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Software: Who will benefit? - Views on News from Equitymaster
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  • Aug 28, 2001

    Software: Who will benefit?

    Off late software companies, notably in the second rung category, are attracting significant buying interest on expectations of a turnaround in fortunes. These are basically companies, which operate in specific domains like CAD/CAM and call centers. But if the US economy were to turnaround, will these second rung software majors benefit to the extent that is being implied by the recent rise in stock prices?

    Quotes of large software companies
    Quotes of large other software companies

    One of the key differentiating factors of the Indian software segment is its advantage in terms of low employee costs (widely termed as ‘cheap labour’). Though they account for a significant portion of costs of the Indian software companies, salaries are definitely lower when compared with international standards. But cheap labour can’t differentiate software companies in the long run. As Mr. Nandan Nilekani, COO of Infosys, puts it “It is not necessarily about costs, it is about getting maximum value for the money paid by the customer…”. Read Interview And that is where company’s like Infosys are creating a separate niche. Ever since the US economy started to slowdown, US companies started to cut investments and tech spending tumbled. This had a material impact on smaller software solution providers, who were the first ones to be axed by their clients. But as US companies accounted for a significant portion of revenues, profitability fell at a sharper rate for these smaller solution providers.

    And the recent quarterly results vindicate the trend. While companies like Infosys and Hughes Software have posted reduced growth rates, second rung software majors have registered a sharp drops in profitability. While Infosys has managed to add 26 new clients (on an average) per quarter, number of clients for the smaller companies has almost halved. Billing rates have come under extreme pressure and software companies are pruning workforce.

    So, if the US economy were to recover, will the second-rung software benefit? The companies who operate in a niche segment will benefit, but companies whose focus is on maintenance and legacy systems would continue to suffer because companies like Infosys and Satyam will be at a clear advantage. They can offer a bundled package, which could take care of a company’s total software requirement (be it, maintenance, client servers or knowledge management).

    But recovery in the US economy seems to be quite some time away. The slew of rate cuts by the Fed (starting from January 2001) will take some time to reflect in terms of higher demand and lower cost of capital. The recent tax cut by the Bush government is also not expected to result in higher consumer demand in light of an already over-borrowed US consumer. Given the current downtrend, prospects for software companies, in the short-term, continue to remain dull.

    Agreed that there are some niche players in the second rung software sector. But do they have the management expertise to foresee trends and consequently add value to the clients in the long run remains to be seen. Besides, at the end of the day, software companies are all about managing human resources efficiently. If recent surveys are to be believed, in the hierarchy of needs, software professionals are more bothered about job profile and of course, remuneration. So, smaller companies have an in-built risk of higher attrition rates. Given the costs involved in training and development, whether these companies have the financial muscle to withstand downtrend is also a cause of concern.



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