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Indian IT: The challenges ahead

May 28, 2004 12:24 IST

Despite the slowdown that had engulfed technology spending worldwide, the Indian IT industry continued to grow at a robust rate.

According to the National Association of Software and Services Companies -- NASSCOM -- Indian software services exports witnessed a CAGR of around 37 per cent during the period FY99 and FY03. During FY04, software services exports are expected to cross the $12 billion level, implying a growth of nearly 25 per cent over FY03.


Source: NASSCOM

However, at present times and going forward, Indian software companies are likely to face innumerable challenges in their path towards higher growth. While some of these challenges emanate from external factors (like outsourcing backlash in the US), others require a basic change in the business models of most of these companies. Let us discuss some of these challenges in detail.

Need to move up the value chain: As global technology majors ramp up their Indian operations and replicate the Indian offshoring model, the Indian software sector seems to be losing the cost arbitrage edge.

Not only that, global companies are also tapping other countries (like the Philippines, China and Ireland) for low-cost labour and talent. In these competing times, therefore, the biggest challenge for Indian software companies is to move up the software value chain, and that too, rapidly. Penetrating markets for high-end offerings like IT consulting, systems integration, package implementation and products will help Indian software companies establish long-term relationships with clients.

Also, this move will help them in reducing pressure on the margins front as these services generally command higher billing rates than basic services like software development and maintenance.

Maintaining high growth levels: Maintaining high export growth levels of the past is another challenge facing the Indian IT industry. As competition has largely dented prices (billing rates) of software services, growing on the volumes front would be the key factor going forward.

And that would require large size deals to come India's way. While Indian software companies have rapidly scaled up in anticipation of higher volumes going forward, any inconsistency on this front may deeply affect overall growth.

Retaining talent: Rising attrition rates in Indian software companies over the past few years is indicative of a key challenge brewing at the very core of the growth of the Indian software sector.

As global technology majors like IBM, EDS and Accenture target the Indian market for business and establish larger bases in the country, it could be a difficult task acquiring and retaining key employees, especially when the MNCs pay fatter salaries than their Indian counterparts.

However, if Indian companies try to match high MNC salaries (as they are doing now) without a consequent rise in revenues, their profitability might be seriously impaired.

Political challenges: One external challenge that affects all Indian software companies is the backlash against outsourcing that seems to be spreading across the US and European regions.

While no adverse fallout is expected in the long-term, as global companies would continue to outsource non-core operations in order to improve their profitability levels, medium term performance could get affected.

Focusing on the domestic market: As mentioned earlier, the Indian software services exports witnessed a CAGR of around 37 per cent during the period 1998-99 to 2002-03. Contrary to this, the growth in the domestic market was relatively staid at 15 per cent.

The domestic Indian market promises huge potential for the sector in light of the burgeoning IT budgets of Corporate India. Growing this segment, therefore, is a key challenge faced by the sector.

As more customers drive the change towards offshoring and such activities become mainstream, Indian software companies are likely to gain immensely from the potential that exists.

Adding to that, global technology spending seems to be on an up-trend after the past couple of years of slowdown. This provides Indian software companies with a huge potential to grow. And investors are likely to reap advantages of the same.

The only need for them (the investors) is to pick and choose the best companies from the lot and invest with a long-term perspective. Only then would they reap adequate return on their investments. Keep the faith!

Equitymaster.com is one of India's premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India's top companies.



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