Mike Sophie has good reason to smile these days. In a year that’s been rough for almost every business sector, the CFO and vice president of finance at Alameda, California-based UTStarcom is expecting an 86 percent jump in revenue, from $982 million in 2002 to a record $1.8 billion. And he hopes that’s just the beginning. The company, which provides mobile telephony suited to emerging markets, is soon to deploy the technology in South Asia, Africa, and Latin America. To that end, UTStarcom earmarked $25 million in July to expand its research-and-development center and hire about 100 engineers. If that sounds like a lot of bang for the buck, it is—because the R&D center is based in India.
CFOs still wondering whether or not to send back-office functions offshore are far behind the outsourcing vanguard. Increasingly, technology R&D is migrating overseas. Intel, for example, is developing Banias, its next-generation mobile processor, in Israel; Nortel Networks is developing its wireless Internet infrastructure in India.
Cost advantage and a vast talent pool are driving the trend. India is the overall outsourcing leader, followed by Ireland and the Philippines. But China is rapidly gaining ground (see “China Wants Our IT Jobs, Too,” at the end of this article). In general, the movement of high-end jobs offshore can only accelerate, says Partha Iyengar, a research vice president at Stamford, Connecticut-based consulting firm Gartner.
To be sure, there is also a strategic reason why UTStarcom is locating R&D activity outside the United States: it sells almost all of its products and services overseas. Currently the company has more than 1,400 engineers in China, which accounted for 80 percent of 2002 revenues. It also has 150 engineers in India, which should overtake Japan as its second-largest market next year.
Meanwhile, foreign companies are getting in on the outsourcing act. In August, French telecom giant Alcatel raised its R&D investment in China to $100 million. “Our goal is to develop China as an R&D center not just for China, but for the rest of our global business,” says Christian Gregoire, chief technology officer of Alcatel Asia Pacific. The $18.5 billion-a-year firm is betting big on third-generation mobile infrastructure and applications, and chose Shanghai as the first site outside Europe for this development task.
The Shanghai facility has access to Alcatel’s global technology pool, and all projects in China are planned and performed under the same system, and with the same objectives, as other R&D centers worldwide, says Gregoire. “China offers a very cost-competitive talent pool of R&D engineers, so there is ready availability,” he adds.
The trend is not restricted to large companies. San Mateo, California-based E.piphany, an $84 million-a-year provider of customer relationship management software, outsources 15 percent of its R&D workforce to Innova, based in Bangalore, India. It expects to increase this to 30 to 40 percent by the end of 2004, although it may switch the outsourcing to China. “What led us there initially was our desire to have the most cost-efficient, quality R&D organization we can have,” says CFO Kevin Yeaman.
Replacing or Supplementing?
That’s not music to the ears of Ron Hira, chair of the R&D policy committee at the Institute of Electrical and Electronics Engineers USA, a professional society. Hira, who testified before a House of Representatives inquiry in June on the economic impact of outsourcing, blames the global “decentralization” of R&D for the rise of the unemployment rate in the profession to unprecedented levels (7 percent in first-quarter 2003). That rate eased in the second quarter, “but the raw unemployment numbers mask the shift that people are out of work for many more weeks, months, even years before they can get jobs,” says Hira.
No one has yet established that the R&D jobs being created abroad result in a one-for-one loss of the same positions domestically. Kathleen Walsh, senior associate at the Henry L. Stimson Center, a Washington, D.C., think tank, argues that the offshore centers are currently supplemental. Companies send R&D activities offshore and “hope they do good work,” says Walsh, author of a July report, “Foreign High-Tech R&D in China.” “The moves are experimental in many cases, so the jobs are supplemental. It’s not like we’re going to pick it up and move it all over there. It may come to that, but I don’t gather that that’s going on.”
“The employee could be wrong, but if they have a reasonable belief there’s been a violation and the company retaliates against them in any way, it triggers the whistle-blower protection in Section 806 and leaves the company wide open,” says Neil Aronson, a partner with Mintz Levin Cohn Ferris Glovsky and Popeo in Boston.
The case of UTStarcom seems to support that argument. “It’s not really a question of migrating jobs from the U.S. to China,” says Sophie. The company has 400 engineers in the United States, who divide development work with their Chinese and Indian counterparts. Sophie says there are no plans to reduce UTStarcom’s head count in the States, but there are no plans to increase it, either. “We want to drive the growth of our engineering in China and India,” he says, adding that plans are already afoot to further increase investments there.
It’s these offshore gains that come at the expense of U.S. engineers, Hira points out. “To say that Intel or somebody else moving R&D offshore is not going to have some kind of adverse impact in the U.S. is wishful thinking,” he says. “If they’re going to spend $100 million over there, they’re not going to spend $100 million over here.”
That may be. But as far as CFOs are concerned, it’s all for the good of their P&Ls. Sophie says UTStarcom’s engineering costs offshore are about 25 percent of what the company would have spent in the States. This brings his R&D costs down to just 10 percent of sales. “If we were to assume that all those engineers were domiciled in the U.S., our R&D would be well over 15 percent of revenues,” he says.
Similarly, E.piphany’s Yeaman has no qualms about outsourcing R&D jobs overseas. “I can’t tell you what might take the place of the development jobs that are going to be transferred offshore,” he says, “but I can tell you that we need to do what’s best for shareholders, and that is to have the most efficient development organization while maintaining the quality it takes to be an innovator in the industry.”
Outsourcing Vs. Offshoring
The inevitable difficulties involved with the management of outsourcing relationships have led some companies to choose the “offshoring” model of outsourcing R&D, in which companies establish their own subsidiaries rather than farm out the work to third parties. UTStarcom took this path last year when it hired 25 engineers for its initial R&D investment in India. This year it acquired an Indian facility that was controlled by CommWorks, a division inside 3Com that is focused on telecommunications.
Larger companies also prefer full ownership to ease the risk of infringement on intellectual property rights (IPR). In China, companies formerly did much R&D in joint ventures with Chinese firms or universities, says the Stimson Center’s Walsh. Now they are abandoning the joint-venture model in favor of wholly foreign-owned enterprises, to make sure anything they develop in the R&D centers is their own property.
In outsourcing arrangements, U.S. companies ultimately have little power over IPR protection, although Yeaman says that generally, outsourcing pro-viders like Innova have “tight” protection procedures.
Meanwhile, E.piphany is exploring the possibility of full ownership. The company is now analyzing whether to continue the fully outsourced setup, establish its own presence in India or China, or pursue a combination of both, “which may entail working with an outsourcer to build an operation where the intent would be for us to take it over down the line,” says Yeaman.
The CFO is studying the cost and operational implications of each option. All options are feasible in India, where the IT market is mature and there are more established outsourcers. In China, where IT outsourcing is less mature, it’s more difficult to find an outsourcing provider. However, China has a time-zone advantage: the 15-hour difference between California and China, versus 12 hours between California and India, would give U.S. and offshore engineers more time to collaborate. Whatever E.piphany finally decides, Yeaman is confident the cost advantage will be substantial. Year-to-date, the company’s R&D costs have accounted for 38 percent of revenues, versus 41 percent last year. “Ultimately we expect to spend somewhere in the neighborhood of 15 percent on R&D,” he says.
Given such promise, it’s easy to predict that offshoring of R&D could only grow. Gartner’s Iyengar says the next wave of outsourcing in India could be for big pharmaceuticals companies in the United States and Europe to choose India as an offshore location for downstream drug-discovery efforts. In June, the British firm AstraZeneca announced it was increasing its $10 million investment in India by another $30 million, for the development of new treatments for tuberculosis. “This is a very expensive process for these companies, and heavily dependent on high-quality PhDs, which are in abundance in India,” says Iyengar.
To Yeaman, it all makes economic sense. “If you’re going to have the most cost-efficient structure,” he says, “you need today to have an offshore presence.”
Abe De Ramos is executive editor of CFO Asia.
China Wants Our IT Jobs, Too
As if manufacturing jobs weren’t enough, China is grabbing U.S. IT jobs, too. In the next three to five years, China and India may receive almost the same amount of revenue—about $27 billion to $30 billion—from IT outsourcing, according to research firm Gartner.
The lure for U.S. companies to outsource IT jobs to China is obvious: cheap labor costs. “China is about 40 percent less than India right now, and I think that gap will widen over time,” says Gordon Brooks, president and CEO of Waltham, Massachusetts-based E5 Systems, which runs IT outsourcing facilities in Beijing and Bangalore.
A testament to China’s growing role in the industry is the influx of Indian IT-services firms. Well-known providers such as Tata, Wipro, and Infosys have quietly set up shops in the mainland in the past year. “Most of the Indian firms are outsourcing to China; they’re just not telling their customers they’re doing it,” says Brooks. “I don’t think Indian firms want people to understand that China is ready, for the benefit of [preserving their] margins.”
Nevertheless, China is ready. Already, IBM, Microsoft, Hewlett-Packard, and other multinationals are running IT-services support in cities like Shanghai, Wuhan, and Dalian.
Skills-wise, China’s strength is in programming, and less so in systems integration and project management, says Rajesh Rao, COO of Bamboo Networks, a Hong Kongbased provider with outsourcing centers in the mainland. As a result, any CFO attracted by the potential cost savings in China would be wise to consider what applications he or she is planning to outsource. “If you’re going to outsource a relatively recent package like Siebel, I would do that in India, but if I was going to outsource C++ or Java, I’d do that in China,” says Brooks.
As for business-process outsourcing, such as running call centers, processing invoices, and human resources, China remains far behind India. The reasons go beyond the limited use of the English language. “The way of processing invoices and handling human resources, legal matters, and insurance is very different in China,” says Alex K. Lam, Toronto-based COO for Asia of U.S. consulting firm The Outsourcing Institute. Also, despite reform efforts, China still has major obstacles with its banking system, wherein the central government keeps a very tight lid on the movement of foreign exchange. “Because of all these things, the mind-set of the Chinese in terms of business processes is not as—for lack of a better term—advanced as the West,” says Lam. —A.D.R.