Research and development business models


A business model is usually defined as the method of doing business by which a company can sustain its existence and generate revenue. The role of a business model is to specify how a company positions itself within the value chain or, in other words, how the company translates its internal inputs, i.e. resources, capabilities and innovations into economic outputs. This is illustrated in Fig. 1.

Fig. 1. Business model: connecting internal inputs to economic outputs

Source: Business Model: http://www.1000ventures.com/business_guide/business_model.html

       This article is concerned with possible business models of independent R&D organisations, i.e. the organisations for which R&D activities remain both the core area of activity and the major source of income.


General framework for business models

The framework describing the elements of a business model is illustrated in Fig. 2 and includes the following six basic components [1]:

  • value proposition – a description of the customer problem, the company’s approach to solve the problem, and the value of this solution to the customer;
  • market segment – a specific group to target having specific and known needs;
  • value chain structure – the firm's position in the value chain and how the firm captures part of the value it creates;
  • revenue generation and margins – how revenue is generated, the structure of costs, and profit margins aimed;
  • position in the value network – competitors, complementors, and any value chain characteristics that can be utilized to offer higher value to the customer;
  • competitive strategy – how the company develops a sustainable competitive advantage and uses it to improve its competitive position.

Fig. 2. Business model: converting innovation to economic value

Source: Business Model: http://www.1000ventures.com/business_guide/business_model.html

             Malone and others [2] define a business model based on two fundamental dimensions of what the business does:

  • what types of rights are being sold,
  • what type of assets is involved.

            The heart of any business is what it sells, which concerns also a specific kind of legal right conferred to the buyer with the transaction. Malone and others recognise four basic asset rights being sold:

1. A Creator buys raw materials or components from suppliers and then creates a product sold to buyers. This is the typical business model in manufacturing.

2. A Distributor buys a product and then sells essentially the same product to someone else, usually providing additional value by transporting, repackaging, or by providing customer service. A key distinction between Creators and Distributors is that Creators design the products being sold.

3. A Landlord sells the right to use an asset for a specified period of time. The term Landlord describes here not only businesses providing temporary use of physical assets (like houses or airline seats), but also lenders of financial assets, and organisations providing temporary use of human assets.

4. A Broker facilitates sales by matching potential buyers and sellers. A Broker does not own the product being sold (unlike a Distributor), receiving a fee (or commission) from the buyer, the seller, or both. This business model is common in real estate brokerage, stock brokerage and insurance brokerage.

            The other dimension considered is the type of asset for which rights are being sold. Four types of assets are defined:

A. Physical assets include both: durable items (e.g. houses, computers, and machines) and nondurable items (e.g. food, clothing, paper).

B. Financial assets include cash and other assets, for instance stocks, bonds, and insurance policies that give their owners rights to potential future cash flows.

C. Intangible assets include legally protected intellectual property rights (patents, copyrights, trademarks, and trade secrets), and other intangible assets like knowledge, goodwill, and brand image.

D.  Human assets include people’s time and effort, which can be sold for a fee.

            Based on the above definitions Malone [2] recognise business models that are briefly described below:

1A. An Entrepreneur – creates and sells financial assets, including firms. Examples are: serial entrepreneurs, “incubator” firms and other investors active in very early stage firms who finally sell the firms they create.

1B.  A Manufacturer – creates and sells physical assets.

1C. An Inventor – creates and then sells intangible assets such as patents and copyrights. Firms using this business model exclusively are relatively rare, but some technology firms generate part of their revenues this way. Firms that license the use of their intangible assets while still retaining ownership are not classified as Inventors; they are Intellectual Landlords (see below).

2A. A Financial Trader – buys and sells financial assets without significantly transforming (or designing) them. Banks, investment firms, and other financial institutions that invest for their own account are included in this business model.

2B. A Wholesaler/Retailer – buys and sells physical assets. This is the most common type of Distributor.

2C. An Intellectual Property (IP) Trader – buys and sells intangible assets. This business model includes firms that buy and sell intellectual property such as copyrights, patents, domain names, etc.

3A. A Financial Landlord – lets others use cash (or other financial assets) under certain (often time-limited) conditions. There are two major subtypes of this business model: a Lender, who provides cash for a fee, and an Insurer, who provides financial reserves that the customers can use if they experience losses.

3B. A Physical Landlord – sells the right to use a physical asset. The asset may, for example, be a place or equipment. This business model is common in industries like real estate rental and leasing, accommodation, airlines and recreation.

3C. An Intellectual Landlord – licenses or otherwise gets paid for limited use of intangible assets. Three subtypes of Intellectual Landlord are recognised: a Publisher, who provides limited use of information assets such as software, newspapers, or databases in return for a purchase price or other fee, a Brand Manager, who gets paid for the use of a trademark, know-how, or brand, an Attractor, who attracts people’s attention using television programs or web content and then “sells” that attention to advertisers.

3D. A Contractor – sells a service provided primarily by people, such as consulting, construction, education, personal care, package delivery, live entertainment or healthcare. Payment is a fee for service.

4A. A Financial Broker – matches buyers and sellers of financial assets.

4B. A Physical Broker – matches buyers and sellers of physical assets.

4C. An Intellectual Property (IP) broker – matches buyers and sellers of intangible assets.

4D. A Human Resources (HR) Broker – matches buyers and sellers of human services.

These business models can be presented in a more compact tabular form, as in Tab. 1. Four models are distinguished using blue colour. These models are used in the following discussion as reference models for independent R&D organisations.

Table 1. Sixteen reference business models (‘x’ denotes illegal business models that are mentioned only for logical completeness)

 

Type of asset involved (A-D)

A. Financial

B. Physical

C. Intangible

D. Human

Rights

being

sold

(1-4)

1. Creator

Entrepreneur

Manufacturer

Inventor

x

2. Distributor

Financial Trader

Wholesaler, Retailer

IP Trader

x

3. Landlord

Financial Landlord

Physical Landlord

Intellectual Landlord

Contractor

4. Broker

Financial Broker

Physical Broker

IP Broker

HR Broker

Source: Based on: T.W. Malone, P. Weill, R.K. Lai, V.T. D’Urso, G. Herman, T.G. Apel, S. Woerner: Do some business models perform better than others? MIT Sloan Research Paper, No. 4615-06, May 2006, pp. 4-12


Business models for independent R&D organisations

Constant [3] discusses operational characteristics of an independent not-for-profit R&D organisation. Such organisation is similar to an independent for-profit organisation in the sense that it must operate effectively, and therefore has many similar operational characteristics. There are various potential income streams available to an independent not-for-profit R&D organisation:

  • R&D projects,
  • donations and subsidies,
  • intellectual property rights,
  • publishing and education,
  • new product development.


Contract research projects

The principal income stream of the independent R&D organisation is that from contract research operations, which is project based. The income from a project depends on its size and on the type of the contract. Typical contract types for R&D projects are: cost-plus fixed fee, time and material, award fee, fixed price. The fixed fee contracts are the most sound from the financial point of view, however, at a higher risk than the other types. Since the R&D project is usually the financial lifeline of the R&D organisation, it takes a central role in the organisation and is served by all its elements. Using the reference model described above, this revenue path corresponds to the business model of the Inventor (1C).


Donations and subsidies

Depending on the local regulations, donations [3] may be restricted to not-for-profit and non-profit organisations. Usually donations are not as viable source of income as R&D projects are. Moreover, it can take considerable time to meet the specified criteria or to undertake an effective campaign to raise money.


Intellectual properties

Intellectual properties (IP) or intellectual assets (IA) are a very viable option for an R&D organisation. IP rights that are the property of the R&D organisation may come from contract research activities, from a self-funded research or from buying the rights from other parties. The IP rights could:

  • generate new contract research work,
  • constitute the basis for a new venture, e.g. a spin-off company,
  • be sold to another party.

If the IP rights are to be commercialised through a new venture company, the R&D organisation becomes a parent organisation for the new company. The new company could have need for research work to be done by the parent organisation.


Publishing and education

Another income stream available for some R&D organisations is the publication of technical information for sale in the form of articles, books, manuals, DVDs, CDs, or organising professional courses and trainings. This publishing activity may be related either to the established and widely known technical knowledge or to new information, not yet known in the marketplace. The latter case is related to selling IA, for instance know-how.

Using the reference model described above, the revenue paths based on trading IP rights or Publishing correspond to the business models of the IP Trader (2C) or the Intellectual Landlord (3C).


New product development

The R&D organisation can profit from new product development in various ways [3]. For some contract research projects customers (other organisations) want a new product to be developed. The customers introduce the newly developed product into manufacturing and markets, and derive profit from consequent sales. The R&D organisation makes a fee, which is a form of profit for the organisation.

            Gaining profit from product development is dependent on the research contract terms. If staff members working on the project produce IP that are exclusively or partially owned by the R&D organisation, these IP rights can bring financial benefits.

Different marketing strategies can be followed by R&D organisations with respect to its principal revenue paths. Constant [3] recognises three major approaches, two reactive strategies involved with the contract research path for income and the third, a proactive strategy is used in the IP path. The term reactive strategy is used here to express the situation when the activity of the R&D organisation results from the communicated need of the customer – as a reaction to that need. The proactive strategy is followed when this is the organisation itself where the idea for new product or technology is born. And this new idea is consequently developed, managed and marketed to customers.


Reactive strategies – contract research project path

The most common approach is, when the customer – government, industrial, trade or other organisation – develops a written request for proposal (RfP), request for quotation (RfQ) or invitation for bid (IfB) for a specific work to be done. After receiving the request the R&D organisation determines whether or not it wants to respond, taking into consideration different aspects, including:

  • Is it within the current business area?
  • Is any conflict of interest likely?
  • Is it an opportunity to start a new business area?
  • Are capabilities available to complete the job?
  • Will capabilities be available or obtainable if some are missing?
  • Who are the major competitors?
  • Is it really a competitive bid or essentially sole-source proposition, i.e. the job designated for another organisation?
  • What is the competition?
  • What is the likelihood of success?
  • What investments are necessary?
  • What return on investment is expected?

If the initial decision is to respond, a Proposal (or Capture) Team is formed that is led by a Proposal Manager (or Capture Team Leader), who would eventually become the Project Manager in the case the contract is won. The Proposal Team might follow a formalised methodology (called a stage-gate review process [4]) of analysing the problem, developing the proposal and providing ground for organisation’s executives to take decisions at predefined time moments (called gates) on whether to continue the effort (including the final decision to submit the proposal) or to abandon.

            Another reactive strategy appears when the potential client approaches the R&D organisation and presents his need or problem. A meeting, a set of meetings or other type of information exchange between the appropriate staff members and the client is conveyed that is aimed at discussing the need and ensuring that the requirements are thoroughly understood. When the decision is made by the R&D organisation to propose, a Proposal Team is formed to prepare the proposal, as discussed above.

            This latter type of reactive approach can be viewed as having certain advantages for the R&D organisation over the former one – based on an RfP:

  • If the customer need was identified early it is likely that the customer would not approach competitors with the same need.
  • Even if he approaches competitors in order to compare the offers, the first organisation discussing the need has the advantage of shaping the customer requirements in its favour and against the foreseen competitors, making it the essentially sole-source proposition.


Proactive strategy – Intellectual Properties path

The third strategy is based on a new idea the R&D organisation might have. The idea may be client related or not. It may concern a new product or the improvement of a product in terms of reliability, mean time between failures, maintainability, durability, ruggedness, sensitivity, accuracy, adaptability, user friendliness, life, cost, size, etc. The idea for new or improved product is first documented and a patent may be sought before the product is marketed to prospective customers.

One of these three generic strategies is responsible for the R&D organisation obtaining the contract that is sought. The contract gives all requirements to be met and defines how the IP rights shall be handled. The profit path for the R&D organisation is usually built into the contract, such as:

  • the client owns all the IP rights conceived by project staff members,
  • the R&D organisation shares in the right,
  • the fee to be awarded for the contract work done.

In that case IP rights are not based on contract research project work, the benefit is solely that of the R&D organisation with a certain share of profits derived from the IP paid to the staff members who had the innovative idea.


Relations between R&D organisation, production means and sales of products

When considering the ways the R&D organisation can make money on its innovations, the key issue is the relationship between the R&D institution, production capacity and sales. Typically, for an independent R&D organisation, the end product of a contract research project is a prototype of the product, often supplemented with the technical documentation needed to put the new product into production. Some R&D organisations have the capabilities to produce a limited number of units in-house. Alternatively, the organisation can subcontract production to a firm specialised in production in order to do the work.

Depending on the organisation status, the R&D organisation can or can not act as a manufacture of products because of its tax status. In the case of the independent not-for-profit organisations tax regulations can limit the amount of revenues generated from sales of products on the market, or even prevent the R&D organisation from production. In this case the not-for-profit organisation would have to have a separate for-profit division, which aims at commercialising innovations produced by the R&D organisation and to undertake the manufacturing and sales aspects. Alternatively, in order to profit from innovations the IP rights owned by the R&D organisation can be sold to other businesses, e.g. in the form of a license, or know-how.

(MS, 2008)

References

[1] Business model, http://www.1000ventures.com/business_guide/business_model.htm [2008-05-18]

[2] T.W. Malone, P. Weill, R.K. Lai, V.T. D’Urso, G. Herman, T.G. Apel, S. Woerner: Do some business models perform better than others? MIT Sloan Research Paper, No. 4615-06, May 2006

[3] P.C. Constant: Growing a not-for-profit R&D operation, IEEE Engineering Management Review, Vol. 35, No. 1, 2007

[4] J. Herther: The difference between winning and loosing capture efforts, Journal of the Association of Proposal Management Professionals, Spring/Summer 2005