The Indian software story is well and truly on. After going through turbulent times post the bursting of the 'tech bubble', the industry has roared back into contention and in FY05, grew at its fastest rate since the dot-com bust. Offshoring, as a trend, is well established. The very fact that the Accentures and the IBMs of the world are scaling up their own offshore delivery centres in India and other low cost destinations is the biggest vindication of the 'global delivery model'.
Indian software and BPO exports touched US$ 17.2 bn in FY05 and are estimated to touch US$ 22.3 bn in FY06 as per projections by NASSCOM, the industry association. At a recent analysts' conference organised by Wipro, India's third-largest software company, various data points were shown. To substantiate, the total global IT and BPO spending was estimated at nearly US$ 1 trillion in 2005 as per the NASSCOM-McKinsey report published. Of this, the offshore potential is estimated at US$ 330 bn, out of which the actual amount offshored is a mere US$ 30 bn. This is a mere 3% of global IT and BPO spending and less than 10% of the offshore potential. Therefore, the scope for growth is significant, to say the least.
Source: NASSCOM-McKinsey Report 2005
As regards the opportunities ahead for India, the NASSCOM-McKinsey report envisages software and BPO exports to hit US$ 60 bn by FY10, a compounded annual growth rate (CAGR) of 28% over the five-year period. Software exports, which stood at US$ 12.0 bn in FY05, can grow to US$ 35 bn by that time frame, a CAGR of around 24%. BPO exports, on the other hand, have the potential to touch US$ 25 bn by FY10 (US$ 5.2 bn in FY05). In fact, through targeted efforts and expansion of the offshore market and offshorable functions, the total pie can grow by an additional US$ 20 bn to US$ 80 bn.
Source: NASSCOM-McKinsey Report 2005
While we would say that India could certainly achieve these targets, the country also faces certain risks that could spoil the party.
The 'HR' factor - Undoubtedly, this is the biggest threat to India's leadership in the global offshore IT industry. The software industry is a people-intensive one, where quality and skilled human resources are always at a premium. Wage inflation at around 15% annually is very much a reality in this industry, given the fact that demand outpaces the supply. Therefore, attracting and retaining the right talent is the most important aspect for any software company.
While the absolute number of engineers graduating in India is large, a much smaller proportion of them are actually 'employable', This explains as to why companies like Infosys, Wipro and even a mid-sized, niche player like Geometric Software, have set up their own training institutes. This, in our view, is the biggest issue that the industry is facing.
MNC competition - As offshoring has become more and more mainstream, global technology companies such as Accenture and IBM have started to recognise the importance of having centres offshore. In fact, Indian software companies opine that the main reason for these companies going offshore is not because they themselves want to do it. It is more because of client directions! This clearly signifies that offshoring has made many global corporations more competitive and has literally forced the MNC companies to shift to this business model.
Emergence of other low cost destinations - While India is the undisputed leader in the global offshore IT industry, its leadership could be threatened by the emergence of other offshoring destinations such as China, Eastern Europe and South East Asian countries. The low cost advantage may soon be frittered away. The major point to note is that the Indian majors will need to keep on moving up the value chain in order to build on the 'India advantage' platform. Moving to higher-end tasks, such as consulting and package implementation, is the only way to ensure a sustainable competitive advantage for Indian firms at the micro level and India as an offshoring destination at the macro level. Other factors like domestic infrastructure facilities will also influence the cost-benefit analysis going forward.
We remain positive on the Indian software sector from a longer-term perspective. Offshoring as an industry is very much in the 'growth phase' and India is at the forefront of this trend. However, it would certainly be prudent to take into account the above-mentioned risk factors that are likely to impact the industry's growth. As should be the case with any investment, go for companies that are most likely to benefit from the 'offshoring wave' based on factors like management quality, track record of execution and ability to withstand difficult times in business.
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