Thursday, October 18, 2007

Is the Indian IT revolution Over?

Rising Rupee, Prospect of losing income tax holiday, Slowing US economy and the Sub-prime mortgage crisis et al, has taken a toll on the Indian IT sector. Indian IT Giant Infosys is now projecting a moderate revenue growth of 35%. While TCS reported the slowest new growth in last 7 quarters - with net income growth of only 26%.

It is clear that the tough business environment challenges are putting breaks on the rapid growth of Indian IT companies.

Accordingly, the stock markets have punished them. In the recent rally of BSE Sensex, the IT companies are no longer the darlings of the investors. The lack of investor confidence is showing through sagging stock prices. Stock prices of TCS, Infosys, Wipro, HCL, Satyam have all trailed the BSE Sensex.

Does all this mean that the Indian IT revolution is Over?

The answer is both "Yes" & "No".

Yes! The markets have changed

Yes - the era of revolutionary growth of 50%-100% year-on-year growth is over. From now on growth in revenue & profitability will be a major challenge, one that requires bold innovative management. Increasing competition from the global giants will see that Indian IT companies lose some accounts to Global majors.

Yes - the growth revolution is definitely over for small & mid sized Indian IT companies, especially those companies which offer run-of-the mill IT services. Companies such as Patni, Polaris, Aztec, ITC Infotech 3i-Infotech, L&T Infotech, iGate etc will find it harder to compete and some of them will even see a drop in revenue.

No! The growth Story continues

No - the growth story will continue. Indian IT companies will now make a steady march to become the top-10 IT companies in the world. Albeit at a slower pace.

Think of this situation as that of a mountaineer climbing a mountain. Till some stage, one can make a rapid progress, and then comes a point where the progress is slow and painstaking. Only the fit will be able to climb on further towards the summit. In the Indian IT context, only the best IT companies will now be able to grow - while others will falter. Companies which have a strong leadership, a bold vision and deep capability will be able to grow and reach the new heights.

No - The long term market conditions are still favorable to Indian IT companies. The overall global economy is showing a healthy growth. Asia, Europe and Latin America is experiencing very strong growth. Even the US economy is growing - albeit at a slower pace. Intel & IBM recently announced better than expected results - which is a string indication of growth in IT sector. This growth implies that there is a strong demand for IT services. The only question that remains is:

"Who will provide the required IT services?"
"Can Indian IT Companies tap into this growth opportunity?"

Added to the global growth in demand for IT & IT related services, the changing demographics of the US & European population shows a strong promise for the future of Indian IT companies. With an aging US & European population and ever tightening immigration laws means that more work has to be off shored to India or other places.

Thus, in short, the long term prospects for Indian IT companies looks good. The only question that remains is that: "Can Indian IT companies tap into this opportunity?"

What can Indian companies do?

Changing business environment calls for changing strategies as well. What worked in the last several years may not work in the future. Indian IT companies must therefore adapt to the changing situation - and take advantage of it. To begin with, some of the strategies Indian IT companies can adapt are:

Take advantage of the stronger Rupee & Go for Major Acquisitions
Take advantage of the stronger Rupee & go for expansion abroad
Take advantage of the huge human talent available & go for niche markets
Take advantage of Asian growth & Go after Asian markets
Build deeper relationships with customers

Play the Merger & Acquisition Game

Mergers & Acquisitions seems to be the flavor of the month. But I am not suggesting that Indian IT companies to opt for acquisitions just because its fashionable, but now with a stronger Rupee, it makes sense to go for it and acquire tier-II players in US & Europe - especially companies which have revenues of $ 1-8 Billion. These companies in general have lower profitability than Indian IT companies and they also trail the biggies (IBM, HP, Accenture, EDS) in terms of profitability. Companies such as KPMG, Cap Gemini, Unisys, CA, Covansys, Sapient etc., will be a good fit for Indian IT companies. These pure play services firms have high operating costs and merging them with Indian company will help lower their cost structures, improve profitability and deliver higher value to customers. US or Europe based IT services companies have a higher cost structures. Indian IT companies can acquire such companies, and transfer their low cost business models into these acquired entities - thus recovering the investment and gaining bigger chunk of the revenues.

These acquisitions will not come cheap, these acquisitions will be in the range of $3-20 Billion dollars, and Indian companies have to take on debt or do SPV (Special purpose Vehicles) or do an LBO (Leveraged Buy Out). Indian IT companies can take advantage of a stronger rupee and huge US client base to fund for these acquisitions.

Such big ticket acquisitions is not for the faint hearted. It takes lots of management skills, vision and guts to pull it off successfully. Given the history of Indian management talent and abilities, Indian IT companies do have the necessary management capability. Tata's, Lakshmi Mittal, Wipro etc., have shown their M&A skills in the past. Indian companies have the necessary management skills to do a successful acquisition - it now needs a bold vision and daring guts to execute such a move.

Expand Abroad

A strong Rupee & rapid growth in Asia & BRIC countries means that Indian IT companies should now concentrate on these markets for growth. Traditionally, Indian IT companies have depended on US & Europe for business. ( Almost 80% of revenues comes from US for most Indian IT companies).

Another good reason to expand in BRIC, ASEAN countries is that their currencies have not appreciated as much as Indian Rupee against the US Dollar. Chinese Yuan has appreciated by only 2.85% against the US dollar while Indian Rupee has appreciated by ~12%. This means that setting up operations in multiple countries will offset the risks if appreciating rupee and at the same time enable Indian IT companies to tap into the business opportunities in these countries.

Indian IT companies should look at expanding operations in Russia, Brazil, Poland, Romania, Mexico, Egypt, China, & Malaysia. These countries have the necessary talent base. Particularly Russia, Romania & Poland. These countries have first class educational system and Indian companies can hire engineers from these countries to serve the global markets.

Diversifying the talent pool of their employee base will help Indian IT companies compete better and gain a significant competitive advantage in the global markets.

Go for the Niche Markets

India has the second largest pool of engineers and scientists in the world. This talent pool has to be utilized carefully - by going into niche areas where competitive pressures are lower and bill rates are higher. For example, getting into R&D services - like Mindtree & Symphony Services is a good example of going into Niche markets. Targeting niche markets will ensure steady revenue growth.

Indian IT companies can look at growth opportunities in Electronics R&D, Pharma R&D, Aviation R&D, Embedded systems, Automotive technologies etc.
But to sustain high growth in niche markets, Indian IT companies will have to invest in developing the human talent and also invest in marketing efforts to build the customer base. Indian IT companies have the necessary talent - but this human talent has to be repositioned to serve higher margin customers - and that requires investments in training.

Build deeper relationships with existing customers

Having served the customer for several years, Indian IT companies should now aim to build a deeper relationship with them. Probably look at outsourcing the entire IT operations from their customers. (instead of providing piece-meal services) Indian IT companies should look at co-ownership of certain IT services/products and become a profit sharing partner. For example, HCL has entered into various revenue/proft sharing contracts with the customer. TCS won a $1.2 Billion contract from Neilson company.

Closing Thoughts

The current turmoil for Indian IT companies is an opportunity in disguise. This situation calls for consolidation and re-strategize for future growth. The era of rapid growth is definitely over, but Indian IT companies can still look at a healthy growth rates of 25% and above if they have the right vision and right management capability. I have highlighted few options available to Indian IT companies - and that too at a high level. But these options have to be explored further and executed upon inorder to grow and become world leaders in IT services.
Over the next two decades, if Indian companies execute properly, The largest IT companies in the world will be TCS, Infosys, Cognizant, HCL, Wipro, IBM, & Accenture (may not be in the same order)

3 comments:

ajay said...

In recent days the contribution of these IT companies in indian economy is being decreased. Many other companies are coming in competition with these IT companies and it might be difficult to overcome to these companies. Will it be possible for these companies to overcome.

Tom said...

I have a friend who works for IBM (US). She is a Project Manager who does a great deal of outsourcing to India. She complained to me recently about the sharp increase in cost of IT services in India. IBM has redirected some of their business to Poland and the Czech Republic because of the shortages and sharp price increases in India.

I agree with you Arun, the IT industry in India will continue to grow and may indeed be the world leader one day. India will need to watch out and not become arrogant like the US did pre Y2K. There are other players out there that would love to capture some of the market India now holds. Russia could be a major player with its comparable intellectual properties.

Indian companies should act now or take the chance of missing the boat.

Munaz Anjum said...

With the falling dollar value, most of IT/ITES sectors are incurring loss. The impact of dollar depreciation can not only be seen India but also across the Gulf regions. How falling dollar warrants the growth of IT/ITES sectors in India? One simple reason is that with white-collar salaries galloping in India, there is little scope to control costs. The key challenge for the Indian outsourcing industry, therefore, is to find a way to rebalance the business portfolio.

For the industry as a whole, rebalancing will involve seeking more business in Europe and the Asia-Pacific region. Even as outsourcing companies seek to cut their reliance on the United States, they must seek to raise profitability of North American sales. Infosys Technologies, the No. 2 Indian exporter of software services, recently said that it is raising prices for new customers and will seek to negotiate a 2 percent increase in existing contracts.

The appreciation of Indian rupee against dollar is also creating serious repercussion on Gulf economy. “The gap between Indian and Gulf packages is fast closing, making it tremendously difficult for Gulf-based employers to attracts professionals from India, historically the main source of affordable talent,” said the study — “Gulf Compensation Trends in 2007