The Changing Landscape

The information technology sector has been the
breeding ground of garage outfits both in India and the rest of the world. Many of today’s
IT giants were once small teams of highly innovative people set up with little or no
investments. India too has a long list of start-ups which have been built literally from
scratch. Beginning with HCL, Infosys, MicroLand, IIS Infotech, and Mastek, to more recent
ones like Leading Edge, Cybertech, and Sierra Optima, it is these units today which lead
the IT world in India. Presently too, hundreds of small units survive across the country
which are emulating the examples of their older cousins. But as we move on to the next
millennium, will start-ups continue to become tomorrow’s leaders? Will they be able to
beat their larger competitors in India and ones from abroad? In spite of open
technologies, is the IT sector still as open as it used to be 10 or 20 years ago? While we
still cannot say that the days of start-ups are over, we can say that it is a lot harder,
the Internet notwithstanding, than it was a few years ago. The primary reason for this
change is the overwhelming presence of big companies in leading technology and usage
areas. From chips, operating systems, databases, networking to ERP, all markets are
polarized. Even on the Net-the ISPs, the search engines, the electronic stores, or the
utilities-polarization is the name of the game with mergers, buyouts, and takeovers going
on at a frantic pace. AOL-Compuline, Microsoft-Hotmail, and the list goes on. In India
too, size is becoming important. Offshore units have to have a minimum critical size to
succeed while body shopping too is becoming cash-flow sensitive-a lot harder if you don’t
have a US office. Today’s PC assemblers can never hope to become a Shiva and, in fact,
majority of them have been forced to join the GID bandwagon. Equality is no longer a
hallmark of the IT sector.

Net Advantage
The net could, however, be the great
equalizer, being a market where size is irrelevant, where the tiny rub shoulders with the
giants. The net, as we all know, does not differentiate on the basis of physical or
financial size. However, Net presence is not a full substitute for physical presence and
financial muscle. If you have products which you sell on the net, you still need people
and offices to support them and money to advertise your site both on the net and outside
it to avoid the clutter. The net itself, however, continues to remain a place for new
ventures. These may not be strictly IT businesses, but businesses which are born out it.
This world still mimics the IT world of a few decades ago when business followed
innovation. In IT today, while innovation continues, big business controls most of it.

Overall Ranking

Wipro Ltd 1
Cybertech Systems & Software Ltd 2
Pentafour Software & Exports Ltd 3
Infosys Technologies Ltd 4
NIIT Ltd 5
Satyam Computer Services Ltd 6
Unicorp Industries Ltd 7
Orient Information Technology Ltd 8
Eurolink Systems Ltd 9
Leading Edge Systems Ltd 10
Altos India Ltd 11
Aptech Ltd 12
Rolta India Ltd 13
Sierra Optima Ltd 14
HCL Infosystems Ltd 15
Digital Equipment (India) Ltd 16
Binary Semantics 17
Citicorp Information Technology Industries Ltd 18
Tata Infotech Ltd 19
Moser Baer (India) Ltd 20
SRA Systems 21
Software Solution Integrated Ltd 22
Dixit Marketing Private Ltd 23
Nucleus Software Exports Ltd 24
Kale Consultants Ltd 25
Silverline Industries Ltd 26
Adam Comsof Ltd 27
IIS Infotech Ltd 28
Spectra Innovations (India) Pvt. Ltd 29
DSQ Software Ltd 30

The dynamics of IT products and, perhaps, services
sector as well have started looking like the consumer durable market-the importance of
investments, processes, global presence, and finally size are becoming critical. This is
not to say that the days of garage outfits are over. What it means is that while many such
outfits continue to do well, few will grow into independent companies, and most of such
units, even if they are successful, will merge or be bought out by some larger companies.

Whether this phenomenon is a permanent one or just a
passing phase, before the next round of technological innovation creates many more Bill
Gates out of college dropouts, is a million dollar question. In the meanwhile, it would be
worth looking at the consolidation taking place in the Indian IT firmament as we move on
to the new century. While we know and accept that size is important, DATAQUEST looks at
some of the financial performance figures available from Indian companies to seek some
patterns of evolution of the sector.

One last caution before we move on. While we maintain that
the data used here are based on audited accounts and are therefore reasonably objective,
like many other things in our markets, accounting standards in India are weak when
compared to the West. Consequently, managements can use their creative minds to window
dress their numbers. Unfortunately, in spite of the best efforts of some accounting firms
such window dressing usually gets away. Generally, this creative accounting has only one
casualty-the investor. The investor in India not only needs to take care of creative
accounting but also face the problems of heavy speculation in the market which largely
remains unchecked.

In India, we have to deal with more than just the
fundamentals of the companies and the sentiments of the market. Speculation is largely
unchecked in an emerging market like India. Consequently, a few brokers can form a cartel
and rig up share prices of any stock. The public seeing the stock price rise jumps for it.
As the public enters the scrip, the brokers quietly exit the scene, leaving gullible
investors with dirt stocks. This has happened over and over again in India, leaving a
whole lot of sorry investors stuck with stocks which are not worth the paper they are
written on. Software has taken the fancy of some of the speculators in the market and this
has led to many dirt stocks becoming shooting stars of the market. Many of these shares
belonged to companies which were fundamentally weak, and some hardly have any IT-related
operations. In India the accounting standards are poor, marketing regulation is weak, and
brokers continue to have insider knowledge about companies. In this scenario, investors
need to be doubly sure about the credentials of a company and sometimes even its audited
figures before they buy the stock. People in the industry would have a natural advantage
here and should surely check with their colleagues in the company where they wish to

sent a mailer to Top 200 companies
as per the DQ Top 20 survey of 1996-97 as well as collected the annual reports of a
majority of IT companies which are listed on Indian bourses. Being the first of its kind
exercise, success in getting annual reports of privately-held companies has been, to put
it mildly, not an easy task. We hope that with the beginning made with this issue and
increasing transparency in Indian corporate life, next year’s efforts will be more

In all, there are 61 companies in our sample who together
have a turnover which is around 36.2 percent of the DATAQUEST estimates of the total
turnover of the industry. The data used for this study is strictly based on the latest
audited figures available for companies. Consequently, many companies whose fiscal year
ends on March 31, 1998 could not provide audited reports. Also, there are companies whose
latest annual report available is 1995 vintage. Nevertheless, we expect that the data used
reflects more of calendar 1997 than of the current year. While the data may not be the
latest, its authenticity is assured to some extent due to the fact that all figures are
audited. However, given the fact that they pertain to different years, inter-company data
is not strictly comparable nor do they reflect the current performance of a company. The
analysis also does not take into account the associated or group companies as there are no
clear norms for consolidating accounts in the Indian context. This too would affect the
overall objectivity of the exercise, especially in cases of companies who have large

Finally, numbers by themselves do not tell a complete
story. Only an analysis of the ‘real’ company behind these numbers could complete the
picture. Consequently, there are companies in the lists whose performance in the past or
even in the current year has been excellent in terms of numbers but which do not qualify
for a full-throated round of applause. These are, of course, the quirks of any analysis
that is purely based on numbers.

The first step was to rank companies based on certain known
parameters as a starter and we hope to bring in newer facets of the financial position of
Indian IT sector as we move on from this issue. Finding one parameter to rank all
companies of different sizes, ages, and segments is a difficult task. Therefore, we have
used a set of static and dynamic parameters to define our concept of performance. These
include sales, profit after tax, gross fixed assets, and return on capital employed as our
static criterion. Dynamic parameters include growth in sales, profits, and assets of a

To evaluate and rank a company’s performance based on all
the parameters a final ranking has been presented. Starting with sales, most of the
figures reveal a high degree of skewness. This means that a few companies at the top have
very high profits and sales while a vast majority have very low figures. When ranking such
a sample, variances in the data makes simple ranking difficult, and even unfair. To avoid
the problems of simple ranking when the data is skewed, as is the case of IT companies, we
have used proportional ranking for the overall evaluation. This means that the top ranking
company in any parameter, say sales, gets 100 points and the following companies are given
points in proportion to their sales achievement vis-…-vis the first company. Thus a
company which may be second in line but has only half the sales of the first company is
given only 50 points. Similarly, companies which are at the bottom of the list would get
only very few points. This, in overall terms, gives importance to size in ranking rather
than just a position in the list.

Also, while all parameters are not equal in importance, we
have chosen to give equal to avoide any subjectivety in the analysis. Over a period of
time, we would fine-tune this evaluation mechanism.

SALES: Sales is perhaps the most important
criterion for determining the strength of a company as we move into a polarized IT world
where marketshares are supreme. A proof of this polarization is that the top 10 companies
have almost 70 percent of the total revenues while the bottom 10 constitutes less than 1
percent of revenues. Also, we see that very few companies have been able to change their
ranking in a significant way over the previous period. This also reiterates the importance
of size in the Indian IT sector. The importance of software companies in sales turnover
ratings also outlines their growing dominance in Indian IT sector.

PROFITS: While sales may be the most
important factor in the marketplace, in terms of meeting the objectives of the
shareholders, profits are a sacred figure. Here too, the skewness of the distribution
provides a picture of increasing consolidation in the sector. The Top 10 companies have
contributed 70 percent to the total net profits of the sample. At the same time, the
bottom 10 have a negative contribution of almost 2 percent of the net profit. The profit
of the sector is primarily divided across hardware and software (the top 3 companies in
our sample are from the software sector). Indeed considering that hardware companies have
been around for far longer than most of the software companies, this shows the terrible
times the hardware sector has gone through in the recent years.

ASSETS: The Indian IT industry has been a
resource-starved sector and serious investment in fixed assets such as infrastructure has
been made only in recent years. This too has largely been funded by retained profits. More
recently, some companies, most of them in software services, have grown by tapping the
capital markets. Consequently, the skewness of assets is less than that of sales or
profits. Here the Top 10 companies constitute only 64 percent of the total fixed assets of
the sample, whereas in terms of sales or profits the number is over 70 percent. It also
hints at the fact that mere investment into assets does not transform into sales and
profits. The level of investment in the bottom 10 companies is, however, limited to just 1
percent of the sector, pointing to the limited investments made by the smaller companies
due to lack of funding.

SALES GROWTH: In an industry where growth
is the key to survival and prosperity, we see that sales growth too is skewed across our
sample. When we come to the dynamic figures, size is a liability. This is because growth
in percentage is easier when you are small. Consequently, we see a number of small
companies and companies on the comeback trail which are on the top. Moreover, with the
average sales growth at 57 percent, IT sector is definitely in top gear. The top 10
players have almost 100 percent growth over the previous year. The wide disparity in sales
growth also shows that even though the sector is growing rapidly, the growth is very
skewed across companies. Software companies are the ones which have done well here as they
ramp up for the Y2K phenomenon.

PROFIT GROWTH: The line up of Top 50 in
terms of growth in profits seems more or less a repetition of the sales growth list as
profits seem clearly linked to sales growth in the sector. Here also, the companies which
are making an entry into the IT sector or are on a comeback trail reach the top of the
list. Software is a winner here as well. The companies made tremendous gains in profits
with the rising dollar and growth in the number of people, making it one of the
fastest-growing sectors in terms of profitability in India. Profit growth, especially
future profit growth, is a major factor in determining the investment attractiveness of a
stock. Even past profit growth is a good indicator of a company’s likely performance as
many companies are able to show similar profit growth over a period of time. However, very
sharp profit growth can indicate some creative accounting or some large inflows which may
not recur in future.

ASSET GROWTH: Asset growth is based on the
increase of gross fixed assets for a company. Here too, some of the middle market
companies are at the top as they attempt to enter the big league. Some of these companies
would turn out to be the winners of sales and profit growth in the next few years as
investments are necessary for growth even in the software sector-only companies with
well-equipped and state-of-the-art facilities would be able to get business at the price
they want.

ROCE: Return On Capital Employed (ROCE) is
operating profits of a company divided by the total capital employed in a company. This is
the sum of shareholder funds and loans and is perhaps the best measure of a company’s
efficient operations. This has been reduced by the intangible assets such as prior-year
losses, patents, capitalized expenses etc. Other than the companies which are making
losses in the past, ROCE is a measure of how efficiently a company operates both in terms
of its margins as well as usage of capital. In a country and a sector where finance has
been a problem, a high ROCE is a good indicator of a company’s performance. Here apart
from the top player, most of the companies in the Top 10 ranks are the companies which
have been established a few years ago but done extremely well.

OVERALL: The overall winners of the list
are clearly the ones who not only have high investments in fixed assets but also those who
have sizable sales and profits. These companies also put a high premium on growth and yet
are efficient users of capital which is scarce. While most of the members of the Top 10 in
this list are known to be great companies, there are others who could well reach the top
in the near future. These are the companies to watch for. They may lack the size of the
majors, but prove that excellence does not come by size alone.

Looking Ahead
While our companies include the ones which are
not listed, a majority of them are traded on the stock exchanges. No analysis of their
performance can be complete without looking at their rankings on the market
capitalization. These however have not been considered for the overall rankings. The
markets have responded favorably during fiscal 1997-98 to the rising fortunes of the
software companies. In overall terms the market capitalization of the top 10 IT companies
has gone up an astronomical 240 percent against the BSE Sensex which has more or less
stayed in the same position. This increase reflects not only the excellent performance of
the companies involved but also the re-rating the entire IT sector has been going through
in the period. Increasingly, the investor community is being drawn to the sector as rest
of India Inc goes through a tough period.

At the top of the list of market capitalization stands
Wipro whose market capitalization has increased by over 500 percent to enable it to rise
from the third position during the year. While NIIT dropped down to the third position,
Infosys was second. On the fourth position stood Pentafour which has improved its position
by one rank. The fifth highest in market capitalization is Satyam whose share price has
gone up over 300 percent over the period.

As we move to the future, software companies and even some
hardware companies who are moving into system integration and software services business
are likely to improve their market capitalization further. Apart from their performance,
improved communication to the investor community and better accounting standards would
play a major role in this area. Companies would do well to keep their investors informed
about their performance and even an unexpected downturn as the better informed investor
takes more rational decisions. The information technology sector has now got the full
support of the investor community and companies have a responsibility to reciprocate this
faith by providing a true and fair picture of their state of affairs.

As one goes through the numbers and rankings, there is one
factor which stands out across the lists: Invest or perish. Investing in infrastructure,
especially for software companies, has now become a necessity more than ever before.
Starting with Infosys, companies which made investments in software development facilities
were the ones which also managed to get the best rankings in terms of sales growth as well
as profit growth. More than that, it is also clear that most of the companies which made
substantial investments in infrastructure have also done it in the past. This is the entry
barrier of asset size which is slowly rising in the industry and in the coming years, size
of the facilities will determine success or failure of software companies.

As time goes by, companies which don’t have the right
infrastructure are likely to face not only poor sales growth but also find it difficult to
attract people and clients. The larger companies in terms of assets will be able to add
more people each year as well as impress clients with their excellent facilities and team
sizes. The success of a Satyam or a Cybertech is primarily based on the availability of
state-of-the-art facilities and a proactive approach to the whole game of software
business. Even companies like Leading Edge, which are primarily in the body shopping
field, are making investments to move up the value chain.

On the other hand, there are countless companies outside of
the list who prefer to stagnate at Rs 1 crore to Rs 3 crore turnover year after year
without looking at expanding operations. It’s really the chicken-and-egg story. If you
have the orders then you build facilities is the logic. But can you get orders without a
proper infrastructure, without telecom links and the latest software platforms? Will you
get the right people that you want in working conditions which are not up to the mark?
Things are changing fast as we move on to the next century. Given the increasing marketing
power of the big players as well as the entry of the MNCs, smaller companies will have to
make the tough choice of either exiting the business or making adequate investments into
infrastructure. There are few other alternatives.

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