By Pete Engardio
Business Week Online
08/16/08 4:00 AM PT

India's engineers are gaining in skill and experience, leading many
companies to grant autonomy to their Indian divisions. Some are
responsible for entire product lines, from engineering to profits and
losses. All this being done despite the rising wages and overcrowding
that plague modern India.

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Given its skyrocketing wages, tightening labor market, and worsening
infrastructure bottlenecks, one might think India is starting to lose
steam as an offshore research and development haven.

Not a chance. According to a study by Zinnov, a consulting firm that
helps multinationals craft global product-development strategies,
India's R&D scene is not only still gaining momentum, it's also
becoming more strategically important. This is happening even though
the average cost per employee rose 16.2 percent annually in the past
three years.

Offshore R&D has mushroomed into a US$9.35 billion annual industry,
Zinnov reports, and is growing at a 23 percent annual clip. By 2012,
the firm predicts, this business will reach $21.4 billion. The
findings are based on interviews with senior managers of 120
India-based R&D centers of foreign companies.

The key drivers are multinationals. Roughly two-thirds of the work is
done at R&D centers owned by tech giants such as Cisco (Nasdaq: CSCO)
, Motorola (NYSE: MOT) , General Electric (NYSE: GE) , and HP (NYSE:
HPQ) , as well as a growing number of small- and midsize U.S.
companies. The number of such foreign-owned centers has surged from
180 in 2000 to 594 this year.

What's more, the India R&D bases of multinationals increasingly are
becoming the leading sites for developing particular products sold
globally, whether they be new chips, software packages, or telecom
devices. That means they often are responsible for all of the
engineering, strategic direction, and even the profits and losses of a
product line. Currently, 10 percent of offshore centers have "full
ownership" of product lines, Zinnov estimates. By 2012, that will
reach 30 percent.

Affordable Quality and Experience

Why is such Indian offshoring continuing to rise despite higher costs?
One reason, of course, is that despite all the wage inflation, India
remains a lot cheaper than the U.S. The total cost of employing a
full-time Indian engineer -- including wages and benefits, facilities,
telecom, travel, and administrative support -- ranges from $35,000 to
$55,000. The U.S. average is at least three times that, Zinnov says. A
lead engineer in India still averages just $30,000 a year in salary,
while a raw recruit classified as an "associate engineer" draws a mere
$4,440 a year. The growth of Indian engineering wages, meanwhile, is
starting to slow, meaning the gap with the U.S. won't close anytime
soon.

But a bigger reason, asserts Zinnov Managing Principal Vamsee
Tirukkala, is that the growing quality and experience of India's huge
technical workforce is offsetting escalating wages. Some of the
estimated 250,000 Indian engineers working on global R&D, especially
those who have been employed by big Indian software-services providers
including Infosys, Tata Consulting Services and Wipro, now have 10
years of experience working for international corporations, Tirukkala
says. Countless others have received heavy training by their Indian
employers. "The reason to go to India no longer is just about cost,"
he says. "It's about the quality of talent."

That's a big reason Bangalore -- even with its horrible traffic
congestion and soaring costs -- remains by far the most important R&D
base. Of the city's 80,500 engineers working in foreign-owned R&D
centers, according to Zinnov's statistics, about two-thirds have four
to seven years of experience. One-third have seven to 15 years, enough
to qualify as a lead architect for many products. No other city in
India comes close, Tirukkala says.

An influx of returnees from the U.S., Britain, and Australia, many
boasting years of managerial and R&D experience at Western
corporations, is supplementing India's technical workforce. Expatriate
Indians now account for 10 percent to 15 percent of the staff in
offshore R&D centers, Zinnov estimates. The software industry alone
has benefited from the return of 30,000 expatriate professionals,
according to Nasscom, India's information technology trade
association. "The immigrants have brought the high-end talent that
India needs," says Tirukkala.

Up the Innovation Ladder

This greater experience is enabling India to move up the innovation
ladder, Tirukkala argues. More companies are making India the main R&D
base for certain products because they are finding it harder than
expected to control offshore engineers out of the U.S. "Chief
technology officers are finding that globally distributed innovation
is not working," he says. Some companies have decided to move
engineering back to the U.S. But others have shifted top managers to
India to run development work entirely from there. The India country
head of software giant Adobe Systems, (Nasdaq: ADBE) for example, is
also senior vice-president for its global printing and publishing
system product business.

Not all analysts are convinced Indian R&D operations are ready to
assume the lead in innovation, however. Martin Kenney, a University of
California at Davis economist who has studied offshore R&D in India
and China, agrees the trend is still growing in India and that its
workforce is becoming more experienced and innovative. Since 2000, he
notes, U.S. patents awarded to inventors filing from India rose more
than fivefold, to around 550 a year.

But the number of India patents remains very small in the scheme of
things: Last year the U.S. issued nearly 94,000 patents. And Kenney
suspects the vast bulk of India's engineering hordes still is far too
green to do complex design and innovation work. "Bangalore is not like
Silicon Valley, where in a couple of weeks you can round up 10 people
who have already designed chips at three different startups," he says.
"We don't really yet know much about the true quality of the work done
there. There are company anecdotes going both ways. Some of it may not
be what it is cracked up to be."

Kenney believes low cost is still the primary reason U.S. companies
are shifting work to India. "My guess is that if the Indian engineer
cost the same as our engineer, nobody would go to India," he says.

Kenney does agree, however, that India's R&D workforce is steadily
gaining the experience to produce innovation. The debate is whether
that time is another five years away -- or has already arrived.