Invest in Research and Development but Avoid These 2 Practices

Is research and development important for every business? How much should you spend on these ventures?

To create products and services that fulfill future demand, companies must continuously innovate. Therefore, Stephen Denning argues in The Age of Agile, companies must invest heavily in building capacity for research, development, and production.

Here’s more on why every company should invest in research and development that’s beneficial to their strategy.

Invest in Capacity and Innovation

Denning calls for companies to invest in their staff of engineers and developers and to retain expertise.  He explains that many companies fail to invest in developing their innovative capacity because they prioritize shareholder value instead. As a result, they pursue short-term gains at the expense of long-term, capacity-building investments.

Denning critiques two investor-centric practices in particular: stock buybacks and outsourcing. Let’s explore each practice and their drawbacks.

Why Stock Buybacks Are Detrimental

Denning explains that the pursuit of investor returns often leads firms to buy back their own stock. This pleases shareholders because it artificially inflates their stock prices by reducing the number of shares available, which boosts earnings per share. However, Denning argues that this practice only diverts company assets from growth and innovation, weakening the company in the long term. As a result, the firm’s capacity to create real value diminishes, leading to a negative and self-reinforcing cycle where more buybacks are needed to maintain stock prices, further eroding the company’s future prospects.

(Shortform note: While many agree with Denning’s position, defenders of stock buybacks argue that they’re not as detrimental to a company as sometimes portrayed. They contend that companies mainly buy back stock when they have excess capital but have exhausted other investment opportunities. In other words, stock buybacks don’t interfere with investment in growth and innovation. Furthermore, defenders argue that stock buybacks allow capital to be allocated more efficiently throughout the economy. If shareholders are willing to sell their shares back to the company, it probably means that they’re planning on moving their money to better investment opportunities, redirecting capital where it would be most impactful.)

Why Outsourcing Is Detrimental

Furthermore, Denning argues that the pursuit of investor return often encourages companies to focus narrowly on cutting costs to widen profit margins. Like shareholder buybacks, this practice prioritizes short-term gains at the expense of long-term sustainability. 

This is particularly evident in the case of outsourcing, where companies delegate parts of their business to another firm, often in countries where the cost of labor is cheaper. Denning argues that outsourcing can lead to an irreversible loss of knowledge and capability—companies can only innovate processes that they themselves participate in or have direct knowledge of. Once those processes have been taken over by other firms, the company is no longer aware of what goes on behind the scenes. This undermines their ability to improve on those processes, their products, or their services through innovation.

(Shortform note: It’s worth noting that there are potential benefits to outsourcing. First, companies can free up time and money for more important projects by outsourcing functions that other firms do more cheaply. This could allow them to invest even more in the functions that are most important to their business. Furthermore, offshoring jobs to another country gives companies access to a global talent pool, brings jobs to developing countries, and can even strengthen international ties between nations.)