I think the annual NASSCOM conference is always a great time. I get to catch up with old friends, at least one-third of the Indian service providers industry’s leadership attends and it’s an insightful venue for capturing the mood of the industry’s providers. This year the mood was more somber and more reflective than in past years. The Indian service provider industry is clearly grappling with several issues.
Worrisome Decelerating Growth
The first issue is the deceleration in growth. The industry has had four straight quarters of deceleration. Last quarter, the industry grew at 3.1 percent, and the top five Indian firms grew at 7.7 percent. This is the lowest level of growth the Indian service provider industry has ever experienced. This decelerating growth is worrisome.
Behind this growth deceleration is the fact that 78 percent of the industry is now arbitrage-first services – which are now legacy. Collectively, growth in the arbitrage group of services was flat; in fact, it declined by .2 percent. The growth area of the industry is digital first, which now makes up 22 percent of the industry, and it grew at 20.8 percent. The industry is clearly focusing on the rotation into digital.
The inconvenient fact around this digital journey effort is that digital services are less than the mature arbitrage work. Therefore, the faster a provider’s business grows in digital, the more it stresses its arbitrage-first margins.
Activist Shareholders are a Complicating Factor for Growth
The “Elliot thesis” has captured the entire industry’s attention. Elliot Management Corp is an activist shareholder that has taken a position in Cognizant and written an open letter to the board and shareholders. Effectively, Elliot’s thesis states that a provider should constrain its rotation from arbitrage into digital services by increasing margins in arbitrage and returning cash to shareholders. Recently TCS announced it is returning cash to shareholders through a share-buyback.
The Elliot thesis complicates service providers’ business. Now they are not just struggling with how to rotate into digital but also the need to placate their shareholders at the same time. Returning cash to shareholders complicates the digital journey in that it results in less cash available to accelerate their journey by buying digital companies and making other digital investments.
The Trump Effect
That’s the background to the somberness I observed. There’s no denying it’s a tough time for the industry. But recent complicating events raised the stakes: The Trump effect and Brexit are causing a slowdown or pause in globalization.
The talk of the halls at the conference was the Trump effect. It’s very clear that the arbitrage-first industry is facing numerous instances in which companies are delaying or potentially cancelling offshoring/arbitrage initiatives. An additional concern is that some companies may decide to repatriate offshored services, while others may take a fig leaf or olive branch strategy, moving some work back onshore and thus focusing the media on their investment in US jobs.
Real Hope Despite Somberness
Balanced against the factors causing the sobering times for the Indian service provider industry is the bright prospect of a digital-first future. The industry firmly believes that there is significant growth in a digital-first future and that it will not necessarily be without labor arbitrage. Providers believe their digital-first future will pivot to their value being based on the disruptive digital technologies and capabilities, but they will be able to further enhance that by deploying their robust talent coming out of India on an affordable basis.
So, there is some hope, despite the mature arbitrage market and the slowdown or pause in globalization. However, there are real concerns around managing the rotation into digital as well as the impact on profit margins. Certainly, there is substantial uncertainty around at least the short-term prospects for the industry – enough uncertainty in the picture that NASSCOM decided to postpone its annual forecast for the Indian services industry.