The Hindu Business Line : `BPO will lead IT recovery'

The BPO industry which, for long, was seen as the poorer cousin to the IT services industry, may be leading recovery from the recent economic slump. This stems from decision makers needing to cut costs on the operations front, as well as on the technology front. And, across the outsourcing spectrum, first-time outsourcers are trying out India vendors. This is the gist of what Phaneesh Murthy, CEO, iGate, had to say, among other things, when eWorld met him recently.

Aftermath of economic turmoil

There a few trends here. First, the Financial Services companies in the US have reached the end of their M&A work and consequently are starting to make decisions. That's a positive. Normally, you would have expected a flush of projects in the January-March quarter but because of the M&A work, no decisions were made at that time. The most important thing now is that the decisions are getting to be made.

The second trend is that recovery in the outsourcing space will be BPO-driven. Fortune 1000 CIOs spend 17-19 per cent of their IT dollars in India, while the F1000 COOs spend only about 2-3 per cent of their operations dollars in India. With the need to dramatically restructure costs, I see the operations dollar tracking upwards quite significantly now and a big wave of BPO work coming to India. The challenge, on the negative side, is that one never knows if the operations work is going to land in captives (owned by those clients) or with third-party vendors. (Typically, the bulk of IT work always lands with third parties.)

The third trend is that IT will continue to be under pressure, from an overall dollars budgeted this year. .I don't see a significant up-tick in the budget also. In a bad environment, the tendency is to be more conservative. Even 2010 will not be great from an IT perspective but I think there is a lot of BPO revenue that will come our way.

The most fascinating trend I have seen in the recent past has been that for the first time in as much as I can remember we opened four new customers all of which are first-time offshorers.

Challenges to the industry now

The biggest challenge in front of the industry is the lack of Government sponsorship to fight newer regulations on the visa side. In a sense, India's largest natural resource is its people. And that risk has become extremely high in the US. If the Durbin-Grassley Bill gets passed, it will have a huge implication on the industry. Also, Obama's overall mindset on TARP (Troubled Asset Relief Programme) money users not going offshore is a big challenge. He believes that jobs should remain in the US and that has an effect on many corporates. These are the headwinds. Of course, the positives are that we play in a cost reduction game and `faster-cheaper-better' game and hence more and more dollars will end up coming to India. Those are the tail winds, particularly on the BPO side.

The first draft of the TARP Bill had a provision which, thankfully, did not get passed. Recipients of the TARP money were to not award any new contracts where the labour is going to be based offshore nor were they allowed to do any extension/enhancement of contracts where the labour was to be based offshore. So, the idea was basically to keep offshoring minimal, and at the current level, and also all new deals were to remain in the US. The intentions were very clear in the first draft.

Subsequently, it got watered down and there is a final provision in the TARP Bill where the recipients are not to work with any non- American company.

In reality, all the banks are going to be returning the TARP money this year because the executive compensation is otherwise hit. I was in the midst of discussions with three banks in the US about jointly setting up a low cost operations centre in the US for one quarter. In the last few weeks, they have all come back and asked us not to set up as they have decided to return the TARP money.

The atmosphere is improving, which means that we are coming into a valley or slightly upward zone but that just means that the decline has stopped.

Tough recovery slope

The recovery for the Indian IT services industry will only be a `check-mark' recovery, i.e you lose everything in two quarters while you regain it over eight quarters. The upward slope is much more gradual than the downward decline that happened. The long end will get you back to the same point in, may be, the three-four times the time it took to decline.

At a macro level, the financial institutions have taken $1 trillion of charges cumulatively so far. The worst part is that it is anticipated that the total charges will be about $1.8-$1.9 trillion, which means you have got a further $800-900 billion of charges to take. The new charges will take place on prime mortgages, commercial real-estates and consumer credit defaults because people are losing jobs and this is based on a model of 10-10.5 per cent unemployment rate. That's another scary proposition.

While the recovery is definitely under way, it is a weak and gradual recovery and not one that gives a lot of confidence.

Post-Satyam acquisition plans

We looked at a fairly large-sized, broad-based BPO company and it didn't work out, predominantly due to the valuation issue. We continue to look at acquisitions as we are motivated to get up to 20,000-30,000 employees very quickly, from the current strength of 6,500.

The challenge in this market is that everyone looks at the valuation of 12 months ago and is unable not able to come to terms with the current valuation levels. I do believe that the M&A environment is going to be a little muted, except for whom it is an absolute, basic necessity.

For us as an acquirer, it is difficult to go beyond a certain value for the target company. Average market premium is about 15-25 per cent and not too much more.

Also, once you end up doing the acquisition, it should be an accretive acquisition and should not be dilutive to shareholders.

Plans for the healthcare vertical

It is an interesting vertical. It has four elements - Equipment providers, Healthcare providers (Hospitals, Doctors, Nurses), Payers (Insurers who underwrite the risk) and the benefit management companies. We have started working with one company each in three of these four segments and we are also looking for a customer in the fourth segment as well. We believe that thanks to the Bush plan and also the continuing focus by Obama, healthcare will undertake the dramatic transformation in technology over the next many years.

Clearly, the space requires significant amount of domain expertise. So hiring the right healthcare experts is a big investment area. The other is the investment in HIPAA compliance and understanding the compliance and regulations related to this and how to work under those constraints.

Our iTOPS model fits in perfectly in the space between the provider and the payer, which is where apparently there is significant amount of inefficiency in the market. It is here that the administrative cost between the payer and provider is very high.

Expectation from the Budget

The biggest thing we can get from the Budget probably has very little cost impact on the Government. What I am looking for is simplification, rationalisation, accountability and clarification. Is it a fringe benefit to an employee if you give a gift, or travel. I travel 20 days a month and I am told that it is a fringe benefit. I should actually be given a hardship allowance for travel.

The definition of fringe benefit needs to be clarified. Also, there are multiple taxes applied at different points of time, sometimes double taxation. Refund takes a long time. You must make the structure a lot simpler and rationalise it.

STPI extension is important because in a sense we are paying taxes in different ways. We have taken on public infrastructure cost, we run our own power generation plant, our own UPS facility and transport services. In effect, this is like a tax.

Elaborating on the Obama mindset

Obama as a campaigner talking about creating jobs in the US and not sending work offshore to Bangalore, you would normally take it in one ear and out the other. When Obama as a President says that he would rather have jobs in Buffalo than in Bangalore, people start to listen and start thinking about what they should do differently. And Obama as the owner through TARP money is a completely different bowl of fish. When he says, as an owner, that companies cannot increase offshoring, then there is no choice. The companies will move from the third level to the second once they return the TARP money and will make some minor adjustments but broadly they will keep the programmes running in the best interests of Corporations and shareholders.

iGate's itake on the domestic market

We took a decision about six months ago that we will start focusing on the domestic market. We have appointed a head of Indian market. We expect the realisations to grow and the projects to be of fairly good sizes.

"IT will continue to be under pressure, from an overall dollars budgeted this year."

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