Password to crack the new IT matrix

For a while now the two words that have characterised the IT industry are “cost arbitrage”. Investors and analysts now want the industry to learn two new words: Pricing power.

Hit on the cost side because of an increase in employee costs and on the revenue side because of a rise in the value of the rupee against other currencies, the industry needs to figure out if its clients need it enough to allow them to raise prices.

“I think it is obvious that these companies do not have power to renegotiate prices to completely offset the adverse circumstances,” says the India head of a multi-strategy fund that currently managed about $2.5 billion. Most companies are negotiating a price increase of 1-2% on contracts coming up for renewal. This is unlikely to nullify the 5-6% decline in profit margins. No wonder then that most frontline IT stocks have underperformed the Sensex by more than 10% over the last six months.

One stark indicator of the state of the industry is the return on incremental capital employed, essentially the additional profits generated by deploying additional capital in the business. On this criterion, most top firms have shown a decline over the last two years. “These guys have a great business. Profits are growing at 25-30%, and revenue growth is strong. It is just that they may not be great stock market investments because the capital efficiency of the business may have declined,” says the fund manager.

For many industry experts IT companies may not be doing enough. “IT companies have done a reasonable job till now but if the rupee and the wages keep rising then they will need to do a lot more,” says Gartner regional research director Partha Iyengar. The IT industry has always relied on external triggers to show the way.

It was Y2K in 1999 and then the Internet mania in 2000 that shaped the business model of the industry. And that was setting up a process to move work offshore quickly and delivered in a “factory environment”. “Everybody then followed this business model that won the Y2K battle for India. I suspect we may be at a similar inflection point and we will see people now choosing differentiated strategies,” says the head of a private equity firm that has large investments in the IT sector.

For almost all the companies the core of the strategy will really mean figuring out how they deliver their bread-and-butter service: The application development and maintenance or ADM business. Since the ADM business is close to 50% of the revenues any strategic move has to deal with this chunk carefully.

So TCS is talking about using much more automation while Cognizant has set up a software factory at Coimbatore where they will use both scale as well as automation to be more efficient in delivering such services. There are other companies that are taking their ADM businesses away from Mumbai or Bangalore to smaller towns like Nashik, Bhubaneshwar or Pune.

All these are the cost-side measures. Things that can get better margins are as yet unaddressed. “The consulting businesses of these companies are yet to take off and these companies have not been able to identify any high-profit niches,” says the fund manager.

To be fair to the IT companies, they have developed deeper relationships with their clients but not in new areas. So, in normal ADM contracts Indian companies do it almost like a turnkey contract today while four to five years ago they would get all the requirements and only do the programming.

In enterprise solutions (SAP software related work) many India companies have moved ahead from doing just grunge work and writing small time programmes for SAP software. “Most of the global rollouts of enterprise software and its customisation in large companies is being handled right out of India and that is a huge step,” says Mr Iyengar.

But there is nothing spectacular in the pipeline that will transform these companies over a five-year horizon. “I think they need to become much more choosy in where they direct their resources. For example, HCL is not going to rebid for almost $16 million worth of contracts,” says Mr Iyengar.

Choices such as these are clearly difficult. Indian companies do not want to walk away from contracts and give smaller companies an opportunity to enter their accounts. Something they had benefited from when large companies like IBM and Accenture and Cap Gemini chose to focus on higher-end business 7 years ago. But clearly something has to give for the industry to get the buzz back. And no, we are not talking about small-fry acquisitions or sponsored ADS programmes.

Indian geeks rated good citizens in cyber city

Indian geeks are among the most sought after worldwide to tweak, maintain and test code but when it comes to cyber crime, thankfully they are not among the leaders. Research by US-based IT security and control firm SophosLabs shows that though India is one of the world’s most technologically booming nations, it ranks surprisingly low when it comes to churning out malware.

The study shows that only 2.8% spam is relayed from India, whereas the US tops the chart at 19.8% followed by China at 7.5%. The study suggests that the onus for low cyber-crime in India goes to a ‘cultural difference’.

Though the US still produces more malware , viruses and spams than any other country in the world, such jobs are increasingly getting outsourced to countries where labour is cheap and legitimate IT jobs are scarce. So scammers in these countries (like China ) are insulated from laws that protect their victims .

That explains China, Brazil and Russia’s inclusion in the top 10 spam-relaying countries of the world. India ranks 11th in the dirty dozen list.

When compared to other countries which feature in the list, India has legitimate IT jobs and good programming knowledge, which can reasonably establish why Indians shy away from the illegal use of such knowledge. “In India, strong cultural values act as a dampener for any illegal activities and we have already seen cyber-crime cells cropping up in different parts of the country, further reducing chances of relaying malware,” contends Nandkumar Saravade, director of cyber-security at the National Association of Software and Services Companies (Nasscom).

There are 20-million computers in India, under 2% of the population, which indicates below par penetration. “Cyber-crime increases with PC penetration,” claims Deepankar Sanwalka , head of KPMG’s forensic department.

He cites stringent control measures by the ITeS sector off late as a reason why cyber-crime in the country has been under check. New analysis from Frost & Sullivan’s ‘World Anti-Malware Products Markets’ reveals that the world market for anti-virus solutions reached $4.7 billion in 2006, up 17.1% from about $4 billion in the previous year and expects this market to grow at a 10.9% CAGR from 2006 to 2013, reaching $9.7 billion by 2013. According to the Sophos study, the overall volume of spam rose by around 4.2% during Q1 2007, when compared to the same period in 2006.

Emerging Opportunity - Testing Services

The market for offshore Testing Services is growing at a rapid rate and presents a major, untapped opportunity for Indian outsourcing vendors. Most key players in the industry, have in fact, built robust Testing Services portfolios and deployed Best Practices within this segment.

According to Gartner Inc., the worldwide market for Testing Services is forecast to grow to US$ 13 billion by 2010, with 45-50 percent (around US$ 6 billion) getting outsourced. Indian IT-BPO players generated export revenues of about US$ 280 million from Testing Services in 2006. A significant potential therefore exists for Indian IT-BPO companies providing solutions in this space.

The challenge facing the Indian testing services industry

The rapid growth in demand for software testing services has had a corresponding impact on the supply side. Of all the challenges faced by the industry, the most crucial was the paucity of skilled manpower In 2006 alone, there was a shortfall of 15,000 software testing professionals in India. This shortfall is stated to be a result of the following:

- The fact that young professionals are not aware of the career potential of the testing market.

- The lack of higher business domain knowledge, process knowledge and client
management skills among testing professionals, a major requirement for the
market.

- The absence of training and learning programs that cater specially to this
market. As specialized software testing as a career has emerged only in the
last 7-10 years, academic institutions as well as corporate entities are
not geared fully to nurture software testing professionals.

Clearly, Indian IT-BPOs focused on the Testing Services marketplace have to tune themselves to the emerging technology and business trends shaping this opportunity. Investments in the right testing tools, relevant testing methodologies and skilled manpower is becoming a must today. Indian IT-BPO organizations need to keep these factors in mind to step up their share in the fast growth Testing Services segment.