A new golden age?

Henry Ford once famously said, "If I'd have asked my customers what they wanted, they would have told me 'A faster horse.'”

This philosophy was a driving force for Steve Jobs at Apple, who held a clear vision for his products which was initially not accepted by the market. It is easy to forget that in 2003 the Mac's market share was 2%. But Apple kept its nerve and when the iPod took over 70% of the MP3 market, it validated Jobs' model.

Jobs' legacy includes many famous quotations about building products and the confidence that is required to invest in a vision ahead of market demand for it:

"You can't just ask customers what they want and then try to give that to them. By the time you get it built, they'll want something new."

It’s really hard to design products by focus groups. A lot of times, people don’t know what they want until you show it to them.

It’s not about pop culture, and it’s not about fooling people, and it’s not about convincing people that they want something they don’t. We figure out what we want. And I think we’re pretty good at having the right discipline to think through whether a lot of other people are going to want it, too. That’s what we get paid to do. We just want to make great products.

Most people agree that Steve Jobs was an outlier like Thomas Edison or Ford. This raises an important question for CEOs seeking to emulate this success. If you are not Jobs and your company is not Apple, is visionary R&D is the best way to generate shareholder value?

The R&D-led innovation paradigm championed by Jobs emerged from the technology race of the Second World War. It was President Roosevelt’s science policy of separating 'R' from 'D' that laid the foundations for the golden age of Bell Labs, IBM and Xerox PARC. These were innovation-led companies whose scientists and engineers created a stream of world changing inventions.  Nobel prizes and commercial success went hand in hand within these legendary institutions, and provided a template for how innovation happens. However, these innovation hubs were creatures of their time, founded as de facto monopolies.  Their market dominance afforded their people the luxury to build inventions in the knowledge that if they built it then customers would eventually come – after all, what other choice did they have?

Today, innovation happens differently. The end of the Cold War and the intervening triumph of free markets have created a global competitive market across most industry sectors. This has resulted in shrinking product lifespans, ruthless capital markets and the end of tenure at the top table.

The Internet, Big Data and technology have democratised R&D, eliminating many barriers to entry. An open-architecture innovation framework that recruits brainpower from such diverse sources as online gaming communities to solve protein-folding problems or provides a common infrastructure into which independent developers can build software applications is the 21st century’s version of Bell Labs.

That said, the United States is still a huge investor in old-fashioned R&D. The Innovation 1000 (a list of 1,000 inventive US companies) spent over $647 billion on fundamental R&D in 2014.  This spend was across multiple industries and included companies such as Pfizer, Boeing, Siemens and GE.  The top 10 investors in R&D in 2014 – including VW, Samsung, Intel, Microsoft, Roche, Novartis, Toyota, J&J, Google and Merck – invested between 3% and 20% of their gross revenues back into R&D .

The annual peer-reviewed survey of innovation conducted by Booz (now Strategy&) highlights the world’s most innovative companies. This uses peer reviews to differentiate innovative capacity from R&D spend. Booz highlights the notion that innovation success has more to do with aligning business strategy with core competence than investing in lab work. Their list of the most innovative companies for 2014 shows modest overlap with R&D spend, with only Toyota, Microsoft and Intel present in both lists. 

But for investors, the important question is whether any of this generates shareholder value.

The top 10 performing companies of 2014 by share price growth were Actavis, Salesforce, De Vita Healthcare Partners, Amazon, Alexion Pharmaceuticals, American Tower, Eastman Chemical, Flowserve, Apple and Mastercard. This means that only one company from Booz's Innovation List made the cut (Apple), and none from the R&D rankings. Further, if you extend the analysis over five years and compare the stock market performance of the top 10 companies by R&D spend to the index, there is minimal outperformance in terms of stock price. 

You have to look deeper into the drivers of performance to gain some insights into what is driving value.

Actavis is a generic drug maker whose shares (partly driven by M&A) have risen by 231% over five years. As US healthcare reform bites and the patent cliff continues to destroy protected revenue streams for Big Pharma, generic drugs are stealing market share. Actavis is a spectacular growth story in a double-digit growth industry. Salesforce has grown by 170% over three years, partly through the benefit of having no pre-cloud legacy. The company has left the established R&D behemoths of Microsoft, Oracle and SAP in its wake. Momentum and growth into marketing applications are being propelled by acquisitions, which in the words of management "drive growth faster than organic strategies can".

This is the reality in today’s markets. Innovation is no longer the province of quasi-monopolistic companies whose R&D dollars define the product landscape. It is an open source free-for-all where M&A is a more efficient route to market than organic growth. Given the high risk and low productivity of R&D in general, this makes intuitive sense. The public markets reward growth and earnings and are often criticised for this – the implication being that this reflects short-term thinking. But market share is critical in technology industries. Becoming the de facto standard either culturally or operationally creates competitive advantage and builds shareholder value. Speed to market combined with a more efficient R&D or IP strategy is a winning formula.

The take-home message is that we are in a new golden age and experiencing a paradigm shift in innovation and commercialisation. The successful companies of the next decade will be those that can align business strategy with this market reality and adopt R&D and innovation policies that support this approach rather than looking backwards to the 1950s.

R&D matters; innovation matters; but the way in which these critical functions happen in 2015 looks quite different from the past. To quote Jobs once again:

"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 an Insight article, written by a selected partner as part of IAM's co-published content. Read more on Insight

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