This squall will pass

The 2007-08 first quarter results of the top three software companies have come as a bit of a shock to an Indian public which had got used to the regular unveiling of exceptional numbers. The results are still smart by any standard, with the top line going up by between 25 and 34 per cent, year on year, and the bottom line by between 17 and 36 per cent on the same basis. But the 7 per cent rise in the value of the rupee, vis-à-vis the US dollar, during the same quarter has taken a toll which becomes apparent when the latest results are compared with those of the preceding (January-March) quarter. Both Wipro and Infosys have reported a shrinking of the bottom line, whereas Wipro's top line too has fallen and Infosys' has remained static. Wipro, of course, has other businesses but its major non-IT business, consumer care and lighting, has kept pace with the IT business. TCS has probably been able to come out shining more than the other two (it has registered a marginal improvement in both top line and bottom line) because its global revenues are more diversified. This is a great help at a time when the US dollar has fallen against most other currencies. Both Wipro and TCS have a modest presence in the Indian market, but Infosys has virtually none. This is something which the firm is probably thinking about now, though its concentration on the US market continues to give it the best margins in the industry.

In all likelihood, these leaders of the software services industry will be able to ride out the present squall without much by way of a further downside, for two reasons. All three have reported success in obtaining price increases from customers, indicating that they have developed strong customer stickiness (which is apparent also from the high proportion of repeat orders they get). On top of that, continuous productivity gains are a part of their business model. Thus they should be able to go through the present air pocket and retain the market's confidence, if not exactly return to the earlier growth momentum. Besides, the net margins of both Infosys and TCS have not been affected by the latest development. This should take care of a lot of the industry's space as the top five firms now account for half of software exports.

When the focus shifts to the medium and smaller firms, it is evident that they cannot get price increases every time the exchange rate moves against them. Of these, specialised firms like those offering engineering and product development services, and IP-based firms are also seen to have a future as they do not operate on the basis of cost arbitrage. This leaves out the undifferentiated medium and small firms that work only in the development and maintenance space. Quite simply, these do not have a bright future before them.

There is also a need to look at gradual and continued currency appreciation as a clear possibility, and not as an entirely negative phenomenon. A good third of the industry leaders' work is delivered on-shore by their staff working at clients' sites who are paid at rates prevalent in those economies. Plus, all the industry leaders seek to develop their global delivery centres so as to become truly international. For both these reasons, rupee appreciation might help the big software companies in hitherto unsuspected ways.