With its sleek iPod nano and all-in-one iMac computer, Apple ( AAPL) is often perceived by its fans as a pre-eminent innovator.

It may come as a surprise, then, that much of the company's recent financial -- and stock -- success has resulted from merely holding the line on one of the sources of that innovation: its spending on research and development.

Even while Apple's revenue has skyrocketed in recent years -- and even as expectations for future products and success have exploded -- what the company has spent on R&D has risen only modestly. As a portion of overall sales, such expenses have actually fallen by more than half.

Though analysts generally praise Apple for its frugality, some warn there's a limit to how much longer the company can squeeze juicier near-term profits out of its R&D line.

"Ultimately, for them to sustain their growth and be successful in the long term, they're going to have to move in new directions and tackle some new product lines that they don't have and haven't historically done," says Van Baker, an analyst who covers the company for industry research group Gartner. "That's going to take significant investment."

Apple spokeswoman Natalie Kerris didn't know whether the company had set goals for R&D spending. But the pace at which Apple allows its investment in innovation to grow in future quarters will likely go a long way toward determining the company's future profit growth.

Although there's no hard-and-fast rule for what portion of its budget a company should devote to R&D, some analysts say Apple is approaching minimal levels. As a portion of sales, the amount Apple has spent on R&D has fallen steadily every year since fiscal 2001, when the company devoted 8%.

Last year, Apple spent 3.8% of sales on development, and it spent just 3.2% in its most recent fiscal quarter.

Apple hasn't cut R&D spending. The company spent $534 million on development in fiscal 2005, which was 24% more than it spent in fiscal 2001. But the company has clearly been constraining the growth of development spending.

While sales have grown at a compounded annual rate of 27% over the last four years, R&D spending has grown at an average rate of just 5.6% per year over that period.

"At some point, that reaches stasis," says Crawford Del Prete, an analyst with industry research firm IDC. "They can't take it down to 1.5% or 2% of revenue."

Part of the reason that Apple can't let its research spending decline much further is that the company has to bear costs that many of its PC industry competitors don't.

If it wants a new operating system for its Macintosh computers, for instance, Apple itself has to develop it; it can't rely on Microsoft ( MSFT).

Likewise, with so much of its brand reputation centered on developing distinct products, the company can't just rely on the latest reference designs from Intel ( INTC).

But even more than that, Apple is already being vastly outspent by its rivals. Both in dollar terms and as a portion of its revenue, Apple's R&D budget is a fraction of that of competitors Hewlett-Packard ( HPQ), Sony ( SNE) and Microsoft.

The vast amount of money that those companies spend allows them to introduce multiple product lines and spread their risks around, analysts say. Though the companies may have a lower portion of hit products, they're less likely to be hurt if a product fails, analysts say.

Apple's Squeezing R&D
FY '05 FY '01
Sales $13.93 billion $5.36 billion
R&D $534 million $430 million
as % of sales 3.8% 8.0%
Net income $1.34 billion ($25 million)
Compounded annual growth rate
(Fiscal 2001 to Fiscal 2005)
Sales 27.0%
R&D 5.6%
Note: Apple's fiscal year ends in September
Source: Apple's annual reports, TheStreet.com's research

Low-Hanging Fruit
Sales (in billions) R&D in billions R&D as % of sales
Apple $13.93 $0.53 3.8%
Dell 55.91 0.46 0.8
Hewlett-Packard 68.95 3.49 5.1
Sony 63.66 4.28 6.7
IBM 91.13 5.84 6.4
Microsoft 39.79 6.18 15.5
Cisco 24.80 3.33 13.4
Research In Motion 1.35 0.10 7.5
Google 6.14 0.48 7.9
Adobe 1.97 0.37 18.5
Note: Sony's figures were converted to dollars at the March 14 exchange rate.
Source: Companies' most recent annual reports.

In contrast, Apple relies more on hit products. As the company moves more into consumer electronics, it starts to resemble a designer at a Milan fashion show, says Roger Kay, founder of consulting firm Endpoint Technologies. "Every year they have to have a hit," he says. "They can't screw it up."

With Apple's stock up nearly 800% over the last three years, and now trading at more than $65 a share, that pressure has only increased. The widely held expectation among investors is that Apple's growth will continue to outpace the market.

But to do so, the company's going to have to move beyond selling computers and digital music players. "Their challenge going forward is that they basically have to have a pipeline of hits over time within the categories they have. And since those categories will get saturated, they're going to have to bring out new product categories," says Barry Jaruzelski, a vice president at consulting firm Booz Allen Hamilton.

Of course, few analysts believe Apple has a problem now. Many say that what's important is not how much a company spends on R&D but how well it spends it. And for most of those analysts, Apple is a good example of a company that gets a lot of bang for its R&D buck.

"You look at what Microsoft is spending on R&D and I guarantee there's wasted money there," says Kay. Even though Microsoft's research budget is more than 10 times Apple's, "look at what they've produced. It's not controversial that they haven't turned out 10 times as many great products as Apple."

In fact, many analysts praise Apple for not simply throwing money at R&D as its revenue soared. Expectations may be growing for Apple, but companies face a difficult trick in augmenting their research efforts in an efficient, effective fashion.

"If Apple were ramping R&D costs with revenue, we all would be scratching our heads," says Del Prete. "They would be hard pressed to get a payback on that."

And some analysts believe Apple will be able to get into new areas relatively inexpensively. The company's new relationship with Intel should cut some of its development costs on computers.

Much of Apple's recent success has come from designing products using existing technology and from developing business relationships -- such as with the record industry for its iTunes music store, they say.

But even with all of Apple's market and business prowess, the company is still, fundamentally, a technology company -- and one that is expected to lead the charge in areas such as in integrating consumers' computer systems and digital media into their living rooms.

That effort is likely going to demand an investment -- and fewer gains on the operating income line.

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