American technology companies once led the way in developing breakthrough products and services. But today many big tech firms seem to have lost their innovation mojo.
To appreciate just how much things have changed, consider that when I started out at IBM in 1970 the company had only recently released the world’s first interchangeable family of computers, the revolutionary System/360 mainframes. It was a bold bet on innovation that Fortune magazine at the time called “IBM’s $5 billion gamble.”
In today’s money, that’s the equivalent of a $40 billion wager on innovation — one that incidentally required IBM to cannibalize all its existing revenue-producing product lines. But the bet worked. The System/360 line quickly became the dominant mainframe in the market and the de facto industry standard, ensuring IBM’s dominance in the industry for a generation to come.
Back then, it was an axiom of business leadership that today’s investments in R&D lead to tomorrow’s breakthroughs and profits. But today, this ancient wisdom is in danger of being lost. As technology industry analyst Michael S. Malone observed in a provocative Wall Street Journal article last year, “Something fundamental has shifted in Silicon Valley.”
What’s changed is that many big technology firms no longer even try to invent the Next Big Thing. Instead, they buy it, using their multi-billion-dollar cash hoards. The result, noted Malone, is an “innovation slowdown” among the technology industry’s leading companies.
“Look around Silicon Valley and it’s hard to find established companies still devising their next products in-house,” Malone observed. “Seen anything new and big lately from Cisco, Yahoo or even Twitter?” The same might be asked, of course, of Facebook, Oracle, and several others. For these firms, the question is, Why innovate, when you can simply buy?
This slowdown in product innovation is mirrored by a similar decline in basic science research. “American corporate labs used to be the stuff of legend. But those days are long gone,” reported a May 19, 2015 article in the New York Times. “Corporations, constantly pressured to increase the next quarter’s profits in the face of powerful foreign competition, are walking away from basic science, too [and] big companies now more easily buy innovative startups.”
Or, as suggested by Google’s announcement August 11 that it was reorganizing itself as a holding company, some firms opt for organizational change in hopes of staying relevant.
But either way, the bottom line is unavoidable. As the New York Times put it, “The edifice of American innovation rests on an increasingly rickety foundation.”
Three forces are driving this innovation slowdown:
First, some companies see the acquisition of startups as a quick off-budget way to obtain new technology or enter new markets without the need for large R&D investments that dilute the bottom line. This is a recipe that obviously pleases the short-term palates of analysts. And to be fair, innovation-by-acquisition can be an effective strategy in sectors like pharmaceuticals, where it’s responsible for two-thirds of all sales growth among drug firms since 1995. Acquisitions can also offer firms a way to circumvent the torpor and inertia of many big company R&D programs.
But innovation-by-acquisition also carries risks, including the fact that it may undermine a company’s long-term viability. This is especially true if a company, by forsaking internally-generated innovation, loses the organizational capacity and know-how needed to independently respond to market shifts. “In that case, says analyst Chris Donegan of EverEdge IP, “a decline in a company’s inventiveness can have swift and brutal results — consider that the life expectancy of an S&P 500 company has fallen from 61 years in 1958 to only 18 years today.”
A second factor behind the innovation slowdown is the growing number of campaigns waged by activist investors to force companies to cut their investment in R&D and instead boost short-term earnings and stock price. Earlier this year, the activist investor Nelson Peltz tried to force DuPont to shut down its R&D lab and split the company into three parts. This despite the fact that DuPont’s R&D lab was responsible over the years for the invention of rayon, Teflon, Kevlar, and Solamet solar cells. Indeed, in 2014 alone, innovative products from the lab were directly responsible for 32 percent, or $9 billion, of DuPont’s total revenue.
Thankfully, DuPont shareholders rejected the Peltz’ initiative — one of the few defeats suffered by these slash-and-burn activists in recent years. But activist pressure overall continues to have a deleterious effect on innovation. As venture capitalist Marc Andreessen told an investor conference a few months ago, “Public companies are being basically forced by pressure from activists to give back huge amounts of cash instead of investing it in the business.”
The third factor driving the innovation slowdown is the corporate practice of stashing huge amounts of cash overseas — $2.1 trillion dollars by some estimates — to avoid paying tax on it. Last year alone, firms generated $182.4 billion overseas, or roughly 19 percent of their total net income, according to experts. The immediate tax advantage of parking funds overseas is clearly more attractive to some firms than the longer-term benefits of investing in innovation.
This is terribly short-sighted, in my view, and I speak from personal experience. When I took charge of IBM’s global intellectual property function in the early 1990s, Big Blue was in the midst of a near-death experience. For several years running, IBM had suffered the largest losses in U.S. corporate history, and had been forced as a result to reduce its workforce by half. Not widely known was the fact that the company was only 100 days away from bankruptcy.
In response, we began licensing our valuable intellectual property and know-how to other firms — a practice that until then would have been considered corporate treason had it not been driven by our desperate need for cash. Within three years, we were generating over a billion dollars annually in licensing revenue, 98 percent of which was pure profit. This enabled us to maintain our investment in critical R&D programs until these were ready for prime time.
The most important of these R&D projects involved the development of the world’s first copper chip, which enabled microprocessors to run 40 percent faster at 30 percent less cost of manufacture. IBM’s announcement of its new copper chip in September of 1997 rocked the industry. The San Jose Mercury News said IBM’s copper chip “puts it three years ahead of its competitors.” A Japanese newspaper ran a headline simply titled “The IBM Shock!”
Interestingly, we used the experience gained from licensing our intellectual property to make a deal with arch-rival Motorola, which had also been trying to develop a copper chip. We licensed the copper chip technology to them, essentially “hiring” Motorola to fab it for us, and it quickly became an industry standard.
That’s what investing in innovation can do for you.
Now, I am well aware that R&D spending does not automatically equal breakthrough innovation. Microsoft, for example, spends $11 billion a year on R&D, and I am not the only Microsoft alum to wonder what exactly the company gets from all that.
But even with the caveat that R&D does not always result in innovative new products and services, I still believe that the current innovation-by-acquisition craze says more about cheap money and near-sighted management than it does about a sustainable path to corporate growth. When interest rates go up and companies are forced to look elsewhere for performance gains, I’m confident the pendulum will swing back to more organic growth through innovation.
And when that happens, the advantage will go to business leaders who are able to create, lead, and sustain innovation-driven growth. Towards that end, my future columns will offer readers information, insights, and case study examples that can help them revitalize their own company’s innovation capacity. Topics will include:
- Building a Culture of Innovation — Starting at the Top.
- Breaking the Tyranny of the R&D Budget Cycle.
- Tapping Into Today’s Democratized Innovation Ecosystem.
- Surviving Truly-Disruptive Innovation.
- How to Reinvent an Industry.
- Does Intellectual Property Really Matter?
I also plan to offer readers a series of no-holds-barred conversations with high-profile business leaders on the innovation challenges they have faced — and the lessons they learned in trying to overcome those challenges.
This article was written by Marshall Phelps from Forbes and was legally licensed through the NewsCred publisher network.