India Information Technology Report Q2 2008

Market Overview The Indian IT sector is expected to continue on an upwards path through 2008 and beyond. The total size of the IT market is forecast by BMI to increase from US$11.8bn in 2007 to around US$21.7bn in 2012, with drivers including new tax incentives for hardware manufacturers, falling computer prices and the government's ambitions to connect the vast rural areas to the outside world. The pace of India's economic expansion is decelerating but BMI expects the country to weather a deceleration in external demand.

Notebook sales are driving growth as vendors reach out to lower-income segments, smaller and medium businesses and new geographic regions. However, there are a number of risks to our forecast scenario.

India's legal regime for patent protection remains flawed, while measures to encourage the domestic hardware sector have had mixed results, and the important BPO sector faces a strong challenge from other markets including China. BMI forecasts IT-market CAGR during the next two years of our forecast period of 13%, compared with expected GDP growth of between 7%-8%.

The potential of India's IT market is plain: less than 2% of people in India own a computer, about onefifth of the level in China, meaning particular potential in the lower-end product range. Significantly, 45% of India's population is under 25, which should boost PC and IT usage. Mindful of increasing global vendor interest, a number of federal and local government initiatives to encourage hardware production have been designed. Despite a number of potential difficulties, including regional imbalances, low incomes and a possible demand slowdown, India should therefore confirm its potential as a key emerging market over the forecast period.

Industry Developments The IT Ministry has indicated that it is strongly in favour of extending the tax holiday for software manufacturers beyond 2009. Debate had been continuing for some time on the approaching end for the key policy. The scheme as originally conceived had a life of ten years of income tax exemption for software units stationed in software technology parks. Given its success, the scheme now appears likely to continue.

Meanwhile, the government has claimed early success in another key policy launched last year to promote chip manufacturing in India. The policy, first launched in March 2007, proposed a range of incentives, such as tax advantages and subsidies for semiconductor manufacturers. According to the government, after one year of the policy India's semiconductor industry has already attracted around US$7bn in committed investments. There had been some concerns about lack of foreign manufacturer enthusiasm, but the government has pointed to the setting up of assembly plants by Dell, HP and Lenovo as evidence for the success of the policy.

Competitive Landscape Vendor attention is on the lower end of the PC market, which is expected to power market growth over the next few years. In Q108 HCL launched a new lightweight laptop series with prices starting from INR14000 (US$350). The company billed the laptops as being part of a mission to 'take technology to the masses'. Acer also launched a new entry-level consumer notebook for the Indian market as part of its strategy to make 'mobile computing available to all audience segments'. HP is the leader in the PC market including PCs and notebooks and India is now its fastest-growing market. The US giant has around 20% of units shipped. Local company HCL takes second place, thanks largely to its strong performance in the desktop segment. Chinese vendor Lenovo is third, with around 10% of the market.

Turning to software, and applications vendors are increasingly looking for growth in an SMB sector expected to spend around US$8bn on IT infrastructure in the current financial year. In Q108 TCS launched a new business unit to provide customised solutions to SMBs. The solutions will be provided on a subscription based model. For its part, Hyderabad-based Satyam recently launched a new enterprise applications delivery model, which will provide web based EAP applications for use by SMBs.

Computer Sales According to BMI figures, sales in India's hardware market will be worth around US$7.3bn in 2007, up from an estimated US$6.5bn in 2007, with expected tax breaks and subsidies for hardware manufacturers expected to support growth. In the first half of fiscal 2007-2008, notebooks were the main driver of growth according to industry association MAIT (Manufacturer's Association of Information Technology).

Key segments such as government, telecoms, financial services and education played an important role.

Big company sales were less than expected, but this was compensated for by strong demand from smaller and medium businesses. According to the MAIT figures, notebook sales rose 59% in April - September 2007. Total PC sales were 3.28mn units for the period, and MAIT expects total PC sales for 2007-2008 to be in the region of 7.25mn.

BMI predicts the CAGR for the hardware sector as a whole will be around 11% between 2007 and 2012, with unit sales showing strong growth. The average price of a PC has nearly halved over the past few years to less than US$250. Desktops will still account for more than 80% of unit sales, a higher ratio than for many countries in the region. Combined shipments of desktops and notebooks have now comfortably exceeded the 5mn mark. Investments of more than US$18bn in hardware manufacturing in India (including telecoms hardware) have stoked expectations of a hardware boom. However, a high tax regime means that around 25% of the retail price of an average computer goes to the government, and there are fears that this may delay growth. Moreover, it will be difficult for India to catch up with Taiwan and mainland China, given the strong lead these two territories have.

Software Combined software and service CAGR for 2007-2012 is expected to be in the region of 15%. The tax free status of software firms, which has done much to fuel local sector performance, is due to end in 2009 and industry analysts will be watching to see what impact this has. However, the IT Ministry is lobbying the Finance Ministry to extend the exemption for another ten years. Another issue is India's relatively inefficient legal protection system for patents. In August 2007 the first IPR (intellectual property rights) court opened in Karnataka. The new court has been taken as a sign that the issue of illegal software is becoming a more central policy issue for the government. Other states such as West Bengal are expected to follow Karnataka soon. With software piracy in India at around 72%, the moves are a boost for foreign vendors of packaged software.

The local market is likely to sustain vendor investment, with small and medium firms becoming more sophisticated in their demand for customised software and applications to increase business flexibility. A second major driver is the emergence of India as a global centre for outsourcing, with large US and European companies focusing on offshore software development to lower costs. Several sectors are leading the way in this respect, including auto ancillaries and pharmaceuticals.

Services Domestic company demand for IT services is increasing rapidly and project sizes are increasing. This was demonstrated in 2007 by contracts such as HP's seven year outsourcing tender in India with United India Insurance, and by the deal by which Idea Cellular agreed to outsource IT infrastructure and other services to IBM. The deal, which is for ten years and also covers billing and customer management, has a reported value of up to US$80mn. The current trend is that average project size, typically below the US$1mn mark, is now increasing and this has resulted in several projects exceeding the US$100mn mark.

This trend is being accompanied by a conscious move on the part of large players to migrate from just 'cost plus' advantage to that of value-added service provider. The high spending Telecoms industry has particular opportunities for IT services vendors, with huge increases in capital expenditure budgeted by most service providers. A recent report by industry association NASSCOM found that China was unlikely to catch up with India's lead in global IT outsourcing in any significant manner over the next 3-5 years.

E-Readiness Broadband subscriber numbers are consistently falling behind target in India, with only 3.4mn subscribers by the end of 2007, according to BMI figures. The main reason for the slow uptake is thought to be insufficient demand, and the government has taken some measures to reduce tariffs and encourage alternative forms of service provision. One brake on PC penetration is a poor dial-up internet home user experience, even in cities. If this is to change, the government must take the initiative in improving bandwidth availability. Government plans to encourage WiMax network deployment may have some impact on penetration. Broadband subscribers are currently expected to exceed 47mn by 2012, while the number of internet subscribers will rise to close to 450mn within the same period.