Single-Digit Revenue Forecasts The ‘New Normal’ For IT Sector: Morgan Stanley’s Parag Gupta
Will the IT industry see client spends return?
Single-digit revenue forecasts may be “the new normal” for India’s information technology sector, said Parag Gupta, India internet, IT and media analyst at Morgan Stanley. The only way to change that is to boost optimism amongst clients, he told BloombergQuint on the sidelines of the Morgan Stanley Annual India Summit.
If customers [clients] get really positive about their own prospects, so issues like Brexit does not have an impact, or if the new administration doesn’t have an impact on the business sentiment in the U.S., then you can see business spends coming back in. Otherwise I would say this is the new normal.Parag Gupta, India Internet, IT and Media Analyst, Morgan Stanley
Indian IT giants such as Infosys Ltd. and Tata Consultancy Services Ltd. have been witnessing slower revenue growth over the last few years. The sector now faces additional pressure from the stricter visa norms in the U.S.
The rate at which Indian companies are gaining market share from global players have come down significantly in the last 5-10 years, Gupta said, triggering the decline in growth rates. Besides, verticals such as telecom, energy and retail have also been in a “flux”. These two factors, coupled with a fall in quality of client expenditure, has impacted growth figures of Indian IT players, he said.
Here are edited excerpts from the conversation.
Many large-cap Indian IT companies, especially index heavyweights, have lowered their growth guidance from double digits to single digits now. Is this the new normal? If yes, what do they have to do to get back into double digits?
The key reason that growth rate used to be robust in the past was that Indian companies were gaining significant market shares from their global peers. A lot of these projects were traditionally legacy projects, so it involved basic application of maintenance or trading a new application. A lot of that work has already been done. Customers are now thinking about how they should be positioned for the next five to 10 years. So they are talking about how to migrate to the cloud, how do we become more social, etc., and that’s how they want to connect to the customers. As a result, while IT spends are growing, there are new types of spends coming up as well. When you talk to them, you’re essentially talking about two types of spends: run the business, change the business. So, where most of the Indian it companies use to pioneer was to run the business but where incrementally spends are going is ‘change the business’. So, while Indian IT companies are gaining market share, they’re gaining market share at a pace slower than what they gained 5-10 years back.Companies are already talking about growth rates lower than 10 percent because there are a lot of verticals which are in the state of flux…And because of that growth rates are turning out to be lower-than-expected.
Do smaller companies have more flexibility in changing their business models to adapt to new environment? What would you look for in such a company to put an investment in it?
There are two things happening with the smaller companies, say, mid-cap companies. They are the set of companies that are trying to specialise. They are trying to specialise into engineering services. Let’s say they have 10-20 customers, who are extremely critical for them because they’ve to count on them for the bulk of their revenues because they are doing cutting edge work for them. So as a customer, they are your partners…so those are the mid-cap companies that are benefiting from that product or service specialisation. There is another set of vendor looking at cannibalising. So, they’ve nothing to lose, they are bringing in new skill set, automation, artificial intelligence, etc., basically, a service set that is being provided by all. But here they are specialising in that so they go as a specialist and not as a generalist. As a result of this, some of these mid-cap companies are trying to position themselves as the ones who are cannibalising someone else’s revenue. These are the companies that are also seeing growth rates coming in at the expense of someone else and that’s the reason some of these companies are talking about double digit growth. But that growth needs to be balanced with good margins.
Is a dwindling requirement for human workforce inevitable and in that case, what happens to the human work force?
There are two things that are happening with the job opportunities by the Indian IT industry. First, the job opportunities today are much lower than the case, say, a couple of years ago due to bringing in new types of technologies or new ways of delivering services. Automation, artificial intelligence used to be the ‘buzzwords’ two years back, but have now become mainstream. All of these services are essentially trying to create a higher revenue per employee. Is it the need of the hour because you’re trying to save on costs to deliver better margins? I think that’s one part of it. But it is also because customers are demanding this.Second, some of the Indian vendors, at least the larger ones, are talking about creating more job opportunities for on-site locations, which I think is coming in more from a regulatory perspective. I think that’s creating some amount of regulatory pressure as well. So, you have seen a couple of companies talking about ramping up their operations in on-site locations, which will obviously also combat the loss of lack of job creation in low-cost locations such as India. So, it’s a mix of both, but the large chunk of it is coming in from the new way of delivering services.The point is that you have always had new ways of delivering in the past as well, but you just have to keep rescaling your skill. What is happening with the companies today is that they are rescaling their existing employees. At the same time, I would say aspiring engineers should also now start thinking about what is the job of the future and accordingly plan for that.
You have spoken about the penetration of internet in India. Where does it stand now? How are you viewing trends over the next 4-5 years?
Internet penetration is growing at a very fast pace, primarily being driven by two things. One is the whole smartphone proliferation…it’s becoming absolutely affordable for all sections of society. China saw a significant jump in their internet penetration as well. It’s now happening in India. The second thing that’s happened is the whole rollout of telecom infrastructure in India. With telecom companies rolling out extensively, 4G availability is improving at a very fast clip. You now have a population coverage of like almost 75 percent, and companies are talking about going to 95 percent in the next couple of quarters. So, you’ll actually have 4G availability across the country and India will actually leap from technologies and go straight to 4G.
This will happen because your smartphones are all LTE (long-term evolution) enabled. 4G infrastructure is going to be available pan India and the third, data prices are also falling. So, it is becoming absolutely affordable to use data on a wireless network. All these three put together calls for data explosion. So, my view is internet penetration which currently stands at just less than 40 percent will actually be at 60 percent by 2020.Today you have, roughly about 500 million people in India with an internet connection. In 2020, this number will likely exceed 800 million. Ninety percent of internet users will be on a smartphone. So, smartphone will become the device of usage and as a result of that you will actually see significant usage of the internet.
Your recent report suggested that the funds raised by a lot of e-commerce companies in 2017 have been substantially higher than 2016. Is this trend here to stay?
Generally you see funding coming in cycles. A lot of it is driven by sentiment and opportunities. The sentiments went away in 2016 driven by what happened across the globe, with softness coming through in technology companies globally… You saw a little bit of that softness creeping in into India as well. And generally when that softness comes in, there’s a lot more focus that goes on to your operating metrics.
There was also a little bit of euphoria that was built into the Indian market at that point of time, which got corrected in 2016. Usually, when there’s a funding slow down, companies also start going back to their drawing board to figure out their strategy for the next couple of years. A correction or a rationalisation happened on both fronts: start-ups and investors. In 2017, valuations and expectations have corrected, and markets are also doing well, Technology firms globally are doing really well. There is a positive sentiment…It is a big opportunity in India, and hopefully India should be the next big opportunity for us as an investor for the next couple of years as well.
So 2016 should be looked as an aberration, not 2017. Because 2014 was good, so was 2015, 2016 was a big slowdown. Again if you look at the funds raised, it’s raised by a few prominent companies which I think is a very big differentiating factor that comes in. When you have a slowdown , you suddenly start seeing funds getting directed to a few startups because they are the ones that are breaking out from the pact.
And that helps the startups as well as they are suddenly able to differentiate themselves. In the startup world you all talk about what is the mode. One of the biggest modes that you have is funding. Because if you have it and your competitors don’t, you suddenly become the leader. In India, the larger companies, the ones that have a strategy and are executing to that strategy, are the ones who are now able to break out. So it’s tough to say how the funding environment remains through the rest of the year, but we have had a great start so far.
We have had $4 billion of funds raised so far, which is already significantly higher than last year. There are talks about more and more investors looking at India. It looks as if it’s in a strong footing but what’s critical is that companies and startups should continue executing on what they’ve set out for. Funds will automatically come.
