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Indian firms hire europeans and americans for outsourced jobs Original Source Link: (May no longer be active)
http://news.morningstar.com/article/article.asp?id=182041http://news.morningstar.com/article/article.asp?id=182041
A Different View on Indian IT Services Firms
Revenue growth and profitability show few signs of abating at Indian IT firms.
By Mike Ford-Taggart, CFA | 12-27-06
It matters less and less that Indian-based information technology service providers are based in India. As the entrenched Western IT firms establish facilities in India and as the Indian firms open facilities around the world, the geographic source of IT services delivery is becoming blurred. What remains clear--in our opinion--is that the Indian firms will continue to disrupt the global IT services markets, post very strong revenue growth rates, and retain their high levels of profitability for many years to come. We recently took a fresh look at Indian firms Infosys, Wipro, Satyam, and Patni and came away with a few interesting insights.
The Competitive Advantage of Indian IT Firms
Nasscom, the Indian IT software and services trade group, estimates that IT outsourcing in India will grow by 24% on average annually for the next five years. Indian firms are winning outsourcing projects that are larger and more complex, showing that North American and European corporations increasingly trust them. The firms are not winning such deals just because they have lower costs, but because they are also delivering high-quality (often higher)projects in a manner that customers like.
Contrary to popular belief, low labor costs aren't the source of the Indian firms' competitive advantage. Everybody is in India now. Here's how the Indian firms do it. For years, the entrenched Western players dictated a certain way--their way--of providing IT services to clients, relying on partners and their old-boy network to win business. Enter the Indian IT firms with no partners and few contacts, working their way up from low-level application maintenance in the early 1990s and gaining greater exposure during the Y2K software crisis, when Western corporations had to turn to them for help. The Indian IT firms had few clients and were often falsely perceived as low quality (which often goes hand in hand with low cost). As a result, they had to rely on their centralized, disciplined organizational structure, their best-of-breed project delivery processes, and their flexible, transparent contracts to wow clients. And wow them they did. Industry disruption began after the Y2K crisis abated, with existing clients giving them more work and other corporations giving them a seat in the proposal process.
As Indian firms gained market share and disrupted pricing--even on deals they didn't win--Western IT firms began opening facilities in India to take advantage of lower labor costs. However, most of these firms have not altered their fundamental business models to fully integrate global delivery and Accenture being the exceptions, in our opinion), persisting in the view that India is simply a cost management center. Meanwhile, the Indian firms have expanded beyond India, sending consultants and project engineers to U.S. and European clients, opening delivery centers in Canada and Eastern Europe (nearshore), and moving some work to even lower-cost countries (China, the Philippines, Malaysia). Even though Western players have moved strategically to compete head on, we think the Indian firms have remained a step ahead.
Future Challenges
The massive growth of IT outsourcing facilities in India has raised two issues: When will the demand for Indian software engineers outstrip supply and constrain growth? When will rising labor costs crush the Indian firms' profitability? We believe the answer to both questions is: not anytime soon.
As for supply, Nasscom estimates that by 2009, India's universities will not graduate enough engineers to meet demand. But the Indian firms aren't sitting around waiting for the inevitable--they remain the employers of choice for most Indian graduates because of their competitive compensation, their extensive training, and likely their national pride. Infosys only accepts 1.5% of applicants and Wipro accepts 0.8%. Both firms have long-term training programs, with Infosys' Mysore campus set to become the world's largest corporate training facility. Such training programs can take students with no engineering background and train them into software engineers. Indian firms are also hiring more Americans and Europeans for onsite work and more staff to fill their facilities outside of India.
As for labor costs, we do not doubt that they will drive operating margins down from their current high levels (20% to 30%) to be in line with Western firms (high single digits, typically). However, we believe this will take 10 to 20 years to occur. High revenue growth, attrition among higher-paid experienced employees, the perennial influx of lower-paid new recruits, and an increasing proportion of non-Indian-based employees must also be figured into the wage inflation discussion. Infosys, for example, estimates that wage inflation--when viewed across the entire employee base--exerts only 1.3 to 1.6 percentage points of pressure on operating margins. Financial results at the Indian firms support their contention. Our own analysis has shown that operating costs per average employee at most Indian-based IT services firms is actually declining, as operating leverage, greater scale, a larger percentage of higher-margin revenue, increased employee utilization rates, and foreign currency translation effects all get factored into the equation.
Overall, if any of the four Indian IT services firms' ADRs traded in 5-star territory, we would be eager buyers of the shares. Valuations aside, we would prefer Infosys and Wipro because of their larger size and lower risk ratings. While all four are currently trading near our fair value estimates, keep them on your radar screen: your grandchildren will remember you fondly.
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