Many high-tech and technology companies, especially those in their early stages, find it difficult at one stage or another to develop a certain product or technology. This difficulty leads them to consider whether they should hand their development (in whole or in part) over to a third party as part of an outsourcing strategy, or to form a partnership with another third party for the purpose of development, making that third party a partner not only in the development process but also in its products.
There are quite a few issues affecting the decision of such companies when coming to choose between these two options. Such issues include keeping intellectual property within the company, the company’s human capital, the particular field in which the development is required, costs involved in each option, future considerations such as how technical support would be provided for that product or service and by whom, and more.
In this article we will review some of the considerations listed above in order to try to provide a full picture of each of the two options mentioned above: outsourcing and joint development.
The vast majority of high-tech companies and start-ups, which now appear almost daily, rely on the development of technology used in a certain product or service, with the hope that this technology would set them apart from the competition. Therefore, the process of developing that technology usually makes up the most important element for these companies, in terms of both the time and the resources required to accomplish this.
Potential problems begin with the fact that such young companies don’t possess the financial resources required to develop the necessary product or technology on their own, and therefore the only solution at their disposal is in fact to outsource the process to a third party (a company, a consultant, and the likes) which would carry out development for them.
By doing so, even though software development outsourcing may be quite costly, the costs involved are still considerably lower than the costs companies would have paid had they carried the burden of technological development on their own, internally within the company, and this is the important advantage of development outsourcing over internal development inside the company.
In contrast, there are quite a few disadvantages, or shall we call them risks, arising from this type of outsourcing, since the company thus exposes itself to risks involved in a leak of intellectual property, which may occur once it is disclosed to the third party carrying out the development for the company.
Alongside the outsourcing option, another option is to bring a partner into the company, where that partner would not be responsible for development while foregoing any and all rights in intellectual property (as would have been required of a third party as part of an outsourcing process), but rather would constitute a veritable partner in the company or venture.
As mentioned above, there are important considerations to be taken into account before turning toward one of these two paths, some of which we will review in this article:
Intellectual property ownership: When a company decides to turn to outsourcing in order to develop its technology, a contract is signed, which constitutes a legally-binding document. In that document the company will attempt to establish its full ownership of all intellectual property, both its current intellectual property rights and its rights in discoveries and developments made during the development processes, all aiming to protect intellectual property in order to remain its sole proprietor. Even if all such actions are carried out, there is no guarantee that the third party responsible for development (whether directly or through one of its employees) wouldn’t violate this obligation and make use, one way or another, of the company’s intellectual property rights, thus risking and even thwarting the company’s advancement in its market.
In addition, we should also consider that sometimes, companies which carry out development tasks for other companies operate in areas which are identical or similar to the one in which the new company operates, so they would not be able to ensure that all intellectual property would be owned by the company, since the developments on which they have worked (and may work in the future) for other companies may be too similar to be fully separated from one another.
Company value: Every company, especially one in its infancy which may be looking to raise capital, should generate a company value that is as high as possible. In its early stages, the value of the company arises mostly from its human capital. However as the company turns toward outsourcing, it necessarily reduces its human capital, which in turn may reduce its own value.
Future support services: In situations where a company’s technology hasn’t been developed in-house, but rather outsourced, offering technical support to future clients would be challenging. This isn’t impossible, however it requires significantly greater resources compared to a situation where company employees are the ones who have developed the technology, and who are therefore proficient in it and can handle malfunctions and/or train others to handle them more easily.
As a general rule, joint development entails all considerations mentioned above, with some changes. As an example we will mention the issue of intellectual property, which is often considered highly important by the parties involved in the joint development. We shall stress that even in the case of joint development, the partners should clearly define the issue of intellectual property ownership, not only of the new technology to be developed, but also of the intellectual property each one of the partners brings in, which may contribute to that particular development. It goes without saying that each partner should protect the intellectual property they are bringing into the joint venture.
And so, when an entrepreneur decides to partner with another person to develop a new product or technology, they are raising the value of the company by not disclosing their intellectual property to third parties, but they are exposing themselves to the demands of their partner for rights in the development, such as being registered as a patent owner, royalty rights and so on.
We should mention that even in the case of several founders, even (and especially) when their friendly relationships go beyond the limits of professional engagement (even in the case of a founder who seeks the help of a development partner with whom they have a prior connection), it is doubly important to establish the relationship between the parties, in order to protect the venture and the rights in it, the involved parties and the relationship.
The way a company chooses to develop its product or technology directly and significantly affects serious issues at the basis of technological companies – the issue of intellectual property and the possibility of capital raising.
Therefore, each one of the options reviewed above in this article – joint development or outsourcing – has both advantages and disadvantages which should be considered in advance, in order to understand the way in which they would affect that particular company.
We would argue that even though it is not always possible to delineate and mitigate in advance all risks associated with each option, being aware of these complexities allows the company to make informed decisions and to plan its strategy effectively and consciously.