March 2018 Australian Financial Review
Cochlear chief executive Dig Howitt discussed the secrets of global success at the AFR's Business Summit.
Dig Howitt is clear on the ingredients that combined to make Cochlear a world leader in hearing implants and one of Australia's most successful global companies: a global mindset, long-term vision and investment in continued innovation. But the Cochlear chief executive is not so sure Australia has the recipe exactly right to create more global successes like Cochlear, which was floated in 1994 at $2 a share and last traded at $179. Mr Howitt has been Cochlear chief executive for two months. His 17-year career at Cochlear has until now been preoccupied with overseeing manufacturing and the global supply chain, then running Asian operations. Cochlear invests around 12 per cent of revenue each year in research and development, reaching between $160 million to $170 million this financial year. That has allowed it to develop new products like the Nucleus 7, a world-first sound processor that allows patients to stream sound straight from an iPhone, iPod touch or iPad to their hearing implant.
The Innovation and Science Australia 2030 report, which will be considered by Cabinet's expenditure review committee ahead of the budget, recommends better "targeting" of the $3.1 billion a year R&D program by capping cash refunds for smaller companies and introducing new eligibility criteria for bigger businesses. It also recommends increasing support for direct grant programs that target national priorities, arguing that Australia's heavy reliance on indirect R&D incentives is out of step with leading innovation nations such as Israel, Germany, Sweden, the United States and China, and does not necessarily support productive, additional research
Mr Howitt said the ISA recommendations should be implemented quickly, but argued a mix of direct and indirect incentives was still appropriate "because this facilitates both direct funding in priority areas and indirect incentives help make Australia an internationally competitive country to perform R&D”. He said it "doesn't make sense" to cut R&D concessions because this would eventually mean less intellectual property being developed in Australia, which would eventually erode tax revenue. While no one would shut down R&D in Australia over a small tax change, it would impact future R&D decisions.
"As we and others continue investing in R&D, if other countries are making themselves more attractive, that factors into part of the decision over where that R&D is done. The risk is that the marginal R&D, extra R&D slowly moves overseas, not necessarily reducing what we do in Australia, but you grow it overseas in environments that are more tax friendly. That does have an impact because we export 95 per cent of what we make in Australia, but we pay 70 per cent of our global tax here because our IP is here and our manufacturing is here. That's a much bigger economic issue than the million dollars or million and a half dollars that came off our tax rebate.
There are long-run consequences for the decisions around incentives for R&D. We don't want a handout, but we do need to have a competitive environment. For a company that's global, it has to be internationally competitive."
More than half of Cochlear's R&D is conducted in Australia. Last week Cochlear announced a US$10 million gift to the Johns Hopkins Bloomberg School of Public Health to establish the Cochlear Centre for Hearing and Public Health – there is not R&D tax concession attached to this gift, Mr Howitt said. Cochlear was formed in 1981 aided by Australian government funding to commercialise hearing implant technology developed at the University of Melbourne in the 1960s and 1970s by Graeme Clark. Mr Howitt said the business had a global mindset right from the start. One of the founders was the legendary Paul Trainor, who played a crucial role in establishing bio-engineering as an industry in Australia. "Part of Paul Trainor's thinking [was] if you've got something that has global value, you try to realise it," by expanding offshore.
Mr Howitt appeared at The Australian Financial Review Business Summit on Tuesday on a panel that will dissect the secrets of Australia's internationally successful companies, alongside John Walker of Macquarie, Amanda Lacaze of Lynas Corp, and Byron Pirola of Port Jackson Partners.
A crucial element of Cochlear's success, according to Mr Howitt, is that it invests with a 20-year mindset. "The capability people have designed into the core products have taken 20 years to really get value from," said. But Cochlear invested "knowing the idea had potential but not knowing exactly how that potential would be realised, but then being brave enough to say, 'let's spend a bit extra time and a bit extra money, put this in, because we think it's the right thing to do'."
The company's long-term perspective is also tied to the way its hearing implant therapy works. A child who gets an implant is dependent on that implant for the rest of their lives, and "we want that to work ... because the external components of the system will wear out, they're electronics. Cochlear needs to be around for them to hear. We've got a lifetime relationship with all of our customers.” Cochlear seeks out investors who want to invest long-term. The company recently opened its first manufacturing plant in China, in the Sichuan capital Chengdu to increase capacity by 50 per cent, and serve the burgeoning Chinese market. The decision to manufacture in China "is done with a 20-plus year view of the market in China, and that's based on us having over 20 years experience of operating in China," Mr Howitt said. "It's taken time to learn and understand and build capability, and then saying, 'let's look forward 20 years again'," he said.