The Search For Tomorrow
Which corporations are innovating and investing to create future wealth? Which are just coasting? You can tell by looking at their capital spending as well as their research and development outlays. Capital spending gives companies tangible capital such as machinery, while R&D provides them the intangible capital of ideas. Both are critical. Although R&D and capital spending are usually analyzed one at a time, there's no good reason for that separation.
For this 75th anniversary issue, BusinessWeek has devised an index that wraps together R&D and capital spending and calculates the two as a proportion of companies' total outlays. We call it the BusinessWeek Investing for the Future Index. It sheds light on which companies -- and industries -- are devoting the biggest share of their resources to projects whose payoff lies in the future. The tables, drawn from data supplied by Standard & Poor's (MHP ) Compustat (MHP ), should be studied in combination with background knowledge of the companies and industries. If a company occupies a niche with lots of profitable opportunities, then strong spending on R&D and capital goods could be a sign of happy days ahead, says Samuel S. Kortum, an economist who studies innovation at the University of Minnesota.
The biggest name near the top of the U.S. list, at No. 4, is Amgen Inc. (AMG ) in Thousand Oaks, Calif., the biotech company that makes drugs to fight anemia, arthritis, and cancer. Last year it devoted just over half of its total outlays to future-oriented activities, split roughly equally between R&D and capital spending. Also at the top are another biotech company, Biogen Idec Inc. (BIIB ), and two info-tech companies that are spending a big share of their outlays on R&D to build a new generation of products: Applied Micro Circuits Corp. (AMCC ) and PMC-Sierra Inc. (PMCS ) The top 30's well-established giants include Eli Lilly, Pfizer (PFE ), Intel (INTC ), Merck (MRK ), and Microsoft (MSFT ).
As those names suggest, high-tech companies dominate the index. They continue to see their sector favorably, and they're putting their money to work. All of the top 30 U.S. companies except one are in drugs and biotech, semiconductors, software and IT services, technology gear, or health care. The lone exception is eBay Inc. (EBAY ), the online-auction company, which is classified as a retailer.
It's common to rank companies by R&D spending, but that's incomplete. In our ranking, the inclusion of capital spending -- on equipment, software, and structures -- elevates the status of companies such as Intel Corp., which couples respectable R&D spending with heavy expenditures on new chip-fabrication plants. Another company that gets a big lift from the inclusion of capital spending is eBay, which is investing aggressively in tangible assets even though its R&D expenditures are only middling. Oil producers and manufacturers also look better with capital outlays in the formula.
Capital spending isn't as different from R&D as it might first appear. It isn't just about adding capacity. It's also a way to stay abreast of the latest developments, since new machines have the latest technology. Capital spending, with R&D, is especially important in nations such as the U.S. and Germany, where high wages demand correspondingly high productivity. "Our society thrives because it produces knowhow," says Stefan Krause, chief financial officer at BMW, the top auto maker on BusinessWeek's non-U.S. list.
To compare companies of different sizes, we present R&D and capital expenditures as a share of what we call "outlays." Outlays consist of capital spending plus a broad measure of a company's operating expenses, including salaries, cost of goods sold, and R&D, and excluding such items as depreciation and acquisition costs. Expressing R&D and capital spending as a share of outlays (rather than as a share of revenue) shows how companies choose to break down their spending regardless of whether their sales are high or low.
Covered in the initial two tables are the largest companies in the U.S. The U.S. database is the Standard & Poor's 500, which represents 82% of the market value of all U.S. companies worth $1 billion or more. Since innovation is a global business, we also wanted to look at which non-U.S. businesses are more future-oriented, based again on Standard & Poor's rich database. Outside the U.S., the database is the roughly 700 non-American members of the S&P 1200 -- namely, most of the large foreign companies for which it is easy to obtain complete financial data. The tables list only companies that report both capital spending and R&D as separate line items in their financial reports. No financial companies break out R&D, nor do most U.S. utilities and retailers, so they're omitted from the rankings.
For additional insight, BusinessWeek looked at rankings within industries. Eastman Kodak Co. (EK ), spending heavily to to make the leap to digital imaging, was No. 1 in consumer goods, topping the likes of Mattel Inc. (MAT ) and Hasbro Inc. (HAS ) In capital goods, No. 1 is a company that's sometimes still thought of as a low-tech conglomerate: ITT Industries Inc. (ITT ) in White Plains, N.Y. The new, streamlined ITT conducts R&D in such fields as military night-vision gear and avionics.
Overseas, in the auto industry, Japan's vaunted carmakers are outranked by Germany's BMW and Volkswagen. In software, the highest-ranked non-U.S. company is France's Dassault Systèmes (DASTY ), which makes industrial-design software.
WHEN TO SCALE BACK
More isn't always better. Companies in slower-growing, low-wage service sectors such as retailing would be foolish to match the future-oriented spending of, say, software or biotech. And heavy spending can indicate wasteful empire-building, notes Louis K.C. Chan, a finance professor at the University of Illinois at Urbana-Champaign who has studied the topic. Some fund managers look askance at companies that do lots of speculative research. "I'm a bigger fan of the Dell (DELL ) model, including a tight R&D budget," says Daniel Niles, CEO of Neuberger Berman Technology Management.
In industries such as pharmaceuticals, throttling back R&D isn't an option. Pfizer Inc., for example, hasn't had a blockbuster drug it developed itself since Viagra in 1998, yet it keeps plugging away. With drugs going off-patent only seven or eight years after they finally reach the market and senior management seeking 10% annual growth in revenue and profit, "you need to reinvent yourself every decade and double in size," says John L. LaMattina, Pfizer's president for global research and development.
Microsoft has an easier task than Pfizer because its future revenues are more reliable. But it spends heavily on R&D, too. The software giant wants to pioneer information technologies and not just dominate ones other companies have debuted. Chairman William H. Gates III told analysts in July that Microsoft is making "a bet" based on "a very serious belief that innovation investments will pay off in a very dramatic way."
Sure, big bets don't always pay off. But the future belongs to companies that ante up for capital spending and R&D -- and manage to turn their tangible and intangible capital into real wealth.
By Peter Coy
With Ben Elgin in San Mateo, Calif., Amy Barrett in Philadelphia, and Gail Edmondson in Munich