Indian IT Industry

Industry Analysis TRIM 3

Analyzed ByViney Chaudhary Aman Dixit Anuja Dashputre Neha Hasan Rohit Sethi

Table of Contents
I. II. Overview.. 2 I.T industry market characteristics... 3 III. Domestic I.T Market.. 6 IV. General Features 10 V. Industry Attractiveness..12 VI. I.T Penetration sector wise deep down13 VII. Regulations and Government Initiatives.15 VIII. Challenges faced by the industry.16 IX. Trends in I.T industry..18 X. Projected trends for the industry.19

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Overivew
The I.T industry in India has today become a growth engine for the economy, contributing substantially to increases in the GDP, urban employment and exports, to achieve the vision of a young and resilient Indian technology sector will play an important role in meeting the evolving needs of the Indian consumers. It is imperative that end user industries realign their business models and continuously invest in new technologies to provide innovative value propositions to their customers. IT will also be a significant driver in the economic growth of our country due to its effect on increasing productivity and enabling innovation. With its growing influence on the economy, the Indian IT industry is expected to witness about 12 percent growth over the next four years, to reach a market size of about INR1.8 lakh crores by 2016. IT services and software products will lead this growth, due to an increase in IT adoption by companies, shift towards outsourcing and emergence of new technologies. IT adoption across end user industries is not the samesome sectors like banking, telecom and insurance have leveraged IT across their business functions, including the backend organizational processes, customer facing activities and revenue generating initiatives, and are at an advanced stage in IT adoption. Sectors like education, healthcare, media and retail are relatively low IT spenders currently, but are expected to significantly increase their expenditure on this front in the future. The role of IT in organizations is expected to evolve from simply being order takers to transformative business partners. Several domestic IT companies have built strong IT capa bilities in the last decade and today boast of a marquee global client base. While traditional pricing advantage that IT providers enjoy in global markets may not be relevant for the domestic market, they now have the opportunity to play in valueadded areas by serving as optimization agents and transformation partners and deliver value through process improvements and technologyled transformations. IT providers are attempting to understand the unique and evolving needs of Indian end user industries aiming to employ Indiaspecific strategies for the domestic market. IT providers are developing the required partner network, applying multiple cost levers and adapting innovative commercial models to fully tap the Indian opportunity. The Government plays an important role in the IT market, both as a buyer and as a facilitator. In its role as a buyer, the Indian Government needs to catch up with the rest of the world on IT spending its IT spends as a percentage of GDP have been significantly lower than Governme nts for developed economies. In recent years, Government has taken the right steps in some areas for example, UID, education. Going forward, Government needs to focus on providing more ITenabled citizen services, improving efficiencies in the public sector, investing in disruptive technologies, standardizing data, and promoting shared services. These initiatives will need to be supported by a strong execution and governance model to effectively leverage IT.

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I.T industry market characteristics

The structure of the Indian I.T industry can be depicted as follows:

Figure 1

In the current scenario advantage India is what the I.T industry leverages to lure clients across the globe. The diagram below quantifies some parameters of why India is a preferred location for investors.
Figure 2

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Currently I.T industry serves numerous industries and verticals pan India and the major revenue is derived from the following sectors:
Figure 3

BFSI is the key vertical that contributes the most to the I.T industry. It accounted for export revenues of around USD28 billion during FY12, resulting in a share of just over 40 per cent of the total IT-BPO exports from India. US has traditionally been the biggest importer of Indian IT exports; over 60 per cent of Indian IT-BPO exports during FY12 were absorbed by US. Non US-UK countries only accounted for 22.0 per cent of the total Indian IT-BPO exports during FY12. Demand from emerging countries is expected to show strong growth going forward.
Figure 4

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The market structure of the industry in India is fragmented between various national, multinational and small sized players. India being the outsourcing destination of the world today, offers diverse products and services for both its domestic and international customers. This industry however is dominated by large sized players catering 36% share of the total industry revenue.
Figure 5

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Domestic I.T market

A comparison of Indias IT spends with more developed economies shows that the Indias o verall IT spend as a percentage of GDP is less than 1 percentsignificantly lower than the global average of 2.5 percent.

Figure 6

More developed economies typically spend more on IT and as Indian economy grows, IT spending is likely to increase significantly. Greater IT spends lead to productivity improvement through process automation, incremental business on electronic medium and real time access to information. The domestic IT services market is growing the fastest amongst all domestic IT segments. Increase in IT adoption by companies, increase in size and scale of companies, outsourcing of noncore business activities including new transformational IT deals in various industry sectors such as banking and telecom and emergence of new technologies such as cloud and data analytic would drive the future growth of IT services in India. Infrastructure Outsourcing Infrastructure outsourcing is one of the biggest revenuegenerating service lines in the domestic market. This segment is expected to grow at a healthy rate as companies will outsource the setting up and maintenance of IT infrastructure to thirdparty providers, driven by the following factors: Increasing need for companies to focus on their core competencies and invest in their core activities due to intense competition Highend skills required for maintaining and upgrading the complex IT systems to match the industry best practices that will be more difficult to manage internally reduction and lean IT organizations

IT Consulting IT consulting is expected to grow at a robust rate, driven by convergence of IT systems and solutions with business objectives and growing IT adoption to handle business complexities, rapidly evolving technology landscape in the corporate sector and curiosity of companies to test attractiveness of emerging technologies and implement them in business processes.
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Business Process Outsourcing BPO is a relatively small market in India and a large part of it is captive. However, there is a new trend related to thirdparty transformational outsourcing relationships between customers and service providers. BPO companies are also increasingly being established in tier 2 and tier 3 cities to enable service providers to deliver the services at lower costs. Infrastructure and Network Integration Services Demand for infrastructure & network integration services would primarily be driven by a need for synergies in IT systems across the global operations of organizations, emergence of complex IT systems and the need to enable them to communicate with each other. Application and Software Related Services The market for commercial application and custom application services would be driven by the growth in demand for application software, which is expected to grow positively as a result of increasing IT adoption, replacement / upgrading of legacy systems, reducing software license fees and acceptance of payperuse model of software licensing. Demand for applications would also lead to increased demand for software support.

Hardware
The total hardware market for the year is estimated to be around INR 32,500 crores, accounting for almost 32 percent of the total IT market in India. 1. Personal Computers Notebooks / tablets and desktops together comprise a major part of the IT hardware market. The market for notebooks / tablets is driven by the increasing demand for affordable, light weight, and portable computing devices. However, the increasing demand for notebook / tablets will lead to a fall in the demand for desktop PCs. The slower growth of the desktop PC segment shall be driven by the increasing demand for computing devices in education and the ongoing Government initiatives to increase the reach of IT. 2. Network Equipment Network equipment is another big revenuegenerating segment in the overall hardware market. It is expected that increasing investments by companies in expanding and upgrading their current IT infrastructure would lead to increased investments in network equipment by most of the enduser industries. 3. Servers and Storage Growing acceptance of cloud computing, virtualization and digitization is expected to drive the demand for servers and storage in future.

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Software Products
The total software products market for the year 2013 is estimated to be around INR 17,800 crores, accounting for around 18 percent of the domestic IT market. 1. System Infrastructure Software This segment primarily comprises of systems software, security software and system and network management software. The systems software market is more mature and developed. However, current technology and business trends such as adoption of disruptive technologies like cloud and mobility and growing business threats point toward a strong market potential for security software as well as system and network management software. Growing adoption of cloud computing and virtualization, with concerns for security and improved customer services, would drive companies to invest in these applications. 2. Application Development Software The market for application development software is expected to grow at a healthy pace, primarily driven by the use of cloud leading to redefinition of methods of design, testing and deployment of applications as well as emerging mobile applications, systems and devices. However, leading providers will face some stiff competition from the growing presence of opensource software.

3. Application Software Some of the key examples of application software include enterprise software, accounting software, office suites, and graphics software. The use of application software is increasing due to multiple factors including replacement / upgrading of legacy systems, increasing IT adoption across industries, reducing licensing fees, and increasing acceptance of payperuse model (software as a service) for software licensing.

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The value chain of the industry in broad terms can be depicted as follows:

Figure 7

PORTERS FIVE FORCES

Figure 8

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GENERAL FEATURES OF THE MAJOR PLAYERS IN INDIAN IT INDUSTRY

We have analyzed three players in this industry- Infosys, TCS and HCL Technologies. And we have seen some trends across these players.
DEBT TO EQUITY RATIO

None of these companies have high debt to equity ratio. HCL has been reducing its debt over the years while Infosys is a zero debt company. Most of their projects are funded through internal funds. So maybe they dont take debt. Also their actual assets are human capital which cannot be acquired.
DEGREE OF OPERATING LEVERAGE

DOL (TCS) DOL (Infosys)

1.170881945 0.602079776

In IT industry, variable expenses are higher as compared to the fixed expenses. Therefore the Degree of operating leverage is very low in IT industry.
FOREIGN EXCHANGE IMPACT

A majority of the business of Indian IT services players is transacted in foreign currencies, which makes the industry vulnerable to fluctuations of the Indian rupee against major global currencies, namely, the US dollar, the British pound, the Japanese yen and the euro. Different companies follow different hedging proportions and strategies. Out of all the major players Infosys has a stable and consistent hedging strategy. TCS has a varied policy for hedging its currency risk. TCS has a mix usage of options and forward contracts as hedging instruments. Some companies like Infosys have only foreign currency.
EMPLOYEE MANAGEMENT

In I.T companies the major asset is the employees. The comparative analysis of the three companies depicts that the number of employees of TCS manages is far more as compared to HCL and Infosys. Market downturns have not affected the company as its continuously expanding its employee base for the past five years. For HCL and Infosys also the employees are increasing but the percentage increase is not more than TCS which is the market leader.
Figure 9 300 250 200 150 100 50 0 INFOSYS TCS HCL TECHNOLOGIES NO. OF EMPLOYEES

FY09 104.9 143.8 50.7

FY10 113.8 160.4 54.2

FY11 130.8 198.6 64.4

FY12 150 238.6 77

FY13 156.7 276.2 85

INFOSYS

TCS

HCL TECHNOLOGIES
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ATTRITION

Attrition, which is defined as employees resigning or retiring and does not include people who were fired, has a direct relation to the growth of the sector and India's GDP. At Tata Consultancy Services (TCS), 10.6 per cent of the workforce quit in FY13, lower from 12.2 per cent a year earlier. Attrition at second-rung Infosys Ltd rose to 16.3 per cent (14.7 per cent in the previous year).
COST DRIVERS

According to CIMA, cost driver is any factor which causes a change in the cost of an activity. A cost driver is the unit of an activity that causes the change in activity's cost. IT industry is primarily driven by its employees. The various are the major cost drivers identified in the I.T Industry are:

Communication Costs - Messaging, Internet, Intranet Server Platforms Employee Hiring and Training PC Services and LAN/WAN Services Marketing & Advertising Costs Software Development Costs Other costs not identified explicitly

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INDUSTRY ATTRACTIVENESS

1. An attractive market with a challenging business environment- Indias appeal lies in its competitive labor costs, lucrative domestic market, and its skilled workforce. Foreign investors also applaud its strong management and business education system, as well as its improving telecommunications infrastructure. However, the countrys weaknesses are its under-developed infrastructure and a restrictive operative environment. 2. One of the top FDI destinations across industries- India was the fourth-largest recipient of FDI in terms of projects started in 2012, and in terms of value, it accounted for 5.5% of global FDI. Investors across the world recognize Indias FDI potential. Between 2007 and 2012, the US invested the most in India, with 30.2% of projects, followed by Japan with 10.4%. Seven of the top 10 investors in India during 2007-12 were from Western Europe, led by the UK and followed by Germany and France. 3. High expectations for 2020- India is expected to be among the top three economies of the world in 2020, particularly for economic growth and manufacturing according to EY survey 2014 and 2012 results. Also, this year only 5.2% of respondents expect India to be surpassed by competition from more dynamic countries, compared with 11% last year. Strengths such as a burgeoning middle class, growing domestic consumption levels and a skilled workforce are helping India to strengthen its position in the global marketplace.

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I.T PENETRATION SECTOR WISE DEEP DIVE

BANKING
Current I.T Adoption

INR 18,500 crores IT spends in banking

Figure 10

TELECOM
Current I.T Adoption

Figure 11

INR 15000 crores IT spend on telecom Large strategic outsourcing deals a norm in telecom

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MANUFACTURING
Current I.T Adoption

Figure 12

INR 12,300 crores IT spend in manufacturing, adoption levels still low I.T service typically deals with infrastructure outsourcing and project development

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REGULATIONS & GOVERNMENT INITIATIVES

Regulations
After the economic reforms of 1991-92, liberalization of external trade, elimination of duties on imports of information technology products, relaxation of controls on both inward and outward investments and foreign exchange and the fiscal measures taken by the Government of India and the individual State Governments specifically for IT and ITES have been major contributory factors for the sector to flourish in India and for the country to be able to acquire a dominant position in offshore services in the world. The major fiscal incentives provided by the Government of India have been for the Export Oriented Units (EOU), Software Technology Parks (STP), and Special Economic Zones (SEZ).

Government Initiatives
FDI up to 100 per cent under the automatic route is allowed in Data processing, software development and computer consultancy services; Software supply services; Business and management consultancy services, Market Research Services, Technical testing & Analysis services.

The Government of India's move to do away with the mandatory requirement of 10 hectares of minimum land area for setting up an IT and ITeS special economic zones (SEZ) is expected to provide a major boost to the real estate and IT sector.
Some of the major initiatives taken by the Government to promote IT and ITeS sector in India are: The Government of West Bengal plans to spend INR 41 crore (US$ 7.37 million) to roll out citizen-centric services electronically across 19 districts including Kolkata. Kerala has set an ambitious target of becoming a cent per cent digital state in governance. The State has around 600 small, medium and large IT firms employing over 80,000 professionals directly and nearly three times the number indirectly. The Cabinet has recently approved the National Policy on Information Technology 2012. The policy aims to increase revenues of IT and ITES industry from US$ 100 billion to US$ 300 billion by 2020 and expand exports from US$ 69 billion to US$ 200 billion by 2020. The Government of India plans to set up 15 new laboratories for testing hardware and software products under public-private partnership (PPP) model. The Ministry of Finance has issued a circular to chairmen of public sector banks and regional rural banks, which all payments to customers, staff, vendors and suppliers as well as disbursement of loans and payments towards investments should be made only through the electronic mode.
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CHALLENGES FACED BY THE INDUSTRY

In India, workforce is available at relatively lower costs, making it challenging for IT providers to pitch the effectiveness of their solutions purely based on the cost advantage. IT providers, therefore, need to identify alternative value propositions for the domestic market. Process optimization and business transformation are what Indian companies need, and many times this can be challenging to provide at the price levels they demand.
Indian companies are late adopters of IT

Indian companies, being late adopters of IT, do not have historical investments in building IT capabilities for their businesses. As a result, companies start from a very low baseline of IT management capabilities and infrastructure, in contrast with their counterparts in developed countries who have an established basic infrastructure. IT providers, thus, need to play an end toend role where they partner with clients to help adopt IT, build IT systems from scratch, and implement transformative business processes, all at the same time.
Indian companies are cost sensitive

Several Indian companies still consider IT as a cost center, and not a driver for value addition and business growth. In order to control costs, companies tend to resort to hard negotiations, prefer integrated deals and press for outcomebased pricing models. Due to this mindset, companies may eventually compromise on some key aspects of the implementation, to be able to accommodate costs within the allocated budget. For IT providers, this cost consciousness translates into lower margins in India compared with the global market.
Client Relationship Management is important

The pattern of IT buying by Indian companies differs significantly from that observed in other countries. Given the relatively inadequate internal capabilities, Indian companies are typically high touch clients and prefer more hand holding from their vendors. They expect the providers to become business partners who will make up for the lack of internal IT capabilities. IT providers, thus, need to possess strong account management capabilities with dedicated resources to be able to serve Indian clients effectively.
Expectation of high quality of delivery

While Indian companies are late adopters of IT and cost sensitive, they are quite discerning as buyers, demanding the same quality of delivery as promised by IT providers to foreign clients. They expect vendors to assign quality resources for their projects, as well as ensure delivery on key aspects like cost, schedule, and quality of service. Put simply, there is a gap between the end user companies expectations in terms of delivery quality IT providers thus, need to balance the expectation of high quality delivery with the price points demanded in the Indian market.
Billing rate risks

Billing rate risks refer to the potential danger of clients renegotiating billing rates, causing them to move southward. A fall in billing rates may adversely impact revenues.

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Concentration of verticals

Verticals refer to various industries from which a firm derives its revenues. For a firm focused on a limited number of verticals, a downturn in any of those verticals, or structural changes that the industry goes through may adversely affect its revenues. Currently industry is too much dependent on BFSI sector.
Concentration of service offerings

Changes in the service mix can impact a company's overall performance. Traditionally, Indian firms have focused on providing application development and maintenance services. Commoditization of these service-lines could adversely affect billing rates and, in turn, revenues. In order to mitigate this risk, firms need to ensure that they operate in a variety of service-lines. Besides, they also need to ensure that they gradually move to higher-end servicelines such as package implementation and systems integration to command a higher price.
Risk associated with exchange rate fluctuations

A majority of the business of Indian IT services players is transacted in foreign currencies, which makes the industry vulnerable to fluctuations of the Indian rupee against major global currencies, namely, the US dollar, the British pound, the Japanese yen and the euro.
Immigration regulations

Most employees employed by Indian firms are Indian nationals, while majority of their clients are US-based. A proportion of services offered to clients needs to be performed on site. The ability of IT professionals to work in other countries depends upon the necessary visas and work permits that they need to acquire. Any change in immigration regulations by any particular country can adversely impact the revenues of the Indian IT firm e.g. the infamous U.S immigration bill.
Broad Skill set gap
Figure 13

Out of around 0.4 million engineering students graduating every year in India, only 20% are readily employable. By 2020, the country is expected to face a shortage of 13 million mediumskilled workers, posing a big impediment to labor-intensive sectors. Around 93% of the Indian workforce is employed in the unorganized or informal sector, which lacks any kind of formal skill development system. Barely 2.5% of the unorganized workforce reportedly undergoes formal skill development, vis--vis 11% in the organized sector.

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TRENDS IN I.T INDUSTRY

Players focus on domestic market for strategic reasons

Although the domestic market is not as profitable as exports, many players are taking up projects in the Indian market for various reasons. Competency building and competitive advantage are the two most important reasons among those.
Competency building

Many times, vendors use the experience gained from executing a project in the domestic market in a bigger project to be executed for a developed market.
Domestic projects involve delivery of end-to-end solutions

Indian IT players, to date, have been unable to establish themselves successfully in high-end IT consulting, system integration and infrastructure management services and continue to lose out to global players. In contrast, projects offered in the domestic space require end-to-end IT implementation encompassing consulting, implementation, system integration, testing and infrastructure management services (IMS). Such contracts provide ample opportunities to Indian IT service providers to develop their capabilities and win clients abroad.
Cloud to gain traction across SMEs

Cloud services (Iaas and PaaS) are also on rise as these services are offered using pay-per-use model. CRISIL Research believes that cloud services would result in significant uptake of IT by SMEs. Subcontracting, standardizing and shared risk-reward improve project viability.
Small and medium businesses

Wipro is offering cloud services to SMBs in an attempt to become the largest IT vendor in the domestic market. In the last two quarters of FY11, the company doubled its SMB customer base. TCS iON has garnered 235 customers in the domestic market.
Increased adoption of I.T by the government

The government is taking numerous initiatives across various segments thus increasing the expenditure and adoption. The sectors in ROJECTED TR focus are:
Figure 14

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PROJECTED TRENDS FOR THE INDUSTRY

STPIs, SEZs and Tier II & Tier III cities are projected to be the most revenue generating sources for the IT sector in the future because of the following advantages:
Figure 15

PARAMETERS Term Fiscal benefits

STPIS 10 years 100 per cent tax holiday on export profits Exemption from excise duties and customs

SEZS 15 years 100 per cent tax holiday on exports for first five years Exemption from excise duties and customs

Location and size restrictions

No location constraints 23 per cent STPI units in tier II and III cities

Restricted to prescribed zones with a minimum area of 25 acres

Further trends in the Tier II & Tier III cities have been pretty encouraging as depicted by the following facts which is driving big MNCs as well as Indian companies to these more profitable locations: 1. 43 Tier II/III cities are emerging as I.T delivery locations 2. The cost in newer cities is expected to be less than 28% than the leading cities 3. Over 50 cities have the basic infrastructure and human resource to support the global sourcing and business servicing industry. 4. Some cities are expected to emerge as regional hubs for the large domestic companies. 5. Jaipur is emerging as an I.T city with exports of over USD 64 million in FY10. India is expected to have the largest workforce in the world by 2025, with around 2 billion English-speaking people by the end of 2020. Within the same period, India has the potential to have a surplus of around 47 million skilled workers through its skill development program, while across the world are expected to witness a shortage of around 56.5 million skilled workers (Source NSDC).

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Redefining Boundaries

The major revenue of Indian I.T industry is presently concentrated from U.S and U.K majorly. BRIC nations, continental Europe and Japan have IT spending of over USD183 billion but contribute only 12 per cent of Indias IT revenues. The need of the hour is to focus on these diverse geographies to reduce dependence on the western powers and become self-sufficient. Further adoption of technology and outsourcing is expected to make Asian nations like Singapore, Philippines etc. the second largest IT market.
Redefining Verticals

Over 85 per cent of the total Indian IT-BPO exports is across four sectors viz. BFSI, telecom, manufacturing and retail. Public sector, healthcare, media and utilities have IT spend of over USD587 billion but constitute only 20 per cent of Indias IT revenues. The following are the sectors to be focused on moving forward.

MEDIA
This sector is approximately INR 700 billion in revenues and is expected to grow at 15% per annum till 2016. 40 percent revenue of this industry comes from advertisements, which is the area to be tapped by I.T industry. The opportunities are: Analytics and business intelligence for targeted marketing, dynamic pricing and market research to use viewer feedback Increased need for social media and mobile based applications to increase reach and revenues

HEALTHCARE
The healthcare market in India is estimated to be INR 300 billion. While the reach of the Governmentmanaged public healthcare network is higher, private institutions have a larger share (approximately 60 percent) in terms of the total number of institutions. The public healthcare system mainly consists of district hospitals, Primary Health Centers (PHCs) and Community Health Centers (CHCs). The private sector is a mix of specialty hospitals, national chains, independent hospitals and small clinics / nursing homes. Opportunities for I.T are: Patient management- kiosks at hospitals Clinical layer- disease management software, electronic medical records etc. Systems like Virtualization, PACS, BI Hospital Information Exchanges(HIE) Telemedicine & E-prescription

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