How Much Should You Be Spending on R&D?

In today’s hyper-competitive world, new products and new services are paramount to a company’s survival.  And with the exception of some commodified process manufacturing industry segments with narrow product portfolios, the R&D involved in developing new products can be expensive.  Data from as recently as 2018 show that R&D spending was around $2 trillion USD.  And of that figure, the top 1000 companies worldwide account for 40% of that total.

The focus on R&D can be vastly different between small and large companies, as well as within different types of industry.  And facing steep challenges and fierce competition, all but a few companies can afford to forgo R&D altogether.  How then does a company determine the level of R&D that’s right for them?  

Measuring the Impact of R&D

Before a company can set a target level for R&D expenditures, they must first decide on how to measure its success.  The intuitive answer for many business leaders is to tie R&D to results.  And while this should be high on the list of evaluation criteria, it comes with the caveat that R&D by nature carries with it the assumption of failure for a large number of projects.  

As a result, many companies have adopted ways to measure the effect of R&D against the bottom line.  These measurements may include:

1. Patents – Patents aren’t just for technology companies.  Manufacturing, services, and software also account for a large part of patent applications as well.  While patents can point to a high degree of innovation, many patented products never see the light of day.  Companies may also look to things such as trade secrets for formulations, code, or process improvement in lieu of patenting to make the most of their R&D expenditure.  

2. Competitive Analysis – Benchmarking or comparing yourself against what the competition is doing has been around for ages.  Many companies using this method of measurement must decide on whether to match, exceed or lag competitors in research.  This method also assumes that competitors have at least as good or perhaps even a better understanding of consumer preferences and markets as you do.  However, should this prove inaccurate, the result could be lost research dollars.  

3. Vitality – Some companies use a measurement of “vitality”.  Vitality is defined as the percentage of a company’s revenue that comes from new products.  By measuring in this way, companies can create an index that is uniquely suited to their size, scope, market position and industry.

What is “More”?

How much to spend on R&D should be approached as more a relative question than absolute.  And for most companies, the definition of how much more will depend on many factors.

• Type of Industry – For heavily commodified process manufacturers, 5% might be a lot, perhaps even extravagant.  While in other industries such as internet technology, 25% may be what is required to remain competitive.  Each company will need to understand the norms for their industry to determine where to set R&D budgets.

• Size of Company – The size of an enterprise may help dictate the level of R&D that can practically be undertaken regardless of the level desired by its leadership.  In these cases, skillsets available for effective research may not be present or if they are, can be overloaded.  This is not necessarily a bad thing.  It forces small companies to prioritize, set realistic goals and pursue only what advances their product base.  With a more focused scope, lean R&D efforts can lead to research money better spent.  This is especially true of SMBs and startups with a limited product portfolio, although technology tools, IIoT and other advances are helping to level this aspect of the playing field.

• Purpose of the Increase – Companies should also define the purpose of the increase in R&D or risk throwing valuable cash away at vaguely defined or disorganized projects.  Is R&D being done for revisions, iterations, or improvements to existing products or for completely new product lines?  Is the research being conducted for innovation or is it for a fast track to a truly disruptive product or technology?  Each of these answers will inform the type of research – and its cost – that a company should focus on.

Should You Spend More?

In asking how much should be spent on R&D, one thing is clear.  Through the 1970s, companies spent almost the same on advertising and R&D.  However, that number has shifted dramatically to the point that R&D spending is ten times greater than marketing and advertising today.  

Some of this shift may be attributable to a better ROI on marketing dollars due to a more sophisticated understanding of customer base.  It may also be due to new and cheaper channels for advocacy such as social media. And it may also come through growth of data analytics software.  Whatever has driven the increase, companies have placed a renewed effort on R&D as a way to greater profitability.

For companies struggling to understand the right level of R&D for their business, the best path is one of honest evaluation.  This includes identifying their business in relation to their core industry, understanding their size and scope relative to competitors, identifying the goals and priorities for the research, and setting a method to evaluate the success of the effort.