Indian Telecom Equipment Cos.

India is finally seeing the emergence of a small number of communication equipment companies that are getting to reasonable size and competing on an international scale. Some of these include Tejas Networks (which appears well on its way to an IPO), Telsima (India’s leading Wimax equipment company) and Ordyn, an optical networking vendor that also has a Wimax.

 Whether some of these become India’s answer to a Huawei, ZTE or UTStarcomm remains to be seen, but all of them have benefited from the low-cost structure that a 100% India-based operation allows. How sustainable is this advantage and where truly does this cost-competitiveness actually come from?

I’ve mapped out the cost-structure of a typical US optical equipment vendor and compared it with an Indian based vendor.

 

	West	India
Revenue	100	75
COGS	60	60
Gross Profit	40	15
R&D expense	12	3
S&M expense	12	4
G&A expense	5	1
Operating profit	11	7
Operating Margin %	11%	9%

 

 

GM Drivers: Margins for optical and other access equipment are in the 40-45% range in the US. For simplicity lets assume a US vendor can sell a box (some kind of SONET/SDH mux for instance) for 100 that costs 60. In terms of manufacturing cost drivers, nearly every telecom equipment vendor in the world outsources the actual manufacturing to EMS companies like Solectron, Flextronics or Jabil etc. These EMS companies typically have plants in low-cost locations like Malaysia. Scale is the only way to get a better price from the EMS companies (think volume discounts).

So from a cost perspective, it costs an Indian vendor at least $60 to “make” the same box (maybe more since their volumes may be a bit smaller owing to their more recent history). 

On the revenue side though, the price-points at which an Indian operator (or any other Emerging markets operator for that matter) will even look at a vendor is usually at least 20-25% lower than the corresponding Western price point. If AT&T is willing to pay $100 for a 64×64 OC-48 optical grooming switch, you can bet that BSNL or Reliance is unlikely to pay more than $70-80. Why? Many reasons – some have to do with institutionalization of these price points (more on this later), some have to do with the need to support legacy network; some have to do with ARPU realities.

In any event, the point here is that while the COGS is the same across the West and the East (“emerging markets”), the EM vendor takes a big hit on the GM line.

 The key to profitability and sustainability is therefore clearly not on the GM front, but on the opex-lines of R&D, Sales & Marketing expenses and on G&A.

 R&D – mostly the salary of engineers and costs of lab equipment, testers etc; since an IXIA box costs the same in the US and India (maybe more in India because of customs duties etc.), the real savings comes from lower engineer salaries. I’ve assumes typical engineer salaries in India are ¼ that in the US.

S&M – salaries of sales people, travel costs; I’ve assumes 1/3 the costs in the US

G&A expenses – other overhead; senior management pay, other staff; I’ve assumed 1/5 the costs

 With a 25% “hit” on the sales price, an Indian vendor can still get comparable margins to a US vendor. Discount the price any further and you start running into trouble.

 

Key Takeaways: 

1. “low-cost” means low operational cost-structure – it is difficult to play the low-cost manufacturing game
2. For the more commoditized products, Indian vendors should beat western vendors every time (in theory) when selling to Indian telcos (and yes, most optical networking gear is commoditized)
3. The real opportunity lies in Indian vendors selling “commoditized” products to the West, where they can still offer a very competitive offering and still increase their margins. Over time, there’s no reason why these vendors can’t move from access/transport gear into the domain of SP routers and enterprise L3 switches.
4. Western vendors selling products into India will have a hard time until a substantial portion of their workforce is in India or countries with a low-cost structure. Otherwise, profits from India will not even be near-enough to cover the high cost of operating in a high-wage country like the US, Canada or Germany. That’s why for companies like Cisco, “Globalization” is an imperative, not a choice. Its quite simple – if you expect more revenue from India you better have more people based out of India, otherwise your overall cost-structure takes a hit.