I.T.'s turning point?

There are signs of foreign firms increasing their presence in an increasingly concentrated information technology sector.

TIMES are hard for the world economy, particularly the United States economy. This should make the period difficult for any industry that depends on global markets, especially the U.S. market, for much of its demand.

This, unfortunately, is true of Indias information technology (I.T.) industry, dominated by exports of software and IT-enabled services (ITeS). Yet there are signs of cautious optimism among some industry insiders and observers based on the premise that the cost-cutting encouraged by slow global and U.S. growth will increase outsourcing to low-cost locations such as India, which would be good for growth even if not necessarily for margins.

It is too early to empirically confirm this speculation, but the evidence permits some initial judgments. In July every year, Dataquest releases its data on the performance of the top 200 I.T. firms in India the previous financial year. The information, unlike that of NASSCOM, covers the whole of the I.T. sector, including hardware, software, software services and ITeS. It also provides detailed information on the top 20 firms in the composite industry.

This data set, especially more information on the ways in which data are collated in the case of firms whose performance indicators and financial accounts are not easily available in the public domain, leaves much to be desired. But with almost all the data on the Indian I.T. industry being collated by private organisations such as NASSCOM, MAIT, Dataquest and IDC India, this information, which covers both the hardware and software segments, has been an important basis for analysing industry trends in the country.

As yet, we have access only to the first round of data released by Dataquest (July 15), focussing on the top 20 firms in the industry, in the export sector and in the domestic market. The information on the top 20 is an adequate basis for analysing industry trends, not only because they account for an overwhelming share of the revenues of the top 200 (64 per cent in 2007-08) but also because these are the most dynamic firms and have remained industry leaders for a long time. The top 20 list includes industry veterans such as Tata Consultancy Services (TCS), WIPRO and Infosys, which epitomise Indias I.T. success.

On the surface, there is a sameness about the trends the data on the top 20 reveal. The top firms in the industry continue to grow at a scorching pace, with the trend rate of growth until 2007-08 amounting to 34 per cent per annum whether we take 1991-92 or 2001-02 as the base year to make our calculations. Services firms dominate the industry in terms of number and revenues, with 95 of the top 200 companies engaged in services delivery and another 20 in the production and sale of software products. And export revenues still constitute the mainstay of the industry, with the revenues of the top 20 exporters (at Rs.1,02,451 crore) far exceeding those of the top 20 revenue earners in the domestic market (Rs.74,843 crore).

These perennial positives notwithstanding, there is some cause for caution. With the U.S. remaining Indias principal market, the growth slowdown in that country together with the long-run depreciation of the dollar (despite fluctuations) has begun to tell on export performance. The top 20 exporters from the industry recorded a growth in export revenues of 30 per cent in 2007-08 as compared with 45 per cent in the previous year.

Since the growth of revenues of the top 20 firms catering to the domestic market was also slightly lower at 27 per cent in 2007-08 as compared with 31 per cent in the previous year, the performance of the top 20 firms in the industry was disappointing. Top 20 revenues rose by just 23 per cent in 2007-08 as compared with 42 per cent in 2006-07, pointing to the beginnings of a slowdown that could last for a long time. This could be the first sign that the software and ITeS boom is losing momentum.

This slowdown has been concealed by two factors. First, there have been individual companies that have recorded remarkably high rates of growth of revenues, albeit from small bases in the case of some. Thus, 13 of the top 200 companies covered by Dataquest registered triple-digit growth rates in 2007-08. Second, there have been a few companies that managed to expand their net revenues significantly in the financial year gone by. These trends have conveyed the impression that despite being dependent on the U.S. market, the Indian industry is decoupled from a growth slowdown in the U.S. market because the deceleration in growth is more than neutralised by enhanced outsourcing by firms in a recessionary environment.

The slowdown in growth is not the only new, even if disconcerting, aspect of the figures for the last financial year. The numbers released thus far by Dataquest point to a consolidation of certain trends in the industry that have some troubling long-term implications. The first of these trends is a tendency towards increased concentration of revenues generated by firms in the industry. The top 200 firms account for an overwhelming share of the industry.

In 2005-06, for example, the revenues of the top 200 firms were placed at about 85 per cent of the total industry revenues. What is noticeable is the growing concentration within the top 200 segment. If we take the group of firms constituting the top 200, the top 20 firms (or 10 per cent of the number) accounted for 63 per cent of the revenues of the top 200. The next 30 (15 per cent) accounted for a near proportional 17 per cent of the revenues. And the remaining 150 (or 75 per cent in numerical terms) contributed just 20 per cent of the revenues.

Consolidation and concentration are part of the industrys maturity. Underlying this concentration is a change in the nature of the firms that constitute the top 20 in the industry as a whole. Increasingly, firms with foreign parents populate the top 20 league tables. While 67 of the top 200 firms are foreign companies, 13 of the top 20 are known international companies. This is indeed a relatively new tendency. The number was as low as three out of the top 20 ten years ago and seven at the beginning of this decade.

What is interesting to note is the differential distribution of foreign companies among the top exporters and top suppliers to the domestic market. While 12 of the top 20 exporters of I.T. products and services from India are Indian firms, only four of the top 20 revenue earners in the domestic market are Indian. It has been known that foreign companies have been displacing Indian firms as major exporters, especially with the growth of the captive outsourcing facilities of foreign firms in the country. But this process has not yet displaced Indian companies such as TCS, Infosys, Wipro and Satyam, service providers that remain the top exporters.

The situation is different in the domestic market. Over the past two decades, an increasingly liberal hardware and software import regime and a liberal policy with regard to foreign presence in the domestic hardware and software market has substantially increased the foreign share in these markets. This did not matter when the size of the domestic market was small in both absolute terms and relative to export revenues. However, as the diffusion in the use of I.T. increases, this unusual distribution of target markets between foreign and Indian firms can become significant.

What is noteworthy is that as the use of I.T. in business and in government increases rapidly, with a limited effort to shift away from proprietary to open source software, the presence of international software product suppliers in the Indian market is increasing rapidly. At a time when the diffusion in the use of I.T. in the country is increasing rapidly, foreign firms have displaced domestic firms in the domestic market at a much faster rate.

At first this was predominantly in the hardware segments where a liberalised import regime and substantially lowered tariffs helped international firms out-compete not just Indian brands but the huge assembled personal computer industry in the country. But, more recently, software presence is becoming important. For example, two global software majors Microsoft and SAP registered revenue growth of 29 and 104 per cent respectively in the domestic market in 2007-08.

The emerging picture is clear. Even while Indias scorching pace of I.T. services export growth slows, there are signs that foreign firms are increasing their presence in an increasingly concentrated I.T. sector. This has two implications.

First, I.T. export revenues are increasingly being garnered by foreign firms. But more importantly, as the domestic market for I.T. hardware and software grows, fuelled by increased government expenditure aimed at increasing I.T. use, foreign firms are coming to dominate the rapidly growing domestic market for both hardware and software. This would mean that slowing revenue and employment growth would be accompanied by a shift in the net foreign exchange earned by the I.T. sector, even leading, perhaps, to a net outflow sometime in the foreseeable future.

Indias software and ITeS industry was seen as different from much else of modern business in India because it was a high-growth sector driven by huge net foreign exchange earnings. It was pampered with tax concessions for this reason, and the concessions that were to end in 2009 have now been extended to 2010. But more recent evidence shows that as the industry grows to maturity, the features that made it unique are losing their significance.