Here is an excerpt from an article written by Vanessa Chan, Marc de Jong, and Vidyadhar Ranade for the McKinsey Quarterly, published by McKinsey & Company. As they explain, a survey finds that when it comes to reallocating R&D expenditures, more isn’t necessarily better. To read the complete article, check out other resources, learn more about the firm, obtain subscription information, and register to receive email alerts, please click here.

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Mounting evidence finds that the habit of allocating the same levels of resources to the same business units year after year undermines corporate performance — and even lowers the odds of a lengthy tenure for CEOs. Put another way, in a fast-changing competitive environment, companies that succumb to resource inertia will probably struggle to meet their strategic goals.

New McKinsey research paints a complementary, though more nuanced, picture for reallocating innovation and R&D resources. Our survey of senior executives at companies with revenues of more than $1 billion showed that the average level of annual R&D reallocation is relatively consistent — 12.7 to 13.7 percent—regardless of a company’s innovation performance (see sidebar, “About the survey”). Parsing the data in a finer way to highlight the distribution of reallocation behavior further emphasizes the fact that when it comes to reallocating R&D expenditures, the message is subtler than “more is better.”

Reallocation sweet spots?

As the exhibit shows, top-quartile innovators may be identifying sweet spots where adequate (yet still substantial) levels of R&D reallocation are bolstering innovation performance: 75 percent of executives at top-quartile companies say they reallocated 6 to 30 percent of their R&D budgets in each of the past three years compared with 37 percent of the respondents at bottom-quartile performers.

Annual R&D reallocation, on average, is relatively consistent, yet top-quartile innovators may be identifying sweet spots where reallocation bolsters innovation performance. [To check out an exhibit of survey findings in the form of analytics, please click here.]

http://www.mckinsey.com/insights/innovation/finding_the_sweet_spot_for_allocating_innovation_resources

Only 5 percent of the top-quartile innovators reallocated more than 30 percent of their R&D budgets each year. By contrast, 16 percent of the bottom-quartile innovators did so, and 9 percent of the bottom-quartile companies reallocated more than 40 percent of their R&D budgets. That’s a big adjustment for any large organization and a threshold none of the top-quartile companies breached.

The poorest performers, in fact, seem divided between two camps. At one extreme, there’s a near-majority of companies that are sleepwalking through their R&D-reallocation decisions, moving 5 percent or less of their R&D resources a year among businesses and divisions. At the other extreme, a second group is placing huge bets in an attempt to jump-start performance or perhaps to make drastic course corrections. Time—and further research—are needed to determine if these low-performing innovators have awakened in time or are in fact doing additional damage through panicky reallocations.

Take a hard look

The nuanced picture our research paints should not be surprising. After all, the right amount of annual R&D reallocation for an individual company depends on its industry, strategy, and competitive situation. Furthermore, shifts don’t necessarily translate into quick performance gains. However, the data suggest that any large company on the left-hand side of the chart (below 10 percent and certainly below 5 percent) should investigate its levels of R&D reallocation to make sure that its portfolio is aligned with its innovation strategy and that it isn’t nurturing stalled projects at the expense of more promising alternatives. And while operating closer to the sweet spot highlighted on the exhibit doesn’t guarantee success with innovation, a steady, consistent level of R&D reallocation year after year is highly consistent with successful innovation at scale.

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For more about the practices associated with top innovators, please click here to download The Eight Essentials of Innovation Performance (PDF–458KB).

Vanessa Chan is a principal in McKinsey’s Philadelphia office; Marc de Jong is a principal in the Amsterdam office, where Vidyadhar Ranade is an associate principal.

The authors wish to thank Peet van Biljon for his contribution to this article.