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Outsourcing: An Executive Dilemma

Outsourcing: An Executive Dilemma
by Louis M. Scarmoutzos, Ph.D.

A question often asked by many senior managers and executives is whether to develop proprietary products in-house or to outsource the effort. This question may be answered quite simply in many situations by asking the following basic question: "Do we have the resources to develop these products in-house?" Obviously, if the appropriate resources are lacking, the solution is to outsource product development. The decision is less clear in those situations where you have the resources and can either contract the work out or develop the products in-house.

The Pros and Cons

Some of the advantages of outsourcing include ready access to technology and expertise, flexibility, costing and additional contacts. Outsourcing often provides a company with technology and expertise that the company needs but is unwilling or unable to invest in. This technology can be "breaking technology" (or resources) to which the company might not have access, or it can be technology (or resources) in which the company is simply not yet willing to invest.

It is often more economical for a company to outsource its product development activity. This can be due to either the capital expenditure involved with the project or simply the lower costs associated with hiring an outside contractor.

Outsourcing provides a company with a great deal of flexibility. It allows companies to utilize in-house capabilities to their fullest potential without disrupting their on-going schedule and tap into outside sources for additional capacity. This additional capacity may be used to broaden the product base or simply to test "high risk" waters.

Independent contractors and consultants usually have their own network of contacts and "spheres of influence" which they have built over the years. Outsourcing can provide a company with ready access to this additional skillbase.

The major disadvantages of outsourcing product development include loss of project control, potential tax impacts, and less than full utilization of in-house resources and capacity. Many companies are uncomfortable with the loss of control that results from outsourcing and feel that they must control the everyday product development effort. Additionally, companies are concerned that their proprietary information may become available to third parties or competitors.

Companies may lose certain tax breaks and benefits if they outsource their product development efforts. Product development efforts that require capital expenditures or that might involve R&D may have very different tax consequences and benefits if conducted in-house or are outsourced to independent contractors.

Outsourcing may not fully utilize the existing product development potential and capability of a company's own in-house resource base and capacity. In-house development of new products and technologies may also yield "hidden" or serendipitous developments. Yet in today's "lean and mean" economy, most companies no longer have the luxury of additional capacity. Product development would most likely come at the expense of other income-producing endeavors.

The decision to outsource can be a difficult one, particularly when a company has the resources to develop the products in-house. However, not all of the product development effort and tasks need to be outsourced. A compromise might be to outsource only certain portions or tasks of the development effort that promise the best advantage if outsourced.

Several issues need to be addressed once a decision to outsource product development has been made. In addition to the obvious issues regarding "deliverables" and compensation, there are important issues regarding proprietary information, intellectual property and contractor status that should be addressed. Professional counsel and legal assistance may be desirable and often necessary, particularly as it pertains to contracts and agreements.

The issue of proprietary information can often be and is easily addressed by use of a Non-Disclosure Agreement. There are many standard "boilerplate" agreements that will usually suffice. Intellectual Property (IP), which consists mainly of patents, trademarks, service marks, trade secrets and copyrights, can be addressed by a Product Development Agreement, which explicitly incorporates ownership or assignment of any and all IP developed or discovered by all parties involved in the product development efforts.

Often during the outsourcing of product development, positive, lasting working relationships develop between the company and contractor. In these situations, which usually evolve with time, the same contractor is chosen and used regularly as an outside, independent contractor. This is most often a very good thing since it is derived from comfort and trust.

However, the company needs to be cognizant of the differences between the outside contractor and what the government may potentially classify as an "employee"--temporary or permanent. The classification of a "contractor" as an employee vs. an independent contractor has very different consequences as it relates to taxes (both state and federal) as well as to how it relates to company entitlements vis--vis benefits and compensation.

If you often hire outside contractors for product development work, you may want to do several things. First, have all of your independent contractors sign an Independent Contractor Agreement that explicitly addresses the issues and criteria that the government uses to classify "employees". Second, amend your company benefit plans to exclude "temporary employees" from coverage, thereby allowing for the classification of contractors as employees without having to suffer additional coverage costs. Again, you may want to seek legal and professional counsel regarding these issues.

Finally, once outsourcing is decided--in part or in whole--two key factors will dictate the successful outcome of all of your present and future outsourcing efforts: the development of mutual trust and respect amongst all the players, and being able to work together as a team--in other words, the "chemistry" must be right.

Louis M. Scarmoutzos, Ph.D., is president and founder of MVS Solutions Inc., a consulting firm that provides business and technical assistance to companies in the natural products and related industries. He can be reached at or at (617) 283-2182.

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