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Write an invoice for Research and Development

How much should a company spend on R&D? What is the spending level on research and development at world class companies? How do R&D expenses vary across industries? Very valid and interesting questions, as research and development spending is often seen as an important (expense) investment in the future. Let’s take the 30 companies in the Dow Jones Industrial Average as a benchmark, and review their R&D spending levels in 2017. In order to provide meaningful comparisons, let’s first take the companies in banking, financial services and insurance out of our sample. We can also take out companies in the retail sector, as well as those in food and beverages. We now have 21 companies left. Take a good look at the logos of these companies, as we have a polling question coming up. Which of these companies has the highest R&D spending as % of revenue in 2017? Is it semiconductor company Intel, pharmaceutical company Merck, software company Microsoft, or pharmaceutical company Pfizer? When you are logged in to YouTube and are watching this video from a computer, then please click the voting card on the top right to submit your vote. Which of these companies has the highest R&D spending as % of revenue in 2017? These four companies are the top 4 in R&D spending % in the sample of the Dow Jones Industrial Average. One question that I am expecting to get from some of the viewers is: where is Apple? Well, even though Apple is in the top 3 of spenders in absolute terms in our sample ($11.6 billion is a lot of money!), it is not among the top spenders in relative terms as you compare it to Apple’s revenue which is a stunning $229 billion. Which of these companies has the highest R&D spending as % of revenue in 2017? Pharmaceutical company Merck, at 25% of revenue. Semiconductor company Intel in second place with R&D spending at 21% of revenue, and a shared third place for Microsoft and Pfizer, both with R&D spending at 15% of revenue. Here is the data for the 15 companies out of the Dow Jones 30 that have R&D spending of more than 1% of revenue: 3M 6%, Apple 5%, Boeing 3%, Caterpillar 4%, Cisco 13%, DowDuPont 3%, GE 4%, IBM 7%, Intel 21%, Johnson&Johnson 14%, Merck 25%, Microsoft 15%, Pfizer 15%, Procter&Gamble 3%, United Technologies 4%. Clearly, pharmaceutical and computer/software related companies are at the higher end of the range. How important is the metric of R&D expense as percentage of revenue? What are its limitations? First of all, there is not a linear relationship between R&D spending and benefits, results depend on how much you spend, what you spend it on, and a mix between skill and luck. Companies could also grow through acquisition, buy a company that has progressed to a certain stage of development on its own, which for the acquiring company is mostly a balance sheet transaction involving intangible assets and goodwill. Different industries have different product development cycles: R&D spending today could lead to incremental revenue and margin next year, or five years from now, or ten years from now, or twenty years from now, if at all! Absolute $ versus relative % spend: as we saw with Apple, they spend a significant amount of money on R&D ($11.6 billion), but due to their high revenue, the percentage works out to be relatively small. Companies in the embryonic or growth stage of their development may have the opposite: a very high R&D expense % due to relatively low revenue (in the denominator). Innovation and business improvement in general can occur outside R&D. Lastly, there is R&D OpEx (expenses), and there is R&D CapEx (capital investments). R&D expense as percentage of revenue does not capture both. Hopefully this puts the discussion in perspective. R&D as percentage of revenue is an interesting metric, but like so many other metrics, it only tells part of the story! Thank you for watching! If you enjoyed this R&D benchmarking discussion, then please give it a thumbs up! On this end screen, there are a few suggestions of videos you can watch next. Please subscribe to the Finance Storyteller YouTube channel! Thank you.