The quality of R&D spending

[Aurel]

Hey Guys,

 

I am looking for good literature how R&D spending can impact the future performance of a company. Generally, or by different industries.

 

Most of the stuff I am finding, is about macro-based spending and their impact. I am looking for any comments, papers, or studies on a micro-based spending and the "quality" of this.

 

Thanks,

Aurel

 

[ratiman]

I don't know much about this but I found this article, analyzing Amazon's R&D back in 2012, interesting.

 

https://seekingalpha.com/article/603331-making-sense-of-amazons-market-value

[SharperDingaan]

The reality is that at the 'micro' level it doesn't happen ;)

 

It is far smarter to invest the R&D as incremental working capital in more efficient P&E. In the brewing world, this is shared brew-level collaborations with other brewers, using contracted facilities. 2+ brewers sharing the incremental cost of brewing a batch at 3-4x 'normal' volume, to lower unit costs by 35%+. Licensing your brew to a local foreign brewer, rather than making locally and shipping it.

 

Long-term is 4 years, the length of the strategic plan. For most, the focus is on operating leverage at the expense of financial, where this is R&D it's essentially self-funded small-batch experimentation. Continually prove the market as you move along, or drop it.

 

SD

 

[Aurel]

The reality is that at the 'micro' level it doesn't happen ;)

 

It is far smarter to invest the R&D as incremental working capital in more efficient P&E. In the brewing world, this is shared brew-level collaborations with other brewers, using contracted facilities. 2+ brewers sharing the incremental cost of brewing a batch at 3-4x 'normal' volume, to lower unit costs by 35%+. Licensing your brew to a local foreign brewer, rather than making locally and shipping it.

 

Long-term is 4 years, the length of the strategic plan. For most, the focus is on operating leverage at the expense of financial, where this is R&D it's essentially self-funded small-batch experimentation. Continually prove the market as you move along, or drop it.

 

SD

 

Thanks SD, thats exactly the stuff i wanna hear about. I just ask myself, lets say in healthcare, how much of the R&D-expenses really filling the pipeline for new products. Or how to anlayse and value R&D-costs better.

 

And thanks for the link ratiman! Good post.

 

FYI: Percentage of global research and development spending in 2018, by industry:

[beerbaron]

Well, I'm a Director of R&D and let me tell you what you are asking is almost impossible to measure. First, R&D can be applied to anything, to use a baseball analogy, singles, doubles or home-run. Who wins the game depends on skill and luck but you can't measure the skill in a short timeframe, home-run R&D projects takes years to materialize into sales.

 

Furthermore there are companies that are R&D and patent heavy (IBM for example), but in reality their patent portfolio is so broad that they can't seem to be able to enforce their rights. To enforce your right you must have:

1- A rock solid patent. This is rarer than it seems.

2- People that find the infringers. If you are not focused it's likely going to be under your radar. If it's very technical it will very likely go below your radar.

3- A profitable proposition to enforce your patent rights.

 

So how exactly do you spot good R&D spenders? Well the first I'd look at is consistency in market success (singles). If there is a lot of singles that means the product group identifies opportunities for the R&D team to work on. That also means the product teams know when a homerun is feasible.

 

If you can, you should try to identify an all star R&D head. Usually that all star will not be the one solving problems but will have enough leadership to steer the product and marketing group away from technical pitfalls.

 

I' recommend that you read Skunk Works, it's about the engineer that led the development of the first stealth plane. I'd call that a home-run... but it's boss (who was very competent and a legend) told him to drop it. It goes to show that luck and vision plays a role as much as skill.

 

BTW, I take R&D spending at face value when reading annual report, if it's within the industry norm that is fine.

 

Thanks

BeerBaron

 

 

[SharperDingaan]

The reality is that at the 'micro' level it doesn't happen ;)

 

It is far smarter to invest the R&D as incremental working capital in more efficient P&E. In the brewing world, this is shared brew-level collaborations with other brewers, using contracted facilities. 2+ brewers sharing the incremental cost of brewing a batch at 3-4x 'normal' volume, to lower unit costs by 35%+. Licensing your brew to a local foreign brewer, rather than making locally and shipping it.

 

Long-term is 4 years, the length of the strategic plan. For most, the focus is on operating leverage at the expense of financial, where this is R&D it's essentially self-funded small-batch experimentation. Continually prove the market as you move along, or drop it.

 

SD

 

Just to add to this:

 

With big batches, the process and precision is quite different to small batches. Your brew masters are learning from the master brewer in charge, and the topics range from ingredient control through to eventual packing and conditioning. Brewing to profile tolerances of 2-3 ppm, despite the quality of your ingredients, the practical pro's/con's of various bits of kit, etc. That's the R&D.

 

Most craft brewers have subscription based 'growler' clubs, where members can try-out/taste the weird/wonderful first. You're looking for different flavor combinations, intensities, and brew techniques - with each batch being its own market test. Generally, the more outrageous the better, as scaling up results in compromises. The more traditional R&D.

 

All valuable to the overall process, but next to impossible to put a valuation on.

 

SD

 

 

 

[ValueArb]

The reality is that at the 'micro' level it doesn't happen ;)

 

It is far smarter to invest the R&D as incremental working capital in more efficient P&E. In the brewing world, this is shared brew-level collaborations with other brewers, using contracted facilities. 2+ brewers sharing the incremental cost of brewing a batch at 3-4x 'normal' volume, to lower unit costs by 35%+. Licensing your brew to a local foreign brewer, rather than making locally and shipping it.

 

Long-term is 4 years, the length of the strategic plan. For most, the focus is on operating leverage at the expense of financial, where this is R&D it's essentially self-funded small-batch experimentation. Continually prove the market as you move along, or drop it.

 

SD

 

Thanks SD, thats exactly the stuff i wanna hear about. I just ask myself, lets say in healthcare, how much of the R&D-expenses really filling the pipeline for new products. Or how to anlayse and value R&D-costs better.

 

And thanks for the link ratiman! Good post.

 

FYI: Percentage of global research and development spending in 2018, by industry:

 

In 2018 the average Computer/Electronics company spent 22%  on R&D.

 

In 2018, Apple spent 6% on R&D, and historically spent less than 5% and as little as 2%.

[Spekulatius]

I have worked at 3 different companies and got an inside look into a few more and R&D spent isn’t equally applied even within the same industry.

In the industry I work in,a typical R&D spent is in the single digits,  but I did work for a company that had R&D spent of almost 20%. However much of this R&D spent was mostly one off spent to get a certain product ready for a specific customer and in my opinion it really was sort of an Opex spent, because it didn’t really create a lasting benefit for anything but a specific use case that likely was a one off (custom).

 

My take from this is that one should take reported R&D spent with a grain of salt and should be suspect of outliers and see if it created any visible moat in terms of sales growth or higher gross margins. If it doesn’t it either waste of just misclassified.

[Guest cherzeca]

great post above by beer baron.  in my career, I had the opportunity to do DD on five "shhh...this is breakthrough stuff" venture capital potential investments, and guess what...all came to naught. R&D is both necessary and unreliable. there is no guideline to follow. it is all luck as far as I can tell

 

now, having said that, you can find certain companies that seem to have the knack to be able to produce great products (AAPL) or services (AMZN). these companies are worth investing in, not just for their R&D (which is great) but because of their whole process of moving idea to reality.  imo, it is a more holistic concept, which is show me a great company generating great new products/services, not just a great R&D department...3M is another company that comes readily to mind

[Aurel]

This community is pure gold! I really appreciate your comments. It helps a lot!

 

I just ordered Skunk Works.

 

@beerbaron: Ok, that is sounds like a good idea. First take the R&D @ face value and after some DD maybe mark it up or down. Plus have an eye on the industry norm.

 

@Valuearb: That is an interesting fact, too. Never thought or read about that.

 

 

Maybe that is one of the points Buffett likes consumer brands a lot, where you don’t have to think a lot about R&D costs...

 

 

 

 

 

[ValueArb]

This community is pure gold! I really appreciate your comments. It helps a lot!

 

I just ordered Skunk Works.

 

@beerbaron: Ok, that is sounds like a good idea. First take the R&D @ face value and after some DD maybe mark it up or down. Plus have an eye on the industry norm.

 

@Valuearb: That is an interesting fact, too. Never thought or read about that.

 

 

Maybe that is one of the points Buffett likes consumer brands a lot, where you don’t have to think a lot about R&D costs...

 

It's got an enormous revenue base, so that probably helps keep R&D down as a percentage. But also 6% now vs. 2% at a fraction of the sales requires a massive increase in R&D spending, maybe their Titan (car) program and VR?

 

The reason I used Apple is I think its a great example of quality, targeted R&D. Jobs was famous for killing almost all of the existing R&D projects at Apple when he rejoined, too many without hard goals that could produce products within the next half decade. Secondhand, it sounds to me like he was a fan of putting more resources into fewer projects, and carefully selecting those based on real innovative opportunities.

 

One example include the original iPad, which he canned at the product launch meeting when it couldn't meet his high standards. And the iPhone, which he allowed the iPad team to compete against the iPod team to design. He invested a lot into building a strong team to make a tablet computer, when it was early to market he kept that expensive team together merely as a backup plan to the iPod Phone. So spending extra for two competing teams didn't phase him because he believed it was an important market worth a lot of R&D investment. And it turned out the backup plan won, and he threw a thousand engineers at Project Purple to get it done, which had to be over $250M a year.