Low margins may force rethink on biz models

It is no secret that large parts of the information technology business have become commoditised with players forced to compete on price.

This could lead to net margins of Indian software companies being reduced to single digits unless they rework their business models, say industry experts.

The tremendous pressure faced by the Indian companies on pricing clearly reveals that none of top players have made much headway in this regard.

The sheer fact that Infosys’s 12.8 percent revenue growth in Q4 FY03 was offset by 5.1 percent price decline shows that Indian companies need to cover much ground in this regard.

Another major issue confronting the industry was the possibility of global IT services majors such as Accenture, EDS and IBM Global Services taking on the Indian IT companies with a low-cost option.

The industry has also not made much headway in its attempt to derisk the business by ending its over-dependence on the US market.

Though companies have succeeded in making a foray into Europe and Japan, the US still accounts for more than 70 percent of the business of the top players. In FY03, the US accounted for 71.7 percent of Infosys’ revenue while Europe provided 18.4 percent—a marginal increase compared to 16.4 percent in FY02.

“The margins for mainstream offshore work will dip to 10 percent shortly and then move into single digits. There is a low entry barrier in the industry (in India) and there is overcapacity. The double-digit margins (of Indian firms) were the result of a combination of high-margin work and low-margin operations,” said Harry You, chief financial officer, Accenture, at a recent ‘Global Software and IT Services Conference’ hosted by Lehman Brothers.

“Interesting business models are being evolved by Indian firms. In certain sections of their business such as maintenance, low level development, business process outsourcing—they act as software factories, where they control costs in a very strict manner. Then, they offer consultancy services, often by hiring expensive consultants. In effect, there are also distinct and separate sections within a IT firm,” says an industry consultant.

Another strategy is to develop products within a services company. Product development is an inherently risky business, but the payoffs (if successful) can be big.

“Services firms are trying to mix segments with differing margins. Development and maintenance, which account for over 50 percent of most Indian companies’ revenues, are a low margin business. Services such as package implementation, which have seen a lot of traction recently, provide better margins. High margin services include consultancy and product or IP-based solutions,” the consultant adds.

— The Financial Express