India’s IT sector at the crossroads

NEWS FEED: LIVE MINT

http://www.livemint.com/Opinion/3IfGSmr9cQvbwOZ4aollCL/Indias-IT-sector-at-the-crossroads.html

The better-than-expected third quarter earnings of Infosys Ltd may have come as a balm for India’s information technology (IT) sector which last fortnight reeled from the reverberations caused by employee firings at Tata Consultancy Services Ltd (TCS), but the worries remain. Many fear that the chickens may finally be coming home to roost for the sector, which through the years of high growth (the industry grew at a compound annual growth rate of 13.1% during FY08-13) and bumper profits, refused to move up the value chain. As the controversy at TCS shows, there are far too many people in the middle of the pyramid now, men and women who stopped coding long ago in quest of general management functions which yielded higher salaries but gave fewer opportunities for creative innovation.

The net result has been that through the years that India dominated as one of the fastest-growing IT services markets in the world, accounting for more than 50% of the $124 billion market, it created little by way of intellectual property rights. With the rapid development of smart software increasingly reducing the need for mere warm bodies and leading to falling growth in the demand for purely back-end maintenance services, the sector’s future looks uncertain.

Currently, the IT industry accounts for 7% of gross domestic product (GDP) according to industry body NASSCOM, up from 1.2% in 1998. That this contribution comes on the back of a mere 10 million people employed directly or indirectly, makes it a vital driver for the economy. As growth slows, its ability to act as a lever for services growth will also be seriously impacted. Any serious slowdown also threatens the vital second leg of the paradigm on which the IT services success story has been built. The wage advantages that stem from the lower cost of Indian software developers and gives the cost arbitrage to companies in the country is also complemented by the relatively higher salaries that this industry has offered professionals. This last is vital to the supply of a large pool of trained programmers and coders. Slowing demand and the collapse of the rouble as well as the decline in many east European currencies against the dollar means that the Indian software professional’s earnings capacity is severely dented.

In the new era of lower growth, as Indian companies adjust to a completely different cost structure, the lack of differentiation between the biggest Indian IT services firms shows up in the similarity of their business models. Globally, the digital economy’s market leaders, Apple, Google, Microsoft, are companies that use very different business models. This competition fosters tremendous innovation and creativity which is the hallmark of the knowledge industry.

Vitally, it is a country’s performance in knowledge-based industries that will determine its place in the global economy in the coming decades. An Organisation for Economic Co-operation and Development (OECD) report titled New Sources of Growth: Knowledge-Based Capital released in May 2013, talks of the higher growth that results from business investment in non-physical assets such as research and development, data, software and patents. In many OECD countries, business investment in knowledge-based capital (KBC) has increased faster than investment in physical capital (machinery, equipment, buildings). The report goes on to state that the value of many of the world’s most successful companies resides almost entirely in their KBC. In 2011, for example, physical assets accounted for only about 13% of the value of Nestlé, the world’s largest food company. Across countries, there is a positive correlation between the market value of firms and investment in KBC.

The development is evident in recent manufacturing trends. At the annual Consumer Electronics Show in Las Vegas this year, Germany’s Daimler showcased its self-driving cars, the futuristic Mercedes-Benz F 015 concept, loaded with software-driven features like high resolution touch-screen display panels on the doors that allow passengers to use touch, gestures, or eye movements to navigate or browse, as well as pseudo auto-pilot, LED lights in the vehicle’s grill that light up and can project a crosswalk on the street to let pedestrians know it’s safe to cross.

The F015 is an example of the growing focus within the automobile industry on tech-assisted driving. It is no surprise that at the forefront of developing and testing self-driving technologies is a technology company, Google.

India’s IT firms are truly at the crossroads. Having created a new and influential industry out of a tiny sliver of an arbitrage opportunity, they can now slip into mediocrity or participate in the brave new world of creating knowledge-based capital.