What Is Research and Development (R&D)?

Businesses put a lot of time and energy into developing the products and services they put out on the market. This gives them a competitive advantage over their peers. These efforts require investment in what the financial industry calls research and development (R&D). This is a series of activities that companies undertake to innovate and introduce new products and services.

R&D is often the first stage in the development process. The goal is to take new products and services to market and add to the company's bottom line. Companies don't conduct their R&D to make an immediate profit, which makes it different from other corporate activities. It helps companies achieve their long-term growth potential, which can lead to copyrights, patents, and trademarks.

Some industries spend more on R&D than others, including telecoms, computing, health care, chemicals, and software. This article looks at how research and development factors into the pharmaceutical industry.

Key Takeaways

  • Research and development is often the first stage in the development process.
  • The goal of R&D is to take new products and services to market and add to the company's bottom line.
  • Out of the top 20 largest R&D spenders, pharmaceutical companies account for nearly half.
  • Pharmaceutical companies rely on R&D to develop new drugs.
  • Johnson & Johnson spent $82.6 billion in R&D in 2020 while Merck laid out 28.3% of its revenue on R&D in 2020.

Research and Development (R&D) Spending in the Pharmaceutical Industry

The pharmaceutical industry is responsible for discovering, producing, and marketing drugs for use in the health care sector. These drugs are used to treat and cure short- and long-term medical conditions. This is considered to be one of the largest sectors in the global economy.

According to research, the pharma industry recorded more than $1.23 trillion in sales in 2020, with about 46% of sales coming from North America. Sales are expected to grow to $1.7 trillion in 2025. Getting to this point doesn't come without R&D.

R&D is the pharmaceutical industry's lifeblood. The success of major drug companies almost wholly depends upon the discovery and development of new medicines, and their allocation of capital expenditures (capex) reflects this fact. Although the average spending is over 25% of revenues, some companies spend substantially more.

Pharmaceutical companies spent, on average, over 25% of revenues on R&D in 2018 and 2019, making it one of the biggest spenders in this area. Outside of the semiconductor industry, no other industry spends more on R&D. In fact, of the 20 largest R&D spending industries in the world, the pharmaceutical industry makes up nearly half the list.

Who Are the Big Spenders?

Among the largest pharmaceutical companies in the industries in 2020 were:

  • Johnson & Johnson: $82.6 billion
  • Roche: $26.9 billion
  • Novartis: $48.7 billion
  • Merck: $48 billion
  • Pfizer: $41.9 billion

As noted above, many of these firms spend as much as 25% of their revenue on R&D. But just how much did these firms spend on R&D? Here's a breakdown of how much they spent in 2020:

  • Johnson & Johnson: $12.2 billion (14.8% of revenue)
  • Roche: $6.5 billion (24.1% of revenue)
  • Novartis: $9 billion (18.5% of revenue)
  • Merck: $13.6 billion (28.3% of revenue)
  • Pfizer: $9.4 billion (22.4% of revenue)

Some of the other major names in the industry include AstraZeneca, which spent $6 million in R&D compared to $26.6 million in revenue (22.6%), and Eli Lilly, which earned $24.5 billion in revenue and spent $6 billion in R&D (24.5%).

Pharmaceutical companies determine their R&D expenses by estimating their revenue earned by developing and marketing a new drug.

Spending During COVID-19

The global COVID-19 pandemic forced pharmaceutical companies to reevaluate their R&D activities. Not only did a number of companies have to interrupt the clinical trials for some of their drugs, but many found themselves rushing to step up to help the general public. A number of these corporations helped by providing medical supplies to health care providers and patients.

Some major pharma companies ramped up their R&D efforts to develop vaccines, according to a report by McKinsey & Company. The study reported that 90% of the companies polled executed emergency protocols under their business plans, with more than 50% of these companies pausing existing clinical trials until things return to normal. As much as 50% of the industry was operating under normal capacity with productivity dropping by as much as 75% because of telecommuting.

Research and Development (R&D) Spending by Industry

R&D is an important component of any business model, regardless of the industry. R&D in the pharmaceutical sector, though, continues to have a great impact on global spending in this business area. Health care, which includes the pharmaceuticals sector came in second with a total of 21.7% in spending. The computing and electronics sector spent the most on R&D in 2018 with a total of 22.5% of its total revenue.

Spending by technology and internet companies is closer to that of pharmaceutical firms. Total spending during the 2018 fiscal year amounted to 22.5%. The chemicals sector, one of the larger R&D sectors, spends an average of 4.1%. Aerospace and defense firms only dedicated about 2.8% of revenues to R&D spending in 2018.

The Bottom Line

Research and development is a pivotal component of any company's success, whether that's a chemical, energy, computer, or pharmaceutical company. Companies that fall into the latter sector are among the top spenders when it comes to R&D. The high level of R&D expenditures in this industry is easy to understand given the cost of developing a new drug and bringing it to market. The average R&D to marketplace cost for a new medicine is nearly $4 billion, and can sometimes exceed $10 billion.