Planning Your Firm's R&D Investment

OVERVIEW:Setting the level of R&D spending is one of the most important strategic decisions made by top management of technology-based firms. The delay between the commitment to expenditure for R&D and the realization of consequent revenues and profits complicates the analysis of R&D budgets. Common budgeting practices often fail to reflect the likely revenue consequences of incremental changes in aggregate spending for R&D. The authors suggest that this “missing dimension” should be incorporated in analysis of budgeting choices. They propose a framework for R&D budgeting and incorporate a measure of the missing dimension, named “R&D Gain,” defined as the ratio of the lifetime revenue of products launched in a particular year to the total investment needed to develop those products. This Gain can be estimated from historical data on revenues and R&D expenditures, and used to project future revenues.