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Software Sector Analysis Report 

[Key Points | Financial Year '14 | Prospects | Sector Do's and dont's]

  • Global IT spending, which picked up in CY13, is expected to maintain a decent growth in CY14 as the economic situation in the US and Europe continues to improve. Discretionary spending on IT budgets by large global corporations has ticked up compared to last year but is limited to the new digital technologies. In terms of industry verticals, Banking, Financial Services and Insurance (BFSI) and Energy are the growth drivers.
  • Indian IT companies had a good year in terms of financial performance, driven by factors like such as the improvement in the quality of service offerings, stable pricing environment and the depreciation of the Indian rupee. Indian IT firms continue to move up the value chain by providing more end-to-end solutions and engaging more closely with clients. They are also increasingly relying on internal cost optimisation measures to improve profitability.
  • India's IT industry can be divided into five main components, viz. Software Products, IT services, Engineering and R&D services, ITES/BPO (IT-enabled services/Business Process Outsourcing) and Hardware. Export revenues, primarily on project based IT Services continue to drive growth with IT Services. This accounts for 54.2% of total revenues followed by BPO and Engineering services at 19.5%, Software Products at 15.3% and hardware at 11%. Multi-year annuity based outsourcing agreements continue to increase at a steady rate. In terms of total export and domestic revenues, Application Development and Maintenance (ADM) still continue to be the bread and butter for Indian IT companies; however traditional services have become increasingly commoditised.
  • Labour arbitrage has been the competitive edge of the Indian software sector over the last few years. However, the focus has now shifted to providing value to clients beyond cost savings. Software services are being increasingly demanded by global MNCs which can boost sales as well as improve internal efficiency.
  • Increasing competition, pressure on billing rates of traditional services and increasing commoditization of lower-end services are among the key reasons forcing the Indian software industry to make a fast move up in the software value chain. The companies are now providing higher value-added services like consulting, product development, R&D as well as new digital technologies like social media, mobility, analytics, and cloud computing (SMAC).
  • The new Indian government is emphasizing on better technology enabled delivery mechanisms for a multitude of government projects. Further, with the new digital India initiative being launched, the domestic market for software services looks forward to a bright future.

How to Research the Software Sector (Key Points)

  • Supply
  • Abundant supply across segments, mainly lower-end, such as ADM. Lower supply in higher-end areas like IT/Business Consulting, but competition is very tough.
  • Demand
  • The global downturn had put considerable pressure on global IT spending but the situation is now improving.
  • Barriers to entry
  • Low, particularly in the ADM & BPO segments as these are prone to relatively easy commoditization. It's high in value-added services like IT/Business Consulting and R&D where in-domain expertise creates a barrier. The size of a particular company/scalability and brand-image also creates barriers to entry; as such firms have built up long-term relationships with major clients.
  • Competition
  • Competition is global in nature and stretches across boundaries and geographies. It is expected to intensify due to the attempted replication of the Indian offshoring model by MNC IT majors as well as small startups.
  • Substitution of IT services and products
  • IT continues to be a driving force towards all aspects connected with our lives. While a particular technology may become obsolete and a particular company specializing in it may suffer, the obsolete technology can only get substituted by a newer technology offered by the same/different player in the IT/ITES industry.

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Financial Year '14

  • The Indian IT/ITES industry earned revenue of over US$ 109 bn during FY14. Out of this, exports accounted for 69.7% of the industry's revenue.
  • In terms of growth by industry verticals, BFSI, Telecom, Manufacturing and all emerging verticals are expected to grow at 14%, 9%, 14% and greater than 14% respectively.
  • The USA accounts for about 53% of the export revenue followed by the UK and Continental Europe, with 15% and 10% respectively. Other regions such as Asia Pacific are catching up, with a contribution of 6.5%.
  • At the end of FY14, India's share in the global outsourcing market stood at 55%.

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  • As per NASSCOM, the Indian IT/ITES industry is expected to maintain a growth of 13-15% in FY2015. NASSCOM has also envisaged the Indian IT/ITES industry to achieve a revenue target of USD 225 bn by 2020 for which the industry needs to grow by about 13% on a YoY basis in the next six years.
  • Technology research firm Gartner, expects global IT services spending to grow marginally by 4.2% in CY2014 to cross US$ 3,749 bn. As the global sourcing industry continues to grow and as Indian IT companies continue to increase market share, outlook for the sector remains robust.
  • Emerging protectionist policies in the developed world are expected to affect the Indian IT companies. Due to US restrictions on visas as well as rising visa costs, most Indian IT companies are increasingly subcontracting onsite jobs to local employees in the US. Additionally, the new immigration bill is still under consideration in the US which, if implemented, will significantly raise employee costs for onsite workers. This would adversely affect margins of Indian IT companies.
  • Indian IT companies are increasingly adopting the global delivery model. They are setting up development centers in Latin America, South East Asia and Eastern European countries to take advantage of low cost and also cater to the local market. In the US, such centers will help mitigate the risks of the new immigration bill and increase the probability of winning projects in highly regulated sectors such as healthcare, government services, utilities etc.
  • ADM services, which used to provide major chunk of revenues to the domestic IT players, are getting affected due to the falling billing rates. Hence, the companies are now venturing into new high value services such as IT Consulting, Product Development, and the new digital SMAC services.
  • The integration of IT-BPO contracts is expected to become more common, as clients look out for end-to-end service providers. Large Indian companies like Infosys, TCS, Wipro, Tech Mahindra and HCL Technologies, will benefit from this trend.
  • Billing rates are expected to remain under pressure in the short term. Therefore companies are expected to preserve their margins through effective cost containment measures like shifting more wore work offshore and improving employee utilisation. Lessons learnt during the global financial crisis can benefit them in the long run.
  • Billing rates are expected to remain under pressure due to commoditization of traditional services. Therefore companies are expected to preserve their margins through effective cost containment measures like shifting more wore work offshore, improving employee utilisation and the increasing use of automation software.

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Related Links for Software Sector
Quarterly Results | Sector Quote | Over The Years

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