Why doesn't R&D spending correlate with financial performance?

As part of my research for this year’s ASSEMBLY Top 50 story, which appears in the October issue of ASSEMBLY magazine, I also looked at R&D spending for the top 50 publicly owned manufacturing companies in the United States. I assumed that the highest ranked companies in the Assembly Top 50 would also be among the biggest spenders on R&D.

In fact, there was no consistent correlation between R&D spending and financial performance. For example, 11 companies in the Assembly Top 50 have posted three or more consecutive years of double-digit revenue growth. Of those, only one, No. 16 Motorola, was among the top 10 in R&D spending, and just two more-No. 4 GE and No. 24 Cisco Systems-were in the top 20. The company with the highest ratio of R&D spending to gross revenue-No. 49 Sun Microsystems-has ended five straight years with a net loss. Similarly, No. 26 Delphi ranks 20th overall in R&D spending, and it’s among the top 10 in terms of R&D spending as a percentage of gross revenue. Ironically, however, the automotive supplier has experienced two straight years of declining revenue and four straight years of net losses.

What gives? Intuitively, my original thesis-a linear relationship between R&D spending and greater revenue and profits-must be true. No. 2 Toyota spends more on R&D than any other automotive OEM. It can hardly be a coincidence, therefore, that the company will almost certainly take over the No. 1 spot in the Assembly Top 50 within the next two years.

Perhaps it’s not the quantity of R&D spending as much as the quality. No. 33 Apple Computer spent $712 million on R&D in 2006. That’s 65 percent less than Sun and 82 percent less than Cisco Systems. And yet one good idea-the iPod-has completely transformed the company. Indeed, sales of Apple’s digital music player now exceed sales of computers.

For an answer to this paradox, we need only look to Major League Baseball. For the past seven years, the New York Yankees have had the highest payroll in baseball, and yet they haven’t won the World Series. In contrast, the Colorado Rockies are poised to win the National League pennant with a fraction of the Yankees’ payroll, solid young talent, and a hitter-friendly ballpark.

Similarly, lavish R&D spending does not necessarily guarantee higher sales and profits. However, by hiring the right people, providing an environment to succeed, and focusing R&D resources on a handful of projects with the greatest potential, manufacturers can still hit home runs and win the game in the end.

The following table shows how the Assembly Top 50 stack up according to R&D spending. (Note: Data on R&D spending could not be found for No. 27 Magna, No. 34 Flextronics and No. 36 Whirlpool. Spending figures are in millions of U.S. dollars.)

Company Rank Net Income Gross Revenue R&D Spending % Change from ’05 R&D as % of Sales
Toyota 2 13,987 203,710 7,826 13.1% 3.8%
Ford 5 -12,613 160,123 7,200 -10.0% 4.5%
J & J 14 11,053 53,324 7,125 12.9% 13.4%
General Motors 1 -1,978 207,349 6,600 -1.5% 3.2%
Siemens 6 3,848 110,798 6,374 2.6% 5.8%
IBM 9 9,492 91,424 6,107 4.5% 6.7%
DaimlerChrysler 3 4,259 200,052 5,331 -5.6% 2.7%
Honda 7 5,035 94,241 4,691 8.1% 5.0%
Robert Bosch 12 2,864 57,650 4,418 21.4% 7.7%
Motorola 16 3,661 42,879 4,106 11.6% 9.6%
Cisco Systems 24 5,580 28,484 4,067 22.4% 14.3%
Nissan 10 3,920 89,049 3,954 3.4% 4.4%
General Electric 4 20,829 163,391 3,700 8.8% 2.3%
Hewlett-Packard 8 6,198 91,658 3,591 2.9% 3.9%
Boeing 11 2,215 61,530 3,257 47.7% 5.3%
BAE Systems 25 3,210 26,960 2,444 -1.8% 9.1%
Philips 20 7,107 35,614 2,420 22.5% 6.8%
Abbott Laboratories 29 1,717 22,476 2,255 23.8% 10.0%
Texas Instruments 43 4,341 14,255 2,195 8.9% 15.4%
Delphi 26 -5,464 26,392 2,100 -4.5% 8.0%
Sun Microsystems 49 -864 13,068 2,046 14.6% 15.7%
Alcatel-Lucent 39 -173 16,209 1,935 25.9% 11.9%
United Technologies 15 3,732 47,829 1,529 11.9% 3.2%
Honeywell 22 2,083 31,367 1,411 31.6% 4.5%
Caterpillar 17 3,537 41,517 1,347 24.3% 3.2%
Lockheed Martin 19 2,529 39,620 1,139 9.3% 2.9%
Xerox 40 1,210 15,895 922 -2.2% 5.8%
Tyco 18 3,713 40,960 914 9.7% 2.2%
Valeo 46 219 13,310 872 15.0% 6.6%
TRW 48 176 13,144 825 5.8% 6.3%
General Dynamics 28 1,856 24,063 775 12.8% 3.2%
Johnson Controls 21 1,028 32,235 743 -9.1% 2.3%
Deere 30 1,694 22,147 726 7.2% 3.3%
Rolls-Royce 45 1,947 14,016 725 49.5% 5.2%
Apple 33 1,989 19,315 712 33.3% 3.7%
Kodak 47 -601 13,274 710 -20.4% 5.3%
Northrop Grumman 23 1,542 30,148 574 6.7% 1.9%
Raytheon 31 1,283 20,291 464 -7.8% 2.3%
Dell 13 2,614 57,095 463 0.0% 0.8%
Schneider Electric 35 1,777 18,119 432 33.3% 2.4%
Faurecia 41 -591 15,373 402 30.9% 2.6%
CNH Global 50 292 12,998 367 24.0% 2.8%
Emerson Electric 32 1,845 20,133 356 17.5% 1.8%
Lear 37 -707 17,839 170 -2.3% 1.0%
Paccar 38 1,496 16,454 151 28.0% 0.9%
Illinois Tool Works 44 1,718 14,055 145 13.3% 1.0%
Electrolux 42 477 15,172 33 22.2% 0.2%
Totals 125,082 2,417,005 110,649 7.9% 4.6%