In an earlier article, Benefits of Licensing-In, we suggested to product-line manufacturers that there are only 3 sources for new products: Internal R&D, Corporate Acquisitions, and Licensing.

We argued that manufacturers must look much more actively to Licensing as their source for new products, because 1) the escalating costs of Internal R&D have made that option unaffordable to small, and many mid-size, companies, and 2) most companies (regardless of size) do not have the superlative people-management skills required to make Corporate Acquisitions a viable option.

There is a 4th source we didn't mention -- the use of outside Technical Service Providers. We excluded that option because, at least in our opinion, the necessary infrastructure has not yet sufficiently evolved.

Currently, technical service providers are used primarily as a supplement to internal R&D, providing input (counsel or actual development) in their area of specialty. An electronics company, for example, may occasionally require the services of a chemist, or structural engineer, or cooling specialist, etc., and will go outside to buy those services.

Technical service providers are also used by (intelligent) companies as a check and balance on their internal R&D (much more so on the Coasts than here in the Midwest -- but that's another story).

However, if small and mid-size companies can no longer afford adequate internal R&D, it's clear there exists a market need for outside technical services that can viably replace Internal R&D. If a company can't afford to employ an adequate staff of engineers, one solution is to hire a time-shared piece of such a staff.

The Outside R&D Firm

Two elements are necessary to the successful evolution and growth of this infrastructure. First, manufacturers must become aware of the option and benefits of outsourcing their R&D. Second, the R&D firms must clearly understand the needs of the manufacturers and find ways to satisfy those needs and provide the expected benefits.

Functions

What are those needs?

First, the R&D firm must offer, and accept, a responsibility for the manufacturer's R&D. This implies an on-going relationship -- not the contract job relationship that currently prevails. The R&D firm must thoroughly understand the manufacturer's marketing and manufacturing strengths, and innovate (or seek out) a continual flow of new products that take advantage of those strengths.

Second, the R&D firm must find ways of providing that service The manufacturer can afford -- at best -- to buy a time share of a normal in-house engineering staff. It can't afford to buy time at rates that are inflated to cover long periods of seeking customers, and simple inactivity, as is too often the case in the current technical services market.

This is a catch-22 situation. The R&D firm needs sufficient on-going business to allow it to operate economically, but it can't get that business until it can offer that economy.

Possible solution -- minimize overhead. Don't start an R&D firm with office and employees. Instead, work out of your home. Broaden your network of inventors, freelancers, moonlighters, and manage them (at minimum rates) until you build up enough clients to safely start acquiring space and employees. With e-mail and fax, you can effectively manage technical resources over a much broader geographical region than ever before.

Another possibility -- offer clients (and your technical resources) success-sharing arrangements. Offer early clients bare-minimum out-of-pocket costs (just enough to keep you going) in return for a piece of the action, e.g., a percent of sales on products you develop or, better, on the product line you'll be developing for.

You can tempt more dollars out of a manufacturer by taking on some of his risk. But keep in mind that over the long run, what he can afford is limited by his sales. If his market can afford R&D at 5% of sales, that's all that's going to be available to you, regardless of whether those dollars are now or deferred. (Therefore, it's desirable to move to real-time dollars as both parties gain confidence in the relationship.)

The way to get more dollars from a client is to increase his sales -- which you're in the ideal position to do by feeding him more and better products -- and doing so is clearly and visibly in both your interests.

There's another potential for efficiency (hence, economy) in the outside R&D firm. Those of you who have managed in-house R&D groups know the inefficiency of those groups -- even in the small companies that aren't subject to the vagueries of upper-management's ever-changing plans-by-committee.

Large companies still get no more than a 10-20% efficiency out of their R&D efforts. Even small companies get no better than 30-40%.

Achievement in typical in-house R&D groups moves inherently in fits and starts -- in almost predictable cycles. Given any new product proposal, there's always a lot of stewing around and arguing about the "best" solution. Finally, work starts -- usually slowly -- and then a seemingly infinite array of sub-problems arise, each of which has to be stewed over and argued about.

As the release-to-production deadline approaches, this activity picks up speed, usually culminating in demands of super-human effort in the weeks prior to release. And, of course, those demands lead to a let-down after release, which requires a lengthy recovery period before the participants can reasonably be expected to tackle a new job.

After a couple of times through this cycle, engineers started feeling "used". And bored. Working in the same market all the time, all they find themselves doing is taking advantage of advancing technologies to improve the cost and performance of the same old product line. The result is either they leave (which costs both hiring and new-hire-learning time), or they "retire on the job" and find their challenges in outside interests.

Advantages

Why should an outside R&D firm be able to do better?

First, since it's time-sharing its services over several clients, it's effectively working for multiple manufacturers in multiple markets. It should be more difficult for boredom to set in.

Second, the relationship is changed. What was "management" becomes the "customer". Decisions are more likely to be made on economic bases, and less on bureaucratic or political. If the R&D firm feels a client is being unreasonable, uncooperative, or is heading down a non-productive path, the firm is free to drop him for a more promising client. Likewise, if the client feels he's not getting the products he needs from the R&D firm, he's free to move to a different firm.

Third, I suspect that the better R&D managers, freed from extant corporate policies and reporting requirements, will find much more efficient ways of managing the R&D function. Perhaps managing a "looser" team -- more work-at-home -- more pay-by-accomplishment -- more emphasis on learning -- more varied assignments -- more cross training, etc.

Perhaps through better understanding of the process of innovation. Balancing the pull of market and the push of technology as only the market-aware technologist rationally can. Or using the tools of the professional inventor. The professional inventor always has a dozen projects going. When he hits a roadblock on one, he simply shifts to another, lets his subconscious work on the block, and when the solution comes, simply shifts back.

Future

Simply by trying. The current outside R&D situation is analogous to the outside manufacturing situation in the local electronics industry 20 years ago. There were only a couple of contract manufacturing shops in the area. They weren't very good. Their equipment was old. They could only offer partial services. They could stuff boards, but not solder -- or solder, but not test -- or test but not purchase, etc. A manufacturer could use them for odd jobs, overflow work, etc., but no way would they dare to outsource their manufacturing to them.

Today there are many competent, capable, full-service contract manufacturers in the area. Only an ill-informed, ill-advised, or inept electronics entrepreneur would even think about setting up his own manufacturing facility today. The existing shops aren't perfect -- they're still improving, as they must -- but for startups, small, and even mid-size companies, they will provide lower costs, better quality, and more reliable scheduling, over the long haul, than the equivalent in-house facilities.

There's one lesson these shops haven't learned yet. When they do, they'll take a major step forward. That is to work together. They still see themselves as competitors. They're not. Their real competitors are the companies who are still manufacturing in-house. Would that they'd get together and take on their real competitors. Would, also, that those considering evolving outside R&D firms not make that same mistake.