Over the last three decades, outsourcing has had a big influence on the international division of labour. It is clear that it has been a major reason for the enormous build-up of production capabilities in the developing world, in particular in the export platforms of Asia. However, we do not know whether the outsourcing of production and services from OECD to developing countries has triggered the transition from production to innovation capability or not. In particular, it is not clear whether and how outsourcing contributes to the formation of advanced innovative capability. This is the question addressed in this thesis. It examines this question by focusing on the global software-outsourcing industry and the supply platform in Bangalore (India), one of the most prominent cases of latecomer development in the global economy. In order to examine this question, the thesis suggests new categories for assessing innovativeness in this complex sector. It shows that there is considerable scope for innovation as an incremental extension of routine outsourcing. A segment of Bangalore software suppliers has entered a new phase of building innovative capability. This capability is not restricted to process and organisational capability but extends to problem-framing innovative capability. This challenges the widely held opinion that only lower-order activities are outsourced and that relationships are unlikely to evolve beyond certain threshold levels because they do not provide proximity to tacit knowledge and domain expertise. This finding goes against the view that Bangalore's software industry has not progressed beyond producing to customers' specifications. More generally, it challenges the view that advanced innovation capabilities are beyond suppliers in global value chains. While the documentation of advanced innovation capability is an important contribution in itself, the main contribution lies in showing how capability development occurs in global value chains. 'Supplier learning' is often assumed, but it remains a 'black box' in most of the literature on outsourcing. The thesis shows how outsourced activities focused on labour-intensive 'production activities' can (over time) provide a stepping-stone for acquiring high-order innovative capabilities. It examines the factors that explain this transition on the supply side and the demand side. On the supply side, the study focuses on learning events as the main unit of analysis and examines how outsourcing influences the formation of new innovative capability. The thesis emphasises that while outsourcing creates new spaces, the exploitation of these spaces is not automatic; it shows how projects undertaken by suppliers have mobilised resources - ideas, investment and knowledge - to capture new opportunities in global chains. This creation of capability at the project level is important, but new capability is only fully realised via firm-level competence leveraging across different buyers and business lines. The main determinants of the acquisition of new capabilities are global linkages and firm internal strategies and initiatives. Local linkages play only a minor role. This poses important questions for the debate on local clusters and innovation systems. On the demand side, the thesis compares three software buyer segments and shows that practices differ between these groups of buyers. It also shows that buyers' outsourcing strategies change over time and that the 'space' for innovation by suppliers has increased. Critical to this analysis is the distribution between 'integrated' and 'standalone' innovation activities. They key finding is that the greatest advances in acquiring innovation capability are made in the integrated activities where knowledge use and knowledge creation are tightly connected. Other studies have come to more pessimistic findings because they have tended to concentrate on standalone innovation activities. The two-pronged approach using supply and demand side informants enables the triangulation of findings. It also makes it possible to examine how demand-side and supply-side dynamics interact. The thesis shows how 'innovation-push' by specialising buyers and 'innovation-pull' by increasingly capable suppliers reinforce each other. Most studies tend to focus on only one side; but the key is to see them in conjunction. The thesis suggests that their co-evolution changes not only the scale of outsourcing but also its contents. It indicates that a qualitative shift in the global division of labour is underway.