Risk and Reward: sustaining a higher value-added economy - Business and Enterprise Committee Contents

2  The higher value-added economy

What is a higher value-added economy?

20.  The need to create a higher value-added economy is widely taken as a given in public policy debate—but what exactly does this apparent platitude mean? Just as policy interventions can only be considered appropriately with an understanding of the real context, so it is necessary to understand exactly what the desired outcome, in this case a higher value-added economy, might be. As NESTA said, "A high value-added economy focuses on those activities that generate a large margin between the final price of a good or service and the cost of the inputs used to produce it, and thus create higher profits for businesses and higher wages for workers."[16]

21.  There are some sectors which are clearly higher value-added, such as pharmaceutical development and advanced engineering. However, a higher value-added economy may encompass a far wider range of activity. The Committee received a large amount of evidence exploring the concept. Here we reproduce some of the most eloquent submissions.

22.  The CBI gave the following explanation:

The term "value added" refers to the differential that can be achieved between the cost of a service/product/process etc. and the price that can be charged for it. In turn, 'higher value-added' concerns maximising that differential, be it through reducing input costs (e.g. reducing material, labour or process costs etc) or increasing the price that can be realised (e.g. through brand association, improved quality, innovative features, faster delivery, higher specification etc.), or some combination of the two … The global accessibility of inexpensive labour means that UK-based businesses cannot compete in markets for internationally traded goods and services on the basis of low labour costs alone. Thus our economy naturally tends to focus on higher value and higher value-added activity where investment in skills, knowledge, technology and innovation more broadly are important factors.[17]

23.  The Engineers Employers Federation said that:

investing in technology or in research and development (R&D) tends to be associated with rising levels of value added but focusing exclusively on this would ignore the range of routes that companies follow to achieve business success. These include innovation in products, processes or services that might not be particularly high-tech but that generate an increase in productivity, helping to establish a niche market or allowing a company to charge a premium over its competitors. For manufacturers, operating in intensively competitive markets, becoming higher value-added essentially involves any activity which allows them to move away from competing mainly on price.[18]

24.  Advantage West Midlands (the Regional Development Agency (RDA) for the West Midlands) noted the importance of innovation, saying: "'value added' is taken to mean the increase in the value of goods or services that arise as a result of the production process before they are taken to market. Innovation is therefore a critical factor in raising product value (and therefore, ultimately, price), thus accruing greater wealth and prosperity",[19] whereas the TUC noted that "Skills and design will be two important concepts in any discussion of high value goods and services. The market, through the basic rules of supply and demand, plays a role in setting the price, of course, but value added refers more closely to the quality of the product."[20]

25.  The higher value-added economy depends on a range of factors, many of which interact. It is not simply about R&D, or high technology manufactures; it goes far wider and depends on many different factors. We look at some of them here.


26.  Innovation is a key source of competitive advantage in a higher value-added economy. Traditionally, innovation has been associated with the high technology and manufacturing sectors, with measurements of innovation ranging from the number of patents registered to productivity rates. It is, of course, far wider than this. Innovation Nation states: "Innovation ... can be defined as the successful exploitation of new ideas, which can mean new to a company, organisation industry or sector. It applies to products, services, business processes and models, marketing and enabling technologies".[21]

27.  Nor is innovation simply a matter of producing a new idea and bringing it to market. As we discussed with Professor Eric von Hippel of MIT, innovation can come from users. Companies may pick up ideas from their customers, and make them into new products or services. To give one prominent example, Apple has encouraged others to develop applications for the iPhone, and secured market advantage from so doing.


28.  A higher value-added economy needs a strong manufacturing sector. As Sir John Rose, Chief Executive of Rolls-Royce Group said in the Gabor Lecture at Imperial College, "high value-added manufacturing drives demand for supporting industries and services"; it drives demand for skills, and it provides employment. Industry is also essential for developing the technologies needed to tackle problems like the need to reduce greenhouse gases, or aircraft noise. Wider ties may be built with developing markets by providing the goods needed to develop their infrastructure. As Sir John said "there are high barriers to entry because of the financial cost of taking part, the level of technology required and the customer knowledge that helps prioritise the application of innovations".[22] The country already has extremely strong pharmaceuticals and biotechnology, and aerospace and defence sectors, as can be seen from the discussion of R&D intensity in paragraphs 48 to 52 below. Our recent inquiry into the Automotive Assistance Programme highlighted the United Kingdom's strength in the premium motor industry.[23] Any strategy for ensuring that the United Kingdom has a higher value-added economy must not look simply at new opportunities flowing from new technologies or new challenges, such as the move to a low-carbon economy, but must also identify, safeguard and build on existing manufacturing strengths.


29.  Although manufacturing is important, the higher value-added economy is not just about high-tech manufacturing. A December 2008 speech by Lord Mandelson gives some idea of the range of activities such an economy might encompass:

our specialisations must be built on knowledge and value-added. They will be in business and financial services, where smart regulation, combined with the depth of commercial and legal experience in the City, for example, have the potential to make Britain a clear market leader—even if it's not fashionable to say it right now. But they will also be in the knowledge and creative industries and the technological and manufacturing process revolutions that will define the current century, for example in the biosciences. The global shift to cleaner and more efficient energy usage will also throw wide open the market for new forms of energy generation and a host of other low carbon or post-carbon goods and services.[24]

30.  The knowledge industry is not just about services, and services themselves are not just about finance, or retail. As Will Hutton told us, financial services:

are simply part of a more general phenomenon which is the rise of knowledge services. The truth be told, in terms of employment generation or improving their share of Britain's knowledge service exports, the story is not that great. The real story in the last 10 years has been our great teaching hospitals, our great drugs companies, our great manufacturers like Rolls-Royce and what is happening in culture and the creative industries and what has been happening in ICT and in things like auctioneering. I suppose the Big Four accountancy firms, although they are not conventional financial services …. They have been really just going like a steam train, really benefiting from globalisation. The much vaunted City has been doing satisfactorily but it has not been growing as rapidly as some of these.[25]

31.  Indeed, in some cases, the distinction between goods and services is unclear. The Sainsbury Review gives this example:

Software for an aeroplane produced by an aeroplane manufacturer is classified as manufacturing, but if it is outsourced to a computer services company it is classified as a service. Jet engine manufacturers such as Rolls-Royce no longer sell engines and spare parts, but propulsion services, because the value of services on a product through its lifespan can exceed original sales by as much as five times.[26]

Sir John Rose pointed out that "services" could entail a great deal of intellectual property:

We are providing engineered solutions, so "services" is a useful descriptor of that part of our business in the sense that we are providing services that are ancillary to and post the original equipment sale. The services are fundamentally enabled by the fact that we do the research and technology in the first place, that we develop the product, that we certify it, that we understand its operation in service, that we have the skills and capability to monitor it, that we can view the use of our product across geographies and applications, and that we can therefore act with the customer in a way that improves their business and improves the operation of our product in service, which is very meaningful to them, because for most of our customers our product has a significant impact on the success or otherwise of their business. It is not that we are going around and saying we happen to understand the civil market or the defence market or the energy market and we can do some service things because of that; it is fundamentally to do with the fact that we own the intellectual property and the relationship with the customer.[27]

32.  Although we recognise and emphasise the importance of manufacturing, it is only part of the economy. In the manufacturing strategy published in September 2008, the Government stated that "our future lies in a mixed and balanced economy with manufacturing and services reinforcing each other".[28] We agree. We should celebrate the fact that the United Kingdom is the second largest exporter of services in the world.

Creative business: branding and design

33.  Both services and manufacturing can benefit from harnessing creativity to add value. The Design Council told us that "the UK design industry is the biggest in Europe with a total turnover of £11.6 billion and has an international reputation for quality and value", although it warned that other countries were developing their capabilities. Its research "shows that companies that invest in design outperform in practically every measure of business performance including market share, growth, productivity, share price and competitiveness" and that "adding value through design brings market confidence and competitive advantage and reduces the need to compete on price."[29]

34.   Value can also be added by exploiting intellectual property, not just in obvious ways but through measures like branding. A successful brand is not a static entity; it can be a source of value, and provide a framework for innovation. The British Brands Group (BBG) told us that the creation and management of brands generates £15.85 billion for the UK economy in the United Kingdom.[30] The Committee notes that, apart from a study by Westminster Business School that identified the potential scale of branding's contribution to the UK, little research has been done into the effect of branding on innovation, for example. Branding is an area where the UK creative industries are strong but which is talked about far too little in public debate. Government policy must sustain the creative industries that are responsible for the successful development of brands in the United Kingdom, and must protect effectively the intellectual property of the brands themselves.


35.  Successful innovation often depends on networks. In some cases, these are driven by academia, or involve academia and business. But there is also scope for industry collaboration, both in working on ideas which may come to market soon, and in more speculative research. For example, we visited the perhaps misleadingly named and remarkable Media Lab at MIT. Here a range of companies collectively sponsor research, gaining access to creativity which can often transform 'far out' research into useful products. The range of research extends from the immediately obviously useful to the truly beautiful. On our visit we talked to the people behind many intriguing innovations from those using high-technology sensors and materials to develop far better prosthetic limbs, to those developing technology to allow bottles to make sounds. We saw 'bottled music', but it would also be possible to arrange for jars to announce their contents when opened. Intellectual property rights need not be a barrier to such collaboration. The Media Lab has developed a framework which effectively allows participating companies access to the technology developed there while protecting any further developments they may make.

The higher value-added ecosystem

36.  If the higher value-added economy is so multi-faceted, what does it need to thrive? Our visit to areas in the US where higher value-added businesses were strong lead us to the following answers:

Skills: the successful centres we saw built on the intellectual capital around them. This was not just about the successful exploitation of research; the skills which were cultivated were far wider.

Ideas: the areas we visited had centres of research excellence. It was accepted that many people would be focused on research, not on business, and we observed a delight in ideas for their own sake, as well as for their commercial potential. But there were also many organisations dedicated to ensuring ideas could be successfully commercialised. Sometimes these were at the university level, sometimes, as in the Massachusetts Institute for Technology Transfer, the state had invested in them.

Networks: ultimately, the success of the areas we visited appeared to owe a great deal to the fact that different parts of the system were connected to one another. Universities and technology transfer organisations collaborated; venture capitalists had links to universities and to the local government. Networking events were commonplace.

Finance: there was ready access to risk capital, and also encouragement and help for would be entrepreneurs.

Leadership: this could come from business, from academia, from state level government or from the federal government. Often, a variety of organisations worked together, or complemented one another.

Culture: it was taken as read that good ideas should be commercialised (although not necessarily by their originator), and that enterprise was to be encouraged. It was also accepted that not every initiative or business would succeed, and that failure was not necessarily blameworthy.

The United Kingdom already has the resources for ideas, skills and leadership in place. Increasing attention is being paid to developing networks. However, as we explore in this Report, more could be done to foster higher value-added activities. In particular, as we shall see, the United Kingdom's risk-averse culture needs to change,

37.  The United Kingdom cannot build a higher value-added economy on a single sector, or type of intervention. Many different factors come into play. For example, a wide range of skills is needed if we are both to sustain manufacturing and maintain our strength in services and the creative industries. Government undoubtedly has a role to play in creating the right environment for innovation, and responsibility for this spreads beyond the remit of the Department for Business, Innovation and Skills. However, central government cannot foster innovation alone. Local policy makers, academia and, above all, industry itself—of all sizes—need to be involved.

Government policies

38.  The Government is engaged with innovation policy. Over the last year it has published at least five strategy and policy papers on the matter:

  • Creative Britain: New Talents for the New Economy, Department for Culture Media and Sport, Department for Business, Enterprise and Regulatory Reform and Department for Innovation, Universities & Skills, 22 February 2008.
  • Innovation Nation, Department for Innovation, Universities & Skills, Her Majesty's Treasury and Department for Business, Enterprise and Regulatory Reform, March 2008.
  • Enterprise: Unlocking the UK's Talent, Department for Business, Enterprise and Regulatory Reform and Her Majesty's Treasury, March 2008.
  • Manufacturing: New Challenges, New Opportunities, Department for Business, Enterprise and Regulatory Reform and Department for Innovation, Universities & Skills, September 2008.
  • Building Britain's Future: New Industry, New Jobs, HM Government, April 2009.

These papers are summarised in Annex A of this report. On one hand, we welcome the Government's commitment to identifying British strengths, and shaping policy to promote enterprise and innovation. However, there is inevitable overlap between the papers and it will take time for policy aspirations to become translated into action. Over the last year, the Government has produced a succession of strategy and policy papers related to innovation and industry. Their proposals cannot be implemented by the Government alone. All those involved now need to ensure that the emphasis is on the actual delivery of policies designed to support innovation, rather than producing further policy documents.


39.  Policy delivery is not just a matter for the central government. Many local and regional bodies have an important role to play. Mr Halkett, the Chief Executive of NESTA, told us:

We produced a series of reports at the end of last year, one on innovation in the city, one on regional innovation coalitions and one on what we called rural innovation. They all demonstrated that, whilst you should have a national standard of policy, it needed to be able to be tailored for local and regional industrial and demographic structures and priorities.[31]

Local leadership is essential to ensure that innovation policy meets regional needs, and leadership roles can be taken by many sorts of organisations. Our evidence paid tribute to the way in which in some areas, local government leadership had helped build city economies.[32] We were also very impressed by the work done by Scottish Enterprise, and our recent report on Regional Development Agencies noted the positive assessment of their effectiveness.[33] Often work is done in collaboration with the private sector, such as in Longbridge Innovation Centre, where Advantage West Midlands is working with a property developer to transform the site.

40.  Although we emphasise the importance of local or regional bodies in shaping innovation policy in their area, there has to be care that regions do not duplicate one another's work, or try to compete in sectors where other parts of the country have a competitive advantage. Mr Halkett warned against regional 'boosterism' and noted that although regional clusters of expertise and industry could stimulate growth, creating them would be extremely difficult.[34] Successful local leadership, such as that we saw in the West Midlands or in Scotland, identifies local strengths and builds on them. It can help transform local economies. There is a very delicate role for central government in this; it needs to maintain awareness of what regions are doing to foster innovation and a higher value-added economy, and to exert its influence when it appears that there is excessive duplication of effort. It also needs to identify and build on best practice. However, it must do so while leaving regional bodies free to innovate; it must act as a broker and guide, not as a director.


41.  One of the issues in our original call for evidence was the effectiveness of government arrangements in encouraging innovation and creativity. The Committee has recently taken evidence on the likely effectiveness of the recent and unexpected machinery of government changes that led to the abolition of the Department of Innovation, Universities and Skills (DIUS) less than two years after its creation.[35] The range of policy documents listed above, and the number of those which were produced by two or more departments suggest that previous arrangements were unwieldy. The CBI originally welcomed the creation of DIUS, in part because it had explicit responsibility for innovation. However, it was concerned that this arrangement separated innovation from business, and considered that robust links between DIUS and the Department for Business, Enterprise and Regulatory Reform (BERR) were of critical importance. Now, in evidence to the Committee, the CBI has welcomed the merger of BERR and DIUS.[36] Had the merger not taken place, it is very likely that this Report would have called for the return of innovation policy and intellectual property issues to BERR. However, there will always be boundary problems. The British Brands Group, for example, was critical of the fact that government responsibility for brands does not fall within one department but is now divided between DBIS and the Department for Culture, Media and Sport (DCMS).[37]

42.  If times are becoming tougher, then it becomes even more important that public policy does all it can to support British business. Measures to provide short-term support have already been developed, and we have examined some of them in recent reports. In the longer term, government needs to ensure that it has a range of policies in place to encourage innovation. Some of these policies, such as Research & Development (R&D) tax credits, will need to be simple, consistent and widely available. Some will require the Government to support a range of innovative approaches, to accept that one size will not always fit all, and that some of the policy interventions sometimes will not succeed. It will be a challenge to sustain this blend of stability and flexibility, but as we shall see, government policy is, largely, heading in the right direction. At this stage, although we make no comment on the inclusion of higher and further education within the new Department for Business, Innovation and Skills, we acknowledge the vital importance of improved skills to all British industrial sectors. We believe that the new department is a welcome opportunity to coordinate policy on innovation, and to ensure that policy is consistent.

16   Q 213 Back

17   Ev 147 and Ev 148 [CBI] Back

18   Ev 174 [EEF] Back

19   Ev 117 [Advantage West Midlands] Back

20   Ev 275 [TUC] Back

21   Innovation Nation, DIUS, March 2008 Back

22   Why Manufacturing Matters, Gabor Lecture, Imperial College, 15 November 2007 Back

23   Business and Enterprise Committee, Ninth Report of Session 2008-09, The Automotive Industry in the UK, HC 550 Back

24   Speech to the Royal Society for the encouragement of the Arts, Manufacturers and Commerce by Lord Mandelson in London on 18 December 2008 Back

25   Q 187 Back

26   HM Treasury (2007), The Race to the Top, A Review of Government's Science and Innovation Policies conducted by Lord Sainsbury of Turville; HM Treasury (2006), p38 Back

27   Q 84 Back

28   Manufacturing: new challenges, new opportunities, BERR and DUIS, September 2008 Back

29   Ev 164 and Ev 165 [Design Council] Back

30   Ev 128 [British Brands Group] Back

31   Q 156 Back

32   Q 189 Back

33   Business and Enterprise Committee, Fourth Report of Session 2008-09, Regional development agencies and the Local Democracy, Economic Development and Construction Bill, HC 89-I, para 40 Back

34   Q 157 Back

35   Uncorrected transcript of oral evidence taken before the Business and Enterprise Committee on 30 June 2009, HC (2008-09) 754-i, Q 54 [Mr Lambert] Back

36   Ev 158 [CBI], HC 754-i, Q 54 [Mr Lambert] Back

37   Though it was previously between BERR, DUIS and DCMS as laid out in the memorandum. Ev 128 [British Brands Group] Back

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