R&D organizations are slowly increasing the amount of R&D they outsource, even as the work increases in complexity and political issues mount.
Outsourcing of various aspects of an organization's business functions has been happening for decades. In recent years, much of this work has been in the information technology (IT) area, although product development work and actual R&D for manufacturers has been working its way up the "food chain" as well, as suppliers and focused companies provide lower cost, faster response solutions to the sponsoring organizations' product needs.
The majority of outsourcing in the U.S. has been to other U.S.-based organizations (84%) that focus on mostly on manufacturing, although Asian (50%) and European (25%,multiple sources result in more than a 100% total) offshoring continues to take a bigger share.According to a recent reader survey (May 2007) by the editors of R&D Magazine, about 18% of those organizations outsourcing R&D have sent some of their work to China, and 19% have sent some of their work to India.
A similar R&D reader survey performed in May 2002 provides a look at the trends in outsourcing over the past five years. Looking at these trends reveals that, while the number of companies outsourcing their R&D work stayed about the same, the amount of work that they outsourced increased from an average of 21.5% in 2002 to 24.4% in 2007.A summary of the results of the 2007 survey is given in the charts below.
A similar survey, Next Generation Offshoring-The Globalization of Innovation, by The Fuqua School of Business at Duke Univ., Durham, N.C., and management consulting firm Booz Allen Hamilton Inc., N.Y., also found that companies across all industries are increasingly moving sophisticated, mission-critical functions such as product design and R&D to China, India, and other offshore locations. The reasons cited for these moves are primarily that these countries can provide highly skilled scientific and engineering (S&E) workers who are in short supply in the U.S. Indeed, the Duke study found that nearly three-quarters of the 537 companies surveyed reported that access to qualified personnel was the most important driver of their offshoring strategy. In the R&D survey, 52% of the nearly 400 respondents indicated that the expertise of the outsourcing organization was their most important reason for outsourcing their R&D.
In the Duke study, the number of industrial firms offshoring some of their R&D nearly doubled from 16% in 2002 to about 31% in 2007. Indeed, the number of new implementations of R&D offshoring increased by 38% from 2005 to 2006. Three implications of the Duke study are stated—“core” activities of a company may be entirely redefined, offshore labor will become a significant part of a company's overall workforce, and increased offshoring will change the global mix and quality of available jobs.
The drivers for offshoring appear to have changed over the past two years, according to the Duke study. Cost reductions seen from lower labor costs is still the primary reason for offshoring, with 80% of the respondents in their 2006 survey indicating that this is an important or very important reason for offshoring—this is up from about 70% in the 2004 Duke survey.Access to qualified personnel is growing the fastest— from less than 40% in 2004 to more than 60% in 2006. Business process redesign and increased speed to market are similarly growing faster than cost effects. Competitive pressures and access to new markets are declining in importance as offshoring drivers.
The Duke study identifies differences between those companies that are currently offshoring and those considering offshoring. The largest differences are in the access to qualified personnel where those currently involved say this is more important (70%) than those considering offshoring (62%). On the other side, the study indicates that the resultant business process redesign is more important to those considering offshoring (67%) than to those already offshoring (50%).
The Duke researchers note that it is no longer sufficient to just simply move work to a lower-cost location. Companies want quality improvements to their overall organization as well.
The Duke study states that the quality of jobs available in offshore locations is expected to continue to improve and will provide tremendous opportunities for people in countries that are offshoring destinations.
Another recent survey, Sharing the Idea—The Emergence of Global Innovation Networks, by the Economist Intelligence Unit of The Economist, London, UK, states that 65% of the 300 surveyed global executives in Nov. 2006 indicated that their organizations performed at least some of their R&D offshore. They predict that this will increase to 84% by 2010. Of all the countries in the world, these executives chose India (26%) as being the best offshore location for R&D. The U.S. was the second- most popular choice (22%), China was third (14%), and Canada was fourth (7%).
When asked about what geographic areas will see increased levels of R&D investments over the next three years, respondents in The Economist survey said that the Asia-Pacific region would see the largest investments (2.1 rating on a 1 to 5 sliding scale with 1 = substantial increase, 5 = substantial decrease).North America was second again with a 2.6 rating, and Europe was third with a 3.0 rating.
U.S. still preferred, but declining
The U.S. is still the richest country in the world, and most of the respondents in these three surveys indicate that its high-quality workforce, robust intellectual property (IP) protection, and integrated infrastructure outweigh its relatively high labor costs as a preferred destination for R&D. The expanding economies of countries like India, China, and Eastern Europe, however, are on track to close the gap and possibly overtake the U.S. in the future. India, for example, produces a million English-speaking graduates/year, and by 2008 will have more technology graduates than the entire population of the UK.
As a destination for R&D, China is still being held back, according The Economist survey, by its relatively poor IP protection and the vagaries of its legal system. In the R&D Magazine survey, IP protection issues is listed as the main reason that companies don't outsource their R&D, although the response rate for this particular item dropped from 65% of the respondents in 2002 to 58% in 2007.
Despite the U.S.’s long-standing leadership role in R&D, the Asia-Pacific region as a whole is expected to receive more offshore R&D over the next three years than any other region, including North America.
The increasing size of the technology sector and resultant middle class in Asia, however, has encouraged companies in both Europe and North America into restructuring their companies to see how they can localize their product development efforts (in situ innovation) and grow their overall companies.
Offshore restrictions
Globalization of the world economy is working to more evenly distribute technology resources as well.Adding to this situation, India, China, and other Asian countries are increasingly putting stipulations on foreign companies doing business in their countries. Ten years ago, these restrictions required that at least some manufacturing be performed in their countries in order to sell products there. Those restrictions have expanded now to include R&D work and the creation of technology jobs as well.
While most of the world's tastes and preferences have been and are still currently influenced heavily by Western culture and lifestyle, the cultural redistribution due mostly to globalization effects will see changes in this area with a resulting need to satisfy regional customer market requirements. This will result in increased product development focused on the regional requirements. These changes are already occurring with globally-based companies often ensuring that their R&D departments are distributed where they do business. Some companies, according to The Economist study, while not increasing their overall headcount, are establishing target headcount levels for their foreign operations.
Outsourcing implications
Outsourcing, and in particular its offshoring variant, has become a significantly more strategic issue to companies, and it is becoming integral to the conduct and performance of business. Many companies are already gaining experience and confidence in their abilities to use this practice to deliver strategic business benefits such as improving their business efficiencies and their speed to market. This can be seen in highly integrated companies such as Boeing where components for its new state-of-the-art 787 aircraft are designed, developed, and manufactured at multiple locations (and companies) throughout the world and delivered to Boeing’s U.S. final assembly plant for integration into the final qualified aircraft. This has obviously been done in the past, but never in such a distributed manner and never with such a large number of dramatic changes in manufacturing techniques and materials.
Another trend noted by these studies is that the era of employees moving to where work is available is changing to a new reality in which companies are moving work to where the best and most highly skilled employees are available.As more and more companies locate their R&D work offshore, it will change the way these companies are structured and how their business functions will be staffed.
According to the Duke study, “companies will become more globally integrated and be more sensitive and adaptable to the global supply and demand for talent.”
A concluding result from these studies is that the offshoring of innovation- centered functions, including R&D, product design, and engineering, that have already been implemented have not been associated with job losses in the companies’ onshore staffing. Long a political hot potato of suspected diminishing domestic high-tech capabilities, according to the Duke study, 90% of the R&D projects where offshoring was involved did not see any onshore job reductions. This obviously is not the case for finance and accounting, human resource, procurement, and other primarily administrative functions where offshoring was involved.
Published in R & D magazine: Vol. 49, No. 6, June, 2007, p.26-29.
