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Electronics Production | March 09, 2009

Outsourcing of product development in recession

Is it possible to find quick savings by outsourcing product development? Nicolette Lakemond, doctor for outsourcing and product development at Linköping University was interviewed to take a view on the subject matter.
While in recession all costs of businesses are questioned, including those for product development. Development plans are reviewed and projects are placed on hold or are abandoned, which often leads to a waste of resources and non-renewal as a result. But cost reduction has no immediate effect on corporate profitability. This is, because a large proportion of costs are fixed costs for offices, laboratories and staff.

When cuts are made – the reduction of these costs are related to staff dismissal and the termination of leasing contracts – with a timeframe of between 6 months to about three years. In the worst case, this can coincide with the period when the economic cycle has already turned.

A rough rule of thumb is that approximately 50% of the total R&D budget is related to expenditure in development projects that provide direct saving effects. But you will often find penalty clauses that provide for fines when deliveries to suppliers and customers stop. This reduces the impact of the cost cuts – with what in financial statements is called one-off costs. Here you can read that companies seem to be happy if they reach a net 25% of the total reduction potential during the first year.

Are there alternatives?
Is there no alternative to closure and cuts? An interesting alternative could be the outsourcing of product development. To get perspective on this, Jonas Hjelm, product strategist at Oxyma Innovation, talked to Nicolette Lakemond at Linköping University. Ms Lakemond has a doctorate in outsourcing of product development in Industrial Organization. She believes that there are several reasons which motivate the outsourcing of product development and cost reduction is only one of those. As it only has a limited effect – only under certain circumstances - means that you cannot take it as a short term miracle cure.

It is difficult to generalize, but if companies are looking for cost reduction, the highest ratio of outsourcing is with more standardized products and peripherals, and through stronger cooperation with component suppliers. An important reason for outsourcing of product development is an increased innovation. The driving force is that businesses need access to knowledge from component suppliers, research institutions or specialist consultants. Ms Lakemond emphasizes that it is important to be aware of the differences in the driving forces and the need to manage them differently.

The degree of integration is important
You cannot say that the conditions for outsourcing differ between different stages of product development or in the different phases of the product life cycle. Ms Lakemond says that it is a matter of product complexity and if there are clear modular interfaces that can part-supply under the product development time.

“A technically complex product is often knowledge-intensive, which gives a coordination complexity, which in turn creates a favourable environment for communication problems and delays in development”, says Ms Lakemond. This gives of course no productivity gains. But in cases where you work is the development of complex components – which have a high level of integration in the final product - supplier will link closely with the client.

Here are different degrees of organisational integration and Ms Lakemond says that you can vie it as a grey-scale – going from "black box" through "grey box" to "white box". Where you have the lowest level of integration - black box is a customer-supplier relationship, where the purchasing department is the customer. Grey box represents different degrees of common interest between the development departments of the supplier and customer. An interest in the outcome of product development is good. White box means that the supplier only has an informal involvement and consults on certain issues. The ‘grey box’ system is the most difficult to manage. The reason of this is obviously the diversity of integration and cooperation, but also to the emergence of many coordination costs, which are not anticipated and which threaten the development cooperation.

Formal or personal relationship
Regarding the question of how a long-term relationship between suppliers and customers for product development can be best ensured, Ms Kalemond answers: “Sure, there must be an agreement and a LoI (Letter of Intent), but the personal relationships are much more important.”

But for this to work, you must have a sound commercial basis. That is to say that both parties actually make money. Ms Lakemond states that open books gives a slightly positive effect, but that just tends to proof that the buyer is stronger than the supplier.

Productivity may increase
The total productivity may increase in outsourcing because of cross-functionality and diversity increases. This in turn improves the prospects for new ideas and solutions. Here Ms Lakemond emphasizes that it is very important to have a common goal and some similarities in approach between client and supplier. She warns however, that in some projects clients have difficulties with the transparency and it is difficult for them to continue. In the worst case, the consultancy part develops its own live and follows its own goals, which in turn reduces productivity.

This is a dilemma and it is partly built into the consultant’s role and differs in part from the component supplier's incentives to streamline its product development – which more closely conform to the client’s. Unfortunately, there is a tendency to ‘milk’ the contract by pulling out on them. Consultancies have to become better and develop a clearer common target with the client.

Ms Lakemond ends by saying that the outsourcing of product development may not go too far, because the client must have the resources and skills to integrate the supplied. For the relationship between client and supplier to work, it requires an overlapping of competences. This provides better conditions – the client is competent enough to clearly articulate their needs and requirements.

Outsourcing, no quick fix
Outsourcing of product development must be a strategic decision and not be rash with poor analysis, because it can produce large negative consequences. For those companies that have low levels of outsourcing when cost saving becomes an issue – the outsourcing of product development is by no means a quick fix.

But the companies that have followed a deliberate and long-term strategy in outsourcing of its products also have a much greater flexibility when they want to adjust through cutting costs. In recession, those companies are not fixed on structural costs and those so-called one-off costs are significantly lower. To minimize problems that may arise between the purchaser and the supplier of product development, the two sides need to formulate a common strategic objective.

Author: Jonas Hjelm, product strategist Oxyma Innovation

Image source: Davab

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