VCs Turn Their Gaze Offshore

International outsourcing has been a way to cut costs. Now, investors are recognizing that it can also generate hefty profits

By Gabor Garai

Outsourcing isn't just for the big boys any more. Venture capital firms are getting in on the act with the small companies they back. One major American venture capital firm, for example, is understood to insist, as a condition of investment, that any company it invests in outsource its computer programming tasks to the greatest extent possible.

In another, even more vivid situation, several American and European investors recently put up several million dollars to back a Hungarian clinical research outfit whose main line is obtaining outsourcing business from American pharmaceutical companies.


  What makes this business noteworthy, both as a business and as an indication of future direction for venture investors, is that the Hungarian company, Goodwill Research, isn't just handling repetitive or mundane tasks, like software service calls or data-entry work. Rather, it is a highly sophisticated medical-services company that specializes in conducting clinical trials for pharmaceutical companies -- at one-fourth to one-third the cost of the going rates in the U.S.

Clinical testing is one of the most daunting tasks facing any pharmaceutical company. Completing it efficiently and effectively is key to obtaining approval from the U.S. Food & Drug Administration (FDA) for new drugs, which is required before any drug can be marketed in the U.S.

Clinical trials present hurdles on a number of fronts. It can be difficult to recruit enough patients because of the requirement that studies be double-blind. Patients in the grip of a worsening disease often resist the notion that they may be consuming a placebo instead of the new drug being tested. If patients drop out during a study, the results may become questionable. In addition, studies may extend longer than expected, and costs increase beyond budgets.

Moreover, laboratories must be highly reliable. The data must be expertly recorded and maintained.


  Hungary has a highly sophisticated scientific community with much experience in many aspects of medicine and medical research. Even more significant from a business perspective, Hungary's personnel and facilities costs are a fraction of America's. In addition, it is easier in Hungary to obtain volunteers for double-blind studies, and they tend to stick with the studies, reducing time and money expenditures further compared to the U.S. Already, Goodwill Research is working with a number of sizeable American pharmaceutical companies, lowering their costs for conducting clinical trials.

This kind of situation tells us several things about the outsourcing phenomenon, especially as it affects venture investing:

• Outsourcing offers smaller companies significant business opportunities, no matter where they are located. Not only can smaller American businesses benefit from outsourcing tasks, but smaller overseas companies can benefit by positioning themselves to seek out companies that need to outsource tasks.

• Outsourcing is moving up the so-called "value chain." The tasks being outsourced are increasingly sophisticated, and thus less subject to commoditization down the road. . In Hungary, a number of small software development companies are beginning to focus on the outsourcing opportunity, serving as innovators rather than simply programmers.

• As a result of the first two items, companies that make effective use of outsourcing will increasingly attract the attention of venture investors. They seek out companies with sustainable competitive advantages, intellectual property, and other key indices of long-term and appreciating value.

All this means that outsourcing will increasingly be viewed by venture capitalists as not just a way to save money, but to make money. If done right, outsourcing is a way for small companies to speed development and focus on their core competencies by leveraging cash. A small company's ability to attract venture capital won't be limited to its location, but increasingly to its ability to make the best use of its assets -- both physical and intellectual. If done right, outsourcing can help smaller companies attract venture capital.

Editor's note: Offshore outsourcing is a subject much on the minds of many U.S. entrepreneurs, politicians, managers, and workers. Here are some other recent BW Online Small Business columns and stories on the subject:

"U.S. Programmers at Overseas Salaries"

"The Truth, No Matter What"

"A New Tide in Offshore Outsourcing"

"The Changing Face of Offshore Programming"

"Offshore Outsourcing: Time to Get Creative"

Gabor Garai is a partner in the Boston office of the national law firm Epstein Becker & Green, specializing in the financing and growth requirements of small and midsize companies.

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