A bad quarter for global software product engineering service providers though Indian providers shine!

Q1 CY23 turned out to be a bad quarter for global software product engineering service providers. All leading global software product engineering service providers who declare their financial results witnessed negative QoQ growth anywhere between -0.3% to -3.7%. Surprisingly Indian software product engineering service providers are doing better.

Why did revenue decline for global software product engineering service providers in Q1 CY23?

This is because of a combination of many factors coming together.

• Mega growth followed by slowdown: Software product engineering witnessed mega growth when the pandemic started as the world started going digital. Software product engineering is the plumbing or underlying foundation for digital initiatives, be it platform engineering, cloud engineering, data engineering, etc. In hindsight, it was a medium-term pandemic-driven hyper-growth that was not sustainable. As digital growth is slowing down, so is software product engineering growth prospects.
• Headwinds in a few verticals:  Few specific verticals, such as  BFSI, hi-tech, and retail, are facing headwinds because of overall macro and sector-specific challenges, and it is reflected in sales numbers across IT service providers. Software product engineering service providers are also facing similar headwinds.
• Client preference of insourcing: Many clients, especially in the hi-tech sector, are right-sizing themselves and doing layoffs. One strategy few of these clients are adopting is to shift some of the outsourcing work in-house to minimize layoffs. This is impacting software product engineering service providers' business in the short term.  
• Slow ramp-ups: Many times, projects and deals have been signed up, but ramp-us are slow because of macro or company-specific concerns. Though this is assured business in the medium term, it creates short-term growth challenges.
• Supply-side competition: In the early days, few specialized service providers dominated the software product engineering services landscape. In fact, they created a separate category differentiating themselves from IT or application service development and maintenance work. When the world recognized the importance of software product engineering in the digital push, almost all major IT service providers, both large ones and mid-tiers, have either launched or repackaged their offerings to software product engineering. Many such mid-tier software product engineering service providers are backed by Private Equity and have huge growth and value-creation aspiration. While the market growth rate is slowing down from its peak, the competition has increased significantly in software product engineering.

Why are Indian software product engineering service providers doing better than global ones?

 Indian software product engineering service providers are seeing some slowdown compared to their growth rates in the last two years. But overall, they are holding better and not in negative growth territory yet. A couple of reasons

• More offshoring: In this macro environment, clients prefer saving costs, so software product engineering clients are cutting onshoring or nearshoring more than offshoring.
• Favorable client mix: The client mix also explains why Indian software product engineering service providers are doing better. Some large ISVs, hyperscalers, and digital firms have scaled down more than others.

Short-term outlook of software product engineering service providers

• Slowdown to negative outlook this year: Many global service providers have given next quarter and this year's outlook and some of them are giving guidance for the negative growth. One thing is clear overall growth in software product engineering will be down this year.
• Acquisitions will drive growth: When the market slows, acquisitions become viable with a correction in valuations. Acquisitions in software product engineering are a good way to drive top-line and build capabilities in different areas and geographies.
• Watchful for Indian providers: Indian software providers are holding well so far, but how long can they remain immune to this? Will they get hit later if the environment deteriorates further? I think Indian providers can hold a quarter or two, and hopefully, the market will start recovering by then.

Bottom Line: The recent purple patch of software product engineering service providers looks to be over. These service providers were in the right place at the right time with their capabilities when software product engineering took off. In the medium and long term, there will be good demand for software product engineering services as digital adoption is far from over. But there is good growth in supply too, and software product engineering service providers will face hyper-competition. Now growth will be less market-driven and more driven by service providers' strategy and execution. Many software product engineering service providers will realize that tailwind is not a strategy!