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Software: New service lines show the way! - Views on News from Equitymaster
 
 
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  • Nov 30, 2005

    Software: New service lines show the way!

    The offshoring story is well and truly on. In a globally competitive environment, where getting one's products to the market faster and keeping a tight rein on costs are priorities, it only makes sense for a company to focus on its core competencies rather than tasks of a repetitive nature that are only a burden on valuable management time. Such tasks are generally outsourced/offshored.

    These days, the focus is increasingly on the 'offshored' part of outsourcing. This is because the offshoring model mastered by the Indian companies is inherently superior to the traditional delivery model. Given the cost-effectiveness of this model, highly skilled technical and managerial talent available in India and process efficiency of Indian firms, this makes for an enviable combination. In this article, we give a perspective about the new service lines of Indian firms, the value proposition offered by them and thoughts on the future.

    Going up the value chain
    As can be seen from the table below, it has clearly been the higher-end services that have driven topline growth for the major software companies. Infosys has, in fact, continually invested in businesses like testing and package implementation and these have grown at a considerably faster rate than the overall revenue growth. Its consulting subsidiary, Infosys Consulting, is also ramping up at a fairly rapid rate and is already giving serious competition to the likes of incumbent players like Accenture and IBM.

    As can be seen, services like package implementation and testing have shown strong growth over the past few years for Infosys, growing at much above the overall revenue growth, while application development and maintenance (ADM) has been steady. As a result, the share of the new services has risen steadily and this trend is likely to be maintained going forward.

    (Rs m) FY02 FY03 FY04 FY05 CAGR (%)
    Total revenues 26,036 36,400 48,530 71,297 39.9%
    ADM 15,882 21,949 27,079 37,858 33.6%
    Package implementation 2,552 4,004 7,037 10,837 61.9%
    Testing 755 1,238 2,572 4,135 76.3%
    BPO - 182 776 1,925 225.2%
    % of total revenues FY02 FY03 FY04 FY05  
    ADM 61.0% 60.3% 55.8% 53.1%  
    PI, Testing and BPO 12.7% 14.9% 21.4% 23.7%  

    For Satyam, it has undoubtedly been the package implementation business that has played the major role in revenue growth over the past few years. While ADM has grown at a fairly subdued pace, the package implementation business has clocked a scorching CAGR of nearly 65%, over thrice the overall revenue CAGR. Satyam's strength in this business is reflected by the recent order win from the World Health Organisation (WHO) spanning 140 countries, a truly global win.

    (Rs m) FY02 FY03 FY04 FY05 CAGR (%)
    Total revenues 19,668 22,220 25,605 35,208 21.4%
    ADM 16,081 16,825 15,209 19,083 5.9%
    Package implementation 2,742 4,739 8,306 12,274 64.8%
    % of total revenues FY02 FY03 FY04 FY05  
    ADM 81.8% 75.7% 59.4% 54.2%  
    Package implementation 13.9% 21.3% 32.4% 34.9%  

    The figures are not too different for Wipro and TCS either. The main factor to understand here is that the Indian software companies give a very strong value proposition to their clients. A robust global delivery model, coupled with execution excellence and the ability to send offshore, the most insignificant of tasks, resulting in a too-good-to-resist pricing structure, has led to Indian companies starting to effectively cross-sell the higher-end offerings to their clients. This has worked well for these companies so far.

    However, going forward, what the Indian companies will have to focus on is vertical and domain expertise and the ability to handle increasingly complex engagements. The execution ability and cost effectiveness have always been there and now it is clearly the time to move higher up the value chain.

    Conclusion
    We are positive on the overall growth prospects of the IT industry, going forward. The offshoring trend is only just taking off and, in the context of an industry lifecycle, it is very much in the growth phase. The increasing contribution of higher-end services will help act as a 'force multiplier', that is, give more downstream ADM business to these companies and given higher billing rates, topline growth will also be aided.

    However, margins are unlikely to be maintained for long at current levels. Given increasing competition and MNC software companies starting to 'poach' the territory of the Indian companies, due to reasons like wage inflation and price competition in future, margins could taper slightly downwards.

     

     

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