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How Innovation Really Works

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U.S. Companies are failing at innovation!

That bold statement was at the top of a letter I received, and it got my attention. I started to read about the reasons many organizations are struggling to innovate. It led me to the research by Anne Marie Knott, PhD. She’s a Professor of Strategy at the Olin Business School of Washington University. She was previously an Assistant Professor at the Wharton School. Her research is focused on innovation ranging from entrepreneurship to large-scale R&D. Her new book is How Innovation Really Works: Using the Trillion-Dollar R&D Fix to Drive Growth .

I followed up with her to talk about innovation, R&D, and what can be done about the current problem.

Companies Have Become Worse at Innovation

You say that companies have become worse at innovation despite the fact that it’s more important than ever. Why is this?

While companies have become worse at innovation, I don’t actually argue that innovation is more important than ever. It has always been the chief source of companies’ as well as the economy’s growth. I think the reason if feels innovation is more important is that companies’ R&D is only 1/3 as productive as it was in the past. Therefore, they need to do three times as much to generate the growth they used to enjoy–actually more than three times because each additional R&D dollar is less productive.

What’s RQ?

The catchy answer is that RQTM (short for research quotient) is the company equivalent of individual IQ—it’s how smart companies are. The precise answer is that RQ is the percentage increase in revenues a company gets from a 1% increase in R&D investment. So companies that have high RQs derive more revenue, profits and market value per dollar of R&D than low RQ companies.

How was it developed?

I didn’t set out to develop RQ (though I knew I needed such a measure from my time in industry). I actually stumbled upon it while trying to solve an academic puzzle, in much the same way that Percy Spencer stumbled on microwave cooking while working on combat radar systems for Raytheon.

Once I discovered RQ, however, I went through a similar process companies go through with their R&D. I worked out the theory to characterize how it related to growth; I tested alternative versions; then I validated that the current version matches theoretical predictions using 47 years of data across the full spectrum of US companies conducting R&D.

What are its implications?

RQ has a number of implications. First, by tracking their RQ over time, companies can determine whether their R&D capability is improving or deteriorating. If companies could have done this 30 years ago, it’s likely R&D capability wouldn’t have deteriorated so much. Second, because RQ is derived from economic theory, companies can use RQ to determine how much an additional dollar of R&D should increase revenues, profits and market value—this helps them set their R&D budgets. Third, RQ provides investors a way to value R&D, so now even Warren Buffet can invest in technology firms. More importantly, when investors know how to value R&D, they won’t pressure companies to cut R&D…

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