Business Accent

Improving the profitability of Indian Software (Part 2 of 2)

This is a look at the problem of linear growth in the Indian software industry and how it can handle this problem effectively and increase its revenues.

Neeraj Verma

This is the second part of a look at the problem of linear growth in the Indian software industry and how it can handle this problem effectively and increase its revenues.

The combination of Offshore-Onshore development is working as a panacea for the Indian software industry but companies like IBM or Accenture are moving fast in the same direction and the day is not far when the competitive advantage of the global delivery model will start eroding for Indian software companies. Indian companies need a new strategy for growth which should not be completely based on linear growth patterns.

Profitability on the product front: global

Product development is different from project based development. It requires proper research, funding, branding and intelligent marketing communication. The global packaged software market has been projected to be worth $350 billion in 2007. Indian software companies can leverage the market but the Achilles heel for an Indian Software Company is that it does not have many recognised products in the market. Indian software products, which are global brands, can be counted on your fingers and the major reason is investment. Any software company needs to invest a huge amount of resources in brand building and marketing and the top management is unwilling to do that. Take for instance behemoths like TCS or Infosys. Even as they gather growing global clout, their top management publicly announces their desire to emulate an IBM Global Services, EDS or Accenture but never do they ever dream of trying to become the next Microsoft, Oracle or SAP. That is the Indian dichotomy, on the one hand we are the leader of global services and on other hand we stand relatively nowhere when it comes to products.

The software industry in India contributes to about 4 percent of the country’s GDP and nearly 20 percent of its exports but it still account for only a meagre 0.2 percent of the $180 billion global market. It shows that without software products the dream to become an IT powerhouse is likely to remain just that, a dream. According to a study conducted by IIM-Bangalore the revenue potential of India’s software products is as high as $7 billion by 2010—a near 10-fold rise from current levels. However this is still a drop in the ocean.

Many small Indian software companies have tried to make an entry in the global market but they could not survive due to extreme competition or lack of funds. The most important reason was lack of knowledge of the culture abroad. When Indian software companies enter the global market they face an alien culture without having any insights into it resulting in a less than successful entry. Global leaders are using extensive market research data and analytics to get an in-depth understanding of what the customer wants and what he is willing to pay for a product. Successful products can change the fate of an Indian software company .The biggest advantage is that they need not concentrate on the whole market to grab the business opportunity. Make a competitive product for the market and concentrate on branding and customer communication .Once the product is successful then the same product or product line can be a major revenue earner for the company without large expansion in the team size. It takes years to create a product that is a successful brand and Indian companies must have that much of patience if they wish to step away from the linear growth mentality.

The biggest challenge for Indian companies in raising their market share is to understand the difference between project and product development. Projects require understanding of only one customer whereas products require understanding of the whole market. If the project does not meet the requirement of the client it can easily be redesigned according to what suits the customers but in case of a product the customer either selects or rejects it. In many cases it is possible that product companies may face failures but there lies the art of survival of any product based software company and it hugely depends on the funding as well as the research and development. The speed with which a company can eliminate causes of failures once the product is launched in the market is of utmost importance. The most successful word processing software in the market Microsoft Word also faced stiff competition in its early days in 1981 from WordPerfect. Customers were reluctant to buy Word at that point as they were unwilling to shift to a new product from the existing one. Microsoft learned from the market and Word is the most popular word processing product today.

Profitability on the product front: India

It’s not only in the global market, opportunities exist in the domestic market as well and only a handful of companies have tapped this so far. Tally is a case in point of a product that has understood the needs of Indian Small and Medium Businesses (SMBs) and enjoys the status of being a preferred brand for accounting in India. 94 percent of the product revenues of Tally Solutions are generated from India itself which is similar in the case of Polaris/Orbitech (90 percent domestic) or Infosys BBU (Finacle: 47 percent domestic). Most other companies like i-flex Solutions (5 percent domestic) still heavily depend on the global market.

The biggest hurdle in the Indian market is the fact that most solutions are not affordable for SMBs. So either they turn to open source solutions or to copyright infringement. Still the way business is done in India is very traditional and not only large businesses but SMBs are also family run with a thrifty mentality. Huge investments in IT are considered unnecessary. When IT is perceived as a necessity, the business relies heavily on pirated software. Software as a service (SaaS) is a potential solution. So far the SaaS market has dominated by the Salesforce.com and RightNow Technologies; companies that have stressed or focused on SFA (Sales Force Automation) and CRM .However with success of this concept, companies hopping on to the SaaS bandwagon are offering everything from ERP to collaboration tools from SCM to HRMS. The approval of the success of this model is evident from the fact that even a traditional software company like Oracle that gets most of its revenue from licensing is talking about the SaaS model of business .Gartner predicts that by 2010, around 30 percent of new license purchases (in APAC excluding Japan) will be in form of SaaS or delivered through this Model. If Indian companies come with less expensive solutions to cater to the domestic market it can dramatically boost the revenue of software companies because India is heavily dependent on foreign players as far as software products are concerned.

Future trends and tactics

The last decade was the decade of Indian software. India has been the leading offshore destination during the period and now accounts for 65 percent of the global industry in offshore development. Benefits of the global delivery model will induce more companies to outsource to India in the new decade. According to a McKinsey–NASSCOM report in 2005, the addressable market for global offshoring is $300 billion and so far we have realised only 10 percent of this market. While the addressable market is very big the realisation of this market depends on two things—global and domestic demand and the supply of resources (productivity and quality).

Indian companies will have to understand the changing demand patterns of the global market and build core competencies by any and all means necessary. In the next decade we will probably see Indian companies working with global players in joint ventures and negotiating terms as per their needs. The supply of competent resources primarily depends upon the Industry-Academic partnership and diversified training of personnel. Till now Indian companies have gained an advantage in the latter but the relationship with academic institutes is still in a nascent stages. Only the bigger players are connected with academic research and development projects and that also in a partial way. In the future we can expect a stronger relationship between the industry and academia, not only at the domestic level but also at the global level. The line between software and services continues to blur. The notion of SaaS and Hosted Application Management (HAM) services are well known and are proving to be quite disruptive to the software industry. These new models of software development and distribution have gathered momentum and customer mindshare in previous years and are expected to continue to do so in 2007. The Indian software industry has a bright opportunity to tap the market with its low cost, better quality solutions in this area. Indian software companies should develop competencies in these areas to tap the market as soon as possible.

Tier I cities in India (Mumbai, Bangalore etc) are already running out of resources. Companies will have to shift their operations to Tier II cities to gain a competitive advantage. Infrastructure is the biggest issue in tier II cities. It requires huge investments from government and private bodies. China has developed a huge amount of infrastructure to lure foreign players and it is currently getting more FDI than India. Public-Private partnership becomes the most important priority to tackle the growing competition from China and other countries. In the future we will see a number of SEZs and software parks in India but the concept of Tax Holidays for software companies is the most disputed topic in the political corridor nowadays. The software industry must deal with political and government bodies to enjoy significant tax benefits that are a major benefit to the industry over others. The involvement of the government in the development of software companies is becoming more essential over time.

Indian software companies are in a confident position in terms of going out to the US and Europe to acquire companies. Still a lot can be done in the European market. Developing countries should also be there in the list of Indian companies. If the market cannot be captured directly then the partnership model can be used to make a local presence in a new or underdeveloped market. In the future Indian software companies will have to compete on several fronts. Global IT services and consulting companies are expanding their operations in India. Accenture has built human capital of almost 50,000 employees in India alone to gain a significant cost advantage. More than 80000 employees of IBM global services are operating in the Asia-Pacific region. It is an alarming sign for the Indian software companies. They will have to move up the value chain and form joint ventures among themselves to deal with global giants.

Till now India is the preferred offshore destination due to its cost advantage. NASSCOM has predicted that Philippines, China, Malaysia, Mexico, Brazil, Poland, Hungary, Russia etc. are in a good position to compete with India. The Philippines is at par now with India as far as the labour cost in concerned ($13 per hour as compare to $12 per hour for India). Improvement in productivity is a must for the Indian software industry to sustain strategic benefits. Indian software companies will have to be one step ahead by increasing their presence in other low cost countries as the salaries in India are surging due to lack of skilled professionals and the entry of MNCs in the Indian market.

The first decade of IT services was dominated by labour arbitrage, the second decade by process improvement and this decade will be dominated by the creation of IP assets. The bigger players have a head start but the smaller players are far behind. The creation of huge IP assets will be the greatest challenge for the Indian software industry. IP assets will drive the future of the industry in the new decade but it requires a large amount of investment from any company. Even bigger players are hesitant to invest a large amount of money in building IP assets and this could turn out to be harmful to the Indian software industry in the long run. Another important area is consulting which is one of the most profitable areas and Indian companies stand far behind in comparison with global players here. In the future Indian companies must increase their revenue from consulting front to deal with the problem of linear growth.

Indian companies will have to do both: not demolish the business of development and maintenance which is still a cash cow and build an IP-driven business for the future.

Leading Indian companies are realising the necessity to reengineer themselves. They are investing enough now in terms of non-linear models though not as much as they should. Many of them are building infrastructure so that they can drive 8 to 10 percent productivity growth a year, and also 8 to 10 percent growth. That means that they need not scale up in terms of headcount. Successful implementation of this strategy depends on the increase of the number of people vis-à-vis revenue. Problem of growth without scalability is solved if a company raises its productivity by X percent without increasing its headcount or if the company is increasing its headcount by Y percent then certainly productivity should increase by more than Y percent to maintain sustainable growth. Indian companies are headed in the right direction with an average growth rate of 30 percent as compared to global players which are growing in the range of 10 to 12 percent annually. But the problem of scalability can be solved only when their will be a limit to the linear growth pattern. All the development which is visible to us is the effort of a couple of decades and the industry will require more time to mature. It all depends on the visionary leadership of the industry and where they want to land in the future—a successful industry which caters to the nation and its people effectively or an industry which is struggling to manage its internal infrastructure and resources to become more productive and effective to survive in ruthless competition.