Wharton report predicts doom of IT sector by 2033

A yet to be published Wharton study by Colin Ward predicts that by 2033 IT sector will transition to decline phase by 2033. He applied asset pricing to find future valuation of IT sector. His model indicates that growth of IT sector is already in the transition phase and transition to end roughly by 2033. He cliams to "develop a new method that puts structure on financial market data to forecast economic outcomes."

"I apply it to study the IT sector's transition to its long-run share in the US economy, along with its implications for future growth. Future average annual productivity growth is predicted to fall to 52bps from the 87bps recorded over 1974-2012, due to intensifying IT sector competition and decreasing returns to employing IT. My median estimate indicates the transition ends in 2033. I estimate these numbers by building an asset pricing model that endogenously links economy-wide growth to IT sector innovation governed by the sector's market valuation.", He elaborates.
   The paper is accessible at

 https://dl.dropboxusercontent.com/u/11770278/JMP_Ward_ITrevolution.pdf
If you find the paper little too technical and finance-oriented for your interest, there is another way of testing the hypothesis. We could try to extrapolate the future based on the patterns that we see now. The way we see the IT industry today was unimaginable in 1974, though people consider 1974-80 to be the beginning of the growth of the industry. The industry experienced the growth
in massive scale during 1995-1999 and most of that rode on banking industry's fear of Y2K glitch. Once that crest passed, the industry saw first massive slump in 2001. Very few imagined that trough will come so soon after crest, because it was never seen before. Industrial revolution lasted for a long time before people saw the economy decline.
   People accepted dot-com bust to be credible explanation although banking industry's IT budget also showed fast contraction right after year 2000. Traditionally IT consumption always showed sharp increase or decline as an effect of overall economy's growth/collapse.
One must not miss the fact IT needs are not fueled by direct consumption from the consumers [which has direct impact on real-estate, manufacturing, luxury and cosmetics items, electronic equipment etc] but by those industries that serve
the consumers and those industries increased IT budget as a response to threats such as probable banking software malfunction due to Y2000 round up or pressure from business consolidation.Business consolidation happens organically in any industry when growth slows down and large players invest in IT to leverage information availability. Thus a bank upgrades its back-end software and IT hardware as a need to remain competitive [it improves scale of operation, information flow and customer response] when it faces slow growth. Retail
industry upgrades its CRM and analytics software in order to capitalize faster the retained data of its consumer base. Now once they upgrade (spend in IT) their IT setup, next upgrade would happen only if they outgrow their present capacity.
                 There is another dimension to it. Given that the IT providers themselves are coming up with innovations faster that brings down the overall cost of IT in order to remain competitive, the value of IT erodes faster. For example setting up a CRM for a retail chain is lot cheaper today when compared to that a decade back. The solution today is lot more open, agile and powerful compared to what they used to get a decade back.
Compare this with any other Industry e.g. automobile or nuclear reactor. The price of automobile such as Toyota Corolla has consistently gone up over the years and so has the cost of a nuclear reactor. Unfortunately same cannot be said about IT produces.
 Also over the last few years, industries witnessed fast transition from in-house IT setup to outsourced IT setup. Salesforce has consolidated CRM of many of its clients who earlier had their own CRM solutions. Salesforce thus brought down the consolidated IT expenditure of its clients to a fraction of what they used to spend together. And it is clear that this transition is going to be faster in next 10 years as SAAS become mature and more secure. IT budget will shrink sharply once the transition reaches 70-80% of total market. Mainstream industries will not buy IT product, they will simply consume IT as service, just like they consume electricity or water. Net effect? Growth disappears!
Colin's model gives us another tool to reach the same conclusion, albeit with far more analytical rigour.

the Software Industry and its malaise

First Quarter results of the companies are coming out. While TCS reported the strongest result of all the biggies of India, others did not fare too badly. Infy's and Wipro's results may be a bit disappointing for their shareholders, but it is still not something to be alarmed about.  Irrespective of the results, all have expressed high confidence in the long term growth of the sector and the prospect for their organization, although hardly there were any mention about their future growth engines. If there is anything, there is a mention of cost rationalization in Wipro executive's statement: "We have improved our people pyramid cost. Our margins have expanded by 60 basis points because of the higher proportion of freshers." With consistent downward pressure on outsourcing pricing, it is only rational that cost of service must be brought down to maintain profitability margin. And Wipro is not alone there. Almost all Indian medium and large software companies have adopted this method of cost reduction i.e. by increasing the share of freshers and junior practitioners in its employee-base. The trend is not limited to service-based profit centres like Wipro, Infy, the trend is equally strong with Indian cost centres of large software MNCs. A casual scan on all job portals will tell you that demand, wherever there is, is almost always in 0-8 years experience bracket.
So what happens to not-so-junior practitioners? That's a question, both media and company executives would like you to not ask, which gives a perfect alibi to talk about in this blog.

Big Fame of software Industry and its blindside

Software Industry got its fame particularly on couple of accounts:

1. Spectacular company growth and
2. Spectacular increase in salary during boom time.

First one brought a lot of eager shareholders and fans and second one brought many people fresh out of college opting to join the IT industry. In US, there was another very strong incentive, possibility of a startup company making big and its employees retiring rich on its shares at young age.  Retire by 40 was the catchline, not too long ago. In India, since successful startups hardly come by, one incentive that worked for it was 'assignment abroad'. However none, if you look closely, actually are about structural strength of the industry. If one compares the industry with other engineering industries [with an obvious exception to Financial Engineering Industry], there is a stark difference. In those companies a typical growth incentive was to participate and contribute to large and complex engineering projects and thereby make one's mark in the Industry. Credibility and market value of a firm in those Industries were expected to grow only when the firm brings out better products, executes engineering-wise ambitious projects. That was good incentive to retain experiences and knowledgeable people. In Software Industry, it is generally accepted that technology changes lot faster. So organizations need people nimble and adaptable enough, who can learn fast and deliver faster. It is also commonly accepted that younger people are more adaptable and faster than older colleagues. Naturally software firms tend to bias towards younger lot. Most of the companies prefer average age to be closer or below 30.That needless to mention, helps the company in keeping the cost down. The tagline is bring more people at the bottom of the pyramid and flatten/trim the middle layers of the pyramid as much as possible. Net effect, as engineers become senior they become more vulnerable to be replaced by younger ones. If you are thinking this is only true for Indian software Industry, think again!
A recent article in Bloomberg talks about how software professional in US are vulnerable to lose job as they approach 40. The article argues that unlike legal, medical or educational profession, software engineers tend to be less desirable as they age.  The article observes,"even if the 45-year-old programmer making $120,000 has the right skills,“companies would rather hire the younger workers.”  To add to their woes, the article reports, there are young engineers from India with H1-B visa who are cheaper and easily available to American companies. The author clearly is unaware that same treatment is meted to experienced professionals in India.
'So what?', you may ask, 'if the industry prefers younger population, as long as the Industry grows? It is not that all the people above 40 are getting laid off!'
Absolutely! But is the Industry really growing? If the industry really could grow as it used to be there won't be any need to remove people. And secondly what happens when one trades experience with cost?
Let's look at each question carefully.
If we look at the results from Indian software vendors, it is fairly evident that they are struggling to maintain even low double-digit growth rate [previously average rate of growth used to be 35%] and if we follow closely executives' discourse, it is clear that they are focussing more on pushing the bottomline in order to improve profitability. Above 95% utilization of existing resources and reducing average cost/resources figure prominently in strategy-speak. Even a college kid understands that only when the topline projection flattens, people get forced to find ways to push the bottom-line further. If this is true for Indian Software vendors, let's look at IBM. One blogger observes that IBM's strategy to improve EPS [Earning/share] in next 3-4 years hinges upon reducing cost of their work-force. One may argue that it is in tune with global macro-economic scenario; if the global economy is in tatters, software industry cannot escape from that. While that statement is generally believed to be true, one cannot miss that Apple also became enormous during this time. It is those software firms that primarily look at cost arbritage for software development as the primary determinant, are particularly finding growth as challenge and that covers majority of the known software houses.
Coming to the next question, let's look at the effect of reducing senior people from rosters. Long-time customers [e.g. Walt Disney] are walking away from companies like IBM because they do not find the quality and timeliness as they used to get from IBM earlier. Many attribute that to large segment of young relatively inexperienced work-force who fill the botttom rank of IBM's cost pyramid. You can bet that other software vendors face similar challenges. Customers often complain about skill and experience inadequacies in the vendors' resources and relatively  poor (technically speaking) fixes or long fixing time for a customer issue. There is overwhelming belief in many of the software companies that Quality processes adequately take care of loss of experience. Those who have seen it from close quarter, know well that it is cultivated myth. Fact is impact of loss of experience never seriously mattered to those who matter in these firms. It is not much of surprise that Sofware engineering fares lot worse compared to other engineering stream when it comes to long-term quality [durability, scalability, maintenability] or execution success rate. Standish Chaos 2009 report showed only 32% success rate for software projects. Dr. Dobbs journal who question methodology of Standish Chaos report, report for 2010 from their own survey

Ad-hoc projects: 49% are successful, 37% are challenged, and 14% are failures.

Iterative projects: 61% are successful, 28% are challenged, and 11% are failures.

Agile projects: 60% are successful, 28% are challenged, and 12% are failures.

Traditional projects: 47% are successful, 36% are challenged, and 17% are failures.

Irrespective of which side you are, it is not a pretty picture, even though you may question about sampling universe. Any other engineering stream report lot better statistics.

So what is it really?

One can blame on many things for that bad score, like poor requirement definition or poor change tracking or poor project execution, but chances of getting it right is low. Fact is software Industry is not going to be like any other Industry. Most of the software projects, successful or not, very rarely finish the way they were envisaged in the beginning. Understanding what is to be developed, many times build up gradually. Because of this reason, the cost of repairing an error is less of a consideration in determining 'success' of a project, which for any other engineering trade, constitutes one of the primary metrics. That translates to real lack of motivation for creating objective measure of cost of losing experience and skill depth but there are both carrots and sticks to reduce the project expenses. Company managers take this advantage by stressing (quite mechanically at times) on following process at the cost of prople but that hardly solves the issue, as the scorecard shows. Quoting Steve Jobs [source], "Companies get confused, when they start getting bigger they want to replicate their initial success and a lot of them think well somehow there is some magic in the process of how that success was created so they start to try to institutionalize process across the company. And before very long people get very confused that the process is the content.” The managers forget that process is not the end goal but the product is and it is peeople who develop the product and more experienced a person is better is his output quality. Following process can be easily monitored but hardly that guarantees great product. In other words, one can keep expanding the base of pyramid but that will never give a company run-away success or high double digit growth. Having the right vision for the product/solution for the customers, getting the right people who know how to develop product and retaining them are critical for that. That needs inspriring leadership, creative passion for the products/vision, skill depth and experience which the organizations trade for lower expense today. As long as the executives are measured against the numbers but not the creative forces that they unleashed in the organization, it is very unlikely that the present scenario of the Industry will change. 

IT Industry in India and China

In the backdrop of shrill-chill in US to stop outsourcing of software jobs, I thought it would be interesting to take a look at where the software Industry stands in these two countries. In August this year, China dalily reported, " China's software industry revenue expanded at faster pace to 152.3 billion yuan ($23.8 billion) in July, a year-on-year increase of 31.4 percent, the Ministry of Industry and Information Technology (MIIT) said Wednesday.
The software industry's growth rate in July was 2.9 percentage points higher than a year earlier."
   Nasscom, the association of software industry in India in a recent press release also said that," The growth in software and services export is expected to be 16-18 per cent and the sector is slated to bring in revenues of $68-70 billion. The growth in the domestic market is estimated to be 15-17 per cent, with revenues of about $19-20 billion. " The projected growth figure of 15-17% is very likely to come down to 11-12% as the year closes, as observed by an Industry leader.
Interestingly, China clocked higher growth compared to last year while India actually clocked slower growth compared to last year with projection following the trend.  The reason of this skew is quite obvious. India's software industry is majorly [almost 90%] export-based while China's software industry so far is mostly driven by domestic demand. As per NASSCOM, US and Europe contribute around 90% of IT/ITES revenue and with slowdown of those two economies, Indian IT industry has suffered the hit in the growth of this sector.
Chinese software export too were hit this year. Reading the same report from China daily:
Regarding the exports of the software industry, the growth rate fell sharply to 3.9 percent in July, the lowest monthly increase in the first seven months of this year amid economic uncertainty in the United States and the European Union.
Exports in the Jan-July period rose 15.7 percent to $15.46 billion, compared to last year's growth rate of 26.2 percent.
Interesting aspect is both the countries are betting big on the IT export. While Chinese Govt has provided some tax holidays, developed zones and offered incentives to the promoters to grow the software parks, India already has established regulations and tax-breaks [STP and now SEZ] to help the software export. Like China, software industry in India is also centred around few big cities.

Some key data from NASSCOM presentation and outsourcing portals:

1.  India's share in global IT and BPO sourtcing: 55% as on 2010.
2.  India's domestic IT market size in 2010 was Rs 659 billion i.e. $14.3 billion roughly
3.  As per NASSCOM, IT-BPO industry in India directly employs 2.54 million with approx. 2 million in IT alone and expects 10% growth Y-to-Y. Some claim that China too has around 2 million software engineers working as on 2010.
4. China's average software engineer's salary is almost double to the average salary of a software engineer in India and when it comes to customer service representatives, Chinese salary is differs in magnitude. In short resources are constlier in China. More details can be found at Sourcingline.
5. Almost all independent commentators rate Indian IT Industry more competitive compared to Chinese counterpart.

<><><>The table below provides a revenue comparison. As it shows, China's IT industry is dominated by domestic demand while India is slowly developing its domestic IT market.<><>

FY11 software revenue comparison	Domestic	Software Export
Indian Industry	$14.3 billion	$59   billion
Chinese Industry	$23.8 billion	$15.5 billion

One aspect that does not come out well, is China's industry has more product-centric. Huawei, ZTE are globally recognized names and they are showing fastest growth in telecom space [while US telecom companies are shrinking]. In fact Govt. regulation and control helped these companies to grow faster and become formidable competitor internationally. Even in the new world of social media, Govt. censor has helped coming up of Chinese counterpart of facebook and twitter. Weibo for example is a twitter equivalent in China and quite popular too. Renren procliams to be Chinese facebook but wetern commentators think renren is too small to be compared with facebook. However, there is distinct trend of product cumture in China just like India predominantly has services culture. One reason could be that the Chinese language and culture have created the necessary barrier for the product development culture to flourish, just like having the English as the link language in India helped Indians to flourish service culture.
The question however is, can India continue to grow its IT services revenue without the support of strong product-base? With the present negative job growth and associated negative sentiment against Outsourcing in US and Europe makes the question all the more important.  However,if we follow what NASSCOM and likes of Infosys, TCS are talking, Indian IT industry decidedly continue to see themselves as pure-play consulting/services vendors. It is to be seen though with continuous downward pressure on IT services rate and rising inflation pressure on IT salary, how long they continue the profitability and competitiveness of their present model of business.
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Later Updates: Vivek Kulkarni, erstwhile IT secretary of Karnataka wrote in ToI sometime back on Indian IT industry and its issues. I pulled the link for the curious lot: http://articles.timesofindia.indiatimes.com/2011-03-22/edit-page/29174251_1_manufacturing-sector-foreign-currency-tax-incentives