ET now caught up with Phaneesh Murthy, CEO, iGATE for his take on the IT sector. Excerpts: Let us talk about the IT environment.Infosys is in trouble, TCS is charged up. Do you think the IT sector is now getting more and more polarised?
Phaneesh Murthy: We are starting to see some differences in the performance of companies. Companies have been following different models and at certain points of time, some models were more effective and at different points of time, different models were more effective. But certainly, you are starting to see a little bit of difference in strategies, which may have been adopted 5-7 years ago or 8-10 years ago, starting to create little divergence now.
Has 2012 turned out to be worse than expected or do you think there are indications of things improving till the end of the year?
Phaneesh Murthy: Overall calendar 2012 has probably been a little worse than expected for multiple reasons. One of them is the fact that Europe was pretty much dead. Barring one or two months in the US, where the sentiment was fairly positive, overall the sentiment has been negative.
Spending in the IT industry in the US in 2012 has been less than budgeted, which means that people are holding back even if they had budgets, which just shows you how much of uncertainty and doubt they had in various things. There are quite a bit cost containment and cost pressures.
I did a survey of about 100 of our customers and I was quite disappointed to find that for 2013, only about 20% are very positive that their budgets will go up. About 30% to 40% believe that their budgets might come down and about 50% believe that it is going to be relatively stable. If you look at even from a forward-looking perspective, it is not looking all that great and that is the reason why the sentiment has been generally negative and that is why 2012 ended up being a little worse year for the whole industry than was expected.
So what about discretionary spend? Is that picking up?
Phaneesh Murthy: The discretionary spend is there, it is just that it is in different areas. We are seeing discretionary spend in customers stickiness, CRM, analytics, anything that can help you with the customer, but the problem is that those kind of projects seem to be much smaller than the big projects that were there earlier. You are trying to build a mobility app to help a certain segment of your customer base and that is in the hundreds of thousands of dollars. Nothing is reaching in the millions of dollars in terms of the discretionary spend in each of the projects. So that actually is part of the challenge that we have. This broader miniaturisation affect has started to come into IT services.
I used to write an order processing application on the mainframe, it used to cost the customer $8-10 million. By the time the client/server and the web world came on, it was costing $3-4 million. By the time these new mobility technologies are here, your order processing application is meant to do very specific things and it is costing you $300,000. There is that miniaturisation effect which is happening, which has to play out slightly differently. I am convinced that we need to move the model of the industry a little more towards IP-based services rather than just pure services.
As of now, Nasscom is still maintaining that for FY13 the Indian IT industry on a cumulative basis could grow in the range of about 11% to 14%. Do you think they need to revisit these estimates?
Phaneesh Murthy: I know that Nasscom considers a lot of other factors, but if I look at the vendor group, I do not think that number will be met. The vendor group will be in single digits.
There seems to be no clarity on where pricing is likely to move because analysts feel that it will come under pressure sooner or later while companies have been maintaining that it is going to remain stable. What is your sense on where billing rates are headed?
Billing rates are going to head a little south. It has been relatively stable. But it is the first time in the last 20 years that I have seen that the preponderance of the deals that we are seeing. We are actually winning against some other player. In the last 20 years the bulk of the deals was actually the customers' work which was coming out, particularly in the larger deals.
Now if we are winning, it is some other vendor which is losing and that is actually the other factor which Nasscom may or may not have considered. When company A wins, company B loses and therefore the net effect on the industry is actually not much and because you are winning against work which has already been done by a competitive player, in effect unless you have so much more efficiency improvement, etc, I believe that the pricing will end up coming a little south to just win those deals.
My sense is that, it is just pure economies, right, growth rate slowdown, we are hungrier for more growth, you do whatever it takes to get that more growth. So one aspect is you put more intellectual capital on the table and you do more from an investment perspective. Another aspect is that you cut a little bit on prices so that you are hoping to win more deals, etc. If I were a betting man, I would say over the next 12 months pricing would probably trail a little downwards.
What kind of range do you think large cap ITs or midcap IT companies could be looking at because the threshold number is that operating profit margins or Ebitda margins like we measure for large cap IT, has been in the range of about 25 to 27, or midcap IT, it is the range of about 18% to 21%?
Phaneesh Murthy: The margin structures of some of the best performing companies are lower. They have set themselves up for flexibility and for investment climate by selling to the street that they will have a lower margin structure but higher growth to make up for that. Deals are not going to impact the overall margin structure, but pricing is definitely going to decline a little and when I say a little, it may be 2% or 3% over the next 12 months.
Therefore, the impact on the margins on those deals versus the total is probably going to be in the decimal points. It is not going to be very dramatic now, but over the next three to four years, margins will start trailing down unless we can come up with completely new ways of doing things.
What about verticals which are going to do well in 2013? Do you think BFSI will contribute?
Phaneesh Murthy: Manufacturing and retail distribution logistics vertical is the strongest. That is the one where the people are willing to do large projects. They are willing to do transformation projects and so on and so forth. The BFSI vertical is very uncertain and all of their measures are towards efficiency and cost cutting. That is the kind of deals that we are seeing, including if company A is doing something, can you come in and take a look at it, increase the scope a little and figure out a way to do it for either the same cost or less. It is really very cost containment, efficiency kind of improvement, but in the manufacturing industry we are continuing to see some positive momentum in transformation deals.
Healthcare is another industry where we are seeing fair amount of traction in terms of ITinvestments and particularly if Obamacare does stay, the spending on that will go up and that will obviously be an output of the presidential elections that we are going to have next month.
Do you see an increase in commitment after the US presidential elections? Are you getting a sense that some of your clients they want to spend more but they are holding on, they want to only decide after they know that who will be the next president of US?
Phaneesh Murthy: There is a little bit of that, but it is very-very small. The real problem in the US is really the structural economy itself. Unemployment is high, consumer sentiment is very negative. Problem with consumer sentiment being negative is even if I have money in my pocket, I do not go out and spend it versus in a phase where consumer sentiment is positive where even if I do not have money, I will go out and spend something.
I do not believe that it is really the presidential election or this campaign which has cost the industry too much or any growth. There maybe at the margin a couple of customers who said that instead of starting in Q2 or Q4, they may start in Q1 or Q2, but that is just too small to worry about in the overall scheme of things. The problem is actually that the low hanging fruit has been won by the IT industry and now you are starting to basically take money from each other and that is not going to increase the growth of the industries, it is just basically increasing the growth of more competitive companies versus not.
The intellectual capital that you have to bring to bear to get what I call the other $1.5 trillion of work, my whole thesis that we are operating in a $1.5 trillion of market space, but the industry is about $100 billion. That balance business has to come by putting significant intellectual capital on the table and that is what we have to start working on desperately.
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