The Sharp End of KPO: Outsourcing R&D

SSON News and Analysis
Posted: 07/09/2012

(Phanish Puranam is Associate Professor of Strategic & International Management at the London Business School. His research into strategic relationships between organizations has won him international renown; he has worked in an advisory capacity with companies including Microsoft, Deutsche Bank and CapGemini. Recently, Professor Puranam has spoken on knowledge process outsourcing (KPO), in particular the research and development operations which not too long ago were regarded by many firms as too sacrosanct to offshore. SSON caught up with him to find out more.)

SSON: You've said in the past that "there is really no limit to what can be provided in an outsourcing and offshoring environment"; where will be found the major impetus for the transition from a service-based to an innovation-based environment? 

Phanish Puranam: By impetus I assume you mean which companies and which organizations are going to be at the forefront of doing this. In terms of state involvement I think it will be minimal – at least that’s what we’ve seen so far. Most of the experimentation with relatively high-end complex innovation-oriented work is actually happening within captives; it’s mostly the owned subsidiaries of MNCs which are setting up operations in India and China.

SSON: What are the countries of origin of these MNCs?

PP: I think the majority are US-owned. There are a few European firms – a couple of German pharmaceutical companies – but by and large it’s dominated by the usual list of US MNCs.

SSON: What sparked this movement off – was it purely cost-based?

PP: No, I think it’s more than that. If you look at the way that say a Microsoft or a Sun or an IBM has set up their research and development centers in India, they don’t compete for the same talent pool as the Indian software vendors. They’re looking at slightly higher-end candidates with better qualifications or at least with similar qualifications but from better schools. They’re in a different business; they’re not looking to move to India for the same reasons as the IT service guys, because they’re actually looking to use this staff as an internal R&D unit which does relatively high-end work.

SSON: So now it’s simply the attractiveness of the talent that’s on offer that’s drawing companies to KPO in India?

PP: That’s correct. I think cost is obviously still quite important – I mean the wage difference still remains huge – but even more important in many cases is the large and expandable talent pool.

SSON: And what will be the major obstacles to the development of this space?

PP: The single biggest concern I think is scalability. At this level of high-end work that we’re talking about it doesn’t bite immediately because we’re not talking about hiring thousands of people every year. So most of these R&D centers are quite small – under a thousand people or so. But it certainly can be an issue as they scale up because the supply pool looks quite large on paper in India but the actual employability is relatively small, so the more of these companies get in the game the more they start competing with each other to hire these people, and you see wages spiraling upwards, you see attrition, and you see all the same problems that are happening in the BPO space as well.

SSON: You've spoken about the incredible growth in patenting activity in India and China; where is the investment coming from to propel this growth onward? 

PP: In terms of patenting I want to be clear that what I’m going to talk about is patenting in the US PTO system. There are also domestic patenting regimes in both India and China which we haven’t really looked at very closely. In the US patenting system what’s happening is that, if you look at the top 20 patent filers as defined as patents in which as least one of the inventors is stated as being located in India, then more than half of the companies in this list are actually multinationals, mostly American. What this means is that a lot of the impetus for patenting activity in the recent past is actually coming from the subsidiaries of MNCs operating out of India. In China that’s not the case; most of the patenting is actually happening through domestic firms – in the US system. So MNCs play a much smaller role in China than they do in India, in terms of using these countries as platforms for innovation.

SSON: And in which sectors is this activity taking place?

PP: There are clear differences in sector. In India the top 4 are organic chemistry  (which tends to get dominated to quite a large extent by domestic firms); information technology which is heavily dominated by foreign firms and their subsidiaries; pharmaceuticals and cosmetics, again dominated more by domestic firms; and telecoms which is heavily dominated by foreign firms. In China by contrast the number-one category is something called design patents; these are essentially improvements in design or functionality in various kinds of consumer products. The dominant kind of organization there is actually domestic firms. The next three in China are electrical machinery, IT and consumer goods – and for all of those domestic firms are much more important than foreign firms.

SSON: Can you explain a little about the differences between the two environments? You've said, for example, "Indian patents have greater impact relative to Chinese patents"...

PP: That’s correct. What we do is, we look at the impact of a patent by looking at how often it gets cited by future patents, and you can simply count off how many additional patents are filed in the future go back to the original. If you make adjustments for the sector and for the technology class and the year it turns out that the patents coming out of India on average generate more impact in the future, because future patents end up citing them more often.

SSON: How much of a threat to the growth of this sector is what might be seen as institutional disregard for intellectual property conventions in the major emerging economies?

PP: I think it’s less of a concern today than it used to be six or seven years ago, and partly that’s because of the change in the intellectual property [IP] regime that happened; but I also get the sense from talking to these companies that they see this as an ongoing challenge that they have to deal with. They don’t think the IP regime in either China or India has improved to the point of being comparable with the West, but they think that’s just a cost of doing business here.

SSON: Who are going to be the main players in cleaning this up; how much of a role do you see, say, NASSCOM playing in India?

PP: NASSCOM is playing quite an important role in data protection and IP protection in India. I think the largest story here is that many of these high-end activities which happen within captive units to begin with will eventually start percolating into the third-party space, and I think at that point the third-party companies are going to be competing among each other to generate guarantees for their clients about the quality of their IP protection. So that process more than anything else I think will drive up the quality of IP.

SSON: You've written on how collaborations can stumble due to "coordination failures"; do you see the outsourcing and offshoring space developing to a point where such coordination failures will be eradicated?

PP: Probably not – I think this is just a part of being human. There will never be a situation where coordination will always be seamless, but I definitely see a clear upward trajectory in terms of improving how to do it.

SSON: Surely the risk posed by such failures in R&D outsourcing is much greater than in a typical BPO environment?

PP: Yes and no. Yes in the sense that the dollar value of the projects tends to be typically larger. But no in the sense that these failures will rarely see the light of consumer scrutiny. It’s much more visible when a call center screws up in some way or an IT service provision center screws up, but if an R&D project essentially does not work out very well, or goes over budget, then people are not that surprised. The baseline understanding is that these things are risky.

For more from Professor Puranam see his faculty page at http://faculty.london.edu/ppuranam.

SSON News and Analysis
Posted: 07/09/2012

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