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Indian software industry suffers growing pains

Anshuman Daga in Bangalore | May 05, 2003 13:57 IST

The shining glass facades, swimming pools, gyms and in-house pizza joints are still there, but the mood is sombre on the campuses of India's software firms.

Gone are the days when Bangalore's army of software engineers scrambled to meet demand from US-based clients and could confidently charge a premium for their services.

The game has shifted to volumes, discounts and more spending to boost sales as software services risk becoming just another commodity like soap.

"The bread-and-butter business of software maintenance will always be there, but that's where the greatest threat of commoditisation is coming from," Jerry Rao, chairman of mid-sized software firm MphasiS BFL Ltd, told Reuters.

Top-end work such as research and development still earns a premium, but a slowing global economy has hit demand even there. And competition has depressed profit margins: average hourly rates for software services have fallen to $20-25 in Bangalore from $25-30 two years ago, analysts say.

"The days of very high profit margins in the industry are gone," said Kiran Karnik, president of the National Association of Software and Service Companies. "Margins were unrealistic, unsustainable and attracted competition."

Indeed, home-grown companies such as Infosys Technologies Ltd are also facing pressure from global giants such as Accenture, which are setting up their own shops in India.

A shake-out is looming in the sector, which has 3,000 firms but only five companies with annual revenues of more than $200 million. Two years ago, the industry had less than 1,000 firms.

Infosys bombshell

Tremors started flowing through India's $10 billion-a-year software export industry last month when Infosys shocked investors with a forecast for 12 to 13 per cent earnings growth, compared with 18 per cent growth the past year.

Infosys, India's largest listed software exporter, was the first Indian firm to list on the Nasdaq and ranks alongside Wipro as India's software showpiece.

The Infosys warning slammed software stocks and wiped out a fourth of the sector's market value in two days.

Bombay's infotech index has slumped 39 per cent so far this year, against a 12 per cent fall in the Bombay share index. Investors have started to question the higher price-to-earnings ratios Indian tech companies command over old economy sectors such as cement.

The slump should attract some bargain hunters, though.

"Can we make money from the sector? Yes. The downside has been priced in, while the upside is not," said Avinash Vazirani, chief investment officer for South Asia and Africa at BNP Paribas Asset Management, which manages $200 million in Indian stocks.

Tough negotiations

Indian firms are sacrificing profits for volume in an industry where profits nearly doubled every year in the late 1990s. Net profit margins for leading companies have fallen to about 25 per cent from roughly 35 per cent about two years ago.

Infosys, for one, is projecting 30 per cent volume growth this year, showing that demand is not the main problem.

"So, the key challenge is going to be what price we get these deals at rather than what is the deal flow," said the company's chief executive, Nandan Nilekani, last month.

Customers are getting tough.

"I'm not negotiating for (lower) prices every day, but we are extracting more value for dollars," said Sridhar Chityala, head of consumer financial services e-business at JP Morgan Chase, which outsources software work to Wipro, MphasiS and others.

(Additional reporting by Denny Thomas in Bombay)

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