Shades of domestic outsourcing

The domestic outsourcing market in India encompasses everything from the $200 million mega deal to the mid-sized ones that total $15 to 20 million. Prashant L. Rao traces the pattern that this market is taking

According to Nasscom, Domestic IT-BPO revenues are expected to grow at almost 8.5% to reach Rs. 1,088 billion in FY2010. Domestic IT services are expected to grow by 12% in FY2010. According to Jens Butler, Principal Analyst, IT Services and Sourcing Asia Pacific, Ovum, “The total domestic market size is about $11.3 billion with growth expected to be above 26% over the next three years. This is split between Apps, Infrastructure and Business Process Outsourcing with Apps and Project Management services being the largest proportion of the market.”

In the past couple of years, the biggest spender on IT has been the government. While telecom and banking accounted for the large deals that made the headlines, it was the government that stepped up to the plate and kept domestic IT ticking over at a healthy rate. As Sujit Mohanty, head, Sonata Information Technology Limited (SITL) - the Indian division of Sonata Software Limited, Sonata, put it, “If you look at the past three years, all of us survived because of government spending. Even today, be it UID or transport ticketing—for most IT vendors, 50% of the RFP response is to the government. For Sonata, there are a lot of deals—small and medium—with the government. While, on the one hand, there are the highly publicized deals, at the same time, every department, ministry or PSU has lots of maintenance and small developments of up to Rs. 1 crore. This is the limit up to which they can avoid the tendering process and we operate in that segment. It's a huge segment. If you take out the top six or eight vendors, most of the others get their government business from that. We don't see that this is going to come down in the next two-three years as maintenance contracts run for a minimum of three years.”

Domestic outsourcing in India has grown considerably from the early days when the domestic market was seen as the poor cousin of the lucrative US market. Anurag Mehrotra, Vice-President & Head, Client Relationship Group, India, Middle East and Africa, Wipro, said, “In the last ten years, the market has transformed itself. In the late 1990s or early 2000s, the focus was on boosting internal efficiencies. That has become par for the course across segments and it involves solutions such as ERP, Core Banking, OSS/BSS etc. Today, IT investments are focused upon gaining a competitive advantage. Ten years back, a lot of stuff was done in-house. As the focus shifted, nowadays, IT is no longer seen as a core competence to be developed within your organization. One type of outsourcing is around sustenance in order to keep the lights on; that's outsourcing for sustenance and maintenance. The second type is that of transformational outsourcing where the customer gives the contract to a vendor. Here the latter's also responsible for technology transformation and the changing needs of the business. Sustenance outsourcing is six to seven years old. Transformational outsourcing has become prevalent in the last two-three years.”

Wipro defines a outsourcing deal as one where a long-term contract includes two or three lines of business within the company. “If a customer gives me infrastructure and application sustenance as part of a long-term contract, then it is an outsourcing deal. It could be about outsourced infrastructure also. I don't count regular managed IT services as IT outsourcing. As per IDC estimates, this market is in the region of $1.6 to 1.9 billion per year (this includes infrastructure and not just services),” he added.

Gitanjali Puri, Director, Marketing and Communications, CSC, India, commented, “The domestic demand for IT services is growing faster than the export market and represents a sizable opportunity for IT services and IT product vendors.” She pointed out that while the export market, due to the economic downturn, grew just at 5% during the past two years, the domestic market grew much faster by 18% in the previous year. The contribution from captive centers of MNCs forms a significant part of the landscape. The domestic total outsourcing market has witnessed a CAGR of over 60% in last three years. As per an analyst firm, the domestic IT services market will be worth $13.6 billion by 2014.

Everest Research Institute's data indicates that India accounts for as little as 5% of the outsourcing deals on a global scale. Having said that, a lot of deals in India are small—by the standards of the mammoth deals that get all the ink in the financial papers—but together, they add up to quite a substantial amount. What's interesting about the domestic outsourcing market is that the bulk of the deals are IT deals and not BPO—only one in eight deals is BPO-related. Government and BFSI account for the lion's share of the deals followed by Energy & Utilities. Other verticals including manufacturing, telecom, healthcare, services, etc. altogether account for less than either Government or BFSI by itself.

“The domestic outsourcing market is maturing fast. There has always been a lot of talk about the potential of domestic outsourcing. Over the last year or so, we have seen the evidence of this potential,” commented Amneet Singh, Vice President - Global Sourcing, Everest Research Institute.

Persistent Systems specializes in undertaking OPD. Nitin Kulkarni, Chief Operating Officer, Persistent Systems, said, “We feel that the domestic market is at a stage where there's no legacy involved. Indian customers are more innovative than those outside. Their acceptance of a product-driven solution is higher. We work with ISVs across the board from small to large. A lot of SMBs are interested in bringing their product to India and we see ourselves as a good enabler for this.”

Sumit Sood, VP Middle East & Asia, Virtusa, said, “In the Western world they didn't have a lot of choices in terms of robust IT systems and, therefore, firms had to make redundant investments in IT systems that they didn't really need. A lot of them spun out the IP—the airline system, IATA, is owned by Delta etc. Indian enterprises have started hitting scale and there are a lot of options available to them where they can procure solutions rather than build them.” Today, Indian companies haven't really started to use IT as a strong business differentiator. IT is just another operating department with the CIO reporting to the CFO. Outside IT, only a handful of Indian MNCs such as ONGC, Aditya Birla or the Tatas are becoming major global players. “As their scale of operations grows, you will see more IT outsourcing in the Indian context. From SMBs and large enterprises to global players that journey will define how the Indian outsourcing industry evolves,” he added.

A lot of the MNC players—Deustche Bank and Vodafone etc.—are bringing in systems that they use elsewhere. Citibank uses the same core banking system that it uses in other countries. “This market is a significant one for MNCs. The local subsidiaries are saying that 'we need more control over our IT systems' and they are breaking away from global diktats to tap this market,” added Sood. When it comes to MNC captive centers that are serving overseas needs but operating out of India, there are two extremes—one being 'I'll do everything on my own and bring in flex capacity from vendors' while the other extreme is to just do program management and leave the day-to-day execution of IT to suppliers and vendors.

The market is humongous. “It runs into billions. Government spending is a huge driver here. As government departments and PSUs are starting to operate as businesses,” stated Sood citing UID, a project that not only identifies everyone in the country but also builds a business model to recover the cost of issuing these IDs. As the government focuses on law and order, IP etc. that's going to be a huge initiative. “It is close to the largest segment in the domestic outsourcing pie,” he said.

Virtusa started focusing on the domestic market during the last 18 to 24 months. “We have grown fairly significantly. It is the fastest growing segment in the organization currently and accounts for 5% of the top line. The domestic market is a strong focus area for us and we continue to increase our investments. We haven't fully tapped into government opportunities. Being a US firm, we are working through some of the regulations that apply,” commented Sood.

Interestingly, Indian enterprises are willing to pay Western money for the right value. “We have negotiations with customers, which are at par with what a US or European firm would pay,” said Sood.

Sonata plays in the domestic market in two areas namely software assets and services. When it comes to the software assets business, Mohanty pointed out, “Nobody buys an Office suite just for the sake of buying it. The cost of acquisition is so high that customers are looking at RoI. This becomes almost part of your infrastructure services. It's a major share of the revenue for any software major. In the case of applications and pure-play services, it's about Oracle ERP or Microsoft CRM or SCM. Here we are talking about product implementation services and core development on .Net or Java.”

Deal sizes

“The average deal size has been in the realm of $48 million (down from about $65 million in 2009) with an average contract length of just above four years (which has dropped from last year, when it was closer to five years),” commented Butler.

“Deals in India have historically accounted for about 5% of global outsourcing market volume. Since 2009, they have remained pretty consistently in the range of 5-6%,” added Singh explaining that the reason for increased interest was that the Western markets were affected by the downturn and, as a result, service providers had diversified some of their business from these markets to India. The other driver is that Indian companies are globalizing rapidly and they need to compete with bigger companies across the globe and, in order to be successful at this, they need to access best practices and innovative solutions through IT. The government and public sector is probably the largest segment in terms of IT spend and as the government at the center/state levels starts to focus on improving public services, it will need to make the requisite investments in IT. Projects such as UID lead to a lot of business for service providers.

“The majority of the domestic outsourcing business is catered to by Indian players although MNCs such as IBM and Accenture have also started focusing on this market. They have a 20-30% share whereas the rest is with the Indian companies. Not all of the top five Indian software services providers have had equal success in the domestic outsourcing market. Wipro, TCS and HCL to some extent have succeeded. Infosys and Cognizant haven't really achieved much in the Indian market. Part of it could be due to lack of focus. If you go by their announced intent, these players have said that they want to grow in India but they haven't succeeded in doing that. When it comes to tier 2 providers, they account for a fragmented but sizable portion of the global as well as the domestic outsourcing market,” he added.

Puri commented that, “The average deal size in the domestic market is low with few high value deals occurring. The Total Contract Values (TCV) for IT outsourcing in India varies from approximately $75-100 million.” The good news, however, is that customers are slowly moving up deal sizes and bundling application and infrastructure outsourcing needs, which requires that suppliers possess end-to-end capabilities. The length of the total outsourcing engagements is decreasing—from an average length of 8.6 years in 2005-06, the length of contracts in 2009-10 has risen to 7.6 years.

“Deal size is rising. From a point where you would get to talk about opportunities where a crore was a large number to a stage where people don't blink about Rs. 5-10 crore deals. It is psychological. With large deals such as the IBM-Jet Airways deal for Rs. 250 crores being announced, people are used to hearing about larger deals and they are not afraid of spending. Having said that, Indian CIOs maintain a tight rein on spending,” said Sood.

“The typical deal size in OPD is about $500,000 involving 15-20 people. OPD is more sticky than most people think it is. You have the first deal for version one of the product followed by version two, three and so on. Most of our customers have been with us for quite a long time,” said Kulkarni.

Mohanty, commented, “In today's market, on the assets side, Rs. 50-60 lakhs is normal. There's a huge SMB market where deal sizes range from Rs. 10-20 lakhs. In the enterprise market deals amounting to Rs. 2-3 crores are common. The average deal size is around Rs. 60 lakhs. For ERP it works out to Rs. 80 lakhs plus. For SMBs, ERP deals work out to about Rs. 25 lakhs. On the apps and services side, the market took off four to five years back. If you look at the top 300-400 IT savvy customers they deployed apps eight or nine years back. At that time an average deal was Rs. 7-10 lakhs and an ERP deal was around Rs. 15-20 lakhs. Today, in IT services, the standard deal size is Rs. 40-60 lakhs. In the case of companies that have been availing of these services for the past three to four years, the average deal size works out to Rs. 80 lakhs to 1 crore. If you look at PSUs, their pending tenders are all for Rs. 1 crore plus. Enterprises that had gone in for ERP systems 10 years back are now going in for an upgrade and spending Rs. 50-60 lakhs on the same.”

Kinds of deals prevalent in the market

Puri said, “Infrastructure projects are slowly beginning to gain traction, driven by the need for rapid expansion. The market is seeing increased investments in unified communications (UC), virtualization, open source software, green IT and cloud services. There is greater focus on projects and packaged software implementation as opposed to application development and maintenance projects. The nature of contracts within the domestic IT outsourcing market has shifted to outcome-based versus fixed price, service fee, and/or T&M based projects due to a greater focus on business growth and new product/service line additions.”

Butler said, “A large proportion of deals are partial/selective with splits amongst providers for some of the larger engagements (such as UID), but the mix is not just simply an apps development piece; it is becoming more mixed with apps management, BPO and network management, for example.” Telecom has been a big spending sector (Bharti being the standout) and the banking sector has arisen from its slumber with a number of smaller deals.

Wipro is a large company in the context of the domestic market. “We have crossed the $1 billion mark and have end-to-end capability. We focus on the higher end of the market, on the top thousand accounts in the country. We have broken these into three categories: the 84 top accounts, the enterprise 500 and the mid-market which consists of the remainder. Today, about a third of our domestic business comes from each of these three categories. We want the top end to become a larger part of the pie. Some total outsourcing deals won by Wipro include Uninor and Aircel—in both cases the complete IT infrastructure has been outsourced to Wipro including transformation. In the case of the RRBs of nationalized banks, we have won three or four deals including UCO Bank. This is again a transformational outsourcing deal to implement and sustain the core banking system over time. As an example of sustenance outsourcing, we have a JV with Delhi International Airport with the mandate to run the IT operations at the T2 and T3 terminals. HDFC Bank was another example of sustenance outsourcing,” said Mehrotra.

Sood said, “There are two broad buckets namely the management of data center infrastructure and the management of apps and solutions. In the case of data center infrastructure, you encounter more end-to-end deals. These involve a large Indian SI managing the entire infrastructure of a large enterprise. On the applications side of things there is a tendency to do things in-house. As the scale of the enterprises increases, they would need to bring specialists who have knowledge from a global enterprise environment. Today, they still have a hundred people on the IT staff. That will not change in twelve months. From a long-term perspective, however, this change has to happen.”

Mohanty singled out telecom and banking as the two verticals where the maximum outsourcing action was taking place. “In telecom it is about the cost of maintaining and building fresh infrastructure. Almost all the telcos have gone in for total outsourcing. In the banking segment, banks are getting into B & C class cities and they need the help of software-services players to do that,” he said.

Trends in domestic outsourcing

Puri commented, “The domestic market is witnessing high demand in various industries including banking, telecommunications, government, insurance and utilities. According to a well known analyst firm, the Indian financial services industry is the largest driver of IT services demand contributing to 24% of the market. This is followed closely by the public sector at 21%. Manufacturing comes in third at 17%. The government remains the sector to watch with large scale e-governance projects; however, these projects are still in the early stages and the opportunity differs from enterprise projects in terms of the revenue model, the decision cycles as well as the implementation and collection cycles.”

Mehrotra pointed out that the opportunity in telecom over the next few years was going to be huge. The next big wave here is going to be around networks. Technologically all networks are moving towards IP and there's a huge transformation from a technology perspective. All operators will look for an SI to run their networks. What we have seen so far is only the IT outsourcing part.

“Banking outsourcing opportunities will not be big bang like what we saw in telecom. Banks have various partners who do activities for them. They will move to a scenario where they would like to consolidate everything under a single partner and convert these contracts into outsourcing contracts,” he added.

Insurance is also expected to witness considerable activity. The only concern is that the regulator is coming up with guidelines on outsourcing and that the draft guidelines will make even IT management outsourcing difficult. “The potential is high, however, because the regulator has changed the rules of the game and all insurers have to become asset light. Traditionally, they used to conduct business through agents. Today, the IRDA has made it unattractive to be an agent. With transparency coming in, their ability to make money will be impaired and one way out would be to make assets light by outsourcing,” commented Mehrotra.

“UID keeps floating tenders and there's a big drive for doing field work and we have won quite a few deals for that. Every district will have a requirement for field work and it is a big opportunity for everybody,” he added.

“Indian companies give us a lot of business and we tend to focus more on them as all the decision making happens locally. Large MNCs necessarily follow the guidelines laid down by their head offices and, even if you have a great idea, it won't go through their system,” said Mehrotra.

The driver for outsourcing for SMBs is going to be quite different from that for larger accounts. Their ability to invest on IT is limited. “It's a question of whether you can spend all that's required to get things done. The second thing is going to be their ability to attract talent and to manage IT by themselves. Our strategy for SMBs is to offer Cloud solutions to them. We have an ERP on the Cloud. There are some industry-specific solutions that we are putting on the Cloud. We also have Microsoft solutions in the Cloud and are looking at how we can offer SAP on the Cloud,” he added.

“The Indian business has a lot of products thrown in whereas internationally we don't do products. The growth of the services business in India is comparable to that abroad. The slowdown has had an impact but we have figured out ways and mean to mitigate that impact. In India, you have to have a solid value proposition. Internationally, to begin with, it was about cost arbitrage. It's taken us 30 years to reach a billion dollars in India,” he concluded.

From Virtusa's standpoint, BFSI is the fastest growing vertical. This also happens to be a highly regulated sector and recent regulations that the IRDA has rolled out have put a huge strain on insurers. “When somebody buys a policy you can't allocate over 20% to OPEX. The same thing is happening on the banking side as well with regulatory reporting etc. creating those mandates. Telecom, in India, is leading the revolution in terms of VAS and what you can do on your phone. I don't see a cut down happening here. For telcos, it's about capturing market share. Media & entertainment is a sector that can do with a lot more of spending on things such as DRM and monetizing assets. We are seeing the initial forays in this sector to figure out how they can tap into additional revenue opportunities by exposing their assets to a larger, global audience and the kind of IT investments that they need to make in order do that,” commented Sood.

“If you look at it from a long-term perspective, India's population is getting younger and the consumer base will grow. These people will have an entirely different set of expectations,” added Sood. “BFSI is the vertical that's contributing the most to our business. We foresee that this vertical will continue to contribute significantly in the days ahead.”

Mohanty's take was that, “Manufacturing is the one to watch as India's success story of 9% growth is due to this sector.”

Ananth Padmanabhan, Head - Services Business, Sonata Information Technology Limited, stated, “The mid-market is growing significantly. Organizations that were small have grown into largish mid-market companies that need ERP etc.” Sonata defines mid-market as 'take out the top 700-800 companies and everything left falls into the mid-market'.

The company has seen its software licenses business grow by 15% versus 12-15% for the overall market that also includes players such as Redington and Ingram. In pure play services, the market has been growing by 30-40%; Sonata grew 108% in this area last year.

And in the end

There's no doubt that this is going to be India's decade to shine as a market. The US is mired in a stubborn recession and while Indian software services companies can always attempt to carve out a bigger slices of a stagnant market, sentiment is building up in the US against outsourcing—be it to an Indian company or to the Indian subsidiary of a US company. The obvious solution, particularly in the backdrop of India's continuing strong growth, is to focus on the domestic market, which is what the smarter players are doing.

prashant.rao@expressindia.com