Effective long-term capital allocation is fundamental for innovating and creating value; investment in research and development (R&D) fuels this growth. Successful R&D can be transformational for an organization and for broader society. But while worldwide spending on R&D has slowly increased, R&D returns have been declining. What’s driving this decline? Emerging evidence suggests a short-term mindset lies at the heart of this puzzle.
R&D spending, especially long-horizon R&D project spending, faces a unique set of short-term pressures relative to other types of long-term investment. When facing short-term financial pressures, behavioral biases including manager risk aversion and uncertainty around forecasting potential future returns (among other things) lead to a tendency among management teams to cut long-horizon projects first. The declining tenure of managers, the lack of innovation-linked metrics in incentive compensation plans, the typically asymmetric return profile of long-horizon projects, and an investment community that often ignores the potential impact of long-horizon innovation spending in a company’s valuation analysis all contribute to this problem.
Our analysis suggests the tendency to cut long-horizon projects has left companies and investors with unbalanced innovation portfolios, favoring short-term projects that offer more certain, albeit ultimately lower, incremental returns. Unfortunately, it is often those same long-horizon projects, left on the cutting room floor, that deliver the most longterm value creation potential. The overweighting of short-term projects sacrifices significant return potential offered by long-horizon, transformational innovation, and similarly transformational returns.
Alternative ways to structure, value, and manage long-horizon R&D investments could bring R&D portfolios back into balance, delivering better returns across the investment value chain. Companies can make a variety of changes across their strategy, governance, engagement, and incentive plans to support long-horizon innovation spending—and investors can support this shift by engaging around companies’ R&D investment philosophies and rewarding companies for the optionality offered by of long-horizon innovation investment. Getting these activities right is essential.
Strategy | Article
9 December 2019 - Returns to successful R&D can be transformational for an organization and for the broader society in which it operates.
Strategy | Toolkit
9 August 2020 - An interactive R&D Scenario Engine that allows corporate boards, executives, and risk committees to determine their optimal R&D allocation between short, mid, and long-range projects.
Strategy | Press Release
10 August 2020 - New report from FCLTGlobal aims to rebalance long-horizon R&D investing