Why Your R&D Budget Should Be the Last Place You Cut

Adapted from Go Long: Why Long-Term Thinking Is Your Best Short-Term Strategy, by Dennis Carey, Brian Dumaine, Michael Useem and Rodney Zemmel, copyright 2018. Reprinted by permission of Wharton Digital Press.

When Sir George Buckley assumed the chairman and CEO role at 3M in 2005, he found a company that had long been known for innovation -- it had created Scotch tape, Post-it Notes and thousands of other consumer and industrial products over its proud 100-plus year history. He also found a company that was suffering from sluggish growth and had just gone through severe layoffs and a bout of cost cutting. In the four years before he arrived, capital spending had been slashed by 65 percent and R&D by 25 percent. Earnings had indeed improved under Buckley's predecessor, but the newly installed CEO was worried about the future.

Related: 6 Ways R&D Tax Credits Can Help Save You Money

The executive team and workforce he says he encountered when he arrived at 3M were demoralized and scarred by years of cutbacks. How could he get them to rekindle their imagination, take more risks and become more innovative again?

We identified five critical principles that led to 3M's turnaround.

Know short-termism hurts innovation.

What Buckley knew from previous experience was that you can't compete in today's environment without spurring cutting-edge R&D. As we all well know, the rise of big data, next-generation analytics, artificial intelligence, the internet of things and robotics is turning multiple sectors of the global economy upside down. All this disruption also means that over the next decade there will be a heightened premium on innovation. To compete, more established companies will need to spend a great deal of capital to constantly keep their products and services a step ahead of their rivals'.

Related: The $250,000 Tax Credit You Could Be Using for Your Business

Find the money elsewhere.

If Buckley was to get 3M to reach his goal of getting at least 30 percent of each division's revenues from products introduced in the last five years -- he knew he would have to find the money to fund R&D without diluting earnings. He did two things: He freed up capital by reshaping his portfolio of businesses and also by making his supply chain and operations more efficient.

Listen to the rank and file.

Now Buckley had to decide where to spend his R&D war chest. Buckley and CFO Pat Campbell listened to the input offered by the leaders and employees of their 37 divisions. Each was asked to put together a one-page business plan to talk about new product and growth potential, as well as the split between capital expenditure and how much they wanted to spend on expenses, R&D included. Then the duo ranked them based on the quality of their ideas and on their historical growth rates in sales and earnings.

Related: When It Comes to Innovation, Go Big or Go Home

Nurture an innovation culture.

Money is a necessary but not entirely sufficient means to spur innovation in organizations. CEOs must create a culture where people feel they are not only supported by the executive team but also safe to take risks and perhaps even fail. Whether you worked in 3M's biggest or smallest division, you had a shot at getting increased R&D and growth funding. And once people started realizing that projects they had been afraid for years to propose might get funding, a floodgate of ideas opened. During his first year in the job the number of ideas increased from none to 60. By the end of the second year the executive team had twice as many good ideas as it could fund without affecting operating margins. And employee engagement numbers had risen significantly -- at the end of his tenure, they had risen by a factor of five.

Seek innovation in the everyday.

Any CEO wanting to spur innovation should understand that there can be as much gain in improving processes and materials as there is in new product launches. In other words, innovation can be about not just adding technology but doing something you used to do at a fraction of the cost. 3M, for example, is the largest respiratory mask maker in the world. At a strategic planning meeting Buckley asked what it cost to make each mask. He was told it cost over a dollar. So, he then challenged the leader of that division to make one for just five cents.

She looked at Buckley from the other side of the table and said, "George, it's impossible" -- the cost of the material alone, she said, was vastly more than five cents. She soon took up the challenge, and a year later, 3M released a mask to market that cost less than 10 cents to make.

"There's not a product in the world you can't innovate," says Buckley. "Just use your imagination, laud successes and ignore some of the failures, and this will change people's attitudes to the point where they start to think they can really do this."

And at 3M, they did.