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Second Annual IT Services Trip: LT drivers exist, 2012 outlook hazy
Second Annual Indian IT Services Trip: Offshore on secular trend
We hosted our Second annual Indian IT Trip from Sep 6th-9th and met Indian
& MNC firms, Tech Research firms and industry bodies. In the backdrop of
current global concerns, our trip provided us with a reasonably solid view of
the secular growth trajectory for the global delivery model of Indian IT,
growing recognition of quality as a reason to outsource vs. cost arbitrage
alone, supply- side dynamics adequate to meet demand. However, the 2012
outlook remains hazy, as firms have not yet started budget discussions with
clients and the impact remains uncertain.
Structural growth drivers for LT intact, though models are evolving
Growth drivers highlighted were opportunities for market share gain as
well as expansion in the addressable market, driving a mid-teens growth
for the industry over the next 3-5 years. Additionally, firms were optimistic
on gaining traction with newer verticals which have not taken to offshoring
like Healthcare, Public sector and are seeing greater willingness now.
Europe was highlighted as another large opportunity, esp. for 2012, despite
the negative headlines.
Technology evolution bringing in newer opportunities for IT Svcs
Larger firms were positive about newer growth areas of Cloud computing,
Mobility and Analytics over the MT to LT. Managements spoke about their
investments in tech platforms, kick-starting pilot projects and the potential
to significantly increase non-linear revenues from these streams.
Infrastructure Mgmt Outsourcing – most sought after service area
While newer models are emerging, IMO surfaced as the most sought after
area for most of the firms. IMO is being seen as a blend of defensive and
high growth area, and the offshore potential in this space has been tapped
the least. Today’s note on HCL Tech: IMO: A sustainable advantage;
incremental US$1bn by FY14, discusses this opportunity in greater detail.
HCL Technology & Infosys remain our top picks in Indian IT
We prefer HCL Tech (17%/21% revenue and EPS CAGR for FY11-FY14E)
and Infosys (limited downside on valuations) as our top picks. Key upside
risks for the sector are recovery in the developed markets, INR
depreciation; downside risks are deteriorating outlook in the US/EU zone.
Click for company specific details:
Click above for company specific details:
India IT Services Trip assures long term growth story is intact
We conducted our Second Annual India IT Services Investor Trip 2011 during the
week of 6th September. We visited about 15 companies in Delhi, Mumbai, Chennai,
and Bangalore meeting CXOs of major Indian IT players, MNCs, software firms,
industry bodies and consulting agencies. Our trip provided us with increased
confidence on the longer-term sustainability of the offshore industry for the next
decade, provided the Indian companies continue to evolve and enhance/expand their
prospects for global service delivery, as they have done in the past decade.
These are the key takeaways:-
1) Increased confidence on the long term IT outsourcing industry as Indian vendors focus
on new initiatives to tap the next leg of growth.
2) Indian firms could face stiffer challenges and need to revisit business models as MNC
peers increase their offshore base more aggressively than ever.
3) 2011 budget cycles remain intact and corporate are better prepared to tackle 2012.
4) Supply-1side dynamics show marginal signs of improvement though attrition remains
high.
5) Shift to fresher hiring is the theme for FY12 as focus is to augment the bottom layer of
the pyramid.
6) Volume growth to continue to drive revenues for the next 2-3 years.
7) De-risking by investments into new geographies could be a key to long term growth.
8) India may become a prominent addressable market in the next three years.
9) Momentum towards diversifying delivery to China has slowed down.
10) Pure-play BPO business model is becoming dependent on scale and capabilities.
11) Visa concerns are leading to a slow but structural shift to more onsite local hiring.
12) Mid-cap companies continue to struggle except where a niche is developed.
13) Reorganization of business structures has become important with dynamic business
environments – verticalization dominates senior management focus.
14) Non-linear initiatives gain momentum and real impact on fundamentals could be felt in
2-3 years from now.
15) Infrastructure management surfaced as the most sought after service area – blend of
growth and defensive attributes
Summing it up, we reiterate our views in three timeframes :
1) Near term – Demand backdrop remains steady and the corporates continue to hire to
ramp up for the pipeline. 2011 budgets remain intact with almost no companies citing
any pressures from their customers.
2) Medium term – Going into 2012, macro uncertainties in US/EU could impact the dollar
value of IT budgets as customers start their budgeting process over the next three
months. Much could be decided by fall of this year as to what shape 2012 can take but
a mid-teens growth looks the most likely scenario with the current visibility.
3) Long term – Low- to mid-teens growth over the next ten years doesn't look
challenging through market share gains, offshore shift, steady innovations adapting to
newer technology trends (cloud, mobility, platforms), and constrained IT labor supply.
Key industry takeaways confirm stable 2011 but uncertain 2012
Long term IT outsourcing story is intact as Indian vendors focus on new initiatives to
tap the next leg of growth
Our discussions with the CXO’s of all the major firms in the Indian IT services space
resulted in the conclusion that the long term IT outsourcing story is still intact with market
share gain as well as expansion in the addressable market providing sufficient opportunity
to grow in the next 3-5 years. Other key takeaways are:-
Outsourcing is not a point of contention for the CIO’s anymore during the customer
discussions. Hence, it is given that companies will outsource, however, market share
gains and outcome based pricing are coming up as the main area of discussion.
Public sector across the geographies have been showing greater willingness to accept
offshoring as long as data confidentiality is maintained.
Offshore cost arbitrage could remain over the longer term, but outsourcing customers
at Indian vendors are no longer looking for cost but for flexibility in their offerings.
As per one of the advisory firms, of the global 200 companies, only 700-800 companies
are catering to mainstream offshoring. Another 300-400 have done it on an ad-hoc
basis. The rest of the 800 companies are likely the next market opportunity for the
Indian vendors. At present, only about 10% of the IT services market is offshored.
Offshore competition likely to intensify as MNC vendors shift to offshore more
aggressively
Most of the MNC vendors stated that they are resorting to increased offshoring and are
looking to aggressively increase their presence in India. One top European vendor even
said that they are not facing any internal or external pressures against shifting towards
offshoring. Hence, an increased intent from the MNCs could heat up the supply- side
dynamics in the country and may lead to sustained levels of attrition and wage hikes. It
may also lead to stiffer competition to the Indian vendors in their arena of application
development and maintenance as the bigger MNC vendors are able to offer competitive
pricing through offshoring. Some companies have already started seeing IBM and ACN as
their lead competitors in some of the large ADM deals.
2011 budget cycles remain intact and corporates are better prepared to tackle 2012
Most customers have not yet reduced their IT budgets. In order to cut the overall IT
budgets without impacting efficiency of the business models, companies may move
towards offshoring. Some corporates have already started to ask for higher offshore
mix for fresh engagements.
Managements felt their clients are better prepared to handle a slowdown in growth
and demand as compared to 2008. The difference this time around is that 2008 came
as a sudden crisis for which neither IT vendors nor their clients were prepared.
However, companies are aware of the risks of not investing in to business to prepare
when demand returns back as was accepted by INFY and Wipro.
Supply-side dynamics show little signs of improvement; attrition remains high
A surprise observation was that the supply-side dynamics are still skewed in favor of the
employees with not much change in the attrition levels in the lest three months. One
reason attributed to this may be that the wage hikes and promotions for most of the
companies have been given the last 3-6 months and this is the peak season for attrition.
However, the deteriorating economic outlook has not transpired into the supply-side
dynamics as yet. We believe that the aggressive hiring plans of the top companies may
keep the supply-side pressures in the near term, unless we see cuts in the hiring plans.
Shift to fresher hiring is the theme for FY12 as to flatten the pyramid
Last year (2010) was the year of lateral hiring where greater proportion of laterals vs
freshers were hired as the demand resumed in a strong way and companies had to resort
to immediate hiring. It resulted in inflating the wages for the laterals and thereby
increasing the overall costs for the companies, as companies scouted for right capabilities.
We believe that 2011 is a different year as demand moderates and cost pressures rise.
Most companies reiterated their strategy of a high proportion of freshers to flatten the
bottom of the pyramid. One implication of that would be most of the growth would be in
the form of volume growth as higher number of freshers are hired. Managements are also
planning to visit campuses for next year’s offers. The season starts from 4QCY11 and
companies have not taken any slices in offering freshers.
Volume growth to continue to drive revenues for the next 2-3 years
For the Indian IT services industry, the biggest concern is the sustainability of the link
between revenues and volumes. At some time, the Indian IT companies would become too
big to manage and the linearity model needs to be broken. However, most of the
companies reiterated that over the next two-three years, volume growth could be the key
driver for revenue growth. Despite concerns on the demand outlook for 2012, comments
from two managements of the top 5 companies stood out. Whereas one company said that
they do not see any impediment for a 20%+ growth over the next three years, another
company management mentioned that they will continue to grow more than others, in a
response to that.
De-risking by investing into new geographies will be a key to long term growth
We came back from the trip with the impression that the importance of the US market
could be receding as a growth market for the Indian IT companies, though it will remain the
largest market in terms of revenue share. We may see a slow period of growth in the EU
market. Most of the Indian companies see the economic crisis in the EU region positively
and as an opportunity to gain market share. First time outsourcers are outsourcing more
and we are seeing increasing traction. Nordics, France, Germany are at tipping point of
opening up for outsourcing. Most European companies are not open to offshoring as yet
and hence EU may become an attractive addressable market for the Indian companies.
Infrastructure management surfaced as the most sought after service area – a blend
of growth and defensive attributes
Infrastructure management emerged as the service area with the highest growth in the last
three years. Infra management has a blend of defensive as well as high growth attributes
and the characteristics are : (1) It is a high growth space now with corporates looking for
high value propositions, (2) It is a low margin business though with around 14% operating
margins after squeezing out the India offshore advantage, (3) It has revenues in the nature
of annuity and with a much smoother sequential growth which provides stability to the
earnings for the growth. We believe that HCL Tech is one of the leaders in this space and is
in a sweet spot with its differentiated value proposition. (For details, refer to our report
dated Sep 29, 2011, IMO: a sustainable advantage; incremental US$1bn by FY14).
India may become a prominent addressable market in the future
India, as an addressable market, is becoming more prominent in the last couple of years.
TCS and IBM have been the first movers (along with Wipro) to tap the Indian market
through various IMS deals, especially in the public sector. India IT revenues is currently far
less penetrated than other major economies. Large IT deals like UID implementation, SAP
implementation in PSU banks and Indian Postal departments are landmark deals which
showcase India’s potential as an end market.
Momentum towards diversifying delivery to China has slowed down
Over the past few years, China has emerged as one of the largest threats and opportunities
for the Indian dominance. In our report dated Sep 6, 2010, Indian IT in no danger of being
‘Dalianed’: Views from over the wall, we assessed China as a long-term opportunity from
the delivery as well as client opportunity side. In our recent meetings, we witnessed a
change in the momentum towards diversifying delivery to China. Despite every company
accepting that they continue to expand operations in China, except Infosys, most
companies reiterated that it will take 3-5 years before scale can be achieved in China and it
becomes prominent on the global map. We were surprised to hear that showcase IT cities
like Dalian are already becoming expensive and supply side balance is becoming
unfavorable. Hence, despite government support on infrastructure and tax incentives,
wage hikes and lack of availability of talent may lead to a slower move to China.
Pure-play BPO business model is becoming dependent on scale and capabilities
As the corporates move towards doing more total outsourcing deals and as the bigger IT
vendors expand their service offerings by including BPO capabilities as well, it will become
more and more difficult for the pure-play BPO companies to justify their business case and
survive at a respectable profitability. Our discussions concluded that only scale and
capabilities will allow the pure-play vendors to co-exist in the BPO space and the likes of
Genpact and EXL Services are benefitting from the same.
Visa concerns have led to a slow but structural shift to more onsite local hiring
Issues and concerns raised over visa applications has clearly resulted in two things :
(1) visa approval time has increased on an average by 50% with more rejections than
witnessed in the past. It signals that the visa application process has become more
stringent on the back of scrutiny on the entire process. Some countries have also started
taking salary as a benchmark to decide the capabilities and the applicable visa for the
employees.
(2) Most of the managements stated that they have increased local onsite hiring in the last
six months. Though they are not facing problems in getting H-1B visas, it's the L-1/L-2 visas
which have become difficult. The fact that cost differential between an H-1B employee and
a local employee is not significant has also led to this structural shift. As we had assessed
in the note dated. May 30, 2011,”Assessing industry impact on the current debate over US
visas”, though the shift to increased hiring looks imminent, it should not structurally
remove the margin advantage of the Indian companies and could impact it by 50-100 bp in
the long term.
Mid-cap companies could continue to struggle except where a niche is developed
With the large companies becoming larger and the smaller companies not having a real
differentiated product, It is becoming difficult for customers to go to Tier- II companies now
and they will do so mostly for more flexibility in contracts or for very specialized services.
Hence, we believe that mid-size companies could struggle to attain greater scale unless
they offer niche capabilities which are not offered by the larger players, who can work with
their scale strength and higher profitability to get deals. Higher margins for Tier 1
companies are more related to the economies of scale, quality of fresher hiring, and
intellectual capital.
Reorganization of business structures has become important with dynamic business
environments – verticalization is the key mantra
As the Indian companies became bigger, it has become an organizational challenge to
handle different verticals, service areas and geographies. Hence, over the last three years,
companies have to resort to some reorganization to remain important. As a common
theme, verticalization has been adopted by various companies. Cognizant was the first one
to restructure themselves into verticals. Most of the other top tier companies have
migrated towards the same model now with Infosys being the latest participant.
Non-linear initiatives gain momentum but real impact still looks 2-3 years away
Larger firms were positive about newer growth areas of Cloud computing, Mobility and
Analytics over the MT to LT. Managements spoke about their investments into developing
solutions, kick-starting pilot projects and the potential to significantly increase non-linear
revenues from these streams. Cloud, mobility and platforms remain the most important
long term growth driver.
NASSCOM (Mr. Som Mittal, President)
1) Industry would grow at mid-teens over the medium term – Indian IT sector should
be able to grow at mid-teens levels over the medium term and may extend the same
growth till 2020 as they continue to grow up the value chain of outsourcing.
2) Supply side shortage is not a concern – India should not have a supply side shortage
in the near to medium term, especially at the entry level. India is producing enough
engineering as well as non-engineering graduates to cater to the mid-teens growth in
the medium term. Only areas where it can face a shortage for sporadic periods of time
is for domain specialists.
3) Visa issue could get resolved soon – They are confident that the visa issue that has
arisen over the past few months could get resolved. NASSCOM has been working with
the US over the visa issue in the recent past. However, they did mention that the visa
issuing process has become more stringent and companies may start looking to
increase local hires too, despite a shortage of local talent in these regions.
4) China is becoming expensive, Dalian is the best example – China as an outsourcing
destination is becoming expensive as the cost arbitrage is reducing due to high
inflation in China. Dalian, which is a showcase IT city in China, is already facing supply
side issues. Hence, over and above the concerns regarding IP, security, language
barriers etc, inflation is unbalancing the dynamics in China.
5) Margin expectations should be reset – NASSCOM president articulated that the
Indian IT companies may have to reset their margin expectations in order to stay
competitive and relevant over the long term. Hence, margin trajectory for some of the
large vendors may structurally come down over a longer term.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Second Annual IT Services Trip: LT drivers exist, 2012 outlook hazy
Second Annual Indian IT Services Trip: Offshore on secular trend
We hosted our Second annual Indian IT Trip from Sep 6th-9th and met Indian
& MNC firms, Tech Research firms and industry bodies. In the backdrop of
current global concerns, our trip provided us with a reasonably solid view of
the secular growth trajectory for the global delivery model of Indian IT,
growing recognition of quality as a reason to outsource vs. cost arbitrage
alone, supply- side dynamics adequate to meet demand. However, the 2012
outlook remains hazy, as firms have not yet started budget discussions with
clients and the impact remains uncertain.
Structural growth drivers for LT intact, though models are evolving
Growth drivers highlighted were opportunities for market share gain as
well as expansion in the addressable market, driving a mid-teens growth
for the industry over the next 3-5 years. Additionally, firms were optimistic
on gaining traction with newer verticals which have not taken to offshoring
like Healthcare, Public sector and are seeing greater willingness now.
Europe was highlighted as another large opportunity, esp. for 2012, despite
the negative headlines.
Technology evolution bringing in newer opportunities for IT Svcs
Larger firms were positive about newer growth areas of Cloud computing,
Mobility and Analytics over the MT to LT. Managements spoke about their
investments in tech platforms, kick-starting pilot projects and the potential
to significantly increase non-linear revenues from these streams.
Infrastructure Mgmt Outsourcing – most sought after service area
While newer models are emerging, IMO surfaced as the most sought after
area for most of the firms. IMO is being seen as a blend of defensive and
high growth area, and the offshore potential in this space has been tapped
the least. Today’s note on HCL Tech: IMO: A sustainable advantage;
incremental US$1bn by FY14, discusses this opportunity in greater detail.
HCL Technology & Infosys remain our top picks in Indian IT
We prefer HCL Tech (17%/21% revenue and EPS CAGR for FY11-FY14E)
and Infosys (limited downside on valuations) as our top picks. Key upside
risks for the sector are recovery in the developed markets, INR
depreciation; downside risks are deteriorating outlook in the US/EU zone.
Click for company specific details:
HCL Technologies (HCLT.BO, Buy, On Conviction List)
Infosys (INFY.BO / INFY, Buy)
Tata Consultancy Services (TCS.BO, Neutral)
Wipro (WIPR.BO / WIT, Neutral)
Mphasis (MBFL.BO, Neutral)
Cognizant Technologies (CTSH, Buy)
ExlServices Holdings (EXLS, Neutral)Genpact (G, Neutral)
SAP (SAPG.DE, Buy, On Conv. List)
Capgemini (CAPP.PA, Buy)
Click above for company specific details:
India IT Services Trip assures long term growth story is intact
We conducted our Second Annual India IT Services Investor Trip 2011 during the
week of 6th September. We visited about 15 companies in Delhi, Mumbai, Chennai,
and Bangalore meeting CXOs of major Indian IT players, MNCs, software firms,
industry bodies and consulting agencies. Our trip provided us with increased
confidence on the longer-term sustainability of the offshore industry for the next
decade, provided the Indian companies continue to evolve and enhance/expand their
prospects for global service delivery, as they have done in the past decade.
These are the key takeaways:-
1) Increased confidence on the long term IT outsourcing industry as Indian vendors focus
on new initiatives to tap the next leg of growth.
2) Indian firms could face stiffer challenges and need to revisit business models as MNC
peers increase their offshore base more aggressively than ever.
3) 2011 budget cycles remain intact and corporate are better prepared to tackle 2012.
4) Supply-1side dynamics show marginal signs of improvement though attrition remains
high.
5) Shift to fresher hiring is the theme for FY12 as focus is to augment the bottom layer of
the pyramid.
6) Volume growth to continue to drive revenues for the next 2-3 years.
7) De-risking by investments into new geographies could be a key to long term growth.
8) India may become a prominent addressable market in the next three years.
9) Momentum towards diversifying delivery to China has slowed down.
10) Pure-play BPO business model is becoming dependent on scale and capabilities.
11) Visa concerns are leading to a slow but structural shift to more onsite local hiring.
12) Mid-cap companies continue to struggle except where a niche is developed.
13) Reorganization of business structures has become important with dynamic business
environments – verticalization dominates senior management focus.
14) Non-linear initiatives gain momentum and real impact on fundamentals could be felt in
2-3 years from now.
15) Infrastructure management surfaced as the most sought after service area – blend of
growth and defensive attributes
Summing it up, we reiterate our views in three timeframes :
1) Near term – Demand backdrop remains steady and the corporates continue to hire to
ramp up for the pipeline. 2011 budgets remain intact with almost no companies citing
any pressures from their customers.
2) Medium term – Going into 2012, macro uncertainties in US/EU could impact the dollar
value of IT budgets as customers start their budgeting process over the next three
months. Much could be decided by fall of this year as to what shape 2012 can take but
a mid-teens growth looks the most likely scenario with the current visibility.
3) Long term – Low- to mid-teens growth over the next ten years doesn't look
challenging through market share gains, offshore shift, steady innovations adapting to
newer technology trends (cloud, mobility, platforms), and constrained IT labor supply.
Key industry takeaways confirm stable 2011 but uncertain 2012
Long term IT outsourcing story is intact as Indian vendors focus on new initiatives to
tap the next leg of growth
Our discussions with the CXO’s of all the major firms in the Indian IT services space
resulted in the conclusion that the long term IT outsourcing story is still intact with market
share gain as well as expansion in the addressable market providing sufficient opportunity
to grow in the next 3-5 years. Other key takeaways are:-
Outsourcing is not a point of contention for the CIO’s anymore during the customer
discussions. Hence, it is given that companies will outsource, however, market share
gains and outcome based pricing are coming up as the main area of discussion.
Public sector across the geographies have been showing greater willingness to accept
offshoring as long as data confidentiality is maintained.
Offshore cost arbitrage could remain over the longer term, but outsourcing customers
at Indian vendors are no longer looking for cost but for flexibility in their offerings.
As per one of the advisory firms, of the global 200 companies, only 700-800 companies
are catering to mainstream offshoring. Another 300-400 have done it on an ad-hoc
basis. The rest of the 800 companies are likely the next market opportunity for the
Indian vendors. At present, only about 10% of the IT services market is offshored.
Offshore competition likely to intensify as MNC vendors shift to offshore more
aggressively
Most of the MNC vendors stated that they are resorting to increased offshoring and are
looking to aggressively increase their presence in India. One top European vendor even
said that they are not facing any internal or external pressures against shifting towards
offshoring. Hence, an increased intent from the MNCs could heat up the supply- side
dynamics in the country and may lead to sustained levels of attrition and wage hikes. It
may also lead to stiffer competition to the Indian vendors in their arena of application
development and maintenance as the bigger MNC vendors are able to offer competitive
pricing through offshoring. Some companies have already started seeing IBM and ACN as
their lead competitors in some of the large ADM deals.
2011 budget cycles remain intact and corporates are better prepared to tackle 2012
Most customers have not yet reduced their IT budgets. In order to cut the overall IT
budgets without impacting efficiency of the business models, companies may move
towards offshoring. Some corporates have already started to ask for higher offshore
mix for fresh engagements.
Managements felt their clients are better prepared to handle a slowdown in growth
and demand as compared to 2008. The difference this time around is that 2008 came
as a sudden crisis for which neither IT vendors nor their clients were prepared.
However, companies are aware of the risks of not investing in to business to prepare
when demand returns back as was accepted by INFY and Wipro.
Supply-side dynamics show little signs of improvement; attrition remains high
A surprise observation was that the supply-side dynamics are still skewed in favor of the
employees with not much change in the attrition levels in the lest three months. One
reason attributed to this may be that the wage hikes and promotions for most of the
companies have been given the last 3-6 months and this is the peak season for attrition.
However, the deteriorating economic outlook has not transpired into the supply-side
dynamics as yet. We believe that the aggressive hiring plans of the top companies may
keep the supply-side pressures in the near term, unless we see cuts in the hiring plans.
Shift to fresher hiring is the theme for FY12 as to flatten the pyramid
Last year (2010) was the year of lateral hiring where greater proportion of laterals vs
freshers were hired as the demand resumed in a strong way and companies had to resort
to immediate hiring. It resulted in inflating the wages for the laterals and thereby
increasing the overall costs for the companies, as companies scouted for right capabilities.
We believe that 2011 is a different year as demand moderates and cost pressures rise.
Most companies reiterated their strategy of a high proportion of freshers to flatten the
bottom of the pyramid. One implication of that would be most of the growth would be in
the form of volume growth as higher number of freshers are hired. Managements are also
planning to visit campuses for next year’s offers. The season starts from 4QCY11 and
companies have not taken any slices in offering freshers.
Volume growth to continue to drive revenues for the next 2-3 years
For the Indian IT services industry, the biggest concern is the sustainability of the link
between revenues and volumes. At some time, the Indian IT companies would become too
big to manage and the linearity model needs to be broken. However, most of the
companies reiterated that over the next two-three years, volume growth could be the key
driver for revenue growth. Despite concerns on the demand outlook for 2012, comments
from two managements of the top 5 companies stood out. Whereas one company said that
they do not see any impediment for a 20%+ growth over the next three years, another
company management mentioned that they will continue to grow more than others, in a
response to that.
De-risking by investing into new geographies will be a key to long term growth
We came back from the trip with the impression that the importance of the US market
could be receding as a growth market for the Indian IT companies, though it will remain the
largest market in terms of revenue share. We may see a slow period of growth in the EU
market. Most of the Indian companies see the economic crisis in the EU region positively
and as an opportunity to gain market share. First time outsourcers are outsourcing more
and we are seeing increasing traction. Nordics, France, Germany are at tipping point of
opening up for outsourcing. Most European companies are not open to offshoring as yet
and hence EU may become an attractive addressable market for the Indian companies.
Infrastructure management surfaced as the most sought after service area – a blend
of growth and defensive attributes
Infrastructure management emerged as the service area with the highest growth in the last
three years. Infra management has a blend of defensive as well as high growth attributes
and the characteristics are : (1) It is a high growth space now with corporates looking for
high value propositions, (2) It is a low margin business though with around 14% operating
margins after squeezing out the India offshore advantage, (3) It has revenues in the nature
of annuity and with a much smoother sequential growth which provides stability to the
earnings for the growth. We believe that HCL Tech is one of the leaders in this space and is
in a sweet spot with its differentiated value proposition. (For details, refer to our report
dated Sep 29, 2011, IMO: a sustainable advantage; incremental US$1bn by FY14).
India may become a prominent addressable market in the future
India, as an addressable market, is becoming more prominent in the last couple of years.
TCS and IBM have been the first movers (along with Wipro) to tap the Indian market
through various IMS deals, especially in the public sector. India IT revenues is currently far
less penetrated than other major economies. Large IT deals like UID implementation, SAP
implementation in PSU banks and Indian Postal departments are landmark deals which
showcase India’s potential as an end market.
Momentum towards diversifying delivery to China has slowed down
Over the past few years, China has emerged as one of the largest threats and opportunities
for the Indian dominance. In our report dated Sep 6, 2010, Indian IT in no danger of being
‘Dalianed’: Views from over the wall, we assessed China as a long-term opportunity from
the delivery as well as client opportunity side. In our recent meetings, we witnessed a
change in the momentum towards diversifying delivery to China. Despite every company
accepting that they continue to expand operations in China, except Infosys, most
companies reiterated that it will take 3-5 years before scale can be achieved in China and it
becomes prominent on the global map. We were surprised to hear that showcase IT cities
like Dalian are already becoming expensive and supply side balance is becoming
unfavorable. Hence, despite government support on infrastructure and tax incentives,
wage hikes and lack of availability of talent may lead to a slower move to China.
Pure-play BPO business model is becoming dependent on scale and capabilities
As the corporates move towards doing more total outsourcing deals and as the bigger IT
vendors expand their service offerings by including BPO capabilities as well, it will become
more and more difficult for the pure-play BPO companies to justify their business case and
survive at a respectable profitability. Our discussions concluded that only scale and
capabilities will allow the pure-play vendors to co-exist in the BPO space and the likes of
Genpact and EXL Services are benefitting from the same.
Visa concerns have led to a slow but structural shift to more onsite local hiring
Issues and concerns raised over visa applications has clearly resulted in two things :
(1) visa approval time has increased on an average by 50% with more rejections than
witnessed in the past. It signals that the visa application process has become more
stringent on the back of scrutiny on the entire process. Some countries have also started
taking salary as a benchmark to decide the capabilities and the applicable visa for the
employees.
(2) Most of the managements stated that they have increased local onsite hiring in the last
six months. Though they are not facing problems in getting H-1B visas, it's the L-1/L-2 visas
which have become difficult. The fact that cost differential between an H-1B employee and
a local employee is not significant has also led to this structural shift. As we had assessed
in the note dated. May 30, 2011,”Assessing industry impact on the current debate over US
visas”, though the shift to increased hiring looks imminent, it should not structurally
remove the margin advantage of the Indian companies and could impact it by 50-100 bp in
the long term.
Mid-cap companies could continue to struggle except where a niche is developed
With the large companies becoming larger and the smaller companies not having a real
differentiated product, It is becoming difficult for customers to go to Tier- II companies now
and they will do so mostly for more flexibility in contracts or for very specialized services.
Hence, we believe that mid-size companies could struggle to attain greater scale unless
they offer niche capabilities which are not offered by the larger players, who can work with
their scale strength and higher profitability to get deals. Higher margins for Tier 1
companies are more related to the economies of scale, quality of fresher hiring, and
intellectual capital.
Reorganization of business structures has become important with dynamic business
environments – verticalization is the key mantra
As the Indian companies became bigger, it has become an organizational challenge to
handle different verticals, service areas and geographies. Hence, over the last three years,
companies have to resort to some reorganization to remain important. As a common
theme, verticalization has been adopted by various companies. Cognizant was the first one
to restructure themselves into verticals. Most of the other top tier companies have
migrated towards the same model now with Infosys being the latest participant.
Non-linear initiatives gain momentum but real impact still looks 2-3 years away
Larger firms were positive about newer growth areas of Cloud computing, Mobility and
Analytics over the MT to LT. Managements spoke about their investments into developing
solutions, kick-starting pilot projects and the potential to significantly increase non-linear
revenues from these streams. Cloud, mobility and platforms remain the most important
long term growth driver.
NASSCOM (Mr. Som Mittal, President)
1) Industry would grow at mid-teens over the medium term – Indian IT sector should
be able to grow at mid-teens levels over the medium term and may extend the same
growth till 2020 as they continue to grow up the value chain of outsourcing.
2) Supply side shortage is not a concern – India should not have a supply side shortage
in the near to medium term, especially at the entry level. India is producing enough
engineering as well as non-engineering graduates to cater to the mid-teens growth in
the medium term. Only areas where it can face a shortage for sporadic periods of time
is for domain specialists.
3) Visa issue could get resolved soon – They are confident that the visa issue that has
arisen over the past few months could get resolved. NASSCOM has been working with
the US over the visa issue in the recent past. However, they did mention that the visa
issuing process has become more stringent and companies may start looking to
increase local hires too, despite a shortage of local talent in these regions.
4) China is becoming expensive, Dalian is the best example – China as an outsourcing
destination is becoming expensive as the cost arbitrage is reducing due to high
inflation in China. Dalian, which is a showcase IT city in China, is already facing supply
side issues. Hence, over and above the concerns regarding IP, security, language
barriers etc, inflation is unbalancing the dynamics in China.
5) Margin expectations should be reset – NASSCOM president articulated that the
Indian IT companies may have to reset their margin expectations in order to stay
competitive and relevant over the long term. Hence, margin trajectory for some of the
large vendors may structurally come down over a longer term.
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