Organizational RQ

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by Anne Marie Knott of Washington University in St. Louis

by Anne Marie Knott of Washington University in St. Louis

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  • 1. Organizational RQ Anne Marie Knott Professor of Strategy, Washington University Director, Berkeley Research Group _______________________________________________ April 17, 2012 SIKM Leader’s Community Call
  • 2. My life before academia2
  • 3. The innovation engine is broken  Historically R&D viewed as engine Impact of R&D on GDP growth of economic growth 14.00%  Obama in State of the Union 12.00% address holds it up as solution to 10.00% 8.00% growth problem 6.00% GDP growth  Valid through the space race 4.00% 2.00% R&D intensity  No longer seems to be the case 0.00% 1950 1960 1970 1980 1990 2000 2010 Axis Title3
  • 4. The Problem: Firms and policymakers fly blind4  No good measures of R&D effectiveness – R&D spending is an input measure (51% of firms using) – Patents neither universal or uniform • Less than 50% of firms doing R&D patent; universality • 10% of patents comprise 85% of economic value; uniformity – Neither Patents nor R&D spending is reliable • Anomaly in their relationship to market value • Booz study each year says no correlation with firm growth  Implications – Front-end: Firms use rules of thumb to choose R&D investment levels – Back end: Can’t tell whether given practice helps or hurts capability4
  • 5. Front-end: unsure how much to spend 10000 Majority of firms are spending sub-optimally 8000 6000 Actual R&D 4000 2000 0 0 20000 40000 60000 80000 Optimal R&D (R*)5
  • 6. Back end: Unsure what makes them effective Increasing IQ Cross Plot of Old IQ versus New IQ 200 Changes appear random 150 Number of Mean Statistically 100 Firms Change Significant Increasing IQ 178 13.0 70 Decreasing IQ 184 -12.5 65 50 0 0 50 100 150 200 Firm IQ 1987-1996 Decreasing IQ6
  • 7. A real world illustration of both problems Charles House, a former longtime H.P. engineer …now at Stanford University, openly rejoiced when he heard that Mr. Hurd was leaving. “I think the sexual harassment charge was a total red herring,” Mr. Hurd was systematically destroying what had always made H.P. great. … The research and development budget used to be 9 percent of revenue, … now it was closer to 2 percent.  Is Mr House right: Did Hurd destroy what made HP great?  With existing measures, we have no way of knowing! – Whether R&D capability has deteriorated, or by how much – Whether the correct investment is 9% or 2%7
  • 8. Solution: Organizational IQ…well now RQ  Derived from firm’s production function Y = A aB b Output = Capitala *Laborb8
  • 9. Organizational RQ extends the PF in two ways  Expand to include R&D: Output = Capitala *Laborb * R&Dg * Spilloversd * Advertisinge  Make all the exponents firm-specific: – Raw RQ is the exponent, g, on R&D • “firm-specific output elasticity of R&D” • % increase in output from 1% increase in R&D – Reported RQ rescales g to the human IQ scale (m=100, s=15)  Interpretation: – Analog to individual IQ: • Those with higher IQ solve more problems per unit of input: • time (individuals), money (firms) – Need to generate AND exploit innovation9
  • 10. Some properties of RQ Variation (within industry) > Normally distributed Variation (across industries) Distribution of Firm IQ 10 300 IQs by Industry 150 130 Firm-Level IQ 110 IQ Mean 200 90 IQ Max IQ Min 70 50 30 100 34 35 44 72 76 77 51 61 63 74 79 90 25 42 45 61 70 72 73 28 28 28 35 35 35 36 36 36 36 36 36 38 38 38 38 73 73 73 Industry SIC 0 0 50 100 150 200 Q10
  • 11. Its most important properties  Universal: RQ can be estimated for all firms doing R&D  Uniform: An RQ of 100 (or any other number) means the same thing across all firms regardless of currency  Reliable: It “predicts” firm behavior and market value11
  • 12. The IQ Guessing Game: The Business Week 5 Distribution of IQ guesses for BW5 1.0 Percentage of guesses 0.9 0.8 Apple 0.7 Google 0.6 0.5 Microsoft 0.4 IBM 0.3 0.2 Toyota 0.1 0.0 <85 85-95 95-105 105-115 >115 IQ guess12
  • 13. Comparing RQ to other innovation indices Business Week Rank vs RQ Forbes 100 vs RQ 130 180 160 120 Organizational IQ (2004-2010) 140 110 120 IQ 2004-2010 100 100 80 90 60 40 80 20 70 0 0 10 20 30 40 50 0 20 40 60 80 Business Week Innovation Rank 2010 Innovation Premium13
  • 14. Using RQ immediately: Set R&D budget14  IQ defines optimal R&D investment Optimal R&D and Market Value both increase with RQ d Õ d é b 1 b 2 RQ b 4 b 5 b 0 = ë K L R S A e - (dK + L + R + A)ù û dR dR 80 3.5 70 3.0 1 æ 1 ö RQ-1 R* = ç ÷ 60 2.5 Optimal R&D spending b1 b 2 b 4 b 5 b 0 è (RQ)K L S A e ø 50 R&DIQ 2.0 40  Theory tells us profits should increase by 30 1.5 é R RQ - R RQ ù - R opti ë 2 1 û 1.0 mal 20 R  Both predictions hold in the real world! 10 0.5  Firms with Higher RQ tend to spend 0 0.0 0.02.03.04.05.06.07.08.09 0.11.12.13.14.15.16.17.18.19 0.21.22.23.24.25 0 0 0 0 0 0 0 0.1 0 0 0 0 0 0 0 0 0.2 0 0 0 0 more on R&D IQ  Market value increases if you RQ increase R14
  • 15. The REAL promise of RQ: firms can change theirs  Firms can change their RQ! – Though currently random Growth versus RQ  There is no theory to tell us how 4.00 3.50 much this increases growth, but… ln(revneue growth 2000-2007) 3.00 – Empirics tell us 10% increase in RDg 2.50 2.00 increased growth rate 3.2% 1.50  The holy grail: RQ will do for R&D 1.00 0.50 – What TQM did for manufacturing cost 0.00 – What hospital report cards do for -1.00 -0.50 -0.50 0.00 0.50 1.00 1.50 2.00 -1.00 morbidity and mortality -1.50  Firms are real ln(RDg) implementors, ….but analysts are fuel!15
  • 16. RQ Summary  The most intuitive measure you can construct for R&D effectiveness  It’s universal, uniform and reliable  Application – Solves the up-front problem of setting R&D budgets: • Immediate benefit: $1 trillion increased market cap just for top 20 firms! • Medium term benefit: Better R&D allocation should increase RQprofits and market value – Solves back-end problem of knowing effectiveness: • Medium term benefit: Keeping what’s effective (dropping what isn’t) should increase RQprofits and market value  To learn more: – Harvard Business Review article “The Trillion Dollar R&D Fix” hits online and newsstands today: http://hbr.org/magazine • Includes online tool to lookup firms’ RQ – www.amkANALYTICS.com offers firm reports and subscriptions to RQ data – For help implementing RQ:www.brg-expert.com/professionals-anne_marie_knott.html16