Is R&D Spending Ready to Blow?

Companies remain reluctant to spend their cash but are starting to get more innovation-minded, creating some new priorities for CFOs.
David McCannJune 27, 2013

Companies are poised on the cusp of a transition from the cost-saving and cash-hoarding mode many have been in since 2008, to a more innovative mindset marked by a willingness to resume spending on research and development. CFOs will be point people for executing that transition.

So says David Axson, executive director of Accenture’s Finance & Enterprise Performance consulting group. “There’s not a lot of optimism [about the economy], but there’s a bit, and organizations are beginning to look for sources of growth,” says Axson, who spoke at last week’s “Budgeting for Innovation” conference in New York City, hosted by CFO.

Growth-minded companies are finding the pricing on acquisitions to be “a little high” right now, and few companies these days are able to exert much control over the pricing of their products and services. Therefore, they’re looking more at organic growth, Axson tells CFO in an interview following his address.

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Global R&D spending is projected to be about $1.5 trillion this year, up 3.7 percent from 2012, according to a forecast by R&D Magazine.

But even though innovation and risk go hand in hand, companies are leery of spending much of their rainy-day kitty on product and service innovation without strong evidence that the investments will pay off. “They’re not just going to write big checks like they did before,” he says. “The financial crisis was a game-changing event [whose impact on corporate strategy] will last for a whole generation. Most organizations are reluctant to eat into their cash pile.”

That means a shift in focus for finance chiefs. “We’re beginning to see CFOs take a much more active role in understanding the relative risk-and-return tradeoff around innovation,” says Axson.

Finance leaders engaged in such efforts should look to instill more discipline in the process of evaluating and allocating capital to potential R&D investments, he advises. “Where’s the line item in the budget for innovation? Well, you probably don’t have one. There’s a little bit buried in an IT project over here, a little bit in a customer service program over there. You’re not really managing innovation in a holistic way at the moment.”

The goal is to be able to tell the board of directors, “Here’s what we’re going to spend to keep the business running, here’s what we’re going to spend on process improvement, and here’s what we’re going to spend on new products, new markets and new technologies.” And the investments should be classified by type: big, “change-the-world” ones and point-solution ones around a specific product or customer group.

But for Axson, the most important aspect of managing innovation successfully is establishing firm criteria for pulling the plug on an R&D effort that’s not paying off and investing the cash in something else. “The big thing about innovation is that most of it will fail,” he says. “The key is how quickly you identify that something is going to fail.”

Analyzing R&D investments requires different tools than CFOs use in most of their other endeavors, notes Axson, who co-founded The Hackett Group, a finance benchmarking firm. “By definition you can’t benchmark innovation. There’s nothing to compare it to,” he says. And it requires more than traditional tools like a cash-flow analysis, net-present-value and internal-rate-of-return calculations, and a return-on-capital estimate, or even modern tools like activity-based costing, zero-based budgeting and balanced scorecards.

Rather, it may be necessary to use nontraditional tools like real-options analysis and five forces analysis.

For his part, Axson thinks companies are being too conservative with their cash. But while CFOs are often seen as the folks who cut budgets and quash ideas, he doesn’t blame them. “They’re paid to be relatively cautious and the conscience of the organization, so I can’t criticize them,” he says.

Rather, the reluctance to spend is an organizational trait that likely originates above the CFO. “The cash sitting on balance sheets isn’t earning any money. Ultimately you’ve got to find something profitable to do with it. Right now there’s a lot of pressure to return it to shareholders through dividends and share buybacks, but at some point the topline has to grow.”