The rising ruppee - opportunity for Indian IT companies

September 15 , 2007

By Sudhakar Ram

Over the last few months, there has been much discussion about the negative impact of the rising rupee on the profitability and competitiveness of Indian exports in general, and IT companies in particular. There has been a demand from certain quarters for RBI intervention to keep the rupee down. In my view, this demand is short-sighted and does not take into account the enormous opportunity that the rising rupee could present to export-oriented industries.

Before launching into a discussion on the opportunities, I think some basic premises need to be stated. Firstly, as Indians, we should be proud - the strength of the rupee is an indication of the underlying strength of the economy. Secondly, in today's global economy, any attempt to tamper with natural market mechanisms driving currency values is likely to lead to disastrous consequences as many countries have realized (and some countries will in the years to come). In the medium to long term, with global market mechanisms in operation, a rising rupee should lead to decreased costs and hence, a marginal impact on our global competitiveness.

The rising rupee, however, does throw up challenges in the short term and therein lie our opportunities. Being most familiar with it, I will present these opportunities from the perspective of the IT industry and let the readers draw the parallel to their own industries. In essence, the thrust of my argument is two-fold:

1. The rising rupee will force the IT industry to look beyond labour cost arbitrage to create value for its customers - what I call the Third Wave approach; and,

2. It will refocus the industry on driving new efficiencies and improving productivity to remain competitive.

The Third Wave - Beyond Labour Cost Arbitrage

When we look at globalization, specific industries in emerging economies typically go through three waves of evolution. The electronics industry, first in Japan, then in South East Asia and now in China, are good examples of this. In the first wave, companies in emerging economies typically act as component suppliers to developed countries that manufacture the complete product. In the second wave, the local industry gains enough expertise to provide cost-effective contract manufacturing services - of either the entire product or major sub-assemblies. The third wave is when a set of firms start marketing these products under their own brand - initially within their own countries, and then going international.

We can trace the evolution of the software services industry in India using a very similar paradigm. As shown in the table below, the Indian software industry has gone through two waves already - as a component supplier and as a contract manufacturer.

Wave 1 started in the 70s and 80s and peaked in the mid-90s; it established that the Indian software professional was competent and the industry got results largely through staff augmentation.

Wave 2 established India as a destination for low-cost, high-quality programming services. The catalyst was the Y2K bug and Indian companies' success in delivering these projects in a cost-effective manner. Many Fortune 1000 companies discovered that moving their application maintenance and on-going development activities to India was viable and attractive. The Second Wave of Indian IT started in the mid to the late 90s, and is at its mainstream phase today. Like all mainstream markets, this is characterized by the emergence of a few leaders, namely the Tier 1 IT companies, who demonstrate high rates of growth and profitability and increasing market share.