Wipro recently announced its intention to acquire the assets and the software professionals working at Ericsson’s R&D centres in India. The significance of the deal lies in the fact that this is the first time ever that an Indian company has acquired an entire R&D arm of an MNC customer. Srikanth R P analyses the deal and finds out whether it will trigger off a new outsourcing trend in India

A year ago gloom was the prevailing sentiment in Indian Software Inc. First it was the tech meltdown in the US that pulled the sentiment down, then came the 9/11 attacks, which further affected the US economy and thus threw the plans of every Indian software company into a tizzy. But today, almost 14 months and some tough balancing acts since 9/11, Indian software companies are now looking optimistically at the next big boom in outsourcing. And just as industry bodies like Nasscom had predicted, the global downturn has perhaps turned out to be a blessing in disguise for Indian software companies.

But it’s not like the glory days are here all over again—competition in this area is tough with more than 50 top Indian companies—consisting of both the top-tier and middle-tier—competing aggressively for a share of the outsourcing pie. Every major company worth its salt has been trying to gain a competitive edge in this space through innovative strategies. Wipro went one step further when it announced its intention to acquire the three Indian research and development (R&D) centres of its client and global telecom major, Ericsson. Though from the outside this looks like just another acquisition, in reality it can be termed as the first instance of a total R&D outsourcing deal in the history of the Indian software industry.

The deal itself
According to the letter of intent that Wipro has signed, the deal will involve Wipro picking up assets, including personnel, of Ericsson’s R&D centres in Bangalore, Hyderabad and New Delhi. Around 300 software professionals who were part of Ericsson’s units would now be on Wipro’s payroll. This would take Wipro’s overall Ericsson-related team size close to 400 software professionals, as the software major already has around 100 people working on Ericsson’s projects. While the financial terms of the agreement are yet to be worked out, the deal does throw up interesting pointers on what Indian companies can do to gain a competitive edge.

Rather than term this deal as an acquisition, Wipro is calling it an ‘outsourcing deal’. Wipro intends to run the centres in the form of an outsourcing contract, wherein it will undertake the entire responsibility for all the R&D work of the Swedish firm done in India by taking over assets and people.

While MNCs have been outsourcing R&D requirements for a long time to Indian software companies, the current competitive scenario has changed things a bit. At present, the R&D outsourcing services market is taking on a hue similar to the IT services scenario. For instance, when companies first began outsourcing their R&D services to India, the billing rates quoted were premium rates. But as more and more Indian companies ventured into this market, billing rates fell drastically and MNCs started dividing their work between their own Indian R&D centres and a handful of Indian software companies.

Due to the turmoil in the global telecom industry these MNCs have been looking at the best way to cut costs
without compromising on R&D. For instance, a year ago Ericsson had announced that it wanted to increase investments in its Indian R&D arms. The telecom giant had plans of scaling up manpower in these centres even though it cut manpower requirements massively in other centres. But in the light of the massive slowdown in the telecom sector, Ericsson thought it prudent to write off its assets in the Indian centres, while still retaining its competitive advantage by selling the centres and the people working there to its partner, Wipro. As a result the deal has created a win-win situation for both companies, or so it seems.

From Ericsson’s point of view, it can get the same work done by its own ex-employees—at a fraction of the cost—without compromising on R&D. In addition, this deal frees up essential capital. In fact, Ericsson has been aggressively selling its assets of late. Just a few weeks ago it signed a similar deal with TietoEnator, one of Finland’s biggest IT services companies, for the sale of its Finnish R&D centres.

Says an analyst with a leading investment firm, “One important point to be noted in this deal is that customers are increasingly looking to outsource more work to India to increase return on investment (RoI) from technology spend. But the point here is not so much about the capital-intensive nature of operations, but rather the overall cost of software development, which is lower in the case of Indian vendors. This is why it makes much more sense for Ericsson to outsource its R&D work to Wipro.” Analysts also believe that it is easier for vendors like Wipro, rather than customers like Ericsson, to keep up with the latest technology trends.

How Wipro gains
At a time like this when companies are losing more clients in a quarter than adding them, thanks to the tough business climate—it has become essential for software companies to build a more compelling long-term relationship with their clients. This deal can help Wipro build such a relationship. For instance, Wipro is already doing around $5 million worth of business each quarter with Ericsson. With the signing of the agreement, revenues could quadruple since the number of people that Wipro has working on Ericsson’s projects would also increase from 100 to 400. Also, till now Ericsson has never been a top customer for Wipro, but this deal could turn things around. Though it is believed that Ericsson has not signed any exclusivity clause with Wipro for outsourcing its R&D work only to these centres, analysts say that in the short term there is no doubt that Wipro will be the preferred partner.

Also, though this deal is based offshore, it will offer considerable outsourcing experience to Wipro, as Ericsson’s Indian R&D arms were involved in developing core technologies for cellular, switching and transmission equipment. Now, Wipro can leverage its expertise and experience in these technologies to bid for larger outsourcing projects. In the future, if Wipro manages to leverage its engagements in the offshore mode and get some onsite projects, it could translate into higher margins.

In addition to increasing business from Ericsson, Wipro can also utilise the team’s expertise for projects at other telecom majors, with provisioning for IP protection clauses. Says Aman Chauhan, an equity analyst with Taib Securities, “From the moment the deal gets finalised Wipro will immediately get the projects on its books, which were till date routed through Ericsson’s Indian R&D arms. And as time goes by, the whole centre can be expected to scale up.” More importantly, analysts believe that till date MNCs have been outsourcing piecemeal R&D projects to Indian companies. But with the acquisition of Ericsson’s R&D centres, Wipro would get a chance to do more complex end-to end R&D projects for Ericsson.

The cons
But the going may not be all rosy. As Wipro is also taking on 300 of Ericsson’s employees, there may be a salary differentiation issue. This is because MNCs typically operate on a higher pay scale as compared to Indian companies. Typically, the ratio can be 1:1.5 in favour of MNC salaries. But considering the size of Wipro’s operations, this will be a minor issue that can be sorted out.

Though in the short term Wipro can count on steady business coming in from Ericsson, in the long term this may not be the case. Ericsson may not like to put all its eggs into one basket and it could try to hedge its bets by pursuing options with other Indian players. And when that happens, billing rates would go for a toss.

Comments an IT analyst from Indiainfoline.com, “While the advantage is in the form of business for Wipro, the disadvantage is that the telecom industry globally is yet to show signs of recovery, as it is suffering from excess investment and abundant capacity. Hence, there is nothing concrete about the deal unless one gets to know about the deal amount.” Also, as the IT and telecom industries are R&D-intensive industries—for MNCs to survive it is essential for them to focus on R&D, which is the core strength of any technology-intensive industry. Most analysts believe that while the experience garnered by Wipro will be great, MNCs have been typically outsourcing appendages of R&D to Indian IT companies.

So, till the actual details come out, it remains to be seen whether Wipro will really gain, as Ericsson may not outsource its core R&D work. But beginning with this deal, the next few years may well see a trend where MNCs instead of investing in their own R&D arms may prefer to outsource it to Indian software companies by keeping only the core R&D areas with themselves.

Some analysts whom we spoke also pointed out that while it has been a common strategy for vendors to take on skilled people from a customer not many companies prefer to take on physical assets. Industry watchers say that Wipro may have missed a trick or two as it is also taking control of the physical assets of Ericsson.

Conclusion
Though it is too premature to pass judgement at this stage, especially since the financial details are yet to be worked out, this move by Wipro could bring about an interesting change in the outsourcing business. If Wipro’s move succeeds in bringing long-term assured business—it could trigger off a spate of similar moves by other leading software companies.