The Economic Times, Sep 26 2008

India might be better known as a software services outsourcing giant to most but if you look internally, there is a new revolution brewing–the product revolution. There are hundreds of startups in the software products space, which are throwing up some very interesting products in the market.

While i-flex, Tally and Subex might still be the most recognisable Indian IT product companies, there is a whole new breed of firms that is all set to conquer the domestic market as well as dent the international markets soon. According to a recently released Nasscom-Zinnov Software Product Study, Indian software product businesses are approaching an inflection point in their evolution.

“MNCs have created product development setups in India, which have spawned a new breed of product development professionals over the last few years,” says Sudhir Sethi, chairman & managing director, IDG Ventures India. These are the entrepreneurs of the new world today who are putting down their ideas to create product-driven businesses. In the last 22 months, the team at IDG has looked at over a 1,000 new startups of which 60-70 percent are product startups in the areas of security, digital consumer electronics, telecom, semiconductor, Internet, and mobile VAS. In 2004, this figure would have been less than 40 percent. IDG has invested in eight startups of which five are IT product companies.

While India’s role in global technology IP creation has grown steadily, several challenges have constrained the growth of homegrown software product businesses. The domestic market was small and there was a lack of experienced product development talent. The venture capital firms were skeptical of funding product startups and of course the entrepreneurs who were launching these new companies lacked adequate exposure to international markets.

These are things of the past, it seems. Today, a lot of the local technology entrepreneurs have a better perspective on IT products and their demand, having worked on key technologies at large Indian IT companies. Others who have worked in global markets have a better understanding still. They comprehend the gaps, are a lot more networked, and hence sales and marketing is not such a tough nut to crack for them today.

“The domestic market is also developing, and with the Indian economy growing so is the size of the domestic business,” says Saurabh Srivastava, chairman, Indian Venture Capital Association. A number of products designed for the local market to cater to call centres, mobile companies, BPOs are coming out of product startups. Srivastava feels that most foreign VCs actually prefer product startups (product or IP based) because they know that model best. It also helped that in the last 7-8 years, lots of Indian startups in the US because successful. “This helped local Indian startups. VCs now understand that Indian product companies today are serious,” he says.

Interestingly, building a services company in India is hard today because of the kind of competition prevalent in the market. Unless you find your niche, which fits well, it is difficult to scale. As competition intensifies, the profitability and growth of services-based small companies is much lower than their larger counterparts. It is that much more difficult for a small services company to scale, though they can still survive.

In the product space though, things are a little different. There might not be great competition in that segment but the economics of product startups are challenging. While one needs scale to survive, it takes a lot more capital too. “The product play requires one to spend a lot more on R&D to keep it going,” says Srivastava. And that is where the VCs come in. Adds a Mumbai-based analyst, “A software service company requires scale and more employees unlike a software product company. If a product is good even a small company has great future.”

“The Indian market will demand more of intellectual property (IP) and start-ups and emerging companies can tap that. The next decade belongs to companies, which can create scalable IP, which has strong market adaptability,” says Gautam Patel, partner, Battery Ventures, a US-based VC fund, which has been investing mainly in IT companies. The fund plans to invest close to $ 200 million within two years. Patel says they would be investing in companies that have developed an IP, which has or can have an addressable market, a good management team and has the capacity to scale if need be.

Many companies in the IT sector are already preparing to take the opportunities that are being created in India as well as in other markets. Enterprise communication solutions company, Avaya Global Connect, is looking at introducing more products in its portfolio for Internet Protocol based telephony that caters to SMEs.

Last year, IT product companies received a total VC investment of $156 million, according to data released by Zinnov. Sangeeta Gupta, vice president at Nasscom feels that with the domestic market growing rapidly, startups today have an option of testing their products in the Indian market before launching internationally. It is like a large beta site to test your IPs. “As the domestic market is booming and IT penetration is growing among the SMBs in India, a large number of companies are starting to develop products to cater to this market,” says Pari Natarajan, CEO, Zinnov Management Consulting.

There are an estimated 35 million SMBs in India and the PC penetration in these is growing at a fast pace. The Nasscom-Zinnov report also says that by 2015, Indian software product business revenues would be more evenly balanced between domestic and export based sales and share of revenues from the domestic market would increase from 32 percent in 2008 to an average of 41 percent by 2015 to reach $4-5 billion.

“Key parameters such as proximity of Indian software product businesses to the local market requirements, excellent understanding on localisation requirements, and ease of adopting customised and targeted sales approach would fuel this growth,” says Natarajan.