By Michael Kanellos
Tuesday, June 28 2005 05:15 PM
URL: http://www.zdnetasia.com/insight/business/0,39051970,39239418,00.htm

BANGALORE, India--The outsourcing boom that has transformed this country's economy can be traced in part to a technology discovery made in 1995.

That year, engineers at Tata Consultancy Services found that a set of software tools called CasePac, developed to convert code for IBM, could be used to change the date field in other programs.

"We realized this could be used for the Y2K problem," said Nagaraj Ijari, a senior executive at Tata's offices, located in this city at the epicenter of India's thriving technology industry. Companies from around the world sought Tata's outsourced services to fix the millennium bug," and the company's annual revenue has climbed from less than US$170 million to US$2.24 billion in the years since.

The success story illustrates how quickly India's fortunes have changed in just a few short years, as the country's burgeoning technology industry has provided such services at a fraction of the cost of Western counterparts. Building on this foundation, India is now entering an important new phase in its economic evolution.

Once fairly anonymous organizations hired to run support desks and develop server applications for large multinational corporations, Indian companies are raising their profile as brand name suppliers in hardware design, software development, consulting services and virtually anything else in technology. Infused with new blood from a young tech-savvy work force, the new movement is a major advance toward economic independence that carries broad ramifications for a country whose past includes colonial rule, experiments in socialism and devastating poverty.

"There is a huge Indian domestic opportunity and an export opportunity beyond outsourcing," said Rishi Navani, managing director of WestBridge Capital Partners, a venture capital firm specializing in Indo-American deals. "Over the next 12 months, you will see three to four new Indian Nasdaq listings."

India's growing entrepreneurial spirit is reflected in its forays into consumer electronics--a highly competitive market that has long been considered the province of Japan, China, South Korea and other Asian nations, as well as the United States.

Tata recently won a deal to create an environmentally friendly cell phone for a U.S. carrier, for example, while rival Wipro Technologies is designing MP3 players for Europe and a flat-panel TV for an American company. Such entrepreneurial ventures in the consumer market are not confined to the largest players: Mumbai-based Celetronix produces set-top boxes for a U.S.-based satellite TV carrier.

"Our evolution will be similar to the evolution of Taiwan," said Ramesh Emani, president of Embedded & Product Engineering Solutions at Wipro, noting that in India, there would be greater emphasis on hardware design than on manufacturing.

As was the case in China, domestic demand is a significant factor in India's technological expansion.

India has only 100 million phones for its population of 1 billion people--including both cellular and land lines--but that number is expected to grow to 250 million in the next two years. Cellular service costs only about US$4 to US$7 a month, and future phones will also sport cricket scores, lottery ticket purchases and other types of services seen in South Korea and Japan.

"The volume is enormous," said Sanjay Nayak, CEO of network equipment specialist Tejas Networks, which has won large contracts in India against multinational competitors.

High growth is also expected for the computer market in India, which counts only 14 PCs for every 1,000 people. Several companies hope to court that market with computers priced at less than US$250, many of them packaged with residential broadband service that costs about US$12 a month for a 128kbps connection.

"It is our fastest-growing emerging market," said Ketan Sampat, president of Intel India. "We've had a growing middle class. PCs are part of that."

Beyond the home, some hardware companies are targeting the enterprise market in and outside India. VXL Instruments, for example, delivers stripped-down desktops to the likes of Air France and Goodyear Tire & Rubber.

New Delhi's FinalQuadrant Solutions sells a server appliance for the travel industry. Travel agents pay only a modest amount for the server but hand FinalQuadrant a small fee for each hotel room night or travel leg booked through the system.

"We're making every single (travel) reseller as powerful as Expedia," CEO Anuj Gupta said. The company, which made US$1 million in net profit in 2004, has mostly sold its products in Europe and is expanding to the United States.

For India's service companies, perhaps the most natural expansion is the consulting business. Outsourcing stalwarts such as Tata, Wipro and Infosys Technologies have begun significant consulting operations as outgrowths of their outsourcing work. Each of these "Big Three" companies has seen revenue grow in

the 30 to 50 percent range every year for the last five years--a period in which Western companies saw revenue flatten or decline.

Most of their consulting engagements largely address how best to implement services already provided by these companies. But they are nevertheless long-term commitments that will pit them against the formidable white-collar armies at large U.S. companies for years to come.

"We are not McKinsey. We do not want to hand over the report and run away," Tata's Ijari said. "Our competitors are Accenture and IBM."

The new competition on many fronts from India has prompted U.S. companies to increase their presence in the country. Western companies such as Sun Microsystems and Hewlett-Packard have set up shop in India as part of the outsourcing trend, to keep engineering labor costs in line with those of their competitors. But U.S. companies face a problem: Other types of employees, such as managers and sales executives, also have relatively low salaries--meaning they cost India rivals less.

Such concerns explain why U.S. venture capitalists are increasingly insisting that any U.S. start-up seeking funds maintain a presence in India. A company might cost $50 million to $70 million to build in the United States but, with relatively inexpensive labor overseas, might cost US$12 million to US$20 million in India.

U.S.-Indian businesses can take all manner of hybrid forms. Some were conceived in the United States and have built research and engineering departments in India. Others were born in India but have located high-level executives in America. Still others, such as Tejas and Telsima, are founded and based in India.

Whatever the mix, functions often monopolized by Silicon Valley in the past are now spreading overseas. To lure new investment, for instance, Silicon Valley Bank brought a number of American venture capitalists to India in September 2003 and subsequently opened offices that it lends to visiting VCs and their budding start-ups.

"Before, India was an afterthought," said Ash Lilani, head of global sales and marketing at Silicon Valley Bank. "Now it is thought of at birth."

From blackouts to corruption
Still, challenges persist. With an estimated 600 additional cars on Bangalore's streets every day, traffic has ground to gridlock. The five-mile drive to Electronics City, the main tech hub, can take an hour from the center of town. An express road that was supposed to have been completed last year remains a tangle of rebar and cement pilings.

Electricity is another pressing concern. In nearly every Indian city and state, power outages occur fairly regularly. The lack of an adequate power grid is one reason that no foreign company has built a semiconductor fabrication facility in the country. A South Korean entrepreneur has signed a preliminary agreement to build a chip foundry near Hyderabad, but many sources privately doubt that the project will get far, because of the water and power demands of a modern fab plant.

"The government realizes that there needs to be foreign investment" in infrastructure, WestBridge Capital's Navani said, adding that development funds are being negotiated with large banks.

Tech companies also routinely complain about India's tax system. On the plus side, the onerously large import duties of the past are fading away, and the government has passed laws requiring the equivalent of benefits offered by places like China and Taiwan, including one that gives companies exporting tech products a 10-year exemption from income taxes.

Yet executives are well aware that the government has a history of adding taxes through its national budget, as exemplified recently with a so-called fringe benefit tax. Under this provision, companies that throw parties for clients or host them at conferences must pay a tax on the expenses, said Ravi Pradhan, India manager for Via Technologies.

Moreover, as in other parts of the world, corruption remains a problem when it comes to influencing clients and government officials. "In America, you might take them to the Super Bowl. Here, you give them money," one source said.

And even for Indian entrepreneurs who know how to navigate the unofficial ways of doing business, help from multinational manufacturers is still necessary to build their industry.

"We have engineers who are good technicians, but we need product managers," said Vinod Dham, founder of NewPath Ventures, a venture capital firm that specializes in Indian investments. The services business, he added, has "made a culture of people who say, 'Tell me what to do.'"

Reverse outsourcing
This should lead, at least in the near term, to a form of reverse outsourcing, with U.S. experts heading overseas to provide services for Indian businesses. Indian-based companies, for their part, will need to install an increasing number of employees in Europe and North America to land contracts--which means paying higher Western salaries.

"You need guys who worked on Wall Street," said Jessie Paul, head of marketing for iGate, a Bangalore-based company that provides consulting and other information technology services.

However, while these factors may temporarily slow progress, few expect it to stop the industry. Many Indian companies are becoming more integrated into the business processes of their customers, making offshore outsourcing a permanent arrangement.

"The level of people who are visiting us today is very, very high. They are actually the strategic decision makers. In the dot-com days, it was more reactive," said Srinath Batni, a board member of Infosys. Outsourcing, he added, "has become a long-term strategy."

That marathon approach is viewed as a key advantage for India. Many executives and entrepreneurs note that India's tech boom is driven by a demographic bubble that will be difficult to match for other nations. India has a large population of young people who are driven, well-educated and work for relatively low wages.

"The average age of the working population in India is 27 years," said Supratim Sarkar, manager of strategic marketing at Wipro. "That is one of the biggest levers we have."

Not surprisingly, optimism is running high as younger generations come of age. The national exuberance has inspired many entrepreneurs, including Rajesh Jain, who sold an Indian-based Web portal, IndiaWorld, for around $100 million in 2000 and who is now incubating companies that he expects will bring computing to the masses in his country.

"For the first time," he said, "there is confidence that tomorrow will be better than today."