Pfizer says 24% cut in R&D is good for the company

Most high tech companies have ferociously guarded their R&D spending even through the great recession. In fact, cuts in R&D spending have been much smaller than the reduction in revenues. Hence, the R&D as a fraction of overall expenditure has actually increased through the recession. It is known that R&D spending does not guarantee increased profits. Many observers have pointed out that companies might actually be protecting the wrong investments.

Reuters had an interesting article recently about Pfizer cutting their R&D budgets by 24% in 2011 (See Pfizer R&D chief upbeat despite smaller budget):

Mikael Dolsten, Pfizer’s president of worldwide research and development, said making choices about research priorities was a ‘sign of a healthy company culture.’ ‘Our action was more a thoughtful deliberation after looking at how the industry has performed as a whole,’ Dolsten said in an interview on the sidelines of the Bio-Windhover Pharmaceutical Strategic Outlook conference in New York. ‘We feel that the amount of investment in R&D that we are committing to is really the right number to drive the priorities we have put in place.’

May be the cut in R&D spending will actually force managers to think through the R&D pipeline and remove pet projects and dead wood. This is especially important because Pharma R&D seems to have declined in efficiency and return on R&D investments have been falling (See Big pharma’s stalled R&D machine).

However, it is also quite common for CTOs to claim that cutting R&D budgets is a good thing AFTER the R&D funding has been cut. TI’s CTO suggested that their 25% cut in R&D spending actually sharpened their focus. What can R&D managers do to actually get the positive results? Freescale’s CTO made some great points about cutting R&D budgets:

Have a clearly defined strategy that drives investment decisions
Decide on what R&D you are NOT going to do and what you are.
Decide what R&D will be done internally and what will be outsourced to strategic partners
Tie marketing into the R&D planning and align roadmaps with customers

Great advice because pet projects have a way to stick around no matter what. Also, 90% of all cost cuts are reversed in three years unless there is a purpose and drive behind them. Here are some portfolio management best practices that you could follow. There is a lot more about portfolio balancing here.

Article first published as Pfizer Says 24% Cut in R&D is Good for the Company on Technorati.

Why Failure Breeds Winners

Business Week article Intelligent Growth: Why Failure Breeds Winners has two important lessons for R&D managers consider growth or innovation investments (and R&D planning in general):

(1) Define what failure looks like for growth investments—specify when and why disinvestment should occur. Then stick to the plan.

This is quite intuitive, but I have been consistently surprised at the lack of clearly defined goals/objectives for R&D projects. This lack of discipline always results in goal creep, waste of resources and reduction in R&D team morale.
So, the take home message is to develop a clear plan on how the growth bet (or innovation bet) is going to get delivered in products and tie investments to that plan. Also decides what signals a clear departure from the plan and have the discipline to cancel projects if they do. This plan would help combat the valley of death that frequently leads to innovation project failure. Furthermore, this plan would also help to

(2) Upgrade your growth investment process by shifting analytical resources away from up-front screening toward life-cycle analysis. Create a ‘learning loop’ for management by dedicating staff to mid-cycle and post-completion project evaluations.

There is significant evidence that consistent evaluation of innovation projects can have tremendous benefits to the organization in terms of management learning and market understanding. However, this is difficult to do:

Cycle discipline is intuitive but difficult to recreate in a large, complex corporation. Less than 10% of the companies we examined exhibited this kind of financial savvy for more than a few consecutive years at a time.

But well worth trying because the results are impressive:

Companies that are able to consistently grow sales and improve margin across multiple business cycles realize a 4.4% compound total shareholder return (TSR) advantage relative to industry returns over pure growth leaders, and a 5.4% compound TSR advantage over pure margin leaders.

Disruptive Innovation and IP

A quick article that elaborates on something that I have observed in many firms:

Though it may be difficult to convince a business to invest millions in pursuit of a speculative disruptive innovation, it is much easier for a small team to gain support in pursuing low-cost intellectual assets in the name of mitigating potential threats.

I have actually seen empirical data that the aggregate investment in these speculative patents far exceeds the net investment in innovation! The author repeats what many managers believe – patents are cheap so use them to protect markets:

A two-pronged approach is proposed that builds on the authors’ experience at Kimberly-Clark Corporation in dealing with disruptive threats and opportunities. The approach calls for generation of intellectual assets, often using small proactive teams

Specifically, the author suggests:

Protect yourself form other’s disruptive innovation by patenting first;
Use patents to create new business.

This approach though popular, is not easy to execute. It takes more than five years for a patent to issue. If one waits for patent issuance to decide which R&D projects to invest in, they will be far behind competitors and never be able to catch up. Millions of patents are issued each year.

It is pretty much impossible to keep up with issued patents, much less figure out who is infringing your patent and prevent them. So patents are a pretty weak approach to speculatively reducing competitive pressures. We sometimes see Motorola suing Apple. But Motorola has 10,000+ patents in cell phones. The cost of obtaining those patents $300M!

Even if one finds infringement, patent assertions are expensive and a pretty inefficient way to drive R&D strategy. In most cases, assertions take years to conclude. So from the time the inventor had an idea to asserting and changing market landscape will take 10-15 years at the minimum. How can one drive R&D strategy with that kind of a lag?

Finally, if the organization really knows which innovations are valuable, they could develop them in the first place. This approach of trying to do work around poor management decision making can lead to nothing but wasted effort.

Take home message from me is exactly the opposite of what the author suggests. Patent ONLY when you believe it is going to help you develop a significant product. Speculative patents should be limited to foundational technologies not individual products.

R&D Complexity Impacts Number of Concurrent Projects

Here is a quick article with some empirical proof of what we all suspected: Increased complexity of products under development leads to fewer concurrent development projects (Development Resource Planning: Complexity of Product Development and the Capacity to Launch New Products. Abraham Sin Oih Yu. 2010; Journal of Product Innovation Management):

The number of new product families that a firm can effectively undertake is bound by the complexity of its products or systems and the total amount of resources allocated to NPD. This study examines three manufacturing companies to verify the proposed model. The empirical results confirm the study’s initial hypothesis: The more complex the product family, the smaller the number of product families that are launched per unit of revenue. Several suggestions and implications for managing NPD resources are discussed, such as how this study’s model can establish an upper limit for the capacity to develop and launch new product families.

Between Invention and Innovation

Here is something different – an excellent report developed for the National Institute of Standards & Technology on analysis of funding for early-stage technology development. You might want to dig through the 150+ page report when you have time, but here are my notes on what I learned from it:

The project has sought to answer two sets of questions:
– What is the distribution of funding for early-stage technology development across different institutional categories? How do government programs compare with private sources in terms of magnitude?
– What kinds of difficulties do firms face when attempting to find funding for early stage, high-risk R&D projects? To what extent are such difficulties due to structural barriers or market failures?

Some findings:

We found that most funding for technology development in the phase between invention and innovation comes from individual private-equity “angel” investors, corporations, and the federal government-not venture capitalists. Our findings support the view that markets for allocating risk capital to early-stage technology ventures are not efficient. Despite (or in response to) market inefficiencies, many institutional arrangements have developed for funding early-stage technology development. This suggests that funding mechanisms evolve to match the incentives and motivations of entrepreneurs and investors alike.

We also found that the conditions for success in science-based, high-tech innovation are strongly concentrated in a few geographical regions and industrial sectors, indicating the importance in this process of innovator-investor proximity and networks of supporting people and institutions. Among corporations, the fraction of R&D spending that is dedicated to early-stage technology development varies both among firms and within industries. The latter variation may be related to industry life cycles. Overall, we found that the federal role in early-stage technology development is far more significant than would be suggested by an uncritical glance at aggregate R&D statistics. Federal technology development funds complement, rather than substitute for, private funds. Decisions made today regarding the nature and magnitude of federal support for early-stage technology development are likely to have an impact far into the future.

1: Most innovation funding comes from everyone but venture capitalists. As per the article venture capitalists are not in R&D / innovation business, they are in financial business.

Most funding for technology development in the phase between invention and innovation comes from individual private equity “angel” investors, corporations, and the federal government — not venture capitalists.

2. Markets for allocating risk capital to early stage technology ventures are not efficient. Many entrepreneurs remain thirsty for funds while venture capitalist are sitting on funds.

A report from the National Commission on Entrepreneurship notes that “the substantial amount of funding provided through informal channels, orders of magnitude greater than provided by formal venture capital investments and heretofore unknown and unappreciated, suggests some mechanisms for filling the gap may have developed without recognition” (Zacharakis et al. 1999: 33).

3. Geographic concentration because of angels and technologists (needs virtual teams to get products to market?)

Conditions for success in science-based, high-tech innovation are strongly concentrated in a few geographical regions, indicating the importance in the process of innovator-investor proximity and networks of supporting people and institutions.

4. Early stage technology development funding (as a fraction of total R&D spend) varies from 0% in software to 30% in biotech)

Among corporations, the fraction of R&D spending that is dedicated to early-stage development varies both among firms and within industries. The latter variation may be related to industry lifecycles.

Innovation’s Dirty Little Secret

The Businessweek Article Innovation’s Dirty Little Secret talks about how many organizations pay lip-service to Innovation:

Recently I spoke with a group of executives from a $3 billion division of a large industrial company. They were faced with a mandate from the chief executive to expand the firm’s service revenue from 20 percent to 33 percent. That’s almost $400 million in new revenue, yet when I asked how many people were on the team, the leader replied meekly: “Two.”

Some organizations like IBM clearly seem to invest a lot in Innovation and have found ways to make it successful (I am not sure what is innovation in a transformation from product to service business…)

Rosabeth Moss Kanter’s October 2009 Harvard Business School case study, ‘IBM in the 21st Century: The Coming of the Globally Integrated Enterprise,’ details many acts carried out by the leadership team during the company’s fabled transformation from a product to a service company. Executives were prepared to put big money where their mouths were when it came to supporting service-based ideas, such as ‘Innovation Jam,’ or such businesses as ‘On-Demand’ software, and strong messages about the importance of services were sent.

One last interesting learning from Kaiser – it is a great approach to make sure high risk high reward projects actually get implemented:

when a promising innovation project is about 50 percent complete, she brings together representatives from information technology, patient services, and facilities management to assess how to scale it across the company’s vast system. By evaluating the “O-Gap”—that is, the space between pilot and operations—this group takes into consideration everything from process realignment to environmental modifications, as well as the training requirements needed to foster wide adoption of the change.

Are Companies Protecting the Wrong R&D Investments? – Scott Anthony – Harvard Business Review

An older HBR article talks about Are Companies Protecting the Wrong R&D Investments.

An article in Monday’s Wall Street Journal suggests that many executives understand this dynamic. The Journal found that R&D spending at 28 large U.S. companies dropped a mere 0.7 percent in the dismal fourth quarter of 2008.

Is maintenance of R&D budgets a good thing? We have found a couple of examples (TI and FreeScale) that leveraged the downturn to eliminate low return R&D projects from the pipeline. There is also some evidence that R&D spending does not automatically guarantee profits. This article reinforces that theme – use downturn to evaluate and prune the R&D project pipeline, but do not focus exclusively on near-term projects because that will have a negative long-term impact on competitiveness.

Research by Innosight Board member Clark Gilbert found that when companies perceive a threat, they tend to become very rigid in their response. The very act of “protecting” R&D budgets could lead to high degrees of rigidity, which could lead companies to missing the most important innovation opportunities.

Companies should use today’s tough times as an excuse to critically evaluate their innovation investments. As I argue in Chapter 2 of The Silver Lining (coming next month!), companies need to think about prudently pruning their innovation efforts to focus on ideas with the most potential. Companies should seek to balance focus on near-in opportunities with appropriate investments in exploring new markets that have the potential to be tomorrow’s core business.

While we are on the subject, here is another article suggesting the same thing – Cut Costs, Grow Stronger:

“If you are a corporate leader, you have probably been spending a lot of time lately thinking about costs. In the aftermath of the global economic crisis of 2008–09, the pressure to cut costs — whether driven by cash flow, shareholders, uncertainty, or investment needs — has been extraordinary. Many businesses are struggling to survive. Others, even if they’re doing relatively well, are reducing expenses to make sure they are well prepared for future uncertainties. But there is a positive side to this situation. Dramatic cost cutting gives you a chance to refine or even reformulate your company’s overall strategy. After all, you’re never just cutting costs. You’re making a decision that something is no longer strategically relevant, and that other things are essential to keep. Yes, you may have to lose some product lines and activities, and perhaps some of your employees and customers. You also, however, have the opportunity to help your company grow stronger in the process. We reject the idea that cutting costs in itself makes a business weaker or more limited. To be sure, if you reduce expenses in a panic, or without an eye to strat egy, you could do great harm to your company’s competitiveness. But if you focus on your priorities and on your future potential, cutting costs can be a catalyst for ex actly the change a company needs.

Finally, here is a simple framework that can be a good reminder of what to keep and what to cut:

Freescale CTO on R&D Strategies

NE Asia Tech-On has interviewed Freescale CTO on R&D Strategies. The interview does focus quite a bit on the semiconductor industry, but there are some useful hints for R&D managers everywhere.

First – a clearly defined strategy is quite useful do build focus and drive efficiency (even though it is not done very effectively in many organizations):

Before the Lehman Shock, we detected a sign of business recession. So, we decided to retreat from the business for mobile phones and announced it in October 2008. At the same time, we decided to focus on four areas, namely, automobiles, networking, consumer and industrial products.

Among them, we will cover almost everything in the fields of automobiles and networking, which we consider are our core businesses. In the fields of consumer and industrial products, we will cover part of them such as smartbook PCs and electronic book readers in the field of consumer products and smart meters, smart grids and home-use mobile medical devices in the field of industrial products.

It is also important to define what will be done in-house and what will be sourced from the outside. Many organizations run into problems with open innovation when there is a conflict between what is being done internally and what is sourced:

We did basic researches when we were a part of Motorola. But, currently, we do not do basic researches in our company. We tie up with colleges and consortiums for them. For semiconductor makers, the day of technological development for technologies ended long ago.

There is also a need for tighter communications between R&D and marketing, and FreeScale clearly recognizes it

What is important now is to solve customers’ problems. Therefore, the ideas of the R&D division are summarized as PowerPoint files. The sales stuff and marketing people bring them to our customers and ask their opinions. If the customers do not like the ideas, they will be dumped

However, I am not sure if PowerPoint files are the best approach to communicate R&D intent to customers for many organizations. Who will be developing these documents? How does one maintain version control? How does one bring feedback from the customers back and incorporate the into R&D – through PPT?

Finally, one more hint about being responsive to customer needs vs. being submissive to customer demands:

We cannot make products that have an impact on business just by using the ideas of the R&D people. We are doing research and development by considering customers’ opinions and market needs as well as taking advantage of our technologies. I said that we tie up with colleges and consortiums. But, in addition to that, we are collaborating with the industry leaders and our partners to solve our customers’ problems.

Six Myths of Corporate Strategy

Corporate Executive Board had a very good summary of Six Myths of Corporate Strategy:

Myth 1: Most Executives Want a Clear Strategy
Myth 2: Employees Want Strategies to Succeed
Myth 3: Visionary Strategists Deliver Premium Returns, Silencing all Opposition
Myth 4: Executives Should Force-Rank Investment Opportunities Based on Expected Return
Myth 5: Strategists want to Maximize Shareholder Value
Myth 6: Strategists Should Start with the End in Mind

I have found many an organization where executives do not wholeheartedly support a well defined strategy / plan because it would make them more accountable (someone can measure performance relative to plan – probably erroneously). Sometimes organizations are very afraid of failure and this makes executives hedge plans to make sure success can be declared every time. This has been a very important lesson for me to learn: In one of my consulting engagements I followed what the executive said literally and tried to come up with a clear strategy. I was redirected quietly and quickly. This is not a criticism of executives in any way. Just something all R&D managers must keep in mind. One has to deliver the right results within the boundaries of existing culture and organization.

Employees pretty consistently vote for their personal gain rather than company strategy. One example of this behavior is patent protection. Patents are very very expensive to obtain. In most cases, patent protection will not generate a positive return on its investment. Most employees understand this quite well, but still want patents because it makes their resume much stronger.

I think processes and tools need to be flexible enough to allow R&D managers to make practical decisions within organizational realities. For example, it may not be optimal to rank all R&D opportunities based on pure financial metrics. R&D investment management is a balancing act – satisfying a plethora of conflicting needs – from near-term market entries to long-term disruptive technologies to skill-set improvements. We need tools that effective allow R&D managers to make these trades.

2010 Global R&D funding forecast at greater than $1.1 Trillion

R&D magazine produces an annual Study on global R&D funding forecast that is full of great information. In 2010 R&D spending is going to exceed $1.1T globally (flat from 2008). US continues to lead at almost 35% of the global R&D budgets, but the share seems to be flat to declining. Finland and Sweden lead the world in number of scientists/engineers per million people.

Almost 75% of the organizations have changed R&D plans because of the recession and a similar fraction has actually reduced focus on R&D.

Lots of interesting data. Check it out…

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