It recession
- 1. Global economic slowdown and its impact on the Indian IT industry April 2009
- 2. Contents Executive summary 3 1. Current global scenario & the uncertainties involved 4 2. Structure of the global IT industry 5 3. Structure of the Indian IT industry 7 4. Impact of the recession on the IT sector of the Indian economy 9 5. Future outlook 14 6. Conclusion 18 Contacts 19 2
- 3. Executive summary The current global economic slowdown has its epicenter Interestingly, the Indian IT / ITES sector has so far been in the United States (US) but the contagion is being resilient in spite of the global slowdown. Part of this is witnessed in all major economies of the world. Several due to the segmentation in the Indian IT / ITES sector countries are experiencing rapid contraction in their whereby some of the firms are the back office support Global Domestic Product, rising unemployment levels service centers of large global multinationals while the and an overall slowdown in the pace of investment other is the indigenous IT service companies of Indian activity. What started as a shock in the financial markets origin. While the current slowdown has impacted the has spread to all sectors of the world economy and the indigenous IT companies business in India, a part of exact depth and breadth of the impact is still unclear. this has been offset by a greater amount of business flowing to the captive units of foreign companies India’s economy has been fuelled by the growth in operating in India owing to the pricing and margin the technology sector in the recent past. A large part pressure in their local markets. of this growth is dependent on the “outsourcing” or “off shoring” of key business processes and software The indications are also that the next decade will be development activity (and related services) by large very different from the last one, with structural shifts global corporations and other organizations. Hence, the in demographics that will reflect more prominently in global slowdown has also affected the business climate international trade and economics. Technology evolution within India and the growth rate of the Information and adoption is expected to witness some disruptive Technology (IT) and Information Technology Enabled changes as the Internet generation takes over the Services (ITES) sector is also experiencing the tremors workforce. of the global recession. The Indian IT software and services industry which has seen a Compounded Annual Experts suggest that the performance of the Indian IT Growth Rate (CAGR) of around 30% over the last three software and services and ITES industry, while impacted or four years is now projected to grow at 20%. Indian by US economic slowdown, will be catalyzed by a IT sector’s derives approximately 61% revenues from revival in technology spending during the first half of the US based clients. The revenue contribution from US 2009. There are some offsetting factors softening the clients to the top five Indian IT companies (who account revenue slowdown - favorable Rupee-Dollar exchange for 46% of the IT industry’s revenues) is approximately rate expected to lead to higher INR revenue growth 58%. Hence, the impact of the slowdown in the US is figures during the year, growth de-risking through other likely to have a deep impact on the prospects of the emerging markets, growth in non-financial verticals, Indian IT sector. and growth through countercyclical new business initiatives. Moreover, about 41% of the IT industry revenues in India are estimated to be from financial services. Since this sector has been affected most severely in the current climate, the impact on Indian companies catering to this sector has been (and will continue to be) more acute. The margins are prone to be challenged on account of the slowing growth in the US and European Banking and Financial Services Industry (BFSI) sectors. 3
- 4. 1. Current global scenario and the uncertainties involved As 2008 ended, predictions of where the world • All stock exchanges across Asia / Pacific have been economy is heading turned dire. The World Bank directly impacted in a significant way, with an average projected world output to grow by a mere 0.9% in 2009 loss of 45% from November 2007 through October (as compared with 2.5% in 2008 and a high of 4% in 2008 2006) and world trade to contract by a significant 2.1% (compared to positive rates of growth of 6.2% Impact on exchange rates in 2008 and a high of 9.8% in 2006). Asia Pac is likely • Currency exchange rates have been affected, but to witness a sharper fall in the growth rate, i.e. from on a more-isolated basis. Australia, China, New 13.4% in 2007 to 5.5% in 2010E in comparison to the Zealand and Singapore are experiencing drops in their world growth estimated at 6.3% in 2010E from the currency against the U.S. dollar 2007 figures of 9.7%. • In addition, India has seen its currency increase The overall impact of the global financial crisis has substantially and later fall against the U.S. dollar been felt in Asia / Pacific in terms of the local stock exchanges and currency exchange rates and lower • As a result, there is an assumption that there will be GDP growth forecasts for 2009. some impact on IT spending across Asia / Pacific due to the increase in the cost tied to the technology Impact on stock market spending • The year 2008 saw the credit crisis push several major economies, with banks particularly being badly hit The global outlook is bleak and recovery is still far. - many requiring government bail-outs. Shanghai The current global financial turmoil has hit almost all the which had soared more than 300% in 2006 and 2007 economies around the world deeper than anticipated. had its share values wiped nearly by $3 trillion (£2.1 Industries globally are impacted by the slowdown. The trillion) turmoil is taking a toll on the global IT industry – one of the leading contributors to the global GDP, led by • Japanese shares also suffered their biggest yearly uncertainties in the demand environment in both decline, with the Nikkei dropping 42% as world’s new and existing businesses. Hence, there appears to second-largest economy slid into recession be a reason to fear that the crisis will swamp emerging markets and other developing countries, cutting into the • India’s main index sensex plunged nearly 50% during considerable economic progress of recent years. the year. All global markets saw record falls in 2008 as the financial turmoil and economic slowdown ended the stock market boom Indian equity market on a ‘free fall’ 600 500 400 300 200 100 0 04 04 05 05 05 06 07 07 08 08 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Brazil China Chile India Argentina Hungary Source: Forrester report 4
- 5. 2. Structure of the global IT industry Growth of global IT economy The Western and Central Europe markets will have The global IT industry has matured over the years and growth in local currency that is closer to 1%. By 2010, has emerged to be a chief contributor to the global the US market will shift to 7.3% growth, not far behind economic growth. The global IT sector, constituted the 9.5% growth in the other Americas, well ahead of by the software and services, Information Technology the 5.5% growth in Asia Pacific and 5.3% growth in Enabled Services (ITES) and the hardware segments, has Western and Central Europe. been on a gradual growth trajectory with a steady rise in revenues as witnessed in the past few years. 2008 was a strong year as the number of contracts; the total value and the annualized contract values exceeded that of the preceding year. Among all users above average growth The global IT sector, constituted was witnessed in the government, healthcare and the manufacturing segments. by the software and services, The global software and services industry touched Information Technology Enabled USD 967 billion, recording an above average growth of 6.3% over the past year. Worldwide ITES grew by 12%, Services (ITES) and the hardware the highest among all technology related segments. Hardware spend is estimated to have grown by 4% from segments, has been on a gradual USD 570 billion to nearly USD 594 billion in 2008. growth trajectory with a steady Currently, the global IT industry is experiencing a slump with the recessions in the US and many industrial rise in revenues as witnessed in countries with the level of impact varying by country / market and industry. the past few years Forrester in its recent report has predicted that the US IT market will dip to 1.6% in 2009, down from 4.1% growth in 2008 (see figure below). The Asia Pacific region, using a weighted average1 of local currencies, will do a bit better in 2009, with 3.1% growth. 16.0% 14.0% 12.0% 10.0% 8.0% 8.0% 7.3% 6.0% 5.3% 5.5% 4.0% 5.3% 4.8% 2.0% 0.0% 2005 2006 2007 2008* 2009* 2010* US in US dollars Western and Central Europe in euros Asia Pacific in weighted averages of currencies Source: Forrester report 5
- 6. Global scenario - IT purchases The global IT purchases are expected to plummet as As it stands, the US market accounts for majority of strong dollar would hurt dollar-denominated growth the global purchases of IT goods and services. The US rates for IT purchases going ahead. The British pound market which represented 37% of the global market was 23% lower in Q4 2008 from the year-ago level, the for IT goods and services in 2005 had shrunk to 33% Indian rupee is down 20%, the Canadian dollar is 19% share in 2008. Western and Central Europe would see weaker, and the euro is down 9%. Only the Japanese its share of global IT purchases fluctuate between 26% yen and the Chinese yuan renminbi have gained in value and 28% between 2008 to 2010; Eastern Europe, the against the US dollar. While these currency swings are Middle East, and Africa and Asia Pacific are expected to likely to reverse in 2009 as the financial crisis fades, the hold their share positions. dollar is still likely to remain above 2008 levels for most of the year. That will dampen global IT market Total IT purchase (by value) 2008* growth measured in dollars and hurt the reported revenues of US vendors like Accenture, Hewlett-Packard (HP), and IBM with large overseas operations. With global tech market in US dollars likely to shrink, global IT vendors’ revenues is expected to equal $1.66 Asia Pacific trillion in 2009, declining by 3% after an 8% rise in 26% United State 2008. The Asia Pacific region has been a major 33% growth engine for the tech industry. Its total purchases of IT goods and services of $448 billion in 2008 were almost as large as Western and Central Europe’s. Countries like Hong Kong, India, Malaysia, Singapore, Others South Korea, and Taiwan, have seen growth slow as 13% exports to the US and Europe slowed. Western and Central Europe 28% Asia / Pacific would experience a delayed impact of the global financial crisis. Gross Domestic Product (GDP) growth is expected to slow in most countries / markets in 2009, which will affect IT spending. Asia / Pacific is Source: Forrester report still growing more aggressively than other regions in GDP and in IT. As a result, vendors would be looking to this region for growth and stability. Asia / Pacific is still growing more aggressively than other regions in GDP and in IT. As a result, vendors would be looking to this region for growth and stability 6
- 7. 3. Structure of Indian IT industry The IT-ITES industry in India has today become a growth • Ease of scalability engine for the economy, contributing substantially to The vast and trained labor pool of technically increases in the GDP, urban employment and exports, competent, English speaking people has made it to achieve the vision of a powerful and resilient easy for the Indian companies to enter and exit this India. While the Indian economy has been impacted industry. Moreover, the ease with which a company by the global slowdown, the IT-ITES industry has can scale its operations (up or down) has been a great displayed resilience and tenacity in countering the value driver for the success of the Indian IT / ITES unpredictable conditions and reiterating the viability service sectors growth story of India’s fundamental value proposition. Performance of the Indian IT-ITES industry Value proposition The information technology sector has been playing a The main reasons for the successful establishment of key role in fuelling the Indian economic performance software companies in India and its strong performance which has been stellar with robust GDP growth. India’s can be attributed to the following: total IT industry’s (including hardware) share in the global market stands at 7%; in the IT segment the • Cost advantage share is 4% while in the ITES space the share is 2%. Given the labor market conditions in India, there The industry is dominated by large integrated players exists substantial scope of cost arbitrage for consisting of both Indian and international service performing services from India. This, along with a providers. During the year, the share of Indian providers large pool of talented and English people labor force, went up to 65-70% due to the emerging trend of was the genesis of the IT sector’s dominance in the monetisation of captives. MNCs however, continued to world IT services industry make deeper inroads into the industry and strengthened their Indian delivery centres during 2008. • Breadth of service offering and innovation Service offerings have evolved from low-end The continuing contribution of this sector to the application development to high-end integrated IT Indian economy is evident from the fact that revenue solutions generated from this sector has grown from 1.2% in FY 1998 to an estimated 5.8% in the FY 2009. The net • Quality / maturity of process value added by this sector to the economy is estimated Having made its mark as a center of low-cost and at 3.5-4.1% for FY 2009. wide range of service offerings, the Indian IT / ITES sector has also proved its mettle in the quality of the service offerings, as demonstrated by the fact that it hosts more than 55% of SEI CMM level five firms and the highest number of ISO certified companies 7
- 8. Some of the key highlights2 of the Indian IT / ITES target destination for multinationals to back end their IT industry for FY 2009 are enumerated below: operations in India owing to its strong value proposition. We have witnessed an increased use of offshoring by • The export revenues are estimated to gross USD 47.3 global and European outsourcers, and the emphasis on billion in FY 2009, accounting for 66% of the total productivity and delivering value by select Indian players. IT-ITES industry revenues • IT services exports grew substantially on account of The Indian IT / ITES sector can be viewed from two increasing traction of the industry in emerging markets perspectives - Indian global IT and Indian IT offshorer. such as remote infrastructure management and The globally IT companies are increasingly looking traditional segments such as application management inwards and focusing on process benchmarking, • Domestic market continued to gain momentum, enhanced utilisation of infrastructure and talent, growing at 26% in INR terms on account of the increasing productivity and greater customer overall positive economic climate, increased adoption engagement. global companies with roots in India are of technology and outsourcing increasingly ‘offshoring’ work in order to cut cost, as a • Engineering services and software product exports result of which India is witnessing a revenue growth. increased by 29% (USD) • Direct employment reached nearly 2 million - with On the other hand, as the offshore market is getting 1.5 million in the exports segment, a YoY increase tighter, the Indian IT offshorers are facing hard times in of 26% in 2008. The indirect employment multiplier getting contracts or replenishing their orders. The crisis suggested that the industry created between 6-8 in the U.S. financial services sector will have an impact million additional jobs in the short term on Indian outsourcers, as new projects • US and UK together constituted 79% of the global may get delayed. This has impacted the revenue flows exports in FY 2008 thereby dominating the export and would need a substantial increase in SG&A to markets ramp up their volumes. • BFSI remained the largest market followed by Hitech / Telecom which together accounted for more than In spite of the negative effect of the outsourcing 60% of exports business, there has been relatively lesser impact on the Indian IT growth due to the offsetting effect of Global IT and Indian IT offshore the favorable revenues on account of the global IT Today’s escalating, competitive and demanding offshorers. environments have forced companies to be more efficient, operate leaner and continuously create new procedures to keep ahead of competitors - adding final consumer value to a product or service in the form of lower prices, quality and better service has become an essential requirement in the global marketplace. Corporations are trying to adapt with increasing India has become a target competitors’ innovations to find global opportunities and resources, focusing on core competencies and destination for multinationals to mutually beneficial relationships, and finally, outsourcing those activities which can be performed more quickly back end their IT operations in and at lower costs by subcontractors. In a globally integrated economy, outsourcing is leading to overall India owing to its strong value benefits for the source economies, providing significant monetary and employment benefits. India has become a proposition 8
- 9. 4. Impact of the recession on IT sector in the Indian economy The current global economic slowdown has made it a roller coaster ride for the world economies. Asia / Pacific is experiencing a deferred impact due to the “domino effect” of the current crisis. With the expectations of a sluggish GDP growth and consequent reduction in IT spending, countries / markets which have a higher dependency on the export markets are expected to be affected more than other countries / markets with stronger domestic demand. India being one of the world’s fastest-growing tech markets, thriving mainly on exports is also experiencing the tremors of the global economic crisis. IT spending as a percentage of revenue normally varies from 3.5% in manufacturing companies, 5-6% in global retail chains to about 9.5% in the banking industry. These could see marginal decline as companies will tend to hold spends on new IT deployments. A recent study by Forrester reveals that • 43% of Western companies are cutting back their IT spend and nearly 30% are scrutinizing IT projects for better returns. Some of this can lead to offshoring, but the impact of overall reduction in discretionary IT spends, including offshore work, cannot be denied • The slowing U.S. economy has seen 70% of firms negotiating lower rates with suppliers and nearly 60% cutting back on contractors. With budgets squeezed, just over 40% of companies plan to increase their use of offshore vendors • The IT services and outsourcing market is currently undergoing a structural transformation that will have a profound effect on how IT service providers will have to conduct their business Customers have started to reduce project scope and / or postpone new development. However, they are also trying to move more work to lower cost offsite locations, which could increase IT budgets towards tangible cost saving measures. 9
- 10. The impact is likely to be higher for discretionary This clearly indicates the adverse effect that the US outsourcing expenditures rather than for critical, recession is likely to have on the Indian IT sector. The ongoing Application Development and Maintenance industry has been constantly seeking to diversify its (ADM) services. Indian IT companies3 which are focused markets to offset its reliance on the US, which remains more on providing basic ADM services, and with long the largest outlet for India’s software sector. term outsourcing contracts, could exhibit more stable earnings in this environment. Furthermore, whilst The impact has been more severe in the case of the discretionary expenditures are being reduced, ongoing Banking, Financial Services and Insurance (BFSI), projects will likely continue, at least in the near term, which accounts for around 40% of the industry’s export especially those which are in the more advanced stages revenues, and in retail and certain manufacturing of progress. Fitch expects IT services companies to sectors. Other verticals like telecom and automobile are report marginally positive revenue growth (in dollar also likely to have a delayed budget process and budget terms) over 2009. cuts. However, the industry focus is likely to shift to areas such as manufacturing, healthcare, retail and With decisions on IT budgets being deferred and utilities. Healthcare industry is likely to witness increased sales cycles having elongated from 3-6 months to 6-9 IT investments due to increased focus on public health. months, companies are seeing a significant drop in client Other industries that will see growth include telecom, additions. Moreover, the number of targeted large deals retail and utilities. has more or less dried up. According to TPI4, mega deals have fallen to levels lower than those seen in 2001. Some vendors who have a greater exposure to BFSI segment will be more impacted when compared to their Verticals counterparts with less significant exposure (table on next The current US-led crisis parallels the 2001-2002 page). The effect of this crisis would be more evident in Dotcom Bubble burst especially for India’s IT (export) the coming quarters. The overall revenue impact on the sector. Approximately 61%5 of the Indian IT export’s IT and ITES industry, as a result of the BFSI meltdown, revenues are from US clients. If we consider the top five could be anywhere between $750 million and $1 billion. India players who account for 46% of the IT industry’s revenues, the revenue contribution from US clients is approximately 58%. 45% 40% 40% 39% 35% 30% 25% 22% 20% 19% 15% 15% 13% 10% 8% 5% 5% 4% 3% 1% 0% FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 BFSI Manufacturing Healthcare Construction and utilities Hi-tech / telecom Retail Airlines and transportation Others Source: NASSCOM 10
- 11. BFSI share Exposure of BFSI (in USD million) Companies Key BFSI client (%) * Jan-Mar 2008 Apr-Jun 2008 Change (%) American Express ,Citigroup, Credit Suisse , Cognizant 46 292.4 314.2 7.46 JP Morgan, Metlife ABN Amro, Bank of America ,JP Morgan, Infosys 34 387.1 398.5 2.94 Washington Mutuals ,UBS AIG, American Express ,Bank of America, Citigroup, TCS 42 664.4 648.2 -2.44 Deutsch Bank, Fortis, JP Morgan, Merrill Lynch Wipro 25 256.8 271.1 5.57 Credit Suisse, Lehman Brothers, UBS *As a percentage of total revenue; BFSI contribution sourced from company reports ,BFSI clients from equity analysts • Infosys - The revenues from BFSI that were at 37% in Impact of exchange rate on revenues June 2003 have stayed more or less unchanged as a In IT sector, the margins are likely to be challenged percentage of total revenues. In the December 2007 on account of the slowing growth in the US. Rupee quarter, Infosys got close to 37% of its revenues from depreciation seems to be the only tailwind that the BFSI. This slipped to 34% of revenues in the March sector enjoys. This can be evident from the fact that the 2008 quarter. In the quarter ending December 2008, out of the increase in the IT export revenues for FY 2008 BFSI showed a sequential growth of 4% in volume over FY 2007, almost half of the increase could be attributed to the rupee depreciation during the same • Wipro - India’s third-biggest software exporter, and period. Cognizant, ranked sixth, have seen revenue from the key Banking, Financial Services and Insurance (BFSI) Pricing poised for decline in favour of volumes vertical rise by about a fifth between Oct-Dec 2007 Pricing has been difficult in this sector compared to and July-Sept 2008 other sectors: On an average, the US financial sector has driven bulk volumes through lower onsite pricing, higher • April-June 2008, Cognizant recorded the highest offshoring and aggressive volume discounts. It is safe to growth from financial services vertical among the infer that BFSI application business margins especially in offshore peers. This was mainly due to the type of the top companies are a few percentage points below financial services clients in the portfolio and the the higher margin verticals like, say, energy. Hence, multiple operating levels (table above) a replacement of financial services business with business from other verticals is likely to positively • Tata Consultancy Services, for example, earned 42% impact the bottom line. A speedy replacement is of its revenue in the second quarter of CY 2008 from however, easier said than done. the BFSI 11
- 12. Volumes are expected to remain weak over the next Volume Price three quarters for most players forcing further price 7500 15 cuts. The reduction in pricing is expected to be lower in 13 magnitude compared to FY 02-FY 03. This is because Pricing poised for a fall as volumes decline 7000 11 the current pricing has not touched the FY 02-FY 03 9 bubble proportions. Infosys has already reported 1.8% decline in blended pricing (constant currency) in Q3 FY 6500 7 09 while HCL Tech announced free transitioning for 5 deals amounting to $1billion bagged during the quarter 6000 3 as a strategy to garner volumes. TCS and Wipro too 1 Volume growth aided by a declining pricing regime have acknowledged pricing pressures and the impact 5500 -1 would be more visible in the coming quarters. -3 5000 -5 Fitch Rating expects the sector to face margin Q1 FY 02 Q1 FY 03 Q1 FY 04 Q1 FY 05 Q1 FY 06 Q1 FY 07 Q1 FY 08 Q1 FY 09 pressures over 2009 and 2010 due to the intensified competition for new contracts, thereby putting pressure on billing rates. Competition even for smaller contracts Blending pricing has increased, as companies try to maintain utilisation Volume growth levels. Customer cost pressures could also result in re- Source: Centrum research negotiations of maturing contracts at lower terms. There could also be an increased shift from traditional hourly billings towards a new return on capita based price Fitch believes that the large Indian IT players will gain contracts providing tangible savings, while variable market share. However, these risks to operating margins time / material contracts could be renegotiated at lower are partly offset by the fact that Indian IT services levels. Vendor consolidation will be the order of the day retains some flexibility in terms of their cost model. in the current environment, as this would result in cost As the impact of the slowdown becomes more severe, savings for customers. companies will increasingly look at cutting costs in the form of overheads and reduction in variable pay / annual increments. The industry has also been reducing its hiring, as well as changing the hiring profile to ensure that operating costs are in control. The US financial sector has driven bulk volumes through lower onsite pricing, higher off shoring and aggressive volume discounts 12
- 13. Hiring trends The Indian IT industry witnessed plunge in all the three segments – IT Services, ITES and domestic market, as depicted below: 80% 69.81% 70% 60% 50% 40% 30% 20.59% 20% 15.74% 12.83% 10.09% 11.11% 10% 0% FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 IT services ITES Domestic market Source: NASSCOM The above graph depicts the decline in the employee numbers over the years in all the three sectors viz. IT services exports, ITES exports and the domestic market. The ITES segment witnessed the greatest plunge from 69.81% in FY 2003 to 12.83% in FY 2009. The high attrition rate coupled with the current gloomy economic scenario can be the reasons attributed to the massive fall in the numbers. 13
- 14. 5. Future outlook Fogged out The current situation however looks fogged out, with 2008 was a transformational year for the Indian no clear visibility. Some hitches faced by the IT industry Information Technology-Information Technology are; Enabled Services (IT-ITES) sector, as it began to re-engineer itself to face the challenges presented • Uncertainties high: Churn in client base, elongated by a macroeconomic environment which witnessed sales cycles and headwinds from a harsh currency substantial volatility in commodity prices, inflation, environment render high uncertainties for IT and decline in GDP rates, cross-currency movement, companies finally culminating in the economic downturn. In an increasingly globalised world, significant complexity and • Signs of revival in the US appear bleak, at least uncertainty is getting attached to this unprecedented in the near future: Conference board’s 10 Leading economic crisis. The Indian economy has also been Economic Indicators (LEI) continue to be negative, impacted by the recessionary trends, with a slowdown showing no signs of near term revival in GDP growth to 5%. The focus and exponential growth in the domestic market & presence of global • Price cuts to hit margins: With volumes drying up, IT offshorers has partially offset this fall, resulting companies are expected to cut pricing in favour of in net overall momentum. The slowdown is expected volumes to persist, as lead indicators of US economic health (the US accounts for 40% of global IT spend) continue • Revenue visibility fogged out: IT companies to be extremely negative. That being said, India may normally have a one year revenue visibility of >60%. be better positioned for a quick recovery and for However, with an already stressed client base, given future growth than many of the other developing the prevailing tough environment, revenue visibility economies. There is a sense that the international appears fogged institutions will be remade to reflect the current balance of power, and that India may be able to turn this crisis • Uncertainties weigh on valuations: Current into “a permanent place at a new high table”. valuations factor in the rapidly deteriorating environment and the same is expected to remain depressed until companies improve revenue and volume growth 14
- 15. • Powerful forces are driving change in the IT The belief is that there is a strong correlation between services market, including: India IT sector revenue growth and US GDP growth, • The current tough economic condition is driving which implies that a revival in revenue growth would many companies to look to outsourcing as primarily coincide with an uptick in US economic growth. The 10 a cost-cutting initiative. To meet their needs the possible indicators in this sector to track are: providers are now investing in delivery centers around the world beyond India, although it remains 1) Working hours as the leading offshore services destination 2) Jobless claims 3) New orders for consumer goods • The current economic condition spares no vendor. 4) Vendor performance Even the growth of the once highflying Indian 5) New orders for capital goods providers has moderated considerably, driving many 6) Building permits to further their efforts and focus on the European 7) S&P 500 market 8) Money supply 9) Interest rate spread • Cloud computing and SaaS paradigms are 10) Consumer expectations redefining how computing resources can be accessed and paid for An economic downturn / recession places high stress on the business and the IT organization. There are • The boundary between software and IT services different stages to a downturn, and there are ways business models are blurring, leading to each to foresee them and manage them. The first stage encroaching on the other’s space experiences decline in economic output numbers like GDP, corporate earnings, asset values and diminishing Signposts to a revival return on investments, as markets start to slow. In The IT market is currently undergoing a structural the second stage although the signals are marked transformation that will have a profound effect on how by denial, fear and pessimism, the regulators of the IT service providers will have to conduct their business. economy try to pump in measures to tide over the Market forces of commoditization, miniaturization, negative sentiment and manage the crisis, with the industrialization, and globalization, along with changing result of gradual improvement in customer expectations, buyer sentiments, would accelerate a shift in the increase in demand and resultant rise in employment dominant form of IT delivery in the coming years - from levels. The following stage is characterized by the buyers self-integrating technology to outside providers increased confidence and growth in customer orders, assembling and managing it for them. As service increase in consumption and rate of earnings which providers prepare for these changes, they are looking to provides breathing room to invest in growth projects. redesign their solutions portfolio. 15
- 16. The major changes organizations must make between • India is also fast becoming a hot destination stages are a focal point of risk and opportunity for the for outsourced e-publishing work. As per a business. Figure below illustrates the recovery cycle Confederation of Indian Industry (CII) report, the with productivity on the y-axis and time on the x-axis. industry is growing at an annual rate of 35% and Productivity decreases during a full blown recovery India’s outsourcing opportunities will help make the as companies start piling up their work force and publishing ITES industry worth US$ 1.46 billion by capacities in anticipation of demand. The chart shows 2010 a recovery after Q2-Q3 FY 10. • With growing interest in utility type models, software and IT services business models are converging Employment with software companies, incorporating IT services growth and software as a service (SaaS), while IT services Increasing working hour providers are architecting and selling asset-based offerings that do not rely solely on leveraging labor Interest rate as the underlying ingredient for revenue and profit Productivity spreads show margins a bull steeping • Virtualization will tend to be a growth catalyst in Improving data on new the software market and open source software a Improving consumer orders for consumer possible alternative to the proprietary software which expectations and goods, capital new building permits, goods and vendor is still perceived as the more-expensive option expanding money supply performance Looking Ahead Recession As we look ahead India would recognize need for 03 FY 08 03 FY 09 02-03 FY 10 transformation and change. Indian IT services industry Time landscape has graduated from being a low value Source: Centrum research long term services provider offering cost and labour arbitrage to provider of high value one time / Few emerging trends long time services such as discrete and end to end • Verticalisation of IT services is a definitive emerging outsources facilitated by its scalability. trend and users are demanding services tailored to their needs. Mature IT customers are today looking Expansion into tier 2 / 3 cities can reduce pressure. for total solutions that can solve their business Currently there are seven centres that account for over challenges rather than at IT hardware, software, and 95% of exports. By 2018, it is forecasted that 40% of IT services as discrete elements / ITES exports will originate from non-leader locations. The potential of near shoring needs to be tapped fully, • The sector is also eyeing remote infrastructure as customers are on the lookout for the geographically management services “as the next big opportunity” close and culturally similar centres. after the success of ITES. India is “well positioned to capture a disproportionate share of this growth Key global sourcing drivers will continue to be cost, by 2013 that is about $ 13 to $ 15 billion out of the access to talent, business improvements, increasing total potential annual revenue of $ 524 billion, from speed-to-market and access to emerging markets. The the current share of $ 6 to $ 7 billion”, a report by future outlook for all these drivers is positive, leading to Nasscom and McKinsey said increased momentum for global sourcing. 16
- 17. India’s exports have been hit due to the global financial The BFSI sector one of the largest spenders on IT and crisis. India has a large domestic market that can help one of the worst hit in the current economic slump. to offset the export business. Gartner expects some With the trouble brewing in the BFSI sector, the industry impact on IT services providers that rely on offshore focus is likely to shift to areas such as manufacturing, discrete projects coming in from the U.S. and Western healthcare, retail and utilities. Europe where projects are being scaled back or cut. To counterbalance the offshore work, these IT services Indian service providers are increasingly engaging in providers will most likely focus on India. M&A activity as they seek to expand their customer base into new geographies. India-based providers India’s burgeoning domestic market, fuelled by the demonstrated in H1 2008 an appetite for making economic growth will be a one of the focal points acquisitions, particularly in geographies or countries for the IT sector in the coming days. As the Indian where they wanted to grow their customer base. economy further opens up, other verticals including Companies like Wipro, TCS, and Infosys were all near manufacturing, travel and tourism, healthcare and the top of the list of most actively partnering service entertainment will increasingly look towards IT to providers; between them, they account for 41% of all increase competitiveness. For both new and existing the partnerships. verticals, the Small and Medium Business (SMB) segment will represent an important source of growth for the Sustained demand, robust fundamentals and a domestic IT services market. supportive business environment will help realise the significant potential the IT-ITES industry offers, both for While the 2009 outlook for global technology related exports and the domestic market. The Indian IT-ITES spending is affected by the recessionary environment, industry is now at a critical point in its evolution. Behind a rebound is expected from 2010 onwards. The it stands a decade of stellar performance which has opportunity for India is tremendous since currently it left a deep imprint on the Indian economic and social accounts for just over 4 % of worldwide technology landscape. Moving forward, it faces a transforming related spend. Additionally, growth in global sourcing macroeconomic environment, rapidly changing is estimated to be almost four times that of technology customers and needs, evolving services and business related spend. India currently generates the bulk of its models, and rising stakeholder (employees, investors) IT-ITES revenues from the US, and the BFSI sector, while aspirations. These forces are expected to redefine the accounting for a miniscule part of technology spend in nature of demand and supply for the industry, and also other geographies and verticals. redefine the strategic imperatives for businesses in 2009. Indian economy further opens up, other verticals including manufacturing, travel and tourism, healthcare and entertainment will increasingly look towards IT to increase competitiveness 17
- 18. 6. Conclusion While there are growth-related challenges in the short- All in all, the environment looks weakest in a long while, to-medium term, there seem to be some opportunities and yet there remain pockets of opportunity. These for managing the bottom line for the rest of the year. areas, if tapped intelligently, would enable the IT firms The macroeconomic environment is depressing and to ease the blow of this financial crisis and help them has impacted the overall confidence in the sector from tide through the tough times. The crisis has now spread a market perspective. A US recession, in all probability, globally, and further reduces room to maneuver. will last through 2009 and more, in making this period a challenging one for growth. To conclude, we are tempted to use a popular aphorism; the Chinese character for “Crisis” represents two Despite the foreboding financial crisis, the opportunities symbols “Danger” and “Opportunity“. The choice is are massive. Making the growth vs. profitability trade-off ours. early on during the slowdown is just one of them. Profitability levers are still available if growth is sacrificed where required, and managed well. Endnotes 1 The weighted average of local currencies has been used considering a basket of local currencies in the Asia Pacific region, weighted for each region’s share of the global IT market to neutralize the impact of currency changes 2 As per NASSCOM factsheet updated Feb 2009 Mindtree Limited, IBM India Private Limited and Tech Mahindra Limited 3 4 TPI is a leading global sourcing advisory firm 5 As per NASSCOM factsheet updated Feb 2009 18
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