Research & Development: Smarter Spending

With limited R&D resources but plenty of new product concepts, manufacturers are learning to focus on affordable product strategies.

Toyota spends an average of $22.7 million per day on research and development, according to James Press, president of Toyota Motor North America. Microsoft Corp. CEO Steve Ballmer says the Redmond, Wash.-based technology firm will spend more than $6 billion in research and development in 2006. And aerospace giant Boeing Co. said in July that it expects R&D outlays to be approximately $3 billion in 2006 and 2007, "reflecting higher investment in planned product development programs such as the 787, 747-8 and international tanker."

Industrial expenditures on research and development are forecast to reach $211.9 billion in 2006, an increase of 3.5% over the previous year, according to the annual Battelle-R&D Magazine forecast issued in January. More recently, Boston Consulting Group (BCG) released survey results that show 72% of companies worldwide will increase spending on innovation in 2006.

While research and development is an important component of many manufacturers' business strategies, determining how much to spend and on what projects is no easy feat. Indeed, "one of the most common questions we get asked by senior executives is, 'How much should I be investing?'" says BCG's James P. Andrew, Chicago-based senior vice president and head of the consulting firm's worldwide innovation practice. "And competitive benchmarking is rarely useful -- the required level of detail and comparability simply cannot be obtained in most cases."

At Chicago-based Boeing, planning the R&D budget is a formal, six-month process that occurs annually, says Robert J. Krieger, chief technology officer and president of Phantom Works, the company's advanced research and development unit. "We start about this time of year [July] and by the end of the year have an R&D plan in place that we execute for the following year."

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Research and development is important both to Boeing's growth and productivity. "It's not unusual to think of R&D driving growth and driving new products," Krieger says. "But it's also very important to keeping your current products affordable, keeping them current in technology. The tendency is to focus on the growth drivers R&D gives you and not the productivity within the current products." (Among new products for which Boeing has received much advanced publicity is the Dreamliner 787, billed as extremely fuel-efficient. First delivery is slated to occur in 2008.)

The drive to determine what R&D projects Boeing pursues starts with each business unit's product lines reviewing their product strategies and determining what capabilities they would like to enhance for current or future products, Krieger says. Of course, a wealth of additional factors also come into play -- affordability, for one. "How much can we afford to do and still be profitable in the near term but invest enough to have improved productivity and growth in the future?" he says.

There's also the value proposition of proposed projects. "Is it going to help me acquire more orders if we are successful at this R&D project, or is it going to make my current product more valuable?" Krieger asks. Answers to these questions also help prioritize Boeing's projects.

A third consideration is risk. R&D involves stepping into areas that haven't been explored, so there exists both the risk of being unsuccessful or of a project costing significantly more than planned for. "Sometimes you are willing to take more risk if there's a big payoff," Krieger says.

Krieger points to the Phantom Works unit as an example of how a company with multiple product lines can use its R&D resources more efficiently. Located in St. Louis, Phantom Works is a centrally managed R&D organization with personnel spread across the enterprise and in many locations. Its role is to look across the entire Boeing portfolio -- which includes commercial and military aircraft, as well as integrated defense products -- and find opportunities to perform common R&D that is applicable and beneficial to more than one product line.

A Shade Generous

Microsoft wields a big R&D budget and weighs in with bold statements about innovation efforts. "If you believe in the opportunity we believe in, you've got to invest behind it," stated

Microsoft's Ballmer in a speech he gave in May. "You've got to be optimistic about your ability to change the world. You've got to make big, bold bets."

Few likely would argue that Microsoft has made its share of big, bold bets. That's not to say, however, that its focus isn't on spending its money wisely. According to Ballmer, "You can do something for $100 million, or you could do it for $80 million . . . but what you really want to do is make sure that the $100 million helps you generate $1 billion instead of half a billion. So when we look at an R&D investment . . . we're always grinding and grinding and grinding, and we can always grind harder."

And when push comes to shove? Ballmer admits that he tends to err on the side of being just a shade generous - not in terms of the R&D team's requests, but in terms of his own instincts. "It's almost worse on the revenue side to miss a good opportunity, or to present a hole in our overall strategy to competition, than it is to be slightly high on R&D," Ballmer explains.

Where To Begin?

Boston Consulting's Andrew suggests that answering three questions may help a company determine the appropriate amount of funding it should invest in research and development:

  1. What are your objectives? "Investing to lead, especially when working in areas of fundamental science [in the technological area], can be extraordinarily expensive," according to Andrew. "On the other hand, the cost of a ticket to watch, with the resulting lag time, is usually much lower."
  2. How much can you invest in this area on a consistent basis? "The most difficult budget to manage for results is usually the one that fluctuates wildly from year to year," he notes.
  3. How much is needed to generate some sort of critical mass? Andrew describes this as the most difficult, and the most important, question to address. "We often see companies 'participating' in areas with investments far below the level required to meet their objectives, but nonetheless still significant in absolute terms."

Boeing's Krieger advises manufacturers trying to build an R&D budget to keep a strict focus on product strategy. "You have to keep asking: Is there a strategy here? Is there a capability that strategy demands, and is there an R&D project that can provide that capability?" he says. "There's a danger of just having an R&D project that may or may not link with strategy if you're not careful. There are plenty of ideas out there and ways to make things better or make a product that may be competitive, but you really need to keep going back and asking, 'Have you linked this to strategy and capability?'"

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