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SOFTWARE EXPORTS - Hour Of Reckoning

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DQI Bureau
New Update

If in 1998-99 fiscal, Infosys’ debut on Nasdaq grabbed

headlines, the 1999-2000 fiscal was memorable for the astounding market

capitalization (m-cap) that Indian software companies commanded on the domestic

bourses. In fact, the extent was such that Wipro replaced Hindustan Lever as the

number one company in terms of m-cap, touching a peak of Rs 69,528 crore on

January 4, 2000, though for a short period.

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There were expectations round the year of companies going to

tap the US capital markets. However, except for Satyam Infoway, which became the

first Indian ISP to be listed on Nasdaq, none of the other Indian companies

tried their luck on the US bourses. The volatility at Nasdaq and the battering

that IT companies, including Infosys, took there had more to do with the Indian

companies postponing their plans for a listing.

Indian software companies made their presence felt worldwide

with the Y2K projects that they had undertaken. And the time came for these

companies to show that they were not just groups of coders and programmers, but

also entrepreneurs willing to get into new areas and new domains. A skilled,

English-speaking workforce went unmatched. Besides, the ability to adapt and

learn the emerging technologies, and get into areas of cutting-edge technologies

also stood the companies in good stead. The competitiveness, rather than coming

from other countries, came more from the Indian companies themselves, rubbing

shoulders with each other to bag contracts and projects. And this clearly

demarcated the leaders among others. It also established companies with valued

systems and processes, and sound management principles and business models, on

the global front.

Thinking global

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The ‘think global, act local’ catchword caught up with

software majors at the fag end of the millennium. Globalization became the

buzzword and with the Indian software industry’s strength being recognized

worldwide, it was not surprising that some of the companies did try to take the

initiative, by moving their chief executive officers (CEOs) to the US. Vivek

Paul of Wipro, Vijay Thadani of NIIT and K Sridharan of BFL Software have set up

their offices in the US, while NR Narayana Murthy of Infosys concentrated on the

global markets. Not to speak of Shiv Nadar of HCL, who has been based abroad for

long. In the near future, we are definite to see more and more among the top

management moving to the US, with the companies’ workforce remaining back

home.

Globalization is the driving force and localization the

driving need that has made companies opt for this route. The underlining factor

is that if a company wants to have a global presence, it is imperative that the

top management sits at a place where the majority of its customers are located.

With the majority of business for software companies coming from the US, it has

become a need rather than a means to be close to customers. It helps them

understand the problems of the customers and reach out to them. Over and above,

it helps them in forging long-term relationships with customers and realizing

the needs of the markets as well as acting according to those needs. Also, major

US dotcoms and ebusinesses have shown how business can be generated and run

using the new click model rather than by sticking to the traditional

brick-and-mortar model. As such, it has become imperative for the top management

of software companies to be in the thick of action to guide and take the company

forward in the new economy. CEOs are therefore opting for a hands-on approach to

drive their businesses by setting up their bases overseas.

Interestingly and ironically, with the teams staying back and

the CEOs going overseas, a gap is definitely going to take place, which may act

as a hurdle. There is even a school of thought that says the teams outside India

can be at an advantage, by not having their CEOs there. With the CEOs not

involving themselves in the operational details of transactions, it was left to

managers responsible for the teams to resolve the issues. The other school of

thought says that the decision-making process becomes faster and the

localization process gets seamlessly integrated between the companies’ Indian

and global operations.

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Low margins

Most of the software export houses still rely on the low-cost

model, which in the long run will prove to be unsustainable. Most of the

companies announced high growths in revenues as well as net profits. But a close

look at these companies show that they have not been able to improve upon their

margins. And this doesn’t augur well for the Indian software industry. Looking

into the fine print, for these companies, it is a clear indication that they

have not been able to renegotiate the contracts they had bagged during the

pre-Y2K era. For instance, Silverline Technologies, which breaks into the top 20

software export companies list with 84% growth in export earnings, had an

operating margin of 41% in the last fiscal as compared to 49% in 1998-99. Satyam

Computers has been another company that has had a 2% drop in its operating

margin. While for the whole year, Satyam’s operating margin was 37%, down from

39% a year ago, for the January-March quarter, it was 35% as compared to 40% a

year ago. BFL’s operating margin dropped to 10% in the last fiscal from 34% in

the 1998-99 fiscal. While the middle-rung companies were the worst affected,

top-rung companies like Satyam did not have a good margin to speak of either.

Incidentally, though Infosys improved upon its operating margin for the whole

year, if the January-March quarter of the last fiscal were to be taken into

account, it fell to 39% from 41% a year ago. Pentamedia Graphics also reported a

lower margin of 20% in the fourth quarter of the last fiscal as compared to the

third.

Major reasons attributed to the lower margins were: increase

in competition and heavy dependence on a few clients. This has prevented the

middle-rung companies from increasing the billings to keep in tune with the

increase in employee salaries. Another factor is that the rupee ruled steady

against the US dollar during the last fiscal. The steady rupee-dollar rate meant

that software export income could not gain much from the depreciation of the

currency, as in the previous years. This fiscal, though there was a balance

between the onsite and off-shore work being pursued by the software companies,

ecommerce projects, which call for a lot of onsite work, have definitely lowered

the margins. Long-term contracts with clients also led to a decrease in margins.

All this leads to the conclusion that the low-cost model pursued by many of the

Indian software companies as a unique selling point is unsustainable in the long

run.

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Branding has become important and companies have to invest in

branding if they have to keep up the momentum. But analysts are not worried

about the ecommerce projects as they will reap rich dividends in the long run.

However, it is a general opinion that these projects and contracts should be

subject to periodic reviews, where the companies are able to renegotiate the

rates with the changing circumstances.

A Nasscom-McKinsey report estimates that, at modest returns

on invested capital and low price to earning levels, the stock market expects

today’s players to generate $45 billion in revenue from current products and

services in 2008. Therefore, to achieve the rest of the targeted growth in

revenues ($42 billion) and any shortfall in the target for current services and

products, Indian players will need to seed ventures in existing and new growth

areas. Failing to do so will mean not only forgoing exponential growth but also

losing what has already been achieved.

Mergers and acquisitions....>>>

Mergers and acquisitions

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It was also a period of mergers and acquisitions, not only

worldwide, but also in India. Satyam Infoway acquired IndiaWorld in an all-cash

deal, Leading Edge took over eCaptial and BFL acquired Mphasis. Pentafour, in

contrast, hived off its two divisions into separate companies, Pentamedia

Graphics and Pentasoft Technologies. Acquisitions have been among the reasons

that prompted the Indian companies to go for overseas listings. With Infosys and

Wipro asking the government for a blanket nod for acquiring companies overseas,

other software companies would have started searching for talents and buy-outs,

and eyeing the American Depository Receipt (ADR) route. (A recent report though

says that the finance ministry has informed the Reserve Bank of India that Wipro’s

and Infosys’ proposals be deemed as closed, and the duo need to put in fresh

proposals, because of the high values of their acquisitions.) Moreover, with

more and more globalization taking place, it was becoming clear that if Indian

IT companies had to retain their talent pool, it was necessary that employees be

given dollar-based stock options. The brand value attached to being listed on

the US capital markets, given the stringent accounting and disclosure norms that

the companies have to follow, is also looked upon by the companies as a way of

increasing their valuations on the domestic bourses.

The finance ministry, in a radical departure from earlier

times, gave a blanket nod for overseas acquisitions by domestic companies in

specified sectors through stock swaps up to a limit of 10 times the companys’

export earnings. The export earnings as shown in a company’s audited balance

sheet of the preceding year will be considered for this purpose. The new policy

will give automatic approval to companies that seek permission for overseas

buy-outs by issuing ADRs and Global Depository Receipts (GDRs), within the

specified limit of 10 times their export earnings. For a higher limit, the

companies will have to approach the Special Composite Committee. Henceforth,

there will be three windows for overseas acquisitions: the automatic route where

companies, irrespective of the sector, are allowed to make ADR or GDR-funded

acquisitions up to $50 million, the automatic route extending up to $100 million

and limited to knowledge-based sectors; and the 10 times export earning

criteria. But the much-awaited acquisition by Infosys still failed to

materialize.

The show goes on

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The software export industry, in 1999-2000, showed a growth

of 63%, slightly lower than the earlier fiscal’s 67%. Despite a belief to the

contrary, the lock-down period in the US as part of the Y2K bug had its impact

on the Indian software export business as growth fell by 4% over the previous

year. But while software exports during the 1998-99 fiscal had recorded an

earning of Rs 10,500 crore, last fiscal it went up to Rs 17,150 crore.

The top and middle rung companies, having already grown by

three-digit figures, attained realistic levels during the last fiscal and

continued to maintain a steady growth. However, the small and medium-sized

companies contributed to almost 50% of the total software export revenue. With

the companies’ bases also growing, it is no surprise that the top 20 companies

all showed a sub-100% growth. Due to smaller bases in the last fiscal, they had

grown more than 100%.

To get into some statistics, as we had mentioned last year,

companies that depended too much on the Y2K component took a solid beating. For

instance, IMR India had close to 60% of its revenue coming from Y2K operations

in the 1998-99 fiscal. Last fiscal, its topline dropped by 13%, with a growth of

36% in the last fiscal. It still had 10% of its revenue coming from Y2K and

post-Y2K related work in the fiscal. CBSI is another company which showed a drop

of 3% in its turnover last fiscal as compared to a whopping 104% growth in

1998-99. And the company still has 14% of its revenue coming from Y2K and

post-Y2K related work. While on an average the top 20 software exporters grew by

around 40%, despite the general belief that the lock-in during the Y2K will not

affect the Indian companies, it did make a dent in the companies’ earnings.

While in the 1998-99 fiscal, the top 20 software exporters had contributed Rs

6,196 crore, last fiscal they contributed Rs 8,642 crore, again a growth of 40%.

Mastek showed the largest growth among these companies–86% in turnover.

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Infosys has become the benchmark for the Indian IT industry.

With its global delivery model, spread of clients and a good mixture of onsite

and offshore projects, Infosys today is perhaps the only company that has been

able to keep up with challenges and competition, and been able to successfully

renegotiate its per man hour charges. It commands a reported $90 per hour from

its clients. Naturally therefore, its processes and quality initiatives are

being followed by many companies. Companies increasingly realized that it was

imperative to have good quality processes in place, if they were to move up the

value chain. And with at least 13 companies having attained the SEI-CMM Level 5,

Indian companies definitely carved out a niche for themselves on the global

arena.

Good revenue mix...>>>

Good revenue mix

If we take a look at the spread of the revenue that accrued

during the last fiscal, we find an almost equal onsite-offshore ratio. While

onsite work contributed 50% to the software exports revenue, offshore jobs

brought in 49%, with the remaining 1% being contributed by other projects. The

fiscal was more skewed towards onsite projects, with 54% of the total revenue

from software exports coming from this area. However, with ecommerce catching

up, the ensuing fiscal will see more and more companies implementing onsite

projects. But this is no cause for fear because of the long-term benefits that

ecommerce accrues to a company, provided the company is able to position itself

such that it can command a competitive price from its clients.

The US continued to be the favorite hunting ground for Indian

software companies and brought in the largest chunk of revenue–67%, up 4% over

the previous year. Indian software companies have not been able to make any

significant inroads into the European market, with the region maintaining a

steady 21% of the total revenue. Incidentally, Japan has been one country where

Indian companies have lost ground. While in the 1998-99 fiscal, 4.5% of the

revenues came from this region, it dropped to 2.5% in the 1999-2000 fiscal.

Considering there has been enough scope for exports, it is disturbing to note

that Indian software companies have been losing ground year after year.

The year that went by also saw Y2K projects continuing to

bring in revenue, albeit low. It brought in just 4% of the revenue last fiscal,

as compared to 17% in the previous year. Euro currency projects were the single

largest contributor to the software exporters’ kitty, roping in 40% of the

total accrued revenue. And middle-rung and lower-rung companies benefited the

most from the euro wave. Web-based or ecommerce areas also showed marked

improvements, garnering 16% of the total revenue. These also emerged as

promising areas that can propel the Indian software industry on to a higher

growth path. As was expected, revenue from ERP projects came down from 13% to 6%

over the two fiscals. Traditional areas of business like datawarehousing,

migration and porting were also down drastically to around 7% in the last

fiscal, as against 28% during fiscal 1998-99. Though most of the software

companies did brand themselves as high-end IT consulting companies, if we look

at the statistics, consulting per se brought in only 25% of the total revenue

accrued on account of software exports, while projects contributed 63%. Though

both the areas have shown a marginal growth as compared to the previous year,

the figures prove once again that Indian software companies continued to depend

on projects to boost their topline as well as their bottomline.

Growth areas

With a workforce of over 3 lakh, the Indian software industry

definitely shows that there is still a lot of



scope for skilled workforce. And with more and more start-ups being born, and
more and more experts and veterans in the field taking up the challenge, it is

expected that more and more skilled workers will be in demand. The

Nasscom-McKinsey study has said that India can achieve exports worth $50 billion

by 2008. For achieving this target it has specified seven ‘growth enablers.’

They are:

  • Building a supply base of the world’s best knowledge

    workers

  • Creating the ideal regulatory environment

  • Building anchor Indian IT MNCs

  • Creating the India Inc brand

  • Opening new opportunities through country-specific

    initiatives

  • Achieving global parity in telecom infrastructure

  • Unleashing the Indian venture creation and incubation

    engine

And the challenges lie in making full use of our strength in

new exciting opportunities like e-enabling both the traditional as well as the

dotcom businesses, and migration of applications to web-based services and

software-enabled mobile and other networked devices. Another interesting segment

that is going to throw up a lot of opportunities for Indian software companies

is the application service provider (ASP) market. As the study points out,

"Providing rapid implementation and integration services upfront for

upgradation is one of the key factors for the success of ASPs. ASPs recognize

that winning does not require owning all the pieces and are partnering with IT

service providers." And this is the area that Indian software companies

should look forward and tap into. The internet has thrown up a plethora of new

and innovative opportunities, and rather than joining the dotcom bandwagon,

Indian companies should try and make themselves the pick and shovels for the

dotcoms.

Indian software industry’s strength lies in its deep

understanding of technology and in delivering quality services through the

projects it undertakes. And this should be the future agenda of the software

exporters too.

All said and done, the hour of reckoning has come for the Indian software

export industry. The falling margins and low growth rate should not be taken as

a source for distraction, but be considered as a passing or temporary phase. For

the software houses to move up the value chain, it is imperative that they take

a second look at their business models, and realign and reinvent themselves

according to the changing circumstances. India should not be happy with a lone

Infosys or a TCS. The onus lies on all Indian software export companies to match

up to global standards and face competition by bettering their global delivery

models, and by spreading their businesses across clients and geographical

locations. 

Highlights: Indian SW Exports, 1999-2000....>>>

Highlights: Indian SW Exports, 1999-2000

  • Software exports grow by 63% over

    the previous year

  • The US is favorite hunting ground

    garnering 67% of the revenue

  • Over 300,000-strong workforce and

    increasing constantly

  • India’s top 20 software

    exporters show growth of 40%

  • TCS continues to be the top

    software exporter though with a lower growth rate

  • Mastek shows largest growth among

    top 20 software exporters, with 86% growth

  • Silverline, IIS Infotech make

    debut into the top 20 software exporters club

  • Single largest export revenue of

    40% gained from euro currency projects

  • Low margins stare at software

    exporters

  • Satyam Infoway makes Nasdaq debut

  • Larsen and Toubro Information

    Technologies Ltd and Tata Infotech show negative growth in software exports

  • Y2K continues to bring in 3.6% of

    revenue

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