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When a sub-prime earthquake hits

September 17, 2008

Ever since the sub-prime crisis hit the US economy and began to impact its financial sector firms, the debate in the Indian software sector was whether the slowdown staring it in the face would be as bad as in 2001-02, when the technology and telecommunications bubbles burst and terrorist attacks hit New York.

Now, with the US financial sector going through an earthquake, the debate over whether things are 'as bad' has taken on a new, even fearsome, meaning. As much as 60 per cent of the revenue of India's software firms comes from the global financial sector, so the plight of the Indian IT sector can well be imagined.

Currently, the key vendors to the two casualties, Lehman Brothers and Merrill Lynch, are all claiming that they will not be seriously affected. But how serious is 'serious?'

Leading Indian IT firms, which had lately been acquiring consulting skills, will find their financial clients' appetite for contemplating 'transformational' change in their business models virtually gone. Indian firms have of course been trying over the last few years to de-risk their businesses by seeking growth in verticals like telecommunications, manufacturing and logistics, but it takes years to change a business mix and the present crisis has come too soon in the day.

The immediate challenge facing Indian firms will be the consolidation that will take place in the Western financial services industry as leading firms go belly up and are quickly taken over by the handful of firms which have not lost either their capital or the ability to raise fresh funds. The consolidation in the industry will affect not just its own staffing but also the vendors. With severe cuts in budgets all round, outsourcing spend is likely to be affected.

The saving grace is that nameplates can be replaced but legacy systems cannot, and the most important part of Indian IT's revenue still comes from the maintenance of such systems. Such jobs will continue to be outsourced, but vendors will have to face cuts in rates that will eat into not just top line but also margins.

Understandably, there is gloom all round, but innovative IT firms like Tejas Networks and Ittiam are either selling their own boxes or developing entire reference designs of gadgets like MP3 players and video phones, many of them made and sold under East Asian labels. Large Indian companies are needed who can take such products global under their own brand names.

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