This is no ordinary IT slump

Rajkamal Rao | Updated on October 19, 2012

Finally, the IT sector is all about cost arbitrage in these difficult times. — G.R.N. Somashekar

Rising protectionism and lack of growth in business could pose an exceptionally daunting challenge.

B loomberg News recently reported that Infosys lowered its forecast for this fiscal year’s revenue to Rs 39,580 crore from a July estimate of Rs 40,360 crore — a whopping reduction of Rs 780 crore. It quoted Infosys CEO S.D. Shibulal as saying that the “business environment continues to be challenging.”

Critics have charged that the problems of Infosys are local to it and that clear differentiation has allowed competitors such as TCS and HCL to do better. But Shibulal may have been talking about an environment that is becoming increasingly difficult for all the Indian majors to operate in, not just Infosys. If promise of growth is what drives market performance, the coming years are likely to be a rough ride. The reasons are as follows.


Lower world economic growth: Of the four pillars of wealth in the world, three (the US, Europe and Japan) are facing major fiscal crises. The International Monetary Fund states that Japan’s debt will rise this year to 237 per cent of its GDP. (Greece, at 198 per cent, and Italy, at 126 per cent, look, like champions by comparison!) If these regions implement the IMF’s urgent recommendations to act, austerity measures (spending cuts and increased taxes) will kick in, resulting in lower growth for many years to come. Translate these lower growth rates to fewer opportunities for the Indian software sector.

Changing regulatory environment in the US: The financial services and the healthcare sectors underwent massive regulatory changes (Dodd-Frank and Obamacare) in the last two years with most new policies yet to be implemented. Many of these rules are related to compliance, audit and governance — energising new business for US-based lawyers, assurance firms and Wall Street companies; these areas that are not strong points for the Indian IT majors.


US, European and Japanese companies are increasingly setting up their own subsidiaries in India. Since 2009 captives have experienced a compound annual growth of 11.6 per cent with more than 200 new captives added. A Nasscom report from March 2011 said that captives employed over 440,000 employees, accounting for over 20 per cent of the total exports’ employee base. What factors are driving captive growth? First, innovation is a key differentiator in an increasingly global economy (just look at the Apple-Samsung wars) and companies prefer to incubate and develop their own centres of excellence rather than transfer intellectual property to third-party service providers.

Second, companies are beginning to focus more on data privacy as governments force companies to step up data governance in the wake of increasing data theft. It is easier to manage data when your Bangalore office is no different from the one in Phoenix.

Third, vendor management of third-party service providers is time-consuming and expensive — it is not uncommon for buyers to negotiate for nearly a year to ink a three-year IT service contract! There are no such contracts with your own captive.


A nascent truth of the stock market is that one person’s gain is another person’s loss. Similarly, as contracts get renegotiated every few years, a win for Wipro might simply be a loss for TCS. The overall pie is not growing but the allocation of the pieces of the pie is changing.

The reason is that at its core, the Indian software sector continues to be all about cost arbitrage. This results in a hyper-competitive sector where each player seeks to out do the next by quoting lower. The demand for lower prices is coming from IT departments whose own budgets are shrinking. (The venerable UBS is expected to reduce its IT spend by an incredible 33 per cent by 2015.)


Protectionism is at an all-time high and if Barrack Obama gets re-elected, it does not augur well for the Indian software export sector; jobs are likely to grow in the US rather than be outsourced. When the Obama stimulus Bill was passed in 2009, a “Buy American” provision required that infrastructure projects use US-made materials and equipment. During the current US presidential election season, both Obama and Mitt Romney are pandering to the average US voter that each will not outsource jobs, but would rather bring jobs back home. Romney has said that if elected president, he will support reform that would stamp every foreign student’s masters or Ph.D. degree in the science, technology, engineering and mathematics (STEM) fields with a green card.

Many Indian majors provide offshore labour to US clients on high-margin, low-risk staff augmentation contracts. But US labour unions have begun to notice. For example, about two years ago, Wells Fargo Bank and its employee unions agreed to stop this practice by implementing the so-called “18 month rule”. Accordingly, no contractor (US or foreign) can work for more than 18 months at a stretch and if it does, it will have to wait for another 18 months before being re-hired. After this rule got implemented, managers were at pains to transfer knowledge from the contractor to a bank employee.


Some Indian majors are trying to avoid being stereotyped as low-cost commodity providers by getting into higher-margin management consulting which can also front-end their bread-and-butter technology teams in India. But going against established strategy firms such as McKinsey, Bain and BCG and systems integration firms such as the ‘Big-4,’ IBM and HP is not an easy proposition. These firms have invested for decades in building client relationships that can be hard to undo. There’s an old saying in the industry that a consulting contract is rarely won because of a good proposal response.

Indian companies have been in holes before and have emerged successful. Each time, their value proposition won them a new contract or a renewal.

This time, though, the landscape appears to be different.

(The author has been a US-based management consultant.)

Published on October 19, 2012

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