Why Small Tech Companies Aren't Outsourcing

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This allowed them to dramatically increase their development capacity and add product features that would otherwise not be cost-effective. Companies also benefited from having 24/7 development, so that one team could be fixing errors while the other slept. Venture capital firms also provided strong encouragement for companies within their portfolio to leverage the capital efficiencies of offshore development.

But only four of the 16 companies that were developing core products abroad either in their facilities or through an outsourcing partner had actually chosen to do so. The rest were founded or acquired abroad. The CEOs gave many reasons for not being able to develop their core products abroad:

Hurdles to Going Overseas

1. Communications/customer needs. Developing a product requires a deep understanding of customer needs and extensive user interaction. Locating R&D personnel away from customers limits the ability to develop innovative products that meet market needs.

2. Components must fit together. Complex software is more like a Swiss Army knife than a meat cleaver. The blade, bottle opener, and screwdriver have to work in an elegant manner and can't be developed independently. In a similar way, software development teams need to work closely together.

3. Management bandwidth. It is a lot more challenging to manage diverse teams at multiple locations and in different time zones. Additional layers of management are often required.

4. Fewer developers can often produce more. In the tech world, scaling up development teams doesn't always lead to greater productivity. Small teams are often the most innovative and productive.

5. Skills scarcity. The specialized skill and mindset that tech companies look for are hard to find. For example, India doesn't have programmers who have grown up to understand the intricacies of computer game development because few can afford the high-speed Internet connections needed for playing these games. Swiss programmers tend to be more process-oriented and less innovative. And Russian programmers usually have language issues, according to the study.

6. Intellectual-property issues. The greatest concerns were about China, where it is almost impossible to protect trade secrets and piracy is rampant. Employees often leave to start ventures that compete directly with their foreign employers, and the laws provide little protection because they aren't enforced (see BusinessWeek.com, 7/12/07,""Broken China"").

7. Competition for talent. In countries like India, potential employees place greater value on the brand and prestige of the company they are joining than on stock options in a company no one has ever heard of. They put a premium on job security and career opportunities. So companies such as Infosys (INFY.O) and Wipro (WIT) get their pick of talent. And these outsourcing companies usually assign their top performers to large corporations that provide them with multiyear, multimillion-dollar commitments rather than to their small clients.

Not for Outsiders

I've founded two technology companies that outsourced some product development to Russia (see BusinessWeek.com, 3/12/04, ""My Son, It's Time to Time to Talk of Outsourcing…""). I was one of the pioneers in outsourcing and have lived through the difficulties and know of the potential rewards.

But if I were building a new technology, I wouldn't trust an outside team to innovate for me. Outsourcing testing and support is one thing, but when you're starting up, all you have is an idea. You learn as you go and can never predict what will captivate the market (see BusinessWeek.com, 5/4/06, ""Countdown to Product Launch (Part I)""). You simply can't outsource your success to others who don't have as much skin in the game as you do. Bottom line: Entrepreneurship and innovation is alive and kicking in the tech world. It won't be outsourced. It is one of America's greatest strengths and will help the country keep its edge in a globalized economy.

Vivek Wadhwa, a former tech entrepreneur, is the Wertheim Fellow at the Harvard Law School and an executive-in-residence at Duke University. He writes a column on policy issues affecting entrepreneurs every month.