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Software: A paradigm shift

Mar 11, 2005

The Indian software industry is one of the most high profile and widely tracked industries of the economy. And not without reason, it must be said. The industry has grown at a scorching pace over the past few years, showcasing Indian technical and managerial talent to the world. It has probably created more millionaires than any other industry, and has been instrumental in giving India some serious economic leverage in today’s highly globalised world, where interdependence among nations is not a choice, but an imperative. With its low cost and high skills base, India has been the destination of choice for global corporations looking to cut costs and become more competitive through creating a sustainable competitive advantage by the strategic deployment of technology in their respective organisations, which is in sync with their overall business objectives. In this article, we attempt to take a look at where the software industry is currently positioned, and where it is likely to go in the future.

At the crossroads?

The Indian software industry is currently at the crossroads. It has, by and large, graduated from lower end services like ‘body shopping’, and has started moving up the software value chain in earnest. The labour cost advantage can only sustain the industry for so long, and no more, and this advantage is slowly but surely petering out, as global software majors recognize the advantages of global delivery pioneered by Indian software companies like TCS and Infosys, and themselves start setting up development centers in India to take advantage of the low cost-high skills factors offered by India. In this regard, the top-rung companies are making sincere efforts to start providing better services to their clients, and delivering more ‘returns per IT rupee/dollar of investment’ to them. Taking Infosys just as an example, a close look at its annual report reveals that an increasing proportion of its revenues are being earned from providing ‘high-end’ services like package implementation, systems integration and IT consulting.

The companies in the industry can be classified into three layers:

  1. End-to-end service providers:  Examples are Infosys, Wipro, TCS and Satyam. These players aim to provide services across the entire spectrum of activities, ranging from custom software development and maintenance, to high-end services like consulting. Read more

  2. Niche players:  Companies like i-flex, Geometric Software and Hughes Software (now known as Flextronics Software Solutions) can be classified under this category. These players are focused companies providing specialised services to a specific industry, requiring a high level of expertise. These companies, being focused on one industry, are relatively high-risk players, and any slowdown in their industry of expertise could affect them adversely. However, the entry barriers are high, and the level of competition in these areas is relatively lower than for services like custom software development, since the level of expertise required is high.

  3. Product companies:  These companies are at the higher end of the value chain, and though revenues from products tend to be volatile in nature owing to factors such as ‘tank size’ and milestone implementations by the company, over a period of time, margins are among the highest in the industry for these players, since revenues from products flow straight to the bottomline after recovering the costs of developing the product. i-flex is an example of a product company.

The BPO factor!

The BPO/ITES industry in India has started coming into its own, growing at a scorching pace of over 50% annually over the past few years. Low cost and high skilled labour, a large pool of English speaking graduates, the strong value proposition offered by outsourcing of non-core processes to India, a unique geographical location that enables 24x7 service offering and reduction in turn around time due to time zone difference, and a regulatory environment that encourages growth and development of the BPO/ITES industry are factors that have contributed to the growth of this industry.


Source: NASSCOM

Since its beginnings in lower-end services like customer call centers, the BPO/ITES industry has matured rapidly. Global corporations like financial institutions, banks, brokerages and investment banks are not averse to outsourcing high-end functions to India, such as equity research and claims processing. They realise that there is a clear value proposition when making the outsourcing decision, and that they would be the losers if they decided to say ‘no’. Thus, doing nothing is not an option for managers making the critical decisions for an organisation, and despite objections to outsourcing due to reasons such as losing control over processes and data, and loss of jobs for the home country, at the end of the day, if the company is not able to cut costs and stay competitive, it will surely perish.

A new wave of thinking has emerged in the industry. Companies no longer see outsourcing as a ‘necessary evil’ just to cut costs. Decision makers are now realising that they need to view the outsourcing function as a strategic business decision, that is aligned to the overall business goals and objectives of their organisation, rather than merely as a cost-cutting measure. It has the potential to provide a sustainable competitive advantage to them, and help them in their quest to stay competitive and gain market share, and grow in size in the highly competitive global marketplace.

Conclusion

Thus, as we have seen, a new paradigm shift is being observed in the industry. Unlike in the beginning, when global corporations viewed India as merely a low cost base, today it is being viewed as something that can actually deliver tangible business benefits to their enterprises, through the strategic deployment of technology in their organisations, aligning it to their business objectives, and viewing it as a long term partnership that will grow and add greater value for both parties.

As far as software companies are concerned, a slow but steady move up the value chain is imperative if they want to compete, and not get bogged down due to certain commoditisation of services at the lower end of the value chain. Services like IT consulting are where the industry needs to aim at, not only to grow in scale and size, but also because of the fact that competition at the higher end of the value chain is lower, since entry barriers are high, owing to the fact that these services require a high level of skills to provide.

The BPO/ITES industry is also maturing fast, and in the near future, as corporations realise the benefits of outsourcing mission-critical functions to destinations like India, we will see companies in the industry get business in high-end functions like payroll processing, equity research, insurance claims processing, HR outsourcing and tax processing. The levels of attrition are also expected to drop as the industry stabilizes, and companies providing higher-end services will benefit, since attrition rates here are typically lower than in other services like call centers.

As we have seen, the Indian software and BPO industries are at a critical phase in their respective industry lifecycles. There are huge opportunities for growth and expansion, and in the next few years, we can only expect to see a higher level of growth in these industries. Companies with scale, size, and a solid reputation of seamless execution will prove to be the key beneficiaries of this growth, and are expected to witness greater increase in business, and hence, provide good value for investors looking for solid, fundamental growth opportunities. Investors, please take note!


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