1. Is Research and Development in the Cosmetic
Industry Linked to Revenue Growth?
MAIRIN O’CONNOR
ABSTRACT
This study examines the relationship between cosmetic companies’ yearly
expenditure on research and development and their revenue growth, over a
period of 20 years. After using Forbes and Statista to determine 10 of the
most profitable cosmetic companies in the world, I collected data from Com-
pustat in WRDS for each of these companies, over the period of 1995-2015.
Then, I examined the correlation between percent change in revenue growth
and percent change in research and development expenditure in the cosmetic
industry. An analysis of the resulting correlation demonstrated that there is
a moderately strong, but positive, relationship between research and devel-
opment investment and revenue growth in the cosmetic industry. This paper
presents stakeholders in the cosmetic industry with pertinent information to
their success, informing them that research and development investments are
linked to revenue growth.
The effect of a company’s research and development expenditure on their success, is
a highly researched topic, as both academics and stakeholders in all industries are trying
to determine if it leads to improved performance, in various aspects. This is a topic that
impacts both internal and external stakeholders in any company. Findings from studies
about research and development will influence not only senior management’s decisions to
boost or reduce research and development investment, but also shareholders’ decisions to
invest in companies with such operating expense characteristics. A study done by Reuters
demonstrates that the top innovators in research and development consistently outper-
formed the S&P 500, in every factor of business success1
. Cosmetic industry trends
indicate that focus on research and development will promote a company’s growth in
today’s competitive international markets2
. With markets constantly changing and in-
vestors constantly trying to find new ways to determine a company’s success, every factor
that affects a business’ success is important. During the 2008 recession, companies ex-
perienced tremendous pressure to efficiently allocate their resources. They continued to
focus on future revenue opportunities by maintaining research and development spending
1. Gaze, L. (2013). Proof: R&D Investment Pays Off. Global R&D Funding Forecast.
2. McDougall, A. (2013). Euromonitor: P&G no match for L’Oreal as R&D is Diluted. Cosmetics
Design-Europe.

2. in products that would optimize revenue growth. These actions provide evidence that
research and development is a key tool for increasing a company’s success3
.
One issue in studying the effect of research and development investment on a com-
pany’s success is determining the best methodology to measure the success of such an
investment. Financial research across various industries demonstrates that companies are
spending more on research and development than ever before4
Therefore, this suggests
that a company’s ability to invest in research and development could be an impediment
to their success. Companies with lesser revenue relative to their peers face limitations
in their choice of allocating operating expenses towards innovative products that drive
future revenue opportunities.
Due to the fact that this is a highly researched topic, there are many ways that the
effects of research and development have been analyzed in the past. Typically, studies use
the production function to measure the success of research and development investments.
Additionally, academics tend to focus on the industries that are research and development
intensive when conducting their studies (i.e. technology, pharmaceuticals, etc.). However,
as this has proven to be an important investment that affects a company’s success in these
research and development intensive industries, the impact of such investments needs to
be studied as applied to other industries5
. As the cosmetic industry is not considered a
research and development intensive industry, not many studies have been done to analyze
the effect that the investment in research and development has on a cosmetic company’s
revenue growth, or performance in general. Additionally, the studies that have been done
typically utilize different methodology to measure the impact of a firm’s investment in
research and development. Therefore, not only does this paper present a new method for
studying the impact of a company’s research and development expenditure by correlating
it to the revenue growth, but it also presents new findings for an industry where not many
studies have been completed.
I. Related Literature
Although I was unable to find studies that have been done to investigate the correla-
tion between research and development expenditure and revenue growth in the cosmetic
industry, studies have been done to analyze the effect of a company’s research and devel-
opment investment, in other industries. These studies are discussed below.
In a study analyzing the U.S. pharmaceutical industry, Baily (1972) studied both the
costs and returns of research and development. For this research, the number of new
products was related to the expenditure in real dollars on research and development (not
including labor and capital costs). In addition to using a production function, the study
utilized a return function in order to relate the company earnings to the number of new
drugs produced. An important factor that this study noted was that a complete mathe-
matical model would include capital and labor inputs when calculating the resources put
into research and development. This study concluded that the earnings of each company,
3. Mattioli, D. (2009). With Eye on Competition, Firms Keep Spending on R&D. The Wall Street
Journal.
4. Philips, M. & Coy, P. (June 4, 2015). Look Who’s Driving R&D Now. Bloomberg Business.
5. Gara, T. (2014). Boosting R&D Spending: U.S. Companies Lead, But Volkswagen is King. The
Wall Street Journal.
1

3. over time, were clearly related to how many patents were held, and therefore research
and development does have a relationship to a company’s success. However, as a note
of limitations, the study emphasized that it is not clear exactly what is causing the cor-
relation between patents held, earnings and research and development expenditure in
the pharmaceutical industry. Therefore, further research is needed in order to determine
causation.
Gerybadze (2010) studied leading technology companies’ investments in research and
development as related to their revenue growth and success. The study examined compa-
nies in the top five R & D intensive industries: pharmaceuticals and biotech, IT hardware
and equipment, automobiles and parts, software and computer services, and electronic
and electrical equipment. This study is similar to mine in that it examines the revenue
growth of a firm, but the methodology differs from mine in a few aspects. Firstly, this
study analyzed the different strategies of research and development: incremental inno-
vation, dynamic growth strategies and industry creation. Additionally, when analyzing
these companies, the study looked at research and development expenditures, research
and development as a percentage of sales and research and development over the last
4 years. In conclusion, Gerybadze (2010) found that technology companies must invest
between 10-20% of their annual revenue in research and development in order to keep
growing.
Furthermore, in another approach to studying research and development, Eberhart,
Maxwell, and Siddique (2004) examined firms that increased their research and devel-
opment expenditure by significant amounts, over the years 1951-2001, studying a total
of 8,313 cases. The data used in this study included the return on stock and operating
performance, as pulled from Compustat. It was found that when companies increased
their expenditures for research and development, they experienced abnormally positive
stock returns and positive long term operating performance. This study established that
not only is increasing investment in research and development a positive move for firms,
but the market is also slow to react and investors underreact to this. Therefore, when
a firm invests more in research and development, the firm will experience positive long
term operating performance and investors should react quickly and positively to such
investments.
Moreover, Griffith (2000) used a different method in order to prove that research and
development is not only important for companies, but also for society. This study ana-
lyzed the social rate of return of a research and development investment, demonstrating
that governments should subsidize research and development for companies. Typically,
the private rate of return on a research and development investment is used to deter-
mine if a firm should further invest in research and development, but Griffith (2000)
demonstrates that this is not an accurate depiction of the importance of research and
development. This study measures the elasticity of output in relation to capital stock in
order to demonstrate the increase in output in relation to the level of research and devel-
opment investment input. Griffith (2000) utilizes the private rate of return calculation
(elasticity of output in relation to R & D) in order to demonstrate the spillover effect of
a company’s research and development investment, therefore proving that a company’s
investment in research and development benefits society. Although this paper argues that
research and development should be further subsidized by the government, it was incon-
clusive as to how much the government should subsidize such an investment, because of
2

4. the various problems related to these subsidies.
In his book, Motohashi (2015) investigated the success of one of the top cosmetic com-
panies in the world, Shiseido, in China’s emerging markets in the 80s and 90s. Through
the study of Shiseido’s growth in China over this time period, the author demonstrated
that their success was related to the opening of new research and development centers
that focused on Chinese medicine and beauty methods throughout China. In conclusion,
Shiseido was able to achieve success in China by investing more in research and devel-
opment. This case study is important because it establishes that investing in research
and development has previously led to success for one of the top multinational cosmetic
companies.
In an attempt to analyze all studies on research and development, Griliches (1979)
studied the commonly used approach to analyzing returns on research and development:
the production function. This study demonstrated the limitations that most studies of
research and development face. In assessing the difficulties of standard research and
development studies, Griliches (1979) reviewed the standard methods and equations that
are typically used to measure a company’s success as a result of spending on research
and development. One of the main difficulties that researchers face is defining what
constitutes research and development capital. Secondly, those who study research and
development need to expand the database that they have in order to measure research and
development. This study emphasizes the need to improve our knowledge of research and
development, as it has a very important economic impact. In conclusion, the study shows
that there is a need for improvement in research and development studies at both micro
and macro levels. Some such improvements are as follows: production functions need to
use consistent output and capital definition methods, enhancement of data collection, a
new panel in the published (SEC) record, better measurement of social return of research
and development and more attention paid to lag structures. In total, this study found
that the metrics that are typically used to analyze a company’s research and development
investment are inadequate and do not provide a complete picture of the effects of such
investments.
This purpose of this study is to determine if there is a link between research and
development and revenue growth in the cosmetic industry. Although none of these studies
directly study the exact same factors in the industry, they are important in establishing
that research and development has proven to be an important investment that affects the
success of companies in across a multitude of industries.
II. Descriptions of Data, Sample, and Tests
A. Description of the Data
The financial data for my research was extracted from Wharton Research Data Ser-
vices, a comprehensive database offered by the Wharton School of Business at the Uni-
versity of Pennsylvania. In this database, I specifically utilized Compustat to collect the
full financial statement for each cosmetic company. In order to decide which cosmetic
companies to analyze, I researched cosmetic companies listed in the Forbes Global For-
tune 500 list and 20 leading beauty manufacturers worldwide (by profit), as ranked on
Statista. Forbes is a global financial media company that provides up-to-date, precise
3

5. financial news and information. It is one of the most trusted financial news resources
in the world. The Global Fortune 500 list ranks companies by their total revenues, for
each of their fiscal years that ended on or before March 31, 2015. Each company on the
Forbes Global Fortune 500 list reports part or all of their financial data to the govern-
ment. Statista is a renowned statistics company that provides users with tools to analyze
quantitative data and statistics: this resource has statistics and studies from over 18,000
sources. After utilizing Forbes and Statista to decide which cosmetic companies were
among the top in the world, I used Compustat to collect the data on the research and de-
velopment expense and revenue each year, per company. In Compustat, the tool function
gives the user access to fully formatted financial statements, as found with a company’s
stock ticker symbol, over a period of years that the user specifies.
B. Description of the Sample
The sample of data that was analyzed in this study is compiled from financial state-
ments for 10 of the most profitable cosmetic companies in the world, for the time period
of 1995-2015. When assessing the most profitable cosmetic companies, recent rankings
(2014-2015) were used. For each company, both the research and development expense
and the revenue, per year, were extracted from the complete financial statement. This
twenty year time period was selected in order to have a statistically significant amount
of data to analyze. By collecting data from 10 companies, over 20 years, 200 total figures
(for both research and development expenditure and revenue) were analyzed.
C. Description of the Research Design
As described earlier in this paper, the purpose of my research was to determine if
there is a correlation between the amount of money that cosmetic companies invest in
research and development and their revenue growth. The null hypothesis that is raised
by this study is presented as follows:
H0 : Cosmetic industry revenue growth and research and development expenditures are
unrelated.
In order to test this hypothesis, the percentage growth of revenue and research and
development for each firm was calculated over a 20 year period. This data was then
analyzed with a standard correlation equation, which is presented below:
ρ =
Covariance(X, Y )
σXσY
(1)
where X = Percent change in sales and Y = Percent change in R & D
By analyzing 200 figures for both research and development expenditure and revenue,
and calculating this correlation, a pattern for the cosmetic industry was determined. A
correlation between 0 and 1 would indicate that there is a positive relationship between
the two data sets, and would therefore lead one to reject the null hypothesis 6
. This would
then cause one to conclude that there is a positive relationship between the amount of
6. (2015). Positive Correlation. Investopedia.
4

6. money that cosmetic companies are spending on research and development and their
growth in revenue.
III. Empirical Results
A. Descriptive
After calculating the percentage change in revenue and the percentage change in re-
search and development for all 10 cosmetic companies over 20 years, I calculated the
correlation between this data set. The correlation between the percent change in revenue
and the percent change in research and development over 20 years, for top performers
in the cosmetic industry, is .387067. This correlation indicates that there is a positive
relationship between research and development investment and revenue growth in the
cosmetic industry. The correlation is moderate, as it is below .5. Although it is mod-
erate, the correlation does indicate that when a company invests more in research and
development, there is an increase in revenue.
B. Test Results of the Hypothesis
Based on the results of this study, I reject the null hypothesis that cosmetic industry
revenue growth and research and development expenditures are unrelated. Although
the correlation is moderate, at .387067, it nonetheless indicates that there is a positive
relationship between a company’s expenditure on research and development and revenue
growth in the cosmetic industry.
IV. Conclusion
The purpose of this study was to determine if research and development in the cos-
metic industry is linked to revenue growth. The figures for research and development
expenditure and total revenue were collected from the complete financial statements for
each company, over 20 years (1995-2015), as accessed through the Compustat database.
The sample consists of 10 of the top cosmetic companies in the world.
After collecting all of this data, I calculated the percentage change in revenue over the
20 year period, and then the percentage change in research and development expenditure,
for each cosmetic company. In order to test the null hypothesis, I utilized a standard
correlation equation to analyze these two sets of data, which resulted in a correlation
coefficient of .387067.
Based on the results of this study, I reject the null hypothesis, in support of the alter-
native hypothesis that, in the cosmetic industry, research and development expenditure
and revenue growth are related. Although the correlation is moderate, it indicates that
cosmetic companies that invest more in research and development do experience revenue
growth. Therefore, all stakeholders in the cosmetic industry should be concerned about
the amount of money that cosmetic companies are investing in research and development,
as it is linked to their revenue growth, and as a result, their success.
5

7. V. Future Research
In the future, I would add more variables to my research in order to give it a broader
scope and more precise conclusion. Firstly, I would research more studies in this field, in
order to determine what factors typically constitute research and development. In doing
this, I would test what the best way is to measure research and development expenditure
i.e. including the cost of labor and capital (going beyond the research and development
expenditure on the income statement). I would also expand my existing research by
examining the correlation between research and development expenditure and revenue
growth, per company, and then by industry. Additionally, as many of these cosmetic
companies own a multitude of smaller cosmetic brands, I first would research how much
they are investing in research and development as a whole. I would then examine how
much of this investment is geared toward each brand and investigate if the expenditure
per brand is the same. Furthermore, I would also research the correlation between other
factors and research and development in the cosmetic industry. One such factor that
I would potentially investigate is the correlation between net profit and research and
development expenditure in the cosmetic industry. A limiting factor in this study was
the fact that private cosmetic company information is not readily available. Therefore,
I would like to conduct a study on private cosmetic companies separately, collecting as
much information as possible, in order to test the null hypothesis for private companies.
In total, each of these suggestions would further expand the results that were found in
this study on research and development expenditure and its link to revenue growth in
the cosmetic industry.
6

8. REFERENCES
Baily, Martin Neil, 1972, Research and development costs and returns: The u.s. phar-
maceutical industry, Journal of Political Economy 80, pp. 70–85.
Eberhart, Allan C., William F. Maxwell, and Akhtar R. Siddique, 2004, An examina-
tion of long-term abnormal stock returns and operating performance following rd
increases, The Journal of Finance 59, pp. 623–650.
Gerybadze, A., 2010, Innovation and International Corporate Growth (Springer).
Griffith, R., 2000, How important is business r and d for economic growth and should
the government subsidize it?, The Institute For Fiscal Studies pp. 1–12.
Griliches, Zvi, 1979, Issues in assessing the contribution of research and development to
productivity growth, The Bell Journal of Economics 10, pp. 92–116.
Motohashi, K., 2015, Global Business Strategy (Springer).
7