Software Sector Analysis Report

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[Key Points | Financial Year '14 | Prospects |

Sector Do's and Dont's]

Global IT spending, which picked up in CY13, is expected to maintain a decent growth in CY14 as
the economic situation in the US and Europe continues to improve. Discretionary spending on IT
budgets by large global corporations has ticked up compared to last year but is limited to the new
digital technologies. In terms of industry verticals, Banking, Financial Services and Insurance
(BFSI) and Energy are the growth drivers.

Indian IT companies had a good year in terms of financial performance, driven by factors like such
as the improvement in the quality of service offerings, stable pricing environment and the
depreciation of the Indian rupee. Indian IT firms continue to move up the value chain by providing
more end-to-end solutions and engaging more closely with clients. They are also increasingly
relying on internal cost optimisation measures to improve profitability.

India's IT industry can be divided into five main components, viz. Software Products, IT services,

Engineering and R&D services, ITES/BPO (IT-enabled services/Business Process Outsourcing)

and Hardware. Export revenues, primarily on project based IT Services continue to drive growth
with IT Services. This accounts for 54.2% of total revenues followed by BPO and Engineering
services at 19.5%, Software Products at 15.3% and hardware at 11%. Multi-year annuity based
outsourcing agreements continue to increase at a steady rate. In terms of total export and
domestic revenues, Application Development and Maintenance (ADM) still continue to be the
bread and butter for Indian IT companies; however traditional services have become increasingly

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commoditised.

Labour arbitrage has been the competitive edge of the Indian software sector over the last few

years. However, the focus has now shifted to providing value to clients beyond cost savings.
Software services are being increasingly demanded by global MNCs which can boost sales as
well as improve internal efficiency.

Increasing competition, pressure on billing rates of traditional services and increasing

commoditization of lower-end services are among the key reasons forcing the Indian software
industry to make a fast move up in the software value chain. The companies are now providing
higher value-added services like consulting, product development, R&D as well as new digital
technologies like social media, mobility, analytics, and cloud computing (SMAC).

The new Indian government is emphasizing on better technology enabled delivery mechanisms

for a multitude of government projects. Further, with the new digital India initiative being launched,
the domestic market for software services looks forward to a bright future.

Key Points
Supply
Abundant supply across segments, mainly lower-end, such as ADM. Lower
supply in higher-end areas like IT/Business Consulting, but competition is
very tough.
Demand
The global downturn had put considerable pressure on global IT spending
but the situation is now improving.
Barriers to entry
Low, particularly in the ADM & BPO segments as these are prone to
relatively easy commoditization. It's high in value-added services like
IT/Business Consulting and R&D where in-domain expertise creates a
barrier. The size of a particular company/scalability and brand-image also
creates barriers to entry; as such firms have built up long-term relationships
with major clients.
Competition
Competition is global in nature and stretches across boundaries and
geographies. It is expected to intensify due to the attempted replication of the
Indian offshoring model by MNC IT majors as well as small startups.
Substitution of IT
services and
products

IT continues to be a driving force towards all aspects connected with our

lives. While a particular technology may become obsolete and a particular
company specializing in it may suffer, the obsolete technology can only get
substituted by a newer technology offered by the same/different player in the
IT/ITES industry.
TOP

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Financial Year
'14
The Indian IT/ITES industry earned revenue of over US$ 109 bn during FY14. Out of this, exports
accounted for 69.7% of the industry's revenue.

In terms of growth by industry verticals, BFSI, Telecom, Manufacturing and all emerging verticals
are expected to grow at 14%, 9%, 14% and greater than 14% respectively.

The USA accounts for about 53% of the export revenue followed by the UK and Continental

Europe, with 15% and 10% respectively. Other regions such as Asia Pacific are catching up, with
a contribution of 6.5%.

At the end of FY14, India's share in the global outsourcing market stood at 55%.
TOP

Prospects
As per NASSCOM, the Indian IT/ITES industry is expected to maintain a growth of 13-15% in

FY2015. NASSCOM has also envisaged the Indian IT/ITES industry to achieve a revenue target
of USD 225 bn by 2020 for which the industry needs to grow by about 13% on a YoY basis in the
next six years.

Technology research firm Gartner, expects global IT services spending to grow marginally by

4.2% in CY2014 to cross US$ 3,749 bn. As the global sourcing industry continues to grow and as
Indian IT companies continue to increase market share, outlook for the sector remains robust.

Emerging protectionist policies in the developed world are expected to affect the Indian IT

companies. Due to US restrictions on visas as well as rising visa costs, most Indian IT companies
are increasingly subcontracting onsite jobs to local employees in the US. Additionally, the new
immigration bill is still under consideration in the US which, if implemented, will significantly raise
employee costs for onsite workers. This would adversely affect margins of Indian IT companies.

Indian IT companies are increasingly adopting the global delivery model. They are setting up

development centers in Latin America, South East Asia and Eastern European countries to take
advantage of low cost and also cater to the local market. In the US, such centers will help mitigate
the risks of the new immigration bill and increase the probability of winning projects in highly
regulated sectors such as healthcare, government services, utilities etc.

ADM services, which used to provide major chunk of revenues to the domestic IT players, are

getting affected due to the falling billing rates. Hence, the companies are now venturing into new
high value services such as IT Consulting, Product Development, and the new digital SMAC
services.

The integration of IT-BPO contracts is expected to become more common, as clients look out for
end-to-end service providers. Large Indian companies like Infosys, TCS, Wipro, Tech Mahindra
and HCL Technologies, will benefit from this trend.

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 Billing rates are expected to remain under pressure in the short term. Therefore companies are
expected to preserve their margins through effective cost containment measures like shifting
more wore work offshore and improving employee utilisation. Lessons learnt during the global
financial crisis can benefit them in the long run.

Billing rates are expected to remain under pressure due to commoditization of traditional services.

Therefore companies are expected to preserve their margins through effective cost containment
measures like shifting more wore work offshore, improving employee utilisation and the increasing
use of automation software.
TOP

Related Links for Software Sector: Quarterly Results

NEW

| Sector Quote | Over The Years

VIEWS ON NEWS

Nucleus Software Exports: Not realizing full potential (Cool Hand Luke)
(Mar 20, 2014)

Luke Verghese discusses that Nucleus Software Exports remains dormant

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Wipro Limited: A well managed company (Cool Hand Luke)

(Mar 13, 2014)

Luke Verghese discusses that Wipro Ltd is a finely managed company

Zensar Technologies: Financially well run (Cool Hand Luke)

(Feb 13, 2014)

Luke Verghese discusses that Zensar Technologies is a well managed business

Mindteck India: Lacklustre financial performance (Cool Hand Luke)

(Jan 10, 2014)

Luke Verghese discusses that Mindteck India's financials are not great

Tech Mahindra: Good times to roll (Cool Hand Luke)

(Nov 18, 2013)

Luke Verghese discusses that Tech Mahindra is well geared to capitalize on demand
More Views on News

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Busting a few more real estate myths (The Daily Reckoning)

(Jan 21, 2015)

Those who make their money out of real estate will always try to justify high prices, one way or other.

An 80% chance for a market decline? (The 5 Minute Wrapup)

(Jan 24, 2015)

Going by this, it seems the Indian markets are about to enter the frothy zone.

Wipro: Good bottomline performance

(Jan 16, 2015)

Wipro has reported a 2.3% QoQ increase in the topline and an increase of 5.2% QoQ in the
bottomline for the quarter ended December 2014.

The impact of Swiss currency on India Inc. (Chart Of The Day)

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(Jan 17, 2015)

Will there be a rise in repayments for India companies on Swiss loans?

Why focused investment works? (What We're Reading)

(Jan 16, 2015)

Here is today's recommended reading list from Equitymaster...

More

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S&P BSE IT
11,098.64 (-0.49%)
Jan 29, 2015 11:34 AM
View Detailed Quote

5-YR ANALYSIS (FACTSHEET)

INFOSYS LTD

TCS

WIPRO

MAHINDRA SATYAM

HCL TECH.

TECH MAHINDRA

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COMPARE COMPANY
INFOSYS LTD (Change)

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