Higher R&D spending doesn’t mean greater innovation

Companies are investing ever-greater sums into research and development, but throwing money at the problem will never supersede a coherent strategy

  • By Mansoor Iqbal | Tuesday, June 6th, 2017

Investment in innovation goes much further when targeted at specific areas of need. Quality trumps quantity every time

In order to remain competitive in the 21st century, companies must continue to innovate, generating new products, streamlining the production process, improving delivery, and refining the customer interface. Investment in R&D is key. It is no coincidence many of the companies appearing on Strategy&’s 10 Most Innovative Companies list also feature in the Top 20 R&D Spenders list. Certainly, even companies synonymous with innovation – Apple, Alphabet and Amazon, for example – can only maintain their status through substantial investment. In 2015-16, Apple invested $8.1bn in R&D, while Alphabet and Amazon both spent in excess of $12bn.

However, spending is not a prerequisite for innovation. Despite playing host to some of the world’s largest spenders – notably Roche ($10bn), Novartis ($9.5bn) and Johnson & Johnson ($9bn) – the health sector fails to place on the technology-dominated innovation list. The same can be said for the automotive industry, which occupies a number of the top spending spots, but can only lay claim to one of the world’s most innovative companies: Tesla.

Despite ranking fourth on Stategy&’s list of most innovative companies, Tesla spent just $700m on R&D in 2015-16; a fraction of the figures posted by the 20 largest R&D spenders

Utilising R&D spending
Despite ranking fourth on Stategy&’s list of most innovative companies, Tesla spent just $700m on R&D in 2015-16; a fraction of the figures posted by the 20 largest R&D spenders. With the world’s largest corporate investors racking up a combined R&D bill in excess of $680bn, there is no question innovation costs. But, as Elon Musk’s outfit has illustrated, the correlation between investment and innovation is not quite as simple as one might assume. There’s no shortage of literature mapping the relationship between R&D investment and economic growth on a national scale, but we should not assume the same holds true at a corporate level. Indeed, industry commentators have repeatedly asserted there is no significant parallel between the amount a firm invests and its subsequent financial performance. That said, a failure to invest does tend to have a negative effect; the bottom 10 percent of firms in terms of R&D investment lag behind their competitors in a number of financial metrics.

Of course, the level of R&D intensity (investment measured against sales) varies across different industries, with some, such as healthcare, requiring far higher levels of investment. One thing that does remain certain, however, is that investment into R&D in no panacea for poor performance. Barry Jaruzelski, John Loehr and Richard Holman of the Financial Times left no room for doubt in their analysis: “We have tested this issue over 10,000 different ways and the answer remains the same.” It seems it is not the size of the R&D investment that counts, but rather how it is utilised. Leading innovator and apparent big spender Apple reinvests just three percent of its revenue in development. Meanwhile, Google and Microsoft also have relatively conservative strategies, investing 10.4 percent and 12 percent respectively. Yet these companies remain at the top of the innovation rankings.

Companies must develop innovations that are not necessarily the most advanced or the best available, but which meet the specific needs of the market. Strategy&’s report highlighted firms investing over 25 percent of their R&D budget in software enjoyed stronger revenues than those investing less in the area. Equally, it predicted the percentage of R&D budgets allocated to product offerings would fall from 46 percent to 37 percent by 2020.

How innovation delivers value
We need to note, however, that there is no one-size-fits-all approach to innovation. The most important thing, according to Harvard Business School professor Gary Pisano, is to have a coherent innovation strategy that closely aligns with the overall strategy of the business. To allow the best ideas to flourish, there must be structures in place to dictate how a company identifies, develops and allocates funding to the ideas that resonate with its overall goals.

This ultimately provides scope for the trade-off decisions that allow innovations to move forward, shaping systems that can be moulded or improved over time according to each company’s needs. Crucially, this will also help to resolve interdepartmental tensions, namely between those focused on developing new ideas and those responsible for maintaining or developing relationships with clients in the short term.

Pisano divides innovation into quadrants: routine, disruptive, radical and architectural

In order to shape a strategy, a company must understand how its innovation will deliver value to the customer, and, when successful, how it will retain the majority share of this value against its competitors. In this vein, Pisano believes technical innovation is not always the best way to achieve a competitive advantage, suggesting firms can often find greater prosperity in business model innovation. Indeed, many of the companies considered to be among the most innovative – Netflix, Uber and Amazon, for example – have benefitted from this model.

Pisano maps this assertion by dividing innovation into quadrants: routine, disruptive, radical and architectural. While routine innovation leverages both an existing business model and existing technical competencies, a disruptive model provides a new business model for existing technical competencies. Alternatively, radical innovation uses the existing business model to promote new technical competencies, while an architectural model of innovation is completely original.

With a strategy identifying whether a company is primarily looking to innovate technically or strategically – or both, or indeed neither – each proposed idea can be placed on this matrix. Despite sounding the least impressive, Pisano stresses routine innovations are not to be sneered at, with the annual rush for the latest model of the iPhone an example of how routine innovation can consistently drive revenue. But blindly investing in R&D provides no guarantee of revenue-generating innovation. Successful innovation strategies must be a little more nuanced.

Unconscious bias in the selection process
Even with a coherent strategy and structure in place, firms must ensure they identify the best ideas. In a paper published in 2016, Professor Paola Criscuolo of the Imperial College Business School identified an unconscious bias commonly found within R&D selection panels. The study found panels would often err towards R&D proposals with an intermediate level of ‘novelty’: ideas or concepts considered to be new to the firm itself.

Criscuolo stated: “Companies shouldn’t invest their whole R&D budget in radical new projects, but if they don’t invest enough in products with a high level of novelty, they run the risk of losing their competitive advantage in [the] marketplace. ‘Next’ projects are the ones that have [the] highest impact in terms of generating new clients and of deepening the expertise of those who work on them.”

Criscuolo suggested this unconscious bias can lead to difficult conversations; after all, there is little point investing in ideas so radical they will never conceivably be implemented. This, once again, highlights the necessity of a coherent strategy. Furthermore, research found personal endorsements from within the company were often highly influential in funding decisions, particularly among panels lacking expertise. Ideas presented by applicants with a track record of receiving funding also stood a far better chance of being selected. Interestingly, members of the panel were more sceptical of novelty ideas pitched by colleagues they worked closely with – perhaps in order to avoid charges of nepotism or to distance themselves from high-risk projects.

What can firms do, then, to ensure unconscious bias doesn’t have a negative effect on the R&D process?

What can firms do, then, to ensure unconscious bias doesn’t have a negative effect on the process? According to Criscuolo, the answer is simple: “Letting managers know that they could unconsciously select certain types of projects can be very powerful.” Criscuolo found that being made aware of unconscious biases can often have a profound effect on decision makers. Meanwhile, building a panel of experts from a number of different disciplines ensured the plausibility and potential of each idea was properly assessed. Criscuolo provided another clear recommendation: “Companies should consider having meetings when a certain threshold of ideas has been reached. There is sometimes an obsession with doing things quarterly, meaning selectors end up with 150 projects to look at and are not able to give them the proper amount of attention.”

Another way to counter this issue is through collaboration. Companies will often seek the consultation of external experts when expanding their business into unchartered territories, but due to the sensitive nature of R&D, the process can become complicated. This is not to say it cannot be successful, however. Criscuolo cited GlaxoSmithKline’s continued use of external experts as a great example of collaboration providing substantial financial benefits. Again, it seems shrewd selection is an essential element of successful R&D.

Consider R&D collaborations
Companies must, therefore, be careful when considering with whom to collaborate. Professor Annique Un, an international business and strategy expert at Northeastern University, found that, when it comes to process innovation, firms had greater success collaborating upstream than downstream. Un believed working with partners further up the knowledge chain, namely universities and suppliers, was far more beneficial than working with those further down – consumers and competitors, for example.

“The reason is that the main objective of process innovation is to improve efficiency. Upstream partners know more about the internal processes of the firm than downstream partners. They know more about… processes such as the flow and quality of its input, [or] where and how to make the changes in the company to reduce costs and improve quality.”

However, Un stressed this particular observation is specific to process innovation. In more general terms, Un believed partners with a contextual difference – consumers and universities, for example – offer greater benefits to companies seeking to innovate. This is because they often provide an alternative knowledge base to the company in question.

There are, we can safely conclude, a great number of factors to consider when investing in R&D – only some of which have been touched upon here. But one thing is for certain: building and executing a leading R&D strategy (one that takes into account the size and market position of the company, stipulates the type of innovation it hopes to achieve and articulates how ideas are selected) should be the fundamental practice of any company hoping to compete in the modern marketplace.