Pictures of the Future    Fall 2006

R&D Spending: How Much is Enough?

Interview with Steven Veldhoen

What was the goal of your "Global Innovation 1000" study?

Veldhoen: We wanted to use hard facts to demonstrate how important innovation is for business success. That’s because in our consulting work with customers we noticed that they have been placing ever greater priority on the issue of innovation over the last ten years—but there were hardly any reliable figures to help us understand the true impact of innovation on business results. So the first thing we did was to identify the top 1,000 companies in terms of their published figures on R&D expenditure. We then analyzed key figures for sales, costs and profitability over the last six years and compared them with R&D expenditure.

What did you find?

Veldhoen: We were shocked by the fact that there was no correlation between a high level of R&D expenditure and a company’s success. In other words, we had to abandon the widespread conviction that "a lot helps a lot" because the performance of the top ten R&D companies is not disproportionately better than the mid-range companies that spend less on R&D. Nonetheless, the adage that stinginess will be punished does apply, as the ten percent of the companies examined that spent the least on R&D fell far behind their competitors with regard to earnings and return on equity. So spending too much doesn’t help, but spending too little can damage a company—that’s what the results come down to. We also found a connection between a company’s size and its R&D budget. The bigger the company, the less it needs to spend on R&D, as the leverage effect of R&D is stronger at large companies. So a good innovation by a global player will have a more significant impact on its sales and earnings than the same innovation made by a smaller company. This is valid for nine of the ten industrial sectors we studied.

How can a company determine what its optimal level of R&D expenditure should be?

Veldhoen: Our study shows that this is very difficult. If you look at the data according to industrial sectors or geographical location, you won’t find anything to give you an optimal level of expenditure. However, you can get closer to such a determination if you look at companies that have enjoyed similar results within the same sector with similar products. Still, even then it’s hard to come to a firm conclusion. If, for example, the optimal figure for R&D investment proves to be 9.3 % of sales, you still don’t know what you should be spending that money on, or how to manage expenditure in a manner that yields the highest possible return.

How do your results differ from those of similar studies, such as one conducted by the Boston Consulting Group (BCG)?

Veldhoen: Some studies that have looked at specific subsets of data have shown somewhat different results. For example, some years ago an academic study of companies listed on the London Stock Exchange showed that for the period of time studied a high level of R&D expenditure had guaranteed superior business performance. All I can say is that our study, which had a wider scope, could not confirm these prior results on a global basis. But our study and BCG’s do not contradict each other. We both argue that companies that create effective innovation environments have a chance to thrive. But our study specifically cautions that the answer does not lie in "spending your way out of the problem." BMW, for example, has a highly efficient R&D management system. Despite a large-scale model offensive, the percentage of BMW’s sales spent on R&D is only slightly higher than the automotive industry average—but it posts much higher business growth and earnings than most of its competitors.

Does a leader in technology always have to spend more on R&D than its competitors?

Veldhoen: No. Toyota, for example, is only number three in terms of R&D expenditure, but it’s still the industry benchmark for many. Toyota has its process and product strategies so under control that it’s been able to become the world market leader in hybrid technology in just a short period of time. Then there’s Apple, which is a good example of a company with an excellent portfolio strategy. Still, it invests relatively little in R&D. After 1996, Steve Jobs began abandoning a lot of research projects and focusing on three or four products. This was a daring move—but it led to the creation of the iMac, the iBook, the iPod and iTunes, which today give Apple its reputation as one of the world’s most innovative companies.

What can we conclude from such success stories?

Veldhoen: We’ve identified four factors for achieving success with innovations. First of all, a company has to align its innovation strategy with its overall corporate strategy. That’s not as evident as it seems—in fact, a lot of companies don’t do it. Second, it must have a stringent portfolio strategy targeted at the right products and business areas. Third, such companies manage their innovation processes quickly and efficiently—in other words, they have their R&D pipeline under control. Finally, successful corporate innovators must have a healthy culture of innovation throughout their organization.

What role does networking between internal and external experts play here?

Veldhoen: It’s a type of ecosystem for innovation that’s extremely important for a company. This can range from close ties with universities to optimal relations with suppliers and customers, who need to feel they’re being listened to. Toyota, Bosch, Siemens and Honda, for example, are companies with acknowledged histories of innovation. That’s why they attract the best engineers in the world.

How can the quality of employees be assessed in an R&D benchmarking study?

Veldhoen: You can look at facts such as your R&D staff’s level of education, training and experience. There’s no doubt that a solid development team is one of the most important factors for successful innovations. That’s why many companies are searching for talented staff and new ideas around the world and opening development centers in places like China and India. This is only partly due to these countries’ lower wage levels—it also has to do with many companies’ desire to enter into interesting new markets and recruit the world’s best developers.

Is it possible to precisely measure "return on innovation investment?"

Veldhoen: That’s not easy. In fact, it can only be done in a very rudimentary manner after a technology has matured and become available on the market. Profits aren’t the only criteria to be considered here, however. You also need to know how important a particular technology is for your most important customer groups, and whether or not competitors also have that technology in their portfolio, or instead will not even be able to develop it because you hold all the key patents.

                                                                                      Interview by Nikola Wohllaib