In 2007, the software & computer services sector was the
third largest contributor to R&D in the UK850 and the fourth
in the G1400
- Two of the top 25 R&D investors globally are software & computer services companies: these include Microsoft, the world’s largest investor.
- R&D spending by companies in the UK software & computer services sector remains relatively fragmented: the five largest companies in terms of R&D spent 36% of the sector total.
- Six more software & computer services companies entered the UK850 bringing the total to 131, more than any other sector.
- R&D in the software & computer services continues to grow more quickly than sales amongst the largest investors.
This summary provides a brief overview of R&D expenditure by companies within the software & computer services sector based on the data which underpin the 2008 R&D Scoreboard. It:
- describes the broad features of R&D in the sector;
- explains the pattern of R&D both in the UK and globally;
- identifies the leading investors in the UK and globally; and
- highlights key trends in R&D spend by the sector.
The software & computer services sector
The products of the software & computer services sector have a relatively short life cycle which creates a a constant need for companies to develop and upgrade new software and associated services. R&D is a critical source of value creation for the sector.
Relatively low entry barriers mean that competition is intense, often unconstrained by national borders. Small companies, including start-ups, are an important source of R&D and innovation in the sector. There are many examples of start-up companies entering the sector, quickly introducing new software and establishing new businesses and brands. Notable recent examples include Google, YouTube (now part of Google) and Facebook. In recent years, the internet has become a focal point for R&D. In contrast, to complement their own R&D investments, major companies in the sector often acquire companies to capture innovative new products.
The pattern of R&D expenditure
Amongst UK firms
R&D investment by UK firms in the software & computer services sector amounted to £1.3 billion in 2007, making it the third largest investor in
the UK850.
There were more firms (131) from the software & computer services sector than any other sector in the UK850.
Most of the sector’s total R&D, about £1.3 billion, was invested by companies that are small relative to those in other UK sectors. Only one company is in the FTSE 100 – Sage – and most of the sector’s companies are either listed on AIM (and other smaller exchanges) or are unlisted. Put another way, the 124 software & services companies outside the FTSE 100 and the FTSE Mid-250 accounted for 79.2% of the sector’s R&D. This illustrates the relatively fragmented nature of the sector: market entry is relatively straightforward for firms and entrepreneurs with relevant skills and knowledge. It also demonstrates why larger companies – both in the UK and globally - pursue parallel R&D strategies which combine in-house R&D and acquisitions of smaller firms.
Reflecting the relatively short life cycle of software, R&D was a much higher proportion of operating profits in 2007 (152.4%) than it was across the UK850 (13.4%) (see Table 1). This contrast reflects the relatively low profitability of the sector rather than a particularly intense R&D effort. The sector needs to develop and release new software relatively frequently to remain competitive and companies are reluctant to cut too deeply into R&D to improve profits. In addition, smaller firms are under constant threat from new entrants which can quickly establish themselves if they manage to create innovative software. The sector has relatively low capital expenditure needs but high R&D needs. Consequently, the ratio of R&D to capital expenditure and sales was high relative to the UK850 in 2007.
Table 1: The UK software & computer services sector – key facts
Amongst global firms
In 2007 G1400 firms in the software & computer services sector spent about £19.6 billion on R&D, some 7.1% of the G1400 R&D spend.
The top five companies in the G1400 accounted for 54% of total R&D global spending by firms in the sector: this compares with 37%of R&D spend which was spent by the five biggest investors in the UK850.
The major players are global in their approach to the market. They adapt products to local needs where appropriate which means that they are able to justify relatively large R&D budgets, as they can leverage ideas across an international network of businesses.
The major firms
In the UK
None of the leading UK investors in R&D is amongst the 25 largest companies in the UK850. The largest – Amdocs – ranks 26th.
Although the UK sector is relatively small, many companies operate across a number of countries although they have relatively specialised product portfolios. Sage focuses on software & services for small and medium size businesses. NDS focuses on software and solutions to help prevent piracy of media content.
The software & computer services sector has been increasingly locating its R&D activities in lower cost countries. This trend can be expected to continue as broadband networks improve in speed and capacity and as the supply of skilled computer programmers improves in lower cost countries.
Table 2: The top five UK investors in R&D in the software & computer services sector
* - foreign owned firm
# - accounts not prepared using IFRS
Globally
Microsoft is the world’s largest investor in R&D and IBM ranks eighteenth: none of the other three companies is in the top 25.
Of the top five investors in R&D globally, three are from the US and one each from Japan and Germany. Each of the companies is orientated to business customers but less so for Microsoft. Consequently, their R&D budgets reflect their customer orientation.
The R&D intensity of the five largest investors varies significantly: three of the largest investors spent over 10% of their sales revenue on R&D, and the exceptions were IBM and Fujitsu. Companies in the sector that only sell software and services – Microsoft, Oracle and SAP – tend to have a higher R&D intensity. IBM has been switching its portfolio towards software & services and away from computer hardware. Consequently, its R&D intensity can be expected to increase in the future. Fujitsu retains a mix of hardware as well as software & services and this is reflected in its lower R&D intensity.
Table 3: The top five global investors in R&D in the software & computer services sector
# - accounts not prepared using IFRS
Trends in R&D expenditure
In the UK
For the companies in the UK850 within the sector, sales grew by 12.8% over the last year and R&D grew by 8.3%. By comparison, sales of the non-UK companies in the G1400 grew by 12.6% whilst R&D increased by 13.1% over the same period.
To some degree, the slower growth of UK850 companies compared with G1400 companies from outside the UK reflects lower levels of profitability in the UK. Average UK sector profitability was 4.8% compared with
16.8% globally.
Sales growth in the UK sector has been driven by strong demand from the financial services sector – a significant customer for the sector – the commercialisation of the internet, growth in the communications sectors (notably the internet and mobile communications), and from the Government’s spending on IT in the NHS.
Globally
Amongst the G1400, R&D expenditure has increased by 13.1% over the last year and 39.0% over the last four years. The sector is now the fourth largest in terms of its R&D expenditure having been fifth last year. A key driver of this growth has been the development of software to enable the commercial exploitation of the internet, manage business operations and drive company sales.
Sector sales grew by 43% over four years with R&D spending growing over the same period at 39.0%.
For the 109 companies outside the UK in the G1400, 53.3% of the sector’s operating profit was invested in R&D compared with 84.8% for the 13 UK companies. R&D expressed as a proportion of sales was 9.8 among the global companies outside the UK whereas among the UK companies the ratio was 8.2%.
