How to Turn Money Into Innovation

Publicat per Business Week

Jessie Scanlon

The Global Innovation 1,000 survey shows which companies are just throwing money into R&D and which ones can boast about innovation

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.