• India enjoys an advantage over China and others because it has already optimized the business of IT offshoring, which can be easily adapted to serve the engineering sector. India alone could expand its revenues from engineering services by 25 to 30 times, reaping a market potential of $50 billion in 2020.
• As the market expands, new players will step into the ring. Eastern European countries will play an increasingly important role in catering to markets in Western Europe. Within the next decade, the low-cost position currently held by India could shift to countries such as South Africa, Philippines, and Vietnam.
• Outsourced innovation will move upstream. The activities performed today for aviation and automotive clients, for example, tend to be rudimentary: documentation, basic simulations, and basic computer-assisted design and computer-assisted engineering work. But by 2010, highly complex engineering, such as composite structure design and thermomechanical analyses for aerospace companies, could be commonly outsourced. And by 2015, outsourcing whole processes and systems — the design of simple climate-control systems for low-end vehicles, for example — will be routine. (See Exhibit 2.)
• The expansion of offshored innovation services will lead to total job gains globally.
The implications of these findings for corporate decision makers are profound. The market environment has never been fiercer, with a continuously fragmenting customer base demanding an increasing number of ever more complex products. Today’s cars, for example, use far more intricate electronics — and more of them — than they did a decade ago. Even as managers must keep cutting costs, they face strategic pressures to boost quality and productivity and speed time-to-market. Squarely answering those challenges are the potential benefits of outsourcing innovation: labor arbitrage, added capacity, access to talent, increased productivity, market entry, and proximity to the customer or end-user. Companies will succeed only if they optimize their innovation footprint to exploit the full spectrum of competitive advantages now offered by emerging markets.
Not Just about Cost
Although labor arbitrage will continue to be an important factor — the pressure to cut costs shows no signs of abating — it will increasingly share importance with more strategic drivers in the decision to outsource engineering services. By 2015, the proportion of companies that are outsourcing primarily to reduce spending will drop 26 percent, while the share of those motivated primarily by other benefits, such as boosting capacity, will multiply by as much as 10 times. (See Exhibit 3.)
A host of industry leaders are already expanding their innovation footprint to tap into the skills and creativity in the emerging world. One major automotive component supplier is aggressively expanding its network into China and India. At its automotive R&D innovation site in Bangalore — one of the largest in India — 3,000 employees are working on high-end electronic control units, tools, and diagnostics. A second facility is planned for Coimbatore (about 150 miles south of Bangalore) by 2010, where 6,000 employees will work on software and engineering. Toyota has set up a center for small truck design in Thailand, its first non-Japanese product design facility, but likely not its last. And of all the regions in its network, Cisco is winning the most U.S. patents for new products developed at its Indian R&D operation.
Locating R&D facilities in emerging economies gives companies a number of site-specific benefits. Proximity to burgeoning markets makes for an easier and more responsive process for customizing products to those markets, and it makes it easier to meet varying regulatory requirements. For example, Nokia can simply develop cell phones for the Chinese market out of its product-design facility in Beijing. And, as different regions develop their own areas of expertise, such as small cars and fuel-efficient engines in India and China, and commercial aircraft design in Russia, companies can exploit those strengths by building facilities to tap into nearby pockets of expertise. Furthermore, several countries are offering appealing incentives to lure R&D spending. And Beijing will not grant a company access to its market unless it sets up shop locally.