When comparing Apple (NASDAQ:AAPL) to other big tech companies such as Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL), Microsoft (NASDAQ:MSFT), and Facebook (NASDAQ:FB), the iPhone maker invests substantially less money than its peers in research and development, especially when measuring R&D spending as a percentage of revenue.
This can be an important reason for concern among investors; the smartphone industry is maturing, and Apple will need to rely on innovation to compensate for slowing growth in the iPhone segment with new products and services in the coming years. On the other hand, successful innovation is about much more than investing enough money in research and development.
Is Apple underinvesting in R&D, or do things just work differently for the company?
On R&D dollars and percentages
When it comes to big tech companies such as Apple, Alphabet, Microsoft, and Facebook, comparisons are not very straightforward. These are fairly unique companies with their own business models and strategies, so it makes sense to expect some differences in R&D spending in relation to sales. However, the difference is still quite noticeable, and Apple is way behind the other tech leaders in this regard.
Apple allocated $8.1 billion to R&D during the fiscal year ended in September of 2015 -- this means roughly 3.4% of revenue during the period. In comparison, Alphabet invested nearly $7 billion in R&D during the first nine months of 2015, amounting to 16% of revenue. During fiscal 2015, Microsoft allocated $12 billion to R&D, or 13% of sales. Facebook comes in well ahead of its peers: The social network invested $3.5 billion, or 29% of revenue, in R&D during the nine-month period ended in September.
Scale is an important factor to consider when analyzing these kinds of figures. Reinvestment needs typically slow down as a company grows in size -- all else the same, a company with higher revenues tends to spend less money in R&D as a percentage of sales.
Since Apple is much bigger than Alphabet, Microsoft, and Facebook in terms of revenue, it makes sense to expect a smaller ratio of R&D spending in relationship to sales for the Cupertino giant. But the difference is still staggering, and Apple is going through a crucial stage in which innovation could be of utmost importance for the future of the business.
What would Steve Jobs say?
Steve Jobs was clearly one of the most successful and innovative business leaders in history. His vision and philosophy are still a big part of Apple's culture, and he never believed that money was the most important factor when it came to driving successful innovation.
In an interview with Fortune in 1998, Jobs noted:
Innovation has nothing to do with how many R&D dollars you have. When Apple came up with the Mac, IBM was spending at least 100 times more on R&D. It's not about money. It's about the people you have, how you're led, and how much you get it.
This is a crucial differentiation. The company's leadership and culture can be much more important than money when it comes to making innovative breakthroughs. You can't just buy your way to successful innovation when you don't have the vision and skills.
Besides, Apple is different than most other companies in the tech industry. Apple likes to focus its attention and financial resources on a few projects with big potential, while most other tech players typically diversify their R&D spending on a larger amount of projects at the same time. Apple puts quality over quantity when selecting projects for R&D spending.
Besides, Apple's gargantuan scale is a crucial advantage in this area. When a supplier is working on a new semiconductor, a better screen, or a camera with higher resolution, selling it to Apple can have a major impact on the business, so suppliers have huge financial incentives to develop innovations and take them to Apple.
Since suppliers are doing much of the heavy R&D spending for Apple, the company can selectively focus on the few important projects where it believes its own money, time, and human resources are truly well spent.
Whether Apple can continue bringing successful new products and services to the market remains to be seen, but one thing is quite clear, innovation is about much more than money, and Apple has a very particular way of doing things. With this in mind, investors in Apple don't have many reasons to be concerned about relatively low R&D spending as a percentage of sales.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Andres Cardenal owns shares of Alphabet (A and C shares), Apple, and International Business Machines. The Motley Fool owns shares of and recommends Alphabet (A shares and C), Apple, and Facebook. Try any of our Foolish newsletter services free for 30 days.