Wednesday, December 31, 2014

Putting a Price on Innovation: Measuring a Firm’s Ability to Adapt

From the CFA Institute blog:
A company’s success depends on its ability to develop innovative solutions to problems, and a company’s culture will determine how well those solutions are implemented. However, innovation and culture are difficult qualities to define and hard to measure. Some analysts compensate for this difficulty by using more easily measured substitutes, such as research and development (R&D) spending, when valuing a company’s future prospects.

Barry Jaruzelski, creator of the Global Innovation 1000 Study, has been analyzing R&D investment at the biggest-spending public companies in the world. He published the first version of his annual study in 2005, and he warns against confusing dollar amounts spent on research with the future profits that could result from that research. According to Jaruzelski, his study’s long-standing finding is that that a company’s financial performance and innovativeness do not correlate with how much it spends on R&D.

Anne Marie Knott, professor of strategy at Olin Business School, agrees that R&D spending alone is not a good indicator of a company’s performance. “The trouble is,” she wrote in Harvard Business Review, “it’s also hard to measure strategic alignment and culture, let alone link them to profitability or market value.” Knott has developed a measure for R&D productivity that she calls RQ, short for research quotient.

Knott’s RQ equation uses a standard regression analysis to define the relationship between a firm’s spending on inputs and its revenues from output. Knott notes that “economists have been calculating capital and labor productivity for years — that is, determining the marginal value of increasing either one.” She argues that R&D productivity can be determined using the same method. Both the RQ equation and the Global Innovation 1000 Study show that the link between research and innovation is not as simple as more research dollars leading to more innovative breakthroughs.

A 2014 report from Bernstein Research found that tech companies with the lowest R&D spending were some of the best performers on Wall Street, further complicating the relationship between research spending and financial performance. And companies that change their R&D strategies make things even murkier....MORE
See also:
Inventing the Future
Inventing the Future II
Really Smart Investing: Ocean Tomo's 3D Printing Patent Study (AMAVF; DDD; SSYS; MTLS)