India's Software Industry Reboots

Over the years, Indian IT service companies have established themselves firmly on the global stage. More than two-thirds of Fortune 500 firms turn to them for part of their IT and business process outsourcing needs. Some, such as Tata Consultancy Services (TCS), Infosys Technologies and Wipro Technologies, have become global brands, competing head-to-head with multinational IT service providers.

The software products story, however, is different. To be sure, many global companies, including SAP, Microsoft and Oracle, leverage India for product development either through their subsidiaries or by outsourcing to Indian technology service providers. And a few Indian firms have developed their own products and are commercializing them through the licensing model. But homegrown successes are limited when it comes to full-fledged software product companies – those that develop and own software, and sell it themselves or through partners.

The National Association of Software and Service Companies (Nasscom) estimates that of India’s total software and services revenue of $52 billion in fiscal 2008, the software product segment accounted for a mere $1.4 billion, with the top 10 companies taking in more than 80%.

This could well change in coming years. Software products form the fastest-growing segment of the U.S. $1.3 trillion global IT industry. According to a recent study by Nasscom and Bangalore-based management consulting firm Zinnov Management Consulting, sales of software products are expected to increase from $294 billion at present to $537 billion by 2015. The study estimates that by 2015 the addressable market for Indian software products could be $290 billion to $315 billion.

Som Mittal, president of Nasscom, is bullish about India’s prospects. “We believe that the Indian software product industry is at an inflexion point and has the potential to grow to $9.5 billion to $12 billion by 2015,” he says. Subash Menon, chairman of the Nasscom Product Forum and founder-chairman, managing director and chief executive officer of Subex Ltd., agrees: “Recent market indicators suggest that this segment is undergoing rapid transformation and is approaching a new phase of accelerated growth.”

The optimism is not unfounded. Since 2001, India has produced 371 product start-ups. Two-thirds of these were formed in the last three years, 100 in the last year alone. While most of the early players in the Indian software product space focused primarily on the financial and accounting segments, the newer companies are looking at areas such as business intelligence, security and content.

In the last three years, total venture capital investment in India grew at a compound annual rate of 42%, reaching $543 million in 2007. Funds invested in the software product segment grew slightly faster – by 43% – to $156 million. Says Sudhir Sethi, chairman and managing director of IDG Ventures India: “We are extremely bullish about software product firms from India.”

IDG Ventures India is a $150 million venture fund that has made eight investments in the last 18 months, five of them in the software product space. Soon it will fund another software product firm. “Of our total investment of $50 million until now, $38 million has been in software product firms. We have put our money where our mouth is,” says Sethi. According to S. Sadagopan, director of the International Institute of Information Technology, Bangalore, “It is just a matter of time before software products from India will explode.”

Reasons for Optimism

To understand where the optimism stems from requires a look back in time. India’s software products business dates back to the early 1980s, when companies such as HCL, Softek, Wipro and TCS launched Unix-based compilers and office applications in the domestic market. According to the Nasscom-Zinnov study, from 1985 to 1990, India was home to some 350 software product companies.

These companies faced the inherent challenges of the software product business: gestation periods of three to five years and the need for deep pockets. Lack of a domestic market and a dearth of professionals with relevant experience added to their woes. Over time, some of these companies shut down. Most others morphed into services firms. “This was the time that the services business had started to grow and it was a much easier alternative,” notes Bharat Goenka, cofounder and managing director of Tally Solutions. Goenka was one of the few who stuck it out. Today, Tally is among India’s top 10 software product companies by revenue.

While many of the challenges continue, a confluence of factors including a strong and growing domestic market, disruptions in technology and business models, a growing talent base, a now-well-established “India” brand, and increased venture capital funding is expected to boost the segment in coming years.

Take the domestic market. When it lacked strength, Indian players were compelled to build software products for other markets, such as the United States. Capturing the nuances of customer requirements was tough, and marketing the product was expensive. In recent years, however, a thriving economy has fueled the growth of domestic technology demand. Nasscom estimates that the total domestic IT market (comprising hardware, software, services, business process outsourcing, etc.) has jumped from $8 billion in 2004 to $23.1 billion in 2008. Over the next few years, India is expected to be the world’s fastest-growing IT market, according to the Nasscom-Zinnov study.

The domestic market accounts for $500 million of the Indian software product segment’s $1.4 billion in revenue. The Nasscom-Zinnov study anticipates that, in line with Indian companies’ increased technology spending, revenue from the domestic market will grow to $4 billion to $5 billion by 2015.

Sharad Sharma, co-chair of the Nasscom Product Forum and chief executive officer of Yahoo! R&D India, notes that software products are typically formed in the shadow of early adopters and friendly, sophisticated companies. Until now it had been hard to find these in India. Now the possibility exists in both the corporate and consumer sides. Citing the example of Bharti Airtel, India’s largest mobile services provider, known for its innovative business model, Sharma says: “Close proximity to such companies gives Indian firms a new product-friendly environment to work in.”

Much of the growth in the domestic market, however, will be fueled by demand from the small and medium business (SMB) segment. There are two key reasons for this. First, the Nasscom-Zinnov study estimates, the SMB share of domestic IT spending will increase from 38% at present to 50% by 2015. Second, SMBs’ requirements and buying patterns open a door for domestic providers.

According to Pari Natarajan, chief executive officer of Zinnov, “Multinationals find it easy to sell to large Indian enterprises because their buying patterns are similar to that of large enterprises elsewhere in the world. But SMBs have very different and localized needs. This makes it difficult for multinationals to address them and presents a huge opportunity for Indian players.”

Working closely with Indian SMB customers will also help Indian companies make their products both “enterprise-ready” and suitable for other markets, especially emerging markets, Subex’s Menon says. “The domestic market is a great place to make mistakes and learn, and that too at the lowest cost. It is also a great place for building references.”

Delivery-model Disruptions

Recent disruptions in delivery models as well as advances in technology may also work in favor of Indian software companies. Take Software as a Service (SaaS), for instance. Under this delivery model, the ownership of the deployment, integration and maintenance of the IT infrastructure moves from the customer to the vendor. This shift could make it financially more viable for Indian customers, particularly those in the SMB segment, to opt for software products.

The SaaS model has another advantage. Typically, vendors spend huge amounts on supporting multiple platforms for different customers. With an SaaS model, this money can be spent on driving innovation more quickly.

Zinnov’s Natarajan, meanwhile, is betting on Service Oriented Architecture (SOA). With its loosely coupled architecture and ease of integration, he says, SOA will help Indian companies sell their products globally, even in companies well-penetrated by IT. “SOA allows different vendors to act independently of each other. Large global companies are therefore now willing to look at niche solutions from smaller players.”

Yahoo!’s Sharma is optimistic about cloud computing. He sees it as having the potential to change the software product landscape the way merchant foundries did with chip design in the late 1980s. The emergence of merchant foundries such as Taiwan Semiconductor Manufacturing Company, which manufactured other companies’ chips, separated chip design from the expensive activity of chip manufacturing. This led to a spurt of companies engaged only in chip design, fostering innovation. “To my mind, the same analogy works with cloud computing,” Sharma says. “It is a great leveler for Indian companies.”

An Easing Talent Crunch

The challenge from a talent crunch continues, especially in the area of product management. But a growing pool of professionals with expertise in software products gives cause for cheer even here. An estimated 170,000 product R&D professionals (including 30,000 expatriates with global experience) work with multinationals’ subsidiaries, Indian technology service providers and Indian software product companies.

According to Haragopal Mangipudi, vice president and business head of Finacle, the banking product from Infosys Technologies, “Earlier, when we looked for people for product management, product alliances or product marketing, we could not find people with the relevant experience. While the challenge does remain, it is far easier now.”

Software products being designed and developed from the ground up at multinationals’ subsidiaries in India are expected to produce more experienced people. Since March, Yahoo! India has been launching a fully “made in India” product every month. Symantec’s India center works on a complete ownership model for products including Security 2.0, Information 2.0 and File System Analyzer. Google Map Maker is one of the most recent products from Google India. All of these are global products. Says Vinay Goel, head of products at Google India: “Professionals are now able to get the relevant product experience without having to move outside India.”

This pool of professionals is expected not only to add value to the current players, but also to spawn start-ups – especially with the Indian software service industry no longer providing easy pickings. “The market has changed,” says Zinnov’s Natarajan. “Unless one is in a very niche segment, one can no longer be a small service player from India and survive. It therefore does not make sense for wannabe entrepreneurs to set up services companies.”

This is not to say that every new software product start-up from India will find the going easy. One of the biggest constraints at present is angel funding. In Silicon Valley, angels play a critical role in identifying and supporting a start-up and building it to a size where it catches the interest of venture capitalists.

Natarajan estimates that the United States has 225,000 such angels, among which many support software product start-ups. India, he says, has about 225 angels, of which very few fund software product firms. Sharma of Yahoo! cites this factor as the “weakest link in the chain.”

Investors need to be far more knowledgeable, patient and comfortable with funding product start-ups, adds IDG Ventures’ Sethi. “Given the nature of the software product business, the failures are higher than in the services business. But even failures will have a positive spin-off. The experience that comes from these will add strength to the product ecosystem.”

Reprinted from knowledge@wharton