Thursday, July 19, 2007

Indian Outsourcing Has a Hedge in Its Backyard

Source: Bloomberg

Indian software companies, which compete furiously with each other for global outsourcing deals, are now facing a common enemy in the rising rupee.

Infosys Technologies Ltd., India's second-largest computer- services provider, last week pared its full-year sales and profit estimates. A strengthening home currency is reducing the rupee value of its dollar revenue and earnings.

Tata Consultancy Services Ltd., Infosys's bigger rival, this week reported that its profit margin was hurt by 2.6 percentage points in the three months ended June 30 by, among other things, a 7 percent appreciation in the rupee against the dollar, the biggest quarterly gain in more than three decades.

The company said it managed to ``largely offset'' the impact on net income by hedging its revenue against an increase in the rupee's value.

Although the day-to-day volatility in the exchange rate has abated since the end of April, the challenge of long-term competitiveness remains for Indian exporters.

As the Indian economy expands 9 percent a year, soaking in larger amounts of overseas capital, the real effective exchange rate of the rupee is bound to rise.

Since inflation tolerance in India is low, much of this adjustment will occur through an appreciation in the nominal currency value. The Indian central bank will try to hold the rupee down when it can afford to loosen monetary conditions at home. It would be less willing to protect a competitive exchange rate when doing so could lead to overheating.

All is not lost for Indian software exporters. The economics of outsourcing are still in their favor, though wage costs are galloping, too.

A Blueprint

Partha Iyengar, vice president at research firm Gartner Inc. in India, has a blueprint that Indian companies can use to mitigate cost pressures.

Their first task should be to walk away from simple code- writing and testing -- the ``$10-an-hour'' work that Iyengar estimates still makes up 55 percent to 65 percent of the revenue generated by top Indian software exporters.

Beaten in Backyard

Out of the several large outsourcing deals from India in the past several years, few have gone to Indian companies.

In March 2004, IBM won a $750 million order from Bharti Tele-Ventures Ltd., an Indian mobile-phone service provider.

Around the same time, Dabur India Ltd., a local maker of shampoos and beverages, asked Accenture to manage its computer systems. A 10-year, $150 million order from Bank of India, a state-owned commercial lender, went to Hewlett-Packard Co.

Meanwhile, IBM and Accenture are expanding in India, hiring the same programming talent as their homegrown rivals. Unlike the latter, however, they also have a larger pool of business consultants, people who understand clients' needs.

``It won't take an IBM six months to line up a supply-chain specialist to go talk to the board of directors of a prospective client,'' Iyengar said.

Neglected Home Market

To stake a credible claim for, say, a $2 billion global outsourcing order, Indian companies must first show their ability to execute large projects at home, says Iyengar.

This reality is still not widely understood.

At Infosys, revenue generated within the Indian market is just 2.4 percent of North American sales.

Telecommunication, Retail

These are also businesses that are most likely to place large outsourcing orders. When Bharti Airtel Ltd., as the company is now called, placed its order with IBM, it had 7 million mobile-phone subscribers. Now it has 43 million.

Had an Indian outsourcing company won the chance to meet the company's information-technology requirements during this explosive growth, it could have leveraged that experience to seek deals from Vodafone Group Plc or Sprint Nextel Corp.

The same is true now for retail.

Mumbai-based Reliance Industries Ltd., which began setting up supermarkets last year, intends to make it a $25 billion business by 2011. According to media reports, it's going to spend at least $250 million on technology.

These local growth engines offer learning opportunities. Indian outsourcing companies must tap them if they want to go beyond being low-cost service providers.

Apart from its other advantages, local, rupee-denominated revenue will also serve as a natural currency hedge.