Michael Schrage wrote a great op ed piece for the Financial Times on November 8. Under the headline of “For innovation success, do not follow where the money goes”, Michael rips in to those who equate R&D spending with innovation in response to a recent UK Department of Trade and Industry report focusing on global R&D spending.
I urge you to read the whole piece; it is unrelenting in its attack. Let me just quote some of the juicier pieces:
Any policymaker, chief executive or innovation champion who relies on R&D intensity and R&D budgets as a meaningful or usable metric to assess global competitiveness virtually guarantees shoddy analysis and distorted decisions. Few things reveal less about a company’s ability to innovate cost-effectively than its R&D budget. Just ask General Motors. No company in the world has spent more on R&D over the past 25 years. Yet, somehow, GM’s market share has declined.
Michael makes clear that R&D spending is only an input:
The simple fact is that R&D spending – whether in euros, dollars or as a percentage of sales – is an input, not a measure of efficiency, effectiveness or productivity. Ingenuity, invention and innovation are rarely functions of budgetary investment.
He also makes an important point about some of the most innovative companies in the world today:
While Wal-Mart, Texco and Dell have miniscule R&D budgets, their quality, procurement and growth requirements have probably done more to drive productive innovation investment than any five European Union funding initiatives.
Finally, Michael draws some important implications for public policy:
Growing market competition, not growing R&D spending, is what drives innovation. A successful innovation policy is a competition policy where companies see innovation as a cost-effective investment to differentiate themselves profitably.
Right on! In my consulting career, I have participated in many analyses seeking to draw a correlation between R&D spending and business performance in specific industries. The conclusion: there is absolutely no correlation – what you get is a scatter diagram.
I only wish that Michael had gone a bit further and spent more time attacking a related fallacy: equating patents with innovation. At least this approach focuses on outputs, rather than inputs, but it focuses too narrowly on only one kind of output. In effect, it equates innovation with invention. This immediately narrows the focus to product innovation and largely ignores process and business model innovation. The longer I work on innovation, the more convinced I have become that process innovation is far more powerful than product innovation – it has a multiplier effect that product innovation can rarely match.
Bottom line, the only effective measure of innovation activity is the rate of productivity improvement in an enterprise – the growth in value added generated per employee. There are lots of ways to “game” productivity in the short-term – for example, by raising prices or by cutting staff and forcing the remaining people to work harder. But these can’t be sustained – over time, they generate diminishing returns or, in the extreme case, lead to productivity erosion. That’s why static productivity measures can be misleading. What really counts is the ability to sustain and amplify productivity improvements through innovative products, process improvements or new business models.
From a competitive viewpoint, what matters is the relative rate of productivity improvement. R&D spending and patent filings will matter little if they do not translate into faster productivity improvement – in fact, they can be a significant distraction. Those who understand this will have a significant edge as competition intensifies in the global economy.