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Software: Will the shift happen? - Views on News from Equitymaster
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Software: Will the shift happen?
Jul 5, 2007

The IT industry faces a unique range of risks. Profits are highly volatile and development cycles are reasonably long. Vendors are very sensitive to a market, which is in a regular state of rapid change, while a many of other factors such as software piracy and evolving standards can dramatically impact the bottom line. The Indian IT industry faces many risks. However, while the broader fundamentals of the Indian IT industry look good for the next 35 years, in the long term, there is likely to be pressure on margins and a decline from current growth rates. Salary hikes are greater than the hikes in billing rates. In the past, IT sector has seen annual salary hikes of around 12% to 15% and billing rates hikes of around 5% to 7% per annum. If this continues, it would put pressure on competitiveness and therefore growth and margins. Moreover, the linear business models of the Indian IT companies and a growing MNC presence and their adoption of the global delivery model to reduce their cost of delivery will add to the woes of the former.

But there are certain positives to the entire story. More than ever the clients are looking to outsourcing to attain tangible business benefits. Despite the outsourcing backlash in the US and UK, the service provider and their customer appear positive about their sourcing relationships. Although, currently, the sourcing practices are working but how well they are delivering the benefits and how long these practices will continue remains to be seen. However, the services business going forward could very well witness a severe talent crunch.

The problem with the Indian IT industry for a long time has been that there are not many established software products companies. Products business offers more scalability to the software companies inspite of the fact that it is more risky than the services business. Developing a product requires spending more time and capital and if the product becomes successful it aids the profitability of the company.

What is the solution?

Indian IT companies need to move up in the value chain and increase the contribution from software products in order to sustain profit growth in the future. Depending on a liner business model like IT services where employees have to be added on a consistent basis in order to growth sales and profits might turn out to be a growth issue for these companies. While some of the large companies are already ramping up their presence in services like IT consulting and systems integration that are higher up the value chain, the commensurate benefits are not being seen in their margins.

While a few companies like i-flex and 3i Infotech are showing the way in terms of consistently focusing on their products business, either by developing their own products or by acquiring niche players globally, the momentum is still not strong.

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