While we were happy to escape New England winter, we couldn’t help feeling that maybe we brought some of that Arctic air with us to India. Nearly everyone said Mumbai has been experiencing its coldest winter in 46 years. Temperatures have dropped as low as 46 to 47 degrees (8 to 9 degrees Celsius), some 20 degrees (10 degrees Celsius) colder than normal. We have been more fortunate, though. As of 6 p.m., the current temperature is 82 degrees, down three degrees from the high. Tonight’s low will be near 67. The unpredictable chill seems to be an apt analogy for the Indian software and services market. After the weather, the next most popular subject was the state of the U.S. economy and its possible effect on India. The Indian IT software and services market last experienced a downturn at the start of this decade, thanks to the fall in the global economy and the end of Y2K projects. During an interview with CNBC-India in October 2001, then chairman of Infosys N.R. Narayana Murthy said of the market’s uncertainty, “There is so much fog on the windshield, and I don't think anyone has a crystal ball.” When I saw an abridged version of that quote in the morning newspaper, I was tempted to title this, “The 2008 NASSCOM Diaries: Ice on the Windshield.” While far more dramatic than “more fog” and more reflective of the recent chilly nights, I don’t think we will see a sharp downturn this year. That’s not to say there aren’t risks, starting with the United States. United States, financial services account for 61.4%, 40.4% of the export market We sent four people to Mumbai to attend NASSCOM’s India Leadership Forum 2008, the annual meeting of India’s top software and services firms. This year’s event drew nearly 1,900 participants from all corners of the globe. While this was only my second time at the event, this is the fifth year that AMR Research has attended the conference. While the industry is about to close another strong fiscal year, much of the talk at NASSCOM has been about the potential impact of a recession or slowdown in IT spending in the United States. According to the latest NASSCOM Strategic Review 2008 distributed at the conference, the United States accounts for 61.4% of the market. While this is down a few percentage points from last year, it could be true that when the United States sneezes, India catches a cold. Local Indian newspapers are already warning of lost business or smaller deals for companies selling to banks, credit card issuers, and mortgage firms. Likewise, if any segment of the global financial services market stopped or slowed spending on IT services and business process outsourcing (BPO), it would have a devastating effect. NASSCOM’s study shows that banking, financial services, and insurance represent 40.4% of a $31.4B export market. The fear is that a slowdown in this sector could also pull down spending in high tech and telecom, which represents the second largest vertical and 19.1% of the market. No one we talked to has seen any slowdown in spending or postponed or cancelled projects. The general mood seems to be cautious optimism, with the largest firms confident that a slowdown will have more of an impact on the second-tier firms. Some companies are concerned, though, that they have allowed too much of the business to come from the United States. They are looking to hedge their exposure with new investments in Europe and Asia. Others, like HCL, are continuously creating new services (more on this in a future update). Potential exposure: engineering services Can spending stop? I saw NASSCOM’s Gaurav Singh in the hallway and asked him about his members’ perspectives on the market. He said that there was more concern three months ago. We then discussed the percent of 2008 revenue that might be assured thanks to long-term contracts. Without having the data at his fingertips, he offered his best guess that half to two-thirds of all BPO spending and at least 40% of outsourced-related IT services are locked into multiyear deals. There may be some risk of softness in the $6.3B product engineering market, as third-party spending here may be more discretionary. While usually associated with computer hardware and telecommunications, India has become an extended R&D lab for everything from semiconductors to airplane and automotive parts to medical devices, biotech, and pharmaceuticals. This diversity should provide added protection against a downturn. Rupee appreciation, higher wages, skills shortage may be the bigger risks The rupee has appreciated 12% against the dollar over the past 12 months. One newspaper noted that, for the months of April through December, the rupee was up 8.6% compared to less than 1% the same three quarters in 2006. The impact is felt immediately on the bottom line. The same paper quoted Infosys’ CFO as saying that every 1% fall in the dollar resulted in a 0.5% cut in profitability. At the same time, Indian newspapers were reporting that wages paid by Tata Consultancy Services, Infosys, Wipro, and Satyam are expected to rise 7% to 8% this year. While this is down from 15% to 20% hikes last year, it still hurts margins, especially when paired with the strong rupee. Whether you call it a skills shortage or a “lack of employable talent” (see this week’s Quote of the Week), NASSCOM estimates that the industry will need an additional 2.62 million professionals by 2012. Only an estimated 25% of engineering graduates can be employed; the other three-quarters lack the right language or technical skills. Many companies told us that they were opening offices in Tier 2 cities as a way to reach new employees. They are also expanding remote delivery into Latin America and even the United States to cope with the overheated Indian market. Indian IT/BPO market to reach $75B by 2010 While there may be fog on the windshield today, NASSCOM anticipates a very bright future. For FY08 (ends March 31), the organization expects the market to reach $64B, a 33% increase from last year. By FY2010, NASSCOM is forecasting total revenue of $73B to $75B. There seems to be unlimited potential as the use of Indian firms spreads from U.S. and UK companies (79.2% of the FY08 market) to organizations around the world. Several executives cited the Middle East and North Africa as exciting new markets. They have offered to introduce me to clients in Dubai during a planned visit in April. The continued success of the software and services sector is critical to the country’s continued transformation. In FY98, this industry represented 1.2% of India’s GDP. It’s now 5.5%. I’m not sure about the direct correlation between increased percentage of GDP and infrastructure improvements. If the two are tightly linked, I’m hoping for another strong year for NASSCOM members. Their country needs it. Coming up: highlights from our meetings During our visit, we spent a few hours with a Fortune 100 company and TCS to talk about a new shared services center they built to support the global supply chain. I don’t know many other companies that have done this successfully. We also met with nearly two dozen software and services firms as well as several CIOs. Look for more insights from India over the next few weeks. In the meantime, what do you think? Is 2008 the year that America sneezes and India wishes it had a flu shot? Will the subprime banking mess pull down the IT services and BPO business? Can India ever catch up to the skills shortage? As always, I welcome your feedback and ideas—brichardson@amrresearch.com.
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