Research & Development And Capital Expenditures: A Lever For Industrial Firms To Think Boldly Amid COVID-19

Bain & Company research finds that companies in the industrials sector that manage R&D and capex cuts wisely are best placed to bounce back from the crisis

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Bain & Company

Sep 24, 2020, 08:00 ET

BOSTON and MUNICH, Sept. 24, 2020 /PRNewswire/ -- The sudden shock from the COVID-19 pandemic means that conserving cash and containing costs are urgent priorities, now and for the near term at the very least. For industrial companies, this means cutting back on crucial areas of Research & Development (R&D) and Capital Expenditures (Capex).

According to new research from Bain & Company, Focusing R&D and Capex to Win, industrial companies plan to pull back significantly more on research and development, and nearly as much on capex investments, as they did during the Great Recession. The lessons from previous downturns suggest that many companies will waste valuable capex and R&D. In an analysis of 516 industrial companies, Bain found that 26 percent spent above the average on R&D and capex over the past decade but didn't turn that into superior results for their shareholders. On the flip side, one in four industrial companies spent below the average for their peers, but still managed to generate above-average returns. These "efficiency heroes" provide valuable lessons on how to allocate both cuts and spending well.

"As tempting as it may be to make cuts across the board, leading companies can position themselves for a rebound by thinking about where they want to be after the crisis and then reallocating resources to make sure they can get there," said Thomas Lustgarten, global head of Bain & Company's Advanced Manufacturing & Services practice and one of the authors of the report.

Looking at more than 900 industrial companies, Bain & Company found that R&D spending is set to drop by -10 percent to -15 percent and capex by an even sharper -20 percent to-30 percent in the aftermath of the pandemic. In order to cut costs without affecting the business's ability to lead in its field there are five points to consider:

Slash and burn creates severe risk: Many companies typically respond to the intense pressure of a crisis by cutting evenly across their business and product portfolio, offloading costs wherever possible. This might help to conserve liquidity for a year or two, but it also cuts muscle and severely stunts the company's growth potential once the economy rebounds. Leading companies in past crises have taken a more discerning approach. They start by defining the company's post-crisis strategy and target product portfolio, and use that to guide selective cuts and thoughtful investments.
Define the strategy, then execute: The most successful companies navigate periods of upheaval by focusing their attention and resources squarely on the businesses where they have the best odds to lead the market. Besides generating superior profits and cash, market leaders usually have stronger balance sheets and get better financing terms, which creates a virtuous circle that breeds more success.
Drastically reduce costs in the core business: An effective forward-looking strategy involves careful coordination between the core businesses and newer business lines – what Bain calls 'Engine 1' and 'Engine 2'. The goal is to streamline Engine 1 in a way that keeps it humming, but also frees up enough cash to build a strong Engine 2. Many industrial companies' recent cost-reduction efforts are only trimming the fat of their existing structures, say by ratcheting down the operational costs of their manufacturing footprint. But this doesn't go far enough. The unprecedented nature of the current crisis calls for a different mindset. For traditional Engine 1 businesses, that means reducing fundamental complexity with moves such as streamlining product offerings. The most meaningful actions include cutting low-volume, unprofitable products and making the rest modular, which reduces the effort and cost of creating product variations.
Think about what will drive the company in the future: Companies have a narrow window to make the transition to the business lines of the future (Engine 2). This current business shock makes it both more imperative and, in some important respects, more possible to make that leap, because of critical actions underway to drastically streamline Engine 1 businesses. Gearing capex and R&D to make Engine 2 the leading priority is the only way to secure the future.
Play offense if possible: While many companies currently have a small financial cushion and must play defense just to survive, plenty of others have a strong balance sheet that gives them the flexibility to go on the offensive, too. That means they can invest more than their cash-strapped competitors on organic growth engines such as R&D and capex, and they can actively pursue inorganic growth through M&A. Those with the resources will find compelling opportunities to acquire new capabilities over the next couple of years.

"The COVID-19 pandemic has upended the world as we know it but now is the time to think ahead and to think boldly," said Mark Gottfredson, co-head of Bain & Company's Americas Automotive and Mobility practice and a co-author of the report. "The industrial leaders of tomorrow will be those that clearly define their strategy and know where to cut – but also where to invest."

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