Gunning for growth

The outsourcing story is intact. To scale up and improve margins, software firms are getting aggressive about acquisitions, product development and consulting, says Venkatesh Ganesh

What started out as a backlash against outsourcing in early 2004 turned out to be just a passing phase for the Indian software sector. That said, the ground realities remain the same. US companies continued to outsource with the same fervour as before. According to Nasscom, IT services and software exports grew by 33 percent in FY 2003-04 clocking revenues of $12.8 billion. Nasscom predicts that the IT services and software exports industry is likely to grow by 35 percent to touch $17.5 billion in FY 2004-05. Custom application development and maintenance account for approximately half of India’s IT services exports.

The IT consulting front saw some action as a host of Indian majors started beefing up their capabilities in this area. Margins are typically higher in consulting—compared to $20 per hour in vanilla services, rates in consulting are upwards of $100 per hour. Infosys Technologies has spent $20 million setting up a business consulting subsidiary in

the US. Similarly, TCS acquired Aviation Software Development Consultancy India (ASDC), a company focussed on providing consulting and solutions to the aviation industry. Wipro’s process consulting division generated revenues of $20 million during the first nine months of the current fiscal, 2004-05 compared to $10 million for 2003-04.

Offshore’s share in overall IT services and ITeS revenues rose from 57 to 64 percent in 2003-04. Going forward, Nasscom believes that Indian R&D services and software product development sourced out of India will grow rapidly. Analysts expect the Indian R&D services and software products market to tot up anything between $8 and $11 billion by 2008-10.

In terms of markets, North America and Europe are crucial, accounting for 69 percent and 22 percent of the total IT and ITeS export revenues respectively. Between them, these markets accounted for over 90 percent of the Indian software industry’s export revenues in 2003-04. This is expected to remain unchanged in fiscal 2004-05. India now has three companies—TCS, Infosys and Wipro—whose annual turnover top a billion dollars.

Size does matter

While the Indian software services sector is booming thanks to the offshore wave, many small and mid-sized Indian organisations do not want to repeat the mistakes of the past. Consequently, Tier 2 companies such as MphasiS and Geometric Software have gone in for acquisitions.

MphasiS was the most aggressive player in the mid-tier acquiring two companies in 2004. With the intent of penetrating the healthcare and telecom verticals, the company acquired Kshema Technologies for $21 million. Subsequently, it acquired the SAP implementation practice of MIRC Electronics. It followed this up by sewing up a deal to acquire Princeton Consulting, a London-based consulting company.

The burgeoning demand for SAP services can be seen from two deals last year. In addition to the MphasiS deal, Cognizant Technology Solutions acquired Ygyan Consulting, a Pune-based SAP services provider. With the Ygyan acquisition, Cognizant brought 85 SAP consultants on board. Similarly, Geometric Software signed an agreement with OnCourse Technologies Inc to acquire Teksoft Inc and Cimtronics Inc for $1.75 million. i-flex Solutions acquired the US-based BPO firm, Equinox Corp and obtained a stake in French software company, Login SA for $5 million.

Remote infrastructure management

This opportunity is valued at $111 billion (Source: Forrester Research) that has not been tapped by most Indian companies. Indian firms are approaching this space in the same way that they approached the software services market—start by offering on-site support and, once the client is confident of capabilities, move work offshore. TCS, Wipro, Infosys, Patni and Cognizant are competing with established vendors such as IBM and EDS in this space.

Offshore product development

Nasscom estimates that the value of offshore product development sourced from India has risen from $560 million in FY 2002-03 to $710 million in FY 2003-04. In addition to the number of MNCs setting up base in India, US-based venture capitalist firms are driving their clients to use India’s offshore capabilities for product development.

Looking beyond

Indian firms have also started looking beyond the US market for growth. For example, the German IT services market is worth 26.5 billion Euros. The opportunity is huge as Germany accounts for only 2.8 percent of India’s software exports. Companies such as Hexaware have been quick to spot this opportunity. Of the 25 percent revenues from the European market in the first half of 2004, 15 to 20 percent was contributed by the company’s German unit. Currently, Hexaware has clients such as Citibank, Lufthansa Systems and Deutsche Leasing in Germany.

Smooth passage on the silk route

Indian companies also did well in taking on the Chinese dragon. Research firm Gartner says that although China will catch up with India by 2006, Indian firms will be a part of the Chinese software story eventually controlling 40 percent of China’s IT services exports.

Comments Girija Pandey, Regional Director and Head of TCS' Asia Pacific Operations, “Our strategy in China is to address the domestic market and we are looking at serving other Asian countries using our Chinese base. Additionally, we can even cater to the needs of global companies located in China.” This is a game plan that most Indian companies have adopted to gain a foothold in the Japanese market.

China has been a favoured nation for Japan’s software imports. The synergy begins with the cultural affinity to other areas like familiarisation with the ‘double byte’ system that is used in generating Chinese and Japanese characters.

The domestic market

The Eldorado Computing acquisition is part of MphasiS’ overall business strategy to strengthen our footprint in the US and enter the healthcare insurance and payment market Jerry Rao Chairman and CEO MphasiS BFL

The domestic market was considered to be the weak link for Indian software companies. That’s all changed. Indian software services players had focussed on export opportunities due to the lack of a strong domestic market. As outsourcing deals materialise, and big ones at that, India is becoming a market that cannot be ignored. For the record, Bharti Telecom signed a record $750 million contract for ten years with IBM wherein the latter would manage Bharti’s entire IT infrastructure. This agreement follows two other major outsourcing deals—Hewlett-Packard Services with Bank of India, and Dabur with Accenture. Recently, Wipro bagged a total outsourcing deal with Yes Bank.

Last year saw industry associations recommending an increasing focus on the domestic market. Research firm Gartner opines that the Indian market is set to grow at a CAGR of 17.3 percent until 2008. This is almost three times the rate of the US and European markets, which are likely to grow at 6 and 8 percent respectively. At the current estimated size of $3.6 billion, the domestic market is not something to be looked down upon any more.

Says Craig Baty, group VP and Chief of Research, Gartner, “By 2008, the Indian domestic market will be almost 1.5 times the size of the IT markets of Singapore, China and Australia.” In India, vendors such as TCS and Wipro Infotech and CMS are active on the domestic front.

According to Nasscom, telecom (22 percent share) is the most sought after sector followed closely by banking and finance (with a 21 percent share). Then come manufacturing, training and government. While the 17 percent growth forecast is promising, India’s IT market is starting from a smaller base than that of many other countries. Says John McCarthy, VP, Forrester Research, “There are thirty-eight ‘billion dollar’ Indian companies (across verticals), which can contribute immensely to the domestic IT spend.”

Apart from this, opportunities in verticals such as energy, manufacturing, education and small and medium businesses (SMBs) can be tapped. Says Kamesh Ramamoorthy, EVP, Enterprise Solutions, Ramco Systems, “We intend to consolidate our presence for Ramco e.Applications in the SMB market through channel partnerships in India.” According to IDC, 70 percent of Indian enterprises fall into the SMB segment.

George Paul, VP Marketing, HCL Infosystems says, “The industry has seen a surge in demand in smaller towns and we see SMBs emerging to drive a significant portion of the regional IT market’s growth.” Instead of competing head on with MNCs, Indian players can adopt a two-pronged strategy. Firstly, they can team up with MNCs for system integration, implementation, maintenance and support. They can also tap the SMB space as these companies have not invested much in IT to date.

A case in point is CMS, which is focussing solely on the domestic market and derives the bulk of its revenues from it. Says S Ramadorai of CMS Computers, “We were among the first to identify the domestic market. Even as networking vendors make huge investments in the Indian market, system integrators have a role to play as around forty percent of the cost of networking goes towards administration and maintenance.”

Another move that can pay dividends, which Indian companies have not looked into, is the acquisition of Tier II or Tier III companies, similar to the TCS acquisition of CMC. For TCS, the domestic market contributes close to 7 percent of its total revenues excluding CMC whose acquisition reinforces the company’s domestic focus.

BFSI has always been a forerunner in automation. It accounts for 28 percent of the domestic IT market. Spending by the BFSI segment is expected to jump to Rs 9,800 crore during fiscal 2004-05. Most Indian vendors have been focussing only on this segment in the domestic market.

Experience of global best practices and reach are also factors that come into play when domestic clients pick a vendor for their outsourcing contracts. Says Datar of Gartner, “Some Indian vendors lack knowledge of global best practices and this sometimes acts as a deterrent to their prospects.” Indian companies are addressing this issue by building alliances with MNC vendors. For example, Infosys partnered with HP for the Bank of India deal.

Product play

As the software services game becomes a volume play, smaller vendors are looking at creating Intellectual Property (IP). While India’s expertise in software services is well known, some mid-sized firms are dominating the product space. India has product firms in almost every category be it ERP, CRM, accounting or even remote infrastructure management.

Take the case of Ramco Systems. The company has registered a 40 percent growth rate as compared to 2003. It is banking on VirtualWorks as a development and delivery platform Says Kamesh Ramamoorthy, EVP-Enterprise Solutions, Ramco Systems. “Ramco Systems has now reached an inflection point with the maturity of the VirtualWorks platform, establishment of market & partner initiatives and successful implementation of mission critical enterprise-wide solutions.”

Ramco is looking at consolidating its presence in high potential segments viz. manufacturing, transportation and e-Governance solutions. It plans to establish technology & market-driven partnerships, create an increased global presence for Ramco DecisionWorks in the corporate performance management space.

Indian vendors have also been smart enough to develop expertise in niche verticals such as telecom fraud management. For example, Subex started by developing a product in the niche domain of fraud management for telecom operators. Its clientèle includes top names such as Bharti, Hutch and Reliance.

Says Subash Menon, the company’s President and Chief Executive Officer, “Our flagship product, Ranger has the second-largest installed base in the fraud management space within three years of its launch in 2000.” Subex acquired the fraud management group of French major Alcatel for $3 million. Subsequently, the company acquired the ‘Fraud Centurion’ product from Lightbridge Inc, a transaction processing company. This acquisition added nearly 14 new clients positioning Subex as the market leader for fraud management solutions.

To gain a foothold in China, Subex entered into a partnership with BOCO Inter-Telecom, a provider of software solutions to telecommunication carriers in China. Apart from Subex, a couple of strong product players such as Zycus Infotech, Financial Technologies, Newgen and Zenith Infotech have emerged on the product scene.

Document management solutions player Newgen is betting big on Business Process Management as the next big wave to help it emerge as one of India’s leading product players. Most large application server and EAI vendors today claim to have a BPM component as part of their suite. Comments Sugato Basu, General Manager-Products and Solutions, Newgen Software Technologies “There is a concerted effort by most BPM vendors to move towards BPML or BPEL and adding Web services integration as part of their suite.” Last year, Newgen bagged customers both in India and overseas. In India, the company gained customers like Sahara Life Insurance Company India, Airtel, Hutch, Bajaj Allianz General Insurance and iGate. Customer wins abroad included SEC-Philippines and Kenya Airways.

Tapping the IP mine

Software SMBs have realised the need for creating IP. Geometric Software, Ittiam Systems and MindTree have focussed on creating IP in niche domains.

Geometric, incidentally, was one of the first Indian companies to take the IP licensing path when it licensed its geometry-based algorithms to other companies for improving their CAD/CAM processes. Today, Geometric gets its revenues from a variety of sources such as software services, products (through OEM deals), IP-based services and IP licensing. Geometric’s IP is the reason why the company is ranked among the very best in the global PLM space. For instance, in 2001, Spatial bought out Geometric’s translation technology for over a million dollars.

While most Indian firms have a mix of product, pure services and IP-led services, some players such as Ittiam are betting on IP licensing. Comments Srini Rajam, Chairman and CEO of the company, “Unlike the product business, licensing IP does not require huge investments in manufacturing, sales, marketing and distribution.” What’s advantageous is that margins are high in the IP licensing game.

Sasken follows a model wherein the company offers a combination of IP components and consulting services. Comments Rajiv Mody, Chairman and Chief Executive Officer, Sasken, “The IP licensing model is a high-barrier business where you are unlikely to be displaced by a competitor.” This is especially true in segments like mobile phones where the volumes are considerable. In 2005, analysts expect a rise in the number of SMBs venturing in the risky but potentially rewarding products or the IP licensing game.

A niche in time

The Indian ITeS-BPO sector continued to record dizzying growth rates. According to Nasscom, total revenues earned by the Indian ITeS-BPO industry grew by 45.3 percent from $2.7 billion in FY 2002-03 to $3.9 billion at the end of FY 2003-04. Nasscom predicts that the industry will grow approximately 44.4 percent and reach $5.7 billion by the end of FY 2004-05.

Among segments, customer care and support services remained the largest segment accounting for a third of the segment’s revenues. Finance, administration and content development were the next three segments contributing 23, 14.9 and 15 percent respectively to the revenues. HR outsourcing is a relatively new trend. In India, MNCs such as Fidelity, Exult and Hewitt have started using India as a base for HR outsourcing.

While existing players are trying to expand their services portfolio, smaller BPO firms have realised that they need to focus on niche markets. For instance, Ugam Solutions started its BPO operations by concentrating on high-end data analytics. Barring the bigger players, Wipro Spectramind, ICICI OneSource and WNS, most Indian outfits are not even close to the requisite scale for competing with global players. Competitive advantage can vanish overnight as was proved by the acquisition of Daksh by IBM. Indian companies have realised this and are bidding aggressively for global BPO companies in niche verticals to gain size and domain expertise. Analysts expect Indian vendors to make acquisitions in untapped segments such as HR outsourcing and healthcare in 2005.

venkatesh@expresscomputeronline.com