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Software Sector Analysis Report

 

[Key Points | Financial Year '13 | Prospects | Sector Do's and Dont's]

  • Global IT spending, which was muted in CY12, picked up in CY13 as the economic situation in the US and Europe improved marginally. Discretionary spending on IT budgets by large global corporations saw an uptick compared to last year but was still far from encouraging. The Banking, Financial Services and Insurance (BFSI) vertical, from which Indian IT companies derive the largest amount of revenue, led the recovery as more global and regional banks invested in IT infrastructure to cut costs and remain competitive. The global spending on technology services in CY 2012 was US$ 1900 bn, a growth of 4.8% over CY 2011.

  • Indian IT companies delivered a modest year in terms of financial performance, driven by an overall improvement in the quality of their service offerings combined with a flat pricing environment. They are now attempting to move up the value chain by providing more end-to-end solutions and engaging more closely with clients.

  • India's IT industry can be divided into five main components, viz. Software Products, IT services, Engineering and R&D services, ITES/BPO (IT-enabled services/Business Process Outsourcing) and Hardware. Export revenues primarily on project based IT Services continue to drive growth with IT Services accounting for 59% of total revenues followed by BPO and Engineering services at 20% and Software Products at 19%. Multi-year annuity based outsourcing agreements are expected to increase going forward. In terms of total export and domestic revenues, Application Development and Maintenance (ADM) still continue to be the bread and butter for Indian <> IT companies, contributing to roughly 60% of their total revenues.

  • Labour arbitrage has been the competitive edge of the Indian software sector over the last few years. However, this seems to be threatened now by MNCs who are replicating the Indian outsourcing model and setting up captive bases in the country. A new trend of 're-shoring' has been observed, where US corporations are increasingly shifting operations, which were outsourced earlier, back to the US.

  • Increasing competition, pressure on billing rates and increasing commoditization of lower-end ADM services are among the key reasons forcing the Indian software industry to make a fast move up the software value chain by providing higher value-added services like consulting, product development, R&D, social media, mobility, analytics, cloud computing and end-to-end turnkey solutions.

  • With the Indian government emphasizing on better technology enabled delivery mechanisms for a multitude of government projects like e-passport, Unique Identification Scheme, along with a big investment of US$ 1 trillion towards infrastructure development, the domestic market connected with software services looks equally promising.


     Key Points


    Supply

    Abundant supply across segments, mainly lower-end, such as ADM. Lower supply in higher-end areas like IT/Business Consulting, but competition is very tough.

    Demand

    Due to the ongoing global downturn, the global IT spending is expected to continue to face pressure. Emerging economies such as India and China have also slowed down.

    Barriers to entry

    Low, particularly in the ADM segment as this is prone to relatively easy commoditization. High in value-added services like IT/Business Consulting and R&D where-in domain expertise creates a barrier. The size of a particular company/scalability and brand-image also creates barriers to entry; as such firms have built up long-term relationships with major clients.

    Competition

    Competition is global in nature and stretches across boundaries and geographies. It is expected to intensify due to the attempted replication of the Indian offshoring model by MNC IT majors as well as small startups.

    Substitution of IT services and products

    IT continues to be a driving force towards all aspects connected with our lives. While a particular technology may become obsolete and a particular company specializing in it may suffer, the obsolete technology can only get substituted by a newer technology offered by the same/different player in the IT/ITES industry.

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     Financial Year '13


  • The Indian IT/ITES industry earned revenue of over US$ 100 bn during FY13. Out of this, exports accounted for 68% of the industry's revenue.

  • In terms of industry, BFSI contributed to 41.2% of the IT/ITES sector's export revenues followed by Telecom, which contributed roughly 19%. All other industries taken together contributed to 39.8% of the IT/ITES sector's revenue.

  • The USA still accounts for roughly 60% of the export revenue followed by the UK and Continental Europe, which together contributes roughly 29%. Other regions such as Asia Pacific are catching up, registering a growth of roughly 18% for exports made to this region.

  • At the end of FY13, total outstanding capex in the IT/ITES industry stood at more than Rs 1765 bn spread over 437 projects.
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     Prospects


  • As per NASSCOM, the Indian IT/ITES industry is expected to maintain a growth of 12-14% in FY2014. NASSCOM has also envisaged the Indian IT/ITES industry to achieve a revenue target of USD 225 bn by 2020 for which the industry needs to grow by about 13% on a YoY basis in the next seven years.

  • Technology research firm Gartner, expects global IT services spending to grow by 4.2% in CY2013 to US$ 3700 bn. Currently India accounts for less than 5% of the global technology spending and this provides huge opportunities for the growth of the Indian IT-BPO industry. However, Indian IT companies are expected to face competition from emerging outsourcing destinations like Philippines, Poland, Hungary, Romania, etc.

  • Emerging protectionist policies in the developed world are expected to affect the Indian IT companies. Due to US restrictions on visas as well as rising visa costs, most Indian IT companies are increasingly subcontracting onsite jobs to local employees in the US. Additionally, a new immigration bill is under consideration in the US which, if implemented, will significantly raise employee costs for onsite workers. This would adversely affect margins of Indian IT companies.

  • Indian IT companies are increasingly adopting the global delivery model. They are setting up development centers in Latin America, South East Asia and Eastern European countries to take advantage of low cost and also cater to the local market. In the US, such centers will help mitigate the risks of the new immigration bill and increase the probability of winning projects in highly regulated sectors such as healthcare, government services, utilities etc.

  • ADM services, which used to provide major chunk of revenues to the domestic IT players, are getting affected due to the falling billing rates. Hence, the companies are now venturing into new high value services such as IT Consulting, Product Development, and end-to-end turnkey solutions.

  • The integration of IT-BPO contracts is expected to become more common, as clients look out for end-to-end service providers. Companies like Infosys, TCS, Wipro, Mahindra Satyam, HCL Technologies and Mphasis, all of which are also into BPO, will benefit from this trend.

  • Billing rates are expected to remain under pressure in the short term. Therefore companies are expected to preserve their margins through effective cost containment measures like shifting more wore work offshore and improving employee utilisation. Lessons learnt during the global financial crisis can benefit them in the long run.

  • Rupee's depreciation against the US dollar and other major currencies is expected to provide relief for Indian IT companies in the near term, offsetting the pricing and demand pressures to some extent.
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