Platt Perspective on Business and Technology

Pure research, applied research and development, and business models 4

Posted in strategy and planning by Timothy Platt on May 16, 2017

This is my 4th installment to a series in which I discuss contexts and circumstances – and business models and their execution, where it would be cost-effective and prudent for a business to actively participate in applied and even pure research, as a means of creating its own next-step future (see Business Strategy and Operations – 4, postings 664 and loosely following for Parts 1-3.)

Every business that is planned out and every business plan that is implemented and carried through upon faces two fundamental financially driven processes that they have to effectively reconcile of they are to succeed: expenses and cash flow out, and revenue generation and cash flow in. A nonprofit business might seek to essentially break even in this with any potential profitability expended towards realization of their founding mission and vision, net any financial reserves set aside for the explicit due diligence purpose of maintaining ongoing organizational stability. And a not-for-profit might similarly seek to balance its books with a minimal-at-most “excess” profit generated, by for example passing on greater savings to its customers or clients to balance its books. But of importance to this discussion, even the most assiduously maintained nonprofit or not-for-profit business or organization faces this cash flow dynamic – and not just their for profit enterprise peers and businesses that seek to maximize realized profitability.

In a fundamental sense this entire series is about finding ways to achieve an effective balance there, when the additional costs and risks of pursuing next-step-forward research are added into the mix of what might be carried out by an organization. I have been discussing timeframe and risk management issues in installments leading up to here in this series. And I step back from that level of consideration here, to reconsider the above-noted accounting balance and its impact on what would and would not be maintained in-house, from what might be the most cogently fundamental level that this can be viewed from: consideration of what makes a unit or area of a business a cost center or a profit center per se.

• As a cartoonishly simplistic starting point, I note that bottom line, a cost center requires more funding in its maintenance and operations than it can or does generate as new revenue generated. More money goes into it than comes out of it.
• And a profit center correspondingly generates more new revenue than it expends in its maintenance and operations, making it a net revenue generator. So the distinction is simply one of overall cash flow balance.

As a first complicating factor that I would add to that in to make this discussion more realistic, I raise the possibility that a putative cost center as determined by this bare bones analysis, might enable that business’ primary profit center for it, to be able to generate revenue. In this case, a valid analysis of that “cost center” area of the business would require a more comprehensive consideration of both that functional areas itself, and analysis of its functionally connected and supporting context. Such a business unit might appear to be a cost center when only considered as if in a vacuum, but a realistic analysis of its true status there might require coordinate consideration of what it has direct and in this case facilitating, enabling impact upon in the business as a whole too. And that can turn a seeming cost center into an enabling profitability center and even an essential one. Conversely, a seeming profit center – when considered in vacuo, might be found to in fact qualify as more of a cost center when considered in its larger context, and certainly if maintaining and operating it as is, simply means that it will continue robbing resources from what could be much larger and more effective profit centers in that business. A marginally effective profit center can, under the wrong circumstances achieve and maintain that status by in effect robbing the business that it resides within from what could be greater sources of profitability potential elsewhere in it.

This second level analysis can cut both ways in forcing a reconsideration of what is and is not a cost or profit center for a business. And effective ongoing strategic business management has as one of its key goals, the identification of the types of inefficiencies that can turn a seeming profit center into a more actual cost center, or a seeming cost center into more of a profitability enabling one, and with a larger overall goal of optimizing within and across the business for greater overall financial effectiveness in general.

But returning from that higher level organizational point of consideration to focus on the individual functional unit or area in a business, let’s specifically consider an organized effort to create new and next for it, and with a goal of keeping that business effectively competitive long term: let’s consider research and product design and development here.

I focused in Part 3 on timelines, and the issues that arise in that context are critically important here. Realistically, a short timeframe, or even a single instant snapshot-in-time approach to evaluating cost and profit center positioning in a business might or might not make sense, depending on the business and its overall business model and its overall expected timeframe of operation.

If the business under consideration is a long-term venture, at least as a matter of intent, then it becomes important to take longer-term time frames into account when balancing overall incoming and outgoing cash flow considerations for areas of it that under analysis for this. To put this into a specific context, consider what might be considered business units that might be considered borderline for their fiscal balance and for whether it makes sense to maintain them as is.

• Would it make sense to keep some particular seeming-borderline unit of a business and its function in-house, or would it be more cost-effective to outsource it to a specialist partner business and not have to pay out all of the maintenance costs for keeping it in-house?

The word “longer” as just used in the preceding paragraph, and what that actually means becomes important here, and certainly for businesses that see cyclical patterns of profitability with for example recurring peak revenue-generating and slow break-even or low level loss seasons. And this analysis would probably be undertaken at least twice: once considering that unit of the business as if in vacuo and entirely on its own, and a second time when taking into account its functionally connected contexts – and here over at least one complete peak and trough cycle for seasonally driven businesses.

But this only applies to long-term ventures and businesses that are at least intended to follow that pattern. And perhaps more importantly it specifically applies to businesses that would be expected to follow more predictable patterns for when they would face high profitability and when they would see business really slow down. Uncertainty there would skew any cost center versus profit center calculations too, making potential cost centers that much more risky for their downside potential and certainly in the face of (less predictable in detail or timing but still quite expectable) lean times.

Scale of operation and particularly larger scale of operation with capacity to build and maintain greater reserves can reduce risk from maintaining true cost centers in a business, by reducing the overall level of risk that they might generate for the business as a whole. But efforts to make the organization lean and agile and functionally efficient might still significantly drive initiatives to the identify and remove or at least limit cost centers per se, except when specific modulating factors would dictate that they need to be maintained and in-house anyway.

Addressing that from the perspective of a specific case in point example: research and development:

• Outside competitive challenge and rapidly changing marketplace demand can create that type of countervailing pressure to maintain in-house new product development, including at least some relatively basic supportive research that could feed into it, as a here-relevant case in point.

As already discussed in this series in its opening installments, short-term businesses, and short-term opportunity ones would be hard pressed to find reasons for ever really looking beyond the immediate here-and-now snapshot view of what is a cost or a profit center for it. And all effort would be made to develop and maintain profit centers and immediately weed out any sources of loss or potential loss, however brief for that. Such enterprises and their business models would never be expected to support research or development efforts and would in most cases seek to start out with essentially their full realizable range of products and services already planned out and ready to provide, market and sell.

Now let’s reconsider the above lines of discussion in a bit more detail, and in a research unit context. And I begin that with a key issue that I have just been citing: “uncertainty.” I briefly sketched out what pure and applied research and targeted product development are in Part 2 of this series. And one of the core distinctions that I made note of between them there, at least from a business perspective is that of uncertainty of pay-out, and both for their overall potential profitability and for their timeframes of that profitability being realized. A larger stable business that can more readily maintain supportive reserves for among other things bankrolling its future through research, and a business that can more reliably long-term predict and manage its revenue flows is going to be in a stronger position to take the risks of maintaining longer-term potential areas that might create profitability at some future date but only then: such as longer-term research. Smaller and less fiscally protected enterprises would be less secure in attempting this. And with that, I have just restated the basic conceptual model underlying the default vision of only large and established corporations being able to develop and sustain real research and certainly anything like pure research in-house.

I am going to examine the assumptions made there in justifying a big business only approach to research, and in this series up to here as a whole, in my next installment where I will at least briefly consider and sketch out a smaller, lean and agile research-focused business model alternative – and how this briefly sketched description of it need not automatically be seen as a contradiction in terms. Meanwhile, you can find this and related postings and series at Business Strategy and Operations – 4, and also at Page 1, Page 2 and Page 3 of that directory.

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