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Will the US slowdown hit the ITeS sector?
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February 06, 2008
With software giant TCS [Get Quote] slashing the variable component of staffers' salaries, the impact of a US slowdown/recession on the sector suddenly looks quite real.

Siddharth A Pai
Partner & Managing Director
TPI India [Get Quote]

"The era of labour arbitration is ending. Yet, a handful of service providers have re-oriented. In the short term, they'll feel the impact of recession."

Despite the sub-prime crisis, most commentators (myself included) doubted the predictions of a US recession a few months ago. This confidence has steadily eroded -- the IMF has slashed its US forecast and warned that no country will be immune from a "global slowdown". 

Across industries, companies that outsource are evaluating the recessionary trends. Will an economic slowdown in the US automatically translate into more interest in offshore outsourcing? Outsourcing is a strong business proposition in good times, and it's an even stronger proposition when bad times last. 

Offshoring will accelerate over the long term, since it drives cost savings. However, this might not be quite so in the short term, especially for India heritage service providers.

Some of the India heritage providers have so far enjoyed superlative performance -- driven by a unique set of factors such as a highly under-penetrated offshore market in their primary service segment (application development and maintenance) and a favourable tax regime in India. None of these favourable circumstances is reflective of a normal business scenario.

Moreover, these factors are changing; tax breaks in India are on their way out. India heritage service providers have won significant market share in their primary service segment. Our last TPI Index (Q4, 2007) indicates that the total contract value won by the India heritage providers increased by about 42 per cent year on year.

Recession or not, the outsourcing industry has changed enormously -- not least by the India heritage providers themselves. The era of labour arbitrage orientation is ending. 2008-10 will witness an updation of historically simple offshore relationships to complex bundled arrangements for managed services.

Corporations are now concerned with business resilience -- with having the kind of capacity that facilitates continual operations. Hence, any dependence on a particular country, or a particular network, is coming under scrutiny.

The second issue relates to data privacy.  The perception that offshoring of data increases the risk level may mean that corporations choose not to offshore.

As competing for large transactions in the marketplace is increasingly driven by resilience and data privacy, the only way forward for India heritage service providers is to globalise:

Spread geographical presence for both sales and delivery.

Hire foreign (non-Indian) nationals in greater proportions.

Delegate greater authority down the line.

Assume more risks in the contracting process.

All of this has been apparent for a while, even before the onset of recession. Despite this, few of the India heritage providers have made significant attempts to globalise. Though they will benefit in the long run, they are unlikely to escape the immediate and short-term effects of the global recession on IT spending.

Ashok Soota
Chairman & Managing Director
MindTree Consulting [Get Quote]

"No one is talking of a cut in US IT budgets and, at a time when there's a need for a bigger bang for the IT buck, we will make more inroads"

Every industry from time to time goes through cycles of macro-economic challenges. For the Indian IT/ITeS industry, it has been the sudden appreciation of the Indian rupee against the major world currencies, particularly the US dollar.

However, despite the 15-per cent plus appreciation, the industry leaders have done a commendable job of maintaining their profit margins, which I think is an indicator of the resilience of the Indian IT industry. If the rupee appreciates at a gradual pace of 3-4 per cent per annum in the future, I think the industry can cope with it through productivity gains, price increases and operational efficiency improvements.

Nowadays, we constantly hear about the impact of the US slowdown on the Indian IT industry, for instance, uncertainty regarding customers' IT budgets as the US economy enters a slowdown phase and sectors like banking and financial services (BFS) being hit by the sub-prime crisis.

What is perhaps not getting highlighted is the fact that there are no signs of any cuts in IT budgets in absolute terms.

The worst that analysts are predicting is slower growth in IT spending compared to 2007; but spending in absolute terms will grow nevertheless. Usually in such times, customers tend to expect more out of the actual dollars spend, which leads them to outsource and offshore more.

I believe that the Indian IT industry has an opportunity to make further inroads into the US market during the slowdown phase of US economy. Just so we know the facts, no major IT company has reported a fall in its revenues from the US or from BFS industry this year.

In terms of overall revenues, the industry continues to grow at 30 per cent annually in dollar terms, which is in line with the long-term projections from Nasscom.

The industry has added more than 100,000 people to its workforce during the first nine months of this financial year and made thousands of campus offers, based on the business pipeline.

One may note that there is a global market of $300 billion to be tapped, that there are regions in the world like continental Europe and Japan, which are still opening up to offshoring, and that India's advantage in terms of size of its talent pool and institutional maturity continues to be unmatched. The big picture tells us that we ought to be looking forward to a much larger opportunity for the industry.

The sharp currency appreciation this year affected the economics of the Indian IT/ITeS industry, which the market has already factored into the companies' stock prices. Going forward, there is no reason why the valuations should not reflect the prospects of continued growth and profitability of the industry.

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