Themes > Features
IT Trends : Behind the Hype
The dramatic expansion of India's Information technology (IT) sector during the 1990s, albeit from a low base, is widely seen as heralding India's emergence as a global IT and software powerhouse. This 'popular' perception has underlying it a less pervasive but more sophisticated argument. According to that argument, there are certain defining features of the information technology industry which provide a new digital opportunity to countries with the requisite knowledge- and skill-base and with the appropriate policy regime. And as nations like India exploit that digital opportunity, it is expected, that the wide, persisting and even growing technology, productivity and income gaps between the developed and developing countries would shrink, creating a whole new international economic order.
The new optimism generated by the IT 'revolution' stems in part from the rapid proliferation of an almost borderless industry. The two main sources of information on the IT sector in India are IDC (India) and the National Association of Software and Service Companies (NASSCOM). According to IDC (India), the annual rate of growth of IT spending in India was well above 20 per cent in most years during the 1990s, with growth peaking at a remarkable 59 per cent in 1994-95. NASSCOM's figures too reflect a rapid growth of the IT market in India from Rs. 32.3 billion in 1993-94 to Rs. 135.7 billion in 1998-99 (Chart 1). The turnover of the IT industry was, however, much larger than this, given the rapid increase in software exports. Software exports have risen at a remarkable rate, from an estimated $150 million at the beginning of the decade to close to $4 billion in 1999-00. According to NASSCOM, software exports rose by 57 per cent in 1999-00.
The current size of the domestic IT industry can be gleaned by combining figures from IDC and NASSCOM. Domestic IT spending is estimated at Rs. 16,538 crore in 1999-00 by IDC. Add to this NASSCOM's estimate of software exports to the tune of Rs. 17,150 crore in that year, and we are speaking of an industry with a turnover of around Rs. 35,000 crore a year. NASSCOM estimates that the IT industry grew from about Rs. 6345 crore ($2.04 billion) in 1994-95 to Rs.24,781 crore ($6.04 billion) in 1998-99 (Chart 2).
At the core of the industry's expansion worldwide and in India lies the dramatic increase in computing power being delivered at ever-decreasing costs by the emergence and rapid transformation of microprocessor technology. The consequent ability to process and execute a huge number of instructions in imperceptible time spans has had revolutionary implications. First, it has created an industry which produces the hardware and software needed to allow individuals, organisations, small businesses and corporations to directly exploit the benefits of such computing power. Second, it has substantially transformed other industries, which can now use the capacity to store information and execute instructions to automate and change the manner in which they conduct and manage their processes and operations. Information technology is in part revolutionary because it ensures and necessitates the transformation of productive capacity in almost all sectors. Finally, it leads to a dramatic expansion of the size and scope of the services sector (across a wide spectrum including finance, banking, trade, entertainment and education). This results partly from associated technological developments that find new uses for the massive computing power that is cheaply available, partly from the huge market that developments in communications and networking technology create, and partly from the fact that the increasingly ubiquitous PC becomes the vehicle to deliver a range of services, besides being a device in its own right. The microprocessor is not just the core of the IT revolution, but stands at the centre of the convergence of the information, communication and entertainment sectors.
But it is not just this remarkable and wide-ranging expansion of the information technology sector that generates the new optimism with regard to the prospects for developing countries within the current world order. That optimism also stems from the understanding that, unlike the 'routinised' technologies which dominated development during the immediate post-World War II years, the new 'entrepreneurial' technologies driving the IT sector are seen as being characterised by a knowledge-base for innovation, which is more rapidly transmitted across the globe, and levels of investment that are much lower and often easily afforded by even private investors in developing countries. This facilitates entry by small players from developing countries into a rapidly expanding segment of the global economy. Further, since much of IT production from assembly to software generation is skilled-labour intensive, the availability of cheap skilled labour in countries like India is seen as giving them a decisive edge in the international competitive battle in this sector.
Routinised technologies, such as those characteristic of the 'older' steel and chemical industries, were embodied in large continuous process plants requiring 'lumpy' investments in innovation, commercialisation, capacity creation and market acquisition. This made access to a critical size of capital crucial for entry, queering the pitch for the big players from the developed industrial countries. Moreover, dramatic innovations in these sectors were few and far between, with much technological development consisting of marginal changes that were cumulatively, rather than instantaneously , significant. These marginal changes were, in turn, very often stimulated by knowledge gained in the act of production, which led up to expensive R&D exercises that created new commercially-usable knowledge. Thus not only were these industries dominated by big firms created with lumpy investments, but much of the technological change that occurred in the industry originated within or as a result of the activitiy of these big firms themselves. Entry into the industry by new, especially small new, players was rare. Competition was restricted to that between the dominant oligopolistic firms straddling domestic and world markets. To the extent that technological change could trigger a competitive challenge from outside the industry, this was largely the result of the emergence of substitute products or wholly new industries that rendered the older industries less significant or even irrelevant.
As compared with this the IT sector is seen as characterised by low costs of entry and an easily accessed and almost universally available knowledge-base for innovation. What is of special significance is that the sources of this knowledge in a significant segment of the hardware and almost all of the software segments of the industry are conventional routes such as journals, conferences, seminars and publicly or privately financed training programmes. This makes it easy for wholly new entrants to acquire the knowledge base required for cutting edge technological contributions to the industry, as was and is true of at least some of the myriad start-ups in Silicon Valley. It is also true, that the production of a range of products varying from components like printed circuit boards to peripherals like modems, on the one hand, and the assembly of personal computers, on the other, do not require large investments for entry. These, unlike other IT products, are heterogenous products that can be put together on the basis of a combination of internally produced and externally sourced intermediates and components. The real 'technology' here is a system architecture that maximises the benefit derived from an appropriate combination of sub-systems, components and peripherals. That is, the heterogenous nature of the product allows a producer to restrict his own production activity to a sub-set of the total elements that enter the product and/or just the design and assembly of the final product. This requires that the technology in the sense of the knowledge for system design is freely available and is easily appropriated. But once such technology is available, the investment required for entry can be kept to the minimum, with labour intensive assembly often involving negligible investment in capital equipment. This allows for the emergence of international brands from the developing world, as is true of Acer from Taiwan.
The logic of easy entry is even more true of the software sector, which is skilled-labour intensive and requires little by way of capital investment. Not surprisingly, over the years the software segment of the IT sector has come to dominate the industry in India. As Chart 3, which details the structure of the Indian IT industry in 1999-00 shows, software production accounts for two-thirds of the turnover of the industry. However, with software exports accounting for 45 per cent of the turnover, it should be clear that hardware sales marginally dominate the domestic market. But with software exports growing at a much faster rate (57 per cent in 1999-00) than domestic IT expenditure (30 per cent), it should be obvious that the industry would soon be almost overwhelmed by software production. And, software is the segment where the advantages of easy technology access and low entry-level investments are most prevalent.
As mentioned earlier, in the past, these special characteristics of the IT sector, which substantially reduce technological and financial barriers to entry by small players, were seen as underlying the success of small Silicon Valley start-ups. Those start-ups not only challenged traditional giants like IBM, but have since grown to become major players in their own right and have changed the structure of the industry. The growth of the IT industry in India and elsewhere in the developing world and India's success as a software exporter, seem to suggest that these characteristics hold for firms in developing countries as well. Not surprisingly, it is now being argued that what was true for the Silicon Valley start-ups in terms of their ability to break through barriers to entry should be true for the developing countries. It is this perception that underlies the optimism that information technology heralds a new era of reduced international inequality.
It should be obvious that this argument cannot be extended beyond a point, especially in the hardware sector. The core of the computing business is dominated by a capital-intensive and oligpolised product like the microprocessor, the market for which is dominated by a few producers like Intel, Motorola and AMD. And the technologies driving a range of peripherals like printers and networking products, for example, are proprietory and are not replicated without a licence. Further, while capital investment requirements for production may be small, production for geographically and quantitatively large national and world markets require high sunk costs. This takes the form of initial expenditures on marketing, retailing and the creation of an after-sales service network. Deep pockets and/or access to large sums of capital are therefore a prerequisite for entry into this segment of the hardware sector.
This has resulted in an unusual situation in the PC market in countries like India, where there are a few international brand names like IBM, Compaq, Dell, and HP, selling at a premium, while there are a number of cheaper and exclusively national and local brands. It needs to be noted that, barring a few exceptions like Acer and Samsung, most international brands originate in the developed countries. These branded products service a premium market which is willing to pay a price for the reliability of branded products and for the assurance of quality after-sales service that come with them. But as the PC market grows and brings into its fold a large number of small businesses and home users, price becomes an issue among a large share of consumers, creating a separate market segment serviced by small assemblers. In India for example, during the first six months of 1998-99, PC assemblers accounted for a 53 per cent share of units sold in the Indian market and 45 per cent of the value of that market (Chart 4).
However, most of these assemblers were extremely small in terms of the number of unirts produced (Chart 5). This must mean that the margins in this extremely competitive market must be extremely small. On the other hand, as Table 1 shows, the branded products market was dominated by international brands, with only few Indian players like HCL, Zenith, Wipro and Vintron. In fact with liberalisation, many of the larger domestic players like Wipro have become sales agents for international brands like Acer and Apple, rather than producers of PCs themselves.
Needless to say, with imported components accounting for a substantial share of the value of PCs assembled by both the international players and domestic assemblers, the domestic linkage effects of the growth of PC sales could only be limited. Much more employment is likely to be created by the growing demand for maintaining and servicing the installed PC base (estimated at 4.3 million). Further, besides low overheads, one of the advantages enjoyed by domestic assemblers was allegedly their ability to avoid payments of a range of duties, especially customs duties. However, as India's opportunities for software exports have grown, there has been substantial pressure on the government to liberalise imports of computer hardware and reduce import tariffs substantially. With the government having succumbed to this pressure, a part of the competitive advantage of assemblers has been eroded so that we can expect the share of the larger international players to increase substantially. This would be all the more true as the market for 'higher end' products like notebooks and servers increase (Chart 6). In the event, not only would the linkage effects of the growth of the PC market be minimal but whatever value is added domestically would accrue in the hands of large international firms.
These features of the PC market, which would be even more true of the peripherals market, indicate that, in the wake of liberalisation, the emergence of a strong indigenous industry that engages world markets is not likely in the hardware segment. Thus, if the case that India is likely to emerge an IT powerhouse which invades developed country markets and challenges developed-country players is valid at all, it can only be true of the software segment.
However, while the aggregate figures on software exports are indeed remarkable, a closer look indicates that a few players operating at the lower end of the value-chain in software production account for much of these export revenues. The IT sector's software revenue in 1999-00 amounted to Rs. 24,350 crore, of which Rs. 15,890 crore came from the export market. Around 1250 companies were involved in activities that helped garner this export revenue. However, only 37 of them had an export turnover of more than Rs.100 crore. The top 5 exporters (TCS, Wipro, Infosys, Satyam and HCL) alone accounted for 29 per cent of total exports. And the largest exporter, Tata Consultancy Services, garnered revenues of Rs. 1,820 crore from the export of software services. The export sector is dominated by a few players.
What is noteworthy, however, ia that even the big exporters obtained little by way of revenues from frontline software products or higher end consultancy and software generation services. To quote a senior executive from the Indian software sector: India, somewhere down the line, has to make up its mind whether it would be a quality software developer or concentrate on quantity If you look at the typical structure of the IT services provided to any of the global companies on the bottom layer is outsourcing, above it software development, on top of that is technology development and higher up is networking services and, finally, IT consulting. As you move up, you get higher billing rates, higher revenues, higher gross margins and, thereby, high profitability because the complexity of the transaction is higher. According to industry insiders like Naraya Murthy of Infosys, this move up the value chain has hardly occurred and is not India's priority. In a recent interview Murthy said Indian software expertise in customised services had a long way to go in quantity and quality before focusing entirely on other fields. ``Yes, moving up the value chain is a good idea. We are at it ourselves - about Rs. 20 crores, which is just 8 per cent of our total business and not the main,'' he said. There are others, line Vinay Deshpande of NCore who feel that while software services should not be sneered at, the contract should be properly designed. ``If the job is just another cover for body shopping, then there is little technology that accrues to the contractor Except a few, such contracts mainly mean deputing engineers from here. The parent company does not get any fresh infusion of technology in this case. I strongly believe that even in service industries, contracts should be such that there is technological upgradation.'' He feels technology thus acquired could then be leveraged to develop indigenous products for, in the long run, the money is in developing products.
The difficulty is that the move up the value chain may not be a matter of pure choice, but structurally limited. While there have been instances of Indian companies delivering high-end products, like the banking and e-commerce software product, BankAway, from Infosys, the industry generally accepts that much of the exports from India consists of low end outsourcing and IT enabled services. This limited success in terms of the composition of exports may be because there indeed are barriers to entry into higher end software.
Take the case of software products for mass use for example. Creating such a product starts identifying a felt need (say, for a browser once the internet was opened up to the less computer savvy or for a web-publishing programme once the internet went commercial). The persons/firms identifying such a need must work out a strategy of generating the product, by hiring software engineers, at the lowest cost in the shortest possible time. Once out, the effort must be to make the product a proprietary, industry standard. This involves winning a large share of the target consumers, so that the product becomes the industry standard in its area. Once done, the product becomes a revenue generating profit centre. The investment required is the sums involved in setting up the company, in investing in software generation during the gestation period, and in marketing the product once it is out so as to quickly win it a large share of the market. Needless to say, while entry by individuals or small players are not restricted by technology, they could be limited by the lack of seed capital. This is where the venture capitalists enter, betting sums on start-ups which if successful could give them revenues and capital gains that imply enormous returns.
There are, however, two problems here. The first is one of maintaining a monopoly on the idea during the stage when the idea is being translated into a product. The second is that of ensuring that once the product is in the public domain it is not replicated by competitors who win the market before the originator of the idea consolidates. It is here that a feature of 'entrepreneurial technologies' the easy acquisition and widespread prevalence of the knowledge base needed to generate new products - considered an advantage for small new entrants actually proves a disadvantage.
There are two aspects of technology that are crucial in this regard. First, their source. Second, the appropriability of the benefits of a technology. As mentioned earlier, in industries with routinised technologies the source of technology was in significant part the activity of incumbent firms themselves. On the other hand, in the case of entreprenurial technologies the sources were in the public domain. This was where the advantage lay for the small operator. But once a technology is generated based on some expenditure in the form of sunk costs, there must be some way in which the innovator can recoup these costs and earn a profit as incentive to undertake the innovation. In the Schumpeterian world this occurred because of the 'pioneer profits' that the innovator obtained. The lead time required to replicate a technology itself provides the original innovator with a monopoly for a period of time that generates the surplus which warrants innovation.
Most often this alone is not enough to warrant innovation and in the software sector lead times can be extremely low, especially if the competitor invests huge sums in software generation, reducing the lead time substantially. It is for this reason that researchers have defended and invoked the benefits of patents and barriers to entry in production, which allow innovators to stave off competition during the period when sunk costs are being recouped. Unfortunately, neither are the status of patents and copyrights in the software area clear ( as illustrated by the failure of Apple to win propietary rights over icons in user interfaces), nor are their barriers to entry into software production.
This has had two implications. First, the importance of secrecy in the software business. The 'idea' behind the product must be kept secret right through the development stage, if not competitors can begin rival product developments even before the original product is in the market. A feeble attempt to institutionally guarantee such secrecy is the now infamous 'non-disclosure agreements' which prospective employees, financiers and suppliers are called upon to sign by the innovator who is forced to partially or fully reveal his idea. Secondly, even after the product is out, since the threat of replication remains, it is necessary to strive to sustain the monopoly that being a pioneer generates. This requires 'locking in' users with the help of an appropriate user interface which they become accustomed to and are reticent to migrate away from, and locking in producers of supportive software with an appropriate 'applications programming interface'. It should be obvious that sustaining monopoly to recoup sunk costs can indeed be difficult.
Such strategies did help the early start-ups, resulting in the jeans-to-riches stories (Microsoft, Netscape, etc.) with which Silicon Valley abounds. But more recently it has become clear that start-ups undertake innovative activities only to create winning products that the big fish acquire. This is because of the possibility of easy replication and development of an original product, which can be done by dominant firms with deep pockets that allow them to stay in place and spend massively to win dominant market shares. In the event, the likelihood that a small start-up would be able to recoup sunk costs, clear debts and make a reasonable profit is indeed low. Selling out ensures that such sums can indeed be garnered.
Given this feature of the software products market, it is not surprising that small players (such as Netscape and Vermeer Technologies that delivered Frontpage) are mere transient presences in key areas even in the developed countries. To expect developing country producers to fare better is to expect far too much. The latter can merely be software suppliers or outsourcers for the dominant players.
What is disconcerting is that even as outsources India still remains a lower-end supplier of IT-enabled services. This involves not just body-shopping in the form of temporary export of software professionals to undertake specific jobs in large projects designed and executed in the West, but the sale of cheap skilled and not-so-skilled labour services whose output is transmitted via modern commucation technologies to sites where those services are required. That is, there are a whole host of services that can now be provided without having to move the person supplying the service to the point where the service is being delivered. Typical examples are a range of backoffice services and medical transcription.
The possibility of such service delivery has helped India circumvent the obstacle to service exports created by immigration laws in the developed countries. That is, a large part of software exports is not very different from the exports of nursing, carpentry, masonry and other such services, except for the fact that unlike those exports, the presence of the service provider at the point of sale is not required in the case of IT enabled servcies.
Seen in this light, conceptually, India's software thrust of the 1990s is not as spectacular as it appears. It is substantially a technology-aided expansion of the of the waves of migration by services providers of different descriptions: doctors, nurses, and blue-collared workers of various kinds. An expansion of that kind cannot be the basis for the redressal of international inequality that it is made out to be. But that is not all. Even in quantitative terms this development is not spectacular. The 'net foreign exchange revenue' to the country from migration of the old kind, captured by the volume of remittances into India, is in the range of $10-12 billion. The gross foreign exchange revenue from software exports is just $4 billion. The real question is, whether India can continue to exploit the possibilities of arbitrage generated by differences in software and IT-enable service costs between onsite sources and offshore centres, so as to more than triple its current gross revenues. That possibility is threatened not merely by the emergence of alternative offshore centres, but also by a reduction in the onsite-offshore cost differential. It is for this reason that industry-insiders keep emphaising the importance of moving up the value chain in software production. But that movement is possible as structurally constrained as the effort at increasing sophisticated manufactured exports from the developing to the developed world was.
© MACROSCAN 2000