11 March: At a Lehman Brothers' Annual Global Software and IT Services Conference, Harry You, CFO at global consulting major Accenture, declares his firm will fight "toe-to-toe on a cost basis" with Indian technology vendors.

Mid-March: US research firm American Technology Research promptly puts out a report saying that Accenture plans to displace Indian IT service providers from North American and European corporate accounts. The analyst goes on to describe the Accenture stock a "better value" than shares of publicly traded Indian technology services companies.

10 April: Infosys announces its numbers for the fourth quarter and the year ended March 31, 2003. Margins are under pressure, and the guidance for the following year is sober.

17 April: Wipro's report card isn't better; profits are down 6 per cent for the year.

MARGINAL THINKING IT biggies' margins have come under attack like never before.

Nandan Nilekani/ Infosys: Infy's net margins skid to 26.44 per cent from 31.03 per cent in 2002 Vivek Paul/Wipro Wipro's marketing spend was seven times its 2002 figure at Rs 550.6 crore The Indian infotech majors, who have been living it up with net margins (net profit as a percentage of sales) of 30 per cent-plus, have now got to start learning to live with a sobering reality. That such chunky margins are history, as is amply evident in the report cards of the IT sector's bellwethers, Infosys and Wipro, for the year ended 31 March 2003. Whilst Infosys' net margins are down to 26.44 per cent from 31.03 per cent in 2002, Wipro's have slipped 4.81 percentage points to 20.17 per cent (although that number is for the whole firm and not just the IT services arm). Industry experts expect the IT services sector's margins to dip to around 20 per cent, a plunge from the 27 per cent levels of 2001. "There are pricing pressures. Which industry can operate on a 30 percent margin? Over the next two years margins should settle at 22-25 per cent which is reasonable," shrugs Phiroz Vandrewala, Executive Vice President, TCS. One major contributor to the dip in margins is the surge in 'marketing and selling' expenditure. Infosys spent Rs 266.98 crore on marketing in the year just concluded, up 106 per cent from the previous year's Rs 129.79 crore. Wipro's splurge was even higher, almost seven times the 2002 spend of Rs 80.57 crore, at Rs 550.60 crore. That's a surefire indication of the cut-throat competition and the pricing pressures. And don't forget the global nature of the competition. "MNCs that have set up shop here will improve their margins (which are currently single-digit globally) while those of Indian vendors will dip," says Vijay Khare, Senior Vice President, Patni Computer Systems. If you think the industry leaders are having a rough time, spare a thought for the tier-two players, who struggling to keep their top line in ship shape. Mastek's sales for the fourth quarter have plunged 19 per cent over 2002's corresponding period, and margins sunk under 20 per cent in the March ended quarter. The shakeout begins...

You could blame it on the recession in the US, or the war in Iraq, or even the sars virus in the Far East, but the chronology of events between March and April reveals one of the more ominous reasons for the squeeze in margins being faced by India's IT services giants: The aggressive competition from the multinational IT bandwagon. Over the years, a host of MNCs has hammered the pegs of their tents firmly into local shores, the objective clearly being to leverage the similar low-cost, high-quality advantage the homegrown firms enjoy. The early birds IBM Global Services, Oracle, EDs, CSC and Cognizant have now been joined by other IT consulting giants like Gap Gemini Ernst & Young, Sapient, Keane, and Accenture.

If you think Accenture's unbridled aggression directed at Indian IT services firms is an isolated case, check out what one leading industry player has to say, strictly on condition of anonymity. "One of the reasons for the industry leader's lower earnings guidance for the year ahead is that an MNC vendor has actually offered clients with whom the Indian company has fixed-price one-year contracts the same services at prices 12 per cent lower." V. Srinivasan, MD and CEO, ICICI Infotech, confirms the trend of pressure on pricing. "There are some cases where the clients actually want to renegotiate the contract mid-way itself; they are not even willing to wait till the end of the contract."

The MNCs for their part have their own very good reasons for stepping on the gas in India. Their gung-ho expansion plans come in the wake of a global consolidation, which resulted in IBM's acquisition of PricewaterhouseCoopers consulting business and Cap Gemini taking over Ernst & Young's consulting business. Thus, they're now able to provide end-to-end services (right from it services to strategy consulting), and that's what clients are naturally expecting. With the MNCs willing to match or even go below prices being offered by Indian vendors, there are those clients who feel they're getting much more value from the global majors for the same price they would otherwise be paying the Indian IT services players.

"IT outsourcing is getting more and more strategic to the end customer and it's the CEO rather than the CIO who is getting increasingly involved. Consequently, the demand is for end-to-end services. The CEO doesn't care what programmes the IT vendor specialises in, he is more concerned with strategic and cost implications. So we have to go to him with a complete and cost effective offering" explains Amitabh Ray, Director (Exports) at IBM Global Services. Adds Salil Parekh, coo (Asia-Pacific), Cap Gemini Ernst & Young: "Pricing is always going to be an issue in this market but we are banking on the fact that our clients see our processes and methods as superior to those followed by Indian vendors. And it's available at the same price.''

If the perception still exists that the MNCs will be charging more than their Indian counterparts, Amit Govil, Managing Director, Sapient India, dispels that myth. ''We cannot price ourselves any higher than our Indian competitors just because of our brand name. We're going to have to compete head-on by offering value at competitive prices,'' he says.

Staging A Fightback

The Indian vendors may be hurting, but they're fighting back with strategies that range from broadening their service offerings, to tapping new markets and market segments with products, to more ambitious and far-reaching strategies like acquisitions to beef up their front-ends. Companies like i-flex are banking on niche offerings and domain expertise as well as the "made by India" brand, as CEO Deepak Ghaisas puts it. Others like ICICI Infotech plan to move away from the "cost-arbitrage model to products and intellectual property rights," says Srinivasan, in addition to tapping markets like the Middle and Far East. Patni Computer Systems Senior Vice President Vijay Khare points out that Indian vendors should start focussing on verticals, and areas like BPO, infrastructure management, and real-time embedded systems.

The biggest challenge for the Indian sector, however, is to create a marketing face-that vital front end-to compete with the MNC competition whose stronghold is the consulting space. Whilst the task for the domestic industry is to integrate forward, the MNCs have to focus on building a back-end. And both sectors are doing just that. Wipro, for instance, recently acquired the utility division of consulting firm AMS in the US. And Keane picked up SignalTree, a US-based Indian vendor with development centres in India. The IT and consulting sector is clearly going through a mammoth consolidation phase, the aim being to put together an efficient end-to-end service offering.

So what's going to be tougher-integrating forward or backward? "Both are tough, but I would say that the integration of a back-end is the tougher of the two since the delivery model has to be perfected," says Lakshmi Narayanan, President and Chief Operating Officer, Cognizant Technology Solutions, a US-based company that has a completely Indian back-end. Companies like Accenture, IBMGs and Sapient, however, are banking on their global delivery resources model, which includes several thousands of professionals across countries.

As the war between homegrown IT vendors and the MNCs plays out, investment bankers, who are expecting a wave of accelerated deal-making in the near term, are licking their chops. Munesh Khanna, Managing Director, nm Rothschild & Sons India, says the results posted by the tech majors have already resulted in valuations plummeting across the sector. "What happened last fortnight (to Infosys and Wipro) will be a trigger for mergers and acquisitions. Second-tier companies that have been holding out will have to take a call now. As for the majors like Infosys, Wipro, Satyam and Patni, they should be looking at cross-border acquisitions if they want to sustain their growth rates." What won't make it easier for the second-rung IT services companies is the war for talent, which can only succeed in pushing up their wage costs up, by as much as 15-20 per cent. Clearly, only the more cost-effective, and the more integrated, will last the long haul in this highly-competitive landscape.