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Home > Business > Special

Indian IT cos global giants? Not yet

Leslie D'Monte | June 19, 2007

The fundamentals are in place and so is the growth story of the Indian information technology and related sector (ITeS or BPO): it is well on its way to becoming a $60-billion entity by 2010.

With its sizeable English-speaking population, a skilled IT and engineering workforce coupled with low wages, India has always been, and currently remains, an attractive destination for companies that intend outsourcing their IT requirements. This eco-system helped Indian IT companies register $31.6 billion in exports in 2006-07, according to Nasscom.

There is, however, another side to this story. Analysts are sceptical about Indian IT firms sustaining the 30-50 per cent year-on-year margins in profits and revenues over the coming two-three years.

The concerns are many - rupee appreciation, wage inflation, high attrition rates, onslaught from global IT majors, the US' hardening stance on outsourcing and a softening of the total outsourcing market. Outsourcing research firm TPI predicts a continuing of the slowdown that first became apparent in the second half of last year.

Yet it projects an approximately 4 per cent growth across 2007, driven by a 4.4 per cent year-on-year increase in IT outsourcing.

There's also concern on the profit margins of Indian IT firms (especially smaller and medium-sized ones) post 2009, when the Software Technology Parks of India scheme expires.

Meanwhile, more service providers are now nibbling at the outsourcing pie. The number of providers winning contracts has increased by 64 per cent in the past four years - from 55 in 2002 to 90 in 2006.

The Big Six of outsourcing - Accenture, ACS, CSC, EDS, HP and IBM - still dominate the offshore outsourcing market, having won 73 per cent of all contracts in 2006, compared to 18 per cent for the Indian providers (source: TPI).

The good news for Indian IT firms, though, is that the Big Six are winning a decreasing proportion of deals valued at over $50 million (over Rs 200 crore). In 2006, the India-based providers achieved 7 per cent of the total market share, up from a minuscule 0.5 per cent in 2002.

Moreover, the multi-million dollar deals are being split between Indian and foreign IT firms. For instance, in the biggest outsourcing deal coming out of Europe ever - when ABN Amro Bank awarded its $2.2-billion outsourcing contract in September last year, about $400 million worth of contracts were awarded to Tata Consultancy Services [Get Quote] ($260 million) and Infosys [Get Quote] ($140 million), besides old-timers like IBM and Accenture.

So it pays to be a big brand

The top 10 Indian IT firms account for nearly 60 per cent of the total revenue. The turnover of the top four Indian IT service providers - TCS, Infosys Technologies, Wipro [Get Quote] and Satyam Computer Services [Get Quote] - stood at around $12 billion (Rs 52,825 crore), a jump of over 46 per cent over last year's Rs 37,682 crore (RS 376.82 billion).

Alok Shende, vice-president, ICT practice, Frost and Sullivan, says: "The leaders are growing at above industry average growth rates, belying the hypothesis that size and growth rates do not go together."

Mid-cap IT companies, too, performed well in 2006-07, riding the outsourcing wave. The total net profit of the top 20 mid-cap companies last year grew 47.79 per cent year-on-year, beating that of the top five IT majors (44.43 per cent over the same period). One reason is that many mid-caps are not US-centric like some of the bigger players.

For instance, Subex Azure's [Get Quote] revenues are equally distributed among the US, Europe and emerging markets segments. Or they could be niche players like Tech Mahindra [Get Quote]. However, analysts caution mid-cap IT companies against over-dependence on top clients.

"Large firms need to invest in R&D to draw an increasing pie of the revenues from value-added services. They also need acquire more companies. For mid-sized players, the real challenge is to re-invent their business models. The starting point should be to identify uncontested territories," says Shende.

And get a global footprint

Even the big Indian IT firms need to become truly global. To some extent, that's already started.

For instance, TCS CEO and MD S Ramadorai says the company's global network delivery model is "much more than having an India-centric delivery model with near-shore (close to the client's location) centres".

TCS is increasing market share in established markets like the US, the UK and Europe, besides driving business in Latin America and moving to newer markets like China, Japan, Africa and west Asia. In India, it is concentrating on projects like the National Stock Exchange or mission-critical projects like the ministry of company affairs' MCA-21 initiative.

Infosys, Wipro, Satyam, HCL [Get Quote] and scores of other IT firms echo this line. But are these measures enough?

Siddharth A Pai, partner, TPI, says: "Most Indian IT firms do not build long-term teams abroad. They merely send people to work onsite and call them back after the project is over. Moreover, to compete with the global IT majors, Indian IT firms have to be present in most geographies extensively, and not with a smattering of people."

He points to IBM as a case in point: the company has a presence virtually all over the globe, with over 50,000 employees in India alone.

The firms appear to be listening. Says Wipro Technologies Chief Strategy Officer Sudip Nandy: "We are increasing our focus in continental Europe, Germany, Canada and Australia."

The global delivery model also ensures that IT firms reduce their exposure to the US (to beat the rupee appreciation). Around 50 per cent of Wipro's revenues come from the US; India accounts for around 24 per cent and Europe, 20 per cent.

It also has a presence in west Asia through a joint venture with the Dar Al Riyadh Group in Saudi Arabia, Japan and China.

Inorganic growth helps

Wipro is looking at larger acquisitions this financial year. While the combined value of all the acquisitions made in FY06 was about $120 million, it now plans to acquire companies with a deal size of $100 million, to fill various technology gaps and reach new geographies.

The Bangalore-headquartered company, which is sitting on cash reserves of about $1 billion, prefers cash acquisitions to equity.

In fact, all the top five Indian IT firms have piled up net cash in excess of Rs 20,000 crore. Besides distributing dividends, they plan to use the cash primarily for acquisitions, as also capital expenditure requirements (not a significant amount: these are service firms, after all).

But don't ignore the local turf

The Indian domestic outsourcing market, of deal sizes above $50 million, is estimated to be around $2.2 billion.

Wipro, with a few banks on its client list, appears to have made inroads here (24 per cent of its revenues come from India). HCL and TCS are making slow progress, while Satyam and Infosys are just about starting up.

However, they still lose out to their MNC counterparts when it comes to striking big deals, primarily because they currently do not offer a suite of services (including storage, database, servers, PCs, software and infrastructure management) that the Big Six do.

Besides, they are not aggressive enough. Some argue it's the low margins in India that deter Indian IT firms from pitching for deals. This line of thinking is moot.

India-based service providers are particularly successful in the Applications Development and Maintenance sector, having grown their market share from 8 per cent in 2003 to 36 per cent in 2006.

In contrast, the Big Six have seen a decline from 76 per cent of the ADM market in 2003 to just 38 per cent in 2006, states a TPI study. However, the Big Six are strong in providing end-to-end solutions, according to K K Raman, executive director, KPMG, especially in the systems and consultancy arena.

"Indian IT companies do not put their best foot forward when it comes to pitching for domestic deals. It will be only a matter of time before the global majors lap up all the Indian blue-chip deals across verticals (Bharti-IBM, Dabur-Accenture and Bank of India-Hewlett Packard)," rues Partha Iyengar, research vice-president, "This can be addressed by acquiring smaller firms in this space," Raman says.

Indian IT firms, however, are beginning to be acknowledged as infrastructure management players too, he points out.

In sum

An inescapable reality is that of wages for low-cost countries. It comprises around 70-75 per cent of the total expenses of an outsourcing firm.

Indian IT-BPO firms counter the 12-15 per cent annual rise in wages by hiring freshers and students with non-engineering backgrounds, besides moving to smaller cities, increasing billing (by about 3-5 per cent - current rates hover around $20-25 an hour for offshore and around $65 for onsite) and employee utilisation rates (60-70 per cent currently) and improving the business mix.

"Despite the increase in wages, India has the cost advantage for 15 years over the US and the UK (largest markets for Indian IT firms), where wages are increasing at 4 per cent," asserts Pradeep Udhas, global partner-in-charge, sourcing advisory, KPMG.

Moreover, wages are increasing not only in India, but across all the low-cost offshore markets (read competing countries for the offshoring pie), including Romania, Poland, China, Vietnam and the Philippines. Besides, the selling, general and administration expenses for Indian-headquartered IT firms will always be lower than their global counterparts.

However, there's no room for complacence. Management guru Jagdish Sheth recently made an alarming prediction that in the next five years, the largest IT firm in India will be a non-Indian one since Indian IT firms are becoming "complacent and arrogant

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