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September 24, 2007

IT Services & BPO: Are the best years behind us?

There are now several voices raising concern on the future of the Indian IT Services and BPO sectors. Business Standard has kicked off a four part article series on the topic.
Rising wage costs, competition from countries like China, the impending withdrawal of tax incentives under the STPI scheme, the slowdown in the US and the rising rupee have all punctured the optimism of the industry.

With the dollar falling below Rs 40, the margins of IT companies have been cramped even more. Ashish Basil, a partner with professional services firm Ernst & Young, says the falling dollar has impacted the BPOs more than software services exporters because all their costs are borne in India.

“Most software firms have a large number of employees abroad. A falling dollar reduces the salary burden of these employees to that extent,” he said, adding, “For a two per cent fall in the dollar, the margin of a software firm will go down by 0.6 per cent and of a BPO outfit by 1.5-1.6 per cent.”

How are PE/VC investors viewing these developments?

I threw the "Are the best years over for the Indian outsourcing industry?" question to Sanjeev Aggarwal, Managing Director of Helion Ventures who was part of a panel that I was moderating at the CII-Connect 2007 conference in Chennai last week. This is what Sanjeev (who earlier founded and led pioneering BPO firm Daskh - before selling it to IBM in 2004) had to say:
Only a small sliver of the global outsourcing pie has actually moved to India. The penetration in IT services is just about 5% of the world market and in BPO it is even lower at 2-3%. Also, no other competing country has been able to demonstrate the same level of scale (as India). When I was at Daksh, we tried various locations, but found that countries like Philippines maxed out when the numbers hit 3,000-4,000. So, if we can tackle the supply side situation, there is a lot of headroom for growth.

However, (going forward), the growth will come not from horizontal services like application services management or call centers, but more from vertical industries like equity research outsourcing, business intelligence, LPO, etc. So, we are very optimistic. Out of the 11 investments we have made, five are in IT Services or KPO. And we feel the best is yet to come.

Basab Pradhan, former head of sales at Infosys and now Co-founder & CEO of Gridstone Research (incidentally, a Helion portfolio company), has an interesting blog post on the same topic providing some options for entrepreneurs in the industry:

* Diversify – ...Look at services where you can hire graduates and make it work. Also, BPO is not one service line. There is a large variety in the kinds of services, markets, and talent required, that all fall under the grab bag called BPO. * Look for growth outside the US...

* Specialize – ...Emerging technology areas like Open Source products offer good opportunities for specialization.

* Build IP...

* Invest in Sales and Marketing...

* Cash in – If you don’t have scale and you don’t have or don’t want to do any of the above – sell the company. You’ll still get a nice multiple today and save yourself a lot of trouble. You’ve built something of value. Maybe its future is better served as part of a larger enterprise.


For more on this topic, check out the post event newsletter of Venture Intelligence's recent conference IT Services & BPO Connect here.

Arun Natarajan is the Founder & CEO of Venture Intelligence, the leading provider of information and networking services to the private equity and venture capital ecosystem in India. View free samples of Venture Intelligence newsletters and reports.