An obvious comment and appropriate question is that perhaps we really don’t need innovation to grow? We may disparage the last plateau stage in the “Simple Business Maturity S-Curve” figure as being an unattractive area of commoditization, low profits and no growth. Before dismissing this as bad business however, one has to remember that when commodities are related to scarce natural or man-made resources, they can become extremely attractive business. Take the example of oil. When oil was plentiful the oil companies continued on a slow mature rate of growth and return on investment to those people investing in them. When world consumption of oil increased with the developing countries of India and China in the mid-2000’s, the demand for oil skyrocketed. With only so much oil available in the ground and with limited refinery capacity prices rose dramatically. At same time developing countries during that period also caused a rush and an increase in value for natural resources companies producing copper, steel, and polymer materials used in the building and infrastructure markets. Part of any companies’ solid strategic plan is to look at the underlying industry growth rate and profitability of its core products and services. Only then can the “Simple Business Maturity S-Curve” figure be interpreted correctly and R&D for growth invested wisely.
Another example of how to allocate money on R&D and withhold it in some areas has to do with companies who have broad portfolios of businesses. For example, a large U.S. Corporation in the mid-1990’s had 60 different operating businesses around the world. Not all those businesses were the same value to the corporation. When one looks at the economic value in the
“Economic Value of a Large Corporation’s Individual Operating Divisions in Millions of Dollars” figure there are only a few very valuable business units. In fact just five of the 60 units produced over half the corporation’s economic value added.
As a point of clarification, note that economic value added (EVA) is used for many business decisions because it allows a close apples to apples comparison of businesses. It represents as closely as possible the underlying cash value of an ongoing business. From the financial perspective note that economic value comes from knowing the gross investment, CFIRR, growth rate assumptions, fade rate assumptions, and the underlying discount rate; CFIRR comes from the book investment, the gross cash flows, and adjustments for the asset life and the residual value. EVA values help determine how to invest R&D in different business environments.
Clearly organizations which have low EVA’s, operate below the corporation’s real cost of capital, and because of market conditions in their market segment have little chance of improving, were not targeted for R&D and new business development initiatives. See the “Percentage CFIRR of a Large Corporation’s Individual Operating Divisions” figure as an example.
From this plot is easy to see where to invest R&D. The high return businesses were ones that were well supported with next-generation and break-through activity. Those divisions earning adequate returns and were of high economic value had some next-generation activity mostly targeted at improving either their market share or their profitability. NPD and NBD efforts in these businesses were very focused initiatives. The groups labeled in the figure as having Inadequate Returns were ones that were analyzed for their business potential. If they were in operating in markets where there was a good likelihood that improved products and services would generate a return for the organization, investment was made in R&D. If the market conditions didn’t indicate good business segment potential they were slated for divestiture. Clearly the sustained negative return organizations were slated for closure or divestiture. Now that’s not to say that really good breakthrough ideas weren’t welcomed and funded for any business, it is just as a technology leader it would be inappropriate to make a business bet on underperforming business unit initiatives when there were much higher probability of success options available elsewhere in the corporation. It’s tough but resources are never unlimited and when deciding on which portions of a portfolio to invest, picking those which have the best market environment appropriately get the lion’s share of the funding.
Here a quick digression is appropriate. Growth is clearly part of most companies mission and a reason for existence. From growth comes increased profits and increased returns to shareholders. It serves all stakeholders and often provides a healthier more robust and stable work environment for employees. It is not to say however that a high growth strategy is the only appropriate strategy for a company. In the early 2000’s Patagonia, a clothing company, made a deliberate choice to limit their growth. They found that growing too quickly reduced the value to their shareholders, to their customers, and employees were not having as much fun at work. I’ve had an opportunity to work for very rapidly growing companies, ones that were slow-growing ones, from Global 1000 to small garage shop startups. Each has its benefits to the shareholders, employees and customers. It is extremely important that a company continuously look at its mission, why it’s in existence, and make sure it matches and gives maximum value for all classes of stakeholders. There are certainly times where low or no growth is the best course of action.