4 Strategic Approaches for Finance in R&D Management (Cost Savings 3 of 3)

During an interview for an FP&A role at a biotech company several years ago, the head of R&D asked how I would evaluate their sizable annual R&D investment. I suggested project-level discounted cash flows (DCFs), but my answer was impractical and incomplete.

R&D is often a challenging area for finance professionals, requiring a delicate balance of strategic alignment, cost control, and value creation. While project-based DCFs would be ideal in a perfect world, that’s not the right starting point for most companies.

Here are four initial approaches to think about R&D as a finance professional:

𝟭. 𝗖𝗮𝗹𝗰𝘂𝗹𝗮𝘁𝗲 𝗥&𝗗 𝗮𝘀 𝗮 % 𝗼𝗳 𝗦𝗮𝗹𝗲𝘀
While this may be obvious, R&D as a % of sales is a good starting point. While this metric alone will not provide the full picture, it establishes a baseline for comparison:

• Is R&D as % of sales increasing or decreasing year-over-year? Why?
• How does R&D as % of sales compare with competitors? Can you articulate why your company is higher or lower?

If the narrative around the trends does not make sense, there may be potential to better understand R&D effectiveness or even rationalize.

𝟮. 𝗜𝘀𝗼𝗹𝗮𝘁𝗲 𝗣𝗿𝗼𝗱𝘂𝗰𝘁 𝗗𝗲𝘃𝗲𝗹𝗼𝗽𝗺𝗲𝗻𝘁 𝘄𝗶𝘁𝗵𝗶𝗻 𝗥&𝗗
Once you’ve established a baseline using R&D as a % of sales, the next step is to unpack what’s included. Most people associate R&D with developing products for customers, but it often includes additional expenditures, such as:

• Product managers supporting sales teams in pitching new business (S&M)
• Engineers working on internal tools for employees (COGS or G&A)

The goal is to understand how much is spent on product development, so that you can start to think about the return on that investment. However, it’s useful to ask about the ROI on the non-product spend as well or analyze as part of another function.

𝟯. 𝗕𝘂𝗰𝗸𝗲𝘁 𝗥&𝗗 𝗦𝗽𝗲𝗻𝗱 𝗶𝗻𝘁𝗼 𝗖𝗮𝘁𝗲𝗴𝗼𝗿𝗶𝗲𝘀
Once you’ve isolated product development, bucket spend into different categories such as:

• 𝗘𝘅𝗶𝘀𝘁𝗶𝗻𝗴 𝗽𝗿𝗼𝗱𝘂𝗰𝘁𝘀: Enhancing features, fixing bugs, etc.
• 𝗣𝗿𝗼𝗱𝘂𝗰𝘁 𝗲𝘅𝗽𝗮𝗻𝘀𝗶𝗼𝗻𝘀 𝗼𝗿 𝗮𝗱𝗷𝗮𝗰𝗲𝗻𝘁 𝗼𝗽𝗽𝗼𝗿𝘁𝘂𝗻𝗶𝘁𝗶𝗲𝘀
• 𝗠𝗼𝗼𝗻𝘀𝗵𝗼𝘁𝘀: High-risk, high-reward bets

Google popularized the above categories and sought a balance of 70/20/10, but the buckets and allocations will be different for every company. The goal is to clarify investments, seek alignment and potentially reduce lower value spend.

𝟰. 𝗦𝘁𝗮𝗿𝘁 𝘁𝗼 𝗠𝗲𝗮𝘀𝘂𝗿𝗲 𝗥&𝗗 𝗘𝗳𝗳𝗲𝗰𝘁𝗶𝘃𝗲𝗻𝗲𝘀𝘀
Although challenging, it’s important to start to look at R&D effectiveness. A few metrics to start:

• 𝗡𝗲𝘄 𝗣𝗿𝗼𝗱𝘂𝗰𝘁 𝗩𝗶𝘁𝗮𝗹𝗶𝘁𝘆 𝗜𝗻𝗱𝗲𝘅: Revenue from products launched in the past 2-5 years as a percentage of total revenue
• 𝗥&𝗗 𝗥𝗢𝗜: Revenue, or profit, from new products over associated R&D spend
• 𝗥&𝗗 𝗜𝗻𝗱𝗲𝘅: Y/Y organic revenue growth over R&D spending as a percentage of revenues during the first year