Widely viewed as the key to corporate success, innovation has become a constant topic of discussion in business. Sophisticated investors need to understand the relationship between the R&D investment and corporate success, so that they can properly appraise investment opportunities. For example, they may find an under-performing company and be able to turn it around by injecting R&D funds – or so it would seem. It is not quite that simple.
R&D spending and growth
Received wisdom had been that improved company performance automatically followed increased R&D spending, but no research supported this. Throwing money into R&D does not guarantee positive results. Rather, for positive returns from increased R&D spending, more than cash is required. The company has to effectively exploit the technology outcomes of the R&D.
Some of the biggest innovation successes in recent years were not produced with big budgets, and extra resources could actually impede effective innovation. Free-issue resources tend to get squandered, and when cash is plentiful, it can get wasted too.
Threshold of R&D spending
Although R&D spending and corporate success are not closely coupled, analysis has shown that a threshold exists. Performance suffered if the company fell into the lower 10% of R&D spending in its peer group. However, there was no serious impact on the performance if the company was in the middle or the top 10% of the peer group. Interestingly, this might also suggest that there is an upper threshold.
So, it is not about how much a company spends on its R&D. Rather, it is about how the company goes about utilising what it possesses. These are: the tools, the processes, the culture, the organisation, and the shape of its product portfolio.
Studies have identified companies that consistently outperformed their rivals even while spending less on R&D (we talked earlier about an upper threshold). These companies were significantly different from their competitors in several aspects. What they were doing was utilising a model for high-leverage innovation.
Another misconception is the role of patents as an indicator of the success of innovation. The number of patents was closely linked to R&D spending, but shareholder returns, profitability and company growth were not linked to patent registration rates.New technology and innovation
New technology is not synonymous with innovation unless it starts to drive significant new revenue streams. Otherwise, it cannot be considered as real business innovation.
MP3 players existed before the iPod, and so did online purchasing and downloading of music. The iPod was not really innovative. Rather, it was iTunes and the easy to use one-stop shop for music which was the real innovation – a business model innovation. The innovation transformed the digital music industry.
It is a stark example of taking the customer’s perspective and innovating.
Clearly, the more closely linked the innovation strategy and the business goals, then the better the performance in terms of income growth and shareholder value. Companies that are the most fanatical about satisfying customers tend to be the sector leaders.
Fundamental innovation strategies
There are three distinct fundamental innovation strategies:
- Technology driven innovation.
- Market based innovation.
- Need based innovation.
Technology-driven innovation is a ‘push’ strategy and does not succeed unless an effective innovation capability exists: ‘we’ve invented this, now what can we do with it?’
Need-based innovation strategies are ‘pull’ strategies where R&D seeks to satisfy an existing need: ‘People want to buy music from one online store – any music, any time. How can we satisfy that need’?
Market-based innovation strategies can use marketing to create a need. In this respect it sits between the other two. Feminine hygiene/deodorant products are an example of a need being created by marketing, and a whole new product category being created which leveraged existing technology.