Strategy

R&D Spending Doesn’t Spell Profit

A new study finds no discernable link between research-and-development spending and nearly all measures of business success, including growth, prof...
Craig SchneiderOctober 11, 2005

Increased investment in research and development rarely buys the financial returns and growth that managers are seeking, according to a new study by Booz Allen Hamilton.

The consultancy — which analyzed data from the 1,000 companies in the world that had the highest R&D spending in 2004 (and that reported their expenditure) — found no discernable link between spending levels and nearly all measures of business success, including growth, profitability, and shareholder return. The only statistical relationship that Booz Allen identified was that R&D spending appears to yield better gross margins.

Even so, managers seem to believe that ramping up R&D is required to fuel their future growth, noted the report. The 1,000 companies examined by Booz Allen spent $384 billion on research and development in 2004, representing 6.5 percent annual growth since 1999 and a 11 percent growth since 2002.

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Investing too little in R&D can hurt results, Booz Allen acknowledged: Of the 1,000 companies studied, those in the bottom 10 percent of R&D spending as a percentage of sales underperformed their competitors on gross margins, gross profit, operating profit, and total shareholder returns. Companies in the top 10 percent, however, displayed no consistent performance differences with the others.

“Successful innovation demands careful coordination and orchestration both internally and externally,” said Booz Allen vice president Barry Jaruzelski, in a statement. “How you spend is far more important than how much you spend.”

Not surprisingly, larger companies have an advantage in that they can spend a smaller proportion of revenue on R&D than smaller businesses without noticeably affecting their performance, the report also noted.

North American, European, and Japanese companies account for almost all of the R&D spending examined in the survey. While those businesses and have annual R&D growth rates in the single digits — likely a reflection of company maturity and the magnitude of their current spending, according to Booz Allen — China and India have growth rates of 21 percent.

The report also noted that differences in the industry mix allow developing economies to show a higher ratio of R&D spending to sales. As a percentage of revenue, China and India spend only 1 percent on R&D, compared with 4.9 percent for businesses in North America, 4 percent in Europe, and 3.8 percent in Japan.

The top 10 global R&D spenders in 2004, according to the study, were Microsoft, Pfizer, Ford, DaimlerChrysler, Toyota, General Motors, Siemens, Matsushita Electric, IBM, and Johnson & Johnson.

Other findings include:

• Patents don’t always lead to profits. In a separate analysis, Booz Allen found no relationship between the number of patents issued to an organization and its performance.

• The technology, health, and automotive sectors spend the most on R&D, with 25 percent, 20 percent, and 18 percent respectively.

• The fastest pace of R&D growth over the past five years was in the software and Internet sector (15 percent per year), and the health sector (12 percent); telecom (2.2 percent) and chemicals and energy (1.4 percent) grew the slowest.