Naughty And Nice (R&D) Toy Companies

In 2014, CNBC launched a new ranking of R&D All-Stars, the RQ50, identifying the U.S. companies whose R&D drove the greatest growth. The ranking utilized the RQ measure of companies’ R&D productivity featured in the May 2012 Harvard Business Review article, “The Trillion Dollar R&D Fix”.

The list revealed that spending more on R&D was a poor gauge of companies’ innovativeness. Moreover, because most investors use R&D spending to gauge innovativeness, RQ identifies firms that fall below other investors’ radar. This is why the RQ50 portfolio historically outperforms the market.

Forbes rules don’t allow writers to publish rankings, so instead I’m sequentially profiling firms from the RQ50. Since its the holiday season, let’s start with a toy company which has made the RQ50 all nine years since CNBC published the initial ranking: HasbroHAS
(RQ rank 26 of 288).

Toys don’t ordinarily come to mind when thinking about R&D, so probably the best way to understand what makes Hasbro exceptional is comparing the company to its main rival, MattelMAT
(RQ rank 275 of 288). Comparing to a rival strips away things that vary across industries, making it easier to tie differences in RQ to things the companies are doing differently.

Throughout most of its history, Hasbro has maintained a higher RQ than Mattel despite similar ages, revenues, and levels of R&D. Higher RQ means higher market value, all else equal, and the relative stock performance of Hasbro and Mattel bears that out.

What explains Hasbro’s higher RQ?

Three factors contribute to a company’s RQ, or ability to drive growth from R&D: quality of the idea portfolio, ability to convert the idea portfolio into commercial products/services, and capacity to exploit the commercialized ideas. Let’s take each of these in turn.

Idea Portfolio

Mattel’s idea portfolio is highly concentrated. Barbie accounts for 27.6% of Mattel’s sales, while Hot Wheels another 17.6%. In contrast, Hasbro’s portfolio is diverse. Its Franchise Brands segment, which includes Clue, Dungeons and Dragons, Magic: The Gathering, Nerf, Peppa Pig, Playdoh and Transformers, among others, comprises 22% of Hasbro’s sales, less than Barbie alone does for Mattel.

This portfolio diversity has two advantages. Defensively, Hasbro is less susceptible to catastrophic risk in any of its product lines. Offensively, it forces the company to continuously identify new opportunities. Indeed, Emerging Brands comprises the largest segment within Hasbro (29% of sales). Thus, Hasbro’s portfolio is not only more diverse, it appears to be refreshed at a higher rate as well.

Where do these ideas come from?

Both Hasbro and Mattel maintain R&D labs, so certainly some new ideas come from their internal engineers and designers. Classic examples are Mr. Potato Head and G.I. Joe at Hasbro, and Barbie at Mattel. However, it is more common for toy industry ideas to come from external sources. One source of external ideas is independent inventors, so both companies maintain portals for inventors to submit ideas: Spark at Hasbro, and MyMattelIdeas at Mattel. Each company receives thousands of ideas through these portals each year, and of those, roughly 100 might make it to the C-Suite for further consideration.

A second source of external “ideas” is acquisitions—wholesale purchase of companies with existing product lines. Both companies have utilized this strategy over the years. Hasbro, for example acquired Dungeons and Dragons Beyond this year, and Mattel acquired Mega Brands in 2014.

Of these two approaches to external ideas, Hasbro tends to favor independent inventors, while Mattel tends to favor acquisitions: Hasbro’s royalties comprised 9 to 13% of sales over the past three years, while Mattel’s comprised 3.5 to 5% of sales. In contrast, Hasbro made three acquisitions totaling $336 million over the past 15 years (0.5% of sales), (excluding the 2019 Entertainment One acquisition, which didn’t pertain to the idea portfolio). Mattel similarly made three acquisitions over the same period, but these totaled $1162 million (1.5% of sales).

Licensing from independent inventors represents organic growth—bringing in new ideas, and the possibility of discovering a new classic. In contrast, acquisition brings in ideas whose potential has been realized, which means acquirers pay the net present value (NPV) of that realized potential. These acquisitions only makes sense if the acquirer can enhance the market potential of those products, or if the acquisition brings resources that enhance the value of the acquirer’s existing portfolio. An example of the latter is Hasbro’s 2019 acquisition of Entertainment One, to create programming from its intellectual property.

Development capability

Even when Hasbro or Mattel licenses an idea from an independent inventor, the company expends considerable effort to further develop the idea internally. This includes refining its playability, enhancing its manufacturability, ensuring its safety and designing its packaging. Since the companies are global, all these efforts must take into account the variety of tastes and conditions of the countries where the products will be manufactured and sold.

While I don’t have details on these development efforts, Hasbro does two things typically associated with higher RQ. First, it maintains internal manufacturing capability. It even does contract manufacturing for other companies. Keeping at least some manufacturing capability in-house ensures that product development is sensitive to manufacturing concerns. Mattel also does internal manufacturing however, so this doesn’t contribute to the RQ difference. Second, Hasbro has “termination capability”—the ability to recognize when products should be killed and the will to kill them, as it did in 1992 with Savage Mondo Blitzers.

Exploitation capacity

The final factor, and often the most important factor contributing to a company’s RQ, is its ability to generate revenue from any given idea. Often this is defined by the company’s scale, in that larger companies tend to be in more markets. This means they can exploit existing distribution and sales channels to introduce new products to those markets. Hasbro and Mattel are in the same markets, so the biggest difference in their exploitation capability may be Hasbro’s move toward incorporating more of its intellectual property in media. This means each new idea gets distributed not only as a physical product, but in media, as well. This mimics Disney’s ability to generate total movie revenues of three times their box office, through merchandising, programming, and theme parks. Indeed 15.5% of Hasbro’s FY2021 revenues came from its TV/Film/Entertainment segment.

Summary

Hasbro appears to have a better idea portfolio, better ability to develop those ideas, as well as greater opportunities to exploit them. Moreover, there is coherence to these pieces, which is the real hallmark of an RQ “Hall of Fame” company—R&D isn’t the cart, it’s the horse.