The Hindu Business Line : ABN-Amro deal: TCS, Infy make a bundle

IT IS rare for a single offshoring deal to buoy the optimism of the entire software services industry. But the mega $2.2-billion (1.8 billion euro) deal from the Dutch financial powerhouse, ABN Amro, has done that and more. Not just in terms of size — the $400-million five-year application support contract to Tata Consultancy Services (TCS) and Infosys Technologies represents the largest outsourcing deal bagged by the IT industry so far — but also in quality.

The selection of three Indian vendors — Patni Computers, TCS and Infosys — among the five preferred vendors for application development raises the competitive bar in the services arena.

Sitting pretty, having bagged an enviable order: Mr N. R. Narayanamurthy (left), Mentor and Chairman, Infosys, and Mr Nandan Nilekani , CEO.

Beyond just this deal

The significance of the ABN Amro contract goes beyond size and quality. For once, the deal is set to change the paradigm for the software industry from three key angles:

Unbundling of deals: It is expected to give a significant strategic push to unbundling of mega outsourcing contracts to multiple vendors as opposed to the hitherto single-vendor norm.

This structural change in global services that has been expected for the past year has become a reality.

It is the first IT outsourcing deal that was broken down into three components: IT infrastructure, application support/enhancements, and application development, with multiple vendors invited to bid for them.

With TCS and Infosys walking away with the application support/development part of the contract, the deal has clearly established the power of the offshoring model. And its success is bound to pave the way for similar mega contracts from global majors such as General Motors, Nissan and Shell.

Geographic diversification: Coming from a Dutch company, this deal has opened the doors to Europe for Indian offshore vendors.

As this continent has remained largely insulated from offshoring, this deal, with competitive implications for its peers, can usher in greater openness in unbundling other deals from Europe.

For Indian vendors looking to reduce their dependence on the US, too, it may be a big step forward.

Direct competition with MNC vendors: In a deal of this size and scale, frontline Indian vendors have competed and won against their multinational counterparts.

It is apparent that IBM has won the IT infrastructure deal component, valued at $1.8 billion (Euro 1.5 billion euro), or 80 per cent of the deal size.

But the significant point is that the frontline Indian vendors have won on their core strengths in application development/support.

According to Mr Siddharth Pai, partner in the global sourcing advisory firm, TPI, "... a lot of these first or second generational deals that were done in the late 1990s are now being restructured and coming up for renegotiations (for unbundling)."

Unbundled mega deals of the ABN Amro kind will bring Indian vendors into direct competition with the MNC vendors.

Pressure on MNC vendors

Though billion-dollar deals will continue to happen, the prospects for unbundling may be much higher in the next couple of years than in the past.

If a few deals of the General Motors variety open up, they are bound to quicken the pace of the direct tussle between MNC and Indian vendors. Both will have to reorient their strategies to fit into this new competitive landscape.

The key challenges that the MNC vendors will face over the next year or so will be:

Getting the offshoring act together: A few of the North American MNC vendors such as IBM, Accenture, Sapient and ACS (Affiliated Computer Services) have been on an aggressive recruitment drive to build up offshore capability.

In recent times, there are indications that the recruitments by IBM and Accenture have even outpaced that of the Indian vendors.

The key issue, however, is to replicate the delivery model established by the Indian vendors to be able to compete with them on an equal footing.

In the light of the ABN Amro deal, it is evident that MNC vendors will have to embrace the offshore model wholeheartedly, even if it means taking a hit in their global revenues.

Unless that happens, the MNC vendors cannot compete on a level field with the robust offshoring engine of Indian vendors.

Making disruptive moves: A few key American and European vendors, such as Bearingpoint, EDS, Cap Gemini, Atos Origin and Unisys, significantly lag their peers such IBM and Accenture in building offshoring resources.

This may place them at a competitive disadvantage vis-à-vis the Indian vendors.

Given the pace of employee addition across the offshoring arena by frontline MNC and Indian vendors, these players will have no choice but to make a large acquisition or a series of mid-sized acquisitions, if they have to stay in the offshoring race. This is particularly applicable to the European vendors as clients from Europe unbundle existing deals.

Advantage Indian vendors

As the ABN Amro deal has highlighted, the Indian IT majors are likely to have the edge over their MNC peers in reaping the benefits of unbundling and multiple vendor relationships. Not only does the market widen for the Indian vendors, but the scope for cross-selling their new service lines, such as infrastructure management, BPO or testing, improves significantly.

As more unbundling contracts open up, they will play to the strengths of the Indian vendors in different domains such as Wipro in telecom, utility and manufacturing, or Satyam in manufacturing/automotive.

At the same time, Indian vendors will also have to contend with such challenges as:

Cap on billing rates: While the ABN Amro deal is likely to enhance the revenue/volume cushion for TCS and Infosys, the pressure on pricing is likely to continue. As MNC vendors slowly get their act together and Indian majors compete with them on direct terms, billing rates may be capped.

Though frontline Indian companies have been talking about stable billing rates for the past four quarters, only the new clients have been coming in at higher billing rates. Unless the Indian vendors are able to keep a tight rein over costs, margin pressures may begin to show up.

Multiple location and employee takeover: The key challenge for Indian vendors will be successfully setting up development centres in multiple locations worldwide. As the war for software talent intensifies, wage inflation will erode the cost-competitiveness of the Indian players.

Unless the frontline players set up centres in other low-cost geographies — say, in China or Eastern Europe or Latin America — and scale-up to reasonable numbers, client comfort will not increase.

In the ABN Amro deal, for instance, the presence of TCS in Latin America must have worked to the latter's advantage in bagging a large proportion of the deal.

Second, the frontline Indian firms continue to be averse to takeover of employees in mega deals which, in a few cases, is dictated by regulations in different countries.

Though takeover of employees is a risky exercise, Indian vendors will have to work around this issue as deal sizes get bigger or come with such conditions attached.

Portfolio choice

THE ABN Amro deal has worked to the advantage of frontline Indian vendors. As visibility has increased for TCS and Infosys, in our view, staying invested at current price levels appears prudent.

The margin pressures arising from this deal may not be substantial.

Despite the recent run-up in prices, our preferred plays will be Infosys, TCS, Satyam and Wipro, in that order.

As the demand environment continues to be positive and more unbundled deals may be in the offing, any weakness in the broad markets may be used to step-up exposure in these stocks.

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