From software services to R&D services: local ... - Semantic Scholar

Environment and Planning A 2006, volume 38, pages 1269 ^ 1285

DOI:10.1068/a38102

From software services to R&D services: local entrepreneurship in the software industry in Bangalore, India Balaji Parthasarathy

International Institute of Information Technology, 26/C Electronics City, Bangalore-560100, India; e-mail: [email protected]

Yuko Aoyama

Graduate School of Geography, Clark University, 950 Main Street, Worcester, MA 01610-1477, USA; e-mail: [email protected] Received 21 March 2005; in revised form 3 August 2005

Abstract. In this paper we analyze the emergence of R&D services in Bangalore, India, by focusing on the process of technological upgrading in the Indian software industry. The development trajectory of the Indian software industry and the upgrading it has experienced, from providing low-skill software services to providing high-skill R&D services, are examined using evidence from interviews with Indian firms in Bangalore. Whereas most research on the Indian software industry thus far has emphasized the role of the state and multinational corporations, in this paper we argue that active local entrepreneurship is playing an increasingly important role in technological upgrading and in the shift from low-skill to high-skill services in Bangalore. These shifts are being facilitated by growing institutional thickness, as evidenced by the accumulation of local expertise, increasing local entrepreneurship addressing specific market niches, and the development of a local technical community.

1 Introduction Developments in the Indian software industry in the 1990s are now well documented, particularly with respect to the role of the state and the emergence of software services (Evans, 1995; Heeks, 1996; Heitzman, 2004; Parthasarathy, 2000, 2004), the role of multinational corporations (MNCs) (Aoyama, 2003; Fromhold-Eisebith, 2002), and the role of nonresident Indians (NRIs)öespecially in Silicon Valley (Saxenian, 1999; Saxenian and Edulbehram, 1998). Yet India has so far been viewed exclusively as a provider of low-wage, low-skill, software services (Arora et al, 2001; Balasubramanyam and Balasubramanyam, 2000; Brunner, 1995; Correa, 1996; Evans, 1995; Heeks, 1996; Kambhampati, 2002; Lakha, 1994; Schware, 1992; Srinivas, 1999). However, recent growth of research and development (R&D) services in India calls into question some of these previous assumptions. According to the National Association of Software and Service Companies (NASSCOM), the main industry association, R&D service exports accounted for US $1.21 billion, or 15.8% of India's software exports, in 2001/02. The figures grew to US $1.66 billion and 17.4%, respectively, in 2002/03, and are estimated to reach to US $9.2 billion by 2010 (NASSCOM, 2005; PTI, 2004). Central to the growth of R&D services is the provision of embedded systems; this segment contributed the majority of R&D service exports, and grew from US $0.91 billion in 2001/02 to US $1.1 billion in 2002/03. Yet few studies analyze India's shift from software services to R&D services and how this is linked to local Indian entrepreneurship and the emergence of a local technical community. In fact, the general tone of the literature so far has been one of skepticism, with the consensus being that there are numerous obstacles to the technological upgrading of India's software industry. What are the processes that allowed the Indian software industry to upgrade from being a provider of low-cost, low-skill services to a provider of high-skill R&D services, and how do certain places escape the `` `lock-in' trajectories of marginality'' (Castells,

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2000a, page 167) and ensure upward mobility in the global supply chain of the software industry? In this paper we discuss how local entrepreneurship has contributed to technological upgrading, with the aid of the case of Bangalore's software industry. Bangalore is routinely referred in the international press by terms such as `Silicon Plateau' (Fineman, 1991) or as Ìndia's Silicon Valley' (IDG, 2001), because it exemplifies, in many ways, the process of upgrading in the Indian information technology (IT) industry. Bangalore is not just the leading center for India's software exports, but is also increasingly specializing in embedded systems-design and value-added R&D services, all of which demand hardware knowledge and the creation of intellectual property (IP). The newly created India Semiconductor Association, which had thirty-two members in 2004, is also based in Bangalore to meet the specific needs of embedded systems development. The recent growth of the industry in Bangalore, even amidst the `dotcom bust', is attributed at least in part to the progressive upgrading to higher value-added activities (Srinivas and Jayashankar, 2002). In this paper we draw on a decade of observation and field research conducted in Bangalore. Over a dozen in-depth interviews were conducted in late 2002 with executives and entrepreneurs of Bangalore-based firms to explain the emergence of R&D services. The focus of the discussion is on the process of evolution from low-cost, lowskill, `non-core-competency' software service activities, supported by state-provided infrastructure, to increasingly high-skill, `core-competency'-oriented R&D services with active engagement by local Indian firms. 2 India's local entrepreneurship and its role in her technological upgrading Among various institutions in the developing-country context, the state and MNCs have been studied extensively for their contribution to technological upgrading. For many of the industrial latercomer economies of the Asia-Pacific, the role of the state has been critical in identifying, encouraging, and developing competitive advantages in strategic industrial sectors with a promise of broad export markets, technological transfer, and skill development (Amsden, 1989; Amsden and Chu, 2003; Johnson, 1982). Although Arora et al (2001) explain the rise of the Indian software industry as `à combination of resource endowments, a mixture of benign neglect and active encouragement from a normally intrusive government, and good timing'' (page 1270), evidence suggests that the government's role has been far more than what could be described as `benign neglect'. A major shift, from the state-dominated, autarkic, import-substitution-led industrialization strategy to achieve self-sufficiency and selfreliance which was followed until the early 1980s (Ahluwalia, 1985), to aggressive liberalization of the economy, including devaluation of the rupee, trade liberalization and duty ratinalization, foreign-investment promotion, and a new industrial policy that removed entry barriers for new firms (Acharya, 2002; Oman, 1996) since 1991, undoubtedly contributed to India achieving its objective of becoming to software what Taiwan and, South Korea were to hardware (Lakha, 1990). Software exports grew rapidly in the 1990s, making India the largest non-OECD exporter of software (along with Israel) by 2001 (OECD, 2002). Despite the global slump in demand in 2001,(1) exports more than doubled between 2000 and 2003, to US $9.8 billion, and the share of software exports in total exports grew from 1.9% in 1994/95 to 18.0% in 2002/03 (NASSCOM, 2005). The Indian government played an important catalytic role, particularly in the initial stages of development of the software industry. Establishing the first Software Technology Park (STP) in Bangalore in 1990, as an export zone dedicated to the software (1) In the USA, spending on IT fell by 6% in 2001 after a 16% growth in the previous year (The Economist 2002).

From software services to R&D services

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industry, for example, provided crucial data-communication infrastructure for the industry to grow in the city. The STPs were instrumental in firms shifting to provide offshore services, and gradually moving away from `bodyshopping'öthe practice of providing inexpensive hourly labor for low value-added programming services (coding and testing) at customer sites, mainly in the USA.(2) Bangalore's STP therefore provided the necessary infrastructure to reinforce the formidable skill advantages which the region already possessed, especially in public sector manufacturing industries and laboratories in sectors such as aerospace, defense electronics, and telecommunications. As a result, Bangalore became the first-choice location within India for the large number of MNCs wanting to establish offshore development centers (ODCs) (Parthasarathy, 2004). Whereas the state was responsible for inducing the transition from bodyshopping to offshore services, MNCs played a major role in providing critical professional contacts to global social networks so that cross-border collaborations could occur (Castells, 2000b; Saxenian, 1999; Saxenian and Hus, 2001). Various studies have shown the significant role of MNCs in technological transfer and upgrading in the developing-country context (Byun and Wang, 1995; Menzler-Hokkanen, 1995; Sidharthan and Nollen, 2004). Gereffi (1999) argues that participating in global commodity chains provides important opportunities for local businesses to upgrade their activities. From Mexico's maquiladoras to Malaysia's multimedia corridor, studies that focus on organizational learning suggest that, although technological upgrading occurs in various ways [for instance, see Bair (2002), Bair and Gereffi (2003), and Gereffi (1999) for the apparel industry, and Chang and Tsai (2000), Wang and Yuan (1999) for semiconductors in Taiwan], they generally assume the presence of MNCs in coordinating, subcontracting, and mediating vertical global ^ local partnerships. In the case of the Indian software industry, the role of MNCs in upgrading was particularly important when the industry began shifting from bodyshopping to offshore services. Along with the changing geography of production, firms began acquiring quality certifications,(3) which in turn made it possible to capture turnkey contracts, particularly in domains such as banking and retailing that demanded a wider range of skills going beyond programming, such as project scheduling, quality assurance, and productivity standards. Thus, during this phase, the MNCs played a catalytic role in inducing both `process' and `functional' upgrading; process upgrading referring to upgrading with enhanced production processes, and functional upgrading involving the acquisition of new functions that require higher skills (Humphrey and Schmitz, 2002). However, the mere presence of MNCs does not necessarily translate into either technological spillovers or active local entrepreneurship (Barclay and Gray, 2001; de Mello, 1999; Kokko, 1994). In fact, the shift from software services to R&D services in India today suggests both product and intersectoral upgrading, which involves a migration from old to new industries. This new phase can also be viewed as `path skipping', rather than `path following' (Lee and Lim, 2001), in part because the supposed requirement for local manufacturing capabilities (in this case, fabrication (2) The official encouragement for bodyshopping reflected a limited understanding of the industry on the part of policymakers; software was widely perceived as being `high-tech' without adequate distinction made between the different stages of production or the corresponding value added (interviews conducted 24 ^ 25 June 1996 with N Seshagiri, former Additional Secretary, and N Vittal, former Secretary, both from India's Department of Information Technology). (3) As far back as 1994, Motorola's Bangalore center was one of only two software centers worldwide to attain Level 5 certification of the Software Engineering Institute's Capability Maturity Model (Sims, 1994). By June 2002 eighty-five Indian firms had obtained CMM Level 5 certification, compared with forty-two in the rest of the world (NASSCOM, 2005).

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facilities for the production of semiconductor chips) is circumvented.(4) Why this new phase of technological upgrading in the Indian software industry and, in particular, the emergence of a new generation of local entrepreneurs and start-ups specializing in R&D services, was possible is neither fully explained nor understood. We contend that the role of local entrepreneurs in technological upgrading and the subsequent emergence of local networks are a neglected dimension in research on the Indian software industry. Thus far, India's local firms have been viewed only as passive recipients of technology, faced with the challenges of overcoming many disadvantages vis-a©-vis MNCs. FromholdEisebeth (2002), for example, argues that, in comparison with MNCs, `Ìndigenous IT firms, however, face difficulties in following that example [of upgrading] because they are less flexible in widening their intellectual scope and often depend on foreign know-how inputs for upgrading'' (page 2161). Indeed, research in the 1990s showed that local firms faced significant challenges: the presence of better-paying MNCs meant that local firms were often unable to keep up with escalating wages in Bangalore and were typically faced with rapid labor turnover which, in turn, limited their opportunity to widen the scope of their operations, let alone upgrade their technological capabilities (Parthasarathy, 2000). The predominant view of local firms and entrepreneurs, at least until recently, was their persistent status as low-cost, low-skill operations. The neglect of the role of local entrepreneurship in technological upgrading is in part due to its recent prominence, particularly since the end of the `dotcom bubble', which also coincided with the onset of reverse migration to India. According to NASSCOM, in the two years immediately after the `dotcom bust', 35 000 skilled professionals returned to India, mostly from the USA, with seven out of ten being H-1B visa holders and one out of ten having been away for over a decade (Singh, 2003). The main reason for their return, however, was changing from push (shrinking international opportunities) to pull (India as a place for innovation) factors (Krishnadas, 2003a). With its emphasis on transnational social relations, the diaspora literature on India focuses on relations among MNC-employed skilled professionals relocating between India and elsewhere (primarily the USA), or those between NRI entrepreneurs and their employees in Indian offices. Undoubtedly, Indians returning home made a wide range of skills locally available, including managerial expertise, and international marketing, as well as technical expertise. Yet, as we show in the subsequent section, the notable aspect of the current phase of upgrading is the emergence of `home-grown' local firms and entrepreneurs. Their technological expertise and global business relationships derive from their experience in working in government research laboratories, longstanding local service firms, and ODCs in India. Thus, whereas the presence of returnees is definitely helpful, and may even be regarded a necessary condition, we believe that it is not a sufficient condition to ensure rapid technological upgrading of the sort observed in Bangalore. Local firms and entrepreneurs are beginning to form a technical community and a common agenda for growth in Bangalore, which can be regarded as an aspect of emerging ìnstitutional thickness': a strong institutional presence and a high level of (4)

Lee and Lim (2001) identify three types of technological `catching up': path creating, path skipping, and path following. Whereas upgrading as a gradual process of learning is now widely acknowledged and used in various empirical studies (for example, Hobday, 1994), leapfrogging remains a controversial concept without consensus on its meaning. Steinmueller (2001) defines leapfrogging as ``bypassing some of the processes of accumulation of human capabilities and fixed investment in order to narrow the gaps in productivity and output that separate industrialized and developing countries'' (page 194). Others use the term as an indicator of the ability of an economy to imitate (Thoenig and Verdier, 2003), or define it as a process of technological adoption (Giovannetti, 2001).


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interaction, along with the development of coalitions for collective representation, and mutual awareness of a common enterprise (Amin and Thrift, 1995). Such ìnstitutional thickness' provides business support through dense formal as well as informal institutions, and serves as the key enabler for technological upgrading. In the case of Bangalore, its initial advantage as the location of government laboratories and military research, combined with the early presence of major MNCs, provided the foundation for institutional thickness to emerge around its software industry and allowed technological upgrading. The emerging phase of technological upgrading therefore suggests the formation of an innovative region in a developing-country context. Castells (2000b) argued that Bangalore cannot be viewed as an innovative region because of (1) the lack of technical expertise; (2) the lack of a technical community with a deep and diverse range of capabilities; and (3) the minimal interactions among local firms. As we show, all three dimensions have undergone transformation in recent years, in turn allowing local firms to shift to R&D services. What we are witnessing may well be the process of emergence of a contemporary example of an IT-oriented agglomeration in a developing-country context with strong external links, one that increasingly functions as a specialized hub in global production networks. In the next section, we first outline the nature of R&D services. We then examine the emergence of local firms and entrepreneurs engaging in R&D services in Bangalore. In examining Bangalore's case, we focus on the emergence of a regional technical community through which collaboration occurs, and on how local firms compete with MNCs and leverage their structural weakness to their advantage. 3 The emergence of R&D services The type of R&D services becoming increasingly popular in India involves the sale and transfer of intellectual property (IP) blocks in return for a one-time payment plus volume-based royalty to the provider. An IP block typically incorporates some kind of embedded systems design and development, which is a combination of hardware and software dedicated to perform a specific task without human interventions. Although embedded systems are by no means new, their use has grown with the increasing capability of microprocessors. They are part of everything from consumer goods, such as cell phones and microwaves ovens, to transport equipment, such as automobiles and aircraft, to industrial process control systems. An increasing number of devices use embedded systems to connect to the Internet and to communicate with one another. In these devices, embedded systems take over what mechanical and dedicated electronic systems used to do. Embedded-systems design is about adapting software abstractions, designed to transform data, to meet real-time constraints, power requirements, and safety considerations in various domains while interacting with the physical world through sensors and actuators (Lee, 2000). The designing of embedded systems often requires engineers who are classically trained in the domain of application, for example, communications (Lee, 2000). Even small programs may contain algorithms requiring a deep understanding of the domain and of supporting technologies, such as signal process: `Ìt is very difficult to replicate a toll-quality speech coder or a radio modem with commodity programmers'' (Lee, 2000, page 19). Embedded systems have been responsible for the `softening' of once inflexible hardware, ever since the development of design algorithms for hardware ^ software codesign in the 1980s. According to Vahid (2003), ``today's hardware engineers use methods similar to those that software engineers useöthey write tools and let programs generate the implementation. Thus, not only has the distinction between the physical implementations of traditional software and hardware blurred, but the distinction between software and hardware design processes, and even between

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hardware and software designers, is also blurring'' (page 33). As it became possible to appropriate and simulate the function and other characteristics of electrical and mechanical devices digitally, the importance of embedded systems for various products grew. Organizationally, the Indian design firms were able to take advantage of the industry trend for vertically disintegrated production in semiconductors, and grew without the support of local manufacturing facilities by relying instead on factories in other parts of Asia, especially Taiwan. These global networks facilitated the Indian software industry to `path skip' to R&D services, and served as viable substitutes for local manufacturing facilities. According to NASSCOM (2003), the global embedded software solutions market was worth US $21 billion in 2003. The telecommunications, computing, and datacommunications segment dominated the market with a 34% share, which is attributed to voice ^ data convergence and telecommunications deregulation in the USA in 1996. The convergence required the design of new protocol stacks with open standards, as previously incompatible voice/data equipment of vertically integrated manufacturers needed to communicate with one another. The technological and institutional transformation opened up opportunities for new firms, and this was the segment which Indian firms first entered (Bhuyan, 2002). The global market for this segment is estimated to have grown by 16% in 2004. 3.1 Emergence of the R&D-services industry in India

Although the data indicate that embedded-systems production did not take off in India until the late 1990s, the origins of the industry can be traced back to the pool of IC (integrated circuit) designers employed by the Bangalore-based public sector firms Bharat Electronics and Indian Telephone Industries to meet their own needs (Sridharan, 1995). Texas Instruments (TI) actively exploited this pool of skills when it became the first MNC to establish an ODC in Bangalore in 1985 at the initiative of Mohan Rao, an Indian and a senior Vice President with the firm. Despite the availability of skills, TI did not immediately plunge into design. Instead, the Bangalore center started off with maintenance and application work and it was not until the early 1990s that TI developed a design strategy in India.(5) In 1995 a design center for DSPs (digital signal processors), TI's main line of business, was established, and in 1998, Ankoor, the first commercial DSP fully developed in India, was launched. Since then, many other DSPs have emerged from the center, in addition to 225 patents and many industry awards. Between 1992 and 2002, several Indian firms dedicated almost exclusively to embedded systems and design were established to take advantage of new opportunities (Hari and Anand, 2002). By 2003 the number had grown to more than 100 firms (Hari, 2003) and it was estimated that the IC design and validation industry employed 5000 ^ 7000 engineers, compared with 300 in 1997 (Menon, 2003). Hari and Anand (2002) classify the activities of firms in India in embedded systems into three categories. First are the chip vendors, who design entire chips. Although this is the most profitable category, it also requires deep pockets, and thus is mostly the realm of MNCs such as Intel, Motorola, and TI. In the second category are firms offering design services, and executing specific contracts for customers. Those providing design services constitute an integral aspect of the embedded-systems production chain and interact either with the customer's chief technology officer or the head of the R&D section. In the third category are firms that are increasingly generating IP blocks that go into various (5)

Unless otherwise mentioned, details of TI's activities are from a personal discussion that followed a presentation by Dr Biswadip Mitra, Managing Director, TI India, at the International Institute of Information Technology, Bangalore on 10 April 2004, and from http://www.ti.com/asia/docs/india.


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embedded systems to derive revenue either from a one-time license fee or from recurring volume-based royalty payments, or a combination of both. Although this is very lucrative, especially when compared with the provision of software services on a man-hour basis, it is not without risk. Because generating IP requires familiarity with emerging standards, participating in the process of standard setting is very valuable; this means sitting on the relevant committees of industry associations and public ^ private sector partnerships, and networking with other firms. Hardware capabilities are an essential aspect of embedded-systems design and development, and there is evidence that suggests that hardware-development capabilities, particularly in semiconductor chip design, are emerging in India. Hari and Anand (2002) claim that India is `àchieving some sort of critical mass''(page 35) in chip design. Another indicator of the extent of design capabilities comes from the use of electronic design and automation (EDA) tools that are critical to IC design. The market for EDA tools is estimated to have grown from US $15 million in 1999 (Nair, 1999) to approximately US $60 million in 2003 (Menon, 2003). For example, Cadence Design Systems, the largest EDA tools vendor in the world increased its Indian customer base from mere nine to 100 between 1999 and 2002, although this segment of the industry is still dominated by foreign MNCs (Hari and Anand, 2002; Nair, 1999). Out of the twelve largest EDA tools customers in the world, eleven have R&D facilities in India, including Intel, Motorola, TI, ST Microelectronics, National Semiconductor, and Cypress Semiconductor (Kumar, 2003). These firms have rapidly and significantly expanded their Indian operations even as they have either stopped hiring, or laid off, employees in their home countries (Krishnadas, 2003b). Today, chip vendors such as TI rely increasingly on Indian firms for R&D services. For example, although TI retains DSP-development capability, it has more than 600 independent DSP thirdparty partners globally, from whom it either buys IP or seeks design services. Forty seven of its partners are Indian, of whom thirty one are based in Bangalore. With the growing complexity of embedded systems and the rapid proliferation in their use, the industry is moving toward a design process that creates designs from scratch by integrating reconfigurable, commodity system-on-chip platforms to enable rapid design changes to offer differentiated products for a wide variety of users and application domains (Martin and Schirrmeister, 2002). Legal changes have also facilitated the development of R&D services in India. There is an industry-wide consensus that piracy will destroy businesses in the global marketplace, which is why firms interviewed in Bangalore applied for patents in the United States. NASSCOM has been instrumental in ensuring intellectual property protection for the Indian software industry. The Semiconductor Integrated Circuits Layout-Design Act 2000 (Ministry of Law, Justice and Company Affairs, 2000), provides for the registration and protection of semiconductor IC layouts and designs for a ten-year period. Although the act has been criticized for protecting only the layout, and not going far enough to protect abstract designs and algorithms, even its critics acknowledge that this is a big leap, especially in creating confidence for the growth of the embeddedsystems industry (Krishnadas, 2000). Although software patents are not permitted in India, on 27 December 2004, the Government of India issued an ordinance to modify the Patent Act ``to provide for patents when software has technical applications in industry in combination with hardware'', that is, embedded systems, with effect from 1 January 2005 (Republic of India, 2004). 3.2 Market niches, advantages, and local networks of Bangalore's R&D service firms

Local firms in Bangalore have been involved in embedded-systems design since the 1980s. Before the Indian market was opened, MNCs provided contracts to large

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local firms, such as Tata Elxsi, Wipro, and HCL, to design and develop systems (Evans, 1995). Tata Elxsi at one time manufactured peripheral cards and controllers for Silicon Graphics, and Elxsi, a now defunct US mainframe manufacturer; Wipro and HCL produced PCs and Unix-based mini computers. With gradual liberalization in the 1990s, however, it became increasingly difficult to manufacturer locally and compete with the imports of established brands. For instance, Wipro decided to use its available skills to provide embedded-systems design for firms whose technology it was familiar with, including Intel and Compaq (Hari, 2001). In part because of the nondisclosure agreement that typically binds the developer, and in part because embedded-system design was mostly an in-house activity until the past decade, developers remain largely unidentified. For example, a local firm in Bangalore we interviewed, stated that they had just completed work for a company that received a contract from the eight leading cellular telephone manufacturers to implement a multimedia message service client on a piece of silicon. The chief executive officer (CEO) of the firm stated: `Ìt will not be our name that will be mentioned but we will all know that it is our software running'' (interview, November 2002). Indian software firms in Bangalore today broadly fall into two groups. The first group consists of those that initially entered the industry in the 1980s and became major service providers. This category includes firms that were either a part of existing large firms, such as Tata Consulting Services, which is part of the Tata conglomerate; Wipro, another conglomerate that specialized in edible oils; and start-up firms including the Bangalore-based Infosys. The second group is comprised of a new generation of entrepreneurial start-ups that focus on niche markets. We conducted interviews with firms belonging to both these groups in order to understand the process by which Indian firms are shifting their emphasis from providing software services to R&D services. From our interviews, three broad themes emerged: the maturing of local technical expertise that allowed the shift from software services to R&D services; the advantages of the firm being local in providing R&D services; and the emergence of local networks among local firms which provide R&D services. 3.2.1 From software services to R&D services Local firms that had grown exclusively by providing low-end software services are now becoming involved with R&D services. R&D-service provision is a different type of business altogether, and has a particular niche in the market. The CEO of Tata Elxsi described how R&D services differ from the traditional form of software-service outsourcing, and the difficulties faced by local firms attempting a transition: `Ìt may not be financially very big, may not even be self-standing, but it enhances the image of your organisation and that's why you see all the Indian IT companies, the big boys [such as TCS and Wipro] in particular, are dabbling with R&D services, where they have no real background ... the transition is probably not easy because you have a certain billing rate and a certain lack of risk in the typical IT engagement that Indian companies get involved, in whereas the R&D opportunities are completely different. For every 10 R&D projects that anyone commissions, only 2 ^ 3 see the light of day and the product eventually going to the market'' (interview with Mr Madhukar Dev, CEO, Tata Elxsi, 27 November 2002). For the firms attempting transition to R&D services, the shift is not necessarily motivated by financial gain in the short run but is, rather, an attempt to gain technological legitimacy in the long run. The value of reputation alone may often be sufficient as a justification for an Indian firm to claim to be an R&D-service firm today. The same CEO expressed this as follows:


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``My own view ... is that the Indian IT community has made a lot of money, starting from the Y2K opportunity. Thereafter they have done good work ... but they have not got significant respectability for the work. And one activity that adds appeal to their image is R&D services'' (interview with Mr Madhukar Dev, CEO, Tata Elxsi, 27 November 2002). Sasken Communication Technologies is one Bangalore firm that has successfully made the transition from software services to R&D services. In many ways it is a typical firm established by a returnee. Initially founded in Silicon Valley in 1989, Sasken began as a product-development firm, but began taking on software services, and opened a development center in Bangalore in 1991. Having a front end in the USA was vital for their business at a time when customers were reluctant to give any business to a firm based in India. But in 1993 Sasken relocated its headquarters to Bangalore and the office in Silicon Valley became a branch office for sales, marketing, and some engineering. In 1999 Sasken successfully raised venture funding from Intel and Citibank to begin R&D services, whereas lack of experience had previously inhibited homegrown start-ups and the interest of venture capitalists (Krishnadas, 2003b). Today, the credibility of Indian firms is well established according to its CEO, who explained that a `paradigm shift' has happened wherein: `Ìndia has also emerged as a place where the experience base has increased. ... Companies come over here for complete solutions. For example, a Japanese handset manufacturer has taken our MPEG 4 encoder/decoder on their handset for video streaming for their 3rd generation video phones that are getting launched in ... Europe ... it is no longer cost and quality alone but also that the expertise, knowledge base, credibility exist for companies to come and get these things done over here'' (interview with Mr Rajiv C Mody, CEO, Sasken Communication Technologies, 26 November 2002). Such credibility is based on the maturing of local technical expertise. Another Bangalore entrepreneur, who receives contracts from MNCs to develop wireless products, also argued that the draw of India is shifting from being exclusively lowcost labor to a combination of low costs and a specific knowledge base, and that Indian firms are increasingly responsible for IP development for MNCs. He described how MNCs are no longer in India exclusively to `train' and ùpgrade' workers by providing technological expertise. Rather, they are increasingly taking advantage of local expertise, in this case, in wireless technologies. `Àll these Indian outfits [that work with MNCs] are R&D arms. And here [in Bangalore], they [MNCs] have [access to] wireless competency, locally. That's a big plus for them because they can say, `hey, you know what, here we have wireless competency, so we can put together these sort of solutions' and that is attractive for the global principal'' (interview with Mr Baskar Subramanian, CTO, Impulsesoft, 29 November 2002). The firms interviewed also confirmed that the absence of local manufacturing facilities no longer handicaps them vis-a©-vis their competitors in providing R&D services. First, there are sufficient local manufacturing capabilities in India to produce prototypes, even if not for mass production. Second, local firms have developed the networks that allow them to collaborate internationally to work on the hardware ^ software interface. One entrepreneur considers Taiwanese factories as collaborators rather than as competitors: `Ì see Taiwan as really collaborating with us. ... We have partners in Taiwan [who] are going to [hold inventory of chips and boards] for us ... when the whole thing is designed and sold to the customer, the hardware manufacturing inventory will be handled by Taiwan and software licensing will come from us. So in a sense, it is

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complementary. ... most [Taiwanese firms] are not so oriented towards IP as a business. There are some, but many of them want to play in a different league of hardware chip applications. So they are willing to buy IP'' (interview with Mr Srini Rajam, CEO, Ittiam Systems, 26 November 2002). In sum, the newly available resources, the maturing of local expertise, the desire for increased legitimacy, and global networks combined are making it possible for Indian firms to engage increasingly in R&D services. 3.2.2 The advantages of local firms The maturing of local technological expertise in part allowed the growth of start-ups that specialize exclusively in R&D services. The CEO of Ittiam Systems, a Bangalore start-up which was recently named the most preferred global supplier of DSP-based intellectual property by the international DSP Professionals Survey of 2004 (Krishnadas, 2004), observed real opportunities in R&D services. To him, R&D services are about providing clients with additional sets of `core competencies': `Èach company has a different core competency. Outsourcing is like some generic thingömanagement of a chart system, management of a financial system, management of your Internet, extranet, which are non-core, you tend to outsource. In fact, the typical market the Indian industry has captured is the outsourcing one. IP is a market, which is very much like core competency, except that we don't have it ready and you cannot go and set up today to capture that market. It is also an area, which is one level of value addition to the core competency. Outsourcing clearly belongs to the category of non-core. It is something that will not be a competitive advantage to do internally (interview with Mr Srini Rajam, CEO, Ittiam Systems, 26 November 2002). Software services that are outsourced form a part of the essential informationsupport systems, but do not typically represent the mainstream activity for most customers. The same entrepreneur also offered an explanation for how small Indian R&D service firms can develop a market niche through engaging in R&D services: ``Most of these big companies have what is known as a `list of approved projects' and a longer list of projects that are unapproved. And a big company never invests in a project in a half-hearted way. They only invest if they can line up their R&D, marketing, manufacturing ..., everything into one line, only then they go into the program. Suppose somebody in the company made a call that wireless LAN is not important, [then] that's it, they are not going to touch it. ... Now they are seeing that this is the fastest growing market in the wireless world today. It's not mobile wireless but LAN, 802.11 based. Now they are forced to buy it from someone. That's the kind of scenario where I think independent companies can survive'' (interview with Mr Srini Rajam, CEO, Ittiam Systems, 26 November 2002). Thus, large firms leverage market uncertainty by purchasing R&D services when they find themselves behind in certain technological areas in which they had failed to anticipate growth. Also, for MNCs, size serves both as an advantage as well as a constraint. Another CEO from a Indian firm also argued that large firms effectively purchase time by relying on R&D services: ``The key driver for them [MNCs] is time-to-market. If they can, by outsourcing 4 different elements to 4 different people, run them in parallel and get a product out 4 months sooner öthat would completely alter the fate of the product'' (interview with Mr Madhukar Dev, CEO, Tata Elxsi, 27 November 2002). MNCs are particularly attractive customers for R&D-service firms. Because the service provider typically charges either a one-time licensing fee or on the basis of a per-unit royalty, the larger market shares of MNCs ensure higher returns. Yet, for small


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R&D-service firms, a significant risk exists if they fail to retain a substantial degree of technological expertise. An executive at an R&D service start-up stated that risks can be managed by developing a business focus, and by taking advantage of a small-scale operation: `ìt is a risky proposition to be focusing on one technology. What we see is focus is the only way to be successful ... 40 people company, ... only four people each [technology] ... is just not the way ... . Even if you are doing ISDN today, a dead technology, I can tell you, if you are really focusing on it, you can have a small market for it'' (interview with Mr Baskar Subramanian, CTO, Impulsesoft, 29 November 2002). In addition to such niche opportunities, Bangalore's R&D-service firms are increasingly enjoying advantages in the local labor market. In the past, few local firms managed to control the frantic pace of labor turnover and wage increases, and subsequently, the loss of their top employees to MNCs. Although the interviewed firms varied in their ability to attract and retain quality employees, in general, since the dotcom bubble burst, both turnover and wage increases had slowed. Moreover, along with technological upgrading, worker satisfaction among technology professionals in Bangalore is shifting, so that monetary rewards are no longer the overwhelming consideration. One entrepreneur, for example, argued that one reason for the recent emergence of Indian R&D-service firms is the dissatisfaction of Indian employees working in MNCs: ``those who leave a multinational and come to [us] are never going to want to go back ... because all said and done, a multinational environment has a limitation in terms of what you can do. In a multinational environment, you can do only so much because it is somewhat claustrophobic in the sense that after some time you are not going to be designing your own product code manual, your own customers, your field, your opportunities. So it is limited'' (interview with Mr Srini Rajam, CEO, Ittiam Systems, 26 November 2002). The roles and development tasks of the Indian subsidiaries of MNC's are defined by the global structure of the parent organization, which in turn limits freedom in the development process. A CEO of another Indian firm corroborated this tendency by suggesting that working for an MNC is fundamentally different in nature from working for an Indian firm: ``Some of our very good people who had left us to join big foreign companies are coming back to work for us primarily because they are sick of the work they do there. They get tons of money. But the work that is given to the Indian labs and consequently to the Indian engineers is not so exciting ... . If I work for Intel, say, I will keep doing only one kind of work. And what Intel decided will be done by my lab, whereas if I work for a service provider like Tata Elxsi, today I could be doing work for Microchip, tomorrow, I could be doing work for Hitachi and day after for Texas Instruments. So it gives me a much broader experience'' (interview with Mr Madhukar Dev, CEO, Tata Elxsi, 27 November 2002). This suggests that, in the context of the Indian software industry, the MNC-led model of technological upgrading is reaching its limits, and that technological upgrading is no longer occurring exclusively through MNCs. Entrepreneurs and executives believe that Bangalore's software industry is maturing to point where their price tag is secondary to their overall competitiveness. One entrepreneur described the situation as follows: ``What we are seeing is, when you look at high technology, cost is not an advantage at all. We are actually among the most expensive. We don't sell our stuff on cost at all. We don't say ours is the lowest priced. Actually ours is fairly high. In fact, ... they [customers] would say India is low cost, so why is it so expensive? India was

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always low-cost. That was the wrong idea, that's the whole idea we started breaking [apart]. If you want quality, there is a cost for it'' (interview with Mr Baskar Subramanian, CTO, Impulsesoft, 29 November 2002). Although it is difficult to imagine that price has become entirely irrelevant for customers, it is clear that technological maturity is required for an R&D-service firm to compete on qualityöno matter where it is located. The way in which the CEO of Sasken summarizes the current situation is indicative of the state of the R&D service industry: ``let's be clear. Competition is there from Israel, from UK, from Japan, China, Korea, India. It's a tough world. ... You want to survive, [then] you have to be the best. And your cost effectiveness ... fortunately is already built into the Indian system'' (interview with Mr Rajiv C Mody, CEO, Sasken Communication Technologies, 26 November 2002). 3.2.3 Emergence of informal local networks The forms of relationships among local firms as well as between local firms and MNCs are changing in Bangalore. Previously, there were few localized interfirm links in Bangalore's software industry. Those that were there developed around MNCs, with vertical relationships to local contractors. However, what is gradually emerging is a set of horizontal relationships amongst Indian firms. This development began with the end of the dotcom bubble. One Indian firm we interviewed professed to have forged alliances with half a dozen local firms to provide R&D servicesönamely, to assemble IP blocks and sell a complete solution to MNCs. A CEO speculated about the reasons behind this new trend as follows: ``Today, if we call up any of these [local] partners and say that we want to work together and we want to use your IP in these areas, they are willing. They will come and talk which was not the case a few years ago. And equally, I think, it never occurred to us a few years ago to go and talk to somebody. Because we said, `what does it take, hire 50 more guys and build your own IP'. Because whatever you poured in was getting converted to gold anyway'' (interview with Mr Madhukar Dev, CEO, Tata Elxsi, 27 November 2002). According to another entrepreneur, the development of local networks translates into a real pay-off in his business. Through partnerships, R&D-service firms develop advantages over their competitors by adopting a coordinator role and assemble expertise from multiple local firms: ``how do I get more business? ... My principal comes, my Vice President comes ... and asks, `how are you doing better than the guys there?' So here you can say that there are local guys who have done that, I can partner, I can build the solution kind of thing. That's a big advantage'' (interview with Mr Baskar Subramanian, CTO, Impulsesoft, 29 November 2002). Thus, in addition to the `deepening' of talent in R&D services, local networks are being developed among domestic firms in Bangaloreöin part because of the emergence of local business opportunities, and in part because of a greater interest among firms in the exploitation of new opportunities. These developments may well mark a nascent locally networked technology district. Today, these networks are largely developed around informal social networks: ``Whatever information we have about who is doing what, what capability exists, is completely through informal means'' (interview with Mr Madhukar Dev, CEO, Tata Elxsi, 27 November 2002). Impulsesoft, a local start-up that specializes in wireless-technology products, is a typical example of a firm that evolved out of local networks, and the firm continues to


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use those networks extensively to generate its customer base. The company was founded in 1998 on the shared dream of three engineers who were classmates in college and worked as colleagues at TI for three years. Although working at TI deeply influenced their approach to technology, by their own admission they had little idea of how to run a start-up. Nonetheless, they managed to establish their own firm after they met the current CEO, who has a PhD from the University of California, Berkeley, with prior working experience in strategic marketing for National Semiconductor and Synopsys, as well as international marketing experience (in Israeli and Japanese markets) at another Indian start-up, Sasken. A year later they added the current chairman of the board, who brought additional management experience (in the United Kingdom and Africa). The chairman not only brought to the firm managerial experience from his advisory role to many IT start-ups, but also his professional and personal ties with N S Raghavan, a founder of Infosys, a leading Bangalore-based software-services firm, which led to Mr Ragharan coming on board as an advisor and angel investor. Today their business is R&D services, and their informal networks include local TI spin-offs as well as larger Indian firms to collaborate and generate business. An executive from the company described the presence of local networks as follows: ``Yesterday we were talking about Ittiam. ... I talk to Satyam once in a while about how it is going. We are all from TI, they are from TI, so we have very good relationships. ... they also do a bunch of things ... they said we will go together and pitch. ... All these Tata Elxsi, the Infosys, the TCS are good marketing people. They have sales guys all over and they are not in the business of developing IP ... . In fact, TCS suggested our solutions. Use their sales share, use our IP, it's a win ^ win situation'' (interview with Mr Baskar Subramanian, CTO, Impulsesoft, 29 November 2002). For these firms, informal local networks are an essential aspect of risk-hedging strategy. To complement these informal networks, formal institutional mechanisms are also emerging to facilitate the development of local entrepreneurial networks. For example, the role of NASSCOM has changed significantly in the recent past öfrom regulatory to industry promotion. Between its founding in 1988 and 2000, the role of NASSCOM was almost exclusively limited to lobbying for benefits based on personal contacts in the government. Since 2000 it has transformed itself into a more professional organization, increasingly relying on research to influence policy (Kanavi, 2004). It has also become more actively involved in promoting start-ups, innovation, and incubation. These changes are viewed favorably by industry insiders. According to the CEO of Tata Elxsi: `Ì am quite impressed with the kind of transformation that is taking place within NASSCOM. You know, from just lobbying with the tax authorities and the government and so on, they are now trying to propel business in a particular direction. The kind of information that they keep feedingöabout specific countries and specific technology areas, what opportunity, the size of the marketöheavily researched, authenticated, data, I think that's very supportive and that's what's going to lead people to make investments and doing things'' (interview with Mr Madhukar Dev, CEO, Tata Elxsi, 27 November 2002). 4 Conclusion The recent rise of R&D services around Bangalore, India, suggests that the Indian software industry has reached a new phase of development. The onset of the new phase of technological upgrading is being facilitated by active local entrepreneurship and supported by the gradual thickening of institutions, both formal and informal. There is evidence of local collaboration and networking among Indian firms, as they seek to

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diversify their client base and business opportunities after the dotcom bust. An emerging technical community, comprised of local employees of MNCs, entrepreneurs, and large Indian firms, as well as expatriates returning from abroad, is being formed in Bangalore. Our interviews revealed that the emphasis among Bangalore's software firms was on the business collaborations nurtured locally, and even when the networks do cross international borders, they were often born and nurtured through working locally. The most striking finding from the interviews and the research we conducted was the emergence of truly local executives and entrepreneurs as major players. Although some have spent a significant time overseas, the majority of those interviewed nurtured their experience locallyöalbeit often through working at local ODCs set up by MNCs. This suggests that, though globally connected, business relations have become sufficiently grounded and localized in Bangalore, and that MNCs in Bangalore no longer constitute ènclaves' from which they participate in international supply chains. Another important finding of the field research is that as local firms and start-ups are actively exploiting global opportunities in R&D services, IP-block development, and embedded-systems design, they are emerging as increasingly competitive alternative workplaces to MNCs for Bangalore's technology workers. By entering particular market niches and moving into increasingly high-skill areas of software development, local firms are increasingly capable of attracting top engineers and experienced professionals. The consequent widening and deepening of the local labor market has not only raised the possibilities of bringing together various combinations of skills for MNCs and Indian software-service firms seeking to upgrade, but it has also made entrepreneurship more feasible. Furthermore, global networks are substituting for colocation between manufacturing and software capabilities, that is, alliances between Taiwanese factories and Indian IP-block firms, suggesting the emergence of a new international division of labor involving the Indian software industry. The process of technological upgrading observed in the software industry in Bangalore, however, raises more questions than it answers. For one, it is unclear to what extent the experience can be generalized to technological upgrading among local firms elsewhere. In the particular context of Bangalore, the simultaneous maturing of local expertise, the return of NRIs, the limits of MNCs, and the current technological capability of the software industry have combined to generate a condition for the transformation described in the paper. For another, the extent to which relative cost plays a role as a driver for the growth of the R&D-services segment of the industry is unclear. Nor is it clear whether, with wage increases, the industry in Bangalore will still enjoy the position it does now, and whether Bangalore will emerge as a distinctively innovative region. Finally, although the current emergence of R&D services is undeniable, its long-term future remains to be seen. In particular, whether we are indeed observing the emergence of a unique model of economic development based on technological upgrading of a software industry that is almost exclusively export based, will be determined by whether the current process evolves further, and in which direction. What is clear is that the case of Bangalore contradicts many previous assumptions about the obstacles that developing countries face in achieving rapid technological upgrading and internalizing expertise in their regional economy, especially when powerful MNCs are present locally. The knowledge and expertise present in Bangalore today are dramatically different from even five years ago, and the shift in the types of mobility of labor, both internal and external to the regional economy, are in many ways indicative of the transformation. In the late 1990s all local firms interviewed suffered varying yet significant problems of dramatic wage hikes and of employee


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retention, particularly through loss of their employees to MNCs, and discussions centered around the quantity, not the quality, of labor. By 2002 the shift we described in this paper was already taking place, suggesting a fundamentally changed role for the Indian software industry vis-a©-vis the rest of the world. These dramatic changes, although as yet in only a segment of the overall industry, may point to a significant development of a knowledge industry unprecedented in any other low-income economy. Acknowledgements. The authors thank the editor, guest editors, and three anonymous reviewers for their constructive comments on earlier drafts of this paper. Any remaining errors are solely the responsibility of the authors. The authors also thank interview participants, and Professor S Sadagopan for helping arrange many of the interviews. Janaki Srinivasan provided valuable research assistance. The research was partly supported by the Ridgefield Foundation. References Acharya S, 2002, ``Macroeconomic management in the nineties'' Economic and Political Weekly 37 1515 ^ 1538 Ahluwalia I J, 1985 Industrial Growth in India: Stagnation Since the Mid-sixties (Oxford University Press, New Delhi) Amin A, Thrift N, 1995, ``Living in the global'', in Globalization, Institutions and Regional Development in Europe Eds A Amin, N Thrift (Oxford University Press, Oxford) pp 1 ^ 22 Amsden A H, 1989 Asia's Next Giant: South Korea and Late Industrialization (Oxford University Press, New York) Amsden A H, Chu W-W, 2003 Beyond Late Development: Taiwan's Upgrading Policies (MIT Press, Cambridge, MA) Aoyama Y, 2003, ``Globalization of knowledge-intensive industries: the case of software production in Bangalore, India'' Annual Report of Research Center for Regional Studies 12 33 ^ 50 Arora A, Arunachalam V S, Asundi J, Fernandes R, 2001, ``The Indian software services industry'' Research Policy 30 1267 ^ 1287 Bair J, 2002, ``Beyond the Maquila model? Nafta and the Mexican apparel industry'' Industry and Innovation 9 203 ^ 226 Bair J, Gereffi G, 2003, `Ùpgrading, uneven development, and jobs in the North American apparel industry'' Global Networks: A Journal of Transnational Affairs 3 143 ^ 170 Balasubramanyam V N, Balasubramanyam A, 2000, ``The software cluster in Bangalore'', in Regions, Globalization, and the Knowledge Based Economy Ed. J H Dunning (Oxford University Press, Oxford) pp 349 ^ 383 Barclay L A, Gray S J, 2001, `Ùpgrading the diamond of developing countries through inward FDI: the case of four MNEs in the information service industry of Barbados'' Management International Review 41 333 ^ 357 Bhuyan R, 2002, ``Chipping in'', http://www.dqindia.com/content/search/showarticle.asp?arid=39564 &way=search Brunner H P, 1995 Closing the Technology Gap: Technological Change in India's Computer Industry (Sage, New Delhi) Byun H-Y, Wang Y, 1995, ``Technology transfer and multinational corporations: the case of South Korea'' Journal of Asian Economics 6 201 ^ 217 Castells M, 2000a End of Millennium (Blackwell, Oxford) Castells M, 2000b The Rise of the Network Society (Blackwell, Oxford) Chang P-L, Tsai C-T, 2000, `Èvolution of technology development strategies for Taiwan's semiconductor industry: formation of research consortia'' Industry and Innovation 7 185 ^ 198 Correa C M, 1996, ``Strategies for software exports from developing countries'' World Development 24 171 ^ 182 de Mello L R, 1999, ``Foreign direct investment-led growth: evidence from time series and panel data'' Oxford Economic Papers 51 133 ^ 152 Evans P B, 1995 Embedded Autonomy: States and Industrial Transformation (Princeton University Press, Princeton, NJ) Fineman M, 1991, `Ìndia's new middle class finds home in Bangalore'' The Los Angeles Times 17 December, page 6 Fromhold-Eisebith M, 2002, ``Regional cycles of learning: foreign multinationals as agents of technological upgrading in less developed countries'' Environment and Planning A 34 2155 ^ 2173 Gereffi G, 1999, `Ìnternational trade and industrial upgrading in the apparel commodity chain'' Journal of International Economics 48 37 ^ 71

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