What Do R&D Budgets Actually Tell Us?
June 27 2012 by ChiefExecutive.net
Many companies tout their R&D spending as a way of expressing their commitment to innovation. But correlating R&D budgets to productive output isn’t very easy and often isn’t clear. Writing in The Wall Street Journal, John Bussey observes that while U.S. companies are planning a big increase in their research and development for 2013, companies in Asia are spending so much on R&D that their total spend might pull ahead of total R&D spending in America. Should the U.S. be worried? Companies headquartered in the U.S. are projected to increase R&D expenditure 9.6 percent, a figure that represents a similarly strong boost this year. While U.S. federal government funding is slowing, spending by Asian government such as China is rising across a number of different industries.
Should CEOs be worried? Bussey quotes Michael Schrage, a noted fellow at MIT who follows this subject closely, who says that if the size of R&D spending were truly significant, “we wouldn’t be subsidizing General Motors.” Unfortunately, the relationship between spending and innovation—inputs versus outputs—has never been very strong. Much depends on how well this money is spent.
The problem with coming to grips with the link between R&D and innovation is that most companies appear to use the latter term loosely. In many cases what passes for “innovation” is merely adding new features.
What Are the Right Metrics?
There are of course many metrics which can be used in evaluating the effectiveness of R&D expenditures. Some, like percent of revenue, are of limited utility. Others such number of patents generated, can be directional, but much depends on whether they help drive revenue or control costs. A patent, or any new feature, that isn’t monetized doesn’t have any intrinsic value and falls into the category of an interesting new thing rather than an innovation, i.e., something new that customers want and are willing to pay for.
Companies such as P&G and 3M look at the share of revenue derived from new products that are, for example, less than three years old. Presumably if the trendline moves up, one is getting a better bang for one’s R&D buck. If not it suggests that one is not spending resources on building products or services that meet your target customers needs.
More effective R&D should in some sense help improve margins. But margin improvement is at best an indirect benefit. Some companies measure customer retention or churn rate. This is extremely important as it’s far more costly to acquire a new customer than keep one.
The general question of R&D effectivenessis is very much an industry-specific with a near-unanswerable solution . The Journal’s Bussey points to studies conducted by Booz & Co. where the firm listed the biggest corporate spenders: The top 10 were Toyota, Pfizer, Ford, Johnson & Johnson, DaimlerChrysler, General Motors, Microsoft, GlaxoSmithKline, Siemens, and IBM—all the usual suspects. Booz also drew up a second list of “high-leverage innovators” that included Adidas, Apple, Exxon, Google,Kobe Steel,, Samsung, and Tenneco.
There is a disconnect here, as no company that made the first list also made the second. This divide has always been there, Bussey argues, in part because innovation is more than R&D and technology. It is about people, talent, process and strategy. He quotes Boston Consulting Group’s Andrew Taylor, “If you have a new insight into a customer group, that’ as valuable as creating a new molecule.”
It is well to note that the value of a company lies entirely in the future. The past does little more than offer insight into how the business has performed thus far. Comparisons of dollars U.S. companies spend compared to Chinese companies tell us very little, as these are mere inputs.