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Software Sector Analysis Report 

[Key Points | Financial Year '11 | Prospects | Sector Do's and dont's]

  • The global IT spending increased exponentially for years before the onset of global recession in 2008-09. Riding the wave, Indian Information Technology (IT) industry grew at impressive rates of above 30% during that time to the tune of over US$ 60. The global meltdown dented the scene, with businesses across the globe, cutting on discretionary IT budgets. However, it created a huge pent-up demand in the software sector. With the economic recovery, the sector witnessed a surge in the demand across markets, both traditional and emerging. As a result, Indian IT industry performed well on back of superior quality and execution efficiency.
  • India's IT industry can be divided into five main components, viz. software products, IT services, engineering and R&D services, ITES (IT-enabled services) and hardware. Export revenues primarily on project based services continue to drive growth. Multi-year annuity based outsourcing agreements are expected to increase going forward. However, the majority share of the project based revenues is going to continue on the back of custom application development and application management.
  • Cost leadership has been the competitive edge of the Indian software sector over the last few years. However, this seems to be threatened now by MNCs who are replicating the Indian outsourcing model and setting up bases in the country. Going forward, the advantage of low employee costs could peter out and the sector could get commoditised.
  • Increasing competition, pressure on billing rates and increasing commoditisation of lower-end application development and maintenance (ADM) services are among the key reasons forcing the Indian software industry to make a fast move up the software value chain. IT companies have to move up the value chain to provide higher value-added services as consulting, product development, R&D and end-to-end turnkey solutions. Therefore, companies have started shifting their focus towards high end as well as value added services to keep their competitive advantage intact. Now they are also looking at emerging business themes like analytics, mobility, cloud computing.
  • The software services segment of the industry continues to grow by leaps and bounds. With the government emphasizing on better technology enabled delivery mechanisms for multitude of government projects such as e-passport, Unique Identification Scheme, eLearning, virtual classrooms, telemedicine, remote consultation, and mobile clinics, the domestic market looks equally more promising.

How to Research the Software Sector (Key Points)

  • Supply
  • Abundant supply across segments, mainly lower-end, such as ADM. Lower in higher-end areas like IT/business consulting, integration, transformation, package implementation but competition is very tough.
  • Demand
  • Despite rising uncertainties in the global economic environment, the global IT spending is expected to increase. However, demand environment would remain volatile. At the same time, a good growth is expected in fast-growing economies such as India and China.
  • Barriers to entry
  • Low, particularly in the ADM segment this is prone to relatively easy commoditisation. High in high-end services like IT/business consulting where-in domain expertise creates a barrier. The size of a particular company/scalability and brand-image also creates barriers to entry, as these firms have built up long-term relationships with major clients.
  • Bargaining power of suppliers
  • Low, due to intense competition (oversupply), particularly in the lower-end ADM space. Low differentiating power is also another reason. Bargaining power is high, at the higher end of the value chain.
  • Bargaining power of customers
  • High, mainly due to intense competition among suppliers/vendors. However, it is lower in higher-end services like consulting and package implementation.
  • 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 and as well as small startups.

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Financial Year '11

  • As per NASSCOM's 'Strategic Review 2011' report, the global IT products and services related spending reached US$ 1.6 trillion in 2010. This was a growth of 4.0% over 2009. This came on the back of 6.4% increase in worldwide hardware spend which witnessed a pent-up demand during economic recovery. Please note that the global hardware market was badly hit during 2008 meltdown, with almost 8% decline during the year. During 2010, IT services spend grew by 1.4%, within which IT outsourcing grew by 2.4%. Within IT outsourcing, global sourcing grew by 10.4% in 2010.
  • The Indian IT/ITES industry earned revenues of around US$ 88.1 bn during FY11. The IT software and services industry (excluding hardware) accounted for US$ 76.1 bn.
  • At the end of FY11, the Indian IT/ITES directly employed around 2.5 m people (an addition of 240,000 employees), while indirect job creation was estimated at 8.3 m. As a proportion of India's GDP, the sector revenues have grown from 1.2% in FY98 to 6.4% in FY11. The industry's share of total Indian exports (merchandise plus services) increased from less than 4% in FY98 to 26% in FY11.
  • Indian IT firms (especially the top notch Indian firms like TCS, Infosys and Wipro) are increasingly competing against top global players such as IBM, Accenture and EDS for large deals. The top Indian IT companies are more frequently being invited to bid on large deals that were earlier closed to them. India's top outsourcers are competing effectively with the top three global service providers on large deals. Moreover, global IT biggies like Accenture who used to deal mostly in premium-priced high-end IT services have entered the space of low-end IT services at a competitive price. This has added to the competition.

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  • The global IT services market is expected to grow by 3.5% in 2011, and 4.5% in 2012 as companies are focusing not only on controlling costs but also increasing efficiency and productivity using more and more information technology to improve their competitive advantage.
  • Developed markets constitute the largest share of IT spend. However, emerging markets are also contributing to the growth of the sector as a large consumer base is increasingly becoming tech-savvy. At the same time, many companies have started adopting IT solution to improve their global competitiveness. These emerging opportunities both in the global and domestic markets are expected to propel revenues from Indian IT sector to US$ 130 bn by FY15.
  • The integration of IT-BPO contracts is expected to become more common, as clients look out for end-to-end service providers. Companies like Infosys, TCS, Wipro, Mahindra Satyam, HCL Technologies and Mphasis, all of which are also into BPO, will benefit from this trend.
  • Billing rates will remain stable with negative bias in short term. These would not lead to the spectacular growth rates that most companies have been used to seeing in the past. Companies are expected to preserve their margins through effective cost containment, higher employee utilization, offshoring and shifting their focus towards high end as well as value added services. Lessons learnt during the crisis can benefit in the long run.
  • Attrition and Rupee’s volatility against the US dollar and other major currencies is expected to remain a major concern for Indian IT companies.

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

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