Structure of the Indian IT Industry - Case Study Example

Table of Contents Table of Contents 1 Introduction 2 Structure of the Indian IT industry 3 Important sectors and geographies 3 Uncertainties IN the business environment 4 Exchange Rate 4 Uncertainty in the order pipeline: 5 Uncertainty in the Political and legal Environment 5 Uncertainty in the Stock Markets 6 FDI and FII inflows in the country 6 The Satyam Scandal 7 Terror Attacks 7 The overall economic outlook 8 Going ahead 8 Conclusion 8 References 9 Introduction The current economic crisis which started in the US is unique in many senses. In no previous crisis the countries of the world were so deeply interconnected with each other as today. As a result the effects of the crisis were not visible not only in the US but also in the all the countries of the world. The crisis which started in the US then affected the EU and then rest of the world. This is evident from the dropping GDP, rising unemployment and lower investment in the economies worldwide. Although recent times have witnessed a ray of hope as a result of the Government bailouts but the actual impact of the crisis has not been confirmed yet. Even the developing countries such as the Brazil, Russia, China, and India were not isolated from the affects. Certain core sectors in these countries faced major impacts as a result of the crisis. For example, the textile, gems and the IT industry which were predominantly export-oriented have seen the major affect in India. India’s IT industry has been the major driver for the country’s economy since the process of liberalization initiated in the early 1990s. The majority of this progress is on account of the off-shoring where large companies in the US outsourced the key business processes and software development activity to India. This was beneficial as India was a market with abundant cheap labour. Because of this dependency of the Indian IT industry on foreign clients, it was majorly affected by the crisis. The crisis along with certain other reasons led to many risks (Bedi, 2004) in the operating environment of the Indian IT companies. The uncertainty regarding the legislation and rules regarding SEZs and STPIs led to Legal and regulatory risk. The uncertainty of the outcome of the General Elections led to political risk The overall gloomy macro-economic outlook both in India as well as outside led to direct environment risk through exchange rates, investment, IT spends etc. All these factors make it an interesting case to analyze the impact of the crisis on the Indian IT industry. This projects attempts to analyze the same factors, the problems in assessing political and economic risk while doing international business taking cues from the Indian IT industry. Structure of the Indian IT industry Important sectors and geographies The Indian IT industry catered to the needs of an entire gamut of sector from automobiles to finance. The industry was however majorly catering to the needs of the BFSI sector. In the year 2008, almost 41% of the revenues of the Indian IT industry were from this sector. BFSI is the most affected sector of the crisis. This resulted in an unfavourable impact on the industry. The industry witnessed uncertainty in the order and contracts. Major banks and financial institutions withdrew their contracts, others renegotiated the existing ones, and many contracts that were in the pipeline were halted as a result of the crisis. Figure 1 The various verticals of the Indian IT Industry (Source: Nasscom) The clients of Indian IT companies have their locations throughout the world. However, majority of the clients are in the developed US and EU markets (Nasscom, 2009). As these are the most affected regions of the crisis, the Indian IT industry suffered major blows. Uncertainties IN the business environment The Indian IT industry which was not aloof from the rest of the world had major impacts as a result of the financial crisis. Some of the uncertainties that IT companies faced as a result of the recession and the general business environment are: Exchange Rate Being an export-oriented industry, the fluctuations of exchange rate play a major role in the bottom lines of companies. Companies usually indulge in mitigating the exchange rate risk by entering into options, futures and other derivatives. The current economic scenario has made it extremely difficult to predict the likely direction of the currency. This is evident from the graph showing exchange rate of INR v/s USD. As shown in Figure 2, the fluctuations have been haphazard and it is difficult to predict the movement of currency. This makes it difficult for companies to go into derivatives as well as high value contracts. As a result, most of the companies are finding it difficult to minimize their exchange-rate risk. Uncertainty in the order pipeline: The IT companies have a long order cycle where finalizing an order and coming to a final contract deal takes a long time. Because of the economic crisis, various orders have been cancelled midway, clients refused to make payments in the middle of the project, and some clients even went bankrupt. All this leads to a lot of uncertainty in the order pipeline of the IT companies. Companies can no longer believe that a particular sales prospect will culminate into a profitable one or not. Besides this uncertainty, companies have also been facing downward trend on the pricing front. Companies are also uncertain about the prospects of a particular sector. Although all the sectors have been impacted deeply by the crisis, companies are of the opinion that sectors such as manufacturing and telecom will take time to come out of the slowness. However, sectors such as banking, retail, utility and financial services are beginning to show signs of recovery. Recent months have however suggested more confidence in the order pipeline and a slight hint of recovery (Chatterjee, 2009). Uncertainty in the Political and legal Environment 2009 was the year of the general elections in the country. Before the elections it was assumed that the government in power will be a form of coalition government. On account of this uncertainty, IT companies were not able to plan their operations ahead. Different political parties had different viewpoint towards the Indian IT industries. With uncertainty in the possible form of government, it was difficult for the companies to draft a clear strategy. However, the general elections results were counter-intuitive and Congress witnessed a clear majority in the house. This has bought certain amount of stability and confidence in the Indian market. A major legal driver which impacts the strategy of IT companies is the Software Technology Parks of India (STPI) scheme. This scheme exempts software companies from paying taxes for business conducted outside India. Earlier it was applicable till March 2009, but on account of the sub-prime crisis, the scheme was extended till 2010 (IndiaInfo, 2008). This scheme however is said to be more favorable to the larger players and smaller comapnies do not possess the adequate size to take advantage of this scheme. Nevertheless, the extension of the STPI will help IT companies to a certain extent. Uncertainty in the Stock Markets Stock markets are an important indicator of a country’s economic scenario. The financial crisis had a deep impact on the stock markets of every country. The benchmark stock index in India is the BSE. The figure below shows the movement of the Sensex-30 Figure 3: The BSE Sensex Chart from September 2008-September 2009 (Source: advfn.com) The early effects of subprime crisis were visible in September 2008. The bankruptcy of Lehman Brothers was the first symbol that led to a downfall in the stock market of India. As a result of this drop, IT companies were not able to raise capital from the market for a long period. Moreover, there were very less investment activities in the country as well as the rest of the world. The clients of IT companies did not have enough funds to initiate large-scale IT projects. All this led to a decrease in the orders of the IT companies. IT companies had to rely on their own cash reserves during this period. FDI and FII inflows in the country The IT companies are amongst the biggest receivers of the FDI and FII in India. With the major economies of the west reeling under recession the FDI and FII inflows in the country suffered a major downfall. The drop in the investor confidence in the country also meant that Indian IT companies can not raise capital through the QIPs. Because of the uncertain time line of the recession and the environment of the Indian IT industry, the drop in FDI/FII resulted in cash crunch in the Indian IT companies. The Satyam Scandal All the reasons above made it difficult for companies to survive. These factors led to the exposure of biggest corporate fraud in the Indian history. The Satyam Scandal which has been among the top 4 IT companies of India was one thing that the Indian IT industry could have done without. The low cash from the sock market and foreign investors forced the company founder Ramalinga Raju to admit the true financial status of the company which was covered up by fraud financial statements for many years. Although this was considered as a one-off incident (Iyengar & Karamouzis, 2009), yet, the investor confidence in the Indian IT industry was terribly shaken. Foreign investors were now more apprehensive of investing in tech stocks in India. The episode also led to a decrease in the credibility of the IT industry and companies who were in the order pipeline withdrew there offers because of this. Terror Attacks The Mumbai terror attacks in November 2008 were another blow that hit the Indian IT industry hard. The attacks exposed the vulnerability of the Indian security system. The attacks increased the apprehensions of the foreign investor and investors shied away from the Indian IT market. Clients abroad were also afraid if a terror strikes the campuses of the Indian IT companies and the effect on their operations as a result of such attacks. This increased the focus on a multi-location strategy for Indian IT companies. The overall economic outlook Although the world is seeing slight indications of a recovery in the recent times, yet there is uncertainty in the actual timeline of the recovery. There are also apprehensions if the recovery might be a W shaped and the world may enter into recession again. It companies are facing uncertainty in their demand outlook from existing as well as new businesses. Companies have been cutting on their IT expenditure. The crisis has also led to renegotiation of the contract terms with the suppliers and an overall reduction in discretionary IT spend. All this signal a worrying situation for the Indian IT companies. Going ahead In-spite of the tough economic situations there are certain positives from the current environment. With many companies struggling to stay afloat, they are seeing off-shoring as a major cost-cutting initiative. This can be a major reviving factor for the industry. Previously, the industry was pre-dominantly dependent on the US and UK for its revenues. However, the crisis has signalled the end of US dominance over the world economy. As a result, Indian IT companies can look for clients in other countries. Moreover, new model such as SaaS are redefining the way IT can be delivered. Indian IT companies can look to specialise in these models. Conclusion Although the economic situation is tough and the scenario looks bleak, there appears to be certain opportunities in the long-term. Intelligent use of these opportunities will help the Indian IT companies tide over the crisis. Endnotes References advfn.com. BSE Sensex. [Online]. [Last update on 30th September, 2009]. Available at: http://www.advfn.com/bse/SensexPrices.asp?index=SENSEX Bedi, S. 2004. Business Environment. New Delhi: Excel Books. Chatterjee, S. 2009. Tata Consultancy CEO says demand pipeline good. [Online]. [Last updated on 7th September, 2009]. Available at: http://in.biz.yahoo.com/090907/137/bau5b7.html IndiaInfo, 2008. STPI extension has little for the small guys. [Online]. [Last updated on 30th April, 2008]. Available at: http://finance.indiainfo.com/2008/04/30/0804301258_stpi_extension_has_little_for_the_small_guys.html Iyengar, P., Karamouzis, F. 2009. What the Satyam Debacle Means for the Indian IT Industry. Gartner Research. Nasscom. March 2009. Indian IT-BPO Industry 2009: NASSCOM Analysis. [Online]. Available at: http://www.nasscom.org/upload/5216/IT_Industry_Factsheet-Mar_2009.pdf. Yahoo! Finance. U.S. Dollar to Indian Rupee Exchange Rate, 2009. [Online]. [Last Updated: 28th Sept. 2009]. Available at: http://in.finance.yahoo.com/currency/convert?from=USD&to=INR&amt=1&t=2y Read More