President Obama’s visit to India in November was a welcome opportunity for both the United States and India to focus on the positive aspects of their economic relationship. Rather than directly address the politically delicate issue of outsourcing thousands of U.S. service jobs to India, the President and his entourage of business leaders called attention to the growing volume of trade between the two countries and the vast new opportunities for much closer trade and investment ties in the future. Overall, more than $14.9 billion in bilateral trade deals were either announced or highlighted during the visit, according to the White House, including $9.5 billion in new U.S. exports to India, reportedly supporting an estimated 53,670 U.S. jobs. “These cross-border collaborations, both public and private, underpin the expanding U.S.-India strategic partnership, contributing to economic growth and development in both countries,” said the Office of the Press Secretary in a statement.

India’s role in the global economy — and U.S. perceptions of that role — continue to evolve at a rapid pace. Less than two decades ago, conversation about India in the U.S. often focused on its poverty and the foreign aid that the U.S. and other developed countries offered to alleviate it. Now, the emergence of Indian companies on the world stage draws increasing notice. Such players include Tata Motors, which owns prestigious British brands Jaguar and Land Rover, and global IT service providers like Infosys.

Too often, however, India’s growing prowess in networked business process outsourcing (BPO) attracts negative attention, especially among those Americans who feel their jobs are threatened. In 2009, U.S. companies bought $2.3 billion worth of BPO services in India, up from $1.5 billion in 2007, as Indian firms continued to improve the range of their offerings . But as President Obama’s visit highlighted, there is a lot more to the U.S.-India business relationship than India’s enormous skill at supplying back-office services.

Although U.S.-India trade is still overshadowed by trade with China, India is gradually becoming an important partner for the United States. U.S. exports to India have expanded from just $3.6 billion in 2000 to $18.2 billion in 2010 (12 months through June), compared with $69.6 billion in U.S. exports to China in 2009. On the other side of the ledger, U.S. imports from India have grown from $10.5 billion in 2000 to $26.4 billion in 2010 (12 months ending June), still dwarfed by the $296 billion in imports from China in 2009. Much of the growth in commodity trade is occurring in non-consumer sectors that attract little public attention but where U.S. manufacturers remain highly competitive. During his visit, President Obama announced 20 export deals, some involving big-ticket items like passenger jets, gas and steam turbine engines and oil-and-gas equipment supplied by such Fortune 500 names as Boeing and GE.

In what other ways is the U.S.-India business relationship likely to evolve? And what are the remaining weaknesses in India’s infrastructure and workforce that will affect this relationship as well as India’s future growth?

Redefining Business Processes

While an estimated 85 million to 100 million Indians have already moved out of poverty into India’s middle class, that’s only a small percentage of the country’s 1.17 billion people. The country’s workforce still has a long way to go before it can match up with that of the major industrialized nations of North America, Europe or East Asia, notes Ravi Aron, a senior fellow at Wharton’s Mack Center for Technological Innovation who is also a professor at the Johns Hopkins Carey Business School.

At the highly regarded top of India’s pyramid, notes Aron, there is a relatively small group of “extremely capable entrepreneurs who are redefining business” so that India can overcome its remaining weaknesses. They are the internationally recognized elite who are leading India’s emergence as a global center for outsourcing services. Below them, in the middle of the pyramid, says Aron, is a second group, “the growing lower middle class that is making it possible. This is the labor force that executes the vision of the group at the top.” 

Below that second group is the old India: an enormous third group of workers whom Aron describes as “the victims of the state,” workers ill-suited for playing a role in a modern industrial society. These are the people, he says, who might have been better off if the Indian government had not left the country’s economic emergence largely to the small group of entrepreneurs at the top. “This underclass votes on the basis of caste and religion, and you get terrible politicians who keep them down,” says Aron.

The whole world knows that China’s recent transformation into a modern nation is based on enormous government-led initiatives to improve that country’s infrastructure, both physical and human. But the situation in India is quite different, notes Aron. The entrepreneurs who have led India’s limited transformation have done so despite the continued poor quality of its physical infrastructure — its broken-down roads, bridges, power grids — and the unwillingness of Indian politicians to invest in that infrastructure or in the country’s emerging pool of workers. Indian companies have succeeded despite the country’s infrastructure, not because of it. “They find ways to get around its frailties and develop certain unique capabilities,” says Aron.

Ironically, some of those unique capabilities “have become devastating weapons to take on other multinationals” from outside India, according to Aron. “Many of the early IT majors learned how to manage [in India] in spite of the lack of infrastructure” because they had to do so in order to survive. They figured out how to offer their Indian customers back-office processes that had predictability, reliability and scalability. Having learned how to provide high-quality services “in a place where there is every possible frailty you can think of,” Aron says, these Indian firms gained confidence that they could compete elsewhere. They did that by offering the same sorts of services to multinational companies on the backs of the world’s most reliable telecom networks, which are far more predictable than those in India.

Training in the Private Sector

In another creative adjustment to local frailties, the leading home-grown entrepreneurial companies have responded to the shortage of formally trained, high-level engineers by taking it upon themselves to train their own people to meet the highest global standards. As recently as 2005, McKinsey reported that only 25% of engineering graduates in the Hyderabad region were “suitable for employment in multinationals.” McKinsey then went on to make a disturbing forecast: Demand for engineers would reach 138% of supply by 2008, leaving India unable to develop its full potential for outsourcing IT services. 

Aron says the situation was even worse than that, and it remains bad. He estimates that “only about 10%” of engineering graduates currently meet the highest global standards. The good news: Because the Indian government did not invest in training programs for its young engineers, “the onus fell on private industry” to train the bright prospects in-house — and they proceeded to do so. In the process, the Indian firms learned valuable lessons about how to train and manage labor, according to Aron, and have used that knowledge to provide services for U.S. and other foreign companies. “You impose an entirely new set of quality requirements [on such engineers] because you know what it takes.”

Likewise, India’s emergence as a location for outsourced legal services also reflects its creative adaptation to its own weaknesses — in this case, the dreadful condition of its over-burdened courts. “Indian courts are extremely slow,” notes Aron, so a case can go on for as long as 25 years before it is resolved. With all its delays and inefficiencies, “India has a huge number of lawyers who are constantly on call.” The result is a new service for export:  English-speaking Indian lawyers who are available to provide legal services for multinationals on the other side of the globe.

Legal services is one way in which Indian providers are expanding their range of outsourced offerings, and demand for their offerings is strong, says Jacob Shasho, president of Hyderabad-based NAPS India, which locates and hires employees for U.S. multinationals that outsource medical billing and other back-office processes to India. “We get to the point where the client doesn’t feel any difference between dealing with an employee who is next door and an employee [who is] in India,” notes Shasho. “Imagine a very long cord to the client in India.”

Despite India’s well-deserved reputation for call centers, Shasho says that most outsourced services are not voice services. Instead, most employees are engaged in such activities as medical billing, programming, accounting/bookkeeping and legal research. Although the rise of outsourced legal services may seem threatening to U.S.-based lawyers, Shasho points out that Indian workers are not allowed to provide legal advice since they are not licensed to practice law in the United States. “They don’t have direct contact with clients in India unless the client needs legal services for a case that takes place in India.”

Shasho says that India’s technical infrastructure is “very advanced. The Indian economy is really dependent on BPO and KPO [knowledge-process outsourcing] for such services as accounting and legal research. You don’t need all of the more than one billion people in India. You need only to take the cream of the cream. Maybe only 10% to 20% of the population can be in the IT sourcing sector, but this cream-of-the-cream is huge” because the size of the population is so large.

Growth Opportunity for Transportation Specialists

The weaknesses in India’s physical infrastructure could turn out to be a growth opportunity for foreign companies that supply critical transportation services. As demand for manufacturing and agricultural products expands, supply chains for manufacturers and agribusinesses — which have tended to be localized — will need to extend across the country so that companies can distribute their products cost-effectively, according to a recent report by Frost & Sullivan, a business research and consulting firm. Spending on transportation and logistics in India, which reached $75.19 billion in 2009, about 6.2% of the country’s total GDP, is expected to grow at a compound annual rate of 9.9% between 2009 and 2014, to $120.42 billion. Despite India’s shortcomings, U.K.-based Transport Intelligence Ltd. rated the country highest in its Emerging Markets Logistics Index because of the huge potential size of the market and its “growth attractiveness.”

The problem with most industrial and retail sectors is that there are multiple levels of intermediaries, says Srinath Manda, a Frost & Sullivan industry analyst, in the firm’s recent report. Because companies will be hard pressed to serve such an intricate network, logistics service providers — including multinationals like UPS and FedEx — could expand their sales in the country. “Apart from the steady expansion of operations by large domestic industrial groups, an increasing number of global majors in industries ranging from automotive and electronics to pharmaceuticals and cement have been targeting a spot in the highly lucrative Indian market,” says Manda. “While foreign companies need to engage logistics service providers  — since they are not conversant with the culture, government policies, or distribution landscape of the country — domestic companies are outsourcing their logistics activities to organized third-party logistics [firms] to focus on their core competencies.” 

Manufacturers and logistics companies are hampered the most by the country’s poor infrastructure connectivity in rural areas, says Manda, especially in the consumer goods, food processing, pharmaceuticals and consumer durables industries, which have a huge potential consumer base in these areas. “Apart from the development of dedicated railway freight corridors, the focused development of inland waterways and the strengthening of road networks through the national highway development program are expected to improve the market reach of most industries,” notes Manda. “Owing to these efforts, professional logistics services can be extended up to rural areas, leading to a higher scale of logistics activities outsourcing.”

Already, some Indian entrepreneurs are finding innovative ways to leverage the weaknesses of India’s transportation infrastructure to their competitive advantage, according to Aron. Bombay-based Tata Motors, for example, has taken advantage of the peculiar characteristics of India’s supply chains, which are more localized, less differentiated and less specialized than those in North America. “You don’t have 14 or 15 grades for the same auto part in India,” says Aron. These characteristics have made it possible for Tata to source car components closer to its factories, and coordinate R&D and production efficiently. Otherwise, the process of coordinating the flow of components to various factories would have been more costly. That makes it possible for the company to manufacture the world’s least-expensive car, the Tata Nano, which sells for only 100,000 rupees, little more than $2,000. “Even if you doubled the cost, it would be very cheap,” says Aron. And it gets 3.5 times the mileage of a Toyota Camry. 

As for the design of the Nano, it, too, takes advantages of India’s weaknesses. “The roads are terrible, and the Nano had to be very agile” to move between cows and bullocks on the road, notes Aron. “You overcome your handicaps and so you become very effective in competing around the world.”