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Indian IT: The real concerns

May 17, 2007

An invincible blend of low costs, adequate technical and language skills, established vendors and encouraging government policies have taken India to the top of the global destinations for technology offshoring services. But over the past few months, the IT stocks have been at the receiving end on the bourses. Is rupee appreciation against the US dollar the only reason for this beating or there are some other reasons? Let us find out in this article.

CAGR Revenues Staff costs EBITDA PAT
Infosys 39.3% 46.6% 33.8% 35.5%
TCS 35.2% 41.2% 32.4% 32.5%
Wipro 30.4% 56.7% 25.6% 28.0%
Satyam 32.1% 41.2% 22.0% 19.3%
HCL Tech 26.2% 36.3% 19.3% 14.8%

The Indian IT companies generally hedge one to two quarters of their earnings receivable in foreign exchange and the rupee has been appreciating for not more than last seven to eight months. So what is the real cause?

If one were to analyze the above table, one will find that the CAGR in staff costs have easily outpaced the revenue growth. The lower growth rate in case of EBITDA and PAT when compared with the growth rate in revenues clearly indicates that the sector does not have operating leverage. Going forward, the people intensive IT industry will have to de-link manpower growth from revenue growth. Companies are trying to extract more revenue per employee and doing more with their manpower. Although this will not reduce the number of jobs for IT professionals, as the demand is huge but it will definitely result in much-needed innovation, higher productivity and better use of resources.

Talent crunch, rising attrition rates and rising employee costs have prompted IT companies to look at reducing their dependence on 'employee-dependent' growth. The purpose should be to improve productivity and enhance revenues per employee thereby enhancing the operating leverage. The industry will have to dismantle the traditional linear relationship between manpower and revenue growth as going forward in the next three years there will be atleast a gap of 15% between demand and supply. Indian contributes to just 3% of global IT services revenue while the US contributes to 57% of the global IT services market. If Indian software vendors have to reach even half the size of the current US share then they will have to make major acquisition or else it will take them many years to reach there.

We believe that there are no indications that the sector is heading for a downturn in global IT spending. However, if the slowdown in the US economy is persistent, then it might take its toll on the IT and ITeS sector as most of our IT companies are US-centric. Having said that, we believe that the main concern for Indian IT is not in overall worldwide IT market growth but more in the domestic arrangement in IT outsourcing, labour supply, and competition from other developing and emerging countries like Brazil, China, Russia and Mexico.

The Indian software players who pioneered the concept of global delivery, which helped them to differentiate themselves in the global software market and build exceptional brand equity, are now facing the challenge of losing its competitive edge, which we feel, will definitely fade away in next few years. The only way to counter this challenge is by building a new set of strong differentiators in the global markets. Also, the governments of the emerging markets are positioning their countries to take the advantages of the IT sector and newer centers are emerging in different regions of the world.

Another major challenge (in the short term) will be to tackle the constant rupee appreciation as it has touched newer heights in the recent past. With US$ touching the Rs 40 mark it remains to be seen how the IT bellwethers restructure their hedging policies.

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