MEASURING EXCELLENCE IN RESEARCH AND RESEARCH TRAINING
Canberra, 22 June 2004

Excellence in industry-funded research
Dr Bob Watts

I guess it is slightly difficult for me to talk to an audience like this, because I am normally speaking in terms of assessing value to an industrial organisation rather than to what is, I think, largely academics and CSIRO. So what I will do is that as I go through I will try to draw some analogies with some of the things that I have heard this morning and, of course, that I am aware of through my contacts with universities.

The first thing I wanted to draw your attention to, in case you hadn’t noticed it, is that we are existing in a world of constant uncertainty and constant change. As you will see in a few minutes, that has to be built in to any assessment of excellence.

I will just put that into context for industry. Probably most of you know that up to, say, 15 years ago, through the ’80s, industry had very large, well-funded, interest-driven research labs. Famous ones were Bell Telephone Labs, with a number of Nobel Prize winners, the IBM labs and so on, and even within BHP at that time there were some 650-odd people.

Some time in the early ’90s the bean counters, as they are called, started to ask the question, ‘What value is coming out of this?’ And that is exactly the question, I believe, that the university community is being asked now by the public, through the politicians and of course through the Public Service: ‘What value is being given to society?’

In the case of industry, the answer from the researchers was exactly the sort of arguments I have heard from other speakers this morning: ‘It is self?evident that we are adding value.’ That is a simple way of putting it. So the answer in industry was quite simple. They cut the funding. All those giant labs were torn to pieces. In the BHP case, in the second half of the ’90s we took those 650 people down to 100 or so. And then we were asked the question, ‘Well, if you want to grow, you had better show you create value.’

How do you measure value? It is quite simple in industry: it is cash. If you can put a dollar value on it, then you get somewhere. So we had to develop methods, which I will talk about in a few moments, for persuading the management that we were creating value for the company.

Scientific excellence is obviously necessary if you are going to create value through technology, but it is not sufficient to say, ‘We are scientifically excellent.’ You have to show what value you are creating, in terms that the management understand. And what you heard from Robin Batterham this morning, whether you like it or not, is that he is telling you, I believe, that you are going to have to show that you are creating value for the country, using methods that the country can understand.

Methods of economic valuation used by Industry
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What we had to do was first of all to find out how the management itself valued its own activities, and then embed our technology within it. We developed within BHP – and these methods are used quite widely within industry – in our case four methods of actually putting a dollar value on what we were doing.

The first one, which we called a ‘quick & dirty’ net present value calculator, is essentially analogous to the way in which you calculate your mortgage repayments, or put a slab of money in and get your pension out. It is quick and dirty. We have a slab of money within BHP for curiosity-driven research – it is a pretty generous sum – and if anybody came to me and asked for funding from that they had to bring with them a very first estimate, using that first estimator: ‘How much money is it going to make for the company?’ Quite simple.

There are more complicated models. The next one is the discounted cash flow. Both of those models I believe have an analogy in what you are seeing at the moment from the government agencies where they are asking you to give citation indexes and so on – simple counters that they are trying to assess the value. What they have not done yet is turn it into dollars; however, dollars are embedded deeply in what you do. Whether you like it or not, every grant you get is given in dollars. So ultimately these measures will have to be mapped onto dollars.

The two methods at the bottom of the slide, on which I will not go into any detail, of course, are basically taking into account the huge uncertainties that surround research. Is it going to work? Will it not? What are the probabilities of it? And, in the industry context, will it make money? These methods were taken directly from the financial areas of the company, and essentially we have developed methods which are a generalisation of the share option process, the share option market. We treat research as an option.

I will show you that in a moment, but basically what it does is to allow you to include the huge uncertainties surrounding research, and markets, and make money from it.

There are some pretty clear uncertainties that come about if you are trying to say how much money a new area of research is going to make. Supposing CSIRO is getting into titanium. (BHP started that as well and we already have a pilot plant in Australia.) In order to get the funding for that, which is very significant, we actually had to consider, among other things, all these distributions. We had to work out, ‘What is the selling price going to be? How is it going to vary over the next 40 years?’ and the production costs, construction costs and so on. Then we had to do this so-called Real Options Analysis, and by going along to the management and saying, ‘By taking into account all these things, including the probability of technical success, we believe that this project can make $100 million’ – or whatever the figure is – ‘for the company,’ we found then the management was willing to say, ‘We will fund it.’

When we said less quantitative things like, ‘It’s obviously good to have a great titanium industry. We don’t have one at the moment,’ or whatever, they just shrugged.

So they fund it if you can present to them, in terms they understand, the value that in this case the company is going to make. And I repeat that I believe that what we heard from Robin Batterham this morning is basically a plea to the universities and research institutes that are government funded that they have to start thinking this way, if they want to go for more and more money. If you think about it, there is several billion a year going into universities and related institutes now – huge sums of money.

Real Options Analysis enhances R&D investment decisions
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With that background, then: in industry – and I should say that the methods that are being used in BHP Billiton now have been embedded quite strongly into drug research, drug companies and so on – basically we have managed to change management’s view that R&D is not a discretionary cost to be saved when times get hard but rather an investment that can add value. If you think about it, that is exactly the same type of switch that we need to bring about in government circles when they look at universities. It is not a cost to be cut, it is an investment and it can add value. But you are going to have to use their methods of thinking to show them that.

The important point in this slide that I also wanted just to mention is that the company now sees research and development as a series of ‘option plays’. If you are familiar with the share market and options in that sense, you will know that you can make money by, for example, not taking up an option – in this case, by cutting a project.

Regular toll-gate reviews determine continuation of project
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All of the projects in BHP Billiton are reviewed on a continuing basis, every six months, and very interestingly the people that come and do the reviews are not the technologists, they are the management, the people who are ultimately going to use it. At each review stage there are clear criteria established, if it is going to continue beyond the next review, and at that review you ask, ‘Has it met it?’ Having said that, I have to point out that often at those reviews the actual direction of the research will change. In other words, the findings over the previous six months or so will affect the outcomes quite strongly. So there is very clear guidance from management, from the people who have a vested interest in the outcomes.

In Australia, within the university and national lab type context, I think Michael Barber has shown us that CSIRO is starting to move this way with its BHAGs, and in terms of the universities, the best we do at the moment is that page review you write to ARC every year to say what you have done – which is not really looked at very seriously. I think that will probably change also over the next few years. People are going to more closely look at the outcomes.

The last point on the slide is also important. In industry you will stop a project because it is not going to add value, in terms of economic value, even though the science may be doing remarkably well. And again I think what you are seeing with the National Research Priorities is some of that thinking coming into the government areas.

Associating value with intangibles
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This slide I think has got some lessons for us all. When I gave you the uncertainties, I picked on obvious things like the price and the cost of building the plant and all the rest of it – easily quantifiable measures. Unfortunately, we are now having to grapple in industry with associating dollar values with intangibles. And much of what Bob Graham, for example, said this morning was tied up with saying, ‘You can’t put a dollar value on intangibles.’ Well, unfortunately, at least in industry, you can put a dollar value on intangibles.

Let’s look at the first one, to give you a quick example: environmental effects and the licence-to-operate issues. I am sure almost everybody in this room remembers BHP and Ok Tedi, the copper mine in New Guinea. BHP took a decision in the early ’80s, after two tailings dams had fallen over, not to put up a third one. This saved many millions of dollars. Ten or fifteen years later, that came back to bite them and it bit them badly. To tell you how badly they were bitten, if you think about it, in 1996–98 the share price went from about $20 down to $12, largely driven by intangible issues like the Ok Tedi thing putting them on the television screen every night. Huge value was destroyed by something that, up front, you don’t know how to put a dollar value on, except in terms of whether to spend money on a dam or not.

Health and safety issues are also now having to be quantified, as are political and country risks.

Within the Australian academic context, what we have had for many, many years is people saying, ‘Interest-driven research is valuable.’ I will give you two examples: ‘Look what relativity did for us’ – after about 70 years – and, as I heard the other day, ‘Look what Tolkien did. He didn’t set out to make money when he wrote The Lord of the Rings, and look at the couple or three hundred millions that have been made in the past year or so for New Zealand.’ Whether you like it or not, I think, if you want the money to keep increasing, you are going to have to quantify the intangibles on which we all say, ‘Take it for granted.’

I will give you another example, because when Bob Graham was speaking it occurred to me. Supposing the Sydney Opera is on at the Opera House. Would you pay $5000 for a ticket? Most unlikely. Every time you buy an opera ticket you are putting value on something that I think Bob said you can’t put value on – music. Yet you do. To go to some pop music, the teenager will spend twice as much as you will to go to the Opera House. So whether you like it or not, in your everyday life you put value on it, and what you are hearing from Robin Batterham and the government I think is that you are going to have to put value on it.

A couple of final thoughts for you. In industry people keep saying to me, ‘Do you use outsourcing? Do you give contracts to CSIRO, or to universities, or do you do your own research?’ Well, the answer to whether or not a company does that is really tied up very closely with its policies. If you have got a strong, well-funded internal R&D program, that is invariably associated with a company policy to create value and growth through innovation. And to give you an example there with BHP Billiton, three or four years ago it didn’t do that. Because after the merger of BHP and Billiton the company became so large that any regular method of growth was going to be attacked by government regulators for monopolies and so on, it was decided that a well-funded internal R&D program is necessary. The funding has tripled in the past two to three years. In other industries you will find a strong emphasis on outsourcing, but in that case the company policy is to emphasise efficient production and not to grow through innovation. So those are two thoughts.

In industry you need a balanced technology portfolio, with revolutionary technologies – for example, the titanium exercise I mentioned earlier – which are going to drastically change cost structures and introduce new products and processes; you need some evolutionary stuff which brings about significant improvements in efficiency to established methods; and you have to have some tactical technology supports for when something seriously goes wrong and has got to be fixed in a moment.

Those methods I had a few minutes ago of estimating the value of technology are all applied to these things in one form or another.

Here are a couple of comments on the roles of universities and national laboratories, in terms of industry-funded research. We would see universities and national laboratories – a bit of American language there, I am afraid, for CSIRO, but not to worry – as a major source of new concepts and ideas, extremely important as training grounds. We have heard nothing this morning to speak of about the training role of research in this country, but that is where we see the training occurring – an excellent source of generic R&D support for industry, stuff that is not going to give competitive advantage to one firm over another, and often you get strong tactical support. There are one or two research centres in Australia that are very strong in that area.

Some of the issues that we grapple with all the time? The first one is that intellectual property expectations by universities and national labs are frequently quite unreal. It is startling how many times we end up in months and months of discussion over something that is not going to add much value, and yet the universities can’t see it. You have got to have continuous interaction to have effective investment; and you need to make sure you have got agreement on timelines and so on.

Questions/discussion

Francis Rose – I was interested in your ‘balanced technology portfolio’, in which you had three items, which however have different time scales for delivery, different time scales for completion. I wonder if you could elaborate on how you set the balance, and how that is consistent with a review process which you mentioned earlier was a six-monthly review process.

Bob Watts – What we call revolutionary technologies would typically be more than five years before they go to commercial, five, six, seven, eight years to commercialisation from when somebody has walked in, say, to my office and said, ‘Look, I’ve got this idea.’ The evolutionary ones, where you take existing technology and make significant changes, would typically be, say, three to five years out. And the tactical stuff is short term. Is there a clear boundary between them? No. We don’t say, ‘If it’s three years, it’s evolutionary,’ or whatever. But obviously anything greater than a year or so’s time scale is subject to six-month reviews. The tactical stuff is usually funded directly from the people with a problem and you don’t have six months to fix it, you’ve got about three weeks.

Christa Critchley – Bob, I want to ask you whether you think the scientific research training model that relates to the apprenticeship-type system that I think has been used or is naturally being used in scientific research training is still appropriate. Do you believe it could be changed or it should be changed, especially with a view to training researchers that are more in tune with the industry and community needs of research outcomes?

Bob Watts – We’ll talk about research level people, so PhDs, Masters and so on. Honours students we take in as well. The major requirement for industry is that they are able to work in teams and can work across several areas. That is a major requirement, and we can usually teach it. By switching people every few months, that will happen anyway. By far the greatest need, of course, is to have people thoroughly understanding the care and rigour that is needed to undertake research.

So I don’t see a drastic need to change the current quasi-apprentice type mode, except perhaps to have a little more emphasis on teamwork.

Jim Peacock – Bob, do you think there is much incentive for universities to train researchers for industry, if industry regards the R&D teams as a red-line target?

Bob Watts – I don’t think industry sees them as a red-line target if you make sure you sell the R&D efforts in the language that the management understands – which is the great change, I suppose, that we put into our company. I obviously glossed over an awful lot with Real Options Analyses and all the rest of it, but I had to go and learn that stuff and then go and develop methods so I could present the R&D portfolio using that language. And as I said, the budget tripled, having been cut by a factor of six to eight (I’ve forgotten exactly) in two weeks. We went from 450 or 500 people down to about 100. The guy came and said, ‘Right, you’re gone in a month.’ So it happens that quickly.

If you speak their language you can persuade them that there is value in it. This is why it concerns me when I keep hearing from the university sector a rejection of what started probably as a request and is now getting stronger, really from the politicians, who are only reflecting the constituencies. You’re hearing from them, ‘We don’t see what value you have added.’ And it is just wrong to say you can’t associate a real dollar value with it. We do it all the time, every time we give out an ARC grant – $100,000 is a regular one. Where did that figure come from? So yes, you can do it.

Your question was whether you can persuade people to go into industry. BHP Billiton is now hiring steadily. I know the Australian context is bad at the moment, but right across the US, if you look at the government labs, they are under constant pressure to show they are producing value. If you look at the industry labs in America, you will find that after those huge cuts in the early ’90s they are all building up, but in a very different way from what they used to be. So it is happening.

Steve Gower – I was one of those 100 that were left from those cuts, if you like. I would like to ask from BHP Billiton’s perspective, but more importantly from your perspective of driving the research within that: how do you see the effectiveness of the government’s CRC program – the opportunities and weaknesses of that program?

Bob Watts – Well, that’s a Dorothy Dixer or what! I’m sure a number of people have heard me say in the past that I am not a great fan of the CRC program. BHP Billiton, as you would be well aware, in many cases got badly burnt. Having said that, I must admit that last year I actually signed off on membership of four.

I think some CRCs are extremely successful from the industry perspective, and some are not. And I think it requires very careful involvement from the industry side if you are to get value from them.

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