Infosys Technologies, the software services bellwether, has delivered earnings numbers for the third quarter that are broadly in line with market expectations. Relative to the frenzied trading activity of the two previous quarters, following the upward revision of guidance by Infosys, this quarter proved a quiet one. Traditionally, as the October-December period has fewer billable days, the earnings expectations are usually subdued, with fewer surprises in store.
The conclusion of this quarter, however, is far more significant strategically for IT service companies as it helps them take stock of the headline trends for the coming year. In our view, for frontline software players, 2007 may be defined and dominated by three key trends:
Strong lead indicators: According to software outsourcing advisory firm TPI, in 2006, India-based service providers nearly doubled their market share to 7 per cent in contracts above $50 million vis-à-vis a 4 per cent share in 2005. And the biggest losers in market share were the Big Five in Europe. This was revealed by TPI in its fourth quarter TPI Index announced last week. This clearly is a reflection of the scalability of the business model of the frontline software companies.
As high-profile Fortune 1000 clients start firming up their IT budgets for 2007, the initial indications from the top managements of Infosys and iGate in their conference calls were positive. Preliminary estimates suggest that IT budgets are likely to expand by 2-3 per cent during the year, dispelling fears of a slowdown in IT spending during the year. In their financial guidance, Nasdaq-listed Cognizant and Hexaware, which follow the calendar year as their financial year, are likely to provide further colour to growth projections.
Offshoring shift from labour to value: There is likely to be a keen tussle between the clients and frontline software vendors to move offshoring from a pure labour arbitrage equation (primarily time and material) to value-based pricing. In the quest to maintain their margins, Indian software vendors are likely to demand a greater proportion of the new service offerings pie from the clients, as application development and maintenance (ADM) contracts are getting somewhat saturated.
TPI in its latest briefing has added that in the ADM space, the market share of Indian service providers is touching 36 per cent, within striking distance of the 38 per cent share of the Big Six in this service offering. And clients, on their part, are likely to demand a share of the productivity gains.
The first phase of this tussle will be linked to old contracts coming up for renegotiation, where frontline companies are likely to drive a harder bargain for billing rate increases. So far, a predominant chunk of billing rate hikes has been confined primarily to new clients. Considering that these vendors will be facing a third successive year of 12-15 per cent salary hikes, billing rate demands are likely to intensify.
Multinational march and consolidation: In the backdrop of the recent Cap Gemini acquisition for Kanbay, it is becoming obvious that the top-rung European service providers are also jumping onto the offshoring bandwagon.
While this is likely to help them protect their eroding market share, the battle between domestic frontline vendors and MNCs (both North American and European) for business volumes and human talent is set to reach a feverish pitch this year. As the number of unbundled large deals is mushrooming, increasingly, MNC and Indian vendors are competing head-to-head on several of these deals in the IT services space.
To top it all, if there is a big bang acquisition by an MNC vendor (such as IBM or EDS) for any domestic software vendor in the Nasscom top ten (by revenues) this year, it can dramatically alter the competitive dynamics in the high stakes battle for market share.