Non Linear Models Driving The Next Phase Of Growth For The Indian It Industry

Non-linear models
Driving the next
phase of growth for
the Indian IT Industry

kpmg.com/in

Foreword

The Indian IT industry has entered the post-adolescent stage now. Since its birth in
late ‘70s and 80’s, it has seen birth of a sibling (BPO) in 90’s. It has seen two inflection
points, Y2K and DotCom, which propelled its growth and then has seen atleast two
economic shocks during DotCom bust and 2009 meltdown - making him a “man” out of
adversity.

However, now it is facing major challenges and opportunities. The tax holiday has
ended, MAT on SEZs have made them irrelevant, competition from other “offshore”
countries is increasing and multinationals like IBM and Accenture have cracked the
Indian model. The labor arbitrage can not sustain for more than 10-12 years.

The industry needs to reinvent itself. It needs to define a compelling new
business model. The industry needs to dramatically change revenue per
employee equation, thus bringing “non-linearity” Can it do it? In order for it to
.
succeed, many factors will have to fall in place. The ecosystem involving the
government, trade bodies and academia is missing maturity and involvement
of two critical components - (1) Consultants / Advisers (strategy, accountants,
lawyers) and (2) VC/PE community. When they all work in tandem with the
industry, the transformation will come.

“Indian IT industry has to change its
business model whereby it can create
more value to its customers by facilitating
business process transformation, using
technology innovations. Indian companies can
no longer sit back and expect to do low-end
work as what they have been told to do by their
customers as in the past. This paradigm shift
would require IT companies to acquire in-depth
understanding of their customers’ business and
consulting skills to advocate and facilitate business
Pradeep Udhas process changes. Vertical domain specialization
Partner and Head within their hitherto technology horizontal operation
IT - BPO Sector will be a key requirement going forward”
KPMG in India

VK Mathews
Chairman - India IT Summit 2012 &
Executive Chairman - The IBS Group

© 2012 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Our thanks to these leaders
for their insights

Mr. N. Chandrasekaran
CEO & MD,
TCS

Mr. Bhaskar Pramanik
Chairman,
Microsoft India

Mr. Vineet Nayar
Vice Chairman & CEO,
HCL Technologies

Mr. C. P Gurnani
.
CEO,
Mahindra Satyam

Mr. Harsh Manglik
Former Chairman NASSCOM, and Former Chairman and
Geography Managing Director of Accenture-India

Mr. N.V. ‘Tiger’ Tyagarajan
President and CEO,
Genpact


Table of Contents

Executive Summary 1

Section 1 - Background 3
Overview & Evolution of the Indian IT-BPO Industry 3
Changing Dynamics of the Businesses 6
Geo political – The Cocooning West 6
Market conditions – High client expectations, low spend 7
Socio-technological & cultural untethered access everywhere 7
Governance & regulatory – Killing the golden goose 8
Human resource – Ready to pay but no availability of skills 8
Need for Transformation – Non-linear Model, Driving the Next Wave of Growth 9

Section 2 - Non-linear Growth Model 11
Non-linear growth model – Redefining business dynamics 11
Intellectual Property 12
Cloud Computing 18
Platform BPOs 23
Non-linear Pricing Models 26
Delivery Accelerators 29
Branding 32
Mergers and Acquisitions 36

Section 3 - The Way Forward 41
Implications for players in the ecosystem 41
Government 41
Industry Bodies/ Associations 42
Academia 42
Clients 43
PE/VC 43
Consultants – Business, process and financial 43

About KPMG in India 45
About CII 46
Glossary 47


1 | Non-linear Growth Model – Driving Profitability, Bolstering the Indian IT Industry

Executive
summary

The Indian IT-BPO industry today stands at employee conundrum. With rising attrition,
an inflection point in its evolution. While, the wage inflation and non-availability of skilled
industry expanded from a mere USD 8 billion employable talent pool, companies are
in 2000 to USD 88 billion in 20101, contributing wondering what their strategy should be in an
significantly to India’s economic progress over industry which has traditionally been highly
the last decade, business leaders now agree people-dependent.
that the next decade will be substantially
different from the previous one, in which new
business models will emerge to deal with a IT-BPO Industry Challenges
rapidly changing marketplace and customer • Geopolitical - Protectionist policies, new
needs1. Thus, while remarkable progress has visa policies, falling discretionary spends,
been exhibited by the Indian IT-BPO industry emerging markets not compensating for
in the past, the future brings increasing overall decline
complexity • Market Conditions - Increased competition
among vendors, low-cost destinations,
The industry has had its share of turbulent
Client maturity, high-end services eluding
times; it has grappled with adverse
Indian players
protectionist policies, visa regulations, falling
discretionary spends and slower scale of • Socio-Technological & Cultural - Social
adoption in newer markets. Market conditions media, mobility, convergence, disruptive,
have become tougher due to heightened technologies
competition among vendors, emergence of • Regulatory – Taxation, IP protection
other low-cost destinations and increasing
maturity of clients now demanding more • Human Resource – Attrition, wage inflation,
accountability. Technological disruption is huge employee base, employability.
shaking up the vendor landscape, where
players are racing against time to respond to
change. Domestic regulatory environment At this critical juncture, firms need to look
comprising of issues of taxation, transfer beyond the conventional linear growth models
pricing and lax IP Protection laws are further and turn to innovative non-linear forms of
adding to woes of the industry. But the most growth.
important challenge of all is perhaps the

1. NASSCOM Strategic Review


Non-linear Growth Model – Driving Profitability, Bolstering the Indian IT Industry | 2

Based on the industry trends, KPMG has • D
elivery accelerators to deploy reusable robust infrastructure and aiding in domestic
identified 7 emerging models increasingly tools across multiple customers growth through e-governance measures.
being adopted by companies to accelerate accelerating set up time and attaining It is the Academia’s imperative to nurture
their non-linear growth2. They are: efficiency the next generation of talent, by fostering
a thinking mindset, offering vocational
• Branding to command a premium over training for ‘ready to work’ human capital and
competition
Non-linear Models promoting partnership with the industry to
• Intellectual property • Mergers and Acquisitions as means prepare students as they enter the workforce.
to acquire new ideas, clients, service A more proactive role should be played by
• Cloud computing
extension, patents and enter new markets. private equity funds and venture capitalists by
• Platform BPOs identifying early stage technology start ups
• Non-linear pricing models Today, there is an urgent need for innovation and nurturing them through their lifecycle.
on multiple fronts – across products, services, Of course, one of the most important
• Delivery accelerators delivery models, pricing and branding, a need stakeholders, the client, will have to shed its
• Branding further accentuated by the recent slowdown. inertia and seek transformational deals with
We believe it will be a combination of all these service providers, who they should see as
• Mergers and Acquisitions.
factors that will equip the Indian software strategic business partners. Joint initiatives
industry to stay on top of their game, at an for new technologies, an open mindset,
equal footing with global giants and transform transparency and calculated risks would help
• Intellectual property so that companies
India to a technological behemoth from just contribute to this end. In that last endeavor,
can monetize their intellectual property
being the world’s back office. consultants would come into the picture
portfolios
keeping vendors and clients ahead of the
At this watershed moment in the Indian
• Cloud computing to use flexibility, curve and help conceptualize new products
IT-BPO industry, all important stakeholders
scalability and cost benefits made available and markets based on their experience and
in the technology ecosystem comprising
through the ‘as-a-service’ paradigm exposure.
service providers, clients, government,
• Platform BPOs to use a common business industry bodies, academia and consultants With successful adoption of the seven
platform for multiple clients & services will need to work cohesively in order to models of non-linear growth and incorporating
develop a long-term, holistic growth strategy. them in their strategy, Indian IT majors
• Non-linear pricing models linking client The government’s role here is envisioned can emerge as this decade’s leaders in
expenses to business outcomes or usage to be multifold, in creating an environment technology, pioneering the next phase of
instead of headcount and effort spent conducive for innovation, rationalizing tax exponential growth.
structures and transfer pricing laws, building

2. India IT Services, Primer on Non-Linear Pricing Models and Their Implications, March 2010, Morgan Stanley



Section 1
Background

Overview & Very few industries in modern economic
history have replicated the success story of
of series of measures to encourage the
growth of the IT industry was framed. In
Evolution of the the Indian IT-BPO industry. The industry, which
was almost at nascent stage till late 1980s,
1985, all the software export revenue was
exempted from income-tax3. Domestic
Indian IT-BPO grew at tremendous pace after early 1990s.
The IT exports have grown by 100 times over
firms shifted from exporting programmers
to outsourcing custom software while
Industry the last 15 years1. few others started venturing into product
development.
The Indian IT industry has witnessed five
distinct stages through its evolution. It has The 1990s: Booming of India’s IT sector
faced different circumstances and challenges, The 1990s were the turning point in the story
and has emerged triumphant at each stage. of India’s IT industry. The economic reforms of
1991 reduced tariffs and other taxes that were
The 1970s: Birth of Indian IT Industry plaguing the industry. The 1990s also saw the
The Tata group (in the late 1960’s) has been return of IBM to India, which sent a positive
instrumental in the inception of the IT industry signal to other global majors that India’s IT
with the establishment of Tata Consultancy industry, was open for business. Several
Services2. As software development could new Indian IT firms were started during the
not come to India, Indian programmers were decade, which also saw TCS, Infosys and
sent to developed countries. Towards the Wipro pull ahead of the pack to emerge as
later part of the decade, the government the market leaders by the end of the decade.
began to realize the potential of Information These firms started scaling up increasing
Technology, and gave the go ahead for setting their global reach in small but eventful steps
up the National Informatics Centre (NIC) in in global outsourcing market which was
1975. dominated by global IT players.

The 1980s: Setting up of new IT firms 2000-2010: Surging ahead – Indian
As the 1970s gave way to the 1980s, the IT becomes IT behemoth
industry experienced a radical transformation. The past decade witnessed an explosive
On the domestic front, policy reforms that growth for the industry. It has surpassed all
reduced costs of imported hardware and expectations, and has become a behemoth
software caused the Indian software industry today. The IT-BPO industry is a significant
to shift from supplying programmers to growth catalyst for the Indian economy and
supplying software programs. Huge cost has grown 11 times in the last decade, up
arbitrage and English language skills were from USD 8.2 billion in 2000 to USD 88.1
the other two most important competitive billion in 20114. IT services continues to be
advantages which India had in its favour. the largest share of all segments followed by
Government policy also changed to a the BPO, ER&D segment and the hardware
supportive stance during the 1980s; and a industry4.
New Computer Policy (NCP-1984) consisting

1. NASSCOM, KPMG in India - CII Summit 2012, Non-linear models 2012 Analysis
2. An inside look at the making of a giant, Tata Review, December-2011
3. Origins and Growth if the Software Industry in India, Rafiq Dossani, Stanford University
4. NASSCOM Strategic Review 2011



India’s IT-BPO Industry Journey

Source: KPMG in India - CII Summit 2012, Non-linear models 2012 Analysis

5. Origins and Growth if the Software Industry in India, Rafiq Dossani, Stanford University 9. http://www-07.ibm.com/in/careers/milestones.html
6. NIC Website 10. NASSCOM Strategic Review 2011
7. http://www.nasscom.in/vision-and-mission 11. “BPOs hunt for recruits among various professionals” Dec 2010, Daily Bhaskar
,
8. “Offshoring: Why businesses launch IT operations in India” Sep 2010, Silicon.com
, 12. Draft National IT Policy, 2011



2010 and Beyond: Continuing the saga
India’s IT-BPO Industry - Snapshot13 Not being content with executing basic due to industry level initiatives countering
application development and maintenance competition . Further, there exists a significant
• I
ndia’s market share in global sourcing (ADM) projects, Indian IT firms are offering headroom for growth through innovation
industry - ~55 percent (2010) a complete integrated suite clubbing high which can propel revenues to the tune of USD
• Fastest growing sector among all end services like consulting, Business 300-310 Billion by 202014. Nevertheless, the
services in India Intelligence, Infrastructure Management, decade ahead seems to offer great promise
Product Development etc. Firms were able for Indian IT firms, as they seek to overcome
• Contribution to GDP – ~6.4 percent to withstand the tumultous period and their current challenges and tread on to new
(2010) have emerged stronger than ever. As per avenues moving from their traditional linear
NASSCOM India’s IT-BPO sector revenue is models to the non-linear growth models.
• Contribution to India’s service sector –
likely to reach USD 225 Billion by 2020
~10 percent (2010)

• Indian IT companies
-- Presence in ~52 countries
-- 400+ global delivery centers India’s technology and business services export market - scenarios 2020
-- 750 captives

• Employment to ~10.8 Million
-- Direct Employment - ~2.5 M
-- Indirect Employment - ~8.3 M
-- 60,000 foreign nationals

• Domestic IT-BPO sector – INR 1321
Billion, growing at ~16 percent (FY2011)

• I
T Services – INR 501 Billion and BPO
– INR 127 Billion; both growing at ~17
percent (FY2011)

• I
ndian Software Product segment – INR
157 Billion

India IT-BPO Market Segment
Breakup
Figure : India’s technology and business services export market - scenarios
Source: NASSCOM Perspective 2020: Transform Business, Transform India” NASSCOM, April 2009
,

Summing up the Journey
Industry has witnessed a complete
transformation from delivering stand-alone
hardware, software and services, to moving
up the value chain and providing a complete
suite of end-to-end integrated offerings
coupled with high-end services like consulting
in large transformational deals. Disruptive and
Source: NASSCOM Strategic Review 2011
emerging technologies such as virtualization,
cloud computing, social computing etc. have
further brought revolution in the IT space. The
Several top Indian IT firms have reached
linkages between processes, infrastructure
considerable scale and feature in the global
and software are likely to get tighter and
lists like Fortune 500, and Forbes 2000.
pricing models such as pay-per-use and
With the domestic market opening up,
outcome-based pricing expected to gain more
almost all major global IT-BPO firms have a
prominence. All these developments are
presence in the Indian market in one form
compelling vendors to transform themselves
or the other. Indian IT firms have also hit
and adapt to the changing ecosystem.
their stride, and have expanded globally
across all major geographies, acquiring
both clients as well as other companies.

13. NASSCOM Strategic Review 2011
14. “NASSCOM Perspective 2020 : Transform Business, Transform India” NASSCOM, April 2009
,



Changing Dynamics Maintaining the same level of rapid growth
as registered in the past decade is going to

of the Businesses be a challenge for Indian firms. The current
market is characterized by uncertain demand,
increasing competitiveness and changing
technology landscape.

IT-BPO Industry – Changing Dynamics

Source: KPMG in India - CII Summit 2012, Non-linear models 2012 Analysis

To sustain sharp growth registered by punish the US companies outsourcing their
vendors, there is a constant impetus customer calls by denying them federal grants
on companies to innovate and undergo or loans for a span of five years15. Operators
transformational changes to stay relevant would need to disclose their location to
in the market place. Like any other industry customers and offer them the option of being
during its growth phase, this industry is also serviced by an alternate US call centre. In a
going through its share of turbulence. separate move last year, the State of Ohio had
banned outsourcing in government funded
projects5.
Geo Political – The Cocooning West
New Visa Policies
Extreme measures by western economies
New visa norms are making it more
to prevent jobs from flowing out of their
challenging for the industry players to serve
countries to destinations like India are
their customers in their biggest markets.
weighing heavily on Indian exports, especially
Last year, US government imposed a steep
the Indian IT-BPO industry.
hike in the visa fees for work permits for the
Protectionist Policies skilled workers to fund the security on Mexico
border16. This steep hike could potentially
The economic crisis resulting in rising jobless
make it difficult for some of the IT resources
claims has once again forced the west to
to visit US for work. UK government has also
raise anti-outsourcing flags and promote
taken few measures making it difficult for
protectionist policies. For example, the
companies in UK to hire workers from outside
recent US Call Center Worker and Consumer
the country.
Protection Act introduced by some members
of US House of representatives seeks to

15. http://www.thehindu.com/opinion/editorial/article2738977.ece
16. http://articles.economictimes.indiatimes.com/2010-08-13/news-by-industry/27603986_1_visa-costs-hike-in-visa-fees-protectionist-move



Alternate markets growth not fast enough
North America, UK and Western Europe comes to outsourcing. They have better incomplete without the social layer today.
are the largest markets for outsourcing. controls in place, not just to manage More companies are now interacting with
On the other hand, the rate of growth outsourcing but also measure the quality of their customers directly, through various
in outsourcing has been highest among delivered goods. As a result they have turned mediums not confined to the traditional
emerging economies though the base is still more demanding towards the vendors and channels. While the IT vendors create
relatively small. The lower volume and low their expectations are sky high. The cost business tools or various enterprise
scale of IT adoption in emerging markets is pressures on them just makes it worse, applications, now they need to think about
not proportional to the contribution made by since their expectations are still high but their social interactions right from the inception
western countries and has not been able to spends are not increasing considerably. during conceptualization phase and not
compensate for the decline in growth from relegate it to an after-thought. Whether it is a
West. Consulting to implementation: The elusive bank or a retailer or a telecom firm, customer
value chain interactions are no more limited to branches
Domestic market emergence Despite the top Indian players having or outlets. Consumers are connecting to the
While the industry has primarily been established their brands globally and having companies from anywhere now – whether its
export-centric, India’s domestic market is cutting edge solutions across certain verticals desktop, laptops, phones or tablets. They are
now also gaining traction, the expected size and functions, boardroom access still eludes using the likes of Facebook and Twitter as a
of Domestic market is USD 29 Billion17. The most of them. They are still looked upon medium of expression, and given the extent
market size of domestic BPO is expected to as vendors instead of partners – as against to which the organizations might be exposed,
reach USD 2.47 Billion by 201418. Domestic IT how the global players are positioned in the they can do anything but ignore it.
spend is USD 16 Billion18. The Indian software marketplace.
product segment fuelled by replacement of in- Mobility in enterprise
house software applications to standardized Falling discretionary spends Workforces are getting mobile at a rate
products from large organizations and The slower than expected and uncertain faster than ever before. Desktop/workspace
innovative start-ups is estimated to be USD economic recovery has made companies are losing their definition as the new order
3.5 Billion18. The government (state and cautious in making any discretionary demands people to be able to work and
centre) annual spend on e-governance is investment decisions for the future. This have complete access from wherever
also expected to be USD 4-6 Billion over the resultant decrease in discretionary spend they are. While ‘Blackberry’ and VPN were
next couple of years19. Most of the IT-BPO from clients has impacted the order pipeline synonymous with ‘work from home/
companies now have an independent vertical of IT companies and delayed contract anywhere’ in the past decade, the coming
for Government17. closures. decade will have the employees’ entire office
‘move’ with them giving them the ‘access’
to everything which they had from their
Market conditions- High client Socio-technological & cultural- workspace in office. The larger challenge will
be to provide this not on a single medium like
expectations, low spend untethered access everywhere
desktop/laptop, but other digital mediums
The sector where “stock performance” Social layer which has spread itself atop too like phones or tablets as the employee
is directly linked with quarterly results, almost every consumer-related service, is might choose. ny web/online presence
companies are in constant pressure to now spreading fast into enterprise space. or an enterprise application tool dealing
perform and deliver while facing issues of Adding to this is the new “mCulture” that with customers is incomplete without the
margin pressure due to rising wages, lower is defining the lives of next generation of social layer today. More companies are now
billing rates and forex volatility . consumers wherein “touch” and “share” is interacting with their customers directly,
ubiquitous and mobile is the new desktop. through various mediums not confine
Heightened competition between vendors
Limited client spending in a recessionary Mobility in consumer space
environment has led to intense competition • G
lobal market size for Enterprise Mobility - Past 3-4 years have seen the growing use
amongst Indian IT vendors, often leading USD168.8 Billion by 201520 of ‘Smartphones’ and more recently the
to undercutting of prices to win a bid. This • Over 840 Million active mobile ‘Tablets’. The underlying principal to the rapid
is leading to pricing pressure as contracts subscribers21 expansion of these new product types is quite
are won based on lowest price bids. This simple – mobility. IT/technology vendors and
heightened competition is leading to • 15 million mobile subscribers are added
clients alike will need to think ‘Mobile up’
increased cost pressures on the companies every month21
design strategy rather than create a solution
as margins get hit. • Smartphone market share - 15 percent21 and then making it mobile enabled.
New low-cost destinations • Laptop market growing at the rate of CAGR
Communication is changing
50 percent21
Emergence of low-cost destinations like To get a perspective: The number of social
Philippines, Eastern Europe and Latin America • Banking, Manufacturing and Retail are media accounts is 3 times more than the
is also adding to already existing competitive leading the way in applying mobility service email accounts. Email has seen a 59 percent
environment; as a result, unlike in the past to their operations21 decrease in usage amongst 12 to 17 year-olds
where India was the default destination for • Over 34 million22 Facebook users and over and 12 percent decrease amongst 45 to 54
outsourcing, the customer today has options, 13 million Twitter users23 year-olds24. This implies that ‘instant/social’
and they are using them. This too is exerting is to communications today to like what
pressure on the Indian players. ‘email’ was 10 years ago. Adding to this is the
Social- The new ‘uncontrollable’ channel existence of multiple platforms unlike single
Maturing clients- demanding high quality
Any web/online presence or an enterprise platform in the past decade. The consumers
Clients are now way more matured when it
application tool dealing with customers is of today want to communicate from

17 NASSCOM Strategic Review 2011
. 21. The Enterprise Mobility Study-India Market Analysis, Zinnov
18. http://www.indianexpress.com/news/indias-domestic-bpo-market-to-be-worth-1.4/775190/ 22. http://fbupdates.com/2011/09/india-34-million-facebook-users-and-numbers-on-a-rise/
19. Press Information Bureau – Government of India, July 17 2010,E-Governance Projects
, 23. http://asiancorrespondent.com/71003/india percentE2 percent80 percent99s-digital-media-not-fad-not-bubble-its-just-
20. ttp://www.prweb.com/releases/enterprise/mobility/prweb4370204.htm getting-started/
24. http://www.huffingtonpost.com/ryan-holmes/social-media-holiday-retailers_b_1158356.html



anywhere through any device or any SEZ: Imposition of MAT Captives centers
application. Hence, communication needs Minimum Alternate Tax at 18.50 percent (plus The captive centers being ‘low-risk’ and
to be treated as a platform over which other applicable surcharge and cess) of book profits involved in ‘low-end’ functions are typically
experiences are built, and not vice versa. has been made applicable to SEZ Units and remunerated by their foreign affiliates
SEZ Developers vide Finance Act 201126. between 10 to 15 percent on their cost.
While earlier, the ‘market’ for all the latest in Although, a Company may claim set off of However, the IRA have adopted an aggressive
technology used to be the west, thanks to taxes paid under MAT against taxes payable approach and expect a return of as high as 25
the demographics and the rate of technology under normal provisions in future years, it is to 35 percent from the captives by comparing
adoption in emerging countries like India, the possible that the set off may not be available them with full fledged entrepreneurs. Denial
market is now shifting close to home. India in its entirety. In such a scenario, taxes paid of economic adjustments for functions &
is central to the global mobile and internet under MAT would become a cost for the risk differences and single customer risk are
revolution having one of the highest rates of Company. Further, Dividend Distribution few pain areas for captive centers. Further, in
growth of user penetration. This gives the Tax at 15 percent (plus applicable surcharge the recent transfer pricing audits the captive
Indian technology firms an opportunity to and cess) has also been made applicable centers are looked upon as creating unique
use the domestic market as testing grounds to SEZ Developers27. These developments intangible and a portion of the profits earned
for path breaking technologies and solutions have adversely impacted the prospective by the foreign parent at the global level is
like mobile workspace, mobile peer-to-peer investment in the SEZ scheme demanded.
payments, mobile banking, mobile shopping
etc. before they take their solutions to global Intellectual Property (IP) protection Companies focusing on R&D
platform. Software industry is currently plagued with The Indian Revenue authorities also claim
weak patent protection and high piracy rates. that the Indian subsidiaries engaged
In order to foster R&D, there is a need for in undertaking contract research and
Governance & regulatory- Killing the the government to put in place a strong IP development (‘R&D’) activities, create
golden goose protection law (and enforcement). As of today, intangibles for the foreign parent. The
Past couple of years have seen the the IP protection laws in India are tenuous at intangibles and the proprietary product
government rolling out policies that are not best. Looking at the ongoing patent disputes so created are commercially exploited by
favorable for the industry. In addition, the across the world, especially in the mobile the foreign parent to earn super normal
Tax authorities have been very aggressive space (Apple vs. Google, Apple vs. Samsung, profits while the Indian captive centre is
with respect to imposing tax regulations on Motorola vs. Microsoft etc.) there is a strong remunerated with a ‘low’ mark-up on its
the Indian IT players as well as MNCs who need to evaluate whether current IP laws costs. This happens despite the fact that the
have set up captive centers in India. Adding and judicial systems are geared up to handle R&D centre in India does not assume any risk
to these is the lack of clarity on agreements cases of complex dimensions, should they for the work done by them and perform only
with various countries for avoidance of double arise in the future28. limited functions.
taxation. Current taxation measures from
government authorities need to consider the Transfer pricing: Affecting MNCs and These multiple regulatory issues are
current market situation, the challenges and Indian players alike impacting the industry growth potential and
needs of the industry. This calls for an open India is an attractive destination for MNC’s to would need attention from government so as
dialogue between the government and the set up and operate their Captive units, R&D to give the required boost and support to the
industry representatives which would lead and ODC. The conducive tax environment industry.
to formulation of favorable policies by mutual in the form of tax holiday benefits given to
consent. IT-BPO industry under the STPI, EOU and
SEZ schemes have acted as a catalyst in its Human resource- Ready to pay but
Tax growth. However, this has not come without no availability of skills
Upto Financial Year (‘FY’) 2010-11, the increased scrutiny from the Indian Revenue Attrition and wage inflation
Income-tax Act, 1961 (‘the Act’) provided Authorities (IRA) especially in the area of
for deduction from profits generated from Indian IT-BPO industry is facing challenges
transfer pricing where there is a steep rise
exports of computer software and IT-BPO in hiring, managing and retaining talent in
in the transfer pricing adjustments. Key
service25.In the last few years, the IT-BPO current environment. Availability of abundant
Challenges faced by the IT-BPO companies
Sector has not seen the high growth rates opportunities has led to rapid job switches
have been mentioned below.
experienced by it in the earlier part of the among professionals leading to high attrition
decade. Indian players levels. An effect of this is the wage inflation
which is adding to margin pressure on firms.
The IRA considers Indian entrepreneur
Further, while the Industry has grown big, To contain attrition, companies have to
players to be the technology and brand
a major portion of the industry revenue is invest proactively in hiring, training, cross
owner. Accordingly, the Indian players are
concentrated with the top 10 players. Small skill development, managing motivation and
expected to retain higher profits in India and
and Medium Businesses (‘SMBs’) are large paying higher salaries to employees. All these
compensate the foreign affiliates at minimal
in number, have a low revenue base and measures lead to further cost escalation
cost plus margin. Another key challenge
they are the ones who constitute the bulk aggravating margin pressure on the firms.
for the Indian players is that the IRA are
of companies registered under the STPI increasingly trying to compare prices of
scheme. The expiry of income-tax benefits Huge Employee Base leading to
software products supplied to domestic
under the STPI scheme from 1 April 2011 (i.e. operational complexity
parties with exports being made to overseas
FY 2011-12) would impact the SMB sector in The top Indian companies in the IT-BPO
affiliate company despite there being
a big way. sector have an employee base greater than
significant differences in terms of geography,
100,000 and are hiring in the rage of 40,000
market dynamics, marketing expenses being
employees to 60,000 employees annually29.
accounted for in the pricing etc.

25. Section 10A / 10B of the Act 28. “Patents dispute between Google and Apple gets ugly” Sep 2011, CS Monitor; “Samsung widens patent
,
26. Section 115JB of the Act dispute with Apple” Sep 2011, The Wall Street Journal; “Judge sides with Microsoft in Moto patent dispute”
, ,
Dec 2011, CED News
27 Section 115O of the Act
.
29. Company data, KPMG in India - CII Summit 2012, Non-linear models 2012 Analysis



Managing such a massive employee base “investments” to build best of the breed
is becoming a mammoth challenge owing talent are increasingly being viewed as cost
to its operational complexity which leads to amongst companies.
increased HR costs.
Factors such as wage inflation, skills
Employability shortages, rising attrition and operational
With a large pool of graduating engineers complexity in managing large pool is making it
largely unemployable due to deficiencies in difficult to source talent in the industry. These
the current system of education, the IT-BPO challenges are forcing IT-BPO companies to
sector is grappling with the issue of not being re-calibrate their strategies and shift focus
able to recruit the ‘right fit’. The wide industry- from cost competitiveness to providing
academia gap is forcing companies to invest increased value in terms of domain expertise
heavily in training to convert “qualified” and efficiencies to customers. As part of
manpower to “billable” resources. Owing to larger strategy to de-risk, thrust is on moving
current falling margins and pricing pressure, from being “people dependent” to “process
dependent” .

Need for Given the many challenges the Indian
software faces currently, linear growth

transformation - Non- i.e. proportional increase in headcount to
augment revenue is neither desirable nor a

linear model, driving sustainable model.

The impact of linear growth could be gauged
the next wave from the fact that at the current revenue per
employee levels of top Indian vendors, the
growth employee base could double by FY2014 at
current growth levels30. From the current
employee base of ~493,000, the top 4 Indian
firms could add another ~430,000 employees
over 3 years to reach a total of ~923,000 by
FY201430. Managing such a massive base
could become a herculean task and might be
unsustainable over long-term.

Employee headcount growth- Top 4 firms

Figure : Employee Headcount growth of Top 4 India-based IT firms
Source: Company Annual Reports, “Global IT Services” Morgan Stanley Research, September 2011 Includes data for TCS, Infosys, Wipro, HCL Technologies
,

Revenue per employee (RPE) ratio – Global Indian firms33. Also, on the RPE metric (one
IT services vs Indian IT services firms of the metrics to measure non-linearity), the
Over the last 5 years, the aggregate revenues RPE of global firms has been ~3-4 times
of top pure play global IT services firms31 have the RPE of Indian counterparts33. Over the
been in the range 2-4 times the aggregate years, while the revenues of Indian vendors
revenues of top Indian IT services firms32 have been growing at a CAGR of 21 percent,
while the employee base of global majors the employee headcount has also growing
has been proportionately declining, reaching at a slightly lower rate (CAGR ~18 percent)
at 30 percent lower level (2011) than the top making the RPE metric nearly constant over
the years33.

30. Global IT Services, Morgan Stanley, September 23, 2011 32. Indian IT services Firms – TCS, Infosys, Cognizant, Wipro, HCL Tech.
31. Global Pure play IT Services Firms – Accenture, Capgemini, CSC, Atos Origin 33. Company data, KPMG in India - CII Summit 2012, Non-linear models 2012 Analysis



Revenue and employee growth - Global IT services vs Indian IT services

Source: Company data, KPMG Research; Indian IT Services Companies – TCS, Infosys, Cognizant, Wipro, HCL; Global IT Services – Accenture, Capgemini,
Atos Origin, CSC

Revenue and employee growth - Global IT services vs Indian IT services

Source: Company data, KPMG Research; Indian IT Services Companies – TCS, Infosys, Cognizant, Wipro, HCL; Global IT Services – Accenture, Capgemini,
Atos Origin, CSC

It is because of these reasons that companies
are eyeing non-linear growth models which
can deliver higher revenue per employee
value. This would enable these players to
stay lean and deliver sustainable growth and
profitability. To achieve this, it would require a
clear shift from “labor-based service delivery”
to “asset-based service delivery” .

Gradually, this is leading to a change in the
rules of the game and a transition to non-
linear growth model, which is expected to be
the next driving force of the industry.



Section 2
Non-linear growth
model

Non-linear growth In the next phase of growth, the Indian
software industry is attempting to move
(e.g.: cloud, products, platforms, M&A)
and some incremental (CoEs, Delivery

model- Redefining away from delivering a cost advantage
to clients to delivering value for them, by
Accelerators, Pricing Models, Brand), a move
to non-linearity is inevitable.

business dynamics exploring different avenues of non-linearity.
While, a majority is focusing on creating IP/ Based on the practices prevalent in the
products and platforms, some are exploring industry, there are primarily following seven
novel pricing mechanisms; few are building models through which vendors are redefining
efficiencies into how they deliver service their services in their endeavor to deliver
using repeatable modules. Though the effect value to their clients.
of some effect of some could be disruptive

Non-linear growth models

In the subsequent sections, we explore each
of these models in more detail, identifying
trends, current scenario and imperatives for
players attempting to use these levers of non-
linear growth.

• Intellectual Property • Delivery Accelerators
• Cloud Computing • Branding
• Platform BPO • Mergers and Acquisitions
• Non-linear Pricing Models


Non Linear Models Driving The Next Phase Of Growth For The Indian It Industry

Non Linear Models Driving The Next Phase Of Growth For The Indian It Industry

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