December 19, 2014

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7 Demand Side Drivers Propelling the Engineering Services Industry

NASSCOM puts Indian Engineering and R&D services exports at $17 billion in 2013, and expects it to grow with CAGR of more than 14% to reach $ 37-45 billion by 2020. Let us look at some key market drivers which will lead the industry into this remarkable growth journey.

  1. Leading global OEMs are differentiating themselves through software and services: In the digital era, software capabilities are no longer nice to have, but a business imperative. Across industries, software is the new means of interacting, engaging and retaining consumers. Even for the world’s most innovative OEM - Apple, the fastest growing segment is ‘software & services’, and for the global office automation OEM - Xerox, the future lies in its ‘managed print services’. However, the hi-end software expertise required to enable and create this, may well lie beyond the ‘core-competency’ of an OEM, and hence, the case for an engineering service partner makes business sense.

  2. As everyone is keen to ride the M2M/IoT wave, ESPs can become the ‘technology integrator’ and ‘customized solution’ provider: Cisco estimates that more than 50 billion devices will be intelligently connected by 2020. This confluence of devices, people, process and data will enable over $19 billion in economic value between CY13 and CY20. Some use-cases which have already gained traction include: smart – factories, power grid, building and cities; connected – healthcare, transportation and marketing. Even though things are still evolving, some ESPs are already developing vertical/customer specific solutions on top of IoT frameworks and taking up the role of technology integrators of third party platforms to IoT customers. 

  3. The financial crisis compelled companies to re-assess their R&D expenditures and improve ROI: The crisis started in 2008 but has its repercussions even today, with Europe still struggling to recover and Japan again plunging in to recession. European Union data indicates that R&D intensity (R&D as a % of sales) which stands at 5%, 3.4% and 2.8% for U.S., JP and EU headquartered companies in 2013 has been flat and in to decline post the crisis. Initiatives are being taken to improve ROIs.  In such a scenario, Engineering Services Outsourcing has demonstrated the ability to achieve R&D cost optimization through its scale, offshoring models, availability of talent pools, and flexibility in scaling resources up or down. 

  4. Faster technology migrations boosting demand for sustenance/end-of-life engineering: Consider the case for telecom;  the global share of 3G connections is going to double to reach 30% by 2017, and that of 4G is going to increase tenfold to reach 12-15% at the same time. On the other side, 2G share is expected to fall from 80% in 2010 to less than 50% by 2017. So what was core or ‘star’ a decade ago has entered ‘dog’ category in 2014. As the R&D focus of Telecom firms shift to 4G or higher technologies, it leaves 2G/3G technologies to be co-managed or sustained by an external engineering and R&D partner. It’s important to note that 85% of users in China and India still use 2G connections.

  5. Uncertain market conditions and stiffer competition makes co-invested, shared risk-reward, and output-based ESO models attractive: Fast contracting product lifecycles, ambiguous demands, competition from new quarters and quick commoditization of technology are impacting ESPs engagements. OEMs are expecting co-investment (turning some capex into opex); shared risk-reward (deferring financial transactions to post-launch scenarios) and output-based models (payments linked to business outcomes). ISG predicts that the share of fixed, output-based and risk-reward pricing contracts will increase from 25% in 2013 to over 70% by 2017. Though it does add some risk to the ESPs, it also significantly increases the profile of deal size TCVs and the scope of ESO work, thus, overall boosting the industry.

  6. Convergence of tech and non-tech verticals opens immense platform engineering opportunities: Engineering services has always being associated with ‘technology’ and ‘product’ companies. But as a major trend, companies from ‘brick & mortar’ industries like retail, banking, healthcare and transportation are aggressively embracing mobility, analytics, cloud, e-commerce, etc. to expand their businesses. These non-tech companies are actually driving the digital or platform engineering market. IDC predicts that spend on 3rdplatform (SMAC applications) will constitute almost 98% of the incremental ICT budgets between 2013 and 2020.

  7. Being ‘closer to markets’ and ‘reverse innovation’ pushing value engineering and supplier source innovation: According to KPMG China hosts the innovation centres of more than 400 of the Fortune 500 corporations, and as many as 1,400 in-total centres of U.S. or European corporations. Parallel numbers for India stand at 350 and 1,100 respectively. This evidently makes clear the ‘collaborative’ R&D approach of global companies that expect not only value/frugal engineering but also innovation from their R&D counterparts in Bangalore, Shanghai or Beijing. GE’s policies of ‘In China, for China’ and ‘Reverse Innovation’ are a few of the many testimonies.