'IT sector growth may not match 2004-05 levels'

SMART TALK/ S Mahalingam, chief financial officer, TCS

, chief financial officer, Tata Consultancy Services (TCS), expresses his views on the software services sector and TCS. A chartered accountant, Mahalingam joined TCS in 1970.

He has been instrumental in the growth of TCS into Asia's largest IT services company with over $1.5 billion in revenues, employing over 30,000 professionals. Excerpts from the interview:

What kind of growth do you see for the IT sector this year?

The industry is doing well as the push towards off-shoring continues. But the interesting thing is outsourcing as a concept is gaining acceptance in most corporations.

Small and medium enterprises are also looking at it favourably, especially when you look at Europe. Companies with scale and ability to manage it have been able to capitalise on this.

In my view, we may not see the same level of growth as 2004-05. Because bigger the base, the more difficult it is to grow. In absolute terms, there will be growth but it won't be as good as this year.

How is TCS positioned?

You need to look at TCS's position in the context of dollar depreciation. The dollar is depreciating across all currencies. But still you have to do a good amount of business with US because it has tremendous business potential.

At the same time, you also need to diversify to the extent possible. In this respect, TCS already has the largest geographical spread among Indian IT companies.

We have seen growth across geographies in the past quarter, too. We have had much greater push in some new geographies like continental Europe.

Our model is oriented towards relationships with the emphasis on both fixed-price (where the investment that the customer has to make is capped) and time and material contracts, serving customers across geographies (since we are talking about multinations) and then utilising alternate development centres whether it be India or other growing areas like China, Hungary, South America and Uruguay.

What is your view on the profitability of the sector and TCS?

As we grow in size, we need to invest a lot. We need to invest in newer technologies. We need to get into more selling and branding exercise.

So some changes will have to take place. My personal view is that on a long-term basis, as we grow bigger and bigger, margins will reduce. The reduction will happen when operational efficiency parameters are optimised.

There will be a period where margins might improve or stay in line even as the dollar depreciates, the wage inflation takes place and prices may stay constant or marginally increase.

But at some point that will level off. This is a period of increase in efficiency. If you see TCS' result in that light, we have improved operating margins.

We have improved through efficiency gains, and improvements in pricing are coming from increased value added services.

Would you say billing rates are on a rise?

Customers do not pay more for the same service. They ask for more. There is a geograhical dispersion, which mean we can acquire a new customer in a new geography at a higher price point for the same work. But for the same service you may not be able to get better prices in the same geography.

However, if you unbundle the services or package it in a way that you offer more - say in the form of consulting or process management or performance tuning and so on - then you can charge a higher rate.

The pre-1999 prices are not going to come back. But after that and 9/11, billing rates came down sharply. Even that is past. Now, prices have stabilised.

How are you protecting yourself from the risks of dollar depreciation?

It is difficult to take a call on the currency. At TCS we believe that we should be prepared for dollar depreciating to around Rs 42-43. At that level, can we maintain certain absolute value in terms of profits.

We are interested in terms of the absolute number, because we have certain plans in terms of capex and so on. And even the stock markets plot a company based on the returns it is able to generate.

Earlier, we used to say if we booked debtors at a certain price, we should be able to get it back at the price we booked or better. We restricted ourselves to three months of debt position.

But with the currency yo-yoing we decided that we needed to look beyond that. So, now, we look at a maximum of 12 months and strategise based on the net position since we have both dollar revenues and dollar expenses.

At the end of December 2004, we had a forward cover of $600 million or about 8.5 months of receivable was hedged. Contracts are on an yearly basis; so we may book revenues in terms of our monthly bills.

But we are trying to protect profitability at the customer level, too. Since exchange rate has a major impact on profits, we do this exercise constantly. It is a part and parcel of doing a global business.

Do you see a polarisation in the sector, that the large players are growing bigger and mightier, but smaller ones are getting marginalised?

I thought everyone was smiling. One can't make a judgement based on performance in a particular quarter. If we are saying that tier one is growing while tier two is not and there is a period of consolidation, I would want to give it some more time.

Because you need to view this from the customer's point of view. As customers grow, they look to diversify and also look to those who can provide better service.

Now, whether these customers will give that additional business to other Indian players or to players outside India is a matter of choice. So we need to wait and watch.

Do you have any self-imposed restrictions in terms of acquiring a certain size of customers/contracts?

No. We look at all customers. There are no size restrictions. We look at customer-level profitability. In small ones, we look at growth potential.

In other words, how big can the customer become over the next three years or so.

Do you see an increase in off-shore revenues as a proportion of total revenues in the ensuing quarters?

We are currently at 40 off-shore and 60 onsite. We think it will go up. In the December quarter, it went up by 2.5 per cent. But this has been in the making for the past three quarters.

There will be smaller accretions in the future and we will keep moving.

Your operating margins do not look too impressive compared to peers...

Excluding our Indian operations (CMC), our margins are more or less equal - if not higher - compared to others.

Your staff costs seem low compared to peers. By corollary, does this mean wage inflation could hurt you more than the others?

We go through a detailed exercise. To a certain level we are all right but in some places there is a disparity. So we need to make corrections.

All such corrections are through changes in variable allowances. Next year we are looking at a 15 per cent increase in wages (Indian pay).