Does R&S spending lead to better profitability? No, according to a study released last month A Select Set of Companies Sustain Superior Financial Performance While Spending Less on R&D Than Their Competitors:
A select group of the world’s 1,000 largest corporate R&D spenders perform significantly better than their competitors over a sustained period while spending less on R&D than their industry rivals, according to management consulting firm Booz Allen Hamilton’s second annual global innovation study. The study found that although R&D spending of these 1,000 companies rose last year by more than $20 billion, money simply can’t buy effective innovation.
The bottom line finding is that more R&D money is not the answer to innovation. The quality of the research and the business operations that turn the research into products is far more important - what they call High Leverage Innovators.
These High-Leverage Innovators use many different models and approaches to outperform their competitors, but are generally noted for their distinctive skill in at least one element of the innovation process and are adept across all of the stages. Google, for example, is known for generating new ideas with blistering speed. Toyota excels at developing its products and processes far more efficiently and effectively than most other companies. And Apple is noted for its well-honed capabilities in project selection and customer understanding.
Much has been made of one of the findings of the study (as quoted in Business Week):
The second annual study examines the link between R&D spending and business performance, and it suggests that some long-held beliefs about R&D and innovation are wrong: for example, that a bigger R&D budget tends to deliver more patents—a common metric for measuring innovation. In fact, there's no correlation between the number of corporate patents and financial performance.
This statement is true as far as it goes. But this misses the key points of the study:
Companies are getting better at squeezing benefits from their R&D spending. Although R&D spending by the Global Innovation 1000 rose last year by more than $20 billion, revenues rose at an even faster rate. Indeed, the most meaningful indicator of innovation investment, R&D spending as a percentage of sales, has decreased steadily since 2001, and by that measure, only 40% of the companies actually increased their spending rate in 2005.
Deep pockets can be dry wells. Analysis of the 2005 Global Innovation 1000 confirms the major finding from our initial study last year: Money simply cannot buy effective innovation. There are no significant statistical relationships between R&D spending and the primary measures of financial or corporate success: sales and earnings growth, gross and operating profitability, market capitalization growth, and total shareholder returns. Gross profits as a percentage of sales is the single performance variable with a statistical relationship to R&D spending.
Bigger can be better. Scale provides advantages to R&D spenders. For the largest 500 companies, median R&D spending was only 3.5% of sales in 2005, compared with 7.6% for the 500 smallest firms.
Patents generally don’t drive profits. Boosting R&D spending can increase the number of patents that a company creates, but there is no statistical relationship between the number or even the quality of patents and overall corporate financial performance.
One size does not fit all. R&D budget levels vary substantially, even within industries, which suggests there’s no consensus on the right level of innovation investment, since companies are using a range of different innovation business models.
Effective innovators excel at four key elements. The high-leverage innovators distinguish themselves not by the money they spend, but by building strong capabilities in the four principal elements of innovation: ideation, project selection, product development, and commercialization. High-leverage innovators listen closely to their customers across the entire innovation cycle. Companies such as Stryker and Black & Decker design their innovation strategy around a keen understanding of their end customers’ needs.
For me, a key finding is the "one size does not fit all". In some case, there is a clear link between R&D and product development, such as in pharmaceuticals. In fact, drug giant Pfizer recently conducted a dog and pony show for analysts and investors touting its R&D and drug pipeline. In other industries, informal research is much more important. If I have a criticism of the study, it would be on its failure to look at informal research spending.
I also have a concern about the use of patents as a metric of innovation. I am not surprised by the finding that patents don't drive profits. My friends in the patent sales game hate this finding. And there is a counter-finding by Ocean Tomo that patent rich companies outperform others. But, as was emphasized at a recent conference on patent monetization, a patent has little value until it is "baked" into a product. What counts is the product development process, which often but does not necessarily include patents.
The Booz Allen Hamilton may be embraced by some and critiqued by other. I hope it will at least shake up this linear model that we have of R&D spending leads to patents lead to innovation. As the song goes, "it ain't necessarily so."
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