The Meltdown



The meltdown which has brought the US economy to the brink of recession, has
made vulnerable the Indian outsourcing industrys biggest marketthe US. And of
course, financial services is the largest market among verticals. As the
undercurrents are being felt in Europe and the crisis percolates down to other
sectors as well, the question is imminent: Is this the end of the golden age of
outsourcing for India, as a Forrester analyst pointed out?

Views are abundant, but there is consensus on one big thing: that India
cannot remain unaffected. We do see these incidents having a direct impact on
our industry, and those likely to create a downstream impact on other sectors of
the US economy and worldwide markets, says a statement issued by Nasscom.

More specifically, many of the financial institutions that have gone down
(bankrupt or acquired) have multiple vendors, including many tier-1 vendors,
servicing them. At the basic level the revenue from these customers will take a
direct hit. And further, as many more financial institutions shall come under
the axe, it will have a spiraling impact on revenue.

At a broader level, the Indian IT and BPO industry is bracing for a slower
growth as new projects will take a hit and there will be slowdown in IT spending
at least over the next few quarters. Earlier this year, Nasscom had moderated
the growth rate estimated for this year to 21-24% factoring in the subprime
crisis. However, factoring in the recent global meltdown, the growth rate is
likely to end up even lower, though Nasscom has not revised its growth
projection yet. According to Phaneesh Murthy, CEO, iGate, Since financial
services account for 40% of Indias technology and operations in the IT export
revenue, I anticipate slower growth in the next two years or so."

The HR Crisis
Another area that will take a big hit is hiring, considering that manpower
is one of the biggest cost factors. Industry experts estimated a 25-30% drop in
hiring as companies get into a cost saving mode. According to Ganesh Natarajan,
Global CEO, Zensar Technologies, there will be a slowdown for three to four
quarters while the global financial sector corrects itself and the impact on
other sectors is addressed. According to Rishi Das, co-founder, CareerNet
Consulting, there is likely to be a 30-40% drop in hiring at the Indian campuses
this year, especially the IITs. Even the IITs are feeling the heat. In fact,
they are likely to be more affected than the smaller institutes as the companies
may resort to hiring from smaller campuses for cost savings, he adds.

Manpower is one the biggest cost factors in the knowledge industry.
Therefore, most of the companies are planning to wait out till next year and
analyze the situation before they start aggressive hiring again from campuses.

In the short-term vendors will
continue to get the same growth rate


Sumeet Salwan, director, advisory services NeoIT

Murthy confirmed that his companys hiring plans have slowed down and the
percentage of just-in-time or reactive hiring to the total hiring has increased.
NIIT Technologies too has confirmed cautiousness in terms of hiring. The company
has stopped hiring to the bench resorting to only just-in-time hiring.

All this could result in a lowering of IT industry growth by six to seven
percentage points and a lowering of new job creation to about 200,000 in the
current year. According to Thakker, most vendors will continue to focus on
optimizing their resourcing and staffing to minimize bench time and maximize
utilization.

Business Impact
In some ways, the Indian IT and BPO industry is at the same stage today as
the slowdown in 2001-2003. Though, in others it could be much worse this time.
For one, this has hit the Indian IT and BPO industry close on the heels of the
rupee appreciation crisis. This was at the time when the industry was just
reeling out of the rupee appreciation crisis and had not fully recovered yet.
The slowdown, therefore, adds cumulatively to it. Further, the US sub-prime
crisis, spiraling into a credit crisis has shaken up the very foundations of the
financial industry, and is already being termed as the worst financial crisis
since the Great Depression of the 1930s. In a scenario like this it takes some
time before the fundamentals are back in place.

Notwithstanding the fact that cut in IT budgets would also mean more
outsourcing at some stage, Indian outsourcing has definitely taken a hit. India
being the largest, vis–vis the other outsourcing destinations, also means that
it is going to be the most impacted. Within that its the companies with bigger
exposure to the BFSI sector and the US market that have already started feeling
the heat.

According to Nasscom, the BFSI sector accounts for 30-40% of the work
happening in the Indian IT-BPO industry. This indicates a high exposure to the
sector. For many tier-1 companies, including some of the top 10 software and
services companies, on an average 30-40% of revenue is contributed by financial
services. Then there are companies like Polaris and i-Flex which have a major
portion of their business coming from the BFSI space. Then there are the smaller
players, especially in the KPO domain, that are solely catering to the financial
services sector. Geographically too, even though the companies have been
diversifying their operations over the years, a major portion of the business
continues to come from the US. With many companies the exposure could even be
more than 50%.

The Specifics
In order to gauge the impact of what is soon turning out to be a global
financial crisis, as a starting point it will be apt to understand the specific
vendors that have been impacted with the axe falling on their customers.

The meltdown has meant that some of the larger clients that were being
serviced by various offshore players have actually either been acquired or have
gone bankrupt, and as a result their business is in itself in doubt, says
Keshav Murugesh of Syntel. Since these were large players like Bear stearns,
Lehman, Washington Mutual, Wachovia, Fortis, etc it has brought in a lot of
uncertainty to players exposed to them. According to GB Prabhat, Founder & CEO,
Anantara Solutions, the disappearance of prominent US firms implies the
disappearance of an equivalent volume of business.

So, which are these offshore players that have exposure to some of the big
financial names that have come down? As per sources, Satyam, Patni, IBM, Perot
Systems, and TCS were among the vendors servicing Merrill Lynch, which was taken
over by Bank Of America. Since TCS is a vendor for both Merrill Lynch and Bank
of America, being there in the camp of the acquirer, the takeover of Merrill
Lynch may not directly impact TCS.

Lehman Brothers, the investment bank that filed for bankruptcy is speculated
to be serviced by TCS and Wipro among other vendors. Similarly, Washington
Mutual, which has been taken over by JP Morgan Chase will bring Wipro and
Cognizant under pressure. On the other hand, US banking giant Wachovia, which
also crumbled under the weight of bad mortgage loans, has been outsourcing work
to Genpact. Its takeover deal is yet to be finalized. AIG, which has been
nationalized with an $85 bn bail-out by Federal Reserve, is speculated to be
dealing with TCS among various other vendors. In fact, most of the tier-1 firms
like TCS, Infosys, Wipro, and Satyam have had some exposure with the names that
have gone down through their subsidiaries or in some form or the other. While
the nature of the impact on tier-1 vendors will be more in terms of bottomline,
the impact on the tier-2 and tier-3 players will be directly on the topline.

Milan Sheth, Partner, advisory services, Ernst & Young, brings in yet another
perspective to this: A lot of the US companies are not just outsourcing to
Indian service providers but also to the global service providers who are
catering to them through their delivery centers in India. IBM and HP-EDS are
among the major global vendors that service these companies out of their Indian
centers. Besides, some of the companies that have gone down also have their
offshore captive centers in India, which are now up for grabs.

The Broader Picture
The crisis though isnt going to be restricted to the vendors exposed to
these companies alone. The heat will be felt across the industry as the crisis
leads to an overall slowdown in IT spends. Overall, the market will don a more
conservative approach toward any spending, including IT spending, as the
companies want to wait and watch whats going to happen to the business. When
the whole industry is in turmoil, companies become cautious and step back to
think how and where to spend, explains Arvind Thakur, CEO, NIIT Technologies.

Preliminary analysis of the current scenario indicates an impact on
discretionary spend on IT due to the uncertainty and customer decisions being
postponed. According to Sumeet Salwan, director, Advisory Services of NeoIT, In
the short-term the vendors will continue to get the same growth rate. While
non-discretionary spend is not going to get much impacted, the discretionary
spend (on new technologies and integration of new technologies) is going to be
limited. Non-discretionary IT spend will typically include existing work, live
projects and maintenance kind of work.

This will have a broader impact on the dynamics of the horizontal service
offerings. Though application development and maintenance and support kind of
work will continue, it is the areas of new technologies and migration
technologies that will take a hit as companies get more risk averse. There will
definitely be some impact on the way organizations look at their IT budgets.
Though new initiatives may be stalled, basic IT services such as support
functions will continue to be outsourced due to the cost advantages, concurs
Anil Kumar, CEO & co-founder, Quinnox. According to Natarajan, consulting and SI
may be a little slow in the short term

According to Viral Thakker, partner, practice lead, India, sourcing advisory,
KPMG, apart from spending curbs at large clients for discretionary projects
there will also be uncertainty caused by potential closure of captive units due
to their parents bankruptcy/merger.

Many US
companies are not just outsourcing to Indian service providers but also to
global service providers who are catering to them through their delivery
centers in India

Milan Sheth,
partner, advisory services, Ernst & Young

Some broader trends that are going to be in play, which the Indian IT and BPO
companies will need to brace up for over the next few quarters, include impact
on the additional work flowing in. As a result, companies will be cautious in
giving out additional work. Also, due to high volatility in the short term,
Murthy anticipates slower decision-making: In the short term, there sometimes
tend to be delays in clients making the call, level of due-diligence go up,
number of approvals needed go up, etc. All this tends to stretch the sales cycle
but the deals are still happening, explains Eddie Chandhok, president, global
delivery organization, Infogain. Among the short-term challenges will include
slowdown in the availability of funding.

According to Prashant Bhatt, CFO, Fractal Analytics, after all these
historical events Lack of faith amongst the lenders and investors will haunt
the segment at-least in the short to medium term.

On the BPO front specifically, Sheth points out that a lot many deals in the
last five years have been part of large transformation contracts. Since these
will be on hold, it will impact new deals in the BPO industry. However, as there
are no discretionary and non-discretionary spends in the BPO industry and also
since most of the ongoing contracts are multi-million dollar deals spanning over
a large period, there is likely to be lesser impact as compared to the IT
industry.

Long-term Play
In the longer term, due to consolidation in the financial services sector,
Murthy expects there to be rationalization in total spend on technology and
operations. Federal Reserves bail-out plan may seem like a good option to ride
over smoothly in the short-term, but the nationalization of the big financial
institutions may also put some curb on outsourcing in the long term. According
to Deepak Ghaisas, formerly CEO of i-Flex, With the government having equity
they are going to have a say in the decision making. With the government
overseeing the whole thing there might be a different approach to outsourcing
and it may not happen as aggressively, he explains.

However, overall, the sentiment is upbeat about the India value proposition
being strong enough to override the storm in the long term. We are at the same
stage today as the slowdown (dotcom bust) was in 2001-2003. That was followed by
four to five good years, as people realized that Indian IT could give quality
service. Similarly, the next couple of years will be watershed years for the
industry where more companies will look for outsourcing which will augur well
with India, explains Suresh Sundaram, vice president, corporate marketing, HCL
Technologies. Giving the BPO perspective, Sandeep Aggarwal, EVP, sales,
solutions, transition, Intelenet Global Services points out that while the
credit crisis in the US is currently a cause for concern for the Indian BPO
industry, in the long term the impact will be minimal as the industrys
fundamentals are strong and the value proposition continues to hold good.


Since financial services
account for 40% of Indias IT export revenue, I anticipate slower growth in
the next two years or so

Phaneesh
Murthy, CEO, iGate

Also, companies are foreseeing opportunities with respect to more outsourcing
work coming to India owing to the greater focus on cost cutting. They are also
eyeing increased opportunity in terms of integration work, with takeovers being
the flavor of the day. However, companies will need to be cautious as ultimately
takeovers and mergers will mean one company outsourcing instead of two. As
Salwan points out, two companies coming together doesnt mean theres more work
as there will be systems that will become redundant.

The Others
According to Kumar, the ripple effect of the financial sector turbulence has
just started spilling to other industries like retail, consumer goods, etc. The
widespread credit crunch and high rate of infrastructure borrowings may see the
effects of the slowdown spill over to aviation, leisure, tourism, hospitality,
and other such industries. According to Thakur, CEO of NIIT Technologies, in a
situation of tight credit there will be impact on other sectors of the economy.
It will be a matter of time before the other worldwide markets get affected,
he adds.

According to Sachdev Ramakrishna, director, marketing, Steria India, There
is a repercussion in the global industry. This is like a Tsunami. You can see
the waves affecting your shores and your environment. There will be an impact on
the other sectors as well due to dependency on equity and capital market.

Murthy points out that any industry which avails credit facilities including
real estate, high-end consumer goods, etc, will be impacted over the next year
or so.

Geographically, the impact is gradually percolating to the European market as
well. One is already seeing consolidation activity becoming rampant among the
European financial institutions. There are some early signs of two financial
companies in the UK going down. The US impact is already percolating to Europe.
This slowdown will certainly hurt the India plans of the leading companies,
says Thakker.

Shipra Malhotra
shipram@cybermedia.co.in

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