Problems of Economic Transition, vol. 53, no. 11, March 2011, pp. 6878. 2011 M.E. Sharpe, Inc.

. All rights reserved. ISSN 10611991/2011 $9.50 + 0.00. DOI 10.2753/PET1061-1991531105

S.A. ZaBOLOTsKII aND L.S. MaRKOV

Innovation Activity of Firms in the Domestic Chemical Industry

The article species the parameters of innovation activity and its general development trend, identies the factors inuencing the innovation activity of Russian chemical rms, and formulates the priority directions of investment and innovation development of Russian chemical companies for the near future.

The following parameters are taken as a measure of a rms innovation activity: spending on research and development (R&D) as a percentage of the cost of production and revenues, and the number of patent applications submitted by the rm. Only patents obtained on inventions are taken into account. The analysis was based on statistical data from the Ekspert rating agency,1 the BiznesInfoResurs consulting agency,2 and also the quarterly reports of the sixty largest rms in the Russian Federation. We used a data array that includes information on the production and economic activity of the fty largest chemical companies in the United States,
English translation 2011 M.E. Sharpe, Inc., from the Russian text 2010 EKO. Innovatsionnaia aktivnost predpriiatii otechestvennoi khimicheskoi promyshlennosti, EKO, 2010, no. 3, pp. 6475. The article was prepared based on materials from studies conducted as part of the basic research program of the Presidium of the Russian Academy of Sciences, no. 24, Fundamental Problems of Spatial Development of the Russian Federation: Interdisciplinary Synthesis (Project 10.3, Mechanisms for Stimulating Innovations in Mesoeconomic Systems of Siberia). S.A. Zabolotskii and L.S. Markov are Candidates of Economic Sciences afliated with the Institute of Economics and Organization of Industrial Production of the Siberian Branch of the Russian Academy of Sciences, Novosibirsk. Translated by James E. Walker.
68

MARCH 2011 69

Table 1

Research and Development Spending as a Percentage of Total Revenues of Russian and Foreign Chemical Firms in 2004 and 2007
Average rate of increase in 20042007 3.3 0.5 12.1 2.4 0.2 3.8

Region United States European Union Canada Japan Developed countries Russia

2004 2.8 4.6 8.6 3.0 3.7 0.25

2007 3.1 4.7 5.8 3.2 3.7 0.28

Source: Chemical and Engineering News.

Canada, European Union, and Japan.3 In relation to the general population, the sample was biased toward large-scale rms because they are the ones for which questions of reequipment and increasing the innovation component are the most critical. R&D in Russia and abroad Russian chemical rms invest signicantly less money in research and development than foreign companies do. On average for the sample, spending on R&D in 2007 was just 0.28 percent of total revenues (the average gure for developed countries is 3.7 percent) (Table 1). About 11 percent of Russian rms in the sample have not carried out scientic and technical activity for more than fteen years. This can be explained by the fact that chemical rms use innovative developments obtained from other business units in holding companies of which they are a part. Analysis of the rate of change in spending on R&D shows that almost two-thirds of the companies are oriented toward the growth of innovation activity and, in this case, order R&D from outside organizations. Among rms in the Russian chemical complex, no correlation was found between the percentage of investments in R&D and efciency parameters (and no signicant differences were revealed in the average

70 PROBLEMS OF ECONOMIC TRANSITION

protability gures between chemical rms that do and do not engage in innovation activity). Apparently, the existing economic growth indexes in Russia are based on extensive production buildup, and the growth of innovation activity as a whole has not been strengthened by the growth of the introduction of achievements. Among foreign rms, on the other hand, the percentage of spending on R&D correlates strongly with their protability: 0.653 (001) in 2007. Horizontal integration Horizontal integration can result in the concentration of market power in the relevant markets and lead to reduced competition and, accordingly, decreased spending on innovation activity. A horizontally integrated rm has additional competitive advantages thanks to reduced spending (as a result of consolidating marketing services and production processes) and a synergetic effect (from combining its R&D experience). One rm in a holding company can use inventions and efciency experts developments from other rms in the holding company (this can partly explain the lack of correlations mentioned above). Signicant differences in average R&D spending, for example, for fertilizer producers show that horizontally integrated organizations spend considerably less for this purpose but are ahead of independent companies in their return on assets (Table 2). Unfortunately, industrial collusion leading to a decline in the intensity of competition can occur under the guise of establishing vertical and horizontal ties in certain markets. Why develop a new product or technology, investing enormous sums in innovation, if you can prot from other competitive advantages? For example, relatively cheap gas feedstock provides an advantage for producers of nitrogen fertilizers. A group of rms that enjoys monopoly power obtains independence from competitors for a long time and can fully afford not to increase R&D spending. Marketing Business practice in the petrochemical sector involves distinctive technological features of production, transportation and marketing of the products, and petrochemical centers are located close to oil-rening centers, transportation and energy infrastructure, and large water supply sources.

MARCH 2011 71

Table 2 Return on Assets and Portion of Spending on Research and Development (R&D) for Horizontally Integrated Organizations and Independent Firms (fertilizer producers) in 2007 (%)
Average R&D spending as percentage of cost of production 0.07 0.74

Firms Horizontally integrated holding companies Independent rms

Average protability of the rm (return on assets) 27.3 9.9

A fairly inexible structure of production has been established, and there are serious constraints on transportation and sales of the products. In this business, everyone knows who sells what to whom. The nal product obtained from increasingly advanced processing is no longer tied to processors of intermediate products. A producer of mineral fertilizers receives ammonia through a pipeline and then produces a product from it that has to be sold. In the international economys contemporary realities of tight competition, the creation of a distribution network serves as a guarantee of success and efciency in running a business. For example, the Akron Holding Company bought a fertilizer sales chain in China at the right time and by doing so greatly improved its economic indexes. Therefore, the type of market in which a rm operates is an important factor in the efciency of innovation activity because different markets have different needs for sales promotion. The difference is particularly great between markets for industrial and consumer goods. In this case, it is important to understand that the entry of a rm that traditionally operates in an industrial market that produces, for example, polypropylene (material for plastic products) into a market for consumer goods (e.g., the market for extruded polypropylene products) requires an increase in marketing expenditures and the creation of an extensive sales network. Here, innovations and the creation of sales networks are complementary. A high level of orientation toward the consumer increases the rate of technological innovations. Setting up sales networks helps a rm to better interact with the nal consumer and, being focused on the consumers needs, to develop or improve the rms products. Proper organization of an in-house or controlled dealer network makes

72 PROBLEMS OF ECONOMIC TRANSITION

it possible to cover a larger part of the product market and to minimize expenses. It is no longer enough to simply develop and produce a highquality and inexpensive product. With a large number of interchangeable alternative types of products in the market, it is necessary to motivate the customer to buy the product. This is not easy to do. In the petrochemical industry, the marketing function is performed by a distribution network that provides for personal work with consumers, service after the sale, and exible contract nancing, as well as reliable and timely logistics. But a high level of orientation toward the consumer has a ip side: it can slow the rate of technological innovations. In contrast to ordinary ones, breakthrough innovations require a search for new customers, which frequently involves a change of consumers and the geography of product sales. In addition, the creation and servicing of a sales network is a diversion of signicant resources away from the basic activity, which, in conditions of limited nancial resources, also affects the funding of research and development (R&D). For example, the DuPont chemical company spends twice as much on marketing existing products as on developing new ones: $3.2 and 1.3 billion, respectively.4 The main question that managers of chemical companies have to answer is, where is the balance between investments in R&D, spending on promoting existing products, and investments in creating innovative ones? Patent activity of Russian and foreign companies The leading American, European, Canadian, and Japanese chemical companies register about forty to fty patents per year on average, while Russian chemical giants register eight to ten. Data on the patent activity of foreign and Russian rms (Table 3) indicate that saturation in producing existing products has been attained in the economies of developed countries, and hence chemical companies are doomed to an ongoing search for innovations. New materials and technologies According to Russian patent statistics, the number of patents registered in the past ve years for new technologies to produce existing chemical products and auxiliary substances was 70.9 percent of the total number of patents. This is three times more than the number of patents for in-

MARCH 2011 73

Table 3 Breakdown of Patents Obtained by Russian and Foreign Chemical Companies in the Past Five Years (%)
Percentage of total number of patents In Russia New technologies for producing existing chemical products New chemical products (including new brands of existing products and chemical compounds) New technologies for producing auxiliary substances (catalysts, inhibitors, modiers and other additives, etc.) New auxiliary substances New technologies for reducing pollutant emissions Energy-saving technologies Other Total 53.0 In developed countries 29.1

16.2

42.2

17.9 3.6 4.1 2.7 2.5 100.0

15.4 7.7 1.2 4.2 0.2 100.0

ventions of new chemical compounds and products. The gap between these types of patents has increased at an average rate of 5 percent per year in the past ve years. The reason is that the Russian market for traditional types of chemical products is not yet saturated, and the innovation process takes place in the technological sphere of improving traditional products. An analysis of Russian patent activity showed that a larger number of patents for technologies to produce existing products corresponds to a larger number of patents in the eld of invention of new chemical products. In this case, the correlation coefcient, 0.631 (001), means that product innovations are closely interrelated with process innovations. Unfortunately, the method for studying rms innovation activity according to the number of patents registered is imperfect. A patent is only one way to protect new ideas and technologies; it is easiest to check patent violations in the sales stage and almost impossible to do so in production. Therefore, many rms use a different means of protection: commercial secrets.

74 PROBLEMS OF ECONOMIC TRANSITION

Product diversication Producing different nal or intermediate products makes it possible to insure against cyclicity of demand because all products do not usually go into a downturn at the same time. The analysis of data for the past ten years 5 reveals a signicant correlation between the degree of product diversication and the effectiveness of innovation activity (correlation coefcient 0.598 [0.01]). Firms with a more diversied product line generally conduct research in more than one direction at the same time. This is because chance plays a fairly signicant role in the organization of research: some of the best chemical compounds, materials, and chemical technologies to date were invented more by a stroke of luck than as a result of purposeful research. Consequently, rms that have a diversied product line invest in several directions of research simultaneously, thereby increasing their chance of making a discovery. With research in one direction (improving one substance or technology), the limit of possibilities may be reached sooner. In turn, research diversication fosters innovation efciency, although it is hard to foretell what percentage of new products will be obtained as a result of R&D. Some chemical rms start as many projects as they can (within the rms core competence and relying on its accumulated scientic and production experience) in the hope that some of them will be successful. In this case, so as not to miss promising directions, the question of specialization or diversication should be decided personally in each specic case by the researcher (or developer) whose job it is to look for new ideas. Special chemistry imports To produce not feedstock but high-quality nished products it is necessary to use what is called special chemistry. This refers to all kinds of catalysts, active auxiliary substances, stabilizers, inhibitors, additives, colorings, and substances that improve or modify the properties of plastics, rubber products, chemical bers, and synthetic detergents. There is obviously a shortage of Russian high-tech developments, and the necessary substances cannot always be purchased abroad; they are frequently the know-how of a particular competitor. If these additives

MARCH 2011 75

are not used, then the consumer properties of the product will be low, which may have a bad effect on its fate in the market. The correlation between the percentage of the cost of production spent on R&D and on imported feedstock is negative: 0.578 (001). Acquiring highly effective additives and reagents makes it possible to increase the economic effect of basic petrochemical production processes and save a signicant amount of money on research and development, and it minimizes all kinds of risks when these substances are introduced into the production process. Moreover, many chemical and petrochemical plants in Russia are technologically reequipped through the introduction of imported technologies. Equipment is supplied on strictly regulated credit terms that obligate the purchaser to also buy all kinds of chemical additives in coming years, since distinctive characteristics of the technological process are specially designed for a particular reagent or catalyst. Thus, by importing special chemistry we are funding the foreign scientic and production base for the development of improved catalysts, inhibitors, and modiers. The way out is obvious: we need to revive our own production of special chemistry. Promising development directions In recent years, demand for polymers such as low- and high-density polyethylene (LDPE, HDPE), polyvinylchloride (PVC), and polypropylene (PP) has grown rapidly, thus also increasing the demand for the intermediate products from which they are produced. We know that innovation and investment activity in this segment was a consequence, in turn, of precrisis growth of demand on the part of the construction sector. It is not expected that the galloping precrisis growth rates of housing construction will resume, although the construction of infrastructure facilities and low-rise construction may provide the necessary demand for a number of petrochemical companies that produce construction materials from these polymers. Following current trends is not always helpful to innovation processes. For a professional whose habits and attitudes were shaped by a growing market and reinforced by successes that have been achieved it is very hard to see different approaches to things that have been known for a long time. The professionalism that he has attained does not allow him to see a problem differently, but breakthrough innovation strategies require new approaches and distancing from traditional ways of thinking

76 PROBLEMS OF ECONOMIC TRANSITION

and acting.6 That is why, even though the rst signs of stagnation in the construction sector already appeared in 2004 (HDPE, PVC, and PP are used in producing plastic windows and linoleum, plastic pipe, etc.), many rms continued to increase their output and invest in new capacities for producing these polymers. There is a clear example from international practice when rapid growth of demand for terephthalic acid (an intermediate product for producing polyethylene terephthalate) caused a price increase to $1,000 per ton in 1996 and motivated producers all over the world to invest in constructing additional capacities. When they went into operation, prices fell to $250300 per ton.7 Innovations largely follow market trends. This explains why in the Russian chemical industry innovations are seen in the sphere of improving the technologies for traditional products rather than creating new ones. At this time, there are not many plants, or whole subsectors, in Russia that could meet the domestic demand. More than 50 percent of Russian consumption is covered by imports in the following groups of polymers: linear high-density polyethylene, polyethylene terephthalate, acrylonitrile butadiene styrene (ABS) plastic, polyurethane, polycarbonate, polybutylene terephthalate, and uoropolymers, including polytetrauoroethylene (Teon), polyacetates, and polysulfones, as well as various silicone polymers (Table 4). In the near future, major Russian polymer producers undoubtedly will start moving into these market niches. The only question is, will a backlog be created for a Russian research and design component? Or will all of the equipment be acquired from foreign colleagues, and will turnkey plants be built? However, this way can also be successful: in China (back in the day of Deng Xiaoping) they followed the principle of technology in exchange for the market, which meant letting foreign companies have part of the local market in exchange for supplying modern, progressive technologies. Of course, this meant creating joint ventures. It might be possible for Russian industry to follow this principle, the more so as the crisis has led to a considerable decrease in the cost of foreign technologies. Conclusions With a certain degree of caution, it can be said that the innovation component of business in the Russian chemical

MARCH 2011 77

Table 4 Imports of Polymers Consumed in Russia in 2007

Polymers Polybutylene terephthalate Polycarbonates Linear high-density polyethylene Polyethylene terephthalate ABS plastic Fluoropolymers Expanded polystyrene (EPS) Polypropylene Polyvinylchloride Polyamides General-purpose polystyrene (GPPS) Impact-resistant polystyrene % 100 99 90 74 65 60 40 35 30 28 12 10

industry remains low. While most rms do systematically engage in technological innovations, they resort to using foreign scientic developments increasingly often and sometimes use turnkey construction to modernize their production process. The concentration of financial and human resources, and accumulated experience, is also an important factor. For example, two or three companies that have concentrated all of the scientic engineering potential are dominant in the United States and Western Europe: Lummus, Kellog (United States), Linde (Germany), and Technip (France). These companies create all of the signicant breakthrough inventions and sell licenses and technologies to other rms (which, in turn, produce the nal chemical products). In Russia, efforts are dispersed among a large number of companies; a critical mass of knowledge, experience, and nances is thus lacking, and inventions only involve improving what has already been invented. Emergence of a critical mass capable of creating breakthrough technologies, materials, and chemical compounds requires the accumulation of all types of resources. For an individual business that has limited nancial capabilities, it is too risky to invest in innovation projects. Under

78 PROBLEMS OF ECONOMIC TRANSITION

these conditions, the intensive intervention of government institutions is needed, at least to create the infrastructure and legal conditions for future construction of innovative rms. Notes
1. Khimicheskii kompleks Rossii, no. X, RA Ekspert electronic database, 2007. 2. BiznesInfoResurs analytic information system, http://bir.prime-tass.ru. 3. Chemical & Engineering News, reports, http://pubs.acs.org/cen. 4. K. Lukach, My liubim sotrudnichat. Etim i unikalny, Ekspert, 2007, no. 46 (587); vailable at http://expert.ru/printissues/expert/2007/46/qa_lukach. 5. Only patents for the invention of new chemical products or technologies are taken into account; patents for producing prototypes and trademarks are disregarded. 6. C. Bijon, La strategic de rupture, Harvard-Lexpansion, Autumn 1984, pp. 98104. 7. O.B. Brazinskii, Mirovaia neftekhimicheskaia promyshlennost (Moscow: Nauka, 2003).

To order reprints, call 1-800-352-2210; outside the United States, call 717-632-3535.