The Hindu Business Line : Growing drop by drop

Software companies in the domestic scene are learning their lesson - staying small won't pay. Either go for mergers with like-sized players or keep growing on your own. Either way, the drop needs to become bigger. eWorld tracks the survivors and their strategies.

IF you are a $30-million company in revenues, you can't hope for a $50-million order. For that, you need to be a $300-million company," a CEO of a medium-sized company told eWorld in a recent interview. Sounds very simple, doesn't it? But it holds the key to what small companies ought to be doing — Grow. And they should, either by raking in more business or merging with other companies to grow overnight.

The last three years have been tumultuous for the IT software industry. Nasscom's Top 20 rankings for the years 1998-99 and for 2002-03 show that the top six have remained more or less constant. Among the rest, some have disappeared, while some others have slipped rankings. On the revenue front, Infosys has grown over 600 per cent between these two years, while smaller companies have grown at rates lesser than 20 per cent. Typically, growth over a smaller base would be easier to achieve. Also, the median revenue in that list has gone up from about Rs 220 crore to Rs 423 crore. Median revenue indicates that point in a list, above and below which there are equal number of companies. This, along with the fact that revenue has grown faster than median revenue, shows that big companies have done better than smaller ones.

So how are small companies handling this? Is there a future for them? If there is, what should they be doing to ensure their place in the sun?

The last two years have brought in news on the merger front. Polaris doubled its size to about Rs 600 crore of revenues by merging with Orbitech Solutions, a product software company from the Citigroup stable. Early this year, Megasoft Ltd joined hands with Xius India, another products company. SSI Ltd, which earlier made a string of acquisitions that didn't meet management expectations, merged with Scandent, promoted by Ramesh Vangal of Seagram fame.

Many small companies have had trouble raking in the revenues. And, if business did come pouring in, escalating expenses have taken their toll on profits. For, revenue per employee is going down — which means that companies, to earn the same revenues they did earlier, have to use more employees. Also, with competition increasing, companies have to spend more on marketing their wares. And that costs.

Let us look at two categories of small- and mid-sized companies — the ones that did merge with others for size, and the ones that have pulled through without a merger, so far.

Hexaware Technologies is an example of a company that has not gone in for a merger. In fact, it sold off Mentorix, a software developer that it acquired earlier. Hexaware has done better in the latest December quarter as compared to a year ago quarter. Ask Rusi Brij, CEO, Hexaware, about the three years he has spent in the company and he says, "The slowdown affected mid-sized companies more than it did the larger ones." For, clients began asking questions on the financial stability of the vendor. In some cases, he says, clients limited many deals to vendors above a certain size. "Typically, the base was $200 million in revenues, if you wanted to bid for a contract."

And if big companies such as Infosys, Wipro and the like grew tremendously in the four years between 1998-99 and 2002-03, he credits that to their going marketing-savvy. According to him, "Mid-sized companies typically underspend on sales and rely on channels and third-party relationships. Unless they invest and build up their sales team, they cannot reach a larger market. They cannot compete effectively and their targets get limited to smaller and smaller clients. Big companies became big because of very good sales management."

He feels that unless small companies replicate that, the future could look bleak. "There is enough competition even for mid-sized vendors so there is no specific segment that can be ascribed safely to these vendors. Market dynamics have changed after 2001."

So, what did Hexaware do to address this challenge? He says, "In the under-$100 million category, we spend the most in sales. Our sales and marketing costs were over 12 per cent of our revenues last fiscal." Another big focus area for the company was bringing in better-qualified account managers. This was necessary, he says, "to protect our clients from other vendors when business became slow. Also, existing customers know you best and are most willing to increase their spend regardless of vendor size."

Zensar Technologies has not made any major acquisitions or mergers in the last three years. However, it is looking out and it is early days to comment on that front, says Ganesh Natarajan, deputy chairman, Zensar Technologies. Natarajan feels that the important thing for a software vendor is being the right size. "We tell our clients that we are big enough to deliver, and small enough to care." Interestingly, in several of its deals, Zensar co-exists with larger Indian and global vendors. Says Natarajan, "In some cases, we garner a larger share of the business than some of them."

So what have companies done right that has helped them survive, or even thrive? Says Brij, "There were several market segments that we could not participate in, reasons for which included the base revenue size of $200 million of the vendor bidding for it." So what Hexaware did was to develop niche competencies. These included technology (expertise in the PeopleSoft software environment), industry vertical (airlines), and geographical focus, (Germany).

Says Natarajan, "In terms of new accounts, our view is that the only way for any mid-sized company to get into large accounts is through a distinct niche focus. Zensar has carved out such a niche by pioneering the Solution BluePrint (SBP) framework that provides major gains through innovations in the area of software engineering."

Interestingly, the small companies around today are able to pitch and get through to big-ticket deals. Hexaware's biggest order on hand is worth between $35 million and $40 million over 3-5 years, says Brij.

"We have two such clients. We also have won the largest deals awarded to any Indian vendor in the airlines segment — $20 million over five years, with Air Canada."

Also, on the other niche segments that Hexaware focussed on, it has won deals in excess of $35 million each with a couple of clients, thanks to its skills in PeopleSoft. In the geographic context, it had won a $30-million deal with Deutsche Leasing.

A player such as Zensar is able to get through in the around $1 million deal for its first-time engagements with customers. Says Natarajan, "Typically the range of orders is from $250,000 to almost $ 1 million for the first engagement." Zensar's largest customer accounts for over $10 million annually.

Mastek, which has seen some tough times, recently, did not reply to eWorld's queries by email.

SSI Ltd is an example of a small player that has opted for a merger with a like-sized player to gain advantages of size and scale. Its board recently approved a merger of its technology division with the Scandent group. In reply to queries from eWorld, Kalpathi S. Suresh, chairman and CEO, SSI Ltd, declined comment on specific issues, preferring to focus on general issues. He says, "Vendors with a greater range of services ranging from application development to support to maintenance to BPO capabilities are preferred. For, they can handle the wide range of activities involved in large outsourcing contracts. This clearly puts larger vendors at an advantage over smaller vendors."

According to him, there is always a market for the tightly focused small vendor who offers a niche expertise which larger firms may not offer. "Such firms may be highly specialised in one or few areas, and are geared to respond nimbly to customer needs."

He says that SSI had, over the last few quarters, focussed on that market (with its focus on banking, capital markets and government services). "While doing this, we also realised that we needed to augment size and the range of skills, and were exploring merger and acquisition opportunities." According to him, "the proposed merger expands our verticals to include enterprise and engineering services and broadens our skill sets to include several horizontals."

Interestingly, Brij is not too keen on the mergers-and-acquisitions route. "Two minuses don't make a plus. Such merger theories are not applicable in the Indian context." He argues that there is enough of the pie for all aspiring vendors to bite from. "Barring a few under-$50 million companies, none have folded up. Despite slowing business, most Indian companies have enough cash to last out."

To round it off, a Mumbai-based analyst with a foreign brokerage says for now, things are looking up for every company. So, in the short term, many small companies could grow at a healthy rate. But he feels that this pace may not be sustainable. This means that the big ones will rule the roost in the long term.

bharatk@thehindu.co.in

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