R&D Intensity and the New Product Development Portfolio

A key metric for assessing innovative activity at the firm level is R&D intensity. R&D intensity is the ratio of a firm's R&D investment to its revenue (the percentage of revenue that is reinvested in R&D). Empirical and anecdotal evidence suggests that R&D intensity within an industry tends to be remarkably consistent. Despite this consistency in R&D spending, however, firms differ with respect to their new product development (NPD) portfolio strategy and overall performance. This paper seeks to explain how R&D intensity can be so consistent at the aggregate level, while NPD portfolio strategies and firm performance are so varied at the firm level. We develop a model that considers firm level factors, such as the NPD portfolio composition and risk levels, as well as industry level factors, such as competition intensity and environmental stability. We show how a simple evolutionary process links aggregate R&D intensity and firm level portfolio choices. Our results highlight that R&D intensity alone does not explain firm performance. Rather, it is the proper alignment between R&D intensity (how much the firm invests) and an NPD portfolio strategy (how the firm invests the money) that drives profitability.