The Hindu Business Line : On course, for now

PHEW!!! What a turbulent period it has turned out to be for the software sector, since Infosys Technologies, the tech bellwether, announced its earnings performance on April 14.

The lower-than-expected earnings guidance and a flat first quarter forecast by Infosys combined to fuel an across-the-board sell-off among frontline and mid-cap technology stocks.

On the same day, at the global level, IBM's weaker-than-expected actual earnings for the first quarter of 2005 sparked the sell-off in the Dow Jones Index.

Coming as it did close on the heels of an indifferent performance from Unisys Corp and Sun Microsystems, worries on the pace of technology spending resurfaced at the global level, after having receded late last year.

To compound matters, Tata Consultancy Services, the big daddy of the Indian software sector, announced a disappointing fourth quarter on April 19 and rattled the markets completely.

Later in the week, however, Satyam Computers and Wipro's Global IT Services business came up with relatively encouraging numbers for the fourth quarter and triggered a mini recovery in the markets.

Slowing outsourcing momentum?

Did this sharp sell-off reflect fears of a slowdown in technology spending and by extension, the outsourcing momentum in the US geography?

At the global level, IBM, Accenture and Unisys Corp have indicated in their latest quarter's performance that their order bookings for outsourcing have either been flat or lower-than-expected.

Besides this, it is true that some top companies in the Fortune 500 list, who are offshoring clients of the Indian frontline companies such as General Motors, American Express, American International Group or Hewlett-Packard, are facing some problem/internal reorganisation.

For instance, GM, which is one of Wipro's top five clients, is facing severe financial problems, with a $1.1-billion loss in the latest quarter. But the Wipro management recently indicated that they do not see any imminent change in GM's outsourcing plans. American Express, which is one of Infosys' top 10 clients and also a TCS client, is undergoing internal reorganisation involving a spin-off of its American Express Financial Advisors division to American Express shareholders in the third quarter of 2005.

Based on anecdotal evidence, drawing such a conclusion will be premature, as there are not enough data points to suggest that customer demand may be slackening and tech spending tapering off as a consequence.

A closer examination of the trends at the global level (drawn from the performance of IBM or Accenture) and the domestic level (from the likes of Infosys, TCS, Satyam and Wipro) can help draw some inferences about the fundamentals of the entire services sector and factors that will continue to play to India's offshoring advantage such as:

IT spending not losing momentum: IT Spending Surveys conducted by CIO magazine and Merrill Lynch confirm that IT spending may be on the rise and less uncertain than in the past.

In the monthly poll for March done by CIO magazine, CIOs (Chief Information Officers) predicted that spending would rise 6.4 per cent during the next 12 months, up from a 12-month growth rate of 5.9 per cent they had predicted in February.

The poll added that the two months of higher spending expectations followed three straight months of declining numbers. Also, the Merrill Lynch Survey and feedback from outsourcing advisory firms or consultants such as TPI, Everest, Forrester or Gartner suggest that IT spending is showing no signs of losing momentum.

Since Indian frontline companies are servicing only a small fraction of annual IT budgets of Fortune 500/Global 1000 corporations (with average budget in excess of $100-250 million), the potential for volume growth from offshoring remains fairly strong.

Shrinking deal sizes: Over the past year, there has been a structural change in the global services marketplace.

The mega billion dollar deals of the likes of Bank of America, Procter and Gamble or JP Morgan Chase signed with vendors such as IBM, Accenture or EDS or CSC in 2002 have become less of an industry norm in recent times.

This trend is something that has also been confirmed by Accenture in the latest earnings call in early April. But they have also added that though the size of the deals is smaller, the volume and velocity of opportunities continues to be good.

As the deal sizes decline, it is beginning to play to the strength of the Indian offshore vendors. Since the top three companies — TCS, Infosys and Wipro — are already servicing $40-50 million clients offshore, these translate into onsite revenues of over $80-100 million. It effectively means that Indian companies will be in a position to participate in most deals that matter in the $100-500 million range. This will be barring deals that are struck purely on a relationship basis and do not come within the purview of an RFP (request for proposal).

Longer sales cycle: As confirmed by IBM, at the global level, short-term order bookings have been slow.

According to the IBM top management, a sharp decline in short term contract signings (or order book) compared to long term signings in late March in Global Services led to lower revenue growth rate in the first quarter ended March.

First of all, the drop-off in short term contract signings does not reflect a trend, as the management has indicated that it will be in a position to regain signings growth in the second quarter ending June.

Secondly, IBM has claimed that its order pipeline for Global Services is 30 per cent stronger at the end of the first quarter than it was at the start of the quarter.

Just like IBM, the Indian frontline companies will also be facing a longer sales cycle. Since the US economy is a little jittery at the moment, decision-making may be slower than usual.

As fears of US economic slowdown ease, it will be business as usual for all outsourcing players. However, competitive intensity will be far greater than in the past among multinational and Indian outsourcing vendors.

New service lines/geographies: For IBM, in the latest quarter, outside its core services business, its new service lines - Business Performance Transformation Services (BPTS) and Engineering and Technology Services — have done exceptionally well, with both growing 40 per cent and 55 per cent year-on-year.

In BPTS, IBM is directing a lot of research efforts into new business applications and industry processes, which are expected to be a big engine of growth in future. The service signings have gone up 90 per cent for both BPTS and engineering services.

Similarly, IBM is also diversifying its revenue streams beyond the US and Europe into emerging geographies. It has been continuously shifting its investments towards China, Russia, India and Brazil, which together grew 18 per cent in the first quarter of 2005.

If we examine the revenue breakdown of the top three domestic software companies - TCS, Infosys and Wipro — it is interesting to note that new service lines, be it package implementation, infrastructure management, testing, BPO and consulting (business, technology and quality) account for over 20-30 per cent of revenues.

Given the sharp ramp-up in this space by all the frontline companies over the past year or so, these will help drive their growth rates ahead of the overall industry.

These players are also slowly putting a similar strategy of diversifying across geographies in place. If the US economy manages to ride out this economic storm, the offshoring trend has the potential to completely reshape the global services landscape over the next few years.

maverick@thehindu.co.in

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Chennai tunes in

Out of reach...

Whistle for a `photo taxi'

I'd rather read

On course, for now

All or nothing

Tailored fit eludes software

Booting advice

Slow loading of desktop

This one got away

A choice pick

There are over 600 identified IT vulnerabilities...

Cartoon