Why 3M Is an Effective Innovator
Close customer relationships allow the wide-moat firm's return on R&D spending to be meaningfully higher than peers.
Joshua Aguilar: Recently we were able to dig into the topic of 3M's innovation. We've said for a long that 3M benefits from intangible assets, which are byproducts of these innovation efforts. These intangible assets include strong brands, customer relationships, patents, proprietary technology, and other valuable IP. But we had never specifically looked at how efficiently the company was spending their R&D over a cycle, nor how their results compared to other innovative companies.
It's well known that 3M spends about 6% of sales on research and development and the company emphasizes organic sales growth as a key performance indicator to track these efforts. But what we said was knowing these data points is really nice, but a good metric should have both 1) a divisor to track the effectiveness of that spend, and 2) should tally these results over a period of time to get a normalized picture of the company. What we found was that 3M earns about a quarter shy of $9 in returns on research capital over a five-year cycle, which is the amount of gross profit in the current year for every dollar of R&D spent the prior year. We're also predicting this will continue.
What was interesting is that when you compare these results to other innovative companies, not only does 3M spend about 50 basis points more as a percentage of sales compared to a group of 100 innovative firms, their returns on research capital were 57% greater than other highly innovative firms. About 70% of their product pipeline comes from their one-on-one work with customers as opposed to alternatives competitors may typically rely on, like focus groups. While many companies cite customer relationships as a competitive advantage, we think these results lend credibility to the argument that customer relationships really are part and parcel of 3M's wide moat.
Joshua Aguilar does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.