The year 2001-2002 was the software export industry’s rite of passage from youth to adulthood. A year in which the industry took some knocks, cut some flab, discovered old weaknesses and some new strengths. A tough year—but for all of that, a year of consolidation after a decade of rampant growth

The IT industry has been heavily dependent on US exports. The challenges of last year have made companies realize that broader geographic reach and a wide service portfolio make for a sustainable model in the long run

Dataquest’s annual industry survey isn’t due till July , but according to recently - released Nasscom numbers, software exports grew 21% in what has been one of the toughest economic environments in recent history. The good news—compared to other sectors of the industry, the rest of the economy and the global slowdown, it’s still a very healthy number. The bad news—this is a one-third of the 65% growth the industry witnessed a year before.

As Nasscom president Kiran Karnik said while releasing the report, "The IT industry today has become one of the biggest contributors of Indian exports with its share going up to16.5%. The 29% growth (including IT enabled services) is enviable in view of the 2% growth for the economy." Here, we take a look at what went wrong in FY 2001-02; what went right; what the outlook for the ongoing year is; and finally what, if any, lessons have been learnt from the past year.

Mistakes made yesterday
A lot of what went wrong was external to the industry. The first innocuous portents of a slowdown came in November 2000 when HP reported falling PC sales. This was followed by fourth quarter results of 2001 that showed that in contrast with previous years, the fourth was not the strongest quarter. Till almost August last year however, most companies believed the slowdown was a brief phenomenon that would quickly pass away. And then came September 11.

Says Aztec country head, Chinni Krishna Kommi, "Last year was very tough for the industry as well as Aztec, especially in relation to the previous year. The last quarter of 2001—post September 11—can pretty much be rated as the most difficult quarter in the recent past for the industry." With September 11 also came the realization that all predictions of a ‘V’ curve or ‘W’ curve recovery notwithstanding, the slowdown was in no hurry to go away.

Trends Billing pressure continues A crackdown on flab and layoffs keep profits from falling too heavily  Companies turn to call centers and BPO due to slower growth in core software business. (Infy setting up a separate BPO company, Wipro invests about $10 million in a call centre company called Spectra Mind, MphasiS call center subsidiary MsourcE does far better than MphasiS itself) Financial services continues to be the key vertical Continuing shift away from the US market as exporters explore other geographies more aggressively Business models move more and more toward offshore development, where prices are lower but margins comparatively higher Indian exporters tilt more toward the Fortune 1000 companies—investing time and effort on what could be long-term contracts, as against the smaller West Coast players (as was often the case earlier) Many believe we are at the cusp of Web Services, being the next engine of growth in 2003 Niche players in stable segments—iFlex in banking, for instance—show more stable growth rates Increasing contribution of fixed-price contracts among ‘Top Five’ companies Top five exporters stable, but widely varying growth rates among the smaller players

With the slowdown came greater customer stress on return on investments. Early on, many in the industry believed that greater RoI focus would work well for Indian software exporters who have one of the lowest billing rates in the world. What it resulted in however, was billing pressure and a customer driven shift to offshore development models. Indian software exporters, it turned out, were their own biggest competitors.

By the end of the year, most exporters had seen average billing rates fall between four to 10% quarter on quarter. In Q4 for instance, software revenues for Infosys grew 1.5% compared to Q3. This comprised a volume growth of 6.3% offset by a price decline of 4.8%. As Nandan Nilekani says, "Last year was difficult for both Infosys and the Indian software industry. There is an enhanced interest in the offshore model. However, the sales and ramp-up cycles have elongated, and pricing pressure continues."

There were other irritants. The telecom equipment manufacturers’ industry—earlier a significant vertical for software exporters—went tumbling, forcing many companies to reduce their exposure to this sector. Said Wipro Technologies head Vivek Paul announcing Wipro’s annual results, "There has been a planned ramp down of our exposure to telecom equipment manufacturers. We are now focusing instead on telecom service providers." Among the others hurt by this sector was Hughes Software Systems.

Perhaps the worst hit were venture capital funded dotcoms and startups. A fund squeeze forced many to shut down or scale down operations. Money hadn’t disappeared, it just wasn’t available to them as freely as it had been.

Fewer mouths to feed
The industry has reacted to this on many fronts. The first attempt has been to cut flab and the most visible part of this exercise was the series of layoffs and a substantial clamp down on pay hikes. It was also the most painful part. Software employees, pampered as they were, suddenly found that job security had become a major concern. Job hopping slowed down and attrition rates fell as the job market tightened Pay hikes of 50% disappeared, replaced by far lower hikes quite often linked to company performance. And for the first time, companies struggled with the etiquette issues arising out of firing people in such numbers.

Crawford Beveridge, V-P, Sun Microsystems and its chief human resources officer who was in Bangalore recently said, "I’ve been in the technology industry since 1968. Its not as we’ve not had recessions before. Just none that came on so suddenly. In HR terms, last year was probably the worst we’ve ever seen."

Aside from HR, the upside of this downturn was that ongoing changes in business models were hastened. The quest for non-American markets became that much more important and significant inroads were made in Europe, especially in the United Kingdom, Germany and France. More companies began to look at the Japanese market seriously and there were also some forays into China, notably by Satyam and Zensar. The country’s second largest exporter, Infosys, declared the launch of a China initiative that would most likely begin with the setting up of a development center there late this year. The extremely fragmented Asia-Pacific region, however, still remained elusive as exporters continued to struggle with local languages and rules.

Big ships hold their ground
Most of these were however changes that were set into motion in previous years. There were other more fundamental changes with far reaching consequences that took place in FY 02. One of them was the increasing importance of size and the increasing polarization of industry growth rates. According to Nasscom, the Top 5 players contributed to 55% of the industry growth while the Top 10 players contributed a whopping 73%. This despite the fact that growth rates of most large players fell anywhere from 50% to 75% compared to FY01.

Among the SMEs (small and medium-sized enterprises), growth rates varied wildly. Digital GlobalSoft, mired in the slow lane since its take over by Compaq, clocked a massive 75% growth to touch Rs 342.25 crore. Admittedly, much of it came from the Compaq business alone, which grew 73%. However, for the first time since the takeover, the company’s non-Compaq business grew to Rs 50 crore, its utilization rates increased to 75% and it was among the few companies to actually increase employee staff strength by 25%.

Chennai-based Polaris, on the other hand, saw revenues grow only four percent from Rs 282.5 crore to Rs 293.8 crore while Hyderabad-based VisualSoft’s annual revenues actually fell over 20% while net profit was down by close to 59%.

SMEs move their cheese
In FY 02, large as well as SME exporters began to wean themselves away from the smaller start-ups and venture capital funded dotcoms almost completely. Large software exporters concentrated on the Fortune 1000 companies with far greater growth potential. If sales cycles were to be long anyway, it made sense to invest time and money on a potentially large and stable account than on smaller companies whose future was not entirely certain in this economic climate.

Nasscom president Kiran Karnik says in the report, "Not only is the Indian software and services industry growing quantitatively but qualitatively. We are seeing multi-year contracts coming to India. Further, Indian companies now service nearly 220 global 1000 customers."

Even small and medium exporters who had grown on the back of mushrooming Internet start-ups in the last couple of years decided to move away from that line of business. Says Aztec’s Kommi, "The Internet start-up type of companies spread mostly over the West Coast (of the United States) will take a long time to recover. So we made a major shift in strategy last year and moved our client base from smaller customers to big and medium ones. We’ve now moved offices from the West Coast to the East Coast. Our CEO sits in Boston now."

ITeS steals the show
The really big development however, was the growing importance of IT enabled services even among the large software exporters. In a year when software and services exports grew by a mere 21%, revenues from IT enabled services grew by 73.2% from Rs 4100 crore to Rs 7200 crore. According to Nasscom’s projections, this growth will continue into the next year. It estimates that while software and services growth will remain flat at around 22%, ITeS will grow at around 65%.

It wasn’t entirely surprising then that companies like Infosys and Wipro have begun to eye this sector. Wipro invested $10 million in a company called Spectramind while Infosys recently announced the setting up of a separate company for business process outsourcing. Companies with a foot in both boats have seen the contrast most significantly. MphasiS BFL’s core software and services business grew a little over 8% in FY02 while its call center MsourceE grew nearly 360%. Even accounting for the smaller revenue base of MsourcE, it’s a significant difference. Today, 705 of the company’s 1945 people are employed in the call center division.

Is this an entirely desirable trend however? It certainly has the potential to be the bread and butter of the industry in trying times. But it also has the potential to draw focus away from the industry’s attempts to move up the value chain. Says R Chandra Sekaran, senior VP, Cognizant Technology Solutions, "When a new opportunity surfaces, the magnitude of the opportunity seems very high. ITeS is indeed a good opportunity that has the potential to make India the preferred back-office of the world. But it will be far easier for competitor countries to replicate ITeS and BPO (business process outsourcing) than software services, which is at the higher end of the value chain." Infosys also realizes this.

Bite only what you can chew
There were lessons to be learnt here though. One of the most important – how not to over-hire in times of plenty and then either sack or keep employees on the bench when projects dry up. Another—keep moving up the value chain. Says IBM Global Services India (Exports) director Dr Uday Shukla, "The Indian IT industry has been heavily dependent on the US exports market. The challenges of the last year have made companies realize that broader geographic reach and a wide/diverse service portfolio, including high-end services with commitment to quality and strong R&D make for a more substantial business model in the long run."

There is lower margin for growth in manpower-intensive low-level services and in the long run, it’s the quality of projects and level of work that will drive growth. "Larger companies offering products and services higher up the value chain have a better grip over their market segments and customers. And they are thus less susceptible to market fluctuations and price wars," says Dr Shukla. So what does financial year 2002-2003 look like? Pretty much of the same actually. Continuing billing pressure, more offshore development, more focus on larger customers, continuing attempts to penetrate non-US markets and of course, ITeS.

No one is making predictions of next quarter turnarounds though many believe that things should begin to look up after the end of the year. Nasscom predicts a recovery in the third and fourth quarter of FY 03 and projects that growth in software exports and services will remain flat at 22%. The upside according to it—"We are optimistic of sustaining our growth rate even on a much larger base for next year". According to Arun Kumar, Nasscom chairman and CEO of Hughes Software Systems, "It’s going to be a slow recovery. Things will be challenging for another two quarters, but the worst is now over." Gerhard Watzinger, CEO of Mascot Systems says the company touched bottom in Q4 of last year and he now hopes for a quarter on quarter recovery.

These predictions have been made before. Infosys, which has so far been the fairest judge of things to come, believes that a recovery is not around the corner. At its annual results meeting this April, CEO Nilekani further pushed down Infy growth projections to 19-22% in FY ’03. His projection: "We believe that the outlook for the next 12 months will continue to be challenging."

DQ Report

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