Financial Daily from THE HINDU group of publications
Sunday, Mar 31, 2002
Info-Tech - Software
Frontline software companies -- Trying to move up value chain
WHAT a difference a year makes? In 2001, the growth rates of the software industry came down from the stratospheric levels of over 80-100 per cent (for frontline companies) to a more reasonable 30 per cent. When Infosys announced in early April 2001 that its revenue growth would be 30 per cent for 2001-02, that was one of the defining moments for the software industry. It established the cyclicality of the industry, almost in line with other industries and forced the frontline players to re-examine their business model. Over the next few months, as the economic downturn in the US worsened, it became obvious to these companies that in the areas of traditional strengths application development, maintenance, migration and re-engineering they were likely to face intense competition and lower billing rates. As the prospect of "commoditisation of software services" began to emerge, it led to a flurry of revenue/earning downgrades by established frontline companies such as Satyam Computers, HCL Technologies and Hughes Software.
However, the industry began to slowly reconcile itself to lower growth rates. In the first few months of 2001-02, Nasscom (National Association for Software and Service Companies), the apex industry body, put on a brave front, asserting that the software industry would grow above 40 per cent. But after the events of September 11, Nasscom lowered its growth projections for Indian software exports to 30 per cent (in rupee terms) and around 26 per cent (in dollar terms). The industry is expected to record revenues of Rs 37,000 crore ($7.8 billion) in 2001-02, up from Rs 28,350 crore ($6.2 billion) in 2000-01.
Transformation of business model
With the commoditisation of the existing markets and no short-term opportunities such as Y2K or e-commerce (with time-to-market considerations) to bolster revenues of frontline companies, the software industry was forced to reinvent its business model this year. After paying lipservice to "moving up the software value chain", for the first time, the industry chalked out growth plans to make this transformation happen. And realising that there are no easy pickings, the industry is assuming a more realistic picture by addressing the issue of growth from multiple flanks:
High-end services: From a broader perspective, frontline companies are aiming to move up the software value chain by focussing on the high-margin segments of IT consulting or systems integration or even high-end business process outsourcing (BPO). For instance, Wipro has spelt out plans to focus on systems integration and IT consulting to target the high-value-added segments in the software value chain. Similarly, Infosys has focussed on the IT consulting market, where it intends ramping up its revenues sharply over the next couple of years. But the ground reality is that even establishing a marginal presence in these segments will take at least two years for most frontline players (unless they resort to a string of high profile acquisitions). And on top of that, these companies are once again switching to the high risk-high return investment paradigm.
Transition opportunities: In the transitionary phase, according to Nasscom, the three areas where Indian frontline companies can channel their energies are processing services, IS (Information Services) outsourcing and packaged software support and installation. It is intriguing to note that the traditional strength of India in custom application development and maintenance accounts for only 5 per cent of the global IT services market aggregating $440 billion in 2001. And the scope for growth outside this area is phenomenal. Processing services are basically back-end work in industry verticals such as finance, insurance or manufacturing. As India has been slowly garnering expertise in different verticals, this segment must be relatively easy to tap and holds a lot of promise in the coming year. Similarly, packaged software implementation and support has seen a relatively strong growth in recent times from frontline companies such as Satyam and Wipro. In the quarter ended December 31, 2001, Satyam recorded nearly 5 per cent growth in packaged implementation services on a sequential basis, accounting for 16.65 per cent of its revenues.
Broadbasing client base: Over the past year, Indian software companies frontline and medium-sized have pitched the offshore outsourcing model to Global 2000 companies, thereby widening the customer base for the industry as a whole. This strategy makes eminent sense, as in the recent downturn, it was the big spenders in the Fortune 500 / Global 1000 space, apart from telecom/hardware majors such as Nortel, Cisco Systems, Lucent, Motorola, Ericsson, Alcatel, Apple Computers and Nokia which had cut their IT spending drastically. Broadbasing the client base to Global 2000 companies in turbulent times may turn out to be the best cushion for better times. Even though client ramp-up may be slow and uncertain for these companies, it still represents a good opportunity for the future.
Focus on verticals/geographies: This growth hiatus also offers software companies the time to further enhance its skill-sets and expertise in high IT service spend verticals such as banking, insurance, financial services, manufacturing, retail and the government.
At the same time, this period will also help these companies scale down exposures in telecom and the investment banking segment of the financial services which were devastated during the recent downturn.
Over the next year or so, the frontline software companies will have to make attempts to penetrate the under-penetrated markets of Japan and Western Europe and Latin America. This will help reduce the excessive dependence on the US for its revenues in the past.
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