What's next for Indian infotech?

When Cognizant Technology Solutions wants to hire, its recruiters do not simply go to the top engineering colleges and pick up their brightest graduates. They go to B-schools, to colleges that boast of strong mathematics departments, to technical training institutes and even schools of humanities. They end up hiring an eclectic mix of statisticians, program specialists, experts in analytics, and econometrics, language specialists and the like. The reason: Cognizant never wants to tell a client that it does not have a particular specialist to deal with specific problems.

Of course, Cognizant does hire a large number of engineers (30,000 last year) who form the base of the pyramid. Unlike the other big players in the Indian IT industry, it has focussed on aspects like employing one MBA for 20 software professionals. The MBAs also tend to be lateral hires with at least four years of experience. Its focus on bulk hires at the entry level has been minimal. That’s been the preserve of the Big Three in Indian IT—Tata Consultancy Services (TCS), Infosys Technologies and Wipro Technologies—who do it on a regular basis. In a good year, each of them hires over 40,000 engineers. These companies, along with several others, have completed a decade of growth relying almost entirely on offshoring services, run by the bulk hires, to cut costs for clients primarily in North America. As their business models have become more robust, the Big Three account for about a fifth of the industry revenue of $76 billion (Rs 3.44 lakh crore).

Companies that rely on value-added offshoring offer customers a low-cost model; at the same time, they keep shareholders happy by maintaining high margins of 30% or so. The labour-based arbitrage model of offshore delivery is still robust enough, and successful enough, to attract large projects, at least for the top-tier companies. The problem is this won’t be enough of a differentiator for the big IT firms from India a few years from now.

By not paying attention to their clients’ larger business problems—and thus failing to come up with innovative solutions—IT companies risk eroding their customer base. “Indian IT companies have five or six years to build new capabilities and transform themselves to meet the challenges of a changed market scenario,” says Anand Rangachary, managing director (South Asia and Middle East), Frost and Sullivan, a global business research and consulting firm.

BUILDING STRONG RELATIONSHIPS and focussing on custom innovation is where future growth is likely to be. That’s something IT players such as HCL Technologies and Cognizant, mid-tier companies Tech Mahindra and Polaris Software Lab, and even the likes of Syntel are doing. The big Indian IT companies need to make the leap from delivery to innovation. At the risk of reduced margins for some quarters, they will need to expand into new verticals (perhaps through mergers or acquisitions), place non-dollar bets on the domestic market, and invest in building local relationships, competencies, and custom innovations.

On the face of it, such a prognosis may seem counter-intuitive for big IT. Focussing on offshore delivery alone might get the top IT companies to the $10 billion mark. S. ‘Kris’ Gopalakrishnan, CEO and managing director of Infosys, cites data from Nasscom, the trade body of the IT-BPO sector in India, to illustrate the latent value of offshoring. “Offshoring has been continuously increasing at 18% to 19%. That is why the Indian IT industry has been growing significantly faster than the global growth of IT services at 4%,” he says. N. Chandrasekaran, managing director of TCS, echoed this view on the sidelines of the Nasscom India Leadership Forum: “Clients want an optimum business model; so while we have local presence in the U.S., India will continue to host the prime locations.”

Overnight, India cannot move away from the offshoring model, notes Roopen Roy, managing director of Deloitte Consulting in India. “When new services gross a mere $2 billion of the $70 billion-odd industry, it cannot throw away its outsourcing play.” He adds the best Indian IT companies can do is reduce the share of offshoring to the total business to 40% by 2020. By then, locations in Ghana, Argentina, the Philippines, Vietnam, and Indonesia would have evolved as offshoring destinations.

The trouble for Indian IT companies is though they are accused of chasing margins at the cost of innovation, investors still want a billion-dollar revenue rate every quarter coupled with high margins. Such expectations could jeopardise a large IT company’s attempt to be accepted as a global enterprise. “When I invested Rs 400 crore (to develop financial-technology products), my stock came down to Rs 40,” recalls Arun Jain, chairman and CEO of Polaris Software Lab, a $300 million company that specialises in creating banking products. “As a promoter, I was able to survive. If I was an independent CEO, I would have been thrown out by the board.”

It isn’t as if the big companies have ignored the need for innovation and customer focus; it’s just that too few of them are actually doing something about it. The biggest of them, TCS, is one of the few. In mid-February this year, the $6.3-billion behemoth announced its cloud initiative for SMEs in manufacturing, wellness, retail, and education sectors. With over 130 customers signed on already, this effort would help build accounts that will grow in the domestic market. Chandrasekaran hopes to take the SME vertical to 1,000 customers within a year and the billion-dollar mark in the medium term.

The biggest problem for IT companies here is they have grown too used to the pyramid structure of staffing. “The trick is to drive the work down as far as possible to the young people, the new people...The more you engage the younger and cheaper workforce at the bottom of the pyramid, the more profitable you can be,” says Peter Bendor-Samuel, founder and CEO of Everest Group, a Dallas-headquartered global consultancy, who has engaged with Indian IT since 1991.

Drill down to the fundamentals of the IT universe in India—its demographic muscle—and what is seen is a steady output of nearly 400,000 engineering graduates, a large percentage of them joining domestic or multinational IT companies. What is relatively less-obvious is the 15% to 24% attrition rate of the past nine months. For every person who quits, a technology-services company hires up to four new graduates every year. Coupled with fast growth for young performers, this cycle is astonishing for its sheer continuity. It helps maintain the desired level of wages. With the culture of offshore delivery, employees at this level rarely get the environment to innovate or think out of the box.

However, there are signs of change. Vineet Nayar, CEO of HCL, fourth on Nasscom’s ranking of Indian infotech companies, says “hierarchical models, command-and-control structures [are] all going to become obsolete”. The core, he says, is the employee, who will drive innovation. “He is going to become the centre of the organisation rather than the bottom of it.”

INDIAN IT TYPICALLY FOLLOWS one of two pricing models. In the time-and-material model, the value of a deal is calculated by multiplying the number of people by the total number of hours. The other is a fixed price model, where the client is billed a specific amount for an application custom-built and managed by the IT vendor. In both cases, companies are forced to boost workforce numbers to keep up with demand.

The more agile players such as HCL and MNC major Accenture are experimenting with non-linear pricing models. In the cloud model, which TCS is trying out, companies charge per methodology sold, much like a prepaid cellphone tariff plan. The other model being tried out is the outcome-based pricing model, where companies look to hire specialists instead of hordes of programmers. The focus is on value of services (as opposed to a fixed price) in a business environment where clients want fewer vendors.

For example, Nayar talks of one of HCL’s telecom clients, which had 1,400 people working with three vendors in India. It was an effort-based deal. Converting that into an output-based contract meant that the job could be done with just 800 people. “There were 600 people reduced just by converting the contract from time-and material-based to output-based,” explains Nayar. “Customers will migrate to the outcome-based model because there are hidden inefficiencies in the conventional models. We attack the problems by removing our inefficiencies and investing in higher levels of automation and tools to take significant costs out.”

This approach is more holistic than plain vanilla IT delivery. A business transformation exercise widens the scope of a technology-services implementation on the face of it. More significantly, it gives companies the portfolio and pedigree of projects to command a premium price.

The objective is to enhance domain expertise—the cornerstone for outcome-based pricing. That is why the likes of Cognizant have been regularly picking subject-matter experts from non-IT firms for their vertical specialisation in the past three years, a strategy followed by companies such as Accenture and IBM. It also ensures a large-size vendor is more nimble and agile, and that hiring strategies will be moderate, focussing on niche qualities than high-standard quantity. This approach can, however, mean a higher level of investments, either on inorganic expansion (perhaps in non-IT areas) or buying niche talent, which can dent margins.

Non-linear business generally accounts for 10% to 15% of revenue annually for Big Indian IT. “Outcome-based pricing calls for a large part of the engagement at the client end,” says Rajan Kohli, chief marketing officer of Wipro. That is where Big IT must brand itself away from offshore delivery. For Infosys and Wipro, the first tech champions on the stock markets, that is a difficult leap. Gopalakrishnan of Infosys asserts that operating margins will be in the 30% region, as attrition rates too have moderated in the past few quarters.

This can come at the cost of developing onsite resources. For instance, when the recession hit North America in early 2009, onsite managers of Indian origin working for a Big Three company were discouraged to stay on after completion of project. The managers had to fly back home, and filled in the positions of project managers—an area of scarcity. Meanwhile, competitors in the U.S. used the vacuum to build relationships with clients. Those engagements would be leveraged later.

One of the most talked-about IT acquisitions of the recent past has been Tech Mahindra’s buyout of Satyam. One way for the Mahindra Group to integrate the estimated billion-dollar Satyam with the $977-million Tech Mahindra is to marry the two entities to give it cross-vertical breadth and size of over $2 billion. There is, however, another approach mooted within, and that is to draw from the telecom vertical expertise of Tech Mahindra. “Tech Mahindra has predominantly been known for its capabilities in the telecom space, and Mahindra Satyam for its capabilities across enterprise solutions, IMS (infrastructure management services) and BPO,” says C.P. Gurnani, CEO of Mahindra Satyam. “We have already started working closely to co-develop enterprise mobility solutions and services for our stakeholders.”

PHANEESH MURTHY, CEO OF IGATE, has always made the case for outcome-based pricing with an eye to acquiring accounts that iGate can mine beyond IT services. But iGate’s compounded growth in five years has been sporadic, at about 7%. The $193 million company has now acquired the roughly $700 million Patni Computers for $1.2 billion. The acquisition gives iGate size as well as domain depth in areas such as manufacturing and insurance.

The buyout also gives iGate some features of a micro-vertical. First, it is looking to go beyond the CIO (chief information officer) or IT person to the head of global business services suite. “You also need consultative ability in the organisation to take the customer on his journey,” says Murthy. “And you need to have a base of people whom you didn’t have earlier, even which I call a cost account. We should be able to know what it costs to create an outcome in the domain concerned.”

Sunil Chitale, chief strategy officer of Patni, agrees. “We must transition from the technology domain to a business domain.” Towards verticalisation, Patni has made six buyouts since 2003, before being acquired by iGate. “If you are not differentiated in this space, will a client be more comfortable with you bringing more things to the table—
or less?” asks Murthy. There are more chances that a client will buy if a company is properly differentiated. And differentiation resides in the verticals. “Many a time, IT vendors themselves may not know how much it costs to produce an outcome,” he says. That comes through experience in the industry.

Forrester Research predicts mobile apps in developed markets outpacing even the cloud trend. That might explain why companies are choosing to specialise in the mobile services space. From Wipro and Cognizant to Mahindra Satyam, there are opportunities to build relationships with clients who want to simplify mobile apps and systems.

“Some 10% of (client) enterprises open private app stores, which simplify firms’ distribution of mobile-enabled corporate applications,” states a January report of Forrester. More than 25% of business smartphone owners use such app stores to download work related productivity applications. The private app stores inside the corporate firewall will let IT control and sanction a set of approved mobile apps for employees. In such contexts, each vertical for an IT-service provider will seek to become billion-dollar babies—and build business (not IT) relationships.

Both TCS and Cognizant were aggressive in boosting revenues using right-brain approaches in the past year—one, entrepreneurial; the other, based on building business relationships. They have been nimble, and demonstrative of micro-verticalisation and new services that lend itself to deal chasing. Nayar explains how this works in the case of HCL. “Our micro-vertical heads act like an entrepreneur, and we have defined the rules of the game for him. He may be small but he runs it independently and we do not try to integrate it with others. It starts with a strategic business unit structure, and then they integrate everything.”

In the long run, the success of Indian IT will depend on customers and investors being willing to back companies when they take chances. “The industry and clients should be more willing to forgive companies that are willing to take risk. We need not have only people who work on surety of making millions of dollars,” says Jan Erik Aase, principal analyst, Forrester Research.