The Hindu Business Line : `Indian biz models sustainable, innovative'

THE momentum that was kicked-off last year with homegrown software majors TCS and Infosys biting off $400-million chunk of the ABN-Amro deal has been sustained with HCL Technologies bagging a $330-million five-year contract from DSG International.

The robust deal flow is showing signs of acceleration with 325 global deals coming up for renewal in 2006 and 2007, representing over a fifth of the active contracts. According tosourcing advisory firm TPI, $100 billion worth of outsourcing contracts are due for renewal in the next two years, of which 72 per cent is held by the big six — the likes of Accenture, ACS, CSC, EDS, HP and IBM.

As the market gears up for an outsourcing blockbuster, Business Line caught up with Mr Dennis McGuire, Founder and Chairman of TPI, to find out more about the perceived opportunities for the Indian IT companies, and trends in the outsourcing space. Excerpts:

What will be the important or interesting trends to watch out for in 2006?

We have seen a marginal decrease in the size of individual large deals, and an increase in the average number of suppliers that share each large outsourcing contract. There has also been a noticeable surge in the number of contract renegotiations of large sourcing deals, and we see these as trends that are likely to continue. The US-based Big 4 and European Big 6 have lost some ground to India-based pure plays, but the latter have won relatively small portions of the overall deal.

Delivery globalisation is another strong trend that will continue for some time, as multinational firms expand their low-cost delivery capacities and India-based suppliers expand their global footprint. Today, vendors can either play a `economies of scale' game or offer good solutions in their chosen industry verticals or horizontals.

Will the greater diversity in the number of vendors and higher competition have any impact in the mega deal category— of over $1 billion— in which the Big 6 dominate?

The trend towards renegotiation is seen across categories but is more prominent in the mega deal category. We are yet to see any significant erosion of the share of contract value enjoyed by the American Big 6 — Accenture, ACS, CSC, EDS, HP and IBM — barring a few examples where a small part of the contract went to an India-based pure play. In the non-mega deal category, there is a greater propensity for supplier base expansion.

The TPI analysis shows that 83 per cent of offshore contracts are competitive and the share of the Big 6 has been steadily falling, even in 2005. You have also indicated that most Indian providers have rarely won deals over $200 million. As the deal size gets bigger, is the bidding restricted only to vendors willing to take over employees and having delivery centres in different geographies, as in the TPI-advised ABN Amro deal?

India-based pure plays claim an increasing willingness to step out and do things that they were traditionally averse to. For example: Employee takeover and asset takeover. That said, the number of deals where we saw this happen has been very small in relative terms. We cannot comment on specifics of any one deal we have advised on.

Indian companies have consistently enjoyed operating margins in the 25-30 per cent band in the past few years. Will large deals be typically margin dilutive for Indian companies and if so, to what extent?

We cannot comment on specifics like supplier margins, but margin dilution is a possibility in large deals, especially where asset takeover and employee re-badging are involved. Further, since large deals by definition are highly competitive, the winning supplier(s) would have pared down their price structure to the lowest level that their competitive position would support.

Where do you see the salaries in the Indian IT service market moving this year? What would be the impact of rising salaries on the cost, competitiveness and margins of Indian vendors?

We are already seeing some erosion of the cost arbitrage that India-based pure plays enjoyed as salaries shoot up every passing year. While this keeps pushing the base costs upwards, we also see the larger pure plays being able to innovate on their processes to improve productivity and efficiency continuously. Another little reported fact is that the workforce utilised by India-based firms consists primarily of fresh graduates. Salaries at these levels have stayed more or less constant over the last few years, thereby bringing down the average salary costs for providers in India. This indicates a healthy sustainability in the business models. As the forces of globalisation push India-based pure plays to expand geographically, labour cost arbitrage will become less and less of a competitive advantage.

Do you think the plain vanilla time and material contract structures will continue for some more years?

We are seeing innovation along several dimensions. There are new operating models that are becoming popular (for example B-O-T - Build-Operate-Transfer) and then there are fixed price contracts with risk reward share built in. TPI's industry standard large contracts' pricing model that uses fixed annual pricing with incremental resourcing credits or costs, is becoming more common.

We see a diversification of sourcing portfolios among customers that are ahead on the sourcing maturity curve, with many of them adopting a mix of supplier offshoring, captives or B-O-Ts.

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