The new logic of offshoring: the next generation of offshoring—innovating and engineering—is at hand

Chief Executive, The, Sept, 2007 by Jennifer Pellet

In its earliest phase, offshoring was driven by cost reduction and limited to non-mission-critical work such as call centers, credit card processing and administrative work. Companies raced to source work in Asia-Pacific, South American and Eastern European countries where workers are plentiful and wages are low. Over time, the level of work being performed abroad began to move up the value chain, encompassing more technical work, including finance and accounting.

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The next wave--where companies move work even more essential to competitive success, such as innovation and engineering, overseas--is now upon us. Already, IBM has established an R & D lab in New Delhi and announced intentions to recruit some 14,000 additional "software inventors," according to a recent report by Duke University and Booz Allen Hamilton. Motorola currently operates 16 R & D centers in China, which collectively employ 1,800 engineers, a tenth of the company's total global R & D head count.

These are not anomalies. According to a recent survey by the Economist Intelligence Unit, a research firm headquartered in London, a growing number of companies are outsourcing and/or offshoring aspects of the innovation process. Some 65 percent of companies surveyed said that at least some of their R & D activity is taking place overseas; 64 percent reported currently outsourcing part of the innovation process to outside organizations.

Done well, leveraging the less costly talent pools of foreign shores can clearly offer a huge competitive advantage, noted CEO participants in a roundtable discussion cosponsored by Butler International. In countries like India, China, Mexico and Russia, technical know-how is available at a fraction of what it would cost in the U.S. Companies able to tap this pool effectively can create and roll out prototypes at a fraction of the cost it would take competitors sourcing innovation in the U.S. or Europe.

Strategic Sourcing

At first blush, moving core processes like innovation to foreign shores seems like a huge leap. But it's actually a natural next phase of the offshoring movement, pointed out Joe McGrath, CEO of Unisys. "The global arbitrage of labor, the talent available around the world, and the number of engineers graduating in [developing economies] have led us to move functions you wouldn't have expected offshore," he said. "Because of Sarbanes-Oxley, for example, it's hard to get internal auditors in the U.S. So we've sourced all our recent hires in Shanghai. Who would have thought that your core auditing practice would be in Shanghai, Budapest or Hungary? But that's where it is."

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Companies are no longer just moving things that are easy to do offshore," agreed Gary Gereffi, a professor in the Department of Sociology and Markets & Management Studies Program at Duke University. "Microsoft's Beijing R & D Center is doing things with character recognition software that they think are as advanced as anything going on with that issue anywhere in the world. And GE's [research] of environmental issues in China is also unique. As capabilities grow, companies are trying to find places around the world that can tackle global problems in the best possible way."

A confluence of factors is driving this trend. In a world where great ideas are quickly assimilated across global markets, continual innovation is crucial to competitive success. At the same time, the development of ever-more-sophisticated technology is driving an increase in both the cost and complexity of R & D activity for most companies.

"Outsourcing is something of a misnomer," noted Ron DeFeo, chairman and CEO of Terex, who says the word often has undeserved negative connotations among the general public. "The term tends to politicize the practice, when in reality we are not giving something up, we're looking for the best answer," he adds. "If that best answer sits next door to me and is affordable, I would be foolish not to go there. If it sits halfway across the globe and is difficult to achieve but is my best solution, I'd be stupid not to go after that."

And even companies with the deepest of pockets find themselves grappling with shortages of specialist talent in their local marketplaces. A recent study by Duke University suggests that the long-lamented decline in the number of Americans graduating with engineering degrees is not as significant as early statistics suggested (see chart p. 40). But U.S. CEOs still report facing a shortage of workers capable of developing next-generation technologies and managing R & D teams.

Why the dearth of qualified candidates? "One issue is that we have a hard time getting the best and brightest U.S. undergraduates to go into engineering and science," said Gereffi. "They have lots of other attractive options."

"When parents look at what they want to encourage their children to do, they almost always consider where the money is," agreed Leif O'Leary, senior vice president of Parametric Technology. "The most lucrative opportunities in America are almost always investment banking, financial services and consulting."