The Indian IT Industry

The Information Technology (IT) sector in India holds the distinction of advancing the country into the new-age economy. The growth momentum attained by the overall economy since the late 1990s to a great extent can be owed to the IT sector, well supported by a liberalised policy regime with reduction in telecommunication cost and import duties on hardware and software. Perceptible is the transformation since liberalisation – India today is the world leader in information technology and business outsourcing. Correspondingly, the industry’s contribution to India’s GDP has grown significantly from 1.2% in 1999-2000 to around 4.8% in FY06, and has been estimated to cross 5% in FY07. The sector has been growing at an annual rate of 28% per annum since FY01.

Indian IT companies have globally established their superiority in terms of cost advantage, availability of skilled manpower and the quality of services. They have been enhancing their global service delivery capabilities through a combination of organic and inorganic growth initiatives. Global giants like Microsoft, SAP, Oracle, Lenovo have already established their captive centres in India. These companies recognise the advantage India offers and the fact that it is among the fastest growing IT markets in the Asia-Pacific region.

Summarising some key highlights of the sector in FY06:

• Software and services exports were estimated to have grown by 32% in dollar terms to exceed US$ 23 bn.

• ITeS-BPO exports were estimated to touch US$ 6.3 bn, a growth of 37%

• IT-ITeS export revenues from engineering and R&D services, offshore product development and made-in-India software products touched an estimated US$ 3.9 bn from US$3.1 bn in FY05

• Sales of Personal computers crossed 4.7 mn units; a growth of 20% compared to 3.6 mn units sold in FY05

• As of Dec 06, around 440 Indian companies had acquired quality certification with 90 companies certified at SEI CMM Level 5, higher than any other country in the world

• The total number of IT and ITeS-BPO professionals employed in India was estimated to have grown to 1,293,000 from 1,058,000 in FY05

Industry Structure

The size of the Indian IT industry, according to NASSCOM, has been estimated to be around US$ 47.8 bn. The Indian IT industry can be broadly divided into two markets: domestic market and exports market. The exports market constitutes the largest segment accounting for 75% of the total revenue generated by the Indian software industry.

The domestic IT market is broadly divided into the following four segments: IT Services, software segment which includes engineering and Research & Development (R&D) services, IT-enabled Services and Business Process Outsourcing (ITeS-BPO), and Hardware. While IT Services accounted for 34% of the total revenue generated by the domestic market in FY06, the Engineering Services, R&D and Software Products segments together accounted for 10% of the revenue. The ITeS-BPO segment, on the other hand, contributed 7%. Hardware is the dominant segment with a share of about 49%. The domestic IT market grew at a CAGR of 21.9% during FY02-06 to touch US$ 13.2 bn, and is projected to grow to US$ 15.9 bn in FY07, registering a growth of 24% y-o-y.

The exports market is dominated by the IT services market holding a share of 56.4% in the software and services exports in FY06, followed by the ITeS-BPO segment with 26.7% share and the software products and engineering services segment with 16.9% share.

The Indian hardware industry is at present estimated to be in the proportion of 30% domestic, 1.25% exports and the remaining being imports. The domestic market itself offers tremendous potential for hardware companies, thus having very few companies venturing into hardware exports. Imports of IT hardware which form a large component of the industry are mainly from Taiwan, China and Korea. Lately, however, MNCs in the hardware segment have been viewing India as a hub for setting up hardware manufacturing facilities, for instance Dell.

India’s IT Industry (US$ bn)

Source: NASSCOM

IT Services Exports

Indian IT Services exports grew from US$ 10 bn in FY05 to US$ 13.3 bn in FY06, registering a growth of 33.4%, and is further expected to reach US$ 18.1 bn in FY07, posting a growth of 36%. Revenue from ‘projects’ dominated the IT Services exports with a share of 58%, with outsourcing and support & training activities accounting for 33% and 9% respectively.

Source: D&B Research

Within the ITeS-BPO segment, Customer Interaction Services (CIS) account for nearly India’s IT Exports XIV 45-50% of the total ITeS-BPO services exports while finance & accounting contributes for the remaining 40-45%. Human resource and other high-end knowledge-based processes account for 2% and 8-10% respectively.

The Software product, Engineering services and R&D segment contributes around 17% of the software and services exports. India is well positioned in the engineering and R&D services segment. Apart from Indian companies offering these services, several foreign companies (both captive and third party) are also setting up base in India to provide these services. Overseas companies operating in sectors like high–tech, telecommunications, automobile, aerospace, heavy machinery, construction and industrial products are looking at off-shoring their engineering and R&D related work to India.

Few important characteristics of the Indian IT sector include:

• Export intensive: Ever since the industry’s evolution, exports has been the major contributor to the industry.

• Concentration on Low-end services: Low-end services such as customised software services and maintenance have been the key strength of the Indian IT companies. These companies are now however moving up the value chain offering end-to-end solutions to clients.

• Labour intensive industry: The very nature of the services offered by the industry makes human resources a significant driver for the industry.

• Fragmented industry: D&B’s inhouse database has identified over 8,000 companies which operate in the IT space in India, offering a wide range of software products and services. A large number of these companies are unorganised players

• Skewed concentration: The revenues of the top four companies, TCS, Infosys, Wipro and Satyam, including income of their subsidiaries, account for around 22% of the overall industry. This skewness is all the more pronounced in the case of software services.

Emerging Trends in the Indian IT Services Industry

While the global IT players are aggressively scaling up their operations in India, due to the advantages that the Indian industry offers, the Indian IT companies are also preparing to tap the global market. The companies are witnessing significant change with regard to their service offerings and geographical concentration. Today, companies are expanding their service offerings from application development and maintenance to high end services like testing, consulting and engineering designing. The global delivery model has not only facilitated the companies in delivering quality of work but also helped them to control costs.

Emerging IT Services Dynamics

Source: D&B Industry Research Service

Over the years, the Indian companies have positioned themselves well to reap benefits of the emerging scenario in the IT sector.

New Service Offerings

The Indian IT companies are expanding their service offerings to provide a complete basket of services to their clients. These new services include IT consulting, testing, business process management and IT infrastructure services, which in a way allows the IT companies to de-risk their business from pricing pressures and enter into newer areas which provide them higher growth and profitability.

Larger Deal Size

Indian IT companies have successfully scaled up operations and made a mark in the global outsourcing market, evident from the large deals bagged by the Indian IT companies in the past one year, including the British Telecom-Tech Mahindra deal which was worth US$ 1 bn, the Pearl Insurance-TCS deal (£ 486 mn), the Skandia-HCL Technologies deal (US$ 200 mn) and the Kimberly-Clark-TCS deal (US$ 100 mn). Most of the deals bagged by the major companies were in the Banking and Financial Service space which reiterates the growth in this vertical. As per the data compiled by Technology Partners International (TPI), the Asia Pacific region witnessed a significant increase in total deals amounting to US$ 10 bn in 2006 from US$ 6.1 bn in 2005. Indian companies bagged contracts (above US$ 25 mn) worth US$ 2.7 bn in 2006, with a market share of 25% in the Asia Pacific region.

Growing presence of MNCs

Cost arbitrage and the availability of a large talent pool has attracted several MNCs to India. Big players like IBM, Accenture, Capgemini and Oracle among others have not only increased their headcounts in India but also outperformed their global performance in terms of revenue growth. Their Indian operations are witnessing strong growth as compared to their global business. Some of the major global companies like Intel, IBM and CSC are cutting jobs abroad and shifting their base to India.

Investment Plans of MNCs in India

Source: D&B Industry Research Service

Emerging Markets: In terms of geographical contribution, the US continues to remain the key market for Indian IT companies, accounting for 67.2% of the software and services (including BPO) exports from India. However, Europe is also emerging as an important market for the Indian IT industry, considering the fact that the share of exports to Europe from India increased from 22.2% in FY03 to 25.1% in FY06. After the US, Indian companies are looking at the European region as a potential market for exports and also to expand their global presence. Mergers and acquisitions has been one of the routes that the Indian companies have adopted to enhance their presence in European markets.

Changing Growth Drivers: There has been a change in the revenue composition of companies in recent years. The revenue contribution of high-growth segments such as infrastructure management services, package implementation, testing and consulting has witnessed a continuous increase. This is in sharp contrast to the earlier trend wherein almost all companies were largely dependant on the Custom Application Development and Maintenance (CADM) services segment for their revenues. Today, the share of CADM has decreased to 49% in FY06 from 80% in FY01. 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.

New End-users: In terms of user industries, the BFSI and hi-tech/telecommunication industries remain the leading verticals for the Indian IT companies. Together, these sectors account for 58% of the Indian IT-ITeS exports. Though these verticals have good growth potential, other sectors such as manufacturing, retail, healthcare, utilities, etc., are also emerging as promising segments for the Indian IT companies. While the BFSI sector has the potential to provide large size contracts to the IT companies, the manufacturing sector can provide large number of deals/assignments to the Indian players.

Presently, the Indian IT companies are on a hiring spree which indicates their bullishness on their order flows. All the major players have increased their manpower by 15-50%, and the trend is expected to continue further. As a result, the companies are expected to scale up their operations. The Indian IT companies are also vying for inorganic growth, with a quest for newer geographical areas, service offerings, domain expertise, customers and markets.

Concerns for the Indian IT Industry

Though demand conditions have been optimistic, the Indian IT sector is exposed to certain risks which may deter growth. An appreciating rupee, anticipated slowdown in the US economy, shortage of skilled manpower, limitations in domestic infrastructure and competition from other global players offering manpower at low cost like China, Philippines and Vietnam can have a negative impact on the performance of the Indian IT companies.

Besides, increasing activities of global MNCs in India will make difficult employee retention for Indian companies. NASSCOM opines that there will be a shortage of half a million people in the IT and ITeS segments by 2009. With an industry attrition level hovering around 20-25% (often higher for smaller players), companies are likely to offer an increase of 10-15% in salaries in the coming years.

On the financial front, wage inflation of 10-15% and forex fluctuation can reduce the top line as well as the bottom line of the companies. Unless the Government defers the withdrawal of tax incentives which is due to expire after 2009, IT companies operating out of the Software Technology Parks of India (STPIs) are likely to witness an increase in their tax liabilities, which may reduce their profitability further.

Key Positives & Negatives for the Indian IT Industry

Some Acquisitions in the IT Space in 2006

	Source: D&B Industry Research Service