Innovative Strategies for Effective R&D Budgeting

Tobias Gutmann - a professor at EBS Business School and Head of the Siemens Product Innovation Lab, and Oliver Hirschfelder - a strategy and sustainability consultant at Siemens Energy, took on the question of how companies can make decisions about what they want to invest in versus what they can afford to spend, in their recent Innov8rs Learning Labs session.

As Tobias and Oliver say, R&D budgeting is not merely about allocating funds to different projects. It's a nuanced process that involves balancing an organization’s aspirations for groundbreaking innovations with the practicalities of the bottom line.

Rethinking R&D Budgeting

There’s no denying R&D budgeting can be a bit of a rollercoaster, as companies navigate the uncertain outcomes, costs and timelines associated with transforming their ambitious ideas into market-changing innovations.

It’s a classic case of the innovation dilemma: balancing the need for innovation with the limitations of available resources. In other words, weighing the anticipation of future gains carefully against present investments.

The dynamic nature of R&D, coupled with rapid technological advancements and shifting market demands, adds another layer of complexity to the budgeting process. Furthermore, the allocation of R&D funds involves navigating the intricate interplay between different types of innovation, each requiring different investment strategies.

You might have lots of dreams as a private person, but you’ve also got limited resources. It's the same for companies; there are a lot of dreams for R&D but limited resources such as money and people.

At the same time, it’s also true that just spending more money on R&D won’t necessarily mean your company is going to be more innovative.

Traditionally, R&D budgeting has been driven by historical data and centralized decision-making, as part of traditional, top-down budgeting approaches. However, some companies are doing things differently.

Following its carve-out from Siemens, for example, Siemens Energy faced the challenge of determining its R&D budget independently. This transition involved a reevaluation of budgeting processes for the new organizational context. It’s a task that’s typically both strategic - aligning R&D investments with corporate goals and market opportunities - and cultural, as the organization embraces more agile and responsive budgeting practices.

Strategies for Effective R&D Budgeting

In this process, Siemens Energy explored various budgeting strategies, including R&D intensity, peer benchmarking, and aligning the budget with company capabilities and innovation ambitions.

There are a five key ways of approaching your R&D budget:

1. R&D intensity: this metric assesses R&D expenditure against sales, so it's simple and easy to use. Its challenges lie in the fact that accepted rates of R&D intensity vary from industry to industry, and it’s also influenced by changes in sales. When using this metric companies should establish a floor and a cap for R&D spending, but allow for adjustments within these limits based on strategic needs and financial capabilities.

2. Peer benchmarking: comparing R&D efforts against those of competitors enables organizations to identify best practices and areas of improvement, and to easily position themselves within the market. If following this approach, organizations still need to decide what kind of benchmarking metrics they’ll use (for example absolute vs relative spending), and whether or not they’ll assess non-financial metrics too such as innovation outcomes. Peer benchmarking also requires available, accurate data and for comparisons to be made with similar companies only.

3. Company capability and ambition: it’s crucial for companies to align their R&D budgeting with their ambitions and capabilities around innovation. This involves carrying out a thorough assessment of their position as a market leader or follower, their innovation goals, and the resources they have available for R&D activities.

4. Resource-based budgeting: This approach focuses on available resources, both financial and human, and their alignment with R&D projects. It involves a critical evaluation of the skills, competencies, and financial resources at the company’s disposal and the strategic allocation of these assets to projects with the highest potential for success and to areas of highest impact.

5. Commitment vs Wish List: This approach considers everything a company would like to achieve in an ideal world (its dreams), set against the practical constraints of budgeting (its commitment). This is about managing expectations, and prioritizing R&D projects based on their strategic importance, potential for innovation, and alignment with long-term goals.

“R&D budgeting is not a mere allocation of funds, but the careful nurturing of a seed. With the right strategies, that seed can grow into a tree that bears fruit year after year.”

The Critical Role of Dialogue and a Shared Language

These strategies were not applied in isolation but rather as part of a comprehensive budgeting framework that considered the nuances of Siemens Energy's operational environment and strategic direction. The company took this holistic approach in order to optimize its R&D spending, and focus on projects with the highest potential for innovation and business impact.

A key takeaway from Siemens Energy's experience is the critical role of dialogue in effective R&D budgeting.It’s proven critical to engage a broad range of stakeholders in the budgeting process, from R&D managers and corporate strategists to financial officers.

This inclusive approach fosters a shared understanding of strategic priorities and enables a more nuanced allocation of R&D resources within the organization. It also helps in navigating the complexities and uncertainties inherent in innovation projects, allowing Siemens Energy to make informed decisions about where to invest its R&D funds.

Effective R&D budgeting also requires a shared language within the organization around innovation. Tobias and Oliver advocate for the use of frameworks, such as a modified Ansoff matrix, to help companies articulate their innovation goals, categorize innovation efforts and align their R&D budgets with their strategic priorities.