A recent study by Bangalore-based management consulting firm Zinnov titled, “Operating Costs Benchmarking Study 2012,” suggests that India continues to be an attractive destination for multinational companies (MNCs) to set up their captive research and development (R&D) centers. According to the report, the average operating costs for MNC R&D centers in India has declined by 6% in U.S. dollar terms in fiscal 2011-2012 (FY12). The cost per employee was at US$40,604 in FY12 as compared to US$43,174 for FY11. The study, based on a survey among a sample of 55 R&D centers with over 37,000 employees across India, says that over the past five years, MNC R&D centers in India contributed to a net savings of over US$70 billion for the headquarters.

India has an installed R&D talent pool base of more than 210,000 engineers. Over the past five years, this has been growing at an average of 9% a year. At present, more than 870 multinationals have R&D centers in India, an increase from 836 in 2011. One driving force behind the growth is that while earlier India was seen primarily as a resource pool, increasingly it is also becoming an important market across verticals for the multinationals. In an earlier India Knowledge at Wharton article, Biswadip (Bobby) Mitra, president and managing director of Texas Instruments India, had said: “We see India as a big growth market. It has important top management attention, and we are betting big on it.”

According to Praveen Bhadada, director of market expansion at Zinnov, many of the MNC captive centers are doing high-value-addition work in India. “The Indian R&D ecosystem started 25 years ago based on the huge cost arbitrage it offered to headquarters. The fact that MNC R&D centers are now increasingly focused on innovation, leadership and better value addition and yet are able to deliver cost savings of over US$70 billion in the past five years is a significant advantage.”

The report notes that various factors have led to the drop in operating costs. These include optimization of the talent pyramid by hiring aggressively at the junior levels and increase in contract resource hiring, use of technology for collaboration and for limiting project-critical travel, consolidation of offices into single-facilities, reduction of professional services costs by building in-house talent and negotiating on third-party vendor fees. The weakening of the rupee vis-à-vis the dollar and the euro has also played a role. “Multinationals are increasingly looking to tier-2 cities where costs are lower,” adds Bhadada. “We are confident that India will continue to maintain its competitive advantage over other emerging markets for a long time.”

Another study from Zinnov on engineering R&D and the product engineering services segment in the country says this market is expected to grow at a 14% compound annual growth rate from US$14.7 billion in FY2012 to US$42 billion by 2020, outpacing the IT growth rate in the country. Pointing out that India is the leading offshore destination for product engineering services with 22% market share, the study titled, “Engineering R&D: Advantage India,” suggests that the “ecosystem connect between captives, service providers and start-ups gives India a unique advantage to innovate for local as well as global markets.”

Sundararaman Viswanathan, manager of consulting at Zinnov, says: “As relationships mature, service providers and customers will enter into pricing models based on market outcomes. Further, with emerging nations growing in importance as key markets, MNCs are set to leverage the inherent competencies in India to build products for local and global markets.”

At the same time though, the study also cautions Indian players against complacency. It notes: “The Indian service providers will face stiff competition from Russian and Chinese service providers who are building strong domain capabilities in ISV [independent software vendors] and telecom segments.”