The Indian IT services market has witnessed strong growth over the past few years, on the back of increased offshore outsourcing initiatives from global corporations. More and more global corporations are trying to improve their cost efficiency and, thus, outsourcing their technology requirements to low-cost countries like India.

In fact, it is the offshore component that has been seeing impressive traction, driven by increasing acceptance of the 'global delivery model'.

While the rupee's appreciation against the US dollar and rising wages have taken some toll on the companies' profitability, the fact that demand now seems to be shifting from low-end services to high-end ones, like IT consulting, package implementation and systems integration, seems to augur well for the larger and more technology intensive players in the sector.
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Industry wish list

NASSCOM wish list

• Continue the STP scheme and tax incentive under section 10A/10B beyond 2009, for the next ten years
• Broaden the eligibility criteria for Large Tax Payer Unit (LTU) scheme
• Relevant provisions need to be incorporated in the domestic law to provide a mechanism for allowing full credit for foreign taxes paid
• Advance Pricing Agreements (APA) to provide upfront tax certainty
• Refund of service tax paid on services utilised for export of computer software and BPO services
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Budget over the years

Budget 2005-2006

• Zero customs duty on items bound under the Information Technology Agreement.
• In order to provide a level playing field to the domestic industry, customs duty on specified capital goods and all inputs required for the manufacture of ITA bound items has been removed.
• Additional countervailing duty (CVD) at 4% has been imposed with immediate effect from 1st March 2005 only on items bound under the Information Technology Agreement, and on specified inputs/raw materials for manufacture of electronics/IT goods. Credit for the CVD will be available against payment of excise duty.
• IT software and documents of title conveying the right to use IT software will not be subject to this levy.

Budget 2006-2007

• Excise duty of 12% imposed on computers. Excise duty on DVD drives reduced to nil.
• Excise duty of 8% imposed on over-the-counter (OTC) packaged software, excluding software downloaded from the Internet and customised software.
• Duty on clearances to Domestic Tariff Area from Export Oriented Units or units in Electronic Hardware Technology Parks, Software Technology Parks etc. is being changed from 50% of the aggregate of customs duties to 25% of basic customs duty plus full CV duty.
• For the purpose of fringe benefits tax (FBT), valuing the benefit in the form of 'tour and travel' at 5% instead of 20%.
• The service tax has been increased from 10% to 12%.

Budget 2007-2008

• Minimum Alternative Tax (MAT) to be applicable on IT companies.
• Fringe Benefit Tax (FBT) to be levied on Employee Stock Option Plans.
• Dividend Distribution Tax to be increased from 12.5% to 15%.
• Increased allocation to Rs 7.2 bn as against Rs 3.9 bn in the previous year for ambitious e-governance project.
• A new scheme of manpower development for the software exports industry launched with allocation of Rs 330 m.
• Benefits of investment in Venture Capital Fund extended to Information Technology sector, by giving a pass-through status to the same.

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Key Positives

Huge outsourcing potential: Offshoring has been well and truly accepted as a major strategic decision that can enhance the competitive advantages of global corporations. The value proposition of offshore development has been proved beyond doubt and as an industry, offshoring is still very much in the growth phase.

Even among the global 1000 companies, the offshoring penetration levels are not that high. This is a significant point, since these are companies with IT budgets in the range of US$ 500 m to over US$ 1 bn. The global market share of Indian companies is also miniscule.

Thus, these pointers are clear indications that there is plenty of room for the Indian software industry to grow, given the immense and untapped potential. Offshore outsourcing to India offers considerable economical benefits for those who are prepared to exploit the advantages of outsourcing.

Moving up the value chain: Indian software companies are consistently broadening their portfolio of offerings and moving fast up the value chain. Given that traditional services, such as application development and maintenance (ADM), are getting commoditised, it is imperative for these companies to move higher up the value chain into areas like consulting, package implementation and systems integration. Not only will this help Indian companies get higher billing rates from their clients, it will also give them an opportunity to work closely with the top managements of client companies.

Other positives: Among other positive factors for the Indian software industry, the major ones are large availability of talented manpower, cost advantage and geographical advantages (time-zone advantages). The companies involved in IT outsourcing in India provide high quality work, meeting international standards and complying with the ISO & SEI-CMM standards. Three out of every four SEI-CMM 5 companies worldwide are located in India.

Key negatives

High reliance on the US markets: The US market's share in India's software and services exports is fairly high, at around 60% to 65%. Even though it has come down a little during the last year but such a large degree of dependence on a single geographical location spells high risk for the Indian software sector. Over that, the backlash in the US against outsourcing of jobs to low-cost countries like India has raised some medium-term concerns for Indian software companies.

Decreasing competitive advantages: Increasing competition from global technology majors has not only threatened the Indian IT industry's cost leadership, Indian software companies have also been made to face intense competition for talent. All these pressures mean flat billing rates and higher employee costs going forward. This is likely to affect margins and, consequently, the profitability of Indian companies.

The BPO service providers have achieved maturity in practices like relationship management and knowledge management. They need to diversify to employee engagement, process improvement, recruitment, migration planning and workforce management. If this is not done, the IT companies could find maintaining the current client satisfaction level as challenging.

High rates of attrition: High attrition, especially in the middle and senior positions, continue to damage the performance of Indian software companies to a certain extent. The average industry rate is around 18% which when compared to other industries is on the higher side.

The companies, in a bid to overcome high attrition rates, are recruiting science graduates and training them, which means higher training cost and loss of billable hours. Apart from competition for talent from MNC technology majors, internal factors like job dissatisfaction and higher aspirations (in case of BPO companies) have led to such high attrition rates in the Indian software sector.