What Is Research and Development (R&D)?
What Is Research and Development (R&D)?
Research and development (R&D) is the series of activities that companies undertake to innovate. R&D is often the first stage in the development process that results in market research product development, and product testing.
Key Takeaways
- Research and development represents the activities companies undertake to innovate and introduce new products and services or to improve their existing offerings.
- R&D allows a company to stay ahead of its competition by catering to new wants or needs in the market.
- Companies in different sectors and industries conduct R&D—pharmaceuticals, semiconductors, and technology companies generally spend the most.
- R&D is often a broad approach to exploratory advancement, while applied research is more geared towards researching a more narrow scope.
- The accounting for treatment for R&D costs can materially impact a company’s income statement and balance sheet.
Understanding Research and Development (R&D)
The concept of research and development is widely linked to innovation both in the corporate and government sectors. R&D allows a company to stay ahead of its competition. Without an R&D program, a company may not survive on its own and may have to rely on other ways to innovate such as engaging in mergers and acquisitions (M&A) or partnerships. Through R&D, companies can design new products and improve their existing offerings.
R&D is distinct from most operational activities performed by a corporation. The research and/or development is typically not performed with the expectation of immediate profit. Instead, it is expected to contribute to the long-term profitability of a company. R&D may often allow companies to secure intellectual property, including patents, copyrights, and trademarks as discoveries are made and products created.
Companies that set up and employ departments dedicated entirely to R&D commit substantial capital to the effort. They must estimate the risk-adjusted return on their R&D expenditures, which inevitably involves risk of capital. That’s because there is no immediate payoff, and the return on investment (ROI) is uncertain. As more money is invested in R&D, the level of capital risk increases. Other companies may choose to outsource their R&D for a variety of reasons including size and cost.
Companies across all sectors and industries undergo R&D activities. Corporations experience growth through these improvements and the development of new goods and services. Pharmaceuticals, semiconductors, and software/technology companies tend to spend the most on R&D. In Europe, R&D is known as research and technical or technological development.
Many small and mid-sized businesses may choose to outsource their R&D efforts because they don’t have the right staff in-house to meet their needs.
Types of Research and Development (R&D)
There are several different types of R&D that exist in the corporate world and within government. The type used depends entirely on the entity undertaking it and the results can differ.
Basic Research
There are business incubators and accelerators, where corporations invest in startups and provide funding assistance and guidance to entrepreneurs in the hope that innovations will result that they can use to their benefit.
M&As and partnerships are also forms of R&D as companies join forces to take advantage of other companies’ institutional knowledge and talent.
Applied Research
One R&D model is a department staffed primarily by engineers who develop new products—a task that typically involves extensive research. There is no specific goal or application in mind with this model. Instead, the research is done for the sake of research.
Development Research
This model involves a department composed of industrial scientists or researchers, all of who are tasked with applied research in technical, scientific, or industrial fields. This model facilitates the development of future products or the improvement of current products and/or operating procedures.
The largest companies may also be the ones that drive the most R&D spend. For example, Amazon has reported $1.147 billion of research and development value on its 2023 annual report.
Advantages and Disadvantages of R&D
Advantages
There are several key benefits to research and development. It facilitates innovation, allowing companies to improve existing products and services or by letting them develop new ones to bring to the market.
Because R&D also is a key component of innovation, it requires a greater degree of skill from employees who take part. This allows companies to expand their talent pool, which often comes with special skill sets.
The advantages go beyond corporations. Consumers stand to benefit from R&D because it gives them better, high-quality products and services as well as a wider range of options. Corporations can, therefore, rely on consumers to remain loyal to their brands. It also helps drive productivity and economic growth.
Disadvantages
One of the major drawbacks to R&D is the cost. First, there is the financial expense as it requires a significant investment of cash upfront. This can include setting up a separate R&D department, hiring talent, and product and service testing, among others.
Innovation doesn’t happen overnight so there is also a time factor to consider. This means that it takes a lot of time to bring products and services to market from conception to production to delivery.
Because it does take time to go from concept to product, companies stand the risk of being at the mercy of changing market trends. So what they thought may be a great seller at one time may reach the market too late and not fly off the shelves once it’s ready.
-
Facilitates innovation
-
Improved or new products and services
-
Expands knowledge and talent pool
-
Increased consumer choice and brand loyalty
-
Economic driver
-
Financial investment
-
Takes time
-
Shifting market trends
R&D Accounting
R&D may be beneficial to a company’s bottom line, but it is considered an expense. After all, companies spend substantial amounts on research and trying to develop new products and services. As such, these expenses are often reported for accounting purposes on the income statement and do not carry long-term value.
There are certain situations where R&D costs are capitalized and reported on the balance sheet. Some examples include but are not limited to:
- Materials, fixed assets, or other assets have alternative future uses with an estimable value and useful life.
- Software that can be converted or applied elsewhere in the company to have a useful life beyond a specific single R&D project.
- Indirect costs or overhead expenses allocated between projects.
- R&D purchased from a third party that is accompanied by intangible value. That intangible asset may be recorded as a separate balance sheet asset.
R&D Considerations
Before taking on the task of research and development, it’s important for companies and governments to consider some of the key factors associated with it. Some of the most notable considerations are:
- Objectives and Outcome: One of the most important factors to consider is the intended goals of the R&D project. Is it to innovate and fill a need for certain products that aren’t being sold? Or is it to make improvements on existing ones? Whatever the reason, it’s always important to note that there should be some flexibility as things can change over time.
- Timing: R&D requires a lot of time. This involves reviewing the market to see where there may be a lack of certain products and services or finding ways to improve on those that are already on the shelves.
- Cost: R&D costs a great deal of money, especially when it comes to the upfront costs. And there may be higher costs associated with the conception and production of new products rather than updating existing ones.
- Risks: As with any venture, R&D does come with risks. R&D doesn’t come with any guarantees, no matter the time and money that goes into it. This means that companies and governments may sacrifice their ROI if the end product isn’t successful.
Research and Development vs. Applied Research
Basic research is aimed at a fuller, more complete understanding of the fundamental aspects of a concept or phenomenon. This understanding is generally the first step in R&D. These activities provide a basis of information without directed applications toward products, policies, or operational processes.
Applied research entails the activities used to gain knowledge with a specific goal in mind. The activities may be to determine and develop new products, policies, or operational processes. While basic research is time-consuming, applied research is painstaking and more costly because of its detailed and complex nature.
R&D Tax Credits
The IRS offers a R&D tax credit to encourage innovation and significantly reduction their tax liability. The credit calls for specific types of spend such as product development, process improvement, and software creation.
Enacted under Section 41 of the Internal Revenue Code, this credit encourages innovation by providing a dollar-for-dollar reduction in tax obligations. The eligibility criteria, expanded by the Protecting Americans from Tax Hikes (PATH) Act of 2015, now encompass a broader spectrum of businesses. The credit tens to benefit small-to-midsize enterprises.
To claim R&D tax credits, businesses must document their qualifying expenses and complete IRS Form 6765 (Credit for Increasing Research Activities). The credit, typically ranging from 6% to 8% of annual qualifying expenses, offers businesses a direct offset against federal income tax liabilities. Additionally, businesses can claim up to $250,000 per year against their payroll taxes.
Example of Research and Development (R&D)
One of the more innovative companies of this millennium is Apple Inc. As part of its annual reporting, it has the following to say about its research and development spend:
In 2023, Apple reported having spent $29.915 billion. This is 8% of their annual total net sales. Note that Apple’s R&D spend was reported to be higher than the company’s selling, general and administrative costs (of $24.932 billion).
Note that the company doesn’t go into length about what exactly the R&D spend is for. According to the notes, the company’s year-over-year growth was “driven primarily by increases in headcount-related expenses”. However, this does not explain the underlying basis carried from prior years (i.e. materials, patents, etc.).
What Is Research and Development?
Research and development refers to the systematic process of investigating, experimenting, and innovating to create new products, processes, or technologies. It encompasses activities such as scientific research, technological development, and experimentation conducted to achieve specific objectives to bring new items to market.
What Types of Activities Can Be Found in Research and Development?
Research and development activities focus on the innovation of new products or services in a company. Among the primary purposes of R&D activities is for a company to remain competitive as it produces products that advance and elevate its current product line. Since R&D typically operates on a longer-term horizon, its activities are not anticipated to generate immediate returns. However, in time, R&D projects may lead to patents, trademarks, or breakthrough discoveries with lasting benefits to the company.
Why Is Research and Development Important?
Given the rapid rate of technological advancement, R&D is important for companies to stay competitive. Specifically, R&D allows companies to create products that are difficult for their competitors to replicate. Meanwhile, R&D efforts can lead to improved productivity that helps increase margins, further creating an edge in outpacing competitors. From a broader perspective, R&D can allow a company to stay ahead of the curve, anticipating customer demands or trends.
The Bottom Line
There are many things companies can do in order to advance in their industries and the overall market. Research and development is just one way they can set themselves apart from their competition. It opens up the potential for innovation and increasing sales. However, it does come with some drawbacks—the most obvious being the financial cost and the time it takes to innovate.
link