Research and development in the service sector

by J.Rosa and F. Gault*

Introduction

Services dominate the Canadian economy, accounting for 68% of industry GDP and 75% of employment. One of the key developments for the service sector in the last 10 years has been the sharp growth in information and communications technology (ICT) activities. Between 1997 and 2002, the real output of ICTs attributable to the service sector jumped 81% from $24.5 to $44.6 billion, whereas ICT growth in manufacturing was 55%. Many technology-intensive activities other than ICTs also are in the service sector, including biotechnology, environmental, health and logistics services.

All these services require a substantial level of specialized human resources support. Indeed, as we will see in this paper, these services are knowledge-intensive; that is, they often require a highly specialized university or technical education. This characteristic gives the service sector some capacity to conduct research and development and produce radical new or significantly improved products or processes.

To maintain or increase their market share, businesses operating in these leading-edge areas need to engage in activities ranging from R&D to product quality improvement, and they must have a desire to acquire knowledge, without which they inevitably lose their competitive edge. More generally, R&D driven innovation contributes to our economic growth.

The traditional assumption is that R&D tends to be a feature of manufacturing. Yet the service sector has an increasingly important role to play in R&D. This article provides a descriptive examination of R&D in the service sector. We will paint a general picture of R&D activity and how it has evolved between 1997 and 2002, paying particular attention to human resources engaged in R&D, and describe R&D in certain leading-edge growth activities such as biotechnology, information and communications technologies, and logistics, health and environmental services. Lastly, we will look at the issue of funding and control of R&D activities in Canada.¹

Commercial services

The service sector generated over two-thirds of GDP in 2000. Public utilities, education, health care and government accounted for 16%. The remainder is attributable to commercial services, with 51% of GDP. Table 1 provides a breakdown for commercial services by industry.

Table 1: Industry share of services, 2000

The finance and real estate industry accounted for a fairly high proportion of the commercial services, represending 19.4% of GDP. On the other hand, its contribution to the labour force was three times lower. The opposite was true in business services and retail trade, as their workforce made up 16.4% and 11.9% of the total, respectively, whereas their share of the GDP was 9.8% and 5.3%.

R&D by sector of performance and funding

In 2001, gross domestic expenditure on R&D (GERD) totalled $20,871 million, or 1.9% of GDP, up 26% from 1.5% in 1990. The GERD share of all sectors declined between 1998 and 2001, except for higher education (Table 2). This reverses what was observed in the 1993-1996 period, when the share improved for the business sector and decreased for all other sectors (Gault 1998). Higher education also significantly increased their funding share between 1998 and 2001, while other sectors either reduced their share or raised it very slightly. In fact, in recent years, higher education institutions have been increasing their share of R&D in the service sector.

Table 2: Percentage of GERD* by performance and funding sector

R&D in services

R&D by service firms accounted for nearly 29% of total business enterprise R&D (BERD) in 2002. Of that percentage, 17.3% was attributable to business services. Between 1998 and 2002, BERD grew by 35% in business services (Table 3). The industry not only carries out the most R&D but also funds the most R&D.

From 1998 to 2002, the average annual growth rate for R&D in commercial services was 3.8%, slightly lower than the rate for the rest of the economy. Growth was particularly steady in transportation and storage and business services. The business services industry’s strong performance was due in part to the meteoric rise of ICTs. The transportation and storage industry’s growth is harder to account for; possibly in recent years there has been a surge in logistics services that provide better planning and more efficient management of merchandise flows and inventories (see Bess and McKeown 1997). It is also worth noting that a small number of large companies conduct virtually all of the R&D in that industry.

Table 3: R&D by service industry (millions of dollars)

Human resources in R&D

Commercial services employ 37% of the total R&D workforce, of which 64% are professionals, 27% are technicians, and the remaining 9% are split among the other categories (Table 4).

Table 4: Number of people engaged in R&D by occupational category in commercial services, 2000

The proportion of personnel engaged in R&D in commercial services is quite comparable to the proportion in manufacturing, and they are becoming an increasingly heavy user of skilled labour. The relative percentage of R&D jobs is higher than the relative percentage of R&D expenditures (29%) in the sector. The use of new technologies is placing greater emphasis on knowledge and at the same time reducing the need for support staff.

In terms of growth, the number of R&D workers in commercial services grew at the same pace as the rest of the economy between 1997 and 2000. In general, the growth in R&D jobs followed the upward trend in R&D spending, but at a slower pace. The one exception was finance and real estate, where higher R&D expenditures were accompanied by a sharp drop in the number of R&D jobs (see Table 5 below). It is quite possible that R&D expenditures in those industries went mainly to physical capital rather than human capital.

The activities that employ full-time R&D workers are mostly those involved in software development, ICTs and biotechnology. However, biotech and environmental activities have the largest proportions of employees with master’s degrees and doctorates working on R&D, with 23% and 18% of the total R&D workforce in their industry.

Table 5: Number of people engaged in R&D by industry

Performance indicator for R&D

Table 3 does not contain the figures needed to compare the level of effort in terms of R&D spending per R&D worker. To make such a comparison between companies or at the aggregate industry level, we have to compute the ratio of R&D expenditures (Table 3) to the number of people working full time on R&D (Table 5). That ratio is an indicator of the performance of R&D spending (Table 6).

However, caution is advised, since the denominator includes professional, technical and unskilled personnel. For example, an industry with proportionally more unskilled workers and relatively little capital invested in R&D should have a low ratio. Conversely, an industry with proportionally more capital invested in R&D and proportionally more professional workers should have a high ratio. This may explain the performance of the distribution services industry, which has relatively fewer professional workers than unskilled workers, and the poor performance of management and scientific consulting services. Nevertheless, it is worth noting that between 1998 and 2000, the ratio in the finance industry rose sharply as a result of a decline in the denominator.

Table 6: Ratio of R&D expenditures to people in R&D, 1998-2000

R&D in fast-growing services

R&D is part of the national system innovation, which includes R&D, inventions, technology innovation and dissemination, and the specialists involved in all these activities (Gault, 1998). In the next few sections, we present a few highlights of R&D in selected growth areas in the service sector. The above-mentioned activities are not mutually exclusive. Some of them do not fit into an official classification, but all of them are of increasing interest to the scientific community and have a significant impact on activity in the service sector.

Most of the data are from the 2001 Survey of Research and Development in Canadian Industry (RDCI). In that survey, 7,896 companies reported conducting R&D activities in 2000, and 3,856 of them were in the service sector.

(a) Biotechnology

Biotech activities are aimed at transforming processes, products and services, mostly in health care, agriculture (particularly agri-food) and natural resources. It is a growth area in terms of the amount spent on R&D, rising to $649 million in 2000 from $425 million in 1997. Of the total for 2000, 66% was for biotech R&D activities in the service sector. In 2000, biotech R&D activities accounted for 5.7% of total BERD.

Biotech generates substantial intrasectoral trade since it also depends on computer and communications technologies. In other words, the growth in biotech activities can have a significant impact on many industries, particularly other leading-edge technologies.

(b) Environment

Our survey collects data on R&D spending on prevention, processing and reuse of waste and pollutants and on energy use reduction. In this area, 329 companies reported R&D activities, and half of them (156) were in the service sector. This R&D expenditure made up only 2.5% of total BERD in 2000, but only 12% of environmental R&D spending takes place in the service sector. This modest share of R&D spending is probably an understatement since it does not include R&D whose primary purpose is to improve production (Statistics Canada 1997).

Pollution abatement and control is an objective whose long-term benefits should offset the costs of not taking action today. The urgency of taking action accounts in part for the fact that environmental R&D activities are booming. Between 1997 and 2000, BERD in the service sector’s environmental industries rose by 88%. Public concerns about decontamination of polluted sites and the recent Kyoto accords are indicators that R&D expenditures in this area will continue to grow.

(c) Health

R&D spending in the health care part of the business services sector is estimated with data on the pharmaceutical products and drugs industry, the drug wholesaling industry, the health care and social services industry and selected firms in other industries (Statistics Canada 2002b).

The health sector has experienced generally steady growth in its share of gross expenditure on R&D (GERD) since 1988, from 13.5% in 1988 to 20.5% in 2001. Expenditures totalled $4.2 billion, more than half of which (60%) was attributable to higher education. R&D in this industry is performed mainly by universities, hospitals, government laboratories and non-profit institutions (Statistics Canada 2002b).

The aging of Canada’s population has intensified the need for care of all types. New technologies must constantly be developed to improve diagnostic accuracy. Medical and diagnostic analysis laboratories are the most R&D-intensive. Over 60% of all R&D activity in the health care and social services industry is attributable to medical laboratories and diagnostic analysis centres (Statistics Canada 2002a).

(d) ICT

ICT industries have probably contributed most to changes in the nature of activities in the service sector. ICT activity is unevenly divided between manufacturing and services, the latter having the larger share at 69% of ICT output in 2001. Of that percentage, 64% is performed by the telecommunications industry, and 26% by the computer systems industry; the remainder is split among software publishers, cable services and other services.

Though very dynamic, ICT industries have suffered a setback since the second half of 2000. The downturn was entirely due to declines in the ICT manufacturing sector, as services grew. The decline reflects anemic sales of broadcasting and communications equipment and telephone equipment.

R&D activities are just as unevenly distributed in the ICTs. In 2002, services accounted for only 21% of the R&D in ICTs, down from 24% in 1997. Still, R&D spending on ICTs by the service sector increased by 28% between 1997 and 2002.

Telecommunications dominates ICT activity in the service sector. However, its R&D spending dropped by 28% between 1997 and 2002, largely due to a decrease in the number of R&D-performing companies from 48 to 28.

Informatics R&D is another important component of ICTs. Software development accounts for a very large proportion of those activities. A total of
$3,581 million was spent on R&D in software development, 30% of it in the service sector. What is remarkable is the large number of companies performing R&D in this area, which increased from 252 companies in 1997 to 1,135 in 2000. Software development is closely tied to other leading-edge areas. The communications, logistics, biotechnology and transportation industries are heavy users of those types of products and services.

(e) Logistics services

“ Logistics services activities strive to ensure an efficient flow of products through the supply chain” (Bess and McKeown, 1997). Though general, this definition indicates what type of activities logistics services are involved in: reducing shipping and warehouse management costs or improving the quality and timeliness of those services.

In recent years, R&D has surged 70% in this industry between 1997 and 2000. The rapid growth of ICTs, deregulation of transportation in the 1990s, and the free trade agreement between Canada, the United States and Mexico have helped the logistics industries improve their services.

In 2002, R&D spending in logistics services was over $52 million, surpassing environmental R&D ($33 million in 2000) and nearly equalling telecommunications R&D ($57 million in 2002). The number of logistics companies conducting R&D has remained fairly stable since 1998, oscillating between 88 and 92.

Who is funding R&D?

Nearly 31% of total R&D spending ($3,492 million) comes from foreign sources, compared with 2% from the federal government and 4% from other Canadian sources (Statistics Canada 2002b). However, R&D funding from foreign sources remains relatively weak in the service sector. Of the total of R&D funding from foreign sources, only 10%, or $364 million, goes to the service sector, compared with 89% to manufacturing (Statistics Canada 2002c).

Conclusion

This article has shown that R&D spending in commercial services accounts for nearly one-third of total R&D. We also found that the service sector, notably business services, is a heavy user of highly skilled R&D labour. In addition, we noted the substantial R&D spending in certain fast-growing industries in the service sector. In those industries, information and communications technologies and biotechnology appeared to be important players in R&D, but other less traditional service activities have been booming since 1997, notably environmental and logistics services. The structure and vigour of R&D in services are evolving rapidly.

While services dominate Canada’s economy, we are not yet able to grasp all the effects that new industries are having on the economy and the organizational changes they involve. R&D is one of the indicators that will help us understand these changes. R&D growth provides us with useful information about the direction that the new technologies in services may take. However, we still need to put considerable effort into understanding how knowledge is transferred in services. Our approach, which provides statistics on economic activities not covered by an official industry classification, shows that understanding technology and innovation does not depend directly on any such type of classification, but rather on a need for information about an evolving economy. To that end, we should keep in mind that R&D and innovation are activities and not industries and that they cannot be adequately captured by the current industrial classification system.

References

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Ertl, H. and C. Vaillancourt (2001). Information and Communications Technologies in Canada: A statistical profile of the ICT sector, Statistics Canada, Catalogue No. 56-506.

Gault, F.D. (1998). “Research and development in
a service economy”, Research Evolution, 7(2),
p. 79-91, August 1998.

Hagedoorn, J.and S. Lundan (2002). Strategic Technology Alliances: Trends and Patterns Since the Early Eighties. The Dynamics of Industrial Collaboration. Edited by Plunket, A., C, Voisin and B, Bellon. Edward Elgar.

Jankowski, J.E. (2001). “Measurement and Growth of R&D Within the Service Economy”, Journal of Technology Transfer, 26(4), p. 323-336, October 2001.

Statistics Canada (2002a). Industrial Research and Development, Catalogue No. 88-202, October 2002, Ottawa.

Statistics Canada (1997). Service Bulletin, Science Statistics, Catalogue No. 88-001, 12(21), November 1997, Ottawa.

Statistics Canada (2002b). Service Bulletin, Science Statistics, Catalogue No. 88-001, 26(3), April 2002, Ottawa.

Statistics Canada (2002c). Service Bulletin, Science Statistics, Catalogue No. 88-001, 26(4), July 2002, Ottawa.

Young, A. (1996). Measuring R&D in the services. STI Working Papers, OECD/GD (96)132, OECD Paris.

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Note

¹. It is worth noting that Jankowski (2001) has described R&D in the US service sector, providing an international comparison based on OECD data.

* Adapted from Services Indicators, Catalogue no. 63-016.