The first countries to develop software industries primarily for export rather than domestic purposes were Ireland and Israel. The big player to come in a little later was India, beginning in the mid-1970s and growing rapidly from the late 1990s. To some degree, a global division of labor is beginning to form: India serving the English-speaking world, Eastern Europe and Russia serving Western Europe, and China serving Japan. But India is also providing service to Western Europe, and China provides service to the United States. In addition, there are many smaller supplier countries. The greatest attention is given in this report to the United States and India, the two biggest players.
The United States has historically dominated and continues to dominate the software and services industry, with about 80% of global revenue. It is highly dominant in the packaged services industry, with 16 of the top 20 companies worldwide, and slightly less commanding but still dominant in the software services sector, with 11 of the top 20 companies. This dominance is due to a number of factors, including a legacy of government funding of R&D, computer science research in the open US higher education system, a skilled workforce created by a strong university system, a culture of risk taking and the capital to finance risks, early adoption by sophisticated users, the world’s largest economy and market, and leading semiconductor and data storage industries that helped to spread the use of computing.
The centrality and dominance of the US industry has been a given during the past five decades. What is emerging is the globalization of the software and software services industry. This creates opportunities around the world for people and companies in both developed and developing countries to participate in this profitable industry. It also creates challenges for the former leaders, notably the United States, Western Europe, and Japan.
Software services is India’s largest export. As a large developing nation, India faces many challenges, including high rates of poverty, corruption, and illiteracy; a substandard infrastructure; excess government regulation; and various other problems typical of a poor nation. These challenges are offset by a number of strengths, especially for software and services production. It has a long history of developing capable mathematicians. India is unique because of the large number of individuals with adequate English language capability, and also for the large cadre of Indian managerial and technical professionals working in North American and, to a lesser degree, in European high-technology occupations and organizations. For those who can afford it, India has a strong and highly competitive K-12 educational system emphasizing science and mathematics. Despite its democratic socialist tradition that involved large amounts of bureaucracy and state regulation, it has been a market economy and has a history of managerial education and competence. These assets have given India many advantages in establishing a software export industry.
India’s software export industry began in 1974, when it began sending programmers to the United States to do work for the Burroughs Corporation. Political liberalizations related to trade in the 1970s and again in the early 1990s helped to support the development of the Indian software industry. Offering solutions to the Y2K problem helped the industry to grow substantially. The industry expanded beginning in the late 1990s, first by bringing back to India much of the software development, maintenance, and testing work it had previously done on the client’s premises, then developing export businesses in business process offshoring, call centers, and research and development. India is moving up the value chain and is seeking people with considerably more skill than low-level programmers to do these higher value jobs. Software and service export firms in India are growing at 20 to 25% per year according to the best statistics available, and each of the three leading Indian software firms (Infosys, TCS, and Wipro) already employs over 40,000 people.
India is likely to continue to grow its software industry in scale, scope, and value-added. There is little reason to believe that offshoring as a process will end in the foreseeable future, but it could slow down. The enormous investment by leading software multinationals will expand the number of Indian project managers with strong managerial skills. This, together with the relocation of portions of startup firms to India, is likely to result in greater levels of entrepreneurship and lead to firms able to sell their skills on the global market. The offshoring of IT services and software for export will dominate the near future of the Indian software industry. There are several possible trajectories. Custom projects could become more complex and large, leading Indian software professionals to move from programming into systems integration and systems specification and design. The average size of projects Indian firms are undertaking has already grown from 5 person-years in 1991 to 20 person-years in 2003. As multinationals deepen their Indian operations, domain skills are developing in India and some other nations, so that managed services are likely to become more important; this will match global trends in the outsourcing of applications management and business processes.
Despite the fact that India’s software production for the US market exceeds that of any other nation, it holds only a small share of the global market for all software value-added. The only part of the software value chain in which India has made substantial inroads is in applications development, where it has captured 16.4 percent of the world market. But applications development is only approximately 5 percent of the entire global software services market. This implies that there is much room for growth. In order to grow, the Indian industry will have to shift to more complex activities by securing larger projects, undertaking engineering services, integrating and managing services, or bidding on projects that include transforming a client’s entire work process. India, however, will have some difficulty achieving this growth unless it strengthens its R&D capability.
Software offshoring to India is likely to grow, not only through the continued growth of indigenous Indian firms, but also because foreign software firms are increasing their employment in India in product development and particularly in software services. Competition is likely to grow between multinationals based in developed countries, such as Accenture, IBM, and Siemens Business Services, and the large Indian firms, such as HCL, Infosys, TCS, and Wipro, as the Indian companies expand their global reach and the multinationals expand their operations in low-cost countries. The Indian subsidiaries of multinationals play an important role in the development of India’s software capabilities, because they are more willing to undertake high value-added activities, such as software product development, within their own subsidiary in India than they are to send the work to an Indian independent firm.
For at least the medium term, India should be able to retain its position of primacy for software offshoring from the English-language world. In the longer term, unless India makes an even greater effort to upgrade its universities and the technical capabilities of its graduates, China may become an important alternative destination.
China’s software and services industry does not currently have a major impact on the world economy. The industry is highly fragmented into many small companies, few of which are large enough to take on large projects for developed nations. The hardware industry is well established in China, and in the future it may drive the software industry to a focus on embedded software. Unlike India, where the multinationals are focused mainly on serving the world market, in China multinationals are more focused on positioning themselves to serve the enormous, emerging domestic Chinese market.
Japan has the second largest software and services industry in the world, after the United States; and it is the fastest growing industry in Japan. Japan makes games software and custom software for the world market and packaged software for its domestic market. It imports a significant amount of systems and applications software from the United States; and it calls on China and India to provide custom software.
There are three typical patterns of Japanese offshoring. Most commonly, a Japanese firm will identify a need for custom software, contract with a Japanese IT company to provide the software, and the IT company will in turn contract with a Japanese subsidiary of a Chinese firm to do the programming work. This programming used to be done almost exclusively in Japan, but as the cost of locating Chinese workers in Japan has become expensive, more and more of the programming is being done in China. A second approach that is more recent is for Japanese firms to invest in China to form wholly owned subsidiaries or joint ventures with Chinese firms. A third approach is for multinational corporations to move programming and back-office functions of their Japanese subsidiaries to lower-cost locations, often in China. The Dalian software park in China is growing rapidly as a result of this emerging Japanese business. The amount of offshoring from Japan is still small, but cost pressures are likely to cause it to increase; and since Japan has such a large software industry, the opportunities for offshoring are considerable.
The European Union represents the second largest market in the world for software and IT services, after the United States. There are many differences, however, from country to country, and the European Union cannot be viewed as a unified, homogeneous market. The European software industry and employment patterns are different from those of the United States, with much more software production done in-house and embedded in physical products. This does not prevent offshoring, and certainly many leading European industrial firms are establishing offshore facilities to produce embedded software. Much of this employment is subsumed under R&D and other activities such as application-specific integrated circuit design.
About two-thirds of the work offshored from Europe is offshored by the United Kingdom. Continental European firms continue to lag UK firms in sending software work across their borders. The Germanic and Nordic nations have only recently begun to build offshore software and software service delivery capabilities, but firms with global practices such as SAP, Siemens, and others are moving rapidly to build their offshore capabilities in Eastern Europe, China, and India. The geography of European offshoring will be somewhat different from that of the United States in that Nordic and Germanic firms will use Eastern Europe and Russia in addition to India. Latin (Romance-language-speaking) Europe has been slower to begin offshoring, but now its major firms are sending work to Romania, Francophone Africa (particularly Morocco), and Latin America in addition to India. Despite these geographical differences, there is no reason to believe that the pressures to offshore software-related work will be substantially different than in the Anglophone nations. In part this is because the US-based multinationals with strong global delivery capabilities, such as Accenture, EDS, Hewlett-Packard, and IBM, are present and competitive in all European markets. European firms may continue to experience a lag due to union and government opposition to offshoring, but their cost and delivery pressures are similar to those experienced by US firms.
In Russia, software was a relatively neglected field during the Soviet era, but in the 1990s as the country transitioned to a market economy, many scientists and engineers moved from low-paid government and university positions into entrepreneurial firms and Russian subsidiaries of multinationals; and some of these people entered the software field. So far there are relatively few programmers. Wages are low. Technical skill level is high, but there is little project management experience. Software firms are typically small, not able to take on large international software integration projects. Nevertheless, the high skill level of the Russian research community, a legacy of its Soviet history, has led Intel and a few other multinationals including Boeing, Motorola, Nortel, and Sun to open R&D facilities in Russia.