The Choking of Innovation: India’s much-vaunted IT Industry has to dramatically change if it to maintain its leadership role in the next 10 years.

[Guest post by Sanjay Anandaram, sent in response to Vishal’s post on IT Biggies being the ‘Axis of Evil’ for Indian startups. Sanjay wrote this article in 2005 and it’s surprising that most of what he wrote 3 years back still holds true! The article talks of ‘tangible’ aspects that brings in innovative mindsets. A must read.]

The Choking of Innovation

A fundamental re-think of the business has to occur with innovation on the front-burner if it has to continue to grasp the world’s attention.

“On January 6, 2005, the prime minister spoke about his intention to set up a Knowledge Commission to  look into the issue of building quality human capital. The government believes that investments in institutions of higher education and R and D organisations are as important as investments in physical capital and physical infrastructure. What we need are world class universities and we must make a beginning with one institution.

“We must have a university that will be ranked alongside Oxford and Cambridge or Harvard and Stanford. I am happy to inform the House that we have selected the IISc, Bangalore, which enjoys a high reputation as a centre of excellence in R and D. We shall work to make IISc, in a few years, a world class university. I propose to provide an additional sum of Rs.100 crore as a grant for this purpose”, Finance Minister P. Chidambaram in his 2005 budget speech

Perhaps for the first time, an Indian Finance Minister had actually acknowledged and acted upon the need for developing R&D excellence as a policy measure for achieving national
goals. It is an acknowledgment also of the fact that for India to find its place in the sun in the years to come, R&D based excellence – or, innovation based solutions – is mandatory.
That if India’s destiny lay in just being a low cost supplier of the world’s goods and services, then the tryst with that destiny would be short -lived. But if India’s destiny lies in being an international leader in the supply of goods and services then it has no choice but to embrace innovation and R&D based excellence.

Over the past 57 years, India’s share in world trade has shrunk from over 2% to about 0.6% today. Of India’s top items of merchandise export are in traditional commodity items like textiles, gems and jewelry, leather, chemicals, engineering goods, minerals, and agroproducts. The value-added by India in the commodity items is minimal and hence prone to
significant international price pressures. Due to the lack of investments and innovation along the entire value-chain, from design to marketing to technology to the business model itself, these industries capture just a tiny share of their global markets. These industries have grown in large part due to the natural advantages enjoyed by India of which an abundant supply of low cost labour is a significant part. In the world of tomorrow, innovation has to take centre-stage if these industries are to have positions of dominance on the world stage.
Non-traditional businesses like IT services and pharmaceuticals have grown significantly in the last decade and are now recognized as having “arrived” on the global stage. Both these businesses are knowledge driven and employ a significantly different profile of employees than the traditional businesses. It is therefore imperative that with their arrival on the global stage, with their access to world class talent and capital, cost & quality led advantages, and with high global demand, they do not become complacent and lose their leading positions much like the traditional businesses have done.

With over 300,000 engineers graduating each year, India is sitting on a human capital goldmine that most countries can only dream about. However, the issue of global leadership isn’t one that’s only about numbers. After all, with only 7000 engineers graduating each year, Israel with 6.5m people has over 100 innovative companies listed on Nasdaq! And India
with over 250m head of cattle – the world’s largest – is not even a player in the global dairy business!

Indian pharmaceutical companies have already realized that in the post WTO world, they need to compete with multinationals in India and in global markets. “In this new patent era”,
says Ajit Dangi, director general of the Organization of Pharmaceutical Producers of India, “unless Indian companies can rapidly change their business model from imitation to innovation, by 2010 there will be just 500 to 1000 companies.” (from the current 10,000 plus companies).

Indian pharmaceutical companies spend about 8% of revenues on R&D today; In the fiscal year ended March 2004, a total of 855 drug patents were filed by Indian companies, up
from virtually zero 10 years ago.However, no such resolve or action is seen from the Indian IT services companies. The industry that has put brought India into the collective consciousness of the economic world – terms such as outsourcing and offshoring were even raised in the US Presidential elections – is growing by leaps and bounds. Why should they be worried? After all, the industry is growing at 25+% and the prospects look very good for the foreseeable future. Or do they?

For one, the next 10 years for the industry will not be anything like the first 10 years. Increased globalization, increased choices for employees and customers, and increased
competition will force huge changes. While the industry has grown admirably over the past decade and a half from an almost standing start to reach its current size, it has also attracted the attention of the rest of the world. That means Indian IT services now have to contend with really brutal global competition and market demands.

If we believe, however, that the next 10 years will play out as the previous 10 years have then we have nothing to fear and the industry and its stakeholders can all sleep well at night. This article will also then be quite irrelevant. However, if the next 10 years are not replicas of the previous 10, then we have a lot to worry about. For then, India would have lost
an opportunity to achieve true global leadership in IT. We would have once again snatched defeat from the jaws of victory. But I believe that the next 10 years will be different.
I believe that there are serious issues that need addressing if the Indian IT (as opposed to MNCs leveraging India through captive units) industry is to continue to create value 10
years from now.

The Serious Issues :

Structure of the industry

According to data published by Nasscom in its Strategic Review 2005, the top 20 companies (of these, 5 are quasi -captive companies of overseas companies e.g. Digital Globalsoft – now HP – which derive a significant chunk of their revenues from their financial and other relationships with their overseas sponsors/parent companies) accounted for nearly 63% of the industry’s exports in 2003-04.
Which means that approximately 3200 companies in India (out of the universe of about 3200) delivered 37% of the industry’s exports or about US$ 3.4 billion. Put another way,
the average size of these 3000-odd companies is just US$1.13 million or Rs 49 million! And, a vast majority of these companies is over 7 years old. If this situation were to be
put in a social context, it is as if we had a society composed of the few extremely wealthy and a vast number of poor buttressed by a negligible sliver of the middle-class – an
unhealthy state for any economy let alone one that’s ostensibly a knowledge driven one.

The Paradigm

The paradigm of the Indian software services industry most closely resembles that of “made-to-order” contract manufacturing (CM).

Worldwide, CM companies under margin and revenue growth pressures have been morphing into OEMs (original equipment manufacturers) to ODM (Original Design and
Manufacturing). Today, the entire design, development, sourcing, manufacturing, testing, packaging, shipping is undertaken by the larger ODMs leaving their customer, say
Cisco, to manage the customer, channel and marketing relationships. Some ODMs are venturing into launching their own brands (e.g. Haier, BenQ) in carefully chosen markets. Complex technological products from PDAs to PCs to Digital Cameras to Phones to Networking gear are being increasingly supplied by ODMs from Taiwan and China. More importantly, these companies are investing heavily in innovation in technology, marketing and business models!

Indian IT services need to see the writing on the wall and start investing in innovation now when they have the luxury of enviable margins and revenue growth. Investments in R&D,
Sales & Marketing, and business development activities have to dramatically increase. Such investments take time to fructify and will stand the Indian companies in good stead when
growth starts tapering off over the next few years as it inevitably will . The past 10 years has seen the Indian IT services industry successfully perfect the equivalent of the CM business
model but will the next 10 see them perfect the equivalent of the ODM model? After all, pay-offs from investments in soft infrastructure like R&D, culture, and mindsets take a lot
longer than investments in hard infrastructure like land and buildings.

Maturing of the Industry

The results of the top Indian IT services companies (TCS, Wipro, Infosys) for the year ending March 2005 brings another aspect to light. That their growth is being largely driven
by volumes (increased deployment of headcounts) as opposed to increases in prices. It is no surprise then that the Nasscom Strategic Review 2005 goes on to say that the industry is
maturing. The ability of the large companies to continue to hire and deploy large pools of manpower appears to be the only constraint to growth at this point. However rising costs,
attrition rates due to increased choices for employees, increased awareness of customers about India and other geographies, competition from other countries, and concerns about
availability of skilled and trained talent will start to make an impact on these impressive growth rates.
As in any services industry, the industry is clearly quite skewed in favour of the large companies since the drivers of value are scale (armies of programmers are required since revenues are proportional to headcount) and scope (a wide suite of services is offered to customers – different services across different industry verticals). The small companies do not offer any differentiated services and are more often than not, hamstrung by lack of capital and lack of management talent. Mergers and Acquisitions are the way out for many of the smaller companies that offer any set of differentiated capabilities. The others continue to struggle against market forces to remain afloat.

That the industry has matured is evidenced also by the fact that no IT services startup has been financed by VCs in the last 3 years. On the other hand, capital is however available for
purposes of consolidating holdings and undertaking M&As.

Impact of MNCs

Global companies are becoming “Indian” faster than Indian companies are becoming “Global”. IBM, Accenture and HP alone employ over 50,000 people in India today as part of their global services operations. They also have operations in many low cost countries around the globe to which they are rapidly moving low end, price sensitive activities to face the threat from Indian IT services. As their headcounts in India (& in other lower costs locations) increase as a proportion of their global headcounts, their ability to effectively compete on
price against vendors from India (& other low cost countri es) will only increase. Indian companies, on the other hand, have their centres of gravity and the locus of operations in India: they are yet to make serious investments in building capacity, competence, and relationships globally. In the coming years, notwithstanding their “global delivery model”, Indian services companies will need to aggressively step out of their India centric delivery models and invest in global workforces, global relationships and partnerships with customers, partners, and vendors. Meanwhile, here’s what Claudia Van Munce, Managing Director of IBM’s Venture Capital Group has to say in a March 23rd 2005 interview with Always-On “..IBM used to be known as the company that only played with the large corporations. But then if you look at NASDAQ, 70 percent of the NASDAQ 100 was at one time a venture-funded startup. So, we’re obviously casting our net in areas where these companies can be very successful and become critical partners of IBM”.

In addition, companies like IBM and Accenture invest in research in different industries, subjects, and technologies to gather insight into how they can impact their customers. For
example, Accenture has its Institute for High Performance Business that does research in areas like strategy, innovation, CRM, Supply Chains, and business models. IBM works with
academia and key technologies on a global basis to devise next generation innovative solutions for its customers.

Lets take an example: India’s top three IT services companies together employ over 10,000 people in their BFSI (banking, financial services and insurance) groups and generate over a
$1billion in revenues. Most of the top banks in the world are their customers. Yet, can these 10,000 generate an original technology vision and thought leadership for say, the global
insurance industry, without regurgitating analyst reports from various analysts? Generating thought leaders is a critical element of innovation and requires investments.
As the Indian market grows, MNCs will start aggressively going after “local” business. Already, the signs are ominous. For example, the 10 year deal between Accenture and Dabur for management of Dabur’s IT needs, the Bank of India-HP deal for branch office computertisation, $750m Bharti-IBM deal and the mega Reliance Infocomm telecom network & Reliance retail petrol pump projects with IBM are clear indicators of what can happen in the Indian landscape. A look at the Indian domestic IT market amply illustrates this – once owned by Indian brands, it is dominated by MNCs brands today. MNC consulting companies generate higher revenues per employees from Indian customers than Indian consulting companies. Brand value, domain knowledge and experience are clearly the major differentiators.

Lack of eco-system development

The Indian industry has grown in an ad-hoc manner where supply side advantages (cost, quality, availability, English language skills, project management) in India meshed with global
demand for capacity (Y2K & e-Commerce being among big drivers). As a rising tide lifts all boats, so too did the entire Indian software industry get lifted by these drivers.

Unfortunately, the effect of the rising tide was such that it forced the all too ready Indian industry to further focus only on the supply side of the equation since demand generation
became essentially a passive activity. This, unfortunately, in turn forced companies into vigorous competition for talent rather than co-operation. Therefore what could or perhaps should have resulted in companies forging alliances and partnerships amongst themselves for accessing resources relating to technology, markets, vertical domains, best practices did not quite materialize; Linkages with academia or industry too did not take place: IT services companies did not see it worthwhile to partner with domain or technology experts or with companies in specific verticals like telecom, automotives, FMCG, and hospitality. In other countries, one sees linkages and meshes (formal and informal) between smaller and larger companies that benefit all players e.g. Taiwanese hardware industry, Japan’s automotive industry, intense co-operation & competition amongst Silicon Valley companies. Here companies operate in isolation and in a vacuum. Domain knowledge, intellectual property, best practices and the like are not shared. There are no programmes with large companies to work with smaller, innovative or differentiated companies.

Industry bodies which had performed yeoman service championing the cause of the fledgling IT industry in its early days appear to be currently satisfied with maintaining the status quo with regard to taxation policy, visas to the US and UK and the token event or conference. Development of a conducive eco-system say, by becoming the facilitator for capital, mentoring, technological tie-ups, managerial inputs, partnerships and alliances for the benefit of the 3000 smaller companies does not appear to be a priority. The approach of MNCs in India like Texas Instruments, Analog Devices, and IBM is illuminating. They work closely with several small companies providing marketing and technological support and with academia in developing or testing hypotheses. They also work with venture capitalists to get share insights about market & technology trends; small companies are tracked for potential partnering purposes, for possible M & A transactions, and for getting an understanding of the local market and technological capabilities.

“BPOisation” of industry

The BPO business (incl call centres) from India is over $5billion in size today from an almost standing start in 1999. The business was fuelled in large part by private equity and venture capital funds who invested an estimated $200m in this sector in the period 1999- 2001. Today, the business is dominated by the large (quasi)-captive units of MNCs like GE,
HSBC, Citigroup, Dell and AOL or by large 3rd party players like Convergys. Large Indian companies entered the arena through the M&A route (Wipro-Spectramind) or organically by raising many millions of dollars from investors (Progeon-Citi, Satyam-Olympus-Intel). The business has rapidly matured in just 5 years and is displaying all the characteristics of the
more mature IT services industry; namely, the concentration of business in the hands of the few large players and the squeezing out of the smaller players due to reasons of size, lack of differentiation, capital, management talent and the like.
While the employment generation outlook for this sector is undeniable, the rush to BPO everything (from insurance claims to sales orders to filing legal drafts to reading X-rays to
even preparing tax forms for clients overseas) is seeing mundane tasks being done by overqualified Indian employees. We have accountants doing ledger entry, statisticians running
SAS/SPSS packages, and engineers doing low end engineering drawing. Since the focus on innovation is low (with process compliance, quality, and maintenance of service levels being
of predominant interest) and the lure of BPO so high, the possibility of more and more Indian companies hiring away under-paid and under-appreciated engineers, doctors, and
scientists to BPO work is very real.

Or is it? Do we need to really worry that the knowledge workers of the Indian economy are being transformed into robots? Is this fear alarmist, irrational and over the top?

Contrast this with the following comments by John Chambers, Cisco’s CEO:

“When he looks at China and India, Chambers sees two countries -each with more than a billion people – that are methodically focusing their efforts on improving the math and science skills of their top students. For every new engineering graduate in the U.S., which has a much smaller population to begin with, there are five in China, he says. “In China and India, they clearly understand that if they get the engineers, then they get the managers, then they get the companies, then they get the innovation.”

This is from a top person of a top company from the top country in the world today! This article and others talk of how top technology business leaders like John Chambers, Jeff Immelt of GE, and Craig Barrett of Intel are paranoid about the US losing its competitive edge due to a shortage of engineers and scientists. How many of our top leaders worry about losing their competitive edge of innovation due to the country’s scientists and engineers migrating to performing outsourced tasks?
The very nature of a BPO business with its relentless focus on volumes, high standardization, low variance, managing costs, process compliance, managing service levels agreements, managing hiring and attrition issues, simply cannot be conducive for the emergence of innovation from Indian companies.


This is the single most important aspect for innovation to happen. I recall sitting in, a couple of years ago, on a meeting to discuss innovation in a top Indian services company. This
company had set up an innovation council and appeared to be serious about engendering from Fortune’s David Kirkpatrick’s March 30th 2005 column “Cisco CEO on US education – We’re losing the battle” innovation in-house. The meeting lasted about 2 hours and for most of the time the discussion centered around the processes to be followed by the company to ensure that the process of innovation discovery was compliant with various internal standards and practices that the corporate quality group had laid out!

In another case, the group was set up to pursue “innovation”. This group had developed interesting technology building blocks and was wondering about the next steps. There was
no plan for any cash investment for travel to meet customers, to do some market and customer validations, to hire experts. The only resource made available was some engineers.
Losing patience with the group, the company decided to quickly convert these engineers into “billable resources” and when I last checked, one of the experts was an account manager for a top customer!
Now see how Jeff Immelt, CEO of GE a $152 billion company and one of the largest companies in the world is “turning GE’s culture upside down, and demanding far more risk and
innovation”: “..
Jeff Immelt admits to two fears: that General Electric Co. will become boring, and that his top people might act like cowards.
That’s right: cowards. He worries that GE’s famous obsession with bottom-line results – and tendency to get rid of those who don’t meet them – will make some execs shy away from taking risks that could revolutionize the company..”
The article goes on to say how CEO Immelt is trying to shift the GE mindset:

  • Pay: Link bonuses to new ideas, customer satisfaction, sales growth with less emphasis on bottom line results
  • Risk: Spend billions to fund “imagination breakthrough” projects that extend the boundaries of GE
  • Experts: Rotate executives less often and bring in more outsiders to create industry experts instead of professional managers

Indian IT services companies are prisoners of their own success. Enjoying unprecedented market capitalizations thanks to their terrific earnings growth, they find it hard to make the
investments with unsure time horizons and unsure pay-offs. Investments will dent their earnings and affect stock prices. Investments in exploring new business models, in
partnerships, in undertaking M&A transactions of any significance, in hiring globally, in research, and in creating organizational change are sure to impact near term earnings. But
what of the serious possibility of a bigger impact on the business in a few years by not making these investments now?

Instead of investing their cash surpluses in making long term investments of the types mentioned above, Indian companies tend to reward their shareholders with hefty tax-free
dividend payouts (thereby enjoying shareholder loyalty) and perform treasury management functions by investing the money in safe mutual funds. Clearly, these companies are
signalling that they have no other productive or imaginative use for this capital (e.g. investing in long term competence and capability development) than paying dividends. The
conservativeness of management is reinforced by the pressure of maintaining quarterly earnings.

It is disheartening from an industry standpoint to see hundreds of millions of dollars simply lying on the balance sheet and not being invested in creating innovative competitive
advantages for the future. It is disheartening to see companies lack ing confidence in taking big, bold steps even after 20 successful years in the global arena. The ability to dream big on a global level and then take the required confident steps to realize these dreams is what will distinguish the true global players from the also-rans in the next ten years.
Mindsets need to change dramatically especially amongst the leadership levels. From managing status-quos to managing risks, from managing people to managing businesses and
leveraging opportunities, from managing Indians to managing a diverse global workforce, from a “span of control” to a “span of competencies”, all need to happen. Career paths for
R&D technologists and industry experts for example need to be made as attractive as jobs that are oriented to regular people-management routines. An entrepreneurial environment
and mindset has to be put in place.

A Presumptuous Prescription

Let me be presumptuously prescriptive. Why cannot the large companies look at developing their own “global eco-systems” much like the MNCs have done:

Activities along each spoke have to be driven by qualified entrepreneurial business managers with clear goals and objectives; Access to organizational resources must be made available – this availability will only be guaranteed if executive management sponsorship at the hub of the activities is real and visible. Initial failure must not force the company to immediately
withdraw and get into a “I told you so” mindset. For all of this to ha ppen, companies will need to acquire & develop new competencies and capabilities. And as always, the change has
to be driven from the top. And again, the mindset change has to be driven by a recognition of the impending reality of the next 10 years.

Some of the larger companies are thinking of such things and have taken their first hesitant steps. But is it displaying the confident strides of a 20+ year old industry with a global
footprint, global recognition, enviable top and bottom line growth, and access to large amounts of cash? The answer cannot be “Yes”.
I, for one, as a well-wisher of Indian IT am keeping my fingers firmly crossed! Is the picture so disquieting that innovation is unlikely? The answer, as always, is that innovative people always find a way and, as everywhere else people in small companies are the forefront of this effort. There’s a quiet but rapidly developing wave of innovation taking place in Indian companies.

What’s your opinion?

[The article was first published in Business World magazine, June 20th 2005]

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