Large base of small clients to save the day for IT

[dhilipkumar]

NEW DELHI: Even though the future outlook for the $50-billion IT services industry looks promising, companies will have to live with lower growth

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rates, volatile markets and lack of new IT spends. Billing rates for Indian IT services companies are expected to fall by at least 10% in most large contracts coming up for renegotiation.

Yet, the silver lining amidst the dark clouds for the companies is the large base of small clients with contracts worth less than $10 million a year. Most of these clients are experiencing high cost pressures, but are unable to renegotiate lower billing rates due to high bargaining power of IT companies, analysts say.

A CFO of a tier-I IT company said he expects things to improve by 2009-end. "We are also hand-holding some clients in terms of billing rate downgrades as they are going through severe pain. Everybody is waiting for February-March when CIOs announce their IT spends for next year," he added.

According to a Merrill Lynch report, the Indian IT sector may see one of the worst quarters in the past 10 years with a drop in margins, billing rates, new business and even volumes. While revenue growth is expected about 12-15%, margins might remain flat on account of the rupee depreciation.

"This is the first time in 10 years, we could see volumes declining sequentially this quarter. Compounded by weakening of European currencies, we forecast a q-o-q decline in the dollar revenues for all IT majors. Contrary to expectations, the rupee depreciation may not help IT companies too much," says Pratish Krishnan, research analyst at DSP Merrill Lynch (India). "In fact, this time, clients have been asking vendors to take extended vacation, which could impact volumes and employee utilisation," he adds. This means, while the FTEs (full-time equivalents) keep getting their salaries, they are not actually billed.

Clients are also shifting from FTE-based pricing to transaction-based pricing of contracts. Even smaller clients are preferring financially-stable IT vendors in these uncertain times. This has become an advantage for large IT companies as they have larger bargaining power with smaller clients when it come to renegotiation," says Motilal Oswal Securities.

The share of revenue contribution from fixed-price projects for Infosys, Wipro and HCL has gone up by almost 400 basis points and 100 basis points on y-o-y and q-o-q basis, respectively, says Anand Rathi Securities. This adds more certainty to businesses as the service providers are not locked in short-term deals.

Companies are betting big on pharma, utilities and telecom sectors as financial sector is down. For instance, Infosys bagged a three-year

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multi-million-dollar contract from AstraZeneca for tasks like supply-chain management, applications development and maintenance. IT companies were not available for comment due to the silent period, pre-results. Clients are also increasingly taking time to announce their discretionary spend as everybody is holding on to their most precious asset in these times — liquid cash.

On the other hand, the large-scale bankruptcies, mergers and consolidations of large financial companies is having a negative impact.

Risk of vendor consolidation has pushed offshore prices to sub-$20 (per hour) in many cases. "The industry has frozen hirings and seeing a rate cut of more than 10% in some cases. Unless the trillion-dollar bailouts that have been announced start to show results, the industry might face a crunch situation," says Vishnu Dussad, CEO of Nucleus Software, which has also frozen hirings. Infosys has frozen new hirings for next year, but is scheduled to fulfill its targetted hirings of about 25,000 for 2008-09.

Additionally, cross-currency hedging and revenue mix is likely to impact revenues, due to currency volatility. The GBP & euro have depreciated versus the dollar by about 15% during the quarter. FIIs are pulling out their money in major stock markets which has led to a dollar demand and its appreciation. "This could erode at least 4.5% of dollar revenues if these two currencies formed 30% of revenues. But the rupee has weakened about 10% against the dollar this quarter. Thus, rupee revenues could still see a positive 4-6% currency impact," says Merrill Lynch.

Interestingly, Gartner, in its IT Services forecast 2008-2012, raised its IT services demand-growth estimate from 9.5% to 11.3% in 2008. But according to Anand Rathi Securities, due to currency movements, the future growth (that is global IT services demand) may be lower at 5.3% compared to 8.6% CAGR in the past five years.

Nasscom is also expected to further downgrade its forecast of 21-24% growth in Indian IT-ITES revenues in January.