How HP thinks about R&D: It's about new products not spending

Hewlett-Packard is a lean scalable machine that is pumping out earnings nicely, but can the company apply the same efficient approach to its research and development that it does with its overall operation?

Hewlett-Packard is a lean scalable machine that is pumping out earnings nicely, but can the company apply the same efficient approach to its research and development that it does with its overall operation?

During HP's earnings conference call Wednesday there was a telling exchange about how CEO Mark Hurd approaches research and development. HP's R&D spending has been falling in recent years. For the year ending Oct. 31, HP spent $2.82 billion on R&D, down from $3.54 billion a year earlier. In 2007, HP's R&D spending was $3.6 billion.

For comparison's sake, IBM spent $5.82 billion on revenue in 2009, down 8.2 percent from 2008. As a percentage of revenue, R&D spending remained 6.1 percent of IBM's revenue.

The real eye opener on the HP conference call came from Sanford Bernstein analyst Toni Sacconaghi. He asked HP executives---Hurd and CFO Cathie Lesjak---the following:

You commented on the need to invest heavily going forward. I think if you just looked at R&D dollars it looks like you’re actually going to spend less on R&D in 2010 than HP did in 2000. HP’s revenues were less than $50 billion in 2000 and will be more than $120 billion today. So how do we think about that? Is that just that you have a lot of wasteful R&D spending before or your portfolio is really different or how do we reconcile those statements?

My jaw dropped when I heard that---partially because it wasn't some analyst model question about deltas and financial mumbo jumbo only designed to make spreadsheets look pretty. But Sacconaghi's numbers check out. For fiscal 1999, HP spent $2.4 billion on R&D.

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So how should we think about this? HP has become a massive company, but R&D isn't rising accordingly. Does R&D have scale?

Lesjak and Hurd think so. Here are some key excerpts from Lesjak's answer:

One of the things you got to look at is that there are inputs and outputs. And the outputs in R&D really are helping to give us win in the marketplace. The innovation that we see, whether that’s around the G6 Blades, the Slate products that we’ve announced, the Web-connected printer, kind of on and on.

We’ve got good new products coming out that are helping us win in the market, and our market share gains frankly prove that. But then that there are also the inputs into R&D. You want to make sure that you are investing in the most efficient way that you can. And what we have found is that there are real opportunities to think about R&D as a series of processes and make sure that we are doing those processes in an efficient way.

Lesjak added that R&D has a bevy of inefficient processes. An operation like HP Labs has a lot of little processes with equipment. That costs money.

"If you go to a more virtualized environment, that’s going to be a much more efficient flow. It didn’t change the amount of innovation that the R&D engineers are doing. It’s just simply changed the process and the dollars associated with that process," explained Lesjak. Real estate and IT expenses are other areas that can cut the R&D benefits.

Hurd continued:

R&D was one of the biggest consumers of overhead in the Company. That’s one point. Second point, we’re in a mode to look for processes that we can

standardize. Simple things like testing, QA, how many development tools we’ve got. All of these have been, because of acquisitions, very random and very unique, and very, if you will, siloed.

So our ability to get standardized on those processes gives us an opportunity to take out cost.

We look at R&D in the context of overhead, maintenance and innovation. What we are trying to do is get the innovation dollars up. So when you look at the total R&D spend, it’s down, and yet the yield to the product road map is up.

As I'm listening to this Hurd's approach to R&D I'm taken back to a briefing a few weeks ago with John O'Dea, CEO of a company called Crospon. In a nutshell, Crospon licensed HP's inkjet technology to come up with a drug delivery patch to replace needles. The patch is really a series of microneedles (backgrounder).

By repurposing inkjet technology, Crospon can create a more effective drug delivery platform.

"Drugs don't work because people aren't taking them. It's a compliance problem," said O'Dea. "With this technology there's a microprocessor that tracks what the patient takes and you can have multiple drugs on one patch. It's a hybrid infusion pump and patch. It could be used for insulin."

How much of that discovery from HP Labs was process vs. taking a think-tank approach? Is there serendipity to R&D that makes it different than procuring components?

We'll find out. Hurd may have the right approach to R&D, but the thinking here is different than the old academic think tank approach. For Hurd, R&D is all about the products.

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