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R&D Outsourcing: A road less traveled - Views on News from Equitymaster
 
 
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  • Dec 15, 2001

    R&D Outsourcing: A road less traveled

    “There are five types of companies; those who make things happen; those who think they make thing happen; those who watch things happen; those who wonder what happened; and those that did not know that anything had happened”. It does not take much of a thought to predict what kind of companies will survive in the future. The companies that create market for themselves will emerge as the winners, i.e. the ones that make things happen.

    Not so long ago business requirements set the pace for technology development. But as the wheel turns a full circle, today it is technological innovations that are creating new business models and setting the pace for business. Thus, the onus has shifted from business houses to the technology companies. The call is for the technology companies to create new technologies that open up a world of possibilities and answering to the call is the only way a technology company can hope stay ahead in the race. Consequently, the spending on R&D on computers and electronics products in the US has grown at a CAGR of 2.8% between 1997 and 1999.

    R&D expenditure on computing and communications
    (US$ m) 1997 1998 1999 CAGR
    Computers and peripheral equipment 7,718 8,276 4,126 -26.9%
    Communications equipment 2,751 8,456 5,797 45.2%
    Semiconductor and other electronic components 14,033 9,072 10,624 -13.0%
    Source: National Science Foundation

    Technology companies like IBM, Lucent, Nortel and Cisco are pouring billions of dollars into research & development to realize these goals. However, increasingly shortages of time, skill sets, people and capital are increasingly driving these organisations to outsource R&D. By outsourcing R&D, companies can save themselves from the cost and effort of long and expensive learning cycles during the introduction of new technologies. Also, many of the vendors to which these companies outsource their R&D activities have a fixed price model. This gives the company a tight control over costs and the down side is limited.

    Insuring future growth…
    Company R&D spend as
    % of revenues
    R&D spend
    (US$ m)
    Year end
    Cisco Systems 17.6% 3,922 Jul 2001
    Lucent 16.5% 3,520 Sep 2001
    Nortel 13.2% 4,005 Dec 2000
    Intel 11.6% 3,897 Dec 2000
    Nokia 8.5% 2,298 Dec 2000
    Alcatel 9.0% 2,514 Dec 2000
    IBM 5.8% 5,151 Dec 2000

    The technology that is being developed has a certain amount of software content. The software component has increasingly increased over the years. For example, IDC estimates the spending on software component in communications to increase from 7% in FY00 to 9% in FY04.

    These two factors combined have opened up a significant market for the Indian software companies since the Indian software sector offers the best value proposition. These companies offer offshore development services in this space at almost half the cost. This is due the fact that talent is available at a very low cost to the Indian companies as compared to their western counter parts.

    Consequently, many of the top rung organisations have a strong focus on the R&D space. Infact the Indian software sector is clearly divided into two groups based on the focus of the companies. The first set is more inclined towards enterprise solutions or providing solutions to businesses and the second group is technology oriented. The first group comprises of organisation like Infosys and Satyam. The companies with technology focus are Wipro, HCL Tech and Hughes. However, both the groups have interests in the activities of the other group in an effort to diversify business risk.

    For technology solution providers the pluses are that there is a certain amount of immunity from the economic environment as they derive their revenues from the R&D budgets of their clients. These companies have higher billing rates due to the complexity of work involved and the barriers to entry are high. On the other hand, enterprise solution companies have a wider market to address and thus client risk is diversified. However, IT spend of their clients is the first area to take a hit in case of a tough market environment. These companies have to face tremendous competition due to low entry barriers in the segment. Hence, there is severe pricing pressure.

    According to industry estimates, about 15% of the software exports from India are towards R&D services. Considering the export market size of US$ 6 bn in FY01, the market for R&D activities could be put at US$ 1 bn (Rs 48 bn).

    The R&D outsourcing opportunity for the Indian software companies lies mainly in the areas of telecommunications software and embedded systems. Increasingly, the networks are relying on software for switching and bandwidth management. Presently organisations use separate networks for voice phone calls, emails and data exchange. It is just a question of time before all of these will be available on a single network. The voice over Internet protocol (VoIP) that allows voice to be transported over the Internet and thereby eliminates the needs for the POTS (Plain Old Telephone Networks). Companies like Hughes Software have created protocols for convergent networks of the future that can handle all kind of traffics.

    The world in the future will be a networked one. All electronic devices will be able to communicate with each other and thus, make life a lot more convenient. Chips embedded into these devices will be able to communicate using a Wireless Ethernet or Bluetooth technology. These embedded microprocessors will also have some memory capabilities that will allow the electronic devices to be programmed. This has created a demand for services in areas including chip design, and system-on-chip solutions. Companies like Wipro and HCL Technologies are tapping this market.

    Company Revenues of R&D
    services (Rs m)
    % of total revenues
    in FY01
    Growth in
    FY01
    Wipro* 8,845 50% 128.3%
    HCL Technologies 6,323 45% 101.0%

    Total revenues considered for Wipro Technologies

    At one end Wipro has the distinction of being the second company in the world that has all its Bluetooth offerings qualified by a Bluetooth qualification body (BQB). On the other hand, HCL Tech is working on a product that will allow fleet operators and fleet managers to view important in-vehicle data including speed and pressure. This will help them to generate real time reports of their fleet, to find out what is the position and status of each of their vehicles. This is possible through wireless vehicle data collection subsystem (DCS) (embedded chips), which is running on a real-time-OS and has a communication gateway that allows it to transmit as required.

    These are just a few examples of Indian software companies working on R&D projects that have been out sourced. The list of offerings and opportunities is vast and is beyond the scope of this short feature.

    The software boom started with organisations outsourcing low-end work to Indian companies to avail the advantage of cheap labour. And this continues to be a very rude reality of the Indian dream to a great extent. However, some companies have chosen to be different and have taken on the challenge of working in the area of technology development. They have chosen to travel on the road less taken. And this could be the key to their success over others. Pioneers like Wipro and HCL Technologies have just begun on the quest that would justify the software industry being called the knowledge-based industry.

     

     

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