India Software Inc globalises in search of growth

After a not-so-exciting last year, the smile is finally back on faces in the Indian software services sector. Apart from reports predicting an upsurge in global IT spending, there has also been a significant increase in the offshore component of the software services business vis-à-vis the onsite model. Srikanth R P looks at the Indian software services industry, which has learnt hard lessons from the past and is now cautiously planning future moves through a mix of acquisitions and expansion into emerging markets such as China

Though the head honchos of India Software Inc. aren’t all smiles when you ask them about the $50 billion mark (targeted exports by 2008) the mood now is certainly very upbeat. Industry body Nasscom estimates the Indian software services industry at approximately $12.2 billion today (Rs 59,472 crore), including domestic revenues of $2.7 billion. For the next year, Nasscom estimates the Indian software and services industry will grow to $15.5 billion (Rs 70,860 crore), with the domestic market contributing close to $3.5 billion.

While stratospheric growth rates are certainly history now, thankfully, the recent uncertainty in getting business has disappeared too. Also, compared to last year, the indset of most Indian companies has changed with most players now looking at becoming global companies.

Says Kiran Karnik, president of Nasscom, “If you look at the evolution of Indian software companies, you will notice that Indian companies are now looking at becoming truly global companies. Compared to earlier years, when Indian companies had concentrated on opening up marketing offices, this time around Indian software companies have set up development centres overseas. There is also recognition among Indian companies of the need to hire local talent in different geographies. One more distinct trend I see is the increasing thrust of software companies on IP creation and R&D services.”

The thrust on IP creation and R&D services is clear from the following statistics: The contribution of the software services segment, which includes various service lines such as custom application development, maintenance and IT consulting has come down from approximately 65 percent in 2001-02 to 58 percent in 2002-03. The share of R&D services, which includes product development, design and embedded software has increased from less than 16 percent in 2001-02 to approximately 17.50 percent in 2002-03—which indicates the importance Indian companies are giving towards moving up the value chain.

The approach of Indian companies looking at becoming global companies can also be seen from the fact that many Indian companies have started acquiring foreign companies to cater to new markets. In April 2003, Wipro acquired NerveWire, a business and IT consulting company based in the US. Another traditionally acquisition-shy company, Infosys, acquired Expert Information Services, an Australian IT services firm. Indian companies have also expanded in a big way into China—a country that is seen as the biggest future challenger to the dominance of Indian majors in the software services market.

Geographical breakdown

The US continues to be the top market for Indian software exports. North America represented 69 percent of Indian software exports, with Europe coming second at 22.25 percent of total exports. Nasscom estimates North America will continue to dominate Indian software exports since North America accounts for over 50 percent of global IT services spending. Indian software exports to North America have increased continuously, with its revenue share growing from nearly 67 percent in the last year to 69 percent currently.

Europe is the next big market, accounting for approximately 30 percent of the global IT services market. Indian software companies have been gradually able to increase the European share despite challenges like protectionist labour laws and cultural differences. Software exports to Europe grew by an impressive 18 percent.

In the Asia-Pacific market, Japan, the second largest economy in the world, is clearly the market to tap. Currently, Japan contributes a measly 2.82 percent to the Indian software services export pie. The other large potential markets are the Australia-New Zealand region, followed by the China-Hong Kong region and South Korea. The potential of the Australian market can be seen from Infosys’ recent acquisition of Expert Systems—a move the Indian major has made to take a leadership role in the Australian market. Though the Asia-Pacific market is a $101 billion market, the percentage of software exports to the Asia-Pacific region is only 7.93 percent of the total pie. But unlike earlier years, most software majors have entered markets like China through alliances or joint ventures and are clearly in a position where they can be a part of the growth stage of the Chinese software industry.

Verticals

Banking, financial services and insurance (BFSI) continues to account for the largest market share at 39 percent. Indian vendors are well poised to address the requirements of IT spending by banks to meet not only customer demands but also for fulfilling regulatory requirements (Basel II norms). According to IDC, IT spending by banks will reach $60 billion in 2007, growing by more than 5 percent between 2002 and 2007. Industry analysts estimate that the top areas of IT spending in the US banking industry would be enterprise integration projects, security, enterprise portals, knowledge management and CRM.

The recovery in the telecom sector has helped Indian companies like Hughes Software, Mahindra British Telecom and Wipro. According to Nasscom, in 2002-03, the telecom equipment sector accounted for around 13 percent of Indian software and services exports. In 2003, IT services spending by the telecommunications sector was around $53 billion, including $36 billion by telecom equipment vendors and $17 billion by telecom service providers. While IT investments by telecom equipment manufacturers are likely to grow at around 9 percent, IT services spending by telecom service providers is forecast to grow at a CAGR of around 16 percent.

Players like Mahindra British Telecom have carved their niche in the telecom domain and believe that their concentration on a single domain has paid them rich dividends. While concentration on a single domain is risky, domain strength can be the key differentiator between mid-sized companies and large players as the software services industry has become a volume game where the size of the company is important in winning contracts.

The manufacturing sector is another stable sector for Indian software companies, accounting for 12 percent of Indian software exports. IT services spending in the manufacturing sector was estimated at around $100 billion in 2003.

Emerging verticals

While the mainstay of Indian software vendors are sectors like BFSI, telecom and manufacturing, Indian vendors can grow more than the average industry rate if they concentrate on untapped verticals like healthcare, utilities, retail and logistics. A report by CRIS INFAC, a subsidiary of CRISIL, estimates that Indian software services exports (excluding ITeS/BPO) can grow from the current $9 billion to $44 billion in the next five to ten years.

Says Sachin Mathur, head—Research, CRIS INFAC, “While Indian vendors have nothing to fear on the volume front, they need to change their focus from a project-based approach to a solutions-based approach. This is the only way they can achieve differentiation.” What’s heartening is that India’s market share in the global IT services market is only 2 percent—a number that analysts estimate will increase with more and more work being moved offshore. Additionally, in view of the recent study by McKinsey & Co, which stated that every dollar of work offshored adds $1.12 to the US economy, the trend of outsourcing to destinations like India will likely remain strong.

CRIS INFAC estimates that Indian vendors can benefit a great deal from sectors like utilities (estimated to grow at a CAGR of 40-45 percent, driven by deregulation of markets like US and Europe) and healthcare (estimated to grow at a CAGR of 40-45 percent, driven by regulatory norms like HIPAA and HL7). The US healthcare sector spent $15 billion on IT in 2002. According to Nasscom estimates, the healthcare sector accounted for around 5 percent of Indian software exports in 2002-03. The utilities segment accounted for around $16 billion of global IT services spending. Industry analysts believe that the outsourcing trend is just starting to emerge from the utilities segment and will be a big sector for Indian software vendors to tap.

Retail, transportation and logistics are other big sectors that are expected to grow at a CAGR of 40-45 percent. The retail and wholesale trading sector accounted for approximately $41 billion in global IT services spending in 2003.

Service lines

Indian players have also expanded their breadth of service offerings by offering high-end work such as infrastructure management, package implementation and IT consulting.

Infrastructure management outsourcing is probably the biggest market for Indian software services players and estimated to be as big as the application development market. The infrastructure management outsourcing market represents a massive $126 billion opportunity and is virtually untapped by Indian players. While this market is still a tough one to crack and is dominated by global giants, pure-play Indian software services firms like Wipro, TCS and Infosys are trying to get a foot into the door by leveraging their offshore expertise.

Almost the entire Indian IT services industry depends on three categories of services. The first segment is system integration, which includes packaged application implementation, custom application development and integration. The market size for this is approximately $98 billion. The second segment is application outsourcing, which includes support and maintenance services. This market is estimated to be close to $15 billion. The third segment is IT consulting, which includes strategic consulting, business process consulting and change management. This space is estimated to be worth close to $25 billion.

But as traditional markets have started entering the commodity phase, Indian players have no other choice but to expand the scope of the markets they are addressing.

The potential in the infrastructure management outsourcing space is best outlined by Sudin Apte, country manager, India, Forrester Research when he says, “The total IT services space that Indian players have addressed is said to be close to $138 billion. But Indian companies do not get much business from IT consulting, as even large companies don’t do more than 10 percent of their business via this route. So, Indian IT services providers have really flourished only inside a market size of approximately $120 billion. Now take a look at

IT infrastructure outsourcing. Mainframe-related outsourcing is a $29 billion market. Network-related outsourcing is a $7 billion market, while the desktop outsourcing market is a $18 billion market. Add to this the distributed environment-related outsourcing market, estimated to be close to $57 billion. If you sum up the numbers, you would see that it comes to $111 billion, close to the same market size Indian players have been addressing over the years with falling margins.”

Another big potential market is package software implementation and support is one of the largest segments of the global IT services market, accounting for 15 percent of total global IT spending. In 2002-03, revenue from packaged software support and implementation was $350 million, compared to $300 million in 2001-02, a growth of approximately 17 percent. Currently, India has a significant presence in only two of the ten major IT services. Custom application development, maintenance and application outsourcing account for nearly 88 percent of total software exports.

IP—the key differentiator

Indian companies have also realised the importance of IP (Intellectual Property) to maintain a competitive edge. While the number of companies in the IP licensing game is probably even fewer than the number of Indian software product vendors, Indian companies like Wipro, Sasken, Geometric Software, Ittiam, Aftek Infosys and Mistral Software are actively leveraging their IP to boost revenues.

While IP licensing is attractive, a business model based around pure IP licensing is perhaps a tad too risky for Indian companies—it would be prudent for Indian companies to adopt the hybrid path—develop IP for value and take the services route revolving around the IP for volumes. Take for instance a company like Sasken, which gets close to 55 percent of its revenues from IP (licensing, customisation and royalties) and the rest from services.

Says Dr G Venkatesh, chief strategist at Sasken, “We were the first company in India to adopt a hybrid business model, in which we derive roughly half of our revenues through IP licensing and another half through services. A significant point to note is that the two business models are not entirely independent of each other and there are considerable synergies to be exploited between them. Sasken has been able to differentiate itself from competition in the services space on account of the competencies it has built in the IP space.” This hybrid model of IP may be the model of the future for the Indian software services industry.

While IP-based licensing is comparatively less riskier than the products game, it is not risk-free either. It’s not easy to build the capabilities required to develop a unique technology that is difficult to copy and at the same time with potential for deployment in high volumes or one that possesses high value.

Additionally, at a panel discussion during Nasscom 2004, it was pointed out that over 80 percent of Indian IT companies do not have any check in place in order to ensure that they are not infringing on other companies’ IPs. Says Alok Aggarwal, founder and chairman, Evalueserve, “Not many Indian companies know that process methodologies are patentable in the US. Many Indian software companies who have a lot of process and delivery expertise should look at patenting their unique processes.”

Conclusion

Though the growth of the Indian software service industry will not continue at the phenomenal growth rates we have seen in the past, industry analysts believe that the foundation of the Indian software industry looks strong and the industry is poised for strong growth again.

N R Narayana Murthy chairman, Infosys Technologies says, “Be seen as value creators, not job stealers.” India Software Inc. has to articulate this value clearly to avoid any ill effects from the backlash in the West.

Expected growth rates and drivers of growth
Verticals	Growth (CAGR) for the next 3-4 years	Drivers
Financial services	25-30 percent	Increased competition, Basel II requirements, CRM, e-solutions, banking software.
Telecom Manufacturing	15 percent 20-25 percent	Need to save costs and realign R&D spends.Increased focus on RoI and implementation of SCM, ERP across the enterprise.
Utilities	40-45 percent	Deregulation of markets in US and Europe.
Healthcare	40-45 percent	Regulatory compliance with HIPAA, HL7, 21CFR 11.
Retail	40-45 percent	Recent tax breaks and robust increase in consumer spending in the US.
Transportation and logistics	35-40 percent	Revival in business travel/tourism, robust economic growth and need for better supply chain management.
Source: CRIS INFAC estimate

Indian software services and BPO (ITeS) revenues by verticals (2002-03)
	2001-02	2002-03
Banking, financial services and insurance (BFSI)	35%	39%
Manufacturing	12%	12%
Telecom equipment	12%	9%
Government	1%	1%
Retail	4%	5%
Utilities	2%	3%
Transportation	1%	1%
Telecom service provider	3%	4%
Healthcare	3%	5%
Others	27%	21%
Total	100%	100%

srikanth@expresscomputeronline.com