A projection of 10 per cent annual revenue growth and 20 per cent wage inflation over a period of five years would bring margins down from 33 per cent to 6 per cent
Indians expect a 14 per cent increase in their income annually, and up to a 40 per cent gain if they change jobs
The $88 billion IT/ITeS industry faces challenges ranging from wage inflation, talent deficit to sustainability of being a preferred outsourcing destination. The turn of events in the US, a key market of the IT/ITeS industry, has further accentuated the industry’s problems. The question worth pondering over is how best can the Indian IT/ITeS industry turn the current challenges into opportunities and embark on the path of becoming an industry worth $225 billion by 2020. People Matters talks to industry and academia, and seeks answers to how Indian IT/ITeS can catch up with change...
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 such as China 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.
Standard & Poor’s downgrading of the US economy from AAA to AA+ has exposedthe inherent economic ills of the world’s largest economy thereby further deepening the recessionary fears. At the same time, Europe is mired in a debt crisis. Amidst such a milieu, the export-laden Indian IT industry finds itself in a fix. 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. Any sign of potential slowdown in the world’s biggest outsourcing market is bound to raise concerns and more so for the Indian IT/ITeS industry which derives more than 60 percent of its revenue from the US. The S&P decision will certainly have a downward correction on the revenue projections of the industry. Geographical diversification will, to some extent, help cushion the impact of the downgrade. However, the current turn of global economic events also brings with it a set of opportunities for the Indian IT/ITeS companies. It needs to shed its linear revenue model, look for new markets and at the same time, look within for domestic opportunities.
While concerns remain, the business process outsourcing (BPO) industry, which is as export-oriented as the information technology services industry, is relatively unperturbed despite the macroeconomic challenges and problems that are haunting the US, its biggest market. Many industry leaders, strategists and analysts feel that a slowdown, if the global economy were to face one again, would not affect the prospects of the $17 billion BPO industry. This is given the fact that global clients have already undergone significant restructuring with no headroom for further cost reduction. The impact, if at all, will be positive since clients will be forced to outsource more to optimize costs, and the benefits of that will accrue to global outsourcing services providers.
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, “India enjoys a cost advantage of around 30-40 percent as compared to source markets,” says N S Rajan, Partner and Global Practice Leader, People & Organization, Ernst & Young. However at a strategic level, wage inflation is a hanging sword over the industry and could turn out to be especially damaging. According to Aon Hewitt, a global human resources company, Indian salaries will increase by 13 percent this year from 11.7 percent last year. The 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% increase in their income annually, and up to a 40% 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. It is not only the bigger players in the IT/ITeS industry but numerous medium-sized companies which are fighting a sharp rise in salary demands as they strive to hold on to scarce talent, i.e. avoid attrition and attract talent in a competitive recruiting market. Industry bodies and CEOs agree. A study by ASSOCHAM, an industry body, predicts that talent gaps in the IT/ITeS sector could lead to salaries growing by 30 to 40 percent in 2011. Says Ganesh Natrajan, Vice Chairman & CEO, Zensar Technologies, “In the 7 cities which constitute 95 percent of the talent pool for the IT/ITeS industry, the cost of talent is certainly going up.”
Increasing talent costs will certainly make India less competitive. A simple projection of 10% top-line annual revenue growth and 20% 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% 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. Innovation needs to be in terms of business models, ecosystem and knowledge. As we speak of innovation in the context of business model, Indian IT/ITeS companies would do well by looking at non-linearity in growth through products and platforms. However true it might be that revenues of the top companies have grown constantly over the years, it is worthwhile to realize that the increase in revenue has been accompanied by a proportionate or larger increase in headcount. In a way, they are trapped in the curse of a linear model that was once the cornerstone of growth in their industry.
With wage hike as a given reality, companies need to break the umbilical cord tying revenue growth to headcount addition. It is time companies start measuring growth by the number of value-added services they offer to their clientele by introducing non-headcount related services like platform based solutions, invest in creating intellectual property rather than purely focusing on application, development and maintenance. 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 and for the same the companies need to pursue disruptive strategies which are distinctly different from the incremental initiatives they have been adopting for linear revenue growth. 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.” As companies chart this non-linear growth trajectory, and focus more on consolidating and moving up the value chain by providing end-to-end value added services, by enhancing the role of technology and providing new engagement models; employees will have to work smartly as well as differently by enhancing their skill sets and expertise.
It is a fact that a number of Indian IT/ITeS companies come into the picture only when the client CIO or CTO floats a request for information or request for proposal; whereas global giants like IBM and Accenture come into play at a much earlier stage, translating business needs into technology needs and thereby providing higher value IT consulting services. Raghavendra K, Vice President and Head, HR, Infosys BPO, is of the belief that Indian IT/ITeS companies need to move up the value chain, try to capture such consulting contracts and look at building capability for high-end processes. He says, “The industry very clearly has to move from a transactional mindset to focus on driving outcomes and support a complete transformation.” 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.
IT companies at this stage have the opportunity to become more innovative, and push its limits into providing value-added services and move up the value chain. Companies can beat the completion with enhanced focus on integrating service offerings, providing differentiated services and with the use of enhanced technology, help clients move along the course of change. For that matter, a few companies are embracing commercial, input process and technology innovations to improve quality and reduce costs at the same time, providing the clientele with commercial value by taking upon the responsibility for the projects & its business outcomes as opposed to providing people on a time and material basis.
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. “The more significant threat is the dearth of talent,” says Prof. Vasant Dhar, Stern School of Business, NYU while Prof. Phuranam, says, “the erosion of cost advantage, which, in itself, in part is driven by the limited employable talent pool, is a big issue.” For an industry which will still add over 2 lakh employees in the current fiscal, the quality of the available talent pool becomes all the more important. So, in an environment where there is scarcity of talent pool, a text book solution would be to improve the quality of potential recruits. Laxmikanth, agrees as he says, “There is a need to educate the industry to invest in building expertise, skills and depth.” 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. The IT/ITeS industry should take this as an opportunity to collaborate with the government, NGOs and academia. 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. On the talent front, companies are launching innovative talent management practices to retain people. They are emphasizing on employee value proposition, deeper emphasis on high performers, flexible variable pay options, career mapping, succession planning, and improved work-life balance. “In essence, there needs to be mindset change in companies to make at least 5 percent of its talent world-class experts,” avers Laxmikanth. Those companies that can differentiate itself in terms of its talent base will stand to gain in the future.
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. While talk of such reform has been aplenty over the last few years, the political will and direction for such reform has sadly been missing in India.
The Chinese threat
Adding to the talent gap, the fact that global companies are also tapping other countries (like the Philippines, China and Ireland) for low-cost labor and talent. The smaller emerging economies like Philippines, Vietnam, some Latin America countries will certainly bite into the global software outsourcing pie and reduce India’s share. 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 its money. At present, the predominance of China continues to be in the manufacturing arena, but as it makes strides in the services arena with its continued focus on bi-lingual skills to service English speaking markets, China has the potential to displace some of the businesses that have traditionally been Indian strongholds. NASSCOM, an industry body, reasons that China has the potential to develop a large IT-BPO industry, thanks to its substantial domestic market potential, a sizeable educated workforce and strong government support on developing the IT-BPO sector. N S Rajan explains the advantages of China vis-a-vis India, “Unlike India, which is highly export-oriented, the Chinese IT industry has a huge domestic market as well to cater to that significantly reduces its risk of over-exposure to western export markets. Chinese companies also have a huge penetration in the Japanese and Korean markets where India is yet to make a foray. Further, China has a huge control over the appreciation of Yuan against dollar which helps in maintaining its competitive edge over India.” While the capabilities of China may be a threat, it could well turn out to be an opportunity in disguise for Indian IT/ITeS companies. A closer scrutiny further reveals that China is becoming an attractive offshore destination not only for global companies but also for the Indian BPO sector. 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. Perhaps, driven by this philosophy, many BPO majors, including Aegis, TCS BPO and Hinduja Global Solutions are either looking at entering or expanding their presence in China.
The way forward
As the global economy comes to terms with new realities, successful IT/ITeS companies will have to choose to redefine their business models. Their ability to innovate and survive with proven resilience in the past (the financial meltdown) 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. Indian IT and BPO companies have displayed amazing dexterity and inventiveness at the time of the last crisis, and there is no reason, why they should not be able to do the same again if the situation so warrants. The industry also has the added advantage of mid-level talent who have an average expertise of 15 years, which is far beyond that of most other countries. 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. At the same time, the improvement needs to be more qualitative than quantitative. If Indian IT services firm are to be a leading player in the $1.5 - 2.0 trillion IT and BPO market, the need of the hour is that Indian IT and BPO companies build strong domain expertise and embrace disruptive innovation to remain globally competitive.