IT Services: the rise of Captives and end(?) of Onshoring?
IT Services is the largest component of India’s exports. As per the RBI’s latest survey, India’s IT Exports were US$130bn in FY21. And despite the pandemic, there was a modest growth (low single digits) during the year. Over the past 5 years, India’s IT Exports have grown at almost 9% in US Dollar terms and 11% in Rupee terms. Not quite earth-shattering growth, but given the scale, not bad either…
Over the years we have picked up some interesting trends from the RBI survey mentioned above. One is the changing composition of exports at an entity level. The second being the declining share of onshore revenues. And the third being the continued growth of BPO exports.
The rise of Captives
There are two distinct categories of IT services firms. The large Indian IT Services firms operate as Public Limited Companies while the subsidiaries of foreign corporations (commonly referred to as Captives) operate largely as private limited companies. Operating as Private Limited companies allow them to operate with lower regulatory compliance requirement. Given that they have no intention of listing on Indian stock exchanges or raising capital for that matter, this suits them better. Smaller Indian firms and startups would also operate as Private Limited companies, but these would be small from the perspective of IT Exports. These would largely cater to the domestic market. In terms of size, Captives would dominate the IT Exports as compared to smaller Indian firms operating as Private limited companies.
In the past 5 years, IT Exports by Public Limited Companies have grown at just 5% Cagr (USD terms). In contrast Exports by Private Limited Companies have grown at almost 13% Cagr – more than 2x the pace of Public Limited Companies. Consequently, Private Limited Companies now account for a majority of India’s IT Exports. Their share in total exports has increased by ~10ppt in the last 5 years. Note that these calculations exclude the revenues of Indian IT Companies from their overseas (outside India) subsidiaries.
The large Indian IT Companies have thus massively underperformed a combination of Captive Development Centers by Global Corporations and smaller Indian IT Companies. This trend possibly reflects a combination of two factors. First, Global Corporations are outsourcing complex or critical work to India and it by nature cannot be outsourced to third-party vendors. Second, at the lower end, given the scale at which work is being outsourced to India, setting up operations in India has become more cost-effective.
So, while India remains an attractive market for offshoring, the large Indian IT companies are not as big a beneficiary of it as before. But from the perspective of Job creation, Investments etc. this changing mix does not matter a lot.
The end of onshoring?
In FY16, over a third of IT Exports were derived either by overseas subsidiaries of Indian IT firms or by staff of Indian IT firms being located overseas – what is generally called as onshoring. But since then, the proportion of such revenues have declined in every single year falling to just 21% in FY21.
In part this reflects the faster growth in exports out of India and captives (as discussed above) have been a contributor to this growth. But equally, in absolute terms, onshore revenues have not grown even in Rupee terms. In FY16, the onshore revenues were estimated to be ~Rs2.5tn and in FY21 they are estimated to be Rs2.4tn. And within this onshoring pie, the revenues of the overseas subsidiaries/establishments of Indian IT companies have declined almost 20% in the last 5 years.
And given that almost every large global corporation is setting up a development center in India (and thus attractiveness of India as an offshore center remains high), this makes total sense.
BPO – still going strong
BPO as a business is generally looked down upon for being low margin, commoditized etc. Companies have generally wanted to grow and get out of this business into more ‘value-added’ services. But the fact is BPO exports have grown faster than IT services exports. In the last 5 years, BPO services have grown at almost 13% Cagr (USD terms) as against a 9% growth in overall IT Exports from India (USD terms). BPO now accounts 28% of India’s IT Exports as against 23% in FY16.