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Krishnan Thiagarajan

Mr Phaneesh Murthy now runs Primentor, a US-based consulting outfit that provides business process-related advisory services. He was earlier the head of global sales at Infosys Technologies. In an interview with Business Line, Mr Murthy provides his perspective on the theme of outsourcing and the various issues confronting the Indian IT industry.

Excerpts from the interview.

Trends from almost all research outfits, such as IDC or Gartner, seem to suggest that the global technology spending will continue to remain depressed for 2003. Do you think that spends on IT itself may suffer, affecting growth in application development activity through offshore outsourcing?

Overall spending levels are expected to be down in 2003. This is due to a combination of many factors — more consolidation of data centres, more offshoring, less investment in newer initiatives and so on.

But the trend towards offshoring remains very strong, and this means that the application maintenance and application development work will continue to move offshore in addition to some new services. I anticipate that there will be volume growth in excess of 30 per cent to India this year.

Even though offshore outsourcing has become mainstream and strategic, the demand visibility continues to remain poor. Market intelligence seems to suggest that decision cycles continue to be six to nine months long...

Demand visibility is not very poor — I think we have just got spoilt in the past — most of the large companies in the space should have a visibility in excess of 80 per cent of the year's revenue at the start of the year. I consider this very good. The problem, I think, is that margin visibility is reduced because of renegotiations and so on.

Decision-making cycles are the same but as the Indian companies go for the larger deals — they have to contend with longer decision cycles.

I think this is less a factor of the environment and more a factor of deal size.

For almost all the frontline companies, the onsite to offshore conversion appears to be slowing down.

Though the higher onsite contribution is being attributed to package implementation and other high-end areas, do you sense that this conversion is having an impact on operating margins of different companies?

Margins are coming down largely because of lack of investment, and in this environment people are not planning to invest more in building solution sets, frameworks, and so on. Only when you do that can you offshore work more easily even in areas such as package implementation.

I maintain that there is potential to have PAT of over 25 per cent if the right investments are made in both solution sets and the brand.

The management guidance by Infosys and the performance of Wipro clearly show that gross/operating/net margin are under pressure for these companies. How much of this, in your opinion, is purely attributable to billing rate pressures?

Almost all the current margin pressures are because of billing rates. In this industry, there are three main levers for margins — the bill rates, the onsite offshore mix and the utilisation (particularly onsite, but also offshore). The bulk of work to India continues to be on a T&M (time and material) pricing structure and, hence, the bill rates play a serious influencer on margins. Also, without higher value services having a market right now the services mix also puts pressure on bill rates.

To what extent have frontline companies, such as Infosys or Wipro, built up board level connections to undertake more high profile multi-million dollar, multi-year relationships, going forward?

Board connections are there for Infosys or Wipro. Wipro probably acquired some based on its consulting companies' acquisitions.

But can they put together the stories and solutions that make sense at that level and do they have the appetite for the kinds of deals that are done at that level?

It is being said that billing rate pressures have emerged from two fronts: One, the US and European companies have understood the Indian offshore business model so well, that in a downturn driven by cost efficiencies they are forcing volume discounts, price re-negotiations more often than at any time in the past.

Second, the global vendors, such as Accenture or IBM Global or EDS, are offering the same rates for outsourcing as the Indian companies and, thereby, they have built an artificial cap on billing rates, and they also have aggressive ramp-up plans for the future...

I absolutely agree that with the offshore model gaining maturity and customers knowing what it takes to manage them they are more willing to work with lower cost players which forces the larger companies to lower prices to keep the customers. Also, the pressure of companies trying to build critical mass in India is quite high with prices in the high teens.

Unfortunately, I think that the current situation requires more thinking and innovative models, and while I see Wipro trying to address some of these challenges the others do not seem to be.

On the other hand, Wipro's top line growth continues to remain weaker than the other big players.

Do you think that billing rates alone explain the current predicament of the industry? Despite fall in billing rates, the utilisation rates continue to be near optimum levels of over 70 per cent. Do you think that trial projects are being billed free of cost, and that is further affecting the billing rates of the industry as a whole?

I think that billing rates are the primary reason for fall of margins.

The smaller companies have always done projects free of cost but the larger ones I think have stayed away from these and continue to stay away.

Both Infosys and Wipro have recruited 3,000-4,500 employees this year.

Do you think that this recruitment is aligned to the volume-led growth of these companies, or do you foresee any near term glitches on this front?

I think utilisation levels will fall for a couple of quarters as these people get trained and then get absorbed — but this is the recruitment time and they have to make the offers for people to join in the June/July time frame.

If you are committing revenue growth and prices are going down, then the growth only comes from volume and that this bet that these companies are making.

What is your opinion on the scope for acquisitions for large players such as Infosys and Wipro? How do you perceive Wipro's strategy of three acquisitions in the past six months?

Each company makes acquisitions based on a broader philosophy and whether the benefits of the integration are good.

Companies with strong homegrown cultures have a bigger problem in integrating acquisitions and companies with their own, and rightly tend to be more conservative and wary of these.

It is difficult to comment on right or wrong here until the integration benefits show.

On moving higher up the value chain

WHAT is higher up the value chain? Can we not move up the value chain in each of the areas that we are working?

Maintenance can be done on a fixed price with tools used to reverse engineer and gain knowledge and tools used to increase productivity. Indian companies, in general, prefer the bull method of putting more bodies on the problem: This gives quicker returns. IT outsourcing deals do involve people and asset transfers and there are likely to be negative or flat margins for one or two years, and then higher margins down the line.

I think that largely M&A within and among Fortune 1000 companies has been low — except in the telecom sector — in most other sectors the acquiree has been a smaller company and that seems to be the lower appetite now for risk.

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