Cadence, Electronic Arts Lead Silicon Valley Companies in R&D Spending

Cadence Design Systems Inc., Electronic Arts Inc. and Synopsys Inc. top the list of Silicon Valley companies pouring money into research and development, committing at least 32 percent of sales to R&D in the past year.

Silicon Valley businesses, whose fortunes depend on creating new products, together invested billions of dollars in research on everything from software and computer chips to Internet services and biotechnology. R&D spending rose 13 percent in the latest quarter from a year earlier, the fastest pace in two years.

While many companies in the San Francisco Bay Area curtailed travel, shut offices and trimmed headcount last year to ride out the recession, some used the slowdown to develop new products for when the economy rebounds. Others in hotly contested markets spent on R&D to keep from falling behind. Together, 56 companies in a Bloomberg regional index spent $42.2 billion in the four most recently reported quarters.

“Companies that invest earlier are the ones that survive and win,” said Ray Wang, an analyst with the Altimeter Group in San Mateo, California. “How much companies spend on R&D depends on how much they can reuse, repurpose and extend what they develop across customers.”

On average, software and Internet companies invest 11.4 percent of their sales on R&D, according to Barry Jaruzelski, a partner with consulting firm Booz & Co. who analyzes the world’s biggest R&D spenders. The average for hardware companies is 7.1 percent.

Design Intensive

Individual companies may spend markedly more, depending on their markets. Consider Synopsys and Cadence Design, the No. 1 and No. 2 makers of software used to design computer chips.

Such software helps fulfill Moore’s Law, first described by Intel Corp. co-founder Gordon Moore, which predicts that computer chips will double their number of transistors every two years. Much of the burden is on makers of chip-design software to deliver that complexity. It’s why makers of chip-design programs devote at least 30 percent of revenue to R&D.

Cadence Design invests more than that. In the most recent four quarters, the San Jose, California-based company spent 40 percent of revenue, or $349.4 million, on development projects -- the highest percentage among Silicon Valley companies.

In comparison, Synopsys invested about $433 million, or 32 percent of revenue. The Mountain View, California-based company can’t afford to skimp on its investment, Chief Executive Officer Aart de Geus said in an interview.

“Technology is part of our DNA, and any investment that makes our DNA stronger has a direct impact on our short- and long-term well-being,” de Geus said. “If our customers win by using our software, they spend money with us, which we funnel back into R&D and keep the machine moving.”

Catching Transitions

Electronic Arts, the world’s second-biggest video-game publisher, is in the middle of a market shift, moving away from its declining console business, which accounts for almost two- thirds of annual sales, and toward games that are played online.

Last year, the company closed studios, said it would fire 1,500 employees, moved jobs to lower-cost regions and paid $400 million to buy Playfish Inc., a maker of games played on the Facebook social-networking website. That pits Electronic Arts against Zynga Game Network Inc., the biggest provider of Facebook games.

“All gaming companies have been aggressive in taking costs out,” said Atul Bagga, an analyst for ThinkEquity LLC in San Francisco. “They are gearing up for the next wave.”

Going Online

In the most recent four quarters, Electronic Arts spent about $1.23 billion on R&D, or 34 percent of its revenue, mostly to develop online gaming services. That makes the Redwood City, California, company the second-biggest R&D spender in the region, as a percentage of sales.

“Having seen digital distribution disrupt the distribution of newspapers and retail music, EA is determined to lead the game industry’s online transformation,” spokeswoman Holly Rockwood said.

Yahoo! Inc., owner of the second-most-popular U.S. Internet search engine, is working to reverse falling sales. In the 12 months ended in June, the Sunnyvale, California-based company cut R&D spending by 7.8 percent to $1.15 billion. Its staff has been working on a new home page and other ways to drive traffic to its sites.

That investment, representing 18 percent of revenue, hasn’t paid off yet. Last week, Yahoo reported second-quarter sales that missed analysts’ estimates after losing ground in the search market to Google Inc. Yahoo’s operating profit margin in the period was 11.6 percent, up from 9 percent a year earlier. Google, by contrast, posted an operating margin of 34.7 percent.

“Innovation is core” to Yahoo’s business, spokeswoman Dana Lengkeek said.

‘Great Yield’

“Investors look to see if there’s a great yield on that R&D dollar,” said Brent Thill, an analyst with UBS AG in San Francisco. “If a company can generate healthy operating margins, market share and revenue, it doesn’t matter what they’re spending.”

Rivals Cisco Systems Inc. and Juniper Networks Inc. both viewed the recession as an opportunity to accelerate their R&D efforts. Cisco, the world’s biggest maker of networking equipment, amped up development by 13.5 percent while Juniper, No. 2 in the market, boosted spending by 22 percent.

Both companies told analysts last year that they would cut costs where they could while devoting money to where it mattered: on new products.

“This is the engine that will fuel our acceleration out of the downturn,” said Stefan Dyckerhoff, Juniper’s executive vice president, at an investors’ conference last month.

Big and Small

Juniper, based in Sunnyvale, set aside 22 percent of sales for product development in the past year. San Jose-based Cisco spent 14 percent. Yet even with that percentage difference, Cisco’s dollar outlay dwarfed Juniper’s because its sales are more than 10 times larger. Cisco spent $5.16 billion on R&D in the period, compared with Juniper’s $804.2 million.

There are two things worth remembering when looking at R&D spending, Jaruzelski of Booz & Co. said.

“Bigger companies can spend a smaller percentage on R&D relative to smaller players, and get similar outcomes,” he said. And after reaching a certain critical mass, “it’s not about how much you spend, it’s about the quality of the people, your discipline and deciding where to put your investment.”

Which brings up the example of Apple Inc., arguably the most innovative company in Silicon Valley right now. The Cupertino, California-based maker of the iPhone, iPad and Macintosh spent only 2.9 percent of revenue on R&D, ranking near the bottom of Bloomberg’s list.

Yet that 2.9 percent, or $1.65 billion, produced some of the best returns in the technology industry.

“Apple has a deep understanding of customers and a rigorous focus on a small number of products,” Jaruzelski said. “You don’t see them throwing a lot of products against the wall and hoping some of it will stick with the customer.”

To contact the reporter on this story: Rochelle Garner in San Francisco at rgarner4@bloomberg.net

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