A new Booz Allen Hamilton (BAH) report (registration required) has been published on the relationship between R&D spending and corporate performance. The report details their analysis of the financials of the top 1000 corporate R&D spenders, the Booz Allen Global Innovation 1000. This report is timely because there have been several stories recently on how the US is losing their innovation lead in the world, and Congress just announce a National Innovation Act that will double federal research funding and promote corporate innovation.
BAH found no correlation between the percentage of sales spent on R&D and several performance metrics such as sales growth, gross profit, and market cap. The figure here shows one set of data indicating little correlation between R&D-to-Sales Ratio and Sales Growth. The only significant correlation in the data is that if a company's performance will be hurt if is in the bottom 10% of spending.
The basic conclusion of the report is that companies cannot blindly throw money at R&D and assume that innovation will develop and performance outcomes will improve. The authors suggest that effort must be spent on improving the innovation process. Companies can do this by incorporating marketing and sales into the R&D process to ensure that innovations created have relevance to their customers and market. BAH do not suggest other ways in which the innovation process can be improved, although this is clearly an important issue for companies to focus on. Gordon Graham at Broken Bulbs addressed this is in a recent post on how companies can improve product success in the marketplace and he provides a list of questions to help analyze one's own innovation process.
Here are some highlights from the BAH report:
- Increased R&D spending does result in increased gross margin, likely due to expertise applied to optimizing product cost and manufacturability. BAH don’t mention this, but this is probably also due to high levels of R&D resulting in highly innovative products that command a premium in price and a high margin.
- The former chief scientist of DARPA was quoted saying, “It’s absolutely a myth that money alone will solve vexing technical problems.”
- “…marketing analytics have become more sophisticated, marketing budgets have increasingly gravitated towards an optimal level. The same may ultimately happen for R&D and innovation budgets, but there’s no sign of it to date.”
- “…companies can maximize their return on innovation investment through better processes for ideation, project selection, development, and commercialization.” This is easy to say, but the key is issue is how to do this.
- “Successful innovation requires an exceptional level of cross-functional cooperation among R&D, marketing, sales, service, and manufacturing.” Absolutely. I’ve been a big believer in cross-department cooperation ever since I ignored a company policy years ago prohibiting communication between R&D and Marketing and instigated a successful and lasting cross-department cooperation.
- After Jobs came back to Apple, their R&D budget remained below that of their competitors--in fact Jobs cut it even more--and this led to incredible innovation creation. “…Apple cut a large percentage of projects, focused its development resources on the short list of those that had the greatest potential, and started an innovation machine that eventually produced the iMac, iBook, iPod and iTunes.” This required someone (Jobs) who could force sales, marketing, R&D, manufacturing, and software services to all work in synchrony with their corporate innovation strategy. The presence of someone like Jobs within a company who has this cross-department vision and ability to integrate them into a consistent strategy is rare.
- “Align innovation strategy with corporate strategy…” Again a statement that is true but difficult to do or know how to develop such an alignment successfully.
- “There is a clear link between a corporation’s organizational DNA profile and its performance results from innovation…” This relates to a previous BAH report analyzing corporate personality and performance.
The take home message for me is the emphasis on integrating other departments into the R&D process, something that I’ve been a strong believer in and seen companies struggle with this because of the typical mistrust among the departments: engineers of marketing motives, sales of R&D’s understanding of customers, etc.
I see one problem with the correlation analysis done and that is that there is no control over other factors that influence performance outcomes. To really show that R&D spending has no impact on performance, one wants to keep all factors constant except for R&D spending. This can be done by observing a company’s performance over time during which the company significantly increased or decreased R&D spending while not changing other aspects of their business. This is the closest one can come to the scientific method of controlling for other factors other than the one under investigation.