R&D spending under pressure

Yes, R&D spending is down in this economy, but how the big players are reacting may surprise you.

When Teck Cominco Ltd. (TSX: TCK.B) said in January that it would reduce its workforce by 1,400, the mining giant didn’t limit the cuts to the corporate and production levels — research and development was also chopped. But Teck isn’t the only firm reducing R&D these days.

“We certainly have prioritized, rather than stop things,” says John Thompson, Teck’s Vancouver-based vice-president of technology and development. Projects that provide short-term improvements remain on the company’s to-do list, but investments in long-term technologies for improved production efficiency in, say, five to 10 years, have been put on the back burner.

“Quite a number of the people we had to lay off worked in that area,” Thompson says. His department used to have 200 employees, but now has about 140.

Teck isn’t alone. According to Research Infosource Inc., which publishes a list of Canada’s top R&D companies each year, plenty of this country’s biggest research and development spenders are rethinking their investments during these difficult economic times.

While the recession causes companies to adjust their R&D and prioritize projects, Ron Freedman, Infosource’s CEO, doesn’t expect to see a major shift in the kinds of companies that top Infosource’s R&D spending list. Telecom companies such as BCE (second biggest spender in 2007) and aerospace companies like Pratt & Whitney Canada (fourth place) will continue to spend. Biotechs such as Apotex Inc. (10th) will probably always show well. And even Nortel, in first place for 2006 and 2007, will likely soldier on with substantial R&D budgets, provided the company remains in business.

“Many companies will cut back on R&D spending — particularly companies that don’t have profits,” says Freedman.

Witness Teck. In February the company reported a net loss of $607 million — $1.28 per share — for Q4 2008, thanks in part to falling commodity prices. Bombardier Aerospace, the aeronautical arm of Bombardier Inc. (TSX: BBD.B) and the world’s third-largest civil aircraft manufacturer, in February reduced its workforce by 4.5% or 1,360, and in April cut another 3,000 in response to decreased demand for its business aircraft.

And of course there’s Nortel Networks (TSX: NT), now bankrupt after what seemed to be quarter after quarter of bad news dating back to 2001, when an apparently insatiable demand for the company’s network equipment suddenly dried up. But despite the persistent troughs in its profit track record, according to Infosource, Nortel was Canada’s biggest R&D spender in 2007, shelling out $1.8 billion for research and development that fiscal year. In early March, reporting its Q4 2008 numbers (including a US$2.1 billion loss), Nortel said its R&D expenditures rang in at US$335 million, down from US$475 million in the same quarter the previous year.

How are businesses prioritizing their R&D in the recession? The answer depends on whom you ask.

Despite bankruptcy, Nortel continues to pour money into a wireless networking technology dubbed LTE. But the firm has turned away from a competing technology called WiMAX because it didn’t jibe with the company’s recovery plans, according to Vish Nandlall, chief technology officer of Nortel’s carrier networks division.

“WiMAX was shaping up to be a technology implemented by alternative operators,” not the established “incumbent” network operators Nortel sees as its main customers, he says. “We believe 80% of the incumbents will move to LTE.”

At Teck, a promising long-term project for improved production efficiency has been put on the slow road. Known as CESL (pronounced “Cecil”) this new twist on hydrometallurgy could help mining companies extract more metal from concentrate in a less environmentally harmful way than other methods. CESL could also allow the metal to remain at mine sites, deferring the cost of transporting concentrate to a smelter. Thompson says most new mining projects across the industry are likely to be delayed by at least two years because of market conditions.

Meanwhile, Bombardier Aerospace seems ready to maintain its R&D spending. In FY09 the company invested US$171 million on R&D, up from US$140 million over the same period in FY08. According to Francois Caza, vice-president and chief engineer, in its quest for lighter airplanes and better fuel efficiency, Bombardier is focusing on advancements such as composite materials, which replace aluminum in parts such as the fuselage. The company is also researching new electrical systems that operate more efficiently than traditional turbine-powered systems.

“Our process for research and development and demonstrating technology ahead of any program launch is one tactic we’ve used and we’ll continue to use,” Caza says. “Even through economic downturns, we have to be ready for the future launches. … It’s important that we don’t miss an opportunity.”

If a company reduces its R&D spending, will the firm necessarily find itself operating at a competitive disadvantage? For research-intensive sectors such as telecommunications and high-tech, pullbacks could be disastrous. “To be in the telecom equipment business, you have to be spending 15% to 20% of revenue on R&D,” says Infosource’s Freedman. “It comes with the territory.”

But it’s less of a concern for sectors in which everyone has cut back, such as mining. “It’s industry wide — balance sheet conservation as a strategy,” says John Hughes, a Desjardins Securities analyst covering Teck. Businesses that reduce their R&D exposures in these areas “would not be missing much,” he says, because no one would have the competitive advantage.

By contrast, Research In Motion Ltd. (TSX: RIM) has said it will hire 3,000 new staff members to help maintain its momentum in the mobile communications market. In January the company shipped its 50 millionth BlackBerry smartphone, and in February won the best mobile technology breakthrough award at the Mobile World Congress in Barcelona for the touchscreen BlackBerry 9500. (RIM was unavailable for comment.)

Microsoft Corp. (Nasdaq: MSFT) certainly isn’t struggling for its life the way many commodity-driven businesses are, but the software giant isn’t insulated from the recession either. In January the firm announced it would lay off 5,000 employees in numerous departments, including R&D. Company representatives wouldn’t expand on the cuts or say if there would be any layoffs at its Richmond, B.C., development centre, but company watchers are keeping an eye out.

Jeff Gaggin, senior analyst at Avian Securities, says he’d like to see Microsoft focus its R&D on specific areas: “Continued investment on the client side and the server tools business. They have to step up efforts in online and search, in terms of building partnerships to increase their distribution.”

Gaggin’s Microsoft outlook includes a share price near US$24 — about 14 times the company’s 2009 earnings, calculated by the calendar year, and well above the US$17 average it maintained in late February. He says the company could cut into its R&D spending more if it had to consider another round of layoffs. “They’ve cut back a bit, but they need to maintain an investment to take market share. If the economy takes a bigger dive they’ll make adjustments.”