The Unique Advantage 2(The Habits of Mis-investment)

Mature industries are beset by underlying dynamics that make it difficult for them to invest their money in the kinds of innovation that lead to long-term success. Companies such as Campbell Soup Company, General Mills Inc., and Kellogg Company spend an average of 1 to 2 percent of sales on R&D. Although a number of studies have shown that higher R&D spending does not guarantee success, a minimum innovation investment is required for breakthrough thinking. Without it, companies tend to fill the pipeline with the “base hits” of line extension. They fall into a self-created loop of low investment, low returns, and steady but slow growth. In the end, the slow growth is not enough to keep them from falling behind competitors because everyone is in the same boat; but it does provide the illusion that the company is succeeding — or at least not shrinking — which is then taken as proof that this strategy is smart.
When the money not spent on R&D is instead spent on marketing, it reinforces the problem. Inflated advertising budgets often reflect a defensive mind-set: When competitors launch products with a full-bore assault in the media, executives conclude that they must follow suit with equally pricey campaigns or risk losing consumer share-of-mind. Money that goes into this type of “quick fix” is not available for the more fundamental solution of breakthrough innovation.
Another factor in the misplacement of investment is the predisposition of the R&D organizations themselves. Eighty percent of new products in a typical mature industry yield less than $7.5 million in sales their first year. (See Exhibit 1.) (To put that number into perspective, grocery is a $350 billion wholesale business globally, and sales of a major brand can top $500 million a year.) The industry logic is that competitors are continually introducing new versions of their products, so players are at a disadvantage if they don’t match that steady clip. The tendency is for companies to focus on relatively small, often superficial line extensions that can be churned out quickly, as when Mars rolled out Tropical and Wild Berry Skittles candies in the early 1990s.



No one would argue that advertising can’t pull the occasional rabbit out of a hat or that companies should stop launching line extensions. But when excessive advertising and line extensions become habitual solutions, it suggests that a company is locked into a pattern of high marketing spending and a need for endless small launches, and is under-investing in the kinds of R&D efforts that would lead to greater profits.