Credibility Crisis

Financial scandal at outsourcing company rattles a developing

countryproclaimed a New York Times headline on January 7, the same day Satyam

chairman B Ramalinga Raju admitted to years of fraudulent and inflated

accounting in the company.

It did not take even a full day for the description to change. The emerging

IT superpower, the country with unlimited talent pool, and the center of the

flat world, was reduced to what it was two decades backjust a developing

country.

That gives you a fair idea of what to expect from the Western media in the

days to come. In earlier occasions, even isolated DNC (do not call) violations

by Indian call center agents have been played up to paint the entire Indian

industry as incompetent. This is a far more serious issue and a genuine cause

for concern. Not the least because Satyam, the fourth-largest IT outsourcing

company from India has, among its clients, some of the largest corporates in the

US, Europe, and Australia. If something severe happens to the company, they will

be directly affected. Unlike small security lapses and DNC violations, this is

not extrapolation of isolated incidents to conclude that clients and their

customers might be hit. It is a very real possibility.

There is no doubt that this is a huge black mark for Indian IT, says

Akshaya Bhargava, CEO of London-based Butterfield Fulcrum Group, a hedge fund

administration firm and a veteran of the services industry, who has been

associated with the Indian outsourcing industry in various capacities. Bhargava,

however, clarifies that this type of outright fraud could happen anywhere in the

world, pointing to examples of Enron, Madoff and Parmalat.

In fact, that probably explains why the Western media has not engaged so much

in India-bashing in its coverage of the Satyam story, which we have seen in the

past, in reaction to far more trivial incidents. But then, it is not motivated

media reports but confidence of customers in their suppliers that determines the

extent of business. That confidence may not have been completely shaken yet, but

it surely is not what it was before January 7.

Credibility Hit



It may be still early to definitively say how exactly the Indian IT industry

will be impacted because of the Satyam incident and to what extent. But all who

Dataquest spoke to seemed to agree that the credibility of the industry has been

hit, even though the consensus was lacking on the exact implications.

Yes, the Satyam incident will affect the credibility of the Indian IT

firms, says Avinash Vashistha, founder and CEO of sourcing advisory firm,

Tholons.

The buying process for major services contracts has a lot of qualitative

factors involved, not just quantitative parameters. Something like this will

clearly impact the credibility, adds Jens Butler, principal analyst, IT

services and sourcing, Asia Pacific with research firm, Ovum.

The sentiment is echoed by Forrester analysts Sudin Apte and John C McCarthy,

For years, clients have praised Indian firms as transparent and forthcoming in

addition to applauding their quality, client service, and software delivery

process superiority. The recent Satyam events, including the chairmans

resignation, bring that well-cultivated image into question, they said in a

statement.

Predictably, that kind of skepticism is challenged by Nasscom president Som

Mittal. We must not overlook the fact that even with Satyam, it was real

business, real clients, and real employees. It is just about a few people

getting together to manipulate the numbers. How does that challenge the entire

industrys quality of delivery and process excellence?

That raises an important question, the answer to which is still not known at

the time of writing thisdid Satyam intermingle its accounts, in some way, with

services and billings to clients? If not, it is simply a question of the ethics

of a few people. The investors still need to worry. But it does not really

impact the customers business in any way. But if it did that, it would be a far

bigger issue than what we are seeing it as today.

Even now, Mittal does not completely dismiss the fact that the Satyam episode

has raised some questions of credibility of the industry. The industry has to

re-establish the confidence among customers, regulators and investors, he

admits.

Will the Top Three be Exceptions?



While there is a broad agreement that the Satyam scandal has created a

credibility issue for the industry, the opinion, however, is divided on whether

the impact will be secular on everyone. Some say that the top three IT services

firmsTCS, Infosys and Wipro, will not be impacted negatively, in fact, they may

even gain because of this. Others say there is no reason to believe that the

clients will distinguish between large companies and small companies.

Investors, so far, have believed that the large companies will be exceptions.

On the day the news broke, Satyam fell 78% in the Bombay Stock Exchange. While

the 30-share Sensex slid by 7%, Infosys held steady. Since then, even some

customer movements have endorsed this belief. World Bank, which banned Satyam as

a supplier, said that it awarded part of the contract that it canceled with

Satyam to TCS. Infosys too claimed in the recent earning conference that many of

its common clients with Satyam have already approached it to see if it can take

up the existing Satyam work.

Forrester clearly foresees this possibility as what it calls the polarization

of offshore suppliers. Offshore providers that are either family-owned or part

of large industry conglomerates, will face more financial scrutiny. With these

smaller firms facing the brunt of extra checking, top Indian providers like

Infosys will continue to take market share, it says in its statement.

Vashistha of Tholons has similar views. The top three will be exceptions

because of their stronger relationships and strong perceptions. I feel they will

tend to benefit in terms of getting additional business because of the higher

level of trust clients would place on them. It will be difficult to establish

the credibility of smaller firms, he says.

Not everyone is so optimistic about the large companies, though.

The Satyam story represents a breakdown in trust and has set the entire

Indian IT industry back. Everyone, including the top three, will just have to

work much harder to convince customers, says Bhargava, who headed Infosys BPO

as its CEO before moving out as a partner of UK-based private equity firm 3i, as

head of its BPO investments.

Says Butler of Ovum, Looking at what has occurred since then (referring

obviously to the banning of Wipro as a supplier by the World Bank), I do not

think the top three will be exempt.

The Wipro revelation, coming just a few days after the Satyam news broke, has

created a major question of credibility. Though nowhere comparable to Satyams

fraudulent accounting, there are three reasons why it has snowballed into a

major issue. First, of course, is the reason why World Bank says it banned Wipro:

providing benefits to its staff, which according to the Bank was improper. The

media has since reported that it is common practice to use benefits for

executives in client companies to further sales interests, prompting many

analysts to comment that the creativity is not limited to accounting alone.

Second is the fact that the announcement came only when World Bank decided to

make it public. Wipros logic that it had no major impact on revenues may be a

rational explanation, but not everyone is convinced that not making something

like this public is good ethics.

Third is that it has come at a time when the entire IT community globally and

the entire India is shocked by the Satyam revelations. Many had taken solace in

the fact that Indias largest IT companies are above all questions. Wipro,

especially, is known for its strong values.

We still do not have a clearer answer to the question, but the events of the

next few weeks may answer at least this question fairly decisively.

Long Term Impact? Not Really



While there is a clear agreement that the event has badly affected the

credibility of the Indian IT industry, there is an equally strong, if a little

uncanny, agreement that the impact that it would make on the sector will not be

very long-lasting.

This is because of a combination of reasons. First and foremost, events like

these have an immense shock value which makes them look earth shattering in the

immediate aftermath. Over a period of time, people take decisions based on

reason. So, while it would make potential clients a little more vigilant, the

business may not be affected too much in the long run. Says Peter Brudenall,

partner, Global Technology and Outsourcing Practice at London-based law firm,

Hunton & Williams, which advises its clients on legal issues in offshoring and

outsourcing: It is too early to say that the Satyam issue has any broader

impact on the Indian outsourcing community.

Two, many have been pleasantly surprised by the swiftness the government has

shown in trying to solve the issue. The government moved fast to take control of

the situation and appointed a three member board. If the government continues

to handle it as well as they have done and the board is seen to be taking strong

and positive actions, there is nothing to fear: the company will pull through

and the industry will not be tarnished, says Ganesh Natarajan, chairman of

Nasscom. Also, what makes people hopeful is that the Indian IT industry has

successfully met many challenges earlier and most believe that even though there

will be some changes in the way business is done, the industry will steer

through the crisis. When asked to compare it with the anti-offshoring campaign

in the 2004 US presidential electionsthe last major non-economic crisis the

industry as a whole facedmost said the two situations are not comparable.

Normal political/economic events and fraud are quite different from each

other. However, the Indian IT industry has overcome many challenges and is a

resilient group. I am confident that the industry will move on from this, says

Bhargava. Vashistha of Tholons. He feels it is a comparatively easier challenge

to tackle than the anti-offshoring campaign, while Butler of Ovum says it is a

lot tougher.

But even those who believe that the credibility is hit badly, believe that it

will affect only in the short run. Butler says it would affect new contracts in

the three to six months period. Agrees Bhargava of Butterfield Fulcrum, In the

long run, I dont see much impact. Agrees Vashistha of Tholons, I think the

client concern will be short-term. Nasscoms Mittal, of course, is equally

optimistic.

One reason, and that is left unsaid by all, is that despite everything there

is no credible large alternatives to India. Isolated events like this result in

drastic decisions when the cost of switching is low. So, it is not surprising to

find that most of the clients considering switching from Satyam are looking at

another Indian alternative. It would have been different had it happened

probably ten years earlier.

What Should Clients Do?



At the time of writing this, most Satyam clients are still in the

wait-and-watch mode. That was expected, as no one was prepared for something

like this. Very little is heard from other clients and potential clients. While

agreeing that the event by itself will not impact long-term outsourcing

potential to India, it is sure that the India offshoring strategy would not be

the same again.

Two clear changes are imminent: more derisking and a greater due diligence,

leading to tighter contracts.

If I were a large client, I would institute a policy of always having at

least two Indian IT vendors and split the business between them as a derisking

measure, says Bhargava.

We have already seen an increased focus on risk management over the past 18

months. This event, coupled with the recession, will only increase the firms

focus on this area as a key responsibility of the vendor management office, add

Apte and McCarthy of Forrester.

Derisking strategies apart, most agree that the level of due diligence should

and will increase as a fallout of the Satyam scandal. This may lead to tighter

contracts.

Companies should ensure that contractual relationships with Indian, and

other, outsourcing vendors enable appropriate get out clauses as well as

sufficient levels of access to information, intellectual property and know-how,

says Brudenall of Hunton & Williams. He suggests several measures including

looking at obtaining financial guarantees from the vendor if the contract needs

to be terminated. The current spectacle ought to remind us all of the risks

inherent in any significant long-term relationship and the importance of

constructing protections not only against ordinary risks, but also against the

lightning bolts which strike less often, but with devastating consequences, he

adds. Agrees Bhargava, Customer diligence will increase and contractual exit

provisions will become tighter. The sentiment is shared by Ovums Butler,

expect the risk/ethical factor of vendor selection to gain an even greater

weightage as a decision criterion.

What Changes for the Industry?



The change in client strategy would have implications for the industry. The

derisking strategies may not affect smaller vendors too much, as they were

anyway used to split contracts. In fact, if anything, more clients many now look

at splitting the contracts, leading to an increase in the base of suppliers that

they shortlist. This will help good but smaller vendors. However, this may also

mean that the selling India phase that everyone seemed to agree had had a

logical end, would be back.

But what will hit most is the fact that thanks to added levels of scrutiny

during due diligence, the sales cycles will be longer. That may affect the

pipeline, not a great situation in a recessionary phase. But as most observers

agree, it may not impact much in the long run.

Of course, corporate governance is back on the agenda. In earlier years, we

at Nasscom used to focus a lot on corporate governance issues but we thought

that had stabilized. This incident brings the entire issue back to the forefront

again.

Smaller companies who may not have given enough attention to this aspect will

have to tighten their belt, as an incident like this would result in governance

being there on the marketing presentation. That requires some tangible measures.

Expect some proactive measures to obtain certifications in client markets. The

same way, Indian companies took to CMM and COPC in earlier years, we may see

some rush for some external endorsements in corporate governance. And that will,

of course, cost time, money and energy. There is very little choice.

Says Mittal, What happened at Satyam is a black and white issuea violation

of law. That must and will be tackled by regulators. Governance is more a gray

issue. The differentiation will have to happen in this gray area.

So, call it the next phase of Indian outsourcing: the proactive governance

phase. We have seen capability, quality, and innovation being the buzzwords in

the past. It is time for governance to take over.

Shyamanuja Das



shyamanujad@cybermedia.co.in