Booz, Allen, Hamilton recently reported on their Global Innovation 1000 research in “Money Isn’t Everything.” We briefly mentioned the report here. However, the findings are significant enough that an indepth discussion is needed.
So, why do I think the findings of the research are significant?
We argued here that self-orientation, even if it works for your business, shouldn’t be confused with understanding customers. Money Isn’t Everything provides the following insight into expenditures on research and development (R&D): “when a company is seeking to grow through innovation, it’s more important to develop a robust business model and good cross-functional capabilities than to boost the R&D budget” (p. 6) The authors use the R&D-to-sales ratio as the measure of how much real spending companies do on R&D and what their return is on that investment. Their findings are very interesting in relation to the self-orientation of some companies.
“We found only one strong performance correlation. Higher R&D-to-sales ratios were associated wtih higher gross margins: the percentage of revenue left over after subtracting the costs of materials, labor, manufacturing, and direct shipping, and after paying other expenses incurred in making the products or services sold…Gross margin percentage is an indicator of product differentiation, low manufacturing cost, or both” (p. 5).
The Booz, Allen, Hamilton research goes on to note that R&D efforts in the Global 1000 are succeeding in the traditional sense of the term, i.e., building better mousetraps: “products and services that are less expensive to build (like a Dell computer), desireable enough to sell at a premium (like a BMW car), or both (like an Apple iPod)” (p. 6). Nevertheless, they point out that, if you include all the indirect expenses into the calculation, the gross margin benefit is masked and the relationship between spending and performance disappears. So, does that mean companies should just cut their R&D budgets? No, not necessarily.
The research cautions about cutting R&D as well as adding to R&D. It contends, “There are signs that both overspending and underspending may contribute to the performance disconnect in the Global Innovation 1000″ (p. 7). In other words, it depends on what you spend relative to your competitors. Companies spending in the bottom 10 percent of indexed R&D-to-sales ratios do worse than everyone else. So, there is a negative for not spending enough on R&D and remaining self-oriented in your innovation efforts. However, the research adds that spending in the top 10 percent did not prove statistically significant to better performance when compared to the middle 80 per cent of companies in R&D-to-sales ratios.
So, what can we glean from these somewhat paradoxical findings of the Booz, Allen, Hamilton researchers? We suggest the following lesson to take away from their research, and it calls into question the decision of many companies to remain self-oriented, focused inward, as they develop products and services:
Develop more organizational ways to engage ideas from outside the corporation and encourage dialogue with the individuals or groups offering them.
The development of open innovation through use of global and/or cross-company innovation networks is a good example of one implementation. One of the reasons research and development spending doesn’t show statistically significant results in enterprise performance is that many research and development efforts still occur in corporate “silos,” separated from manufacturing, marketing, and sales. Yet, 70 percent of the cost of a product or service results from design decisions made by staff, such as parts standardization, suppliers used, and the complexity of the product’s features. So, open innovation must also involve dialogue and collaboration among cross-functional areas. A dialogue-based innovation strategy will focus on networks of collaboration across the enterprise, with business partners, and with networks of customers.
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