INSIGHT: R&D growth shifts from EU to emerging markets, but challenges remain

By Heidi Finch

LONDON (ICIS)–Research and Development (R&D) spending could rise by more than €25bn in China by 2020 while spending in the EU climbs by just €9bn, research from consultants Arthur D Little suggests.

The disparate spending pattern would reflect the shift of growth in the industry over the past decade and more towards China, which now is the largest chemicals market by sales and market share.

Despite slowing European R&D spending growth, chemical sales in Europe still grew over the 2003 to 2013 timeframe and Europe remains a solid performer in high quality chemical research and development.

However, there are challenges that need to be overcome concerning innovation in China, as well as in Europe, especially post-Brexit, as discussed with Arthur D Little partners, Michael Kolk and Frederik van Oene in an interview with ICIS.

China’s share of the global chemicals markets was about 9% in 2003, but this had risen to well above 30% by 2013. Europe accounted for about 30% of the market in 2003, but its share declined to just under 20% by 2013, according to Arthur D Little analysis of Cefic data.

Absolute market size; being close to the end-market; technology and expertise; the manufacturing cost advantages and strategic goals in R&D footprint have all played out positively for China. They have underpinned rapid growth in chemicals R&D expenditure in China which jumped from some €1.5bn in 2003 and is estimated to be to around €10-11bn this year, according to Arthur D Little analysis.

“China is very big market, it makes sense to have local production and local R&D spending. More sales means more R&D spending,” said Michael Kolk. He went on to say that “it [the growth in R&D spending in China) is not just because of the market but local know how.”

China’s government encourages partners to the country who have R&D spending as part of their proposal and it can open the doors to valuable things such as resources, money, and access to favourable locations, where there are interesting technical clusters. “These incentives can take many forms,” said van Oene.

While R&D spending in China grew rapidly between 2003 and 2013 relative to developed areas, due to demographic and economic megatrends, R&D intensity (R&D spending as a percentage of sales) in China lagged in relative terms, dropping from 1.1% to 0.7%.

This is because China has been in the early stages of the R&D process, which starts with local R&D for local consumption and requires lower-quality innovation. Over time, however, R&D intensity should grow reflecting more sophisticated local demand and more advanced chemicals R&D. “R&D intensity in China is catching up, as more infrastructure is being built,” said Kolk. 

There is a push for renewable energy in China and a high speed network connecting the cities which is dwarfing the rest of the world, added van Oene. This local sophisticated demand has triggered the need to develop special performance characteristics linked to the extreme temperature differences across the country.

It is worthwhile for European chemical companies to tap into the more sophisticated local demand needs in China and develop different products using lower cost raw materials or different types of technology in the emerging markets, said van Oene. 

This is known as “frugal innovation” and can be exported to benefit other countries in the world, he added.

Reinforced glass window frames are an example of this type of innovation, where a different material has been developed with interesting stiffness and heat conductivity properties to compete against other more traditional materials such as polyvinyl chloride (PVC), he said

When moving to emerging markets, multinational companies typically first focus R&D at the  local level. But some add global competence centres over time, according to the Arthur D Little analysis.

By 2020, for instance, it is estimated that 50% of BASF’s R&D will take place outside of Europe, with 25% in the APAC (Asia Pacific) region.

DuPont has de-centralised research activities in more than 90 countries, with 12 main innovation centres, of which nine are in the emerging markets, according to Arthur D Little research.

It is important to scale up R&D activities from a local and regional level to global technological centres of excellence to consolidate the innovation process.

However, it is worth noting that while Asia is growing, this does not mean that the majority of centres of excellences are there yet, remarked van Oene.

He went on to say that it all depends on where the R&D is best placed in terms of strong historic clusters of expertise, among other factors. 

While the expansion in R&D spending to China has brought some benefits, there are also some challenges and other factors that need to be addressed.

There have been cost advantages in producing in China, but this is becoming less the case, as salary costs are not that low any more. In addition, there is a great deal of economic uncertainty, with slower than expected economic, currency volatility and the ongoing concern about overcapacity.

Intellectual property (IP) protection remains a challenge, because of the high turnover of staff in China, which means that there is a risk in knowledge being leaked to competitors.

The loss of intellectual property in China among European manufacturers limited potential profits by 20%, according to the US Government, as mentioned in the Arthur D Little analysis.

However, it is worth pointing out that while IP protection is a concern, it does not prevent R&D spending in China and things are improving.

The language barrier has been challenging to the R&D process in China but non-local companies have also faced cultural differences, in particular “the low individual initiative and innovative mindset”, according to Arthur D Little.

In China, it is important to show respect and follow in the footsteps of the leader, which works fine if it is an innovative leader, said van Oene. But if not, the innovation process takes longer and different ways of thinking have to be encouraged in order to challenge convention and think outside the box.

India is also on the R&D radar of multinational companies and some companies have built and strengthened their R&D presence in the country but not to the same extent as in China. Chemical sales in 2013 in China for example accounted for €1.05 bn, while India accounted for India €72 bn, according to Arthur D Little analysis of Cefic data.

While India is not in the same league as China in terms of global chemicals market share, chemical sales or R&D spending, R&D intensity in India is disproportionately favourable, said van Oene. The consulting firm’s analysis showed India to be more focussed on the more advanced pharmaceuticals sector, for example.

While sales and R&D spending have been directed towards faster growing, emerging markets in the sector, chemicals R&D is still strong in Europe. It is of high quality with strong clusters of scientists with decades of experience and a strong historical advantage.

However, it is important that European players take advantage of these factors and that the culture and mindset among European players is conducive for innovation, said van Oene.

“Over 40% of chemical innovations now come from Asia,” warned president of the German chemicals trade group, the VCI, Marijn Dekkers, recently, who went on to say “Therefore politicians and companies must act now to make sure that we are still competitive in 10-20 years. This will require a culture change to make it easy to be innovative.”

It is still too early to gauge to what extent the UK’s vote to exit the European Union will impact chemical R&D growth in the UK and mainland Europe, although it does not bode well, said Kolk.

With EU membership a lot of R&D public funding, which the UK will no longer be eligible for and there is a lot of other uncertainty, he added. Companies are expected to be cautious about investing until the implications of ‘Brexit’ are better understood.

“It is important to have well-oiled clusters of great people, scientists, of interconnected infrastructure and whatever comes next will impact the flow of scientists, the cross border education and interconnected supply chains,” said van Oene.

He went on to say that if the UK needs to pay import duties, then this will undermine research clusters – and anything that undermines the cluster is not good. “If people are wise, they will stop these clusters breaking up,” he commented.

Both the emerging markets and developed areas have their part to play in nurturing and consolidating the innovative process, encouraging a culture and mentality of positive change to address local needs and challenges to benefit the global market and for the sake of sustainable innovation.