Can India Learn to Innovate?

About one thing there is no debate: Indian businesses know how to leverage factor cost advantages. Two of India’s most impressive companies — Infosys Technologies and Wipro IT Business — have built their business models and their reputations on offering proficient, efficient technology outsourcing and consulting and, in the process, have done much to shape the Indian economy. That is where the debate begins.

Sramana Mitra, a Silicon Valley entrepreneur and consultant who follows India’s economy closely, recently suggested in Forbes magazine that the spectacular success of Infosys and Wipro got India stuck in an “outsourcing rut” by spawning thousands of entrepreneurs who started similar companies. She contends that this reliance on outsourcing, along with a myopic preference for service over product development and an overemphasis on information technology at the expense of areas ripe for development, such as health care and microfinance, has contributed to an “innovation gap.” A generation of Indian talent has opted for secure work in established industries and enterprises rather than pursuing new ideas and business models.

Mitra is not alone. Many are disappointed with what they see as India’s unfulfilled potential to produce more of the homegrown, innovative start-ups that are necessary to create the next wave of jobs. “People fret that India will remain a low-cost satellite office of the West for the foreseeable future,” the reporter Vikas Bajaj wrote in The New York Times.

Rajeev Mantri, executive director at Navam Capital, thinks it is only a matter of time. “Speculating whether India can spawn innovative companies like Apple and Google is a favorite parlor game among venture capitalists and entrepreneurs,” he said. “But it’s clear that there is staggering talent and creativity in the country, and it seems more a question of when and not if, provided the proper environment is created.”

Still, many believe that creating the proper environment will not be easy. They point to India’s lack of a robust innovation ecosystem — an optimal mix of inventors, entrepreneurs, mentors and investors underpinned by a supportive financial system, friendly government policies and conducive cultural attitudes. Tellingly, Nadathur S. Raghavan, a founder of Infosys and now also an investor in start-ups, recently said that India is held back by a financial system that is reluctant to invest in unproven ideas, an education system that emphasizes rote learning over problem solving and a culture that looks down on failure and unconventional career choices.

Analysts also note that India’s corporate spending on research and development is significantly lagging. In fact, the rate and scope of outsourcing-driven success may itself be hampering R&D. “The ease with which a company’s core business grows can mask the need to invest in innovation,” said Scott D. Anthony, managing director of Innosight, a consulting firm in Watertown, Mass.

Neither has the Indian government traditionally done much to encourage innovation. Although it has recently begun to show some interest in reforms that would favor entrepreneurs, it still engages in protectionism, often stymies new enterprise — especially in manufacturing — with thickets of red tape, and has been known to eschew foreign investment. Up to now, “India has embraced foreign direct investment far less than China has,” said Harvard Business School Professor Tarun Khanna.

Nevertheless, there are plenty of contrarians and contraindications to the pessimistic view of Indian innovation and entrepreneurship. “There are at least 150 incubators in India, and the track records of the India Institute of Technology’s incubators in Bombay and Madras have been exceptional,” said Pradeep Gupta, CEO of Cyber Media India. Gupta is also president of the Delhi chapter of The Indus Entrepreneurs, a nonprofit organization with 1,000 charter members that “has played a very important role in mentoring” local, early-stage start-ups, according to Gupta.

Indeed, venture capital funds have been flowing into India in recent years. Large venture capital firms, such as VantagePoint Venture Partners, Sequoia Capital and DCM, have expanded their presence there, although they have up to now mostly been investing in later-stage operations. “If you want to raise $3 to $4 million, it’s doable,” said Sumir Chadha, a managing director of Sequoia Capital India. But it is difficult if you want to raise a more typical early-stage investment of $300,000 to $400,000, he said.

Early-stage angel investment has also been far scarcer in India than in the West, but some are bridging the gap. Both N.R. Narayana Murthy, chairman of Infosys, and Raghavan have funded their own venture initiatives, and a group called Mum-bai Angels regularly gathers entrepreneurs to pitch ideas to affluent investors.

Canaan Partners of Menlo Park, Calif., is one venture capital firm that has, to a great extent, bucked the late-stage investment trend. Since opening its Indian offices four years ago, Canaan has concentrated on early-stage investments and closed 10 deals. General Partner Deepak Kamra said that his firm is able to consider smaller bets on smaller companies because it is possible to take a company public in India without having to grow it as large as you would in the United States. Canaan has even invested in microfinancing, which Kamra said would not work in the United States because the returns would not be deemed large enough to justify the risk.

Vivek Wadhwa of The Center for Entrepreneurship and Research Commercialization at Duke University is among those most optimistic about India’s innovative capabilities. He does not see that there is necessarily a conflict between innovation and an outsourcing-driven economy. In fact, he believes that to a great extent India’s role in the world economy can be as an outsourced provider of critical R&D in areas such as semiconductor design, aerospace, automotive, network equipment and medical devices. He noted that many multi-nationals, like IBM, Oracle and Microsoft, have already formed partnerships with Indian R&D operations and that the Palm Pre smartphone, Amazon’s Kindle and the Intel Xeon processor all have key components designed in India.

Wadhwa sees great potential in Indian grassroots entrepreneurship as well. “Not all Indian start-ups are developing breakthrough technologies, but many of them are solving problems that U.S. companies have thus far failed to solve, and doing it with fewer resources,” he said. “So, when will there be enough innovative start-ups to support an explosion in venture capital? I’d argue: sooner than you realize.”