Scrambling Up The Development Ladder
By leveraging software wizardry and low-cost talent, India is eyeing the next level: Tech innovation

Congenia, a two-year-old Italian drug company, can't match the cash of Big Pharma. So when it needed help in developing medicines to combat the diseases of aging, it turned to an unlikely source -- India. Congenia in June tapped Tata Consultancy Services Ltd. for drug-discovery software and a team of programmers and life scientists in Hyderabad. The software, Bio-Suite, simulates the interactions of molecules with proteins, whittling down the universe of potential drug candidates from millions to thousands in about half the normal time. That also halves research costs.

With so much riding on its ability to discover new drugs, why would Congenia rely heavily on a company like TCS, which is mainly known as a low-cost supplier of computer services? Congenia Chief Executive Paolo Fundaro acknowledges he is taking a risk, but he's confident of TCS' skills. "There's no reason Indian companies shouldn't be on the front edge of tech in every field," he says.

This is a message Indian companies like TCS hope will spread far and wide. Over the past five years they've burst onto the world scene in software development, tech support, generic drugs, and back-office services. These businesses are nothing to sniff at. But in many cases they simply involve following orders from overseas clients or reverse-engineering.

Now, India is gearing up to reach the next level -- technology innovation. By leveraging their software wizardry and cheap engineering and software talent, Indian companies are starting to develop their own products. Software companies such as i-flex Solutions Ltd., with its banking programs, are selling globally. "We have to build products that can be sold again and again, like Microsoft does. We have to continually go up the value chain," says Chairman Rajesh Hukku. On Aug. 2, in an affirmation of Indian software, U.S. software giant Oracle Corp. (ORCL ) said it will pay $900 million for a controlling interest in i-flex -- but leave the current executives in charge.

Hukku isn't alone. Pharmaceutical companies such as Nicholas Piramal India, Ranbaxy Laboratories, and Biocon are making strides in drug discovery and patenting their own compounds. This creative ferment could push Indian pharma output from $5 billion last year to $25 billion by 2010, predicts consultant McKinsey & Co. And a Nasscom/KPMG study predicts that Indian IT industry revenues -- which swelled 32% last year, to $22 billion -- could reach $148 billion by 2012. Industry leaders figure they have the chance to design and even make advanced products of all kinds. "The big opportunity for India is when it all comes together in manufacturing," says Ravi Gopinath, TCS' vice-president for engineering and industrial services. The Indians, in fact, hope to change the global game in industries from vehicles and machine tools to medical systems.

India, a manufacturing powerhouse? Still sounds off. Last year, India exported $1.7 billion in electronics goods. That could reach $12.5 billion in 2010, projects Evalueserve Inc.

But India would still be a manufacturing minnow compared with China, which expects to export $175 billion worth of electronics this year. Besides, highways, ports, air terminals, and other infrastructure aren't yet adequate to support an export boom.

Yet India produces hundreds of thousands of industrial and software engineers yearly. And as more functions for cars, consumer electronics, and complex tools are packed onto semiconductors, the need for embedded software -- an Indian expertise -- is expanding fast. "That means India is well positioned to be a development hub in all kinds of industries," says A. T. Kearney high-tech consultant John Ciacchella.

STILL GROWING UP 
Internet connections and advances in interactive design software, meanwhile, make it increasingly possible to design, test, and reassemble industrial prototypes of highly complex products on computers. Using 3-D computer simulations of a virtual prototype, mechanical engineers and fluid dynamics specialists at Onward Technologies Ltd. in Pune are helping to design virtually every piece of a three-cylinder tractor engine due out in 2007 from a major farm-equipment company. Says Onward Chairman Harish S. Mehta: "This industry is in its infancy, but in two years you will see this really take off." Indian product engineering revenues rose 30%, to $2.7 billion, last year.

A handful of Indian outfits are rapidly moving along the path to hardware innovation. Wipro (WIT), Ittiam, HCL Technologies, and others are bringing together chips, circuit boards, embedded software, and industrial design -- the whole stack of skills and technology needed to create a finished product. That can shave months and even years off product development, a godsend for Western companies under great pressure to cut costs.

India's industrial engineering firms are also moving beyond limited contract jobs for clients like Ford (F), General Electric (GE), and Airbus and starting to cook up original prototypes for everything from machine tools to power generators. Bangalore's HCL designed a backup navigation system for the Airbus A340 and A320 jetliners in just 18 months. HCL clients often provide a mere two- or three-sentence description of the desired product and price target, and Indian engineers do the rest. "India will be very important for the world in hardware product development," predicts HCL Chief Executive Shiv Nadar.

The model for some Indian design houses is Taiwan. Big Taiwanese electronics companies like Quanta, Compal, and BenQ design and manufacture notebook PCs, cell phones, digital cameras, and other electronics for such brands as Dell (DELL), Hewlett-Packard (HPQ), and Apple (AAPL). Instead of mass-produced consumer items, though, India's niche could be industrial goods involving smaller production runs but high engineering content.

The breadth of research and development at TCS evinces the new vision for Indian tech prowess. Working from digital prototypes, its 850-engineer center in Bangalore is helping a U.S. auto maker design the drive train, outer body, and interior layout of a future passenger car. For a leading U.S. developer of orthopedic implants, TCS engineers analyze CAT scans and custom-design replacement hips, knees, and wrist bones to fit patients awaiting surgery in American hospitals. For other U.S. clients, TCS has helped develop a forklift, a small earthmover, a golf cart, and high-security locks. For the Indian air force, it has even designed a test jet. Over the next half-decade, TCS plans to create a hybrid business model with 40% of revenues coming from licensing its technology and selling its own products, such as BioSuite.

SMATTERING OF STARTUPS 
The Indians are starting to come up with original consumer electronics designs, too. Ittiam Systems Ltd. of Bangalore specializes in integrating multimedia into low-cost devices. It licenses core designs to makers of in-flight entertainment systems, digital cameras, and video cell phones. Ittiam is preparing to release designs for portable iPod-like devices to play video downloaded from the Web.

A smattering of startups have taken the next step. They're both designing and selling their own cutting-edge hardware. Four-year-old Tejas Networks India Ltd., for instance, has become one of the leading sellers of optical networking gear in the rapidly growing Indian market. It has also begun selling its machines globally through Western networking suppliers. "The vision is to become one of the next Ciscos (CSCO) or Nortels (NT) of the world," says Chief Executive Sanjay Nayak.

What could delay India as it strives to innovate and build its own global brands? "It's a capital-starved country," says Sanjay Anandaram, a partner in JumpStartUp Fund Advisors Ltd., a Bangalore venture-capital firm. Startups with one foot in Silicon Valley have the edge. HelloSoft, a leading supplier of signal-processing technology for voice-over-Internet communications, raised $16 million from U.S. VCs on June 30. It was started by Indian entrepreneurs but its headquarters are in San Jose, Calif.

Indian startups don't have such ready access to cash. A recent scene inside the tiny conference room of JumpStartUp, located across from a crumbling Hindu temple, illustrates the problem. Weary from a red-eye flight from overseas, Sanjay Shah, CEO of three-year-old Skelta Software Ltd., a maker of corporate workflow programs, was making a presentation. JumpStartUp's partners, although sympathetic, peppered him with questions about how Skelta would gain credibility in the West and compete with Microsoft. Shah only wants to raise $1.5 million but sounded discouraged after the meeting. "I don't know how many VCs will be interested in funding me, and I don't see that changing fast," he says. "Without venture capital, India won't become powerful globally in software products."

But players like Shah don't need much money to make a difference. Engineering salaries are so low in India -- even now, after rising 5% to 10% per year -- that Skelta can afford to employ 30 engineers even though it only expects $2 million in revenues this year. This gives it an advantage over its main rival, SourceCode Technology Holdings Inc. of Redmond, Wash., which does much of its programming in the U.S.

Where there's hype, there's hope. Oracle's acquisition of i-flex shines a spotlight on India's nascent software products industry. And that could stimulate a flowering of new ideas and companies. "We're convinced that a good portion of the next generation of software companies will be emerging from India," says Oracle President Charles E. Phillips Jr.

I-flex Chairman Hukku urges his comrades to concentrate on developing software products tailored to particular industries.

That won't be the only path to software innovation, however. Trying something brand new is another option. Ramco Systems Ltd., for instance, which stumbled in its attempt to compete against Oracle and other leading corporate software makers, is being reborn with a new business model that could knock some of the established players off balance. Instead of selling packaged applications for accounting and manufacturing, which often don't fit a particular business, it builds software components that can be mixed and matched for a more custom fit. "They have been laboring away quietly," says University of Michigan management professor C.K. Prahalad. "This is going to surprise a lot of people throughout the world."

Indians know it's now or never. The advantages of low costs will last perhaps another 15 years, and competition from the likes of China, Brazil, and Ukraine is intensifying. "We are at a point in this country where if you don't innovate, you just won't exist," says S. Sadagopan, director of the Indian Institute of Information Technology in Bangalore. The Indians don't just want to exist: They want to flourish.

By Steve Hamm, with Pete Engardio in Bangalore