Interesting views have been shared in media. Views of whether the Indian Rupee is appreciating or the US Dollar is depreciating. Or there is a combination of both. This debate will continue till the 'cows go home'. The point is; whichever side we look at it, profitability of Indian IT companies is getting hit.
To recap, the 1st wave of outsourcing was about sending engineers to the US to work here at low salaries. The 2nd Wave was about taking applications and moving them offshore. Using low cost labor and gaining out of labor arbitrage. Profitability is based on the value difference between the Indian Rupee and the US Dollar – of course, the standard of living and competitive industry salaries were the key factors which kept the salaries lower in India. The Western world gained from this. This helped them reduce their costs and keep the light burning.
Here's a view of Indian IT companies have depended on till date:
- Playing the price game in a commodity market – Large enough market for this
- Zero differentiation
- key earnings come from Labor arbitrage
- Zero differentiation
- Strong processes supporting the 2nd wave in the framework of a lower valued Indian Rupee
- More emphasis on volume of programmers rather than quality of talent
- Finally, they have focused on breadth
- More the verticals the merrier
- Scale is the game
- More the verticals the merrier
In one line, cheap commodity business, with high operating costs and a shot gun approach.
This is exactly how the second wave of outsourcing describes a successful company. Exactly how each of the biggies of the Indian IT industry has grown. So what's wrong with this silver bullet today?
Moving back to today's scenario of Indian Rupee going stronger against the US Dollar (relative to the earlier years), there is a reality check that every outsourcing firm grappling with. The issue is simple. Less Indian Rupee flows in for every US Dollar of earning. Hence, the charts show a dip in profitability. If profitability is lower, can the industry continue with the ride that it has had over the years?
During a Sunday brunch in Redmond, WA, a prominent person from the Indian IT industry spoke about the pressures he is facing from investors and how difficult it is to get clients to pay more money, "we can't expect them to pay us higher monies for the same work. Some client may pay us more, but that is a short term solution". He is bang on target; this is certainly not a solution as the 'green' is depreciating back here in the US. Outsourcing companies are riding the 2nd wave of outsourcing – it has been a successful one – till now. I presume it will still hold good for the next 2-3 years. But there will be pressures on new business acquisition, quality of talent, process efficiencies, margins and finally valuations.
Why does this change / fluctuation in the currency (hope it is only a fluctuation and not a change) get Indian IT companies sweating? One, it has real and tangible impacts on their businesses in the short and long term and two, it is difficult to change the way they have been working – doing incredibly well for a couple of decades.
If (God or markets forbid) the Indian Rupee appreciates to a high of below mid 30s against a USD, hell will break loose. The IT industry could bottom out due to profit pressures and marginalization of quality resources. The silver bullet needs to be changed to something that provides tangible value in a more differentiated market – the 'new', 'improved' and 'power packed' silver bullet. The objective is not to make it sound threatening – it's just a reality. Part of a business cycle.
In the next article, I will try to provide options of tiding this business cycle. In the mean time, your comments, your thoughts and views are welcome.
