HP Sharply Underspending On R&D, Moody's Finds

Just how did Hewlett-Packard get itself into this pickle?
That’s a complicated question, which includes a rotating door in the corner office and some remarkably odd decisions by the company’s board. But the root of the matter might simply be this: HP, a company that once used as its marketing slogan the word “Invent,” has been dramatically under-spending peers on research and development. What they’re not doing enough of, in short, is inventing.

Moody’s senior VP Richard Lane took a close look at HP’s R&D spending habits in a new report and finds clear signs of decay. His approach: consider the R&D spending by a collection of peer companies, tote up what HP’s spending would have been if HP  spent at the same pace based on a percentage of revenue, and compare the results. You can’t really look at how HP spends R&D dollars on a granular basis, but on a collective basis, it is clear that HP has been under-investing.

Moody’s chosen peer set include Lexmark (in printing); Dell and Lenovo (in PCs); IBM (in servers); Accenture and Infosys (in services); EMC and NetApp (in storage); Cisco and Juniper (in networking) and Oracle (in software.) Those companies report R&D spending as a percentage of revenue ranging from 1.2% (for the PC companies) to 14% (for the networking companies.) Lane’s approach: apply the percentage of spending used by those companies to HP’s lines of business, and come up with what HP would have spent to be at parity.

For the September 2012 fiscal year, HP reported R&D spending of $3.399 billion, which is 2.8% of revenue. Lane finds that if all parts of the company were spending at the same rate as peers, R&D would have been $4.5 billion – about $1.1 billion higher. And let’s remember that this is nto a new pattern. Ergo, HP has been under-investing in research for years now, a factor that no doubt has contributed to the fact that the company is shrinking at the top line. By Lane’s calculations, the company underspent its peers on R&D as a percentage of revenue for the last six years in a row. And he notes that HP’s growth rate has been below peer average for the last three years running. (Actually the company showed top line declines in FY 2012 and 2011.

Lane notes in the report that the R&D rate used in the printing category was adjusted down from the 9.2% actual rate reported by Lexmark to reflect the fact that HP sources laser engines and toner from Canon, which does most of the R&D for HP’s laser printer business. For PC’s, he looked at Dell’s investment level through 2010, before the company began investing aggressively in storage and networking.

“We believe approximately three quarters of HP’s revenue base has low revenue growth prospects and has commodity characteristics that limit the ability to differentiate through R&D,” Lane writes in the report. “The commercialization of effective R&D is a multi-year prospect with uncertain outcomes, where success requires re-invention to stay ahead of the technology curve. As we have stated in previous research, there is no ‘magic bullet’ for HP to suddenly revive its broad portfolio. Rather, HP needs to consistently and effectively invest in R&D to at least match the broad competitive landscape.”

That would be consistent with CEO Meg Whitman’s stated view that she needs five years to really turn the company around. Spending more on R&D won’t be an instant cure for what ails HP, but it will have to be part of the formula.