For innovation success, do not follow the money
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The “Chicken Littles” of Eurocompetitiveness are clucking in despair. The latest research shows that yet again, American and Asian companies have boosted their rates of research and development spending even as Europe’s own innovation investment has gone flat. Brussels’ growth-oriented Eurocrats are getting nervous.
The good news is that Germany’s own DaimlerChrysler topped the UK Department of Trade and Industry’s “international research and development scoreboard” with reported annual R&D spending of $7.69bn (€6.5bn). The bad news is that the DTI survey confirmed that Europe’s aggregate corporate R&D investment has not budged in four years. Worse yet, Europe ranked last in the key global benchmark of “R&D intensity” – R&D spending as a percentage of sales. While US companies invested an average 4.5 per cent of sales in R&D and Japan’s spend averaged 4 per cent, Europe’s R&D intensity petered out at a lowly 3.3 per cent. You can almost hear the Eurocrats crying: “The innovation is falling! The innovation is falling!”
Is it perhaps time for some European soul-searching into the short-sighted and risk-averse nature of the continent’s industrial elite? Hardly. These global R&D budget numbers are an exercise in accurate rubbish. They simultaneously deceive and mislead.
Any policymaker, chief executive or innovation champion who relies on R&D intensity and R&D budgets as a meaningful or usable metric to assess global competitiveness virtually guarantees shoddy analysis and distorted decisions. Few things reveal less about a company’s ability to innovate cost-effectively than its R&D budget. Just ask General Motors. No company in the world has spent more on R&D over the past 25 years. Yet, somehow, GM’s market share has declined.
“There is no correlation between the percentage of net revenue spent on R&D and the innovative capabilities of an organisation – none,” Bart Becht, chief executive of Reckitt Benckiser, the Anglo-Dutch consumer cleaning products leader, said recently. The $8bn-per-year revenue company reports an R&D intensity of 1 per cent. Nevertheless, Mr Becht’s company enjoys a reputation both for innovation and for relatively high margins of its global products. Similarly, Illinois Tool Works – a diversified $11bn industrial products company – spends but 1 per cent of its revenues on R&D across its 665 business units. Yet the 93-year-old company is likewise regarded as a premier industry innovator that consistently ranks in the top 100 of US corporate patent recipients. Even Apple Computer defies the high-tech, high R&D intensity stereotype associated with successful innovation icons. Apple’s 2004 R&D intensity of 5.9 per cent lagged behind the computer industry average of 7.6 per cent. More significantly, its $489m annual R&D spending was a fraction of larger competitors such as Sony or Microsoft. Yet the iPod, iTunes and iBook enjoy breakthrough status as profitable innovations that have extended the company’s global reach.
This anecdotal evidence is not atypical. Last month, Booz Allen, the consulting giant, published a report confirming the fears of executives who see innovation as a holy grail to market share and profitability. The survey of the world’s top 1,000 corporate R&D spenders found there was “no discernible statistical relationship between R&D spending levels and nearly all measures of business success including sales growth, gross profit, operating profit, enterprise profit, market capitalisation or total shareholder return”. In other words, more is not better. Econometricians may quibble over the survey’s methodological details but it is intriguing to note that the companies in the bottom 10 per cent of R&D intensity significantly under-performed their competitors on gross margins, gross profit, operating profit and total shareholder returns. Alas, the top 10 per cent of R&D spenders enjoyed no consistent performance differences compared with companies that spend less on R&D. But why should R&D spending be exempt from the iron laws of diminishing returns? The only surprise here is that anyone is surprised. The simple fact is that R&D spending – whether in euros, dollars or as a percentage of sales – is an input, not a measure of efficiency, effectiveness or productivity. Ingenuity, invention and innovation are rarely functions of budgetary investment.
What rational investor believes that a $100m big-budget Hollywood movie will be 10 times more entertaining – let alone 10 times more profitable – than a skilfully marketed $10m independent film? Not even the studios believe that now. Giving a hedge fund manager an extra $100m does not assure greater return on investment. Quality of management matters far more than quantity of money, to pretend otherwise is delusion.
These issues are particularly acute for R&D spending. For example, €1m today buys vastly more computing power than even five years ago. Indeed, pharmaceutical, financial service, telecommunications and consumer electronics companies get far more design value for far less money from their information technology spending now than a decade ago. Similarly, global market leaders such as General Electric, Microsoft and Unilever are doing more R&D in developing markets such as China and India where quality research is much cheaper than in the west. Consequently, comparisons between the corporate R&D intensities of today with the intensities of yesteryear become even less meaningful.
R&D productivity – not R&D investment – is the real challenge for global innovation. Innovation is not what innovators innovate, it is what customers actually adopt. Productivity here is not measured in patents granted but in new customers won and existing customers profitably retained. While WalMart, Tesco and Dell have minuscule R&D budgets, their quality, procurement and growth requirements have probably done more to drive productive innovation investment than any five European Union funding initiatives. Growing market competition, not growing R&D spending, is what drives innovation. A successful innovation policy is a competition policy where companies see innovation as a cost-effective investment to differentiate themselves profitably. If a 1 per cent R&D intensity buys market leadership, more power to them; if 15 per cent is what it takes to keep up with the competition and satisfy customers, that is fine, too.
What is not fine – what is deceptive and destructive – is perpetuating a myth that the economic health of a country or of a global enterprise can be measured by how much it allegedly spends on R&D as a bid to invent the future. Europe should pay far more attention to the innovation value it creates rather than the level of corporate R&D funding. Its economic future depends on it.
The writer, a researcher at the Massachusetts Institute of Technology and Sweden’s Royal Institute of Technology, advises global companies on the economics of innovation
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