The Hindu Business Line : Lemme in

The Indian IT services sector is swinging up on good times. While the big players make merry, the small and medium enterprises too are looking for space on the stage. How do they manage entry? eWorld tracks the small guy's big plans.

THE Indian IT services sector has never had it so good in the recent past. With outsourcing becoming mainstream and offshoring gaining momentum, the industry is brimming with optimism and major players are poised for scorching growth. However, the small and medium software services companies are not fully geared to take advantage of the upturn in the sector. These small- and medium-sized firms, which were forced to downsize their operations during the technology downturn for survival, have realised that size does matters and have now started talking about reaching the `optimum size' to stay afloat, grow their businesses and catapult themselves into the bigger league.

As a result, the industry is abuzz with rumours of mergers and acquisitions (M&A) and observers see consolidation happening in the near future with several deals set to fructify over the next three to four months. The industry, of course, has witnessed several deals such as the Scandent Group acquiring SSI's software services business, iGATE's take-over of Ideaspace and Quintant, KPIT Cummins buy-out of Panex Consulting, among others, in the recent past.

Industry players and merchant bankers feel that the next phase of growth in the IT services sector will be primarily driven by the M&As in the small and medium enterprises (SME) space. In order to sustain growth, the smaller firms have no other option but to go in for mergers and acquisitions, says Srinivas T.R. of Taib Bank. "We expect at least six to seven deals to happen over the next three to four months," he says.

"It's now the opportune time for mergers and acquisitions as the industry is on a recovery path and making positive strides, backed by strong outsourcing momentum," says Anant Koppar, Chairman and CEO, Kshema Technologies, a Bangalore-based software firm. Kshema, which had bid for SSI's services business but couldn't make it, realises that size has become an important factor to compete with big players and also to bag large orders.

According to Krishnakumar Natarajan, Vice-Chairman and President, MindTree Consulting, "The whole concept of offshoring is gaining mainstream and a lot of companies, which have not been exposed to outsourcing, are getting into the bandwagon of outsourcing. Since they do not have experience, they would like to work with companies which can give them attention, and work along with them to initiate a successful outsourcing strategy. This market scenario provides SMEs a lot of opportunities from business and growth prospects."

Although there has been news of much M&A activity over the last few months, in real terms very few deals have been struck. "They have been few and far in between," says Krishnakumar adding that "the time, in terms of services, for SME consolidation is right, but the strategies for consolidation have to be based on a common vision."

Moreover, Krishnakumar feels that the size of opportunities that the combined entity would be targeting and how they position themselves differently and add value to the customer matter a lot. "Consolidation that has been intended with the primary objective of becoming larger in size alone will not find acceptance in the market place since differentiation and ability to add value on a continuing basis to the customer have become key differentiators in surviving and growing," he adds.

Consolidation would definitely enhance the delivery capabilities of these SMEs, improve their scale of operations and eliminate the risk of client concentration, says analyst Dheeraj Sachdev of ASK Raymond James. However, it is not a must for companies that have carved a niche for themselves and are doing pretty well, he says, adding that such companies could scale up organically.

With size becoming a major problem for software SMEs, they are unable to keep pace with the growth rates of their bigger peers. Compared to the way in which the top-tier IT services companies such as TCS, Infosys, Wipro, Cognizant and HCL are growing, the growth of the SMEs in reality is not as anticipated, says Koppar. SMEs continue to face problems and they have not been able to make up for the losses incurred during the technology meltdown. Getting a new client is becoming a major issue for these SMEs. Not only are they forced to compete with big guys on their expertise and strengths, but also in terms of rates as well. Moreover, the customers have become conscious after burning their fingers with small- and mid-sized vendors, says Koppar.

Customers are looking to get more from their spends and hence mostly prefer going to larger companies because of better cost efficiencies. It also proves advantageous to them as volume business to larger players yields good discounts, he adds. Another interesting factor that the technology meltdown has thrown up is that of vendor consolidation. Earlier customers used to sign up with different vendors for different types of services. But now they want a single vendor to meet their entire requirements.

"This vendor consolidation has impacted the SMEs a lot, as many of them have lost customers," says Koppar. Kshema, which witnessed a flat growth in 2003, has taken a fresh look at its M&A strategy and is aggressively scouting for acquisition targets. "We feel a head count of 1,000-1,500 people is essential to reach the optimum size and to bid for large deals and compete with major players in the market place," Koppar says. The company, which currently has some 450 people, may take about 18-24 months to reach the size of 1,500 people. "But will the industry sustain the growth momentum that it is witnessing today? Or would the buoyancy in the market stay for that long?" he asks.

Moreover, we need to give an exit option for our investors, Koppar says, adding that, "a couple of quick acquisitions is a must for a company like ours to reach the optimum size and we are actively moving towards that."

The company has zeroed in on one firm in India and two in the US and expects to conclude the deals soon, he says.

Many venture capitalists who had invested in IT services companies several years ago are looking at exit options. These VCs are toying with the idea of merging two to three of their investee companies to form a single entity and take them to market, says Srinivas of Taib Bank.

Companies such as BlueStar Infotech and MindTree Consulting are seriously considering acquisition as part of their growth strategy. "Our primary focus is to look at specialised segments where companies can bring in key value and together the merged entity can offer significantly higher value-add to the customer on a continuous basis. We have identified a few such segments and are currently in the process of evaluating potential partners for integration," Krishnakumar says.

Infosys Technologies may have sent the signal securing a solid maiden acquisition of Australia's Expert, and the SMEs are sure to take the cue and strengthen their presence in the global IT map. However, choosing the right partner is always a long and tedious process and there are enough reasons to believe that these firms are definitely sifting through probable candidates for that correct "half".

Picture by Bijoy Ghosh

vishwa@thehindu.co.in

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