The Future of Corporate R&D: Enlightened External Innovation
Looking ahead to 2025 and beyond, we predict companies will embrace an R&D strategy that combines the best of internal and external innovation.
Introduction
In the coming years, how should companies adapt their research and development (R&D) practices to stay competitive? For many managers, this question hinges on changes in both corporate strategy and macroeconomics. In this article we explore the latter: how macroeconomic forces influence the corporate innovation environment and what companies should do given predicted changes in 2025 and beyond.
At Roundtable we foresee the rise of “enlightened external innovation” – a hybrid corporate R&D approach that leverages the strengths of internal and external innovation. This approach is characterized by a return to internal, corporate-led R&D for later-stage technologies alongside a deepened engagement with the external innovation ecosystem for early-stage research. In the sections ahead, we’ll unpack the key forces driving internal and external innovation, share our analysis, and outline actions for you to take advantage of this trend.
Background: The Cost-Driven Nature of Innovation
Before World War II, much of American science was funded by industrialists and corporate laboratories. After the war, corporate R&D investments grew but not nearly as quickly as government R&D, which peaked in the 1960s (U.S. government research reached 0.6% of GDP, while industry research was around 0.3%). In subsequent decades, these roles reversed: government research funding has declined to about 0.4% of GDP, while industry research has risen to 0.6% [1].
These trends in innovation are fundamentally influenced by cost considerations [2],[3],[4]. In other words, people seek the cheapest ways to develop ideas (groundbreaking, I know). For companies, that means evaluating whether to develop ideas in-house (‘internal’ innovation) or acquire them from others (‘external’ innovation). And while geopolitical factors play a major role (see “Navigating US Tariffs: Threats and Opportunities for Innovation Leaders”), long-term corporate R&D trends have been shaped primarily by the shifting relative costs of these two approaches:
Costs of Internal Innovation
Operational Costs: R&D is inherently expensive, from research to prototyping and system development. And since the 20th century, real costs of R&D projects have steadily increased, except in categories like internet-based software [2]. Additionally, since the 1980s, financial pressures have intensified scrutiny on corporate R&D investments in favor of short-term profitability [2].
Cost of Capital: Companies’ discount rates, particularly the ‘wedge’ (the difference between a company’s discount rate and its weighted average cost of capital, or WACC), heavily influence R&D investment decisions. In fact, between 2002 and 2021, this wedge widened 7.5 to 10 percentage points, resulting in estimated trillions of dollars in "missing investment." This phenomenon stems from challenges in calculating and recalibrating WACC in a lower-interest-rate environment. [5].
Costs of External Innovation
Cost of Experimentation: The capital needed to evaluate ideas and start businesses has dramatically dictated the financing landscape for startups. Since the mid-2000s, the rise of cloud computing and lower interest rates were found to have fueled the “spray-and-pray” venture capital model [4].
Cost of Acquisition: Acquisition costs include both the price of acquiring innovations (ex: licensing, mergers), as well as the associated transaction costs, which are heavily influenced by the regulatory environment. Since the 1980s, two forces have led to reduced acquisition costs for companies: I) the Bayh-Dole Act, which boosted the supply of innovations from universities and startups and II) relaxed antitrust pressures, which reduced concerns over acquisitions.
Looking Forward: Trends Shaping Innovation
We understand that there is tremendous trepidation and uncertainty with evolving technological and political landscapes in 2025 and beyond. But we are confident that following trends will shape corporate R&D practices:
Operational Costs: The complexity of cutting-edge technologies like AI models, biotech, and deep tech will continue to demand significant investment. For example, training state-of-the-art AI models can exceed millions of dollars, while developing a drug takes about ten years and more than $2B [6].
Cost of Capital: Persistent inflation suggests that interest rates will decrease more slowly than expected. And with the ‘neutral nominal rate’ projected at 2.9%, we’re unlikely to see near-zero rates return [7]. Furthermore, as the NBER research shows, we should expect that corporate discount rates will adjust downward at an even slower pace, further suppressing large-scale investment [5].
Cost of Experimentation: While training AI models remains costly, they also promise to dramatically reduce costs for the development of other technologies like AI agents and drugs [6]. And with more than $1T being spend on data centers, we can expect inference costs to continue to decline [8].
Cost of Acquisition Although startup formation and venture capital deals have decreased from their peaks, these trends could rebound [9]. Meanwhile, the incoming Trump administration looks to be more favorable for corporate dealmaking (although a comparison against Lina Khan’s leadership FTC is a low bar) [10]. But expect continued regulatory concerns ranging from a distrust of big tech to protectionist interventions like Nippon Steel’s halted acquisition of US Steel.
The Rise of Enlightened External Innovation
Amid these chances, we predict the emergence of what we’ll call "enlightened external innovation," a strategy that combines the strengths of internal and external R&D in this environment:
Collaboration in early-stage research: Companies will increasingly collaborate with startups, universities, and suppliers to learn, influence and acquire early-stage technologies. By investing more in early external innovation, companies can leverage the growing scientific ecosystem while minimizing capital expenditures and acquisition scrutiny.
In-house development: As technologies reach higher readiness levels, companies will shift investments back in-house to build and test systems. This paradigm will coincide with the anticipated reductions in the cost of capital amid sustained regulatory concerns surrounding large M&As.
Recommendations
At Roundtable, we’re excited about the evolving innovation landscape and believe it will foster more impactful applied research and commercial technologies. Our aim is to help companies navigate the ‘enlightened external innovation’ strategy. To that end, we recommend:
Stay agile: Prepare to adapt your R&D strategy based macroeconomic factors like technology costs, interest rates, and regulatory changes. In particular, regularly reassess discount rates to reflect your WACC more accurately.
Acquire knowledge: Expand your external innovation network through partnerships and sponsorships for early-stage research. Collaborating with universities, startups, and other entities can enhance your organization’s knowledge base and technology pipeline while mitigating the downsides of internal R&D.
Looking to explore R&D ideas or collaborations? Reach out to us at Roundtable—we’d love to help!
Thanks for reading. If you have any topics you’d like us to cover, leave a comment or reply to let us know!
[1] New ways to pay for research could boost scientific progress | The Economist
[2] Money for nothing: How firms have financed R&D-projects since the Industrial Revolution - ScienceDirect
[3] The Changing Structure of American Innovation: Some Cautionary Remarks for Economic Growth - NBER
[4] Cost of Experimentation and the Evolution of Venture Capital
[5] Corporate Discount Rates | NBER
[6] AI will boost drug development in 2025 | The Economist
[7] The Federal Reserve takes on Trump—and stubborn inflation | The Economist
[8] Will the bubble burst for AI in 2025, or will it start to deliver? | The Economist
[9] The world’s most innovative country | The Economist
[10] What Trump’s new antitrust enforcers mean for business | The Economist