Research and development, or R&D for short, is the field of the advancement of knowledge that a private or public sector organisation may undertake, in order to develop or create new products, processes or services, or to improve upon those already offered. In other words, R&D, as a concept, represents the pursuit of innovation within the context of business. Research and development is often carried out by a separate section of employees within a company, and generally is not an activity performed with the expectation of immediate profit, but rather with the hope of an eventual payoff further down the road, and with the long-term profitability of a company in mind. Research and development can be thought of as a cycle, with a constant study of the efficacy and efficiency of a company’s existing products and services leading to new ideas and experimentation, followed by research and more in-depth exploration of new ideas and potential products, to the eventual design and testing of new products. And then the cycle completes or repeats with the continuing study of the newly created product’s efficacy and efficiency, suitability, desirability among customers and performance in the market. This research and development cycle is often the earliest stage of the development for new products and services, and as such, is inherently risky as the outcomes are uncertain – there may be uncertainties around whether a new development is technologically or economically feasible, or even possible, or more commonly, whether the research and development will result in meaningful gains for the company, whether through new or improved products and services, valuable intellectual property or patents.
However, while investing in research and development does carry some inherent risk, a company not investing in research and development is guaranteed to not come up with new knowledge, new products and services, intellectual property and patents – and there is every chance that a company that doesn’t invest in research and development will stagnate and fall behind, especially in this increasingly globalised and knowledge based commercial world, as competitors seek to increase their own market share, often at the expense of the company that didn’t invest enough in R & D.
Saving money on R & D in the short term can end up costing businesses severely in the longer term, as they become increasingly irrelevant and their previous customers move onto new products and services that are either better, or offer better value for money. R&D is more important in some industries than others; technology such as computer hardware, semiconductors or telecommunications equipment, pharmaceuticals and life sciences such as biotechnology, are particularly reliant on R&D, or “R&D intensive”, while software, construction and engineering, manufacturing, the automotive, aerospace and defence industries are also heavily reliant on research and development, as well as, to a lesser degree, food and drink industries. Whatever the industry though, the world does not stand still, and other companies will no doubt be attempting to follow the example of an already successful competitor, and to improve on their pre-existing solutions, to take their market share from them.
R&D generally falls into one of two categories; Basic research, which is more general in its aims, and is about building knowledge and understanding that a business may use to its advantage, and can be the foundation of further research (and development) projects, and provide context and analysis to help with a business’ strategic decisions. The second category is “applied research” – this has more defined goals, often looking to achieve a specific objective, and often leads directly to the development of a product. It can also look at reaching new markets, cutting costs, improving safety or making use of available new technologies.
Companies fall behind or fail completely for many reasons, and it can be difficult to apportion blame in the aftermath of a business’ collapse, but failure to adequately fund research and development can often be a contributing factor in the demise of a company. It’s impossible to say whether for example, if the former Blockbuster CEO John Antioco had chosen to invest more in R&D, that they could have fought off competition from the likes of Netflix and remained competitive and relevant in the era of digital downloads and streaming services such as Netflix and Apple TV. Nor is it possible to say whether retailers such as BHS or Woolworths could have retained a space in the increasingly internet dominated retail market if they had spent more on R&D. However, you only have to look at the companies which have the largest budgets for research and development to see some very familiar, household names, market leaders in their respective fields, proving that these industry leaders of today, experts in the creation of wealth, clearly value research and development, dedicating often tens of billions of dollars annually to the pursuit of new knowledge and new, improved products and services, in the hope of remaining competitive and relevant, in the cut-throat world we live in. Amongst the biggest spending companies worldwide, according to the 2018 EU Industrial R&D Investment Scoreboard, are South Korean tech behemoth Samsung at number one and Google parent company Alphabet at number two, while Volkswagen, the largest car manufacturer in the world, ranks third, and tech companies Microsoft, Huawei, Intel and Apple all rank within the top ten. As well as technology and automotive companies, pharmaceutical companies feature highly in the list of companies spending the most on R&D, for example the two Swiss giants Roche and Novartis, German multinational Merck and American “big pharma” corporations Johnson & Johnson and Pfizer.
There is certainly a correlation between the highest performing companies and the amount that they spend on R&D, but, do the highest performing companies hold their positions because of the large amounts of capital they dedicate to investment in R&D, or are they able to dedicate the large amounts of money to R&D that they do because of their leading position in the market? The answer is probably a little bit of both; companies such as Apple and Google are well known for having ploughed money into R&D, and for having made major market gains as a result,as well as a few relative failures. However, the runaway success of the iPod, which set the stage for the iPhone, the App Store and the Apple we know today, was to a large extent a matter of Apple being lucky to have the right product at the right time. Had the iPod been released a few years prior, it could have been an absolute failure, and Apple as we know it today might never have even existed. As it happens, the iPod was a roaring success, and paved the way for the even more successful iPhone as well as the iPad, not to mention the Apple software ecosystem, with iTunes providing an early example of success by Apple in the software and online retail sector.
Research and development can gain a company intellectual property and patents, as well as allowing them to remain competitive in the market by creating actual new products or services for their customers, or becoming more efficient at producing or providing the products or services that they already offer, again, helping them to remain competitive and to hold onto a place in the market. The intellectual property and patents gained from research and development can become highly valuable in and of themselves, and provide a secondary source of income, often from competitors wishing to make use of technologies and developments made by the company holding the patent. The mobile phone market is infamous for its interconnected spider webs of patent claims made between the various manufacturers, often highly fought over in court.
It can be all too easy for a company to fall behind in the area of research and development; an already profitable business may be averse to spending money on something that will not provide immediate gain to the company, and may feel confident enough in their business and believe that they are still providing their customers with what they want. There are indeed highly successful companies that spend little on R&D, Walmart being but one example. Walmart provides a service that technology and the internet can only offer so much in competition; people will always value having a bricks and mortar store to shop from. Even as they take advantage of the convenience that online retailers offer, a bricks and mortar store offers its own conveniences and that is unlikely to change anytime soon, Covid-19 pandemic notwithstanding. Certain industries are less R&D intensive, particularly state-owned enterprises such as Russia’s Gazprom or Malaysia’s Petronas, although renewable energies are a notable exception. Opening a traditional chain of fried chicken shops may provide immediate revenue, but investing in a more “R&D intensive” business should provide greater good to society, as well as far greater potential for long-term profit.
R&D spending by country
In terms of countries that spend the most on R&D, China and the US top the list with each spending over half a trillion dollars annually, while the United Kingdom sits at number eight in raw spending (figures from Wikipedia), behind countries such as Japan, Germany, South Korea, Brazil and India, and spending $44.8 billion annually, or 1.7% of the UK’s GDP, around £700 per capita. Predictably, the list of nations that spend the most on R&D looks remarkably similar to a list of the largest economies; a better metric is perhaps the percentage of its GDP that a nation dedicates to R&D spending. Again, from Wikipedia, figures show that Israel tops the world with 4.9% of GDP spent on research and development, followed by South Korea with 4.29%, and Finland, Sweden, Japan, Austria, Taiwan and Denmark each spending above 3% of their respective GDP on R&D. The UK ranks 21st worldwide with just 1.7% of our GDP spent on research and development, behind countries such as Switzerland, Germany, the United States, China, Belgium, Slovenia, Czechia, Singapore and Australia. Israel’s high spending can be attributed to both a highly educated population, and a necessarily large domestic defence spending (and necessity being the mother of invention, as they say) second only to Saudi Arabia, with 5.3% spent on defence according to figures from the Stockholm International Peace Research Institute, resulting from the nation being in a near constant state of war with its largely hostile neighbours since it declared independence in 1948, although Israel is also known for its technology sector including a healthy culture of tech start-ups. This includes a large number of cybersecurity companies, again in large part due to its status as one of the most embattled countries on earth, surrounded by hostile neighbouring states. Second to Israel in R&D spending as a percentage of its GDP, South Korea’s foreign relations are also defined by its relationship with hostile neighbours – or in this instance a single hostile neighbour – in the form of its northern cousin the DPRK, or North Korea, run by belligerent dictator Kim Jong-un. However, whilst South Korea does have a decently sized defence sector, and spends a relatively high 2.7% of its gross domestic product on its military, the bulk of South Korea’s R&D spending goes to its huge tech sector, as well as its similarly huge automotive sector; Samsung, Hyundai, LG and Kia being some of South Korea’s most well-known and successful companies, and operating in sectors heavily reliant on R & D spending. Whilst often held up as a paragon of free market economics, South Korea’s economic success and rapid growth since the sixties was actually the result of both free market and state interventionist policies, with the “chaebols” – literally “rich families” – a uniquely South Korean term referring to its huge corporations such as the aforementioned Samsung, Hyundai, LG and Kia, benefiting from state subsidies and tax breaks, something we will look into in the context of the UK later.
Other countries high up on the list of R&D spenders include Germany, Japan, the US, China and Taiwan, as well as, notably, the Nordic countries, among other European nations – Finland, Sweden, Denmark, Austria and Belgium being high spenders. While it’s clear that such richer countries, like the aforementioned Finland, Sweden, or Switzerland, have the obvious luxury of easily being able to afford to spend more on R&D, research and development itself should certainly not be seen as a luxury, rather an important and necessary investment to secure the long-term economic competitiveness and economic health of both a company and the economy of a country, and society as a whole.
Society as a whole
R&D benefits not just the investing company, but the economy as a whole and wider society – for example, lifesaving or life-improving new medical treatments, or instant, mobile access to encyclopaedia-quality articles and knowledge, something that would have required at the least a trip to the library just a couple of decades ago. Technologies that make our lives easier, more healthy, or happier even; whether by reducing arduous labour, allowing easier and better quality long-distance communication between loved ones, reducing the burden of medical conditions, or allowing the attainment of greater knowledge at the touch of a button are a real benefit to humankind that investment in R&D has made possible, and that would not have been possible had companies only been looking for immediate profit.
At the company level, greater investment in R&D often provides a company with the knowledge it needs to remain competitive in the global market. This further benefits society by providing jobs, and also providing extra tax revenue to the government to spend on healthcare, social security, education and the general wellbeing of the nation as a whole.
With these benefits in mind, governments, including our own in the UK, often provide incentives in the form of tax relief or tax credits, to encourage companies to invest in the not immediately profitable R&D. Incentives can even be claimed on projects that end up failing, so the government (or taxpayer) effectively shares some of the risk with the company doing the R&D. From the UK government’s website: “Research and Development (R&D) reliefs support companies that work on innovative projects in science and technology. It can be claimed by a range of companies that seek to research or develop an advance in their field. It can even be claimed on unsuccessful projects.”
We will look in more detail at the tax incentives offered by the UK government in a further article, and further information about the benefits of R&D tax reliefs can be found on our website here.