Sunday, August 5, 2012

India's mid-tier information technology firms

MUMBAI: India's mid-tier information technology firms have reported better sales and operating profit growth compared to the biggies in the business at the aggregate level in each of the past five quarters, riding on their intrinsic strengths of operating in niche segments and strong demand in select verticals and bucking the trend of smaller companies taking a beating during a downturn.

At a time when industry leaders such as Infosys and Wipro have provided a sluggish future growth guidance, a clutch of mid-tier IT companies sound far more confident about growth in the next few quarters of FY13. Both analysts and industry officials reckon that this trend is likely to be maintained for at least the next couple of years, which could lead to an improved valuation of these companies.

An ETIG analysis of 17 tier-2 IT firms, which announced their financials for the quarter to June 2012, shows a growth of 38.4 per cent in revenue and an impressive rise of 78 per cent in net profit at the aggregate level from a year ago. For the top four IT companies - TCS, Infosys, Wipro and HCL Technologies - sales rose 33.5 per cent, while profit grew 43.4 per cent. Besides, half of the companies among the 14 tier-2 players that reported double-digit topline growth surpassed revenue growth reported by each of the top four firms, the analysis shows. 

Mid-tier companies such as Geometric, KPIT Cummins, Hexaware Technologies, Mastek, NIIT Technologies and Zensar Technologies reported a strong performance for the June 2012 quarter. In contrast, top tier players such as Infosys and Wipro reported deceleration in sales and profit growth. Though their relatively smaller scale of operations has indeed helped, the changing trend in vendor allocation by global clients, a favourable currency movement, and strong demand in select verticals, which are niche areas for medium and small IT vendors helped them record a stellar performance.

Industry officials also say that long-term management stability in these firms has been critical to their success. "The large players that are not doing well have seen management churn. If you look at mid-size companies that are doing well, they have all had consistent management," says Pradeep Udhas, who is partner and head of IT-BPO consulting firm KPMG. According to him, a stable leadership has helped the smaller companies to specialise and compete with large companies. What counts in the final analysis, he says, are leadership and the ability to be agile.

Select tier-two or mid-rung companies were also able to expand their operating margins against the backdrop of tight IT budget spending. "Compared with top-tier companies, small and medium firms have more levers to improve performance - be it tweaking of employee matrix to include more freshers or reduction in selling and administrative costs," says Angel Broking's IT analyst Ankita Somani.

She draws attention to the fact that historically, smaller IT companies had just over 10 per cent freshers in the employee pyramid compared to over 30 per cent for the top IT companies. A higher proportion of employees with less than three years of experience helps in bringing down operating costs.

The robust show of these companies has not gone unnoticed by the big daddies in the industry. Rajeev Gupta, president of Fujitsu Consulting India (FCI), the Indian arm of global IT solutions firm Fujitsu says that the smaller firms are more agile when it comes to projects worth less than $10 million. "The robust show of tier-2 firms is not only because of a depreciating home currency, it is also about the way clients have started allocating a chunk of their projects to smaller companies."

Global clients are now more than willing to open their doors to second-rung Indian IT companies that are more than willing to take up smaller assignments. "The large IT firms don't go after $5-10 million deals, which we are quite happy to accept," says Zensar Technologies' Ganesh Natarajan. Deals worth $50-100 million are fewer as companies are cutting back on spending or postponing investments, he says.

Their upbeat performance has also helped such companies control employee attrition rates. Most mid-tier firms, which announced results for the quarter to June, showed lower attrition rates. Hexaware, headquartered in Mumbai, reported 9.6 per cent rate of attrition, the lowest compared with 12-16 per cent reported by the top four IT firms. "We declared a salary increase of 10.5 per cent this year, but it is not only about money. Employees are excited about the kind of projects we are handling," says Hexaware's chairman Atul Nishar.

What has also helped is the renewed focus on the manufacturing sector, which has boosted the performance of companies such as Cummins and MindTree, thanks to the rebound in the manufacturing vertical. However, companies such as Persistence Systems, which focus more on discretionary solutions, are likely to report weak numbers. Companies such as KPIT Cummins have taken the inorganic route to enhance skill sets. KPIT's acquisition of Systime in May 2011 strengthened its enterprise solutions offerings and also provided it access to the Brazilian market. "Strategically, the acquisition fits very snugly," says KPIT's chairman Ravi Pandit.

Analysts reckon that the momentum will continue at least in the medium term, given the trend of clients slashing large deals into smaller tranches and engaging mid-tier companies during vendor allocations. "We are likely to see sustained performance by some of these companies, considering their strong order pipeline," says Angel Broking's Somani.

FCI's Gupta also says that the trend should continue for at least another two years. According to industry trackers, the smaller firms are often quick to adapt to the changing requirements of clients, helping them bag deals and expand the scope of services over a period. 

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