Peeling the IT Layers

Today’s guest blog on what a recession could mean for the IT sector comes from Dinesh Goel, Project Director, TPI.

The era of abnormal growth for India-based IT service providers is nearly over. They’ve reported lower growth rates on both top-line and bottom-line performance in their latest quarterly results.

So what does this mean? Is the IT sector heading for a downturn in the wake of a tough U.S. and global economic environment?

Most equity analysts are already moving India-based providers down to “underperform” or “sell” ratings. Newsprint is consumed with stories and interviews on how the tough business conditions will promote cost-cutting outsourcing and off-shoring. Bottom line is: there’s too much confusion in the marketplace regarding the performance of IT sector.

To understand this financial performance from the Indian IT companies we need to peel back the layers a little. Firstly, the results appear subdued if you see them in relative terms. The picture is not as bad if you measure performance in absolute growth or business volume terms.

Secondly, rupee-dollar fluctuations have been unpredictable and companies have found themselves caught on the wrong foot with large forex forward cover positions used to hedge against a strengthening rupee. While currency fluctuations are short-term and an external phenomena, the percentage growth is reflective of the size these companies have achieved now.

But growth rates around 50 percent are simply not sustainable for a long period of time in most businesses. In fact, growth rates reported even now may not be sustainable as they’re still in multiple of overall industry growth rates.

As far as profitability is concerned, the industry has to converge with the settling Indian providers’ profit margins vis-à-vis global peers. To compete for large outsourcing transactions, investments in beefing up global sales and delivery capabilities are imperative.

My take is that India-based providers will continue to do well in the foreseeable future. However, the era of abnormal growth is nearly over for them and coping with the U.S. recessionary conditions is causing providers to channel management bandwidth into Europe and Asia Pacific. As a result, globalization is gaining momentum for them at a quicker pace.

Comments

[Phil Fersht]

Dinesh,

Good thoughts here - thanks for sharing. Agree that there is an inevitable slowdown in the future with ITO (especially apps outsourcing), but this is only natural economics. We're currently experiencing the peak of the application outsourcing market, and this is going to have some tail on it before we reach single-digit growth. Bottom-line, there is little reason for many global firms to keep many of their application developers inhouse:

1) In the old days, IT guys would get trained by their firms in all sorts of new code / software development skills. Why should firms pay for this today? If you were an IT professional, wouldn't you prefer to work for an IBM or a Cognizant, which would probably pay you more, in addition to giving you the best-in-class skills training?

2) Most firms today simply don't have the skills or resources inhouse to develop much of their IT;

3) It's cheaper to have a third party manage your apps in this competitive climate;

4) Much of IT simply isn't as core to the business these days - it has become a mainstrean support commodity.

Phil Fersht

[Dinesh Goel]

Phil,

Thanks for your comments. You're right - most firms are realizing that IT is best left to the vendors than run it yourself. While IT function is assuming greater significance to the businesses, it makes sense for them to retain only the strategic aspects of it and lose the tactical or operational parts to the service provider. Regarding war for talent, most of the good IT professionals work and would want to work for leading IT companies than their customers except for those who carry the CXO titles where the thought process is more strategic than IT oriented to impact business. IT outsourcing will only grow deeper and wider in times to come but at the same time, there's going to be greater competition in the marketplace for grabbing a share. Interesting times ahead as the battles to help businesses become more competitive take a global centerstage.
Dinesh

[Sai Mandapaty]

Dinesh, while it is true that these companies have posted muted revenue growth this quarter, i think it is too early to conclude that the era of fast growth (25+ YOY) is over. there are 3 reasons for this:
1) recent studies from gartner and forrester indicate robust IT investment growth for next few years. infact I saw one recently predicting a US services spend growth of close to 10% next year.
comments
2) As you mentioned in your response to Phil
more CXOs are charged with "thinking" about strategic use of IT and Indian IT vendors are beginning to get a greater mindshare at the CXO level thinking and are adding more value in transformation initiatives - no longer restricted to CIO. The deeper and wider you mentioned is already on.
3) In spite of all the hype and visibility, tHe market share of Indian IT is still very small. under 5%. Given the still viable cost arbitrage value proposition and the growing pie itself, i think there is still a lot of opportunity here. we also need to remember that Indian IT is no longer just development- it is truly becoming end to end - strategy to BPO and Infrastructure.

Two important changes i anticipate are:
1) Some companies cease to exist in the inevitable market consolidation
2) Sharper differentiation amongst the remaining in a bid to stand out in the market.
Therefore a pertinent question i think is which of the Indian companies survive and in what flavor. Interesting times indeed.

[Dinesh Goel]

Sai,

Appreciate your interest in my blog entry and your comments. I don't disagree with you on the fact that Indian companies market share is still too small and they are broadening their service offerings. All these efforts will certainly pay off to the winners in their growth and profitability. The counter forces, however, include their current size and scale (large top line effect) for percentage growth, the need for investments, imperatives for inorganic growth, globalized depth of delivery capabilities etc which are all good for the business but will drive them closer to the global Big Boys in terms of their financial performance. That said, my view is that Indian providers will still have an advantage over global large players since they are starting from the other side of the world without any legacy structures/costs. Interesting times to watch for sure...!!!