Looking at last quarter’s performance, Infosys and HCL Tech posted top-line growth of approximately 18% each, while Wipro registered a jump of 26%. TCS on the other hand was the standout performer, clocking an impressive growth of over 36%. Revenue growth was driven by solid performance from traditional verticals like BFSI, while emerging verticals like Healthcare and Retail also posted robust gains. A discernible trend among all these companies was the underperformance of the Telecom vertical, which was a laggard for all the major players and has been so for the last couple of quarters.

Another trend evident in the results was the strong performance from European operations. Defying most investors (and indeed most analysts), Europe continued to show resilience delivering robust growth for all four companies (Infosys, TCS, Wipro and HCL), that ranged from Wipro’s 11% growth to TCS’ staggering 50% jump.

On the operating front as well, most of these players reported an expansion in margins, albeit mostly due to the steep INR depreciation against the dollar. Infosys was the only one to attribute the increase to a jump in pricing even if the increase was just under a percent.

However, despite the seemingly robust results, a large number of investors were left unhappy. The reason – the bearish outlook provided by all these companies. Infosys, which has traditionally been the most conservative of the lot, scaled back it dollar revenue guidance, while Wipro too indicated that sequential growth will be in the modest range of 1%-3%. TCS on the other hand, provided some interesting if not downright worrying statistics. The TCS management indicated that around two thirds of their top clients 120 clients had either increased their IT budgets or left them unchanged. Not to be the pessimist, but that essentially means a third of their top clients had slashed their IT budgets for 2012. In addition, the company also added that out of a sample of 130 discretionary projects being negotiated by the company, 50% were facing delays in finalisation!

Against the background of last quarter’s performance it looks difficult to ascertain the exact cause of this bearish outlook. Most of the companies have cited the current crisis in Europe has made the macro-economic environment uncertain. However, all of the above mentioned companies have done exceedingly well in Europe, and have done so consistently over the last couple of quarters. In addition, the problems in Europe have been persistent for well over a year now and to be honest a concrete resolution does not seem to be imminent in the near future. What then is the cause of this pessimism? In my opinion, the tone reflects the overall mood of the global economy, which has been that of extreme caution over the last one year or so. I believe, fundamentally the Indian IT Services industry remains robust and poised for growth in the coming quarters as well.

Having quickly understood the KPO business, let’s also quickly look at the strategies/methodologies/tools Project Managers, Business Unit Heads and Quality managers have available at their disbursal to improve quality and efficiency of the services provided to the Clients. There are Six Sigma, Lean Management, Kaizen, Poka Yoke, TRIZ, PDCA, Kan Ban, OQM, ISOs etc.  I find Six Sigma more applicable to KPOs given its broad scope and flexibility to adapt changes. One should note that Six Sigma is a principle or strategy and not a procedure. It approaches any business issue using a simple step by step method inspired by Deming’s Plan-Do-Check-Act (PDCA) cycle. A typical Six Sigma approach is Define-Measure-Analyze-Improve-Control (DMAIC). Six sigma covers almost every quality management theory/methodology previously discussed. You can use fish bone diagrams, TOC charts, House of Quality (Quality Function Deployment), SIPOC etc for the D phase… Check sheets, Histograms, Scatter plots, SPC for M and A… Run charts, SOPs, Control Charts, Process flow diagrams for I and C phases.

Priority for most of the Project Managers, Business Unit Heads and Quality managers, while establishing a quality management system is Improve and Control. A Project Manager, Business Unit Head and Quality manager should first focus on clearly defining the client’s requirements. As we have understood the KPO business earlier, its most likely that as a KPO service provider you will come across vague/open requirements and hence clearly Defining the scope of the work is important. Hence it is suggested that one should take reasonable time to define and document the scope of work as clearly as possible. In case the Client is struggling to define the requirement the Project Manager/Business Unit Head should facilitate the Client with his experience and expertise to define the requirements. This approach results in elimination of almost 80% of the quality issues right at the beginning and also enables the team to lead the curve and positively surprise the client.

While defining the scope of work, the Quality Manager should also participate in the discussion to understand the key metric that quantitatively defines the quality of the work. For example, for data centric work, 100% accuracy of the data is a default however the key metric from a quality perspective is turnaround/cycle time. For information (quant + text) centric work (e.g. thematic research reports) number of incorrect data points, time frame for study, interrelationship of scattered data points are some of the key parameters. For content centric work the focus is more towards content flow, structure and grammar. If the Quality Manager is able to plug any gaps on these abovementioned levels, it’s easier for the Project Managers/Business Unit Heads to engage the Client in a discussion which would add value.

So Define first and then start working …….

– Mao Zedong, founding father of the People’s Republic of China

One might have thought that the unraveling of the cold war following the disintegration of the erstwhile Soviet Union would usher in an era of relative calm across the world. Alas, it was not to be. The rise of borderless threats such as terrorism, rapid advances in warfare technology and proliferation of weapons of mass destruction amongst allied states has exponentially increased the risk factors to sustained global peace. Over the past few centuries, European nations jostled for power to wrest control of global trade; whereas in the twenty first century, the growing geo-political claims of Asian countries has given rise to several hot spots within the region. In fact, the birth of new nations following World War II has spawned multiple new theatres of armed conflicts (e.g. the Indian subcontinent, Korean peninsula and the Middle East), which threaten to disrupt world peace with the snap of a finger.

The economics of war are mind boggling, to say the least. Global military spending rose to USD 1.6 trillion in 2010, a modest 1.3% growth in real terms (Source: SIPRI – Stockholm International Peace Research Institute), dragged down by weak spending from western nations. Spending by United States grew a mere 2.8% to USD 698 billion (a steep moderation compared to 7.7% in 2009); whereas Europe reduces it wallet size by 2.8% to USD 382 billion. Surprisingly, South America, a region that appears to be geographically insulated from conflicts, led the way with a 5.8% increase in military spending in 2010. Latin America’s increasing affinity for military hardware may be attributable to its growing regional commercial interests with significant scarcity value (e.g. commodities ranging from metals, grain and offshore oil). Moreover, the recent commodities boom has financially empowered governments in the region to boost their defense spending. Brazil recently signed an agreement with France for acquiring the technology to build nuclear submarines, aimed at protecting its offshore oil assets. Meanwhile, Argentina’s navy has initiated aggressive patrolling near the disputed Falkland Islands, which are currently controlled by the United Kingdom.

Unlike in the past, it is almost impossible for any nation which aspires to be recognized as a powerful military or economic force, to remain non-aligned in the current scenario. The intensifying clash in ideologies over the structure of societies (e.g. democracy v/s socialism, secularism v/s extremism etc.) and conflicting sovereign claims over lands has spurred nations to try and outdo each other in a seemingly unending arms race, thereby further deepening the divide between them. Hence, defense spending may be widely perceived by competing regimes a necessary evil, even if it is made at the cost of social infrastructure development.

In the wake of Japan’s crisis, many governments have voted for the closure of nuclear plants. Germany and Switzerland have decided to phase out nuclear power by 2022 and 2034 respectively. Moreover, Belgium has reached a conditional agreement to abandon nuclear power in two steps by 2025 and Japan too announced a 40-year nuclear phase-out.

The fading of nuclear energy paves the way for alternative energy as the acceptable and sustainable source of energy for the long term. Amongst alternative energy technologies, Wind and Solar energy are the most worthwhile options. However, they are still short of commercial viability and survive on Government subsidies. As per World Energy Outlook 2011(IEA) estimates, subsidies to the renewable energy sector need to rise from USD 66 billion in 2010 to USD 250 billion in 2035. In contrast, there is a strong likelihood of reduction in subsidies following the current European sovereign debt crisis. Hence, renewable energy industry faces some stagnancy, at least in the medium term, considering the refinancing issues.

There is a growing acknowledgment that “Energy Saved is Energy Gained”. US for instance had recently achieved the aggressive goal to reduce energy waste (USD 4 billion initiative) in approximately 600,000 low-income homes with energy efficient upgrades such as insulation, air-sealing, and more efficient heating and cooling systems. This is commendable given the fact that buildings account for nearly 40% of U.S. energy consumption and carbon emissions. Thus, re-creating our world – homes, vehicles and businesses with energy efficient technologies seems to be the untapped solution for energy crisis.

In the above contexts, Energy Efficiency sector, with its wide range of products, offers a ray of hope for the investors and consumers to meet the energy challenges.

A couple of centuries ago, we were a race of 800 million living beings with lesser needs and even lesser luxuries. There was a lot of arable land that was unexploited then. The question of sustainability would probably not have been as important as it is today. An economist named Malthus (who I quote at the beginning) drafted his “population principle” around the same time, and predicted that the world would one day run out of resources to feed mankind. Today, we are 7 billion people with most arable land around the world already under cultivation. Various estimates cite the world’s maximum carrying capacity at 14 billion people, with the mean hovering around 5-8 billion – which we have already crossed. As such, a serious question poses before us today: Will ampleness of food transform to a probability from an assumption? This question, in itself, has two perspectives.

Firstly, it marks the beginning of a new revolution in global agriculture, and underlines the massive investment opportunity the sector has over the coming decades. With global water issues and the reducing arable land availability, the mammoth and urgent need for rapid advancements in agricultural technology is evident. According to a report by The Economist, agriculture used to account for 90% of total global water consumption, today it accounts for 70%. Increasing urbanization in the wake of a growing, richer population has single-handedly changed the consumption dynamics of water around the world. As the report rightly puts it, “the only reliable way to produce more food is to use better technology”. This will be covered in more detail in the second section of this three-series blog.

Secondly, the question highlights the scope for better global food management which we discuss in the third and final section of this series. Generally, when you can’t earn, you save. Put in other words, you waste as less as possible. Exactly this is what the world needs to implement in terms of food. According to the Food and Agricultural Organization, an average consumer in the developed world wastes 95-115kg of food a year, while the average consumer in sub-Saharan Africa, south Asia or south-east Asia wastes 6-11kg. In terms of growth opportunity, the opportunity lies in the developing world rather than the developed world, not only because of the obviously higher population-led consumption growth, but also because of the immense scope for better supply chain management and reduction of middle-men. Overall, the probability that we might not be able to produce as much as we did earlier would (or at least, should) translate into improved efforts towards lowering global food wastage.

The idea stems from the fact that the Eurozone taken together has a healthier sovereign balance sheet compared with, say, the US. Debt to GDP ratio in the US stands at 93.6% compared to the Eurozone’s aggregate of 85.1%, while the 2010 budget deficit of 6% of GDP for the Eurozone compares favourably with the US’s figure of 10.6%. Therefore, bonds issued jointly by the Eurozone countries will have a better credit standing, not only compared to the US but also compared peripheral European economies. As such, they would be able to reduce borrowing costs for not only peripheral sovereigns but also for stressed core sovereigns, such as France. Moreover, the banking sector can be insulated from the default risks of individual sovereign bonds as banks would increasingly hold these Eurobonds rather than individual sovereign bonds from their own countries. On the face of it, therefore, Eurobonds look like a win-win solution for most participants in the European debt markets.

The European Commission has outlined three options for stability bonds. The first option is a joint bond, in which the respective member states are only liable for a part of the bond according to a distribution ratio. In principle, this is similar to the EFSF bonds. The second option moots some safeguards on top of the first option, which would ensure that the entire bond would be repaid in the event of a member state defaulting. The third option talks about unlimited liability of member states for these jointly issued bonds. Under the third option, national government bonds could be replaced fully or partly by Eurobonds.

While the various options will need to be analyzed and debated in the context of their efficacy in stemming the Eurozone crisis, prima-facie the third option seems the only credible solution to stem the current debt crisis.  The European Commission has sought replies from member states by January 8, 2012. However, it will take considerable time to make suitable amendments to the EU treaty and create the right incentive structures under which the market for Eurobonds can thrive.

Despite the Eurobonds being beneficial to the peripheral Euro zone nations, core countries are likely to oppose the move, judging by the initial negative reactions coming from the German Chancellor. The nature and extent of incremental stress on core sovereigns’ balance sheets can’t be gauged so soon. Moreover, issues of leverage, credit rating, marketability, etc. will need to be sorted out. Most importantly, however, the proposal will give rise to fresh debates about a two or even three-tier bond markets in Europe. Since EFSF-backed bonds are expected to effectively subordinate the normal sovereign bonds, the introduction of Eurobonds is likely to cause further complications in the bond markets.

So, how are the KPO firms faring in the wake of economic recovery? Are they benefitting from the improving economic scenario in the US and Europe? Well, the answer to the question depends largely on the clientele of the KPO firms. While, the overall demand scenario has improved considerably, however clients have become very price sensitive while awarding new outsourcing contracts.  The fact that western job markets are flush with qualified people who are willing to work at reduced rates has proved to be a dampener on the billing rates of also reduced the pricing power of KPO firms.

Market research and KPO firms in India have largely responded to this threat by giving increased emphasis on productivity. Higher productivity has become a need of an hour to sustain the value proposition of the KPO firms. To supplement these measures, KPO firms are adopting processes and technologies to enable optimal utilization of the current employees within the organization, before starting to hire fresh. Retention of key talent also assumes priority, with good stable companies continuing to invest in training, personal development and career enhancement.

While the short term prospects of KPO industry in India appears challenging, it is apparent that some of the steps taken by KPO firms to enhance productivity and reduce costs are already showing results.

The IRS regulation 409A requires companies issuing stock options to price the options at or above the fair market value (FMV) of the common stock. Companies that are public have a sense of their FMV as it is the price at which the common stock is trading on the stock exchange. On the other hand, the common stock of private companies does not trade on any stock exchange and the frequency of transactions is few and far between. Also, given the nature of private companies, especially early start-ups, success or failure in their business milestones leads to a tremendous jump or drop in their equity value.  Moreover, as private companies have a limited amount of cash at their disposal, the only way they can woo and retain talented and experienced employees, is by issuing stock options to them. Hence, it becomes all the more important for private companies to get themselves valued prior to issuing stock options. Private companies are the unfortunate martyrs caught-up in the cross fire between the IRS and public companies.

On the brighter side this has lead to a boom in the number of firms providing private company valuation services, but more on that later. First let’s stress on the importance of getting a 409A valuation done. There is no better or more impactful way to highlight its importance than talking about the risks and penalties in case the IRS finds the price at which options were issued does not comply with the 409A regulations.  The consequence of being in such a position are that the option holder gets taxed at the highest marginal income tax rate on the difference between the grant strike price and what the IRS deems the correct value, as if it was income given to him by the company along with an additional 20% tax on top of this in further penalties. Over and above this, he must pay interest of the IRS ‘late payment’ rate plus 1% from the date of the option grant to the sale. The company also gets penalized on withholdings it should have made on this additional income it provided to the employee. Now that we understand the importance of getting a 409A valuation done, let’s see what options companies have to perform such a valuation.

The IRS provides 3 choices to perform a 409A valuation:

1. Arrive at the value in the old fashioned way (the company board determines in good faith the FMV). In this scenario, if an option holder comes under scrutiny by the IRS, and they think the strike price is not truly the FMV, then the option holder has the burden of proof to show otherwise.
2. A person, internal to the company who has “significant knowledge and experience or training in performing similar valuations”, creates a written valuation report providing details of the FMV of the common stock. If the IRS decides the person isn’t qualified and/or they didn’t follow a ‘reasonable’ methodology, the burden of proof lies with the company.
3. Hire an independent valuation firm, with the necessary qualification and experience, to create a written valuation report. If the valuation firm follows the procedures correctly, the IRS has the burden of proof to show that the valuation was ‘grossly unreasonable’, the key word here being grossly, which is a difficult task.

Companies are increasingly becoming aware of the benefits of getting a valuation done by an independent appraiser. These include, avoiding lengthy audit review, considerable time saving of the management and most importantly averting the risk of an IRS scrutiny, which far outweigh the cost of conducting such a valuation. Moreover, private company valuations are more complex as traditional valuation approaches, which are extensively used for public companies, have to be adjusted for extraordinary factors relating to the innate nature of private companies along with their stage of development. This complicates the valuation process and makes it highly subjective. Independent appraisers are the best equipped, due to their knowledge, experience and unbiased nature, to strike a balance between the art and the science of valuing a private company.

Now that we have established the importance and benefits of getting an independent appraisal let’s get to the financials, because after all it is the major cause of concern for both the management and board of directors. There is no straightforward answer here as prices range from USD3,000 (when performed by an outsourcing or overseas firm) to more than USD15,000 (when performed by the big names in the valuation world). As one can see the price gap is huge, more than 5 times on extreme ends, with not much difference in terms of the quality of the final output. The price advantage enjoyed by countries such as India, which is already synonymous with the word KPO, is because of the abundance of qualified and talented employees, with a good command over the English language. This along with the lower standard of living has given a competitive edge in terms of price to Indian KPOs. There were some initial reservations with regards to the reliability of reports being produced by outsourcing companies; however auditors seem to have given them the green chit due to the quality and depth of analysis being expressed in these reports.

Some US valuation firms are trying to maximize the use of technology to negate the cost advantage enjoyed by the outsourcing model. On the other hand there are also firms in the US that are choosing to take advantage of the cost benefits and are either setting up their own captive units in India or partnering with Indian outsourcing companies.  Due to the growing acceptance of KPOs in the valuation world, more and more Indian KPOs are now starting to focus their time, energy and money on setting up a specialized valuation team. Earlier, the services being provided by Indian KPOs included equity research, market research, business research, data management, etc. Besides these outsourcing services, the latest to feature on websites of almost all the top Indian KPO companies is valuation advisory or valuation services. The valuation team in these companies range from 5 research analysts on the lower side to more than 35 research analysts in some. The main reason behind this much interest and focus being shown in IRC 409A is because Indian KPOs see private company valuations as an additional and potentially large stream of revenue.

Egyptian government blocked the critical life line of services outsourcing companies, KPO’s and BPO’s, the communication networks. Also key global communication lines connecting Europe and Asia run through Egyptian waters potentially jeopardizing operations of India and Philippines based BPO’s, KPO’s and outsourcing companies. Outsourcing companies tackle these risks by having global multi-location outsourcing centers for seamless business continuity between outsourcing locations. This could significantly increase the costs for the outsourcing companies due to duplication of the outsourcing infrastructure, but a small cost to pay for ensuring business continuity of outsourced services.

Also the trunk route for sea borne trade connecting eastern US, Europe with GCC, Asian and Australian continents pass through the Suez Canal controlled by Egypt. Any disruption in canal’s operation during the civil protests would have resulted in major disruption in global outsourced supply chains.

Financial Institutions and retail banks in particular are heavily regulated institutions resulting in significant regulatory and compliance overheads when outsourcing any customer demographic or transaction information to an outsourcing company especially overseas outsourcing companies. Consumer data security laws restrict or outright ban outsourcing of customer information to outsourcing companies in certain jurisdictions. Security and confidentiality of the customer transaction data becomes a major issue when outsourcing the core banking IT system to an outsourcing company or the customer contact center of the financial institution.

The total cost of outsourcing is an important, often the primary consideration when outsourcing a transaction based process to an outsourcing company. However, the ability of outsourcing company to deliver the quality outsourced service vis-à-vis the earlier in-sourced services is an important consideration for the outsourcing organization. Besides these issues other issues such as the acceptability of the outsourced services to its customers and the effective working of the internal people with the external outsourcing companies people  also plays an important part before outsourcing work by the financial institutions.