What Is Research and Development (R&D)?

What Is Research and Development (R&D)?

Research and development (R&D) is the series of activities that companies undertake to innovate. It's often the first stage in the development process that results in market research, product development, and product testing.

How Research and Development (R&D) Works

The concept of research and development is widely linked to innovation in both the corporate and government sectors. R&D allows a company to stay ahead of its competition. A company might not survive on its own and may have to rely on other ways to innovate without an R&D program such as engaging in mergers and acquisitions (M&A) or partnerships. Companies can design new products and improve their existing offerings through R&D.

R&D is distinct from most operational activities performed by a corporation. The research and/or development is typically not performed with the expectation of immediate profit. It's instead expected to contribute to the long-term profitability of a company. R&D may often allow companies to secure intellectual property including patents, copyrights, and trademarks as discoveries are made and products are created.

Companies that set up and employ departments that are dedicated entirely to R&D commit substantial capital to the effort. They must estimate the risk-adjusted return on their R&D expenditures which inevitably involves risk of capital. There's no immediate payoff and the return on investment (ROI) is uncertain. The level of capital risk increases as more money is invested in R&D. Other companies may choose to outsource their R&D for a variety of reasons including size and cost.

Companies across all sectors and industries undergo R&D activities. Corporations experience growth through these improvements and the development of new goods and services. Pharmaceuticals, semiconductors, and software/technology companies tend to spend the most on R&D. R&D is known as research and technical or technological development in Europe.

Types of Research and Development (R&D)

Several different types of R&D exist in the corporate world and within government. The type used depends entirely on the entity undertaking it and the results can differ.

Basic Research

There are business incubators and accelerators where corporations invest in startups and provide funding assistance and guidance to entrepreneurs. The hope is that innovations will result that they can use to their benefit.

M&As and partnerships are also forms of R&D as companies join forces to take advantage of other companies' institutional knowledge and talent.

Applied Research

A department staffed primarily by engineers who develop new products is one R&D model. This is a task that typically involves extensive research. There's no specific goal or application in mind with this model. The research is done for the sake of research instead.

Development Research

This model involves a department composed of industrial scientists or researchers, all of whom are tasked with applied research in technical, scientific, or industrial fields. This model facilitates the development of future products or the improvement of current products and/or operating procedures.

Advantages and Disadvantages of R&D

Advantages

Research and development offers several key benefits. It facilitates innovation, allowing companies to improve existing products and services or letting them develop new ones to bring to the market.

R&D also is a key component of innovation so it requires a greater degree of skill from the employees who take part. This allows companies to expand their talent pool which often comes with special skill sets.

The advantages go beyond corporations. Consumers stand to benefit from R&D because it gives them better high-quality products and services as well as a wider range of options. Corporations can therefore rely on consumers to remain loyal to their brands. It also helps drive productivity and economic growth.

Disadvantages

One of the major drawbacks to R&D is its cost. It requires a significant investment of cash upfront. This can include setting up a separate R&D department, hiring talent, and product and service testing.

Innovation doesn't happen overnight so there's also a time factor to consider. It takes a lot of time to bring products and services to market from conception to production to delivery. Companies stand the risk of being at the mercy of changing market trends because it takes time to go from concept to product. What they thought may be a great seller at one time may reach the market too late and not fly off the shelves when it's ready.

R&D Accounting

R&D may be beneficial to a company's bottom line but it's considered an expense. Companies spend substantial amounts on research and trying to develop new products and services. These expenses are often reported for accounting purposes on the income statement. They don't carry long-term value.

R&D costs are capitalized and reported on the balance sheet in certain situations:

• Materials, fixed assets, or other assets have alternative future uses with an estimable value and useful life.
• Software can be converted or applied elsewhere in the company to have a useful life beyond a specific single R&D project.
• Indirect costs or overhead expenses are allocated between projects.
• R&D purchased from a third party is accompanied by intangible value. This intangible asset may be recorded as a separate balance sheet asset.

R&D Considerations

Companies and governments should consider some of the key factors associated with R&D before taking on the task of research and development. Some of the most notable considerations include:

• Objectives and Outcome: One of the most important factors to consider is the intended goals of the R&D project. Is it to innovate and fill a need for certain products that aren't being sold or is it to make improvements on existing ones? It's always important to note that there should be some flexibility as things can change over time.
• Timing: R&D requires a lot of time. This involves reviewing the market to see where there may be a lack of certain products and services or finding ways to improve on those that are already on the shelves.
• Cost: R&D costs a great deal of money, especially when it comes to upfront costs. There may be higher costs associated with the conception and production of new products rather than updating existing ones.
• Risks: R&D doesn't come with any guarantees despite the time and money that goes into it. Companies and governments might sacrifice their ROI if the end product isn't successful.

Research and Development vs. Applied Research

Basic research is aimed at a fuller, more complete understanding of the fundamental aspects of a concept or phenomenon. This understanding is generally the first step in R&D. These activities provide a basis of information without directed applications toward products, policies, or operational processes.

Applied research entails the activities that are used to gain knowledge with a specific goal in mind. These activities may be to determine and develop new products, policies, or operational processes. Basic research is time-consuming but applied research is painstaking and more costly because of its detailed and complex nature.

R&D Tax Credits

The IRS offers an R&D tax credit to encourage innovation and significantly reduce tax liability. The credit calls for specific types of spend such as product development, process improvement, and software creation.

This credit was enacted under Section 41 of the Internal Revenue Code and encourages innovation by providing a dollar-for-dollar reduction in tax obligations. The eligibility criteria were expanded by the Protecting Americans from Tax Hikes (PATH) Act of 2015. They encompass a broader spectrum of businesses. The credit tends to benefit small-to-midsize enterprises.

Businesses must document their qualifying expenses and complete IRS Form 6765 (Credit for Increasing Research Activities) to claim R&D expenses. The credit typically ranges from 6% to 8% of annual qualifying expenses. It offers businesses a direct offset against federal income tax liabilities. Businesses also can claim up to 500,000ドル against their payroll taxes as of 2025.

Example of R&D

One of the more innovative companies of this millennium is Apple Inc. It had this to say about its research and development spending as part of its annual reporting:

Apple reported having spent 29ドル.915 billion in 2023. This was 8% of their annual total net sales. Apple's R&D spending was reported to be higher than the company's selling, general and administrative costs of 24ドル.932 billion in that year.

The company didn't go into length about what exactly the R&D spend was for. The company's year-over-year growth was "driven primarily by increases in headcount-related expenses," according to the notes. This doesn't explain the underlying basis carried from prior years for materials and patents.

The Bottom Line

Companies can do many things to advance in their industries and the overall market. Research and development is just one way they can set themselves apart from their competition. It opens up the potential for innovation and increasing sales but it does come with some drawbacks. The most obvious are the financial cost and the time it takes to innovate.