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Software: Betting on ITBPO - Views on News from Equitymaster
 
 
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  • Apr 20, 2002

    Software: Betting on ITBPO

    Sometime back, in September 2001 to be precise, McKinsey & Co, a management consultancy firm, outlined four different growth options for the erstwhile software and now the IT services industry. The future directions for growth according to McKinsey were contract manufacturing, systems integration, information technology & business process outsourcing (ITBPO) and technology innovation. The Indian IT industry has chosen to bet on ITBPO.

    IT Outsourcing
    The task of keeping IT 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. 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.

    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. 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.

    Providing IT outsourcing services means that the vendor has to have large IT infrastructure in terms of data centres and network management centres. This makes the IT outsourcing business capital intensive in nature. 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 be very comfortable with security of information in the hands of the IT vendor.

    BPO Outsourcing
    However, some organisations in the west have gone a step further. They prefer to focus on core business areas and outsource certain non-core aspects of the business. This is known as business process outsourcing. The business areas that are the most likely candidates for outsourcing are human resources management and customer care management. According to Gartner the global market for BPO will nearly triple from US$ 106 bn in 1999 to US$ 301 bn in 2004. Dataquest forecasts that the markets for human resources (HR) BPO will grow from a US$ 26 bn in 1999 to US$ 76 bn in 2004. Supply chain and distribution BPO is expected to grow from US$ 31 bn to US$ 82 bn in the same period. And customer care BPO should more than triple from US $11bn to $39 bn.

    However, one key aspect of BPO is that vendor providing these services should have sound knowledge of the process that is being outsourced. While IT infrastructure and application outsourcing is capital intensive, BPO is domain knowledge specific. Thus, the quality of people employed becomes very important and domain knowledge becomes a high barrier to entry.

    It is more than likely companies would prefer to work with a single vendor for IT and BPO outsourcing. Therefore, companies, which have deep pockets and can attract the right kind of talent will be able to provide the whole spectrum of services.

    The whole premise of IT and BPO outsourcing growing rapidly in India is based on the cost leader ship strategy. The lucrative growth rates will cause many players to enter into the business. This will eventually lead to a price war. Thus, economies of scale is very important in this business as its going to be a volumes game. From the clients’ perspective, business continuity of the vendors is a must. Therefore, corporates are likely outsource from organisations that are better known.

    Thus, it is more likely that large IT companies like Wipro, Infosys, HCL Technologies and HCL Infosystems are likely to benefit from the emerging opportunities.

    Infosys in its 4QY02 results announced that it had forayed into the IT outsourcing space by taking over the management of applications for two of its clients. According to one of agreements, the company will provide 24x7x365 support to mission critical applications for a financial services company from India. The company also announced its foray in the BPO space with the formation of Progeon Ltd, a company in which it would hold a majority stake. Infosys with its 4QFY02 results announced an investment of US$ 5 m (Rs 242 m) in the company. The initiative has already attracted Citigroup Investments that has invested US$ 20 m (Rs 970 m). Thus, Infosys plans to provide services across the whole ITBPO spectrum.

    IT major ITES company % stake Rs m US$ m
    Wipro Spectramind eServices Private Limited 17% 480 15
    Infosys Progeon Majority 243 5
    HCL Technologies E-Serve 100% 47 1

    Meanwhile, HCL Commnet, the wholly-owned subsidiary of HCL Technologies, has managed to make much headway in this business already. The company currently has five international clients and 51 domestic clients. The company manages 5,300 devices spread across 400 cities in 3 continents. Expectations are running high. The company expects the revenues from this business to grow by five fold in the next two years. That translates to a steep target of servicing 25,000 devices by 2004.

    Others like HCL Infosystems have chosen to concentrate on the customer care business. While the company plans to provide traditional help desk services, it has gone a step ahead and is providing call centre consulting services. This will help others set up their call centre business. HCL can offer end-to-end solutions in the space as a major portion of its revenues comes from selling hardware. The company also plans to extend its service offerings to data management.

    While the future growth from these segments is almost certain, the concern is that whether the growth will be sustainable going forward. The cost leadership strategy is very easy to replicate. Countries like China seem to be a potential competition in the years to come.

    Also, India has certain infrastructure problems. The bandwidth and power costs are very high as compared to the rest of the world. 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. But power availability and costs continue to be problem.

    There is a challenge on the human resources front too. Since many of these businesses will be back offices or customer contact centres for companies in the west, the job is likely to involve working night shifts. Not a very interesting proposition. Attrition rates in the call centre business and telemarketing activities, which are currently around 25% are expected to move up to 35% as the industry matures. Attrition rates are lower among the business process outsourcing (BPO) firms at 10% to 12%.

    While Indian software majors that have firmly established their brands, and have very deep pockets to fund infrastructure of gigantic proportions are going to find the business a major revenue driver. The smaller players will make hay while the sun shines. And when it sets we will once again see that be once again see that only a few survive.

     

     

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