The Indian software sector is in fine fettle. The successful companies in this space have indeed come a long way. From humble beginnings in the 1980s, these firms have changed the way that India is perceived globally. Fast growth, good corporate governance standards and a youthful workforce made the sector the Indian economy's stand out performer. Relying on the advantages of labour arbitrage and the increasing trend towards outsourcing, Indian IT firms like Infosys, TCS and Wipro created huge Investor wealth. However, over the last few years, this sector had to face multiple headwinds.
The global financial crisis of 2008-09 hit this sector hard. Many marginal players went out of business. The Satyam scandal tarnished the image of the sector. On the operational front, labour issues started to show up. The industry's traditional services started to get commoditised. As pricing power in these service lines diminished and clients became more cautious, Indian IT firms started to explore new strategies to keep up the momentum. The most important trend has been the shift to non-linear services. One example is product development. Revenues from newly patented software can be scaled up by selling the product as a service. This 'software-as-a-service' model de-links the number of employees with the revenues earned. This has contributed to the unprecedented attrition levels that the industry is witnessing. As the labour force is the backbone of the sector, will these companies manage to keep up the good work?
We believe they can. The large, well established IT firms have faced these issues and have come out unscathed. They have even gained market share over their global rivals. However, on a comparative basis some companies will do better than others. The recently released numbers for the first quarter tells us most IT firms still have a lot of work to do. While TCS has led the way by dominating growth in traditional services, Infosys and Wipro have struggled to keep pace. Infosys has even appointed its first non-founder CEO, Vishal Sikka, to lead the company in these difficult times.
We believe that the fortunes of Indian IT firms will not move in the same direction. The companies which adapt best to the new challenges that the sector faces will come out on top. Thus investors in this sector will be best served if they follow a stock specific bottom-up approach. A repeat of the year 2013, in which all IT stocks outperformed at the same time, is unlikely to happen again.
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