Planning Report 05-1

Measuring Service-Sector

Research and Development

Prepared by:

RTI International

for

National Science Foundation

and

National Institute of

Standards & Technology

March 2005

U.S Department of Commerce

Technology Administration
 

*RTI International is a trade name of Research Triangle Institute. 

 RTI Project Number 

08236.002.004 

Measuring Service-Sector 

Research and Development 

Final Report 

March 2005 

Prepared for 

John Jankowski 

National Science Foundation 

 Division of Science Resources Statistics 

4201 Wilson Boulevard. 

Arlington, VA 22230 

Gregory Tassey, Ph.D. 

National Institute of Standards and Technology 

Acquisition and Assistance Division 

Building 101, Room A1000 

Gaithersburg, MD 20899-0001 

Prepared by 

Michael Gallaher, Ph.D. 

Albert Link, Ph.D. 

Jeffrey Petrusa, B.A. 

RTI International* 

Health, Social, and Economics Research 

Research Triangle Park, NC 27709 
iii 

Contents 

1. Introduction 1-1

1.1 Trends in Research and Development (R&D) Activity.................1-3

1.2 Institutional History of Sampling Nonmanufacturing R&D 

Firms ............................................................................................1-4

1.3 Unresolved Issues........................................................................1-5

1.4 Focus Industry Case Studies .......................................................1-6

1.5 Outline of the Report ....................................................................1-6

 2. Currently Reported Service-Sector R&D 2-1

2.1 Definition of R&D..........................................................................2-1

2.2 R&D Expenditures by Sector .......................................................2-2

2.2.1 R&D Flows Within and Between Sectors........................2-3

2.3 R&D Measurement and Classification Issues..............................2-6

2.3.1 Identifying Service-Sector R&D ......................................2-6

2.3.2 R&D Measurement Issues in the Service Sector............2-7

2.3.3 Industry Classification Issues..........................................2-8

2.4 Summary of Composition of Current R&D Statistics....................2-9

 3. Innovative Activity in Services 3-1

3.1 Innovative Activity in Manufacturing.............................................3-1

3.2 Innovative Activity in The Service Sector.....................................3-3

3.3 Differences Within Service-Sector Innovation Activities ..............3-6

 4. Recommendations for the RD-1 Survey Instrument and 

Instructions 4-1

4.1 Recommendations for Existing Survey Instrument and 

Instructions...................................................................................4-2

4.1.1 Recommendation for Title...............................................4-2

4.1.2 Recommendation for the Definition of R&D in the 

Instructions......................................................................4-2

4.1.3 Recommendation for Question 3 ....................................4-2
iv

4.1.4 Recommendations for Question 4 ..................................4-3

4.1.5 Recommendation for Question 7: Source of 

Federally Funded R&D....................................................4-3

4.1.6 Recommendation for Question 8: Source of 

Federally Funded R&D....................................................4-4

4.1.7 Recommendation for Question 9: Types of R&D 

Expenses.........................................................................4-4

4.1.8 Recommendations for Question 10 ................................4-4

4.1.9 Recommendation for Question 13 ..................................4-5

4.2 New Questions.............................................................................4-5

4.2.1 New Question #1.............................................................4-5

4.2.2 New Question #2.............................................................4-5

4.2.3 New Question #3.............................................................4-6

4.2.4 New Question #4.............................................................4-6

4.2.5 New Question #5.............................................................4-6

 References R-1

 Appendices 

A: Telecommunications Sector.........................................................A-1

B: Financial Services Sector Case Study.........................................B-1

C: Systems Integration Services Sector .......................................... C-1

D: Research Development and Testing Service Sector .................. D-1

E: Definitions of R&D........................................................................E-1

F: 2003 Survey Instructions and Instrument ....................................F-1
v

Figures 

 Figure 1-1 Real Industrial R&D, Total, and Nonmanufacturing Performance 

($1996)...................................................................................................1-3

 Figure 1-2 Nonmanufacturing Share of Total Business R&D in 2001, 

Selected OECD Countries .....................................................................1-4 

 Figure 3-1 Model of Innovation in a Technology-Based Manufacturing 

Industry ..................................................................................................3-2

 Figure 3-2 Model of Innovation in a Technology-Based Service Industry...............3-4
vi

Tables 

 Table 1-1 Traditional Comparison of Manufacturing and Services Systems’ 

Traits ......................................................................................................1-2 

 Table 2-1 R&D Expenditures .................................................................................2-4

 Table 2-2 R&D Intensity of Inputs and Value Added .............................................2-5
1-1

1 Introduction 

The U.S. service sector is the largest sector in the economy1 and 

accounts for an increasingly significant share of gross domestic product 

(GDP).2 If we define the service sector as the nonmanufacturing, 

nonagricultural, nonmining, and nonconstruction sectors, it accounted for 

78.9 percent of GDP in 2002 (Council of Economic Advisors, 2004) and 

for 83 percent of nonagricultural employees (Council of Economic 

Advisors, 2004). In addition to being a driving domestic economic force, 

service-sector revenues in the United States account for about one-third 

of service-sector revenues worldwide.3

Service-sector industries are characterized by a close interaction 

between production and consumption, high information content, the 

intangible nature of their output, and a heavy emphasis on labor capital 

in the delivery of their output (Sirilli and Evangelista, 1998). Historically, 

the service sector was viewed as having little or no productivity growth 

and an inability to innovate. It was also characterized by low-paying 

jobs, low levels of technological dependence, and a relatively 

undeveloped level of institutional organization (see Table 1-1). In 

contrast, the manufacturing sector, producing tangible outputs, was seen 

as the source of most innovation. 

 

1The service sector is also referred to as the nonmanuracturing sector. However, there is 

some disagreement among policy makers and economists as to a precise definition of 

what constitutes the service or service-providing sector. 

2From a North American Industry Classification System (NAICS) data classification 

perspective, the definition of services is still evolving. See Mohr (1999). 

3Between 1980 and 2001, revenues from U.S. service industries relative to the rest of the 

world have averaged 32.3 percent. See National Science Board (2004). 
Measuring Service-Sector Research and Development 

1-2

Table 1-1. Traditional Comparison of Manufacturing and Services Systems’ Traits 

System Trait Manufacturing Services 

Intellectual property rights Strong; patents Weak; copyright 

Technology orientation Technology “push”; science 

and technology led 

Technology “pull”; consumer/clientled (co-terminality) 

Research/innovation “In-house” Out-sourced—embodied in 

purchases, inputs 

Labor productivity High impact High impact (since the 1980s) 

Innovation cycle times Short Long (except for computer services) 

Product characteristics Tangible, easy to store Intangible, difficult to store 

Spatial scale of system or “reach” National, global Regional, national 

Source: Adapted from Howells (2000a). 

The intangible nature of service products makes distinguishing between 

product and process difficult.4 For this reason, industries in the service 

sector have traditionally been viewed as “laggards” or static, technologyconsuming, noninnovative companies that provide nontechnical products 

(Tether and Metcalfe, 2002; Tether, Hipp, and Miles, 2001; Sundbo, 

1997; Miles, 1993). 

In recent years the service sector has come to be viewed as a dynamic 

component of the economy, characterized by the large consumption of 

new technologies and human capital. As one example, the observable 

growth in Internet and Web-based services and high-technology 

environmental services indicates that knowledge-intensive services are 

taking on a more active economic role (Howells, 2001). As a second 

example, the NAICS is revising its classifications to represent more 

accurately the evolving nature of services. Traditionally, services were 

described narrowly as discrete products. However, as the nature of 

services has become more complex largely because of technological 

advancements, service providers are offering bundles of products. As a 

result, organizations in the service sector are becoming more research 

intensive and are, in fact, taking on a central role in the innovation 

activities of their client industries. 

 

4According to Mohr (1999 p. 4), “A service is a change in the condition of a person, or a 

good belonging to some economic entity, brought about as the result of the activity of 

some other economic entity, with the approval of the first person or economic entity.” 
Section 1 — Introduction 

1-3

 1.1 TRENDS IN RESEARCH AND DEVELOPMENT 

(R&D) ACTIVITY 

Innovative activity in the service sector is difficult to define. R&D activity 

in that sector has been measured using the RD-1 survey, which was 

primarily developed for manufacturing firms. Figure 1-1 shows real, 

inflation-adjusted R&D performed in industry (company and other, 

nonfederal funds for performance) over the years 1986 through 2001 in 

total and for nonmanufacturing (defined as total less manufacturing 

R&D).5 

Figure 1-1. Real Industrial R&D, Total, and Nonmanufacturing Performance ($1996) 

$-

$25,000

$50,000

$75,000

$100,000

$125,000

$150,000

$175,000

$200,000

1985 1987 1989 1991 1993 1995 1997 1999 2001

Year

Millions ($1996)

Real Total Real Nonmanufacturing

From a National Science Foundation (NSF) (2000) reporting perspective, 

the nonmanufacturing sector includes transportation and utilities (e.g., 

communications); trade; finance, insurance, and real estate; and 

services (e.g., health). In 2001, the nonmanufacturing share of total 

industry R&D was about 40 percent. That percentage, which was 38 

percent in 1999, has increased steadily over the years shown, in part 

because of improved sampling procedures by NSF to collect 

nonmanufacturing sector data, as discussed below. 

 

5Nominal R&D data came from NSF (1998). The calendar year GDP deflator was used to 

adjust for inflation (see National Science Board [2004] Appendix Table 4-1). 
Measuring Service-Sector Research and Development 

1-4

For purposes of comparison, the nonmanufacturing shares for selected 

Organisation for Economic Co-operation and Development (OECD) 

countries is shown in Figure 1-2 for 2001.6 Except for several 

Scandinavian countries, the United States reports a larger share of its 

R&D as nonmanufacturing compared to most OECD countries. 

0 5 10 15 20 25 30 35 40 45 50

Japan 

Germany

France 

Sweden

Finland

Korea

Belgium

Poland

United Kingdom

Netherlands 

Italy

Ireland 

Canada

Czech Republic

Denmark 

Spain

Australia 

Norway 

Country

Percent Share of Total Business R&D Expenditure

 1.2 INSTITUTIONAL HISTORY OF SAMPLING 

NONMANUFACTURING R&D FIRMS7

Since 1953, NSF has collected and published industrial R&D statistics. 

Historically, a sample of firms was selected every 4 to 6 years for the 

RD-1 survey. In the intervening years, a subsample of only the largest 

firms was surveyed. In the early years of the RD-1 survey, R&D was 

performed in a small number of industries, and it was reported along with 

 

6See OECD (2003). Data in the figure are generally for 2001. The exceptions are 

Australia, France. Germany, Japan, Netherlands (2000), Ireland (1999), Denmark 

(1999), and Norway (1998). 

7This section draws directly from Jankowski (2001) and from the technical notes in 

Research and Development in Industry (OECD, 2001). 

Figure 1-2. 

Nonmanufacturing 

Share of Total 

Business R&D in 2001, 

Selected OECD 

Countries 
Section 1 — Introduction 

1-5

a catch-all category of nonmanufacturing. For example, in 1987 a 

sample of about 14,000 firms was selected to receive the RD-1 form. 

From 1988 through 1991, about 1,700 of these firms were resurveyed, 

and about 300 of the 1,700 were companies from nonmanufacturing 

industries. 

In the early 1970s, there was a general recognition at NSF that more 

detailed information on nonmanufacturing R&D was needed, and 

recognition continued into the 1980s. Beginning in 1987, NSF’s annual 

R&D reports included R&D estimates separated into three broad 

groupings: communication, utility, engineering, architectural, research, 

development, testing, computer programming, and data-processing 

service industries; hospitals; and medical labs. By 1992, a decision was 

made to draw new samples annually with broader industrial coverage, 

increase the sample size from 14,000 firms to 23,000 firms, and add 25 

new nonmanufacturing industries to the sampling panel. Included in 

these 25 new industries were finance, computer and other business 

services, and engineering and management services.8 In 1992, the 

number of manufacturing firms nearly equaled the number of 

nonmanufacturing firms—11,818 compared to 11,558. However, in 1993 

and 1994, the nonmanufacturing firms sampled fell below the number of 

manufacturing firms sampled. 

In 1995, the sample of nonmanufacturers was expanded by 60 percent. 

In that year, R&D expenditures for the following industries were for the 

first time reported in Research and Development in Industry (OECD, 

2001): transportation and utilities, including communications; trade; 

finance, insurance, and real estate; services, including computer-based 

business services, health services, and engineering and management 

services; and other. In 1998, 19,973 nonmanufacturing firms were 

surveyed compared to only 4,836 manufacturing firms. 

 1.3 UNRESOLVED ISSUES 

Although NSF had responded to underrepresentation of the 

nonmanufacturing sector in national R&D statistics, it has done so using 

a single survey instrument, the RD-1 form that was originally developed 

on the basis of an understanding of the manufacturing innovation 

process (Link, 1996). By so doing, it is implicitly being assumed that the 

 

8A complete listing of the new industries is in Technical Note 47 of Research and 

Development in Industry: 2000 (OECD, 2001). 
Measuring Service-Sector Research and Development 

1-6

innovation process underlying the expenditure of R&D is the same in 

manufacturing as in nonmanufacturing. 

The first objective of this report is to posit a model of the innovation 

process relevant to the nonmanufacturing sector, the service-providing or 

service sector in particular. This model is posited on the basis of both 

the extant literature and the information learned through case studies 

conducted in four industries. The second objective of this report is to 

recommend changes in the RD-1 form to capture more accurately firm 

investments in innovative activity. 

 1.4 FOCUS INDUSTRY CASE STUDIES 

Throughout this report we draw inferences from case studies conducted 

for four service-sector industries: 

• telecommunications 

• software 

• financial services 

• research development and testing (RD&T) 

The purpose of the case studies was to determine the nature of the 

innovation process therein and from that information glean an 

understanding of whether there are areas of significant over- or 

underreporting of R&D activities and to assess issues of 

misclassification. In addition, we investigated how each industry 

categorizes its own R&D activities and how these activities relate to 

NSF’s definition of R&D. 

 1.5 OUTLINE OF THE REPORT 

The remainder of the report is outlined as follows. Section 2 begins with 

the definition of R&D and current R&D statistics. Then we discuss 

measurement and classification issues related to service-sector R&D 

expenditures. Section 3 presents a model of service-sector innovation 

(largely based on four industry case studies that are presented in 

Appendix A through Appendix D) and discusses the process by which 

firms develop and acquire intellectual capital. Section 4 then presents 

taxonomies for service-sector R&D and provides recommendations for 

modifying and enhancing the RD-1 survey instrument used by the U.S. 

Bureau of the Census to collect R&D data. 
2-1 

 Currently Reported 2 Service-Sector R&D 

Innovation and technological change in services are increasingly 

dependent on service-sector R&D, in addition to acquired technology 

(Pilat, 2001). As discussed in Section 1, the service sector accounts for 

an increasing share of total R&D expenditures in the United States. 

However, this trend is a result of many underlying factors, some of which 

reflect actual increases in R&D activities and some of which are 

reclassifications of R&D activities. In addition, there is concern that 

current R&D statistics do not fully capture the level of R&D activity being 

performed within the service sector or indirectly the level or rate of 

change of innovative activity therein. 

This section begins by presenting the definition of R&D and current R&D 

statistics. We then discuss measurement and classification issues 

related to service-sector R&D expenditures. 

 2.1 DEFINITION OF R&D 

For reporting purposes, R&D is defined slightly differently across 

different U.S. and international agencies. However, most U.S. agencies 

and many foreign agencies follow NSF’s definition of R&D. The 

definition of R&D makes no distinction between manufacturing and 

service-sector R&D. However, as discussed in the following sections, 

determining which innovative activities targeted at developing new and 

improved services qualify as R&D under current definitions is less clear. 

Based on NSF’s definition, an activity is considered R&D if it is related to 

one or more of the following goals: 

• Pursue a planned search for new knowledge, regardless of 

whether the search has reference to a specific application. 
Measuring Service-Sector Research and Development 

2-2 

• Apply existing knowledge to problems involved in creating a new 

product or process, including work required to evaluate possible 

uses. 

• Apply existing knowledge to problems related to improving a 

present product or process. 

“Research” is defined as a systematic study directed toward fuller 

knowledge or understanding of the subject studied. “Development” is 

defined as the systematic use of knowledge or understanding gained 

from research, directed toward the production of useful materials, 

devices, systems, or methods, including the design or development of 

prototypes or processes. 

Research is further classified as either basic or applied, dependent on 

the objectives of the investigator. 

• Basic research is research directed toward increases in the 

knowledge or understanding of fundamental aspects of 

phenomena and of observable facts without specific application 

toward processes or products. This type of research is limited to 

the federal, university, and nonprofit sectors. 

• Applied research is research directed toward gaining knowledge 

that will meet a specific need. This includes research for specific 

commercial objectives. 

Development is defined as the systematic use of knowledge directed 

toward the production of a product, service, or method. This includes the 

design and development of prototypes and processes. However, it 

excludes quality control, routine product testing, and the development of 

internal software for internal business use. 

Appendix E provides additional detail on NSF’s definition of R&D and 

also includes a discussion of R&D definitions used in Europe and for 

U.S. tax laws. 

 2.2 R&D EXPENDITURES BY SECTOR 

NSF’s Survey of Industry Research and Development is the primary 

source of information on R&D performed within the United States. The 

survey results are used by government agencies, corporations, and 

research organizations to assess trends in R&D expenditures. The data 

are also used to investigate productivity determinants, to formulate tax 

policy, and to compare company performance with industry averages. 
Section 2 — Currently Reported Service-Sector R&D 

2-3 

Table 2-1 summarizes U.S. R&D expenditures by industry. 

Manufacturing accounts for approximately 62 percent, with the largest 

sectors being classified under NAICS 33, which includes transportation 

equipment, electrical equipment, and metals. Nonmanufacturing 

accounts for the remaining 38 percent of U.S. industry R&D, with trade 

and scientific information R&D services accounting for the largest 

shares. The telecommunications sector is not disclosed but also 

accounts for a significant share of nonmanufacturing R&D. 

Professional, scientific, and trade services account for 11 percent of U.S. 

R&D, with the two major sectors being scientific R&D services and 

computer system design and related services. Entities in these sectors 

are a combination of large and small companies and are engaged in a 

wide variety of activities ranging from systems integration to 

biotechnology research. 

Table 2-1 also indicates the source of the funding—federal versus 

company. Federal funding accounts for approximately 10 percent of 

manufacturing R&D expenditure and 7.6 percent of nonmanufacturing’s 

R&D. 

 2.2.1 R&D Flows Within and Between Sectors 

It is widely accepted that a significant share of R&D conducted in the 

manufacturing sectors supports the provision of products and services 

provided by the nonmanufacturing sectors. Service-sector industries’ 

increased reliance on information technology is a prime example. Using 

both direct R&D expenditures and indirect R&D consumed, such as R&D 

incorporated in equipment and intermediates, provides a different 

estimate of technology intensity for the service industry. In a study by 

Amable and Palombarini (1998), when assessing both direct and indirect 

R&D, some service sectors incorporate as much or more R&D into their 

products and services as compared with manufacturing industries. 

However, with increased outsourcing, a growing share of R&D 

supporting the manufacturing sector is now captured under servicesector activities. For example, pharmaceutical companies use RD&T 

companies to conduct a significant amount of their Phase III testing for 

drug development, and manufacturing companies of all types are 

conducting less software development in house and relying on large 

computer and information service providers. 
Measuring Service-Sector Research and Development 

2-4 

Table 2-1. R&D Expenditures 

Total (Basic, Applied, and Development)

2000 Industry NAICS Code 

Total 

($ millions) 

Percentage

of Total 

Federal 

($ millions) 

Company 

($ millions) 

All industries 199,539 100.0% 19,118 180,421 

Manufacturing 31–33 124,078 62.2% 13,328 110,750 

Food, tobacco, and textiles 31 1,828 (D) 1,828 

Wood, paper, petroleum, coal, 

chemicals, plastics, and mineral 

32 27,265 (D) 27,265 

Metals, machinery, computer, 

electrical, transportation, furniture, 

and miscellaneous products 

33 103,907 24,800 79,107 

Other Manufacturing 339 2,642 93 2,549 

Nonmanufacturing 21–23, 42, 44–81 75,461 37.8% 5,790 69,671 

Trade 42, 44, 45 24,959 12.5% 30 24,929 

Information 51 16,830 8.4% 540 16,290 

Software 5112 12,639 6.3% 78 12,561 

Telecommunications 5133 (D) (D) (D) (D) 

Other Information 51 (minus 5112, 

5133) 

2,844 1.4% 81 2,763 

Finance, insurance, and real 

estate 

52, 53 4,024 2.0% 0 4,024 

Professional, scientific, and 

technical services 

54 22,577 11.3% 4,628 17,949 

Computer systems design and 

related services 

5415 5,169 2.6% 226 4,943 

Scientific R&D services 5417 12,892 6.5% 3,177 9,715 

Other professional, scientific, 

and technical services 

54 (minus 5415, 

5417) 

4,517 2.3% 1,226 3,291 

Health care services 621–23 536 0.3% 59 477 

Other nonmanufacturing 21, 22, 23, 48, 49, 

55, 56, 61, 624, 

71, 72, 81 

6,515 3.3% 513 6,002 

(D) = Not disclosed. 

Source: NSF, 1998. 

In addition, most service firms expect that their R&D activities will result 

in productivity impacts on their customers that include intermediate 

suppliers in both manufacturing and nonmanufacturing industries. This 

pushes the productivity effect to their downstream industries. Lecht and 

Moch (1999) found that R&D in information technology (IT) conducted by 

service-sector firms greatly affected the flexibility of manufacturers in 
Section 2 — Currently Reported Service-Sector R&D 

2-5 

adjusting products to customer needs, user-friendliness of the products, 

and the temporal availability of delivery speed. 

Table 2-2 provides summary information that illustrates the flow of R&D 

for selected service industries. The table was constructed from the 

Bureau of Economic Analysis’s (BEA, 1998) input-output tables in 

conjunction with NSF’s sector-level R&D expenditures. A description of 

the underlying data and the calculations used in Table 2-2 is presented 

in Appendix C. 

Table 2-2. R&D Intensity of Inputs and Value Added 

R&D Embedded in 

Inputs from Outside 

Sector (million $1998) 

R&D Embedded in 

Inputs as a Share of 

Input Expendituresa

R&D Expenditures 

within Sector 

(million $1998) 

R&D Expenditure 

as Share of Value 

Added 

Telecommunications $1,369 0.72% $2,015 0.98% 

Finance $2,458 0.45% $1,850 0.32% 

Computer and data 

processing $1,411 0.93% $14,822 4.12% 

Legal, engineering, 

accounting, and related 

servicesb

 $693 0.53% $11,835 4.81% 

Health services $3,316 1.08% $1,207 0.26% 

a

Underreporting of service-sector R&D may be contributing to the relatively low R&D shares (%) for both inputs and 

expenditures. b

RD&T is included in this category. 

Note: Sectors were built up from Standard Industrial Classification (SIC) code definitions and aggregated to 

represent service sectors of interest. Thus, R&D expenditures do not directly map to expenditures listed in 

Table 2-1 that are based on NAICS code definitions. 

The first data column in Table 2-2 represents a measure of the R&D 

consumed by a sector through the products and services it purchases as 

inputs from outside its own sector. For example, an estimated $1,369 

million in R&D is embedded in the inputs the telecommunications 

industry purchases from outside its sector (i.e., all 

nontelecommunications inputs). The second data column shows the 

relative level of R&D intensity of products and services purchased by 

each selected service sector. Health services have the highest share of 

embedded R&D in the inputs they purchase, reflecting large-scale 

purchases of medical equipment and medicine. 

The third data column shows the R&D expenditures within each selected 

service sector, and the fourth column provides a measure of R&D 

intensity defined as R&D expenditures divided by value added. The 
Measuring Service-Sector Research and Development 

2-6 

table indicates that the highest levels of R&D intensity are in computer 

and data processing and legal, engineering, accounting, and related 

services (which includes RD&T). Telecommunications and finance both 

conduct approximately $2 billion in R&D per year, but this amount 

represents a smaller share of their total value added. Finally, the withinsector R&D conducted by health services and other business services is 

relatively small compared to their value added. 

 2.3 R&D MEASUREMENT AND CLASSIFICATION 

ISSUES 

Worldwide, services account for an increasing share of reported R&D. 

However, the service sector’s share of R&D varies greatly across OECD 

countries. For example, in Canada and Australia the service sector 

accounts for approximately 35 percent of industry R&D, whereas in the 

United States and Great Britain, the service sector’s share is about 20 

percent, and in Germany and Japan it is less than 10 percent (OECD, 

2001). In contrast, the service sector’s role in terms of its share of 

economic activity and growth is similar across most of the OECD 

countries. 

These cross-country differences highlight the difficulties in identifying, 

measuring, and classifying R&D expenditures in the service sector. 

These issues are further complicated by the background of individuals 

completing the surveys and the diversity of business lines within modern 

evolving corporations. 

 2.3.1 Identifying Service-Sector R&D 

Classifying innovative activities in the service sector as R&D-driven or 

not is frequently difficult. The service sector has developed and 

implemented significant innovations related to Web-based applications, 

information management, and data transfer. In addition, new sectors 

have evolved that supply system and component integration services to 

manufacturers and service providers. However, the historical view of 

R&D and product development (engineering design, prototype testing, 

and manufacturing process design leading to mass production) does not 

fit well when services are built on unique applications that are continually 

customized, incorporating incremental improvements (as opposed to 

discrete new product models or software versions). 

The classical definitions of R&D are grounded in the creation of an 

“artifact” or physical product (Tether, Hipp, and Miles, 2001) and 
Section 2 — Currently Reported Service-Sector R&D 

2-7 

therefore are harder to apply to intangible outputs of services, such as 

methods or organizational theory. For example, Sundbo and Gallouji 

(1999) identify four major categories of service innovation—product, 

process, organizational, and market—not all of which are considered 

R&D. In addition, the difficult distinction in services between product and 

process, also referred to as “coterminality,” often makes it difficult to 

interpret what is R&D and non-R&D (Evangelista, 1999; Sirilli and 

Evangelista, 1998). 

 2.3.2 R&D Measurement Issues in the Service Sector 

Classifying Innovative Activities in the Service Sector 

as R&D vs. Non-R&D 

In addition to identifying R&D activities, service-sector R&D is also 

inherently more difficult to measure. For example, R&D can be carried 

out in formal R&D departments or in an informal nature carried out in 

facilities where R&D is not the main activity. In theory, NSF’s Survey of 

Industry Research and Development should identify and measure all 

resources devoted to R&D. However, breaking out informal R&D may be 

difficult or costly in some businesses. 

Because service innovations are more likely to be customer driven, 

related R&D activities are typically integrated into user companies’ 

business units. There is less likely to be a stand-alone R&D facility or 

division in which R&D activities can be readily quantified by existing 

accounting systems. 

Service innovation is more likely to be carried out in a multidisciplinary 

business unit that combines IT system integrators, managers, and 

market researchers. This places more responsibility on the organization 

to determine what share of its innovation expenditures is to be classified 

as R&D when completing the survey. 

In addition to business units composed of teams of multidisciplinary staff, 

it is also common for individual staff members supporting innovation in 

the service sector to have multiple responsibilities and functions. For 

example, IT managers need to maintain and improve their networks and 

systems. It is not uncommon for them to spend part of their time 

managing and overseeing the day-to-day operations of the system and 

also to contribute to developing the next generation system or service. 

Again, this makes quantifying R&D difficult, because fractions of 
Measuring Service-Sector Research and Development 

2-8 

expenditures based on existing accounting systems (primarily staff labor) 

need to be assigned as R&D. 

Multidisciplinary business units and staff with multiple responsibilities are 

not business structures unique to the service sector. IT managers in 

manufacturing companies also pose the same measurement issues. 

However, the problem has historically been more pervasive in service 

firms because the R&D supplier and user are more often the same firm, 

implying that the same individual can be involved in operations/delivery 

and R&D activities. 

 2.3.3 Industry Classification Issues 

Because the Survey of Industry Research and Development is enterprise 

based, NSF tabulates each establishment by the major NAICS code of 

the company as determined by the company’s payroll. This results in all 

of a firm’s R&D expenditures being assigned to a single NAICS category, 

regardless of the actual focus of R&D activities. 

The industry sector to which R&D expenditures are assigned may have 

little relationship to the underlying focus of R&D activities (Payson, 

1999). For example, in the health care industry, continual innovation in 

medical services results from R&D performed outside the health services 

industry in the manufacturing of pharmaceuticals and medical equipment 

(Jankowski, 2001). 

Large conglomerate and diversified companies may be a major source of 

industry misclassification. For example, patent-holding companies 

account for a large share of R&D reported as being conducted by the 

financial services sector. As a result, a large share of the R&D reported 

under finance (NAICS 52,53) is associated with biotech and 

pharmaceutical research and is virtually identical to R&D conducted in 

the chemical industry. However, because of ownership, this R&D is 

classified under financial services even though it is not related to the 

provision of financial services such as banking or stock market 

transactions. 

Similar issues exist in the RD&T sector in which outsourcing has resulted 

in a shift of activities previously classified as manufacturing R&D to now 

being classified as service-sector R&D. Outsourcing does not change 

the fundamental research activities being conducted, but it does have the 

potential to change its industry classification. 
Section 2 — Currently Reported Service-Sector R&D 

2-9 

A parallel but opposite trend is that many service activities, and hence 

their supporting R&D, have migrated from the service sector to the 

manufacturing sector. Many large manufacturers have financing 

divisions that compete directly with traditional financial service 

companies. This trend in bundling products and services includes 

maintenance and in many cases has evolved to the provision of the full 

service provided by the manufacturer’s product. Xerox was one of the 

first manufacturing companies to provide full-service leases, in effect 

selling the service of copying. Today, full-service leases are common in 

automotive, aircraft, and agriculture equipment industries. They are also 

common in these industries for companies that provide financing 

services. Thus, industry misallocation of R&D activities (service related 

vs. manufacturing related) may go both ways. 

Misallocation due to servicisation also implies that, if service R&D 

measurement issues discussed above are leading to 

underrepresentation of service R&D expenditures, this could affect both 

the manufacturing and service sectors. For example, if manufacturing 

firms do not completely capture their service R&D as they increase 

service provision, this could result in misleading trends in decreased 

R&D intensity for some manufacturing sectors. 

 2.4 SUMMARY OF COMPOSITION OF CURRENT 

R&D STATISTICS 

Current institutional definitions of R&D are not completely applicable for 

the service sector because the historical definitions and examples have 

evolved primarily to characterize manufacturing-sector R&D activities. 

As a result, the definition of which service activities fall under the R&D 

classification may not accurately or fully capture service-sector R&D. A 

review of existing literature and informal interviews with industry have led 

to two preliminary observations. 

First, it appears that the distinction between the manufacturing and 

service sectors is becoming increasingly blurred. For example, 

preliminary case-study research and interviews indicate that in some 

industries, a significant share of the R&D reported under service-sector 

NAICS codes is product/production-related research outsourced from 

traditional manufacturing sectors. Also, published literature highlights 

the trends of manufacturing firms increasingly providing services and 

hence conducting service-related R&D activities. 
Measuring Service-Sector Research and Development 

2-10 

Second, the industry misclassification issue, driven by the unavoidable 

need to aggregate R&D to the establishment level, has led to uncertainty 

in trends for R&D activities targeted at service innovation (i.e., efforts 

targeted at advancing the provision and content of services). A 

significant amount of literature has been devoted to discussing 

misclassification issues with little success at quantifying the impacts on 

aggregate R&D statistics used for policy analysis. As a result, what is 

lost is the potentially important distinction between R&D expenditures 

targeted at enhancing manufacturing vs. service activities across all 

sectors of the economy. This distinction may be as important as gaining 

a better understanding of the types of R&D activities conducted by 

manufacturing vs. service-sector firms, as classified by establishment 

NAICS codes. 
3-1 

 Innovative Activity 3 in Services 

As stated in Section 1, a purpose of this report is to posit a model of the 

innovation process relevant to the service-providing or service sector. 

Such a model is important because it serves as a basis, or conceptual 

framework, for policy recommendations regarding changes in the RD-1 

form. It highlights differences in service-sector investments in innovative 

activity from the manufacturing sector and more broadly helps to inform 

policy makers about unique characteristics and interrelationships 

associated with innovation in the service sector. 

For decades, academics and policy makers have theorized about the 

innovation process as it relates to traditional manufacturing firms. This 

was logical because innovative activity had long been unique to 

manufacturing firms. Also, Vannevar Bush’s report, Science—The 

Endless Frontier (1945) sowed the seeds for thinking of innovation in a 

linear framework because that is what was observed in practice during 

the post-war era. However, the United States is no longer an economy 

in which manufacturing dominates, and innovative activity and R&D 

spending are no longer the sole purview of manufacturing firms. 

As a benchmark for understanding innovative activity in service firms, we 

begin with a basic model of innovation activity in manufacturing. 

 3.1 INNOVATIVE ACTIVITY IN MANUFACTURING

A well-established model of innovation activity relevant to a technologybased manufacturing industry comes from Tassey (2005). Figure 3-1 

illustrates the different technology elements, which have slightly different 

degrees of public good attributes. These distinctions make the Tassey 

model especially relevant for policy analysis, but also useful as a 
Measuring Service-Sector Research and Development 

3-2 

Figure 3-1. Model of Innovation in a Technology-Based Manufacturing Industry 

Strategic Planning Production Process

Development

Market

Development

New Value-Added

Product

Risk Reduction

Infrastructure

Technologies

Science Base

Entrepreneurial

Activity

Proprietary

Technologies

Generic

Technologies

Technology

Development

benchmark for manufacturing and thus a point of departure for modeling 

service-sector innovation. 

At the root of the model is the science base, referring to the 

accumulation of scientific and technological knowledge. The science 

base resides in the public domain. Investments in the science base 

come from basic research primarily funded by the government and 

primarily performed globally in universities and federal laboratories. 

In the manufacturing industry, technology development, in the form of 

basic and applied research, generally begins within industrial 

laboratories. It involves the application of scientific knowledge toward 

the proof of concept of a new technology. Such fundamental research, if 

successful, yields a prototype or generic technology. If the prototype 

technology has potential commercial value, follow-on applied research 

takes place toward development, and if successful, a proprietary 

technology results. 

Basic, applied, and developmental research occur within a firm as a 

result of the firm’s strategic planning and guide entrepreneurial activities. 

Entrepreneurial activity implies perception of opportunities and the ability 
Section 3 — Innovative Activity in Services 

3-3

to act on those perceptions (Hébert and Link, 1988). Much of the 

product and process development research is conducted as part of the 

entrepreneurial activity. 

Infrastructure technologies, or infratechnologies, support the processes 

that lead to both generic and proprietary technologies. Infrastructure 

technologies are a diverse set of technical tools that are necessary to 

conduct all phases of R&D efficiently. Following Tassey (1997, 2005), 

examples of infrastructure technologies include measurement and test 

methods, process and quality control techniques, evaluated scientific and 

engineering data, and the technical basis for product interfaces. 

The managerial skills necessary for a firm to move its proprietary 

technologies to a value-added product or process are also shown in 

Figure 3-1. After production, market development takes place. Markets 

do not always accept new technology for a number of reasons, including 

transaction costs associated with verification of the new technology’s 

attributes and interoperability of the new technology with existing 

technologies. Infrastructure technologies can reduce such risks and thus 

speed market development. 

 3.2 INNOVATIVE ACTIVITY IN THE SERVICE 

SECTOR

To compare and contrast the established manufacturing innovation 

model with innovation in services, we conducted four case studies 

investigating telecommunications, financial services, systems integration 

services, and RD&T services. Each case study is discussed in detail in 

Appendices A through D. 

Based on the case studies, several themes emerge regarding innovative 

activity in service sectors. Many of the fundamental characteristics of the 

innovation process differ between manufacturing and services. These 

include the following: 

• Ability to develop and protect proprietary technologies: 

Imitation is simpler in the services sector—process/system 

patents are more difficult to obtain and protect. 

• Incremental nature of innovation versus discrete technology 

transition/obsolescence: Because of competitive pressures 

and the relatively low cost of modifying service provision 

(compared to changes to manufacturing processes), services are 

continually evolving. 
Measuring Service-Sector Research and Development 

3-4 

• Degree of interoperability required among related 

technologies: Service innovations involve interactions among 

many products and systems, and a large part of the R&D 

process involves systems integration. In addition, because 

services are less likely to be stand-alone products, they need to 

be integrated with larger IT and societal systems. 

• Ability to build prototypes or conduct tests in a controlled 

environment: Services need to be tested with real customers, 

making it difficult to isolate R&D testing activities in stand-alone 

laboratories, limiting the number of tests that can be performed, 

and increasing the cost of poor performance or failures. 

Based on these generalizations, Figure 3-2 is posited as representative 

of an economic model of innovation in a technology-based service 

industry. A mathematical model of the process underlying Figure 3-2 is 

in Appendix F. The following discusses the components of the 

innovation process in the service sector and describes how they differ 

compared to their manufacturing counterparts. 

Figure 3-2. Model of Innovation in a Technology-Based Service Industry 

Strategic 

Planning

Product or Service 

Enhancement and 

Systems Integration

Market 

Development

Enhanced ValueAdded Service

Risk Reduction

Infrastructure 

Technologies

Science Base

Entrepreneurial 

Activity

Purchased Technical 

Services

Purchased 

Technologies

Competitive 

Planning

Strategic Planning. Both manufacturing and service innovation 

processes are driven by strategic planning. However, service-sector 

activities are more influenced by competitive planning because the 

technology-based service firm is more likely to innovate on the basis of 

customer input and on the basis of competitors that continually seek to 

challenge the firm for its customers. Whereas manufacturing firms 
Section 3 — Innovative Activity in Services 

3-5

strategically formulate road maps for developing new emerging 

technologies, in the service-sector firms strategically formulate road 

maps for deploying modifications of existing products. Because 

manufacturing firms are more likely to target discrete technology jumps, 

creating new technologies that make their competition obsolete, their 

strategic plans are long term and are linked less to current competitive 

planning. In contrast, service firms’ strategies are typically focused on 

retaining or gaining market shares and involve more 

continual/incremental transition strategies that are/will be integrated with 

competitive planning. 

Entrepreneurial Activity. Both strategic and competitive planning drive 

the firm’s entrepreneurial activity. Whereas entrepreneurial activity 

drives the manufacturing firm toward the production of new products and 

processes, the entrepreneurial activity of the service firm drives 

enhancements (redesign or reconfigure) of its existing products. At the 

root of entrepreneurial activity are others’ intellectual capital and 

technologies that are licensed or purchased to meet the firm’s road maps 

for deploying modifications of its existing products. 

This product and service enhancement often involves system integration 

where systems integration facilitates the intersection of hardware, 

software, and the synthesis of application domains such as finance, 

manufacturing, transportation, and retail. 

Technology Development. A key distinction between manufacturing 

and service firms’ R&D is that manufacturing firms conduct a larger 

share in house, and the output of that internal activity is more likely to be 

a proprietary technology. In the service sector, little research (R) occurs 

in house, and the development (D) activity that occurs is primarily related 

to enhancing, redesigning, or reconfiguring others’ proprietary 

technologies. 

Whereas manufacturing firms license/purchase others’ technologies in 

the form of intellectual capital or equipment to be used to produce 

proprietary technology, service firms purchase others’ technology in the 

form of equipment to be modified and integrated into their operational 

system to deliver modifications to existing products. In addition, 

manufacturing firms strategically, through their research, introduce new 

technologically advanced products and processes to anticipate new 

consumer wants; whereas service firms strategically, through information 

gathering, modify existing products to meet existing consumer needs. 
Measuring Service-Sector Research and Development 

3-6 

Science Base. Both manufacturing and service innovation is built on the 

scientific base of knowledge. The manufacturing sector is more likely to 

build on the science base directly or in collaboration with universities. In 

contrast, the service sector purchases inputs (products and services) 

that have incorporated others’ research from the science base. 

Infrastructure Technologies. The role of infrastructure technologies is 

different between the two sectors. Whereas infrastructure technologies 

reduce the market risk (from the introduction into the market of a new 

product or process) of the manufacturing firm, infrastructure technologies 

ensure that purchased technologies interface or integrate with the 

service firm’s existing systems. Such infrastructure technologies 

emanate from the science base, and it is the science base that is at the 

root of purchased technologies. 

Risk Reduction. An important component of the innovative process in 

both manufacturing and service sectors is risk reduction. However, the 

focus of the activities differs. In the manufacturing sector, innovation is 

likely to be less integrated with marketing. Once a new product has 

been designed and tested, technical risk may be relatively low, but 

market risk may be significant because the product needs to be accepted 

and integrated into existing systems. In contrast, service-sector 

innovation is more likely to involve enhancements to products in existing 

markets, lowering market risk. However, limitations and the cost of 

testing increase technical risk, making risk reduction a key objective of 

the product enhancement phase of service innovation. 

 3.3 DIFFERENCES WITHIN SERVICE-SECTOR 

INNOVATION ACTIVITIES

Figure 3-2 presents a generic model of innovation in a technology-based 

service industry. However, as the four case studies included in the 

appendices confirm, the service sector is an extremely diverse set of 

industries. One difference that is important for identifying R&D activities 

is the distinction between 

• firms that assimilate technologies to provide enhanced services, 

and 

• firms that provide/develop technology as a service. 

Figure 3-2 illustrates the process by which service firms access and 

integrate technology with the goal of developing and providing enhanced 

services to their customers. These firms lead the strategic planning and 
Section 3 — Innovative Activity in Services 

3-7

entrepreneurial activities, as well as market deployment. They are likely 

to be heavily involved in the final stages of developmental research but 

may outsource a large share of the applied research and early stage 

developmental research. Their role is often an integrator of existing 

technologies; however, they may also outsource significant systems 

integration activities. Telecommunications- and financial services-sector 

firms are examples of technology integrators. 

In contrast, many service firms provide research as their primary service. 

These firms provide a key input into entrepreneurial activities similar to 

the purchase of technology embedded in products or licensing of 

technology. These include biotechnology firms in the RD&T sector as 

well as systems integration firms in the information services sector. In 

many ways technology/research service providers follow an innovation 

process similar to that illustrated in Figure 3-2. They conduct strategic 

planning, build on the scientific base, leverage purchased technologies 

and manage risk—all as part of their innovative process to remain 

competitive. However, the distinction is that a much larger share of their 

activities is likely to be classified as formal R&D as opposed to non-R&D 

innovative activities. 

4-1 

 Recommendations 

 for the RD-1 Survey 

 Instrument and 4 Instructions 

One goal of this study is to make recommendations for more accurately 

measuring service-sector R&D; thus, most recommendations are 

proposed changes in terminology and examples to clarify the innovative 

activities conducted by service firms that qualify as R&D expenditures. A 

second goal of this study is to achieve the first goal in a manner that 

facilitates meaningful comparisons between manufacturing R&D and 

service-sector R&D investments. 

To these ends, recommendations are put forth for modifications to 

existing questions and for new questions that could be added to the 

RD-1 instrument. The recommendations were developed in light of the 

following assumptions and limitations: 

• There will remain only one survey instrument (i.e., separate 

surveys for manufacturing and nonmanufacturing are not a 

viable option at this time). 

• The core definitions of basic, applied, and developmental 

research will not be changed to maintain longitudinal 

consistency. 

• The length (burden) of the survey will not be increased 

significantly. 

This section begins with recommendations for modifications to the 

existing survey instrument and to the survey instructions. Each 

recommendation contains specific suggestions along with the general 

rationale and relevance for the service sector. Recommendations are 

presented in the order in which they occur in the 2003 RD-1 survey and 

its instructions (see Appendix F). They are followed by suggestions for 
Measuring Service-Sector Research and Development 

4-2 

new questions that could be added to the RD-1 to better assess activities 

and trends in service-sector R&D and innovation in general. 

 4.1 RECOMMENDATIONS FOR EXISTING SURVEY 

INSTRUMENT AND INSTRUCTIONS 

 4.1.1 Recommendation for Title 

Change the name of the survey from “Industrial” R&D to “Private Sector” 

R&D. 

Rationale 

The survey is no longer administered solely to industrial firms. 

 4.1.2 Recommendation for the Definition of R&D in the 

Instructions 

State that expenditures qualifying under the NSF’s definition of R&D 

should be reported even if they are not classified internally by the 

organization as R&D or even if staff are not specifically classified as R&D 

personnel. 

Rationale 

R&D activities are frequently decentralized through different business 

units in the service sector. Particularly, the IT staff members in small to 

medium-sized organizations are likely to split their time between R&D 

activities and internal system operations. 

 4.1.3 Recommendation for Question 3 

Either expand the scope of full-time equivalent personnel referenced in 

Question 3 to include any IT and information management specialists or 

add a separate question that focuses on research conducted by these 

specialists. 

Rationale 

In the service sector, workers other than computer scientists and 

engineers are critical to the process of development, but the term 

“computer scientist” may not cover all the IT and information 

management research activities being conducted in the service sector. 

Computer science may be interpreted as primarily hardware and 

software development. Information management encompasses 

information security, reliability, and accessibility research. 
Section 4 — Recommendations for the RD-1 Survey Instrument and Instructions 

4-3 

 4.1.4 Recommendations for Question 4 

a) In Question 4.C, define development to more closely align with the 

description of development in the instructions to RD-1. 

Rationale 

In Question 4.C, the description of development emphasizes the 

transformation of research into new or improved goods, but in the 

instructions the emphasis is broader—on transforming knowledge toward 

not only new or improved goods but also toward product and process 

improvements. In the service sector, the latter is critically important. A 

potential change would be to emphasize in the instructions “systems 

engineering” as an important part of R&D to capture service companies’ 

integration of hardware and software imported from manufacturing. 

b) Break “Company and other” column into “R&D internally funded” 

(overhead or internal IR&D projects) and “Nongovernment external 

funding” (i.e., contract research or part of services provided). 

Rationale 

This change would provide insights into the motivation and initiatives 

driving R&D in the service sector. For example, RD&T firms could be 

conducting entrepreneurial R&D research for themselves or they could 

be conducting outsourced R&D research on behalf of other companies. 

c) Expand the examples in the instructions describing development 

(page 10) to include more service-sector activities, such as systems 

integration services. 

Rationale 

The term “software development” may be too restrictive because it 

implies that only commercial, off-the-shelf software development 

qualifies as R&D. Customization and systems integration research 

should also be included. 

 4.1.5 Recommendation for Question 7: Source of Federally 

Funded R&D 

Add India and China to the list of countries in 7B. 

Rationale 

The relatively low wages of computer scientists and engineers in these 

countries make them attractive in a global research market. 
Measuring Service-Sector Research and Development 

4-4 

 4.1.6 Recommendation for Question 8: Source of 

Federally Funded R&D 

Add NIH to the list of options. 

Rationale 

Health-related research is an important and growing part of servicesector R&D. 

 4.1.7 Recommendation for Question 9: Types of R&D 

Expenses 

In the instructions, add guidance or procedures for estimating what share 

of building/equipment depreciation or secretaries are allocated to R&D. 

The issue is that a company with a centralized R&D laboratory counts 

the entire building and all support staff as an expense. Companies, 

especially service-sector companies, with decentralized or fragmented 

R&D activities will need guidance on what to count. 

Rationale 

In general, this may be too difficult or time consuming to estimate, and it 

may be a source of underreporting. The survey needs to address the 

situation where a division or group of staff members spends only some 

fraction of their time on R&D activities. This is much more common in 

the service sector. 

 4.1.8 Recommendations for Question 10 

a) Regarding Question 10.A.4, list specific areas here, such as the 

modification of purchased technology or the integration of purchased 

technologies into an internal system, and then add 10.A.5 as Other 

Areas. 

Rationale 

In services, the role of purchased technology that is either modified 

toward new or improved products/services or integrated into systems 

that provide new or improved products/services is dominant. 

b) In Question 10A.2 change “software development” to “software and 

information systems development.” 

Rationale 

As previously discussed, the term “software development” is too 

restrictive. 
Section 4 — Recommendations for the RD-1 Survey Instrument and Instructions 

4-5 

 4.1.9 Recommendation for Question 13 

Add “Industry Consortium” to the list of collaborators identified in 

Question 13. 

Rationale 

There is an increasing trend for service firms to perform their R&D 

cooperatively through consortia and other partnership mechanisms. 

 4.2 NEW QUESTIONS 

The following are new questions that potentially could be added to the 

RD-1 survey to gain more insight into the differences between servicesector and manufacturing R&D, in particular, and service-sector and 

manufacturing-sector innovation, in general. 

 4.2.1 New Question #1 

What share (%) of your company-funded R&D is targeted at developing 

• ___ generic/fundamental technologies? 

• ___ discrete proprietary technologies (including distinctly new 

service innovations)? 

• ___ entrepreneurial proprietary technologies (systems design 

improvements, organizational/delivery modifications)? 

• ___ infrastructure technologies? 

Rationale 

Service-sector firms are more likely to engage in entrepreneurial 

(systems design improvements, organizational/delivery modifications) 

innovative R&D and less likely to develop proprietary technologies. 

However, the share of activities devoted to infrastructure technologies is 

unclear because of the series sectors focus on information services. 

 4.2.2 New Question #2 

What share (%) of your company-funded R&D is conducted in 

conjunction with 

• ___ your company’s marketing department? 

• ___ your customers? 

• ___ your suppliers? 
Measuring Service-Sector Research and Development 

4-6 

Rationale 

Little is known about service-sector firms’ involvement in collaborative 

research relationships. Collecting such information may indicate that 

service-sector firms engage in similar or different R&D strategies. 

 4.2.3 New Question #3 

Company-funded R&D represents what percentage of your investment in 

product or process innovation? 

Rationale 

Formal R&D represents a smaller share of innovative activity for servicesector firms compared to manufacturing firms. Thus, R&D expenditures 

alone many not be an accurate measure of innovative activity or future 

productivity trends. 

 4.2.4 New Question #4 

What share (%) of the R&D conducted by your company is performed at 

the following venues: 

• ___ centralized R&D laboratories or science parks? 

• ___ decentralized business units? 

• ___ customers’ facilities? 

• ___ others? 

Rationale 

R&D conducted at decentralized locations or on customers’ premises is 

more difficult to measure and may be underreported. 

 4.2.5 New Question #5 

What share (%) of your company’s R&D would you describe as 

• ___ parallel research between two competing companies that 

results in almost identical products? 

• ___ research associated with integrating technologies acquired 

from outside the company (embedded in purchased or 

licensed products or processes)? 

• ___ research associated with adopting an existing technology 

or process? 

• ___ entrepreneurial activities associated with system 

improvements? 
Section 4 — Recommendations for the RD-1 Survey Instrument and Instructions 

4-7 

Rationale 

In manufacturing, research to develop generic and proprietary 

technologies is at the core of the innovative process and is 

unambiguously R&D. In services, entrepreneurial activities are at the 

core of the innovative process. It is unclear what share of these activities 

is being reported as R&D versus non-R&D innovative activities. 

R-1 

 References 

Amable, Bruno, and Stefano Palombarini. 1998. “Technical Change and 

Incorporated R&D in the Service Sector.” OECD. 

<http://netec.mcc.ac.uk/WoPEc/data/Papers/ 

cpmcepmap9808.html>. 

Bureau of Economic Analysis (BEA). 1998. Annual Input-Output (I-O) 

Accounts Data. Washington, DC: BEA. 

<http://www.bea.doc.gov/bea/dn2/i-o_annual.htm>. 

Bush, Vannevar, United States Office of Scientific Research and 

Development. 1960. Science, The Endless Frontier. A Report to 

the President on a Program for Postwar Scientific Research. 

July, 1945, Science—the Endless Frontier. National Science 

Foundation, Washington DC. 

Council of Economic Advisors. 2004. Economic Report of the President. 

<http://www.gpoaccess.gov/eop/index.html>. 

Evangelista, Rinaldo. 1999. Knowledge and Investment. Northampton, 

MA: Edward Elgar Publishing Inc. 

Hébert, Robert F., and Albert N. Link. 1988. The Entrepreneur: 

Mainstream Views and Radical Critiques, Second Edition. New 

York: Praeger. 

Howells, Jeremy. 2000a. “Services and Systems of Innovation.“ In 

Birgitte Andersen, et al. (eds.), Knowledge and Innovation In the 

New Service Economy. Northampton, MA: Edward Elgar 

Publishing Inc. 

Howells, Jeremy. 2001. “The Nature of Innovation in Services.” 

Innovation and Productivity in Services. OECD Proceedings 

Industry, Services and Trade. Paris: Organisation for Economic 

Co-operation and Development (OECD). 

Jankowski, John E. 2001. “Measurement and Growth of R&D Within the 

Service Economy.” Journal of Technology Transfer 26:323-336. 
Measuring Service-Sector Research and Development 

R-2 

Lecht, Georg, and Dietmar Moch. 1999. “Innovation and Information 

Technology in Services.” Canadian Journal of Economics

32(2):363-383. 

Link, Albert N. 1996. “On the Classification of Industrial R&D.” 

Research Policy 25:397-401. 

Miles, Ian. 1993. “Services in the New Industrial Economy.” Futures

July/August:653-672. 

Mohr, Michael F. 1999. “Identification and Classification of Service 

Projects: Phase I of an Initiative to Create a North American 

Product Classification System.” Mimeograph. 

<http://www.census.gov/eos/www/napcs/papers/cacapr99.pdf>. 

National Science Board. 2004. Science & Engineering Indicators, 2004. 

Arlington, VA: National Science Foundation. 

National Science Foundation (NSF). 1998. “Survey of Industrial 

Research and Development.” <http://www.nsf.gov/sbe/ 

srs/nsf01305/pdf.start.htm>. 

National Science Foundation (NSF). 2000. “Research and Development 

in Industry: 1998 Detailed Statistical Tables.” Arlington, VA. 

<http://www.nsf.gov/sbe/srs/nsf01305/pdfstart.htm>. 

Organisation for Economic Co-operation and Development (OECD). 

2001. Research and Development Expenditure in Industry 1987-

1999. Paris: OECD Publication Service. 

Organisation of Economic Co-operation and Development (OECD). 

2003. “The Science, Technology and Industry (STI) Scoreboard 

2003—Towards a Knowledge Based Economy.” Paris: OECD. 

<http://www.oecd.org/document/21/0,2340,en_2649_33703_ 

16683413_1_1_1_1,00.html>. 

Payson, Steven. 1999. “National Patterns of R&D Resources: 1999.” 

NSF 99-335, Arlington VA. <http://www.nsf.gov/sbe/srs/ 

nsf99335/pdf/nsf99335.pdf>. 

Pilat, Dirk. 2001. “Innovation and Productivity in Services: State of the 

Art.” In Innovation and Productivity in Services, pp. 17-58. 

Paris: Organisation for Economic Co-operation and 

Development (OECD). 

Sirilli, G., and R. Evangelista. 1998. “Technological Innovation in 

Services and Manufacturing: Results from Italian Surveys.” 

Research Policy 27:881-899. 

Sundbo, Jon. 1997. “Management of Innovation in Services.” The 

Services Industries Journal 17:432-456. 

Sundbo, Jon, and Faïz Gallouji. 1999. “Innovation in Services in Seven 

European Countries.” Report to the EU Commission. Research 

report 99:2, Roskilde University, Roskilde. 
References 

R-3 

Tassey, Gregory. 1997. The Economics of R&D Policy. Westport, CT: 

Greenwood Publishing Company. 

Tassey, Gregory. 2005. “Underinvestment in Public Good Technology.” 

Journal of Technology Transfer 30(1-2):89-113. 

Tether, Bruce, and Stan J. Metcalfe. 2002. “Services & Systems of 

Innovation.” Paper presented at the DRUID Academy Winter 

Ph.D. Conference, Aalborg, Denmark. 

Tether, Bruce, Christiane Hipp, and Ian Miles. 2001. “Standarisation 

and Specialisation in Services: Evidence from Germany.” 

Reseach Policy 30:1115-1138. 

A-1 

 Appendix A: 

 Telecommunications 

 Sector 

Telecommunication has facilitated the “death of distance,” enabling 

service providers and users to conduct business without regard to 

geographical location. Information and communication technology has 

become an inseparable component of any business in the economy of 

the 21st century. The telecommunications industry’s innovations have 

lowered transaction costs to domestic businesses and individuals 

through continued efforts toward developing and improving standards, 

technological infrastructure, reliability, and security. R&D in the 

telecommunications industry ranges from basic and applied research for 

electronic devices to development for the integration of networks and 

systems. However, almost all of the R&D expenditures reported for 

NAICS 5133 appear to be directly related to the provision of 

communications services. 

This appendix begins with a profile of the telecommunications industry 

and its ongoing R&D expenditures and activities. We then present a 

case study focused on the development of wireless communications 

(specifically, Wi-Fi [short for wireless fidelity] applications) to investigate 

the roles different stakeholders play in the technology development and 

deployment process. 

 A.1 INDUSTRY PROFILE AND R&D STATISTICS 

The telecommunications industry consists of a broad range of firms 

operating, maintaining, or providing access to facilities for the 

transmission of voice, data, text, and full motion picture video between 
Measuring Service-Sector Research and Development 

A-2 

network termination points and telecommunications reselling. Local, 

long-distance, and international voice telephony and data transmission 

services are the three main sources of service provider revenue. In 

1997, total revenue for this sector exceeded $260 billion with 

employment of approximately one million. 

In recent years, the telecommunications industry has been integral in the 

development of the information economy. Telecommunications is a 

dynamic industry that has undergone tremendous change. Today’s 

telecommunications market is the product of deregulation, consolidation, 

and technological innovations. 

During the 1980s, partial deregulation focused on long-distance 

operators at a modular point of intersection between local and long-haul 

voice networks. Deregulation intensified in the 1990s, resulting in the 

1996 U.S. Telecommunications Reform Act. This prompted investment 

for innovations in areas outside the traditional telephone market of the 

telecommunications industry. The local area network (LAN), a simple, 

flexible technology enabled by Internet protocol (IP) and ethernet 

standards, spawned innovations such as the multiprotocol router that 

disrupted a series of highly reliable but rigid incumbent technologies and 

accelerated the rise of a new paradigm. Improvements in Voice over IP 

(VoIP) technology are finally enabling the multiplexing of voice, video, 

and data onto a single data network (Christensen, Anthony, and Roth, 

2001). 

Once closely linked, division has emerged between transport and 

services since the emergence of IP networking. IP networking allows the 

decoupling of network services from their reliance on transmission 

media. Another important distinction is that of wireless versus wired 

connections. Although still dependent on the transmission network 

infrastructure for origination and completion, wireless technologies have 

untethered devices from the Public Switched Telephone Network (PSTN) 

and enterprise data networks, creating new opportunities associated with 

mobility. 

Regarding the size (sales) and technology areas of telecommunication 

companies, the top 10 publicly traded telecommunication companies are 

listed in Table A-1. R&D expenditures for most large companies are not 

available in COMPUSTAT. 
A-3 

Table A-1. Top 10 Telecommunications Firms by 1999 Sales 

Name NAICS 

Number of 

Firms 

Sales 

($ millions) 

R&D 

($ millions) 

Employme

(thousand

Wired telecommunications carriers 5171 72 $271,927 $314 811 Wireless telecommunications carriers (except satellite) 5172 41 $79,937 $16 176 Telecommunications resellers 5173 15 $3,316 $10 12 Satellite telecommunications 5174 8 $7,625 $33 3 Cable and other program distribution 5175 13 $22,159 $56 74 Other telecommunications 5179 23 $3,635 $74 21 Telecommunications 517 172 $388,598.82 $503.44 1,097.64 

NA: not available from COMPUSTAT. Source: COMPUSTAT, 2003. 
Measuring Service-Sector Research and Development 

A-4 

AT&T, the largest company by sales, had R&D expenditures of $550 

million in 1999. The firm provides a variety of services covering the 

spectrum of media delivery systems, from television and telephone to 

Internet and satellite. AT&T operates its own R&D research labs working 

on innovations in communications based on network operations, IP 

applications, and systems automation, in addition to other more longterm interests in communications technology. GTE, which is currently 

owned by Verizon, reported $131 million in R&D in 1999. Verizon 

specializes in telephone services through wire line and cellular telephone 

technology designed for personal or business applications. Verizon also 

acts as an Internet service provider (ISP) with digital subscriber line 

(DSL) capabilities. 

Table A-2 provides a list of sample companies with significant R&D 

expenditures based on information contained in COMPUSTAT (2003). 

The list does not contain the largest telecommunications firms, but it 

does contain a mixture of multimedia service providers. 

The most rapidly evolving areas in telecommunications are related to 

wireless application. Wireless service technologies, such as 1G–

Analog,1 2G–Digital,2 and 3G–Broadband, are the focus of significant 

R&D. Consolidation in the industry has produced the following domestic 

leaders in wireless communications services: 

• Verizon (merger of Vodafone and AirTouch [GTE]) 

• Cingular (merger of SBC Communications and BellSouth) 

• AT&T 

• Sprint 

• Nextel 

 A.2 R&D ACTIVITIES IN WIRELESS 

COMMUNICATIONS SERVICES 

In the telecommunications industry, our investigations focus on research 

to support wireless communication services. Moving into the 21st 

century, wireless communication has expanded rapidly. While 

maintaining wireless telephone service, service providers have begun to 

offer business applications such as wireless LANs (W-LAN), pagers, 

 

1Analog is a continuous electrical signal that sends and receives information. 

2Digital is the replication of signals through the translation to and from binary code. 
Appendix A — Telecommunications Sector 

A-5 

Table A-2. Sample of Telecommunications Firms with Significant R&D Expenditure in 

1999 

Name NAICS 

Employment 

(thousands) 

Sales 

($ millions) 

AT&T Corporation 517110 61.6 $34,529 

Echostar Communication Corporation 517510 15.0 $5,739 

Echostar DBS Corporation 517410 NA $5,732 

IDT Corporation 517110 3.8 $1,835 

General Communication 517110 1.3 $391 

PTEK Holdings Inc. 517910 2.0 $381 

ITXC Corporation 517310 0.2 $338 

Corvis Corporation 517910 1.2 $314 

ZTEL Technologies Inc. 517110 1.2 $289 

LodgeNet Entertainment Corporation 517410 0.79 $250.15 

NA: not available from COMPUSTAT. 

Source: COMPUSTAT, 2003. 

laptops with wireless modems, personal digital assistant (PDAs) with 

wireless connectivity, and cellular phone service. In general, wireless 

communications services can be grouped as follows: 

• Hybrid approach: The hybrid approach is personal 

communication services (PCS), which incorporates both wire 

and wireless technology. Hybrid technology allows carriers to 

bypass the traditional stationary wireless local loop technology. 

• Dispatch Services: Intercom communication for people who 

need to communicate frequently each day. 

• Wireless Data and Internet Access: Combination of W-LAN and 

broadband to create fixed wireless broadband services like local 

multipoint distribution service (LMDS) and multichannel 

multipoint distribution service, which support simultaneous voice 

and data transfers and eventually video. 

• Wi-Fi: Wi-Fi (short for wireless fidelity), also referred to as WLAN, is the transmittance of data over high radio frequencies 

(2.4 GHz) designed for short distances such as a hotel, office 

building, or college campus. 

The wireless industry categorizes its technologies by generations. The 

first generation (1G) was the introduction of analog service using 

advanced mobile phone service (AMPS), a standard developed in the 

1980s used predominantly in the United States. 
Measuring Service-Sector Research and Development 

A-6 

2G was the introduction of digital wireless service using code division 

multiple access (CDMA), which allowed for several voice or data packets 

to be transmitted over the same frequency. CDMA began to address the 

issues associated with limited bandwidth access. However, it was 

limited in that it was based on circuit-switch communications and 

required users to dial in to a network. 

3G is the combination of high-speed data, advanced voice capacity, and 

streaming video transmitted over broadband high-speed, packet-based 

wireless networks. 3G’s network is “always on” and does not require 

dialing in. In 2002, 2.5G was rolled out as an interim stage for the United 

States. 

Today’s wireless service providers are working to improve security, 

accessibility, reliability, and speed through advances in the wireless 

technology. 

Below is a brief discussion of R&D activities in these areas. This is 

followed by a case study of the Wi-Fi technology supply chain. 

 A.2.1 Security 

A recent survey conducted by CIO Magazine found that enterprise 

wireless solutions (a.k.a., wireless broadband) are becoming increasingly 

important in business operations for both manufacturing and 

nonmanufacturing companies. Companies are increasing consumption 

of the wireless infrastructure motivated by productivity increases, 

streamlining, and customer satisfaction. 

As businesses become more dependent on wireless networks for their 

operations, the demand for security has dramatically increased. Security 

was the primary topic of a recent meeting of the world’s largest 

communications companies, as the industry organization Alliance for 

Telecommunications Industry Solutions (ATIS) hosted a security summit 

entitled “Security of Service Provider Infrastructure in the Era of 

Convergence.” The wireless communication industry is increasingly 

interested in eliminating unauthorized access to operations support 

systems. 

The 3G Partnership Project, a consortium of wireless industry global 

leaders formed to develop and standardize 3G technology, is addressing 

the security issues related to 3G wireless technology. Their research 

activities include 
Appendix A — Telecommunications Sector 

A-7 

• general packet radio service (GPRS ) ciphering algorithms, 

• immediate service termination (IST) and access security for 

IP-based services, 

• network domain security (NDS), 

• requirements for security architecture and interfaces, 

• interoperability of multitechnology networks and encryption, and 

• user authentication of information as it travels from server to 

user. 

 A.2.2 Improved Accessibility 

Research to support accessibility includes developing and standardizing 

wireless markup languages. Wireless providers are working to further 

the wireless application protocol (WAP) programming languages. WAP 

is a grouping of standards related to accessing the Internet, using e-mail, 

receiving faxes, and conducting monetary transactions via digital 

wireless products such as mobile phones, pagers, and PDAs. 

Other activities include “Bluetooth” technology research to offer shortrange wireless connections between mobile phones and headsets, 

keyboard or mouse with personal computer or mobile phone and PDA. 

This includes research on Wi-Fi and W-LAN to support the transmittance 

of data over radio frequencies designed for short distances such as a 

hotels, office buildings, or college campuses. This technology is 

preferable to its wired counterpart LAN, mostly because of the increase 

in mobility of workers across a workspace. 

 A.2.3 Reliability 

Wireless networks pass large amounts of information through the air 

quickly. In early wireless applications, reliability was always an issue. 

Mobile phone users could suddenly lose their connection or intercept 

other information. The Institute of Electrical and Electronics Engineers 

(IEEE) developed a set of standards known as 802.11 that were 

designed to manage data packets as they are transmitted across the 

wireless network to avoid collision and disruption. 

 A.2.4 Improved Transmission Speed for Voice and Data 

Synthesizing voice, data, and video requires large amounts of 

information to be transferred from sender to receiver. 3G technology is 

therefore concerned with increasing the speed of transmission. 2G 

technology is relatively slow because the data connections are circuitswitched resulting in transmissions at 14 Kbps (kilobytes per second). 
Measuring Service-Sector Research and Development 

A-8 

2.5G technology was designed to use packet-switched networks 

combined with always-on data connections as a way of increasing the 

rate of transmission to about 56 Kbps. 3G has the capability to transmit 

data at 384 Kbps, fast enough to allow streaming video (Dunne, 2001). 

There is an ongoing debate concerning what wireless markup language 

should be used. Most wireless service providers in the United States 

during the early 1990s implemented CDMA or code division multiple 

access, while their European counterparts implemented global systems 

for mobile communications (GSM).3

CDMA separates transmissions, used by wireless companies, including 

Sprint PCS and Verizon, that are traveling in a bundle on a single 

wireless signal. CDMA compresses transmissions on a signal requiring 

less bandwidth. 

CDMA2000 is a 3G technology that offers both high-speed and highquality transmission. CDMA2000 is an evolution of CDMA technology. 

WCDMA digitizes and transmits data on a range of frequencies. 

WCDMA requires more bandwidth but optimizes the use of multiple 

wireless signals. 

General packet radio service (GPRS) is a technology designed to work 

with GSM to send data packets across a wireless network at 114 Kbps. 

The technology for GPRS is a step above circuit-switched methods and 

creates an always-on wireless device, eliminating the need to dial in for 

downloads. 

 A.3 CASE STUDY OF THE WI-FI TECHNOLOGY 

SUPPLY CHAIN 

RTI conducted interviews with five organizations throughout the supply 

chain for Wi-Fi products and services. Wi-Fi has become a catch phrase 

to describe W-LANs, electronic equipment, and services enabled by one 

of several 802.11 standards from the IEEE. Wi-Fi functionality includes 

the ability to share resources such as Internet content, e-mail, voice 

communications, and video and pictures. 

Table A-3 lists the names of the companies interviewed. Three original 

equipment manufacturers (OEMs) were interviewed to obtain their 

 

3GSM (65 percent of the world market) is the predominant markup language worldwide and 

especially in Europe, while CDMA (15 percent of the world market) is used only in the 

United States and Korea. 
Appendix A — Telecommunications Sector 

A-9 

Table A-3. Organizations Interviewed Related to Wi-Fi Services 

Name NAICS 

Sales 

($ millions)

Employees 

(thousands)

R&D 

($ millions) Service Description 

AT&T Corporation 517110 $34,529 61.6 $277 Multimedia delivery service

Corvis Corporation 517910 $314 1.2 $59 Networking equipment 

design 

Echostar Communication 

Corporation 

517510 $5,739 15.0 $32 Satellite network services 

TIVO Inc. 517510 $141 0.3 $22 Cable and other program 

distribution 

Echostar DBS 

Corporation 

517410 $5,732 NA $20 Wired telecommunications 

carriers 

IBASIS Inc. 517110 $178 0.2 $13 Wired telecommunications 

service 

Boston Communications 

Group 

517212 $103 0.4 $13 Cellular and other wireless 

telecommunications 

XM Satellite Radio Inc. 517410 $92 0.4 $12 Satellite 

telecommunications 

PTEK Holdings Inc. 517910 $381 2.0 $9 Other telecommunications 

ZTEL Technologies Inc. 517110 $289.18 1.19 $6 Wired telecommunications 

carriers 

NA: not available from COMPUSTAT. 

Source: COMPUSTAT, 2003. 

perspectives on the role that Wi-Fi service providers play in developing 

new or enhanced products and services. RTI contacted numerous 

network operators, including market leaders such as BellSouth and 

T-Mobile, and aggregators such as Boingo Wireless and iPass. 

Unfortunately, only two network operators responded to our requests for 

an interview, and none of the aggregators we contacted agreed to talk 

with us. 

 A.3.1 Description of Wi-Fi Services and Technologies 

Wi-Fi technology allows the exchange of information, such as Internet 

content, e-mail, and digital images, at speeds ranging from 2 to 100 

Mbps (megabytes per second) from a remote location over a W-LAN. 

The market for Wi-Fi products such as notebooks and other portable 

devices has been growing for several years. Based on a study 

conducted by Pyramid Research, the number of individual Wi-Fi 
Measuring Service-Sector Research and Development 

A-10 

subscribers is projected to increase from 12 million to over 700 million in 

the next 5 years. 

There are a number of variations to the 802.11 standard. The most 

current version relating to access speed is 802.11g. Ratified by the IEEE 

standards committee on June 12, 2003, this standard allows information 

transmission rates of 20+ Mbps in the 2.4 GHz radio frequency 

spectrum. Wi-Fi network equipment currently available to consumers is 

built on 802.11g or one of two older standards known as 802.11a and 

802.11b. Devices enabled with the most recent standard are compatible 

with the 802.11b standard equipment and devices. The equipment 

market for Wi-Fi includes network infrastructure, end-user devices, backend software applications, authentication software, and subscriber usage 

track software. 

Network infrastructure includes access points or “hotspots” that transmit 

and receive Wi-Fi signals from individual user’s devices. Hotspots 

consist of a radio frequency base station and a wired high-speed network 

connection. Depending on the location, hotspots also use amplifiers, 

antennae, cellular-to-Wi-Fi switching devices, and network management 

platforms to manage and extend the reach of a network connection. 

Furthermore, networking equipment designed for commercial use is 

integrated with back-end network management software applications, 

allowing the network operator to monitor, manage, and track subscriber 

usage and to allocate additional bandwidth during peak usage. A 

network operator provides high-speed connection services to subscribers 

using this equipment. 

Wi-Fi service is defined as the aggregation of the equipment outlined 

above to allow an end user or service subscriber, such as a business 

traveler, to connect to the Internet via one of the network’s hotspots. 

Wireless Internet service provider (WISP) is the term used to describe 

firms that provide wireless Internet connectivity. Similar to cellular phone 

carriers, WISPs monitor their networks, track usage, and expand their 

coverage to remain competitive. Activities performed by the service 

providers include developing customized access portals to ensure 

security and privacy to subscribers, monitoring subscriber usage, 

adjusting broadband allocations to individual hotspots, and expanding 

the reach of their existing network infrastructure. 

Software development of access portals is performed in house or 

outsourced depending on the level of complexity and required security 
Appendix A — Telecommunications Sector 

A-11 

encryption. Billing system software applications integrated with 

subscriber usage tracking software (which represents component 

technology) can be purchased or developed through in-house R&D. 

Expansion of the network is another activity service providers perform. 

However, networks suffer from the limited reach of access points. As a 

result, WISPs, much like cellular phone providers, enter into service 

roaming agreements with other regional-specific networks as a way of 

expanding the number of access points a network operator can offer to 

its subscribers. 

 A.3.2 Wi-Fi Equipment Manufacturers and Service Industry 

Description 

This section identifies the key participants in the supply chain for the 

development and deployment of Wi-Fi services and products. The 

supply chain is identified as beginning with OEMs and software 

programmers, most of whom participated in developing the 802.11 

standard within the IEEE standards organization. Equipment and 

software applications developers then work with Wi-Fi service providers 

to help them develop network connectivity and security services. There 

activities would fall under the category of systems management R&D. 

Also supporting network operators are system integration companies and 

business support software developers. Network operators then provide 

services either directly to end users (e.g., individual consumer, 

institution, or enterprise) or through aggregators. Figure A-1 illustrates 

the development supply chain for Wi-Fi services. 

IEEE develops network standards using input from manufacturers, 

vendors, and network operators from around the world. Participation in 

wireless networking standards development has traditionally been 

dominated by OEMs. However, the number of service providers 

participating in these standards committees has been growing rapidly 

(Meyers, 2004). Telephony Online, a communications industry 

information source, points out the trend in increased participation from 

service providers in the standards development of wireless broadband 

access technologies. Two major reasons for the increased participation 

reported in the TelephonyOnline.com article for involving service 

providers were to educate them on the technology’s capabilities and to 

gain information on the functional requirements that need to be included 

in the standard. 
Measuring Service-Sector Research and Development 

A-12 

Figure A-1. Development Supply Chain for Wi-Fi Services 

Subscribe

Equipment

Subscribers

End Users

Supply Chain Participants

Products or Services

Access to

Network

Accounting

Services

Integration

Services

Commercial

Network

Deployment

OEM

RD&T Firms Standards

Orgs.

Small Network Operator

Aggregators

Systems

Integration

Network/

Settlement

Agency

The equipment market is built on a number of strategic partnerships 

between OEMs and software development firms. OEMs spend 

considerable time identifying the operational needs of their Wi-Fi service 

provider customers. Operation requirements articulated by service firms 

include interoperability with existing data services, security, and 

accounting systems. OEMs, in cooperation with specialized “back-end” 

business process software development companies, then create both a 

Wi-Fi networking technology business platform and the equipment 

required to operate a network. OEMs often contract with other upstream 

suppliers to build and install the network access points or hotspots. 

Wi-Fi service providers’ overall strategy for market growth is to target 

people in transit. This targeting includes business travelers, public 

service employees on the go, and metropolitan public networks. The WiFi service market (or hotspot market) revolves around expanding the 

overall reach or scope of a service provider’s network. The goal is to 

maximize the number of locations that the service provider can offer to 

subscribers as access points. Taking the purchased technology platform 

developed by the OEM, the Wi-Fi service provider builds out a physical 

network of access points in a certain geographical location. Most likely 

this location is in an urban setting, where there is potential for a large 
Appendix A — Telecommunications Sector 

A-13 

number of mobile users. Another strategy has been to build networks in 

more remote locations to act as a “last mile” option for rural communities, 

where the cost-effective concerns have limited the development of wired 

network infrastructure. The Wi-Fi service provider then manages access 

and authentication, security, and roaming subscriber authentication 

through an operation support system (OSS) that enables the operator to 

manage a large hotspot market. 

Aggregators specialize in developing roaming agreements that expand 

the reach of any single network.4 These firms do not operate networks 

but instead develop a subscriber base under a brand name (e.g., Boingo 

Wireless, iPass, and GRIC) and then contract with existing Wi-Fi network 

operators to gain access for their subscribers to an assortment of 

networks, thereby expanding the reach of a given network for the end 

user. Conversely, the aggregator can work as a contract vehicle, 

providing a network operator with extended network roaming capabilities 

for its subscriber base via the network roaming agreement that the 

aggregators have already established. 

 A.3.3 Wi-Fi Technology Development and Deployment 

Process 

The origin of the Wi-Fi service market lies in specifying the new 802.11 

standard for wireless networking from IEEE. Following (and even during) 

ratification of 802.11g by the IEEE in 2003, electronic and networking 

equipment manufacturers began to integrate this new wireless 

networking technology into their existing products (such as laptops) and 

develop a network management platform for Wi-Fi network operators. 

The development and deployment process is described for two types of 

service firms: wireless service providers without traditional R&D 

activities and wireless service providers with traditional R&D activities. 

Service Providers Without Traditional R&D Divisions 

Wireless service providers use technology products manufactured by 

OEMs to allow subscribers to wirelessly connect to the service provider’s 

network. The extent to which a service firm plays a role in developing 

new products and services is determined largely by the overall size of 

the firm, either in revenue or market share. This section describes the 

 

4Aggregators include companies such as Boingo Wireless, iPass, and, GoRemote 

(formerly GRIC). These companies are involved in building access agreements 

between numerous independent wireless networks enabling nationwide access to 

customers without having to build out independent network infrastructure such as 

wireless towers and access nodes. 
Measuring Service-Sector Research and Development 

A-14 

development process for Wi-Fi services and identifies possible R&D 

activities performed by smaller wireless network operators. A typical 

company might be MHO Networks, which offers regional service in 

Denver, Colorado. This firm started out as a retail custom computer 

reseller and has evolved to a full-blown wireless network operator 

offering wireless network access in select cities and communities 

throughout the state of Colorado. Figure A-2 depicts a small network 

operator’s involvement in developing its wireless service capabilities 

(technologies) and its interactions within the supply chain. The figure 

illustrates that small network operators are involved in product 

development primarily through 

• providing feedback into OEM road-mapping activities, 

• providing feedback into product specifications, 

• participating in deployment tests, 

• coordinating system integration, and 

• leading service support software development. 

Figure A-2. Development Activities Performed by Small-Sized Network Operators 

Product

conceptualization

Roadmap

Basic research

Technology development

Strategic trajectory

Target markets

Product

specification

Platform customization

Conformance

testing and

error

correction

Deployment

tests

Standards configuring

Network monitoring

Software development

Billing recognition

software development

Authentication software

versions

Beta Version

Market Assessment

Product Specification

Trouble Shooting

OEM Small Network Operator

Contract research

Process Improvement

Systems Integration Network/Settlement Agency

Subscribers

End Users

Aggregators

Supply Chain Participants

Activities

Flows of Information

Products or Services

Access to

Network

Accounting

Services

Integration

Services

Installation and

maintenance of access

points

RD&T Firms Standards Orgs.

Accounting software

development

Standards

specifications

Commercial

Network

Deployment

Subscribe
Appendix A — Telecommunications Sector 

A-15 

OEMs coordinate the product development process, building on basic 

and applied research performed through a combination of in-house, 

institutional, and commercial partnerships. The OEM typically identifies 

those industries or markets that would derive the greatest benefit from 

wireless technology. Then in conjunction with the current technology 

capabilities and trends in future standards development, the OEM 

articulates a technology road map. The road map aligns the firm’s 

internal strategic trajectory with the current and future trends of wireless 

technology. The manufacturing firm leverages input from the industry 

leaders, such as existing network operators, to fine tune a technology 

road map, aligning its development strategy with market trends reported 

by the perspective consumers. OEMs spend considerable time iterating 

with network operators to ensure that the product or equipment being 

developed under the 802.11 standard addresses the operator’s business 

process needs. 

Equipped with knowledge of the network operator industry’s market 

trends, the OEM engages in product conceptualization and begins to 

build the wireless networking platform aimed at addressing the business 

needs of the targeted industry of wireless network operators. The OEM 

partners with software application development firms that specialize in 

back-end business software for the wireless network operators to build 

the initial structure of the wireless networking platform. Following the 

development of the platform, the OEM again seeks network operators’ 

feedback on product specifications, and for larger service firms this may 

include some customization. The network operator articulates the 

specific capabilities and operational requirements that the networking 

platform must address to meet their business needs. 

Next, the platform enters a conformance testing (also known as alpha 

testing) phase, where network operators take part in developing test 

scenarios that will allow the product designers to evaluate how well the 

product will perform in a real business environment. The service firm 

provides feedback on bugs and glitches in the system. The OEM then 

sends the initial product to wireless network operators to use in a realworld environment. This portion of the process is known as a 

deployment testing phase (also referred to as beta testing). At this point, 

the network operator takes a role in the development process through 

testing and offering feedback to the OEM, creating a virtually integrated 

supply chain for R&D activities. Once all issues and bugs have been 
Measuring Service-Sector Research and Development 

A-16 

sufficiently addressed, the OEM can roll out its new wireless networking 

platform. 

The network operator purchases the platform from the OEM and then 

begins to build out its wireless network. The operator integrates the new 

platform with any existing data services it operates. The operator then 

develops customized software for authentication and access applications 

and ensures security and a methodology to ensure that the network is 

configured to meet all current standards in use. In addition, network 

operators work to develop methods to more effectively track subscriber 

usage and link usage to billing software applications. Development of 

the physical infrastructure, such as access points, is typically outsourced 

to network construction service companies. 

Once their local network is in place, network operators use aggregators 

to maximize geographical coverage. This optimization enables the 

subscribers to have the greatest mobility and variety in access points 

from a particular network operator. Roaming agreements allow networks 

to expand without large capital investments. 

Service Providers with Traditional R&D Divisions 

Network operators with larger development budgets have more 

traditional research labs. Product and service development occurs in 

much the same way as described above, but the large network providers 

internalize more of the development process within technology divisions. 

These larger firms, unlike smaller firms, tend to lead (as opposed to 

participate in) development activities related to 

• technology road mapping, 

• service conceptualization, 

• compliance testing, 

• integration of new systems with existing legacy systems, 

• deployment testing, 

• standards configuring, and 

• accounting and billing software development. 

Technology divisions for larger network operators serve to maintain an 

awareness of the existing and emerging equipment and software on the 

market for various networking standards and technologies, including 

Wi-Fi, VPN (virtual private network), and WiMax. This technology 

monitoring is used to inform their strategic planning, and these service 

providers are likely to lead the development of their own technology road 
Appendix A — Telecommunications Sector 

A-17 

mapping activities (whereas in the case of small network providers, the 

firm simply provides input on emerging market industry trends). Large 

network operators have knowledge of available equipment and systems 

and their capabilities. 

The network operator’s in-house resources allow it to conduct 

compliance and deployment testing and network modification internally. 

However, the carrier still offers feedback to manufacturers during the 

development of the platform and networking equipment. Figure A-3 

suggests an optional scenario in which these larger firms conduct more 

development activities in house. 

In Figure A-3, the network operator is still providing market assessment 

input to the OEM’s product development process and some product 

specification. However, compliance and deployment testing, as well as 

required modification, is typically conducted internally. 

Figure A-3. Development Activities Performed by Large-Sized Network Operators 

Deployment testing

Standards configuration

Accounting and billing

Software modification

Network equipment

Installation

Market Assessment

Large Network Operator

Aggregators

Supply Chain Participants

Activities

Flows of Information

Products and Services

Standards

specification

Subscribe

R&D

Equipment

Software Applications

Roadmapping

Target markets

Strategic trajectory

Service

conceptualization

Compliance tests

Modification to

address legacy

issues

Subscribe

Standards Organization

Business Operations

Needs

OEM

Network Access

Larger network operators also invest significant resources in standards 

development organizations as noted earlier in this discussion. Their 

involvement in developing standards serves three purposes. First, they 
Measuring Service-Sector Research and Development 

A-18 

are exposed to the array of competing vendors for various technologies, 

which allows the network operator to make a better informed purchase of 

networking equipment that will meet the specific business needs of 

individual network operators. Second, by offering knowledge of business 

operations requirements, network operators shorten the time required to 

bring new or improved services to subscribers. Finally, these firms are 

enhancing their ability to absorb future technology change through 

establishing a continued presence in the standards development 

process. 

 A.4 SUMMMARY OF ACTIVITY CATEGORIES AND 

RESEARCH TAXONOMIES 

Network operators are involved in the product development process 

throughout the technology supply chain. Both large and small network 

operators contribute to similar development tasks to roll out new 

services. However, in the case of a small network operator, many R&D 

activities take place outside the firm, with suppliers receiving input from 

the network operator, while the larger-sized firms are more likely to 

internally lead many of the activities, such as compliance and 

deployment testing activities and customization. 

Potential R&D activities conducted by network operators include 

• road mapping activities (in house or supporting suppliers) and 

participation in standards organizations; 

• product conceptualization, specification, and customization (in 

house or supporting suppliers); 

• compliance testing (alpha testing); 

• deployment testing (beta testing); and 

• development and integration (often with legacy systems) of 

network monitoring and business support software. 

These product development terms are used by the telecommunications 

industry, and they could be used in the RD-1 instrument/instructions to 

describe potential R&D activities. 

 A.5 REFERENCES 

Christensen, Clayton M., Scott D. Anthony, and Erik A. Roth. October 

2001. “Innovation in the Telecommunications Industry: 

Separating Hype from Reality.” Harvard Business School 

Working Paper. <http://newsroom.cisco.com/dlls/tln/ 

Disruption_study/telecompaper.pdf>. 
Appendix A — Telecommunications Sector 

A-19 

COMPUSTAT. 2003. American Stock Exchange Database. Contennial, 

CO: Standard & Poor’s, McGraw Hill Companies, Inc. 

Dunne, Danniel. 2001. “What is 3G Technology?” DarwinMag

<http://www.darwinmag.com/learn/curve/column.html?ArticleID=

182>. 

Meyers, Jason. 2004. “Telephony’s Complete Guide to WiMAX: The 

Business Case for Service Provider Deployment.” 

<http://telephonyonline.com/ar/telecom_telephonys_complete_ 

guide/index.htm>. 

B-1 

 Appendix B: 

 Financial Services 

 Sector Case Study 

Over the past decade, changes in the economy and the increased use of 

information technology in financial services have significantly influenced 

innovation activities in the financial services sector. Increased 

competition through deregulation, consolidation, and disintermediation is 

forcing the financial service companies to innovate to maintain 

profitability. 

At the same time, there is an increased demand for financial services as 

the “baby boom” generation approaches retirement. The simultaneous 

increase in competition and demand is driving the industry to increase 

R&D to develop both new services and also efficient and low-cost 

delivery devices for new and existing services. 

The introduction of e-money, smart cards, e-checks, e-funds transfer, 

and improved encryption are some of the innovations developed in 

financial services in the 21st century. An additional trend influencing 

innovation is the “disintermediation” of financial services as 

manufacturers begin to “encapsulate” their products with services and 

deal directly with customers. This is forcing service firms to reduce costs 

by developing more efficient technologies and move into new product 

and service areas to maintain profitability. 

This case study begins with a profile of the financial services sector and 

its ongoing R&D expenditures and activities. Findings from industry 

interviews are presented to provide an overview of the technology 

development and deployment process, with a focus on financial Webbased services. 
Measuring Service-Sector Research and Development 

B-2 

 B.1 FINANCIAL SERVICES (NAICS 52, 53) R&D 

EXPENDITURES AND ACTIVITIES 

The financial services sector, as defined in NSF’s R&D performance 

reports (see NSF, 1998) includes NAICS 52 and 53. Firms in this sector 

consist of depository institutions; nondepository institutions; security and 

commodity brokers; insurance carriers; insurance agents, brokers, and 

services; real estate; and holding and other investment institutions. 

• Depository institutions include firms engaged in deposit banking 

and fiduciary activities. 

• Nondepository institutions include firms engaged in extending 

credit in the form of loans but not engaged in deposit banking. 

• Security and commodity brokers, dealers, exchanges, and 

services include firms engaged in the underwriting, purchase, 

sale, or brokerage of securities and other financial contracts on 

their own account or for the account of others, and exchanges, 

exchange clearinghouses, and other services allied with the 

exchange of securities and commodities. 

• Insurance carriers include carriers of insurance of all types, 

including reinsurance. 

• Insurance agents, brokers, and service include agents and 

brokers dealing in insurance and organizations offering services 

to insurance companies and to policyholders. 

• Real estate includes real estate operators and owners and 

lessors of real property as well as buyers, sellers, developers, 

agents, and brokers. 

• Holding and other investment offices include investment trusts, 

investment companies, holding companies, and miscellaneous 

investment offices. 

In 1999, total revenue for this sector exceeded $1.9 trillion with 

employment of approximately 4.3 million. The Census Bureau 

aggregates firms classified under the financial sector into seven 

subcategories by NAICS code. Table B-1 provides numbers of firms, 

employees, and revenue for each of the eight subsectors. 

Table B-2 lists the top 10 finance firms by sales. When ranked by sales, 

the financial sector’s top 10 are familiar names such as Merrill Lynch, 

Citigroup, Morgan Stanley, and Chase Manhattan. These large financial 

institutions characterize the financial sector; however, their R&D 

expenditures were not available. Table B-3 provides a sample of publicly 

traded finance firms with significant R&D expenditures contained in 

COMPUSTAT. 
Appendix B — Financial Services Sector Case Study 

B-3 

Table B-1. Summary of Financial Services Sector 

NAICS Name 

Number of 

Firms 

Employment 

(thousands) 

Sales 

($ millions) 

5222 Depository Institutions 672 2,228 $715,938 

5222 Nondepository Intuitions 99 359 $217,974 

5231 Security, Commodity Broker 98 322 $188,342 

5241 Insurance Carriers 200 1,007 $694,385 

5242 Insurance Agents, Brokers, Services 43 165 $30,021 

5311 Real Estate 92 79 $14,533 

5511 Holding and Other Investment Offices 875 168 $66,600 

52, 53 Finance, insurance, and real estate 2,079 4,329 $1,927,792 

Note: Based on companies contained in COMPUSTAT. 

Source: COMPUSTAT, 2003. 

Table B-2. Top 10 Finance Firms by Sales 

Name 

Employment 

(thousands) NAICS Code 

Sales 

($ millions) 

Citigroup Inc. 115.0 5223 $82,005 

Prudential PLC-ADR 23.0 5241 $51,745 

Bank of America Corporation 155.9 5221 $51,526 

ING Groep NV-ADR 82.7 5241 $43,819 

American International Group 55.0 5241 $40,656 

Fannie Mae N/A 5222 $36,968 

Merrill Lynch & Company 67.2 5231 $34,879 

Morgan Stanley Dean Witter 55.3 5231 $33,928 

Chase Manhattan Corporation 74.8 5221 $33,544 

Allstate Corporation 52.0 5241 $26,959 

COMPUSTAT contained no R&D information for the top 10 finance firms by sales. 

NA: not available in COMPUSTAT. 

Source: COMPUSTAT, 2003. 
Measuring Service-Sector Research and Development 

B-4 

Table B-3. Sample of Firms within NAICS 52 and 53 with Significant R&D 

Expenditure 

Name 

Employment 

(thousands) 

NAICS 

Code 

Sales 

($ millions)

R&D Expenses 

($ millions) Business Description

SEI Investments 

Company 

1.5 5239 $456 $43 Investment technologies 

firm 

Anglo American PLCADR 0.2 5239 $11,923 $34 Holding company 

Gemstar-TV Guide 

International Inc. 

0.3 5331 $241 $24 Global media and 

technology company 

MIPS Technologies Inc. 0.1 5331 $71 $21 Technology design and 

patent leasing 

Interdigital 

Communications 

Corporation 

0.3 5331 $70 $20 Designer of wireless 

telecom technologies 

IGEN Inc. 0.2 5331 $14 $14 Biodetection platformleasing 

Investment Technology 

Group Inc. 

0.3 5231 $232 $10 Technology-based 

trading company 

Health Risk 

Management Inc. 

0.9 5242 $162 $9 Managed health care 

and consulting 

Macrovision 

Corporation 

0.1 5331 $37 $9 Patent manager and 

software design 

Rambus Inc. 0.2 5331 $43 $8 Licenses semiconductor 

chip connections 

Source: COMPUSTAT, 2003. 

As shown in Table B-3, most of the firms with significant R&D 

expenditures in COMPUSTAT are holding or technology investment 

companies and are not necessarily conducting R&D related to the 

provision of financial services. For example: 

• SEI Investments Company is a consulting firm specializing in 

financial management and investment technology solutions. 

Although the firm is oriented around the financial sector, the R&D 

reported seems to be emerging from the development of 

software applications that enable clients to make decisions 

concerning their investment portfolios. 

• Anglo American PLC-ADR, with the second largest reported 

R&D expenditure, is a holding company, controlling the majority 

of shares for some of the world’s largest diamond (45 percent of 

DeBeers), gold (53 percent Anglogold), and platinum (50 percent 

Anglo American Platinum) companies. Also Anglo American 

PLC-ADR is one of the world’s largest independent coal miners, 
Appendix B — Financial Services Sector Case Study 

B-5 

with interests in ferrous and base metals, industrial minerals, and 

forest products. Only $4 million, or 0.17 percent, of the total $2.4 

billion operating profit for Anglo American was dedicated to 

financial services in 2001, yet they reported a $34 million 

investment in R&D. Given the brief company description, it is 

unlikely that the amount invested in R&D is being used to 

innovate in the financial sector. 

• IGEN Inc. is another example of a company whose product is not 

related to the financial sector. IGEN designs and manufactures 

diagnostic systems that aid in the mapping of the human 

genome. It holds the patent rights for this cutting-edge 

technology and leases its use to clients such as the Human 

Genome Project and other molecular biologists. The firm’s SIC 

code 6794 classifies the company as a patent owner and lessor. 

The company’s description demonstrates that the R&D reported 

to COMPUSTAT is advancing medically related service 

industries, not the financial sector. 

• MIPS Technologies is a design company, classified as a patent 

owner and lessor, specializing in developing the low-power 34 

and 64 bit core chips that are found in most video game 

consoles in today’s markets. In addition to gaming system chips, 

they offer microprocessors and architecture design systems. 

Instead of manufacturing these products, they simply license 

their intellectual property to large manufacturers of high-tech 

products, such Hewlett-Packard, NEC, and Philips 

Semiconductors. 

• Rambus provides chip and system companies with interface 

solutions to enable high performance and system bandwidth for 

a range of consumer, computing, and networking applications. 

Rambus provides its customers with interface solutions and 

comprehensive engineering services to support implementation 

of its interfaces in customer products. 

Table B-4 provides a sample of firms with R&D expenditures contained 

in COMPUSTAT that are performing R&D activities related to the 

financial sector. 

For those firms reporting R&D expenditures in COMPUSTAT related to 

the financial sector (Table B-4), their Web sites revealed the following 

innovation activities: 

• Investment Technology Group Inc. is a full-service trade 

execution firm that uses technology to increase the effectiveness 

and lower the cost of trading by emphasizing R&D in the 

products they offer, which are as follows: 

– POSIT: an electronic stock crossing system 

– QuantEX: a Unix-based decision-support, trade 

management, and order routing system 

– SmartServers: server-based implementation of trading 

strategies 
Measuring Service-Sector Research and Development 

B-6 

Table B-4. Sample of Companies Reporting R&D Expenditure in COMPUSTAT Related 

to Financial Services 

Name 

Employment 

(thousands) NAICS 

Sales 

($ millions) 

R&D 

Expenses 

($ millions) 

Investment Technology Group Inc. 0.3 5231 $232 $9.7 

A B Watley Group Inc. 0.1 5231 $21 $6.0 

ILIFE.com Inc. NA 5231 $12 $3.0 

Mortgage.com Inc. 0.5 5223 $43 $2.9 

LendingTree.com Inc. 0.1 5223 $7 $1.1 

NA: not available in COMPUSTAT. 

Source: COMPUSTAT, 2003. 

– Electronic Trading Desk: an agency-only trading desk 

offering clients the ability to efficiently access multiple 

sources of liquidity 

– ITG Platform: a PC-based order routing and trade 

management system 

– ITG ACE and TCA: a set of pre- and posttrade tools for 

systematically estimating and measuring transaction costs 

– ITG/Opt: a computer-based equity portfolio selection system 

– ITG WebAccess: a browser-based order routing tool 

– Research: research, development, sales, and consulting 

services1

• A B Watley Group Inc. is a New York registered broker-dealer 

that operates both direct-access trading and third market 

institutional sales trading brokerage businesses. The company 

offers a proprietary technology called Direct-Access Vertical 

Exchange (DAVE) to brokerage and banking industries. DAVE 

consists of a ticker plant, order entry and trade processing, and 

data delivery engines. 

• LendingTree.com Inc. is a lending exchange that attracts 

customers looking for loans and processes loan requests 

through a number of banks. LendingTree licenses their 

technology platform LEND-X(SM) (which powers their Internetbased lending exchange) to other businesses to create 

exchanges on their own Web sites. 

 

1Company product information was retrieved from the SEC’s 10-K fillings archive. 
Appendix B — Financial Services Sector Case Study 

B-7 

 B.2 R&D CHARACTERISTICS AND ACTIVITIES 

The finance industry, at the NACIS two-digit level, is too large to examine 

in its entirety. In addition, much of the R&D performed by companies 

classified under NAICS 52 and 53 is not directly related to the provision 

of financial services. Therefore, the focus of the remainder of this case 

study is the financial organizations classified under NAICS 523 as 

securities, commodity, contracts, and other financial investments and 

related activities. 

A report by Mintel International Group Ltd.2 suggests that the financial 

services industry is in the midst of redefining its business processes by 

developing and adopting technologies such as data warehousing and 

mining, customer service and support software, and client relationship 

management tools. Their goal is to provide either the individual or the 

corporate investor with easy and reliable access to real-time market 

investment information. These services are being provided via networks 

that require higher levels of security to ensure the confidentiality of 

monetary transactions. 

In addition to improving the services for customers, financial institutions 

are also interested in developing technology for investment tools that will 

enhance a financial analyst’s ability to make the most lucrative 

investment decision and gain competitive advantage. Industry leaders 

have focused on developing databases that update information in real 

time, thus equipping investors with up-to-the-minute market information 

and assisting investment managers in decision making. 

The following examples describe the types of R&D activities performed 

by financial services companies. Financial markets can be extremely 

volatile in both the short run and the long run, and without a way of 

providing up-to-the-minute market information investment managers’ 

firms may realize large losses. 

• Morgan Stanley has developed real-time international hedge 

fund and equity indices informed by market data via Reuters and 

Bloomberg. Morgan Stanley will be able to offer emerging 

market, regional, country, and sector equity indices in real time. 

“Real time indices provide a unique insight into the intraday 

movements of the global equity markets and enable clients to 

evaluate their portfolios’ performance versus the benchmark 

(Morgan Stanley) index at any point in the day.” 

 

2Downloaded from www.marketresearch.com/product/display.asp?productid=805899. 
Measuring Service-Sector Research and Development 

B-8 

• JP Morgan’s Investor Services product development division 

announced in October 2002 a strategic alliance with Investors, a 

leading supplier of performance measurement services for equity 

research. The collaboration goal is to develop an integrated 

research and benchmarking tool that will “help institutions 

maximize returns through better analysis of their supplier 

networks and relative contribution to performance” (JP Morgan, 

2002). Benchmarking tools are a way for financial institutions to 

demonstrate the value added from their research and evaluate 

comparatively the performance of research analysts in house 

against other institutions. 

• Merrill Lynch decided to enhance its services by developing a 

superior platform for their financial advisors. In November 2002, 

they partnered with Thomson Financial, a unit of the Thomson 

Corporation, to develop a “Wealth Management Workstation” 

(WMW). The workstation will be designed to support financial 

advisors through the use of robust market data, news and 

portfolio management tools, and client relationship management 

(CRM) software. 

In addition to product development efforts using partnerships as 

exemplified above, broad research consortiums are formed to conduct 

and coordinate generic and infrastructure R&D. Interoperability issues 

can be addressed through the cooperative efforts of member 

organizations, with individual institutions realizing gains in competitive 

advantage through the development of proprietary technology. For 

example, the Financial Services Technology Consortium (FSTC)3 is a 

member organization of the leading financial firms in North America. The 

FSTC coordinates collaborative technology research and development 

through pilots, proof of concept, tests, and demonstrations to develop 

interoperable, open-standard technologies that answer core competency 

needs for industry. FSTC prototypes new infrastructures for financial 

transactions, confirms new specifications for the industry, and evaluates 

new technologies in lab settings. 

The FSTC has conducted projects since 1994 in areas such as customer 

authentication, branch automation, check truncation, Web services, 

wireless banking, and biometrics. By developing these services through 

cooperative efforts of the organization’s members, the technology 

developed ensures open architectures and interoperability. The financial 

services industry identified the need for technological innovation in the 

areas of voice authentication, Web services for corporate cash 

management, automated intrainstitutional exchange systems, and 

 

3See www.fstc.org for additional information. 
Appendix B — Financial Services Sector Case Study 

B-9 

electronic checking. The following are some examples of the type of 

projects performed by the consortium’s working groups. 

• Universal value exchange (UVX) is a set of protocols that 

define the internal architecture, interfaces, and gateways to 

existing payment systems for financial institutions. Thought to 

be “middleware,” the UVX protocols will support payment 

processing such as paper check processing, wire transfer 

services, ACH, ATM/EFT, and credit card processing. Initially, 

the architecture is planned for transactions between banks and 

patrons; however, following the adoption by two or more banks, 

UVX is designed to conduct intrainstitutional transactions. The 

technology goal is to reduce the operational costs of legacy 

payment systems by connecting existing systems to a modern 

payment infrastructure using XML, state-of-the-art security 

technology, and current Internet protocols. 

• The ANS X9.85 project will test the viability and performance of 

a prototype check validation program by designing a system that 

uses the ANS X9.85 standard, “Specifications for Automated 

Identification of Security Features.” The system will be 

evaluated using a metric developed by financial institutions. The 

goal of the project is to surmise the degree of difficulty in 

modifying current check-processing systems to identify security 

features, assess the scalability and ease of integration with 

existing systems, and specify technical and operational barriers 

to implementation. 

 B.3 FINDINGS FROM FINANCIAL SERVICES 

SECTOR INTERVIEWS 

RTI conducted interviews with five firms from the financial services sector 

(see Table B-5). The financial services firms interviewed included large 

retail banks and major investment service institutions. Web services 

technology was identified for this project as a case study to demonstrate 

how innovation occurs within financial services firms. However, in a 

number of our interviews there was a shift in the discussion from Web 

service innovation to more general concepts about R&D, how those 

activities are measured, and how they relate to the innovation process in 

general. 

 B.3.1 Defining Financial Services 

Companies interviewed defined financial services as an industry that 

provides services in, but not limited to, retail banking, debt and asset 

management, and private and institutional investment. Financial 

services firms provide service to a variety of clients, ranging from 

individuals to large institutions. Institutional client services include debt 
Measuring Service-Sector Research and Development 

B-10 

Company Name Position 

Computer Service Companies 

Accenture Associate Partner for Financial 

Services Group 

Niteo Partners Project Manager 

Financial Service Institutions 

Merrill Lynch Chief Technology Architect 

JP Morgan Chase VP of Treasury Security Services 

Wachovia VP of Retail Integration 

Industry Research Company 

Forrester Research Principal Analyst 

management, capital financing, public and private offerings of debt (stock 

and bonds), and equity, as well as other securities. The provision of 

these services is based on a skills set of underlying knowledge and 

experience to ensure high returns on investment for the client 

(consumer) and the financial services firm (producer). 

Financial services change over time in response to consumer 

preferences. Firms are continuously working to develop higher quality, 

more efficient, and less expensive products that will allow them to gain 

competitive advantage in their industry or sector. To this end, 

technology is developed and/or acquired and used to increase the 

productivity of the existing service and to develop new services. The 

development and application of intellectual capital (IC) is the driving force 

behind innovation. 

Financial services can be either labor intensive, relying heavily on 

personal interactions and human capital, or capital intensive, relying on 

automation to lower the cost of transactions and the dissemination of 

information. During our conversations with industry, we focused on two 

general categories of services: investment services and retail banking. 

The distinction between these two segments lies in the level of 

technology needed to meet consumer demand for services in the 

respective segments. 

Investment services rely heavily on a number of different technologies to 

ensure that accurate and complete information is available to investors. 

A high rate of innovation is required as the leading firms compete for 

customers through differentiation via technology. We found that 

Table B-5. Financial 

Services Firms 

Interviewed 
Appendix B — Financial Services Sector Case Study 

B-11 

investment services firms were conducting a large share of innovation in 

house. The largest investment services firms even have teams referred 

to as Advanced Development Groups (ADGs) that are responsible for 

innovation and development projects within the firm. 

Conversely, retail banks see themselves as competing for customers 

through the quality of service rather than the development of and 

innovation within services. Retail banks believe they have found an 

optimal distribution between maintaining and enhancing the level of 

technology facilitating the provision of retail banking service. In recent 

history, the trend in the provision of services has been to move from 

human interaction toward total automation via the Internet and ATMs. In 

some cases, banks began to charge customers for using bank branches 

and human tellers to make transactions. However, recent literature 

suggests that this trend is reversing. Although retail banks are 

maintaining the use of the Internet and ATMs for simple banking 

services, such as balance inquiries, deposits, and withdrawals, these 

banks are relying more on face-to-face interactions when providing more 

complex services, such as mortgages and mutual fund investments. 

Clearly there are many differences in the level of technology and 

innovation required to be competitive in investment and retail banking. 

Informed by interview responses, RTI constructed a model of innovation 

relevant to the financial services industry, which we outline later in this 

discussion. By applying this innovation model to both investment 

services and retail banking, we begin to see where the most 

concentrated development activities lie. 

 B.3.2 R&D and Innovation 

NSF’s definition of R&D activities includes the following components: 

• the planned, systematic pursuit of new knowledge or 

understanding toward general application (basic research); 

• the acquisition of knowledge or understanding to meet a specific, 

recognized need (applied research); and 

• the application of knowledge or understanding toward the 

production or improvement of a product, service, process, or 

method (development). 

Based on our interviews, we found that these concepts of R&D did not 

resonate well within the financial services industry. None of the firms 

interviewed indicated that they conduct activities in either basic or 

applied research. Most of the individuals interviewed could relate to the 
Measuring Service-Sector Research and Development 

B-12 

concept of development; however, traditional research, either basic or 

applied, was not commonplace in their operations. RTI found that the 

ideas underlying the development phase of R&D resonated best for 

investment services institutions. However, only the largest retail banking 

firms thought that they were performing development activities, and the 

smaller retail banks indicated they were not doing any R&D. 

For large investment firms, development activities mentioned in the 

interviews included conceptual design, articulation of technical 

specifications and capabilities, integration, and deployment of new 

technology. The research activities of large retail banks are primarily 

related to initial conceptual design, with only a small role in the 

development and deployment of the technology. Table B-6 identifies and 

compares development activities performed within investment and retail 

service firms. 

Table B-6. Differences in Investment Service and Retail Banking Development 

Strategies 

 Investment Services Retail Banking 

Innovation Process 

In 

House Vendor Consortiums

In 

House Vendor Consortiums

Generation of new technology 

idea 

● ● 

Initial development ● ● 

Sources of generic technology ● ● ● ●

Technology Infrastructure ● ●

Modification and implementation ● ● ● 

Operation and maintenance ● ● ● 

Bullets indicate the stages in the innovation process where the financial 

services firm or the external technology vendor is conducting 

development activities. This table highlights the fundamental difference 

between investment services and retail banking in terms of development 

activities performed in house versus by vendors. Large investment 

services firms conduct most of their development activities in house, 

relying on external technology vendors only for existing technologies that 

meet capability requirements and for assistance in implementing the 

purchased technology. Retail banking firms perform very few 
Appendix B — Financial Services Sector Case Study 

B-13 

development activities in house, relying on off-the-shelf technologies 

developed by vendors. 

The interviews suggested that different types of financial services require 

different levels of technological innovation. In addition, a firm that is 

considered a market leader may differentiate itself from other competing 

firms through the continued development of new products or services. 

Smaller industry participants are reluctant to compete in innovation and 

instead find it more cost-effective to adopt off-the-shelf innovations from 

vendors. 

 B.3.3 Innovation Process 

The innovation process is a term used to describe the continuum of 

activities associated with how firms or industries develop and deploy new 

ideas and technologies. This process has long been discussed in the 

academic and policy literatures with respect to the manufacturing and 

industrial sectors of the U.S. economy (e.g., research, prototype 

development, and scale up to full production). 

However, RTI found the same process does not characterize financial 

services. Innovation in financial services seems to be driven by 

customer demand, where only the larger firms participate in innovative 

activity and that activity is a strategic response to compete for 

customers, as is the case in manufacturing firms. Smaller financial 

services firms do innovate but generally not in terms of enhancing stateof-the-art consumer services. Rather, smaller firms innovate by 

providing consistency in the level of customer service.4

Larger financial services firms are conducting activities that 

conceptualize and develop technological advancements. Retail banking 

firms innovate through the adoption and some modification of existing 

technologies from vendors. Large investment firms either develop 

technologies in house or purchase technologies from vendors. Large 

firms then significantly modify vendors’ technologies to meet their system 

needs. Smaller investment firms, on the other hand, could be 

considered imitators. They adopt technologies developed by external 

vendors, similar to the approach taken by smaller commercial banks and 

use that modified technology to provide a differentiated product. 

 

4Small manufacturing firms behave similarly in that they locate close to the downstream 

customer (such as an OEM) to provide quick and consistent delivery and after-sales 

service. 
Measuring Service-Sector Research and Development 

B-14 

The innovation process for financial services firms begins in house with 

the following steps: 

• The firm identifies a new service product to meet an actual or 

perceived customer need. 

• In-house development occurs to specify the attributes of the 

needed innovative technology that will support the new or 

enhanced service. 

• The firm contracts an IT specialist to build the new technology. 

• The firm incorporates the purchased technology into its business 

process. 

Retail banks conduct very little of the development activities in house. 

However, based on our interviews, investment firms spend less than 20 

percent of a project’s total cost on purchased technology from external 

vendors. The majority of the costs are incurred though in-house 

activities relating to the adoption and modification stages of this 

innovation model. 

The following are examples of innovation from our interviews: 

Retail banking: 

• ATMs and the Internet—Retail banks incorporate Internet 

capabilities into retail banking ATMs by purchasing ATMs from 

vendors and then incorporating Internet capabilities (in house) to 

allow customers to perform online activities, such as bill paying 

and financial transfers to third parties. The distribution of 

development costs for this service was 40 percent to purchased 

IC and 60 percent to in-house adoption and modification. 

Purchased IC is embedded in ATMs from vendors and the 

application of existing technologies related to Internet Web 

services. In-house activities include the large amounts of 

computer programming necessary to synchronize the ATM’s 

Internet-based transactions so that the customer’s accounts are 

updated automatically. 

• Web Services—This area involves the adoption of Web service 

technology to increase efficiency in intrainstitutional banking. 

This innovation is taking place through a collaborative costsharing project at the FSTC in cooperation with NEC and 

Stanford researchers. The distribution of development costs was 

80 percent to purchased IC and the remaining 20 percent of 

costs accounts for in-house activities. In the case of Web 

services, only a small amount of development was done in 

house. Purchased IC is embedded in technical consulting 

services from Niteo Partners. In-house activities include the 

bank’s time spent overseeing the project and offering insight into 

the business practices the consultants were trying to model in 

their Web services applications. 
Appendix B — Financial Services Sector Case Study 

B-15 

Investment services: 

• Virtual Desktop—This technology allows a financial firm’s 

employees to log in to an institution’s internal system via the 

Internet to conduct business or modify documents. The 

innovation is that the virtual desktop will not lose data if the 

user’s connection is terminated. This means that an employee 

working off-site can log in to a firm’s internal system, work off of 

shared documents that are housed on a server, terminate his or 

her connection, reconnect, and continue working on the same 

document without losing any information. The distribution of 

development costs for this example was 5 percent to purchased 

IC and 95 percent for in-house development activities. 

Purchased IC is embedded in the computer software platform 

developed by a vendor. In-house activities include performing 

tasks such as writing code, integrating the information format 

from the vendor with the in-house code, testing, and 

implementing the technology. 

• Virtual Private Networks (VPNs)—Aimed at addressing the 

security issues associated with connecting and conducting 

monetary transactions over the Internet, this technology ensures 

that the customer is able to access all or almost all of the firm’s 

internal information system from a remote location as if he were 

accessing the system on site or from within the firm’s network 

firewall. The distribution of development costs for this example 

was 20 percent to purchased IC and 80 percent to in-house 

development activities. Purchased IC is embedded in 

networking consultancy services specializing in network security. 

The consultant was responsible for developing the security code 

specification that ensured the security of information shared 

between the financial institution and the customer over the VPN. 

In-house activities include the articulation of specifications and 

capabilities that the VPN needed to meet. After the consultant 

built the VPN, the financial institution took the system and 

integrated it into the institution’s existing line of service products. 

 B.3.4 R&D Metrics for Financial Services 

NSF has traditionally reported the ratio of R&D to sales as a metric to 

characterize the investment innovation intensity of manufacturing firms. 

Academics and policy makers have similarly relied on this measure, and 

the measure is one that aptly characterizes manufacturing’s view. From 

a policy perspective, maximizing the R&D intensity of firms is viewed as 

a positive (and meaningful) objective to achieve growth. 

However, our interviews indicate that this metric may be less useful for 

firms in the financial services sector. First, R&D is not a generally 

accepted descriptor of innovative investments, and second, no individual 

in financial services spoke of maximizing innovative investments as 

being associated with growth. Growth, in the traditional paradigm, 
Measuring Service-Sector Research and Development 

B-16 

comes from in-house development of proprietary knowledge that is either 

cost reducing or product enhancing. In fact, whereas innovation in 

manufacturing is often cost reducing, that concept is orthogonal to 

strategic planning in services. Semantically, financial services firms do 

not call this R&D, but compared with activities that occur in 

manufacturing this activity is the same in nature as what many 

manufacturing firms call R&D. 

For the financial services sector, a more relevant metric proposed was 

the ratio of dollars spent to maintain existing technology versus the 

dollars spent to enhance or purchase new technology. An industry rule 

among larger retail banking institutions is 70 percent maintenance and 

30 percent enhancement, or 2.3 to 1. If a firm moves closer to 80 

percent maintenance and 20 percent enhancement, or 4 to 1, that firm 

would not view itself as competing successfully for customers. Small 

retail banks do not follow this metric because of their strong reliance on 

prepackaged software and off-the-shelf solutions. 

The 30 percent in enhancement or innovation is then optimally (i.e., in a 

cost-minimizing manner) allocated between in-house development 

activities and the purchasing of IC from vendors. This rule could be 

considered the optimized innovation ratio for financial services firms. 

In investment services, an “efficiency measure” in technological 

innovation was suggested as the best way to evaluate a firm’s level of 

innovativeness. This metric measures technological success through a 

ratio of the cost of technology to the firm’s revenues. The cost of 

technology represents the sum of purchased intellectual property from 

outside the firm and in-house development activities. Holding the quality 

of service constant, the firm’s goal should be to minimize the ratio of its 

total technology-related expenditures to services. As part of meeting this 

goal, the firm minimizes technology costs by optimizing the ratio of inhouse development activities to the purchasing of IC from vendors. 

To illustrate the in-house development versus IC purchase decision, 

consider the diagram in Figure B-1 that depicts what could be referred to 

as an iso-technology curve, To. The vertical axis represents purchased 

IC. The horizontal axis represents in-house IC. Purchased IC generally 

takes the form of purchased equipment and labor including human 

capital, and in-house IC generally takes the form of human capital. For 

the financial services sector firm at point A, corresponding to a given 

level of purchased and in-house IC, innovation by the firm could be 
Appendix B — Financial Services Sector Case Study 

B-17 

Figure B-1. Iso-Technology Curve 

Purchased 

Intellectual 

Capital 

(PIC) •

C

•

B

•

A

T2

T1

T0

Technology 

pathway 

(Engle Curve)

PIC0

PIC1

PIC2

IHIC0 IHIC1 IHIC2

In-House Intellectual Capital (IHIC)

Purchased 

Intellectual 

Capital 

(PIC) •

C

•

B

•

A

T2

T1

T0

Technology 

pathway 

(Engle Curve)

PIC0

PIC1

PIC2

IHIC0 IHIC1 IHIC2

•

C

•

B

•

A

T2

T1

T0

Technology 

pathway 

(Engle Curve)

PIC0

PIC1

PIC2

IHIC0 IHIC1 IHIC2

In-House Intellectual Capital (IHIC)

described as an outward shift in T0 to T1, where T1 represents a new 

bundle of services to meet customer needs. 

A firm maximizes technology output by selecting the most cost-effective 

combination of in-house to purchased IC. As technology demands for 

new products and services increase, the optimal pathway for service 

firms may diverge from manufacturing firms because of differences in 

core capabilities and business models. Although RTI did not collect 

financial information from those interviewed, it was our impression that a 

greater percentage of IC in service firms came from purchased 

technology than from in-house technology. And this trend was likely to 

increase as systems become more complicated, resulting in the 

curvature of the technology pathway. 

 B.4 WEB SERVICES CASE STUDY SPECIFICS 

This section takes a closer look at the role retail banks play in technology 

development activities and investigates if they contribute to applied 

research being performed to support the financial services sector. The 
Measuring Service-Sector Research and Development 

B-18 

following is a case study of the proof-of-concept project performed by a 

group of retail banks in cooperation with NEC and Stanford University 

through the FSTC.5 We find little evidence that retail banks were 

involved in applied research other than through funding of consortium 

activities. Our interviews indicate that NEC performed all basic and 

applied research and that only a small percentage of the total project 

cost was spent by banks for in-house development activities. 

FSTC recently completed the proof-of-concept project related to Web 

services. The project’s goals were to promote shared learning and 

develop technologies related to Web services for identification, 

aggregation, and composition of corporate account data and services. 

The Web services project was cosponsored by NEC’s Niteo Partners 

and three retail banking firmsWachovia, Bank of America, and JP 

Morgan Chase. 

Niteo Partners is a wholly owned subsidiary of NEC (NEC has worked on 

innovation in technology for over 100 years). NEC has a large 

investment in technology research labs around the world. These labs 

work on issues related to Internet software, nanocomputing, quantum 

cryptography, and other networking-related technologies. In addition to 

applied technology research, NEC also invests in academic or basic 

research. NEC has worked closely with a multidisciplinary research 

faculty at Stanford University. Areas of research include 

• knowledge representation, 

• machine-to-machine communication and interaction, and 

• automated computing. 

NEC invested $2 to $3 million for academic research in machine-tomachine interactions and wanted to set up a project that would advance 

awareness of its technology. NEC was looking for market exposure in 

the financial services sector specifically. NEC called on their wholly 

owned subsidiary, Niteo Partners, to design or craft a project in 

conjunction with the Stanford research team that would demonstrate the 

machine-to-machine interaction technology in combination with existing 

standards related to Web services to reduce the cost of intrabank 

interactions. 

 

5The term “proof-of-concept” is used by the participants in this case study to refer to 

applied research to demonstrate real-world applications of a technology. 
Appendix B — Financial Services Sector Case Study 

B-19 

The goals of this project were to 

• gain market exposure for NEC technology related to Web 

services and 

• demonstrate what Web services have the potential to provide in 

the future for the financial sector. 

When Niteo approached the FSTC, they discovered that the financial 

services sector was just beginning to understand the current capabilities 

and applications for Web services. Niteo spent 6 months educating 

industry participants on the state of standards related to Web-service 

applications. Niteo then created case examples to demonstrate the 

market potential for Web services in the financial services sector. 

Once the returns on investment were visible, retail banking institutions 

entered into a cost-share project with Niteo through FSTC. This project 

allowed industry experts to share knowledge of the business and specify 

the special needs that the technology needed to address. Niteo used 

this input to develop reference materials that could be implemented in 

house by the participating banks. 

The latter project was co-funded by NEC and the FSTC participants, 

including 

• Bank of America, 

• Wachovia, and 

• JP Morgan Chase. 

These firms agreed to fund the proof of concept jointly in return for the 

rights to core findings and any intellectual property developed. 

Niteo ran the project. The knowledge and learning occurred at Niteo but 

was informed by the business expertise of the banking executives from 

the participating banks. The project has moved into a second phase 

concerned with implementing the findings from Phase 1. Phase 1 lasted 

approximately 2 years. 

As part of the implementation phase of the project, participating banks 

have the opportunity to become more involved in developing and 

deploying the technology. At this point JP Morgan Chase is the only one 

of the three banks that is proceeding with implementation. They are 

funding the implementation of the basic standardized codes developed 

as part of Phase 1 and are creating a test bed to work through the 

remaining technological issues. Most of these activities will be 

conducted in house, with NEC working as a consultant. Insights gained 
Measuring Service-Sector Research and Development 

B-20 

in Phase 2 will be IC owned by JP Morgan Chase and will not be shared 

with the other banks that participated in the first phase of the project. 

 B.5 REFERENCES 

COMPUSTAT. 2003. American Stock Exchange Database. Contennial, 

CO: Standard & Poor’s, McGraw Hill Companies, Inc. 

JP Morgan Press Release. October 2, 2002. 

National Science Foundation (NSF). 1998. “Survey of Industrial 

Research and Development.” <http://www.nsf.gov/sbe/ 

srs/nsf01305/pdf.start.htm>. 
C-1 

 Appendix C: 

 Systems Integration 

 Services Sector 

Software has become an intrinsic part of business activities. Virtually 

every business in the United States depends on software to aid in the 

development, production, marketing, and support of their products and 

services. This software may be written either by developers who offer a 

shrink-wrapped product for sale or developed by organizations for 

custom use. 

Software development is a “gray” area and is often not covered by R&D 

definitions (Marklund, 2000; Young, 1996). For software development to 

fall under R&D, it must embody scientific and/or technological advance, 

and the project’s goal must be resolution of scientific and/or technical 

uncertainty on a systematic basis. However, firms seem to be unclear as 

to how much of software development conducted as part of the 

innovation process should be reported as R&D expenditures (Marklund, 

2000). This appendix investigates innovation in the Computer Systems 

Design and Related Services (NAICS 5415) sector. 

 C.1 INDUSTRY PROFILE AND R&D STATISTICS 

The software industry is defined as computer and data processing 

services (NAICS 5415). Within computer and data processing, there are 

computer services (IBM), computer programming services (Complete 

Business Solutions Group), packaged software (Microsoft), computer 

integrated designs (Unisys Corporation), data processing services 

(Automatic Data Processing), information retrieval services, computer 

facilities management, computer rental and leasing (Comdisco Inc.), 
Measuring Service-Sector Research and Development 

C-2 

computer maintenance and repair, and computer-related services. Table 

C-1 lists sales, employment, and R&D expenditures for companies 

contained in COMPUSTAT by four-digit NAICS codes. 

Table C-1. Software Services Sectors 

Software 

NAICS Description 

Number of 

Firms 

Sales 

($ millions)

R&D 

Expenses 

($ millions)

Employment 

(thousands) 

R&D 

Intensity 

($ per 

employee) 

5415 Computer services 272 $104,595 $6,118 671.3 $9,114 

5415 Computer 

programming services 

25 $6,090 $38 67.9 $556 

5112 Packaged software 488 $86,523 $325 13,988.1 $23 

5415 Computer integrated 

designs 

185 $34,442 $180 2,426.6 $74 

5142 Data processing 

services 

20 $19,992 $133 690.1 $193 

 

Note: R&D intensity based on information in COMPUSTAT by four-digit SIC code. Note that NAICS 54191 (On-Line 

Information Services), NAICS 541513 (Computer Facilities Management), NAICS 811212(Computer Maintenance 

and Repair), and SIC 7379 (Computer Related Services) have no entries in COMPUSTAT but are included in the 

software services sector for this study. 

Note: Computer Integrated Designs (5415 NAICS) includes companies engaged in the writing, modifying, and 

supporting software to meet the needs of a particular customer and/or planning and designing computer systems 

that integrate computer hardware, software, and communications technologies. 

Source: COMPUSTAT, 2003. 

The last column of Table C-1 reports the estimated R&D intensity per 

worker in each of the different subsectors. The subsector computer 

services has a high level of R&D intensity per worker compared with the 

other subsectors for the software industry: $9.1 thousand per worker. 

Computer programming follows at a distant third with $556 per worker. 

Table C-2 lists the top 10 publicly traded software publishers by sales. 

International Business Machines Corporation (IBM) holds the top spot for 

1999 at $87.5 billion, followed by Microsoft at $19.7 billion, Computer 

Associates with $6.1 billion, and Oracle at $10.3 billion. 
Appendix C — Systems Integration Services Sector 

C-3 

Table C-2. Top 10 Software Publishers by Sales 

Name 

Employment 

(thousands) NAICS 

Sales 

($ millions) 

R&D 

Expenses 

($ millions) 

International Business Machines 

Corporation 

307.4 5415 $87,548 $4,575 

Microsoft Corporation 31.4 5112 $19,747 $2,970 

Electronic Data Systems Corporation 121.0 5415 $18,534 NA 

Oracle Corporation NA 5112 $10,130 $1,010 

Computer Sciences Corporation 58.0 5415 $9,371 NA 

Unisys Corporation 35.8 5415 $7,545 $339 

Computer Associates International Inc. 21.0 5112 $6,103 $1,363 

Automatic Data Processing 37.0 5142 $5,540 $412 

First Data Corporation 31.0 5142 $5,520 NA 

Sap Ag-Adr 21.7 5415 $5,071 $750 

NA: not available in COMPUSTAT. 

Note: Figures are total company sales and R&D, not just for software 

Source: COMPUSTAT, 2003. 

Table C-3 provides a sample of companies in the software services 

sector with significant R&D expenditure in 1999 for the software industry 

based on COMPUSTAT (2003). 

IBM, the largest producer of R&D in the software industry, designs both 

hardware and software system applications. IBM spent $4.6 billion on 

R&D in 1999. Microsoft Inc. is the second largest with reported $2.9 

billion in R&D expenditures. Microsoft specializes in developing software 

applications for multiple computing devices. Microsoft’s products include 

scaleable operating systems for servers, business solutions applications, 

software development tools, server applications, personal computers, 

and other various specialized products. 

 C.2 R&D CHARACTERISTICS AND ACTIVITIES 

Similar to the telecommunications industry, the software industry is well 

defined in that most companies classified under NAICS 5415 are 

conducting R&D related to the sector’s classification. CSTB reports that 

over the past 20 years the areas of computer architecture, compliers, 

and memory management have seen the largest number of innovations. 

The factors that are impeding further progress and areas in which new 
Measuring Service-Sector Research and Development 

C-4 

Table C-3. Top 10 Sample of Software Service Firms with Significant R&D 

Expenditure, 1999 

Name 

Employment 

(thousands) NAICS

Sales 

($ millions)

R&D 

Expenses 

($ millions) Business Description 

International Business 

Machines Corporation 307.4 5415 $87,548 $4,575 

Software design and 

services 

Microsoft Corporation 31.4 5112 $19,747 $2,970 Software design 

Computer Associates 

International Inc. 21.0 5112 $6,103 $1,363 Data management 

Oracle Corporation NA 5112 $10,130 $1,010 Enterprise software 

Automatic Data 

Processing 37.0 5142 $5,540 $412 Data communications 

Unisys Corporation 35.8 5415 $7,545 $339 Computer services 

Peoplesoft Inc. 6.9 5112 $1,429 $297 Software design 

BMC Software Inc. 6.7 5112 $1,719 $294 Software design 

America Online Inc. 12.1 5415 $4,777 $286 Internet service 

Electronic Arts Inc. 3.1 5112 $1,420 $267 Gaming software 

NA: not available in COMPUSTAT. 

Source: COMPUSTAT, 2003. 

R&D is being focused on a wide range of general issues, including 

scalability, complexity, interoperability, flexibility, security, and emergent 

behavior in systems (CSTB, 2000). 

• Scalability is an important issue pertaining to systems 

integration in two ways. As systems expand, they require more 

components and are expected to serve a larger number of users 

simultaneously. 

• Complexity results because the number of required 

components, lines of code, and elements that interact and share 

information, combined with the accompanying feedback loops, 

create a complex system, which makes understanding the 

underpinnings of systems functioning more difficult. 

• Interoperability results because when systems are built, the 

components come from a wide array of vendors all using 

different object-oriented coding. The vendors have no way of 

knowing what systems or applications certain software will need 

to communicate with. This issue requires that the computer 

science community develop a well-understood methodology to 

avoid system design failures. Currently, there is no accepted 

method or standards other than trial and error. 
Appendix C — Systems Integration Services Sector 

C-5 

• Flexibility means systems must have the ability to integrate 

smaller systems and components that apply to the design phase 

as well as after deployment. Because of the time span for the 

larger system development projects, the initial demands and 

objectives for the system can change. These systems are 

characterized by long life spans once the system is put into use, 

and the components will require replacements and more 

frequent upgrades to the most recent technology without having 

to restructure the entire system once any new component is 

introduced. 

• Trustworthiness is becoming increasingly important as the 

amount of “critical infrastructure” becomes dependent on 

networking, which creates opportunities for outside sources to 

corrupt systems. 

• Security is becoming increasingly important as industries such 

as health care and e-commerce develop a larger need for 

passing personal information over a networked system. A 

breach in the security of a networked system could result in huge 

financial loss, accidental disclosure of personal medical records, 

and reduction of consumer confidence. 

• Availability and Reliability is the concern that a large-scale 

system will be available and functioning when it is needed 

despite varying environmental conditions. Distributed computing 

is an area of study concerned with computer systems 

interconnected via networks, and researchers have started to 

develop algorithms that ensure delivery of data packets despite 

changing factors in the performance of the network. 

• Systems Operation and Management has become 

increasingly difficult to control because of the size of systems 

and the management responsibilities delegated over several 

organizational units. Increased automation in operational 

support and enhanced tool kits could potentially facilitate and 

improve efficiency in distributed systems. Solutions to these 

types of problems have yet to be adequately addressed in the 

research community. 

 C.3 INTERVIEWS WITH SYSTEMS INTEGRATION 

COMPANIES 

Since 1992, systems integration has been the most rapidly growing 

component of the computer industry. RTI conducted informal interviews 

with industry experts to investigate the types of research activities 

performed in systems integration. RTI conducted 10 interviews with nine 

systems integration services firms (see Table C-4), including large and 

small corporations. 

The CSTB (2000) states that total revenues for custom integrated 

system design and custom programming services rose from $34 billion in 
Measuring Service-Sector Research and Development 

C-6 

Table C-4. Organizations Interviewed Related to Systems Integration Services 

Company Name Position 

Carolina Advanced Digital Inc. President and Chief Scientist 

Computer Science Corporation Practice Manager of IT Strategy and Architecture 

Computer Service Partners Inside Account Manager 

Concurrent Technologies Corporation Director of Systems Integration 

EMC Corporation Chief Information Officer 

Infosystems Technology Inc. (ITI) Founder and President 

Integrian Inc. Business Development 

IBM Systems Integration Project Manager 

IBM Vice President of Assets Innovation 

PeopleSoft Project Manager 

1990 to $76 billion in 1997. Systems integration services facilitate the 

intersection of hardware, software, and pragmatic industry knowledge 

that provide the foundation of IT systems. The CSTB defines systems 

integration as “the ‘wiring’ together, via hardware and frequently very 

complex software, of the often already existing islands of computer 

applications into a coordinated enterprise-wide distributed network 

system.” Systems integration includes more than just physically allowing 

incompatible components to communicate. It is the synthesis of 

application domains such as finance, manufacturing, transportation, and 

retail and the supporting information infrastructure including databases, 

operating systems, architectures, networks, communications devices, 

and security measures (CSTB, 2000). 

The remainder of this appendix is based on the findings from the 

interviews and discusses the innovation process for developing systems 

integration products and services and the activities that are typically 

classified as R&D. 

 C.4 DESCRIPTION OF SYSTEMS INTEGRATION 

SERVICES 

The market for systems integration services is evolving. This evolution is 

largely based on how data are managed and communicated internally 

between different areas’ business operations and externally between 

other organizations within a supply chain. As supply chains increasingly 
Appendix C — Systems Integration Services Sector 

C-7 

become virtually vertically integrated, the level of detail and the quantity 

of data a firm is required to manage are increasing exponentially. 

Today’s systems integration services help client organizations manage 

data and provide innovative ways to exploit the knowledge nested in the 

large amounts of data that exist both inside and outside of a firm’s 

business operations. To this end, systems integration services have 

been evolving over time from the simple task of “wiring” two or more 

systems together to enabling information transfer across different 

companies, platforms, and standards protocols. 

As this highly competitive industry grows, integration services firms are 

forced to seek out ways to differentiate their services. In the 1980s and 

1990s almost all systems integration activities involved computer 

programming labor services. Customizing software programs, 

translation algorithms, and other middleware were commonly needed to 

interconnect legacy information infrastructures to more modern business 

software applications. Today’s systems integration firms rely less on a 

set of software programs that were developed traditionally as a unique 

solution for each project and more on developing and leveraging capital 

and intellectual assets that can provide a competitive advantage. This 

can include developing either generic technology solutions that require 

relatively minor adaptations to individual customer needs or software that 

is sufficiently flexible to allow the customer to make adaptations. 

The trend is for an increasing share of systems integration services to be 

“commoditized.” For example, software vendors have begun to 

specialize in a specific industry or business process software. Over time, 

the high costs of setting up custom-built systems has motivated the 

software industry to identify common needs across numerous clients and 

collapse the commonalities into products that are closer to the concept of 

“shrink wrapped” software. These packaged applications can then be 

configured with relatively little additional effort to meet the needs of many 

firms within a single industry. 

As the components of systems integration services become 

commoditized, leaders in systems integration are differentiating their 

services from basic labor exercises aimed at linking several systems in a 

business operation through computer programming. The service 

provider differentiates its services through “asset innovation,” leveraging 

its internal assets to assist in developing solutions for a client. For 

example, many companies’ strategic plans include accumulating and 

maintaining industry-specific knowledge in business operation 
Measuring Service-Sector Research and Development 

C-8 

optimization, which is sold to industry as a service. As a result, we are 

increasingly seeing a distinction between traditional programmers-based 

service systems integration firms and more diversified companies that 

also have detailed scientific or industry-specific knowledge that can be 

bundled with their systems integration services. 

 C.4.1 Systems Integration Service Development Process 

Companies interviewed were asked to describe the process by which 

they develop the IC underlying their products and services. Figure C-1 

illustrates the information flows that characterize innovation for systems 

integration activities. The center horizontal row represents an average 

product life cycle and the different stages associated with it. 

Figure C-1. Example Illustration of the Information Flows for Systems Integration 

Activities 

The upper horizontal row represents the information flowing into the 

company’s product development from outside the company and/or 

industry. The lower horizontal row represents R&D that is performed 

within the company, which is embedded in the product development 

Enabling 

Knowledge 

(outside 

Company) 

Physical 

Dimension 

R&D 

Knowledge 

(inside 

Company) 

Market Research 

• Consumer Preference 

• Technology Status 

• Regulations 

Strategic 

Planning 

Product and

Service 

Development 

• Industry Standards 

• Interface standards 

• Patent and License 

• Basic R&D (public) 

• R&D Embedded in 

Components 

• Imitation 

Labor to Provide 

Service 

Service 

Provision 

• Development of 

Quality Systems 

Management and 

Operation 

• Enhanced Customer 

Service/Billing 

Systems 

• Labor (human capital) 

Value 

Added 

Received 

by 

Customer 

• Systems Integration of 

Physical Components 

• Customization 

• Enhance Tools and 

Process 

• Testing Methodology 

• R&D Lab Work 
Appendix C — Systems Integration Services Sector 

C-9 

process. The development stage includes any activity associated with 

pushing the frontier of knowledge related to each bullet point. It is 

important to note that in a competitive industry, such as systems 

integration, developed knowledge is considered a trade secret. As a 

result, each company in the industry could potentially be required to 

reinvent existing technology already developed by a competing company 

to maintain a competitive edge in the market. This is merely an example 

of the types of activities that could occur in a systems integration 

company. 

 C.5 R&D ACTIVITIES 

Systems integration companies devote a significant resource to 

developing and enhancing the skills and knowledge required to provide 

their services. Many of these innovative activities occur “on the job” as 

part of software customization or trouble shooting system problems. 

However, some people disagreed about whether many of these activities 

met the definition of R&D. 

Table C-5 illustrates the diversity of companies providing systems 

integration services in terms of the variance in their R&D reporting. 

Service-only firms are generally less likely to report their systems 

integration activities as R&D expenditures. In contrast, diversified firms 

such as IBM and Hewlett Packard classify one-quarter to one-half of 

systems integration activities as R&D; thus, the level of reported R&D 

spending by diversified service firms is significantly greater than that of 

service-only firms. 

This variance in reported R&D for systems integration is likely due to 

several factors. As mentioned above, larger systems integration firms 

differentiate themselves through the IC and assets they offer in 

conjunction with traditional integration services. This can be in the form 

of detailed knowledge of the hardware and software products these firms 

provide or through specific industry knowledge of selected sectors’ IT 

needs. In these instances, companies introduce products and services 

with IC developed through strategic R&D initiatives. 

For example, IBM conducts research to ensure its hardware and 

software will interoperate with legacy and competing systems and then 

promotes this research as part of a strategy to market their systems 

integration services. In this way it leverages its technical expertise 

related to its proprietary hardware and software technology. 
Measuring Service-Sector Research and Development 

C-10 

Table C-5. R&D Investments of Representative Systems Integrators, 1998 

Company 

Systems Integration 

Revenues ($ millions) 

Percentage Systems 

Integration R&D 

Services-Only Firms 

Accenture Consulting $8,307 0% 

American Management Systems $1,058 77% 

Computer Sciences Corporation $7,660 0% 

Electronic Data Services $16,891 0% 

Keane $1,076 3.5% 

Diversified Firms 

IBM $28,916 25% 

Hewlett Packard $6,956 50% 

Lockheed Martin $5,212 36% 

Source: Computer Science and Technology Board, 2000. 

In contrast, smaller service-only systems integration firms are more likely 

to solve their problems in the field through on-site modification of 

software programs and development of work-arounds. From this 

perspective they have no “R&D staff,” and any “research” they might 

conduct is considered an integral part of the integration service being 

provided. In addition, it is likely their customized integration services 

have less potential for reuse (although lessons learned build the IC and 

capabilities of service-only firms). 

Larger firms follow a model of innovation moving from concept stage, 

where a potentially marketable solution is developed, to proof-of-concept 

stage, where risk is evaluated in terms of marketability, and finally to pilot 

project, where risk assessment is continued before moving into mass 

production. Small firms are more likely to implement existing service 

integration technology, which involves some development/engineering of 

a “commodity” service integration approach, but minimal activities related 

to seeking out novel approaches to integration. 

 C.5.1 Categories of R&D 

Firms generally grouped their research into four categories: 

• Building New Systems for clients—activities for this category 

resemble software design and the synthesis of hardware and 

interface applications. Products developed in this category are 

one of a kind. 
Appendix C — Systems Integration Services Sector 

C-11 

• Maintenance of Code—rewriting code is necessary to maintain 

the system’s integrity with respect to its operational environment. 

• Support—(applied research) researching better processes for 

server maintenance and monitoring and system tracking for 

trouble shooting. 

• Break/Fix Maintenance—(applied research) research consists 

of designing better processes and establishing generic protocols 

across all products. 

The large corporations such as Unisys, Electronic Data Systems, IBM, 

and Computer Science reported that they were undertaking at least 

some “basic research.” These companies maintain large facilities 

dedicated to noncommercial research programs. Smaller firms 

consistently reported zero activity in “basic research.” Respondents 

explained that the smaller business model for systems integration was 

focused primarily in applied research with respect to the overall objective 

of completing the project. 

Directors from large firms identified “applied research” as the area in 

which their division spent the largest share of time, whereas directors 

from smaller firms attributed only a small portion of their activities to such 

research. Identifying practical applications for emerging technology was 

the primary activity that respondents associated with this category of 

research. 

“Development” activities were reported as the second largest share of a 

systems integrator’s time from large firms and the largest share by 

smaller firms.1 The types of activities respondents associated with this 

category of research were writing code, setting up infrastructure, wiring, 

and “putting the system together.” While building systems was a major 

activity for the larger companies, it was not an activity mentioned by the 

smaller firms. Over time, the high costs of setting up custom built 

systems have motivated the computer services industry to identify 

common needs across numerous clients and collapse the commonalities 

into a “shrink-wrapped” product. 

 C.5.2 Labor Versus Intellectual Capital 

Conceptually, Figure C-2 highlights the spectrum of systems integration 

services and the shift between labor and IC as inputs to providing 

integration services. On the left-hand side, the service-only firm relies 

 

1National statistics indicate that development activities are typically the largest component 

of R&D expenditures. The emphasis on applied research provided by participants 

interviewed as part of this study highlights the difficulties in distinguishing between 

basic, applied, and developmental research in the systems integration services sector. 
Measuring Service-Sector Research and Development 

C-12 

Figure C-2. Spectrum of Systems Integration Service Firms 

Development

Applied Research

Basic

Research

Service

Only

Diversified

% of Service

Inputs

Intellectual

Assets

Labor

0%

100%

R&D as a % of

Integration

Services

100%

0%

heavily on basic labor (computer programmers and some managerial 

workers) to implement a standard set of activities that integrate multiple 

systems. As one moves from left to right in Figure C-2, the share of the 

labor versus IC that goes into providing a systems integration service 

increases. The IC consists of input from skilled scientists (possibly 

involved in hardware or software development) and industry specialists, 

in addition to proprietary technologies such as algorithms and other 

patentable or licensed technology. 

R&D intensity increases as intellectual assets become an increasing 

share of providing integration services. The lower box in Figure C-2 

shows this increase in R&D intensity, highlighting the type of R&D 

potentially conducted as a systems integrator becomes more diversified. 
Appendix C — Systems Integration Services Sector 

C-13 

In general, systems integrators are most likely to engage in 

development, working to enhance or create new service offerings. 

As a firm continues across the spectrum and leveraging related 

technologies becomes more important, the firm may conduct applied 

research to incorporate these technologies into its service offerings. In 

the extreme, larger firms may conduct basic research to support systems 

integration, such as involvement in standards and protocol development, 

as well as basic research into business organization and 

communications. 

 C.6 SERVICE-ONLY VERSUS DIVERSIFIED FIRMS’ 

R&D ACTIVITIES 

A distinction can be made between two general types of systems 

integration firms: service-only and diversified service and product firms. 

Service-only systems integration firms primarily provide services in 

computer programming and reconfiguration of packaged software, 

leveraging experience gained over time from previous (often similar) 

projects. Diversified systems integration firms (such as IBM) provide 

hardware and software products as well as integration services that can 

be bundled. In addition, diversified systems integration firms are typically 

much larger service firms that acquire and use a pool of technology and 

intellectual assets that the company can leverage to differentiate their 

services from those of competitors. 

 C.6.1 R&D Activities of Service-Only Integrators 

From our interviews, service-only firms responded that they engaged in 

few activities that would be considered R&D. Service-only firms 

commonly build on business software applications using “open” 

architecture that allows the integrator to easily configure prepackaged 

applications purchased from a vendor to meet the needs of the client. 

Using XML and other open-source networking languages, the integrator 

brings together various components of a client’s business operation. 

However, those interviewed in the service-only firms were concerned 

with protecting and managing their IC, which is largely the ability to 

engineer commodity software systems. Service-only firms interviewed 

reported that they were managing the IC developed from years of 

experience on different projects. 
Measuring Service-Sector Research and Development 

C-14 

Larger service-only firms often create executive positions known as Chief 

Knowledge Officers to manage and coordinate the IC developed by the 

firm. Larger firms, such as Computer Science Corporation (CSC) 

reported developing formal methodologies for enterprise architecture, 

product life-cycle management (PLM), enterprise resource management 

(ERM), and managing operations centers. These methodologies are 

documented through white papers and in-house presentations at 

company research conferences. 

Service-only firms generally grouped their methodologies and 

development activities into four categories: 

• Building new systems for a client—including software design 

and systems engineering (synthesis of hardware and interface 

applications). Products developed in this category are one of a 

kind. 

• Systems configuration—turning certain options within 

purchased software applications off or on to maintain the 

system’s integrity as products/systems evolve. 

• Support research—researching better processes for server 

maintenance and monitoring and system tracking for trouble 

shooting (one firm classified this as applied research). 

• Break/fix maintenance—designing better processes and 

establishing generic protocols across all products. 

In addition, service-only firms also perform scoping exercises to 

determine the capabilities of future technologies. As part of these 

exercises, they research the technologies that will be most influential 

over the next 30 years by scanning the scientific literature and 

technology news sources. This information is then used to conceptualize 

how the integrator can create new services or incorporate the capabilities 

into existing services. 

CSC reports that 24 months is a minimum required lead time that an 

integration firm must have on the emerging technology markets if the firm 

wants to remain competitive. The optimal lead time is 4 to 5 years. 

However, this amount of lead time is generally only possible if the 

integration firm is taking part in the technology development process. 

Service-only integrators rarely have access to emerging technology at its 

earliest stages of development. 

 C.6.2 R&D Activities Cited by Diversified Integrators 

In contrast, diversified integrators not only have access to the IC 

accumulated through experience on previous integration projects, but 
Appendix C — Systems Integration Services Sector 

C-15 

they also have access to the technology being developed in the design 

and manufacturing division of their company and to the researchers 

leading these activities. IBM Global Services reports that they are 

working with their company’s technology experts who design computing 

equipment to conceptualize how existing equipment or capabilities can 

generate new service offerings. IBM is creating new services by moving 

away from the labor exercise that integration has become and attempting 

to leverage internal and external IC to innovate their integration services. 

One example of leveraging IBM equipment technology to innovate 

integration services is Global Services’ new offering called WebFountain. 

This new service offers clients the ability to harness the power of a super 

computer to scour the Internet for all the published or online information 

on a given topic. The service is composed of five servers with over a 

petabyte of data storage programmed with unique algorithms designed 

to seek out Web content on specific topics. The amount of data the 

technology can gather allows the client to examine trends in consumer 

preference or identify cultural norm differences across society. In its 

traditional form, this type of research would be very expensive and 

require several years of research. WebFountain reduces the costs of 

research in product design and increases revenue by shortening the time 

required to bring a product to market. 

Integration of systems in a business operation setting requires 

understanding the role that information plays in the business. Global 

Services is taking this concept one step further to better understand the 

nature of work within different industries. IBM has anthropologists who 

specialize in researching the way professionals in different industries use 

information to maintain large business operations systems. IBM 

considers their research in this area as a basic research exercise. 

Although the study of human behavior is a social science area, the end 

use is to increase the effectiveness of an integration service. 

Global Services has also used its engineering staff, which normally 

specializes in designing super computers and deep computing 

technology, to develop a cryptographic scheme to code electronic 

signatures for the French land titling system. The French government 

wanted to modernize their real estate titling system, converting all hard 

copies to digital online documents. However, the French government 

required a guarantee that no technology would emerge that could make 

the system vulnerable to computer attacks for the next 25 to 30 years. 

IBM was hired to create a system that met the French government’s 
Measuring Service-Sector Research and Development 

C-16 

requirements. The system required a combination of hash and 

cryptographic schemes. As part of this project IBM Global Services 

leveraged its deep computing R&D division to develop a scheme that 

met the government’s requirements. 

 C.7 SUMMARY 

Today, business must rely on the efficient and reliable transfer of data 

internally and externally across an entire supply chain; this includes 

design, supply logistics, production, distribution, and marketing. 

Systems integration services require both a stock of IC to understand the 

hardware and software configuration and more importantly a conceptual 

understanding of the role the IT infrastructure plays in the client’s 

industry or supply chain. 

The firms we interviewed responded that systems integration firms 

conduct R&D activities in the following areas: 

• developing methodologies to improve processes and 

implementation, 

• adopting existing or emerging technologies in equipment and 

systems, and 

• examining how people use information in different industries and 

business operations. 

These examples could apply to any integration service firm. However, 

service-only firms typically focus on developing ways to improve the 

efficiency of labor through detailed methodologies that standardize the 

integration process. Diversified firms are more likely to conduct complex 

research in technology adoption and tailor their service to industryspecific uses. 

 C.8 REFERENCES 

COMPUSTAT. 2003. American Stock Exchange Database. Contennial, 

CO: Standard & Poor’s, McGraw Hill Companies, Inc. 

Computer Science and Telecommunications Board (CSTB). 2000. 

Making It Better: Expanding Information Technology Research 

to Meet Society’s Needs. Washington, DC: National Academy 

Press. 

Marklund, Goran. 2000. “Indicators of Innovation Activities in Services.” 

Services and the Knowledge Based Economy, Mark Boden and 

Ian Miles (eds.), New York: Continuum. 
Appendix C — Systems Integration Services Sector 

C-17 

Young, A. 1996. “Measuring R&D in the Services.” STI Working 

Papers. Paris: OECD. <http://www1.oecd.org/dsti/sti/ 

prod/wp_7.htm>. 

D-1 

 Appendix D: 

 Research 

 Development and 

 Testing Service 

 Sector 

The expansion in service-sector R&D is in large part due to an increasing 

dependence by large firms on “outsourcing” as the vehicle for 

accomplishing innovation in products and production (Jankowski, 2001; 

Amable and Palombarini, 1998; and Howells, 1999; Pilat, 2001). 

Outsourcing is a common approach for conducting research in areas of 

interest that require expertise outside of a firm’s core competencies. As 

of 2000, engineering and scientific contract research accounted for 

between 5 and 12 percent of industrial R&D in most industrial economies 

(OECD, 2001). 

The literature has yet to agree on a common set of factors that motivate 

firms to contract out scientific R&D. In general, RD&T services 

commonly outsourced have traditionally been viewed as “formal, routine, 

repetitive, and cost based with short time horizons” (Andersen et al., 

2000). However, this appears to be changing as RD&T firms are 

establishing long-term partnerships with client industries and increasingly 

providing core research functions to support strategic initiatives (Howells, 

2000b). 

This appendix begins with an overview of the broader RD&T service 

sector and its R&D activities. This is followed by a more in-depth 

analysis of R&D activities and the innovation process in the 

biotechnology industry, which is one of the largest and fastest growing 

segments of the RD&T service sector. 
Measuring Service-Sector Research and Development 

D-2 

 D.1 RD&T INDUSTRY PROFILE AND R&D 

STATISTICS 

The RD&T sector (NAICS 5471, also referred to as Scientific R&D 

Services) performs R&D activities in the fields of physical, engineering, 

life sciences (NAICS 54711), social science, and humanities (NAICS 

54712). Most firms classified as RD&T perform R&D by contract or fee 

for either manufacturing or nonmanufacturing industries.1

Table D-1 lists the top 10 RD&T firms by sales based on the 

COMPUSTAT database. In general, these firms are of modest size with 

fewer than 5,000 employees. For example, AAI Pharma, employing 

1,200 workers, considers itself a specialty pharmaceutical company. 

The firm acquires branded pharmaceuticals that it believes hold potential 

for further development and improvement. AAI Pharma also offers 

pharmaceutical R&D services on a fee-for-service basis. The firm 

supports R&D activities to formalize categories of “products” (IV 

nutritional fluid and immunosuppression drugs) and “technologies” (drug 

delivery systems). They reported net revenue of $141 million in 2001. 

Their SEC 10K report cites R&D expenditures as 8 percent of net 

revenues. As a stated goal, the company tries to keep its expenditures 

on R&D between 8 percent and 10 percent of the budgeted annual net 

revenues for the following year. 

Table D-2 shows a sample of firms with significant R&D expenditures in 

2001 based on COMPUSTAT. Most of these firms are engaged in some 

form of biotechnology research.2 

Because of the predominance of RD&T firms engaged in biotechnology 

research (including genetic bioscience research, drug discovery, 

pharmaceutical testing, etc.), the remainder of this appendix focuses on 

the biotechnology biopharmaceutical industries and their relationship 

with RD&T firms (outsourcing of R&D). 

 

1Because social science and humanities research falls outside NSF’s definition of R&D, 

this case study focuses primarily on physical, engineering, and life science research 

firms—specifically biotechnology firms. 

2 The composition of biotechnology research and definitions of the biotech industry are 

discussed in Section D.1.2. 
Appendix D — Research Development and Testing Service Sector 

D-3 

Table D-1. Top 10 RD&T Firms by Sales 

Name 

Employment 

(thousands) NAICS 

Sales 

($ millions) 

Covance Inc. 7.2 5417 $856 

Charles River Labs International Inc. 4.0 5417 $466 

Pharmaceutical Product Development Inc. 4.4 5417 $432 

Parexel International Corporation 4.6 5417 $388 

Inveresk Research Group-Redh 2.3 5417 $156 

Kendle International Inc. 1.8 5417 $154 

AAI Pharma Inc. 1.2 5413 $141 

Albany Molecular Resh Inc. 0.5 5417 $98 

Huntingdon Life Science-ADR 1.3 5417 $95 

Source: COMPUSTAT, 2003. 

 D.2 BIOTECHNOLOGY 

The term “biotechnology industry” is widely used by public policy makers 

as well as the popular press. However, no group of homogeneous firms 

or organizations (or NAICS code) clearly defines the biotechnology 

industry (Toole, 2003)3 because of the rapidly evolving nature of the 

industry and the diverse set of technologies used to develop applications 

from bioscience research. The biotechnology industry crosses over 

many disciplines from agriculture and the environment to health care and 

industrial applications. However, individual biotech firms typically 

specialize in and develop core competencies in specific genes and 

treatments that increase their probability of success. 

In general, the biotechnology industry is not identified by a set of 

common products that are produced by similar techniques, but rather by 

its applications. Prevezer (1998) defines the biotechnology industry in 

terms of the following applications: 

• therapeutics (drugs) 

• diagnostic applications 

• chemicals (pesticides, insecticides, and new chemicals) 

• agricultural (seed, plant, and animal applications) 

 

3Throughout the following discussion, we present statistics and discuss research activities 

based on similar, but not necessarily identical definitions of the biotechnology industry. 
Measuring Service-Sector Research and Development 

D-4 

Table D-2. Sample of RD&T Firms with Significant R&D Expenditures Based on 

COMPUSTAT, 2003 

Name 

Employment 

(thousands) NAICS

Sales 

($ millions)

R&D 

Expenses 

($ millions) Business Description 

Exelixis Inc. 0.57 5417 $41 $89 Genomics-based 

pharmaceuticals company 

Curagen Corporation 0.51 5417 $23 $66 Genomics-based 

pharmaceuticals company 

Maxygen Inc. 0.31 5417 $30 $64 Genomics-based 

pharmaceutical and 

agriculture 

Genaissance 

Pharmaceuticals 

0.16 5417 $5 $46 Genomics-based 

pharmaceuticals company 

Deltagen Inc. 0.30 5417 $10 $45 Genomics-based 

pharmaceuticals company 

Symyx Technologies 

Inc. 

0.20 5417 $60 $39 Genomics-based 

pharmaceuticals company 

Microvision Inc. 0.23 5417 $11 $33 Optical scanning systems 

Paradigm Genetics Inc. 0.25 5417 $24 $28 Life sciences in agriculture 

and human health 

Arena Pharmaceuticals 

Inc. 

0.21 5417 $18 $23 Biopharmaceutical company

Exact Sciences 

Corporation 

0.07 5417 $0.05 $14 Applied genomics company 

Source: COMPUSTAT, 2003. 

• food and cosmetics 

• environmental 

• energy (biomass) 

By all definitions, the biotechnology industry has experienced rapid 

growth in the past 2 decades. October 2002 marked the 20th 

anniversary of the first Food and Drug Administration (FDA)-approved 

biotechnology drug (Biotechnology Industry Organization, 2002). Today, 

there are 141 biotech-based medicines and vaccines on the market in an 

industry valued at $198 billion. The biotech industry, which includes 

1,457 firms and employs 191,000 people in the United States, spent 

$15.7 billion on R&D activities in 2001 (Ernst & Young, 2002). 

A recent study by the U.S. Department of Commerce (DOC) surveyed 

1,031 firms conducting R&D in biotechnology-related applications. A 
Appendix D — Research Development and Testing Service Sector 

D-5 

large majority were conducting R&D activities in the area of human 

health in support of the pharmaceutical and the medical device industries 

(DOC, 2003). A large number of these biotechnology companies are 

relatively young, independent firms (established after 1990), employing 

fewer than 100 researchers. The DOC report states that most small 

firms conducting human health research focused on applied research 

and larger firms emphasized product and process development. 

Table D-3 provides a list of some of the top biotechnology firms in terms 

of estimated R&D expenditure in 2002. These firms are increasingly 

outsourcing R&D activities to RD&T service firms. 

Table D-3. Top Biotechnology Firms by R&D Expenditures, 2002 

Company 

Estimated 2002 R&D 

($ millions) 

Percentage 

Change from 2001 

R&D as Percentage 

of 2002 Revenue 

Amgen $967.1 11.8% 19.4% 

Genentech $613.1 16.5% 24.0% 

Millenium Pharmaceuticals $510.0 27.3% 123.4% 

Biogen $365.7 16.2% 30.9% 

Chiron $361.0 4.8% 27.0% 

Immunex $258.6 26.3% 20.0% 

Genzyme Corp. $238.5 27.2% 20.1% 

Vertex Pharmaceuticals $212.0 55.1% 113.9% 

Human Genome Sciences $205.8 40.7% 954.2% 

Incyte Genomics $183.0 –10.0% 116.6% 

ICOS $173.0 54.7% 211.0% 

Inhale Therapeutic $160.0 14.6% 190.5% 

Abgenix $155.0 54.4% 328.7% 

Gilead Sciences $145.0 –21.9% 36.2% 

Celera Genomicsa

 $142.4 –31.4% 103.4% 

Total R&D Expenditure $4,690.2 

a

Celera was a major contributor to the Human Genome Project and completed a draft of the human genome in June 

2000. 

Source: Standards & Poor’s Biotechnology Industry Survey, May 2002. 
Measuring Service-Sector Research and Development 

D-6 

Examples of health-related biotechnology R&D include the following: 

• Molecular modeling is the three-dimensional modeling of 

nucleic acids and protein structures based on a one-dimensional 

amino acid sequence; however, researchers are missing a 

description of the relationships between the one-dimensional 

sequence and the three-dimensional structure. 

• Genomics is the study of disease origins at the molecular level, 

which is then used to inform drug researchers of new potential 

therapeutic targets. 

• Proteomics is the identification and understanding of the 

function and interrelationships among proteins. Proteins are the 

product of genes following transcription (the transformation of 

information from DNA sequences into RNA) and translation (the 

transformation of the information in RNA into proteins). Disease 

processes become apparent at the protein level of activity. 

 D.3 BIOPHARMACEUTICAL INDUSTRY 

A larger, more encompassing industry description used in professional 

literature and policy discussions is the term “biopharmaceutical industry.” 

Biotechnology firms commonly enter into commercialization agreements 

with large pharmaceutical companies. Large pharmaceutical companies 

finance the R&D for biotech firms with potential drug targets in exchange 

for exclusive distributing rights and a royalty fee should the drug survive 

clinical trials and gain FDA approval. 

The term “biopharmaceutical industry” captures all major participants in 

the drug development supply chain, including identification and 

discovery, pre- and postclinical trials, and production activities. In 

addition to large biotechnology pharmaceutical firms, this includes 

smaller RD&T firms, contract research organizations (CROs), and 

contract manufacturing organizations (CMOs). 

The pharmaceutical industry is rapidly expanding with the advent of 

biotechnology-related drugs and gene therapies otherwise known as 

biopharmaceuticals, in addition to efficiency improvements in 

technologies that analyze potential drugs. As the “new drug” market 

expands, many companies are focusing their internal resources on drug 

discovery. As a result, the contract research industry has experienced 

rapid growth in the past 2 decades and now is extremely diversified in 

the variety of services and tools offered. The tools and services vary 

dramatically across the spectrum of R&D activities required to discover 

and develop a new drug. 
Appendix D — Research Development and Testing Service Sector 

D-7 

Figure D-1 shows the four major players in the supply chain involved in 

the drug development, identification and discovery, pre- and postclinical 

trials, and production activities. These include large biopharmaceutical 

companies, smaller RD&T companies, CROs, and CMOs. RD&T 

companies and CROs are mostly involved in the product development 

phase of the supply chain and are typically classified as services 

providers. CMOs support the process side of drug development. This 

appendix discusses the drug and therapies development supply chain, 

focusing on the roles the RD&T companies and CROs play in the 

development process. 

Figure D-1. Drug Development Supply Chain 

CMOs

Process

Development

CROs

Small RD&T

Companies

Product

Development

Large

Biopharmaceuticals

 D.3.1 The Drug Development Process 

RD&T biotechnology firms are integrally involved in drug development. 

Development of a new drug costs on average $800 million for each new 

drug. A large share of the total R&D dollars by these industries pays for 

outsourcing development services and process and manufacturing 

services. Drug discovery and development is a well-documented 

process that includes several stages, starting with discovery of a 

potential targeted compound or therapy, followed by FDA-regulated 

preclinical and clinical trials, and ending with the successful marketing of 

a new drug or therapy. Assuming the newly discovered compound or 
Measuring Service-Sector Research and Development 

D-8 

therapy clears the FDA approval process, the total time from discovery to 

market can be 10 to 15 years. This process is both costly and time 

consuming. 

The innovation process for biotechnology-related drug treatment 

products and processes is closely aligned with that of the pharmaceutical 

industry’s drug development model. Figure D-2 illustrates the innovation 

process in biopharmaceuticals over several phases of R&D. The model 

identifies phases required to bring a drug to market in the United States. 

The arrows indicate the direction for the flow of information. Basic 

research originating in the information technology, manufacturing, and 

physical and biological sciences sectors is synthesized by the 

biotechnology sector and applied to identify possible drug targets. Tools 

and processes used in the discovery include 

• genomics, 

• proteomics, 

• molecular cloning, 

• recombinant DNA, 

• protein engineering, 

• bioinformatics, 

• automated analyzer, and 

• microarray technology. 

In most cases, biotechnology firms, like large pharmaceutical firms, are 

scanning millions of possible compounds or genetic combinations for any 

variation that may improve human health in some measurable way. 

Much of this applied research is conducted by small RD&T companies 

and then transferred (through purchasing or licensing agreements) to 

larger pharmaceutical firms. Once a compound is discovered, the 

biopharmaceutical firm must decide where the drug has the greatest 

potential for market success. Firms will often contract with large CROs 

that have knowledge of various disease markets in the hopes of tailoring 

their R&D efforts towards a disease with the highest probability of 

success both in clinical trials and marketability. Following discovery of a 

new drug or treatment, the development diverges on two tracks: product 

and process. 

Product Development 

On the product side, the drug company is required to demonstrate a 

drug’s efficacy and safety to FDA, evaluated through several years of 
Appendix D — Research Development and Testing Service Sector 

D-9 

Figure D-2. The Innovation Process in Biopharmaceuticals over Several Phases of 

R&D 

Equipment & 

Manufacturing 

R&D 

Information 

Technology 

R&D 

Physical & 

Biological 

Sciences R&D 

Tools & Processes to Aid Discovery In 

Biotechnology

• Genomics 

• Proteomics 

• Physisomics 

• Molecular Modeling 

• Cell Culture Technology 

• Molecular Cloning 

• Recombinant DNA 

• Protein Engineering 

• Tissue Engineering 

• Nanobiotechnology 

• Bioinformatics 

• Automated Analyzer 

• Biosensor 

• Microarry 

Biotechnology Industry: 

Pharmacogenomics 

• Discovery 

• Target development 

Pre-clinical Development 

• Biological Tests 

• Analytical Characterization of 

molecules 

• Animal screening 

• Pharmacological and pharmokinetic 

studies 

• Reproduction 

• Mutagenicity tests 

• Design model 

Process Research 

for Target 

(1 gram – 1 kg)

• Explore alternative 

synthetic routes 

• Evaluate production 

at lab level 

• Produce small 

amounts of drug for 

clinical trials 

Clinical Trials

• Phase I: Safety 

o Healthy volunteers

o Maximum tolerable dose

o Side effects

• Phase II: Efficacy

o Afflicted patients

o Bioavailability of different 

formulations and doses

• Phase III: Efficacy

o Large-scale multisite trials

o Proof of safety and efficacy 

in long-term use

o Comparative studies

Approval

• Documentation of clinical trial data 

• Expert opinion on data 

• Documentation and validation of process 

technology 

• Finial preparation and submission of NDA 

Pilot 

Development 

(1 kg – 100 kg)

• Evaluation of 

process in pilot 

plant. 

• Kinetic studies 

• Optimization of 

reaction conditions 

• Supply materials 

for clinical trials 

• Design of 

equipment/facility 

Commercial Plant 

Transfer/Startup 

(100 kg – metric 

tons)

• Transfer of 

process to 

commercial plant 

• Optimization of 

processs under 

commercial 

conditions 

• Validation of 

manufacturing 

process 

Basic Research 

Marketing and 

P d ti

Applied R&D Activities 

Development 

R&D Activities 
Measuring Service-Sector Research and Development 

D-10 

clinical trials. Stages in the product development process include 

preclinical testing; clinical trial Phases I, II, and III; FDA review and 

approval; and Phase IV postmarket testing. Each stage takes at least 1 

year or more to complete. Figure D-3 outlines the various stages in the 

product development process. 

The preclinical testing stage indicates likely safety and efficacy attributes 

in living organisms through animal testing and toxicology studies. These 

studies show biological activity of a compound against a targeted 

disease. Additionally, risk assessment and market viability are 

established at this stage as well. The type of information that comes out 

of these studies includes detailed descriptions of 

• the new drug’s chemical structure, 

• how it works in the body, 

• any toxic effects, and 

• how the drug will be manufactured. 

These sets of information are submitted to FDA in an Investigational New 

Drug (IND) application. The IND specifies the how, where, and by whom 

the clinical trials will be conducted. The five remaining compounds enter 

into clinical trials. Over 50 percent of the product development effort is 

spent in clinical trials. Over the course of 6 years, the drug is tested on 

real human patients to evaluate the drug’s safety and dosage range. 

Phase I of clinical trials generally takes about 1 year to complete. These 

studies enroll about 20 to 80 normal, healthy volunteers to determine 

how the drug is absorbed, distributed, metabolized, and excreted and the 

duration of its effects. Phase II uses volunteers that suffer from the 

targeted disease to study the drug’s effectiveness. Phase II usually lasts 

2 years. Finally Phase III is a nationwide study enrolling 1,000 to 3,000 

real patients in clinics and hospitals around the country. Phase III 

requires physicians to monitor patients to determine efficacy and adverse 

effects. Upon successful completion of clinical trials, trial data, expert 

opinion data, and validation of process manufacturing data are compiled 

and analyzed. 

A New Drug Application (NDA) submitted to FDA includes the final 

analysis and all the data gathered since the discovery of the new drug 

compound. The NDA regulatory submissions are typically over 100,000 

pages and require an average review period by FDA of 30 months. 

Following the approval and marketing of the new drug, the drug company 
D-11 

Figure D-3. The Stages in Drug Development 

Clinical Trials 

Preclinical 

Testing Phase I Phase I Phase I FDA 

Years 

3.5 1 2 3 2.5 

Test Population 

Laboratory and animal studies 

20 to 80 healthy volunteers 

100 to 300 patient volunteers 

1,000 to 3,000 patient volunteers 

Purpose 

Assess safety and biological activity 

Determine safety and dosage 

Evaluate effectiveness, look for side effects 

Verify effectiveness, monitor adverse reactions from longterm use 

Review Process 

Approval 

Success Rate 

5,000 compounds evaluated 

File IND 

at FDA 

5 compounds enter trials 

File NDA 

at FDA 

1 compound appro
Measuring Service-Sector Research and Development 

D-12 

is still required to periodically report any adverse patient reactions and 

conduct (Phase IV) long-term effect studies on existing patients. 

Additionally some drugs are discovered to have additional positive 

effects that were not specified in the IND submission. One example is 

Welbutrine; this drug was originally approved as an antidepressant but 

has been found to mitigate the withdrawal symptoms associated with 

quitting smoking. To market the existing drug for a new purpose, the 

drug company must go through the entire FDA approval process again. 

Process Development 

Process development begins even before preclinical testing. Newly 

discovered compounds must be manufactured in small amounts and the 

process for manufacturing must be determined in the IND regulatory 

submission to FDA. Depending on the size of the drug company, the 

firm may or may not have the resources and knowledge to efficiently 

evaluate how best to produce the newly discovered compound. Drug 

companies with limited resources, especially small biopharmaceutical 

companies, will outsource the drug manufacturing to a CMO that 

specializes in chemical or biological manufacturing. Although the CMO 

provides a service, these firms are generally classified under the industry 

classification medicinal manufacturing (NAICS 3254). 

CMOs, like the traditional pharmaceutical manufacturing company, 

perform research to determine the availability and affordability of the 

components for a drug compound. Process research is intent on 

developing more cost-effective avenues for the drug’s production. A 

team of process engineers, chemists, and/or geneticists is assigned to 

examine the underlying chemistry behind the new drug or therapy, in the 

hopes of finding ways to produce the drug on a larger scale in a 

commercial manufacturing plant. Following the firm’s IND with FDA, 

clinical trials will begin, and additional testing demands larger quantities 

of the drug to be available. 

CMOs also offer services to develop the packaging and labeling for a 

new drug. This process is generally done in close cooperation with the 

drug company and the CRO managing clinical trials. Controlled testing 

requires adherence to a strict protocol in the drug’s composition and 

exterior appearance and packaging. The dosages must look the same 

for all three phases of clinical trials. Finally the drug’s packaging must 

meet child safety regulations while being used in the clinical trial. Blister 

packets are one example of packaging services that a CMO might offer. 
Appendix D — Research Development and Testing Service Sector 

D-13 

CMOs perform process engineering, manufacturing, and package and 

labeling development services on a contract basis with sponsor drug 

companies. CMOs play a significant role in the supply chain for drug 

development. Although it is important to highlight the services CMOs 

provide, they are primarily manufacturing facilities and are classified as 

such and therefore are not in the scope of this study 

 D.4 INTERVIEWS WITH RD&T BIOTECHNOLOGY 

FIRMS 

To investigate the R&D in the drug development process, RTI 

interviewed several small biotechnology RD&T companies and larger 

CROs. Interviews were conducted with the companies’ research 

directors. The biotech companies were small start-up firms (see Table 

D-4) conducting contract research for larger pharmaceutical companies 

or conducting independent research (funded by venture capitalists) with 

the hope of being bought out or going public once innovations have 

proven successful. Their activities are characterized as high-risk, highreturn research, and risk sharing is one of the “services” they provide. 

Although their research eventually affects health care services, most of 

their research activities are in biological sciences similar to those 

conducted by large pharmaceutical and medicine manufacturing 

companies found in NAICS 3254. 

Table D-4. Small RD&T Biotech Services Organizations Interviewed 

Company 

Name Contact Research Activities 

BioMachines Frank Wang 

Director of R&D 

Designs bench-top computer analysis solutions to automate 

proteomic R&D 

Nobex Robert Soltero 

Director of R&D 

Develops and markets various methods for delivering drugs to 

a patient (e.g., transdermal patch, time release pills) 

Zen-Bio Renee Lee-Currie 

Director of R&D 

Licenses tissue engineering technology associated with human 

fat cells (adipocyte) 

In addition to small biotechnology organizations, RTI interviewed four of 

the largest CROs in the United States. Table D-5 lists the names of the 

companies interviewed. CRO is a generic term used in the 

pharmaceutical industry to label firms that perform research on a 

contractual basis for a sponsor pharmaceutical company. The contract 
Measuring Service-Sector Research and Development 

D-14 

Table D-5. Large Organizations Interviewed Related to RD&T Services 

Company Name Contact Research Activities 

Covance Dianne Sheehan 

Client Services Director 

Preclinical pharmacological studies, and Phases I 

through IV clinical trials and postmarketing studies 

InGenium 

Research 

Leslie McCriminon 

Public Relations Directory 

Phases II through IV clinical trials 

Inveresk Jon Koch 

VP Global Commercial 

Services 

Process engineering, data management software, 

assay development 

Quintiles 

Transnational 

Dick Jones 

Director of Corporate 

Communications 

Preclinical pharmacological studies, and Phases I 

through IV clinical trials and postmarketing studies 

research industry has experienced rapid growth in the past 2 decades, 

and research performed by CROs spans the preclinical and clinical 

phases. 

Several biotech firms interviewed are developing technologies, such as 

assays,1 to support drug discovery and development of new vaccines. 

These companies either sell the assays directly to biopharmaceutical 

companies or use them to provide services. 

Few of the experts interviewed considered their company a service 

provider. Most saw their business as a small player in the rapidly 

growing sector of pharmacogenomics (development of patient-specific 

therapies based on the individual’s genetic makeup). Although most of 

the experts did not consider their business a service, their research was 

primarily funded by pharmaceutical companies. They indicated that “big 

pharma” typically focus on their areas of core competencies and 

outsource to biotech firms to research unexplored gene therapies. This 

practice reduces risk while expanding the number of markets in which a 

pharmaceutical company can compete. 

Of those interviewed, none reported performing basic research. 

However, they often partner with local universities to adopt and leverage 

knowledge as it emerges. In addition, many firms purchase the rights to 

existing research on a particular compound and continue its 

development. Respondents reported that basic research is often too 

costly to perform in house because it “generates little or no revenue.” 

 

1Assays are in-vitro cells with characteristics similar to a human cell. They are marketed 

for use in preclinical tests to prove efficacy of a drug before entering costly clinical trials. 
Appendix D — Research Development and Testing Service Sector 

D-15 

The biotech firms interviewed attributed the largest share of their R&D 

activities to performing highly specialized applied research to support the 

creation of proprietary technology, which in turn can be marketed as a 

service through licensing or contracting. 

Responses varied for development activities depending on the firm’s 

area of research and business interest. Following the completion of 

preclinical trials, biopharmaceutical companies either complete 

development in house, through CROs, or by allowing larger 

pharmaceutical firms to take over development. Firms specializing in 

assay design reported their largest share of R&D was spent in 

development. 

 D.4.1 Small RD&T Biotechnology Research Activities 

The biotechnology industry crosses over many disciplines from 

agriculture and the environment to health care and industrial 

applications. However, smaller individual biotech firms typically 

specialize and develop core competencies in specific genes and 

treatments that increase their probability of success in discovering a new 

marketable compound, therapy, or process. 

These smaller biopharmaceutical companies want to rapidly bring 

compounds to market using as few internal resources as possible. 

Outsourcing by small R&D companies to CROs is becoming increasingly 

more common for achieving this goal. Preclinical testing is normally kept 

in house to ensure proprietary information is kept confidential. However, 

given very few resources to spare, smaller biopharmaceutical companies 

will often outsource some of the more time-consuming studies to a CRO. 

Examples include bioavailability, drug optimization, and toxicology. In 

summary, the biotechnology service firms we spoke with had little 

problem classifying their activities as R&D and were familiar with the 

distinction between basic, applied, and developmental research. 

However, even though many were conducting contract research for 

larger biotech or pharmaceutical companies, none of the companies we 

contacted consider themselves a “service” firm. 

Although many research projects fail, the small biotech firms that 

encounter a successful outcome from their applied research are 

frequently purchased by a large pharmaceutical company; transfer all or 

part of the IP to a partner through a licensing of the proprietary 

technology; or create a third jointly owned entity. Such business models 
Measuring Service-Sector Research and Development 

D-16 

may be supported by the RD&T service sector just as independent 

biotechnology firms use these services. 

However, in recent years, many smaller biotech companies have 

become more independent because of increases in capital availability. 

Standard & Poor’s (S&P’s) industry profile reports that from 1999 to 2002 

the biotech industry raised approximately $60 billion through a variety of 

public and private financing sources, whereas only $15 billion were 

raised from 1996 to 1998. Nevertheless, the huge total cost of bringing a 

new drug to market necessitates both hybrid organizational strategies 

and the extensive use of efficiency-enhancing RD&T service firms. 

Even though small biotechnology firms conduct R&D activities in a wide 

range of areas (including human health, animal health, agriculture and 

aquaculture, marine and terrestrial microbial applications, industrial and 

agricultural processing, environmental remediation, and natural resource 

recovery), their research activities fall into several common categories. 

The DOC reports R&D activities performed by biotechnology firms can 

generally be classified as follows (DOC, 2003): 

• DNA based 

– gene probes, DNA markers 

– bioinformatics 

– genomics, pharmacogenetics 

– DNA sequencing/synthesis/amplification, genetic engine 

• Biochemistry/immunology 

– vaccines/immune stimulants 

– drug design and delivery 

– synthesis/sequencing of proteins and peptides 

– cell receptors/signaling, structural biology 

– combinatorial chemistry, 3-D molecular modeling 

– biomaterials 

– microbiology, virology, microbial ecology 

• Bioprocessing based 

– culturing/manipulation of cells, tissues, and embryos 

– extractions, purifications, and separations 

– fermentation, bioprocessing, and biotransformation 

• Environmental 

– bioleaching, biopulping, biobleaching, and biodesulfurization 

– bioremediation and biofiltration 
Appendix D — Research Development and Testing Service Sector 

D-17 

 D.5 CRO R&D ACTIVITIES 

Outsourcing by both large and small pharmaceutical companies is 

generally done when the drug company believes that it is overburdened 

by work relating to the drug development process or believes that a CRO 

may have expertise that allows it to conduct aspects of the process more 

efficiently. CROs work with their sponsor client to develop trial protocols, 

standardize their methods for data analysis and regulatory submissions, 

and create a seamless interchange of communication and data 

exchange. 

CROs specialize in every aspect of drug development, including 

medicinal chemistry, preclinical testing, clinical trials, sales and 

marketing, and postmarket testing. Of those we interviewed, none 

reported performing basic research. CROs leverage technology 

emerging from universities and software vendors to supply their clients 

with the most efficient tools and processes to conduct the studies they 

have been contracted to perform. 

The CROs interviewed described the small share of their R&D activities 

directed at applied research to be targeted at the creation of proprietary 

technology, which in turn can be marketed as a service through licensing 

or contracting. This research is centered in process engineering with a 

focus on assay development and testing techniques. 

The CROs interviewed attributed the largest share of their R&D to 

performing development activities. CROs adopt existing technologies 

from various industries and convert the technology to meet their 

business needs. Much of the development is aimed at streamlining the 

information flows between the sponsor and the CRO and improving the 

speed and accuracy at which the data can be acquired and analyzed. 

Following the completion of preclinical testing and the submission of an 

IND to FDA, biopharmaceutical companies will most likely contract with a 

leading CRO that can conduct the clinical trials and efficiently process 

and analyze data from the field to maximize the speed at which the new 

drug moves through the FDA approval process. As discussed earlier, 

many types of CROs specialize in one or all of the services a 

biopharmaceutical company may need. However, the core mission is 

always the same—provide efficient and accurate methods and tools to 

ensure timely completion of the clinical trials and regulatory submissions. 
Measuring Service-Sector Research and Development 

D-18 

From RTI’s interviews, we found that some of the largest CROs in the 

United States were conducting R&D in support of their research services. 

The most common areas of development were in 

• process engineering in service delivery and 

• software development in data acquisition, exchange, and 

security. 

Process engineering was cited as an area of constant reworking in the 

industry. CROs compete on the promise that their firm has the fastest, 

most efficient, and streamlined system for moving the drug company’s 

IND through clinical trials. As a result, the larger, more competitive 

CROs spend large sums of money on research to streamline processes 

in site recruitment, communication with sponsors, and the efficiency and 

accuracy of data delivery and analysis. 

CROs interviewed also mentioned software development as another 

source of R&D conducted internally to enhance their services. In all 

cases, this generally included purchasing existing software from thirdparty vendors such as Oracle that specialize in clinical trial database 

management applications. Once purchased, CROs modify these 

applications to meet the needs and specifications that they believe will 

have the greatest impact on the quality of services they provide. In 

addition to modifying existing software, the CROs in cooperation with the 

pharmaceutical industry have recently developed an industry standard 

for how data are defined across the industry. The Clinical Data 

Interchange Standards Consortium (CDISC) is the industry organization 

leading this initiative. 

Electronic data capture (EDC) is another area of software development 

that CROs are working on. Massive quantities of clinical data are 

generated in each of the three phases of trials. This information was 

traditionally filled out on a bubble sheet questionnaire by the physician or 

patient volunteer and then mailed or faxed back to the CRO where the 

data were entered into a database. In the late 1990s, CROs began to 

conceive of compiling trial data over the Internet. Today, Web services 

allow physicians and patients around the world to enter clinical data into 

laptops, cell phones, or palm devices, which then send the data over the 

Internet directly to the CRO’s database. Security becomes an important 

issue as EDC technologies are developed. CROs are forced to comply 

with the sponsor’s strict confidentiality requirements while transferring 

data and must develop security protocols that ensure that the data will 

not be captured during transmission from the field to the CRO. 
Appendix D — Research Development and Testing Service Sector 

D-19 

 D.6 CMO R&D ACTIVITIES 

Biopharmaceutical drug development also requires some special 

research on the manufacturing side as well. CMOs research the most 

efficient process for manufacturing large quantities of the new drug. For 

this reason CMOs adopt many of the same technologies the 

biopharmaceutical company used to discover the drug. The following 

tools are used to perform basic and applied research that will ultimately 

lead to the discovery of a novel pharmaceutical application or gene 

therapy, new medical diagnostic device or method, or a preventative 

vaccine. These technologies can also inform and facilitate the product 

and process development activities conducted at CMOs further down the 

pipeline. Other examples include the following: 

• Bioprocessing technology—uses single-cell microorganisms to 

catalyze biochemical reactions that in turn produce new 

products. This technology is used to create insulin, 

biodegradable plastics, and vaccines for various blood-borne 

pathogens. 

• Cell culture—growing living cells outside of living organisms. 

• Recombinant DNA technology—the preferential genetic selection 

and expression. This technology is used in combination with 

cloning or protein engineering to achieve new genetic properties 

in existing cells or proteins. 

• Cloning—the production of genetically identical copies of a 

molecule, cell, or animal allows researchers to study genetic 

diseases and processes and discover potential drugs and 

therapies. 

• Protein engineering—technology is used to improve the chemical 

structure of proteins and enzymes to be used in drug 

development, food processing, and industrial manufacturing. 

• Biosensors—attaches biological components to transducers to 

measure extremely low concentrations of certain substances. 

This technology allows for the development of products that 

measure nutritional value of food or allows physicians to 

measure the levels of vital blood components. 

• Nanobiotechnology—is the combination of nanotechnology with 

microbiology to discover stable micro-structures that can be 

employed to create nanoprocessors to channel electronic 

signals. 

• Microarrays—are used to study gene structure and function at 

the DNA or protein molecular level. Arrays are used to monitor 

and detect mutations in genes and diagnose infectious diseases. 

These arrays also support the drug discovery and development 

of new vaccines. 
Measuring Service-Sector Research and Development 

D-20 

 D.7 REFERENCES 

Amable, Bruno, and Stefano Palombarini. 1998. Technical Change and 

Incorporated R&D in the Service Sector. OECD. 

<http://netec.mcc.ac.uk/WoPEc/data/Papers/ 

cpmcepmap9808.html>. 

Andersen, Birgitte, Jeremy Howells, Richard Hull, Ian Miles, and Joanne 

Roberts (eds.). 2000. Knowledge and Innovation in the New 

Service Economy. North Hampton, MA: Edward Elgar 

Publishing Ltd. 

Biotechnology Industry Organization (BIO). 2002. Biotechnology 

Industry Organization. 2004. The Editors’ and Reporters’ Guide 

to Biotechnology. Washington, DC: Biotechnology Industry 

Organization. <http://www.bio.org/speeches/pubs/er/ 

BiotechGuide.pdf>. As obtained on July 19, 2004.

COMPUSTAT. 2003. American Stock Exchange Database. Contennial, 

CO: Standard & Poor’s, McGraw Hill Companies, Inc. 

Ernst & Young. 2002. “Convergence: Ernst & Young’s Biotechnology 

Industry Report Millenium Edition.” <http://www.ey.com/global/ 

download.nsf/US/Convergence_Biotechnology_Millennium_ 

Report/$file/ConvergenceBiotechnologyRpt.pdf>. 

Howells, Jeremy. 1999. “Research and Technology Outsourcing.” 

Technology Analysis & Strategic Management 26(1):17-29. 

Howells, Jeremy. 2000b. “Understanding the New Service Economy.” In 

Birgitte Andersen, et al. (eds.), Knowledge and Innovation In the 

New Service Economy. Northampton, MA: Edward Elgar 

Publishing Inc. 

Jankowski, John E. 2001. “Measurement and Growth of R&D Within the 

Service Economy.” Journal of Technology Transfer 26:323-336. 

Organisation for Economic Co-operation and Development (OECD). 

2001. Research and Development Expenditure in Industry 1987-

1999. Paris: OECD Publication Service. Pilat, Dirk. 2001. 

“Innovation and Productivity in Services: State of the Art.” In 

Innovation and Productivity in Services, pp. 17-58. Paris: 

Organisation for Economic Co-operation and Development 

(OECD). 

Prevezer, M. 1998. “Clustering in Biotechnology in the USA.” In The 

Dynamics of Industry Clustering, M. Prevzer and D. Stout (eds.), 

Oxford: Oxford University Press. 

Standard & Poor’s. Standards & Poor’s Biotechnology Industry Survey. 

May 2002. 
Appendix D — Research Development and Testing Service Sector 

D-21 

Toole, A.A. 2003. “Understanding Entrepreneurship in the U.S. 

Biotechnology Industry.” In The Emergence of Entrepreneurship 

Policy: Governance, Start-Ups, and Growth in the U.S. 

Knowledge Economy, D.M. Hart (ed.), Cambridge: Cambridge 

University Press. 

U.S. Department of Commerce (DOC), Technology Administration and 

Bureau of Industry and Security. 2003. “A Survey of the Use of 

Biotechnology in U.S. Industry.” Washington, DC: U.S. 

Department of Commerce. <http://www.technology.gov/reports/ 

Biotechnology/CD120a_0310.pdf>. As obtained on July 19, 

2004. 

E-1 

 Appendix E: 

 Definitions of R&D 

Most U.S. agencies and many foreign agencies follow NSF’s definition of 

R&D. However, R&D is defined slightly differently across different U.S. 

and international agencies. This appendix describes and contrasts R&D 

definitions used by NSF, OECD, and U.S. R&D tax credit codes. 

 E.1 NATIONAL SCIENCE FOUNDATION’S 

DEFINITION OF R&D 

The NSF was created in 1950 by the National Science Foundation Act. 

This act directs the NSF to collect, interpret, and analyze data on the 

availability and need of scientific and technical resources. The NSF Act 

also instructs the agency to provide a source of information for policy 

formulation for other federal agencies. Since 1953, NSF’s Division of 

Science Resources has sponsored and managed a survey of industrial 

R&D. This survey is the method by which NSF collects R&D data from 

manufacturing and service industries. From 1953 to 1956, the Bureau of 

Labor Statistics (BLS) in the U.S. Department of Labor conducted the 

R&D survey. Since 1957, the Bureau of the Census in the U.S. 

Department of Commerce has conducted the survey. 

NSF has adopted a widely accepted definition of R&D that comprises 

three general categories of research: basic, applied, and development. 

These categories are distinguishing between R&D-related activities and 

all other activities, as stated clearly at the beginning of the survey. 

These categories are defined as follows: 

• Basic research is research directed toward increases in the 

knowledge or understanding of fundamental aspects of 

phenomena and of observable facts without specific application 
Measuring Service-Sector Research and Development 

E-2 

toward processes or products. This type of research is limited to 

the federal, university, and nonprofit sectors. 

• Applied research is research directed toward gaining knowledge 

that will meet a specific need. This includes research for specific 

commercial objectives. 

• Development is the systematic use of knowledge directed toward 

the production of a product, service, or method. This includes 

the design and development of prototypes and processes. 

However, it excludes quality control, routine product testing, and 

production. 

Based on NSF’s definition, an activity is considered R&D if it is related to 

one or more of the following goals: 

• Pursue a planned search for new knowledge whether or not the 

search has reference to a specific application. 

• Apply existing knowledge to problems involved in creating a new 

product or process, including work required to evaluate possible 

uses. 

• Apply existing knowledge to problems involved in improving a 

present product or process. 

R&D includes the activities described above, whether assigned to 

separate R&D organizational units of the company or carried out by 

company laboratories and technical groups not part of an R&D 

organization. 

NSF’s definition specifically excludes the following: 

• R&D from acquired companies prior to acquisition; 

• amortization above actual cost of property and equipment related 

to R&D activities; 

• test and evaluation once a prototype becomes a production 

model; 

• routine product testing; 

• geological and geophysical exploration activities; 

• technical services such as 

– quality and quantity control, 

– technical plant sanitation control, and 

– trouble-shooting in connection with breakdowns in full-scale 

production; 

• advertising programs to promote or demonstrate new products or 

processes; 

• assistance in preparing speeches and publications for persons 

not engaged in R&D; and 
Appendix E — Definitions of R&D 

E-3 

• social science R&D, which is defined to encompass those 

activities devoted to further understanding the behavior of groups 

of human beings or of individuals as members of groups. Some 

of the topics include the following: 

– personnel R&D 

– economic R&D 

– artificial intelligence and expert systems R&D 

– consumer, market, and opinion R&D 

– engineering, psychology R&D 

– management and organization R&D 

– actuarial and demographic R&D 

– educational processes and applications R&D 

– R&D in law 

 E.2 FRASCATI MANUAL 

In 1963, the OECD produced the first draft of The Proposed Standard 

Practice for Surveys of Research and Experimental Development, or the 

Frascati Manual. This manual is part of the OECD series, “The 

Measurement of Scientific and Technological Activities.” The Frascati 

Manual attempts to measure the R&D of OECD member countries that 

have similar economic systems. The OECD designed the manual for the 

experts who collect and issue national R&D estimates. 

The Frascati Manual defines R&D as comprising “creative work 

undertaken on a systematic basis in order to increase the stock of 

knowledge, including knowledge of man, culture and society, and the use 

of this stock of knowledge to devise new applications” (OECD, 1994b, p. 

7). R&D is a term covering three research activities: basic research, 

applied research, and experimental development. Those activities are 

defined in the Frascati Manual as follows: 

• Basic research is experimental or theoretical work undertaken 

primarily to acquire new knowledge of the underlying foundations 

of phenomena and observable facts, without any particular 

application or use in view. Basic research analyzes properties, 

structures, and relationships with a view to formulating and 

testing hypotheses, theories, or laws. The results of basic 

research are not generally sold but are usually published in 

scientific journals or circulated to peers. Occasionally, basic 

research may be kept confidential for security reasons. 

• Applied research is also original investigation undertaken to 

acquire new knowledge. It is, however, directed primarily 

towards a specific, practical aim or objective. The results of 

applied research are intended primarily to apply to a single or 
Measuring Service-Sector Research and Development 

E-4 

limited number of products, operations, methods, or systems. 

Applied research develops ideas into operational form. The 

knowledge or information derived from it is often patented but 

may also be kept confidential. 

• Experimental development is systematic work, drawing on 

existing knowledge gained from research and practical 

experience that is directed to producing new materials, products, 

and devices; to installing new processes, systems, and services; 

or to improving substantially those already produced or installed. 

The basic criterion for distinguishing R&D from related activities is the 

element of novelty and the resolution of scientific and/or technological 

uncertainty. Institutions and firms whose principal activity is R&D often 

have secondary, non-R&D activities (e.g., scientific and technical 

information, testing, quality control, and analysis). If the secondary 

activity is undertaken primarily in the interests of R&D, it is included in 

R&D activities. However, if the secondary activity is designed essentially 

to meet needs other than R&D, it is excluded from R&D. 

The Frascati Manual specifically excludes a number of related innovation 

activities from its definition of R&D. These include the following 

activities: 

• education and training. 

• other related scientific and technological activities. 

• other industrial activities. 

• administration and other supporting activities. 

• scientific and technical information services (collecting, coding, 

recording, classifying, disseminating, translating, analyzing, 

evaluating services, technical personnel, bibliographic services, 

patent services, scientific and technical information extension 

and advisory services, and scientific conferences), except where 

conducted solely or primarily for the purpose of R&D support. 

• general-purpose data collection to record natural, biological, or 

social phenomena that are of general public interest or that only 

the government has the resources to record (routine 

topographical mapping; routine geological, hydrological, 

oceanographic, and meteorological surveying; astronomical 

observations; and marketing surveys). 

• testing and standardization. This refers to maintaining national 

standards, calibrating secondary standards and routine testing 

and analyzing materials, components, products, processes, 

soils, atmosphere, etc. 

• feasibility studies. Investigation of proposed engineering 

projects using existing techniques to provide additional 

information before deciding on implementation. In the social 

sciences, feasibility studies are investigations of the 
Appendix E — Definitions of R&D 

E-5 

socioeconomic characteristics and implications of specific 

situations (e.g., a study of the viability of a petrochemical 

complex in a certain region). However, feasibility studies on 

research projects are part of R&D. 

• specialized medical care. Refers to routine investigation and 

normal application of specialized medical knowledge. There 

may, however, be an element of R&D in what is usually called 

“advanced medical care,” carried out, for example, in university 

hospitals. Usually such advanced medical care is not 

considered R&D, and all medical care not directly linked to a 

specific R&D project should be excluded from the R&D statistics. 

• patent and license work. All administrative and legal work 

connected with patents and licenses. However, patent work 

connected directly with R&D projects is R&D. 

The activities that are a part of the innovation process, but rarely involve 

any R&D (patent filing and licensing, market research, manufacturing 

start-up, tooling up and redesign for the manufacturing process), are 

excluded from the R&D estimates. However, some activities, such as 

tooling up, process development, design, and prototype construction, 

may contain an appreciable element of R&D. This makes it difficult to 

identify what should or should not be defined as R&D. One of the 

greatest sources of error in measuring R&D lies in the difficulty of 

locating the cut-off point between experimental development and the 

related activities. 

 E.3 R&D TAX CREDIT—DEFINITION OF R&D 

Congress enacted the R&D tax credit in 1981. It is important to 

understand the tax credit definition of R&D because it may influence a 

company’s internal tracking of R&D expenditures. The tax credit 

definition of R&D is more exclusive than NSF’s or Frascati’s. Tax credits 

are awarded to firms or individuals who engage in “qualified research.” 

Since its inception, the bill has been extended eight times. 

Qualified research is defined as 

• Research undertaken for the purpose of discovering information 

– that is technological in nature and 

– whose application is intended to be useful in developing a 

new or improved business component of the tax payer. 

3⁄4 Business component is defined as any product, process, 

computer software, technique, formula, or invention that 

is 

 held for sale, lease, or license; or 
Measuring Service-Sector Research and Development 

E-6 

 used by the taxpayer in trade or business of the 

taxpayer. 

– Special rule for production processes: 

3⁄4 Any plant process, machinery, or technique for 

commercial production of a business component shall be 

treated as a separate business component (and not as 

part of the business component being produced). 

– Substantially all activities of which constitute elements of a 

process of experimentation for a purpose (listed below). 

• Purposes for which research may qualify for credit: 

– In general, research shall be treated as conducted for the 

purpose of 

3⁄4 developing a new or improved function, 

3⁄4 performance, or 

3⁄4 reliability or quality. 

Qualified research excludes the following: 

• Research after commercial production of the business 

component. 

• Adaptation of existing business components and any research 

related to adapting an existing business component to a 

particular customer’s requirement or need. 

• Duplication of existing business component; that is, any research 

related to reproducing an existing business component (in whole 

or in part) from a physical examination of the business 

component itself or from plans, blueprints, detailed specification, 

or publicly available information with respect to such business 

component. 

• Surveys, studies, etc. 

– efficiency survey 

– activity relating to management function or technique 

– market research, testing, or development (including 

advertising or promotions) 

– routine data collection 

– routine or ordinary testing or inspection for quality control 

• Computer software, except to the extent that provided in 

regulations, any research with respect to computer software that 

is developed by (or for the benefit of) the taxpayer primarily for 

internal use by the taxpayer, other than for use in 

– an activity that constitutes qualified research or 

– a production process with respect to which the requirements 

of qualified research (criteria) are met. 

• Foreign research—any research conducted outside the United 

States. 
Appendix E — Definitions of R&D 

E-7 

• Social sciences, etc.—any research in the social sciences, arts, 

or humanities. 

• Funded research—any research to the extent funded by any 

grant, contract, or otherwise by another person (or governmental 

entity). 

 E.4 SUMMARY OF R&D DEFINITIONS 

Table E-1 summarizes the three different definitions of R&D described 

above and presents them side by side to illustrate their similarities and 

differences. NSF identifies basic research, applied research, and 

development as the three types of activities classified as R&D for 

reporting purposes. All three activities require either the creation of new 

knowledge or a novel application of existing knowledge. Once a 

production model is established, all activities associated with further 

development are not considered R&D. Furthermore, NSF omits all social 

science research from its definition of R&D activities. 

The Frascati Manual classifies R&D activities into the same three 

general categories: basic research, applied research, and experimental 

development, where all activities classified as R&D must be in the pursuit 

of new knowledge or the discovery of new applications for existing 

knowledge, product, or process. The Frascati definition lists fewer 

disqualifying criteria for R&D activities, compared to the R&D tax credit 

and NSF’s definition. 

The R&D tax credit bill uses the term “qualified research” to identify 

activities aimed at creating new information or product and new 

applications of existing knowledge as applied to existing products. The 

tax credit bill addresses the issue of modification or adaptation, omitted 

by the other two institutional definitions. The bill says that modification or 

adaptation of existing products to meet a client’s needs is not considered 

R&D. 
Measuring Service-Sector Research and Development 

E-8 

Table E-1. Summary of R&D Definitions 

NSF Frascati Tax Credit Bill 

Included in the definition of R&D 

Basic research: Pursue new 

knowledge whether or not the 

search has reference to a 

specific application 

Limited to federal, university, 

and nonprofit organizations 

Basic research is work done to 

acquire new knowledge, without any 

particular application or use in view 

Research that is undertaken to 

discover information technical in 

nature, and holds applications 

useful in developing a new or 

improved business componenta

of the taxpayer 

Applied research: Apply 

existing knowledge to 

problems involved in the 

creation of a new product or 

process

Applied research is original 

investigation to acquire new 

knowledge directed towards a 

practical objective or a single 

product, operation, method, or 

system 

Research that seeks a new or 

improved function performance, 

reliability, or quality 

Development: Apply existing 

knowledge to problems 

involved in the improvement 

of an existing product or 

process 

Experimental development is 

systematic work, drawing on existing 

knowledge aimed at producing new, 

or to improving substantially, 

existing products 

Not specified 

Not included in the definition of R&D

Not specified Not specified Adaptation of existing business 

components to fit a particular 

customer’s requirements 

R&D from acquired companies 

prior to acquisition 

Not specified Not specified 

Amortization above actual cost 

of property and equipment 

related to firm R&D 

Not specified Not specified 

Test and evaluation once a 

prototype becomes a 

production model 

Not specified Research after commercial 

production of the business 

component 

• Routine product testing 

• Consumer, market, and 

opinion R&D 

• Advertising new products or 

processes 

• Routine product testing 

• General purpose data collection 

• Market research, testing, or 

development (including 

advertising or promotions) 

• Routine data collection 

Geological and geophysical 

exploration activities 

Analysis of soils and atmosphere Not specified 

Quality and quantity control Not specified Routine or ordinary testing or 

inspection for quality control 

Trouble-shooting for 

breakdowns in production 

Scientific and technical information 

assistance 

Scientific and technical 

information assistance 

 (continued) 
Appendix E — Definitions of R&D 

E-9 

Table E-1. Summary of R&D Definitions (continued) 

NSF Frascati Tax Credit Bill 

Not included in the definition of R&D (continued)

Social sciences, etc.: any 

research in the social 

sciences, arts, or humanities 

Social sciences, etc.: any 

research in the social sciences, 

arts, or humanities 

Social sciences, etc.: any 

research in the social sciences, 

arts, or humanities 

Not specified Feasibility studies: (e.g., a study 

of the viability of a petrochemical 

complex in a certain region) 

Efficiency survey 

Management and organization 

R&D 

Administration and other supporting 

activities 

Activity relating to management 

function or technique 

aBusiness component is defined as any product, process, computer software, technique, formula, or invention that 

is held for sale, lease, or license or used by the taxpayer in trade or business. 

 E.5 REFERENCES 

Organisation for Economic Co-operation and Development (OECD). 

1994b. Proposed Standard Practice for Surveys of Research 

and Experimental Development. Frascati Manual 1993, Paris. 

Organisation for Economic Co-operation and Development 

(OECD). 

F-1 

 Appendix F: 

 2003 Survey 

 Instructions and 

 Instrument 
U S C E N S U S B U R E A U rd1ip1_03 1

RD-1(I) U.S. DEPARTMENT OF COMMERCE 

(2-10-04) Economics and Statistics Administration 

 U.S. CENSUS BUREAU 

 2003 Survey of Industrial Research and Development 

Form RD-1 

Instructions 

Page 

General Instructions ..................................................................................................... 2 

Survey Definition of R&D ......................................................................................... ...... 5 

Question-by-Question Instructions .................................................................................. 7 

 Question 1 .......................................................................................................... 7 

 Question 2A ........................................................................................................ 7 

 Question 2B ........................................................................................................ 8 

 Question 3 .......................................................................................................... 8 

 Question 4 .......................................................................................................... 9 

 Question 5 .......................................................................................................... 12 

 Question 6A ........................................................................................................ 12 

 Question 6B ........................................................................................................ 12 

 Question 7A ........................................................................................................ 12 

 Question 7B ........................................................................................................ 12 

 Question 8 .......................................................................................................... 12 

 Question 9 .......................................................................................................... 13 

 Question 10A ...................................................................................................... 15 

 

 Question 10B ...................................................................................................... 17 

 Question 11 ...................................................................................................... . 17 

 Question 12 ....................................................................................................... 17 

 Question 13 ....................................................................................................... 19 

 Question 14 ...................................................................................................... 19 

 Question 15 ...................................................................................................... 19 
U S C E N S U S B U R E A U rd1ip2_03 2

2003 Survey of Industrial Research and Development 

Form RD-1 

General Instructions 

Changes from 2002 to 2003 R&D survey year 

1) Some item headings and numbers have changed. The five mandatory items are now as follows: 

• Question 2, line A 

• Question 2, line B 

• Question 4D, column 1 

• Question 4D, column 3 

• Question 11 

2) The categories for energy in Question 12 are changed so that conservation and utilization are now 

reported under “All other energy.” 

How this information is used 

Information about corporate research and development (R&D) activities is important in assessing our 

nation’s scientific and technological resources. Your survey answers help us to provide national data 

on industrial R&D. This information is not available from any other source. Your participation is 

appreciated so that we can produce timely and comprehensive data. 

Who fills out this survey? 

U.S. publicly traded and privately owned, nonfarm business firms 

This survey does not include: 

• Operations owned by Federal, state, or local governments 

• Nonprofit organizations 

• Trust or pension plans performing only investments 

If you received this form in error, please explain in the Remarks section on page 10 of the survey form 

and return the form. 

Which company operations should you include in your survey answers? 

Report all domestic operations of your entire consolidated domestic enterprise, including all U.S. 

subsidiaries, affiliates, and branches. 

Report all parts of the company located in the 50 United States and the District of Columbia (D.C.), 

except where indicated differently. 

For holding companies, report for all U.S. subsidiaries, affiliates, and branches under the ownership 

and control of the holding company. 

EXCEPTION: If you report separately for a component of this company based upon an arrangement 

with the Census Bureau, please continue to do so. 
U S C E N S U S B U R E A U rd1ip3_03 3

Reporting period for your survey answers 

Please provide calendar year 2003 information, if possible. If not, please use your fiscal year ending 

between September 2003 and March 2004 

Comparing your 2002 and 2003 responses 

If your company reported for 2002, entries from that form are preprinted on this form. (If you would like 

to correct these figures, please do so.) If your answers for 2003 are substantially higher or lower than 

your 2002 answers, you may comment on the reasons in the Remarks section on page 10 of the survey 

form.” Such reasons may include new government contracts, a revised accounting method, or an R&D 

unit that was acquired or disposed of during 2002 or 2003. 

How to report tax incentives for R&D 

The Federal government and many states offer incentives for research and development activity. For 

purposes of this survey, please report your total R&D expenditures regardless of any tax incentives. 

For further information on the Federal research tax credit please go to: 

 http://www.irs.gov/businesses/

For further information on state tax incentives, please contact the Comptroller of the Treasury in your 

state. 

To request more time to complete your form or additional copies of the form 

Please provide your 11-digit identification number (ID) as printed on the form above your address when 

you contact us.

For more time, call the Census Touchtone Data Entry System: 1-800-851-2014. 

For official copies of the form, call (812) 218-3331. 

OR 

Write: U.S. Census Bureau 

1201 East 10th Street 

 Jeffersonville, IN 47132-0001 

To obtain a sample copy of the form, please visit the following web site. However, that sample copy 

cannot be used to submit your survey response because it lacks the appropriate labeling. 

http://help.econ.census.gov/econhelp/rd/
U S C E N S U S B U R E A U rd1ip4_03 4

For answers to your questions regarding this form 

Write: 

U.S. Census Bureau, Manufacturing and Construction Division 

ATTN: Special Studies Branch 

Room 2135/4 

Washington, DC 20233–6900 

Phone: 

1 –800-851-2014 (option “0”) 

Use our web site at http://help.econ.census.gov/econhelp/rd/

• Submit e-mail via our secure server to encrypt your message and to keep your survey 

participation confidential 

• See answers to frequently asked questions 

Electronic alternative for reporting 

An electronic questionnaire may be used to report your responses. This electronic alternative 

potentially saves time for you and helps us to reduce processing costs. If you use the electronic 

alternative, please do not mail in the paper form. For questions about installing or using the electronic 

questionnaire, please call the Electronic Reporting Staff at 800–838–2640. 

System Requirements 

1. Microsoft Windows 98 or higher. 

2. Microsoft Internet Explorer or Netscape Navigator 4.0 or above (128-bit encryption). 

3. If you set your screen display for 16-bit color or higher, the forms will be easier to read. The 

forms are harder to read with 256-color display. 

Have your username (UID) and password (PW) handy. The username and password are case 

sensitive. 

1. Go to the following Business Help Site at: www.census.gov/econhelp/rd

2. Click on Electronic Reporting 

3. Follow the instructions for downloading software. 

Transmitting your data 

You may transmit you completed data to the Census Bureau electronically via Internet, or by mail. 

Burden hour estimate 

Public reporting burden for this collection of information is estimated to average 18 hours per 

response, including time for reviewing instructions, searching existing data sources, gathering and 

maintaining the data needed, and completing and reviewing the collection of information. Send 

comments regarding the burden estimates or any other aspects of this collection of information, 

including suggestions for reducing this burden, to: 

Suzanne H. Plimpton 

National Science Foundation 

4201 Wilson Boulevard, Room 485 

Arlington, VA 22230. 
U S C E N S U S B U R E A U rd1ip5_03 5

Survey Definitions of R&D 

R&D includes the following: 

• the planned, systematic pursuit of new knowledge or understanding toward general 

application (basic research); 

• the acquisition of knowledge or understanding to meet a specific, recognized need (applied 

research); and 

• the application of knowledge or understanding toward the production or improvement of a 

product, service, process, or method (development). 

This survey covers industrial R&D performed by people who are 

1) trained—either formally or by experience—in engineering or in the physical, biological, 

mathematical, statistical, or computer sciences, and 

2) employed by a publicly or privately owned firm engaged in for-profit activity in the 50 U.S. 

states or D.C. (This also includes R&D they may perform outside of the 50 states and D.C.) 

This survey specifically excludes quality control, routine product testing, market research, sales 

promotion, sales service, and other nontechnological activities; routine technical services; and research 

in the social sciences or psychology.

This survey defines basic research, applied research, and development as follows: 

Basic research is the pursuit of new scientific knowledge or understanding that does not have 

specific immediate commercial objectives, although it may be in fields of present or potential 

commercial interest. 

Applied research applies the findings of basic research or other existing knowledge toward 

discovering new scientific knowledge that has specific commercial objectives with respect to new 

products, services, processes, or methods. 

Development is the systematic use of the knowledge or understanding gained from research or 

practical experience directed toward the production or significant improvement of useful 

products, services, processes, or methods, including the design and development of prototypes, 

materials, devices, and systems. 
U S C E N S U S B U R E A U rd1ip6_03 6

Survey Definitions of R&D (continued) 

Types of R&D activities to consider for this survey 

INCLUDE: EXCLUDE:

• Activities that incorporate: 

– Basic and applied research in the 

sciences and engineering 

– Design and development of new 

products and processes 

– Enhancement of existing products and 

processes 

• Activities carried on by persons trained, 

either formally or by experience, in: 

– Biological sciences (e.g., medicine) 

– Computer science 

– Engineering 

– Mathematical and statistical sciences 

– Physical sciences (e.g., chemistry and 

physics) 

• Activities that take place in: 

– Separate R&D organizational units of the 

company 

– Company laboratories 

– Technical groups not part of an R&D 

organization. 

• R&D from acquired companies prior to acquisition 

(in-process R&D) 

• Amortization above the actual cost of property and 

equipment related to your R&D activities 

• Test and evaluation once a prototype becomes a 

production model 

• Routine product testing 

• Geological and geophysical exploration activities 

• Technical services such as: 

– Quality and quantity control 

– Technical plant sanitation control 

– Troubleshooting in connection with breakdowns 

in full-scale production 

• Advertising programs to promote or demonstrate 

new products or processes 

• Assistance in preparation of speeches and 

publications for persons not engaged in R&D 

• Social science R&D including: 

– Personnel R&D 

– Economic R&D 

– Artificial intelligence and expert systems R&D 

– Consumer, market, and opinion R&D 

– Engineering psychology R&D 

– Management and organization R&D 

– Actuarial and demographic R&D 

– Educational processes and applications R&D 

– R&D in law 
U S C E N S U S B U R E A U rd1ip7_03 7

Question-by-Question Instructions 

Question 1 

Question 1 asks about your company’s ownership as of December 31, 2003. 

If “yes,” your company was owned or controlled by another company on December 31, 2003, follow 

the instructions below: 

Your situation Action to take 

Your company was purchased by another 

company after March 31, 2003 

Note the new owner and purchase date under the 

Remarks section on page 10 of the form. 

Complete the rest of the form for the months 

prior to the purchase of your company. 

Your company was purchased by another 

company on or prior to March 31, 2003 

Note the new owner and purchase date under the 

Remarks section on page 10 of the form and 

return the form without completing the rest of it. 

If you have questions, please call the R&D Survey staff at 1-800-851-2014 (option “0”) to determine 

whether you are required to complete the form. 

Question 2A 

Question 2A covers domestic company sales. Report only the parts of your company located within

the 50 United States or D.C.

INCLUDE: EXCLUDE: 

• Sales, operating receipts, and revenues from all 

domestic operations of the company, net of 

returns and allowances

• Receipts from sales of products and services 

provided to other companies, individuals, U.S. 

Government agencies, and foreign countries 

• Net selling value of shipments, f.o.b. plant, after 

discounts and allowances minus freight charges 

and excise taxes 

• Revenue from investments, rents, and royalties 

only if it is the principal business of the company 

• Interest, dividends, commissions, and rental 

income as part of revenues only if you are a 

finance, insurance, or real estate company 

• Value of assets sold under a capital lease 

agreement 

• Export transfers to your foreign subsidiaries, 

affiliates, and branches. 

• Sales and other taxes collected and paid 

directly to government taxing agencies 

• Domestic intracompany transfers 

• Receipts from sale of products and services 

provided by your foreign subsidiaries, 

affiliates, and branches. 

• Receipts from sale of products and services 

provided by your subsidiaries, affiliates, and 

branches in Puerto Rico and other U.S. 

territories outside the 50 United States and 

D.C. 

• Income from interest, dividends, and 

commissions (Exception: Companies in the 

finance, insurance, and real estate industries) 

• Other nonoperating income (e.g., royalties)
U S C E N S U S B U R E A U rd1ip8_03 8

Question 2B 

Question 2B covers domestic company employment. Report only the parts of your company located 

within the 50 states or D.C.

INCLUDE:

• Full- and part-time employees of the company as defined on Treasury Form 941, 

Employer’s Quarterly Federal Tax Return, and Circular E, Employer’s Tax Guide, if 

filed for the entire company 

• Number of employees in all activities within the 50 United States or D.C. during the 

pay period that includes March 12, 2003 

• Persons on paid sick leave, paid holidays, and paid vacations during the pay period 

that includes March 12, 2003. 

Question 3 

Question 3 covers the scientists and engineers who are employees of your company and perform R&D 

activities. It asks for the number of full-time equivalent (FTE) scientists and engineers who work on 

your company’s R&D within the 50 United States or D.C. 

There are two steps to calculate the number of FTEs for R&D scientists and engineers: 

1. For company laboratories performing only research and development, count the number of 

scientists and engineers employed in January 2004. 

2. For employees whose activities are not solely devoted to R&D, use the proportion of their time that 

is devoted to R&D to compute the number of full-time equivalent R&D scientists and engineers. For 

example, if a company had 60 scientists and engineers in January 2004 and one-fourth of their time 

was charged to R&D projects, then that company would have 15 full-time equivalent R&D scientists 

and engineers. Add these full-time equivalents to the count from the previous step. 

INCLUDE:

• All persons engaged in scientific or engineering work at a level that requires 

knowledge of physical or life sciences or engineering or mathematics 

• Persons with experience equivalent to completion of a 4-year college course with 

majors in these fields, regardless of whether they actually hold degrees in the fields 
U S C E N S U S B U R E A U rd1ip9_03 9

Question 4 

Question 4 covers the R&D that is performed both (1) within your company and (2) within the 50 

United States or D.C. 

How to decide which expenditures to include as R&D costs 

INCLUDE: EXCLUDE: 

• Wages, salaries, and related costs 

• Materials and supplies consumed 

• R&D depreciation 

• Cost of computer software used in R&D 

activities 

• Utilities, such as telephone, telex, electricity, 

water, and gas 

• Travel costs and professional dues 

• Property taxes and other taxes (except income 

taxes) incurred on account of the R&D 

organization or the facilities they use 

• Insurance expenses 

• Maintenance and repair, including 

maintenance of buildings and grounds 

• Company overhead including: personnel, 

accounting, procurement and inventory, and 

salaries of research executives not on the 

payroll of the R&D organization 

• R&D from acquired companies prior to 

acquisition (in-process R&D) 

• Capital expenditures 

• Test and evaluation once a prototype 

becomes a production model 

• Patent expenses 

• Income taxes and interest 
U S C E N S U S B U R E A U rd1ip10_03 10

Question 4 (continued)

How to decide which category of R&D 

1. Basic research Projects that pursue new scientific knowledge or understanding that does not 

have specific immediate commercial objectives, although it may be in fields of 

present or potential commercial interest 

2. Applied 

research 

Projects that apply the findings of basic research or other existing knowledge 

toward discovering new scientific knowledge that has specific commercial 

objectives with respect to new products, services, processes, or methods 

3. Development Projects that are directed toward the systematic use of the knowledge or 

understanding gained from research or practical experience directed toward 

the production or significant improvement of useful products, services, 

processes, or methods, including the design and development of prototypes, 

materials, devices, and systems

INCLUDE: EXCLUDE: 

• Expenditures for designing and 

conducting clinical trials of drugs, 

pharmaceuticals, or other products 

that have not been marketed 

• Software development 

– Designing and/or adapting 

software if the application has 

commercial value (exclude 

software development for internal 

use) 

– Beta version of software being 

developed that has potential 

commercial application 

– Design and operation of pilot 

plants and semiwork plants 

• Engineering activity required to 

advance the design of a product or 

process so it meets specific 

functional and economic 

requirements 

• Design, construction, and testing of 

prototypes and models including test 

models for defense contracts 

• Designs for special manufacturing 

equipment and tools 

• Preparation of reports, drawings, 

formulas, specifications, standard 

practice instructions, or operating 

manuals 

• Software development intended 

for within company use only 

• •Routine technical services to 

customers 

• Tool making and tool tryout 

• Production of detailed 

construction drawings and 

manufacturing blueprints 
U S C E N S U S B U R E A U rd1ip11_03 11

Question 4 (continued)

How to decide which category to use for sources of R&D funding 

Source of 

R&D INCLUDE: EXCLUDE: 

Federal 

funds

• Federally funded R&D performed within

the company. Include only the amount of 

work done on Federal R&D contracts or 

subcontracts in the current year. 

• R&D portion of procurement contracts or 

subcontracts 

• Federally funded R&D contracted or 

subcontracted to or otherwise 

performed by others outside of your 

company. (Report such funds in 

Question 6, line A.) 

• Expenditures for independent research 

and development (IR&D). (Report in 

column 2, Company funds.)

Company 

and other 

• R&D from company and other nonfederal 

sources that is performed within the 

company. 

NOTE that “company and other funds” 

and “company funded” are used 

interchangeably in the Form RD-1. 

• R&D your company performs under 

contracts you have with non-Federal 

sources 

• Costs for independent research and 

development (IR&D). We define IR&D 

funds as R&D performed by the company 

for which you anticipate reimbursement by 

the government through indirect charges 

for the purchase of products or services. 

Qualified projects usually have potential 

interest to the Department of Defense or 

other agencies of the Federal government. 

These IR&D funds are excluded from 

federal funds received for federally 

sponsored research and development 

contracts.

• R&D from nonfederal sources that is 

contracted to or otherwise performed 

by others outside of your company 

(Report such funds in Question 6, line 

A.) 
U S C E N S U S B U R E A U rd1ip12_03 12

Question 5 

Question 5 asks for an estimate or projection of the cost of R&D your company expects to perform in 

2004 in the 50 United States or D.C. that will be funded by company and other non-Federal sources. 

Question 6A 

Question 6A covers the R&D that was both performed for your company (1) by others outside your 

company such as contractors, and (2) within the 50 United States or D.C. 

Include payments for R&D projects, contracts, or services performed for your company by contractors, 

suppliers, educational institutions, or other organizations. 

Question 6B 

Question 6B asks for the type of organizations that performed the portion of your answer to question 

6A for company and other nonfederal sources of R&D funding. 

Definitions for types of organizations 

For-profit companies A company that is organized to pursue 

profit

Universities and colleges A degree-granting institution of higher 

learning, having facilities for teaching and 

research 

Other nonprofit organizations An organization that is not organized to 

pursue profit. However, universities and 

colleges are reported in another category. 

Question 7A 

Question 7A covers R&D performed outside the 50 United States and D.C. including R&D performed in 

Puerto Rico. 

For Question 7A, line 1, report payments for R&D projects, contracts, or services performed for your 

company by contractors, suppliers, educational institutions, or other organizations. 

Question 7B 

Question 7B provides more detail for your answer to Question 7A, line 4. If a country is not listed, 

please include the R&D in the “Other” category. 

Question 8 

Question 8 covers domestic federally funded R&D by agency. 
U S C E N S U S B U R E A U rd1ip13_03 13

Question 9 

Question 9 covers R&D by type of expense 

A. Wages and salaries of R&D personnel 

INCLUDE: EXCLUDE: 

• Gross earnings paid in calendar year 

2003 to employees engaged in R&D 

(follow the definition of salaries and 

wages that is used for calculating 

withholding tax) 

• Salaries of officers in the research 

establishment(s) of a corporation 

• Payments to proprietor or partners if an 

unincorporated concern 

• Employee fringe benefits (Report under 

“B. Fringe benefits.”) 

B. Fringe benefits of R&D personnel 

A fringe benefit is an employment benefit granted by an employer that has monetary value but does 

not affect basic wage rates. It includes any benefits given in addition to wages. 

INCLUDE: 

• Disability benefits 

• Life and medical insurance 

• Paid holidays 

• Retirement benefits, pension, and social security 

contributions 

• Stock options 

• Time-off benefits 

• Vacation, annual, sick, and maternity leave 

C. Materials and supplies consumed 

Report the delivered cost for all purchased materials consumed. 

INCLUDE: EXCLUDE: 

• Materials and supplies that were: 

– Received from other companies 

– Withdrawn from inventory 

– Received from other establishments of this 

company 

• All work done for your laboratories and other 

technical units by noncompany organizations; 

for example: Model construction by a noncompany model shop 

• Purchases from other R&D 

organizations 
U S C E N S U S B U R E A U rd1ip14_03 14

Question 9 (continued) 

 

D. Depreciation on R&D property and equipment 

INCLUDE: 

• Depreciation and amortization charged during the year against property 

and equipment related to your R&D activities 

• Depreciation and amortization against property and equipment acquired 

since the beginning of the year that was sold or retired during the year 

and not in service at the end of the year 

• Depreciated amounts no higher than the actual cost of property and 

equipment 

E. All other R&D expenses 

INCLUDE: 

• Books and periodicals 

• Company overhead 

• Property and other taxes 

• Utilities 
U S C E N S U S B U R E A U rd1ip15_03 15

Question 10A 

Question 10A covers R&D by selected technology area. 

A. Biotechnology 

Definition of biotechnology for this survey: 

Biotechnology is the application of science and technology to living organisms, as well as parts, 

products, and models thereof, to alter living or nonliving materials for the production of 

knowledge, goods, and services. 

INCLUDE: 

• DNA technologies such as: 

– Genetics 

– Pharmacogenetics 

– Gene probes 

– DNA sequencing/synthesis/simplification 

– Genetic engineering 

• Protein and molecular technologies such 

as: 

– Protein/peptide sequencing/synthesis 

– Lipid/protein glycoengineering 

– Proteomics 

– Hormones 

– Growth factors 

– Cell receptors/signaling/pheromonics 

• Cell and tissue culture and engineering 

including: 

– Cell/tissue culture 

– Tissue engineering 

– Hybridization 

– Cellular fusion 

– Vaccine/immune stimulants 

– Embryo manipulation 

• Process biotechnologies such as: 

– Bioreactors 

– Fermentation 

– Bioprocessing 

– Bioleaching 

– Biopulping 

– Biobleaching 

– Biodesulphurization 

– Bioremediation 

– Biofiltration 

• Subcellular organism research including: 

– Gene therapy 

– Viral vectors 

• Other biotechnology areas such as:

– Bioinformatics 

– Nanobiotechnologies
U S C E N S U S B U R E A U rd1ip16_03 16

Question 10A (continued) 

B. Software development 

INCLUDE: EXCLUDE: 

• Application development tools and 

environments 

• Applications software 

• Computer-aided design tools and 

methods 

• Computer systems software 

• Software programming or engineering 

used exclusively for internal company 

operations such as financial 

management or human resources 

C. Materials synthesis and processing 

Formulation and manipulation of new or improved materials using the data and techniques of science 

and engineering 

INCLUDE: 

• Advanced structural materials in the industrial machinery, medical, 

building, and construction industries 

• Higher performance semiconductors and photonic devices in the 

semiconductor industry 

• Ceramics and alloys designed to withstand extreme temperatures and 

stresses for use in engine and structural parts in the aerospace and 

automotive industries 

• Composite materials for use in sporting goods 

• New and significantly improved synthesis and production techniques for 

existing materials 

D. Other areas 

Report the remainder of R&D costs so that the total for this question matches Question 4, line D, 

column 3. 
U S C E N S U S B U R E A U rd1ip17_03 17

Question 10B 

Question 10B asks for the nanotechnology proportion of the R&D expenditures provided in Question 

10A. 

For example, if about a fourth of your biotechnology R&D expenditures was devoted to 

nanotechnology projects, report 25% in Question 10B. 

Nanotechnology is the creation and utilization of materials, devices, and systems through the control 

of matter on the nanometer-length scale, that is, at the level of atoms and molecules in the range of 1 

to 100 nanometers. 

INCLUDE: 

• Materials and systems that exhibit novel and significantly 

improved physical, chemical, and biological properties; 

phenomena; and processes because of their size 

Question 11 

Question 11 covers R&D for each state location where your company has research and development 

laboratories or facilities.

It is not necessary to calculate separately individual assignments made outside the home state of a 

particular research staff. 

Question 12 

Question 12 covers R&D by type of energy source. 

The types of R&D projects that are included: 

INCLUDE: 

• R&D to increase energy resources or capabilities 

• Development of energy equipment 

• Products and processes for exploration, extraction, transportation, 

processing, storage, generation (including conversion), 

distribution, conservation 

• Present, new, or improved forms of energy 

How to estimate if the project is for joint or multiple purposes 

Estimate the portion of the cost incurred for energy purposes. 

Include the total cost of the R&D energy spending if the primary purpose of the project is energy R&D 

and costs cannot be apportioned. 

Exclude costs if the project is not primarily for energy research and development and the costs cannot 

be apportioned. 
U S C E N S U S B U R E A U rd1ip18_03 18

Question 12 (continued)

What is included for each type of energy: 

Type of energy INCLUDE: 

Nuclear • Fission and fusion 

Fossil fuels • Oil 

• Gas 

• Shale 

• Coal 

– Including synthetic fuels designed to 

convert coal to gaseous and liquid 

products 

– Including equipment and techniques 

to improve the productivity and 

recovery rates of coal mining 

Geothermal and solar • Geothermal heat pumps 

• Geothermal power plant generators 

• Photovoltaic technology 

• Solar water-heating systems 

All other energy sources • Conservation and utilization R&D to 

reduce consumption either at the point 

of energy use or in the transmission, 

transportation, storage, and conversion 

of energy including such activities as: 

– Reduce fuel consumption in 

manufacturing 

– Improve the efficiency of 

transportation of energy products 

– Produce an end product that is more 

efficient in energy consumption 

• Wind, waste, hydroelectric 

• Other energy R&D that cannot be 

classified above 
U S C E N S U S B U R E A U rd1ip19_03 19

Question 13 

Question 13 covers your share of R&D expenditures funded by company and other nonfederal sources 

for collaborative R&D by type of R&D partner. These joint activities may or may not be organized as 

alliances, partnerships, or joint ventures. 

INCLUDE: EXCLUDE: 

• Activities performed jointly with other 

organizations including legally distinct 

business units, universities, government 

agencies, or nonprofit organizations 

• Alliances 

• Partnerships 

• Joint ventures 

• Purchasing, funding, or financing 

relationships that do not involve 

joint or collaborative R&D 

Definitions of types of R&D partners 

For-profit companies A company that is organized to pursue 

profit

Federal laboratories An organization of the U.S. government 

Universities and colleges A degree-granting institution of higher 

learning, having facilities for teaching and 

research 

Other nonprofit organizations An organization that is not organized to 

pursue profit. However, universities and 

colleges are reported in another category. 

Question 14 

Question 14 asks for information on the time period that your survey responses cover. It also asks 

about your company organization. 

Question 15 

Question 15 provides space for your contact information. Please give the name and telephone number 

of the person in your company to contact regarding this report. 

Remarks 

The Remarks section provides space for your comments and explanations. 

WARNING CONCERNING ELECTRONIC MAIL: The Internet is not a secure means of transmitting 

information unless it is encrypted. If you choose to communicate with the Census Bureau via 

electronic mail, the Census Bureau cannot guarantee the privacy of the information while transmitted, 

but will safeguard it in accordance with Title 13. Be advised that making inquiries regarding this survey 

via electronic mail may divulge your participation in this survey. 
U.

S.

DEPARTMENT OF COMMERC

E

BUREAU OF THE CENSUS

U.S. DEPARTMENT OF COMMERCEEconomics and Statistics AdministrationU.S. CENSUS BUREAUFORMRD-1 (02-13-2004)

2003 SURVEY OF INDUSTRIAL RESEARCH AND DEV

OMB No. 

Mail yourcompleted form to

U.S. CENSUS BUREAU1201 East 10th StreetJeffersonville, IN 47132-0001

Please read the accompanying instructions before answering thequestions.Need help or have questions about filling out this form?Visit our Web site at www.census.gov/econhelp/rdTo speak with an analyst, call 1-800-851-2014, option "0" between8:00 a.m. and 5:00 p.m., Eastern time, Monday through Friday.

- OR -

Write to the address above. Include your 11-digit IdentificationNumber (ID) printed in the mailing address.

YOUR RESPONSE IS REQUIRED BY LAW. Title 13, United StatesCode, requires businesses and other organizations that receive thisquestionnaire to answer the questions and return the report to theU. S. Census Bureau. By the same law, YOUR CENSUS REPORTIS CONFIDENTIAL. It may be seen only by persons sworn touphold the confidentiality of Census Bureau information and maybe used only for statistical purposes. Further, copies retained inrespondents' files are immune from legal process.

You will satisfy the mandatory reporting requirements for this surveyif you answer 2 , lines A and B; 4 , line D, columns (1) and (3); and 11,

columns (1) and (2).

Name of person who supplied 2002 data

(Please correct any errors in this mailing add

Except as noted, this report covers your entire consolidated domestic enterprise, including all U.S. subsidiaries, affiliatReasonable estimates are acceptable.

1 Was this company owned or controlled by another company on December 31, 2003?

001 Yes - See instructions. No - Go to 2 .

HOW TO REPORT DOLLAR FIGURES Dollar figures should be rounded to thousands of dollars.

If a figure is $1,025,628.79: Report

$ 

2

A. What was the amount of your company's domestic sales, shipments, operating receipts, or revenues, net of returns

and allowances? (EXCLUDE domestic intracompany transfers and sales by foreign subsidiaries. INCLUDE receiptsfor sales of products and services provided to other companies, individuals, U.S. Government agencies, and foreigncountries.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102

$ 

B. How many employees worked in the United States for your company on March 12, 2003? (Include number of fulland part-time employees whose payroll was reported on Internal Revenue Service Form 941, Employer's Quarterly

Federal Tax Return.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112
Form RD-1 (02-13-2004) 

3 What was the number of full-time equivalent (FTE) scientists and engineers employed by your company as of

January 1, 2004 who worked on the following types of R&D?(See instructions for the definition of FTE scientists and engineers.)

Janu

Num

A.B.C.

Federally-funded R&D . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Nonfederal R&D funded by your company and other nonfederal sources . . . . . . . . . . . . . . . . . . .TOTAL (Sum lines A and B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

204205206

4 What was the cost of R&D performed within

your company in the 50 United States and D.C.?(Please report R&D performed for each sourceof funding.)A. Basic research (Research for the

advancement of scientific knowledgewithout specific immediate commercialobjectives.) . . . . . . . . . . . . . . . .

2003

Federal funds Company and other Total (Columns (1)+(2))

(1) (2) (3)

$ Bil. Mil. Thou. $ Bil. Mil. Thou. $ Bil. Mil. Thou.

Federal funds 

(4) 

$ Thou. 

304 305 306

B. Applied research (Research directed

primarily towards a specific commercial orpractical objective.) . . . . . . . . . . . . .

314 315 316

C. Development (Activity translating research

into new or improved goods, services orprocesses.). . . . . . . . . . . . . . . . .

324 325 326

D. TOTAL (Sum lines A through C) . . . . . .

344 345 346

5 For 2004 what is your projected cost for company-funded R&D

performed by your company in the 50 United States and D.C.?(Comparable to the 2003 figure reported in 4 , line D, column

(2).) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 401

2004

$ Bil. Mil. Thou.
If not shown, please enter your 11-digit Identification

Number (ID) from the mailing address.

Form RD-1 (02-13-2004) 

6 A. What was the cost of R&D performed by

others for your company in the 50 UnitedStates and D.C.?(Please report R&D performed for eachsource of funding.) . . . . . . . . . . . . .

2003

Federal funds Company and other Total (Columns (1)+(2))

(1) (2) (3)

$ Bil. Mil. Thou. $ Bil. Mil. Thou. $ Bil. Mil. Thou.

Federal funds 

(4) 

$ Thou. 

354 355 356

B. What was the cost of company-funded R&D performed by

others for your company in the 50 United States and D.C. bythe following types of organizations?1. For-profit companies . . . . . . . . . . . . . . . . . .2. Universities or colleges . . . . . . . . . . . . . . . . .3. Other nonprofit organizations . . . . . . . . . . . . . .4. TOTAL (Sum lines 1 through 3. The sum should equal

the total reported in line A, column (2).) . . . . . . . . .

Key

code

8

2003

(1)

$ Bil. Mil. Thou.

2002

(2)

$ Thou.

11213141
Form RD-1 (02-13-2004) 

7 A. What was the cost of your company-funded R&D performed

outside of the 50 United States and D.C. by your subsidiaries,affiliates, or branches, or by other organizations in which yourcompany owns the following percentages of voting stock orequivalent interest?1. 0%. . . . . . . . . . . . . . . . . . . . . . . . . . . 3632. More than 0% but less than 10%. . . . . . . . . . . . . 3643. 10%-50% . . . . . . . . . . . . . . . . . . . . . . . . 3654. More than 50% . . . . . . . . . . . . . . . . . . . . . 3665. TOTAL (Sum lines 1 through 4.). . . . . . . . . . . . . 369

2003

Company and

other

(2)

$ Bil. Mil. Thou.

2002

Company and

other

(5)

$ Thou.

B. What was the cost of your company-funded R&D that was

performed outside the 50 United States and D.C. by yoursubsidiaries, affiliates, or branches, or by other organizationsin which your company owns more than 50% of the votingstock or equivalent interest in the following countries andPuerto Rico?1. Canada. . . . . . . . . . . . . . . . . . . . . . . . .2. Germany . . . . . . . . . . . . . . . . . . . . . . . .3. France . . . . . . . . . . . . . . . . . . . . . . . . .4. Japan . . . . . . . . . . . . . . . . . . . . . . . . .5. United Kingdom . . . . . . . . . . . . . . . . . . . .6. Puerto Rico. . . . . . . . . . . . . . . . . . . . . . .7. Other - Specify

1209

8. TOTAL (Sum lines 1 through 7. The sum should equal

the amount reported in line A4.) . . . . . . . . . . . . .

Key

code

12

2003

(1)

$ Bil. Mil. Thou.

2002

(2)

$ Thou.

0102030405060710
If not shown, please enter your 11-digit Identification

Number (ID) from the mailing address.

Form RD-1 (02-13-2004) 

8 What was the cost of the Federally-funded R&D your company

performed in the 50 United States and D.C. for each of theseFederal agencies?A. Department of Defense (DoD). . . . . . . . . . . . . . . .B. National Aeronautics and Space Administration (NASA) . . .C. Department of Energy (DOE) . . . . . . . . . . . . . . . .D. Other Federal agencies . . . . . . . . . . . . . . . . . . .E. TOTAL (Sum lines A through D. The sum should equal the

total reported in 4 , line D, column (1).) . . . . . . . . . . .

Key

code

5

2003

(1)

$ Bil. Mil. Thou.

2002

(2)

$ Thou.

1121314151

9 What was the cost relating to the total R&D performed within

your company in the 50 United States and D.C. for the followingtypes of expenses?A. Wages and salaries of R&D personnel

Key

code

6

2003

(1)

$ Bil. Mil. Thou.

2002

(2)

$ Thou.

B.C.D.E.F.

(Include scientists and engineers, technicians, secretaries,and other personnel.) . . . . . . . . . . . . . . . . . . .Fringe benefits of R&D personnel(Include taxable and nontaxable benefits, 401K plans,employers' contribution to health plans.) . . . . . . . . . .Materials and supplies consumed(Include the cost of all purchased materials consumed.) . . .Depreciation on R&D property and equipment(Include depreciation and amortization costs for property andequipment used for R&D during the year.). . . . . . . . . .All other R&D expenses(Include R&Ds share of company overhead and otherexpenses such as utilities, books and periodicals, andproperty and other taxes.) . . . . . . . . . . . . . . . . .TOTAL (Sum lines A through E. The sum should equal thetotal reported in 4 , line D, column (3).) . . . . . . . . . . .

112131415161
Form RD-1 (02-13-2004) 

10 A. What was the cost relating to total R&D performed within

your company in the 50 United States and D.C. for thefollowing types of technologies?1. Biotechnology (The use of scientific and engineering data

and techniques for the study and solution of problemsconcerning living organisms.) . . . . . . . . . . . . . .

2. Software development (The formulation of programs,

applications, routines, etc., for computers, excludingthose used exclusively for internal company operations.)

3. Materials synthesis and processing (The use of scientific

and engineering data and techniques for the formulationand manipulation of new materials.). . . . . . . . . . .

4. Other areas . . . . . . . . . . . . . . . . . . . . . .5. TOTAL (Sum lines 1 through 4. The sum should equal

the total reported in 4 , line D, column (3).) . . . . . . .

Key

code

7

2003

(1)

$ Bil. Mil. Thou.

2002

(3)

$ Thou.

1121314151

B. What percentage of the R&D costs reported in 10A are

attributable to nanotechnology for each of the followingtypes of technologies?

(Nanotechnology is defined as the creation and utilization ofmaterials, devices, and systems through the control of matteron the nanometer scale, at the level of atoms and moleculesin the range of 1 to 100 nanometers.)1. Biotechnology (The use of scientific and engineering data

and techniques for the study and solution of problemsconcerning living organisms.) . . . . . . . . . . . . . .

2. Software development (The formulation of programs,

applications, routines, etc., for computers, excludingthose used exclusively for internal company operations.) .

3. Materials synthesis and processing (The use of scientific

and engineering data and techniques for the formulationand manipulation of new materials.). . . . . . . . . . .

4. Other areas . . . . . . . . . . . . . . . . . . . . . .

Key

code

7

2003

(2)

Whole

percents

2002

(4)

Whole

percents

11 % %21 % %31 % %41 % %
If not shown, please enter your 11-digit Identification

Number (ID) from the mailing address.

Form RD-1 (02-13-2004) 

11 What was the cost of the R&D your company performed in each of the fifty States and the District of Columbia?

(Please report R&D performed for each source of funding.)

Key code

9

State

2003

Federal funds Total funds

(1) (2)

$ Bil. Mil. Thou. $ Bil. Mil. Thou.

2002

Federal funds Total funds

(3) (4)

$ Thou. $ Thou.

Key code

9

State

2003

Federal funds Total funds

(1) (2)

$ Bil. Mil. Thou. $ Bil. Mil. Thou

01 AL 19 LA02 AK 20 ME03 AZ 21 MD04 AR 22 MA05 CA 23 MI06 CO 24 MN07 CT 25 MS08 DE 26 MO09 DC 27 MT10 FL 28 NE11 GA 29 NV12 HI 30 NH13 ID 31 NJ14 IL 32 NM15 IN 33 NY16 IA 34 NC17 KS 35 ND18 KY 36 OH

CONTINUE WITH 11 ON PAGE 8
Form RD-1 (02-13-2004) 

11 What was the cost of the R&D your company performed in each of the fifty States and the District of Columbia?

(Please report R&D performed for each source of funding.) - Continued

Key code

9

State

2003

Federal funds Total funds

(1) (2)

$ Bil. Mil. Thou. $ Bil. Mil. Thou.

2002

Federal funds Total funds

(3) (4)

$ Thou. $ Thou.

Key code

9

State

2003

Federal funds Total funds

(1) (2)

$ Bil. Mil. Thou. $ Bil. Mil. Thou

37 OK 45 UT38 OR 46 VT39 PA 47 VA40 RI 48 WA41 SC 49 WV42 SD 50 WI43 TN 51 WY44 TX

TOTAL (Sum of lines 1 through 51. The sum should equal the totals reported in 4 , line D,

columns (1) and (3).) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

954

12 What was the cost of the energy-related R&D your company

performed in the 50 United States and D.C. during 2003?(Include the portion of project cost incurred for the purpose ofincreasing energy resources or capabilities for each source offunding. These expenditures should also be included as part ofthe information reported in 4 , line D, columns (1) and (3).)

Key

code

10

2003

Federal funds Total funds

(1) (2)

$ Bil. Mil. Thou. $ Bil. Mil. Thou.

2

Federal funds 

(3) 

$ Thou. 

A.B.C.D.E.

Nuclear . . . . . . . . . . . . . . . . . . . . . . . . . .Fossil fuels . . . . . . . . . . . . . . . . . . . . . . . .Geothermal and solar . . . . . . . . . . . . . . . . . . .All other energy sources . . . . . . . . . . . . . . . . . .TOTAL (Sum lines A through D) . . . . . . . . . . . . . .

1121314151
If not shown, please enter your 11-digit Identification

Number (ID) from the mailing address.

Form RD-1 (02-13-2004) 

13 What was the cost of the R&D performed by your company in

the 50 United States and D.C. company-funded in collaborationwith the type of R&D partner listed below?(These expenditures should also be included as part of theinformation reported in 4 , line D, column (2).)

Key

code

11

2003

(1)

$ Bil. Mil. Thou.

2002

(2)

$ Thou.

A.B.C.D.E.

For-profit companies . . . . . . . . . . . . . . . . . . . .Federal laboratories . . . . . . . . . . . . . . . . . . . .Universities or colleges. . . . . . . . . . . . . . . . . . .Other nonprofit organizations. . . . . . . . . . . . . . . .TOTAL (Sum lines A through D) . . . . . . . . . . . . . .

0102030410

14 A. Do the R&D expenditures reported on this form cover the entire fully consolidated enterprise, including all subsidiaries, affilia

50 United States and D.C.? (Mark "X" only ONE box.)1301 Yes

No - Please explain in the "REMARKS" section.

B. Was your company publicly or privately owned? (Mark "X" only ONE box.)

1302 Publicly owned

Privately owned

C. Other than the parent company, how many subsidiaries, affiliates, or branches located in the 50 United States and D.C. owne

(by means of voting stock or other equivalent interest) are included in this report? (Mark "X" only ONE box.)1303130413051306

None12-5More than 5

D. Other than the parent company, how many subsidiaries, affiliates, or branches located outside the 50 United States and D.C. 

company (by means of voting stock or other equivalent interest) are included in this report? (Mark "X" only ONE box.)1307130813091310

None12-5More than 5
Form RD-1 (02-13-2004) 

14 E. What percent of your company was owned or controlled (by means of voting stock or other equivalent interest) by one or mo

50 United States and D.C.? (Mark "X" only ONE box.)131113121313

0%More than 0% but less than 10%10%-50%

1314 More than 50%

F. What percent of your company was owned or controlled (by means of voting stock or other equivalent interest) by one or mo

the 50 United States and D.C.? (Mark "X" only ONE box.)13151316

0%More than 0% but less than 10%

13171318

10%-50%More than 50%

15 CONTACT INFORMATION

Is the time period covered by this report a calendar year?

0078 Yes 0079 No - Enter time period covered FROM 0070

Month Year

TO 0071

Month 

0072 Name of person to contact regarding this report 0073 Title

Telephone 0074

Area code Number Extension

-

Fax 0075

Area code Number

-

0076 Internet e-mail address

Datecompleted 0069

REMARKS (Please use this space for any explanations that may help us in understanding your reported data.)

Thank you for completing your 2003 SURVEY OF INDUSTRIAL RESEARCH AND DEVE

PLEASE PHOTOCOPY THIS FORM FOR YOUR RECORDS AND RETURN THE ORIGINA