The Hindu Business Line : Uncertainty in business momentum looms large

Bangalore, Dec. 22 Growth for the Indian IT sector came under a reality check in the year that saw major global customers in US and Europe wilt under the weight of an economic recession.

The Indian IT sector earns about 90 per cent of its revenues from the US and Europe. It is now aggressively shifting its focus to the domestic market and emerging markets.

Large Indian firms such as TCS, Infosys, Wipro, Satyam, Cognizant and HCL Technologies, collectively referred to as SWITCH vendors, are now forced to reconcile to a lower growth rate as their large banking and auto clients became victims of the financial crisis. The SWITCH vendors account for over half of the country’s software exports.

The industry, which grew by 30 per cent on a compounded annual basis over the past five years, is likely to see its growth rate halve this year as the economic turmoil intensifies. Taking advantage of the low-cost labour, depreciating currency and tax holidays, the sector had seen a healthy growth all these years.

Nasscom, the apex body of software and services companies, which forecast a 21-24 per cent growth for fiscal 2009, expects to revise it downwards as the industry reels under the impact of the crisis.

Outlook clarity in April

The industry players expect uncertainty in the demand environment to continue at least for the next four to six quarters. The troubles that started with the banking and financial services sector have now spread to verticals such as automobile, retail and telecom. There are fears of ripple effect across other sectors that include telecom hardware. Despite having long-term relationships with customers, the vendors are not in a position to provide any insight on the outlook as the uncertainty prolongs.

However, some clarity on the customers’ technology budgets is likely to emerge in April when vendors such as Infosys and Satyam issue the outlook for the year ahead. An earlier indication could emerge when Cognizant announces its 2008 year-end results and the outlook for 2009 in the beginning of the New Year.

In the year that went by, the uncertainty in the business momentum did force large vendors such as Infosys, Cognizant and Satyam to revise their forecast downwards. Grappling with a volatile currency in the March and June quarters, vendors saw new concerns emerge in the second half as sluggish volumes, coupled with pricing pressure, made a comeback after a gap of five to six years.

Acquisitions

Slowing volumes from existing customers forced vendors to get into acquisition mode as companies such as HCL Tech and TCS concluded large buy-outs during the year. HCL Technologies acquired Axon Group Plc, a UK based firm, for £440 million, the largest deal in the Indian IT sector till date, which helped the company to expand its footprint in Europe and the US, in the SAP implementation area. Infosys did make an initial bid for Axon, but backed out after HCL’s higher counter bid.

The Indian industry’s largest vendor TCS acquired the captive BPO business of Citigroup in a $505-million deal that provided the Indian firm an assured business worth $2.5 billion over 9.5 years.

An attempt by Satyam to diversify into real-estate sector by acquiring stake in companies of the promoter’s son has thrown up corporate governance issues, and to an extent, created apprehension among customers and employees.

Gearing up for the next phase of growth, the top three vendors TCS, Infosys and Wipro restructured their operations and added more service lines such as software-as-a-service and platform-based BPO offerings, among others.

Steps to rein in costs

Unlike in the previous slowdown, large Indian vendors now have a broader global footprint and have better balance sheets to counter the slowdown. Also they have a diversified portfolio of service offerings that ranges from consulting to back-office to infrastructure management, besides the traditional application, development and maintenance, that is helping them compete in the large, long-term outsourcing deals.

With earnings coming under pressure as the current slowdown intensifies, these vendors are now switching to newer pricing models such as fixed price contracts and the gain-share model, where gains are linked to productivity levels. A variable pay structure, coupled with moderation in wages and low attrition levels, could help the companies rein in costs.

Considering that Indian IT exports of $40 billion account for a mere 5 per cent of the global IT services spend of $800 billion, the potential to increase the market share is huge.

The industry has benefited from downturns in the past and is well positioned to take advantage as offshore provides a way to cut costs for the customers. But consolidation and cost rationalisation are likely to remain the focus areas for big companies to survive adverse market conditions. Therefore, it is anybody’s guess on the impact of such moves on the domestic vendors/ suppliers by cross border customers.

Increasing competition from global vendors, who have successfully replicated the offshore model in India over the past few years, is also a challenge that is unlikely to vanish in the near future, for Indian IT biggies.