Some corporate expenses are non-negotiable. You need lights. You need workers. You need to buy the raw materials with which to make your widgets. Compared to these tangible concerns, you might think that research and development ("R&D") spending is less critical. You'd be wrong.
Great companies change and evolve over time, and R&D often fuels those changes. Apple
Clearly, companies need to improve and expand existing offerings and establish new lines of business, both of which depend heavily on R&D. But merely throwing money at research and hoping for success just isn't enough.
According to a recent study by the folks at the consulting business Booz & Company, Microsoft
Booz & Co. found how well and consistently a company focuses on and executes a set of critical innovation capabilities matters more than how much it spends. The study listed three particular innovation strategies that companies can pursue:
- Need seekers work with consumers to determine what's needed and desired, then aim to be the first to bring those offerings to market. Many companies do so via focus groups.
Market readers observe customers and competitors closely, tweaking and improving their offerings and developing new ones from observed trends. Procter & Gamble
(NYSE: PG), keeps releasing newer and better razors. Toyota saw growing interest in alternative-energy vehicles, and introduced the successful Prius.
- Technology drivers often "solve the unarticulated needs of their customers via new technology." Consumers didn't initially know how much they needed an iPad until Apple presented it to them.
While Booz's list of the 10 biggest spenders spent an average of 13.2% of sales on R&D, its list of the 10 most innovative companies averaged just 7.2%. The two top innovators with the lowest spending "intensity" were General Electric
Both companies highly value innovation. In an interview, former Procter & Gamble CEO A.G. Lafley once said, "The name of the game is innovation. We work really hard to try to turn innovation into a strategy and a process that's a little more consistent [and] a little more reliable."
GE CEO Jeffrey Immelt similarly noted, "It's important to make growth a process … I want a pipeline of innovation."
The big picture
Booz also found that good R&D is not enough, either. The most successful innovators also excel in manufacturing, logistics, sales, marketing, and human resources.
How big an opportunity are you going after here? … What will drive its value? Where are the biggest technical risks? What might cause the project to fail? … Where there's risk, you have to put in the extra work to ensure you capture the potential value.
Investing in innovative companies can pay off with blockbuster results. When you're sizing up prospective stock picks, look at total R&D spending -- but also make sure to check how effectively a company is coming up with new offerings.
Microsoft is a Motley Fool Inside Value choice. Apple is a Motley Fool Stock Advisor recommendation. Johnson & Johnson and Procter & Gamble are Motley Fool Income Investor recommendations. The Fool owns shares of and has written covered calls on Procter & Gamble. Motley Fool Options has recommended diagonal call positions on Johnson & Johnson and Microsoft. The Fool owns shares of Apple, Johnson & Johnson, and Microsoft. Try any of our investing newsletter services free for 30 days.
Longtime Fool contributor Selena Maranjian owns shares of Apple, General Electric, Microsoft, Johnson & Johnson, and Procter & Gamble. 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 is Fools writing for Fools.