Long before the term ‘GFC’ became common parlance, cost cutting was part of the fabric of business. For important functions that couldn’t be reduced or cut, outsourcing was (and still is) the most popular source of cost reductions. The question is: are all departments of an organisation eligible for outsourcing or should some be kept close to the company’s chest? Peter Lewis looks at what can be done with Research and Development.

For the most part, Research and Development (R&D) budgets have tended to survive cutbacks. Generally, this is because many enterprises see their software code or R&D as ‘secret sauce’ and the basis of their competitive advantage — as something to be kept close. Often it’s the (clever) Chief Technology Officer (CTO) who baffles the Board with technical sounding bullshit as to why this shouldn’t occur.

However, while maintaining some aspects of R&D as a core internal function may be a sensible move, there are a number of powerful reasons for outsourcing non-core R&D — both financial and technological — that are worth considering.

To that end, and over two articles, I intend to examine the benefits of outsourcing your R&D and then outline a number of guidelines around how to outsource without tears (i.e. get great innovation, protect your IP, get the results you hope for and not pay too much).

Short-term benefits of outsourcing

Most companies tend to look at getting their R&D done externally only in the event of an internal problem that needs a quick fix or fast response. Typically, the sorts of events that prompt a company to outsource R&D include:

• The need to respond quickly to a new offering by a competitor;
• The need to find and fix unexpected bugs in your code;
• The need to accelerate a project that is running overtime;
• The need to overcome quality problems; and/or,
• The need to overcome the departure of key staff.

All these issues are common enough in any industry.

The knee-jerk reaction of most businesses to these sorts of issues is often to try to hire more staff. But this is not always possible and takes time. Finding, interviewing and appointing capable new hires, bringing them up to speed, getting them to work as a team (etc, etc, etc) can be vastly time consuming and can make or break a company’s response to the problems noted above.

For example, at Hydrix, we have a permanent job ad posted seeking good software and hardware engineers. We only employ the best and brightest (i.e. Honours degrees and a demonstrable track record of success) and, in our experience, we find it can take between three and nine months (depending upon the seniority) to find, filter, interview and appoint quality proven software or hardware programmers who won’t then take another six months to get up to speed.

Strategic benefits of outsourcing

There are a number of less obvious but nonetheless extremely valuable strategic drivers as to why you may wish to consider getting some or all of your R&D done externally. Such drivers are often proactive and complex, and typically driven by company reorganisation, refocussing, the potential to enter new markets or take advantage of new technologies.

The major strategic drivers include:

• Freedom on senior management — to focus on the core business, sales and marketing, IP generation, new product  ideas or something else.
• Mitigation of risks — whether they be financial targets, the time to market, the system or product complexity, new technology etc
• Improved end-customer satisfaction — through the introduction of improved processes or design rigour not previously part of your company’s culture or experience
• Reduced staffing overheads — hardware, office space, training, retention, access, upgrading, management, super, payroll taxes etc.

What about cost?

One of the key differentiators between in-house and out-sourced design and development is cost.

One major problem with cost analysis is the failure to consider the overheads of the department. While staff costs and individual salaries are easy to calculate, the cost for the support, administration, redundancy, sickness, paternity leave, capital investment, IT infrastructure, skills updating etc. is usually less clear.

R&D Magazine ^[1] published an insightful cover story for its July 2007 issue on the future of outsourcing. Titled ‘R&D Outsourcing Becomes More Strategic’, the article shared the results of its May 2007 survey on outsourcing.

Interestingly, according to the story, 51% of those who responded to the survey disclosed that the major reason for outsourcing was the expertise of the external R&D company. Manpower came in second on their list of reasons, while third was workload.

Surprisingly, cost ranked fourth.

Other cost benefits include:

• Project enhancement through the introduction of better program management methodologies or technology infusion from a wider knowledge resource — often from more experienced or expert sources.
• Better and improved overall visibility of cost accounting, as project performance is now a business-to-business process, providing cost reductions, reduced volatility of cost, etc.
• Reduced capital investment in equipment, facilities and plant and the added potential to release assets or convert assets from the balance sheet (i.e. no need to pay extortionate rent or waste time in trying to find additional office space nearby).
• Competitive response in the need for faster time to market, inherent shorter product life and more customisation needs.

Tax Benefits

An additional and very significant financial benefit occurs if you outsource your R&D to a Registered Research Agency ^[2]. Namely, you can accelerate your tax concessions even with small projects.

Normally companies can only claim their R&D tax concessions at the end of a project and then perhaps 12 to 24 months later get the concession back via their tax return.

By contrast, if a company uses an RRA for a its eligible R&D and registers its R&D plan with AusIndustry, it can claim the tax concession up front, before the project has even started.

In other words, companies that head down this path are helping the government underwrite a big chunk of their R&D. For every $100k you plan to spend on R&D, you can claim and receive a payment of $37,500 to $45,000 from the ATO.

Moreover, there is no minimum R&D spend required when you use an RRA. Normally, to be eligible, a minimum R&D spend of $20k is required.

In my next article, I will outline a number of guidelines that will assist companies ensure that their outsourcing goes to plan, to budget and gets the outcomes needed.

Peter Lewis is the General Manager of Hydrix with extensive experience in strategy, sales and marketing, product development and IP commercialization, drawn from across the US, Asia and Australia.

Photo: HikingArtist ^[3]