DSIJ Mindshare

Where's IT Headed ?

The IT industry is on the cusp of a defining change, with software products and platforms about to take off in a big way, says Krishnakumar Natarajan, Chairman, NASSCOM. Untapped geographies along with emerging technologies are likely to help it along on this growth trajectory. Sagar Lele tells us how the evolving face of technology will make a big difference in the coming years.

The Indian IT industry has been one of the major growth drivers for the Indian economy in the last 20 years, with revenues growing from USD 100 million in 1992 to USD 108 billion in 2012. In this process, garage start-ups became multi-nationals earning billions, India became the offshoring hub with a share of 52 per cent in 2012 in the global offshoring market and domestic companies developed the muscle to battle the likes of Accenture and IBM. Over the years, the industry has grown so big that in FY12, revenues from the sector as a proportion of the national GDP touched an estimated 7.5 per cent. The industry’s share of the total Indian exports came to about 25 per cent in FY12.

In the last five years, the BSE IT index has consistently performed better than the Sensex. Gains on the IT index have always been higher and losses have been lower than those on the Sensex. But lately, the industry has been facing tremendous pressure from global macroeconomic trends. Enterprises have been cutting their technology spend, the environment has not been conducive for ramp-ups and decision-making has been delayed. Moreover, the rupee has been tremendously volatile, causing higher fluctuation in the performance of the Indian IT firms.

There has been a noticeable slowdown in the traditional services provided by IT firms. Demand and pricing have been under pressure, companies have been slowing down in terms of growth and more importantly, their outlook has turned cautious. Agreed that macroeconomic trends have been largely responsible for this, but there is a lot more going on in the industry. Secular changes have been taking place in companies’ offerings, the way they operate and how they deliver. These emerging trends have been forcing companies to restructure the way they function.

Surely, the industry has been going through a process of transition. Now, we have two ways of looking at this. Either we thrash down companies based on our traditional understanding of the dynamics of the sector by terming the so-called underperformers as major laggards, or we look at the opportunity that lies in their strategy  and invest in it to make the most of the next big wave.

Drawing from the latter conclusion (which we think is the way to go), we feel that this not the time to go short on the IT sector by reading too much into the slowdown in traditional serv- ices, but rather to go long based on the potential that the revamped strategies hold out. In accordance with this, we have selected companies that seem to have prospects of delivering value for their customers and eventually for investors in the long-term.
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What Has Changed For Companies?

Services To Solutions

The foremost change in the industry has been in terms of the demand from customers. The IT industry has gradually gained the status of being a relationship-based one. This requires service providers to work closely with their customers towards achieving organisational goals rather than plain offering of services. The mandate has been rather simple – to provide for solutions on an integrated platform and to drive cost-savings. In this process, the clients’ focus has shifted towards a service provider who will have deep domain expertise, a strong onsite presence and most importantly, the ability to provide tailor-made solutions.

So, while in the past, IT firms would have to respond to a request for proposal (RFP) that required the provision of a list of services, the operational model has now changed to understanding the industry and system and working closely with the client towards business success.

Now, it may look like these changes are qualitative and more on the functional side of things. But the larger implications of this change are extensive. Customers are now mov- ing towards a readiness to pay more for these services. The nature of these services being more ‘solution-based’ now allows them to command a high premium.

SMAC-ing The Enterprise Model

There is nothing radically new about SMAC (Social, Mobility, Analytics and Cloud). These have been existent (and highly successful) on the consumer side, and in fact have been rather explosive in disrupting consumer experience over the last few years. However, what’s new is that they have now entered the corporate IT architecture and show the potential to change more than was ever imagined. Through the integration of these technologies, clients are looking at better organisation of processes, efficient allocation of resources, reinvention of knowledge processes and re-shaping the very nature of work.

SMAC is now redeveloping operations by enabling the creation of hyper-intelligent software platforms that can be used across the board, ranging from designing their own intellectual property that consist of various products and platforms to providing  customer service. These emergingtechnology architectures can be leveraged to transform businesses. Not surprisingly, IT firms are increasingly concentrating on building IP assets in each of these areas.

For instance, Airtel chose the Infosys IP solution ‘Finacle Digital Commerce’ as the core of the mobile commerce platform ‘WalletEdge’, which is the largest mobile wallet business platform deployed at Infosys and available to its customers. It supports multi-bank, multi-agency, multi-language and multi-channel access, delivered at a low cost per transaction through a platform model.

Likewise, TCS provides for a service model called iON for Small and Medium Businesses (SMBs) that is based on scalable cloud technology. This eliminates the need for these businesses to invest in IT assets and  retaintechnology talent. It operates on a pay-per-use business model and provides for services like document management, email, CRM (customer relationship management), HR management, payroll and project management systems, etc. It addresses the core industrial vertical needs through a comprehensive ERP (enterprise resource planning) solution. Revenue-wise, how much is TCS targeting from iON by 2015? USD 1 billion!
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New Growth Markets

For years, the US and Europe have been the primary markets for Indian IT firms. Surely, the kind of slowdown these economies have faced lately does not need elucidation. So, companies are now looking at other markets and seeing phenomenal growth rates in these when compared to the traditional markets.

Take TCS’ Q4FY13 earnings for example. Sequential growth in North America was 1.4 per cent, while that in Latin America grew by 9.1 per cent. Growth in UK was -1.9 per cent, while that in Continental Europe was 2.5 per cent. Similarly, in the case of Wipro, while constant currency sequential growth from the Americas and Europe was one per cent and -0.9 per cent respectively, that from India & Middle East and APAC and Other Emerging Markets grew by seven per cent and 4.3 per cent respectively.

Clearly, these markets have been witnessing much higher growth rates than the saturated developed markets which Indian IT firms have been crowding in order to capture larger market shares. But with this trendin place, companies are now moving their concentration and resources to these markets.

Homeward Bound

One major point to note here is the demand from domestic markets. This has been turning out to be a major game-changer in the current IT landscape.

In Q4FY13, TCS, Infosys and Wipro showed sequential growth of 17.2 per cent (in INR terms), 10 per cent and eight per cent (including the Middle Eastbusiness) respectively. These rates are way higher than the overall sequential growth rates. Where is this growth coming from ?

The government has been a major source of business for Indian IT companies. It has been under tremendous pressure for more efficient delivery systems for the provision of various certificates, applications for various schemes, disbursements, etc. “There is going to be an exponential increase in the deployment of applications, digitisation of databases and rolling out of electronic delivery of services. In doing so, technology will be consumed to answer all the key challenges”, says Rajiv Gauba, Additional Secretary, Ministry of Communications and IT, Department of Electronics and Information Technology.

The increasing trend of digitisation in government projects has presented a humongous opportunity for private players, with work ranging from development of front-end delivery systems to systems management. The remarkable points about these contracts are the sheer scale and thus, the potential to gain from volumes. Recent examples of big-ticket projects coming in from the government are Infosys transforming financial services at 150000 post offices in the country as part of the ‘India Post 2012’ modernisation programme and TCS signing a deal with the government for the passport automation project.

A Changing Yardstick

With so many drastic and major changes taking place across the industry, companies are evolving and how. They are fast expanding their offerings, and at the same time are changing their delivery systems. This naturally entails a large amount of qualitative transformation in the operations of the industry. But at the same time, there are massive changes in the financial and operating metrics of the companies. Chiefly responsible for this is the increasing non-linearity in the IT industry.

Projections and forecasts in the case of IT companies are made using the number of billable people multiplied by the dollar per hour rate charged, factoring in the number of billable hours in a particular period. This would be done separately for onsite and offshore revenues and then summed up to arrive at the revenues. Thus, IT companies practice disclosing metrics like total headcount, utilisation, person-months  billed, price realisation, onsite-offshore revenue and employee mix, etc.

Why these metrics are losing relevance is because a higher amount of revenues are being booked under ‘Fixed Price Projects’ than on a ‘Time & Materials’ basis. Moreover, increasing revenues from consulting, infrastructure management and intellectual property have been distorting this linearity to a large extent. Consider this. 69 per cent of Infosys’ revenues in FY08 were reported on a Time & Materials basis. This figure stood at 60 per cent in FY13. Now let’s extend the timeline a little. In FY02, Wipro earned 73 per cent of its revenues on a Time & Materials basis, while in FY13, this stood at 53.6 per cent.

What does this shift imply? Reducing reliance on and relevance of the traditional disclosures made by IT companies! A company may report lower hiring and this may get investors worried. But what if the company has been getting more revenues from the IP-led business, which would require lesser people for more revenues? Or from consulting, which is a high margins business? Or by offering specialised services that command a higher premium?
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This raises an important question. Does it really make sense to go all out to sell a stock that does not show up well within the traditional parameters of evaluation?

The answer to this lies in considering parameters based on a company’s individual pattern of functioning and in companies disclosing more than they do right now. Parameters like order book, execution time frame, quality of employees, revenue productivity per person, attrition levels of senior employees, client mining capacities, YoY growth in terms of IP-led revenues, etc. can be of more relevance in the current situation.

What also plays a major role during such transitional phases is the strategy that the company is adopting. This will define how the company will decide its focus areas, allocate its resources and make the most of the opportunities offered.

It is evident from organisational behaviour and data that companies are trying to cope with changing trends. They are re-aligning themselves to make the most of the opportunities offered by these trends. The potential these hold is large, and optimal strategising will lead to sustainable long-term growth.

The Big Four

Of the big four of the Indian IT (TCS, Infosys, Wipro and HCL Tech), TCS and HCL Tech have been consistently outperforming, while Infosys and Wipro have been having trouble coping. In the last four quarters, the average sequential growth shown by TCS and HCL Tech has been 3.5 per cent and 3.25 per cent respectively, while that of Infosys and Wipro has been 2.3 per cent and 0.8 per cent respectively. All these are big names in the IT industry and have grown manifold in the last few years. So, where’s the difference now?

TCS has embarked on a long-term growth strategy to extend its core IT services business by expanding in terms of geography, industry and services and also deepening existing client relationships, building or acquiring emerging businesses and adopting/creating new business models and business solutions driven by innovation. This comprehensive strategy takes care of broad-based growth on different fronts and also takes into consideration the changing trends in the industry by focusing on emerging businesses, models and the need for deeper client engagement.

It has been building on a non-linear growth model that can enable revenue growth without keeping it directly linked to a proportional increase in headcount. This model is being pursued by TCS by focusing on the initiatives of software products, platform-based BPO services and iON.

HCL Tech had on board a strategy that concentrates on large deals to bring about significant transformation. As application outsourcing became increasingly commoditised and pricing came under significant pressure, HCL Tech transformed itself to concentrate on multi-service deals that moved higher in the value chain. This strategy has been helping the company to increase customer touch points, with the end result being a larger impact on customer costs. It broadly impacts not only the growth of emerging services, but also drives an increase in core software services.

The impact can be seen from its results, wherein growth has been broad-based and across the plate. On a YoY TTM basis, HCL Tech grew by 12.5 per cent. Growth was uniformly distributed across geographies, services and verticals. Such homogeneous growth has been aided by its strategy, which has definitely helped it emerge as a clear outperformer in the industry.

While TCS and HCL Tech have been displaying consistent performance, Infosys has had the markets swinging for a while now. The company’s revenue growth has been inconsistent and the outlook has been rather cautious. In fact, its guidance has been rather bleak as compared to industry standards.
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But Infosys has devised Infosys 3.0, a strategy that would make sense of changing trends and help realise the potential of the enterprise. Through Infosys 3.0, the company plans to scale its core business and rebuild the organisation. What has changed since this strategy was launched 18 months ago?

Infosys has been focused on its core business of IT services and has been trying to tap technological advancements, wherein it launched services like infrastructure testing. It has a consulting-led approach that was aided by the acquisition of Lodestone in September 2012. The company also focuses on products and platforms. In Q4FY13, Infosys had 12 wins (6 products and 6 platforms) across industries and geographies, taking its total clientele to over 75. It now has launched over 20 products and platforms and announced the plan to grow its Product Research and Development Centre over the next two years. It has also recognised the growth potential in emerging markets like India, Ethiopia and Vietnam and plans to scale operations up there.

The strategy definitely seems to be placed in the right direction and execution is visibly progressive. While, the short-term outlook for the company remains gloomy, overall Infosys 3.0 seems to be the solution to its slowed growth story.

To compete with peers and catch up with their growth, Wipro has devised a strategy that would see it focus on new services, strengthen existing services, concentrate on large deals, try and get niche deals, focus on emerging geographies, aid inorganic growth and step on the gas in the BFSI vertical. Moreover, in a bid to further concentrate on its core business, Wipro recently demerged its non-IT businesses and flagged a different entity off that. However, its performance has not been reflecting any improvement so far and the outlook remains negative.
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The Power Of The Small

In the last year, when the IT industry faced multiple headwinds and various factors that caused it to oscillate in terms of perception and performance, a trend that we have seen is that the performance of smaller (smaller than the big four) IT firms in the markets has been exceptionally good. The average returns of the big four over the last 12 months have been 7.16 per cent while those of the other IT companies have been a far superior 20.06 per cent. Have the changes in industry trends put the smaller guys at an advantage as compared to their larger peers?

Industry Focus

Becoming an integral part of an ecosystem is becoming an increasing need as clients look for strategic relationships with IT service providers to work towards achieving goals and targets. In this sort of engagement, clients would prefer their IT partners to bring with them deep expertise in the industry they operate in. IT firms that have led an industry-focused approach have undoubtedly benefited in due course.

Products and solutions in this case are specialised, and thus, much of the performance depends on the quality of solutions and the ability to meet complex demands than on the cyclicality of business.

KPIT Cummins focuses on the verticals of Automotive & Transportation and Manufacturing, and derives 73.82 per cent of its revenues from these industries. Using industry-specific experience and trying to respond to key industry trends, the company brings Engineering and IT services to these verticals.

Similarly, Geometric generates 78.2 per cent of its revenues from the Automotive and Engineering segments. The company enables manufacturers to formulate, implement and execute PLM strategies that ensure efficient product realisation. This enables them to integrate product data across the complete value chain, with effective collaboration across multiple sites, suppliers and vendors. It also provides computer-aided (designing, manufacturing, engineering) solutions, services in software engineering, application management, product engineering, manufacturing engineering, industrial and production engineering and model-based enterprise.

Geometric also supports customers in developing products in the embedded systems area. Its specialised offerings include test automation of automotive infotainment systems, safety-oriented drive assistance systems, etc. This stands clearly apart from traditional IT services, demands deep knowledge and commands a premium. The company thus looks likely to be less affected by cyclical and systemic factors and more by company-specific factors that have more to do with products and services offered. Moreover, Geometric has adopted a strategy that would enable it to focus on the geography of Europe, the vertical of aerospace and the service of embedded systems, which seems promising in terms of prospective growth.
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However, problems of client concentration have affected its performance. The company has been facing lower growth as a fallout of a certain client’s underperformance. Performance is expected to bounce back in FY14 when theclient’s outlook improves.

The Product Trajectory

“Across India today, including the larger players, product revenue would be less than a billion dollars. But clearly in the next eight years, that can increase manifold to become a USD 30-50 billion industry. So, that is clearly one big growth area”, said Krishnakumar Natarajan, Chairman, NASSCOM.

Polaris FT gets a significant amount of revenues from the products business. It has several products, including hubs for payment services, working capital and enterprise risk, workstations for relationship managers and dealers, platforms for core banking, cards, lending, cash and wealth man- agement and cloud services to run banking infrastructure. With a range of products and services catering to the BFSI vertical, Polaris has been able to provide clients with solutions to deal with complex deals. It has also kept itself in sync with changing trends by launching cloud platforms for the banking and insurance sectors. It launched the world’s largest FT Grid, a cloud offering that enables offering financial technology infrastructure and banking products on a pay-per-use model. However, lately it has faced pressure because of flat service revenues, the lumpy nature of product revenues and because of losses on IdenTrust, an acquisition it made in April 2011.

Persistent Systems is a company that has been extensively benefiting from intellectual property (IP) revenues, which doubled over FY13. This has also helped its revenue growth, which came in at a robust 29.4 per cent. Of the company’s total revenues for FY13, IP-led business constituted 17.20 per cent as compared to 8.8 per cent in FY12. The number of its clients in this segment has risen from 76 in Q1FY13 to 418 in Q4FY13.

Persistent’s IP portfolio consists of various products including location infrastructure products for telecom operators, interactive learning platforms, cloud assessment tools, device  monitoring systems, etc. It has adapted to the inclusion of disruptive technologies in their offerings. Today, 40 per cent of its revenues come from the technologies of SMAC, we learnt from an interaction with the company’s COO, Nitin Kulkarni. Persistent plans to continue its focus on the generation of IP and revenues from this front to further boost its growth trajectory.

The Inorganic Growth Slice

Mergers and acquisitions are coming to form an important part of the IT industry. While firms have been re-aligning their strategies and in cases, shifting focus, they are also facing a pressing need to expand. This expansion can be brought about through the acquisition of suitable businesses where such entities match the strategies of the acquiring firms.

The several advantages of inorganic growth include cross-selling of offerings, integration of products, services and customers, expansion in terms of geography, service and vertical presence, access to IP, knowledge base and skill sets and financial leverage, among others. Several companies have been eyeing acquisitions more actively and have been benefiting extensively from these transactions.

A major deal in the IT industry is the recent merger between Tech Mahindra and Mahindra Satyam. This merger is expected to create a robust consolidated entity with revenues of USD 2.4 billion, 75000+ employees, 350+ clients and a presence in 50+ countries. The entity will combine Tech Mahindra’s expertise in mobility and systems integration with Mahindra Satyam’s diverse set of clients, and will allow humongous cross-selling opportunities and upward movement in value proposition.
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Both these companies have been quite active on the transaction front. In FY13, Tech Mahindra acquired a 51 per cent stake in Comviva Technologies, a Bharti Group company that addresses mobile service providers by providing them solutions in the areas of value-added services (VAS), mobile applications, platforms, mobile financial solutions, etc. Since Tech Mahindra derives revenue primarily from technology services provided to clients in the telecommuncations industry, this acquisition has helped the company to leverage its position.

Similarly, Mahindra Satyam acquired a majority stake in Complex IT, one of the largest SAP consulting providers in Brazil. The acquisition would help the company reach out to the enterprise solutions market in Latin America for large manufacturing, financial and consumer service companies.

Of other recent acquisitions that have been perfect fits for the acquirers’ strategies are Infosys’ acquisition of Lodestone, TCS’ acquisition of Alti, Geometric’s acquisition of 3Cap and Persistent’s acquisition of Doyenz’s rCloud and NovaQuest.
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Immigration Hassles: A Temporary Strain

There have been a number of discussions around the new immigration bill unveiled by the ‘gang of eight’ US senators. The bill aims to reform border security, and legalise illegal immigrants and temporary visas. However, the perception has largely been that it is going to negatively impact the Indian IT firms. The key points proposed under the bill and their implications are as follows:

Although the bill seems negative in terms of its impact on Indian IT firms, there are some positives like raising the cap of 65000 H1-B visas to 110000. A very high number of applications recently forced the immigration authorities to resort to a lottery system for the issuance of visas. Moreover, the bill proposes to exempt doctoral degree holders in STEM (science, technology, engineering and mathematics) from annual limits on employment-based immigrants and proposes to allocate 40 per cent of the worldwide level of employment-based visas to holders of a master’s degree or higher in the fields of STEM from an accredited US institution of higher education.

An important thing to remember is that the bill has been introduced in the Senate. It will go through a judiciary committee, then a mark-up committee and then be put up for a vote in the Senate. If passed here, it would go to the House and follow the same process. At all stages, the bill would undergo amendment and would thus go back to both the houses for another round of voting. If passed, it would then go to the President for approval. Point being, the bill is likely to be moulded at every stage in the process and the proposals are likely to change in the process.

The government of India and NASSCOM have been taking efforts to work on this and come to an agreeable consensus that will not hamper the functioning of Indian IT companies abroad. The bill is likely to create an advantage for MNC players against Indian players. An impact is expected on the margins of Indian companies due to these costs and thus on their competitiveness. Overall, the bill seems to be skewed towards a disadvantage for the Indian IT companies at the moment. However, the final impact can only be assessed once the bill passes through the entire process.
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Where To Invest?

Overall, the performance of IT companies has been under pressure lately. The changing trends have created the need for companies to change the way they operate. Amidst this, investors need to carefully analyse the trends in the industry and the strategies and performance of companies to hunt down investment options that are sustainable in the long run. It is important that investment decisions be made considering future prospects.

In a scenario as dynamic as this one but with a potential undermined by many, companies that have the capability to ride on the next wave need to be invested in. The opportunity is big, the underlying currents are visible and strategies are in place. In line with the factors highlighted in the story and the table above, we are bullish over the long term on TCS, Infosys, HCL Tech, Tech Mahindra, Mahindra Satyam, KPIT Cummins, Persistent Systems, NIIT Tech, Geometric and Polaris Financial Technology.

The growth story of the IT industry is far from over. Emerging technologies, geographies and trends have the capacity to drive the industry to new levels, and investors can make the most of it by staying invested in the sector.

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Enormous Potential From Domestic & Export Demand

Dr Ashwini Kumar Sharma

Managing Director
National Institute of Electronics & Information Technology (NIELIT)

The Indian IT industry is expecting to see huge demand growth especially from the government as well as from emerging countries which are seeing an opportunity here. Dr Ashwini Kumar Sharma, Managing Director, National Institute of Electronics & Information Technology (NIELIT) speaks to Amit Bhanot, Sr. Assistant Editor, Dalal Street Investment Journal and talks about the potential that this sector has and the role of NIELIT in furthering IT literacy among the masses.

The government has been emerging as one of the largest technology consumers. How do you see this trend shaping up in the near future?

You are right that the government has been emerging as one of the largest consumers. It is planning to ensure delivery of services to the doorstep of citizens on a transparent, effective and low cost basis, and this is only possible through the use of technology, especially in a country like India. This is evident from the emphasis that the state governments and the Govt. of India is laying on the transfer of subsidies/cash and services to citizens through the use of Information Electronics Communication Technology (IECT). Efforts are also being made to use mobile devices as one of the tools for the delivery of services and transfer of funds. In the process of meeting this target and vision of the government, it is sure that penetration of technology will grow.

How much potential do Indian IT companies have to benefit from domestic demand? Do you see the domestic market grabbing a larger share as compared to the export market for Indian technology firms?

Indian IT companies have enormous potential from domestic demand, being well aware of the customers’ requirements. Along with this, it is also well known that the size of the population and the fact that India is a developing country gives reason for foreign countries to jump into the Indian market. Thus, there is no doubt that Indian companies will benefit from both domestic demand as well as the export market.

According to NASSCOM, the Indian IT industry is poised to become a USD 225 billion industry by 2020. A McKinsey report titled ‘Perspective 2020: Transform Business, Transform India’, says that the exports component of the Indian IT industry is expected to reach USD 175 billion in revenues by 2020.

Over 80 per cent growth is expected from non-traditional sectors such as public sector, media and utilities. In addition, strong demand is expected from emerging countries, which currently account for only 20 per cent of global IT spending. At the same time, the domestic component will contribute USD 50 billion in revenues by 2020. India is truly considered to be a global hub as far as the availability of skilled talent is considered.

How do you plan to meet the challenges with regard to IT literacy in the country?

Bridging the ‘digital divide’ is a concern which NIELIT has endeavoured to address. I am happy to share with you that we have taken a lead in this area through its flagship programmes on IT literacy for the masses. The popularity of its CCC programme (Course on Computer Concepts) can be gauged from the fact that as on date more than 7.5 lakh people have benefited from this programme. In addition to the CCC programme, NIELIT has also introduced the BCC (Basic Course on Computers) with a view to ensure that students from the various vocational trades have a basic proficiency in using computers.

What are your future plans for the expansion of your organisation?

Since its inception, NIELIT, also known as the DOEACC Society, has contributed significantly by way of quality courses in the area of IECT, besides being a trustworthy agency for accreditation of training institutes in the private sector for running non-formal courses.

The Minister for Communications and Information Technology, Shri Kapil Sibal has given us a mandate to transform NIELIT into an Institute of National Importance so that we get autonomy to design and run multiple courses on our own. We are targeting to have 1500 institutes authorised to conduct accredited courses in the country, thus enhancing the number of institutes threefold and coming out with an incentive scheme for more accreditation. The thrust is also on setting up of excellence centres in the fields of Electronics, Cyber Crime, e-Security, etc.

What are the major challenges in the implementation of e-governance projects?

Ownership of the project and expectations management are among the other challenges in the execution of e-governance projects. In any project that is technology based, typically one has to go for technology management, financial management, HR management and legal management. Expectations management is a crucial issue that one has to face, as all citizens are stakeholders and expectations vary from individual to individual.

Also, being a government system, it is difficult to pinpoint who owns the project. It is felt that since it is an IT project, it is the responsibility of the IT person to implement it, whereas in reality, it is more a governance project and IT has a small (though important) role to play.
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Integrated Solutioning: The Way Of The Future

The face of the Indian IT industry is fast changing and NASSCOM is a body that has always acted as a good support system for the industry. Vikram Limsay, Consulting Editor, Dalal Street Investment Journal spoke to Krishnakumar Natarajan, Chairman, NASSCOM about the current state of the industry and its future prospects. Excerpts from the chat.

What is your take on the Indian IT industry in its current form? How important is it to create a brand in this sector?

What I do believe is that the IT market is not a winner-take-all type of a market compared to other markets, say Auto or even Pharma. IT is a very relationship-oriented business.

How do you feel 2013-14 will be for the IT sector from a market perspective?

I believe that when compared with last year, FY14 will be better. What we have observed is that in the last six years starting 2008 when Lehman happened, everyone had certain concerns about what would happen to the financial market and the main street, which led to a sudden compression of demand. This carried on for almost 15 months. But what happened after the compression was like a spring effect. Immediately, the demand took off. In that period, though enterprises had enough cash they restrained investment in technology. So, technology spending certainly slowed down a bit. Compared to that, we are now seeing some part of the spring effect coming back. So essentially, what I feel is that the industry will be better in FY14 as compared to FY13.

For the Indian IT companies, do you think that domestic demand is going to make up a significant percentage of their business starting this year?

I certainly think so. Not only are Indian companies upping their spends, but the overall universe of companies doing so will increase. In fact, last year the export growth was about 10 per cent and domestic growth was marginally higher at 12 per cent. In the next couple of years down the line, the domestic demand will be higher than the export demand.

But most importantly, the big ticket spends are happening through government projects. Case in point being the Department of Post, Revenue Departments, etc.

But are the margins good enough in these government contracts?

Well, the volumes are large and the scope is wide. Over a period of time, these contracts will eventually be very valuable.

And is there a fear of policy paralysis that looms over such spends? Or of any kind of knee jerk change in policy? That doesn’t happen here, correct? Once the decision is taken, it is taken.

No, that does not happen here. In fact, the government is very proactive and all policymakers understand the long-term implications.

And at which level of the IT infrastructure pyramid do you see the spends happening? Software, applications, services?

To my mind, the software-as-a-service (SaaS) model seems very positive. There are interesting start-ups which are coming and saying, ‘do not bother about anything, we will take an integrated solutioning approach’. The whole model is changing.

So, those companies which operate in this domain are future winners?

Oh yes, absolutely !
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Which are the companies that you feel will be benefited by this kind of a model?

There are a number of SaaS companies in India presently, but they do not have scale. What I do believe is that once they futureproof themselves in the Indian context, scaling would be much easier for them. So suddenly you will find a hockey stick for many of these companies. This hockey stick will not only be in terms of users, but also in terms of pricing. In India, they charge Rs 10 and after taking the same technology to Singapore they could charge USD 8. So they make money on the spreads significantly.

Do you think smaller players will have an advantage over the big boys?

You will find many companies getting vertically specialised and reaping benefits. Like even in case of a company like ours, Mindtree, we have a very good story in some very specific verticals and domains like FMCG and CRM etc.

But why is this standard grouse that IT companies don’t operate in the products space? Is that a genuine lament?

Yes, to some extent it is a genuine lament. The typical rhythms of a product company and a service company are very different. In services, the customer tells you what to do. At best, I tell the customers that I have already built something and that I would modify it for them. In case of products, the customer is not telling you anything. You have to imagine what the customer wants and then build it for a multitude of customers. So, you need to have the capability of visualising what a set of diverse customers would want, then bring in the right technology.

The real ability of a product is, you build the right intellectual property and use it many times. That is where the real value comes in. The fact is, products in India are at an early stage but the opportunity is huge.

Even now, do you feel that we are at a nascent stage on the product curve?

Yes, you can say that. We are at a nascent stage. But, you can see a genuine impetus all round. Even at NASSCOM, we have launched a new programme called the ‘10000 Start-ups’. This is actively supported by the government with a vision to have a significant number of tech start-ups in India in the next 10 years.

How does this work? Will the government fund it?

What the government is saying is that you raise some private funds and we will equally fund it. We do have some private companies like Google, Verisign and Microsoft which have pledged to the idea. The government is not directly promising any equity though.

We see significant VC activity in the tech start-up world. Would these companies be eventually accessing the capital markets?

We hope so. In fact, two years ago we did a tie-up with the BSE, which has an SME exchange. We did joint road shows with them. But the fact is that it has still not caught on.
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The question still remains as to why the capital market is not attractive for these guys? Is it because they are looking for huge or unrealistic valuations?

Maybe partially. If you analyse the tech space, you will find that a majority of them have been started by people who have spent some time in Silicon Valley, come back and started off on their own here. For many of them, valuation is a big thing and they tend to get swayed by the US valuations. But each country and its markets have its own characteristics.

Have you spoken to stakeholders in BSE and NSE, someone like Chitra Ramakrishna (the new NSE Chief), about this?

We are taking many approaches – in any knowledge business, beyond a certain point everybody feels that the idea is the key thing, but not all entrepreneurs have the ability to scale up an organisation. So in NASSCOM, we have created an ‘M&A Connect’. At certain stages, we are encouraging companies to come together. Ultimately, the key thing is about creating stakeholder value. You are of course correct in saying that we need to create a lot more capital market activity.

The Indian capital markets are bound to become more inclusive in the future and participation will increase. May be the sector will look at them with renewed interest?

An important point is – though I may not be completely correct on this – it takes time to convince people to believe in these companies. For example, we worked very closely with SIDBI (Small Industries Development Bank of India) to look at an intellectual value-based model differently from a conventional asset-based model. Things are changing.

What are the questions that you feel analysts should really ask or that the stock exchanges should ask in order to understand the sector better?

Within the analyst community, there are some people who are definitely the forward thinking guys and who ask the right questions. When you are running a business, you look at what your revenue productivity per person is and what the growth is. You also look at elements like service line and the corresponding margins. Ultimately, it is about moving towards value-based productivity. You need to keep tracking what technology is doing for your business. That will unravel the real value of technology.

Some companies like Infosys, TCS and Wipro have sensitised people about IT stocks being great buys. It’s just that people don’t understand. Do you think it would be a good idea on NASSCOM’s part to educate investors on that front?

Yes, we will surely try. The fundamental thing is that people need to understand IT as an industry. They need to get the feel of what the industry is about.

The next year is going to see significant government and domestic spends on IT apart from the existing customers spending more. So generally, the scenario looks positive for IT stocks?

Yes, I should think so.

What segments are going to be major growth drivers over the next year for the industry to take off?

Across India today, including the larger players, product revenue would be less than a billion dollars. But clearly in the next eight years, that can increase manifold to become a USD 30-50 billion industry. So, that is clearly one big growth area.

Considering the internet businesses, India has something like 400 million internet users today. This segment is going take off in a big away, ultimately impacting the IT industry.

Do you think the Indian IT companies can make a dent in the Chinese markets? Or is it still restricted?

It is very interesting. From the Indian government’s perspective, the balance of trade with respect to China is negative. This is because of the quantum of imports. Thus, there is a lot of pressure from the government with regard to increasing value-added exports to China – viz. Pharma and IT. So, for a long time, everybody has been trying. I think there is some momentum being seen. A lot of Indian firms have struggled in China. Some companies are now doing well through joint ventures, etc.

What is your view on the developments in US immigration laws with regard to the H1-B visa? Will it really have an impact?

What is strange is that this is actually a trade issue. There is a lot of dialogue going on that you can’t bring a trade issue into immigration. N Chandra (CEO & MD, TCS) is in the US working on this.

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