India is already the champion in application software. Now a set of small firms is turning it into a top destination for product development.

Persistent and Aditi are among the pioneers of software product development in India-a country known the world over for its exceptional talent in software application development (or ADM, in industry parlance) but never a force in product development. But now, a new set of Indian companies-Aditi, Persistent, Aspire Systems, AztecSoft, IndusLogic, Ness Technologies, PSI Data, Symphony Services, Vertusa and so on-are making a mark in the world of product services domain by partnering with independent software vendors (ISVs) like Microsoft, Google, Oracle, Adobe arid Computer Associates.

Termed outsourced product development, or OPD, this involves out- sourcing of activities, either in part or the whole, related to the development and maintenance of a software product. Take Microsoft for example. It has a huge product catalogue and billions of dollars are spent every year to launch newer ones. Naturally, it has finite resources, which would be better spent on cutting-edge R&D. So it outsources maintenance of older products (Windows 98) or upgrades of existing products (Windows XP) to a third party. If it helps save time and money, even bits and pieces of its new product development (Vista) could be outsourced. And this is where niche OPD players come into the picture.

Coming Of Age
"Product development was once considered the last area that a software product company was willing to outsource to India. This has changed," says Singh of Aditi. He says that OPD in India began with product testing, which required people to manually test new software products; the next wave involved adding new functionalities to existing software products; and, since then, the industry has moved to building competitive software products.

The customers are essentially of two genres. First there are the large ISVs that begin with outsourcing just one or two activities and, only after they are confident with the delivery capabilities of their OPD partner, look at expanding the relationship further. And then, there are start-ups that are open to outsourcing all the product development activities so that they can focus on defining and marketing the product.

All OPD companies we spoke to admitted to having a mix of both. While larger product companies bring bigger deal sizes and are obviously more stable, the sales cycle is longer and rates comparatively lower. The start-ups, on the other hand, are willing to cough up a little more and close the deal faster but there's always the risk of failure and the venture folding up. Either way, there is no denying that the quantum of OPD work coming India's way is on the rise. Nasscom, for example, forecasts that the OPD market in India will touch $8-10 billion by 2008 from a little over $3 billion in 2005. It was just a $300-million industry in 2001.

And the quality of work is also improving. T R Madan Mohan, Director, Consulting, ICT Practice, Frost & Sullivan, says, "Companies are handling more core research and development projects, unlike few years back where they were handling more 'D' (development without doing the research) projects. While this is definitely more visible in start-ups, this is also being seen across the client base of Microsoft, IBM and Sun." Gowri Shankar Subramanian, CEO, Aspire Systems, agrees, "As the OPD model and product building proficiencies in India increase, larger customers will also move towards outsourcing more and more mission-critical work."

But what's driving this business? Cost is the obvious answer-opinions vary on the amount saved, but most analysts say it is in the 30-35% range. But cost is not the sole driving force. Globally, product companies are under pressure to release newer products/versions and frequently to beat competition. Outsourcing helps them cut time-to-market.

Then there's the issue of scaling up the in-house technology team-easily done by tapping into India's large talent pool. Here setting up captive facilities may not be the answer. Sudin Apte, Senior Analyst and Country Head (India), Forrester Research, explains, "Our research shows that the captive approach does not suit everyone and there are several instances of challenged captive centres. Firms like BEA Systems and Yahoo, which started with purely captive facilities now rely more heavily on third-party providers in India."

Tip Of The Iceberg
In fact, many Indian OPD firms see this as the beginning of a trend where a number of small software development firms will either close down or get transferred to their Indian vendors. “This is the tip of the iceberg,” says Amitava Roy, President, Symphony. Citing AT Kearney’s research findings, Roy says, “By 2008, captives will account for just 20% of the off- shoring market in terms of employment as against 70% at present.”

Madan Mohan of Frost & Sullivan says he sees OPD as a major growth driver for Indian companies. "Growth will come from e-governance, health, banking, telecom and open source areas. Companies like Aspire and Aditi have made major strides in developing products for non-governmental organisations, health and banking, financial services and insurance sectors for medium-size companies in the US and Europe," he adds.

Apte of Forrester says, "As companies across a range of verticals, from aerospace to medical instruments, grapple to add more value-added software to their product while cutting overall research and development costs, this offshore segment will expand dramatically."

And how does the OPD space compare in terms of pricing? Most companies say it depends on the nature of the work. For challenging assignments, the rates may be 20% higher than software application development services. But for routine, contextual work, billing rates could be lower than ADM. Speaking on the condition of anonymity, officials of a mid-sized ISV told us that they had recently outsourced some contextual work to an OPD player for $l8-19 per hour. V Chandrasekaran, CEO and Managing Director, AztecSoft, the only listed player in the OPD segment, says billing rates are typically lower than Tier I ADM vendors. "But margins at the gross level are roughly equal because OPD has a much larger offshore component," he says. So, what are the challenges ahead? Sampath Iyengar, CEO, PSI Data Systems, says, "Today, the OPD market in India is in a growth phase so everyone's doing well. But we see it maturing over the next three years and that's when domain expertise will come to play a bigger role as companies will need to offer a differentiated model in order to ink better deals and fetch higher rates."

Agrees Anand Deshpande, Founder, Chairman and Managing Director, Persistent, which boasts of funding from Intel Capital and Norwest Venture Partners. "Currently, the OPD space is largely being driven by cost arbitrage and process efficiency, but once the market matures, the focus will turn to design efficiency and we want to be ready," he says. For this, the company has come up with a Go-To-Live offering, which includes every aspect of product development including research and design, quality analysis, cross-platform development, deployment, integration, etc. Aditi, on its part, is betting heavily on migration (partnering with product companies to help them migrate to newer Microsoft platforms), while Symphony has forayed into new areas like embedded software for the automotive, consumer electronics and telecom verticals. As Madan Mohan says, "One major change I foresee in OPD would be more on the lines of open innovation, where the partner is very tightly embedded into the product roadmap but with enough flexibility and resources to design, test, and deploy 'new products'". "I believe companies will have to develop processes and skill sets to manage OPD more on ownership model than a project- transaction model," Deshpande adds. Some companies have come to realise this and are beginning to think ahead-of a time when growth will not come in fast and furious and differentiated offerings will command a premium over the routine ones. Those who can deliver on this will be tomorrow's winners.

"Margins at the gross level are roughly equal because OPD has a much larger offshore component"
V CHANDRASEKARAN, CEO AND MD, AZTECSOFT

"Product development was the last thing a software firm wanted to outsource to India. That has changed"
PRADEEP SINGH, FOUNDER AND CEO, ADITI

"By 2008, captives will account for just 20% of the offshoring market in terms of employment versus 70% now"
AMITAVA ROY, PRESIDENT, SYMPHONY

"Currently, OPD is being driven by cost arbitrage, but once it matures, design efficiency will be the focus"
ANAND DESHPANDE, FOUNDER AND CMD, PERSISTENT SYSTEMS