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Software update: R&D services - Views on News from Equitymaster

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Software update: R&D services

Aug 21, 2007

Among the most technology intensive and value added services that Indian IT companies provide to their global clients, the R&D services tops the list. This service, which involves outsourcing R&D requirements of global corporations in spaces like engineering, automobiles, telecom and aviation, is though a high-risk game. This is because, in times of a downturn or a slowdown in technology spending, R&D initiatives are the first to take a cut. This was witnessed in the early part of this decade, when IT companies providing R&D services lost business as clients cut down on their research initiatives following the technology and telecom bubble burst. In this article, we take a brief look at the history of technology R&D services and its prospects going forward. This is a part of the series of articles that we have been doing explaining the different verticals where Indian IT companies operate. We have already reviewed industries like BFSI and telecom, manufacturing and retail, and healthcare and transportation.

Brief profile
The R&D services story started when Texas Instruments (TI) established its development centre in Bangalore in November 1985. At that time, Wipro and HCL started working on R&D projects for TI. Today, there are many small players apart from Wipro, HCL, Sasken and MindTree who work in this space. R&D services outsourced to India include product development, embedded technology and chip design services. Earlier, R&D used to command a premium in billing rates and pressure on rate cuts was negligible. However, post the downturn in the early part of this decade, things have changed for the sector. In fact, companies like MindTree have reported slower growth in the R&D vertical than IT services mainly due to lumpiness attached to this segment.

The Indian scenario
Barring Wipro and HCL Tech, none of the Indian players have end-to-end offerings in R&D space. Other companies like Sasken and MindTree are domain experts in a particular vertical. While Sasken specialises in telecom, MindTree has an edge in Internet technology IP creation. The industry has also seen consolidation in its client base. Of late, many MNCs have started setting up offshore product development centres in India. Several Indian companies perceive this trend as an opportunity in disguise because the activity of MNC captive centres contributes towards positioning India as a technology R&D hub.

Inherent risk with R&D
After the bloodbath in the global telecom space in 2002-03, a lot of Indian biggies saw their outsourcing opportunities evaporate. Telecom was the most lucrative source of revenue for most R&D players. Large companies used to outsource heavily till the slump after which they scaled down projects. This is perhaps the biggest risk attached with R&D. In the event of a downturn or slowdown in tech spending, this is the first segment to get hit. This is because companies, in a bid to control costs, cut down on their R&D spending while continuing with their existing services.

The opportunity
Indian R&D services and software product exports, though at a growing stage, are expected to grow rapidly (forecasts are for Indian technology R&D exports to touch US$ 11 bn by FY10 - Source: NASSCOM). The key opportunity areas within R&D services and software products include embedded software and systems and offshore product development. A number of large multinational corporations source a part of their embedded system requirements from India either through captive design centres or through vendors. Some of these companies include Samsung, Texas Instruments, Delphi, Motorola and Intel.

We believe that the opportunity for Indian IT companies is pretty large as far as tech R&D offshoring is concerned. Established players are also likely to benefit on account of high entry barriers in this space. On a broader scale, while IP creation is expected to grow at a much faster pace to benefit companies like MindTree, rise in telecom spending across the globe will benefit companies like Wipro and Sasken in the long run.

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