As the offerings of the Indian IT companies get more and more commoditized, sustaining today's attractive profit margins will be yet another challenge
Given the increasing pace of globalization, its focus on English and soft skills, China can certainly give Indian companies a run for their money
For the USD 88 billion Indian IT/ITeS industry, the woes inflicted upon it are yet to ease. Rising wage inflation, talent deficit and declining growth of domestic economic indicators have started posing a problem. Post September 2011, the rupee has depreciated and is pegged at a 2-year low. The value of repatriated earnings has increased since then and the industry is in a more commanding position as it embarks upon a journey to become an industry worth USD 225 billion by 2020
Projected to become a $225 billion industry by 2020, the Indian information technology industry has been a significant growth catalyst for the Indian economy and has transformed India into a global player for providing world class technology solutions and business services. As an export-oriented industry, export revenues are estimated to have aggregated to $59 billion in FY2011 and contributed 26 percent as its share in total Indian exports (source: NASSCOM). The dependency of the industry on a few select markets (US and Europe) and the inability to penetrate quickly into large markets have increasingly become a cause of concern. While the industry performed admirably in spite of a financial meltdown in 2008-2009, the current situation exposes some structural flaws both on the demand side and on the execution side. As the Indian IT/ITeS industry grapples with its inherent problems of the erosion of cost arbitrage vis-à-vis other markets, limited pool of talent, wage inflation, linear revenue growth model, lack of domain expertise/specialization in moving up the value chain; the question remains as to what could be the pertinent hurdles as well as enablers in its journey.
Wage Inflation – a potential dampener
One of the reasons that have been attributed to the success of the Indian IT industry by experts and alike is labor cost arbitrage. This advantage is still formidable, however at a strategic level, wage inflation is a hanging sword over the industry and could turn out to be especially damaging. Research from Aon Hewitt also highlights the fact that on an average, across the services industry which accounts for more than half of the country’s gross domestic product, Indians expect a 14 percent increase in their income annually, and up to a 40 percent gain if they change jobs. Further, there is huge competition for talent from other industries. Apart from economic activity, talent supply & demand, rising inflation is also playing a role in determining salary increase budgets. Increasing talent costs will certainly make India less competitive. A simple projection of 10 percent top-line annual revenue growth and 20 percent wage inflation over a sustained period of five years would bring down margins at some of India’s most competitive IT majors from 33 percent to as low as 6 percent. In the backdrop of rising wage inflation, the question of companies sustaining 15 percent plus top-line growth becomes all the more important.
From optimizer to multiplier
As the offerings of the Indian IT companies get more and more commoditized, sustaining today’s attractive profit margins will be yet another challenge. Amongst several measures that industry leaders opine, the first and foremost step that needs to be taken is to create an environment for innovation which can be carried over a sustained period of time.
With wage hike as a given reality, companies need to break the umbilical cord tying revenue growth to headcount addition. For the bigger IT companies with more than a lakh employee on their rolls, it is important that they turn their attention to non-linear revenue model. V. Laxmikanth, MD, Broadridge India, shares his thoughts on non-linearity, “There is a need to move away from the people-centric model to a more product-centric model; growth must be seen not in terms of number of people alone, but the value contribution to productivity and revenue. Prof. Phanish Puranam of London Business School argues that the Indian IT/ITeS heads must move from establishing relationships with the CIO to the CTO and instead of managing costs and profitability over relatively short-term contract, the companies must move to long-term contracts with associated higher risks.
Surplus labor, yet talent deficit
As irony would have it, despite being labor surplus, there is an apparent talent deficit in India. Estimates suggest that only 25 percent of the 4.5 lakh engineering graduates every year are considered employable by IT/ITeS companies. So, in an environment where there is scarcity of talent pool, a text book solution would be to improve the quality of potential recruits. It is time that we overhaul the scope, content, design and training methodology in our education system and this has to be followed up with utmost diligence to bring about the desired results of having a large pool of talented people who are ready for transition into the industry from educational institutions. To ensure that there is availability of talent, there has to be a lot of focus on developing talent from the grassroots. On the positive side, with skill shortage being a major cause of concern, a lot of IT/ITeS companies have tied up with the National Skill Development Corporation and are even adopting ITIs to develop vocational skills.
At the end of the day, however, broad-based issues about engineering talent supply and lack of employability of engineering graduates will have to be addressed by reforming the poorly regulated education sector that, apart from a few notable exceptions, mostly draws entrepreneurs known less for their vision and more for the political patronage they enjoy.
The Chinese threat
Adding to the talent gap, global companies are also tapping other countries (like the Philippines, China and Ireland) for low-cost labor and talent. At this juncture, it is important to understand the potential challenge from China. Given the increasing pace of globalization, its focus on English and soft skills, China can certainly give Indian companies a run for their money. Howsoever much Indian software leaders may claim that China is the hardest outsourcing market to crack, if they are to compete with their Chinese counterparts globally, then it is important that they successfully market their products and services in China. After all, shunning the lucrative opportunity presented by large, fast growing Chinese companies does not make business sense in a globalized world.
The way forward
As the global economy comes to terms with new realities, Indian IT/ITeS companies will have to choose to redefine their business models. Their ability to innovate and survive with proven resilience in the past should help them take necessary steps to safeguard their turf and expand, even if that involves tweaking the business model or bringing about a change in the product mix. The silver lining of the current crisis is that it has provided an opportunity to enhance efficiency, introspect and work on improving process benchmark, customer delivery and engagement and utilization of infrastructure and talent. The need of the hour is that Indian IT and BPO companies build strong domain expertise and embrace disruptive innovation to remain globally competitive in the $1.5-2.0 trillion IT/ITeS market.
No Freeze on Hiring
As the news of S&P downgrading the US economy from AAA to AA+ gained momentum, there was a hue and cry over the issue and its possible repercussions on the IT-ITeS job market. The industry leaders denied any downsizing initiatives on their part as unlike 2008 there was no systemic collapse of any business or financial institutions. IT industry leaders such as TCS, Wipro, Infosys, Cognizant and others have made record hiring in the second quarter. The level of hiring indicates that IT-ITeS industry continues to see a robust pipeline and clients are not slowing down their decision making processes as they continue to shift work to global delivery models. The recent news of TCS winning a USD 2.2 billion order to provide back-end administration of pensions and insurance policies issued by UK based Friends Life, and Hexaware Technologies bagging a contract worth USD250 million from a UK based client further corroborate the industry viewpoint. Meanwhile, Gartner projects that IT spending in India will grow to USD79.8 billion in 2012.
The cost arbitrage strategy has become untenable. The Indian IT-ITeS industry has incorporated genuine offerings in its portfolios to protect its dominance in the outsourcing market. This initiative by the industry will further increase opportunities for profitability. The likes of TCS, Infosys, Wipro have all moved up the value chain, thereby focusing on systems integration, product development, R&D, market entry and consulting services. While a few are focusing on non-linear growth by implementing CMM and internal process re-engineering; there are others who are creating knowledge based, high value complex offerings from professional services. Recent re-organizations at Infosys from a vertical market-line focus to consulting services are seen as part of its effort to accentuate and solidify its move away from a ‘technology company’ to a solution provider. For instance, Minacs - the BPO unit of Aditya Birla conglomerate has a new go-to-market approach in place, which has the company proactively presenting proposals to clients rather than merely responding to request for proposals, or RFPs, floated by outsourcers. Industry veterans agree that moving up the value chain will help Indian IT-ITeS companies to remain competitive in the USD1.5-2.0 trillion market.