Driving Research & Development in a Downturn

In challenging times, the natural reaction of many businesses is to minimise expenditure in an attempt to ride out the storm. Research and development investment may be seen as an unjustifiable expense. However, studies of past recessions have shown that companies that maintain, or even increase, research and development levels during downturns outperform others when market conditions improve.

In a 2003 study of nearly 1000 businesses from around the world and across a wide range of industries, Roberts found that investments in marketing, product development and customer-perceived quality were “good costs” that should be increased during market recessions in order to maximise growth and market share upon recovery.¹ As shown below, firms that increased spending on marketing and product development increased their ROCE (return on capital employed) and market share over the recovery, as did firms whose product quality was seen to have increased.

Product Development Spend

Customer-Perceived Quality

Others have found that research and development spending increases growth in times of market stability, and that this effect is magnified during recessions.² In the period from 2004 to 2009—spanning the 2008-2009 global financial crisis—Norwegian firms with low R&D spending grew by 29% on average, while firms with high R&D spending grew by 103%. This effect was most pronounced during the crisis – the high R&D firms grew by over 10% in this period, while other firms contracted.

Investments in innovation and product development may not pay immediate dividends, with benefits typically not accruing until after the worst of the recession has passed. This illustrates the importance of long-term strategic thinking over knee-jerk reaction. The passing of the baton from the US to Japan in the field of semiconductor manufacture illustrates this point.

In the early 1970s, US suppliers of semiconductor devices outsold their Japanese counterparts by more than two to one. However, by the end of the 1980s they had fallen behind the Japanese. Writing for the MIT Sloan Management Review, Ghemawat notes that in the aftermath of the 1974-1975 recession, US companies eased up on investment, while Japanese companies held firm.³ In such an innovation-driven and rapidly changing industry, this brief pause was enough to fall behind. To take a specific case, US manufacturers failed to invest in production capacity for 16 kilobyte dynamic random access memory (DRAM) chips during the downturn, which left them unable to meet demand from IBM when the upturn came. This forced IBM to turn to Japanese suppliers, who by 1979 had captured 43% of the US market for 16 k DRAM chips.

Of course, businesses operate under financial constraints and any money spent on research and development is money that is unavailable to spend on other things. The right level of investment will be a balance between the competing requirements of retaining sufficient resources to see out the difficult times and setting the stage to benefit once market conditions improve. One way that this balancing act can be made easier is for the Government to subsidise R&D costs, which has been shown to increase overall R&D expenditure.⁴ Research and development during difficult times benefits a society as a whole, as does a thriving and competitive market, making it an ideal use of public funds.⁵ The Singaporean Government has recognised the importance of this and recently increased funding levels available under its Enterprise Development Grant up to 90% for companies severely affected by COVID-19. In Australia, the ATO is allowing IP assets to be immediately deducted against taxable income, rather than depreciated, under an expanded Instant Asset Write Off scheme. In New Zealand, a number of funding sources and tax credits are available. In addition, Callaghan Innovation has indicated increased flexibility in relation to R&D grants due to the impact of COVID-19, and we hope new programmes will be forthcoming soon.

The message from history is clear: money spent on research and development during a recession has been shown to have general and specific economic benefits. A positive strategy including an active research and development programme can have many other positive effects at the company level. It allows the company to retain quality staff by giving them satisfying and engaging work when they might otherwise be underutilised, retain existing clients and gain new ones with superior products, and be ready to capitalise on new products and skilled staff during the recovery. Where companies are not in a position to invest in research and development, there is a role for Government to provide subsidies to promote public well-being and economic growth.

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¹ Roberts, “What strategic investments should you make during a recession to gain competitive advantage in the recovery?”, Strategy & Leadership, Vol. 31 Iss 4 pp. 31–39.

² Lome et al, “The effect of R&D on performance: Do R&D-intensive firms handle a financial crisis better?”, Journal of High Technology Management Research.

³ Ghemawat, “The Risk of Not Investing in a Recession”, MIT Sloan Management Review Spring 2009, Vol 50 No. 3.

⁴ Hud et al, “The Impact of R&D Subsidies During the Crisis”, Centre for European Economic Research Discussion Paper No. 14-024.

⁵ Barlevy, “On the Cyclicality of Research and Development”, Economic Research, Federal Reserve Bank of Chicago.