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Software: R&D - slow outsourcing

Feb 17, 2003

Not so long ago, the top rung Indian software companies could be divided into two groups. One that focused on technology solutions and the others that were more focused on business related solutions. At one time, revenues from the telecom vertical were taken as an indication of the company doing high-end work. However, post the technology meltdown, the same is being termed as ‘exposure’, very much the same way that dot-coms are referred to today. While Wipro and HCL Technologies belonged to the elite technology solutions provider group, Infosys and Satyam chose to focus on business related solutions. The investor community, including us, held the companies focused on technology solutions in awe. The strong investment positives were the higher barrier to entry and secondly, with revenues coming from the R&D budgets of their clients, spends were less prone to being lowered during tough times.

However, we are a lot wiser now. The revenues from the technology domain were the worst hit. This is evident from the fact that the domain’s contribution to revenues for HCL Technologies came down from 44% of total to 31% of total, a decline of 18% in quarter ended December 2002. Wipro had a similar story to tell.

Company (Rs m) Quarter ended
December 01
Quarter ended
December 02
Change
HCL Technologies      
Revenues from R&D services 1,766 1,451 -17.8%
% Contribution to revenues 44.0% 31.0% -
Wipro      
Revenues from R&D services 3,105 2,831 -8.8%
% Contribution to revenues 51.0% 38.0% -

The reason for the steep decline in revenues from the technology segment was the troubled telecom clients. The telecom companies can broadly be classified into the telecom equipment (or box) manufacturers and the telecom service providers. The box makers make equipments that move data and voice from one end of the globe to the other in absolutely no time (like routers and switches), while service providers buy these equipments and provide telecom and/or internet services i.e. move data and/or voice (like MTNL and VSNL in India). During the technology boom, as Internet opened new business possibilities, these companies set up huge capacities, committed significant amount of capital and now, are not finding many takers for their products and services. Consequently, their financial statements are looking really ugly. Both the segments of the industry are victims of their irrational exuberance.

However, one hopes that the imperative to bring in customers profitably using new technologies would force companies to outsource R&D work to Indian vendors. Thus, the development costs of new technologies would become lower. Telecommunication technologies have been one of the most dominant forces shaping the face of mankind in the recent past. Business models have evolved around newer possibilities offered by these technologies, and will continue to do so. Thus, the software companies that have competences in this domain are likely to see a lot of business coming in.

However, the growth could be much slower than expected. Many of these companies have chosen to establish their own R&D set up in India to lower costs. This would to a certain (and probably significant) extent lower the quantum of business that is expected to be outsourced to the Indian IT services companies. Further, functions like R&D provide the edge to companies against competition. Thus, sharing technical know how that is almost critical to survival would be something that the global companies may not be very comfortable with. The list of global technology majors that have set up R&D outfits in India include Motorola, Intel, Cisco and Texas Instruments.

In FY02, about 7% of the total software exports came from R&D services. This translated to a growth of 4% from this segment, significantly lower compared to a 19% growth posted by the IT services industry as a whole. While slowdown in the telecom industry was the main culprit, technology majors choosing to do it on their own, may also have contributed to this. Thus, the growth in revenues from R&D services is likely to be much sober. Meanwhile, Wipro’s acquisitions of Ericsson’s R&D centres in India and Hughes taking Lucent’s development team into its fold, shows that the Indian software companies are trying even harder to get a larger share of the pie.


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