Cost recovery from publicly funded research

By Denzil Doyle

As the budgets of publicly funded R&D laboratories become tighter and as the demands on those budgets expand, the managers of these laboratories are under constant pressure to pursue avenues of cost recovery. The major emphasis tends to be on the licensing and sale of technology and the delivery of services such as contract research because the paybacks usually go directly to the laboratory and are very visible.

What seems to be overlooked in the mad scramble for such dollars is the relationship between cost recovery and economic payback to the taxpayers of Canada who financed such research in the first place. The politicians and bureaucrats who carry out their wishes operate on the assumption that, if a lab with a $100 million per year budget can reduce its burden on the taxpayers by going out and getting $20 million into the till by selling or licensing some technology or by doing some contract research for an outside firm or another government agency, it is a win-win situation for everyone.

A closer examination of what constitutes real economic payback from licensing shows that it takes the following forms:

a) Licensing revenues from companies that use the technology to produce products. A recent study by Doyletech Corp for the Communications Research Centre (CRC) in Ottawa estimates that, for every dollar of licensing revenue, there would be $40 of such products sold by the company.

b) Licensing revenues from the sale of services. In this case, the incremental sales would be $20.

c) Licensing revenues from the application of a process. In this case, the incremental sales would be $10.

d) Licensing revenue from other government departments or agencies. In this case, the incremental sales would be zero because it did not result in any commercial activity.

In the CRC study, it was assumed that the same multipliers would apply to technology that was acquired through the outright sale of technology or by contract research carried out for clients by CRC.

Based on data provided by CRC on its licensing and contracting activities over the 16-year period between 1989 and 2005, it was determined that the sum total of revenues generated by CRC from all of the above sources was $33.7 million — a very impressive number. By breaking out the Canadian portion of this total ($17.3 million) and segmenting the recipients into the four categories listed above, it was estimated that this resulted in incremental sales of $520 million and incremental employment of 2,602 person years for Canadian industry over the 16-year period.

Yet these numbers tell only part of the story. An analysis was also done on the impact of spin-off companies, specifically companies that would not be in existence today had it not been for the transfer of either people or technology out of CRC. Spin-offs from those companies were also included in the analysis. The following are the results of that analysis:

a) The number of spin-off companies still in existence in 2005: 62

b) The number of employees in those companies: 6,378

c) The annual sales of those companies: $1.61 billion in 2005

As impressive as the licensing/contracting numbers are, they don't hold a candle to the spin-off numbers. A quick look at a few Canadian high-tech companies (I used Mitel and Newbridge since I served on both of their boards, as well as a few other private companies in which I was involved) will show that for every dollar of sales, they will generate about 20 cents worth of tax revenues, mostly from employee income taxes. Applying this number to the $1.61 billion figure above would suggest that these spin-offs are returning about $320 million annually to Canadian taxpayers. That seems like a pretty good return from an establishment that has an annual operating budget of well under $50 million.

For the returns on licensing/contracting activity, the $520 million of cumulative sales during the 16-year period would have generated about $100 million in tax revenues. It should be emphasized that this $100 million is a one-time figure while the $320 million from the spin-offs is an annual figure.

It should not be assumed that every R&D laboratory with an annual budget like CRC's will produce numbers like this. Many of the early spin-offs were the result of a lot of individual effort on the part of people like John Chapman, who was determined to build a Canadian space industry and Lew Hatton, who was determined to build a wireless industry. If they were alive today and in R&D jobs in the public sector, they would feel the heat of cost recovery and it is interesting to speculate on how successful they would be at the spin-off game.

While the margin of error in the above numbers is probably pretty large, they do suggest that the payback is something greater than zero, which is what was implied in a report that was widely quoted a few months back. Apparently prepared by Industry Canada, it attracted the following headline in the Oct. 10/06 edition of the Ottawa Citizen: "Government R&D Spending of Little Short-term Value".

Too much emphasis on short-term cost recovery can have a serious indirect impact on any R&D laboratory. It can actually encourage laboratory managers to keep the technology in-house and use it to provide a service that will generate revenues on a continuing basis rather than getting it over the wall as soon as it can be turned into a product or service or process. For example, lab managers are inclined to get into the testing business as opposed to encourage the formation of an outside company (or a new product line in an existing company) to perform such a service — or better still to supply a product that would allow users to do their own testing. The ultimate consequence of pursuing such end uses as revenue generators is that the scientists quickly lose their technical advantage that allowed them to come up with the superior method of testing or whatever in the first place.

Denzil Doyle is chairman of Doyletech Corp, an Ottawa-based company specializing in providing consulting services to entrepreneurs, investors, policy makers, and economic development authorities. From 1963 to 1981, he directed the affairs of Digital Equipment Corp's Canadian operations. From 1995 to 2005, Doyle served as chairman of Capital Alliance Ventures Inc., an Ottawa-based venture capital firm specializing in technology investments. In 2001, he was invested as a Member of the Order of Canada in 2005.