Five reasons why the growth of Indian ER&D captives is slowing down
The Indian ER&D sector is growing at a good rate. In 2017, the Indian ER&D sector grew by 12%. In comparison, IT services and BPM grew by 6% and 8% respectively. But if we deep dive into the ER&D growth numbers, it is apparent that the relative growth of ER&D captives is slowing down, as shown in Exhibit 1.
Exhibit 1: Revenue and Growth Rates of Indian ER&D Captives and Service Providers
Source: NASSCOM, HfS Research, 2018
The ER&D captive slowdown is not a global phenomenon as, according to our 2017 ER&D captive analysis, the captive activity increased in 2017 as compared to 2016. Overall, the number of captive center announcements in 2017 is more than that of 2016. In 2017, we observed a total of 284 captive ER&D center announcements, including 43 expansions, and the establishment of 241 new R&D centers. Whereas, in 2016, we identified a total of 271 captive ER&D center announcements, including 44 expansions, and the establishment of 227 new R&D centers.
In this PoV, we analyze five possible reasons for this slowdown based on our 2017 ER&D captive data.
Key reasons:
- India is lagging in the automotive, chemical, industrial, and telecom sectors due to other locations, in addition to China, becoming more appealing: India leads in the aerospace & defense, consumer electronics/hi-tech, and internet/ISV domain, whereas China and the United States lead in others with respect to captive center announcements. Though China, India, and the United States have dominated the captive center announcements, some new geographic destinations have emerged in the automotive, consumer electronics/hi-tech, and chemical domains, as shown in Exhibit 2. These new countries are Serbia, Portugal, Vietnam, Ukraine, Belarus, South Africa, Morocco, Luxembourg, Slovakia, and Austria. Some of the reasons we identified for this are localization requirement, talent availability, and increase in domestic manufacturing activities among others. For example, Embraco, the Brazilian refrigeration compressor manufacturer, established a technology center at its European production plant in Spisska Nova Ves, Slovakia. Grab opened R&D center in Ho Chi Minh City, Vietnam to tap the engineering talent pool in Vietnam. LafargeHolcim established innovation center to develop construction solutions that match the needs of the Moroccan and African markets.
Exhibit 2: The Percentage of ER&D Center Announcements by Industry in 2017
Source: HfS Research, 2018
- China started leading in the captive center announcements from mid-2017, driven predominantly by automotive and industrial sectors: Since Q3 2017, China has been ahead of India in terms of the number of captive center announcements, as shown in Exhibit 3. Overall, the automotive industry made most of the captive center announcements, followed by the consumer electronics/hi-tech domain in China and India.
Exhibit 3: The Number of Captive Center Announcements in China and India over the Quarters
Source: HfS Research, 2018
- The pace of total captive center announcements in India slowed down as other locations become more competitive: The number of ER&D centers in India has declined to 46 centers in 2017 from 78 centers in 2016. Since the focus is on capability development in emerging software technology areas, we are observing more captive center announcements in high-cost countries such as the United States, Germany, the United Kingdom, Israel, and Ireland, and a decrease in the percentage of announcements in low-cost countries in 2017 as shown in exhibit 4. The growth of automotive ER&D centers in the United States is one of the reasons for the high captive center announcements in the country. ER&D centers are spreading globally because of access to local talent and manufacturing ecosystems and localization. Many enterprises are opening ER&D centers in different locations to work on developing products for that region. Among the low-cost countries, a majority of the ER&D captive centers were announced in China, followed by other prominent countries such as Malaysia, Romania, Thailand, and Vietnam.
Exhibit 4: The Percentage Distribution of ER&D Center Announcements by Countries in 2016 and 2017
Source: HfS Research, 2018
- Enterprises are prioritizing R&D centers in their home country locations as R&D and manufacturing become more integrated: We have identified that enterprises are prioritizing research investment in their home country locations over making such investments in other countries (as shown in Exhibit 5). In many cases, they are also consolidating R&D operations across the geographies for more synergy. For example, Luxembourg based OCSiAI, a hi-tech company producing TUBALL single wall carbon nanotubes, plans to build the world's largest nanotube production facility and an adjacent R&D center in Differdange, Luxembourg. P&G is expanding its Whitley headquarters and is planning to close its Greater London Innovation Centre in Egham and move 250 staff members to Berkshire.
Exhibit 5: Comparison of the Number of Captive Center Announcements in the Same Country Location of Enterprise Headquarters in 2016 and 2017
Source: HfS Research, 2018
- High growth of India engineering service providers, as product life cycles get shorter and service providers mature: The revenue growth for Indian service providers has outperformed the revenue growth for IT services as the business case for outsourcing becomes more attractive. In Q4 2017, the growth rate in engineering services for Indian service providers was more than 2.5 times the rate of growth of IT services. From Q3 2016 onward, the gap between engineering services and IT services has widened, as shown in Exhibit 6. Engineering service providers collaborate as well as compete with ER&D captives, and the flip side of high growth in Indian service providers is that some of it might have come at a cost to ER&D captives.
Exhibit 6: Comparison of Engineering Services Growth Rates and IT Services Growth Rates of Leading Indian Service Providers
Source: HfS Research, 2018
The bottom line: India cannot afford to be complacent about being the preferred destination for ER&D captives
Once decisions are made to move to new locations they are very costly to reverse. The ER&D sector is growing and the number of ER&D captive center announcements has been increasing over the years, but the competition is also catching up. Apart from China, other countries are also competing with India. Enterprises are trying fresh locations in both low-cost countries as well as high-cost countries for different value propositions. The growth of ER&D service providers is costing captives, too. Though a slowdown in one year cannot be called a definite trend; nevertheless, it is a warning sign that India cannot be complacent about being the preferred destination for ER&D captives.