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Software: Opportunity in outsourcing

Apr 3, 2002

In an unprecedented move, Tata Chemicals outsourced its complete IT requirements to Tata Consultancy Services. Most of the Tata Chemical employees were transferred to TCS payrolls and the company now maintains a very lean IT department. Corporates in the west have most of mission critical applications running on legacy systems. The task of keeping these systems up and running is daunting and more importantly, expensive. Companies are increasingly finding it more beneficial to completely outsource their IT requirements to IT services companies. While there are qualitative benefits in terms of reduced time to solutions, better availability of skill sets and disaster recovery, the real catch lies in the quantitative benefits.

Unlike IT projects which results in improved efficiency of operation and reduced cost of operations over a period of time, the impact of outsourcing is almost immediate. Corporates like Tata Chemicals no longer need to maintain an IT department. To put things into perspective, many of the mega corporates in the US have IT departments that are larger than most Indian software majors. Thus, the saving potential just in terms of manpower costs is immense.

While at one end human resources costs are saved, at the other, there is substantial saving in terms of infrastructure cost also. The corporates do not need to have huge information technology divisions, which are expensive to set up and maintain.

While the benefits of outsourcing are crystal clear, the biggest impediment is the fact not everybody is comfortable with the idea of outsourcing mission critical operations. Organisations need to very comfortable with security of information in the hands of the IT vendor. Added to this is the issue that since the scale of operations is very comprehensive not many are going to change vendors’ everyday. The business continuity of the vendors is a must. Therefore, corporates are likely outsource from organisations that are better known.

From the vendors’ perspective, economy of scale is important. To manage operations virtually the companies need to have huge bandwidth availability. Infrastructure like data centres also has to be large. This would mean that gradually the business would become capital intensive. Thus, only large IT companies like Wipro and HCL Infosystems are likely to benefit from the emerging opportunities. According to Gartner, the IT outsourcing market in North America will grow from US$ 101 bn in 2000 to US$ 160 bn by 2005. This translates to a CAGR of 10%. Outsourcing contracts are typically very large in size. They run into hundreds of millions of dollars and many times are over a billion dollars. Also, these contracts run into several years giving the IT services companies’ strong revenue visibility.

While size is an impediment, another barrier to entry is the availability of skill sets. Only the top rung software companies are capable of providing end to end IT services (from consulting to maintenance). Many companies do not have infrastructure like data centres to address this kind of markets. Currently, application development and maintenance dominates the portfolio of the Indian software sector. But companies are moving up the value chain. Wipro and Infosys have been concentrating on higher end of the value chain like consulting for the past year or so.

While Indian companies have an advantage in terms of manpower costs, this benefit is offset to a certain extent in terms of high bandwidth and power costs. However, bandwidth costs are falling steeply. The cost for 155 Mpbs for a year has steeply declined to Rs 60 m (US$ 1.2 m) from Rs 300 m (US$ 6 m) previously. It is question of time before the Indian software sector gets a piece of the outsourcing pie.

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