A select group of the world’s 1,000 largest corporate R&D spenders perform significantly better than their competitors over a sustained period while spending less on R&D than their industry rivals, according to management consulting firm Booz Allen Hamilton’s (BAH) second annual global innovation study.
“Innovation can lead to higher performance, but the process isn’t automatic and it does not necessarily require above average levels of investment. The most successful companies combine an integrated process and a supportive culture to create a sustainable competitive advantage,” Barry Jaruzelski, A Vice President of Booz Allen Hamilton. “There’s no silver bullet, and just throwing money at the problem is not the answer.”
The study found that although R&D spending of these 1,000 companies rose last year by more than $20 billion, money simply can’t buy effective innovation. However, a group of 94 “high-leverage innovators,” including Toyota, Apple, Christian Dior, Google and Caterpillar spend less than their competitors on research and development, yet consistently outperform their industry rivals across a broad set of performance measures.
“This survey reveals the significant impact overspending on R&D can have,” added Jaruzelski. “As companies in the Middle East grow and are able to compete on a more multinational level, they will increase their R&D expenditures, but they must be wary. This study shows that diverse companies located all over the world suffer from inefficient, and poorly thought out research spending that does not necessarily result in healthy returns. These are problems any type of business can have without proper preparation.”
BAH’s landmark study concluded from their global innovation study the following about R&D spending and corresponding success or failure:
• Less than 10% of companies are High-Leverage Innovators. Using a basket of seven performance measures from 2000 through 2005 BAH found that 94 of the 1000 major corporations that were analyzed 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. These High-Leverage Innovators use many different models and approaches to outperform their competitors, but are generally noted for their distinctive skill in at least one element of the innovation process and are adept across all of the stages. Examples of these High-Leverage Innovators include Toyota, Google and Apple.
• Companies are getting better at squeezing benefits from their R&D spending. Although R&D spending by the Global Innovation 1000 rose last year by more than $20 billion, revenues rose at an even faster rate. Indeed, the most meaningful indicator of innovation investment, R&D spending as a percentage of sales, has decreased steadily since 2001, and by that measure, only 40% of the companies actually increased their spending rate in 2005.
• Deep pockets can be dry wells. Money simply cannot buy effective innovation. There are no significant statistical relationships between R&D spending and the primary measures of financial or corporate success.
• Bigger can be better. Scale provides advantages to R&D spenders. For the largest 500 companies, median R&D spending was only 3.5% of sales in 2005, compared with 7.6% for the 500 smallest firms.
• Patents generally don’t drive profits. Boosting R&D spending can increase the number of patents that a company creates, but there is no statistical relationship between the number or even the quality of patents and overall corporate financial performance.
• One size does not fit all. R&D budget levels vary substantially, even within industries, which suggests there’s no consensus on the right level of innovation investment, since companies are using a range of different innovation business models.
• Effective innovators excel at four key elements. The high-leverage innovators distinguish themselves not by the money they spend, but by building strong capabilities in the four principal elements of innovation: ideation, project selection, product development, and commercialization.
• Nearly two-thirds of the 2005 total was spent in just three industries: computing and electronics (26%), health (22%), and automotive (17%).
• The Global Innovation 1000 companies spent a total of $407 billion on research and development in 2005, up 6% from 2004 — an amount larger than the combined Gross Domestic Product of Denmark and Norway and roughly equivalent to the budget of the U.S. Department of Defense.
• Global R&D spending is highly concentrated among the top 1,000. The next 1,000 companies spent a total of a mere $25 billion in 2005.
• The top 10 global R&D spenders in 2005 were, in descending order: Ford, Pfizer, Toyota, Daimler Chrysler, General Motors, Siemens, Johnson & Johnson, Microsoft, IBM, and GlaxoSmithKline.
To get the vital information required for this survey Booz Allen Hamilton identified the 1,000 public companies around the world that spent the most on research and development in 2005 (companies for which public data on R&D spending was available). Subsidiaries that were more than 50% owned by a single corporate parent were excluded because their financial results were included in the parent company’s reports.
“Our research found that most companies can achieve a greater return on their R&D spending if they view innovation as an end-to-end process that begins with a new idea and ends with a satisfied customer,” said Kevin Dehoff, Vice President at Booz Allen. “The most effective innovation is often not the most expensive.”
Booz Allen then analyzed key financial metrics for each of the top 1,000 companies for 2000 through 2005 — sales, gross profit, operating profit, net profit, historical R&D expenditures, and market capitalization. In addition, total shareholder return was computed and adjusted for each company’s corresponding local market total shareholder return.
“Middle East businesses can garner an incredible amount information from this study,” said Jaruzelski. “In a region that is becoming famous for its excess liquidity, local businesses here can use their vast resources to more efficiently develop useful innovation that will help them in the long run. The current temptation is to simply throw money at the problem, but as this study shows, that will not necessarily create a solution.”
The lessons gained from this study show a very international trend, making it apparent that overspending on R&D is not a regional problem, but a global one. Fortunately the solutions available to the problem are not regionally specific either, but can be implemented in any environment, including the Middle East.
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About Booz Allen Hamilton
Booz Allen Hamilton has been at the forefront of management consulting for businesses and governments for 90 years. Booz Allen, a global strategy and technology consulting firm, works with clients to deliver results that endure.
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