Indian IT Industry An Insider Analysis

Prepared By
Ashish Kumar Das ePGP-03-018

Managerial Economics Assignment

Submitted to
Dr. Kausik Gangopadhyay Indian Institute of Management, Kozhikode 31-Dec-2010

Table of Contents
1 2 3 Scope ................................................................................................................................................... 3 Information Technology Industry An Overview........................................................................... 3 Market Structure ................................................................................................................................. 3 3.1 3.2 3.3 3.4 4 Industry Organization ................................................................................................................... 3 Price Rigidity.................................................................................................................................. 5 Entry and Exit of Firms .................................................................................................................. 6 Market........................................................................................................................................... 7

Competition and Pricing .................................................................................................................... 8 4.1 4.2 4.3 Hyper competition ........................................................................................................................ 9 Value chain .................................................................................................................................... 9 Price determination ...................................................................................................................... 9

5 6

Conclusion ......................................................................................................................................... 12 References ........................................................................................................................................ 12

1 Scope
The objective to this study is how Indian IT industry primarily as an oligopolistic group is transforming into highly competitive industry. This also analyses the competition and the market potential available in India. It also focuses on the latest trends on pricing model used in IT industry.

2 Information Technology Industry An Overview

The Information Technology industry has become one of the most significant growth catalysts for the Indian economy. In addition to fuelling Indias economy, this industry is also positively influencing the lives of its people through an active direct and indirect contribution to the various socio-economic parameters such as employment, standard of living, education and diversity among others. Growing at an extremely high pace, the industry has demonstrated a decade of strong growth growing 15 times to aggregate revenues of USD 69.4 billion in FY2009. In addition, as one of the largest employers in the organized private sector, it provides direct livelihood to 2.2 million people. The IT industry has played a significant role in transforming Indias image from a slow moving bureaucratic economy to a land of innovative entrepreneurs and a global player in providing world class technology solutions and business services. The industry has helped India transform from a rural and agriculture based economy to a knowledge based economy.

3 Market Structure
The IT industry in India had humble beginnings with a few Indian entrepreneurs setting up IT services companies and select MNCs such as GE, Texas Instruments and American Express setting up their captive centres in India. Cost arbitrage through abundant talent pool available in India was the key driver for offshoring to India.

3.1 Industry Organization

The Indian software industry has a pyramidal structure, with a few large indigenous firms dominating the sector. Smaller firms play a more significant role in the domestic market where they supply software services to small and medium sized firms in different sectors. Currently in the Indian IT Services Industry the tier 1 players have the lions share of the business, the tier 2 companies and the offshore centers come in second and finally the ever increasing list to the already existing set of emerging industries who have about 15% of the market share, What needs to be seen is how are things going to pan out? Consolidation seems imminent in the industry. Consolidation/Acquisitions are likely to be done for two purposes, first people/talent/raw material and two moving up the value chain or completing the offering.

Figure 1. Industry Organization

The information technology market was primarily oligopoly market but with emergence of new small and midsized player it is going to be highly competitive in nature. Initially there are only few major players like IBM India, Infosys Technologies, Tata Consultancy Services (TCS), and Wipro Technologies but over the last decade many other small to midsized companies like HCL Technologies, L&T Infotech, Cognizant, Mind Tree, i-Gate are emerging in India as major technology and solution providers. Global IT leaders such as Microsoft, Adobe, Oracle, SAP, Google and Yahoo have set-up their full fledged R&D centres in India with focus on product innovation. These Indian centres have been the incubators for some of the most successful products of these companies who now view India, not only as a source for talent, but also as a promising market for their products and services. As a result, the Indian R&D units of many major companies are largest (in terms of number of employees) outside their home country.

Figure 2. Magic Quadrant IT Service Providers

Figure 3. Global IT Outsourcing Companies

3.2 Price Rigidity

Oligopolistic markets often have some degree of product differentiation. With time most of the offshoring companies had matured in the quality of deliverables and type of service offerings and there is not much of differentiation left in the type of service offerings and quality of deliverables. As many firms compete in the market, each firm is facing a direct competition for its products and services. When the product and service of all the firms in a market are perfectly substitutable with one another, that is when they are homogenous no firm can raise the price of its product and service above the price of other firms without losing most of its business. The consumers can easily switch to a rival firm if a current supplier raises its price. Oligopolistic market has a strong desire of price stability. Many of the IT firms today are reluctant to change prices to sustain margins even if costs or demands change.

Figure 4. Kinked demand curve

Each firm believes that if it raises its price above the current price P* (as illustrated in above figure), none of its competitors will follow suit, so it will lose most of its sales. It also believes that if it lowers price, everyone will follow suit, and its sales will increase only to the extent that market demand increases. As a result, the firms demand curve D is kinked at price P*, and its marginal revenue curve MR is discontinuous at that point. If marginal cost increases from MC to MC, the firm will still produce the same output level Q* and charge the same price P*. In todays IT market, each firm faces a demand curve kinked at the currently prevailing price: at higher prices demand is very elastic, whereas at lower prices it is inelastic.

3.3 Entry and Exit of Firms

Many Indian firms have been started by entrepreneurs who acquired some wealth and experience working in large established firms and then set up new companies. The high profitability and relatively low risks of the industry has attracted large number of professionals. Also entry cost is relatively low. To start software company it does not require huge investments in land, plant, or machinery. Most of the assets can be acquired on lease without upfront investment. The lead time for generating revenues is also much shorter than in many other industries. There is no special cost that makes a new firm either to enter the industry and produce or exit if it cannot make a profit. This free entry and exit is important for the competition to be effective.

3.4 Market
India information technology (IT) spend is forecast to reach $71. 9 Billion in 2011, a 10.3 percent increase from 2010 spending of $65.23 billion, according to Gartner, Inc. IT services is showing the strongest annual revenue growth at 22 percent in 2010. Double-digit growth across all sub segments of the IT space will drive the growth this year.

Figure 5. Geo Spread of IT Spend (* figures are indicative)

The India market is in a growth stage and is the fourth largest software market in Asia-Pacific after China, Australia and South Korea. There are sizeable opportunities within manufacturing, retail, transport and hospitality, as well as the already established opportunities in government, telecom, financial sectors and IT services. India continues to be a vastly underpenetrated IT market relative to its potential. Infrastructure projects undertaken by Indias government will strongly drive IT, in conjunction with the growth of the hypercompetitive financial services in India, which requires highly sophisticated IT systems. At the same time, manufacturing in India is beginning to take off, and is expected to show strong growth through 2014.

2009

2010

2011

2012

2013

2014

CAGR 2009-2014

Hardware ($M)

6,388

7,558

9,290

11,152 13,257 16,152

20.4%

Software ($M)

2,112

2,421

2,768

3,124

3,521

3,960

13.4%

IT Services ($M)

6,223

7,591

8,774

10,181 11,815 13,691

17.1%

Telecommunications 42,100 47,664 51,097 54,487 58,178 61,668 ($M)

7.9%

Total IT ($M)

56,823.5 65,233.9 71,927.9 78,943.8 86,770.4 95,470.6

10.9%

CAGR = compound annual growth rate

Table 1.

IT End-User Spending Forecast, India, 2009-2014

Source: Gartner (November 2010)

4 Competition and Pricing

India's IT services companies have had a golden run. Over the past decade, the industry has achieved average annual growth of 40 percent as businesses from banks to manufacturers in Europe and North America have shifted routine back-office tasks and IT functions to India's talented, low-cost workers. The country's top three IT services companiesInfosys Technologies, Tata Consultancy Services (TCS), and Wipro Technologieshave evolved rapidly into established players, each with annual revenues ranging from $1.4 billion to $1.6 billion.

That rate of growth could falter, however, unless India's IT companies fend off rising competition by expanding beyond the country's borders to build truly global businesses. As wages in India rise and its supply of skilled workers tightens, its advantages relative to Central Europe, China, and specialized locations such as Brazil and the Philippines could erode. Corporate customers will increasingly demand that Indian companies move beyond supplying a pool of low-cost labor and embrace a business model that incorporates more complex technology and greater industry expertise. India IT industry faces rising competition in the low end of the business from other Asian countries like China, Vietnam and the Philippines. With salaries in software companies here rising at more than 15 percent a year, India must expand into new areas that promise a higher return. What gives us an edge is that our education system has a bias toward mathematics and engineering. As the market matures, competition will intensify and then lead to consolidation. This is evident from the recent news on i-Gate bidding to acquire Patni Computer Services to quickly gain some weight and size. Vendors that are unable to find a niche for themselves, or smaller vendors with no real differentiators, will be acquired by larger, more-aggressive competitors.

4.1 Hyper competition

Hypercompetition essentially refers to a buyer's market in IT services, where a combination of factors coexist that drive widespread, cost-based decision making. Hypercompetition drives lowest-cost deals but the real threat is the sustainability of those deals. The economic realities create a short-term buyers' market, but a long-term problem for buyers and providers.

4.2 Value chain

Service value chains will redefine competition and how IT services are consumed and paid for. A new maxim for the future regarding service provisioning is that "the whole is greater than the sum of the parts." Organizations must become more proficient their ability to examine their providers' partners and their value chains.

4.3 Price determination

Business priorities have changed enormously with the advent of the downturn .Now there is an increased focus on improving the efficiency and getting more from every dollar spent without comprising on quality. Traditionally IT projects are priced on effort (time and material) or on fixed prices. Alternate pricing model (e.g. user based pricing, unit of work, ticket based pricing, value based pricing, revenue share pricing) can potentially change the game and create paradigm shift. It directly tie-in the cost of IT with the values derived by it. The value based pricing model help to reduce the overall cost of ownership with increase in volume of work giving economies of scale.

Companies IBM

Accenture

TCS

Wipro CTS HCL Infosys

Price Models Transaction Based Pricing Gain Share Joint IP Development Gain share Outcome based pricing Production bundled pricing Contracts committing to benefits Revenue Sharing User based Pricing Outcome based pricing Aggressive SLAs/Risk based pricing Aggressive SLAs/Risk based pricing Ticket/Unit based pricing Aggressive Risk and Reward model Device based pricing Unit of Work based pricing IP/Royalty based pricing Outcome based pricing

Table 2.

Industry Alternate Pricing Trends

The generic term UoW (Unit of Work) based pricing refers to a pricing schedule where the price for each unit is pre-determined. The simplest example of a UoW pricing is two-part tariff in which consumer pays an initial fixed fee for the first set of units ( an agreed to number or range of work units),plus a smaller constant price for each subsequent unit or bundle of units.

Figure 6. Leverage by managing demand

While fixed price and T&M pricing models will continue to thrive in todays IT industry, UoW based pricing models have a potential to further optimize outsourcing cost. This will allow analyzing the demand pattern and adjusting the work buckets of demand. Service utilities are becoming a major focus in the IT services industry. For consumers, one benefit of a service utility is being able to purchase as much of a service as needed at any given time without purchasing the complete infrastructure. The ability of customers to increase or decrease their consumption level at any time creates a need for new service utility pricing models. This is what we refer as pay as you go or utility pricing model.

Figure 7. Utility Pricing Model

Utility pricing provides a customer with a financial plan to enable a monthly cost for using a resource based on an agreed usage. There are caveats for this pricing structure that include an up-front flat-rate charge such as a utility standard charge (USC) and the possibility of over or under-utilization. Estimates are put in place to accommodate peaks and troughs in resource consumption. Therefore, the supplier will need to recover the costs over a given time period, and is likely to seek to do so within the agreed contract period.

Figure 8. Market Model for Software Pricing

5 Conclusion
Though the industry is on a positive footing small to midsized firms with no differentiating factor or the size and scale are struggling to compete with large firms and the industry is moving towards consolidation. Emerging and marginal players could face touch times in near future. Moreover the competition has also increased among the tier1 players in this oligopolistic market and to sustain and survive each of these players has to come up with strong differentiation strategy and value based services for the customers. Today most of the companies seem to be executing the alternate pricing model with varying degree of investment and aggressiveness.

6 References

Gartner Analysts Reports - http://www.gartner.com/technology/analysts.jsp New Engagement Model - http://www.infosys.com/SAP/news-

events/Documents/engagement-models-web.pdf Sun Blueprints - http://www.sun.com/blueprints/0703/817-3177.pdf

Nascom Research Reports -

http://www.nasscom.in/upload/68924/Impact_Study_2010_Exec_Summary.pdf Book on Microeconomics by Robert S Pindycki,Daniel L. Rubinfield Prem L. Mehta