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A
recent Nasscom report states that the Indian software industry
clocked 31 percent growth for the first three quarters of
2001-02. On the face of it, growth itself is an achievement.
What is alarming however is the slowing sequential growth
on a quarter-to-quarter basis. Some companies have even seen
negative growth rates in the third quarter. Pankaj Mishra
analyses the factors posing a threat to the industry
In
early 2001, tier one firms like Infosys, Wipro and TCS were
reticent to talk about the possible affects of the US slump
on their business prospects. They were busy talking about
how the Indian software industry was positioned to take advantage
of the slump. Some industry players predicted that software
outsourcing to India would rise exponentially. Outsourcing
did increase, but it also brought in highly demanding vendors
who started renegotiating billing rates and were very price
sensitive. Today, everyone from Azim Premji to N R Narayana
Murthy is not only admitting to price pressures, but are also
defining the future outlook as ‘uncertain’.
Financial performance
Even a casual look at the latest financial results of tier-one
firms like Wipro and Infosys reveals that the slowdown is
bottoming out. However, if we segment Indian tier-one firms
on the basis of their sustainability in these hard times,
apart from Wipro and Infosys, no one seems to be doing well.
The mammoth gap between tier-one and tier-two firms is increasing,
while tier three firms are yearning to be acquired by some
‘big fish’.
For instance, Bangalore-based Sonata Software’s woes
continue as the company’s net profit has declined by
almost 74 percent between Q2 ended September and Q3 ended
December 2001. Satyam, which is still at number three, is
now limping as net profit has declined from Rs 134 crore during
Q2 (July-Aug-Sep) to Rs 119 crore in the quarter ending December
2001. The industry is teeming with rumours of EDS planning
to buy out Satyam Computer Services.
Training blues
One clear trend that emerges after analysing the financial
performance of software companies is the worsening situation
for training majors like NIIT, Aptech and SSI. All of them
have substantial dependence on the IT training segment, which
explains the poor showing they have made. SSI’s net for
the nine months period ended December 2001 shows a loss of
Rs 9.89 crore. Aptech is still undergoing restructuring after
announcing the merger of services wing Hexaware with parent
Aptech. For NIIT, Q2 was somewhat better when it reported
a net profit of Rs 12.5 crore, but in Q3 net profit stood
at Rs 3.46 crore, down by almost 72 percent.
Tier-two woes
Amongst the tier-two firms, Mphasis was one of the very few
companies to register consistent growth. Net profit in Q1,
Q2 and Q3 stood at Rs 5.94 crore, Rs 8.87 crore and Rs 12.9
crore respectively. Others like Chennai-based Polaris have
seen a decline in net profit by 1.2 percent between Q2 and
Q3. Digital is another performer whose net profit grew by
10.4 percent on a sequential basis between Q2 and Q3 ended
December 2001.
Another haunting issue for tier-two firms is the direct competition
from big players like Wipro and Infosys. Bigger players are
now bidding at lower rates to woo new clients. “Strength
of resources are playing a decisive role in bidding rates.
Bigger players have better capacity in terms of manpower to
bid low,” says Ravi Ramu, chief financial officer, Mphasis-BFL.
De-risking
The US charm has definitely faded, but it is still the largest
market for the Indian software industry. Europe, APAC and
India have emerged as compensatory markets for Indian firms.
Wipro, for example saw its revenues from the US decline from
64 percent in the quarter ended
December 2000, to 51 percent in the quarter ended December
2001. Amongst tier-two firms, Polaris has shown significant
improvement revenues accruing from India. The company’s
revenues from India have increased from 4.7 percent during
the quarter ended December 2000, to 17.3 percent in the third
quarter of December 2001.
HCL’s US revenues are down from 77.2 percent during the
nine-month period ended December 2000 to 69.2 percent in the
same period ended December 2001.
Utilisation rates
“Bench
and retrench rhyme well,” quips the CEO of a Bangalore-based
start-up. His company had laid off more than 200 software
professionals recently. Deferred offer letters and non-renewal
of contracts have become the order of the day. To cite an
example, during Q2 ended September 2001, Wipro ‘lost’
around 348 employees.
A financial analyst brings an interesting perspective to the
utilisation rate. “Most software firms do not include
trainees while calculating utilisation rates. When trainees
are taken into account, rates fall drastically,” he says.
If we study the utilisation rates at Infosys for the nine
month period ended December 2001, the picture becomes clear.
The utilisation rate for the 9-month period ending December
31, 2001 including trainees stood at 69.3 percent while the
same figure excluding trainees stood at 72.9 percent.
Billing rates
“Slump,
what slump?” said the CEO of a leading Indian services
company during November 2001. How things change. Industry
sources say a recent deal clinched by Satyam was billed at
around $6! Today, existing clients of many software firms
are re-negotiating rates and Indian firms are trading margins
for higher volume. Pressure is more intense on second tier
companies like Mphasis, Polaris and Mascot who cannot offer
low rates at par with the likes of TCS and even Infosys.
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Mphasis’
Ramu says strength of resources will play a key
role in helping companies tide over the slowdown |
Financial
muscle is defining the rules of the game.
However, some of the tier two firms like Mphasis are still
able to command good rates because of their domain expertise,
especially in the niche areas like finance. Analysts are also
predicting that some of the big Indian firms might sub-contract
projects to the tier two and tier three firms in the near
future. Once this happens, the Indian firms will achieve synergy
amongst themselves and taking on the global ‘big five’
might become an easier task.
Cash Reserves and M&A
Though Indian firms cannot be compared to their global counterparts
on the basis of financial muscle, most tier-one Indian firms
are sitting on enough cash reserves to fuel inorganic growth.
Shiv Nadar’s HCLT has Rs 1,363.8 crore of cash reserves
in hand, which explains the company’s aggressive approach
towards M&As. “HCL’s focus is on small transactions.
Small transactions lend themselves to simpler, more disciplined
structuring and integration and minimises the risk of failure
to the enterprise,” says HCL CFO Arun Duggal.
“Our
strategy is to develop front end capabilities in the US by
acquiring a consulting organisation. We are also looking at
expanding our presence in Europe through an acquisition,”
says Kris Gopalakrishnan, deputy MD, Infosys Technologies.
Infosys is yet to make any acquisition though it has Rs 866.3
in cash and cash equivalent.
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HCLs
Duggal says companies should focus on smaller transactions
in these troubled times, as they are safer |
Tier-two
firms are not pursuing acquisitions very aggressively at present.
Chennai-based Polaris has already burnt its fingers during
a bid to acquire Data Inc, and has Rs 68.8 crore as cash reserves.
The company is now treading cautiously. “The Strategic
Practice Units (SPUs) have been empowered and encouraged to
create new, innovative service offerings each quarter,”
says Raghuram Balakrishnan, VP, Communications, Polaris.
Conclusion
The results for the nine-month period ended December 2001
reflect a not so unexpected trend. The biggies are getting
bigger, and the smaller ones are facing tremendous pressure
on their bottomline. It is also possible that some big players
like Satyam might sell off an equity stake in order to beat
the slowdown.
One of the reasons for this is the small domestic market.
Most Indian firms are export-oriented, and therefore any downturn
in the US or other export markets dampens business. One of
the few segments in India showing exponential growth is the
banking and finance segment, as old economy banks seek the
IT advantage to compete with nimbler foreign and private banks.
“As
of Q3 FY02, the domestic market contributed around 17.3 percent
to revenues (as against 4.7 percent in Q3 FY ?01). With the
globalisation of the Indian economy and the privatisation
of commercial banks, there exists a huge potential for IT
solutions in the banking and financial services space, which
provides a good opportunity for growth in the domestic segment,”
says Balakrishnan.
The coming quarters are certainly going to be even more uncertain,
or as Ravi Ramu of Mphasis puts it ”The pot-holes are
getting filled and the worst might just be over”. Whichever
way it goes, India’s software industry is still holding
its breath.
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