Prevailing wisdom suggests that Indian software firms are slashing billing rates battered by client demands. However, Pankaj Mishra says there’s more to it than meets the eye, and suggests that some tough, yet necessary measures are needed to arrest the free fall in billing rates

High quality, low cost. The very mantra that India Software Inc leveraged to carve a place for itself in the global software services sector seems to have now blown up in its face, preventing leading Indian firms from commanding rates close to those enjoyed by the Big Five consulting firms. An offshore rate of $20 to $25 is considered good in these tough times, but industry sources say that actual rates can be as low as $6!

For instance, market rumours speak about Satyam Computer Services recently clinching a deal with a Detroit-based auto major at $6. It’s not just actual prices that have crashed, but many tier one companies have also resorted to offering free services as part of big contracts to sweeten the deal for clients.

After registering exponential growth for the last seven years, it makes the observer wonder if the Rs 9,100 crore Indian software industry today has reason to ask itself whether it has become a victim of its own success. The cost-effective positioning adopted by tier one firms has now become a problem for the industry. A recent study by consulting firm McKinsey & Co predicts that Chinese software services companies will be able to offer the same skills at rates which are 15 to 20 percent cheaper in two to three years. India Software Inc’s share of the global market now stands at a tiny 1.6 percent, as we are engaged in areas that account for only 12.6 percent of the entire market.

A few quarters ago, most Indian vendors denied that they were cutting billing rates in order to become more competitive. But an analysis of offshore billing rates of most software services companies for the current and previous quarter clearly depicts the widespread stagnation. Adding to the pressure on billing rates is the fact that many second-rung companies who initially entered the market with competitive billing rates have now established adequate credibility, and have emerged as competition to top-line companies. These include Mascot, Polaris and Mindtree. In fact, most software companies now openly admit that offshore billing rates have been under pressure on account of the US slowdown and a fall in technology spending.

Blame the clients?

Most firms outsourcing business to India, such as GE and Volvo, usually go by their relationship with Indian software companies while determining prices. Such vendors look for dependability when finalising a deal with an Indian software company.

Reliability, in fact, tops the priority list of most vendors. “We have to understand that pricing pressure is coming from the industry and not from clients. Companies are sacrificing margins for volumes,” says Pawan Kumar, founder of vMoksha and ex-chief of IBM Global Services India.

Jawahar Bekay, Co-CEO of Planetasia adds that market prices and pressure from clients are influencing billing rates today. “Cost is reality while price is policy. What we are witnessing today is ‘loss leader’ pricing wherein margins are being sacrificed for volumes,” he explains.

Others like Jayesh Chakravarthi, VP & head, India and Middle East Business, Mindtree agree: “I don’t think that the pressure is coming from traditional outsourcers such as GE. These companies fall under the category of mature outsourcers and they understand the dynamics of the Indian outsourcing industry. The pressure comes from newcomers to the outsourcing business who don’t understand the mechanics. They come here, conduct tours across several companies and then ask for bids.” But even as most in the industry agree that pricing pressure does not primarily come from existing clients, but rises internally thanks to competition and new clients, what’s alarming is that some of the mature clients may not remain clients any longer. According to McKinsey, over 75 percent of the global top 40 IT companies were setting up or building operations in India, which means they will have their own Indian development centres.

Pressure on rates

vMoksha’s Kumar says that the pressures on billing rates are not from clients but rather from the industry itself

And with hundreds of professionals on the bench in many Indian firms, it’s no wonder that Indian software firms are sacrificing margins and resorting to measures like offering ‘free maintenance’ for a year or so. “This is not what you call knowledge services. This phenomenon is new and dangerous,” warns Kumar. An industry source disclosed that one of India’s biggest software companies recently clinched a deal by giving away close to $100,000 worth of services for free to the client.

Analysts believe that lowering of billing rates by tier one companies is mainly due to the large bench in many Indian firms. In a bid to reduce pressure on their bottomlines, companies are going for almost-ridiculous billing rates. “I think it’s high time for Indian companies to come out of the closet and rationalise the bench. What these biggies are doing now is just a distress measure. If they cut down or lay off employees, it will make them more efficient,” says Chakravarthi. The question is, can Indian companies break the mould and implement harsh measures? “If you have a huge bench, then it makes sense to lay off,” says Prashanth Prakash, CEO, Netkraft.

Netkraft’s Prakash says you cannot have your cake and eat it too—you have to chose between the bench and profit

MNCs like IBM Global Services, Accenture or EDS have no compunctions in ruthlessly cutting down their workforce during these challenging times. Thousands have been laid-off by some of these firms globally, because this helps them in mitigating pressure on their bottomline.

Employee costs for Indian companies will only go up because of new recruitment and salary hikes (however marginal) for existing employees. As a result, profit margins of Indian companies could come under increasing pressure over the next few quarters.

Time to rationalise

Billing rates are not a welcome topic amongst Indian software companies, and especially so today. Most of them however admit that the ‘blended pricing’ model has proved to be detrimental. “TCS gave the blended pricing model to this industry, but now we have to position ourselves to command value pricing. This will not be easy as enough efforts have gone behind entrenching India as a low cost destination,” says Kumar of vMoksha. According to him, the Big Five command 50 to 60 percent more margins than their Indian counterparts owing to brand equity and domain expertise.

This gap according to many is increasing quarter by quarter, even as the Big Five themselves face pressure on margins. Indian companies, especially the tier one firms, will have to either go in for overseas acquisitions or acquire smaller domestic players in order to narrow the gap.

Planetasia’s Bekay says Indian firms are sacrificing margins for volumes

The blended pricing model, prevalent in the Indian software industry, will have to be rationalised if Indian companies want to position themselves as consulting firms. This will also enable them to demand ‘value pricing’ based on the competency level and kind of project being executed. It is perhaps also high time that Indian companies stop shying away from the stigma of laying off those on the bench. True, most listed companies do not resort to cutting down staff for avoiding negative stock market reactions, but on the flip side, low margins also evoke a negative response from investors and the market.

As some of the companies we spoke to admitted, client visits have increased during the last few weeks. The pressure may mean that this is an opportune time to adopt a sustainable branding strategy and undertake cost-cutting measures like rationalising the bench.