Understanding India : Technology, Innovation and Capital

September 2005


India is currently generating a great deal of interest among information technology and investment circles.  The following brief summary provides a realistic assessment of the state of innovation, entrepreneurship and capital in India today.  I propose to turn this into a fuller briefing paper during early 2006:

(-) Venture capital is a relatively new phenomenon and broad cultural awareness of it is low.
(-) Several US VCs are developing a small presence on the ground in India in order to support their US portfolio companies, whom they feel must have an India strategy. To date, few invested actively in Indian start-ups.  New Enterprise Associates, Battery and Nokia are getting active in 2005.
(+) The amount of funding available will grow rapidly from a small base.  Westbridge has just closed a $200 million India fund.  Softbank has earmarked $100 million for India.  Total raised by US VC firms for India is expected to reach $1 billion this year.
(+) India is experiencing rapid growth in mobile phone penetration, PC penetration, internet usage and broadband, again from a small base.  Mobile penetration currently stands at 4%, but will quickly represent one of the largest groups of mobile users in the world.  
(+) Consumption of goods and services is rising rapidly.  Large numbers of wealthy urbanites are acquiring habits of conspicuous consumption.  A growing rural middle class is further boosting the consumer market.
(+) Deregulation across industries from telecommunications to insurance, to low cost airlines is causing growing domestic competition, which is rapidly increasing quality and innovation in Indian products and services.  Products and services designed specifically for developing world conditions (such as low cost PCs) may find unexpected markets abroad.
(+) IT outsourcing and BPO continues to grow despite Western concerns about job displacement.  The revenue of the Indian IT industry crossed $17 billion in 2004-05.   Indian firms are supplying services in a growing number of fields, and moving up the value chain from coding to project management and R&D.
(+) Demand for manufacturing and design services is emerging.  Indian firms or employees are designing mobile phones for LG, semiconductors for Intel,  MP3 players and flat panel TVs.  India is being positioned as a higher quality higher cost manufacturing and design centre than China.  
(+) Many Indian manufacturers are OEMing for foreign brands today.  However, technology transfer and a growing entrepreneurial culture is likely to lead to more Indian product companies in future.
(+) Contract R&D is growing. and western companies are building large R&D centres in India.  R&D outsourcing will grow from $1.3 billion in 2003 to cross $8 billion by 2010.  This is likely to create a spin-off economy of suppliers and start-ups in years to come.
(+) India continues to churn out increasing numbers of well qualified engineers and scientists from an education system of variable quality - the top institutes are excellent.  The supply of qualified labour will be boosted by India's demographics, which are skewed heavily towards the young.  The average age of the working population in India is 27 years.
(-) However, there is a shortage of suitable talent being created in certain regions such as Bangalore, where salaries for the best engineers are already approaching US levels. 
(-) While the education system is good, the quality and quantity of research conducted at universities is relatively poor.  IITs are the exception, with good research and increasing commercial funding. Innovation is more likely to be driven by the eco-system of corporate research labs than by the university system. 
(+) The opening up of India's economy has continued at a steady pace and in a constant direction through several changes of government.  This is strong source of reassurance for foreign investors.  Prime minister Manmohan Singh: "We accept the logic of globalization. We recognize that globalization offers us enormous opportunities in the race to leapfrog in the development processes"
(+) India is a complex but highly functional democracy, unlike China.  This means that India's progress must always combine economic growth with social development, taking the needs of the broad population into account (including those who are 'non-participants' in the mainstream consumer economy).  India's economic growth may be slower and initially less appealing to Western companies than that of China, but will ultimately be more resilient and politically stable.
(-) Traditional barriers, red tape and permits required to set up and operate small companies are still onerous.  Labour flexibility is low.  The government is taking heed and is reducing the burden, especially in special economic zones, industrial development areas etc.
(-) Government continues to play a very large part in the domestic economy.  For example, Indian Railways, Air India, Indian Airlines, the Oil and Natural Gas Corporation (ONGC) and Indian Oil are all state owned.  The pace of disinvestment (privatisation) has slowed under the current coalition government. 
(-) Corruption pervades every level of government, especially procurement (something that is played down when India is talked about in the West).  India ranks equal 90th with Russia in Transparency International’s 2004 index  (compared to Japan 24, China 71,  South Korea 47).  Corruption stacks the system against new players with fewer connections or cash.
(+) The government is taking steps to spur specific industries.  For example, the 2004 biotechnology policy opened up special economic zones for biotech parks and research centres.  India is actively looking at ways of reducing hydrocarbon dependence.  This month (Sep 2005) the ministry of information technology has allocated money to enhance microchip fabrication capabilities, as well as to spur innovation in microwave engineering, electro-magnetic technology, electro-magnetic interference and RF communications, microelectronics and nanotechnology development .  These initiatives comprise public-private partnerships with IIS Bangalore, IIT Mumbai and other educational institutes.
(-) There is not a well-developed IPO market within India.  Investors are often required to set up complex multi-national structures in order to facilitate future listings in Hong Kong, London or NASDAQ,  Founders circuit around infrastructural impediments by setting up Indian companies in Singapore, Mauritius, the Cayman Islands or in the US, where investors feel safer investing.
(+) Trade sales of venture backed Indian companies are becoming increasingly common.  Larger Indian companies are gaining better access to capital due to increased investment in the stock market.  These large companies are expanding through acquisitions both in India and abroad.  India may soon be an important exit market for US start-ups.
(-) Traditionally, there has not been a strong culture of risk-taking and entrepreneurship among the educated middle class within India.  Government or large corporate jobs allowed people to overcome infrastructure impediments by providing housing, transportation, schools, employment security and other perks.  Stable corporate jobs have traditionally been seen as the best careers.  This culture will take time to change.  Entrepreneurship is more clearly present among the non-urban middle class.  Certain communities (e.g. Gujaratis) have a stronger propensity to start their own businesses.
(+) The level of original R&D investment is still low (0.8% of GDP, compared to China's 1.4%).  There are fewer Indian companies based on original R&D - most succesful firms so far have been in the service sector - IT outsourcing, consulting, BPO
(+) Increasing foreign investment in software development, R&D, manufacturing and design is resulting in a technology transfer that is likely to lead to world class local businesses being created within India.  Outsourcers are already moving up the value chain

In summary, what is lacking for VCs at present is stronger homegrown R&D, a more entrepreneurial / risk-taking culture, reduced government dominance of the domestic economy, and transparency in government procurement.  There is widespread awareness of the need to invest in physical infrastructure, and this is something that is now being addressed.  

Jay Marathe

Digital Convergence


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