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The outsourcing question... - Views on News from Equitymaster
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  • Nov 11, 2003

    The outsourcing question...

    In the last decade, India has emerged as one of the fastest growing economies in the world, growing at an average of about 6%. During this period, India has made a significant transition from being primarily an agrarian economy to an economy where manufacturing and services now play an important role in aiding the country's GDP growth. Further, India's success in outsourcing capabilities has already put the country on the global map. The software-outsourcing story is already in top of the league. Some other industries, which aim to follow a similar growth path, are pharma and auto ancillaries.

    In a poll conducted last week on Equitymaster, we tried to find out as to what do our readers think about - Which sector will benefit the most from the growing outsourcing trend? The options given to them were auto ancillaries, pharma and software. The results of the same are depicted in the chart above. Not much to our surprise, the software sector (51%) continues to dominate investor expectations of growth and benefits from the outsourcing trend. Pharma outsourcing was second with a distant 26% followed closely by auto ancillaries (23%).

    The outsourcing story has been in the limelight ever since major world economies started witnessing a slowdown. With global companies finding it difficult to grow, they increasingly looked at destinations that could help them to reduce their costs, for both manufacturing as well as services sectors. India was an ideal destination for outsourcing as it offered quality services at reasonably low costs. Indian companies even now are able to offer their expertise at relatively lesser costs than their international counterparts. While the biggest outsourcing story so far has been in the software sector, auto ancillaries and Pharma are also likely to be a thriving outsourcing hub for major global companies and economies.

    Auto ancillary companies in the country have already proven their mettle in the international markets. This is evident from the robust increase in exports, which were close to US$ 800 m worth (a jump of 40% over last year) of auto components from the country in FY03. Further with major global auto majors of the likes of Ford and GM increasingly looking at India for outsourcing auto components in an attempt to reduce costs, the story is far from over.

    On the pharma outsourcing front, we feel that the potential of Indian pharma companies to produce low cost quality-competitive pharma products in large quantities augur well for the domestic industry. Further, with India having USFDA approved manufacturing plants, India would be an ideal outsourcing destination. Indian companies have also proved their mettle in the pharma research field and due to this we may witness high-end research work also coming to the Indian shores. Already we have witnessed an early indicator of the same. Domestic pharma major, Ranbaxy and US major GSK Consumer have already entered into a drug discovery and clinical development collaboration.

    However, all said and done, up till now, the biggest outsourcing story for India has been in the software sector. While, off late, there have been campaigns against outsourcing in certain US states, because of job losses in government departments due to outsourcing of jobs to India, this is not likely to spread to the private sector companies. In fact, the economical sense that outsourcing makes would prevent this backlash from spreading too far. At the same time, the fact is that while the pressure on billing rates is likely to continue, Indian software companies are trying hard to grow on the volumes front. To gain acceptance in the global market, you need size and Indian companies are well on course to achieving the same.

    In conclusion, while all of the above sectors seem well poised to grow, we feel that the software and the pharma industries are best placed at the moment to reap the benefits of the growing outsourcing opportunities because size does matter and both these industries are relatively larger than the auto ancillary industry. Further, amongst the two mentioned above, the software sector has already shown rapid growth over the last couple of years and hence, while the growth will definitely continue, it will be at a relatively slower pace.

    At the same time, for the pharma and auto ancillary sectors, the outsourcing story has just begun and we may witness strong growth rates in business over the coming years. However readers must realise that not all companies in these sectors will benefit in the same way. So to sum it up, we feel that one can zero-in on 'select' stories across the three sectors, which are yet to unfold. However as we continue to stress, the selection should be based on solid fundamental factors.



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