Where does the industry go from here? Who are its future competitors? What are the opportunities waiting to be seized? How do we redress our shortcomings? Punita Jasrotia & Shipra Arora look at the big picture

Kiran Karnik predicts that in the coming years Indian companies will have to deal with competition from Ireland, Russia and China and also the growing trend to outsource near shore

The past one year has been quite eventful for the Indian software and services industry. While it was hit by the tech slowdown, there was a ray of hope in the form of outsourcing business, that soon became a buzzword for most companies. 2003 is being viewed as the year when outsourcing and exploring newer geographies and verticals will be the drivers behind increased investments in the country.

While some might dismiss this as being too optimistic (considering that many companies are still in the process of closing down their businesses), going by the revised Nasscom-McKinsey Study 2002, things look bright at all levels. According to the study, by 2008, exports from IT services are expected to touch $28-30 billion, with the ITES sector accounting for $21-24 billion, while the products and technology services industry is expected to contribute around $8-10 billion to overall revenues. In addition, the domestic software market will generate revenues of $13-15 billion.

This will also translate into an increase in the contribution, to the GDP from 0.3 percent in 1998-99 to 7 percent in 2008. IT software and services export revenues will account for more than 30 percent of all foreign exchange inflows in 2008, from 8 percent currently. There will also be an increase in jobs generated—around two million—out of which the software field would be contributing approximately 1.1 million by 2008. In addition, the parallel support services industry will create employment for another 2 million people. According to experts, in spite of tough times, what has worked in India’s favour is its cost advantage, language skills and experience with offshoring, besides increasing IT requirements across the world.

On the negative side, the slowdown has also lowered profit margins, due to which many IT companies had to make considerable changes in their business models.

Guided by the cost factor, the past one year has seen an increase in outsourcing activity, with more companies either directly outsourcing or setting up partnerships with Indian companies. While many big players decided to enter the BPO space, others have ventured into newer territories to explore business propositions.

Exploring different verticals
The slowdown has also made companies take a look at verticals other than manufacturing and banking, financial services and insurance (BFSI). The idea is to foray into new service lines and gather domain expertise to service a larger number of clients, thus increasing volumes.

Rising cost pressures and regulatory discontinuities have opened fields not only for current IT services players, but also for many who have been wanting to explore new opportunities. According to an industry report, newer verticals like healthcare, retail, telecom carriers and utilities are growing substantially. However, there are some other verticals that are still significantly under-exploited: transportation, government, education and construction.

Industry statistics reveal that of India’s IT services exports, verticals constitute somewhere around $6.2 billion, of which the BFSI, manufacturing and telecom segment account for nearly 44 percent. BFSI leads with a 20 percent share followed by telecom (equipment) and the manufacturing segment (discrete manufacturing) with an equal share of 12 percent each.

One major problem plaguing the industry is the strong incumbency factor. Since early entrants have been able to make a mark in terms of reputation for high-quality execution at low cost, they enjoy long-standing relationships with several large anchor customers. This leaves hardly any substantial share for smaller players. As per statistics available, presently 55 percent of the BFSI market (constituting $1.24 billion) is held by the Top 5 players.

Experts say that in such cases what most companies should do is exploit untapped verticals and build their expertise in those domains. These verticals are expected to surge with increasing business connectivity requirements felt at all levels across the world. Right now the government and retail verticals lead in this segment. As per the Nasscom-McKinsey report, in 2001, globally, the government sector (which comprises central, state and local governments, as well as defence, administration and justice departments) is estimated to have spent close to $46 billion on IT services; this share is expected to grow at a 11 percent CAGR over the next four years.

Besides these, other potential verticals are telecom service providers, transportation, utilities, healthcare and education.

Diwakar Nigam believes that managing software projects seems to be the biggest challenge for the Indian software industry

What is significant about the utilities sector is that due to deregulation in the US market, over 50 percent of customers will be able to choose their service provider, up from less than 20 percent in 2000. Already, several utilities players have begun working with Indian companies like Infosys, TCS, Wipro and Patni on large scale projects.

In addition, the US healthcare software and services market is projected to grow robustly, primarily due to improvements in provider economics (increase of government funds) and growing consumerism (demand for better quality of care).

The convergence of IT, communications and entertainment is also opening up huge opportunities for IT service providers in the media and telecommunication verticals. An opportunity is also emerging in the e-games industry. According to V Srinivasan, managing director and chief executive officer of ICICI Infotech, there are other specialised areas like pharmaceuticals, chemicals, plastics, cement, sugar, auto ancillaries and food which are emerging.

The key is specialisation. Companies need to select one or two verticals to establish a presence and develop their distinctive/niche capabilities which will help them get a substantial share of the revenue pie. Says Diwakar Nigam, managing director of NewGen Software, “You just can’t enter verticals. It takes years of effort; you need actual experience with customers in that specific vertical before you can build solutions. Aspiring companies should enter only those verticals where there is not much competition.”

Mapping new geographies
While traditionally the Indian software industry has focused on established markets such as the US and UK (which account for close to 75 percent of software exports), the large non-English speaking markets of Japan and Western Europe are still under-penetrated by Indian companies. Statistics reveal that these two markets alone offer Indian industry over $5-6 billion in export potential. The reason why Indian companies don’t show up here is because they face barriers in terms of language, unwillingness to outsource, or strict labour laws. But current market conditions being what they are, more companies are willing to explore newer geographies to increase business.

In future, the Japanese and German markets are going to be extremely attractive for Indian players—they have potentially large anchor customers, shortages of skills, and a favourable billing rate differential with India.

Japan
Take the case of Japan, which is the world’s second largest IT services market, and accounts for more than 12
percent of world’s IT services spend. Due to the prolonged downturn in the Japanese economy and its skills shortages (especially in new and emerging technologies), the country is being forced to outsource.

While India has been able to make considerable inroads in the Japanese R&D services market (embedded software), a recent study by the Japanese government reveals that Japan will be short of 3 lakh high-technology workers in three years. Thus, creating an opportunity for Indian companies. Wipro has a significant presence in Japan (over $30 million in revenues) with a dedicated ODC for BSI that works in the hi-tech telecom areas of Internet and wireless applications. There is a sizeable opportunity for high-end players as most Japanese IT services companies do not play in this segment of the market, ie., IT consulting and networking consulting, which is dominated by global IT consulting majors like Accenture. Indian companies therefore have a good opportunity to compete in this segment if they build the requisite skills and offer a competitive proposition.

Other geographies
There are also ample opportunities in English-speaking geographies like Canada, Netherlands, Sweden and Australia. Together, these markets would represent an opportunity of $1.2 billion by 2008. All these countries—along with Brazil, Switzerland, Spain and Belgium—account for 90 percent of the IT services spend in the world. As per the Nasscom-McKinsey report, at present, Canada and three non-English speaking geographies—Japan, Germany and France—are priority markets for Indian companies. Canada is the third-largest English-speaking market and potentially a core market for India. While traditionally Nortel has been the only significant customer giving business, other prominent customers (Royal Bank of Canada) have also started making a move.

Germany
Germany, which earlier was not too attractive, is slowly gaining a reputation as a potential market for Indian companies. According to IDC reports, the market here is expected to grow to $40 billion by 2005. Moves are on to relax immigration rules, increase its level of outsourcing of non-core activities, and increase the use of IT self-service applications over the Internet. Moreover, it is estimated that Germany faces a shortage of skills to the extent of 75,000 people in several emerging technologies.

However, the German market poses some major challenges. For example, at least 10 of the top 20 German companies have in-house IT services arms or have spun off erstwhile IT services arms into independent companies. Other challenges are the absence of lighthouse customers who can act as strong references for India, tough labour laws, and language barriers—Indian software engineers don’t know German.

Asia Pacific
The Asia Pacific market is another region that is gaining significance. Though some countries in the region are still at the developing stage, the market boasts of rapid development in the IT industry and is seen as an attractive outsourcing destination. Privatisation and deregulation of economies and industries within the region are forcing increased competition, causing countries to seek efficiencies in IT. This has led to a lot of opportunities for Indian players, especially in South East Asian countries. Recently, many Indian companies have announced mergers and alliances to create a presence and gain business opportunities; more are expected to follow.

Says P K Gupta, director, strategic development, international operations, Legato Systems India, “South Korea, which is in its third phase of e-governance, will soon get into electronic content management, which will increase storage and security needs. Besides, the government of Korea has asked all Korean companies to have their disaster recovery management plans ready, while the government of Australia has asked all Australian companies to keep details of their e-mail transactions for the last 3-4 years. This translates into huge storage and security requirements.” Even in India, the RBI has directed all brokerage houses to have a disaster recovery plan ready.

Lakshmi Narayanan says the future will belong to Global 15 IT services companies that offer end-to-end services and the challenge is for India to produce companies that fit this slot

Emerging markets
The Middle East is another area which should see increased demand for e-governance and automation projects. Other emerging markets are some parts of Africa and Latin America, especially Chile and Peru. According to Makrand Padalkar, head of product marketing and chief of staff, executive management office, i-flex Solutions, the company will be aggressively focusing on the Latin American market for its product offerings.

Challenges
While these opportunities no doubt exist, experts point to the biggest obstacles to Indian companies wanting to capitalise on them are factors like lack of awareness, cultural reluctance to outsource offshore, regulatory hurdles, and the very predictable language barrier.

Take the cases of China and France, which have proved difficult markets for Indian IT services companies. Even though France is comparable to Germany in terms of overall market attractiveness, (the market is expected to attain a size of $38 billion by 2005), there is resistance to offshoring in the current economic environment. While Indian players have got some offshoring work through companies like Airbus and France Telecom, most French companies prefer operating through outsourced development centres in France itself, or in countries closer home, like Romania, which have a sizeable French-speaking population.

There is a significant negative sentiment about French companies outsourcing their activities to countries like India and China. Thus, only about 30 percent of projects are expected to be outsourced—and that too primarily to French companies.

Experts believe that Indian companies planning to tap the French market need to adopt a long-term investment mindset. They need to demonstrate sustained commitment and patience, build visibility for their brand, and develop relationships with potential influencers in the French community. Skills like network and telecom architecture, IS security management and embedded software will be in demand in future, say experts.

In China, Indian IT companies face stiff competition in R&D services due to China’s own initiatives in the sector. However, companies like TCS have been successful in setting up their development centres in that country.
Another example is the Japanese IT services market. In spite of its size and growth, Indian companies have managed to corner only a 0.4 percent share. This is because of the dominance of local players—five of them control over 70 percent of the market. Since they enjoy long-standing relationships with these local players, customers often do not feel the need to talk to other vendors.

Language is also a genuine barrier since Japanese customers expect employees of Indian companies to be fluent in Japanese. Thirdly, most of these companies are sister concerns of trading companies, which often control the distribution and licensing of many packaged software applications in Japan. As a result, the SI arms of these trading houses have the first right of refusal for all package implementation projects.

Industry experts say that India needs to ally with Japanese providers for accessing large customers. It should also explore the possibility of leveraging China to target Japan, particularly in R&D services. Companies should choose between setting up a wholly foreign owned entity and partnering with Chinese players.

In terms of competition, Kiran Karnik, president of Nasscom, says that Ireland, which has grown at a slower rate—a CAGR of 18 percent over the last eight years—is India’s closest competitor in the export of IT services. “It currently has a mature industry with sizeable exports, enjoys strong government support, and has a deep understanding of Europe. However, driven by the need to boost productivity because of labour supply constraints, Ireland is moving away from IT services towards software products.”

In the next 3-5 years there is going to be increased competition from China, Russia and Philippines; as they are expected to move up the curve on the quality and sophistication of their value propositions. Says Vishnu Dusad, managing director of Nucleus Software, “This is going to be formidable competition due to a combination of low cost coupled with extremely high capacity to do hard work. What Indian companies need to do is take steps to move up the chain to counter this strategy.”

S Ramadorai says Indian firms should adopt the high-value brand objective and focus on expanding their portfolio to include new services such as systems integration, R&D and BPO skills

This also applies to smaller players who have to identify their value proposition and consolidate. Collaboration should be the key to their marketing strategy, as they can develop a niche product and collaborate with a large player to market it in multiple markets. “India started as a low-cost location for IT. But today we have moved up,” says S Ramadorai, chief executive officer of TCS. The objective should be to establish India as a high-value brand. This means that companies have to focus on expanding their portfolio to include new services such as systems integration, R&D and BPO, and build high-end skills like project management and solution architecting. The need is to continuously improve productivity, embrace higher levels of quality standards, and expand software operations to second-tier towns to enhance cost competitiveness.

Adds Lakshmi Narayanan, president and chief operating officer of Cognizant Technology Solutions, “There is also the challenge to build three or four global businesses in terms of size, customer base, market presence and solution diversity by making commensurate investments in sales and marketing. Clearly, the world will belong to Global 15 IT services companies that offer end-to-end services, spanning the entire spectrum from entry-level BPO to high-end consulting. Given this scenario, the challenge for the Indian software services industry is to produce two companies in the Top 5 category and four in the next 10 group of global companies. Unless size and capability is built rapidly all major Indian players will fall by the wayside in the global context.”

Nigam believes that managing software projects seems to be the biggest challenge for the Indian software industry. “While Indian companies have been very good in building skill sets, they are not the best when it comes to planning and managing projects and customer expectations. We do very well when American/European managers are managing the project, and Indians are executing. In case we are move to less developed geographies, we have to improve our management skills further.”

Another challenge which the Indian IT services industry has been facing is an internal one, self-induced by some in the small and medium enterprises (SME) segment. The slowdown led many of them to adopt unreasonable cost-cutting methods without thinking about the repercussions. The attitude was, ‘Take the contract and we will somehow do it.’ Later on, this strategy backfired.

Future course
According to experts, the US will continue to be the major outsourcer, with the UK also increasing its outsourcing activity. Says Ravindra Datar, senior analyst, IT services & BPO at Gartner India, “Indian vendors still have a lot of opportunity untapped in the American and European markets. While the focus has been mainly on the Fortune 500 companies, there is scope to do business elsewhere. The potential for cost savings and our good quality of work could be attractive to foreign SMEs too.”

Narayanan says that despite the US slowdown, America will continue to contribute around 60 percent of the Indian software industry’s earnings, with much of the rest coming from Europe and Japan; it is unlikely that this pattern will change significantly. While China will emerge as a major IT products and services user, its demand will be met internally.

However, Karnik points out that in spite of China having a substantial talent base, a large domestic market, strong government support, and strong hardware and embedded technology skills, unlike India, it suffers for the want of front-end consulting skills. “The substantial language barrier and an immature vendor base with limited international exposure are the other factors that affect China’s potential,” he says.

Also, while India as of May 31, 2002 had 42 companies at SEI CMM Level 5, China does not have a single company that is above CMM Level 3. Further, China is far behind India in terms of industry capabilities like project management skills and domain expertise. Russia too is known for its high-quality talent pool, but the lack of an industry association and poor government support has limited Russia’s ability to attract customers. “In the coming years we’ll have to deal with competition from countries such as Ireland, Russia and China, but also the growing trend to outsource near shore, due to the perceived risk associated with outsourcing long-distance. Thus, Indian companies will not only have to build a strong value proposition for themselves, but will also have to develop robust disaster recovery and business continuity plans to address all such fears,” Karnik adds.

In addition to the above, Indian companies should explore the possibility of leveraging China as an additional low-cost offshore base, or through remote tie-ups. This will also help them penetrate the Japanese market. Indian companies should also leverage Chinese strengths (especially in chip design and telecom equipment) to build world-class R&D services capabilities.

Besides, India needs to grow domestic demand for IT services by expediting deregulation in key sectors such as telecom, financial services and retail, and also by increasing the pace of IT adoption.

Says Commodore Navin Chandra, (Retd), VSM, now chief executive officer of Infinite Computer Solutions, “Indian companies account for only 3 percent of the total IT services spend in the world, so we can certainly double this figure in the next 4-5 years. We also believe that the Nasscom figure of $57 billion in IT exports from India is achievable. If this has to happen we will need to produce at least half a dozen more Infosys-sized companies. This means that a lot of companies in the Rs 100-300 crore turnover group will have to multiply rapidly.” On its part, Infinite has laid out its road map which consists of diversification into the BFSI sector, enhancement of both onsite and offshore delivery capability, and expansion of its geographical reach in the Asia Pacific and European region.

Makrand Padalkar says i-flex Solutions will focus on the Latin American market for its product offerings

The way things will be Experts point out that while every company has its own strategy based on its strengths and business model, it is strong offshore capability along with an onsite option which will provide the competitive edge in the future. Another aspect which Sudhir Gera, marketing head at Blue Star Infotech, points out is that the conventional transaction-based business model will no longer be predominant in major deals, while models like build-own-transfer, intellectual property sharing and joint ventures will be the trend of the future.

The industry will go through a further consolidation phase and many small and medium non-niche players will be challenged. “The industry structure will change, with the top 10 dominating the field, accounting for over 60 percent of revenues. The top 10 players will also go global in the true sense of the term, and establish development centres outside India, covering all addressable markets,” predicts Narayanan.

In the short-term, according to Nigam, large companies will get more BPO business and manage some growth, while smaller companies in niche areas will survive and also manage some growth. However, non-niche small software companies will have difficulty surviving. Unfortunately, while there will be an increase in IT implementation in Indian corporates, banks and financial institutions, e-governance in India might remain a pipe dream. Says Navyug Mohnot, QAI India, “Those who leverage, combine and recombine core competencies (like software engineering/project management with domain knowledge like telecom, automotive, etc.) to identify raging customer needs will become the big boys. Also, CEOs have to evolve their own vision. Emerging opportunities will no longer be incremental, but will be in terms of defining new businesses.”

Another visible trend is that of multinationals such as EDS, Cognizant, Accenture and IBM setting up development centres or expanding operations in India and other offshore locations. These players will increase competition in the IT landscape and challenge traditional vendors due to the shift in business models and adoption of newer technologies.