Cutting R&D Expenditures is Not Always the Wrong Move

by: William Trent, CFA

USA Today had a breathless story yesterday on US firms cutting R&D and fears that this could make the companies and the country less than competitive. While R&D are usually good uses of money, sometimes they can be taken too far.

Look at all of the inventions made at Xerox’s (NYSE:XRX) Palo Alto Research Center that were not commercialized until outsiders came in for a look-see. Research is no good unless it leads to development and ultimately to sales. According to the article,

IBM on Wednesday plans to launch a consulting service to help businesses manage R&D efforts. It’s needed because companies increasingly must do more with smaller budgets, (NYSE:IBM) executive Melvin Weems says.

Sounds reasonable to us, although we question whether the reduntant R&D savings will offset the consultant overhead, but that is another story.

The article continues:

Many cuts came from some of tech’s most innovative companies:

• Sun Microsystems (NASDAQ:SUNW) last month announced a restructuring that includes a “significant reduction in non-core or redundant R&D,” CEO Jonathan Schwartz said. The computer-maker had already trimmed its budget 7% in 2005 from 2004.

• Bell Labs, the research center behind the fax machine and other innovations, may soon face cuts. Parent company Lucent Technologies (LU) in April announced plans to merge with French rival Alcatel and cut 10% of the combined staff. Every business unit is likely to be affected, Lucent says.

• Hewlett-Packard (NYSE:HPQ) cut its R&D budget to $3.5 billion from $3.7 billion in its 2003 fiscal year. The unit was overhauled to be more efficient and product-focused, spokesman Mike Moeller says.

• Microsoft (NASDAQ:MSFT) cut its R&D budget to $6.2 billion in its 2005 fiscal year from $6.6 billion in 2003. Microsoft attributes some of the drop to an accounting change.

These are the “most innovative companies?” What blockbuster product has Microsoft developed with its $18 billion+ in R&D spend?

Hewlett Packard cuts R&D and - what do you know - profit surges. Short sighted? The long-sighted approach was tried for 20 years and got nowhere.

Sun? Lucent? They were innovative. Now they need to survive, and survival doesn’t come from doubling an expense.

Meanwhile, there is still plenty of innovation going on in the US. Much of it is still being done in privately held companies where it is off the radar screen. But all you need to do is look at how your lifestyle has changed through new and innovative products to see that it is still happening.

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