The Hindu Business Line : Be different

OUR recipe is that every medium-sized (software services) company must have some differentiation and focus," said Rusi Brij, CEO, Hexaware Technologies, in an interview to this paper late last year. Absolutely true. Can anyone quarrel with a statement like this? For that matter, over the past year or so, select listed medium-sized companies have demonstrated that with a business model focussed on a few verticals, a stream of annuity business and niche technologies, they can grow revenues faster or comfortably in line with the overall industry growth rates.

Take, for instance, KPIT Cummins, which has used Cummins as a strategic anchor customer and broadbased its model by bringing in four or five Fortune 500 customers as support engines across two verticals. Or better still, see the Hexaware model, where the company has forayed into the German geography, built up PeopleSoft practice which accounts for 30 per cent of its revenues and entered into multimillion dollar annuity contracts with a few key clients. But the dynamics of the industry are undergoing a change at a frenetic pace and with that, these business models may also be put to test.

Widening portfolio choice

With the listing of Tata Consultancy Services soon and Patni Computers earlier this year, investors will have a fairly sizeable software portfolio of half-a-dozen companies to invest in. Starting with TCS at $1.5 billion, Infosys and Wipro in the $1-billion bracket, Satyam Computers and HCL Technologies in the $500-650 million bracket and Patni Computers in the $300-million bracket, investor choice is widening all the time.

As offshoring gathers greater momentum and premium Fortune 500/Global 1000 companies gravitate towards the large vendors, the competitive pressures on medium-sized companies is expected to rise sharply. First of all, at 25-40 per cent revenue growth rate, each of the top five companies is expected to add Rs 500-1,000 crore of additional revenues every year. The additional revenues are typically equivalent to twice or even three times the size of a mid-tier company.

Secondly, going by the experience in the economic downturn between 2001 and 2003, larger vendors are also equipped to play the volume game as well, if not better than the mid-tier companies. The employee-addition numbers, especially of freshers in the last year by the top five companies, clearly show that this is quite feasible.

Business model challenges

Even as the IT spending climate improves and billing rate pressures begin to ease, medium-sized companies are in no position to take their foot off the competitive pedal. These companies are expected to face challenges on at least four fronts from frontline companies on an ongoing basis:

Differentiation in offerings: Anecdotal evidence from Gartner, IDC or TPI shows that the participation in large RFPs (Request for Proposal) is slowly being restricted to the top 10 vendors that include multinational and Indian vendors in select verticals.

As the top Indian vendors are also steadily differentiating themselves across verticals and concentrating on building annuity revenue streams, mid-tier companies have no choice but to build differentiation in their set of offerings.

Take, for instance, the recent attempt by iGate Global to offer what it calls an Enterprise Data Pyramid, through which the company plans to differentiate itself in the enterprise solutions (or package implementation) segment. The senior management hopes that this will provide it with the right breaks in this space. Or say, MphasiS BFL's efforts to integrate its offerings in the software and BPO (through MsourcE) space as much as possible. Secondly, as clients become comfortable with entering into fixed-price contracts with frontline companies, mid-tier companies will have no choice but to use tools or reusable frameworks increasingly to offer the same solution efficiencies or productivity pay-offs as the former.

Preferred vendor status/star customers: Fortune 500 or Global 1000 companies who have been working with the offshore model for over three years may accelerate their shift from multiple vendors to a limited set of preferred vendors (say, two or three at the most). So, both preferred vendors/star customers of mid-tier companies may be at risk. Consider, for example, a large vendor like Patni Computers. In the January-March quarter, on account of vendor rationalisation (which essentially means shrinking the number of vendors), the company lost a good chunk of application-support revenues from one of its large clients.

While Patni was able to use its size to tide over this problem, most mid-tier companies may not have this luxury. Even otherwise, the dependence on a few customers will keep the threat of billing rate pressure hanging over their heads.

Client replacement risk: As long as the annuity revenues are flowing in, medium-sized companies remain on comfortable terrain. But if and when the annuity revenues start drying up, the client replacement risk can be very high. For that matter, these companies are always caught balancing between project-based and annuity revenues.

Between the two, companies continue to favour annuity revenues, because they impart greater stability to revenue streams and also bring down selling and marketing expenses sharply. But project-based revenues are the ones that offer expertise and variety to hone vertical or horizontal skills for bagging future contracts. For players such as Mastek that have focussed more on project-based revenues, shifting their focus towards annuity revenues makes sense. Hence, striking the right balance between the two appears to be the key to sustainable growth.

Picture by K. Ananthan

maverick@thehindu.co.in

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