Companies cutting R&D spending

Photo courtesy of photosteve101 on Flickr

Photo courtesy of photosteve101 on Flickr

Rob Swystun, Pristine Advisers

In a disturbing trend in corporate America, corporations are skimping on the very thing that made them profitable in the first place: innovation.

USA Today’s Matt Krantz (as seen on CNBC) reports that 27% of the 121 companies on Standard & Poor’s 500 have reported cuts to research and development spending in the first quarter of this year compared to 2013. Thirty-three companies, including Merck, IBM and Texas Instruments, decreased their R&D budgets by 9% on average, based on the USA Today analysis of data from S&P Capital IQ. This carries on from last year when 55 of 225 companies that reported R&D spending said they cut their budgets in that area.

Katz says this is a disappointing trend to see, as profit and revenue growth have both stalled, with earnings inching ahead by 3.4% according to S&P Capital IQ and revenue expected to grow by pretty much the same amount at 3.3%.

If it’s any consolation, just 12 of the companies that cut their R&D budgets in the first quarter did so for the full year in 2012 and 2013. Plus, of all the companies that reported R&D spending in the first quarter, that spending actually rose 12%, up from a 9.6% increase in R&D spending in 2013.

Perhaps it’s the type of companies that are cutting back on R&D that is the real surprise. Many large companies that rely on having a stable of new products ready to launch have cut back, including the big drug makers like Pfizer and Bristol-Myers Squibb, who not only cut their R&D spending in the first quarter, but also over the past two years. Katz says Pfizer cut its R&D budget by 11% in 2013 and 14% in 2012 and an additional 1% in the first quarter this year. Merck has gone the opposite direction, actually raising its R&D spending by 1% in 2012, cutting it by 9% in 2013 and slashing it a further 18% in the first quarter of 2014.

But, drug makers aren’t the only ones. Truck parts maker PACCAR cleaved its R&D budget by 27% in the first quarter, by 10% in 2013 and by 3% in 2012.

Counterintuitively, investors are actually rewarding these companies for the research rollback and design decimation. Shares of companies that have cut R&D spending through the past two years and the first quarter of this year are up almost 25% over the past 12 months, way ahead of the 15% gain seen by the entire S&P 500 over that same period.

There’s a chance this R&D slashing is temporary like it was at Boeing, which upped R&D spending by 15% in the first quarter after cutting it by 7% in 2013, 16% in 2012 and 5% in 2011.

The big question is why these companies are cutting their R&D spending. We can only speculate, but considering that their stock prices have outperformed the S&P on average, maybe it’s for those short term gains?

There is some interesting speculation in the comments section of Katz’s article (which you have to wade through a bunch of trolling to get to) that suggests corporations are focusing more on buying smaller companies than investing in their own R&D. The thought is that companies keep an eye on these startups that are funded through angel investors and the ones that turn out to be successful are snapped up by the bigger companies, meaning they don’t have to take on the risk of failure if a new product turns out to be unsuccessful.

What do you think is behind companies cutting R&D spending?

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