How far are we from $87 billion?

Nasscom and McKinsey’s famous study findings released in December 1999 dreamt big dreams for India’s software industry. But with the slowdown coming in, and with many “growth enablers” to achieve those dreams still not completely in place, where is India placed on the road to achieve those dreams? Ivor Soans, Rajneesh De and srikanth r p report

IN THE NEWS

At 2:30 pm on Wednesday, February 6, Nasscom 2002 has a seminar titled simply: Nasscom-McKinsey update. No speaker name is mentioned on the schedule, unlike all the other sessions at Nasscom 2002, and the post-lunch timing when everyone’s in a sedate mood, is a bit uncharacteristic too.

After all, the Nasscom-McKinsey study is arguably the most quoted document when it comes to the future of the Indian software industry. And that figure of $87 billion in 2008 ($50 billion coming from software exports and the domestic software market making up the rest) is definitely the best known figure in India’s software industry.

Therefore, when a session that seeks to provide an update on this most important of studies on the Indian software industry is almost hidden away, it makes one wonder. Perhaps the new post-Dewang Nasscom no longer puts much weight behind the McKinsey study. Perhaps everything’s gung-ho, going so well and perfectly on track that the session will simply be just another feel-good session for a few insomniacs. Or perhaps Nasscom and McKinsey have updated the figure by such a significant margin that they don’t want to let the cat out of the bag a minute earlier than necessary, and don’t want to scream from the rooftops that big calculations might have gone a bit awry—with the slowdown perhaps being the fall guy.

Whatever the truth is—both Nasscom and McKinsey aren’t telling anything right now. No numbers, no status report on just how far we’ve come down the $87 billion dollar road, where we stand today—everybody’s willing to talk only after the seminar at Nasscom 2002. But then, the question still nags. In the light of the biggest mauling that India’s software industry has ever got—thanks to the slowdown, 9/11, etc, are we still doing good time on that road, or as some sceptics say, are we still on the road in the first place?

That’s the answer we seek to find as we examine some individual areas of the original report. But if it’s any indication of how the industry sees things, most CEOs we spoke to believe that $87 billion seems a tad too long to reach for, at least as things seem today. One exception is N R Narayana Murthy of Infosys: “Though the current slowdown has made many sceptics doubt the potential of the Indian market to develop into an $87 billion IT market by 2008, we believe that the potential still exists. There may be a slowdown in certain services now, but simultaneously there a lot of other potential sectors opening up. Though on paper the target seems ambitious, we are on track to achieve it.”

But most others like don’t seem that confident. Ganesh Natarajan, deputy chairman and managing director of Zensar believes from a current standpoint that the 2008 figure will be closer to $60 billion, with $40 billion coming from software exports and $20 billion coming from the domestic market. “We have hit a roadblock, and the whole trend of the industry has changed. Take just manpower needs for instance—all those projections of needing millions of people, have hit a roadblock. What the Indian software industry needs to do is to move to a higher level of capability, and I feel that only 20-25 companies will be able to successfully make this transition.”

Coming down to brass tacks, the original study said that India has unique opportunities in four broad export areas: valued-added IT services, software products, IT-enabled services and e-business. The study went on to say that exceptional execution against seven “growth enablers” (supply base of knowledge workers, ideal regulatory environment, Anchor MNCs, India Inc. brand, country-specific initiatives, communications infrastructure and venture creation) will be necessary for Indian companies to successfully capture this opportunity.

IT services

Indian companies have definitely made the most of the opportunity to Web-enable legacy applications, and in middleware-based legacy systems integration. Ditto with Web/package-based services in e-commerce, but not so much in knowledge management and convergence. Two sectors that the study had recommended that Indian firms focus on here—ASPs and dot-coms, have virtually bitten the dust. And while the move up the value chain too is happening as Indian firms see this as one sure way to move away from low margin to high margin, high value business in the form of high-end consulting, it’s only the large players who might be able to make the shift successfully. The emergence of countries like China into the lower-end may in fact completely skew calculations, especially if smaller Indian software firms bite the dust.

Products

Ah, products! For years, the pundits have been telling us that we need to move into product development, and the Nasscom-McKinsey study spoke in the same vein. But sadly, not much seems to have happened on the ground in this space. The same players continue to hog the limelight. High investment into R&D for development of products is still strictly a no-no for most Indian companies. Many Indian companies who were initially inspired by the success stories of companies like i-flex have now stopped all plans to make their foray into product development. The slowdown has made every company stick to its model of the ‘safe and tested model’ of offering services. ‘Survival’ is the mantra today, rather than ‘growth.’ Banking seems to be the only segment where Indian firms have hit it big in the product space. Banking products from i-flex, Infosys, TCS and Nucleus compete globally, and are respected globally too. Financial accounting packages like Tally and EX have also gone global. One interesting trend here is that most global product giants have significant R&D bases in India. So, while Indian firms themselves haven’t gone too far down the product road, the MNCs are leveraging Indian minds in this space.

IT-enabled services

The Nasscom-McKinsey study felt that India could build a $17 billion IT-enabled service industry by 2008. The fastest growing segment within the IT-enabled services market, digital content development (or animation), is estimated to rake in revenues worth Rs 1,600 crore in 2001 and employ over 27,000 people countrywide. Services worth $300 million have already been outsourced by major studios because of the cost advantage.

Call centres are also going great guns. Nasscom estimates that the call centre industry had a turnover of Rs 850 crore besides employing 16,000 people as of March 2001, with Rs 400 crore and 8,600 being the corresponding figures for 2000. The industry size is predicted to reach Rs 1,000 crore in 2001-02 and Rs 3000 crore in 2002-03. The domestic call centre industry employs an estimated 5,000 to 10,000 people and is growing at 30-40 percent per year, while international call centres employ over 25,000 people and are growing at 50-70 percent per year.

While great opportunities exist in medical transcription too, lack of trained manpower and government bungling may affect this sector. In fact, consolidation is already taking place within this space, with a large number of small units shutting shop, while the big guns in the urban areas are doing well.

BPO is the new buzzword in IT-enabled services. This includes outsourcing administration, finance, HR, payment services, sales and marketing functions to Indian companies. Says Sujay Chohan, country director, Gartner India, “Currently Indian companies have been bagging basic people-intensive projects, but what must be kept in mind is that this whole movement towards BPO is still relatively new and is only now beginning to gain momentum.”

E-business

E-business transactions in India has been witnessing a steady growth from Rs 131 crore in 1998-99, Rs 450 crore in 1999-00 and Rs 2,300 crore in 2000-01 touching Rs 7,500 crore in 2001-02. And this volume is expected to touch Rs 20,000 crore in 2002-03 and a whopping Rs 195,000 crore by 2005 which would make India a major player in the world e-business scenario.

There are many problems besetting the adoption of e-business solutions by the Indian industry. Foremost is the issue of technological uncertainty. Improper telecom infrastructure is a major bottleneck. The first and foremost problem being infrastructure issues such as the Internet backbone. We have seen several players who have invested in laying fibre optic cables across the country and this issue should be hopefully resolved in the coming months.

Strategic uncertainty is another major concern. Here, various organisations are coming up with different strategies, thus causing a lot of uncertainty. E-business is a vast arena and every new entrant seems to concentrate on different strategies. Again, payment systems are not formalised and organisations can have different strategies regarding this. Moreover, lack of proper regulatory mechanisms is stifling the growth of payment gateways or EFTs, a vital component in any e-business setup. Early Mobility Barriers is another drawback. In this industry, it is the concept or idea that gives a firm an advantage over its competitors. Proprietary technology in this industry is the idea, the rights to which rest solely with the creator/owner. This creates an effective entry barrier for other aspirants. There is a definite cost advantage associated with the technology as well as the volumes of transaction a firm is able to generate. These economies of scale form another entry barrier.

Domestic spending

While the financial services industry is the largest constituent of business for Indian software companies, and growth there is on track, the same cannot be said of government spending. Says a software company CEO, “Indian states are broke, and while big plans are drafted, budgets simply don’t exist.” And e-governance, another vital pillar of government spending on IT, is virtually turning out to be a joke. Of the targets set by the Ministry of Information Technology in 1998, 40 percent remain unachieved, and most of them are related directly or indirectly to e-governance. And local language software, an important part of pushing up domestic consumer spending, continues to lag. Neither users nor vendors seem to be enthused in this space.

Venture funding and regulatory environment

Though in the year 2001, investment to the tune of $1 billion was made by venture capitalist firms in India, the Indian government remained bureaucratic and highly regulated, making it an extremely difficult environment for any VC to operate. There continues to be a confusing array of newly created statutes and regulatory bodies in place.

Income tax rules provide that VC funds may invest only up to 40 percent of the paid-up capital of a recipient firm, and also not beyond 25 percent of their own funds. Finally, SEBI regulations do not have any sectoral investment restrictions, except to prohibit investment in financial services firms. The result of these various restrictions is a micromanagement of investment, complicating the activities of VCs.

India’s corporate law does not provide for limited partnerships, limited liability partnerships, or limited liability corporations (LP, LLP, and LLC, respectively). Moreover, corporate law allows equity investors to receive payment only in the form of dividends (i.e., no in-kind or capital distributions are allowed). Disclosure requirements are however consistent with best international practices. However, in the absence of seasoned institutional investors, advanced-country standards of investor protection that would normally be imposed by such investors have not developed.

The restrictions on venture capital extend beyond the framework of corporate law. For instance, tax restrictions on corporations require that corporations paying dividends must pay a 10 percent dividend-distribution tax on the aggregate dividend. On the other hand, trusts granting dividends are exempt from dividend tax. For India to have an optimal environment for venture capital, it requires a tax regime that is fiscally neutral from the viewpoint of tax revenue. The environment should also be tax-competitive with other domestic uses of institutional and private equity finance, particularly the domestic mutual funds sector. However, the tax code in 2001 is disadvantageous from the viewpoint of the international venture capital investor. Earnings from an international venture capital investor are taxed even if it is a tax-exempt institution in its country of origin.

Currently, foreign venture capitalists require permission from the RBI/FIPB for each investment and liquidation. The RBI’s formula for disinvestment is based on physical asset value and benchmark price-earnings ratios, both of which are often irrelevant. For example, a firm that has primarily intellectual property and makes a loss may still be valuable, but Indian rules do not allow it to be valued properly. Finally, foreign and domestic firms cannot repatriate capital or earnings without further regulatory involvement.

Cyber laws are finally here, but many vital issues like recognition of any kind of digital signature, are still lacunae that need to be dealt with. And most experts say that India has gone overboard on the Convergence Bill (Malaysia is the only other country with a convergence law). There are still serious doubts about the role of the regulator and issues related to free speech in the Convergence Bill.

Telecom infrastructure

This area has definitely seen a lot of progress, but unfortunately things in all segments here haven’t progressed as quickly as was needed. BSNL has been set up, private national long distance is finally here, international long distance privatisation is well on the way, but many issues still hang. For instance, inter-connect, CPP (calling party pays) have yet gone nowhere. On the local loop, the recommendation to bring in a bill of customer rights with stringent penalties for failure to meet service levels has also not progressed.

The National Internet Backbone is progressing, but at a slower place. And the much-touted Sankhya Vahini project was finally given a formal burial recently. While international gateways were allowed sometime ago, the fracas between VSNL and FLAG ensured that no submarine cable-based gateway could be set up by private players. It’s only days ago that the government finally put its foot down and ensured that FLAG could sell to private players, and also brought down bandwidth costs. Private submarine cables are also expected only next year or so, and till then, bandwidth prices will continue to remain quite high.

And VoIP will only be legalised by April this year, but the confusion over ISPs not being allowed in this space means that lots more issues are yet to be sorted out.

Country initiatives

This is one area where Indian software firms have definitely shown much results. However, more than the recommendations of the Nasscom-McKinsey study, what prompted the move to Europe, Japan, etc, has been the US slowdown. However, the US still remains the biggest market for Indian software. While business in geographies like Europe and Japan is growing at a fair clip, Indian firms have miles to go before they dominate in these complex markets where language and cultural issues create multiple impediments.

OPPORTUNITIES

IT services
Software products
IT-enabled services
E-businesses
Domestic market

GROWTH ENABLERS

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