Engg Services & Design: Growing In a New Niche

It was the TCS' deal with Ferrari last year that grabbed
media attention and since then offshore engineering services is being touted as
the next big opportunity in the offshore IT services space. The export story in
the engineering services space has been evolving over the last couple of years.

The expansion in the range of activities included in
-engineering services and the corresponding increase in market -potential is
visible today with a maturing vendor landscape; traditional EPC companies
adapting to the global sourcing model, IT services firms expanding their
engineering services practice, the emergence of specialized (non-IT) firms
offering these services, and the distinction between the buyer organizations for
these services with separate R&D and IT budgets. The scope of engineering
services in its present state, that is, what is considered to be outsourceable
currently, spans product design (both electronics and mechanical) plant design,
process engineering, enterprise asset management, and plant automation services.

The maturity curve in the outsourced engineering services
in India has originally evolved from outsourced product engineering (mechanical)
services. Basic drawing conversions and CAD migration assignments have moved
through 2D-3D modeling and digital mock-ups, conceptual design, analysis and
validation; complete design outsourcing, manufacturing coordination, CPC/PDM;
overall process quality improvement, e-engineering solutions, remote monitoring,
and system architecture development over the last couple of years. Engineering
services provided out of India today are primarily centered around the discrete
manufacturing industry with an emphasis on product development services such as
automotive engineering design.

The worldwide market for outsourced engineering was worth
$69.8 bn in 2001 and is forecast to grow at a five-year CAGR of 12.2% to reach
$23.9 bn by the end of this year, according to industry estimates. The worldwide
opportunity in engineering services was valued at around at $7 bn. Currently,
around 20% of the overall opportunity in engineering services is coming as
offshoring to third party vendors in India, Taiwan, and China. These estimates
still remain primarily focused on the design engineering and address only a part
of the market potential for engineering services. The potential for process
engineering, plant automation, and enterprise asset management services lies
relatively unexamined. Industry estimates peg the market potential for process
engineering, asset management, and industrial embedded systems at over $5 bn,
taking the total offshore market potential to approximately $12 bn. This entire
market is estimated to reach a size of $60 bn by 2008, according to industry
research. Says Prashanth Chunduri, head, Marketing and HR, Neilsoft, “India is
in a position to capture 4-5% of the $60-bn opportunity. Says Ravi Gopinath, VP
(Engineering Services), TCS, “We estimate the current size of the market to be
in the range of $650-700 mn.”

Product design engineering, which is where most of the
action is presently, encompasses mechanical as well as electronic engineering
disciplines. The services -offered extend from the early stages of idea
generation, through engineering analysis and design, virtual simulation,
documentation and conversion, prototyping and production, testing,
knowledge-based engineering, and PLM solutions. Key phases in the product design
(mechanical) include concept development, preliminary design, detail design,
validation, pre-production, and production. The rest of the pie, which is really
insignificant in comparison to product design engineering, is taken up by
process engineering, plant automation, and enterprise asset management services.
Few players like TCS have been able to establish a footprint in the entire pie.

While engineering services market has been picking up over
the years now, the real hustle and bustle actually began around three years
back. The last fiscal was significant enough for Indian players to look at
special branding strategies in engineering services. Infosys, for example, is
pitching heavily on innovation product lifecycle and engineering services.

There are several factors that are driving the steady
growth in the export opportunity in engineering services, especially product
development. One, as more manufacturers move to the next stage in their
transformation journey and drive market differentiation and growth through
innovation, there's an increased focus on design process. Two, while the focus
on innovation will increase, the locus of innovation is moving beyond the
confines of internal R&D in the organization. Product companies are also
increasingly leveraging extended engineering across all stages of product
development lifecycle. Supply-demand economics of engineering talent is playing
a vital role in influencing companies to leverage outsourcing for design and
engineering. All these factors are working in favor of engineering services
moving to remote destinations. Finally, it's the cost arbitrage that is the
main driver of this huge boom in offshore engineering services. Engineering
cycle time can drop by 25-30%, in addition to 30-45% in cost; 20-30% improvement
in production efficiency, and 15-20% reductions in maintenance cost. While these
are the generic benefits of outsourcing engineering services, independent
players promise better returns and margins. Infosys innovation in media product,
for example, reduced the cost to 1/10th of its earlier avatar, according to
company sources. Another innovation of the wireless simulator saved an Infosys
customer close to $40 mn.

Riding on Automotive

It was the automotive industry that was the first to -realize the benefits
of outsourcing engineering services to low-cost destinations like India. This is
what saw the first wave of outsourcing to India through captives of auto majors
like General Motor, Nissan, Toyota, and Johnson Controls.Â
Automotive design forms the largest segment, accounting for 65-70% of the
market, according to a Nasscom report. The automotive segment spends an average
of 3-5% of its annual revenues on R&D activities, and engineering design is
a critical component. Design spends account for nearly half of an auto
company's R&D spending and according to industry estimates, nearly $4.8 bn
of this R&D budget is outsourceable.

Beyond the Wheels

Though aerospace segment holds a great potential for engineering design, the
outsourcing in this domain is still low. A significant trend in this space is an
increasing drive toward gathering domain knowledge and creating a USP for the
customer. TCS and HAL have commenced collaboration to provide end-to-end
engineering solutions to global aerospace customers. TCS has several years of
experience working with many aerospace companies like AVIO, Boeing, B/E
Aerospace, EADS CIMPA, Dunlop Aerospace, GE Aircraft Engines, SME Aerospace,
Goodrich, Pratt & Whitney, and others. On the other hand, HAL works with
Boeing, Airbus, Honeywell, BAE System, EADS, SNECMA group, Rolls Royce, and
others. Bangalore-based QuEST is betting big on Aerospace and Energy and
estimates both domains to occupy 70% of the market. Says Bejoy George, VP
(Marketing & Business Development), QuEST Global, “Currently, the boom in
aerospace and energy (Power Generation and Oil & Gas) sectors can be
attributed to a shortage of skilled engineers in the West.”

Nasscom estimates that design spends of the top 10 players,
who account for over 90% of the entire design spend in the aerospace industry
amount to nearly $2.8 bn every year. The outsourceable portion of this spend is
estimated to be at over $1 bn. Outsourcing in aerospace primarily revolves
around four major sub-systems of the aircraft-structures, avionics, engine
performance and analysis, and systems. Currently, aerospace constitutes 15-16%
of the offshore engineering services pie, according to Nasscom estimates.

Electric and electronic machinery design constitute around
10-12% of the pie. Other key vertical segments considered good targets for
outsourced engineering services include construction, utilities,
pharmaceuticals, and heavy engineering.

Growing Exuberance

Offshore engineering services landscape in India can be divided into
captives, IT vendors with engineering services practice, OEM vendors and
specialist engineering services vendors. The first category comprises the
captive units of international engineering, -automotive, aerospace, ICT and
other industrial -majors such as Bechtel, Flour Daniel, Kvaerner, Ford, -Daimler
Chrysler, General Motors, Caterpillar, Texas Instruments, Motorola, Cadence,
etc. who undertake work for their own (parent) consumption globally. The second
category comprises large IT players such as HCL Technologies, Satyam, TCS, and
Wipro that have leveraged their skills in the engineering domain coupled with
project management and global service delivery to become important players in
this space. The third category consists of the OEM players with sizeable design
departments that offer these services on an outsourced basis. These include
players such as L&T, Thermax, Mahindra, and Hero Global Design. The fourth
category comprises a relatively newer set of firms such as Nielsoft, Sierra
Atlantic, Infotech Enterprises, etc. that are focused on engineering
outsourcing. Companies such as Geometric Software Solutions or Rolta India have
one of their divisions dedicated to providing these services. With the increase
in sourcing options, several MNCs have adopted hybrid sourcing strategies and
are working with outsourced vendors in addition to the work undertaken in their
captive units in the country.

The overall growth in this space from the industries
standpoint is around 30% year-on-year, according to -industry estimates. TCS's
engineering services revenue in FY 2005—06 stood at Rs 940 crore, clocking a
growth of 62%. This is far higher than last year's growth of 50%, which was
calculated on a lower base. TCS' headcount in engineering services alone was
1,600 at the close of last fiscal and is expected to grow to 2,000 by the end of
the current fiscal. For Infosys, product engineering services contributed close
to 10% to total revenues and it employs approximately 5,000 Infoscions. TCS'
engineering services arm contributed 7% of its revenues last fiscal. HCL
Technologies' engineering services operations clocked a 40% growth rate and
closed last fiscal at Rs 1,067 crore.

For boutiques players like Neilsoft, growth has been around
40% in the last fiscal. The company closed FY 2005-06 on a revenue of Rs 40
crore. Neilsoft has recently begun its next phase of expansion, wherein it plans
to grow 10 times in the next six years. The short-term goal of this major
expansion plan is to expand capacity to over 1,000 seats in the next 18 months
(from the current 500 seats). QuEST is looking at 40-50% increase in revenues
every year for the next three to five years.

Moving Up the Value Chain

The engineering services industry has seen good growth rates in the last few
years, and more international companies have begun leveraging offshoring to
improve their engineering efficiencies and cost structures. Says Chunduri,
“There has been an increase in the number of engineering services outsourcing
deals and also an increase in the size of the deals. As clients become more
comfortable with the success of the global delivery model in engineering
services, they outsource larger portions of their engineering value chain.”

Opines George, “Although the work coming to India has
moved up the value chain from the initial days of CAD, we still haven't really
seen new product development work (R&D) coming our way.” However,
there's increasingly more work coming in product reengineering/redesign,
product innovations, product lifecycle enhancement, and sustenance work, in
addition to full product responsibility. As more and more of the activities,
which are currently considered core activities, are seen as non-core to a
customer, the higher end of work opportunity will be given to vendor partners.

For QuEST, one of the most significant deals has been with
Rolls-Royce. Today, tasks vary in size from less than 100 hours to large data
conversion programs-10,000 hours and more.Â
The scope of the work is drawn from across the Gas Turbine Lifecycle.Â
Skills in the office range from Component & Systems Design, Cost
Reduction Design, Modeling & Detailing, Engineering Analysis, Gas Turbine
Performance work, Experimental Engineering, Ground Support Equipment Design, and
Technical Publications.

Says Gopinath, “Increasingly, Indian players are moving
from offshore services to being global engineering partners delivering not only
from low-cost locations but from their own premises as well, acting as
extensions of their -engineering teams.”

Big vs Small

While engineering services in its current state is going great guns,
increased opportunity is coming from newer areas like utilities, medical, and
scientific equipment and marine. As competition heats up, it's really about
how boutique players match up to the large IT vendors when it comes to grabbing
a deal. Engineering services and IT services share some common attributes, but
are different across many dimensions. With the IT majors betting on this area,
we see more awareness and branding of this segment happening which is good in
the long run. Says Chunduri, “The market size is huge and growing, and
there's enough room for growth for everyone. Specialist engineering vendors,
while smaller in size compared to large IT vendors, have the advantage of having
engineering specific domain knowledge, culture, processes, and delivery
model.”

“A large number of medium size companies ($500 mn to $5
bn in revenue) would prefer -focused companies like QuEST, for the speed of
response, technical depth, and complete attention to engineering services,
rather than the IT biggies that happen to have engineering services as a low
single-digit percentage contribution to their revenue,” opines George.
Counters Gunaseelam N, VP, Technology-Led Services, HCL Technologies, “The
larger Indian players that have developed a complete set of end-to-end offerings
spanning multiple technologies and different industries will move into more
strategic partnerships with customers, which will not be limited to back-end
product development and maintenance work.” Gunaseelam sees large players
sharing a risk-reward partnership with their customers and engage at a level
where direct value will be provided to the customer's end-customers. The
smaller players on the other hand are likely to find it difficult to scale to
this strategic level, as they'll lack the depth of domain expertise, the
portfolio of IP, and the breadth of design and engineering expertise, according
to industry biggies.

However, the present opportunity in outsourced engineering
services remains big enough for everyone to smile back home. And, that indeed,
is great news for the future of India's exports in IT.

Bhaswati Chakravorty

bhaswatic@cybermedia.co.in