1 Area Apple Lags the Competition, and Why It Doesn't Matter

Apple's (NAS: AAPL) fiscal year closes at the end of its September quarter, which means shortly after its fourth-quarter earnings release each year, investors get access to its 10-K. While the headline numbers such as sales and earnings were revealed in the company's earnings release, the 10-K offers a more detailed view into the company's financials, including its spending on property and equipment, its disclosures of risk factors, and more detailed information on executive compensation. It doesn't always sound like the most exciting areas, but there's definitely a lot to be learned. 

However, among the many storylines from Apple's 10-K release, the media curiously latched onto the company's jump in research and development (R&D) spending, which jumped 40% from the prior year to $3.4 billion. This is curious not only because Apple had already noted its $3.4 billion in spending in the week prior when it released its 8-K, but also because Apple's R&D spending pales behind its competitors. 

Is there any cause for alarm with Apple's R&D spending, is it even a particularly relevant area for Apple investors to be watching? Let's take a deeper look. 


Putting R&D in perspective
The first area to note about R&D is that spending varies wildly among tech companies. There is no golden rule to a spending level. Intel  (NAS: INTC) , sitting at the cutting edge of the semiconductor space, has used its ability to outspend the competition to keep rival AMD back for years. However, Dell has razor-thin margins in the PC space and could see its earnings sunk by letting R&D get out of control. There's a careful balance to the amount of R&D to pour back into a business. There's also the little matter of where to focus R&D spending. 

In total, 41 technology companies spent more than $1 billion on R&D spending in the past year. Putting a list of top spenders that includes Apple requires a good size table; the company ranks 14th in terms of R&D spend in spite of being the most profitable tech company by far. 

Tech's big R&D spenders

Company NameR&D Expense (LTM)Revenues (LTM)Net Income (LTM)
Samsung  $10,169.2 $172,804.6 $18,423.0
Microsoft (NAS: MSFT) $9,942.0 $72,359.0 $15,706.0
Intel  $9,827.0 $53,751.0 $11,897.0
Nokia (NYS: NOK) $6,507.4 $41,276.6 $(5,625.1)
IBM (NYS: IBM) $6,277.0 $102,634.0 $16,261.0
Google (NAS: GOOG) $6,208.0 $47,543.0 $10,555.0
Cisco Systems (NAS: CSCO) $5,488.0 $46,061.0 $8,041.0
Hitachi  $5,296.1 $121,308.5 $4,189.9
Ericsson  $4,878.5 $34,137.4 $2,036.1
Oracle (NAS: ORCL) $4,674.0 $36,928.0 $10,175.0
Canon $3,921.8 $44,847.2 $2,886.6
Huawei  $3,758.8 $32,348.6 $1,861.6
Qualcomm (NAS: QCOM) $3,652.0 $18,368.0 $5,894.0
Apple  $3,381.0 $156,508.0 $41,733.0

Source: S&P Capital IQ. All figures are in millions of US Dollars. LTM = Last twelve months.

Some of the names on this list could surprise you. As an example, Huawei, a Chinese networking company that's been undercutting pricing on Western competition, comes ahead of Apple. Then there's Nokia at double Apple's R&D or Microsoft at triple its spend!

Big spending: not a potion for success
However, absolute dollars don't tell the whole story. Apple raced ahead of Nokia and Microsoft in spite of their huge dollar spends. That's in part because while Nokia and Microsoft have far more resources, they were less focused on efficient projects. 

Exhibit A would be this recent New York Times article that praises advancements in Microsoft's research that include things such as an Outlook feature that could suggest whether users want to read specific emails that come in. A similar feature known as "Priority Inbox" has long been implemented into Google's Gmail.

A Businessweek feature from 2011 demonstrated the waste in Nokia's R&D spending. The article told an anecdote where Nokia researchers chainsawed a ton of ice into 50 cm blocks and mounted them with infrared sensors, all in the attempt to study touchscreens. 

The point isn't that there are tremendously innovative ideas coming from these company's R&D departments. Instead, the point is they often lack focus, with political in-fighting among different groups holding these innovations back until competitors have already leapt ahead or taken technology in a whole different direction. 

Apple: a different R&D beast
Considering that Apple spends dramatically less than its main competitors and has built the most profitable tech company in the world, it's doing something right with its R&D. Booz & Co. just released its yearly study on innovation and once again found Apple to be the most innovative company. 

Part of this comes from focus. Apple's main product lines -- the iPhone and iPad -- both rely on a common operating system. Instead of pouring money across many different ideas, Apple has kept its money more concentrated around iOS innovations.

Also, while Apple spends less on R&D relative to competitors, its been shifting how it allocates its vast cash pile. While R&D increased 40% last year, its capital expenditures increased a whopping 95% to $8.3 billion. With the iPhone 5 still having long wait times, Apple's money might be spent better on ensuring that its supply chain is in order and that it has the capacity to accommodate massive product ramps. 

Benefits and negatives of R&D
In the end, there's a double-edged sword to Apple's R&D increase. On one hand, a $1 billion increase last year is nothing compared with its $41.7 billion in earnings. Areas such as margin swings -- in large part a supply chain issue -- have a far higher impact on Apple's bottom line. Recent poorly received products like Maps and Siri show that as Apple begins offering more services and expands its cloud offerings, it could benefit from ramping its R&D spend.

On the other hand, expanding R&D too far could be more than a waste of money. It could show that instead of focusing on making a few areas "insanely great," such as hardware design and iOS, Apple is getting distracted by offering too wide a variety of services. The focus on R&D in very select areas isn't about saving money; it's about the foundation of what Apple is. 

The spend on R&D might be trivial to Apple's bottom line, but the effects of how the company manages R&D spending is anything but. 

More Apple advice?
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The article 1 Area Apple Lags the Competition, and Why It Doesn't Matter originally appeared on Fool.com.

Eric Bleeker owns shares of Cisco Systems. The Motley Fool owns shares of Apple, Google, IBM, Intel, Microsoft, Oracle, and Qualcomm. Motley Fool newsletter services recommend Apple, Google, IBM, Intel, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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