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Are Investments in Innovations Worthwhile?

25 June 2008 - Features - Editor

The ultimate goal of innovation is to implement positive change, and innovation is an important factor for the increase of wealth in an economy. However, often the financial benefits of innovation are only realized in the long term. This can be a problem for a management team that is focused on appeasing investors above all else and are, therefore, driven by quarterly results. They may be reluctant to invest in innovation, no matter how promising, for fear of negatively impacting on short-term financial performance.

This raises the question of whether investment in innovations adversely affects stock prices. This issue is addressed by American professors Tellis and Sood in their paper “Do Innovations Really Pay Off? Total Returns to Innovation”, which has been published in the marketing journal, Marketing Science. Gerard J. Tellis is a professor of marketing at the Marshall School of Business associated with the University of Southern California, and Ashish Sood is an assistant professor of marketing at the Goizueta Business School associated with Emory University.

The professors’ research suggests that companies under-invest in innovation due to the high costs involved, as well as the relatively long waiting period before reaping market returns. Another factor in under-investment in innovation is the uncertainty of whether a product will, in fact, reap returns at all. Tellis and Sood would like management teams to recognize the necessity for innovation, as well as its potential power to affect the economy through the introduction of new products and even promoting the global competitiveness of nations. The ability to accurately assess market returns to innovation could provide the necessary motivation for companies to invest in innovation.

Tellis and Sood use an event study method that analyzes all announcements made by a company with regard to a project, as well as the stock market’s reaction to the announcements. Rather than looking at one event, as has been the case with previous research, the professors emphasize that it is essential to look at the entire project, incorporating all announcements made. To better assess market reaction, the announcements are placed in three groups: the activities relating to the initial setup of the innovation project; the activities relating to the development of the new product; and activities relating to the marketing and commercialization of the product.

Their findings have revealed that focusing on only one or two types of announcements tends to lead to an underestimation of total returns, whereas in reality returns to overall projects are generally substantially greater than returns to individual events. By categorizing the announcements as they have, the professors have established that the markets react most strongly to the development phase of a new product, which indicates that the stock market is not as short-term in its outlook as many may think. This also shows that it is vital for companies involved in an innovation project to keep the market updated with regard to its progress. However, it must be noted that the quality of the announcements is of more importance than the quantity.

 


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