Invest 10-20% of your gross profit into R&D.
Many business owners look for that “Holy Grail” statistic that gives them all the answers. It’s true in all sorts of situations, like “how many staff should I hire?”, or “what price should I charge?”. Trying to predict 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 business operates, and the business’ stage of growth or maturity.
In this post, we answer some common questions when it comes to 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 important for today’s emerging enterprises and provide you an early-universal guideline to allocate an appropriate budget toward your R&D activities.
What is R&D?
If you’re new to the research and development world, just remember that it has two main components,which you can probably deduce from its name:
- Research is a “discovery stage” where a company finds 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” that happens when a company uses the findings of its research to produce new materials or systems and methods of doing business.
For the most part, R&D ends at the prototyping stage. After that, it’s all about engineering and commercialisation to transform the R&D plan into usable products that belong in the hands of consumers.
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 end result may only come after years of development, prototyping, andproduction. It’s a sad reality that many innovative ideas don’t even get to market!
But that doesn’t mean that R&D should be completely ignored. 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 own 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 for yourself 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 around the world. (All numbers in 1000s)
The thing that we like to point out in this data set is the gross profit. That’s the amount left over 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 actually 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, ison 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 but 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. It’s no surprise to see them putting forward so much investment to 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 when it comes to the“big pharmaceutical” industry. In such an industry, new developments are essential to staying ahead of diseases. The expenses of bioresearch are extensive.
What does it all mean?
Well, here’s one way to look at it: when planning your own budget items,consider your R&D dollars relative to your other budget items. No business exists in a vacuum, meaning that a business decision is dependent on elements of 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. As an example, prior to 1980, companies spent about the same (ormore) on advertising than they did on research and development. That trend has changed – significantly. Now, it’s common 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 flipin relative spending? To be sure, marketing is still an extremely relevant and important part of doing business, but 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 the need for added marketing. The most extreme example can be seen in 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, 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 interesting 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 specialty companies only utilise technologies that are developed elsewhere in the supply chain. Once developed, 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 that a company performs throughout the year in a financial statement. Sometimes the way that companies innovate is 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 – into today’s complex business world, no two companies are entirely the same. 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 obvious that you should be spending at least something on research and development. When it all comes down to it, the question remains: 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 the companies that we work with. So let’s do just that. If you’re just starting out 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 start feeling anxious that your 10% investment is well below Samsung’s 28%, just consider one simple truth: you’re not Samsung. And you’re not Huawei. 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.
Actually, 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 at the end of the financial quarter, take a look at your numbers. How can you take the amount that’s leftover 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 emphasize product improvement since it’s an accessible type of research that you can perform on your own.
- 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 important to stay on top of industry news and trends in order to steer your R&D decisions. Why waste time and energy on your own 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 own business activities. If you’re not quite ready to innovate with an entirely new product, try to think about how you can improve what you’re already doing, and invest some thoughtful R&D dollars toward bettering your internal business.
Still unsure where to start allocating your 10-20% of 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 the process of picking out custom-tailored R&D budgets and strategies for your business.