RESEARCH AND DEVELOPMENT isn’t core anymore. More and more U.S. companies are outsourcing R&D projects to offshore service providers as they look to cut costs and take advantage of available expertise in Asian countries such as India and China.
The potential benefits of an offshore R&D-outsourcing strategy are compelling: companies can save money because of lower labor costs and gain an early foothold in some of the fastest-growing overseas markets by having an R&D presence in those countries. But offshoring R&D also comes with challenges and risks, such as overcoming language and cultural barriers; security and regulatory issues; protection of intellectual capital; and the high turnover rates of employees in foreign countries.
However, these and other concerns are not stopping increasing numbers of U.S. companies from shifting at least some of their R&D efforts offshore. Some of the work is conducted in captive (company-owned) centers, but more of it is sent to third-party service providers. Some of the work results in functionality embedded in cell phones or laptops, but quite often the work involves commercial software.
A practice that began with General Electric hiring engineers in India more than a decade ago is becoming pervasive in the IT industry, with technology-sector heavyweights such as Microsoft, IBM, Cisco, Intel, AMD, Motorola and Texas Instruments moving some product development to India or China. U.S. companies in industries such as electronics, pharmaceuticals, automotive manufacturing and biotechnology are outsourcing more R&D work to service providers in China, India and other countries.
“Currently larger amounts [of work] are flowing into China in the area of new product development and manufacturing research,” says R. Balachandra, Professor, College of Business Administration, Northeastern University, Boston, Mass. “The flow to India is in the area of pharmaceuticals and in high-level R&D, which is expected to increase significantly in the future.”
“Essentially, the main driver is growing demand for innovation that U.S. companies face on a global scale,” says Navi Radjou, VP, Forrester Research Inc. “Unfortunately, U.S. firms lack in-house capabilities to effectively meet that growing demand.”
The transformation in R&D strategy is reflective of changing corporate views of risk and reward. R&D is both a business expense — and a risk — that doesn’t always pay off. In contrast, the concept of transferring R&D risk to a third party that guarantees results begins to persuade corporate strategists. It’s becoming too expensive for corporations to adopt a “not invented here” attitude.
But, of course, there’s a trade-off. It’s harder to manage what you don’t control in-house.
Heating Up
Consulting firm Frost & Sullivan has estimated that the IT R&D outsourcing market in India alone will increase from $1.3 billion in 2003 to $9 billion by 2010, at a compounded annual growth rate of 32%. The R&D outsourcing market for telecom in India is expected to increase from less than $1 billion in 2003 to $4.1 billion in 2010, at a CAGR of 29%.
Ernst & Young’s 2005-2006 Global Transfer Pricing Survey released in November 2005, which polled 348 multinational companies and 128 subsidiary companies in 22 countries, found that about 10% had created either new or relocated R&D operations in the past two years. Of these, 27% said India was the leading destination for relocation, while 17% identified China as the leading destination.
The offshore R&D-outsourcing market has attracted both large service providers and smaller niche players that focus on specific industries. Among the companies offering services are Wipro, MindTree, HCL Technologies, Sasken Communication Technologies, Satyam Computer Services, Ness Technologies and Office Tiger.
