STRATEGY

The Thinking Man's Outsourcing

A surprising number of U.S. companies are sending their most complex activities overseas.

Kathryn Cook

GLOBE TROTTER CEO Brian Reale (center) outsourced his R&D (and himself) to Bolivia.

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If life as a billionaire technology maverick grows stale, Niklas Zennstrom can always get a job promoting Estonian business development. In 2003, Zennstrom, who is Swedish, and his partner Janus Friis, a Dane, launched their Internet telephony company Skype in Luxembourg, with sales offices in London. But they outsourced product development to Estonia, the same fertile womb that had earlier gestated their music-sharing system, Kazaa. "There is a spirit there that fosters change and advancement," Zennstrom wrote in an essay for the engineering journal EETimes. "This is the kind of progressive mindset that shapes the development of disruptive technologies. This is the mindset of innovation."

The traditional outsourcing model of domestic brain and foreign brawn is changing. For years, functions such as product design, engineering, and R&D stayed in the United States and Western Europe, under the eye of expensive talent. Manufacturing, call centers, tech support, and brute-strength programming traveled to developing countries where they could be done cheaply and well enough. But now "companies are going offshore for the high-end things," says Joe Collard, co-founder of Sumpraxis, an outsourcing management company in Delray Beach, Florida. "I call it 'knowledge outsourcing.' "

Knowledge outsourcing is still about cutting costs, but cutting them in a company's most fundamental activities--those that produce growth. In an ongoing study of 377 outsourcing initiatives by the Fuqua School of Business at Duke University, 73 percent of respondents cited growth as a principal motivation for moving operations overseas, and 71 percent mentioned access to qualified personnel, which is related to growth. The sample ranges from global corporations to start-ups.

Check, Please

Bootstrappers, in particular, are exploiting this turn by outsourcing functions such as R&D from the get-go. Some say it is the only way to find the best talent willing to work at top speed for a reasonable price. And while they acknowledge those who criticize outsourcing as a drain on U.S. employment, they point out that this strategy makes possible the creation of some new businesses--and with them new jobs. "If these companies couldn't do this cheaply and quickly, they would run through their capital before they got to market," says Arie Y. Lewin, a professor of business administration at Fuqua and principal investigator for the study.

Speed was on Devin Green's front-most burner when he decided to outsource most of his start-up's product development in 2004. ESP Systems, based in Charlotte, North Carolina, creates technology that allows restaurant patrons to control the pace of their meals by sending messages directly to the restaurant staff. Success hinged on first-mover advantage, Green believed, but when ESP approached U.S. equipment manufacturers, the company was told to stand in line. "They were interested but not as interested as if we were a large wireless company with an established marketplace," says ESP's COO, Todd Binkowski. "They said they wouldn't be able to put someone on the project for months. For us that was a nonstarter."

"If these companies couldn't do [R&D] cheaply and quickly, they'd run out of capital before they got to market." --Arie Y. Lewin, Duke University

Instead, ESP signed on with Flextronics, a $16 billion contract manufacturer, which for 20 years has been acquiring R&D facilities around the world. Contracting directly with the company's foreign design centers, ESP's founders estimated they could slash start-up costs by almost half, shave months off development, and tap into some very impressive craniums.

A team of eight engineers in Shenzhen, China, figured out a way to triple the number of square feet ESP's radio frequency system can cover. The project took 10 months; at crux points ESP simply slapped more talent in place. Now, tooling for ESP's manufacturing is being done in Shenzhen, although, in a twist on how things often go, the manufacturing itself will take place in North Carolina.

Taking on Tramite

In-country innovation is the logical culmination of this trend. Lewin says overseas employees are already starting to design products specific to their home markets. That's what happened at business software company Colosa. A few years ago, CEO Brian Reale essentially outsourced himself to La Paz, Bolivia, where he hired 16 developers for the cost of two in the U.S. Reale chose to live in La Paz because he likes it--the mountain climbing's great--and because he wanted to be with the talent while Colosa was finding its legs. Co-founder Robert Vernon and one other employee held down the U.S. fort in Coral Gables, Florida.

Reale and Vernon launched Colosa to build an online marketplace for insurance companies. But while overseeing that product's creation, Reale found himself coping with really long lines. In Bolivia, "you see lines of people three or four blocks long waiting to fill out a form or get a license," says Reale. "The Spanish word for that is tramite. We saw an opportunity to build a system to reduce tramite." Colosa's employees jumped on the problem, which they understood intimately. They designed software that streamlines processes and also exposes all of their parts. That transparency takes a bite out of corruption, something developing countries have plenty of. Colosa's early customers were the World Bank, the International Finance Corp., and other organizations struggling to do business in places like Bolivia. "Part of our strategy became trying out a product in a slightly less developed market until it was ready for prime time in a developed market," says Vernon. Colosa subsequently launched a version of the software for U.S. companies trying to improve efficiency. Colosa now has more than a thousand customers in the U.S.

Perfecting the Prototype

Reale says his Bolivian developers are as capable as their U.S. counterparts and are extremely hard workers. Danny Briere has also been impressed by the work ethic of people from different cultures. Briere is founder of Mblast, an online information exchange for marketers, publishers, and PR firms. The company hires foreign software engineers and architects √ la carte off the Web, using an online test to screen for talent.

Briere came to outsourcing after a U.S. firm that he had engaged to do development work let him down. "The bills kept racking up, and we got nothing usable," says Briere. His own small IT staff was able to create a prototype, but it needed to be further refined.

That's when Briere decided to try outsourcing. He searched the Web and soon discovered sites where programmers from around the world offer their services on a per-month or per-project basis. Contractors from Eastern Europe and the Pacific Rim now handle 90 percent of the company's basic programming and all but the highest-end elements of architecture design. Without them, says Briere, a market-ready model of Mblast could not have been built for the $3 million he spent. "There are three reasons to outsource," says Briere. "One is cost reduction. Two is growth. Three is existence."

Leigh Buchanan can be reached at lbuchanan@inc.com.

Participate The Fuqua School of Business is recruiting companies of all sizes to participate in its ongoing study of outsourcing. For information, contact Jeff Russell (jrussell@duke.edu).

Last updated: May 1, 2006

LEIGH BUCHANAN | Staff Writer | Editor at Large, Inc. Magazine

Leigh Buchanan is an editor-at-large for Inc. magazine. A former editor at Harvard Business Review and founding editor of WebMaster magazine, she writes regular columns on leadership and workplace culture.




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