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Software: Changing gears…

May 14, 2003

Despite the economic downturn that has been sweeping the worldwide markets and has contributed to the overall reduction in momentum of growth in the Indian IT sector, the software services segment has held its head steady. Riding the wave of growth in exports to the tune of 27% during 2002-03, the software services segment has been one of the key growth drivers for the Indian IT industry. Exports from this segment accounted for the major portion of the IT sector revenues of Rs 475 bn during 2002-03, up from Rs.365 bn during 2001-02. During 2002-03, as a part of rationalisation of IT spending, companies worldwide increased their software development outsourcing to low-cost offshore centers such as India. Also, Indian companies seem to have managed to increase their share in the global outsourcing business pie. However rationalisation of global IT spends by clients and increased competition based on the ‘Indian offshoring model’ has lead to a change in the dynamics of the Indian delivery model. This is apparent from the pressure on margins seen by Indian software companies.

Indian companies have always given a higher weightage to the offshore model understanding the cost benefits of the same. In the offshoring model a part of the clients requirements are met in an offshore location (like India), leading to cost savings. This (offshore) segment now contributes around 58% to India’s IT export revenues, while the share from the onsite segment is down to 39%, from 56% in FY01.

Contribution to export revenue (Rs crore)
Segment 2000-01 2001-02 2002-03
Onsite 56% 45% 39%
Offshore 39% 51% 58%
Products 5% 4% 3%
Source: Nasscom

While revenues from the offshoring model have gone up for the Indian IT companies, margins continue to remain under pressure. This is due to the fact that global IT majors like IBM, EDS, Accenture have been setting up their own development centers in India. These global majors have realised the potential of the Indian offshore model and are now in a position to compete with their Indian counterparts on the pricing front. These multinationals are also attracting talent away from Indian companies, thus giving the latter a run for their money.

Increased competition has forced a realisation among Indian companies that complete reliance on the offshore model is not sustainable in the long-term. Thus, increasingly Indian companies are trying to alter the composition of their service offerings in order to attract higher volumes of business and to a certain extent to reduce pressure on margins. This alteration could be achieved by moving up the value chain, i.e., delivering services or products for which the customers are willing to pay a higher price because they perceive a higher value. From providing maintenance and implementation services, companies are moving towards newer service areas like IT consulting, package implementation, IS (Information System) outsourcing, and infrastructure management.

For moving up the value chain, Indian companies need to enhance their competencies further. For example, consulting projects would involve the service provider to have a deep understanding of the business processes of the client. This would thus entail a substantial amount of re-skilling for existing staff in order to increase their competencies. Indian companies would also need to show a higher focus on branding and marketing fronts, where they already seem to have started showing progress, as seen by the rise in marketing expenses of these companies. While the transformation has begun it may be a while before its rewards start to flow to Indian software companies. Investors may want to look closely at the strategies adopted by Indian software companies in order to make their investment decisions.

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