INDIAN ITES INDUSTRY

ICRA

ICRA Sector Analysis

INDIAN ITES INDUSTRY
March 2005

Industry Comment

www.icraindia.com

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Contacts:
Dr. Soumya K. Ghosh Manager
Rajeev Thakur Research Head
Amul Gogna Executive Director

Date March 2005

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Table of Contents

ENVIRO NMENT ANALYSIS – PORTER’S MODEL ............................................................................... 4

STRUCTURE OF THE IND USTRY................................................................................................................5

DEFINITION .............................................................................................................................................................5
E VOLUTION OF ITES I NDUSTRY IN INDIA .......................................................................................................... 5
SIZE OF THE I NDIAN ITBP MARKET .................................................................................................................... 7
M ARKET PLAYERS IN THE ITBP INDUSTRY .......................................................................................................8
RECENT DEVELOPMENTS ...........................................................................................................................10

KEY ISSUES .......................................................................................................................................................... 11

BPO BACKLASH ................................................................................................................................................12

TRENDS IN CAPACITY...................................................................................................................................13

DEMAND SUPPLY POSITION ......................................................................................................................14

REVIEW OF PERFORMANCE IN FY2005................................................................................................14

OUTLOOK.............................................................................................................................................................15

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ENVIRONMENT ANALYSIS – PORTER’S MODEL

ITES INDUSTRY

Entry Barriers: Low

The initial entry barriers in the software
industry are low. For instance, to set up
an ITES business, the initial
investments per seat are significantly
lower than the revenue realisation per
seat.

Bargaining Power of the Bargaining Power of the

Suppliers: Not relevant
Several Indian software companies
in the ITES business have been
accessed at SEI-CMM levels 4 & 5.
Hence, most of the software
companies have in-house expertise
of software development, implying
that the bargaining power of an
individual supplier is not really
relevant.
Inter Firm Rivalry: Medium to
High
The Indian ITES market is characterised
by intense competition, within the service
providers, which are either Indian-owned
or multinational corporations (MNCs).
Buyers: High
The competitive nature of the
world software market allows
the buyer industry the option of
dictating the terms to the ITES
vendor.

Threat from the unorganised sector: Not

relevant
Even though the Indian ITES industry is characterised
by intense competition, the players (particularly the
ITES players) have established a very strong brand for
their services by offering a comprehensive range of
services, emphasizing on R&D and providing quality
solutions. However, a significant number of
companies, which were earlier involved primarily with
low-end services, have disappeared or are struggling
for survival because of the challenging market
conditions.

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STRUCTURE OF THE INDUSTRY

Definition
Business Process Outsourcing (BPO) is defined as the delegation of ownership,
administration and operation of a business process or processes to a third party, or external
service provider. The external service provider, in turn, administers and manages the process
or processes in compliance with some measurable performance metrics.

The terms Information Technology Enabled Services (ITES) and BPO are often used
interchangeably. However, strictly speaking, ITES involves outsourcing of business processes
that can only be combined with Information Technology (IT). Such services are delivered
through a telecommunication or data network or other electronic media. ITES is therefore a
subset of BPO as Exhibit 1 shows.

Exhibit 1: ITES and BPO BPO

ITES

Non-ITES

Compiled by INGRES

The business processes of a company may be broadly classified as ITES and Non-ITES
processes. These processes may be further sub-grouped into the following categories:

• Core processes: These processes lend strategic advantage to a company. Typically,

core processes are directly related to the production of goods and services (for
instance, Research and Development, or R&D, and contract manufacturing in the
manufacturing sector) and are vertical -specific (offering more critical services in the
same domain). Usually, core processes are not outsourced as the company invests in
them.

• Critical non-core processes: These processes are important to a company but are not
competitive differentiators. Critical non -core processes may directly link the company
with suppliers (supply chain management) or with customers (sales, marketing and
customer care), and also involve support functions like Accounting and Human
Resource (HR) administration. Some of the critical non-core processes may be
outsourced to BPO providers who in turn are likely to invest in them, thus raising their
own importance with the outsourcing company.

• Non-critical non-core processes: These processes are important to a company but

can be outsourced in totality (for instance, back-office operations and day-to-day
administrative functions). The number and type of non-critical non-core processes are
currently expanding, which in turn is reflected in the increasing pace of growth of BPO
in recent times.

Evolution of ITES Industry in India

The Indian ITES-BPO industry (referred to as ITBP from here on) has evolved significantly
over the past few years. For instance, the size of the Indian ITBP industry has increased to
Rs. 71 billion (bn) in FY2002 from Rs. 24 bn in FY2000. In FY2003, the size of the Indian
ITBP industry has touched Rs. 117 bn. The evolution has been facilitated by the global
economic meltdown and the success of the Indian IT sector in servicing Fortune 500 clients,
among others.

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ICRA believes the Indian ITBP industry is currently in the fourth phase of growth (refer bullet
below), with several Indian companies acquiring new businesses abroad.

• First Phase of Evolution: In the first phase of evolution of the ITBP industry in India,
multinational corporations (MNCs) established a plethora of captive units in the
country for customer support and transaction processing. These included American
Express (in 1993), British Airways (in 1996) and General Electric (in 1998).

• Second Phase of Evolution: In the second phase, ITES units were set up in India by
MNCs (for outsourcing activities), non-resident Indians (NRIs), Indian independents,
and Indian subsidiaries. Established software services ventured into the ITBP
business in 2002 by establishing subsidiaries.

• Third Phase of Evolution: The third phase of evolution of the ITBP industry in India
has been characterised by the increasing trend towards geographical dispersion of
activities; mergers & acquisitions (M&As) have also taken place within the industry in
this phase (refer Table 1).

Table 1
M&As in the Indian ITBP Industry
Company Acquirer Seller* Remarks
Customer ICICI Onesource Promoters (100%) Deal at US$19.3 million
Asset
EXL Service Oakhill Partners Conseco Inc, USA NA
IbackOffice Optimus (Polaris) Global Technology Ventures NA
Intelenet Household Credit Tata Consultancy Services (TCS), Company valued at US$100
Housing Development Finance million
Corporation (HDFC)
Progeon Citigroup Infosys (20%) Company valued at US$100
million
Spectramind Wipro Chrysalis, HDFC (100%) Deal at US$100 million
WNS Warburg Pincus British Airways (70%) NA
*Figures within parentheses indicate the percentage of stake acquired by the buyer. NA: not available
Compiled by INGRES

• Fourth Phase of Evolution: In the current and fourth phase of evolution of the ITBP
industry in India there is an increasing trend towards Indian companies acquiring small- to
medium-size businesses in overseas locations. These foreign acquisitions mark a
contrast to the practice of foreign MNCs setting up BPO units in India to take advantage
of the lower costs here. Also, these acquisitions are probably in the nature of a market
entry strategy.

Table 2
Acquisitions by Indian Players in the ITBP industry
Company Acquirer Seller (and stake) Remarks
Aegis Communication Group, Essar Aegis (40%) Aegis is a US$150 million
US listed company
Apollo Contact Centre of HCL British Telecom HCL has paid US$11.5 million
British Telecom, Northern Technologies (90%) to acquire a 90% stake and is
Ireland expected to acquire the
remaining 10% after three
years for US$1.2 million.
Upstream, USA Godrej Upstream, USA NA
White Label LLC, USA Datamatics White Label LLC Deal worth US$10 million

Compiled by INGRES

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Size of the Indian ITBP market

The size of the Indian ITBP market was $ 3600 mn in FY2004. Of th e total market, finance &
accounting and customer services accounted for 56%. Also, the size of the Indian BPO
market at $1475 mn in FY2002 (we have taken FY2002 as data for the global market is
available till 2002 only) was around 0.19% of the total global BPO market.

Table 3
Indian ITBP Industry in FY2004
FY2002 $ mn FY2003 FY2004
Employees Revenues Employees Revenues Employees Revenues
Customer Care 30000 400 54000 700 95000 1200
Finance 15000 300 21000 450 40000 820
HR 1500 30 1600 35 3500 90
Payment 7000 110 9500 190 21000 430
Services
Administration 14000 185 25000 350 40000 540
Content 39000 450 60000 650 46000 520
Development
Total 106500 1475 171100 2375 245500 3600
Compiled by INGRES

Exhibit 1: Share of different segments Exhibit 1: Share of different segments

FY2002 FY2004

Content
Development
Content Administration 15%
Development Customer Care
15% Customer Care
31% 27%
33%

Administration Finance Payment

13% 20% Services
12%
Payment HR Finance
Services 2% 23%
7%

HR
2%

Compiled by INGRES Compiled by INGRES

The total number of people employed in the ITBP business in India in FY2004 was 0.24 mn .
In FY2003, the size of the employment in the Indian ITBP industry is estimated at around 0.17
mn.

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Exhibit 2: ITBP Industry (% growth year-on-year/y-o-y)

US $mn y-o-y
4000 80

3000 60

2000 40

1000 20

0 0

FY2000 FY2001 FY2002 FY2003 FY2004

Compiled by INGRES

Market players in the ITBP Industry

The Indian BPO market is characterised by the large number and diversity in the size of the
service providers, which are either Indian -owned or are MNCs. These service providers either
take up outsourced work or serve as captive units of MNCs. The following discussion
presents an overview of the types of service providers operating in the Indian BPO market,
going by their ownership (Indian or MNC) and nature of operation (outsourced or captive
work).

MNC Captive Players

The MNC captive players include the oldest BPO entities in India: American Express
(operating since 1993), General Electric (1998), and a host of others. In fact, General Electric
is now the largest BPO employer in India, with its staff strength in excess of 12,000 (the
company expects the figure to increase to 20,000 in CY2004). The MNC captive players
constitute the largest segment of the Indian BPO industry, accounting for nearly 64% of the
total industry size (figure as of 2004).

Even as MNCs with existing Indian operations have set up BPO facilities in the country, there
are others that have hitherto no Indian operations but have now established captive BPO
facilities in India. In fact, since 2000, a large number of Fortune 500 corporations have set up
bases in India and gradually scaled up their operations.

Capti ve BPO units in India have several advantages (both existing and potential), some of
which are discussed here:

• The captive units have guaranteed markets and are well equipped to carry out even
value-added services. For instance, General Electric’s Indian operations have moved up
the value chain and have now added employees for actuarial support, data modelling and
portfolio risk management.

• A potential advantage is that with the scope of BPO services expanding, the MNC captive
players in India may offer their services in the open market. Already, some of the largest
BPO entities are planning to offer services to external customers. If this practice takes
root, captive MNC units can turn into profit centres from the cost centres that they are
now.

M N C Outsourcers
The MNC players that are not captive include those that are pure outsourcers or specialists.
MNC outsourcers include entities like Convergys that have enormous domain knowledge,
which makes them significant players in the Indian market. In 2001, Convergys launched its
Indian operations in Delhi, and by April 2003, this unit was employing over 3,000 persons.
Convergys is now building a second facility in Bangalore, which will employ over 3,000
persons. It is likely that faced with cost pressures, MNC outsourcers would transfer more of
their activities offshore so as to remain cost competitive.

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The MNC non-captive players include multinationals that can perform labour-intensive
speciality services. Such services are wide-ranging and are based on domain expertise.
Examples of this type of work include medical transcription, map digitisation, cartoon
animation, and document conversion. Individually, these activities have limited employment
potential, but in aggregate their significance is much greater. For instance, there are close to
0.3 mn medical transcriptionists currently in US and this job may be outsourced from India.

Indian Players
In addition to MNC players, there are a host of Indian players operating in the BPO market.
These include venture capital funded BPO entities, Indian specialists, Indian IT Industry
subsidiaries, Indian non-IT Industry subsidiaries, and Indian players in the financial sector.

The venture capital funded BPO entities came up during the dotcom boom, seeking to provide
back-office services to US Internet firms. However, these firms reworked their corporate
strategies since the end of the brief boom in 2000. Nevertheless, the venture capital funded
BPO entities, by and large, remain dependent on large MNCs for business and these entities
have been forced to include BOT provisions in their contract. Also, the dependence on single
MNCs has made these BPO entities vulnerable to cyclical downturns in the businesses of the
MNCs. For instance, EXL Service was deriving a significant percentage of its business from
US insurance firm Conseco, but with the latter’s collapse, EXL has been forced to revise its
strategy.

Indian specialists are also specialising in areas like medical transcription and map digitisation.
Moreover, these specialists are well equipped for software development (Kale Consultants),
which facilitates their BPO operations.

An important group of Indian players in the BPO market includes subsidiaries of Indian IT
majors. Such majors include companies like Wipro, Infosys, HCL, Satyam and TCS.
However, some of these companies have decided to enter the BPO market in a different way.
While Infosys and Satyam have established dedicated BPO subsidiaries, others like TCS
have entered the BPO market through joint ventures, even as Wipro and HCL have entered
the business through acquisitions.

The segment of Indian non-IT industry subsidiaries includes entities established by large
Indian business conglomerates. This segment is the latest in the Indian BPO market (for
example, ICICI Onesource, Jindal Transworld and so on).

In the financial sector, a number of banks have now decided to outsource their business to
domestic BPO entities. For instance, State Bank of India (SBI) has recently announced that it
will outsource the task of networking 1,500 of its branches and around 3,000 automated teller
machines (ATMs) in over 49 cities to Datacraft India. Similarly, Bank of India, HDFC Bank,
and ICICI Bank have decided to outsource their non -core activities. These apart, players like
Carretek are offering services to offshore companies.

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MNC Captives
MNC Captives (New)
MNC Outsourcers
MNC Specialists
NRI- Funded Entities
Indian Specialists
Indian IT Subsidiaries
Indian Non- IT Subsidiaries
Indian Financial
Specialists
Compiled by INGRES
Table 5
Select Players in the Indian BPO Market
Players Service Lines (Illustrative) Outsourced Employment Size
(nos).
AMEX, Hongkong and Data Management, Accounting, No 250- 12,000
Shanghai Banking Back Office, Administration, HR,
Corporation  HSBC Finance, Customer Care,
Canon , GE Capital, JP Processing and Documentation
Morgan Chase, Standard
Chartered, World Bank
AOL, Axa, Dell, Fidelity, Data Management, Accounting, No 500- 3000
Ford Business Service Back Office, Administration, HR,
Finance, Customer Care,
Processing and Documentation
Convergys, Sitel, Customer Care, HR Services, Yes 500- 2000
Teleperformance Database Management and
Accounting
TeleAtlas, eBrookers, Geographical Information System Yes 500- 2000
Kampsax (GIS), Medical Transcription and
Publishing
eFunds, Genisys, General Outsourcing, Medical Yes 500- 2000
Heartland, Max Transcription and Publishing
Healthscribe, Techbooks
247 Customer, Daksh, GIS, Customer Care, HR Yes 500- 2000
Epicentre, EXL, First Ring, Services, Database
iSeva, Infowavz, Msource, Management, Publishing, Travel
Kale, Tracmail, and Accounting
Transworks, Vcustomer,
WNS
Progeon, Wipro Banking, Financial Services, Yes 500- 5000
Spectramind, HCL, BPO, Securities & Brokerage,
TCS Insurance, Finance & Accounting,
and Telecommunications
ICICI Onesource, NA Yes 500- 2000
Ienergizer, Jindal
Transworld, Zenta
Datacraft, India Switch Banking Yes NA

RECENT DEVELOPMENTS
• Oak Hill Capital Partners, a $1.6 -billion private equity firm and General Atlantic have
agreed to pay about $500 million for 60% of General Electric's business-processing
operations in India. The transaction, values GECIS at $800 million. GE will retain 40%
stake in GECIS and use the proceeds of 60% stake sale to fund growth. Both
General Atlantic Partner and Oak Hill are equal partners in this transaction. GECIS
will continue to serve GE under a multi-layer contract and the current GECIS global
management team would also be retained. About 1,000 GECIS employees will also
remain with GE.

Even though the captive BPO units in India have potential advantages (in terms of
guaranteed markets) this particular move by GE has to be viewed in the context of
the current scope of BPO services. In effect, with BPO services expanding to more
value-added services and given that GECIS has already expertise in areas like
actuarial support, data modelling and portfolio risk management, GECIS after this
move may now offer its services in the open market. This will enable it to charge a
higher premium than the existing one.

• The controversy over the taxation of business process outsourcing units in India has
been resolved with the Income -Tax department clarifying that tax would be attributed
to a foreign company only if its dependent BPO outfit in India was a "permanent

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establishment  PE". The definition of a PE includes an office, a branch etc in the

source country. PE also covers three categories, Basic PE, Installation PE and
Agency PE. Preparatory and auxiliary activities, carried out in the source country,
such as the maintenance of a fixed place of business for storage of goods, collection
of information, etc do not create PE. Even a subsidiary, which is a separate legal
entity does not constitute a PE unless it is a dependent agent. Additionally, the
revised circular has also withdrawn the distinction between core and non-core
businesses, for determining the activities to be taxed.

KEY ISSUES
Declining revenue realisations in specific segments
There was a decline in revenue realisation per employee for specific segments like finance
and HR in FY2004.

Table 6
Revenue Realisation per Employee (in US$)
FY2002 FY2003 FY2004
Customer Care 13333 12462 12632
Finance 20000 21250 20500
HR 20000 21429 20000
Payment Services 15714 19091 20476
Administration 13214 12400 13500
Content Development 11538 10568 11304
Total 13850 13735 14582
Compiled by INGRES

Moving up the value chain

Given that the revenue realisation per employee has not expanded significantly in low value-
added segments like customer care over FY2002 -2004, the ITBP industry needs to move up
the value chain. In fact, such a trend is already visible with the industry already extending its
lines of service to value-added areas like package software implementation, system
integration, (R&D), engineering, engineering design, biotech research, research outsourcing,
customer analytics, market research, and equity research. Moving up the value chain in BPO
services is also important for better price realisations (for example, prices of medical
transcrip tion service is about $6-$8/hour, whereas, inbound technical helpdesk services may
be priced at $17-$22/hour) and stickiness of the relationship with the customer.

Declining share of Third Party vendors

Even though there are a large number of ITBP players in the Indian market (around 400), the
percentage of third party vendors to total players have declined from 57% in FY2001 to 36%
in FY2004, while that of captive players have increased from 43% to 64% during the same
period. This relative decline in the share of third party vendors may be explained by the
mergers and acquisitions currently taking place within the industry. ICRA expects that one of
the major issues regarding the success of third party vendors will be determined by the ability
to scale up rapidly to take advantage of the fast expanding market.

Changing Consumer behaviour

A number of large customers, are currently showing a preference for outsourcing business to
multiple vendors. In some cases, the customers are asking the ITBP providers to build
business for them on a build-operate-transfer (BOT) basis. Subsequently, the ITBP players
need to accustom themselves to grow the business to a certain size and then hand them over
at the end of a pre-determined period to the customer.

Cost Competitiveness
For an overseas business corporation, the primary reason for relocating business to an
offshore location like India is typically cost saving. However, in achieving this saving, the

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corporation also has to factor in the parameters of quality and productivity, which is usually
done through monitoring against some defined performance metrics. In this section, the
issues of cost savings, quality and productivity are taken up.

The Indian ITBP industry is competitive as far as cost is concerned. The costs of significantly
qualified and competent labour in India are among the lowest in the world. Such savings may
be discussed under the following heads.

Gross savings: Gross savings may be defined as the savings against salary benefits and
overhead costs. For instance, according to industry estimates labour costs for a call centre in
the US are around US$10/hour, as against US$1.5/hour in India. If the centre operates in two
shifts a day, the total labour costs in the US would be around US$57,600 a year, as against
US$8,640 a year in India. This translates into a cost saving of around 85% purely on labour.

Alternatively, gross savings may also be defined in terms of the overall savings in a particular
year (the total savings in costs after accounting for labour and all other costs like general and
administrative expenses, property rentals, telecom, depreciation and so on: ICRA estimates,
that on an average these costs are higher by 5-10% in India). Thus, the total savings in the
above case could be as much as 75-80%.

Net savings: Net savings are the savings projected over the duration of the contract, taking
into account the up -front investment in selecting a provider, setting up the offshore centre,
effecting knowledge transfer, and so on.

Budgetary savings: The percentage of savings actually reflected in the offshoring

corporation’s bottomline might be termed as budgetary savings. Budgetary savings may be
impacted by the percentage of work deployed offshore. An independent study reveals that of
the current US$2340 billion cost base of global financial services, there will be a bottomline
cost savings of nearly US$138 billion by 2008 because of outsourcing. In the Indian context,
General Electric is reported to have achieved annual savings of US$340 million per year from
outsourcing its services (client, server, network and application) to its Indian operations.

Quality and Productivity

Apart from potential cost savings, an ITBP entity also provides for improvements in quality
and productivity. ITES set-ups in India serve a multitude of divisions within the company
facilitating the transfer of best practices across all of them. Consequently, ITBP entities in
India have been able to effect sharp improvements in process quality and productivity in their
operations. For instance, independent estimates show that the average speed of answer for
an Indian ITBP entity (in seconds) in India is around 8, whereas it may be as high as 20
seconds for a US facility.

Mergers & Acquisitions

The pace of mergers and acquisitions (M&As) in the Indian BPO sector increased in CY2002.
Venture capital funds (Oakhill, General Atlantic Partners, Westbridge Capital, and Warbug
Pincus) also invested close to US$300 mn in Indian BPO companies in CY2002. Further, two
MNCs divested part of their equity stakes in their captive units (British Airways in WNS and
Conseco in EXL) and decided to bring in strategic investors instead.

BPO Backlash
• A bill entitled “The United States Workers Protection Act” has been introduced CY2004 in
the United States Senate by Democrat, Christopher Dodd of Connecticut. The bill seeks
to prohibit taxpayer’s money from being used to outsource or take offshore those jobs
formerly done in the U.S. The legislation focuses on at least three areas of government
contracting: privatising of federal work, federal procurement of goods and services and
state procurement using federal funding. Under the Bill, the states will not be eligible to
receive federal money unless they certify every year that this will n ot be going offshore.

• Nearly 50 members of the US House of Representatives have announced that they are
introducing a bill entitled “The Defending American Jobs Act ” that would deny American
companies Federal financing and loan guarantees if they shift the jobs overseas.

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• A bill entitled “ Jobs for America Act” has been introduced in the United States Senate by
Tom Daschle in CY2004. The bill requires companies that plans to lay off 15 or more
workers and send those jobs overseas to disclose how many jobs are affected, where the
jobs are going and why they are being offshored. Apart from giving workers three months’
notice, the companies will be required to notify federal and state agencies responsible for
helping laid-off workers. The bill also calls on the Department of Labour to compile
statistics of offshored jobs and report it annually to US Congress.

However, these bills are unlikely to pose a serious threat to the Indian BPO market over the
short to medium term. In particular, the bill refers to “state government business getting
outsourced”, keeping all private sector businesses outside its purview. The bill also avoids
challenging the US government's right to give projects to contractors. But it provides that
contracts cannot be subcontracted out by the outsourcing mechanism to India or other
countries like China, Russia to cut costs.

According to ICRA estimates, the size of the US BPO market was $507 billion in 2003, of
which the size of the state government BPO businesses accounted for $36.7 bn (US
government and US defence department) – that works out to around 7.2% of the total market.
However, given that only 1.3% of such BPO businesses were offshored, the total size of the
offshore BPO market for state government jobs was only $513 million in 2003. In other
words, the US bills would at best choke up only $513 million of the offshore BPO business
(the Indian BPO market is estimated at $3600 million in FY2004) that would have come to
India, or other low-cost destinations.

Sensitivity of the ITBP Industry to Govt. Policies

The ITBP industry is sensitive to government policies. In particular, several government
initiatives in recent years have given a fillip to the ITBP sector by considerably enhancing the
locational attractiveness. Some of the important measures taken by the Government of India
(GOI) in this include:

• The GOI has allowed complete tax exemption under section 10A and 10B and partial
tax exemption under section 80HHE. Sections 10A & 10B allows tax incentives for
software development centres located in “Software Technology Parks (STP)” or
“Export Processing Zones” or which are 100% “Export Oriented Undertakings”.
Section 80HHE allows for tax exemption in respect of profits of export of computer
software. However, the Finance Act 2003 specifies a progressive decline in the tax
exemption limit over the next 10 years, beginning April 1, 2003.
• The GOI has promoted several STP in several locations across India. Units located in
STP enjoy the benefits of single-window clearance fo r all regulatory compliance
issues. This apart, the units enjoy duty free imports of professional equipment
(customs duty is waived) and duty free purchases (excise duty is waived).
• The GOI allows for 100% FDI equity in ITBP companies.
• Liberalisation of the telecom sector allowing private players in International Long
Distance (ILD), National Long Distance (NLD) and leased line services.
• This apart, various state governments have introduced initiatives to encourage
investments in the ITBP sector. For instance, the states of Andhra Pradesh, Tamil
Nadu and Maharashtra have initiated steps to ensure uninterrupted power supply.

Trends in Capacity
The Indian ITBP industry has witnessed a significant increase in capacity. The number of
seats has increased from 140,000 at the end of March 2003, to a projected 210,000 in March
2004. Most of this increase has been from Indian vendors and captive units. The share of
captive units is between 65-70% and is expected to grow even further.

Most of these third-party vendors made investments in improving infrastructure and quality,
training and re-skilling staff, expanding service portfolio, marketing, and recruiting technical
personnel. The Indian third-party vendors also included IT service companies expanding their
offerings to include ITBP services by creating own units or entering into joint ventures (refer
Table 7).

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Table 7
Strategies of Indian IT Firms to Enter BPO Business
Firm Strategy Employees Location
(nos.)
Tata Consultancy Joint venture with HDFC— Intelenet 900 Mumbai
Services
Infosys Established a subsidiary—Progeon 3,000 Bangalore
Wipro Acquired Spectramind in 2002 for US$93 3,200 Delhi
mn Mumbai
HCL Technologies NI Acquired 90% in BPO division of British 2,500 Delhi,
Telecom Chennai
Satyam Established a subsidiary —Serwiz Not Available Hyderabad
Compiled by INGRES

Demand Supply Position

The demand growth in the ITES industry is likely to be export-led. The demand share of the
domestic segment is likely to remain modest over this period. The industry is poised for rapid
growth over the medium term. In particular, the size of the export (BPO) segment of the
industry (more than 90% of the turnover) is likely to grow at a healthy rate by 2006. The
assumption of a healthy growth rate is substantiated by the fact that the CAGR of the ITES
industry during FY1999-2004 has been in excess of 60%. The high growth rates in the Indian
BPO industry would be enabled by the abundance of low -cost significantly qualified labour in
the country, improvements in the domestic telecommunications infrastructure, and India’s
brand image in the IT market. The high growth projections are also based on the expectation
that Government policy would continue to be congenial (incentives were announced in 2002
for the BPO industry).

However, on the downside, currently 90% of India’s export market are to USA and UK and the
US market is likely to grow slowly relative to other regions in the medium-term. As a result,
Indian ITES companies will also need to diversify the export market to be able to maintain the
current high growth trajectory.

Review of performance in FY2005

A large number of companies in the ITBP sector have started their operations in recent times.
Also, most of the companies in the ITBP business are not listed. As a result, a discussion on
the industry financials for the ITBP companies may be limited to the following points.

Spectramind and Progeon have witnessed an increase in revenue growth rates (compared to
the previous quarter) for the quarter ended December 2004.

Revenue of Wipro-Spectramind
(Rs. mn)
Q3FY2005 Q2FY2005 Q1FY2005 Q4FY2004 Q3FY2004 Q2FY2004 Q1FY2004
Total revenue (Rs mn) 1794 1649 1374 1365 1219 958 785
Q- o-Q growth rate (%) 9 20 1 12 27 22 19
Y-o-Y growth rate (%) 47 72 75 107 116 217
Compiled by INGRES

Revenue of Progeon
($ mn)
Q3FY2005 Q2FY2005 Q1FY2005* Q4FY2004* Q3FY2004 Q2FY2004 Q1FY2004
Total revenue 11.9 9.1 7.2 5.8 4.78 3.72 2.74
Q- o-Q growth rate (%) 32 26 25 21 28 36
Y-o-Y growth rate (%) 151 145 163 168 181 807
*As compiled from reports
Compiled by INGRES

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• Spectramind has witnessed a marginal detoriation in average revenue per employee for
the quarter ended Q3FY2005. However, for Progeon there was an increase.

Annualised Average Revenue per Employee for Spectramind

(Rs lakhs)
Q3FY2005 Q2FY2005 Q1FY2005 Q4FY2004 Q3FY2004 Q2FY2004 Q1FY2004
5.0 5.07 5.11 5.87 5.15 4.51 4.86
Compiled by INGRES

Annualised Average Revenue per Employee for Progeon

(Rs lakhs)
Q3FY2005 Q2FY2005 Q1FY2005 Q4FY2004 Q3FY2004 Q2FY2004 Q1FY2004
6.16 6.09 5.71 5.52 6.14 6.45 5.59
Compiled by INGRES

As far as the profit margins are concerned, it may be said that the profit margins in the
BPO business of the software companies are low when compared to the margins from
the software business. However, the revenue from BPO business accounts for not more
than 10% of their overall revenue. For instance, in the case of Wipro-Spectramind, the
revenue from the BPO segment is less than 10% of the revenue, whereas the operating
margin in the BPO segment is around 15% as against the total operating margin of more
than 25%. The lower profit margins in the BPO businesses of these software companies
may be attributed to the competitive nature of the business and the relatively recent
vintage of their BPO operations.

Outlook
The Indian ITBP industry is poised for growth over the medium term. ICRA expects the size of
the domestic ITBP industry to touch Rs. 591 bn (US$12 bn) by 2006. ICRA also expects the
Indian ITBP industry to employ 0.4 mn people by 2006. Such likely growth rates in the Indian
ITBP industry would be enabled by the abundance of low-cost significantly qualified labour in
the country, improvements in the domestic telecommunications infrastructure, and India’s
brand image in the IT market. The high growth projections are also based on the expectation
that Government policy would continue to be congenial (incentives were announced in 2002
for the ITBP industry).

Within the Indian ITBP industry, ICRA expects both a vertical movement (offering more critical
services in the same domain) and a horizontal one (expanding service portfolio by moving
into sophisticated areas like accounting), which in turn would improve realisations. Already,
some offshoring corporations are now outsourcing entire technology operations or business
processes, including logistics, customer relationship management, and finance to Indian ITBP
service providers. In human resources, outsourcing was initially restricted to pension plans
and payroll, but now covers even recruitment and performance management. For ITBP
service providers, moving up the value chain is also critical, given that attrition rates in the
industry are on an average higher in low value-added segments (in call centres) as compared
to higher value-added segments (engineering).

However, as the global ITBP industry grows rapidly, the developed nations (the largest
outsourcers) would probably have to suffer some amount of local job loss, the extent of which
is uncertain as of now. Independent estimates suggest that 2 mn jobs from the largest 100
global financial institutions will be moved to India by 2008 (of which 851,000 jobs will be from
the US). It is to be seen how political and economic considerations interact in influe ncing the
growth of the ITBP industry in the near future.

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