The Indian IT industry has witnessed an exceptional growth over the last two decades, led by the 1990s, when companies were notching up 50-100% growth rates. Such was the momentum that even the dot-com bust of the early 2000 and the global economic slowdown only marginally impacted growth, keeping it above the 30% mark. The excellent performance was in large part due to the vast talent pool harnessed by industry leaders and their investments in process capability.
The global delivery model, created as a result, was a disruptive innovation enabling the industry to comfortably ride the economic downturn of the early 2000. The model is now being universally adopted, leading to commoditization of traditional IT services around vanilla technologies. Companies are differentiating their services by moving up the value chain and acquiring domain capabilities.
Seeing the rapid acceptance of the lower-cost offshoring model, global multinational consulting firms have dramatically scaled up their presence in India. From less than 10,000 people in 2002, the top six global consulting firms now account for a headcount of more than 150,000. This rapid growth and our own success in scaling business have put huge pressure on sourcing and retaining quality talent. As a result, wages are increasing, adding to the overall cost of doing business.
Strong and steady growth in the domestic economy is moving global capital to the country and making the rupee stronger. Between January and December 2007, the rupee appreciated 11% vis-à-vis the dollar, dramatically impacting margins of the predominantly export-driven software and services firms. And the rupee is likely to continue to rise.
The twin challenges of the appreciating rupee and rising cost structures are accelerating the search for non-linear business models, where revenue expansion does not imply a proportionate headcount increase. The industry is exploring new services for exploiting the offshore potential, building Internet Protocol (IP)-based software assets that can be customized to rapidly deliver solutions, or simply creating innovative commercial models that shift the terms of engagement away from headcount. As I had mentioned at a recent Nasscom meet, three non-linear business options are promising.
1) Managed services: Services around applications, development and maintenance (ADM) were the first to be offshored. According to a 2006 Nasscom-McKinsey study, this is a $35 billion opportunity. It indicates that offshore services around IT operations represent a $75-$80 billion market. While more than 30% of the ADM offshoring opportunity has been penetrated, the field of IT operations is wide open for Indian IT services players.
IT infrastructure has traditionally not been offshored largely because of inadequate communications infrastructure, high perceived risks and limited automation tools. These notions are beginning to disappear.
The remote infrastructure management services segment is growing rapidly, with large organizations providing a complete end-to-end solutions portfolio. This market, incidentally, is not just for big players. Mid-sized organizations, too, have established their presence in it. Global research body Forrester in its report, Smaller India-Based Infrastructure Providers Can Be The Right Size For The Right Clients, has showcased a clutch of smaller organizations building successful models in this space.
Managed services segment encompasses both infrastructure and applications. It optimizes the complete user experience. The essence of contracts is the service levels to be maintained and not headcount. The segment thus offers long and stable non-linear revenue streams.
2) IP asset-based services: Delivering solutions around IP assets (frameworks, reusable components, and productized services) is a powerful service differentiator and a significant margin lever. Implementing such solutions requires significant customization—a strength of Indian services providers. Contracts can include both licensing and services components, with support revenue streams, making it another good non-linear option.
Compared with the pure-play products business, IP asset-based solutions will be easier for the industry to adopt. Large players are investing in this capability although revenue streams currently are a small part of their business. Smaller players are taking the inorganic route to acquire such IP assets.
3) Software as a service (Saas): The philosophy behind Saas rests on the concept of positioning an application as a set of services as opposed to a licence. The customer is charged for usage rather than outright ownership. Recently, enterprise solutions?giant SAP?announced its “Business by Design”?programme in the US, where it will offer its applications at a charge per user per month, which is a path-breaking development in the packaged software world. Saas by its very definition is non-linear, since revenues are linked to usage and the transactions performed. Being a relatively new concept, it’s too early for market sizing but it remains one of the most promising disruptive approaches to delivering IT solutions.
The global delivery model that emerged from India has changed the way IT services are delivered. The industry, in essence, redefined software development by converting the art form of programming into an engineering discipline. The industry has benefited from the early-mover advantage of adopting this innovative process. However, with increased global presence offshore and a challenging environment, Indian IT services providers will need to transform with newer services.
In the short term, firms will build domain and front-end capabilities to supplement their technology competence, and compete effectively, as they continue to extract efficiency through measures such as price increases, improved offshore mix and managing the experience profile in delivery teams.
Over the long term, the industry will require growth engines to be created around non-linear services. Some of these will need upfront investments, which will take a toll on margins in the near term. Given the environmental challenges, these will be essential to sustain growth in the long term.
Arvind Thakur is CEO, NIIT Technologies Ltd. Comments are welcome at email@example.com