Indian BPO industry suffering from cost pressures

The following from India's Business Standard warns the easy growth is over for India's BPO industry:

Rising costs, Re make IT chiefs nervous

IT AT THE CROSSROADS

Ishita Russell / New Delhi September 25, 2007

Raman Roy is the original poster boy of the Indian information technology industry. After working with GE Capital, he had set up Spectramind with help from private equity funds, and subsequently sold it to Wipro for over $90 million.

With that money, he set up another BPO firm, Quattro. He has lived the great Indian IT dream to the fullest.

Talk to Roy these days and the note of caution is unmistakable. “Yesterday’s newspaper is used to wrap fish. We can’t rest on past laurels,” he said.

Not just Roy, a cross-section of Indian IT firms, exporters of software services as well as BPO outfits Business Standard spoke to were nervous about the future.

Rising wage costs, competition from countries like China, the impending withdrawal of tax incentives under the STPI scheme, the slowdown in the US and the rising rupee have all punctured the optimism of the industry.

With the dollar falling below Rs 40, the margins of IT companies have been cramped even more. Ashish Basil, a partner with professional services firm Ernst & Young, says the falling dollar has impacted the BPOs more than software services exporters because all their costs are borne in India.

“Most software firms have a large number of employees abroad. A falling dollar reduces the salary burden of these employees to that extent,” he said, adding, “For a two per cent fall in the dollar, the margin of a software firm will go down by 0.6 per cent and of a BPO outfit by 1.5-1.6 per cent.”

What worries IT firms more is that the STPI scheme, which exempts their export earnings from tax, will be withdrawn in 2009. The industry is lobbying hard with New Delhi and even BPO firms have raised the demand for similar benefits. So far, the finance ministry has given no indication of warming to the idea.

On his part, finance minister P Chidambaram this year brought IT firms under the minimum alternative tax. He had earlier imposed the fringe benefit tax on all firms including IT exporters.

”If India wants to continue being the prime destination for IT, provide employment to 10 million people by 2010 and if it needs to retain its market share in the outsourcing business, continuing the STPI scheme is a must,” says HCL Technologies President Vineet Nayar.

Nor are people like Nayar enthused by the tax breaks offered in special economic zones. Since firms are not permitted to move existing resources into SEZs, they would have to set up these facilities from scratch. “It will be nothing less than setting up a new company,” said an industry expert.

While there are few takers for SEZs amongst Indian firms, China is scaling up its IT infrastructure in a big way. Several Indian companies including HCL, Satyam, Wipro, TCS and Genpact too have set up shop there.

According to Nasscom, there is no imminent danger to Indian software services firms from China. But China’s IT exports are growing rapidly. The value of IT software and services exported from China was estimated at $1.8 billion in 2006, a growth of 41 per cent over the previous year.

In comparison, the Indian software and services exports were$31.4 billion in 2006-07 and are likely to reach $60 billion by 2010, registering an annual growth of 28 per cent.

However, companies have started locating BPO units in countries like the Philippines. “India is not the only player in the market now. There are other options also available,” says Roy.

However, some experts say India’s critical mass of IT professionals will hold it in good stead. “These countries are good for small centres of up to 500 seats. But if you are looking for a centre of 10,000, there is no place like India,” said Basil.

But there are indications that the country might be losing this advantage too. IT salaries, on an average, have been rising 15 per cent per annum for the last few years, closing the gap in salaries between India and other emerging IT destinations.

“Other markets that will eat up the India advantage if we do not manage the spiralling employee costs and the talent shortage issue better,” said Nayar.