The Hindu Business Line : Moving up the IT value chain

The post-9/11 drop in spending by US firms and growing competition in the sector have forced IT companies to rethink strategies. IT firms have no option but to provide such higher value-added services as consulting, product development, R&D, and end-to-end turnkey solutions, says V. Ranganathan.

IT IS a time of mixed fortunes for the Indian information technology industry. On the one hand, IT is gaining importance and is perceived as a key business driver rather than a mere tool to expedite processes. For example, ERP (enterprise resource planning) today is at the core of all business processes. Such changes in the way businesses operate are opening up new vistas, with greater opportunities and complexities. On the other hand, the industry is facing sustained pricing pressure, intense competition and falling revenues.

Post-September 11, the drop in IT spending by US companies and the intense competition among Indian firms for projects have forced prices downwards. The situation is complicated by the entry of a few consulting companies, such as Ernst and Young, in such areas as application development and call centres. The growing competition from countries such as China, Ireland and the Philippines has further added to its woes.

In such a situation, given the new opportunities and challenges, a well-managed IT services entity has no option but to ascend the value chain and provide such higher value-added services as consulting, product development, R&D, and end-to-end turnkey solutions.

The value chain in the IT industry refers to a whole gamut of activities ranging from the introduction of a top management strategy by the customer to the installation of the final software solution for the strategy, in a descending order in the value chain. It has close correspondence with the software development process which, essentially, has the following phases: requirement analysis, specification, planning, design, implementation, testing and maintenance.

Indian IT companies are mostly operating in the later stages — that is, the lower end of the value chain — characterised by low risk and low return. On the other hand, the first few stages, which constitute the higher end of the value chain, are dominated by accounting/consulting firms such as PricewaterhouseCoopers and McKinsey, and product-oriented software organisations such as Oracle, etc.

The Indian IT firms' revenue per employee is of the order of $45,000 per year, compared to $4,80,000 (about 11 times) for the Irish market. However, the higher value-added segment is characterised by high risk and high return, and requires high brand equity, interface skills between management and IT, and domain knowledge in the case of sector such areas as telecom and electricity.

One reason for the high number in the Irish market is that many IT firms work in such close concert with MNC consulting firms that the lines of separation are indistinguishable. The customers find the consulting companies more `user-friendly' for their IT solutions than directly dealing with the IT companies.

This is due to the lack of adequate domain knowledge on the part of IT companies — be it in the area of management or in such sectors as telecom — making it difficult to clearly translate the requirements as stated by the customer into software.

On the other hand, the management and sector consulting firms have found it much easier to downward-integrate into the IT business.

Though the IT companies are very much aware of all the implications, it has remained difficult for them to take the plunge in moving up the value chain. There are a number of factors contributing to this.

The market perception of Indian companies is that of low-cost and, hence, low-value service providers. Customers, generally, do not rely on them for high-end mission-critical works, but instead deal with the consulting firms to avoid uncertainty. This is where the brand equity comes in.

Though the industry today has no dearth of quality technical knowledge, Indian companies are, with a few exceptions, way behind in domain knowledge. This directly implies that the time and effort required for them is higher than those (read consultancies) that have thorough domain knowledge.

R&D involves very high costs, a long time-span and technical competence, and is a complex process. Very few Indian companies are in this area. On the other hand, the consultancies and the MNCs have invested quite a lot of resources into research and are reaping the harvest.

The market seems to be clearly segmented into low-value-added, low-risk competitive market with many (IT) players and high value added, high risk, oligopolistic market with strong entry barriers like brand equity and interface skills, which are in short supply, and high marketing costs for standard products.

We do not find many Indian products in the market that an average consumer might recall whereas the products from Microsoft, Oracle, etc., are very much on every one's recollection.

The tendency to remain in risk-free areas with continuous revenue, such as IT-enabled services, maintenance, etc., holds many Indian companies back from moving up higher in the value chain, considering the higher risk involved there.

For entering the standard product market one has to consider certain risk factors involved in new product development. For example, because of the fast-changing technologies, there is the possibility of a product becoming obsolete even before it is launched in the market.

Although India is blessed with low-cost, high-quality manpower, the attrition rate is quite high in the IT companies. The firms have found it increasingly difficult to retain their software professionals. Often, the latter leave to join the more lucrative offers from MNCs, disrupting entire project schedules.

It is for this reason that many software firms in Bangalore decided to sponsor their bright young recruits to IIM-B for a part time diploma, so that they remain with the company for at least three years! Yet, ironically, this may help them move up the value chain, by providing the candidates with the critical skills to interface IT with management.

The situation, though, is not as murky as it might seem, and there are still many possibilities for Indian companies. The very first thing that Indian companies need to do is to take a calculated risk. It is possible that moving up the value chain will deprive the firms of the quick buck that is there in the `techno-cooling', to use a C. N. R. Rao phrase.

Firms that can indulge in this luxury of high-end value chain should also make the effort to transmit this intent to the market, so that they are not punished for their foresight by yield-oriented investment analysts.

Indian companies should concentrate on new segments, such as system integration, embedded software development, bio-informatics and biometrics, security solutions and in the engineering domain.

Knowledge sharing and selection of a particular market are also crucial for product development. Companies should look for new markets where the competitors are not Microsoft or Oracle, to sell its product. Such markets have untapped potential, and a proper strategy must yield long-term revenue.

While moving into the product space, the companies should do it in their chosen verticals — that is, sectors in which they have already provided ample service at the low end — rather than unnecessarily diversify into a variety of sectors and dilute their core competencies.

The experience gathered, along with the feedback received during maintenance, can be well utilised in the process. This will curtail the cost involved in experimentation with different designs.

Such Productising of Customised Service, as it is called, is seen in the classic example of I-Flex's Flexcube, where the experience the company gained in giving a facelift to ICICI Bank's system empowered it to bring out the product which, today, occupies second position worldwide in the banking sector.

The fast-track strategy for IT firms to get into the high-value-added segment is through acquisition of sector or management consulting firms. For instance, recently Wipro acquired the Hyderabad-based GE Medical Systems IT Private Ltd., a healthcare and life science sector company, while IBM Global acquired PricewaterhouseCoopers (PwC), to become the world's largest consulting service organisation.

The second important thing for Indian IT firms to remember is that they must make that big transition from techno-centric to business-centric operations by spending megabucks in marketing.

Microsoft and Oracle spend on sales and marketing twice as much as they do on R&D.

Complementary to moving up the value chain would be cross-selling other services and products and providing end-to-end solutions which result in a lot of downstream activities, which the companies might capture in order to expand the breadth of their bottomlines.

Even the domestic market has vast potential for Indian IT players. Indian customers are much more price-sensitive and, so, may well rely on Indian companies for their business process reengineering. Here, one must recall that the government is still by far the largest employer in India, and so projects in e-governance areas might be good money-spinners. Marketing in such niche categories will be a good move and will offer little competition.

(The author is Professor of Economics and Energy, Indian Institute of Management, Bangalore. His students V. P. Mishra, Devesh Ranjan, Karthick Vasanth and Saravana Pandian contributed to the article.)

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