Research & Development

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