Forget R&D Spending-Think Innovation

Article excerpt

"Remember, Spend Less on R&D for Best Results," headlined Barron's Jan. 1 news report of the second annual Booz Allen Hamilton "Global Innovation 1,000" study. Authored by Barry Jaruzelski, Kevin Dehoff and Rakesh Bordia, and published in the consulting firm's Winter 2006 strategy + business, the 2005 study analyzed the world's 1,000 biggest public R&D spenders and the influence of R&D on their business performance between 2000 and 2005 (see p. 70 this issue).

Like the earlier 2004 study, Global Innovation found no statistical relationship between R&D spending and sales growth, earnings or shareholder returns. Gross profits as a percentage of sales was the single performance variable with a statistical relationship to R&D spending. This wasn't quite what the Barron's headline said but undoubtedly enough to trouble those corporate chieftains who continue to wonder what they actually get for their R&D dollar.

The story is more complicated, though. Considerable press attention was drawn to the Booz Allen finding that although 94 "high-leverage innovators" like Toyota, Google and Caterpillar spend less on R&D/sales than their competitors, they consistently outperformed them across seven performance measures, including sales growth and shareholder returns, between 2000 and 2005. As Booz Allen vp Jaruzelski explained, "Innovation can lead to high performance, but the process isn't automatic and it does not necessarily require above-average levels of investment. The most successful companies combine an integrated process and a supportive culture to create sustainable competitive advantage. There's no silver bullet, and just throwing money at the problem is not the answer."

Still, another Booz Allen consultant, Steven Veldhoen, cautioned a Siemens AG publication that, "the adage that stinginess will be punished does apply, as the ten percent of the companies examined that spent the least on R&D fell far behind their competitors with regard to earnings and return on equity. So spending too much doesn't help, but spending too little can damage a company-that's what the results come down to."

Another View

Nevertheless, the Financial Times observed in its Nov. 13, 2006 issue that the Booz Allen findings may only deepen the debate over the effectiveness of R&D spending because they appear to contradict the conclusions of the latest R&D Scoreboard from the UK Department of Trade and Industry (www.innovation.gov.uk). Produced annually since 1991 the Scoreboard tracks the top 1,250 global investors (many unlisted) plus the top 800 UK companies.

As in previous years, the 2006 Scoreboard finds links "between R&D growth and intensity on the one hand and performance measures on the other such as above-average wealth creation efficiency, higher sales growth and portfolio growth."

For example, since 1997, companies in the FTSE 100 portion of the Scoreboard that devote more than 4 percent of sales to R&D have increased in market value by 73 percent while the FTSE 100 has only increased 16 percent. Among the 15 largest industry sectors in the Scoreboard, the five most profitable (operating profit as percent of sales) include three that are R&D-intensive (health, pharmaceuticals, software) and two highly-capital-intensive (oil and gas, telecoms). "For the 12 sectors where R&D and capex investment is significant, over 75 percent of companies having above-average wealth creation efficiency [value-added output divided by employee and depreciation costs] also had above-average investment intensity," the analysis says.

In addition, the 2004, 2005 and 2006 Scoreboards all report a clear relationship between R&D growth and sales growth for global technology hardware and software companies. For example, of 16 large software companies with R&D growth over 20 percent, 13 have sales growth over 20 percent; of 3 companies with R&D growth under 5 percent, two have negative sales growth while the other has sales growth of 3 percent. …