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INDEX

Overview

I.T industry market characteristics

Domestic I.T market

General features of major players

Industry attractiveness

I.T penetration sector wise deep down

Regulations and government initiatives

Challenges faced by the industry

Trends in I.T industry

Projected trends for the industry

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OVERVIEW

The I.T industry in India has today become a growth engine for the economy, contributingsubstantially to increases in the GDP, urban employment and exports, to achieve the vision of ayoung and resilient Indian technology sector will play an important role in meeting theevolving needs of the Indian consumers. It is imperative that end user industries realign theirbusiness models and continuously invest in new technologies to provide innovative valuepropositions to their customers. IT will also be a significant driver in the economic growth of ourcountry due to its effect on increasing productivity and enabling innovation. With its growinginfluence on the economy, the Indian IT industry is expected to witness about 12 percent growthover the next four years, to reach a market size of about INR1.8 lakh crores by 2016. IT servicesand software products will lead this growth, due to an increase in IT adoption by companies,shift towards outsourcing and emergence of new technologies.

IT adoption across end user industries is not the samesome sectors like banking, telecom andinsurance have leveraged IT across their business functions, including the backendorganizational processes, customer facing activities and revenue generating initiatives, and are at

an advanced stage in IT adoption. Sectors like education, healthcare, media and retail arerelatively low IT spenders currently, but are expected to significantly increase their expenditureon this front in the future.

The role of IT in organizations is expected to evolve from simply being order takers totransformative business partners. Several domestic ITcompanies have built strong ITcapabilities in the last decade and today boast of a marquee global client base. While traditionalpricing advantage that IT providers enjoy in global markets may not be relevant for the domesticmarket, they now have the opportunity to play in valueadded areas by serving as optimizationagents and transformation partners and deliver value through process improvements andtechnologyled transformations. IT providers are attempting to understand the unique and

evolving needs of Indian end user industries aiming to employ Indiaspecific strategies for thedomestic market. IT providers are developing the required partner network, applying multiplecost levers and adapting innovative commercial models to fully tap the Indian opportunity.

The Government plays an important role in the IT market, both as a buyer and as a facilitator. In

its role as a buyer, the Indian Government needs to catch up with the rest of the world on IT

spendingits ITspends as a percentage of GDP have been significantly lower than

Governments for developed economies. In recent years, Government has taken the right steps in

some areas for example, UID, education. Going forward, Government needs to focus on

providing more ITenabled citizen services, improving efficiencies in the public sector, investing

in disruptive technologies, standardizing data, and promoting shared services. These initiatives

will need to be supported by a strong execution and governance model to effectively leverage IT.

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I.T INDUSTRY MARKET CHARACTERSTICS

The structure of the Indian I.T industry can be depicted as follows:

In the current scenario advantage India is what the I.T industry leverages to lure clients across

the globe. The diagram below quantifies some parameters of why India is a preferred location for

investors.

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Currently I.T industry serves numerous industries and verticals pan India and the major revenue

is derived from the following sectors:

BFSI is the key vertical that contributes the most to the I.T industry. It accounted for export

revenues of around USD28 billion during FY12, resulting in a share of just over 40 per cent of

the total IT-BPO exports from India.

US has traditionally been the biggest importer of Indian IT exports; over 60 per cent of Indian

IT-BPO exports during FY12 were absorbed by US. Non US-UK countries only accounted for

22.0 per cent of the total Indian IT-BPO exports during FY12. Demand from emerging countries

is expected to show strong growth going forward.

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The market structure of the industry in India is fragmented between various national,

multinational and small sized players. India being the outsourcing destination of the world today,

offers diverse products and services for both its domestic and international customers. This

industry however is dominated by large sized players catering 36% share of the total industry

revenue.

DOMESTIC I.T MARKET

A comparison of Indias ITspends with more developed economies shows that the Indiasoverall IT spend as a percentage of GDP is less than 1 percentsignificantly lower than theglobal average of 2.5 percent.

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More developed economies typically spend more on IT and as Indian economy grows, IT

spending is likely to increase significantly. Greater IT spends lead to productivity improvement

through process automation, incremental business on electronic medium and real time access to

information.

The domestic IT services market is growing the fastest amongst all domestic IT segments. In-crease in IT adoption by companies, increase in size and scale of companies, outsourcing of noncore business activities including new transformational IT deals in various industry sectors suchas banking and telecom and emergence of new technologies such as cloud and data analyticwould drive the future growth of IT services in India.

I nf rastructure Outsourcing: Infrastructure outsourcing is one of the biggest revenuegeneratingservice lines in the domestic market. This segment is expected to grow at a healthy rate ascompanies will outsource the setting up and maintenance of IT infrastructure to thirdpartyproviders, driven by the following factors:

Increasing need for companies to focus on their core competencies and invest in theircore activities due to intense competition

Highend skills required for maintaining and upgrading the complex IT systems tomatch the industry best practices that will be more difficult to manage internally

reduction and lean IT organizationsI T Consulting: IT consulting is expected to grow at a robust rate, driven by convergence of ITsystems and solutions with business objectives and growing IT adoption to handle businesscomplexities, rapidly evolving technology landscape in the corporate sector and curiosity ofcompanies to test attractiveness of emerging technologies and implement them in businessprocesses.

Business Process Outsourcing: BPO is a relatively small market in India and a large part of it iscaptive. However, there is a new trend related to thirdparty transformational outsourcingrelationships between customers and service providers. BPO companies are also increasinglybeing established in tier 2 and tier 3 cities to enable service providers to deliver the services atlower costs.

I nf rastructure and Network I ntegration Services: Demand for infrastructure & network integra-tion services would primarily be driven by a need for synergies in IT systems across the globaloperations of organizations, emergence of complex IT systems and the need to enable them tocommunicate with each other.

Appl ication and Software Related Services: The market for commercial application and custom

application services would be driven by the growth in demand for application software, which isexpected to grow positively as a result of increasing IT adoption, replacement / upgrading oflegacy systems, reducing software license fees and acceptance of payperuse model of softwarelicensing. Demand for applications would also lead to increased demand for software support.

HardwareThe total hardware market for the year is estimated to be around INR32,500 crores, accountingfor almost 32 percent of the total IT market in India.

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1. Personal Computers:Notebooks / tablets and desktops together comprise a major part ofthe IT hardware market. The market for notebooks / tablets is driven by the increasing de-mand for affordable, light weight, and portable computing devices. However, theincreasing demand for notebook / tablets will lead to a fall in the demand for desktopPCs. The slower growth of the desktop PC segment shall be driven by the increasing

demand for computing devices in education and the ongoing Government initiatives toincrease the reach of IT.2. Network Equipment:Network equipment is another big revenuegenerating segment in

the overall hardware market. It is expected that increasing investments by companies inexpanding and upgrading their current IT infrastructure would lead to increased invest-ments in network equipment by most of the enduser industries.

3. Servers and Storage: Growing acceptance of cloud computing, virtualization anddigitization is expected to drive the demand for servers and storage in future.

Software Products

The total software products market for the year 2013 is estimated to be around INR17,800crores, accounting for around 18 percent of the domestic IT market.

1. System Infrastructure Software: This segment primarily comprises of systems software,security software and system and network management software. The systems softwaremarket is more mature and developed. However, current technology and business trendssuch as adoption of disruptive technologies like cloud and mobility and growing businessthreats point toward a strong market potential for security software as well as system andnetwork management software. Growing adoption of cloud computing and virtualization,with concerns for security and improved customer services, would drive companies toinvest in these applications.

2.

Application Development Software: The market for application development software isexpected to grow at a healthy pace, primarily driven by the use of cloud leading to redefi-nition of methods of design, testing and deployment of applications as well as emergingmobile applications, systems and devices. However, leading providers will face somestiff competition from the growing presence of opensource software.

3. Application Software: Some of the key examples of application software include enter-prise software, accounting software, office suites, and graphics software. The use of ap-

plication software is increasing due to multiple factors including replacement / upgrading

of legacy systems, increasing IT adoption across industries, reducing licensing fees, and

increasing acceptance of payperuse model (software as a service) for software

licensing.

The value chain of the industry in broad terms can be depicted as follows:

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PORTERS FIVE FORCES

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GENERAL FEATURES OF THE MAJOR PLAYERS IN INDIAN IT

INDUSTRY

We have analyzed three players in this industry- Infosys, TCS and HCL Technologies. And we

have seen some trends across these players.

DEBT TO EQUITY RATIO

None of these companies have high debt to equity ratio. HCL has been reducing its debt over the

years while Infosys is a zero debt company. Most of their projects are funded through internal

funds. So maybe they dont take debt. Also their actual assets are human capital which cannot be

acquired.

DEGREE OF OPERATING LEVERAGE

DOL (TCS) 1.170881945

DOL (Infosys) 0.602079776

In IT industry, variable expenses are higher as compared to the fixed expenses. Therefore the

Degree of operating leverage is very low in IT industry.

FOREIGN EXCHANGE IMPACT

A majority of the business of Indian IT services players is transacted in foreign currencies, which

makes the industry vulnerable to fluctuations of the Indian rupee against major global currencies,namely, the US dollar, the British pound, the Japanese yen and the euro.Different companies follow different hedging proportions and strategies. Out of all the majorplayers Infosys has a stable and consistent hedging strategy. TCS has a varied policy for hedgingits currency risk. TCS has a mix usage of options and forward contracts as hedging instruments.Some companies like Infosys have only foreign currency.

EMPLOYEE MANAGEMENT

In I.T companies the major asset is the employees. The comparative analysis of the three

companies depicts that the number of employees of TCS manages is far more as compared to

HCL and Infosys. Market downturns have not affected the company as its continuouslyexpanding its employee base for the past five years. For HCL and Infosys also the employees are

increasing but the percentage increase is not more than TCS which is the market leader.

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ATTRITIONAttrition, which is defined as employees resigning or retiring and does not include people whowere fired, has a direct relation to the growth of the sector and India's GDP.At Tata Consultancy Services (TCS), 10.6 per cent of the workforce quit in FY13, lower from

12.2 per cent a year earlier. Attrition at second-rung Infosys Ltd rose to 16.3 per cent (14.7 per

cent in the previous year)

COST DRIVERS

According to CIMA, cost driver is any factor which causes a change in the cost of an activity.A cost driver is the unit of an activity that causes the change in activity's cost. IT industry is

primarily driven by its employees. The various are the major cost drivers identified in the I.T

Industry are:

Communication Costs - Messaging, Internet, Intranet Server Platforms Employee Hiring and Training PC Services and LAN/WAN Services Marketing & Advertising Costs Software Development Costs Other costs not identified explicitly

FY09 FY10 FY11 FY12 FY13

INFOSYS 104.9 113.8 130.8 150 156.7

TCS 143.8 160.4 198.6 238.6 276.2

HCL TECHNOLOGIES 50.7 54.2 64.4 77 85

0

50

100

150

200

250

300NO. OF EMPLOYEES

INFOSYS

TCS

HCL TECHNOLOGIES

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INDUSTRY ATTRACTIVENESS

1. An attractive market with a challenging business environment- Indias appeal lies inits competitive labor costs, lucrative domestic market, and its skilled workforce. Foreigninvestors also applaud its strong management and business education system, as well as

its improving telecommunications infrastructure. However, the countrys weaknesses are

its under-developed infrastructure and a restrictive operative environment.

2. One of the top FDI destinations across industries- India was the fourth-largestrecipient of FDI in terms of projects started in 2012, and in terms of value, it accounted

for 5.5% of global FDI. Investors across the world recognize Indias FDI potential.

Between 2007 and 2012, the US invested the most in India, with 30.2% of projects,

followed by Japan with 10.4%. Seven of the top 10 investors in India during 2007-12were from Western Europe, led by the UK and followed by Germany and France.

3. High expectations for 2020India is expected to be among the top three economies ofthe world in 2020, particularly for economic growth and manufacturing according to EY

survey 2014 and 2012 results. Also, this year only 5.2% of respondents expect India to be

surpassed by competition from more dynamic countries, compared with 11% last year.

Strengths such as a burgeoning middle class, growing domestic consumption levels and a

skilled workforce are helping India to strengthen its position in the global marketplace.

I.T PENETRATION SECTOR WISE DEEP DIVE

1. BANKING

Current I.T Adoption

INR 18,500 crores IT spends in banking

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2. TELECOM

Current I.T Adoption

INR 15000 crores IT spend on telecom Large strategic outsourcing deals a norm in telecom

3. MANUFACTURING

Current I.T Adoption

INR 12,300 crores IT spend in manufacturing, adoption levels still low I.T service typically deals with infrastructure outsourcing and project development

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REGULATIONS & GOVERNMENT INITIATIVES

Regulations

After the economic reforms of 1991-92, liberalization of external trade, elimination of duties onimports of information technology products, relaxation of controls on both inward and outwardinvestments and foreign exchange and the fiscal measures taken by the Government of India andthe individual State Governments specifically for IT and ITES have been major contributoryfactors for the sector to flourish in India and for the country to be able to acquire a dominantposition in offshore services in the world. The major fiscal incentives provided by theGovernment of India have been for the Export Oriented Units (EOU), Software TechnologyParks (STP), and Special Economic Zones (SEZ).

Government Initiatives

FDI up to 100 per cent under the automatic route is allowed in Data processing, softwaredevelopment and computer consultancy services; Software supply services; Business andmanagement consultancy services, Market Research Services, Technical testing & Analysisservices.The Government of India's move to do away with the mandatory requirement of 10 hectares ofminimum land area for setting up an IT and ITeS special economic zones (SEZ) is expected toprovide a major boost to the real estate and IT sector.Some of the major initiatives taken by the Government to promote IT and ITeS sector in India

are: The Government of West Bengal plans to spend Rs 41 crore (US$ 7.37 million) to roll

out citizen-centric services electronically across 19 districts including Kolkata

Kerala has set an ambitious target of becoming a cent per cent digital state in governance.The State has around 600 small, medium and large IT firms employing over 80,000professionals directly and nearly three times the number indirectly

The Cabinet has recently approved the National Policy on Information Technology 2012.The policy aims to increase revenues of IT and ITES industry from US$ 100 billion to

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US$ 300 billion by 2020 and expand exports from US$ 69 billion to US$ 200 billion by2020

The Government of India plans to set up 15 new laboratories for testing hardware andsoftware products under public-private partnership (PPP) model

The Ministry of Finance has issued a circular to chairmen of public sector banks andregional rural banks, that all payments to customers, staff, vendors and suppliers as wellas disbursement of loans and payments towards investments should be made only throughthe electronic mode

CHALLENGES FACED BY THE INDUSTRY

In India, workforce is available at relatively lower costs, making it challenging for IT providers

to pitch the effectiveness of their solutions purely based on the cost advantage. IT providers,

therefore, need to identify alternative value propositions for the domestic market. Process

optimization and business transformation are what Indian companies need, and many times this

can be challenging to provide at the price levels they demand.

Indian companies are late adopters of IT

Indian companies, being late adopters of IT, do not have historical investments in building IT

capabilities for their businesses. As a result, companies start from a very low baseline of IT

management capabilities and infrastructure, in contrast with their counterparts in developed

countries who have an established basic infrastructure. IT providers, thus, need to play an end

toend role where they partner with clients to help adopt IT, build IT systems from scratch, andimplement transformative business processes, all at the same time.

Indian companies are cost sensitive

Several Indian companies still consider IT as a cost center, and not a driver for value addition

and business growth. In order to control costs, companies tend to resort to hard negotiations,

prefer integrated deals and press for outcomebased pricing models. Due to this mindset,

companies may eventually compromise on some key aspects of the implementation, to be able to

accommodate costs within the allocated budget. For IT providers, this cost consciousness

translates into lower margins in India compared with the global market.

Client Relationship Management is important

The pattern of IT buying by Indian companies differs significantly from that observed in other

countries. Given the relatively inadequate internal capabilities, Indian companies are typically

high touch clients and prefer more hand holding fromtheir vendors. They expect the providers

to become business partners who will make up for the lack of internal IT capabilities. IT

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providers, thus, need to possess strong account management capabilities with dedicated

resources to be able to serve Indian clients effectively.

Expectation of high quality of delivery

While Indian companies are late adopters of IT and cost sensitive, they are quite discerning asbuyers, demanding the same quality of delivery as promised by IT providers to foreign clients.

They expect vendors to assign quality resources for their projects, as well as ensure delivery on

key aspects like cost, schedule, and quality of service. Put simply, there is a gap between the end

user companies expectations in terms of delivery quality IT providers thus, need to balance the

expectation of high quality delivery with the price points demanded in the Indian market.

Billing rate risks

Billing rate risks refer to the potential danger of clients renegotiating billing rates, causing them

to move southward. A fall in billing rates may adversely impact revenues.

Concentration of verticals

Verticals refer to various industries from which a firm derives its revenues. For a firm focused on

a limited number of verticals, a downturn in any of those verticals, or structural changes that the

industry goes through may adversely affect its revenues. Currently industry is too much

dependent on BFSI sector.

Concentration of service offerings

Changes in the service mix can impact a company's overall performance. Traditionally, Indian

firms have focused on providing application development and maintenance services.

Commoditization of these service-lines could adversely affect billing rates and, in turn, revenues.In order to mitigate this risk, firms need to ensure that they operate in a variety of service-lines.

Besides, they also need to ensure that they gradually move to higher-end service-lines such as

package implementation and systems integration to command a higher price.

Risk associated with exchange rate fluctuations

A majority of the business of Indian IT services players is transacted in foreign currencies, which

makes the industry vulnerable to fluctuations of the Indian rupee against major global currencies,

namely, the US dollar, the British pound, the Japanese yen and the euro.

Immigration regulations

Most employees employed by Indian firms are Indian nationals, while majority of their clientsare US-based. A proportion of services offered to clients needs to be performed on site. The

ability of IT professionals to work in other countries depends upon the necessary visas and work

permits that they need to acquire. Any change in immigration regulations by any particular

country can adversely impact the revenues of the Indian IT firm e.g. the infamous U.S

immigration bill.

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Broad Skill set gap

Out of around 0.4 million engineering students graduating every year in India, only 20% are

readily employable. By 2020, the country is expected to face a shortage of 13 million medium-

skilled workers, posing a big impediment to labor-intensive sectors. Around 93% of the Indian

workforce is employed in the unorganized or informal sector, which lacks any kind of formalskill development system. Barely 2.5% of the unorganized workforce reportedly undergoes

formal skill development, vis--vis 11% in the organized sector.

TRENDS IN I.T INDUSTRY

Players focus on domestic market for strategic reasons

Although the domestic market is not as profitable as exports, many players are taking up projectsin the Indian market for various reasons. Competency building and competitive advantage are thetwo most important reasons among those.

Competency building

Many times, vendors use the experience gained from executing a project in the domestic marketin a bigger project to be executed for a developed market.

Domestic projects involve delivery of end-to-end solutions

Indian IT players, to date, have been unable to establish themselves successfully in high-end ITconsulting, system integration and infrastructure management services and continue to lose outto global players. In contrast, projects offered in the domestic space require end-to-end ITimplementation encompassing consulting, implementation, system integration, testing andinfrastructure management services (IMS). Such contracts provide ample opportunities to IndianIT service providers to develop their capabilities and win clients abroad.

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Cloud to gain traction across SMEs

Cloud services (Iaas and PaaS) are also on rise as these services are offered using pay-per-usemodel. CRISIL Research believes that cloud services would result in significant uptake of IT by

SMEs. Subcontracting, standardizing and shared risk-reward improve project viability.

Small and medium businesses

Wipro is offering cloud services to SMBs in an attempt to become the largest IT vendor in thedomestic market. In the last two quarters of FY11, the company doubled its SMB customer base.TCS iON has garnered 235 customers in the domestic market.

Increased adoption of I.T by the government

The government is taking numerous initiatives across various segments thus increasing the

expenditure and adoption. The sectors in ROJECTED TR focus are:

PROJECTED TRENDS FOR THE INDUSTRY

STPIs, SEZs and Tier II & Tier III cities are projected to be the most revenue generating

sources for the IT sector in the future because of the following advantages:

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PARAMETERS STPIS SEZS

Term 10 years 15 years

Fiscal benefits 100 per cent tax holiday on

export profits

Exemption from excise duties

and customs

100 per cent tax holiday on

exports for first five years

Exemption from excise duties

and customs

Location and size restrictions No location constraints

23 per cent STPI units in tier

II and III cities

Restricted to prescribed zones

with a minimum area of 25

acres

Further trends in the Tier II & Tier III cities have been pretty encouraging as depicted by the

following facts which is driving big MNCs as well as Indian companies to these moreprofitable

locations:

1. 43 Tier II/III cities are emerging as I.T delivery locations2. The cost in newer cities is expected to be less than 28% than the leading cities3. Over 50 cities have the basic infrastructure and human resource to support the global

sourcing and business servicing industry.

4. Some cities are expected to emerge as regional hubs for the large domestic companies.5. Jaipur is emerging as an I.T city with exports of over USD 64 million in FY10.

India is expected to have the largest workforce in the world by 2025, with around 2 billion

English-speaking people by the end of 2020. Within the same period, India has the potential to

have a surplus of around 47 million skilled workers through its skill development program, while

across the world are expected to witness a shortage of around 56.5 million skilled workers(Source NSDC).

Redefining Boundaries

The major revenue of Indian I.T industry is presently concentrated from U.S and U.K majorly.

BRIC nations, continental Europe and Japan have IT spending of over USD183 billion but

contribute only 12 per cent of Indias IT revenues. The need of the hour is to focus on these

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diverse geographies to reduce dependence on the western powers and become self-sufficient.

Further adoption of technology and outsourcing is expected to make Asian nations like

Singapore, Philippines etc. the second largest IT market.

Redefining Verticals

Over 85 per cent of the total Indian IT-BPO exports is across four sectors viz. BFSI, telecom,

manufacturing and retail. Public sector, healthcare, media and utilities have IT spend of over

USD587 billion but constitute only 20 per cent of Indias IT revenues. The following are the

sectors to be focused on moving forward.

MEDIA

This sector is approximately INR 700 billion in revenues and is expected to grow at 15% per

annum till 2016. 40 percent revenue of this industry comes from advertisements, which is thearea to be tapped by I.T industry. The opportunities are:

Analytics and business intelligence for targeted marketing, dynamic pricing and marketresearch to use viewer feedback

Increased need for social media and mobile based applications to increase reach andrevenues

HEALTHCARE

The healthcare market in India is estimated to be INR 300 billion. While the reach of the

Governmentmanaged public healthcare network is higher, private institutions have a larger

share (approximately 60 percent) in terms of the total number of institutions. The public health-

care system mainly consists of district hospitals, Primary Health Centers (PHCs) and Community

Health Centers (CHCs). The private sector is a mix of specialty hospitals, national chains,

independent hospitals and small clinics / nursing homes. Opportunities for I.T are:

Patient management- kiosks at hospitals Clinical layer- disease management software, electronic medical records etc. Systems like Virtualization, PACS, BI Hospital Information Exchanges(HIE) Telemedicine & E-prescription

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