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Motorola's Earnings Problem: Its R&D, Um, Sucks

Although it's still losing money, shares of Motorola Mobility (MMI) rose after the company reported better than expected results for last quarter. Better than expected they may be, but they're still lousy. Motorola is growing, but so are its costs. Even though quarterly sales were up 30 percent year over year to $2.1 billion, the company still lost $89 million.

That's far better than the $192 million loss from last year -- but how much money does Motorola have to bring in to become financially stable? In other words, can the company come up with enough hit products to get over this hump? Maybe, but it has to figure out how to get much more efficient with its R&D spending, which is high enough to weigh the company down.

Look at Motorola's statement of operations with the numbers expressed as percentages of net revenue (click to enlarge):

A couple of things jump out. One is that Motorola's gross margin is low at about 25 percent. Compare it to HTC's 28.9 percent or Nokia's 29.6 percent. Apple's (AAPL) gets nearly 70 percent gross margins on iPhones, but that's sprinkling salt on the wound.

Making engineers more efficient
Motorola is immediately down 4 to 5 percent compared to major competitors. And then it takes an even bigger hit on the R&D line at 11.8 percent. Admittedly, here it's doing better than some rivals. Look, for instance, at Nokia, which last quarter spent 14.1 percent of revenue on R&D and 15 percent the year before, all without producing much in the way of compelling products -- or even getting phones with what was to be its new operating system out the door.

HTC, by contrast, did quite well in 2010, spending only 4.6 percent of revenue on R&D. Or, to really put things into perspective, look at Apple's overall 2.2 percent R&D spending for the first six months of the current fiscal year. It's impossible from the financials to tell what the percentage for the iPhone would be, but still, that's amazing efficiency.

How Apple does it
The reason for Apple's effectiveness boils down to the simplicity of its product lineup. Apple has one basic iPhone with some minor variations, rather than a collection of completely different devices it developed in hopes that at least one would be a hit.

In a rare interview, Jonathan Ive, senior vice president of industrial design, explained the underlying Apple design difference to the British Council Design Museum:

So many companies are competing against each other with similar agendas. Being superficially different is the goal of so many of the products we see. A preoccupation with differentiation is the concern of many corporations rather than trying to innovate and genuinely taking the time, investing the resources and caring enough to try and make something better.
Apple makes one product that is significantly better at satisfying customers and so doesn't need to create a spread of also-rans that drive up expenses. The difference between Apple's R&D and Motorola's as a percentage of revenue is 9.6 percent.

Granted, Apple has those huge margins and revenue to amortize research and development. But surely by designing smarter, even if it couldn't boost gross margins, Motorola could save at least a few points in R&D. Even if the best it would do was double what HTC managed, that would still be 2.6 percent of revenue less than it currently uses, which would have brought the quarter almost to breakeven.

Maybe one secret to success in the wireless business is to design smart so you don't have to design more.


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