BANGALORE, INDIA: The subprime crisis and the subsequent meltdown has been the subject of much discussion

in the recent past. The magnitude of the crisis, the impact it has had on what we thought were rock-solid institutions and the ripple effect across the globe have been mind-boggling. What I'd like to focus on, in this article, is the impact this will have on the Indian IT services industry and the opportunities it is likely to throw up for companies operating in the Third Wave. Before getting into the impact of the crisis, let's look at the Three Waves of Indian IT. Three waves of Indian IT industry 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. Wave 1 (Proving Capability through People): Started in the 70s and 80s and peaked in the mid90s; it established the competence of the Indian software professional and the industry got results largely through staff augmentation. Wave 2 (Offshore Development): 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. Wave 3 (Strategic Value Delivery): Which is emerging, will be characterized by Indian companies moving up to high-value, IP-led services that are strategic to the customer and hence command premium, value-based pricing. As we have seen, the industry is already facing a severe shortage of talent (as opposed to mere numbers), rising attrition levels and increasing salary costs. There are enough indications to suggest that the linear relationship between growth and headcount will not be sustainable for much longer. The future is in creating strong brands out of India, whether in services, products or solutions, that command the respect and trust of large global customers and hence, the appropriate value. Orders of short-term impact Moving on to the impact of the crisis, the first order impact is obviously related to the banks that have either been unable to survive as stand-alone entities (like Bear Sterns and Lehman) or have taken a deep hit and are trying to recover on their own. Since most of these institutions have been large customers of Indian services firms, some of the contracts may be cancelled while others will probably be downsized, with a view to keeping costs under check. This will have an immediate impact on the Indian firms serving these customers.

The second order impact will be on other firms with large investment portfolios that have directly or indirectly been exposed to subprime lending. As an example, some of the insurance companies may be impacted by this, the prime example being AIG. In such cases, the firms may tend to get more conservative on new initiatives and discretionary projects, thereby impacting the revenues of Indian firms that service them. The third order impact is based on fears of recession and the general conservatism that it is likely to bring in with respect to any discretionary spending. Given that 30-40 percent of Indian IT services revenues emanate from the BFSI segment, NASSCOM has brought down its growth estimates from 30 percent to between 21 percent and 24 percent for the year. Longer-term opportunities When we dig into the reasons for the crisis, while we can blame blind optimism and greed, at a more fundamental level it is a failure of systems.

The quality of underwriting at the point of loan origination had failed. Systemic controls that ensure uniform and consistent application of underwriting rules could have done much to avoid bad loans. Credit scoring that took into account not just the propensity to pay but also the quantum of debt that a person had any hope of repaying would have brought these issues to light much earlier. Better transparency and visibility of the underlying asset portfolio, and a more balanced approach while packaging a set of mortgages into bonds would have helped monitor the health of the assets and the loans on a real-time basis. Better controls and risk management systems governing individual firms as well as the entire financial system would have helped to track the quantum of leverage and the risks associated with it both from the perspective of board governance and regulatory oversight.