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Software: What is the right choice? - Views on News from Equitymaster
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  • May 3, 2004

    Software: What is the right choice?

    Through the FY04 results have emerged two Indian software majors that have crossed the crucial US$ 1 bn revenue mark - 'crucial' because size matters a lot while showcasing one's ability to scale up business in a highly human resources oriented sector.

    This landmark has raised the bar for other competitive software companies in the Indian software sector. In this write-up, we shall discuss about what these two companies have been doing and what changes are they undergoing at present.

    In order to move towards the higher echelons of growth, the company has remodeled its business based on domains. This is a shift from the earlier model where the company was divided into business units based on geographies. Now, there have been separate business units created within the company and each unit has competencies in a particular domain, like engineering services, telecom, retail, utility and banking & financial services. This domain specific focus has helped Infosys in aiding the company's cause of garnering high-value customers. For example, in FY04, the company won a US$ 50 m contract from the Australian telecom major for providing the latter with development services in the telecom domain.

    * 'New' services include services other than software development,
    maintenance, reengineering and products.

    Another shift that the company has witnessed is the contribution of high-end services to its total revenues. These 'new' services, apart from helping Infosys earn relative higher billing rates than basic software development and maintenance services, have also aided the company in establishing close relationships with global majors. This is because most of these new services have a high onsite component. Through increasing revenue contribution from these services, Infosys has put a foot forward into the domain of global corporations like IBM, EDS and Accenture that have proven capabilities in these high-end domains.

    Over the past two years of slowdown in global technology spending, Wipro had been one of the hardest hit due to its over-dependence in the technology R&D domain. However, the company has restructured its business and has reduced its dependence on R&D spending. One of the ways to attain this objective was growing inorganically, specifically in FY03. Wipro acquired Spectramind in the BPO space, NerveWire in IT consulting and Ericsson's R&D Centre in the telecom space. The company's strategy has been to acquire companies that are niche players and have high levels of competencies in their respective areas of work.

    The graph above is indicative of the wide-range of high-end services that form a part of Wipro's portfolio of offerings. While the company's acquisition strategy has put pressure on its margins and is likely to do so in the medium term, we believe that in the long-term, the acquisitions would play a key and constructive role in Wipro's growth

    Given this backdrop, what does it mean for a retail investor when it comes to choosing the right stock in the technology sector? Before you take any investment decision, ask yourself the following questions...

    1. Give the human resources intensive nature of the software sector, not all companies have the capability to scale up business. So, an investor has to ascertain this vital factor from stats like attrition rates, average revenue per employee and profit per employee. A comparative analysis with a peer group will be of great help.

    2. Secondly, what is the company's management's vision? Have they been consistent over the last five years? If one were to look at the trend in 2000 or even more recently, some companies tend to venture into businesses just because they are 'hot'! For instance, one can count the number of companies that have ventured into the BPO spectrum without any significant scale in their core businesses.

    3. The ability to deliver services to clients across the globe is of long-term significance. How many companies in the software sector have managed to grow their business despite robust expansion in the global markets? At the end of the day, scalability it extremely critical.

    4. More importantly, software is a dynamic sector and is, therefore, susceptible to changes in technology. Does the management have the required expertise and vision to be attuned with global industry trends? Remember, outsourcing is not a new thing for India. The likes of Infosys, TCS and Wipro have been doing this for more than a decade now. But count the number of companies that are making noises off late about the potential of software outsourcing.

    If you are able to derive a convincing answer to these questions, probably, you have made a right choice!



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