US offshore outsourcing of R&D: accommodating firm and national competitiveness perspectives.

SUMMARY

In the United States (US), the policy debate surrounding offshore outsourcing of 'white collar' service jobs, many of them high-paying, professional and technical positions, has recently focused on an area having potentially serious consequences for America's long-term national competitiveness: the business strategy of offshoring firm research and development (R&D) activities of critically important industries, such as information technology (IT) and pharmaceuticals. The author argues that, from a business perspective, an effective R&D offshore outsourcing strategy embraces an 'Open Innovation' approach, which emphasizes a careful balance between retaining core internal R&D capabilities while leveraging formal, collaborative technology relationships that enhance new product development and protect the corresponding intellectual property. US public policy complements this private sector strategy by establishing a foundation for improving the technological capabilities of the citizenry, restricting technology-sensitive areas from offshore outsourcing due to national security imperatives, and providing tax incentives for domestic R&D investment (and eliminating public financial incentives) for offshore outsourcing.

KEY WORDS

cost; information technology; open innovation; outsourcing; pharmaceuticals; research and development

INTRODUCTION

In the United States (US), the policy debate surrounding offshore outsourcing of 'white collar' service jobs, many of them high-paying, professional and technical positions, has recently focused on an area having potentially serious consequences for America's long-term national competitiveness: the business strategy of offshoring firm research and development (R&D) activities of critically important industries, such as information technology (IT) and pharmaceuticals.

Offshore outsourcing of R&D is a growing strategic phenomenon in the IT industry, with industry leaders such as Intel, Microsoft, Motorola, and Texas Instruments having moved product development centers to China, and Accenture, AMD, Cisco Systems, Google, IBM, and Microsoft outsourcing product development centers to India. Microsoft is reportedly planning to invest additional $400 million in India and $750 million in China on R&D between 2004 and 2006 (Austin, Hills and Lim, 2003) with Accenture and IBM adding 15,000 additional positions India by the end of 2005 (Travis, 2004). Frost Sullivan, another market consulting group, estimate that the IT R&D outsourcing market in India will increase from the present level of $1.3 billion annually to $9 billion by 2010 (Frost & Sullivan, 2004). According to AMR Research, this translates to 800,000 IT-related jobs being offshore outsourced from the US to India by 2008 (Travis, 2004).

For the US pharmaceutical industry, offshore outsourcing has become an increasingly utilized R&D strategy over the last few years. In a recent study, private banker UBS Warburg found that of the $30 billion that the US pharmaceutical industry invested in R&D in 2001, around 20 to 25 percent of this was spent on outsourcing; analysts predicted that this outsourced portion of pharmaceutical R&D spend would expand by 1 percent through 2005 (Pharmiweb.com, 2004). This pharmaceutical R&D strategy has been embraced by GlaxoSmithKline, which is planning to conduct four clinical trials in India in 2004 (Frost & Sullivan, 2004).

But other industry sectors, such as automotive, are also moving R&D offshore. Examples include vehicle systems and glass supplier Visteon which is launching R&D centers in China; and General Motors, choosing India to outsource product development work in the near future (Frost & Sullivan, 2004). Furthermore, industrial systems technology leader General Electric already employs 6,000 scientists and engineers in ten foreign countries (Austin, Hills and Lim, 2003).

To address the US R&D policy debate concerning sustainable competitiveness for the firm and nation-state, this article will first introduce the managerial motivations for offshoring R&D activities. Second, organizational and environmental factors inhibiting offshoring R&D activities will be identified. Third, the potential consequences of exporting R&D and its impacts on national competitiveness will be briefly discussed. Finally, a business and public policy model--which can influence the development of a consensus R&D offshore outsourcing policy framework accommodating both private and public sector competitiveness concerns--will be presented for private and public sector consideration.

MANAGERIAL MOTIVATIONS TO OFFSHORE R&D

The primary driver of US firms' R&D offshore outsourcing is ostensibly cost-savings. The business press points out that IT and telecommunications development work, costing $100 an hour in the US, can be performed for as low as $20 an hour in India or China. However lower costs is only one factor, albeit an important one, in this strategic decision-making process. The primary driver of offshore outsourcing of R&D is the availability of highly-educated intellectual capital. For example, one-third of the 180 computer scientists at the Microsoft Beijing research center have PhDs from US universities and are responsible for developing the 'digital ink' that makes handwriting show up on Microsoft's new tablet PCs (Engardio et al., 2003). In the IT field, India has the largest number of Java-certified developers in the world and its scientists and engineers are fluent in English, thereby reducing communication problems found in other countries popular for outsourcing (Frost & Sullivan, 2004). Moreover, India offers IT R&D opportunities in an array of computer sub-specialties, including computing architecture, encryption and network security, human computer interface, programming language and software engineering (Offshore Outsourcing World, 2004). Similarly, in telecommunications R&D, business support systems, new versions of IPv6, video servers and wireless sensors opportunities are available for offshore outsourcing on the Indian sub-continent.

Foreign companies are also attracted to Asia's academic institutions as a source of intellectual capital, with companies looking to leverage foreign research efforts and facilities. Moreover, firms now have the ability to perform R&D 24 hours a day, seven days a week. For example, programming code is developed in the US during regular work hours, and then follows the time zones to India, on to Europe and back to the US for the beginning of the next 24-hour period (Babcock, 2004). The Boston Consulting Group (BCG) reports that its study of offshore outsourcing found that US firms with major operations in low-cost countries (China and India, for example) report faster R&D (Blustein, 2004). Furthermore, the BCG study found that mid-level engineers in offshore locales tend to be more motivated than mid-level engineers in the US and Europe.

The ability of these offshore R&D centers to support co-located manufacturing activities that have previously moved offshore contributes to product development efforts--improving product cost, quality, performance and availability. This allows firms to accelerate the availability and acceptance of state-of-the-art technology and products to business and consumer markets in these underdeveloped market areas. Firms who maintain R&D technical centers worldwide contribute to the local economies of those countries, typically by leveraging such centers of R&D to stimulate their own economies. Those R&D centers ultimately become part of those nations' economic development strategies which result in improving consumer income levels that, in turn, allow for the purchase of higher value-add business and consumer products (National Science Board, 2002).

In the pharmaceutical sector, Ernst & Young (2004) identifies India as an emerging hub for collaborative and outsourced pharmaceutical R&D. India can combine lower-cost manufacturing with adequate regulatory protection of intellectual property (IP), resulting in a potential 30-50% cost saving for global companies. A recent phenomenon has Indian companies shifting their strategic models from business-driven research to research-driven business. According to Ernst & Young, Indian companies are adopting a combination of alternative business models to navigate competition and opportunity. These include:

* Focusing on export led growth through subsidiaries or acquisitions in high margin regulated markets;

* Bolstering research capabilities;

* Partnering across the value chain with multinationals multinationals through licensing, collaborative R&D or co-marketing arrangements;

* Contract research and manufacturing.

FACTORS INHIBITING OFFSHORING OF R&D

Given the reasons cited above, one would think that it would be a relatively easy decision for management to offshore R&D. But like many so-called obvious decisions, the devil is in the details. For example, when AMR Research concluded that the benefits of offshore outsourcing of R&D are too great to ignore, the market research firm also noted that it will take the implementation of three projects before a firm will benefit from any cost savings (Watkins, 2004). Too often, companies do not make the financial investment that is required to make offshore outsourcing cost-effective. For example, the total cost of outsourcing (TCO) in the IT industry includes:

* Expenses involving selecting a vendor (two percent); transitioning work over to the offshore partner (from two to three percent);