Pricing pressure and the rising costs of acquiring new businesses are eating into the profitability of Indian software companies.

Software majors Infosys and Wipro reported lower profits despite growth in revenues in the fourth quarter of 2002-03.

Analysts said this was because of the high cost of acquiring businesses and skills to handle complex and long-term projects.

"If you look at the projects acquired by some leading companies like Infosys, Wipro or Tata Consultancy Services, most of them are long-term multi-million dollar projects. Since the costs of acquiring such businesses are high, the investment needed to acquire and train people in such businesses is also high. This leads to a decline in profits," said Phaneesh Murthy, founder of Primentor, a firm that helps companies work out outsourcing deals in India.

Murthy also said companies were renegotiating deals at lower prices.

"In some of the renegotiated outsourcing deals, the billing rates have come down as much as 25 per cent," he said, adding that profits were likely to improve marginally in the future because the cost of running these projects was likely to stabilise in the long-run.

"In general, margins of all infotech companies are under pressure due to the downward revision of billing rates in line with higher volumes, increased sales and marketing costs," said Nasscom vice-president Sunil Mehta.

"Companies that are bagging higher business from existing clients and are being able to negotiate prices and control costs are enjoying better margins. But these are very few," Mehta said.

Indian companies are also likely to face strong competition from global majors, which are ramping up their operations in India.

According to market analysts, this may lead to work being diverted from Indian companies to these global vendors.

Polaris chief executive Arun Jain said high costs of hiring people, increase in salaries and falling prices were lowering profits.

"The cost of operation has gone up with the increase in salaries. Besides, when your clients know that you are operating at margins as high as 40 per cent, they keep the billing rates down," Jain said, adding that margins had come down to as low as 12-15 per cent for the software industry.

Hughes Software Systems Managing Director and CEO Arun Kumar said the pressure on margins would continue with overseas clients looking at cutting costs by reducing billing rates.

"At the industry level, there is a downward pressure on pricing, which goes up as the size of a project increases. With the size of operations increasing, the cost of managing the company also goes up," Kumar said.