The Hindu Business Line : Software earnings: Firing on all cylinders, but...

INFOSYS Technologies, the IT bellwether, has launched into 2004-05 on a rollicking note. Buoyed by a strong double digit quarter-on-quarter revenue and post-tax earnings growth in the first quarter, Infosys has revised both its revenue and per share earnings projections upwards by nearly 12 per cent for the year. (See Corporate Insight page). Other prominent medium-sized software companies, such as MphasiS BFL and Mastek, have also turned in a robust performance in the latest quarter.

Emerging from a year gone by that has been somewhat of a rollercoaster for the entire software industry, all the business and operational variables which were bearish have suddenly turned favourable over the past three months. A strong undercurrent of bullishness has been fuelled by these elements:

Buoyant volume growth: As offshoring has gained widespread acceptance in the US, client visits have soared for practically all the companies, frontline or medium sized.

For software (though not to the same extent for BPO), this has and is expected to translate into higher business volumes across-the-board.

For Infosys, both the client addition numbers and scale-up in each of the different client categories say, from $1 million to $20 million has moved up steadily. This has strengthened the predictability and potential of the offshore model.

Focus on software development: Corporate IT spending which has been sluggish over the past couple of years are showing signs of a nascent recovery. This is expected to shift the focus from cost-cutting and operational efficiencies to higher spends on software development.

To some extent, this has been evident in the telecom vertical and may spread to other verticals. If software development picks up, the flexibility available to frontline companies on both the volume and pricing front will look up.

Stable billing rate: Over the past six months, the pricing pressure has eased and the average billing rates are beginning to stabilise.

This signals that a turnaround is coming after nearly six to seven quarters of pricing decline on the onsite and offshore front. If the business momentum in the US is sustained, it is likely that new clients will be contracted at higher billing rates and even existing contracts may be renegotiated at higher rates. But it is too early to reach such a decisive conclusion.

Rupee depreciation: Rupee which has been steadily appreciating against the dollar (up by nearly 8.7 per cent in 2003-04, with the biggest appreciation in the fourth quarter of 2003-04) has reversed course in the first quarter ended June 30, 2004.

The rupee depreciated by nearly 5.6 per cent (on a point-to-point basis) in the latest quarter and is expected to remain weak against the dollar at least for the next couple of quarters as the new UPA Government (supported by the Left parties from the outside) settles down at the Centre.

Outsourcing backlash: The fears of an outsourcing backlash from the US which had reached a feverish pitch in the January-March quarter has since quietened down after the Iraq war and its nasty after-effects.

But with four months left for the US elections in November, this may not be a closed affair as yet. Even the Indo-Pak relations have improved leading to a more comfortable risk position than in the past.

New game, new rules

All the software companies in India, especially the frontline companies have recognised that the rules of the offshoring game have changed over the past year. Every frontline company has been gearing up for this challenge by restructuring their operations across verticals, strengthening the market in the US and Europe and taking the first steps to set up development centres in different geographies. Each one of these moves are encouraging, but it is hard to underestimate several challenges which every frontline (and some extent, medium sized companies) may face this year and over the next couple of years such as:

The multinational vendors led by the likes of IBM Global, Accenture or Cap Gemini are expected to reach a critical threshold in terms of employee numbers this year. Over the past year, these MNCs have proved to be less of a potent threat than they were expected to be.

But if we assume that moving offshore is an inevitable element of their strategy, their impact will be felt on two specific areas. As the engagement sizes for offshore deals rise to over $100 million and above, better relationships of the MNC's and superior project management skills will give them an edge over the Indian frontline companies.

And second, given their deeper pockets, they will be in a position to undercut and keep the billing rates under pressure even when the IT environment improves.

The need for Indian frontline companies to broaden their service offerings has become imperative. While penetration among software development and maintenance is getting stronger, this year will prove whether their forays into consulting, systems integration, project re-engineering and infrastructure management is as successful as that of package implementation.

There is a likelihood that Fortune 500 or Global 1000 companies who have been working with the offshore model for over three years may accelerate their shift from multiple vendors to a limited set of preferred vendors (say, two or three at the most). These moves driven by the need for greater productivity improvements and cost efficiencies may induce a second round of billing rate pressures among frontline companies.

On the manpower front, the attrition levels among middle level management of frontline companies may get pronounced during the year. Attractive salaries from MNC's and greater operational freedom offered by medium-sized companies will put pressure on frontline companies to retain their top-notch middle management talent.

Moreover, as Tata Consultancy Services moves into the public domain with an IPO later this month, the competitive bar will only be raised higher for all the other frontline companies such as Infosys, Wipro and Satyam.

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