Complementary and continuous innovation: case of the Indian software industry.

ABSTRACT

Indian software services exports have been growing at a spectacular rate for over more than a decade now. Global resource shortage and labour arbitrage have often been cited as reasons for this growth. In this paper, we go beyond these arguments in explaining this phenomenal growth that is remarkable due to its consistency and resilience in the face of technological and business volatility. In the process, we identify a series of complementary and continuous managerial innovations witnessed in the industry that resulted in creation of superior customer value. The industry exhibited dynamic capability in continuously morphing its business proposition, first by facilitating optimal usage of client resources and subsequently enabling diversification of risks arising out of technology churn and business volatility. Therein, we believe, ties the true explanation for the industry's ability to convert a limited opportunity window into a sustainable business of global proportions.

1. INTRODUCTION

Indian software services exports have grown at a spectacular rate of 42% over the past fifteen years. While the volume of growth, from a mere US$ 52 million in 1987-88 to US $ 10 billion in 2002-03 is spectacular by itself, what is noteworthy is its consistency in the face of rapid technological changes and business volatility. Moreover, this remarkable growth has come from a nation that had significant disadvantages associated with emerging economies, such as inexperience in building a global industry, weak domestic market and 'country of origin' risks associated with less developed countries like India (Cordell, 1992).

However, explanation of this remarkable growth in the face of adversity has seldom gone beyond country specific advantages like 'wage arbitrage' and 'knowledge of English'. We believe this to be too simplistic. The growth was a consequence of continuous and complementary managerial innovations exhibited by leading players of the industry. In an environment of rapid technological change, value creation is contingent upon organization's dynamic capability of honing internal technological, organizational and managerial processes to create new forms of competitive advantage (Teece et al, 1997). In this paper we explain how the Indian software industry, thorough continuous and complementary managerial innovations, was able to adopt, integrate and reconfigure organizational competencies to match the demands of a changing environment.

2. INTELLIGENT OPPORTUNISM TO RESOURCE OPTIMIZATION

Over the last decade, the increasing use of information and communication technology in contemporary society has led to an explosion in the demand for production of software. However, the supply of skilled software professionals, critical for production of software, was limited, leading to scarcity of human resources, especially in developed nations. India, with its large pool of English speaking engineering graduates became an ideal destination for sourcing skilled software professionals. Wage arbitrage that existed between India and the developed nations made such sourcing even more attractive.

During late eighties, several Indian organizations capitalized on this opportunity and started acting as suppliers of software professionals to their clients in the developed nations. The dominant model for meeting this demand was that of resource augmentation, where the software was developed on client premises or 'on-shore'. However, Indian organizations made conscious efforts to move their onsite engagements to off-shore locations, and to reduce their exposure to one-time opportunities like Y2K. Today about 60% of the industry revenue comes from projects carried out from the premises of the Indian software service organization. This migration from an on-shore model to that of off-shore outsourcing was made possible, to a large extent, by leveraging process quality certifications that has become a dominant characteristic of the Indian industry.

2.1 Quality Processes: Leveraging for Remote Location

Process standardization efforts in software development started with the aim of improving productivity. The capability maturity model (CMM) developed by Software Engineering Institute (SEI) of Carnegie Mellon University pushed it forward. SEI CMM is a framework that lays down an evolutionary improvement path of software development--from an adhoc immature process to a mature disciplined process. Review of literature suggests that software process standardization was largely conceptualized for a single location software development process. The Indian software industry innovatively leveraged it to enable offshore outsourcing. More than using SEICMM as processes for quality and productivity improvement, Indian software industry used SEI CMM certification to unbundle the software development process so as to achieve economies of global division of labour.

The sequential life cycle model of software development comprises distinct stages such as feasibility study, requirement analysis, detailed design, coding and unit testing, system integration and postproduction support. While the upstream processes are iterative and unstructured in nature, the downstream processes are often routine and labour intensive. Upstream processes also required co-location of developers with end customers in order to track the various technological and market changes that were likely to impact solution design. Since the developed nations provided the largest markets for software solution, out-location of upstream processes was difficult. However, the labour intensity and routine nature of downstream processes made them ideal candidates for out-location, provided the software development life cycle could be unbundled. This unbundling was made possible by leveraging the SEICMM process quality certification.

For any organization, outsourcing is risky because outsourced tasks cannot be monitored or controlled from close quarters. SEI CMM framework, through rigorous standardization of various process parameters, made it feasible to remotely monitor downstream activities of software development, in terms of schedule, productivity and quality. Unbundling the software development process enabled offshore outsourcing that resulted in cost reduction and productivity improvement due to country specific advantages. The time difference between India and USA--the largest market for Indian software services exports, could also be leveraged to enable '24 X 7 software development', resulting in significant productivity gains. Standardization of project tracking and reporting enabled process control from remote location, mitigating client apprehensions. Governance devices built around process control mechanisms generated trust in client supplier relationships such that, over a period of time, clients were comfortable in outsourcing larger modules of work to the Indian service providers

2.2 Beyond Control: Knowledge Continuity

This resulted in the industry moving from a predominantly 'on-shore' to 'off-shore' model. Leading players of the Indian software industry set up dedicated off-shore development centers in anticipation of a long term relationship that would result in successive projects from clients. The inherent interdependencies within activities of the software development process as well as across various versions of the software solution create need for knowledge continuity across development teams. Dedicated offshore development centers ensured such continuity, which benefited the client and eventually resulted in clients providing successive projects, often from a particular product line, to the same software service provider. Resource intensive activities such as platform migration, application maintenance or fixing the Y2K bug became ideal candidates for outsourcing, which resulted freeing of expensive client resources that could be deployed for carrying out business critical tasks. Over a period of time, especially in projects involving maintenance of certain mature software products, Indian organizations were able to acquire sufficient product knowledge, so as to develop patches and feature upgrades, which extended the lives of such products. Thus, in more ways than one, offshoring of downstream activities to Indian organizations resulted in optimal resource utilization for client organizations. For the Indian software services organizations, this resulted in more business from same clients as well as reference sites that facilitated new customer acquisition. It was thus their ability to supplement process standardization with suitable governance mechanisms within the offshore development centers and to continuously seek opportunities for extending the scope of their engagement that enabled the industry to grow rapidly and consistently.

The Indian software industry, like other high growth industries, had to grapple with the problem of high attrition. High demand for software professionals, especially with project management skills provided opportunities for mobility across organizations in the industry. Many highly skilled professionals were also attracted towards working directly for client organizations overseas resulting in flight of talent from Indian organizations. This would have acted as a serious constraint for maintaining knowledge continuity, had it not been for another initiative among leading players of the software service industry in the form of 'employee stock options' (ESOP). Several Indian organizations started offering stock options to their employees with vesting spread over several years. Given the rapid appreciation of stock prices of most software services organizations in the equity market, ESOPs became an attractive financial incentive--hitherto unheard of in the Indian industry. By retaining critical talent (ESOPs were selectively given to high performers) Indian software organizations were able to retain client specific technical and relational knowledge that is highly tacit in nature. This ensured knowledge continuity within the organization, as well as facilitated transfer of tacit and complex knowledge between the client and the offshore development centre by creating enduring relationships.

2.3 Overcoming Perceptions: Mitigating the Country of Origin Problem

Emerging nations from the third world, like India, often suffer from 'country of origin' risks, implying adverse perceptions in developed markets about products and services from less developed nations due to unfavorable image of less developed countries in markets of developed nations (Cordell, 1992). However, the fact that SEICMM certification came from a renowned institution of USA, the Carnegie Mellon University, helped to mitigate some of the perceived risks typically associated with developing nations. For Indian organizations the journey towards high quality processes have continued beyond CMM level 5, wherein today many of them have obtained People CMM (PCMM), CMM integrated (CMMi) and Six Sigma certifications, which extend quality standardization to a host of other organizational processes, beyond software engineering. We believe that this relentless pursuit of quality certification, especially from renowned third party agencies, enabled the Indian service providers to mitigate, to a large extent, the country of origin risks associated with India.

Over and above the favorable impact of quality certification, there were a series of initiatives both at organizational and at industry level that created a favorable image of the Indian software services industry in the global marketplace. At an industry level, NASSCOM, an association of software organizations was set up as the trade body and chamber of commerce of software and services industry in India. As an industry body, it was first of its kind in India, set up with the aim of promoting the cause of the industry both at a national and at international level. Noteworthy among NASSCOM's several activities towards reputation building was a study instituted with international strategy consulting firm McKinsey, who highlighted the unique position of strength of the Indian software exports industry and predicted that the industry can grow to US$ 80 billion by 2008. This provided instant credibility to the industry and helped the software organizations to successfully bid for projects from Fortune 500 customers, many of whom use McKinsey as their strategy advisor.

In March 1999, Infosys Technologies became the first Indian company to get enlisted on NASDAQ with an offering of over US$ 2 billion. While the apparent reason for this listing was to raise capital for funding international acquisitions it was leveraged to create an international profile for the organization. NASDAQ listing enforced reporting of results as per US GAAP, which was more rigorous than Indian accounting and reporting practices, thus ensuring an international standard of information disclosure and transparency. In fact, Infosys had started disclosing their results as per US GAAP three years prior to the listing to set norms of transparency for the industry and thus, in some way distinguish the software services industry from other traditional industries in India. Infosys' action was soon followed by other large software service firms. International listing also ensured that these organizations as well as the entire Indian software service industry came within the radar of international technology analysts like IDC and Gartner and investment bankers like Lehman Brothers and Goldman Sachs, all of whom started tracking the performance of the industry and enlisted organizations, and thereby inform existing and potential clients. These resulted in high visibility and credibility for the Indian software services industry and provided the industry with a cachet of being global and world class.

3. FROM RESOURCE OPTIMIZATION TO RISK DIVERSIFICATION

Skilled human resources are the most critical input for knowledge intensive industries like software development. Dynamic industries like information technology and communication are characterized by widespread demand fluctuations even in the short and medium term (Bourgeois & Eisenhardt, 1988). Since planning and budgeting cycles in organizations are typically done on a yearly basis, accommodating short and medium term fluctuations become very challenging. Indian software firms viewed the resource volatility faced by their clients as an unsystematic risk that can be reduced my means of diversification. Akin to investors diversifying their portfolios through investments in uncorrelated securities, they started to have relationships with a large number of clients from a variety of industries. Contrary to popular wisdom of developing exclusive customer relationships, software services firms catered to the development needs of customers coming from a wide spectrum of industries such as telecommunication, utilities, banking and financial services, retail and manufacturing. Moreover, even within the same industry such as telecommunication, they started to work with a large number of players, each of who were taking bets with different technologies. This multiple layers of diversification allowed them to minimize the unsystematic risk that might be associated with a particular organization within an industry, or with an entire industry itself. It was hence of little surprise that the Indian software industry in general and its major players in particular were able to successfully get over the downturn that followed the dot-corn bust in the global information technology industry.

3.1 Low End as a Strategic Choice

Popular press has often berated the Indian software service industry for 'going after whatever projects came on their way' instead of developing specific industry focus. This has been cited as a lack of any coherent strategy and an inability to develop core capabilities. We believe that diversification by Indian software services firms was a conscious strategic choice. The Indian software services firms created a flexible resource pool for their overseas client. By building up scale and catering to a large number of clients, they systematically diversified the risk that came from demand fluctuations from individual clients, which the clients by themselves were not in a position to mitigate. However, in order to do that, Indian software firms needed to have employees who had fungible skill sets, such that employees can be swapped across projects, depending upon the demand fluctuations. This automatically required that the services these firms render be confined to the low end of the software development cycle such as coding, testing and maintenance. The relatively structured nature of these activities made them amenable to be executed with a set of skill sets that are standardized and fungible. The managerial insight lay in realizing the critical interdependence between fungible skill sets and manpower risk diversification through scaling. While risk diversification was a customer need, it could only be achieved through rapid scaling of skills that were portable across projects, which in turn created greater capability of risk diversification. It was this virtuous cycle of value creation that acted as the engine of growth for this industry.

Contrary to popular belief that there is little scope of individual learning in this industry due to the fungible nature of skill sets required across projects, we find evidences of active learning that is required for porting ones skill sets from the context of one project, e.g., inventory management in the retailing industry to a completely different one such as upgradation of a billing software for a telecommunication service provider. The organizational achievement lies, on one hand, in training non-computer science engineers and leveraging their basic analytical skills to write and maintain software code and on the other hand, provide continuous training for porting such skill sets across multiple industry contexts. Catering to a broad spectrum of demand from a wide variety of industries also implied that organizations needed to maintain the entire repertoire of software skill sets spanning across multiple technology, multiple programming languages and associated tools and methodologies. There in lay the operational innovation that facilitated risk diversification, which we believe has been a critical value proposition of this industry.

4. CONCLUSION

In this paper we show how the Indian software services industry, by means of continuous and complementary innovations, was able to create superior value for their customers in a rapidly changing business environment. The dynamic capability that the software services industry exhibited in continuously morphing their business propositions, first by enabling optimal usage of client resources and subsequently diversification of risks arising out of technological churn and business volatility, helped them to convert a limited opportunity window into a sustainable business of global proportions. We believe that ours is a first attempt to go beyond the traditional explanations of growth of this industry, which largely centered on country specific advantages like wage arbitrage, availability of English speaking engineers and time zone differences. Organizations from emerging economies lack resources and infrastructure critical for making fundamental technical innovations, which they compensate for by innovating in other areas of business like operations, logistics and customer service (Sull et al, 2003). Likewise the Indian software industry faced serious challenges in terms of its inability to retain world-class scientists and researchers, distance from key markets, inadequate capital and adverse perceptions associated with the country. However, the industry overcame such formidable obstacles by making a series of organizational and managerial innovations that enabled them to create a world class service delivery model in one of the most dynamic and volatile industries in the world.

REFERENCES

Bourgeois, L J. Ill and Eisenhardt, K M., "Strategic Decision Processes in High Velocity Environments:", Management Science, Vol.34, 1988, 816-835

Cordell, V V., "Effect of Consumer Preference for Foreign Sourced Products", Journal of International Business Studies Vol.23 (2), 1992, 251-269

Sull, D N., Ruelas-Gossi, A and Escobari, M., "Innovating Around Obstacles" Strategy and Innovation, 2003, November-December

Teece, D J., Pisano, G and Shuen, A., "Dynamic Capabilities and Strategic Management" Strategic Management Journal, Vol. 18 (7), 1997, 509-33

Author Profiles:

S. Mukherji obtained his doctorate from the Indian Institute of Management (IIM) Bangalore. He is currently Assistant Professor in Organization Behaviour at IIM Bangalore. Prior to this, he worked as a strategy consultant for the Boston Consulting Group.

J Ramachandran is BOC Chair Professor of Business Policy at the Indian Institute of Management (IIM) Bangalore. A qualified Chartered and Cost Accountant, he obtained his doctorate from IIM, Ahmedabad. He has been the Harry Reynolds Visiting International Professor at the Wharton School of the University of Pennsylvania, a Visiting Professor at INSEAD, Fontainebleau, France and the Carlson School of Management, University of Minnesota, USA.