It's almost a year and a half that I started the MBA. Today for the first time I'm going to fulfill a promise to a friend who asked me to post papers that I wrote along the way. I haven't done so before because most of my papers are group papers and it feels weird posting something that is not entirely your own and people here might get "offended" or something.
So, I'm posting this paper for two reasons. First, it was written by myself and, second, I got very good comments from my professor.
Seba, I hope you enjoy it.
Now I can say I'm a published author hahahahahaa.
By the way, if someone thinks I might be infringing some copyright law or whatever just let me know and I take this out, this paper was done for academic purposes. And if someone wants to use its contents in a not-for-profit manner remember to reference the original sources please. Be nice ;-)
Regards,
Mateo
PS: This is copied from word so I don't know how neat it will be.
Appropriate ways to recognize and measure the performance of an “innovator corporation”. For the purpose of assessing the global technology competitiveness of a nation’s firms.
Abstract
This paper analyzes several studies that ranked companies in terms of R&D spending and tries to relate those figures to companies’ performance as “innovator corporations.” Then the paper provides dissimilar opinions of renowned personalities of the US business arena which, when aggregated, tend to show a shift in thinking to the approach of R&D spending and how it relates to innovation. This shift entails moving from a “spend as much as you can to be innovative” approach to a “be smart in what and where you spend to be innovative” approach. Then, the paper provides information of a survey done to more than a thousand executives performed by a popular business publication, which reflects this shift in thinking. Finally, the paper concludes that both quantitative and qualitative indicators have to be used in conjunction to determine a firm’s potential regarding innovation. All these indicators taken together would then lead to the notion of “quality of innovation.”
Body
A potentially useful indicator to determine performance of an “innovator organization” is the amount of R&D expenses either in absolute terms or relative to sales, profits or employees. These indicators are good because they are relatively easy to obtain and they are as objective as one can get. However, companies often report R&D in a way that makes it unclear how much they are spending in particular business areas. Particularly in today’s business conglomerates. Additionally, accounting rules could have a significant impact in this issue, especially if we are talking about global companies where different national generally accepted accounting principles exist. So far, the vast majority of studies that rank innovative companies are based on these indicators or a combination of them.
Studies on R&D Spending.
In December, 2005 the IEEE Spectrum magazine[1] published a study with R&D spending of companies around the world. This study shows some interesting results. For example, in the Technology Hardware and Equipment sector, from 2000 to 2004 R&D has decreased, both in absolute terms and relative to sales, by 9%. In the same period, the Software and Services sector while increasing R&D spending in absolute terms by 41%, its relative to sales R&D spending decreased R&D by 1%. The Telecommunications Services sector experienced a similar trend. Absolute R&D spending increased by 16% but it decreased by 23% relative to sales. In part, the dot.com bust explains the absolute reduction in R&D spending for these sectors. On the other hand, sales grew 3%, 42% and 51% respectively so one could think that R&D spending should have grown in similar terms if the correlation pays off. Nevertheless, these three sectors are considered high technology innovators sectors and the list of innovations during that five year period would be huge, particularly for the last two sectors. This implies that R&D spending was probably used more efficiently.
Another recent study done by the National Science Board[2] has several facts that are worth mentioning. For instance estimates of worldwide R&D spending went from $377 billion in 1990 to $810 billion in 2003 and this number is probably bigger since it is very difficult to accurately estimate it. Additionally, developing economies appear to take on a larger share of the total spent on R&D, this is implied from the fact that OECD countries’ share dropped from 93% to 84% over that period. This perhaps can be seen as an alarming fact for the US or US corporations, but the study also shows that globalization is leading to cross-border R&D investments. That is, more and more US firms (or from any country) are spending more on R&D outside their country of origin than they used to do it. For example, R&D expenditure of US corporations abroad went from $12 billion in 1994 to $21 billion in 2002. Or, the case of the United Kingdom that had more than a quarter of its industrial R&D supported by foreign owned corporations. So the real issue here is not where the money is spent rather than who gets the benefits of it.
The study does show some troubling statistics for the US though. For instance the US high-technology trade balance turned negative in recent years. Beginning in 1998, US high-technology industries’ imports exceed exports. A similar picture is drawn for US trade in goods with high-technology contents. Furthermore, an increase in growth rate of Asian patent filings proves growing technological sophistication among countries of that region. Besides, if patent filing is used as an indicator of innovation then it could be implied that the US is loosing ground vis-à-vis the Asian region.
These past studies imply as if something else besides R&D spending alone drives innovation. The leading question then is, what? In the next section some renowned personalities of the US business arena share their opinions on this matter.
Craig Barret, Intel’s Chairman and former CEO.
Clearly Craig Barret, Intel’s former CEO and current Chairman, believes that big R&D spending drives innovation. According to an article by Mike Ricciuti, Barret “poured cash into R&D while institutional investors called for layoffs.”[3] That would explain Intel’s top 15 position in the list of the IEEE study mentioned before with a budget of almost $4.8 billion in 2004 which grew to a current level of $6 billion according to a recent article in Knight Ridder Tribune Business News.[4] In addition, Mr. Barret believes the US has the most productive economy worldwide because of the amount of investments in Information Technology.[5]
Michael G. Carr, Business Consultant.
Michael G. Carr, the author of the 2003 Harvard Business Review article “IT Doesn’t Matter”, gives a somewhat dissimilar view on a recent interview with The Wall Street Journal.[6] Mr. Carr gives more importance to the where and how much companies encourage innovation than to the specific amount of R&D spending. He says that companies have to be prudent. Also, he advocates for companies to spend in areas where innovation can provide a return to them and where it would create a competitive advantage for them.
To achieve this, companies should align R&D spending with their corporate strategy. For example, Dell saw its competitive advantage on being a low-cost integrator of different technologies, while Apple saw its competitive advantage on its products. Thus, Dell focused its innovation efforts in its basic processes such as supply chain and Apple spends most of its innovation efforts in product design and development. Both companies are very successful at what they do. On the other hand, Gateway tried to do both things, innovate in processes and in products, at the same time at a large scale. This led the company to fail in such attempt and now is far behind its competitors.
Finally, Mr. Carr argues that innovation teams should not be overwhelmed by rules and regulations but that they should stay focused in the adequate areas of the company. Management’s role should be to keep them focused in those areas.
Jonathan Schwartz, Sun Microsystems’ CEO and President.
Jonathan Schwartz, Sun Microsystems’ CEO and President, has similar views to Mr. Carr’s view on innovation. Mr. Schwartz argues in a Financial Times article[7] that the key to true innovation is “a commitment to innovation that extends beyond the company’s research and development budgets to include every person, practice and policy within the organization.” Additionally, Mr. Schwartz mentions that an analysis of the top 1,000 global R&D spenders performed by Booz Allen Hamilton showed no statistically significant advantage to huge R&D spending leading to the conclusion that it is the process of managing R&D expenses what matters, not the amount by itself.
This is easier said than done. It takes courage to push for changes in the business model of a company, or its technology roadmap. Since the global economy places greater value on economies of speed, scope and skill rather than economies of scale, Mr. Schwartz says that innovation must be achieved by different, and smaller, departments and business units within an organization instead of huge R&D departments working in isolation. He also notes that innovation must include partners, suppliers and customers as well. These are great sources of new and innovative ideas.
Mr. Schwartz proposes five principles to build an innovation strategy. First, hire the best and let them lead you. Second, share with partners, customers and business groups to allow collaboration and open innovation. Third, create small groups and give them autonomy. Fourth, allow public debate. And fifth, have the courage to make hard decisions. Sun Microsystems based its innovation strategy in these five principles and on his opinion, it is working.
Apparently then, there is a shift in thinking from “spend as much as you can to be innovative” to a “be smart in what and where you spend to be innovative”. This shift is not only reflected in the personalities mentioned before, but also on the press as the following survey shows.
Survey: The World’s Most Innovative Companies.
This change in thinking is reflected somehow by a survey done by BusinessWeek magazine on The World’s Most Innovative Companies.[8] The resulting list based on answers from more than a thousand executives around the world does not match other lists based on R&D spending. For example the first two companies in the survey, Apple and Google, do not even appear in the top 100 of the IEEE Spectrum study.
Survey respondents considered 20 out of the first 25 companies to be product innovators. But the survey was not limited to that type of innovation; it also included process innovation and business model innovation. Thus, with the exception of 2 companies, all other companies were considered to have at least two of these types of innovation. This gives the message that innovation is becoming an even broader term. The report also states that, to expand opportunities, R&D labs should be opened to collaborate with suppliers and customers, share code with programmers, and tap into professional networks to obtain the best ideas. In addition, most respondents to the survey said that upper management, the CEO or Chairman in particular, was responsible for driving innovation.
On the other hand, the main issues that worked against innovation were; lengthy development times; lack of coordination; and risk-averse cultures within companies. Similarly, lack of customer insight or customer awareness is seen as a big obstacle to innovation.
Regarding the issue of how to measure innovation success, most respondents used overall revenue growth, percentage of sales from new products or services and customer satisfaction as possible metrics for it.
Another article[9] from the same report shows that more than half of the Top 25 innovative companies have better profit margins and higher stock prices than their competitors and their industries. For example these companies achieved a median profit margin growth of 3.4% a year since 1995 while the median for the S&P Global 1200 was 0.4%. In the same period the median annual stock return was 14.3%, three percentage points better than the S&P Global 1200. These facts should serve as encouragement for firms to innovate, and not just do it to survive or be able to compete efficiently.
Conclusion
Factual indicators such as the ones mentioned in the studies analyzed in the first part of this paper; absolute R&D spending, R&D as a percent of sales, as a percent of profits or per employee; do not seem to effectively reflect innovation performance. However, these cannot be discarded when analyzing performance of an “innovator organization.” At the same time, these indicators cannot be used in solitude, they need to be paired with other more “qualitative” indicators.
These indicators can be; top management commitment to innovation; alignment of innovation efforts with corporate strategy; and openness of R&D departments to partners, suppliers and customers.
Furthermore, innovative companies can be identified as leaders in their corresponding industries or sectors given its growth in sales and profit margins; sales coming from new products or services; or overall customer satisfaction.
These indicators taken as a whole would lead to what I call the notion of “quality of innovation” which I tend to think similar to what accountants call for “quality of earnings” when analyzing the financial aspects of a company.
Reference List[1] R&D 100, IEEE Spectrum, December 2005
[2] Science and Engineering Indicators 2006, National Science Board, February 2006
[3] Mike Ricciuti, Craig Barret: Inside Intel’s Future, ZDNet, October 22, 2003.
[4] Dean Takahashi, Intel still on the prowl: Chip maker pursuing range of markets in search of next breakout application, Knight Ridder Tribune Business News, September 30, 2006 < url="http://proquest.umi.com/pqdweb?did=" sid="5&Fmt=" clientid="31812&RQT=" vname="PQD">
[5] Mike Ricciuti, Craig Barret: Inside Intel’s Future, ZDNet, October 22, 2003.
[6] Interview to Nicholas G. Carr, “How to be a smart innovator”, The Wall Street Journal, September 11, 2006,
[7] Jonathan Schwartz, The five founding principles that drive innovation, FT.com, September 12, 2006, < url="http://proquest.umi.com/pqdweb?did=" sid="1&Fmt=" clientid="31812&RQT=" vname="PQD">
[8] The World’s Most Innovative Companies, BusinessWeek, April 24, 2006
[9] Creativity Pays. Here’s how much. BusinessWeek, April 24, 2006
