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


Examination of Witnesses (Questions 140-159)

NESTA

2 APRIL 2008

  Q140  Mr Bailey: I welcome your comment that scientists write in English. I must admit there have been occasions when I have not thought that! There is a perception that this country is good at research but poor at innovation. How far do you think that is true?

  Mr Halkett: Traditionally this is thought of because of our high research standing based on citations and our relatively low patent production compared to the rest of the world. Firstly, I dispute that that defines innovation. I would say that if you wanted to look at research-based new to the world innovation, then those metrics become valid. I do not think that that is necessarily true. It has changed repeatedly in recent years. The Sainsbury Review did a very good job of recounting increases, particularly in university licences. There has been a decrease in university spin-outs but, frankly, it could be argued that that is probably a good thing in terms of the competitive advantage of universities, that increases in licences and decline in spin-outs might be a good idea. In terms of research income that comes in from the outside, that is all on an upwards trend. When you are looking at innovation as a whole, where you are thinking about innovation in services, basing it on those metrics makes it too simplistic. I think that it is wrong to think that is the character of the UK.

  Mr Bailey: Picking up a couple of points, I am not clear why you say the increase in licences but a reduction in spin-outs for universities is a good thing. Secondly, could I add this? There is also a perception that we do the research and some foreign competitor somehow pirates that research and benefits from all the commercial aspects that arise form it.

  Chairman: "Pirate" may be quite a strong word.

  Q141  Mr Bailey: I tried to be a little colourful.

  Mr Halkett: I think the word "pirate" is interesting. In terms of the spin-outs, the point is that every institution, every actor, needs to play their best and most appropriate role in the innovation ecosystem. Are universities best at forming companies? Probably not. Are universities excellent at generating world leading knowledge? Yes. Therefore the question would be: how can that best be turned into economic and social value? Sometimes that will be through spinning out companies but more often than not it is likely to be through licensing it to people who know how to start up companies and know how to then grow those companies into world class competitors. I am not saying that that does not happen in universities. There are some notable examples from the UK and also from the US that everybody knows that have demonstrated that, but certainly a fixation on the university spin-out as the main vehicle of knowledge transfer out of universities and into business I think probably is not sensible. On the idea that knowledge gets generated here and is exploited elsewhere, whether it is pirated or not, those are two different questions. Exploited implies that maybe it is taken up by a major US-based multinational and actually turned into world leading drugs or some sort of engineering product. I will deal with that first. Pirating implies the intellectual property problems in Asia. I suppose that may be what you are getting at. On the first one, is that a problem? If we have effectively functioning intellectual property, then if you generated the knowledge, you should be getting the returns from that knowledge. The innovation process is extremely costly, of which the initial invention, although it is critical to it, is only a very small part of the expenditure. We have a research strand developing at NESTA on growing innovative companies. We are trying to find out if it is a problem that young, innovative companies in the UK rather than maybe growing to become international giants—they are called gorillas in the parlance of the investment companies—get bought up by large multinationals. Is that a problem or is that an effectively functioning innovative ecosystem for a country that is the size of the UK? I think that is an open question. First, we do not know if it is true yet. Secondly, when we do find out, the question is: do we care? We are mainly interested not necessarily in national virility symbols but in terms of delivering social and economic value to the UK. The question of knowledge being pirated is a different one. Of course control over intellectual property and the illegal use of it is a real problem and is an issue of international concern. That then takes us into the question of intellectual properly more generally and you do not want to throw the baby out with the bath water. If you stiffen the intellectual property laws too much, then you could certainly end up in a situation where you are discouraging follow-on invention, which frankly was the whole purpose of intellectual property in the first place. You get protection in return for disclosure. Particularly with new currents of innovation around open innovation, sharing knowledge and collaboration, you could end up in quite hot water indeed.

  Q142  Mr Bailey: What is your take on the decision of 3i no longer to invest in technology starts?

  Mr Halkett: It is an unfortunate occurrence for two reasons. The first is the signal that it sends. The second one is the reality of the fact that 3i has moved out of that sector. It is not surprising. The British Venture Capital Association has reported aggregate returns to the very early stage of investment of -1.5% over time. That does not seem like a good business to be in, certainly compared to when you are looking at the high returns from management buy-outs of private equity further up the spectrum. If you are managing large amounts of assets, where would you choose to put your money? I think that that is a problem. One matter we are very keen to point is that the question of stages of investment is very important here. Early stage masks a multitude of definitions. In our venture capital operation at NESTA, we invest in what we call the seed stage, which is the very earliest pre-revenue stage of the very highest risk companies. That is a very hard area to work in. We are working very hard there. We have a well qualified and experienced team that is trying to demonstrate that you can make commercial returns in that space, but there are perpetual problems in terms of doing that. Businesses require different types of support; they require different types of investment. The decision of 3i is disappointing. On their behalf, it is clearly rational. Does it represent a problem for the UK? I would say "yes". Obviously the enterprise capital funds are meant to be moving into that space to some degree but we are still witnessing a problem in the sub-£2 million investment gap. We have some new research that will be coming out towards the summer that uncovers that.

  Q143  Mr Bailey: My next question was going to be: is this indicative of the venture capital market failing to invest in product innovation? I think you have partly answered that. Is there anything else you would like to look at there?

  Mr Halkett: I think that it is important to recognise that the very early stage of funding being available is a critical part of any innovation system. The point is that there are public goods that result from that that do not reward the private investor directly. It is a very high risk area. If you think about the returns that can be made from investing £20 million into a later stage business, the amount of due diligence, the amount of specialist knowledge that you need is probably relatively similar to what you need to be investing a couple of hundred thousand pounds into a very small, high risk biotech business. There is a question there about allocation of resources and the way in which people would want to place their resources if they are an investment company. I think there remains a strong case for public involvement. What we are trying to find is what is the most effective way for that to happen because that has been a difficult story worldwide, not just in the UK, over the past 20 or 30 years.

  Q144  Mr Bailey: How does NESTA ensure that money it invests in new companies is not tantamount to charitable giving?

  Mr Halkett: We invest around £10 million a year into the earlier stage companies and funds that invest in early stage companies. We ourselves alone are not going to transform the UK's early stage investment market. Our goal is to demonstrate the kinds of returns and models of investment in terms of business support and in terms of the structure of funding that we give that will draw other people into the market. We want to make this commercially attractive. If we do that, then other people will enter. We invest with a very hard-nosed commercial approach, but linked to the very early stage of investment, if you see what I mean. That is the way in which we ensure that we are not doling out money that effectively becomes grants. As I said, we have also invested heavily in giving ourselves a fully qualified and very professional investment team.

  Mr Bailey: I will be a little provocative and ask if there are any funds that you would categorise as charitable giving?

  Q145  Chairman: The Chief Executive has said there is a danger of public funds degenerating into charitable giving, for example.

  Mr Halkett: There are a couple of problems with that. The first one is that if funds are given targets, and particularly if they are targets that may be linked in recent years, not necessarily any more, around regional development or with multiple bottom lines or tied to particular universities, then the chances are that they are going to be looking to meet somewhat arbitrary targets around numbers and amounts of investment, rather than the fundamental target of actually delivering good returns and making good investments. I think that there is a danger and there might have been some problems with that in the past, but that is definitely changing. People are hungry to learn how to make this work. That is where we hope to be able to both theoretically and practically contribute to that.

  Q146  Chairman: You have referred to a report that your organisation is producing. Tell me the subject of that report in this context of funding.

  Mr Halkett: We are doing a couple of things. We have a piece of work under way which looks at the equity structure of successful innovative businesses over time, over the course of their development: to what extent was early stage funding important; to what extent any type of grant type funding was important; but also angel investment and the rest. We understand what we call their equity fingerprint through that time. The second thing we are doing is a quantitative analysis of the sub-£2 million investment area. Crucially, that is because the BDCA in particular qualifies early stage as sub-£10 million. You could understand that even if early stage potentially is going up in that definition, you still would not be supporting the very earliest stage of innovative businesses. We are looking at the specific niche in which NESTA operates, and we are finding a decline in investment in that space over recent years.

  Q147  Chairman: Will you be bringing forward proposals to put that right or is it just a piece of analysis?

  Mr Halkett: At the current stage, it is a piece of analysis but of course we will be developing proposals to put it right because that is why we exist.

  Q148  Mr Weir: Your evidence suggests that traditional innovation measures are heavily biased towards R&D and patent intensive industry such as aerospace or pharmaceuticals. What impact do you think this has had on policy making in this area?

  Mr Halkett: I am normally a big fan of evidence-based policy. That is something that is quite often lacking and it is to be encouraged. The problem we have is that if you depend on evidence constantly and singly and it is the wrong evidence, because then we are chasing the figure. There was a Chief Economist at the Bank of England called Charles Goodhart, who developed something called Goodhart's law, which was that once an indicator has been established as the basis for a target, it loses all meaning because people chase the indicator. You can see some of this, although I am not an expert in health, with waiting list times where suddenly that was a useful indicator of the health of the system but then became the target in itself. You see that with patent applications, with patents granted and with R&D spend. They are useful indicators as a health check of parts of the innovation system, but if we actually establish those as the only targets that we have, and over the past couple of decades they have consistently been the only reported ones, then of course policy is built to try to stimulate to meet those targets because that is a better story to be able to tell. In the Innovation Nation White Paper we have been asked to produce a new innovation index that balances this more effectively and it provides a more balanced appreciation of the UK's economy and social and innovation system there. We will be making sure that we at least embed those indicators in a package of other ones that are relevant to other sectors as well, so that hopefully then, if you are following the evidence, as a policy maker, what you will actually be doing is hopefully also improving innovation.

  Q149  Mr Weir: What are the outcomes from that? Presumably patents are used because they have a definite outcome: this research and innovation has produced a patent and presumably it will produce profit at some point in the future. Is it your argument that innovation is wider than just simply new products, in effect?

  Mr Halkett: Absolutely, and to reinforce the point, patents are a very useful measure for a very small but particular sector of the economy. I do not want to say that they are not useful; they just cannot bear the weight that is currently put upon them. For instance, patents currently only apply to products; they only apply to new to the world inventions of those products, not new applications of older technologies. The other thing about them is that patent application is not really a great indication of success. Patents granted can be, but more import would be an indication of patent citation or patent value. We know from research that has been done in the past that the vast amount of value from patents is delivered by a very, very small proportion of those patents. Just to look at those in particular, they do not work in the services industries; you cannot do a business model or a business process patent in the UK like you can in the US, although I am not advocating that. For instance, what you are really looking at there is probably a useful indicator, but then only a partial indicator for a relatively small section of the UK population. It would, for instance, be useful for the pharmaceutical industry. I would not want to challenge it enormously there, but other indications of innovation would be important in those industries as well.

  Q150  Mr Weir: What would be these other indicators? Presumably anybody looking to invest is looking for an indicator that will show an outcome rather than just to invest in innovation; they want to see something with an outcome to it. What indicators would you be looking for?

  Mr Halkett: There are a few sectors where it is relatively obvious. If you are looking, for instance, at the health of the creative industries, then you would be looking at copyright and design applications more than at patents.

  Q151  Mr Weir: Does that not amount to much the same thing? A copyright and a patent are different ways of giving protection for an innovation, are they not?

  Mr Halkett: I think that is right. That is one of the most straightforward ways in which the indicators can be improved, if we just gave equal weight to the idea that copyright, which is relevant to the 7.5% or so of the UK economy that is based on creative industries, is perhaps the indicator of choice when compared to patents maybe that are important to high-tech manufacturing, which represent around 2.5% of the economy. The problem comes when we look at the health of the whole of the economy based on the patents or the R&D statistic alone.

  Q152  Chairman: Copyright protects brand value as well, though, does it not?

  Mr Halkett: Yes.

  Q153  Chairman: It is much wider than just the narrow creative sector?

  Mr Halkett: It is, but again it is a question of the most appropriate indicator there as well. In other sectors you would see it as well. For instance, we have work underway, and we have been doing this in partnership with BERR but also some of our own work, on the question of innovation in services. If you look at the companies in the services sector that are most innovative, a very important indicator of that is the level of management training that those businesses have, particularly their ability to understand innovation, deploy information and communications technology and think in a way that is conducive to innovation. They produce very few patents. Of their innovation expenditure that they self-identify in services, less than 20% qualifies as research and development. For instance, you would have some idea of a health check of the innovation capability of the services sector if you did understand that level of management capability. These all need to be refined. The question is: how do we improve on the existing indicators that we have? A sectoral approach is going to be important. We need to look at the relevance of the different regions because of industrial structure and demographic structure in different regions. We need to be thinking about the flow of talent. Clearly skill levels are very important to innovation, but they are important in different ways for different sectors. We need to strike a balance between over-complicating what is currently too simple a system but also not ending up back where we are right now, where we have unsatisfactory proxy indicators for the whole of the economy.

  Q154  Mr Weir: I think I understand all that. How do you get across to an investor the idea of investing in innovation in, say, a service industry? Anybody investing in manufacturing and the creative industries can see an outcome, apart from the copyright or whatever. What you are saying seems very ethereal, that there is innovation within the service business. How do you measure it and put it in a way that investors can understand that they are investing in something that will be taken forward and provide profit in the future?

  Mr Halkett: Investors tend to have a strong understanding of innovation in services because they are very close to the business, because they look at businesses individually; they understand those businesses and they are not trying to aggregate them too much. The problem we have, in terms of innovation indicators and metrics, is on the national or the regional level when we are looking at whole swathes of the economy. For instance, we look at the UK's pharmaceutical sector which invests 14% of its revenues in research and development, which is a very high level globally and it is also a leading sector. There is a link there and so it is appropriate for that area. Investors in those businesses would understand that. The Government understands that as well. The problem, of course, is that it only represents about 6% of the economy and therefore its actual impact on the overall innovation statistics is less than perhaps it could be. What we need to look at is understanding how innovation happens in these different sectors and then we will be able to develop indicators based upon that. A classic is in the public sector where currently we do not really measure innovation at all. In the report Hidden Innovation that we produced, one of the classic examples we came across was genetic testing in the NHS. Over a decade, we produced around 300 new genetic tests in the NHS; none were produced in the traditional way; none generated patents; none were based on venture capital funding, but those deliver important social value to the UK and sometimes economic value as well. It is a question of knowing what we are looking for and that is what we are going to undertake.

  Q155  Mr Weir: This takes us back to where we started. We had Sir John Rose of Rolls-Royce before us previously. He suggested that aerospace R&D spending was under-supported in the UK. Would you agree with that statement?

  Mr Halkett: He is more of a specialist on the aerospace industry. On the question of R&D support, there is evidence but it is scarce that a 10% reduction in the cost of research and development through whatever means but potentially by government subsidy, through something like an R&D tax credit, over time leads to a 10% increase in R&D, but we would expect that because companies are rational. There is very little rigorous evidence currently of the link between research and development and innovation, as opposed to just increasing R&D spending and the link between it directly and productivity growth over the long term. Would aerospace like additional support for its research and development activities? Yes. Would that in my opinion directly increase the innovation performance of the UK? I think that is a question that is still out there. Knowledge moves quickly; companies move quickly; people move quickly. Investing on a national level on something like that with the idea that it will improve your innovation performance is an interesting question. Whether R&D tax credits or support for R&D is actually just a part of international tax competition attracting large companies that we prefer to have rather than other people have is another matter. That is a judgement that goes beyond the realm of innovation policy. If you are looking specifically at innovation, there is more work to be done to suggest that large-scale support for research and development increases the innovation that matters to the UK economy.

  Q156  Mr Wright: If we briefly turn to regional policy, the Lambert Report identified an increased role for regions as a key part of innovation policy. The evidence that we have received suggests clearly that companies find dealing with different funding bodies in different areas frustrating. Do you think we have the balance right between promoting regional clusters and recognising that companies do not necessarily follow administrative boundaries?

  Mr Halkett: I think this is work in progress. We have two findings from our research that are important here. The first is that we need increasing regional tailoring of innovation policies. One size does not fit all; it certainly does not work nationally. 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. The default that we have gone into is that because we have aimed at entirely national policies that cannot really be tailored, we have ended up with an innovation policy that not just favours science and high-tech manufacturing, but basically favours the greater South-East above and beyond the rest of the UK. That is because it is an easy default to go to. The first finding is that it is very important to have a level of regional devolution to ensure that capacity. The other finding is exactly what you found, which is that people are currently unsatisfied with the capability at the regional level to deliver a very high standard of innovation policy and innovation support, particularly when there are problems with cross-administrative boundaries. You certainly see that many organisations, for instance say around the Cambridge area, would have much closer relationships with London than they would maybe with Ely, and yet Ely is covered by the same development agency and London is not. That clearly is a bit of a problem. RDAs may not be moving as fast as we would like but they are moving in this regard. The best example and the one that we are closest to is the Northern Way, the collaboration between Yorkshire and Humberside, between the NorthEast and the Northwest Development Agencies, where they are working upon pan-northern issues collaboratively: research into transport linkages, innovation support, business support, things that actually work across. Of course part of that is trying to establish the M62 corridor as a strong economic independent entity and perhaps a rival pull to the South-East, but it also I think represents quite a forward-looking and intelligent step when it comes to thinking about the realities of innovation policy.

  Q157  Mr Wright: With regard to the RDAs, in your evidence you mention the fact that in terms of the priority areas eight of the nine RDAs include biotechnology or health sciences. All right, competition is fine between the areas. Do you think that should be led by the Government to say it is for each RDA to say what area should be looked at? Clearly, they are the builders ultimately of the priority areas. The competition is going to be strong and you are duplicating a lot of the public expenditure.

  Mr Halkett: To an extent over the past decade this has been a necessary evil. In return for the development of regional autonomy and regional interests, you have regional `boosterism' as well. Of course everybody wants to jump on the biotech bandwagon and say that their area is going to be world leading. Equally clearly, that is absolutely not true. The idea of particularly generating a biotech cluster essentially out of thin air is not really going to work. There is almost no evidence globally that you can create clusters. You can certainly build, stimulate and grow them; you can certainly take good ones to great ones, but the idea of literally creating one is extremely difficult. I would say: yes, there has been a problem. We talk about the question of intelligent competition. This is a fine balance. Can you have central government direct that is going to be the champion for biotech within the UK? That is a problematic area but if you look at it, it is quite clear that there are a few front runners. Obviously there is the area around Cambridge; the area between Glasgow and Edinburgh; and a couple of other pockets. Obviously we had the news story this morning about the embryos from the North East. There are ways in which these are going to work together. The point is that when we look at globalisation and at the rise and rise of other centres of excellence, at the fact that people and knowledge are moving faster and faster, the chances are that the currently excellent places are going to become more excellent and therefore there are going to be fewer of them. The leading scientists and researchers will literally move there to work with the best in the field. As an aside, we will also see the same in the services industry. You see the ever growing rise of London as a financial services centre. Clearly there is a bit of a clustering effect going on there and it is to the detriment of other people. When we are looking at this, I think we are clearly moving to a world where the UK will have a couple of globally competitive areas in something like the biosciences and, yes, there will be other areas but they have to recognise their position as feeders into those national centres. I would prefer for those to emerge rather than be chosen but government chooses all the time. Apart from the paranoia we have about "well, I am not picking winners, but ... " as we always hear in ministerial speeches, the point is that governments the world over pick winners all of the time. If we look at the vast increase in health care spending by the US Government, theoretically the home of the free market, it is up to about $29 billion a year now through the national institutes of health. Then suddenly you are noticing that countries all over are essentially picking winners. They are picking sectors, they are not picking firms. I think that is a more intelligent way to go. Should there be a government committee that sits there and makes some sort of decision and then awards a bioscience excellence centre to Cambridge? That would not make an awful lot of sense, I do not think, but certainly there are going to be choices made. The idea of almost arbitrarily going against that tide to boost other areas seems nonsensical.

  Q158  Mr Wright: Briefly, do you consider that in, say, five years' time eight out of the nine RDAs that have been given a priority area would be reduced down to four perhaps or five because they will recognise that they cannot keep pace with areas such as Cambridge?

  Mr Halkett: I would strongly hope that that would be the case and that they would choose to focus on other areas of their clear strengths. Those strengths are distributed across the UK. Each region has its own particular strengths it can build on. There is a glamour attached to a minister wrapping himself around the latest biotech piece of machinery that they want to announce and everybody wants the person to go to that area and wants to work in that space. I think what we want to see is a more intelligent approach to that. However, that will depend on a very proactive and realistic approach from regional development agencies and from city councils.

  Chairman: We are really enjoying this evidence session, as I thought we would. We are not half-way through our questions, so can we go through our menu of questions and try to avoid detailed expositions. We can come back to this at a later date and explore things in more detail. I am afraid it is frustrating but can we move on faster?

  Q159  Mr Wright: Turning to government and policy, how would you assess the Enterprise and Innovation White Papers?

  Mr Halkett: We were involved in the development of both. We were particularly close and DIUS is our sponsoring department and therefore we were involved in the development of Innovation Nation. I was very pleased with how it turned out. I think that it sets a clear intellectual leadership centre in the UK Government. I think that globally it has been recognised as quite a step forward. In particular, if you look at the contents page, there is a chapter on demand, which is very unusual in international innovation strategies. Innovation in public services is attracting a lot of international attention. I have been getting international comments on it. Those are the areas where people are focusing. I think it has done that very well. The point is that it is going to be very challenging to implement. What we are looking at now is DIUS having to work an awful lot through other government departments to achieve its goals. That is critical. We have made the comment that we think non-innovation policy is almost more important than innovation policy when you are considering innovation performance and therefore it is a necessary evil. That is an interesting challenge for the structure of a department. I thought the enterprise strategy was a good start and they have made it quite clear that this is the beginning of a real focus on the enterprise agenda. I look forward to working with them further on that.


 
previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2009
Prepared 25 September 2009