In 1999, when Vivek Paul left his job as the global head of GE Medical Systems to join Wipro, the Bangalore-based IT services firm had about $150 million in revenues. By the time he stepped down last month as Wipro’s CEO and vice chairman, the company’s revenues had increased to $1.4 billion. Now Paul is changing gears to become a partner with the San Francisco-based investment firm Texas Pacific Group. Paul, who will specialize in IT and life sciences at TPG, spoke with Ravi Aron, a professor of operations and information management at Wharton, and to Knowledge at Wharton about what it takes to succeed in the fast-changing pharmaceuticals market, and why he thinks India lags behind when it comes to innovation despite the country’s proliferation of PhDs.

Aron: I’d like to lead with a generic question. Given that you have a very technical background with GE and with Wipro, and you’ve got the grime of IT on your fingers — you know it backwards and forwards — what made you suddenly switch to life sciences?

Paul: Well, first of all it’s not just life sciences — in fact I’m going to be a general partner in two funds. One is a technology fund, which will keep that IT grime under my fingernails; and the second is the life sciences fund. I will be doing life sciences on top of what I’m doing right now. But initially, many people shared that confusion, that I was switching from IT to life sciences. I think the opportunity is very strong in both areas.

Aron: Could you tell us about the nature of the stuff you’ll be backing?

Paul: Well, first of all I should caution you that my knowledge of this space is abysmally poor, considering that I’ve just committed the rest of my career to that. But the reality is that in some sense I have an idea at a higher level as to what to do; but I could not today give you specifics of the deals I’ll do.

However, I see two very interesting trends in the pharmaceutical industry. On the one hand, there’s the fact that the traditional pharmaceutical small molecule game is coming to an end. Now you have more big molecules that are more customized. So they actually have a different impact on different kinds of profiles of people. So you realize that you need a whole different game in terms of how you define those molecules, and how they tie to imaging agents, in a way that you never had to do so closely before. That creates opportunities in imaging agents and opportunities in developing and defining new molecules.

The next issue is that you have the manufacture of these large molecules, which is a very different process [from manufacturing small molecules]. It’s much more difficult to mass produce these. In some sense you’ve got to “cook” them in vats rather than make them in gigantic factories. And there is a higher labor and knowledge intensity with regard to the way the manufacturing process works. If you fold the proteins or molecules the wrong way, the critical effect is completely different. That also creates opportunities for the manufacture of these large molecules, particularly in places like India. As a result of that combination, what used to be a very vertically integrated industry, the pharmaceutical industry, now lends itself to a more horizontal format. It’s just like computers — which created a whole new opportunity for a new industry to be unleashed. And then on the device side, you’ve got continuous improvement from people who are developing new devices that can do more and more. I think that is another area — devices — that I can play with.

Aron: Some of this leads into the R&D area. The componentization of the pharmaceutical industry is beginning, just as it happened with semiconductors, which became flattened and horizontal. When we spoke with companies like Shantha Biotechnics [a Hyderabad-based biotech firm that makes recombinant DNA products] two years ago, they were looking at three different phases in the small molecule area. They said that formulation advances by trial and error; it’s not a customized solution, so if you are looking for something for color blindness, it would generally work for color blindness or not at all. So they looked at formulation, synthesis and manufacturing. They said in the synthesis stage, work is very labor intensive because there are hundreds of trials and errors that have to be made, and India would be a natural place to do that because it’s easy to find the resumes you need in a short time there. In the large molecule era, you just pointed out that some of these things are very labor intensive — the structure of the molecule can get denatured if it falls the wrong way. Do you think there’s an R&D place for India in the large-molecule era, starting with the labor-intensive processes? What’s the difference?

Paul: As you see the shift in the pharmaceutical space, the challenge for India in terms of doing more of the design of these larger molecules will be the shortage of expertise and the lack of an entrepreneurial ecosystem. And it’s a big bet. If you look at the number of biotech companies that went to launch “killer” drugs, there aren’t many that have been successful. As someone who is providing the capital to this crowd, you might feel like you’d be better off putting your money on a roulette wheel.

Aron: So you’re saying the risk is very high.

Paul: Absolutely. And I think because of that, India lends itself to lower risk, and more processed activities, rather than taking a gamble on those kinds of investments. I don’t think that you have the entrepreneurial instinct in that ecosystem that can make the stuff come out.

Aron: In the absence of such an entrepreneurial ecosystem, would funds such as yours be looking to incubate businesses in India?

Paul: I talked about the fact that pharmaceuticals are being pushed in two directions, but I just focused on one. The second is generics and the ability to operate in an environment where drugs are going off patent in record numbers. So if you look at the opportunities to play in India, I think they’re in the process area rather than in innovation. Now that doesn’t mean that you can say “never”; of course there will be anomalies. But I think the play will be more along the lines of: Can we create a mega-generics pharmaceutical company that can have both the production capability, the cost position, and give them the branding so they’re readily accepted? There’s a lot of stuff you can build out of India. Then you have all the other stuff like contract research outsourcing, and clinical process outsourcing – that’s also interesting.

Aron: When you say you see opportunities in the process space in India, do you expect formulation R&D to occur in the U.S. or advanced economies like Germany and the U.K. and that manufacturing and production will take place in India?

Paul: That’s right. Of course I’m generalizing, so by definition I’m wrong. But largely speaking, that’s what I would say.

Knowledge at Wharton: Where do you see opportunities in India, on the IT side and the life sciences side? And where do you think India’s competitive advantage might lie compared with other countries?

Paul: It goes back to the abundant supply of trained labor. That doesn’t necessarily mean just cost. It means cost, process and availability. So I don’t think that at this moment in time [the question is] “how do you build the manufacturing of a pharmaceutical” or “how do you do the clinical process.” Are there ways for you to do more of the generics side? Are there derivative drugs that you can develop? People are finding that you can create drug cocktails, and come up with a different kind of an outcome versus an individual drug you can make somewhere else. Those are very interesting areas.

Aron: Wipro, which you did so much to grow over the past five years, has been doing a lot of captive R&D for other companies. Do you see that as something that can be replicated by other companies? Is there a profitable and robust revenue stream in India for such services?

Paul: If you look at the service business, absolutely. But if you look at that service business as leading to innovation and product outcomes, the answer is absolutely not. Frankly, I feel that when people work in a service business like ours, it’s almost like we give them a lobotomy. I don’t think — and I hope I’m wrong — you will see a single successful product startup coming out of people who were working at Wipro or any other similar companies. You’ll find that innovation comes from people who worked for Intel India; they’ll go off and come up with a new chip. Or someone at Cisco India will come up with a new router. Why that is, God knows. But I truly believe that there is some sort of inadvertent lobotomy that we give people.

Aron: So you believe that some sort of self-selection is taking place? That those bright people who are risk-averse, who want to be very good at process detail, those are the folks who will come and join service businesses? And those who have an appetite for risk, who are willing to look at messy, ambiguous situations, will go off and try to do R&D?

Paul: I don’t know. I just have that observation. I have not spent any time thinking about what the root cause might be. But there it is.

Aron: Where do you see high-end R&D opportunities in general? For instance, there’s a lot of R&D being done in China, in Ireland and in Finland by American companies. Do you see those kinds of captive R&D centers coming up, or better still, ones that give R&D projects to a third party and say “I want you to come up with a new circuit board for my cell phone?” Do you think that kind of thing could happen?

Paul: It’s already happening. The stuff that’s been done in India is staggering in terms of range and depth. I don’t think that anyone can say that the work we’re doing is trivial. But the work we’re doing is under somebody else’s direction. Let me put it this way: For an engineer, there’s a big difference between discovering something, versus discovering something that you know somebody else says can be done. That difference is the difference between the service business and the products business. In the service business, what you’re doing is great stuff, but it is in some sense something that someone else told you to do.

Aron: Let’s talk about doing something under someone else’s direction, after someone says, “This can be done, do something better for me.” That mindset works in the services business, but to succeed in products you have to go off and discover the possibilities. Is that correct?

Paul: Yes, and there’s a second quality I didn’t mention: Knowing what you want, or what the market wants, versus being told what to do.

Aron: Given that none of the Indian technology companies have market proximity, other than the Indian market, they don’t know what people in the U.K. or California want. In the absence of market proximity, can they be anything other than supply-chain feeders?

Paul: Having market proximity is not necessarily a requirement for doing product development. For example, the U.S. can develop products that serve China. And the Chinese market, you might argue, is unique. Having said that, I think that Indian companies lack that will, or sometimes that will gets drained out of you when somebody’s telling you what to do.

Aron: But U.S. companies that are developing products for the Chinese markets usually have a Chinese presence. Motorola has a Chinese presence and so do companies like Sony, and Nokia, and Ericsson. They own those customer relationships. Off the top of your head, can you think of two or three areas in India where there may be R&D opportunities even if India does not own the customer relationship?

Paul: I really don’t know yet. I’ve lived in the service world so far, and I’m just entering the other side. I’ll get a good feel for that once I meet entrepreneurs.

Knowledge at Wharton: Based on your experience, are there any lessons to be learned by Western companies that want to outsource R&D to India; and for Indian companies that want to get into R&D?

Paul: Well, it’s tough to get into it now. The opportunity that existed five or six years ago is closed, and the costs of entry have gone up dramatically. Also, the big spots are taken and it’s very difficult to unseat those companies. So unless you’re going to play in a particular niche where you have a specific advantage, being a platform outsourcing provider in this market is a very tough spot to be in. Also, you have to think through what value your corporation adds. A service business is really individuals working for someone else. Why would a customer pay any markup to the salaries of the people that he or she is applying? So unless you have a very clear view of your corporation’s value added, you have no entitlement to an enterprise value.

Knowledge at Wharton: Is there a tie-in between more liberal economic policies in India and an increase in intellectual capital? When economic policies have been liberalized, the auto and other industries have boomed. Is it just a matter of time until this occurs in IT and other areas?

Paul: I think it’s the opposite way. The political leaders in India have not been leaders. Instead, they have been led by the social consensus. The social consensus when India first liberalized was forced because India was bankrupt. The “dream team” that has been in place for the past 12 months has basically done nothing, relative to the expectations. They will go up to the line that they feel the social consensus in India will allow. IT and certain other industries created a wave of optimism and confidence in the country — even though they represented less than 1% of the population of India. But it created confidence for all of India, and the social consensus about opening up the market increased. The politicians, ever so shy about getting out ahead of anybody, were happy to follow that trail. If we spread that optimism across more areas, then the pace of change might increase.

Aron: At the lowest level, the foot soldier in IT happens to be somebody with an engineering degree: he’s a programmer. But the foot soldier in coal manufacturing or in chemicals is a blue-collar or factory worker. Typically these are unionized workers who are more resistant to change. Could that be why the service industry is liberalized and the factory industry is not?

Paul: First, I think that the service industry was able to take flight because it did not carry the weight of the existing regulations that the manufacturing industry faced. But to the extent there is the ability for other markets to open up and therefore to create more employment, that will happen. But there is still skilled and unskilled labor. So even if your labor costs a fraction of that in developed markets, if you’re not applying lean manufacturing techniques you will more than offset your cost advantage. It’s not just “brainless” blue-collar workers who are working for you — they have to be adept at some pretty advanced skills.

Knowledge at Wharton: You spoke about the inability of the Indian leadership to go beyond the social consensus. If the task of leadership is to define a vision and then find ways to attract constituents toward that goal, what accounts for this leadership failure?

Paul: Politics.

Aron: France, and to a lesser extent, Italy and Spain also face this situation. Is that inherent to democracy?

Paul: The reality is that it has been that way for a long time. Now you have the occasional oddball like JFK and the moon shot — he wanted to do what was right — and George Bush, who invaded Iraq because he wanted to do what he thought was right. But generally, politics has been bad for democracy. Even outside democracies, why are dictatorships cautious about what they force on the population? You can’t go too far beyond the social consensus before someone says, “Hack his head off and get a new dictator.”

Aron: Your point about social consensus is well made. But looking at successful multinationals, many of the big players are already in India. Do you think that they will get more entrenched, or will their activities go to a plateau and basically level off?

Paul: The question is whether optimism leads to success. At a U.S.-India Council session in Washington, D.C., [GE CEO] Jeff Immelt was a speaker and he said, “Every time we bet on the Indian market, we failed. But I’m willing to place that bet again.” Sometimes just the willingness to place the bet itself is good. It can be a positive, self-fulfilling prophecy. But investments based on such expectations can also evaporate rapidly.

Aron: But if you consider a huge company like Citibank — pretty much every bet it’s made on India has paid off. Perhaps the optimistic, 240-million-strong middle class in India is an attractive market?

Paul: I don’t know why Citi would be successful when GE is not. But the problem isn’t that GE can’t sell to the middle class. The problem is that sales to India don’t merit a visit from GE’s chairman.

Knowledge at Wharton: Returning to R&D, I wonder if you would care to predict what future scenarios might come to exist.

Paul: I think you will see more employment through company-owned subsidiaries in India as opposed to service companies. You’re going to see the kind of work that’s being done there is as good as anywhere else in the world. And you’re going to see entrepreneurial spin-offs come more from company-owned centers than from service providers. As a couple of industries take flight, they will encourage others to take flight.

Knowledge at Wharton: Who’s waiting in the hangars?

Paul: I think the next wave will be from retail finance and logistics. That’s in the domestic market, and I think it’s critical for India to grow the domestic market.

Aron: The Indian diaspora [in the U.S.] is at least 1.6 million strong. In the last 20 years it’s essentially been skilled people like you who have come here and become senior executives with a lot of decision-making ability in many companies. Do you think that could have an impact on the willingness to start and fund enterprises in India?

Paul: People are doing that, but the notion of an enterprise in India is questionable. What do you call a Silicon Valley company that has two people in the U.S. and 12 in India? Is it an Indian company or a U.S. company? The Indian diaspora is already in some ways investing in India, but not in the classic, “incorporate an entity in India and hire people” way. Instead, it’s more like, “Boy, in my next startup in the [Silicon] Valley, I’ll make sure I have an India piece.” If I am going to set up something for India, I’m going to put it in a tax haven. A lot of that is going on, but it’s difficult to measure and track.

Aron: There are 20 million Indians abroad in the U.K., the U.S. and parts of Europe and Africa, and many are very wealthy. But they tend to go where the opportunity is, rather than try to create opportunity in India.

Paul: That’s true. As a venture capitalist I’d like to be in India, but I’d be failing my job if I pushed India even if it’s not the best opportunity.

Aron: Why is the venture capital scene in India so low key?

Paul: It’s because of a lack of innovation. The service companies are a desert. It’s only now that you’re beginning to see some ideas emerge. But venture capital is starting to get pretty active in areas like business process outsourcing, and public equity kind of plays. But if you look at classic private equity, which involves restructuring the balance sheet, particularly for public companies the regulatory environment is very, very difficult. It can take two years for a company to go from public to private. So that has been a bit of a hurdle. But my sense is that there will be increasing amounts of venture capital coming into India. The stronghold that the lalajee [the traditional moneylender] has had, that you can’t do anything unless the lalajee gives you money, will go away. Money will be available.