Will Mid-Tier Indian IT Companies Sink or Swim in the Era of Digital and Automation?

IT firms that are still not the billion-dollar babies they wanted to be have rebooted to seize the digital opportunity in a choppy sea.

Last Friday, Bengaluru-headquartered Mindtree BSE -4.36 % informed stock markets about independent director VG Siddhartha stepping down from the board to focus on his business, Coffee Day Group.

Siddhartha continues to be invested in the $780-million IT services firm, but it was the end of a tenure spanning 18 years. During this period, he witnessed the abrupt departure of executive chairman and Mindtree’s first chief executive Ashok Soota in 2011 (when the company was less than half its current size).

In 2016, the Mindtree board appointed its third chief executive, Rostow Ravanan, who succeeded Krishnakumar Natarajan. However, for at least a decade, each of these top managers often faced one question — when will Mindtree cross $1 billion in revenue? It hasn’t happened in 19 years.

In its first decade, a couple of investors rued the fact that Mindtree’s annual business was what the larger IT companies did in a couple of months. The IT services providers were competing to expand repeatable outsourcing services, known within industry as ‘application development and maintenance.’ Such deals were typically multi-year contracts, which meant predictability of revenue.

A similar wave — infrastructure management — followed, which HCL Technologies BSE -4.20 % focused on to sneak into the Big IT Club, behind TCS BSE 0.12 %, Cognizant, Infosys BSE -2.16 % and Wipro BSE -2.60 %. The top four had ridden the Y2K wave at the turn of the century.

For companies such as Mindtree, which haven’t touched the $1-billion mark yet, the question now is, how prepared are they to win business in the era of digital and automation? For enterprise clients globally, the new wave involves amortising investments that have been made in the past decade or so, while building for consumers who spend more time online and on smart devices.

For the IT companies that serve them, it is about winning digital IT dollars – which begin as projects – while applying automation to rein in productivity and improve margins. And by the way, it is still intensely competitive. It is also more fragmented. Amit Singh, who heads the IT practice at advisory Avendus, says the IT services outsourcing business is worth around $1 trillion.

“The 25th company in the pecking order is about $1 billion in size and the top 25 corner $350 billion of the market,” he explains. That leaves a considerable $650 billion to fight for between companies that make less than $1 billion in annual revenues. “This is a hugely fragmented market, with a whole lot of small- and midtier companies,” Singh adds. Among these fragmented players are lots of “relics of the past,” says Sanjay Kukreja, partner, ChrysCapital. “In IT services, it is very easy not to change as you make good margins. But these (companies which don’t change) are the ones which will be irrelevant very soon.”

Even as most might perish, large companies will emerge from this fragmented heap. “The death knell for mid-tier has not been rung. But they should not try to be the next labour arbitrage guy. You need the right technology, people and platforms to succeed,” says Kukreja.


DAVID VERSUS GOLIATH
Hexaware is one of the pack that has grown and expanded its senior leadership. The process began after founder Atul Nishar brought in R Srikrishna as chief executive from HCL Technologies in 2014. Hexaware crossed the $600-million mark in financial year ending December 2017. “We are not just going up against somebody our size. But we fancy our chances to beat the Goliaths each time,” Srikrishna says, referring to the importance of culture to run small multi-disciplinary teams. “This is David versus Goliath.”

At a time when digital project sizes are small, that is not a bad analogy. Mid-sized companies aim for projects in the $0.5-5 million range—not the $10-50 million a year deals like before. Liken these to the stones for Davids’ slings. “Earlier, the biggest concern for the market was that mid-sized companies’ revenue were concentrated with one or two clients,” Srikrishna says. “So growing in the middle is a positive long-term win—each of these clients has an opportunity to go upward in deals pipeline.”

In financial year 2017, Hexaware took its $1-5 million deal tally to 71, from 64 in the previous year. Srikrishna says this tastes just as sweet as the six deals won in the $10-20 million bracket (twice the number of deals in 2016). “‘Land and expand’ is a big thing,” says Sunil Bhatia, chief executive of Infogain, a Silicon Valley headquartered firm, backed by ChrysCapital. Estimated to be less than $200 million in revenue, it employs 4,000 persons, mostly operating in Noida and Bengaluru. “We have 25 of the Fortune 1000 companies as customers.

The first strategy is to land the business and second is to get repeat business and expand. We have to bring high-touch services to the customer.” Arvind Thakur, managing director of NIIT Technologies, agrees, emphasising the need for a culture shift inside the company to provide high-touch services outside. Digital revenue accounts for a quarter of NIIT’s business, up from 11% in the previous year.

The digital business has five paths: first, creating omni-channel experiences for enterprise clients, or designing solutions that use technology to deliver a great physical experience for clients’ end customers. Second, analytics and business intelligence. Third, helping clients migrate applications to cloud. Fourth, digital orchestration and integration.

“Data resides in legacy systems — we are helping by integrating digital with legacy and orchestrating new processes to offer hyper specialisation to customers,” Thakur says. Finally, acquisitions such as Incessant Technologies in 2015 and RuleTek last year. Incessant enables clients to automate and integrate back-end systems with a digital front end, through alliance partnerships with platform providers like Pegasystems and Appian, while RuleTek in the US helped NIIT improve digital integration capabilities and to expand its North America footprint.

CULTURE KEY

Last year, NIIT invited management thinker Ron Kaufman, who runs a company that specialises in customer experience. “Based on interactions with Kaufman, we put in place the building blocks to drive new ideas, behaviour traits and create new role models. We educated everyone on service excellence experience,” Thakur says.

Bhatia says building this culture is a huge opportunity for mid-sized companies while competing against the service providers that generate more than $10 billion revenue per year. “Changing the culture of a 10,000-people company is far easier than trying to change the mindset of 2,00,000 employees,” points out Thakur. Bhatia cites ChrysCapital-backed LiquidHub, which was acquired by Capgemini recently. LiquidHub focused on a few areas and created a position in digital transformation that Capgemini found attractive. “In the new era, you don’t need truckloads of people—you need more brain than brawn,” says Bhatia.

Not everyone is convinced. Sudheer Guntupalli, equity analyst, Ambit Capital, says scale begets scale in IT services. “Clients seek to do business with vendors who have a certain number of client references from the same industry segment and geography,” he explains. They check for adequate number of trained resources and cutting-edge capabilities in relevant service lines. “That’s why they prefer working with vendors who have the highest scale in the relevant geography, vertical (industry) or service lines.”

Prateek Majumdar, partner, Bain & Company, begs to differ. Scale is no longer as important as it used to be. “What matters more are the capabilities and IP the company has. That’s why some digitalfocused mid-tier companies have been doing really well.” According to Sid Pai, managing partner, Tekinroads Consulting, mid-sized companies need to be aware of the ratio of traditional to new business (digital). In his career as an enterprise client advisor, he saw the likes of Infosys and TCS seize the Y2K wave, followed by the infrastructure services wave that HCL pounced upon.

“While absolute size still matters, the ability to harness the current opportunity depends on relative exposure to traditional business,” Pai says. “There is a large-scale transformation underway in the market, which will take 3-5 years to play out. Some organisations will move faster than other organisations. So, it is about being faster and nimbler players.” Mindtree, which started building its digital story in 2011-12, referred to the lessons during its December 2017 analyst earnings call. Digital revenue is realised differently from the traditional multi-year (predictive) revenue model.

“Price realisation increased mainly due to additional revenue generated with some projects moving from transition to steady state,” said chief financial officer Jagannathan CN. During the transition phase, the client is paying multiple vendors, so transition pricing tends to be lower than “steady-state” pricing. “As (more) work gets picked up and it moves into steady state, revenues are higher.” Equally, there is a danger for the middle rung. With vendor consolidation, midsized companies get pushed out. “Clients can re-evaluate outsourcing partners at any time and if they want to reduce the number of vendors, it’s usually the small, mid-tier ones,” says Milan Sheth, technology leader at advisory EY India.

Remember, mid-sized firms lack pricing power as they don’t have the economies of scale of larger IT firms. “It puts pressure on margins as they offer services at costs lower than their larger peers,” Sheth explains. “For a long time, their business grew because they were cheaper than larger players, not because they differentiated.” So, how will the Davids fight the Goliaths? The big IT companies are organised— to be harsh, even siloed. Pai says, “What is going to make a difference in the market for mid-sized companies is to go after deals with smaller teams of highly capable people who can go all the way, from assessing customer need to design needs to actually building technically, and then managing and delivering it right across the stack.” Picture a rugby scrum.

Srikrishna is confident his teams at Hexaware are already making an impact. “Team and solutions go hand in hand. Its strategy is focused on “bringing together man and machine” to deliver for clients. “It’s very hard for a legacy player to execute that way. Digital is not the only thing we will do. We will focus on traditional outsourcing but deliver it in differently.” The $1 billion milestone isn’t the vanity metric anymore, as execution on a projectby-project basis has taken precedence, especially for an industry which trade body Nasscom estimates will grow 7-9% over the next fiscal. “Growth has slowed down in the industry overall, for large and midtier players. But, we should see at least a couple of players hit the $1-billion mark relatively soon,” says Majumdar of Bain.

Mphasis has breached the billion-dollar mark and Larsen & Toubro Infotech (LTI) is not far behind. The latter is spearheaded by Sanjay Jalona, who ChrysCapital’s Kukreja describes as “among the brightest talent in IT services business.” Jalona came from Infosys and has, in turn, hired 30 others in the last 12 months from across companies to beef up digital services. “The changing technology landscape is resulting in shrinking of deal sizes, bringing mid-sized and large sized players onto a level playing field,” Guntupalli says. “In that context, high quality mid-sized companies can overcome the scale disadvantage that they earlier had.”

News Originally Posted on: TheEconomicTimes

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