How do businesses decide how much to invest in R&D?

R&D is related to long-run goals, competition, judgment, and financial capabilities of the organization. It is a key driver because in one way future revenues are dependent on the R&D efforts of today.

Remember, Nokia ignoring Android Or Kodak ignoring Digital cameras?

On the other hand, Netflix invested in the OTT technology early while still being a DVD rental company.

Companies that don’t invest in R&D will eventually have an impact on their competitiveness in the future.

Budgeting R&D leads to discussions and decisions such as

Which business units should receive R&D resources?

Which products and services should receive funding?

Which products should have the green light?

R&D is not only connected to new products, new services.

A lot of R&D investments in improving the existing processes are directly connected to production, manufacturing, and service delivery. And we can see the connection between R&D, production and manufacturing budget.

There is a time lag between revenue earned today and the expenses incurred in the past. So, there is a connection between today’s profits and yesterday’s R&D budget. Acknowledge this relationship. Similarly, today’s R&D budget will impact next year’s Revenue and profits.

How do businesses decide how much to invest in R&D?

There are different approaches. Let’s look at some of them.

1. We can define a part of the company’s cash flow that will be used to fund R&D projects. For example, say we decide that 2% of the revenue will go to R&D.
2. We can apply the same percentage as last year’s revenue to R&D investment.
3. Adopting the same level as our competitors are investing in R&D to be competitive in the face of benchmarked companies.
4. Same level that the company has been investing in R&D from a historical perspective. Notice: this is different from Point 1% of revenue as this may remain constant even though revenue increases.

In the next episode, let’s continue this discussion and look at some of the commonly asked questions and challenges FP&A teams face while doing the R&D Budgets.