The final part of the series “The three questions R&D gets asked most often” will deal with probaly the most controversial question of all of them – Money.
Part 4: Why is R&D so expensive?
It may seem obvious to most of us, yet for one reason or the other it needs to be restated over and over again: Only profitable companies will have sustainable marked success. As basic as this is, there is no unprofitable company that survives in the long run. R&D spend makes up a significant chunk of expenditure and reductions in R&D spend may have a significant positive effect on the P&L in the short run. Yet, is this a viable way in the long run?
Cutting R&D costs will hurt your innovativeness in the long run.
In a fast-paced world where everything seems to be available right away, where investments need to return benefits almost instantly, it is sometimes hard to negotiate for R&D investments that will pay back after months or even years. On the flip-side cutting R&D cost will most probably not have an immediate impact on successful product developments. Rather it will be a slow but steady decline that may be detected only years after.
For a primer, please check out the Boston Consulting list of the most innovative companies.
Pick three companies relevant to your business, compare their ranking, their stick market performance and their R&D expenditure. I’m confident that you will see that companies in the ranking have a track record in investing in R&D and that their recent stock market performance was most likely better the higher they are in the ranking.
Drivers for R&D costs
The drivers for R&D costs can be sorted into three distinct categories
- Material costs: Often new products are made from non-standard parts that achieve economy of scale only after maturity
- Raw materials including formula prototyping
- Packaging material including packaging prototyping
- Material to create the aforementioned prototypes
- This also includes costs for external development work/ external testing
- Equipment/ infrastructure costs: Standards, regulation and legal texts set forth the need for specialised equipment and infrastructure.
- Laboratory space and infrastructure
- Storage space
- Office space
- IT infrastructure
- Personnel costs: You want the best and they come at a price.
- Teams of highly skilled technicians that do the actual development work.
- R&D managers with excellent leadership qualities to give guidance and motivation to their teams.
Optimising R&D costs
When asked about how future R&D costs should be higher or lower it is typically Marketing, Sales, Controlling wishing for lower R&D costs in order to allow for improved margins. Higher R&D costs are typically the wish of R&D itself. Needless to say that often organisations go to extended debates about who is right. Well, who is right?
The answer: both sides.
The insight that is typically lacking in these organisation is: What is the business need of new products of the next 12 – 60 months?
A joint view of all functions on this insight will create a tremendous amount of synergies.
Repeating reevaluation of this insight will help stay on track with R&D costs.
And for R&D it will allow for cutting unnecessary slack or strategically investing into new capabilities to meed the business needs of the next 5 years.
Negotiating for R&D costs
Put yourself into the shoes of a R&D executive who identified a great innovation opportunity that will boost company results in a 1 year horizon (in case you aren’t yet in these shoes already).
Unfortunately the budget is spent. I know a lot of R&D executives that would stop here, because no money – no invest.
While this is perfectly understandable, it would mean that a company would miss out on a great business potential in the future.
So, what to do?
I recommend to approach this like
- Create a simple business case that contains the invest and how it returns profits in the future based on a realistic worst case scenario.
- Get help from sales, marketing, controlling filling the business case with realistic worst case figures. Does the case still check out? Proceed to step 3
- Get buy in from sales, marketing. Figures are convincing and they should help you get the support of these functions.
- Pitch to top level management with the support of the functions you involved.
Most likely top level management will share your view that this is a profitable investment.
If they say yes – excellent, you opened up great new opportunities for your company.
If they say no – still great, the organisation just took a conscious decision based on solid data to move the business forward a different direction.
Want to know more?
Please don’t hestiate to contact us for a free strategy session, where we can determine how your organisation can optimise their R&D costs.
