June 4 2007 by C. J. Prince
In 1999, while dot-com CEOs were popping champagne corks, Whirlpool, the 96-year-old appliance maker, was arriving at a depressing crossroads. Across the appliance industry, product prices had been falling year over year thanks to greater commoditization and a crowd of new Web players selling faster and cheaper. With no way to differentiate its products in “a sea of white,” as CEO Jeff Fettig calls the appliance showroom, Whirlpool had to take a hard, sobering look in the mirror.
“What we concluded was that the industry was not innovating, and we were not innovating,” says Fettig, who was president and COO at the time. The choice was simple: either continue to cut costs and try to compete on price, a la Wal-Mart, or go the innovation route and bring new products to market by wholly transforming the company’s culture. Senior management chose the latter. “It was a rallying point where we said, we have to change this-and more importantly, we can change this,” says Fettig.
That year Whirlpool launched a worldwide effort to make innovation a core competency for the company, introducing processes for including every employee in idea generation, and initiating executive compensation tied to pipeline targets, among other changes. The initial growth came in fits and starts, Fettig says, but today Whirlpool values its new product pipeline at between $4 billion and $5 billion, up from $3.5 billion in 2006. He estimates the company will generate $2 billion of revenues this year just from new products. “And we think innovation has added three points to our traditional growth rate,” Fettig notes. Shareholders are likely pleased as well: At $113 as of May 21, the company’s shares are trading at almost double their mid-’99 price.
Whirlpool’s transformation to a culture of innovation-at times painful, and impacting far more than just the company’s R&D unit-is just the kind of sweeping change that CEOs have been reluctant to make. For decades, senior executives have held a certain reverence for R&D, even when they don’t understand everything being done on that side of the wall.
“This country has built this myth that corporate R&D is the main source of competitiveness and growth,” says Navi Radjou, vice president at Forrester Research. “But there are cracks emerging in the veneer of the R&D function and as the cracks appear, people get a glimpse into what’s happening inside and what they see inside is not pretty.”
Inside many organizations is an outdated R&D model dating back to the industrial era that doesn’t work in today’s globally connected world where technologies can be copied and commoditized in a nanosecond. A tech company can spend billions developing a new chip only to have its investment wiped out when a major customer chooses to go with a cheaper version. Ditto a multibillion-dollar investment in a new pharmaceutical drug that vanishes on the day the U.S. Food and Drug Administration rejects it. “Pfizer spent $7 billion on R&D in one year, and they have nothing in the pipeline,” says Radjou.
The old model has kept R&D siloed within many organizations, unintegrated with business functions, particularly sales and marketing, and therefore not aligned with business strategy. As a result, R&D processes are unable to keep up with the pace of changing customer demands and can’t churn out high quality products at a rate needed to meet that demand. “Companies have this disconnect between the senior executive/CEO level in charge of the business strategy and R&D,” says Andrew Buss, director of strategic innovation with Archstone Consulting, an advisory management consultancy in Stamford, Conn. “R&D is a black hole where they pour money in and they’re just praying that one day something comes out of it.”
There are signs of pushback, however. Radjou notes that growth of R&D spending as a percentage of sales is slowing, even for technology-dependent firms. And at least one recent study makes a case that simply pouring in more money won’t help any company become an innovation leader. Booz Allen Hamilton’s expansive look at R&D spending around the globe has found for the past two years no link between how much companies spent and their financial performance or return to shareholders. “We looked at it against every kind of measure of corporate goodness-revenue growth, operating profit, net profit, gross profit, total shareholder return, market cap growth, etc.,” explains Barry Jaruzelski, vice president and lead marketing officer for Booz Allen. “The short of it is, there really is no statistical relationship.”
In fact, the study revealed a fair number of companies outperforming competitors while underspending them in R&D. (See chart)
The results of the study have been contentious in both corporate and academic circles. One critic, Christian Terwiesch, associate professor of operations and information management at Wharton, argues that the exercise of searching for a link between R&D and financial performance is sketchy at best because the lag between innovation and positive return from the market varies greatly between industries. “In some companies it might be two years and in others it might be 10 years,” he notes. Luck is a factor in success as well, he adds, which further mucks up the analysis because a company might be doing everything right and still face a bad run. Finally, different industries require different investments in R&D and will need to spend differently.
Despite the study’s shortcomings, the data do suggest that successful innovation isn’t about how much is spent on R&D, but how the process is managed. “Our innovation isn’t R&D driven, it’s consumer need-based driven,” says Fettig. “The starting point is really understanding our targeted branding consumers better than anyone and how we can bring innovative solutions to meet their needs. Part of that answer may be R&D.”
Indeed, many companies lauded for their innovation strategies focus more on the ï¿½ï¿½D’ than the ï¿½ï¿½R,’ Jaruzelski points out. Apple’s iPod phenomenon did not begin with new technology; rather, it took existing technology in the MP3 world and repackaged it with the features and functions consumers most valued. “It actually has fewer features than existing products on the market,” notes Radjou. “But because of Apple’s longstanding investment in understanding how consumers use technology, they understood which features really mattered.” Other companies, like Xerox and Intel, send ethnographers into the field to observe consumer psychology and buying behaviors, bypassing focus groups that, while efficient, are not always reliable. “There are ways you can make R&D more market-focused by getting marketing and product managers involved in R&D governance,” he adds.
Marc Bernstein, president and center director for the Palo Alto Research Center, a wholly owned subsidiary of Xerox, agrees, noting also that the CEO must ensure that all departments within the company have the same vision for where the world is headed. “CEOs need to spend some time nurturing the vision of those people in the organization who are responsible for thinking about the future,” he says, adding that “CEOs by and large look at the world through a quarterly continuum.”
For a true culture transformation that would reinvigorate R&D, CEOs need patience to invest in an initial learning period without expecting much return. “In the early years, we spent somewhere in the neighborhood of $50 million and got absolutely no results,” Fettig says, adding that employees across the organization had plenty of ideas, “but none of them had anything to do with our business.” That startup phase was critical, however. “We wouldn’t have gotten the creativity started had we not done that.”
Today, Whirlpool’s teams still generate plenty of ideas, but they make sure to quickly cross off those that have no potential for revenue generation and keep a close watch on their “kill rate,” or the number of projects axed at the early stage. Experts note that one of the most common ways companies fell their own R&D efforts is by placing too many bets in an attempt to up their odds of success. “You have a few major projects and then a litany of small projects and the small projects are so underfunded that they never can do anything meaningful,” says Jaruzelski. “So you never get the potential upside, but you still spend the money.” The companies getting the best value for their R&D investment focus on just a few projects that have the greatest promise of becoming commercially viable.
Successful R&D players are also making another departure by opening up their innovation process to partners and even competitors, creating a network that amounts to “virtual R&D,” says Paige Olson, strategic innovation manager of Archstone Consulting.
When the idea can’t be built in-house, companies are more often spending money to purchase that innovation, says Jules Duga, senior analyst for global science and technology firm Battelle in Columbus, Ohio. “Corporate R&D may look like it’s going down, but in fact it’s being shifted to corporate purchasing,” he says. For example, Esselte, a $1 billion office product supplier, realized its products were well made but lacking in stylistic appeal. So the company purchased a design firm, XPD, to give them that capability. Duga notes the acquisition strategy is generally positive, though “by delegating much of the R&D activity to somebody else you lose a little bit of the tie between the lab and the boardroom.”
At Whirlpool, that tie is squarely in place, as one knows just listening to Fettig. Though supportive of the “organized chaos” that leads to idea generation, he recognizes that, as CEO, it’s his job to rein in that energy. “Our view is draw the box and let people innovate within the box. But we’ve learned that if you want output, you need a business process to lead that.”