Engineering services : In the Limelight, Finally

Labeling FY 09 a tough time would be a huge understatement. The automotive
industry, traditionally one of the two largest verticals for the Indian
engineering services exporters, was going through one of the most turbulent
times in its history, with many large manufacturers queuing up to file for
chapter 11. Quite a few of them ultimately did, though only in April-June 09
(and most of them came out of in surprisingly short time, but that is another
story). The list included OEMs like GM and Chrysler as well as tier-1 suppliers
like Visteon and Lear Corporationall significant practitioners of offshoring to
India, both through the captive and outsourcing models.

It is in this context that the performance of engineering services exports
has to be seen. So, while the rupee growth at 30% over last year actually saw
acceleration as compared to 26% in FY 08, that was more due to the exchange
rate fluctuations. The dollar growthprobably a little better indicator of the
market realities at 13% was surely not spectacular, but surely modest,
considering the turbulent times in not just the automotive industry but the
global economy in general and developed market economies in particular.

CyberMedia Research    DQ Estimates
*DQ Estimates.
Does not include revenues from telecom, IT, semiconductor segments

Last Years #4, Satyam is missing from the list, while Infosys has come in
as the new #3. The huge others includes Satyam revenues

Focus Re-branding
Ironically, this was a period in which engineering services received all the
attention at homepartly due to the slowdown, and partly despite it. At the
industry level, Nasscom also became more active and thought a little re-branding
with a little more hype could helpnot just in attracting customers and more
players, but also private equity, a key ingredient for healthy growth in an
emerging opportunity area. The result is a new annual forum that Nasscom is
organizing in Pune, which should be on by the time this issue reaches your
hands. It is also releasing a new full study on the potential of engineering
services, three years after it released the first engineering services study by
Booz Allen & Hamilton.

CyberMedia Research  DQ Estimates
Even with most
engineering segments severly affected by the downturn, engineering services
to India acclerated, thanks to the increasing pressure on margins

At the individual company levels too, many IT firms finally decided to
address it as a focus area. While for some it was a completely new target, many
others had earlier addressed it in fragmented ways, often clubbed with
traditional IT services in a vertical, and had never even measured it as a
special horizontal, let alone do focused business development. Infosys is a case
in point. It started measuring engineering services separately and the figures
that it arrived at made it jump to third position in our ranking, just a little
behind #2 HCL. In fact, Infosys response to our survey also reflected this
change. For the first time in three years of this survey, Infosys returned our
form filled in all respects, with all the information, something that it does
usually when it comes to IT services and BPO.

CyberMedia Research    DQ Estimates
While the share of
captives is falling in BPO and IT, engineering services still sees
significant interest in this model

Interestingly, after keeping away from the area for a long time, large
non-Indian IT services firms too started looking at this area seriously. IBM,
which had the capability but hardly spoke about it, started focused activities.
Accenture started building its capability in India while Perot Systems too
announced its foray into engineering services. Some of them are looking at
acquiring a specialized company and while the number of potential target
companies is small, we may see one or two announcements this year.

CyberMedia Research  DQ Estimates

If one has to add
captives, the share of aerospace would drop significantly, while those of
construction and others would go

If you thought that meant the game was fast being decided in favor of IT
services firms, there was more zealous, though not as high profile, movement
among the specialized services players tooowned by large automotive groups as
well as niche independent companies. In the former category, Hinduja-owned
Ashley, M&M-owned Mahindra Engineering Services stepped up their activities
while Hindustan Motors entered the space. While Ashley went for a re-branding,
Mahindra Engineering Services acquired an Italian motorcycle design firm Engines
Engineering SpA to enter that space. Hindustan Motors, apart from its Chennai
center, set up an onshore center in Japan, a market that has not been tapped in
a big way by Indian companies. It is understood that Mitsubishi Motors, a
partner of HM for selling its vehicles in India, is an initial client of the

Among the independent companies, a few companies worth mentioning are Pune-based
Tooltech, Noida-based Axis AT&T, and Bengaluru-based AugenTech. Tooltech, which
acquired two automotive engineering companies in SwedenIdeteknik and Aspinovahas
transformed itself from a CAD company to a product engineering company. Axis
IT&Tas the erstwhile IT&T is known after it acquired engineering services firm
Axissaw 61% of its stake being acquired by BPL boss Rajeev Chandrasekhar
through a company owned by his Jupiter Capital. According to sources, Axis IT&T
is seriously looking at the construction equipment segment and if the industry
grapevine is to be believed, Chandrasekhar is also keen on aerospace and may
invest in a Bengaluru-based company with aerospace industry expertise. AugenTech,
which with a revenue of Rs 16 crore in FY 09, is still small, is a company to
watch out for.

The period also saw vigorous re-branding activities, largely among the
specialized players. Tata Technologies, majority owned by Tata Motors, which had
started rebranding itself as INCAT, after acquisition of the London-listed firm,
did a U turn, re-branding again as Tata Technologiesa clear testimony to the
fact that post Nano and post JLR, the Tata brand is a far stronger engineering
brand globally. Vadodara-headquartered L&T Integrated Engineering Services, part
of L&T, but often overshadowed by more high profile L&T Infotech too started
doing focused marketing and branding exercise. It participated directly in our
survey for the first time in three years that this research has been in
existence. The Hindujas, which had promoted an engineering services firm, Ashley
Design and Engineering Services, re-branded it as Defiance Technologies, after
merging it with Defiance Testing & Engineering, a Detroit-based firm that group
flagship company Ashok Leyland had acquired in 2007. Recently, they decided to
demerge the combined entity from Ashok Leyland.

CyberMedia Research                                                                                              DQ Estimates
The list is still
getting bigger. Also, we do not claim it is a comprehensive list as many
small operations are not captured in this

While all this was happening, the most important event of last year in the IT
industry had its impact on the engineering services segment too. Fall of Satyamwhich
had a strong engineering services practice, the veracity of which is even
acknowledged by competitorsled to a lot of good talent being available to the
industry in general. And the industry did acknowledge it with hiring many ex-Satyamites
to top positions. While the former Satyam engineering services head TS
Krishnamurthy was roped in by Wipro to lead its not-so-successful foray into
mechanical design, Defiance Technologies of Hindujas too hired former Satyam SVP
and head, manufacturing and automotives vertical, Subu D Subramanian as CEO
recently. Perot Systems too acquired an ex-Satyamite too head its newly
announced engineering services business.

However, the year did not see too many large acquisitions, and certainly not
by the large players. Some acquisitions like INCAT by Tata Technologies,
Quantech by Wipro or Modern Engineering by Geometric which happened earlier had
no parallel in FY 09, the only exception probably being that of Quest Global,
which acquired ASE Technologies, a Cincinati-based engineering services firm
with more than hundred engineers.

Sizing Up the Market
Like Dataquest has been doing for the last two years, this year too, our
study on engineering services exports market in India does not include high tech
segments, namely telecom, IT hardware, software, and semiconductor industries,
while some embedded design work done by companies directly for automotive OEMs
or other end users have been included. The idea behind omitting these segments
out of the analysis is not to undermine their importance or to suggest in any
way that they are not engineering, but to highlight the other areas like
mechanical and construction engineering services which are newer areas for
Indian offshoring.

This segmentengineering services exports excluding those done for high-tech
verticalsrose by 30% in FY 09 to reach 13,128 crore. This was an accelerated
growth as compared to 26% in FY 08. However, in dollar terms, the growth slowed
down from 40% in FY 08 to 13% in FY 09. The total revenues in dollar terms
stood at $2.82 bn.

The captives increased their share, even though the contribution of few
non-Indian players that are active dropped further (See pie). Aerospace emerged
as the #1 segment for Indian service providersinteresting considering that
India does not have an active aerospace industry. While automotive continued to
remain the #2and a segment that most companies (almost all the thirteen
companies ranked here) have a presence inplant and industrial machinery saw a
solid growth and is now a clear #3. The verticals that are picking up momentum
are oil & gas, utilities, and construction, going by the growth expected in
value terms. But those will be driven by a few companies. The most popular area
that almost every company is excited about seems to be medical electronics and
healthcare equipment followed closely by consumer products.

Of course, one major company that is missing from the ranking is Satyam,
which we decided to drop, as the audited revenue figures are not available.
However, the estimated Satyam revenue has been taken in the others revenue to
compare with last years growth.

Trend 09: Moving Up
It is a little unusual at a time that is considered to be the most severe
downturn in many decades, with the brunt on engineering-intensive industries
being more severe than on any other, probably with the exception of financial
services. But the engineering services exports segment in India chose this time
to vault into the next phase in its evolution: marked not only by the
re-branding execrcise and high pitch marketing that is only getting louder but
also continuing its search for newer opportunities for growth as well as its
effort to move up the value chain.

Interestingly, unlike IT services, and probably a little like BPO services,
the industry did not act with a herd mentality of everyone running after the
same opportunity but actually differentiating themselves not only in the way
they position their services but also in targeting completely different
verticals. While traditional areas of aerospace and automotive still contributed
the highest share of revenues, many companies are trying to grow completely
different areas. Infosys, #3 in our list, for example, draws 20% of its revenues
from plant and industrial machinery, which #4 Tata Technologies hardly
addresses. Quest Global, another fast growing pure play engineering services
company, makes 59% of its revenues from utilities and oil & gas, which most
others are just beginning to address. Neilsoft, a much smaller company, has
chosen to grow its construction vertical and getting into areas like detailed
engineering, more than modeling, the traditional strength of Indian engineers,
which comes historically from taking a software-centric approach. Rolta has
already formed a joint venture with Shaw, one of the top players in the nuclear
engineering area, to tap the Indian market.

CyberMedia Research                                                                                              DQ Estimates
Five verticals,
five different companies at the top; just shows how broad is the definition
of engineering services

The differentiation is not restricted to targeting different verticals,
though that kind of differentiation is more tangible to show. Companies are
taking different approaches to move up the value chain and drive growth in
higher value areas, that they already address.

Concept to Manufacturing: This is something that we identified last year as
an experimentation with potential to become a trend. It has surely become more
prevalent, if not the standard norm. Not only has TCSwhose success in
convincing an Italian aerospace company to outsource end-to-end work from
designing of a manufacturing tool to getting it manufactured in India at a lower
cost, we elaborated last yeargot more such orders from the same customer, it
has managed to sell the idea to many more customers. In the arrangement, the
engineering services firm takes end-to-end responsibility from design to
manufacturing and delivers the end product to the customer. Typically, the
manufacturer (in case of TCS, a group company, TAL Manufacturing Solutions)
delivers directly to the customer because of tax efficiency but the program
management is done by the outsourcing firms like TCS and they get paid for that
as service.

Since then, Tata Technologies, the other Tata company in our list, has also
started pitching similar solution to its clients and is again banking on group
companies to get the manufacturing done. Quest has gone a step further. It has
started a manufacturing services business and has even set up a SEZ to do
manufacturing. The idea, again, is to provide end-to-end services to customers.
Hinduja-owned Defiance Technologies has also announced its entry into
manufacturing services. The much-talked about Indias services capability
fueling manufacturing is finally happening, though it is baby steps still. Wipro,
while it has not got into manufacturing, has recently started a product testing
lab, Tarang, with a high profile inauguration by former president APJ Abdul

Creation of IP: Realizing that a pure manpower-intensive model would not
sustain in the long run, no matter how much domain and software expertise a firm
gets, many companies are moving in the direction of own IP creation. Today, most
companies are trying to create some sort of standardize tools for reuse and many
have already done so. But only a few have completely productized them. Clearly
ahead in this game is Geometric, thanks to its experience in developing as well
as implementing PLM products for global vendors like Dassault, combined with the
engineering services experience. Neilsoft too has a few productized offerings.
Tata Technologies is also proceeding on this path. We believe this is something
that will become an industry norm sooner than latter. Since most firms have
solid expertise in IT, this may well be the first standardized India advantage
other than cost and availability of talent.

More end-to-end; emerging markets as the driver: While end-to-end and
delivering a full program sounds fashionable, few Indian companies ever bagged
a true end-to-end project, just a few years back. Since then, a few things have
changed. The customers have become more comfortable with the idea of offshoring
to India, partly because of better awareness about Indian capability, partly
because of Indian companies maturing, and partly because of their own urgent
need to cut costs. While the first two are part of a natural evolution and
similar to what we have seen in IT and BPO as well, the last is a direct fallout
of the severe downturn. For example, Chrysler has stepped up offshoring to its
own captive in India as well as to most of its vendors here.

But this new desire to outsource end-to-end is not always because of cost
reasons or change of heart. Increasingly, vendors that sell to consumers as well
as small businesseslike car manufacturers, consumer appliance makers, medical
electronics and surgical equipment companiesare looking at emerging markets for
future growth. They have realized that it is not always possible to do a little
modification to the existing products that have worked in developed markets and
sell them in emerging markets. Most of them are creating products that are
seeing work from grounds up. These are the projects where Indian engineering
services vendors are being considered for an end-to-end contract. What is
driving this trend are a few factors. One, these projects need faster
development; two, they need lower development cost; and three, there is no cost
of migration (including social cost) as these are greenfield projects. But what
the service providers are also offering is field testing in India, not just one
of the biggest potential market itself, but also a good microcosm for the
emerging markets.

Apart from emerging market-specific products, in new areas like clean fuel
and hybrid automotive too, a lot of new projects are being considered to be
outsourced to India.

Managing Cost: In the last few months, when the slowdown became acute, many
companies in the US and Europe looked at immediate cost cutting and that
provided some opportunity for vendors who could quickly come up with a solution.
A few engineering service providers like TCS responded and ended up winning a
few value engineering and should costing (process of determining what a product
should cost based upon various components and services that go into it) on
projects. Today, what started as a reaction to a customer need is an established
expertise within the company, with ability to charge a premium pricing and in
some cases, even as a percentage of cost saved by the clientsurely, a move
towards output based pricing.

The Infosys ExperimentPower of Process: Is engineering services very
different from IT and BPO? Yes, say most of the vendors that we spoke to. No,
says Infosys. The #2 IT services firm from India is betting on the same
principle that has worked for it and others in IT services and BPO: the power of
process efficiency. The principle sounds very simple and is familiar to most of
us: de-construct the process in such a way that you do not require too many
specialists and can easily move people from one type of project to another,
while keeping a bare minimum of domain experts. While most engineering services
firmsas well as engineering firms themselvesbelieve that it is not possible to
move someone who has worked in aerospace for years to an automotive project,
Infosys maintains the importance of domain is over-hyped and it is not the most
important strength of an outsourcing company. It maintains that it is only by
de-constructing a process well and running it well that an outsourcing firm can
add value to the job. Otherwise, it would always be dependent on individual
strength and not organizational strength. Infosys says that it has managed to
convince a few clients on this, while admitting that it will take some time to
change the mindset. For the time being, Infosys is alone to take a stand like
this. It will be interesting to see how companies like TCS and Wipro react.

Whither Slowdown?
The positive signals from the Indian automotive segment and the quick return
from bankruptcy of automotive companies notwithstanding, the world economy will
be in a recessionary phase for some more time, especially in industries that
engineering services firms target. The first signs that we have seen from the
industry in terms of being able to handle it is encouraging. The biggest
challenge, as the BPO industry has also seen, is neither a predominantly
negative impact because of business slowdown nor a significant positive impact
because of urgent need to drive down cost. It has been a slowdown in decision
making, something that the industry veteran VK Magappu of L&T sums up nicely: it
is like almost one year is written off. One hopes that will change this year.

Shyamanuja Das

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