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Establishing business operations in far-flung corners of the world has become a routine challenge for many companies. The practice of locating production lines in developing markets where labor is cheap, and fast-growing markets easily accessible, is almost mundane. But manufacturing products globally is one thing: creating them is another. Until recently, much of the brainwork of the organization has been concentrated in the home market. This has been particularly true of research and development, that part of the business that is so integral to the creation of new products and innovative ideas. Now there are signs that companies are redistributing their product innovation, and in some cases even basic and applied research, across global networks.
Research and development, often referred to as R&D, is a phrase that means different things in different applications. In the world of business, research and development is the phase in a product's life that might be considered the product's 'conception'. That is, basic science must exist to support the product's viability, and if the science is lacking, it must be discovered - this is considered the research phase. If the science exists, then turning it into a useful product is the development phase. Further terminology refinements might call it engineering to refine production so that the product can be made for a cost that appeals to consumers.
Research and development is an investment in a company's future - companies that do not spend sufficiently in R&D are often said to be 'eating the seed corn'; that is, when their current product lines become outdated and overtaken by their competitors, they will not have viable successors in the pipeline. So how much is reasonable to spend on research and development? That is highly dependent both on the technology area and how fast the market is moving. Two percent of company revenue, not profit, might be enough in a fairly sedate market, but to keep up in rapidly changing markets, companies should expect to spend fifteen percent or more in research and development just to keep up with the rest of the pack.
There are serious drawbacks to using the price mechanism; the costs of learning about available goods, the costs of learning prices, the costs of negotiating contracts, and so on. As communication, both electronic and physical, has become easier, these costs have declined, and this has led to a tremendous increase in outsourcing. Firms purchase cafeteria services as well as goods from outside suppliers. Why not R&D? It is much easier to outsource R&D than formerly. The technology area is much more competitive, with many willing suppliers among contract houses, universities, as well as large research institutes and other corporations. And indeed we do see R&D done under contract. However, that is happening in restricted domains, primarily when the product can be specified precisely. In those areas, it is sometimes even feasible to send the work to India. There are serious limitations to this process, though. In areas of advanced development and especially research, where there are substantial uncertainties about the cost and outcome of a project, coordination and negotiation costs are overwhelming. This is very noticeable in the dealings between AT&T and Lucent, for example. While the two companies were one, a research project could be launched based on a few conversations between researchers and managers and perhaps a memo for record. Now, after the breakup, relations are like those of a typical pair of unrelated firms. Months of negotiations involving lawyers are required. How tight are the deadlines, who bears cost overruns, who owns the patent rights or software? All these questions need to be spelled out and their implications carefully considered. When the goal can be precisely specified, there are standardized procedures developed through long practice that simplify the process.
However, for research and parts of developments, the uncertainties create barriers and thus costs that discourage outsourcing. In general, there are many attractions to outsourcing R&D. There is potential for more flexibility with a greater variety of solutions, lower costs through competitive procurement and targeting only the specific areas that are of immediate interest, and better solutions through choice of the best technologies. Perhaps most important of all, there is so much technical knowledge relevant to just about any R&D project that no single firm can hope to possess it all. On the other hand, there are almost always many competent suppliers of any required expertise.
While there are attractions to outsourcing, there are also serious limitations. There are the negotiation and coordination costs mentioned above. There is loss of control over the technology and expertise with outsourcing. There is also potential loss of customer perception of technical leadership, and the loss of the technical expertise that is needed not just for effective implementation, even for selecting technologies and projects in the first place. These and related limitations have meant that advanced development and research tend to be done internally. Even when U.S. firms do use programmers in India and Russia, they tend to employ them directly, to avoid such difficulties.
Outsourcing of R&D is providing new opportunities for businesses to draw on local strengths and specializations on a global scale. The resulting global trade in knowledge and intellectual property and the strengthening of economies through R&D can provide economic benefits similar to other forms of trade. By the same token, companies and nations will find traditional strengths challenged by others, so those who are able to respond effectively to the competition will only realize these gains.
The commercial reasons for drawing on an international research base are concerned primarily with business strategy and a capacity to address changing business objectives. Cost is one, but should not be the chief determining factor in decisions to establish new R&D facilities, which are more concerned with access to markets, people, facilities and standards. The availability of well-educated workforces and increasingly affluent customers in China and India means that these regions are becoming more attractive locations for business R&D.
Outsourcing of R&D is not a new phenomenon but has taken on greater momentum in today's world, often described in terms of Open Innovation and globalization. Open Innovation assumes firms can and should use external ideas as well as internal ideas, and internal and external paths to market, as the firms look to advance their technology. Under open innovation, both external and internal ideas are used to create value, and internal mechanisms are defined to claim some portion of that value. Open innovation assumes that internal ideas can also be taken to market through external channels, outside the current businesses of the firm, to generate additional value. Ideas can also start outside the firm's own labs and can move inside. Open innovation allows the recovery of overlooked innovations. Now there's a greater chance the projects will find value in a new market or be combined with other projects, because everything is more open and flexible.
Companies supplement their in-house capabilities through relationships and contracts with academic groups, commercial laboratories and other companies. They can now search the world for these partners. R&D is going global and this is strengthening competition.
In responding to these trends, it remains important for governments to establish fair rules and efficient procedures across a wide range of public policies, concerning the use and protection of intellectual property, and to ensure the education and mobility of talented people. So why do businesses locate R&D facilities elsewhere?R&D is an integral part of business strategyCarrying out R&D is an integral part of running a business rather than somehow to be seen as an independent activity. The planning and execution of this R&D reflects and derives from considerations of the company's business strategy. Developing successful strategies depends on first answering the question "Where are the markets?" While in the first instance, R&D is usually based close to headquarters, as the company grows, its R&D will also develop to reflect changes in its markets. The movement may be less rapid or delayed by the time and costs involved in establishing top-quality facilities, but the trend is the same.
Companies locate R&D in regions that offer the potential for controlled, sustainable market growth, because they need to understand and be well connected with the needs of their customers in these regions. Currently, Asia offers the greatest potential for new and rapidly expanding markets, while markets in North America tend to be more flexible than those in Europe.
The consequences of open innovationIn the past, it was appropriate to distinguish between research activities, which were often more fundamental in nature, and development, which is necessarily carried out closer to market. Today, this distinction has become less relevant. Models are shifting away from supply-side models towards more demand-driven approaches that combine "R" with "D" and focus on speed and reducing complexity. The trends in managing research and development are towards closer collaboration between talented researchers in different public and private institutions and between companies, their suppliers and their customers.
Practices in internationalization of R&D reflect this need and possibility to establish useful connections with partners, customers, public institutes and other bodies, whose knowledge will contribute to producing and supporting the required products and services. Restrictions placed on the use of this knowledge, for example, by requiring domestic companies handle that implementation, can act against the interests of host nations.
Access to human capitalLeadership in a knowledge economy depends entirely on the quality of human talent that is available and the ways and areas in which these talented people choose to work. Large countries, like India and China, which are now producing large numbers of scientifically and technically proficient people, can and will host significant volumes of leading R&D activity. Competition for this talent, improved communication technologies, good infrastructures and easier market access will drive the process of R&D globalization.
Strong academic communities linked to dynamic business communities within supportive government frameworks are essential features of the growth and clustering of R&D. It is not only the developing countries that attract such R&D clusters. Such movement is also taking place within the OECD. It is worthwhile to note the relative strengths of the biotechnology and information technology sectors in the US compared to Europe. The capabilities of the native workforces were no different. Different patterns of strength today have clearly been influenced by flows of students from other parts of the world. While there are differences among European countries, Europe has not benefited in recent years from the same influx of foreign human talent as the US.
The obvious consequence of a shortage of human capital is that technology-dependent business growth will occur somewhere else. The business community does not regard the globalization of its R&D as "off-shoring" but as the management of excellent people needed to support business growth.
Localized knowledge and access to marketsWith today's products demanding the integration of knowledge from many disciplines, it is important to have people who have local expertise and knowledge of local standards. It is also important for multinational companies to demonstrate strong local presence and commitment to the development of these standards.
A more market-oriented approach to R&D drives the R&D community to work more closely with customers in the development of new products and services. Given the increasing quality of production facilities in developing countries, it makes sense to conduct process R&D close to these facilities. It also allows the company to develop solutions tailored to local needs, to understand local technical challenges and contribute to the emergence of suitable technical standards.
Cost reductionDespite public belief that globalization is mainly about reducing labor costs, other factors are more significant than local wages in determining the cost of operating research centers.
It is very expensive to set up a high-quality R&D facility in any location. These costs relate to establishing a laboratory with the critical mass of tools, people and technologies to do sustainable top quality work. The best people are in demand internationally. But once a facility is operating successfully, there are also high disincentives to relocate again.
There are clear economic reasons for locating certain types of R&D work in countries that currently have lower wage costs, but it is not the lower wages, which provide the main reason.
Regulation and public attitudePublic attitudes towards science affect market opportunities and are one of the factors driving regulation. Taken together, this combination of regulation and public attitude influences the internationalization of R&D, which will tend to become stronger when the pathways to market are smooth and when there is a clear perception by the consumer that the results of new science offers real value.
This has been well demonstrated recently by the example of genetically modified foods. The European public has so far failed to see much value and this has damaged the region's strengths in relevant areas of biotechnology. Similar situations are likely to play out again and again: for example as experiences with products like asbestos affect the introduction of materials based on the fruits of research in nanotechnology; as attitudes towards safety issues, waste disposal and climate change influence the rate of development of technologies associated with nuclear power and renewable energy sources; and as perceptions of the moral status of the embryo affect work in stem cell research.
In seeking to embed a research-led culture within a region, it is important that companies and governments demonstrate the real value that new science and technology can offer, particularly where this value may not be self-evident to the final customer. With a general shift from a "Trust Me" to a "Show Me" world, this often depends on bringing stakeholders together to talk through these matters.
Intellectual property and the protection and movement of knowledgeIn order to gain most value from knowledge, it is also important to balance the protection and free movement of intellectual property. The effectiveness of IPR regimes to serve the needs of knowledge economies will influence the extent to which companies will locate their research activities in a given region. Equally, knowledge is carried largely in the brains of people. The quality of the education system at all levels from kindergarten through to continued adult education, and the ease with which people can move, for short periods as much as on a permanent basis, will underpin the attractiveness of different locations for R&D purposes.
There are some differences in which what constitutes "allowable research" from country to country. An example today is stem-cell research.
While respecting the sovereignty of the nation state, it is important to ensure that foreign national research workers do not suffer because of differences in what is permitted in their home territories and in the territories where they currently work.
Public Policy: The Role of GovernmentsGaining full benefit from R&D depends on providing effective and consistent policies across a wide range of public affairs. Innovation has to be seen more broadly than traditional notions of R&D and intellectual property. As internationalization of R&D progresses, the consequences of shortcomings in individual areas of public policy are likely to become more significant.
First, economically-sound innovation, competition, tax and regulatory policies provide the fertile ground in which R&D can flourish, because these policies provide the basis for achieving effective markets.
Second, the availability of sufficient human talent and people's attitudes towards the value of science and entrepreneurship depend upon providing top-quality education systems at all levels from primary school to higher education and on achieving effective public debate on these matters. Universities must be challenged to provide the right talent for the future; steps taken to improve mobility; labor laws made more flexible; and risk taking encouraged.
Third, the community's ability to gain full benefit from its science base and the ability to provide advanced, relevant life-long learning depends on reforming the university system in ways that improve connections between universities and industry and the transfer of knowledge to market without harming the fundamental purposes of these universities to educate people and perform advanced research.
Fourth, while market competition will generally provide the main stimulus for growth, in some situations, progress will occur within public-private partnerships. A great deal needs to be done in order to ensure that these partnerships can operate effectively.
Fifth, governments need to deliver regulatory policies, particularly on matters of human and environmental protection, which do not stifle the ability to innovate competitively.
Sixth, the potential benefits of Open Innovation are likely to be reduced by restrictions that constrain the formation of partnerships or whereabouts the resulting knowledge must first be transferred to market.
Finally, it is important for governments, just as for companies, to reflect upon questions of sustainable competitive advantage. What is it that one region can offer that another cannot? In this regard, countries should invest in their R&D strengths and be innovative when deciding how to use public R&D funding.
In order to maintain the scientific and technological leadership needed to stay at the top of the value chain, corporate R&D develops according to the requirements of business strategy. It is inevitable, considering the dynamics of global business development that R&D will tend to be located in regions that offer a higher speed of innovation; where entrepreneurship and skilled workforces can bring knowledge more rapidly through to market; and where the opportunities for market growth are greatest.
Globalization of R&D is no different in this respect to globalization of trade and information. The general economic principle of comparative advantage applies without exception. Everyone benefits when everyone finds his or her competitive niche. Eventually, these benefits go beyond the country where one particular activity is located.
RLK Media's survivalWhile it's not uncommon for companies to outsource routine business tasks, they have been less inclined to outsource activities that involve intellectual property, such as research and development. But general resistance to outsourcing R&D is lessening. Drivers include a desire to reduce the cost of innovation, tap into a larger talent pool, increase speed-to-market and make the innovation process more efficient. Top concerns include a loss of control of R&D activities and fear of intellectual property theft.
Globalized R&D offers huge opportunities to enhance and accelerate the innovation cycle, but there are also substantial challenges. Foremost among these challenges for RLK is the need to protect IP. Along with IP, attracting top research talent is a very important or critical challenge to consider globalized R&D. Researchers are happiest when they feel like an integrated part of the firm, though this can be hard to achieve in today's disparate R&D networks. Aside from intellectual property and attracting the best R&D talent, the other key challenges for RLK Media is organizational. Global R&D strategies are doomed to failure unless the company can foster effective collaboration between international teams. RLK Media must collaborate on the following principles prior to outsourcing R&D.
First, overseas salaries may be dirt-cheap but any bottom-line savings of globalizing R&D are rarely equivalent to wage savings. Companies that globalize primarily to save money in low-cost regions may be disappointed. Second, regardless of why the company decides to globalize its R&D efforts, their home market may interpret globalization as a threat to jobs. RLK Media should prepare in advance for such reactions so they are not taken by surprise. Third, when globalizing R&D, they should start with activities such as customization, product support and manufacturing processes rather than jumping in headfirst. Fourth, clear, direct and standard R&D approaches can be key to the company's R&D success, regardless of where a lab is located. Fifth, clear communication and constant reiteration of their R&D goals is critical to keep everyone on track. Sixth, finding the balance between letting overseas labs be independent enough to make a difference but similar enough so that contributions will be on target will be a key challenge for RLK Media and Inova. Seventh, to overcome cultural differences, it helps if the researchers know and understand one another. This will include frequent visits and open collaboration for both companies. Eighth, while it's fine to break up development projects among teams around the world, the RLK Media must always have a leader who can set the goals and verify that plans are on track. That leader, Ray Kelner, must be willing to overcome his reservations and embrace the new opportunities. Ninth, Lars must keep the company's long-term future in mind. R&D results aren't sustained in a day so decisions on globalizing R&D will be with them for years to come. Finally, much of globalizing R&D is a painstaking process that requires years of investment. RLK Media should continually be evaluating their strategy, even if they don't adopt immediately.
The globalization of RLK Media's R&D is a major undertaking. It takes careful planning, sophisticated communications solutions, and clever ways to increase productivity without stifling innovation, for firms to be successful. For all the challenges, companies that get it right can expect substantial rewards, including lower R&D costs, improved access to the world's fastest growing markets, and, above all, a steady stream of innovative products. RLK Media can improve its position if it can first overcome the obstacles. I believe Azim Premji best concludes by stating "Lars is making a mistake in thinking that the only solution is to either outsource the whole of software development or bring the entire function in-house. Neither choice is optimal." (Nohria, p. 28) The company must find the balance between their two options and continually work to make it succeed.
References: Koch, Christopher. (2005, January 15). Innovation Ships Out. CIO.
Nohria, Nitin. (2005, July - August). Feed R&D - or Farm It Out? Harvard Business Review.
Outsourcing. Wikipedia. http://en.wikipedia.org/wiki/Outsourcing Accessed February 23, 2008.
Research and Development. Wikipedia. http://en.wikipedia.org/wiki/Research_and_developmentAccessed February 23, 2008.