Categorized | Economy, India

Indian IT – Free Fallin?

– The Economist

Most foreigners visit Mysore to see its many
palaces, testaments to bygone royal splendor. But the city, south of
Bangalore, is also a good place to observe monuments to India’s modern
might.

One of its suburbs contains a lush campus with a collection of
futuristic buildings: the Global Education Center, one of the world’s
largest corporate-training facilities, operated by Infosys, a leading
Indian information-technology services firm.

Visiting the center, you would think that for India’s IT businesses,
the sky is the limit. Rarely has an industry grown so rapidly for so
long. It has boasted annual growth rates of nearly 30 percent in the
past 10 years, with revenues now nearing $50 billion, about 5.4 percent
of India’s GDP.

But some in India are starting to worry that the industry is heading
for a fall. At the very least, analysts say, the industry’s leading
firms — Tata Consultancy Services (TCS), Infosys and Wipro, to name
only the three largest — need to do more to adapt their business
models as the industry matures.

The “IT” in India’s IT industry has always been something of a
misnomer. True, most of its more than 1.6 million employees sit in
front of computers, writing software for Western firms, remotely
maintaining their computers and electronically handling some of their
operations. But the business is mostly about people and processes. The
very essence of India’s IT firms is their ability to marshal huge local
work forces to supply high-quality services.

One of their biggest innovations has been to borrow ideas from
manufacturing and apply them to services, by building a sophisticated
human supply-chain, for instance.

They have also focused on certification and continuous improvement
— a result of having to be, at least initially, better than their
Western rivals in order to win business, says Girish Paranjpe, the boss
of Wipro’s consulting arm. Today more Indian than American firms meet
the highest internationally recognized standards for software
development.

All this has enabled Indian firms to take advantage of a rare, if
not unique, set of market conditions. On the demand side, Western
companies needed to cut costs, but their computer systems still
required a lot of human labor. On the supply side, there was an army of
well trained, English-speaking engineers demanding only a fraction of a
Western salary.

Fast fiber-optic links brought both sides together and a favorable
exchange rate made this global connection even more attractive:
customers paid in dollars, and employees were paid in rupees. The
result was a “low-risk, high-margin business,” says Kiran Karnik, the
outgoing president of Nasscom, the industry’s trade group.

To increase sales, firms could hire more people without caring too
much about productivity, with the result that growth in revenue
correlated closely with growth in headcount.

So why the concern? Indian IT faces a host of threats, says Sudin
Apte of Forrester Research, a consultancy, who argues that the industry
needs to reinvent itself. The most immediate difficulty is the rapid
appreciation of the rupee against the dollar in recent months.

Since its low in mid-2006, it has gained 16 percent. This has made a
liability out of what had been a big asset for Indian IT firms —
making most of their sales in America. The strong rupee has also thrown
other structural problems into relief. These fall into three categories.

First come the familiar problems. One is India’s clogged and
insufficient infrastructure: workers in Bangalore can spend four hours
a day in traffic. Then there are the tax breaks that subsidize the
industry, some of which expire in 2009.

There is also a growing talent shortage. Indian engineering schools
award around 200,000 diplomas each year, and produce around 250,000
graduates, but only half are employable by the IT industry.

Employees have learned to switch jobs for better pay, and salaries
are going up by 10-15 percent a year. For senior staff, they will soon
reach Western levels.

Second, competitors are starting to emerge. IT industries in other
parts of the world, such as Central Europe, may never match India’s in
size, but they can still pick off valuable contracts. Meanwhile,
foreign IT firms have been beefing up their Indian subsidiaries.

In 2002 the six biggest — including Accenture, IBM and HP — had
fewer than 10,000 employees in total in the country. Their combined
Indian work force now exceeds 150,000. This enables them to rival the
Indian firms in scale and cost, while exploiting their stronger brands
and international scope.

The third category concerns future threats. In the short term a
slowdown in IT spending looms as America’s economy weakens. In the
longer term Indian firms must keep abreast of technological changes.
Many of the services they now provide will eventually be automated;
this is already starting to happen, for example, in software testing.

Western firms, meanwhile, increasingly want Indian providers to do
more than just keep systems running; they want help in developing new
solutions to business problems — something few Indian firms are set up
to do.

The question is whether the industry’s business model can cope with
these threats even as the potential for growth in its established
markets declines.

According to calculations by CLSA, a French-Asian investment bank,
Indian IT firms will soon have a share of nearly 20 percent of their
addressable market’s value and almost 40 percent of its volume. They
will also struggle to make their existing business more efficient: most
fat has already been cut.

Many think that Indian IT firms need to move into new, higher-
margin services and to cut the link between revenues and headcount, for
instance by offering more consulting, developing more intellectual
property and making acquisitions abroad.

To be fair, the leading firms are already doing this. Infosys now
generates nearly a quarter of its revenues from consulting, says its
new boss, S. Gopalakrishnan; and Wipro recently paid $600 million for
Infocrossing, an American firm, the largest in a series of acquisitions
by Indian firms.

But is the industry moving fast enough? Nasscom’s Karnik says no, but he thinks there is still time to change things.

Partha Iyengar of Gartner, another consultancy, sees more urgency.
He expects slower growth and lower margins if the big firms are not
making most of their money in consulting and other high- margin areas
within three or four years.

This will be hard, he says: today’s focus on people, processes and
profits may keep many firms from reaching the next level. But, he says,
India’s IT firms have shown before that they can change if they really
need to.

Even if the heavyweights stumble, smaller firms are ready to take up
the baton. For example, MindTree Consulting was founded 1999 in
anticipation of the very threats that have now materialized. However
potent these threats prove, they have already demonstrated that for all
the talk of the world being flat, economic gravity still applies.

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