Recent R&D Investments by Foreign Chemical and Pharmaceutical Corporations in Japan Michael L. Riordan Foreign Corporations Group International Loan Department The Industrial Bank of Japan Tokyo 25 duly 1986Abstract During the past two years, several foreign chemical and pharmaceutical companies have initiated major R&D programs in Japan. This report (i) describes the R&D investments currently being made by these companies; (ii) discusses the rationales behind these investments, and their accompanying perceived benefits and drawbacks; (iii) reviews various approaches that these companies have used in implementing their R&D programs in Japan; and (iv) gives a preliminary assessment of how well some of these R&D programs are faring. The report is based primarily on interviews with executives of Japanese subsidiaries of foreign companies, industry observers, and members of the Industrial Research Department of the Industrial Bank of Japan.II. III. Iv. vi. VII. VIII. Table of Contents Introduction Rationales for Investing in Japan-based R&D Reservations and Potential Drawbacks Methods of Implementing Japan-based R&D Programs Preliminary Assessments of R&D Implementation Conclusions Exhibits Acknowledgments Page Page Page Page Page Page Page Page 1 3 14 16 22 23 26 30I Introduction Several foreign pharmaceutical and chemically-related companies have in the past two years announced substantial capital investments in Japan-based research and development. Chief among these are Du Pont, which is establishing a new technical center in Yokohama at a cost of ¥16 billion; Upjohn, which is investing ¥14 billion in a research facility at Tsukuba "Science City"; Eastman Kodak, which is committing ¥10 billion to new R&D and product development labs; and Ciba-Geigy, which will be spending ¥9 billion to expand its R&D program. other companies have also announced substantial new investments in R&D, as noted in Exhibit 1,* and there are indications that additional foreign firms will be making R&D investments in Japan in the near future. Although foreign computer and electronics companies such as DEC, IBM and Texas Instruments have long had technical development labs in Japan, the recent initiatives by pharmaceutical and chemically-related companies represent a qualitative and quantitative expansion in foreign corporations’ overall commitment to Japan-based R&D. Japan's technological preeminence in many fields and its key positioning in the Asia-Pacific region, which many multinational companies regard as the major area for growth in the coming decades, make it an attractive R&D location for firms in numerous industries. In particular, several recent trends in the pharmaceutical and chemical industries have made it imperative that multinational companies in these lines of business consider expanding R&D capabilities in Japan. (Sales figures for most of the companies under discussion appear in Exhibits 2 and 3.) * Exhibits are at the end of the text.Advances in materials science, polymer chemistry and biotechnology, as well as the increasing connection between chemicals and electronics, have raised new opportunities and threats for both pharmaceutical and chemical companies. Japan has been and is likely to be a source of many of these advances, and is the home of sophisticated end-users whose demands often drive technical refinement and innovation. Thus the many chemical companies that are now actively trying to diversify out of commodities and further into high-performance materials ana electronics-associated chemicals have a particularly strong incentive to have a technical development capacity in Japan, where these fields are advancing most rapidly. So far most of the R&D by foreign chemical companies in Japan has been almost exclusively applications work and product development aimed at responding to customer needs; however, some of these companies indicate that their activities in the future may extend further into the basic research end of the R&D spectrum. In pharmaceuticals, severe cuts in standard drug prices by the Ministry of Health and Welfare have severely pinched margins, sharply increasing the incentive to more rapidly generate new drugs, which are usually granted higher prices by the government regulators. Thus many foreign pharmaceutical companies which originally established development labs and clinical testing capacity in the 1960s and '70s -- to satisfy government requirements for local testing of new drugs -- now have an incentive to boost new drug development within Japan by increasing R&D capabilities here. The size of the Japanese pharmaceutical market, second only to that of the U.S., and the relatively low penetration of that market by foreign companies give additional importance to choosing an effective R&D strategy in Japan.II. Rationales for Investing in Japan-based R&D Executives of foreign corporations interviewed for this report noted several possible advantages to locating R&D facilities in Japan. Their relative emphases varied greatly from company to company, as did the exact nature of the "R&D" involved. For many firms, RsD often implies technical service or product modification labs, as opposed to technology development or fundamental research; therefore, in the following discussion of rationales, some attempt will be made to delineate basic research, development and technical service. Among the potential reasons for establishing or expanding R&D in Japan are the following: To improve responsiveness to customers Technical service and new product development capabilities within Japan are clearly advantageous to many chemical companies, whose Japanese customers often demand product changes, unique specifications and high tolerances to a degree not found in other markets. In many instances such capabilities are essential; to quote one American chemical company executive, "If we didn't have tech service labs, we wouldn't have sales." Not only do new product development labs help keep customers happy; they also help keep the foreign chemical company up to speed with the dynamic technologies employed by their customers, which in many cases are world leaders. For example, Du Pont and other companies that supply engineering plastics to leading-edge automobile and electronics manufacturers in Japan obviously are induced to stay on the leading edge of their respective product fields if they have labs that can respond to increasingly sophisticated customer requests. There are numerous examples, in fact, of joint customer-supplier development of new technologies and products in such circumstances.Following similar reasoning, Monsanto is locating an R&D facility for wafer fabrication in Japan because that is where the major share of the global silicon market is expected to remain, and because some of the technology Monsanto is pursuing derives from Japanese R&D; for instance, it is investigating magnetic crystal pulling techniques licensed from Sony. Likewise, there can be spillover into other markets from staying on top of new product development in Japan. A U.S manufacturer of printing inks, for example, was prompted by customer demands to develop in its Japanese labs new inks with higher performance than have heretofore been used in Furope and the U.S.; consequently the company is in a position to offer higher quality products in those markets as well as in Japan. It is considerably more difficult to apply the "staying close to your customers" analogy to pharmaceutical R&D, but some parallels do exist. For example, refining formulation technologies to stay ahead of the meticulous physicochemical standards met by most pharmaceutical producers in Japan may yield superior manufacturing methods applicable elsewhere. Also, there are substantive differences in medical practice in Japan vis-a-vis other countries, such as heavier prescribing of antibiotics and more extensive use of intravenous plasma products, that imply that advantages may accrue to those companies which are able to innovate locally. on balance, however, “improving responsiveness to customers" is not a powerful incentive for locating primary R&D in Japan, since the ultimate "customer," basic human physiology, varies relatively little across races-- differences in local disease patterns notwithstanding. To monitor and maintain access to new technologies Virtually all the interviewees for this report cited technology monitoring as a major benefit of local R&D. Company scientists and engineers within Japan can become part of the local scientific and industry circles, attending conferences building contacts, and receiving word of new technologicaladvances before they would otherwise have been detected. In addition, if an interesting technology is identified, in many cases a collaborative project or licensing agreement will only go forward if there is a pre-existing relationship among the pertinent researchers, and such relationships are much easier to establish if there are company researchers within Japan. According to one executive, "You simply must have R&D people based in Japan to have the access you want to new technologies." The specific scientific fields in which Japanese firms and research institutions were thought by foreign chemical companies to have promising technologies, and which therefore warranted particular attention, included: - special polymers, including photosensitive materials, optical storage media and optoelectronics generally (in the words of one R&D manager, "optical storage happens in Japan"); engineering plastics; synthetic membranes; and industrial films; - silicon chemistry and wafer fabrication technology ~ fine ceramics, including both integrated circuit packages and structural uses; high performance composites; - biotechnology, particularly cell culturing and fermentation, bioprocess engineering, biosensor technology and enzyme technology ("Japan is the cradle of enzyme science; 70 to 75 percent of all enzyme-related patents are Japanese," states one R&D executive); - technologies that complement chemical manufacturing or chemically-related products, such as high-precision process control, or hardware and software for digital processing, e.g. of images. Having an R&D staff within Japan may also help foreign companies become "part of the club" when industry research associations or consortia are formed. For example, Roche and 5DEC recently became members of a newly established Protein Engineering Research Institute, a joint research program partially funded by the Japanese government, with at least seven other Japanese companies on its roster. Having substantial R&D programs already in place in Japan no doubt put them in a better position to participate; as reported by one business journal, "The two companies were approved to join the research company, as they have subsidiaries as well as research centers in Japan." One other European chemical company was invited to participate in the Institute, which is to have its own laboratory, 60 researchers and a ¥30 billion budget over eight years; however, the company declined because of its involvement in a similar program in the united Kingdom. Some foreign companies look to the large research complex being developed at Tsukuba as a route toward integrating into Japan's technology infrastructure, and in fact the Tsukuba district has been especially attractive to the chemical and pharmaceutical industries. 19 companies, or 70% of the firms that have decided to establish labs at Tsukuba, are in chemicals and pharmaceuticals; two of these are foreign: ICI and Upjohn. According to an R&D executive of a large U.S. chemical company that does not have facilities in Tsukuba, "having a lab there and relationships with National Labs [sponsored by the government] would give us much better technology aécess." Some companies are especially eager to tap into research areas to which the Japanese government has decided to give special funding and technical support, such as certain fields within biotechnology and special materials. This phenomenon naturally raises an interesting question as to whether a foreign company with a local R&D presence can itself ride on the coattails of the government-sponsored industrial "targeting" that Japan in the past has been noted for.To utilize a large pool of well-educated, dedicated researchers Many companies cited this is as a significant attraction, noting that there is an enormous reservoir of talent in Japan that on average may work more diligently than workers in other countries. ‘The workforce in general has an exceptionally high level of training in the sciences through high school and college; and graduate scientific and engineering training in Japan, although less prevalent than in the U.S. or Europe, was given very high marks by most interviewees. In addition, one R&D director noted the tendency of Japanese researchers, especially at the applications stage of R&D, "to always try one more time, and not give up" in attempting to solve laboratory problems; several other interviewees conveyed similar impressions. Even at the basic research end of the R&D spectrum, which Japan has been faulted for deemphasizing in favor of applications-oriented R&D, there are indications that Japanese researchers are on a par with those in the U.S. and Europe. For example, a U.S. commercial officer investigating biotechnology in Japan notes that a survey on molecular biology research showed that scientific journal reports from Japanese labs are cited in the international research literature about one-eigth as frequently as reports from U.S. labs. (Frequency of citation is an indication not only of volume of report output, but also of quality or importance of that output.) Bearing in mind that Japan spends between one-sixth and one-tenth as much on molecular biology research as the U.S., it appears that there is at least rough parity in basic research productivity per unit of funding in the two countries. Other characteristics of the technical workforce that are attractive to foreign companies are those which allow the company to diversify, in a qualitative way, its approach to R&D. For example, one R&D executive suggested that the team approach to R&D common in Japan might provide a good complementto the more individually-oriented RsD in the U.S. and Europe. This team-orientation also may contribute to the frequently oberserved swiftness of many Japanese companies in designing and developing new products-- clearly another attribute that many foreign companies hope to harness. A few interviewees said they anticipated additional diversification advantages due to other, more abstract aifferences in how problem-solving is performed in Japan. As one executive tried to express it, "if we were to merely add more staff to our central R&D [rather than establishing research labs in Japan], it would simply be adding more of the same in terms of types of scientific approach." In some instances, foreign companies locating R&D in Japan may be seeking to benefit from specific types of technical expertise among the workforce. In pharmaceuticals, for example, a few executives noted that drug formulation and manufacturing technologists in Japan achieve greater quality and consistency in drug preparations. Also, Japan has had longstanding excellence in antibiotic chemistry that some firms have tapped into via local labs. And in certain fields pertinent to biotechnology, such as large-scale fermentation and biochemical processing of food, Japanese engineers have a considerable experience base that is of interest to some foreign companies. A more general expertise, cited by many interviewees, is the superior ablility of Japanese researchers and engineers to make "zero-failure" manufacturing processes and ultrafine methods of process control. To signal long-term commitment to the Japanese market A substantial fixed investment in RspD facilities can assure customers of long-term, reliable supplies, and demonstrate a willingness to meet special requirements of individual client firms; both of these are of course hallmark criteria for doing business effectively in Japan, Likewise, such an investment can be further assurance to the company'semployees --in technical positions as well as other functional areas-- of job security, another vital ingredient for establishing and building a subsidiary in Japan. As one vice president put it, "commitment to basic R&D in Japan is the final stage of corporate commitment to this market, and will change how people view us; they will know we're not just a temporary company." So potentially useful is this signal that some foreign companies have tried to capitalize on it prematurely; at least two foreign pharmaceutical companies have in the last year made announcements of impending "research institutes" or "major new R&D facilities" that have not received any detectable follow-up. The president of a foreign pharmaceutical company described the phenomenon in this way: "It's sort of a fashion now to announce new R&D; many companies overlooked Japan, and now that it's booming, they ask, ‘where are we?! and then try to rush in.” To facilitate regulatory approval for new products There was disagreement among the interviewees on this point. In chemicals, having a local R&D capability beyond the bare minimum required for standard new compound testing generally was not felt to ease the passage of new products through regulatory channels a priori; however, some interviewees felt that in the event a new compound became held up in the registration process, having technical people available to immediately respond would be advantageous. In pharmaceuticals, the initial incentive for foreign companies to set up laboratories in Japan was the introduction of local testing requirements by the government in the late 1960s. Such laboratories generally were far from full-spectrum RsD labs, and instead merely performed routine preclinical testing and supported clinical trials. The recent relaxation of some of these regulations, which now generally accept foreign data for stability, toxicology and pharmacologytesting, and some reference clinical data, have if anything reduced the benefits of having sizable facilities for such routine testing in Japan, when duplication can be avoided by performing it one central facility. In addition, many in the industry expect further standardization of preclinical and clinical testing requirements in different countries, and increasing acceptance of data between industrialized countries, including Japan. A more salient advantage related to regulatory approval, which was cited by several pharmaceutical executives, is the added ability of a pharmaceutical company having well-established, high-caliber, Japan-based R&D to attract respected clinical investigators at Japanese medical institutions. These clinical investigators play a key role in documenting the clinical usefulness of new drugs, and in establishing new therapies as standaré medical practice in Japan. Several interviewees pointed out that the primary criterion by which clinical investigators choose new drugs to evaluate is of course the intrinsic merit of the active substance; however, the back-up technical support and prestige offered by a high-quality, local R&D program was acknowledged to be a positive consideration as well. Another potential advantage of local pharmaceutical R&D stems from the perception that in some therapeutic areas, the Japanese Ministry of Health and Welfare is more liberal than, the U.S. in granting registration; in particular, Japan is seen by some in the industry as more lenient in approving new agents for the treatment of cancer, senility and liver disorders. In Japan, the criteria for new drug approval focus on safety, whereas the U.S. FDA requires proof of both safety and efficacy. Thus it may be possible to introduce new drugs in selected areas more readily in Japan. If in fact true, this may or may not ultimately be an advantage; on the one hand, earlier approval in Japan may help a multinational company position a new product for later entry into other markets; on the other hand, if liberal approval in Japan is not followed by 10approval in the U.S. or Europe, the foreign pharmaceutical company may be stuck with high development costs for a drug it can only sell to a portion of the world market. In the agricultural chemicals field, to test products on indigenous crops Development of products such as rice herbicides, intended for East Asian markets, is best performed in a lab with ready access to soil conditions, climate and farming practices under which those products will ultimately be used, so certainly Japan is a likely candidate; given Japan's scientific superiority in Asia, it is generally the preferred lab location among the major agricultural chemical companies. While it is obvious that field testing for the Asian agricultural market requires some sort of regional site, it is not by any means obvious how much of the R&D supporting the field testing should be adjacent to it. Thus only recently have several large agricultural chemical (ag chem) companies started or augmented their R&D programs in Japan, and some of these are still struggling with the issue of how much basic research to position in Japan. For example, currently there is considerable internal dispute in one foreign chemical company as to whether capabilities in new chemical synthesis --the earliest stage in conventional ag chem should be added to their existing later-stage capabilities in biological evaluation, environmental sciences ané formulation chemistry. research: The president of another chemical company that does not have local R&D facilities suggests that wholly-owned biological testing capability in Japan would circumvent the difficulties that arise when a foreign company asks a Japanese ag chem firm to do biological screening on its behalf; often in such cases the Japanese company tacitly expects to be given some portion of the marketing rights to resultant products, which the foreign corporation may in the end be reluctant to concede, but forced to accept in order to avoid friction. 11Among the companies that have recently augmented their ag chem R&D in Japan are Dow, Monsanto and Hoechst; and other interviewees are considering a similar move in two to three years. Said one company president, "as for the other foreign companies, if they don't have R&D here yet, they will get it.” To capitalize on potentially lower RED costs Despite a wide range of opinions on this subject, on balance, most interviewees thought the overall cost of doing R&D in Japan was moderately lower than the cost in the U.S., and on a par with the cost in Europe, at least until the recent dramatic appreciation of the yen. Only in two instances was a perceived lower cost a significant factor in deciding to place R&D facilities in Japan; however, for a few other companies it was a secondary factor in the decision. Notably, except for acknowledging the extremely high cost of real estate in and near Tokyo, no observers considered overall R&D costs to be higher in Japan than in the U.S. or Europe. Of course estimations of the "cost of R&D" are elusive, since it is difficult to reliably evaluate and compare the productivity of different R&D groups, and hence it is a difficult task to determine a cost per unit of R&D output. One vice president of a U.S. chemical company, however, stated that his company had estimated its U.S. fully-allocated R&D costs to be roughly $250,000 per research person, approximately twice the ‘cost they estimated for equivalent "results output" in their Japanese labs. They believed that much of the difference was attributable to lower salaries for mid-level scientists and a greater number of hours worked per lab member in Japan. Additional anticipated advantages included a greater propensity to build continuity in the lab's experience base, and the ability in Japan to infuse at a younger age and lower salary new technical staff directly from universities, who are then trained within the lab by very experienced staff. Although this estimation of equal results for half the 12cost is an extreme example, several other interviewees acknowledged that salaries for mid- and high-level R&D staff are considerably higher in the U.S. than in Japan. Costs for lab support staff, however, were seen to be higher in Japan. The marked appreciation of the yen in recent months has of course cast doubt on historical estimates of effective R«D costs for non-yen-based companies. Indeed, the Japanese Labor Ministry estimates that at an exchange rate of ¥160 to $1, average Japanese wages on a dollar basis are the world's highest. It is likely that any R&D cost differentials between Japan, the U.S. and Europe are smaller than the recent foreign exchange fluctuations, and thus lower cost is not a valid motive for locating long-term R&D facilities in Japan. To establish a firmer presence in the Asia-Pacific region Although already alluded to in the introduction, this reason was mentioned so often by interviewees that it bears repeating. For a majority of companies the Asia-Pacific region is one of the most important market growth areas, and in many cases is the single most important strategic region. A more solid base in Japan, including R&D, is regarded as not only essential for participating in the large Japanese market, but also as a launching point for greater participation in the promising markets of Korea, the People's Republic of China, Taiwan, Singapore, and Malaysia. With particular regard to bolstering overall corporate presence in Japan, some of the companies who have already invested heavily in Japan-based R&D suggested that there are preemption advantages to being among the first wave of companies to "take the plunge;" for example, it may be easier to secure Japanese R&D staff before, rather than after, other foreign companies start competing for personnel in an already tight market for skilled R&D people. Also, given the long lead time necessary to establish a strong corporate image in Japan ~-which is necessary to recruit effectively, as will be discussed later-- sooner may be better than later. 13III. Reservations and Potential Drawbacks Most of the reservations and potential drawbacks confronting foreign companies' establishment of RsD in Japan can be grouped into three categories: (i) concerns relating to centralization versus decentralization of R&D; (ii) expectations of difficulties in recruiting, managing and securing a Japanese R&D staff; and (iii) specific unfavorable trends in the Japanese market, particularly in pharmaceuticals. The classic dilemma in considering whether to set up more than one R&D facility --be they in different countries or the same country-- centers on the potential costs of duplication of effort. Many interviewees explicitly stated that duplication was a concern in setting up their R&D facilities ("we don't want to reinvent the wheel") and that this issue had been a stumbling block during internal corporate debate on whether to augment R&D in Japan. A related concern is that R&D requires a critical mass of equipment, facilities, support staff, and technical staff from several different fields in order to to be effective. Thus many companies are concerned as to just what this minimum threshhold commitment is, and whether it in fact is too costly. The most prevalent and severe concern foreign companies have is that they will be unable to recruit high-caliber technical staff and R&D managers. Certainly this has been painted as one of the most ominous hurdles by the business press, and there have been numerous reports of new foreign ventures coming up empty-handed in the face of the well-documented preference of the Japanese to work for large, established Japanese companies. This issue is especially acute in staffing for the basic sciences, where the reservoir of scientists with graduate or postgraduate training is relatively small On top of this is the concern of foreign companies that 14managing a new Japanese R&D staff is unfamiliar territory, and that there will be an inherent conflict between the customary seniority-based promotion system in Japan and the more performance-oriented style found in the U.S. and Europe. Another personnel issue that appeared in only one interview was that in deciding on what degree of technology disclosure to make to a Japanese subsidiary lab, one U.S. chemical company's headquarters had reservations about whether crucial, proprietary information would leak to competitors via the local R&D staff. In this instance, the decision was subsequently made to give unhindered disclosure to the technical staff in Japan. Notably, no company representatives --neither those with basic research labs nor those without-- expressed any concern over the alleged lesser propensity of Japanese scientists to think creatively. Most directly disagreed with this generalization, suggesting that creativity in Japanese R«D staffs is merely elicited in different ways. As alluded to previously, the ongoing cuts in standard drug prices by the health insurance payment regulators have cut pharmaceutical profitability considerably, raising the concern that if a foreign company's Japan-based R&D is targeted primarily toward the Japanese market, it may never reap an appropriate return, As an executive at a long-established foreign pharmaceutical company described it, the effect of the price cuts is "very bad; we won't have any immediate cuts in Red, but if the trend continues for two or three more years, it may cause troubles for doing R&D in Japan; but for the time being, we will continue to try to establish a stronger research base here." A final, more onerous reservation expressed by several executives was that the absolute newness of setting up an R&D facility in Japan was intimidating, and made it entirely uncertain whether they would succeed. And, knowing that any large R&D program in Japan must be a long-term commitment with attendant long-term employment obligations, the costs of failure are exceedingly high. 15IV. Methods of Implementing Japan-based R&D Programs Recruiting high-caliber Japanese staff is a major undertaking and is perceived as the most difficult aspect of establishing a new R&D center; thus the following discussion will focus on various approaches to recruiting, after which access to technology and logistical and organizational aspects of implementation will be briefly discussed. Recruiting Strong relationships with Japanese university faculty are especially valuable, if not indispensable, in hiring. Professors exert considerable influence on their student's job decisions, and if they have developed a confortable working relationship with a company, they are more likely to steer their better students toward it, Likewise, a new graduate is more likely to take the unconventional route to a foreign company if some measure of security is ensured by his professor's endorsement of the company and confidence in its long-term viability. Such relationships can be fostered through personal contacts of the company's senior staff, scholarship support to the university, invitations to visiting lecturers, and part-time consultancies. Another effective mechanism for maintaining close faculty relations, which is employed avidly by Japanese companies and is becoming more and more recognized as an essential tool by foreign companies, is direct funding of faculty research, usually on a no-strings-attached basis, but also for proprietary development. Direct donations to professors at national universities are generally limited to a maximum of ¥500,000 per “project;" for greater amounts the required government paperwork is too onerous. However, the limitations on the number and frequency of "projects" are not necessarily so clear-cut. 16Most of the interviewees whose companies had or were in the process of establishing R&D programs were already employing all of the above methods. Another source of R&D staff, outside the usual pool of new graduates and mid-level personnel at Japanese companies, is researchers and managers who face mandatory retirement in many Japanese companies at age 55, but who have many productive years and a great deal of experience yet to contribute; it is at this age, in fact, that their essential industry and academic contacts are probably most numerous. Also, many foreign companies are aggressively seeking Japanese scientists and engineers who have been training abroad, and who are probably more amenable to working for a non-Japanese company on their return home, and who may be more comfortable working in a more Western-style management framework. There are a considerable number of such students and trainees abroad; in 1983, for example, the U.S. National Institutes of Health alone had 158 Japanese enrolled in its "Visiting Program" and 32 in its "Guest Researchers Program." Another under-utilized source of well-trained staff is Japanese women who have received technical college or graduate training; the well-known male biases of Japanese industry make it difficult for even the brightest women science graduates to find meaningful R&D positions with Japanese companies, and hence they are more willing to consider foreign-based employers. Eight of the fourteen members of one foreign biochemical company's research staff are women, in fact. These alternative sources aside, the main targets for R&D hiring by foreign companies are male new-graduates and mid-level experienced personnel from local companies. What are the major reasons for their reluctance to join a foreign company? A major one of course is the relatively lower prestige and security that they think most foreign corporations are able to provide. In addition, many younger recruits are concerned that foreign companies may not offer the continuity and quality of in-house training that is a hallmark of many aqtechnology-oriented Japanese companies. Also, some potential hirees express reservations about American companies" reputations for not promoting R&D staff to the highest positions within the company, unlike Japanese companies, which they believe value more highly the managerial input of scientists and engineers. . There are numerous ways in which foreign pharmaceutical and chemical companies can respond to these reservations. ‘The first and most important is a long-term task: to build corporate recognition and image within Japan, thus affording new hirees more prestige; and to convince them of the company's commitment to Japan, thereby assuring them of more job security. One pharmaceutical executive was understandably pleased he could report to potential hirees that his company, even though American, had never laid off anyone in its 100-year history. Building national corporate image is of course an expensive endeavor, which several foreign companies are doing through advertisements in mass media, technical journals and student magazines. One major U.S. chemical company reported that it spends more on corporate image building in Japan than in the U.S., the main purpose being to increase reputability for recruiting. Affirmed one vice president, "We want them to know that we are going to be here forever." There are, in addition, some attractive features that foreign firms are in a better position to offer than Japanese companies. Greater flexibility in choosing R&D assignments; more freedom to initiate new projects; the opportunity to get in on the ground floor of a new R&D program that will offer more responsibility and in the near future will be promoting People to new department head positions; as well as a more merit-based promotion system-- these are often appealing to would-be technical staff at both the new-graduate and mid-career levels. Many domestic Japanese companies, faced with plateauing growth rates and rigid, seniority-based personnel structures are not able grant these benefits. 18Japanese scientists and engineers returning from abroad are particularly susceptibility to the greater autonomy in foreign R&D programs; returning to Japanese companies from post-doctoral positions in the U.S. or Europe, "these Japanese researchers often feel stifled; this is a pity... on the other hand, it's an opportunity for foreign companies," reports an R&D director at a European chemical company. Higher salaries are also frequently offered by foreign corporations, but this is rarely a major factor in a new recruit's decision to join. Another potential attraction for ambitious researchers is the chance to be part of and draw on a high-powered, global R&D network, which many multinational pharmaceutical and chemical companies can point to. Responding to concerns about in-house training programs, at least a few new entrants into Japan-based R&D have formulated comprehensive training sequences even before setting up shop. Monitoring scientific circles and promising technologies The typical approaches of being active in professional associations and scientific meetings, regularly inviting speakers, hiring professors as consultants, joining consortia and participating in joint technical review committees with Japanese companies, go a long way toward keeping on top of new developments, and most foreign companies with R&D staff in Japan are now quite facile in using these tools. In addition, several firms have staffs specifically assigned to keep track of new technologies; Dow Chemical, for example, has six senior managers in Tokyo who do this exclusively. And at least one chemical company has committed $3 million to a Japanese venture capital firm as a means of gaining access to new technologies arising in smaller Japanese companies. 19Logistics of setting up facilities and coordinating R&D Foreign companies have used a variety of approaches in coping with the logistics of site selection, identification of principal managers, general recruiting and equipment procurement. Some have gone it alone altogether, in every aspect from real estate to recruiting by many as extremely time consuming and exhausting. Most have an endeavor described instead used an assortment of consultants, headhunters, banks leasing agents and contractors, as well as government-sponsored support, such as that provided by MITI and prefectural governments. ‘There are no ready generalizations as to the methods of financing fixed R&D investments, as these have been through cash equity, local borrowing, foreign borrowing, and combinations of these, depending upon the cash flow status of the parent and the subsidiary As to the relationship between corporate R&D and that in the Japanese subsidiary, here too there is a diversity of approaches. In some instances, the Japan-based R&D is intended to be an integral part of the company's central R&D, reporting to it directly rather than to subsidiary management. This is often the case with Japanese pharmaceutical subsidiaries having considerable basic research capability. In other instances, particularly in product development labs, the R&D has a specific focus on the Japanese market and thus is quite disconnected from corporate R&D, although in these cases the companies usually maintain some cross-fertilization between headquarters and the subsidiary. As mentioned, most companies studiously try to avoid redundancy of research scope; however, for those involved in basic research this is necessarily difficult, and some firms in fact encourage some degree of redundancy, since there must be some common ground between researchers at headquarters and in Japan, “otherwise they won't be able to talk to each other.” 20ve Preliminary Assessments of R&D’ Implementation In general, most executives report that the difficulties in setting up RsD in Japan have not been as great as anticipated, and there is general satisfaction thus far with the productivity of Japan-based RsD. surprisingly few "negatives" arose in the interviews. Recruiting Recruiting of technical staff and principal managers has been slow in some cases, but most companies have been able to gradually build their image and recruit top-notch people. Some firms have in fact been able to do this quickly, based on their already established reputations internationally and within Japan. Du Pont, for example, has already noted an upsurge in interest from recruits since the announcement of its large technical center. This interest has been generated not only among applicants for R&D positions, but also among applicants in other functional areas. Du Pont estimates that over the past few years it has been able to increase its percentage of new-hires coming from top-tier Japanese universities from 20% to over 40%. Comments such as these were not uncommon: "We have not had that much difficulty staffing up our labs because of our company's strong name in Japan." “The people we've been able to get are outstanding; they impressed our R&D people back in the U.S. when they were there for training." “Compared to what we read about other foreign companies’ difficulties recruiting, we're doing extremely well." Of course such statements must be taken with a grain of salt because their sources are hardly unbiased, but nonetheless they reflect a general optimism that is somewhat unexpected. 21There were varying responses as to which types of personnel were easier to recruit: experienced staff versus new graduates. Most, however, indicated it was easier to hire experienced personnel, rather than new graduates, since the latter are more susceptible to wanting a big, domestic "name" company, and are swayed by their professors, who in general are also inclined toward the large Japanese firms. Turnover of personnel is reported by many to be low, and several R&D managers anticipate greater continuity within their labs than they would have in the U.S. or Europe. R&D productivity Even if it were possible to accurately judge RsD "productivity," in most instances it would be too early to evaluate foreign companies' Japan-based R&D. However, the subjective views of several interviewees suggest that the output from their labs in Japan is on a par with, or superior to, that of European or U.S. labs. Again, of course, this appraisal must be viewed as coming from biased sources, and most of the evidence is anecdotal at this point. The R&D director for one pharmaceutical company's joint venture in Japan, for example, notes that the joint venture has three new products currently being reviewed for registration; of these, two were initiated and developed by the joint venture company. And of the three drugs the company has in the clinical trial phase in Japan, all were initiated and developed by the joint venture's R&D, not the foreign parent. The parent R&D organization, although several times larger, has in fact not produced any solid new drug leads for about five years. The technical director at the Japanese subsidiary of a U.S. chemical company states that the subsidiary's development laboratories are regarded by headquarters as the most productive lab group, in terms of new product development, new business sales and ROI. As another example, one foreign company's ag chem R&D 22program after two years has two products approaching commercialization: one at the regulatory testing stage, and another at the final product development stage. "Overall," says its director, "the lab has been very productive.* An R&D manager with another company having long-established applications labs in Japan comments, "the speed of development here is hardly beatable." And another executive is more blunt: "Lab tech people work faster here than in the U.S.; they don't mind overtime and holiday work so much, and they work extra hard to make target dates." on balance, most of the interviewees were impressed with the dedication and skill of their RsD staffs in Japan. VI. Conclusions 1) There is an increasing trend among foreign chemical and pharmaceutical companies to establish new R&D facilities in Japan or augment existing ones, and several new entrants are expected. Although the recent appreciation of the yen has probably tempered some companies’ enthusiasm for capital investment, the essential driving forces for locating RéD in Sapan will persist, and increase. 2) Among the many different rationales for Japan-based R&D, two are especially salient. For chemical companies, the requirement for direct responsiveness to technological changes induced by leading-edge customers necessitates R&D and technical service labs in Japan; these companies simply cannot afford to be left behind in the technology-intensive fields they have targeted as key areas for future growth. For foreign pharmaceutical companies, the prospects of tapping into a pool of research talent that offers qualitatively different scientific approaches and faster product development are compelling. 233) Although lower cost may have been a factor in some companies' decisions to establish RsD in Japan, and may in fact have been a legitimate advantage, this is no longer a salient rationale for R&D investments. 4) In general, foreign corporations have encountered less severe difficulties in sétting up R&D programs than they had anticipated. Effective recruiting, in particular, has been achieved by many companies. 5) Pricing turmoil and changes in the Japanese pharmaceutical industry are shifting the chief incentives for Japan-based R&D labs, and may threaten the viability of major R&D programs. Most corporate strategies to overcome the squeeze in margins by more quickly generating new drugs are critically dependent upon the assumption that the government will continue to assign new drug prices that are high enough to ensure appropriate returns on those R&D efforts. This critical assumption may not hold true, which implies that a more legitimate purpose in augmenting Japan-based R&D is to bolster overall corporate R&D for global markets, not the Japanese market in particular. 6) Further entry into Japan by foreign chemical and pharmaceutical companies, especially via Japan-based R&D programs, will in the long term induce structural changes in these industries in Japan. The relatively greater expenditures of U.S. and European pharmaceutical companies on R&D (3-118 of sales, versus 6.5% by Japanese companies) suggest that there may be some displacement of domestic pharmaceutical companies, especially if price cuts indeed necessitate faster new product introductions. Likewise, the more aggressive R&D initiatives by foreign chemical companies (which spend approximately 4.2% of sales on R&D versus 3.5% by Japanese companies) could result in displacement of some domestic customer-supplier 24relationships that heretofore have been sustainable in part because of the absence of R&D and technical service competition from foreign companies. 7) Preliminary indications are that Japan-based R&D and product development labs are very productive, and foreign pharmaceutical and chemical companies have so far been satisfied with their output. 259 Exhibit RECENT ReD INITIATIVES BY FOREIGN CHEMICAL ¢ PHARMACEUTICAL COMPANIES 1 JAPAN company _—frnount of | year ‘type of RED Piannes siz Conments ltnvestmene Jof Technical Kanner state Bayer Yakuhin| 900 foomplated | Expansion of pharmaceutical ao Other Bayer affiliates also have labs 1966 development capabilities, including for development, applications work formulations no baste rei spprex, now in Polyplastice firet built technical (Polyplastics [1,120 )prenntag service 1ab 1983 Joint Venture} btage ciba-celgy 9,000 announced |pasic research in pharmaceuticals | 130 by 1990 | atready hae pharmaceutical development i986 fond new Industrial materials Tabs and agchem faci lies Dow chemica1 | 480 [nov in| agchem, epoxy reaine, fon exchang 30 (eat.) | Investment 1 expansion of existing lab Planning | resin with 65 staff, Now ouns approx. 60 of stage Funai Pharmaceuticala, which hi approx, 100 staff in development labs Dow-corning 960 under con-|si1fcones: applications research 4s Opened 35-person lab facility 2 y struction [and new product development agor currently 165. people in technical Gevelopnent bu Pont 16,000 |to be |New technical center for product aso Plana to expand staff to over 300 in completed |developnent and fer include areas see in engineering p! life sclences. for electronieas no basic re Several Du Pont-affiliated labs inietally already established Eastman Kodak4 10,000 announced |Appiied research and software for | 150-200 ises nage processing) electronica) new materiale Hoechat na J compteted |Agchem experimental station for m™ Also hes 200 pharnaceution) nip staffs ise sereening € registration testing in beaie research, including BlotechnoteayLe Exhibit 1 (continued) company | Amount of | Year Type of RED Planned size Comments Investment. Jot Technical (oui T16n)| Beate rer 3,000 J announced | Applications and product 50 Stafé may be expanded by 100 in lat i506 Aevelopnent for electronics-related phases. Agchem research center also ‘and high-performance Slated for 1887 Monsanto ‘agchem, 4,000 | competed |agchon screening, development and | 35-40 isee formulation chemistry Silicon | 14600 |completion| Silicon wafer manufacturing 30 Wafer in'l966 — |technologies; research on wafer neq cleaning, magnetic crystal pulling Peizer Taito] 3,000 |compietea |pasic pharmaceutical research, wn Investment 1s expansion of existing i965, including chemical synthesis Labs for pharmaceutical development, with staff of approx. -100 Upsohn 14,000 | announced 400 Full staff of 500 (including drug i966 registration) will be reached in 1995 development. Hot (2) Table describes only recent, major RED investments, and thus does not include companies with existing RED facilities, have. long-atanding ReD programs. ) Wa» Not Available chemical or phi fof {te chemical RED bi Because ) For investwent figures originally given in v, snd recent divers $+ yen conversion tical conpeny per 20; Eastman Kodak wa jon into pharmaceuticals. jeveral ‘e.g. several other pharmaceutics! companies 10 at ¥1G0~S2. includedExhibit 2 (1985; in Billion Yen) Ciba Geigy Group Union Carbide Du Pont Hoechst Bayer Exxon Chemical BASF Polyplastics (Celanese Joint venture) Degussa Dow Chemical Rhone-Poulenc ICI Stauffer Borg-Warner Monsanto Uclaf Lubrizol Montedison W. R. Grace Atochem Dow Corning 97.8% 86.2* (1984) 81.0 76.5 66.7% 50.1 45.5 40.3* (1984) 34.5 33.0 30.0 28.0* (1983) 19.8 12.9 12.8 12.2 10.0 10.0* (1984) 8.0 6.0 4.5 Source: Japan Chemical Directory 1986, The Chemical Daily Co. Ltd., except figures marked(*), which are estimated from company reports. Note: Some consolidated chemical sales include pharmaceutical sales. NA: Not Available at time of writing. 28Exhibit 3 Sales by Major Foreign Pharmaceutical Companies in Japan (1984; in Billion Yen) Pf£izer-Taito 63.2 Merck-Banyu 61.2 Ciba-Geigy 44.0% Sandoz 43.2 Bristol-Myers 34.3 Hoechst 34.08 Roche 29.5 Glaxo 28.7 Boehringer Ingelheim 25.08 Schering 22.6 Lederle 22.5 cr 22.5* Upjohn 22.0% Bayer 15.1 Essex (U.S.Schering) 14.4 Source: Data Book 1986, Japan Pharmaceutical Manufacturers Association, except figures marked(*), which are from 1986 Current Status and Mid-term Prospects for the Japanese Pharmaceutical Industry, Kokusai Shogyo Shuppan. 29VIII. Acknowledgments Much gratitude is owed to the following interviewees for generously allocating some of their time to discuss the topic of this report, and for their insightful, astute comments. While their observations contributed greatly to the content of the report, they are in no way accountable for the opinions expressed. Dr. Udo F. Axen Vice President, Pharmaceutical Research & Development-Japan, The Upjohn Company Vice Chairman, Upjohn Pharmaceuticals Ltd. Mr. Thomas C. Boersig President & Representative Director Essex Nippon K.K. Mr. Brian Booth Director Eli Lilly Japan K.K. Mr. Charles W. Cook, Jr. Vice President Monsanto Japan Ltd. Electronic Materials Division Mr. Harold L. Dean President FMC Far East Ltd. Mr. David Dible Stock Analyst: Pharmaceuticals Hoare Govett (Far East) Ltd. Mr. William Dixon Manager, Far East Emery Industries Dr. Karl-Heinz Feuerherd Manager Research & Development Planning BASF Japan Ltd. Dr. Robert K. Fujimura First Secretary (Biological Sciences) U.S. Embassy 30Dr. Howell A. Hammond Vice-President Director of Research & Development Kodak Japan K.K. Mr. Alex Hendrickson President Novo Industri Japan Dr. Tetsuichiro Horio Chief Department Manager Technical Center Travenol Ltd. Dr. Thomas F. Jordan Vice President- Corporate Strategy Du Pont Japan Ltd. Mr. Hideo Kato Manager Hoechst Japan Ltd. Mr. Mark E. Kelly Director, Office of Technology Vice President Dow Chemical International Ltd. Mr. Saburo Kimura Commercial Section (Pharmaceuticals) U.S. Embassy Mr. Hajime Komori Manager, Planning & Controlling Dept. Sandoz Pharmaceuticals Ltd. Mr. Klaus Kran President & Representative Director Searle Yakuhin K.K. Dr. Christian Leriche Scientific Delegate Societe Nationale Elf Aquitaine Mr. George A. Luers Director of Research Corning Japan Inc. Mr. John P, Madden Director North Asia Oxygenated Products ARCO Chemical Asia Pacific, Ltd. 31Dr. Mitsuru Maekawa Scientific Representative-Asia GE Corporate Research & Development Mr. Tadahiro Miyatsuchi Commerical Section (Chemicals) U.S. Embassy Mr. Roger Moore President Novo Yakuhin K.K. Mr. Yukio Morita Director, Systems & Finance Lederle (Japan) Ltd. Mr. Kyle Murphy Commercial Officer U.S. Embassy Mr. Frank J. Nagy Vice President Du Pont Japan Ltd. Mr. Kazuyoshi Ogura Director, Research & Development Lederle (Japan) Ltd. Mr, William Parker President and Representative Director Mallinckrodt Japan Co. Ltd. Dr. Robert J. Prochaska Vice President Celanese Japan Ltd. ~ Mr. Stanley A. Ridgwell President & Chief Executive IcI Japan Ltd. Mr. Oskar Rohde President Bayer Japan Ltd. Dr. Gerhard Roth Manager, Business Planning & Licensing Pharmaceutical Division Hoechst Japan Ltd. Mr. Takashi Seo Director, Public Affairs Pfizer Taito Co. Ltd. 32Mr. Katsuyoshi Shimatani Assistant Manager, Research & Development Sandoz Pharmaceuticals Ltd. Mr. Frank Stewart Vice-President, Technical Director Dow Corning Japan Ltd. Mr. Takao Sudo Assistant Manager, Research & Development Sandoz Pharmaceuticals Ltd. Mr. Eugene C. Sullivan Chairman and Representative Director Monsanto Japan Ltd. Dr. Nob Tamagawa Technical Director, Electronic Products Du Pont Japan Ltd. Mr. William R. Udell Manager, Research Asia-Pacific Research Station Director Agricultural Chemicals Division Monsanto Japan Ltd. Mr. J. 8. Walker President & Representative Director Exxon Chemical Japan Ltd. Mr. Leighton A. Willgerodt General Manager Hercules Far East Ltd. Mr. Kuni Yamamoto Managing Director Genetics Institute Inc. of Japan 33