Overview of Indian IT Industry

The Information Technology (IT) sector is one of the fastest growing sectors in the country, envisaging dimensions of growth and globalisation, achieving new milestones over the last decade. The growth momentum attained by the overall economy since the late 1990s to a great extent can be owed to the IT sector, led by a liberalised policy regime with reduction in telecommunication costs have led to spurt in investments by MNCs as well as domestic companies in the country. 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 gone up significantly from 1.8% in FY00 to around 5.4% in FY07.The sector has been growing at a CAGR of 30.3% since FY04.

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 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.

Key Highlights of the sector in FY07

Industry Structure

According to NASSCOM, the size of the Indian IT industry, has been estimated to be around US$ 47.8 bn in FY07. 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 around 65.5% of the total revenue generated by the Indian IT industry including hardware in FY07.

Importantly, in the exports market, IT services segment contributed highest share with 57.5% in FY07, followed by the ITeS-BPO segment with 26.8% share and the rest shared by the software products and engineering services & R&D.

The domestic IT market is broadly classified into the following four segments: (i) IT Services, (ii) software products, engineering and R&D services, (iii) IT-enabled Services and Business Process Outsourcing (ITeS-BPO), and (iv) hardware. While IT Services accounted for around 34% of the total revenue generated by the domestic market in FY07, the engineering services, R&D and software products segments together accounted for 9.7% of the revenue. The ITeS-BPO segment, on the other hand, contributed 6.7%. Hardware contributed major share of the domestic market with about 49.7%. Notably, the domestic IT industry grew at a CAGR of 25.7% during FY04-07 to touch US$ 16.5 bn.

Source: MAIT

According to Manufacturer Association for Information Technology (MAIT), the Desktop PC market (including notebooks) showed an upward trend totaling over 6.34 mn units in FY07, registering a growth of 25.65% over the same period last fiscal. Desktop sales accounted for more than 86.5 per cent of the total sales, while the remaining was shared by notebook sales. This was largely due to the buoyant mood in IT consumption which saw a significant growth in notebook sales by 97%. MNC’s have been increasingly raising their share in Indian desktop market from 35% in FY05 to 39% in FY07. Driven by growing domestic demand mainly in notebooks segment, as sales of MNC brands grew by 33% and that of assembled by 22% in FY07.

The high growth in PC sales was accelerated due to increased consumption by industry verticals such as telecom, banking and financial services, manufacturing, education, retail and BPO/IT-enabled services as well as major e-Governance initiatives of Central and State Governments. The domestic hardware market offers tremendous potential for hardware companies, thus attracting plenty of domestic hardware as well as MNCs in the domestic market. As, few MNCs in the hardware segment have been viewing India as a hub for setting up hardware manufacturing facilities, for instance Dell. Imports of IT hardware which form a large component of the industry are mainly from Taiwan, China and Korea.

Indian IT Industry Structure (In US$ bn)

Source: NASSCOM

IT Services, ITeS-BPO, Engineering and R&D Services Segment

The demand for IT across the world is witnessing a tremendous growth, 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 take innovating and unique ways of doing business’s. Service industry has also entered into a new era with the growing acceptance of IT based services.

Source: NASSCOM

As per NASSCOM, Indian IT Services both domestic and exports market grew from US$10.4 bn in FY04 to US$ 23.6 bn in FY07. During this period, its contribution to the total IT industry has gone up marginally from around 48.2% to 49.4%.The project oriented IT services contributed around 57.9% in FY07, while outsourcing IT services accounted for around 32.8% of the total revenues of IT services segment in India.

Within the ITeS-BPO segment, Customer Interaction Services (CIS) accounted for nearly 45-46% of the total ITeS-BPO services exports while finance & accounting contributed for roughly around 40-41%. Human resource and other high-end knowledge-based processes account for 3% and 11% respectively.

The Software product, Engineering services and R&D segment contributed over 13.8% of the total IT industry in FY07. In addition to this, 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.

IT-ITeS Exports share to India’s Services export

India’s services exports has been growing rapidly over the last couple of years, recorded a CAGR growth of 44.7% during FY04-07. The share of India’s service exports in the world has gone up from 0.6% in 1995 to 2.2% in 2005, largely driven by offshoring of IT & ITeS-BPO sector. The trend withstands India’s position in the Global IT map, where India remains an attractive destination for IT-ITeS services due to its low cost, high quality of product and services, skilled manpower and favourable government policies etc.

Source: NASSCOM

Few important characteristics of the Indian IT sector include:

Export intensive:Indian IT industry is predominantly export driven, with exports contributing over 60% of its revenue since FY03.

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

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, account for over 25% of the overall industry. This skewness is all the more pronounced in the case of IT 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 Research

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, IT consulting, 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 TCS – AC Nielsen contract valued at US$ 1.2 bn, the Social Security Institute of Mexico (IMSS) -TCS deal worth US$200 mn, Satyam-FIFA contract, and the BSNL-HCL Infosystems deal valued at Rs 5.9 bn to name a few.

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, Google, Yahoo, 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.

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 total IT-ITeS 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 FY07. Indian companies are increasingly enlarging their footprints to countries in Latin America, Eastern Europe, and Asia Pacific region. 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 & consulting has been witnessing rapid growth over the last couple of years. These, newer service lines are not only enabling Indian companies to increase their sales by cross-selling to their existing customers, but also improve 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. However, the Custom Application Development and Maintenance (CADM) services continue to contribute a larger share towards IT services segment revenue. The CADM accounted for around 39.6% to the total IT services segment revenue of US$23.6 bn in FY07, and it witnessed a growth rate of 35.3% in the same period.

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 accounted for around 58% of the Indian IT-ITeS exports. Though these verticals have good growth potential, other sectors such as manufacturing, airlines and transportation, 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 sized contracts to the IT companies, the manufacturing sector can provide large number of deals/assignments to the Indian players.

Issues and challenges

Indian IT industry has been witnessing several issues and challenges which may deter the growth in future, despite the fact that demand conditions have been optimistic. Therefore, companies must adopt best practices to address those issues in order to sustain the current growth momentum. Several larged and mid sized companies are taking innovative measures to address those issues, for example, in view continuous rupee appreciation against the US dollar, the companies are keen to expand their business to other emerging markets like Europe, Asia Pacific region, Middle East etc.

• Rising attrition rate: Growth and attrition rates seem to be following a similar trajectory for most Indian software service companies. With a McKinsey report stating that India will need an additional 1 mn employees to join the IT-BPO workforce by 2010 in order to maintain its current market share, the attrition phenomenon has come into the limelight. Managing attrition in the IT industry holds significant importance because skilled professionals form the crux of this knowledge-intensive industry. Apart from the loss of skill sets, the cost of recruitment and training is a huge investment for most IT firms. Consequently, as most major players have realised, attrition affects the quality of service, leading to greater expenditure on training and development, thereby affecting the overall performance, including improving utilisation rates of the company.
  
  Major players in the Indian software industry — Tata Consultancy Services (TCS), Infosys Technologies, Wipro, and Satyam Computers — are currently witnessing high attrition rates. TCS reported an attrition rate of 11.5% — up from 10.6% a year ago; the attrition rate at Infosys was 13.7% in FY07 — higher than 11.2% recorded in FY06; the attrition rate at Satyam declined from 19.2% in FY06 to 15.7% in FY07; whereas the rate at Wipro witnessed a surge to 17.4% as against 14.6% during the previous fiscal, in its global IT services and product business.

• Rupee appreciation: The rupee gained almost 12.5% against the US dollar in mid-October, 2007 vis-à-vis the same period in the previous year, denting the earnings of the IT industry (the industry earns its highest revenue from the US). On October 17, 2007, the rupee surged to 39.68 against the US dollar — its highest rate in 9 years. Importantly, during January–October 2007, the rupee appreciated at more than 10.6% against the US dollar. For software firms whose expenses are mostly in the local currency, the rupee appreciation reduces the rupee equivalent of every dollar they earn overseas, thus affecting their margins to a great extent. Margins have already begun to face the effects of the rupee appreciation and most Indian IT players are forced to adopt forward-trading to help mitigate losses. Apart from losing out on margins, Indian IT companies might lose the competitive edge over international firms if the trend continues for long. For example, China is holding its currency steady, offering stability, which might turn out to a distinguishing factor for survival in the long run.

• Emerging new territories: According to an IDC study, three Indian cities rank at the top in the Global Delivery Index today in the top 10 off-shore destinations of Bangalore, Manila, New Delhi, Mumbai, Dalian, Shanghai, Beijing, Sydney, Brisbane & Auckland in the Asia-Pacific region. However, the Indian IT industry is gradually facing stiff competition emerging from new territories like China, Malaysia, Philippines and Mexico. The study also states that although Mumbai & Bangalore may be favourite off-shoring destinations as of today, Chinese commercial hubs like Beijing & Shanghai are set to overtake Indian cities by 2011. A similar competitor would be Malaysia having a stable socio-economic environment, excellent infrastructure, low attrition rates, & skilled talent pool as key advantages.
  
  Though China still faces some challenges in capabilities such as language, risk to intellectual property (IP), and some infrastructure issues, 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.

• End of tax benefits at STPIs: Uncertainty about the continuation of the tax holiday may slow down future expansion proposals. With dissimilarity in tax regimes, the existing STPI units would opt to re-invent themselves as SEZ units. It should be also noted that low-cost competitors like China are rapidly emerging as attractive alternative destinations, where province-level authority on economic administration is provided to SEZs, for better economic benefits.

Key Positives & Negatives for the Indian IT Industry