Assessing the Impacts of Changes in the Information Technology R&D Ecosystem: Retaining Leadership in an Increasingly Global Environment (2009)

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1 Defining the Information Technology R&D Ecosystem In this study, the term ecosystem is used in the sense first introduced by James F. Moore when he applied biological concepts to the world of business. Referring to a business ecosystem, Moore wrote that it is— an economic community supported by a foundation of interacting or- ganizations and individuals—the organisms of the business world. This economic community produces goods and services of value to custom- ers, who are themselves members of the ecosystem. The concept of a national innovation ecosystem was further devel- oped and refined by such scholars as Michael Porter and Scott Stern and, more recently, Egils Milbergs. This report focuses on the complex interre- lationships among information technology (IT) researchers and scientists (and their institutions), IT businesses (both large and small), IT custom- ers (consumers, businesses, governments), and the powerful contextual forces such as regulatory and legal environments, the supply of financial and human and intellectual capital, the economic infrastructure, and the James F. Moore, “Predators and Prey: A New Ecology of Competition,” Harvard Business Review 71(3):75-86, May/June 1993. Michael Porter and Scott Stern, The New Challenge to America’s Prosperity: Findings from the Innovation Index, Council on Competitiveness, Washington D.C., 1999. Egils Milbergs, Innovation Vital Signs—Framework Report, Center for Accelerating Innova- tion, Washington, D.C., 2007. In this report, the term information technology is used broadly to include computing and communications components, equipment, software, and services. 14 

defining the information technology R&d ecosystem 15 pressure of international competition, in the production of IT-based goods and services that create economic wealth, jobs, and societal benefits. A healthy and vibrant IT R&D ecosystem is characterized by the following: • The quality and quantity of intellectual property that it generates over time, • The economic value of the businesses that it creates, • The richness of the goods and services that it produces or enables, • The number and quality of the jobs that it creates, • Its ability to adapt to changing environmental conditions, and • Its ability to collaborate with and compete against other IT R&D ecosystems around the globe. Precise measurements along these various dimensions are not always practical or available, but a detailed examination of each reveals enough information to allow an educated opinion to be formed about the relative health of the U.S. national IT R&D ecosystem today, relative to the past, relative to other nations, and relative to this nation’s own potential. anatomy of the Ecosystem The national IT R&D ecosystem is complex, involving many actors and many types of relationships. When well tuned, it produces industry- leading innovative products and services that benefit virtually every aspect of our society and economy and generates returns that substan- tially justify the enormous financial risks incurred in the early stages of a technology cycle. To be sure, risks and returns are not evenly distributed. Some firms that incur large costs for technology and market exploration and make large investments in infrastructure will succeed (and reap large returns); others will not. Some incumbents will face dislocation costs as new entrants and new products succeed. The early to mid-1990s—the years immediately preceding the period of interest (1995 to 2007) for this report—was a time of economic expan- sion led by IT-induced productivity enhancement when the U.S. IT R&D ecosystem was broadly perceived to be very healthy and competitive. To understand how parts of this system could drift out of kilter and how these local disequilibria could impact the output of the system as a whole, one must examine the anatomy of this ecosystem in terms of some of its key elements and relationships, as shown in Figure 1.1. As Figure 1.1 shows, the ecosystem is populated with a number of actors, ranging from individuals (for example, students and ­researchers), to institutions (such as industrial and government laboratories), to 

16 Funding Performers Technology, Infrastructure Context and and Human Applications, and and Public Capital Flows Resources and Users Platforms Policy Trade Small, Medium, Broadband Large Technology Markets Mobile Financial Firms Accounting Consumer, Service, Commercial, Industrial Rules and Venture and Local, National, International Regulations Angel Capital Open Industrial and Community Government Intellectual Development Laboratories Product Development Property Industry R&D Tax Universities Technology Credits Advanced Concept Platforms Government Pensions Health Care Applied Research Research Computing Immigration and Networks Foreign Foreign K-12 Workers Students Government Basic Research and Industry Policies for Technology Applications R&D Push Pull Funding Figure 1.1  Some key elements and relationships in the U.S. information technology research and development (R&D) ecosystem. Figure 1-1.eps landscape 

defining the information technology R&d ecosystem 17 g ­ overnments. Several elements that are key to the committee’s assess- ment of the impacts of changes on the IT R&D ecosystem are described in the following section. Selected Key Elements of the ecosystem Research Universities U.S. research universities carry out the majority of the fundamental and advanced IT research work in this country. They have been and con- tinue to be one of the primary competitive assets in the IT R&D ecosystem. They attract the best research talent from around the world, including the most talented domestic and foreign students and faculty, and receive an increasing amount of attention and sponsorship from foreign firms. The largest and most significant source of research funding for research universities remains the federal government, through its key grant-mak- ing agencies (e.g., those agencies that participate in the Networking and Information Technology Research and Development program). K-12 Schools, Colleges, and Universities U.S. schools and colleges are the primary source of human resources for the nation’s research universities. The quality of middle and high school science, technology, engineering, and mathematics education is a primary determinant of the strength and motivation of the cohorts of students that will attend U.S. universities in years to come.  Innovative Start-up Firms The entrepreneurial culture that characterizes much of American heri- tage and values has found fertile ground in the field of IT. The United States is home to the largest number of and most talented IT start-up firms, concentrated primarily in clusters such as in Silicon Valley and a number of other areas. These start-up firms are a major source of innova- tion and national competitiveness in the field of IT. In recent years, firms such as Google and Facebook have risen to prominence and wield signifi- cant influence in the Internet industry. Grades 5 through 8 are crucial years for cultivating or discouraging students’ inter- est in STEM careers. Students begin losing enthusiasm for STEM fields in elementary and middle school. See, for example: J. Jovanovic and S.S. King, “Boys and Girls in the P ­ erformance-Based Science Classroom: Who’s Doing the Performing?” American Educational Research Journal 35(3):477-496, Autumn 1998; and T.A. Greenfield, “Gender, Ethnicity, Science Achievement, and Attitudes,” Journal of Research in Science Teaching 33(8):901-933, 1996. 

18 assessing the impacts of changes in the it R&D ecosystem A trend of immigrant-led high-technology entrepreneurship that was first documented for Silicon Valley has spread nationwide: for at least one-quarter of the U.S. engineering and technology companies started between 1995 and 2005, at least one of the key founders was born outside the United States. Almost 80 percent of these immigrant-founded com- panies were in two industry fields: in software and innovation and in manufacturing-related services. Medium-Size and Large Corporations Successful start-up firms can rapidly grow into medium-size and large corporations. Historically, examples of IT start-ups that have become industry leaders include Microsoft Corporation, which is a leader in per- sonal computer (PC) software; Intel Corporation, a leader in semicon- ductors; Dell, in PCs and peripherals; Cisco Systems, in networking and communications technologies; and Oracle, in database and enterprise software systems. Sometimes start-ups grow into very large companies that later on must adapt to changing markets and enter new ones. IT com- panies that have navigated this path include Hewlett-Packard ­Company, which adapted to become a leader in PC hardware, imaging, and print- ing; and International Business Machines Corporation (IBM), which now focuses on enterprise computing and services. Together, in late 2007, the firms listed in this paragraph had a market capitalization in excess of $1 trillion and employed almost 900,000 people. Note that although only a few corporations participate directly in the IT industry by producing or selling IT components or solutions, virtually every corporation today uses IT products and services to deliver its own goods and services into the marketplace and contributes its own experience and innovation to the IT industry and the ecosystem in which it participates. End Markets One of the reasons why most IT firms need to have a strong presence in the United States is that this country (still) represents the largest IT market in the world. Industry sectors such as financial services, where the United States is particularly strong, are heavily dependent on the quality and performance of their IT infrastructure and tend to be early Vivek Wadhwa, AnnaLee Saxenian, Ben Rissing, and Gary Gereffi, “America’s New Im- migrant Entrepreneurs: Part 1,” Duke Science, Innovation, and Technology Paper No. 23, January 4, 2007, available at http://ssrn.com/abstract=990152; accessed December 26, 2007. Together, the firms listed in this paragraph had 894,295 full-time employees worldwide and a total market capitalization of $1.09 trillion on September 27, 2007, according to infor- mation compiled from NASDAQ and New York Stock Exchange financial data, available at Yahoo! Financial data, http://finance.yahoo.com; accessed October 28, 2008. 

defining the information technology R&d ecosystem 19 adopters of new technologies. More recently, however, consumer markets, particularly in such segments as digital entertainment and communica- tions, have become important IT markets. As the shift in the importance of consumer markets continues, the leadership of U.S. IT end markets may be challenged because of demographic considerations—for example, there are other nations whose markets are as large as those in the United States—or because of niche specializations in certain markets as in the case of computer games produced in Korea. Private Capital Start-up companies tend to receive their initial funding from private- capital sources such as angel investors (affluent individuals who invest their own funds in start-ups) and venture capital. The U.S. venture capi- tal industry has led the world in the magnitude of the funds raised and deployed, as well as in the number of successful firms that it has enabled and the financial returns that it has generated for its investors. In recent years, private equity firms have become more prominent in acquiring and recapitalizing medium-size and large IT corporations. These new owners have a natural focus on economic returns rather than on long- standing ties to particular sets of employees or certain locations. Thus, the increased prominence of private equity capital may tend to increase the movement of IT jobs and capabilities overseas, at least in the short term, in order to increase profits, reduce costs, or seek additional markets. A recent empirical study prepared by the World Economic Forum on the impact of private equity investment on the behaviors of firms post-transaction considered such factors as the impact on investment in innovation and employment. It found that firms that undergo a buyout pursue inventions that are more economically important (as measured by patent citations). Increased patent citation rates indicate that inno- vation becomes more targeted post-buyout and that patent portfolios become more focused on core technologies. The same study found that the observed impact of private equity on employment was mixed, but pri- vate equity was seen to speed up the pace of acquisitions and divestitures: “private equity groups act as catalysts for change in the economy.”  Josh Lerner and Anuradha Gurung, “Executive Summary,” The Global Economic ­ Impact of Private Equity Report 2008, World Economic Forum, p. xi; available at http://www. weforum.org/pdf/cgi/pe/Executive_Summary.pdf; accessed April 16, 2008. Companies tended to have workforce cuts in the years immediately before and after a buyout trans- action, as well as adding some new jobs afterward, for a net decrease overall. The study did not look at jobs created in or transferred to other countries. The entire report is avail- able at http://www.weforum.org/en/media/Latest%20Press%20Releases/PrivateEquity_ P ­ ressRelease; ­accessed April 16, 2008. 

20 assessing the impacts of changes in the it R&D ecosystem Public Capital The traditional and ideal trajectory of a successful IT start-up firm includes the milestone of a public stock offering along the way. The U.S. stock markets have attracted the largest numbers of IT start-up initial public offerings. The liquidity and vitality of U.S. markets have helped fast-growing IT firms gain access to the financial capital that they require to fund their growth. In recent years, other markets have developed that offer access to public capital (both debt and equity) on competitive terms, in both Europe and Asia. These markets have improved, but they are not yet comparable to the NASDAQ (National Association of Securities Deal- ers Automated Quotations) in depth, breadth, or quality. Regulatory and Legislative Bodies The U.S. regulatory and legislative environments have a significant influence on the quality and transparency that IT firms demonstrate, as well as on the administrative overhead and other sources of friction that they must deal with in their operations. Enlightened regulations and laws can be a major source of national competitive advantage when their rigor supports the quality of the market and provides a stable rule of law for contracts and investments. Conversely, the U.S. IT R&D ecosystem can be hampered by regulations and laws that have not kept pace with tech- nological advances or whose benefits do not outweigh the costs. There is a balance to be struck between disclosure, honesty, and transparency that can increase investor confidence on the one hand and, on the other, regulatory burdens that can retard markets and chill the flow of capital to worthy firms. Global Context The U.S. IT R&D ecosystem has been materially transformed in recent years by globalization. Markets, financial flows, access to human resources, and intellectual property are now global phenomena. As a result, an assessment of the U.S. IT R&D ecosystem and measures taken to strengthen it must reflect the ecosystem’s interactions with those of other nations. Relationships and Interactions among major actors in the ecosystem The complexity of the U.S. IT R&D ecosystem precludes exhaustively enumerating (or drawing) the relationships and interactions among the 

defining the information technology R&d ecosystem 21 major actors shown in Figure 1.1. The most important of these for the purposes of this study are the following: • A large fraction of the graduate students recruited and graduated by U.S. research universities come from overseas. • The funding for IT research in U.S. research universities comes pri- marily from the federal government and secondarily from private sources, of which foreign corporations represent a small but growing percentage. • IT companies (small, medium-size, and large) must access global markets to design, manufacture, and sell their products and services. A growing percentage of employment in IT research and development is overseas for a variety of reasons, including market access, access to ­cutting- edge knowledge and consumers, and lower-cost trained personnel. • The creation of intellectual property in the field—whether formally protected or not—is the primary basis on which IT firms get started and continue to grow and compete over time. The flow of entrepreneurial tal- ent out of universities into young start-up firms is particularly vital in the U.S. IT R&D ecosystem. The collaboration between U.S. universities and small, medium-size, and large IT firms enables the rapid productization and commercialization of the most promising discoveries. It is critical that the ability to connect intellectual property to markets be kept vibrant and efficient. • Access to financial capital at different stages of growth is one of the important characteristics of the U.S. market that has made it competitive since the dawn of the IT industry. These various capital flows are now far more complex and far more global. These topics are discussed in the following chapters.