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FEB. 11, 2007
 Cover Story
 BT Special
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Taxing Times
The phase-out of central sales tax is yet another move towards ushering in the national goods and services tax (GST). The compensation to the states, in lieu of CST phase-out, will include revenue proceeds from 33 services currently being taxed by the Centre as well as 44 new services of an intra-state nature that will be traded by the states. However, VAT is the way forward, though much needs to be done to iron out the anomalies in the current VAT regime.

India, Ahoy!
Indian investments overseas are growing and how. For instance, total Indian investment in Latin America and the Caribbean has topped $3 billion (Rs 13,500 crore) so far. The latest investment is by ONGC Videsh, which acquired an oilfield in Colombia for $425 million (Rs 1,912.5 crore). Earlier, ONGC bought an offshore oilfield in Brazil for $410 million (Rs 1,845 crore).
More Net Specials
Business Today,  January 28, 2007
Reinventing Indian IT
Sure, their revenues and profits are still surging, but Indian IT vendors have realised that their linear business model-more code jocks is equal to more revenues-is under threat. Result: They are reinventing themselves before it's too late.
Techies at work: Worryingly, productivity per employee is declining. But baby steps to reinvention has begun
It's a rather windy January morning in Bangalore, with a slight nip in the air. But inside the glass-and-chrome Corporate Block's J.R.D. Tata Auditorium, on Infosys Technologies' manicured campus on the city's outskirts, it's all smiles and sunshine as Nandan Mohan Nilekani, the company's 51-year-old CEO & MD, takes centrestage to enact what has become the most awaited quarterly spectacle in the it industry: Announcement of the tech giant's quarterly results. Once again-as for almost 16 quarters since the tech winter of 2002-Nilekani is wearing a broad smile. It has been yet another stellar quarter. Infosys has clocked 45 per cent growth in revenue in the October-December quarter compared to the same period the previous year. The bottom line has performed even better; it has surged a staggering 51.5 per cent to Rs 983 crore. And things look so good, Nilekani says, that the company is revising full-year guidance upwards-it will hit the $3-billion (Rs 13,500-crore) mark in revenues come end of March this year, and if it continues at the same pace of growth by April 2009, it will be $6-billion (Rs 27,000-crore) big.

HCL Tech: It believes that the top IT companies offer more or less the same proposition. Hence, a differentiated strategy is vital. Shiv Nadar/ Chairman & CEO
A couple of days later in Mumbai, the usually phlegmatic CEO and MD of India's largest it company, Tata Consultancy Services (TCS), Subramanian Ramadorai, 62, is all smiles too, as he announces his company's quarterly numbers. TCS becomes the first Indian it company to hit the billion-dollar revenue mark in a single quarter. Its revenues for the third quarter are up 41 per cent and net profit by 45 per cent. Back in Bangalore, the third company that completes the ruling triumvirate of Indian it, Wipro, announces equally spectacular results: Revenues are up 45 per cent and the bottom line, 41 per cent.

As is evident, things couldn't be better with Indian it. According to Nasscom, the industry lobby, Indian it exports (including it-enabled services, ITEs) will touch $29.4 billion (Rs 1,32,300 crore)-a 26 per cent growth over 2005-06. And if this trend continues, the industry may well rake in $60 billion (Rs 2,70,000 crore) by 2010-a number considered very ambitious when a Nasscom-McKinsey report first talked about it in 2005. "Barring a geo-political seismic shock or totally unforeseen event, the Indian it industry will coast comfortably at close to 30 per cent growth rates for the next three years at least," declares Sudip Nandy, Chief Strategy Office, Wipro.

10 things Indian IT vendors need to do to improve revenues and profits per employee.
Focus on Consulting: Derive greater portion of income from Consulting, which generates higher margins. At present Tier-I Indian companies derive anywhere between 5-8 per cent of their revenues from consulting.

Target Specific Verticals: Grow verticals like IMS, SI and Retail which are not just revenue but margin accretive as opposed to verticals like testing and ADM.

Offer Productised Services: Offer productised services in the areas of say web security or hosting. Doing so spreads development costs over a number of customers.

Build Frameworks: These could be easily customisable off- the-shelf packages, which ensure that one need not reinvent the wheel again and again.

Develop Layered Applications: Piggyback on enterprise software sellers like a SAP, Oracle, Microsoft to develop add-ons and value-added applications.

Think Service-oriented Architecture: Wherever possible opt for SoA as opposed to object oriented architecture, as this enables one not to be tied to a particular technology. However, customers must agree to it.

Invest in Innovation: Move away from commodity play. Create IP. Generate licensing revenues that will add to the top line year after year.

Move from offshore to 'bestshore': Recognise that India does not have a monopoly on talent. Explore other low-cost destinations like China, Vietnam, and East Europe.

Go ToS: Win more of the Total Outsourcing Solutions contracts, where margins can be better controlled.

Invest in Training: It is a people's business at the end of the day. So upgrade the skillsets of your employees and also invest in enlarging the talent pool itself.

So, why is Business Today hell-bent on playing spoilsport by talking about a need to reinvent Indian it? Because, impressive as the numbers are (the industry's compounded annual growth rate for the last five years works out to 26 per cent), they don't tell the whole story. Look at the bar charts on the previous spread and this one. They tell you a story: Of how the Tier-I players have been unable to delink revenue from headcount-revenues go up in proportion to the number of software engineers added. More worryingly, productivity, as measured by revenue and net profit per employee, has been declining-yes, declining-over the last five years for all the Tier-I companies. For instance, Wipro's revenue per employee has dropped from Rs 36.28 lakh to Rs 19.95 lakh and net profit from Rs 9.20 lakh to Rs 3.88 lakh in that period. In the case of Infosys, per-employee revenues have dropped from Rs 24.25 lakh to Rs 18.06 lakh, and earnings from Rs 7.52 lakh to Rs 4.66 lakh (See Revenues and Headcount...).

WIPRO: The tech giant has developed frameworks for verticals that are easily customisable, off-the-shelf packages. Azim Premji/ Chairman & CEO
INFOSYS: It has invested more than Rs 90 crore to jump-start its consulting arm, which will give it access to senior client executives. Nandan Nilekani/CEO & MD
Sure, the surge in headcount is partly due to an aggressive ramp up of BPO business at most Tier-I companies, but, still, the problem with this sort of growth is obvious: One, it is inefficient and, two, should a downturn occur, the impact will be worse, since not only will it mean loss of productivity due to 'benching' but actually a loss, since the salaries would still need to be paid. There's a third problem with this model: It assumes that the supply of cheap and skilled labour is endless. But as the IT companies are already discovering, that is far from the case. A country of a billion-plus people does not translate into annual supply of 500,000, 200,000 or even 100,000 highly-skilled software engineers.

A Risky Game

Alarm bells in the industry have been ringing for about two years now, starting with a Nasscom-McKinsey study projecting a shortfall of 500,000 knowledge workers by 2010. With the industry growing at a pace faster than originally predicted, the shortfall-in view of the new demand projections-has widened. Says T. V. Mohandas Pai, Director and Head (HR) of Infosys: "Getting business is not the biggest challenge. Attracting and retaining talent is." Also, unlike in the past, Indian it industry for the first time has had to compete for the best talent with other sectors like telecom and retail, which have been experiencing explosive growth.

Siddharth 'Sid' Pai, a partner and head of the Indian operations at TPI, a sourcing advisory solutions company, echoes Pai's concerns. Being a consultant who plays the matchmaker between global companies wanting to outsource it and Indian vendors, Pai gets to keep a finger on the industry pulse. And he believes that India's it majors should start worrying. "Indian it companies started life as body shoppers (literally, hiring out 'techno coolies'), evolved into the much celebrated Global Delivery Model, but will now have to reinvent themselves," he says. To support his argument, Pai points to one practical problem the IT biggies are likely to run into: of having to manage a workforce of more than 100,000 in the near future. "There will come a tipping point-though nobody knows when exactly-when handling scale itself will become an issue," notes Pai. "The time for Indian it companies to reinvent is now, when everything is going well."

How do the global it giants such as IBM and Accenture manage their vast workforce (IBM Global Services employs 190,000 people and Accenture 133,000)? Presumably, with great difficulty and skill. But there's an important difference between them and their Indian competitors. Their workforce is far more productive and profitable. Wipro's Nandy points out that the earnings before interest and tax (EBIT) per employee is in the low-to-mid $20,000 (Rs 9 lakh). "In contrast, the EBIT per employee for TCS, Wipro and Infosys ranges from $10,000 to $12,000 (Rs 4.5-5.4 lakh). We need to get this right," he says.

Vineet Nayar, President of HCL Technolgies, agrees that things need to be improved. He says that there is very little to differentiate the top 10-20 Indian it companies, since every one has some sort of CMM level 5 certification and thousands of employees doing the same cost-based work. While that may have been a source of advantage some years ago, it is no longer the case. Why? Because the global it giants-IBM, Accenture, EDs, CapGemini, and Perot Systems-themselves have set up back offices in India. As a result, a large chunk of the outsourced it market has become commoditised, especially after the advent of concepts such as service-oriented architecture and software as a service. In fact, the process of application development itself has become highly automated. "Indian companies will have to evolve a differentiated strategy to stay competitive in this market," says Nayar.

Vendors spend a fortune every year on skilling and re-skilling their techies.
Infosys' Mysore Institute: A monument to its people
Infosys spends a whopping $145 million (Rs 652.5 crore) a year on training its fresh recruits and upgrading the skills of existing employees, according to Mohan Das Pai, HR head of the company. Satyam's CFO Srinivas Vadlamani says his company will be spending $80 million (Rs 360 crore) in the current year on employee training. Ditto TCS, Wipro, Tech Mahindra and HCL.

Why does training need such eye-popping budgets? One reason is the ever-changing technology environment, which means companies need to keep making on-going investments in upgrading the skills of their employees and keeping them up to date. More important is the second reason, which Infosys Chairman N.R. Narayana Murthy pointed to recently when he said that "about 75 per cent of India's 4 lakh-plus engineers are unemployable."

Such is the crisis that companies are being forced to look beyond engineers to meet their manpower requirements. TCS, for instance, has hired science graduates, who will be put through an eight-month intensive training before they are put to work. Pai of Infosys says that because of inadequacies in the education system companies are being forced to foot the bill of manpower training.

A Nasscom-McKinsey report has indicated that the country would suffer from a shortage of 5 lakh knowledge workers by 2010. With the IT industry hiring more than a lakh of people this year alone, companies will be faced with ever mounting training bills, unless flaws in the education system are addressed. While most of the IT companies are working with universities and colleges to rectify this, they are scared of the bureaucratic maze within the education system, not to mention the various lobbies within it.

Some of them are, therefore, looking at alternate models to mitigate the manpower shortage. Says Sudip Nandy, Chief Strategy Officer of Wipro: "As global proponents of outsourcing, we have to examine whether Indian IT companies can look at outsourcing their own training." NIIT already offers a customised training package in association with ICICI Bank for entry-level jobs in the financial services industry. This is how it works: Anyone who meets certain criterion can sign up for the training and upon completion, apply for a job in the industry (currently, only ICICI Bank). "What this also does," says Nandy, "is to transfer the burden of training cost from the company to the prospective employee. This is a good model and I think all of us will have to seriously examine it."

The Game Changes

TCS: India's biggest, this vendor has productised some of its service offerings, allowing it to customise them at no great extra effort or cost
S. Ramadorai/ CEO & MD
It is evident that Indian players recognise the need to change and, in fact, have taken some steps towards moving to, what could be called, Ver. 3.0 (if body shopping can be considered Ver. 1.0 and the global delivery model, Ver. 2.0). At the Tier-I companies, this reinvention goes under different names. Infosys calls it GDM Plus, TCS has named it GNDM (where N stands for Network), while Wipro's Nandy calls it GDM II. In a research paper to be published shortly, Senior Analyst and Country Head of Forrester Research (India), Sudin Apte, argues that Tier-I players have already recognised this need and are embracing innovative concepts such as solution accelerators and agile development to grow without adding pro rata bodies and costs (See Indian IT is Fast Polarising).

One way to reduce the linearity between revenue and employee numbers as well as to increase revenue and profit per employee will be to grow high-margin areas of the business like consulting. Kris Goplakrishnan, President and coo of Infosys says, "This is precisely why we invested $20 million (Rs 90 crore) to jump-start our consulting arm; we needed to get the ear of CXO-level executives." Deepak Khosla, Senior VP of Patni, says that the CXO relationships are important because Indian players will have to transform themselves from being good low-cost executors of projects to business advisors, and this role requires access to the C-Suite. This requires a change in both skill-set and mindset of employees, err..., consultants. That would also enable them to bill clients on outcomes rather than cost savings. Three years after devoting serious attention to growing their consulting practices, the Tier-I vendors have tasted some success-5-8 per cent of their revenues now come from consulting.

Srinivas Vadlamani, CFO of Hyderabad-based Satyam Computer Services, says that Indian players will have to additionally look at growing key verticals such as IMS (Infrastructure Management Services), SI (System Integration), extended engineering solutions or outsourced R&D. "Areas like testing and ADM (Application Development and Maintenance) will remain fast growing verticals, but most of those are commodity play with little room to dramatically improve margins," he says.

Indian IT Is Fast Polarising

By now it has become a routine: come quarterly results season and the IT bellwethers-Tata Consultancy Services, Infosys and Wipro-wow the industry watchers with superlative numbers in terms of revenue growth and profitability. All's well, happy investors say, with the Indian offshore model. If only they cared to look closely enough, they would find a different story. Let me delineate the important threads of the changing story, as I see it:

Indian IT industry is polarising fast: The large Indian IT firms-especially the top three firms with revenues hovering around $3-4 billion each-continue to grow profitably amidst rising MNC competition, ever increasing attrition and complexity of deals. They have been growing at over 35 per cent, consistently performing better than the industry average. In contrast, an analysis of the next 15-18 players (firms with around a billion dollars in revenue and smaller) reveals a different picture. These players-unable to differentiate, and beaten by scalability and volume pricing of big Indian players-are struggling to match the pace of large players. The gap between the top three and the rest is widening with every passing quarter. In addition, entrenched MNCs such as IBM and Accenture make 'India advantage' a commodity that is no longer the prerogative of Indian firms. A majority of firms in this size range recorded, on an average, 20 per cent revenue increase. Further, comparison of their growth and their inability to add enough new clients show that not only they got fewer orders, but got less profitable business as well. Average profitability of these 15-18 firms is half that of the top three, and some of them have a very thin line dividing profit and loss.

What is accelerating this polarisation? The common answer is scale, but that's not the only reason. I believe it's their strategic initiatives that separate the top three from the rest.

Scale allows investments to build sophistication: Top firms such as TCS and Infosys have emerged as multi-line, multi-domain firms. Many of the service lines of Tier-I are bigger than the overall size of most Tier-II and 3 firms. Size offers the top players advantages such as low-cost, tiering of skills, bench affordability, and ability to handle large projects vis-à-vis Tier-II and Tier-III. They are also able to invest enough in building excellence and domain expertise. Also, when deals get bigger and clients consolidate vendor base, mid-size firms are the ones that get dropped.

Cost and Quality are a given. What's next? Offshore companies today are facing a fundamental challenge with their business model as their traditional and unique differentiator-low costs and quality-is getting eroded with multinational services firms establishing themselves in India. An already-squeezed human resource market is falling short of growth demands, increasing staffing costs and attrition. The challenge is to remain competitive. The top Indian firms have begun taking some steps in that direction.

Can you grow without adding pro rata bodies and costs? The most significant initiative is about non-linear growth. The Tier-Is are building and embracing innovative concepts such as solution accelerators and agile development, helping them de-link revenue growth from sheer addition to the workforce. Infosys, which leads the pack on this front, generates around 7-8 per cent of its revenue from such initiatives. Wipro is working on improving productivity-per-resource and deploying low-cost, non-engineering resources.

Other important initiatives include investments in account management and sales force refurbishing. As services lines get broader, deals become bigger and geographically spread, things such as age-old sales models, body shop mentality of lower ranks, programmers-turned-marketers are falling short of client demands and new competition. Superior process and quality back-end need an equally strong front-end-like Infosys' sales force efforts and TCS' training and revamped sales processes to improve its field face. Besides, the Tier-I players are investing in internal management tools-tools dealing with building skill management, dashboards, and client visibility, to name a few. One rarely sees any substantial efforts once you go beyond the top few.

So don't be surprised if you soon find small and mid-sized players, barring those that have already carved a niche for themselves, either selling out or turning into niche, specialised players for survival.

Sudin Apte is Sr. Analyst & Country Head (India), Forrester Research

Automating Low End

How do you beat the billing pressure in low-end commodity work? By letting software, and not your valuable software engineer, do most of the work. It's called productising your service offerings, but does not necessarily mean a shrink-wrapped product like the Microsoft Vista. Explains N. Chandrasekaran, Executive Vice President and Head of Global Sales & Operations, TCS: "There are three layers: technology, functional and customisable layers. Some of our offerings in the financial services space have been productised, where only the customisable layer is tweaked and the rest is in the form of a product." Wipro also has similar productised services in several areas, including web security and hosting (See The Value Boosters).

In fact, some consultants would have the Tier-I players take greater risk-invest in creating intellectual property (IP). "If you look at IBM, Accenture and hp, a significant portion of their revenues comes from licensing and royalty. Indian it firms have to create their own intellectual property so they can get recurring income from a one-time investment," says S. Sabyasachi, Research Director of NeoIT, a strategic advisory firm. Interestingly enough, that's already happening. Gopalakrishnan of Infosys points out that his company has already made 100 patent filings of which 20 have received preliminary approvals. Wipro, too, has created extensive IP, especially in VLSI design and outsourced R&D, which are its areas of strength.

Finally, Indian vendors may have to look outside of India for talent. So far, offshore has largely meant India, but, as Wipro's Nandy points out, no one country has a monopoly on software talent. "We have to move from offshore to 'bestshore'. Explore talent in countries like China, the Philippines, Malaysia and East Europe," he says. It seems Indian IT's Ver. 3.0 may not be too long in coming. Satyam Computer, for instance, already has a new mantra that sums up the industry challenge: 'Beyond Engineers, Beyond India'.
additional reporting by Rahul Sachitanand