WSJ Outsourcing Innovation

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By MICHAEL A. STANKO , JONATHAN D. BOHLMANN and ROGER J. CALANTONE

When should companies try to come up with new ideas themselves—and when should they give the job to outside experts?

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It's a question many companies are facing these days. As budgets tighten, businesses are outsourcing research and development and the creation of new products as a way to slash costs, speed development time and tap into top talent outside the company.

But it can be tough to strike the right balance between internal and external efforts at innovation. How much outsourcing is too much, or too little? What amount produces the best results?

To find an answer, we studied the sourcing habits and innovative performance of 359 companies based in the U.S. and reviewed existing research on outsourced innovation.

The Right Times

In our analysis, the companies that had the most success with innovation—as measured by the number of patents they produced, and how many subsequent patents built upon them—used outsourcing in four circumstances. When firms strayed from this basic approach, their results suffered.

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The four situations that call for outsourcing:

1. When companies would need to add lots of new knowledge to innovate, such as figuring out how to work with an unfamiliar chemical compound to make a different line of pharmaceuticals.

2. In the early stages of a project, when there are lots of technical hurdles to be overcome and the outcome is far from certain.

3. When intellectual property isn't well protected in the industry. In these cases, since new ideas spread quickly from company to company, it may not be possible to differentiate products with innovations. So, businesses turn to outsourcing to limit spending.

4. When companies have had lots of experience with outsourcing. Let's say all the factors above are equal—it's basically a toss-up between working on a project in-house and outsourcing it. In these cases, companies with a long track record of contracting tend to hand off the job to outsiders—three times as often, in fact, as businesses with average levels of experience in the practice. The costs and benefits of outsourcing are more certain for experienced firms, and they can better manage the situation to produce effective results.

The Results

So, how does outsourcing innovation affect performance? Let's look at some common measures of performance.

COST: Conventional wisdom says that outsourcing innovation is a cost saver. But it isn't that simple. Our own research shows balanced outsourcing may raise costs slightly, but also may create more "bang for the buck" from innovation spending, making outsourcing a relatively wise allocation of resources.

But beware: Our study also shows that proportionately too much outsourcing will result in dramatically higher total costs compared with too much internal product development. This is likely due to several factors, such as an inability to control spending to vendors, expenses associated with modifying existing contracts, added costs from coordinating internal and external efforts, or simply an attempt to grow quickly through outsourced development of new products, regardless of cost.

LEVEL OF INNOVATION: Businesses that followed the guidelines presented above saw big dividends here. They developed more patents, and their patents were more influential—that is, they were cited more often in ensuing patents.

On the other hand, businesses that outsourced too much or too little—by just 1%—saw an 11% decrease in the expected number and influence of their patents. Even small changes made a big difference.

Another drawback that researchers have found to outsourcing product development: Companies that outsource can end up with generic products. Why? For one thing, their contractors sometimes were dealing with multiple clients that had similar needs.

TIME TO MARKET: One common problem researchers have identified was turning to outsourcing too late in the development of a product, which raised a lot of thorny problems. For instance, contractors had to learn a lot more about the work that had already been done in-house.

Conversely, outsourcing can help companies keep their options open and reduce time to market. Consider car makers, which face lots of uncertainty about which alternative fuel technology to pursue. By outsourcing, they can look into a number of technologies—well beyond what they might be able to do internally—and get to market quickly once a decision is made.

— Dr. Stanko is an assistant professor of marketing at North Carolina State University's Jenkins Graduate School of Management. Dr. Bohlmann is an associate professor of marketing at the Jenkins Graduate School. Dr. Calantone is Eli Broad chaired university professor and chair of the marketing department at Michigan State University's Eli Broad Graduate School of Management. They can be reached at reports@wsj.com .

Original Source: Wall Street Journal