Indian IT Firms: Is the Future Theirs?

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In the old days – say, five years ago – Indian IT firms existed in a kind of tech ghetto. Prosperous American IT companies were the stars of the show, the go-to companies that clients hired when they had mission critical assignments. The Indian companies were the low-cost choice, the place to ship non-essential work to if you needed to shave costs.

But what a difference a few years can make. Many American (and international) IT companies have opened facilities in India, while several India IT firms have opened offices around the world, including in North America. Location matters less and less. And when big bucks clients send out a request for proposal, Indian firms bid right alongside blue chip U.S. firms.

At this point, Indian IT outfits like Infosys, Satyam, Wipro and Patni stand as equals – in some eyes, at least – to any IT solution provider on the planet. In fact, in a development that causes deep heartburn in a segment of the American IT community, some observers view the Indian tech companies as a step ahead of their international competitors – including those based in the U.S.

How, exactly, did this situation come about? And more importantly, will it continue in the future?

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In the early ‘90s, much of the work that Indian IT firms did was of the bargain-basement variety. Staffing call-center help desks, application maintenance: Indian firms landed these outsourced assignments by offering deep discounts. While U.S.-based IT companies leveraged a network of personal relationship to help them land contracts, Indian companies were on the outside looking in.

The Indian firms took a step up in the world as Y2K loomed. Companies scrambled to find programming talent, and many hired Indian companies. By the time the dust settled around 2001, the leading Indian IT firms had gotten their toes into plenty of doors.

Moreover, the Indian shops had proven themselves to be truly competent. It turned out that shipping work to Indian wasn’t like buying a low quality product for low cost; the offshore companies produced solid code. Still, there remained a cultural reluctance to send work to Asia. When the job really counted, it tended to stay in the U.S.

Then came a big change, says Mike Ford-Taggart, a Morningstar analyst who tracks Indian IT outfits.

“I would argue that something happens in 2002 and 2003, where they [the Indian firms] reach some sort of a tipping point,” he says. The buyers of IT services, big American companies, were suffering badly in the bear market, and shareholders were demanding cost cuts. Since the Indian shops typically work for 25-35% less, their offers suddenly looked quite attractive.

Instead of being a choice of last resort, the Indian firms got a chance to bid on many projects, stepping up the value chain. And even on bids they didn’t win, they tended to be “disrupters,” forcing U.S. and European tech companies to shave their bids.

Fast forward to 2007, and the Indian shops are becoming a major force in the IT business. According to a report from TPI, over the next 18-24 months, some $100 billion worth of IT contracts around the world is up for grabs. It’s expected that Indian companies will be invited to bid on these contracts. “At which point, that $100 billion automatically becomes $65-70 billion,” Ford-Taggart says. Clients will invite the Indian firms to the table to – at the very least – squeeze the U.S. vendors on price.

Shorter Contracts

Another trend that’s increasing the influence of Indian IT providers: outsourced contracts now tend to be shorter, and more divided between multiple providers.

“In the past, companies used to award IT outsourcing contracts that were longer, 7-10 years. They would hire one firm to do it, and that firm would have subcontractors,” Ford-Taggart says. Now, big clients split up major projects and request bids on individual components. “Then they’ll say, “Look, we can have this portion done in India for 30% less.’”

This might cause more managerial headaches for the client company, but in fact it’s less risk: clients have fewer eggs in a basket with any one IT firm, so if a projects goes bad or creates cost overruns, the entire project won’t take such a big hit.

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Cultural Stigma

A certain cultural stigma continues to cloud the perception of Indian IT companies. “As we often do in America, we equate low price with low quality,” Ford-Taggart says. Throughout the ‘90s (and still somewhat today) outsourcing to India was like buying a product from Japan in the 1950s – a cheap price for shoddy goods.

Some of this stigma comes from the experience of American consumers who get routed to Indian call centers. Frustration is a constant. These phone operators are at the bottom of the training rung and are equipped to solve only minimal problems.

“People take their personal experience with the call center and extrapolate that to anything else coming out of India,” he says. But in fact, the Indian call center workers and the Indian IT workers are two very different groups of people.

The Secret Sauce

Indian IT firms are more likely than U.S. firms to benefit from centralized process control, Ford-Taggart says.

From their origins in the ‘80s, Indian companies have developed standardized processes that they use for all clients, honing these processes over many, many projects. In contrast, U.S. companies often work on a partnership model. “In the partnership culture, in New York it could be very different from the way [the office] operates out in San Francisco, which could be very different from the way a partnership of the same firm operates out of Miami,” he says.

This model creates a challenge for U.S. IT providers. “You have all the U.S.-based firms claiming they have a global delivery system because they’ve set up facilities in India, and maybe in Eastern Europe, [but] it’s much harder to create a global delivery model when you don’t have the centralized processes in hand.”

“That’s why I think the Indian firms can be so disruptive, because as the U.S. firms turn around and try to create a global delivery model by opening up facilities in lower cost areas, they’re still looking at those lower cost areas as a cost center move. And they have to kind of recreate the processes to put them on a global platform to deliver them from around the world.”

Pleasing Clients

In terms of the quality of work done by Indian firms versus that of their American counterparts, “I would argue that if it [the Indian work] isn’t higher quality, than it’s high quality,” Ford-Taggart says. “They’re doing best practices, and that’s exactly why this growth is not going to stop.”

He points out the Indian firms are now winning some big contracts, assignments that are too important to the clients to shovel off to second-class providers. “You’re not going to trust the Indian firms to…redesign your software architecture just because it’s going to save you 30%, if it’s going to create a total disaster down the road,” he says.

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Indeed, most of the revenue growth of Indian shops comes from existing clients, not new business – even though they’re adding new clients all the time. “Most of the growth comes from the fact that their existing clients work with them and say, “Holy cow, this stuff’s good’ and give them more business.” In this way the Indian shops have taken on increasingly more sophisticated jobs.

“Every year, you hear, “Oh, this kind of growth can’t continue, and then it does. And in fact in the last couple years the revenue growth of Indian companies has accelerated.”

Invading India

In the last few years, many American and European IT firms have opened facilities in India. These companies know that they can hire Indians engineers for about one fifth to one eighth of what they’d pay for American tech pros. The typical first-year Indian IT trainee makes $450-500 per month. The average salary for experienced IT staffers is $850-900 a month.

This influx of new employers has upped the demand for Indian talent, which in turn has upped the wage pressure on Indian IT employers. Indian firms have been forced to boost compensation about 15% per year, squeezing their profit margins.

In theory, these hefty increases suggest that, at some point, the wages of Indian IT workers and American IT workers will reach parity. The math works like this: assuming that wages in the U.S. increase about 3% a year, it will take 19 years for Indian and U.S. IT salaries to converge.

This would indicate that, within 20 years, the engine driving Indian IT – low wages – will run out of gas. Not true, says Ford-Taggart. First, it’s unlikely that Indian wages will continue to spiral up 15% a year; that wage growth will almost certainly moderate.

Also, Indian firms are continuing to scout for still cheaper workers. For instance, one Indian IT shop recently opened up an office in Malaysia to take advantage of lower labor costs. (Which creates the specter of Indian IT staffers someday complaining that jobs are going offshore in search of cheaper labor – an odd thought, indeed.)

Media reports say that Indian public schools aren’t graduating enough students to supply the country’s rapidly burgeoning tech industry. Yet even this concern doesn’t seem to cast too much of a cloud. The leading Indian companies accept less than 2% of applicants into their trainee programs. Yet if they needed to accept, say, the top 5-7%, they’d still be working with top talent.

In truth, the lack of employees “is not yet the concern that the media makes it out to be for the Indian firms,” Ford-Taggart says.

A Mere Sliver of the Pie

Perhaps the most surprising aspect of the Indian outsourcing discussion is how small a slice of the pie the Indian firms currently own. Offshore outsourcing gets a lot of headlines, and generates a lot of concern, but doesn’t actually attract that many dollars in relative terms. Estimates vary, but only about 4% of global IT projects are outsourced offshore, with much of this going to Indian companies. Clearly, the Indian IT presence is in its infancy.

And for all their growing strengths, there’s no guarantee that the upward trajectory that Indians firms have enjoyed will continue at the same pace. The global nature of the IT market works both ways: as Indian companies open offices from Eastern Europe to the Middle East to the UK, they face entrenched local competitors in all these markets.

And companies from all these locations open offices in India seemingly on a weekly basis, using cheap Indian labor as leverage to combat the Indian-owned firms. Still, the Indian companies are showing no ill effects from this increased competition, Ford-Taggart says. “In fact in a way it’s legitimizing their model.”

Where the future of global IT competition is headed isn’t precisely clear, but one thing’s for certain: the Indian IT firms will be a major factor.