Free Trade in the Marketplace of Ideas

Free Trade in the Marketplace of Ideas

When R&D spending shrinks, the drop is alarming to those who believe that the R&D spending drives profits.

  • min read


Free Trade in the Marketplace of Ideas

CEOs tend to talk about research and development the way that farmers talk about seed corn—with a gleam in their eyes at the prospect of bumper crops to come. Some swear by figures that indicate a one-dollar increase in R&D translates into a two-dollar increase in profit and a five-dollar increase in market value over a seven-year period.

So when R&D spending shrinks, as it has so far in 2002, the drop is alarming to those who believe that the R&D spending drives profits. Half the largest U.S. companies, including Lucent Technologies Inc., Motorola Inc. and International Business Machines Corp., reduced their research outlays in the first half of 2002, cutting R&D by more than $3 billion (3.01 billion euros)—almost 15%. The other half, including Johnson & Johnson, Pfizer Inc. and Intel Corp., kept up their spending despite a tough economy. Who's right?

Usually we'd assume that decreased spending would mean decreased innovation—a weakness that would be reflected in profits and market value. But a new system is challenging that: If the squeeze on resources drives companies to find productivity gains outside their four old-economy walls, innovation can actually get a boost. Think of it as free trade in the marketplace for new ideas.

The prospect of being able to sell off ideas that are costly or less than perfect is especially appealing in today's tighter market conditions: Managers are under pressure to rein in costs and find new sources of growth. Ford Motor Co. and General Motors Corp. took a significant step on Oct. 10, announcing plans to jointly develop a fuel-efficient automatic transmission, trying to catch up with Japanese and European competitors. The rare collaboration between bitter rivals could help Ford, in particular, as it struggles to bring its inflated costs for product development back into line.

Open-market innovation works for the same reason that free trade works: It enables the laws of comparative advantage to govern the allocation of R&D resources. In essence, a company gets lower-cost, higher-quality ideas from the best sources in the world, allowing it to refocus its own innovation resources where it has clear competitive advantages. With the right people in place to recognize beneficial trade-offs, the company is able to "export" ideas that other businesses could put to better use.

It's not as antithetical to market competition as it seems. A number of companies that rely on the strength and flexibility of their research departments, like Eli Lilly & Co. and Procter & Gamble Co., have begun to incorporate open-market innovation swapping into their business models. Until recently, P&G guarded its innovations as corporate secrets and took a dim view of licensing. But in the late 1990s, under pressure to increase productivity and speed product development, the company set up a special group to solicit complementary technologies from the outside that fill gaps in its intellectual-property portfolio. It never turned back.

Today, technology "entrepreneurs" at each of P&G's business units use search engines and other tools to mine billions of pages on the Web, in global patent databases and scientific literature. One specialist has gleaned critical leads from sources outside of the cleaning industry, which have subsequently been shepherded inside P&G through joint-development deals—resulting in breakthroughs in cleaning performance.

The effect has been, in the words of P&G President and CEO A.G. Lafley, like "pulling weeds from the innovation garden." Creating a focused portfolio that targeted innovation expenses at the company's core brands, like Pampers, Pringles and Crest, brought innovations and a leaner, meaner profile that Wall Street liked. Despite reducing its R&D spending by 9.5% to $1.6 billion during fiscal 2002, P&G's sales, net income and productivity all grew. The company had six of the top 15 new consumer goods products last year, according to the Industrial Research Institute.

P&G also earns millions of dollars a year in royalties from the patents it exports. But the money may be less important than the signal it sends to an organization: Act fast on promising ideas or risk seeing them offered to outsiders, even competitors. Knowing that good ideas won't get buried helps keep creative talent on board.

The best hope for companies to keep innovation alive while R&D spending falls is to lower their barriers and to let ideas flow freely. Intangible goods in the end are no different from French Roquefort or Colombian coffee. Back in 1815, David Ricardo explained that businesspeople benefit when they concentrate on the things they do best. The winners in the marketplace for new ideas would recognize Mr. Ricardo as one of their own.

Messrs. Rigby and Zook are Bain & Company directors in Boston.

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