By Ross Weir
Maximising ROI in research might mean changing our view of what ROI can be.
I read a very interesting article recently https://chiefexecutive.net/examining-the-roi-of-rd/ , written in 2011, it remains relevant. It got me thinking about the sporting goods industry and my own experience wanting to show the value of the work we conduct. Everything we do at Progressive would benefit from showing a net positive return for our partners. If we could show this in a tangible way, it would really help our partners get the budgets they need.
In the past, it seemed that CEOs, CTOs and CFOs treated R&D with kid gloves, wary of stifling innovation with inadequate R&D budgets, “They wanted to avoid killing the goose laying the golden eggs by overly measuring either the eggs, or the goose,” Dale Buss notes in his article. But we’ve seen this change and it happened almost overnight.
After the 2008 crisis, in which Progressive experienced a cull of R&D activities, those in management are now looking carefully inside the ‘black box’ that was once R&D to see if there are ways to establish accurate ROI metrics.
Underlying the cut backs in R&D we saw, was the fact that R&D teams couldn’t represent their work in terms of standard ROI metrics, not with the same rigour and accuracy as the marketing department or the sourcing team could for example.
Growing open innovation practice has also increased the complexity of tracking ROI. Dale Buss notes that supply chain innovations may need to be teased apart from cost of goods, or funding with a university may become hidden in general expenditure, its all part of other functions. He proposes that focus on ROI is also being brought about due to increased competition from developing territories like India and China. This in itself driving a new urgency in R&D, demanding management teams make bigger and quicker decisions related to such activities.
Buss goes on to report that efficient and transparent R&D processes are likely to offer a key competitive advantage. Having information on the status, and prospects for positive ROI, from each project allows for informed decisions to be made on what projects to fund, or shut down. But its challenging to come up with useful numbers to report to the CEO as a large portion of creativity, innovation and R&D practices create real but intangible benefits.
Playing with the standard measure of ROI is a starting point. The article notes that in 2006 Hewlett Packard switch to measuring ROI on R&D expenditures as a percentage of gross margin, instead of as a percentage of sales. HP believed that innovation should drive gross margin, as commodity business can drive revenues but maybe not profits i.e. if you can generate gross margin, you know your innovation is working.
In the highly competitive globalised markets we operate in, measures like new-product-development lead time may be a suitable way of gauging the progress of R&D efforts. This also mirrors the use of a so-called “freshness index,” which measures the percentage of sales or profits over a given number of years that are represented by new products and services. ROD, return on development, is a measure of gross margins realised from particular R&D outputs against the costs of the investment in that initiative.
Of course, its quite right for CEOs to have transparency on R&D outlays and ROIs, but Buss suggests that this is applied with flexibility and recognition of the intangible benefits. For example, what is the value of Nike’s overtly technical approach to product development? I’d argue its worth a dollar per sneaker to the consumer as they evaluate the brand values presented.
Buss’s Key Takeaways
1. Today’s R&D favours companies with tight discipline, streamlined processes and an opportunistic mindset.
2. Measurement of returns should stretch beyond traditional percent-of-sales numbers into other metrics and recognise the intangible.
3. Significant improvements are available to most businesses and R&D functions will be held in higher regard.
A leading example given by Buss is Apple. The company consistently spends relatively little to obtain its stellar returns from new product developments. In terms of R&D “intensity” (spending as a percent of sales), Apple ranked in the top 10 of the top 1000 in 2017. They achieve this by running extremely good processes that are disciplined; they have good talent; they rely on third parties and they focus their efforts on where they can meet unmet needs.