As the festivities subside and it is back to business, the New Year has brought along with it a niggling worry for the Indian IT services players. It won?t be just the appreciating rupee that would be in focus this quarter. With a possible slowdown in the US economy and the sub-prime meltdown impacting large banks and global financial institutions, it is the IT budget of the US corporates that is going to be on the radars of the Indian IT services firms, especially the Tier-II companies.
While small and medium firms have put up a brave front and have dismissed concerns over the IT budgets impacting them in a big way, there are definitely reasons for them to be worried. In what is reminiscent of the 2001-2003 downturn, when Indian IT companies maintained that they would not be impacted by any adverse effect on the US economy, this time too they seem to be making the same mistake.
While the US constitutes 66.5% of the total exports of $31.4 billion (fiscal 2007), the banking, financial services and insurance (BFSI) sector is the biggest contributor to this pie for Indian software companies. In a recent report, global investment bank J P Morgan said their checks with the CIOs in large banks and global financial institutions indicate pressure on IT budgets. ?Most CIOs indicated that recent write-downs on back of sub-prime/ credit meltdown in the US have put pressure on budget planning for 2008. While no one was willing to give us an exact estimate of 2008 budget, almost all indicated that there would not be increase in IT budget for 2008,? the report said.
But ask the Indian players and they are quick to brush off these worry lines and point out that any pressure on IT budget would only be good for the offshore business. ?The early indications and from past experiences we are seeing that offshore should get a disproportionate proportion of the IT budgets. Offshore is mainstream now and companies derive value, and the value will drive the decisions. The trend will continue,? Infosys CEO S Gopalakrishnan had told FE in early December.
Cognizant also said that in a survey they conducted, IT decision makers maintained that they didn?t see the offshore pie shrinking.
?Despite the uncertainty in the market about the economic outlook for 2008, 92% of our clients do not expect their overall IT budgets to decline going into 2008. Only 19% of the respondents said that an overall IT budget reduction would meaningfully impact their offshore spending plans in 2008. Outsourcing budget growth is expected to outpace overall IT budget growth in 2008 with 90% of respondents citing continued growth in offshore development spending,? says Cognizant president R Chandrasekaran.
He says the financial services customers also did not expect any reduction in IT budgets. ?About 90% did not expect their IT outsourcing budgets to decline in 2008,? says Chandrasekaran. Cognizant derives 47% revenue from the BFSI and roughly half of that comes from banking, including commercial and investment banking, while the other half comes from insurance, transaction processing and credit card processing companies.
MindTree Consulting CEO Krishnakumar Natarajan also is of the view that the pressure would be more on effective utilization of budgets. ?We anticipate budgets to be at the same level or decrease marginally. Any pressure on the budget is good for offshore services because enterprises want to get more work done at lesser cost,? he says. MindTree that rakes in nearly 65% of its revenues from the US has 20.5% exposure to the banking and financial services and capital markets.
So, what does this mean for the Indian IT? Basically, a negative impact in the short-term. The volumes of small companies will decline in the first half of the next fiscal and pricing would be under pressure.
?CIOs are looking at several direct and indirect ways to cut prices. For offshore players in particular, CIOs indicated that Indian IT players have quite healthy margins and should be willing to take some margin hits (if required),? says the J P Morgan report. Though these CIOs are aware of appreciating rupee, with wage-hike already making a dent in the margins, they are still looking at renegotiating the prices downwards.
?One CIO indicated double-digit price reductions being contemplated. Another indicated reducing number of offshore vendors from 4-5 to 3 and asking vendors to compete on price to decide which 3 to chose, and yet another CIO is looking for price cuts but promising higher volumes. In fact, all CIOs indicated that volumes for offshore players should increase in 2008 over 2007 though there might be a decline in first half of 2008 followed by increase in second half. However, in most cases these higher volumes would come at lower prices,? the report adds.
But Indian IT players constantly maintain that the pricing environment is stable and they have been able to increase the prices or renegotiate prices upwards. Here is what experts have to say. ?Pricing is impacted by overall costs and customers know that the costs in India are going up. So, the environment for pricing is actually favourable,? says Gopalakrishnan. ?The pricing environment is stable,? says Krishnakumar. Adds Chandrasekaran, ?The pricing environment has been in line with our expectations.?
This is what leads to the 2001-03 scenario when the managements were all bullish through 2000 in spite of the fall in share prices and the companies began to see negative impact on their earnings and businesses only in 2001.
Also, companies are now seeing new models in pricing coming up. ?We are seeing outcome-based pricing or pay-per-use models emerge in newer service lines such as infrastructure and BPO services, which lend themselves better to such types of pricing or contracting,? says Chandrasekaran.
With Indian IT companies deriving about two-thirds of their revenues from the US market, it is time for them to start derisking the geographies and addressing other growing markets. ?We have derisked our geography presence by addressing markets like Asia-Pacific (A-Pac) which are fast growing. We are present in growing markets in Europe and A-Pac and this will offset any possible slowdown in the US,? says Krishnankumar. Also, with the appreciating rupee, the companies have started pushing up utilisation of employees and better operational efficiency
?As part of our strategy to offset the impact of the appreciation of the rupee, we are increasing our employee utilization levels, which is lower than our comparable peers. Due to scale economies and heavy over-investment in strategic buffer resources, we are able to successfully further increase our utilization rates during the third quarter to about 65%, up from 61% in Q1,? says Chandrasekaran.
Although the companies remain bullish, maintaining positive outlook and indicating robust pipelines, strong business growth and no project cuts, they also throw in a word of caution.
?Enterprises are planning their approach to spending and it may be too early to judge that discretionary projects may be cut. One message that we hear from the customers is need for better models for maintenance of current applications. Organsiations realize that just cutting discretionary projects would be at the cost of future business and hence the need to optimize on current maintenance spending. Customers are still waiting and watching. A clear position on the budget will emerge only in late January-early February,? says Krishnakumar.
But it is the uncertainty that is more troublesome to the Indian IT firms.
As Gopalakrishnan says: ?If there is a slowdown, companies will learn to manage, if there is no slowdown, things are OK. But the uncertainty delays decisions.?