Research and development (R&D) is a process intended to create new or improved technology that can provide a competitive advantage at the business, industry, or national level. While the rewards can be very high, the process of technological innovation (of which R&D is the first phase) is complex and risky. The majority of R&D projects fail to provide the expected financial results, and the successful projects (25 to 50 percent) must also pay for the projects that are unsuccessful or terminated early by management. In addition, the originator of R&D cannot appropriate all the benefits of its innovations and must share them with customers, the public, and even competitors. For these reasons, a company's R&D efforts must be carefully organized, controlled, evaluated, and managed.
OBJECTIVES AND TYPES OF R&D
The objective of academic and institutional R&D is to obtain new knowledge, which may or may not be applied to practical uses. In contrast, the objective of industrial R&D is to obtain new knowledge, applicable to the company's business needs, that eventually will result in new or improved products, processes, systems, or services that can increase the company's sales and profits.
The National Science Foundation (NSF) defines three types of R&D: basic research, applied research, and development. Basic research has as its objectives a fuller knowledge or understanding of the subject under study, rather than a practical application thereof. As applied to the industrial sector, basic research is defined as research that advances scientific knowledge but does not have specific commercial objectives, although such investigation may be in the fields of present or potential interest to the company.
Applied research is directed towards gaining knowledge or understanding necessary for determining the means by which a recognized and specific need may be met. In industry, applied research includes investigations directed to the discovery of new knowledge having specific commercial objectives with respect to products, processes, or services. Development is the systematic utilization of the knowledge or understanding gained from research toward the production of useful materials, devices, systems, or methods, including design and development of prototypes and processes.
At this point, it is important to differentiate development from engineering. Engineering is the application of state-of-the-art knowledge to the design and production of marketable goods. Research creates knowledge, and development designs and builds prototypes and proves their feasibility. Engineering converts these prototypes into products that can be offered to the marketplace or into processes that can be used to produce commercial products and services.
R&D AND TECHNOLOGY ACQUISITION
In many cases, technology required for industrial purposes is available in the marketplace—for a price. Before embarking on the lengthy and risky process of performing its own R&D, a company can perform a "make or buy" analysis and decide whether or not the new R&D project is justified. Factors that influence the decision include the ability to protect the innovation, its timing, risk, and cost.
If a technology can be safeguarded as proprietary—and protected by patents, trade secrets, nondisclosure agreements, etc.—the technology becomes exclusive property of the company and its value is much higher. In fact, a valid patent grants a company a temporary monopoly for 17 years to use the technology as it sees fit, usually to maximize sales and profits. In this case, a high-level of R&D effort is justified for a relatively long period (up to 10 years) with an acceptable risk of failure.
On the contrary, if the technology cannot be protected, as is the case with certain software programs, expensive in-house R&D is not justified since the software may be copied by a competitor or "stolen" by a disloyal employee. In this case, the secret of commercial success is staying ahead of competition by developing continuously improved software packages, supported by a strong marketing effort.
If the market growth rate is slow or moderate, in-house or contracted R&D may be the best means to obtain the technology. On the other hand, if the market is growing very fast and competitors are rushing in, the "window of opportunity" may close before the technology has been developed by the new entrant. In this case, it is better to acquire the technology and related know-how, in order to enter the market before it is too late.
Inherently, technology development is always riskier than technology acquisition because the technical success of R&D cannot be guaranteed. There is always the risk that the planned performance specifications will not be met, that the time to project completion will be stretched out, and that the R&D and manufacturing costs will be higher than forecasted. On the other hand, acquiring technology entails a much lower risk, since the product, process, or service, can be seen and tested before the contract is signed.
Regardless of whether the technology is acquired or developed, there is always the risk that it will soon become obsolete and be displaced by a superior technology. This risk cannot be entirely removed, but it can be considerably reduced by careful technology forecasting and planning. If market growth is slow, and no winner has emerged among the various competing technologies, it may be wiser to monitor these technologies through "technology gatekeepers" and be ready to jump in as the winner emerges.
For a successful product line with relatively long life, acquisition of technology is more costly, but less risky, than technology development. Normally, royalties are paid in the form of a relatively low initial payment as "earnest money," and as periodic payments tied to sales. These payments continue throughout the period of validity of the license agreement. Since these royalties may amount to 2 to 5 percent of sales, this creates an undue burden of continuing higher cost to the licensee, everything else being equal.
On the other hand, R&D requires a high front-end investment and therefore a longer period of negative cash flow. There are also intangible costs involved in acquiring technology—the license agreements may have restrictive geographic or application clauses, and other businesses may have access to the same technology and compete with lower prices or stronger marketing. Finally, the licensee is dependent upon the licensor for technological advances, or even for keeping up to date, and this may be dangerous.
MOVING AHEAD WITH R&D
R&D can be conducted in-house, under contract, or jointly with others. In-house R&D commands a strategic advantage: the company is the sole owner of the know-how created and can protect it from unauthorized use. R&D is also basically a learning process; in-house research thus trains the company's own research people who may go on to ever better things.
External R&D is usually contracted out to specialized nonprofit research institutions or to universities. These institutions often already have experienced personnel in the disciplines to be applied and are well-equipped. The disadvantages are that the company will not benefit from the learning experience and may become overly dependent on the contractor. The trans for the technology may turn out to be difficult and leaks to competitors may develop. Using university research is sometimes slightly less expensive than engaging institutes because graduate students rather than professionals do some of the work.
Joint R&D became popular in the United States after antitrust laws were relaxed and tax incentives were offered to R&D consortia. In a consortium, several companies with congruent interests join together to perform R&D, either in a separate organization or in a university. The advantages are lower costs, since each company does not have to invest in similar equipment; a critical mass of researchers; and interchange of information among the sponsors. The disadvantages are that all the sponsors have access to the same R&D results. However, because of antitrust considerations, the R&D performed must be "precompetitive," legalese meaning that it must be basic and/or preliminary. A company must take joint research beyond the "joint" stage to make money on it; it can use this type of result as the foundation, not as the innovation itself.
R&D PROJECT SELECTION, MANAGEMENT, AND TERMINATION
Industrial R&D is generally performed according to projects (i.e., separate work activities) with specific technical and business goals, assigned personnel, and time and money budgets. These projects can either originate "top down" (for instance, from a management decision to develop a new product) or "bottom up" (from an idea originated by an individual researcher). The size of a project may vary from a part-time effort of one researcher for a few months with a budget of thousands of dollars, to major five- or ten-year projects with large, multidisciplinary teams of researchers and budgets of millions of dollars. Therefore, project selection and evaluation is one of the more critical and difficult subjects of R&D management. Of equal importance, although less emphasized in practice, is the subject of project termination, particularly in the case of unsuccessful or marginal projects.
Selection of R&D Projects
Normally, a company or a laboratory will have requests for a higher number of projects than can be effectively implemented. Therefore, R&D managers are faced with the problem of allocating scarce resources of personnel, equipment, laboratory space, and funds to a broad spectrum of competing projects. Since the decision to start on an R&D project is both a technical and a business decision, R&D managers should select projects on the basis of the following objectives, in order of importance:
- Maximize the long-term return on investment;
- Make optimum use of the available human and physical resources;
- Maintain a balanced R&D portfolio and control risk;
- Foster a favorable climate for creativity and innovation.
Project selection is usually done once a year, by listing all ongoing projects and the proposals for new projects, evaluating and comparing all these projects according to quantitative and qualitative criteria, and prioritizing the projects in "totem pole" order. The funds requested by all the projects are compared with the laboratory budget for the following year and the project list is cut off at the budgeted amount. Projects above the line are funded, those below the line delayed to the following year or tabled indefinitely. Some experienced R&D managers do not allocate all the budgeted funds, but keep a small percentage on reserve to take care of new projects that may be proposed during the year, after the laboratory official budget has been approved.
Evaluation of R&D Projects
Since R&D projects are subject to the risk of failure, the expected value of a project can be evaluated according to a statistical formula. The value is the payoff anticipated—but discounted by probabilities. These are the probability of technical success, the probability of commercial success, and the probability of financial success. Assuming a payoff of $100 million and a fifty-fifty rate of technical success, a commercial success rate of 90 percent, and a financial probability of 80 percent, then the expected value will be $36 million—100 discounted by 50, 90, and 80 percent respectively.
Consequently, project evaluation must be performed along two separate dimensions: technical evaluation, to establish the probability of technical success; and business evaluation, to establish the payoff and the probabilities of commercial and financial success. Once the expected value of a project has been determined it can be compared with the projected cost of the technical effort. Given a company's usual rate of return on investment, the cost may not be worth the expected value given the risks.
Needless to say, such statistical approaches to evaluation are not silver bullets but as good as the guesses that go into the formula. Businesses use such evaluations, however, when many projects compete for money and some kind of disciplined approach is needed to make choices.
Management of R&D Projects
The management of R&D projects follows basically the principles and methods of project management. There is, however, one significant caveat in relation to normal engineering projects: R&D projects are risky, and it is difficult to develop an accurate budget, in terms of technical milestones, costs, and time to completion of the various tasks. Therefore, R&D budgets should be considered initially as tentative, and should be gradually refined as more information becomes available as a result of preliminary work and the learning process. Historically, many R&D projects have exceeded, sometimes with disastrous consequences, the forecasted and budgeted times to completion and funds to be expended. In the case of R&D, measuring technical progress and completion of milestones is generally more important than measuring expenditures over time.
Termination of R&D Projects
Termination of projects is a difficult subject because of the political repercussions on the laboratory. Theoretically, a project should be discontinued for one of the following three reasons:
- There is a change in the environment—for instance, new government regulations, new competitive offerings, or price declines—that make the new product less attractive to the company;
- Unforeseen technical obstacles are encountered and the laboratory does not have the resources to overcome them; or
- The project falls hopelessly behind schedule and corrective actions are not forthcoming.
Due to organizational inertia, and the fear of antagonizing senior researchers or executives with pet projects, there is often the tendency to let a project continue, hoping for a miraculous breakthrough that seldom happens.
In theory, an optimal number of projects should be initiated and this number should be gradually reduced over time to make room for more deserving projects. Also, the monthly cost of a project is much lower in the early stages than in the later stages, when more personnel and equipment have been committed. Thus, from a financial risk management viewpoint, it is better to waste money on several promising young projects than on a few maturing "dogs" with low payoff and high expense. In practice, in many laboratories it is difficult to start a new project because all the resources have already been committed and just as difficult to terminate a project, for the reasons given above. Thus, an able and astute R&D manager should continuously evaluate his/her project portfolio in relation to changes in company strategy, should continuously and objectively monitor the progress of each R&D project, and should not hesitate to terminate projects that have lost their value to the company in terms of payoff and probability of success.
TAX ADVANTAGES FOR R&D
In the period 1981 through 2004, corporations had a R&D tax credit—had the ability to deduct research and development expenditures from income. The tax credit was renewed in 2004 and lasted through 2005, but the tax bill signed in May of 2006 left the provision out. This outcome no doubt pleased those who thought that government subsidies of corporate development were out of place—and energized those who saw the credit as nationally important to attempt to have the credit reinstated.
SMALL BUSINESS AND R&D
Research and development in public the public domain as well as in the media suggests big business, huge labs, vast testing fields, wind tunnels, and crash dummies flailing around as autos are crashed into walls. R&D is associated with the pharmaceutical industry, miracle cures, laser eye surgery, and super fast jet travel. To be sure, a vast amount of the money expended on formal research is expended by large corporations—often on relatively trivial improvements of products already doing quite a good job—and by government on weapons systems and space exploration. The glory and the power thus displayed before our eyes on television fail to remind us that the crucial research and development on which much else is based has been—and continues to be—the work of small entrepreneurs.
The explosive development of the oil industry was triggered by the invention of an effective kerosene lamp by Michael Dietz in 1859. Dietz ran a small lamp production business. Oil drilling began in earnest to support such lighting applications. An unwanted residue of kerosene refining was—gasoline, burned off as useless waste—until the first cars came along. The story of Thomas Edison is worth rereading occasionally to correct ones vision of modern R&D. Chester Carlson, the inventory of xerography, perfected his invention in part-time labors in a makeshift lab while working as a patent attorney. The computer revolution came about because two young men, Steve Wozniak and Steve Jobs, put together a personal computer in a garage and thus triggered the Information Age. Countless innovations large and small were made by tinkering individuals or small business people trying something new. The fact that many of these entrepreneurial, inventive, innovative, and persistent individuals are the fathers and mothers of great companies—indeed of whole industries—that now dominate formal R&D should not obscure their humble beginnings and catch-as-catch-can methods of discovering the new.
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