Bangalore's Teeming Software Bazaar

India doesn't have enough software developers like Narendra Kumar. In 1989, the 25-year-old Kumar borrowed $300 from his father and disappeared into his bedroom to work feverishly for a year. He emerged with a virus-combating software package that he has been promoting furiously throughout India ever since. His Nashsoft Systems Ltd. in Bangalore has sold 20,000 units so far and is trying to launch its software in Singapore and, eventually, the U.S.

With its abundance of low-wage, well-educated programmers, India's software industry earned $840 million in revenues during the past fiscal year--58% of that from exports. The industry association optimistically estimates sales will hit $5 billion by 2000. The action is concentrated in the southern city of Bangalore--dubbed India's Silicon Valley.

But there's mounting evidence that India might not be able to achieve its software dreams so easily. One reason, says Kumar, is that Indian companies "are too busy making money from the flesh trade"--using cheap labor to write customized software for big corporate customers. What they're not doing is investing in design and retail distribution of software for broader individual use. That strategy is at risk because big U.S. companies such as Oracle Corp. and Novell Inc. are hiring more researchers, designers, and programmers in India, making the pool of English-speaking technical talent more expensive.

COZY NICHE. Indian competitors are also suffering from geographic isolation. No matter how mathematically gifted and computer-literate they are, they remain out of touch with trends in the U.S. and Europe. The burst of software being distributed over the Internet in America, for example, is changing the industry. But Indian software players are only beginning to explore the Internet connection.

So the Indians risk being trapped, in effect. In their customized software niche, they account for 12% of the world market. But the rising labor costs and shrinking demand for such products mean profits are in trouble. "We are earning our livelihood. We are not making money," says Ayyagari Rao, vice-president at Wipro Systems Ltd., one of India's largest software outfits. Some companies are turning to ready-made products, such as accounting packages, that can be sold to multiple customers. But too many large companies are loath to invest in these new products.

Labor, the foundation on which the industry was built, is turning out to be its Achilles' heel. India's largest provider of big customized software networks, Tata Consultancy Services, has 4,700 employees and just $112 million in revenues. But it doesn't enjoy economies of scale: Each new customer means hiring more employees to do the work. Revenues rise, but profits do not.

In fact, profits from customized software are starting to fall, as labor costs rise 25% a year. India's technological institutes aren't churning out enough graduates to fill the demand. Indians returning from universities or research institutes abroad typically get jobs with foreign companies that have set up software research and development operations in India. Motorola's unit in Bangalore, for example, is producing world-class multimedia software.

The technical talent is attracted to the U.S. and other foreign giants not only because of the sophistication of their products but also because of the 20% pay differentials they offer. Depending on seniority, that can amount to $1,000 to $4,000 a year, which is big money by Indian standards. In response, Indian companies have to keep raising their own wages. "Year after year, our profit margins are bleeding," moans N.R. Narayana Murthy, managing director of Infosys Technologies Ltd.

Clearly, India's software industry has to make important shifts in strategy if it is to sustain its growth. Many companies are developing products that need to be only slightly customized and can be sold to niche clients--financial packages for banks or warehouse management software for manufacturers. Instead of a one-time sale of a $1 million customized unit, they are looking to sell dozens of, say, $100,000 units that need slight customization. "People will simply buy stuff off the shelf and tweak it," predicts Vikram Shah, managing director of Novell's India operation.

Even this hybrid software will represent a challenge--at the distribution end. "Indian companies' strength is not marketing. It's software development," says Infosys' Murthy. Infosys, like many others, is choosing to open up offices in markets they want to enter--primarily the U.S. "You can't sit in India and be up to date on what software people want," says Ashank Desai, managing director of Mastek Ltd., which has an office in Santa Clara, Calif. His company specializes in object-oriented software.

Other companies are responding by setting up marketing alliances with foreign partners. That includes Tata Consultancy. Even though it has 37 offices worldwide to provide support for its customized software, it is also forming alliances with computer marketers and distributors to help sell its products.

Of course, Indian companies need to find money to pay for all this. Although many companies have gone public, raising additional equity in the domestic markets has proved difficult. "Indian investors don't yet give a very high value to technology sectors," says Kislay Kanth, a computer industry analyst at DSP Financial Ltd. in Bombay.

The key is venture capital, but that industry is just getting off the ground: So far, there are only a dozen or so venture-capital funds in India. They are lending about 10% of their money, or $20 million a year, to high-tech industries, and they are targeting those companies expanding beyond customized software. When talking to a software company, "We ask if they have a road map to be a product company in the next five years," says G. Sabarinathan, vice-president of Technology Development & Information Co. of India. The company, based in Bangalore, runs a $90 million fund.

DESIGN GAP. The Internet could eventually help solve some of India's problems--without huge sums of equity. The Indians hope to begin distributing semicustomized products through the Internet, which would be much cheaper than setting up retailing and marketing networks. "We have a greater ability to understand the Internet from over here than we do understanding the American or European markets," says V. Chandrasekaran, president of Wipro Systems. He's looking for a joint-venture partner to help get his products on the Net.

Will the world buy Indian software? Ultimately, it boils down to the quality of what Indians can design. So far, they haven't established themselves in the top tier of the mass market. "We are mostly perceived as cheap labor rather than quality products," says DSP's Kanth. What India needs is to produce just one or two products that achieve world acclaim. Hugely ambitious, the Indians predict their first hit could arrive within five years. Some even dream that India might one day produce its own Bill Gates. But before that can happen, the Indian industry has some growing up to do.

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