Financial and market success for any company is determined by a variety of factors, one of which is research and development strategy. In the era of globalization and increasing competition, innovations are one of the key factors allowing the companies to gain and retain market leadership. Moreover, without business evolution and expansion, companies cannot remain in the industry for a long time, even if they are market leaders (David, 2008). Thus, research and development budget is one of key determinants of business success. However, significant R&D investments do not guarantee success, if these investments are used ineffectively (David, 2008). A vivid example of the importance of well thought-out R&D financing is the mobile telecommunications industry, and two its large players, Apple and Nokia. In 2009 and 2010, Nokia’s research and development budget constituted about 10 times more than Apple’s R&D spending. Nevertheless, Apple devices are having immense success, and the demand for them seems to grow every day, and Nokia is struggling and losing market share at the smartphone market, because the company is outpriced by the competitors in all price segments. Thus, it is not the size of R&D budget which is important for the company’s success and growth, but the strategy of development of this budget and the strategy of using this budget (David, 2008). The purpose of this paper is to consider four basic approaches to determining R&D budget, their pros and cons, and to recommend one R&D budget development strategy for a pharmaceutical company.
The goals of research and development activities are to develop new products to gain market leadership, to improve quality of the products or services, reduce costs by improving manufacturing processes, etc. These goals might differ for different companies, regions and industries. It should be noted that there are no ready solutions for determining R&D budget for a particular industry or type of company, and prior to determining the strategy of R&D budgeting, the company should perform an assessment of its R&D goals (Bragg, 2007) and align these goals with the general business direction chosen by the top management.
Overall, R&D costs for introducing a new product or service are comparable with the sum of marketing startup costs and manufacturing expenses (Bragg, 2007). There are four key approaches to R&D budget development which are actively used in the business world (David, 2008):
- financing as many proposals of new projects as it is possible;
- allocating a certain percentage of sales on R&D needs;
- estimating the amount of financing that competitors spend on R&D, and budgeting a similar amount;
- deciding how many successful new products are currently required by the market needs, and performing a backward estimate of the necessary R&D investment.
Before choosing a strategy for R&D budget development, the company should also perform R&D audit, which might include analysis of the following issues (David, 2008): the availability of R&D facilities and adequacy of these facilities, potential of using the services of external R&D firms and costs associated with outside research, qualification of R&D personnel of the company, effectiveness of R&D resource allocation, adequacy of computer systems and management systems, effectiveness of communications between R&D and other company departments, and the competitiveness of existing products. The characteristics of the above-mentioned factors should be used as the bases for choosing a particular strategy for R&D budget development.
The competition in pharmaceutical industry is rather intense, and there is a need to identify new discoveries in this sphere and to utilize them. Basic experimental research might be required for companies operating in this industry (Cooper & Edgett, 2009), and additional R&D activities will be associated with the analysis of functioning mechanisms of the new medicines, and with identification of different components of the medicine. Such issues as safety testing, proof of concept, analysis of delivery mechanisms and ideal doses of the drug might also need significant R&D financing (Cooper & Edgett, 2009).
From business point of view, pharmaceutical industry is characterized by intense competition, short life cycle of the products, high consumer power (and as a result, the changing tastes of the consumers), growing threat of foreign competition and active use of new technologies and discoveries. Thus, the costs of developing new products are rather high, and significant marketing effort is required to make the product popular among customers. Associated costs such as licensing, safety testing and other expenses are also rather high (Bragg, 2007), and it is evident that companies operating in pharmaceutical sphere need to focus on several particular products, which would match current requirements of the market and company’s competencies best of all. Thus, the strategy for R&D budget development for a pharmaceutical company should be the fourth one: the company should decide how many new successful products are currently required, and perform a backward estimate of the required R&D budget.
In addition to this, pharmaceutical companies should consider the possibilities of external research and development (Bragg, 2007); it might be effective to explore partnerships with leading universities, as the universities generate a lot of research level products, and collaboration might be mutually useful. It is possible to purchase licenses for ready medicines or for particular new components; another approach is to hire scientists working with research level products, and invest into their R&D activities (Cooper & Edgett, 2009). The phase of development for new drugs can be handled by the company itself, or shared with the university, depending on the type of the agreements. Thus, companies in pharmaceutical industry should plan their R&D budgets according to the fourth type of R&D development strategy (identification of several new successful products and backward budget estimate), and should also consider external R&D activities, such as collaboration with universities or individual researchers.
Bragg, S.M. (2007). Financial analysis. John Wiley and Sons.
Cooper, R.G. & Edgett, S.J. (2009). Product Innovation and Technology Strategy. Stage-Gate International.
David, F.R. (2008). Strategic Management: Concepts and Cases. Pearson Education.