A recent report looked at the finances of Indian computer software companies through an unusual lens, examining what these superbly successful businesses might look like minus a favourable exchange rate.
The results of First Global Securities Ltd’s study are quite shocking. If it weren’t for the 36% depreciation in the Indian currency in the past 11 years, the latest full-year profits of the top five Indian software services exporters would be lower by anywhere from 40% to two-thirds, the report shows.
The high net profit margins of Indian software companies, in a 19-27% range, are only possible because of a “currency subsidy,” First Global says. “Stripped of that, the business looks like a dog,” the firm said in its note.
Conjuring up scenarios of what might have been is always problematic. Economic conditions under which the rupee might have remained at 33 to the dollar would have been very different from the ones that prevailed in the year ended 31 March when, admittedly with some help from the central bank, the Indian currency averaged about 45. Who’s?to?know if in those changed circumstances, the homegrown software companies wouldn’t have pursued a different growth track?
Even so, the study does raise a pointed question about the viability of the business model, especially now when, following a 6.8% surge in the local currency in the last quarter, expectations of a sustained rupee rise are gaining ground.
Most Indian software exporters are looking at an increasingly disadvantageous exchange rate as their biggest long-term challenge. They’ve won a temporary reprieve thanks to the subprime-related seizures in the credit market and the attendant loss of appetite for emerging market currencies.
The exchange rate, at the end of last week, was 40.88 to the dollar. On 24 July, when the currency was at a nine-year high of 40.27, Azim Premji, chairman of Bangalore-based Wipro Ltd, India’s third biggest computer services provider, called the strengthening rupee a “coolant”. “It’ll hurt our competitive position globally in most export industries, and that’ll cool part of the domestic growth rate,” he said.
For now, the Indian economy seems to be surprisingly resilient to both a stronger currency and higher interest rates. An appreciating currency is a bigger challenge for Indian software vendors than the prospect of a marked slowdown in the US economy. A US recession, were one to occur, would be a problem in the short run and may even spawn new outsourcing opportunities as more American companies try to prune costs.
A long-term erosion of the cost advantage that lies at the very heart of outsourcing is a different matter altogether. At present, almost four-fifths of India’s annual $40 billion (Rs1.6 trillion) revenue from software and back office transaction processing comes from exports, with the US accounting for at least half the sales of the top companies. This leaves Indian vendors with a preponderance of dollar revenue and rupee-denominated expenditure. With white-collar salaries galloping in India, there’s little scope to control costs. The key challenge, therefore, is to find a way to rebalance the business portfolio, says Ed Cohen, who heads leadership development at Hyderabad-based Satyam Computer Services Ltd, India’s fourth largest software exporter.
The home market, too, is offering more opportunities. As economic growth creates capacity shortages across the Indian economy, the underdeveloped local market for technology sales is beginning to stir. Mumbai-based Tata Consultancy Services Ltd, the industry leader, last week bagged a $140 million contract from state-controlled telecommunications company Bharat Sanchar Nigam Ltd. Large outsourcing deals are also expected from Indian banks and railways. Even as outsourcing companies seek to cut their reliance on the US, they must seek to boost profitability of those sales. Infosys Technologies Ltd, India’s No. 2 exporter of software services, recently said it is raising prices for new customers and will seek to negotiate a 2% hike in existing contracts.
The other part of the game plan should be to turn down what Partha Iyengar, a vice-president at research firm Gartner Inc. in India, calls “$10-an-hour” work. That, too, is being tried. HCL Technologies Ltd, the fifth biggest computer services provider, has decided to concentrate on large, multiyear deals. Finally, there are strategies for the long term that must be set in motion now to lock clients into tighter relationships. Satyam is trying to boost its engagement with customers by sending leadership consultants to coach teams working onsite on key accounts. It plans to cover as many as 62 of its customers this year, encouraged by the success of a recent experiment at a General Electric Company unit in Atlanta, Cohen says.
Outsourcing may not be a dog yet. And if the leaders of India’s software companies react to the rising rupee in time, using the billions of dollars they accumulated to acquire brand names and technical competence, they might still be spared that dire fate. BLOOMBERG
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