R&D spending does not deliver profits

Oct 12 2005 by Brian Amble Print This Article

Companies which invest heavily in research and development may be wasting their money. According to a new study, there is no direct relationship between R&D investment and significant measures of corporate performance such as growth, profitability, and shareholder return.

But despite the absence of a clear return on investment, the pace of corporate R&D spending is accelerating, suggesting that many executives continue to believe that enhanced innovation is required to fuel their future growth.

According to consultants Booz Allen Hamilton, who analyzed the world's top 1,000 corporate research and development spenders, innovation spending is still a growth business. This 2004 Global Innovation 1,000 spent $384 billion on R&D in 2004, representing 6.5 per cent annual growth since 1999.

And the pace is accelerating. Measured from 2002, the annual growth rate jumps to 11.0 per cent.

While the top 1,000 corporate R&D spenders invested $384 billion in 2004, the second 1,000 spent only $26 billion - only an additional 6.8 per cent beyond the top 1,000 spenders.

Yet as the study also points out, being large is an advantage when it comes to R&D. Larger organisations are able to spend a smaller proportion of revenue on R&D than smaller one with no discernable impact on performance.

But while spending more doesn't necessarily help, spending too little will hurt. Companies in the bottom 10 per cent of R&D spending as a percentage of sales under-perform competitors on gross margins, gross profit, operating profit, and total shareholder returns.

However, companies in the top 10 per cent showed no consistent performance differences compared to companies that spend less on R&D.

"There is no easy way to achieve sustained innovation success - you can't spend your way to prosperity," said Booz Allen Vice President Barry Jaruzelski.

How you spend is far more important than how much you spend
"Successful innovation demands careful coordination and orchestration both internally and externally. How you spend is far more important than how much you spend."

In other words, the study argues, it is the process, not the pocketbook that counts. For example, Apple's 2004 R&D-to-sales ratio of 5.9 per cent trails the computer industry average of 7.6 per cent, while its $489 million spend is a fraction of its larger competitors.

But by rigorously focusing its development resources on a short list of projects with the greatest potential, the company created an innovation machine that eventually produced the iMac, iBook, iPod, and iTunes.

The study also found that spending is heavily concentrated in the Technology, Health, and Automotive sectors. Computing & Electronics tops the list representing 25 per cent of total spend by the Global 1,000; Health follows with 20 per cent, and Auto with 18 per cent.

Reflecting this mix, the top 10 global R&D spenders in 2004 are Microsoft, Pfizer, Ford, DaimlerChrysler, Toyota, General Motors, Siemens, Matsushita Electric, IBM, and Johnson & Johnson.

"The competitive value of a fast and effective innovation engine has never been greater," said Kevin Dehoff, Booz Allen Vice President.

"Yet of all the core functions of most companies, innovation may be managed with the least rigor. The key is to identify the priority areas where process improvements will have the greatest impact."