Research and Development: Advantages And Disadvantages

When people buy, they generally buy those products or services that offer the greatest utility to them, since that is the most effective way of using their money — it maximizes their utility for their limited income. If a product does not increase their total utility, then people will probably not buy it. Which is why there are many new products that were developed that were not successful. Most inventions and innovations are incremental improvements to existing technology. It is very rare that any company will ever develop a great leap in technology.

For a new invention to be successful, the product must offer greater utility for its price. For process innovation, current products must be manufactured at a lower average total cost (ATC) to increase sales and revenue. Process innovation reduces ATC by increasing the total product per unit of inputs.

Research and development (R&D) is the activity that produces new products or better processes, but it is not only expensive but also risky, for it is difficult to know beforehand what will work or what will sell. Even if a product is successful, then its essential features will eventually diffuse throughout the industry, or other firms will copy the product or the process to become more competitive. Indeed, some large firms wait until small firms develop a successful product or process so that they can just copy whatever is successful. This, what is sometimes called a fast-second strategy, was used extensively by Microsoft, because it could easily let others take the risk of developing new products and marketing the products, then quickly develop a comparable product or method, especially since it had enormous profits from its monopoly on operating systems and office software.

Sometimes, larger firms will simply buy out smaller firms that successfully develop a new product or process. This eliminates possible patent infringement, copyright, or trademark infringement claims against the company. The company also learns the acquired firm's trade secrets. This acquisition of firms also saves time over developing the product from scratch, doesn't require hiring new personnel or shifting personnel from other projects, and it eliminates a competitor in the marketplace.

Nonetheless, in spite of diffusion, research and development does have its advantages. A firm that first develops a product or process can protect it legally by obtaining patents on the new product or process, copyrights on the original writing or other media developments, and trademarks. For instance, Apple developed a lot of trademarks regarding its products, such as the iPod, the iPad, and the iPhone. Innovative companies also can develop brand name recognition. Moreover, the innovating company can develop expertise in producing the invention or in taking advantage of a process and key developments can be protected as a trade secret. It also gains a significant amount of time over other firms to develop economies of scale and to market the new product.

Buyouts commonly occur with Internet companies, since competition is keen, and it is it difficult to determine what will be successful beforehand. For instance, Google, Microsoft, and Facebook buy many companies that have developed technologies useful to their business or that competes with their business. Not only do the companies gain the products and know-how, but they also get the engineers and the people who were responsible for developing the product. Hence, it is a valuable way to get great talent.

One of the most important benefits of R&D, in many industries, as the procurement of patents. Patents can not only give monopoly power to single firm but it can also give market power to an oligopoly through cross licensing of patents. Because it is so expensive for a firm to defend itself against patent litigation, unless it can countersue based on its own patents, it simply becomes a sitting duck, where, even if the firm does not infringe a patent, if it does not have the financial wherewithal to defend itself, then it will lose. For instance, Google recently purchased Motorola for its 17,000 patents so that it can defend itself against infringement suits brought by Apple and other companies. In the American legal system, because defendants have to pay their own costs, if a company cannot countersue, then the plaintiffs have little to lose and everything to gain. Hence, the necessity for patents that could be used to countersue.

Firms in a pure competition market rarely spend money for research and development, because they do not earn economic profits. For instance, farmers use well-established methods to compete in the marketplace, but most of the innovations in farming come not from farmers, but from the government and from technology companies that develop specific products for farming, such as the development of new seeds.

Certain industries present more opportunities for research and development than others. Most prominent of these are the development of computers, software, and robotics. In these areas, technologies are changing so fast that even monopolists such as Microsoft spends billions of dollars every year for research and development, because even though it has a monopoly, it is rapidly being eroded by open source software and software being developed on other platforms, such as smart phones and tablets.

Creative Destruction

The relentless advance of technology causes what Joseph Schumpeter called creative destruction in his book Capitalism, Socialism and Democracy, published in 1942, when new technology creates whole new industries and destroys the old ones, such as when the auto industry destroyed the blacksmith industry, or transforms them, such as the transformation of family farms into giant enterprises that use large machines to reduce costs in farming. Computers, robotics, and software are accelerating the pace, so that any company that does not adjust to the times and the continually evolving competition, will cease to be a going concern.