IT sector reaping dividends of innovation

INDIA’S information technology sector seems to be having a dream run. The industry association, Nasscom, has projected that the sector is likely to end the current financial year (2021-22) with a total turnover of $227 billion after growing at 15.5 per cent, the highest in over a decade, by adding $30 billion in revenue.

If the industry maintains an 11-14 per cent growth rate over the next few years, it is projected to reach a formidable total turnover of $350 billion by 2026.

Other than its own growth prospects, the sector is critical for the country as software and services exports account for nearly half of India’s overall exports. According to RBI statistics, in 2020-21, India’s overall exports touched $291 billion, with the software and services part within it accounting for $134 billion.

The sustained growth of the IT sector has been made possible because the industry now has more going for itself than just the cost — the lower pay by global standards which Indian engineers are willing to work for — which earlier used to be its sole differentiator. The industry can now boast of rapidly developing an innovative capability which is delivered in two ways.

One is industry leaders offering total solutions to businesses instead of delivering just individual tasks and projects. Indian IT leaders now increasingly sit down with senior executives of their clients to determine what is good for the business and then devise an IT pathway to get there. For this, they have had to acquire what is called domain knowledge — what moves the particular industry. So, they are now delivering not just IT solutions but also consultancy services which help in devising the IT roadmap in which the IT solutions and projects are a part.

The second way of delivering innovation is through startups. These are now mushrooming and, in many instances, drawing foreign funding through private equity and venture capital players. The fact that startups are going places is indicated by three aspects — total number of startups, total funding coming in, and what is most dramatic, the burgeoning number of unicorns — privately held firms that achieve a valuation of over a billion dollars (valuation is the perceived value of the company, arrived by the total number of shares multiplied by the share price). All startups, not just unicorns, are high-tech driven and substantially powered by IT.

Startups have gone from over 700 in 2016-17 to over 14,000 in 2020-21, that is grown 20 times in four years. The list of global investors in Indian startups and unicorns is led by Sequoia, Tiger Global, Accent and Softbank — the biggest of names. Venture capital funds worth over $6 billion were launched in India in 2021. More than $39 billion has been invested in Indian startups in 2021 alone. The sharp rise in the funding of Indian startups has been driven by the recent success of public issues of startups and the pandemic pushing digital adoption, all underlining the role of tech companies.

Early this year, India could boast of 83 unicorns. Of these, as many as 44 have been added last year (2021), which underlines that this is a very recent phenomenon. India now hosts the third largest number of unicorns in the world, after the US and China, in the process overtaking the UK, which is now at number four.

The good fortune of the industry is that it has all through its life received active support from the government of the day, right from the 1991 Budget in which the then Finance Minister Manmohan Singh exempted software export earnings from income tax. Thereafter, successive governments have proactively changed the regulatory environment for the industry so that the ease of doing business — the bugbear of a lot of industries — keeps getting better.

Mid last year, the current government brought in reforms for the ‘other service providers’ so that work from home and work from anywhere were made easier and distinction between domestic and international ‘other service providers’ was removed. It has other reforms in the pipeline, like in the sphere of SEZ exemptions.

It is not as if the IT sector does not have its share of problems and challenges. The foremost of them is the shortage of skills. When a people-driven sector grows this fast, sector players compete with one another in trying to attract skilled people. This competition is leading to a very high attrition rate — staff leaving for better offers. In the process, IT companies are forced to sharply hike the compensation packages that they are offering to retain staff or be able to attract the right sort of staff. In the process, IT companies are pushing up their staff compensation bills to a level where it is bound to affect profit margins.

Till now, we have been talking about the number of startups emerging, the investment they are attracting and the valuations they are achieving. But valuation is also an arithmetical, and at times, theoretical figure. When a company successfully closes a new round of funding of, say, a couple of hundred million dollars, then the price that it gets per share issued determines the value of the company.

But it is not as if that valuation is always realisable. In fact, it is often not. Valuations start to tumble when there is a bear run in the stock markets, which impacts how much and at what cost companies are able to raise capital in the near future. This is, in fact, what is happening right now. The threat of a war breaking out over a feared Russian invasion of Ukraine has set the stock market stumbling and this is bound to affect future valuations.

Hugely rising compensation bills of companies have a negative impact on what ultimately matters: the bottomline. Profit levels and profitability go down, reducing the attractiveness of future stock offers among ordinary investors. The big challenge that the Indian IT companies will now be facing is ensuring that their profits grow healthily, even though by not as much as their revenue.