Finance:Offshore software R&D

Offshore Software R&D is the provision of software development services by a supplier (whether external or internal) located in a different country from the one where the software will be used. The main reason behind companies using offshore software development services is the higher development cost of the local service providers. The global software R&D services market, as contrasted to ITO and BPO, is rather young and currently is at a relatively early stage of development.

Countries involved

While India, Ireland, Canada and Israel were the four leading countries that controlled this business in 2003, the percentages shifted by 2009 when the front-runners, India and the Philippines, had a combined share of the world market for business process offshoring of about 50 percent. The UN Information Economy Report 2010 reads that "the second largest exporter, Canada, continued to shrink to 21 percent by 2009. Beyond these top three locations, several economies from all continents are making inroads as offshoring destinations. The group of 'other destinations' in figure III.5 surged from 4 percent in 2004 to 16 percent in 2009. The main such locations in 2009 included China, Thailand and Sri Lanka in Asia;26 and Argentina, Brazil, Colombia , Costa Rica and Mexico in Latin America. On the African continent, Egypt, Mauritius, Morocco and South Africa all have more than 10,000 offshore jobs in the IT and ICT-enabled services sector (Everest Research Institute, 2009). The share of countries in Central and Eastern Europe was unchanged at 6 percent between 2008 and 2009." According to Gartner Group, only these four countries are capable of scaling up enough to meet the demands of large-scale projects. Brazil has been attracting attention due to the closer timezone to the US eastern coast, besides closer cultural affinity. Similarly, countries like Colombia, the third largest Spanish speaking country by population, have become popular "nearshoring" destinations due to their proximity to the US . Other offshore software development destinations include Western Europe (Portugal), Central Europe (Poland , Czech Republic, Slovakia, Hungary, Serbia, Croatia, Bosnia and Herzegovina), Eastern Europe ( Romania, Ukraine , Belarus , Russia), Asia (Armenia, Pakistan , Nepal, Vietnam, Bangladesh, Sri Lanka), Africa ( Egypt, Morocco), South America ( Argentina , Bolivia, Chile ), and Philippines .

Offshore R&D hubs

According to Gartner group's report, global cities are categorized into Tier I, Tier II and Tier III based on numerous factors such as the quality of infrastructure, global connectivity, and availability of human capital, in order to rank the best places to set up an offshore R&D location. The report concludes that cities like Bangalore, Yerevan, Mumbai , Ahmedabad, Bucharest, New Delhi, Hyderabad, Ho Chi Minh city, Chennai, Pune, Indore, NOIDA, Gurgaon, Thiruvananthapuram, Greater Toronto Area, Ottawa, Montreal , Haifa, Tel Aviv, Dublin, Lahore, Kiev, Minsk, Moscow, and St. Petersburg would be the ideal places, and hence "Tier I" cities to offshore R&D.

Western dilemma

Outsourcing R&D has also become a solution to some issues facing certain Western countries, especially United States and Canada, even though they have traditionally tried not to lose their technological advantage to Asia. United States and Canada are producing little more than half the required number of graduates in science and technology. Many of the MSc and PhD students in these countries are international students. North America has an ageing population and many people in senior positions are heading towards retirement. Both of these countries are falling behind in growth and competitiveness, and the productivity gap between them and smaller industrialized nations continues to widen. Short term solutions to these problems aren't available in Western countries, as even immigration is a long and cumbersome process. It is therefore beneficial for these countries to offshore development.

Labor issues in Japan

Japanese companies often exploits the foreign labors, particularly Chinese and Vietnamese, by violating the Employment Security Act, and Labor Standard Act set by ministry of health and labors in Japan using the name of offshoring.

Article 44 of Employment Security Act in Japan implicitly bans the domestic/foreign workers supplied by unauthorized companies regardless of their operating locations. Law will apply if at least one party of suppliers, clients, labors reside in Japan, and if the labors are the integral part of the chain of command by the client company, or the supplier.

No person shall carry out a labor supply business or have workers supplied by a person who carries out a labor supply business work under his/her own directions or orders, except in cases provided for in the following Article.

– Employment Security Act

Those deemed to violate will be punished with

A person who falls under any of the following items shall be punished by imprisonment with work for not more than one year or a fine of not more than one million yen

– Employment Security Act states, Article 64

as well as the punishment defined by the article 6 of Labor Standards Act in Japan,

Unless permitted by act, no person shall obtain profit by intervening, as a business, in the employment of other

– Labor Standards Act

Victims can lodge a criminal complaint against the CEO of the suppliers and clients in the Labor Standards Inspection Office (only applicable to Labor Standards Act) or Public Prosecutor's Office of the respective company location. Due to the risk of the CEO's arrest, Japanese company accustoms to the private settlement with financial package in the range between 20 and 100 million JPY (200,000 - million USD).

Usability issues in offshore development

The main driver for offshoring development work has been the greater availability of developers at a lower cost than in the home country. However, the rise in offshore development has taken place in parallel with an increased awareness of the importance of usability, and the user experience, in software. Outsourced development poses special problems for development, i.e. the more formal, contractual relationship between the supplier and client, and geographical separation place greater distance between the developers and users, which makes it harder to reflect the users' needs in the final product. This problem is exacerbated if the development is offshore. Further complications arise from cultural differences, which apply even if the development is carried out by an in-house offshore team.

Historically offshore development concentrated on back office functions but, as offshoring has grown, a wider range of applications have been developed. Offshore suppliers have had to respond to the commercial pressures arising from usability issues by building up their usability expertise. Indeed, this problem has presented an attractive opportunity to some suppliers to move up market and offer higher value services.

Legal issues

Offshore Software R&D means that company A turns over responsibility, in whole or in part, of an in-house software development to company B whose location is outside of company A’s national jurisdiction. Maximizing the economic value of an offshore software development asset critically depends on understanding how best to use the available forms of legal regulations to protect intellectual rights. If the vendor cannot be trusted to protect trade secrets, then the risks of an offshoring software development may outweigh its potential benefits. Hence, it is critical to review the intellectual property policy of the potential offshoring supplier. The intellectual property protection policy of an offshore software development company must be reflected in these crucial documents: General Agreement; Non-Disclosure Agreement; Employee Confidentiality Contract.

Future trends

In 2003, a survey by Santa Clara University showed that R&D sector would be the next target of outsourcing. The same survey also mentioned that even as of 2003, many United States-based companies were adapting to a new business model where they would have the ownership of the intellectual property, but the outsourcing vendor would be given the contract for development with well defined goals in a certain period of time. Outsourcing research operations is currently a small sector in the offshoring business; however, it is growing very rapidly. As of 2006, India alone was getting 25% of new global investments on research. Hundreds of major multinational corporations have set up R&D centers in India, the list of such companies include several big names such as Oracle Corporation, Intel, Adobe Systems, STM, SAP, IBM, and Microsoft.

India's software exports are growing by more than 30% per year, which has triggered protectionist measures on the part of US government, especially the IRS, which recently passed regulations to make outsourcing research harder. However, these regulations don't forbid outsourcing research, and many Western corporations like Eli Lilly and Company, P&G, Henkel, Dow AgroSciences, Novartis and Indian scientists are using web as a forum to easily get around such regulations lawfully. Many R&D contracts have been given to Indian universities and labs in this way, but only some research solutions are patented during this process. In a 2011 article, Forbes magazine suggests that it is increasingly more dangerous to offshore IP sensitive projects to India, because of India's continued ignorance of patent regulations. In this manner, companies such as Pfizer and Novartis, have lost rights to sell many of their cancer medications in India because of lack of IP protection, an Indian policy that is soon to include not just cancer drugs, but a larger variety of medications. As a result, many Western pharmaceutical corporations are reconsidering offshore R&D in India, since the loss in revenues is in many cases larger than the cost-savings of offshore R&D.

Offshore R&D depends on availability of highly skilled labor in offshore destinations. Eastern European countries, from Belarus to Ukraine , will continue to offer a highly skilled technical workforce, because of their vast education infrastructure. There is currently 17.2 million people in tertiary education across the region including Russia, compared to 13.6 million in India. That paired with cost-efficiency and higher security guarantees makes Eastern Europe a very attractive offshore R&D destination.

India's technical workforce is also increasing, but at a slower pace. It is estimated that very soon there could be a 25-30% gap between supply and demand of PhD's in India. However, increased FDI and creation of a lot of well-paid job opportunities are encouraging enough to motivate more Indians to pursue PhDs. Moreover, many Indians have recently moved to India from Silicon Valley, and a lot of them are technically specialized and hold advanced degrees from world's premier institutions, which considerably enrich India's workforce. While the number of technically skilled labor grows in India, Indian offshore companies are increasingly tapping into the skilled labor already available in Eastern Europe to better address the needs of the Western European R&D market.

Vietnam’s IT services sector boomed in recent years as international companies raced to capitalize on the country’s low-cost tech talent. Although many came in search of cheap workers for basic tasks, some now see the country as a viable provider of higher-value services, including complex software development, data analytics, and even original R&D.

Generating transparency on such service providers available on a global scale is the aim of dedicated B2B marketplaces offered as online service.

As B2B marketplaces often only cover short-term or freelance one-off engagements, premium Clients looking for long-term strategic partnerships makes use of independent and on-demand 'Software Outsourcing Advisory as a Service' platforms to match the hundreds of parameters in an outsourcing strategy with the tens of thousands of Independent Software Vendors available worldwide.

Governance

An important aspect of offshore software development is to implement an efficient governance structure for the remote applications development. Effective governance can be achieved by using the proper business model that provides the right amount of flexibility, scalability and risk management. Models widely differ based on business needs, and can involve a lot of integration, for example in joint venture and group captive models, or can be less involved, as is the case with Remote Insourcing, managed services and "build-operate-transfer" models. It is important to note that all models require significant investment in communication process and change management, especially at the beginning of the process.

To measure efficient governance an automated generation of meaningful Key Performance Indicators is helpful and topic of research.

Focusing on software quality metrics is another good way to maintain track of how well a project is performing and whether the governance models fit the project. If the resulting outcome is not on par with expectations, which will be rapidly obvious when looking at software quality metrics, then executives know they must improve governance (whether through implementation of a new model or improving one aspect of the existing process).

See also

• Global sourcing
• Globally Integrated Enterprise
• Low-cost country sourcing
• Offshore Development Center
• Offshore company
• Offshore outsourcing
• Offshoring