Indian software companies, which compete furiously with each other for global outsourcing deals, are now facing a common enemy in the rising rupee.
Infosys Technologies Ltd, India’s second largest computer-services provider, last week pared its full-year sales and profit estimates. A strengthening home currency is reducing the rupee value of its dollar revenues and earnings.
Tata Consultancy Services Ltd, Infosys’s bigger rival, this week reported that its profit margin was hurt by 2.6 percentage points in the three months ended 30 June by, among other things, a 7% appreciation in the rupee against the dollar, the biggest quarterly gain in more than three decades.
The company said it managed to “largely offset” the impact on net income by hedging its revenue against an increase in the rupee’s value.
Although the day-to-day volatility in the exchange rate has abated since end April, the challenge of long-term competitiveness remains for Indian exporters. As the Indian economy expands 9% a year, soaking in larger amounts of overseas capital, the real effective exchange rate of the rupee is bound to rise.
Since inflation tolerance in India is low, much of this adjustment will occur through an appreciation in the nominal currency value. The central bank will try to hold the rupee down when it can afford to loosen monetary conditions at home. It would be less willing to protect a competitive exchange rate when doing so could lead to overheating.
All is not lost for software exporters. The economics of outsourcing are still in their favour. Partha Iyengar, vice-president at research firm Gartner Inc. in India, has a blueprint that Indian firms can use to mitigate cost pressures. Their first task should be to walk away from simple code-writing and testing—the “$10 (Rs404)-an-hour” work that Iyengar estimates still makes up 55-65% of the revenue generated by top Indian software exporters. Replacing low-end tasks with better-paying work is an obvious route to boosting revenue per employee. But competing for such assignments against an IBM or an Accenture Ltd won’t be easy.
Capabilities need to be created, or acquired. The best place to build those muscles, Iyengar says, is in the domestic market, in which local firms have shown very little interest. Out of the several large outsourcing deals from India in the past several years, few have gone to Indian companies.
In March 2004, IBM won a $750 million order from Bharti Tele-Ventures Ltd, an Indian mobile phone service provider.
Around the same time, Dabur India Ltd, a maker of toothpaste and health supplements, asked Accenture to manage its computer systems. A 10-year, $150 million order from the state-owned Bank of India went to Hewlett-Packard Co. “If you’re being beaten in your own backyard, you can’t chase large global deals,” Iyengar said in an interview last week in Singapore. “Those clients will say, ‘we don’t believe you have what it takes; you haven’t demonstrated it’.”
Meanwhile, IBM and Accenture are expanding in India, hiring the same programming talent as their homegrown rivals. Unlike the latter, however, they also have a larger pool of business consultants, people who understand clients’ needs. “It won’t take an IBM six months to line up a supply-chain specialist to go talk to the board of directors of a prospective client,” Iyengar said.
To stake a credible claim for, say, a $2 billion global outsourcing order, Indian firms must first show their ability to execute large projects at home, said Iyengar. This reality is still not widely understood. At Infosys, revenue generated within the Indian market is just 2.4% of North American sales. The neglect of the home market was a logical thing to do when it was small, dominated by government orders.
Now, when some of the fastest growing companies in the world are in India, the apathy is strange. In the current fiscal, which will end in March 2008, the domestic software and services industry is expected to grow 22% to $10 billion in revenue. Sure, exports will be three times as large. That, however, is no excuse to ignore the home turf anymore.
From retail and transportation to hospitality, banking, insurance and telecommunications, there are many domestic businesses in which Indian companies are scaling up at a breakneck speed to meet burgeoning demand.
These are also businesses that are most likely to place large outsourcing orders. When Bharti Airtel Ltd, as the company is now called, placed its order with IBM, it had 7 million mobile phone subscribers. Now it has 43 million. Had an Indian outsourcing company won the chance to meet the company’s information technology (IT) requirements during this explosive growth, it could have leveraged that experience to seek deals from Vodafone Group Plc. or Sprint Nextel Corp. The same is true now for retail.
Mumbai-based Reliance Industries Ltd, which began setting up supermarkets last year, intends to make it a $25 billion business by 2011. According to media reports, it’s going to spend at least $250 million on technology. State-controlled Indian Railways will invest $1.5 billion in IT over the next five years.
These local growth engines offer learning opportunities. Indian outsourcing companies must tap them if they want to go beyond being low-cost service providers. Apart from its other advantages, local, rupee-denominated revenue will also serve as a natural currency hedge. For that benefit alone, Indian companies should look more closely at the business in their own backyard.
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