Indian Software Industry Moving Up The Value Chain?

Jaydeep Chakraborty
Chitrita Bhattacharya
Xavier Institute of Management
Bhubaneswar-751 013

Executive Summary

Indian software companies have been in the business of application development and maintenance for global clients for a decade now.  This model of doing business has been a high revenue generator so far bringing a high return on investment (ROI). However, in this age of competition, price undercutting and rise in salaries, this model may not yield the desired returns for long. Figures prove that had market forces been solely allowed to influence the revenues of Indian software companies, they would have been in the red since 2003-04. The depreciation of the Indian Rupee and the infrastructure facilities provided by the Government at a low cost have so far minimized the effects of these market factors. Therefore, it is imperative that Indian software companies look at the higher end of the value chain to sustain themselves and improve their profitability.

There are two broad ways Indian software companies can move up the value chain consulting and product development.

Indian companies have built up substantial domain knowledge through application development and maintenance to get into the business of consulting. However, as a first step, they need to metamorphosise their image of low cost back-office service providers to product developers and domain consultants.

Product development, on the other hand, is a high risk business. This is because the product might fail in the market thereby sinking the entire investment made on it. However, the pros far outweigh the cons. By not getting into the business of product development, Indian companies are likely to miss the exponential revenue growth associated with successful products.

The major areas where Indian software companies can make their mark are

    o E business
    o Open source software
    o Domain specific proprietary software.

Many Indian companies are already trying to scale up the value chain. Companies like I-Flex, Wipro and Infosys generate some part of their revenue through product development and consulting. Many smaller companies are also joining the bandwagon. This augurs well for the future of Indian software.

Our paper explores these possibilities with respect to changes in existent business and revenue models and suggests possible measures that can be adopted to derive greater benefits by scaling the IT value chain.

The scenario so far

Over the past decade, Indian software companies have been providing offshore development worldwide. This was a feasible business model given the business environment then. However, business today is more competitive. Software companies are faced with rising costs and huge billing pressures for their traditional businesses. It is therefore time to take the next step and move up the value chain. This would require a right mix of infrastructure, operations and business intelligence. The perception of India being just a low costs solution provider needs to be upgraded to a perception of better value.

Moving up the value chain is also imperative now as India now faces competition from countries like China, Russia and Poland.  India is also losing its cost advantage its USP for a long time due to rise in wage rates in the software industry. To understand the reasons for the high wage arbitrage, the key lies in analyzing the following forces acting on the wage rate arbitrage.

    o Price undercutting by competitors.
    o Shift towards offshore development due to an increased understanding of the cost structures of Indian companies among its customers.
    o The low barriers to entry in this industry means increased competition from companies in India and abroad.
    o Increase in wage rates in the industry and also the issues involved with the retention of talent by companies.

The advantages of low cost would perhaps last for another fifteen years. After that, we cannot survive unless we innovate. Therefore, increasing competition and increase in billing rates are the factors that will eventually force the Indian software companies to move up the value chain.

A look at the following data on revenue productivity depicts the urgency required on the part of the Indian software companies to move along the value chain.

A comparison of Revenue Productivity (Figures in $)

                                                    FY01          FY02              FY03         FY04

Revenue Productivity per employee     57002         59852            62845      65987

Employee Cost                                28285          35356           44195      55243

Other Cost                                     13953          14790           15677       16618

Profit                                             14765          9706            2973        (-)5874

Source India Infoline

Here, we see that left to the market forces completely; the Indian software companies should have made losses from FY 2003-04 onwards. One of the reasons it has not happened is the depreciatiation of the rupee. Another reason is that many Indian software companies, particularly the tier I companies have successfully lobbied with the government to provide them with huge infrastructure facilities at rates substantially lower than the market rates.

Therefore, we conclude that Indian software companies can maintain profitability by either going up or by going down the value chain. Moving down the value chain might appear attractive in the short run as it means shifting the projects to offshore from a mix of offshore- onsite model. This means the expenses will be in rupees while the income will be in dollars. However, the major flaw of this argument is that the customers of the companies do not reduce their billing rates so that the companies continue to enjoy huge margins. This is an impossibility as we can see from the current situation.   Therefore, the only logical way to keep up profitability is to move up the value chain. 

Product development is a high risk - high gain proposition. On the positive side, if a company is successful in developing a hit product it can experience an exponential growth in revenue and profits. On the flip side, there are chances of the product failing in the market. There is also a chance that the product is marginalized by a superior product of the competitors having same attributes, providing same benefits and similar value proposition. Most Indian software companies stayed away from product development to earn handsome margins on relatively lower investments thereby reducing risks.   

Strengths that Indian software industry can leverage

India produces thousands of software engineers yearly. This huge pool of manpower is well versed with English - the language of international communication. As companies worldwide pack in more functions of cars, consumer electronics etc into the chip, the need for embedded software is increasing. This is clearly one of India's core strengths.

Through Application Development and maintenance (ADM) Indian companies are acquiring domain knowledge. To beat the competition, the companies today are providing high - end services like package implementation, IT consulting and systems integration. The industry is moving towards more domain intensive solutions. This is in line with the Indian software industry's movement up the value chain. The industry needs to build on this and move to the next higher level.

A typical high end IT project in India consists of three stakeholders the Indian software company, the client whose expertise is normally not technology (e.g. banks) and a consultant hired by the client. This consultant (normally a company with expertise in the domain of the business of the client and also in technology) advises the clients on the technology to adopt, the software package to implement, the customizations required to suit the requirements of the client business etc. In short, the consultant acts as the project manger for the client. Indian software companies are trying to move into this area by leveraging on the domain expertise they have gathered over the years.  However, Indian software companies are still not perceived as having sufficient skills to move into this area. They therefore need to develop such expertise. This is the reason for the need of high end application development; something that businesses believe is worth investing in. 

Opportunities for moving up the value chain

The Indian software companies have built up huge cash reserves by earning huge profits over many years. They therefore have the financial muscle to invest in development of high end products and technologies.

E business consulting is an area where Indian software companies can command premium prices. This offers these companies an opportunity to improve revenue productivity.

E-commerce offers a wide variety of new and expanded channels and other opportunities to grow revenues for a company. These companies can exploit the ubiquitous, global nature of the World Wide Web to access new customers in new markets almost as easily as they serve local customers. The very nature of the medium is well suited to creation and delivery of electronic products and services that do not exist outside the e-commerce arena (e.g., online gaming, music downloads, etc.). E-businesses generate these revenues in an integrated fashion and turn those revenues into profits.

Strategic Business Model

Target customers


Financial institutions like Insurance Companies, Cooperative Societies, etc.

    * Increased reach to customers
    * Digital services in the form of transactions and data validations
    * Increased communication of services and promotions

Retail sales

    * Products to manage backend services of online companies
    * Enhanced customer data management for targeted sales promotions

Brick and mortar companies

    * Improved inventory management.
    * Improved supply chain management

Potential sources of revenues:

The revenue opportunities represented by e-business can be classified into three broad categories. These are:

  • Enhanced access to customers
  • Enhanced sales to existing customers
  • Electronically enabled products
    • * Companies using E-business can therefore look towards a larger customer base which can drive up their volume sales and subsequently their profitability.

      * These companies can also expect a higher customer lifetime value from their existing customers.

      * Enabling the customers to design the product according to their requirements also represents huge potential sources of revenue.

Such a product can therefore be much in demand with the customers of the Indian companies developing them and represent major sources of revenue.

Open source software development is another area where Indian software companies can venture into. It has wide scope with opportunities of converting open standards into actual software, increased reliability and robustness combined with rapid bug fixes and customization of the software at the user's own schedule. In addition, peer and public reviews ensure enhanced security.

Strategic Business Model

Target customers


Banking , other financial institutions and service sectors

    * Enhanced security
    * Customized solution
    * Reliable and robust performance

Retail chains

    * Improved inventory management
    * Enhanced customer data management for targeted sales promotions

Academic institutions

    * Development of web based library systems
    * Development of content management systems

Potential sources of revenue:

In case of open source software development, revenue is generated in mainly two ways:

  • The first is where the company which develops the product gives it away to the users. The users are then are allowed to modify the product and resell it. The modified product however, still carries the company's brand name. The company also provides after sale services.
  • The other way is generally used where the software is necessary to drive hardware. The customers i.e. the hardware companies buy these open source software to get better drivers and cheaper interface tools. Continuous innovation by the company developing the open source software is therefore necessary to maintain its revenue flows. 

Domain specific proprietary software is also a largely untapped market. Here, the Indian software companies can leverage upon their domain expertise in banking, telecom etc to develop products which suits a wide range of needs of different companies.

Potential sources of revenue:

  • The product being proprietary in nature, will earn royalties for the company when being used by the customers. The company therefore does not have to give up its control over the software while at the same time it can generate a steady flow of revenues.

Challenges likely to be faced while trying to scale up the value chain

Over a period of time, Indian software companies have acquired the image of being application maintenance shops who take projects from international companies by quoting the lowest prices possible. This image hinders their being considered for high end jobs where rates are high.

Indian companies also need to retrain their human resource pool so that they are able to work in the changed environment. This apart from being a big technological challenge is also a major HR challenge.

Except for a handful of Indian companies, most do not work to develop products as of now. Therefore, to move up the value chain, these companies would have to reorient their business models.

For smaller companies trying to enter this market (the tier II companies) generating the revenue to start such operations in a big way is a challenge. Product development being a high risk game might not find much favour with venture capitalists.

The recent measures taken

Companies worldwide are trying to find ways to do business better and more efficiently. They are looking for ways to use technology in order to maintain their competitive advantage.

Many software companies are already getting into product development and consulting in a big way. I-Flex generates about 63% of its revenues from Flexcube, while for TCS the figure stands at about 66 crore. Smaller companies like Polaris and Orbitech are also following suit.

About 37% of all the products developed are sold in the domestic market. Product exports constitute only about 2% of the total software exports. This indicates to the enormous opportunities that beckon the Indian software companies in their quest to move up the value chain.


Jaydeep Chakraborty
Chitrita Bhattacharya
Xavier Institute of Management
Bhubaneswar-751 013

Source : E-mail November 18, 2005




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