The Hindu Business Line : Widening gap

Top Indian software companies have made it to the billion-dollar club. But this only means mid-tier companies will have to fight harder, and smarter, to stay in the race.

THE Indian IT services sector is witnessing a sharp polarisation even as it grows at a healthy pace, riding the strong offshore momentum.

Tier I vendors Tata Consultancy Services (TCS), Infosys Technologies Ltd and Wipro Ltd have already entered the billion-dollar league over the last couple of years.

Other biggies, such as Satyam Computers and HCL Technologies, are also in the run-up to crossing the billion-dollar mark. The next rung of the tiered value chain is also being created, with companies such as Patni Computers taking up the slot.

The heralding of the biggies into the billion-dollar club may indirectly force the Tier II vendors to evolve a new set of strategies since competing with the biggies and winning deals against them might get difficult.

Industry analysts say these Tier II players need to do things differently to keep winning deals and maintain their growth.

Of the over dozen firms that are medium-sized in nature, only a handful appear capable of making it to the billion-dollar league over the next few years.

Clients normally consider the big vendors for larger deals, as they are more confident with them, says Ravindra Datar, Gartner's principal analyst for IT services and BPO for the Asia-Pacific region.

Most large vendors act across multiple industry verticals and horizontal offerings. A majority of these vendors have seen significant growth across all verticals and have some product or the other of their own. They also offer services for other products, besides a wide variety of offerings, says Datar.

Mid-sized companies are focussed on certain verticals. Some have a strong niche in particular areas, an advantage that cannot be overlooked.These companies need to stay focussed till such time they can develop the scale and spread required to operate in multiple verticals, says Datar.

Anant Koppar, president, Mphasis Technologies, agrees with Datar on the need for mid-sized companies to focus on niche areas. Bigger companies, with their sheer size and skills, would get deals easily, whereas mid-tier companies need to sell their special skill-sets.

"We need to sell as specialists rather than generalists," he says, adding customers are looking for niche focus.

"If you have carved out a niche for yourself in specific verticals, even bigger clients are willing to work with you." However, with many a large client tending to go with bigger vendors for larger projects, Mphasis has decided to concentrate on the second-rung companies, says Koppar.

To sharpen focus, Mphasis has divided its operations based on the industry verticals. While the financial services solutions group deals with the BFSI (banking, financial services and insurance) space, the Technology Group takes care of related areas.

The verticals under this group are healthcare, life sciences, industrial automation, embedded software, mobile technology, logistics and transport.

Also, the ability to win deals and execute them is linked to how passionate you are, says Koppar.

"As I see from my tenure, as companies become larger and larger, some sort of unknown arrogance comes to the sales people. This is where we see an opportunity and want to cash in on that," Koppar says.

He feels the small and medium guys are more passionate about winning and executing deals.

However, tapping niche areas is not just enough for mid-size vendors, says Datar. They need to get stronger in the niche they operate in, should be able to take up work and demonstrate their capabilities effectively as scalability is a key issue.

Moreover, mid-size companies also need to look at different services and products apart from tapping newer verticals and spreading geographically.

In short, mid-size companies need to get aggressive in their own verticals and also grow in size. They need to pursue alliances and joint deals to enhance their scale, Datar stresses.

Multivendor strategy

Changing market dynamics indicate that mega deals from US clients are going the multi-vendor way. This is primarily because customers are splitting large contracts into smaller pieces, as they do not want to be bound to one vendor with a large contract over a long period of time.

Clients are dividing their outsourcing contracts into parts, for instance, applications, networking and hardware may be different pieces given to different vendors.

This may augur well for Indian vendors, especially Tier I players. Tier II players with niche focus in specific domains may also stand to benefit from the trickle-down effect as such a trend opens doors for service-specific contracts.

And so it comes about that clients working with Tier 1 companies also add other companies to their list over a period of time - even a mid-sized player. For instance, clients in the financial services space, after having Infosys or TCS as their vendors, are comfortable with other vendors specialising in financial services, such as Kanbay, a strong player in this vertical.

The same trend may increasingly apply to other verticals such as retail or telecom.

Rusi Brij, Vice-Chairman and CEO, Hexaware, confirms this trend, though, as he says, the beneficiaries of such a change may vary from one mid-sized company to another.

Kanbay, listed on Nasdaq, acquired Accurum, a company specialising in solutions for the capital markets, so that it can offer end-to-end solutions in the financial services space.

Ganesh Natarajan, Deputy Chairman and Managing Director, Zensar Technologies, feels the multivendor strategy is getting slowly entrenched among large, established multinational clients. His company, he says, has "added large retail clients and secured a systems integration deal recently."

In his view, a medium-sized company will have to identify its own niche and offer specialised solutions in that space.

Differentiation

Greater differentiation in product and strategy will help companies stay ahead but this is something that needs to be done quickly, and all the time. Otherwise, companies will face billing pressure and will have to sacrifice margins.

In true spirit, over the past year or so, select listed medium-sized companies have demonstrated that with a business model focussed on a few verticals, a stream of annuity business and niche technologies, they can grow revenues faster or comfortably in line with the overall industry growth rates.

Take, for instance, KPIT Cummins, which has used Cummins as a strategic anchor customer and broad-based its model — by bringing in four or five Fortune 500 customers as support engines across two verticals.

Or better still, see the Hexaware model. The company has forayed into the German geography and built up the PeopleSoft practice — acquired by Oracle recently (and as a part of this change, the India Services Centre was also taken over by Oracle and the transition is to be completed by October).

It has also entered into multi-million dollar annuity contracts with a few key clients.

But the dynamics of the industry are changing at a frenetic pace and with that, these business models may also be put to test.

To grow in the niche product life cycle management (PLM) space, Manu Parpia, CEO of Geometric Software, has set store by partnerships. As a focused PLM player, his company, he says, offers end-to-end solutions (which include technical help desks and maintenance of PLM applications, added recently).

It works with select partners and bids jointly for projects as a part of its overall growth strategy.

Widening portfolio choice

With offshoring in full steam and premium Fortune 500/Global 1000 gravitating towards large vendors, competitive pressures on medium-sized companies are expected to rise sharply. First of all, at 25-40 per cent revenue growth rate, each of the top five companies is expected to add Rs 500-1,000 crore of additional revenues every year.

The additional revenues are typically equivalent to twice or even three times the size of a mid-tier company.

Second, going by the experience in the economic downturn between 2001 and 2003, larger vendors are equipped to play the volume game as well, if not better than the mid-tier companies.

The employee-addition numbers, especially of freshers in the last year, by the top five companies, clearly show that this is quite feasible.

Business model challenges

Even as the IT spending climate improves and billing rate pressures begin to ease, medium-sized companies are in no position to take their foot off the competitive pedal.

They are likely to face challenges on the following fronts from frontline companies on an ongoing basis:

Differentiation in offerings: Anecdotal evidence from Gartner, IDC or TPI shows that participation in large RFPs (requests for proposal) is slowly being restricted to the top 10 vendors that include multinational and Indian vendors in select verticals.

As the top Indian vendors are also steadily differentiating themselves across verticals and concentrating on building annuity revenue streams, mid-tier companies have no choice but to build differentiation in their set of offerings.

Second, as clients become comfortable with entering into fixed-price contracts with frontline companies, mid-tier companies will have no choice but to use tools or reusable frameworks increasingly to offer the same solution efficiencies or productivity pay-offs as the former.

Client replacement risk: As long as annuity revenues flow in, medium-sized companies remain on comfortable terrain.

But if and when the annuity revenues start drying up, the client replacement risk can be very high.

For that matter, these companies are always caught balancing between project-based and annuity revenues.

Between the two, companies continue to favour annuity revenues, because they impart greater stability to revenue streams and also bring down selling and marketing expenses sharply.

But project-based revenues are the ones that offer the expertise and variety to hone vertical or horizontal skills to bag future contracts.

Hence, striking the right balance between the two is the key to sustainable growth.

Preferred vendor status/star customers: Fortune 500 or Global 1000 companies who have been working with the offshore model for over three years may accelerate their shift from multiple vendors to a limited set of preferred vendors (say, two or three at the most).

So, both preferred vendors/star customers of mid-tier companies may be at risk.

Even otherwise, the dependence on a few customers will keep the threat of billing rate pressure hanging over their heads.

vishwa@thehindu.co.in

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