The Rupee-Dollar Tango
Though there was good news on all fronts, Indian IT services exports industry ended the year with a lot of worry and anxiety, if not gloom because of what many call, not very correctly, the challenge of the rising rupee. It was more of the dollar depreciating against most currencies, though more rapidly against the rupee.

The figures in our calculations do not agree. The annual average of dollar value of rupee that we have taken for calculation that are based on the average of four quarterly average exchange rates taken from sites like xe.com, Rs 45.05 is actually higher than the average exchange rate in FY 06, which was Rs 44.11 for a dollar.

But that was because the dollar was appreciating till mid-2006 and reached a high of more than Rs 46 for a dollar before starting to slide. Initially, the industry shrugged it off by calling it "volatility" but by the end of the year (March 07), it was clear that it was a one-way movement. The dollar was steadily moving southwards.

But it was still around Rs 44 level. Since then, it has slid to Rs 40 levels. That has already affected the margins of many firms like Infosys and Wipro in Q1 FY 08. Infosys guidance says it expects the weakening dollar/stronger rupee would affect its margins in the coming quarters as well.

So far, the favorite derisking strategy of most firms have been to reduce dependence on the US market and look at Europe. But with the rupee becoming stronger against these currencies as well, geographic diversity may not be enough to counter what could well now be a real rise of the rupee.

Industry leaders like Narayana Murthy, of Infosys have called for an increase in productivity. That sounds extremely simple as a solution but a tough one to execute. But then, in the long run, it may be the only sustainable solution. Infosys has already announced a revenue productivity gain of 4% in FY 07.

Dissecting the Market
Services Lines: Almost all offshore services firms started with application development and maintenance (ADM) services, not because it is easier to execute or it is low value work, but because the contracts are shorter as compared to say infrastructure management. In the last three years, almost all firms have consciously tried to bring down their dependence on ADM. The efforts have finally paid off. The ADM revenue of the industry is down to 59%. If that figure still seems high, it is because the smaller firms still have a higher percentage of their revenues coming from ADM. Also, three of the top players Infosys, Wipro and Cognizant have more than half of their revenues coming from ADM.

If the ADM revenue dropped, infrastructure services, almost non-existent three years back, accounted for 5% of the revenue. Engineering services, a non-traditional area, accounts for another 4% of the industrys revenue. Other services include a large chunk of package implementation services like testing, which has of late become an independent service line by itself, embedded software, product development for ISVs and consulting.

Infrastructure services and BPO (which is excluded from our study) are long-term priority areas for almost all companies, small and large, thanks to their high growth potential. Consulting and engineering services are thrust areas only for larger companies and a few specialized companies. Package implementation that recorded impressive growth last year is a short-term, tactical priority.

Geographies: Even before the dollar depreciation started, many Indian firms had identified Europe as a major growth opportunity because of its largely untapped market. Unlike American players, few large European players have scaled up their own offshore activities barring Capgemini. That throws a major opportunity at the Indian vendors.

In FY 07, the top eight services firms (the DQ Top 20 pure play services firms) drew 29% of their revenue from Europe, up from 25% in FY 06.

Verticals: Though BFSI continued to rule, followed by telecom and manufacturing, retailthanks to some large deals in last two yearshas overtaken healthcare to emerge as the fourth largest vertical. Utilities showed marked improvement in the percentage share to become a dominant vertical for Indian IT firms.

Products: This could be a very small but definite trend. Though they are yet to show up in the big radar, products, especially vertical solutions in banking, insurance and telecom, are now being seriously pushed by both small and large firms. Most companies offering these solutions have taken a micro-vertical approach and are creating solutions for areas such as money laundering and Islamic banking. Apart from i-flex, Infosys, TCS and Polaris, smaller companies such as Nucleus, Infrasoft, and CashTech have also made an impact globally through their products. Kale Consultants and Skyteh in Airlines; Tech Mahindra, Aricent, Subex Azure and Aftek in telecom; and Mastek in Insurance, have also made their presence felt.

Looking Beyond IT
The traditional customers for IT companies worldwide have been the CIOs and the IT managers, in charge of enterprise IT. So, the global IT outsourcing market has often been classified under four dominant categoriesADM, infrastructure and managed services, package implementation and system integration, and IT consulting.

Indian IT services firms, however, have gone far beyond that to tap opportunities that have traditionally not been part of enterprise IT. Areas such as embedded software, outsourced product development, engineering services and BPO require the IT services firms to target managers who are used to running profit centers, often being responsible for the companys core function.

It is to the credit of Indian firms that they have not only succeeded in selling these business managers the concepts but have delivered on their promises. It is rarely discussed but about 8-15% of the revenues of top tier Indian IT firms today come from these areas.

Areas like engineering services, BPO, product development and testing are growing faster than the overall business of these firms, meaning their dependence on the enterprise IT spend alone is on the decline. With business consulting also being added to this list, the question is: can we still call it IT services?

Shyamanuja Das
shyamanujad@cybermedia.co.in

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