Is Indian IT Slipping? ‘The Economist’ Misses The Woods For The Trees

In an article dated 21 January titled ‘Reboot’, The Economist made some startling remarks about Indian IT sector based on misconception and prejudice. It effectively downgraded the achievements of the Indian software services industry, as if to suggest that performance can happen only in the charmed circle of Organisation for Economic Co-operation and Development (OECD) countries.

The essence of the article was that Indian IT was nothing more than an "outsourced back-office" , Indian IT has become a place where "rich country companies could lower costs by getting tedious behind the scene IT work done by cheap engineers in India". Indian IT does not see much digital action, it does not drive innovation, "designing a mobile banking app for millennial, say is a far cry from parsing lines of code for bugs".

The article says further that Indian IT is in structural decline with minimum salary costs in the US for H1B visas likely to rise from $60,000 to $100,000, visas likely to be cut from 65,000 by the new Donald Trump Administration. It goes on to say the Indian IT is behind the curve etc etc... Many statements based on conjecture without much research and taking some research reports out of context.

Let us get the facts right. Five of the top 10 IT services companies in the world by market capitalisation are Indian. About 75 per cent of their total employees of around 2 million are Indian. The IT services exports from India this year is expected to be around $115 billion, the street value, value in terms of billing for the same services at US rates, is estimated closer to $200 billion.

This remarkable global domination has come about not because these are "cheap engineers" but the extraordinarily high standards in delivery of IT services, epitomised by the largest number of CMM level 5 companies in the world, the best in class training given to employees, high quality processes and project management, great leadership and above all the exceedingly high quality workforce from the top 20 per cent of university graduates. Indian IT delivers complex quality projects and are not cheap body shops as The Economist could be hinting. All this has made only India amongst all countries so successful in a fast changing high tech industry. If this was based on cheap labour only, many other countries would have been competing too.

The systems of many large global corporations are managed and run by these companies, a critical function, the failure of which could disrupt the banking system and paralyse their operations. No major company will go with "cheap engineers" to run their critical systems unless they trust the high quality standards and ability of these companies. Yes, costs are lower but evaluation is based on a risk weighted basis, not mere costs. The costs are lower because of the model, with other major Western companies having large workforces in India too and competing. Despite this competition the Indian companies have superior margins. The major work is not an outsourced back office, but enterprise resource planning (ERP) installations, new software applications, upgradation of systems, maintenance of critical systems calling for great capability and some consulting services.

As for digital action, digitisation is a natural development of web-based systems. They are largely set up by Indian IT from legacy systems. Most changes globally are led by start-ups and the big companies soon get their share. Indian IT has gone from mainframe systems to client servers to Y2K to web-based systems to the ERP wave to the mobile apps and now digitisation over the last 20 years, with many Western competitors falling by the wayside in this transition. As for innovation, the biggest innovation over the last 20 years is services, which made major corporations more efficient and competitive. It was the global delivery model, which calls for a sophisticated approach to software engineering on a 24/7 basis. This innovation fundamentally changed the way software was delivered globally and destroyed the earlier proprietary expensive model! Services and products are different businesses. Products require a different ecosystem, the reason why only the US has so many great product companies. Europe has only one global product company in the same league despite a $17 trillion economy.

As for innovation - "designing a mobile banking app", hundreds of young engineers do this in Bengaluru. This is par for the course and not an innovation any more. Mobile apps are easier to do than complex applications, and they are done easily in these companies. Let us remember the Indian IT is largely B2B and comparing them with B2C start-ups is comparing apples with oranges.

As for the structural decline, a large $115 billion industry cannot grow at 15-20 per cent simply because it is not a sample anymore, and being large is linked to economic growth in the OECD, the main market. When the OECD grows at 2-3 per cent per year, a large industry with a 60 per cent market share of outsourced work, growing at 7-9 per cent per year, three times economic growth is commendable. By its very nature, the industry on account of its lower offshore cost is deflationary, and releases money for further investments to its clients by its growth. As the Indian companies now dominate and largely compete amongst themselves, pricing will not rise but their profits margins will remain superior to their global competitors for years. Just look at the largest player from the US whom The Economist may categorise as innovative and as a leader, their margins have declined and top line declined over the last six years, with not much hope of change in the future. Compare that with the top five Indian companies, the contrast is clear. This biggie has possibly one of the largest employee base in India also.

As for the new "threat" from the Trump Administration, it is something that has come up before though now it is more unpredictable. Let us get the facts again. In the US, there are between 4-6 million employees in the IT sector, depending on what you count as IT. Unemployment is between 3-4 per cent much lower than the overall unemployment of 4.9 per cent, the lowest in many years. This is more because of an unwillingness to relocate than lack of jobs with a large number of vacancies. Many companies are hit due to a lack of IT employees. With rapid shifts in technology the situation will worsen. Recent press reports say that about 50 per cent of science, technology, engineering and mathematics (STEM) graduate students are from overseas, making the situation worse in future.

The US issues 65,000+20,000 H1B visas every year, the latter for graduates from US universities. The visa is on a 3+3 year basis. Over six years, there should be about 510,000 people on visas but because of dropouts, shifts etc about 400,000 visas remain. Indian IT maybe having around 200,000 visas as they have reduced applications over the last three years. Of this, about 150,000 people could be on projects in the US at any one time. About 35 per cent of their total staff in the US is local or on green cards. Of the total work in the US on projects about 10 per cent could be shifted back offshore, reducing the gap to reach a 50:50 workforce or a local company could be acquired for this purpose. So the threat of a 50:50 workforce for visas is not a great threat anymore.

The other move is to raise the minimum salary to $100,000 from $60,000 to make sure that "cheap labour" does not come in. The average salary for Indian IT onsite is now around $75,000. Compensation above $60,000 does not need prior notifications. If the minimum wage increases, there will be a decline in margins of around 100/150 Bips but Main Street America will see a massive increase in IT costs as compensation will increase in an already resource-constrained market. Yes, the big companies in Silicon Valley are willing to pay above $100,000, but they are a small part of the industry; Main Street America will suffer a lot and drive more work offshore at a time many of them see cost pressures due to low unemployment. The demand for talent is driven by shortage not by costs alone.

If the visas are reduced from 65,000 or visas are banned for service providers, there will be a deep impact over time, though new technology could mitigate part of the impact. This is most unlikely even for Trump as American industry will fight back. Automation, AI, ML, Robotics certainly are big threats to Indian IT, but they are also driving this themselves. Yes, the Trump Administration has increased uncertainty, but Indian IT will have to live through this.

The Economist’s blinkered stand is evident from an out-of-context quote of a letter from a chief executive officer to his employees to buttress its views. It forgot that the same IT major is leading the digitisation wave globally.