Third wave in Indian IT: Deliver Complete Solution

The software and services sector (not including Business Process Outsourcing, BPO) has had a phenomenal run in India. From a base of just under $100 million in 1990, it has grown to over $13 billion in 2006, a compounded growth rate of around 34 per cent per annum, constituting 2- 3 per cent share of the world IT services market. Assuming that we sustain a 20 per cent compound annual growth rate over the next decade or so, the IT services segment could grow into a $170 billion industry by the year 2020, garnering 12-15 per cent of the world market. This is difficult but not impossible. However, we need to make some fundamental shifts as an industry to make this happen.


This article provides an overview to the nature of these shifts by looking at how the industry has developed and by discerning the underlying waves that it has gone through. An understanding of these waves will help us plan the strategy for the next level of growth.

As we have seen in the electronic industry, first in Japan, then in South East Asia and now in China, the evolution goes through three waves. The first wave is typically as a component supplier to other countries that manufacture the complete product. In the second wave, the local industry gains enough expertise to provide cost-effective contract manufacturing services – of either the entire product or major sub-assemblies.


The third wave is when a set of firms start marketing these products under their own brand–initially within their own countries before going international.

The software services industry in India has had a similar pattern of evolution, going through three waves of development. Each wave has brought about a tremendous shift in the value proposition to the customers, the growth of the industry, the nature of work delivered and the firms that have succeeded. Let's look at each of these waves:

Wave1: Establishing Indians as software professionals

The first wave of the industry which started in the 1970's, was to establish that the Indian software professionals were good and could hold their own against the best in the world. This was the equivalent of being a component supplier. During this wave, Indian professionals were typically deputed onsite, to work along with customer teams, to deliver projects under customer management.

The value proposition to customers was that they could deploy competent programmers in a flexible and cost-effective manner, depending in project staffing requirements.

This wave started hitting its peak in the late 90's, during the heady days of the dot com boom, when money was being spent on technology as if there was no tomorrow, and competent professionals were in tremendous short supply, especially in the US. Estimates show that at its peak during the year 2000, staff augmentation would have generated around US$2 billion in revenues for Indian industry.

Wave 2: India as a programming destination

In the early 90's, a few visionary American companies saw the potential of India as a base for software development, in the light of the spiralling IT costs in their own parts of the world. Companies like Texas Instruments and Motorola started their own Research & Developmental centres in India to capitalise on Indian talent.

On the other hand, companies like Nortel and GE decided to partner with local Indian software services companies to set up offshore development centres.In parallel, Indian software companies were making significant investments in quality. Quite similar to the TQM movement in manufacturing in Japan, Indian companies realised that they needed to convert software development and maintenance from a craft model to an engineering discipline, if they were to be able to reliably deliver to their customers abroad.

It started off as a movement for ISO certification, an external seal of approval that the companies had a documented process of software development and that these were strictly adhered to in delivering software to the customers.

The ISO movement gave way to the CMM movement which was developed by the Software Engineering Institute of Carnegie Mellon, specifically catering to software development processes. Unlike ISO, the CMM saw software development processes as something that needed to evolve from a ‘Chaotic’ stage to an ‘Optimising’ stage–level 1 to level 5. Today, almost every firm in India considers CMM Level 5 assessment to be a hygiene factor, and almost three quarters of the world's level 5 companies are now in India.

New awakening

The next critical event that triggered the growth of India as a software destination, was the Y2K (Year 2000) bug. The late 90's witnessed a tremendous anxiety about whether software systems could handle the turn of the century, since many legacy systems (with a low expectation of their own life) had provided only two digit fields to handle the year instead of four. The estimates of what it would cost the developed world to fix this problem was widely varying, but usually in the tens of billions of dollars.

The fact that Indian companies were ready and able to handle the Y2K scare at a fraction of the cost using very systematic and mature development processes in their offshore centres was a turning point. While Y2K was the starting point, companies soon began to realise that if India could deliver Y2K programs reliably, why not all application maintenance and even some development. And that's how offshore development grew in India.

Today, offshore development and maintenance has dwarfed staff augmentation services, and probably generates around US$10 billion of revenues. It is my estimate that this wave is still at its growth phase and would reach its peak around 2010.

In many ways, this wave is similar to the contract manufacturing wave of the electronics industry–where the basic driver is cost-arbitrage and the basic value proposition is scalable capacity at very attractive prices.

However, the Indian firms are not perceived as adding value in terms of intellectual property or consulting and design inputs.

Wave 3: India as a ‘Solutions Brand’

Just as the industry grew by almost one order of magnitude by transitioning from being a provider of competent people to a provider of high quality service, the next quantum jump can only happen if we manage to make the next transition to India as a trusted brand for delivering complete solutions. Let's look at some of the facets of this transition:

nStrategic Impact: While India is perceived by its customers as a reliable provider of programming services, the value delivered is largely cost-arbitrage and not strategic impact. The next stage of evolution will be for Indian firms to come out from ‘under the hood’ to being perceived as a strategic partner by the C level executives in our client organisations.

Depending on the firm, the impact could be based on scale, or innovation support or both.

The larger Indian firms could follow an IBM or EDS model of creating a strategic impact by large scale outsourcing–where they create significant cost-savings, headcount reduction and free up management to focus on their core business. In the last couple of years, we have seen deals of this scale and magnitude coming to Indian companies.

The other way of creating the impact could be the Consulting model, where through consulting and thought leadership backed by strong deliveries, Indian firms help their customers in deploying new IT platforms that support innovations or new capabilities in product development, distribution and customer service.

In both cases, firms have to earn the trust of their customers and be perceived as strategic partners who can deliver substantial value.

nIntellectual Property Development: The other facet of being a solution provider is to create very strong differentiation through Intellectual Property (IP) development. This could be in a variety of forms - methodologies, frameworks, tools, platforms or packages - each calling for a different level of investment and a correspondingly different level of differentiation.

Till about a year back, I was convinced that Indian companies had no competitive advantage in building IP.

However, working in the US over the last year and a half has changed my mind. I do believe that India has a great future in products, especially application products, where our development predictability, quality and costs can constitute a significant advantage.

nBusiness Domain Expertise: While, for a service provider, domain expertise is nice to have, for a solutions provider it is a must. To make the transition to a solutions provider, Indian firms must invest in building a cadre of domain experts in their target industries or develop strong partnerships with firms that can bring in that expertise.

The domain experts will play big role in providing consulting inputs to the customer, as well as act as a bridge between the customer and the development teams in solutions development.

nTruly Global: Another major shift the firms need to make is to move away from an India centric approach to a truly global approach. This transition is a lot more than hiring local talent in each country. It is in being able to operate as a network across countries and harnessing the full power of the global capabilities in serving every local customer better.

There are huge pay-offs in being able to make the transition to Wave 3–the industry can grow form its current levels of $10 billion to $100 billion or more. However, making this transition requires concerted action among many industry players as well as the government. There have been many cases of countries not being able to make this kind of a transition.

The purpose of this column is to encourage dialogue and debate among all the participants in the industry so that Indian industry can actually capitalise on this enormous opportunity. The payoffs are enormous when Indian Software reaches the same stature as French Wine, Swiss Watches or Japanese cars.

The Rising Rupee

An opportunity for Indian IT companies


Over the last few months, there has been much discussion about the negative impact of the rising rupee on the profitability and competitiveness of Indian exports in general, and IT companies in particular. There has been a demand from certain quarters for RBI intervention to keep the rupee down. In my view, this demand is short-sighted and does not take into account the enormous opportunity that the rising rupee could present to export-oriented industries.

Before launching into a discussion on the opportunities, I think some basic premises need to be stated. Firstly, as Indians, we should be proud – the strength of the rupee is an indication of the underlying strength of the economy. Secondly, in today’s global economy, any attempt to tamper with natural market mechanisms driving currency values is likely to lead to disastrous consequences as many countries have realized (and some countries will in the years to come). In the medium to long term, with global market mechanisms in operation, a rising rupee should lead to decreased costs and hence, a marginal impact on our global competitiveness.

The rising rupee, however, does throw up challenges in the short term and therein lie our opportunities. Being most familiar with it, I will present these opportunities from the perspective of the IT industry and let the readers draw the parallel to their own industries. In essence, the thrust of my argument is two-fold –

The rising rupee will force the IT industry to look beyond labour cost arbitrage to create value for its customers – what I call the Third Wave approach; and,

It will refocus the industry on driving new efficiencies and improving productivity to remain competitive.

The Third Wave – Beyond Labour Cost Arbitrage

When we look at globalization, specific industries in emerging economies typically go through three waves of evolution. The electronics industry, first in Japan, then in South East Asia and now in China, are good examples of this. In the first wave, companies in emerging economies typically act as component suppliers to developed countries that manufacture the complete product. In the second wave, the local industry gains enough expertise to provide cost-effective contract manufacturing services – of either the entire product or major sub-assemblies. The third wave is when a set of firms start marketing these products under their own brand – initially within their own countries, and then going international.

We can trace the evolution of the software services industry in India using a very similar paradigm. As shown in the table below, the Indian software industry has gone through two waves already – as a component supplier and as a contract manufacturer.

Wave 1 started in the 70s and 80s and peaked in the mid-90s; it established that the Indian software professional was competent and the industry got results largely through staff augmentation.

Wave 2 established India as a destination for low-cost, high-quality programming services. The catalyst was the Y2K bug and Indian companies’ success in delivering these projects in a cost-effective manner. Many Fortune 1000 companies discovered that moving their application maintenance and on-going development activities to India was viable and attractive. The Second Wave of Indian IT started in the mid to the late 90s, and is at its mainstream phase today. Like all mainstream markets, this is characterized by the emergence of a few leaders, namely the Tier 1 IT companies, who demonstrate high rates of growth and profitability and increasing market share.

Wave 3, which is emerging, will be characterized by Indian companies moving up to high-value services that are strategic to the customer and hence command premium, value-based pricing. As we have seen, the industry is already facing a severe shortage of talent (as opposed to mere numbers), rising attrition levels and increasing salary costs. There are enough indications to suggest that the linear relationship between growth and headcount will not be sustainable for much longer. The future is in creating strong brands out of India – whether in services, products or solutions -- that command the respect and trust of large global customers and hence the appropriate value.

In my view, the Third Wave is not just about better margins. It’s also about true global scale. It’s about the industry achieving new heights – growing from the $20 billion currently to over $100 billion in the next decade, as shown in the graph below. It’s about moving up in value from an ‘order taker’ to a true strategic partner.

In many ways, the appreciation of the rupee has shaken up people and possibly accelerated the Third Wave of Indian IT. I see the possibility of a similar phenomenon in many other export-oriented industries, given the right vision and leadership.

New Efficiencies and Increased Productivity

Another opportunity that the rising rupee gives us, as an industry, is the necessary impetus to take a fresh look at cost structures, productivity and financial metrics.

At the entry level, the IT industry has created a fair amount of pressure for the other industries in terms of salary levels. This has cascaded up to all levels. The rupee pressure will force all of us to reassess salary levels and maintain them at realistic levels. We are already seeing signs of this in the salary increases granted this year.

In terms of productivity, a large proportion of work carried out from India tends to be on a Time & Material (T & M) basis. In general, there are few incentives in T & M contracts to raise productivity. With rising costs and shrinking margins, I see the possibility of at least some of these contracts being renegotiated as fixed-price contracts, around work packages. This gives an incentive to the service providers to improve productivity and margins. I also believe that this will help in developing the competence of software professionals.

As regards financial metrics, the IT industry has so far focused on Returns on Sales as the basic metric. Given the shortage of talent and the high proportion of salaries in total costs, the industry has already started measuring Return on Talent through metrics like EBIDTA per employee, PAT per employee etc. This will help us generate the best value for the talent we have, rather than selling them by the hour!

In summary, while the rising rupee does create issues for all of us in the short term, rising to the challenge and generating value-based strategies will not only be beneficial to individual firms but to the industry as a whole. Let’s not forget that the US dollar was just around Rs. 13 in 1987 and Rs. 36 in 1997. As with liberalization, I am sure we will look back 10 years from now and see this as a landmark event that changed the basic complexion of Indian industry.