16/09/2018 How-to Benefit from R&D, Innovation Article | Inc.

com

How-to Benefit from R&D

By Inc. Staff

Small businesses may see as much as a three percent increase in

market value for every 10 percent hike in investment in research and
development (R&D), according to a March 2009 study sponsored by
the U.S. Small Business Administration (SBA). The study found that
the relationship between R&D and business growth and innovation
can vary according to industry. Industries such as industrial
machinery, trucks and tractors, computing equipment, and
mechanical goods manufacturing were the most likely to benefit from
increased R&D spending.

"The industries that are typically associated with rapid technological

improvements benefit from greater R&D expenditures. Industries with
more mature activity or that are service-oriented may not reap as
much benefit from greater R&D expenditures," say the study's
authors, C.J. Isom and David R. Jarczyk, of the Ceteris Inc., an
independent economic consulting group.

Many in the public think of R&D as something that only big

businesses undertake, plowing billions into 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
businesses and entrepreneurs.

The pages below will outline the role that R&D can play in small
business, how to select and terminate R&D projects, and tax
advantages of an R&D strategy.

Objectives of R&D in a Small Business

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Small businesses are instrumental in fueling the U.S. economy, as

they employ half of all private sector employees and generate more
than half of the nation's non-farm gross domestic product, according
to the SBA. Small firms have also been a harbinger of technological
change. They are awarded 13 to 14 more times more patents per
employee than large firms, the SBA notes.

Just look behind some of the nation's most profitable industries today
and you often find an entrepreneur or a small business. 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.

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.

Types of R&D
The National Science Foundation (NSF) defines three types of R&D:
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Basic Research. 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. 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. 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 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.

Selecting R&D Projects

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

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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.

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:

1. Maximize the long-term return on investment;

2. Make optimum use of the available human and physical resources;

3. Maintain a balanced R&D portfolio and control risk;

4. 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.

Evaluating 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

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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.

Managing 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.

When to Terminate 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:

1. 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;

2. Unforeseen technical obstacles are encountered and the laboratory

does not have the resources to overcome them; or

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3. 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 of R&D

In 2008, Congress extended the R&D tax credit for corporations,
which allows businesses to deduct R&D expenses from income. The
tax credit was initiated in 1981, but expired in 2004 and has had to
be renewed every few years. It expired again in 2007, but in October
2008, Congress renewed the tax credit for two years as part of the
U.S. mortgage industry bailout. While the tax credit has sometimes
come under criticism by those who believe that government
subsidies of corporate development are out of place, it's backed by a
wide-range of industry groups representing such sectors as
technology, manufacturing, chemical, and pharmaceuticals.

BIBLIOGRAPHY
Bock, Peter. Getting it Right: R&D Methods for Science and
Engineering. Academic Press, 2001.

Dankbaar, Ben. Innovation Management in the Knowledge Economy.

Imperial College Press, 2003.

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Ison, C.J., and David R, Jarczyk. "Innovation in Small Businesses:

Drivers of Change and Value Use." Sponsored by the U.S. Small
Business Administration. March
2009. http://www.sba.gov/advo/research/rs342tot.pdf

Khurana, Anil. "Strategies for Global R&D: A study of 31 companies

reveals different models and approaches to the conduct of low-cost
R&D around the world." Research-Technology Management. March-
April 2006.

Le Corre, Armelle, and Gerald Mischke. Innovation Game: A New

Approach to Innovation Management and R&D. Springer, 2005.

Miller, William L. "Innovation Rules!" Research-Technology

Management. March-April 2006.

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