What Is Research and Development (R&D)?
Research and development (R&D) includes activities that companies undertake to innovate and introduce new products and services. It is often the first stage in the development process. The goal is typically to take new products and services to market and add to the company's bottom line.
- R&D 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 term R&D 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 separate 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 lead to patents, copyrights, and trademarks as discoveries are made and products created.
Companies that set up and employ entire R&D departments commit substantial capital to the effort. They must estimate the risk-adjusted return on their R&D expenditures—which inevitably involves risk of capital—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 (RTD).
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.
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.
Who Spends the Most on R&D?
Companies spend billions of dollars on R&D to produce the newest, most sought-after products. According to public company filings, these companies incurred the highest research and development spend in 2020:
- Amazon: $42.7 billion
- Alphabet, Inc.: $27.6 billion
- Huawei: $22.0 billion
- Microsoft: $19.3 billion
- Apple: $18.8 billion
- Samsung: $18.8 billion
- Facebook: $18.5 billion
$42.7 billion of research and development costs later, Amazon was granted 2,244 new patents in 2020. Their patents included advancements in artificial intelligence, machine learning, and cloud computing.
Types of Research and Development
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.
The second 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.
There are also 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.
Also, M&As and partnerships are forms of R&D as companies join forces to take advantage of other companies' institutional knowledge and talent.
R&D 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.
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.
What Is an Example of Research and Development?
Consider the example of Alphabet, which has allocated over $16 billion annually to R&D in 2018. Under its R&D arm X, the moonshot factory, it has developed Waymo self-driving cars. Meanwhile, Amazon has spent even more on R&D projects, with key developments on cloud computing and its cashier-less store Amazon Go. At the same time, R&D can take the approach of a merger & acquisition, where a company will leverage the talent and intel of another company to create a competitive edge. The same can be said with company investment in accelerators and incubators, whose developments it could later leverage.
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.