Is the world really flattening. A question like that may seem terribly out of place as the opening sentence of an analysis of Indian IT services exportsthe very phenomenon that gave the idea of flat world to Tom Friedman. Yet, something somewhere says probably the flattening forces are quite content with leveling the developing and developed worlds, they have not yet touched the Indian IT services industry. That sounds ironic, but then as they say, there is your side of the story; there is my side of the story, and then, there are facts.
And here are the factssome pointers to that something which forces us to play the Doubting Thomas. In FY 07, the IT services exports from India grew 37.2 percent to reach Rs 103647 crorethat is more than a trillion rupees! In dollar terms, this is a little more than US dollar23 bn. Excellent by all standards.
But the big seem to be getting far bigger than the rest. The Top 20 exporters grew 44.2 percentmuch faster than the industry average. In other words, the gap between top players and the next tier is widening.
Call it the Offshore Divide if you like, this trend is noticeable within the Top 20 list itself. While the Big Three are growing at close to 40 percent, other offshore companies like Satyam, Patni, Syntel, Hexaware, MphasiS and SISL are all growing at less than 35 percent; of course, not counting IBM, HP, Capgemini, Perot and the like, whose India exports may not tell their entire story.
This is not an entirely new observation. The tier 2 offshore companies are experiencing the heat for the last three to four years, struggling to keep pace in revenue growth and more importantly in margins. Incidentally, this has been a period in which the top threeTCS, Infosys and Wiprohave clearly moved into the big league in global IT services market, competing more as equals with the traditional leaders in North America, and of late, in Europe.
While the top three companies have now started competing on their specific strengths, not to mention their proven ability to scale up, low.cost often euphemized as the India advantage is still the major selling point for most of the tier 2 and 3 companies. The me.too strategy, which works fairly well during the hype phase, is difficult to sustain in the long run. And offshoring is no more hype, it is the mainstream outsourcing strategy for corporations globally.
While there has been a lot of concern and a fair bit of analysismost of these companies are listedon the slowing down of the next tier IT services firms, this years Top 20 analysis does throw a heartening new trend.Differentiation, at least of one kindfocused playis actually paying off for companies which are pursuing it in an undiluted fashion. Take all the three IT services companies in the DQ Top 200 list that have had a three digit growth, namely, Tech Mahindra, Tata Technologies, and GlobalLogic. They have very little commonality, be it in size, growth strategies, or the kind of things that they do. But one thing puts them in one category: they are completely focused on what they do. For Tech Mahindra, it is a vertical ,telecom, for Tata Technologies, it is a service line, engineering services, and for GlobalLogic, it is both, product engineering for the ISVs.
Others who have grown impressively anywhere between 50.90 percent are Geometric Software, Infotech Enterprises, Sasken, Subex, and Helios and Mathesonall share the same philosophy: undiluted focus. Yes, many of them have grown by inorganic means, but that option was available to others too, and many others have exercised that as well, but have not been able to match these focused companies in terms of growth, even with the acquisitions.
It is difficult to say if focus alone will sustain the growth momentum for these companies in the long run. But for the time being, it surely is paying off. The IT services exports landscape in India is far from flat. In fact, these few companies with impressive performance, distributed throughout the list suggest that the Indian IT services exports landscape is actually spiky
By the Numbers
In India, arguably the best performing among emerging economies in the last couple of years, a growth figure of an industry at 37.2 percent may still result in some bit of introspection, but by all other global standards, it is simply outstanding! The Top 20 together accounted for 77 percent of the market, which was an increase from the last years share of 73 percent. The next 20 accounted for a mere 11.4 percent.
The growth of the Top 20 accelerated to 44.2 percent, as compared to 38.7 percent in FY 06, and 42.7 percent in FY 05. In fact, this years growth for Top 20 exporters is the maximum in this millennium. Apart from credible performance by the offshore services firms especially Tech Mahindra and Cognizant, this has been possible because of large ramp.up by IBM and Capgemini
The New Leaders
The FY 07 also saw the top tier Indian firmsTCS, Infosys, Wiprofirmly establishing themselves among the leading global players in IT services. In fact, the global IT services industrytraditionally categorized across the geographic origins of vendorsthe North American Big Six IBM, Accenture, HP, EDS, ACS, CSC, the European Big Five Atos Origin, T Systems, Siemens Business Systems, Capgemini, and BT and the offshore challengers TCS, Infosys, Wipro, Satyam, HCL, and Cognizant, has been clearly redefined.
The New Leaders, as many analysts put them, who play by the new rules of the game, irrespective of their origin and size, are IBM, Accenture, TCS, Infosys, and Wipro. Those, which are staking a serious claim to a membership of that club, are Cognizant, HP and Capgemini, while many of the traditional leaders in North America and Europe, though still large in terms of revenue, thanks to long.term infrastructure management contracts and government contracts, have clearly fallen behind. EDS is trying to make a serious comeback.
The New Leaders distinguish themselves by their ability to offer innovative solutions, greater accountability, newer pricing mechanisms as well as their ability to make an impact on business, rather than just lowering cost. But apart from these, one important and tangible difference has been their offshore read India delivery strategy. All the New Leaders have a very strong India presence. Apart from the Indian firms, IBM and Accenture have significantly scaled up their India presence though because of lack of availability of accurate information, we have not ranked Accenture. We have taken its revenue estimates into account.
It is also no coincidence that from the older firms who are trying to transform themselves to break into the new league have started with strengthening their India presenceincidentally with acquisitions. EDS acquired Mphasis and Capgemini acquired Kanbay to beef up the India presence. MphasiS and EDS which have been put separately in this list as their merger was not completed by last year, together would have ranked at no12, much above where MphasiS with its standalone revenue stands.
If the non.Indian services firms were looking at building depth and breadth in India delivery, the Indian firms, with deep execution capability at home built in, tried to match the traditional leaders in all possible parametersglobal delivery footprint, breadth of services, deal size, and global market access. On many fronts, they succeeded.
While Indian firms had started their global delivery journey and global market access initiatives earlier, last year saw many of them taking steps to move into high value services and beef up deal size. Consulting was an area that all of them entered with multiple objectivesto add value to their IT and BPO offerings; to increase margin; to gain respectability; and to gain access to the client boardroom. Infosys, which was the first to take the plunge, saw its revenues grow more than 50 percent in FY 07 to reach Rs 500 crore including the Rs 213 crore of Infosys Consulting; TCS saw its revenues from consulting growing about 79.5 percent. The growth rates notwithstanding, the Indian IT firms have to go miles before they can gain either that respectability or the size when its margins can make an impact to the overall company margins. In the next two years, DQ expects that this is going to be the most important area of action for Indian companies. TCS has already announced its targets from consulting: US dollar650 mn by 2010.
In deal size too, Indian firms managed to climb up the ladder. HCLs US dollar200 mn deal with Skandia and US dollar70 mn deal with Teradyne; TCS US dollar90 mn deal with Qantas, US dollar140 mn deal with Banco Pichincha, US dollar100 mn deal with Bank of China; Satyams US dollar55 mn deal with Qantas and US dollar200 mn deal with Applied Materials were some of the US dollar50 mn deals announced by Indian firms. Last year also saw the first billion dollar deal coming the way of an Indian company when BT awarded the big contract to Tech Mahindra. TCS signed as many as twelve US dollar50 mn plus deals in the year.
The Rupee.Dollar Tango
Though there was good news on all fronts, Indian IT services exports industry ended the year with a lot of worry and anxiety, if not gloom because of what many call, not very correctly, the challenge of the rising rupee. It was more of the dollar depreciating against most currencies, though more rapidly against the rupee.
The figures in our calculations do not agree. The annual average of dollar value of rupee that we have taken for calculation that are based on the average of four quarterly average exchange rates taken from sites like xe.com, Rs 45.05 is actually higher than the average exchange rate in FY 06, which was Rs 44.11 for a dollar.
But that was because the dollar was appreciating till mid.2006 and reached a high of more than Rs 46 for a dollar before starting to slide. Initially, the industry shrugged it off by calling it volatility but by the end of the year March 07, it was clear that it was a one.way But it was still around Rs 44 level. Since then, it has slid to Rs 40 levels. That has already affected the margins of many firms like Infosys and Wipro in Q1 FY 08. Infosys guidance says it expects the weakening dollar..stronger rupee would affect its margins in the coming quarters as well.
So far, the favorite derisking strategy of most firms have been to reduce dependence on the US market and look at Europe. But with the rupee becoming stronger against these currencies as well, geographic diversity may not be enough to counter what could well now be a real rise of the rupee.
Industry leaders like Narayana Murthy, of Infosys have called for an increase in productivity. That sounds extremely simple as a solution but a tough one to execute. But then, in the long run, it may be the only sustainable solution. Infosys has already announced a revenue productivity gain of 4 percent in FY 07.
Dissecting the Market
Services Lines.. Almost all offshore services firms started with application development and maintenance ADM services, not because it is easier to execute or it is low value work, but because the contracts are shorter as compared to say infrastructure management. In the last three years, almost all firms have consciously tried to bring down their dependence on ADM. The efforts have finally paid off. The ADM revenue of the industry is down to 59 percent. If that figure still seems high, it is because the smaller firms still have a higher percentage of their revenues coming from ADM. Also, three of the top players Infosys, Wipro and Cognizant have more than half of their revenues coming from ADM.
If the ADM revenue dropped, infrastructure services, almost non.existent three years back, accounted for 5 percent of the revenue. Engineering services, a non.traditional area, accounts for another 4 percent of the industrys revenue. Other services include a large chunk of package implementation services like testing, which has of late become an independent service line by itself, embedded software, product development for ISVs and consulting.
Infrastructure services and BPO which is excluded from our study are long.term priority areas for almost all companies, small and large, thanks to their high growth potential. Consulting and engineering services are thrust areas only for larger companies and a few specialized companies. Package implementation that recorded impressive growth last year is a short.term, tactical priority.
Geographies.. Even before the dollar depreciation started, many Indian firms had identified Europe as a major growth opportunity because of its largely untapped market. Unlike American players, few large European players have scaled up their own offshore activities barring Capgemini. That throws a major opportunity at the Indian vendors.
In FY 07, the top eight services firms the DQ Top 20 pure play services firms drew 29 percent of their revenue from Europe, up from 25 percent in FY 06.
Verticals.. Though BFSI continued to rule, followed by telecom and manufacturing, retailthanks to some large deals in last two yearshas overtaken healthcare to emerge as the fourth largest vertical. Utilities showed marked improvement in the percentage share to become a dominant vertical for Indian IT firms.
Products.. This could be a very small but definite trend. Though they are yet to show up in the big radar, products, especially vertical solutions in banking, insurance and telecom, are now being seriously pushed by both small and large firms. Most companies offering these solutions have taken a micro.vertical approach and are creating solutions for areas such as money laundering and Islamic banking. Apart from i.flex, Infosys, TCS and Polaris, smaller companies such as Nucleus, Infrasoft, and CashTech have also made an impact globally through their products. Kale Consultants and Skyteh in Airlines, Tech Mahindra, Aricent, Subex Azure and Aftek in telecom; and Mastek in Insurance, have also made their presence felt.
Looking Beyond IT
The traditional customers for IT companies worldwide have been the CIOs and the IT managers, in charge of enterprise IT. So, the global IT outsourcing market has often been classified under four dominant categoriesADM, infrastructure and managed services, package implementation and system integration, and IT consulting.
Indian IT services firms, however, have gone far beyond that to tap opportunities that have traditionally not been part of enterprise IT. Areas such as embedded software, outsourced product development, engineering services and BPO require the IT services firms to target managers who are used to running profit centers, often being responsible for the companys core function.
It is to the credit of Indian firms that they have not only succeeded in selling these business managers the concepts but have delivered on their promises. It is rarely discussed but about 8.15 percent of the revenues of top tier Indian IT firms today come from these areas.
Areas like engineering services, BPO, product development and testing are growing faster than the overall business of these firms, meaning their dependence on the enterprise IT spend alone is on the decline. With business consulting also being added to this list, the question is: can we still call it IT services?
