Date: Thu, 8 Jan 2004 23:33:02 -0800 From: Norm Matloff To: Norm Matloff Subject: another offshoring horror story To: H-1B/L-1/offshoring e-newsletter http://www.mercurynews.com/mld/mercurynews/business/7659988.htm Thu, Jan. 08, 2004 Offshore labor drove firm to brink By Matt Marshall Mercury News Go ahead, join the lemmings in the rush to India. But if you're a Silicon Valley entrepreneur or venture capitalist still considering it, contemplate the over-the-cliff tale of Ishoni Networks. Last month, the Santa Clara start-up filed for bankruptcy, a victim of moving to India too quickly. Backed with more than $68 million from venture capitalists from the United States and elsewhere, Ishoni once was branded a rising star. It was developing a cutting-edge chip to allow voice and data services over a single Internet connection -- and was valued as high as $200 million and employed 170 people. Seeking to cut expenses, Ishoni created a subsidiary in Bangalore, India, and hired software engineers there on the cheap. Weirdly, though, the subsidiary stopped returning phone calls from Ishoni's Santa Clara-based chief operating officer, Amin Varis, early last year. Varis made a surprise visit to India in May and learned a big lesson about how much damage 12,000 miles of distance -- even when connected by Internet and phone lines -- can do. Indian executives, he found, had forced their engineers to join a rival firm, Ample Wave Communications, apparently in a scam to scoop up Ishoni's intellectual assets and then bankrupt it. Ishoni notified police, and three Ishoni India executives were charged with illegally copying Ishoni's software -- a fiasco first reported in August by online optical networking publication Light Reading and followed by Private Equity Week. The outcome of that case is not known. Neither Ishoni nor any of its dozen or so venture investors -- including names like Credit Suisse First Boston, Deutsche Bank, Infinity Capital, Lucent Venture Partners and John Grillos, formerly of MVC Capital, who is the sole VC board member listed for the company -- returned phone calls. However, a spokesman for electronics giant Philips, which owned 51 percent of Ishoni after a $25 million investment in 2002, confirmed Ishoni is being liquidated. It won't take very long: A blue padlock already hangs on Ishoni's Santa Clara office door. Inside are empty cubicles, deserted desks and disconnected phones. So, what's the lesson? The growing hysteria and hand wringing over job loss to India sounds similar to the worries during the rise of the Japanese threat in the 1980s. But soon after gobbling up U.S. companies and real estate, Japan hit its own internal limitations -- namely bad credit, cronyism and market interventionism. Japan foundered, and has never been considered a danger since. True, India's vast, cheap labor supply poses a different, more permanent threat. Skilled Indian engineers who speak great English won't be going away anytime soon. But increasingly, VCs say outsourcing to India has limitations. Ravi Chiruvolu, a partner at Charter Venture Capital, wrote a column for Venture Capital Journal in March titled: ``Tech Start-ups Should Be Entirely Built in Asia.'' However, Chiruvolu, 35, has since been eating his hat. While he's still keen on doing business with India, the challenges were greater than expected, he says. Foreign companies are considered easy targets by Indian technocrats and power brokers, he explains. They'll charge for leases and other services up to 10 times the amount they do for local companies. Companies like Intel and i2 took baths on their long-term leases, with i2 paying 100 rupees per square foot for its 10-year lease, compared with the going rate of 10 rupees, says Chiruvolu. And prices are heading up. Land prices have gone up three-fold over the past few years, Chiruvolu notes. Labor in Bangalore -- India's Silicon Valley -- has even become scarce, and you have to pay the average head-hunter about $500 an employee just to do a search, he says. You pay up front, and sometimes hear nothing back. Many Indians will forsake start-ups and flee to a brand-name company -- say Intel, Oracle or Sun Microsytems -- the first chance they get. Even getting the electricity turned on in an office is a chore, Chiruvolu says, estimating that it takes about six months to get an office registered with the government and ready to use -- far more than the eight to 10 weeks promised by the Indian government. Bandwidth can cost more than four times than in the United States, he adds. Chiruvolu reached a conclusion: Don't go to India for cost reasons alone. ``You should go to India being committed for the longer term, not buckled for a one-year cost reduction.'' Dell and a few other companies have already moved work back from India to the United States. Dick Kramlich, a partner at Menlo Park's New Enterprise Associates, and one of the valley's most experienced venture capitalists, has a few start-ups with business in India, but he says: ``If you're doing it for labor arbitrage, you're making a mistake, because it's only a short-term gain. You'd better do it for quality.'' _________________________________________________________________ Termsheet -- a name drawn from the formal proposal that a venture capitalist offers to an entrepreneur -- is a biweekly column about venture capitalists and the companies they fund. Beginning Jan. 27, the column will be published Tuesdays. Contact Matt Marshall at mmarshall@mercurynews.com or (415) 477-2518.