Picking up Pace

It has been an old adage in the IT industry–watch those PCs; they are a
good indication of what’s up with the market. Almost three years ago, HP’s
global PC sales slowed down. Within three months of HP’s results in October
2000, the more far-sighted CEOs of the Indian IT services industry knew the
coming months would bring trouble. They did.

This October, HP specifically, and the worldwide PC market in general, have
shown robust growth. The Palo Alto-based company’s PC business grew by 19%
this quarter, while Dell’s grew by 22% (it’s expecting a 25% growth in the
next quarter). Worldwide PC sales, in general, have been up 15.7% while the APAC
region including India has soared. For the first time, this recovery looks like
it has come to stay.

This
time around though, what does it really mean for the Indian IT services
industry? The answer is a little mixed. In the US, much has been written about
the ‘jobless recovery’ where economic indicators have begun to look up but
somehow, these have not led to more jobs being generated. Something similar
seems to be happening here. Top line figures in the first half of fiscal 2003
indicate that a recovery may be on the way. Revenue growth at the large majors
has remained steady while tier-2 companies like MphasiS and Digital GlobalSoft
have actually seen growth rates increase. However, this is coming at a cost–margins
pressures. If one were to draw a parallel, the jobless recovery of the US might
be mirroring the ‘margin-less’ recovery in the software services sector in
India. In short–the business is coming in and indeed, might be growing. But
the pricing pressure is continuing, relentlessly.

Topline Growth

Toplines of most Indian software companies have grown at a robust rate in the
first half of fiscal 2003. Infosys’ topline grew 35% (compared to 39% during
the full fiscal 2002); Wipro’s 29% (steady at 29% in fiscal 2002); Digital
Globalsoft’s 45% (up significantly from 27%); MphasiS 42% (up marginally from
37%). (See table 1). In fact, both Infosys and Wipro hope to join TCS in the
exclusive league of Indian software companies that clock annual revenues of over
a billion dollars.

"We expect our revenues for the financial year to exceed $1 billion. In
1999, the revenues of our company were $121 million, which means that in five
years the revenues have grown from a little over $100 million to over a $1
billion," said Infosys CEO Nandan Nilekani, announcing the half yearly
results of the industry bellwether. "Two years ago, our revenues were about
half a billion dollars and have almost doubled since," he added.

Wipro too aims to join the club by the end of the financial year.
"Translating second quarter’s IT revenues of $268 million on an
annualized basis puts us into the billion-dollar league," said Wipro
corporate executive V-P (finance) Suresh Senapathy at the half-yearly results
announcement.

Part of this stupendous topline growth can be attributed to the fact that
both outsourcing and offshoring have now become mainstream. More importantly,
the international telecom industry–a key vertical for Indian services players–has
begun to look up again after two years even as the banking and financial
services industry continues to spend.

"In terms of verticals, we have recently seen an increased growth in the
banking and financial services as well as in telecom. In telecom, this growth
has come primarily from the service provider segment," says Infosys COO
Kris Gopalakrishnan. That also showed up in the results of companies like Hughes
Software, which gets a good chunk of its revenues from this vertical.

There is a caveat though. In companies like Wipro Technologies, the topline
growth now includes its BPO business from Wipro Spectramind. This is significant
since Spectramind has been a huge hirer during this half year and is likely to
have significantly boosted the revenue growth figures. The same would apply to
Digital GlobalSoft whose Digital Contact Center (DCC) has grown rapidly during
the year.

That was the good news. The bad news is that other things haven’t changed.
Three issues that had plagued the industry during fiscal 2002 continue to have a
significant impact on companies’ finances–margins squeeze, an appreciating
rupee, and the backlash against outsourcing.

The Big Squeeze

Analyze this: during the first half, Wipro’s topline grew by 29% even as
profit before tax grew by a mere 6%. Digital Globalsoft’s topline grew by 45%
while net profit grew by 27%. Satyam revenues were up 24% as compared to an 18%
growth in net profits. Part of this is of course because of significant
investments made during the year by some of these companies. Wipro Technologies
bought over NerveWire while others like Satyam and Digital have invested in and
expanded their BPO businesses.

However, that doesn’t explain it all. Adding to the squeeze is the fact
that renegotiation of deals is continuing, especially from larger, older
customers who have large volumes of business with any one company. "We have
several hundred customers and only about 15 of them have actually renegotiated
prices in the last six months. What happens though is that typically the
renegotiations happen when the volume with the customer goes up. And because
they tend to be larger customers, the impact is something that you feel,"
said Nilekani.

That’s the demand side pressure. Adding to supply side pressure is the very
fact that offshoring has become mainstream. As a result, global services
companies and systems integrators have continued to expand heavily in India,
often hiring people at significantly higher salaries to get the momentum going
quicker. Two of the big hirers of the year are, IBM Global Services that is now
approximately 5,000-strong, and Accenture that has also been accused of pushing
billing prices down over the last few months.

This has forced companies like Wipro and Infosys to hike salaries during the
half-year under consideration, even though margins have not improved. How long
the impact of this supply side pressure is likely to last is difficult to say at
this point of time. While Wipro Technologies is acutely aware and chary, Infosys
is aware but not yet worried. Says Infosys COO Gopalakrishnan, "In some
instances, the global SIs are offering higher salaries… It doesn’t have a
significant impact on Infosys right now. However, we are looking at how salaries
will move over the years, and have increased salaries for our employees this
year." That too, though, comes with a caveat. "By and large, we have
made this hike a variable component of salary so that if the company does well,
the employee gets more and if there is a downturn, then the company is also
protected."

The Twin Pains

While the margin squeeze is a continuing saga, the other two issues have
only exacerbated over the year. While presenting the half-yearly results in
2002, Nilekani had expressed worry on two main fronts–the possible effect of
the appreciating rupee and the possible effect of a growing backlash to
outsourcing. Both possibilities have since become realities. The rupee continues
to appreciate steadily while not only have H1B quotas been cut down to 65,000
from 195,000 but the L1 visas have also come under closer scrutiny.

First the rupee. According to Infosys CFO Mohandas Pai, "The key issue
is the impact of the appreciating rupee. Loss of revenues due to the rupee’s
appreciation this quarter is about Rs 58 crore, and loss of revenues for the
half year is about Rs 90 crore, assuming the same kind of average as you had the
previous year." It boiled down to a negative impact of 5.1% on the topline
and a negative impact of 0.75% on the operating margin.

For Bangalore-based Digital Globalsoft, the issue is of top priority because
for every 1% appreciation in the value of the rupee, it’s a 0.5% hit on the
bottomline. "One of the uncertainties is the rupee-dollar rate; so while
everything else in under our control, at the moment, we have some
quarter-to-quarter drive to manage the affect of the appreciation. Some of it is
done by hedging and since some of the hedging happens against our expenses that
are getting incurred in overseas currencies, the impact is significant. …The
biggest uncertainty remains there," said Som Mittal, president and CEO of
Digital Globalsoft, during the company’s results conference call.

Also, for an industry that was writing off the backlash against outsourcing
as a media hype, the slashing of the H-1B quota has come as a bit of a shock. In
October, the H-1B visa quota dropped to 65,000 and while the impact may not be
immediately felt, this is something now being watched very closely. For one, one
will need those extra visas if the recovery actually does happen and the
business booms. More so because companies like TCS and Infosys have seen onsite
revenues go up over the last couple of years due to change in service lines.
Also because the H1B visa issue has led to closer scrutiny of the blanket L
visas that all the big IT services companies have and use extensively. Infosys
HR head Hema Ravichandar said, "On the H1 front, we currently have about
4,800 visas and 50% of those are utilized. We have a significant number in the
pipeline as well… we don’t see it making a very significant impact right
now, but going forward, we are looking at it very closely."

Going forward though, the key challenge will continue to be with margins. As
MphasiS CEO Jerry Rao put it, "Our #1 concern is that we have to keep the
trajectory of clawing back on the gross margins in software services. We had
said that we had lost 5-6% points and we will claw it back over the next
two-three quarters; if not all of it, at least some of it. We have clawed back
1.6% this quarter and we have to continue to do that." The rest of this
fiscal should be interesting to watch.

TV Mahalingam

Hardware: PC Sales Lead the Charge

Desktops

In India, PC sales are on the rebound. According to IDC India’s quarterly
PC tracker, PC unit shipments in the third quarter of 2003 grew 17.6%
sequentially and 24% on a year-on-year basis in JAS ’03 to reach 700,000
units. Introduction of new price points and aggressive promotions by the branded
PC vendors saw consumer desktop sales growing by 16% to 218,000 units. Also
strong buying by BFSI, BPO and manufacturing segments saw commercial ddesktop
sales posting a 25% jump to 446,000 units.

"With all sectors of the economy, viz agriculture, manufacturing and
services showing buoyancy, there is a boom in the stock market, and the return
of consumers’ confidence is encouraging buying." says Aman Munglani,
head, computing products research, IDC India.

HCL gained market share and maintained the top spot in the commercial desktop
space in the quarter with 11.3% share. HP also gained and totaled at 10.4% share
of the commercial desktops market. IBM maintained its third place in this space.

Laptops

Laptop sales have also been picking up, thanks to some really low pricing
schemes by vendors. According to IDC, last year’s notebook sales stood at
48,666, while in the last three quarters of this year alone more than 57,762
units have been sold. Further, laptop sales saw an astronomical growth of 81.9%
annually and more than 27% sequentially.

According to IDC, India is the third fastest growing notebook market in the
Asian region, with a compounded annual growth rate of 21.9%. "Consider
this: the ratio of desktops to notebooks in India is 1:30, while even Thailand
boasts of a ratio of 1:6, with notebook sales outpacing those of desktops. We
aim to change the equation in India with this sub-50,000 notebook range,"
said Ravi Swaminathan, V-P for the personal systems group at HP India.

Continuing from the last quarter, the notebook segment witnessed growth
primarily driven by corporate and government demands.

Assembled

The quarter also witnessed initiatives from branded players trying to tap
into the burgeoning assembled PC market that accounts for over 60% of India’s
2.4 million annual PC sales. HP has begun a pilot project to sell its
non-branded personal computer kits to local assemblers. HP India has tied up
with Redington to distribute kits to nearly 200 assemblers in an initiative
called ‘Impact’, that will be rolled out in Karnataka, Tamil Nadu and Andhra
Pradesh. The price for the end consumer will be approximately Rs 29,000,
inclusive of the operating system.

Microsoft is reportedly tying up with lesser-known Indian personal computer
assemblers and hopes to help them with after-sales support for their customers,
offer training to the customers as well as help the partners tap the home and
small business customers.

With the introduction of such initiatives, PC sales are expected to go up in
the coming quarters.

Services: BPO Steps up Hiring

Fueled by the hiring of their BPO arms, services companies continue to add
heads at a relentless pace

The first half of this year will be remembered for the prolific hiring by
most Indian software services players. In most cases, their BPO arms fueled the
hiring. For example, Wipro’s employee strength grew by nearly 17% in the half
year to reach approximately 24,500. Of this, nearly 16,000 employees employed in
the IT services business and 8,000 in Wipro Spectramind. The company added 3,091
employees during the last quarter, of which 65% (2,030) were hired for
Spectramind.

Infosys too hired by the hordes. The company’s headcount grew by nearly 25%
in the first half of the year. Infosys today employs around 19,120 employees of
which 2,595 were added in the second quarter of this year. Net additions for the
quarter stood at 2,025 as compared to 1,739 in the previous quarter. The company’s
BPO arm Progeon’s headcount stood at 1,038, of which 156 were added during the
quarter.

Satyam is also fast tracking its hiring process. The Hyderabad-based company
will now be hiring 3,000 employees over the financial year instead of the 1,500
indicated at the beginning of the year. During the first half of the year, the
company hired about 1,500 employees, taking the total headcount to 11,250.

Digital GlobalSoft’s headcount shot up by nearly 78% in the first half of
the year. The company added 1, 203 people in the second quarter alone, thereby
taking the overall headcount to 4,440. Of this, 906 people were recruited for
its contact center business (Digital Contact Center), while 260 were hired for
the software services business. 

Companies are bullish about hiring even more in the near future. CEO of
Digital GlobalSoft, Som Mittal says, "I am not sure what the number would
be, but I will be surprised if we are not at least 5,500-people strong by next
March."

Answering a query about the break-neck pace of hiring at the half yearly
results investor conference call, Infosys CFO Mohandas Pai said, "I
remember about four to five years ago, somebody came and asked, ‘Will you be a
10,000-person company?’, and we told them ‘Look, there is this big company
out there as competition, which is 60,000—80,000-people.’ Today we have
20,000 people and have managed to hire 4,500 people in the first half of this
year and have said that we will hire about 3,000 people in the second half. That
makes it 7,500."

Meanwhile, the MphasiS BFL group’s headcount grew by nearly 22% in the
first half of the year. MsourcE, the group’s BPO arm grew by 21% from 2,587
employees at the end of fiscal 2003 to 3,138 employees by the first half of this
fiscal. Bangalore-based iGate Global’s headcount grew by 79% during the first
half of the year. The company attributes part of this huge jump to the
acquisitions of Quinatant and IdeaSpace Solutions.