Outsourcing Provides Innovation In Addition to Reduced Costs


By Don Clark From The Wall Street Journal Online

Naveed Sherwani, a former executive at Intel Corp., literally wrote the book on designing one popular variety of computer chip. He is equally expert in the technical talents available in his native India. That's why he has set up a chip-design center there for his Silicon Valley start-up, Open-Silicon Inc.

"We didn't go to India just to reduce cost, but to increase our reliability and predictability," Mr. Sherwani says.

Decisions like Mr. Sherwani's are another wrinkle in the relentless globalization of high technology. While companies often outsource jobs for lower wages, many are also going to China, India and other emerging economies for brain power and product ideas. The trend raises the specter of stiffening global competition involving innovation as well as cost.

The shift is particularly striking for the chip industry. It began moving labor-intensive assembly operations to Southeast Asia nearly 40 years ago. But American chip companies kept their control of many industry segments by designing key products at home.

Now, many of these companies are nurturing a growing pool of designers in Asia and Eastern Europe. Locally owned chip-design companies are also springing up, particularly in China.

Moving chip design abroad may not threaten the U.S. semiconductor industry, many industry executives say. Most chips developed in those regions have been relatively simple, nothing on the order of Intel's flagship Pentium line. Moreover, Mr. Sherwani and some other executives believe the spread of chip-design activity abroad is helping boost sales at U.S. technology companies by addressing talent shortages that slow the delivery of new products.

"New engineering resources allow their world-wide business to grow, which helps them hire more people in the U.S. than they would otherwise," argues Walden Rhines, chief executive officer of Mentor Graphics Corp., Wilsonville, Ore., which sells software used to design chips.

But the rising number of engineers emerging from universities in Asia and Eastern Europe, and their increasing sophistication, points to the possibility that tech companies in the U.S. and other established economies could eventually lose their dominance in chip innovation.

"The attitude here is that they aren't real engineers, they aren't that good," says T.J. Rodgers, CEO of Cypress Semiconductor, a San Jose, Calif., chip company that has a 165-employee chip-design center in the Indian high-tech center of Bangalore. "Nobody should rely on that."

The trend is still in its early stages. ISuppli Corp., an El Segundo, Calif., market-research firm, estimates that about 7,000 people design chips in China, compared with 40,000 to 50,000 in the U.S. Only 3,000 to 5,000 are designing chips in India, the firm says, compared with estimates that more than 660,000 people there work in computer programming and technology services.

But the growth is accelerating. Mr. Rhines says Mentor's sales of chip-design software in China have tripled in two years, with India and Eastern Europe growing just a bit slower than that.

One reason is a big shift in chip consumption. Companies in Taiwan and China design and build a huge share of the circuit boards and computers that eat up chips. By 2003, chip sales to companies in North and South America had sunk to 19% of global consumption, down from 32% in 1998, according to the Semiconductor Industry Association. Countries in Asia rose to 37% of chip consumption from 21% over the period.

Companies that design chips frequently need close collaboration with customers, particularly those in large markets with specialized needs. China has further fueled that trend by setting unique standards for chip-based products, such as wireless communications on laptop computers.

To boost their foreign presence and get closer to customers abroad, U.S. chip companies such as LSI Logic Corp. have purchased semiconductor companies in China and India. And locally based chip companies in developing nations are building businesses around their knowledge of regional requirements. ISuppli for the first time last year added 17 Chinese chip companies to its database.

Talent is the other driver. Cypress first set up its Bangalore operation to avoid losing one Indian engineer, who wanted to return home after working for the company in Mississippi. Other chip makers have opened similar design operations in far-flung places to retain or attract prized designers.

Intel, which has operations in Beijing and Shanghai, has particularly aggressive plans for Bangalore. About 900 chip designers work there for the company. The No. 1 chip maker plans to expand its technical staff there to 2,000 by 2006, at a time its U.S. staff isn't likely to grow much. Though engineers in Bangalore start at around one-third of Intel's usual salaries, an Intel spokesman says its strategy is not to have them do existing work for less money. Rather, the new design teams in India help create new products.

"This is not India vs. the U.S. -- this is India plus the U.S.," says Ketan Sampat, president of Intel's Indian subsidiary. He says designers in Bangalore are doing "some of the most complex work there is on the planet."

Open-Silicon, which has raised $19.5 million in venture capital, limits its business to relatively simple custom chips. It has landed nine design jobs, all from North American companies.

Dale Ford, an analyst at iSuppli, says other kinds of relatively simple design jobs could be transferred to lower-cost locations abroad. Mr. Sherwani and other executives argue that U.S. chip companies should continue to lead the market, as long as other U.S. companies keep designing advanced gadgets that need sophisticated chips.

"Innovation will continue to thrive here and be funded here," said Ronnie Vasishta, LSI Logic's vice president for technology marketing.

-- Scott Thurm contributed to this article.

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