Research & Development expenses as a percentage of revenue

Companies usually spend a lot on their research and development activities. You may have an in-house R&D team whose sole aim is to innovate and introduce cutting-edge products or services. Start-ups need to invest only in quality talent that can effectively conduct market analysis and come up with a sought out product or service.   

Building out, maintaining and upgrading a SaaS company's technology stack is a big chunk of the work done at a SaaS business. The costs associated with these activities are considered Research and Development (R&D) expenses. It's common for SaaS businesses to look closely at R&D expenses as a percentage of revenue to understand their investment compared to other business areas. This metric also allows SaaS firms to benchmark their R&D expenses against peers and set targets to keep their costs under control. 

What are Research and Development expenses as a percentage of revenue? 

Research and development expenses as a percentage of revenue simply indicates how much you spend on research and development in comparison to the revenues you collect. You need to study this metric so that you can make comparisons with your competitors. To make a business successful and ensure that you are keeping up with your competitors, you must spend carefully on research and development activities. This metric allows you to benchmark your R&D expenses.  

This metric shows the percentage of revenue spent on Research & Development during a given time period. The metric is a useful measure of how much is being spent on product-related activities at SaaS organisations. SaaS businesses are bound to lose their revenues to their competitors if they don’t innovate to solve their customers' real problems.

Now the real questions are how much a company should spend on research and development and how to optimise these costs. And how to determine R&D expenses.  

What to include in Research & Development expenses? 

In simple words, Research and development expenses include all the costs spent on research and development activities. The expenses related to acquiring Intellectual Property (IP) are also included in R&D expenses. For example, you would need to file a patent or copyright application. There would certainly be some registration costs.  

To be more specific, R&D is one of the four fundamental expense categories for a SaaS company. The other three are Cost of Goods Sold, Sales and Marketing, and General and Administrative. 

Accounts that are typically mapped to the R&D expense category are: 

• Engineering salaries
• Specialist software used by product and engineering
• Customer research 
• AWS bills

For R&D accounting, we include the salaries of all the engineers and designers who work on research and development. They must have the required resources to carry out their research. The required resources are usually software tools, cloud infrastructure, and others. We account for all the costs spent on acquiring resources that researchers need. And at last, we account for the costs involved in getting patents and copyrights.  

Research and development expenses are all-time high when you work on launching a new product/service. You need to create prototypes or produce a Minimally Viable Product (MVP). MVP is an initial phase of a product that is consumable by customers. It then builds up on customers’ feedback. R&D expenses narrow down for an already put-in-place product or feature.  However, companies still need to spend on R&D so that they stay in the market and entertain discretionary customers.

R&D expenses as a percentage of revenue tend to decrease as the product becomes more mature. Later-stage companies with an ARR of more than $100 million spend 35% of revenue on R&D. However, for early-stage, VC-backed startups with an ARR of less than $10 million, the average is 95%. (Source: Bessemer Venture Partners)

How to calculate Research & Development expenses as a percentage of revenue?

It is calculated by dividing Research & Development expenses by the total revenue earned by the company. The number is then multiplied by 100. 

R&D expenses as a percentage of revenue =     (Research & Development Expenses  /Total Revenue) * 100

This metric allows you to compare your company or SaaS business with other companies out there. You would be able to analyse how much you are spending on research and development activities in comparison to the revenues you collect. For companies that thrive on technologies, it is extremely important for them to optimize research and development expenses. 

What is good spending on R&D?

You will soon notice that R&D expenses depend on the industry you are operating in.  Companies that have a dependable consumer base would not need large amounts to spend on research and development activities. However, there are certain industries that are always in need of innovation and patents. 

For example, pharmaceutical companies spend a huge amount of money on their research and development. The aerospace and defense industry also finds itself earmarking a big chunk of money for research and development. SaaS companies invests a lot of money to gain new knowledge on how they can make improvements to existing products.

According to a study in 2020, SaaS companies spend 23 percent of their revenue on research and development. The median R&D spending by SaaS companies is $21 million. However, smaller businesses and startups, unsurprisingly, spend more on research and development. We can also look into absolute terms that how much companies spend on research and development activities. 

Alphabet inc. spent $31.56B on research and development in the year 2021. The revenue they collected in the same year was $257.637B. Hence, the research and development expenses as a percentage of revenue were 12.429%. Also you cannot deny that one of the factors for Alphabet's growth is their spending on R&D.

Apple spends 5%, Cisco 13%, IBM 7%, and Intel 21% on their research and development. However, Merk, a pharmaceutical company, happens to be a business that spends the highest percentage of revenue on R&D expenses. 

Optimising Research & Development expenses for more profitability

Want to benchmark your Research & Development expenses as a percentage of revenue? 

We are currently offering a free template to help SaaS organisations benchmark their valuation, LTV, Net Revenue Retention, MRR, Net Revenue Retention Rate, revenues and expenses against 200 VC-funded private companies in the Bessemer Venture Partners portfolio.

Conclusion

Research and development expenses as a percentage of revenue is a useful metric that enables you to optimize your research and development costs. Anyway, you need to spend on research and development to introduce a cutting-edge feature in the market or to innovate your products and features and maintain and improve customer satisfaction.

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