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How to
Turn Money into Innovation
The Global
Innovation 1,000 survey shows which companies are just throwing
money into R&D and which ones can boast about innovation
10/26/2006
By
Jessie Scanlon
Given today's focus on innovation, it should
come as little surprise that research and development spending is
on the rise. In 2005, the 1,000 companies from around the world
with the biggest R&D budgets spent a combined total of $407
billion—$20 billion more than the top 1,000 of 2004.
But you don't have to read further than the
No. 1 spender to realize this is no panacea. The company with the
biggest R&D budget in 2005 was Ford Motor (F). Eight billion
dollars later and the company is hardly a paragon of innovation.
In other words, money simply can't buy effective innovation.
The list of top spenders is one element of
the Global Innovation 1,000 Survey, released on Nov. 13 by the management
consulting firm Booz Allen Hamilton. 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. And as the Ford example proves, a well-funded
R&D engine can take you nowhere.
Emerging Trends
The researchers focused on the 1,000 public companies from around
the world that spent the most on R&D in 2005, and analyzed those
budgets against seven key financial metrics from 2000 through 2005—sales,
gross profit, operating profit, net profit, historical R&D expenditures,
market capitalization, and total shareholder return. The researchers
crunched the data across industry sectors and geographic regions,
looking for trends and patterns.
The trends include an increase in R&D
funding in countries other than the U.S., Japan, and European nations—notably
in India and China. While a few years ago, companies were offshoring
for cost reasons, the shift is now driven by strategy and the need
to build out global innovation networks and move closer to fast-growing
foreign markets.
Another trend: While total R&D spending
is on the rise, R&D as a percentage of overall sales is falling.
One reason for this is size; companies are growing and larger ones
have economies of scale. Another factor is the shift of R&D
sites to low-cost countries. But a third is simply this: Companies
are optimizing their innovation pipelines so that they get more
for their R&D buck.
High Leverage
Innovators
One of the more surprising findings is that 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," according to the report. (Gross
profits as a percentage of sales is the single performance variable
with a statistical relationship to R&D spending.)
This explains why Ford's return on R&D
investment is low—and why it's not alone. In fact, of the companies
that spent the most, only one—Toyota (TM)—ended up on
the researchers' list of "high leverage innovators," 94
companies that "consistently outperformed their peers over
the entire five-year period, while spending less on R&D as a
percentage of sales than their industry median." In other words,
they have a higher return on investment than their competitors.
While it sounds as improbable as an "eat
more, weigh less" fad diet, the Booz Allen study shows that
some companies can underspend and overperform. The list of high
leverage innovators cuts across industries, including companies
as varied as Kellogg (K) and Apple (AAPL), Boston Scientific (BSX)
and Tata Motors (TTM), and Christian Dior and Kobe Steel.
What's the secret that enables them to spend,
on average, half as much on R&D as their industry peers but
perform two to three times better?
Traversing the
Value Chain
There's no one answer. The high leverage innovators depended on
different models and approaches to outperform their competitors.
For instance, Black & Decker (BDK) has no centralized R&D
group; while worldwide design is coordinated out of its headquarters
in Towson, Md., R&D is tightly aligned with individual business
units. In contrast, key product development and strategy decisions
at SanDisk (SNDK) are made by a small group of senior executives
who meet twice a week.
In many cases, the company's success is attributed
to a distinctive skill. As the report concludes, "Google (GOOG),
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."
But the researchers did identify some common
factors, none particularly surprising. First, while there's no silver
bullet, there is a silver thread, or what the Booz Allen report
calls a value chain. The most successful companies exhibited strong
capabilities across four key areas: ideation, project selection,
product development, and commercialization. "The leaders tend
to think about innovation companywide," says Kevin Dehoff,
a vice-president who leads Booz Allen's innovation service offerings.
"Innovation is about R&D, but R&D
alone doesn't equal success." Sustainable innovation depends
on having the tools and processes to move from ideation through
commercialization. Second, successful companies link R&D with
C—customers. At Illinois Tool Works (ITW), for example, R&D
engineers are required to spend time working in customers' plants.
Unanswered Questions
Overall, the Global Innovation 1,000 finds are both promising and
frustrating. On the positive side, it proves that at least some
companies have found a way to increase the efficiency and effectiveness
of their R&D investments. "That means we can do better,
we can raise that innovation effectiveness curve," says Dehoff.
"We can build the processes that will get more bang for the
buck."
But while the Global Innovation 1,000 Survey
is insightful and provocative, it is maddening in that it raises
as many questions as it answers. For instance, the research showed
that there was no overall "best organizational structure."
But is a decentralized model more effective in certain industries—or,
say, for larger companies—while a lean, highly centralized
model is better for others? Does the trend of moving R&D to
low-cost countries represent a danger that companies will lose touch
with their core consumers or an opportunity to understand and connect
with new ones?
Still, this year's study goes further than
last year's, and Booz Allen continues to refine the process, to
push for deeper understanding. As Dehoff readily admits, "We
didn't think we'd cracked the code." Yet.
Scanlon is Innovation & Design editor
for BusinessWeek.com.
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