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

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

Utility=Users2

Law of disruption: The network effect

Law of disruption – Until a critical mass of

users is reached, a change in technology only affects the technology.

– Once critical mass is attained, social, political, and economic systems change 0

30

60

90

120

‘22‘30‘38‘46‘54‘62‘70‘78‘86‘94‘02

Us

ers

(M

illio

ns

)Internet

Years to reach 50M users:

Radio TVCable

Radio= 38

TV= 13

Cable= 10

Internet = 5

Source: Morgan Stanley.

…Led to more information at a lower cost

Source: UNDP 2001

The dot-com boom and bust

Internet revolution fuelled corporate tech spending…

Source: U.S. Department of Commerce.

PC Introduction

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1960

1961

1963

1964

1966

1967

1969

1970

1972

1973

1975

1976

1978

1979

1981

1982

1984

1985

1987

1988

1990

1991

1993

1994

1996

1997

Commercial Internet

US-based IT spending as a share of business capital equipment spending

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.

…And increased funding for startups

US technology funding (US$ billion)

$0

$20

$40

$60

$80

$100

$120

$140

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

IPO proceeds of techcompanies

VC funding to techcompanies

Source: Morgan Stanley

Technology statistics for 1999 and 2000 as a percentage of total for last 21 years

70%

56% 54%62%

Venture capitalfinancing

IPO financing Follow-on financing M&A (dollarvolume)

The highpoint in funding

Source: Morgan Stanley

...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

0.1470.4

3.8

0.792

Technology companies thatIPO'd between 1980 and 1999

The Internet sector

US$ t

rillion

Market value creation

Technology wealthcreation

…And also opportunities for new categories of companies

B2B providers Ariba and Freemarkets

Business reengineering verticals

eBay

Online commerce companies

Amazon.com

Content and aggregation providers

America Online and Yahoo!

Internet software providers

Netscape

Internet Infrastructure

Cisco and UUNet

1994 1995 1996 1997 1998 1999 and 2000

The genesis of the boom? The 1996 Telecommunications Act

Required Bell companies to open their local networks to competitorsStipulated 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 deregulatedCreated 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 businessLed to Competitive Local Exchange Carriers (CLECs)

Effects of the Telecommunications Act

Source: FCC reports and Bear, Stearns & Co

Decreasing prices

Increasing share of CLECs

The telecom sector witnessed strong growth...

TelecomBoom

Accelerated Innovation and Infrastructure

Expansion

IncreasedInvestments

And New Entrants

Improved Utility, Price Performance

and Profits

Increased Bandwidth Demand

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

Increase in investments and new entrants– Carriers increased capex

Increase in bandwidth demand– Dot-com boom

Improvements in technology– Dense Wavelength Division Multiplexing (DWDM)

DWDM advancements

832

160

320

0

50

100

150

200

250

300

350

Past Present Future

Number of wavelengths

Sources: CSFB and Kaufman Bros

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

Source: Morgan Stanley

Technology wealth creation (US)

0.40.7

0.15 0.24

3.8

2.5

0.790.22

Technologycompanies that IPO'dbetw een 1980 and1999 as on Jan 31,

2000

Technologycompanies that IPO'dbetw een 1980 and2000 as on Dec 31,

2000

The Internet sector as on Jan 31, 2000

As on Dec 31, 2000

US

$ t

rillio

n

Market value creation

Invested amounts

The impact of the downturn

Short term impact of the shifting paradigms

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“New” Economy

Traditional IT Markets in Recession

The Old and New Economy Converge

“Old “Economy

Global Economy

Long term impact of the shifting paradigms

“New” Economy

Traditional IT Markets in Recession

The Old and New Economy Converge

“Old “Economy

Global 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?

Growing at twice the rate of overall e-commerce sales

Source: Goldman Sachs, Yahoo Finance

eBay

Yahoo

Amazon

Trends in market capitalization

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 be more customer-friendlyCRM

Extranet

Electronic Delivery Channels

Global call center

Electronic markets

Corporations will use technology to improve internal processesIntranet

Computer Integrated Manufacturing

Office productivity tools

Teleworking

Video conferencing

Corporations will use technology to closely integrate with vendors and suppliers

SCM / ERP

EDI / Intranet

Electronic markets

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

Source: Booz Allen Hamilton.

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

$1.20

Transaction Costs (Banking)

Cos

t / T

rans

actio

n

Branch

TelephoneATM

PC BankingInternet

Technology in bankingNet transactions cost far less than transactions through traditional channels

Investment for a commercial bank to reach 10M potential customers

–Bricks & Mortar: $900M

–Internet: $1M

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

Co

st

Transaction cost

Reduced optimal size of firm

Increasing levels of integration

In-house cost

Lowering in-house costs

Lowering transaction costs fueled by

outsourcing companies

Earlier optimal size of firm

Forces defining level of integration of the 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’ business and domain

critical 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 needsBring out your best in all client interactionsDevelop high touch and high quality relationshipCreate a client first mindset within the

organizationsNew 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

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

The road ahead: Explore new avenues

Finally, our learnings

A strong, de-risked business model helps succeed in both growth and recessionary environments

Openness and adaptability to change is keyCut costs but focus on sustaining growth even in

difficult timesCapitalize on opportunities thrown up by the

turbulent environment– Offshoring opportunities– Change in competitive landscape

Thank you