Increased R&D spending is vital to the software industry

In tough economic times, if the largest software vendors don't fund innovation, who will?

News of a recession can conceal a multitude of sins. For example, was it really the economic downturn that prompted IBM to issue all of those pink slips to U.S. workers, or was that just part of an ongoing process of systematic outsourcing? And what about the layoffs at Microsoft -- were they the result of the financial crisis, or was it something else?

If you believe an alliance of "investor activists" calling itself the Crandrea Group, it isn't the economy that's dragging Microsoft down, and cutting its salary budget won't make much difference. According to the Crandrea Group, the bigger problem is the billions Microsoft squanders each year on fruitless R&D.

[ Yesterday, Microsoft announced it was boosting its R&D spending by $1 billion and focusing on public safety. ]

All right, stop. At this point I'd like to emphasize that I'm well aware that the demands of outspoken investors are almost always skewed toward short-term gain rather than sensible product strategy. Furthermore, I have no idea what this so-called Crandrea Group really is, who its members and supporters might really be, or whether it represents a fiscally significant portion of Microsoft shares. I suspect that it doesn't.

Be that as it may, the Crandrea Group's claims regarding Microsoft's R&D expenditures are worth discussing because they raise important questions. What is the appropriate rate of investment in research and development for software development companies in a bear market? And as budgets tighten across the software industry and beyond, how can we ensure that software remains one of the hotbeds of innovation in the global economy?

Microsoft R&D: Money down the drain?
So far as I am aware, no company spends more on software R&D than Microsoft, with the total tab ringing in excess of $7.5 billion per year. To me this seems only appropriate -- after all, few companies come close to matching Microsoft's software sales revenue.

The problem, according to the Crandrea Group, is that one doesn't follow the other. The purpose of R&D spending is to drive innovation, yet innovative products aren't what drive Microsoft's revenue. Instead, Microsoft owes the bulk of its fortune to a few cash cows, including Windows and Office.

These are hardly the most innovative products. Sure, the "ribbon" interface introduced in Office 2007 was a fairly significant change -- I'm a fan, others hate it -- but under the hood, Office 2007 is still just an office suite. And remember all those innovative new features that were going to ship with Windows Vista, née Longhorn? The most exciting ones seemed to fall by the wayside.

"Microsoft, after a decade of acquisitions and R&D spending, is equally dependent on its cash cows for revenue as it was a decade ago," says the Crandrea Group's Craig Montgomery in a blog post titled "Could Microsoft Become the Next General Motors?" What's more, he says, the company has "the mentality of protecting the cash cows," while truly innovative products tend to wither on the vine. (That's if you consider the Zune innovative, I guess.)

Up to this point it's hard to argue with Montgomery's findings. What bothers me, though, are the Crandrea Group's proposed solutions. "It is critical that Microsoft utilize its R&D budget and focus on improving its core products," reads the group's strategy statement. "Rather than deploying capital to create new products, it is crucial to direct capital to improving existing products to secure consumer confidence and loyalty."

In other words, the problem isn't that Microsoft's attempts to innovate have failed. The problem is that Microsoft tried to innovate in the first place!

Whither software innovation?
See what I mean about investors focusing on short-term gain? And yet in a shrinking economy, the urge to circle the wagons, hang onto existing customers, and downplay cost centers is only natural. The larger the vendor, the more it stands to lose as customers tighten their belts.

But if Microsoft decided that its $7.5 billion would be better spent on security patches, bug fixes, and incremental upgrades, what would that say for the $3 billion that Oracle spends on R&D each year or the $6 billion that IBM spends on R&D annually across all of its hardware and software product lines? If the big vendors divert funds away from "pure" R&D in favor of safer ventures, just where is the next wave of software innovation going to come from?

Traditionally, one solution has been to turn to new blood. There's still plenty of room for promising new startups in the software industry. Unfortunately, this is one of the worst times for venture capital in recent memory. We've seen investment plummet 40 percent year over year, and there's no telling when the situation will improve.

Others say open source could be the answer. For example, Nokia claims open sourcing Symbian will streamline its R&D by eliminating duplicate efforts across its industry. But that kind of "cooperative competition" can only take care of the boring stuff : The low-level internals. The stuff that doesn't provide competitive advantage. The stuff Microsoft can afford to do on its own (or Google, for that matter).

As promising as it may be, open source software is still playing catch-up in most major application categories, and lack of protection against patent claims and other intellectual property issues still limits the community development model's effectiveness at true R&D. Can open source innovate? Sure -- but only when the funding is there to back it up.

That's why we should view Microsoft's promise to increase R&D spending as a good thing, despite what the Crandrea Group says. Should Microsoft take a hard look at how its research dollars are spent? Should it eliminate bureaucracy and excess middle management? Of course it should. But to cut back on R&D for the sake of short-term returns would be folly, and doubly so given current economic conditions. Now more than ever, we're going to have to rely on the largest software vendors to lead the way in R&D spending if this industry is to remain healthy and innovative.

Incidentally, one of the Crandrea Group's more bizarre suggestions for Microsoft is that it should acquire the Canadian mobile phone maker Research in Motion. I was a little perplexed until I noticed that the group claims to be a consultancy based in Canada. Would I be jumping to conclusions to put two and two together? Microsoft's management and board may have made missteps in the past, but to fall for such a blatant cash-grab now, with the economy itself in crisis, would be practically criminal.

Copyright © 2009 IDG Communications, Inc.

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