Vision on Innovation: 1. European innovation performance

European innovation policies: Paralysis by analysis ?

The topic of innovation and entrepreneurship has become a main theme of political debate in Europe. In March 2000, the European Council Union leaders, assembled in Lisbon, agreed that the Union must become the most competitive and dynamic knowledge-based economy in the world capable of sustainable economic growth with more and better jobs and greater social cohesion. Innovation is seen as the cornerstone of the so-called Lisbon Strategy, alongside social and environmental policies that ensure sustainable development and social inclusion.

Half of the 10 years reform period has passed and the EU is clearly far from being on track. The burst of the bubble and the strong economic recession thereafter hit the EU hard and its economic performance has been significantly below that of the other major economies in the world, the US, China and India in particular. A mid-term review of the Lisbon strategy took place in 2004 leading up to the re-launch of the Lisbon reforms from March 2005 onwards. The new approach emphasizes the responsibility of the member countries through national reform programs (NRPs), to be reviewed by the EU on an annual basis and puts more focus on economic growth and employment and less on social and environmental aspects. Many of the national governments have pushed the responsibility further down to local regions and cities.

The ambitions of the Lisbon reform program are bold and point in the right direction, but how can they be achieved ? Can innovation be steered from the top ? What levers do governments have to increase innovation performance ? What role should knowledge institutes, multi-nationals, small and medium enterprises, venture capitalists and entrepreneurs play and how should they work together ? What can and should be done at the EU level, the national level and the regional and city level ? How do we measure progress ? How do we get the biggest bang for the buck ? These and other questions have triggered a significant amount of analysis; the formation of many steering committees, review- and monitoring organizations; keep a sizeable group of policy makers fairly busy and provides a decent income for many consultants. We have worked our way through many of the available academic studies, consultant's reports, committee recommendations and policy documents. To be honest, we found it difficult to see the wood from the trees and to understand how it all comes together to realize the rightful ambitions of the Lisbon strategy.

Is there a better alternative ?

Rather than just criticizing the current approach on innovation governance, we have asked ourselves: "What would we do if we would in charge". We have therefore started to construct a high level, coherent and actionable vision on innovation and its relation to economic performance. We have reviewed some of the leading theories on the dynamics of innovation; studied the success stories of some of the most successful companies in the ICT and media industry and combined that information with our own experience as strategic marketers, business developers and entrepreneurs. This lead us to the formulation of some key hypotheses which form the core of our story and are subject to further verification (or falsification) and refinement. Our story is structured in five sections. Section 1 (this page below) starts out with a definition of the term innovation and from there on explores how economists attempt to measure the drivers of innovation (input) and its results (output). We believe that perhaps the most significant long-term indicator for innovation is the public stock market and provide an alternative indicator on that basis. From that indicator we conclude that the US has been outperforming Europe significantly for many decades on the creation of extremely successful fast growing companies. Section 2 reviews some of the academic literature on the dynamics of major technology innovations. It serves to understand how fast growing companies are formed and to explore the interdependence of successful companies and the economic factor conditions of regions and nations. In Section 3 we state our hypothesis why the US has been outperforming Europe in the creation of fast growing companies, thereby focusing on the ICT and media industry. We discuss in Section 4 what instruments governments have to stimulate innovation and suggest a decision making process to further improve the effectiveness, efficiency and consistency of innovation policies. Section 5 summarizes the main findings of our analysis and concludes with a concrete and specific proposal for the Dutch government to implement a public/private funded innovation system that will support high-ambition entrepreneurs to build the fast growing companies that we need to boost economic performance and create new jobs.

What is innovation ?

Innovation is the exploitation of ideas or technologies to create new or radically changed products or services that match market needs: The term innovation is often used as an abstract "container concept", quite comparable to the term "quality" that became popular in the eighties, without bothering to define it. However, a fairly significant body of academic literature exists on the definition and classification of innovation, as well as it sources. We have settled for the definition given above, which stresses the source of innovation (ideas or technologies), its result (new or radically changed products or services) and states a limiting condition to qualify as an innovation (that the result matches market needs). For example, a nuclear-powered vacuum cleaner (as proposed by Lewyt Corporation in 1955) may be a new product, exploit new ideas and technologies, but would not qualify as an innovation because no consumer is likely to buy such an hazardous device. The term "changed" in our definition may pertain to the functional attributes of a product or service or its price. Changes in marketing, distribution, organization, processes or supply chain would qualify as an innovation under our definition if they yield a radically changed proposition or improved price/performance ratio that is valued by the market. The term "radically" excludes minor product and services upgrades from being innovations.

How can we measure innovation and what does that tell us ?

The performance of different countries on innovation and entrepreneurship is usually monitored by multi-indicator scoreboards like the ones provided by the European Innovation Scoreboard (EIS), the Global Entrepreneurship Monitor (GEM) and the OECD, but we believe that perhaps the most significant long-term indicator for innovation is the public stock market: The European Innovation Scoreboard (EIS) provides a good example of how economists attempt to measure the innovation performance through a system of indicators for both the drivers (input) and the results (output) of innovation. The EIS is the instrument developed by the European Commission, under the Lisbon Strategy, to evaluate and compare the innovation performance of the Member States. The EIS 2005 includes innovation indicators and trend analyses for all 25 EU Member States, as well as for Bulgaria, Romania, Turkey, Iceland, Norway, Switzerland, the US and Japan. A list of 26 indicators grouped in 5 categories (innovation drivers, knowledge creation, Innovation & entrepreneurship, application and Intellectual property) is evaluated for each country and aggregated into a single indicator by country, the Summary Innovation Index (SII). The figure below compares the EIS 2005 scores of the Netherlands, the US and Japan on the individual indicators relative to the corresponding EU averages (where we omitted those indicators for which the data was incomplete, thereby retaining 16 out of the 26 indicators).

The insights that can be obtained from such indicators are, for instance, that The Netherlands scores below average on Science and Engineering (S&E) graduates, business R&D expenditures and employment in media-high and high-tech manufacturing and scores above average on broadband penetration (the highest in Europe), population with tertiary education, as well as on patents & trademarks (which possibly says more about the many companies that maintain headquarters in The Netherlands and file for patents than the strength of the local research base).

To measure is to know ("meten is weten" in Dutch), we believe in support of this approach, but what exactly do we know from these measurements and what do they tell us about the actions to be taken in order to improve the innovation performance of a nation ?; What governments typically try to do is to to correct the low scores. In the Dutch case this leads to policy measures to promote beta-studies, make R&D fiscally more attractive for businesses and stimulate the knowledge transfer from scientific institutes to companies through innovation vouchers and the like. Is that all there is to innovation governance, we wonder ? How do we know that we are addressing the root cause this way and not just fighting symptoms ?

We took an alternative approach and used the publicly available stock market data to obtain an indicator for the long-term innovation performance by country. We started with the STOXX 1800 index , representing the 1800 largest companies in the world in terms of market capitalization, and sorted the companies by founding year and country of origin. By country we evaluated the total current market capitalization of all companies that were founded prior to a certain year. The figure below shows the result for the Dutch STOXX 1800 companies (29) and the US based STOXX 1800 (558) companies relative to the total current market capitalization. The market capitalization was evaluated on the basis of the end-of-day stock price of 17 March 2005.

This data shows that only 5% of the market capitalization of the Dutch companies on the STOXX 1800 index comes from companies founded after WWII and similar data is obtained for other European countries. The corresponding figure for the US is 33%. The inevitable conclusion, we believe, is that Europe in comparison to the US has been heavily under performing for decades in the creation of extremely successful fast growing companies: Where are the European equivalents of companies like Wall-Mart, Tyco, Merill Lynch, Intel, Federal Express, Comcast, Microsoft, Apple, Home Depot, Oracle, SBC, Dell, Cisco, Qualcomm, Yahoo!, Amazon, eBay and Google to name just a few of the post world-war II US giants. Yes we have Nokia and SAP, but what else ?

One may argue that the indicator fails to account for innovation within old companies, e.g. the creation of fast growing new business units. However, if we take The Netherlands again as an example, we conclude that the established Dutch companies have been relatively unsuccessful in capitalizing on new market opportunities as well, e.g.: Philips (1891) with a market capitalization of € 27 billion is placed on position 111 of the STOXX 1800. Intel (1968) is 4 x bigger than Philips, Microsoft (1975) 7 x, Dell (1984) 3 x (again based on the end-of-day stock price of 17 March 2005). A fair comparison should account for the market capitalization of Philips spin-offs like ASML (with a market capitalization of € 8 billion) and Polygram. Indeed, the analysis could be refined, but it would not change the general picture.

We believe that the observation that Europe in comparison to the US has, for many decades, been significantly less successful in capitalizing on new market opportunities, in general, and the formation of large new enterprises, in particular, should be central to the debate on innovation. Many policy documents, consultant's reports and special task force recommendations have appeared over the last couple of years in relation to the Lisbon reform program, but, to the best of our knowledge, the key observation made above on the basis of public stock market data, has not been generally recognized and addressed. The importance of fast growing new companies for the creation of jobs and GDP growth, obviously, has been recognized, but Europe's significance under performance to create such companies has not been a main theme in the debate so-far. We believe it is pivotal to the European innovation policy to gain a better understanding why European has been under performing so significantly along this dimension and what needs to be done to reverse the trend.