Page | 1 Scale and Scope Externalities in Growth of IT Industries in India: An Agglomeration Perspective Robert J. Kauffman Director, MIS Research Center and Professor of Information and Decision Sciences [email protected]Ajay Kumar Doctoral Program [email protected]MIS Research Center, Carlson School of Management, University of Minnesota Minneapolis, MN 55455 Last revised: January 17, 2007 ______________________________________________________________________________________ Abstract Externalities occur among agglomerated firms. Scale externalities occur between firms in an industry with similar activities. Scope externalities occur when heterogeneous activities are placed in proximity. Combined scale-and-scope externalities exist when the scale of one industry is beneficial to the growth of another collocated industry. We use the agglomeration perspective to explain the growth of IT industries in India. We study growth patterns of four IT industries: computer and peripheral equipment manufacturing, semiconductor and other electronic components manufacturing, software and IT-enabled services. Our analysis suggests the existence of scale, scope and combined scale-and-scope externalities in IT industry growth. We also find that the growth of IT industries has had a significant positive effect on national development. Keywords: Agglomeration, collocation, economic analysis, scale/scope economies, India, IT industry, knowledge spillovers. __________________________________________________________________________________
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Scale and Scope Externalities in Growth of IT Industries in India: An Agglomeration Perspective
Robert J. Kauffman Director, MIS Research Center and Professor of Information and Decision Sciences
Abstract Externalities occur among agglomerated firms. Scale externalities occur between firms in an
industry with similar activities. Scope externalities occur when heterogeneous activities are placed in proximity. Combined scale-and-scope externalities exist when the scale of one industry is beneficial to the growth of another collocated industry. We use the agglomeration perspective to explain the growth of IT industries in India. We study growth patterns of four IT industries: computer and peripheral equipment manufacturing, semiconductor and other electronic components manufacturing, software and IT-enabled services. Our analysis suggests the existence of scale, scope and combined scale-and-scope externalities in IT industry growth. We also find that the growth of IT industries has had a significant positive effect on national development.
Keywords: Agglomeration, collocation, economic analysis, scale/scope economies, India, IT industry, knowledge spillovers. __________________________________________________________________________________
Natl. Ctr. for Software Technology 1975 Bangalore Software development Natl. Informatics Center 1977 Delhi and state capitals Network, software
solution support Telecomm Consultants India (TCIL) 1978 Delhi Telecomm consulting, engineering Semiconductor Complex Ltd. (SCL) 1983 Chandigarh Design, mfg. VLSI systems, subsystems Center for Development of Telematics
(C-DOT) 1984 Delhi Design, develop
telecom products, services
NA Bangalore, Kolkata Videsh Sanchar Nigam Ltd. (VSNL) 1986 Mumbai International telecom
services Ctr. for Development of Advanced Computing (C-DAC)
1988 Pune Design, develop, deploy advanced IT solution
NA Bangalore, Noida, Delhi, Chennai, Chandigarh, Hy-derabad, Kolkata, Trivandrum
Source: Company, government and other Web sites; NASSCOM and other publications. NA = not available
Peutronics 1986 Bangalore Software ICIM (Intl Comp) NA Pune Computer mfg. DEC India Ltd NA Bangalore IT services Honeywell CII NA Bangalore Computer mfg. Satyam Comp. Serv 1987 Hyderabad ITES Mahindra British Telecom 1988 Pune Develop software Hewlett-Packard India Software Op Pvt Ltd
1989 Bangalore Software solutions
Tata Elexi Ltd 1989 Bangalore Software solutions Source: Company, gov’t and other Web sites, NASSCOM and other publications and studies. NA = not available
U.S. demand for programmers began to spill over to India in the late 1980s and this led to the spurt
in the growth of the software industry. The export-oriented software industry was initially for low-end
software services. This phase is identified w ith ―body-shopping‖ (Desai, 2003). Body-shopping is
positioning a programmer or other software personnel on the site of the customer for their software
Page | 15
needs. But an externality of a different form would help the industry to leapfrog to the next level of
delivery. Texas Instruments (TI) set up a development center in Bangalore in 1985 and a satellite link
to headquarters in Dallas, Texas. TI was the first private company to be permitted international
connectivity, which was then the monopoly of the government, operated by Videsh Sanchar Nigam
Ltd. (VSNL). Since TI did not need it, it sold bandwidth to local industry. This revealed the benefits
that connectivity could bring. In 1989, VSNL commissioned a high-bandwidth link to the U.S.
(Dataquest, 2002b). Then in 1993, the first earth stations were commissioned for Bangalore and
Hyderabad. A s India’s connectivity improved in the early 1990s, software services could be provided
from India itself, without foreign personnel having to physically go there. This led to large-scale
growth in software services. It also marks the evolution of IT industries in India, where their scale
grew to a level where it impacted complementary sectors of economy (e.g., telecom and HR
development, etc.). This represents the third-order impacts of IT industries on development (Sein and
Harindranath, 2004). The connectivity also opened up opportunities for data processing and the ITES
industry. ITES grew in India as the software service industry showed that services could be provided
from offshore locations. The ability of ITES to grow from software was partially because the software
industry in India, unlike that in Israel, was developed around software services and not around
software products (Athreye, 2005). ITES growth from the software industry points to scale-and-scope
effects between these industries.
Huge export demand for software services and ITES led many companies (e.g., Wipro, PSI Data
systems, HCL) previously in computer manufacturing to diversify into software services and ITES.
Digital Equipment India Ltd., a subsidiary of Digital Equipment Corporation, also switched to
developing software for its own systems. This diversification from hardware to software and ITES
Page | 16
shows the scale-and-scope effects between computer and peripheral equipment manufacturing, and
the software and ITES industries.
Growth of the ITES industry also led to entry by smaller players into the industry. In the 1990s,
some smaller Indian firms in Bangalore and other IT cluster cities tried to start in the software
industry through data entry and transcribing activities (Latheef, 1997). With passage of time, foreign
software vendors, including IBM, Microsoft, Oracle, and SAP, moved from using units in India to
crank out code to helping to design and develop commercial software (McDougall, 2005; Zhao,
2006). The software industry climbed the value chain, and part of this was aided by the presence of
scale economies in the ITES industry, another reflection of scale-and-scope effects between ITES and
software industries.
A more recent trend has been the growth of the semiconductor and other electronic components
industry, which had been lagging compared to growth of other IT industries. This industry has shown
signs of growth, especially around Bangalore and Hyderabad. Motorola set up a design center in
Bangalore and Hyderabad. Intel India Development Center, set up in Bangalore, has more than 3000
employees, and is in the process of designing new chipsets for small form-factor notebook and low
cost notebook (Indo Asian News Service, 2006). A US$3 billion semiconductor complex by AMD-
SemIndia consortium now is being set up in Hyderabad. We argue that the growth of the
semiconductor and other electronic components industry has been induced by the growth of the
software industry due to synergies between the software industry and the design and planning aspects
of semiconductors (De Micheli and Gupta, 1997). Heeks (1998) recognizes that growth in the
software industry can lead to induced growth in services and hardware industry. The scale-and-scope
effects between different IT industries are examples of the third-order impacts of IT industries on
national development in the framework proposed by Sein and Harindranath (2004).
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3.3 Scale-and-Scope Effects: City-Level Analyses
Having outlined the overall synergies, we next examine how the scale, scope and the combined
scale-and-scope effects translated into industrial growth at the city level. We focus on IT industry
growth patterns in two cities: Bangalore and Hyderabad. These cities themselves are evidence of
economies of scale in IT industries, or else such large-scale IT clusters would not be possible. More
evidence of scale effects is that many foreign companies, which started with small operations in these
IT clusters, have expanded over time. A similar trend is visible for domestic companies as well. Still
we will emphasize how one IT industry has facilitated growth in another IT industry in these cities.
Bangalore. According to a cliché, Bangalore is the ―Silicon Valley of India.‖ In the m id -1980s,
Bangalore was home to several electronic hardware and computer manufacturing firms. (See Tables 2
and 3.) The Bangalore-based public sector firm, BEL, led the development of semiconductor and
electronics hardware technology in the early 1960s and 1970s. More significantly, BEL provided the
first training ground for engineers in IT. BEL’s Bangalore location, thus, had to do with the city’s
eventual success in the IT sector (Dataquest, 2002a). ITI, ISRO, HAL were other major public sector
units, employing thousands and manufacturing electronic hardware. In addition, major private sector
computer and peripheral equipment manufacturers were also located in Bangalore. The pool of
knowledge resources and social capital existing in Bangalore in the mid-1980s helped in the growth
of the software and ITES industries in the 1990s. This reflects a scale-and-scope effect from the pre-
existing hardware and computer and peripheral equipment manufacturing industry to growth of the
software and ITES industries.
Major computer and peripheral equipment manufacturers in Bangalore, including Wipro, PSI Data
Systems, and multinationals, DEC and Honeywell, diversified into the software services and ITES
industries. Motorola, which manufactured electronic components for pagers, diversified into software
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development in its research center in Bangalore (Latheef, 1997). Many top software companies in the
world set up wholly-owned subsidiaries or joint ventures with Indian companies in Bangalore
(including IBM, Oracle, Novell, Fujitsu, NEC, HP and Sun Microsystems). Many other
multinationals (e.g., Siemens, Deutsche Bank, Motorola, Citicorp, and VeriFone) set up software
development centers in Bangalore for their entire systems. CISCO also set up a software solutions
center for enterprise network management products. And Dell set up a development center in
Bangalore for development and management of applications used in its operations. Bangalore also
became headquarters to a large number of Indian software companies. Wipro and Infosys are
specifically notable. By 1995, 56 of the top 200 software companies were located in Bangalore
(NASSCOM, 1995). Likewise, other companies entered the ITES industry. In the ITES industry,
Bangalore specialized in call center, transcription, and back-office operations services. The city also
had a reasonable number of companies in database management, development, data processing,
management and engineering, design, and geographical information system (GIS) services. (See
Table 4.)
Another scale-and-scope effect w itnessed in the grow th of B angalore’s IT industry is the im pact of
the ITES and software industries on computer and peripheral equipment manufacturing. With the
growth of ITES and software in the 1990s, the scale of these industries induced growth in the
com puter and electronics hardw are. T he ―S im puter,‖ a com puter for R s10,000 (~ U S $230) w as
launched by Pico Peta Simputer Pvt. Ltd. and Encore Software Ltd. in 2001. And then PARAM
Padma, a supercomputer with the computing power of one teraflop, was launched in 2003 by CDAC.
In 2003, IBM launched its low-end e-server in Bangalore. The export level from the electronic
hardware industry in the Electronic Hardware Park there is a good indicator for growth in computer
and peripheral equipment. (See Table 5.)
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Table 4. Export of Software and ITES, Bangalore
YEAR # FIRMS EXPORTS US$ MILLIONS
EXPORT GROWTH
1991-92 13 2.17 NA 1992-93 29 7.10 227% 1993-94 53 29.57 316% 1994-95 79 63.76 116% 1995-96 125 136.29 114% 1996-97 163 272.22 100% 1997-98 207 432.57 59% 1998-99 267 752.59 74% 1999-00 782 1010.33 34% 2000-01 928 1598.93 58% 2001-02 1038 2029.30 27% 2002-03 1154 2570.24 27% 2003-04 NA 3975.66(a) NA 2004-05 NA 6366.78(a) NA Source: Department of IT and Biotechnology, Govt. of Karnataka and IndiaInfo.com (May 11, 2005). Exchange rate as of January 1 each year. (a) Includes exports from other cities of Karnataka. NA = not available.
Bangalore has become a design hub in the Asia-Pacific region for Intel and Motorola in
semiconductors and electronic components. In 2001, Intel set up an R&D center with 1,200
employees and expanded to 3,000 employees in 2003. It provides R&D for very large scale
integration (VLSI) and microprocessors, and e-business solutions. The presence of firms like BEL
and TI, which arrived in Bangalore in 1985, also provided scale effects to the growth of this industry.
Also, semiconductor and electronic component design has similarities to software industry activities.
So semiconductor growth in Bangalore can be attributed to scale-and-scope effects from the software
industry’s scale.
Hyderabad. Referred to as ―C yberabad,‖ the IT cluster here traces its history to the base built by
two national-level public sector undertakings, ECIL and CMC. ECIL was the major computer and
peripheral equipment manufacturer in the pre-reform period responsible for government and public
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sector installations in the 1970s. ECIL nurtured the best engineering talent in the country when the IT
industry was in its infancy (Dataquest, 2002a). CMC was responsible for maintaining 800-odd IBM
installations when IBM left the country in 1978, and other computers made by foreign suppliers. It
developed expertise on 40 foreign platforms and in hardware and software maintenance (Dataquest,
Growth in the R&D and software industries has led to growth of the semiconductor industry in the
city. Motorola was first to expand from Bangalore to Hyderabad. Establishment and growth of a large
number of embedded systems and VLSI design companies occurred in the past two years also (Jafri,
2004). In February 2006, plans for Fab City, a silicon chip facility, were finalized there with a US$3
billion investment by the AMD-SemIndia consortium. Fab City will have multiple units making
silicon wafers, solar power and liquid crystal displays (LCD), and thin film transistor (TFT) chips.
Intel Technologies will partner with others in the Fab City project.
Growth patterns in Hyderabad show scale-and-scope effects like B angalore’s. S uch effects m oved
from the pre-reform computer and peripheral equipment industry to software services initially, in
software services to ITES in the 1990s, and now from software to semiconductor manufacturing.
A lthough our analysis doesn’t provide a basis to generalize from , it supports the idea that one IT
industry’s scale m ay benefit a collocated IT industry.
Table 6. Software & ITES Industry Exports, Hyderabad
YEAR TOTAL SOFTWARE AND ITES EXPORTS
ITES EXPORTS
SOFTWARE EXPORT
2002-03 763.4 293.7 469.7 2003-04 1100.0 513.8 586.2 2004-05 1907.7 NA NA Source: Indiainfo.com, May 11, 2005. All figures in US$ millions. Conversion via January 1 exchange rate. NA = not available
4. DISCUSSION
Porter, stressing the importance of collocation, posits that even as old reasons for clustering (e.g.,
proximity to markets, labor, or capital) have diminished in importance with the growth in
globalization, new influences of clusters on competition have become key in a knowledge-based
economy (Porter, 2000). Tan and Leewongcharoen (2005) also point out the importance of
geographical location in the development of IT industries in developing countries. As an industry
becomes leaner and more flexible, lateral inter-firm relationships take higher policy priority. Our
analysis of the growth of IT industries also points towards benefits of locating in clusters. Similar
growth patterns for IT industries in Bangalore and Hyderabad support existence of agglomeration
externalities.
In India, the software service industry influenced growth of the ITES industry, and both software
and ITES induced growth in semiconductors. The software services industry in India also benefited
from the scale of computer and peripheral equipment manufacturing. The software industry in U.S.
did not show similar results (Kauffman and Kumar, 2006). One reason could be because in India
software services are a dominant component of the industry, whereas in the U.S. software
development is the principal part. Another possible reason is the exogenous effect of outsourcing.
Although outsourcing has caused diminution in software growth in the U.S., it has enhanced the
growth of software industry in India (Dutta and Roy, 2005). In addition, there may be country
specific differences which may account for the differences in knowledge externalities (Appleyard,
1996).
Some scholars question whether knowledge spillovers have relevance to Indian IT industry growth
(D ’C osta, 2002a; 2002b) and argue that growth is totally export-driven. We argue that local
externalities cannot be ignored. Multinational firms are increasingly conducting R&D related
activities in India (Zhao, 2006). Todo and Miyamoto (2006) study the knowledge spillovers due to
foreign direct investment (FDI) to domestic firms in less developed countries and finds that local
R&D by foreign-owned firms in the host country enhances knowledge spillovers from R&D. Bwalya
(2006) shows that there are significant inter-industry knowledge spillovers in Zambia occurring
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through linkages due to FDI. Patibandla and Petersen (2000) showed knowledge spillovers between
collocated foreign and Indian firms. Leading software vendors like Adobe. are releasing products in
the U .S w ith labels ―M ade in India‖ indicative of brand value associated w ith such labeling (S axena,
2006). A study by Indian government agency, National Institute of Science, Technology and
Development Studies (NISTADS) shows that between 1990 and 2002, most patents registered in US
from a foreign country were from India— 266. These patents primarily belonged to the
pharmaceutical, electronics and other hi-tech sectors. While more than half of these patents were
owned by foreign companies operating in India, remaining were by Indian organizations (Chauhan,
2006). as Part of these spillovers may be due to weak intellectual property protection and partly due
to labor pooling between different IT industries. Lal (1996) reports that the electronics industry in
India was R&D intensive, indicating that firms attached importance to innovation for growth.
International trade involves competition among nations, so innovation is needed for the Indian IT
industries to grow. By climbing the value chain, the Indian software industry has shown its success
with innovation. So knowledge spillovers in collocated industries are likely to be present.
Additionally, the impact of knowledge spillovers is only one of the reasons for local externalities
(1920) and externalities could arise due to other factors such as input sharing or labor pooling as well.
The study has implications for economic development, especially in developing countries. We
show that collocation of IT industries supports accelerated growth. A policy implication is that
support for the ―IT park‖ model should also encourage proximate collocation. In addition, since there
are scale-and-scope effects between different IT industries, governments should consider placing
electronic hardware IT parks close to software parks.
There are indirect policy implications that result from the second and third-order effects of IT
industry growth on national development (Sein and Harindranath, 2004) . IT industry does not merely
Page | 24
augment GDP. Kraemer and Dedrick (2001) refer to effects of IT industrial growth on
complementary sectors, including manpower, R&D and infrastructure, for eleven Asia-Pacific
countries. In India, we discern evidence of both second and third-order effects of IT industries.
Consider the second-order effects first. The increased-scale export-oriented IT industries brought in
foreign exchange, crucial in 1980s India. The country also experienced third-order effects as growth
in IT industries boosted employment opportunities, which in turn had multiplier effects on overall
economic growth. Another complementary effect was the growth of IT education to cater to the
increase in demand for IT manpower. Growth also led to better telecom infrastructure and overall
infrastructure (roads, housing, etc.) in cities with concentrations of IT industries.
IT industrial growth also has other third-order effects (Sein and Harindranath, 2004). We have
discussed how scale-and-scope effects between different IT industries led to ITES growth in the early
1990s and, more recently, to semiconductor growth. Furthermore, the growth of IT exports facilitated
globalization of the economy, which boosted other sectors (e.g., tourism, financial services and
manufacturing). Venture capital and stock markets became stronger and FDI inflows increased.
Outsourcing had spillover effects on clinical trials and biotech industries. The second and third-order
effects that we have mentioned above are not comprehensive, but corroborative of the growth of IT
industries. They have multi-dimensional effects on the development of a developing country.
Our qualitative analysis of the growth of Indian IT industries shows that combined scale-and-scope
effects have played a role in India’s IT industrial growth. These effects also show some degree of
robustness across two different developmental contexts: India and the U.S., as described in Kauffman
and Kumar (2006). This raises opportunities to explore the reasons why synergies exist between
different industries which result in combined scale-and-scope effects.
5. CONCLUSIONS
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Our agglomeration perspective based on scale, scope and combined scale-and-scope externalities,
provides a new understanding of growth patterns for IT industries in India. Previous research has not
provided a suitable lens on this interesting research phenomenon. We report qualitative evidence of
combined scale-and-scope effects in collocated IT industries in India. We find that the ITES industry
gained from the scale effects of software and computer and peripheral equipment manufacturing, and
the semiconductor industry gained from the scale of the software and ITES industries.
Our research also explains how externalities (scale, scope and combined scale-and-scope) lead to
second and third-order effects in national development. This underlines the need for greater focus on
planning and promotion of the IT-producing sector. Scale and scope economies can also have
implications for firm performance (Macher, 2006), so this work provides firms with guidance about
selecting locations for new IT firms. The study also has important implications for the regional
planners and technology research park developers.
The study makes contributions to the IS literature for developing countries (Walsham and Sahay,
2006). Hanna (1994) argues that IT is a strategic sector with capabilities to transform a developing
country into a modernized global economy. Haltiwanger and Jarmin (2000) also say that although e-
commerce and IT-related production is credited with one-third of economic growth, yet the economic
literature offers very little coverage at the macroeconomic level. Kauffman and Walden (2001) also
have argued that there is need for better understanding of IT-related industry growth and
performance. This study addresses this issue.
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Acknowledgments. We benefited from input offered by the co-chairs of the IT and International Development Mini-Track at HICSS 2007, Sajda Qureshi, Maung Sein and Peter Wolcott, several
anonymous reviewers, and participants in our research presentations in Applied Economics and the Carlson School of Management of the University of Minnesota. Rob Kauffman thanks the MIS Research Center at the University of Minnesota, and its Assistant Director, Donna Sarppo, for partial support.