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Saturday, October 30, 2004

Investor Perspective

Joe Thomas, writing in the Investors Chronicle (29 October, 2004), casts doubt on the benefits of R&D. "It now seems to be accepted wisdom that more R&D spending by business is good for innovation and that, in turn, is good for profits. ... The problem is that investors don't seem to believe it."

This statement is based on Joe's interpretation of some data contained in the R&D ScoreCard 2004, published by the UK Department for Trade and Industry (DTI). The report includes a chart comparing R&D intensity (defined as the proportion of sales revenue that is spent on R&D) with the market-capitalization-to-sales ratio. I've extracted some of the data into the following table.

R&D intensity



sales ratio

High Telecoms, Food Producers Health, Pharma, IT, Software

Construction Electronics, Aerospace

Joe interprets the data to mean that R&D isn't consistently delivering shareholder value across all sectors, at least from an investor perspective. "If investors did think that higher R&D spend would lead to higher sales and/or higher profitability, then you might expect sectors with the highest R&D intensity to have the highest market-cap-to-sales ratios." The table shows that this is true for some sectors. but not for others.

Joe is undoubtedly correct about the lack of consistent benefits. But there are other ways of looking at the table. Many companies innovate in ways that are not reflected in R&D spend. Conversely, there are many companies with high R&D spend which fail to innovate in other areas. Thus R&D intensity is not a valid indicator of overall innovation within a company or sector. What we may note is that for some companies - perhaps especially those in the top left quadrant - innovation is dominated by product innovation, carried out within R&D. In other companies, innovation is found in other areas: quality, process improvement, production efficiency, manufacturing excellence, marketing, customer relationships, brand. The table therefore reflects the contribution of R&D to innovation as a whole, and is not just about the investment returns from R&D.

For further comments on the R&D Scorecard, see Innovation or Refinement?

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