2008 podcast hughes the hidden secrets

The hidden secrets of US innovation

11 September 2008

The article at a glance

Professor Alan Hughes, Director of the Centre for Business Research at Cambridge Judge Business School, has studied the US innovation-led growth story. …

The hidden secrets of US innovationProfessor Alan Hughes, Director of the Centre for Business Research at Cambridge Judge Business School, has studied the US innovation-led growth story. He explains that businesses can learn much from copying the US, but cautions that in order to create a truly effective innovation programme, the underlying factors that have driven the recent growth in the US need to be fully understood and coupled with an analysis of what is unique about each organisation’s own economy.

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The US has been the world’s laboratory in innovation-led growth since the 1990s. As a consequence, officials around the world have tried to identify the underlying factors behind the acceleration in US productivity growth, so that they can copy them. The problem with this approach, however, is that they may be exaggerating some factors and underplaying others, argues Professor Alan Hughes, Director of the Centre for Business Research at Judge Business School. According to Professor Hughes, fashioning a truly effective innovation programme means making sure you really understand what has driven the recent growth in the US and that you also understand what is unique about your economy.

Professor Hughes provides a more rounded assessment of the US innovation story which is based just as much on the successful utilisation of new technology by service sector companies, such as Wal-Mart, as on the emergence of new high-tech start-ups.

The US has been able to improve its rate of productivity growth faster than other countries due in part to its innovation. The statistics bear this out. The country went through a sluggish period until the mid-1990s when suddenly US growth of real GDP per hour almost doubled. So, naturally enough envious policy-makers across the world looked to the US for answers to their own lacklustre performance. They assumed, again naturally enough, that all they had to do was analyse the causes of North America’s extraordinary productivity growth and copy it.

People generally assume that the US holy grail of innovation stems from the growth of high-tech firms, some of which have been spun-off from top US universities. In 2000, the EU pinned its hopes for a more innovative Europe on its ability to produce a similar stream of new companies in the ICT and biotech fields.

Professor Hughes is not saying that such notions are wrong. But he provides four good reasons why the policy-makers should not assume it is all about VC-funded start-ups.

Firstly, and most surprisingly, the great driving force of productivity growth in the US has come from the service sector including retailing, wholesaling and transport. Companies such as Wal-Mart have found ways to improve their efficiency through the use of new technology. For example, the application of new technology to inventory management revolutionised the way companies such as Wal-Mart transported their goods around the world and filled their shelves. So, companies like Microsoft have been critical in terms of supplying the technology that the Wal-Marts of this world have used. But it is the way the technology has been put to use that has driven the growth. “It is a Wal-Mart, not a Microsoft led turnaround. The traditionally identified R&D intensive sectors have not carried most weight,” notes Professor Hughes.

The second lesson to be learnt from the US is that new start-ups are not the great panacea they appear to be. A few of them will succeed beyond a VC’s wildest dreams and create enormous wealth for them and other shareholders, but most of them will not. The odds of scoring a ‘home run’ in a start-up venture from a university are relatively small, warns Professor Hughes. Almost 200 university institutions in the US owned 27,322 patents in 2004. But only 193 of them made over $1 million. Every year, 500,000 new companies are started in the US but only a handful can be classified as high-tech start-ups from universities. Connected to this, Professor Hughes also compared the impact of older, established firms on productivity growth with the ‘new kids on the blocks’. And surprisingly, the ‘golden oldies’ had far more impact provided that they had found ways to transform their performance.

Thirdly, businesses don’t see universities as the source of all great wisdom related to innovation, a point that has also been shown to be true in the UK. Universities have a very important role to play. But it is not necessarily related to the knowledge they can impart to managers hungry for the secrets to innovation. Instead, they are more likely to go to other companies for this kind of information, notes Professor Hughes. These might be competitors, suppliers or customers. Universities, on the other hand, can help by offering a ‘public space’ in which business people can ‘play’. They can meet each other and explore together important new areas of research. This means policy-makers who think universities are important as sources of licenses and spin-offs might be missing a trick. They can help businesses grow in other ways too.

Finally, the last but not least important lesson from the US is that many new start-ups were financed in their early years through a government scheme called the Small Business Innovation Research Programme (SBIR). It was set up to stimulate the growth of high-tech firms by offering government contracts to those that won the bids. It is a very significant source of money for the seed stages of new companies, a time when such companies find it hard to win VC funds. About $2 billion a year is poured into this scheme, through placing public sector R&D contracts.

How then can countries emulate the United States and ramp-up their innovation-led productivity growth? As Professor Hughes has shown, they cannot simply copy what they believe to be the underlying drivers generating the extraordinary innovative capacity in North America. He has shown that in doing so they might exaggerate the importance of some factors such as the rate of spin-offs in the high-tech field whilst underestimating the significance of the impact of applying general technology in the service sector. Success in America has come from the way companies such as Wal-Mart have taken advantage of new technology rather than by the growth in the high-tech sector in its own right. But understanding the true drivers of US success is still not enough, according to Professor Hughes. Every country will have its own unique characteristics with specific advantages as well as disadvantages. Few people would have realised how significant India was to become in the IT services field, supported by its growing talent base of highly skilled computer engineers. But in the space of twenty years, Bangalore has become India’s Silicon Valley, producing world-class IT firms such as Infosys, TCS and Wipro. Latin America has produced innovative companies such as CEMEX which have developed new business models, unleashing greater productivity. They were shaped by the tough and volatile economic environments of their home markets. The most successful nations will be those that try to understand their own economy’s strengths and weaknesses and do what they can to encourage innovation policies shaped to their own institutional circumstances and geared to meet international competition.

Further Reading & Listening

Hughes, A. (2008) “Innovation policy as cargo cult: Myth and reality in knowledge-led productivity growth.” In Bessant, J. and Venables, T. (eds): Creating wealth from knowledge: meeting the innovation challenge. Cheltenham: Edward Elgar.

Hughes, A, and Scott Morton, M. (2006) “The transforming power of complementary assets.” MIT Sloan Management Review, 47(4)

Hughes, A. and Grinevich, V. (2007) “The contribution of services and other sectors to Australian productivity growth 1980-2004.” Sydney: Australian Business Foundation.

– Research article produced by Morice Mendoza