A significant component of economic activity in Australia is carried out in the sector of capital goods. Compared with our knowledge of innovation in consumer goods, capital goods are a poorly understood part of the Australian economy. Broadly speaking, capital goods can categorized as follows (Acha et al. 2004):
(a) Constructs required for production of goods and services (e.g. buildings, ports, rail, mines)
(b) Plant and machinery required for production (including the obvious high-tech components such as IT, software and telecommunications)
(c) The raw materials and components used in production that eventually results in consumer goods and services.
Innovation in capital goods, particular those described under (a) and (b) are of vital importance for the future prosperity of Australia. Solutions for managing water, infrastructure, telecommunications, and capital goods that support the production of goods and services will be underpinned by innovation in the capital goods sector. ‘Complex product systems’ (also called CoPS) is one particular class of capital goods that has been shown to be highly innovative. CoPS are high-cost engineering-intensive products, systems, networks and constructs (Davies and Hobday, 2005). In Australia, we can point to innovations in high-speed catamaran design (i.e INCAT and Austal Ltd) and air-traffic control systems, which imply that CoPS can be radical innovations that are just as significant as better publicized innovations in pharmaceuticals or IT.
The primary problem is that this type of innovation just doesn’t register on our standard measures of innovation performance and therefore becomes neglected as a focus for industry policy and management.
An overview of innovation in CoPS
CoPS have been shown to be a significant contributor to the UK economy. One review by Acha et al. (2004) showed that CoPS share of UK GDP for total manufacturing and construction was close to 19% in 1999. These businesses employed 1.2 million people at nearly double the average wage of other non-CoPS firms in the manufacturing and construction sector. The study used three tests to classify CoPS businesses. These were (1) high unit costs, (2) low volume and (3) a high degree of customization. These three features signal a departure from conventional thinking on innovation that is based on manufacturing and 1960s innovation models where inventions proceed down the commercialization pathway to become successful products.
In CoPS businesses, the model of innovation that begins with R&D that results in a discovery or invention that is then commercialized by mass manufacturing or licensing is quite meaningless. CoPS businesses continually innovate as part of the customization requirement. Much of this innovation can be classified as incremental but some CoPS firms routinely achieve breakthroughs in design. For example, Dodgson et al.’s (2007) case study of international engineering company ARUP and their revolutionary design for elevators that can be used to escape fires is a good example of this. Also, because this innovation is continuous and embedded in the customized solution process, the usual innovation measures of patents and R&D expenditure do not fully capture the innovative activity of these companies. While many manufacturing companies will protect their intellectual property with patents, CoPS companies can use product complexity to protect IP from replication by competitors. For example, McGaughey et al.’s (2000) study of INCAT showed that large high-speed catamarans were continually evolving in design as a way of responding to the next customer’s needs. Complexity and continual development meant that patents were not required to protect IP.
Anyone ranking the innovativeness of these CoPS companies using the standard measures of patents and R&D would conclude that these businesses were not an important contributor to the Australian innovation system. This is highly misleading and contributes to policy that does not recognize the importance of innovation in this economically significant category of firms.
System Integrators, CoPS and Project-based innovation
Many CoPS businesses evolve to become systems integrators where the expertise in designing and coordinating complex capital goods becomes the focus of the company’s competitive advantage. In these cases, the businesses become pure service providers. An example of this type of business is the renewable energy company Roaring 40s that evolved out of the Tasmanian Hydro Electric Commission. Roaring 40s is currently involved in a very large wind-farm joint venture in China, even though the physical components of the wind-farm will be provided by the joint venture partner and other suppliers.
Not all CoPS become systems integrators and many, like INCAT, retain a significant proportion of component and construct production in-house. Also, there are some businesses that are not truly CoPS but still have a significant part of the business organized around project-based production of CoPS-related capital goods such as constructs, plant and machinery. In Australia an important example of this is the resources sector. While these firms produce commodities such as gas, coal, iron ore and copper there is a significant component of innovation in the design and management of mines and oil fields. For example, Rio Tinto would be regarded as a consumer rather than producer of innovations. However, an internal report into knowledge sharing and innovation commissioned by Rio Tinto Coal Australia showed that production processes were being made more efficient by searching and recombining the expertise that was distributed among the several hundred employees (Rio Tinto, 2007). Interestingly, Rio Tinto uses a world-wide online expert forum to support the interaction that stimulates innovation. For Rio Tinto, this is a highly significant source of value-creating innovation, but it does not register on measures of new products, patents or R&D expenditure.
We need to pay a lot more attention to innovation in the capital goods economy. ‘Sexy’ industries like biotech and IT are important, but do not address the critical future challenges of energy, water and transport.