This is the cost of discovering and developing new products or services that fill market needs, including any labor, raw materials, clinical trials, and other costs incurred during the process.
Research and development (R&D) can be thought of as investments to fuel new products that provide higher margins or increased market share. Research and development expense is common throughout most companies that produce some product or service- companies like Nike (NKE), Procter & Gamble Company (PG), and Pfizer (PFE) all invest heavily in R&D. This metric is oftentimes expressed as a percentage of revenue (R&D/Sales Ratio, calculated by dividing research and development expense by total revenue. R&D as a percentage of revenue is useful to compare the effectiveness and efficiency of R&D expenditures between companies in the same industry.
R&D expenses differ greatly across different industries- the Drug Manufacturers generally have the one of the higher R&D/Sales ratios. For example, Pfizer (PFE)'s R&D totaled to 16.5% of its revenue in 2008. Computer Software and hardware companies like Microsoft (MSFT) and Cisco Systems (CSCO) also have similar R&D/Sales ratios.