How to Outsource R&D

R&D isn't just for big corporations. Here's how you can use innovation to build your business, from selecting projects to tax advantages.

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The objective of research and development (R&D) in a small or mid-sized business is to obtain new knowledge, applicable to your business' needs, which can eventually result in new or improved products, processes, systems, or services that can increase your business' sales and profits. R&D can be conducted in-house, under contract, or jointly with others. While in-house R&D commands a strategic advantage in that the business is the sole owner of the know-how created and can protect it from unauthorized use, the rise in popularity of outsourcing business functions in the last several years has increasingly included R&D.

According to a survey of businesses by R&D Magazine published in 2007, the benefits that business leaders see in outsourcing R&D include the following:

• the outsourcing firm may have more expertise,
• the business may have a shortage of manpower,
• outsourced R&D can be less expensive,
• and it may mean a faster time to market for a product or service.

The most common type of R&D function that is outsourced is technology. The magazine found that business leaders say they outsource R&D most often for component innovations, design, new process innovations, new product innovations, and software design, the magazine found. Organizations that do outsourcing R&D work for businesses include the following: universities, government labs, independent R&D organizations, suppliers, and other companies.

The pages below discuss how to outsource technology R&D, what some of the drawbacks of outsourcing R&D may be, and the different types of outsourcing of R&D that your business can conduct.

Dig Deeper: How to Benefit from R&D

How to Outsource Research and Development: R&D and Technology Acquisition

In many cases, technology required for industrial purposes is available in the marketplace -- for a price. Before embarking on the lengthy and risky process of performing its own R&D, a company can perform a "make or buy" analysis and decide whether or not the new R&D project is justified. Factors that influence the decision include the ability to protect the innovation, its timing, risk, and cost.

Proprietary Character. If a technology can be safeguarded as proprietary -- and protected by patents, trade secrets, nondisclosure agreements, etc. -- the technology becomes exclusive property of the company and its value is much higher. In fact, a valid patent grants a company a temporary monopoly for 17 years to use the technology as it sees fit, usually to maximize sales and profits. In this case, a high-level of R&D effort is justified for a relatively long period (up to 10 years) with an acceptable risk of failure.

On the contrary, if the technology cannot be protected, as is the case with certain software programs, expensive in-house R&D is not justified since the software may be copied by a competitor or "stolen" by a disloyal employee. In this case, the secret of commercial success is staying ahead of competition by developing continuously improved software packages, supported by a strong marketing effort.

Timing. If the market growth rate is slow or moderate, in-house or contracted R&D may be the best means to obtain the technology. On the other hand, if the market is growing very fast and competitors are rushing in, the "window of opportunity" may close before the technology has been developed by the new entrant. In this case, it is better to acquire the technology and related know-how, in order to enter the market before it is too late.

Risk. Inherently, technology development is always riskier than technology acquisition because the technical success of R&D cannot be guaranteed. There is always the risk that the planned performance specifications will not be met, that the time to project completion will be stretched out, and that the R&D and manufacturing costs will be higher than forecasted. On the other hand, acquiring technology entails a much lower risk, since the product, process, or service, can be seen and tested before the contract is signed.

Regardless of whether the technology is acquired or developed, there is always the risk that it will soon become obsolete and be displaced by a superior technology. This risk cannot be entirely removed, but it can be considerably reduced by careful technology forecasting and planning. If market growth is slow, and no winner has emerged among the various competing technologies, it may be wiser to monitor these technologies through "technology gatekeepers" and be ready to jump in as the winner emerges.

Cost. For a successful product line with relatively long life, acquisition of technology is more costly, but less risky, than technology development. Normally, royalties are paid in the form of a relatively low initial payment as "earnest money," and as periodic payments tied to sales. These payments continue throughout the period of validity of the license agreement. Since these royalties may amount to 2 to 5 percent of sales, this creates an undue burden of continuing higher cost to the licensee, everything else being equal.

On the other hand, R&D requires a high front-end investment and therefore a longer period of negative cash flow. There are also intangible costs involved in acquiring technology -- the license agreements may have restrictive geographic or application clauses, and other businesses may have access to the same technology and compete with lower prices or stronger marketing. Finally, the licensee is dependent upon the licensor for technological advances, or even for keeping up to date, and this may be dangerous.

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