What Is Research and Development (R&D)?

What Is Research and Development (R&D)?

Let me explain to you what research and development, or R&D, really means. It's the series of activities companies undertake to innovate, often starting with market research, moving into product development, and including product testing. This is typically the first stage in bringing something new to life or refining what's already there.

Key Takeaways on R&D

You should know that R&D represents the efforts companies make to innovate and launch new products or services, or to enhance their current lineup. It helps a company stay ahead of competitors by addressing emerging market needs. Various sectors conduct R&D, with pharmaceuticals, semiconductors, and tech firms spending the most. R&D often takes a broad, exploratory approach to advancement. Remember, how R&D costs are accounted for can significantly affect a company's financial statements.

How Research and Development (R&D) Works

R&D is closely tied to innovation in both corporate and government settings, and it allows companies to outpace their competition. Without a dedicated R&D program, a company might not survive independently and could turn to mergers, acquisitions, or partnerships for innovation. Through R&D, companies design new products and refine existing ones.

R&D differs from regular operational activities because it's not aimed at immediate profits; instead, it contributes to long-term profitability. It often leads to intellectual property like patents, copyrights, and trademarks as discoveries happen and products emerge.

Companies that establish full R&D departments invest substantial capital, estimating risk-adjusted returns on expenditures that carry inherent uncertainty—no guaranteed payoff, and higher investments mean higher risks. Some outsource R&D due to factors like size or cost.

R&D occurs across all industries, driving growth through improvements and new goods. Pharmaceuticals, semiconductors, and software/tech companies invest the most. In Europe, it's called research and technical or technological development.

Many small and mid-sized businesses outsource R&D because they lack the in-house staff to handle it effectively.

Types of Research and Development (R&D)

Different types of R&D exist in the corporate and government worlds, depending on the entity and desired outcomes. Basic research involves business incubators and accelerators where corporations invest in startups, providing funding and guidance in hopes of usable innovations. Mergers, acquisitions, and partnerships also count as R&D by leveraging others' knowledge and talent.

Applied research typically features departments of engineers developing new products through extensive research, without a specific goal—it's research for its own sake.

Development research uses industrial scientists or researchers for applied work in technical, scientific, or industrial fields, aiming to develop future products or improve current ones and procedures.

The largest companies, like Amazon which spent $88.54 billion on R&D in 2024 (up from $85.62 billion in 2023), often drive the most spending.

Advantages and Disadvantages of R&D

R&D offers key benefits by facilitating innovation, allowing companies to improve products and services or create new ones for the market. It demands skilled employees, expanding the talent pool with specialized expertise.

Beyond companies, consumers gain from better, high-quality options and more choices, fostering brand loyalty. It also boosts productivity and economic growth.

However, the major drawback is the cost—significant upfront cash for departments, talent, and testing. Innovation takes time, from conception to delivery, leaving companies vulnerable to shifting market trends. What seems promising initially might fail to sell by launch time.

R&D Accounting

While R&D benefits the bottom line, it's treated as an expense. Companies spend heavily on research for new products and services, reporting these on the income statement without long-term value.

In some cases, R&D costs are capitalized on the balance sheet: when materials or assets have alternative uses with value and life; software applicable beyond one project; indirect costs allocated between projects; or third-party R&D with intangible value recorded as an asset.

R&D Considerations

Before diving into R&D, consider objectives and outcomes—whether to innovate for unmet needs or improve existing products, allowing flexibility for changes. Timing is crucial, as R&D takes time to assess markets and refine offerings. Costs are high, especially for new products versus updates. Risks are inherent, with no guarantees of ROI if the product fails.

Research and Development vs. Applied Research

Basic research seeks fuller understanding of fundamental concepts without specific applications, providing the basis for R&D. Applied research targets knowledge for goals like new products or processes, being more detailed, time-consuming, and costly.

R&D Tax Credits

The IRS provides R&D tax credits to encourage innovation and cut tax liability, covering spends like product development, process improvement, and software creation. Enacted under Section 41, it offers dollar-for-dollar reductions, expanded by the 2015 PATH Act for more businesses, especially small-to-midsize ones.

To claim, document expenses and file IRS Form 6765; credits range from 6% to 8% of qualifying costs, offsetting income taxes, with up to $500,000 against payroll taxes by 2025.

Example of R&D

Take Apple Inc., one of the most innovative companies today. In 2023, they spent $29.915 billion on R&D, which was 8% of their net sales and exceeded their selling, general, and administrative costs of $24.932 billion. The spending grew year-over-year, mainly from headcount increases, though details on materials and patents from prior years aren't specified.

Frequently Asked Questions on R&D

What is research and development? It's the systematic process of investigating, experimenting, and innovating to create new products, processes, or technologies, aiming to achieve objectives and bring items to market.

What types of activities are in R&D? They focus on innovating new products or services to keep a company competitive, advancing its product line on a longer-term horizon without immediate returns, potentially leading to patents or breakthroughs.

Why is R&D important? It helps companies stay competitive amid rapid tech changes, creating hard-to-replicate products, improving productivity, increasing margins, and anticipating customer needs.

The Bottom Line

Companies have various ways to advance, and R&D is one method to differentiate from competitors, unlocking innovation and sales potential. It has drawbacks like high costs and time, but the rewards can be substantial.