New rules for global component sourcing: the quality imperative in electronics, Economist Intelligence Unit, 2004, London, New York, Hong Kong.
Global sourcing is becoming more complex, moving from a tactical task to a strategic one for large electronics manufacturers. It provides flexibility and cost advantages, but as it gets more complex, other factors come into play as well. As the level of complexity rises, firms must share more information with their suppliers and manage them more closely.
Some interesting results from the EIU's survey of 70 senior exeutives in the electronics industry:
Price isn't the only factor anymore. The top 2 most important business benefits of respondents' sourcing initiatives remain reduced labor costs (40%) and reduced direct materials costs (56%). However, the third most important is "access to unique materials, services or R&D assets" (37%).
40% of respondents named "mitigating risks involved with long-distance business relation ships and multiple hand-offs" as one of their top 3 biggest risk management issues in developing a global sourcing initiative -- outweighed only by (1) responsiveness toward variations in demand and (2) ensuring that total acquisition costs (materials, logistics, customs) do not erode the net benefits promised by the initial purchase cost. By contrast, "cross-cultural communication in both negotiation and execution" was mentioned least (26%).
Showing posts with label globalization. Show all posts
Showing posts with label globalization. Show all posts
Monday
Global R & D
Harnessing innovation: R&D in a global growth economy, Economist Intelligence Unit, 2004
The Economist Intelligence Unit has published a new white paper: Harnessing Innovation. It is based on an online survey and in-depth interviews with companies such as Agilent, IBM, AMD Siemens, BMW and Nokia.
From the results:
Market- and customer-driven innovation has moved from buzz-word to reality, although keeping customers focused on innovation projects is a significant challenge once initial enthusiasm has ebbed.
The survey clearly indicates that R&D is high up the hierarchy of corporate priorities — asked to identify their overall strategic priorities, respondents put product development third, just behind cost-cutting and strengthening customer relationships. But the emphasis rests heavily on the D(evelopment)part of the equation. Market pressures to keep up with competitors’ innovations and to satisfy more demanding customers are the two top drivers of R&D activity, according to survey respondents. In this environment, anything companies can do to reduce the odds of failure as they embark on new research projects is critical.
A more market-oriented approach to R&D is driving R&D leaders to work more closely with customers as they develop new products and services. But there are challenges in this approach. While collaboration is key for creating demand-driven innovations, survey participants also noted that maintaining customer involvement ranked as one of the leading roadblocks to successful R&D projects. This evolving innovation landscape promises a more effective R&D process, one that sharpens the decision-making process as firms choose where to allocate their R&D spend and that increases the chances of launching commercially viable new products. It may also encourage an even more pronounced division of labour in the world of research, with governments, universities and start-up companies focusing on “blue-sky” research projects and companies working on more incremental development activities.
R&D has gone global with many firms distributing their R&D centers around the world. This is driven by quality and time-to-market factors rather than just cost-cutting. In some cases research is still centralized and locations further afield focus on development and process innovation.
Competition for talent, new technologies and easier market access have accelerated the process of R&D globalisation, with countries such as India and China hosting significant volumes of R&D activity for multinationals. Cost is a driver of globalisation too, but its significance can be overplayed as far as R&D goes. Once infrastructure and coordination costs for managing distributed R&D facilities are included, the total savings are not as huge as popular headlines suggest. Speed of development is a more important benefit of the global research economy.
The survey finds organizational problems to be the single greatest challenge for R&D efforts. It is therefore especially interesting to note the different models implemented by firms that distribute R&D activities globally.
If you have research and development activities in time zones around the world,how do you coordinate that activity?
The report provides very little information on how global R&D management is implemented, although the challenges are certainly highlighted.
Although there are clear economic reasons for locating certain R&D work in lower-cost countries, relocating R&D resources solely because of labour costs is a losing proposition. “There is no such thing as low-cost intellectual property”, declares IBM’s Dr Horn. Aside from the travel, coordination and communications expense, the labour rate itself is climbing as recipient countries become more sophisticated economies. The current rule of thumb among India’s IT professionals is to expect a 15% pay rise every year. Such narrowing becomes even more pronounced once top management cost is included.
More important to the globalisation trend is the ability to innovate around the clock. But it is no small task to manage this process. According to Fred Weber, chief technology officer for AMD, a leading semiconductor manufacturer, companies must avoid the pitfalls of compartmentalisation. “Whenever possible, we try to ensure that a remote site does not build up its own little fiefdom of products that it is making. Rather we aim to develop an integrated global engineering force. So we might split projects across multiple locations.”
AMD ’s latest Opteron processor resulted from teams working simultaneously in Texas, California, Singapore and Dresden in Germany, for example. But the challenges posed by this structure can be formidable, acknowledges Mr Weber. “When you see somebody everyday and you have lunch with them, you understand them a lot better than when you talk on the phone to them once a week and see them once a year.” Cultural differences further exacerbate this lack of face-to-face contact.
The Economist Intelligence Unit has published a new white paper: Harnessing Innovation. It is based on an online survey and in-depth interviews with companies such as Agilent, IBM, AMD Siemens, BMW and Nokia.
From the results:
Market- and customer-driven innovation has moved from buzz-word to reality, although keeping customers focused on innovation projects is a significant challenge once initial enthusiasm has ebbed.
The survey clearly indicates that R&D is high up the hierarchy of corporate priorities — asked to identify their overall strategic priorities, respondents put product development third, just behind cost-cutting and strengthening customer relationships. But the emphasis rests heavily on the D(evelopment)part of the equation. Market pressures to keep up with competitors’ innovations and to satisfy more demanding customers are the two top drivers of R&D activity, according to survey respondents. In this environment, anything companies can do to reduce the odds of failure as they embark on new research projects is critical.
A more market-oriented approach to R&D is driving R&D leaders to work more closely with customers as they develop new products and services. But there are challenges in this approach. While collaboration is key for creating demand-driven innovations, survey participants also noted that maintaining customer involvement ranked as one of the leading roadblocks to successful R&D projects. This evolving innovation landscape promises a more effective R&D process, one that sharpens the decision-making process as firms choose where to allocate their R&D spend and that increases the chances of launching commercially viable new products. It may also encourage an even more pronounced division of labour in the world of research, with governments, universities and start-up companies focusing on “blue-sky” research projects and companies working on more incremental development activities.
R&D has gone global with many firms distributing their R&D centers around the world. This is driven by quality and time-to-market factors rather than just cost-cutting. In some cases research is still centralized and locations further afield focus on development and process innovation.
Competition for talent, new technologies and easier market access have accelerated the process of R&D globalisation, with countries such as India and China hosting significant volumes of R&D activity for multinationals. Cost is a driver of globalisation too, but its significance can be overplayed as far as R&D goes. Once infrastructure and coordination costs for managing distributed R&D facilities are included, the total savings are not as huge as popular headlines suggest. Speed of development is a more important benefit of the global research economy.
The survey finds organizational problems to be the single greatest challenge for R&D efforts. It is therefore especially interesting to note the different models implemented by firms that distribute R&D activities globally.
If you have research and development activities in time zones around the world,how do you coordinate that activity?
30% Research and development is coordinated on a regional basis (eg,EMEA,the Americas)
30% Research and development is managed globally,with round-the-clock teams who work consecutively on the same projects
25% Research and development is carried out separately in each country
16% Other
The report provides very little information on how global R&D management is implemented, although the challenges are certainly highlighted.
Although there are clear economic reasons for locating certain R&D work in lower-cost countries, relocating R&D resources solely because of labour costs is a losing proposition. “There is no such thing as low-cost intellectual property”, declares IBM’s Dr Horn. Aside from the travel, coordination and communications expense, the labour rate itself is climbing as recipient countries become more sophisticated economies. The current rule of thumb among India’s IT professionals is to expect a 15% pay rise every year. Such narrowing becomes even more pronounced once top management cost is included.
More important to the globalisation trend is the ability to innovate around the clock. But it is no small task to manage this process. According to Fred Weber, chief technology officer for AMD, a leading semiconductor manufacturer, companies must avoid the pitfalls of compartmentalisation. “Whenever possible, we try to ensure that a remote site does not build up its own little fiefdom of products that it is making. Rather we aim to develop an integrated global engineering force. So we might split projects across multiple locations.”
AMD ’s latest Opteron processor resulted from teams working simultaneously in Texas, California, Singapore and Dresden in Germany, for example. But the challenges posed by this structure can be formidable, acknowledges Mr Weber. “When you see somebody everyday and you have lunch with them, you understand them a lot better than when you talk on the phone to them once a week and see them once a year.” Cultural differences further exacerbate this lack of face-to-face contact.
Tuesday
The locus of globalization
Global networks - Linked cities (Introduction), Saskia Sassen, 2002
Saskia Sassen has been following global capital markets for years. In the introduction of this edited volume, she uses capital markets to explain the strange relationship between economic globalization and geography. While Sassen focuses on global cities (New York, London, Hong Kong, Tokyo, and more recently Sao Paolo, Mexico City, Johannesburg, Bombay, Shanghai, etc.), many of her insights are applicable to specialized clusters. Since much of her analysis is based on the finance industry, the leap to apply it to other information-based industries is not very large. Of course, her aim is a different one than mine. In the larger argument on globalization, financial markets are probably a better indicator of the global economy than the new technologies I'm looking at.
By analogy, her comments on the relationships between global cities is also much-welcome support for my proposition that we are seeing a network of cooperating and competing hi-tech clusters emerge. As Sassen sees it, such a network of global cities already exists.
There is a growing number of transnational actors: not only MNCs, but also NGOs, government regulators, professional associations, mayors etc. As the nation state loses power (e.g. by giving up state monopolies), other geographic entities gain: cities, regions, cross-border regions, and supranational entities (e.g. the EU). Add to this the existence of new 'virtual spaces' and the picture can easily become confusing. On the one hand, cities and regional economies are becoming more important, agglomeration economies are increasingly powerful. On the other hand, ICTs allow a dispersion of information, capital, and thereby business. According to Sassen, these two trends are not wholly contradictory, and 'global cities' are the links between national economies and global circuits.
Cities provide the pronounced territorial concentrations of resources necessary for the management and servicing of more dispersed and mobile resources. By doing so, they reinforce the global influence and the global links of their respective cities - strengthen their position in the global economy. While they therefore remain dependent on their surrounding regions, these cities become a part of the global center: the network of global cities.
The geography of globalization contains dynamics of both dispersal and centralization. The massive trends toward the spatial dispersal of economic activities at the metropolitan, national, and global levels that we associate with globalization have contributed to a demand for new forms of territorial centralization of top-level management and control functions. Insofar as these functions benefit from agglomeration economies even in the face of telematic integration of a firm's globally dispersed manufacturing and service operations, they tend to locate in cities. An important reason why they might benefit from agglomeration economies lies in the presence of business networks.
By central functions I do not only mean headquarters functions; I am referring to all the top-level functions necessary to run a corporate organization operating in multiple countries. These central functions are partly embedded in headquarters, but also in good part in what has been called the corporate services complex, that is, the network of financial, legal, accounting, and advertising firms that handle the complexities of operating in more than one national legal system, national accounting system, advertising culture, and so forth and do so under conditions of rapid innovations in all these fields. Such services have become so specialized and complex that headquarters increasingly buy them from specialized firms rather than produce them in-house. These agglomerations of firms producing central functions for the management and coordination of global economic systems are disproportionately concentrated in an expanding network of global cities. This network represents a strategic factor in the organization of the global economy.
Further, leading firms in information industries require a vast physical infrastructure containing strategic nodes with hyperconcentration of facilities; we need to distinguish between the capacity for global transmission/communication and the material conditions that make this possible.
Sassen goes on to explore the new economic geography that combines agglomerations and global dispersal.
This type of analysis of globalization, which seeks to map the strategic sites with hyperconcentration of resources as well as the cross-border networks that link these sites and others, helps us understand to what extent there is a specific geography of globalization and the fact that it is not a planetary event encompassing all of the world. It is, furthermore, a changing geography, one that has undergone multiple, often specialized transformations over the last few centuries and over the last two decades, and most recently has come to include electronic space.
Today, partly as a result of the new technologies, the spatial correlates of the center can assume several geographic forms, ranging from the CBD (central business district) to a new global grid of cities. Simplifying one could identify three forms of centrality today.
First, while there is no longer a direct relation between centrality and geographic entities such as the downtown, the CBD remains a key form of centrality. But the CBD in major international business centers is one profoundly reconfigured by technological and economic change. ...
Second, the center can extend into a metropolitan area in the form of a grid of nodes of intense business activity. ... Insofar as these various nodes are articulated through cyberroutes or digital highways, they form a grid that is a geographic correlate of the most advanced type of "center." The places that fall outside this new grid of digital highways, however, are peripheralized. This grid of nodes represents, in my analysis a reconstitution of the concept of region. Far from neutralizing geography, the grid is likely to be embedded in conventional forms of transport infrastructure, notably rapid rail and highways connecting to airports. ... (Compare this to the Silicon Valley notion that the diameter of the cluster is defined by a 2-hour drive.)
Third, we are seeing the formation of a transterritorial "center" constituted via telematics and intense economic transactions. It consists of the multiple and diversifying inter-city links that take place partly in electronic markets and transactions and partly through the intensifying circulation of goods, information, firms, and workers. In this regard this is both a territorialized and deterritorialized space of centrality. It requires both a specific logic for territorial development and the infrastructure for global networking technologies.
The relationship of cities within this last transterritorial center sounds much like that of organizations within a conventional agglomeration economy.
The global integration of markets make many ... activities redundant and makes collaboration a far more complex matter, one that has the effect of sharpening the division of labor within the network. Beyond the necessary range of specialized services present in all these centers, we now also see a trend toward the formation of specialized capabilities that partially differentiate centers and simultaneously integrate them into a larger global network. This configuration also promotes the formation of strategic alliances. ...
In my reading the globally integrated financial system is not only about competition among countries as is typically assumed. The trend is toward an increase in specialized collaborative efforts among these centers. Further, insofar as markets are integrated, growth overall is maximized through growth in all centers.
But why have financial centers at all? It comes back to well-known arguments about social networks and interpretation vs/ information.
The continuing weight of major centers is, in a way, countersensical, as is, for that matter, the existence of an expanding network of financial centers. The rapid development of electronic exchanges the growing digitization of much financial activity, and the fact that finance produces a dematerialized and hypermobile product, all suggest that location should not matter.
3 reasons that explain the trend toward consolidation in a few centers rather than massive dispersal:
a) The importance of social connectivity and central functions.
First, while ICTs do indeed enable geographic dispersal of economic activities without losing system integration, they have also had the effect of strengthening the importance of central coordination and control functions for firms and even for markets. ...
One fact that has become increasingly evident is that to maximize the benefits of ICTs firms need not only the infrastructure but a complex mix of other resources. Most of the value added that these technologies can produce for advanced service firms lies in so-called externalities - material and human resources such as state-of-the-art office buildings, top talent, and the social networking infrastructure that maximizes connectivity. ...
A second fact that is emerging with greater clarity concerns the nature of "information." There are two types of information. One is the datum, which may be complex yet is standard knowledge: the level at which a stock market closes, a privatization of a public utility, the bankruptcy of a bank. But there is a far more difficult type of "information," akin to and interpretation/evaluation/judgment. ... Access to the first kind of information is now global and immediate ... But the second type of information requires a complicated mixture of elements, which we could think of as the social infrastructure for global connectivity. It is these specialized kinds of social connectivity that give major financial centers a leading edge. ...
b) Cross-border mergers and alliances.
Global firms in the financial industry need enormous resources, which is leading to rapid mergers and acquisitions of firms and strategic alliances among markets in different countries. ...
I would argue that another kind of "merger" is the consolidation of electronic networks that connect a very select number of markets. In the late 1990s several financial exchanges sought to form highly integrated alliances. ...
What we are seeing now is a ... pattern whereby the cooperation or division of functions is somewhat institutionalized: strategic alliances not only between firms across borders but also between markets. There is competition, strategic collaboration, and hierarchy.
c)Denationalized elites and agendas. ...
Major international business centers produce what we can think of as a new subculture, a move from the "national" version of international activities to the "global" version. ... I would posit that major cities, and the variety of so-called global business meetings (such as those of the World Economic Forum in Davos and other similar occasions), contribute to denationalize corporate elites.
Essentially: The global economy and the people that are more part of it than of their national/regional economies still need a place or home. Global cities provide it.
Some numbers on the global economy:
By 1999 companies had well over half a million affiliates outside their home countries accounting for U.S. $11 trillion in sales, a very significant figure if we consider that global trade stood at U.S. $8 trillion.
The orders of magnitude of cross-border financial transactions have risen sharply, as illustrated by the 1999 U.S. $68 trillion in the value of internationally traded derivatives, a major component of the global economy.
Saskia Sassen has been following global capital markets for years. In the introduction of this edited volume, she uses capital markets to explain the strange relationship between economic globalization and geography. While Sassen focuses on global cities (New York, London, Hong Kong, Tokyo, and more recently Sao Paolo, Mexico City, Johannesburg, Bombay, Shanghai, etc.), many of her insights are applicable to specialized clusters. Since much of her analysis is based on the finance industry, the leap to apply it to other information-based industries is not very large. Of course, her aim is a different one than mine. In the larger argument on globalization, financial markets are probably a better indicator of the global economy than the new technologies I'm looking at.
By analogy, her comments on the relationships between global cities is also much-welcome support for my proposition that we are seeing a network of cooperating and competing hi-tech clusters emerge. As Sassen sees it, such a network of global cities already exists.
There is a growing number of transnational actors: not only MNCs, but also NGOs, government regulators, professional associations, mayors etc. As the nation state loses power (e.g. by giving up state monopolies), other geographic entities gain: cities, regions, cross-border regions, and supranational entities (e.g. the EU). Add to this the existence of new 'virtual spaces' and the picture can easily become confusing. On the one hand, cities and regional economies are becoming more important, agglomeration economies are increasingly powerful. On the other hand, ICTs allow a dispersion of information, capital, and thereby business. According to Sassen, these two trends are not wholly contradictory, and 'global cities' are the links between national economies and global circuits.
Cities provide the pronounced territorial concentrations of resources necessary for the management and servicing of more dispersed and mobile resources. By doing so, they reinforce the global influence and the global links of their respective cities - strengthen their position in the global economy. While they therefore remain dependent on their surrounding regions, these cities become a part of the global center: the network of global cities.
The geography of globalization contains dynamics of both dispersal and centralization. The massive trends toward the spatial dispersal of economic activities at the metropolitan, national, and global levels that we associate with globalization have contributed to a demand for new forms of territorial centralization of top-level management and control functions. Insofar as these functions benefit from agglomeration economies even in the face of telematic integration of a firm's globally dispersed manufacturing and service operations, they tend to locate in cities. An important reason why they might benefit from agglomeration economies lies in the presence of business networks.
By central functions I do not only mean headquarters functions; I am referring to all the top-level functions necessary to run a corporate organization operating in multiple countries. These central functions are partly embedded in headquarters, but also in good part in what has been called the corporate services complex, that is, the network of financial, legal, accounting, and advertising firms that handle the complexities of operating in more than one national legal system, national accounting system, advertising culture, and so forth and do so under conditions of rapid innovations in all these fields. Such services have become so specialized and complex that headquarters increasingly buy them from specialized firms rather than produce them in-house. These agglomerations of firms producing central functions for the management and coordination of global economic systems are disproportionately concentrated in an expanding network of global cities. This network represents a strategic factor in the organization of the global economy.
Further, leading firms in information industries require a vast physical infrastructure containing strategic nodes with hyperconcentration of facilities; we need to distinguish between the capacity for global transmission/communication and the material conditions that make this possible.
Sassen goes on to explore the new economic geography that combines agglomerations and global dispersal.
This type of analysis of globalization, which seeks to map the strategic sites with hyperconcentration of resources as well as the cross-border networks that link these sites and others, helps us understand to what extent there is a specific geography of globalization and the fact that it is not a planetary event encompassing all of the world. It is, furthermore, a changing geography, one that has undergone multiple, often specialized transformations over the last few centuries and over the last two decades, and most recently has come to include electronic space.
Today, partly as a result of the new technologies, the spatial correlates of the center can assume several geographic forms, ranging from the CBD (central business district) to a new global grid of cities. Simplifying one could identify three forms of centrality today.
First, while there is no longer a direct relation between centrality and geographic entities such as the downtown, the CBD remains a key form of centrality. But the CBD in major international business centers is one profoundly reconfigured by technological and economic change. ...
Second, the center can extend into a metropolitan area in the form of a grid of nodes of intense business activity. ... Insofar as these various nodes are articulated through cyberroutes or digital highways, they form a grid that is a geographic correlate of the most advanced type of "center." The places that fall outside this new grid of digital highways, however, are peripheralized. This grid of nodes represents, in my analysis a reconstitution of the concept of region. Far from neutralizing geography, the grid is likely to be embedded in conventional forms of transport infrastructure, notably rapid rail and highways connecting to airports. ... (Compare this to the Silicon Valley notion that the diameter of the cluster is defined by a 2-hour drive.)
Third, we are seeing the formation of a transterritorial "center" constituted via telematics and intense economic transactions. It consists of the multiple and diversifying inter-city links that take place partly in electronic markets and transactions and partly through the intensifying circulation of goods, information, firms, and workers. In this regard this is both a territorialized and deterritorialized space of centrality. It requires both a specific logic for territorial development and the infrastructure for global networking technologies.
The relationship of cities within this last transterritorial center sounds much like that of organizations within a conventional agglomeration economy.
The global integration of markets make many ... activities redundant and makes collaboration a far more complex matter, one that has the effect of sharpening the division of labor within the network. Beyond the necessary range of specialized services present in all these centers, we now also see a trend toward the formation of specialized capabilities that partially differentiate centers and simultaneously integrate them into a larger global network. This configuration also promotes the formation of strategic alliances. ...
In my reading the globally integrated financial system is not only about competition among countries as is typically assumed. The trend is toward an increase in specialized collaborative efforts among these centers. Further, insofar as markets are integrated, growth overall is maximized through growth in all centers.
But why have financial centers at all? It comes back to well-known arguments about social networks and interpretation vs/ information.
The continuing weight of major centers is, in a way, countersensical, as is, for that matter, the existence of an expanding network of financial centers. The rapid development of electronic exchanges the growing digitization of much financial activity, and the fact that finance produces a dematerialized and hypermobile product, all suggest that location should not matter.
3 reasons that explain the trend toward consolidation in a few centers rather than massive dispersal:
a) The importance of social connectivity and central functions.
First, while ICTs do indeed enable geographic dispersal of economic activities without losing system integration, they have also had the effect of strengthening the importance of central coordination and control functions for firms and even for markets. ...
One fact that has become increasingly evident is that to maximize the benefits of ICTs firms need not only the infrastructure but a complex mix of other resources. Most of the value added that these technologies can produce for advanced service firms lies in so-called externalities - material and human resources such as state-of-the-art office buildings, top talent, and the social networking infrastructure that maximizes connectivity. ...
A second fact that is emerging with greater clarity concerns the nature of "information." There are two types of information. One is the datum, which may be complex yet is standard knowledge: the level at which a stock market closes, a privatization of a public utility, the bankruptcy of a bank. But there is a far more difficult type of "information," akin to and interpretation/evaluation/judgment. ... Access to the first kind of information is now global and immediate ... But the second type of information requires a complicated mixture of elements, which we could think of as the social infrastructure for global connectivity. It is these specialized kinds of social connectivity that give major financial centers a leading edge. ...
b) Cross-border mergers and alliances.
Global firms in the financial industry need enormous resources, which is leading to rapid mergers and acquisitions of firms and strategic alliances among markets in different countries. ...
I would argue that another kind of "merger" is the consolidation of electronic networks that connect a very select number of markets. In the late 1990s several financial exchanges sought to form highly integrated alliances. ...
What we are seeing now is a ... pattern whereby the cooperation or division of functions is somewhat institutionalized: strategic alliances not only between firms across borders but also between markets. There is competition, strategic collaboration, and hierarchy.
c)Denationalized elites and agendas. ...
Major international business centers produce what we can think of as a new subculture, a move from the "national" version of international activities to the "global" version. ... I would posit that major cities, and the variety of so-called global business meetings (such as those of the World Economic Forum in Davos and other similar occasions), contribute to denationalize corporate elites.
Essentially: The global economy and the people that are more part of it than of their national/regional economies still need a place or home. Global cities provide it.
Some numbers on the global economy:
By 1999 companies had well over half a million affiliates outside their home countries accounting for U.S. $11 trillion in sales, a very significant figure if we consider that global trade stood at U.S. $8 trillion.
The orders of magnitude of cross-border financial transactions have risen sharply, as illustrated by the 1999 U.S. $68 trillion in the value of internationally traded derivatives, a major component of the global economy.
Monday
The cost of losing R&D
The Economist carried a comparison of US and European pharmaceuticals industries (based on a Bain study) a while back. In their analysis, they debunk the idea that Europe is benefiting from a free ride. Government pricing regimes may be keeping drug prices low, leaving American patients and insurers to pick up the tab of ever more expensive drug development. However, they are losing out overall - the policy is currently incurring a net loss in Germany for one.
As Europe becomes a less attractive market and red tape further hinders innovation, R&D (and the jobs that go with it) and cutting edge health care are moving to the United States.
IN THE drug industry, they call it “Europe's free ride”. Government pricing regimes mean that prescription drugs cost far less in Europe than in America, where a growing proportion of new drugs are developed—presumably because Americans are willing to bear the lion's share of development costs. On the face of it, Europe reaps big rewards. It spends 60% per head less on drugs than America. In 1992, the gap was 30%. Had spending kept pace with America, last year alone Europe would have shelled out an extra $160 billion. The cumulative “saving” since 1992 is approaching $1 trillion—quite some free ride.
But is the saving from cheap drugs more apparent than real? And are Europe's drug firms in fact struggling to keep up with more dynamic American competitors? A new study by Bain, a consultant, argues that the existing pricing regimes are bad for everyone, including patients. “The free ride is not free,” argues Paul Rosenburg, a co-author. “If governments and drug companies begin to accept this, then future policy on health-care innovation and spending can be far more rational.”
On the other hand, America gains from its growing dominance of drug research and development (R&D). A decade ago, Europe and America each spent roughly $10 billion a year on drug R&D. Now, America spends almost $30 billion annually, and Europe a little more than $20 billion. A growing number of firms now base their R&D efforts in America. Drugs R&D in Germany fell by 3% in 1992-2002.
One result is a striking decline in European drug innovation. Bain examined how many so-called new molecular entities (NMEs) have been produced in recent years. In 1993-97, Europe launched 81 NMEs and America 48. But in 1998-2002, the respective figures were 44 and 85, almost an exact reversal.
Exactly how drug-pricing regimes influence innovation is complex—and much debated. According to Bain, research shows that the main economic factor driving where firms locate their R&D is how big, and quick, are the potential profits. That gives America an advantage over Europe, where price controls slow down profit-taking. True, early-stage research can take place anywhere in the world—and big drug firms are increasingly looking to shift this to lower-cost places. (GSK recently linked up to do research with Ranbaxy, a leading Indian drug firm.) But the bulk of costs are incurred in the development phase between early-stage and market. And the process of drug approval remains very much a national, as opposed to global, activity. So it makes sense for firms to put promising drugs on trial in the market where there is most to gain—namely, for now, America.
According to Bain, a proper accounting for Germany's spending on drugs produces an alarming result. In 2002, Germany saved $19 billion because it spent much less per head than America on drugs. On the other hand, says Bain, in the same year, Germany lost out on $4 billion from R&D, patents and related benefits that went elsewhere. It lost $8 billion because high-value jobs went somewhere else—plus the benefits of those jobs from the “multiplier effect”. German drug firms would have made $3 billion more profit if they had kept pace with rivals elsewhere. A further $2 billion was lost as the country shed corporate headquarters and the benefits they bring. The cost of poorer-than-necessary health was $5 billion.
Of course, these calculations rely on some rough and ready assumptions. Even so, Bain arguably errs on the side of caution. It plays down, rather than up, the multiplier benefits of jobs in the drug industry, for instance. In sum, it reckons that Germany's $19 billion saving is in fact a $3 billion net loss. “When you add up all of the costs, the free rider model is actually quite expensive,” argues Mr Rosenburg.
As Europe becomes a less attractive market and red tape further hinders innovation, R&D (and the jobs that go with it) and cutting edge health care are moving to the United States.
IN THE drug industry, they call it “Europe's free ride”. Government pricing regimes mean that prescription drugs cost far less in Europe than in America, where a growing proportion of new drugs are developed—presumably because Americans are willing to bear the lion's share of development costs. On the face of it, Europe reaps big rewards. It spends 60% per head less on drugs than America. In 1992, the gap was 30%. Had spending kept pace with America, last year alone Europe would have shelled out an extra $160 billion. The cumulative “saving” since 1992 is approaching $1 trillion—quite some free ride.
But is the saving from cheap drugs more apparent than real? And are Europe's drug firms in fact struggling to keep up with more dynamic American competitors? A new study by Bain, a consultant, argues that the existing pricing regimes are bad for everyone, including patients. “The free ride is not free,” argues Paul Rosenburg, a co-author. “If governments and drug companies begin to accept this, then future policy on health-care innovation and spending can be far more rational.”
On the other hand, America gains from its growing dominance of drug research and development (R&D). A decade ago, Europe and America each spent roughly $10 billion a year on drug R&D. Now, America spends almost $30 billion annually, and Europe a little more than $20 billion. A growing number of firms now base their R&D efforts in America. Drugs R&D in Germany fell by 3% in 1992-2002.
One result is a striking decline in European drug innovation. Bain examined how many so-called new molecular entities (NMEs) have been produced in recent years. In 1993-97, Europe launched 81 NMEs and America 48. But in 1998-2002, the respective figures were 44 and 85, almost an exact reversal.
Exactly how drug-pricing regimes influence innovation is complex—and much debated. According to Bain, research shows that the main economic factor driving where firms locate their R&D is how big, and quick, are the potential profits. That gives America an advantage over Europe, where price controls slow down profit-taking. True, early-stage research can take place anywhere in the world—and big drug firms are increasingly looking to shift this to lower-cost places. (GSK recently linked up to do research with Ranbaxy, a leading Indian drug firm.) But the bulk of costs are incurred in the development phase between early-stage and market. And the process of drug approval remains very much a national, as opposed to global, activity. So it makes sense for firms to put promising drugs on trial in the market where there is most to gain—namely, for now, America.
According to Bain, a proper accounting for Germany's spending on drugs produces an alarming result. In 2002, Germany saved $19 billion because it spent much less per head than America on drugs. On the other hand, says Bain, in the same year, Germany lost out on $4 billion from R&D, patents and related benefits that went elsewhere. It lost $8 billion because high-value jobs went somewhere else—plus the benefits of those jobs from the “multiplier effect”. German drug firms would have made $3 billion more profit if they had kept pace with rivals elsewhere. A further $2 billion was lost as the country shed corporate headquarters and the benefits they bring. The cost of poorer-than-necessary health was $5 billion.
Of course, these calculations rely on some rough and ready assumptions. Even so, Bain arguably errs on the side of caution. It plays down, rather than up, the multiplier benefits of jobs in the drug industry, for instance. In sum, it reckons that Germany's $19 billion saving is in fact a $3 billion net loss. “When you add up all of the costs, the free rider model is actually quite expensive,” argues Mr Rosenburg.
Subscribe to:
Posts (Atom)
