Academic Henry Chesborough might have published his book, Open Innovation: The New Imperative for Creating and Profiting from Technology, back in 2003, but the ramifications of his insight – that no company has a monopoly on the smartest people and so it needs to look to external sources for useful ideas – has continued to ring true.
It is instructive, therefore, to look at the main tools some of the world’s largest companies have for managing their internal and external innovation strategy to see how resources are being allocated. One conclusion is that while there can be an upper limit on internal research and development (R&D) expenditure there appears to be almost no ceiling for bringing in external ideas through mergers and acquisitions (M&A) and corporate venturing (CVC) – R&D, M&A and CVC are known here collectively as the innovation spear. But increasing resources flowing to successful companies in the digital era are creating risks of overconcentration and few champions.
R&D
Taking as a starting point the top 1% of 2,500 corporations by their R&D expenditure, as tracked by the European Commission (EC) in its 2016 Industrial Investment Scorecard, then nearly half (12) have cut the amount they have spent either by absolute value for the 2015-16 period against the previous year or by the percentage this R&D takes of net sales in the latest year compared with three years earlier (2013).
Of these 25 companies, which make up a little more than a quarter of the total R&D of all 2,500 companies, Novartis led the cuts in R&D in absolute terms with a 9.5% drop to €9bn ($10m) in 2015-16 compared with the year before, according to the EC’s scorecard. Pfizer cut its R&D by 7.7%, Merck & Co by 4.7%, Ford by 2.9%, Samsung by 1.7%, Cisco by 1.4% and Microsoft by 0.5%.
Looking at so-called R&D intensity, the percentage of expenditure as a total of net sales, a further group of these top 25 corporations reduced the proportion they spent in the 2015-16 period compared with three years earlier.
Huawei led the fall on this measure with a more than 10 percentage point drop to 15% in 2015-16 from 25.6% in 2013. Robert Bosch cut its R&D intensity to 7.4% from 10.1%, Cisco to 12.6% from 13.4%, BMW to 5.6% from 6.3%, Honda to 4.9% from 5.4% and Daimler to 4.4% from 4.6%.
However, most groups are still increasing their R&D investment, including Germany-based car maker Volkswagen, which increased its expenditure by 3.8% in 2015-16 to €11.7bn at a 6.4% intensity, up from 6% in 2013. Others in the top 25 – Alphabet, Huawei, Apple, Daimler, AstraZeneca and Bristol-Myers Squibb – increased their R&D by double-digit percentages in this past year.
M&A and CVC
But almost all the groups seem to have increased their M&A activity in the past three years. Using M&A data from Mergermarket, Crunchbase and public sources, Global Corporate Venturing added and then annualised all the deals for the three-year, 2014-16 period and then compared this with the annualised M&A rates tracked in the EC’s previous 2014 investment scorecard covering the period 2007-13.
Volkswagen acquired 29 companies in this 2014-16 period, according to Mergermarket, compared with six tracked by the EC in the 2007-13 period. And while its most recent deals include truck maker Scania for $9.1bn 2014, other deals seem to be increasingly for more entrepreneurial businesses. Volkswagen bought PayByPhone at the end 2016 and its Audi car subsidiary, an existing investor in Silvercar, is set to acquire the airport car rental app developer in a deal announced in April this year.
Last year, Volkswagen was reported by news provider Financial Times as undergoing its “biggest change process” by relying on CVC and M&A in the wake of a diesel fuel emissions scandal and a shift towards digital, autonomous and electric vehicles. Volkswagen’s Porsche Digital CVC unit launched in May last year, while Audi started venture investing from late 2015 and Scania Growth Capital was founded after its takeover last February.
Similarly large increases in M&A featured at South Korea-based conglomerate Samsung and US-listed chip maker Intel, ranked second and third by R&D, respectively.
Samsung completed 18 M&A deals between 2014 and the end of 2016, according to Mergermarket, compared with 11 in the 2007-13 period. However, after a range of large and entrepreneurial acquisitions, such as vehicle systems company Harman International Industries for $8bn, announced in November and completed in March this year so falling outside Mergermarket’s numbers, and Viv, an artificial intelligence platform, agreed in October for $215m, Samsung has reportedly virtually stopped its M&A and investment activities after its de facto leader, Lee Jae-yong, was arrested in February.
Samsung’s well-established CVC unit, Samsung Venture Investment Company, was joined at the start of this year by the $150m Samsung Next Ventures fund, and it had been increasing its minority dealmaking last year compared with the year before, according to GCV Analytics.
Intel has been increasing its majority and minority investment pace under Wendell Brooks, who has headed both M&A and Intel Capital since the start of last year. Mergermarket identified 49 M&A deals by Intel between 2014 and the end of 2016, with its biggest deal, the acquisition of Altera in June 2015 for $16.7bn, coming in the middle of this period. Its second-largest, Intel’s purchase of Mobileye for $15.3bn in March, shows the pace has continued and for his GCV Powerlist 100 nomination, Brooks said Intel Capital had invested more than $400m in the first three months of this year as it focused on relatively fewer deals but ones it would lead.
Of the three main sectors – IT, healthcare and automotive, making up the top 25 corporations in the EC’s list – IT companies have been the most rapidly expanding in all three areas, reflecting their often-dramatic increases in market capitalisation and free cashflow.
Although Mergermarket disclosed fewer M&A deals by Alphabet and Microsoft than in public databases, the two tech companies were still completing more deals in the 2014-16 period than their annualised run-rate from 2007-13. Alphabet, the holding company for the Google search engine provider and ranked fourth by R&D, agreed more than one M&A deal a month in its latest period. Its purchase of UK-based machine learning and artificial intelligence (AI) company DeepMind – which just trounced the world’s best player in the game Go – and home energy efficiency company Nest Labs from its CVC portfolio holdings have seen the company push beyond its traditional frontiers.
Alphabet runs two CVC units – GV, formerly Google Ventures, and CapitalG, formerly Google Capital, as well as a new AI fund set up in the past few weeks.
Microsoft, meanwhile, was ranked fifth by R&D after being overtaken by Intel, and Alphabet between 2013 and 2015-16 has similarly committed itself to greater activity across CVC and M&A. The software company acquired networking company LinkedIn for about $26bn in June and AI company Maluuba in January after exploring whether the company sat best as a subsidiary or CVC portfolio company under its Microsoft Ventures unit set up by Nagraj Kashyap last year. Kashyap agreed 19 deals in 2016, according to GCV Analytics, and has shown no signs of slowing down as his team continues to expand.
Of the other IT companies in the top 25, Huawei agreed eight deals in the 2014-16 period, Oracle 20, Apple and Cisco both had 28 and Qualcomm 43, according to Mergermarket. These were respectively all higher on an annualised based than their 2007-13 deal totals.
Oracle’s deals included its largest, Netsuite, at $9.3bn last year, on top of increased CVC investment activity tracked by GCV Analytics, while Apple spent heavily on such deals as headphones maker Beats Electronic ($3bn) and has recently committed $1bn to SoftBank’s Vision Fund, which made its first close at $93bn last month.
Qualcomm’s 43 M&A deals, compared with 17 tracked by the EC in the 2007-13 period, included its $47bn purchase of chip peer NXP to help it break into autonomous vehicles.
Apart from Volkswagen, other traditional car and parts makers, such as General Motors (GM), Toyota, Daimler, Ford, BMW and Robert Bosch, have also been relatively more active in both M&A and CVC activities in the past few years, according to Mergermarket and GCV Analytics. Other than Honda, for which Mergermarket had no data, most autos groups seemed to be at least doubling their M&A activity, with GM paying a reported $1bn for Qualcomm Ventures-backed Cruise Automation last year, as well as increasing CVC activity.
GM Ventures posted 15 deals last year, according to GCV Analytics, while Toyota set up its Mirai Creation Investment unit at the end of 2015 and Ford starting doing deals out of its California-based research and innovation division as well as through Fontinalis, the VC unit of its chairman, Bill Ford.
Daimler has been seen as a sporadic CVC investor, with notable deals including electric car maker Tesla. Robert Bosch Venture Capital closed its third fund last year with €150m from its parent, while BMW i Ventures increased its new fund to €500m in 2016.
The drugs and biotech companies that round out the R&D top 25 list have seen mixed results from their innovation tools. While most groups, such as Novartis, Roche, Johnson & Johnson (J&J), Merck & Co and Sanofi, slipped in their ranking in 2015-16 compared with 2013, mainly as a result of others increasing their investment, some, such as Pfizer, Bristol-Myers Squibb and AstraZeneca rose up the list. All the healthcare companies are conducting only a handful of M&A deals in recent years, according to Mergermarket. In early 2016, AstraZeneca closed a $4bn purchase of venture-backed Acerta Pharma, while about a year earlier Merck & Co acquired antibiotics maker Cubist Pharmaceuticals for $9.5bn.
All these companies have established and active CVC units, led by the sector’s oldest, J&J Innovations–JJDC, which was founded in the early 1970s and agreed 63 deals last year alone, according to GCV Analytics, and this year J&J closed on its purchase of Actelion for $30bn.
Consolidation
The EC said in its scorecard that the aggregate R&D expenditure of the top 100 were responsible for about €369.3bn, or 53% of the total. With the top 25 (see Amazon box above) making up €189.8bn of this, the top 1% comprise just more than a quarter of nearly all R&D.
In corporate venturing, GCV Analytics last year found the top 20% of firms were responsible for about 85% of deals.
Just the 25 were involved in 390 of the near-2,000 CVC deals last year. And these corporate venturing units are helping the entire venture capital industry scale up. The near-2,000 deals involving corporations last year was about a fifth of the near-10,000 tracked by data provider Preqin. But, by value, CVCs were involved in rounds worth an aggregate $83bn –about two-thirds of the $134bn venture total identified by Preqin. They are increasingly taking the industry to new levels, with the SoftBank Vision Fund’s $93bn first close a signal for how it is thinking beyond traditional private equity and venture capital models to a broader category of innovation capital.
GCV Analytics found three-quarters of the Fortune 100 list of largest floated companies had active CVC operations last year, up from 50% in 2014.
Although global M&A last year, at 17,369 deals worth a disclosed $3.2 trillion, according to Mergermarket, was substantially bigger, factoring in the concentration of R&D expenditure and CVC activity by these top firms raises concerns about the implications for competition through innovation capital concentration and market consolidation encouraged by M&A dealmaking.
As news provider Economist in April said: “A big trend in American business is the collapse in the number of listed firms. There were 7,322 in 1996; today there are 3,671. The value of listed firms has risen from 105% of gross domestic product in 1996 to 136% now. But a smaller number of older bigger firms dominate bourses. The average listed firm has a lifespan of 18 years, up from 12 two decades ago, and is worth four times more. The number of companies doing initial public offerings, meanwhile, has fallen from 300 a year on average in the two decades to 2000 to about 100 a year since.”
But venture’s role in providing capital and support to these companies can be significant.
Academics Ilya Strebulaev and Will Gornall in their paper – How much does venture capital drive the US economy? – said of 1,330 public US companies founded from 1979 to 2013, 574 or 43% had been VC-backed. These VC-backed companies comprised 57% of the market capitalisation, 38% of the employees and $115bn (82%) of the total research and development in 2013.
At the other end of the scale, there are fewer startups. US-focused non-profit startup research group Kauffman Foundation last month said the rate of new entrepreneurs decreased in 2016 to 0.31%, or 310 out of every 100,000 adults starting new businesses each month, below the level when the ratio was first calculated in 1996, albeit still higher than in most intervening years.
At 85.4 per 1,000 companies, the number of startup firms – those less than one year old employing at least one person besides the owner – has been at record lows since the start of this decade and about two-thirds of the rate 20 years earlier, the foundation added.
This is leading to market share consolidation at the top. Using the US’s five-yearly economic census, the Economist in March last year divided the US corporate landscape into 893 individual industries – from coffins to credit cards. Between 1997 and 2012 the weighted-average share of the top four firms’ revenues had risen from 26% to 32% of the total.
Concentrated industries, in which the top four firms control between a third and two-thirds of the market, saw their share of revenues rise from 24% to 33% between 1997 and 2012. And just under a tenth of the activity takes place in industries in which the top four firms control two-thirds or more of sales.
Economist David Autor and four colleagues in looking at similar data over a longer period said competition had failed to chip away at the market position of the leading companies because they were very good at what they did. Autor and his colleagues call these leaders “superstar firms”, as they tend to be more efficient, and by selling more at a lower cost have a larger profit margin.
In examining Autor’s data on May 19, news provider Financial Times said: “Google is the purest example. Its search algorithm won market share on merit. Alternatives are easily available, but most people do not use them. But the pattern holds more broadly – superstar firms have grown not by avoiding competitors but by defeating them.”
Google, owned by Alphabet, and social network Facebook have about 85%, and rising, of the US online advertising market, according to venture capitalist Mark Meeker in her Internet Trends Report 2017 published at the end of last month. Noted tech analyst Ben Thompson in his Stratechery blog has warned about “Facebook and the cost of monopoly” and in February said the economy was under monopolistic pressure as “power comes not from production, not from distribution, but from controlling consumption – all markets will be demand-driven. The extent to which they already are is a function of how digitised they have become.”
These digitised returns are throwing off the cash for companies to rapidly climb the innovation expenditure scoreboard and try to reinforce their monopolistic position in the way Microsoft could in software.
Meeker, a partner at Kleiner Perkins Caufield & Byers, in her latest report, said the top 20 private and public internet companies were worth $3.8 trillion in aggregate. The leading ones in the US – Apple, Alphabet, Amazon and Facebook – and in China – Tencent and Alibaba – were the largest listed companies on their local stock exchanges, with combined market capitalisations of more than $2.5 trillion at the end of May.
Apple’s cash pile swelled to $256.8bn in the fiscal second quarter, up more than $10bn from the previous quarter, it reported last month. Alphabet has $92.4bn in cash and short-term investments and last year posted $25.8bn in free cashflow. Amazon has $21.5bn in cash and short-term investments, and Facebook $29.45bn last year.
A response is required
But attempts to defeat competition are driving innovation capital trends, particularly between Alphabet and Facebook, and Tencent and Alibaba, as examples.
Alphabet doubled research expenditure between 2013 and 2015-16 and now is fourth in R&D ranking at $11bn even with 16% intensity, according to the EC. Alphabet is also a clear M&A leader in terms of number of acquisitions, according to Crunchbase and Mergermarket, and in CVC through its GV and CapitalG units as well as increasingly at Google company level.
Facebook had a similar jump in R&D expenditure to €4.4bn, quadrupling from 2013 to 2015-16, and inside the top 100, with R&D intensity at a quarter, but has also made large acquisitions of WhatsApp, Instagram, Oculus and LiveRail.
Alibaba, which was not on the EC ranking, reported its R&D expenditure at €2.1bn last year, while Tencent invested €1.54bn – putting both about 85th on the list. However, Tencent and Alibaba also invested billions in hundreds of CVC deals last year and similar amounts in previous deals across healthcare, mobility, e-commerce, fintech, media and gaming.
Extreme competition expressed in innovation capital expenditure among a few companies can be good for consumers in the early stages of development but if, as Prof Yuval Harari asked at the end of his book – Homo Deus – algorithms know people better than they know themselves, then the ability to control consumption falls into the hands of relatively few companies, which could stifle future innovation.
As Standard Oil was broken up in 1911, or AT&T in 1984, and as the EC attempted with Microsoft from the mid-1990s, so regulatory actions can have an influence, but technology shifts can create new champions.
A question for countries and regions, such as Europe – which has no companies in the list of largest internet value, according to Meeker’s report – that effectively missed out on the last value-creation shift, is how to develop internal competition characteristics while allowing the market to develop in a global ecosystem.
The EC said in its 2016 scorecard that 14 EU member companies and 36 non-EU companies were in the top 50 corporations by R&D, compared with 18 and 32 respectively in its first scorecard in 2004. In the EU group, seven companies left the top 50 – Alcatel, Istituto Finanziario Industriale, Philips, Renault, BAE Systems, Peugeot and Nokia – and three companies joined the top 50 – Boehringer Ingelheim, Fiat Chrysler and SAP.
In the non-EU group, 10 companies left the top 50 – Fujitsu, Canon, Matsushita Electric, NEC, Motorola, Nortel Networks, Wyeth, Delphi, Sun Microsystems and Toshiba – and 14 companies joined the top 50 – Abbvie, Amgen, Apple, Denso, Nissan, Gilead Sciences, Alphabet, Huawei, LG Electronics, Oracle, Panasonic, Qualcomm, Takeda Pharmaceuticals, Facebook.
Data from Prof Max con Zedtwitz’s Glorad institution, shown at the GCV Symposium by Martin Haemmig, adjunct professor at Cetim, identified 2,027 companies applying for at least 10 patents each last year, but they were outside the top 100 list of most active.
These companies are what in Germany, which has 196 of them, would be called “mittelstand”, as they are often family-owned medium-sized enterprises. Europe has the densest concentration after the US’s 613 and ahead of Japan’s 416, but providing them with the resources to accompany any ambition to invest in innovation capital is a challenge. However, an opportunity lies in how entrepreneurs with global ambition want to connect with investors with international reach.
Silicon Valley in California, the UK’s capital London, and Singapore are the three main hubs where entrepreneurs connect with each other, according to Startup Genome’s Global Startup Ecosystem 2017 report presented by Haemmig at the GCV Symposium. Corporate venturing units are more likely than independent VCs to be international. Fewer than a third of VCs invest in more than one country, according to data provider PitchBook. However, about half of CVCs invest in more than one country, according to GCV Analytics.
The flows of CVC capital, therefore, seem a better match to the interests of entrepreneurs trying to take their business international. Haemmig, using GCV data for last year, found US-based CVCs invested in 1,049 deals, of which 764 were domestic and 285 outside the US. In turn, 485 US-based entrepreneurial rounds had an overseas investor. In Europe, excluding Russia, Turkey and Israel, Haemmig said local CVCs invested more outside the continent (227 deals) than inside the EU (205), while 99 deals came from foreign CVCs. In Asia, local CVCs’ 607 deals were split 328 within the region and 279 outside it, Haemmig said, while 155 came from foreign groups.
Reinforcing and building on these natural inclinations appear to be opportunities for those seeking to build an innovation capital ecosystem as it scales up.
Chamath Palihapitiya, CEO at VC firm Social Capital, said in a blog post last month that in addition to “software that empowers the fundamental process of decision-making, capital allocation and risk management”, to scale up the venture industry requires “a mindset that I summarise as being open for business”.
He wrote: “What this means is the strategic capability, insight and wherewithal to work with all kinds of organisations all over the world. Governments who want to transform their economies, balance sheets needing to invest hundreds of billions of dollars and companies who need a partner to help navigate all of the technological disruption they may or may not see. Each of these entities has repeatedly tried to engage with us in a scaled way, and frankly struggled.”
He said Marc Mezvinsky had joined Social Capital as vice-chairman to help it do so, probably in the way SoftBank has worked with Saudi Arabia and the United Arab Emirates to provide the bulk of the commitment to its Vision Fund.
The global venture capital industry is expanding at an accelerating pace, with total assets under management reaching $524bn as of June last year, the latest data available to Preqin, and now nearly double the total recorded in 2008 ($271bn). But the influence of governments can be hidden. China reportedly raised about RMB1.5 trillion ($231bn) in state-backed venture funds in 2015, according to local data provider Zero2IPO. In addition, research by Global University Venturing has identified more than 200 university venturing funds, of which more than 100 have in-house mandates.
With the aid of this triple helix of corporations, governments and universities, venture is finally shaking off its cottage industry status and scaling up.
This is an extended version of an introduction made by James Mawson, founder and editor-in-chief, at the Global Corporate Venturing Symposium in May 2017 in London and incorporating with permission some data shared by Martin Haemmig at the same event.