Reevaluating Incremental Innovation
Swinging for the fences can yield lower returns.
ADECADE AGO, INSEAD marketing professor Marcel Corstjens was consulting with employees at a multinational consumer packaged goods (CPG) company about ways to rejuvenate one of its biggest brands. During three days of meetings, he found a one-hour presentation by the company’s R&D team deeply fascinating. But no one else did. “There were many ideas that could have been developed,” he says, “but at the end of the R&D session everyone said, ‘OK, let’s get back to the communications and advertising issues,’ and nobody ever talked about the R&D again.” It’s no secret that large CPG companies are marketing powerhouses, but this apparent disregard for R&D insights stuck with him. Although CPG companies rank far behind high-tech and health-care companies in R&D spending, some do devote more than $1 billion a year to R&D. Corstjens wondered: What kinds of returns are they getting?
To find out, he and two colleagues conducted a statistical analysis of R&D spending and growth, using data on the world’s top 2,500 firms. After excluding companies with less than $1 billion in revenue, they examined the relationship between sales and a number of variables: R&D spending, labour costs, capital expenditures, and marketing spending (using selling, general, and administrative expenses as a proxy). They then calculated each variable’s effect on sales growth. They conducted their analysis first by industry, focussing on pharmaceuticals, food, and CPG, and then by company.
The industry analysis showed that in the CPG firms, R&D spending did not drive sales; marketing spending
seemed to be the primary driver. But in the pharmaceutical industry, the researchers found strong and significant gains from both R&D and marketing spending.
Turning to individual CPG companies, the researchers discovered a distinction between those with relatively large R&D budgets and those with smaller ones. The former (including Procter & Gamble, whose $2 billion R&D budget is the world’s largest) saw no measurable relationship between that investment and sales. The latter (including Henkel, L’Oréal, Beiersdorf, and Reckitt Benckiser) did see a correlation.
After studying the pattern and interviewing experienced R&D executives, the researchers concluded that companies with very large R&D budgets are incentivised to pursue expensive, large-scale innovation efforts that have the potential to become blockbuster new products – and that those projects receive the bulk of R&D funding. The problem with this high-risk, high-reward strategy is that it may not pay off. “Despite spending on average $2 billion per year on R&D for the past 15 years, P&G has had far more failures than hits,” the researchers write. “Simply put: The company has bet big and lost big.”
The researchers found that, in contrast, Reckitt Benckiser – the British firm whose brands include Clearasil, Lysol, and Woolite – exemplifies a more profitable strategy of pursuing less ambitious innovations that, without fanfare, drive sales higher. They call this the Lorenzian strategy, after the MIT mathematician Edward Lorenz, who described how a small action (such as a butterfly’s flapping its wings) can lead to an improbably large event (such as a tornado). “[Reckitt Benckiser] doesn’t have the deep pockets to spend on big-bang innovation,” they write. “So it opts for a different approach: spend small, but focus that investment on marginal improvements in their most valuable brands, aimed at solving real consumer problems, that consumers value and would pay a little more for.” They cite the company’s Finish brand of dishwasher detergent. Decades after the original product’s launch, Reckitt Benckiser added a rinse agent and changed the name to Finish 2-in-1. A few years later, it added a salt component and renamed the detergent Finish 3-in-1. Today the product is Finish All-in-1, owing to the addition of a glaze-protection agent. With each incremental improvement, sales and profits grew.
Other successful small-scale innovations involve packaging. In 2004, when McDonald’s changed how it sold its milk, going from cardboard boxes to translucent plastic jugs resembling old-fashioned milk bottles, sales tripled in just a year. Heinz has grown sales of ketchup by introducing new packaging, including bottles that are stored upside down (to facilitate easy pouring) and fast-food dipping trays that make it less messy to eat ketchup with fries.
On the basis of their interviews with R&D employees, Corstjens and Professor Gregory Carpenter of Northwestern’s Kellogg School of Management conclude that companies placing bigger bets on R&D do see some returns on those investments, but they may not be obvious, top-line payoffs. For instance, he says, R&D can help a company reduce costs, thereby increasing profits without generating additional revenue. He points to one company where researchers focussed on ways to increase food products’ shelf life. Still, he observes that companies operate under two distinctly different philosophies depending on the size of their R&D budgets. “The motto of companies with big R&D budgets is ‘ bigger, better, faster,’” he says, whereas companies with smaller R&D budgets “seem to do extremely well by tweaking and improving things in their brands and creating a lot more sales.”
The tension between the pursuit of ambitious R&D efforts and more-incremental innovation isn’t new. In a classic 2007 HBR article (“Is It Real? Can We Win? Is It Worth Doing?: Managing Risk and Reward in an Innovation Portfolio”), Wharton professor George Day describes various methods companies can use to ensure the right balance of highrisk, high-reward innovations and safer, targeted ones. (He calls the two types Big I and Little I innovations.) Interestingly, when he surveyed the landscape a decade ago, he reached a conclusion opposite to the one in the new research: that most companies were overinvesting in Little I innovations and needed to pay more attention to potential game changers.
Corstjens’s team notes that the different approaches to R&D are not only a function of budget size; they also stem from culture. Among the firms in the study that favour smaller innovations, some have roots in the chemical or pharmaceutical industries, where the R&D function typically enjoys more power and respect than at CPG firms. The researchers believe that in the latter, R&D is often overshadowed by marketing, reducing the likelihood that spending on it will translate to sales. “When R&D has a respected voice and collaborates with marketing, firms have more success with innovation,” they write.
COMPANIES PLACING BIGGER BETS ON R&D DO SEE SOME RETURNS ON THOSE INVESTMENTS, BUT THEY MAY NOT BE OBVIOUS, TOP-LINE PAYOFFS. R&D CAN HELP A COMPANY REDUCE COSTS, THEREBY INCREASING PROFITS WITHOUT GENERATING ADDITIONAL REVENUE