Phaneesh Murthy: Indian IT industry will grow slower than Nasscom's prediction

Mitu Jayashankar
Updated: Mar 10, 2012 09:19:18 AM UTC

When the enfant terrible of the Indian IT industry makes a significant prediction, you can do one of the two things. You ignore him thinking he is seeking attention, or you sit up and take notice.

Last week I met Phaneesh Murthy, CEO of iGate who says that the IT industry this year would grow only 8-10 percent (between January-December 2012). The last time the industry grew in single digits was FY 09, after the Lehman crisis. This time Phaneesh predicts a much longer winter, a secular trend that will last more than a year. Even worse, he says, is that there will be a decline in offshore rates as the year progresses.

That is a significant prediction; Nasscom has just put out numbers last month that the industry growth will be 11-14 percent in FY 13. Interestingly in March 2012, the industry (exports plus domestic) will cross $100 bn. For 2012, the industry growth rate was at 16.3 percent. An 8-10 percent growth rate, if true, is significant because it affects everything - hiring, valuations, bonuses etc.

Of course it can be argued that when the industry touches $100 bn some amount of maturing is normal. But in the case of the IT industry the change is a bit sudden. In July 2008, before the Lehman crisis, Nasscom had forecast revenue growth rate in the range between 21 and 24 per cent in FY08-09. Which means that the growth rates are down to half of that level in four years.

Phaneesh has a lot riding on the market, perhaps more than any other CEO. Last January he paid over a $1 bn to acquire Patni, one of the oldest offshore firms in India. When I wrote the story (http://forbesindia.com/article/boardroom/phaneesh-murthy-is-the-new-big-boy-in-town/22082/1), many people told me that Phaneesh was taking a significant risk by acquiring Patni, and that he was gambling with other people’s money. The naysayers felt there was no logic in the deal except a bulking up advantage. Phaneesh laughs when I tell him this, asking in all mock seriousness, ‘what is wrong with doing that”? Phaneesh’s logic then and now is the same, there was no future in the middle, and eventually the large players would have squeezed him out.

Nine months later he says the integration with Patni has progressed smoothly and while the market conditions are making things look different, in hindsight he says acquiring Patni was the right thing for iGate.

Read the edited excerpts of the interview to understand why he says that and the prediction that he is making for the market,

How is the overall environment these days?

The bigger challenge now is that more and more deals are coming at the cost of someone else. Budgets are not going up, more projects are not happening so you are coming in at the cost of somebody else (i.e displacing customer’s staff).

Especially in large application maintenance and application support deals, if earlier we used to see that in 5% of the deals, now we are seeing in 35-40% of the deals.

This is worrying for the outsourcing industry because, someone will whisper that Americans are losing jobs and these guys will knock off 50% of the visas.

In this negative environment - transition is more complex, more challenging and knowledge transfer is that much more difficult.

The BPO deals were always like that. It is now happening more and more in the tech space as well.

What will be the larger impact of that on the industry?

The second problem is that we are genuinely seeing rates fall in the US. If you look at the call center industry, the whole value proposition was on the basis that the US rates were $27-28 an hour and the Indian rates were $12 an hour.

In spite of 60-70% attrition, Indian BPO industry was still making it work. Today I am seeing US based call centers quoting $19-20 an hour, which really means people in the US are willing to work for less.

Previously if you were saving 25% through outsourcing, now you may be saving only 15%. And at that point you may decide that you don’t want to outsource for this kind of saving. That’s economics at work. I have seen enough instances to indicate that this is not just anecdotal anymore.

Based on the supply side problems in terms of the Visas, based on the demand side problems and based on the US supply side reorienting itself, my prediction is that this year will be an 8-10% growth trajectory rather than the 11-14% growth that Nasscom has been predicting.

What are you doing to manage this environment?

The way we are preparing for it is that we are trying to go after what I call the $ 2 trillion (addressable space for technology and operations) minus $75 billion (the total offshore IT industry) bucket. A lot of the rest of the work is currently done in-house like mortgage work, reference data work and thousands of pieces of work like this.

That will only start coming if you start building IP and put more solutions on the table, which gives the customers the confidence that someone else can do it.

With more and more regulatory and compliance needs for financial institutions, BPO work in financial services to third party vendors will start coming down. From the employment perspective it will be fine, but from an industry growth perspective, it will come down. Many of these institutions believe they have enough critical mass (in captive centers) so they don’t have to do it through partners, unless there is some serious IP on the table.

So the labour arbitrage model through a third party is gone. Labour arbitrage will be achieved through captives. They know they can generate 2000 or 3000 people to be working from India

You have been talking on IP creation for a long time. How have you seen the needle move in the last five-six years?

I am seeing it now. The fact is that more and more companies are talking about platform-based plays. Our whole iTOPS model is based on solving a business process problem through technology solutions.

(Before we did the Patni deal) iTops was close to 20% of revenues at iGATE. At that time, I thought I will touch the 30% mark in a couple of years. However, with the acquisition of Patni, we are now less than 10% of revenues of the combined entity.

We have been able to take the outcome-based model to almost all of the Patni customers. Almost, everyone has started some initiatives in it. We have started service levels based, outcomes based, transaction based in almost all the customers, which were staffing earlier.

How has the Patni deal progressed?

Things are going on well from the business side. My bigger concern is growth. From an iGATE investor perspective, we grew 40% in top line in 2010 and 90-95% in earnings before we did the deal.

Now, we have a temporary dip as a result of the acquisition. We wanted last year to be one of protecting the customer, in the hope that the revenue curve will grow faster than before. And this was based on some market assumption.

My original theory was that in 12-15 months the iGATE investors will he happy. Because of the market condition, I am wondering if that would take a little longer. It could still be an 18-24 month period.

Investors are delighted right now because they have seen huge value because of the acquisition. We have saved $32m, our share price is back to where it was a year ago. Looking at multiple indicators, everything is looking comfortable.

If the game were over right now, everyone would call it a big victory. But the game has barely begun.

If you had known the market would slow down like this would you still have done the Patni acquisition?

I would have. But I would have positioned it differently. Instead of an offensive play, I would have made it a defensive deal.

We are in the midst of two deals, which are in the hundreds of millions of dollars of deal size. We were not present in these kinds of deals earlier. Now we are in the short list. And it would not have possible if we were not of the $1billion size and the scale of 27,000 people.

Also, we would not have been in the short list if we were not for the solutions we have created. These are iTOPS based solutuons applied in specific micro verticals in specific areas.

Before we acquired Patni, iGate had a 75% exposure to BFS space and the industry was coming crashing down. With the acquisition, we have de-risked the vertical to a 27% vertical.

The thoughts and opinions shared here are of the author.

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