Strategic Assessment of Indian offshore IT and IT Enabled Services Industry

Introduction

Outsourcing is a strategic decision taken by firms to achieve competitive advantage whereby products or services are produced more effectively and efficiently by outside suppliers. As par McCarthy & Anagnostou (2004, p. 63), "outsourcing is an agreement in which one company contracts-out a part of their existing internal activity to another company."

Offshore business process outsourcing refers to outsourcing to vendors outside the country, predominantly to developing nations to leverage the cost advantage. To remain competitive and focus on core competencies, companies are driving toward offshore outsourcing as it helps free up resources (SCHEIBE, MENNECKE, & ZOBEL, 2006, p. 283) and help higher management focus on core business requirements (Blumberg, 1998). The offshoring provides effective means of reducing cost by outsourcing non-core activites to third party who can provide similar, if not better, services at lower cost.

India is the favourite destination for offshoring Information Technology (IT) and IT enabled Services. The Indian IT/ITES industry commands more than 50% of global ITES offshoring market share. The IT/ITES exports are set to cross USD 60 billion by 2010 (Mathur, 2007) and Nasscom (The National Association for Software and Services Companies), estimates that the industry will account for USD 63.7 billion of revenues and direct employment is expected to reach nearly 2.3 million. The IT industry contributes around 26 per cent of India's total exports and was around 6.1 percent of India's GDP for financial year 2009-2010 (NASSCOM, 2010).

Strategic Industry Analysis

Porter's Five Forces

Michael Porter's Five Forces Model is most widely used framework for strategic analysis of the industry. Five forces analysis looks at five key areas- the threat of entry, the power of buyers, the power of suppliers, the threat of substitutes, and competitive rivalry.

 

The five forces determine the competitive intensity and the profitability. The corporate strategy would be to manipulate these forces to improve organisations position in the market. Three of the Five Forces refer to competition from external sources and other two are internal threats.

"Understanding the competitive forces, and their underlying causes, reveals the roots of an industry's current profitability while providing a framework for anticipating and influencing competition (and profitability) over time. "

(Porter, 2008, p. 80)

Threat of Entry & Barriers

A new entrant to the industry brings new capacity and competition to gain market share. Most of the new entrants are diversifying to Information Technology Enabled Services (ITES) in India and thus can leverage on their existing business model in terms of financial capacity and other resources. ITC, L&T and Mahindra & Mahindra are example of such new entrants diversifying from Tobacco, Construction and Automobile sectors respectively. The more ITES sector is growing, it is attracting new companies.

Current favourable policy by government for new ITES-BPO firms is creating competitive situation for the established players like Tata Consultancy Services (TCS), Wipro Technologies, Patni Computer Systems (PCS) and Infosys Technologies. However, the existing firms are focusing more on maintaining core competencies and adopting quality standards such as SEI-CMMI, ISO, HIPPA and 6 Sigma. The process certifications act as barriers for new and upcoming IT firms for getting big contracts from multinationals. Outsourcing firms in developed nations are too cautious about sending sensitive data and work to offshore and quality management certificates like ISO series or Information Security Management certification BS7799 make sure that offshoring contracts go to competitive firms. As a consequence, the threat of new entry is minimized by the reputation of existing IT companies and high cost of maintaining quality of the offshoring process. Moreover, IT professionals flock to blue chip companies to join as employee despite the fact that they are offered around 30% less remuneration package then the new start-ups.

Threat of Service Substitute

Indian IT firms face stiff competitions from their counterpart in other emerging market like Russia, Brazil, Mexico, Philippines and China. The ITES providers in these markets charge competitive rates than Indian IT firms. However, Indian offshore industry thrives on fact that India has biggest skilled resource pool of graduates. As par Nasscom (2010) report, India adds 3.7 million graduate per year to the skilled IT resource work pool. These resources are highly talented in the work they do and very flexible in terms of working environment, technology and location they work on.

Additionally, the ITES industry has been exceptionally quality focused, with India based centres accounting for the largest number of SEI CMM (Software Engineering Institute Capability Maturity Model) Level 5 certifications achieved by any country. India with high-skilled pool of knowledge workers with English speaking capabilities has upper edge over other offshore locations like China, Philippines or Latin American countries (Mathur, 2007).

Power of Suppliers

Powerful suppliers can take their cut from the profit by unfavourable lease agreements on IT parks and charging higher cost for supply of resources (IT labour). To thwart these risks offshore IT firm go for long term lease or buy out lands in IT parks from local government bodies. Various State Governments in India offer incentives for IT companies to set-up their shops in particular city. IT firms in India directly go to the graduate schools to recruit the young talent in thousands (Sify, 2010) and train them based on the project requirements.

Threat of forward integration by suppliers is rare phenomenon however in some cases suppliers can influence the industry by becoming direct competitors adjacent to existing market players.

Hindustan Computers Limited (HCL) was major hardware supplier to Indian ITES companies. It spun off its R&D centre to form Software delivery centre, HCL Technologies in 1997. HCL Technologies is now one of the top 10 ITES firm in India with consolidated revenue of USD 2.5 billion as of 31st December 2009 (HCL, 2010).

Industry Competitors

Rivalry between Indian IT firms is intense. After initial growth phase, the market leaders (Wipro, Infosys and TCS) are focusing on gaining core competencies, domain knowledge of the sectors they are competing. In view of the fact that, the services offered are nearly identical, Porter (2008) claims that switching between the service providers is easy for clients encouraging reduction in service costs. In 1995, General Electric proposed price cuts to Infosys, when Infosys refused to lower its rates and backed out of the contract, the multi-million contract went to another Indian IT firm. GE was contributing about 25% to the bottom-line of Infosys (Forbes, 1997). Today TCS is biggest offshore partner of GE.

Resource poaching: IT firms are involved in fierce completion to get hold of experienced IT professionals or to retain the employees with core competencies.

Power of Customers

Porter (2008) argues that customers can capture more value by forcing down prices, demanding better quality or more services thereby driving up costs. For ITES and BPO offshoring work, there are number of Indian IT firms competing for the contracts and customers want to reduce their cost by igniting rivalry among industry participants by floating tenders.

The more offshoring becomes a trend; the clients are becoming well informed about the available players, quality of services they are offering and how much they can be squeezed.

Threat of backward integration by clients cannot be ruled out. Offshoring give cost and time advantage and consequently many of Western IT products and services firm opened offshore development and delivery centres in India. However they chose to outsource non-core business processes to Indian IT firms. As a result firms like Microsoft and Oracle have their own offshore development centres in Indian city of Hyderabad and continued to work with Indian IT giants Infosys or TCS containing any threat to become a substitute.

SWOT Analysis

It is useful to use Porter's Five Forces strategic assessment of Industry segment along with the SWOT (Strength, Weakness, Opportunity and Threats) analysis. Porter's Five Forces is best tool to analyse external environment of the Industry. 'SW' (strength and weakness) will provide glimpse of internal environment of the ITES industry. Whereas OT analysis will discuss how the future for the sector will be.

Strength

Low Cost Advantage

Indian IT/ITES firms have leveraged upon the abundant supply of high skilled English speaking work force and comparatively low cost. Salary paid to software developers in India is around one sixth to their counterpart in developed nations like US and UK. Office rental space is cheaper in many cities in India than that in UK, US or any European cities. Moreover, State Governments give incentives to setup IT parks, provide land at low cost and bestow tax breaks.

IT Infrastructure

Autonomous bodies like Software Technology Parks (STP) and Specialised Economic Zone (SEZ) provides office rental space with all prerequisites to start IT firm with high speed satellite link, broadband connectivity, uninterrupted power supply and even computer hardware on rent. Firms can start working within few weeks after renting space. In addition, export oriented ITES firms operating in STP's are given tax break on export income.

Quality

High quality Maths and Science graduate pool of India provides strength to IT/ITES firms India to strengthen its place as world leader in offshoring market. In addition, a majority of the ITES firms in India have already updated their internal processes and practices to follow international standards such as ISO, CMM (Capability Maturity Model for Software), Six Sigma, etc. (Mathur, 2007).

Weakness

Infrastructure

There are serious infrastructure related issues in India. Inadequate power supply forces firms to run their own small captive power plant running on fossil fuel which being an avoidable cost impacts the company bottom-line.

Inadequate data bandwidth, low penetration of PC and Internet and lower computer literacy rate creates lower domestic demand for IT software products. This provides no hedging for the ITES industry which remains dependent on export of IT software and services.

Domestic Market

For year 2009, Indian domestic IT Service market is estimated to be USD 4.8 billion compare to ITES export of USD 60 billion in same year. IBM Global Services, IBM's Indian subsidiary firm and provider of business and technology services has emerged as the largest vendor in the IT Services market in India with a market share of 10.8 percent (Times of India, 2009). Furthermore, in recent years IBM bagged 3 billion $ worth contracts from India's top three Telecommunication firms.

IT/ITES firms in India are overlooking at their home ground and focusing more on software exports. This has created an opportunities for multinational companies like IBM to hedge their business from economic slowdown in developed countries.

Opportunities

Current economic recession is forcing companies to make the most of the information technology to build competitive advantage. Organisations are trying to cut costs not only by downsizing but also changing the business processes by outsourcing much of the IT and even human resource and payroll activities. Current offshoring market is a very small part of overall outsourcing economy. McKinsey's review report expects the global market for offshore business and technology services to grow to about $500 billion by 2020 (Kaka, 2009). Being market leader in offshoring market and with biggest English speaking talented work force in world, Indian IT/ITES firms have opportunity to grab what's on offering. Indian IT firms are not only involved with information technology projects but helping their clients niche segment for managing business processes, HR and payroll activities through global delivery centres.

Expansion

Slower economic growth in western countries coupled with strengthening Rupee value against dollar is providing new opportunities for Indian IT/ITES Industry to expand their foothold in western market and gaining core competencies. Prime examples are TCS buying Citigroup Global Services (Ciol, 2008) or Infosys's GBP 407 million buyout of UK based Axon group (The Hindu, 2008).

Threats

Economic Slowdown

Recent economic slowdown and worst recession since World War II has posed new threat of protectionism in the Western Developed countries as a growing anger against job losses due to offshoring activity to developing nations like India and China. Some governments have already started talking about tax incentives for companies who prefer local talent or outsourcing rather than offshoring non-core business to another country.

Software Piracy

Software piracy is major concern for Indian IT firms. It is estimated that every two in three consumers PC has at least one pirated software installed, either known to the user or they assume it is legal as it comes pre-installed on assembled PC. Business Software Alliance (2009) study shows positive trend in reduction of pirated software by 6 percentage points from 74% in 2004 to 68% in 2008 however, it is double than in western countries like US or UK.

New Entrants

The wedges for Indian IT professionals are keep rising in recent years. This may shun the low-cost advantage of the Indian ITES industry and pose an opportunity for other offshore markets with English speaking workers employed in IT/ITES sector. Moreover, English speaking ability can be acquired and a new offshore market can emerge to threat India's top position as preferable IT offshore destination (Mathur, 2007).

Suma Athreye (2005) notices signs of Schumpeter's creative destruction among Indian IT players. The market share of top 10 Indian companies is gradually going down. Whereas, foreign IT firm like IBM, Accenture, Oracle and Cognizant is gaining foothold organic or inorganic expansion (e.g. Oracle bought controlling stack of i-Flex solutions). Noshir Kaka (2009), Somesh Mathur (2007), K.G.K. Nair and P.N. Prasad (2004) et al. reiterates the threat that China, Vietnam, Pakistan, Maxico, Brazil and other countries too wants to join the offshoring bandwagon by improving IT infrastructure and offering tax breaks.

Conclusion

IT offshoring is still a very small part of total outsourcing market. It is expected that offshoring will keep growing at 25-30% annual rate for near future. Indian firms with highly skilled English workforce have competitive advantage over other part of the world. Furthermore, Indian IT firms have increased investment in staff training, designed flat hierarchies across organisation to promote knowledge sharing and entrepreneurship (Mathur, 2007).

Nevertheless there is need for Government to focus on infrastructure mainly Power and Road/Transport infrastructure which in current scenario can't keep up with rapid economic growth. To remain competitive and thwart off any threat from other offshoring market like Malaysia, Philippines, Mexico or Russia, investment in Education and training to make graduates employable is essential. With world recovering from economic crisis, Indian IT/ITES firms need to focus long term to remain competitive.

Until then Indian IT/ITES firm are playing by basic rules by forming stability where competition threat ensures a coarse environment in which established players are continuing to enjoy oligopolistic profits (Whittington, 2001, p. 95).

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