about us
  areas of expertise
  our projects
  ideas & resources


Index of Articles         Index of Perspectives           Next Article



Whither Indian IT?

Omkar Goswami


As the Indian IT industry faced its first global crunch and the new cult heroes of the brave new cyber world announced some of their worst financial results, the National Association of Software and Service Companies (NASSCOM) said that it stood by its earlier forecast of $50 billion industry in 2008. Was this a realistic assessment of global demand? Or was NASSCOM, like many other industry bodies, trying to create a “feel good” factor in difficult times?


Let’s start with the $50 billion estimate for 2008. According to NASSCOM’s estimates, available in its website, the Indian IT business (including hardware, peripherals, networking, software and IT services) was $16.5 billion in 2002-03. Of this, the Indian software and services business was $12.5 billion. I am not quite sure whether the $50 billion target refers to the whole gamut of activity, or only software and IT services. If it were the former, then Indian IT would have to grow at a compound annual rate of 22 per cent. And if refers to the latter — only software and IT services — then the industry would need to grow at 28 per cent per annum over the next five years.


The first target — growing the overall IT business by 22 per cent per year — is achievable. After all, despite much more stringent global IT spends in 2001-02 and 2002-03, the industry has grown by 23 per cent in dollar terms over the last four years. Given our cost advantages and our well established brand equity, there seems to be no reason why this growth can’t be replicated for the next five years. The second target — 28 per cent growth of software and IT services — is more difficult to achieve. Even so, I do believe that with a little bit of luck, this can also be realised.


The more important issue is what will happen to the margins of Indian software and IT service providing companies as they collectively reach the $50 billion target. Unfortunately, every indicator suggests that the bottom line story may not be as buoyant as the top-line one.


The battering of technology stocks that began with the declaration of Infosys’ results on 10 April 2003 and continued for over two weeks is a harbinger of things to come. Consider Infosys’ performance for 2002-03. In difficult times, the company had exceeded both its revenue and profit growth targets for the year. Three things smashed the bell-weather chip: first, that average billing rates for 2002-03 was down by 5 per cent; second, that the company’s guidance for revenue growth for 2003-04 was lower than that of the previous year; and third, the profit growth estimate was not only lower than before, but quite a bit less than the revenue growth estimate. Then came Wipro’s confession that its net profit for 2002-03 was lower by 8.5 per cent. And finally, Satyam declared fourth quarter losses in excess of Rs.35 crore. Suddenly, the darlings of Indian bourses suddenly seemed to have feet of clay.


Now for some crystal ball gazing. First, there will be severe billing pressures going forward. For one, every major IT customer abroad faces severe budget constraints, and every Chief Information Officer has to deliver bang for bucks like never before. For another, there are enough Indian IT majors who are going after the same customers, and nobody has any compunction of quoting lower prices to grab the business. The CIOs know this very well, and are playing off our IT companies against one another in their beauty parades.


Second, every major international customer now has a keen understanding of the blended costs of Indian software and IT service providers. In part, our companies have made this easier by offering detailed financial disclosures in annual reports and analyst meets. But even without these, the customers would have discovered the pricing margins. Given that none of our companies — including TCS, Infosys, Wipro and Satyam — are really major global players in the IT space, the customers are squeezing margins. In an increasingly commoditised industry, we have become price takers, not price setters. The pricing pressures are going to be even more severe for IT out-sourcing and BPOs.


Third, many global IT majors such as IBM, Accenture and EDS, have understood the India advantage and have set up large and growing offshore operations in the country. Thus, the few Indian companies that are bidding for projects at the high value added end of IT space are now facing price competition from the international biggies — something that they didn’t witness even a year ago.


Fourth, some of the Fortune 500 companies who are significant buyers of IT services are setting up Indian back-ends. GE Capital is the largest example. As these operations ramp up, we will see a sizeable chunk of the middle- to lower-end transactions oriented IT business going to the Indian back offices — again to the detriment of India’s IT service providing companies.    


The long and short of it is that while Indian software and IT services should attain NASSCOM’s $50 billion goal in 2008, the margins historically associated with such companies are going to be things of the past. Let me put it in a quantitative perspective. Today, the better performing manufacturing companies are posting net profit margins of around 10 per cent, and their bottom lines are growing at about 8 per cent. IT companies enjoy huge tax shields. Even so, I don’t see them earning average PAT margins in excess of 15-18 per cent in the next few years; and I don’t see earnings growing by much more than 12-13 per cent per year. Given that IT is getting  commoditised, there is no reason why it should not be benchmarked against the best in Indian manufacturing. So, you calculate the average P/E for Indian IT companies over the next three to four years. That’s where I think the market will eventually settle to. And Indian IT will be none the worse for it.   


 Published: Business World, May 2003


              Index of Articles         Index of Perspectives           Next Article