Jorg Lorscheider
Partner and CMO
Syncroness Inc.
Westminster, Colo.
Edited by Kenneth J. Korane ken.korane@penton.com

To gain a competitive edge, OEMs are increasingly outsourcing noncore activities such as manufacturing, IT, accounting, sales, and human resources. Engineering and product development are among the last areas affected by this trend. The question is, can new-product development (NPD) outsourcing be effective and economical, and should companies give it serious consideration? Here are some observations based on our research and experience providing product-development services to U. S. industry.

Potential benefits
Companies need to focus on their core business activities and, for most, this does not entail providing engineering services to their customers. Therefore, firms can potentially outsource large portions of R&D. Important factors to consider include:

Lower costs. Outside companies are almost always faster than internal teams at developing new products because they apply a heightened focus and dedicated resources to the project. This can cut costs in the short term, and getting products on the market faster can boost profits over the long term.

Overload. Product-development departments are often inundated with work. Corporate management tends to oversimplify the NPD process, which means design teams are typically overloaded with projects that require wide-ranging expertise. Most organizations would benefit by letting their engineering departments focus on fewer projects. In effect, that is exactly what outsourcing provides: dedicated resources focused on the completion of a single project.

Innovation. Innovation becomes increasingly difficult as organizations grow. Reasons include a history of doing things a certain way; risk aversion; a narrow focus on one’s own industry; and worry over cannibalizing existing products and revenue. Companies can overcome or mitigate these powerful factors through external product development.

Productivity. As organizations grow, teams spend less time on NPD versus maintaining existing products. For example, as companies grow and add products, they must use a greater portion of engineering resources for sustaining engineering. This limits the time available for NPD. The problem worsens until an organization separates NPD from other engineering functions, but this is usually feasible only in large organizations.

Expertise. Most NPD requires diverse skills and experience. Relying only on internal resources makes it almost impossible to ensure the necessary expertise is always available when needed. External resources broaden an organization’s knowledge and experience base. Also, augmenting internal resources with an outside firm widens the support network of suppliers, vendors, prototype houses, and the like. This, too, can help accelerate a project.

Understanding outsourcing issues
Over the past 13 years, we have worked with a diverse set of customers. We find that regardless of the type and size of company, their level of product-development experience is critical when outsourcing a process as complex as NPD. This maturity level is also influenced by industry regulations and security requirements.

It might seem obvious that organizations less experienced in NPD should solicit more-advanced services in order to compensate. However, the exact opposite is what we observe. Underfunded start-ups almost always select the least-costly service rather than the most experienced. This usually produces unsatisfactory results.

Expectations regarding NPD projects also vary significantly among companies and individuals and that, too, is affected by experience and a realistic understanding of true costs.

Many companies do not value internal and external costs equally. There is a natural tendency to view existing resources as costing little or nothing. Therefore, outside resources appear more expensive.

Two costs are most important. One is the internal cost of hiring and maintaining employees. Usually, this hourly cost is similar to the cost of using outside resources. But most organizations have no reliable productivity measures that reach senior management. This creates a tendency to view internal resources as a fixed cost. Few companies know how much it really costs them to develop a product, taking into account all the fixed and variable costs. They often neglect to calculate items such as benefits, software/hardware, overhead, and efficiency even though they are real costs.

To address this problem, Syncroness has developed analysis tools which help companies calculate their true internal costs and make better decisions about the costs of outsourcing NPD projects. A labor-rate calculator in Excel is available at www.syncroness.com under the Resources/Publications section.

The more-important factor is opportunity cost, because delays in bringing a product to market are usually quite expensive. But most companies lack a good understanding of how delays affect the bottom line. This cost is often high but, without definition, delays cannot be factored into the decision-making process. As a result, companies make decisions based on invalid information. As seen in the nearby graphic, while outsourcing may be expensive, the payoff from being quicker to market can make it well worthwhile.

Finally, it is relatively simple to obtain quotations on various components for new products. However, all predesign quotes contain only limited information. A wide range of pricing is often the norm for developing components because suppliers are unsure of their costs. Some might provide low quotes and raise the price before the product reaches production.

Often, the cost of product development is not the main issue. Rather, it’s the uncertainty of the cost that is the root of the problem. Outside resources can reduce the ambiguity. Most top engineering firms will work on a fixed-cost basis, provided a project has sufficient definition.

Additional factors
Aside from financial issues, other concerns include:

Loss of control. Undoubtedly, managers feel they are losing some control over outsourced projects. This natural reaction is usually without merit because managers often have more control over outsourced resources than internal ones. Product-development firms are usually bound by cost and budget, which highly motivates them to accomplish the work. That’s not always the case with internal personnel.

Purchasing issues. Many companies are not accustomed to purchasing a service where the deliverables often arrive by e-mail or other electronic means, instead of on the loading dock. This can cause delays and additional effort for the purchasing department to validate that the work meets the terms of the contract. Additionally, product development is a fluid process where costs can vary. Changes to contracts are common but modifying purchase orders can be slow, difficult, and impact the project pace. For this reason, fixed-cost pricing is usually a better option compared to time and materials pricing.

The learning curve. The largest obstacle to effective outsourcing is it initially requires effort to change existing behavior. There are learning curves on both sides of the outsourcing transaction, and it takes time for the customer and outsourcing vendor to get up to speed on a project. However, the benefits over time can be significant as everyone learns to operate efficiently as an extended team.

Making it work
As noted earlier, firms with experienced developers and good processes are better positioned to take advantage of engineering outsourcing. However, inexperienced companies that add contract-engineering services or outside consultants will likely have more difficulty. These companies should hire firms with the depth of experience and management expertise they lack. While costs will initially be higher, companies will benefit in the long run. Here are other helpful tips:

Be specific. Time pressures often result in a lack of clear project guidelines. However, it is critical to define the product in as much written detail as possible. Not all requirements can be set up front. But the better the definition, the better the project will progress and the less it will cost.

Be patient. It is common for stakeholders to want to see immediate progress in some tangible form, such as a 3D model or prototype. However, most larger developments require a lot of up-front planning and concept generation that management has difficulty perceiving as progress. Further, start-up costs are usually higher because they include a variety of team members in the concept-generation process. This adds uncertainty that the program is on track and on budget.

Communicate. Everyone talks about the importance of communication, but it’s often neglected. Be sure to focus considerable effort on quality interaction with the vendor.

Realistic expectations. Product development is complex and unpredictable. You must be realistic. Many NPD activities cannot be directly controlled (supplier delivery times, for example), so don’t expect an outsourced service to control them any better than you can.

Buy-in. Almost any development goes through periods where the entire project is in question. Don’t be in a hurry to blame the outside service unless they have done something wrong. Too often teams assign blame without knowing all the details to appease senior management. This will not move a project forward.

Avoid “last-resort” outsourcing. Outsourcing opportunities often arise when a company is in crisis but lacks the internal resources or expertise to develop a product or solve a problem. Therefore, the outsourcing effort is usually unbudgeted. Entering into an outsourcing partnership while under pressure is not ideal.

Resources. Look for companies with the specialized expertise and experience your project requires. Likewise, make sure they have the necessary resources such as software and project-management tools. It is risky to hire companies without the proper software licenses and other infrastructure.

Check financials. Ensure outsourcing partners have the financial resources and history that make you comfortable in conducting business with them. Their financial house should be in order, and they should be large enough to absorb errors without folding.

Cultural fit. Make sure you have a positive working rapport with the chosen company and individuals. Bear in mind that larger firms likely have alternatives should personality clashes arise.

© 2011 Penton Media, Inc.

Psychology of outsourcing

Based on a survey by Syncroness, significant resistance to product-development outsourcing centers around learning curves and quality of service. Many companies have horror stories about past outsourcing efforts, due in part to the nature of product development, where designs almost never go according to plan; and to behavioral, learning, or business issues. Several behavioral trends appear to interfere with the success of outsourced projects.

Previous pain. Almost all manufacturers have paid a high price to learn what they know about a particular product or market. It is natural to believe that companies working from the outside will not be aware of these lessons and, therefore, are doomed to repeat them. An example might be a design issue that became a significant quality concern after launch, requiring replacement or recall. This leads to the belief that outsourcing is too difficult, or that without specific expertise in the product area, it cannot be successful.

Tribal knowledge. Product development generates a huge volume of knowledge. Some is documented, but a large portion is not. Many engineering organizations rely heavily on the “tribal knowledge” of individuals within a group. It is natural to assume that outside organizations will lack access to similar information and, thus, will be ineffective. Or that communicating knowledge to the vendor will take a lot of time.

Exposure. It is often threatening to work with an outside entity. There is the subconscious threat of being perceived as incapable, compounding the concern that management might seek outsourcing more frequently to reduce personnel. The result is often subconscious self-sabotage leading to project failure, which justifies avoiding outsourcing in the future. This is a potent dynamic in many companies.

Loss of control. It can be unsettling for established engineering departments to work with an outside entity. Indeed, it requires change in managerial style often perceived as a loss of control or ownership. Additionally, managing an engineering organization is decidedly different from managing an outsourced engineering effort, and it requires a different skill set.

Business issues. Outsourcing product development can also be hindered by business issues, such as difficulty measuring return on investment, accounting headaches, and adherence to existing procedures.