STRATEGY

Grist: The Investment Trap

Companies that pump more money into RD do not show better results, in terms of growth or profitability. Yet RD spending continues to surge.
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Innovation is our economy's growth hormone, and all businesses spend an increasing amount of energy in its pursuit. In doing so, it's tempting to believe that R&D spending and corporate performance are linked--that the more you invest in the future, the more the future will be on your side.

Well, hold on to your budget. The consulting firm Booz Allen Hamilton recently examined the performance of 1,000 companies over the past six years. Among its findings: Firms that pumped more money into R&D did not show better results, in terms of either growth or profitability, than those that didn't. "You can't spend your way to prosperity," says Booz Allen's Barry Jaruzelski. Yet R&D spending continues to surge--because, according to the survey, many executives continue to believe that enhanced innovation is required to fuel future growth.

I confess that I'm among those who have fallen for the conventional wisdom that those who fund R&D generously will outperform their rivals. The survey's results drove home the extent to which I've been programmed to believe that more money leads to better ideas. And I suspect I'm not alone.

How did we get it so wrong? I'm inclined to place the blame on a single word, one that inevitably accompanies any discussion of R&D spending: invest. It seems innocuous enough, but talking in terms of "investing" in a business venture is a way of sugarcoating the risk involved. Compared with, say, "spending," investing implies long-term vision and prudent allocation of resources. It makes us feel better about parting with our money. It's why colleges talk about investing in your child's education.

Consider for a moment how different everything would seem if the term "invest" were replaced by a more accurate one: "gamble." Can you imagine saying to your shareholders, "Next year, we'll be gambling 20% more on our R&D budget"? Or producing a presentation that proudly proclaims, "Gambling on our people is part of our culture"?

The simple truth is, when you put money into any initiative, you're rolling the dice. The challenge is to place intelligent bets, or hedge the really risky ones. One of the masters of this is Apple Computer. According to the Booz Allen survey, Steve Jobs's idea factory had a 2004 R&D-to-sales ratio of 5.9%--far less than the computer-industry average of 7.6%. And Apple's total R&D budget for the year, $489 million, was a fraction of that of larger rivals like IBM. How does Apple do it? "It's the process, not the pocketbook," the study's authors note. Rather than going off on ill-conceived economic safaris, Apple focuses its resources on a few big initiatives, recognizing that they are high-risk/high-reward gambles. Then the company energizes its entire culture around those wagers. Think of it in terms of chemistry: Gambling drives adrenalin; investing, melatonin.

What would happen if you looked at all of your funding allocations as a series of Las Vegas alternatives? My sense is that you would recognize that no single part of a company is inherently more worthy of money than another. And that there are no correct, or safe, answers to budgetary questions, either.

I hereby propose that the word invest be banished from all corporate discourse--particularly from budget meetings. Once that word is gone, it might be easier to get a handle on some of the skittering emotional and psychological factors that go into making financial decisions. And let's cop to the amount of risk we're dealing with here. Smart gamblers know when to hold them and when to fold them. And so do smart entrepreneurs.

Adam Hanft (grist@inc.com) is founder and CEO of Hanft Unlimited, a Manhattan-based consulting, advertising, and publishing firm. For more Grist, visit the Marketing Resource Center.

Last updated: Dec 1, 2005




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