R&D investment does not guarantee marketable innovations

A common question in today’s market and business environment is whether R&D investment translates into a profitable and marketable solution or product. This question is addressed in a recent Booz & Company survey, which maps the efficiency of R&D investment against the ability of each company to market goods and services.

One of the facts that stand out in the survey is that Apple, one of the main examples of transforming innovative ideas into marketable products, spends roughly 2.2% of sales on R&D, well below the industry average of 6.5%. This is another example of the lack of correlation between investment in R&D and the development of marketable products.

The survey also reveals that companies that engage customers in order to understand their needs and wants and then try to be first in developing new products that respond to those needs, tend to be more effective in their early-stage innovation efforts.

One of the  survey’s main conclusions is the notion that the financial crisis did not slow down R&D investment, as companies are keener to generate profit from new products and ideas. However, successful innovation does not appear to necessarily involve new techniques (e.g. social networking and co-creation, cutting edge physics) just the knowledge of what works and what does not really work in the marketplace.

The chart below shows the effectiveness of innovation (measured as a trade-off between idea creation and conversion):

 The effectiveness of innovation can also be measured by the amount of innovation pursuers and GDP % of investment in R&D. The chart below shows the tendencies of this indicator for OECD countries.

Finland is the country with the highest number of scientists and engineers and higher percentage of R&D investment. Israel is an interesting case, as the country invests heavily in R&D yet does not need a high number of scientists in order to do so – an example of efficiency. At the other end of the spectrum is Greece, which produces a high number of scientists yet does not invest in R&D.

Innovation, nonconsumption and the Portuguese education system [barrier]

The recently published IMF report on Portuguese public sector reform (“Portugal: Rethinking the State—Selected Expenditure Reform Options”) lists several reform options and advice based on country data and comparisons to international standards. The comparison is drawn mainly with EU15 countries, which is a sub-group of countries in the EU comparable to Portugal.

While innovation is not directly mentioned in the report, some of the measures suggested are really about process innovation. In the private sector, process innovation is constantly used to gain a competitive advantage in the marketplace and to create wealth. In the public sector, process innovation should be used as a tool for creating efficiencies in government organisations, which lead to better services for the public.

In his article “Why Innovation Matters In Politics And The Public Sector”, Faisal Hoque approaches innovation in the public sector with business and financial concerns that are basic and widespread in the private sector. Return on investment, risk management, technological innovations and efficiency are essential for the success of any company and should also be a concern of Government officials and managers when investing public funds in critical sectors such as health and education.

In the education sector, the IMF identifies a serious inefficiency in the management of schools. The IMF’s analysis reveals that there is over staffing and that career progress for teachers is based solely on seniority. Schools have very limited management leeway and in fact cannot choose whom to hire. Can you imagine a company being managed without the ability to choose its own staff? This is what happens in this case: every year, a number of teacher positions become vacant nationwide. Teachers apply and the choice is made based on seniority.

Taking a step back, a useful concept to describe the failures of the Portuguese education system is nonconsumption, which describes an area which appears unattractive to the companies or institutions that offer a service and where at the same time, some people would like to do something but are unable to get access to the available offering. At first sight, there are no obvious areas of nonconsumption in education: everyone is required to attend school up to a certain age. However, if you look deeper, you will probably find that a large proportion of Portuguese students simply do not manage to reach higher education, although they would like to, because they failed to grasp the more basic concepts between ages 12-18. This is the crucial problem that needs to be addressed. The first step towards solving this problem is to place motivated and capable teachers in front of those students that aspire to attend university but do not have the means or the background to do so. This is simply not achievable if the schools cannot differentiate between teachers based on their competences.

These problems have plagued the education system and seem to have flown under the radar screen of previous (and numerous) reforms of the education system in the past. The IMF suggests a better appointment system for teachers (not only based on seniority but on competence) and a framework whereby money would “follow the student”, which would allow better teacher hiring practices and a more efficient provision of education services.

While some other measures proposed by the IMF in the report are painful, involving loss of jobs or the reduction of income for civil servants, this type of reform is really about the implementation of important and sometimes long overdue structural reforms.

Free valuation e-book: Modelling Innovation – Chapter on Comparable Companies Analysis

We are now releasing the preview of the next Chapter of our free valuation e-book, which can be downloaded here.  Continuing with the company valuation theme, Chapter 6 focuses on describing the methodology on how to perform a comparable companies analysis, answering the following questions:

• What is the Efficient Market Hypothesis?
• How is a comparable companies analysis structured?
• How to perform a practical comparable companies analysis.

We look forward to hearing from you, so do let us know your comments.