India’s service sector and its growing significance

Economic liberalisation in early 1990s has transformed the entire business scenario in the country, as it has encouraged the entry of various global conglomerates in India. The government has not only made significant investments in developing infrastructure, but also in introducing several path-breaking initiatives to attract investments both from the domestic and international entrepreneurs. These initiatives have ensured rapid industrialisation and have generated ample employment opportunities.

With a rise in the economic activities in the country, there was an increasing need for quick and efficient service accessibility that was crucial for the productivity and competitiveness of the economy. The growth in the agriculture and manufacturing sector, for instance, largely depended on efficient and competitive services provided by banks, infrastructure companies, IT service companies and several other business services. As these services grew hand in hand with the major industries, there was a structural change in the Indian economy post-Independence, and there was a substantial change in the sector-wise composition of total output of the economy. In view of changes in the economic and business environment, rapid technological innovation and wide utilisation of internet and globalisation, the market has become more competitive and has forced corporations to adopt new ways of doing business. Service industry entered a new era with the growing acceptance of IT-based services.

As on FY09, services accounted for more than half of India’s GDP (56.3%), up from around 42% in 1990. This increase in the growth of service sector share in GDP highlights a structural change in the Indian economy and brings it closer to the fundamentals of developed economy. For example: in the US, the service sector’s share in GDP is estimated at nearly 75% as on 2008. Similarly, in Japan, it is estimated to be around 65% during the same year¹.

The rapid growth of service sector in India has therefore increased its share to world service exports over the years. In 2007, India was the seventh-largest service exporters in the world with a market share of 2.6% up from merely 0.6% in 1995. This growth in the export of service sector is mainly due to growth in IT services exports.

India’s service sector witnessed higher growth than the world average during the past decade or so, thereby raising its share in the country’s GDP. The IT-BPO industry had a noteworthy role to play in this growth.

Overall sales of IT companies grows annually by 23.8%in FY09

The contribution of service sector towards overall economy, for instance, has gone up remarkably sinceIndependence from around 29.5% in FY51 to 42.7% in FY91, and to more than 54.7% in FY08. On the other hand, the share of agriculture to national income declined from over 55.0% in FY51 to around 17.8% in FY08.

Structure of India’s service exports

India’s service exports have contributed significantly to foreign exchange earnings; this has acted as a cushion for controlling the trade deficit at comfortable level. Notably, the total services exports stood at USD 101.2 billion for FY09 up from USD 16.3 billion in FY01, growing at a CAGR of 25.6% during the same period.

Over the years, software has emerged as the leading contributor to India’s service exports with a share of 46.4% in FY09 up from 39.0% in FY01. For the period Apr 09 - Dec 09, software’s share has further moved up to approximately 54% of the total service exports. Whereas the export of other services share, which includes travel, transportation, insurance and other miscellaneous services such as business and financial services has fallen from 59% in FY06 to around 54% in FY09 and has further dropped to around 46% during Apr 09 - Dec 09 period. These changes in the composition of service exports highlight the growth and increasing significance of software exports to the Indian economy.

Indian IT-BPO Industry – In Transition Phase

The Indian IT-BPO industry acts as a growth engine for the overall economy. It contributes significantly to the GDP, exports and has even facilitated the growth of other related industries such as real estate and transportation, banking; thus it has spawned ample employment opportunities in the country. Today, India is one of the most favorable countries in the world in information technology and business outsourcing services.

The IT-BPO industry’s contribution to India’s GDP has gone up significantly from 1.2% in FY98 to an estimated 6.1% in FY10. The factors that have driven this growth are low cost of operations as compared with other countries, increased adoption of IT across various sectors, availability of large talent pool and English speaking population, state-of-the-art technology and favourable government policies.

According to Nasscom, the IT-BPO sector created direct employment to 2.3 million people and generated revenue worth USD 73.1 billion in FY10, which grew by 5.4% over FY09. However, its growth was much below the historic growth rates because global recession affected its major export destination, mainly the US and Europe markets, and its major demand source, the BFSI segment. Besides, rising competition from emerging low-cost destinations such as Philippines, China, Brazil, Mexico, Scotland and Ireland also affected its growth.

Global economic slowdown has changed the business scenario across the globe because the changing market dynamics have created new challenges for players who need to reinvent themselves to sustain. Understanding this changing market, players are adopting fresh approach to tackle the situation by finding out alternative markets, adopting innovative business models, further improving the quality of services, diversifying service line, and essentially, focussing on other emerging verticals such as the government, telecom and healthcare among others, which hold significant opportunities.

Historically, the industry has been export-oriented; however, due to slowdown in the global economy, the domestic market is emerging as an attractive potential market. The domestic industry has evolved remarkably with the increasing number of end users ably supported by the large number of vendors with superior capabilities. The growth rate in the domestic IT services segment is estimated to outperform the IT services export segment in FY10 as the domestic IT services segment has grown at a CAGR of 17.4% during FY07-FY10. The high growth in the domestic market is largely driven by the major government initiatives such as increased spending on e-governance projects and increased IT adoption across verticals due to rising competition.

The industry has come a long way from just offering traditional services such as application development and maintenance, testing services, outsourced data entry and processing, customer support services work to providing high-end knowledge-based services such as consulting, analytics and high-tech engineering solutions. Yet there is a vast untapped universe in the Indian IT-BPO industry, which represents tremendous growth opportunities for the industry players.

Going ahead, the challenge for the industry players lies in maintaining the level of competency and offering high-level customer satisfaction at an affordable price. The changes in macroeconomic fundamentals, protectionism measures are few important risks looming large on the sector.

Indian IT Industry Structure

The Indian IT-BPO industry is highly fragmented. Over 5,000 companies operate in the IT space in India and these companies comprise a mix of large integrated players and small and emerging players who offer a wide spectrum of software products and services. The export revenue share of the industry is dominated by few big integrated players that include both Indian and foreign companies. During FY09, the big players contributed around 43-45% to the total export revenue, similarly, mid-sized players accounted for approximately 35-37% of the total export revenue and small and emerging players shared the rest².

The Indian IT industry can broadly be divided into two markets: domestic and export. The export market accounted for around 69% of the total IT-BPO revenues including hardware during FY10.

According to Nasscom, the size of the total Indian IT industry is estimated to have grown at a CAGR of 15.1% from FY07 to FY10E and reached around USD 73.1 billion in FY10. The growth is likely to be driven primarily by the growth in IT services and BPO segment (both domestic and exports), which is estimated to grow at a CAGR of 17.1% and 19.2%, respectively, during the same period.

Export Market

Exports are the principal sales channel for the Indian IT-BPO industry. The Indian IT-BPO exports sector is predicted to record a revenue growth of 5.4% at USD 50.1 billion in FY10 over FY09.

In the export market, the IT services segment is estimated to have contributed the highest share of 54.5% in revenue in FY10, followed by the ITeS-BPO segment with a 24.8% share and the rest by software products & engineering services and hardware segment. BPO has evolved as the fastest-growing segment growing at CAGR of 19.2% during FY07 to FY10 driven by implementation of innovative delivery models, increasing service lines and tapping new verticals.

IT services exports

The project-oriented IT services such as consulting, testing, systems integration is estimated to contribute around 51.2% in FY10, while IT outsourcing services such as application management, information systems (IS) is estimated to account for 41.1% of the total export revenues of IT services segment in India. Within the IT services segment, CAD is estimated to be the highest contributor at 37.4% during FY10; however, its share in the contribution has fallen by 3.6% as compared with FY07. Network consulting and integration is projected to be the fastest-growing segment within project-based IT services division registering a CAGR of 18.4% during FY07 to FY10.

The growth in the IT services exports is mainly driven by the growth in outsourcing services, which recorded a CAGR of 23.5% during FY07 to FY10. This segment is driven by the growth in IS outsourcing segment, which is projected to be the fastest-growing sub-segment that is estimated to grow at a CAGR of 38.9% from FY07 to FY10.

BPO exports

The BPO sector recorded a CAGR of nearly 18% from FY07 to FY10. In the BPO export sector, finance and accounting is estimated to constitute 22.7% of the total BPO export earnings worth USD 12.4 billion in FY10 after having grown at a CAGR of 23.4% from FY07 to FY10. The growth of the BPO sector can be credited to the up-and-coming high-end services such as knowledge-based services and the growth in BFSI and other emerging verticals.

The US has the maximum share in the total BPO exports of India and in FY10, the US accounted for around 60% of exports that was 6.8% higher than in FY09. The budgetary constraints in developed countries like the US have led to the increased focus on outsourcing services. However, Asia Pacific and other small emerging regions have shown the highest growth in exports, as the Indian IT companies are trying to diversify their client base and tap this potential region.

Software product and Engineering services exports

India is now well-positioned in the engineering and R&D services export segment. Outsourced engineering services have graduated from basic drawings and CAD assignments to high-end work such as conceptual design, digital models, complete product responsibility, e-engineering solutions and system architecture development. The Software product and Engineering services segment together contributed 20% to the total IT-BPO industry exports during FY10, growing at a CAGR of approximately 15% during the same period. Overseas companies operating in sectors such as high-tech, telecommunication, automobile, aerospace, heavy machinery, construction and industrial products are offshoring their engineering and R&D-related work to India.

The US continues to be India’s largest export market for IT-BPO with 61% share in FY10, followed by Europe including the UK with 30%. They (both US and Europe) collectively constitute around 90% of India’s IT-BPO exports. However, India’s export share to the US has declined sharply over the last couple of years from around 68% in FY04 to 61% in FY10, indicating that the Indian IT companies have recently started exploring other markets to reduce the over dependence of the US market. Needless to say that, the US market has witnessed the menace of worst ever recession since World War II. Consequently, clients have delayed many projects and discretionary IT spending has taken a hit. Nonetheless, as the business environment is improving, large deals are expected to flow as clients are looking at controlling their costs.

Europe’s (including UK) share is estimated to go up from around 23% in FY04 to 30% in FY10, as other European nations such as Germany, France, Italy, Netherlands are increasingly adopting offshoring services who’s share in India’s IT-BPO exports has gone up sharply from 8% in FY04 to 18% in FY10.

Indian vendors are also expanding their focus on APAC region, as it helps to diversify their business from core markets. Within the APAC, Japan is recognised as the prospective market for Indian IT companies.

Domestic Market

The Indian IT vendors are increasingly focusing on domestic market, as there are several opportunities imminent. The domestic IT-BPO market is estimated to have reached USD 23 billion in FY10, increasing at the rate of 5.2% over FY093. Some of the key drivers for growth in the domestic IT market include:

• Increased IT expenditure by government in e-governance initiatives
• Increased expenditure by corporates due to rising competition
• Potential opportunities in verticals such as healthcare, energy, education, telecom and retail
• Increased penetration of computers in the households and adoption of broadband services
• Increased usage of non-PC devices like cell phones
• Increased IT investment by small players particularly SMB’s (Small and Medium Business) who need to survive in the market and expand scale

The hardware sector dominated the share in domestic IT-BPO revenues in FY10 with close to 39% share, which remained flat as compared with the previous year, followed by IT services (38.9%) and the rest shared by software products and engineering services and BPO segment. Domestic BPO notably has been emerging as one of the fastest growing segment that grew at a CAGR of 27.8% during FY07 to FY10.

Domestic IT services

The Indian IT companies have traditionally been strong in providing ADM services to its clients. With the industry maturing rapidly, these IT companies have focused on providing a basket of IT services such as systems integration, IS outsourcing and consulting. The domestic IT services market grew from USD 5.5 billion in FY07 to an estimated USD 8.9 billion in FY10. System integration is estimated to be the highest contributor in the domestic IT services segment and its share in the segment grew at a CAGR of 19.7% during FY07 to FY10 and reached a share of 39% during FY10. Support and training is projected to be the top growing segment registering a CAGR of 31.7% during FY07 to FY10 though its share in the domestic IT services is still small highlighting its strong growth potential.

Domestic BPO

Unlike the overseas business, cost arbitrage does not drive the domestic BPO market. Strategic factors such as need to focus on core competencies, growth, improved productivity and reduced time to market are driving the domestic BPO demand. Voice-based services such as customer support and telemarketing services are estimated to contribute utmost in the domestic BPO revenue. Due to the growing attractiveness many international players are entering this space through both organic as well as inorganic route. The domestic BPO sector has recorded a CAGR of nearly 28% since FY07 to FY10.

Domestic Software product and Engineering services

The domestic software product and engineering services segment contributed 12% to the total domestic IT-BPO industry revenues during FY10. Application software continues to drive the growth in the domestic market, followed by system infrastructure software and application development and deployment software. ERP was among the top 5 growing segments of the domestic software space.

Domestic Hardware

The share of domestic hardware in the domestic IT-BPO market gradually fell to less than 40% in FY10 registering a CAGR of 4.1% during FY07 to FY10. According to the Manufacturer’s Association for Information Technology (MAIT), the desktop PC market (including notebooks) recorded reduced sales of 6.79 million units in FY09, compared to 7.34 million units over the same period in the last fiscal year. Desktop sales accounted for nearly 78% of the total PC sales, up from 75% a year ago, while the remaining was shared by notebook sales. MNCs have been increasingly raising their share in the Indian desktop market from 35% in FY06 to 51% in FY09. The Indian branded desktop PCs have seen a decline in their market share from 28% in FY06 to 18% in FY09, while the market share for assembled PCs has declined from 37% to 31% during the same period.

The high growth in PC sales accelerated due to increased consumption by the government because of various new e-Governance initiatives started by the Central and state governments. The lower pricing strategy adopted by the desktop manufacturers also helped boost sales, as consumers curtailed their impulsive buying of notebooks and instead purchased desktop PCs due to economic recession.

With the economy showing signs of revival from recession and clients beginning to finalise their IT budgets, hardware companies in India are beginning to see growth potential after almost a year, thus attracting plenty of domestic hardware as well as MNCs in the domestic market. Few of the MNCs such as Dell and HP in the hardware segment have been viewing India as a hub for setting up hardware manufacturing facilities. Currently, India imports a large component of its IT hardware requirements mainly from Taiwan, China and Korea.

Recent Trends in the Indian IT-BPO Industry

The global downturn has resulted in IT vendors drastically altering their organisational and marketing strategies. They are increasingly focusing on cost reduction, improving productivity, tapping newer geographies, developing innovative service models and changing pricing strategies. In short, the IT firms have considered recession as an opportunity to reorient themselves in the changing scenario that will drive the growth in future.

• SMB segment:

  Formerly SMBs favoured to stay away from IT implementation due to pre-conceived perception of high cost associated with the same. However, this belief is changing swiftly due to innovation in cost structures and SMBs are recognising the long-term benefits of this service like increased productivity. After identifying SMBs as the driver for future growth, IT vendors are taking steps to address them more effectively. Large companies such as Microsoft, Oracle are developing products to meet the needs of this small segment. Microsoft offers its ERP application to SMBs through the SaaS model. Wipro has collaborated with Microsoft to deliver ERP software through SaaS model for an auto parts supplier. During 2009, expenditure on IT by SMB segment was 30% of the total IT spends valued at over Rs 300 billion.

  

  As shown in the above chart, IT services accounted for the largest share in the worldwide IT spends at around 37% worth USD 194.2 billion in 2009. The share is estimated to grow at a CAGR of 6.4% during 2009 to 2013 to reach USD 249.2 billion. During the same period the expenses on PCs and peripherals are expected to grow the fastest by around 8%.

• New technology models: The Indian IT companies are developing innovative technology models to make available a complete basket of services to their clients. These new services include Grid and Cloud computing, SaaS, Knowledge-as-a-Service (KaaS), Service-Oriented Architecture (SOA), Utility Computing among others that offer IT companies higher growth and profitability.



• MNCs ramping up operations in India: The availability of a large talent pool has attracted several MNCs to India. Big players such as IBM, Accenture, Google, Yahoo, Oracle, CSC, Cognizant, and Microsoft among others have not only rapidly increased their work force in India but also outperformed their global performance in terms of revenue growth. Some of the major global IT companies like HP, IBM and CSC have also set up their research and manufacturing base in India.



• Emerging Geographic Markets: Indian companies are increasingly increasing their footprints in emerging countries such as Mexico, Ireland, the Netherlands, Philippines, China, Brazil apart from core markets such as the US and the UK. Though these markets are small, they are expected to drive growth in future. Also, by concentrating on these markets, businesses can diversify their risks across regions. The Indian IT companies have adopted both the organic as well as the inorganic route to enhance their presence in these emerging markets. For example, during the previous two years, Wipro started operations in Philippines, Brazil and China. Infosys also opened up centres in Brazil and New Zealand in 2009 to offer a complete suite of services to its local clients.

Japan as an emerging market

Japan is one of the crucial emerging markets for Indian IT vendors to invest. Japanese companies are increasingly looking at low-cost sourcing destinations because Japan was severly affected by subprime crisis.

Moreover, the Japanese economy is currently facing the problem of having a majority of aging population. India on the other hand, has a huge skilled workforce and its quality service delivery and capability complement the requirements of Japanese market. However, penetrating one of the biggest IT services market in the world is a major challenge for the Indian IT vendors.

The total Japanese IT services market is valued at USD 108.6 billion, out of which offshoring is limited to less than 10% (USD 10.8 billion) at present. India accounts for around 13% of the offshoring pie, which is valued at around USD 1.4 billion4. This offers immense opportunity for Indian IT companies.

• Exploring other service offerings: In recent years, the revenue composition of companies has changed. The revenue contribution of high-growth segments such as infrastructure management services, package implementation, testing and consulting has been witnessing rapid growth. Thus, newer service lines are not only enabling Indian companies to increase their sales by cross-selling to their existing customers, but also improving their average billing rates and recognition of being end-to-end service providers. These segments are experiencing high growth rates over the last couple of years. For instance, IT consulting and IS outsourcing registered a CAGR of 15.7% and 36.3% respectively during FY07-FY10E.



• New end-users show signs of untapped growth opportunities:

  

  Global vertical-wise IT spending is projected to reach USD 1488.8 billion in 2010 up by around 3% from 2009, as per Nasscom. Government, Healthcare and Utilities are emerging as the highest growing segments.

  Evidently, the BFSI vertical has been the worst hit during the recession and in 2009 it witnessed a decline of around 5% after witnessing a below average growth rate of 3.6% in 2008; as a result, Indian IT companies are looking at increasing their presence in other promising verticals, which are also showing signs of increasing IT expenditure. The expenditure on IT in government segment went up by 1.6% in 2009 as compared with 2008 primarily due to across-the-board computerisation of government departments, increased focus on e-governance system and national security-related expenditure. It is also interesting to note that healthcare segment, which is still at a nascent stage is projected to grow at the highest CAGR of 5.6% during 2008 to 2013 due to increased focus on public health services.

• New-age business/revenue models

  The industry has been proactively implementing innovative solutions to reduce clients cost as more customers have been focusing on cost reduction. The changing business scenario has led to the evolution of fresh business strategies and new age personalised services such as on-demand services, subscription based or pay per use services, performance or outcome-based pricing, revenue-sharing delivery models, which are tailored to deal with the downturn. For instance: Infosys and iGATE practises various alternative pricing models namely transaction based and performance based among others with its clients to help them control their cost and leverage the benefits of resource pooling.

• Green IT

  The IT sector globally accounts for 2% of the world’s carbon emissions5. Indian IT firms are increasingly transforming their approach towards using green technology. They are gradually taking steps to deliver green IT solutions to their clients. The result of this is reduced environmental hazard and maximized value to the client and helps IT vendors to remain competitive. For instance, companies who are practising green IT implementation include TCS , Accenture , and Wipro among others. Even Infosys won the 2008 Infoworld 100 award in the green IT implementation category⁶.

• Increased government spending in the domestic market:

  The Indian government’s IT expenditure is expected to touch nearly USD 5.1 billion in FY11, growing at a CAGR of around 28% from FY09 to FY11, as per Nasscom.

  Power Sector

  In the last couple of years, the Indian government has increased its spending on IT adoption in various sectors. The GoI has realised that there is a need for widespread usage of IT in the power sector. Currently, around 30% of the total power produced in India is lost in transmission and distribution each year due to pilferage and technical snags. In July 2008 the Indian government initiated a reform programme known as ‘Restructured Accelerated Power Development and Reforms Program’ (R-APDRP) to bring down the losses to sustainable levels. The GoI has appointed Power Finance Corporation (PFC) as the nodal agency for carrying out reforms in the power sector. PFC focuses on IT solutions for the companies involved in generating and transmission of power. The R-APDRP focuses on providing IT solutions to companies engaged in power distribution, as per the Ministry of Power. The R-APDRP has divided its tasks into three parts. Part A includes the project for establishment of baseline data and IT consumer service centres. Part B includes system improvement, strengthening and augmentation, and Part C involves enabling activities, which is to be implemented by the Ministry of Power. The government has allocated Rs 515.77 billion for the programme, of which Rs 100 billion will be allocated for Part A activities, Rs 400 billion for Part B activities, and the balance Rs 11.77 billion for Part C activities. During FY09, PFC already sanctioned financial assistance to the tune of Rs 1,088 million (Rs 80 million for Chhattisgarh State Electricity Board, Rs 13 million for Power Transmission Corporation of Uttrakhand, Rs 200 million for MSETCL and Rs 795 million for UPRVUNL).

  e-Governance

  The Indian government has identified e-Governance as another area where it is investing heavily in implementing IT solutions. The government has initiated the National e-Governance Plan to make all government services easily accessible to the common man, while bringing in efficiency and transparency in the process. The Indian government has separately allocated USD 9 billion for investment in NeGP projects7. In Jan 2008 the government identified three critical areas, State Wide Area Network (SWAN), State Data Centres (SDC) and Common Service Centres to successfully implement the NeGP. The main function of SDC is to ensure better operations and management control and minimise overall data management, IT management and deployment costs. As of Dec 2009, the government approved budgetary sanctions to 31 states/UTs. Six states are already ahead on this programme and have completed the bid process for selection of the data centre operator, while it is in progress in nine states. By July 2010, it is expected that between 8 to 10 SDCs are to be set up and start operations.

  Implementing e-Governance initiatives in other government departments

  The Indian government has also undertaken the task of replicating successful e-Governance initiatives in other departments. Through this, the GoI intends to spread the benefits of e-Governance to other departments under its control. Accordingly, initially the GoI has undertaken the process of digitising land records, property registration and transport department of various states on a pilot basis. The GoI has also entered agreements with private companies to complete these projects on a public private model in select states. The land records computerisation process has already been completed in Jharkhand, Pondicherry and Punjab, while it is currently under implementation in Meghalaya and Assam. Similarly, the GoI has completed the computerisation of property registration process in Punjab and Pondicherry, while it is currently under implementation in Rajasthan, Meghalaya and Uttarakhand. The transport department is also being computerised in Punjab. Once these models are successfully implemented in these states, the government will widen its project scope to cover the entire country.

  Implementation of e-Governance in government departments like Income tax and Passport has led to improvement in the efficiency of government processes and benefited the end users through reduction in number of trips and fall in waiting time.

  In 2009, the GoI announced one of its biggest projects - Unique Identification Number (UID) system to over 1.2 billion residents of the country. The proposed system foresees substantial domestic IT opportunities. In the Union Budget 2010-11, the government allocated Rs 19 billion for this project8. This scheme will be a big platform for the Indian IT industry after the financial turmoil.

  Recent government IT contracts awarded to IT providers

  • In Mar 2010, 4G Identity Solutions won two bids to provide fingerprint and IRIS recognition devices to the UIDAI (Unique Identification Authority of India). These devices will be used in the UIDAI Proof of Concept (PoC) tests.
  • In Mar 2010, the state government of Maharashtra and TCS formed a JV to commence an internet-based online citizen service in the state through a portal - Maharashtra Online - that will offer integrated services to the citizens through use of information and communication technologies. The portal will present an electronic gateway into the state government’s portfolio of services to citizens and businesses.
  • In Sep 2009, the AP state government awarded the SWAN Project to TCS and this project envisages connecting state headquarters with 1088 mandals (administrative units) and 23 district headquarters.
  • In July 2009, The Government of India awarded a 10-year contract to Infosys to design, develop and support a portal for the Ministry of Commerce and Industry. This project is one of 27 projects that are a part of the government’s NeGP. This project involves designing, executing, maintaining and expanding a web portal that would provide companies easy access to government information and services.
  • In Mar 2009, Wipro Infotech won an IT outsourcing contract from the ESIC, a statutory company, under the Ministry of Labour & Employment, GoI. The project titled ‘Project Panchdeep’ envisages improving healthcare services for its beneficiaries, by providing online facilities to employers and insured people for registration, payment of premium and disbursement of cash benefits. The contract is valued at Rs 11.8 billion.
  • In Oct 2008, the GoI awarded the Passport Automation Project to TCS. The project cost has been valued at over Rs 10 billion.

  Issues and challenges

  The Indian IT-BPO industry has been witnessing several issues and challenges that may affect its growth in future; therefore, companies must adopt best practices to address these issues to sustain the growth momentum. The Indian IT companies are taking several austerity measures to address those issues such as looking for new business markets and segments, cost-cutting initiatives such as rightsizing resources, curtailing business travel, increasing adoption of video conferencing facilities, reducing administration cost and so on.

• Major dependence on BFSI vertical: The BFSI vertical has been the mainstay of the Indian IT industry, as this vertical is considered the earliest adopters of technology. The vertical, however, has been one of the worst-hit sectors of the sub prime crisis and the following global economic recession. Evidently, many large banking and investment institutions scaled down their IT requirements after the crisis, which resulted in many IT deals being put on hold by clients, resulting in loss of revenue for the Indian IT companies. During this phase, companies, which catered to diverse verticals, were relatively less-affected. Consequently, companies have started offering services to a wider set of verticals, thus reducing their exposure to any one vertical.



• Slow pace of recovery: The US economy is showing promising signs of recovery after facing the worst recession since World War II. According to IMF World economic Outlook, April 2010 the US GDP is forecasted to grow by 3.1% in 2010, after witnessing a decline by 2.4% in 2009 over its previous year. While the economic environment is improving in the US, weakness in certain areas of the economy is hampering a full recovery as the unemployment rate still remains at elevated level of 9.9% as on April 2010 and the beleaguered housing market is yet to recover.

  The recent turmoil in the Europe is also an increasing concern among the Indian IT vendors. The growth outlook for European nations has turned uncertain as sovereign debt level in several Eurozone countries such as Greece and Italy stood as high as around 115% of GDP in 2009, similarly in Belgium at around 97%, France, Portugal and Germany at over 70% each, UK at about 68% and Spain at nearly 53% among others9. Most of these liabilities were incurred to bail out banks and financial institutions in the aftermath of the global financial crisis which occurred in 2007. This is drying up government spending and investments across sectors including IT. Some of the European nations are reconsidering IT deals to control the budget deficit. These Eurozone countries are now taking austerity measures such as slashing wages, raising taxes such as VAT, income tax, corporate tax and reforming pension bill among others to rescue and stabilise the economy. Due to the mounting debt concern Euro currency value may also further decline against rupee which can hurt the margins of Indian IT companies as these firms derive sizeable business from these markets.

• Emerging low-cost destinations: According to the International Data Corporation (IDC) study, three Indian cities rank at the top in the GDI (Global Delivery Index) of the top 10 offshore destinations namely Bengaluru, New Delhi, Manila, Beijing, Auckland, Shanghai, Mumbai, Brisbane, Dalian, and Kuala Lampur in the Asia-Pacific region. However, the Indian IT industry is gradually facing stiff competition emerging from newer regions such as China, Malaysia, Philippines, Ireland and Mexico. Indian metro cities namely Bengaluru, New Delhi and Mumbai have emerged as favourite off-shoring destinations, but Chinese commercial hubs namely Beijing and Shanghai are expected to give tough competition to the Indian IT companies in the near future. A similar competitor would be Malaysia, which has a stable socio-economic environment, excellent infrastructure, low attrition rates and skilled talent pool as key advantages.

  Though China still faces some challenges in capabilities, such as language and risk to intellectual property (IP) to name a few, the country is emerging as an attractive alternate location for outsourcing IT, R&D, and procurement services. Massive investments in infrastructure, English language training, reliable Internet connections, technical skills etc are the factors acting in favour of China. On the other hand, GDI criteria such as political risk, labour costs, and language skills are some of the areas where India scores over other destinations.

• Ceasing of tax benefits for STPI (Software Technology Parks of India): The uncertainty ruling over continuation of tax holiday after Mar 2011, may slow down future expansion proposals. Large companies would be able to alleviate the tax burden arising from the expiry of tax holiday by moving into SEZs. However, SMBs, which form the bulk of the companies registered with STPI, will be severely affected, as they are still struggling post-global recession and do not have the level and financial resources to face this challenge.
  
  
• Rupee appreciation

  Rupee appreciation against the US Dollar means rupee has become more expensive in relation to the US Dollar. This also means that less rupees is paid to buy a US dollar or one gets less rupees for a US dollar. The rapid economic growth in India created enormous opportunities for foreign players, which boosted overall capital inflows into the country. This inflow is in the form of FDI, FII, ECB, remittances etc. India’s growing competitiveness has turned it into an attractive export base, thus increasing demand for domestic currency thereby appreciating value of rupee against the US dollar. Appreciation of rupee makes it difficult for exporters, as they get fewer rupees in return, which in turn affects their margins. The Indian outsources are more worried as majority of their business comes from the US.

  According to the RBI data, the rupee’s average annual exchange rate against the US dollar stood at 47.4 during FY10. The rupee gained about 3.3% against the US Dollar during FY09 to FY10.

  

  Fighting the trend, the Indian IT companies have opted for hedging foreign currencies using options such as derivatives and are taking de-risking measures like diversifying geographies. They are also employing more cost-effective techniques to balance the rupee effect like using local currency billing system. For instance, Polaris Software Lab entered a strategic partnership with City Networks in February 2008 to provide ongoing product development and support services to City Networks. In this deal, Polaris looked at local currency billing for Citi Group to counter the rupee appreciation effect.

• High attrition rate

  High attrition rate poses as one of the major challenges for the Indian IT-BPO industry. In India, the average attrition rate in the BPO sector is approximately 30-35%, mainly due to high salary levels, better career growth, higher studies amongst others. Controlling attrition and retaining talent is one of the important tasks of these companies, as it drives up the cost of staffing and training. Therefore, it is necessary for the IT companies to invest in their employees and design reward packages in such a way that they can hold on to their staff.

• Protectionism

  The risk of protectionism is further adding to the worries of Indian IT companies. The US President’s proposal to tax expenditure incurred by the US companies on availing services from outside the country from 2011 has created ripples in corporate India. The move has been adopted to discourage and control the offshoring of jobs to overseas low-cost countries. The US has been under tremendous pressure to protect local jobs, as the unemployment rate in the US surged to 8.1% in February 2009, which was the highest in the past 25 years. Any protectionist measures by the world’s largest country can encourage similar steps by other nations as well.

• Software Piracy:

  Software piracy is an important hurdle in the growth of worldwide IT industry. It costs billions of dollars annually to the IT companies. According to BSA and IDC’s joint study on global software piracy, the piracy rate stood at 43% in 2009 valued at over USD 51 billion which registered a 2% increase over 2008. This is largely fueled by the growth in PC sales. India, Chile and Canada each saw the maximum improvement in reducing software theft, each achieving a 3% point decline in their piracy rates in 2009. India witnessed a drop from 68% in 2008 to 65% in 2009, as per Business Software Alliances. This is due to several measures taken by government and IT companies, such as industry education campaigns and workshops, enforcement actions and technology shifts, such as the increased deployment of digital rights management and greater use of software asset management to address under-licensing issues in the work place.

³Nasscom Strategic Review 2010
⁴ Nasscom Strategic Review 2010
⁵ Nasscom
⁶ www.infosys.com
⁷ Nasscom
⁸ http://uidai.gov.in/documents/post_budget_press_note
⁹Eurostat