R&D vs. Ads in Battle for Bucks

Engineers Gaining on Admen as Corporations Stress Innovation

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It's the product, stupid.

That appears to be the thinking in Corporate America today, with the share of money spent on R&D increasing relative to the amount spent on advertising.

Of course, more innovation means more products to sell tomorrow-and total ad spending is still bigger than R&D spending (in 2003, the last measurable year, U.S. companies laid out $1.34 on advertising for every dollar spent on product origination and development). But R&D outlay is multiplying faster than ad bucks, and has been for decades, as products from cars to computers get ever more complex and companies strain for the killer innovation to give them the edge over their competitors.

Fifty years ago, companies spent more than $3 on ads for every research dollar, according to Ad Age's analysis of R&D data from the government's National Science Foundation and ad spending from Universal McCann's Robert Coen. By 1970, advertising's take had fallen below $2 for every R&D dollar. By 1995, the ad advantage was down to $1.52.

Advertising and R&D have enjoyed extended runs of growth over the years, with a small advantage to R&D. U.S. ad spending over the past 50 years declined three times (recessions of 1961, '91 and '01); company-funded U.S. research fell once ('02).

Public companies have been required to disclose "material" worldwide R&D costs since 1975 and advertising costs since 1994, but there's no guarantee that spending produces results. As accounting regulators noted when they set the first R&D disclosure rules: "A direct relationship between research and development costs and specific future revenue generally has not been demonstrated, even with the benefit of hindsight."

But companies, often accused of managing for the short term, pump money into R&D because they believe it will produce long-term benefits. A review of worldwide spending by top marketers shows the high-stakes bets many are making on R&D.

In a deep dive into securities filings for the 100 Leading National Advertisers, Ad Age found 18 companies-from Altria Group to Yum Brands-that disclosed worldwide ad and R&D spending in both 2005 and 1995. Dozens more disclosed pieces of information. When analyzed together, these filings show how spending is shifting.

In the 1995-2005 period, 13 of the 18 blue-chip marketers with full disclosure cut the ad budget as a percent of revenue; 11 raised R&D's share of revenue. (Revenue grew through inflation, mergers and business expansion, so nominal-pre-inflation-budgets typically got bigger even if percent-of-revenue shrunk. Among the 18 companies, 14 raised the ad budget and 16 boosted R&D spending.)

Reliance on scientists and engineers varies sharply by industry. On the LNA 100, Ad Age found 28 companies that disclosed 2005 ad and R&D spending. Thirteen of them spent more on R&D than ads; that group consisted entirely of autos (the Big 3, Toyota Motor Corp. and Honda Motor Co.), tech (from Microsoft Corp. to IBM Corp.) and pharma (including Pfizer and GlaxoSmithKline).

The rest of the 28 spent more on ads than science. These marketers by definition are focused less on the labs and more on marketing: package goods and food (Procter & Gamble Co., General Mills), phone service (AT&T, Sprint Nextel), toys (Mattel). There was one outlier: Dell spends far more on ads than R&D. Explanation? The PC assembler and direct marketer leaves heavy lifting on R&D to suppliers such as Intel Corp. and Microsoft.

Automotive, the No. 1 U.S. ad category, also is the biggest spender of R&D dollars. Struggling General Motors Corp., the top R&D spender in 1995, by last year had fallen to third in R&D spending behind Ford Motor Co. and Toyota. R&D as a share of auto revenue has been comparatively stable: The Big 3, Toyota and Honda last year spent 4% of revenue on R&D, about even with the 4.1% that Detroit spent 10 years earlier.

But it's not easy to make generalizations about auto R&D. Floundering Ford last year had about the same revenue as Toyota, but Ford spent more on R&D. Honda plowed 5.4% of sales into research, a high figure in part probably reflecting that Honda, as a smaller company, has to kick a bigger share of revenue into development to keep up with the likes of Toyota.

Pharma, the nation's fourth-largest ad category and second-largest R&D spender, may be the biggest surprise. The R&D trend isn't surprising: Major pharmaceuticals spent 14% of revenue on worldwide R&D in 2005, up about two points from 1995, according to Ad Age's review of securities filings. That continues a decades-long trend of ever-bigger research spending in search of the next blockbuster drug.

What's intriguing, though, is that pharma advertising as a share of revenue actually fell from 1995 to 2005 even as marketers pumped billions into direct-to-consumer ads for prescription drugs.

One explanation could be that revenue got a kick from sales of higher-priced drugs. But another is that DTC is largely a U.S. phenomenon. The U.S. accounted for 77% of worldwide pharma advertising in 2004, according to the Ad Age DataCenter. Pfizer, the top prescription drug marketer, did more than three-fourths of its '04 advertising in the U.S., but its home country accounts for little more than half of its revenue.

For the industry, U.S. ad spending grew over the past decade, but worldwide R&D grew faster. Brand building is important in pharma, but there's no denying the critical role of long-term R&D. "In the pharmaceutical business," Novartis noted in its latest annual report filing, "the research and development process can take up to 12 years, or even longer, from discovery to commercial product launch."

On a worldwide basis, drug makers on average last year spent less than a nickel of every revenue dollar on ads and more than 14? on R&D. That makes pharmaceuticals one of the most research-intensive industries.

Software publishing is the nation's third-biggest industry in R&D spending, according to the National Science Foundation. But Software companies spend a higher percentage of revenue on R&D than do any other product marketers.

Case in point: Microsoft Corp., which raised the share of sales spent on R&D to 15.5% last year from 14.5% in 1995. That doesn't sound like a big change until you see how Microsoft has grown: It spent more on R&D last year ($6.2 billion) than it had in revenue in 1995 ($5.9 billion). Ad spending has grown in dollars but declined in percentage: 2.5% of sales last year, down from about 3% 10 years ago.

R&D spending is a far smaller issue for marketers of food, soap and other package goods. Food and beverage companies spend about a half cent of each U.S. sales dollar on R&D, according to the National Science Foundation. Some top marketers, such as PepsiCo, don't bother to disclose R&D spending in their annual reports.

But some package-goods sellers are strong believers. Procter & Gamble, fanatical in its quest for the new (!) and improved (!), is by far package goods' biggest R&D spender in dollars (nearly $2 billion last year, or one-third of its ad budget). Procter's R&D spending as a share of revenue (3.4%) was significantly above that of key rivals.

Diageo has one of the smallest reported product-development budgets among food and beverage marketers last year, spending $29 million-a fraction of a penny per dollar of sales-on R&D. "The overall nature of the group's business does not demand substantial expenditure on research and development," the colossal spirits marketer said in its annual report. "However, the group has ongoing programs for developing new drinks products." You may call it bartending. At Diageo, it's R&D.
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