Software: Benched!

It began quietly, with two events separated in time by a few days, in distance, by a few continents. The first was a letter from a factotum at the Software Technology Parks of India (STPI, pronounced essteepeeai by most Indian software pros) that went out to 2,500 software companies located in the 18 STPS across the country in early March.

There are disturbing reports, which are appearing in the press that there is a slowdown of the American economy and as a consequence American companies are laying off several it professionals. There are also reports to the effect that a few it companies are also shifting their operations from India to countries like China, Malaysia, Singapore, Hong Kong, etc.

The government as such feels that these may be mere speculations by the media and as such there is no truth in them. However, STPI and Ministry of it is very keen that we are not caught unawares if there is slight truth in these reports...

Signed
Software Technology Parks of India
(An autonomous society of the Ministry of Information Technology, Government of India).

The second, which happened a few days after the first, was a call Avinash Singh (not his real name) received from his project manager. Two months back, when Singh, a techie at Infosys' Bangalore HQ, packed his bags and left to work on an assignment in the US, he believed he had made it. There he was, 34 years old, working for the best-known Indian it services company in the world, and headed for the most happening it services market. Singh expected to spend six months in the US, and he was looking forward to getting richer, and not just in terms of experience.

The Ups & Downs

THE THREATS
ť Billing rates could come down
ť Utilisation and salary growth could go south
ť Hiring freeze
ť Shake out in second tier companies and those with weak business models
ť Earnings and profit revisions

THE OPPORTUNITIES
ť More offshore work could come to India
ť Big companies may benefit from the situation
ť Larger client and geographic spread will help companies emerge stronger

The call changed all that: his project, he was told, had been cut short. He would be returning home in April, not July. Worse, when he lands in India, Singh won't be assigned to a project. Instead, he'll linger on as some sort of idle (or excess) capacity. Companies like Infosys call this benching. So in April, Avinash Singh will join the swelling rank of Infoscions who have been benched.

This could well be Indian it's summer of corruption. Tech-campuses across the country, those sprawling habitats of warm bodies scurrying around writing code, are playing host to emotions new to the typical software pro: fear, insecurity, and uncertainty. The symptoms are unmistakable; it's the American (tech) Flu. As companies in the US, tech and non-tech, cut back on their it-expenditure, their suppliers in India may be the ones to feel the pinch. At stake is India's vocalised positioning as the world's preferred it-outsourcing destination; a clutch of ambitious earnings estimates; and the reputation of being the country's most happening sector. And the numbers are depressing: one out of every five engineers in the country's finest it companies could soon have nothing to do; salaries, which grew by between 20 and 30 per cent last year will grow by just 0-5 per cent this year; entry-level intake will decline by 20 per cent (that'll mean nearly 2,500 less jobs across the India's top five software companies); and earnings could dip by between 2 and 13 per cent.

Which could explain why there's a suspicion of uncertainty and a large dash of optimism in the it industry's favoured contrarian theory, that companies in the US seeking to prune tech-spend have no option but to outsource, and what better place to do that from than India. But the fear remains.

Indian it's number #2 spokesperson, Pramod Mahajan, the Minister of Information Technology, mentions, without prompting, to most people he meets that he's heard of the slowdown in the US economy and, in the same breath, dismisses any impact on Indian software service companies. Still, the STPI, which is part of Mahajan's dominion did send that letter out requesting companies for to-the-date information on exports and layoffs.

One Down...

Rajendra Pawar, CEO, NIIT

IIT CEO Rajendra Pawar probably wanted to buffer against a possible harsh reaction from the market when he issued a mid-quarter profit warning on March 7. But the 15 per cent drop in stock price was the slap in the face he got in return from an unforgiving market.

Why should a company that earns only 50 per cent of its revenues from the software business, with a relatively stable education market feeding the other 50 per cent, be the first to bleed, the market seemed to wonder. ''We were hoping to grow US revenues by 50 per cent but it has grown by only 20 per cent,'' Rajendra Pawar, CEO of NIIT, explains.

NIIT's explanation for slower revenues was that two of its US clients had merged, their projects were being consolidated, and, therefore, its cash flow was being disrupted. If nothing else, that was an indication of over-relying on very few customers in a market that allowed the company to add Rs 320 crore (26 per cent) to its revenues during last fiscal.

Expectedly, the stock had to brave the fury of the markets. It was hammered down 15 per cent from Rs 1,180 to Rs 1,003. Over the next few days, severe selling pressure saw the scrip fall to Rs 652 before closing at Rs 865 on March 15, 2001.

''We are hoping for a turnaround in the next two quarters,'' says Pawar. But to keep pace with the market expectations. NIIT will have to milk the education reserves, a cash cow that contributed Rs 611 crore to its topline last year.

Late last year, NIIT had unveiled its 'FastForward' plan, crafted to catapult the education major to a Rs 10,000 crore company by 2006. Surely, an early blow to its plans does not augur well for the ambitious programme.

The essteepeeai's concern isn't uncalled-for. Although the government has had little to do with its success, the software sector, with exports of $6.24 billion in march, 2001, and estimate exports of $50 billion by 2008, is its favourite child. It may be too soon to predict how the slowdown in the US economy will impact the sector, but the signs are ominous. Cisco, Nortel, and Lucent, key customers for India's software notables, are among the companies that have issued earnings warnings. And in mid-March Cisco announced that it was cutting 8,000 jobs.

A trickle down effect on the Indian software services industry seems imminent, although the financial statements and order books of most software companies belie this. Order positions are strong, the third quarter has been good for these companies, and there is logic in the contrarian theory, that the quest for more bang for the buck will lead to more US companies outsourcing their it requirements to India. As Infosys coo, Nandan Nilekani puts it: ''There are indications to suggest that the offshore revenues will increase. Since the Indian it industry is able to offer value.'' Harris Miller, the President of the Information Technology Association of America, the US' version of India's Nasscom, agrees with Nilekani: ''Cost will be an issue and more companies will look at India as an option. I cannot take names but can certainly tell you that more companies are looking to outsource from India.''

That sanguinity could stem from merely looking at the best-case scenario. Which could explain why the equity-research division of Foreign Institutional Investor Credit Lyonnais Securities has announced an earnings downgrade in the it sector. Fine, nothing will happen this quarter; nothing may happen next quarter, too; but things are expected to change after that. Explains Mastek CEO, Ashank Desai: ''The impact will not come immediately. Some impact can be seen one or two quarters later if this slowdown continues.''

That looks a very possible if. A recent survey of the Chief Information Officers of American companies by Merril Lynch threw up the finding that it spending, which grew by 12 per cent in 2000, will grow by 6 per cent this year. The impact, everyone seems to suggest, will first be felt by bodyshoppers, companies with huge onsite businesses or those with some chinks in their business model (like a small client base, a weak client-relationship, or a restricted geographical spread). Explains Hitesh Zaveri, an Analyst with brokerage Prabhudas Lilladher: ''Tier 1 Indian companies may not issue profit warnings, but it will be much tougher for tier 2 companies. You need to be entrenched with a good number of clients in larger projects so that client risk is lower. The ability to execute complex projects is more important today, and larger companies have this.'' But the first victim of American flu is a biggie, NIIT, with a turnover in excess of 1,200 crore. Just about half its revenues come from software services, the rest comes from education, and the company has never hesitated to tell the world that it considers its software-plus-education model far more resilient than any pure play. But in early March, NIIT issued a profit warning. ''Growth didn't meet expectations in one market because a couple of customers had problems in the marketspace,'' is all the company's Chairman Rajendra Pawar will say. Fact is, the company, a relative new entrant in the American space was relying on too few clients.

Things don't look like they will get better any time soon. Goldman Sachs does not expect the NASDAQ (composite index) to move up till after September, 2001; worse, the firm predicts the slowdown in the US will continue till mid-2002. Says Partha Iyengar, India Country Manager of the Gartner Group: ''There will definitely be more profit warnings. And technologies are so intertwined that a slowdown in one area will invariably affect another.''

The first signs of the fever are here. The number of jobless engineers in the US is on the increase. Estimates put the number of people who have lost their jobs in the US in the last three months, at 70,000, and some of this number are Indians working there on h1b visas. The ranks of jobless h1bs in on the increase, and even engineers whose companies haven't laid off anyone yet are frightened to make their annual summer-trip to India for fear that their job may be cut while they're away. ''The number of people approaching us for a job has increased,'' says R. P. Agnihotri, Senior Partner, Mascon Global, a Delhi-based Software Services Company. ''There are hundreds of H1B (visa) holders floating on the streets.'' Seconds Sriram Iyer, Managing Partner of Second Foundation, a US-based internet solutions firm: ''I'd put the average bench strength in Indian companies at 20 per cent, although I know of companies where it has crossed 30 per cent. It would have been higher, but companies are laying off people.'' Iyer may be a little off the mark when it comes to the laying off bit-none of the software service companies BT spoke to would admit to that although the buzz in Bangalore is that Wipro may be cutting 2000 jobs-but his take on the benches is right on target. Infosys' bench is reported to have swelled to 2,500 from normal levels of 700-800. The company denies this, but claims that it is maintaining a 'loose bench' on purpose to cater to an anticipated increase in demand. That's standard industry practice, although it could change now: given the increase in the number of software pros looking for a job companies could well move to just-in-time hiring. The rumours about Wipro may have been fuelled by its huge exposure to the telecom sector that's been worst hit in the US: 31 per cent of its revenues come from this sector, a fact that prompted CLSA to change its recommendation from 'hold' to 'sell'. And six of Wipro's top 10 clients have already issued either profit or earnings warnings.

Business isn't exactly easy to come by either. Capacity-utilisation in most of the second-rung software companies have slipped, in some cases to as low as 60 per cent. Rues Govindarajan V.R., the CEO of the Bangalore-based Aztec Software: ''Six months ago our utilisation was 100 per cent; now it is between 70 and 75 per cent. We added some staff in the hope business would come, but that hasn't happened.''

It hasn't happened yet, but it could. Thus far, none of the large clients who've issued profit or earnings warnings have sought to renegotiate their contracts with their vendors in India, but it's just a matter of time before they get around to doing so. Says Srinath Mukherjee, the Head of consulting firm Arthur D Little's Indian operations: ''Bill(ing) rates will go down. The pressure will be more on companies that have large onsite revenues. I'm certain the profitability of Indian companies will decline.'' Ramalinga Raju, the CEO of Satyam disagrees with Mukherjee: ''The difference (between what Indian companies charge and what others do) is so high, that we have a chance for business.'' That's a fact: the rates charged by the better Indian it service companies for high-end offshore work is between 50 and 90 per cent lower than that charged by competitors in the US.

Still, if the Aztec experience is anything to go by companies can choose between laying people off or chasing low-end work. Chief executives will have to decide whether they wish to maintain the same billing rates, which will lower utilisation-rates, or accept a marginal reduction in gross margins in the quest for volumes. It won't be easy to accept lower rates; not for companies that have just graduated to the premium-pricing model; and certainly not for companies that have been making noises about moving up the value chain. But as Aditya Pant, Head (Research) of IDC says: ''You can't command a premium in a market like this; margins will definitely be under pressure.''

If there's one thing the fever that threatens to rage through India's it industry has done, it is to reacquaint the Indian it industry with its competitive advantage: quality work at affordable rates. Actually, the profit-squeeze, when and if it happens, isn't an indictment of the offshore model most software honchos talk about; it will be a fallout of not moving rapidly enough to that. Onsite work accounted for 51.5 per cent (in the third quarter) of Infosys' 2001, turnover; 52 per cent of Wipro's. And as the number of jobless techies grows in the American market, and as the economic engine sputters, American it service companies will surely slash their billing rates.

The prevailing belief in the tech-firmament is that companies can make up what they lose in terms of billing rates, by upping volumes. Explains Phiroz Vandrevala, Executive V-P, Tata Consultancy Services: ''For every $1 a company can save by letting one person go in the US, he can get two people in India. We will see a big boom in offshore work.'' Initial reports from the US indicate that while there may be new customers wishing to tap India, existing ones aren't exactly looking to increase the level of their outsourcing to India. But there could be trouble if companies decide to restrict their IT-spending to mission critical work, putting everything else on hold. As a report issued by one investment bank warns: ''It is important for investors to thoroughly analyse the possibility of purchases being deferred for a few quarters.''

Salaries that'll increase, if at all, by a fourth or fifth of what they did last year constitute just one part of the story. American Flu-related anxiety could, temporarily if not otherwise, loosen the stranglehold software engineers have over their companies. Mobility is down; a good software professional can still make a switch to another company, but the process won't be as easy as it was before. And horror stories from the US, some real, other apocryphal, continue to percolate down. Like that of Vivek Mehra (name changed) who moved to the US in 1994, set up his own one-man consulting firm two years ago, and serviced clients like AT&T and Merrill Lynch. Now, business is drying up and one of his clients, realising that its more cost-effective to have a reasonably-expensive employee on board, than pay good money to a consultant, has given him an ultimatum: join up or we'll look elsewhere.

Entry-level employees will be the worst hit. Campus talk has it that Infosys, which hired close to 3,500 freshers last year, may hire just about half that number this year. Says NIIT's Pawar: ''It (the lowdown) will have a sobering effect on software developers.''

The silver lining to the touch of grey: the supply situation could improve making it easier for companies to hire people. ''Right now, everyone is dumping unwanted people,'' says Manoranjan Mohapatra, COO, Hughes Software, ''but if things continue to worsen, more good people will become available.''

In the long-term there may well be an increase in the quantum of offshore work companies in the US and elsewhere outsource to India. And as Dewang Mehta, the President of Nasscom and the number #1 spokesperson for the Indian it industry says, ''this is a challenge for Indian companies to tap new companies and new domains.'' In June, Mehta will lead a delegation of Indian software companies on a roadshow in the US. The objective is to get 315 of the Fortune 500 companies currently not sourcing work from India to do so. The mission may succeed, or Indian companies may be able to increase, after quelling competition from tech hothouses in Israel and Ireland, their presence in European markets (Europe accounts for just 23 per cent of Indian software exports). But one thing is certain: things will never be the same again.