Research Policy 30 (2001) 1267–1287The Indian software services industryAshish Aroraa,∗, V.S. Arunachalamb, Jai Asundic, R...
1268 A. Arora et al. / Research Policy 30 (2001) 1267–1287Delhi, where we interviewed nearly 75 senior man-agers and softw...
A. Arora et al. / Research Policy 30 (2001) 1267–1287 1269Table 1India: growth in domestic, export and total revenuesaYear...
1270 A. Arora et al. / Research Policy 30 (2001) 1267–1287Table 2Israel: growth in export and total revenuesaYear Exports(...
A. Arora et al. / Research Policy 30 (2001) 1267–1287 1271By this time a number of Indians were working inUS firms. Some of...
1272 A. Arora et al. / Research Policy 30 (2001) 1267–1287Table 5Revenue distribution of NASSCOM member firms by geographic...
A. Arora et al. / Research Policy 30 (2001) 1267–1287 1273market are probably accounted for by imported soft-ware products...
1274 A. Arora et al. / Research Policy 30 (2001) 1267–1287Table 9Nature of export projects undertaken by Indian firmsaServi...
A. Arora et al. / Research Policy 30 (2001) 1267–1287 1275Table 12Perceived location of primary competitorsaOne of top thr...
1276 A. Arora et al. / Research Policy 30 (2001) 1267–1287Table 13Fixed fee versus time and material export contractsaAll ...
A. Arora et al. / Research Policy 30 (2001) 1267–1287 1277ware platforms for which they provide services. Onereason that w...
1278 A. Arora et al. / Research Policy 30 (2001) 1267–1287Table 14Software professionals: comparative salaries, 1997aDesig...
A. Arora et al. / Research Policy 30 (2001) 1267–1287 1279don’t want to be branded by my customers as a guywho hires NIIT ...
1280 A. Arora et al. / Research Policy 30 (2001) 1267–1287Table 16Revenue per employee, by quality certification: CMM level...
A. Arora et al. / Research Policy 30 (2001) 1267–1287 1281recently announced the establishment of Indian Insti-tutes of In...
1282 A. Arora et al. / Research Policy 30 (2001) 1267–1287software services and use the cash generated to fundproduct deve...
A. Arora et al. / Research Policy 30 (2001) 1267–1287 1283costs, and providing higher value services beyondsimple coding. ...
1284 A. Arora et al. / Research Policy 30 (2001) 1267–1287turnover. Nortel Networks, a big long-term customerfor the large...
A. Arora et al. / Research Policy 30 (2001) 1267–1287 1285operations, often by spinning them off as stand alonecompanies. ...
1286 A. Arora et al. / Research Policy 30 (2001) 1267–1287to walk on two legs entry strategy”(Schware, 1992)was being prac...
A. Arora et al. / Research Policy 30 (2001) 1267–1287 1287and advice from many colleagues, especially AshokDesai, Naushad ...
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IIMRA Indian Software Industry Growth trend

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IIMRA Indian Software Industry Growth trend

  1. 1. Research Policy 30 (2001) 1267–1287The Indian software services industryAshish Aroraa,∗, V.S. Arunachalamb, Jai Asundic, Ronald Fernandesaa H. John Heinz III School of Public Policy and Management, Carnegie Mellon University, Pittsburgh, PA 15213-3890, USAb Engineering and Public Policy, Robotics and Materials Science and Engineering, Pittsburgh, PA 15213-3890, USAc Engineering and Public Policy, Pittsburgh, PA 15213-3890, USAReceived 13 February 2000; received in revised form 14 June 2000; accepted 7 November 2000AbstractThe Indian software exports have grown in spectacular fashion. Its success has, for the most part, been a combination ofresource endowments, a mixture of benign neglect and active encouragement from a normally intrusive government, and goodtiming. The bulk of the Indian software exports have consisted of fairly mundane services such as low level programmingand maintenance. The marked reliance on access to low cost human capital has prompted considerable scepticism about theability of the Indian software industry to sustain its performance, given the rapid growth in the demand for engineers andthe relatively inelastic supply of engineers. This paper reports on the results of research on the Indian software industry.We use a variety of sources, including a questionnaire survey of Indian software firms, and field visits and interviews withindustry participants, observers, and US based clients. Although, maintaining the current rate of growth will pose a number ofchallenges, these challenges are not insurmountable. Not only can the available pool of human capital be expanded by tappingand training the very large pool of English-speaking college graduates, the leading Indian firms are making strong effortsto move up the value chain by acquiring better software project management capability and deeper knowledge of businessdomains, and reducing costs and improving quality by developing superior methodologies and tools. Moreover, the greatestimpact of the software industry on the Indian economy may well be indirect, in its role as an exemplar of the new businessorganisational form and as an inspiration to other entrepreneurs. © 2001 Elsevier Science B.V. All rights reserved.Keywords: Software; Exports; Indian software industry; Economic growth; Human capital1. IntroductionTechnological revolutions sometimes bring unex-pected opportunities for countries. India, a relativelaggard among developing countries in terms of eco-nomic growth, seems to have found such an opportu-nity in the information technology revolution as an in-creasingly favoured location for customised software∗ Corresponding author. Tel.: +1-412-268-2191;fax: +1-412-268-5161.E-mail addresses: ashish@andrew.cmu.edu (A. Arora),vsa@andrew.cmu.edu (V.S. Arunachalam),asundi@andrew.cmu.edu (J. Asundi),ronald@andrew.cmu.edu (R. Fernandes).development. India’s success at software has led tospeculation about whether other developing countriescan emulate its example, as well as whether this con-stitutes a competitive challenge to software industriesin the developed world.In this essay, we focus on the Indian software exportsector. After briefly describing the main features ofthe industry, we analyse the major challenges it facesand assess its prospects for the future. We also brieflydiscuss the implications of the Indian experience forother developing regions and for software industriesin the developed world.Our analysis is based on field visits to over 40Indian firms in Bangalore, Bombay, Hyderabad and0048-7333/01/$ – see front matter © 2001 Elsevier Science B.V. All rights reserved.PII: S0048-7333(00)00148-7
  2. 2. 1268 A. Arora et al. / Research Policy 30 (2001) 1267–1287Delhi, where we interviewed nearly 75 senior man-agers and software professionals. These interviewswere loosely structured around a questionnaire that wedeveloped in consultation with industry experts andwere followed by interviews with 15 US based firmsthat had outsourced software development to thesefirms in India. 1 We complemented the field researchwith publicly available data on firms (NASSCOM,1994–99), as well as information from a question-naire survey administered to over a hundred Indiansoftware exporters. 2 Finally, we had brief structuredinterviews with 60 software development profession-als in Indian firms to understand better where andhow they are trained and the nature of the workthey do.Section 2 places the development of the Indiansoftware industry in an international and historicalcontext. Section 3 discusses the main features of theindustry, and Section 4 describes how software serviceexports by Indian firms are organised. As late as 1998or 1999, the picture that emerges is of an industrythat is based primarily on providing relatively simplesoftware programming and coding services, exploit-ing its superior access to a supply of cheap softwareprogrammers, and with only limited degree of techni-cal and managerial contribution. Though this situationhas improved in a number of ways since 1998, there isno doubt that low cost human capital remains an im-portant source of advantage. 3 In Section 5 we analysethe supply of human capital, along with other factorinputs.In thinking about the future prospects for the Indiansoftware sector one must recognise that this is differ-ent from the fate of individual Indian software firms.In principle, the Indian economy could do quite wellmerely for quite some time simply as a source oflow cost programming talent, and by tapping the verylarge pool of English-speaking graduates to supply thegrowing demand for Internet enabled services, such1 The questionnaire, along with other background informationabout the project and some of the outreach activities is availableon the project website, at http://www.heinz.cmu.edu/project/india.2 The National Association for Software Service Companies isan industry organisation that represents the interests of softwarefirms to the various government departments.3 Since then, a number of the leading firms have demonstratedthat they may have accumulated sufficient market and technologicalknowledge to compete in other ways.as medical transcription and call centres. However,clearly the Indian economy could do even better ifindigenous firms could leverage this talent to producehigher value services and products. More precisely,in Section 6 we identify at least three distinct strate-gies that Indian software firms have adopted, albeitwith varying degrees of success. The first involvesthe acquisition of greater user-sector specialisationand the accumulation of domain knowledge, enablingthe firm to offer “solutions”. This is complementedby a second strategy that involves good software de-velopment methodology and high quality standards,and the development of tools to provide these solu-tions in a cost effective and timely fashion. The thirdstrategy, which as yet very few firms have adopted,involves developing products. Section 7 summarisesour findings and concludes.2. Background2.1. Packages, services and customdeveloped softwareSoftware development can be broadly categorisedinto custom developed software and packages orgeneric software products. Customised softwaredevelopment involves close interaction between thedevelopment team and the end-user. Software prod-ucts may be targeted to a vertical segment or maycut across segments, but rarely to a specific user. Insome cases, business software products, such as ERPpackages that manage the flow of inputs, work in pro-cess and shipments in a company, are very large andcomplex. These require a great deal of customisationbefore they can be used. Often, this customisationis done by outside software consultants. Informationtechnology consultants, such as Anderson Consulting,provide “solutions”, which may involve some combi-nation of custom developed software and commercialoff-the-shelf software and hardware products.Software development involves a number of stages:conceptualisation, requirement analysis, high-leveldesign, low-level design, coding, testing and support.These stages roughly correspond to stages describedin the waterfall model of software development,shown in Fig. 1 (Royce, 1970. See Boehm (1981)for an alternate model of software development, the
  3. 3. A. Arora et al. / Research Policy 30 (2001) 1267–1287 1269Table 1India: growth in domestic, export and total revenuesaYear Exportsin US$ MTotal US$ M Employment Revenue/employee (US$)1993–1994 330 557.9 90000 6198.51994–1995 485 825.8 118000 69981995–1996 734 1249.4 140000 8924.51996–1997 1085 1765.8 160000 110361997–1998 1800 2700 180000 150001998–1999 2650 3900 250000 156001999–2000 (Est.) 3900 5600 n.a. n.a.2000–2001 (Est.) 6300 8600 n.a. n.a.a Source: Nasscom and CMU Software Dataset.Fig. 1. The waterfall model of software development.Spiral Model). Indian software exporters largely pro-vide services rather than products. Further, Indiansoftware exports consist largely of low-level design,coding, and maintenance services, which are consid-ered to be low in the value-chain of software services.2.2. The Indian software industry in aninternational contextEven though its US$ 5.7 billion software revenuesin 1999–2000 was a tiny fraction of the estimatedworld software market of over US$ 300–500 billion,the Indian software industry has attracted a dispropor-tionate amount of interest as a source of software. 4There are some compelling reasons, nonetheless, forthe attention on India. The Indian software industryhas captured a significant portion of the world trade insoftware services. One estimate suggests that India has16% of the global market in customised software, andthat more than 100 of the Fortune 500 had outsourced4 One must note that this does not include the software developedby users themselves, nor does it include embedded software.to India (Dataquest, 31 July 1996; pp. 43–44). 5Table 1 describes the growth in revenues and em-ployment in the software industry, and shows that theindustry has grown at over 50% per year over the last5 or 6 years. 6Assuming this growth rate can be sustained, theindustry association, NASSCOM, has projected 23%share of world customised software market and 5% ofproducts and packages market 2003. NASSCOM alsoprojects that software exports will constitute about 25per cent of India’s total exports by 2003, up fromits current level of 5%. Even if these projections areonly partially fulfilled, the Indian software industryshall still have achieved a substantial role in the worldsoftware industry, especially in customised softwareand software services.The Indian industry is comparable to that of the Irishand Israeli software industries in terms of revenuesand exports. Table 2 reflects the emergence of Israelas a source of entrepreneurial firms developing soft-ware products in areas such as security and anti-virustechnology. In 1997, there were about 300 softwarefirms in Israel, employing nearly 10,000 people, with5 In 1995, the global market for computer services was estimatedby IDC as being over US$ 220 billion. Of this, a substantial fractioninvolved outsourcing of some part of the software development andmaintenance process: custom software development was estimatedto be nearly US$ 16 billion, systems integration at US$ 32 billion,IT consulting at US$ 11 billion and business service outsourcingat US$ 9 billion.6 Indian industry grew at an average rate of 7.6% while the servicesector grew at an average rate of 8.2% over the same period. (In-dian Budget 1999–2000 Table 1.2a., www.ieo.org/budget99/table1.2a.html).
  4. 4. 1270 A. Arora et al. / Research Policy 30 (2001) 1267–1287Table 2Israel: growth in export and total revenuesaYear Exports(US$ M)Total(US$ M)1989 65 3801990 89 4501991 110 5401992 135 6001993 175 7001994 220 8001995 300 9501996 400 11001997 540 13001998 700 1500(Est.)a Source: Israeli Association of Software Houses, Israel.Table 3Ireland: growth in export and total revenuesaYear No. offirmsTotalemploymentExports(US$ M)Total(US$ M)1991 365 7793 2266.3 2436.71993 417 8943 2594.5 2805.71995 483 11784 3959.3 4221.31997 679 18300 5942.5 6283.3a Source: National Software Directorate, Ireland.total revenue of over US$ 1.5 billion. A large fractionof the firms are engaged in developing software pack-ages, often technically highly sophisticated, for exportmarkets. As well, many of the world’s largest com-puter companies including Microsoft, IBM, Digital,Hewlett Packard, National Semiconductor, Motorolaand others have set up software development centresin Israel. 7The Irish software industry develops softwareproducts, as well as provides a variety of softwaredevelopment and support services. Table 3 providedata on the growth in exports, total revenues, firms7 These features reflect the large number of technically skilledpeople with high entrepreneurial drive available in Israel. Report-edly, about 20% of Israel’s population consists of those who ar-rived in the last 5 years, doubling the number of technicians,engineers and scientists. Israel now has 135 engineers and tech-nicians for every 10,000 people, compared with only 18 for theUS and 40 for India. (Economist, 20 February 1999, p. 27). Andventure capital has flowed. There are said to be over 50 venturecapital funds operating in Israel and more than US$ 4 billion wasinvested in high technology start-ups in Israel in 1998.and employment in the Irish software industry. TheIrish industry employed over 18,000 people, with1997 revenues of over US$ 5.5 billion as well. Thesoftware sector comprises more than 600 companies,of which about a fifth are overseas firms.Note that India has the largest number of peopleworking in the industry as well as apparently thehighest rate of growth of revenue, but also the low-est revenues per employee. Revenue per employee isabout US$ 150,000 in Israel and Irish firms appearto earn US$ 60–800,000 per employee. 8 By compar-ison, Indian exporters earn only about US$ 20,000,and even the established firms earn only a little overUS$ 30,000. Since the Irish industry is closer in itsactivities to India, the comparison is especially rele-vant. The Indian industry is much larger, is growingsomewhat faster, but is markedly less productive.2.3. A brief historical backgroundThese features of the Indian software industry arerooted in the factors that underpin its rapid rise. TheIndian success story has, for the most part, been acombination of resource endowments, a mixture ofbenign neglect and active encouragement from a nor-mally intrusive government, and good timing. Bythe late 1980s, India was graduating, approximately,150,000 English-speaking engineers, with only a lim-ited demand for their services from the rest of theeconomy. By the late 1980s as well, India’s economicliberalisation was also well under way. Around thistime, the information technology revolution in thedeveloped world had begun to take root and shortagesof skilled programmers and IT professionals werebeginning to develop. 98 Overseas firms in Ireland have revenues per employee in excessof US$ 400,000. However, these firms have strong tax incentivesto book revenues in Ireland for products and services sold allover Europe, and therefore, the true productivity is likely to besubstantially lower.9 A frequently cited study concluded that there were an estimated346,000 IT positions currently vacant in the US, in three core IToccupational clusters (programmers, systems analysts, computerscientists and engineers) (ITAA, 1998). Barr and Tessler (1996 and1998) claim that the shortage is part of a secular trend that had,in the past, been disguised by cuts in defence spending in the USbetween 1988 and 1993, that resulted in 75,000 programmers beinglaid off in Orange county alone. The shortage was further maskedby downsizing in the IS departments of many major corporations.
  5. 5. A. Arora et al. / Research Policy 30 (2001) 1267–1287 1271By this time a number of Indians were working inUS firms. Some of them played an important, althoughas yet undocumented role, in bridging the gap andmatching the buyers in the US with the suppliers inIndia. Responding quickly to the growing demand, anumber of Indian firms arose in quick time. Contraryto its normal practice, the State encouraged this growthby considerably simplifying the process for obtainingthe numerous clearances and permits that any firm inthe organised sector in India typically needs. Finally,the low levels of initial investment required to start asoftware services firm meant that finance was not aserious constraint upon entry.The Indian software industry consists of a large andgrowing number of firms: using NASSCOM member-ship as a measure, the number of Indian software firmshas grown from around 38 (accounting for 65% of in-dustry revenue) in 1988 to over 545 (accounting forover 95% of industry revenue) in 1999. Table 4 showsthat many of these firms entered the industry duringor just before the economic liberalisation in 1991, andfew have exited. A few big companies dominate theindustry, with the top 25 companies accounting for58.67% share of software exports revenue in 1997–98,whereas nearly 125 firms, or over a quarter of all firms,had revenues below US$ 250,000.The market leaders in the Indian software firms are,for the most part, relatively new themselves. Further,with a few exceptions, notably Wipro and Satyam,these firms specialise in software alone. This is inmarked contrast to early entrants into the industry, whohad close links with computer hardware development(Heeks, 1996, p. 69). With a growing need for main-tenance services many firms entered the industry byTable 4Age distribution of Nasscom member firms in 1997 (n = 426)aYear of establishment Number Age (years)≤1980 31 ≥191981–1985 33 14–181986–1990 111 9–141991 27 81992 43 71993 31 61994 49 51995 38 41996 48 31997 15 2a Source: CMU Software Dataset.providing these services, often by sending softwareprogrammers to the client on a temporary basis.These entrants were of two types. The first typeconsists of existing firms diversifying into software,including computer hardware firms, such as HCLand Wipro, as well as firms with large in-house dataprocessing and system integration capabilities suchas Larsen & Toubro (LTITL). Others such as BFL,Sonata, Satyam and Birla Horizons began as divisionsof industrial groups. 10 The other type of entrantswas new start-ups, such as PCS, Datamatics, Infosysand Silverline. Indeed, managers at a large numberof software firms have worked in these companiesearlier in their career. One of the best-known softwareexporters, Infosys, was founded by a group of sevenPCS managers who broke away from PCS. Infosys’sfirst contract was a support and maintenance contractwith a client in the apparel industry for whom PCShad finished a large project.Many MNCs have set up liaison offices andsubsidiaries as well. Initially, they intended to sellhardware and software in the Indian market, often inpartnership with a domestic firm. Increasingly, how-ever, the objective is to use India as a place for softwaredevelopment. Many MNCs have established softwaredevelopment centres in India, and are exporting pack-ages or components of systems to other countries fromIndia. 11 As well, there are a number of US firms withlarge Indian operations that are very similar to Indiansoftware firms. Firms such as Mastech (now IGate),Information Management Resources (IMR), Syntel,Cognizant (a subsidiary of Dunn and Bradstreet) andCBSL use their India operations much in the way thatIndians software export firms do, to tap a large pool10 In addition to these firms that focused on software exports, therewere others that served domestic users, most notable ComputerMaintenance Corporation (CMC). Responsible for maintainingcomputer systems after IBM left India, CMC has grown to over2000 employees and developed the ability to develop and im-plement large and complex projects, especially for infrastructuresystems. CMC has also proved to be a good training ground formanagers that would later be employed by other, private sectorfirms.11 For instance, the operating system for the “Network Computer”introduced by Oracle is said to have been designed entirely in India.Similarly, the Texas Instrument R&D centre in India is capable offairly sophisticated work, including analogue chip design. Otherprominent MNCs operating in India include Motorola, Siemens,Hughes Network, Computer Associates, Microsoft and Cadence.
  6. 6. 1272 A. Arora et al. / Research Policy 30 (2001) 1267–1287Table 5Revenue distribution of NASSCOM member firms by geographicregion, 1997aRegion Revenue (US$ M) NumberBombay & Pune 597.5 107Bangalore 323.6 84Delhi 285.8 95Chennai 130.9 34Hyderabad 62 21Calcutta 44.8 26Gujarat 3.1 13Kerala 1.4 7Other 8.3 18a Source: CMU Software Dataset, N = 405.of relatively cheap but skilled workforce for providingsoftware services to US based clients. Virtually, all areheaded by entrepreneurs of Indian origin, and startedtheir existence, as did many of the leading Indianfirms, by supplying software professionals such as pro-grammers and analysts to clients in the US. As Indiansoftware exporters establish overseas subsidiaries, thedistinction between the two will tend to diminish.Contrary to popular belief, as Table 5 shows, theindustry is not concentrated exclusively in Bangalore,although Bangalore is certainly a very prominentlocation, along with Bombay, Pune, Madras andHyderabad are important as well. However, with theexception of the region around Delhi, there are no no-ticeable clusters in the northern or the eastern regionsof India. The distribution of engineering colleges,concentrated in the western and southern regions,closely mirrors the distribution of the software in-dustry. As Table 6 shows, engineering colleges areheavily concentrated in these two regions, which alsoaccount for the greater part of employment in theIndian software industry.Table 6Number and capacity of Indian engineering colleges, approved by 1998–1999, by regionaRegion Number ofcollegesSanctioned capacity(no. of students)% of sanctioned capacity atself-financed collegesCentral 50 9470 0.52East 25 4812 0.26North (incl. north–west) 140 25449 0.42West 140 34165 0.74South (incl. south–west) 308 82597 0.79Total 663 156493 0.69a Source: Ramarao, 1998.Table 7Composition of Indian software development and services (do-mestic and exports)aSoftware activity Domestic (%) Export (%)Turnkey projects 28.6 31.5Professional services 4.1 48.4Products and packages 52.0 8.8Training 6.1 1.5Support and maintenance 3.2 3.0IT enabled services 6.0 6.8a Source: NASSCOM.3. Characteristics of the Indian software industryThe Indian software sector displays many unusualfeatures compared to most Indian industries. The mostobvious one is its export orientation: exports accountfor 65% of the total software revenue. Given India’ssize and history of inward development, most indus-tries tend to be driven by the domestic market.3.1. Domestic marketThere are important qualitative differences betweenthe export market and the domestic markets. Thefirst relates to different types of software developed.Table 7 gives the composition of the domestic and ex-port software development and services market. Thedomestic market has a higher proportion of revenuesfrom the sale of software packages and products.Whereas products accounted for nearly 40% of thedomestic market, they account for a little under 10%of exports. Over 80% of exports are software ser-vices, which includes custom software development,consultancy and professional services. Even thoughthe bulk of the product revenues in the domestic
  7. 7. A. Arora et al. / Research Policy 30 (2001) 1267–1287 1273market are probably accounted for by imported soft-ware products, a number of Indian software firms havealso developed software packages for the domesticmarket and other developing countries. However, withsome exceptions, these packages, which included ac-counting software, Indian language word processingpackages, and banking and accounting products, havenot been very successful. 12Although it is tempting to blame weak intellectualproperty rights for the failure of Indian firms to de-velop successful packages, our interviews suggest that,at least as important, if not more, has been the lack ofexperience in design and marketing. In many cases,firms simply overestimated the willingness to payand underestimated the difficulties of developing andsupporting products. The reluctance of Indian users topay large sums for software products has undoubtedlybeen very important, as has the slow rate of comput-erisation of the Indian economy. The result was thatsince the early 1990s, firms recognised the higher prof-itability of service exports compared to other types ofsoftware development and even firms that are productfocused have added software services and consultingto fund product development (see also Udell, 1993).The second difference between the domestic andexport sectors relates to the stages of softwaredevelopment as described earlier. For domestic clientsthe industry provides a wider range of services thatusually spans the entire lifecycle of software deve-lopment. Domestic projects are larger and more chal-lenging than export projects, with the screen basedtrading system for the Bombay Stock Exchange andthe Reservation System for Railways, being two re-cent examples. Until recently, the bulk of Indianservice exports have consisted of low-level design,coding and testing. Further, Table 8, showing resultsfrom our survey, shows that most Indian softwarefirms provide services to a diverse set of industries in-cluding manufacturing, banking and insurance, retailand distribution and telecommunications. They rarely12 An ERP package by Ramco has enjoyed some success. A sub-sidiary of Citicorp, which has successfully exported its bankingproducts to a large number of developing countries. Other firmshave also targeted other developing countries as outlets for spe-cialised products for the financial, banking and hospitality indus-try. Firms like TCS and Infosys have their own banking packages,which they have exported to other Commonwealth countries withreasonable success.Table 8Industries served by Indian software exportersaDomain area Numberof firmsPercentageof firmsBanking 45 50Medical 23 25.6Retail, warehousing 47 52.2Multimedia and entertainment 27 30Education 23 25.6Travel and tourism 16 17.8Manufacturing 46 51.1Government related 22 24.4Transport 27 30a Source: CMU Software Dataset – CMU Survey of IndianSoftware Industry, N = 90.specialise in a particular sector. This observationsuggests that the firms are working in that area ofsoftware development where business knowledge isleast required. However, there is anecdotal evidencethat the extent to which Indian firms have providedhigher value services like problem-conceptualisationand high-level design has increased.Interestingly enough, firms do not appear to deriveany advantage from domestic consulting experience inthe export market. The CEO of a software subsidiaryof a very large Indian engineering firm explicitly notedthat the considerable experience his firm had in exe-cuting large in-house software development projectswas of limited use in exports.“As far as functional skills are concerned, these dif-fer from country to country and client to client andthere is a learning curve there. Domestic expertise maybe useful in gaining technical expertise such as in cod-ing and project management. However, domestic andexport projects are two different ball games.”3.2. ExportsAlthough some of the leading firms are beginningto differentiate themselves from the rest, the leadingIndian software export firms are remarkably similar interms of their activities. These activities include main-tenance tasks for applications on legacy systems suchas IBM mainframe computers, development of smallapplications and enhancements for existing systems,migration to client–server systems, and increasingly,e-commerce related services and “solutions”. The
  8. 8. 1274 A. Arora et al. / Research Policy 30 (2001) 1267–1287Table 9Nature of export projects undertaken by Indian firmsaService Numberof firmsPercentageNetwork designing and engineering 19 20.4Conversion project 25 26.9System integration 22 23.7Application solution software 71 76.3System/utility software 28 30.1Application tools 22 23.7Operation and network mgmt 7 7.5Help desk operation 12 12.9Datacentre management 12 12.9a Source: CMU Software Dataset – CMU Survey of IndianSoftware Industry, N = 93.Year 2000 (Y2K) problem had also opened a largemarket for firms that were traditionally doing main-frame based maintenance projects. Table 9, displayingresults from our survey, shows that application solu-tions are the most common type of export, followedby re-engineering (which is the term used to describeporting applications from one platform to another)and conversion projects, such as Y2K projects. Al-though Y2K projects were an important source ofrevenue, most of the leading Indian software firmshave limited their dependence on such projects, andthis is reflected in the sustained growth of the Indiansoftware exports in 1999 and the first half of 2000.Managers at most of the US firms we interviewed in1998 agreed that the type of work outsourced was nei-ther technologically very sophisticated nor critical totheir business. 13 Requirement analysis and high-leveldesign is typically done either in-house or by US basedconsultants. However, smaller firms may rely moreheavily upon their Indian suppliers, as was the case ofa small firm developing medical software.13 The managers at a leading electronics and telecom firm said theyoutsource work related to sophisticated but mature digital signalprocessing software to their Indian subsidiary. The telecom firmswe interviewed outsourced domain related software maintenance ortool development for the maintenance or enhancement of existingapplications. The manager at a value added telecom services firmsaid that they were outsourcing testing of their existing softwareand to some extent maintenance of their old UNIX based software.However, we did find one exception to the idea that the outsourcedprojects are not mission-critical: a leading computer manufacturerout sources critical device-driver software that is shipped directlyfrom the Indian vendor for distribution.Table 10Destination of Indian software exports, 1997–1998aDestination region % of exportrevenuesUSA 58Europe 21SE Asia 6Japan 4Australia & New Zealand 2West Asia 2Rest of the World 7a Source: Nasscom.Not only is the work outsourced technologically un-demanding, the projects are typically small. The meannumber of man-months involved in the most importantexport project in 1998 for firms that participated inour questionnaire survey is 510 man-months, whereasthe median is only 150 man-months. Since the ques-tion related to the most important project, it impliesthat the typical export project is quite small.Table 10 shows that the US accounts for over half ofall export revenues (58% in 1997-98), compared with21% for Europe and 4% for Japan. Many of the largerUS firms we interviewed are knowledgeable about out-sourcing software development and the strengths andweaknesses of Indian software services firms. Someof these firms have also outsourced software develop-ment to firms based in other countries like the Ireland,Philippines, Russia and South Africa.The US is not only a major market; US based serviceproviders are important competitors. Although com-petition from other countries such as Philippines andChina is typically cited in the press, as Tables 11 and12 show, most software exporters indicate that theirTable 11Location of primary competitors of Indian software firmsaLocation ofcompetitorsNumberof firmsPercentageof firmsIndia 75 82Israel 12 13Ireland 12 13USA 58 63Singapore 19 21Philippines 6 7Eastern Europe/Russia 10 11a Source: CMU Software Dataset – CMU Survey of IndianSoftware Industry, N = 92.
  9. 9. A. Arora et al. / Research Policy 30 (2001) 1267–1287 1275Table 12Perceived location of primary competitorsaOne of top three locations Small Medium LargeIndia 39 21 15USA 27 17 14Other countries 24 14 9Total in category 48 28 16a Source: CMU Software Dataset – CMU Survey of IndianSoftware Industry, N = 92.main competitors are located either in the US or inIndia itself. However, with few exceptions, most ofthe US based competitors are themselves firms thatextensively recruit Indian software professionals.4. The organisation of softwareoutsourcing to India4.1. A typology of software exportsSoftware exports can be divided into three cat-egories based on where software is developed andhow the development is managed and organised. Thefirst category is onsite consultancy or onsite projects,where the Indian company provides the US client withsoftware professionals with the particular technicalskills asked for by the client. In essence, the entireproject is executed at the client’s site. The clientmanages the project, controlling the deliverables anddeadlines. The software is developed according to theclient’s processes and a more accurate descriptionwould be to label this supply of staff augmentationservices to overseas clients. 14The second category of exports has a mix of workdone offshore (i.e. in India) as well as onsite. In thismodel, the Indian company sends a few software pro-fessionals to the client’s site for requirement analysisor training in a particular system. These profession-als then bring back to India the specifications forthe software and a larger team develops the softwareoffshore. If the project is large, a couple of Indianprofessionals remain at the customers site acting asliaisons between the project leaders offshore and14 A common term for some of these “onsite projects” is “body-shopping” wherein all that the client gets is programmers. Thereis no value-add in terms of accumulated knowledge/expertise.the clients. Sometimes these onsite professionals areneeded for emergency operations and for reassuringthe client that the project is proceeding accordingto schedule. To execute such projects, a firm needsnot only skilled professionals, but also a softwaredevelopment process and methodology, and an abilityto manage software development. Unlike in onsiteprojects, the Indian firm provides technical and man-agerial expertise for offshore projects.The third method of software export, similar insome respects to offshore development, is in the formof an Offshore Development Centre. An OffshoreDevelopment Centre is a popular organisation form,especially for firms based in the US and Europe andwho wish to take advantage of the skilled talent pooland lower wages in India. An offshore developmentcentre involves an umbrella contract with a long-termagreement on prices for time and materials (usuallystandardised on a man-hour basis). Periodically, theclient sends projects to the centre. For each project,the negotiations are largely restricted to the resourcesand time that will be required. In some cases, the placewhere the work is done is physically separate (from therest of the Indian company) and secured. Many of theestablished Indian software firms will have more thanone development centre, and we interviewed firms thathad five or six offshore development centres or more.Firms that have been outsourcing software to Indianfirms for a long period prefer this form of organisationsince they are confident of the Indian firm’s capabili-ties and rely on their processes for delivering software.Our survey (sample of 65 software export firms)indicates that on average 42.7% of the total workwas done offshore for the most important project,consistent with NASSCOM estimates of 41%. Thedistinction between offshore and onsite work is im-portant because offshore development is more costeffective. Our interviews suggest that one man-yearof onsite work is billed at about US$ 90,000–100,000while comparable offshore work is billed at US$25,000–35,000. The bulk of the difference is ac-counted for by the higher cost of living in the US, aswell as greater overheads and communication costs.Offshore work is widely believed to be more profitablefor the vendor. However, there are some importantlimits to the extent of offshore work. An importantreason is the need for face-to-face communication.Further, since many projects are cost plus (“time and
  10. 10. 1276 A. Arora et al. / Research Policy 30 (2001) 1267–1287Table 13Fixed fee versus time and material export contractsaAll firms (%) Small (56 firms) (%) Medium (32 firms) (%) Large (14 firms) (%)Time and materials contract 53 52 53 57Fixed fee contract 42 45 41 36Firms that have had both 3 2 3 7Other 2 2 3 0a Respondents were asked about the nature of their most important export contract. Source: CMU Software Dataset – CMU Survey ofIndian Software Industry, N = 102.materials” is the term used in the industry), clientshave to trust the supplier to not overcharge them(Gopal, 1996; Bannerjee and Duflo, 1998).Fixed fee contracts involve greater risk taking bythe vendor in contrast to cost plus or time and materialcontracts. With greater risk also comes greater controlover the organisation and management of work. Theavailable evidence suggests a steady increase in thefixed price component of work, indicating the growingmaturity of the Indian software firms, an impressionconfirmed by several of the managers we interviewed.Bannerjee and Duflo (1998) present data from a sam-ple of 236 contracts (not including offshore develop-ment centre contracts) from 125 software companies.They find that 58% are fixed price contracts, whileanother 27% are “mixed”. Only 15% of the contractsare pure time and material contracts. This tends to ex-aggerate the differences because the dynamic natureof software development results in changes in require-ments and specifications, resulting in frequent timeand cost over-runs, which are often shared between theIndian vendor and the overseas client. From Table 13we see that 53% of the firms we surveyed indicatedthat their most important export project in the last12 months was a cost plus contract. The 42% of thefirms had a fixed price contract for their most impor-tant export project. Interestingly, 32% of all the firmsalso claimed that their contract contained a penaltyor incentive clause related to quality or schedule.4.2. US experience with software outsourcing to IndiaTypically, the US firm begins by outsourcing afairly small project to the Indian vendor, with theobjective of gauging the latter’s capabilities. Notonly are the initial outsourced projects small, muchof the work boils down to the Indian firm supplyingsoftware programmers to work onsite. The shiftto offshore work requires substantial investment inphysical infrastructure (including secure physical andcomputing infrastructure that some clients demandto protect their intellectual property). It also requiresthat the Indian firm be able to demonstrate projectmanagement capabilities. 15The most frequently cited reasons for outsourcinghave to do with the shortage of skilled profession-als in the US. Firms claim that they simply cannotfind enough software professionals fast enough. Inaddition, firms outsource because they do not wantto invest in in-house capability in areas outside theircore-competence (such as developing applications forold computing platforms) and to free their in-houseIT staff from mundane maintenance tasks for morecreative projects. US firms engaged in developingsoftware products emphasised the need for accelerat-ing product development in the face of ever-shorterproduct lifecycles.In some cases, US firms outsource to Indian firmsto get access to more specialised engineering talent,particularly in the area of telecommunications. Otherreasons include the option of round the clock oper-ations and the ability of Indian vendors to assemble“functional” teams of engineers at a very short notice.Most of the US managers we interviewed commentedon the excellent programming and coding skills avail-able in India. They also noted that their Indian ven-dors were good and willing learners, receptive to newideas, and flexible in terms of the software and hard-15 Managers at a large software product firm said that given therapid pace and nature of product development, they mostly reliedupon onsite work. In effect, they use their Indian vendors as astaff augmentation agency, while for the Indian firm, this is anopportunity to train its staff in the tools and methodology used atone of the largest software producers in the world.
  11. 11. A. Arora et al. / Research Policy 30 (2001) 1267–1287 1277ware platforms for which they provide services. Onereason that we expected to hear but frequently did not,was outsourcing to reduce costs. Many of the respon-dents downplayed this issue, insisting that cost wasa relatively minor consideration. This appears to bea response to the prevailing concern in the US aboutthe possible harm to US engineers from software out-sourcing and inflow of foreign software programmers.The apparent lack of concern with cost is inconsistentwith the extensive price competition that prevails inthe Indian software industry, and with the actual be-haviour of some of the firms that outsource to India. 16Our interviews with US firms also revealed a num-ber of areas of dissatisfaction. Many of the intervie-wees thought that the Indian firms had no domainknowledge and poor management skills. Even a highlyrated Indian subsidiary of a leading electronics andcommunication firm was considered 4–5 years behindthe latest communication technologies by managersin the US. Most of the managers believed that Indianfirms could not work on high level specifications orproject definition stages of a project, although for themost part, this belief had not been tested. Indian pro-ductivity levels are lower as well. For instance, man-agers at the electronics and telecom firm noted thatthey needed to assign more engineers to a task in theirIndian subsidiary than would be assigned in the US.Many were critical of the Indian system of pro-moting software programmers to managers based onseniority rather than on proven managerial ability.Interviewees felt that this weakened project man-agement. Indian firms, on the other hand, cited thispractice as a way of providing a career path to theirprofessionals and a major part of their attempts to holddown employee attrition. However, software firms arenow actively recruiting MBA students from Indiancolleges like the IIMs as project managers. Thoughtypical business undergraduate or MBA courses do16 For instance, one of the telecom firm we interviewed had, inaddition to a couple of prominent Indian firms, a firm largelyin the business of “body-shopping” among its list of preferredvendors. Our interview suggested that this was a way of promotingcompetition and keeping prices down. This firm’s policy was toensure that its business accounted for a substantial (but less than50%) share of the vendor’s revenues and that no single vendorhad more than 25% of its business. These policies ensured that ithad considerable bargaining clout in the pricing negotiations withits Indian vendors.not cover issues such as design and software projectmanagement, firms themselves try to develop theseskills through on the job training or other types ofin-house programs.A very large fraction of the managers we inter-viewed considered employee attrition a big problemand wanted their Indian suppliers to tackle it quickly.Some of them recounted experiences where virtuallythe entire project team left after the first 6 months,causing substantial delays. A manager at one of thetelecom firms that had had considerable experiencewith Indian software vendors spoke at some lengthabout how frustrated he was with the apparent inabil-ity or unwillingness of Indian firms to move up thevalue chain. He claimed that his firm would like tobe able to outsource more software design and devel-opment tasks to its Indian vendors. In particular, thisfirm would like its suppliers to display more initiativein identifying business problems that it faces and pro-pose solutions. Even though this manager claimed tobe willing to help the suppliers to acquire such capa-bilities, in his view, the suppliers were not responsiveenough to this opportunity.In addition, there were a number of cultural andpolitical issues that US managers perceive as irritantsor barriers. One such issue is the apparent unwill-ingness of Indian software professionals to point outpotential problems up-front, and in general, an un-willingness to say no for fear of offending the clients.Another related weakness is the lack of familiarity ofmany Indian firms and professionals with the work cul-ture and work norms in the West, and especially in theUnited States. 17 Other difficulties included resistancewithin the US to foreign programmers, poor telecom-munication infrastructure, and the delays in obtainingthe required visas for Indian programmers.5. Factor supplies5.1. Human resourcesIt is widely believed that the key to the success ofthe Indian software exports is the supply of trained,low cost software professionals. Table 14 shows that17 This includes the sideways movement of the head to indicateagreement, as opposed to the Western nod.
  12. 12. 1278 A. Arora et al. / Research Policy 30 (2001) 1267–1287Table 14Software professionals: comparative salaries, 1997aDesignation United States(US$ per annum)Indiab(US$ per annum)Programmer 32500–39000 2200–2900System analyst 46000–57500 8200–10700Programmer analyst 39000–50000 5400–7000Network administrator 36000–55000 15700–19200Database administrator 54000–67500 15700–19200Help-desk support technician 25000–35500 5400–7000Software developer 49000–67500 15700–19200a Figures are starting salaries for large establishments employing more than 50 software professional’s. Salaries for a particulardesignation would vary due to factors such as educational and experience profile of the professional, platform of operation, nature ofassignment (contract/full-time) location of the employer and additional technical/professional certification. Source: INFAC (1998), Mumbai.b Converted at exchange rate of Rs. 41.50/US$.estimated wage costs in India were about 1/3rd to 1/5thof the corresponding US levels for comparable work.Other estimates suggest that once all costs are factoredin, the cost of software development is only half thatin the US. Despite the large stock of engineering grad-uates in India, NASSCOM claims that by year 2000,demand will outstrip supply. If this were to happen,the present rates of growth could not be sustained.We believe that although investments in engineeringeducation are necessary, a bigger part of the solutionlies in a more efficient use of existing human capitalresources.The tight labour market conditions are reflected inthe 20% increase in wages and in attrition rates thatare said to be nearly 20–25% for the industry. 18 Webelieve that demand already exceeds supply for expe-rienced project managers. Many of our intervieweesmentioned their difficulty in recruiting professionalswith 4–6 years experience, even though nearly 40%of the workforce is reported to have 4–6 years ex-perience. Experienced software professionals tend tomove to the US through the H-1B visa route, adding18 India graduates about 155,000 engineers of various sorts, andanother 200,000 diploma holders from a variety of private traininginstitutes per year. About 60,000 of these enter the IT sector.In 1999, the total number of software professionals in India wasestimated to be about 250,000 compared with 200,000 in theprevious year, with a median age of 26.2 years (NASSCOM, 1999,p. 16). Virtually all of these professionals have either engineeringor computer science degree or a Masters in Computer Applications(MCA).to the problem and the entry of new firms exacerbatesthe situation (Nidumolu and Goodman, 1993). 19To a considerable extent, this reflects the relativelyinelastic supply of engineers (as compared to stu-dents trained by private training institutes) and themarked preference for engineers (of all types, not justsoftware engineers or computer scientists) by Indiansoftware firms. Responses to our questionnaire sur-vey indicate that 80% of the software professionalsemployed had engineering degrees, while 12% onlyhad diplomas from private training institutes. Few ofthe firms we interviewed admitted to hiring graduatesfrom private training institutes, although since thebulk of the engineering graduates are not trained insoftware engineers or computer science, a substan-tial fraction also have diplomas from private traininginstitutes. Further some of the smaller and youngerfirms do hire graduates from these institutions, as dosome domestic market focused firms.This preference from engineers is even morepuzzling since the bulk of the work is relativelynon-technical and requires mostly logical and method-ical work and a familiarity with software developmenttools and languages. As one CEO we interviewed put it“Take somebody from a good college (any of thetop 20 colleges in India), give him 3 months of ori-entation and they are ready to take up a programmingassignment. I don’t need all these engineers. . . . But I19 The US Consulate India estimates that around 30,000 H1-Bvisas were granted in 1999, mostly for software professionals (TheEconomic Times, 1999).
  13. 13. A. Arora et al. / Research Policy 30 (2001) 1267–1287 1279don’t want to be branded by my customers as a guywho hires NIIT graduates.” (Emphases added)Given the large number of science and arts grad-uates, and the widespread availability of privatetraining, the pool of potential software professionalsis much larger than merely the engineering gradu-ates. However, software firms are reluctant to tap thispool because of the potential negative signals to theircustomers. 20 This is a clear instance of a “race tothe top” rather than a race to the bottom. With onlylimited market power, Indian software exporters tryto distinguish themselves from the competition bypointing to the quality of their processes and people,and when possible, their experience. Firms also havequality concerns. Managers we interviewed believethat an engineering education imparts a set of prob-lem solving skills, methods of thinking logically andlearning tools that help quick adaptation to changesin technology, domains and tasks. Since Indian firmsprovide services across a range of platforms and do-mains, this is an important asset. The CEO of a smallfirm developing innovative products statedBecause things are changing so fast in this industry,knowledge of a particular operating system, a par-ticular language, a particular technology is not asimportant as the ability to learn and adapt to change.Despite paying substantially above Indian stan-dards, virtually all firms find it difficult to retain tal-ented professionals. All the firms we interviewed anda very large fraction of the over one hundred firms wesurveyed mentions employee turnover and difficultyin attracting suitable employees as a major problem(Table 15). High rates of employee turnover constituteone of the most important challenges to the ability ofIndian firms to progress beyond providing low-endsoftware coding, development and maintenance ser-vices. The loss of employees is especially severeamong consultants (programmers and analysts) sentoverseas to work onsite in the US, and a very substan-tial fraction quit within 2 years. 21 The situation is20 US visa restrictions are another reason why firms prefer engi-neering graduates.21 However, high turnover is also common in US software devel-opers and in other service industries such as accountancy firms,and as the CEO of a rapidly growing software services firmput it-“paying a premium price for talented people. This is aworld-wide phenomenon.. . . I am not worried”.Table 15Major problems for Indian software firmsaProblem Export DomesticManpower shortage/skills 57 32Employee attrition 44 27Physical infrastructure 12 12Commercial infrastructure 24 17Quality certification 11 6Visas 33 NAFinance/capital 20 14Marketing access 42 17Lack of domestic computerization 6 21Lack of government support 10 11Tarrifs and other barriers 11 8a The firms were asked to indicate their top three problems.Source: CMU Software Dataset – CMU Survey of Indian SoftwareIndustry, N = 104.particularly acute for experienced project managers,typically software professionals with 4–6 years ofexperience, and for talented software designers. Vir-tually all the firms we interviewed noted the difficultythey have in retaining experienced software profes-sionals, many of whom are lost to firms overseas.Firms are responding to the problem of employeeattrition in a number of ways. One popular way isby providing opportunities to work in the US. Manymanagers also stressed quality of life issues. Somefirms stressed their ability to provide a career path fortheir employees, wherein they could move to beingmanagers and would not have to remain programmers,apparently something valued by Indian professionals.Interestingly enough, few claimed to pay more thantheir competitors although a number of firms wereactively considering stock options, something that fewfirms in India had done by 1997, with Infosys beingan important exception.Some firms expressed the need to make the organ-isation individual independent by addressing the lossof knowledge due to employee turnover. Thus, oneCEO told us that although,Our attrition is . . . better than average. . . . it is dif-ficult to retain the segment (of the workforce with)6–8 years experience. We are tackling this by mak-ing (our) organisation individual independent, andstressing training & process methodologies.Our sense, however, was that efforts at insulating theorganisation from employee turnover are very much
  14. 14. 1280 A. Arora et al. / Research Policy 30 (2001) 1267–1287Table 16Revenue per employee, by quality certification: CMM level 3 in year 1999aYear Non-CMM firms CMM certified firms t-statistic for difference of meansSamplesizeMean revenue peremployee, in US$ 1000SamplesizeMean revenue peremployee, in US$ 10001995 38 21.31 17 27.51 1.241996 46 22.80 18 32.11 1.891997 46 20.13 18 29.14 1.791999 46 23.71 18 35.82 2.74a Firm sample does not include subsidiary firms like Motorola, Texas Instruments etc. Source: CMU Software Dataset.Table 17Revenue per employee, by size of firm in year 1997aYear Small firms (<250 empl.) Large firms (>250 empl.) T statistic for difference of meansSamplesizeMean revenue peremployee, in US$ 1000SamplesizeMean revenue peremployee, in US$ 10001995 31 19.01 24 28.67 1.961996 39 22.19 25 30.46 1.841997 39 19.85 25 27.05 1.611999 39 22.89 25 33.71 2.28a CMU Software Dataset.in their infancy, and firms are still very vulnerableto the problem of retaining experienced and talentedworkers.In addition to improving retention rates, an impor-tant part of the solution is a more efficient use ofthe available human capital. As noted earlier, thereare a large number of non-engineering graduates thatare trained by private training firms such as NIIT andAptech. Indeed, as Tables 16–18 shows, the trainingsector industry has grown along with the software in-dustry, with total revenues in 1997–98 estimated at Rs.8.56 billion (about US$ 225 million), up from Rs. 6.6billion the year before. Even if one accepts the dubi-Table 18Revenue per employee, by age of firms in 1999aYear Young firms (<9 years) Older firms (>9 years) T statistic for difference of meansSamplesizeMean revenue peremployee, in US$ 1000SamplesizeMean revenue peremployee, in US$ 10001995 25 24.81 30 21.91 −0.521996 30 26.75 34 24.25 −0.551997 30 22.18 34 23.09 0.211999 30 28.35 34 26.03 −0.51a CMU Software Dataset.ous proposition that such graduates are not well suitedfor software development, they are well suited for pro-viding support and maintenance, for back office oper-ations, and for a variety of IT enabled services suchas medical transcription and claims processing for theinsurance industry. Moreover, the current wage trendswill provide incentives for firms to use engineeringtalent more efficiently and to substitute software pro-fessionals with other backgrounds where possible.Although the supply of engineering graduates is rel-atively inelastic in the short-run, there are a numberof public sector and industry initiatives to increase thesupply of software professionals. The government has
  15. 15. A. Arora et al. / Research Policy 30 (2001) 1267–1287 1281recently announced the establishment of Indian Insti-tutes of Information Technology, along the lines of thewell-known Indian Institutes of Technology. A numberof engineering colleges have increased their emphasison information technology and, in some cases, havestarted IT management programmes. A potentially se-rious constraint on the ability to rapidly increase theoutput of trained software and computer engineers isthe shortage of engineering doctorates being awardedin India. Recent data show that the PhDs awarded inengineering disciplines have fallen from their high of675 in 1987 to 375 in 1995. Concurrently, the numberof engineers with postgraduate training has also risenonly slowly, from a little over 12,000 in 1987–89 toa little over 17,000 in 1990–92. Surveys of the IITsshows that a very large fraction of postgraduates en-ter the IT sector, in some cases as many as 90%! Al-though there are a substantial number of engineeringdoctorate holders of Indian origin working outside In-dia, a long run solution will require an increase in thepostgraduate research and training infrastructure.5.2. Communication and physical infrastructureGood communication infrastructure is consideredvital for the continued growth of the industry. This ismost obviously the case in software service exports,and especially for offshore software development.Overall, the data communication infrastructure inIndia is expensive and in limited supply. Some USbased clients do find the slowness of the networks andthe general problem with the communication infras-tructure a major irritant. 22 However, as with finance,most firms consider the problem of communicationinfrastructure to be less important than the problemof finding and retaining qualified software profes-sionals, and the problem of physical infrastructuresuch as roads and power. Indeed, most Indian firmsseemed quite content with what was available. Twoinferences, quite different in implication, are possi-ble. The first is that communication infrastructure isadequate, or that firms have found ways around thehigh price and low availability constraint. The otheris that the offshore component of the tasks being22 The managers at one of the largest US software firms said thatthe connectivity to India was poor and the networks were veryslow, making onsite presence almost a requirement.carried out in most Indian firms requires only limitedcommunication so that the existing bandwidth is ade-quate. Consistent with the latter interpretation is thatexport projects are simple and small and reasonablyeasy to specify in detail in advance. 23 Clearly, thepoor communication infrastructure has affected thediffusion of the Internet domestically, and throughthat, has discouraged the growth of new firms thatcould provide software services for and through theInternet.5.3. FinanceSoftware services, especially for export, are a veryprofitable business with good cash flows and limitedrequirements for up front investment. Therefore, fi-nance is not a major problem for software servicefirms, unless a firm wishes to expand rapidly or wishesto expand overseas. More than half of the firms we sur-veyed indicated that they relied upon personal fundsfor start-up finance. Many of the firms we interviewedappeared to rely on equity financing as the primarysource of capital, although they had other diversi-fied sources of finance such as loans and lease fi-nance. Others relied upon financing from their parentfirm or from business groups with which they wereaffiliated.Obtaining finance is, however, a major concern forfirms developing software products. In contrast to ser-vices, a substantial investment is required to developthe product, and even more to market the product.Firms that are trying to develop software products havefaced problems in getting finance, in part because theinexperience and conservatism of Indian venture cap-ital funds. 24 A common strategy has been to provide23 In late 1998, the government of India announced that a highbandwidth (2.5 GB) fibre-optic backbone would be set up. Thismay open up many new possibilities, including a significant in-crease in the offshore component of software exports.24 A manager for a venture fund run by a public sector investmentbank noted that, although they had invested in as many as 32firms in the past, only five were product focused, the rest beingsoftware service firms focusing on exports. However, this venturecapital operation no longer invests in start-ups. Instead, they fundexpansion or new product development by existing firms withgood track records, or by proven star managers in the industry.Funding investments are in the range of Rs. 15–20 million (US$400,000–500,000) but the firm can come back for more as soonas the financing is exhausted.
  16. 16. 1282 A. Arora et al. / Research Policy 30 (2001) 1267–1287software services and use the cash generated to fundproduct development. An interesting example is a firmstarted by an entrepreneur who had worked for manyyears in a large US software firm who was financingthe venture himself, but was also using supplying soft-ware services to his earlier employer to generate rev-enue. A firm affiliated with a large banking group alsoused its earnings from its services business to fundproduct development.A venture capitalist affiliated with a well-knownSilicon Valley venture capital firm agreed with theview that venture financing in India for start-ups fo-cusing on packaged products is limited. He indicatedthat the existing tax laws made it more profitable tomake equity investments in a US firm rather than anIndian firm but to then have a wholly owned Indiansubsidiary to make its financial reports in India andget tax exemptions. He also noted that debt ratherthan equity fund most start-ups. Therefore, having aservice component to a product strategy made sensesince services provide a relatively easy way of enter-ing the market and gaining experience. Services alsoprovide cash, which start-ups are unable to get fromelsewhere.The problem, it appears, is as much on the demandside as on the supply of venture capital. Venture cap-ital funds associated with well-known Silicon Valleyventure capitalists, such as Draper International, haveonly been able to use 60% of the allocated funds.In addition to the usual problems involved in settingup businesses in India, venture capitalists are inter-ested primarily in products developed for large mar-kets, and therefore, for products that can succeed inthe US. Developing products for the US market fromIndia is widely thought to be very difficult. Table 15shows that it does not appear that lack of venture cap-ital is the major constraint for developing softwareproducts.Moreover, as discussed later, in recent years a num-ber of firms focused on product development, or oninternet and e-commerce have emerged, and along-side, there has been a concomitant increase in thesupply of venture capital and venture capital firms. In1998, about US$ 1.3 billion had been committed inventure capital and following policy changes in 1998,a number of firms, included overseas funds, have en-tered the market. The number of venture capital fundsregistered with SEBI increased from 8 in 1996–1998to 14 in 1999–2000. 25 A number of prominent expa-triate Indians are also increasingly important as angelinvestors, and as links between Indian firms and USbased venture capital funds. The actual amount ofventure capital and angel capital invested in the ITsector in India has increased from US$ 20 millionin 1996 to over US$ 300 million in 2000. Thoughvery small in magnitude, it does point to the growingdemand for this type of risk capital in India.6. Moving beyond low wage costsIndustry leaders, academics and government offi-cials alike have stressed that software firms need toprovide more value-added services — to move up thevalue chain to ward off the growing wage pressuresat home and the potential competition from China,eastern Europe and others. Many observers have alsoargued that the prospect of short term gain offered bythe simple service exports described in Sections 3 and4 are seducing Indian firms away from making thesubstantial investments required to develop products,or even to move up the value chain. Further, they arguethat the absence of a sophisticated domestic marketfurther exacerbates the problem (e.g. Heeks, 1996;D’Costa, 1998). Finally, they argue that this, coupledwith the inevitable shortage of engineers, constitutesa serious impediment to the sustained growth of theIndian software industry.Although there is an important element of truth tothis observation, our sense is that this is overly pes-simistic. First, as noted earlier, a considerable fractionof the current services supplied by the Indian softwareindustry does not require an engineering backgroundand, consequently, suitably trained non-engineers,whose supply is far more elastic, can be substituted.Second, overseas firms can supply some of the re-quired technology and managerial expertise. Indeed,a number of them are setting up research and productdevelopment centres in India, typically headed bymanagers of Indian origin. Finally, there is evidence,albeit anecdotal, that Indian firms are responding tothe rising wage pressures by improving software de-velopment practice and developing tools to reduce25 http://www.nasscom.org/template/Venture%20Capital1.htmdownloaded on 10 August 2000.
  17. 17. A. Arora et al. / Research Policy 30 (2001) 1267–1287 1283costs, and providing higher value services beyondsimple coding. As well, some firms are investing inresearch and in developing new products.6.1. TechnologyA brief look at the evolution of software servicesin India shows that firms were very quick to migrateto newer platforms and adapt to new technologiespertaining to software development. From the tradi-tional mainframe based systems, firms quickly movedto open system platforms like UNIX and Windows.The skill level of firms in the open systems is consid-ered to by customers to be on par with that of any USbased firm.Relatively few firms have invested in R&D. As longas firms primarily provided coding services to foreigncustomers, the need for R&D was minimal as therewas no new technology being developed and the ser-vices were mostly application solutions. In the pastfew years, the R&D is largely the province of firmsfocused on semiconductor intellectual property (IP) orthe larger firms like TCS.More recently, some indigenous firms have begunto pay attention to technology development as well.Wipro has been developing semiconductor IP and hadrecently started a subsidiary, EnThink, to market thesemiconductor designs developed in Bangalore. An-other firm, Silicon Automation Systems has been de-veloping a range of speech compression products anddesign tools for semiconductor design. Newgen Tech.,a New Delhi based company, licensed their documentmanagement technology to Canon for 5 years for US$2 million (Computers Today, March 1998). Infosysbuilt a CNC machine controller (Gamana) which they,consequently, sold. Infosys also invested US$ 3 mil-lion in CiDRA Corp., which manufactures photonicdevices for high precision wavelength managementand control of next-generation optical networks. TCShas a research division in Pune, where research in dif-ferent areas of computer science and multimedia iscarried out. Graycell technologies (now Unimobile)is probably the best example of a technology focusedfirm. Graycell develops software for mobile devicesand its technology was attracted well known angel andventure capital investors from the US, who, subse-quently, moved the company to California, much likemany technology based Israeli software firms. Anothersuccess story is that of Pentamedia, a spin-off of froma traditional software service exporter, in animationsoftware and related technologies.6.2. Maturity of software processand improved qualityMost firms have responded to wage pressures andemployee turnover by focusing on improving theirsoftware development process and developing tools.Since the early 90’s Indian software firms startedto get their software processes certified accordingthe ISO 9001 standard or got assessed according tothe Capability Maturity Model (CMM). Indeed, overhalf of the CMM level 5 firms in the world are inIndia.Although quality certification is often to signal topotential clients rather than to improve the qualityof software produced, there is growing evidence thatfirms are in fact developing software developmentmethods and project management skills to be able toundertake larger and more complex projects. Firmscertified at CMM level 4 and 5 are better able to pre-dict time and costs involved in such projects, and thusbetter able to bid for fix priced contracts (as opposedto the more common time and material contracts).This ability also complements other skills importantfor moving up the value chain, such as requirementsanalysis and high level design.TCS has executed a number of large export projectsand moved into newer areas like data warehousingwhich involves a closer link to the customer’s busi-ness objectives. Long term relationships between In-dian firm and customers seem to be typical of mostexport projects. Of the firms we surveyed, over 93%said that their most important export contract involvedwork for a company they knew earlier or was part ofan ongoing relationship with the client. The fact that32% of the firms surveyed also said that they had apenalty clause in their contract points out that firmsare getting increasingly mature and are able to makeprojects more predictable.Some of the leading firms have adopted a strategyof developing tools that embody some of the busi-ness and technical knowledge accumulated by the firmin the course of serving overseas clients. Not onlydo they lower costs and improve delivery time, theyalso help partially insulate the firm from employee
  18. 18. 1284 A. Arora et al. / Research Policy 30 (2001) 1267–1287turnover. Nortel Networks, a big long-term customerfor the large software firms like TCS, Infosys, Wiproand Silicon Automation Systems, recently announcedthat they would share royalties with these companiesfor the tools and products developed.6.3. Moving up the value chain: solutions& productsDeveloping tools is one way of reducing costs. Acomplementary strategy is to try to “move up the valuechain”, by providing services beyond simple program-ming services, intensive in industry specific businessknowledge (domain expertise) and technical capabil-ity. Together, these enable the software supplier toprovide “solutions” to business problems, rather thansimply programming services to implement solutionsthat the customer or firms such as Anderson Consult-ing and Oracle provide. 26 Documenting the acquisi-tion of such capabilities is not easy, however. Thereis ample anecdotal evidence that firms such as Wipro,Infosys, Mastek, NIIT, Satyam and TCS are alreadyoffering solutions in areas such as e-commerce andtelecommunications. 2726 However, some believe that such a strategy, which ultimatelyinvolves getting involved in business process re-engineering foroverseas clients, is not feasible for Indian firms. The CEO ofone such firm, a wholly owed subsidiary of a very large Indianengineering firm, believes that it is better remain a subcontractorto the established systems integration and IT consulting firms inthe West.“It is much better to piggy back on the Big Six who have largeorganisations, credibility and have done this (business processre-engineering) for years. Better for us to do level two workon logical and physical systems . . . maybe the implementationpart but onsite. . . (Our parent firm) has ES 9000s and IBMmainframes. It was the first firm to use IBM mainframes inIndia for a very long time. . . . We have the most qualifiedexperts on IBM mainframes. So as far as legacy maintenanceon IBM mainframes is considered, we know the technologyinside out.. . . (but) technology is not such a critical factor ascompared to understanding business practices.”27 One type of service that is considered to be moderatelyvalue-added but quite specialised is the writing of software forspecific hardware components, such as printers, cell phones, andmodems. Device drivers, as they are called, involve a varied levelof sophistication as far as programming talent is concerned. Wipro,BFL software, Silicon Automation Systems and Srujana Technolo-gies are among the firms that provide device driver related servicesto clients.Sometimes, these solutions are based on products.For instance, TCS and Infosys have launched bank-ing products in the Commonwealth countries and havehad some success. CITIL (now I-Flex) has a bank-ing product Flexcube, which they have just started tomarket throughout the western world after testing it inthe eastern markets. The product strategy behind thelarger companies is to build products out of servicesthat they have provided to the past customers. In manycases, packages or tools built for the customers haveto be modified slightly to be more applicable to mar-ket needs. This seems a viable strategy in the years tocome, considering that Indian firms would continue toprovide services for the export market.Despite the lack of success for most firms that fo-cused on software products in the early 1990s, a fewproduct focused firms have soldiered on. Ramco hasoffered an enterprise resource planning (ERP) productfor some time, but are only now making inroads in theexport market. In the past couple of years, there havebeen new entrants in the ERP market like VisheshInfosystems and Nexgen Technologies. Nonetheless,most products being sold or developed today are ex-tensions of the packages that the firms developed fortheir earlier customers. In the last couple of years,the entrance of a new set of entrepreneurs, eitherhome-grown or US returned, has led to the resurgenceof product oriented firms, seeking to exploit lowerdevelopment costs. Improved communications andlinks with overseas markets reduces the disadvantageof being far away from customers, helping developersin India keep in touch with the latest trends in themarkets overseas and keep tabs on their competitorsand their product releases. 28In the mid 1990s, when concerns about the futureof Indian software exports were first raised, manyexhorted software service firms to develop products,and some product developers used service exportsto fund product development. But managing servicesand product development in the same firm has provedto be challenging, and many firms have separated theirproduct development divisions from their software28 Examples of products being developed include Smartifacts withWebVU and Ruksun Technologies with LiveJam, which allowsmusic artists to “jam” across the Internet, and EasyDiary, whichis an online calendar program similar to those offered by Internetportals like Yahoo.
  19. 19. A. Arora et al. / Research Policy 30 (2001) 1267–1287 1285operations, often by spinning them off as stand alonecompanies. This also suggests that one should lookto later entrants, not the established software servicesfirms, for successful product development. 296.4. Assessing success: revenue per employeeOne measure, albeit an imperfect one, of measuringthe effectiveness of these strategies, is revenue peremployee. This commonly used measure of labourproductivity is particularly apt for comparing firmsthat are labour intensive and where there is no rea-son to suspect significant economies of scale fromlarge fixed assets. In the Indian context, this mea-sure has a significant problem in that firms that relyheavily on onsite work and body-shopping will tendto have higher revenue per employee, even thoughthey are lower in the value chain and less productive.Tables 16–18 compare revenue per employee for agroup of firms registered with NASSCOM for whichhave consistent data over several years. To facili-tate comparisons we removed divisions and whollyowned subsidiaries of overseas firms (such as TexasInstruments and Motorola) and also excluded productfocussed firms and domestic oriented firms.Table 16 shows that firms that are quality certifiedat CMM level 3 or higher have higher revenue peremployee than non-certified firms and the statisticalsignificance of the difference tends to be high. Table 17shows that large firms (with more than 250 employeesin 1997) similarly tend to have higher revenue peremployee. Further, the absolute difference in revenuesper employee between CMM and non-CMM certifiedfirms, as well as larger and smaller firms has tended togrow over time. However, older firms (that entered theindustry before 1990) do not have significantly higherrevenue per employee.29 One of the earliest instances was Yantra, till recently a US sub-sidiary of Infosys Technologies (which still owns a considerablestake in the company). Yantra, which develops supply-chain man-agement software, got US venture capital funding and appears tobe quite successful. Since then, Infosys has also spun off OnscanInc., a wireless Internet solutions company that it had incubated.Another relatively well known case is of Talisma, a front officeproduct from Aditi Technologies. This product was developed asan extension of the in-house tool that they used to provide e-mailsupport to customers. Talisma was recently hived off from Aditias a separate entity.It is extremely unlikely that CMM level 3 and higherfirms and larger firms have a higher fraction of on-site and body-shopping projects. It is more likely thatthe higher revenue per employee reflects higher valueadded. In a related study (Arora and Asundi, 1999) weexplored the economic returns to ISO 9001 softwarequality certification. The empirical results show thatfirms that did get quality certified do not get betterrates for their services. Quality certification, however,allowed the firms to take on larger projects and grow.Further, the results indicate that increased size enabledfirms to increase revenue per employee. Our interviewsalso suggest that the ability to take on larger, morecomplex projects and manage projects better is an im-portant type of value addition strategy for softwarefirms. As well, many of the larger firm have developedindustry specific solutions that yield higher revenuesper employee. Finally, the absence of a substantial dif-ference between older and younger firms indicates thatthis ability is not simply a matter of learning by doingbut rather requires deliberate investment by the firm.Further, it points to the relative immaturity of the in-dustry as a whole in that early entrants do not appearto have a significant advantage over later entrants.On the whole, these results do not support an overlypessimistic view of the future. Earnings per employeehave increased, particularly for the more establishedfirms and those that have invested in developinghigher quality software development practices. Fur-ther, this growth has taken place even as these firmshave decreased the extent of onsite work, implying agreater increase in value addition than reflected in thefigures in revenues per employee.7. Summary and conclusionsThe picture one gets of the Indian software servicesindustry is a mixed one. On the one hand, there is agreat deal of excitement about its rapid growth and itsexport success. On the other hand, the kind of workbeing performed is typically fairly mundane. The do-mestic market provides far more challenging projectsbut is financially less rewarding. Moreover, the linksbetween the domestic market and exports is, at present,very tenuous. There is little evidence for the idea thatexperience with complex domestic projects has had ahigh payoff in the export market or that the “learning
  20. 20. 1286 A. Arora et al. / Research Policy 30 (2001) 1267–1287to walk on two legs entry strategy”(Schware, 1992)was being practised by Indian firms. 30These observations are consistent with the other re-search in this area (e.g. Heeks, 1996; D’Costa, 1998).Both of these authors have argued that the export ori-entation and routine tasks that exports involve havelimited learning potential for Indian firms. Heeks hasnoted that the reported export revenues are mislead-ing insofar as a substantial fraction of these are ac-counted for by onsite work, that in turn requires thata substantial fraction of the revenues be spent outsideIndia. D’Costa has highlighted the limited potentialfor leapfrogging of most export-oriented activities inwhich Indian software firms are currently engaged.In out interviews, US clients convey the sense thattheir Indian suppliers are competent (by and large)at providing a limited range of services but only afew have moved to where they offer solutions toclient problems.In the last couple of years, there is evidence thatthe established Indian firms are maturing and growingin their ability to execute larger and more complexprojects, as well as execute higher value added partsof such projects (such as requirement specificationand high level design). These firms can act as thenucleus around which the industry can develop andmature. We also see a entry of new entrepreneurs thatare experimenting new product ideas. The strategiesthat firms are adopting to climb the value chain differsbut can be broadly divided into: (a) developing ma-ture software development processes to take on larger,more complex, and higher paying projects and effec-tively do more value added work; (b) understandingbusiness needs of the customer and proactively de-veloping business and technical solutions to existingproblems; (c) developing products from the servicesprovided earlier (“productized” services) and (d) en-tering emerging technologies and businesses such asmultimedia and e-commerce.Executing these strategies is not easy. Firms have toinvest a great deal in hiring, training and retaining theiremployees, in expanding overseas and establishing (oracquiring) subsidiaries in the US and Western Europe,as well as in acquiring the technological and business30 Many firms that began with a domestic market focus seemto have moved away towards less challenging but more lucrativeexport tasks.expertise needed. Furthermore, such investments willhave to be made for long periods, possibly well inadvance of any return on the investments. As notedabove, thus far Indian firms have been able to enjoyhigh profits without having to expose themselves tosuch risk. Thus, although most of the established firmshave employed these strategies, the effectiveness withwhich they have deployed these strategies has varied.However, our optimism about the beneficial impactof the Indian software industry on the Indian economyin the long run is not based entirely on the quanti-tative importance of the relatively smaller number ofsuccesses among software service exporters. We thinkthat in the shadow of the much more prominent soft-ware services firms, we are finding firms developinga variety of new software products, components andtechnologies. Further, the software service firms areexemplars of organisational forms and practices thatare relatively new to India. A large number of soft-ware firms are de novo start-ups, indicating that thesupply of entrepreneurial talent appears to be forth-coming when the opportunity arises, even in new andtechnology intensive sectors. These software firms arerelatively flat organisations, with young managementteams, informal but professional management styles,and with an emphasis on efficiency, punctuality andother virtues that an export orientation brings. Topmanagers of the leading software firms have beenprofiled in the popular press in India and are viewedfavourably by many Indians, particularly in compari-son to traditional Indian business leaders. Further, thisindustry has pioneered equity stakes and stock optionsfor employees in India, and many of these companiesare star performers on the Indian stock market. Thus,unlike in the past, the fruits of the success of theindustry have been shared far more broadly. The im-plications of the success of this industry, at a time ofslow but far ranging changes in the Indian economy,can be immense and far-reaching.AcknowledgementsWe thank the Alfred P. Sloan Foundation for sup-porting this research. We are grateful to the manypeople in the software industry, both in India and theUnited States, who have given generously of theirtime and expertise. We have benefited from the help
  21. 21. A. Arora et al. / Research Policy 30 (2001) 1267–1287 1287and advice from many colleagues, especially AshokDesai, Naushad Forbes, Raj Reddy and BankimShah, and seminar participants at the NBER, Bostonand SPRU, Sussex. Seema Chawla provided helpfulsuggestions for the research. Zhaoli Rong, HairongHe and Jason Wang provided competent researchassistance. To preserve confidentiality, firms andrespondents have not been identified. We welcomecomments and suggestions.ReferencesArora, A., Asundi, J., 1999. Quality certification and the economicsof contract software development: a study of the Indian softwareservice companies, Heinz School of Engineering and PublicPolicy, Carnegie Mellon University, Pittsburgh, unpublishedmanuscript.Bannerjee, A., Duflo, E., 1998. Reputation effects and the limitsof contracting: a study of the Indian software industry, MIT,Cambridge, MA, unpublished paper.D’Costa, 1998. Technology leapfrogging: software industry inIndia. In: The 2nd International Conference on TechnologyPolicy and Innovation, Calouste Gulbenkian Foundation,Lisbon, 3–5 August 1998.Gopal, A., 1996. An empirical analysis of offshore software deve-lopment: a first look at some explanatory factors, Communi-cations of the ACM, submitted for publication.Heeks, R., 1996. India’s Software Industry: State Policy, Libera-lisation and Industrial Development. Sage Publications, BeverlyHills, CA.ITAA, 1998. Help wanted 1998: a call for collaborative actionfor the new millennium, Report published by InformationTechnology Association of America and Virginia Polytechnicand State University, March, Washington, DC.Nidumolu, S.R., Goodman, S.E., 1993. Computing in India: anAsian elephant learning to dance, in Communications of theACM, 36(4).Royce, W.W., 1970. Managing the development of large softwaresystems: concepts and techniques, 1970 WESCON technicalpapers, Vol. 14, p. 723.Schware, R., 1992. Software industry entry strategies fordeveloping countries: a “walking on two legs” proposition,World Development, Vol. 20, No. 2. Pergamon Press, Oxford,pp. 143–164.Wipro Launches University Degree Verification in The EconomicTimes, Hyderabad Edition, 30 June 1999.Udell, J., 1993. India’s Software Edge, Byte, pp. 55–60.

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