By: Paige Eaton
What is Research and Development (R&D)? Seems like the answer should be simple… I mean just look at the name! The simple answer is, it’s the investigation of business activities to improve or create products and/or procedures.
R&D events can be an internal operation or outsourced to specialists. Many small business owners take advantage of outsourcing R&D work because they lack knowledge of design and engineering for their new-found concepts. R&D activities vary from industry to industry, but they always contain these three steps:
1. Basic Research – The exploration to obtain a more complete understanding of fundamental aspects of a concept.
2. Applied Research – The investigation of methods to obtain specific objectives regarding product or processes.
3. Development Research – The examination of the implementation of research knowledge and designs for production.
There is no guarantee to the outcome of R&D. Many companies spend a large amount of money on research and development activities and never realize a return on their investment. Some companies utilize R&D with the knowledge that they will not immediately profit, but instead focus on the long-term profitability. How much is spent on R&D isn’t a measure of success, rather, it is the balance between technical risk and market risk, all of which need proper investment and management. Forbes uses this equation to model the success of research and development: innovation = invention + customer value + business model
There are many factors that contribute to the decision of whether to pursue R&D. The following are the top four:
1. Proprietariness – Is the nature of the research unique such that it can be protected through patents or non-disclosure agreements? Having that level of protection makes R&D much more valuable.
2. Timing – Starting R&D is best when the market for the product is slow or moderate in growth.
3. Risk – R&D is a high-risk activity. Lowering the risk could mean acquiring the research to produce marketable products or processes.
4. Cost – Expenses for R&D activities can be very costly and produce a negative cash flow before returning a profit. In the next article, I will discuss how much and what is spent on Research and Development.
Whether success or failure, all those expenses don’t have to be a burden of loss. The Research and Development Tax Credit, made permanent through the Protecting American Against Tax Hikes (PATH) Act during 2015, allows businesses a credit for qualified research activities and expenses. This will be discussed in a later article.