Do You Know Your Research
Quotient For R&D Spending?
Early adopters will have a competitive advantage as they gain familiarity with this new
approach to the management science of investing in R&D.
How does your company determine how much to spend each year on R&D? Likely, a group of senior
executives get together and offer their
thoughts on what the figure should be for the
next year. After a back and forth discussion
focusing on the right amount for R&D, other
corporate financial considerations are then
put on the table that compete for monies that
might go to R&D.
Now, with everything on table, the group
decides what it will spend for R&D. So, one
question is answered. What will we spend
next year? But, the more important question
is not answered. What is the right amount
to spend on R&D? Each year management
answers the “how much” question, but for
decades management has never known if it is
the “right amount” to spend.
Numerous R&D spending
gauges exist
Competitive alignment: Some of the figures
that are put on the table every year are the
amounts that key competitors are spending;
and there is always a range of spending across
those key competitors. Discussions about
the range often include comments such as
“Competitor A is inefficient so they are not
a good comparison.” Or, “Competitor B is
playing catch-up so they are spending too
much.” Or, “Competitor C is riding their
brand value and has been cheating spending
for years.”
At the time these comments are made,
they are mostly conjecture as it is impossible
to know if they are accurate until years later.
Regardless, it is always good practice to know
what competitors are spending. But, those
figures do not answer the question about what
your company should spend.
Desired Vitality Index: Since 3M created
the Vitality index in 1988 to measure 3M’s
ability to produce new revenues from
investments in R&D, the Vitality Index
has steadily been adopted by corporations
around the world. Today, this metric is
the number one performance metric for
R&D in most companies. Also known as
“new product sales as a percent of total
sales,” this metric is effective at getting at
one of the tangible outputs of investments
in R&D—new revenues. However, vitality
is not perfect indicator as it does not
address the profitability of new products,
the capital investments that were required,
and a host of other operational and
financial considerations. If revenues were
all that counted—assuming a consistently
performing R&D organization—executives
could simply modulate R&D spending to
produce their desired Vitality Index each
year.
Baseline spending: If it is not broken, don’t
fix it. This mindset leads executives to always
start the discussion about the next year with
percentages from the prior years. If Wall Street
rewarded the company in the past year, or
was at least neutral because annual corporate
performance is not just about R&D, then
nothing was broken and keeping the same
figure for the next year can’t be penalized.
In fact, it might even be risky to change it
as it gives analysts something else to inquire
about. Other considerations then enter. Are
we doing any big stretch projects? Do we
need to replace a platform we currently sell?
Are we discontinuing products or product
lines that consumed large amounts of prior
year spending? Depending on the answers
to these questions, management might then
modulate R&D spending for the next year
up or down. With the baseline approach, if
analysts or anyone else inquires about the
changed amount, the answer is strongly
by Bradford L. Goldense, Goldense Group Inc.
Credit: Knott, “How Innovation Really Works,” 2017