Can Apotheker Reverse HP's Decade-Long R&D Slide?

| About: HP Inc. (HPQ)

If you listened closely enough the biggest difference between the Leo Apotheker era at Hewlett-Packard (NYSE:HPQ) and Mark Hurd’s can be summed up in three characters: R&D.

On Hewlett-Packard’s earnings conference call executives mentioned research and development repeatedly. Analysts sounded a bit wary since R&D roughly translates into higher expenses. Apotheker said that R&D spending grew faster than revenue growth in the fourth quarter and would continue to do so. Apotheker also said HP would spend more on its employees.

He said:

First of all, there’s always an opportunity to drive increased productivity, in particular, relative to our scale. And you can rest assured that we will never stop driving more efficiency, and there are some very strong programs in place to make that happen, be it supply chain, or in our services business. And we are all committed, and I am in particular committed to continue our focus on operational efficiencies. However, you need to invest to create sustainable operating leverage. And you need to do this on a continuing basis as well. And we will use some of the savings that we generate from our efficiency initiatives, to continue investing in more R&D and into more sales. And we are also investing a little bit into our own people. All of this, in order to ensure that we have a strong business going forward.

And later he came back to the R&D point:

We are the only Company in this industry that is equally good on the consumer side, and on the Enterprise side. And if we manage, and we will work very hard to do that, to leverage the rapid innovation cycle that occurs on the consumer side, basically the Enterprise, make it (inaudible) more scalable, and then use that to our benefit, I think that will give us an immense competitive advantage, which is one of the reasons why we need to spend a little bit more money on R&D, and one of the reasons why we need to invest into our sales force, so we can bring all of this to bear, in a very effective way to the market.

As a small bit of proof that HP is serious about R&D, executives noted that spending was up in the fourth quarter sequentially. Indeed, R&D spending was $814 million in the fourth quarter, up from $742 million in the third quarter. In the fourth quarter a year ago, R&D checked in at $704 million.

However, that little boost in R&D spending is a drop in the bucket. HP’s sales have surged, but spending on R&D has fallen. How bad was R&D starved? Here’s the decade in HP’s R&D spending from a bevy of SEC filings.

  • 2010: $2.96 billion, or 2.3 percent of sales
  • 2009: $2.82 billion, or 2.4 percent of sales
  • 2008: $3.54 billion, or 2.7 percent of sales
  • 2007: $3.61 billion, or 3.4 percent of sales
  • 2006: $3.59 billion, or 3.9 percent of sales
  • 2005: $3.49 billion, or 4 percent of sales (Mark Hurd became CEO March 29, 2005).
  • 2004: $3.56 billion, or 4.5 percent of sales
  • 2003: $3.68 billion, or 5 percent of sales
  • 2002: $3.31 billion, or 5.9 percent of sales
  • 2001: $2.72 billion, or 6 percent of sales
  • 2000: $2.63 billion, or 5.4 percent of sales

For comparison, IBM spends about 6 percent of revenue on R&D each year. Oracle (NASDAQ:ORCL) spent 12 percent of revenue on R&D for the 12 months ended May, 31, 2010. If HP is going to compete with its two largest rivals it has to step up its innovation game and invest accordingly. Dell (NASDAQ:DELL) has spent about 1 percent of revenue on R&D for the last three fiscal years.

Now you can argue that HP’s R&D spending as a percentage of revenue is skewed. Hurd argued that R&D isn’t about spending—it’s about producing products. After all, acquisitions have boosted HP’s sales. But generally speaking R&D spending is at dot-com bust levels. Simply put, that level of spending isn’t good enough.

Apotheker’s job is to reverse that R&D decline and do it efficiently.

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