Friday, November 20, 2009

Why Hawaii Technology Companies Should Consider Outsourcing Their R and D Work

Hawaii technology companies are typically underfunded with venture capital by 1/5 to 1/10 what Mainland competitors can command for a comparable venture proposal. The funding deficit for tech companies here has gotten even worse with the current recessionary economy, pullback of venture capital firms from startup funding in general, and collapse of Act 221 tax credit incentives for Hawaii investors. As a result, Hawaii tech companies with good research innovations may have insufficient funds to conduct the R and D work needed to validate proof-of-concept into a commercializable or licensable product. Even if they can accomplish this step, commercialization would be difficult to achieve given Hawaii’s underdeveloped business infrastructure and impediments to cost-effective manufacturing, distribution and shipping to global markets.

One promising avenue for Hawaii tech companies to bridge their funding deficit and achieve commercialization is by outsourcing their R and D work to foreign countries having professional workers with high STEM skill levels employable at low labor rates relative to those in the U.S. Many countries produce STEM graduates with skill levels comparable to ours, but at 1/5 to 1/10 the wage cost. Countries like China, India and the Philippines are especially attractive given that English is spoken universally by science and engineering graduates and by most educated businesspeople.

I recently toured a number of cities in the Philippines as part of a trade mission organized by the Filipino Chamber of Commerce of Hawaii. Besides promoting tourism to Hawaii and sister-city-state relationships with Philippine cities and provinces, the trade mission also explored possibilities for business relationships between Hawaii and Philippine companies. Business process outsourcing (BPO), such as for call-center operations, CAD and architectural drafting, medical records transcription, and data entry of written records, has developed into a major industry in the Philippines in recent years. With increasing technical sophistication, it is now moving into knowledge process outsourcing (KPO), such as agricultural field testing, medical clinical trials, IT programming, and ICT engineering.

A business model for a Hawaii tech company working with a Philippine partner might work like this:

1. The Hawaii tech company develops a new technology covered by U.S. and international patent filings, has a system design ready for testing, but has a small U.S. R and D budget.

2. A Philippine tech partner can do the field testing under an outsourcing contract on a wage scale 1/5 to 1/10 of the U.S. The Hawaii budget can therefore be stretched to encompass at least 2X or 3X more than can be obtained with the same budget in the U.S.

3. The Hawaii partner pays the contract price upon completion and assigns the technology rights and PI patent filing rights to the PI partner to exploit the technology in their own domestic PI market.

4. Successful exploitation by the PI partner in the domestic PI market validates the technology for sales or licensing in other countries in which the Hawaii partner holds strong IP rights, such as Japan, China, Korea, Hong Kong, Singapore, and Australia.

5. The Hawaii partner gains a tested system on a small budget and can exploit the product for sales or licensing in global markets. The PI partner can manufacture and ship the product for the Hawaii partner to nearby Asian markets at a much lower cost than from the U.S.

While corruption and cronyism may continue to impede foreign investment in established business areas like Manila, newly developing areas of the Philippines can provide a more conducive business environment for foreign investment. For example, the Subic Bay Metropolitan Authority (SBMA) is constituted to develop the 67,000 hectare former U.S. naval base as a Freeport and Special Economic Zone into a self-sustaining industrial, commercial, financial, investment, and academic center.

SBMA is only 100 kilometers from Manila and connected by the new SCT Expressway. It has complete deep-water port facilities and is only 24 hours sailing time to Taiwan, 28 hours to Hong Kong, 53 hours to Shanghai, and 70 hours to Kobe, Japan. Subic has an onsite international airport and is also only 45 minutes drive away from the larger Clark airfield that has large available capacity for international flights and airfreight. New condo buildings, trade office towers, university extensions, and affordable housing constructions are slated for completion beginning in mid to late 2010. Hanjin Industries of Korea has invested $2 billion in upgrading shipbuilding and port loading/unloading facilities, and Philippine contractors in manufacture and metal-working are lining up to provide skilled labor. SBMA will thus have state-of-the-art infrastructure for tax-free manufacture, assembly, and shipping of technology products to ASEAN and other Asian markets.

By outsourcing R and D work to suitable foreign partners in developing economic zones like Subic Bay, Philippines, Hawaii technology companies can overcome their funding deficit and have the necessary work done by their foreign partner leveraged several times more than what their budget could accomplish in the U.S. Further, by enabling their foreign partner to successfully exploit the now-proven technology in their own domestic market, the Hawaii tech company gains validation of the technology for sales or licensing in other countries in which it holds strong IP rights. The foreign partner would also be enabled to manufacture and ship the product to orders for the Hawaii partner to global markets at a much lower cost, and therefore greater profitability, than from the U.S.