If there is any year which would earn the sobriquet, Year of the Crab, it was fiscal 2005. A clear promotion from the Year of the Tightrope Monkey that was fiscal 2004, when a resolute Indian IT industry dodged barrages of criticism from anti-outsourcer labor unions to H1B visa reductions to an appreciating rupee coupled with taxation issues, not to mention, margins crises. And yet, it clawed higher up the value (and revenue) chain. Fiscal 2005 had all of the above issues to browse through all over again and still have topline profits to show. Again, the software and services industry more than fulfilled expectations on the profits and margins front, and faced the anti-outsourcing brigade in style by adding clients, people and revenues.

Yes, for after the storm came the rain-on the ramp-up and revenue fronts. Among Indian companies, the ones with least pain in FY 2004-05 were those who have major projects with old economy companies like TCS, Wipro, IBM Global Services, HCL, Infosys and Satyam, and companies with niche offerings, like Polaris and i-flex in financial services. Save for some third-quarter hiccups, they helped propel total software exports to Rs 56,000 crore in FY 2004-05-in a Rs 80,000 crore (including ITeS-BPO) export market. Software services exports shot up 40% in FY 2004-05 unlike the marginal growth of just 17% seen last year.

The Top 20 software exporters took off from where they left off last year, putting a distance of over Rs 10,000 crore between FY 2004-05 and FY 2003-04 revenues-a soaring increase of 40% over last year, compared to 28% and 16% in the previous two fiscals. Besides old economy clients mentioned above, their service lines continued to widen. Existing clients brought in at least 80% of the business of the Top 5, and margins were maintained on strong operational efficiencies and well-maintained SG&A (sales, general and administration cost) expensing. A few of them did cut down on compensation spends to keep margins well under control into the fourth quarter of the fiscal.

The Top 5 companies grew at industry rates, at 40%. The Rs 1,000-crore revenue ceiling was smashed all the way down to No 9 on the Top 20 list of companies. The bottom 10 players grew at a clip lower than the Top 5, at 39%.

Raising the Innovation Bar
The ascent of the Top 20 in the last three fiscals has been rapid and steady. More steady than rapid this year, when Top 20 companies maintained their 69% share of total software exports. Not unimpressive, considering that the overall software exports market grew 37%. And, a closer revenue breakup gives a clearer picture. The Top 5 pecked away at the pie to account for 45% of total software exports. This number has been steady from 45% last year, and 42% and 36% in the previous two. The next five companies accounted for 13% of the total export revenues (up from 10% last year, and 9% and 7% in the previous two). The other half of the Top 20-the next 10 companies-again accounted for 11% of software exports.

Manufacturing and R&D continued to be key growth catalysts for Top 5 companies this year, in addition to the traditional mainstays of BFSI and IT/telecom maintenance contracts for the Top 3-TCS, Infosys and Wipro. The sustained value-add on the services side has been in embedded software development, high-end design as well as remote apps maintenance contracts for clients sitting continents away.

Companies ranked sixth to tenth viz, Cognizant, IBM Global Services India (IGSI), Patni Computer Systems, Mahindra British Telecom and i-flex, showed stupendous vertical growth in key areas of telecom and IT services, and segments like government and BFSI. IGSI's growth to about 14,000 employees in FY 2004-05 was matched by a 108% growth in exports revenues and further leverage with key telecom and banking clients.

Customized software development and apps maintenance has not lost its sting on the services front. Besides being the biggest cash cow for Indian IT services vendors for many years now, FY 2004-05 also saw the Top 10 companies pushing in over 60% of their employee bases into this key revenue earner. Banking solutions provider i-flex actually saw 46% of its revenues coming from core customer-oriented tweaking and apps billing for its bestselling banking software.

The upward mobility of IGSI, Cognizant and Perot Systems this year was at Patni's expense. But the good news: fellow 'Mumbaikar' Mastek braved the heat to increase its software exports by 45% and move 3 points up from 20th position last year.

However, the general recovery in mid-2004 did not clearly manifest itself in the number of companies with revenues between Rs 500 crore to
Rs 1000 crore. There were just 8 companies in this bracket this year, as opposed to 10 last year. Four of them-Hexaware, Mastek, L&T Infotech and Siemens Information Systems-were new entrants.

The Agony....
Obviously, it's now a tried-and-tested reality that there is no undermining of the long-term case for investment in Indian technology. The contribution of Indian IT services vendors to global IP has grown hugely. Revenues from this stream have been notable and show the impact that it is making in global IP generation.

The greater integration of IT and BPO contracts seen for the first time last year, has strengthened, best exemplified by Wipro and Infosys. Greater adoption of a global delivery model, with Indian vendors establishing their presence in high-margin segments, with a steady growth in traditional service lines has also been happening in FY 2004-05.

The big headlines of fiscal 2004 had come from the acquisition spree of Indian IT vendors, and the results from these were amply evident in fiscal 2005. The acquisitions will help some of the Top 20 companies to further accelerate their domain competencies and expand services as well as customer reach, in a market which they fear could grow leaner into the third quarter of FY 2005-06.

A big scare of the year was the buffeting which the tech stock took on the Sensex, after TCS, Infosys and some Tier 2 companies like iGate, NIIT and Mphasis reported less-than-expected results. The long-term outlook looks promising on the strength of strong fundamentals, stable people management and the highly experienced top rung of these companies.

Another cloud which soon turned a shade lighter was moves in the US to restrict trade in IT and BPO. The industry put on a brave face to news of a slew of anti-outsourcing laws in the offing-the proposed introduction of more than 112 anti-outsourcing bills across 40 US states-during the first three months of 2005. While state government contracts accounted for about 2% of the total IT work that US outsourced to Indian companies in fiscal 2005, analysts expect this figure to grow further.

The government and industry bodies prepared to address these threats against hi-tech commerce "squarely", for fears of the renewed R&D growth of Indian vendors being stymied are very real. Industry sources say that R&D has the potential to bring in an average of 30% of the revenues for the Top 5 companies by 2007.

At the same time, repeated pleas by the US government to lower barriers for greater market access to US firms and products in high-tech areas were another angle to the issue. Familiar hypocrisy, coupled with even more offshoring contracts from US companies made the day for Indian IT vendors.

The Ecstasy
That's right. The "derisking" strategy to insure Indian IT's fortunes against the anti-offshoring brigade seemed to have finally taken wings in FY 2004-05. The higher margins which clients realized by outsourcing apps, network and database management to datacenters in Bangalore, Mumbai, Pune, and Gurgaon in FY 2004-05 saw total onsite revenues fall from last year's high of 56% to 55%. Onsite revenues skid a few percentage points for the Top 3 vendors. Also, the share of US clients in software exports revenues declined. Infosys saw a 6-point shift in the onsite-offshore mix in FY 2004-05, Wipro saw a 2-point shift with US revenues declining 7% from FY 2003-04. Both companies saw a 7% decline in their US revenues and European revenues creeping marginally upward.

Videoconferencing and remote network management have made it easier for more onsite tasks to be offshored to IT vendors' Indian operations. So, expect the onsite component to diminish further in fiscal 2006. In fact, in FY 2004-05, the Electronic and Computer Software Export Promotion Council (ESC) made clear its intention to further bring down the dependence on the North American market for software exports and to spread it widely to other destinations, including new markets.

While total offshore development revenues in FY 2004-05 increased by 2% to form 45% of total exports, the US share of the pie fell to 65% from 68% in the previous year. The growth areas of 2005 were the Asia-Pacific (Far Eastern countries like Singapore, Hong Kong, Korea) which grew from 3% to 5% of total exports this year, and Rest of the World (areas like Middle East, Africa, Latin America) which touched 6% of export revenues from 2% in 2004.

Composite billing rates per hour did drop mildly in FY 2004-05. With some compromise on rates and reduction of the onsite component, Top 5 companies in FY 2004-05 largely saw fixed-rate contracts-these factors helped maintain stability and served as ample insurance against billing pressures. With sufficient operational efficiencies built into the implementation process, this did work in their overall favor in 2005.

Regardless of things easing on the billing front, it was a mixed year for the Top 10 companies on operating margins (OM). Margins exercised lesser pressure compared to FY 2003-04, but older BFSI customers were obviously unrelenting. Add to that, slower third quarter revenues for TCS and Infosys piled on the tension and had an adverse effect on their overall operating margins (and the Sensex). Both Wipro and HCL prevailed this year on the OM front. Wipro bounced back with a 4.5% OM improvement over last year and HCL increased margins by over 3 points to 18.52%. But TCS dropped from 31.07% to 29.85%, Infosys barely managed to equal its 32.85% operating margins of last year, Satyam fell about 2% over 2004, while i-flex saw margins dropping from 55% to 48%.

Fresh Pastures
Wipro shareholders were a happy lot when the company declared a 1:1 bonus issue, the second in FY 2004-05. For the full year, the basic earnings per share (EPS) for Wipro was Rs 23.4 as against Rs 14.8 in FY 2003-04. Satyam is expected to join the billion-dollar club in FY 2005-06.

Analysts are optimistic of tech stocks recovering on the back of reasonably good corporate performance, and the client-side demand further improving in the Asia-Pacific.

The widening market for IT outsourcing and an evolution toward higher-value IT services is now a reality. IT offshore outsourcing is becoming more generally accepted. Within the financial services sector, the insurance industry will increasingly be using the help of IT services vendors to modernize highly complex processes such as claims processing, rate changes and policy and plan management.

The addressable growth opportunity in FY 2004-05 is clearly expanding in two ways, say industry observers. First, the overall number of financial services companies realizing the value of globally delivered IT services continues to grow, particularly in areas like insurance and capital markets. Second, clients were demanding more complex industry-specific solutions in FY 2004-05. This allowed companies, especially, TCS, Wipro and Infosys with domain expertise to add more value to their clients and offset expected pricing pressures for the IT services industry.

Like last year, BFSI and IT/telecom segments were the top two revenue earners for the Top 10 companies in FY 2004-05. However, manufacturing continued to be a key area for revenue augmentation. Product and embedded software design for the entire spectrum of overseas industry-automobile makers, telecoms, cellphone manufacturers, aviation companies, space agencies, bankers-spurred R&D shares in export revenues to an average of 20%-25% in the Top 4 companies.

Bringing in 19% of TCS' software exports, manufacturing was again the company's second highest revenue earner in fiscal 2005. This year, this 'star' segment brought in 15% of Infosys's export revenues.

And, for government ministries and agencies worldwide faced with an increasingly young workforce being saddled with legacy systems, upgradation and automation will become a greater obligation in 2005-06. Young workers joining public service are often not trained on the older, custom systems that predominate. With governments becoming inclined to outsource upgradation of systems, this factor will be among the great opportunities ahead for vendors out of India.

In fiscal 2005, this opportunity was most exploited by Wipro Technologies, a pioneer in this area. Wipro saw exports to government agencies touching 8% of its software exports revenues.

Unlike the long procurement cycles which most companies exhibit, government agencies in the West have faster procurement times, and hold outsourcers to longer contracts with fixed prices that guard against incurring future unknown costs. Industry sources say that government clients still have fixed billing to guard against currency fluctuations.

Future Shocks?
Besides the much-hated anti-outsourcing bills, two things could change the way governments do contracts: the Sarbanes-Oxley Act and the OMB Circular A-76. While the ramifications of complying with Sarbanes-Oxley provisions, did by its own admission, lead to slower billing cycles for Infosys in the third and final quarters of FY 2004-05, OMB Circular A-76 could stir up things on the bidding side of things in fiscal 2005. The Circular will open the way for extended competitions to win an outsourcing contract with many vendors saying that the cost involved in preparing bids and fighting it out may not be worth the effort.

The Circular, however, was not imposed by most US clients in FY 2004-05. IT vendors point out that some of the larger clients preferred Performance-Based Contracting (PBC) in FY 2004-05, instead of the earlier Request for Proposal or fixed-rate contracts. In a PBC, the vendor develops a solution to achieve the client's stated goal, and doesn't get paid if the required milestones are not reached. The accountability involved here is much higher because the vendor is judged purely on goals met. At least 15% of worldwide government and corporate contracts to India-based IT vendors were performance-based in FY 2004-05, making the achievements of the Top 5 on the margins front all the more creditable.

And, the crux of the issue: the so-called Indian "software coolie" companies-TCS, Infosys, Wipro and Satyam-showed software exports growth of 40% in 2005, in the face of service line diversity and many an adversity. While, many "cutting-edge" companies, including some MNCs, have sunk with huge losses.

All said, human compassion has a bottomline which no "topline" growth can deliver. Another "IT story" of fiscal 2005 was the tsunami of December 26, 2004 as the third quarter closed, which saw the ghastly loss of thousands of lives and the subsequent efforts of the IT industry to emotionally recover, start fundraising efforts and send relief and manpower to the affected regions. A tale as incredible as the comeback from the heartaches of fiscal 2004.

Ravi Menon