Software companies live by the mantra of “innovate or die.” As a result, research and development programs are among their most indispensable functions. The average software company spends about 20% of revenue on R&D; some spend more than 40%. The effectiveness of R&D teams—chiefly, their ability to innovate—is in many cases a software company’s most significant differentiator.
Unlike most other aspects of business, however, R&D doesn’t scale with size. Indeed, recent BCG research shows that smaller companies tend to outperform their larger competitors in returns from R&D investments and speed to market. This may seem obvious—after all, older companies generally have more mature products in slower-growth markets—but we found that market maturity alone doesn’t explain declining RDIs.
In fact, the nuances and outliers in our analysis convinced us that we had to look deeper and answer these questions: What separates the software companies that have successfully scaled their R&D from the many competitors who have not? What are the factors that get in the way of companies as they scale? Finally, what can software companies who want to grow without losing their edge in innovation do to solve the R&D conundrum?
When R&D Lags
BCG recently analyzed nearly 200 mostly public software companies from around the globe to compare the change in one-year revenue growth (excluding acquisitions) against the percentage of revenue allotted to R&D.1 This ratio is what we call the Research and Development Index (RDI). The companies we examined are young to old, small to large, and with varied growth strategies. Our analysis shows that as a company matures and increases in size, its RDI falls, in large part because its R&D budget expands commensurately while not delivering an equal amount of revenue gains. (See Exhibit 1.)