Is the Indian IT Services party over? Is a decade of growth and wealth creation coming to an end? And if that is so, what can we read in the tea leaves.
There are three fundamental reasons why the IT Services industry finds itself in a challenging environment. One, the dollar-rupee rate. Two, wage growth. And three, slower revenue growth.
The dollar is now under Rs. 40 to a dollar. That is a huge movement within a short time span. However, the effect of this, while significant, is perhaps a little less than you might imagine. For an IT Services firm, the wage costs directly attributable to projects that are rupee denominated are typically less than those that are denominated in US$ or EUR. This is because while the offshore effort might be 70%, the wages onsite are much higher. As the dollar gets cheaper, revenue from US clients shrinks, but so does the project costs that are onsite as well as the largely onsite Sales and Marketing costs.
The other thing that mitigates impact of the weaker dollar is that Europe is a large and faster growing share of revenues for most large firms. And the Euro has not depreciated as much.
Nevertheless, a weakening dollar is bad news, and it isn’t expected to improve anytime soon.
Wage growth is another long-term secular trend. This trend is now no longer linked to the growth of the IT Services industry. Domestic demand for talent across industries is also contributing to spiraling wages now. This is good news for Indian graduates and IT workers, but it squeezes margins unless you can pass on the cost increases to clients.
In the past few years revenue growth hasn’t slowed down much for the IT majors, in spite of dire predictions from some analysts. But it may be different now. There is the law of large numbers of course – i.e. it is much harder to grow by 30% on a $4B revenue base than it was on a $1B revenue base. But I believe that there is ample opportunity for growth in the markets. This is a huge industry ($400B by some estimates) even if you don’t include BPO in it. While a US slow-down or recession may be a thing to worry about in the short-term, outsourcing is a long-term trend that is alive and kicking. So I don’t think the market opportunity will put the brakes on growth.
However, on the delivery side, the story could be different. The law of large numbers applies to recruitment and availability of talent. Within delivery the complexity levels can climb rather quickly beyond a point. Trying to do larger and larger projects with less and less experience isn’t fun. And it doesn’t scale well.
So what should an IT Services company do in this environment?
- Diversify – Look at your portfolio of services. You might think that you have a well-diversified set of services, but if you have to hire engineers for all services, unfortunately they are all exposed to the same employment market issues. Look at services where you can hire graduates and make it work. Also, BPO is not one service line. There is a large variety in the kinds of services, markets, and talent required, that all fall under the grab bag called BPO. If you paint the entire BPO opportunity with the same brush “Oh, we don’t want to do call-center stuff” you are doing your company a disservice.
- Look for growth outside the US – This is tough. The US is the largest IT market by far and the most accepting of outsourcing. But Europe is getting there. And the cost advantage is greater in Europe. I hear there are companies who have single-mindedly focused on Japan for years and are finally seeing the light at the end of the tunnel.
- Specialize – Vanilla services are dime a dozen. If you are a big player, it might still work. But if you are below $1B, you’ll keep losing deals unless you have something to offer that they don’t. We recently contracted someone in Ukraine just based upon a reference because they were specialists in SugarCRM. Emerging technology areas like Open Source products offer good opportunities for specialization.
- Build IP – If you want your bill rates to go up, you need to build IP. If you want to differentiate yourself you have to build IP. If you want to excite talented people who work in your company you have to build IP. If you want to…you get the point.
- Invest in Sales and Marketing – Only those companies will be able to pass on rising costs to clients who provide value and have account control. If you don’t have the salesforce that can build trusting relationships with clients, its time to start investing in it.
- Cash in – If you don’t have scale and you don’t have or don’t want to do any of the above – sell the company. You’ll still get a nice multiple today and save yourself a lot of trouble. You’ve built something of value. Maybe its future is better served as part of a larger enterprise.