October 26, 2023 • By The UCI Paul Merage School of Business
For the longest time, financial and business experts have measured innovation largely by examining how many patents a company owns or how much it spends on research and development. But, as Devin Shanthikumar, Associate Professor at The UCI Paul Merage School of Business, and her co-authors found, just counting patents may be missing a much bigger picture. In their article, "Bringing Innovation to Fruition: Insights from New Trademarks”, which was published by the Journal of Financial and Quantitative Analysis (JFQA), there may be a more accurate measurement of innovation that, until now, no one has really paid much attention to.
“People in general, especially in the United States, assume that innovations occur in the high-tech world,” says Shanthikumar, “but our research team wanted to show that there’s a lot of innovation happening at other companies. We were interested in documenting all the other innovation that’s happening in our economy that is mostly ignored.” Shanthikumar and her team believed, and found, that a new measure would allow them to provide new insights into innovation, applicable to many companies which had been neglected by prior research.
Counting patents or tallying up the amount companies spend on research and development have historically served as benchmarks for measuring innovation. Shanthikumar and her team found that these approaches fail to account for significant innovation that doesn’t neatly track with spending or patent filings.
“We’re often impressed to hear how many patents were involved in the development of the iPhone, for example,” Shanthikumar says. “But, what about the other 30 companies that are building some truly innovative things using that same underlying technology? Those companies aren’t filing patents, but they are building interesting and innovative products. That’s why we came up with this idea of using trademarks to measure innovation. Trademarks allow us to capture the data on the new products being developed.”
Measuring R&D spending has similar problems. Many companies don’t report investments in R&D as a separate line item in their financials. That hides the raw data researchers would need to properly quantify the scope of innovation taking place within a business or across a sector. “For example, we found that 56 percent of all S&P 1500 firms did not report R&D during our sample period, and 47 percent did not register patents,” Shanthikumar says. “Of the firms that do have product trademarks— which means they are innovating in terms of creating new products—50 percent of those did not report R&D, and 46 percent didn’t register patents. So, we can see this isn’t a reliable measure for innovation.”
If roughly half of S&P 1500 firms conduct product innovation without generating patents or readily accessible R&D budgets, Shanthikumar and her team knew they needed to find other ways of measuring innovation. “When we looked at measuring innovation using trademarks we realized this is very important, even for those high-patent industries,” she says.
Understanding the role patents play in different industries is important to grasping the limits of patents as a useful measure of innovation. “In our paper we document how patents are really restricted to a small subset of industries,” she says. “But almost everyone is creating new products.” Along with examining all firms together, the team split their data between high-patent and low-patent industries.
“Our focus was to see what was happening in these low patent organizations, since patents aren’t a real measure of innovation for those companies,” Shanthikumar says. “But we also found that trademarks were important for high-patent industries. Firms in both groups gain additional performance improvements if they engage in more product development. In other words, even for high-tech firms, it isn't just about coming up with new tech, it's also important to ensure that the technology results in new products.”
The study produced two main sets of results. “There’s been a lot of research already about how to get high-tech firms to innovate, but, until now, there hasn’t been any research on other industries in terms of innovation,” Shanthikumar says. “What we found was that the same types of CEO incentives that drive high-tech innovation —things like option compensation and other risk-taking measures—also drive trademarks and new product innovation in low-patent firms, and in both low-patent and high-patent firms together.”
The team’s second insight relates to how trademark innovation impacts firm performance. “What we found was that this innovation also drives improvements in cash from operations, return on investment, and so on. Basically, firms do better the more product innovation they create,” she says.
Innovation, it turns out, can happen within or across categories, Shanthikumar says. “If we take a food and beverage company, for example, there’s going to be innovation within that space, but there might also be innovation in the sense that they may create products in new categories that didn’t previously exist for them. So, there’s a lot of innovation happening right now within the alcoholic beverage industry. For example, Bud Light recently introduced a seltzer that has no alcohol content, and lots of companies in this space are trying to create new beverages that might appeal to a new demographic. This is the type of innovation that I find so fascinating to study,” she says.
When companies provide innovation-related incentives it does actually work: Innovation increases and that innovation drives new products which, in turn, drives improved market performance. But there are even bigger implications to this research, as Shanthikumar explains: “When you think about our current situation, we know that there are going to be only a very few companies in the future that are developing truly brand-new AI technologies. But every company can develop new products that take advantage of those technologies. Our Merage School tagline about ‘leadership in a digitally-driven world’ takes on greater meaning in light of this. It means every company can and should innovate through new products, and in order to do so, you need to motivate your employees and your CEO as innovators and this, on average, will lead to improved performance in your market.”