ISA recommends that Government rebalance its policy mix to support business investment in both non-R&D innovation and R&D, specifically with significant additional support for non-R&D innovation for a defined period, say, 5–10 years.
Australian businesses are increasingly recognising the importance of non-R&D innovation in addition to more traditional R&D
Innovation is key to business success, but where innovation comes from is changing. Today’s firms are looking beyond R&D to drive innovation.  While business investment in R&D remains important, Australian data shows our firms are investing in innovation activities beyond R&D.  These investments are in non-R&D categories such as enhanced business models, marketing and branding, productivity-enhancing technologies (including software and systems) and intellectual property acquisition. Investments are also being made in tangible assets such as innovation-related machinery and equipment. We refer to these as investments in non-R&D innovation.
Investment in non-R&D innovation is important
The OECD has found that non-R&D innovation plays a significant role in increasing business value. For example, between 1995 and 2010, United States (US) spending on R&D rose from 2.3 to 2.4 per cent of value-added across the economy. Over the same period, business spending on non-R&D innovation increased from 8.5 to 11.2 per cent of value-added across the economy.  Similar results were found in many other countries. Overall, private R&D stocks represented no more than 20 to 25 per cent of the total private stocks of business investment in innovation.
Innovation can spur economic growth because the initial cost incurred in developing some types of knowledge does not need to be incurred again when that knowledge is used in production. Once created, some forms of innovation (such as software and some designs) can be replicated at almost zero cost and this can lead to increasing returns to scale in production.
Asset-light, customer-loyalty focused businesses (such as Google and Amazon) are prime examples of the value created by non-R&D innovation, combined with R&D investments. Research suggests that technological progress and the accumulation of intangible capital have accounted for over half of the increase in output, per hour, in the US. Similar findings have been made in comparable economies. 
The European Commission has found that intangible assets are at the heart of firm competitiveness and are vital for productivity and economic growth.  Firm-level productivity increases as a result of R&D investments were also demonstrated for other intangible assets categories including human capital, organisational capital, customer capital and computerised information (software and databases). The paper notes that there is a need to improve the measurement of intangible assets to capture the ongoing shift from tangible to intangible investments and to ensure evidence-based policy making. 
Non-R&D innovation can also play an important complementary role to R&D investment. R&D may generate significant local process or product innovations. However, non-R&D innovation diffuses global and local innovation through the economy and boosts firm performance through smaller and more continuous innovations.  A recent OECD report has found robust evidence that digital adoption is associated with productivity gains at the firm level. 
Examples of how Australian business invests in non-R&D innovation
Australian firm RedEye creates value for its clients through investment in R&D and non-R&D innovation. RedEye was founded in Brisbane in 2012 to improve the way clients manage assets and critical infrastructure. Based on an identified need in the market, the RedEye founders developed cloud-based engineering software that allows secure sharing of engineering data across locations and teams. RedEye also provides training and support services for its clients.  The company raised $10.4 million from the Queensland Government’s Business Development Fund and US investor Energy Innovation Capital in 2018 to help fund its international expansion. RedEye now employs about 100 people and has clients who manage more than $200 billion worth of critical infrastructure. In 2018–19, RedEye established its third office in North America, opened a new office in New Zealand and is furthering plans to enter Europe. 
Abbe Corrugated manufactures a variety of corrugated packaging, from cardboard packaging for fruit and vegetables to specialised packaging for chemicals and dangerous goods. Abbe recently developed a marketing strategy to support new market growth opportunities. They invested in new technology to support these growth plans, including multi-million dollar specialist printing equipment from Spain – the only equipment of its type in Australia. This technology has allowed Abbe to deliver new products and services, including tailor-made printed packaging for customers’ specific needs. A new digital workspace allows customers to visit the factory and acquire a greater understanding of Abbe’s products and how they can be customised to their needs. Through these non-R&D innovation activities, Abbe has created 23 new jobs. The result has been an increase in revenue, profits and market opportunities.
Subcon is a market-leading company that provides solutions to some of our most vexing marine challenges. The company draws on expertise in marine engineering, construction and knowledge of the oil and gas industry to create innovative products that meet critical fisheries needs.
Subcon has invested in non-R&D innovation in its innovative business model. Its flexible business model allows the firm to be highly responsive to customer needs. Constant exposure to customer needs has created opportunities for Subcon to improve its current technology. For example, Subcon’s repurposing of oil and gas platforms was an innovative solution to meet customer needs and address an environmental problem.
BERD is not a strong predictor of innovation investment
AlphaBeta analysis shows sectors where many firms are actively innovating are more likely to have greater productivity, whether or not they conduct R&D.  Australian firms that invested in innovation (both non-R&D innovation and R&D) had higher revenue and job growth than those that did not.
Australian firms invest just as much in non-R&D innovation as they do in R&D
Australian business investment in both R&D and non-R&D innovation is estimated to be two per cent of gross domestic product (GDP) or $32–$36 billion per annum (see Exhibit 2).
Exhibit 2 demonstrates that non-R&D innovation investment is at least as widespread as business investment in R&D.
AlphaBeta analysis also shows only 5.8 per cent of Australian firms reported investing in R&D, while 32 per cent invested in at least some form of innovation (that is R&D, non-R&D innovation or both). Also, of those firms that did invest in R&D, four in five spent more than half of their innovation budget on non-R&D activity.
Small firms are more likely to invest in non-R&D innovation than large firms. This is important due to the central role small firms play in Australia’s economy.  As previously mentioned, international research points to a strong correlation between intangible capital investment and an increase in labour productivity growth, and economic growth. 
Exhibit 2: Australian business investment in innovation, 2016–17
Source: BERD: ABS (2017), 8104.0 (for 2015–16); Total business investment in innovation: ABS (2018) 8158.0 Appendix 1: Explanatory Notes: Innovation Expenditure by Dollar Ranges (for 2016–17); Non-R&D innovation calculated as the difference between BERD and Innovation. (It is likely that the measure of R&D in ABS 8104 is more reliable than any measure that could be inferred from ABS 8159.)
Australian firms that invested in innovation (either non-R&D innovation, R&D or both) had higher revenue and job growth than those that did not
AlphaBeta found that, on average, large and small firms that invested in innovation outperformed firms that did not invest in innovation.  ASX200 firms in the top quartile, by intangible asset share of total assets, grew revenue 1.3 percentage points per year faster than the average ASX200 firm revenue growth. This analysis also found that large firms that reported spending on intangible assets or spending on R&D activities were more likely to survive than those that reported neither. 
For SMEs, those that accelerated their investment in technology and were more sophisticated users of IT, had higher revenue and employment growth than those that didn’t conduct innovation activity or invest in IT.  SMEs with high growth in technology spending increased revenue by an additional 3.5 percentage points per year faster and employment by an additional 5.2 percentage points faster than those with low technology spending growth. Similarly, SMEs that adopted at least one business software application, in areas such as finance, human resource management, marketing and sales, increased employment by 2.2 percentage points faster than others.
Why should the government support non-R&D innovation?
As businesses are already increasing their investment in non-R&D innovation, the question that could be asked is, “Why should government encourage additional non-R&D business investment? Where is the market failure?” Despite the relative buoyancy in non-R&D innovation, Australian business investment in innovation lags behind developed country averages.  Australia’s business innovation as a share of GDP is at 1.9 per cent, just two-thirds of the European average of 2.9 per cent.  Given the revenue and jobs growth correlations with business non-R&D investments, there is a case to encourage and accelerate greater non-R&D innovation.
Government intervention to accelerate non-R&D innovation investment is appropriate for reasons similar to those that have long underpinned government support of R&D; namely that non-R&D innovation investments produce spillovers and synergies that cannot always be captured by the business investing. Intangible assets, which include R&D and many non-R&D categories, are often especially valuable when combined with other intangibles and human capital.  For example, a change in business model may trigger additional investment in information and communications technology (ICT) systems and software that is supported by additional training of staff to maximise the benefit from the new investments.
When ISA asked firms about barriers to non-R&D innovation investment, businesses identified information asymmetry challenges such as barriers to enabling greater collaboration, supply chain partnering, and working more closely with customers. There was a lack of understanding of the potential benefits of collaborating, a lack of information about potential partners and high costs to identify them, and a lack of trust in dealing with business partners. Businesses also highlighted the burden of high cost legacy ICT systems and identified access to finance as a key barrier to investing and participating in the ‘new’ economy.
All these market failures impact on the ability of businesses to create thriving industry ecosystems and result in a sub-optimal investment in innovation.
There is a role for government to coordinate, facilitate and act as a catalyst for innovation and develop new markets for businesses.
Given the potential for non-R&D innovation investment to boost productivity, jobs and growth potential, it is imperative that government supports and accelerates business investment in non-R&D innovation to quickly realise these gains.
Examples of government-led initiatives
Example A. Greater investment in technology
ISA recommends that Government reduce reliance on the R&D Tax Incentive (R&DTI) as the primary support to businesses and complement support with direct measures (such as grants) to encourage non-R&D innovation investment.
As a high priority, direct measures need to be used to encourage greater investment in technology and digital innovation. An example of such a support measure could be a business ICT modernisation fund to help businesses move from legacy ICT systems to more modern capabilities.
Over time, government support for business innovation has favoured measures focused on increasing the supply of R&D, rather than support for a range of activities across the innovation spectrum. The Productivity Commission reported that total Commonwealth support for business R&D has remained steady over five years, representing around $4.1 billion.  The R&DTI accounts for the bulk of the government’s R&D support to industry. The Science, Research and Innovation (SRI) Budget Tables estimate the cost of the R&DTI to the government at $2.06 billion for FY 2019. 
Direct support measures can play an important role in providing targeted support for business investments in general-purpose technologies. They have also been shown to be particularly effective for young firms that lack the upfront funds or collateral to finance an innovative project.  There is a need to support non-R&D innovation through more direct and targeted support measures.
Government could use a number of different direct mechanisms to rebalance the support between R&D and non-R&D innovation investments. The most appropriate mechanism should be determined through more detailed analysis. However, ISA believes a focus on software, digital transformation and ICT is warranted because these technologies act as enablers of productivity across multiple sectors.
Example B. Government procurement
ISA recommends that, where appropriate, government leverage its procurement of products and services to promote a more innovation-oriented response from business and build business capability. In particular, there needs to be a focus on procurement policy that can deliver innovative solutions for government and growth opportunities for innovative firms.
Many countries have used government procurement, including challenge-based approaches, to support the development of an innovation ecosystem and drive productivity growth. The US’ Small Business Innovation Research program, the United Kingdom’s (UK) Small Business Research Initiative, and Innovative Solutions Canada are all designed so that government can solve problems with the help of innovative SMEs.
Governments in Australia have been using challenge-based procurement such as the Business Research and Innovation Initiative and Small Business Innovation Research for Defence. However, these are not on a scale to create sufficient demand for innovation from firms and truly move the needle.
Government is a major purchaser and its procurement processes are a training ground for customer engagement. The use of government procurement to increase business investment in innovation could impact how businesses think about the value of innovation and drive considered risk taking.
There are opportunities across governments in Australia to leverage and coordinate challenge-based procurement programs. This would build scale, provide innovative solutions to governments and generate more customers for innovative firms.
There are examples of the Australian Government creating opportunities for Australian firms using procurement. For example, the digital marketplace channelled $300 million of IT procurement, from a $9 billion budget, to SMEs.
Overall, the government spent $71.1 billion on procurement contracts in 2017–18.  Some of this expenditure could be used to support the business innovation ecosystem. There is evidence that procurement can significantly boost innovation spillover effects, in particular in social and environmental areas. 
Case study 1: GreenBe – example of R&D and non-R&D innovation
GreenBe’s innovation journey demonstrates the importance of investing in both non-R&D innovation and R&D, and the critical role government procurement played in the organisation’s success. Read Case study 1: GreenBe.
- OECD. (2013). Supporting investment in knowledge capital, growth and innovation, p. 17. ↵
- AlphaBeta. (2019). Australian business investment in innovation: levels, trends, and drivers, p.5. ↵
- OECD. (2013). New sources of growth: knowledge-based capital key analyses and policy conclusions synthesis report, p. 13. ↵
- Corrado, C., Hulten, C., & Sichel, D. (2009). Intangible capital and US economic growth. Review of income and wealth, 55(3), 661-685. and Corrado, C. A., & Hulten, C. R. (2010). How do you measure a "technological revolution"? American Economic Review, 100(2), 99-104. ↵
- Thum, A. E., Voigt, P., Bilbao-Osorio, B., Maier, C., & Ognyanova, D. (2017). Unlocking Investment in Intangible Assets (No. 047).
Directorate General Economic and Financial Affairs (DG ECFIN), European Commission. ↵
- Thum, A. E., Voigt, P., Bilbao-Osorio, B., Maier, C., & Ognyanova, D. (2017). Unlocking Investment in Intangible Assets (No. 047).
Directorate General Economic and Financial Affairs (DG ECFIN), European Commission, p. 19. ↵
- AlphaBeta. (2019). Australian business investment in innovation: levels, trends, and drivers, p. 24. ↵
- Gal, P., Nicoletti, G., Renault, T., Sorbe, S., & Timiliotis, C. (2019). Digitalisation and productivity: In search of the holy grail-Firm-level empirical evidence from EU countries. ↵
- Further information is available on the Redeye website. ↵
- This information has been taken from the Trade and Investment Queensland Annual Report 2018–19. ↵
- AlphaBeta. (2019). Australian business investment in innovation: levels, trends, and drivers p. 39 and Palangkaraya, A., Spurling, T., & Webster, E. (2016). What drives firm innovation? A review of the economics literature. ↵
- AlphaBeta. (2019). Australian business investment in innovation: levels, trends, and drivers, p. 9. ↵
- Palangkaraya, A., Spurling, T., & Webster, E. (2016). What drives firm innovation? A review of the economics literature. ↵
- Thum-Thysen, A., Voigt, P., Maier, C., Bilbao-Osorio, B., & Ognyanova, D. (2017). Unlocking investment in intangible assets in Europe. Quarterly Report on the Euro Area (QREA), 16(1), p. 25. ↵
- AlphaBeta. (2019). Australian business investment in innovation: levels trends, and drivers, p. 35. ↵
- AlphaBeta. (2019). Australian business investment in innovation: levels trends, and drivers, p. 35-36. ↵
- AlphaBeta. (2019). Australian business investment in innovation: levels trends, and drivers, p. 38. ↵
- AlphaBeta. (2019). Australian business investment in innovation: levels trends, and drivers, p. 24. ↵
- AlphaBeta. (2019). Australian business investment in innovation: levels trends, and driver,s.p. 24. ↵
- Haskel, J., & Westlake, S. (2018). Capitalism without capital: the rise of the intangible economy. Princeton University Press. ↵
- Australian Productivity Commission. (2017-18). Trade and assistance review, pp. 5–6. ↵
- View the SRI Budget tables. ↵
- OECD. (2015). The innovation imperative – contributing to productivity, growth and well-being, STI policy note, p. 6. ↵
- Australian Government Department of Finance, Australian Government Procurement. ↵
- Mazzucato, M. (2015). The entrepreneurial state: Debunking public vs. private sector myths. (Vol. 1). Anthem Press. ↵