Understanding the Dynamics
The successes of the MNCs (IBM and HP) in contrast to the Indian companies (barring TCS and Wipro Infotech) in the domestic services market even in FY 07 raised the question: why do most Indian IT services companies (including a giant like Infosys) flinch away from the domestic market? Though sizes of domestic contracts still remained the most plausible reason, making it difficult for Indian companies to sustain lower margins, there were other factors too leading to this dichotomy. After all it would be unfair to expect Indian companies like Infosys in the $4 bn range to obsorb the impact of lower margin the way a $50 bn IBM Global Services could effort to do. After all, IBMs and HPs actively seeking out Indian enterprises following the saturation of the develop market.

Besides, unlike IBM and HP, not too many Indian players are into hardware and software also; that perhaps explains why non of the Indian players barring Wipro are going into these total outsourcing kind of deals. Not that total outsourcing deal like the IBM-Bharti and HP-Bank of India ones are very popular in more mature market; India is perhaps now experiencing what develop markets had few years back.

The way Indian enterprises looked at outsourcing was significantly different from how organizations approached it in the developed markets. If in the West, the motivation was primarily cost saving, in India, the primary motivation was scalehow could companies scale back-office and IT? Also, because of the large software services market in India (so many exports players), it is harder for most enterprises to attract or retain talent. Result: as the Infys and Satyams make a mark globally, even in FY 07, it was the IBMs and HPs, or even an Accenture that dominated domestic IT services. Reverse globalization, or two-way globalization, whatever you might call itIT services has proved to be a great leveler.

That India is yet to become a homogenous market, especially with the maturity level of SMBs and large enterprises still a schism apart, (though many large organizations are as good as their global peers) would be another logical explanation. For SMBs yet to attain puberty either technologically or strategically, the IT services companies need to create an environment encouraging them to outsource, primarily by investing in the market to educate customers. MNCs, because of their experience in developing markets, as well as deeper pockets therefore had an edge over Indian companies when it came to outsourcing by SMBs.

The process expertise gained by these MNCs with their global deals, especially the capability to handle multi-year contracts, also tipped the scale in their favor for large enterprise deals. However, by FY 07, the scenario was changing fast, with even Indian majors like Wipro Infotech or TCS/CMC leveraging their global expertise to attract large domestic customers. Note: TCSs agreement with Tata Teleservices runs for seven years, while Wipros with HDFC Bank runs for ten.

The advantages of multi-year contracts that became mainstream in the domestic IT services market were not far to fathom. Many of the Indian outsourcing contracts prior to FY 07 failed owing to a base erosion taking place over the years. Since most of these used to be annuity-based deals, obsolescence and depreciation within one or two years would make the contracts worthless. The trick was to try to grow and protect the base value of the contract. This was achieved either by associating a profit sharing mechanism (a sort of risk and reward model) like that in the Bharti-IBM deal or by standardizing on a fixed plus variable revenue model, with more emphasis on the fixed component.

The transition from the traditional model of facilities management, where vendors were taking the entire manpower themselves, to the current model of asset stripping, where device-based resources are outsourced, also changed life for most enterprises. IT was now looked at as an operational expenditure and not as capital expenditure in the balance sheet by most corporates. The shift was good news for vendors too since facilities management was getting commoditized and margins were therefore getting squeezed.

Domestic IT Services Revenue Facilities Management 2,506 Managed Services 1,154 Maintenance--Own Systems 1,492 Third Party Maintenance 1,987 Customized Software Development 1,603 Packaged Software Implementation 1,676 Network Integration 6,734 Network Management Services 709 Hosting Services 628 Security Services 221 Total Outsourcing 159 Consulting 2,079
Source: DQ estimates CyberMedia Research
Though network integration, AMCs and facilities management are still the bread and butter for most IT service providers managed services an packaged software implementation have emerged as their caviar

Domestic IT outsourcing in FY 07 thus helped reduce operational costs by turning what was a fixed cost into variables, getting assets off the balance sheet, and freeing up cash for investments. However, both the CIOs and service providers realized during the year that the value of outsourcing could be derived only in long-term contracts, especially those beyond three years. While the dangers of base erosion would probably still remain, service providers would need at least three years so that they can give sufficient inputs for process re-engineering for their customers.

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