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Research report: May 2008

Total Innovation
Why harnessing the hidden innovation
in high-technology sectors is crucial
to retaining the UK’s innovation edge
Total Innovation
Why harnessing the hidden innovation in high-technology
sectors is crucial to retaining the UK’s innovation edge


Innovation is vital to the UK’s future economic prosperity and quality of life. So it is crucial that we
understand where innovation comes from, who does it, what stimulates it, and how it benefits our
economy and society.

In October 2006, we published the first in a series of reports on what we call ‘hidden innovation’
– the types of innovation that tend to be neglected by traditional indicators. We suggested that an
‘innovation gap’ had opened up between these indicators, the reality of innovation in the UK, and
the policy intended to stimulate and support it.

Much has changed since then: a new UK government department for innovation; a White Paper
that explicitly recognises the importance of hidden innovation; and the announcement of a major
new effort to measure innovation in ways that more accurately reflect the UK’s economy and

But much remains to be done. This report, the third in the series, focuses on high-technology
sectors such as aerospace and pharmaceuticals. It reveals the increasing importance of hidden
innovation in these sectors, and the surprising ways in which our most innovative firms have
adapted to technological change and international competition.

What is clear is that, in this rapidly changing world, more of us need to be prepared to be
innovative. We need, in particular, to rethink some of our most fundamental and long-standing
assumptions about innovation, and to consider new, perhaps unfamiliar ways of responding. This
is as much a challenge for our politicians and policymakers as it is for our firms and entrepreneurs.

We would greatly welcome your views on our proposals, and to hear your own.

Jonathan Kestenbaum

May, 2008

NESTA is the National Endowment for Science, Technology and the Arts.
Our aim is to transform the UK’s capacity for innovation. We invest in early-
stage companies, inform innovation policy and encourage a culture that
helps innovation to flourish.

Executive summary
There is both too much pessimism and too much complacency about the UK’s
high-technology sectors. Too much pessimism because the UK remains strong
within major sectors such as aerospace, pharmaceuticals and automotive;
too much complacency because the nature of innovation in these sectors is
changing rapidly and may overtake UK industry and the policies designed to
support it.
Innovation is about more than product breakthroughs resulting from scientific
and technological research. It can be as much about new ways of doing things,
or new business models. Such ‘hidden innovation’ enables UK firms to change
and adapt in the face of rapidly increasing international competition.
Just as firms need to harness several different forms of innovation from new
technologies to new business models – a process known as ‘total innovation’
– policy also needs to reflect this broader understanding of what innovation
is and where it comes from. Most importantly, the UK needs to develop
strategies to stimulate total innovation if it is to remain competitive in
today’s world.

The UK appears to perform poorly in Aggregated figures for national investment in

innovation and the focus of policy has R&D fail to acknowledge the different patterns
been on improving this performance of specialisation in different countries. The UK
retains strengths within the six sectors that
In an increasingly competitive global economy, represent the majority of R&D expenditure in
innovation – the ‘successful exploitation of the UK, from pharmaceuticals to electronics
new ideas’ – is the major source of competitive including:
advantage for mature economies like the UK.
• The second most significant pharmaceuticals
But the UK performs poorly on traditional sector in the world, home to globally-
innovation indicators, such as public and renowned firms such as GSK and
private investment in formal research and AstraZeneca.
development (R&D) and the number of patents
registered. • The second largest aerospace industry in
the world: Rolls-Royce is one of only three
Unsurprisingly, policy has focused on major manufacturers of civil aeroengines
improving the UK’s performance according worldwide.
to these indicators. The result has been a
comprehensive range of initiatives that have • Expertise in automotive engine development
focused on support for technology-focused and manufacture, as well as the world’s most
innovation. These have included Knowledge successful motorsport industry.
Transfer Networks (KTNs), Knowledge Transfer
Partnerships (KTPs), and R&D tax credits. • Major telecommunications firms such as
Scotland, Wales and Northern Ireland have BT and Vodafone that have pioneered
reflected a similar emphasis, as have initiatives new network infrastructures, products and
in the English regions. services.

• Highly innovative UK-based software

and IT services firms, such as Sage, Misys
The UK has world-leading strengths in and Autonomy, and some of the most
some high-technology areas but is up technologically advanced and creative games
against rapidly increasing international software developers in the world.
• World-leading electronics firms such as ARM,
There has been too much pessimism about CSR and Wolfson.
UK high-technology sectors

Much of this has been achieved by moving and innovation in services. However, the
successfully to higher-value-added activities White Paper has less to say about what policy
in the face of competition from lower-cost mechanisms are required to stimulate and
countries. support this hidden innovation.

However, international competition is Much hidden innovation can be found in

intensifying research-intensive sectors
The increasingly distributed nature of UK high-technology firms, in sectors
innovation and the outsourcing of ever higher- such as pharmaceuticals, aerospace, and
value-added activities to firms in emerging telecommunications, increasingly recognise
economies is increasing their ability to compete the need to innovate in new ways. Four types
with Western firms. This can be seen across of hidden innovation can be seen in high-
many sectors: China, India and some Eastern technology sectors.
European countries in pharmaceuticals,
automotive and electronics; Brazil, Japan and • Type I hidden innovation is identical to
China in aerospace; India in software and traditional innovation but is not included
telecommunications. in its measurement. For example, much
technological innovation in aerospace firms
The Indian software and business process is not captured in narrow R&D measures. The
outsourcing industry is expected to achieve effective use of new composite materials in
$60 billion in exports of software and services Boeing’s new aircraft manufacture requires
by 2010; the UK is the second largest market learning ‘on the job’ (not in the lab) about
for the Indian software sector after the US. how to manufacture and tool such materials.
Similarly, China is now the world’s largest Yet such practical research often lies outside
electronics manufacturer. In 1997, it accounted formal R&D processes – particularly in small
for 4 per cent of global electronics output; by and medium-sized (SME) firms without
2005, its share was touching 20 per cent. Such formal R&D programmes. However, such
rapid growth is not merely a matter of ‘market innovations can save millions of pounds in
forces’; it often also reflects concerted and increased efficiency and higher engineering
coordinated efforts at building new national performance.
champions in these emerging economies.
• Type II hidden innovation happens in non-
scientific and technological forms such as
new organisational structures and business
In the face of this competition, UK firms models. For example, in pharmaceuticals,
need to harness ‘total innovation’ some large firms have reorganised to reflect
the structures of more entrepreneurial
We have neglected the ‘hidden innovation’ small biotechnology firms. GlaxoSmithKline
in the UK economy, including in (GSK) has created new semi-autonomous
manufacturing business units called Centres for Excellence
Traditional indicators of innovation are based in Drug Discovery (CEDDs). GSK now has
on a model that is increasingly irrelevant, many more – and more radical – drugs in
especially to the UK. Indicators such as R&D development, and leads other large firms
expenditure and patent production assume that in the mid- to late-stage development of
innovation is synonymous with scientific and products. Organisational innovation can
technological invention born of new research- also markedly improve productivity (as
driven knowledge. with ‘Lean manufacturing’ to cut the costs
and production time of cars and aircraft),
However, many forms of innovation are and provide new services for customers
neglected by this traditional ‘linear’ model, for (for example, firms such as Rolls-Royce are
example new organisational forms and business increasingly making the majority of their
models. These are examples of what we call revenues from long-term maintenance and
‘hidden innovation’. support contracts with customers).

Recently, policy has begun to recognise • Type III hidden innovation comes from the
this hidden innovation. Most importantly, novel combination of existing technologies
Innovation Nation, the White Paper published and processes. Because some of these
in March 2008 by the UK’s Department for technologies aren’t new-to-the-world, the
Innovation, Universities and Skills (DIUS), innovation doesn’t get counted in traditional
gives a prominent place to hidden innovation metrics. For example, in software, official

definitions of R&D only acknowledge important. Doing so could help to free them
software development that represents to engage in new forms of technological
a ‘scientific and technological advance’. development and to enter new markets.
Yet much software development involves
the creative use of existing functions and Remaining competitive requires ‘total
routines to deliver new and sometimes innovation’
innovative services. Some leading established firms – including
Rolls-Royce, BT, Toyota and GlaxoSmithKline
• Type IV hidden innovation takes place – are taking a broader approach to innovation.
‘under the radar’ of many surveys. In many By seeking to integrate innovation in new
areas of engineering, there are small-scale technologies, products and processes with
problems and challenges that are dealt with innovation in business models, organisational
outside R&D programmes. For example, forms and market positioning, they create
the Toyota Production System (TPS) greater profits and protect their market
represents a highly successful approach position. This is ‘total innovation’.
to generating such ‘micro-innovations’.
TPS organises manufacturing and logistics More UK high-technology firms need to
to eliminate waste and inconsistency in develop the capability for total innovation.
products through an emphasis on continuous Too many firms are unprepared for the ways
improvement, teamwork, and becoming a in which foreign competitors are developing
‘learning organisation’. Through this, Toyota wholly new approaches that are not limited to
implements one million new ideas each year new technologies.
(3,000 each day).

Without hidden innovation, there is a

danger that established UK firms become Recommendations: The UK needs
‘locked-in’ to existing technologies and Total Innovation Strategies for high-
business models value-added sectors to retain its
Technological R&D can become locked into innovation edge
existing ‘platforms’ and focus on incremental
improvements to these platforms. This Innovation policy should be focused on
innovation can raise marginal performance or supporting the types of innovation that
reduce costs, but is not going to lead to the contribute to business growth
fundamental change that is often needed to Policy for high-technology sectors still focuses
stay competitive. overwhelmingly on R&D and technology
development. This focus should shift from
This lock-in is often reinforced by the supporting research to stimulating a wider set
established organisational structures, of innovative activities that can contribute to
business models and related investments business growth.
made by firms around the existing platforms.
For example, the large-scale manufacture Of course, the UK needs to remain an attractive
and distribution systems required by steel place for major firms to locate their R&D
car body structures in automotive, the activities, so policymakers rightly support R&D
‘blockbuster’ drug development business in these sectors. But this is no longer sufficient.
model in pharmaceuticals, and the revenue Firms and entrepreneurs need to explore and
charging model for mobile calls and data in experiment with new business models and
telecommunications, all potentially prevent different commercial strategies.
firms focusing on more transformative change.
Extend sector-focused innovation policy
The danger of such lock-in is that established Focusing on total innovation reinforces
firms fail to respond quickly or radically the importance of sector-focused support.
enough to the increasing international Technology ‘roadmaps’ which identify longer-
competition in these sectors. This is why much term trends, support for specific emerging
radical innovation often comes from new technologies, and strategic alliances within
entrants; they are freer – organisationally and industries can all help to stimulate and support
conceptually – to do so. longer-term R&D. Some of this already
happens (especially in aerospace and, to some
In this context, for incumbents the ability to extent, in electronics), but it rarely seeks to
develop new business models, organisational stimulate or support wider forms of innovation,
forms and processes becomes even more

or to help in the development of new business coming changes in knowledge, technology,
models. trade, demographics and industrial structure
that have bearing on competitive strategy
Better coordinate the ‘non-innovation or socially-desired outcomes. Industry
policy’ that influences innovation and government should then apply this
Typically, what is designated as ‘innovation understanding to the UK’s current positioning
policy’ does not encompass the wider set and identify a small number of likely routes to
of policies that also influence innovation in competitive advantage. Finally, these strategies
businesses – from taxation and regulation to should lay out a plan for passive and active
public procurement, intellectual property rights government support, primarily centred around
to education and skills. While innovation policy the need for greater coordination of policy.
cannot be all-encompassing, these other areas
of policy need to be aligned with the objectives These strategies should be led jointly by DIUS
of innovation policy – especially given the and the Department for Business, Enterprise
breadth of total innovation. and Regulatory Reform (BERR) – working with
HM Treasury, the Technology Strategy Board,
The demands of total innovation require devolved administrations and relevant agencies
stronger and broader skills such as regulators and sector skills councils
High-technology sectors need a strong supply – and shaped by ongoing engagement with
of people skilled in science, technology, industry.
engineering and mathematics (STEM). More
students need to be inspired to study these Collectively, these strategies should represent
subjects, and STEM careers must present an the UK’s national mission for innovation.
attractive alternative to employment in other
sectors. Policy should be informed by new
measurements for total innovation
However, narrow technical skills are not The extent and importance of hidden
sufficient for total innovation. Education and innovation in research-intensive sectors
training must develop the capabilities necessary demonstrates the inadequacy of focusing on
for contemporary innovation, specifically more research-focused indicators.
interdisciplinary skills and stronger strategic
business skills. In firms, the increasing importance of
total innovation makes formal R&D spend
The new UK Commission for Employment and increasingly unhelpful as a guide to innovative
Skills (UKCES) should build on the work of the performance and hence business growth. In
sector skills councils to provide government policy, the focus on R&D as a proxy for national
with an analysis from the perspective of performance obscures a focus on business
industry regarding the extent and quality of growth from innovation and the wider set of
‘innovation-ready’ skills in the UK, and advise factors that shape innovation by firms.
on how the education, training and skills
systems across the UK might be improved to This will require a new set of broader and more
ensure the better development of these skills. meaningful indicators to guide policy. These
will be considered as part of NESTA’s work on
Government and industry should develop developing a new Innovation Index for the UK.
Total Innovation Strategies for strategic
The UK needs to invest in its strategically
important industries. These are the UK’s current
high-value-added industries and those that
are identified as having the realistic potential
to become high-value-added – our ‘innovation
edge’. ‘Investment’ in this context means
economic and political commitment to their

The UK must develop comprehensive strategies

for these industries. These strategies should
be comprised of three main elements. They
should chart likely changes in the environment
in which these industries operate: present or

This report was written by Dr Michael Harris, Research Director, with Dr Juliet Cox, Research
Associate, at NESTA, in partnership with the case study researchers below:
• Pharmaceuticals – Margaret Kyle (London Business School) with Chris Shilling

• Aerospace – Paul Simmonds, John Clark, Anne-Cecile Olivier (Technopolis)

• Telecommunications – Mike Cansfield (Ovum)

• Software and IT services – Angel Dobardziev (Ovum)

• Electronics and IT hardware – Paul Simmonds, Edward Kitching, Anne-Cecile Olivier (Technopolis)

• Automotive – Peter Wells, Paul Nieuwenhuis (Centre for Automotive Industry Research, Cardiff
Business School).

The following firms and organisations were consulted during the research:

Aercap Aviation Solutions, the Association of the British Pharmaceutical Industry, the BioIndustry
Association, the Biotechnology and Biological Sciences Research Council, Cogent, the Department
for Business, Enterprise & Regulatory Reform (the Aerospace, Marine and Defence Unit, the
Automotive Unit, the Bioscience Unit, the Electronics Unit), the Electronics Knowledge Transfer
Network, the Electronics Leadership Council, the Engineering and Physical Sciences Research
Council, the Engineering and Technology Board, e-skills UK, the Institution of Engineering and
Technology, Intellect, the Motorsport Industry Association, the National Microelectronics Institute,
Pfizer, Philips, Rolls-Royce, the Royal Aeronautical Society, Science and Technology Policy Research
at the University of Sussex, the Society of British Aerospace Companies, Smiths Aerospace
(GE Aviation Systems), and the Technology Strategy Board.

The views expressed in this report represent those of NESTA only. References to other
organisations, including those consulted in the course of the research, does not imply endorsement
by those organisations.


Total Innovation
Why harnessing the hidden innovation in high-technology
sectors is crucial to retaining the UK’s innovation edge

1. The UK appears to perform poorly in innovation and the focus of policy 11

has been on improving this performance
1.1 Innovation is vital to the future of the UK’s economy and society 11
1.2 But the UK performs poorly compared to its competitors 11

2. The UK remains strong in some high-technology areas but is being 11

challenged by the changing nature of innovation and rapidly increasing
international competition
2.1 Focusing on aggregated data neglects how many UK high-technology 11
sectors have moved to become high-value specialists
2.2 Innovation is becoming increasingly distributed between firms, including 12
global suppliers
2.2.1 Innovation is becoming more complex and costly 12
2.2.2 These pressures have led to innovation becoming increasingly 14
distributed and collaborative Firms are drawing on a wider range of actors 14 Large firms are delegating more responsibility for innovation 15
to their suppliers Firms are also relying on universities to conduct research 17
2.3 The increasing distribution of innovation is strengthening 18
international competitors

3. In the face of increasing international competition, UK firms need to 19

harness ‘hidden innovation’
3.1 We have neglected the ‘hidden innovation’ that is crucial to the UK’s 19
economy, including in manufacturing
3.2 Hidden innovation is increasingly important in high-technology sectors 19
3.2.1 Leading high-technology firms are increasingly harnessing 19
hidden innovation Type I: Hidden innovation from technological development 20
not included under the official definition of R&D Type II: Hidden innovation in organisational forms and 21
business models Type III: Hidden innovation from combining existing technologies 22
and processes in new ways Type IV: Micro-innovations that aren’t recorded in surveys of 23
3.2.2 In the face of increasing competition, there is a danger that 23
established UK firms become ‘locked-in’ to their existing
technologies and business models Traditional innovation can become locked into existing ‘platforms’ 23 New firms – including in emerging nations – can develop radical 24
innovations more suited to the major changes taking place in
high-technology sectors
3.3 Remaining competitive demands ‘total innovation’ 25

4. UK policy for high-technology sectors remains narrowly focused on 26
traditional innovation
4.1 Policy has begun to recognise hidden innovation 26
4.2 However, policy for high-technology sectors still focuses overwhelmingly 26
on R&D and technology development
4.3 Policy neglects the hidden innovation in research-intensive sectors 27
4.4 ‘Non-innovation policy’ also shapes innovation in high-technology sectors 27
4.4.1 Regulation, including environmental and safety regulation, plays 27
a major role in informing innovation activities in many sectors
4.4.2 In some sectors, public procurement shapes innovation 27
4.4.3 Intellectual property rights have a major impact on innovation 28
4.4.4 Skills are a crucial factor in innovation capability 28

5. Recommendations: The UK needs Total Innovation Strategies for high 29

value-added sectors to retain its competitive advantage
5.1 Innovation policy should be focused on business growth, embracing 29
total innovation
5.2 This will require an extension of sector-focused innovation policy 29
5.3 The changing nature of traditional innovation and the demands of total 29
innovation require stronger and broader skills
5.4 Innovation policy needs to prompt firms to anticipate – and benefit 30
from – coming disruptions in high-technology sectors
5.5 Policy needs to stimulate socially-desired innovations 30
5.6 These new demands on innovation policy require greater coordination 30
5.7 Government and industry should develop Total Innovation Strategies for 30
strategic industries
5.8 Policy should be informed by new measurements that capture total 31

Appendix A: Pharmaceuticals 33
Innovation through large-scale investments in research but undergoing
radical changes that challenge the traditional ‘pipeline’ model

Appendix B: Aerospace 46
Innovation through technological development and partnerships with an
increasing role for hidden innovation in business processes and services

Appendix C: Telecommunications 57
Innovation through technological disruption and communication convergence
leading to a role for hidden innovation via new service provision

Appendix D: Software and IT Services 69

Innovation through technological disruption, facilitating a role for hidden innovation
in new organisational forms, business models and the provision of services

Appendix E: Electronics and IT Hardware 80

Innovation through technological development but with an increasing role for hidden
innovation through adoption of new business models and a focus on high-value activities

Appendix F: Automotive 89
Innovation focused on incremental product development alongside
process innovation, but with a resistance to new business models

Total Innovation
1. As defined by the then
Why harnessing the hidden innovation in high-technology Department of Trade
sectors is crucial to retaining the UK’s innovation edge and Industry (DTI), see
Department of Trade and
Industry (2003) ‘Innovation
Report, Competing in
the Global Economy: The
Innovation Challenge.’
London: DTI.
2. HM Treasury (2000)
‘Productivity in the UK:
The Evidence and the
Government’s Approach.’
London: HM Treasury.
3. According to the definition
that is used for tax purposes
in the UK, R&D is defined
as any project to resolve
scientific or technological
uncertainty aimed at
achieving an advance in
science or technology, see
Department of Trade and
Industry (2004), ‘Guidelines
on the Meaning of Research
1. The UK appears to perform poorly in scores highly on numbers of scientific papers and Development for Tax
innovation and the focus of policy has produced and citations per capita.8 Purposes.’ London: DTI.
This definition is based
been on improving this performance on the OECD’s Frascati
Unsurprisingly, policy has focused on improving Manual, see Organisation for
Economic Co-operation and
1.1 Innovation is vital to the future of the poor performance in R&D and increasing Development (2002), ‘Frascati
UK’s economy and society investment in science research (see 4.2). Manual 2002.’ Paris: OECD.
4. Organisation for Economic
In an increasingly competitive global economy, Co-operation and
innovation – the ‘successful exploitation of Development (2007) ‘OECD
Science, Technology and
new ideas’ – is regarded as the major source of Industry Scoreboard 2007.’
competitive advantage for mature economies 2. The UK remains strong in some Paris:OECD.
like the UK.1 As a result, HM Treasury has high-technology areas but is being 5. See Organisation for
Economic Co-operation and
identified innovation as one of its five drivers challenged by the changing nature Development (2005) ‘OECD
of productivity.2 of innovation and rapidly increasing Science, Technology and
Industry Scoreboard 2005,
international competition Briefing Note for the United
1.2 But the UK performs poorly compared to Kingdom.’ Paris: OECD.
6. The UK was granted 3 per
its competitors 2.1 Focusing on aggregated data neglects cent of triadic patent families
Traditional innovation indicators, such as public how many UK high-technology sectors have in 2005, far lower than the US
(31 per cent) but also lower
and private investment in formal research and moved to become high-value specialists than Germany (11.9 per cent)
development (R&D) or the number of patents There is too much pessimism about high- and Japan (28.8 per cent).
All data from Organisation
registered, suggest that the UK performs technology sectors in the UK. Aggregated for Economic Co-operation
poorly.3 figures for national investment in R&D ignore and Development (2007)
‘OECD Science, Technology
the different patterns of specialisation in and Industry Scoreboard
The UK’s ‘R&D intensity’ (total expenditure on different countries, making investment in R&D 2007.’ Paris: OECD. A
‘patent family’ is a set of
R&D as a percentage of national GDP) was 1.8 potentially misleading as a way of capturing patents taken out in various
per cent in 2005, below Japan (3.31 per cent), comparative performance in innovation.9 The countries for the purposes of
protecting a single invention.
Germany (2.54 per cent), France (2.2 per cent) UK retains strengths in areas of the six sectors Triadic patents are filed at
and the United States (2.74 per cent).4 UK that represent the majority of R&D expenditure the European Patent Office,
the Japan Patent Office, and
businesses consistently spend less on R&D than in the UK, from pharmaceuticals to electronics. granted by the US Patent and
their US, French and German counterparts, Trademark Office.
and below the OECD average.5 Given the UK’s The UK has the second most significant 7. Organisation for Economic
Co-operation and
comparatively low investment in R&D, it is no pharmaceuticals sector in the world, Development (2007) ‘OECD
surprise that it also lags behind other leading with globally-renowned firms such as Science, Technology and
Industry Scoreboard 2007.’
countries on patenting.6 GlaxoSmithKline (GSK) and AstraZeneca, as Paris: OECD.
well as major R&D centres for international 8. Ibid.
Further, the UK invests comparatively less than firms such as Pfizer. It has the second 9. As argued in National
Endowment for Science,
many other countries in higher education, at largest aerospace industry in the world, with Technology and the Arts
just 0.7 per cent of GDP, compared to 2.36 per Rolls-Royce being one of only three major (2006) ‘The Innovation Gap.’
London: NESTA.
cent in the US, 0.95 per cent in France, and the manufacturers of civil aeroengines, and with
OECD average of 1.42 per cent.7 However, this major development and production sites for
relatively low spending does at least appear one of the two major manufacturers of large
to be highly productive; compared to the US, civil aircraft in Airbus UK. Seven of the global
France and Germany, the UK consistently top ten automotive manufacturers operate

in the UK, with its acknowledged expertise sectors are moving somewhat successfully to
in engine development and manufacture, as higher-value-added activities in the face of
well as the world’s most successful motorsport increasing global competition. In this sense, the
industry. UK is still competing in the ‘race to the top’.11

Major UK telecommunications firms, such What the UK does not have, compared to some
as BT and Vodafone, have pioneered new other countries, are large home-grown mass
network infrastructures, products and services, market manufacturing firms in sectors such as
placing the UK at the forefront of the trend electronics (especially consumer electronics),
of convergence between telecommunications computing machinery, telecommunications,
and other media. There are highly innovative automotive and other transportation
UK-based software and IT services firms, such machinery, and chemicals. This lack of scale
as Sage, Misys and Autonomy in business in some high- and medium-high technology
applications. The UK also hosts some of the sectors contributes to the UK’s comparatively
most technologically advanced and creative poor showing in aggregated R&D figures.
games software developers in firms such as
Codemasters and NaturalMotion. Similarly, in 2.2 Innovation is becoming increasingly
electronics, the UK is home to world-leading distributed between firms, including global
firms such as ARM, CSR and Wolfson, as well as suppliers
many major multinationals.
2.2.1 Innovation is becoming more complex
Collectively, these sectors generate £80.9 and costly
billion in gross value added (GVA) and employ But this should not be a cause for complacency.
1.44 million people in the UK.10 This is around The nature of innovation in high-technology
7 per cent of total UK GVA – more than half sectors is changing rapidly and may overtake
10. GVA measures the of total manufacturing GVA in the UK. Overall, UK industry and the policy designed to support
contribution to the economy
of each individual producer this suggests that the UK’s high-technology it.
or sector.
11. As The Sainsbury Review in
2007 argued, the UK needs
to engage in a ‘race to the
top’ by concentrating on the
development of higher-
value-added industries; see Pharmaceuticals Given the expenditures involved, the
HM Treasury (2007) ‘The
Race to the Top, A Review of ‘blockbuster model’ has been used to
Government’s Science and The pharmaceutical sector makes a large describe the balance between risk and
Innovation Policies.’ London:
HM Treasury. contribution to the UK economy, with a reward: the development costs for all
gross value added (GVA) of £6.5 billion in products are supported by relatively
2004. As the fourth largest pharmaceutical few, very successful products. This is
sector in the world in terms of GVA, it why pharmaceuticals represent the most
directly employs 73,000 people, exports research-intensive large-scale sector in
£13.8 billion worth of goods, and provides the UK economy, with an R&D intensity
a trade surplus of £4.3 billion. The UK is of more than 15 per cent; they also
second only to the US in global medicines account for 35.5 per cent of R&D in the
brought to market; the same is true of UK. Only the US and Japan spend more in
biopharmaceuticals (drugs produced using pharmaceuticals research.
biotechnology). The UK is also an important
centre of bioprocessing (the manufacturing The research-intensive nature of new
sub-sector). pharmaceuticals has been reflected by
the traditional industrial structure of the
Traditional innovation in pharmaceuticals sector. Until the early 1980s, the sector
requires very large upfront investments in was characterised by large, vertically
R&D. Developing a new medicine takes on integrated commercial firms responsible
average 10-15 years and costs more than for the discovery of chemicals, clinical
£550 million. Before it is licensed, a drug development, and marketing and
has to undergo a long and complex process distribution. Firms required and could afford
of testing. Following this, for large-scale large-scale industrial R&D labs, reflecting
manufacturing, firms often need to build the magnitude of research opportunities
new facilities or reconstruct old ones. and unmet needs.

See Appendix A for further detail.

Innovation has become more complex with • In software and IT services, large suppliers
new knowledge bases, alongside other cost have become frustrated with the length,
pressures on investments in R&D. cost, and quality of the software product
development process, not least because
• In pharmaceuticals the nature of drug of the relatively short life cycle of some
discovery is being radically reshaped by the products and the ability of competitors
impact of new biological knowledge derived quickly to launch similar products.
from advances in life sciences and genetics,
but the resulting biopharmaceuticals are far • In telecommunications, de-regulation
more complex to develop and manufacture and technological advances have driven a
than traditional chemically-derived drugs rapid convergence between what would
(and even then may not be adopted by major have previously been separate sub-sectors
purchasers). (voice telephony, data and productivity
applications, and video and television)
• In aerospace, increasing demands for more opening up the sector to new entrants and
efficient and reliable aircraft – with the use new services. This has placed particular
of composite materials in aerostructures, and pressure on established providers, who have
increased use of electronic systems to replace seen revenues from calls and lines decline
hydraulic, mechanical and pneumatic systems from increased competition.
– has made developing and integrating
these elements more complex for major • In electronics, with advances in knowledge,
manufacturers. devices are increasing in complexity with
greater range in functionality, the packaging
• In automotive, despite a generally of components and devices, and the
conservative approach to product design, emergence of new materials (such as plastic
modern vehicles are increasingly complex, for electronics) for use in components. These
example, in the use of electronic components innovations have the ability to improve
to control and monitor functions, making applications in other products (such as
their integration increasingly challenging for mobile phones and digital cameras).
major manufacturers.

Aerospace a change in the physical structure of an

aircraft or its components. These cycles
Aerospace is a comparatively small part are often determined by the relatively rare
of the UK economy, but one which adds opportunities offered by major new large
considerable and growing value. Having civil aircraft development programmes such
increased its global market share from 9 as the Airbus A380 and the Boeing 787.
per cent to 13 per cent since 1995, the UK
aerospace industry is the second largest in Aerospace invests heavily in R&D, with
the world (after the US). Worth £5.5 billion expenditure (including defence) of £2.54
to GVA, it exports 63 per cent of its total billion in 2006 (an R&D intensity of 12.7
sales, contributing a £1.54 billion surplus to per cent). The sector spends 11.4 per cent
the balance of trade in 2006. The UK sector of all R&D in the UK, the second highest
directly employs over 124,000 people R&D intensity after pharmaceuticals.
(a 25 per cent increase since 1995), and
supports 276,000 jobs across the whole UK Some of the most important recent and
economy. ongoing traditional innovation has been in
the development of aeroengines capable
Traditional innovation in aerospace is a of increased fuel efficiency and reduced
mix of applied research and continuous emissions; the use of composite materials
development. It is typically centred on in aerostructures; and increased use of
high-cost and high-risk research-based electronic systems to replace hydraulic,
product development programmes, with mechanical and pneumatic systems.
very long development cycles (often
15-20 years). Such innovation can lead to See Appendix B for further detail.

2.2.2 These pressures have led to innovation in-house but are to be found in smaller,
becoming increasingly distributed and specialised firms. Innovation now increasingly
collaborative takes place through cross-disciplinary
collaborative partnerships and strategic Firms are drawing on a wider range of alliances, where once it might have been
actors largely performed by teams of scientists
These pressures on traditional innovation have and engineers within large internal research
motivated many firms to seek the greatest laboratories. As in other sectors, it is now
possible efficiency from their R&D. This has led commonplace for innovative small and
them to work more collaboratively with other medium-sized firms to be acquired by larger
firms and organisations to innovate.12 firms following the successful demonstration
of a new technology.
• In pharmaceuticals, new biological
knowledge encouraged a major change in • In aerospace, major manufacturers such as
industry structure with the emergence of Airbus and Boeing are increasingly designing
small, specialised biotechnology firms in the new aircraft in collaboration with suppliers,
1980s and 1990s. These biotechnology firms rather than designing them in-house and
exploited their knowledge of new techniques. passing blueprints for parts or sections to
Subsequently, large pharmaceutical firms suppliers. For example, 6,000 engineers
have attempted to capture their capabilities around the world are effectively jointly
through licensing deals, strategic alliances, designing and engineering the new Boeing
and other forms of open collaboration, as 787 aircraft. This has cut the typical four or
well as many mergers and acquisitions. five year time from concept to production by
a year, and reduced development costs by 20
• In electronics, larger firms often now rely per cent.13
12. This also echoes the idea on capabilities that are no longer located
of open innovation, see:
Chesbrough, H. (2003)
‘Open Innovation: The New
Imperative for Creating and
Profiting from Technology.’
Watertown, MA: Harvard
Business School Press; also
Chesbrough, H. (2006) Telecommunications lion’s share of the sector’s annual £1.13
‘Open Business Models: billion investment, much of it in software
How to Thrive in the New
Innovation Landscape.’ Telecommunications is an important sector development. BT’s R&D intensity of 5.1
Watertown, MA: Harvard in its own right, but is vital to the UK’s per cent is much higher than that of the
Business School Press.
13. Bartholomew, D. (2007) wider competitiveness as a knowledge- remaining fixed-line firms.
The Promise and Peril based economy. The sector includes
of PLM PLM: Boeing’s
Dream, Airbus’ Nightmare. fixed-line telephony, mobile and broadband The sector’s most visible technological
‘Baseline.’ 2nd May. services, as well as telecommunications innovation lies in the development of
equipment and network supplies. large-scale infrastructures. These long-term
projects, some initiated a generation ago,
Telecommunications contributed £21.3 enable more recent advances including the
billion in GVA in 2004, 2 per cent of the switch from analogue to digital networks,
UK total. 8,500 firms employ 56,000 then to mobile and wireless technologies,
people directly or indirectly. The sector broadband connectivity, and new internet-
includes both large players who provide a based next generation networks (for
wide range of products, applications and example BT’s ‘21st Century Network’
services, and small firms offering a single programme, in which it is investing £10
product or service. More than 50 per cent billion). Nevertheless, less high-profile
of the sector’s revenues are generated by incremental innovation accounts for a
firms located in London, the South East and significant amount of activity – most
East of England. Cambridge is a particularly firms spend up to 90 per cent of their
important research centre for a number of development resources enhancing existing
multinational firms. products. Operators such as BT also invest
heavily in back office operational support
Traditionally, network operators have systems to automate, integrate and simplify
invested significantly in the development internal IT processes, improve customer
of new technologies. BT is the most services and reduce costs.
important investor in the fixed-line
telecommunications sector. It invests the See Appendix C for further detail.

• In telecommunications, network operators the internet, are challenging the traditional
such as BT work to package products and assumptions of where innovation comes from
services developed with hardware and and who does it.
software suppliers. Such operators also have
to compete directly with some of these Large firms are delegating more
suppliers who have entered the market (such responsibility for innovation to their suppliers
as Cisco and Microsoft). In turn, operators • In aerospace, the traditionally extensive and
have entered the IT services market, complex supplier networks between major
exploiting their expertise in developing manufacturers and first tier suppliers have
software for their own infrastructures. been accelerating and deepening over recent
years, with more responsibility being given to
• Software has perhaps the most well-known the suppliers.
example of distributed innovation in open
source software and Web 2.0 technologies. First and second tier suppliers are being
Open source is built on the principle that the given increased responsibility for traditional
source code of a program should be readily innovation. They are often taking on R&D,
accessible, so that users have the right to engineering and design, tooling, testing, sub-
copy, modify, maintain and redistribute it, system integration and pre-assembly (installing
without paying royalties or fees. Web 2.0 systems such as hydraulics, electronics and
is a general term for web technologies and controls). 80 per cent of the parts in new
design – including wiki, video-sharing, Boeing aircraft are made outside the firm
blogging and consumer feedback sites – – including by Japanese manufacturers,
which aim to facilitate information-sharing, who have for the first time succeeded in
collaboration and creativity among users. gaining extensive and advanced work on
These highly user-driven and collaborative the technology-rich wing design. Airbus also
forms of product development, enabled by intends to outsource around 50 per cent of

Software and IT services the world’s major software firms have a

substantial UK presence, whether for R&D,
Software and IT services are a vitally logistics distribution networks, or sales and
important sector for the UK, in enabling marketing operations. The UK has particular
other sectors to thrive and in underpinning strengths in accounting and finance (Sage),
the modern knowledge economy. The asset management (Misys) and knowledge
sector includes the development of management software (Autonomy).
system or bespoke software, the design
and implementation of large and complex Technological innovation in the sector
business IT systems, project management, is a mixture of radical and incremental
and retailing and support services. innovation focused primarily on new
products. The sector’s £1.2 billion R&D in
The UK sector employs around 600,000 the UK is concentrated in larger firms, with
people (half in software and half in IT over 40 per cent of spending in the top four
services) in 100,000 firms. It has a GVA of UK firms. Large global suppliers with R&D
£23 billion with exports of £4.7 billion in facilities in the UK include IBM, Microsoft,
2004. The UK market for software products Nortel, Northgate Information Systems,
and services is the largest in Europe. There and Toshiba. These firms often engage
are a number of significant clusters: in with smaller firms by buying products or
England, many software and IT firms are services, or contracting tasks to augment
based around Cambridge, the Thames in-house skills and competencies. Software
Valley area, Manchester and the Midlands; development is also closely linked to the
in Scotland there are clusters around Silicon computer hardware industry, as software
Glen and Dundee (which has a significant must be designed specifically to the
concentration of games software firms). hardware on which it will be installed and
The sector comprises some very large,
global players and a significant number See Appendix D for further detail.
of smaller, specialist firms. Almost all

future work, as part of a long-term trend and China. In recent years, their portfolio of
towards globalised production. Sixty per cent services has widened to include more advanced
of Rolls-Royce’s R&D investment and 40 per technologies such as genomics and high-
cent of new product development spending throughput (automated) screening, using
over the past five years has been outside the proprietary techniques for which they often
UK.14 This globalisation is not just driven by own the intellectual property rights. CROs can
cost; often firms hope to gain greater access also offer post-commercialisation services such
to foreign markets through distributing as sales and marketing.
development and manufacturing activities.15
• In automotive, manufacturers also now
• Cost pressures in the pharmaceutical expect their top suppliers to undertake R&D
sector have led to increased outsourcing and manage their own supply base. Suppliers
of the management of clinical trials and now perform 15-30 per cent of ‘design
manufacturing. effort’ (although this is concentrated in
larger suppliers).17
New clinical research management
organisations (CROs) now run many of the In some cases, distributed innovation and
clinical trials required for regulatory approval. collaboration reaches well beyond working with
They account for more than 40 per cent of other firms.
annual research spending by firms, compared
to just 4 per cent in the early-1990s.16 Many • For example, in telecommunications, BT has
CROs are based in Eastern Europe, India been embracing open, user-led innovation.

14. Rolls-Royce (2006)

‘Introduction, Rolls-Royce is
a Global Company Providing Electronics and IT hardware and automotive sectors. Particular UK
Power for Use on Land, at strengths now lie in semiconductor
Sea and in the Air.’ Derby:
Rolls-Royce. Electronic components are at the heart design, photonics, and the manufacture of
15. For example, discussed of most technological products, typically specialist low-volume but high-value goods
in relation to aerospace
in Newhouse, J. (2007) representing more than 20 per cent of the for international markets (such as mixing
‘Boeing Versus Airbus.’ New cost of the product. Moreover, electronics, desks for the creative industries, control
York: Knopf.
photonics (signal processing devices using systems for mineral exploration and medical
16. Business Insights (2006)
‘Pharmaceutical Outsourcing photons) and electric systems underpin monitoring systems for health services).
Strategies, Market activity in virtually all other industrial Some international original equipment
Expansion, Offshoring and
Strategic Management in the sectors. manufacturers firms (OEMs) also locate
CRO and CMO Marketplace.’ parts of their design operations in the UK,
London: Business Insights.
17. Automotive Innovation The UK electronics sector generates £14.8 including Fujitsu, Sharp and Philips. These
and Growth Team (2002) billion in GVA (1.3 per cent of total UK firms are clustered in places like Silicon
‘Design, Development
and Manufacture Report.’ GVA), and accounts for 6 per cent of UK Gorge near Bristol, Silicon Fen around
London: AIGT. manufacturing. The sector employs around Cambridge and Scotland’s Silicon Glen.
216,000 people in over 10,000 firms. Where
it was once dominated by large integrated Electronics is a moderately high research-
‘national champions’ such as ICL and GEC, intensive sector; R&D expenditure in
increasing competition from emerging 2006 was £1.5 billion or 4 per cent of
nations, fuelled by commoditisation and sales. It also accounts for 7 per cent of
lower labour costs, has led to a decline total business expenditure on R&D in
in electronics manufacture in the UK. the UK, third behind pharmaceuticals
Nevertheless, electronics production in the and aerospace. Many new advances have
UK ranked seventh in the world in 2004, resulted from the commercialisation of
and second in Europe behind Germany. research carried out in UK universities, for
example Cambridge Silicon Radio (CSR)
But the nature of the sector has changed. developed Bluetooth-based wireless
The dominance of large and medium- systems. But firms also rely heavily
sized firms has been replaced by a growth on incremental innovations to remain
in small firms, 90 per cent of which have competitive, especially in consumer
fewer than 50 employees. These new electronics.
firms are more specialist and high-value
and work particularly with the aerospace See Appendix E for further detail.

BT has opened up its entire network through established. Major manufacturers, particularly
open protocols and a software development in aerospace, automotive and pharmaceuticals,
kit (SDK) that is downloadable by users, are becoming ‘systems integrators’, pulling
entrepreneurs and firms. This appeals both together the components, skill and knowledge
to large established firms who want to of suppliers, users and partners to deliver ever
integrate telecommunications services in their more complex products, services and systems.
applications, and to users who are inventing
new applications using the internet and Firms are also relying on universities to
traditional telecommunications services. conduct research
Equally, as a result of this complexity and
These trends have put much more pressure cost pressures on large firms, there have been
on the innovative capacity of suppliers. increased links between firms and universities.
The pressure can be too much. Some University research is often playing a greater
manufacturers have overestimated suppliers’ direct role in commercial innovation.
competencies and underestimated the required
levels of expertise and investment required First, universities are increasingly serving
(for example, delays in the delivery of the as research centres for firms. In aerospace,
Boeing 787 are said to be due to suppliers research-intensive companies have traditionally
failing to cope with the extent of their new conducted research in-house, but this is
responsibilities).18 As a result, some major changing. Some firms have particularly good
manufacturers have decided to focus more on links. For example, Rolls-Royce, as part of
the larger, typically more capable suppliers. an overall policy of ‘capability acquisition’,
has outsourced much R&D to universities,
Nonetheless, the trend towards outsourcing establishing ‘University Technology Centres’ in
more of the responsibility for innovation is the UK and across the world. These universities
18. See Bailey, J. and Clark, N.
(2008) Parts Didn’t Click
Together for Boeing Jet.
‘New York Times.’ 17th

Automotive seven and ten years). Manufacturers and

suppliers allocate production capacity well
Automotive remains a major manufacturing in advance, to accommodate production
sector for the UK economy. Many foreign- and renewal of their ranges. It is difficult
owned manufacturers are located here, and expensive to change designs
while home-grown strengths include and specifications once a model is in
engine development and motorsport. production.
Automotive manufacturing contributes
£9.8 billion in GVA (6.2 per cent of total Automotive R&D can be moderately high.
manufacturing value-added); the retail The sector spends 5.2 per cent of all R&D
and service/maintenance sectors generate in the UK, just over £1 billion each year,
a further £22 billion. Automotive is the equivalent to an R&D intensity of 4.3 per
UK’s biggest manufacturing export sector, cent. High performance engineering areas
generating more than £20 billion annually. such as motorsport have much higher R&D
1.65 million vehicles were manufactured in intensities, often more than 30 per cent.
2006 (making it almost a record year), with Because of its scale, the automotive sector
73 per cent of them exported. The sector is the largest R&D investor in Europe,
directly employs 221,000 people. with around 20 per cent of total European
manufacturing R&D.
Traditional innovation in mass market
automotive focuses on continuous By far the largest component of
incremental improvement to core manufacturers’ R&D expenditure is on new
product technologies. Suppliers are often vehicle model development rather than
responsible for important innovations, more ‘blue skies’ innovation. Areas of focus
while manufacturers concentrate on process include more efficient and cLeaner engines,
innovations. This innovation often has long electronic control systems for car functions
lead times; the development of a car – from including safety features, and so-called
design to production logistics – takes up ‘surprise and delight’ features such as
to five years (the development of engines satellite navigation systems.
and transmissions can be longer, between

tend to be particularly involved in researching predicted to grow to $2.5 billion by 2011.24
emerging technologies, such as radically India exported more than $155 billion in goods
different aeroengine designs or the use of new and services in 2008 (up from $63 billion in
materials. 2004).25 The Indian government’s target is
$200 billion in exports by 2020, or 5 per cent
Second, university research and knowledge of world trade; a four-fold increase in the next
are increasingly being commercialised.19 For 12 years.
example, the new biological knowledge in
pharmaceuticals has often been advanced by Similarly, China is now the world’s top exporter.
universities and public laboratories, and later In 2006 it was responsible for 8.2 per cent
in spin-out and start-up firms. This process of global exports (up from 5.9 per cent in
has been facilitated by changes in intellectual 2003). China is the world’s largest electronics
property rights and funded by the increased manufacturer, with more than $300 billion
19. See Section 4, in HM availability of venture capital and angel in products in 2006.26 It accounted for 18
Treasury (2007) ‘The Race
to the Top, A Review of finance. Highly innovative firms have also per cent of global electronics output in
Government’s Science and emerged from universities in sectors such as 2005, compared to just 4 per cent in 1997.
Innovation Policies.’ London:
HM Treasury. electronics and software. In telecommunications, China’s exports
20. NASSCOM (2008) ‘Strategic increased by an average annual rate of 37 per
Review 2008.’ New Delhi: 2.3 The increasing distribution of innovation cent between 2000 and 2006; in automotive
21. Booz Allen Hamilton (2006) is strengthening international competitors products the equivalent figure was 45 per
‘Globalization of Engineering By increasingly being given responsibility cent, and in computer and information services
Services - The Next Frontier
for India.’ McLean, Virginia: for higher-value-added activities (including (including software development) it was 40 per
Booz Allen Hamilton. innovation), firms in the supply chain in cent.27 Half of Chinese suppliers of electronic
22. KPMG (2006) ‘The Indian countries such as India and China are gaining components, consumer electronics, and
Pharmaceutical Industry:
Collaboration for Growth.’ the capabilities necessary to compete with computer and telecommunications products
London: KPMG. Western firms. They can under-cut smaller expect more than 20 per cent growth in export
23. Department of Chemicals
and Petrochemicals,
Western supply chain firms by operating in sales during 2008; a quarter expect an increase
Government of India lower-cost locations, but they also increasingly of 10-20 per cent.28 More than 80 per cent of
(2005) ‘Draft, National
Pharmaceuticals Policy,
draw on a larger number of science and suppliers anticipate increasing their production
2006.’ New Delhi: engineering graduates. capacity by 20-50 per cent. The EU is the main
Department of Chemicals
and Petrochemicals,
destination for these exports.
Government of India. Such countries are using these advantages to
24. Engineering Export develop as increasingly strong challengers in Software illustrates how such competition
Promotion Council (2008)
‘Annual Supplement 2008 to many high-technology sectors: China, India can develop very rapidly. In the early 1990s,
Foreign Trade Policy 2004- and some Eastern European countries in American and European IT and software firms
09.’ New Delhi: Engineering
Export Promotion Council. pharmaceuticals, automotive and electronics; faced the twin pressures of a need to reduce
25. Ibid. Brazil, Japan and China in aerospace; and India costs and a shortage of qualified software
26. Reed Electronics Research in software and telecommunications. engineers in their own countries. So they began
(2006) ‘Yearbook of World
Electronics Data, Volume to locate some routine tasks and activities
3 - Emerging Countries The Indian software and business process (such as IT help desks and call centres) in
2006/2007.’ Wantage: Reed
Electronics Research. outsourcing industry is expected to achieve lower-cost locations, especially India. This
27. World Trade Organization $60 billion in exports of software and services helped develop the IT industry in India, and
(2007) ‘International Trade
Statistics 2007.’ Geneva:
by 2010; the UK is the second largest market led to the rise of home-grown firms such as
WTO. for the Indian software sector after the US, at Infosys, Tata and Wipro. Such firms now offer a
28. Global Sources (2008) ‘China 18 per cent of total exports.20 Similarly, India is wide range of increasingly high-value services
Supplier Survey, 2nd Half
2007.’ Singapore: Global predicted to take a $60 billion share of a total at significantly lower prices than their US or
Sources. $1.1 trillion global spending on engineering European counterparts. Other competitors are
services (including aerospace, automotive and now emerging from Latin America, Eastern
telecommunications) by 2020.21 While today Europe and China, which is predicted to
only $10-15 billion of engineering services is develop its own software industry even faster
off-shored, the market is expected to grow to than India did.
$150-225 billion by 2020. In pharmaceuticals,
India now represents 13 per cent of the global Such rapid growth is not merely a matter of
industry by value and its drug exports have ‘market forces’; it is also often due to concerted
been growing by 30 per cent a year.22 The and coordinated efforts at building national
Indian government estimates that the sector champions in these emerging economies.
has the potential to generate revenues of
$22.4 billion in drug formulation by 2010.23 In
telecommunications, Indian equipment exports
are estimated at $1 billion for 2008, but are

3. In the face of increasing international and third sectors have very different forms of
competition, UK firms need to harness innovation from the science-based model.32
‘hidden innovation’
But hidden innovation is not just about
3.1 We have neglected the ‘hidden innovation beyond manufacturing sectors;
innovation’ that is crucial to the UK’s it is about recognising the neglected
economy, including in manufacturing innovation across the UK’s economy, including
Traditionally, innovation is determined by in manufacturing. Most sectors are likely
research and development, making R&D to contain a varying combination of both
the fundamental source of value creation traditional and hidden innovation.33
(‘traditional innovation’). In this linear (or
‘pipeline’) model of innovation, R&D leads From this, seeking to recognise hidden
to new discoveries that are incorporated into innovation does not imply that the UK is ‘doing
a new product or process and then marketed fine’ or that ‘manufacturing doesn’t matter 29. National Endowment for
Science, Technology and the
to consumers. Because of its presumed anymore’. As The Sainsbury Review in 2007 Arts (2006) ‘The Innovation
importance, R&D has been used as a proxy argued, the UK’s need to engage in a ‘race to Gap.’ London: NESTA.
for innovative performance between firms and the top’ by concentrating on the development 30. National Endowment for
Science, Technology and
between countries. of higher-value-added industries must include the Arts (2007) ‘Hidden
– but is not limited to – high-technology Innovation.’ London: NESTA;
National Endowment for
However, NESTA has argued that traditional manufacturing sectors.34 The UK requires Science, Technology and
indicators such as R&D are based on a model both innovative services and high-technology the Arts (2008) ‘Creating
Innovation, Do the
of innovation that is increasingly less relevant.29 manufacturing to remain competitive in the Creative Industries Support
Such indicators reflect a view that innovation is 21st century. Innovation in the Wider
Economy?’ London: NESTA.
synonymous with scientific and technological 31. National Endowment for
invention, neglecting the many other forms 3.2 Hidden innovation is increasingly Science, Technology and the
Arts (2008) ‘Taking Services
of ‘hidden innovation’ which are crucial to important in high-technology sectors Seriously.’ London: NESTA.
creating value in the economy.30 32. National Endowment for
3.2.1 Leading high-technology firms are Science, Technology and the
Arts (2008) ‘Transformers,
This is particularly important for the UK increasingly harnessing hidden innovation How Local Areas Innovate
because of its lower reliance on manufacturing NESTA has previously identified four main to Address Changing Social
Needs.’ London: NESTA;
and greater reliance on services compared to forms of hidden innovation: National Endowment for
some other countries. The innovation that Science, Technology and
the Arts (2007) ‘In and Out
matters most to services sectors is rarely • technological development that is not of Sync, The Challenge of
science-based.31 More broadly, the public included under the official definition of R&D; Growing Social Innovations.’
London: NESTA.
33. National Endowment for
Science, Technology and
the Arts (2007) ‘Hidden
Innovation.’ London: NESTA.
Boeing’s use of composite materials processes using these materials.35 For 34. HM Treasury (2007) ‘The
Race to the Top, A Review of
example, Boeing engineers discovered that Government’s Science and
In aerospace, much traditional innovation composites are tougher than they initially Innovation Policies.’ London:
HM Treasury.
is led by continuous, incremental (or imagined, and the firm has been able to 35. Smock, S. (2007) Boeing
‘iterative’) development rather than by guarantee customers that maintenance 787 Dreamliner Represents
Composites Revolution.
research; one estimate suggests that the costs will be 30 per cent lower than ‘Design News.’ 4th June.
‘R’ represents only 10-15 per cent of R&D. for aluminium aircraft. This potentially 36. BusinessWeek (2005)
Hence is it likely that much technological represents a bigger saving for customers Boeing’s Plastic Dream
Machine. ‘BusinessWeek.’
innovation is not captured in narrow than the 20 per cent reduction in fuel 20th June.
measures of R&D. costs the 787 can deliver compared with
other aircraft – savings worth more than
The use of composite materials in the new $3 billion over 20 years.36 Such ‘practical
Boeing 787 – comprising 50 per cent of research’ often lies outside formal R&D
the aircraft’s weight – is based on years of processes. But the development of efficient
basic scientific research. But Boeing and production processes for these materials
its major suppliers have also had to learn is crucial to realising their potential
on the job how to manufacture and tool benefits; in this case, unless composites
such materials for the specific requirements can be manufactured properly, they will
of aerospace. The benefits of composites not produce the weight gains and fuel cost
have grown as Boeing’s engineers have savings that airlines demand.
gained more experience in production

• innovation in organisational forms and because practice has helped to improve
business models; effectiveness through improved formulations, a
better understanding of how to use drugs and
• innovation from combining existing the patient groups that will benefit from them,
technologies and processes in new ways; and and how they might be used to treat other
diseases. One example is the developments in
• ‘micro-innovations’ that aren’t recorded in understanding of how to use existing drugs
surveys of innovation.37 in cardiovascular medicine, such as aspirin,
streptokinase, and ß-blockers. Such drugs
These four types can be seen across high- may still be under-exploited; one study has
technology sectors. estimated that 40,000 lives worldwide could be
saved each year – 3,000 in the UK alone – from Type I: Hidden innovation from the greater use of aspirin.38
technological development not included under
the official definition of R&D More moderate R&D intensities in some
Type I hidden innovation comprises research sectors, such as mass market automotive
and experimental development with a scientific with its typical focus on incremental product
and technological basis (the Frascati Manual development, also suggest a significant
definition of R&D), but is excluded from degree of technological innovation that is not
measurement for methodological reasons. captured in narrow measures of R&D. This is
particularly likely with technologies developed
Iterative development can be significant first by competitors and then adopted by other
even in highly research-intensive sectors. In manufacturers. Most core product technologies
pharmaceuticals, such innovation is often as eventually become standard across all brands
important as breakthrough innovation. Later and models, from variable value timing
37. National Endowment for members of a drug product class are better, for engines to satellite navigation. Much
Science, Technology and
the Arts (2007) ‘Hidden
Innovation.’ London: NESTA.
38. Antithrombotic Trialists’
Collaboration (2002)
Collaborative Meta-analysis
of Randomised Trials of
Antiplatelet Therapy for GlaxoSmithKline’s (GSK) Centres for biotechnology firm. CEDDs in the UK
Prevention of Death, Excellence in Drug Discovery (CEDDs) include Neurology in Harlow, Respiratory,
Myocardial Infarction, and
Stroke in High Risk Patients. Inflammation and Respiratory Pathogens
‘British Medical Journal.’ Organisational and business model in Stevenage, and Biopharmaceuticals in
324, pp.71-86.
innovation has helped transform the Stevenage.
39. See GlaxoSmithKline (2008)
‘Answering the Questions pharmaceuticals industry. The contemporary
that Matter, Annual Report growth in scientific understanding has Given the very long lead times for drug
2007.’ Brentford: GSK;
GlaxoSmithKline (2001) ‘It’s created a major change in industry structure development, the full impact of these
About You, Annual Report in the shape of small new biotechnology organisational innovations is unlikely to be
2000.’ Brentford: GSK.
firms. These firms have often been less risk- fully realised for many years. Nonetheless,
averse in selecting and pursuing research following this innovation, GSK has more –
projects. In response, large pharmaceutical and more radical – drugs in development:
firms have attempted to capture the indeed it now has as many radical new
capabilities held by small firms, through products in development as it had total
licensing deals, strategic alliances and other products in development just seven years
forms of collaboration, as well as mergers earlier, with 53 per cent more radical
and acquisitions. new products.39 The firm now leads other
large firms in terms of mid- to late-stage
Some large firms have even adopted the development of products.
organisational forms of small firms. In 2000,
GlaxoSmithKline (GSK) created six new GSK has subsequently taken this model
semi-autonomous business units called further with its Centre of Excellence for
Centres for Excellence in Drug Discovery External Drug Discovery – a form of ‘virtual’
(CEDDs). Each CEDD focuses on a specific CEDD that works through a network of
therapeutic area but has no more than external alliances. Such approaches may
350 scientists each. This limitation is represent the dominant model for the rest
intended to support interaction and reduce of the pharmaceutical sector in a few years’
bureaucracy, so that each unit acts with the time.
flexibility and responsiveness of a smaller

innovation is therefore ‘catch-up’ – new to the Other forms of organisational innovation are
firm but not necessarily new to the sector. focused on improving the efficiency of other
processes, such as ‘Lean manufacturing’ in
Similarly in telecommunications, incremental automotive and aerospace. Lean focuses on
technological innovation is crucial for firms to the elimination or reduction of waste in various
remain competitive against other providers, forms.42 Output per worker is consistently
but may not be considered sufficiently cutting- significantly higher in Lean compared to
edge or novel, especially if such development non-Lean automotive manufacturers (double,
has already been achieved by other firms. in many cases). Toyota, its pioneer, has the
This is also prevalent in areas of electronics, highest consistent output of any major
especially fast-moving consumer electronics automotive manufacturer, equivalent to a
goods. lead in productivity of 5.17 labour hours per
vehicle (or about $300 per vehicle) over the
Furthermore, most small and medium-sized least productive major manufacturer in North
(SME) firms, such as suppliers, may not have America.43 Similarly, Lean has been shown
formal (or significant) R&D programmes, to lead to a 20-40 per cent improvement in
yet they may be engaged in researching, productivity in aerospace SMEs.
developing and refining their products.
Lean and ‘Agile’ development has also spread Type II: Hidden innovation in to the software and IT services sector. Agile 40. ARM (2007) ‘ARM Holdings
Plc Reports Results for the
organisational forms and business models development is an alternative to traditional Fourth Quarter and Full
Indicators that focus on research are blind to product development (which emphasise initial Year 31 December 2007.’
Cambridge: ARM.
innovations in organisational forms or business major planning). Agile promotes development 41. ARM (2007) ‘ARM Annual
models, despite the fact that these have iterations throughout the life-cycle of the Report and Accounts 2006.’
Cambridge: ARM.
become crucial for business performance in project via feedback through tests and releases
42. Toyota developed the
high-technology sectors. of the evolving software (consumers and TPS in reaction to what it
clients form part of this feedback). One survey perceived as the wasteful
overproduction of US
Some forms of organisational and business of 1,700 firms across 71 countries found automakers (particularly
model innovation, such as in GSK, are closely that using Agile processes led to increased Ford), but was also inspired
by a visit to an American
related to research: making R&D more efficient; productivity for 55 per cent of respondents; supermarket chain (called
drawing on and exploiting external knowledge reduced software defects for 54 per cent; and Piggly Wiggly) which only
reordered and restocked
and expertise; or focusing on R&D to the reduced costs for 28 per cent.44 Other benefits goods once they’d been
exclusion of other activities that traditionally reported were better alignment between IT and bought by customers.
43. Harbour Consulting (2007)
firms would also have conducted. business goals and reduced project risk. ‘The Harbour Report™
North America 2007.’
Troy, Michigan: Harbour
Examples of the latter can be seen in the Organisational innovation can also provide Consulting.
electronics sector. Following the loss of the new services for customers. For example, 44. VersionOne (2007) ‘The
large integrated firm in the UK as a result of in aerospace, firms such as Rolls-Royce are State of Agile Development
2nd Annual Survey.’
increasing competition, some UK firms have increasingly making the majority of their Alpharetta, GA: VersionOne.
adopted innovative new business models. revenues from ‘through-life management 45. Rolls-Royce (2008)
Chip manufacture has moved offshore to services’, in part because competitive pressure ‘Preliminary Results 2007.’
Derby: Rolls-Royce.
lower labour cost regions, resulting in a focus on costs has left little or no profit from original
on higher-value activities such as design and equipment and supplies sales. Customers sign
licensing of intellectual property (IP). This has long-term maintenance and support contracts
spawned models such as ‘chipless’ firms that for reliability and predictable costs. In effect,
develop and market semiconductor IP such as the manufacturer is selling services, much of
ARM but do not manufacture themselves, and the value of which is based on brand qualities
‘fabless’ semiconductor firms such as Wolfson like reliability, permanence and expertise. For
Microelectronics that use external third parties civil aircraft alone, Rolls-Royce now generates
for their manufacturing operations. Such more than $2.6 billion in revenues from service
business models can be highly efficient at agreements (63 per cent of its civil aerospace
generating value. For example, ARM has a revenues), and more than £4.2 billion across
growth rate approximately twice that of the the sectors the firm operates in.45 Rolls-Royce’s
semiconductor industry as a whole.40 The firm investment in developing and maintaining
estimates that in 2006, 1.5 billion people – a these services is equal to its investment in
quarter of the world’s population – bought an research and technology programmes.
ARM-powered product, generating more than
£263 million in revenues, yet the firm employs Other firms have considered how to exploit
fewer than 1,500 people.41 their specialised design and technology
expertise outside their own sectors; for

example, McLaren Applied Technologies paying users for its ‘on-demand’ Customer
(formed in 2004) works with a diverse range Relationship Management (CRM) software,
of industries and develops commercial with revenues around $700 million in 2007.
applications for technology developed for Siebel Systems, Microsoft, Oracle and SAP have
motorsport within the McLaren Group. also entered the SaaS market. Tata Consultancy
Services (TCS), India’s largest service provider,
In telecommunications, new services and is introducing a hybrid SaaS/services model
business models have become crucial to that it calls ‘IT-as-a-service’, which is being
competitive survival for firms, especially in aimed primarily at the local SME market and is
the context of deregulation and new market predicted to be worth up to $9 billion a year.48
entrants. Established firms, especially those However, smaller software firms – including
that in the past would have relied on revenues in the UK – may struggle to meet customers’
from their fixed-line networks, now need expectations in being able to deliver their
46. BT Group plc (2007) ‘Annual to think primarily in terms of innovative products in this way. One survey found that
Report & Form 20-F2007.’
London: BT Group plc. services for customers and how these might around 70 per cent of its small UK firms
47. Desisto, R., Pring, be supported by existing or emerging are continuing with the traditional business
B., Lheureux, B. and technologies. For example, BT’s Global model.49 One notable exception is Huddle, a
Karamouzis, F. (2006) ‘SaaS
Delivery Challenges On- Services division focuses on networked IT and UK start-up established in November 2006,
Premise Software.’ Stamford, consultancy services for major corporations, which combines online collaboration, project
CT: Gartner.
48. All, A. (2008) ‘India’s organisations and government. Its revenues management and document sharing using
Tata Consultancy Services increased by 4 per cent to £9.1 billion in 2007, social networking principles.
Introduces Hybrid SAAS
Model.’ [online] Available at: while traditional revenues declined.46
http://www.itbusinessedge. Type III: Hidden innovation from
In software, the development of the combining existing technologies and processes
49. Intellect (2007) ‘Software
and IT Services Report – The ‘Software as a Service’ (SaaS) business model in new ways
Future.’ London: Intellect. is reshaping the sector. In SaaS, software Type III hidden innovation can be created from
50. Previous studies have
emphasised the importance
applications are supplied online and hosted by largely existing components when they are
of this form of innovation, a provider rather than installed on the user’s combined in new ways to deliver new products,
termed variously the
‘recombination and re-
premises, and priced on a per usage basis. services or processes.50 Technology often plays
use of known practices’, This is increasingly overturning the traditional a significant role in this type of innovation, but
‘recombinant innovation’
and ‘architectural
‘licence + maintenance’ business model; SaaS because this technology often isn’t completely
innovation.’ See respectively: is predicted to capture more than a quarter new it doesn’t get counted in traditional
David, P., and Foray, D.
(1995) Accessing and
of the $200 billion business software market indicators.
Expanding the Science and by 2011.47 The market leader,
Technology Knowledge
Base. ‘STI Review.’ 16,
(a US firm founded in 1999), serves more In software, the Frascati Manual only
pp.16-38; Hargadon, A. than 38,000 other firms and has one million acknowledges development that represents a
(2003) ‘How Breakthroughs
Happen: The Surprising
Truth About How Companies
Innovate.’ Watertown, MA:
Harvard Business School
Press; and Henderson, R.
M., and Clark, K. B. (1990)
Architectural Innovation: The
BT’s ‘new wave’ services caller moves out of range then the call
Reconfiguration of Existing is seamlessly transferred to the mobile
Product Technologies and
the Failure of Established
In telecommunications, investments base station of BT’s partner (Vodafone)
Firms. ‘Administrative in developing new technologies and as a mobile call. BT’s new internet-based
Science Quarterly.’ 35,
infrastructure provide the basis for new television service, Vision, connects to the
51. BT Group plc (2007) ‘Annual services. Intense competition, regulation same home hub and provides broadband
Report & Form 20-F2007.’ and technological advances such as mobile video-on-demand via a Freeview digital
London: BT Group plc.
networks, have led to a decline in revenues terrestrial set-top box. BT is securing
from traditional fixed-line networks. content deals with major film and television
Established operators have sought to studios for this service.
develop innovative new services to drive or
renew revenue growth. These innovative products and services
are part of what BT calls its ‘new wave’
BT Fusion is the world’s first ‘intelligent’ activities (primarily networked IT services,
mobile phone service. Customers are broadband and mobile). In 2007, these
provided with a hub and up to six mobile activities generated revenues of £7.37
handsets. When within range of the hub billion (36 per cent of total revenues), an
the call is routed through the hub and increase of 17 per cent on the previous year
into the fixed broadband network. If the (while traditional revenues fell 3 per cent).51

‘scientific and technological advance’ as R&D Type IV: Micro-innovations that aren’t
and hence as innovation.52 Yet much software recorded in surveys of innovation
development is characterised by ‘cumulative Type IV hidden innovation comprises the
technologies’, involving the use and re-use of locally-developed, small-scale, incremental
existing functions and routines which gradually innovation that often goes unnoticed by
evolve through incremental innovation. traditional indicators.

For example, Service Oriented Architecture Such micro-innovations are crucial to any
(SOA) represents a new approach to ‘engineering’-based sector (whether they focus
development, whereby program functions are on the design and development of physical
separated into distinct units (services) which products, or virtual products such as software,
can be distributed over a network and can be or both).
combined and reused in more flexible and cost
efficient ways to create business applications. Finally, such micro-innovations are typically 52. See section 2.4 in
Organisation for Economic
One study estimates that SOA could reduce unsuitable for patenting (another of the Co-operation and
development costs by 25 per cent (about $53 traditional indicators). Even if they were, Development (2002)
‘Frascati Manual 2002,
billion) over five years across the 2,000 largest smaller firms do not have the expertise or Proposed Standard Practice
firms worldwide.53 Some of this work may not resources to engage in patenting procedures, for Surveys on Research and
Experimental Development.’
be counted as innovation since it may not or to defend a patent against possible Paris: OECD.
fundamentally alter underpinning technological infringement, leaving many inventions invisible 53. Aberdeen Group (2006)
standards or make significant advances to such indicators. ‘The SOA in IT Benchmark
Report.’ Boston: Aberdeen
in knowledge. The often continual and Group.
incremental nature of software development 3.2.2 In the face of increasing competition, 54. Somewhat paradoxically,
the costs of such software
– and the virtual nature of the products – can there is a danger that established UK might be eligible under the
add to the marginalisation of these forms of firms become ‘locked-in’ to their existing UK R&D tax credits scheme,
but its use would not tend
innovation. technologies and business models to be counted as being
part of R&D under Frascati
Furthermore, the use of software and other Traditional innovation can become
55. Toyota (2007) ‘Annual
supporting technologies has been valuable in locked into existing ‘platforms’ Report 2007, Building a
improving quality and efficiency in production Much technological R&D can focus on Platform for Growth.’ Toyota
City: Toyota. UK data based
in aerospace and automotive. The use of incremental, augmentative innovation to on a study of the top 850
software in areas such as 3D design and existing ‘platforms’ instead of radical redesigns. UK spenders on R&D, see
Department for Innovation,
product development is making traditional Examples include the internal combustion Universities and Skills/
innovation more efficient, but such software engine and steel car body structures in Department for Business,
Enterprise and Regulatory
may have been developed first in other firms automotive, the gas turbine engine in Reform (2007) ‘The 2007
and often in other sectors.54 aerospace, and the mobile phone network R&D Scoreboard.’ London:
infrastructure in telecommunications. 56. May, M. E. (2007) ‘The
Elegant Solution: Toyota’s
Formula for Mastering
Innovation.’ New York: Free
57. Harbour Consulting (2007)
‘The Harbour Report™
Toyota Production System an emphasis on continuous improvement, North America 2007.’
teamwork, just-in-time inventory, and Troy, Michigan: Harbour
In many areas of engineering, there are becoming a ‘learning organisation’ through
small-scale problems and challenges that relentless reflection.
are dealt with outside of formal R&D
programmes. These efforts may not be One study estimates that through its
captured in traditional metrics. Toyota, a inclusive approach to improving production
manufacturer with a strong reputation for techniques, Toyota – which has two major
new technology development, has a global production plants in the UK – implements
R&D intensity of ‘only’ 3.7 per cent (lower, one million new ideas each year (or 3,000
in fact, than the overall R&D intensity a day).56 Most are small but effective
of the UK automotive sector at 4.3 per solutions to real world problems, but their
cent).55 However, the Toyota Production cumulative impact can be seen in large
System (TPS) represents a highly successful efficiency, quality and productivity gains.
approach to generating and enshrining Toyota earns twice as much as any other
such ‘micro-innovations’. TPS organises carmaker, and in the first quarter of 2007
manufacturing and logistics to eliminate the firm overtook GM in global sales for the
waste and inconsistency in products via first time.57

This innovation helps in increasing marginal It is insufficiently profitable, lumbered
performance or reducing costs, but doesn’t with structural problems: over-capacity
amount to fundamental change. Yet many firms throughout the value chain; high fixed
prefer to focus on it to maximise near-term costs in manufacturing, product design and
productivity from investments in R&D, rather distribution; inflexible production systems;
than engage in longer-term, more speculative and inflexible product designs.59 Reducing the
and riskier ‘blue skies’ R&D. number of vehicles held as unsold stock would
bring an immediate financial benefit to the
In this way, firms can become ‘locked-in’ whole production and distribution chain, and
to their own technologies. This lock-in is would be far less environmentally wasteful.
often reinforced by a firm’s organisational At some point, there is likely to be radical
structures, business models and related restructuring of the global automotive sector.
investments around its existing platforms.
For instance, the large-scale manufacture New firms – including in emerging
and distribution systems required by steel economies – can develop radical innovations
car body structures in automotive, the more suited to the major changes taking place
‘blockbuster’ drug development business in high-technology sectors
model in pharmaceuticals, and the revenue This lock-in explains why radical innovation
charging model for mobile calls and data in often comes from new entrants. Such firms can
telecommunications. be less risk-averse in selecting and pursuing
projects, because they don’t have the same
Such lock-in can inhibit firms from investment in existing processes as established
exploiting new technological possibilities major firms. New competitors often do things
or new ways of serving their customers. For in new ways, because they are organisationally
example, in aerospace and automotive, the and conceptually freer to do so.
58. Paine, C. (2006) ‘Who Killed emphasis on costs and reducing risk can
the Electric Car?’ Culver
City: Papercut Films. lead to conservatism in product design and For example, in pharmaceuticals, small new
59. For example, of major US manufacture. This can be exacerbated by a biotechnology firms were the first to attempt
manufacturers, on each
vehicle sold in North traditional focus on product engineering rather to capitalise on the growth in scientific
America in 2006, Chrysler than customer needs. Such sectors can be understanding. The impact of the new
Group lost $1,072, GM
lost $1,436, and Ford surprisingly slow to adopt new engineering knowledge is still being played out, but such
lost $5,234; see Harbour techniques and methods, or more flexible technologies are likely to allow a small number
Consulting (2007)
‘The Harbour Report™ designs. of patients to be treated more effectively with
North America 2007.’ personalised or specialised therapy. This will
Troy, Michigan: Harbour
Consulting. The result can be a disconnect between represent a major challenge to the blockbuster
manufacturers and customers. For example, model of developing therapies that treat a
airlines who are unhappy about aircraft large population, and so to the traditional
performance and specifications, and customers business model in large pharmaceuticals.
who are not supplied with their desired car
models. In the most extreme cases, established In aerospace, a new paradigm for aircraft
firms fail to respond quickly or radically enough production may be emerging. Cheaper, more
to challenges from new firms. efficient approaches have been demonstrated
by smaller innovative firms. For example, US
To take one example: large automotive firm Eclipse Aviation has launched its Eclipse
manufacturers have tended to resist alternative 500 four-six seater ‘air taxi’. Ex-automotive
technologies to the internal combustion sector executives founded Eclipse with the
engine, such as rechargeable battery electric express aim of producing a highly-reliable, low-
vehicles (BEVs) and hybrid electric vehicles weight aircraft for $1 million. The 500 is 50 per
(HEVs). Yet these technologies have been cent cheaper to operate than similar aircraft.
around for over a century. Electric vehicles Similarly, Toyota and Honda both have small
were once common, and the first hybrid motor aircraft at advanced stages of development.
was developed in 1901 by Ferdinand Porsche.
Major US manufacturers have even been In automotive, the alternatives to the
accused of deliberately sabotaging their own internal combustion engine have remained
electric vehicle production efforts in order not marginalised technologies, but this may be
to threaten their existing business model.58 about to change. Later in 2008, Tesla Motors,
a Silicon Valley start-up firm, will deliver its
Yet the dominant automotive technology Tesla Roadster, an electric performance sports
and business model in automotive is neither car that can accelerate from 0 to 60 mph in
financially nor environmentally sustainable. less than four seconds (a similar performance

to a Lamborghini Murciélago). Another start- approach to innovation. By seeking to integrate
up firm, The Project Better Place initiative, innovation in new technologies, products and
is working to provide the infrastructure and processes (primarily traditional innovation) with
scale necessary to make electric cars a viable innovation in business models, organisational
alternative to fuel-based vehicles, starting in forms and market positioning (hidden
Israel. Another start-up, Zero Pollution Motors innovation), they create greater profits and
(ZPM), expects to produce the world’s first protect their market position.
air-powered car for the US in early 2010. Tata 60. Ernst, D. (2004) ‘Late
Innovation Strategies in
Motors – the producer of the ultra low-cost Internal strategic management and business Asian Electronics Industries:
Nano ‘people’s car’ – will be using the same processes become particularly important in A Conceptual Framework
and Illustrative Evidence.’
technology in its Air Car for India in 2008. harnessing the various different dimensions East-West Centre Working
More generally, the automotive sector is open of innovation, by aligning the full range of Papers Economics Series.
No. 66. Honolulu, Hawaii:
to challenge from radically new business the firm’s resources behind them (including East-West Centre.
models, for example, through innovations such leadership, structure, strategy, processes, and 61. Total Innovation
as repeated leasing of vehicles through their culture). This combination of traditional and Management (TIM)
has been proposed
life cycles, hyper-Lean production with high hidden innovation is ‘total innovation’. as a new paradigm of
levels of outsourcing, and direct sales and innovation management
by the Research Center for
distribution. Perhaps appropriately, the concept has Innovation & Development
emerged from China.61 ‘Total Innovation (RCID) of Zhejiang
University, China. See Xu,
In telecommunications, many new services have Management’ suggests that the successful Q., Chen, J., Xie, Z., Liu,
been developed by new entrants. Start-up firms technology innovation needs to include both J., Zheng, G., Wang, Y.
(2007) Total Innovation
such as Skype have pioneered voice over IP technological and non-technological factors Management, A New
(VoIP) based on using broadband connectivity related to innovation. Traditional innovation is Paradigm of Innovation
Management in the 21st
to by-pass traditional charging models. As no longer sufficient.62 Century. ‘The Journal of
of the last quarter of 2007, Skype had 246 Technology Transfer.’ 32
(1-2). April, pp.9-25.
million customers, and has been acquired by In particular, firms need to develop the 62. This echoes the
the internet auction site eBay. Google also innovative capabilities of their workforces understanding that
technological innovation is
launched a similar service with Google Talk. through ‘people-oriented’ management. only one of the capabilities
Both firms had little experience of operating in Based on case studies of major Chinese that a firm may possess for
its competitive advantage
the sector until they entered the market. manufacturing firms such as Haier and Lenovo, - and is possibly the least
the key to maximising innovative capacity is the distinctive capability,
compared to its reputation,
In electronics, entrants from China, India, philosophy and practice of regarding ‘everyone architecture, and strategic
Korea, Taiwan and Singapore are emerging as innovator’. This means that innovation is not assets; see Kay, J. (1993)
‘Foundations of Corporate
as new sources of innovation and global only the responsibility of the R&D function, Success: How Business
standards. This includes innovations in but should take place throughout the whole Strategies Add Value.’
Oxford: Oxford University
process technology for electronic components value chain – hence the importance of creating Press.
(especially semiconductors and displays), and sustaining an all-encompassing culture of 63. Similarly, Henry Chesbrough
where Korean and Taiwanese firms are among innovation. has emphasised the
importance of business
the industry leaders. This also includes system models in creating value
specification: Asian firms are now producing According to this school of thought, firms fail from technology: “The
value comes from the party
innovations in the design of complex systems to maximise their innovative capacities when that has a business model
in areas like digital consumer systems, wireless their culture lags behind their technology- to create and capture
value from the patent, not
telecommunication systems, and business focused innovation, when such technological from the invention of the
process software.60 innovation is not linked to operation strategy, patentable technology
itself.” Chesbrough, H.
and when they lack internal mechanisms to (2003) ‘Open Innovation:
3.3 Remaining competitive demands ‘total motivate innovation across the whole firm.63 The New Imperative for
Creating and Profiting from
innovation’ Technology.’ Watertown,
For established firms, then, the ability to Following this, it is no longer appropriate MA: Harvard Business
School Press. p.162.
develop new business models, organisational or accurate to understand innovation as the
forms and processes becomes even more ‘successful exploitation of new ideas’. This
important, since this can help to free them definition, while apparently broad, implicitly
to engage in new forms of technological continues to privilege research (‘new ideas’) as
development. This will allow them to enter new the fundamental source and starting-point of
markets – or to remain competitive in existing innovation. In finally breaking from the linear
ones. model of innovation, we need to focus our
understanding on the outputs and outcomes
In the face of intensifying competition and of innovation, and then trace back from these
to ensure future growth, leading established outputs to whatever activities contributed to
firms in these sectors – from Rolls-Royce them. We need to understand innovation as
to BT, Toyota to GSK – are taking a broader

any activities that seek to meet needs in new direction for innovation policy in the UK,
ways. encompassing public procurement, regulation,
access to finance, and intellectual property.
UK high-technology firms need to develop
their capability for total innovation. 4.2 However, policy for high-technology
Survey evidence suggests that larger sectors still focuses overwhelmingly on R&D
UK manufacturing firms in particular and technology development
64. EEF (2007) ‘High-value – are increasingly identifying design and In response to the UK’s perceived R&D
How UK Manufacturing has
Changed.’ London: EEF.
development, and service provision, as their under-performance, policymakers have
65. Ibid. main competitive strengths as their advantages introduced a wide range of initiatives focused
66. Department of Trade and in production and assembly decline versus on science, engineering and technology (SET)
Industry (2007) ‘Innovation
in Services.’ Occasional
foreign competition.64 (Only 2 per cent of based sectors.69 Mechanisms of support for
paper no. 9. London: DTI. firms see research as their main source of technology-focused innovation have included
67. Department for Innovation, competitive advantage65). the Technology Programme, which includes
Universities and Skills (2008)
‘Innovation Nation.’ London: the Collaborative Research & Development
The Stationery Office. Development of fuller innovation capabilities is (CR&D) grant, Knowledge Transfer Networks
68. Ibid. p.13. particularly important for developed countries (KTNs), Knowledge Transfer Partnerships
69. For example, Department
of Trade and Industry because of the increasing challenge from (KTPs), and R&D tax credits for activities that
(2003) ‘Innovation Report, emerging economies in these high-technology qualify.70 Further research funding is available
Competing in the Global
Economy: The Innovation sectors. Too many firms are unprepared for from the relevant research councils, such as The
Challenge.’ London: DTI; these changes: only by integrating all aspects Engineering and Physical Sciences Research
Department of Trade and
Industry/HM Treasury/ of innovation can they cope with and exploit Council, Biotechnology and Biological Sciences
Department for Education these changes, and so continue to create value Research Council, the Medical Research
and Skills (2002) ‘Investing
in Innovation, A Strategy for for the UK. Council, and the Science and Technology
Science, Engineering and Facilities Council.
Technology.’ London: DTI/
HM Treasury/DfES; and
HM Treasury/Department Scotland, Wales and Northern Ireland have
of Trade and Industry/
Department for Education 4. UK policy for high-technology sectors reflected a similar emphasis on SET, R&D in
and Skills (2004) ‘Science remains narrowly focused on traditional advanced technologies, and university-business
& Innovation Investment
Framework 2004-2014.’ innovation collaborations, as have the initiatives of the
London: HM Treasury/DTI/ English regions.71 The English regions and
70. In July 2007, the Technology
4.1 Policy has begun to recognise hidden the devolved administrations all provide local
Strategy Board (TSB) innovation businesses with access to funding and support,
became operational as an The former Department of Trade and Industry from the Grant for an Innovative Idea (formerly
executive Non-Departmental
Public Body sponsored by (DTI) commissioned research on innovation SMART) to the Manufacturing Advisory Service
DIUS. The TSB promotes in services,66 and NESTA and the Department and regional venture capital funds. In addition
and supports research,
development and the for Business, Enterprise and Regulatory to the local delivery of national business
exploitation of science, Reform (BERR) have been working together to support schemes, there are numerous one-
technology and new ideas
to benefit business. The investigate innovation in major service sectors off support schemes, from the collaborative
TSB funds and coordinates in the UK economy through the Innovation in innovation centres (CICs) in Yorkshire, the
Collaborative Research &
Development, Knowledge Services project. Emerging Technologies Scheme (ETS) in the
Transfer Networks and South East to the Intermediary Technology
Knowledge Transfer
Partnerships. Most recently, Innovation Nation, the White Institutes (ITIs) in Scotland. These schemes
71. See Appendix B, National Paper published in March 2008 by the have generally targeted several ‘strategic’
Endowment for Science,
Technology and the Arts Department for Innovation, Universities and technologies and sectors.
(2006) ‘The Innovation Gap.’ Skills (DIUS), gives a prominent place to
London: NESTA.
hidden innovation and innovation in services. Finally, some sectors have explicit, agreed
72. Society of British Aerospace
Companies /Department The White Paper presents a broad vision programmes that encapsulate this support.
of Trade and Industry/ of innovation and its importance not only For example, the National Aerospace
Aerospace Innovation
and Growth Team (2004) to manufacturing but also for services, the Technology Strategy (NATS) is a partnership
‘National Aerospace creative industries, the public sector and between industry, government and academia,
Technology Strategy.’
London: SBAC/DTI/AeIGT. the third sector.67 It explicitly recognises the to identify, research and validate ‘key’ and
73. Ministry of Defence (2005) importance of innovation beyond the invention ‘enabling’ technologies.72 Research and
‘Defence Industrial Strategy,
Defence White Paper.’ of new technological products, by noting that development partnerships have also been
London: HM Stationery the ‘changing face of innovation’ also includes developed through Aerospace Innovation
Office; Ministry of Defence
(2006) ‘Defence Technology services, business processes and models, Networks (AINs) and Aerospace Technology
Strategy.’ London: Ministry marketing and enabling technologies.68 In Validation Programmes (ATVPs). Similarly,
of Defence.
doing so, it takes a significant step beyond the defence sector benefits from the Defence
the traditional focus of innovation policy. Industrial Strategy launched in December
It provides a valuable and challenging new 2005, and the subsequent Defence Technology

Strategy.73 These aim to improve how military regulation to public procurement, intellectual
equipment, supplies and services are procured property rights to education and skills.
and supported.
In pharmaceuticals, the speed and efficiency
4.3 Policy neglects the hidden innovation in with which drugs pass through regulatory
research-intensive sectors stages has a major impact on the returns to
Behind these initiatives lies a potentially pharmaceutical firms’ investments. Every day
dangerous assumption: that improving that a product is delayed reaching the market
investments in formal R&D will be sufficient can cost $1-3 million in lost revenue.74 But,
to ensure the survival of higher-value-added understandably, regulators tend to focus on
industries in the UK. establishing the safety of new products rather
than encouraging investment in new product
In the short- to medium-term, the UK must development.
remain attractive and competitive as a place
for major firms to locate their R&D, hence In telecommunications, 20 years of market
policymakers have been right to support R&D liberalisation in the UK has nurtured
in these sectors and in the economy generally. competition to such an extent that firms
from other sectors, often with no previous
Yet while investments in formal R&D and telecommunications experience, can now
linkages with the science research base will freely enter the market. The so-called ‘super
remain important, not enough is being done regulator’, Ofcom, reflects the convergence in
to stimulate or support total innovation to the sector.
make the most of the opportunities that
that research will present. In the near future, In aerospace and automotive, tighter EU
these high-technology sectors will need to regulations require reduced carbon dioxide
respond not just to unexpected or ‘disruptive’ (CO2) and nitrogen oxide emissions. This 74. PhRMA (2007) ‘Drug
Discovery and Development,
new technologies, but also to new business promotes some forms of innovation: for Understanding the R&D
models, processes and services developed by example in aerospace, it has created strong Process.’ Washington DC:
competitors. demand for lighter aircraft, prompting the
increased use of composites in airframes and
This reveals two major weaknesses in current components, and more efficient engines.
innovation policy.
Similarly, in electronics, UK and European
First, generic policies such as R&D tax credits environmental regulation is increasingly
are useful in subsidising existing incremental informing product design and development,
research-based innovation, but they do not in with more stringent requirements on
themselves steer firms to focus on longer-term, packaging, recyclability, and the use of
potentially disruptive research areas. Initiatives hazardous substances such as lead. These
such as Knowledge Transfer Networks (which can act as both a barrier to and driver
do focus on such areas) embrace far fewer firms of innovation; it can limit the scope and
than generic policies. parameters of a new product, but can equally
stimulate innovation to find alternative oxides,
Second, initiatives focused on potentially alloys and nanocomposites. Furthermore,
disruptive technologies don’t tend to include as in other sectors, energy use is emerging
hidden innovation, such as the new business as a major issue and a likely area for greater
models and organisational forms that might be regulation; the electronics sector will have
needed alongside these new technologies. increasingly to focus on minimising the
consumption of electrical power by making
4.4 ‘Non-innovation policy’ also shapes devices and systems more efficient.
innovation in high-technology sectors
4.4.2 In some sectors, public procurement
4.4.1 Regulation, including environmental shapes innovation
and safety regulation, plays a major role In pharmaceuticals, government is often the
in informing innovation activities in many major purchaser. This informs the kinds of
sectors drugs that are developed. The difficulty for
There is a third weakness in current innovation governments is in determining the desired
policy. Typically, what is designated as trade-off between efficient public procurement
‘innovation policy’ does not encompass and promoting innovation and growth by
the wider set of policies that also influence pharmaceutical firms.
innovation in these sectors – from taxation and

Government is also a major customer of First, new scientific knowledge and technical
software and electronics hardware. Indeed, skills are required. In pharmaceuticals,
growth in the UK software sector is partly due the new nature of drug discovery means
to substantial investment over recent years that firms need skills in new fields such as
in e-government initiatives such as new IT biopharmaceutical formulation, bioprocessing,
systems for the NHS (£30 billion over the last and computational analysis. Firms increasingly
ten years), Transport for London’s Congestion require interdisciplinary knowledge and skills.
Charging and Oyster card projects, and ‘Shared In pharmaceuticals, this means life science
Services’ (sharing back-office resources across graduates with sufficiently strong skills in
councils and government departments). mathematics and physical sciences.

4.4.3 Intellectual property rights have a In telecommunications, rapid changes –

major impact on innovation including developing technologies such as
In pharmaceuticals, the ability of firms to VoIP, WiMax, 4G and next generation networks
generate sufficient returns on their often – as well as convergence demand new and
large-scale and high-risk investments is directly continually up-graded skills.
shaped by IP regimes, especially the length
of protection periods and the enforcement of In software, employers express concerns that
these rights in different territories. At the same university degrees do not keep pace with
time, too much focus on IP can have a negative the rapidly-evolving sector, where current
impact on innovation, where universities software languages did not exist a few years
and other public research institutions focus ago. Furthermore, rapid change means that
on commercialising their knowledge and IT professionals need to undertake almost
expertise rather than blue skies research; or continual professional development to update
where academics and universities have inflated their skills, but as in many sectors with a high
75. Business Software Alliance/ expectations of IP, and deter innovation proportion of small firms, their employers often
IDC (2007) ‘Global Software
Piracy Study.’ Washington, through excessive bureaucracy related to such lack the resources to provide such training.
DC/Framingham, MA: BSA/ expectations.
76. Ricardo UK/Skills4Auto Second, firms need stronger non-technical
(2006) ‘Vision for the In software, a relative lack of IP enforcement skills, in management and leadership, business
UK Automotive Industry
in 2020, Focusing on has become a major issue, especially in some improvement techniques, change and project
Supply Chain and Skills & countries. It is estimated that 35 per cent of management.
Technology.’ Shoreham-by-
Sea/Birmingham: Ricardo software on all computers globally has been
UK/Skills4Auto. Similarly, obtained illegally, equating to £20 billion In aerospace, identified skills gaps include
see Automotive Innovation
and Growth Team (2002) of lost revenues (in the UK, 27 per cent systems thinking and engineering, project
‘Design, Development of software is obtained illegally, meaning management, problem-solving techniques, and
and Manufacture Report.’
London: AIGT. lost revenues of £840 million75). The scale business understanding and strategy.
of IP infringement and lost revenues has a
subsequent effect on the resources available For major automotive manufacturers, the
for further innovation. (Similar issues affect the primary issue remains the quality and
pharmaceuticals sector). Given the increasingly management practices at the first and second
collaborative and open nature of innovation tier suppliers. The UK automotive supply
in software projects, there can be complex chain has been regarded as poor in areas such
questions regarding ownership of the resulting as leadership, programme management and
products. customer care. Thirty per cent of supply chain
firms have no business plan, and fewer than 50
4.4.4 Skills are a crucial factor in innovation per cent have workforce training plans.76
As is widely-recognised, skills shortages In telecommunications, stronger strategic
and lack of ‘work-ready’ practical skills and and management skills are needed to convert
knowledge inhibit innovation in many of these technical innovation into business innovation.
sectors. There are too few suitable graduates Telecommunications workers need to obtain
in areas such as: engineering and physical new business skills to manage technological
sciences, particularly physics and chemistry; development and to integrate this development
computing and IT; and electronics. with the design and delivery of new services,
along with the skills to manage increasingly
However, in many sectors, the changing nature distributed and global relationships with
of traditional innovation and the importance of suppliers.
hidden innovation has emphasised the need for
broader skills.

Similarly, in software, development of complex innovation and change, such as in business
products and projects requires not only in- models.
depth and up-to-date technical skills but also
a sophisticated set of business-oriented skills There are some exceptions that do embrace
and understanding. Integrating technological organisational change. For example, in
knowledge with business skills enables firms to automotive the Supply Chain Groups
engage more effectively with clients, develop programme from 2003-2008 (jointly funded
greater levels of innovation and so ensure by the then Department of Trade and Industry,
sustainable competitive advantage. the English RDAs and the devolved regional
assemblies) focused largely on process
In electronics, UK firms need to be more improvement through Lean manufacturing, and
strategic in addressing skills to raise facilitated major productivity improvements of
productivity and compete effectively. up to 40 per cent.78
Improvements in management and leadership
skills, technical and engineering skills, general At the same time, a sector-focused approach
business skills, procurement and supply chain underlying innovation policy should be
management skills are needed. UK universities carefully constructed so as not to inhibit
have a role to play in advancing supply chain the potential cross-fertilisation of ideas and
management research, and, along with other technologies between different parts of the
organisations, training providers to teach best economy. As NESTA has noted previously, 77. Department of Trade and
Industry (2004) ‘Electronics
practice. Firms need continually to refresh their sectors often draw on technologies and 2015 – Making a Visible
skills in this area and undertake training for ideas from an ‘innovation hinterland’ of Difference.’ Electronics
Innovation and Growth
this.77 traditionally-unrelated areas.79 In the case of Team Report. London: The
high-technology sectors, this can be seen in Stationery Office.
78. This initiative supported
the increasing importance of organisational 62 projects, involving 575
and business model innovation – sometimes suppliers employing 160,000
people; see Department
5. Recommendations: The UK needs drawing on innovations developed in services for Business, Enterprise
Total Innovation Strategies for high- sectors – and in the use of new materials and Regulatory Reform
(2008) ‘Report on the
value-added sectors to retain its originally developed in other high-technology Business Environment for
competitive advantage areas. Japanese Automotive Supply
Companies in the UK.’
London: BERR.
5.1 Innovation policy should be focused 5.3 The changing nature of traditional 79. See section 6.3, National
on business growth, embracing total innovation and the demands of total Endowment for Science,
Technology and the Arts
innovation innovation require stronger and broader (2007) ‘Hidden Innovation.’
The focus of innovation policy should shift skills London: NESTA.
80. See National Endowment
from supporting research to stimulating wider Of course, the performance of high-technology for Science, Technology
innovative activities as they contribute to sectors in the UK will be undermined if there and the Arts (2005) ‘Real
Science, Encouraging
business growth. is an undersupply of people skilled in science, Experimentation and
technology, engineering and mathematics Investigation in School
Science Learning.’ London:
It is much easier for firms to find support for (STEM). More students need to be inspired to NESTA; and National
more traditional research and technology study these subjects, and STEM careers must Endowment for Science,
Technology and the Arts
projects than for innovative business models, present an attractive alternative to employment (2007) ‘Science: An Engine
novel services or risk-sharing partnerships. in other sectors. This means developing of Innovation.’ London:
Increasingly, combining these with more more teachers who can teach these subjects
traditional forms of innovation will prove creatively, increasing the use of ‘enquiry-based
integral to winning the ‘race to the top’, rather learning’ (discovery through experimentation),
than being additional to it. and continuing to improve how the value and
importance of STEM careers is communicated
5.2 This will require an extension of sector- to students.80
focused innovation policy
Total innovation reinforces the importance But narrow technical skills are not sufficient
of sector-focused interventions. Technology for total innovation. Education and training
roadmaps, support for specific emerging must develop the capabilities necessary for
technologies and strategic alliances within contemporary innovation, specifically more
industries can all help to stimulate and support interdisciplinary skills and stronger strategic
longer-term innovation in disruptive areas. business skills.

Such intervention exists in aerospace and As one of its projects, the new UK Commission
electronics, to some extent, but it rarely for Employment and Skills (UKCES) should
seeks to stimulate or support wider forms of build on the work of the sector skills councils

to provide government with an analysis from automotive, there should be more strategic
the perspective of industry regarding the funding in low-carbon technologies. The recent
extent and quality of ‘innovation-ready’ skills King Review of low-carbon cars recommended
in the UK, and advise on how the education, bringing existing low-emission technologies
training and skills systems across the UK might from ‘the shelf to the showroom’ as quickly
be improved to ensure the better development as possible by: ensuring a market for low
of these skills.81 emission vehicles; moving the short-term focus
back to automotive technology from biofuels;
Further, universities and colleges should developing the UK as a location for high
consider how they can provide students technology companies in the field, with good
with greater opportunities to develop businesses support mechanisms encouraging
interdisciplinary skills and awareness, for inward investment and supporting key areas
example drawing on approaches such as of underpinning science and engineering.83
81. The UKCES is intended NESTA’s Crucible and Universities United The Technology Strategy Board Low Carbon
to play a critical part in
securing a highly skilled, initiatives.82 Vehicles Integrated Delivery Programme should
productive workforce and provide greater coordination of activities
increasing employment
levels, particularly for 5.4 Innovation policy needs to prompt firms from university research to future potential
those from disadvantaged to anticipate – and benefit from – coming procurement opportunities, speeding up
backgrounds. It will:
advise government on disruptions in high-technology sectors the time it takes to get low-carbon vehicle
strategy and policies As we have seen, many high-technology technologies into the marketplace.
relating to employment
and skills; assess progress sectors are increasingly experiencing rapid
towards achieving national changes, in scientific and technological 5.6 These new demands on innovation
employment and skills
ambitions for 2020; and knowledge and in their industrial structures. policy require greater coordination
have responsibility for the Given the breadth of policies that affect
performance of Sector
Skills Councils, advising Innovation policy needs to be better informed innovation, there is a need for their better
government on re-licensing. by these changes. This is why ‘roadmapping’ coordination. For example, in pharmaceuticals,
82. Crucible offers early-career can be so valuable. For example, the the better coordination of science funding with
researchers in science,
technology, engineering Knowledge Transfer Network (KTN) in Digital regulation and procurement would provide a
and social sciences an Communications – established in December more informed balance between short-term
opportunity to develop
new collaborations across 2007 covering the telecommunications, IT and drug price containment and the social and
disciplines; Universities broadcasting sectors – aims to identify new economic benefits from radical new approaches
United is a pilot project
to test an interdisciplinary and emerging technologies and the future to the development of drugs.
approach to innovation capabilities needed within the sector to ensure
with a particular focus in
developing innovations for that competitive advantages are realised for In automotive, as noted, regulation can play
social benefit. the UK. a role in stimulating innovation that reduces
83. HM Treasury (2007)
‘The King Review Part I: emissions, alongside direct support for
The Potential for CO2 Firms should be encouraged to explore new increased research. Yet according to one study
Reduction.’ London: The
Stationery Office; HM business models, organisational forms and ways for government: “Uncertainty as to the likely
Treasury (2008) ‘The King of working, to prepare for and profit from these strength of long-term policy for CO2 reduction
Review of Low-Carbon Cars,
Part II: Recommendations changes. in the transport sector means automotive and
for Action.’ London: The fuel companies are uncertain as to the priority
Stationery Office.
5.5 Policy needs to stimulate socially- to attach to carbon reduction/fuel efficiency
84. E4tech (2007) ‘A Review of
the UK Innovation System desired innovations goals relative to other objectives.”84
for Low Carbon Road Innovative approaches are needed to
Transport Technologies, A
Report for the Department encourage socially desirable innovations that 5.7 Government and industry should
of Transport.’ London: may not have a direct economic benefit. develop Total Innovation Strategies for
In pharmaceuticals, the under-supply of strategic industries
development in drugs for diseases that The UK needs to invest in its strategically
primarily afflict poorer countries could be met important industries. These are the UK’s current
by ‘advance commitments’ by governments high-value-added industries and those that
and international agencies. This would are identified as having the realistic potential
involve promises to purchase a given quantity to become high-value-added – our ‘innovation
of a treatment for diseases like malaria or edge’. ‘Investment’ in this context means
tuberculosis that otherwise would attract very economic and political commitment to their
little investment. development.

Equally, innovation policy and regulation The UK must develop comprehensive strategies
in aerospace, automotive and electronics for these industries. These strategies should
hardware could be better used to meet be comprised of three main elements. They
environmental challenges. For example, in should chart likely changes in the environment

in which these industries operate: present or -- Reviewing how current funding,
coming changes in knowledge, technology, interventions and regulations at UK-
trade, demographics and industrial structure wide, national and regional levels are
that have bearing on competitive strategy related – including support for R&D,
or socially-desired outcomes.85 Industry university research, business support,
and government should then apply this public procurement, skills development,
understanding to the UK’s current positioning and trade policy and development.
and identify a small number of likely routes to
competitive advantage. Finally, these strategies -- Establishing mechanisms for the better
should lay out a plan for passive and active coordination of these elements where
government support, primarily centred around there are tensions or contradictions.
the need for greater coordination of policy.
−−Extending current policy mechanisms:
Two sectors have already benefited from
coordinated strategies. As noted, the National -- Commissioning foresight exercises to
Aerospace Technology Strategy (NATS) is stimulate thinking on the new business
identifying, researching and validating ‘key’ models and organisational forms that are
and ‘enabling’ technologies. But NATS, likely to be required in these industries.
however important, is not a national aerospace
strategy, in the sense of a broader vision -- Integrating innovation in business
beyond technology research and development. models, organisational forms and
processes into current mechanisms,
More comprehensively, the Defence Industrial such as the TSB’s Innovation Platforms
Strategy and the subsequent Defence or regional initiatives that seek to
Technology Strategy lay out a long-term, strengthen supply chain firms.
integrated strategy for the sector. The strategy 85. Foundations for this
work already exist or are
encompasses research and technology -- Engaging public and private finance ongoing in some areas.
development, government procurement, to invest in the development of UK Where appropriate, this
work should build on the
education, skills and training needs, improving strengths in these areas. Innovation and Growth
innovation in supply chains, and through-life Teams (IGTs), established
by the former DTI. Similarly,
capability management. These strategies are These strategies should be led jointly by DIUS government has recently
based on a detailed analysis of the defence and BERR, but will demand ongoing industry announced a new IGT for
the UK automotive industry,
industry capabilities we need to retain in the engagement. in particular to explore
UK, with changing needs and increased foreign how it should respond to
low-cost competition and
competition. Collectively, these strategies should represent the move to low-carbon
the UK’s national mission for innovation. transport; see Department
for Business, Enterprise
DIUS, BERR, HM Treasury, the TSB, devolved and Regulatory Reform
administrations and relevant agencies such as 5.8 Policy should be informed by new (2008) ‘Business Minister
Shriti Vadera Announces
regulators and sector skills councils, should measurements that capture total innovation New Investigation into
work jointly with industry to develop Total The extent and importance of hidden Automotive Industry.’ Press
release, 7th April. London:
Innovation Strategies for each strategic innovation in these research-intensive sectors BERR.
industry. These strategies should derive from demonstrates the inadequacy of relying on
the following activities: research-focused indicators alone.

• Charting: Deep analysis of the global threats In firms, the increasing importance of total
and opportunities facing each industry, given innovation makes current indicators such as
the likely changes in the environment for formal R&D spend increasingly unhelpful
these industries. as a guide to innovative performance and
hence business growth. This is because much
• Relating: Determining how the UK can investment in technological innovation is not
respond to maximise its competitive recorded under the official definition of R&D –
advantages in these industries, given our excluded activities include more developmental
current strengths and our ability to respond. and applied forms of innovation, the innovative
re-use of technologies, and ‘micro’ innovations.
• Responding to ensure that the UK is best As we have seen, new organisational forms
placed to maximise these advantages, by: and business models are not registered as
investments and the contributions of smaller
−−Aligning current policy mechanisms: innovative firms are also often excluded.

In policy, the focus on R&D as a proxy for • licensing of UK firms’ IP in electronics and
national performance obscures a focus on of the value added from strategic alliances,
business growth from innovation and the wider partnerships and collaborations; and
set of factors that shapes innovation by firms.
These include regulation, public procurement, • innovations in software development
and education and skills policy. processes, such as Agile and Lean
approaches, or in how services are delivered
This will require a new set of indicators to such as Software as a service.
guide policy. These will need to be broader and
more meaningful than current indicators. Fourth, there could be greater prominence
given to measures of customer satisfaction and
First, R&D and other indicators related to how these relate to new products or services.
research will remain important, but only as part This is important in product-focused sectors
of a broader set of measures, and understood such as aerospace and automotive, where the
in terms of their relative significance for quality of the ‘final’ product delivered can be
each sector, which of course varies greatly. below customer expectations. But it may be
Research-focused indicators could also be even more critical for service-focused sectors
more specific; for example, such measures or sub-sectors; one measure might be the
could track progress in selected, strategically degree to which new software and systems
important areas for innovation, against agreed have contributed to customers’ performance
‘technology roadmaps’. in software. (Indeed, there has been a trend
in the software sector towards ‘value-based
Second, more indicators need to be developed pricing’ whereby suppliers are rewarded with a
for forms of hidden innovation such as services, percentage of client revenues generated as a
new organisational forms and business models. result of new software and systems).
Cross-sector surveys such as the Community
Innovation Survey should record levels of Finally, it would be useful to incorporate social
investments in innovation in these activities, and environmental performance outputs as
to provide a more accurate and comprehensive measures of innovative performance. For
picture. example, in aerospace and automotive, these
could include progress against reductions in
Third, policy requires more suitable and emissions and fuel consumption.
accurate indicators to assess the strength of
business performance in higher-value-added Such measures will be considered as part of
sectors. Such wider ‘health check’ indicators NESTA’s work on a new Innovation Index for
could also provide benchmarks for national the UK.

Unsurprisingly, many firms in these sectors

have adopted broader indicators to track their
own innovative performance. These can include
the number of ideas generated, developed,
refined and delivered, and the returns they
generate; and revenues from new or innovative
services. Industry-led surveys also illustrate
useful indicators that could be included in
these health checks, such as:

• the speed and success at which a firm is

able to advance drugs through phases of
development in pharmaceuticals;

• the adoption of and performance in Lean

manufacturing techniques in aerospace and

• ‘reduced cycle time’ for product development

projects in telecommunications;

Appendix A: Pharmaceuticals
Innovation through large-scale investments in research but undergoing
radical changes that challenge the traditional ‘pipeline’ model

1. Pharmaceuticals are a major export The UK is also an important centre of

earning sector for the UK bioprocessing (the manufacturing sub-sector). 86. Office for National Statistics
(2006) ‘United Kingdom
Major processing sites in the UK include Input-Output Analyses, 2006
The pharmaceutical sector makes a large Merseyside (Lilly), Merseyside (Powderject, Edition.’ London: Office for
National Statistics.
contribution to the UK economy, with a gross now part of Novartis), and Teesside (Avecia). 87. Pharmaceutical Industry
value added (GVA) of £6.5 billion in 2004, Once again, the UK is second only to the Competitiveness Task Force
(2006) ‘Competitiveness
or 6.2 per cent of total UK GVA.86 The UK US.93 There are 22 biopharmaceutical contract and Performance Indicators
sector was the world’s fourth largest in 2002 manufacturing organisations (CMOs) in the 2005.’ London: PICTF.
in terms of GVA (the latest year for which UK, generating annual revenues of over $150 88. The Association of British
Pharmaceutical Industry
internationally comparable data are available).87 million.94 This is equivalent to approximately 6 (2006) ‘Annual Review.’
The UK pharmaceutical industry directly per cent of the global biopharmaceutical CMO London: ABPI.
89. Pharmaceutical Industry
employed 73,000 people in 2004, 27,000 in market. The UK has major firms such as Avecia, Competitiveness Task Force
‘R&D employment’. Lonza and Cobra, alongside a host of smaller (2005) ‘Competitiveness
and Performance Indicators
firms. 2005.’ London: PICTF.
Pharmaceutical exports in 2006 were £13.8 90. Paraxel Publishing (2006)
billion, with a trade surplus of £4.3 billion.88 ‘Bio/Pharmaceutical R&D
Statistical Sourcebook
Of the major medicines sold in the UK, around 2006/2007.’ Waltham, MA:
half were developed in domestic laboratories. 2. Innovation in pharmaceuticals is Paraxel Publishing.
Furthermore, the UK is second only to the US undergoing radical change in research 91. Biopharmaceuticals are
drugs produced using
in global medicines brought to market between and in new business models and biotechnology, see
2000 and 2004.89 UK firms were responsible organisation forms 92. bioProcessUK (2007)
‘bioProcessUK Annual
for 17 (23 per cent) of the world’s 75 top- Review 2007.’ London:
selling drugs in 2003 and 19 per cent of the 2.1 Pharmaceutical is far less linear than is bioProcessUK.
total value of global sales of those medicines, often supposed and the nature of research 93. Ibid.
94. Ibid. Revenue and market
second only to the US in both cases.90 in the sector is changing rapidly share data relates to 2006.

The two major UK firms are GlaxoSmithKline 2.1.1 Innovation in pharmaceuticals still
(GSK) and AstraZeneca. The US-headquartered requires very large upfront investments in
Pfizer, the world’s largest pharmaceutical firm, research and development
discovered four of its ten best-selling drugs at Developing a new medicine takes on average
its European R&D headquarters in Sandwich, 10-15 years and costs more than £550 million
Kent (the only foreign site for R&D established (often more than £120 million for a specific
by the firm). The North West and the South drug and more than £400 million in capital
East are particular centres of drug research and costs and other failed drugs). Furthermore,
development. before it is authorised for use, a drug has to
undergo a long and complex process of testing
In biopharmaceuticals,91 there are 46 UK (see 2.1.2).
companies and five non-UK companies
developing products.92 Again, the UK is second Given the expenditures involved and the very
to the US (although Germany is catching-up low success rate in developing successful
quickly). new drugs, innovation in the sector is very
high-risk. The ‘blockbuster model’ describes

the balance between risk and reward: only ‘Lead’ compounds go through a series
a few, very successful products support the of tests to provide an early assessment
development costs for all products. So-called of pharmacological activity, in particular
‘blockbuster’ drugs are those with peak annual pharmacodynamics (the way the compound
global sales of more than $1 billion. Even then, affects the body) and pharmacokinetics (the
such drugs are likely to have no more than ten way it is processed by the body). The studies
years in the market to recoup development are performed in living cells, in animals and
costs and become profitable. Once their patent increasingly, using computational models.
protection period ends, generic competitors
can enter the market with resulting large price In all, the discovery phase takes several years
and market share falls for a drug’s developer. of intensive work. After starting with between
To balance their exposure to risk, large firms 5,000-10,000 compounds, researchers are left
typically maintain a portfolio of around 50-100 with between one and five candidate drugs to
95. Based on a study of the top projects for which they continually assess the be studied in clinical trials.
850 UK spenders on R&D.
Department for Innovation, scientific, medical and commercial viability of
Universities and Skills/ their portfolios. During development, drugs normally undergo
Department for Business,
Enterprise and Regulatory substantial testing, including clinical trials,
Reform (2007) ‘The 2007 For these reasons, pharmaceuticals are the manufacturing experiments and outcomes
R&D Scoreboard.’ London:
DIUS/BERR. most research-intensive large-scale sector research, before they can be authorised for use.
96. Department for Innovation, in the UK economy, with an R&D intensity The clinical trials activity typically represents
Universities and Skills/ of more than 15 per cent. They account for the largest share of R&D costs (more than 40
Department for Business,
Enterprise and Regulatory 35.5 per cent of R&D in the UK, three times per cent), while the discovery and pre-clinical
Reform (2007) ‘The 2007 as much as aerospace. UK pharmaceutical phase represents only a quarter.100
R&D Scoreboard.’ London:
DIUS/BERR. and biotechnology firms invested £7.4 billion
97. Pharmaceutical Industry globally in R&D in 2006, equivalent to £20 Pre-clinical testing in animals follows the
Competitiveness Task Force
(2005) ‘Competitiveness million a day (£9 million of it in the UK).95 The discovery phase. If a project is pursued beyond
and Performance Indicators biggest global spenders in terms of UK firms this point, costs increase markedly because
2005.’ London: PICTF.
were GSK (£3.46 billion) and AstraZeneca testing in humans is riskier and far more
98. Department for Innovation,
Universities and Skills/ (£1.99 billion); they dominate R&D by UK firms expensive. Only about 20 per cent of drugs
Department for Business, in the sector (representing 73 per cent of all that enter the first phase of testing (there
Enterprise and Regulatory
Reform (2007) ‘The 2007 spend).96 are three over several years) are eventually
R&D Scoreboard.’ London: approved for sale.
99. For more details about this
Only the US and Japan have higher R&D
process, see US Food and spending in pharmaceuticals; the UK represents Even if a drug makes it through these different
Drug Administration, Center
for Drug Evaluation and
around 9 per cent of world pharmaceutical phases (around a 4 per cent chance) there is
Research (1999) ‘From Test R&D, more than double the 4 per cent of the no guarantee that it will be approved for sale.
Tube to Patient: Improving
Health Through Human
global market for medicines represented by the The information gathered through the entire
Drugs.’ Washington, DC: US UK.97 The largest spender on R&D in the world process is compiled in a regulatory dossier
Government Printing Office.
is the American pharmaceutical firm Pfizer that is submitted to authorities around the
100. The Association of the
British Pharmaceutical (£3.88 billion a year).98 world. These bodies consider the evidence
Industry (2007) ‘Investing presented, listening to opinions and advice
in the Future 2007.’
London: ABPI. 2.1.2 New drugs progress through a staged from independent experts, patient interest
process of discovery, development and groups and other stakeholders before deciding
testing whether the drug can be authorised for use.
The model of pharmaceutical innovation has
traditionally been divided into several stages During the final stages of development, firms
of experimentation, information gathering and begin the process of scaling-up manufacturing
development (hence the assumption that it capacity to ensure that the new drug can be
represents a linear model of innovation).99 produced immediately following approval
(by for example building new facilities or
In the ‘pre-discovery’ stage, researchers work reconstructing old ones because the process
to understand the mistakes in the complex differs from drug to drug). Given that a drug
molecular reactions (chemical pathways) can still fail in late-stage development or
which cause diseases. They try to identify and not be approved for sale by regulators, this
validate the drug ‘target’ (the step within the manufacturing development also carries a
molecular pathway which when altered would significant investment risk.
make a drug effective in treating a condition).
They then try to identify the right molecule
(candidate drug) for this target.

2.1.3 The research-intensive nature of are made at each stage based on business
innovation in pharmaceuticals has been projections. 101. Attridge, J. (2006)
reflected by the traditional industrial Innovation Models in the
Biopharmaceuticals Sector.
structure in the sector Second, the linear model fails to take adequate Discussion Paper 2. In
Until the early 1980s, the pharmaceutical account of the final phase of the innovation Atun, R. (ed.) ‘Innovation
in Life Sciences: A
sector was characterised in effect only by process, that of achieving timely market Multidisciplinary
large, vertically-integrated commercial firms. diffusion and adoption to benefit patients.101 Perspective.’ London:
Tanaka Business School,
These firms were responsible for the discovery Firms such as Wyeth and Novartis are moving Imperial College London.
of chemicals, clinical development, and drug to a ‘learn and confirm’ view of pharmaceutical 102. This is why it is misleading
to focus on a simplistic
marketing and distribution. Many firms had research and development, recognising that ‘breakthrough’ versus
roots in the chemical industry and were the key requirement is to provide the evidence ‘me-too’ distinction, as
has been the case in some
located in countries with historic strengths in needed for regulators to feel confident in studies; for example, it has
chemicals, notably Germany, Switzerland, the approving a new drug. This was also inherent been suggested that only
27% of biopharmaceuticals
US, and the UK. in the blockbuster model; large firms were the provide ‘some advance’
only ones with the necessary competencies and only 10% of all
other drugs, see Arundel,
Firms required – and could afford – large- to manage large-scale clinical trials, gain A., and Mintzes, B.
scale industrial R&D labs. This reflected the regulatory approval, and market and distribute (2004) ‘The Benefits
of Biopharmaceuticals.’
magnitude of both the research opportunities drugs. Innogen Working Paper
and of unmet needs, but also the need for 14. Version 2.0. Edinburgh:
Innogen, University of
scale to absorb the risks of drug development. Neglecting these factors helps to privilege Edinburgh.
There were many diseases for which no drugs ‘breakthrough’ over so-called ‘me-too’ drugs.102 103. Swan, J., Robertson, M.,
had previously existed. Faced with a target-rich Yet incremental or ‘continuous’ innovation Bresnen, M., and Newell,
S. (2006) ‘The Evolution
environment but with little detailed knowledge is as important as breakthrough innovation. of Biomedical Knowledge:
of the biological underpinnings of diseases, Later members of a product class are often Interactive Innovation in
the UK and US.’ Swindon:
firms developed an approach now referred the best all-round product, because practice Economic and Social
to as ‘random screening’, by which natural has helped to improve effectiveness through Research Council.
104. Sheridan, D. (2006)
and chemically derived compounds were better formulations, a better understanding of Development
randomly screened in test tube experiments how to use drugs and the patient groups that and Innovation in
Cardiovascular Medicine.
and laboratory animals for potential therapeutic will benefit from them, and how they might be Discussion Paper 3. In
responses. Strong patent protection in most used to treat other diseases. Such innovations Atun, R. (ed.) ‘Innovation
in Life Sciences: A
major world markets, in addition to barriers can emerge long after initial discovery through Multidisciplinary
to entry from regulations, enabled firms to a more interactive innovation process between Perspective.’ London:
Tanaka Business School,
earn favourable returns for their large R&D research scientists, clinicians and experts from Imperial College London.
investments. other fields (who can better identify other 105. Antithrombotic Trialists’
uses).103 One example is the developments in Collaboration (2002)
Collaborative Meta-
Meanwhile, non-profit institutions such as understanding of how to use existing drugs in analysis of Randomised
universities and public research laboratories cardiovascular medicine; aspirin, streptokinase, Trials of Antiplatelet
Therapy for Prevention
produced basic research in chemistry and and ß-blockers were not considered for the of Death, Myocardial
the life sciences. Broadly, these institutions diseases for which they are now associated for Infarction, and Stroke in
High Risk Patients. ‘British
engaged in ‘open science’, with their years or even decades following their initial Medical Journal.’ 324,
unpatented outputs published in scientific introduction.104 Such drugs may still be under- pp.71-86.
106. Hopkins, M., Martin, P.
journals. Such researchers competed for grants exploited; one study has estimated that 40,000 A., Nightingale, P., Kraft,
but rarely had commercial interests. The lives could be saved worldwide – 3,000 in the A., and Mahdi, S. (2007)
The Myth of the Biotech
commercial and publicly-funded sectors were UK alone – from the greater use of aspirin.105 Revolution: An Assessment
largely distinct, the former focusing on applied of Technological, Clinical
and Organisational
research with commercial uses and the latter Similarly, in the biotechnology sector, a more Change. ‘Research Policy.’
on basic, curiosity-driven research – although accurate understanding of innovation would 36 (4), pp.566-589.
there were often significant relationships be as a slow and incremental process of 107. Attridge, J. (2006)
Innovation Models in the
between the two. technology diffusion rather than one of radical Biopharmaceuticals Sector.
breakthroughs.106 Such issues are not merely of Discussion Paper 2. In
Atun, R. (ed.) ‘Innovation
2.1.4 However, ‘traditional’ innovation in academic interest; they can play a critical role in Life Sciences: A
pharmaceuticals is changing rapidly as a in shaping the policies of large state purchasers Multidisciplinary
Perspective.’ London:
result of new knowledge, technologies and who use such classifications to determine Tanaka Business School,
approaches whether or not they will reimburse a new Imperial College London.
product and at what price.107 (See 6.3). Despite its highly research-intensive
nature, the linearity of pharmaceutical Biological approaches represent a new
innovation has often been overstated paradigm for drug discovery
First, innovation in pharmaceuticals is cyclical This new paradigm is the result of advances in
and business-driven. Investment decisions life sciences and genetics. Most important are

the development of techniques to analyse and ‘Rational drug design’ (also known as
manipulate genetic materials, and the impact ‘structure-based drug design’) rather
of the revolution in molecular biology. This than random screening has now become
has led to an increasing convergence between the dominant approach to research in the
traditional medicinal chemistry and the new commercial sector. This approach targets a
biological knowledge. specific biological activity and identifies or
creates a molecule involved in that activity.
Biopharmaceuticals are medical drugs produced This requires greater understanding of biology
using biotechnology (that is, technology that and fundamental mechanisms. Firms build
uses biological systems or living organisms computer models of design targets and then
to make or modify products or processes), analyse the shape and other characteristics that
as opposed to traditional chemically derived likely drug molecules should have in order to
drugs. Biopharmaceuticals fall into a number interact with the target.
of different product classes. These include
recombinant human proteins (the largest Understanding human genetics is now a
group), recombinant human antibodies, major part of drug discovery
vaccines, gene therapies, and cell and tissue We now know that many diseases can be linked
therapies. to genetics. The information gathered through
the successful mapping and sequencing of the
Biopharmaceuticals represent an increasingly human genome is playing a vital role in the
significant proportion of drugs in development. discovery process, helping to identify areas for
They account for more than 10 per cent of scientific exploration and potentially allowing
current pharmaceutical sales worldwide but medicines to be customised to groups of
more than a third of drugs in development.108 people or even individuals. Pharmacogenetics
A number of biopharmaceuticals are now can help to identify whether an individual’s
108. bioProcessUK (2007) classed as ‘blockbuster’ drugs. In 2005, Epogen genetic make-up could prevent them from
‘bioProcessUK Annual
Review 2007.’ London: (recombinant human erythropoietin) was the benefiting from a drug. But this also adds
bioProcessUK. biggest selling biopharmaceutical with sales complexity to existing development.
over $3 billion, while Humira became the first
UK discovered antibody product to achieve Manufacturing many drugs has become
blockbuster status with sales of $1.4 billion (in much more complex
2007 sales had risen to $3.1 billion). Although bioprocessing (or biomanufacturing)
was already applied to the manufacture of
Biopharmaceuticals are far more complex to medicines like penicillin and other antibiotics
develop and synthesise, as they require the derived from naturally occurring bacteria, the
integration of different disciplines, research breakthrough necessary for its systematic
areas and techniques. At the same time, this application was the development of
makes them attractive to pharmaceutical firms, recombinant DNA. This makes it possible to
as it is harder for generic competitors to copy insert DNA encoding for a particular protein
the technologies. into a bacterium or mammalian cell line and
induce it to produce the desired product. There is increasing use of automation The first product based on such genetic
and other process innovations engineering, human insulin or Humulin, was
The industry is as much concerned with launched in 1981.
establishing the methods by which new
drugs can be industrialised as with the drugs Since then, genetic engineering of bacterial,
themselves. Finding the optimal formulation viral, yeast and mammalian cells has given
continues to be a key part of every R&D rise to a broad range of biopharmaceuticals.
project. Manufacturing even the least sophisticated
biopharmaceutical is fundamentally different
Increasing automation has already replaced and far more complex than manufacturing
laborious or time-consuming manual processes, conventional (small molecule) drugs.
reducing costs and greatly improving Environmental factors such as temperature,
throughput. In the past, a chemist might have pressure and growth medium must be tightly
been able to produce between 50 and 100 controlled and consistent to ensure the same
new chemical compounds a year. Using new product is produced each time. This is why one-
techniques and computer-controlled robots, he fifth of the value of a biopharmaceutical drug
or she can produce nearly half a million a week. derives from the wider supply chain (including
raw materials, production and distribution).

109. Coombs, R., and Metcalfe, University research and knowledge are 2.2 Organisational and business model J. S. (2002) Innovation
increasingly being commercialised innovation have become integral to in Pharmaceuticals:
Perspectives on the
These new approaches have often been led innovation in pharmaceuticals Coordination, Combination
by universities, public laboratories, spin-out and Creation of
Capabilities. ‘Technology
and start-up firms (see 2.2.1), facilitated by 2.2.1 The growth in scientific understanding Analysis & Strategic
changes in intellectual property rights (3.5), encouraged a major change in industry Management.’ 14 (3),
funded by the increased availability of venture structure in the shape of small new firms 110. Pharmaceutical patent
capital (3.6), and supported by firms in other A new business model emerged in the 1980s systems in OECD countries
offer twenty years
areas such as information technology and and 1990s: the specialised biotechnology firm. protection from imitators.
advanced materials.109 This has been mirrored As in many other sectors, innovation was first However, patents must
be secured at the time of
by the creation of incentives for scientists in pursued not by large incumbents but by much invention, and hence the
the non-profit sector to patent their work, smaller, new companies.114 These firms were less intervening years needed
for the development of
and has changed the world of open science risk-averse in selecting and pursuing research innovations normally
related to pharmaceutical research. The result projects.115 reduce the effective period
of protection to 10-12
is a much higher rate of collaboration and years.
knowledge transfer between the non-profit and Most were university spin-offs, usually formed 111. Cockburn, I. (2006) Is the
commercial sectors, and a greater similarity of through collaborations between scientists Pharmaceutical Industry
in a Productivity Crisis? In
research style. and professional managers, and backed by Jaffe, A., Lerner, J., and
venture capital. Their specific skills resided in Stern, S. (eds.) ‘Innovation
Policy and the Economy.’
2.1.5 Despite these developments, there knowledge of the new techniques and in the 7, pp. 1-32.
have been increasing concerns about research capabilities in their specific areas. 112. Cockburn, I. (2006) Is the
Pharmaceutical Industry
declining productivity in a Productivity Crisis?
As more drugs are developed, the remaining Choosing the most appropriate business model In Jaffe, A., Lerner, J.,
and Stern, S. (eds.)
diseases are those that are most difficult to has been crucial for biotechnology firms.116 ‘Innovation Policy and the
understand and attack. They are also those for Although many firms were founded with the Economy.’ 7, pp. 1-32; also
Charles River Associates
which it is more difficult to develop new drugs. long-term aim of becoming large integrated (2004) ‘Innovation in the
At the turn of the millennium, despite the pharmaceutical producers (the vertical model), Pharmaceutical Sector.’
London: Charles River
overall growth in the pharmaceutical market, they often experienced organisational and Associates; Messinis,
many top-selling drugs were coming to the end financial constraints (for example, a lack of G. (2004) ‘R&D Price
Inflation, Real BERD
of their patent periods and faced competition experience and capacity to manage clinical and Innovation:
from generics.110 (Between 2001 and 2005, testing or marketing), and many have Pharmaceuticals, OECD
1980-2000.’ Working
branded drugs with total annual sales of $35 subsequently become specialised suppliers of Paper 18. Melbourne:
billion lost patent protection.) In addition, specific techniques and research projects. This Centre for Strategic
Economic Studies, Victoria
pharmaceutical firms have faced increased has created a kind of ‘feeder’ system of new University of Technology.
pressure on prices due to growing demands knowledge and techniques for the sector. 113. Charles River Associates
from governments, insurers and consumers to (2004) ‘Innovation in the
Pharmaceutical Sector.’
lower the costs of drugs. 2.2.2 Large pharmaceutical firms now London: Charles River
approach small, specialised suppliers Associates.
114. The first new
Many of these concerns have been based on as a further source of development biotechnology start-up,
an output measure of new drug launches, opportunities Genentech, was founded
in 1976 by Herbert Boyer,
but it has been suggested that much of the The industry has seen a large number of one of the scientists who
observed downturn in productivity is related to mergers and acquisitions in the last 20 years, developed the recombinant
DNA technique, and
flaws in this measure.111 Current performance with little increased productivity. Whilst these Robert Swanson, a venture
is not particularly low by historical standards, still occur, there has been a significant increase capitalist. Genentech
constituted the model for
factoring in a normal amount of volatility.112 in licensing deals, strategic alliances, and other most of the new firms.
Productivity measures have declined mostly forms of collaboration between firms of various 115. Guedj, I., and Scharfstein,
because of an increase in R&D spending that sizes in the commercial sector as an alternative D. (2004) ‘Organizational
Scope and Investment:
appears to be driven by escalating costs of to outright acquisition. Similarly, firms have Evidence from the Drug
drug development, particularly the need for sought to work more closely with the non- Development Strategies
and Performance of
large scale clinical trials. According to one profit sector (see 3.4). Biopharmaceutical Firms.’
study, from 1995-2005 there was a five-fold NBER Working Paper
10933. Cambridge,
increase in the costs of clinical development However, absorbing new knowledge and MA: National Bureau
and a 60 per cent increase in the real costs of approaches has sometimes proved difficult of Economic Research;
also Styhre, A. (2006)
preclinical development.113 The ‘crisis’ therefore for existing large pharmaceutical firms. It Science-based Innovation
amounts to a failure to increase the number could only be fully exploited through the as Systematic Risk-taking,
The Case of New Drug
of new products whilst overall resources being development of in-house capabilities, which Development. ‘European
invested globally have risen dramatically. made it possible to absorb and complement Journal of Innovation
Management.’ 9 (3), pp.
the knowledge supplied by small firms and 300-311.
universities. This has required radical changes 116. Lim, L. (2003) Bio-
Business Models.
in research procedures, a redefinition of the ‘Cambridge Manufacturing
Review.’ Winter, pp.7.

disciplinary boundaries within large firm firms, and have remained more closely linked
laboratories and some changes in divisional for longer to the cognitive and organisational
structures.117 For example, Pfizer has recently procedures that governed research when
announced the creation of a new biological chemistry constituted the main knowledge
unit that will operate outside of its main R&D base.118 This may have produced a vicious
organisation, although partnering with it. circle, since new biotechnology firms have
sometimes lacked an essential source of
Large European firms have been slower to survival and growth through collaborative
adopt molecular biology compared to US agreements with larger firms.

GlaxoSmithKline Centres for Excellence centralised research groups to identify drug

in Drug Discovery targets and lead compounds (potential
medicines), but these groups are not
GlaxoSmithKline (GSK) created six Centres required to accept these compounds and
for Excellence in Drug Discovery (CEDDs) can deal with external firms to license other
117. Coombs, R., and Metcalfe, in 2000, each focusing on a specific promising lead compounds. The CEDDs
J. S. (2002) Innovation
in Pharmaceuticals: therapeutic area. GSK divided its then assume responsibility for projects once
Perspectives on the 1,900 scientists between these units. they reach the lead optimisation stage.
Coordination, Combination
and Creation of They can also work together, for example
Capabilities. ‘Technology The aim was to improve productivity, where a candidate compound appears to be
Analysis & Strategic
Management.’ 14 (3), especially given the ‘decline’ of the effective against multiple targets. The first
pp.261-271. blockbuster model of development. point at which the process is centralised is
118. McKelvey, M., and
Orsenigo, L. (2001)
Specifically, to maximise the advantages of in development.
‘Pharmaceuticals as scale at the beginning of development (the
a Sectoral Innovation
System.’ Göteborg/
search for validated targets) and at the end This model also incentivises research
Brescia/Milan: Chalmers (the management of large-scale trials and scientists. Previously, scientists were
University/University of
Brescia/Bocconi University.
regulatory approval), while organising the recognised (but often not rewarded) for
119. Huckman, R. S., and middle of the process (converting promising finding targets. CEDDs bring scientists
Strick, E. P. (2005) compounds into viable products) with the more into the drug development process;
Reorganizing Drug flexibility and responsiveness of a smaller they are rewarded for being part of the
Discovery. ‘Harvard biotechnology firm.119 development of successful drugs (echoing
Business Review.’ May,
pp.1-21. the equity-based incentive structures of
120. GlaxoSmithKline (2008) Major pharmaceutical firms have typically small biotechnology firms).
‘Answering the Questions
that Matter, Annual Report
relied on centralised decision-making about
2007.’ Brentford: GSK. whether to progress projects, though this Given the very long lead times for drug
121. GlaxoSmithKline (2001) can be highly bureaucratic. The merger of development, the full impact of these
‘It’s About You, Annual
Report 2000.’ Brentford: Glaxo Wellcome and SmithKline Beecham organisational innovations is unlikely to be
GSK. presented an opportunity to restructure fully realised for many years. Nonetheless,
processes for the new combined firm. following these innovations, GSK has more
– and more radical – drugs in development.
Each CEDD is led by a senior vice-president In 2007, GSK had 157 projects in clinical
and contains no more than 350 scientists development, of which 118 were new
(mostly biologists and chemists but with chemical entities or vaccines; this included
some physicians and clinical researchers). 34 ‘key assets’ in late stage development.120
The size limitation is intended to support This compares to 2000, when the firm had
interaction and reduce bureaucracy. The 118 projects in clinical development, of
centres are structured around biological which only 77 were new chemical entities
therapeutic areas, focused on small sets or vaccines.121 In other words, GSK now has
of diseases or related disease mechanisms, the same number of radical new products
including: neurology; respiratory, in development as it had total products in
inflammation and respiratory pathogens; development just seven years earlier, with
and cardiovascular, cancer and urogenital. a more than 53 per cent increase in radical
new products. The firm now leads other
The CEDDs have relative autonomy; they large firms in terms of mid- to late-stage
can suggest attractive targets to two development of products.

2.2.3 Some large firms have adopted the more able than most firms to conduct studies
organisational forms of small firms on a multinational and multi-centre basis.
GSK has subsequently taken this model further.
Its Centre of Excellence for External Drug In recent years, the portfolio of services
Discovery (CEEDD), created in 2005, is a small offered by CROs has widened to include R&D
executive team accountable for delivering enabling technologies such as genomics, high
proof of concept molecules into late-stage throughput screening, and combinatorial
development through a network of external chemistry, using proprietary techniques
alliances. CEEDD in effect ‘virtualises’ a portion for which they often own the intellectual
of the drug discovery pipeline by acting as property rights. CROs can also offer post-
an ‘external’ CEDD. It is also responsible for commercialisation services such as sales and
accessing innovative approaches to drug marketing.
discovery, that is, for developing process
and organisational innovation, not just new 2.2.5 Open innovation is changing the
products. concept of a firm’s innovation capacity
Finally, the internet has enabled new means of
This approach may represent the dominant sourcing innovation. Firms like Innocentive and
model for the rest of the sector in a few years’ Nine Sigma offer innovation brokering services,
time. By 2015, large pharmaceutical firms are giving pharmaceutical firms access to tens of
likely to focus more on core competencies thousands of creative minds in the search for 122. Business Insights (2005)
‘The Pharmaceutical
such as sales and marketing, supported by a solutions to the challenges of drug discovery. Market Outlook to 2015,
network of R&D organisations including long- Similarly, Imaginatik (a UK firm) is a leading Implementing Innovative,
Long-term Strategies
term relationships with biotechnology firms.122 provider of innovation and collaborative for Sustainable Future
An alternative vision is that firms diversify problem-solving software and processes; Pfizer Growth.’ London: Business
into selling not just products but ‘healthcare has recently invested in the further expansion 123. IBM (2002) ‘Pharma
packages’ including diagnostic tests, drugs of the firm. 2010: The Threshold of
Innovation.’ Somers, New
and monitoring devices, offering personalised York: IBM.
‘targeted treatment solutions’ for patients (a The impact of this change is evident in the 124. Milne, C.-P., and Paquette,
reflection of the new biological foundations for approach taken by Procter & Gamble, who sold C. (2004) ‘Meeting the
Challenge of the Evolving
drug discovery and development).123 off the research arm of their pharmaceutical R&D Paradigm: What Role
business with the intention of sourcing for CROs?’ Boston: Tuft
Center for the Study of
2.2.4 Cost pressures in the sector have led development opportunities externally. Chorus, Drug Development.
to increased outsourcing of research and a firm set up by Eli Lilly to run high-speed 125. Business Insights
(2006) ‘Pharmaceutical
manufacturing proof of concept programmes on parts of Lilly’s Outsourcing Strategies,
Few firms still have large teams of in-house portfolio, manages its projects through a large Market Expansion,
Offshoring and Strategic
clinical researchers. Most rely on clinical network of external suppliers. The ability to Management in the CRO
research management organisations (CROs) coordinate the various contributions across and CMO Marketplace.’
London: Business Insights.
to run the clinical trials required for regulatory this network and provide strong knowledge
approval.124 CROs now account for more than leadership is central to success in this new
40 per cent of annual research spending by model.
firms, compared to just 4 per cent in the
early-1990s.125 Many of the leading CROs have
their European headquarters in the UK and
the UK has a number of world-class CROs of 3. Pharmaceutical innovation is
its own, but Eastern Europe also has a well- determined by many inter-related
developed infrastructure for outsourcing, and government policies that interact with
India and China are expected to account for a the innovation capacities of firms
significantly greater proportion of such work
over the next five years. 3.1 Regulation and public procurement play
a major role in shaping the conditions for
The role of CROs has grown rapidly as a result innovation
of the increasing pressure on pharmaceutical Access to quality, affordable healthcare is
firms to bring drugs to market more quickly increasing regarded as a human right. Medical
and the increased complexity of clinical trials knowledge is therefore seen as a ‘public
and regulatory submissions. The ability of good’. At the same time, pharmaceuticals are
CROs to cut clinical trial times by as much as a private, for-profit sector. As a consequence,
30 per cent has become critical to large firms, government is heavily involved in shaping the
especially given their concerns over R&D environment for innovation in pharmaceuticals,
productivity and generic competition. CROs are through regulation and procurement, but
also research funding and infrastructure (3.4)

and intellectual property rights (3.5). The and promoting innovation. Such agencies can
challenge of providing an attractive investment have different and often conflicting goals.
opportunity in a managed ‘public service’
market is one that is of increasing concern to The voice of the patient is also becoming a
pharmaceutical firms. more significant factor in the provision of
drugs, as evidenced by the public debate
The speed and efficiency with which drugs over the availability of Herceptin in 2006. An
pass through regulatory stages has a major apparently inconsistent policy of providing the
impact on the returns to pharmaceutical firms’ drug led to major protests, even though it had
investments. Every day that a product is not at that point been fully approved for use.
delayed reaching the market can result in $1-3
million in lost revenue.126 3.2 Firms invest in R&D in areas with the
greatest expected profits
126. PhRMA (2007) Government is not only a regulator; it is Firms’ decisions are informed by market
‘Drug Discovery
and Development, also the major purchaser in many countries, potential, which is in turn affected by
Understanding the R&D including the UK through the National regulation and public procurement, the
Process.’ Washington DC:
PhRMA. Health Service (NHS). Both regulation and prevalence of a particular disease, the quality
127. The PPRS was created procurement are major factors in shaping of existing treatments, and expectations about
by negotiation between the incentives for further investment in drug competing treatments and pricing. A 10 per
the government and the
pharmaceutical industry development. cent increase in demand for care in a particular
in 1957. It is normally therapeutic area is associated with a 5-8
renegotiated every five
years; the current scheme In the UK, under the terms of the current per cent increase in R&D spending.129 Firms
dates from 2005. However, Pharmaceutical Price Regulation Scheme also take into account technical feasibility,
the UK government
recently announced that it (PPRS), pharmaceutical firms have the freedom according to their investments in related
is renegotiating the PPRS to set launch prices of new drugs within an areas, their skills and knowledge, as well as
128. Pharmaceutical Industry overall cap on the rate of return they can earn the knowledge and skills of organisations
Competitiveness Task Force from all of their branded sales to the NHS.127 they can work with. Private R&D investment
(2005) ‘Competitiveness
and Performance Indicators This makes the UK a more attractive market can also follow non-profit investment, that is,
2005.’ London: PICTF. than countries where launch prices have to be the supply of knowledge from basic science
129. Ward, M., and Dranove, agreed in advance. However, UK expenditure research.
D. (1995) The Vertical
Chain of Research and on new drugs remains comparatively low.128
Development in the In 2004, 17 per cent of UK drug expenditure The imperative of showing a profit for investors
Pharmaceutical Industry.
‘Economic Inquiry.’ 33 (1), went on products launched during the previous means that, whilst firms do develop ‘orphan
pp.70-87. five years, a lower share than in all other drugs’ (treatments for rare diseases) some
130. This is particularly
pertinent given the
comparator countries except Japan (16 per drugs may not be developed due to limited
increase in clinical trials cent), and well below the 27 per cent in the potential returns. This has sometimes translated
taking place in poorer
countries for drugs that
US. to a lack of focus on diseases that primarily
are aimed primarily at affect people in poorer countries,130 a difficult
Western markets, see Shah,
S. (2006) ‘Body Hunters,
Governments must achieve a trade-off between issue for an industry that is charged with both
How the Drug Industry efficiency in public procurement and promoting shareholder return and public good.
Tests Its Products on the
World’s Poorest Patients.’
innovation and growth by pharmaceutical
New York: The New Press. firms. The benefits from new drugs are often 3.3 Skills gaps may inhibit innovation
131. The Association of British very difficult to quantify and can accrue over In the UK, there are skills gaps amongst
Pharmaceutical Industry
(2005) ‘Sustaining the a long period, despite the public pressure that graduates in a range of technical respects:
Skills Pipeline in the can build up to provide certain new drugs. adequate grounding in higher level
Pharmaceutical and
Biopharmaceutical Regulators also tend to focus on establishing mathematics amongst science graduates;
Industries.’ London: ABPI. the safety and efficacy (relative to the cost inadequate practical experience, particularly
132. SEMTA (2007) ‘Bioscience
Sector Skills Agreement
of purchase) of new products rather than in chemistry, in vivo disciplines, pathology,
Stage 3: Gap Analysis – encouraging investment in new product toxicology and engineering; chemistry and
UK.’ Watford: SEMTA.
development, despite a general acceptance the specialisations which build upon it; and
by many health agencies (including the UK computational analysis skills.131 Skills shortages
National Institute for Health and Clinical and gaps are particularly high in the bioscience
Excellence, NICE) that innovation should be area: the number of universities offering
rewarded with higher prices. bioscience-related subjects is declining; the
number of first degrees gained in bioscience-
In addition, in most countries at least two related subjects has declined over the last six
different public agencies are charged with the years, by 27 per cent in Biological Sciences
separate tasks of providing healthcare to a and 23 per cent in Chemistry; and only a small
country’s population, approving new products, minority of the graduates in these subjects
enter the bioscience industry or go onto

higher degrees in the subject.132 There are industry; inflated expectations of the value of
also related skills shortages in specific areas intellectual property rights (IPR) by academics 133. bioProcessUK (2006)
such as bioprocessing and biopharmaceutical or universities;138 a lack of administrative ‘bioProcessUK Annual
Review 2006.’ London:
formulation.133 support for academics; and excessive university bioProcessUK.
bureaucracy.139 134. Cogent (2007) ‘A Sector
Skills Agreement for
In addition, the UK sector has skills shortages the Cogent Sector UK.’
in non-technical respects: innovation and 3.5 Retaining intellectual property rights is Warrington: Cogent.
Cogent is the Sector Skills
business improvement techniques; change and crucial to ensuring returns on investment Council for the chemicals,
project management; health and safety; and for pharmaceutical firms pharmaceuticals, oil and
gas, nuclear, petroleum
management and leadership.134 Leaders and Two related issues that have been the subject and polymer sectors; these
managers need to be able to adopt a complete of considerable debate are intellectual property skills gaps run across these
value chain perspective of biopharmaceutical rights (IPR) in developing countries, and the
135. See bioProcessUK (2005)
commercialisation, and be committed to impact of expanding IPR on open science. ‘Developing Bioprocess
continuous improvement in bio-processing.135 Leaders Workshop.’
London: bioProcessUK.
First, several developing countries have 136. Furman, J., Kyle, M.,
Furthermore, given the rapidly changing nature decided to ignore IPR on major products. For Cockburn, I., and
Henderson, R. (2006)
of innovation in the sector, there is a lack of example, in 2007 Brazil moved to compulsory ‘Public & Private
strong interdisciplinary skills, for example, life licensing of Efavirenz, an AIDS drug produced Spillovers, Location
and the Productivity of
science graduates with sufficiently strong skills by Merck, after negotiations to lower the price Pharmaceutical Research
in mathematics and physical sciences. failed. Knowledge.’ NBER
Working Paper 12509.
Cambridge, MA: National
3.4 Universities, the research base Second, the expansion of patent protection Bureau of Economic
and research clusters are increasingly to include areas such as the genome, research
137. Zucker, L. G., and
supporting innovation tools, and other forms of scientific knowledge Darby, M. R. (1996) Star
As collaborations have grown, innovation in the has facilitated ‘markets for technology’ and Scientists and Institutional
Transformation: Patterns of
commercial sector has increasingly depended thus made possible small firms that specialise Invention and Innovation
on the research strengths of academic in one aspect of the drug development process. in the Formation of
the Biotechnology
institutions, especially following advances in However, there are concerns that science is Industry. ‘Proceedings
molecular biology. becoming increasingly commercialised and that of the National Academy
of Sciences.’ 93,
this may inhibit further research.140 Although pp.12709-12716.
Despite the global nature of the industry, some of these concerns might be overdone, 138. Jensen, R. A., Thursby,
J. G., and Thursby, M. C.
geography remains important. For example, the potential exists for exclusionary behaviour (2003) Disclosure and
commercial research labs located near to become more prevalent as the potential Licensing of University
Inventions: ‘The Best We
universities tend to be more productive, commercial returns to scientists increase. Can Do with the S**t
suggesting that these labs benefit from We Get to Work With.’
‘International Journal of
knowledge spillovers from their academic 3.6 Venture capital has helped to create Industrial Organization.’
neighbours.136 Some large European firms many new firms but with mixed success 21 (9), pp.1271-1300;
Thursby, J. G, and Thursby,
have chosen to locate research facilities in As we have seen, venture capital has been an M. C. (2003) Industry/
areas close to major academic institutions, increasingly important driver of R&D in the University Licensing:
Characteristics, Concerns
such as GSK in Research Triangle Park, North sector since the 1980s, particularly in the US and Issues from the
Carolina, near three major research universities, but also in the UK. However, attrition rates – Perspective of the Buyer.
‘The Journal of Technology
and Novartis in Cambridge, Massachusetts, through bankruptcy or merger and acquisition Transfer.’ 28 (3-4),
near Harvard and MIT. Similarly, commercial – have often been high. The relatively short- pp.207-13.
biotechnology has grown fastest in the Bay term view in the standard venture capital 139. Kleyn, D., Atun, R.,
and Kitney, R. (2006)
Area of California, where Stanford and two markets means that biotechnology firms which Partnerships and
major University of California campuses are focus on new products now tend to rely on Innovation in the Life
Sciences. Discussion
located, and Boston/Cambridge. large pharmaceutical firms to take drugs into Paper 8. In Atun,
clinical development. However, firms that have R. (ed.) ‘Innovation
in Life Sciences: A
The development of biotechnology firms in the ‘platform technologies’ rely on a broader range Multidisciplinary
US has been aided by two other advantages: of relationships which can be less secure; they Perspective.’ London:
Tanaka Business School,
legislation that facilitated the transfer of have often sold their technologies to major Imperial College London.
technology out of universities to commercial pharmaceutical firms at an early-stage of 140. Andrews, L., Paradise,
J., Holbrook, T., and
enterprises (the 1980 Bayh-Dole Act)137 and development. Bochneak, D. (2006),
a particularly well-developed venture capital When Patents Threaten
Science. ‘Science.’ 314,
industry (see 3.6). pp.1395-1396.

However, collaborations between industry

and universities can be undermined by factors
such as: an asymmetry of knowledge and skills
between partners; insufficient funding by

such as R&D and patents, given the complex
and overlapping network of collaborations and
4. Innovation is hidden because R&D alliances. There can at once be both double-
and patents do not capture broader counting and under-counting of inputs and
investments in innovation, especially in outputs. At present, there is little research on
a rapidly changing industry how the new industry structure compares to
the old model of vertical integration in terms of
4.1 Raw R&D counts do not translate total productivity.141
directly to firm productivity or success
In general, there is a positive relationship Furthermore, traditional R&D and patenting
between the number of patents owned by surveys can overlook the innovation taking
a pharmaceutical firm and the number of place in smaller and newer biotechnology firms,
drugs it ultimately launches. However, firms especially if they do not conduct much R&D.142
141. However, firms that are vary in their efficacy at drug development;
active in a broader range
of diseases appear to for instance, a firm may generate numerous 4.3 R&D indicators do not include
have higher productivity patents (because it provides incentives for therapeutic and social benefit
than focused firms,
see Cockburn, I., and researchers to patent as much as possible, or
Henderson, R. (2001) because they are located in countries that tend An additional problem with raw counts of R&D
Scale and Scope in Drug
Development: Unpacking to grant high levels of patents), but may not and patents is that they do not incorporate
the Advantages of launch many new drugs as a result of poor measures of therapeutic and social benefit.
Size in Pharmaceutical
Research. ‘Journal of management of clinical trials. (Productivity is As a result, they are problematic if used by
Health Economics.’ 20 (6), also challenging to measure in a sector where policymakers to evaluate existing policy. The
pp.1033-1057; Larger and
more experienced firms regulatory bodies have significant influence on difficulty is in identifying the marginal impact
seem best positioned to which products reach the market and the price of policy on the quality and social usefulness of
advance their projects
particularly in phase 3 that can be charged for them.) the outputs of drug development, and not just
clinical trials. on levels of R&D investment.
142. Lhuillery, S., Raffo, Investments in stronger capabilities in these
J., and Carpentier, C.
(2006) ‘Investigating areas are an example of a Type I hidden As the payers (the NHS in the UK) have looked
Data Sources for Biotech innovation – a complementary investment for more evidence of a drug’s social benefit, so
Firms Identification.’
OECD Workshop on in technological innovation. It is why narrow the discipline of Health Economics has become
Biotechnology Outputs measures such as levels of R&D investment, or more important to the sector. Assessing the
and Impacts. Paris 11th
December. Lausanne/ equally the number of patents generated, are impact that a new drug can have on society as
Paris/Paris: EPFL, CEMI/ often insufficient in capturing a firm’s capacity a whole has become as important as its clinical
CEPN, Université Paris
Nord/INPI, Paris. for innovation. efficacy in securing reimbursement.
143. PICTF was a joint
government and industry
task force established Given that the innovation process in
in 2000 to look at pharmaceuticals is actually far less linear than
ways of ensuring that
the UK remained an is often supposed, it is unwise to focus on one 5. Innovation could be better measured
attractive location for the year’s count of R&D investment compared by more detailed surveys
pharmaceutical industry.
See Pharmaceutical to another to compare innovative capacity.
Industry Competitiveness Knowledge and assets investments from the 5.1 A broader range of indicators can be
Task Force (2006)
‘Competitiveness and past – or developed through strategic alliances used to evaluate sector-wide performance
Performance Indicators and other collaborations – may assist a firm in The Pharmaceutical Industry Competitiveness
2005.’ London: PICTF.
Similarly, for the developing new products and bringing them Task Force (PICTF) developed a set of
biopharmaceutical sub- successfully to the market. This can also be indicators for sector-wide competitiveness
sector, see bioProcessUK
(2006) ‘bioProcessUK seen to represent a Type III hidden innovation – and performance.143 These cover a diverse
Annual Review 2006.’ the exploitation of largely existing technologies range of areas, from ‘supply conditions’ (such
London: bioProcessUK.
to support other forms of innovation. as the number of graduates with relevant
science degrees, total hourly labour costs
4.2 The changing industry structure versus comparator countries, and of course
confuses traditional metrics R&D spend), through ‘demand and regulatory
Innovations in organisational forms and conditions’ (including pharmaceutical sales as a
business models represent a Type II hidden proportion of GDP, time for regulatory approval
innovation. As suggested, these have been and from approval to launch), to ‘industry
important for large firms in particular in outputs’ (patents, UK firms’ share in major
adjusting to the changing nature of innovation markets, the trade balance and employment
in the pharmaceutical sector. levels).

Changes in industry structure have also made Similarly, a framework has been developed
it more difficult to rely on inputs and outputs for comparing the performance of national

‘biomedical innovation systems’, covering a Developing countries are increasingly being
range of indicators in ‘knowledge generation’ used for R&D activities, especially through
(such as patents), ‘knowledge diffusion’ the use of contract research organisations
(including the number of biomedical (CROs), particularly in Eastern Europe. These
technology alliances), and ‘knowledge use’, CROs benefit from more than low-cost patient
from early-stage (the market value of listed reimbursement. For example, patients in the
biomedical firms), to pre-product and post- region tend to be less medicated, reducing the
product development (the number of drugs risk of patients using competing medications
approved).144 Such a scorecard of measures and compromising the integrity of data.
helps to produce a more rounded picture of
national sector performance. Some rapidly developing countries are
emerging as major centres of R&D. The Indian
pharmaceuticals sector is developing strongly,
5.2 Individual firm performance in drug through greater involvement by multinationals
development can also be tracked as well as the growth of indigenous firms.
For many years, performance in drug India now represents 13 per cent of the global
development at firm level has been assessed industry by value and its drug exports have
primarily by tracking the speed and success at been growing by 30 per cent a year.147 The
which a firm is able to advance drug candidates Indian government estimates that the sector
through each phase of development. The key has the potential to generate revenues of 144. Rasmussen, B. (2005)
‘Developing the
indicators have been the numbers of drugs $22.4 billion in drug formulation by 2010.148 Biomedical Industries in
entering and exiting each phase, with a focus Some countries have a highly focused approach Canada and Australia:
An Innovation Systems
on ensuring that there is a large enough supply to developing strengths, for example, the Approach.’ Working Paper
to ensure some success based on standard biomedical sciences sector in Singapore. 24. Melbourne: Centre
for Strategic Economic
industry attrition rates. More recently, this has Studies, Victoria University
been joined by estimations of the potential of Technology.
145. For example, Dranove, D.,
value of a firm’s portfolio. 6.2 Policy has focused on supporting and Meltzer, D. (1994) Do
research in new fields Important Drugs Reach the
Market Sooner? ‘RAND
In assessing inputs, finer measures of resources Clearly, then, public support for research is Journal of Economics.’ 25,
committed to R&D may be preferable to the important. However, in the UK, specific support pp.402-422.
R&D number reported by firms for accounting has been relatively narrowly focused. 146. Charles River Associates
(2004) ‘Innovation in the
purposes, such as the number of PhD scientists Pharmaceutical Sector.’
on staff or hours spent on research activity. A national strategy for the bioscience sector London: Charles River
was published at the end of 2003 based 147. KPMG (2006) ‘The Indian
In measuring outputs, simply counting new on the work of the Bioscience Innovation Pharmaceutical Industry:
Collaboration for Growth.’
drug launches neglects the clinical performance and Growth Team (BIGT).149 One of its main London: KPMG.
or commercial success of different drugs. recommendations was to develop a public 148. Department of Chemicals
Despite the best efforts of many researchers, and regulatory environment supportive of and Petrochemicals,
Government of India
it has been difficult to find agreed measures of innovation, as well as attract and retain a high (2005) ‘Draft, National
drug quality.145 Furthermore, new drug counts quality scientific and managerial talent base, Pharmaceuticals Policy,
2006.’ New Delhi:
ignore the incremental innovation to existing through two new programmes to support the Department of Chemicals
developed drugs, such as simplified dosing, interdisciplinary education essential to the and Petrochemicals,
Government of India.
improved delivery methods, or the discovery of bioscience sector. The BIGT also recommended
new uses. This is an area requiring more work: the creation of a National Clinical Trials Agency
these measurements can directly shape health (NCTA) to support excellence in clinical
policy (not least decisions about the purchase trials and clinical research within the NHS,
of a new drug). and establishing a network of bioprocessing
centres of excellence. Subsequently – though
not as a result of the BIGT recommendations
– two world-class Bio-processing Centres of
6. Innovation could be improved by Excellence have been established in Liverpool
going beyond research funding to and Edinburgh. The BIGT report also led to the
ensure a coordinated innovation policy establishment of bioProcessUK, a Knowledge
for pharmaceuticals Transfer Network.

6.1 New competitors are emerging Furthermore, the Bio-processing Research

European pharmaceutical firms face an Industry Club (BRIC), established as a
increasing challenge both from lower R&D public-private collaboration between the
costs in developing countries and a more Biotechnology and Biological Sciences
competitive US.146 Research Council, the Engineering and Physical

149. The Bioscience Innovation
and Growth Team (BIGT) Sciences Research Council, and the UK This requires the better coordination of science
was established in 2003 biopharmaceutical industry, awarded £5 million funding with regulation and procurement.
by the then Department
of Trade and Industry to nine projects in 2006 and £3.5 million to For example, healthcare policymakers
(DTI), the Department eight projects at seven universities in 2007, to understandably focus on short-term cost
of Health and the BIA.
The BIGT consisted of support faster and more efficient development containment, but in doing so they risk
leading figures from and manufacturing techniques. undermining the widespread social and
the bioscience industry,
financial institutions, economic benefits that have long been
universities, research There has also been strong support at the predicted from the radical changes in scientific
bodies and government.
See Bioscience Innovation regional level from local authorities, Regional understanding. In particular, new technologies
and Growth Team (2003) Development Agencies (RDAs) in England and are likely to allow a small number of patients to
‘BioScience 2015 –
Improving National the Scottish Executive and Welsh Assembly be treated more effectively with personalised or
Health, Increasing Government. The Welsh Development Agency specialised therapy, a very different approach
National Wealth.’ London:
BioIndustry Association/ encourages technology transfer through the from the blockbuster model of developing
Department of Trade and Wales Innovation Relay Centre, which runs therapies that treat a large population – and
Industry/Department of
Health. a Bioscience Brokerage Event that brings from existing regulatory models of assessing
150. The review led by Sir David together academic institutions with commercial the ‘value’ and safety of drugs.
Cooksey was established
in March 2006 to examine
partners. Similarly, the RDAs have supported
the best institutional the growth of bioscience, and specific bodies The industry is concerned that Health
arrangements for the new
single fund for health
such as the Eastern Region Biotechnology Technology Assessment (HTA) methodologies
research announced in Initiative and the London Biotechnology might fail adequately to recognise the value of
the Budget. Cooksey, D.
(2006) ‘A Review of UK
Network, which support bioscience clusters. incremental advances, for example, so-called
Health Research Funding.’ ‘me-too’ drugs. In the UK, NICE commissions
London: HM Treasury.
Finally, the Cooksey report in 2006 HTA reports that evaluate ‘technologies’ (not
151. Sheridan, D. (2006)
Development recommended that the Medical Research only drugs but medical devices, procedures,
and Innovation in Council should continue to support screening and settings for care) through the
Cardiovascular Medicine.
Discussion Paper 3. In fundamental science, but that new government synthesis or systematic review of scientific
Atun, R. (ed.) ‘Innovation funding should go mainly to translational evidence. It is important that HTA is based
in Life Sciences: A
Multidisciplinary research aimed at developing treatments and on appropriate methods to establish a drug’s
Perspective.’ London: creating wealth.150 This was based on the view broader value, so that further incentives for
Tanaka Business School,
Imperial College London. that there had been insufficient emphasis on innovation are not undermined.155 This is
152. Attridge, J. (2006) turning achievements into new therapies and particularly important in the context of the
Innovation Models in the
Biopharmaceuticals Sector.
making these commercially successful. debate over the reform of the Pharmaceutical
Discussion Paper 2. In Price Regulation Scheme (PPRS), which the UK
Atun, R. (ed.) ‘Innovation
in Life Sciences: A
6.3 Supporting incremental and continuous government has announced it is renegotiating
Multidisciplinary as well as radical innovation should be part earlier than its previously scheduled date for
Perspective.’ London:
Tanaka Business School,
of a more holistic policy for innovation in renewal in 2010.156
Imperial College London. pharmaceuticals
153. Attridge, J. (2006) However, the continued success of the UK 6.4 The UK also needs to do more to
Innovation Models in the
Biopharmaceuticals Sector. pharmaceutical sector requires more than develop interdisciplinary skills
Discussion Paper 2. In support for research. Given that incremental Given how the sector is changing, stronger
Atun, R. (ed.) ‘Innovation
in Life Sciences: A and continuous innovation is as important as and more widespread interdisciplinary skills
Multidisciplinary breakthrough innovation, policy should try and knowledge are crucial. Pharmaceutical
Perspective.’ London:
Tanaka Business School, to ensure that it encourages and facilitates workers need an understanding across the
Imperial College London. this broader innovation.151 In particular, there manufacturing chain, ‘from the gene to the
154. As argued by Messinis,
G. (2004) ‘R&D Price
needs to be a greater recognition of the product’. They must also understand the
Inflation, Real BERD importance of diffusion and adoption, which relationship between a range of scientific
and Innovation:
Pharmaceuticals, OECD
ultimately generate the returns to fund further disciplines and the business implications of the
1980-2000.’ Working investments in innovation.152 interplay between those disciplines. In addition,
Paper 18. Melbourne:
Centre for Strategic
the ability of physicians to work across a wide
Economic Studies, Victoria This suggests the need to shift away from a range of scientific fields at ‘the bench and
University of Technology.
narrow emphasis on inputs such as the science bedside’ is critical to continuous innovation.157
155. Von der Schulenburg.
J.-M. G. (2006) The base and outputs such as breakthrough
Regulatory Environment products, toward a more balanced support For example, it would be pointless to develop
for Pharmaceutical
Innovation in Europe. for incremental innovation, adoption and a therapy that was not amenable to large-scale
Discussion Paper 6. In diffusion.153 Another way of putting this is manufacturing or where the manufacturing
Atun, R. (ed.) ‘Innovation
in Life Sciences: A that the focus of policy should shift from R&D or formulation costs were prohibitive. And
Multidisciplinary inputs towards R&D productivity and returns to yet, the formulation of biopharmaceuticals is
Perspective.’ London:
Tanaka Business School, R&D, or from science funding towards business not usually covered specifically in mainstream
Imperial College London. performance.154 education (university pharmacy departments
still tend to focus on small molecule

pharmaceuticals). There is also very limited
postgraduate research activity using industrially
relevant models; as a consequence, it is rare to
find anyone with specific qualifications or skills
in the formulation of biopharmaceuticals at any
level of a firm.158

New and emerging fields are very likely to 156. In February 2007, the
Office of Fair Trading
increase the demand for a cross-disciplinary (OFT) recommended that
approach. For example, ‘Systems Biology’ the PPRS be replaced
with a ‘patient-focused
should have a profound effect on drug value-based’ pricing
development.159 This groundbreaking scientific scheme, in which the prices
paid for drugs reflects
approach seeks to understand how all the the therapeutic benefits
individual components of a biological system for patients. See Office
of Fair Trading (2007)
interact in time and space to determine the ‘The Pharmaceutical Price
system’s functioning. It allows insight into the Regulation Scheme.’
London: OFT.
large amount of data from molecular biology
157. Sheridan, D. (2006)
and genomic research, integrated with an Development
understanding of physiology, to model the and Innovation in
Cardiovascular Medicine.
complex function of cells, organs and whole Discussion Paper 3. In
organisms, bringing with it the potential to Atun, R. (ed.) ‘Innovation
in Life Sciences: A
improve our knowledge of health and disease. Multidisciplinary
Yet in general, universities have been slow Perspective.’ London:
Tanaka Business School,
to respond to such changes in the traditional Imperial College London.
boundaries of subjects.160 158. BioIndustry Association/
bioProcessUK (2005)
‘The Challenges
It might also be that universities should include of Improving the
Formulation and Delivery
officially accredited courses on Pharmaceutical of Biopharmaceuticals.’
R&D project management and alliance London: BIA/
management as part of a healthcare curriculum.
159. Academy of Medical
This might also be achieved through an Sciences/Royal Academy
internationally recognised additional module of Engineering (2007)
‘Systems Biology: A
to a PRINCE2 or similar project management Vision for Engineering
qualification. and Medicine.’ London:
Academy of Medical
Sciences/Royal Academy
6.5 Internationally, there should be of Engineering.
innovative policy for neglected diseases 160. The Engineering and
Physical Sciences Research
The under-supply of development in drugs Council’s Life Sciences
for diseases that primarily afflict poorer Interface programme has
established 12 Doctoral
countries has led to a novel and high profile Training Centres that
policy proposal by Michael Kremer of Harvard offer an interdisciplinary
approach to postgraduate
University. Kremer proposes ‘advance training. Given that as
commitments’, or promises to purchase a given noted modern medicine
and biology present
quantity of a treatment for diseases like malaria challenges that require
or tuberculosis that otherwise attract very little input from mathematicians,
physicists, chemists and
investment.161 This policy is an example of a engineers, these Centres,
‘pull’ approach to innovation, which contrasts based at universities, seek
to supply appropriately
with the ‘push’ of sponsoring or subsidising trained people who can
R&D costs in targeted areas. ‘Pull’ refers to the work at the interface
between engineering and
expected payoff from an innovation; ‘push’ the physical sciences and
affects the cost of research. Expected returns the life sciences. However,
each Centre has been
to R&D depend on both the payoffs and the funded to support only up
costs. The advance commitments, which would to five annual cohorts of
up to ten students.
be made by governments of relatively wealthy 161. Kremer, M., Glennerster,
countries or philanthropic organisations, would R., and Williams, H. (2006)
Creating Markets for
guarantee profits to firms that successfully Vaccines. ‘Innovations.’ 1
innovate. (1), pp.67-79.

Appendix B: Aerospace
162. Although the two main
European aerospace Innovation through technological development and partnerships with an
industries in the UK and
France are of roughly
increasing role for hidden innovation in business processes and services
similar size in terms of
turnover; see House of
Commons Trade and
Industry Committee
(2005) ‘The UK Aerospace
Industry, Fifteenth Report
of Session 2004–05.’
London: The Stationery
163. Society of British
Aerospace Companies
(2007) ‘UK Aerospace
Industry Survey 2007.’
London: SBAC.
164. House of Commons Trade
and Industry Committee
(2005) ‘The UK Aerospace
Industry, Fifteenth Report
of Session 2004–05.’
London: The Stationery
165. According to SBAC,
1. Aerospace is a comparatively small In some regions, aerospace forms the centre
recorded in House of but very high-value-added part of the of high-technology clusters of design and
Commons Trade and
Industry Committee
UK economy manufacture, with a large number of SMEs
(2005) ‘The UK Aerospace clustered around major manufacturer-
Industry, Fifteenth Report
of Session 2004–05.’
The aerospace industry involves the assemblers (called ‘primes’) and larger
London: The Stationery manufacture of aircraft and their components suppliers. Examples include the aerospace
as well as their maintenance, repair and industry based around Airbus UK (North
166. Department of Trade and
Industry (2004) ‘National overhaul (MRO). Wales), BAE Systems and Rolls-Royce in the
Aerospace Technology North West of England, which accounts for
Strategy, Implementation
Report.’ London: DTI. The UK has the second largest aerospace 54 per cent of the high-technology jobs in
167. Society of British industry in the world in terms of value the region.170 The Midlands has a significant
Aerospace Companies
(2007) ‘UK Aerospace
added.162 Turnover was £19.81 billion in aerospace cluster which directly generates more
Industry Survey 2007.’ 2006.163 The sector accounts for 0.6 per cent than 45,000 jobs, including Rolls-Royce in
London: SBAC.
of UK gross value added (GVA) or £5.5 billion Derby, Smiths in Wolverhampton and Goodrich
168. House of Commons Trade
and Industry Committee – around 4 per cent of the value added of the in Birmingham and Wolverhampton.171 There is
(2005) ‘The UK Aerospace UK’s manufacturing industry as a whole.164 also a significant aerospace cluster in the South
Industry, Fifteenth Report
of Session 2004–05.’ The indirect contribution made through the West with Rolls-Royce and Airbus UK in Bristol,
London: The Stationery sector’s wider supply chains raises its overall and AgustaWestlands in Yeovil; the South West
169. Society of British
contribution to 1.2 per cent of GVA.165 Regional Development Agency is also the lead
Aerospace Companies region for aerospace.
(2007) ‘UK Aerospace
Industry Survey 2007.’
The UK sector has increased its global market
London: SBAC. share from 9 per cent to 13 per cent since There are currently two prime manufacturers
170. House of Commons Trade 1995.166 The industry is one of the UK’s largest of large civil aircraft (LCAs): Boeing (which
and Industry Committee
(2005) ‘The UK Aerospace exporters; it exports 63 per cent of its total is American) and Airbus (which is European).
Industry, Fifteenth Report sales, with over £12.43 billion of export sales Airbus UK has sites in Filton, near Bristol, and
of Session 2004–05.’
London: The Stationery in 2006, contributing £1.54 billion surplus Broughton, North Wales.172
Office. to the balance of trade.167 There has been a
171. Midlands Aerospace
Alliance/East Midlands
consistently positive aerospace trade balance in Worldwide, there are three prime manufacturers
Development Agency/ the past two decades. of civil aeroengines: General Electric (GE), Pratt
Advantage West
Midlands (2003)
& Whitney (both American) and Rolls-Royce
‘Midlands Aerospace The UK sector comprises over 700 companies (British), all of which manufacture engines
Cluster Strategy.’ Melton
including 400 MRO sites. It directly employs for both civil and military aircraft. Rolls-Royce
Birmingham: Midlands over 124,000 people (an increase of more than is the world’s second largest commercial
Aerospace Alliance/East
Midlands Development
a quarter since 1995), and supports a total aeroengine manufacturer, with its main plants
Agency/Advantage West of 276,000 jobs across the UK economy.168 in the UK in Derby, Bristol, Barnoldswick in
Over half of all establishments employ fewer Lancashire, and Ansty in Leicestershire.
172. GKN has been selected
by Airbus as the preferred than five people, but over two-thirds of total
partner for the acquisition employment is found on sites with more than There are also a number of manufacturers
of the Filton site.
500 people. It is estimated that there may be of airframes and engines for smaller regional
up to 2,500 aerospace SMEs in the UK.169 aircraft. The Canadian company Bombardier
has a plant in Belfast (formerly Short Brothers).
Bombardier Aerospace, Belfast products include

aircraft components and engine nacelles for its Traditional innovation in aerospace is typically
parent company and for Boeing, Rolls-Royce centred on high-cost and high-risk research-
Deutschland, GE and Pratt & Whitney based product development programmes, with
long development and payback cycles.174 This
Major suppliers include Smiths and GKN. innovation results in a change in the physical
Smiths Group is a world leader in electronic structure of an aircraft or the components
systems for civil and military aircraft. It employs within it. These cycles are often determined
5,500 people in 18 sites around the UK. Smiths by the relatively rare opportunities offered
Aerospace was acquired by GE Aviation in 2007 by major new large civil aircraft development
and is now named GE Aviation Systems. GKN programmes, such as the Airbus A380 and the
is a large global first tier supplier, including Boeing 787.
in aerospace, with technology leadership in
advanced aerostructures including composite Aerospace invests heavily in R&D. Business
structures.173 GKN Aerospace has design expenditure on R&D (including defence) 173. Composites are combined
materials which can ensure
centres with over 600 design engineers in was £2.54 billion in 2006 (an R&D intensity lower-weight but higher
Weston-Super-Mare and Cowes in the UK, and of 12.7 per cent), the second largest after strength and stiffness
structures compared to
Nashville, Tennessee, and Melbourne, Australia. pharmaceuticals.175 R&D in aerospace has traditional materials (in
more than doubled in real terms since 1997, the case of aerospace in
particular, carbon fibre
compared with a rise of 12 per cent in reinforced plastics in
manufacturing as a whole. The sector spends place of aluminium and
2. Innovation in aerospace is 11.4 per cent of all R&D in the UK.176 Rolls-
174. For example, Jackson,
increasingly distributed via complex Royce’s R&D intensity in 2006 was 5.7 per I. (2004) The Future of
risk-sharing partnerships but is also cent, Smiths 5.1 per cent, and GKN 2.1 per the Defence Firm: The
Case of the UK Aerospace
embracing new business models and cent.177 Industry. ‘Defence and
processes Peace Economics.’ 15 (6).
Even so, the innovation process is not linear. 175. Society of British
2.1 Traditional innovation – mainly iterative Rather, it is cyclical and interactive, and Aerospace Companies
(2007) ‘UK Aerospace
development – remains crucial but is involves a series of more modest gains made Industry Survey 2007.’
becoming increasingly distributed primarily through incremental improvements London: SBAC.
dictated by the manufacturing cycle, not the 176. Based on a study of the
top 850 UK spenders on
2.1.1 Traditional innovation is a mix of ‘big breakthrough’ of science-push models.178 R&D, Department for
applied research and iterative development In combination, however, incremental Innovation, Universities
and Skills/Department
for Business, Enterprise
and Regulatory Reform
(2007) ‘The 2007 R&D
Scoreboard.’ London:
177. Ibid.
178. Royal Aeronautical
Rolls-Royce Trent 1000 engine The three-shaft design of the RB211 Society (2007) ‘Trade
was an ideal basis for the new family, as and Industry Committee,
Creating a Higher-value-
The Rolls-Royce Trent 1000 is the launch it provided flexibility. The three-shaft Added Economy, A
engine for all three versions of the new system means that the large diameter fan Submission from the Royal
Aeronautical Society 24th
Boeing 787 aircraft. It represents the is isolated on its own shaft. This allows the October 2007.’ London:
latest in a comparatively low-risk policy of rest of the engine to be scaled in a variety RAS.
179. Rolls-Royce (2006) ‘Rolls-
continuously building on proven advanced of proportions to give different bypass and Royce Runs First Trent
technology, in this case the Trent turbofan pressure ratios to suit the specific aircraft 1000 on Schedule.’ Derby:
‘family’ of engines.179 on which the engine is installed.

The Trent family are all derived from the The first Trent in service was the Trent
RB211 engine, originally developed for the 700, which began commercial flights
Lockheed L-1011 (TriStar), which entered on the Airbus A330 in 1995. Trent 1000
service in 1972. In the late-1980s, Rolls- innovations include power extraction from
Royce decided that to succeed in the large the intermediate pressure system to produce
engine market of the future, it would have the required electricity via a gearbox-
to offer engines for every large civil aircraft. mounted generator. This solution, unique to
In view of the enormous development costs three-shaft engines, will result in lower fuel
required to bring a new engine to market, burn. The Trent 1000 also features the latest
the only way to do this would be to have a ‘intelligent engine controls’ – including
family of engines based on a common core. new-generation predictive maintenance
tools (see section

innovation has resulted in significant changes 2.1.2 Traditional innovation is becoming
in the industry and its products. increasingly distributed between firms,
suppliers and universities
The timescale for the research and
implementation of new products can be twenty Suppliers are being given an increasing
years. For example, Rolls-Royce’s R&D ‘Vision’ role in innovation
programme has three broad time bands: up Every prime manufacturer obtains components
to five years (technologies available ‘off- from across the world; all have collaborative
the-shelf’); around ten years (technologies arrangements with firms in other countries.
currently at the validation stage); and up Aerospace has extensive and complex supplier
to twenty years and beyond (technologies networks, especially between airframe
emerging or as yet unproven, the focus for the manufacturers and first-tier suppliers who
firm’s research base). Similarly, Airbus began often share the risk of innovation.
talks with major international carriers about
requirements for a ‘super-jumbo’ passenger While these supplier networks are not new,
aircraft in 1991, but the first A380 plane these processes have been accelerating and
entered service only at the end of 2007. deepening over recent years. Boeing now
outsources 80 per cent of work.180 Airbus’s
Some of the most important recent and intention is to outsource around 50 per cent of
ongoing traditional innovation has been in the aerostructure work for the new A350 XWB,
areas such as the development of aeroengines up from its current rate of 25 per cent.181
capable of increased fuel efficiency and
reduced emissions, the use of composite This is part of a long-term trend towards
materials in aerostructures, and increased use globalised production. A major driver of this
of electronic systems to replace hydraulic, trend is gaining access to markets, particularly
180. House of Commons mechanical and pneumatic systems. in Asia.183 In addition, aircraft are traded
Trade and Industry
Committee (2007) ‘Recent in US dollars, a major advantage for US
Developments with Airbus, manufacturers. European firms have been
Ninth Report of Session
2006–07, Volume I.’ moving to globalised production to reduce their
London: The Stationery
181. Ibid.
182. Ibid.

Airbus wings wing design including landing gear and

fuel systems, as well as some component
Wing design is crucial in improving the manufacture.
performance of aircraft. Throughout the
lifetime of Airbus, the UK has had overall The UK has led the development of new
responsibility for the wings for all Airbus approaches for the A380 wing. These
aircraft. The UK content of Airbus wing include new aerodynamic testing methods
production is about 70 per cent. This covers (such as combined analysis of components),
a range of activities, including design and structural optimisation techniques (for
development. The UK has been named example, using carbon fibre reinforced
‘Airbus Centre of Excellence for Wing and plastic to attach the trailing edge flaps to
Pylon’ (pylons are the mountings which the main wing structure), and materials
affix the engine to the wing). This means (such as composite primary structures in
that Airbus in the UK has supervisory the wingbox, which carries the airloads into
responsibility for any part of the wing built the fuselage). In addition, patented load
anywhere in the world. reduction techniques were developed to
enable the fuel system to control the loads
Broughton in north Wales is responsible actively on the wing in all phases of flight,
for large component manufacture (such as thereby reducing stresses on the wing
wing skins and spars) and sub-assembly, and saving weight, continuing a tradition
wing final assembly and equipping. It is started in the UK with Concorde. Securing
widely acknowledged to be the world’s a risk-sharing partner for the Filton plant
leading manufacturer of large civil aircraft will be crucial to the further transition from
wings.182 Filton near Bristol is in charge metallic to carbon fibre composite design
of engineering research, technology and and manufacturing technology.

disadvantage (a process called ‘dollarisation’). company jointly owned by Pratt & Whitney,
For example, for the first time, Rolls-Royce Rolls-Royce, Japanese Aeroengines
is to assemble some of its engines for wide- Corporation, and MTU Aeroengines (from
body passenger aircraft outside of the UK, by Germany). Each partner contributes an
building test and assembly plants in Singapore individual module to the V2500 engine, an
and in the US. arrangement that enables each partner’s
engineers to focus their attention on
This globalisation is also reflected in the continuously refining that module. 183. In terms of aircraft delivery
value (as opposed to
location of R&D. In 2006 R&D spent overseas numbers of aircraft),
by UK aerospace firms grew by 5.5 per cent Such extended innovation has been facilitated Asia/Pacific is forecast
to become comfortably
and accounted for 16 per cent of total UK by using Product Lifecycle Management the largest market, with a
aerospace R&D.184 There has been an increase (PLM) software and ‘Innovation Technology’ value of nearly $1 trillion,
due to the large quantity
in overseas R&D from £140 million in 1996 (IvT). PLM software manages every aspect of twin-aisle airliners
to £470 million in 2006.185 Sixty per cent of of a product’s life cycle, from concept and expected to be delivered
into the region compared
Rolls-Royce’s R&D investment and 40 per cent design, to manufacturing, maintenance once to the North American
of new product development spending over the product is sold, and through to its eventual and European markets.
See Rolls-Royce (2006)
the past five years has been outside the UK.186 retirement. IvT includes eScience (computer- ‘Market Outlook 2006-
But these headline figures do not provide the intensive science that is conducted through 2025.’ Derby: Rolls-Royce.
whole picture of how innovation is increasingly highly distributed networks), virtual reality, 184. Society of British
Aerospace Companies
distributed. simulation and modelling techniques, and rapid (2007) ‘UK Aerospace
prototyping.190 Industry Survey 2007.’
London: SBAC.
For a start, innovation is increasingly being 185. Ibid.
pushed down supply chains. First and second For the 787, Boeing is using PLM software 186. Rolls-Royce (2006)
tier suppliers are being given increasing to reduce the four-five year time frame from ‘Introduction, Rolls-Royce
is a Global Company
responsibility for traditional innovation, in areas concept to production by one year, or about Providing Power for Use
such as R&D, engineering and design, tooling, 20-25 per cent, and reduce development on Land, at Sea and in the
Air.’ Derby: Rolls-Royce.
testing, sub-system integration and pre- costs by 20 per cent, or from $12 billion to 187. Partners include Alenia
assembly (installing systems such as hydraulics, $10 billion.191 Its distributed approach to Aeronautica of Italy
electronics and controls). innovation relies on a 16 terabyte data master (main fuselage), Japan’s
Mitsubishi Heavy
data repository for all design and engineering Industries (wings), Fuji
This is most prominent in the case of the information located in Bellevue, Washington Heavy Industries (centre
wingbox) and Kawasaki
Boeing 787. In the past, Boeing has designed state. Heavy Industries (part
aircraft in-house, then passed blueprints for of the fuselage as well
as the wings and landing
parts or whole sections to manufacturing However, a greater reliance on PLM and virtual gear), and Goodrich
partners. For its new aircraft, Boeing is turning models and tests (as opposed to costly real- Aerostructures of Chula
Vista, California (nacelles
this process on its head, designing the 787 world mock-ups or trials) can cause problems. and thrust reversers).
in collaboration with partners. In effect, The delay to the production of the Airbus 188. Smith, D. J. and Tranfield,
D. (2005) Talented
6,000 engineers around the world are jointly A380 has been attributed to incompatibilities Suppliers? Strategic
designing and engineering the aircraft.187 in the design software being used by teams in Change and Innovation in
the UK Aerospace Industry.
different countries. This has cost the company ‘R&D Management.’ 35
This trend puts more pressure on the an estimated $6 billion.192 (1), pp.37-49.
innovative capacity of suppliers, and has 189. See Bailey, J., and Clark, N.
(2008) Parts Didn’t Click
encouraged a rationalisation of supply chains Universities are increasingly serving as Together for Boeing Jet.
and a movement towards larger suppliers, with research centres for firms ‘New York Times.’ 17th
primes focusing on procuring from far fewer, Traditionally, research-intensive companies 190. Gann, D. and Dodgson,
more capable ‘talented suppliers’.188 Even have conducted research in-house, using their M. (2007) ‘Innovation
Technology: How New
then, some suppliers are said to be struggling own facilities and regularly recruiting graduates Technologies are Changing
with the new demands of the more delegated and PhDs. University-industry collaboration the Way We Innovate.’
London: NESTA.
innovation process. Delays in the delivery of is not new in aerospace, but some companies
191. Bartholomew, D. (2007)
the Boeing 787 are said to be due to suppliers have been particularly active in establishing The Promise and Peril
failing to cope with the extent of their new links. For example, Rolls-Royce, as part of of PLM PLM: Boeing’s
Dream, Airbus’ Nightmare.
responsibilities.189 In one case, Boeing has had an overall policy of ‘capability acquisition’, ‘Baseline.’ 2nd May.
to buy out a major 787 structures partner, has outsourced much R&D to universities, 192. Ibid.
Vought, in the US because of the impacts that in particular by establishing (currently 29)
Vought’s underperformance was having on the University Technology Centres (UTCs) in the UK
787 programme overall. and across the world.

Second, there are complex and overlapping Similarly, the Advanced Manufacturing
collaborations between firms. For example, Research Centre (AMRC) at the University
International Aeroengines is a multinational of Sheffield is a £45 million partnership with

Boeing that builds on the research within the lost through the very outsourcing that puts a
University’s faculty of engineering. The Centre greater emphasis on systems integration in the
received initial government funding of nearly first place.195
£6 million from the then DTI and additional
support from Yorkshire Forward RDA and the 2.2.2 Lean manufacturing
European Union regional development fund. More generally, Lean manufacturing is
probably the most important organisational
193. These are to achieve Universities tend to be particularly involved innovation for aerospace firm competitiveness.
by 2020: a 50 per cent
cut in CO2 emissions
in emerging technologies. For example, the Efficiency and competitiveness in production
per passenger-km, Environmentally Friendly Engine (EFE) is a processes have become as crucial to aerospace
associated with a 50 per
cent reduction in fuel
collaborative programme for a new generation firms’ survival as technology and product
consumption; an 80 per of gas turbine engines, to contribute to the performance. The importance of Lean is
cent reduction in NOx
(nitrogen oxide) emissions;
performance targets set by the Advisory strongly related to an increasing pressure on
a reduction in perceived Council for Aeronautics Research in Europe costs (see 3.1).
noise levels to half their
current average value;
(ACARE).193 The programme involves 11
and a reduction in engine partners, five from industry and six from Lean was first introduced in the automotive
academia (and is one of the Aerospace industry (see Appendix F) and subsequently
194. Partners in the research
consortium are: Technology Validation Programmes under the extended to aerospace as well as other
Rolls-Royce; Goodrich National Aerospace Technology Strategy, see manufacturing sectors. It focuses on the
Corporation; Bombardier
Aerospace (Belfast); 3.5).194 elimination or reduction of waste in various
HS Marston Aerospace forms, and involves, inter alia, through-life
(Wolverhampton); Unison
Engine Components Aerospace also benefits from management, inventory, cycle and lead time
(Burnley); and the technology transfer from other sectors reductions, and quality management.196
following universities:
Birmingham; Cambridge; Given the complexity of aircraft systems,
Loughborough; Oxford; there are significant technology flows to and Lean can lead to a 20-40 per cent improvement
Sheffield; and Queen’s
Belfast. from other sectors, including defence, marine, in productivity in aerospace SMEs, but UK
195. A point made in energy, ICT and software, and materials firms have lagged behind their US rivals in
Newhouse, J. (2007)
‘Boeing Versus Airbus.’
sciences. In particular, there are many examples implementing Lean processes.197 To address
New York: Knopf. of technology transfer between civil and these performance challenges, a UK Lean
196. Lean has been summarised defence aerospace. For example, Boeing has Aerospace Initiative (UK-LAI) was initiated in
in five principles: precise
valuation of specific benefited from research into composite wings 1998, jointly funded by the EPSRC and SBAC,
products; identification by NASA, and advances in composite fuselages and involves Warwick, Nottingham, Bath and
of the value stream for
each product; ensuring are derived from Boeing’s military programmes Cranfield Universities.198 In addition, the sector
that value flows without including the B2 stealth bomber and the V22 has developed SC21, the Supply Chains of the
interruptions; ensuring
that that value is pulled Osprey joint service tiltrotor aircraft. 21st Century programme.
from the producer; and
that perfection is pursued.
See Womack, J. P., and 2.2 ‘New’ forms of organisational and 2.2.3 Through-life management services
Jones, D. T. (1996) ‘Lean business process innovation are becoming Pressure on costs in both the civil and military
Thinking, Banish Waste
and Create Wealth in Your more important in aerospace markets has left little or no profit from original
Corporation.’ London: equipment and parts sales (see 3.1).199 This
Simon and Schuster.
197. Aerospace Innovation
2.2.1 Major firms are moving to become has led to new business models focussing on
and Growth Team (2003) systems integrators aftermarket and long-term service contracts.
‘An Independent Report Hidden innovation in aerospace focuses on
on the Future of the
UK Aerospace Industry.’ changes in organisation or service delivery
London: Department of (Type II hidden innovation).
Trade and Industry.
198. A US precursor was 3. Aerospace innovation is
launched in 1993 as a One prominent example is systems integration. determined by pressures on costs and
partnership between
the US Air Force, This refers to integrating components, skill environmental impact
Massachusetts Institute of and knowledge from other firms, including
Technology, labour unions,
and aerospace businesses. suppliers, to deliver ever more complex 3.1 Costs and efficiency are the main drivers
199. Ward, Y. and Graves, products, services and systems. of innovation
A. (2005) ‘Through- The aerospace and air travel industries can
Life Management: The
Provision of Integrated Boeing and Airbus have become systems be highly cyclical, depending on the global
Customer Solutions by integrators as they have outsourced more economy. Before 2001, the civil aerospace
Aerospace manufacturers.’
University of Bath School work. Their strategy is to retain their position sector was operating at full capacity with
of Management Working at the highest value-generating point in the record production levels. Since 2001, a number
Paper Series, 2005.15.
supply chain, with close relationships with of events had caused a slowdown in passenger
their customers. But this strategy carries air travel: the impact of the global economic
some risk: the technical skills and intelligence slowdown; the terrorist attacks on the US on
necessary for integrating systems effectively is 11th September 2001; continued uncertainty

in the Middle East, including the conflicts in engineering rather than customer needs.
Afghanistan and Iraq; and the SARS crisis in For example, it can be slow to adopt new
Asia. engineering techniques, easily replicable
designs or more flexible aircraft for customers.
These cycles exacerbated the already often Low-cost airlines in particular require simplicity,
brutal economics of the air travel industry. lower costs and lower environmental impact.
Several major airlines have aging fleets and
have lost over $10 billion each year for the past This disconnect between manufacturers and
five years, making it difficult to invest in new customers can also occur at a macro-level. Over
aircraft. This has driven the growth of leasing; the last two decades, Airbus and Boeing have
now more than 35 per cent of aircraft are persisted in building larger, longer-range, more
leased rather than owned by operators, making technically advanced aircraft, as opposed to
leasing companies very important customers developing a smaller more flexible aircraft for
for aircraft. higher volume single aisle markets. Yet neither
Airbus nor Boeing has designed a new 200
These conditions can drive innovation. seat single aisle aircraft for over twenty five
Incentives to reduce costs are particularly years, despite the fact that this type of aircraft
strong. For airlines, this means more efficient accounts for nearly 50 per cent of all civil
(cheaper to run) aircraft. For manufacturers, aircraft sold. This may present an opening for
it means Lean manufacturing, increased new competition from Asia.
outsourcing, risk-sharing partnerships, supply
chain management, and new business models 3.3 Reducing environmental impact has
such as extended services. become increasingly important
With the upward trend in fuel prices and
3.2 Innovation is often inhibited by risk environmental concerns, there is strong
reduction and conservatism demand for lighter aircraft, prompting the 200. Rolls-Royce (2008)
‘Preliminary Results 2007.’
At the same time, the emphasis on costs and increased use of composites in airframes and Derby: Rolls-Royce.
reducing risk can lead to an understandable components, and more efficient engines. The
conservatism in product design and industry states that it has delivered a 50 per
manufacture. This is a sector already quite cent improvement in fuel efficiency in the last
conservative in its dominance by product 30 years, and a 75 per cent reduction in noise

Rolls-Royce TotalCare thereby accepting much of the financial risk

of malfunction or breakdown; this gives the
TotalCare comprises a suite of aero-engine firm a greater vested interest in the long-
aftermarket (or after-sale) services. Such term reliability of its products.
services have expanded rapidly in the last
five years, such that they now contribute The service innovation of TotalCare is also
63 per cent of Rolls-Royce’s civil aerospace dependent on technical advances, for
revenues (55 per cent of total Group example engine health monitoring (EHM).
revenue, up from 30 per cent in 1991).200 This provides the basis for predictive
More than 55 per cent of Rolls-Royce’s maintenance and fleet planning that forms
modern engine fleet is covered by TotalCare an integral part of the package. 24/7
or similar service agreements, generating Operations Rooms, located in Derby, Bristol
revenues of more than $2.6 billion (more and Dahlewitz in Germany, support a fleet
than £4.2 billion across the sectors the firm of over 3,000 engines that are continuously
operates in). Rolls-Royce’s investment in monitored, collating technical data
developing and maintaining these services streamed direct from the aircraft in flight
is equal to its investment in research and via live satellite feeds.
technology programmes.
As part of its 20-year global industry
Rolls-Royce provides maintenance and outlook, Rolls-Royce forecasts estimate
support for airline customers over the a total market opportunity worth $500
lifetime of the engine, typically more than billion for the provision of product-related
20 years. The company charges a fixed price aftermarket services (compared to $600
per flying-hour that the engine is in use, billion in engine sales).201

nuisance.202 But the issue of the environmental AeIGT also recommended the establishment
impact of air travel is receiving increased public of a National Aerospace Technology Strategy
and media attention. (NATS) as a partnership between industry,
government and academia, to identify,
Tighter EU regulations and the proposal to research and validate ‘key’ and ‘enabling’
include aviation CO2 emissions in the European technologies.205 More partnerships have been
Emissions Trading Scheme (ETS) mean that developed through Aerospace Innovation
there is an ongoing need to reduce CO2 and Networks (AINs) and Aerospace Technology
NOx emissions. Research on lower-emission Validation Programmes (ATVPs). AINs
aeroengine design is progressing in several comprise networked research institutes and
directions, but continued reliance on fossil firms covering core research themes. ATVPs
fuels seems inevitable for the foreseeable for the civil sector include powered wing, the
future (alternative potential sources are ruled environmentally friendly engine, and more
201. Rolls-Royce (2006) out on energy intensity grounds). Greater electric aircraft.
‘Market Outlook
2006-2025.’ Derby: Rolls- environmental sustainability will also demand
Royce. more ‘technology insertion’, reducing the 3.6 Workforce skills are crucial
202. Society of British environmental impact of older but still Aerospace is a particularly skill-intensive
Aerospace Companies
(2007) ‘UK Aerospace operating aircraft. industry. However, there are identified skills
Industry Survey 2007.’ gaps in both technical areas and in wider
London: SBAC.
203. See http://silentaircraft. However, the current evolution of existing skills. The latter include systems thinking
org technologies is reaching its limit, and more and engineering skills, project management,
204. Aerospace Innovation radical designs of aeroengines will be process excellence, teamwork, problem-solving
and Growth Team (2003)
‘An Independent Report needed to achieve environmental goals. techniques, Lean thinking and application, risk
on the Future of the There is research underway exploring how management, knowledge management, and
UK Aerospace Industry.’
London: Department of to reduce aircraft noise, from aircraft design business understanding and strategy.206 Such
Trade and Industry. (shielding engines within the structure) to skills would better support the implementation
205. Society of British
Aerospace Companies /
new operations. A transatlantic collaboration of process excellence throughout the
Department of Trade between Cambridge University and MIT is value chain, and faster and Leaner product
and Industry/Aerospace
Innovation and Growth
working on a silent aircraft project, which has development processes.
Team (2004) ‘National already suggested significant improvements.203
Aerospace Technology
Strategy.’ London: SBAC/
DTI/AeIGT. 3.4 Safety and reliability have always been
206. As identified in the key concerns 4. Innovation is hidden because iterative
Sector Skills Agreement
for the Aerospace, A relatively unusual aspect of aerospace development is not part of formal R&D
Automotive and Electronics innovation is the huge costs at the later stages and because organisational forms of
sectors, completed
in January 2006; see of development for validation and safety innovation are not well captured in
Sector Skills Council for testing. The long-term operation of engines traditional indicators
Science, Engineering
and Manufacturing adds to the importance of this development
Technologies (2006) stage; maintenance firms continue to service 4.1 Much traditional innovation in
‘SEMTA Sector Skills
Agreement, Electronics, engines that were originally designed and aerospace is iterative development rather
Automotive and Aerospace manufactured decades ago. than research
Industries.’ London:
SEMTA. Much traditional innovation in aerospace is
207. Royal Aeronautical 3.5 Publicly-supported strategic research iterative development rather than research;
Society (2007) ‘Trade
and Industry Committee,
initiatives are important for long-term one estimate suggests that the ‘R’ represents
Creating a Higher-value- technological innovation only 10-15 per cent on R&D.207 Hence is it
Added Economy, A
Submission from the Royal
Strategic aerospace R&D and innovation likely that much technological innovation is not
Aeronautical Society 24th in the UK has been strongly influenced by captured in narrow measures of R&D (Type I
October 2007.’ London:
the Aerospace Innovation and Growth Team hidden innovation).
208. Smock, S. (2007) ‘Boeing (AeIGT), established in 2002 by the then DTI.
787 Dreamliner Represents The team comprised representatives from For example, the use of composite materials in
Composites Revolution.’
Design News. 4th June. industry, government, academia and trade the Boeing 787 – comprising 50 per cent of the
unions, with an overall remit of determining aircraft’s weight – is based on years of basic
how to retain and improve the global scientific research into such materials.208 But
competitiveness of the industry. Its subsequent Boeing and its major suppliers have also had to
report recommended a re-focusing of R&D learn on the job how to manufacture and tool
on technologies in which the UK can lead the such materials. The benefits of composites have
world, and strengthening project management grown as Boeing’s engineers have gained more
and business processes in the sector.204 experience in production processes using these
materials, sometimes in unexpected directions,
even opening up new design possibilities. For

example, Boeing engineers discovered that 5. Innovation could be better measured
composites are tougher than they initially by investigating its contribution to
imagined, and the firm has been able to productivity and to environmental
guarantee customers that maintenance costs performance
will be 30 per cent lower than for aluminium
aircraft. This is a potentially bigger saving for 5.1 New measures should investigate
customers than the 20 per cent reduction in the relationship between innovation and
fuel costs the 787 can deliver compared with productivity, including hidden innovation
other aircraft. The savings could be worth more Some measures combine the effects of
than $3 billion over 20 years.209 traditional and hidden innovations. Productivity
measures, such as GVA per worker or total
Such ‘practical research’ often lies outside of factor productivity are probably the most
formal R&D processes. But the development useful.
of efficient production processes for these
materials is crucial to realising their potential Labour productivity (GVA per worker) in the
benefits; in this case, unless composites can be aerospace industry in the UK was estimated
manufactured properly, they will not produce to be ahead of Japan and Spain in 2001, but
the weight gains and so savings in fuel costs behind its major competitors (US, Canada,
that airlines demand. France, Italy and Germany).211 However, the UK
may be catching up.212 209. BusinessWeek (2005)
Boeing’s Plastic Dream
4.2 Organisational and business model Machine. ‘BusinessWeek.’
forms of innovation are not currently Interestingly, UK R&D has increased, but not 20th June.
210. Wang, C. I., and Ahmed,
captured well in traditional metrics as fast as productivity. One explanation for the P. K. (2003), ‘Innovation,
Innovation and learning is a whole organisation rapid growth in productivity in the late 1990s Knowledge Management
and Learning: A Case Study
capacity, which even highly technologically is that it was prompted by hidden innovations. of GKN.’ Working Paper
advanced firms can struggle with.210 Firms need This was indeed the period when organisational Series. Telford: University
of Wolverhampton.
to design effective organisational forms that changes were becoming more common ,
211. House of Commons Trade
ensure the rapid and widespread circulation of including widespread merger and acquisition and Industry Committee
information (Type II hidden innovation). activity, greater supply-chain efficiency (2005) ‘The UK Aerospace
Industry, Fifteenth Report
(including reductions in numbers of suppliers of Session 2004–05.’
Furthermore, levels of investment to develop and increasing roles for those remaining), and London: The Stationery
service innovations such as Rolls-Royce’s increased use of outsourcing. This requires 212. Braddon, D. and Hartley,
TotalCare and similar services are not recorded further investigation. K. ‘The Competitiveness
of the UK Aerospace
in surveys such as the Community Innovation Industry’, Applied
Survey, or often in R&D metrics. 5.2 Other business performance outputs Economics, Vol. 39, Issue
6, April 2007.
could also be used to track the impact of
213. Society of British
4.3 Aerospace also demonstrates the forms of hidden innovation Aerospace Companies
exploitation of largely existing technologies The UK Lean Aerospace Initiative (UK-LAI) has (undated) ‘Aerospace
Metrics Measures for
to support other forms of innovation proposed the following metrics for improved Improved Competitiveness.’
This can be seen in the way that advances in competitiveness in aerospace: London: SBAC.
monitoring technologies have enabled real-
time monitoring services such as that provided • Customer acceptance/rejection rate (quality)
by Rolls-Royce’s TotalCare, or the exploitation
of PLM software to enable new, extended • Achievement of delivery schedules (customer
forms of collaboration. These are forms of Type satisfaction)
III hidden innovation.
• Increased value added through waste
4.4 Small-scale and localised innovation is elimination
also important
As in other areas of engineering, there are • Employee training and development
small-scale problems in aerospace that are
dealt with outside of formal R&D programmes; • Stock turnover rate (inventory reduction)
these efforts may not be captured in
traditional metrics (Type IV hidden innovation). • Floor space utilisation (smoother flows)213
These could include day-to-day creative
improvements in practice, use and adaptation These measures have yet to be applied.
of materials and tools or collaborative working

214. Gindy, N., Hodgson, A.,
and Johnston, S. (2006) 5.3 Topic-specific research programme But the longer-term issue is with higher-
‘Research Opportunities in outputs could also be tracked value-added activities. The cumulative stock
Aerospace Manufacture.’
National Advisory In addition to measuring inputs to innovation, of knowledge of leading aerospace firms
Committee for Aerospace it would be useful to capture progress in represents a major barrier to entry for potential
Manufacturing. NACAM
was sponsored by the then selected, strategically important areas for competitors, as do the huge investments that
DTI through the National innovation, perhaps against agreed ‘technology are required for significant developments in
Advisory Committees
Knowledge Transfer roadmaps’. aircraft hardware.
Network, reporting to the
Aerospace Technology
Steering Group (ATSG) For example, the National Advisory Committee Yet competition from emerging economies is
and the National Defence for Aerospace Manufacturing (NACAM) growing.217 Some countries, such as Taiwan,
Industries Council (NDIC)
R&T committees. Its identified six priority research topics in its 2006 Indonesia and Brazil, have established their
purpose is to advise the UK report.214 These were: surface engineering own aerospace industries. Regional aircraft
on the future direction of
aerospace manufacturing and coatings; net shape titanium; affordable producers such as Bombardier of Canada and
research and technology. It composites; ultra low-cost tooling; digital Embraer of Brazil could move into producing
consists of representatives
from UK industry, manufacture; and assembly integration. larger aircraft. India and China are leveraging
academia, DTI, EPSRC, NACAM suggested through its road mapping market access in return for investment and
and MoD.
215. Royal Aeronautical
exercise that the UK was falling behind the rest collaboration. China and Russia are making
Society (2007) ‘Trade of the world in the development of advanced efforts to develop regional jet programmes,
and Industry Committee,
Creating a Higher-value-
manufacturing technology for aerospace with support from Western manufacturers
Added Economy, A applications. anxious to get better market access. Both
Submission from the Royal
Aeronautical Society 24th
could eventually become significant players
October 2007.’ London: 5.4 Social and environmental performance in partnership with Western firms, especially
outputs should also be taken as a measure with well-funded, highly motivated state-led
216. Rose-Anderssen, C.,
Baldwin, J.S., Ridgway, of innovative performance investment strategies.
K., Strathern, M., For traditional innovations, a list of measures
Varga, L., and Allen,
P.M. (2007) ‘Learning reflecting current objectives and concerns The extent of Japan’s involvement in the
and Development in would include: emissions; noise; fuel development and production of the Boeing 787
Commercial Aerospace
Supply Chains.’ Irish consumption; engine efficiency; aircraft weight. could also represent a major opportunity for
Academy of Management These indications are regularly monitored, and the Japanese sector to advance. Thirty-five per
conference, 3rd–5th
September. EU targets have been set for some of them. cent of the 787 will be manufactured in Japan.
217. House of Commons Trade The country’s aerospace sector has succeeded
and Industry Committee
(2005) ‘The UK Aerospace
in gaining extensive and advanced work on
Industry, Fifteenth Report the technology-rich wing design (and not just
of Session 2004–05.’
London: The Stationery
6. Innovation could be improved by its manufacture).218 Boeing has never before
Office. developing support programmes that handed this kind of work to a subcontractor.219
218. McGuire, S. (2006) ‘The embrace hidden innovation, to respond Japan has now developed expertise in most
United States, Japan and
the Aerospace Industry: to the long-term challenge posed by aspects of aerospace manufacture and has a
Technological Change in new competitors declared intent to increase its share of the civil
the Shaping of a Political
Relationship.’ Working aerospace market to 15 per cent by 2025.220
Paper. Bath: University 6.1 The UK will increasingly need to Mitsubishi and Kawasaki have announced plans
of Bath.
219. One analysis also
compete with new entrants as the global for short-range and regional aircraft.
emphasises that Boeing balance of power begins to shift
gains access to cheaper
finance through this
The UK must retain high level systems In addition, a new paradigm for aerospace
approach, since the first integration capability. This is where the production may be emerging. Cheaper, more
tier suppliers help to
finance the programme;
greatest value is created.215 The assumption efficient approaches to production have been
see Newhouse, J. (2007) that this ‘total capability’ can be maintained in demonstrated by smaller innovative firms.
‘Boeing Versus Airbus.’
New York: Knopf.
leading countries while distributing ever more For example, US firm Eclipse Aviation has
220. As noted in Gindy, capabilities to other countries needs to be launched its Eclipse 500 four-six seat ‘air taxi’.
N., Hodgson, A., and examined more critically. Ex-automotive sector executives founded
Johnston, S. (2006)
‘Research Opportunities in Eclipse with the expressed aim of producing a
Aerospace Manufacture.’ As in so many other areas of manufacturing, highly-reliable, low-weight aircraft selling for
National Advisory
Committee for Aerospace increased competition from low-cost $1 million. The 500 is 50 per cent cheaper to
Manufacturing. economies has increased pressure at the operate than similar aircraft.221
221. For example, the Warwick
Innovative Manufacturing
lower value-added end of the UK aerospace
Research Centre at the supply chain. Small, lower-technology firms Toyota and Honda both have small aircraft
University of Warwick
has begun to investigate
often lack the capacity to make the kinds of at advanced stages of development. The
opportunities for organisational and process changes required to announcements from Honda and Toyota
simplifying aircraft design
through manufacturing
stay competitive.216 on their prototype small executive aircraft
excellence. suggested that, taking account of their history,
the emergence of a new paradigm is highly

possible. The longer-term critical question is What is most crucial is that such support
then whether UK aerospace firms can remain includes a focus on disruptive technology. For
competitive against the emerging threat from example, Rolls-Royce’s core technology and
such new entrants. capability is centred on the gas turbine, across
all of the sectors in which it operates (civil
6.2 Programmes of support should embrace and defence aerospace, marine and energy).
hidden innovation as well as anticipate The relatively rapid emergence of a disruptive
disruptive technologies new technology could seriously challenge its 222. For example, the
Materials KTN supports
– and many other firms’ – existing knowledge, activities such as the
6.2.1 Existing policy interventions focus on expertise, and business models. WINGNet network,
aimed at identifying the
new products, as opposed to business or critical materials science
commercial innovations 6.2.2 Strategic support programmes should required to improve the
UK’s performance in the
In the short- to medium-term, the UK has to be widened to include hidden innovation, sustainable use of materials
remain attractive to major firms as a place to possibly as part of a national policy for in the aerospace sector.
Similarly, the National
locate their innovation activities including R&D. aerospace Composites Network is a
Such competitive pressures demonstrate the In the longer-term, the UK aerospace sector will KTN that embraces the
entire UK composites
importance of government R&D support in need to respond not just to new technologies, industry and its supply
aerospace. but to new business models, processes and chain. It is establishing
Regional Centres of
services developed by competitors. Excellence where firms can
The aerospace sector can apply for support obtain hands-on support
and expert advice, such
for R&D under the Technology Programme, First, the developing challenge from emerging as the Airbus Composite
which includes the Collaborative Research & competitors needs to be formally assessed, Structures Development
Centre at Filton, and
Development (CR&D) grant and Knowledge including a review of their national strategies the GKN Aerospace
Transfer Networks (KTNs), and of course for aerospace.225 Composites Research
Centre at Cowes on the Isle
R&D tax credits for activities that qualify.222 of Wight.
Aerospace was granted around £153 million Second, NATS, however important, is not a 223. Subsidies such as RLI
through the Technology Programme between national aerospace strategy, in the sense of a have been a long-running
matter of dispute between
April 2004 and April 2007 (£110 million from broader vision beyond technology research and the US and Europe on
central funds – more than a quarter of total development. Government should consider the behalf of Boeing and
Airbus. The EU has claimed
Technology Programme funding – and £43 need for such a national strategy in response to that US subsidies for
million from the regions), an estimated £60- the analysis of emerging global competitors. Boeing have cost Airbus
$27 billion in losses, while
£80 million each year through R&D tax credits, the US Government has
Selective Finance for Investment/Regional Third, such a strategy (or failing that, a revised argued that Airbus has
wrongly enjoyed subsidies
Selective Assistance of more than £33 million NATS) should encompass forms of innovation of up to $205 billion
in 2006, as well as support for overseas sales beyond scientific and technological research. over the past decades;
BBC News online (2007)
campaigns. For the UK industry to remain competitive, ‘Boeing’s US Aid ‘Hurting
the AeIGT considered that it must exceed US, Airbus.’ 26th September.
224. Paragraph 37, House
Repayable launch investment (RLI) – commonly French and German productivity levels by of Commons Trade and
referred to as ‘launch aid’ – is also available. 2022.226 Industry Committee (2007)
‘Recent Developments with
This is justified on the basis that aerospace Airbus, Ninth Report of
projects are characterised by high costs and This will require increased performance in Session 2006–07, Volume
I.’ London: The Stationery
long payback periods. RLI payments are all forms of innovation. AeIGT argued in Office.
made for eligible development costs to firms 2003: “Key to driving a step change in UK 225. The House of Commons
in the early years of a project. Repayments performance is recognition that Process Trade and Industry
Committee recommended
to government are usually based on a per- Excellence Implementation is equally as in 2005 that government
aircraft or per-engine basis, with a target rate important as Technology Demonstration.”227 should conduct an official
study into the threat from
of interest and specified time period. The emerging competitors.
provision of RLI is entirely discretionary; there This is why initiatives that focus on developing 226. Aerospace Innovation
is no formal scheme, promotion or budget.223 expertise within supply chains are important. and Growth Team (2003)
‘An Independent Report
Around £1 billion of RLI has been provided For example, in 2006, the North West on the Future of the
since 1997. Aerospace Alliance launched its Aerospace UK Aerospace Industry.’
London: Department of
Supply Chain Excellence Programme in Trade and Industry.
In total, the former DTI estimated that annual partnership with Airbus, BAE Systems and 227. Aerospace Innovation
and Growth Team (2003)
funding for the sector has risen to £45 million Rolls-Royce and with support from the ‘An Independent Report
a year (now around £50 million) – more than Northwest Regional Development Agency. on the Future of the
UK Aerospace Industry.’
twice the level of public support provided This aims to equip firms with the knowledge London: Department of
under the previous funding system, but not yet and skills to manage innovation, at the Trade and Industry: p.91.
at the level of the ‘required’ £70 million per operational and strategic levels. Specifically, it
annum set out in NATS.224 aims to integrate the management of market,
technological and organisational factors to

improve the competitiveness of the North
West’s aerospace firms.

Similarly, the Society of British Aerospace

Companies (SBAC) is currently rolling-out its
supply chain initiative, SC21, across the UK.
SC21 is a broad industrial change programme,
developed by the industry, designed to improve
the competitiveness of the sector by raising
the performance of its supply chain. It includes
Lean production and quality accreditation, and
customer and supplier relationships.

Beyond this, a new set of initiatives is needed

to anticipate a coming paradigm shift in aircraft
manufacturing, from design for manufacture,
new business models and processes, to

Appendix C: Telecommunications 228. This includes: terminal
equipment (fixed line
phones, PBXs and mobile
Innovation through technological disruption and communication handsets); cables and
infrastructure (broadcast,
convergence leading to a role for hidden innovation via new service provision fixed, and radio/mobile);
switching components
and associated installation
services (infrastructure
technologies, offered
as hardware or software
modules and associated
with delivering peer2peer,
push2talk, ad-hoc and
mesh networks, and
SMS-to-voice conversion,
as well as radio frequency
technologies such as
Bluetooth, Sensor Area
Networks (Zigbee), VoiP
and Ultra Wide Band). See
UK Trade and Investment
(2007) ‘ICT Marketing
Strategies: Evidence Base’
[CD-Rom] London: UK
Trade and Investment.
229. Ofcom estimates the
sector to have a turnover
1. Telecommunications is an important sector, with the remaining 28,000 people of around £47 billion. The
economic sector in its own right, employed in other industries).232 discrepancies in the figures
are because ONS estimates
vital to the UK’s competitiveness as a include revenues from
knowledge-based economy The sector includes large players who services such as network
hardware provision and
provide a wide range of infrastructure, maintenance (which
The telecommunications sector involves: products, applications, and services through Ofcom do not regulate).
Office of Communications
(i) telecommunication services (fixed-line to small firms that have a single product or (Ofcom) (2007) ‘The
telephony services, mobile services and service offering. In the UK, BT continues Communications Market
2007’. London: Ofcom,
broadband) and (ii) telecommunications to be the largest fixed-line provider, with Chapter 4: pp.271-272.
equipment and network supplies.228 an estimated overall UK turnover of £17.2 230. The Office for National
billion and accounting for 37 per cent of Statistics (2006) ‘Input
Output Analyses 2006
These two main groupings of activities have total telecommunications turnover.233 Other Edition.’ London: ONS.
a number of important sub-segments, which smaller fixed-line providers in the UK are 231. Inter Departmental
Business Register
comprise the supply chain: Vanco, Eircom, and Kingston Communications (2004-2007) ‘Analysis
(KCOM). These firms have varied business of UK Local Units in VAT
based Enterprises’ [online]
• Network operators (such as BT, Cable & portfolios: Vanco is a virtual operator focusing Available from http://
Wireless, Vodafone, O2, Thus, Orange – who on communications services for enterprise
are fixed line and/or mobile operators); clients, IT outsourcers and carriers. Eircom is
232. e-skills UK (2008)
mainly a fixed line operator, but also has a ‘Technology Counts - IT &
• Systems and networking software mobile business. Kingston Communications Telecoms Insights 2008.’
London: e-skills UK.
(providers of technology such as Convergys, (known as KCOM) sells integrated IT and 233. However, internationally,
LogicaCMG); communications services to businesses, and BT’s revenues are lower
than those of comparable
internet and telecommunications services to European firms, partly
• Data and networking equipment (suppliers of selected consumer markets within the UK (see because it doesn’t
own a mobile network
equipment such as Alcatel-Lucent, Siemens- Section 2.1.1 for further detail.) business. In 2006 BT’s
Nokia, Motorola, Avaya, Oracle, Ericsson, global turnover was £20.1
billion while Deutsche
Cisco Systems); and There are five mobile network operators in Telekom and France
the UK (Vodafone, O2, T-Mobile, Orange and Telecom reported revenues
of £42 billion and £36
• End-user communications equipment (for 3), and together with independent service billion respectively. Office
example, D-Link, Siemens, Telsey). providers and mobile virtual network operators of Communications
(Ofcom) (2007) ‘The
(MVNOs) – such as Virgin Mobile and Tesco Communications Market
Total industry revenue was estimated at £56.7 Mobile – contribute around 35 per cent of total 2007’. London: Ofcom.
Chapter 4: p.272.
billion in 2006.229 The UK sector continues UK telecommunications turnover.234
234. These new entrants to
to make a significant contribution to the UK the sector are discussed
economy, with £21.3 billion in GVA in 2004, The telecommunications equipment in Section 2.2.1. Office
of Communications
equating to 2 per cent of total gross value sector has a small number of large global (Ofcom) (2007) ‘The
added for the UK.230 players.235 Equipment manufacturers aim to Communications Market
2007’. London: Ofcom.
develop products for the next generation Chapter 4: pp.271-272.
There are around 8,500 firms in the UK sector of telecommunications networks. A number
and 56,000 people are employed either of firms have expanded their R&D activities
directly or indirectly in the sector231 (28,000 in key telecoms technologies: Motorola,
professionals are employed directly in the Nortel Networks, Ericsson and Alcatel-Lucent

235. Telecommunications is a
scale economy business, Technologies have established Centres of enabler and transformer in the information,
and so operators looked to Excellence in advanced technologies and communication and technological revolution
buy technology from firms
who could supply industry- have significant R&D facilities in the UK. For More technological innovation took place
wide solutions. This led example, Lucent and Motorola have their world in the telecommunications sector in the last
to the emergence of
national champions within headquarters for UMTS (Universal Mobile two decades of the 20th century than in the
the network equipment Telecommunications System) in the UK because preceding 150 years.240
provider community – GEC
and Plessey in the UK, of the UK’s strengths in wireless technologies.
Alcatel in France, Siemens In addition, Alcatel has its key manufacturing The sector has recently experienced a hugely
in Germany, Ericsson in
Sweden, and Lucent in the operation for the submarine cable sector in the innovative phase, with technologies emerging
US. These firms became UK and Nokia and Siemens have significant that have considerably impacted the evolution
the primary source of new
technology and innovation research centres for third-generation (3G) of modern communications, from distribution
used by operators. mobile in the UK.236 technologies (for example, digital, broadband
236. UK Trade and Investment
(2007) ‘ICT Marketing
and mobile) to consumer devices (for example,
Strategies: Evidence Base.’ Over 50 per cent of the sectors’ revenues are MP3 players, Blackberries and the iPhone).241
[CD-Rom] London: UK
Trade and Investment.
generated by firms located in London, the
237. Department for South East and East of England and this total Traditionally, network operators have invested
Business Enterprise and exceeds 75 per cent when the North West, significantly in the research and development
Regulatory Reform (2001)
‘Competitiveness in the Yorkshire & Humberside and the West Midlands of new technology. BT regularly reported
UK Electronics Sector.’ are included.237 Regional clusters can be found annual investments of around £300 million in
London: BERR. Chapter 2.
238. UK Trade and Investment
near Cambridge, around Bristol and Edinburgh. R&D.242 This resulted in the filing of patents
(2007) ‘ICT Marketing Cambridge hosts research centres for a number (for example, BT developed early fibre optics,
Strategies: Evidence Base’
[CD-Rom] London: UK
of communications multinationals (such as and registered World Wide Web hyperlink
Trade and Investment. ARM, AT&T, Broadcom, Cambridge Silicon patents) and the deployment of proprietary
239. Ibid. Radio, Nokia, Nortel, Qualcomm, Symbian, systems – BT’s proprietary Customer Services
240. The first technical
innovation in the
and Toshiba) building on a long academic and System (CSS) is a good example. Introduced in
sector - the telegraph industry tradition in wireless technology. Virtual 1986, CSS provided BT with all the information
(messaging using Morse
code down wires) - was
groupings such as the Institute of Advanced to support its core customer activities, from
patented in 1836. Voice Telecommunications have also developed, billing and order taking to sales support and
communications followed
in the late 19th century
concentrated around key universities and fault recording. By 1999 it was the biggest
– (Alexander Graham Bell the international research centres of many civilian computer system in Europe.243 Today,
invented the telephone
in 1876) and this quickly
of the largest global firms.238 A number of BT’s R&D agenda focuses on wireless data
became established international firms have established their services, software development to facilitate
as the main form of
European headquarters in the UK (for example, telecommunications networks and upgrading
241. Fairbairn, C. (2006) Serving the Japanese NTT DoCoMo and, more recently, parts of the copper wire networks to higher
the Public Good in the all the Chinese operators). capacity optical fibre networks.244
Digital Age: Implications
for UK Media Regulation.
In Richards, E., Foster, R. The UK is a centre of excellence in niches of Total expenditure on R&D in the fixed-
and Kiedrowski, T. (2006)
‘Communications - The the sector, particularly in the development of line sector in 2006 was £1.127 billion. BT
Next Decade: A collection advanced 3G mobile products and services, accounted for virtually all of this: a total of
of essays prepared
for the UK Office of as well as short-range wireless technologies, £1.119 billion with an R&D intensity of 5.1
Communications.’ London: such as Bluetooth. The UK also has a strong per cent.245 Excluding BT, R&D intensity is
The Stationery Office.
Chapter 2. communications R&D skills base; in particular relatively low for the remaining fixed-line
242. Ten years ago, BT spent in RF and mixed signal design (analogue and telecommunications: with Vanco at 2.8 per
£307 million on R&D.
Many of BT’s peers
digital).239 cent, Eirco at 0.1 per cent and KCOM at 0.1
did the same: in 1999, per cent. Sales in the fixed-line sector grew
France Telecom invested
€593 million in R&D and
by only 4 per cent during 2006 but BT, in
Deutsche Telekom spent particular, chose significantly to increase R&D
€700 million on R&D.
2. Innovation in telecommunications investment (by 54 per cent). The fixed-line
243. Harrison, P. F. (1997)
Customer Service Systems has delivered profound technological telcommunications’ ratio of R&D investment
– Past, Present and Future. changes in recent years, which in to sales has risen sharply over the last five
‘BT Technology Journal’ 15
(1), pp.29-45. turn, is enabling new forms of service years – and is unique in doing so; this matches
244. Department for Innovation, innovation and business models the sector’s growth in R&D investment (up
Universities and Skills/ 54 per cent in 2006 and 94 per cent over the
Department for Business,
Enterprise and Regulatory 2.1 Traditional innovation is technologically average R&D in the four prior years). This is
Reform (2007) ‘The 2007 focused, and is a mix of radical and because the sector has had to invest heavily
R&D Scoreboard – Fixed-
Line Telecommunications incremental development into Internet Protocol (IP) networks (see
Sector Summary.’ London: Section IP networks are expected to
2.1.1 Innovations in technological significantly lower future operating costs and
connectivity, provided by the deliver returns on current investments.246
telecommunications sector, have been a key

The types of technological innovation created Switched Telephony Network (PSTN) and
by the sector – some created a generation ago telex (messaging) were the primary means
but which have enabled more recent advances of communication between two fixed points.
– include: Significant migration of domestic internet
connectivity from dial-up to broadband started The switch from analogue to digital in 2000 and has continued annually.248 With
By the end of the 1960s, the technology for PSTN only voice calls, faxing or making dial-up
switching from analogue (sound waves) to internet calls were possible. Broadband offers 245. Consisting of £741 million
of capitalised software
digital had been tried and proven. The Post a far faster and richer ‘triple-play’ experience development – a re-
Office (the national monopoly operator at (with voice, fast internet access and video focusing of its business
mix towards IT services
that time) was ready to transform Britain’s all available simultaneously), but also the - and £378 million of
telephone network from analogue into potential for the communications operator to R&D operating costs. See
Department for Innovation,
digital based on electronics and binary data offer far more services than it has in the past Universities and Skills/
transmission. This would make Britain’s network (see Section 2.2.2). Department for Business,
Enterprise and Regulatory
one of the most advanced in the world. Reform (2007) ‘The 2007 Internet protocol and next generation R&D Scoreboard.’ London:
System X was conceived by the Advisory Group networks
246. Department for Innovation,
on System Definitions, an alliance involving Most networks have been designed to deal Universities and Skills/
the Post Office and industry groups, and with narrowband (PSTN) communications Department for Business,
Enterprise and Regulatory
set up in 1968 to define the shape of the traffic, with most data traffic handled in Reform (2007) ‘The 2007
future telephone network and how it could overlay networks of various types. With the R&D Scoreboard.’ London:
be achieved. Collaborative development advent of Internet Protocol (IP),249 voice (both 247. In 1975, a new R&D centre
between the Post Office and its three principal fixed and mobile), data, and video traffic can opened at Martlesham
Heath in Suffolk. Today
equipment suppliers – GEC, Plessey and STC – be transported in the same way (as packets of it is one of the most
culminated in the first of the British-designed data) and on the same network. There have advanced centres for
digital switching systems called ‘System X’. been a number of next generation network research in Europe. It has
(NGN) programmes in the sector designed supported many ‘leading
edge’ developments,
The development of System X exchanges to collapse the overlay networks into one.250 including BT’s pioneering
was the cornerstone of modernisation of This move to all-IP networks is only possible work on optical fibre
technology and submarine
the existing network, by replacing analogue because of the move from analogue to digital cable transmission systems.
exchanges with digital switching centres a decade earlier. Moving to all-IP networks Now called Adastral Park,
it is host to a science park
interconnected with digital transmission also enables operators to extend their network and is one of BT’s five
links. It enabled an increased variety of reach beyond the network termination point satellite earth stations.
facilities and services to be made available (NTP, that is, the socket on the wall) into the 248. Fairbairn, C. (2006) Serving
the Public Good in the
to the telecommunications user, resulting in home and office and to offer new services (see Digital Age: Implications
ISDN (Integrated Services Digital Network) Section 2.2.2). for UK Media Regulation.
In Richards, E., Foster, R.,
and ISDN 2. The System X family of digital and Kiedrowski, T. (2006)
exchanges marked a leap forward into the era Next generation networks are a significant ‘Communications - The
Next Decade: A Collection
of microprocessors. focus of R&D investment for the sector and of Essays Prepared
for the UK; IP networks are expected to for the UK Office of
Communications.’ London:
The change from the old-style technology to significantly lower operating costs and provide The Stationery Office.
modern digital switching was a lengthy process, a more flexible platform for new services (for Chapter 2.
involving collaboration, research, development example, consumers will be able to access 249. First developed in the
US in the 1970s, Vint
and testing.247 voice and data from any device). Whilst the Cerf was co-designer
fixed-line sector has had disappointing growth (along with Bob Kahn) of
the mechanisms known
But the switchover changed the underlying and profitability over the last few years, such as transmission control
communications technology and enabled new investments are expected to deliver high protocol (TCP) and the
internet protocol (IP).
far more fundamental change a generation returns in the future. The most prominent The protocol freed up
later. Digital network technology increased NGN is BT’s 21st Century Network programme the amount of traffic
the internet could carry
the bandwidths available and increased data (21CN), with BT investing £10 billion and Cable and the new bandwidth
transference rates dramatically to speed up & Wireless and Colt are also investing heavily opened the doors to all the
content available today
data communications, making the innovative in NGNs. and enabled the internet’s
offering of broadband possible. capability to be used by
everybody. Mobile and wireless technologies The development of broadband The technologies used for communication
During the late 1990s and early 2000s, are changing. Fixed phones and desktops are
broadband became the successor to connected to the fixed network infrastructure
narrowband (public switched telephony service) using either narrowband (PSTN) or broadband
connectivity in the home and workplace. For (usually asynchronous digital subscriber line
most of the 20th century the voice Public – ADSL – technology). Mobile connectivity to

wireless networks uses different technologies, an important part of the innovation process,
most typically UMTS (universal mobile ensuring firms remain competitive with their
telephony service, or third generation mobile service or product offering and retain market
– 3G), GSM (global service mobile, or second share. Indeed, it has been estimated that up
generation mobile – 2G), or WiFi, as used with to 90 per cent of firms’ development resources
laptops. are being used to support the introduction
of service line extensions and feature
The pace of change in mobile technologies enhancements on products.252 For example,
is unrelenting.251 Just as GSM succeeded whilst the underlying technology (2G or 3G)
analogue, UMTS/3G mobile technology remains the same, handsets have continuously
is replacing GSM. The promise of 3G is to improved in terms of functionality (voice, SMS,
deliver broadband-like speeds to mobile MMS, MP3, photos), specification (battery life,
devices, opening the internet to mobile-users. photo resolution, storage capacity), and design
UMTS is in turn being superseded by HSDPA (from tablet to clam shell, and the current
(high speed digital packet access) with the slider-phones). The effect of this incremental
development of 4G predicted as the next new innovation is that it has transformed the
wave of mobile technology. mobile from being a communications-only
device (voice plus text) into one that also
Wireless technologies have also emerged: WiFi caters for entertainment (music and TV) and
250. Department for Innovation, is the most prevalent (offering broadband photography.
Universities and Skills/
Department for Business, connectivity within enabled buildings and
Enterprise and Regulatory public hotspots) for laptops, and WiMax (which 2.1.3 Process innovation
Reform (2007) ‘The 2007
R&D Scoreboard.’ London: offers broadband wireless access for laptops to European operators such as BT, France Telecom
DIUS/BERR. towns and districts). Bluetooth technology is and Deutsche Telekom are all investing heavily
251. Although, the time it takes
to develop and deploy
now widely used for hands-free connectivity in ‘internal IT processing factories’. These back
technology is far longer and technologies such as NFC (Near-Field office operational support systems are intended
than may be realised. For
example, the deployment
Communications) which is used on applications to automate, integrate and simplify internal IT
of third generation (3G) such as the Oyster cards on London transport. processes, radically improving customer service
wireless technology was
four years behind initial
and reducing costs. This type of innovation
expectations. 2.1.2 Incremental innovation is central to the long-term viability of the
252. Innovaro (2005) In addition to the more radical innovation that traditional communications service providers.
‘Innovation Briefing: Teleco
Innovation.’ London: has taken place within the sector over recent Operators will need to become efficient at data
Innovaro Ltd. years, incremental innovation also counts for processing, where the lowest cost will ensure
253. Put simply, a process of
understanding how radio
a significant amount of activity, and remains competitive advantage.255
waves travelled across
geographical environments
and where mast antennas
should be located to
receive mobile signals.
254. Spufford, F. (2003)
‘Backroom Boys. The
Secret Return of the British Vodafone achieved the licence requirement of 90
Boffin.’ London: Faber and
Faber. per cent coverage of the UK population
Vodafone started life in Racal (a military by 1987 (two and a half years early).
electronics company). Along with its US Vodafone and Cellnet competed, but also
partner Millicom (and the other licensee co-operated, in areas such as advertising
BT’s Cellnet), it was the first to get a licence and price, in order to sell the idea of mobile
for public mobile telephone services in communications and to protect revenue, to
1982 (beating companies such as Ferranti, the benefit of both. As Vodafone became
Plessey and GEC). Racal’s system for voice an increasingly large contributor to Racal’s
and data would be called Vodafone. Over income, a decision was taken in 1988 to
a two year period, a small team of Racal turn Vodafone into a company in its own
engineers designed and planned a detailed right. In 1989, the Department of Trade
and innovative approach to a cellular and Industry issued new licences to develop
network.253 Radio planning was to be new networks and increase competition
Vodafone’s technical core competency with enabling Orange and One2One to enter the
which it would compete with its rivals. mobile market. Vodafone has developed
into a global player, with a turnover of
Accepted by early adopters, there were £1.209 billion, and 8.8 million customers
19,000 people signed to Vodafone mobile in 25 countries in Europe, the Middle East,
services by 1985 and Vodafone had Asia Pacific and the US.254

2.2 Technological innovations in companies (Vodafone, T-Mobile, Orange, and
telecommunications are enabling a range O2), and Sky257 have been able to provide
of new service innovations, provided services to customers (such as broadband
by ‘traditional’ operators but also new services at a retail level) stimulating greater
suppliers, and new ways of collaborating competition and innovation.

2.2.1 Innovation within the supply chain is 2.2.2 New service innovations and business
changing, as new suppliers enter the sector models 255. Ofcom (2005) ‘Final
Statements on the
Market liberalisation has nurtured competition New technology enables new services; this Strategic Review of
to such an extent that firms from other sectors, has been evident since the foundation of Telecommunications.’
London: Ofcom.
often with no previous sector experience, can the telecommunications industry.258 With
256. During the last quarter
now freely enter the market. Technological technological advances, traditional revenues of 2007, Skype had 246
convergence is also driving this trend (see from calls and lines have declined. For million customers.
257. Financial institutions (for
Section 3.3). example, mobile telecommunications services example, Fidelity at Colt)
revenues are expected to plateau across and also private equity
(for example, the Carlyle
Traditionally, network operators (such as BT) Europe. Mobile penetration in most developed group) are also entering
provided services to customers based on the countries now exceeds 100 per cent, and the market; see Ovum
(2007) ‘Private Equity
technology and equipment purchased from revenues are expected to continue to grow and Telecoms: Why Now
equipment suppliers (for example, Oracle, slowly as operators offer more services over and What Next.’ London:
Ovum Plc.
Cisco and Ericsson), who in turn purchased 3G networks. Fixed voice telecommunications
258. However, Edquist argues
components from sub-contractors: a ‘bottom- services revenues are declining rapidly but that service innovations
up’ supply chain. Now, operators no longer fixed line data services (broadband) continue and technological
innovations in the
have a monopoly on providing innovative to grow, and the UK has the second highest telecommunications
products and services to customers. New total of broadband connections in Europe after sector are converging
and becoming critically
entrants, from outside the sector, have entered Germany.259 interdependent, see
the market. Suppliers (such as Cisco and Edquist, C. (2003) ‘The
Internet and Mobile
Microsoft) also deal directly with the customer. Consequently, operators have sought to use Telecommunications
Consumers are also feeding into the process innovative new services to drive or renew System of Innovation.’
London: Edward Elgar
(see Section 2.2.3). The supply chain is no revenue growth.260 Examples of mobile Publishing.
longer purely linear and one-way. phone services include voice and messaging 259. UK Trade and Investment
(SMS) and MMS (multi-media messaging (2007) ‘ICT Marketing
Strategies: Evidence Base’
Started in 2003, Skype, for example, launched using photos and video clips) with recent [CD-Rom] London: UK
voice over IP (VoIP) based on using broadband developments including TV services being Trade and Investment.
260. Fairbairn, C. (2006) Serving
connectivity to by-pass PSTN interconnection picked up on mobiles – a service developed the Public Good in the
tolls and access the ‘free’ internet256 and was so in Korea but being trialled in the UK by O2 Digital Age: Implications
for UK Media Regulation.
successful that it was acquired by the internet and Vodafone.261 However, take up of this has In Richards, E., Foster,
auction site eBay. Google also launched a been somewhat poor. Mobile broadcasting is R., and Kiedrowski, T.
(2006) ‘Communications
similar service with Google Talk. Both firms had the least developed of the digital platforms: - The Next Decade: A
little experience of operating in the sector until it does not yet exist in a number of countries. Collection of Essays
Prepared for the UK Office
they entered the market. However, it is estimated that by 2010, most of Communications.’
developed countries will have at least one London: The Stationery
Office. Chapter 2; Cleevely,
By collaborating with network operators mobile broadcast network enabling ‘live’ M. (2006) ‘The Role of
(through wholesale services) and the traditional television channels to be broadcast to Ofcom in Encouraging
Innovation’. London:
technology suppliers, firms such as Tesco, mobile phones and other portable devices Ofcom.
Sainsbury’s, the Post Office, Carphone (complementing other mobile services, and 261. Op cit.
Warehouse, the UK’s four major mobile distributed over 3G networks). 262. Graham-Rowe, D. (2008)
Why Every Home Should
Have One. ‘New Scientist’
8 March 2008, pp.24-25.

Femtocells capacity and are usually faster). Femtocells

are about the size of a Wi-Fi base station
A recent innovation in mobile phone and link a mobile wirelessly to a fixed line
technology has been the development of broadband internet connection. Although
‘femtocells’ – small devices that improve the technology may not be available until
indoor mobile phone coverage, and have early 2009, UK firms, such as ip.access and
the potential to move telephone ‘traffic’ off Ubiquisys are central to developing this
congested cellular networks and onto their emerging innovation.262
fixed line counterparts (which have more

Broadband has been able to offer consumers The next generation of innovation in mobile
a far faster and richer ‘triple-play’ experience, service provision will be in connection with
(with voice, fast internet access and video ‘concept of presence’ (or location-based
all available simultaneously). ‘Quadruple- services). The vision many operators and
play’ (fixed-line, mobile, internet and TV) are their suppliers envisage is that of ‘unified
also now being offered to consumers. BT’s communications’ (UC). Unified communication
current focus is on its ‘new wave’ services: is about being able to communicate from
predominantly broadband, mobility and IT any device, to any device, using whichever
services. BT Fusion (FMC) and BT Vision (IPTV) technology as appropriate. UC solutions are
are examples of this. now being offered (or at least promised) by
operators, and also by suppliers. This means
As a consequence of the provision of new that UC technology will detect where an
services, new business models are emerging. individual is, and then deliver relevant content
For example, some services are sold as bundles (for example, rail or bus timetables, nearest
(for example, broadband line plus IT support) bookshops) depending on where the individual
or a service may be delivered in a different is located. Presence information264 can also
(technologically-enabled) format, such as, inform others where the recipient is located
over a line rather than physically (for example, (for example, a train journey delay, or a parent
digital photo vaults from BT), or advertising looking for a child). Presence information is
services delivered by a provider via the internet an important component of UC – delivering
to a mobile phone. Service innovation and communications in the right format depending
resultant new business models are set to upon the receiver’s situation.
proliferate. One survey found that 69 per cent
of providers worldwide expect business model 2.2.3 Open innovation and collaboration as
transformation to be the primary source of a business model
263. IBM Institute for Business value over the next five years; 72 per cent BT has been embracing open, user-led
Value (2007) ‘Telecoms
Switches Emphasis. expect collaboration with external partners innovation and has opened up its entire
Preliminary Analysis of the will be critical as new business models are telecommunications network through open
2007 Telecoms Industry
Survey.’ New York: IBM structured and implemented.263 protocols and a software development
Global Business Services.
264. These solutions use a mix
of GPS (to identify where
the individual is located),
3G (to link to relevant
websites) and intelligent
systems to provide BT’s ‘new wave’ services broadband video on demand via a Freeview
information of relevance to
the individual situated in a digital terrestrial TV set-top box, and has
location. BT Fusion is a fixed-mobile convergence increased its subscriber base to 150,000
265. BT Group plc (2007) (FMC) phone service. Fusion was a world in just over a year. BT’s revenue comes
‘Annual Report & Form
20-F2007.’ London: BT first when launched by BT in 2005. When from enhanced services, such as a VoIP
Group plc. ordering the service from BT, the customer facility to dial up family and friends while
is provided with a hub and up to six mobile watching TV, or the ability to build personal
handsets. To make a call with the mobile, schedules, use picture-in-picture channel
the customer dials the number in the usual surfing, and to see caller ID on TV sets.
way. When within range of the hub the BT recently secured a content deal with
call is routed through the hub and into the Paramount, giving access to over 150 new
fixed broadband network for delivery. If films. It recently entered into a similar deal
the caller moves out of range of the hub with Disney, for major US television series
then the call is seamlessly transferred to including Desperate Housewives and Lost.
the mobile base station of BT’s partner
(Vodafone) for routing as a normal mobile For BT, in 2007, these activities generated
call. When outside of the home, the Fusion revenues of £7.37 billion (36 per cent of
mobile acts just as any normal mobile total revenues), an increase of 17 per cent
phone. When within range of a BT WiFi on the previous year (while traditional
hotspot Fusion phones also connect directly revenues fell 3 per cent).265 However,
into BT’s network in the same way. these new services may initially have lower
margins than traditional sources of revenue,
BT’s new IPTV service (Vision) also require more complex delivery mechanisms,
connects to the same home hub. Developed and often need partners to support them
in partnership with Microsoft, BT Vision (such as IT support).
– an example of quad-play – provides

kit (SDK) that is downloadable by users, is a ‘super regulator’, founded from the
entrepreneurs and firms. No other Communications Act 2003, from which it draws
telecommunications firm in the world has its statutory duties and responsibilities. Its
embraced this level of openness and access to formation reflected the need for an effective
users. As a result, BT has gained a competitive regulator to deal with the convergence of
advantage in the sector by utilising user the communications markets in the UK.
innovation in its advanced communications It was formed of five previous regulators:
infrastructure. Office of Telecommunications (Oftel);
Radiocommunications Agency (RA); Radio
A major element of BT’s strategy of opening Authority; Independent Television Commission
up to user-led innovation is Web21C SDK. (ITC); and Broadcasting Standards Commission
This software tool allows users unprecedented (BSC).
access to BT’s telecommunications
infrastructure, and enables innovation Regulation takes place under the European
by BT customers. It appeals to both large Regulatory Framework and is incorporated
established firms who want fully to integrate into UK law through the Communications Act
telecommunications services in applications (2003). The Communications Act gave a high
and to users inventing new applications priority to the promotion of competition in
that ‘mash-up’ the internet and traditional the market, whilst also citing innovation as a
telecommunications services.266 France Telecom key priority.269 In addition, Ofcom carried out
and Vodafone267 have also set up versions a Telecommunications Strategic Review (TSR)
of open innovation programmes. However, during 2004-2005. The TSR was undertaken
critics have questioned whether these because: (i) regulators considered that there
open innovation programmes are sufficient was not enough competition to allow sector-
(when compared with other sectors, such specific regulation to be withdrawn. Though
as life sciences and consumer electronics) the review considered some specific issues 266. Lakhani, K. personal
correspondence, 29th
and whether programmes are a core part of relating to mobile networks, the main focus February 2008.
innovation and growth strategies.268 was on fixed telecoms networks. This was 267. Vodafone’s ßetavine
programme is using the
because most existing regulation related to internet as a platform for
fixed networks, and it was in fixed networks research, innovation and
that the most complex competition problems
268. Innovaro (2007)
3. Innovation in the telecommunications were evident; (ii) fundamental changes in ‘Innovation in the
sector has been determined technology and consumer behaviour were Telecommunications
Maelstrom.’ London:
significantly by regulatory reform, underway, which may have rendered existing Innovaro Ltd.
intensified competition, technological regulatory approaches obsolete; (iii) other 269. Cleevely, M. (2006)
‘The Role of Ofcom in
convergence and consumer adoption of countries and markets were adopting different Encouraging Innovation’.
new forms of communication regulatory approaches, and Ofcom needed London: Ofcom.
to consider international and sectoral best 270. Ofcom (2005) ‘Final
Statements on the
3.1 Regulatory reform provided the catalyst practice.270 Strategic Review of
for a more competitive, innovative sector Telecommunications.’
London: Ofcom.
Until 1984 the telecommunications industry The TSR led to a recognition that regulation
in the UK was characterised by a state-owned should not inhibit innovation in a highly
national monopoly. However, in 1982, the UK competitive sector and that Ofcom should be
government decided to privatise and open a ‘light touch’ regulator. The TSR intended
up the sector to market liberalisation and that Ofcom should regulate and create an
competition. Consequently, in 1984 British environment to stimulate competition and
Telecommunications was privatised. In parallel, innovation and to implement this approach
AT&T in the US was broken up into one long within the framework of the Communications
distance and several regional Bell operating Act. Outcomes of the TSR included ensuring
companies (RBOCS), enabling competition that firms allowed consumers to switch
in both long-distance and local markets. The providers easily, as well as highlighting large
deregulation of telecommunications in the UK scale innovations such as next generation
and US acted as models for other countries and networks as a priority. Subsequently BT, Cable
became catalysts for the gradual deregulation & Wireless and Colt were able to invest in
of the sector and the creation of the NGNs, following completion of the TSR, with a
competitive and innovative communications degree of certainty regarding regulation.271
markets seen today.

The sector in the UK is regulated by the

national regulatory authority, Ofcom. Ofcom

3.2 Consequently, competition has increased slowing growth in European markets by buying
significantly mobile businesses in developing countries).276
Competition erodes the value of current
products, therefore increasing the incentives 3.3 Technological convergence is radically
for companies to find new sources of revenue altering the sector
through innovation.272 Before the liberalisation Convergence refers to the increasing ability
of fixed telecommunications in the UK, BT had of one specialist device to undertake several
271. Cleevely, M. (2006) one competitor – Mercury Communications. activities (for example, mobile phones playing
‘The Role of Ofcom in
Encouraging Innovation’.
Competition between the fixed-line suppliers music files).277 This has been a major change
London: Ofcom. has developed rapidly since the early 1990s. from previous decades, when communications
272. Ibid. Although BT’s share of telephone lines is and content were specific to particular devices.
273. Department for Innovation,
Universities and Skills/
static (around 80 per cent), its overall share By the late 1990s, the nature of content
Department for Business, of total fixed telephony revenues has fallen and services provision, over established and
Enterprise and Regulatory
Reform (2007) ‘The 2007
(to around 70 per cent).273 Households can developing technologies, had changed and
R&D Scoreboard.’ London: now choose their fixed link telephone supplier, converged significantly with, for example:
where there was virtually no choice a decade videos on the internet; television content
274. Many new operators offer
‘indirect access’ connection ago. Business users in metropolitan areas now distributed (to some extent) over mobile
to their networks. By have an extremely wide choice of supplier, phones; and voice transmitted through the
simply dialling a four-digit
prefix immediately before and competition has driven prices down and internet (VoIP).278 For the telecommunications
the number dialled, calls quality up. An increasing number of indirect sector, telephony networks – enabled by
can be directed over the
most cost-efficient route. access services274 are now available, offering greater bandwidths – are now able to carry
Normally this prefix is consumers very low prices for calls. music and video as well as text and voice.
dialled for you using a
simple plug-in dialler, or by
reprogramming the PBX. Competition has not only increased nationally, Technological convergence is leading to
In both cases this service
is usually provided free by but also internationally, with firms from sectoral convergence, with a blurring of
the operator. other countries penetrating the UK market. the boundaries between the media and
275. Engineering Export Throughout the 1980s and 1990s, national telecommunication sectors.279 With converged
Promotion Council (2008)
‘Annual Supplement monopolies and national networks collaborated communications, devices and online media,
2008 to Foreign Trade and worked together to provide international successful firms will be those able to manage
Policy 2004-09.’ New
Delhi: Engineering Export calls and services, with many foreign markets many types of content and application across
Promotion Council. being largely closed to foreign operators. Since several technological platforms. Technologies,
276. Parker, A. (2008) Upwardly
Mobile - Emerging Markets deregulation of national telecommunications services and content will also have to be
Shake Up the Old Order in networks in a number of countries, markets delivered so that they appear to consumers
Telecoms. ‘The Financial
Times.’ 11th February have opened up to competition from domestic as integrated, easy-to-use offerings.280
2008, Analysis: p.9. and international operators, with firms Telecommunication firms are also entering the
277. Christensen, C., Raynor, M. incentivised to expand abroad to increase media industry in a search for new revenue
and Verlinden, M. (2001)
Skate to Where the Money revenue and growth. For example, BT now sources, as pure telecommunications revenues
will be. ‘Harvard Business operates in a number of countries worldwide, are squeezed by increased price pressures.
Review.’ November, p.72.
278. Cleevely, M. (2006) through internationalisation strategies For example, BT has entered the digital
‘The Role of Ofcom in developed during the 1990s, which included television market (IPTV) which combines free
Encouraging Innovation’.
London: Ofcom. direct investments, strategic alliances and digital television with on-demand video and
279. Fairbairn, C. (2006) Serving mergers and acquisitions. personal video recording. Mobile operators
the Public Good in the such as Vodafone, O2 and 3 are developing
Digital Age: Implications
for UK Media Regulation. In the mobile sector, ‘developing world’ increasingly rich mobile video and music
In Richards, E., Foster, R., operators are increasing in number and in services.281 Currently, fixed/mobile convergence
and Kiedrowski, T. (2006)
‘Communications - The their scale of operation; operators such as (or the integration of wireless and wireline
Next Decade: A Collection China Mobile and America Movil (Mexican) technologies) is one of the key strategic
of Essays Prepared
for the UK Office of and Bharti Mittal (Indian), MTN (African). issues for telecommunications firms. If this is
Communications.’ London: Such operators are not only leaders in their managed successfully, operators and carriers
The Stationery Office.
Chapter 2. own countries but are increasingly active will be able to provide services that deliver user
280. UK Trade and Investment in western markets, with the advantage of benefits irrespective of their location, access
(2007) ‘ICT Marketing
Strategies: Evidence Base’ lower cost products and services. In India, technology, and terminal.282
[CD-Rom] London: UK telecommunication equipment exports are
Trade and Investment.
estimated at $1 billion for 2008, but are 3.4 Consumer acceptance and adoption is
281. Ibid.
282. Ibid.
predicted to grow to $2.5 billion by 2011.275 helping to drive innovation
For Western operators, with domestic markets The advances in technology have been
saturated, the risk is ‘second-tier’ status if embraced by consumers of communications
emerging markets are not part of expansion services at work, at home, and on the move.
plans (for example, Vodafone is coping with The profound shift in consumer behaviour – in
how we communicate (voice, text, video), with

whom (family, friends, communities of interest, future telecoms workforce and the skills that
strangers), and with what (fixed phone, mobile, will be needed. New technologies such as VoIP,
the PC, laptop, PDA, PSP) – continues. For WiMax, 3G and NGNs enable new applications
example: but demand new and up-graded skills of IT and
telecommunications workers.
• Mobile penetration is now over 100 per cent
in the UK283 More broadly, business and innovation
specific skills are also needed in order to 283. Office of Communications
(Ofcom) (2007) ‘The
• 57 billion text messages were sent during leverage technical innovation into business Communications Market
2007 in the UK284 innovation. Telecommunications professionals 2007’. London: Ofcom.
Chapter 4: pp.271-272.
will need to obtain new business-oriented
284. Mobile Data Association
• 23 per cent of 8-9 year olds in the UK skills to play a key role in the analysis, design (2008) ‘Press Release
now have mobile phones, and by the time and development phases of technological Facts and Figures.’
[online] Available from:
children are 13 this proportion has increased development along with skills to manage
to 70 per cent285 increasingly global supplier relationships.291 PressReleases/Page_Press.
285. Mellor, P. (2006) EU
• The 16-24 age group spends proportionally Investigates Mobile Phone
Danger, Protecting our
more time online than using radio or TV286 Children. [online] ‘PC
and over 70 per cent of the 16-24 age group 4. Innovation is hidden because of Advisor.’ London: PC
use social networking web sites287 incremental development, new service Advisor, July 2006.
286. UK Trade and Investment
offerings and the introduction of new (2007) ‘ICT Marketing
• There were 50 million blogs in 2006 with forms of organisation and collaboration Strategies: Evidence Base’
[CD-Rom] London: UK
around 175,000 new blogs created each Trade and Investment.
day288 4.1 Significant levels of traditional 287. Ibid.
innovation in telecommunications is 288. Cyber Journalist (2008)
‘How Many Blogs are
These technological changes have led to incremental in nature There? 50 Million and
expanded choice for the consumer (for Although radical changes have taken place Counting.’ [online]
Available from: http://
example, new TV channels, easy access to within the sector over the last few years, a
information on the internet); the consumer significant amount of incremental development news/003674.php
taking control of content choices (for to refine existing products and services is 289. Fairbairn, C. (2006) Serving
the Public Good in the
example, audiences are no longer dictated also undertaken by firms within the sector in Digital Age: Implications
to by ‘authorities’ and professionals with the order to remain competitive in the market. for UK Media Regulation.
In Richards, E., Foster, R.,
advent of the personal video recorder and However, incremental improvements, such and Kiedrowski, T. (2006)
internet libraries for example); and individuals as a new pricing structure or a technological ‘Communications - The
Next Decade: A Collection
contributing user-generated content in an development that improved functionality on of Essays Prepared
interactive and iterative way. Sites such as a mobile phone, would not be counted within for the UK Office of
Communications.’ London:
MySpace, YouTube, Bebo and Facebook, traditional measures of R&D as they are not The Stationery Office.
and Second Life have given individuals the considered as significant advances. Such Chapter 2; Leadbeater, C.
(2006) The Genie is Out of
opportunity to connect in new ways, create narrowly focused metrics may mean that some the Bottle. In Richards, E.,
communities of interest and social networks, forms of innovation and value creation are not Foster, R., and Kiedrowski,
T. (2006) ‘Communications
share information and views and produce own- being adequately captured. - The Next Decade: A
generated material and content.289 Collection of Essays
Prepared for the UK Office
4.2 Organisational and business model of Communications.’
3.5 Skills weaknesses are a potential barrier forms of innovation are not sufficiently London: The Stationery
Office. Chapter 5.
to innovation captured by traditional metrics 290. e-skills UK (2008)
A potential barrier to the development of New organisational forms and collaborative ‘Technology Counts IT and
Telecoms Insights 2008.’
the sector and innovation in general, is arrangements have been adopted by firms in London: e-skills UK.
that of skills weaknesses and shortages. the sector and have enabled new, and more 291. Ibid.
Against a wider backdrop of a decline in IT- open, ways of operating with other firms,
related education and gender imbalances in suppliers, consumers and technologies in the
recruitment, for the IT and telecommunications innovation process. However, such Type II
sectors, firms have reported difficulties in forms of hidden innovation are not recorded
attracting individuals with the right skills.290 in traditional measures of innovation, despite
In a recent survey for e-skills UK, 22 per cent the potential of such forms to contribute
of the IT and telecommunications firms who significantly to innovation and performance.
were trying to recruit staff reported difficulties
in attracting applicants with the right skills. 4.3 Exploitation of existing technologies to
For the telecommunications sector specifically, support service innovation
rapid technological changes and convergence A significant source of opportunity has
are expected to impact on the existing and opened up for the sector via technological

convergence. There is great potential to exploit 5.2 Organisational and business model
converging telecommunication technologies innovation could be better measured by
to support new services (such as triple play the rate of adoption and the effect of such
and TV services on mobile phones). Deploying forms on an individual firm level and across
technologies for new service provision (a Type the sector
III form of hidden innovation) is not currently As new organisational forms, more collaborative
captured in traditional metrics despite the arrangements (such as open and user-led
potential contribution this can make to a firm’s innovation) and new business models have
revenue and innovation portfolio. started to be adopted by some firms in the
sector, this Type II hidden innovation could
4.4 Firm-level and localised innovation is be better measured at the firm-level by
important but is unmeasured assessing the contribution and impact of such
At the firm-level, telecommunication firms may forms to firms’ innovation performance and
be innovating on localised, individual projects working practices. Assessments of sector-wide
through sharing experience and knowledge or adoption rates of new organisational forms and
working creatively in practice to solve small- innovative practices could also be added into
scale problems. However, this form of hidden analyses of innovation within the sector.
innovation (Type IV) may not be captured in
a formal way by the firm or recorded in R&D 5.3 Levels of investment in services could be
metrics. Conversely, firms may have formal measured to better capture this important
measures in place for capturing innovative contribution to innovation
and efficient processes in an effort to increase The technologies that have developed in the
effectiveness, but this may still be unmeasured sector have enabled new service provision by
by formal and official metrics for innovation. firms (a Type III form of hidden innovation).
Levels of investment that firms make in service
292. Such as e-skills UK’s innovation, and returns on such investments,
regular IT and Telecoms
insight reports. should be accounted for and recorded in
293. Ovum (2007) ‘BT and its 5. Innovation could be better measured analyses of the sector to give a more accurate
ICT- Two Case Studies.’
London: Ovum Plc.; Ovum by sector-specific surveys to capture and fuller picture of innovation.
(2006) ‘New Metrics for a innovation at a firm level and by
New Age.’ London: Ovum
Plc. including new forms of organisational 5.4 Firm-level estimates of innovation
and business model innovation Some firms in the sector have begun to put
in place more formal measures for capturing
5.1 Sector-specific surveys could provide innovative and efficient practices and processes
a more detailed source for capturing in an effort to increase effectiveness and
incremental and localised forms of performance; such metrics could be more
innovation formally recorded in traditional measurements.
Type I (incremental) and Type IV (localised) For example, BT uses ‘RFT’ (Right First Time
forms of innovation could be better captured – meaning no repeat faults); ‘RCT’ (Reduced
in surveys specific to the sector. Some surveys Cycle Time – reduced costs); and ‘L2C’ (Lead
already exist292 and examine the productivity to Cash – the time it takes to convert a sale to
and competitiveness of the sector and its links revenue) measures to assess the effectiveness
with strategic management and leadership of some business processes.293 Although, BT
skills. Conceivably this type of survey could has yet to publish data on these metrics, and
be expanded to include insights on innovative assuming these measures continue, they could
processes and practices within the sector. The potentially be reasonable measures of Type IV
Institute of Telecommunications Professionals hidden innovation. As a way to incentivise and
(ITP) aims to improve working practices reward innovative behaviour and practices with
within the sector through information and its employees and suppliers, BT also has just
networking activities; more importantly, it aims set up (in 2007) ‘Innovation Awards’. Such a
to inspire broader thinking and promotion of practice could be encouraged across the sector.
best practice within the sector. Surveying ITP Internal measures other firms use within the
members could be an initial way more formally sector to measure efficiency and performance,
to capture the innovative ideas and practices of and the impact this can have on the innovation
individuals working within the sector (see also process, should be investigated further.
section 5.4).

6. Existing government policy has to experience more ‘light touch’ regulation,
focused largely on regulatory activity, with part of Ofcom’s remit to stimulate and
centred around creating a competitive encourage innovation.297 However, with
environment, but policy could do more technological and sectoral convergence,
to support forms of hidden innovation Ofcom needs to ensure that regulation
keeps pace with new and emerging digital
6.1 Existing policy has focused on the technologies and their development and how
regulatory environment, which is centred such technologies need to be regulated. It is
on stimulating competition and promoting possible that new regulatory models may be
availability of technologies for economic needed in the future to fit with converged
and social benefit communication technologies.298
In order to ensure that the UK remains a
competitive place to live, work and conduct 6.2 Broad-scale support to ensure
business, existing government policy (through appropriate regulation and infrastructure of 294. Government policy has
also focused on health
the former DTI and now through BERR and the sector is necessary, but policy needs to and environmental issues
the sector regulator, Ofcom) has been targeted take a more holistic approach to realise the regarding mobile phones.
around promoting an appropriate environment full value of the sector 295. For example, the UK
was the first in Europe
for the telecommunications sector. Given the sector’s social and economic to enter the 3G market,
pervasiveness, and its comparative importance stimulating competition
from other operators. 3G
Started by the deregulation process in the as an enabler to other sectors, the sector is offers the opportunity of
early 1980s, BERR’s responsibilities continue to somewhat neglected in grand-scale support greater capability in data
transmission and new
focus on ensuring that framework conditions strategies compared with the aerospace and services such as video-clips
for a competitive environment for fixed line automotive sectors. However, a recent useful and photo-messaging.
296. Cabinet Office Prime
and mobile telecommunications are in place.294 development has been the Knowledge Transfer Minister’s Strategy Unit
Creating a more competitive environment has Network (KTN) in Digital Communications299 and the Department of
Trade and Industry (2005)
undoubtedly resulted in, for example, greater covering the telecommunications, IT and ‘Connecting the UK: the
choice for the consumer of operator or network broadcasting sectors established in December Digital Strategy.’ London:
HM Stationery Office.
provider, lower prices for calls and new business 2007. Industry-led, with members from
297. Cleevely, M. (2006)
entrants to the market who have brought new across the value chain, academia, the ‘The Role of Ofcom in
technological innovations (such as 3G) to the regional development agencies and devolved Encouraging Innovation’.
London: Ofcom.
sector and wider society and economy.295 administrations, and formed with funding 298. New regulatory models
from the Technology Strategy Board (TSB), may be needed to deal
with broadcast and
With the advent of broadband, government the Digital Communications KTN aims to focus telecommunications
policy has focused on supporting the on facilitating knowledge transfer across the convergence, for example;
see Fairbairn, C. (2006)
development of appropriate infrastructure sector, to act as a ‘network of networks’ and to Serving the Public
for the widespread expansion and utilisation promote innovation. Good in the Digital Age:
Implications for UK Media
of broadband through telecommunication Regulation. In Richards, E.,
next generation networks – a part of the First, the KTN aims to establish technological Foster, R., and Kiedrowski,
T. (2006) ‘Communications
government’s ‘digital strategy’ – to ensure and capability ‘roadmaps’ to identify new and - The Next Decade: A
that the UK remains competitive with other emerging technologies and the capabilities that Collection of Essays
Prepared for the UK Office
countries (such as Korea, Japan, the US and will be needed within the sector in the future of Communications.’
France) who are well advanced in investing to ensure effective implementation and that London: The Stationery
Office. Chapter 2.
in new fibre-based infrastructures. Initially, a competitive advantages are realised for the
299. The term ‘digital
part of the 1998 Knowledge Economy White UK. Issues that will also be covered include: communications’ reflects
Paper, the strategy aimed to make the UK barriers to innovation and development; the the changing nature of the
underpinning technologies
‘digitally rich’ (as it lagged behind European use and role of venture capital; skills needs (which are no longer
and developed world counterparts) by and recruitment issues; and adjacent sector separate and distinct)
and that the sectors are
improving access and utilisation of digital TV, requirements. Second, such road maps will be converging.
broadband, and creating a competitive and benchmarked against other countries, with
innovative deregulated mobile and fixed-line the aim to develop an overarching strategy for
phone market. Deregulation also facilitated the digital communications in the UK.
use of WiFi by operators, facilitating mobility
in communications. Now the digital strategy The Digital Communications KTN is a useful
is carried on through the work of BERR and first step in developing a coherent and current
through the Information Age Partnership.296 understanding of the sector, the changes
that have been occurring and the role that
With the creation of the ‘super’ regulator innovation plays in those changes. The KTN
Ofcom in 2003 and the Telecommunications should provide a coordinated, holistic and
Strategy Review in 2005, the sector began industry-led voice for the sector.

Policy should also consider the broader forms
of hidden innovation and the value that
this creates for the sector. Organisational
innovations can provide firms with new
opportunities for revenue and growth and can
be just as important as technical innovations
for successful commercial exploitation and
operation. Firms should be encouraged to
explore new business models and ways of
working if this brings commercial value and
increases sector performance. However, this
places an important emphasis on their having
the right skills.

As identified by the Digital Communications

KTN, the skills that are becoming necessary
to deal with technological advances and
their commercial exploitation will become
increasingly important, especially given an
increasingly global competitive environment.
Moreover, innovation within the sector will be
improved if skills weaknesses and shortages are
addressed. On the technical side, up-skilling to
deal with emerging technologies (for example,
VoIP, 4G, NGNs) will be necessary for technical
300. e-skills UK (2008) personnel. On the business side, managers and
‘Technology Counts IT and
Telecoms Insights 2008.’ business professionals will need to develop –
London: e-skills UK. alongside a technical understanding – deeper
business and innovation skills to ensure
that technological advantage is turned into
commercial advantage.

To address the wider recruitment issues,

new approaches are needed to attract and
retain individuals into the sector in order to
sustain its growth. For skills needs, initiatives
should encourage employers to invest in
skills and training to address employee skills
weaknesses and gaps. A recent report by
the telecommunications sector skills council
(e-skills UK) recommends that policies should
focus on:

• a clear and simplified national framework

for professional skill progression (including
technical, business and interpersonal

• the targeting of small firms, where

recognition of the need to train and up-skill
employees is traditionally low; and

• up-skilling of professionals from Levels 2

to 3 and beyond. Universities and colleges
may have a bigger role to play in supporting
this workforce development, whilst working
in partnership with employers, to ensure
that education and training meets required

Appendix D: Software and IT Services
301. Related activities of
Innovation through technological disruption, facilitating a role for hidden the sector include:
innovation in new organisational forms, business models and the provision of facilities management,
consulting and training,
services supply of contract staff,
office software and
equipment, software
maintenance, hardware
design, manufacture and
maintenance, information
supply and distribution,
communications services,
research and development.
See The Work Foundation
(2007) ‘Staying Ahead:
The Economic Performance
of the UK’s Creative
Industries.’ London:
Department for Culture,
Media and Sport.
302. Ibid.
303. Office for National
Statistics Labour Force
Survey Jan-Mar 2007;
1. Software and IT services is a vitally a GVA of £23 billion304 with exports of £4.7 Business Register (IDBR)
important sector for the UK, as an billion.305 The UK market for software products ‘2004-2007 Analysis of UK
Local Units in VAT based
enabler of other sectors and activities and services is the largest in the EU306 and Enterprises.’ Newport:
and in underpinning the knowledge growth is expected to continue in the medium ONS.
304. 2006 figures. Forecasts
economy term through to 2012.307 predict growth at an
annual rate of 4-6
per cent until 2011
In the UK, the software and IT services There are a number of significant clusters in (this includes support
sector involves: the development of system the UK: in England, software and IT firms are services, project services,
and IT outsourcing,
software; contract/bespoke software; systems based around Cambridge, the Thames Valley but excludes business
integration; systems analysis and design; area, Manchester and the Midlands; in Scotland process outsourcing). See
Holway@Ovum (2007)
software architecture and design; project there are clusters around Silicon Glen and ‘UK S/ITS Market Trends
management and infrastructure design.301 Dundee (which has a significant concentration Report’ (August). London:
Ovum Plc.
of software games firms). Northern Ireland and
305. Export figures from 2004.
Specifically, the sector can be broken Wales also have small but growing sectors of IT The global software and IT
down into three stages of activity. First, and software activity. services sector generated
revenues of $698 billion in
development: software is developed either 2006. A third of the total
for bespoke use (designed to fit the particular Key consumers of software in the UK are the ($228 billion) was related
to software products and
needs of a customer) or for off-the-shelf use financial services sector, the health services $470 billion on IT Services.
(such as Microsoft’s Office package). Software sector and the communications sector.308 The Ibid.
306. European Information
development is closely linked to the computer UK’s growth is also partly due to substantial Technology Observatory
hardware industry, as software must be investment over recent years in e-Government (EITO) (2007) ‘European
Information Technology
designed specifically to the hardware on which initiatives such as new IT systems for the NHS Observatory Yearbook.’
it will be installed. (£30 billion over the last ten years); Transport Autumn 2007. Brussels:
for London’s Congestion Charging and Oyster
307. Ovum (2007) ‘Ovum
Second, systems design: designing large Card projects; and ‘Shared Services’ (a process Global Software Forecasts
and complex business IT systems requires of sharing back-office resources across Councils (March).’ London: Ovum
Plc.; Datamonitor (2007)
expertise; consequently a consultancy and Departments).309 ‘Global IT Services
industry has arisen around this need. Large Forecasts (September).’
London: Datamonitor.
international consultancies like Accenture The sector comprises some very large, global 308. Department for Innovation,
specialise in providing IT solutions and players and a significant number of smaller, Universities and Skills/
Department for Business,
advice on information management to large specialist software firms in the UK. Almost Enterprise and Regulatory
organisations. all the world’s major software players have a Reform (2007) ‘The 2007
R&D Scoreboard.’ London:
substantial UK presence, whether as an R&D DIUS/BERR.
Third, retail and implementation: computing operation, a logistics distribution network, or 309. UK Trade and Investment
customers will draw on a range of sources to sales and marketing operation, and include (2007) ‘ICT Marketing
Strategies: Evidence Base’
complete their overall package – acquiring Accenture, EDS, Google, IBM, Infosys, [CD-Rom] London: UK
hardware and software through retailers, Microsoft, Oracle, SAP, HP, EDS, CSC and Tata. Trade and Investment.
310. Ibid.
resellers or via IT consultancies.302 Indigenous UK firms include Asidua, Autonomy,
Capita, Lagan Technologies, LogicaCMG, Misys,
The UK sector employs around 600,000 people nCipher, Northgate, RM, Sage, and Xansa.310
(with around half employed in software and
half in IT services) in 100,000 firms,303 with

The UK has established strengths in the The sector is also composed of a significant
software and IT services sector in: accounting number of small firms, particularly in the UK314
and finance software (such as Sage); asset and the R&D Scoreboard for 2007 (based on
management (for example, Misys); content 2006 data) demonstrates that R&D expenditure
management software (for example, by the sector amounted to £1.2 billion, making
Autonomy). Particular strengths are in software it joint third (with the electronics and IT
security (where the UK has the second largest hardware sector) behind the pharmaceuticals
market in Europe, accounting for 22 per cent and aerospace sectors. The top four UK firms
of the total market).311 The games software in the software and IT services sector (Telent,
market is another: three of the best-selling Sage, Misys, and NDS) accounted for 40.6 per
games in the world were created in the UK. cent of R&D investment for the sector.315
The UK is the largest market in Europe and the
third largest market in the world.312 The size of Large, global technology suppliers, which
the UK games sales market in 2006, on sales dominate the sector, have research and
of console, PC and handheld games software, development facilities increasingly located close
console hardware, and console and PC gaming to key skills sources (as in India), to partners
peripherals in the UK, totalled £2.18 billion. (such as Accenture’s Centre of Excellence
There is a significant cluster of games software at SAP’s headquarters in Waldorf, Germany)
firms in and around Dundee in Scotland. or close to clients. Many of these suppliers,
311. European Information including IBM, Microsoft, Nortel, Northgate
Technology Observatory
(2007) ‘European Information Systems, Sage, and Toshiba,
Information Technology maintain research laboratories in the UK.
Observatory Yearbook.’
Autumn 2007. Brussels: 2. Innovation in the software and IT
EITO. services sector has enabled radical R&D resources are used to: (i) investigate
312. Entertainment Leisure
Software Publishers
and emerging technologies which are radically new and emerging areas of knowledge
Association (2006) facilitating new organisational forms (over the medium to long term) and to develop
‘Frontier Economics
Comparative Analysis
and business models the next wave of disruptive technologies (such
of the UK’s Creative as SOA and virtualisation – see Section 2.3);
Industries.’ London: ELSPA.
2.1 Traditional innovation in the software (ii) undertake incremental improvements in
313. IBM (2006) ‘Annual Report
2006.’ New York: IBM; and IT services sector is a mixture of radical existing software products, over a shorter time
Hewlett-Packard (2006) and incremental innovation developed by frame, to maintain competitive advantage.
‘Annual Report 2006.’ Palo
Alto, CA: Hewlett-Packard. large and small suppliers Large suppliers may have technology offices
314. Most of the sector’s firms for this purpose, which draw on and codify
are listed on AIM and other
small exchanges or are
2.1.1 R&D is used primarily for product improvements and repeatable good practice.
unlisted, see Department development by large and small scale
for Innovation, Universities
and Skills/Department
software suppliers Small firms are also important to innovation,
for Business, Enterprise For firms in the software segment of the sector, as they can be more agile and dynamic
and Regulatory Reform
(2007) ‘The 2007 R&D
product innovation is a main focus area of than large firms and respond more quickly
Scoreboard.’ London: R&D, and R&D budgets can be a significant to changes in the market place. Such firms
proportion of costs for large companies. For can often be at the forefront of research
315. Ibid.
316. NaturalMotion (2005)
example, IBM spent $6.5 billion (6 per cent and development, generating new products,
‘Dynamic Motion of revenues) on R&D in 2006, while HP spent services and technologies. Consequently, large,
Synthesis’. White Paper. $3.6 billion (or 4 per cent of revenues).313 global suppliers engage with small firms in their
Oxford: NaturalMotion.

NaturalMotion time by combining artificial intelligence,

biomechanics, and dynamics simulation.316
One example of a university spin-out DMS can be used on PlayStation 3, Xbox
is NaturalMotion. Based on research 360 and PCs (using NaturalMotion’s
conducted at Oxford University, Euphoria product). NaturalMotion
NaturalMotion is now a leading software markets, sells and supports its products
firm which has developed technology that globally to customers in the games, film,
will be used in the next generation of post production and broadcast markets.
video games. Its breakthrough software, Clients include LucasArts and Rockstar, the
Dynamic Motion Synthesis (DMS), creates developer behind one of the world’s best-
high-quality 3D character animation in real selling computer games, Grand Theft Auto.

supply chains by buying products or services, or defects for 54 per cent; and reduced costs for
augmenting in-house skills and competencies. 28 per cent.317 Other benefits reported were
Large firms may go further by ‘buying-in R&D’ better alignment between IT and business
through acquiring small, innovative firms as goals and reduced project risk.
a way to attain access to the next wave of
new generation technologies and to maintain Fujitsu IT Services’ ‘Sense and Respond’
competitive advantage. methodology for IT Service management,
and its ‘Triole’ methodology, is an example
2.1.2 UK universities have a role to play in of a process innovation. The process aims to
the innovation process incentivise continuous improvement in service
A number of UK universities have world-class delivery. Fujitsu’s Sense and Respond approach
research groups specialising in ICT-related is grounded on the Lean and continuous
research. Specialist software research groups improvement principles, with the aim of
exist at Southampton, Edinburgh, Nottingham, capturing, improving and measuring elements
Newcastle, Imperial College, Surrey, Bath, of service provision that create value to clients.
Oxford, University College, Cambridge,
Manchester, and Warwick Universities. 2.2 Innovation is changing in the sector, as
Research carried out in such institutions technology suppliers realise the limitations
may ultimately be developed by firms in the of R&D, and process innovation becomes
software and IT sector, or commercialised via commoditised
university spin-outs. This form of R&D can be Many suppliers of technology and IT services
of crucial importance in making technological are increasingly faced with the limitations
advances in the sector, which can radically alter of R&D-driven product innovation. Large
and shape the future market place for software suppliers have become frustrated with the
and IT. length, cost, and quality of the product
development process. For example, Microsoft 317. VersionOne (2007)
‘The State of Agile
2.1.4 Process innovation is a focus for IT took five years and billions of dollars to Development 2nd Annual
services develop Vista (the latest version of its Survey.’ Alpharetta, GA:
While product innovation is the primary operating system software).318 318. Booz Allen Hamilton
focus for the software segment of the sector, (2007) ‘Money Isn’t
Everything. A Survey
process innovation is more a focus for IT The relatively short life cycle of software of 1000 Global Largest
services, where the process, together with an IT products exacerbates this issue, and is one Spenders on R&D.’ Virginia:
Booz Allen Hamilton.
professional’s expertise, forms the service that reason why some large scale suppliers acquire
319. Department for Innovation,
is provided to clients. R&D budgets are also start-ups with innovative products and services Universities and Skills/
used for process innovation in global firms. For – a process of buying-in R&D (see Section Department for Business,
Enterprise and Regulatory
example, Accenture is investing $450 million 3.2). A second reason is that product or service Reform (2007) ‘The 2007
in developing products and services around innovations (for example, virtualisation, SOA) R&D Scoreboard.’ London:
Service Oriented Architecture (SOA). are relatively rapidly matched by competitors 320. Ovum (2006) ‘Productised
who quickly launch similar products, eroding Business Process Services:
Redefining Software and
SOA is one example of process innovation competitive advantage.319 Services.’ London: Ovum
in the sector, as an innovative new way of Plc.
building and managing business applications. Process innovation in the software and IT
Other approaches such as ‘Agile’ and ‘Lean’ services industry continues to be strongly
software development are also examples driven by intense competition, and price and
of process innovation. Lean is a generic margin pressures (see Section 3.4). These
streamlining approach for all production factors are forcing suppliers to gradually, but
systems, but Agile is specific to product relentlessly, move away from a ‘craftsmanship
development environments. model’ where a highly skilled (and highly paid)
developer or consultant develops or delivers
Agile development is an alternative to the software/service to a more industrialised
traditional product development (which and commoditised ‘factory model’, where less
emphasise initial major planning). Agile skilled (and lower cost) resources can deliver
promotes development iterations throughout equal or better quality with predetermined
the life-cycle of the project via feedback process templates, industry maps or creative
through tests and releases of the evolving work packaging.320
software (consumers and clients form part
of this feedback). One survey of 1,700 firms
across 71 countries found that using Agile
processes led to increased productivity for 55
per cent of respondents; reduced software

2.3 New services, organisational processes, Service Oriented Architecture (SOA) is a
business models and new ways of new approach to building and managing
collaborating are increasingly important business applications by breaking them into
within the sector loosely coupled units (such as Enterprise
Resource Planning (ERP) along with Customer
2.3.1 The emergence of disruptive Relationship Management (CRM) applications).
technologies is changing the nature of SOA is not only reshaping the packaged
software and IT services provision and is software applications market segment, but
facilitating the development of new services is providing new opportunities for IT services
Disruptive new technologies which have projects, as companies move to integrate
emerged from within and outside of the sector legacy custom applications using SOA
– technologies such as virtualisation software, principles.321 One study estimates that SOA
Service Oriented Architecture (SOA) and Web could reduce development costs by 25 per cent
2.0 – are significantly changing the dynamics (about $53 billion) over five years across the
of the software and IT services sector and are 2,000 largest firms worldwide.322
enabling the development of new services.
2.3.2 New technologies are also enabling
Virtualisation software (a technology enabling the development of new business models
a single physical machine to run multiple and new forms of business practice
321. Ovum (2007) ‘SOA Vendor instances of software in parallel) is not only The software sector has traditionally relied
Strategies.’ London: Ovum
Plc. opening a new and growing market segment on the dominant ‘licence + maintenance’
322. Aberdeen Group (2006) in software, but is reshaping the hardware business model. This has been disrupted by
‘The SOA in IT Benchmark
Report.’ Boston: Aberdeen
and outsourcing markets. Virtualisation the emergence of the internet which has
Group. software enables client organisations to use enabled the development of the ‘Software as
323. Ovum (2007) ‘SaaS: fewer physical machines to deliver the same a Service’ (SaaS) business model. This is, in
Opportunity or Threat
for IT Services Vendors?’ computing loads by using computing spare turn, causing disruptions in the organisation
London: Ovum Plc. capacity. This puts pressure on hardware and implementation of IT service processes, as
324. Desisto, R. Pring, B.
Lheureux, B., and
sales, and reduces outsourcing revenues of IT software development for large on-premises
Karamouzis, F. (2006) services companies (who are paid by number of implementations are being reduced and
‘SaaS Delivery Challenges
On-Premise Software.’
machines managed). altered.323
Stamford, CT: Gartner.
325. All, A. (2008) ‘India’s
Tata Consultancy Services
Introduces Hybrid
SAAS Model.’ [online] Software as a Service Siebel Systems, Microsoft, Oracle and SAP
Available at: http://www. have also entered the SaaS market. Tata
sts/?p=324 Software as a Service (SaaS) is where Consultancy Services (TCS), India’s largest
326. Intellect (2007) ‘Software software applications (such as customer service provider, is introducing a hybrid
and IT Services Report
– The Future.’ London: relationship management, human resources, SaaS/services model that it calls ‘IT-as-a-
Intellect. accounting and email) are hosted by a service’, which is being aimed primarily at
provider online, rather than installed on the the local SME market and is predicted to be
user’s premises, and priced on a per usage worth up to $9 billion a year.325
basis. Access to the web and a broadband
connection are the only IT infrastructure However, in the UK, SaaS does not yet
needed. The model makes it easier to share appear to be challenging the dominant
data with third parties, enables backup data licence and maintenance model; its
centres for disaster recovery, and crucially, adoption amongst small UK firms appears to
for smaller businesses, offers access to be limited. For example, one survey found
enterprise level application services that that around 70 per cent of small software
would be difficult to achieve in-house. firms were continuing with the traditional
business model (licence sales, maintenance,
SaaS is predicted to capture more than advice and integration). This may become
a quarter of the $200 billion business increasingly outmoded, as awareness
software market by 2011.324 The market amongst potential users increases and the
leader, (a US firm founded future predicted growth of SaaS occurs.326
in 1999), serves more than 38,000 other One notable exception is Huddle, a UK
firms and has one million paying users for start-up established in November 2006,
its ‘on-demand’ Customer Relationship which combines online collaboration,
Management (CRM) software, with project management and document sharing
revenues around $700 million in 2007. using social networking principles.

Value-based pricing models represent both a Open source software (OSS) is built on the
business model innovation in the IT services principle that the source code of a program
industry, and an enabler for collaborative should be readily accessible, so that users
innovation between suppliers and clients have the right to copy, modify, maintain and
in improving efficiencies and effectiveness. redistribute, without paying royalties or fees.
Value-based pricing is a commercial model in Examples include Linux, Firefox and Wikipedia.
an IT services contract where the supplier is
paid depending on the business outcomes it Open source software can facilitate innovation.
delivers for the client (for example, transactions Open standards in OSS can be the basis
processed) rather than on the more traditional for collaborative innovation as source
contractual arrangement of fixed price or codes are openly documented, published
time and materials. For example, IBM has without restriction and so freely available for
contracted with India’s Bharti Telecom to adoption. Subsequently, standards can evolve
manage their whole IT and telecommunications through collaboration with organisations
infrastructure and applications in return for and communities and create and add value.
a percentage fee of Bharti’s revenues. Driven This could potentially enable breakthroughs
by competitive pricing, and scarcity of skills in in innovation by fostering and generating a
certain localities, IT services firms see value- broader range of ideas and creativity from a
based pricing as a tool for driving ‘non linear’ wider ecosystem of contributors: collaborating
revenue growth, that is, not directly related with partners, clients and individuals for
to the number of people or costs they incur. innovation can help solve real business
Value-based pricing is also seen by suppliers as challenges.
a key incentive for collaborative innovation327
(see section 5.4). IBM, Sun and Novell have endorsed and
contributed to open source software by
2.3.3 New forms of collaboration and releasing industry code to be augmented by 327. Ovum (2007) ‘Innovation
in IT: Vendor Strategies.’
sources of innovation are emerging individuals and academics; adopting open London: Ovum Plc.
Facilitated by the internet, new forms of source applications for enterprise use; and 328. Cohn, O. (2005) ‘Value
Creation through
collaboration are occurring, which is leading sharing intellectual assets. IBM has also Collaborative Innovation.’
to the development of new and more open developed a ‘patent commons’ initiative by Haifa Research Lab: IBM
practices in the innovation process. Open pledging 500 patents to the open source
source software (OSS) has facilitated this form community. IBM maintains that using OSS has
of collaboration. Web 2.0 technologies are indirectly created more value than by limiting
also enabling collaboration and participation the use to inventors.328
and are changing the dynamics between the
software and service provider and the end-user. Web 2.0 technologies, using the internet for
new forms of collaboration and participation,

Autonomy Autonomy has utilised an innovative

business model in its development. The
Founded in 1996 and built on ground- firm has leveraged its IP by avoiding the
breaking research carried out at the small individual user, instead embedding its
University of Cambridge, Autonomy’s software in over 300 other software firms
technology uses a unique combination of who then license Autonomy’s technology to
mathematical principles (Bayesian Inference power their own software products. Clients
and Shannon’s Information Theory) to form include Citrix, Computer Associates, EDS,
a conceptual and contextual understanding IBM Global Services, Novell, Veritas, BAE
of any piece of electronic data, including Systems, Ford, Ericsson, Shell, the BBC,
unstructured information, whether it is and public sector agencies including the US
text, email, voice or video. This is known as Department of Defense, NASA and in the
‘meaning-based computing’. Autonomy’s UK, the Houses of Parliament. Autonomy
products can deal with tasks such as has rapidly become the market leader
enterprise search, taxonomies, compliance, in this area and has generated annual
customer relationship management and revenues of over $250 million.
customer experience management.

are changing the collaboration software Oracle, SAP, HP and EDS). These firms have
market, as well as opening new project services been undertaking acquisitions of both small
opportunities for IT services firms.329 players with promising products and also
medium-sized competitors (as with Oracle’s
Traditionally, most software applications have acquisition of Siebel, Retek and PeopleSoft),
been developed by major suppliers, such as leading to continued industry concentration.332
Microsoft, SAP, Oracle or IBM. With broadband Yet, start-ups with innovative products in new
connectivity now common, a firm can now areas (like VMware in virtualisation) continue
choose to buy from existing large suppliers to mushroom and challenge global giants.
or from the increasing independent software Conversely, many of the successful start-ups
sector. By amalgamating software from these end up being swallowed by one of the global
various sources (a process referred to as ‘mash- players – a large firm strategy of buying-in
ups’), the internet is facilitating innovative innovative R&D.
329. Carter, S. (2006) ‘SOA and approaches.
Web 2.0: The Language of
Business.’ Palo Alto: IBM 3.3 Convergence of technology is increasing
Press. Web 2.0 will become increasingly prevalent competition from within and outside the
330. Intellect (2007) ‘Software in the business-to-business environment – sector
and IT Services Report
– The Future.’ London: the dawning of ‘Enterprise 2.0’ services and SOA and SaaS are driving convergence between
Intellect. applications – with an emphasis on open and the software and IT services sub-sectors, firms,
331. Based on the NASDAQ
share price of $693 on collaborative ways of working with the end- products and services. New sector entrants,
30th November 2007; see user. Rather than software being delivered in a such as telecommunications companies (BT,
also Vise, D. (2005) ‘The
Google Story.’ London: ‘discontinuous and periodic update’ approach, Deutsche Telekom, France Telecom and AT&T)
Macmillan. as is currently used, the availability and use of are also entering the IT services market,
332. Intellect (2007) ‘Software software is likely to become more fluid with particularly in the infrastructure management
and IT Services Report
– The Future.’ London: applications constantly updated and fine-tuned area. Online brands such as Google are
Intellect. on a rolling basis. End-users will become an entering software markets via the SaaS model,
333. The term ‘red oceans’
of highly contested
integral part of the development process.330 enabled by telecommunications firms with
market spaces for highly their hosting and high bandwidth connectivity
competitive markets, and
‘blue oceans’ for emerging
services. Furthermore, pure business process
niche areas where outsourcing (BPO) providers such as Capita
competition is low or non
existent has been used
3. Software and IT services innovation are increasingly competing with IT outsourcing
to identify uncontested is determined by global competitors, firms as business process outsourcing contracts
market spaces; see Chan
Kim, W., and Mauborgne,
concentration and convergence within often include management of both the
R. (2005) ‘Blue Ocean and outside the sector and education technology and the process. The combination
Strategy: How to Create
Uncontested Market
and skills weaknesses of slowing growth, intense competition and
Spaces and Make the new entrants from multiple directions are
Competition Irrelevant.’
Boston, MA: Harvard
3.1 Success and survival are key… all cutting prices and margins, and rapidly
Business School Press. Commercial success and survival are the key commoditising existing software products and
drivers for innovation in the software and IT service offerings.333
IT services sector. Successful innovators,
particularly small start-ups, can earn millions or 3.4 Globalisation, off-shoring and the
even billions of dollars. Google, which was only rise of emerging markets offer both
formed in 1996 on the basis of an innovative opportunities and threats to the UK sector
search technology, is today the largest In the early 1990s, driven by globalisation,
technology firm with a market capitalisation competition and cost considerations, American
of $219 billion.331 For large IT suppliers, the and European software and IT firms began
motivation to innovate is continued market to locate some routine tasks and activities
relevance. The sector is moving at such a rapid (IT help desks and call centres) ‘off-shore’ in
pace that the risk of changes in demand, low-cost locations. India was the favourite
competitive pressures, and technology choice; it was English-speaking, numerate and
obsolescence are very real. Combined, these had comparatively cheaper labour. This began
factors drive the continued acquisition of the development of a fledgling IT industry in
promising start-ups by dominant companies in India, facilitated by the liberalisation of the
the sector. telecommunications sector in the late 1990s,
which led to declining bandwidth costs.
3.2 …which is driving industry
concentration More recently, in the lead up to the year
The software and IT services sector is 2000, US and European firms, experiencing
dominated by a number of very large global a shortage of qualified software engineers
suppliers (such as Accenture, IBM, Microsoft, in their own markets to address the IT issues

predicted with the ‘Y2K’ threat, combined with 3.5 Educational, recruitment and skills
escalating costs of in-house IT, were forced weaknesses are of critical importance for
to look for developers and IT professionals the sector
in emerging (and cheaper) markets such as In addition to the issues of offshore
India.334 relocation,339 the UK software and IT services
sector also faces major educational, recruitment
During this time, India had nurtured a highly and skills weaknesses, which has the potential
educated pool of skilled software and IT to significantly impact not only innovation
experts, leading to the development of within the sector, but its future development.
home-grown firms such as Infosys, Tata and
Wipro. Such firms offer principally custom and First, there has been a decline in the number of
packaged application development, testing and people choosing to study the subject at school
maintenance services (but also IT consulting, and university, and of those that do study
infrastructure outsourcing and business process IT-related subjects, fewer are choosing to enter 334. It has been estimated
that net savings to the US
outsourcing services) at significantly lower and work in the sector. It has been estimated economy, brought about
prices than their US or European counterparts. that employment in the UK’s IT industry is by off-shoring, could result
in $390 billion saved by
This (labour) cost advantage has enabled set to grow around five times the national 2010.
these firms to grow into multi-billion dollar average, and that approximately 150,000 new 335. Ovum (2006) ‘The Impact
organisations (for example, Wipro is worth entrants to the IT workforce are needed each of Global Sourcing on the
UK Software and Services
$25 billion) and become powerful competitors year. However, there is a severe mismatch in Industry. A Study for the
in the software and IT industry to US and the future workforce. Each year, fewer young Department of Trade and
Industry.’ London: Ovum
European counterparts.335 The Indian software people choose to study technology-related Plc.; Nasscom (2007)
and business process outsourcing industry is subjects at school and university. Between ‘Strategic Review 2007:
the IT Services Industry
expected to achieve $60 billion in exports of 2001 and 2006, 43 per cent fewer students in India.’ New Delhi:
software and services by 2010; the UK is the took A-levels in computing and the number Nasscom.
336. NASSCOM (2008)
second largest market for the Indian software of individuals taking IT-related degrees almost ‘Strategic Review 2008.’
sector after the US, at 18 per cent of total halved between 2001 and 2005 (from 27,000 New Delhi: NASSCOM.
exports.336 to 14,700). Few technology graduates choose 337. Ernst, S. (2007) China to
Catch Up with UK in Five
to enter the IT sector and embark on a career Years. In Dialogic (2007)
Other competitors are also emerging from in IT (estimated at only three out of ten ‘Developing the Future: A
Report on the Challenges
Latin America, Eastern Europe and China. graduates).340 and Opportunities
China is predicted to be a particularly strong Facing the UK Software
Development Industry.’
future competitor, potentially even replacing Second, there are questions over the nature London: Microsoft.
India as the choice location for off-shoring and quality of educational provision and 338. World Trade Organization
(2007) ‘International Trade
software and IT activities. Costs of off-shoring concerns that the educational system fails Statistics 2007.’ Geneva:
development to India have risen 15-20 per to ‘pull through’ young people from school WTO.
cent each year. Off-shoring in China is rising to university to the work place. For example: 339. Ovum (2006) ‘The Impact
of Global Sourcing on
at an annual growth rate of 8 per cent in the GCSE in ICT is heavily focused on the the UK Software and
2003 to 11 per cent in 2006. Even Indian acquisition of user skills rather than deeper Services Industry - A
Study for the Department
software development firms now have large study of computing and software technology; of Trade and Industry.’
hubs in China, or plans to develop them.337 there is also a need to increase the number of London: Ovum Plc.;
Confederation of British
China is predicted to develop its own software young people studying STEM subjects, as these Industry and LogicaCMG
industry even faster than India did. Issues of subjects are often required for a career in the (2006) ‘Building a Globally
Competitive IT Services.’
literacy are being addressed, and 35 national sector; at the university level, concerns are that London: CBI.
training schools are aiming to train 800,000 degrees do not keep pace with how quickly 340. Price, K. (2007) To
Succeed in the Global
software engineers. In China, exports increased the sector, and the required skills for this, is economy the UK Must
by an average annual rate of 37 per cent evolving (for example, the current software Commit to Technology
Skills. In Dialogic (2007)
between 2000 and 2006; and in computer language did not exist three years ago) and ‘Developing the Future: A
and information services (including software that graduates and new recruits do not always Report on the Challenges
and Opportunities
development) it was 40 per cent.338 have the necessary ‘work-ready skills’.341 Facing the UK Software
Development Industry.’
London: Microsoft.
Off-shoring has undoubtedly provided UK Third, for the existing workforce, issues of
firms with cost advantages. However, against re-skilling and up-skilling will need to be
a global backdrop of emerging markets, UK addressed, given the rapidly changing nature
software and IT services firms must continue of the sector. This may mean that there is an
to harness and combine creativity, skills and increasing need for IT professionals to become
innovative capability to remain competitive on ‘lifelong learners’ and to undertake continual
the global stage. professional development to update skills
requirements. However, for some employers
– particularly SMEs – this may prove difficult,

as they may not have the resources to provide 4. Innovation is hidden because of
such training.342 incremental development within the
sector and because new services,
Lastly, skills shortages – the greatest gaps are business models and forms of
in high-level technical skills such as computing collaboration are not captured by
and software engineering – are often filled traditional metrics
by overseas developers and engineers (in
2005, around 21,000 software specialists from 4.1 Some traditional innovation in software
overseas came into the UK compared with and IT services is incremental, iterative
around 2,000 in 1995). Whilst this undoubtedly development, which goes unrecorded by
brings its advantages – job gaps are filled, skills formal measurements of innovation
needs are met, new and different sources of The Frascati Manual only acknowledges
knowledge and international experience are software development that represents a
brought into the sector – it also highlights the ‘scientific and technological advance’ as
very real skills gaps for the UK sector. R&D and hence as innovation.344 Therefore,
innovation that is iterative and incremental
Together, these factors are creating a future (Type I hidden innovation) in nature – whether
skills challenge for the software and IT services improving an existing software programme,
sector in the UK in general, and specifically, or enhancing the efficiency of an operating
341. Bowkis, M. (2007) for innovation. Skills, education and training system – may not be counted as innovation,
‘Software Industry
Summit 2007.’ London: develop the knowledge and flexibility to despite the benefits incremental improvements
Department for Culture, adapt and respond to market trends, act may make to a firm.
Media and Sport.
342. e-skills UK (2008)
competitively and to drive innovation. Without
‘Technology Counts IT and individuals with the right skills sets – both 4.2 Innovation in organisational forms and
Telecoms Insights 2008.’
London: e-skills UK.
technical and business-oriented – innovation, business models are not well captured by
343. Business Software and the sector, will not flourish. traditional metrics
Alliance/IDC (2007) New, and more open, forms of collaboration via
‘Global Software Piracy
Study.’ Washington, DC/ 3.6 The issue of software piracy is a major Web 2.0 and OSS can facilitate the innovation
Framingham, MA: BSA/ concern to software suppliers and can limit process. New business models can enable
344. Organisation for Economic
resources for innovation software and IT firms to improve revenue,
Co-operation and It is estimated that globally, 35 per cent of sustain competitive advantage or increase
Development (2002)
‘Frascati Manual 2002,
software on all computers has been obtained performance. But new organisational and
Proposed Standard illegally, equating to £20 billion of lost business models (Type II hidden innovation)
Practice for Surveys on
Research and Experimental
revenues as a result of piracy in 2006 (for the are not sufficiently captured by traditional
Development.’ Paris: UK, the figures are 27 per cent of software measurements.
obtained illegally and around £840 million
of lost revenues).343 The scale of intellectual 4.3 The novel combination of existing
property (IP) infringement and the loss of technologies and processes to deliver new
revenues have an effect on resource availability service innovations in the sector does not
and, arguably subsequently, resources for get counted in traditional indicators
innovation as firms have less financial capacity The use of existing technology or software for
to invest in research and development. a new application or purpose is not considered
to be an investment in innovation. This means
To a lesser extent, IP also acts as a barrier for that combining existing technologies to deliver
collaborative innovation between a technology an innovative new service, such as Software as
supplier and a client in the IT services industry. a Service (Type III hidden innovation) would
The issue often concerns ownership of IP not be considered ‘innovative’ by traditional
developed during an IT project. For example, a metrics, despite the benefits and enhancements
considerable number of process maps, software this may bring to firms developing such
modules and industry maps are created during innovative services, and their recipients.
SOA implementation, and a lack of clarity
regarding who owns the IP, and how the 4.4 Locally-developed, small-scale
benefits are shared from it, can cause friction innovations that take place ‘under the
in the supplier and client relationship and the radar’ of traditional indicators
level of collaborative innovation generated. As the sector comprises a large number of small
Protection and clarity on IP is central to firms, innovation could be hidden primarily
innovation in any market, and infringement because it occurs informally, in the day-to-day
can substantially reduce the incentives for learning practices and processes undertaken
innovation. within SMEs to solve client needs. Very small
firms are also unlikely to have formalised R&D

budgets. This Type IV hidden innovation will a Service – Type III hidden innovation). Levels
therefore not be measured formally. of investment that firms make in these services
and the return on such investment should be
When working collaboratively with a client, large- recorded by new metrics. Other wider impacts
scale suppliers may also deliver improvements and that new service provision has within the sector
efficiencies to its customers when implementing (for example, impact on other firms) should
software and IT solutions. Innovative also be measured.
approaches developed during a supplier-
client engagement, through informal working 5.4 Firms are developing their own metrics
practices and collaborative processes (Type IV for innovative practices, which could be
hidden innovation) will also be unrecorded by used to measure localised innovation
formal measurements of innovation. Whilst small-scale, localised innovations
are difficult to observe and measure (Type
IV hidden innovation) at a firm-level, some
suppliers are developing their own metrics for
5. Innovation could be better measured measuring innovation. These take the form of:
by analyses that are sector-specific number of ideas generated, developed, refined
and which capture innovation at the and delivered, and return on these; number of
firm level and encompass new forms of patents; and revenues from new or innovative
organisational practice service lines. Infosys, for example, uses revenues
from services launched in the last five years as a
5.1 Sector surveys could be used to capture key metric. Other firms, such as Atos Origin and
and evaluate incremental and localised LogicaCMG, also track innovation by assessing
forms of innovation the revenues associated with new services.345
Sector-specific surveys could be used to
capture more accurately wider measures Innovative approaches, delivered through 345. Ovum (2007) ‘Innovation
in IT: Vendor Strategies.’
of performance, efficiency and innovation. a supplier-client engagement can also be London: Ovum Plc.
Surveys such as IBM’s Global CEO study and measured in a number of ways. For example, 346. Examples include number
of service calls answered,
the Economist Intelligence Unit benchmarking one emerging approach is to derive a servers managed,
survey of the IT sector could be adapted ‘balanced scorecard’. Typically, these involve percentage of time an
application was available.
and expanded to include a specific focus on a combination of quantitative (for example,
347. Ovum (2007) ‘Innovation
measurement of incremental and localised service level agreements targets, shareholder in IT: Client Perspectives.’
innovations and the importance of this type value delivered) and qualitative measures London: Ovum Plc.

of innovation to the sector’s performance (number of ideas that led to improvements)

and efficiency (Type I hidden innovation). aimed to augment the more rigid performance
Innovations in processes, such as the Agile, metrics346 and the associated rewards and
Lean and Triole examples, which demonstrate benefits that are part of many IT contracts.
incremental attempts to improve efficiencies Another approach is to measure business
for customers, could also be more accurately outcomes via value-based pricing reward
recorded and measured. schemes, where a supplier will be rewarded
with a percentage of client revenues generated.
5.2 Metrics should include firm-level and Lastly, end-user ratings (by clients) of IT
sector-level rates of adoption of new suppliers’ innovation efforts can also be used
organisational forms and collaboration as a measure.347
As new organisational forms, business models
and different ways of collaborating (Type II
hidden innovation) emerge within the sector,
the rates at which new organisational practices 6. Innovation could be improved in
are being adopted by firms and across the the sector by programmes of support
sector could be measured and incorporated that embrace hidden innovation and
into analyses of innovation. The impact that business capability in IT professionals
such innovative organisational forms have on
performance and working practices within firms 6.1 Existing programmes of support are
should also be assessed in new measurements. focused on pure research and product
development and collaboration between
5.3 Levels of investments in services should academia and industry, but there is a need
be measured to support and develop small software firms
New software and IT technologies have, in in order to compete with emerging markets
turn, facilitated the development and provision Existing government programmes of support
of new types of services (such as Software as for innovation within the software and IT

services sector are focused on pure research markets to ensure that opportunities are not
conducted at universities intended to produce missed.350
the next generation of software and IT
technologies. More recent forms of support are While the UK has around 100,000 small
attempting to link industry more closely with software firms, it lacks ‘gorillas’ – firms such as
academic research in the exploitation of that Microsoft and Google – which grow very fast
research. from start-up into major global enterprises.351
348. Technology Strategy In the UK, the sector is dominated by foreign
Board (2007) ‘Technology
Strategy Developing UK
A number of UK universities have world-class firms; only four of the top 20 software firms
Capability Key Technology research groups specialising in ICT-related and seven of the top 20 computer services
Area – Information
and Communication
research (for example, software research groups providers are British. Whilst this phenomenon is
Technologies.’ Swindon: exist at Southampton, Edinburgh, Nottingham, not unique to the software sector, and reflects
Newcastle and Imperial College universities) the comparatively small local market size of
349. Intellect (2007) ‘Software
and IT Services Report and such groups have each received grants of the UK, this lack of home-grown ‘gorillas’ can
– The Future.’ London: £3 million from the Engineering and Physical restrict market growth and encourage high exit
350. Ernst, S. (2007) China to
Sciences Research Council (EPSRC) for carrying rates (successful firms in the software sector
Catch Up with UK in Five out R&D work for the ICT sector. have often been bought out, for example,
Years. In Dialogic (2007)
‘Developing the Future: A
Lionhead Studios by Microsoft). Poor contract
Report on the Challenges More recently, Knowledge Transfer Networks enforcement of collaborative relationships and
and Opportunities
Facing the UK Software
(KTNs) are helping link industry more closely partnerships and lack or management training
Development Industry.’ with academic researchers. A number of for growing firms are also factors which mean
London: Microsoft.
KTNs are directly relevant to the software/ that firms in the UK often remain small.352
351. Owen, G. (2004) ‘Where
are the Big Gorillas? computer services sector: Cyber Security,
High-technology Digital Communications, Displays, and GRID 6.2 Programmes of support should ensure
Entrepreneurship in
the UK and the Role Computing.348 that, along with technical skills, business-
of Government Policy.’ oriented skills are developed in the sector,
Working Paper. London:
Inter-Disciplinary Institute This form of government support is valuable as this has the power to release wider forms
of Management, London and necessary and has a role to play in the of innovation, crucial to the sector’s future
School of Economics.
352. National Endowment for
innovation process but there is also a strong
Science, Technology and argument for new policy, supporting broader 6.2.1 Address educational, recruitment and
the Arts (2008) ‘Unlocking forms of innovation. skills weaknesses within the sector
the Potential of Innovative
Firms.’ Policy Briefing. Innovation in the software and IT sector will
London: NESTA. Whilst UK software and IT services firms benefit be improved if education, recruitment and
353. Price, K. (2007) To
Succeed in the Global from cheaper skills and labour in their back- skills weaknesses are addressed. A number
Economy the UK Must office operations in India and China, these of proposals put forward by the sector skills
Commit to Technology
Skills. In Dialogic (2007) countries are rapidly developing their own council (e-skills UK) and other interested
‘Developing the Future: A software and IT services sectors. They are now bodies (such as Intellect and the British
Report on the Challenges
and Opportunities competing with UK firms on the world stage. Computer Society) to address these issues,
Facing the UK Software With the increasing growth and prominence of have suggested that the first step is to improve
Development Industry.’
London: Microsoft. these markets, the UK must continue to ensure the sector’s image as a vibrant and exciting
354. At the school-level, an that firms compete more fiercely and develop industry in which to work.353 The sector needs
example of a pilot scheme strengths in higher-value activities. Creativity, to transform the attitudes of young people
run by e-skills UK and
the South East England skills and innovation must be combined and (and particularly women) in order to counteract
Development Agency harnessed to develop competitive advantages recruitment difficulties.354
(SEEDA), and in particular
to target the gender in a global economy (see Section 6.2).
imbalance that exists Educational courses have to become more
within the sector, is CC4G
– after school clubs aimed As users of software and IT services, SMEs relevant to employers’ needs, and can be
to provide compelling, fun are benefiting from global sourcing through achieved by working more closely with
and educational activities
for 10-14 year old girls, reduced prices of software and greater choice employers. This is beginning to happen. For
accessing around 7,000 of standardised, cheaper IT products and example, the Diploma in IT aimed at the 14-19
young women in the
region. services. However, smaller software and IT age range, has been developed in conjunction
services suppliers are less able to exploit the with the sector skills council (e-skills) and
global sourcing trend, due to the prohibitive employers.355 University courses should
costs in setting up off-shore centres relative combine technical IT knowledge with business
to their size, and the challenge of identifying know-how, and could offer more work-based
and creating appropriate partnerships.349 This learning during degree programmes. The
issue is essential to address, and policy should e-skills UK-developed Information Technology
encourage and support those SMEs who want Management for Business degree course
to establish off-shore operations in emerging also demonstrates how this can be achieved.
Designed in conjunction with employers,

and incorporating business, technology, already have training curricula addressing
interpersonal skills and project work and the development of these high-level skills,
‘Business Guru’ lectures from IT firms and and the UK must do so too, if it is to remain
extensive project within businesses, the course competitive and thrive.361 The proposals
has been available since 2005 and runs at 22 suggested by the sector skills agency go some
universities (including Reading, Greenwich, way to addressing this issue, but more must be
Central England and Northumbria) and has done to ensure that the UK does not get left
around 1,000 enrolled students.356 (See also behind. 355. Price, K. (2008) How
the IT Sector Helped to
section 6.2.2). Shape Diplomas. In Ryan,
6.3 Ensure that greater systems of control C. (2008) ‘Staying the
Course: Changes to the
In turn, employers could develop, enhance and are enacted to counter the effects of Participation Age and
invest more in existing education and training software piracy Qualifications.’ London:
The Social Market
programmes for employees and managers, and Software piracy needs to be addressed within Foundation. Chapter 9.
work more closely with schools and higher the sector by more stringent systems of 356. e-skills UK (2005) ‘The
education institutions.357 For small firms, control. Software theft can harm technology Sector Skills Agreement for
IT 2005-2008 Summary.’
greater collaboration and co-operation with suppliers and affect consumers (both London: e-skills UK.
large firms and academia could assist with individuals and enterprises) who may be at 357. Intellect (2007) ‘Software
and IT Services Report
training and education (through increased risk from unwittingly purchasing defective, – The Future.’ London:
use of knowledge transfer partnerships, for counterfeit products leaving them unprotected Intellect. p.14.
example).358 and unsupported. Software piracy has a 358. Dialogic (2007)
‘Developing the Future: A
significant impact beyond the sector itself in Report on the Challenges
6.2.2 Need for deeper business-oriented lost tax revenues, wages and jobs.362 Ultimately, and Opportunities
Facing the UK Software
skills this impacts on levels of innovation within the Development Industry.’
To enable greater development and utilisation sector too. London: Microsoft.
of broader forms of innovation within the 359. Price, K. (2007) To
Succeed in the Global
sector, a wider understanding and knowledge In response to software piracy, governments Economy the UK Must
of business-oriented skills will be needed by IT must combat copyright theft by first, increasing Commit to Technology
Skills. In Dialogic (2007)
and software professionals. public awareness and education of the issue ‘Developing the Future: A
and second, by instigating a more robust Report on the Challenges
and Opportunities
Utilising new technologies with business approach to intellectual property law and Facing the UK Software
know-how can enable the development of enforcement.363 Development Industry.’
London: Microsoft.
new products, services and processes and 360. Dialogic (2007)
improve working practices for companies in the ‘Developing the Future: A
Report on the Challenges
software and IT services sector. These forms of and Opportunities
innovation are likely to be crucial to the sector Facing the UK Software
Development Industry.’
in the future. London: Microsoft.
361. The Economist Intelligence
The novel application of technology across the Unit (2007) ‘The Means to
Compete. Benchmarking IT
sector will not only require in-depth and up- Industry Competitiveness.’
to-date technical skills, but also a sophisticated London: The Economist
Intelligence Unit.
set of business-oriented and management 362. It has been estimated
skills and understanding encompassing that over a four year
period, the UK could miss
communication, team working, project out on £1 billion in lost
management skills and a broad knowledge of taxes, the creation of over
13,000 new jobs and an
IT and business practices.359 IT and software extra £4.46 billion to the
professionals need to be encouraged and economy unless software
piracy is taken more
supported to develop these skills. Combining seriously and a reduction
knowledge of technology with business skills in counterfeit software
takes place, see Business
and applying such integrated higher skills Software Alliance/IDC
can give a firm an opportunity to engage (2007) ‘Global Software
Piracy Study.’ Washington,
more effectively with clients, develop greater DC/Framingham, MA:
levels of innovation and achieve sustainable BSA/IDC.
competitive advantage.360 363. Business Software Alliance
(2007) ‘White Paper:
Necessary Elements for
However, the UK software and IT services Technology Growth.’
Washington, DC: Business
sector needs rapidly to develop and improve Software Alliance.
employees’ integrated technical and business
skills so that the UK has the IT professionals
it needs to succeed across all sectors of the
economy. The US, Singapore and Australia

Appendix E: Electronics and IT hardware
Innovation through technological development but with an increasing role
for hidden innovation through adoption of new business models and a focus
on high-value activities

364. Department of Trade

and Industry (2004)
‘Electronics 2015 – Making
a Visible Difference.’
Electronics Innovation
and Growth Team Report.
London: The Stationery
365. This has made it
increasingly difficult to
delimit the UK electronics
sector and represent it
through trade association
bodies and statistics,
as highlighted in recent
government reports; see
Department of Trade 1. Electronics and IT hardware is vital now has a much more dynamic, distributed
and Industry (2004)
‘Electronics 2015 – Making and its activities are pervasive to all composition with a small number of large firms,
a Visible Difference.’ sectors of the UK economy many small firms, but very few medium-sized
Electronics Innovation
and Growth Team Report. firms. During the 1960s the sector was home to
London: The Stationery The electronics and IT hardware sector involves major electronics firms serving both domestic
Office, Chapter 3; also
Department of Trade the design and manufacture of electronic and international markets, and manufacturing
and Industry (2005) products and services. The sector includes the a range of goods. Primary strengths existed
‘Competitiveness in the
UK Electronics Sector.’ sub-groupings of: machinery components (for in semiconductors, printed circuit boards and
Sector Competitiveness example, microprocessors); telecommunications computer hardware.
Studies No. 1. London: The
Stationery Office. equipment; consumer electronics; medical
366. Office for National equipment; instrumentation; process control; Competition from high-technology
Statistics (undated)
‘Gross Value Added for
optical and photographic equipment; electronic economies368 and developing nations, fuelled
2005 & 2006 at Current systems design; photonics. by commoditisation and lower labour costs, has
Basic Prices: By Industry.’
Newport: ONS.
seen electronics manufacture in the UK recede
367. Department of Trade Electronics and electronic components lie at into the aerospace and defence sectors369
and Industry (2004) the heart of most modern products (typically (see Section 3.1). But this has also led to the
‘Electronics 2015 – Making
a Visible Difference.’ representing over 20 per cent of their cost),364 emergence of a new breed of specialist, high-
Electronics Innovation with electronics, photonics and electric systems value firms.
and Growth Team Report.
London: The Stationery underpinning activity in every industrial sector
Office, Chapter 3; also and throughout the consumer market.365 Regional clusters have been established close
Department of Trade
and Industry (2005) to the sites of former national champions like
‘Competitiveness in the The sector generates £14.8 billion in GVA, or ICL and GEC and key universities. The clusters
UK Electronics Sector.’
Sector Competitiveness 1.3 per cent of total UK GVA.366 It contributes draw on the expertise and skills of former
Studies No. 1. London: The £27 billion a year to GDP, and accounts for employees and current researchers. Dominant
Stationery Office.
368. The high-technology
6 per cent of UK manufacturing. The UK has areas include Bristol (Silicon Gorge), Cambridge
economies in the East strong export markets in manufacturing and (Silicon Fen) and to a lesser extent Edinburgh
traditionally include Japan, metrology equipment and processes and film (Silicon Glen). Particular strengths in the UK
Taiwan and Korea, and
play host to a high number deposition, for example. The sector employs electronics sector now lie in semiconductor
of integrated circuit and around 216,000 people in over 10,000 firms: design, photonics, and the manufacture of
TFT-LCD fabrication
facilities. These began life approximately 90 per cent of these firms have low-volume, high-value goods for international
as low wage/cost regions fewer than 50 employees. UK electronics markets.
but emerged as highly
skilled, highly research- production ranked seventh in the world in
intensive economies 2004, and was second in Europe (behind
strongly supported by
government interventions Germany). It is often suggested that the UK
(tax incentives/loans) and
state research institutes.
electronics industry has declined significantly, 2. Innovation in electronics is
369. Considered more secure but it would be more accurate to say that there increasingly distributed across the
markets that are less likely has been an evolution and re-focusing of the supply chain but has led to innovative
to extend their supply
chains overseas for security industry to fulfil a more global role (see Section new business models and to the UK
reasons. 2).367 developing high-value strengths

The sector, once dominated by large national 2.1 Traditional innovation continues to be a
champions such as ICL, GEC and INMOS, research-intensive activity, with both radical

and incremental forms evident in the sector technical expertise; the complexity of the
UK electronics continues to be a research- standard was a potentially serious inhibitor to
intensive undertaking, with R&D expenditure the widespread take-up of Bluetooth. CSR is
in 2006 at around £1.5 billion or 4 per cent of now the biggest global designer and supplier
sales.370 This annual investment is equivalent of single chip wireless devices for mobile
to around 7 per cent of total business applications, with approximately 50 per cent
expenditure on R&D in the UK and involves market share and over 900 Bluetooth consumer
around 140 individual firms, or 16 per cent products using CSR chips. The firm has used
of all of the UK’s research-active firms (those externally owned foundries for its wafer
spending more than £100,000 a year). This fabrication operations (the ‘fabless’ model)
broad grouping of electronics firms ranks and has worked closely with major equipment
third equal behind the two dominant sectors, manufacturers such as Intel, Nokia and Sharp in
pharmaceuticals and aerospace. the development of award winning Bluetooth,
GPS and WiFi products.372
UK electronic equipment businesses are
increasing their research intensity. Although 2.1.2 Market pull and incremental
their sales have dropped by 20 per cent between innovation
2002 and 2006, their R&D spending only fell The sector also relies heavily on incremental
by 11 per cent over the same period, producing innovations to remain competitive. As
relative growth in R&D spend. By contrast, consumer electronics have grown in importance 370. These figures are taken
from the 2007 R&D
the smaller and more research-intensive and international competition has become more Scoreboard and encompass
hardware sector registered good sales growth intense, the UK sector has been exposed to a two broad product
groups, ‘Electronic &
of 12 per cent in this period, but reduced R&D highly dynamic and free flowing environment Electrical Equipment’ and
expenditure by almost 10 per cent. However, the dictated by marketing and consumer wants. ‘Technology Hardware
& Equipment’; see
2006 figures show an increase in annual R&D To remain responsive to market changes, Department for Innovation,
expenditure for the first time in several years, electronics firms are constantly improving their Universities and Skills/
Department for Business,
suggesting more positive R&D expenditure products incrementally whilst looking ahead Enterprise and Regulatory
growth for the hardware sub-sector. to the next technological cycle. This enables Reform (2007) ‘The 2007
R&D Scoreboard.’ London:
firms both to maintain their market share and DIUS/BERR.
Electronics equipment and hardware firms are to avoid competition from low-cost economies 371. Ibid.
among the top 15 most research-intensive UK- that mass-produce past innovations. 372. Janson, E. (2006) Single
Chip Success. ‘Igenia.’ 27,
owned firms, with four firms in the top seven, June 2006, pp.20-23.
including ARM, CSR, Renishaw and Spirent An example is the development of personal
Communications.371 music players. These have advanced
considerably from the Sony Walkman cassette
2.1.1 Radical innovation and the importance player to the more advanced MP3 players.
of the university spin-out Each technology was developed and evolved
Several new advances within the industry through incremental improvements within their
have resulted from the commercialisation cycle before being eventually superseded by
of university research. These innovations demand for the next generation, which would
emerged from academic research and were again follow improvements in size, battery life
commercialised through spinouts to local and features. The latest cycle is characterised
science parks. It is through this route that by improvements in the capacity, size, and
many radical innovations have been brought to screen of MP3 players such as the Apple iPod
market, some of which have changed the shape or Microsoft Zune player.
of the marketplace.
2.2 Significant changes in the electronics
A good example is Cambridge Silicon Radio supply chain have led to new forms
(CSR), which evolved out of Cambridge of organisational and business model
Consultants in 1998. CSR initially developed innovation becoming increasingly important
Bluetooth systems to provide wireless for the sector
technology for laptops and mobile phones,
based on the founding team’s university 2.2.1 The UK has seen a shift in the value
research. CSR’s product was considered a chain from carrying out the majority of
radical and disruptive breakthrough, as it functions towards an emphasis on service,
married the traditionally separate technical design and support roles, resulting in
worlds of semiconductors, computing, fundamental changes to the sector
consumer electronics, software, radio The electronics sector was once a highly
transmission and cellular telephony. In the late vertically integrated industry with large firms
1990s, few manufacturers had all the necessary dominating the market and carrying out the full

array of functions. Innovation was insular and British firm and the increase in overseas
373. China alone is predicted closed. Following increased globalisation, these competition, UK electronics firms have adopted
to produce $326 billion functions have been dispersed to economies innovative new business models. While chip
(£155 billion) of electronic
equipment by 2009, and firms best suited to dealing with each manufacture has moved to lower labour cost
growing at a compound aspect of the chain. regions, there has been a rise in the number
annual growth rate of 9.4
per cent since 2004. Other of higher-value activities such as design and
key players include Taiwan, Raw material supply and component intellectual property (IP) licensing. This has
Japan, Korea, USA and
Germany. manufacture has shifted to low-cost or high spawned models such as ‘chipless’ – companies
374. Eighty per cent skill/capital-intensive environments such as that develop and market semiconductor IP
of semiconductor
manufacture cost is Eastern Europe and the Far East.373 The UK and ‘fabless’ – semiconductor firms that use
incurred during the design has repositioned itself to perform higher-value externally owned foundries for their entire
phase, see Electronics
Knowledge Transfer functions such as design374 and low-volume, wafer fabrication operations.
Network [online] Available high-value-added products and prototyping.
from: http://www. A leader in Europe, the UK is now home to These models fit into one or more global virtual
Default.aspx over 150 independent design houses. Recent organisations.375 Firms can vary in size, though
375. A group of individual firms, growth in this market reflects over 20 years many remain small as there is little need to
usually geographically
dispersed, working of experience, much of which stemmed from grow to compete. Design can be carried out
together towards a original national champion firms. by a few flexible professionals without a large
common goal, carrying
out functions traditionally organisational structure.376 These models can
carried out within one Innovative new firms such as ARM, CSR and enable a 24-hour global operation by having
physical, or heavily
vertically integrated entity. Digico now lead the way in this truly global different firms operating in different time
376. For example, Frontier environment. Many international equipment zones.
Silicon develop and
design semiconductors for
manufacturers such as Fujitsu, Sharp, Philips,
digital radio, television, and Analog also have design operations located These flexible business models particularly
and mobile television
from bases in the UK and
in the UK. Many UK-based firms and business helped innovative start-ups, as they no longer
Ireland, then have these units fill supporting functions such as testing need to develop capabilities, or incur the costs
manufactured in Korea and
China for leading brands
and validation services and consultancy (Austin of additional functions. They can concentrate
such as Sony and Philips. Semiconductors Europe, for example, operates on their primary expertise within the supply
377. For example, there are now an integrated circuit test facility in Hampshire). chain. This is especially important in electronics
only a few global firms that
could singularly bear the as the cost of investigating and developing
costs of establishing a new 2.2.2 Innovation in electronics is much new technologies has increased year on year.377
chip fabrication facility
(around £3 billion). broader than technological change Users of these business models include ARM,
378. The firm originally alone. New forms of innovation – from ARC, Wolfson and Xilinx. By focusing on high-
identified the market for
its processors through a
novel business models to novel business value activities, firms have been able to remain
collaborative risk sharing partnerships and supply chains – are competitive by adopting new sustainable
partnership with a mobile
phone manufacturer with
increasingly evident in the sector models and joining together in wider virtual
the requirement to produce organisations.
low power consumption
microprocessors. Prior to New business models
this, processor design was Following the disappearance of the large
carried out within large
firm R&D facilities striving
for greater speeds and
capabilities for stationary
computing applications.
Following the rise in
mobile devices such as
walkmans, phones, and
ARM were produced based on the firm’s designs.
digital cameras there was a ARM has adopted the chipless model
need to produce chips that
could run off mobile power
ARM is a British technology firm founded in order to remain flexible and avoid
sources. in 1990 following a spinout from Acorn competing in markets where costs can be
379. ARM (2007) ‘ARM Computers. Its technology is based on driven down by lower cost regions.
Holdings Plc Reports
Results for the Fourth 32-bit microprocessors and can be found in
Quarter and Full Year almost all modern mobile devices.378 They This business model has been highly
31 December 2007.’
Cambridge: ARM. account for over 75 per cent of all 32-bit efficient at delivering value. For example,
380. ARM (2007) ‘ARM Annual embedded Central Processing Units in the ARM has a growth rate approximately twice
Report and Accounts
2006.’ Cambridge: ARM.
market today. However, ARM does not that of the semiconductor industry as a
produce physical chips. Instead it licenses whole.379 The firm estimates that in 2006,
its technology to other chip manufacturers 1.5 billion people – a quarter of the world’s
such as Intel, AMD, and Samsung under population – bought an ARM-powered
the chipless model. ARM generates its product, generating more than £263 million
revenue by charging royalties from chip in revenues, yet the firm employs fewer
manufacturers; in 2005, 1.7 billion chips than 1,500 people.380

82 The rise of collaborative partnerships – for this customised service.381 Specialist
changing research and development practice electronics firms in the UK produce a number
In traditional electronics manufacturing, R&D of products for international markets including
often took place within large internal facilities. mixing desks for the creative industries, control
Large teams of scientists and engineers were systems for mineral exploration and medical
employed to explore and exploit commercial monitoring systems for health services.
and technological opportunities. Today,
innovation increasingly takes place through
collaborative partnerships and strategic
alliances. These often cross disciplines and 3. Innovation in the electronics sector
national boundaries. R&D will typically involve is determined by competition, cost and
engineers, marketing and sales people, as well risk which can be both barriers and
as external stakeholders such as suppliers and drivers
3.1 Competition is increasingly global in
There are two main reasons why this happened. nature
The first is that the electronics sector has Innovation in the UK electronics sector is
been keen to share the risk and costs of new largely driven by global pressures. The cost
technologies. But the second reflects an competitiveness of developing nations and
overall structural shift. As the supply chain has their ability to commoditise products has led to 381. Von Hippel, E. (2005)
‘Democratizing Innovation.’
become less vertically integrated, it has become a decline in UK electronics manufacturing. For Cambridge, Massachusetts:
increasingly necessary to involve external example, China is the world’s largest electronics The MIT Press.
382. Reed Electronics Research
firms, and even sectors, to exploit capabilities manufacturer, with more than $300 billion in (2006), ‘Yearbook of World
that are no longer located in-house. A current products in 2006.382 It accounted for 18 per Electronics Data, Volume
3 - Emerging Countries
example is Apple’s iPhone, which incorporates cent of global electronics output in 2005, 2006/2007.’ Wantage:
technology from more than 15 separate firms compared to just 4 per cent in 1997. Half of Reed Electronics Research.
including CSR and Wolfson. Chinese suppliers of electronic components, 383. Global Sources (2008)
‘China Supplier Survey,
consumer electronics, and computer and 2nd Half 2007.’ Singapore: High-value, low-volume markets and telecommunications products expect more Global Sources.
384. Unico/Universities
the importance of end-users than 20 per cent growth in export sales UK/Research Councils
Firms are now accessing new niche markets during 2008; a quarter expect an increase of UK (2007) ‘Impacts:
Successes from UK
where they compete on quality and function, 10-20 per cent.383 More than 80 per cent of Research.’ Cambridge/
rather than simply on price. Central to this suppliers anticipate increasing their production London/Swindon: Unico/
Universities UK/Research
environment is an understanding of customer capacity by 20-50 per cent. The EU is the main Councils UK.
needs. Innovative arrangements see firms destination for these exports.
working closely with potential owners to ensure
that strict specifications are met. This ‘user- In a sector dominated by small firms,
led innovation’ is a recognition that end-users businesses have to make continuous
are not all the same, they will have individual improvements to existing products or discover
preferences and are willing to pay a premium new technologies to remain ahead. By

Wolfson Microelectronics music player and the Xbox games console.

Employing around 200 people, it was
Wolfson, which spun out of the University listed on the London Stock Exchange in
of Edinburgh in 1985, originally started 2003 with an initial market value of £214
as a design house for leading equipment million.384
manufacturers in Europe. It became a
market leader in the customer design A fabless business model has the
of integrated circuits. In 1996, Wolfson advantages of access to world class
changed its approach to become a fabless manufacturing without the need for high
semiconductor firm, subcontracting all its capital investment and manufacturing
product fabrication, assembly and testing. support costs. This allows the firm to
With this new strategy. Wolfson became a focus on its core competencies of product
global leader in the supply of mixed signal definition, design and marketing. Wolfson
integrated circuits found in consumer utilises several foundries and assembly and
electronics devices such as Apple’s iPod test facilities, mostly in South East Asia.

moving into more specialised, higher-value physical sciences, particularly chemistry, on the
385. In the last two UK functions such as design, and adopting new decline.387 A Select Committee report388 found
Community Innovation organisational models, the UK electronics that universities view the greatest difficulty
Surveys, cost and risk
factors have ranked sector has avoided exposure to many of the for recruitment of new entrants was in the
highest amongst perceived competitive pressures from both low-cost and computer departments, closely followed by
barriers to innovation
within the electronics high-technology economies. electronics. This trend is reflected in A-level
sector. This is particularly choices too, and while non-nationals appear
acute for SMEs, where
funds are limited and 3.2 The pressures of cost and risk can act as to be filling the gaps presently in the public
available venture capital barriers for innovation and private sectors, there is a potential risk
(between proof of concept
and full launch) can be The cost and associated risks of pursuing of future skills shortages in key areas, such as
difficult to acquire. See advances within the sector can act as a materials science. This could impact negatively
Department for Business,
Enterprise and Regulatory major barrier to technological innovation.385 on the UK electronics industry through
Reform (2001; 2005) ‘UK But paradoxically, cost and risk have driven capacity constraints and act as a barrier to
Community Innovation
Survey.’ Division 4 organisational innovation in electronics, innovation.
Statistics SIC 30 and 33. as firms turn to partnerships and strategic
London: BERR.
386. The idea that alliances to spread the cost and risk of 3.4 Users and consumers as drivers of
disequilibrium in the innovation. A key facilitator has been improved innovation
market, brought about by
a new innovation resulting telecommunications, which has enabled There growth of consumer electronics has
in a temporary monopoly, networked organisations and partnerships that changed the focus of the electronics market.
stimulates innovation
within other firms in an no longer need to co-locate. It has become more dynamic as marketing and
attempt to capture or brand image have become more important.
recapture a lead position;
see Schumpeter, J. (1943) Through their radical innovations, spinouts and This environment drives incremental innovation
‘Capitalism, Socialism and very small firms not only provide the necessary given the need to enhance and adapt existing
Democracy.’ London: Allen
& Unwin. churn and disequilibrium to drive innovative products to differentiate from competitors and
387. Department for Education activity,386 they can reduce the costs and risks appeal to consumer requirements.389 Such a
and Skills (2006) ‘The associated with pursing innovation; they can setting requires manufacturers continually to
Supply and Demand for
STEM Skills in the UK also enhance the capability of larger firms. anticipate emerging technologies, capabilities
Economy - Research Indeed, innovative SMEs are often incorporated and designs whilst developing existing product
Report.’ London: The
Stationery Office; into firms following a successful demonstration lines. This drives open innovation and presents
Department for Education of a new technology. CSR’s recent acquisition opportunities for start-ups and incumbent
and Skills (2003) ‘Skills
Strategy White Paper “21st of Cambridge Positioning Systems to increase firms. It also prompts new alliances and
Century Skills - Realising its GPS capabilities is one example. ARM also leads some firms to grow quickly. However,
our Potential”.’ London:
The Stationery Office. follows an ‘innovation by acquisition’ process these market characteristics mean that such
388. House of Lords Select by acquiring innovative SMEs to increase their alliances can be short-lived unless firms can
Committee of Science
and Technology (2002-3)
capabilities. keep up with the pace required by the major
‘Chips for Everything: manufacturers and consumers.
Britain’s Opportunities
in a Key Global Market.’
Conversely, large firms may be reluctant to deal
Session 2002-3 (2nd with small firms as they may have concerns The consumer electronics market has led to a
Report). London: The
Stationery Office.
about the long-term financial viability and growing number of UK-based design houses.
389. A good example is the capacity of a single small scale supplier. They Design is clearly important in a market based
way that mobile phones may prefer to deal with a similar sized firm on brand and consumer emotion. The UK has a
or laptops become smaller
or lighter in response to to protect against losing their main source of strong international reputation and image for
demand, but retain the knowledge or a key firm going out of business. electronic and semiconductor design.390 Sharp’s
same basic features.
390. Department of Trade
The fragmented composition of the sector may UK design unit is investigating advancement
and Industry (2006/7) be a barrier to small-firm development and in liquid crystal display (LCD) technologies
‘Electronics Systems
Design – A Guide to UK
innovation. Building trust and collaborations such as 3D displays for mobile phones. The UK
Capability.’ London: The within the sector could start to spread some of is now home to 31.9 per cent of the chipless,
Stationery Office.
this risk. fabless and integrated circuit design firms in
391. Future Horizons (2007)
‘Annual Semi-conductor Europe391 and contributes approximately 15 per
Report.’ Sevenoaks: Future 3.3 Potential skills shortages could inhibit cent of the world’s ASIC (Application Specific
392. Moor, J. (2006) ‘UK
the sector’s future Integrated Circuit) semiconductor design
Semiconductor Design The available labour market within the starts.392 Expert opinion is divided on whether
Evolves and Grows
Stronger.’ 7th August.
UK will have a major impact on the future design will eventually follow other functions
National Microelectronics success of the electronics market. The UK’s and be outsourced overseas.
Institute [online] Available
stock of science and engineering graduates
uk/press_releases compares well internationally, and the stock 3.5 Regulation can be both a driver and
of graduate scientists in the UK labour force barrier to innovation
has been growing steadily. However, there are UK and European environmental regulation
evident challenges, with the number of British is a major consideration for electronics. New
students opting to study engineering and EU directives393 have implications for both

manufacturers and designers, bringing more fostered further innovative practices such
stringent requirements on packaging, recyclability, as collaborative networks, strategic alliances
and the control of hazardous substances. and cross-disciplinary operations to address
the requirements of the modern electronics
Regulation can both hinder and drive environment.
innovation. In the first instance it can limit
the scope and parameters of a product, in the 4.3 The sectoral composition of the sector,
second it can act as a reason to innovate to with many small firms, may mean that
find new solutions and alternative options. innovation is going unmeasured
One example has been the pursuit of lead-
free electronics production, with a variety of 4.3.1 Day to day problem-solving
lead-free solder alloys having been trialled within SMEs
and released, but often with significant Much electronics innovation could be hidden
compromise on cost, process efficiency or primarily because it occurs on a day-to-day 393. WEEE Regulations 2006
- SI 2006 No. 3289 – The
joint reliability; and more recently through basis within SMEs, with little or no declarable Waste Electrical and
the development of novel oxides and alloys R&D budget. This Type IV hidden innovation Electronic Equipment
Regulations 2006, based
and nano-composites.394 Another is a project is widespread given the composition of the on Directive 2002/96/EC
called ‘Reflated’ (a collaborative research sector, and often takes the form of informal of 27th January 2003 (OJ
No. L173, 13/2/2003) and
partnership)395 which is investigating ways of learning and the development of internal Directive 2003/108/EC of
recycling and reusing liquid crystal displays processes to tackle customer needs on a 8th December 2003 (OJ
No. L345, 31/12/2003)
(such as those found in watches, phones case-by-case basis. Often an SME’s primary – affecting design for end-
and laptops). Over three billion devices with concern is survival: R&D and innovative activity of-life disposal. The EuP
Directive 2005/32/EC,
LCD displays were manufactured in 2006 and may only occur when needed, rather than as a establishes a framework
their environmentally acceptable disposal is formal function. for setting of eco-design
requirements for energy-
a growing problem. At this early-stage of the using products, aiming to
project a number of innovative processes have Further, as previously highlighted, the overall improve the environmental
performance at a very
already been developed. These are being scaled electronics industry is mainly comprised of early-stage in the product
up and market tested.396 micro SMEs which are not fully represented in design (examples include
lighting and on standby
the Community Innovation Survey, which only power). RoHS Directive
considers firms with more than ten employees. – 2002/95/EC covers
the restriction of the
The survey includes various indicators such use of certain hazardous
4. Innovation is hidden because of as type, source of information, and modes of substances in electrical and
electronic equipment.
incremental innovation, the adoption innovation, but will leave the majority of the
394. Novel oxides is one of
of new organisational forms and sector invisible to measure. eight streams being
composition of the sector investigated in the Science
City Bid 2 collaborative
4.3.2 Patenting issues package between
4.1 The importance of incremental Smaller firms can struggle to meet the costs Warwick and Birmingham
innovation to the sector and, sometimes, the requirements of patenting 395. The partners include: the
Electronics firms rely heavily on incremental procedures. This leaves many inventions Technology Strategy Board,
recyclers, technology
product innovation to remain competitive. invisible to measurement. Fears of piracy in developers, a specialist
The pressure to enhance and adapt existing emerging economies cause many firms to rely chemical processor and an
engineering equipment
products requires speedy reaction to changes on secrecy as their main IP protection, rather manufacturer.
in the market and the incremental development than declaring and codifying them through 396. Department for Innovation,
and refinement of products. Similarly, firms a patent. This can leave much of the sector’s Universities and Skills
(2008) ‘Innovation Nation.’
may use existing electronic technologies in new technological innovation hidden. The defence London: The Stationery
or novel ways, contributing to the innovation of a patent infringement is beyond the means Office.

process. This Type I hidden innovation is not of many SMEs, especially if the infringement
recorded in narrow measures of R&D. occurs overseas.

4.2 Organisational forms of innovation are

not measured in traditional metrics
New organisational forms have enabled
innovations that are not reflected in traditional
measures. The drive to reduce costs and
overheads has seen the increasingly widespread
adoption of fabless and chipless models as
the cost of a silicon fabrication facility has
dramatically increased. These new models,
considered Type II hidden innovations,
are innovative in their own right and have

5. Innovation could be better measured distinguish ‘innovative’ acquisitions from all
by adapting existing tools and acquisitions, and the impact on the acquiring
indicators, by incorporating the value business is not elaborated. Additional data
of new organisational forms and by on value-added and productivity might be
tracking small-firm activity necessary to create a useful indicator.

5.1 New measures that better capture 5.3 New measures of innovation could track
UK strengths and levels of incremental small-firm activity
innovation should be developed Given the importance of the small-firm to the
Type I hidden innovation could be measured electronics sector, the number of start-ups and
through new indices combining existing data spin-outs created at a sectoral level could be
sets or by including new questions within measured. New businesses have been critical to
established business surveys. For example, the renaissance of the UK electronics industry
the UK is strong in electronics design, which it and they continue to be a potential source of
then licenses to other firms and manufacturers. important new technologies and successful
Capturing this would require the measurement business models.398 However, existing data
of this flow of knowledge within the UK and on start-ups do not lend themselves easily to
internationally to manufacturing economies. analysis of innovators by sector, as only basic
Currently this data is not collected; however, characterisation and operational statistics, such
397. Work being undertaken the Office for National Statistics (ONS) annual as address and turnover, are gathered. Better
by Jonathan Haskel and
a team at the Centre for survey of R&D expenditure might prove a sample sizes and more specific data on the
Research into Business suitable vehicle for such an enquiry, and should innovativeness of companies might be explored
Activity at Queen Mary,
University of London are aim to represent smaller firms within its sample. with ONS and others.
attempting to measure Similarly, given the positive perception of UK
intangible assets (including
brand value) and assess design internationally, it might be possible Equally, existing statistics on survivability
their contribution to measure the brand value of design house appear to correlate well with dynamism, where
to innovation and
productivity. contributions to give an indication of their the innovativeness of an industry might be
398. A new ‘best way’ of success.397 Given that firms in the sector rely measured by the number of new firms starting
organisation within a
specific sector and context,
heavily on incremental product innovation to up and entering the sector indexed against
rendering previous models remain competitive, sector-specific surveys survival rates.399 Firm growth rates can be a
could be the best way to capture the extent good indicator of innovations past and present,
399. BERR VAT statistics can
be used to identify the and value of this form of innovation. so identification of the fastest growing firms
number of start-ups each in the UK might highlight high growth areas
400. Deloitte Technology
5.2 Organisational and business model within the sector.400 The ONS is also reporting
Fast 500 EMEA ranking innovation could be better measured by the aggregate data on high-growth firms, which
is published every year
to identify the fastest
rate of adoption within the sector and the could be disaggregated. Additionally, the BERR
growing high-technology effect of such organisational forms on firms value-added scoreboard offers potential for
companies in the EMEA
Strategic alliances and partnerships now take further analyses at a sectoral and firm level.
place across the sector. These collaborative These data could be matched with several
arrangements (Type II hidden innovation) other innovation indicators to develop a useful
highlight a fundamental shift to open index of total innovation effort and outcomes.
innovation, one that is central to the sector’s
innovation potential. However surveys do Firms could be surveyed more formally to
not investigate this issue directly: number, measure innovative and efficiency practices
type and ‘value-added’/achieved outcomes and processes within SMEs (Type IV hidden
could potentially be recorded as measures innovation) and the innovation that goes on
of effectiveness of such arrangements to ‘below the radar’.
individual firms. A measure for the sector as
a whole might be the rates at which such
alliances are formed.
6. Innovation could be improved by
As we have seen with ARM and CSR, new greater support for hidden innovation
organisational models have allowed firms to and small firms within the sector and by
become more flexible to their environments increasing skills capabilities
and absorb new capabilities by internalising
innovative new start-ups. The ONS aggregates 6.1 Existing UK measures focus on
statistics on the number and value of deals in ‘traditional’ innovation
the UK (mergers and acquisitions); it may be
possible to develop this further at the sectoral 6.1.1 Strong broad national approaches…
level. However, the data do not automatically Broad domestic national measures range from

R&D tax credits to support for collaboration 6.2 Increase support for ‘non-traditional’
with the university/research institute sector to innovation
support for clusters/networks in strategic and It is clear that support and policy measures
emerging fields.401 Given the pervasiveness of have a somewhat technological character
electronic components and the difficulties with which suits certain types of firm better than
delimiting the sector, electronics has suffered others. Potentially, it is easier for firms to
from a lack of visibility, fragmentation and find support for more traditional research and
support.402 Sector-specific attempts to redress technology projects than it is to find support
these issues have occurred recently with the for innovative business models or risk-sharing
creation of the BERR Innovation and Growth partnerships. Export credit guarantees, launch
Team, the development of the Electronics aid in aerospace, or government procurement
Leadership Council and the Photonics of technology can help small firms to reduce
Leadership Group, and specific electronics risk and nurture critical, new and novel
Knowledge Transfer Networks. Electronics applications.
is now increasingly better supported than
many other sectors in the UK, aside from Helping firms and entrepreneurs to explore
pharmaceuticals, biotech and aerospace. and experiment with new business models
or commercial strategies could be hugely
6.1.2 …but regional approaches must be important, as the growing concentration on IP
strengthened and better coordinated and design could present longer-term risks, as 401. For example, BERR
continues to sponsor the
There are a plethora of innovation support other European and international electronics electronics industries in
schemes available in the regions, with plentiful firms are aggressively challenging the UK’s the form of networking
and advice, and addressing
opportunities for electronics companies to strength in higher-value activities. information failures. The
secure business-development advice, coaching Technology Strategy Board
(TSB) has the ICT field
and financial assistance. The English regions 6.3 There is a need to improve sector- as a major focus, with
and the devolved administrations all seek specific SME support measures the sector accounting
for 15-30 per cent a year
to support prospective innovators, through The small size and knowledge-based nature of of its spending. It has
measures such as the grant for R&D (formerly many UK electronics firms also seems to be a six Knowledge Transfer
Networks which operate
SMART), the Manufacturing Advisory Service complicating factor, since targeted innovation primarily in the electronics
and regional venture capital funds. ICT firms programmes can often favour larger, more area, which aim to assist
with information services
can access all these schemes. There are established firms with a national brand and and networking activities
also numerous one-off innovation support a substantial physical presence. Given the when building supply
chains. The Engineering
schemes, from the collaborative innovation importance of young and small firms within the and Physical Sciences
centres (CICs) in Yorkshire to the Emerging innovation landscape, there could be a case Research Council (EPSRC)
spends as much as £300
Technologies scheme (ETS) in the South East for more sector-specific policies to alert firms million a year on grants to
to the Intermediary Technology Institutes (ITIs) to opportunities for support and to help them the academic partners of
its collaborative research
in Scotland. In almost all cases, they have access and make good use of what can be projects and networks,
targeted strategic technologies and industries; complex and costly schemes. which operate across its
broad remit, and engage
most encompass one aspect or another of with, amongst others, UK
electronics and are actively engaged with The balance of support could be modified electronics firms.
402. Department of Trade
local electronics firms. There are numerous too, with greater support for new firms and and Industry (2004)
general business support schemes too, such as their faster maturation (success or failure). ‘Electronics 2015 – Making
a Visible Difference.’
Electronics Yorkshire, open to electronics firms. There should also be more support for Electronics Innovation
commercialisation activities such as proof of and Growth Team Report.
London: The Stationery
However, these schemes tend to be smaller, concept schemes, tactical and legal advice, to Office. Chapter 3;
more particular and often shorter lived than help innovative firms choose the best strategy Department of Trade
and Industry (2005)
their national equivalents. User surveys to protect their IP. Promising technologies ‘Competitiveness in the
suggest this ‘fluidity’ reduces their visibility could be nurtured and their owners mentored UK Electronics Sector.’
Sector Competitiveness
and attractiveness, leaving most schemes to help them locate sufficient funding and Studies No. 1. London: The
patronised by a rather small proportion of the target the most relevant markets. Stationery Office.
total business population, while most of their
peers proceed without any meaningful support. 6.4 Maintain and develop skills for the
The current business support simplification sector’s future
process is expected to reduce fragmentation By moving into more specialised, higher-
and confusion, while improving efficiency and value functions, the UK electronics sector
effectiveness of delivery. It should increase has been able to avoid exposure to many
effective support. of the competitive pressures from low-cost
economies. However, with the increasing
output of highly skilled engineers and
designers in these countries, the UK will have

to continue innovating and producing skilled an area of high risk/high reward and the
individuals to avoid becoming priced out of its UK holds a leading position in this area,
new market. with a strong research base (for example,
at the Centre for Advanced Photonics and
The Electronics and Innovation Growth Team Electronics at the University of Cambridge
(EIGT) has made a series of recommendations and Cavendish laboratories). Around 30 UK
designed to overcome issues concerned with firms have benchmarked world-class R&D in
leadership, diversity, skills shortages, image, plastic electronics and hold much of the IP
lack of visibility403 and sectoral evolution (which and knowledge of this field. Home-grown
have shifted industry skill needs).404 BERR is companies such as Plastic Logic and Xaar have
working closely with various stakeholders to leading positions in developing and marketing
tackle the anticipated skills gap in electronics early products. The key challenge for policy
with industry placements, recruitment will be to ensure that the UK builds upon
403. Department of Trade incentives, and support for schools seeking this world-leading position and that firms are
and Industry (2004)
‘Electronics 2015 – Making to stimulate interest in electronics. Failure to supported to develop and grow to capitalise on
a Visible Difference.’ recruit suitably qualified individuals will act as a this market for the overall benefit of the UK.
Electronics Innovation
and Growth Team Report. barrier to innovation.
London: The Stationery One final issue is the imperative for using less
Office. Chapter 3;
Department of Trade 6.5 The sector will have to innovate to cope electrical power and energy against the wider
and Industry (2005) with coming technological disruptions backdrop of reducing carbon emissions and
‘Competitiveness in the
UK Electronics Sector.’ A number of emerging technologies are set sustainable development. The sector will need
Sector Competitiveness to lead to new market opportunities in the to find ways to minimise the consumption of
Studies No. 1. London: The
Stationery Office. electronics sector over the coming decade. electrical power through innovative approaches
404. For example, the EIGT in device efficiency and system design.
recognise that the Electronic devices will expand their
electronics sector is
perceived as short- functionality: chips with moving parts
termist in its recruitment are already becoming the basis for new
policies, expanding in
line with industry cycles technologies, such as acceleration sensors in
and reducing numbers the automotive market and electronic and
in downturns. Despite
a number of sectors photonic nano-devices in data processing
employing this flexible and storage. The increased functionality
workforce model, it has
led to negative press and of individual devices will be accompanied
has had an impact on the by innovations in their packaging (such as
attractiveness of a career in
the electronics sector. bonding chips together into a 3D array), which
405. In 1965, the founder of could affect and improve applications such as
Intel, GE Moore predicted
that the number of mobile phone cameras and medical devices.
transistors which could Because of Moore’s Law,405 miniaturisation
be placed on a transistor
would keep growing is not thought to be sustainable. After
exponentially, doubling 2015, there are likely to be opportunities for
every couple of years.
According to sector disruptive technologies such as carbon-based
experts, Moore’s Law semiconductor devices (for example, nanotubes
is likely to have at least
another decade to run, and polymer transistors) and quantum
before silicon-based electronics (quantum dots and wires). The
hardware begins to reach
its physical limits. UK electronics sector currently has strengths
406. The Economist Technology in device and system-level design and must
Quarterly (2007) ‘Crystal ensure that it is well placed to continue
Clear.’ 8th December, p10.
building on its strengths to exploit new and
novel innovations.

Innovations in new materials and substances

are also set to emerge with the advancement of
micro-structured optical ‘meta-materials’ such
as photonic crystals.406 Plastic electronics is an
emerging field and one which is set to disrupt
electronic circuits and flat panel displays,
where new plastic and flexible materials will
be used instead of glass structures. This
will mean changes to the manufacturing
method, and new capabilities will be needed.
Plastic electronics has been highlighted as

Appendix F: Automotive
Innovation focused on incremental product development alongside process
innovation, but with a resistance to new business models

407. Department of Trade

and Industry (2006)
‘Driving Force: Success
and Sustainability in the
UK Automotive Industry.’
London: DTI.
408. European Commission
1. Automotive remains a major of the industry in the UK with around 23 per (2005) ‘CARS 21, A
Competitive Automotive
manufacturing sector for the UK cent of the sector located in the region.410 Regulatory System for
economy, with foreign-owned the 21st Century, Final
Report.’ Brussels: European
manufacturers and renowned strengths The component sub-sector is however Commission.
in specialist areas increasingly dominated by large multinational 409. Department of Trade
and Industry (2006)
firms. Many of these ‘super tier 1’ firms were ‘Driving Force: Success
While there are no indigenously-owned previously owned by major manufacturers.411 and Sustainability in the
UK Automotive Industry.’
‘volume’ vehicle manufacturers left in the UK, Nineteen of the top 20 global tier 1 suppliers London: DTI.
the country is host to a wide range of foreign- and around 20 leading independent automotive 410. See Appendix B, Case
owned and indigenous firms across all sectors design firms also have a base in the UK.412 Study 1, in Athey, G.,
Glossop, C., Harrison, B.,
of the industry. Nathan, M., and Webber,
The UK industry is highly export-oriented, C. (2007) ‘Innovation and
the City, How Innovation
Automotive manufacturing adds £9.8 billion with volume products mainly to Europe and has Developed in Five City-
in value to the UK economy; the retail and specialist products worldwide including to Regions.’ London: NESTA.
411. ‘Tier 1’ firms integrate
service/maintenance sectors generate a further North America. 1.65 million vehicles were whole systems for direct
£22 billion GVA. Automotive manufacturing manufactured in 2006 (nearly an all-time high), supply to a vehicle
manufacturer. ‘Tier 2’
accounts for 1.1 per cent of GDP, 6.2 per cent 73 per cent of which were exported.413 UK firms supply component
of manufacturing value-added and 12.4 per automotive exports, including cars, commercial parts or support services
to Tier 1 suppliers. ‘Tier 3’
cent of total UK manufactured exports.407 (This vehicles and a wide range of components, firms supply raw materials
compares to automotive representing 3 per generate more than £20 billion annually. for the supply chain or
more generic engineering
cent of Europe’s GDP408). This makes automotive the UK’s biggest components and services.
manufacturing export sector. 412. Department of Trade
The sector includes around 3,300 firms and Industry (2006)
‘Driving Force: Success
employing 221,000 people. More than 40 firms Engine development and manufacture are and Sustainability in the
manufacture vehicles, including mass market major UK strengths. Three million automotive UK Automotive Industry.’
London: DTI.
(‘volume’) vehicles, niche vehicles, and heavy engines were produced in 2006; the UK 413. Ibid.
trucks. is a significant net exporter of engines.
Substantial new investments have been made
Seven of the global top ten vehicle at a number of locations both in developing
manufacturers operate in the UK. The UK existing facilities and establishing new ones.
is also home to the world’s most successful By far the most important producer in the UK
motorsport industry as well as a range of is Ford, with two major plants at Bridgend
smaller manufacturers serving specialist and Dagenham, producing around 25 per
markets such as sports cars, luxury cars, and cent of their global engine supply in the UK.
London taxis. There is also a significant UK presence in
contract engine design and testing. Major
The remaining firms are producers of suppliers include Cosworth Technology,
components and smaller vehicle subsystems. Lotus Engineering, MIRA, Millbrook, Pi Tech,
There are 2,600 component firms, 90 per cent Prodrive, Ricardo, TRW Conekt and Zytek.
of which are SMEs, employing around 132,000
people.409 The West Midlands remains the heart Related to this, the UK’s long-established
independent design engineering sector works

with vehicle manufacturers from around the commercial applications for technology
world and offers a full spectrum of services developed within the McLaren Group.
from concept design to limited-series vehicle
production. This includes vehicle and engine
test facilities, design engineering consultancies,
specialised new technology R&D companies 2. Innovation in automotive focuses on
and university research centres. In addition, incremental product development with
414. Motorsport Valley is Nissan chose London as the location for its some major process changes but limited
typically characterised
by a 100-mile crescent
European design centre (see 2.1.4). innovation in business models
from Surrey up through
the Northamptonshire/
Oxfordshire heartland
The UK has specific and under-recognised 2.1 Traditional innovation in mass
across the south midlands areas of leadership. For example, Smith Electric market automotive is focused mainly on
and over to East Anglia;
see Motorsport Research
Vehicles, based in Washington, Tyne and Wear, incremental product development with long
Associates (2003) ‘A Study is the world’s largest manufacturer of road- lead times
into the UK Motorsport
and Performance
going electric vans and trucks.
Engineering Cluster, 2.1.1 Core product technology is the main
Final Report.’ Motorsport
Research Associates.
Finally, ‘Motorsport Valley’ is the premier site focus for innovation
415. Motorsport Research in world motorsport production.414 It is one The car has not greatly changed as a piece
Associates (2003) ‘A Study of the few globally dominant UK regional of technology since the onset of mass
into the UK Motorsport
and Performance clusters in any sector. The UK motorsport production in the 1920s. It is comprised of
Engineering Cluster, industry employs over 40,000 people, of two core technologies: an all-steel body that is
Final Report.’ Motorsport
Research Associates. whom 25,000 are engineers, in more than pressed, welded and painted; and an internal
416. The total turnover the 3,000 firms.415 The engineering sector of the combustion engine (petrol or diesel) that
motorsport sector, that
is, including events,
industry has a turnover of £2.9 billion (with is cast and machined. Alternatives to these
television viewing, and so motorsport-related services earning a further two core technologies have so far remained
on, is estimated at 5 per
cent of GDP (£6 billion)
£1.7 billion).416 More than 50 per cent of marginal to an industry largely concerned with
in the UK – the highest this is in export sales. Of the 22 constructors economies of scale.
in the world; see Henry,
N., Angus, T., Jenkins,
who provide cars to the four global series in
M., and Aylett, C. (2007) 2006, eleven were based within the UK.417 For Traditional innovation focuses on continuous
‘Motorsport Going Global,
The Challenges Facing
the 2008 season, seven of the 11 Formula 1 incremental improvement to core product
the World’s Motorsport teams are based in the UK. Moreover, some technologies, with an essentially conservative
Industry.’ London: Palgrave
motorsport firms have sought to exploit their product design, due to product complexity,
417. Henry, N., Angus, T., specialised design and technology expertise high capital costs, and market competition.
Jenkins, M., and Aylett, outside the sector; for example, McLaren Suppliers of components and materials are
C. (2007) ‘Motorsport
Going Global, The Applied Technologies (formed in 2004) works often responsible for important innovations,
Challenges Facing the with a diverse range of industries and develops while manufacturers often focus on process
World’s Motorsport
Industry.’ London: Palgrave innovations.
418. In 2005 GM announced
a $2.5 million, three-year
research programme
with Stanford University
and Bosch to investigate
HCCI technologies with
respect to sensors, controls Homogenous charge compression need for a spark plug. Overall, the greater
and actuators. Ford has
a similar programme ignition engines efficiency of the combustion process and
underway with MIT. the relatively low temperatures inside the
Jaguar Land Rover has
also conducted extensive An emerging example of incremental cylinder result in low nitrogen oxide (NOx)
research into HCCI with innovation is the homogenous charge emissions compared with spark-ignition
Birmingham University and
other partners. compression ignition (HCCI) engine. Honda petrol and direct injection diesel engines.
419. A lean mixture has a high has been leading its development.418 Moreover, HCCI can be scaled to almost
ratio of air to fuel.
420. Based on a study of the
any size or application from motorbikes to
top 850 UK spenders on The idea of an HCCI engine is hardly new as large ships, and need not be tied to the
R&D, see Department for a technical concept, and is often described traditional fuels of petrol and diesel.
Innovation, Universities
and Skills/Department as combining the advantages of diesel
for Business, Enterprise and petrol. With the homogenous charge, An attractive aspect of this technology
and Regulatory Reform
(2007) ‘The 2007 R&D fuel and air are mixed before combustion, is that the engines could draw on
Scoreboard.’ London: thereby allowing a more uniform burn and modifications to existing designs, and
reducing particulate formation. With high could in theory be produced at low-cost in
compression, the very ‘lean’ mixture419 existing facilities.
ignites within the cylinder without the

421. Toyota (2007) ‘Annual
Even so, R&D in automotive can be moderately The development of a car – from design to Report 2007, Building
high. The sector spends 5.2 per cent of all production logistics – takes up to five years. a Platform for Growth.’
Toyota City: Toyota.
R&D in the UK, or just over £1 billion each The product cycle (the time a model is kept 422. European Commission
year, equivalent to an R&D intensity of 4.3 in production) can be up to seven years. (2005) ‘CARS 21, A
Competitive Automotive
per cent.420 Even a manufacturer with a strong The concept phase and production cycles Regulatory System for
reputation for long-term R&D investments of engines and transmissions can be longer, the 21st Century, Final
Report.’ Brussels: European
such as Toyota has a global R&D intensity of between seven and ten years. Manufacturers Commission.
‘only’ 3.7 per cent.421 As might be expected, and their suppliers plan and allocate production 423. Department for Innovation,
high performance engineering areas such as capacity well in advance to accommodate Universities and Skills/
Department for Business,
motorsport have much higher R&D intensities, production and renewal of their ranges. As a Enterprise and Regulatory
often exceeding 30 per cent (in part because consequence, 60 per cent of the cars that will Reform (2007) ‘The
2007 R&D Scoreboard.’
of their comparatively low sales). Because of be on sale in 2012 are already in production London: DIUS/BERR.
its scale, the automotive sector is the largest today, while another 30 per cent are in This differs from the 80%
that has sometimes been
R&D investor in Europe (20 per cent of total advanced stages of development.426 This gives suggested, see paragraph
European manufacturing R&D) with an annual the sector an almost in-built innovation cycle 9, House of Commons
Trade and Industry
investment of around €20 billion.422 centred on model renewal programmes. It is Committee (2007) ‘Success
difficult and expensive for the manufacturers and Failure in the UK Car
Manufacturing Industry:
The majority of R&D spend is undertaken by to change designs and specifications once a Government Response
vehicle manufacturers rather than supply chain model is in production. to the Committee’s
Fourth Report of Session
firms. By far the biggest spender is Ford, with 2006–07, Third Special
£584 million, 54 per cent of all automotive Given this conservatism and incrementalism, Report of Session
2006–07.’ London: The
R&D in the UK.423 The importance of locating the sector has fewer links with universities than Stationery Office.
R&D activities near to assembly operations some other sectors. Where they exist, they 424. Automotive Innovation
and Growth Team (2002)
varies with type of R&D; vehicle assemblers focus on three areas: engineering, including ‘Design, Development
consider it important in near-to-market stages concurrent engineering; design, including and Manufacture Report.’
London: AIGT.
of vehicle development, but far less important rapid prototyping and tooling; and materials,
425. National Institute of
for ‘basic’ R&D.424 including new manufacturing materials and Standards and Technology
processes.427 Major assemblers including Nissan (2005) ‘Understanding
Private-Sector Decision
By far the largest component of manufacturers’ UK, Ford and others are active sponsors of Making for Early-Stage
R&D expenditure is on new vehicle model research. Beyond these, few tier 1 firms are Technology Development.’
Gaithersburg: NIST.
development rather than longer-term engaged in research activities in the UK.428 426. European Automobile
innovation; one study suggests that 93 per Manufacturers’ Association
(undated) ‘Lead-time is
cent of R&D expenditure is devoted to product 2.1.2 Process technology is the other main Essential and Will Not
development, with only 3 per cent for early- area of automotive innovation Prevent Emissions from
Going Down.’ Brussels:
stage technology development, 3 per cent for Many important innovations have occurred ACEA.
the invention of new concepts, and 1 per cent in process technology or new materials, even 427. Automotive Innovation
on basic research.425 around core technologies such as the all-steel and Growth Team (2002)
‘Design, Development
and Manufacture Report.’
London: AIGT.
428. Automotive Innovation
and Growth Team (2002)
‘Design, Development and
Manufacture Report, Issue
8: Lean Manufacturing
Ultra Light Steel Auto Body (ULSAB) The project reduced the weight of car Knowledge & Lean
Production Dissemination
consortium bodies by up to 35 per cent. It cut costs by in the UK.’ London: AIGT.
14 per cent and improved rigidity. ULSAB 429. The results of Phase 1 of
ULSAB was designed to demonstrate relied on innovative processes and materials ULSAB, which sought to
demonstrate technological
the ability of steel to deliver a significant including: sandwich (laminate) steel potential, were announced
weight reduction in vehicle bodies with which comprises two sheets of CR steel; in September 1995. The
entire design process was
reduced cost without compromising safety hydroforming which involves the three conducted on computer.
and performance.429 It was undertaken dimensional forming of hollow tubes or Phase 2, which sought to
develop actual vehicles,
by vehicle designers and thirty-five sheets to make parts with complex shapes started in 1996, with
steelmakers from around the world. and varying wall thickness; and laser seam actual bodies constructed
by 1998. Alongside this,
ULSAB was not about researching new welding which offers single side access Phase 2 developed more
technologies or materials; rather it was a to the weld, greater vehicle dimensional detailed cost models of
the ULSAB vehicle, a
platform which allowed the steel industry accuracy, and greater stiffness. Various computer-based styling
to demonstrate best practice materials and aspects of the ULSAB approach are already exercise to show how
a completed body and
processes within one vehicle and a holistic in production, but major investments in closures might look, and
design. new process technologies will have to be a crash analysis. Phase 3
will see the transition of
made if ULSAB is to be delivered fully. the design approach into
volume vehicle production.

body, leading to productivity gains and cost For example, hybrid electric vehicles (HEVs)
savings. combine a conventional propulsion system
with an on-board rechargeable energy storage
A recent study of emerging product system to achieve better fuel economy than
technologies reinforces the impression of conventional vehicles without being restricted
largely incremental development in core to short journeys like battery electric cars.
technologies.430 The 33 predicted ‘blockbuster’ The first hybrid motor was developed in
technologies (with the potential to earn 1901 by Ferdinand Porsche. There was some
revenues of €1 billion a year or 100 per cent development through the 1960s and 1970s,
market penetration by 2015) include active but HEVs only became commercially successful
power steering, battery energy management, in the late 1990s when the Toyota Prius and
electromechanical braking, electronically then the Honda Insight were launched. In
controlled air suspension, and NOx catalytic 2005, Toyota announced its intention to
reduction and storage. Suppliers are behind produce 600,000 hybrid cars by 2010 (and
the greatest number of these innovations, more recently, a million hybrids a year within a
but the biggest single innovators are vehicle decade).
Another firm, Zero Pollution Motors (ZPM),
2.1.3 Disruptive technologies have emerged expects to produce the world’s first air-powered
430. Diem, W. (2007) ‘Wyman but remain at the margins car for the US in early 2010 (see also 6.1).431
Study Identifies 33
‘Blockbuster’ Technologies.’ Alternative ways to run vehicles are being ZPM is the US licensee for Luxembourg-, 1st developed. Fuel cells may be the best long- based MDI, which developed the Air Car
431. Sullivan, M. (2008) Air-
term solution because they do not use fossil as a compression-based alternative to the
Powered Car Coming to fuels (a fuel cell is an electrochemical device internal combustion engine. The New York-
U.S. in 2009 to 2010 at
Sub-$18,000, Could Hit
that combines hydrogen and oxygen to based start-up is aiming to produce a 75-hp
1000-Mile Range. ‘Popular produce electricity, with water and heat as its equivalent, six-seat modified version of MDI’s
Mechanics.’ 22nd February.
by-products). However, they are many years CityCAT that could travel 1,000 miles at up to
432. BEVs actually predate
gasoline and diesel from being realised. Other technologies are 96 mph on each fill-up (one tank of air and
vehicles. Between 1832 already available. approximately 8 gallons of conventional petrol,
and 1839, Scottish
businessman Robert ethanol or biofuel). MDI’s dual-energy engine
Anderson invented the first
crude electric carriage. In
1835, Professor Sibrandus
Stratingh of Groningen,
the Netherlands, designed
a small-scale electric car.
433. Paine, C. (2006) ‘Who
Killed the Electric Car?’
Culver City: Papercut Films.
Battery electric vehicles accused of deliberately sabotaging their
own electric vehicle production efforts so
Battery electric vehicles (BEVs) – or electric as not to threaten their existing business
cars – work from chemical energy stored model.433
in rechargeable battery packs. They use
electric motors and motor controllers Yet, the next few years may see a
instead of internal combustion engines. resurgence in BEVs, especially using the
BEVs produce no exhaust fumes (though latest lithium-ion batteries (replacing
of course the original electricity generation nickel-metal hydride batteries, previously
may have produced greenhouse gases) the cheaper option). In 2008, Tesla
and can be cheaper to make and maintain Motors, a Silicon Valley start-up company
than internal combustion engine vehicles producing high performance, consumer-
because they have many fewer parts. oriented electric vehicles, will deliver its
Tesla Roadster. The Roadster (based on the
Historically, plug-in BEVs have been limited Lotus Elise) is a performance sports car that
by high battery costs, limited travel distance can accelerate from 0 to 60 mph in less
between battery recharging, charging time, than four seconds (a similar performance
and battery lifespan.432 Advancements in to a Lamborghini Murciélago) with a top
battery technology have addressed many of speed of 125 mph (limited for safety) and
these problems. Toyota, Honda, Ford and a range of 245 miles. Lotus will assemble
GM produced BEVs in the 1990s to comply the Roadster in the UK. Tesla claims that
with the California Air Resources Board’s the Roadster offers double the efficiency of
Zero Emission Vehicle Mandate. However, popular hybrid cars, while generating only a
the major US manufacturers have also been third of the carbon dioxide.

uses compressed air fed from Airbus-built tanks 2.2 Organisational and business process
to run its pistons. The Air Car variant has a innovation has played a significant role in
supplemental energy source for speeds above improving productivity, with new business
35 mph: a custom heating chamber heats the models emerging at the margins
air to increase volume and so the car’s range
and speed. The Air Car is expected to sell for 2.2.1 Organisational and business process
$17,800. innovation has been crucial in improving
productivity in the sector
2.1.4 Software is making traditional Despite the focus on product development,
innovation more efficient automotive has long been at the forefront of
Innovations in process organisation can apply strategic and organisational innovation. Its
to other areas of the business, notably R&D. practices have subsequently been adopted
The automotive sector has adopted many of by other sectors, among them: the mass
these practices, for example the use of Product production assembly line; component and
Lifecycle Management (PLM) software and material standardisation; the integration of
‘Innovation Technology’ (IvT).434 PLM software all stages of manufacturing from raw material
manages every aspect of a product’s life cycle, to finished product; the de-skilled division of
from concept and design, to manufacturing, labour into short-cycle repetitive tasks; and the
maintenance once the product is sold, and use of financial packages (consumer financing)
through to its eventual retirement. IvT includes to enhance product demand. 434. Waurzyniak, P. (2007)
Enter the Virtual
eScience (computer-intensive science that World. ‘Manufacturing
is conducted through highly distributed Lean production has been the most Engineering.’ 139 (4),
networks), virtual reality, simulation and important contemporary non-technological 435. Gann, D. and Dodgson,
modelling techniques, and rapid prototyping.435 innovation M. (2007) ‘Innovation
Technology: How New
Many of these practices have been popularised Technologies are Changing
Such software tools can greatly reduce vehicle in the West as ‘Lean production’,436 and have the Way We Innovate.’
London: NESTA.
development times, a vital metric with volatile extended well beyond the automotive sector
436. Womak, J. T., Jones, D. T.,
markets and rapidly changing consumer tastes. (see for example Appendix B on the aerospace and Roos, D. (1990) ‘The
sector). Process improvements, particularly Machine That Changed the
World.’ New York: Rawson.
Lean manufacturing, have been the largest 437. McKinsey Global Institute
contributor to productivity growth in the (2005) ‘Increasing Global
Competition and Labor
sector.437 Productivity: Lessons
from the US Automotive
Industry.’ New York:
McKinsey Global Institute.
438. MCAD (2007) Managing
Tolerances at Nissan.
‘MCAD.’ June, pp.36-39.

Nissan Qashqai 3D computer-aided engineering and

visualisation software called aesthetica
Nissan Design Europe digitally mastered (developed by Icona Solutions) allowed
the development of its Qashqai compact Nissan’s designers to visualise extremes in
hatchback/SUV crossover car (rather than production variations before committing
developing a scale model prototype). This to how the car would be tooled. Fifty
produced higher quality development while thousand variations, called variation control
reducing lead-time and costs.438 exercises, were simulated. The software also
enabled designers to uncover issues in the
Although the automotive industry is one design that would not have been identified
of the leaders in the use of digital tools, using existing digital processes.
it still tends to rely on physical prototypes
complemented by digital models. Nissan The Qashqai is the first Nissan vehicle to
aimed to reverse this, since physical be designed, developed and manufactured
prototypes take more time and money to entirely in the UK – and the first to use this
build and are less useful in predicting the software.
effects of variations in production on the
quality of the vehicles that roll off the
assembly line.

93 Effective supply chain management by There is an increasing but variable role
vehicle manufacturers is crucial for suppliers in product innovation
Generally, vehicle manufacturers provide Manufacturers now also expect this smaller
suppliers with a specification for their parts in group of suppliers to undertake R&D and
terms of performance, the space dimension manage their own supply base, though
within which the part has to fit, and anticipated this trend has been more limited than has
cost. The vehicle manufacturer’s main task is to sometimes been suggested.439
439. Prior to this the general integrate these components.
practice was for vehicle
manufacturers to design
Many vehicle manufacturers and tier 1
all of the car and its Given the increased complexity of modern suppliers have overestimated their suppliers’
constituent components,
and to ask suppliers to
vehicles, integration has become more competencies and underestimated the
quote a price for the challenging. Vehicles need repeated testing required levels of expertise and investment
production of those
components against an
and redevelopment to ensure that the vehicle required. This has meant that expected savings
anticipated volume. as a whole works and that it can be built in from devolving design and development to
440. Automotive Innovation a logical and cost-effective manner. Vehicle suppliers have not yet materialised. Suppliers
and Growth Team (2002)
‘Design, Development manufacturers take many steps to reduce still perform only 15-30 per cent of ‘design
and Manufacture Report.’ this burden. Many parts are transferred from effort’.440 Of this, tier 2 suppliers or lower
London: AIGT.
441. Wells, P. (2005) Nissan
one model to the next. ‘Platform strategies’ account for very small amounts of design effort
Sunderland’s ‘Plant Within allow parts and vehicle architectures to be (5-10 per cent).
a Plant. ‘World Vehicle
Manufacturers Analyst.’ 84,
shared across multiple brands: one example
pp.23-24. is Volkswagen’s MLP (Modular Longitudinal As a result, many vehicle manufacturers
442. Barton, H., and Delbridge, Platform); the Volkswagen group has four are now bringing activities back in-house.
R. (2006) Delivering the
“Learning Factory”?, volume brands in Audi, Seat, Skoda and VW, Manufacturers are now more careful to whom
Evidence on HR roles and MLP is being used increasingly across they devolve work and what kind of work
in Contemporary
Manufacturing. ‘Journal these brands. they devolve; careful assessments are made
of European Industrial of each supplier, their track record and level
Training.’ 30 (5),
pp.385-395. As a result, supply chain management has been of competence. Most product innovation
443. Further analysis of Toyota’s a prominent area for innovation. Procurement is trusted with a small number of so-called
approaches has also has developed from the traditional model ‘tier 0.5’ suppliers; firms with a credible level
highlighted the Toyota
Product Development (a large number of suppliers chosen on of expertise and competence at managing
System, which coordinates price from a local cluster), through Lean (as integrated projects. GM has announced that
the activities of a large
number of people to above), towards the ‘extended enterprise’ it will no longer outsource major systems to
enable work to progress approach (a few select suppliers with whom the suppliers, while Nissan has embraced a more
simultaneously instead of
serially, hence making the manufacturer works very closely to optimise innovative approach with its ‘plant within a
firm one of the quickest the whole supply chain). plant’ system whereby the build of the Micra
in the world in product
development. Toyota calls CC has been outsourced to Karmann inside the
this ‘Value Innovation.’ See Nissan Sunderland plant.441
Liker, J. K., and Morgan,
J. M. (2006) ‘The Toyota
Product Development
System.’ Shelton:
Productivity Press.
444. According to an analysis
of units per employee
per year based on Toyota Production System in Lean manufacturers (double that of
data collected by the others, in many cases), and Toyota has the
automotive analysts Ward,
see Vaghefi, M. R., Van Since the late 1980s, a second wave of highest consistent output of any major
Deusen, C., and Woods, transformation in the industry emerged as Lean automotive manufacturer.444 In North
L. (2007) Motor Drive.
‘Business Strategy Review.’ vehicle manufacturers and others sought America, the difference between the most
Autumn, pp.28–32. to emulate the Toyota Production System productive major automotive manufacturer
445. Harbour Consulting (2007) (TPS). (Toyota) and the least productive represents
‘The Harbour Report™
North America 2007.’ 5.17 labour hours per vehicle (or about
Troy, Michigan: Harbour TPS organises manufacturing and logistics $300).445 In the first quarter of 2007 Toyota
446. Piggly Wiggly was also to eliminate waste and inconsistency overtook GM in global sales for the first time.
the first true self-service in products by emphasising continuous
grocery store.
improvement, teamwork, just-in-time Toyota developed the TPS as a reaction
inventory, and becoming a ‘learning to what it perceived as the wasteful
organisation’ through relentless overproduction of US automakers
reflection.442 This has helped Toyota (particularly Ford), but was also inspired by
greatly to reduce lead-time and costs visiting the Piggly Wiggly supermarket chain,
while improving quality.443 Output per which only reordered and restocked goods
worker is consistently significantly higher once they’d been bought by customers.446

2.2.2 New business models are emerging in-car features such as satellite navigation that
from new firms differentiate products in less significant and
As is often the case, new technologies require less risky ways.
organisational and business model innovation
to complement them. For example, the The high barriers to market entry for radical
Project Better Place initiative (another start- new entrants make it difficult for disruptive
up) focuses on the integration of existing business models to emerge that can
technologies and systems to provide the challenge the entrenched positions of major
infrastructure and scale necessary to make manufacturers. Yet the sector’s relatively
electric cars a viable alternative to fuel-based narrow approach to innovation appears unable
vehicles. Its business model is adapted from to restore profitability, hence the need for
mobile phone operators; Project Better Place radical alternatives.
intends to establish a network of charging
spots and battery exchange stations to provide 3.2 The sector has been resistant to new 447. See www.
ubiquitous access to electricity, starting in business models
448. For example, of major US
Israel. Project Better Place will offer consumers Despite the conditions prevailing in the manufacturers, on each
several subscription-based ownership models, industry, new business models are resisted vehicle sold in North
America in 2006, Chrysler
by sourcing the electric cars and batteries by the current infrastructure (existing Group lost $1,072, GM
that will be compatible with the charging manufacturing plants, dealership networks, lost $1,436, and Ford
lost $5,234; see Harbour
network, and subsidising vehicle costs through and suppliers). For example, suppliers Consulting (2007)
leases and credits.447 Prototype vehicles are might hesitate in taking on risky product ‘The Harbour Report™
North America 2007.’
intended to be introduced in early 2008 and development for an untried new entrant, or at Troy, Michigan: Harbour
the company hopes to begin commercial sales least be unwilling to do so at reasonable cost. Consulting.
449. More than half of all
and service by 2010. Renault has announced cars purchased in the
that it will supply cars for this network, using Yet, the sector has a large number of marginal, UK are provided with
funding at the point
lithium-ion batteries developed by NEC Corp. experimental and innovative businesses. Some, of sale (so, excluding
and Nissan. such as TH!NK from Norway, have a long and personal loans or direct
loans). The involvement
convoluted history trying to introduce a highly of manufacturer ‘captive’
innovative product to the market (in this case, finance companies has led
the marketing of finance
a battery electric vehicle made of lightweight to become intertwined
3. Automotive innovation is inhibited materials).450 Aside from a few high-value with that of new cars,
with offers of low or zero
by structural issues in the industry but vehicles it is very difficult for a new entrant interest rate deals used
environmental regulation has become with limited geographic market coverage and as a means to promote
models. See Automotive
increasingly important an unknown brand to persuade consumers of Innovation and Growth
the merit of purchasing a high-cost product. Team (2002) ‘Distribution,
Competition and Consumer
3.1 Conservatism due to high capital Group Report.’ London:
intensity and low margins Equally, no vehicle manufacturer has yet tried AIGT.
The automotive sector is a mature industry; to realise a business model that would threaten 450. Orsato, R., Wassenove, L.,
and Wells, P. (2008) ‘The
it has a relatively concentrated structure its own existing business, however weak that Bumpy Ride of TH!NK.’
characterised by high capital intensity. It business may be. Perhaps the nearest example INSEAD Case Study.
Fontainebleau: INSEAD.
is also insufficiently profitable, lumbered is that of the MCC Smart project (or fortwo as 451. Automotive Innovation
with structural problems: over-capacity it is now known), where over time the more and Growth Team (2002)
‘Environment Report.’
throughout the value chain; high fixed radical aspects of the business plan have been London: AIGT.
costs in manufacturing, product design and diluted.
distribution; inflexible production systems;
and inflexible product designs.448 In effect, the 3.3 Environmental and safety regulation has
mass market production model is being kept become increasingly important
alive by discounting and incentives, paid for Twenty-two per cent of the world’s greenhouse
by lucrative financial services and aftermarket gas emissions result from the transportation
sales (maintenance, repair and parts supply).449 sector; an even higher proportion of urban
emissions in large cities are attributable to
These factors, together with the need to vehicle emissions. There are approximately 700
protect brand reputations, contribute to a million cars on the world’s roads which emit
prevailing conservatism. And this conservatism more than 2.8 billion tons of CO2 per year. An
is reinforced by the high price of the product average car produces four tons of CO2 every
that results in customer caution. The result year, which stays in the atmosphere for 45
is that innovation tends to be channelled years after it leaves the car’s tailpipe. In the
towards reducing per-unit costs, or increasing UK, vehicles are responsible for over a quarter
per-unit revenues and margins. This has led to of particulate emissions and almost half of
process innovations that reduce costs or new total nitrogen dioxide emissions. These have

been linked to damage to both air quality and 4. Innovation is hidden because
health. Although average emissions per car are there are significant levels of more
falling due to engine and fuel improvements, incremental product and process
these reductions will largely be offset by development
increases in traffic.451
4.1 Non-cutting-edge product development
Yet according to one study for government, is prominent in the sector
which examined the ‘innovation system’ for The moderate R&D intensity in the mass
low carbon transportation: “Uncertainty as market sector compared to some other
to the likely strength of long-term policy for advanced engineering sectors, yet a sector
CO2 reduction in the transport sector means that is focused on incremental product
automotive and fuel firms are uncertain as to development, implies a significant degree of
the priority to attach to carbon reduction/fuel technological innovation that is not captured
efficiency goals relative to other objectives.”452 in narrow measures of R&D (Type I hidden
This is exacerbated by insufficient coordination innovation).
of the R&D efforts in all of the technology
areas required. This is likely to be particularly true of
technologies that are developed first by
Furthermore, the production and disposal of competitors before being adopted by other
vehicles have environmental impacts, even manufacturers. Most core product technologies
though manufacturers have made production eventually become standard across all brands
processes less harmful by phasing out mercury and models, from variable value timing for
and CFCs. Manufacturing itself of course engines, through process technologies,
contributes to greenhouse gas emissions to ‘surprise and delight’ features such as
and results in a number of waste products satnav. Much innovation is therefore ‘catch-
452. E4tech (2007) ‘A Review of (water, volatile compounds and solid waste). up innovation’ – new to the firm but not
the UK Innovation System
for Low Carbon Road Additionally, once vehicles reach the end of necessarily new to the sector.
Transport Technologies, A their life, though most of the material can
Report for the Department
of Transport.’ London: be recycled, 25 per cent typically ends up as Furthermore, most SME suppliers may not have
E4tech. waste.453 formal or significant R&D programmes, but
453. Automotive Innovation
and Growth Team (2002) they still develop and refine their products.
‘Environment Report.’ Regulation by national governments and
London: AIGT.
international bodies has been an important 4.2 Organisational and business process
driver of incremental innovation in this area. innovations are not sufficiently recorded in
Regulations have covered safety, exhaust traditional metrics
emissions and recycling; they will in the future Lean manufacturing is an obvious example
limit CO2 output. For example, the recent EU of both a process and an organisational
End of Life Vehicles Directive requires re-use innovation (Type II hidden innovation). Yet
and recovery of materials to rise to 95 per cent investments in developing such practices
by 2015. are not regarded as innovation. Similarly,
innovations in supply chain management,
Regional policy is becoming more influential, despite their importance to vehicle
for example, Transport for London’s congestion manufacturers.
charging zone and intended emissions
regulation in US states such as California. 4.3 The use of software and other
supporting technologies has been valuable
However, there have been significant political in improving quality and efficiency
and lobbying battles over the content of The use of software in areas such as 3D design
regulations (such as the question of whether and product development is making traditional
there should be voluntary agreements or innovation more efficient. But such software
legislation in the EU). The industry is pushing may have been developed first in other firms
for alternative measures, such as better traffic and often in other sectors (in this case, the
management, smoother roads, and teaching aerospace sector). This then represents an
drivers the benefits of fuel-efficient driving. example of Type III hidden innovation; the
exploitation of software in automotive would
not be typically recorded as innovative by
traditional metrics.

4.4 Localised generated innovations are real world problems.455 But their cumulative
incredibly important for some firms impact can of course be seen in the large
As in other areas of engineering, the emphasis efficiency and productivity gains made by such
on continuous improvement, especially manufacturers.
through Toyota’s approaches, can cumulatively
improve production techniques, efficiency and 5.4 Tracking outcomes would also be a
productivity. Yet such ‘micro-innovations’ are meaningful way of measuring innovation
not captured in traditional metrics (Type IV Given the increased social and environmental
hidden innovation). demands on vehicle manufacturers, there
could be a greater emphasis on performance
data linking innovation activities to improved
outcomes. For example, in terms of sustainable
5. Innovation could be better measured production, one trade association survey tracks
by drawing on industry surveys, better inputs into production such as: total combined
incorporating organisational innovation energy use; energy used per vehicle produced;
and tracking outcomes total combined water use; and water use per
vehicle produced.456
5.1 Industry surveys are a more detailed
source for Type I hidden innovation Similarly, recording ‘customer fulfilment’ in a
There is a huge wealth of very specific industry standardised way could be the focus for the 454. Experian (2007)
‘Motorsport 100 Research
data, collected internationally, on everything sector’s improvement and innovation efforts.457 Findings.’ London:
from engine manufacture to inventory, the use Such a measure would represent a fundamental Experian.
455. May, M. E. (2007) ‘The
of materials and development programmes, change in perspective, in that it asks: ‘Did the Elegant Solution: Toyota’s
which could be used to analyse innovation customer get the right car, in the right place, at Formula for Mastering
Innovation.’ New York:
capacity and performance. the right time?’ It has been estimated that half Free Press.
of all cars in the UK do not arrive ‘right first 456. The Society of Motor
For example, a regular survey of the motorsport time on time’ into the hands of the customer Manufacturers and Traders
(2006) ‘UK Automotive
sub-sector captures technological and non- (though there are significant variations Sector Sustainability
technological business trends, such as levels of between manufacturers).458 Report, Production,
Consumption and Disposal
investment in technologies beyond R&D, areas Eighth Report.’ London:
of specific focus for innovation, and linkages SMMT.
457. Roberts-Dear, R. (2007)
with other sectors.454 ‘The Consumer Experience
6. Innovation could be improved by of Buying New Cars.’
Solihull: International Car
5.2 Organisational and business process strengthening design capabilities but Distribution Programme.
innovations could be better recorded by the also organisational and business process 458. Automotive Innovation
adoption of specific organisational forms innovation to respond to the sector’s and Growth Team (2002)
‘Distribution, Competition
Given the importance of organisational major challenges and Consumer Group
innovations such as Lean (Type II hidden Report.’ London: AIGT.
innovation), the adoption of such structural 6.1 Retaining high-value-added activities 459. Automotive Innovation
and Growth Team (2002)
changes (and their impact) could be requires improving R&D and design ‘Executive Summary.’
incorporated into analyses of innovation in the capabilities London: AIGT.
460. Paragraph 2, House of
sector. The extent has already been recorded More basic and labour-intensive aspects of the Commons Trade and
in studies of the automotive supply chain. production process have shifted to emerging Industry Committee (2005)
‘UK Automotive Industry:
Similarly, industry surveys can record how much nations including Eastern Europe because of Government Response
more efficient and effective technologies such lower labour costs. It has been estimated that to the Committee’s
Eighth Report of Session
as the latest design software are being used. UK-based assemblers source well below 50 per 2003–04. First Special
cent of their components in the UK. Where Report of Session
2004–05.’ London: The
5.3 Localised innovation can be estimated at UK-based suppliers retain work, it is often only Stationery Office.
the firm level by transferring their own purchases abroad.
Micro-innovations (Type IV hidden innovation) UK-based suppliers are not just losing work to
are by definition difficult to count, but lower wage countries; much business has gone
individual firms can certainly evaluate to firms elsewhere in Western Europe.459
their effectiveness on their own efforts at
continuous improvement. This is why it may not be sensible to assume
that the industry’s current preference for
One study estimates that Toyota, through its building close to market means that significant
inclusive approach to improving production vehicle production is unlikely to shift from the
techniques, implements one million new UK to lower-cost countries.460
ideas each year (3,000 each day). Most are
inevitably small but effective solutions to

In this context, retaining and enhancing R&D 6.3 More broadly, the current dominant
and technology development in the UK is technology and business model in
obviously important. The UK is already weaker automotive is not sustainable, financially or
as a result of the absence of indigenously- environmentally
owned mass manufacturers. Given the foreign To cite one example, two-thirds of new
ownership of the major vehicle manufacturers car buyers in the UK have their vehicles
and many tier 1 suppliers, many of their supplied from stock – from the pool of cars
461. Ricardo UK/Skills4Auto design and engineering centres are outside already manufactured and located either
(2006) ‘Vision for the
UK Automotive Industry
of the UK. This makes it more difficult for at dealerships or manufacturer distribution
in 2020, Focusing on many UK suppliers to become involved in centres.466 Reducing the number of vehicles
Supply Chain and Skills &
Technology.’ Shoreham-by-
early parts of the R&D process, and to access held as unsold stock would bring an immediate
Sea/Birmingham: Ricardo foreign manufacturers generally.461 Following financial benefit to the whole production
production activities, many European and US and distribution chain, and would be far
462. Automotive Innovation
and Growth Team (2002) firms are relocating R&D activities to emerging less environmentally wasteful. To this end,
‘Design, Development locations (such as central and eastern Europe, the sector needs to shift from its traditional
and Manufacture Report.’
London: AIGT. More India and China). reliance on ‘pushing’ stocks of cars down the
recently, see Department distribution chain to customers to building
for Business, Enterprise
and Regulatory Reform Increasing levels of design devolution from a system where cars are customised to the
(2008) ‘Report on the assemblers to the supply chain mean that customer’s preferences and the process is
Business Environment
for Japanese Automotive the ability to design new products is growing geared to meeting them.467
Supply Companies in the in importance. Increasing the dependency
UK.’ London: BERR.
463. Ricardo UK/Skills4Auto
between assemblers and ‘design capable’ Given that the industry suffers from global
(2006) ‘Vision for the suppliers would therefore generate a reluctance over-capacity and with manufacturing best
UK Automotive Industry
in 2020, Focusing on
to switch sources of supply. More UK suppliers practice rapidly diffused around the world,
Supply Chain and Skills & need to be able to position themselves in this being Lean will not be enough. At some point,
Technology.’ Shoreham-by-
Sea/Birmingham: Ricardo
way. there is likely to be a radical realignment of the
UK/Skills4Auto. Similarly, global automotive sector.
see Automotive Innovation
and Growth Team (2002)
6.2 This means that supply chain
‘Design, Development weaknesses need to be addressed Alternative business models have already been
and Manufacture Report.’
London: AIGT.
Some parts of the UK automotive sector developed. One is the Indego concept, which
464. As identified in the are undoubtedly world class. In part, this is re-imagines the industry without its existing
Sector Skills Agreement because of the UK’s openness to foreign direct encumbrances.468 This anticipates almost 22
for the Aerospace,
Automotive and Electronics investment, which has also helped to transfer per cent operating margins (when 5 per cent
sectors, completed world class practices here. is considered good by industry standards),
in January 2006; see
Sector Skills Council for through innovations such as: repeated leasing
Science, Engineering But for major vehicle assemblers, the primary of the vehicle through the life cycle; other
and Manufacturing
Technologies (2006) issue remains the quality and management consumer costs such as periodic maintenance
‘SEMTA Sector Skills practices at the first and second tier already bundled into the package offered; a
Agreement, Electronics,
Automotive and Aerospace suppliers.462 The UK automotive supply chain hyper-Lean production system with high levels
Industries.’ London: has been regarded as poor in areas such as of outsourcing in development and production;
465. Automotive Innovation
strategy and planning, leadership, programme product minimalism with ‘good enough’
and Growth Team (2002) management, process engineering, continuous quality; and direct sales and distribution.469
‘Design, Development improvement and Lean, and customer care.463
and Manufacture Report.’
London: AIGT. Thirty per cent of supply chain firms have no Such a model might appeal to an established
466. As noted in Cardiff business plan, and fewer than 50 per cent have vehicle manufacturer wanting to introduce a
University/The University
of Bath/The International workforce training plans. new brand or enter a new market, an emerging
Car Distribution vehicle manufacturer or contract assembler (for
Programme (undated)
‘Towards a Customer Skills weaknesses have been identified in: team example, in China), or even a new entrant from
Driven System, A Summary leadership; Lean; top and senior organisational outside the sector. The existing industry could
of the 3DayCar Research
Programme.’ Cardiff/ management; and Level 3, 4 and 5 be threatened if an emerging manufacturer
Bath/Solihull: Cardiff occupational skills.464 Vehicle assemblers predict or new entrant successfully introduced such
University/The University
of Bath/The International that advanced engineering systems will become a model in a relatively short period of time,
Car Distribution increasingly more integrated (and virtual) and having a major disruptive impact (much as low-
467. Automotive Innovation
that this will require the development of new cost airlines have had in their sector).
and Growth Team (2002) engineering management competence in the
‘Distribution, Competition UK to assist vehicle assemblers.465 The recent launch of the Nano, the ‘people’s
and Consumer Group
Report.’ London: AIGT. car’ in India, by Tata Motors at a cost
equivalent to £1,277 demonstrates the
likelihood of this happening.470 The Nano
is the world’s lowest-priced passenger car,

468. Indego was developed by
undercutting by half the former lowest cost viable candidates for commercialisation over the consultants ATKearney
car available in India. Tata initially plans to the next five to seven years. The next step in conjunction with
ex-Ford of Europe board
build 250,000 Nanos annually, rising to one is the TSB’s launch of a Low Carbon Vehicles member Martin Leach
million units a year. In addition, Tata will Integrated Delivery Programme with an initial (later at Maserati, then at
LDV), see Dunne, P., and
start producing the world’s first commercial investment of £40 million jointly supported Young, S. (2004) Thinking
air-powered vehicle, the Air Car, for India in by the TSB, DfT and the Engineering and Beyond 4,000 Pounds
of Metal. ‘Executive
2008.471 Developed by ex-Formula 1 engineer Physical Sciences Research Council (EPSRC). Agenda.’ VII (4), pp.25-31.
Guy Nègre for MDI, this uses compressed air It will provide greater coordination of activities It was based on the
concept of ‘micro factory
as opposed to the gas-and-oxygen explosions from university research to future potential retailing’, see Wells, P. and
of internal-combustion models to push the procurement opportunities, speeding up Nieuwenhuis, P. (1999)
Micro Factory Retailing: A
engine’s pistons. the time it takes to get low-carbon vehicle Radical Business Concept
technologies into the market place. for the Automotive
Industry. ‘Sewells
Tesla Motors and their ilk show that Silicon Automotive Marketing
Valley is emerging as a source of small Yet the development and introduction of a Review.’ 5, pp.3-7.
469. Similarly, the ‘3DayCar’
pioneering ventures that might induce low-carbon transport system still requires a concept. The largest
innovation in automotive, by commercialising long-term government-led strategy. The recent overall time saving in
this approach would be
new technologies, products and business King Review of low-carbon cars recommended achieved by switching
models that could eventually reshape the bringing existing low emission technologies to a system of direct
order input to assembly
sector. In contrast, the (British) Morgan LifeCar from ‘the shelf to the showroom’ as quickly line ‘slots’. See Cardiff
– a lightweight zero emission performance as possible by: ensuring a market for low University/The University
of Bath/The International
vehicle using a radically small fuel cell – will emission vehicles; moving the short-term focus Car Distribution
remain only a demonstration concept car.472 back to automotive technology from biofuels; Programme (undated)
‘Towards a Customer
developing the UK as a location for high Driven System, A Summary
6.4 The UK needs to develop a broader technology companies in the field, with good of the 3DayCar Research
Programme.’ Cardiff/Bath/
programme of support to help retain businesses support mechanisms encouraging Solihull: Cardiff University/
higher-value-added activities and anticipate inward investment and supporting key areas of The University of Bath/
The International Car
coming changes in the industry underpinning science and engineering.475 Distribution Programme.
The project was supported
through the Design and
6.4.1 More strategic funding of new 6.4.2 New business models, business Manufacturing Processes
technologies, especially low-carbon practices and approaches are crucial, strand of Foresight Vehicle.
technologies, is important especially across the whole supply chain 470. In 2008, Tata also bought
Jaguar and Land Rover
The Foresight Vehicle Steering Group was Focusing on technology alone is not enough. from Ford.
set up to guide and support UK R&D in the Innovation also requires the right business 471. Sullivan, M. (2007) World’s
First Air-Powered Car: Zero
supplier sector to help it meet forthcoming practices and business models. Emissions by Next Summer.
environmental and business challenges.473 The ‘Popular Mechanics.’ June.
Foresight Vehicle programme brings together The Automotive Innovation and Growth 472. The LifeCar is a join project
between RiverSimple,
universities and vehicle manufacturers in Team (AIGT) in 2002 suggested that Cranfield University,
new collaborative relationships.474 Five key additional assistance is needed to improve the QinetiQ, Oxford University,
Linde AG and Morgan
sub-sectors have been targeted: engine performance of domestic suppliers through Motor Company, supported
powertrain; hybrid, electric and alternative fuel local initiatives and assembler-focused by a then DTI grant.
473. Foresight Vehicle (2004)
vehicles; software, sensors, electronics and programmes of improvement.476 The AIGT also ‘Foresight Vehicle
telematics; advanced structures and materials; argued that the sector would benefit from a Technology Roadmap.’
London: The Society of
and design and manufacturing processes. The new approach to the training of management Motor Manufacturers and
latter Thematic Group has been established grades in order to redesign and implement Traders. The Foresight
Vehicle programme was
to promote the research, development and changes to the automotive supply chain that launched in November
adoption of efficient, world-class design and will enhance the performance of the sector.477 1997 as the flagship
automotive R&D
manufacturing processes. As the name implies, programme intended to
the Design and Manufactoring Process strand is There has been some progress, but more fund pre-competitive
research. All projects are
process-oriented, whereas the other Thematic could be done. Following the AIGT reports, collaborative undertakings
Groups are primarily product-based. the Supply Chain Groups programme was between business and
academia; the great
established in 2003, jointly funded by the majority of them are led by
In addition, the Low Carbon Vehicles then Department of Trade and Industry, the industry.
Innovation Platform was launched by the English RDAs and the devolved regional 474. The Foresight Vehicle
Initiative is the prime
Technology Strategy Board (TSB) in 2007 assemblies.478 This programme, focused knowledge transfer
to accelerate the market introduction of low largely on process improvement through Lean network for the
automotive industry. It
carbon road vehicles. Its first activity was a manufacturing, came to an end in March 2008, is now administered by
collaborative R&D programme with £20 million after having supported 62 projects, involving The Society of Motor
Manufacturers and Traders
of support from the Department for Transport 575 suppliers employing 160,000 people, and (SMMT), formerly by the
(DfT) and the TSB, focused on bringing facilitated major productivity improvements then DTI.
forward vehicle technologies that could be of up to 40 per cent.479 The New Automotive

Innovation and Growth Team (NAIGT), as part
475. HM Treasury (2007) of its wider strategic review of the challenges
‘The King Review Part facing the sector in the future, will examine
I: The Potential for CO2
Reduction.’ London: and make recommendations to government
Her Majesty’s Stationery regarding future programmes by March
Office; HM Treasury
(2008) ‘The King Review 2009.480 In particular, it has been charged with
of Low-Carbon Cars, Part investigating how the UK industry should
II: Recommendations
for Action.’ London: Her respond to low-cost competition and the move
Majesty’s Stationery Office. to low-carbon transport.
476. The Automotive Innovation
and Growth Team (AIGT)
was the first of several 6.4.3 A broad approach to improving skills in
IGTs to be initiated by the
then DTI. Sir Ian Gibson, the sector is required
former Chief Executive UK government has accepted the
of Nissan’s UK and
European operations, was recommendations of the most recent House
appointed as its Chairman. of Commons report on the sector, that
The primary role of the
AIGT was to identify the industry and government should put extra
key drivers which would effort into improving skills throughout the
determine competitiveness
over the next 5-15 years sector, increasing the commitment to R&D,
and to develop a vision for adopting Lean manufacturing techniques and
the sector in the UK.
strengthening local supply chains.481 These
477. Automotive Innovation
and Growth Team (2002) are the same areas identified by the AIGT in
‘Design, Development 2002.482
and Manufacture Report.’
London: AIGT.
478. In addition, there has been The Automotive Academy was opened in 2004.
significant regional funding
available to the sector. In
The Automotive Academy system was a new
2000–2006, £100 million approach to providing skills and training for
was offered in regional
grants under the Regional
the UK automotive industry workforce with
Selective Assistance core funding provided by UK government (£12
(RSA) and Selective
Financial Investment in
million). The Automotive Academy is now being
England (SFIE) schemes to merged into a new body, the National Skills
automotive manufacturers
and suppliers in England.
Academy for Manufacturing (NSAM).
In the same period, nearly
£150 million was paid out,
including stage payments
The sector needs to equip graduates with
on offers made prior to the technical skills of engineering whilst also
developing the necessary managerial and inter-
479. Department for Business,
Enterprise and Regulatory personal skills. It needs ‘business engineers’,
Reform (2008) ‘Report on with the continuing professional development
the Business Environment
for Japanese Automotive to take a systems view of the industry and its
Supply Companies in the processes, whilst developing their technical
UK.’ London: BERR.
480. Department for
and managerial capabilities. BERR is currently
Business, Enterprise working with the National Skills Academy
and Regulatory Reform
(2008) ‘Business Minister
for Manufacturing and the SMMT Industry
Shriti Vadera Announces Forum to develop a new approach which will
New Investigation into
Automotive Industry.’ Press
use the focus of supply chain improvement
release, 7th April. London: programmes to enhance leadership and
management skills, in addition to the previous
481. House of Commons Trade
and Industry Committee emphasis on process improvement.
(2007) ‘Success and
Failure in the UK Car
Manufacturing Industry: Another skills issue is the need to give
Government Response much greater responsibility to frontline
to the Committee’s
Fourth Report of Session teams for technical problem-solving, which
2006–07, Third Special helps to identify the real quality issues with
Report of Session
2006–07.’ London: The manufacturing processes and to release
Stationery Office. engineers’ time to engage in project activities.
482. Automotive Innovation
and Growth Team (2002)
This is known as Total Productive Maintenance
‘Executive Summary.’ (TPM) and is another concept that originated
London: AIGT.
in Japanese manufacturing, especially at Toyota
and Denso. TPM approaches the engineering
skills issue from the bottom-up rather than a
purely ‘graduate elitist’ approach.

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Published: May 2008