2.1.3 Research and development (R&D) and innovation


    Innovation – the process of using research and development to create new products or   improve products.

    R&D is investment in research with the intention of improving goods and services, introducing new ones, or improving methods of production. This is vital to companies maintaining a competitive advantage through innovation.

    A firm can gain competitive advantage using price, quality, cost or through a niche market. A cost competitive advantage can be through a skilled workforce or good technology, allowing them to lower average costs and therefore charge lower prices but this is hard to maintain this. Essentially, the firm has a unique feature which allows it to stand out and be superior to its competition.


    This is a key strategy for product-oriented markets and firms such as Google and Apple which has allowed them to be front-runners in their respective markets. However, in pharmaceutical markets this is essential, as without R&D they would have no products. Most companies only spend a small portion (5%) of their profits on R&D.

    Innovation helps increase market power as it protects a unique selling point by differentiating them from rival products. It makes it more difficult for competitors to compete against new and improved products.

    Product innovation – when a completely new/improved product or service is created. These can often be cutting edge, but it can also be about small changes to existing products to improve performance and customer satisfaction.

    Process innovation – when new/improved production methods are used, enhancing efficiency and reducing costs. It can also mean improving distribution channels, stock control channels and supply chains.

    Both types of innovation can help a company grow and gain a competitive advantage. An example of process innovation is Henry Ford pioneering the assembly line in the production of the Model T.


    • More product innovation
    • Can often charge higher prices, therefore having higher profit margins
    • Extensive market power
    • Strengthens brand
    • Higher market share
    • Barriers to entry



    • Competition, as innovation and R&D is only beneficial if rivals cannot replicate it in their own firms
    • Uncertain commercial returns as not all products will end up being profitable or sellable
    • Expensive as funding innovation include costs of R&D, paying staff, patents etc.
    • Creative destruction (Joseph Schumpeter) means that creation of new products makes older ones obsolete e.g. each new iPhone makes the previous one more undesirable.



    Increasing R&D can contribute to higher levels of economic growth and other advantages include increases in GDP, higher incomes and lower unemployment rates. As it is expensive for firms to undertake R&D as the positive externalities are not always realised. To overcome this the government may provide subsidies for R&D.


    Support for Innovators, Innovate UK (sponsored by the UK gov.) give grants to fund innovation as well as the English Research, Development and Innovation State Aid Scheme. Large UK businesses receive 11% corporation tax relief on R&D spending. Smaller innovative businesses are able to recover 26% tax relief.

    Costs can fall so rise in real wages, increase in employment levels and exports Opportunity cost to government of spending
    Helps to increase GDP Potential high taxes to fund extra spending
      Firms could be inefficient if they rely on subsidies, since they have less incentive to lower costs
      Causes government failure if inefficient industries are subsidised



    Product life cycle – shows the different stages a product passes through, it begins as an idea and is developed, sells well then becomes obsolete.

    Extension strategies are used by businesses to prolong the maturity phase of the cycle in order to halt decline. These include:

    • Redesigning or updating the product – new and improved features
    • Advertising to new and existing buyers (new market segment)
    • Changing the packaging and rebranding
    • Price changes to improve competitiveness


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