Indian IT: Yet to sell its point! - Views on News from Equitymaster

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Indian IT: Yet to sell its point!

Jan 6, 2004

As companies from the Indian software sector guard themselves against the onslaught from MNCs setting up bases in the country, one factor that has aided them (Indian companies) arise on account of the difficulties that these MNCs have faced in re-adjusting their cost models to match those of their Indian counterparts. Indian software companies have had advantages on the cost front and, thus, it has been taking hard-drawn efforts from the MNCs to compete Indian firms in this area. However, the question that lingers now is in what time would these MNCs be able to replicate fully the Indian outsourcing model, thus nullifying all advantages that the Indian firms have on the cost front.
CZNT (Cognizant), CKPT (Checkpoint), MSFT (Microsoft)

Let us take the example of selling, general and administrative (SG&A) expenses. As seen from the graph above, the Indian software major, Infosys has the lowest of SG&A expenses (as a percent of FY03 revenues) as compared to its global peers. The SG&A component forms a major proportion (after employee costs) of the total costs of software companies, and it is indicative of the initiatives that they are taking in improving their delivery and administrative capabilities. While Indian software companies (like Infosys) have had historically lower levels of SG&A expenses when compared to the global majors, the reason for this is their low level of penetration in the global markets. As a matter of fact, Indian software exports form just over 2% of the global market, and as the size of Indian software companies increase, it would be preceded by rise in their expenditure levels to global standards. The change can already be seen in the rise in employee costs for Indian software firms. SG&A expenses do not seem to be left behind.

While these benefits on account of relatively lower expenditure levels have helped Indian software companies in maintaining higher operating margins than their global counterparts, this advantage is likely to be nullified in times to come. This is mainly due to rising salary levels and continued initiatives by Indian software companies in increasing their reach across the globe by establishing development centres and selling and marketing infrastructure. This would help these companies in gaining a larger share of the global pie, thus making them eligible to garner mission-critical contracts (remember, balance sheet size is an important factor in winning large and high-value contracts).

** includes hardware business

Now, take a look at the revised graph above. While Infosys is at the lowest end of the SG&A spectrum, its operating margins are not the highest of the group. Companies like Oracle and Checkpoint have higher operating margins than Infosys. This is because these two companies have presence in the high-end segments of software products. While Oracle has a presence in the enterprise segment, Checkpoint provides solution for the Internet and networking segments. Also, operating margins for companies like Microsoft are lower because they invest a lot in their R&D initiatives, which is a key factor in establishing strong domain presence for software companies.

Taking cue from the changes that increasing global competition is bringing, many Indian software companies are moving from competing just on the cost front to improving their domain competencies (like establishing greater presence in high-technology telecom and financial services verticals) to compete with global majors in their territories. Some, like Infosys and Wipro, have succeeded to an extent in this endeavour. However, for other Indian companies to make a mark on the global scale, it would require a Herculean effort. They cannot rely on the cost arbitrage advantage for long. And if they do so, investors, better keep a watch!

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