T tremors but not yet an earthquake

Seemingly conflicting signals emerging from the IT software services industry for the last six months or so are bound to confuse the average observer. But on closer observation there is a pattern here; that leads you to believe that things will get better, sooner or later.

Merrill Lynch’s economist David Rosenberg had said in early December last year that he believes the US was already into its first month of recession, based on consumer spending data. The IT services industry, dependent significantly on the US for its revenues, is bound to be equally hit. The question is, by how much, and for how long.
Alarm signals

Last week, IBM cut pay for nearly 7600 technical support employees in the US, or for nearly 6 per cent of its US workforce, according to Computerworld.com. Unconfirmed reports also said that the Big Blue had sent home 700 freshers in India. Tata Consultancy Services confirmed that it had done the same, based on performance, to 500 freshers, over 10 months, while announcing that it cut a small portion of variable pay to make up for an about Rs 70 crore shortfall in an internal target. Despite the company saying that involuntary employee exits on performance happen every year and that the salary restructuring is not significant given that the impact is only about one per cent of its Rs 6000-crore quarterly revenues, all these incidents have sent out alarm signals.

Add to this the ‘cautious optimism’ that top Indian IT services have talked about, with regard to IT budgets. Infosys, during its quarterly results announcements, actually said that annual IT budget decisions in the US, which are decided in the first week of January, are now being postponed, for consideration later this quarter.
Optimists

From the gloomy end of the spectrum, swing forth to the optimistic. Everest Group has predicted that the worst is over and things can only look up now. The research agency explains this saying that outsourcing, or offshoring, abates in only one kind of economic environment – when there is uncertainty. When it is certain that things are good, or that things are bad, offshoring picks up. Now that it is certain that US is going into a slowdown or even a recession, it is good news for offshore vendors.

Suren Gupta, Head, Technology Services Group for Wells Fargo Home and Consumer Finance Group, which offshores IT work to India, is surprised to hear the users like him are still dithering on IT budgets this year. He had sewn up 2008 budgets before 2007 had ended. And, are these budgets growing? “No. They are flat and I’d be happy to see them come down as the year progresses.”

And what that means, claim industry pundits, is that to cut costs clients have no choice but to move work offshore to locations such as India. Carlos Cabrera, CIO, Exide Technologies, during a roundtable discussion jointly organised by Business Line and HCL Technologies, said that offshoring to an Indian player gave him the extra cash to invest in new technologies. Exide had its infrastructure managed by a top US provider. Since the latter proved costly, Exide moved to an Indian vendor. Says Cabrera, “We were short on funds. We had to move offshore. The savings we thus generated went into further technology investments.”
Taking a gamble

So, in the event of a slowdown, momentum towards offshoring would increase once the benefits are evident. Some Indian vendors are betting on this. Headstrong, a high-end software services provider, says it’s taking a gamble on this by recruiting 250 more people in India than it originally planned to, on a current base of 1500. Its belief is that the frenzy for offshore work would increase. If it doesn’t happen in three months, it would happen in six. He’s willing to wait.

But would not the move towards offshoring take some time? After all, post the 2000 slow-down, it was a couple of years before Indian vendors became beneficiaries of work moving to India. The counter to that argument is that the two events are not comparable.

As AMR Research put it in a recent article, last time it was Main Street, this time it is Wall Street. Indian CEOs interpret this to mean that the problem is not widespread across all sectors but is somewhat confined to financial services. And, this time around, the slowdown did not hit the US economy suddenly. Most players have seen it coming. There has been no, or little, blind investments triggered by the chap-next-door investing, before everything collapsed.
‘Good news follows bad”

This gives most Indian CEOs reason to remain optimistic: that the bad news has arrived, but it won’t be long before the good news comes up. Mindtree Consulting, which is yet to see any of its top 30 clients cutting back IT budgets, says if the slowdown hits clients, it would be for a quarter or two. Based on “customer-feedback”, Hexaware feels the ill-effects of a slowdown would last till, at most, September 2008.

But one interesting pattern is emerging. Small players seem particularly eager to make acquisitions. After offshoring momentum picked up in 2002-03, the top five Indian services companies clearly went into the stratosphere, compared to the next 15 in the Nasscom top 20 rankings. Size begot size.

Now, wanting to command scale seems a priority for CEOs of smaller companies. And the bigger you get the more you attention and respect you command. Headstrong, Zensar Technologies, Mastek Ltd, the unlisted Aricent, which is into communications software, are all after acquisitions that would give them scale, or entry into a new geography or industry.

This could be because large spenders on technology, who have exposure to offshoring, would be tempted to offshore more. This means that deals could become complex and larger vendors would be in the fray. Smaller players would remain on the fringes or fall away. Also, no offshoring could be expected from those who have not offshored earlier. Why would they want to add another aspect of uncertainty to an already uncertain environment?

Finally, if the US slows down, how would other parts of the world be hit, primarily Europe? After all, Indian IT services vendors have been doing well of late in the old continent. Gartner’s view is that European financial firms will surprise the IT market and take this opportunity to improve their lead in the global financial services markets and use more global sourcing, which could accelerate demand for offshore services.

CapGemini, a European IT services provider, last week showed a 13 per cent growth in annual revenues and indicated that it is on course to becoming a 40,000-strong organisation in India by 2010, up from 17,000 now. Atos Origin, CapGemini’s competitor in Europe, is hungry for acquisitions in India, driven by client demands for the ‘India story’. It is hoping that a weak stock market would send valuations south enough for it to swallow.

http://www.thehindubusinessline.com/2008/02/19/stories/2008021950130800.htm

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T tremors but not yet an earthquake