How do companies innovate successfully?

They can spend the most money, hire the best engineers, develop the best technology, and conduct the best market research. But unless their research and development efforts are driven by a thorough understanding of what their customers want, their performance may well fall short — at least compared to that of their more customer- driven competitors. John Schiech, president of the DeWalt division of Black & Decker (the division that makes power tools used by professional contractors), put it simply. When asked what made his com - pany so successful, he responded, “It’s engineers and marketing product managers spending hours and hours on job sites talking to the guys who are trying to make their living with these tools.”

This insight represents a further amplification of our ongoing research into the costs and value of corporate innovation. In 2006, as in the two previous years of our annual study of the Booz Allen Hamilton Global Innovation 1000 — the 1,000 publicly held companies around the world that spent the most on research and development — overall corporate revenues among these companies increased 10 percent. Once again, their overall spending on research and development also rose, to US$447 billion this year. And as in years past, we found no statistically significant connection between the amount of money a company spent on innovation and its financial performance. This document presents only a summary of the available research. Download this Booz Allan Hamilton report...

We also compiled a list of high-leverage innovators (see page 13), as we did last year. These were the companies that, compared to other companies in 2006, got a significantly bigger performance bang for their R&D buck. The high-leverage innovators consistently achieve better sustained financial performance than their industry peers while spending less on R&D. We’ve spoken to executives at a number of these companies, including Black & Decker. When listing the reasons for their success, they all mention two key factors. The first is strategic alignment: They work hard to align their innovation strategies closely to overall corporate strategy. The second is customer focus: They all have processes in place to pay close attention to their customers in every phase of the innovation value chain, from idea generation to product development to marketing.

This year, for the first time, we looked more directly into the connections between corporate and innovation strategy, and between innovation strategy and indepth customer understanding. We selected a group of the Global Innovation 1000 companies, representative of the total in their mix of industries and company sizes, that spent a combined total of $68 billion on R&D in 2006. Through surveys and follow-up interviews with C-suite and senior executives of companies such as IBM, Thales, GE, Bayer, 3M, Autoliv, and Denso, among others, we ex plored their approaches to technology, customers, and markets, and how tightly their innovation strategies were connected to their overall corporate goals and direction.

The results were revealing. From our statistical analysis of the responses (see Methodology, page 15), we identified three distinct innovation strategies. Because nearly all the companies favored just one of the three strategies, we classified them into three categories.

Need Seekers: These companies actively engage current and potential customers to shape new products, services, and processes; they strive to be first to market with those products.

Market Readers: These companies watch their markets carefully, but they maintain a more cautious approach, focusing largely on creating value through incremen tal change.

Technology Drivers: These companies follow the direction suggested by their technological capabilities, leveraging their investment in research and development to drive breakthrough innovation and incremental change, often seeking to solve the unarticulated needs of their customers.

Perhaps the most important finding that emerged from the study was that no one of these strategies performed consistently better than any other — indeed, high-leverage innovators can be found in each of the strategy categories. The most significant performance differences correlated not with their innovation strategies but with those critical factors mentioned above: strategic alignment and customer focus. Over the past three years, companies that say their innovation strategies are tightly aligned with overall corporate objectives boasted 40 percent higher growth in operating income and 100 percent higher total shareholder returns than those whose innovation strategies are less aligned. Companies more focused on customer insight or market needs are also more successful than their less-customerfocused peers. In particular, companies that directly engaged their customer base had twice the return on assets and triple the growth in operating income of the other survey respondents. This document presents only a summary of the available research. Download this Booz Allan Hamilton report...