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Indian IT: Surviving the slowdown - Views on News from Equitymaster
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Indian IT: Surviving the slowdown
May 13, 2008

Indian IT sector is under pall of dark cloud of the US credit crisis and the subsequent economic slowdown. The questions, which are haunting managements and investors alike, is – "What will be the impact of economic slowdown in the US economy on outsourcing?" and "Whether the slowdown will clog up outsourcing of IT and ITES (BPO) services to India?" The answer is not simple and straightforward, but if we were to look into annals of history, we will find a hint that work has always moved to place where it can be done most efficiently and at low cost. Manchester, the world’s first industrial city, was once known as the ‘cotton capital’. The city’s economy started to decline as crisis in mass manufacturing, which began in the 1950s continued to accelerate throughout the 1970s and 1980s. During this phase of crisis, manufacturing of machines like the Cockroft (used in textile industry) began to be outsourced to India, Pakistan and South East Asian countries. Manchester’s textile industry was soon entirely shifted to these cheaper labour markets.

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    What history can teach?
    Drawing a parallel from this economic history, it can be assumed that offshore outsourcing is not going to slow down on the back of economic slowdown in the US. On the contrary, the need for corporations to lower their costs to remain competitive, will aid a greater offshoring of processes to low cost destinations (like India). Simply put, a slowdown in the US will force companies to cut down their costs, which will in turn put pressure on their IT budgets, and that in turn would create demand for more offshore outsourcing.

    According to the TPI Index (a sourcing data and advisory firm and a unit of Information Services Group Inc which tracks IT outsourcing contracts worth more than US$ 25 m), the first quarter of 2008 witnessed a 20% YoY increase in total contract value (TCV) and annualised contract value (ACV) of outsourcing projects. As per the firm’s study, 122 outsourcing contracts were awarded during the quarter for TCV of US$ 21 bn and ACV of US$ 4 bn (TCV divided by duration of the contract). TPI Index highlighted in its report that companies in the US are looking to their outsourcing service providers to deliver variability in costs and lower overall expense. It also indicated that there would be significant increase in offshoring in the coming quarters as, apart from the US, more countries from Europe, the Middle East and Africa adopt the offshoring model.

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    What to expect?
    The managements of the large Indian IT companies like Infosys, TCS and Satyam have talked about some near term pain on account of restructuring happening at the clients’ end. The fact that business restructuring and leadership changes at large US investment banks, who are major clients of these tech majors, is expected to impact short term growth for the latter, cannot be denied. However, the managements have talked about renewed traction for offshore outsourcing once the dust settles in about 3 to 4 quarters from now. We are also of the belief that given the value creation abilities of these companies’ businesses and the fact that their stocks are trading at attractive valuations, investors can benefit over the long term. Especially for companies like Infosys, which continue to earn margins of 30% plus and return rations of over 45%, and are expected to grow their earnings at a compounded annual rate of 20%, the current valuations do look fairly attractive. However, the pain might elongate for the mid-size players that face scalability issues and have seen their attrition levels rising at a fast clip.

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