Changing Times for IT Services

The last twelve months have been ugly for IT Services stocks. As an industry it was probably the worst performing industry in the Indian stock market. The chart below of Infosys vs. Sensex makes the point better than I can ever describe it.

sensex, infosys
Source: Bloomberg.com

Going by last year’s results for the bigger players, this deep dive was not quite deserved. If you look at revenue growth, sure there was some slowing down in growth from Infosys and Cognizant, but some of it was expected as the companies grow larger.

revenue
Source: Gridstone Research

There doesn’t seem to be anything particularly wrong with margins either. A few basis points here and there don’t make a trend.

opmgn
Source: Gridstone Research

So what does the market see ahead and why is it punishing the shares of these companies so severely? I think they see three fundamental problems with the industry:

  • Slower growth in a maturing industry. It’s harder to grow on a large revenue base. Also, the industry is much more competitive with the global majors ramping up their offshore capability.
  • The coming recession. It’s still not a foregone conclusion, but if there is a recession in the US economy and perhaps globally as well, that’s bad news for the industry. I wrote about this a few weeks back. (link)
  • Pressure on margins due to a hardening rupee and rising wage costs. The majors should be able to get price increases to offset these effects, but competition in a low growth market can create a buyers’ market which could drag everyone’s pricing down.
  • Do the current prices in the market reflect the above correctly? I think it may have overdone it a bit. But the fundamental shifts are real.

    If adversity is ahead for the industry, it should be interesting to see how different companies handle it. Momentum, which is what the entire industry has enjoyed so far, is a funny thing. It creates inertia. When you don’t have to change anything to grow, you sometimes forget how to effect change. That’s what worries me. IBM and Accenture are already undergoing the pain of change. They will emerge strong with a comparable offshore capability and their quiver full of market-side arrows. When it comes time for the Indian players to change, will they have the imagination and the gumption to do it?

    [Since I write often about the IT Services industry and other public companies, I have added a disclosure to my “About me” page.]

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    9 Responses to Changing Times for IT Services

    1. Suvendu says:

      One area of contention is revenue pie covering US market, most of mentioned names are US lenient though some of them are active diversifying to other geographies. FY08 would be truely challenging since analysts would be waiting to see the steps taken by these biggies in showing better revenue reach from other markets vis-a-vis US and also their capability to generate more consulting revenues with innovative services. Apart from Infy, I can’t visualize any other Indian IT giants waking up to this new demand.

      Like

    2. Sanjay Dutt says:

      As a freelance consultant and advisor to start-ups/ small/ mid-size IT/ BPO firms – I see an interesting trend emerging. Each such firm want to be ‘Infy of its own market-space’. Dig a little deeper and you find choices being made that are so very different from any large IT company – including Infy – at is start (or even now). The services are based on:

      * At least some years of struggle and investment in some intllectual property

      * A maturity and ambition for future – despite the odds – that can leave any seasoned industry guy stunned. Global focus, going-IPO in 4-5 years, global talent hiring, deep branding, investment in leadership development, patents, global alliances, strong foothold in Indian domestic market…

      * A focus on ’emotional capital’ of its people – that is unprecedented leaving it with some very dedicated and skilled talent

      Capital and guidance are the only two pieces these future stars hunger for.

      One could argue that all of these are natural choices given the maturity of the industry, no shareholder pressure, scale of operations etc. And I am sure all of these will be true to some extent. But to me what is outstanding is that in the midst of this seeming inertia of ‘return on capital’ – there are these exotic islands for talent and capital emerging.

      One of the greatest contribution this industry still has the potential to do is to keep inspiring as it does. Unfortunately, it seems others are learning from its mistakes faster than it does itself.

      Like

    3. Shashi says:

      Basab,

      How do you compare current tough times (for IT services companies) with the ones post-2001?

      PS: Full-post feed would be much appreciated. Please.

      Like

    4. Basab says:

      Shashi,

      I will refer you to an earlier post of mine here
      https://6ampacific.com/2007/12/09/how-will-it-services-fare-in-the-coming-us-recession/

      Re full post feeds, that’s what it used to be on 6ampacific, until WordPress 2.1 (I am now on WP 2.3). I either have to show the full post on my home page or if I use the –more– tag it will truncate the posts in my feed as well. Given that many of my readers navigate through search or directly to my home page, it doesn’t seem right to have them load a page full of 10 long posts.

      I did some research on this today and I may have a solution – a plug in called Full Text Feed from cavemonkey50.com.

      Like

    5. Shashi says:

      Lack of attention on my part. My bad.

      Thanks for clarification on full-post feed. I guess 10 full posts on home page is not bad considering your blog is pleasantly lightweight.

      Like

    6. Bhabani says:

      Hi Basab,
      I found your blog is quite resourceful but I wonder what ll be the best policy for tiny outsourcing companies having work force around few hundred or even less. As being a small player, I fell the recession still hurts small company also.
      I have few points to be clarified from your side.

      Apart from financial sector other sector like health & banking are in good shape or they are also doing cost cutting.

      What will be the most promising sector in USA at the moment for small outsourcing company?

      Like

    7. Krishna says:

      Markets can pummel a company black and blue even if it performs. It’s got more to do with tightening liquidity conditions affecting investor sentiment than intrinsic fundamentals of any one sector/company. The entire software sector is flying into headwinds now and the recent whipping meted out to both Apple Inc and VMware, despite their strong quarters testifies that.

      That said, the challenges coming from smugness developed over years of sloth and easy money don’t go unnoticed. Now that they have a triple whammy – a weak dollar, rising wages and a worsening market sentiment that drives them southwards.

      As you say the markets may have overdone it. But markets always forebode and factor in adversities early. When the event actually unfolds, it will be too late to recognize change. Taking a cue from the markets, India’s IT vendors had better pick up the slack now. This is what I think they should be doing if they have to outwit foreign vendors (operating from their own backyard) ;

      -Get more stringent with delivery of SLA commitments;
      -Develop domain consulting expertise, commit to deliver on ROI upfront;
      -Embrace advanced technology that helps develop applications with fewer lines of code, reduce dependence on lateral hires;
      -Get real on R&D spends – those figures in the balance sheets now look like mere rounding errors;
      -Develop SaaS capabilities; alternatively innovate enterprise offerings so that they can be delivered at SaaS price levels;
      -Don’t just spray paint innovation; make it a customer experience and see his delight;
      -Use that cash hoard to acquire $$ assets / LOB expertise near-shore, especially since the $$ is weak;
      -Get rid of that 25-30% margin fixation and pass on the benefit to many a battered clients in their time of crisis. They will remember you when the tide turns for the better.

      Like

    8. Ved says:

      Hi Basab,
      I remember in one of your ealier post you had mentioned the difference between US Business Channel and Indian Business Channel. US business channel primarily discussued about fundamentals whereas Indian channel primarily discussed about sentiment.

      I think same thing is at play here otherwise how can you explain such a mad rush for Reliance Power IPO which does not have any power generation capacity at the momemnt or valuation of RNRL, noone knows what exactly they do.

      Like

    9. Just Mohit says:

      Hi Basab,
      The link to your bio (on your “about” page) is broken & takes one to http://www.gridstoneresearch.com/#basab, which is an ad for “Gridstone’s Excel Add-in”. Just thought you might want to correct it. I found the correct link to be http://www.gridstoneresearch.com/company/default/basab-pradhan-chief-executive-officer.html
      Cheers

      Like

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