Serving the world, the Indian way

2003-04 saw the Indian IT industry consolidating its presence in emerging markets like China. While margins have fallen, billing rates have been stable. Venkatesh Ganesh tries to analyse the road ahead for the Indian software services industry

The mood in the Indian software services industry definitely seems to be brightening. There is a tone of cautious optimism with companies claiming flat IT spending in 2003, after a decline in 2002. This was not merely restricted to India but included the global IT services market. According to IDC, the global services market is expected to witness a 5 percent increase in IT spending in 2004, with some analysts predicting an increase to the tune of 6-8 percent. According to a recent IDC report, globally, system infrastructure service providers showed the maximum growth at about 15.4 percent ($11 billion), followed by application management ($13 billion at 7.9 percent).

Software services reloaded

Nasscom estimates that despite this economically challenging situation prevailing in global markets, the export-oriented software and services sector showed a growth of 26 percent in 2003 (20 percent in 2002). Interestingly, the IT industry’s contribution to Indian GDP has increased to more than 3 percent in 2002-03 and is estimated to further grow to 3.8 percent. In 2002-2003, Indian software services exports touched $92 billion. IT software and services exports accounted for the bulk of revenues generated by the sector, with revenues increasing from $ 7 billion in 2001-02 to $9.5 billion during 2002-03. IT exports, which contributes a major chunk of the software services revenue pie, is estimated to account for 62 percent as compared to 60 percent in 2002-03. IT exports from India will grow approximately by 20.5 percent in 2003-04, touching $ 10 billion.

Traditionally, the entire Indian IT services industry depends on systems integration, which includes packaged application development implementation, custom application development and integration. Application outsourcing, which includes support and maintenance services, is pegged at approximately $15 billion. IT consulting, which includes strategic consulting, business process consulting and change management is estimated at $25 billion.

On the domestic front, Nasscom expects the software and services segment to register a growth of 14.8 percent to reach $3.08 billion in 2003-04. The banking, financial services and insurance (BFSI) segment predominantly drove the domestic bus. Of these, packaged software is estimated to grow at 5 percent, with the SME sector showing a positive intent in implementations, provided it benefited them in the short run. Other growth drivers include enterprise resource plan (ERP), supply chain management (SCM), business intelligence (BI), customised software and consulting.

Application development and maintenance, a staple revenue generator for Indian companies has come down from approximately 65 percent in 2001-02 to 58 percent in 2002-03. On the other end of the spectrum, R&D services (which includes embedded software and product development and design) has garnered 17.5 percent of market share (its share was less than 16 percent in 2001-02) indicating signs of India Software Inc. moving up the value chain in 2002-03.

Sunrise verticals

BFSI still form the backbone of the Indian IT sector, accruing 39 percent of market share. Indian vendors are all set to address the requirements of IT spending by banks to meet customer demands and fulfilling other requirements like Basel II norms. Says Soumitro Ghosh, vice president, Banking, Financial Services and Insurance Solutions, Wipro Technologies, “Our insurance solutions division also recently completed a customer services transformation project for Prudential Plc. This project will help improve customer service levels and reduce the cost of customer services operations significantly.” Wipro was also selected recently as an offshoring partner for Aviva, UK’s largest insurer.

According to IDC, IT spending by banks will reach $60 billion in 2007. Industry analysts estimate that the major areas of IT spending in the US banking industry would be in the spheres of enterprise portals, security, knowledge management, CRM and enterprise integration projects. The de-glamorised manufacturing sector also contributes steadily to Indian software companies’ and accounts for approximately 12 percent of Indian software exports. Besides, 2002-03 also saw a recovery in the telecom sector, which helped companies like Wipro, Mahindra British Telecom and Hughes. Nasscom estimates that in 2002-03 the telecom sector contributed around 13 percent of Indian software and services exports. IT investments by telecom equipment manufacturers are expected to grow at approximately 9 percent and IT services spending by telecom service providers is forecasted to grow at a CAGR of 16 percent.

Indian vendors still have a long way to go in terms of tapping untapped verticals like retail, healthcare, utilities and logistics. A recent report by CRIS INFAC estimates that Indian software services exports (excluding ITeS/BPO) can grow to $44 billion in the next five to ten years. Says Sachin Mathur, head-Research, CRIS INFAC, a subsidiary of Crisil, “Indian vendors can grow faster than the average industry rate if they concentrate on these verticals”. He continues, “Also, Indian vendors have nothing to fear on the volume front and it is paramount for them to change their focus from a project-based approach to a solutions- based approach.” Currently, healthcare accounts for around 5 percent of Indian software exports and other verticals like retail, transportation and logistics are expected to grow at a CAGR of 40-45 percent.

IT spending by the government has increased by 12 percent to $7.6 billion in 2002-03. The Indian government plans to invest around $2.7 billion to bridge the Digital Divide and about $1 billion on e-governance in India, according to Nasscom.

Margin call

Margins of Indian IT companies are showing signs of settling down after considerable fluctuation last year. Says Soumitra Ghosh of Wipro, “We expect margins to stay stable or improve, subject to the rupee rising in future quarters.”

Concurs Ganesh Natarajan, deputy chairman and MD, Zensar Technologies, “Margins have stabilised, albeit at lower levels than the peak days of the IT boom.” With offshore being the latest mantra amongst Indian companies, Soumitra avers that the industry’s focus on moving more work offshore and cost rationalisation would have a positive effect on margins. Avers Atul Takle, vice president of Corporate Communications at TCS, “Indian software firms have had to slash prices and offer discounts during the past two years to retain clients in a fiercely competitive industry that has attracted large players including Accenture and Oracle to India.”

Margins seem to have settled down but industry analysts feel that the Indian offshore players may still have a slight edge over their multinational counterparts. This could mainly be attributed to their low cost structure and locational advantage. As compared to last year, billing rates seem to have stabilised too. Says Ashank Desai, chairman and managing director of Mastek, “Margins have stabilised and the industry’s focus on moving more work offshore and cost rationalisation would have an even more positive effect on margins.”

Areas of opportunity

Traditional service lines and verticals continue to drive growth in the future too. The new service lines that the industry is eyeing are in areas like package implementation, infrastructure management and IT consulting. Realising this imminent need to move up the ‘oft-repeated’ value chain, Indian players are also expanding their breadth of service offerings and thereby aim to contribute a higher percentage to their top lines.

The arc lights are on infrastructure management outsourcing, which is touted as a massive market for software companies and estimated to be equivalent to the size of the application development market. It is still virgin territory and presents a $126 billion market for Indian software services players. At present it is dominated by global giants, but Indian biggies like TCS, Wipro and Infosys are slowly making inroads by leveraging their offshore expertise. According to a CRIS INFAC report, another hot area is package implementation, which is dominated by the bigwigs of the IT industry. The verticals driving growth in this space are high-tech manufacturing, financial services, retail and logistics. Apart from this, growth in this segment can come from corporations rolling out packages across divisions and geographies.

Acquisitions formed a part of the overall strategy and the year saw Wipro acquiring Nervewire in the consulting space, thus adding a new string to their BFSI bow, besides also acquiring AMS for its ‘energies and utilities’ practices. Along similar lines, Cognizant acquired ACES, a Siebel CRM company, in addition to its recent acquisition of Ygyan, a Pune-based SAP services firm. Infosys made its first acquisition by buying Australian IT services firm Expert Information Services for $22.9 million. TCS announced the incorporation of its new subsidiary, Tata Consultancy Services Asia Pacific (TCS APAC) with an investment of more than $6 million.

On the technology front, Indian companies are eyeing emerging technology areas like radio frequency identification (RFID). The RFID IT services market in 2002 was $200 million and is expected to touch around $1.5 billion by 2008, according to industry estimates. A few Indian companies have already eyed this area, the most notable company being Infosys. Says an Infosys spokesperson, “We have architected a solution specifically for RFID adoption. Our solution addresses enterprises intending to evaluate RFID technology, develops a business case and a roadmap for implementation by taking a collaborative approach.”

Awash with offshoring

Beyond a shadow of doubt, offshoring consumed the maximum print, television and all other media spaces and still continues to do so. The dynamics of software outsourcing, especially offshore development has entered a new phase and new adopters are contributing almost 50 percent to the offshore outsourcing pie. Offshore vendors face several challenges like an uncertain political atmosphere, intellectual property violation, etc. when it comes to new outsourcers. Says Stephen Lane, director, IT Services Research, Aberdeen, “Vendors have to look beyond technical expertise and low cost. They have started to differentiate by offering risk mitigation, security and other service offerings”. He continues, “In addition, there is increased competition from multinational IT services suppliers as well as local companies that have developed and/or acquired offshore delivery capabilities.

Agrees Ashank Desai of Mastek, “ The offshore as a model is definitely working and increased competition can expand the market further.”

There is another breed of hybrid vendors emerging on the Indian horizon. These are US or European companies in name, but who perform the majority of their client work offshore. “These service providers offer prospects the comfort of working with people from the same culture and who are acquainted with local business practices, regulations etc, and simultaneously make the offshore process transparent to their customers, reducing their anxieties considerably,” says Lane.

Then there is the omnipresent threat from global multinationals like IBM, Accenture, etc. A recent report by CLSA says that IBM, Accenture, EDS and Cap Gemini would at least double (if not more) their offshore presence to 25,000 by March 2005. The recent emergence of the anti-offshoring lobby in the US is also compounding problems for Indian firms. In addition to this, MNCs are giving lower rates to first time outsourcers. “Indian vendors can overcome these hurdles by engaging locally while delivering globally. This means doing more hiring, not only for sales and marketing but even for project managers and other onsite staff in addition to investing in cultural training and account management,” explains Lane. Battling issues like attrition, RoI and shaking off certain lingering doubts about the industry’s capabilities; the Indian software companies can have most of the shore for themselves.

The way ahead

For Indian companies, the challenge lies in maintaining cost competitiveness while simultaneously diversifying into high-end value services. Says an Infosys spokesperson, We have proven expertise in developing enterprise and wireless solutions and a deep understanding of the domains we target. A combination of these strengths translates into delivering solutions that delivers business benefits.” Says Soumitra Ghosh of Wipro, “We believe increased competition and exposure to global practices will benefit Indian companies in the long run”.

A recent study by McKinley & Co, states that every dollar of work outsourced adds $1.12 to the US economy. With more work being moved offshore, India’s market share in the global IT services market is bound to rise. Indian companies have started calling themselves as IT services companies and the challenge lies in being recognised as one. However, with the US Senate recently passing a bill banning outsourcing of government work, the Indian software industry needs to negotiate with a tiger’s ferocity and protect its turf, which legally conforms to the General Agreement on Trade in Services (GATS) and other global conventions.

venkatesh@expresscomputeronline.com

Software & services export revenue ranking (2002-03)
Company	Rs. Crore
Tata Consultancy Services	4545.3
Infosys Technologies	3543.5
Wipro Technologies	2787.4
Satyam Computer Services	2003.3
HCL Technologies	1530.5
Patni Computer Systems	914
Mahindra British Telecom	634.7
iFlex Solutions	593.3
HCL Perot systems	449
NIIT	426.3
Source: Nasscom

Global delivery to IP creation

As they compete against MNC giants the path ahead for Indian software companies needs a different outlook. In the next few years the industry needs to scale up faster. Come to think of it, both (MNCs and Indian players) are reaching the same goal, but from different directions. The challenge for Indian players is more locations, not just India. Nearshore sites form a part of the strategy pursued by Indian companies. Explains Soumitro Ghosh, vice president, Banking, Financial Services and Insurance Solutions, Wipro, “While IT services majors have realised the significance of having an India delivery capability and definitely have the brand name to attract people, they will face challenges in terms of execution. In this type of a development environment, with a significant part of the team having no real context for the systems or the business environment of the client—the transfer of knowledge related to the project isn’t inherent in the structure of the project team and requires special attention. This is an issue with knowledge transfer to the offshore team as well as transfer of information back to the enterprise”. Indian companies insist that merely setting up development centres won’t help their cause. They contend that there is more than cost advantage that goes into a successful global delivery model. Even US vendors are trying to figure out multiple locations and factors like changing their processes to deal with the fact that all work cannot be done locally anymore. In short, for MNCs it is going to be about changing their cultures around costs. The challenge for Indian players could be in building domain expertise into their culture. Intellectual property differentiators IP licensing is a strategy that has been recently adopted by Indian IT companies. Companies like Sasken, Wipro, Geometric Software, Aftek Infosys, etc. have zeroed in on this area to boost revenues. Take for instance Sasken, which gets approximately 55 percent of its revenues from IP (licensing, customisation and royalties). The other part of the revenue pie comes from services. It is interesting to note that although revenues are split between two different business models, there is a synergy between both these business models. While IP licensing is attractive as a business model, for Indian companies it is a wee bit risky. The hybrid path suits Indian companies perfectly and Sasken follows precisely that. It is not as risky as say products—one cannot presume that IP licensing is risk-free. It is not easy to build the capabilities that go into the making of a new technology that is difficult to emulate and at the same time has strong potential for deployment in high volumes. At the recent Nasscom 2004 event, a stunning fact came out in the open: Over 80 percent of Indian IT companies do not have any checks in place in order to ensure that they do not infringe on other companies’ IPs. Indian companies have an opportunity to look at patenting their process methodologies and adding to their bottom lines, besides being perceived as global players. Navigating software shores The US still continues to be the hotspot for Indian software exports. Despite a slowdown in the US economy, Indian software exports to North America are on the rise, with revenue share growing from 60.5 percent in 1998-99 to 69 percent in 2002-03, according to Nasscom. IDC states that the financial services industry in the US has shown a steady growth in IT spending, driven by increasingly stringent regulatory requirements. Add to this US companies in industries like automobiles, aerospace, telecom and pharmaceuticals, who have been investing heavily in IT to improve product life cycle management. Next comes Europe, where software exports grew by 18 percent (despite challenges related to protectionist labour laws and cultural issues). In the Asia-Pacific region Japan is the market to target, accounting for a paltry 2.82 percent to the Indian software services sector. China is the market that Indian companies are scaling to conquer. Research and advisory firm Gartner says that Indian IT services companies will control 40 percent of China’s IT services exports. One glance at Indian firms doing business in China, by way of alliances, JV or acquisitions reveals a strategic intent on behalf of these companies. From majors like TCS, Infosys and Satyam to mid-sized companies like Zensar and Mphasis, all have chalked out their plans using China as a base. China presents a huge domestic market, but does not possess the requisite technical manpower to service its customers. In addition, Gartner estimates that China has more than 6,000 software and application development companies, but the majority of them have less than 50 people on their payroll. In contrast, India has more than 3,000 software companies, but a majority of them are of a significant size and employ more than 1,000 employees. This issue of size hampers the participation of Chinese companies in participating in larger projects. Further, issues pertaining to process maturity and quality certification dog Chinese companies and this presents a tremendous opportunity for Indian software companies, a majority of whom are SEI-CMM Level 5 certified. Take the case of TCS, Asia’s largest software services player, which has been present for 17 months in India. It has made huge inroads into industries like financial services, telecommunications and manufacturing. Another Indian major, Infosys, is still bullish on China despite numerous hiccups. Says a spokesperson from Infosys, “Infosys has incorporated its wholly-owned subsidiary in China, with around 200 professionals in Shanghai and offering end-to-end services to domestic as well as multinational companies operating in China.” A similar strategy was followed by Satyam, which kick-started Chinese operations by establishing a representative office and in the process became the first Indian company to do so. Another strategy pursued by Indian companies is that of forming alliances with local Chinese companies. TCS tied up with Zoom Electronics, a leading IT and telecommunications service provider and eBis, a leading financial service provider. This strategy has paid dividends and it has signed new contracts worth $20 million. Whether it is acquiring companies, forming JVs or alliances, Indian curry could be the dish served to the Chinese dragon.

Wipro The smile is evident on Vivek Paul’s face. He has a larger-than-life presence in the US, manages more column centimetres in the international press than any other Indian software firm (CBS’s 60 minutes being a recent testimony), and earning accolades for being voted as one of the best managers by BusinessWeek. But what must be of immense pleasure to this media-shy vice chairman would have been the fact that Wipro has discovered the DNA for inorganic growth. Wipro recently acquired Nervewire, a US-based financial services consultant and utilities’ practice of consultancy AMS. This move will definitely give the company a ready installed base of customers in addition to strategic consulting expertise in industries that are already into offshore outsourcing. This combination of high-end consulting and commodity services provides Wipro with an opportunity to capture a larger share of the complete IT lifecycle business. Though nowhere near the famous 4x4 target ($4 billion turnover by 2004), the signs are indicative of Wipro moving towards that direction (Wipro might close this year with around $1 billion in revenues). So, how did Wipro achieve this? Cut to a scene from the year 2001—a general slump in the industry and Wipro’s strength was primarily in the technology solutions area, and so was impacted severely. So Wipro decided to build on the enterprise applications business (which was Infosys’ and Satyam’s forte). The past few years saw Wipro focused on building precisely on this area of business. Cut to the year 2004 and Wipro has identified and built three new businesses that account for 30 percent of its overall revenues, viz. infrastructure management, package implementation (PI) and BPO. These will be their major growth drivers in the future. Spectramind, the BPO outfit that Wipro acquired, has offered tremendous spectrum to the company. It is the largest third-party BPO company in India with approximately 8,500 people on board. Taking the offshoring ideology further, Wipro will provide solutions that will involve multiple services like application outsourcing, package implementation, infrastructure management, etc. Infrastructure management is growing at approximately 50 percent, with over 30 customers, including Lehmann Brothers, BestBuy, etc. Apart from the general growth areas of Wipro, the other area that it has decided to explore is the IP licensing front. Wipro recently announced the licensing of its USB 2.0 host software stack to Wind River. Widening its repertoire in terms of building new business areas and acquiring companies (thereby getting into consulting and outsourcing) figures extensively in Wipro’s scheme of things. The way things are shaping for Wipro, it seems to have finally broken the myth of being a conservative company as perceived by many analysts and industry observers.

Tata Consultancy Services Entry into the $1 billion club was one of the huge achievements for Asia’s largest software player. TCS recorded revenues of $1.04 billion for 2002-03, a growth of 20 per cent, which is higher than the industry average of 18 percent. With this, the company becomes the first Indian software company to reach the $1-billion mark in revenues. Of total revenues, exports added up to $90.9 million while the domestic market contributes $7.38 million. The foray into China 17 months ago paid dividends for TCS. It made significant inroads into industries like financial services, telecommunications and manufacturing. TCS tied up with Zoom Electronics, a leading IT and telecommunications service provider and eBis, a leading financial service provider. This strategy has paid dividends and it has signed new contracts worth $20 million. Besides addressing Chinese domestic requirements, it gives TCS a chance to service global giants like GE, who look at technologically competent players to service them in China. TCS has followed a policy of recruiting local manpower and even locations were chosen strategically. For example, it chose the city of Hangzhou, home to many Chinese educational universities. Also, Tata Consultancy Services (TCS), as part of its periodic compensation benchmarking and review exercise decided to hike basic salaries across the board from 10 percent to 30 percent. The new salary structure will come into effect from April 1, 2004. The market is rife with expectation this year regarding TCS’s proposed IPO, but this time the indicators are quite strong. All the four Tata group IT companies work in close co-ordination with TCS and if the IPO happens, there could be case of merging the four of them into TCS. The company’s policy of investing in technological innovation, people building, and domain building with a focus on the domestic market would be its strength in achieving targets. TCS is making the transition from being an Indian software giant to becoming a multi-cultural global organisation.

Indian software and services exports: Key service lines (2002-03)
All figures in billion dollars
	2001-02	2002-03
Software & services	4.95	5.53
IT consulting	0.05	0.08
System integration	0.15	0.1
Custom application development and maintenance	2.65	3.02
Network consulting & integration		0.03
Hardware support & installation		0.02
Packaged software support & installation	0.3	0.35
IS outsourcing		0.01
Application outsourcing	1.75	1.85
Network infrastructure management	0.05	0.08
IT-enabled services	1.49	2.34
R&D services	1.21	1.66
Product development & design	0.3	0.56
Embedded software	0.91	1.1
Total	7.65	9.53
Source: Nasscom