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The less than expected fourth-quarter performance of the top four Indian IT services companies did not surprise many. People had expected the currency volatility to impact the net profit and margins of industry bellwethers TCS, Infosys, Wipro and HCL Technologies. After all, the fast changing shift in technology and its impact on deal structure is creating variability on agreement closures, which in turn is impacting the Indian companies. But added to this is the competition between the companies that is manifesting itself in a price war.
Analysts covering the sector now believe that this sort of quarterly surprises could well become a trend. Siddartha Pai, partner and president, ISG One, says that the shift in deal structure is as serious as a shift towards offshoring. "The large-deal market is beginning to level off. Multinational companies as well as Indian IT players are engaged in a price war," he points out. He explains that this is happening because many infrastructure service deals are migrating to the cloud. "New players like Amazon and RackSpace that were never seen as players in the services segment are gobbling up deals. This competition is impacting prices which have dropped significantly," he adds.
According to ISG research, prices for compute services were reduced most frequently in 2013. Amazon Web Services (AWS) led the price reductions with 13 in a year. The reductions averaged 32 per cent. Azure slashed prices seven times at an average of 26 per cent and Google, four times at an average of 6 per cent. In 2014, Google prices were reduced 32-85 per cent on compute IaaS offerings. This was followed by Microsoft and AWS.
Even though the senior management of India's top companies says that the future looks good, each of them has spoken about the challenges that are creating uncertainty in the sector. Take , for instance, HCL Technologies, which having blazed a trail in infrastructure management services (IMS), had slow growth to show in the January-March 2015 quarter. Anant Gupta, president and CEO, admits that the competition landscape has changed and says, "The shift we have seen is that the traditional big five companies' shares have dipped further and the competition is coming from local and regional firms."
While announcing the quarterly results, N Chandrasekaran, CEO and MD of Tata Consultancy Services (TCS), acknowledged that the performance of the company platform, Diligenta, had dragged the company's insurance vertical numbers down in the past few quarters. "We see opportunities for Diligenta in the US and Europe, but the nature of business is such that a single account takes anywhere between a year and three years to close," he said.
Price challenge
The top players are finally acknowledging pricing pressure too. Vishal Sikka, CEO, Infosys, had this to say about the fourth quarter results: "Pricing continues to be under pressure due to increasing commoditisation in the traditional outsourcing business, requiring us to ramp up productivity through automation, and enhance our differentiation in large engagements."
Similarly, Wipro CEO T K Kurien has spoken of pricing pressure in new deals. TCS's Chandrasekaran, for the first time, broached the topic of automation and its use by his company for differentiation.
"If you speak to clients there is requirement, but the confidence levels are a tad low," says Sudin Apte, CEO & research director, Offshore Insights. He believes that though the next few months look good in terms of deal flows, there will be sluggishness in decision making. "There is a shift in the SMAC, or social mobility analytics cloud, offerings. SaaS platforms are becoming a sizeable impact on customised development," he adds. "Clients are going for off-the shelf solutions based on platforms. We are seeing a high impact in the IMS and even in application development spaces. The other trend we have seen is that the Fortune 500 companies are done with their IT backend work and to some extent even with offshoring." Clients, says Apte, are more interested in domain expertise.
Rethinking deals
Clients are having a relook at how they can work on their traditional deals that are coming up for renewal. According to ISG Global Outsourcing Index, which measures commercial outsourcing contracts with annual contract value (ACV) of $5 million or more, the market has appeared to plateau in the last few years. Some of the reasons for this include high rate of renewal and renegotiation of first generation contracts (with $100 billion more to come in the next 24 months); increase in the popularity of cloud-based solutions, leading to production environments migrating to the cloud; and an ongoing price war among large service providers.
Companies, of course, aren't sitting back doing nothing about the new challenges. "It's a change that everyone needs to embrace," says Pai. "Indian players are either doing this via an inorganic approach as Infosys has done or setting up a separate team as Wipro has. It remains to be seen how successful they are."
So, TCS is talking about services-as a platform, and has carried out five pilots with customers from banking, retail, manufacturing and utility businesses. Infosy has been acquiring companies that will allow it to cater to new technology. For instance, it acquired Kallidus, a mobile e-commerce company. Having invested in clean-tech start-up Airviz, Infosys has also created a fund of $500 million to invest in similar start-ups and another of $250 million for innovative home start-ups. Wipro has formed an executive committee that will define the company's strategy and translate it into detailed, effective and efficient business plans. The 17-member committee chaired by Kurien will include Rishad Premji.
Defining 2014 as the year for companies to reflect on the model they want to pursue in the future, Sandra Notardonato, research vice president and investment analyst, Gartner, says, "Clients are looking to transform their business and move from more traditional businesses models to digital. Indian companies are preparing to work on this shift and be a part of this change."
Peter Bendor-Samuel, CEO, Everest Group, too believes that the arbitrage-based section of the services business is at an inflection point in a rapidly maturing market. Because of this, most new deals are for already sourced work, forcing players to fight for a share. This is setting the table for a pricing war that will get increasingly fierce. The new growth areas lie in cloud and digital, Bendor-Samuel explains. These, as a service, are less arbitrage-based and so reduce the competitiveness of the big Indian players and require them to change their business models. "It is far from clear if the Indian firms will emerge as industry leaders in these new areas," he says, "and it will take some years for the revenues in these new areas to grow to the size necessary to offset the declines in the core business."
