Large players in the consumer goods industry might see better returns from their R&D if they copied their smaller competitors.
Who are the kings of R&D spending? High tech and health care, of course. These sectors each account for nearly one-quarter of global R&D.1 Consumer goods companies? They’re near the bottom, at just less than 3%.2 But what they do spend is hardly trivial. The largest consumer goods companies each lay out more than $1 billion annually. Spending by one of the biggest, Procter & Gamble, has averaged about $2 billion per year for the past decade.3
What have these behemoths gotten in return for their hefty R&D outlays? Virtually nothing from a sales perspective. In an industry analysis, we found that the consumer packaged goods sector’s biggest R&D spenders saw no appreciable impact on revenue. That’s troubling for companies whose growth has plateaued over the past five years, as new competitors have challenged established brands.
At the company level, however, the picture is more nuanced: Even though (true to the industry average) companies that spent heavily on R&D — such as P&G and Unilever — saw no measurable impact on sales, some outfits that spent less on R&D showed a significant positive correlation. For example, Henkel and Beiersdorf, both in Germany, enjoyed a revenue boost, as did L’Oreal of France and Reckitt Benckiser in the United Kingdom. We’d term Henkel and L’Oreal, which have roots in the chemical industry, as medium spenders and the others as modest spenders.
It turns out, as economist E.F. Schumacher wrote, small really can be beautiful.4 Of course, incremental innovation — reaping healthy returns with small, iterative improvements — isn’t a new idea. Apple has famously boosted sales of its iPhones with incremental tweaks in each product cycle, and brand-name prescription drugs sometimes offer modest upgrades over prior treatments or generic alternatives. But conventional management wisdom, based on years of research, still holds that R&D productivity depends on industrial might: Big companies can spend more on innovation, and as a result, they innovate more — and better.5 In the consumer products world, at least, our analysis suggests that’s not the case.
Different Spending Patterns
To better understand this puzzle, let’s examine two consumer goods companies with starkly different levels of investment in R&D: P&G and Reckitt Benckiser.
Despite P&G’s huge R&D investment — more than $38 billion from 1998 to 2017, compared with Reckitt Benckiser’s $2 billion over the same period — P&G’s outlay has reaped fewer rewards on a key measure: While P&G spent more than 3% of its annual revenue on R&D compared with 1.5% for Reckitt Benckiser, P&G’s sales grew at a compound annual rate of 3.4% while Reckitt Benckiser’s sales grew almost three times faster, at 9% per year. (See “How Judicious R&D Spending Can Pay Off.”) What’s more, P&G has introduced no blockbuster brands since its Swiffer dusters and mops debuted almost 20 years ago.6 (See “Big Investments Don’t Always Yield Big Returns.”) Certainly, a company can succeed at R&D without creating new household names, and large consumer goods companies have generated plenty of patents while reducing the cost and increasing the shelf life and convenience of their products. But given P&G’s R&D spending and its history of developing famed brands like Tide laundry detergent, Crest toothpaste, and Dawn dishwashing liquid, it’s surprising that its blockbuster innovation has stalled.
The diverging innovative fortunes of Reckitt Benckiser and P&G can be glimpsed in their stock prices as well. From 1998 to 2017, P&G’s share price increased by only 2.5 times, while Reckitt Benckiser’s shares increased more than sevenfold.7 A number of factors beyond R&D spending and innovation could have contributed to the companies’ valuations. That’s why we modeled sales as a function of multiple factors. (See “About the Research.”) Still, investors’ conviction about a company depends largely on expectations about its ability to generate sales and growth via strong returns from innovation.
Different Innovation Philosophies
How do we explain our findings? One factor may be that P&G and Reckitt Benckiser seem to embody different philosophies of innovation.
We see the approach favored by big consumer goods companies like P&G and Unilever as analogous to Isaac Newton’s third law: They behave as if for every action, there is an equal and opposite reaction. In other words, they expect big returns from big investments, so they chase blockbusters. But, despite lavishing money on R&D, P&G has produced no more Swiffers.
Contrast that with what we call a Lorenzian approach to R&D investment, which has parallels to the work of MIT mathematician Edward Lorenz, the father of chaos theory. When examining weather patterns, Lorenz discovered that small actions could have large consequences. A butterfly flapping its wings could lead to the formation of a tornado. Like a weather system that amplifies the impact of a fluttering insect, a complex system of companies, customers, competitors, suppliers, and influencers can amplify or diminish the impact of an innovation. In such a world, big ideas can die, and small ones can thrive, as they do at Reckitt Benckiser.
The company doesn’t have a big R&D budget nor a staff of laureled scientists. So it opts to spend small but focus on marginal improvements to its best-selling brands. Reckitt Benckiser starts with deep consumer research to determine how its best brands can be improved and how much more consumers would be willing to pay. From a technical point of view, its innovations are incremental.
Witness the company’s tweaks to Finish, its dishwasher detergent. A few years after launching the product, the company added a rinse agent. It followed a few years later by including salt to soften water and prevent spots and watermarks. And, more recently, it incorporated an ingredient to protect ceramic glazes during washing. While the changes are small, they’re all features that customer research suggests people will value.
Note that Reckitt Benckiser’s approach differs from the standard “versioning” long practiced by big consumer goods companies. Versioning is adding a new model, size, or wrinkle to the base brand in hopes of hitting the next quarter’s sales target or protecting retail shelf space. Thus, consumers are faced with dozens of flavors of potato and tortilla chips and countless varieties of sodas. The problem with this approach is that, even if it works in the short term, over time it can create complexity for the brand owner, especially in production and logistics, and confusion for customers. By contrast, with each product iteration, Reckitt Benckiser looks at the whole line and retires any version that no longer earns its space on the shelf.
Reckitt Benckiser’s R&D projects are less risky and far less costly than those of its bigger competitors. But the company sets an ambitious performance target for each one. It expects a certain percentage of its sales each year to come from new products or better versions of existing ones, and its market-facing executives are rewarded financially when the company hits or exceeds those targets. This pay-for-performance incentive, in turn, motivates the company’s personnel to rally behind R&D-improved products and drive them into the marketplace.8
How Big Spenders Can Improve Their Returns
So what’s the solution for big-spending Newtonians if they want a better R&D return? We see three ways they can change their fortunes: become more Lorenzian, “buy in” promising new ideas, or foster greater collaboration between marketing and R&D.
Make more small bets and fewer big ones. If Newtonians are going to continue to spend heavily on R&D (and in many cases, they should), they need to invest better.9 This means cutting back on big bets offering very questionable potential returns. Instead, they should focus on smaller bets that are based on a deep understanding of (1) consumers’ desires, (2) the significant value a small innovation can add, and (3) the system of retailers and competitors in which the innovation will be introduced.
One might ask, “But shouldn’t companies pursue disruptive innovation before they themselves are disrupted out of business?” In the case of consumer goods companies, not necessarily. If a company has a tradition of success through other means, like marketing, it may lack the R&D chops to produce big breakthroughs.
Plus, while it’s true the occasional breakthrough can radically change a market or a company’s fortunes, it’s equally true that such market-shaking innovation doesn’t suddenly just happen. It often results from solving many smaller problems over an extended period, not just one big problem. Apple’s iPhone followed decades of work on microprocessors and cellular technology, and Amazon Go, the online retailer’s new chain of automated brick-and-mortar stores, was built upon prior advances in smartphones, computer vision, and machine learning. Like big scientific breakthroughs that follow seemingly less-consequential discoveries (Einstein’s remarkable theory of relativity drew heavily on non-Euclidean geometry, for instance), these innovations appeared to burst forth as eureka moments but actually rely on decades of work by informal armies of scientists and engineers.
Winning in markets also requires a willingness to identify and seize small gains. The U.K. cycling team offers another instructive example. Heading into the 2012 Olympic Games in London, the team hadn’t been a world power but wanted to medal. Coach Matt Parker, in his role as the team’s “head of marginal gains,” was a proponent of doing little things to gain an edge.10 He encouraged team members to wash their hands carefully and travel with their favorite pillow. The team sprayed alcohol on tires before races to make them stickier and installed a tiny data recorder under every cyclist’s saddle. At competitions, the team used its own transportation to stave off infections. And it fed its cyclists fish oil and Montmorency cherries because such foods are full of antioxidants. These and other seemingly trivial moves added up. Every British track cyclist improved performance between the semifinals and the finals in the 2012 Olympics. More surprising, the U.K. team won 14 track and road medals during the London games, even though it had few stars beforehand.
There’s an analogy here to the now-famous “moneyball” philosophy in baseball, which recognized that the number of base runners a team got per game correlated more strongly with wins than did the number of home runs it hit.11 That insight prompted the pioneer of the concept, Billy Beane, who was then general manager of the Oakland Athletics and is now its executive vice president of baseball operations, to bring in players adept at getting on base, whether through hits or — this was radical thinking at the time — walks. Not coincidentally, these players were far less expensive than home-run sluggers. Beane parlayed his team’s smaller investment into a big payoff: more victories than teams spending twice or three times as much on players. Eventually, the rest of baseball caught up. Today, the use of advanced statistics to evaluate players and seek competitive advantages is common in Major League clubhouses.
Bart Becht, who was CEO of Reckitt Benckiser from 1999 to 2011, sees the parallel in his world: “Innovation is about getting many base hits and occasionally hitting the home run. You very rarely win a baseball game just by hitting home runs.”12
Buy in new ideas. Newtonian companies also should acknowledge that, while they’re adept at developing and commercializing products, their size and organizational structure aren’t ideal for deep research and invention. As Clayton Christensen, the Kim B. Clark professor of business administration at Harvard Business School, points out in his work on disruptive innovation, big companies are often leaders in their sectors and therefore avoid doing anything that threatens the status quo — because they have the most to lose.13
Thus, they should look outside for help. One way to do this is by outsourcing the “R” of R&D, capitalizing on the fact that other companies — those that are smaller, take more risks, and have more of an innovation culture — can produce better ideas. That’s a model long used in the pharmaceutical industry.14 Although they have strong R&D traditions, the biggest drug companies now often leave the early stages of drug discovery to small companies and university labs. Then, when a breakthrough looks promising, they buy up the little innovators or license the discoveries.
A recent deal between Nestlé and Barry Callebaut, a Swiss maker of chocolate products, provides a consumer goods example of the benefits of buying in innovative ideas. Barry Callebaut caused a sensation last year when it introduced what it calls “the fourth chocolate” — a ruby-colored confection that has taken its place alongside the long-established dark, milk, and white varieties. The company devised a way to process red-hued cacao beans into powder while retaining their color. Ruby chocolate is being marketed as the first natural new color for chocolate since Nestlé created white chocolate 80 years ago — in a product category that’s been around for hundreds of years. Aiming to inject new pizzazz into its product line, Nestlé struck a deal with Barry Callebaut to use its ruby chocolate exclusively for six months. Nestlé unveiled the fourth chocolate in a new version of its KitKat bars, which it launched amid great buzz in Japan around Valentine’s Day.15
There’s debate about whether ruby chocolate is a true innovation or just a marketing gimmick. Both sides have their arguments, but the fact remains that the product came from a smaller player that doesn’t own any brands — Barry Callebaut is a private-label manufacturer, not an industry stalwart that splashes out for R&D.
Another way to buy in ideas is to acquire the innovators themselves, not just their innovations. This is what Unilever did when it bought Dollar Shave Club, a subscription-based seller of razors, and what PepsiCo did when it purchased SodaStream, a creator of home soda-making machines. In both instances, the bigger company got the innovations it needed while focusing on what it excelled at: marketing and commercialization.
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Get marketing and R&D to cooperate. Finally, Newtonian companies must tackle what’s arguably their biggest innovation challenge: fostering collaboration between their marketing and R&D staffs. There’s ample evidence that, when marketing and R&D cooperate, success is greater than when either dominates.16
Take the high-tech industry, where R&D typically rules and marketing has comparatively little power. Intel, long run by scientists and engineers, is a familiar example.17 It could charge a premium for its processors because they had market-leading performance — the best combination of speed and price. However, a competitor, AMD, figured out how to create processors with the same performance and charge less for them. After suing AMD and losing, Intel foresaw a less profitable future of price wars and commoditization if it stayed on its course. In response, its senior management greenlighted the famous (and expensive) “Intel Inside” branding campaign, which not only created greater awareness of Intel but also differentiated its processors in the minds of computer buyers. Without R&D’s willingness to cede some of its power — and resources — to marketing, Intel would likely be a very different company today.
In consumer goods companies, marketing tends to wield more influence than R&D: Marketing builds powerful brands and creates enormous value for investors. Big players in the industry can’t — and shouldn’t — forget that. But their R&D staffs must step up as well. They need to identify promising new ideas, whether inside or outside the company. And they must become adept at finding attractive candidates for buying in. This will require being more visible in and connected to the R&D and startup communities where the best “R” is happening.
On top of this, R&D must be given a stronger voice. R&D divisions need people to champion new ideas and generate enthusiasm among top-level decision-makers. That will secure resources for further development and commercialization. If managers with those skills aren’t already part of the R&D team, it’s time to develop them or, if necessary, find them elsewhere.
At many large consumer goods companies, a reflexive approach to innovation — just spend more! — is failing to generate sales and growth. Making smaller and more-focused bets, buying in ideas, and aligning R&D and marketing can produce better outcomes for big and small spenders alike. Those tactics are already working well for smaller consumer goods players like Reckitt Benckiser, but Nestlé, Apple, and other large companies are benefiting from them, too. Reaping greater R&D returns requires hard thinking not only about what your company is spending but, more important, how it’s spending.