Whither India’s IT Manufacturing Industry?

It has been widely believed for a long time now, both in India and abroad, that it is not practical to develop and

manufacture IT hardware products in India. Liberalization of the Indian economy has reinforced this view. It allowed in multinationals who reached optimal manufacturing costs owing to economies of scale and access to the Indian market. Domestic manufacturers suffered from higher costs due to lower volume, inadequate and expensive

infrastructure, and sky-high working-capital costs. 

Domestic hardware companies had more to worry about–in 1998 customs

duties for components and fully-assembled hardware products were equated. Customs-duty concessions were announced subsequently for import of certain peripherals for indigenous manufacture of computers. Yet, hardware products that do not need these peripherals still suffer a disadvantage. They have to pay duties and taxes on components required for indigenous manufacture of products, which are the same, or in some cases higher than, as on imported fully-assembled products. 

It would seem, therefore, that development and manufacture of IT hardware products indigenously may not be competitive. And if we all join this stream of thought without looking beyond our noses, the ‘Indian IT industry’ will soon be a glorified name for a community of traders.

Yet, even economies considerably insignificant in size compared to India have acted proactively and are already harnessing IT for economic development. Electronic manufacturing exports exceed 50% of the total $200 billion exports from Singapore today. Guangdong in China alone contributes over $40 billion of electronic exports, while in Malaysia, electronic hardware exports have grown to over $45 billion. Likewise, IT manufacturing exports from Philippines are currently over $2 billion. In contrast, Indian IT and electronic manufacturing exports declined from $325 million (Rs1,300 crore) in 1997 to $260 million (Rs1,100 crore) in 1998–less than 1% of the total exports from India.

It need not be so. India can develop and manufacture world-class IT hardware products competitively with concerted action, and derive as much revenue as that generated by the Indian software industry.

Let us look at the Taiwanese success story. Barely ten years ago, nobody would have imagined that by 1997 Taiwan would emerge as the second-largest producer of notebooks in the world, just slightly behind Japan, by producing about 4.5 million notebooks valued at over $6.5 billion! How did they reach this stage? By a systematic progression from low-cost manufacturing to value addition through innovation. The rapid pace of industrialization and exports in the newly industrialized countries would not have been possible had they not shown an ability to adopt, transform and develop industrial technologies in many sectors.

However, to arrive at a correct assessment of the practicality of making IT hardware in India, we must look at our strengths as well as our weaknesses. Foremost among our strengths is the much-touted large pool of engineers.

Admittedly, the majority of them gravitate towards the software industry, mainly because opportunities in the hardware industry are fast vanishing. A large numbers of electronics and computer science engineers graduate from our engineering colleges. Even a small percentage of them–the best–can be easily molded into top-class hardware design, development and manufacturing engineers. This is possible, provided industrialists and R&D institutions

commit themselves to the task. 

Another of our strengths is the cost of skilled Indian manpower, which even today is between a third and a fifth of the cost of manpower with similar skills in advanced countries. Of course, skeptics might question whether

engineering services are available in India to match the quality and delivery standards abroad. We can counter this argument–if there is demand, there will be supply. At any rate, as increasing numbers of Indian manufacturers demand adherence to quality and delivery commitments, vendors will fall in line. Also, greater demand for world-class service and greater exposure to world-class products will make them competent and competitive.

In the area of testing, we can afford to use engineers at lower cost than less-skilled personnel used in other countries, and thus enjoy the dual benefit of higher-quality testing at lower cost. No wonder then that some

multinationals, including contract manufacturing outfits, are considering setting up manufacturing bases in India.

There are two net benefits in the above situation: the cost of developing a hardware product in India is between a third and a fifth of the cost of developing a similar product elsewhere; and our skilled engineers could further reduce production cost through innovation or creative design, thus making the end-user price of the product competitive, even at low volumes. This has been proven by a few companies already–Godrej, Peninsula Electronics, Processor Systems, Sun Fiber Optics and Wipro-GE Medical Systems. 

Nevertheless, in a ‘commodity’ product segment, there are several other factors that come into play, especially in the markets abroad. This makes it impractical for Indian hardware to compete, at least at the present juncture.

These include predatory pricing, distress sales and high-volume

manufacturing. However, products that need some customizing or fully custom-designed products that are designed literally from ‘paper-napkin’ specifications is the area where Indian IT developers and manufacturers can hold their own. Giants perhaps do not find this area attractive as the volumes are relatively small, but for Indian manufacturers, even a few thousand pieces can be an attractive volume. However, we have to first take care of a few of our weaknesses.

First, we have to make the overall environment conducive to timely delivery of products. For this, each individual involved in the development and manufacturing chain must realize and accept that timely delivery is sacrosanct. Also, we must instill in each individual a sense of pride in the product being produced, which will automatically result in a quality product.

This chain includes even customs, shipping and airfreight personnel who should give speed the highest priority. The government can help by changing quirky laws that delay customs clearance. Further, clearance of airfreight consignments must be facilitated 24 hours a day, seven days a week, as there is no luxury of time when competing in the international market. 

Our government must recognize and start to believe in the potential of the Indian IT hardware industry. This could at the very least match that of the Indian software industry, if not overtake it, for products can generate much more revenue than services. Besides, when we talk of hardware

manufacturing, there is much more potential in developing and manufacturing hardware products than in mere contract manufacturing. Indian IT companies must learn to develop and manufacture their own hardware products. For this, they must be allowed quick access to low-cost finance for product development and pilot production, with only the technology, materials and components as security. The EXIM Bank, which is supposed to help increase exports, does not yet have any financing schemes for product development.

Also, our government could think of awarding R&D grants for proactively developing new products, without worrying about whether the beneficiaries are in the private sector or the public sector. If countries such as Japan, Korea, Singapore, Taiwan and the US encourage indigenous product development this way, why can’t we? 

It is innovation that must be encouraged and nurtured. For, without innovation, economic growth is limited by available physical resources. And in a scenario of supply exceeding demand, it implies marginal returns on capital investment. As physical product margins drop, the best way for any nation to break out of these marginal returns is to make better use of resources through innovation.

Consider the case of Godrej supplying electronic typewriters to its German collaborator. It has cut down manufacturing cost by over 20% simply through design innovation.

Government actions often create entirely new public markets that generate large growth opportunities for the nation and for private companies. The American Constitution and early US laws specifically supported only invention and discovery as key growth

ingredients for the nation. 

Virtually every major industry in which

the US dominates today has been generated or nurtured by US Government’s policies. 

The government can improve potential payoff-to-cost ratios in cases where:

• Probabilities of individual project success are too low.

• Need for interacting disciplines is too high.

• Times to payoff are too long for private companies to sponsor the needed development efforts. 

This is done by: 

• Supporting a wider range of options. 

• Extending benefits to a larger population.

• By coordinating the various programs to lower total program costs. 

And the public benefits the government can capture for the whole country legitimately justify investments that private companies would be unwise to undertake. When successful, such endeavors create whole new industries that otherwise would not exist. The question, therefore, is not whether the government has a role in fostering innovation and wealth-creation, but where and how it can participate more effectively.

Therefore, the initiative taken by the Prime Minister of India to set up the National Task Force on Information Technology and Software Development has come as a ray of hope for the Indian IT industry. IT Action Plans II and III focus on IT and electronic hardware manufacturing and R&D in which they have

cogent and integrated proposals addressing burning issues. Needless to say, the industry has to be provided incentives and motivated to put its full force behind R&D and manufacturing. The IT Action Plan recommends revolutionizing IT hardware manufacturing through a stable, transparent and flexible policy structure. 

Objectives of IT Action Plan II and III are:

• Encouraging local manufacturing in IT.

• Attracting investments in IT manufacturing.

• Technology absorption and development of Indian
  
  IPR.

• Creating avenues for employment generation.

• Accelerating PC penetration tenfold.

• Developing and harnessing potential of IT manufacturing exports.

• Increasing IT industry’s contribution to national economic development and the national exchequer.

• Stimulating and facilitating R&D in IT products.

To meet the above objectives, the Task Force has recommended:

• Long-term stable policies–no change in policy framework till 2003.

• Simplification of procedures and transactions.

• Encouragement to IT R&D and manufacturing in India by way of incentives.

• S-BIT Scheme–unification of domestic and exports manufacturing.

The S-BIT scheme (Soft Bonded IT Units) envisages a unified IT manufacturing facility for both the domestic and the exports market. Under the current policy structure, an entrepreneur needs to invest in separate manufacturing facilities for exports and domestic markets, thus leading to under-utilization of both the capacities and no benefits of economies of scale. The scheme envisages creating a system that would be based on fiscal controls rather than physical ones. All the transactions would be based on the principle of self-declaration.

All inputs would be imported free of duty; however, when goods are cleared to the Domestic Tariff Area

(DTA), duty equivalent to that on the imported components would be charged.

The Action Plans are all set to revolutionize IT hardware R&D and

manufacturing in the country. Rationalization of pre and post manufacturing levies is critical to sustaining the entire manufacturing chain–from component manufacturing to finished goods manufacturing and distribution. Duty free imports will instantaneously motivate the gray market to shift to the organized sector and with one stroke an estimated 50% of the PC market, which is currently gray, will fall into the tax net. Indian IT manufacturers and prospective investors are unanimous in welcoming the S-BIT scheme as a pre-requisite for investment and consequent growth. 

Import of key parts and components that are not made in India at nil rate of duty also bring down the price of IT by at least 30%. This would fuel PC demand, which is expected to grow by a minimum of 50% per annum. PC penetration is expected to increase 10 folds to 20 per thousand from the current level of 2 per thousand. Large volumes will ensure economies of scale for the manufacturing sector and motivate the industry for further price cuts, thus creating still more demand and building a multiplier effect. This will also motivate MNCs to shift their manufacturing operations to India.

However, it is time that Indian IT firms started thinking beyond the PC, which is a mature product–it might already be somewhat late for India to make a significant contribution in this area. We have to start thinking about other products as well, especially those arising out of the convergence of computing, communications and networking, and about uniquely Indian solutions for uniquely Indian needs. Besides, IT hardware design is an area with extremely high exports potential, covering the entire gamut of the IT industry–ICs, peripherals, embedded software, firmware and internet appliances. It is estimated that by 2005, design and design-led manufactured exports will be worth $5 billion, growing to $10 billion by 2008. Further, India has a large contract manufacturing potential for components like PCBs, hybrid circuits, discrete semiconductor devices, passive components, subassemblies and computer peripherals. It is estimated that the size of this business could exceed an additional $5 billion by 2005, should the policy framework be conducive.

With the economic downslide in South East Asia, a whole lot of IT

manufacturing firms are looking for safer bets to relocate their plants. With economic stability and the advantages of inexpensive, English speaking and technically trained manpower, India can be the ideal destination for these investments. But the Government needs to act proactively–breathing fresh life into this ailing sector by implementing IT Action Plans II and III in their totality, immediately. 

So, what is the bottom line? There is no question that India can develop and manufacture IT hardware competitively–all we need is for all of us, in industry as well as in government, to realize the importance of doing that, and then getting down to business. To borrow a line from a recent TV commercial, are we up to it?