Lessons from the downturn, and the road ahead.

NASSCOM 2002 Nandan M. Nilekani

Managing Director, President and Chief Operating Officer Infosys Technologies Limited Bangalore, India

The story of IT is of the semiconductor revolution: price and performance improvements…

 Moore’s Law – Number of transistors and performance of processor (measured in MIPS) doubles every 18 month  Today’s computers have 66,000 times computing power, at the same cost, as the computers of 1975

Improvements in communications and death-of-distance

 Gilder’s law – Doubling of communications power every six months • due to advances in fiber-optic network technologies  The cost of transmitting a trillion bits of information from Boston to Los Angeles has fallen from $150,000 in 1970 to 12 cents in 2000 Sources: UNDP, World Bank and The Economist

Metcalfe’s Law: The network effect

 The usefulness, or utility of  a network equals the square of the number of users Utility The more people use a particular software, a network or a book the more valuable it becomes ,and the more new users it attracts , increasing both its utility and the speed of adaptation by still more users. Utility=Users 2 Users

Law of disruption: The network effect

 Law of disruption

Years to reach 50M users: Radio= 38

– Until a critical mass of users is reached, a

120

change in technology only affects the

90

technology.

60

– Once critical mass is attained, social,

30

political, and economic systems change

0 TV= 13 Cable= 10 Internet = 5 Radio TV Cable Internet ‘22‘30‘38‘46‘54‘62‘70‘78‘86‘94‘02

Source: Morgan Stanley.

Source: UNDP 2001

…Led to more information at a lower cost

The dot-com boom and bust

Internet revolution fuelled corporate tech spending …

US-based IT spending as a share of business capital equipment spending 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% PC Introduction Commercial Internet Note: Information technology spending includes purchases of information processing and related equipment (including office, computing, and accounting machinery), computers and peripheral equipment, communication equipment, instruments, and photocopy and related equipment.

Source: U.S. Department of Commerce.

Source: Morgan Stanley

… And increased funding for startups

US technology funding (US$ billion)

$140 $120 $100 $80 $60 $40 $20 $0 IPO proceeds of tech companies VC funding to tech companies

The highpoint in funding

Technology statistics for 1999 and 2000 as a percentage of total for last 21 years 70% 62% 56% 54% Source: Morgan Stanley Venture capital financing IPO financing Follow-on financing M&A (dollar volume)

...Leading to the boom in the year 2000

 US IT Spending Hit a Record $532 Billion – Growth of 23% Over 1999 – 51% of Its Capital Equipment Spending  Since 1960, There Have Been Only Three Years When Annual IT Spending Growth Exceeded or Equaled 23% – All Previous Instances Occurring Prior to 1980 on a Much Smaller Base

Technology wealth creation (US) as on Jan 31, 2000

3.8

0.4

Technology companies that IPO'd between 1980 and 1999 0.792

0.147

The Internet sector Market value creation Technology wealth creation

… And also opportunities for new categories of companies

B2B providers Business reengineering verticals Online commerce companies Content and aggregation providers Internet software providers Internet Infrastructure Cisco and UUNet Netscape 1994 1995 America Online and Yahoo!

1996 Amazon.com 1997 eBay 1998 Ariba and Freemarkets 1999 and 2000

The genesis of the boom? The 1996 Telecommunications Act

 Required Bell companies to open their local networks to competitors  Stipulated that Bells could enter the long distance market upon proving the existence of sustainable local competition – Verizon Communications (formerly Bell Atlantic) was the first Bell to be granted entry into the long distance market in New York State in December 1999  Granted additional spectrum to TV broadcasters to deploy advanced services  Provided a framework under which cable television could be deregulated  Created new funds for the development of telecommunications services in rural and underserved areas. – $5 billion Universal Service Fund  Gave the FCC authority over deregulating the voice business  Led to Competitive Local Exchange Carriers (CLECs)

Effects of the Telecommunications Act

Increasing share of CLECs Decreasing prices

Source: FCC reports and Bear, Stearns & Co

The telecom sector witnessed strong growth...

Increased Investments And New Entrants Accelerated Innovation and Infrastructure Expansion

Telecom Boom

Increased Bandwidth Demand Improved Utility, Price Performance and Profits

And cheap capital led to the telecom exuberance

 Equipment companies aggressively financed the vendors during 1995-1999 – At the end of FY 2000 $25.6 billion worth of loans on books of nine telecom giants: Alcatel, Cisco, Ericsson, Lucent, Motorola, Nokia, Nortel, Qualcomm and Siemens  Total vendor financing by 5 North American companies in the above group equalled 123% of their FY 1999 pre tax earnings  Typically, these loans were at uneconomical terms and for companies with no cash flow promise – 35-40% of the $25.6 billion credit disbursed at risk

Combined with other drivers of growth in bandwidth supply

DWDM advancements

350 300 250 200 150 100 50 0 160 8 Past 32 Present Future

Numbe r of w a ve le ngths

 Increase in investments and new entrants – Carriers increased capex  Increase in bandwidth demand – Dot-com boom  Improvements in technology – Dense Wavelength Division Multiplexing (DWDM) Sources: CSFB and Kaufman Bros 320

Which was not sustainable



Leading to excess bandwidth

 5 percent of the 39 million miles of glass fiber in US networks is 'lit' – 1 percent of the installed fiber of 39 million miles is used

Decline of telecom

Sources: CSFB and Kaufman Bros

The bust after the boom

 Technology IPOs since 1980 lost more than $ 1 trillion by Dec 31, 2000 – Despite additional investment of $300 billion through new IPOs in 2000

Technology w ealth creation (US)

Source: Morgan Stanley 3.8

Market value creation Invested amounts 2.5

0.7

0.4

Technology companies that IPO'd betw een 1980 and 1999 as on Jan 31, 2000 Technology companies that IPO'd betw een 1980 and 2000 as on Dec 31, 2000 0.79

0.15

The Internet sector as on Jan 31, 2000 0.22

0.24

A s on Dec 31, 2000

The impact of the downturn

Short term impact of the shifting paradigms

Global Economy Traditional IT Markets in Recession “Old “Economy The Old and New Economy Converge “New” Economy  Short-term demand tightening   Focus on ROI / business benefits Lengthening decision cycles  Downsizing – throwing out the baby with the bath water  Less willingness to rush into e-business  Carefully evaluating IT initiatives and choosing to work with larger, more stable vendors  Widespread carnage among dot-coms and e consultants  Survivors looking to newer, more cost-effective business models

Long term impact of the shifting paradigms

Global Economy Traditional IT Markets in Recession “Old “Economy The Old and New Economy Converge “New” Economy  Increased customer interest in IT and business process offshoring,  Loss of talent – weakening ability to bounce back  Look to integrate a wide variety of disparate systems, applications and business processes  Look to outsource non core business and IT processes to a reliable cost effective vendor  Survivors look at sustainable business models with a stronger customer value proposition

Technology will continue to be a key driver of businesses worldwide

Impact of technology

Online organizations Companies that deal in technology Companies that are directly affected by digitization Traditional companies that use technology to improve productivity

eBay – the future of online business models?

Trends in market capitalization  Growing at twice the rate of overall e commerce sales

Amazon eBay Yahoo

Source: Goldman Sachs, Yahoo Finance  eBay a powerhouse on Internet – Largest marketplace and community with diverse range of products – Liquid market place – Diverse Revenue streams: international and domestic auctions, fixed price listing, advertising etc – High ROIC (estimated to be 87% for FY 2001) • No investment in warehouses or distribution centers • Neither side of the transaction controlled – Growth opportunities furthered by International expansion, Acquisitions and innovative price and listing formats

Digitization will influence companies to embrace IT – e.g. Kodak

  Traditional film business hit by digital technologies Introduced EasyShare cameras starting at $ 200 – Features include easier-to-download images and longer battery life – In a December 2001 survey, 50% of retailers mentioned Kodak as their best-selling brand Worldwide digital camera shipments (MM)  Purchased Ofoto, online photo service for $58 million – Online imaging products and services.  Document Imaging – Capturing and archiving images – Purchased Bell & Howell ’ s imaging business for $135 million.

Source: SG Cowen 2001 and Merrill Lynch

Traditional companies will continue to use technology in numerous ways

Corporations will use technology to improve internal processes



Intranet Corporations will use technology to closely integrate with vendors and suppliers Corporations will use technology to be more customer friendly



CRM



Computer Integrated Manufacturing



SCM / ERP



Extranet



Electronic Delivery Channels



Office productivity tools



EDI / Intranet



Teleworking



Global call center



Electronic markets



Electronic markets



Video conferencing

 Boeing launched myboeingfleet.com which gives airlines web access to maintenance information for their fleets – Boeing saves on paper, printing, and postage – Airlines benefit by not having to manage paper work Source: BusinessWeek September 18, 2000

Technology in banking

Transaction Costs (Banking)

 Net transactions cost far less than transactions through traditional channels $1.20

$1.00

$0.80

$0.60

$0.40

$0.20

$0.00

 Investment for a commercial bank to reach 10M potential customers – Bricks & Mortar: $900M – Internet: $1M Source: Booz Allen Hamilton.

Moreover, technology enables outsourcing in both old economy and new economy firms

 A firm expands until the cost of performing a transaction inside the firm exceeds the cost of performing the transaction outside the firm – Search costs – Contracting costs – Coordinating costs Forces defining level of integration of the firm

Lowering in-house costs Lowering transaction costs fueled by outsourcing companies In-house cost Transaction cost Increasing levels of integration

Earlier optimal size of firm Reduced optimal size of firm Optimal size of firm due to interplay of two forces

Building durable organizations in these challenging times

Business will remain cyclical

 Forecasts of the upturn vary – V shaped recovery • A sharp upturn – W shaped recovery • A sharp upturn followed by a downturn and then by another upturn – U shaped recovery • A slow upturn

Imperatives before us: Shift from a supply constrained to a more challenging, demand constrained environment

 Clients have become more demanding: – Increased long term interest in offshoring but continuing short term volume and pricing pressures – Demand for end-to-end capabilities – Understanding of clients ’ critical business and domain  Companies have realized the merits of offshoring: – Big 5, other e-consulting firms looking to expand offshore operations – Large telecom and software product majors looking at India as R&D base

The road ahead

 Consolidate and build organizational strengths  Be prepared to capitalize on the upturn – People – Processes – And infrastructure  Look beyond current short term considerations and build durable organizations  Focus on cost control – Manage under low visibility • Budget on a more regular quarterly basis – Link salary hikes to company performance

The road ahead: Competence building

 Implement meritocracy – Strengthen performance orientation – Performance improvement program for low performers – Promotions based on match of skill sets and organizational need  Build next generation of leadership  Ensure employee loyalty through good times and bad – ESOPS

The road ahead: Enhance client relationships

 Enhance footprint w.r.t client ’ s IT needs  Bring out your best in all client interactions  Develop high touch and high quality relationship  Create a client first mindset within the organizations  New service initiatives – Larger, longer term contracts – Improves predictability of revenues – Can possibly lead to more “ follow on ” business

The road ahead: Build new drivers of growth

 Create new services and strengthening existing services – Systems integration – Business process outsourcing – Consulting / package implementation business

The road ahead: Explore new avenues

 Expanding into new verticals and geographies – Look at stable, recession proof verticals • Utilities and healthcare – Build presence closer to customer – Strengthen presence in Indian market

Finally, our learnings

 A strong, de-risked business model helps succeed in both growth and recessionary environments  Openness and adaptability to change is key  Cut costs but focus on sustaining growth even in difficult times  Capitalize on opportunities thrown up by the turbulent environment – Offshoring opportunities – Change in competitive landscape

Thank you