Growth pangs

Suresh Krishnamurthy

THE NASSCOM-MCKINSEY study has indicated several growth options for the Indian IT industry.

It has outlined both vertical and horizontal growth paths. The vertical growth strategy involves the much-used phrase of moving up the value chain. The horizontal growth strategy involves entry into new segments. For example, while Infosys Technologies is more focussed on moving up the value chain, Wipro appears to be moving up the value chain and entering new segments such as e-commerce.

At first glance, the business plan of many small Indian IT companies seems to be to take the horizontal growth plan, outlined by the Nasscom-Mckinsey study. Many companies, such as Ram Informatics, Melstar Information Technologies and KLG Systel, have interest in more than one segment. However, the horizontal growth strategy does not appear to bear relevance to these small companies. Without stabilising their operations in any one business segment, a business plan that involves focussing on more than one segment does not inspire confidence.

The primary issues in small companies are funding and managerial attention. Consider companies such as VJIL Consulting, SQL Star International, Boston Education and Ram Informatics that are into software training and services. The training segment is becoming intensely competitive. The prospects for growth in the Indian IT industry are attracting scores of new players -- both international and domestic. With the accent on brand development, the investment needs of the training business have increased. In short, they guzzle as much capital as the software services business. A company focussed on both segments is unlikely to find the necessary funds to invest in these activities. Also, the management is unlikely to find time to devote time to both the segments, even if they understand the businesses quite well.

The same would hold good for small companies that have other combinations -- software products and services, software products and training. Even a combination of domestic and export businesses in software services does not appear attractive. The demands of both are quite different. For a small company that considers export of software services to be its core operation, focussing on other businesses could not only be detracting but also divert precious resources. It is also unlikely to work to the advantage of the investors, even if the two divisions are made to pay for their own investments. In such a case, given the scarce resource scenario, one business may lag, pulling down the profitability.

Even more glaring is that some small IT companies have made investments in e-commerce. The Indian e-commerce market is in a nascent stage and is likely to require deep pockets and plenty of for efforts to bear fruit. When large Indian companies are being cautious in moving to the Net, the forays by small Indian IT companies do not appear to be encouraging.

However, for companies largely into other segments, software services exports is entirely different. For example, Infotech Enterprises' is more into the geographical information systems market. The demand for GIS services is derived more from companies in industries such as utilities, transportation, logistics and local governments. The company hopes to leverage the domain expertise it acquires in offering GIS services to companies in these segments and offer custom-built software solutions. Similarly, Kale Consultants is primarily into software products for industries such as airlines, banking and healthcare. The expertise it gains in developing products for these industries could be leveraged to offer Custom solutions.

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For the software services exports business, a combination with other business segments would be logical if they contribute critical inputs. For example, Goldstone Technologies' telecom business was what financed its foray into software development. And as long as the cash flows from other businesses are invested in the software services export business, it is indeed a welcome development. However, a business model that diverts the revenues of a small IT company from its software services export business into other segments does not appear to be an optimal strategy. The demergers proposed by small companies such as Soffia Software and Goldstone Technologies, in which the software services export business would remain a separate legal entity, appear to address just such an anomaly.

However, if small Indian companies follow a strategy of remaining focused on more than one business segment because they are wary of their abilities to move up the value-chain in software services exports, then these companies would have to make that clear to stakeholders. Also, whatever may be the risks of not moving up the value-chain in the exports business, being focussed on another equally, or more, competitive segment would only aggravate such risks.

It is quite clear from the challenges small Indian IT companies face in expanding the software services exports business, an exclusive focus is necessary. Even mid-sized companies such as Sonata Software have acknowledged the need to remaining focussed and the company has announced its decision to separate its domestic and exports business.

Horizontal expansion is a reasonable proposition only when the company's exports operations have attained a critical mass, or if the other businesses can meet their own investment needs. If Wipro, NIIT and SSI can focus on more than one segment, they can afford to. However, the small IT companies cannot.