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Thursday, March 1, 2007
Budget, a missed opportunity: Murthy
Never in the history of independent India has such a great opportunity presented itself to any government. Look at the prospects for India: GDP growth at 9%, savings at about 32% of GDP, investment at 34% of GDP, tax growth by 30% in spite of a 20% increase in taxes in the previous year.
All this called for very bold structural transformational moves changing the course of the economy of this country. Yes, to some extent, this has been addressed in the form of higher allocation for the social sector, for school education, for the agricultural sector, for our villages. But none of them is a bold move to change the context.
For instance, a three-year plan could have been evolved to complete all irrigation projects all over the country to accelerate benefits to our farmers. This would reduce the stress on them. Allocation to irrigation has increased, but not to make any discernible change.
Higher education needed priority. A cess of 1% on all income has been levied, which could possibly yield around Rs 5,000 crore, but a substantial part of that would go to fund investment to enhance seats to meet quota requirements. Giving scholarships to 1 lakh children or enhancing grants to certain institutions is not going to transform India. I would have expected a scholarship scheme of Rs 20,000 a year to fund the education of one million youngsters in colleges costing only Rs 2,000 crore. This would have been transformational. I had expected a policy of greater liberalisation for higher education to change the context, but this has not happened.
To my mind, it is a Budget which sets out to meet very many objectives — very incremental, but not transformational. Opportunities like this are few and far between in the life of a nation. In the area of industry, indirect taxes make up between 24-30% of the final cost of the finished goods — obviously very high for an emerging country like India. A 4% reduction in the excise duty on all goods — excluding oil/oil products, tobacco products — would have cost the government about Rs 20,000 crore, but would have substantially increased industrial output and reduced cost and changed the context. It would have made Indian industry more competitive and increased employment. Yes, customs duties have been reduced in many areas as part of an ongoing scheme, and there are marginal changes here and there but none address fundamental issues.
On the income tax side, economists have identified the challenge of the missing middle, and there is an immediate need to bring tax payers having income between Rs 2.5 lakh and Rs 5 lakh into the tax net and increase compliance and thereby enhance revenues. Tax slabs needed to be reset.
Minimum tax liability sets in on Rs 110,000 per individual, but for a family of four with one earning member this is less than the per capita income. Bold moves are required in the areas of administration, citizen services and governance to sustain growth. Overall, the Budget has missed a great opportunity to transform the economy.
All this called for very bold structural transformational moves changing the course of the economy of this country. Yes, to some extent, this has been addressed in the form of higher allocation for the social sector, for school education, for the agricultural sector, for our villages. But none of them is a bold move to change the context.
For instance, a three-year plan could have been evolved to complete all irrigation projects all over the country to accelerate benefits to our farmers. This would reduce the stress on them. Allocation to irrigation has increased, but not to make any discernible change.
Higher education needed priority. A cess of 1% on all income has been levied, which could possibly yield around Rs 5,000 crore, but a substantial part of that would go to fund investment to enhance seats to meet quota requirements. Giving scholarships to 1 lakh children or enhancing grants to certain institutions is not going to transform India. I would have expected a scholarship scheme of Rs 20,000 a year to fund the education of one million youngsters in colleges costing only Rs 2,000 crore. This would have been transformational. I had expected a policy of greater liberalisation for higher education to change the context, but this has not happened.
To my mind, it is a Budget which sets out to meet very many objectives — very incremental, but not transformational. Opportunities like this are few and far between in the life of a nation. In the area of industry, indirect taxes make up between 24-30% of the final cost of the finished goods — obviously very high for an emerging country like India. A 4% reduction in the excise duty on all goods — excluding oil/oil products, tobacco products — would have cost the government about Rs 20,000 crore, but would have substantially increased industrial output and reduced cost and changed the context. It would have made Indian industry more competitive and increased employment. Yes, customs duties have been reduced in many areas as part of an ongoing scheme, and there are marginal changes here and there but none address fundamental issues.
On the income tax side, economists have identified the challenge of the missing middle, and there is an immediate need to bring tax payers having income between Rs 2.5 lakh and Rs 5 lakh into the tax net and increase compliance and thereby enhance revenues. Tax slabs needed to be reset.
Minimum tax liability sets in on Rs 110,000 per individual, but for a family of four with one earning member this is less than the per capita income. Bold moves are required in the areas of administration, citizen services and governance to sustain growth. Overall, the Budget has missed a great opportunity to transform the economy.
End of tax holiday for SW cos?
Effectively, for the $30-billion IT/BPO industry, the tax holiday has ended two years before time. All software firms will now have to pay a Minimum Alternative Tax (MAT) of 11.33% on income for which deduction is claimed under this section.
Small and fledgling IT companies will be the worst hit by the MAT. Companies like Aricent, Infrasoft, Birlasoft and Mindtree Consulting will bear the brunt of this move. Large companies are insulated to an extent because some of them already pay taxes in other geographies and their domestic operations like for example, TCS.
Introduced for the first time in 1996-97 to bring zero tax companies under the tax net, it will now cover IT companies registered under the Software Technology Parks of India (STPI) scheme, export-oriented units, manufacturing and other companies housed in free trade zones and export processing zones. MAT will have an impact to the tune of 1.5% to 2% on the bottomlines of these companies. Companies housed in STPI, free trade zones, export processing zones, electronic hardware technology parks enjoyed this benefit which was previously available till 2009-10. Under Section 10 B, tax breaks are available to companies located in EOUs. Earlier, they could claim full deduction on their export profits till 2010.
“It was agreed that there won’t be any tax till 2009 under Section 10/B. The government is going back on its commitment. Many companies base their investment decisions on the commitments that are given, this sends a wrong signal,” said Ashank Desai, co-founder, Mastek, and a member of Nasscom. “Now there will be an impact of 1.5% to 2% on the bottomline,” said Manoranjan Mohapatra, President & COO of $300 million, Aricent, the erstwhile Flextronics.
Small and fledgling IT companies will be the worst hit by the MAT. Companies like Aricent, Infrasoft, Birlasoft and Mindtree Consulting will bear the brunt of this move. Large companies are insulated to an extent because some of them already pay taxes in other geographies and their domestic operations like for example, TCS.
Introduced for the first time in 1996-97 to bring zero tax companies under the tax net, it will now cover IT companies registered under the Software Technology Parks of India (STPI) scheme, export-oriented units, manufacturing and other companies housed in free trade zones and export processing zones. MAT will have an impact to the tune of 1.5% to 2% on the bottomlines of these companies. Companies housed in STPI, free trade zones, export processing zones, electronic hardware technology parks enjoyed this benefit which was previously available till 2009-10. Under Section 10 B, tax breaks are available to companies located in EOUs. Earlier, they could claim full deduction on their export profits till 2010.
“It was agreed that there won’t be any tax till 2009 under Section 10/B. The government is going back on its commitment. Many companies base their investment decisions on the commitments that are given, this sends a wrong signal,” said Ashank Desai, co-founder, Mastek, and a member of Nasscom. “Now there will be an impact of 1.5% to 2% on the bottomline,” said Manoranjan Mohapatra, President & COO of $300 million, Aricent, the erstwhile Flextronics.
Can acquisitions help Wipro join the big league?
While most Tier One Indian IT services firms are still struggling to take the next big leap for taking on the Global Big Five, Wipro Technologies seems to have discovered the DNA for pursuing inorganic growth effectively. Pankaj Mishra analyses the company’s recent acquisitions and says these initiatives will provide new, robust growth engines to Wipro
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| Led by Azim Premji, Wipro has what is perhaps the most effective acquisition strategy in India IT Inc. |
It has been a tale of more misses than hits. Cambridge Technology Partners, Sapient, Razorfish and several other firms were at different times potential acquisition targets for large Indian software services companies, but none of them were actually acquired by Indian firms. The recent unfolding of Wipro’s diverse acquisition portfolio is a blueprint for its Indian counterparts to pursue effective inorganic growth. Polaris, Pentamedia and DSQ Software would definitely like to replicate the same model on different lines.
Sangita Singh, head of Strategic Marketing at Wipro Technologies describes Accenture and Wipro at two extreme ends of the IT services pendulum. “Companies like Accenture are now adding offshore delivery, while we are bringing more domain expertise for adding business consulting to our portfolio,” she says. Wipro’s acquisition of American Management Systems (AMS), Nervewire and Ericsson’s Indian IT R&D operation will enable it to seek high-end consulting assignments and also bid for large outsourcing deals.
The acquisition philosophy
Wipro has established a small but astute mergers and acquisitions (M&A) team headed by P R Chandrasekar, vice president, New Business Development.
An ex-GE professional, Chandrasekar is the man behind the company’s inorganic growth initiatives. “My responsibility is to drive Wipro’s inorganic growth initiatives on a global basis. Specifically in M&A, I have a small dedicated team working with the verticals/SBUs and external agencies, defining and generating deal flow and involved in the analysis and evaluation process,” he says. This team includes personnel from finance, legal, tax, HR and the respective business units under focus.
The targets
“Wipro’s acquisition of Nervewire and its earlier acquisition of AMS’s energy industry practice gives the company an installed base of customers plus strategic consulting expertise in industries that are already doing a lot of offshore outsourcing. The combination of high-end consulting and commodity services provides Wipro with the opportunity to capture a larger share of the complete IT lifecycle business,” says Stephen Lane, director, IT Services Research, Aberdeen. But there is a word of caution: “The strategy is sound. The question is how successful Wipro will be in executing it,” he adds.
In the last few quarters, Wipro has also been aggressively hiring professionals from Accenture and McKinsey to build consulting expertise. An acquisition like Nervewire brings a strong consulting front-end to the company.
Though many feel Wipro missed out on acquiring some ‘hot’ targets like Cambridge Technology and Sapient, the recent acquisitions reflect a well thought out strategy. Not only are the targets diverse in terms of service lines; they are also quite strategic if we look at the issue of client comfort in offshore outsourcing. According to Gartner, by 2004 almost all Fortune 500 companies will go for offshore outsourcing.
The catch is, they will prefer those vendors that have a well-defined presence in the countries they are headquartered in.
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| Sangita Singh says that Spectramind already gets 10 percent of its revenues from Wipro’s clients |
“Transferring risk is becoming a viable option for decision makers, especially to companies that have an onshore legal presence and assets. After all, if a business relationship falls apart, it makes more sense for a US company to sue a supplier in Manhattan or Milwaukee than in Mumbai, Moscow or Manila,” says an Aberdeen report released recently.
AMS and Nervewire will definitely influence outsourcers to give projects to Wipro as the former imparts proximity and comfort to clients/outsourcers. The global energy practice, acquired by Wipro, has a team of 90 domain experts and IT consultants across USA and Europe. The acquisition brings to Wipro more than 50 client relationships with 15 active engagements across Europe and the USA. This strong client base includes an entire range of entities, including investor owned utilities, public power utilities, regional transmission companies and independent system operators.
Synergies
Spectramind, Wipro’s BPO arm, gets around 10 percent of its revenues from Wipro clients and according to Singh, this will go up. A comprehensive BPO offering coupled with an established clientele in IT services will help Wipro in bidding for bundled contracts.
Companies like Accenture have been selling bundled services (IT services + BPO) for long and this strategy has definitely proved to be fruitful.
The BPO acquisition by Wipro will certainly help the company in pitching for bundled contracts. IBM Global Services was awarded a $2 billion deal by NTL Inc. that covers all operational IT services, call centre management and bill processing. Outsourcers are increasingly looking at bundled contracts because it allows them to deal with a single vendor.
While AMS strengthens the company’s energy and utility practice, Ericsson’s Indian R&D arm positions it to bid for large outsourcing deals in R&D services. Wipro was earning around $5 million from Ericsson each quarter.
Nervewire, which brings a team of 90 domain experts catering to various segments within the banking, financial services and insurance (BFSI) space, is a perfect fit for Wipro’s growing financial services business. Nervewire also brings over 40 client relationships with 20 active engagements. Founded in 1999, the company has a revenue run rate of $20 million, but is still making losses. “Nervewire made for a good acquisition target because it was not making profits,” says Singh.
Multi-year deals
The acquisition of AMS’s global energy group and Ericsson’s R&D arm bring CEO-level contacts to the company. The combined addressable market for energy and utility services is around $4 to $5 billion annually. Most large outsourcers believe in dealing with vendors having the scale to take up large contracts and manage their systems for years. These multi-year deals are key to any Global Big Five strategy as they ensure a perennial revenue flow.
With an offshore bandwidth larger than any MNC in India and the domain expertise of AMS, Nervewire and Ericsson, Wipro can now bid for large deals. There are outsourcers like P&G who do not invite bids from relatively small vendors due to lack of scale.
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| The combination of high-end consulting and commodity services provides Wipro with the opportunity to capture a larger share of the complete IT lifecycle business, says Stephen Lane |
The rationale
The sceptics monitoring Wipro’s acquisitions believe that the company did miss out on acquiring Sapient. But the bigger question is—was Wipro ready to make an acquisition of that scale? Cash reserves are not the only thing you take into account while acquiring.
“Companies such as Razorfish and Sapient rose by floating on top of the dot-com bubble. Moreover, they were highly entrepreneurial and their core business offerings were based more on creativity than the deep technology and business process expertise that is demanded in the current market. On the other hand, most major Indian services companies are highly centralised and hierarchical and follow disciplined processes. I just don’t see how the two different cultures could have meshed,” argues Lane. He also justifies Wipro’s acquisitions. “The acquisitions that Wipro has made to date would seem to be a better fit for the company at both the business and business culture levels.”
As an analyst points out, being a global company means acting like one. Part of moving up the services value chain and coming closer to customers at the executive level means giving geographic and vertical industry business units some degree of autonomy.
A final take
In the past, many analysts and industry observers have been terming Wipro as a ‘conservative’ company and Infosys with its higher market capitalisation as the poster child of the Indian IT services industry. The recent acquisitions made by Wipro reflect an astute roadmap to growth. That small, strategic acquisitions are better than large, full-blown ones has already been proved in the past.
For example, the jury is still out on the merits of Cap Gemini’s acquisition of Ernst & Young Consulting and some analysts are questioning how long it will take before PwC Consulting will become a fully integrated part of IBM Global Services.
What remains to be seen is how far these initiatives are going to help Wipro in joining the Global Big Five league.
| The Acquisition Process |
| How are Wipro’s acquisition targets identified and evaluated? Explains Chandrasekar, “After preparing the target profile, we utilise several sources to identify potential acquisition targets. These include our own SBUs and external agencies like large and small broker firms.” Wipro now has a database of small, niche firms developed over the last two-three years. These firms are on top of the company’s radar screen. Once identified, the targets are evaluated as follows:
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Bringing value to Wipro
| Target | Cost | Value |
| Spectramind | Over $5 million | Addition of new service line, end-to-end positioning |
| American Management Systems | $26 million | Domain expertise in niche products, services and existing client relationships |
| Ericsson R&D unit | Not Disclosed | Expertise in core technologies for cellular, switching and transmission equipment |
| Nervewire | $18.7 million | Front-end consulting presence in the US |
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