Indian outsourcing scandal shakes Silicon Valley

The massive fraud that threatens Indian outsourcing giant Satyam Computer Services has sent tremors 9,000 miles to Silicon Valley, long an investor, partner and promoter of the South Asian country's rising tech industry.
##CONTINUE##
The Satyam scandal, centered on $1 billion worth of falsified financial statements, is a severe blow to the image of India Inc. and is causing executives in the Bay Area to balance the risks of outsourcing against the cost savings. It highlights the dangers of U.S. companies handing over critical work to firms halfway around the world that they cannot control.

There is no evidence that U.S. companies directly lost money from the Satyam fraud. However, many could suffer production delays or other indirect losses.

"The question everyone is asking is: Is this the classic cockroach? If you see one, are there more around?" said Vivek Paul, former vice chairman of Wipro Technologies, India's third-largest software-services company, and now a Silicon Valley investor. "History has proven they never come in ones."

Satyam's 53,000 employees, including hundreds in the Bay Area, could lose their jobs. Numerous Fortune 500 companies, which rely on the Hyderabad software company to handle services such as billing and managing back-end systems, may have to scramble to find new outsourcing partners.

Tech companies that entrust proprietary information with overseas partners are reviewing their trustworthiness. And the Satyam scandal, which exposed the lack of transparency and potential for corruption among family-owned businesses in India, could cause investors to pull back.

India's emergence as a global tech hub during the last decade has rearranged the global software industry. India's software and services industry, including homegrown companies such as Infosys, Tata, Wipro and Satyam, generates $52 billion a year in revenue. It forced competitors in the West to embrace a global work force to save money and gain footholds in emerging markets. Valley companies now employ tens of thousands of engineers in Bangalore and other major cities in the South Asian country.

The full extent of outsourcing by U.S. companies to India is unknown. However, more than $2 billion in venture capital, mostly from the valley, has been funneled into India in the past four years, according to Dow Jones VentureSource.

Satyam has dealings with numerous valley companies, but those companies typically decline to discuss their relationships with Indian outsourcers. Moving jobs overseas has been a highly charged political issue in the United States.

"It's something we are not commenting on," a Hewlett-Packard spokeswoman said in response to questions about Satyam.

Cisco Systems has had negotiations with Satyam about collaborating on a project, and once considered investing in the company, said a company spokesman. "We do not expect the situation to have any material impact for Cisco," the company said in a statement.

Applied Materials has a "supplier relationship with Satyam and they have employees assisting us here and in India," company spokesman David Miller said in an e-mail. "Beyond that our policy is not to comment on our suppliers' businesses or the nature of our business with them."

But experts say that at the very least, Satyam's implosion could cause customers to flee to a competitor, and that in turn could drive up the costs of outsourcing over the short term.

"If I were a customer of Satyam, I would be concerned about the stability of the company's work force," said outsourcing expert Michael Murphy, a partner with Pillsbury Winthrop Shaw Pittman in San Francisco.

The fraud also spotlights how many tech executives from the valley sit on boards of Indian companies. Satyam's board included Vinod Dham, father of Intel's Pentium microprocessor, and Krishna Palepu, a Harvard Business School professor and a corporate governance expert. Both resigned from the board. In an e-mail, Dham said it was not "appropriate" for him to comment about Satyam at this time.

Frequently, valley-based board members attend meetings "by phone in the middle of the night," said Rafiq Dossani, a Stanford University research scholar who specializes in relations between Silicon Valley and India.

"They are probably waking up to some realities," Dossani said. "You better not trust management. You have to ask about margins, visit clients. You are being paid a few hundred thousand dollars. You just can't pocket the money and sleep."

Late last week, Indian authorities arrested Satyam's founder and chairman, B. Ramalinga Raju, a familiar face in the valley who has admitted to misstating financial statements. Authorities also dismissed the remaining Satyam board members and ordered a review of the country's largest publicly traded companies.

For Satyam, the first warning signs came in December when investors revolted against a plan to spend $1.6 billion to buy a couple of family-owned businesses.

In India, investors are accustomed to some "leakage," but if the company is doing well, they're willing to overlook a family business siphoning off some profits, said one Silicon Valley executive with extensive dealings in India.

The Satyam scandal, though, has upended that arrangement, said the executive, who asked not to be identified. "It's fundamentally shaken investors."

While further revelations about Satyam are sure to come, most experts don't believe they will have long-term harm on outsourcing in India.

"What it will do is make outsourcing customers a little more cautious about who they contract with, and more mindful of the financial risks associated with outsourcing," Murphy said. "Until recently, no one was concerned about that."

But if the attention to this scandal exposes corruption in other Indian companies, the budding business relationship between the United States and India could be at risk, warned investor Paul.

"If there were to be one more mea culpa from an Indian company, we'd have a problem," he said.

-----------------------------
BY John Boudreau
Source：Mercury News

Contact John Boudreau at jboudreau@mercurynews.com or (408) 278-3496.