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Time for a balanced act - Views on News from Equitymaster
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  • Jul 21, 2001

    Time for a balanced act

    As the tough times continue for the Indian software sector the companies are finding it difficult to get business, and therefore maintain the growth rates they had shown before. However, it is not that the business is gone. It is there, but the demand is weak and more critically is slightly different from the service offerings of the Indian software companies. This has caused the competition amongst the Indian software companies to increase. To stay ahead in the race companies are cutting billing rates. This consequently has affected the operating margins. Also, the immediate imperative is to expand the portfolio of service offerings.

    The questions that logically follow are: what went wrong and what are the new opportunities? Ironic as it may seem the companies are facing a tough time thanks to their agility. When Y2K was out the companies quickly e-invented themselves and took up projects in the area of e-commerce. Dot coms that hoped to make the most of the e-commerce revolution contributed significantly to the revenues of the software companies.

    Internet /
    E-commerce related
    (Rs m)
    % contribution
    to revenues
    (Rs m)
    % contribution to
    Infosys 1,450 25.8% 1,409 23.0% -2.8%
    Satyam 870 22.5% 811 19.7% -6.8%
    Digital 455 72.8% 393 56.0% -13.6%

    However, with the e-commerce revolution turning out to be an evolution many dots disappeared leaving the software companies with bad debts instead of revenues streams. Not so very long ago the dot com were the clients that offered the highest billing rates to these companies. Today these accounts are referred to as an ‘exposure’.

    Realizing the ground realities the ‘old economy’ companies too have slowed down their spending towards e-commerce projects. As a result the Indian software companies found that the areas they had expected growth from were in fact stagnant. Another sector that all companies were gunning for was telecom software. However, it seems that telecom majors were rather too optimistic about the future. Consequently, they ended up having the maximum the capacity ramp up. As they face uncertain prospects in the immediate future, they are cutting down all kinds of costs, especially towards employees’ and information technology.

    Telecom 4QFY01
    (Rs m)
    % contribution
    to revenues
    (Rs m)
    % contribution
    to revenues
    Infosys 1,028 18.3% 1,023 16.7% -0.5%
    Satyam 326 8.4% 292 7.1% -10.6%
    Digital 38 6.0% 21 3.0% -44.5%

    The results that have come in for the first quarter of fiscal 2002 highlight the impact of these precedents on the Indian software companies. Revenues of Infosys and Satyam from e-commerce and telecom segments have shown significant dips. However, the bread and butter business of maintenance and re-engineering of legacy systems has come to the rescue of these companies.

    Application development
    and maintenance
    (Rs m)
    % contribution
    (Rs m)
    % contribution
    Infosys 3,501 62.3% 3,779 61.7% 8.0%
    Satyam 896 23.2% 1,223 29.7% 36.6%
    Digital 133 21.0% 141 20.0% 6.0%

    The legacy systems are mainly old mainframes that the corporates have been using right from the very beginning of computerization. These systems have been in use for a very long time and the companies have a enormous amounts of valuable information stored in these systems. Therefore, it’s essential to keep these systems up and running i.e. to maintain these systems. This has traditionally been the strong hold of Indian software companies. But increasingly there is a need to migrate legacy systems to new hardware and software platforms because the legacy systems are now expensive to maintain and lack documentation. This is the domain of re-engineering, where in the legacy systems are migrated to more relevant hardware and software. The markets for custom application development and maintenance were of the size of US$ 18 billion in 1999 and is expected to grow at a CAGR (compounded annual growth rate) of 5.4 percent to reach US$ 23 billion in 2001. Though these markets do not have a very high growth rate the Indian software companies have a very strong presence in the segment.

    There has also been a fundamental shift in the premise for IT spends. While earlier the spending was in projects that would result into revenue growth, the focus has now shifted to cost cutting. Earlier the projects were of such a nature that they would generate new revenues streams. Therefore, the new opportunities will be areas like supply chain management, BPO and systems integration – that will effectively result in decreased cost of operations.

    BPO stands for business process outsourcing. As companies concentrate on the core activities IT-intensive business process are delegated to an external service provider. The service provider owns, administers and manages the processes according to a defined set of metrics. Recent improvements in interconnectivity have facilitate this kind of businesses previously impaired by security risks, bandwidth shortcomings and technological inexperience.

    According to Gartner the global market for BPO will nearly triple from US$ 106 billion in 1999 to US$ 301 billion in 2004. Dataquest forecasts that the markets for human resources (HR) BPO will grow from a US$ 26 billion in 1999 to US$ 76 billion in 2004. Supply chain and distribution BPO is expected to grow from US$ 31 billion to US$ 82 billion in the same period. And customer care BPO should more than triple from US $11billion to $39 billion.

    Systems integration involves connecting different IT systems that an organisation has. Many organisations have most of their internal IT systems on mainframes and would now like to make use of the Internet for various processes. Therefore, connectivity between the legacy system and the web infrastructure systems is required. Similarly, there might be many different software systems in an organisation that do not communicate with each other. The markets for systems integration are expected to grow at a CAGR of 13 percent from a size of US$ 59 billion in 1999 to US$ 109 billion in 2004 according to IDC estimates.

    However, as the companies ready themselves for the new set of opportunities for the time being they will have to make the most in the current scenario. As competition hots up, the billing rates will see a decline. But the software companies do have a lot of room to cut costs and therefore, maintain their margins.

    As IT plays a more and more critical role in organisations, the nature of the solutions gets more and comprehensive, therefore the unbranded players will get find it difficult to survive. As a result, the sector would see consolidation. This in turn would help the large software companies in terms of increased business and efficiency of operations. But this would take some time to happen.

    No doubt that the prospects of the software sector seem to be clouded for the moment. However, the silver lining is that the software companies now have a taste of client behavior in uncertain times. The companies would draw a lot of insight from this to be prepared for the future for similar tough times. For the present the companies need a balanced act, i.e. to consolidate on the existing business and rapidly move into the new opportunities.



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