Spring for India’s information technology industry?
A renewed sense of optimism is coursing through the industry, dispelling two years of gloom. Is the comeback for real or just a flash in the pan?
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Bangalore: An air of despondency was palpable in the Indian information technology (IT) sector after it ended the last fiscal year with the slowest pace of growth—10%—since the financial meltdown that followed the September 2008 collapse of Wall Street investment bank Lehman Brothers Holdings Inc.
The consensus among technology leaders and industry experts was that the years of 30-40% yearly revenue growth were history; expanding above 10% would be a quite a feat in a saturated marketplace, with North American clients having maxed out the amount of work they could send to India.
No company reflected this sense of gloom more than Infosys Ltd. Last October, while announcing the results for the three months ended 30 September 2012 (disappointing numbers and a lower guidance for the year), chief executive officer S.D. Shibulal blamed the company’s poor performance on the global economy.
Other companies in India’s $108 billion information technology sector fared no better.
In January, the Economist quoted data from consulting firm KPMG and Florida-based outsourcing advisory firm Hackett predicting that migration of technology services to India and other offshore locations would see a permanent slowdown from 2014 and stop completely by 2022.
Yet, exactly a year after Infosys’s woeful performance, a wave of rejuvenation seems to be surging through the Indian IT industry, with almost all top firms—with the exception of Wipro Ltd—reporting powerful double-digit revenue growth. US-based Cognizant Technology Solutions Corp., which traces its roots to India and has most of its workforce in the country, is yet to report results for the September quarter, but the company, which has in recent times emerged as the bellwether for the IT business, has already raised its forecast for the year.
The commentaries from the CEOs of the top four Indian IT companies have been different, but a common thread of understated confidence runs through them.
That confidence is backed by numbers: Infosys, TCS, HCL Technologies Ltd and Wipro, have all recorded an average 13% year-on-year growth in revenue—nearly twice the growth rate in the same period last year.
So, has demand from top North American clients really returned and can it be sustained?
Has Indian IT finally started achieving more non-linear growth (expanding revenue without workforce additions), the industry’s own elusive Holy Grail?
Or is the current performance just a flash in the pan?
Experts believe it is more the first two, and less the third.
Indian firms, experts say, have begun to register wins against large multinational rivals, offer services such as consulting, and are beginning to add revenue without adding as many people as they used to. All of these, the experts add, are early trends—which means the performance of the IT companies in the quarter ending 31 December merits close scrutiny.
Most experts attribute the turnaround performance of Indian firms to four factors.
“For the bulk of projects what is happening is that clients are saying, we need to get the Indian players in as well, along with the global giants. It’s not an issue for discussion any more,” says Partha Iyengar, vice-president and head of research, Gartner India. “Five years ago, we said we’ll stop talking about the offshore model. It’ll just become traditional sourcing—that has happened this year.”
This theory is backed by the numbers of IBM and Accenture. Both IBM and Accenture have struggled to generate revenue growth over the last few quarters, with Accenture predicting weak growth for the next quarter as well.
“The bulk of the growth of Cognizant and TCS are capturing is coming from traditional incumbents,” said Peter Schumacher, founder of Germany-based Value Leadership Group that advises companies on their European strategy. “So when you look at these firms, and compare how well they have been performing against the Indian firms, you will find that the Indian firms have done much better.”
Two, even as they have done this, other experts say, the Indian companies have started winning high-margin consulting deals—until recently the exclusive domain of their multinational rivals.
“You know, people are still saying, come support me with SAP or Oracle implementations; time and materials projects are still happening; that’s not going away; but Indian firms are increasingly adding value in strategic areas, where co-creation and co-innovation is required,” said R. “Ray” Wang, founder of enterprise research firm Constellation Research Inc.
Three, demand has returned in the US and Europe, with top clients begining to spend more on technology even as the economy looks up. According to outsourcing advisory ISG, top outsourcing clients across the world gave out $6 billion worth of business this quarter to top global and Indian IT firms, the highest total contract value ever recorded in a single quarter.
“One of the things commented on by both Infosys and TCS is momentum in continental Europe. However, I think this is secondary in importance to the increasing demand in the US, which continues to dominate the revenue of all players. For Indian firms it’s a case of ‘you make it there you make it anywhere,’” said Phil Fersht, founder and chief executive of outsourcing advisory firm HfS Research.
Four, Indian IT firms are starting to add revenue with fewer employees than they did before—an indication that they are making the shift towards non-linear growth and improving revenue productivity by investing more in technologies such as automation. According to figures provided by industry lobby Nasscom, the Indian IT industry needed about 26,000 people to earn $1 billion of revenue for the 2012-13 fiscal year, compared to about 38,000 in 2003.
“We have definitely seen evidence of some providers beginning to delineate headcount increases from growth, with TCS and Cognizant as examples of how to rely on more then currency deflation to maintain profitability. Advancements in process automation are beginning to reap benefits in actual hard savings for providers,” said Fersht.
To be sure, Indian software firms are not reporting the 30-40% growth rates they witnessed a few years ago, and probably never will again.
Still, if the trend seen in the June and September quarters keeps up, they will grow at double-digit rates.
Indian IT traces its roots back to the 1960s, when Faqir Chand Kohli—widely regarded as the father of India’s software industry—helped get a fledgling IT services company with less than $10,000 in yearly revenue off the ground.
The wheels were set in motion when TCS won a contract from US-based computer maker Burroughs Corp. to develop a healthcare software package for the company. After Kohli and his team of programmers successfully delivered the project, Burroughs became its first major regular overseas client and TCS never looked back after that.
The birth of TCS spawned an entire generation of technology start-ups in India, including Infosys (founded in 1981).
In 1985, Texas Instruments Inc. opened its first development centre in Bangalore, proving that software for its global operations could be written in India.
The telecommunications boom of the 1980s and the 1990s helped trigger the rise of India’s outsourcing industry.
Infosys, in particular, set the tone for the rest of the industry to follow, building plush American-style campuses to attract global customers and house and train thousands of fresh-out-of-college engineering graduates.
Thus was born the global delivery model where teams of engineers could execute a technology project sitting anywhere in the world. The model involved hiring engineers for specific time-bound projects, with revenue generated from such projects directly linked to headcount and the time taken to execute the project. So, to earn every billion dollar of revenue, top firms such as TCS and Infosys would hire 30,000-40,000 engineers, billing clients based on the number of hours spent on a particular project by the engineers.
But it wasn’t until the Y2K boom and the advent of business process outsourcing—export of tasks such as voice-based customer care and insurance claims—in the 2000s that the floodgates really opened and Indian IT entered the big league. Young engineers from top and mid-tier firms were tasked to resolve the issue of the millennium bug that had caused havoc across computing systems across the world.
Those were the days when the sector witnessed 30-40% growth, sometimes more, with Indian software firms gradually starting to take on more complex development, testing and consulting projects, in the process grabbing market share from global giants such as IBM and Accenture.
Such was the success of the low-cost so-called global delivery model of Indian IT companies that western outsourcing companies rushed to replicate the model, expanding their base in India and hiring hundreds of thousands of engineering graduates.
The honeymoon days of 30%-plus profit margins continued till the collapse of Lehman Brothers in 2008, although there was a brief blip in 1999-2000 when the dotcom bubble burst.
Soon after, 10-15% growth (if that) became the new normal. Clients such as Bank of America Corp. and Target Corp. started opting for pay-as-you-go pricing models, which avoided high upfront investments in outsourcing projects—the bread and butter of Indian IT.
Experts also raised concerns that top American and European clients had already outsourced most of the routine application development and maintenance work and claimed the industry was facing an irreversible saturation point that would lead to stagnating growth rates and falling profit margins, unless firms took up more complex, high-margin projects.
Which is why the September quarter means so much to the companies and analysts.
Still, even as top software firms bask in the glory of the September quarter, much could still go wrong.
The future success of companies such as TCS and Infosys will rest largely on their ability to not just snatch market share away from traditional global incumbents such as IBM, Cap Gemini and Acccenture, but also to figure out what could be the Y2K boom of the 2010s and 2020s.
“In order to continue their rapid growth, Indian firms will need to take more share from these incumbents. This is where the next $10 billion revenue are for (companies such as ) TCS,” said Schumacher of Value Leadership Group.
Experts also warn about Indian IT’s over-reliance on North America.
“Relying predominantly on the US is not going to fuel double-digit growth forever; companies need to look further afield to continue their trajectory,” said Fersht of HfS Research.
And most companies have to invest in sales and marketing.
“I think it’s important for Indian players to get out of their traditional techie-centric mindsets and become savvier in sales and marketing,” said Iyengar of Gartner. “And some, more than others, really need to de-centralize decision-making.” He cited the example of Accenture, where mid-level project managers have been vested with decision-making powers.
The threat of automation looms large and companies such as IPSoft Inc. are threatening to make a large portion of India’s engineering workforce redundant, with the company using software robots to replace engineers at client sites and delivering outsourcing projects at a fraction of the time it takes a human engineer at about one-fourth the cost. Indian companies, still dependant on linear growth models, look bloated in comparison.
“We have a tiger by the tail. It is the responsibility of thought leaders in India to proactively start moulding their workforce towards the new order that is emerging,” said Chetan Dube, chief executive of IPSoft in a recent interview.
To avoid losing business, Infosys and Cognizant have signed revenue-sharing agreements with IPSoft.
Meanwhile, firms such as Google Inc., Amazon Web Services Inc. and Salesforce.com Inc. provide competition in an arena where Indian IT firms still don’t have much of a presence—cloud computing. These companies host the IT infrastructure of large and small businesses in their own data centres, reducing costs of clients by more than 40%.
Even General Electric Co., once one of the largest clients of companies such as Infosys and TCS, is now more of a competitor, selling next-generation software platforms for airlines and power firms and making gigantic strides in the arena of Big Data and analytics.
Indian IT firms have just enjoyed its best quarter in a little over two years. Whether this run of fortune will last isn’t just a function of the environment, but also the courage, ability and willingness of the companies to take difficult decisions on people, technology, and markets.