The new face of IT

With outsourcing on the rebound, the Indian IT and BPO industry is in the midst of an ambitious transformation. Rahul Sachitanand joins the dots.

At Sholinganallur, on Chennai's eastern periphery, one building is quite unlike any other in its vicinity. The latest build out by Wipro doesn't just house hordes of techies writing code for a client halfway across the world.

Instead, this seven floor building is what the soaps-to-software conglomerate calls a "flex" construction, with each level fitted out with its own cafeteria, capable of running 24/7 and completely independent from other floors.

It is not just the building costs that Wipro will amortise over different clients. Inside, it has built out its own technology tools and platforms - such as Wipro BASE for BPO and Net Oxygen Cirrus (the first is a BPO platform and the second a mortgage services platform acquired with its purchase of Gallagher Financial during the peak of the slowdown) - to power its vision for a shared services concept and back its ability to win over customers too. These are early days yet but Wipro says it has some wins already, though it didn't disclose them. No longer does the company want to grow its revenues only by increasing the number of its workers proportionately. "We don't want to double our headcount to double our revenue," says Girish Paranjpe, joint CEO of Wipro's information technology (IT) business.

Some 1,330 km north-west of Chennai, in Mumbai, Asia's biggest software services firm Tata Consultancy Services expects to see its investments in software tools and platforms paying back, too. It expects one-tenth of its sales from what it calls non-linear services - work that yields revenues and profits disproportionately to coders or back office support agents employed.

Chief Executive Natarajan Chandrasekaran says TCS has three different types of software and business process platforms under operation. The first one, called bank-in-abox, was launched for rural and cooperative banks in India and covers some 2,500 branches, charging them as little as 10 paise per transaction in what is increasingly referred to as a pay-per-use model in the industry - a model that lowers costs and processing time. Second, TCS has invested in process or "horizontal" clouds to allow companies to access internal processes such as human resources outsourcing, finance and accounting and procurement online.

This has already attracted some 15-20 companies such as consumer measurement leader Nielsen & Co. Chandrasekaran expects many more to climb aboard as the profitability of this model is proven. Finally, TCS is also building technology to deliver solutions to specific industries such as financial services, manufacturing and telecom.

"We will target large enterprises with these applications, but we also have invested in a cloud application for small businesses, which already has 75 clients and we expect this to expand to a few thousand clients in three years," says Chandrasekaran.

As companies big and small across the world begin to relook at their IT spending, they are pushing vendors - almost all with big operating bases in India - such as Wipro and TCS, as also the foreign-owned ones like IBM and Accenture, to be more flexible in their contracts, shifting from payment models centred around upfront, capital spending to operating expenditure, and devise IT models that allow for more on-demand usage.

For an industry used to working on a linear business model, where additional revenue dollars came through more bodies at work, these kind of developments mark a distinct new phase in the $60 billion IT and business process outsourcing industry. As global tech spending begins to grow - three per cent in 2010, according to research firm Gartner - outsourcers aren't just going back to business as usual. Instead, they're looking to germinate new models of business that mark a sea change from the body-shopping roots of the industry that at last count employed 2.3 million and accounted for 6 per cent of the GDP.

The new normal
While the ride seemed like it would never end, the financial services-led slowdown taught the industry some cruel lessons. As the US and eventually the rest of the world were caught by the recession, companies across the board cancelled or postponed contracts, bruising the infotech industry badly - bellwether Infosys declared its first year of zero growth, others such as Wipro put hiring and promotions on a freeze. The industry, which was growing at 30 per cent annually, suddenly came to grips with expansion just over single digits and was forced to introspect and begin the slow, painful, but inevitable process of re-invention.

After a bruising couple of years, as the IT industry gets slowly back to its feet, the new moves may pay off, analysts say. Brokerage IIFL's Sandeep Mathangi feels top Indian companies are stronger than earlier.

"EBITDA margins of the top three vendors have expanded by 150-450 basis points (bps) over the past two years, and we expect them to increase by up to 150 bps over 2010-12," he wrote recently. EBITDA is a measure of operating profits and short for earnings before interest, depreciation, tax and amortisation, and a basis point is one-hundredth of a percentage point.

This improvement, he explains, will be driven by a glut of manpower, which will keep salary costs under control and better profits as their customers step up discretionary IT spends. "Infosys has grown sequentially by over five per cent in volumes the preceding three quarters and the doubts over strong growth seem to be evaporating," says Infosys Technologies CEO and MD Kris Gopalakrishnan. "The offshore model is evolving and large Indian companies are developing full service capabilities."

In other words, Indian IT companies are moving away from their main business in application development and maintenance (ADM) to higher value businesses such as core R&D outsourcing, IT consulting and what is called total outsourcing (from tech to BPO support). The share of ADM in the revenues of top companies has shrunk by between 15 per cent and 30 per cent in the past five years. This together with worldwide enterprise IT spending expanding nearly three per cent this year and expected to top $2.4 trillion, as estimated by Gartner, spells good news for the Indian tech industry - which accounts for some 60 per cent of all offshored tech spending.

"The offshore services market has come roaring back," says Partha Iyengar, VP and Distinguished Analyst at the research firm. But "the recession has forced companies to change their business models". The emerging importance of cloud computing, which has applications hosted on remote servers and accessed through the Internet, as Infosys's Gopalakrishnan points out as an example. "We risk losing big contracts from not changing our business model quickly."

So, rather than have a 1,000-strong team manage a business software - say, SAP - application for 10 hours a day, Indian IT companies are offering 24/7 coverage at shared services centres, with add-ons such as predictive reporting - telling a manager in advance when his servers could crash - as an added incentive.

Iyengar believes Indian companies could win a quarter of such new businesses as companies move to cloud-based models. Other forces are in play, as well. For one, companies which aggressively outsource tech and support work such as Microsoft, Wells Fargo and JP Morgan are all looking afresh at their outsourcing list - clamping down on the number of vendors they work with. So, Indian outfits are increasingly faced with requests for proposals from clients offering bigger contracts to fewer vendors who are chosen for scale and domain expertise.

TCS, Cognizant and HCLTechnologies have gained from this, not so much the others. Then, India's position as the preferred destination for outsourced IT and business processes has come under sustained fire, with the Philippines hacking away at its dominance in voice-based BPO services and a fastgrowing China adding heft overnight to threaten India's dominance in IT.

Protectionist measures - the United States has doubled fees for certain visas used by tech companies and some states such as Ohio have banned offshoring their work to India - are adding to the nervousness of Indian tech companies. The continued softness in Europe is only adding to their troubles keeping the concentration of business - especially, new wins - firmly in North America.

There are other factors companies are fighting, too. Infosys, for instance, has been struggling to make do with higher prices in contracts to offset rising costs over the past few years. Multiple salary hikes over the past seven years shaved off 8.5 percentage points from Infosys's gross margins, but price hikes could make for just 1.4 percentage points at the EBITDA level notes IIFL in a note. Other analysts say both Wipro and Infosys are also behind on investing in front end sales, marketing and consulting staff (Wipro's sales and marketing expense actually declined last year) and that allowed rivals such as Cognizant Technology Solutions (See The Disruptors) to make noticeable gains in key markets such as financial services.

Despite all such churn, Indian IT is on a definite but measured path to transformation. From being purely India-based providers, companies are firmly on the path to widen their global presence. From being experts in only a select few industries such as financial services and manufacturing, they are entering and expanding into new industries such as government, health care and utilities. From being just providers of outsourced software services, they are becoming end-to-end providers of software services, BPO and consulting services.

Infosys is targeting one-third of its business from what it calls transformative IT deals that will help clients change even fundamentals of their businesses.

The Bangalore company has opened a new subsidiary in the US to get business from public sector clients, until now a preserve of the large American giants such as IBM, Accenture and EDS. It is also expanding to newer markets such as health care. "The traditional markets have become been more comfortable with outsourcing and offshoring , while many of these emerging sectors are yet grappling with these concepts," says Gopalakrishnan. With the global tech and BPO sourcing market predicted to treble to $1.5 trillion in the next 10 years and, importantly, new technologies and business models taking root, the Indian IT landscape could present a different picture soon.