Sometimes Cutting R&D Spending Can Yield More Innovation15 January, 2015 / Articles
This may sound as though we’ve got our facts backward, but your company can significantly increase its knowledge output by cutting R&D spending.
It’s all a matter of when you cut your spending, and why.
Take Cisco, for example. The company’s R&D expenditures dropped by about $1.5 billion from 2002 through 2004. Drawing on data from the U.S. National Bureau of Economic Research, we found that during this period, the company’s patented knowledge output increased significantly.
The chart may appear to show merely that Cisco’s patent filings lagged its R&D spending by three years, but in fact the decline in spending and the rise in patents were part and parcel of a deliberate strategic shift by the company in 2001.
So what was going on? How could a decline in research spending stimulate an outpouring of patents?
What Cisco was doing was shifting its R&D approach from exploration to exploitation. Exploratory R&D, in which researchers cast about for radical new ideas, is expensive and iffy, typically resulting in patents that are relatively few in number but packed with valuable knowledge. Exploitative R&D, in which companies focus on making use of the best ideas they’ve discovered, is less costly and more of a sure thing, often resulting in a vast quantity of incremental and defensive patents built on the foundation of prior exploration. Cisco followed this pattern: In 2001, its patent activity narrowed dramatically from a broad array of technological areas to relatively few.
Over time, many of the best tech companies cycle between exploration and exploitation. Sometimes exploration means creating inventions; sometimes it means acquiring small, inventive companies. But whatever form it takes, exploration in these companies is typically followed by exploitation (a few companies do both simultaneously, but we’ve found that the sequential approach is much more common, probably because trying to do both at once is really difficult).
Exploitation allows companies to monetize their exciting new ideas and thereby relieve some of the stakeholder pressure for short-term earnings. It gives the CEO a breather until the company has to return to exploration to restock its supply of radical ideas.
We’ve found that, in general, companies that move between exploratory and exploitative R&D exhibit superior performance, in comparison with companies that budget R&D expenditure as a fixed percentage of sales, committing neither to exploratory nor exploitative R&D.
Our research shows that Cisco is unusually adept at this sequential ambidexterity, shifting between the two approaches at opportune moments. In fact, we think Cisco is one of the all-time best at this corporate skill.
During exploratory periods, when new opportunities are opening up, Cisco spends generously in search of radical innovations for competitive advantage; once it has identified a good number of them, it shifts to exploitation, which allows the company to cut its R&D budget while producing large numbers of valuable patents, although with narrower scope than during the exploration phase.
Having gone through a period of intense exploration and discovery at the beginning of the 2000s, when the internet was still fairly new, the company changed tack, focusing mainly on exploiting inventions related to the internet’s backbone. It issued numerous upgrades that increased the speed and throughput of its routers and improved the accompanying software platform. Although it expanded into new markets, these moves were based on the company’s existing knowledge: Cisco’s storage-area network products were modified versions of its routers, and even its move into consumer wireless internet relied on mature Cisco technologies.
As of late, Cisco is back into exploratory territory as it leads a push into multimedia conferencing, in large part by acquiring smaller companies. Where will this period of discovery take the company? If the past is prelude, before long we’ll see the company amass a number of valuable ideas related to conferencing, then shift to a lucrative period of exploiting its best ideas.
Cisco’s example demonstrates that corporate vision comes in many flavors. It’s not always just about hiring great minds and giving them the freedom to look for the next big thing. It’s also about knowing when to shift from one mode to another. That requires an understanding of when a set of radical ideas is ripe for monetization and, later, when the returns to incremental R&D are falling, necessitating a return to search mode. Visionary leadership is also about helping the company overcome inertia so that it can shift effectively from one frame of mind to another when the time comes. Few companies pivot easily, but those that do position themselves to ride wave after lucrative wave of exploratory, then exploitative, R&D..