Few fields move as rapidly as technology. Businesses creating outsized profits and returns for shareholders quickly get bull's-eyes on their backs. Other companies clamor to disrupt their products by selling cheaper alternatives that still prove "good enough." Even if a company continues to dominate its particular field, other changes in technology can shift spending away from its products; Microsoft still dominates PCs, but it's watching more of that segment's sales move toward mobile devices like smartphones and tablets.

With that in mind, today we're looking at how NetApp (Nasdaq: NTAP) stays ahead of the pack. Technology companies can innovate either through acquisitions, or by spending more on research and development (R&D). We'll compare NetApp's spending in these areas to that of its closest peers, and assess whether the company is investing enough in its future.

Research and development
Over the past five years, NetApp has spent an average of 13% of revenue on R&D. The table below summarizes how NetApp's R&D expenditure relative to revenue compares to that of some of the company's closest peers:

Company

2006

2007

2008

2009

2010

LTM

NetApp 12.2% 13.7% 13.7% 14.1% 13.6% 12.7%
EMC (NYSE: EMC) 16.6% 15% 15.2% 16.1% 15.1% 15%
Seagate (Nasdaq: STX) 8.7% 8% 8.1% 9.5% 7.7% 8%

Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates above are calendar years, while yearly total is for company fiscal years closing in that period.

As you can see, NetApp traditionally spends at a slower clip than key rival EMC. The gap between 12.7% and 15% spending on R&D might not seem large. But if NetApp were to boost R&D spending to the same level as EMC on a per-sales basis, it would decrease its operating margins a substantial 14%, from $832 million to $712 million. Due to its larger size, EMC also spends more than three times as much as NetApp's total R&D. You can see why battling a storage- industry leader like EMC can be difficult.

In addition to NetApp and EMC's R&D spend, note the lower clip seen at Seagate. While Seagate deals in commodity hard disks, it still requires a fair amount of spending, especially for new initiatives like solid-state drives (SSDs). Seagate's high R&D commitments illustrate why larger IT firms with storage aspirations, like Dell and Hewlett-Packard, might have a tough time gaining traction in mid and high-end storage systems.

Acquisitions
In technology, some of the best companies have turned growth through acquisitions into an art. IBM has adeptly spun off capital-heavy businesses like hard drives and PCs while it focused on acquiring the additional services and software expertise that have transformed its business model.

However, on the opposite end of the spectrum, Hewlett-Packard is often criticized for underinvesting in research and development, to the point where it has to overpay on acquisitions just to catch up with competitors.

Most of all, investors should remember that companies are valued by the cash flow they can bring in for their shareholders over time. If companies must perpetually purchase rivals to keep growing, those outlays effectively reduce their cash flows. Thus, investors should treat acquisition spending as a continuing outflow against cash flow. With that in mind, let's take a look at NetApp's free cash flow over the last five years, relative to cash spent on acquisitions.

Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates above are calendar years, while yearly total is for company fiscal years closing in that period.

Compared to EMC, NetApp has shied away from acquisitions in recent years. NetApp originally bid on data deduplication specialist Data Domain, before EMC swooped in to buy the company for $2.1 billion. With a wave of consolidation sweeping up most the juicy storage plays, there aren't a lot of splashy buys left for NetApp. However, the company might continue picking up smaller additions to complement its storage portfolio along the way.

Final thoughts
In spite of its much smaller size and ability to fund internal R&D and make acquisitions, NetApp has performed admirably in recent years, regularly besting EMC's growth rates in external storage. As the industry continues to deal with growing amounts of data and increasing complexity, the two companies should continue standing at the top of the storage pile for a long time to come.

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Eric Bleeker owns shares of no companies listed above. The Motley Fool owns shares of International Business Machines, EMC, and Microsoft. Motley Fool newsletter services have recommended buying shares of and creating a diagonal call position in Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.