The greater a company’s investment in its knowledge workers and the complementary resources dedicated to its NPD initiatives over the prior 3 to 5 years, the greater the financial return on its new-product effort in the following year.
This may not surprise but until Professors M. Ann McFadyen and David H. Henard reported their research findings at the recent CIMS Sponsors Meeting there had been little empirical evidence to support what many managers assume intuitively. Here’s their summary.
Business analysts and executives view investments in innovation and new product development (NPD) initiatives as strategically effective contributors to a firm’s financial performance. Yet both managers and researchers need three questions answered:
- In which strategic resources should firms invest?
- To what degree should firms invest?
- Is there a quantifiable link between key resource allocation and a firm’s financial performance that justifies the resource investment decision?
Our study focused on two complementary resources in the NPD process: PhD knowledge workers and the financial resources that support them. We investigated the impact of each resource on the firm’s new-product performance over time. Moreover, we captured precise measurements of knowledge workers, financial NPD resource investments, and new-product financial performance.
How This Study Differs
Although most managers intuitively believe that dedicating knowledge worker and financial resources to NPD initiatives will improve firm performance, there’s little direct empirical evidence to support such intuition. While other investigations of the effects of resource dedication on performance have often relied on subjective measures, our study took specific objective measurements to accurately assess the relationships and to analyze those relationships over time.
We tracked the resource dedication and resulting NPD performance of 41 firms over a seven-year period (1). We found that the greater a firm’s financial investment in its knowledge workers and in the resources dedicated to NPD initiatives, the greater the financial return on its new product performance. While the dedication of both types of resources makes a positive impact on new-product performance, the returns from financial investments are immediate while those from investments in knowledge workers are both immediate and linger over time.
The IRI/CIMS Database
We collected both survey and archival data. We obtained survey data from a joint initiative between CIMS and the Industrial Research Institute, the supporters of our study. The IRI/CIMS annual surveys collected detailed data pertaining to the sourcing and allocation of numerous NPD activities from 106 participating firms between 1992 and 1998. The IRI/CIMS database is the only source, to our knowledge, that provides such detailed longitudinal data on dedicated NPD resource investments.
After eliminating firms that did not respond to the survey for two or more of the seven years, and introducing secondary financial data from Standard & Poor’s Compustat database for the participating publicly traded firms, our final database contained 7 years of IRI/CIMS and Compustat data for 41 companies.
How the Study Was Conducted
To understand the impact of dedicated knowledge workers and financial expenditures, we captured new product performance as NPD sales revenues divided by total revenues. We define the dedication of knowledge workers as a firm’s focused commitment to skilled individuals within the organization who are dedicated to NPD initiatives. These people focus solely on new-product development initiatives and often hold doctorates in their respective fields.
Participating IRI/CIMS firms provided us with the total number of such dedicated knowledge workers. To construct this independent predictor variable, we divided the number of dedicated NPD personnel by the total number of employees for each firm.
We defined dedicated financial expenditures to NPD initiatives as a firm’s focused commitment of dollars for NPD activities. Participating firms provided the total dollars that were dedicated solely to specific technical, non-routine activities targeted at transforming research findings into the production and commercialization of new products. They also included dollars that were allocated to any design or engineering tasks required to commercialize a new technology for product launch.
This total dollars figure does not apply to previously commercialized technology nor does it include financial commitments to routine technical activities. To create an appropriate and relative across-firm measure, we divided the total dollars solely dedicated to NPD initiatives by capital expenditures.
Firm investments in R&D programs, as well as firm size, may also influence performance. To control for any effects that firm-wide expenditures on total R&D activities might have on performance, we included a size-adjusted measure of R&D intensity. We created this measure by dividing total R&D expenditures by assets.
We tested our hypotheses with a “fixed effects” data mode, which allowed us to control for any unobserved heterogeneity (e.g., location, industry, unique firm attributes, etc.) that might otherwise affect our empirical results.
What We Learned
Our results indicate that the greater a company’s investment at time t in dedicated knowledge workers and financial expenditures for complementary NPD resources, the greater its new product financial performance at time t+1. Note that each time period (t) is captured as a three-year moving window; i.e., 1980, 81, 82= t1; 1981, 82, 83=t2, etc. Thus, by investing in these dedicated NPD resources during a previous three-year window (e.g., t1=1980, 81, 82), we can expect an increase in in new-product financial performance in the following year, 1983.
We also found a positive statistically significant relationship between knowledge worker NPD resource dedication at time t–1 and firm performance at time t+1. Knowledge worker investments have both a short-term t and lingering effect t–1 on NPD performance t+1.
Financial expenditures only have an immediate effect, most likely resulting from the notion that NPD expenditures are likely to be higher when a firm’s access to cash is strong or when there is an expectation of strong short-term profits.
Implications for Managers
Managers face a difficult predicament. With increased market pressures to produce positive financial results on a short-term, quarterly basis, managers might erroneously evaluate the performance of their NPD initiatives prematurely. NPD spending is often influenced by a company’s current discretionary cash flow situation. Coupling this financial reality with any constraints of quarterly performance targets will likely cause some managers to view NPD expenditures as a short-term investment decision.
The realities of competition today could force managers to base NPD financial investment decisions on their current cash flow while the pressure to produce returns will arguably cause them to allocate greater capital to projects with shorter returns on investment and vice versa.
Our study shows that returns from the dedication of resources to NPD projects should be evaluated over time, and knowledge worker NPD resource dedication, in particular, takes time to fully develop and produce positive results.
Further, we find that dedicated NPD resources — distinct from R&D activities —predicts new product performance. After controlling for R&D intensity and all other firm heterogeneity, dedicating knowledge worker and financial resources to NPD initiatives produces a positive financial return, which can lead to higher discretionary funds available for investment in overall product development initiatives.
With greater dedication of resources to NPD initiatives, managers create an environment where firms are better able to develop tacit skills and exploit marketplace opportunities. Thus, dedicated firm investment in knowledge worker and financial NPD resources, all other elements being equal, is likely to lead to a positive cycle of performance returns and greater discretionary funds available for persistent new-product development investment.
Bottom Line: Managements need to persistently invest in knowledge workers in the NPD process. Recognizing that the return on investments in knowledge workers will linger over time should encourage managers to evaluate their knowledge workers over periods of 3-5 years rather than, say, annually. Put differently, managers (and scholars) should adjust their expectations and anticipate performance to appear “lumpy” rather than a consistent stream of innovations.
Further, firms that maintain a given rate of investment over time produce a larger increment to the overall firm knowledge stock than investing twice this rate over half the time. Without continuing investment in knowledge worker NPD resources, future performance returns will likely suffer.
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