Many business owners look for that “Holy Grail” statistic that gives them all the answers. It’s true in situations like “how many staff should I hire?” or “what price should I charge?”. However, predicting these answers as a universal truth is a difficult (if not impossible) challenge. For the most part, it all depends.
The answers to the all-important questions can depend on the type of business, the size of the business, the industry in which the company operates, and the business’ growth or maturity stage.
This post answers some common questions about a firm’s research and development (R&D) budget. Specifically, how much should an organisation spend on R&D? We’ll give you some advanced insight into why R&D is essential for today’s emerging enterprises and provide you with an early-universal guideline to allocate an appropriate budget toward your R&D activities.
What is R&D?
- Research is a “discovery stage” where companies find new ways of addressing customer needs. The research is guided by commercial objectives related to the company’s products and services.
- Development is the “execution stage” when a company uses its research findings to produce new materials or systems and methods of doing business.
The problem with R&D
We’re going to come right out and say it because you’ve probably already read it elsewhere –R&D can be risky. Sometimes innovation dollars will never be fully actualised. Investing in R&D can feel like throwing your money away because the result may only come after years of development, prototyping, and production. Sadly, many innovative ideas don’t even get to market!
But that doesn’t mean that R&D should be ignored entirely. Here’s why:
- R&D provides you with valuable insight into your new products and services. Whether successful or not, you get market information data on the costs and timeframes for development;
- R&D is a great way to verify the quality of your products and continually update them to stay relevant in the market; and,
- R&D can save you money down the road because it will let you know if product improvements are cost-effective.
What are others doing?
One of the best ways to decide how much you should invest in R&D is to look at what others are doing. Here’s a list of the companies that spend the most on research and development worldwide.
|% of GP|
|Johnson & Johnson||$54,490,000||$9,700,000||18%|
We like to point out that in this data set is the gross profit. That’s the amount leftover from revenue after deducting the cost of the goods and services sold. In other words, it’s the amount of money left over to spend on “the fun stuff.” From our perspective, that means innovation dollars.
So what are the top spenders in R&D spending?
Well, the firms on this list spend an average of 22% of their gross profit on R&D. When you dig a bit deeper, however, you notice that the differences between the R&D investment levels stem from the activities of the companies and the stage of development that they are in.
Huawei, for instance, is on the lower end of the list, with 14% of gross profit spent on innovation.
However, consider that 14% still equates to $12.5 billion in R&D investment, and they’re near the top of the list in terms of volume invested. The Chinese multinational company is a mainstay in the mobile handsets market. Still, their big spending at the moment is on new networks. They are paving the way for constructing ultra-fast 5G networks for cellular devices, which is an expensive undertaking. So it’s no surprise they put forward so much investment in R&D.
On the top end of the list is Roche, with 42% of its gross profit headlining its R&D budget.
That’s staggering but maybe not as surprising as you think about the “big pharmaceutical” industry. New developments are essential to staying ahead of diseases in such an industry. The expenses of bioresearch are extensive.
What does it all mean?
Here’s one way to look at it: consider your R&D dollars relative to your other budget items when planning your budget items. This is because no business exists in a vacuum, meaning that a business decision depends on timing and risk and the ability to invest in R&D at any given time.
To keep track of it all, it’s also important to consider how trends have changed. For example, before 1980, companies spent about the same (or more) on advertising than they did on research and development. That trend has changed – significantly. Now, it’s expected that a company may spend ten times more on R&D than on advertising. Companies big and small have transitioned to engineering and development dollars as a path toward growth. Why such a flip in relative spending? To be sure, marketing is still an extremely relevant and vital part of doing business. Still, there are a few effects that can explain the newfound importance of the R&D dollar:
- It’s a sign of the times. Competition is as intense as ever, and staying ahead of the curve is crucial; and,
- Trends change. After 1980, companies in high-technology sectors have become more prevalent, like bioengineering, technology, or internet-based solutions, which are more reliant on R&D.
There’s another reason why companies might shift toward R&D rather than marketing. The answer, especially for the largest companies, is that technological prowess can create headlines without added marketing. The most extreme example is Elon Musk’s esteemed zero-dollar social ad budget. While some companies spend billions of dollars on advertising, Musk accomplishes the feat of making it into headlines, and social media feeds in a low-cost way. His body of work and captivating innovations (and notoriety) are enough to engage audiences. In many cases, Musk’s innovation efforts often induce free media promotion thanks to his team’s ability to tell an exciting story through the cutting-edge innovations and products that are on display.
Capturing research and development
What happens when you don’t undertake any research and development activities? If you belong to the technology sector, you’ll probably fall behind your competition when it comes to being able to offer the “next best thing”. And that makes you far less competitive than others in the market.
However, the whole affair is, again, dependent on the industry. For instance, some companies don’t do any research and development. Some enterprises like those in the public utilities or other speciality companies only utilise technologies developed elsewhere in the supply chain. Once created, they provide service or functionality to customers in a way that doesn’t require any specific amount of R&D investment. But that doesn’t mean that these companies don’t innovate.
Remember, it’s not possible to include all innovative activities a company performs throughout the year in a financial statement. Sometimes, companies innovate on the softer side of things, like through collaborations, relationship management, and new ideas that spring up through internal discussions. These innovations still help grow their business but aren’t captured in any specific R&D budget.
Remember this – no two companies are entirely the same in today’s complex business world. So what works for one may not work for another.
The guessing game: picking the correct amount of R&D
By now, we hope that it’s evident that you should be spending at least something on research and development. But, when it all comes down to it, how much “dough” should you “blow” on R&D?
We like to make things simple. At Innovolo, we pride ourselves on simplifying complex innovation processes for our clients. So let’s do just that. If you’re starting in the R&D phases of your enterprise, here’s a baseline for your budgeting:
Invest 10-20% of your gross profit into R&D.
It’s that simple.
Before you feel anxious that your 10% investment is well below Samsung’s 28%, consider one simple truth: you’re not Samsung. And you’re not Huawei. So chances are, if you’re reading this article, you’re not investing in constructing 5G networks to pave the way for the next decade of cellular tech advancements. And that’s okay.
It’s preferable because it also means that the flexibility is in your hands to scale your R&D investments for what works for your business. That’s where 10-20% comes in.
Setting a target to help steer your efforts in research and development is beneficial for a few different reasons:
- It’s a simple reminder. Setting a target keeps the idea fresh in your mind, so you don’t forget to invest in R&D;
- Picking a simple number like 10-20% takes the stress out of knowing what’s right or wrong; and,
- It’s adjustable. Try it for a year, and if you feel like you’re not keeping pace with your competitors, bump it up a little. Or, if you feel like you’re cash-strapped in a given year, you can tighten up your 10-20% a little further.
So at the end of the year or the end of the financial quarter, take a look at your numbers. How can you take the excess amount and put it toward research and development? Unsure of where to start? Here’s some advice for spending that 10-20% in an efficient way:
- Develop an R&D strategy. Your strategy should take into consideration the size of your business. Smaller businesses tend to emphasise product improvement since it’s an accessible type of research that you can perform independently.
- Do market research. This will help you identify what your customers are looking for. Be sure to revisit the research frequently to stay abreast of evolving trends and customer preferences.
- Leverage data. It’s a big world out there, and new data is constantly being generated and published. It’s essential to stay on top of industry news and trends to steer your R&D decisions. Why waste time and energy on your research when similar findings are already published elsewhere, waiting for you to learn from, modify and build from.
- Look inward. On top of new product development, R&D can also help you create better processes within your business activities. If you’re not ready to innovate with an entirely new product, try to think about how to improve what you’re already doing and invest some thoughtful R&D dollars in bettering your internal business.
Still unsure where to start allocating your 10-20% gross profit toward R&D? We’re here to help. Reach out to us for a chat and have one of our Innovolo experts guide you through picking out custom-tailored R&D budgets and strategies for your business.