed to R&D in
these countries, and leading edge commercial products are developed in these
countries. However, Trefler (2005) argues that comparative advantage in knowledge-
based industries will continue to be held by the United States and other OECD
countries due to their special characteristics, which make significant innovations
likely to occur. The basis for this argument is the strength of institutions in these
countries, which leads to better ability to produce innovations. This holds, in
particular, in high-tech and innovative industries, which Trefler describes as “contract
intensive” that are only able to flourish in legal environments found in OECD
countries. This approach is, however, somewhat shortsighted, as also developing
countries are continuously developing their infrastructure, governance, and
legislation. Significant improvements in terms of intellectual property rights have
already been made for example in China, and developing countries in general are
catching up also in this sense.
Jaffee (2004) argues that the US continues to be the centre of innovation even when
the new scientifically educated world population catches up. According to him, the
cultural tradition of rewarding innovation and entrepreneurship, allocation of
resources to R&D in the private and the government sector, focus and money for
education, a benign immigration policy with respect to students and technically
skilled people, and legislative system are the crucial factors maintaining the US
leadership.
Acemoglu, Antras and Helpman (2005) argue that countries with good institutions
will gain comparative advantages in production processes that have high
complementarities. If innovation is found to be a process that involves many industry
complementarities, then countries with good institutions should be more prone to
innovation, even as their specific R&D is off-shored to a different place. Levchenko

(2004) presents a pioneering work on institutional quality and international trade and
finds that when utilizing an institutional approach to determine the effects of
international trade (instead of the basic Heckscher-Ohlin model), the results are
different from the traditional findings. Levchenko states that the differences in
institutions can actually determine the balance of trade. This clearly affects the
decision to off-shore, but also has new welfare implications; better institutions lead
to greater trade benefits for developed countries.
Yet another major concern with R&D off-shoring has been the possibility that local
spillovers will be lost, as innovative activity moves away. This approach does not
enjoy full support from the literature; as was already pointed out in chapter 2.2,
international spillovers seem to spread fast and are important for domestic firms.
In conclusion, it seems that developed countries still have certain advantages at the
moment, especially in terms of institutional environment. However, the developed
nations have to prepare themselves for the possibility that the gap is narrowing down
with increasing speed.
4.4 Concluding remarks from the literature
In view of economic literature it is clear that R&D off-shoring can have both negative
and positive effects on the innovation capacity of the home area, in this case the EU.
For example, it is possible that some local spillover effects are lost if research and
development will be conducted off-shore and skilled labor may increasingly start
moving to more attractive locations following off-shoring firms R&D. The ultimate
negative scenario would be that the global key areas of R&D would be located
outside the EU. As R&D is such an important determinant of productivity and
economic growth this could obviously threaten the long run prosperity of the area.
However, it is very important to bear in mind that there are important positive
effects as well, which can more than offset the negative impact. First, even though
part of the R&D by European companies will be conducted off-shore, it is likely that a
significant share of the new innovations leak back to the EU area in form of
spillovers. Thus, the actual location of R&D may not be a decisive factor for
innovation capacity, as the overall innovation capacity is a much broader concept and
the ability to quickly adopt new innovations –even those developed somewhere else-
is of utmost importance. Second, if comparative advantage in R&D in some areas
shifts to non-EU countries, according to economic theory it will actually be beneficial
to transfer R&D activities to these areas. Third, it is not clear yet whether R&D off-
shoring will become a major trend at all, so far only a small share of the R&D

conducted by EU firms takes place off-shore. The EU policymakers can significantly
affect firm level decisions, for example by providing firms with access to skilled labor
at home, and maintaining high protection for intellectual property rights. Also,
increasing the attractiveness of new EU member states as locations for R&D is an
important consideration. Finally, the developing countries will eventually lose their
position as low cost locations, which will somewhat decrease their attractiveness.
In conclusion, the overall effect of R&D off-shoring does not have to be negative,
instead the possibility to off-shore part of R&D may actually result in higher
innovation capacity and growth in the long run. Nevertheless, a careful examination
of the different effects of R&D off-shoring on the overall innovation capacity, i.e. on
the innovation indicators is needed to better understand the potential impacts.
Therefore, let us next focus on the impact of off-shoring on the EIS indicators. The
next chapter will present a qualitative analysis of the potential impact. Part 2 of the
report will then continue with quantitative and empirical analysis.

5 Analysis of the EIS indicators and EIS 2005 survey
The purpose of this study is to study the effect of R&D off-shoring on the innovation
capacity of EU firms. It is important to note that innovation and R&D are interrelated
but innovation is a broader concept. The Oslo manual defines innovation as “the
implementation of a new or significantly improved product (good or service), or
process, a new marketing method, or a new organisational method in business
practices, workplace organisation or external relations”. Obviously, R&D contributes
directly to innovation capacity, because it usually results in new or improved
products, services or processes. In addition, R&D can indirectly affect other aspects
of innovation. The examination of EIS (European Innovation Scoreboard) innovation
indicators is of significance, as the indicators are designed to give an accurate
description of the innovation status of the countries and should detect also some of
the indirect effects. Some indicators are likely to become less affected by off-shoring,
but some of them are expected to change accordingly.
Before going into detailed analysis of the indicators let us first briefly discuss the
results of the latest EIS 2005 survey, which will highlight some of the recent trends
in the innovation in the EU. Next section discusses the potential impacts on individual
indicators on a qualitative basis. It is important to note that at this stage the links
between R&D and EIS indicators have not been established by econometric analysis.
Moreover, some of the links will remain indeterminate, as it is not possible to conduct
empirical assessment. However, some of the links will be verified by empirical
research later.
5.1 EIS 2005 –indicators and general findings of the survey
5.1.1 Indicators and country groups
The central tool in analyzing the innovation capacity of the EU is the Summary
Innovation Index (SII) that has been constructed based on 26 individual indicators
with equal weight. The results for the EIS 2005 are based on the methodology used
in 2004, but the new SI-index includes 8 new indicators and 18 of the old ones. The
SI-index is composed of two main groups of indicators, Innovation Inputs and
Innovation Outputs.
The Input group includes three sub-groups:

Innovation drivers, which measure the structural conditions, required to innovation
potential.

Knowledge creation, which measure the investments on human factors and on
R&D activities.
Innovation and entrepreneurship that measure the efforts towards innovation at
the microeconomic level.
Respectively, the elements of Innovation Output can be grouped into two categories:
Application that measure performance in terms of labor and business activities and
their value added in innovative sectors.
Intellectual property, which measure results in terms of successful know-how,
especially to high-tech sectors.
In EIS 2005 analysis the countries were divided into four groups using cluster
analysis40. These groups include innovative leaders, intermediate countries, trailing
countries, and lagging countries. Among EU-countries Finland, Sweden, and Denmark
belong to the leader group. The intermediate group comprises Austria, Belgium, the
Netherlands, the UK, Germany, France, and Italy. The trailing countries group
includes Spain, Lithuania, Slovenia, the Czech Republic, Hungary, and Slovakia, and
the laggards group includes Portugal, Greece, Estonia, Latvia and Poland.
Another way of classifying countries is to examine the current performance (as

measured by SII) against the short-run trend performance (average growth rate of
SII for three years). Countries can be divided into four groups based on the current
SII score and trend performance. First group, leading countries, includes those
countries that have both high SII growth rate and SII score and resembles the
innovative leaders group above, i.e. includes Finland, Sweden, Denmark, and
Germany41. Most of the new member countries belong to the catching up group,
which means that their current SII scores are still low, but the growth rate of SII is
high. France, Luxembourg, Ireland, United Kingdom, Netherlands, Belgium, Austria,
Norway, and Italy fall to the group of countries showing average performance. The
losing ground-group, which has both low score and low growth rate of SII, includes
Estonia, Poland, Slovakia and Spain.
40
See details in EIS reports at www.proinno-europe under INNO-Metrics
41
Examination of individual indicators reveals that the innovation leaders, Sweden, Finland, Denmark, Switzerland, and
Germany take up 60 per cent of the leading slots.

Figure 5.1. SII and trend performance
Source: European Innovation Scoreboard 2005
Before discussing the individual indicators in more detail a few points should be taken
into account. First, it turned out that many of the new member states belong to the
group of lagging countries. This is partly due to their low patenting activity as
investments in R&D have been low. Second, many of the lagging and trailing
countries do not have the capabilities for creative innovation, thus it might be better
for those countries to concentrate on developing innovation diffusion capabilities.
Third, the indicators can have slightly different interpretation depending on the
country in question. For example, the indicator “sales of new-to-market products”
may mean creative innovation in innovation leading countries with global markets,
while in lagging countries it is likely to refer to product introduction to the domestic
markets, which does not necessarily mean creative innovations by the company
itself. For some indicators the optimal level is also dependent on national
circumstances. For example, high share of university R&D financed by business
sector is good in leading and intermediate countries, but in the lagging countries it
may be linked to very low levels of business R&D42.
42
As business sector does not have the capability to conduct R&D in-house, it is contracted to universities.

5.1.2 Relative performance of the EU compared to the US and Japan
The EIS 2005 composite index confirms the fact that the EU is still lagging behind the
US and Japan in terms of innovation. In fact, the innovation gap between the EU25
and Japan seems to be increasing, while the one between the EU and the US is quite
stable. A linear extrapolation of the current performance in terms of SII and growth
rates of SII provides an estimate that it would take more than 50 years for the EU 25
to reach the US level of innovation performance.
A large share, about 70 per cent, of the innovation gap between the EU and the US
can be explained by lagging performance of EU area in three indicators: USPTO
patents, population with tertiary education, and ICT expenditures. Respectively, the
gap between the EU and Japan is mainly explained by EU’s lagging performance in
USPTO patents, Triad patents and population with tertiary education. However, lower
patenting activity of the EU may be partly due to very low patenting rates of the new
member states, which is primarily due to traditionally low investments in R&D in
these areas.
The closer examination of individual indicators shows a significant increase in the gap
between EU and the US in public R&D expenditures and exports of high-tech
products. Between EU and Japan the gap for ICT expenditures, Triad patents and
both public and business R&D expenditures is increasing too. The EIS 2005 report
also compares the EU and the US in terms of scientific output. According to this study
Europe is significantly behind the US in scientific output per capita, especially in
citations. The report also suggests that, in general, the US universities are more
integrated in the innovation process and contribute significantly to the diffusion of
innovations.
The US outperforms the EU in 11 indicators, while EU is better only in 5 indicators

(S&E graduates, university R&D financed by business sector, employment in
medium-high and high-tech manufacturing, community trademarks and community
designs). Similarly, Japan outperforms EU in 11 indicators, but EU scores above
Japan only in 4 indicators (share of medium high tech and high-tech R&D, university
R&D financed by business sector, community trademarks and community designs).
Furthermore, it must be realized that performance in intellectual property is
somewhat biased, as local companies have a home advantage in the local market.
This explains why EU countries score higher than the US and Japan in community
trademarks and community designs. Regardless of home advantage, EU is not
outperforming the US and Japan in EPO patents, which further underlines the

innovation gap between EU and US and EU and Japan. However, it seems that in
terms of innovation trend, EU shows faster growth than the US in 10 indicators.
Especially the European catching up countries show fast growth in indicators. Japan,
on the other hand, shows higher growth in 9 indicators while the EU only
outperforms Japan in 3.
5.1.3 Differences between EU countries
Another interesting feature of the EU innovation performance is the relatively low

economic performance of some innovation leaders. For example, although Finland is
one of the innovation leaders in the EU, its per capita GDP is below the majority of
countries in the intermediate innovator group, and the labour productivity was only
92.6 per cent of the EU15 average. The growth rates of GDP are higher than EU
average, though, so these countries can be expected to receive a higher return on
investment in innovation in the long run.
In general, large differences among EU countries continue to prevail. EU25 includes

some very innovative countries that score high in terms of SII, while the rest of the
EU, especially the new member states, is far behind the EU average. For some
countries (Malta, Slovakia and Poland) it has been estimated that catching up to the
EU 25 average would take more than 50 years. The time lag is quite long for
Hungary, Slovenia and Italy too; these countries are estimated to reach the EU 25
average level under the current conditions by 2015. In addition, some currently
average countries such as UK and France might regress to the EU average level
possibly within 5-10 years.
Innovation efficiency is a key concept of innovation discussion, as it determines how

efficiently inputs are converted into outputs. The EIS has adopted an input/output
approach that helps to understand the transformation of innovation inputs into
outputs. National innovation efficiency can be measured for example with the ratio
between EIS composite index for inputs and outputs. For EIS 2005 the composite
indicator for Inputs was computed as the average of the 16 input indicators
(Innovation drivers, Knowledge creation and Innovation and entrepreneurship) and
the composite Output indicator respectively was computed as the average of the ten
output indicators (Applications and Intellectual Property). As expected, there is high
correlation between inputs and outputs, such that relative input performance is close
to relative output performance. However, differences in relative performance do exist
for some countries. For example, Germany, Luxembourg, Ireland and Malta show
much better performance on outputs suggesting that these countries are good at
transforming their assets into successful innovations. On the other hand, Estonia,

Lithuania and Cyprus show much weaker performance on outputs than on inputs.
The EIS report suggests that this may be partly related to the population
receptiveness to new products and services. Among ten countries with highest share
of population attracted by innovative products or services43, nine have an above
average output/input rate. On the other hand, among the ten countries with lowest
attraction towards innovations seven have below average output/input rate.
It is important, however, to interpret these results with caution, as the countries are
very diverse. For example, the high output/input group includes both very innovative
countries (such as Germany and Finland), and mid-performing countries (such as
Italy). The output indicator is also somewhat problematic, because it relies heavily on
patenting activity as a measure of outputs. However, there is a lot of variation in this
respect among countries. In addition, one has to take into account that for some
countries and industries the lag between innovative investments and the payoff
might be considerably long.
The challenge in analysing innovation capacity with EIS analysis is that it implicitly
assumes that higher level of an indicator is always better. However, this is not the
case for all indicators and countries. For some indicators there is clearly an optimal
level, above which it is not reasonable to aim. For example, university R&D financed
by business is an indicator having different interpretation depending on a country.
For middle level or high innovation countries it is usually a positive thing is this
indicator increases, but for lagging countries it may reflect a low level of business
R&D. Similarly, for education more is not always better. Although it is imperative to
have enough people with tertiary education not everybody should obtain a university
degree.
Respectively, for example trademarks do not always give a realistic picture of the
innovative activity, as the registration of trademarks in one country does not
necessarily mean that the trademark in question would be new. Trademark
registration is high in many of the new EU members, but this mainly reflects the
registering of trademarks that have already been registered in other countries (by
parent corporations).
5.1.4 Concluding comments of the EIS 2005 survey
In conclusion, it seems that the EU is facing two main challenges with regard to
innovation capacity. First, there is a huge gap between EU25 and US, as well as
43
See the Innobarometer 2005 study

between EU25 and Japan. Second, the differences between EU countries are large, so
there is a challenge to raise the innovation level of the lagging and catching up
countries. It also turns out that sometimes there are differences in the performance
of innovation subgroups within a country44, although most countries perform at a
comparable level in each of the 5 categories. Despite a few exceptions it seems to be
a rule that countries with an even performance in each of these categories tend to
have better performance overall than countries having an uneven distribution. This
suggests that on a country level emphasis should be placed on first improving the
performance in lagging dimensions, instead of trying to further improve the
performance in outperforming dimensions.
5.2 Qualitative analysis of the effects of R&D off-shoring on EIS indicators
5.2.1 Background
Let us next focus on the effect of R&D off-shoring on the EIS indicators. Broadly
speaking, the indicators can be grouped into two groups depending on the type of
impact R&D off-shoring could have. First, some indicators, especially on the input
side, depend on policy makers’ decisions and are not directly affected by firm level
decisions. However, indirect effects may emerge, as policymakers may want to
change their policies as a response to increased off-shoring (or at least firms
anticipate these changes). The second group includes indicators that are directly
impacted by firms’ off-shoring decisions at the aggregate level. The magnitude and
direction of the impact depends (at least) on the following aspects:
• The quantity of R&D off-shored

• The degree of substitution between foreign and domestic R&D
• The type of R&D off-shored (e.g. market seeking vs. technology seeking)
• The amount of spillovers back to home markets (intrafirm, interfirm and
interindustry international spillovers)
• The form of off-shoring (e.g. greenfield, M&A, outsourcing, partnerships)
Fundamentally, a country’s industrial structure is important determinant affecting the

quantity, type and form of off-shored R&D. Further, spillovers depend on many
factors, such as technological and geographical proximity between firms, the form of
44
For example, Germany, Italy, and Luxembourg are performing worse in Innovation drivers than in the other groups. On
the other hand, Estonia, Latvia and Portugal perform considerably better in Innovation and entrepreneurship than in the
other groups and Czech Republic and Ireland show good performance in Applications.

off-shoring, patenting activity, international trade flows, informal communication
etc45.
Let us next briefly summarize the potential factors causing firms to off-shore (firm
level decisions to off-shore are discussed in more detail in literature review in section
2.1). Reasons to go off-shore are obviously various and there is not much systematic
research available yet. However, at least the following reasons have emerged in the
surveys.
1) Possibilities to acquire new technology and to network within research and

business community. This refers to situations where, for example, a firm goes off-
shore to utilize the possible spillovers from other companies and research
institutes within an area, and to access the state of the art know how. In other
words, proximity to research clusters and R&D concentrations sector may provide
an important pull factor. In addition, the size of the R&D sector may be of
significance. On the other hand, the lack to these research clusters at home can
act as a push factor to go off-shore.
2) Market proximity, i.e. possibilities to customize existing products or services to

new foreign markets. This is probably the least problematic type of off-shoring;
when a company wishes to launch is product or service to new markets, in most
cases it is necessary to adjust the product/service to meet the needs of the new
customers. Some R&D is often needed and it is clearly beneficial to conduct these
operations close to future markets. It is difficult to see how this kind of R&D off-
shoring could in any way deteriorate the innovation capacity of the EU area.
3) Cost savings, for example access to low cost labour. This has been important
reason especially for off-shoring of manufacturing and it is undoubtedly important
for R&D off-shoring as well, as for example China and India possess a large
amount of skilled S&T workers available at a lower cost than their colleagues in
the EU.
4) Access to skilled labour. As already mentioned above, many developing and

catching up countries are investing heavily in the education system and especially
in the education of S&T workers. The challenge to the EU is to be able to provide
adequate amount of highly skilled workers and especially invest heavily in the
quality of the education system. This is very important, as survey results have
45
See discussion in section 2.1

shown that access to skilled labour has been one of the most important reasons
to go off-shore.
5) Factors related to business or political environment, and/or economic factors.

These may include for example favourable tax treatment for R&D units, access to
early stage venture capital, quality of relevant legislative system (e.g. protection
of intellectual property rights), general attitudes towards high technology, and
public demand for innovative products
6) Other reasons such as strategic considerations (for example entering new market
area or collaboration with competitors or contractors) and access to global 24/7
processes.
Whatever the ultimate motivation, R&D off-shoring is likely to affect the EU economy
in many ways, which effects the indicators are expected to capture. The next section
discusses the potential impacts on the indicators in more detail.
5.2.2 Analysis of the indicators
Innovation Inputs
I. Innovation drivers
In general it can be stated that the first group, innovation drivers, includes indicators
that are not directly affected by companies’ decisions regarding R&D off-shoring.
However, indirect effects may, and are likely to exist. The level of these indicators is
essentially determined by a political process, which clearly is affected by the public
demand for these inputs. The demand for inputs, in turn, is affected by firms’
decisions; including their R&D strategies. The common property of all these
indicators is that if they are at high level (especially in comparison to foreign
countries), this is likely to act as a pull factor for R&D investment. The opposite holds
for a situation where these resources are weaker than those of other countries.
1.1 New S&E graduates per 1000 population aged 20-29

Due to problems of comparability for educational qualifications across countries, a
broad coverage is chosen and this indicator covers everything from one-year diploma
graduates to PhDs. It has turned out that access to skilled labour is one of the most
important determinants for the location of R&D and can be one reason for R&D off-
shoring46.
46
See for example Freeman (2005) and EIU survey

In principle, if we assume that domestic R&D is increasing, this is likely to increase
the demand for science and engineering graduates. On the other hand, in case R&D
is increasingly going global, this might decrease the demand for local expertise,
provided of course that global R&D is a substitute for local one, i.e. off-shoring R&D
to locations outside home country decreases R&D conducted at home.
Nevertheless, as the number of S&E graduates is determined by education policy,

policymakers can respond to R&D off-shoring by investing more resources in S&E
education to attract R&D to home country. It is important to realize that the time lag
from the decision to invest more resources in education is reasonably long, around 5
years. In summary, the short-term effect of R&D off-shoring on the number of
graduates is negligible, but the long run effect depends on the political process.
1.2 Population with tertiary education per 100 population aged 25-64
This is a general indicator of the supply of advanced skills covering a broader range
of education fields, as in many areas of innovation a wider scale of skills are needed.
Similarly as indicator 1.1 this reflects trends in education policy, but as it covers the
whole of working age population changes occur very slowly. In addition, comparisons
among countries are difficult and should be conducted with caution, as educational
systems differ significantly in terms of access and the level of attainment that is
needed for a tertiary degree.
With respect to R&D off-shoring the same reasoning as with indicator 1.1 applies. As
an input, skilled labour is obviously an important factor for R&D, and access to well
educated labour force seems to be one of the main drivers of R&D off-shoring. In
principle, R&D off-shoring can affect education levels if it causes policymakers to
improve the education system and/or affects people’s interest in higher education.
However, such changes are very difficult to predict and only occur in the long run, if
at all.
1.3 Broadband penetration rate (number of broadband lines per 100 population)
Access to broadband services has become a priority by the policymakers across
Europe, and the Barcelona European Council (2002) attached priority to the
widespread availability and use of broadband networks throughout the Union by
2005. Also national broadband strategies have been developed. In addition to
political factors, the broadband penetration rate is dependent on public demand. In
this sense the general attitudes towards high technology play an important role.
Finally, product market competition has a significant effect, as intensive competition
leads to lower prices increasing broadband penetration.

Clearly the state-of-the art information technology is an essential input for
innovation, as well as for R&D. In fact, many researchers attribute the phenomenon
of R&D off-shoring considerably to improvements in ICT. However, it is fairly difficult
to assess the implications of R&D off-shoring on this indicator, as there is no direct
link between broadband penetration and R&D off-shoring by companies.
1.4 Participation in life-long learning per 100 population aged 25-64

Indicator measuring life-long learning is another input indicator aiming at capturing
the interest in population to engage in ongoing development of skills. Life-long
learning is important not only because of the specific skills people develop, but also
because participation in life-long learning prepares people for “learning to learn”. The
ability to learn, in turn, is important for being able to learn new tasks and skills
needed for example at work.
The relation between R&D off-shoring and life-long learning is an ambiguous one.
Clearly firms appreciate their personnel to be updated about new trends and
information in a society and this is even more important for firms conducting R&D.
Thus, presumably of the workforce at home has better ability to learn, this might
discourage firms of going abroad. On the other hand, firms that are active in R&D are
probably more prone to re-train employees. Thus, should more R&D be outsourced,
this could decrease the life-long learning at home country. However, this is a
marginal effect, at best.
1.5 Youth education attainment level (percentage of population aged 20-24 having
completed at least upper secondary education)
As with other education inputs this indicator aims at capturing the supply of human
capital, in this case especially that of the younger age group. This indicator is
important as the upper secondary education is considered to be the minimum level
required for successful participation in a knowledge-based society. The similar
reasoning as with other education indicators applies.
II. Knowledge creation

The knowledge creation group includes indicators directly reflecting the magnitude of
R&D operations, especially in terms of financing.
2.1 Public R&D expenditures (as a percentage of GDP)

R&D expenditures represent one of the most important forces driving innovation.
There is also a lot of research on the impact of R&D expenditure on economic growth

(see the discussion in the related literature review in chapter 2). The Barcelona
European Council (March 2003) set a target for the EU to increase R&D expenditure
to 3 per cent of GDP by 2010, of which two thirds should come from the business
sector. However, the public sector still conducts a large share of R&D in many EU
countries.
The relation between R&D off-shoring and public R&D expenditures is not a
straightforward one as public R&D spending is subject to a political decision making
process. In principle, R&D off-shoring by domestic firms obviously has no direct
effect on the public R&D spending. However, an indirect effect could emerge. In
principle, a strong public research sector can attract firms to cluster around these
institutes. If we assume that more R&D is being off-shored, the response of domestic
government might be to increase public funding for domestic public R&D and/or
improve the quality of public research. Therefore, off-shoring is likely to increase
public R&D expenditures, provided that policymakers see off-shoring phenomenon as
a threat to the innovation capacity, although the potential impact would only be
indirect.
2.2 Business R&D expenditures (as a percentage of GDP)

Domestic business R&D expenditure captures the creation of new knowledge within
firms, and is particularly important in certain science-based industries where new
innovations are created in R&D laboratories (such as pharmaceuticals, chemicals and
electronics). As such, domestic BERD acts as a valuable proxy for assessing the level
of innovation capacity of domestic firms. The key issue in determining the impact of
R&D off-shoring on business R&D is whether off-shored R&D is substitute or
complement to domestic R&D. In case of complementarity there is no direct effect. If
these two are substitutes, i.e. off-shored R&D replaces domestic R&D this clearly
results in a decline in domestic BERD. However, even in the latter case, there might
appear spillovers to domestic markets, which could improve also the domestic
innovation capacity.
In summary, the effect on this indicator is dependent on the degree of substitution

between domestic and foreign R&D, and the total effect is indeterminate, although a
negative effect is somewhat more probable.
2.3 Share of medium-high-tech and high-tech R&D (as a percentage of

manufacturing R&D expenditures)
This indicator principally indicates the relative importance that a country gives to
R&D investments in new technologies (medium-high-tech and high-tech) with

respect to R&D investments in traditional manufacturing industries. This is important
as the relative importance of R&D intensive sectors in the total business is claimed to
be low in Europe, even though total R&D is as high as in the rest of the world.
Similarly as with the domestic BERD, R&D off-shoring is likely to have an effect on
this indicator. The effect depends on the type of R&D off-shoring conducted, and on
the degree by how much off-shored R&D replaces R&D at home. Traditionally R&D
conducted abroad was mainly market seeking, i.e. home base augmenting R&D,
which does not necessarily qualify for high-tech/medium-high-tech R&D. On the
other hand, technology seeking R&D off-shoring is gaining in importance as many
research clusters abroad attract especially high-tech industries. This may be reflected
as a decreasing domestic high-tech and medium high-tech R&D. Thus, the total
effect is indeterminate, but rather negative than positive.
2.4 Share of enterprises receiving public funding for innovation

This indicator measures the level of government support to innovation activities of
firms, including financial support in terms of grants and loans (direct subsidies as
well as loan guarantees). Thus, it is a more accurate proxy for assessing the
magnitude of public support to firms than indicator 2.1, which includes all public
R&D. This indicator gives an estimate of the scope of public support, and to some
extent captures the distributional patters, i.e. whether it is mostly large firms or
SMEs that are receiving public funding.
The interaction with R&D is that the public support system can be used as a pull
factor for firms to keep their R&D activities at home. Thus, it is expected that in case
policymakers wish to decrease R&D off-shoring or increase innovative activities in
general, they would increase public support at home. The total effect depends on
how the possible policy response is targeted. In case increased support is directed
mostly to firms that have received public funding previously there is probably no
effect, but in case it is targeted to new firms, a positive effect is likely to emerge.
2.5 University R&D expenditures financed by business sector (as a percentage of all
university financing)
The co-operation and interaction between business sector and universities is very
important for fully utilising the domestic firms’ innovation potential, for example in
terms of product development. Although active co-operation between public and
private sector is beneficial for the spill over of innovations, it must be noted that
especially for some new EU-member countries the business financed R&D conducted

at universities may be extensively high. This is due to the low amount of R&D
conducted by the business sector.
In general, however, the quality of universities is an important factor for R&D

location; many important R&D clusters have grown around universities. In this sense,
more business funding for universities might attract firms around universities.
Increasing the quality and broaden the scope of university research might be one
way to persuade firms to finance R&D conducted by home country universities. In
general, this indicator gives a proxy for public private co-operation, which is
important for the innovation capacity of a country. However, opportunities to
collaborate with universities abroad might decrease the domestic business funding
for universities, as firms may want to switch to research collaboration abroad. Thus,
increased R&D off-shoring is likely to have a negative effect on this indicator.
III. Innovation and entrepreneurship

This indicator group focuses especially on the role of entrepreneurship in innovation
creation. The group of small and medium sized companies is very important for
innovation, as small firms are often the most dynamic ones and their propensity to
innovate is assumed to be high. Their role is also very important in terms of job
creation.
3.1 SMEs innovating in-house (percentage of SMEs)
This indicator measures the in-house innovating activity of SMEs. The indicator
includes only SMEs, as almost all larger firms innovate and if these were included,
the countries whose industrial structure is dominated by large firms would have a
higher score by default.
If R&D off-shoring becomes more common, this is likely to affect SMEs as well.
However, presumably those SMEs that engage in R&D off-shoring have been
innovative already before that. Therefore, off-shoring should not have a direct effect
on this indicator. Indirect effects (such as spillover effects to the domestic SME
community through those SMEs that have off-shored) are possible, but only with
marginal impact.
3.2 Innovative SMEs co-operating with others (as a percentage of SMEs)

Similarly as the previous indicator, this indicator measures innovative activities
conducted by SMEs. As R&D partnerships abroad have become more common during
the last few years, the opportunities for SMEs to participate in partnerships abroad
are expected to increase as well. Therefore, some amount of domestic collaboration
might be replaced by partnerships abroad. However, those SMEs that engage in R&D

off-shoring have been innovative and co-operated already before that. As a result,
off-shoring should not have a direct effect on this indicator. Indirect effects similar as
with indicator 3.1 are possible, but again with marginal importance.
3.3 Innovation expenditures (as a percentage of turnover)

This indicator measures the total innovation expenditure and is a broader measure
than business R&D indicator, although these two are partly overlapping. Innovation
expenditures include a broad range of innovation activities: in-house R&D,
extramural R&D, machinery and equipment linked to product and process innovation,
spending to acquire patents and licenses, industrial design, training, and the
marketing of innovations.
As the indicator includes R&D expenditures, assuming that R&D off-shoring increases
R&D in general, this effect is clearly captured by this indicator, which should react
positively. The increase in R&D off-shoring may affect this indicator also through
other channels, provided that R&D off-shoring increases innovative activity at home.
For example, R&D conducted abroad could result in new equipment being used at
home production. However, it is important to note that in some cases, if R&D is off-
shored primarily for cost-efficiency reasons, this might decrease the total
expenditure used in innovative activities.
3.4 Early-stage venture capital (as a percentage of GDP)

The amount of early-stage venture capital is important for new business creation and
thus acts as a proxy for the dynamism in economy in this respect. This indicator
excludes management buy-outs, management buy-ins and venture purchase of
quoted shares, but includes both seed and start-up capital. Clearly, access to early-
stage venture capital is of key importance for innovation and R&D. Presumably,
access to venture capital can be one factor when choosing the location for R&D
activities and in case venture capital would be more easily available outside home
country, this could act as a factor encouraging new businesses to move abroad.
R&D off-shoring does not directly affect this indicator, but indirect effects may arise.
Especially if it turns out that firms are increasingly off-shoring their R&D because of
easier access to early-stage funding, the demand for domestic venture capital might
decrease. The exact effect on this indicator, however, cannot be specified without
further knowledge.
3.5 ICT expenditures (as a percentage of GDP)

This indicator measures the total expenditures on information and communication
technology that is a fundamental building block of knowledge based economies. It
also acts as one of key drivers of innovation. The ICT-indicator includes office
machines, data processing equipment, data communication equipment,
telecommunications equipment and related software and telecom services. It is
supposed to capture innovation particularly through the diffusion of new IT
equipment, services and software. Although this indicator is highly useful in capturing
innovation in knowledge-based economies, it has some disadvantages. First, the
information for this indicator is fundamentally obtained from private sources, which
may contain problems concerning the reliability of the data. Second, part of the
expenditures goes to final consumption and therefore does not have significant
productivity or innovation benefits.
ICT is a crucial factor that has enabled the rise of off-shoring in the first place. Off-
shoring requires constant and efficient communication between business units and
thus the quality of firm’s ICT infrastructure is of key significance. Thus, it can be
assumed that ICT investments increase as R&D off-shoring increases. In the long
run, if R&D off-shoring increases innovation in ICT this may also speed up the
development in this field. Thus, the effect of R&D off-shoring on ICT expenditure is
assumed to be positive.
3.6 SMEs using non-technological change (as a percentage of SMEs)

This indicator is from CIS survey where firms were asked about their technical
innovation (i.e. if they have implemented advanced management techniques, new of
significantly changes in the aesthetic appearance or design in at least one product).
This indicator captures non-technical innovation, which takes places for example in
the services sector.
The link between R&D off-shoring and this indicator is ambiguous. However, if R&D
off-shoring boosts other innovative activities of SMEs the link could be positive.
Innovation outputs
IV. Application
Let us next turn attention to innovation outputs, which measure outcomes of
innovation activity in different ways. This group of indicators is of more direct
relevance for the current study of R&D off-shoring, as R&D off-shoring is likely to
have a direct effect on most of these indicators.
4.1 Employment in high-tech services (as a percentage of total workforce)

This indicator gives the number of employed persons in the high-tech services sector
including post and telecommunications, information technology including software
development and R&D services. The high technology services have a dual role in
economy. On one hand they provide services directly to consumers, on the other,
they provide inputs to the innovative activities of other firms, which can increase
productivity and support the diffusion of a range of innovations.
Provided that R&D off-shoring replaces domestic R&D, that could decrease
employment in high-tech services in the short run, as some activities will now be
conducted abroad. However, if R&D conducted abroad results in new innovations in
high-tech service sector, presumably these could in principle lead to increased
innovation activity in home country as well, causing a respective increase in the
employment. Thus, the degree of complementarity between home-based and off-
shored R&D is of crucial significance, although at least in the short run the impact is
likely to be negative.
4.2 Exports of high technology products (as a share of total exports)

This indicator measures the technological competitiveness of the EU i.e. the ability to
commercialise the results of R&D and innovation in the international markets. In
addition, it presents an estimate of the product specialisation by country. The
indicator includes high-tech exports of the following products: aerospace, computers
and office machinery, electronics-telecommunications, pharmaceuticals, scientific
instruments, electrical machinery, chemistry, non-electrical machinery and
armament.
It is clear that high technology sectors are key drivers for economic growth,
productivity, and welfare, and in general form a source of high value added and well-
paid employment. Thus, their exports are important for global competition. The
problem with this indicator is that sometimes there is some ambiguity as regards the
country of origin as a product may be a result of production process in several
countries and joint ventures.
R&D off-shoring may affect this indicator negatively; if R&D processes will be
conducted abroad, the outputs of these processes will be exports of those countries
respectively.
4.3 Sales of new-to-market products (as a percentage of turnover)

This indicator gives the relation of total turnover of new or significantly improved
products to total turnover for all enterprises. The products included must be new to

the firm and in case of developed countries this often means that the products are
also new to the world. In contrast, for less developed countries, this indicator is likely
to include innovations that have already been introduced onto the market elsewhere.
As R&D off-shoring increases, it may also increase the introduction of new products,
both home and abroad, naturally depending on the strategy of firms. Thus, the effect
of R&D off-shoring on this indicator is expected to be positive as presumably firms
off-shore their R&D activities in order to achieve higher efficiency of innovation
creation, which should be reflected by increasing sales of new-to-market products.
4.4 Sales of new-to-firm not new-to-market products (as a percentage of turnover)

This indicator measures the sales of new or significantly improved products, but
which are not new to the market. Accordingly, this indicator works as a proxy for
adopting technologies or products already introduced elsewhere, i.e. the degree of
diffusion of new technologies.
The effect of R&D off-shoring on the level of this indicator is again likely to be
positive, as proximity to R&D clusters and other potential sources of innovations
(which is often the reason to go off-shore) can help the firm to adopt new
technologies or products which can then be introduced onto the market, both in EU
and abroad.
4.5 Employment in medium-high-tech and high-tech manufacturing (as a percentage

of total workforce)
This indicator gives a proxy of the innovative manufacturing economy. In other
words, it measures the importance of manufacturing industry that is based on
ongoing innovation (as opposed to non-innovative manufacturing). The high and
medium-high-tech manufacturing sectors include chemicals, machinery, office
equipment, electrical equipment, telecommunications and related equipment,
precision instruments, automobiles and aerospace and other transport.
R&D off-shoring can affect employment in these sectors, but the relation is not clear.
On one hand, if R&D off-shoring contributes to the increase in the off-shoring of
manufacturing operations as well, the impact is likely to be negative, as more
workers will be employed abroad. On the other hand, however, if R&D off-shoring
boosts the development of new products and increases manufacturing at home the
effect is clearly positive. In short, the overall effect is indeterminate.
V. Intellectual property

The last group of indicators represents the introduction of new products to different
markets. These indicators capture the innovation capacity of firms in terms of
developing new products and are highly significant for assessing the innovation
capacity of EU as well as the future economic prospects in a larger sense. Clearly, the
capacity of firms to develop new products is crucial for competitive advantage.
Patenting activity does not capture all innovative activities, but as such provides a
good proxy for the productivity for R&D processes.
5.1 EPO patents per million population

This indicator measures the number of patent applications at the European Patent
Office which reflects the number of products innovated for the EU market. The
nationality of the patent application is assigned according to the address of inventor.
This indicator shows the output of R&D activity and thus should R&D increase and/or
become more productive, this is supposed to be shown by an increase in this
indicator.
The relationship between R&D off-shoring and EPO patents is dependent on whether
R&D off-shoring increases or decreases total R&D activity of EU firms, changes its
productivity, or the type of R&D conducted. If R&D off-shored is mainly adaptive and
market seeking (i.e. home base exploiting), it is unlikely to have significant effects
on EPO patenting activity. On the other hand, in case R&D off-shoring is essentially
technology seeking (home base augmenting), this is likely to have a negative effect
on patenting activity at the EU, as new products will be invented abroad rather than
at home. In short, the total effect is likely to be negative.
The problem with EPO indicator is that comparisons for EU and the US or Japan are
somewhat problematic, since EU firms clearly have a home advantage (similarly US
firms have a home advantage with USPTO patent office).
5.2 USPTO patents per million population

This indicator measures the number of patents granted by the US Patent and
Trademark Office (USPTO). USTPO patents are normally allocated to the country of
the inventor, but in case of multiple inventors the allocation is made using fractional
counting. Similarly as EPO patent indicator, this indicator is a proxy for new product
innovation.
The US is a significant market for EU firms and a popular destination for R&D off-
shoring. Therefore, if R&D is increasingly off-shored, part of this flow will go to the

US. Due to this, the impact of R&D off-shoring on the USPTO indicator is likely to be
negative, as with EPO.
5.3 Triadic patent families per million population

This indicator measures the number of triad patents, which means that a patent is a
triad patent if and only if it is filed at the EPO and the Japanese Patent Office (JPO)
and is granted by the USPTO. A patent family is a group of patent filings claiming the
priority of a single filing, including the original priority filing itself, and any
subsequent filings made throughout the world. Trilateral patent families are a filtered
subset of patent families for which there is evidence of patenting activity in all
trilateral blocks (USPTO, EPO, JPO). The advantage of this indicator is that there is
no clear home advantage.
R&D off-shoring is likely to have a negative effect on triadic patenting activity,

similarly as with EPO and USPTO.
5.4 Number of community trademarks per million population

Similarly as patents, this indicator measures the output of innovative process.
Trademarks play an important role especially in the marketing process for new goods
and services as they identify goods and services as those produced by certain
companies. Thus, it measures product and service development type of innovative
activities. Community trademark offers uniform protection in all EU countries with a
single registration procedure.
When R&D is off-shored, part of product and service development clearly moves
abroad as well. Presumably R&D off-shoring leads to the development of new
products and services, at least part of which will then be registered as new
trademarks within the EU, resulting in a positive effect.
5.5 Number of new community industrial design per million population

The last indicator measures the number or registered Community designs, which
means the exclusive right for the outward appearance of a product or part of it (e.g.
aesthetic aspects). Industrial design may consist of two or three dimensional features
(shape, surface, patterns etc) which are applied to a wide variety of products.
The effect is positive if R&D off-shoring results in increased industrial design activity.
Table 1 below summarizes the potential effects of R&D off-shoring on the 26 different
EIS indicators.

TABLE 5.1. Effects of R&D off-shoring on the 26 EIS indicators
Name of the indicator Main impact through The direction of the
firm level decisions (F) impact: positive(+)
or political decisions negative (-)
(P) indeterminate (+/-)
1.1 New S&E graduates per 1000 P +/-
population aged 20-29
1.2 Population with tertiary education P +/-
per 100 population aged 25-64
1.3 Broadband penetration rate P,F +/-
(number of broadband lines per 100
population)
1.4 Participation in life-long learning per P +/-
100 population aged 25-64
1.5 Youth education attainment level P +/-
(percentage of population aged 20-24
having completed at least upper
secondary education)
2.1 Public R&D expenditures (as a P +
percentage of GDP)
2.2 Business R&D expenditures (as a F -
percentage of GDP)
2.3 Share of medium-high-tech and F -
high-tech R&D (as a percentage of
manufacturing R&D expenditures)
2.4 Share of enterprises receiving public P +
funding for innovation
2.5 University R&D expenditures F -
financed by business sector (as a
percentage of all university financing)
3.1 SMEs innovating in-house F +/-
(percentage of SMEs)
3.2 Innovative SMEs co-operating with F +/-
others (as a percentage of SMEs)
3.3 Innovation expenditures (% of F +
turnover)

3.4 Early-stage venture capital (% of P +/-
GDP)
3.5 ICT expenditures (as a percentage F +
of GDP)
3.6 SMEs using non-technological F +
change (as a percentage of SMEs)
4.1 Employment in high-tech services F -
(as a percentage of total workforce)
4.2 Exports of high technology products F -
(as a share of total exports)
4.3 Sales of new-to-market products (as F +
a percentage of turnover
4.4 Sales of new-to-firm not new-to- F +
market products (as a percentage of
turnover)
4.5 Employment in medium-high-tech F +/-
and high-tech manufacturing (as a
percentage of total workforce)
5.1 EPO patents per million population F -
5.2 USPTO patents per million F -
population
5.3 Triadic patent families per million F -
population
5.4 Number of community trademarks F +
per million population
5.5 Number of new community F +/-
industrial design per million population
5.2.3 Summary
The implications of R&D off-shoring as captured by its effects on the indicators are
likely to depend crucially of the following trends. First, the magnitude of R&D off-
shoring is extremely relevant. If off-shoring remains at low level it is unlikely that it
would cause a deterioration of the European stand as one of the global innovation
centres. However, the opposite is clearly true if R&D starts flowing abroad with
increasing speed. Second, the degree at which R&D conducted abroad replaces R&D
at home is clearly important in assessing the overall impact. If R&D conducted off-
shore increases the total R&D by European companies it will not have the same
negative effects as it does in case of replacement. Third, the composition of R&D

abroad affects the final outcome. If off-shored R&D is principally market seeking, it is
likely to result in higher profits and global market shares for European companies,
which further can increase their innovative activities, also at home. Respectively,
technology seeking R&D off-shoring poses a threat, as it may lead to increasing
amount of new knowledge being created outside the EU. Fourth, spillover effects are
important; if new innovations created off-shore are quickly being adopted by
companies at home this can improve the overall innovation capacity of EU firms,
after all innovation is not all about R&D, and not defined by its location. The way off-
shoring is conducted (e.g. in-house vs. outsourced) may also impact spillovers.
Finally, firm level decisions to off-shore depend significantly on the circumstances at
home and abroad, and to some extent the attractiveness of home area can be
increased with policy decisions

PART II: EMPIRICAL EXAMINATION OF R&D OFF-
SHORING IN EUROPE
6 Review of aggregate level data on R&D off-shoring

This section presents the available empirical evidence on the R&D off-shoring
phenomenon in Europe. The focus is on analysing the trends observed in aggregate
level statistics.
The task of measuring the phenomenon is anything but straightforward; as of yet

R&D off-shoring is not directly captured in any official statistics.47 Also, the realisation
of the need of such information has emerged in official discussions only relatively
recently, and the evidence that has been produced to date is largely piecemeal and
country-specific. Given this general lack of good quality information, it will not be
feasible to provide a comprehensive picture of R&D off-shoring in Europe in this
report. Rather, the purpose of the analysis presented in this section is to summarise
the trends arising from the existing data, and to provide a context for the more
detailed analysis of R&D off-shoring using firm-level data, to be undertaken later in
this research project.
This chapter is organised in three sections. The first section provides a general
overview of R&D expenditure patterns in Europe, concentrating on business R&D in
particular. This serves to highlight the role of businesses in conducting and financing
R&D in European countries, and thus sets boundaries for the activity that could be
affected by R&D off-shoring. The second section reviews a number of indicators that
can be used in studying the internationalisation of R&D expenditure in Europe. The
internationalisation indicators studied in this section draw on aggregate R&D funding
data, data on foreign direct R&D investments, and data on patents. In the third
section of this chapter the internationalisation indicators are analysed using statistical
and econometric tools. The purpose is to study the inter-linkages between the
indicators and their relationships between variables defining the general economic
environment in which the firms operate.
47
New developments towards creating a more structured system of documenting the cross-border R&D flows in EU are
currently under way. A notable example is the KEI project (Knowledge Economy Indicators:
Development of Innovative and Reliable Indicator Systems), conducted under the Sixth Framework Programme of the
European Commission. (http://kei.publicstatistics.net/index.html)

6.1 Trends in R&D expenditure in EU
This section presents a general overview of the expenditure and funding patterns of
R&D in European countries. The analysis focuses on three areas. First, it is instructive
to study the overall R&D expenditure in the EU, both as differences across-countries
and changes over time. Second, the R&D undertaken by the business enterprise
sector is studied in more detail. The Business R&D forms a major part of the overall
domestic R&D in most countries, and is also of the main interest when studying the
off-shoring phenomenon. Finally, an overview of the firm-level data on R&D spending
is presented.
The R&D expenditure reported in the national accounts of a country can be broken
down in two ways—according to the sector conducting it, or according to the sector
funding it. Figure 6.1 depicts this difference in a diagrammatic form, according to the
main sectors performing and funding the R&D in most industrial countries.
Figure 6.1 Breakdown of R&D by sector and by activity

R&D funded by sources from R&D funded by government R&D funded by domestic
abroad industry
TOTAL GROSS DOMESTIC

R&D (GERD)
R&D conducted by business R&D conducted by R&D conducted by higher-

enterprise (BERD) government (GOVERD) education (HERD)
Note: Modified from Bloom and Griffith, (2001).
The above figure highlights the multifaceted nature of R&D expenditure and funding
within countries. This also suggests that there could be different ways to look at the
gross domestic R&D expenditure (GERD) that might provide information on the
cross-border R&D flows.
It is also worth noting that the above breakdown applies to the gross domestic R&D—
i.e. all R&D expenditure that takes place within a country, whether conducted by
domestic or foreign entities. This should be distinguished from the gross national
R&D, which relates to all R&D expenditure by the nationals of a country, and would
include R&D undertaken overseas by a domestic company. Studying the differences
of the gross domestic and gross national R&D expenditures would be interesting, as
it would reveal the net R&D off-shoring position of a country (albeit not the actual

flows). However, the gross national R&D expenditure is not directly observable for
most countries, as will be explained below.
6.1.1 Aggregate R&D expenditure in EU
Figure 6.2 shows the gross domestic expenditure on R&D as a percent of total GDP
(R&D intensity) for the EU 15 countries. The figure also shows the change in the level
of the indicator over the last ten years. Large cross-country differences in the
amounts of resources countries devote to R&D can be observed from the figure.
Sweden as the top spender in 2004 had R&D intensity of 3.7%, whereas the
corresponding figure for Greece at the bottom of the table was only 0.6%. Similarly
there are notable differences in the way the R&D intensity has evolved over time.
While Finland has managed to increase its R&D intensity by 1.25% over the last ten
years, for a number of countries this ratio has actually been decreasing.
Figure 6.2 GERD as a % GDP in EU 15, 2004 and change 1995-2004

4.0% 1.4%
1.25%
1.2%
3.5%
1.0%
3.0%
0.77%
Defference between 1995 - 2004

0.73% 0.8%
GERD as % of GDP in 2004
2.5%
0.6%
2.0%
0.39%
0.4%
0.30%
0.26%
0.21% 0.23%
1.5%
0.14% 0.2%
0.09%
1.0%
0.0%
-0.13% -0.15%
-0.18%
-0.22%
0.5%
-0.2%
0.0% -0.4%
en
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2004 Difference 1995 - 2004
Source: Eurostat.
Table 6.1 below presents the full data for R&D intensity in all current EU member
states over the last ten years. The table also reports the averages for the old EU
member states, the new EU member states, US and Japan. The following well-
documented stylised facts are clearly observable from the table:
• The R&D intensity is generally higher in the old EU member states than in the
new member states;

• In some of the more developed countries (such as the UK, The Netherlands
and France) the R&D intensity has been slowly decreasing over time;
• The EU average R&D intensity is significantly below the corresponding figures
for US and Japan.
Table 6.1 GERD as a % of GDP in the EU 25 (%), 1995 - 2004

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Austria 1.53 1.57 1.69 1.77 1.88 1.91 2.04 2.12 2.19 2.26
Belgium 1.72 1.81 1.87 1.9 1.96 2 2.11 1.99 1.92 1.93
Cyprus 0.22 0.24 0.25 0.26 0.31 0.35 0.37
Czech Republic 0.95 0.98 1.09 1.17 1.16 1.23 1.22 1.22 1.26 1.28
Denmark 1.84 1.85 1.94 2.06 2.1 2.27 2.4 2.55 2.59 2.61
Estonia 0.58 0.7 0.62 0.73 0.75 0.82 0.91
Finland 2.26 2.52 2.69 2.86 3.21 3.38 3.38 3.43 3.48 3.51
France 2.29 2.27 2.19 2.14 2.16 2.15 2.2 2.23 2.18 2.16
Germany 2.19 2.19 2.24 2.27 2.4 2.45 2.46 2.49 2.52 2.49
Greece 0.49 0.51 0.67 0.64 0.62 0.58
Hungary 0.73 0.65 0.72 0.68 0.69 0.8 0.95 1.02 0.95 0.89
Ireland 1.35 1.32 1.27 1.23 1.18 1.13 1.12 1.1 1.16 1.2
Italy 1 1.01 1.05 1.07 1.04 1.07 1.11 1.16 1.14 1.14
Latvia 0.48 0.42 0.39 0.41 0.37 0.45 0.41 0.42 0.38 0.42
Lithuania 0.45 0.51 0.55 0.55 0.51 0.59 0.68 0.67 0.68 0.76
Luxembourg 1.71 1.78 1.75
Malta 0.28 0.27 0.29
Netherlands 1.99 2.03 2.04 1.94 2.02 1.9 1.81 1.72 1.76 1.77
Poland 0.65 0.67 0.67 0.68 0.7 0.66 0.64 0.58 0.56 0.58
Portugal 0.55 0.6 0.72 0.85 0.8 0.78 0.78
Slovakia 0.93 0.92 1.09 0.79 0.66 0.65 0.64 0.58 0.58 0.53
Slovenia 1.59 1.35 1.33 1.39 1.42 1.44 1.56 1.53 1.54 1.61
Spain 0.81 0.83 0.82 0.89 0.88 0.91 0.92 0.99 1.05 1.07
Sweden 3.35 3.55 3.62 3.65 4.27 3.98 3.74
United Kingdom 1.97 1.9 1.82 1.81 1.84 1.84 1.89 1.89 1.88 1.79
Average Old EU countries 1.67 1.75 1.73 1.96 1.84 1.89 1.94 1.87 1.94 1.92
Average New EU
0.83 0.79 0.83 0.72 0.72 0.74 0.79 0.74 0.74 0.76
countries
United States 2.49 2.53 2.56 2.59 2.63 2.70 2.71 2.65 2.59
Japan 2.69 2.78 2.84 2.95 2.96 2.99 3.07 3.12 3.15
Source: OECD.
When studying the cross-country differences in R&D intensity, it is important to

remember that the ratio refers to the gross domestic rather than the gross national
R&D expenditure. A decreasing gross domestic R&D intensity might indeed reflect an
increasing internationalisation of domestic companies’ R&D activities, rather than a
decrease in the absolute R&D expenditure by domestic nationals.
6.1.2 Business sector R&D expenditure in the EU
A large part of domestic R&D expenditure is both conducted and funded by the
business sector in most industrial countries. As the R&D off-shoring phenomenon is
almost exclusively related to activities of private enterprises, it is important to review

the role firms play in conducting and funding R&D within the EU. Figure 6.3 below
shows the cross-country comparison of the relative importance of business sector in
conducting R&D in the EU. Again, large cross-country differences can be observed. At
the top of the table, in Luxembourg the business sector conducts 88% of all domestic
R&D. This compares to 21% in Cyprus.
Figure 6.3 Business R&D expenditure as a % of total GERD, 2004
Luxembourg 88.2
Sweden 73.5
Germany 70.4
Finland 70.1
Denmark 69.4
Belgium 68.6
Austria 66.8
United Kingdom 64.9
Ireland 64.6
Czech Republic 63.7
France 62.9
Slovenia 59.5
Netherlands 57.5
Spain 54.4
Slovakia 49.2
Italy 47.3
Latvia 44.5
Hungary 41.1
Estonia 39.0
Malta 33.7
Portugal 33.2
Greece 29.5
Poland 28.7
Average
Lithuania 21.4 (52.8%)
Cyprus 20.8
0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 80.0 90.0 100.0
BERD as % of Total GERD (%)
Note: 2004 data was not available for Italy, Portugal and Austria. Figures for these countries
are latest available (2003 for Italy and Portugal, and 2002 for Austria).
Source: Eurostat.
The bottom of the list is largely dominated by the new EU member states, and those
old member states with relatively low R&D intensity. This observation would suggest
a positive relationship between the R&D intensity of a country and the share of the
total R&D that is conducted by the business sector. Business R&D is often thought to
be the part of the total R&D expenditure that drives the short-run economic growth.
Therefore, the business R&D intensity is of primary importance for countries R&D
policy.
One relevant question is to what extent the magnitude of business R&D correlates
with a high overall R&D intensity—i.e. what is the importance of a large business
R&D sector for a country to achieve a vibrant R&D community. Figure 6.4 plots the

share of business R&D from the total GERD as a function of total R&D intensity for all
current EU countries over the period 1995-2004. The figure suggests that countries
with an active private enterprise R&D community tend to enjoy a higher R&D
intensity, highlighting the importance of business R&D for innovative activity.
Figure 6.4 Relationship between business R&D and total R&D in the EU, 1995-2004
100
80
BERD as a % of total GERD (%)
60
40
20
0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5
GERD as % of GDP (%)
Source: Eurostat, OECD.
Figure 6.5 identifies the relationship between the share of business R&D and the total
intensity for individual countries based on the 2004 figures. The relationship appears
reasonably strong also over a single year. The countries can be roughly divided into
three clusters. At the lower left-hand corner are countries that are associated with a
low industry participation in domestic R&D together with a low R&D intensity (<1%).
This cluster consists of most of the new EU member states and the Southern
European countries. The second cluster consists of countries with a relatively high
industry participation in R&D (60–70%), and a moderate to high R&D intensity (1–
3%). This cluster covers the Continental European countries, together with Czech
Republic and Slovenia. Finally, Finland and Sweden form the third cluster with a high
R&D intensity (>3%) and high business participation in R&D.
An interesting observation is to compare this clustering with the results of the 2005
EIS survey—a very similar clustering of countries is also apparent when observing

the EIS composite innovation indicator,48 further emphasising the key importance of
business R&D for innovation activity.
Figure 6.5 Share of BERD from total GERD, 2004

100
L uxe m b ou rg
80
BERD as a % of total gerd
S we d e n
G erm a ny Fin la n d
D en m a rk
B e lgi um
I rela d R ep u bl ic U nit e d Ki ng d om
C znech
Fra nc e
60
S lo ve nia
N e th e rla n ds
S pa in
S lo va kia
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Est o nia
M a lta
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P orelaec
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Lit h ua n ia
20
C y p ru s
0 1 2 3 4
To tal in tram ural R&D (% GDP )
Source: Eurostat.
6.1.3 Funding of business R&D in the EU
So far the analysis has concentrated on the EU countries’ R&D investments according
to the sector conducting the activity. However, it is also important to study the way
the R&D is funded. Table 6.2 shows the average funding patterns for countries
business R&D for the new and old EU member states for two time periods, 1995–
1999 and 2000-2004. The table shows the percentage shares of funding of domestic
business R&D by the government, domestic industry and sources from abroad.
For the old member states the biggest change over time has been the reduction in
the government funding. This is very likely the result of increased use of incentive
based mechanisms provided for private firms (such as tax breaks) rather than direct
government funding. The reduction in direct government funding has mostly been
compensated by an increase in funding from domestic industry, although there has
48
See section 6.1.

also been an increase in the funding received from abroad. For the new member
states the trend has been the opposite, with an increase in the government share
and a reduction in the funding from domestic industry. However, the reduction in
funding from domestic industry can largely be explained by a reasonably sharp
increase in funding from abroad. This suggests that in the old member states the
funding from domestic industry might have been replaced by funding from foreign
business enterprise.
Table 6.2 The share of various sources of funding for Domestic GERD
Domestic
Abroad Government
industry
Average over 1995-1999
New EU 6.9 49.8 40.9
EU 15 8.8 39.0 50.2
Average over 2000-2004

New EU 10.2 52.1 35.8
EU 15 9.8 33.7 54.3
Source: Eurostat.
6.1.4 Evidence from firm-level data
As explained above, the aggregate R&D expenditure indicators all measure the gross
domestic rather than the gross national expenditure on R&D. It would be interesting
for this research to also identify the gross national part of the business R&D—i.e. the
total R&D investments of domestic firms, whether domestic or abroad. This would
essentially amount to collecting information on firms’ R&D investments as reported in
their annual reports.
Collecting data on all R&D investments by all firms in a country, let alone all
European countries, would not only be an infeasible enterprise within the scope of
this study, but it would also be an impossible one due to restrictions on data
availability. Acquiring data in listed firms’ R&D expenditures is unproblematic as a
result of the disclosure requirements imposed on these firms by the exchanges they
are listed in. This data is also readily available from several commercial financial
databases (such as Thomson Datastream or Bloomberg). The problem relates to non-
listed private firms. While R&D spending data is in most cases available also for these
companies from annual reports, this data is in most countries not collected on
comprehensive and consistent basis. Also, not all countries require publication of
accounting information, which would factually prevent a systematic collection of
figures from these countries.

The publicly available source closest to a comprehensive list is the “EU industrial R&D
investment scoreboard”, published by the European Commission’s Joint Research
Centre and General Research. The 2005 version of the Scoreboard listed the R&D
investments of the 700 top R&D spending firms in Europe. Table 6.3 summarises the
results from the 2005 scoreboard. Based on this data Germany is by far the largest
R&D spender, with 135 companies on the list and total spending figure of €37.9
billion. The list reveals a significant concentration of industrial R&D with the five
largest spenders (Germany, France, UK, Netherlands and Sweden) accounting for
over 85% of the total spending.
Table 6.3 R&D investment by top 700 R&D spending firms in the EU by country, 2004
Number of firms Total spending (€ m) % of Total
Germany 135 37,859 37.0
France 81 19,369 18.9
UK 211 17,090 16.7
The Netherlands 33 7,153 7.0
Sweden 60 6,099 6.0
Finland 43 4,855 4.7
Italy 25 4,401 4.3
Denmark 31 1,806 1.8
Belgium 26 1,453 1.4
Spain 13 946 0.9
Austria 21 374 0.4
Luxembourg 4 363 0.4
Ireland 7 284 0.3
Hungary 2 63 0.1
Slovenia 2 40 0.0
Greece 2 35 0.0
Poland 2 22 0.0
Czech Republic 1 15 0.0
Portugal 1 11 0.0
Total 700 102,238 100.0

Source: European Commission (2005), “The 2005 EU Industrial R&D investment
scoreboard”.
Figure 6.6 below provides the breakdown of R&D investment by industry sector. The
bulk of the commercial R&D investment appears to be concentrated on a few sectors,
automobile and pharmaceutical sectors being the clear leaders. Overall the five top
sectors cover 70% of the total R&D spending by the scoreboard companies.
The 2004 and 2005 EIS has also included a sectoral innovation scoreboard, so it
would be interesting to compare the sectoral innovation performance against the
R&D spending of the companies in each sector. However, the industry sector
definitions of the two scoreboards are not identical, which complicates such
comparisons. The five top innovative industry sectors as identified in the 2005 EIS
sectoral scoreboard were:
• Electrical and optical equipment;

• ICT Information and communication technologies;
• Computer and related activities;
• Chemicals and chemical products; and
• Motor vehicles, trailers and semi-trailers.
Although the sector definitions are not identical, it is clear that all of these sectors
also feature high on the industrial R&D spending list.
Figure 6.6 R&D investment by top 700 R&D spending firms in the EU by sector (€m),
2004
Automobiles & parts (31) 25,174
Pharma & biotech (48) 17,571
IT hardware (93) 10,878
Electronic & Electrical (25) 9,941
Aerospace & defence (21) 7,524
Chemicals (11) 6,877
Engineering & machinery (26) 4,520
Telecommunication services (67) 3,261
Software & computer services (97) 3,028
Oil & gas (7) 1,915
Food producers (43) 1,810
Health (44) 1,713
Electricity (72) 1,064
Personal care & household (47) 1,009
Diversified industrials (24) 845
Media & entertainment (54) 835
Construction & building (13) 718
Support services (58) 701
Household goods & textiles (34) 680
Steel & other metals (18) 559
Utilities - other (77) 398
Forestry & paper (15) 258
Leisure & hotels (53) 193
General retailers (52) 190
Mining (4) 123
Other financials (87) 122
Tobacco (49) 107
Banks (81) 101
Transport (59) 52
Beverages (41) 44
Insurance (83) 16
Life assurance (84) 11
0 5,000 10,000 15,000 20,000 25,000 30,000
Source: European Commission (2005), “The 2005 EU Industrial R&D investment

scoreboard”.

6.2 Internationalisation of R&D in the EU
The previous sub-sections have provided a general overview of the geographical and
sectoral dispersion of R&D investments within the EU. In this section the focus is on
studying the trends in R&D off-shoring. As already explained in the introduction to
this chapter, R&D off-shoring cannot be measured directly from aggregate data.
Therefore, the analysis presented in this section focuses on reviewing a number of
indicators that serve as proxies for the true R&D off-shoring.
Although none of these statistical sources directly measure the trends towards
internationalisation, the data presented in this section still contain valuable
information that can be extracted with a careful analysis. Three different sources of
information are used here. First, the aggregate R&D funding figures presented above
will be studied focusing on the trends that might reveal changes in the geographical
distribution of R&D expenditure. The second source of information used here comes
from a dataset covering the foreign direct R&D investments to and from European
countries since 2002. The FDI represents one important segment of R&D off-shoring
activity, and the data can be used to directly observe the developments that have
taken place during recent years. Third source of information is the historical patent
applications to the European Patent office. The patent applications offer a potentially
very rich source of information on the geographical and sectoral developments of
business R&D, and as such are of obvious importance for this study.
6.2.1 Evidence from aggregate level R&D flows
Several elements in the aggregate R&D figures presented above can potentially
provide information on the cross-border R&D expenditure flows.
The share of R&D funded from abroad is an obvious indicator of inward off-shoring
activity. In this respect the figures reported in table 6.2 above highlight a potential
increase in inward R&D off-shoring both in the old and new member states, but the
impact has been far larger in the new member states. Given the identified drivers for
R&D off-shoring activity, and the small size of the domestic business R&D sector in
most of the new member states, such trends could be expected.49
Figure 6.7 below shows the foreign share of R&D funding for all EU countries. The
figure presents the average figures for two time periods, 1995–1999 and 2000–2003,
49
See Chapter 4.

which allows for comparisons over time and across countries. The foreign funding
shares clearly highlight that for nearly every new member state for which data is
available a clear increase in foreign funding is observable. Indeed, Latvia and Malta
are the two countries with the highest share of business R&D funded from abroad.
Figure 6.7 Share of overseas funding of business R&D (%), 1995-2003

35
30
25
20
15
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Average 1995-1999 Average 2000-2003
Source: Eurostat.
It would naturally also be of interest to study the outward R&D off-shoring using the
aggregate level data. The natural indicator for this would be the difference between
the R&D undertaken domestically by domestic firms, and the total R&D undertaken
by domestic firms. A proxy for the former measure, the domestic R&D of domestic
firms, can be observed indirectly through the share of BERD funded by domestic
industry. However, as explained above, there is no sufficiently accurate way to
measure the total global R&D spending of EU companies. Therefore, using aggregate
R&D data to study outward off-shoring activity is not feasible using the current
information.
6.2.2 Evidence from R&D foreign direct investments (FDI)
This section presents evidence acquired from the R&D related foreign direct
investments (FDI) made to and from the EU 25 countries. The data were obtained
from LOCOmonitorTM database, which contains consistently recorded data on global
FDI flows, and is available from the year 2002 onwards.

FDI represents one important type of off-shoring activity. Also, the data on the FDI
flows is the most direct indicator currently available on the off-shoring activity. The
LOCOmonitorTM data covers both the inward and outward flows of R&D investments
to and from the EU 25, and provides a breakdown of investments according to source
and destination countries as well as industry sectors.
Inward R&D FDI into EU 25

Figure 6.8 shows a quarterly time series for the number of inward R&D FDI
investments made into EU 25. The time series displays a rising trend up until the
second quarter of 2005, after which the growth has levelled down. Translated into
annual figures, a substantial 70% increase is observed in the number of inward
investments into EU 25 between 2002 and 2005.
Figure 6.8 Number of inward R&D FDI projects per quarter, 2002-2006*
* The 2006 figures refer to January.

Source: LOCOmonitorTM.
Figure 6.9 breaks down the quarterly series according to the destination country. The
UK has been by far the preferred destination country with 95 inward R&D
investments received during 2002–2006. France, Germany, Ireland, Spain and
Sweden have also received a relatively large number of inward R&D projects,
suggesting that within the EU the R&D FDI tends to be channelled into the more
advance countries. Out of the new EU member states only Poland, Czech Republic
and Hungary score around the EU average in terms of inward R&D projects, while the
other countries populate the bottom of the list.

Figure 6.9 Number of inward R&D investments by destination country, 2002–2006*

Figure 6.10 provides a sectoral breakdown of the inward R&D FDI into EU 25. Not
surprisingly, ITC, pharmaceutical & biotech, semiconductors and auto components
seem to dominate the inward R&D flows. These are also the sectors dominating the
overall R&D expenditure by European firms, as was highlighted in the Figure 6.7
above.
Figure 6.10 Breakdown of FDI investment projects into EU 25 by industry sector

Finally, the source country distribution for the inward R&D FDI investments is shown
in Figure 6.11. The US has overwhelmingly dominated the inward R&D investment
into EU, with nearly half of all R&D projects originating from there. The other larger
players are the more advance European nations, Japan and Canada.
Figure 6.11 Number of R&D FDI projects to EU 25 by source country, 2002–2006*

Studying the inward R&D FDI flows into EU clearly highlight the increasingly strategic
nature of the R&D off-shoring activity. The main destination countries are the more
advanced EU countries, and the investments have concentrated on hi-tech sectors.
This is a clear indication that the reasons for the off-shored R&D investments have
been related more to market or technology seeking than cost efficiency.
Outward R&D FDI from EU 25

The outward R&D FDI from EU 25 has also shown and increasing trend over the last
five years, as shown in Figure 6.12 below. In 2002 there were 81 outward R&D FDI
investments originating from the EU 25 countries. This number increased to 145 in
2004, representing an increase of 79%. However, the R&D FDI outflow has remained
at a relatively stable level since the third quarter of 2003.

Figure 6.12 Number of outward R&D FDI investments per quarter, 2002–2006*

The geographical distribution of the R&D FDI investments by source country is shown
in Figure 6.13. Companies from Germany, the UK and France have been the most
active in setting up new R&D facilities in foreign locations, while companies from the
new member states have expectedly undertaken only very few cross-border R&D
investments. It is interesting to note that the geographical outward investment
patterns are very similar to the inward patterns, highlighting the fact that within EU
the same countries that are the most important source countries for R&D FDI are
also the main destination countries for inward R&D investments.
The sectoral breakdown of outward investments, shown in Figure 6.14, again exhibits
a very similar pattern to the sectoral distribution of inward projects. The same
pattern of R&D FDI investment that is observed at the country level is therefore also
observed at the industry sector level; the internationalisation of R&D activities in EU
seems to be focussing on a number of key sectors, in which European firms serve as
both destination and source countries for R&D FDI investments.

Figure 6.13 Outward R&D FDI investments by source country, 2002–2006*

Figure 6.14 Breakdown of FDI investment projects by sector
Figure 6.15 shows the geographical distribution of outward R&D FDI from EU 25
according to the destination country where the new R&D facility is established. The
figure clearly highlights the increasing importance of China and India for the R&D
activities of European companies. There have been around 90 R&D investment
projects to both countries by European firms over the last five years, which is almost
double the number of R&D FDI projects off-shored from the EU into the US. Out of

the European countries Spain has been the most popular destination for the R&D FDI
originating from the other EU 25 countries.
Figure 6.15 Number of R&D FDI projects from EU 25 by destination country, 2002–
2006*

The review of R&D FDI flows in and out of EU 25 countries observed from the
LOCOmonitorTM database provide some very interesting insights into the cross-border
R&D flows in the EU 25. First, the majority of both inward projects coming into the
EU 25, and outward flows originating from the EU 25, are associated with the same
countries, dominated by the UK, Germany and France. In other words, there are a
number of countries that are open to both R&D in- and outflows. Second, a similar
pattern applies to industry sectors, where the bulk of both the inward and outward
activity is concentrated on a handful of sectors. Third, there appears to be a clear
difference between the destinations countries for the outward EU investments, and
the originating countries for the inward EU investments. While EU firms increasingly
set up R&D facilities in China and India, the US and other more developed countries
are the main source countries for the EU inward R&D.
6.2.3 Evidence from patents
The statistics on aggregate R&D expenditure and funding patterns and the R&D FDI
presented above provide important information on R&D flows to and from individual
countries. In this section this analysis is augmented by the information available in
international patent applications. Patent applications provide a very rich source of
information on the internationalisation of technological and other inventions, and
have increasingly been used in the academic literature.

Patents are usually granted by government related institutions, of which the most
important are USPTO (Unites States Patent and Trademark Office), EPO (European
Patent Office) and JPO (Japan Patent Office) due to the size and importance of these
markets. Patent rights are commonly granted for a certain geographic area e.g. the
USPTO covers the US and EPO covers the European countries.
The easiest method for firms to apply property rights in foreign countries operates
through The PCT treaty.50 The first step in the PCT process is to apply for the PCT
examination during the application process in the national patent system. The PCT-
application is sent to another patent office where the application is re-examined,
approved and made public. After applying for a patent in a specific country, the next
step in the process is the publication of the patent application in the relevant patent
office, after possible amendments to the application. The time reserved for opposing
the patent is around 9 months, and varies depending of the country in question.
After the opposition period the patent is amended, refused or granted. In an EPO-
member country the inventor may also apply directly to EPO and after this register
the patent in the inventor’s home country.
Three stages can be identified in the patenting process to get a EPO or USPTO
patent, which are the main interest in this study; the Priority Application date
(application to domestic office); application date (application to EPO, USPTO, etc.);
and date of grant (patent is granted). Although the time taken for each stage in the
process varies, in general it takes approximately 12–18 from the priority application
to application in EPO/USPTO, and 3-5 years from the priority application to granting
the patent.
The main tool for analysing the internationalisation of inventive activity that is
available from patent data is the possibility for separately observing the geographical
location of the inventor (the researcher making the invention), and the owner of the
invention (usually a firm). A patent application made by a firm that lists an inventor
residing in a country other than the registered domicile of the firm, provides direct
information on the fact that the firm has innovative activity located in the country of
the innovator, as well as the country of origin of the firm. Therefore, patent
applications provide a natural way to measure the evolution of R&D
internationalisation over time. The potential ways for studying R&D off-shoring
50
The PCT (Patent Cooperation Treaty) is designed to facilitate international patenting through the World
Intellectual Property Organization (WIPO).

activity from indicators constructed from patent data, and their relationship with
aggregate level R&D indicators, are summarised in Table 6.4 below
Table 6.4 Impact of R&D off-shoring on indicators

Impact on aggregate R&D Potential impact on
R&D off-shoring activity statistics patent indicators
Increase in the R&D financed Increase in foreign patents
Inwards R&D investment from abroad with a domestic inventor
Widening difference between Increase in the share

Outward R&D investment total R&D expenditure and domestically owned patens
domestic R&D expenditure of with a foreign inventor
domestic firms
This section analyses the information on patent applications made to the European
Patent Office (EPO), made available by the OECD.51 This data allows for the
construction of two relevant internationalisation indicators that are analysed in this
study:
• The share of domestic of patents that have foreign inventor, from the total
number of patents granted to domestic firms (domestic ownership of foreign
inventions)
• The share of domestically invented patents that have been granted to foreign
applicants, from the total number of patents with a domestic inventor (foreign
ownership of domestic inventions)
Figure 6.16 below shows the figures for foreign ownership of domestic inventions for
those European countries for which sufficient data is available.52 The figures are
presented for two time periods, 1990–1999 and 2000–2005. The cross-country
comparison reveals large differences in the internationalisation of patents across the
countries shown. For Luxembourg the clear majority of domestically owned patents
have an inventor located in another country than the patent applicant, which would
suggests a very high level of off-shoring of domestic R&D. At the other end of the
scale only 6% of patents applied by Italian firms have inventors located in countries
other than Italy. For the majority of the countries the share of domestic ownership of
foreign inventions has increased significantly between the two time periods.
51
OECD, Patent Database.
52
The indicators are only calculated to those countries with a minimum of 250 EPO patent applications during 2000-2003.
This is to prevent biases in the percentage shares that could arise from a very small total number of patents.

Figure 6.16 Domestic ownership of foreign inventions, 1990-2005
100.0
79.479.3
80.0
60.0
48.5
39.940.2
38.6
40.0
31.4
23.7 24.1
21.7
20.3
18.4
20.0 16.6 16.0
14.3 15.315.9
12.6 12.1
9.5 10.2 10.0 10.6
7.6 7.4
6.3 6.2
4.4
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Source: OECD, Patent Database.
Figure 6.17 shows the foreign ownership of domestic inventions, which can be taken
as an indicator for inward R&D off-shoring. Again Luxembourg has the highest share
if internationalisation with close to 60% of domestic inventions being owned by
foreign applicants.
Again the same observation is made as from the FDI data that the same countries
that have a high degree of openness inward also seem to have a high openness
outward. Luxembourg, Ireland, Belgium and The Netherlands feature high on the list
for both indicators, while Italy, Germany, France and Finland display lower levels of
cross-border patenting both inwards and outwards.

Figure 6.17 Foreign ownership of domestic inventions, 1990-2005
80.0
60.0 57.6
47.6
46.4
39.8
40.0 38.6
37.0
35.0 35.7 35.6
29.3 28.4
26.1 26.5
23.7
20.0 18.518.4 17.8

17.3 17.5
16.5 16.4
13.5
11.7 12.1 11.3
10.411.2
8.9
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Source: OECD, Patent Database.
Table 6.4 described the potential impacts of inward R&D off-shoring on the R&D
funding and the patent data indicators. Given that reasonably good proxies for both
of these variables exist, it is instructive to study the potential relationship between
these two indicators—if the indicators are to proxy off-shoring at least at some level,
one would expect to see a positive relationship from the actual data across countries
and over time.
This relationship is depicted in Figure 6.18 below. It is obvious from the graph that
there indeed appears to be a relatively strong positive relationship, which suggests
that the two indicators seem to be picking up similar trends over time. As is shown
on the graph, the observations for individual countries in different years are in most
cases relatively tightly clustered. The main outliers refer to Luxembourg and
Greece—Luxembourg has large number of foreign owned patents relative to the
foreign funding of business R&D, whereas for Greece the opposite is the case.

Figure 6.18 Relationship between foreign R&D funding and patent ownership, 1995-
2003
25 G r ee c e
G r e e ce
Share of BERD financed by sources from abroad (%)
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The EPO patent data also allows studying the internationalisation of patents
according to the partner country. Figure 6.19 shows the domestic ownership of
foreign inventions, according to the country of residence of the inventor. For almost
all countries the most common location is another European Union country. Other EU
countries cover above 50% of the destinations of patents for all countries but the UK,
which has roughly even split with the US and EU. Also, for nearly all countries US is
the second most common destination to own a patent, the shares ranging from 12%
to 40%.
Figure 6.20 below shows the nationalities of firms owning patents that have been
invented domestically within the EU. The pattern is again very similar as with the
domestic ownership of foreign inventions, with a large majority of cooperation taking
place within the EU. Again the US is the second most common owner of patents
invented within EU, with Japanese firms commonly owning a small share between
1% and 2% in each country.

Figure 6.19 Domestic ownership of foreign patents by partner country, 2000-2005
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
ly
en
s
m
nd
n
ria
y
ce
g
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Ire
Au
ng
Fr
Sw
en
Be
Fi
er
m
he
Ki
xe
et
d
Lu
N
te
ni
U
US EU Japan Other
Source: OECD, Patent Database
Figure 6.20 Foreign ownership of domestically owned patents by partner country,

2000-2005
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
ly
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Au
ng
Fr
Sw
en
Be
Fi
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m
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Ki
xe
et
d
Lu
N
te
ni
U
US EU Japan Other
Source: OECD, Patent Database

6.3 Empirical analysis of aggregate level data
The previous section reviewed a number of indicators that can be expected to

capture elements of the R&D off-shoring from aggregate level data sources. The final
step in this analysis is to study these indicators quantitatively. The purpose of this
analysis is to study the correlations of different measures with each other, and also
to examine the main factors in overall economic environment that tends to drive the
R&D off-shoring trends.
Table 6.5 shows the unconditional pair wise correlations between the R&D FDI flows,
the patent indicators, general R&D expenditure figures and the shares of different
sources used to fund the domestic business R&D. A star following a correlation
coefficient denotes a 95% statistical significance level. Several interesting results can
be identified from the table.
First, the two sets of internationalisation indicators are correlated among themselves,
but not with each other. The number of inward R&D FDI projects has a significant
positive correlation with the outward projects. This was expected given the fact that
the same countries that off-shore also attract most of the inward off-shoring.
Similarly, there is a significant positive correlation between the foreign ownership of
domestic patents and the domestic ownership of foreign patents. However, R&D
projects are not significantly correlated with the patent indicators. This is surprising,
but could be a feature of the data, given that the patent application data is complete
only until 2003, and only covers those countries with a sufficient number of patent
applications. This reduces the pair wise observations on the R&D FDI and patent
indicators into only two years, and only covers 14 countries.
The R&D FDI indicators also correlate significantly with the various measures of R&D
expenditure, and with domestic business and government funding of business R&D,
but not with the foreign share of funding. This very likely reflects the fact that the
bulk of the FDI projects were associated with the technologically more advanced
countries, which also have a lower share of foreign funding. The results are roughly
similar with regard to the patent indicators.

Table 6.5 Pair-wise correlations: R&D FDI, patent applications and R&D funding
Govt. Ind.
Patent_fo Patent_d GERD (% BERD (% GOVERD For. BERD
R&D in R&D out BERD BERD
r om GDP) gerd) (% gerd) fund.
fund fund
R&D in 1.0000
R&D out 0.7019* 1.0000
Patent_for -0.1619 -0.2684 1.0000
Patent_dom -0.2885 -0.2883 0.6776* 1.0000
GERD (% GDP) 0.3061* 0.3841* -0.4456* 0.0769 1.0000
BERD (% gerd) 0.3952* 0.3598* 0.1491 0.5624* 0.7365* 1.0000
GOVERD (%
-0.2715* -0.2746* -0.3092* -0.4803* -0.6451* -0.7710* 1.0000
gerd)
For. BERD fund. -0.0778 -0.1363 0.4305* -0.0018 -0.2068* -0.3788* 0.0210 1.0000
Govt. BERD fund -0.3656* -0.3299* -0.3612* -0.6071* -0.7205* -0.9222* 0.7909* 0.0840 1.0000
Ind. BERD fund 0.3216* 0.3484* 0.0517 0.4648* 0.7031* 0.9542* -0.6808* -0.4813* -0.9060* 1.0000
In order to elaborate on the unconditional correlation analysis, an elementary

regression analysis was undertaken using the same data. Two regression
specifications were estimated:
• Regression 1: a poisson count regression to study associations between R&D

FDI projects and general economic variables
• Regression 2: a poisson count regression to study associations between total

patent counts and general economic variables
In addition it would have been interesting to study the relationships between the
patent internationalisation indicators and the general economic variables. This,
however, is not feasible due to the small number of observations available.
Table 6.6 reports the results from the two regression specifications. In the following
the results are briefly analysed.
After controlling for the size of the country by including the population figure in the
regression, the inward R&D FDI flows have tended to be associated with countries
that have high business R&D intensity, and high levels of working population that
have completed tertiary education. The overall R&D intensity or the government R&D
do not show as affecting the attractiveness of a location for inward R&D in a
statistically significantly way. The countries with high outward R&D FDI flows by
contrast have tended to be associated with high total R&D intensity and low
government R&D expenditure. The level of tertiary education is also positively
correlated with the outward R&D FDI flows. Taken together, these results can be
interpreted to suggest that while both inward and outward flows seem to some
extent be associated with the same countries, on balance a slightly higher level of
outward investments seem to happen from the more developed and R&D intensive
countries, whereas countries with lower total and business R&D intensity tend to
attract a slightly higher level of inward investments.

The longer time series and the resultant larger number of observations facilitate a
significantly larger number of explanatory variables to be used regressions using
patent applications in Regression 2. The results for the Regression 2 are reported in
Table 6.7. In explaining the patenting activity, regardless of whether measured by
the number of patents with domestic inventors or domestic applicants, the country
characteristics that reflect higher levels of development and openness appear
statistically significant in the regressions. These include GDP per capita, overall R&D
intensity and foreign funding of business R&D. However, slightly surprisingly the
share of hi-tech exports from total exports appears significantly and negatively
associated with the patenting activity.53 A further interesting observation is that the
signs of the coefficients are the same for both patent indicators, although they
measure the different directions of R&D off-shoring. Again this reinforces the
evidence that the R&D inflows and outflows seem to be associated with the same
countries.
Table 6.6 Results of Regression 1.

R&D in z R&D out z
GERD (% GDP) -0.210 -1.03 0.744 4.07*
BERD (% gerd) 0.062 3.44* -0.041 -1.27
GOVERD (% gerd) 0.032 1.09 -0.054 -2.08*
Tert. education 0.045 2.01* 0.052 2.36*
Population 0.00003 5.07* 0.0001 10.59*
GDP/capita -0.006 -0.55 0.019 1.63
Constant -3.371 -2.43* -1.814 -1.76
Table 6.7 Results of Regression 2.

Domestically Domestically
invented patents z owned patents z
R&D in -0.027 -1.290 -0.028 -1.250
R&D out 0.009 0.870 0.012 1.110
GERD (% GDP) 0.661 3.980* 0.770 4.280*
BERD (% gerd) 0.037 1.710 0.032 1.330
GOVERD (% gerd) 0.172 5.180* 0.180 5.010*
Foreign funding of
BERD 0.073 4.500* 0.058 3.290*
Population 0.00004 5.990* 0.00004 5.360*
GDP/capita 0.066 7.310* 0.078 8.040*
Early VC 12.241 1.660 15.266 1.920
Hi-tec employment -0.255 -0.790 -0.357 -1.020
Hi-tec exports -0.046 -2.990* -0.038 -2.310*
Hi-tec emp. in manuf. 0.053 1.020 0.044 0.780
Tertiary education 0.009 0.530 0.005 0.280
Constant -6.594 -4.770* -7.622 -5.100*
53
This is likely explained by the very high hi-tech export shares in Malta and Hungary.

6.4 Conclusions
This chapter has presented a comprehensive overview of R&D expenditure and its
internationalisation within EU based on publicly available aggregate level data. As
already notified in the introduction, the aggregate level data sources do not lend
themselves to observing R&D off-shoring directly. The approach taken here was to
study several proxy indicators that could provide information on R&D off-shoring, and
to study the development of these indicators over time and across countries. The
main findings from the aggregate estimations are:
1. R&D FDI in- and out-flows are highly positively correlated, indicating that those
countries whose firms’ engage in R&D off-shoring are also attracting inward R&D.
2. The number of R&D inward projects is positively associated with the share of
business funded R&D, tertiary education and size of the country (measured by
population).
3. The number of R&D outward projects is positively associated with tertiary

education and population, and negatively with government share of GERD.
4. The number of domestically invented patents is positively associated with GERD

and government share of GERD, the level of business-funded R&D, population
and GDP per capita. It is negatively associated with the level of hi-tech exports.
5. The number of domestically owned patents displays much the same pattern as
the number of domestically invented patents.
The following overall conclusions can be made based on the reported results:
The R&D intensity measured relative to GDP varies significantly across EU

countries. Also, while the general trend has been towards increasing R&D
intensity over time, for some countries the opposite trends can be observed.
Business R&D appears to be a driving force for achieving higher levels of

domestic R&D expenditure. Large business R&D community also appears to be
related to higher levels of domestic innovative activity, as measured by the
EIS composite indicator.
The funding patterns of business R&D have been evolving over time, with the
share of foreign funding increasing in both old and new member states.

The R&D FDI figures provide evidence that the R&D FDI to and from the EU
25 has been increasing sharply over the past four years. The bulk of both the
in- and outflows of investments seem to be associated with the same handful
of countries and industry sectors. However, while the R&D inflows are mainly
received from the more developed nations such as the US, the EU R&D
outflows are increasingly directed to China and India, which are the two larges
destination countries.
Patent data present another promising avenue for studying the

internationalisation of R&D activities. The observed trends provide a relatively
strong evidence on increased internationalisation over time. The main
destination for outward R&D is still another EU country, the US being a clear
second choice. Similar trend applies to the foreign ownership of domestic
patents.
Some of the indicators for R&D off-shoring seem to be correlated with each
other, suggesting that the indicators are picking up similar developments.

7 Simulation of future development
It is naturally of great interest to policy makers to use quantitative information to try
and simulate future development paths induced by important changes in the
environment. R&D off-shoring is no different in this respect, and to answer this
need, a simulation analysis was performed. In this section we first describe the
approach we took and then provide and discuss the results of the simulation.
7.1 The simulation approach
We seek to answer the following questions with the simulations:

How will the levels of R&D off-shoring change from 2004 to 2009?
What impact on EU member states’ innovation capacity will R&D off-shoring
have in 2009, as measured by the number of domestically invented and
domestically owned patents?
How do the answers to the above questions change if
o EU member states develop slower than expected?
o EU member states develop faster than expected?
We base our simulations on the estimations reported in the previous chapter (Table
6.6) where we explained the number of a) R&D in-shoring projects, b) R&D off-
shoring projects, c) domestically invented EPO patents, and d) domestically owned
EPO patents using various country level variables from the EIS database. We take
the estimated parameters from these models as the first input into our simulation. In
order to be able to simulate performance in 2009 we need to choose values for the
explanatory variables of the estimations in Table 6.6 of chapter 6. We use the sample
average annual country-specific changes of each of the variables as our benchmark
annual change of each variable. Our simulations therefore seek to take into account
the differences in EU member states’ development in the recent years. This allows us
to produce country level simulation results. As our “slow” and “fast” projections we
use the benchmark values from which we subtract or to which we add the country-
specific standard error of each variable over our observation period.
It is important to note that while this method seeks to take into account the
uncertainties that relate to how future development of a given macro-level variable is
associated with its past development, it at the same time ignores a number of issues.
First, we do not seek to look at the effects of some explanatory variables developing
“better than expected” while some develop “worse than expected”. Second, it is
naturally entirely possible that while some member states experience better than
expected development, others fare worse. Finally, and not least importantly, our

simulations are - as is the case in much of the literature – based on the point
estimates and ignore the uncertainty associated with individual coefficients. While
there are ways to take this last source of uncertainty into account quantitatively, we
have opted for a discussion of its likely effects. The reason for this choice is that
already the performed sensitivity analyses show that the results vary to a large
extent depending on what type of development one expects for a given member
state. It is therefore our suggestion that one interprets the findings from this
simulation study with great caution.
7.2 Results of simulations
The results of the simulations can be reported in a variety of ways. Looking first at
the absolute numbers and averaging them over member states, the number of
inward R&D projects is estimated to be circa 7/country in 2009 while the number of
outward R&D projects is estimated to be 8/country. These averages mask wide
variation between countries. Some countries are estimated to have no in- or outward
R&D projects, and the maximum number of in(out)ward R&D projects is 45 (65).
These numbers may sound tiny, but the estimated growth over a 5-year period is in
26% for inward R&D and 58% for outward R&D. Thus, outward R&D is, based on this
exercise, expected to grow faster than inward R&D in the member states. In Tables
7.1-7.4 we report changes in per cent only.

Table 7.1.
Simulation results – Low growth scenario
Variable Mean S.D. Min Max
% change in
inward R&D -49 80 -99 199
projects
outward R&D 107 200 -67 615
projects
Domestically 29 120 -54 290
invented patents
Domestically 95 280 -66 720
owned patents
Table 7.2.
Simulation results – High growth scenario
% change in
inward R&D 1240 2650 -100 9700
projects
outward R&D 74 240 -96 790
projects
Domestically 3700 7000 440 19400
invented patents
Domestically 5800 11700 400 32200
owned patents
Table 7.3.
Simulation results – Average growth scenario
% change in
inward R&D 26 124 -77 400
projects
outward R&D 58 164 -81 490
projects
Domestically 930 1330 68 440
invented patents
Domestically 1490 2420 36 800
owned patents

In order to remind the reader of the uncertainty that is inherent in any exercise of
this type, using the “low” growth scenario yields as the average expected number of
in(out)ward R&D projects 4 (9), and the “high” growth scenario yields an average of
32 (9) projects/country. The minimum predicted country-specific number of inward
projects in the “high” growth scenario is almost exactly the same as the predicted
average number of projects in the “low” growth scenario.
For the 11 countries for which we could simulate the results when using the average
scenario, the number of domestically invented (owned) patents is on average over
8000 (10 000)/country in 2009. The growth from 2004 to 2009 is several hundreds
of per cent when using the “average” scenario. These numbers are however even
more sensitive to the choice of the scenario. In the “low” growth scenario, the
average number of domestically invented patents “only” increases by 30%. Naturally,
in the “high” growth scenario, growth is even faster than in the average scenario.
Table 7.4.
Country level simulation results – Average growth scenario
Variable inward R&D outward R&D domestically domestically
% change in projects projects invented patents owned patents
Country
Belgium 45 190 76 36
Czech Republic -72 -81 380 390
Denmark -37 83 950 200
Estonia 170
Finland 28 490 4400 8000
France 32 -36 68 57
Germany 400 49 170 180
Hungary -38 -80 600 1000
Ireland -75 89 2000 2300
Latvia 100
Poland -77 -45
Slovakia -33
Slovenia -77
Spain -9 220 220 270
Sweden -40 -22
Notes: All variables could not be simulated for all countries because of data limitations.

Looking at the country-level figures when using the average scenario, it becomes
clear that if these numbers were accurate, they would predict quite widely diverging
developments between member states. The lowest growth in the number of inward
R&D projects (among the member states for whom we were able to produce
simulations on this variable) is in the Czech Republic and Ireland where the
prediction is a 75% decline in the number of inward R&D projects. The largest growth
is predicted for Germany, Estonia and Latvia with 400, 170 and 100%.
Looking at the number of outward R&D projects, the Czech Republic, Hungary and
Slovenia fare worst in terms of growth (-81, -80 and -77% growth) while Spain and
Finland fare by far the best (220 and 500% growth). The growth in domestically
invented (owned) patents displays similarly divergent behaviour. While all countries
for which we were able to compute the figures are expected to see the numbers grow
(using the average scenario), growth rates for domestically invested patents vary
from round 70% for France and Belgium to Ireland’s 2000 and Finland’s 4400%.
Growth rates for domestically owned patents vary between Belgium’s 36% and
France’s 57% at the low end and Ireland’s 2300 and Finland’s 8000%.
To take one country as an example of how much uncertainty these numbers mask,
consider Ireland. In the low growth scenario, its growth rates for inward R&D are
90%, for outward R&D 65%, for domestically invested patents 50% and for
domestically owned patent 18%. In the high growth scenario, the respective figures
are -35%, 116%, 1940% and 3220%. Taking the uncertainty of the parameter
estimates into account would yield large confidence intervals for any of the numbers
presented in this section.

8 Findings from the Survey
In order to understand the phenomenon of R&D off-shoring more thoroughly at
micro-level a survey among EU companies engaging in R&D off-shoring was
conducted as part of the project. The results and findings from the survey are
reported in this chapter. Especially three questions were of interest: a) how has R&D
off-shoring developed and is expected to develop in the coming years, b) what are
the reasons behind decisions to off-shore R&D, and c) what kind of effects does R&D
off-shoring has to individual companies as well as to the general innovation capacity
of the EU. Accordingly this section focuses on findings about these questions.
8.1 The Survey and responding companies in short
The Survey was conducted by TNS Gallup in May-August 2006. The purpose was to
interview 200 companies engaging in R&D off-shoring activities. However, it turned
out to be very difficult to find companies that are a) conducting R&D off-shoring, and
b) willing to answer questions about their activities. For this reason the final number
of respondents is 158. TNS Gallup approached executives responsible for target
companies R&D activities by phone. The questionnaire for the interviews was
prepared by LTT and approved by representatives of the EU commission. It contained
about 70 questions related to different aspects of the R&D off-shoring phenomenon.
Responding persons were given the possibility to go through the questions before
replying if they so wished.
The total number of contacted companies was 850. 39 % of these companies refused
to participate in the Survey. A number of remaining companies were rejected
because of various other reasons and, 46 % of the remaining companies did not
conduct R&D off-shoring giving us the final figure of 158 responding companies.
The average turnover of the responding companies was 2.6 billion €. Average R&D
expenditure was 108 million € and companies employed on average 22 R&D
personnel. On average the sample companies also showed negative profits in 2004.
The remainder of this chapter presents the key findings from the survey.
8.2 Trends in R&D and R&D off-shoring
As figure 8.1 illustrates, sample companies have increased their R&D spending over
the last five years. The same is true with R&D off-shoring activities (as can be seen
from figure 8.2).

Figure 8.1. Change in R&D spending over last 5 years
Change in R&D spending over last 5 years
76
80
70
60
50
% of responding
40
companies
30
20 15.2
8.2 6.3
10
0
Increased Decreased No change Don't know
Figure 8.2. Change in R&D off-shoring over last 5 years
Change in off-shoring over past 5 years
69.6
70
60
50
% of 40
responding
companies 30 24.1
20
10 5.1
1.3
0
Increase Decreased No change Don't know
The scale of change in total R&D activities has been limited. Almost 50 % of
responding companies report this change to have been less than 25 %. The change
in R&D off-shoring has not followed the same pattern. Sample companies can be
divided into two categories. In the first category, the change in R&D off-shoring has
been modest. In the other, it has been much more pronounced. Based on the survey
R&D off-shoring translates most of all into R&D investment flows between different
EU member countries. This is in line with the LOCOmonitorTM data, which was

analysed in chapter 6. The fraction of off-shored R&D conducted outside the EU is
small.
Are there any national differences in how R&D off-shoring has developed? It is
impossible to give a unambiguous answer based on the survey. The number of
responding companies in any particular EU country is too small for reliable
conclusions to be drawn. As an example figure 8.3 illustrates how companies from
some selected EU countries (Germany, UK, France, Finland) have answered to the
question about the change in off-shoring activities. It is clear from this figure that the
off-shoring phenomenon appears to have affected EU countries in a similar-like
fashion. Perhaps surprisingly the French companies have increased their off-shoring
activities most but again the sample size is too small for any real conclusions to be
made.
Figure 8.3. Change in R&D off-shoring over last five years in some EU countries
Change in off-shoring over past 5 years
90
80
70
60 France
50 Germany
%
40 UK
30 Finland
20
10
0
Increased Decreased No Effect Don't know
As figures 8.4 and 8.5 illustrate the future of R&D investments as well as of R&D off-
shoring activities appears to be bright. Survey companies expect both the total R&D
expenditure and R&D off-shoring to increase in the near future.

Figure 8.4. Expected change in R&D spending in next 5 years
Change in R&D spending in next 5 years
80 70.9
70
60
50
% of responding
40
companies
30 21.5
20
7 6.3
10
0
Increase Decrease No change Don't know
Figure 8.5. Expected change in R&D off-shoring in next 5 years
Change in off-shoring in next 5 years
80 73.4
70
60
% of 50
responding 40
companies 30
21.5
20
10 3.2 1.9
0
Increase Decrease No change Don't know
Again, about 50 % of the companies expect the change in total R&D investments to
be 0-25 %. R&D off-shoring is expected to increase clearly less than total R&D
spending. About 40 % of the respondents expect this change to be under 10 % in
next five years.
It also seems to be the case that companies from different parts of the EU expect
similar development in the near future as far as R&D off-shoring is considered. Figure
8.6 shows the answers of companies from the same EU countries as before when
asked about the future of the off-shoring phenomenon.

Figure 8.6. Expected change in R&D off-shoring in some EU countries in next 5 years
Change in off-shoring in next 5 years
90
80
70
60 France
50 Germany
%
40 UK
30 Finland
20
10
0
Increase Decrease No Effect Don't know
According to the results companies also believe that the replacement effect of off-
shored R&D replacing domestic R&D has been limited. It has rather been the case
that domestic and off-shored R&D have complemented each other. However, as
figure 8.7 illustrates companies expect the replacement effect to grow in relative
terms in next five years.
Figure 8.7. The replacement effect of off-shored R&D over domestic one
How much R&D off-shoring replaces domestic R&D
60
50
40 In last 5 years
% of responding 30
companies Over next 5 years
20
10
0
1 Not 3 5
replaced Completely

8.3 Reasons behind off-shoring decisions
The survey confirms findings from other studies about the reasons why companies
decide to off-shore R&D. Figure 8.8 illustrates what the sample companies answered
when asked about their reasons to off-shore R&D activities.
Figure 8.8. Why to off-shore R&D?
Possibilities to acquire
Reasons behind off-shoring decisions
new technology and to
network
Market proximity
45
40
35 Cost savings
30
25 Possibilities to improve
% of responding
companies 20 internal processes
15
Access to skilled labor
10
5
0 Strategic benefits
1 Not 2 3 4 5 Very Don't know (alliances)
important important
Investor contacts
It is clear that improving internal processes or investor contacts are not among the
key issues for these decisions. Rather companies seek skilled labour and strategic
benefits. The latter means networks with other companies, institutions, competitors
or customers. A familiar result from previous studies is also the fact that companies
are interested in possibilities to save costs and in market proximity as well as in
possibilities to acquire new technology.
How companies then choose the location of off-shored R&D? Once again confirming
other studies public support is not crucial to decisions about R&D locations. On the
other hand good IPR-protection, quality of the educational system and a developed
infrastructure are highly valued. Figure 8.9 shows these results.

Figure 8.9. Why to locate R&D in a particular location?
Public support (taxes,

Why to choose particular location for off-shored R&D subsidies)
45
Developed infrastructure,
40 size of R&D sector, R&D
35 concentrations
30
Quality of academic
25 institutions and education
% of responding
companies 20 system, links between
15 academia and firms
General attitudes towards
10
high-tech
5
0
1 Not 2 3 4 5 Very Don't IPR protection
important important know
8.4 Effects of R&D off-shoring
R&D off-shoring can of course have very different effects depending on the nature of
the company in question. As always with surveys it is very likely that the responding
persons cannot answer the often specific questions within the short period of time
they have to complete the survey. For these and other reasons care should always be
taken when interpreting results. This is true also with this project.
What is mentioned above should especially be remembered when discussing different

types of innovations and effects of R&D off-shoring. It is unlikely that all of the
responding companies have a clear understanding how to divide their innovations in
different categories. Even more likely this is true when discussing the importance of
R&D off-shoring to these different categories of innovations. With this in mind the
next figure 8.10 illustrates how companies have answered to the question how
different types of innovations have been affected by R&D off-shoring.

Figure 8.10. How R&D off-shoring has affected different types of innovations
How different types of innovations are affected by R&D off-shoring
67.1
70
60
50
40
% of responding 17.1
30
companies 5.1 7.6
20 3.2
10
0
g
l
ow
t
na
uc
tin
es
tio
kn
od
ke
oc
iza
Pr
ar
n't
Pr
M
an
Do
rg
O
An overwhelming majority of the respondents believe that product innovations are
especially vulnerable (in positive and negative meanings of the word) to R&D off-
shoring. Some of the companies name also process innovations but very few feel that
organizational or marketing innovations are affected by off-shoring. One possibility is
that this answer reflects also the nature of the R&D off-shoring that has occurred so
far. It is possible that it has been technical in nature locating product R&D to
locations where inexpensive labour is abundant and markets for the products are
near.
Figure 8.11. Effects of R&D off-shoring
Effects of R&D off-shoring

Has R&D off-shoring
improved or worsened
66.5
the cost efficiency of
70
60.1 product innovation
60 processes?
50
40 36.1
% of responding
companies 30 23.4
Has R&D off-shoring
20
improved or worsened
10 7.6 company's ablility to
2.5 0.6 3.2
learn about R&D
0
Improved Worsened No effect Don't know
conducted by other
firms/institutions?

Results illustrated in figure 8.11 could be inline with this observation. A majority of
companies feel that the cost efficiency of product innovation processes has been
improved due to off-shoring. The same is true with the ability to learn from third
party R&D.
When asked about the effect for the ability to choose successful R&D projects
majority of respondents gave a positive answer. In other words they felt that their
ability has improved due to R&D off-shoring. One third of the companies were unable
to give an answer but practically none of the companies felt that off-shoring had
undermined their ability to choose successful products. When asked about the effect
on time it takes to commercialise an innovative idea the answers were of similar
nature (figure 8.12).
Figure 8.12. Length of time it takes to commercialise an innovative idea
What is the effect of off-shoring to the length of time it

takes to commercialize an innovative idea?
60 52.5
50
40
% of 29.8
responding 30
companies
20
9.5 8.2
10
0
Shortened Lengthened No effect Don't know
The survey companies were also asked directly about new products or services
arising from R&D off-shoring and effects of off-shoring to new-to-firm products or
services. Respondents felt that R&D off-shoring had either positive or no effect on
new-to-firm products or services. None of the companies answered this effect to
have been negative.
Answers about new products or services arising from R&D off-shoring are collected
into figure 8.13.

Figure 8.13. Share of new products originating from off-shored R&D
The share of new products originating from off-shored

R&D
70
60.5
60
50
% of responding 40
companies 30
19.4
20
8.2 6 6
10
0
0-10 % 11-25 % 26-50 % > 50 % Don't know
The share of new products from R&D off-shoring
It is clear from figure 8.13 that despite the positive effects of off-shoring to new
product launches the share of new products originating from off-shored R&D relative
to the total number of new products is limited.
Clear majority of the responding companies felt that at least so far R&D off-shoring
has had no effect on the educational level of persons employed in the home country.
Also marketing and organizational innovations have been largely unaffected by R&D
of-shoring. This gives support to the observation mentioned above: R&D off-shoring
has been most of all a phenomenon affecting product innovations.
A clear result from the survey is the positive impact that off-shoring has had on the
exports of practicing companies. Almost two thirds of the companies felt that their
exports have benefited from off-shoring. None of the companies answered that their
exports have suffered because of decision to off-shore R&D. Public support for
innovations was widely seen as unaffected by R&D off-shoring decisions.
Finally, the companies were also asked to evaluate directly how R&D off-shoring has
affected their general capability to innovate and how they expect the overall
innovation capability of EU-firms to be affected in the future. The results are
illustrated in figures 8.14 and 8.15 below.

Figure 8.14. R&D off-shoring and the general innovation capacity of the sample firms
The effect of R&D offshoring to the general innovation

capacity of the firm
90 82.9
80
70
60
% of responding 50
companies 40
30
20 13.9
6.3
10 2.5
0
Positively Negatively No impact Don't know
Figure 8.15. R&D off-shoring and the future innovation capability of EU-companies
The effect of R&D offshoring to the general innovation

capacity of all EU firms
87.3
90
80
70
60
% of responding 50
companies 40
30
20
3.8 5.7 3.2
10
0
Positive Negative No impact Don't know
The results are clear. The responding companies strongly believe R&D off-shoring to
have been beneficial to them. They have also a very positive view about the future
effects of this phenomenon to companies in the EU area.
Again it is a fact that the answers stay almost the same no matter what is the
nationality of the responding company. Figures 8.16 and 8.17 illustrate the answers
of our countries chosen as examples (France, UK, Germany and Finland).

Figure 8.16. R&D off-shoring and the general innovation capacity of the sample firms in
selected EU countries
The effect of R&D off-shoring to the general

innovation capacity of the firm
90
80
70
60 France
50 Germany
%
40 UK
30 Finland
20
10
0
Figure 8.17. R&D off-shoring and the future innovation capability of EU-companies
according to companies from selected EU countries
The effect of R&D off-shoring to the general

innovation capacity of the EU
120
100
80 France
Germany
%
60
UK
40 Finland
20
0

8.5 Key findings from the survey
The results from the firm-level survey are well in line with the conclusions from other
parts of this project. Individual companies see R&D off-shoring as a positive
phenomenon that has affected positively their abilities to conduct R&D in its different
forms. A majority of them expect off-shoring to also contribute positively to the
general innovation capability of EU companies.
It is also clear from the survey that R&D off-shoring is still today mostly a “national”
issue. Majority of R&D off-shoring locates to and originates from EU countries.
Developing Asia as a destination area for off-shored R&D is not yet as popular in the
real world as one would perhaps expect from public discussion. This confirms also the
findings from aggregate level estimations with FDI-data from the first part of this
project.
Other key findings from the survey are:
R&D spending and R&D off-shoring have increased in a trend-like fashion over
the past five years.
Good IPR-protection, links between the educational system and the private
sector, market proximity and the possibility of cost savings are among
reasons why to decide a particular location for off-shored R&D.
Public support (taxes, subsidies) is relatively unimportant.
Access to skilled labour and strategic benefits contribute to decisions to off-
shore.
Companies have benefited from off-shoring as far as i) the ability to choose
successful R&D projects, ii) length of time it takes to commercialise an
innovative idea, iii) the cost efficiency of product innovation processes or iv)
the ability to learn about R&D conducted by other firms are considered.

9 Econometric analysis of EPO and Survey data
In addition to the descriptive analysis of the survey data described in the previous
Section, we have performed a more in-depth micro-econometric analysis of the
survey data after having matched European Patent Office data on patents and
inventors to the survey data. The objective of this exercise was to study the following
questions:
What determines how much R&D off-shoring a firm practices?
What determines how much R&D off-shoring has replaced domestic R&D?
What determines where a firm locates its off-shored R&D?
What are the effects of R&D off-shoring on R&D performance?
The econometric approach adopted here allows us to control for firm characteristics,
and therefore provides more accurate answers than simple descriptive statistics.
Furthermore, it allows us to quantify the impacts. What it does not allow us to
necessarily do is to draw conclusions about causality. In what follows we discuss our
views on the strength of the causal interpretation of each result separately. The
conservative approach is to view all of them as statistical associations.
The data we use is the sample of firms surveyed for this study. One has to keep in
mind that the survey respondents were selected on the basis of them actually having
off-shored R&D. The implication of this is that whatever results we obtain, those
cannot be readily generalized to the firm population at large, but at best the results
hold for firms already having off-shored R&D.
9.1 Determinants of the level of R&D off-shoring spending
One of the survey questions was: “As a percentage of total R&D spending, how much
is currently off-shored, i.e. conducted outside your home country?” The answers to
this question (which ranged from 0% for 2 firms to 100% for one firm, with the
mean being 20%) were used as the dependent variable. As explanatory variables we
used the following: number of employees (in 2004) as a control for size; R&D as a
percentage of sales (also in 2004) as a measure of R&D intensity; dummies for
country of origin; answers by the firms to questions on the importance of basic and
applied research, and product and process research, each measured on a 5-point
54
Likert scale; dummies for location of off-shored R&D ; and the number of EPO
54
The locations were: EU, non-EU European countries, developing Asian countries, developed Asian countries, Latin
America, North America, and Africa.

patents acquired in 1985-2003 as a measure of past inventive performance. We used
a so-called two-limit Tobit estimator to take into account the fact that our dependent
variable is censored on the left and on the right.
We find the following results in Table 9.1:

Table 9.1
Percent of R&D off-shored (two-limit Tobit)
Variable Coefficient (s.e.)
Number of old patents .05*
(.03)
Employees in 2004 -.3
(.1)
RD intensity .3
(300)
EU 4.2
(4.9)
Europe/non-EU 10.4**
(4.4)
Developing Asia -3.7
(4.4)
Developed Asia 1.1
(4.8)
North America 2.0
(4.6)
Latin America 16.5**
(7.5)
Africa 13.0
(8.3)
Constant 10.6**
(5.4)
Sigma 20.1***
(5.5)
LogL. -450
Nobs 104
NOTES: coefficient and s.e. of employees multiplied by 1000; those of rd intensity
by 100. *** = significant at 1%; ** = 5%, * = 10% level.

First, country of origin, firm size and R&D intensity do not affect the percentage of
R&D that is off-shored. Second, the higher the number of EPO patents, the higher
the percentage of R&D that is off-shored. The causal interpretation would be that a
one patent increase in the number of patents leads to a seven percentage point
increase in R&D off-shoring. As the answer to the question used as a dependent
variable however reflects past decisions, it is not clear that this result can be given a
causal interpretation. Finally, the location to which R&D has been off-shored
“explains” variation in the percentage of R&D being off-shored. Those firms that have
located their off-shored R&D to non-EU European countries and/or to Latin America
have off-shored a higher percentage (10 and 16 percentage points respectively) of
their R&D compared to firms who have not located their R&D into these regions.
9.2 Determinants of R&D off-shoring replacing domestic R&D
A central worry related to R&D off-shoring is that it might replace domestic R&D. To
study whether this is the case we asked the survey respondents two questions. The
first one asked to what degree replacement has already occurred,55 the second the
firms’ view as to what is going to happen in the near future. As the dependent
variable is ordinal in nature, we used ordered probit models in our estimations. We
studied how the same explanatory variables as used in explaining the percentage of
R&D off-shored affect the degree of replacement.
The results, reported in Table 9.2, reveal that as to current level of replacement,
country of origin, firm size and R&D intensity play no role. Because the country
dummies were jointly highly insignificant, we dropped them and re-estimated the
model. We find that location of off-shored R&D is associated with its replacement
effect. R&D located in developing Asia is associated with higher levels of
replacement. There is no statistically significant difference between the other
locations of off-shored R&D. Finally and somewhat surprisingly, the more important
product and process level R&D is to a firm, the lower is the replacement of domestic
R&D by off-shored R&D. Turning the firms’ expectations of future replacement
effects, we find that country dummies, firm size and R&D intensity again play no
role. Firms who have located their off-shored R&D in developing Asia and/or North
America (the latter only marginally statistically significant) expect that in the future,
55
The questions were: By using scale 1-5 evaluate how much has R&D off-shoring replaced domestic R&D conducted by
your company over the past 5 years? 1= R&D off-shoring has not replaced domestic R&D at all,..., 5= R&D off-shoring
has completely replaced domestic R&D. By using scale 1-5 evaluate how much do you expect R&D off-shoring to replace
domestic R&D conducted by your company over the next 5 years? 1= R&D off-shoring will not replace domestic R&D at
all,..., 5= R&D off-shoring will completely replace domestic R&D.

there is more replacement of domestic R&D by off-shored R&D. The type of R&D that
the firm deems important to itself has no effect.
Table 9.2
Replacement of domestic R&D by off-shored R&D (ordered
Probit)
Variable Current Future
Replacement Replacement
Coefficient (s.e.) Coefficient (s.e.)
Employees in -4E-06 -9E-06
2004 (6E06) (6E6)
RD intensity .8 .6
(1.7) (1.6)
EU .3 .3
(3) (.3)
Europe/non-EU .0 .0
(.3) (.2)
Developing Asia .7*** .9***
(.3) (.2)
Developed Asia .1 .1
(.3) (.3)
North America .2 .4*
(.3) (.3)
Latin America -.3 -.3
(.4) (.4)
Africa .3 -.5
(.5) (.4)
Basic research .1 .1
(.1) (.1)
Applied research -.0 .0
(.2) (.1)
Product and -.2* -.1
process (.1) (.1)
development
Constant - -
LogL. -114 -130
nobs 104 104
NOTES: coefficient and s.e. of rd intensity by 1000. *** =
significant at 1%; ** = 5%, * = 10% level.

9.3 Determinants of the off-shored R&D location
We have used the location of off-shored R&D as an explanatory variable in the above
analyses. It is however of great interest to study what determines where a firm
locates its R&D, conditional on it practicing off-shoring of R&D in the first place. To
this end we ran separate logit estimations for each location decision.56 This approach
amounts to us assuming that decisions to locate in different regions are independent
of each other: given our data, this is a necessary assumption. We use as explanatory
variables number of employees for firm size, R&D intensity, the average number of
countries where firms’ EPO patents’ inventors reside (to control for revealed past
internalisation of R&D), answers to questions that indicate what the firm perceives as
important characteristics of a location when considering R&D off-shoring, firms
answers to questions on what type of R&D is important for them, and country
dummies.
The location characteristics that we asked questions on are how important is i) public
support, ii) highly developed R&D infrastructure (incl. size of R&D sector), iii) general
attitudes toward high technology and public demand for innovative products, iv)
quality of academic institutions and the education system, v) the level of intellectual
property protection. We asked firms to evaluate the importance of each of these on a
five-point Likert-scale.
We find (results are reported in Table 9.3) that none of the firm characteristics (size,
R&D intensity, number of EPO patents, importance of different types of R&D,
importance of different receiving country characteristics) explain decisions to
outsource within the EU – only country of origin seems to affect this decision in a
statistically significant way. We however hesitate to give these any interpretation as
they capture everything that is specific to a given country of origin. Firms for which
the infrastructure of the receiving country is important are more likely to locate R&D
facilities in non-EU European countries. Even this coefficient is however only
marginally significant. Firms for whom the public support of R&D (subsidies, tax
benefits) is important are less likely to locate their off-shored R&D laboratories in
developing Asian countries. The larger the firm, the more likely it is to locate off-
shored R&D into developed Asian countries, whereas (somewhat surprisingly) the
more important the general attitude and public demand for innovative products for
56
It is in principle possible to estimate a multivariate probit where the error terms from each equation are allowed to be
correlated with each other. The implementation of such an estimator would require much more data than is available
here.

the location decision, the less likely a firm is to locate into developing Asian
countries.
Table 9.3
Determinants of location of off-shored R&D (Logit)
Variable EU Europe/non- Developing Developed North Latin Africa
EU Asia Asia America America
Employees .2 .0 .2 .4** .4 .3 .1
in 2004 (.3) (.0) (.2) (.2) (.3) (.2) (.3)
Rd intensity -.3 .2 -.8 -1.2 .4 -4.7 -1.0
(.6) (.5) (.6) (.9) (.5) (6.9) (4.5)
Number of -.1 .0 .0 .0 .0 -0 .0
old patents (.3) (.0) (.0) (.0) (.0) (.0) (.0)
Public -.2 -.4 -.4* -.0 .1 .0 .8*
Support (.3) (.2) (.2) (.3) (.2) (.4) (.4)
Infrastr. -.4 .5* .0 -.2 -.3 -.2 -.5
(.3) (.3) (.2) (.3) (.3) (.5) (.5)
Attitude .3 .1 -.1 -.4* .1 -.1 -.1
(.3) (.2) (.2) (.2) (.2) (.5) (.5)
Academia .0 .4 .3 .1 -.2 .2 -.1
(.3) (.3) (.3) (.3) (.3) (.6) (.5)
IPR -.1 .1 .1 -.4 .3 -.9* -.6
(.3) (.3) (.2) (.3) (.3) (.5) (.5)
Basic .1 .1 .2 1.1*** -.2 .0 -.6
research (.3) (.3) (.2) (.3) (.3) (.5) (.6)
Applied .2 -.5 -.4 -.6 .7* .6 -.2
research (.4) (.3) (.3) (.4) (.3) (.7) (.7)
Product and .2 -.2 .4 .7 -.4 1.3* 1.1
process (.3) (.3) (.3) (.4) (.3) (.8) (.7)
development
Constant 18.8*** -20.2 -.2 .3 18.7 -23.8 -21.1
(2.4) (-) (2.1) (2.7) (-) (4.6) (-)
LogL. -44.2 -53.4 -60.5 -47.5 -46.6 -21.7 -18.44
Nobs 93 100 102 102 89 77 92
Country of YES YES YES YES YES YES YES
origin
dummies
NOTES: coefficient and s.e. of employees multiplied by 10 000; those of rd intensity by 100. ***
= significant at 1%; ** = 5%, * = 10% level.

Only one of our firm level variables is associated in a statistically significant way with
the decision to locate R&D into North America: the more important is applied R&D for
the firm, the more likely it is to locate into North America. Those firms for whom
good IPR protection is important are less likely to locate into Latin America, and
those firms for whom public support is important are more likely to locate in African
countries.
9.4 The effects of R&D off-shoring on R&D performance
In studying the effects of R&D on innovative performance, we leaned upon the large
existing literature that uses patents as a measure of innovation output. While this
measure has its well-known problems, it is nonetheless both widely used, and well
understood. Our starting point was to seek to answer how different measures of R&D
off-shoring affect innovative performance after controlling for important firm
characteristics. A major challenge is to control for all those potentially important
unobservable firm effects that distinguish successful innovators from less successful
ones when having access to only a cross section of data (i.e. only observing each
firm at one point in time). Our solution to this problem was to create a variable that
captures how successful the firm has been in the past – this we measure by the
number of EPO patents prior to 2004.
We then proceeded to estimate so-called negative binomial models to explain the

number of EPO patents granted in 2004. As our key explanatory variables we used
two measures of R&D off-shoring: first, the average number of locations of inventors
in the firms past EPO patents and second, the fraction of R&D that has been off-
shored. The former captures the “productivity” effects of R&D off-shoring while the
latter captures the strength of R&D off-shoring in relation to a firm’s overall R&D
effort. As additional explanatory variables we included the following: number of
employees, R&D intensity, measures on what type of R&D is important for the firm,
country dummies, sector (industry) dummies and location of off-shored R&D
dummies.
We find (see Table 9.4) that country of origin, sector and location of off-shored R&D
indicators have no explanatory power (hence we dropped them from the specification
that we report). We find that past performance has (surprisingly) a negative impact
on current innovative performance after conditioning on everything else; that firm
size is negative correlated with the number of patents, as is R&D intensity. These
results are not in line with the existing literature and it is not clear what their
explanation is. They are however very robust in our data.

Table 9.4
Number of EPO patents in 2004 (Negative binomial)
Variable Coefficient (s.e.)
Number of countries of innovators .13***
(.03)
Number of old patents -.04***
(.02)
Interaction between the above two -.19***
(.04)
% of R&D off-shored -.02*
(.01)
Dummy for answering the above question .06
(.69)
Employees in 2004 -.14***
(.03)
RD intensity -.18*
(.10)
Basic research -.33
(.32)
Applied research -.75
(.49)
Product and process development .94**
(.46)
Constant -1.68
(1.84)
Alpha 1.10
(.53)
LogL. -62.1
Nobs 104
NOTES: coefficient and s.e. of the interaction and of employees multiplied by 1000.
*** = significant at 1%; ** = 5%, * = 10% level.
The more important is product and process R&D, the higher the number of patents.
The higher the percentage of off-shored R&D, the lower the number of EPO patents –
this effect is however only marginally significant statistically. In our view the most
important result is however the positive coefficient on the average number of

inventor locations in past patents. This implies that the higher the number of
locations in which past patents have been invented, arguably a measure of success in
off-shoring, the higher the number of patents. This result, especially as we condition
on the number of past patents, suggests a possible causal relation. The interpretation
would be that successful off-shoring of R&D has beneficial effects for the overall
innovative performance of a firm. The causal interpretation rests on the assumption
that past innovation performance captures the otherwise unobservable differences in
firm level innovative performance.
9.5 Summary
The following list summarises the main findings from the survey estimations:
1. What determines R&D off-shoring?
The number of previous patents is associated with (the degree of) off-
shoring.
Firms that off-shore to Europe and Latin America have a higher degree of
off-shoring than those who do not off-shore to these locations.
2. What determines replacement?

Having located off-shored R&D into developing Asia is associated with a
higher degree of replacement than off-shoring to other locations.
Having located off-shored R&D into developing Asia and/or North America is
associated with a higher degree of future replacement than off-shoring to
other locations.
3. What determines where to locate off-shored R&D?

a. Depending on the location, various policy measures have an impact.
The more important the local attitude towards innovations is the less likely it
is that a firm has off-shored to developing Asia.
The more important the infrastructure is the more likely it is that a firm has
off-shored to non-EU Europe.
The more important the public support is the less likely it is that a firm has
off-shored in developing Asia and the more likely it is that it has off-shored
in Africa.
The more important the IPRs are the less likely it is that a firm has off-
shored in Latin America.
b. Depending on the location, various firm R&D emphases have an impact.
Firms for whom basic research is important are more likely to have located
in developed Asia than firms for whom basic research is not important.

Firms for whom applied research is important are more likely to have
located in North America than firms for whom applied research is not
important.
Firms for whom product and process development is more important are
more likely to have located in Latin America than firms for whom product
and process development is not important.
4. What are the effects of off-shoring on R&D performance?

We found no effects of the degree of off-shoring on R&D performance,
measured as the number of EPO patents.
We did find that the higher the number of countries in which the firm’s
patents have been invented, the higher the number of EPO patents.

10 Case studies: The corporate perspective
In order to find out more about the companies’ viewpoints on R&D off-shoring and its
effects on EU firms innovation capacity we have studied several individual case
companies. The objective was to get the management level business view on the
R&D off-shoring issues. 14 company representatives were interviewed successfully.
In addition to the case study information obtained by interviewing we have collected

some already published company cases57. These cases are viewed to be of interest to
the reader because of the detailed descriptions of some situations and company
solutions. These companies are global household names and they provide very
concrete examples. These cases are presented in separate boxes.
This chapter presents the findings - i.e. opinions and views - of the case companies
and the analysis and implications of the findings on a global scale.
10.1 Case study method and description of interviewed firms
Case study as a method focuses on different company cases as such, and the
objective is to find and describe several different cases. The objective is not to draw
any generalisations; for that purpose we have conducted the Survey presented in
chapter 8 and further analysed in chapter 9 of this report. The individual cases are
best read separately and they can be found in the appendix (Cases A-N) with the
case outline including the case interview questions.
The 14 in-depth case interviews took place in the summer and autumn of 2006.
Seven interviews have been conducted on-site, i.e. in company locations either at
headquarters or on off-shore sites and the others over the phone. The companies
that agreed to participate in this case study were promised a confidentiality
concerning the identity of the firm and the interviewee. Therefore the names and any
specific information cannot be disclosed.
Out of these 14 cases one has its headquarters in the US whereas the others come
from nine different European countries. 11 cases represent a multinational enterprise
(MNE) and three are small or medium sized enterprises (SME). Three of the case
studies are conducted from the viewpoint of an off-shored R&D centre and the others
have a centralised corporate view. The nine different business sectors represented in
57
Tekes, Globalisation of R&D (2005)

these cases are aerospace and defence (1), chemicals (1), electronic and electrical
(3), engineering and machinery (1), household goods and textiles (1), IT hardware
(1), pharma and biotech (2), software and computer services (3), support services
(1). The interviewees are mainly R&D managers, vice presidents, managing directors
or site directors.
10.2 Reasons for R&D off-shoring
For global and multinational companies it is natural to have a global presence also in
terms of research and development functions. These companies have their strategy
and business objectives, which usually define where the company wants to be now
and in the future - also in geographical terms. The firms might not talk about off-
shored activities because for these multinationals more or less everything is
somehow off-shored. The company is everywhere and they talk about global
activities. They rotate their R&D staff all over the world in different research centres
where things are done in co-operation with other divisions, with local and
international universities and even with other companies. R&D is done in projects,
which are usually managed autonomously within the centre but controlled centrally
within the whole enterprise.
The studied companies had quite similar views about the reasons for R&D off-shoring
although the criteria vary. The number one reason was customer demand; the firm’s
R&D needs to have a market presence in order to sell the company’s products, to
show their commitment to the market and to localize their products and services.
Customer demand is greatest where the markets are growing and for the company to
be able to grow it has to be present in those growth markets. Additionally, for
manufacturing companies R&D is easily off-shored to where the production already
is.
In search of scarce resources, i.e. talented people, the companies often need to look
into places outside of their own surroundings. They establish research centres in
places where there is a dynamic academic community collaborating commercially
with companies. Several smaller R&D centres are viewed to be more creative than
one large R&D unit (see e.g. Case J) and that is why R&D off-shoring is in most cases
complementary to the national R&D. The increasing knowledge returns are most
likely in areas of high concentration of R&D activity that create economies of scale
and profit from interaction between scientists and researchers. Specialised
knowledge, opportunities for professional development, organisational learning, and
quick institutional adaptation to new ideas can create self-reinforcing processes that
promote further learning in such R&D clusters. However, most of the companies still

want to keep a part of their R&D close to the operative management working in
corporate headquarters in the home country.
Companies that operate in a very competitive industry look for cost savings and
government incentives. They outsource unambiguous R&D projects to their partners
in off-shore locations. That sort of off-shoring might be one-time only or on a
continuous basis and it sometimes substitutes the domestic R&D. Cost factors and
government subsidies are especially relevant to companies whose R&D work is not
complex or specifically and strategically important for the company, and when the
company does not have a technological competitive edge. Yet, many of the case
companies did not see costs as a decisive factor when choosing an R&D site (see e.g.
Case G) and did not consider public funding to be a key factor (Case H).
Multinational enterprises (MNEs) act as coordinators of the global supply chain. They
can facilitate the generation and collection of commercial ideas, create products that
appeal to diverse markets, and set up production sites in a variety of countries. In
this way, MNEs move ideas across borders more quickly than ever before. But in
exchange, MNEs want to accrue the benefits flowing from those ideas. To do so, they
have been moving aggressively to gain greater control by directly owning important
foreign affiliates, coordinating critical activities in central offices and thereby making
themselves a location of idea exchange. They also aim at getting more of their ideas
under patent control. With this goal in mind, many of the case companies have
reduced the number of affiliates in which they have only a minority stake and have
increased the share of affiliates that they fully own.
As MNEs spread their operations across many countries, the fragmented and
distributed production processes make it more attractive for them to capitalize on
local markets and capabilities without incurring the costs and complexities of a joint
venture. As companies become more global and more deeply integrated into the
society of other countries, however, conflicts arise between the interests of the local
entity and those of the company as it optimizes its global network and production
system.
From the firm’s point of view, however, being able to control local operations helps to
make capital decisions and tax planning on a global basis. Such considerations make
ownership and control more interesting to large MNEs, because it gives them more
influence in the host country and more power in the world economy. (See MNE cases
Siemens and GE below.)

Siemens
Increasingly, successful national companies have found that the opportunity for future growth depends on
international markets. For many years, Siemens was the dominant company across a wide spectrum of
industries in Germany, including telecommunications equipment, computer systems, heavy equipment,
automation, and machinery. It had high market share, access to the best talent, and, in some cases,
captive markets. However, as its industries opened to global competitive forces and technology changed
the boundaries, Siemens realized that continued growth required geographic expansion. As the world’s
largest market, the United States became Siemens’ number one priority, and today Siemens has higher
revenues in North America than in Germany. Siemens’ next focus is aggressively pursuing China’s
markets, where it already has a $4 billion business with potential for continued high growth.
As a reflection of this change, in the last twelve years its employment in Germany is down 80,000, while
Siemens has added 90,000 employees internationally. Because it remains an export center, Germany
today still represents 41% of employees though only 23% of sales. But the trend is clear. Future growth in
sales, people, and knowledge is outside Germany and even largely outside Europe. Software is a critical
capability across the Siemens businesses. As a result, the company employs 30,000 software people, a
larger number than many leading software companies. Software now accounts for over 50% of R&D
spending at Siemens. Over the next three to five years, Siemens will move 10,000 R&D positions to China,
India, and Russia for reasons of productivity and cost, but also to access the rich talent base and move
R&D closer to growth opportunities in Asia.
Source: Tekes, Globalisation of R&D, 2005
GE
GE is a global company with over 45% of its sales outside the United States. But GE expects about 60% of
its growth in the next decade to come from developing countries, particularly China and India. This is
dramatically affecting GE’s R&D strategy and the location of future research.
Historically, GE has done almost all of its corporate research in the United States at the GE Global
Research Center in Niskayuna, New York. But in 2002, GE invested $80 million in a Bangalore centre that
does R&D in computer modelling and advanced materials, and in 2003, the company invested $64 million
to open a research centre in Shanghai focusing on power technologies, ceramics, metallurgy,
manufacturing technology, and medical visualization. This centre also provides software and IT support to
GE’s global businesses.
Most recently in 2004, GE invested $52 million in Munich to establish a research hub in the heart of
Europe—and to have a stronger technology capability in Siemens’ home territory—that focuses on
alternative energy, environmental technologies, automotive systems, sensors, electrical systems, and
advanced medical systems. All the international research centres have missions that align with the global
GE strategy. They each have leadership roles and global charters in designated fields and specific
technologies.
In all the ways mentioned, the largest MNEs control the vast majority of R&D
spending. But it isn’t easy. The case company MNEs increasingly struggle with the
need to maintain growth and differentiate their products in very competitive global
markets. Large companies face shareholder pressure for near-term results, more
rapid product development, innovation, and time-to-market improvements.
To meet these challenges, MNEs are relying more on small and medium sized
enterprises (SMEs) - start-ups and small innovative companies - to provide the flow
of new ideas and technology applications (see SMEs in Case D, I and L). SMEs can
provide greater innovation, agility, and a more immediate connection to market and
consumer needs than perhaps a large multinational firm. As innovation becomes the
key driver of corporate growth, more of MNEs’ R&D is being done in collaboration
with universities, start-ups, design firms, leading customers, suppliers, and
consumers.

SMEs’ R&D often takes place in clustered manufacturing sites that specialize in
certain types of products and build a competitive advantage around those specialties.
The key characteristics of these sites are innovation through R&D, entrepreneurship,
a culture of risk-taking, deep local resources and financial investors, and a strong
manufacturing base with lots of SMEs. These places form emerging industry networks
that can do particular jobs very well and attract skilled personnel with good
infrastructure, schools and universities (see e.g. Case F). Exports provide the
entrance to the global market, through MNEs but also through logistics networks that
link all the players in the regions to the larger world. R&D concentrates on product
development linked to local industries and extends internationally. A danger to these
specialized centres is that large firms can move in and buy out their ideas but then
transfer the production to larger markets or lower cost manufacturing locations. This
can occur in rapidly changing technology industries as well as in relatively mature
industries.
When asked about the important determinants affecting the decision to off-shore in-
or outside of EU the case companies criticised inflexibilities in the European labour
markets, slow or unexpected policy changes, relatively low GDP growth and
fragmented markets with too many national barriers. An example of a company
forced to off-shore R&D due to the strongly regulated home market can be found
from Case L (see Appendix) and case Novartis below.
Novartis
Novartis recently made a major strategic move in relocating its corporate research headquarters from
Switzerland to Cambridge, Massachusetts, in order to have access to research universities and the local
biotechnology start-ups there. The company is doubling the number of researchers at the new Institute for
Biomedical Research in Cambridge as it aggressively seeks to attract top talent. A total of 32% of the new
hires have been in biotech, 46% in academics, and only 22% in pharmaceuticals. Novartis has gone as far
as hiring a former Harvard Medical School professor as its Corporate VP of R&D.
With its proximity to the leading researchers, the company will establish an approach to drug discovery it
refers to as “guided serendipity.” One example is Novartis’ collaboration with Harvard and MIT to decipher
the genetic causes of diabetes.
It is interesting to note that in the 1980s about two thirds of pharmaceutical R&D was done in Europe and
now even the remaining independent European pharmaceutical companies spend over 50% of their R&D in
the United States. Novartis still has a major research lab in Basel, a centre in Basel focused on biomedical
research, and other centres in Austria and the United Kingdom. It also has a lab in Japan focused on
oncology and cardiovascular research, and another U.S. lab in La Jolla called the Genomics Institute of the
Novartis Research Foundation, which has grown to over 400 people.
Positive factors in the European business environment consist of high-level

education, position in the technological frontline with Asians and Americans, high
standard of living and a safe social environment. For many multinational case
companies of European origin that have R&D sites in other European countries the
benefits arise also from the similarities in culture and closeness in terms of time and
distance. In general, the impact of the policy environment is viewed to arise from the

knowledge infrastructure, innovation network systems and policies in place, not so
much from financial incentives or subsidies.
10.3 Modern R&D and its requirements
As a result of the way the large and powerful multinational firms are pursuing
innovation in the highly competitive global marketplace, two seemingly contradictory
trends are influencing R&D today: concentration and dispersion. MNEs have a
growing influence in organizing and concentrating R&D. On the other hand, the
expansions of the global economy and the information revolution have enabled the
dispersion of ideas and innovation around the world.
According to some of the case companies, the modern innovation process is

interactive and iterative; the classical linear innovation model (invention,
development, application, product/service, and market) does not necessarily apply
everywhere anymore. Innovation is a joint activity of marketing, technology, cost
optimisation and the knowledge of industrial and economic trends. Successful R&D is
viewed as a combination of invention, innovation and adoption (Case E).
The case companies do hardly any basic research but focus clearly on different forms
of applied research and product development. Some companies do co-creations with
customers and open up their innovation laboratories for interactive development
work. Open standards seem to be a driver and enabler for internationalised R&D.
Firms have had to break down barriers among functional disciplines inside the firm
and open the firm to ideas created outside company boundaries. Innovation comes
from a strong analytic capability, but also from an ability to interpret the market, to
explore the boundaries between different disciplines (marketing, technology, design,
customer needs) and among companies (suppliers, partners, and even competitors).
Firms are learning to send designers out into stores and the marketplace to pick up
ideas — and to build teams to share perceptions and ideas during the design phase
of new products.
Successful R&D off-shoring seems to have some extremely important managerial and
communicational requirements. Usually the management of off-shored R&D is
centrally organised because of the need to have the ownership of the project and be
able to “run the show”. The off-shored R&D centres are relatively autonomous and
work very closely with the headquarters. Internal processes have to be well defined
and in good order so that everyone knows how things work and has easy access to
information. Job descriptions change in this environment quite often and there is a
need to keep them updated in real time and in a transparent way to everyone.

Efficient multi-directional communication is very important especially in 24/7 R&D
environments (see e.g. Case M). Cooperation problems, the “not-invented-here”
syndrome and unhealthy internal competition arise easily between home and off-
shore R&D teams (see e.g. Case K and G).
Cultural awareness is a new requirement in some companies but an inherent

corporate value in some. Whichever the case, the people in charge of off-shore R&D
management need to be aware of different cultures, different ways of working and
communicating. It is too easy to communicate directly only to the closest colleague
whose cultural background is similar to one’s own. The biggest challenges and also
the biggest benefits rise from intercultural communication, through peer-to-peer
learning, working with others and mutually adjusting to one another. Corporate
values are best when they support that notion and when they are truly internalised.
Modern global R&D needs services. As manufacturing becomes more globalised, so

does R&D, leading the way to globalised service sector. Services are critical in
enabling the globalisation of manufacturing and R&D. Effective business services are
appearing in all the places that manufacturing firms operate. Since manufacturing
firms need to have access to the latest information, communications, logistics, and
intellectual property protections wherever they are, they rely on sophisticated
services for their success.
There is a critical difference, though, between the service companies and the
manufacturing companies. While the manufacturing arms are export based and earn
their profits by making and moving goods away from the local markets (for the most
part), the services firms provide most of their activities locally, especially to the
global manufacturing firms in the local area. While some of the services’ growth
represents outsourcing of internal corporate functions to cheaper locations, the vast
majority of global service activities seem to facilitate the local activities of other
MNEs and the local distribution of international goods.
Below are Toyota’s and P&G’s models for modern R&D.
Toyota
Toyota is widely recognized for its superior quality and its factory-based cost advantage with its emphasis
on lean manufacturing and the Toyota Production System (TPS). It also has succeeded in building very
efficient collaborative relationships with its leading suppliers. Toyota is now moving to the next level of
globalization in operations by the application of information technology. Viewing the world as a single
integrated market, it is aggressively moving toward simultaneously launching new models around the
world and having parts manufactured in one country designed for use in vehicle assembly in another. A
new center has been created in Japan called the Global Production Center to train its global workforce in
such developments. At the same time, a new Training and Development Center, jointly managed with the
Wharton School, is preparing Toyota’s current and future leaders on the changing nature of global
business and management practices.

Toyota leverages its worldwide infrastructure by means of its global adaptive assembly system. Plants
around the world (which now number 47 in 26 overseas markets) are designed to customize cars for local
markets but also to shift production to quickly satisfy any surges or changes in demand from markets
worldwide for a particular model. By reconfiguring a factory in one location to support demand in another,
major expenses in new plants can be minimized. This has saved billions of dollars in cost reduction and
process redesign. Toyota has indicated that the new integrated information and operational systems are
50% less capital intensive, and as a result, it costs 70% less to change models on the line.
Over the last 6 years, Toyota has also revamped its ordering, manufacturing, and distribution systems to
reduce from 70 to 14 days the time it takes to put in a typical dealer order and deliver the car to the
customer. A Toyota dealer in the United States, for example, can work with a customer to link into a
computer system tied to the assembly plant for a particular vehicle and put in a request for a specific color
and set of features; this is a real-time build-to-order information system. The system software connects
dealers, factories, and suppliers. It checks the order against the availability of nearby parts, the re-
sequencing of assembly lines, and time-intensive processes like painting and gets the supply chain to
adapt to the new order. So far over 90% of dealer requests have been accepted and met the tighter
delivery deadlines. With about 60% of automotive industry profitability occurring beyond the factory in the
value chain, innovations such as these can be leveraged with dealers and suppliers to gain value and as a
source of differentiation.
P&G
The way P&G innovates has changed dramatically over the past five years. P&G is moving from a
traditional internal R&D model to one that seeks new product ideas through a Connection and
Development (C&D) philosophy. C&D is designed to expand P&G’s capacity for innovation and leveraging
external assets for rapid revenue and profit growth. It taps into the knowledge and expertise of its own
researchers but also researchers and individual inventors outside the company to stay at the cutting edge
of technology and innovation. In 2000, when A. G. Lafley, its new CEO, challenged the company to bring
in the best new product ideas from anywhere around the world, the level coming from outside was less
than 20%. P&G estimates that in 2004, 35% of its inventions and new product ideas came from start-ups,
individual inventors, or other companies, industries, or regions of the world.
The company is getting even more ambitious, having set a goal of drawing 50% of its ideas from external
sources. P&G has 53 dedicated “technology searchers” inside the company who monitor big ideas and
disruptive thinking across the world. P&G also works with both Nine Sigma and InnoCentive, two E-Bay-
like enterprises, to find and access technology and scientists around the world. P&G searchers mine patent
sources, the Internet, scientific literature, technology fairs, and VC portfolios to develop and maintain close
relationships with suppliers of ideas and new technologies and products. They also identify the future
alliances, equity investments, and niche acquisitions that help P&G enter new fields or reduce time to
market. In the last five years, time to market has already been reduced 50%, while internal R&D has been
reduced from 4.5% to 3.5% of sales.
P&G has done an exceptional job of using knowledge management systems and tools to bring its
marketing and R&D organizations together to market innovative new products more quickly and more
successfully. It uses AskMe knowledge-sharing software in its Innovation Net to form a network that links
18,000 of its employees in R&D, engineering, purchasing, legal and patents, information systems,
consumer products, and marketing. This innovation network has been expanded to include outside
companies, start-ups, suppliers, and inputs from consumer groups and individuals. It is no wonder that
Henry Chesbrough, the advocate for “open innovation,” often cites P&G as a role model for succeeding in
an environment that brings together the best from within and outside a company.
10.4 The effects of R&D off-shoring
All the case companies have benefited from their off-shored and globalised R&D. The
new way of thinking about R&D – “the world is our lab” – has enabled companies to
achieve continuous growth and develop better new products more quickly than
before. They have been able to keep the strategic R&D functions at home base when
that has been important. For some companies the off-shored R&D accounts for only a
minimal fraction of the firm’s total R&D investment and costs. In addition, the firms
have also been able to extend the lifetime of older products by using the off-shore
R&D staff in localising and updating the products for their local markets (Case E).
Other firms have focused on leveraging their competences and thus providing

services to other MNEs in off-shore locations (Case N). SMEs are said to benefit from
R&D off-shoring by being focused and operating with a good business partner
(preferably MNE) (Case D).
Sales have increased due to efficiencies brought about by local R&D presence, which
has also contributed to improved customer and brand recognition in new growth
markets. Improved internal processes, increased multiculturalism, valuable
connections to the off-shore company’s university and business partners as well as
increased market intelligence (i.e. knowledge of markets and customers) from off-
shore locations are also the positive effects of R&D off-shoring, which the firms could
not have attained from home markets. R&D off-shoring has served as a strategically
important base for research and development from which the home office and
country benefit greatly (Case I).
Off-shoring has lowered the direct cost of R&D but in many cases there direct
challenges for leadership and project management. In some cases there has been an
additional increase in management costs, i.e. time allocation, travelling etc. that has
usually not been anticipated. Some of the case companies have laid off workers from
the domestic R&D operations but for many firms the off-shored R&D is fully
complementary to the home country R&D. Firms have established R&D centres where
the most amount of skilled people live (Case M) and many of the companies have
been overwhelmed by the amount, high educational level and enthusiasm of the local
R&D staff, especially in China.
As already stated, communication is one issue commonly overlooked and therefore a

potential source of negative impacts. The work environment becomes more
undefined or uncertain, sometimes even indistinct and disorganised because of the
dispersion of the firm’s R&D. This can be very frustrating when the corporate R&D
objective is to shorten the products’ time-to-market and have more efficient product
development processes by working around the clock. These internal processes and
their development have been the indirect results of R&D off-shoring for many of the
case companies (see e.g. Case C). The firms have had to streamline the processes in
order to be able to manage their R&D project portfolio worldwide. That kind of work
needs clear internal structures for transferring the project in the evening from Japan
to Europe’s morning and then further to the morning of the America. However, the
companies that use the 24-hour development cycle recognise these problems and try
to tackle them. Some of the case companies view time differences as an obstacle in
the information flow.

Companies view that the effects of R&D off-shoring on EU are positive. Without off-
shoring and having R&D centres in growth markets the companies would not have
been able to grow as they have – many firms state that establishing a global R&D
network has maintained the firm’s competitiveness. Established connections with
local universities and other companies in off-shore locations have proved to be
valuable and companies have started to look for similar co-operation in home
country’s international universities as well. R&D off-shoring was said to promote
networking and partnering among European countries (Case F).
10.5 What does the future look like?
For some of the case companies the R&D investments in Europe are much more than
their share would be if they were in proportion to sales in Europe (Case C). Off-
shoring is going to increase and the speed will differ across countries, locations,
industries, and companies. Growth potential in Eastern European countries could
attract more R&D off-shoring to Europe (Case E). R&D off-shoring will also start to go
the other way as well; e.g. Indian software companies will have their off-shore R&D
centres in Europe. They want to serve European customers and therefore they need
to be in Europe, probably with local R&D staff. Also the European MNEs continue to
have their R&D centres in Europe, for it is difficult for them to serve customers from
India or China, no matter how talented or inexpensive the work force there is (Case
G). The European firms want to develop a common European strategy on finding the
balance between the high and low cost locations and the collaborative frameworks
between universities and companies.
Companies’ future looks unstable in this stage of the economical cycle and cost
reductions are in the pipeline for many if the consumers decrease their spending in
EU. Whether there will be a recession or not, the European companies will have to
prepare themselves to leverage the growth that is happening outside of Europe. The
largest European companies are multinational enterprises and therefore in reality
they do not represent any single country or even a continent. They look at the world
as a whole and act accordingly. Other MNEs that are of non-European origin also
make their location decisions by looking at the big picture.
Some of the case companies are taking innovative new approaches to address global
opportunities and how they select, prioritise, and perform the R&D vital to their
future success. These early approaches are exciting precursors of how R&D will be
performed in the future. But the reality is that most companies aren’t there yet—that
most companies are at the trial-and-error stage as they seek to master new
approaches and formulate the right strategies for their companies.

So while much effort is underway to establish global networks for production and
R&D, even greater effort is needed to actualise their full potential. To succeed in the
increasingly interconnected global economy, maintaining the status quo is no longer
a viable strategic alternative. The proactive advances being made by the MNEs
described in the cases here bode well for progress in the years ahead. As success
stories multiply, the differences between those who advance and those who do not
change will be magnified and establish which MNEs will not only survive but thrive in
the global economy.
If we want to see EU as an innovation base the focus should be in making the

innovation ecosystem (term adopted from Case C) so original and advantageous that
the companies cannot afford not to be there. The EU policy makers should focus not
only on European companies but also on innovative companies from all over the
world. By creating a unique base where the companies, MNEs and SMEs, can work
together as extended enterprises (term adopted from Case M) and develop open
innovations will the European companies, countries and the Union have something
valuable to offer. What comes to government incentives in attracting the innovators,
some of the case companies prefer undiscriminating tax subsidies to company or
industry specific subsidies. The business environment should be the same for
everyone irrespective of the origin or industry.
A big part of the innovation ecosystem is the university world. Many of the case
companies hope to have international universities close by, with strategic focus
areas, with a lot of exchange students and more possibilities for the companies to co-
operate with the university and other companies. The suggested focus areas for
educating new workers differ: engineers and scientists, creative design workers,
business-orientated people etc. But the most interesting suggestion for EU’s R&D
focus areas was the environmental issues, where Europe is said to be in a lead
position (see e.g. Case H). Below is a case example GE from the US, suggesting the
same.
GE
GE unveiled Ecomagination in May 2005, a massive program to help customers meet environmental
challenges (concerning water, energy, global warming, pollution, and so forth) and push toward a
sustainable world. It is setting up forums with industry, government, academia, and non-profit leaders to
discuss major themes and challenges such as global warming and climate change and what needs to
be done in the next decade.
U.S. transnational companies have lagged behind European companies in matters of the environment, but
GE has concluded that solving environmental problems is good business, a new way to “think green.” GE is
looking to create integrated solutions that address highly complex issues and take the leadership role in
managing them for customers. It sees the potential to grow the current $10 billion in sales associated with
these industry segments to $20 billion by 2010. Toward this end, GE will double its R&D spending in these

areas from $700 million today to $1.5 billion by 2010. GE is pursuing similar strategies in security and
infrastructure protection and health care that address complex, large-scale world challenges.
Some other policy suggestions from the case companies include increasing skilled
worker immigration, developing the infrastructure, softening the adjustment costs of
redeployment, diversifying the financing models to different stages of innovation, and
increasing start-up financing. The real challenge is to keep EU interesting, refrain
from any protectionist measures and focus on developing creative environments for
innovative people and businesses.
10.6 Conclusions
The longer-term economic trends around the world are creating a new environment
for R&D in the case companies. The global supply chain seems to be the most
dynamic part of the world economy right now and will continue to be so over the
decade to come. Manufactured goods are at the heart of international exchange, and
companies that make and distribute goods are the key decision makers. The large
and growing services sector enables the continuing growth and efficiency of global
production and distribution networks.
As a result, multinational companies such as the firms studied in this chapter, will
make more of the critical decisions about how funding flows to innovative firms and
about what innovations get turned into products. Since these firms are rooted in the
countries with the largest distribution networks, they have access to the world’s
largest markets. These three forces — the growing role of the large MNEs in the
global marketplace, the ability to distribute products into the world’s richest markets,
and the insatiable demand for innovation — will drive future R&D policies in countries
big and small.
The way R&D is conducted around the world is changing slowly. The large MNEs are
keeping the most important and longest-term R&D work close to home or in major
developed countries that represent large current business volume, and in the case of
a number of leading high-tech MNEs, are also slowly moving into a few highly
selective countries. But they are moving a good amount of market-oriented
development work closer to low-cost manufacturing centres where the goods are
produced and sold. They are also partnering with a range of smaller R&D firms
dedicated to more narrowly defined areas of research, such as specific software
applications or, in the case of pharmaceutical companies, specific drugs.

Several models for conducting R&D in the global economy have proved successful
and here we will list five models drawn from the case study. No single R&D strategy
is likely to fit all companies at all times; the following different strategies are
interesting initiatives taken by some companies to readjust themselves in today’s
world of widening opportunities. Companies don’t have to choose a single model but
can try multiple approaches to achieve their goals for innovation. Ultimately, it is
about how a company — and the countries in which they are based or doing business
— aligns its R&D priorities with its strategic, operational, and human systems that
converts technology into innovative new products and services.
1) Stay focused
One key principle of R&D strategy is to do the most important innovation work in an
R&D centre or cluster where cutting-edge research and experimentation is going on.
This is a part of the R&D strategy of many large multinational firms. SMEs benefit
from focusing on one area of R&D even though they could not afford operating in the
centre of excellence of that area.
2) Improve operations and customer care

Some firms put innovations into practice more effectively than others. They seek to
stress innovations that focus on improving operations and customer care.
Multinational firms in competitive industries like autos and consumer electronics,
where innovations tend to be incremental rather than disruptive have used
information technologies to maintain leadership positions in the distribution of
products that promise quality and a steady stream of incremental consumer-
responsive innovations.
3) Use open innovation

Information and communication technologies are opening new ways of gathering and
processing ideas from outside the firm. Firms are putting more R&D resources into
innovative ways of getting outside thinkers involved in potential new product ideas
and market solutions. Large multinationals might foster hundreds of ventures with a
wide variety of SMEs and universities that might offer new ideas for next-generation
products.
4) Work with customers

Consumers and customers will be more open to innovation that meets their particular
needs. Many case firms have found that it pays to put R&D researchers directly in
touch with customers: some case firms have taken bench scientists from the lab
directly to the front-line factories and stores to develop customer-centred solutions

to customer problems. Other companies have recognized the inherent power of
information and communications technologies to offer companies the means and
tools to provide direct communications or interactions with customers.
5) Apply your own competencies to serve other businesses

Many companies will succeed by realizing that their competencies in their own core
businesses can provide important services to others. As more companies expand
geographically, they must not only move their goods with reliability and precision,
but also organize chains of workers, suppliers, financiers and customers.
These approaches help keep the companies’ costs of R&D under control, and they
contribute to the further growth of the global economy by injecting investment in
developing regions, where new markets are being created as a result.
These are positive factors contributing to the innovation capacity of EU firms –

according to the case study R&D off-shoring is not damaging or leading to decreased
competitiveness, quite the opposite. The issues discussed in this chapter are also
interesting ideas for EU about how to develop the European markets in a way that
maintains the current R&D concentration and possibly even adds to creativity.
Different EU countries, though representing a single market, are still very different:
large developed countries differ from small developed countries and from developing
countries. MNEs also differ from SMEs.
According to some of the interviewed managers there are clear advantages for the
large developed countries to form clusters of innovation and for big MNEs to organize
large corporate R&D centres. These countries can leverage the nexus of university,
business, and government research in the clusters, with the resulting benefits of
large pools of talented people, large capital flows, high-tech manufacturing
employment, and globally competitive industries. At the same time, the big
companies that can afford the high costs of R&D are in the best position to exploit
the commercial advantages that flow from innovation, and can control their
intellectual property.
On the other hand, the growth of markets around the world, the increase of cross-
border activities, and the new information and communications technologies create
the environment for a more rapid dispersion of innovation and formation of powerful
virtual networks around the world. This can benefit the MNEs by moving innovation
closer to their low-cost production centres and growing new markets, as well as
leveraging the creativity of the rest of the world.

MNEs, smaller countries, and developing countries all have an interest in ensuring
that innovation is dispersed around the world. MNEs need to have global markets to
continue growing, and they need to have new technology developed or existing
technology adapted for those markets. On the other hand, MNEs also have an
interest in controlling the flow of ideas so they can get the maximum benefit from
them. In a couple of cases from manufacturing and business services operations the
managers of MNEs clearly preferred to keep knowledge-based activities inside
directly owned affiliates instead of sharing them by means of alliances, non-equity
ventures, or arms-length transfers of knowledge. This gives them a stronger
commitment and central control over the use of the intellectual property as well as
training and management. We’ll see whether the model of open innovation will
change that.

11 Conclusions from the study
Based on the analysis of literature, aggregate data, the survey and the case studies
R&D off-shoring is a global and complex phenomenon with several implications to
nations, corporations and employees. The off-shoring phenomenon is a process and a
product of general globalisation that is constantly developing It requires great
adaptability from countries actively engaged in global co-operation and international
trade. This chapter pulls together the main findings and conclusions from the entire
study. The purpose is to refrain from excessive discussion and to summarize what we
have learned from the project.
11.1 Conclusions from the literature study
In view of economic literature (Chapters 1-4) it is clear that R&D off-shoring can
have both negative and positive effects on the innovation capacity of the EU area. As
an example, it is possible that some local spillover effects are lost if research and
development is off-shored. Skilled labor may also increasingly start moving to more
attractive locations. The ultimate negative scenario would be that the global key
areas of R&D would be located outside the EU. As R&D is such an important
determinant of productivity and economic growth this could obviously threaten the
long run prosperity of the area.
However, it is important to bear in mind that there are important theoretical positive
effects as well, which can more than offset the negative impact. First, even though
part of the R&D by European companies will be conducted off-shore, it is likely that a
significant share of new innovations leak back to the EU area in form of spillovers.
Thus, the actual location of R&D may not be a decisive factor for innovation capacity,
as the overall innovation capacity is a much broader concept and the ability to
quickly adopt new innovations – even those developed somewhere else - is of utmost
importance. Second, if comparative advantage in R&D in some areas shifts to non-EU
countries, according to economic theory it will actually be beneficial to transfer R&D
activities to these areas. Third, it is not clear yet whether R&D off-shoring will
become a major trend at all, so far only a small share of the R&D conducted by EU
firms is off-shored. The EU policymakers can significantly affect firm level decisions,
for example by providing firms with access to skilled labor at home, and maintaining
high protection for intellectual property rights. At the same time it should be noted
that IPRs themselves are subject to major academic debate. Others believe high
protection of IPRs to be beneficial in the long run while others are more hesitant.
Also, increasing the attractiveness of new EU member states as locations for R&D is

an important consideration. Finally, developing countries will eventually lose their
position as low cost locations, which will decrease their attractiveness.
In conclusion, the overall effect of R&D off-shoring does not have to be negative. The
possibility to off-shore part of R&D may actually result in higher innovation capacity
and growth in the long run.
From the EIS 2005 survey (Chapter 5) we find that the EU is facing two main
challenges with regard to innovation capacity. First, there is a huge gap between
EU25 and US, as well as between EU25 and Japan explained largely by the number of
patents, population with tertiary education and ICT expenditures. Second, the
differences between EU countries are large, so there is a challenge to raise the
innovation level of the lagging and catching up countries.
11.2 Conclusions from the empirical studies
The empirical Part II in this study started with a review of aggregate level data on
R&D off-shoring comprised mainly from Eurostat, LOCOmonitorTM and OECD’s Patent
Database (Chapter 6). The direct results of that analysis were as follows:
1. R&D FDI in- and out-flows are highly positively correlated, indicating
that those countries whose firms’ engage in R&D off-shoring are also
attracting inward R&D.
2. The number of R&D inward projects is positively associated with the

share of business funded R&D, tertiary education and size of the
country (measured by population).
3. The number of R&D outward projects is positively associated with

tertiary education and population, and negatively with government
share of GERD.
4. The number of domestically invented patents is positively associated

with GERD and government share of GERD, the level of business-
funded R&D, population and GDP per capita. It is negatively associated
with the level of hi-tech exports.
5. The number of domestically owned patents displays much the same

pattern as the number of domestically invented patents.

Based on the reported results we conclude that the R&D intensity measured as
relative to GDP varies significantly across EU countries. Also, while the general trend
has been towards increasing R&D intensity over time, for some countries (France,
UK, The Netherlands and Ireland) the opposite trends can be observed. Business
R&D appears to be a driving force for achieving higher levels of domestic R&D
expenditure. Large business R&D community also appears to be related to higher
levels of domestic innovative activity, as measured by the EIS composite indicator.
The funding patterns of business R&D have been evolving over time, with the share
of foreign funding increasing in both old and new member states. The R&D FDI
figures provide evidence that the R&D FDI to and from the EU 25 has been increasing
sharply over the past four years. The bulk of both the in- and outflows of
investments seem to be associated with the same handful of countries (Germany,
UK, France) and industry sectors (IT & Software, Pharma, Telecom Equipment,
Semiconductors, Biotechnology and Auto Components). However, while the R&D
inflows are mainly received from the more developed nations such as the US, the EU
R&D outflows are increasingly directed to China and India, which are the two largest
destination countries.
Patent data present another promising avenue for studying the internationalisation of
R&D activities. The observed trends provide relatively strong evidence on increased
internationalisation over time. The main destination for outward R&D is still another
EU country, the US being a clear second choice. Similar trend applies to the foreign
ownership of domestic patents.
In chapter 7 we conducted a simulation exercise on the future development of R&D

off-shoring and its impact on EU countries based on the differences in these countries
in the recent years. The results are very sensitive to different variables (e.g. the
choice of scenario) especially for the country-specific estimations. We can conclude
that in future domestically invented and owned patents will increase in all EU
countries.
The results from the firm-level survey conducted in summer 2006 by TNS Gallup as
part of this study (Chapter 8) are well in line with the conclusions from other parts of
this project. Individual companies see R&D off-shoring as a positive phenomenon
that has affected positively their abilities to conduct R&D in its different forms. A
majority of them expect off-shoring to also contribute positively to the general
innovation capability of EU companies.
It is also clear from the survey that R&D off-shoring is still today mostly a “national”
issue. The majority of R&D off-shoring locates to and originates from EU countries.

Developing Asia as a destination area for off-shored R&D is not yet as popular in the
real world as one would perhaps expect on the basis of public discussion. This
confirms also the findings from aggregate level estimations with FDI-data from the
first part of this project.
Other findings from the survey are:
R&D spending and R&D off-shoring have increased in a trend-like fashion over
the past five years. Companies expect this to continue.
The fraction of off-shored R&D relative to total R&D spending per firm is
relatively low.
Over 60 % of responding companies have located their off-shored R&D in
another EU country.
Access to skilled labour and strategic benefits (alliances with other
firms/institutions) encourage firms to off-shore R&D in the first place.
Good IPR-protection, links between the educational system and the private
sector, market proximity and the possibility of cost savings are among
reasons why to decide a particular location for off-shored R&D.
Public support (taxes, subsidies) is relatively unimportant in location
decisions.
Companies have benefited from off-shoring as far as the following factors are
considered:
o the ability to choose successful R&D projects,
o length of time it takes to commercialise an innovative idea,
o the cost efficiency of product innovation processes, and
o the ability to learn about R&D conducted by other firms.
The following list summarises the main findings from the more in-depth micro-
econometric analysis where we matched the European Patent Office data to the
survey data (Chapter 9):
1. What determines R&D off-shoring?

a) The number of previous patents is associated with (the degree of) off-
shoring.
b) Firms that off-shore to Europe and Latin America have a higher degree of
off-shoring than those who do not off-shore to these locations.
2. What determines domestic R&D replacement?

a) Having located off-shored R&D into developing Asia is associated with a
higher degree of replacement than off-shoring to other locations.
b) Having located off-shored R&D into developing Asia and/or North America is
associated with a higher degree of future replacement than off-shoring to
other locations.
3. What determines where to locate off-shored R&D?

a) Depending on the location, various policy measures have an impact:
i. The more important the local attitude towards innovations is the less likely it
is that a firm has off-shored to developing Asia.
ii. The more important the local infrastructure is the more likely it is that a firm
has off-shored to non-EU Europe.
iii. The more important the public support is the less likely it is that a firm has
off-shored in developing Asia and the more likely it is that it has off-shored
in Africa.
iv. The more important the IPRs are the less likely it is that a firm has off-
shored in Latin America.
b) Depending on the location, firms emphasize different aspects of R&D in
following fashion:
i. Firms for whom basic research is important are more likely to have located
in developed Asia than firms for whom basic research is not important.
ii. Firms for whom applied research is important are more likely to have
located in North America than firms for whom applied research is not
important.
iii. Firms for whom product and process development is more important are
more likely to have located in Latin America than firms for whom product
and process development is not important.
4. What are the effects of off-shoring on R&D performance?

a) We found no effects of the degree of off-shoring on R&D performance,
measured as the number of EPO patents.
b) We did find that the higher the number of countries in which the firm’s
patents have been invented, the higher the number of EPO patents.
Case studies conducted as part of the project represent a different research

methodology where the purpose is not necessarily to draw generalizations or even to
discover “facts”. Rather the purpose is to form a deeper understanding what the case
companies are thinking of the R&D phenomenon. At a general level it can be stated
that multinational companies such as the case companies studied in chapter 10 are

becoming more and more important in the modern world. This will have an impact
also on the way R&D is conducted around the world. The large MNEs are keeping the
most important and most long-term R&D work close to home or in major developed
countries that represent large current business volume. However, market-oriented
R&D work is gradually been moved closer to other markets and for example close to
low-cost manufacturing centres. Large MNEs are also partnering with a range of
smaller R&D firms dedicated to more narrowly defined areas of research. MNEs R&D-
work benefits from R&D off-shoring due to better access to growth markets, better
access to talented work force, increased international innovativeness and cost
efficiencies.
According to the case studies several distinguishable models for conducting R&D in
the global economy exist that have proved successful:
1) Stay focused
2) Improve operations and customer care
3) Use open innovation
4) Work with customers
5) Apply your own competencies to serve other businesses
11.3 Drivers behind the innovation capacity of EU firms
Largely based also on the case studies we have identified several drivers for the
change in global innovativeness and R&D processes:
Dynamic firms need dynamic markets

Effect of absorption and adaptation capacity on innovation successes
Increased input of customers and retailers on R&D
Need for well-educated people
Services increasing global R&D
New ways of R&D financing
MNEs major role in global innovation successes
Increasing significance of innovative SMEs
IPRs and open technology
Transferability of intellectual property
Open technology policies

This subchapter discusses briefly these drivers in order to give the reader an
understanding about how at least some companies feel about the key factors behind
future innovation capacity of firms.
11.3.1 Dynamic firms need dynamic markets
Effect of absorption and adaptation capacity on innovation successes

Innovations and knowledge-intensive activities are rich resources for the countries in
which they take place. They offer a variety of benefits: high-wage jobs and the
potential for rapid growth; learning and advancement opportunities for the workers
involved; and spillover benefits for other local activities and institutions.
For innovation to be truly shared, however, not only must the entity pursuing R&D be
willing to pass it along, but the entities receiving the R&D must be able to absorb it.
In this way, the R&D itself is only one aspect of how to raise a society’s innovation
level. R&D-intensive firms within a region or a country must also absorb the
underlying principles of the R&D, identify diffusion paths, lower their own cost of
absorption, and learn how to build an organization that can adapt to the changes
brought about by innovation. This has to take place at all levels of a firm — the shop
floor, process engineering, quality management, maintenance, procurement, control,
outbound logistics, relations with other firms, and so on. The R&D function is only
one end of the spectrum—a critical component certainly, but it must be buttressed by
all the elements that allow an organization to respond effectively.
All this applies more generally to the whole population of the R&D location country.
Any country wanting to increase its innovation capacity needs to create markets for
innovative products and services that are based on R&D investments. Dynamic firms
need dynamic markets in order to market their products and services, to grow and
invest in R&D, which again adds to the innovation capacity of the country.
Increased input of customers and retailers on R&D

A dynamic market consists of sophisticated consumers that are more demanding and
experimental, forcing companies to accelerate time to market, to adapt to market
changes quickly, and to work with shorter life cycles. New information and
communications technologies allow firms to learn quickly what works in the
marketplace and to coordinate activity along the supply chain to respond to it. As a
result, multinational companies are becoming much more sensitive to customer
input. This clear trend of the growing importance of customer involvement in the
R&D process itself poses a number of challenges, however. Customer participation is
hard to sustain throughout the innovation life cycle, customers’ input can often

narrow the range of research, and closer collaboration could lead to disputes over
intellectual property rights. Companies also need to design mechanisms that
compensate customers for early involvement without restricting their own profit
potential. Customer-driven R&D is of growing importance, but not easy to perform or
manage.
Need for well-educated people

R&D is performed by specialized knowledge workers. Technology centres must have
a flow of such talented, experienced people to both perform the research and to
integrate innovation into organizations. R&D practitioners are trained in universities
and get their first research experience there. Because of the importance of the
universities in raising a country’s innovation levels, many countries are taking action
to improve research capabilities at the university level.
Services increasing global R&D

Services, especially services directed to helping businesses operate more effectively,
are closely associated with R&D. One of the striking phenomena in the global
economy is the rapid growth in services, particularly high-tech, value added services.
In fact, services have increased their share of all foreign direct investment compared
to primary production and manufacturing over the last decade.
Services are necessary for the growth of international production activities. Included
in services are a variety of activities that spread knowledge and ideas, such as
management advice, sales and marketing, procurement and logistical support, and
information technology. For some companies in the case study R&D actually
represented a service to the main manufacturing function. The fastest growing
services are knowledge-based and aimed at meeting the needs of MNEs deeply
involved in the global supply chain. The fastest growing segments of the service
industry have been logistics and communications (the key elements in the networks
that allow the multiple locations of multinational companies to work as one across
widely dispersed locations) and business activities (the types of services
manufacturing MNEs need to operate in diverse settings: legal, accounting and
marketing).
An important spur to the growth of services is the way the fastest growing companies
today leverage the supply chain by sharing knowledge within the company and
between the company and its suppliers. Globalisation of R&D activity is getting easier
because the internal transactions and coordination costs are falling with the advent of
systems that can improve that sharing of knowledge within a firm. But to be

successful, these kinds of business services must embed their knowledge in people
and processes. The success of innovation in this kind of passing of knowledge is hard
to measure, however. Conventional measures such as R&D spending and number of
patents registered are less indicative of real knowledge gains that help improve the
operation of the global supply chain.
11.3.2 New ways of R&D financing
Not only is more R&D being done in a wide range of firms, but new ways of raising
the funds to finance this work are increasing as well. We know from the Eurostat
figures in chapter 6 that more than two-thirds of all R&D funding has come from the
private sector. But what is really significant about private sector funding is the rise of
new sources of funding from a variety of non-traditional participants willing to place
funds into small, high-risk, potentially high-reward firms.
The spreading of the financial risks of early stage innovation across independent
venture capital funds, investment banks, individual investors (“angels”), and
corporate venture funds makes for a larger pool of money and a greater diversity of
investments available for exploratory research. When private sector funding is
combined with research funding from government agencies and invested in
specialized emerging fields such as biotech, nanotechnology, or materials, there is
even greater leverage and commercial acceleration.
MNEs major role in global innovation successes

Corporations themselves are getting active in venture capital. They follow a number
of models evident in the case studies. MNEs will control much of R&D spending and
the distribution of innovations, but they will continue to integrate new researchers
and new ideas into their activities. Look for a diversity of indicators for fostering
research outside the boundaries of large firms—such as cross-border alliances for
R&D projects and venture investments in small start-up firms — to continue to grow,
but at a slower pace than in the past. The slower pace reflects concerns about control
of intellectual property, the difficulties of setting up and managing joint-venture
agreements, and the trend for MNEs to do more of their R&D in their own foreign
research labs.
Increasing significance of innovative SMEs

An important characteristic of recent R&D activity is the growth of a new form of R&D
enterprise—the small-scale venture-backed firm that focuses strictly on R&D. The
goal of the small R&D entrepreneurial firm is to focus the entire resources of an
enterprise on a tightly defined research agenda and to use alliances or buyouts by

larger firms to handle the development and marketing phases of successful
innovations.
Traditionally, most business R&D has been done in large companies. Now the trend
has been shifting towards increased R&D in SMEs, especially in the US. That could
not have taken place without effective linkages between the small and large firms.
The information and communications revolution has allowed larger firms to enter into
more collaborative ventures than ever before with small outside start-ups,
universities, and even individual inventors. Given the complexity of the multiple goals
for R&D in large companies, these firms are finding that it pays to use partners to
explore new ideas across a broad range of areas, selecting the most promising ones
to introduce into the larger organization. Smaller countries could use this trend to
their benefit.
The smaller firms are likely to be service firms providing software and R&D services
for much larger manufacturing firms. A couple of key factors might explain the shift
away from the largest firms—the decline in the employment size of all companies (as
productivity allowed many firms to operate with fewer people) and the growing shift
of R&D to software, biotech, and service technologies, which often are less capital-
intensive and much easier to do in smaller firms. Some of the funding received in the
small and medium firms comes from the largest firms as they outsource areas of
innovation through equity investments and jointly funded initiatives.
11.3.3 IPRs and open technology
Transferability of intellectual property

Intellectual property laws and practices with regard to patents, copyrights, and other
intangibles make it very risky for a large technology company to transfer its most
advanced new technology outside its control. But the potential rewards of shifting
technology to countries such as China are so large that doing more R&D inside China
or providing Chinese suppliers access to certain newer technologies is viewed as an
acceptable risk today. In fact, for many MNEs, it is seen as a requirement for
achieving more rapid and significant market entry, accessing a large group of highly
skilled researchers, and becoming a player in China, with all the global benefits that
brings.
Multinational firms are thus trying to develop policies for transferring key parts of
their technologies. Most successful efforts have occurred in wholly owned affiliates
where the company brings local talent into its own organization. Transfers within

wholly owned affiliates are much more open than those with local joint ventures,
even when the ventures are mandated by the government.
Open technology policies

Governments have long tried to intervene in the market to increase the flow of
innovations in their own country, either by increasing pressure to transfer technology
as a requirement for MNEs to locate in their country or by offering a positive
environment for investment. All in all, cooperative support seems to work better than
mandate. The most successful promotion strategies seem to be those that provide
incentives to both the foreign affiliate and the domestic supply firms or research
centres to work together. Now many countries promote FDI from firms that bring in
R&D — Ireland and Singapore are two recent successes.
The following Part III will focus on innovation and R&D off-shoring in a policy
framework. We will also discuss some policy recommendations based on the findings
in this study.

PART III: R&D OFF-SHORING IN A POLICY
FRAMEWORK
12 EU innovation policies and R&D off-shoring

12.1 Introduction
The aim of this chapter is to analyse innovation policies in the context of the
internationalisation of R&D. The chapter begins with a description of the policy
context and summarizes relevant findings from the US experience with the
internationalisation of R&D. We briefly discuss liberalisation and protectionist
measures and how innovation policy can affect firms’ location decisions. We describe
the general trends in innovation policy in the EU countries, with particular emphasis
on how the internationalisation of R&D is taken into account in policy-making. This
chapter also outlines the main policy instruments used, and discusses their potential
effectiveness.
12.2 Internationalisation of R&D – US experience
The internationalisation of R&D is an on-going and increasingly global phenomenon,

where Europe and the United States as well as Japan have been, and still are, the
main players. The US national innovation system has experienced a trend of
increasing internationalisation of industrial R&D since the 1980s. There has been
both an increase in R&D off-shoring by US firms and an increase in non-US firms
doing R&D in the US (Mowery, 1998). The growth of incoming R&D investments has
exceeded that of outward investments in the past decade, probably because, as
Mowery (1998) suggests, US firms started to off-shore R&D earlier and others are
now catching up. The share of company-financed R&D performed abroad by US firms
and their subsidiaries (outward investment), and the share of foreign-financed
industrial R&D in the US (inward investment), are both around 13% in 200058.
During the last six years 2000-2005 the FDI flows to and from the US have
fluctuated heavily and somewhat decreased the impact of the US, MNEs with
headquarters in the US are still strong players in the global R&D market59.
58
US Science and Engineering Indicators – 2004, available at www.nsf.gov/statistics
59
UNCTAD, World Investment Report 2006 (annex table B.1., www.unctad.org/fdistatistics)

Firms from a few European countries (Germany, UK, France as well as Switzerland
and Netherlands), Canada and Japan are the biggest R&D investors in the US. 71%
of the investment is by European firms. Most of these countries are also where the
US firms have located most of their foreign R&D, with two thirds of the investment in
Europe. The Asia-Pacific region gets 18.9% of US R&D investment abroad, a share
that is likely to be increasing due to increasing attractiveness of China and India as
off-shoring locations.
The US appears to have been successful in attracting foreign R&D investment. Why
do firms locate their R&D in the US? One of the reasons is the US innovation system,
its supply of quality scientists and research. The US is also a lead market in many
areas. A study of foreign-affiliated R&D laboratories in the USA (Florida, 1997)
indicates that R&D labs have technology-oriented motives in contrast to market-
oriented activities. The main motives include developing new product ideas, obtaining
information on scientific and technological developments in the United States, and
obtaining access to high-quality scientists, engineers, and designers. According to
Florida and Kenney (1994), the location of Japanese R&D sites in the US reflects two
phenomena: firms locating innovation where production is and firms locating in
regional centres of innovation, such as the Silicon Valley.
Criscuolo et al. (2005) use EPO patent citation data to examine whether foreign-
based R&D is mainly asset-augmenting (absorbing knowledge spillovers) or asset-
exploiting (adapting technology in response to demand). Their research also provides
a perspective on US-owned R&D activities in Europe. The results show that the US
firms also pursue asset-augmenting activities to at least the same extent as
European firms in the US, implying that knowledge is created in both regions and
flows in both directions.
Mowery (1998) notes that there were some attempts to limit the international
dissemination of knowledge created by publicly funded R&D, including restrictions or
performance requirements for firms wishing to participate in US programs such as
the Advanced Technology Program or SEMATECH. Other countries met these
restrictions by limiting US firms’ access to their public R&D programs, including EU
programs. At the same time, firms sought other ways to cooperate to overcome
these restrictions. Mowery (1998) sees such policies that restrict international
participation in publicly funded R&D programs as ineffective and ill advised, able to
impair the functioning of the global science and technology system.

12.3 Liberalisation vs. protectionist measures
In terms of regulatory trends relating to investment, the bulk of national regulatory

changes in 1992-2005 have facilitated FDI (UNCTAD’s World Investment Report
2006). The changes have involved simplified procedures, enhanced incentives,
reduced taxes and greater openness to foreign investors. However, there have also
been notable moves in the opposite direction (table).
Table. National regulatory changes, 1992-2005
In both the EU and the United States, growing concerns have arisen over proposed
foreign acquisitions. In early 2006, the acquisition by DP World (United Arab
Emirates) of P&O (United Kingdom), a shipping and port management firm, along
with that firm’s management of some ports in the United States, led to United States
protests on the grounds of security. Similarly, in Europe concerns were voiced over a
bid by Mittal Steel to acquire Arcelor, and broader European opposition to the EU’s
own directive relating to the liberalization of services. National security concerns led
to a blocking of the purchase of Unocal (United States) by CNOOC (China). The
governments of Spain and France tried to prevent the buyouts of Endesa and Suez,
respectively, by companies from other EU countries, and steps were taken to protect
national champions. Japan has postponed the approval of cross-border M&As through
share swaps and adopted some restrictions in the retail industry. The Latin American
oil and gas industry became the focus of attention in May 2006 following the Bolivian
Government’s decision to nationalize the whole industry.
The web of international agreements of relevance to FDI continued to expand. These

consist of bilateral investment treaties, and double taxation treaties, along with other
international agreements containing investment provisions. A number of developing
countries are actively involved in such rule making. A notable trend involves the
conclusion of further free trade agreements and various economic cooperation
arrangements dealing with investment. The universe of international investment

agreements (IIAs) is becoming increasingly complex. The recent IIAs tend to deal
with a broader set of issues, including public concerns related, for example, to
health, safety or the environment. While such quantitative and qualitative changes
may contribute to creating a more enabling international framework for foreign
investment, they also mean that governments and firms have to deal with a rapidly
evolving system of multi-layered and multifaceted set of rules. Keeping this
framework coherent and using it as an effective tool to further countries’
development objectives remain key challenges.
12.4 Innovation policy and R&D off-shoring
Innovation policy has the ability to affect firms’ R&D location decisions by providing
an environment favourable to undertaking research and development (R&D). Policies
that promote the innovative capacity of economy help retain domestic firms’ R&D at
home as well as attract inward R&D investment from abroad. Furthermore,
innovation policies can foster the absorptive capacity of an economy i.e. the ability to
benefit from knowledge generated abroad.
Innovation policies that directly lower the cost of doing R&D include tax incentives
and public financing. Innovation policies that improve the opportunities for
innovation, including framework policies, are also important. For example, policies
that foster a skilled labour force and scientists, basic and applied research, and R&D
cooperation between firms and universities, help provide human resources and ideas
to firms doing R&D. Promoting an innovating SME sector and start-ups can also
benefit the innovation in large firms due to increased opportunities for collaboration
and technology sourcing. On the demand policy side, public procurement is a
measure also used to foster innovation, and where at least the UK government
intends to be active60.
According to recent studies, the factors that most affect firms’ decisions to relocate
their R&D are “proximity to key markets, the availability of skilled researchers, and
convenient access to knowledge infrastructures.”61 Also the findings from the survey
(see chapter 8 in this report) indicate that R&D off-shoring of European firms is
influenced by collaboration opportunities; the quality of academic institutions and
links between firms and academia are mentioned often. The reasons for off-shoring
found in our survey as well as in the case study include access to skilled labour and
60
New procurement guidelines help the Government use “its 125 billion a year purchasing power to drive innovation
through public procurement.” DTI Innovation Report.
61
Raising EU R&D Intensity – Improving the effectiveness of public support mechanisms for private sector research and
development, 2003, Action Plan for 3% Initiative.

strategic benefits such as alliances; also possibilities to acquire new technology and
to network are mentioned as important reasons for off-shoring. Good IPR protection
was mentioned as very important in determining the location of R&D.
In its World Investment Report 2006, UNCTAD concluded that measures to

strengthen local capabilities, markets, and institutions are much more likely to
promote technology transfer and development than interventions in the contractual
process. The WTO has also helped facilitate a more cooperative stance among
members, especially in regard to intellectual property. The TRIPS agreement (trade
related aspects of intellectual property rights) became one of the three key pillars of
WTO when the organization was first established in 1995. It dictated that all WTO
members must accept the rights of those who have a valid claim to intellectual
property. It sets minimum standards for all members and has a dispute resolution
system. With its stronger protections for intellectual property, TRIPS will help foster
an environment conducive to more IP development by companies in other countries.
The results from the survey in this report also confirm previous findings that public
funding is not a key determinant of R&D location. Such national policies are
important, however, in the overall development of the region as an attractive
location for innovation. The key issues seem to be in being able to provide access to
skilled labour and researchers (education and university system), a thriving R&D
sector at home, and opportunities for collaboration with firms and researchers. Thus
the innovation policies play a major role indirectly through their effect on the national
innovation system, which in turn attracts foreign R&D. More direct policies towards
international cooperation are also an important attempt to capture the benefits of
world knowledge.
An innovation system that attracts FDI in R&D is not the only means to benefit from
the globalisation of R&D. Off-shoring can in fact bring about significant benefits to
the home country. Griffith et al. (2004) present results that suggest that the
spillovers from US R&D to UK firms investing in innovative activity in the US
generated significant productivity growth in the UK. The results presented in this
report on firm studies back up the notion that off-shoring is advantageous not only to
the innovative capacity of firms, but also to European innovativeness.
In summary, the trends of increasing internationalisation of R&D activities raise two

types of issues on the policy agenda at both the national and EU level: one, how to
create and sustain a dynamic innovation system that attracts R&D and talent from

abroad; two, how to develop the absorptive capacity of the region to better reap the
benefits from knowledge generated abroad.
12.5 Innovation policies in Europe
European countries generally see innovation policy as an important economic tool

and many follow a national innovation strategy. These strategies typically contain
issues such as skilled labour force, strong basic research through universities,
increasing the industry’s R&D expenditures, facilitating the diffusion of knowledge
between firms and universities, and promoting entrepreneurship, supporting SMEs
and especially high-tech start-ups. For the new EU members, policy issues such as
improving the country’s ICT infrastructure and educating the labour force are on the
top of the list, while financing of innovation and tax issues are also on the agenda.
While most countries emphasize the promotion of favourable conditions for R&D, few
mention attracting foreign R&D investment as a strategic objective or take specific
policy measures towards such goal. Ireland, known to attract FDI, is one exception.
Ireland’s Industrial Development Agency (IDA)62, whose task is to attract new
investment from overseas, also wants to attract companies investing in R&D. Its
R&D Capability Grant Scheme contributes to the costs of establishing a new R&D unit
in Ireland, in addition to other policies in place, including tax incentives63 and R&D
funding.
The UK has also noted the importance of the internationalisation of R&D and
recognizes the need for an overarching national strategy for international
engagement in R&D. The UK Science and Investment framework 2004-2014 lists as
one of the government aims “that the UK should be a partner of choice for global
businesses looking to locate their research and development (R&D), and for foreign
universities seeking collaboration with the science base or business” (p. 127).
At the same time, the report acknowledges: “Ninety percent of the world’s R&D takes
place outside the UK. The UK can benefit from this by linking into international
networks or building international collaborations. (p. 127)”
While national innovation policies have been on the agenda, and goals have been set
at the EU level, the internationalisation of R&D is probably a more recent issue in
that context. However, as the example of the UK government’s strategy shows,
measures need to be taken to attract foreign R&D as well as to better exploit R&D
62
www.idaireland.com/home
63
Ireland introduced tax incentives for R&D in 2004.

undertaken elsewhere. UK’s FDI inflows increased from less than $60 billion to $165
billion in 200564.
12.6 Innovation policy measures
The rest of the section looks at the innovation policy instruments in use in the EU
countries and discusses them in the context of the internationalisation of R&D.65 The
measures discussed include the following: tax incentives, R&D subsidies, R&D
collaboration, technology programs and services for international cooperation. SME
policies including subsidized loans, guarantees and venture capital are briefly
mentioned. Education and science policies such as the funding of universities and
basic research are immensely important for the innovative and absorptive capacity of
an economy but due to the wide variety of the national policies they are not
discussed in this chapter.
12.6.1 Tax incentives66
Many EU countries offer tax allowances or tax credits for R&D. These fiscal measures
vary in design. They can either allow a deduction of over 100% of R&D expenses
from the firm’s taxable income or the deduction of some percentage of R&D directly
from tax liabilities. These tax measures can further be implemented using a flat rate
or volume-based tax (UK, Italy, Netherlands, Denmark) or an incremental rate,
based on the increase in R&D spending (Belgium, France) or a mixture of them
(Austria, Portugal, Spain, Hungary).
The UK’s tax allowance of 150% for SMEs (125% for large companies) is particularly
generous, but SMEs’ R&D that is funded by public sources can claim tax allowances
only at the large company rate. The Belgian tax scheme offers a fixed allowance to
companies for each additional scientific researcher employed, which is paid back in
taxes when the researcher leaves. In some countries, loss-making firms can get a
cash reward (at least in Austria, UK, and France), in the UK 24p per £1 spent on
R&D. The Dutch scheme is different from the rest, as it reduces the wage cost of R&D
by lowering the wage tax and social contributions of R&D personnel. Denmark has a
tax scheme that rewards collaboration between industry and science by giving a tax
allowance of 150% to co-financed R&D.
64
UNCTAD, World Investment Report 2006
65
For a thorough review and evaluation of the various innovation policy measures used in the European Union, please see
the Expert Reports prepared for the Action Plan 3% Initiative (2003), available at
http://www.eirma.asso.fr/f3/showthread.php?t=31.
66
From “Raising EU R&D Intensity – Improving the effectiveness of public support mechanisms for private sector research
and development: Fiscal Measures”, 2003, Action Plan for 3% Initiative.

Germany and Finland are countries that have abolished tax incentives they once had.
Ireland, on the other hand, introduced its tax incentives in 2004. The new EU
members use tax incentives to a limited extent. For these countries, harmonizing the
overall tax system has greater priority.
Countries such as Sweden, Finland and Denmark offer personal income tax
allowances for foreign employees, including those doing R&D. Of course, the effect of
tax incentives on firms’ location decisions needs to be evaluated in the context of the
whole tax system, in particular the corporate income tax and personal income tax.
12.6.2 R&D subsidies
In most EU countries, governments direct money to firms’ R&D projects in terms of

subsidies. In many countries, there is a national technology or innovation agency
that is in charge of most of the implementation of public funding, and there is an
increasing trend towards establishing such an agency. Examples are the Finnish
Funding Agency for Technology and Innovation (Tekes), the Swedish Agency for
Innovation Systems (VINNOVA), the Austrian Research Promotion Agency (FFG), and
the National Agency for Research in France, established in 2004. Other countries
have a number of different agencies delivering innovation support. For example
Germany has 20 “programme managing organizations”, that are independent
organizations that administer and manage innovation policy programmes on a
contractual basis.67
12.6.3 R&D Collaboration
Public R&D funding is often provided not only to support individual firm R&D projects,
but also a large part of this funding is directed towards technology programs and
other forms of collaborative R&D. Fostering cooperation between firms doing R&D
and universities and research institutions doing basic and applied research, is
increasingly on countries’ agenda.
Policies that promote R&D collaboration can be important for the internationalisation
of R&D. Our study has confirmed the results from previous studies in showing that
firms want to locate their R&D facilities where skilled labour, researchers, and good
links to universities exist, seeing such locations as the most fruitful for R&D activities.
How open different countries are to international R&D cooperation and how they
allow foreign organizations access to their knowledge base varies.
67
Innovation Country Report Germany, http://trendchart.cordis.lu/country_reports.cfm

12.6.4 Technology Programmes
Many countries have adopted Technology Programmes, which focus on promoting

specific technology areas by funding collaborative R&D. As an example, in the UK the
Technology Programme of the DTI offers competitive funding in important technology
areas via two support products: Collaborative Research and Development, and
Knowledge Transfer Networks.68
Technology programmes can have an international dimension by including foreign

firms or research organizations in the collaborative network. Such policies favour the
global diffusion of knowledge.
12.6.5 SME financing and venture capital
The performance of the SME sector in an economy may play a role in attracting
foreign R&D investment into the country. An innovating, high-tech SME sector can
provide opportunities for foreign firms’ technology sourcing and attract foreign
partners.
In most countries, public financing schemes have a particular emphasis on SMEs. The
financing instruments used include subsidised loans and loan and equity guarantees.
Examples of these programs are the Small Firm Loan Guarantee Scheme in the UK
and Finnvera’s SME financing in Finland. Some countries (Austria, Germany,
Denmark and Finland) have guarantee schemes targeted towards R&D and
innovation activities. Venture capital schemes to promote high-tech start-ups are
used in many countries.
12.6.6 Policies towards international cooperation
Countries are increasingly adopting policy measures that facilitate the international
partnering of firms. For example, the measures used in the UK include the DTI’s
GlobalWatch service for UK-based companies looking for knowledge of technologies,
advanced skills and scientific advances in other countries, and the UK Trade and
Investment inward investment promotion, e.g. its Global Partnerships Service that
helps potential investors identify technologically advanced British firms for
collaboration.
68
DTI – About the Programme, www.dti.gov.uk/innovation/tech-priorities-uk/about_the_programme

Example: Tekes’ approach to internationalisation
“Tekes is the main public funding organisation for research and development in
Finland. Tekes funds industrial projects as well as projects in research organisations,
and especially promotes innovative, risk-intensive projects. Tekes offers partners
from abroad a gateway to the key technology players in Finland.”69
Tekes has adopted an open approach to the internationalisation of R&D, encouraging

various forms of international networking between firms and research organizations
in Finland and abroad. Tekes itself is also eager to cooperate with funding agencies in
other countries to prepare joint programs. Tekes policy towards foreign-owned firms
registered and performing R&D in Finland is not discriminatory, they are eligible for
R&D funding from Tekes. Tekes has an international presence in offices in Beijing,
Brussels, Shanghai, Tokyo, Washington (DC), San Jose (CA). These offices serve
both Finnish and foreign companies and research organizations, for example in
finding partners for joint projects, technology transfer or simply the exchange of
information. Foreign firms can collaborate with Finnish firms through Tekes’
technology programs or within the European framework. Costs of participation in
Tekes’ technology programs are primarily covered by the foreign entity itself or by
national funding from its own country of origin.
12.7 Discussion
The increasing internationalisation of R&D activities puts many policy questions on

the agenda. While maintaining an environment favourable to innovation through
innovation policy is important, increasingly important is also the use of policy to
enhance the absorptive capacity of economies to benefit from knowledge generated
abroad.
Some research shows that fiscal measures and public subsidies generally have
positive effects on firms’ R&D investment, but current research (David, Hall and
Toole, 2000, Hall and van Reenen, 2000) suggests cautionary optimism as to the
effects of these policy tools and emphasizes that more research is warranted before
conclusions can be drawn. In short, currently there is little evidence to suggest that
either policy tool has a (large) impact. There is also very little empirical evidence on
the effects of these measures on firms’ location decisions for R&D. A study by Bloom
and Griffith (2001) examines the effect of tax credits on firms’ foreign R&D
investments, and finds that increasing tax incentives shifts R&D to those countries.
69
www.tekes.fi/eng/

One danger with tax incentives and subsidies is that countries use them as a
strategic trade tool and start to compete with each other for firms’ R&D. This leads to
a Prisoner’s dilemma, whereby all countries are actually worse off if they pursue
independent (and competing) R&D policies. Another problem with tax incentives is
that creating distorted incentives to do R&D in some countries may actually be
counterproductive (Griffith et al. 2004), because of the benefits associated with R&D
off-shoring and the absorption of spillovers from abroad.
12.8 Summary
Internationalisation of R&D is an on-going global phenomenon. US

multinationals have a long history of off-shoring R&D, mainly to large
European countries, Canada and Japan. Other regions, including Europe, are
catching up in the off-shoring trend.
US Policies attempting to limit international spillovers of knowledge, such as

restricting foreign firms’ participation in public R&D programs, proved
unsuccessful due to retaliatory action by other countries and firms’ ability to
circumvent this by collaborating in other ways.
In terms of regulatory trends relating to investment, the bulk of national

regulatory changes have facilitated FDI. The changes have involved simplified
procedures, enhanced incentives, reduced taxes and greater openness to
foreign investors. However, there have also been notable moves in the
opposite direction.
Innovation policies can help provide conditions that attract foreign firms’ R&D
and retain local ones. Furthermore, innovation policies can enhance the
absorptive capacity of an economy and increase the benefits obtained from
R&D performed abroad.
Innovation policies can influence firms’ R&D location decisions by reducing the
cost of R&D via tax credits or subsidies. Innovation policies can also enhance
the opportunities for innovation, by providing resources such as ideas,
researchers and skilled labour.
Innovation policy objectives are similar among the EU countries and contain
the basic elements for promoting an environment favourable to R&D
innovation ranging from education and research to increasing industrial R&D
expenditures. Some countries or at least the UK has noted that the

internationalisation of R&D provides new opportunities and policy challenges.
Ireland takes an active role in attracting R&D FDI.
Tax incentives are used in many EU countries. There is variation in the design
of these measures.
R&D subsidies are the most common form of public support to R&D. They are
increasingly targeted towards collaborative R&D between firms and research
organizations.
There are also measures that help firms find partners for collaborative
projects or technology sourcing across borders. Tekes in Finland is an
example of an innovation agency that has an open approach to the
internationalisation of R&D.

13 Policy recommendations
13.1 Pros and cons of R&D off-shoring for EU
Summarising the main conclusions in this study: R&D off-shoring is a modern way for
global EU companies to leverage the creativity of the rest of the world. Modern
global R&D includes partnering with a range of smaller R&D firms, universities and
centres of excellence dedicated to more narrowly defined areas of research. This kind
of cooperation and collaboration is beneficial to European Union as a whole,
especially if the political measures are directed towards increasing the lucrative
features of the European innovation environment and developing new ways for
cooperation.
The main challenge in the future for the EU and member countries is how to maintain
and enhance the attractiveness of the innovation environment in the region. Hence,
the correct question is not how to protect R&D work but how to make sure that the
region continues to attract firms engaging in R&D activities. This has major
implications to the policy recommendations that we feel appropriate to give.
It should also be remembered that R&D off-shoring is not a zero-sum game nor is it
a “one-way street”. The general economic rational known as comparative advantage
does in deed apply also to R&D work. Countries and regions should specialize based
on this principle. R&D off-shoring leads to more efficient use of resources if and when
firms estimate rationally the input-output ratio of R&D spending when deciding on
off-shoring. If this is the case R&D off-shoring leads to increased global R&D activity
and thus pushes the global technological frontier further. This leads to better growth
opportunities also for EU countries’ economies.
In addition, based on our case studies there exist clear signs that EU will become
also a target for R&D off-shoring in the near future. For example Asian firms will
move their R&D work in the EU for the same reasons that EU firms are off-shoring to
Asia.
Finally it is worth keeping in mind that R&D off-shoring is still a relatively small
phenomenon. All work in this project suggests this (case studies, aggregate level
data, company surveys). In addition most of the off-shored R&D originates from
another EU country and is targeted to another one.

As discussed in the previous chapter, there is a wide variety of political measures
that are already in place and that have an effect on the innovation possibilities of the
firms operating in Europe. Based on our findings about the issues affecting the firms’
off-shoring decisions, there are some important general business environment issues
that EU governments can focus on in order to maintain and increase the level of R&D
investments in Europe. As concluded in chapter 11 we see no reason to try to
prevent the globalisation of business R&D functions; in terms of the effect of R&D
off-shoring on EU innovation performance, we find that it may have a positive effect
(result #4b in survey estimations). It therefore seems to be important to allow for
and even encourage off-shoring.
In order to ensure that the potential benefits can be reaped EU countries should
continue to liberalise the markets and thereby render possible the inflows of FDI R&D
from non-European countries. The results from R&D off-shoring on a national level
are also dependent on the policy environment, the general infrastructure, the
political institutions and attitude towards innovation and creativity.
The feasibility and effectiveness of any political measures are somewhat dependent
on the country or area in consideration. The country-specific assessment of different
policy measures is outside the scope of this study but it is clear that all the proposed
measures should be tailored to specific circumstances.
The main fear from off-shoring business R&D outside the EU is the decreased
innovation capacity of the European firms. This would in turn lead to sluggish
aggregate productivity development and slower economic growth. The result would
be lower economic welfare in the European Union as well as several negative short-
term effects like reduced level of employment.
Based on the findings from this study we can conclude that there are no real reasons
to expect R&D off-shoring to lead to any of those. Further, the study does not reveal
any implications of European firms losing their competitiveness. In fact, both the
survey results and the different econometric analyses and case studies suggest that
EU firms have either maintained or improved their competitiveness by engaging in
global R&D operations. It is of course possible that also negative short-term effects
arise but the long-term effects of R&D off-shoring appear to be positive for the EU
economy. It should be pointed out that in order to realize the potential benefits from
the phenomenon the EU and EU countries need to be ready to commit to policy
measures that make the continent an attractive business environment in the long
run.

There are no quick and easy solutions to make sure that the potential threats of R&D
off-shoring do not materialize. In short, the future success of EU firms’
innovativeness and positive development of the aggregate EU economy rests on the
EU’s efficient long-term institutional environment. At the same time the results from
work towards more efficient markets, better educational system etc., become evident
only in the long run. This can create commitment problems from the political system
and result in a futile search for the “easy” solutions.
The most important conclusions and policy recommendation in terms of long-run

effectiveness is the following: Above everything else we want to highlight the
importance of not being lured into different protectionist measures. Protectionism has
never been the right answer for better future. This is most certainly true also with
the R&D off-shoring phenomenon. Unfortunately it is questionable whether this is the
most feasible recommendation for the political system. The fear is that governments
want to buy short-run popularity at least in some countries by using protectionist
measures. This is an area where the Union can also have an influence by trying to
maintain a positive and open attitude in the region towards increasing global
interaction.
13.2 Possible political measures
13.2.1 Focus on enhancing the business environment and educational system
Enhancement of the business environment for R&D and high educational

standards lead to more inward investment in R&D
(Result #2 from aggregate estimations)
As was discussed in the economic literature section in Part I, for most countries the
vast majority of information and innovation is produced abroad. Therefore it is of
first-rate importance to maintain the domestic absorptive capacity. The most
effective way to do that is to maintain and increase the innovativeness of the
European business environment. As was observed in the case studies and the
conclusions in chapter 11, dynamic firms need dynamic and absorptive markets. All
the countries, big and small benefit from enabling trade, removing barriers and
creating research clusters and markets especially for R&D intensive products and
services. Making markets also requires that the local area innovation infrastructure is
in place and that people are interested in new products and services and are able to
use them.

Governments can use a wide range of policies to foster the emergence of clusters:
laws that protect and encourage the use of intellectual property, tax incentives for
research and joint venture projects, support for innovative means of spreading
financial risk, laws that encourage non-standard reimbursements for entrepreneurs
and high-risk investors, laws that encourage the movement of knowledge workers
from country to country, and so on. But governments do not create clusters —
research universities, big companies, and small entrepreneurial firms do.
Governments, however, play a vital catalytic role in fostering the climate for creating
innovation clusters.
One of the most important factors in global economy is no longer the competition for
best products, services or capital but for the best people – an opinion that many of
the case companies shared. The ability to attract people is a dynamic and sensitive
process and the success of that process is essential to the dynamic firms and the
future growth in EU. Not only should it produce highly educated individuals but also
people with right talents.
People are the key to quality research. One of the most critical roles of governments
is to increase the number of engineers and scientists prepared to do research by
supporting education at all levels and by recognizing the importance of knowledge
workers from other countries. But the government must also appreciate that R&D
success depends on the quality of a wide range of knowledge workers: business
managers, quality control experts, information systems designers and managers,
human resources administrators, lawyers, accountants, and so on. An excessive
amount of research workers does not necessarily ensure a string of R&D successes —
they need the professional support of the business infrastructure to take an
innovative idea and translate it into products and services. A skilled knowledge
workforce is an essential ingredient in economic growth and prosperity.
Also the links between academia and the private sector are of crucial importance.
More collaboration is needed between companies and universities and research
centres abroad, e.g. in a form of R&D and IPR programs and other public-private -
partnerships (PPPs). The people and firms connected to these universities and
centres of excellence would also benefit from widened student exchange programs,
cross-cultural innovation programs, and world’s leading experts and professors
visiting the universities. These kinds of clusters would also benefit from having
enough resources for facilitating entrepreneurship. Innovative environments and
entrepreneurs many often come as a package, i.e. entrepreneurs create innovative

environments that again make it possible to draw other entrepreneurs to that
location.
We feel that this recommendation is both highly feasible and effective especially in
the long run.
13.2.2 Increase public and private R&D investment
The most effective way to increase the effectiveness of R&D in terms of the
number of domestically invented/owned patents is to increase R&D
investment, both public and private.
(Results #4 and 5, aggregate estimations)
Large rich countries and cities have the advantage of generously funding large
research universities. Such universities not only produce outstanding research
scholars but also form the site of joint research ventures with the private sector and
enable all the cooperation described in previous section. However, it should be
remembered that to our knowledge there does not exist a generally accepted
estimate of what would be the “right” level of R&D investments. The Barcelona 2002
target of 3 % level national R&D investments relative to GDP is merely a political
statement. The right level of R&D investments may or may not be 3 % of GDP and
most likely it is different for different member states.
Our opinion is that this recommendation is highly feasible. Governments can decide
to increase the public R&D expenditure. However we feel that this recommendation
has only medium effectiveness in trying to make sure that the potential positive
effects of R&D off-shoring materialise. We do not know whether it helps to increase
R&D spending to for example the Barcelona 2002 target. No one can tell what is the
“right” level of spending and almost certainly it also varies between different EU
countries.
13.2.3 Concentrate on a well-functioning R&D environment
Firms do choose the location for their R&D partly according to how they value
different policy measures.
(Result #3a in survey estimations)
It is important to provide a broad mix of policy tools, including research

infrastructure, public support and IPR protection in order to attract and retain
different types of firms’ R&D. At the same time it must be emphasized that both for

single firms’ location decisions as for the innovation performance in general, a well-
functioning R&D environment is more important than individual policy measures.
Small countries can focus on providing a welcoming and nurturing environment for
R&D investments. Open trade with financial flows and commercial laws that support
them are obvious elements of any strategy. But countries like Ireland have gone a
step further as discussed in chapter 12. They do very well by supporting the building
of strong supplier networks for foreign affiliates that move into the country. This
includes policies for approaches like directed training in needed skills, payments for
professional managers who can coordinate the relationship of foreign and domestic
firms, quality control experts, and tax breaks and incentives for cooperative
ventures. This creates a non-threatening environment that encourages cooperative
action. It also offers these small innovative countries the opportunity to focus on
specialized technologies or applications and emerge as centres of global excellence
that invite and reward the multinationals’ active presence there.
There are good theoretical rationales for direct public support for private R&D (taxes
and/or subsidies): for example the endogenous growth literature has singled R&D
subsidies as the main policy tool and studied the circumstances under which they
may enhance growth. At the same time it is crucially important to understand that
the empirical research thus far is inconclusive as to the effectiveness of either policy
tool, and to keep in mind that the practical implementation of these policy tools may
fall far short of the theoretical ideal.
Our opinion is that this recommendation has low to medium feasibility. A well-
functioning R&D environment is not a decision governments can take but an end
product from years of wise governing and numerous small decisions. It is also the
case that no single right definition exists of what a well-functioning R&D environment
means. However, in the long run the effectiveness of this recommendation is most
certainly high.

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Appendices
1 Case outline
CASE OUTLINE
1 R&D off-shoring at the firm level
This part of the case will be relatively short, as the topics will already be covered by
the survey. The focus will be on getting more insight and detailed information behind
the firm level decisions.
1.1 Why?
What have been the drivers of R&D off-shoring for your firm? For example,
availability, quality and cost of the production factors; and/or acquisition of strategic
assets and the possibility to access new, larger and growing markets.
1.2 Where?
What have been the decisive factors when choosing this particular location/these
locations for R&D operations? Why is your company not conducting these operations
at home?
1.3 What?
Which R&D operations are off-shored, research (basic, applied, product or process
research) and/or development? Why were these particular R&D operations off-
shored?
1.4 How and with whom?

Why was this particular form of off-shoring chosen (foreign direct investments, M&A,
outsourcing, joint venture/partnership)? In case of outsourcing, what were the
decisive factors in choosing a partner/supplier?
1.5 For how long?

How long has your company conducted R&D operations off-shore?
1.6 Degree of substitution between domestic and foreign R&D

Has off-shoring replaced domestic R&D and if so, to what extent?
1.7 Policy environment

What is the role of policy/legislative/socio-economic environment for the location
choice? Specifically, how important are the following aspects:
· the policy environment and notably the presence of institutions, universities
infrastructures and regulations conducive to business, including effective competition
rules
· the general tax framework
· financial ad hoc incentives (such as subsidies)
1.8 Other topics relating to the R&D off-shoring decision at the firm level
Firm specific aspects that come up in the discussion
2 The impact of R&D off-shoring on case study firms and their operations
This is the key part of the case interview. The purpose is to detect the various ways
through which off-shoring can impact the innovation capacity of a firm both in the
short and in the long run.
2.1 Innovative process

Describe shortly the innovative processes of your company/branch, including possibly
different kinds of innovation: product, process, marketing, organizational
innovations).
What stage of the product innovation process is mostly affected by R&D off-shoring
and how? (E.g. research, development, commercialisation and design)
2.2 Relation between home office and off-shore R&D locations

In general, what is the relation between off-shore operations and home operations?
(close co-operation vs. not much co-operation).
What is the nature of information flows between locations?
How is the management of off-shore operations organized?
2.3 Direct effects of R&D off-shoring

What are the direct effects of R&D off-shoring for this firm? These may include for
example:
· Increased patenting (EPO/USPTO/Triadic patents)?
· New products/services (sales of new-to-market/new to firm products, trademarks,
community designs)
· Other direct effects such as improved innovative processes, higher efficiency in
R&D processes, costs savings?
2.4 Indirect effects

What indirect effects have the company experienced (i.e. not directly impacted by
R&D conducted off-shore)? These may include for example:
· Improved efficiency in other processes
· Improved marketing and/or organizational practices
· New partners/customers/suppliers
· Off-shoring of other operations
· Increase/decrease in ICT expenditures
· New products launched at home market that do not directly result from R&D
process abroad, but have indirectly been affected
· Other possible indirect effects
2.5 Other related spillover effects company has experienced?

For example, these could include learning from R&D partners/collaborators abroad,
better and/or earlier knowledge of new innovations made by foreign
companies/universities/research institutions.
2.6 Competition
Has R&D off-shoring impacted the competitive situation between your company and
other firms in the market?
2.7 Collaboration with universities and institutes at home vs. abroad

Has R&D off-shoring affected your domestic collaboration? Has domestic
collaboration been substituted by foreign collaboration? Has R&D off-shoring affected
university R&D expenditures financed by your company at home?
2.8 Effects on personnel

How has R&D off-shoring impacted the number of skilled personnel working at home
country and/or their duties? Has your company invested more in the education of
personnel at home?
2.9 R&D budget

How has R&D off-shoring impacted the total R&D budget? How has R&D off-shoring
impacted total innovation expenditures?
2.10 Challenges and negative effects

What negative effects have arisen? For example unexpected costs, cultural
differences, IPR problems, lack of coordination, managerial problems, inadequate
information.

2.11 Subjective assessment of the overall impact on your company
Has R&D off-shoring had a positive or negative impact on your company’s
operations? Is the effect significant or small?
2.12 Subjective assessment of the impact of off-shoring on other companies in your

industry?
In your knowledge, what are the common benefits and problems with R&D off-
shoring experienced by other firms in your sector?
3 Future
3.1 Future prospects for R&D off-shoring conducted by own company.
Do your expect R&D off-shoring to increase or decrease in the future?
In case your company has such plans, to what locations, how and why?
3.2 Overall assessment of the future

Do you expect off-shoring to increase in your industry?
What kind of impact do you expect that to have on your industry’s future prospects,
especially in the EU area?
3.3 Overall assessment of the impact on the EU area in general

Do you expect R&D off-shoring to have a positive or negative impact on the EU area
in the future? What are the important determinants affecting the overall impact? How
do you suggest policymakers in the EU should react?

2 The cases
Case A
Company size: Multinational enterprise

Origin: Central Europe
Business sector: Software and computer services
Contact person: Managing Director of a European subsidiary
R&D off-shoring at the firm level
The company began R&D off-shoring in mid-1990s as it did not have enough of
competent resources for worldwide growth in its home country. The main driver of
off-shoring has been the need to find the best skills, which are essential for the
company to be competitive. Another important driver has been customer demand. In
order to be able to respond to worldwide customer demand, the company has to
supplement its in-house competences by off-shoring.
The company’s innovative processes are driven first and foremost by market
demand. In addition, technological knowledge and internal intelligence determine
how to transfer competencies into reliable and long-lasting solutions. The worldwide
composition of R&D operations is designed based on competencies and available
capacity. The company is convinced that mergers are not the right approach for off-
shoring R&D operations. Instead, they have chosen to build in missing technologies
and competences, some acquired and some spin-offs. There are no horizontal cuts in
R&D operations.
The location of R&D is selected mostly by customer demand and where the best
resources can be found. The company also takes into account the possible synergies
that can be established e.g. with local universities and companies. Political or
legislative environment are not the main criteria for the choice of location. For
example, securing sufficient employment in a certain area is not a decisive factor for
the location.
The headquarters is responsible for the management and coordination of the R&D
off-shore operations. The off-shore R&D locations work in very close co-operation
with the headquarters. Modern communication tools, such as net-meetings and
videoconferences shorten the physical distance between locations, and time

difference is thus the only obstacle affecting the information flow. The advantages of
decentralization include synergies with other companies and access to the best
resources. However, the development process has to be continuously checked for
reliability and efficiency, regardless of the location.
The impact of R&D off-shoring on the firm and its operations
R&D off-shoring has had a very positive impact on the company’s operations and it is
vital for its competitiveness. Off-shoring has not replaced but supplemented domestic
R&D. It has brought a broader, multinational influence into the product generation.
The direct effects can be seen in improved internal processes and continuous growth.
Customer recognition is important as well. Customers are satisfied that the company
understands how local markets are developing and what is locally needed. This type
of trusted advice helps them solve the challenges related to local markets, customers
and policies.
Off-shoring has increased multiculturalism in the organization. On one hand, the

more nationalities there are in house, the easier it is to respond to customer needs.
The headquarters learns from off-shore locations; e.g. they have been positively
surprised by good communication skills in India, and university skills in China. On the
other hand, cultural differences can have negative effects as well. The more there are
mixed teams, the more differences there are in working cultures. This also brings
about internal discussions e.g. about the diverse salary structures or legal
advantages in different countries. Dealing with these cultural differences is a
challenge of communication.
The future
The company is on a continuous growth path and it will continue to increase R&D off-
shoring in the future. As business development is based on innovation, off-shoring
offers quick access to where innovation happens. The question is about finding the
right balance between market demand and the best competences. Although regional
co-operation is important alongside with official co-operation, innovation cannot be
managed by politics only.
The company expects off-shoring to increase in the whole industry. It will have a
positive impact on both the industrial growth and the EU area as a whole. EU should
not pay attention only to the negative sides of off-shoring. It will have positive
effects for European countries as companies outside of the EU are looking for new
markets and competencies for their R&D operations. For example Indian companies

will off-shore some their R&D operations by opening affiliates in Europe to satisfy
customer demand. Policy response to this would be education. European countries
would benefit more from openness than from restrictions to off-shoring.

Case B

Origin: Northern Europe
Business sector: Information technology hardware
Contact person: Vice President, Software and R&D subcontracting
For this case company it is the company strategy and business objectives that define
whether or not there is a need to either relocate or outsource any R&D functions. The
company has large research centres in four EU countries, in Northern America, in
China and now the newest in India. The company has different reasons for every off-
shoring decision, depending on (geographical) business objectives.
R&D off-shoring comes in many forms, again depending on the company’s business
objectives. The parts of R&D, which are off-shored differ accordingly. In many cases
the company does internal outsourcing or gives specific assignments and keeps the
so-called intellectual ownership of the process in home country. More long-term off-
shoring comes e.g. in forms of joint ventures.
The main reason to conduct research and development outside of the home country
is the need to be close to customers and to be able to localize the products and
services. The market presence is especially important in China, where the company’s
commitment to the country and the customers has to be shown by employing the
locals in R&D functions, not just in sales and promotion. The company has had a
presence in China for many years.
The company has been decreasing the R&D stakes in Northern America. This is
mainly due to changes in strategic focusing and the rising costs of skilled labour.
Some of the stakes have recently been put in India, where the company has a
factory and some small R&D projects. Cost efficiency is by far the most important
reason for this off-shoring decision.
The company states that at the grass root level of everyday R&D work the EU
countries are preferred to China or India because the differences in culture and time
zone are bigger when looking at Asia than Europe. Europeans are preferred also due
to their stronger ability to take the ownership of any given project. On the other

hand, India’s cost-efficiency is superior when the assignment is unambiguous. Within
EU the new member states are preferred to the old member states due to lower
costs.
The company seems to be patriotic and wants to keep half of the R&D work at home
base. They also state that it is not nearly as important to keep the headquarters as it
is to keep the main R&D functions in home country.
The company estimates that about 10 per cent of company’s total R&D work force
has been transferred outside of home country due to off-shoring. This is not,
however, to say that the domestic R&D has been replaced but rather the growth has
been stronger in off-shored area. According to company’s estimates 1/3 of R&D
functions are transferable.
Legislation and de facto legal environment play a certain role when the company is
contemplating the choice of location. Positive factors include the amount of skilled
labour and its price, i.e. education system and labour laws. Negative risks usually
arise from issues concerning intellectual property rights, which is the case in China.
In terms of infrastructure Chine is well developed whereas India poses bigger risks.
The company’s innovative process is two-fold: research centres acting as business

incubators, and the product-specific development. What seem to have the most
important impact on the firm in general are the economies of scale attained via R&D
off-shoring. Platform developed in home R&D centre is quickly and easily transferable
to off-shore R&D centres for further development. Without R&D off-shoring the
company would not have had as many product lines and variations as it had.
R&D off-shoring has enabled the company to keep the strategically important R&D
functions at home base. The company has transferred less important development
(like testing) to where it is most cost-efficiently performed, and discharged the
domestic R&D staff in a way which lets them focus on the most important
development work.
The company has been forced to bring down the fraction of R&D spending from 12%
to 8% due to tightened competition. This would not have been possible without the
cost savings made possible by R&D off-shoring. The difference in wages is on

average 1:3 (off-shored vs. domestic R&D). In other words, R&D off-shoring has
maintained the company’s competitiveness.
The information flow between the home office and off-shored R&D locations is one-
way, according to the company. Since the outsourced and off-shored work is mostly
done on an assignment basis, there isn’t any notable second flow towards the
principal. However, the company mentions that engaging in off-shore activities
requires that the home base is in good order enabling efficient off-shore project
management.
All in all, this case company maintains that the overall impact of R&D off-shoring on
the firm is positive and they do not admit to any significant, realized negative effects.
The company states very clearly that the off-shored R&D operations e.g. in India do
not paralyze the domestic R&D functions.
The future
The company expects to continue R&D off-shoring for the same reasons it has been
performing outsourcing up to the present. In EU’s perspective the company is certain
that resisting the change is futile. It would only benefit EU countries and it’s R&D
workforce if the European companies are able to reap the benefits of off-shoring by
using the talent in off-shore locations and at the same time allowing the local talent
focus on the strategically most important R&D functions. In future, partnerships
between EU companies and the most innovative off-shore companies will become
very valuable for Europe in the global competition.
It is also the company’s belief that the amount of highly skilled technical work force
continues to rise in India and that they are not going to settle for pure assignment
work forever. The R&D companies in India are developing their own IPR and
internationalisation strategies and they will be competing on the European markets
before long. This future outcome is something that our case company views
inevitable and it is also something that Europe as a whole should be ready for. Asian
companies off-shoring to Europe will also bring new jobs for the Europeans.

Case C

Business sector: Electronic and electrical
Contact person: Vice President, R&D
The company started gradually moving some R&D activities abroad already before
the WW II, starting from the US. Currently the firm has R&D operations in more than
100 locations, a fact that made it a bit peculiar for the interviewee of this truly global
company to talk specifically about off-shored R&D. In a global company everything is
off-shored somewhere.
The main drivers for having R&D operations abroad for this case company are 1)
market growth, 2) global presence for a global company, 3) search for talented
people and 4) cost and government incentives abroad. The company has off-shored
all kinds of R&D, long-term research and close-to-market product development. The
main form of off-shoring is in-house, only a small part is outsourced to universities
(in home country and abroad) or forms of co-operations with universities and other
companies. External suppliers in China, India etc., manufacture more and more of
the products and they also do an increasing part of the R&D related to the process
(as an ODM, Original Design Manufacturer).
The research activities are distinguished from product specific R&D. The company has
60% of research activities and 40% of product specific R&D activities still in the
home country, heavily over represented compared to domestic sales. 90% of
research is in Europe. R&D off-shoring is not a substitute for domestic R&D, but
rather a complement.
Case company representative talks a lot about innovation ecosystem, which should
be suitable and encouraging for companies’ R&D activities: sufficient amount of
people with proper education, interesting market perspective, regulation in place to
ensure translating R&D to innovations, not too high taxes and maybe even some
subsidies. China’s ecosystem has its problems but the number of qualified people is
overwhelming. IPR environment is slowly getting better; the company has some of

their own IPR experts actually teaching IPRs in Chinese universities. Company itself
is one of the companies with most patents in China.
The innovation ecosystem in Europe is not so lucrative as the company would like it
to be. There is no real single market; a lot of national barriers make the EU market
fragmented and less interesting than e.g. the US market. There’s also too much
fragmentation in regulations and R&D efforts, although the Lisbon strategy has
brought about some progress. According to the case company, making the
ecosystem in Europe interesting enough for the big multinationals like this firm is the
only chance to keep the companies in EU area.
The company’s innovation process is centrally managed, both for research and for
product specific R&D. The classical linear innovation model does not necessary apply
– company’s R&D is more interactive and iterative. A lot of research is done at the
product division or even in close collaborations with customers, i.e. co-creations
where ordinary people are exposed to the latest ideas. In the past also this case
company used to do everything itself, linearly, but it has turned to the world and
tried to tap into the ideas and learn from others. The notion is ‘open innovation’,
where the company lets others develop their own inventions and take part in the
iterative process.
The impacts of R&D off-shoring are significant for the firm and its operations. Costs
have lowered; efficiency and improved processes have been positively affected as the
company has opened up to the world. The whole mindset for research has changed
from “Our lab is our world” to “The world is our lab”. Having a global R&D base is a
necessity for a global company. It is also in line with the open innovation principle –
the company exposes itself to new markets, insights and new areas of growth. From
a competitive point of view not having global R&D is not an option. The company also
looks for synergies in working with other companies and universities, increasingly
outside of Europe.
The amount of patents has increased in the company although they do not see that
as being a result of R&D off-shoring per se. The speed with which the company gets
new products to the market has increased and also brought new products to
domestic markets.

Indirect effects from R&D off-shoring are related to the company’s other internal
processes. Off-shored R&D has forced the company to develop better processes in
order to manage the R&D project portfolio worldwide. International but internal
corporate collaboration requires well-organized processes.
The total number of company employees has more than halved over the last years
and the same has happened approximately in the same proportion for the R&D staff.
The home base is now staffed with highly educated R&D and research people. At the
moment the R&D in Europe is out of proportion to sales in Europe. In China there are
20.000 employees from which 1.000 in R&D and nearly 100 in research. The Chinese
innovative ecosystem is better for the company than the European one, because the
amount of highly skilled and energetic people in China is so vast. It is relatively easy
for the company to group their staff together on the local campuses, open up to third
parties and collaborate with local governments and universities.
The future
According to the case company it is a fact of life for both European businesses and
the EU in general that EU based companies of a certain size need to have a presence
and part of their activities outside of EU. They have to venture outside of EU and go
where the growth opportunities are; this is a must in order to survive just in Europe.
Otherwise the company would not be able to grow or even sustain itself, eventually
forcing it to decrease the number of employees.
Off-shoring will increase in general and across the board. That can also be viewed as
an excellent opportunity for EU, not just a threat. Companies off-shoring their R&D
and some other functions are able to grow, offer work at home country and pay
taxes. The challenge is to keep EU interesting and competitive compared to other
locations in the world.

Case D
Company size: Small enterprise

Origin: Southern Europe
Contact person: Managing Director
This case company is situated in the Mediterranean area where it has the
headquarters and 10 per cent of its R&D operations. 90 per cent of the company’s
R&D is off-shored to Northern Europe where the company has merged with a local
firm for high-level R&D purposes. Domestic R&D staff comprises of trainees straight
from university. Off-shored R&D has replaced most of the domestic R&D. The
reasons for the merger are business synergies, market coverage and complementary
nature of products developed in the off-shore location.
According to the company, both the home country and the off-shore country are not
very company-friendly locations in Europe in terms of the social and legal systems
causing inflexibilities in labour, high taxes and therefore high cost of employment.
But the merger has anyhow been very beneficial for the company and brought about
a competitive edge. Estonia, the Czech Republic and Romania are currently viewed to
be countries where an off-shoring firm would get the most cost efficiencies in Europe.
The proximity of universities is not the driving factor for this company when looking
for an R&D location in Europe. Local government subsidies are not viewed as being
encouraging due to the tediousness in drafting applications with uncertainty of
getting the subsidy.
The company’s innovative process is initiated by customer needs, as for many other
small and medium sized companies. The business requirements of new products and
innovations are defined locally and development itself, incl. testing, is done off-shore.
The link to the off-shore R&D company is very strong, probably partly due to the
management team being originally from the off-shore country.
The main reasons for the off-shore R&D company merger were the connections that
the off-shore company has with big companies and market leaders in their field.

These relations have been very important for the case company in their highly
competitive environment. The merged company also had strong ties to local
universities and academic community but that collaboration actually decreased after
the merger when the case company needed to realign the business strategy to be
more commercial. In effect, cost savings were not a factor in this R&D off-shoring
decision and neither was increasing sales. The merged company did get some form
of subsidy from the local technology program, thereby increasing the total R&D
budget for the company.
The biggest challenge for the company with the R&D off-shore and merger decision
was convincing investors. And even that went quite smoothly because the
management team knew extremely well the off-shore location. In retrospect, the
company views that the negative issue with the merger was that the resulting
technical development was actually quite slow and not enough business oriented.
Also the salaries were and still are high. But the positive issues still overweigh the
negatives and the company is happy with their decision. For other firms in their
industry the company sees that cost benefits and flexibilities in outsourcing are the
common benefits. Problems mainly arise from cultural differences and project
management.
The future
The company does not plan to increase its own R&D off-shoring operations but
globalisation will probably increase these operations in companies in general. The
growth will focus on high level R&D, client interface and business development
projects. According to the company this will change the form of work for IT
professionals to be less technologically orientated: in Europe, more business oriented
project management skills are needed and they are outsourced to where they are
inexpensively available; in China and India the focus shifts towards high-level
product design.
The impact of R&D off-shoring will be positive for some and negative for some
others. However, the company does not see any drastic changes in the volume of IT
industry business in Europe. The focus moves to development projects done in close
co-operation with customers, indicating that work has to be done where the sales
take place, i.e. also in Europe. National health and defence projects are examples of
work that will stay in respective countries.

Cost of work force is increasingly important and the education level – although not
the formal academic education but the overall social, language and business skills.
The EU and its national governments should not focus on increasing subsidies, which
might only lead to unhealthy competition and slower transformation of current
situation. There are obvious threats in R&D off-shoring as well as advantages for
early adopters. I.e. subsidies hinder the EU companies from making changes earlier
and transform quickly enough to take advantage of R&D off-shoring. EU could
increase education and research budgets and have less regulation.

Case E

Origin: North America
Contact person: Manager of European Technology Centre
This North American case company has off-shored some of its R&D activities to
Europe over the last ten years. The company has R&D centres in North America,
Europe and Asia but around 85 percent of R&D employees are still based in North
America. The first R&D site outside home country was established in 1996 but the
real milestone was in 2000 when the company began off-shoring to China and India.
Overall investment in R&D is 3.6 % of the total revenue, and off-shoring accounts for
only a minimal fraction of the total costs.
There are three major drivers for R&D off-shoring. Firstly, the company has off-
shored technologies that were reaching a mature state. This strategic decision
enabled the company to focus its innovation path on mainstream technology. It
allowed them to fade away mature technology while maintaining customer support
and satisfaction. Secondly, the company has pursued a strategy that combines R&D
with investments with education. R&D off-shoring supports the company’s program
to aid public education in the technology sector. Thirdly, R&D off-shoring has focused
on growth areas where booming economies provide good business opportunities, e.g.
the Asian economies, oil-producing countries or other emerging economies. The
criteria for off-shoring vary in time and situation but the company favours countries
with high education and an entrepreneurial approach. In some cases, requirements
for customisation and localisation of products call for off-shoring as well.
The company has several R&D sites in Europe. Off-shoring was a way to penetrate to
the European market. A major factor for choosing a location was the opportunity to
recruit a wide range of talented people. It was especially important to find a location
that would attract nationalities throughout Europe. In addition, a dynamic research
and university infrastructure in the region was a decisive factor. The company has
formed a partnership with a local university that has a wide network with several
other universities. The role of policy and legislative environment is central for the
location choice as well. Among other things, this is related to technology regulations

and liberalisation that have an effect on future business operations. Tax benefits
might act as good incentives because they are not direct subsidies as such. However,
although subsidising R&D activities can be beneficial in the short term that might not
necessarily be the case in the long run.
The company policy is that market intelligence and product strategy are centralized
operations in home country but implementation can be done off-shore. R&D for new
technology, especially engineering and the creation of new products, is still
maintained in home country. However, in the initial phase of a product, there are
strong partnerships between North American and European R&D centres.
Off-shoring has been carried out in various forms, from fully owned subsidiaries to
joint ventures and external contract partnerships. The company has one global
strategy but various ways of implementation according to the qualifications of local
markets. There is not a single model for off-shoring. The appropriate form depends
on the type of investment and the structure of the local economy. E.g. the cultural
environment might require a strong form of collaboration such as a joint venture.
Successful R&D is a combination of invention, innovation and adoption. Innovation is

not only about invention. Invention is related to opportunities and education, and it is
something that everyone can do. However, a brilliant idea needs more than just
engineering before the product can hit the market. Marketing is a fundamental part
of the company’s R&D process as well as services support for end-users. Innovation
is thus a joint activity of marketing, technology, cost optimisation, and knowledge of
industrial as well as economic trends. Finally, adoption has to be guaranteed by
being where the market is.
The innovation process begins from identification of market trends and technology
trends. After the growth opportunities have been identified, the company decides on
the portfolio of what is done locally and what can be off-shored. Off-shoring decisions
are made on the basis of market and technology segmentation and cost efficiency.
The management of off-shore R&D is mainly centrally organised. The external

contractors have a centralized financial and legal control. The responsibility is shifted
down to each unit on a project basis. The fully owned subsidiaries usually have a
centralized management. The business units manage their own operations, including
R&D. Off-shore operations have a very close relationship and control with the

headquarters. The internal organizational culture includes e.g. a rotation program for
employees. The nature of information flow is very high and complete.
As a direct effect off-shoring extends the lifetime of mature products to new markets,
which increases customer satisfaction. It also improves productivity and cost
optimisation. Furthermore, off-shoring can contribute to the local educational system.
Off-shoring is an additional tool for competing in the markets. It offers better
relationships with authorities and with potential partners. With global competition,
experience on local trends can improve competitiveness. Being present in the local
markets, the company can gain better knowledge on the dynamics of different
markets and technological development, as well as on financial opportunities.
Obtaining this information in other ways than off-shoring can be very costly.
However, the competitive analysis of off-shoring is complicated because one can only
evaluate the external impacts.
Domestic R&D has not been replaced by off-shoring. The company is doing more
things in a complementary fashion that supports its domestic operations. The total
number of R&D people has increased from 9.000 to 20.000 during the time the
company has done off-shoring. The increase can also be seen in the home country.
There have been shifts of focus from one technology to another as well as changes in
job descriptions. At the moment, the company has a strong growth plan in India. In
Europe, the expected growth rate is more moderate, which will clearly affect future
investments on R&D.
Overall, off-shoring has had a positive impact on the company’s operations by

increased collaboration, business opportunities and market intelligence. The only
negative effect of off-shoring has been the increasing costs in management, time
allocation, travelling etc. These additional costs were not taken into account in the
initial budgets. An unexpected negative side effect has been the increased costs in
India where rotation of engineers has raised salaries rapidly. Cultural differences
have an impact on the loyalty of employees; for example people in China or in
Eastern Europe are more loyal than in India.
The future
It is likely that the company will increase off-shoring as its business is growing.
However, the relative change between domestic and foreign R&D is difficult to
predict. Overall, the industry is on a growth path with a shift of focus in terms of
countries, costs and management. There are a lot of countries with a combination of
high education, low labour costs and a growing economy.

Off-shoring does not mean that all operations will be shifted away from the home
country. The whole industry is now getting to a mature stage of off-shoring. The
initial gold rush seems to be stabilising as companies better understand what can be
off-shored and how it should be done.
One has to acknowledge that the high profit focus of investors and the economy
pushes companies to cost reductions. Investments will be done where there is a
trend of growth, and developed countries have to cope with the fact. There will
always be a trend of shifting operations to new regions, in China today, possibly
Africa in the future. However, off-shoring is not only driven by cost-reduction.
The company estimates that EU will be affected by off-shoring but not necessarily
only negatively. High education level and the growth potential in Eastern Europe can
attract more R&D off-shoring to the EU area. Analysis on the impacts of off-shoring
should measure the overall contribution to the economy, not only the number of
employed people in one location. Local companies can benefit from off-shored R&D
e.g. by technological development or by increased company value.
The case company emphasises that policy responses to off-shoring should be more
sophisticated. They need to be based on the understanding of the dynamics of
business and the reasons for off-shoring. The legislators in Europe and in North
America should act faster to follow the rapid changes in the economy instead of
debating what to do. The economy is accelerating but legislation is slowing down.
Overall feeling is that the administration is one to two cycles behind the reality in
terms of business thinking and overall approach. It would be a good boost for the
economies and for the companies if governments could act faster. Especially national
protectionism is a real threat that should be monitored.

Case F

Origin: Western Europe
Contact person: Director of External Relations
This case is prepared from the perspective of an off-shore R&D centre. The centre
was acquired by a multinational enterprise in 1999. Technological expertise and
success of the R&D activities were the main reasons for the acquisition. The centre
was self-sufficient with the whole R&D process including marketing and follow-up of
products. The centre is located in a region where there is a cluster of similar R&D
technology projects. A critical mass of companies operating in the same field of R&D
creates synergies and makes it easy to attract skilled labour around Europe. The
proximity to airport and presence of international schools were also important
aspects for the choice of location. On the whole, the centre considers off-shoring a
way to be present in the local markets.
The headquarters is in charge of the co-ordination of R&D but product development

is decentralized to off-shore locations. The subsidiary has a holistic approach on R&D
and it operates quite autonomously. The connection with R&D and marketing has
always been important in its product development process. The centre is rather self-
reliant in its R&D process especially as it has several competences to focus on. The
responsibilities of off-shore operations are structured in a way that facilitates the co-
operation of different units. The off-shore locations even have more co-operation
with other R&D units than with the headquarters. However, the level of collaboration
depends on the organization of the business units and product lines.
Off-shoring has not replaced domestic R&D, off-shoring is driven by the growth of the
parent company. The R&D centre believes that one of the benefits of off-shoring are
the possible managerial efficiencies. In a small R&D site, management is closer to
people compared to a large R&D centre. Off-shored locations often have more
freedom in their operations as well. The surrounding environment and the pressure
of local competition has a great influence on the success of R&D. It is easy to

establish networks with local companies, which leads to the creation of synergies.
The centre believes that if an off-shored R&D centre is working well, it can be more
beneficial than what a company would get with the same people in one location. The
richness of different R&D cultures contributes to the internal competition between
off-shore locations. On the other hand, the lack of communication between different
locations is the main problem of off-shoring. Overall, however, the impacts of off-
shoring have been positive for the whole company.
The future
There is a trend of reducing costs that is likely to affect the number of off-shored
locations. In the near future, the company is expected to concentrate on large R&D
centres with a critical amount of expertise. This will lead to small research units
being closed. Off-shoring promotes networking between European countries. The
centre believes R&D off-shoring to improve innovation, and thus the overall impact of
off-shoring will be positive in the EU area.

Case G

Business sector: Electronic and electrical
Contact person: Site Director, R&D centre in Southern Europe
The case company is a part of a multinational company and this case represents the
viewpoints of an off-shored R&D centre. The parent company has a lot of R&D
centres around the world. This one was established in a nice area in Mediterranean
Europe at the end of 1990’s in order to attract talented people. Currently it comprises
of about 100 employees that are all working in R&D. There is a university nearby
from where the company can recruit people and the overall policy environment is
lucrative.
Innovation and product development are the areas of R&D conducted in this centre.
Proximity to customers is an important issue affecting the everyday work.
Concerning the parent company, the R&D work in this centre is complementary to
the work conducted in the country of origin, although in the home country they see
the off-shored unit as their competitor.
The work in this R&D centre is either process research, or turnkey or fixed-price
project work. The work is conducted in close co-operation with the headquarters, but
the way of work is flexible. The business units report to division heads.
The local government supports the R&D centre by paying back certain research
project costs, thereby increasing the R&D budget. Other effects from having the R&D
centre in a ‘pool of creativity’ are the increased number of acquired projects and
sales. For the parent company it is an advantage to have presence in many locations
and be close to customers. The labour costs depend on the location and the total
R&D labour costs for the company have decreased due to off-shoring. The company
also states that there are so many different elements in R&D that the costs are
usually not the main issue anyway.

Problems in communication are mentioned as negative effects of R&D off-shoring.
The problem is common among the international companies; communities even
inside one company can be very diverse and sometimes it is difficult to find the
common ground. For management it is a problem of managing and integrating
projects. The overall effect of off-shoring is still positive.
The future
The company does not have plans to either increase or decrease its R&D off-shoring,
but some modification of the general picture is to be expected about the volume and
location of R&D. Asia with China and India as well as Tunisia are interesting
locations; they have big universities and the necessary will to make things happen.
The centre expects to have less people working in high-cost sites in Europe in the
future, yet the centre expects the lay-offs to start outside of the parent company’s
European home country. That puts them on the line and according to their view the
company itself will not survive if it fails to make the necessary changes and
adjustments to work force.
European companies as well as European nations do not seem to be ready for the
inevitable future changes. People are afraid and shocked when there is any talk
about opening new sites e.g. in China. Protectionism, however, is not the answer.
According to the interviewee we cannot save the future of Europe if we just try to
protect our companies and close our doors. The company would rather have
someone to talk to people and explain that the coming change can be a win-win
situation. We need to anticipate the changes and develop a common European
strategy about finding a balance between the high and low cost locations and also
about the collaborative frameworks between universities and companies and other
partnerships. There is also a need to facilitate the migration of people from one
company to another. Concerning salaries, the current trend seems to be to move out
of Europe but to stay close-by. It is difficult to serve the European customers from
China, no matter how talented or inexpensive the work force there is. The company
has seen the EU’s political message but not real work about what kind of future we
want to have in Europe and how are we going to manage that.

Case H

Business sector: Chemicals
Contact person: Group Vice President, R&D
The company has two corporate research centres in Europe and one in Singapore, as
well as R&D centres in the Middle East, China and the US. The centres are organised
so that the core technologies are developed in Europe whereas the other centres
focus on applications. The reason for off-shoring R&D is the need to be close to
customers who are increasingly located in the eastern parts of the world. The
company’s business model is such that in most cases it requires working with the
client in developing the product. Therefore the R&D functions are located as close to
the customer locations as possible. Cost savings are not important in this case -
skilled labour and good partnerships are.
Applied development and other later stage development and adjustment works are
the main form of off-shored R&D. The off-shored R&D work is additional, i.e. not
substituting the work done in home country. The policy environment is not one of the
key factors when choosing an R&D location, although they were happy receiving
some local public financing for setting up their centre in Far East.
The company has been able to speed up their productivity due to R&D off-shoring,
thereby increasing the outputs. The management is currently more centrally
organised than before, which has brought about efficiencies in capital allocations and
tax planning but also in human relations and leadership. The availability and
proximity of local R&D staff is said to have a huge impact on sales and sales division;
there is a better responsiveness to customer needs. Learning about local markets
and other companies brings better competitiveness and better co-operation with
supply chain.
“Research and Development projects can practically proceed around the clock. When
staff in Singapore sign off for the evening, their colleagues in Denmark and Spain can

take over. After them, colleagues in the USA can pick up the work and hand the
project back to Singapore. With this continual focus we can reduce development time
for new products and get them to market much faster than in the past.”
Managing the communication and IPRs are stated as the main challenges of R&D off-
shoring. The R&D staff at home country has to be willing to have good
communication connection to off-shore locations. The management also has to make
sure that the R&D people at home don’t get the feeling that the company is giving
their work to off-shore offices. Possible job losses may occur in the area of
production activities or other simpler things – the more complex projects are said to
be kept as close to the management as possible. In industries where the fraction of
R&D spending is large the off-shoring decision naturally becomes more important.
The future
R&D off-shoring will increase in this case company and in their opinion also in the
whole industry. Different kinds of testing and customisation functions will be
increasingly off-shored because of the advantages and benefits of local presence.
Globalisation will eventually level out the differences in skills or salaries and the
majority of European companies will keep their innovative processes in Europe. That
is a challenge as well: if we as Europeans don’t produce innovatively and focus on
new research areas, we will lose our vitality. Europe does not really have a
competitive edge in terms of skills compared e.g. to China or Singapore. European
companies should have a comparative advantage in one specific area to do R&D as
well as production.
One suggestion for that new focus area is the environment and issues relating to it.
Europeans are much more aware of environmentally friendly ways to e.g. produce
energy than the Americans or Asians are. The American model concerning the
environment looks at environment as an economy and it is based on innovating for
the companies benefit (industrial emission rights etc.). European companies should
not try to copy the American model because the Europeans cannot beat the
Americans at that. Rather, we should have our own model, which is built on our
common European values. We should have an innovative focus on the environmental
issues, be original and develop it to a level so that it becomes our own, European
model.

Case I
Company size: Small enterprise

Business sector: Healthcare equipment and services
Contact person: General Manager
This small public company is very R&D intensive and has located its two research
teams in its home country and in a UK university city. The off-shored R&D focuses on
basic research done in close collaboration with the university. The off-shoring
decision took place two years ago and was a sum of coincidences and luck. The off-
shored team is partly transferred from the home country but in effect it is an
additional and very valuable part of the company’s R&D. The firm wanted to broaden
the base of highly skilled academic researchers within their business field and the off-
shoring also became a part of their internationalisation strategy. Location in UK has
brought about an easier access to the local, larger public funding.
The small firm with limited resources finds it costly and risky to conduct basic
research. It is costly to have an off-shored R&D staff in UK; both the facilities and
people are more expensive than in home country. This is, however, offset by the
larger talent pool available, efficient R&D work and the innovative image and
increased credibility in the eyes of the investors.
Firm’s innovative process starts from an impulse from the markets. The idea goes
through a multistage evaluation process and a feasibility study after which the
management team views its profitability and strategic fit to the firms operations. If it
passes the management scrutiny it then advances to an initial exploring phase.
The innovation process and the company’s research are quite academic and the firm
is in the worldwide frontline in its field. R&D director is based in the off-shore location
with a separate financial controller and is in contact with the HQ daily. The local
bureaucracy, taxation and differences in practicalities have to be taken into account.

Off-shoring R&D has increased company’s patenting and it serves as a strategically
important base for applied research and product development for home country. The
firm intends to keep its most important operations in its home country regardless of
possible future growth and R&D partnerships. The R&D budget has doubled in two
years and it is financed as a public-private partnership.
The company says that off-shored a unit is generally quite difficult to manage and
integrate to the firm but in their case it has been easier due to the homogeneous,
scholastic nature of the research team. The competitors are bigger, multinational
players and are viewed to be on the alert with this case company, which is waiting
for a breakthrough in their research. Subjectively assessed the company views the
R&D off-shoring in their case as having a significant positive impact. They also see
other firms in their industry probably benefiting from off-shoring to the North
America, Europe and Far-East.
The future
The firm intends to have an open mind about future off-shoring. Chances are that the
current R&D off-shore location might change but the company wants to keep its
options open and see how things unfold. A small firm is best off by taking advantage
of its inherent agility whereas multinationals with a dominating market position focus
on critical masses. It is less of an effort for a big firm with lots of resources to
establish an off-shore R&D centre than for an SME but integrating that unit to the
company is equally challenging. On another point of view, the bigger players very
often buy the innovative SMEs.
The future outlook is that R&D is not diverting out of Europe in the fields of medical
research, healthcare and biotechnology. Public funding is important especially in
basic research and companies collaborating with universities can contribute
significantly to the local and international innovativeness and its commercialisation.

Case J

Origin: Eastern Europe
Business sector: Household goods and textiles
Contact person: General Manager
The company has engaged in R&D off-shoring due to tightened competition in its
industry. It has an R&D centre in connection with its manufacturing plant in home
country and another in a Central European country. The firm is present in over 50
countries but mainly only in sales functions. The firm has off-shored its basic product
development and design; the sales focus is on European markets and the products
need to have a European design. The off-shoring unit was established over ten years
ago and it is conducted via partnership/outsourcing contract and the partner was
chosen based on its cutting edge technology and performance in design.
The case company made a strategic decision to focus on environmentally sound

materials and procedures for which they didn’t have the know-how in-house. They
also thought that best innovations are developed “out there” where the markets and
the most creative people are. They do have some in-house R&D staff that could be
bigger without the off-shoring. The firm says it might have larger R&D staff in their
home country in the future but they cannot have the R&D only in one country
because of loss of creativity. The policy environment is said to have no real effect on
location decisions.
The firm works in close co-operation with its off-shored R&D unit, the information
flows in both directions. The direct effects from R&D off-shoring are shortened time-
to-market, better addressing of customer demand and higher efficiency in product
development. The most important indirect effects are increased brand recognition,
easier marketing and sales, and the recruitment to sales offices around the world.
They have also managed to retain higher profits from their new products.
The firm has been able to develop its understanding about the markets, customers
and even competitors with the off-shored R&D partner. They now have better

products with higher demand and better representation in the markets. The
competition is tougher and many of their competitors use off-shoring as a means to
be innovative and to be able to benefit from the trend changes as quickly and
efficiently as possible. The off-shoring is not necessarily the most inexpensive way to
conduct R&D but it seems to be a good way to stay competitive. The R&D budget has
increased in recent years. Off-shoring R&D also takes more time and effort than
having R&D in-house due to communication requirements. The subjective
assessment of the firm is however that they have benefited greatly from off-shoring.
Quite a few prises for excellent product design speak for that effect as well.
The future
The company expects the co-operation with the off-shore R&D partner to continue
and it also expects to find other additional partners in other markets. They are not
interested in collaborating with competitors or universities. Yet they think that their
current and future R&D partners might benefit from connections to universities with
focus on creative arts and design.
The firm plans to keep its main R&D functions in Europe due to the highly regarded
European design in Asian countries, Australia and also the US. In order to stay
innovative and keep up with the trends it needs to have “sensors” in every continent
it plans to have sales from. The trends change and e.g. the Asian/oriental trends
have a larger impact on the firms’ product development now than a few years ago.
For the European policymakers the company suggests allocating more money on
education in design and cultural issues as well as brand marketing and environmental
issues. According to the firm’s views the EU countries are training too may engineers
and scientists and too few creative people.

Case K

Origin: Southern EU
Business sector: Aerospace and defence
Contact person: R&D Manager
This case company did not want to disclose many of the things the reader of this
report might be interested in. There are still some valuable insights available.
The reasons for R&D off-shoring are the firm’s need to be able to serve a client in
another country, to connect with the already established manufacturing plant and to
access new markets. Majority of the R&D staff is located in the home country,
performing research and design work but a part of the product development is
conducted off-shore. The off-shoring is done in a form of joint FDI where the biggest
owner of the case company is involved financially and operationally. The partner firm
in the off-shore destination was chosen based on its client connections and
references.
The company would not have been able to work with a certain new client unless it
had R&D unit close to the clients manufacturing plant. This is the main reason for
establishing the off-shore unit and because of that there were no replacements in the
home country R&D staff. The company needed to hire additional engineers in the off-
shore destination. The firm has taken part in several government initiated R&D
programs at home country and also worked with universities – these things are
named as being the reasons for continuing to keep the main R&D functions at home
country. There is no financial incentive to relocate.
The firm does not disclose strategically important information on its innovative
process. Based on the information received, the off-shore R&D unit does not have full
R&D capabilities but instead it focuses on one product development project at a time.
There is not much co-operation between the off-shore and home units. The company
has, however, had better customer responses; new customers and increased

customer satisfaction, faster time-to-market for newly designed products, improved
efficiency and increased sales in off-shore location.
Problems in R&D off-shoring have focussed on firm-level integration: the firm does
not have enough resources to have a fully integrated R&D network. There is also
some internal competition concerning the R&D projects; the R&D staff in the home
country does not appreciate the off-shore staff. The company views it cannot fully
utilise the off-shore partner and the work done there, i.e. the information does not
flow freely.
The future
The company plans to keep its R&D staff at home country on the current level but it
needs to re-evaluate the off-shore operations. The off-shore R&D budget has
increased over the years but now the firm needs to focus more on how to benefit
more from off-shore R&D results internally. They do not plan to increase their off-
shoring from current levels. The company states that many companies, also its
competitors have off-shore R&D activities but certain industries are more bound to
their home countries than other industries.
There are no comments on R&D issues on EU level.

Case L
Company size: Medium-sized enterprise

Origin: Western EU
Business sector: Pharma and biotech
Contact person: Vice President
This firm is a part of a larger group operating in several fields. The company is very
focussed and has recently found growth in Asia and Northern America. The
company’s main statement is very clear: Europe in general is not an innovation
friendly continent. The firm views that there is too much regulation concerning
pharmaceutical development work and some EU countries have even tighter
regulations than the EU requires.
The firm has had a strategic investment in the US for 10 years. It has replaced about
50% of the work force that could have been employed in the home country. Because
of the open regulatory environment in the US the firm transferred there a big part of
its R&D operations consisting of basic and applied research and testing. The US offers
company incentives and a large pool of innovative researchers, especially in some
particular locations that have focussed on pharmaceutical development.
Off-shored R&D affects the company’s whole innovation process but the main work
done off-shore is product development, testing and commercialisation of new
products. Initiatives sometimes are European and the European markets are scanned
regularly for any new customer demands. The firm operates in a very close co-
operation with the off-shored R&D site, the information flows in both directions.
The company has an increasing number of USPTO patents and tens of new ones
pending continuously. Other direct effects of off-shoring are new products, faster
commercialisation and therefore higher efficiency and cost saving though the speedy
process. Indirect effects consist of new and better organisational structures, which
the company has been forced to develop. The firm has also succeeded in finding new
markets for its products; presence in the US helps access Canada and Latin America.
Spillovers from the US to Europe are huge and mainly in form of knowledge about

new innovations. Having a base in the US is more of a norm than an exception
because almost all pharmaceutical companies are located there, also the
competitors. The firm has good connections and constant projects with a local
university and the company wishes that the European universities were as well
connected with businesses and internationally orientated. The company is certain
that it would not be able to operate unless it had the option to off-shore its R&D to
the US.
The future
The company will continue its R&D operations in off-shore locations and most
probably increase and combine forces with the parent company. Also, the firm’s own
R&D site in the US is viewed to have become more valuable for it has established
connections to an Indian pharmaceutical company. The future extent of the potential
benefits is unclear but promising.
The company has only one advice for European policymakers, nationally and within
the Union: loosen the regulation.

Case M

Origin: Northern EU
Business sector: Engineering and machinery
Contact person: R&D Manager
This very innovative engineering company has off-shored its manufacturing all over
the world. So far it has been content in off-shoring most its R&D functions to other
Northern European countries and keeping the strategically most important R&D at
home country. The company argues that the R&D costs in North Europe are only
about 1/3-1/2 compared to the US and about 1/2 compared to Germany. The
requirements for skilled work force also have an effect on the location decision.
Looking merely at costs, the company has estimated that R&D in The Czech Republic,
Hungary, China and India are around 1/4 of the costs in home country.
R&D operations in any off-shore country depend on company strategy and the firm’s
history in that location, i.e. what have we done there before. In deciding about the
R&D locations the firm was first most interested in resources, then on technology and
now the focus has shifted on market demand. The company needs to take into
account the need for local modifications. They follow the customer but also recognise
the effect of local policies.
The company has established an R&D site in China some five years ago due to the
political pressure to combine it’s already established manufacturing plant with R&D
operations. Any core R&D activities are not off-shored there because of the high
employee turnover. The company benefits from the lower cost levels (especially low
taxes) and being able to tailor products to local markets more efficiently. The growth
in terms of R&D staff has been in China but it has not been at the expense in other
R&D sites.
Other countries where this blue chip company has R&D operations are in Eastern
Europe, the US and India. The firm’s strategy has been to build a network based on
work mobility and 24/7 development work using different time zones. The network
has been built mainly through mergers and acquisitions.

24/7 R&D environment is extremely difficult and it requires excellent organisational

structures. The company has focused on recruiting open-minded and culturally aware
researchers. The mathematical talent needs to be present as well but in the future
the most needed talent is social talent, which contributes to a positive teamwork
atmosphere.
The off-shore offices are autonomous but on a tight lease: advancements in projects
are controlled weekly in every location. The achievements of the off-shore R&D sites
include new platforms and patents, new products, good localisation processes as well
as better internal organisational processes. As indirect effects the company mentions
new partners, customers and increased sales. The spillover effects are few but all the
more important: learning from others and benefiting from the innovative
environment elsewhere.
The competition between some of the firm’s rivals has turned to co-operation in
some cases. Competitors have become interdependent e.g. on finding new locations
and connections to universities for local multi-partner programs. This has particularly
taken place in India. The company claims that in general there is less and less
competition of resources but admits that there is more competition on results - that
is innovations. There seems to be less of those “mutually exclusive” objectives in
knowledge business because innovations are usually not created at others’ expense.
The effect on personnel both in home country and off-shore is the increased amount
of training. Top-down training includes mainly company processes, teamwork
practices, creativity and cultural issues. Technical training is organised on a peer-to-
peer basis. Increase of contact between peers in different locations enhances the
teamwork considerably. The budget of R&D has increased in absolute terms but
stayed constant relatively to sales. The overall impact of off-shored R&D on the
company has been positive and it would not have been able to grow without the
innovations developed off-shore.
The firm sees a lot of challenges in R&D off-shoring. Firstly, on a company basis, the
R&D team has to understand that the value added from R&D needs to come from the
end-user and that R&D is best used as a means to that end. Secondly, the group
dynamics are important to understand on a manager level; groups in different
locations benefit and work better if they have a common goal that is clearly

communicated to them and where they can have their say. Thirdly, on a market
place level, EU is not using it’s full potential on creating an open innovation network.
From a corporate point of view, it would be good to have the possibility to create so
called “extended enterprises”, i.e. where there are mutual benefits between big
multinationals and a bunch of SMEs around it.
The future
According to this case company in the future it is the operating environment as a

whole that matters. Every business operation has an optimal location globally and
that means that R&D most probably diverges and scatters around. The world and
Europe would be a good place for corporations in the future if it entailed open
markets, flexibility of public structures and long-term macroeconomic policies.
Hopefully also the use of financial incentives is diversified so that they can be used in
a wider selection of corporate operations, thereby clearing the way for the efficient
use of non-linear innovation models. The decision about the location of new European
research centres and innovation centres should be done on the basis of the skilled
people: where the greatest number of the most skilled people of any area of
innovation lives in.
An integral part of public innovation policy in the US is that the public purchases and
acquisitions are done in a way, which supports innovation. The EU member states
could benefit from that kind of public policy as well. Tax incentives are good and
beneficial especially for start-up companies.

Case N

Origin: Western EU
Business sector: Support services
Contact person: Group R&D Manager
An important part of the case firm’s internationalisation strategy has been to use the
leverage of their service know-how globally. The firm goes after intellectual capital
and looks for quality R&D talent and collaboration with universities, and naturally
also the market growth potential. They have been able to cut costs in their back
office services by moving them off-shore; one of the firm’s business areas is to
provide different back office services for its clients in off-shore locations.
Other European countries have been the main location for this company in
developing their services. The areas of Asia Pacific and Middle East are big in terms
of off-shoring service jobs but not R&D jobs. When deciding on the R&D location the
firm looks at local services and infrastructure as critical factors with the talent base.
Off-shoring started about eight years ago and has taken place in a form of FDI, which
the company sees as a good way to establish true and committed partnerships. Off-
shore R&D has focussed on market and competitor research, developing technology
service processes and finding partners for their own clients. There has been about 50
% substitution of the domestic R&D but the company claims that this is more than
offset by new jobs created in Europe by some of their clients outside of EU who have
been off-shoring their R&D to the old continent. The affect of policy environment in
off-shoring decisions comes through research community, national innovation system
and the ease of developing and licensing e.g. technology. Different firms value the
European policy environment differently.
The firm’s innovation process depends on specific contracts and clients but the main
part comes from development work done to the public sector, which the company
uses to develop its own processes. The organisation is non-hierarchical with project-

specific managers in charge. Communication is constant, as well as travelling and
position rotation.
The firm has experienced increased efficiency through R&D off-shoring. Cross-
cultural work atmosphere has brought about higher-level innovation base and
excellent results from knowledge sharing in areas such as public health care,
education, government operations and environmental issues. Lower costs have
contributed to better competitiveness. Spillover effects have constituted a major
effect on business development and growth: the firm has established contacts in off-
shore locations that have enabled it to offer new service off-shoring partners for their
European clients in finance, accounting, HR services and IT industries. According to
the firm other effects from off-shoring include home country labour redeployment on
better-paid jobs.
The competitive situation is getting tougher but the case company enjoys from the
first mover advantage. The collaboration with local universities in home country as
well as abroad is very important and contributes directly into business. In home
country the number of R&D staff has decreased, i.e. halved: 30% have been let go
and 70% have been redeployed inside the organisation. Everyone has been trained
further and the job rotation has been increased. Most of the R&D personnel working
at home are satisfied with the current situation. The R&D budget has increased
tremendously but it is bringing results in increased sales.
The challenges in R&D off-shoring are increased dependence on off-shore R&D, some
bad publicity in home country due to the lay-offs, and implementation and
coordination problems including internal communication. The overall effects are
however positive; the firm says it has benefited from R&D off-shoring.
The future
In the future our case company intends to focus on strengthening the current R&D
network: focus on fully owned subsidiaries and decrease the number of those
affiliates where there is only a minority stake. They view that R&D off-shoring will
reach a steady level in a few years but the services off-shoring will grow manifold
and eventually reach a much higher level relative to off-shored R&D. The global
fragmentation of R&D and services will have implications on all sectors of national
economies. On the other hand, the employment effects of off-shoring are far smaller
than normal fluctuations in demand and technological change.

The company thinks that the EU can benefit from the evolution and receive major
productivity gains if it can remove obstacles to joint research and focus on higher
skilled worker immigration. These measures will lead to more innovation and more
business and this is important for overall competitiveness of European companies
compared to their US competitors. The tightened immigration laws and the less
tolerant general atmosphere have been viewed to adversely affect the US business
environment.
The company thinks that EU could soften the immediate effects of off-shoring on job
markets by easing the transition process and minimise the adjustment cost
associated by redeployment. At the same time protection on local markets should be
reduced and development of both basic and knowledge infrastructure increased. Any
protectionist measures trying to arrest the off-shoring trend would destroy rather
than save jobs. Companies should not be limited in exploiting opportunities to off-
shore because that would harm their international competitiveness, bringing more
serious implications for employment in the future.

CONFIDENTIAL
3 Case summary table
-Æ Reasons for What R&D Domestic Role of policy Direct effects Indirect Operative Effects on Main Overall Future Impact on EU
off-shoring is off- substitution environment of R&D off- effects environment: personnel challenges impact prospects area
CASE R&D shored effect in location shoring competition or
decision collaboration
A Access to the NA Off-shored Not significant Improved Increased Focus on NA Cultural +++ Continuous Positive: e.g.
best skills, R&D is internal multicultura collaboration differences growth, Indian firms
MNE customer supplement processes, lism and synergies increased off-shoring to
demand ary growth, R&D off- Europe
customer shoring
recognition
B Closeness to Depends on 10% of European Increased Ability to Increased Increased Time zone +++ R&D off- EU firms can
customers, business R&D staff policy R&D efficiency keep the competitivene efficiency, and cultural shoring will reap the
MNE product objective, transferred environment and wider strategic ss access to differences not benefits of off-
localisation, mainly off-shore preferred product R&D off-shore paralyse shoring
cost efficiency assignment due to offering resources at talent domestic
work stronger home R&D
growth
C Market From long- Off-shored Focus on Cost A new, Looking for Total R&D Finding +++ Firms need Positive; off-
growth, global term R&D is a innovation efficiencies, open and synergies with staff talented to venture shoring firms
MNE presence, research to complemen ecosystem: EU shortened innovation universities decreased people in outside EU pay taxes to
talented product t to the still very time-to- focussed and firms by 50% Europe as in order to EU and offer
people, cost developmen domestic fragmented market, mindset in over the easily as in grow employment
and t R&D increased R&D, last years China
government number of improved
incentives patents and internal
new products processes
D Business Developme 90% Government Strong ties to Learning Focus on Junior Maintaining + More Development
SME synergies, nt and substitution subsidies off-shore from the competition developers business business projects need
access to a testing viewed to be universities, off-shore in domestic orientation oriented to be done in
big off-shore inefficient more efficient R&D unit, R&D, in academic skills co-operation
client, high- R&D functions i.e. academic R&D work needed, with
level R&D spillovers researchers less customers,
skills in off-shore regulation also in EU
location in EU
E Fading away Many forms No Significant Product Better Collaboration Cultural Increasing +++ Growing High
MNE mature of off- substitution effect; lifetime relationship with university differences: costs in business education and
(USA) technology, shoring, - off- dynamic extension, s with network the most manageme increases growth
investing in focused on shoring academic improved authorities loyal nt, rapidly off-shoring potential in
public R&D supports research productivity and employees rising as well Eastern EU
education, implementa domestic environment and cost knowledge are in salaries in attracts R&D
focusing on tion functions very important optimisation: of off-shore Eastern India off-shoring to
growth areas functions better markets Europe and EU area
competitivene China
ss

CONFIDENTIAL
F Technological Product Has not General Managerial Networks Collaboration Off-shore Communica ++ Concentrati Improves
MNE, expertise, developmen replaced infrastructure efficiencies with local and location tional on on large innovation, a
off- location in a t domestic development firms competition attractive to problems R&D positive
shore clustered area R&D important between R&D employees centres impact
unit -> synergies units
and access to
skilled labour
G Attract Innovation Complemen Lucrative Increased Proximity to Competition Off-shore Diversity + Modification By developing
MNE, talented and product tary to the political sales, customer, between R&D employees and of R&D at a common
off- people developmen home environment subsidies, flexibility in units at home fear of communicat the European
shore t country highly valued decreased work and off-shore losing jobs ional corporate strategy EU
unit R&D total cost of problems level, cost will benefit
labour cutting from R&D off-
shoring
H Need to be Applied and Additional Not a key Increased Local R&D External Internal Communica ++ R&D off- EU would
MNE close to later stage to home factor but efficiencies in staff collaboration, insecurity tion and shoring will benefit from
customers; developmen country public finance productivity improves internal and IPR increase, developing a
good t, R&D work appreciated and local sales, competition competition manageme globalisatio comparative
partnerships, adjustment management customer is a nt n will level advantage in
skilled labour work (both control relations manageme out costs environmental
functions and and nt challenge differencies issues
leadership) supplier co-
operation
I Internationalis Basic Partly Public-private- Efficient R&D Innovative Focus on Homogeneo High labour +++ Growth PPPs
SME ation strategy, research in transferred partnerships work, image and collaboration, us R&D and other options are contribute
access to connection from home have enabled increased financial MNEs as team easy R&D costs kept open, significantly to
high-level with a local country, yet long-term patenting, credibility competitors to manage for an SME benefits innovativeness
academics university additional R&D R&D budget from SME
doubled agility
through PPPs
J Access to Basic Fully No real effect Shortened Increased Off-shoring NA Increased +++ Firm is EU should
MNE creativity, product incremental time-to- brand R&D is viewed R&D costs looking for focus on
know-how developmen market, recognition, as a way to and another off- increasing the
t and customer easier stay communicat shore R&D pool of
design satisfaction recruitment, competitive, ional efforts partner creative
and efficient better profit not interested people, not
development margins in just engineers
collaboration

CONFIDENTIAL
K Serve new Focus on No NA New clients, Higher More Problems Firm-level +-0 Off-shoring NA
MNE clients abroad one replacemen faster time-to- customer competition between integration, is not
and connect developmen ts in the market, satisfaction than co- R&D staff at lack of planned to
with off- tal project home R&D improved operation home and resources, increase
shored at a time staff efficiency, between R&D the off- internal from
manufacturing increased units shore staff competition current the
plant sales level
L More open Basic and About 50% Regulatory Increased New Collaboration NA NA +++ Increased EU needs to
SME regulatory applied replacemen environment number of organisatio with a local R&D off- loosen its
environment, research, t has a patents, new nal university shoring and regulative
skilled labour and testing significant products, structures, consolidatio environment
and well- impact faster access to n expected concerning
developed commercialisa new pharmaceutica
markets tion, cost markets, ls
savings spillovers
M Market Depend on Off-shore De facto 24/7 R&D New Competition Increased End-user ++ R&D Open markets,
MNE demand, other, R&D labour political environment: partners, with the rival training, focus of functions flexible public
skilled work previous growth has environment is new patents, customers, firms has more R&D, group diverging structures and
force, cost operations not been at important products, increased turned into contacts dynamics, and long-term
efficiencies in the the expense localisation sales and co-operation between communicat scattering macroeconomi
location of other processes spillover in some cases R&D units ion around c policies
R&D sites effects
N Intellectual Market About 50 % Infrastructure, High-level Knowledge Firm is Further Increased + Strengthen Services off-
MNE capital, research, replacemen research innovation sharing, operating in a training, dependence the current shoring
collaboration developmen t but their community, base via cross new tough increased of off-shore R&D expected to
with t of clients have national cultural contacts competitive job unit, bad network: grow, should
universities, technology brought innovation atmosphere, environment, rotation, publicity focus on focus on
market service new jobs to system are lower costs, co-operational redeployme because of fully owned highly skilled
growth, local processes EU important better benefits from nts lay-offs, subsidiaries worker
services factors competitivene university coordinatio immigration
ss contacts n problems
MNE = multinational enterprise
SME = small or medium-sized enterprise
PPP = public-private partnership
NA = not available

The Implications of R&D Off-Shoring On The Innovation Capacity of EU Firms

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The Implications of R&D Off-Shoring On The Innovation Capacity of EU Firms

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The implications of R&D off-shoring on

the innovation capacity of EU firms

LTT Research Ltd / 2006 2

ACRONYMS AND ABBREVIATIONS ..................................................................................6

PART I: REVIEW OF ECONOMIC LITERATURE AND ANALYSIS OF THE EIS 2005

2 R&D, INNOVATION AND ECONOMIC GROWTH........................................................13

2.1 Growth models in economics ................................................................................13

3 ECONOMIC THEORIES OF OUTSOURCING AND OFF-SHORING ................................23

3.1 The boundaries of firm –why outsource? ................................................................23

4 BENEFITS AND CHALLENGES OF R&D OFF-SHORING..............................................28

4.1 General reasons for R&D off-shoring .....................................................................28

5 ANALYSIS OF THE EIS INDICATORS AND EIS 2005 SURVEY ..................................36

5.1 EIS 2005 –indicators and general findings of the survey...........................................36

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5.2.2 Analysis of the indicators.............................................................................44

PART II: EMPIRICAL EXAMINATION OF R&D OFF-SHORING IN EUROPE ......................59

6 REVIEW OF AGGREGATE LEVEL DATA ON R&D OFF-SHORING ................................59

6.1 Trends in R&D expenditure in EU ..........................................................................60

7 SIMULATION OF FUTURE DEVELOPMENT................................................................88

7.1 The simulation approach......................................................................................88

8 FINDINGS FROM THE SURVEY ................................................................................93

8.1 The Survey and responding companies in short.......................................................93

9 ECONOMETRIC ANALYSIS OF EPO AND SURVEY DATA ......................................... 106

9.1 Determinants of the level of R&D off-shoring spending........................................... 106

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10 CASE STUDIES: THE CORPORATE PERSPECTIVE................................................... 116

10.1 Case study method and description of interviewed firms....................................... 116

11 CONCLUSIONS FROM THE STUDY......................................................................... 131

11.1 Conclusions from the literature study................................................................. 131

PART III: R&D OFF-SHORING IN A POLICY FRAMEWORK ........................................... 142

12 EU INNOVATION POLICIES AND R&D OFF-SHORING ........................................... 142

12.1 Introduction ................................................................................................... 142

13 POLICY RECOMMENDATIONS ............................................................................... 154

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13.1 Pros and cons of R&D off-shoring for EU............................................................. 154

LITERATURE REFERENCES .......................................................................................... 160

1 Case outline ....................................................................................................... 169

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We conducted a simulation exercise on the future development of R&D off-shoring

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2.1 Growth models in economics

Early neo-classical growth models emphasized the role of capital accumulation. In

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When assessing the contribution of innovation to economic performance it is clearly

2.2 The role of spillovers

2.2.1 General findings in the research

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International diffusion of technology seems to very important factor in global

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2.2.2 The role of international spillovers

The international diffusion of technology is perhaps the most important form of

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Another approach to look at international spillovers is to focus on disembodied

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International partnerships and alliances are another important channel for

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2.3 Empirical research on innovation, R&D and growth

Although many researchers find that R&D is a major contribution to economic

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