INNOVATION SPECIAL.....The Global Innovation 1000: Proven Paths to Innovation Success

The Global Innovation 1000: Proven Paths to Innovation Success

The success of corporate R&D is on every C-suite agenda. Yet wide disparities persist in how well innovation investments actually pay off. As a consequence, R&D is often seen as a black box, where large sums of money go in and innovative products and services only sometimes come out. One of the aims of the Global Innovation 1000 study, our annual analysis of R&D spending, has been to demystify the process—and to find universal principles that can be applied by any company, in any industry.

This year, the 10th anniversary of the study, we looked back at a decade’s worth of research on R&D spending patterns and surveys of innovation executives, plus anecdotal insights about how companies have been improving their innovation performance. We also surveyed more than 500 innovation leaders in companies large and small, across every major region and industry sector, to ask what they have learned in the last 10 years about why some investments work and others do not. We found that it’s really not that mysterious: Over the years, we’ve identified the core strategies that can improve a company’s return on its R&D investment, and we’ve witnessed some consensus around the key success factors that drive results. For example, one of the main messages we heard is that innovation leaders feel they have made real progress in better leveraging their R&D investments, particularly by more tightly aligning their innovation and business strategies, and by gaining better insights into customers’ stated and unstated needs. And in fact, 44 percent of our 2014 survey respondents say that their companies are better innovators today than they were a decade ago, while another 32 percent say they are much better. Only 6 percent say they are doing worse.

For our 2014 study, we also looked ahead to the next decade, asking our survey respondents how they expect their innovation practices to evolve. We found tremendous opportunities for improvement: Only 27 percent feel they have mastered the elements they will need for innovation success over the next 10 years. Gaining that expertise will be important as companies’ innovation goals change in the future. Many of our respondents said their companies plan to shift their R&D spending mix over the next decade—from incremental innovation to new and breakthrough innovation, and from product R&D to service R&D.

Our study also provides some insight into trends in R&D spending during the last decade. The rate of growth in innovation expenditures for the Global Innovation 1000 slowed sharply in 2014, to just 1.4 percent—the slowest rate of growth in the past 10 years for the 1,000 global companies that spent the most on R&D. (R&D spending declined only once during this time period: in 2010, in the wake of the financial crisis and recession, and then only modestly.)

The last two years of decelerating growth—3.8 percent growth in 2013 and 1.4 percent in 2014—could be attributed to the general mood of uncertainty overhanging today’s global economy or the unusual amount of geopolitical turmoil in the world. Looking at 10 years of data, however, suggests another, simpler explanation: reversion to the mean. The sowdown followed two years of above-average growth in 2011 (10.3 percent) and 2012 (9.7 percent), and R&D spending growth will likely move closer over time to the average 5.5 percent compound annual growth rate from 2005 to 2014. It also may be that innovation spending slows about five years after a market disruption. After all, the next-lowest year of R&D spending growth was in 2006, five years after the 2001 dot-com bubble burst (see Exhibit 1).

Another possible explanation for the slowdown in R&D spending growth is that companies, over time, have been learning to do more with less. The long-term rate of R&D intensity (innovation spending as a percentage of revenues), for example, has declined over the last decade at a compound average rate of 2 percent per year. This also reflects one of the major findings of our Global Innovation 1000 research, which has been reaffirmed in each of the last 10 years: There is no statistically significant relationship between sustained financial performance and R&D spending, in terms of either total R&D dollars or R&D as a percentage of revenues. Our inaugural study, in 2005, “Money Isn’t Everything,” found that R&D spending levels have no apparent impact on sales growth, gross profit, enterprise profit, market capitalization, or shareholder return. Since then, we have conducted more than 10,000 statistical analyses of the relationship of research and development spending to corporate success, which have all led to the same conclusion. The only exception is when companies’ R&D spending falls into the bottom decile compared with their peers’ spending, which does compromise performance.

Mr. Innovation himself, the late Steve Jobs, put it more pointedly in Fortune magazine in 1998: “Innovation has nothing to do with how many R&D dollars you have. When Apple came up with the Mac, IBM was spending at least 100 times more on R&D. It’s not about money. It’s about the people you have, how you’re led, and how much you get it.”

Software—and China—Rising

The industry shares of total R&D spending among the Global Innovation 1000 during the previous 10 years have been consistent: The computing and electronics, healthcare, and auto sectors have together accounted for two-thirds of total spending. The largest percentage increase in R&D spending, however, has been in the software and Internet category, which over the last three years accelerated from single-digit to double-digit growth. Growth in the computing and electronics and healthcare sectors decelerated over the last two years, while spending in the auto and industrials sectors continued to rise steadily. Interestingly, growth in R&D spending in the latter two sectors, along with aerospace and defense, may primarily reflect new outlays on software within those companies, resulting from the increasing prevalence of software and computer-controlled systems in both the products they make and the factory automation they deploy.

“Ten years ago, a car radio was a radio with a two-line display and a bunch of buttons,” says Tim Yerdon, vice president of design, marketing, and connected services at Visteon, which supplies cockpit electronics and heating and cooling thermal management systems to automakers. “Today, the radio is basically a computer that’s attached to the car and comes with a large display, anywhere from six inches to as much as 17 inches in a Tesla, for example. The software enables a reduction in the complexity of the hardware because as you add software for that display, it can be applied across different vehicle lines.”

The pervasiveness of software, Yerdon continues, means that auto suppliers are innovating more—and more quickly—than ever before. “If you think of the auto sector as three spinning gears, automotive is a fairly large gear and spins on a four-year cycle, because that’s how long it generally takes to develop a vehicle. The consumer electronics wheel is spinning six to eight times faster, because every six months there’s a new phone or other device or app. As a global supplier, we’re the meshing gear between the two.”

Across regions, we have seen both incremental and radical change in R&D spending patterns over the last 10 years. On the one hand, companies headquartered in North America, Europe, and Japan continue to dominate the total amount of global R&D spending. Yet despite their dominance, Europe’s share has been flat over the last decade at around 30 percent, North America’s share has declined from 42 percent to 40 percent, and Japan’s share has fallen from 24 percent to 18 percent. The rise of China as an innovation powerhouse, on the other hand, has been startling. China’s R&D spending is rocketing upward at sustained double-digit rates, and recent studies suggest that more innovation and fiercer technological competition with established Western players are on the way from Chinese firms.

Alignment and Insight

Our 10-year analysis shows that companies have been raising their innovation game by focusing on two areas: business capabilities, and organization and processes. The five specific capabilities and processes that respondents most often report having improved over the last decade were, in order of selection frequency: (1) aligning the innovation portfolio with customer needs and wants, (2) developing and retaining people with the right technical knowledge, (3) ensuring that innovation leaders and business leaders are aligned, (4) understanding new product- and service-related technologies and trends, and (5) pursuing lean product development. Our analyses have also shown that such focus pays off: The top 25 percent of companies measured by sustained financial performance concentrate on a shorter, more coherent list of innovation capabilities rather than trying to be good at everything.

These observations correspond to key findings from our earlier studies. For example, almost two-thirds of our respondents report that their company’s innovation strategy has become better aligned with its business strategy. This has been a theme throughout our Global Innovation 1000 work, developed most fully in our 2011 study, “Why Culture Is Key.” We have found that companies with more tightly aligned business and innovation strategies had 40 percent higher operating income growth over a three-year period, and 100 percent higher total shareholder returns, than industry peers with lower strategy alignment.

“There has been a strong push over the last 10 years to align what you do in R&D with what you do in the business, and it has gotten better,” says Oliver Nussli, head of project and portfolio management at food and beverage manufacturer Nestlé. “Many companies have streamlined their R&D portfolios because there were too many things going on that were leading nowhere or had little chance of success.” Recently, Nussli says, Nestlé completed a study to design foods that would better meet the needs of elderly people (whose nutritional requirements differ from those of younger people because of bone, joint, and muscle conditions). Both the business and the R&D organizations were intensely involved, and as a result, he says, “the business side knows what it’s going to get, and the R&D side knows what it has to work on.”

Nestlé’s recent study also ties into another key finding from previous years: the importance of gaining deeper insights into customers’ wants and needs. This year, more than three-quarters of the participants said their understanding of customers had become notably more detailed over the last decade. “One of the big changes is the way companies bring in consumer insights,” says Frank Dethier, innovation manager at chemical manufacturer Huntsman Corporation. “Ten years ago, companies or industries defined what the markets needed. Nowadays, consumers are not just asked for their advice and input—they are defining what the products and services should look like, and can even drive and create products themselves on [crowdfunding] platforms like Kickstarter.”

As we noted in our 2007 study, “The Customer Connection,” companies can spend more money, hire the best engineers, develop the best technology, and conduct the best business market research, but unless their R&D efforts are driven by a thorough understanding of what their customers need and want, their performance may fall short. We tested this hypothesis and found that over a three-year period, companies that directly captured customer insights had three times the growth in operating income and twice the return on assets of industry peers that captured customer insights indirectly, as well as 65 percent higher total shareholder returns.

The Need Seeker Advantage

Ten years’ worth of research and insights also illuminate the strengths and challenges of the three different ways that companies approach innovation. In 2007, the Global Innovation 1000 study identified three fundamental kinds of companies, each with its own distinct way of managing the R&D process and its relationship to customers and markets. Every company tends to follow one of these three innovation models; we thus categorize companies as being Need Seekers, Market Readers, or Technology Drivers.

Of course, all three models share the same broad innovation goals. Every company wants to have superior product performance and quality, to make a strong connection with customers, and to feel passion and pride regarding its portfolio. And all three models pursue capabilities for understanding emerging technologies, engagement with customers, and product platform management. Each model, however, also has distinct characteristics and priority capabilities that influence how the company develops and launches new products and services.

Need Seekers, such as Apple, Procter & Gamble, and Tesla, make a point of using superior insights about customers to generate new ideas. They gain this insight through direct engagement with customers (for instance, Apple routinely learns from interactions at its retail stores) and through other means, including analysis of big data. Most important, they develop new products and services based on this superior end-user understanding. Their goal: to find the unstated customer needs of the future, and to be the first to address them. Their cultures encourage openness to new ideas from customers, suppliers, competitors, and other industries, and they prioritize directly generated consumer/customer insights and enterprise-wide launch capabilities. We estimate that 25 percent of the Global Innovation 1000 companies are Need Seekers.

Market Readers, such as Samsung, Caterpillar, and Visteon, make up some 40 percent of the Global Innovation 1000 companies. They focus largely on creating value through incremental innovations to products already proven in the market. They use a variety of means to generate ideas; most involve closely monitoring their markets, customers, and competitors. This implies a more cautious approach, one that depends on being a second mover or “fast follower” in the marketplace. One of their specific innovation goals is customizing products and services for local markets, and they seek a culture of collaboration across functions and geographies. They prioritize capabilities for managing resource requirements and engaging suppliers and partners.

Technology Drivers, such as Google, Bosch, and Siemens, depend heavily on their internal technological capabilities to develop new products and services. They leverage their R&D investments to drive both breakthrough innovation and incremental change. They hope and expect that by following the imperatives implied by their discoveries, they will naturally meet the known and unknown needs of their customers. Their distinct innovation goal is to develop products of superior technological value, and their cultures reflect reverence and respect for technical knowledge and talent. Approximately 35 percent of the Global Innovation 1000 companies are Technology Drivers.

Based on our long-term view of these strategies, we have determined that each can be successful and can enable companies to outperform their competitors if executed well: Apple, Samsung, and Google are all highly innovative, and are recognized as such by the innovation leaders who vote on our study’s top 10 list. In general, the most important success factor is how well companies execute on their chosen strategy—whether they align their innovation strategy with their business strategy, whether they have prioritized the right capabilities, whether they have the right culture to enable their strategy, and whether they are using the tools that will help them develop new ideas and processes that are consistent with their innovation model. The quality of the alignment of all these elements is the key, and it trumps the amount of R&D spending.

Increasingly, we have come to believe that the Need Seeker strategy is inherently advantaged. This is not the only successful model, but it is the most consistently successful. Our 10-year analysis supports this conclusion. Need Seekers, for example, report being better at innovation today than they were 10 years ago at a significantly higher rate than companies following the other two strategies, and they also more often indicate that they are financially outperforming their competitors—a claim supported by our analysis (see Exhibit 2).

Our analysis of Need Seekers in the past has suggested that they tend to focus on more tightly aligning their innovation and business models. In our 2011 study, we found that what sets Need Seekers apart is their ability to execute on their strategy—to combine all the elements of innovation into a coherent whole, with a culture that supports innovation. In a study we conducted in 2012 in conjunction with the Bay Area Council Economic Institute, we found that significantly more of the technical leads at companies classified as Need Seekers report directly to the CEO, and that their innovation agendas are much more likely to be developed and clearly communicated from the top down to the rank and file of the organization. They were also much more likely to point to product development as the function with the most influence on their company’s power structure. (That same study also revealed that Silicon Valley firms are almost twice as likely to follow a Need Seekers model than the general population of companies—46 percent versus 28 percent, a consequence of the startup/venture capital mind-set of tightly aligned business and technology strategies.)

Our 2014 survey produced similar findings: A much higher percentage of Need Seekers reported that their innovation strategy was highly aligned with their business strategy, compared with either Market Readers or Technology Drivers (see Exhibit 2). Such alignment comes naturally for Need Seekers, because their whole ethos is rooted in understanding and being close to the customer through direct exposure to the end-user, rather than relying on market analysis or the views of intermediaries. Interestingly, recent research has found that the Need Seeker strategy is more prevalent among Chinese companies than among the Global Innovation 1000.

The Next 10 Years

As part of our 2014 study, we asked participants to look to the future—to tell us about their expectations for their innovation agendas for the next 10 years. We found that the Global Innovation 1000 companies have some common expectations and goals, and that there is some convergence around areas where they hope to improve their innovation performance. They believe that aligning business and innovation strategies will be the most important driver for innovation success. Interestingly, this and other key areas are the same ones that Need Seekers are already focused on today (see Exhibit 3).

All respondents report that they plan to shift their current R&D spending mix from incremental innovations to more new and breakthrough innovations. Today, 58 percent of R&D spending is directed at incremental or renewal innovations, just 28 percent at new or substantial innovations, and only 14 percent at breakthrough or radical innovations. In 10 years, respondents expect the picture will look quite different (see Exhibit 4).

At Reliance Industries, the energy and chemicals group that is India’s largest private-sector company, Ajit Sapre, group president of research and technology, anticipates that R&D spending on new, substantial, or breakthrough innovations will rise. Reliance is focusing on potential breakthroughs in energy and materials that could help India meet its growing demand for energy and infrastructure—particularly by leapfrogging existing technologies used in developed markets. “The outcomes are fuzzier, and they are much more risky,” says Sapre, “but if we are successful, they could lead to paradigm shifts. If you focus too much on near-term goals, you can miss the long-term opportunities.” The aspiration to seek out new and substantial innovations is understandable, and will certainly pay off for some innovators. To capitalize on such a significant reallocation of spending, however, many companies will need to make major changes in their approaches to innovation and in their capabilities. Breakthroughs, for example, involve higher risk than incremental innovations, so it is important to make sure both that these innovation goals make sense given the company’s market position and strategy, and that the right risk management capabilities are established to handle a higher-beta portfolio. As Fassi Kafyeke, director of advanced design and strategic technology at Canadian plane and train manufacturer Bombardier, told us, “New research projects will continue to involve more collaborators, including universities, suppliers, and other industrial partners. Ultimately, this will make product development more robust and enable greater technology leaps, while reducing risks and cost.”

Companies also expect to allocate more R&D spending to enabling services and less to creating products. The current allocation slightly favors product R&D, 52 percent to 48 percent. By 2024, respondents expect that relationship to flip—with R&D for services rising to 62 percent, versus 38 percent for R&D for products. At Visteon, for example, Tim Yerdon is leading a group exploring services related to connected cars and intelligent transportation systems. The group has already delivered developments such as wireless charging in the car, and is actively developing wireless communication technology enabling cars to communicate with one another. “It’s not a traditional business model for an automotive parts company based in the Midwest—even for a global supplier like Visteon,” says Yerdon. “It’s much more like a tech company in Silicon Valley.” As more companies consider a significant shift to services, it will be important to ensure that the company’s innovation goals are aligned with the needs of the enterprise strategy, and that the business model includes a plan for capitalizing on the envisioned service innovations.

Prescriptions for Innovators

Despite the inherent advantages of the Need Seeker model, it’s not the right approach for every company. Indeed, many Market Readers will be more successful if they concentrate on the capabilities, goals, and attributes that are distinct to Market Readers than if they try to move too far toward the Need Seeker model and get only partway there. The same is true for those following a Technology Driver model (see Exhibit 5).

Need Seekers should hone their distinctive capabilities, which include their proficiency at directly generated deep customer insights, enterprise-wide launches, and technical risk assessment. One priority that Need Seekers cited in our survey this year as being important to their future success—open innovation—complements their approach by enabling them to seek new ideas and insights from a networked community beyond the borders of the company and its traditional partners. They should ensure that their products and services are advantaged by seeking out new ideas from customers, suppliers, competitors, and other industries, as well as by building focused technical innovation networks across the business. They should exploit front-end digital enablers such as visualization and engagement tools.

Market Readers should continue to develop their capabilities in managing resource requirements and engaging suppliers and partners. Their priority for innovation success going forward is to ensure that their innovation and business leaders are aligned. Successful Market Readers replicate and improve on competitors’ innovations quickly and adroitly. Their goals should include customizing their products for local markets, and creating a culture of collaboration across functions and geographies to facilitate rapid, seamless response. They need to be good at assessing feedback from sales and customer support and traditional market research. Digital enablers such as monitoring tools and idea-capture tools are critical, and are consistent with the needs of this model.

Technology Drivers should continue to enhance their product life-cycle management capabilities. Their priorities are strategic platform management and gaining a detailed understanding of emerging product- and service-related technologies and trends. They need to excel at technology road mapping and interacting with the external tech community. Digital enablers will be particularly important for them, including big data, customer profiling, and codesign tools, as well as collaborative environments that connect far-flung teams, customer relationship management systems, and ERP platforms.

Of course, some key imperatives have surfaced in the Global Innovation 1000 studies that apply to all companies seeking innovation success:

• Define your innovation strategy, communicate it throughout the organization, and identify the short list of innovation capabilities that will enable it.
• Tightly align your business and innovation strategies.
• Ensure that your innovation culture is aligned with, and supportive of, your innovation strategy.
• Focus on developing deep customer insight by directly engaging and observing end-users of your product.
• Ensure that the technical community has a seat at the table defining the corporation’s agenda.
• Systematically manage the R&D portfolio, aggressively winnowing out low-potential projects and ensuring that the right risk management capabilities are in place to support big bets.

This list is more important than ever. For every shining example of a market-shaking innovation breakthrough, there are many more examples of companies that struggle to realize adequate returns from their innovation investments. But innovation, although different from operations, sales, and marketing, is nevertheless a function that can be managed: There are principles that are known, capabilities that can be built, and recognized levers that can be pulled to improve the process over time. The stakes for making these efforts are high—the disparities in innovation performance show that there are tremendous opportunities for getting more from your R&D spending, and for improving your competitive position and your financial performance.

• Barry Jaruzelski, Volker Staack and Brad Goehle
• Also contributing to this article were s+b contributing editor Rob Norton, and Strategy& senior campaign manager Josselyn Simpson, senior analyst Jennifer Ding, and campaign manager Kristen Esfahanian.