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The Case for R&D Outsourcing


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In the outsourcing territory, research and development (R&D) is considered the final frontier. That’s because R&D is seen as a source of...innovation – the mother of competitiveness, which is to be protected at any cost. As we all well know, from our business studies text books, core activities should never be outsourced.

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The Case for R&D Outsourcing

  1. 1. Insights The Case for R&D Outsourcing - Dr. Martin Lockstrom Introduction In outsourcing territory, Research & Development (R&D) activity is considered the final frontier. That’s because R&D is seen as the source of innovativeness – the mother of competitiveness, to be protected at any cost. As we all know from our MBA textbooks, core activities should never be outsourced, as this could potentially create a new competitor.
  2. 2. However, this is in fact a truth with a rider or two. Firstly, the R&D function contains an array of business activities that need to be analyzedseparately. Many of these are operational, of low strategic relevance, and could be performed more efficiently by an external service provider ina low-cost offshore destination. Examples of such activities include (but are not limited to) market study, product testing and legal support. Inother words, when making outsourcing decisions, one should not only look at business processes at a functional level, but also dig deeper intosub processes and tasks in order to identify opportunities, which can subsequently be clustered and allocated to external providers in order toachieve efficiency and synergies (see Figure 1). CASE 1 CASE 2 Business Function Business Function 1 Business Function 2 Business Function 3 Figure 1. Clustered sub process outsourcingSecondly, it doesn’t matter where an invention originates (geographically … internally/externally); what matters is who will finally appropriateit. Take for example Skype, founded by a couple of people from Sweden and Denmark, but developed by Estonian programmers. Or the BMWX3 model, which was to a great extent developed by Magna Steyer and produced at its plant in Austria. And at P&G, more than half of theirproduct innovations originate outside the company today.In sum, the capability to turn inventions into innovations and successfully bring them to the market is far more important than the inventionsper se. This is true in most industries where patents provide limited Intellectual Property (IP) protection and can often be circumvented throughalternative designs; research says that only the chemicals and pharmaceuticals industries have adequate patent protection. In other industries,patenting is merely a tactic to fend off competitors in the short to medium term.R&D Outsourcing Drivers Adapt. Besides increasing simplicity in R&D (i.e. reducing complexity), R&D outsourcing also increases adaptability since creative thoughtSo why do companies outsource in the first place? Well, for starters, processes can be handled in a more autonomous, decentralizedthe basic idea is to get a job done by whoever is best suited to do it. fashion without being overburdened by overheads and administration.However, as mentioned earlier, first companies need to come to grips This characteristic is becoming increasingly important with productwith what they really do best and what differentiates them from their lifecycles shrinking and short time-to-market becoming critical tocompetitors, in order to determine which business activities to retain competitive advantage. This is especially important in industriesin-house. When executives and senior managers are asked about their such as consumer electronics, where patents offer limited protectioncompanies’ core competencies, surprisingly, few have a clear answer. and delay means lost revenue that cannot be recouped easily. To citeThis phenomenon, combined with the fact that many executives are one example, this is why Apple uses an ecosystem approach, whichincentivized to trim their balance sheets can explain the frequent loss enables external firms to develop its smartphone apps.of competitiveness through poorly executed outsourcing decisions.As part of the Infosys Building Tomorrow’s Enterprise (BTE) framework, Collaborate and Learn. In today’s fast-paced economy, no singlethe following themes help uncover those opportunities that need a company can alone possess all the knowledge and capabilitiesgreater share of R&D outsourcing. required to bring new innovations to the market. In fact, when external competencies complementing the company’s core abilities are combined and integrated in unique ways, they can add significantSmarter Organization value. Outsourcing of R&D and joint activities can greatly increaseSimplicity. Research shows that company size is strongly linked to productivity be expanding the flow of knowledge outside the firm’sR&D productivity; the larger the organization, the lower the marginal boundaries. Take for example the frying pan coating Teflon, whichreturn on every dollar invested in R&D. In the past, many companies was discovered by accident by the company Kinetic Chemicals, a jointerroneously believed that R&D productivity could be increased by venture between DuPont and General Motors.creating economies of scale, but alas it is not so. The specific causesfor this are beyond the scope of this article, but nevertheless this is Emerging Marketsthe reason why most disruptive innovations originate from Small andMedium Enterprises (SMEs). And since complexity tends to grow with Over time, emerging markets have become extremely important tocompany size, R&D outsourcing is often an effective means to passing companies of any size across all industries: Here’s the view on R&Don some of that to an external party. outsourcing to emerging markets from a BTE perspective.2 | Infosys
  3. 3. Growth Momentum. Emerging markets have become more important Hence, the supply of engineering talent is vastly bigger in emergingthan ever due to a couple of reasons. Firstly, companies in mature economies. For instance, in 2010, China and India produced more thanmarkets are facing the headwinds of slumping consumer demand 2.6 million and 1.19 million science, technology, engineering and mathcaused by the recent global financial crisis. This means that Multi graduates respectively. Even though the majority of fresh graduatesNational Enterprises (MNEs) have to increasingly seek new revenue may not be globally competitive, the numbers are still attractive.opportunities in emerging markets where growth numbers are still Smart Sourcing. Due to the many institutional voids – weak legalrelatively healthy. Secondly, this means that companies also have system, poor infrastructure and so on – frequently encountered into localize R&D activities in order to better serve local consumers emerging markets, it is necessary to have an adequate network ofin emerging markets where competition is rapidly gaining pace. external knowledge partners. The most common way of buildingFor instance, companies like GE and Novartis have located global strategic ties is by setting up a joint venture (JV) with a local player,R&D centers in Shanghai, China, each of which employ more than a who can provide the necessary guidance on navigating the localthousand people. market, accessing local governments etc. The foreign MNE partner,Innovation Hubs. Although new market access and cost reduction are on the other hand, usually brings in the required management andtwo important drivers of R&D outsourcing, another key driver is access technological expertise. Even though JVs are declining in popularityto talent. Whereas the interest in pursuing engineering and natural in countries like China, they are still a viable approach for overcomingsciences as a career is on the decline in the West, these subjects are local obstacles in the early stages of market entry.a big draw for the youth in emerging markets like India and China.Making the Outsourcing DecisionThe R&D outsourcing decision cannot be finalized overnight. It must consider all the above mentioned important aspects. Above all, it is criticalthat the outsourcing decision not be driven by personal incentive. What’s more, as mentioned earlier, it is necessary to analyze not only functionsand processes, but also sub processes and tasks. The following checklist can add clarity to the R&D outsourcing decision making process. If theanswer to any of the questions is “yes”, the corresponding activity must not be outsourced. Does the activity help to Core activities are those that make a company unique among its competitors. create a differentiated market Keeping these proprietary and protected from competitors enables the company position (i.e. core activity)? to command premium product/service pricing and in turn, superior profit. Most companies, if at all, usually only pay attention to core activities. However, Is the activity directly the outsourcing of complementary activities that support core activities can supporting a core activity? put the company in an adversarial dependency position with an external service provider and should hence be retained in-house. CHECKLIST COMMENT Does the activity utilize or generate Intellectual property is the output of core activities. According to the logic in strategically important intellectual points (1) and (2) above, activities using or generating strategically important property? IP should be performed in-house. In order to avoid adversarial dependency situations, there must be a sufficient Are there less than two number of service providers available in order to obtain competitive pricing capable external service and quality of service. For instance, all too cozy supplier relationships at NASA providers available? led to spiraling costs and closure of the shuttle program. Is the internal option better than the A competitive offer from the external provider must also be more competitive service provider’s offer in terms of than the in-house alternative. If not, the outsourcing decision cannot be cost and quality of service? economically justified.Another important decision is whether or not to retain the organizational capability underlying an activity that has been outsourced; in otherwords, the make-or-buy decision has to be made in conjunction with the outsourcing decision. Retaining in-house capability makes it mucheasier to reverse an outsourcing decision. In other words, the outsourcing decision is not painted black and white, but rather in grey tones. Infosys | 3
  4. 4. Conclusion Outsourcing has become commonplace in most companies and virtually every industry. However, many companies are reluctant to outsource R&D activities for the fear of IP loss. This fear is not baseless, as history is replete with cases of IP theft. Nevertheless, in order to identify potential candidates for R&D outsourcing, companies must analyze the R&D function at sub process or task level. Also, they must base their decision on a solid business case, which factors the impact of outsourcing on not just R&D, but also the rest of the organization. About the Author Dr. Martin Lockstrom Principal Consultant, Building Tomorrow’s Enterprise, Infosys Labs Martin is a specialist in Supply Chain and Operations Strategy, Outsourcing/Offshoring and International Management. During a six-year stint in China, he established the research and education activities at the SCM, Sustainability and Automotive academic centers at China Europe International Business School, Shanghai. He established the first endowed chair for Purchasing and SCM in China at Tongji University, Shanghai, and was also responsible for setting up Supply Chain Management Institute China, an international network of SCM research and education hubs. Martin co-founded Procuris Solutions, an IT company specializing in SCM-related solutions, offering consulting services to companies like Accenture, Ariba, BMW, Clariant, Dell, Dow, Ernst & Young and Intel, among others. He has a Ph.D. in Supply Chain Management from European Business School, Germany, a bachelor’s and master’s degree in Industrial Engineering and Management, from Chalmers University of Technology, Sweden. He speaks Swedish, English, German and Chinese, has published over 50 articles and papers and presented at more than 60 conferences.About InfosysInfosys partners with global enterprises to drive their innovation-led growth.Thats why Forbes ranked Infosys 15 among the top 100 most innovativecompanies. As a leading provider of next-generation consulting, technologyand outsourcing solutions, Infosys helps clients in more than 30 countriesrealize their goals. Visit and see how Infosys (NASDAQ: INFY),with its 150,000+ people, is Building Tomorrows Enterprise® today.For more information, contact© 2012 Infosys Limited, Bangalore, India. Infosys believes the information in this publication is accurate as of its publication date; such information is subject to change without notice. Infosys acknowledgesthe proprietary rights of the trademarks and product names of other companies mentioned in this document.