The Hindu Business Line : Changing times at HCL

Forthright, lucid and imaginative. That would describe Vineet Nayar, President, HCL Technologies. Nayar spent an hour with eWorld, the second time this calendar, to spell out how the transformation journey he, and his company, embarked on in April 2005, is changing phase, and, gear. Excerpts from the chat:

Is there a structural change in the nature of the animal that is Indian IT software services?

There are three aspects to this, from HCL Tech's point of view. First is, we started this transformation journey in April last year - that is the reason you are seeing the growth numbers of HCL to be among the fastest growing companies in IT.

We looked at the application industry on a stand-alone basis. It faces threats from various fronts: First, is the threat of commoditisation, by packaged-application vendors such as SAP, Oracle and Microsoft, which are developing packages where you normally use custom applications. Then, it is threatened by SOA (services-oriented architecture). It would allow plug-in compatible software, therefore implementation, transformation, moving from one platform to another, all those things will not be required. Then comes the threat of on-demand delivery of application.

Given this, we recognise that being large in the application space is wrong and therefore you have to do something different. So we did three things differently.

We launched a multi service concept, where we said that the mother of all industry is the total IT outsourcing industry. And under the total IT outsourcing strategy, we have done all the deals that you have seen and more deals will be announced on similar lines.

The second thing we did was re-aligning on the pricing front: away from input-based pricing towards more and more output-based pricing, where output could be device-based, transaction-based or per policy-based (in the case of an insurance client). This helps you retain the efficiency gains that originate on what you deliver to the customer. That way, you mitigate rising costs. That strategy has worked pretty well.

Deed number three is exemplified by the relationship we announced with Celestica.

The first two strategies largely looked at our remote infrastructure management, our application services, our enterprise services and consultancy. But what we had not touched was our 30-35 per cent of the business in the engineering space.

What we discovered is that we start early in the food chain where we go to our customer and say "Can I design something for you?" And he says maybe yes, maybe no. And then we spend a lot of time convincing him that we need to design.

After we design, his design cost is only 5 per cent of his total. The revenue opportunity lies in the balance 95 per cent. He is in control of that 95 per cent. Sometimes he does a good job, sometimes not. But, he never comes back to me and every time I have to re-design it.

On the client pipeline front, almost 25 per cent of it relates to multi-services deals. What is the difference in ramp-up capabilities between the client pipeline you have shown across different buckets in terms of the standalone business and multi service deals ? Basically how do you move from $1 million to $5 million, $ 5 million to $10 million? Many are multi service deals.

I believe in the philosophy of not wanting to fight with anybody, to compete with anybody... I want to create uncontested market space. I want to be ahead of the market, this is exactly what we did for infrastructure management. For this whole multi service strategy, we go to market at such a speed that today I say that 36 of these clients are already multi service clients.

My philosophy is not to do single-service deals at all but that whenever a single service deal will come to me I will push, push very hard to convert it into a multi service. Why? Because, on a single service it is very difficult to compete and win. Instead of spending energies on competing and winning a single service deal I would spend all my energy in converting all single service deals into multi services.

Three benefits stem from this: One, the customer suddenly feels HCL as a value company as then we are looking at it as a customer value rather than our ability to convert; two, they get a feeling that HCL is a pro customer company; third, if we do convert them into multi service deal, then we have the sole right to winning it as nobody else has the experience that we have on multi service deals, executing them, implementing them and delivering the values that we have talked about.

As to the other aspect of multi-services, you have to see multi service along with my output-based pricing strategies. So when you get a multi service deal, you tell the customer that `not only can I do the deal for $500 million instead of $700 million, but you know what I will charge you per transaction or I will charge you as a percentage of revenue.' The moment I do that, then everybody else vanishes from the face of the earth from a competitors' point of view. We are sharply focused on creating unique differentiated value propositions. That sharpness of focus on all these strategies is what you see in our financials.

OK. But, you have been trying to create an uncontested market space, which means that you try to pick and choose the kind of clients who can go for multi service deliveries. Or, are you staying away altogether from the RFP (request for proposal) processes that have been contested at different places?

Yes, largely so. A billion-dollar company in my mind is a small company. So, if that company has a $100-million marketing and selling budget it's a pretty small budget compared to an IBM whose budgets will run into $5 or $6 billion. If you do not spend those $100 million correctly then you lose. In the market, a lot of things are happening, you have to pick an area where you have a higher probability of winning.

For us, that area is multi service deliveries. And in that, whenever we get any of the existing RFP client we try very hard to convert it into a multi service. If we do not succeed, then we try to convert into output-based pricing, so we change our pricing.

How much is the opportunity landscape there, is that basically below a size say $500-million bracket. Comment with respect to individual clients, in terms of the total IT spending of the companies that you target, and the overall opportunity space that you are addressing.

In management, there is a very important concept called momentum. I personally feel that one should not try and create something that you are the first to deliver because that would take 10 years to establish. Create a new way of doing something. That is creating momentum. That means if something is being done in a certain momentum, try an alternate way of doing it rather than tell people to do something completely different. Instead of devising ways to fly to the moon, find a way for people to navigate traffic in India.

And, $90 billion worth of world class IT outsourcing contracts are coming up for re-negotiations in the year 2007-2008. This is larger than the piece that we as an IT industry are chasing. Our eyes are set on this sum. All the customers whose contracts are coming up for re negotiations, we have listed. All the customers who are happy/unhappy are known. So if a manageable list of customers you know are coming up for re negotiations, we know some of them are unhappy with their existing customers, we know the processes they will follow...

On the other front, it is very interesting now that you have defined competition as total IT outsourcing, then you see what happens to the big boys who have been doing that for a living. Now what we discussed is that for billion-dollar plus deals, we don't stand a chance. For, clients want to see if you have done a billion dollars before. They don't want to give you an order unless you have done it before. At the same time in the billion-dollar transaction, the big 5 are playing a dominant role. So we said to ourselves, `just ignore it.'

Below the billion-dollar level, there are things that attract customers. One, they want flexibility from vendors but don't get it. Two, they want attention but don't get it because they are the smaller deals compared to the bigger deals the big 5 are doing. Three, they want transparency in costs which they don't get from the big 5, because they don't know how to do transparency in costs, which only Indian IT companies do. Four, they want competence.

So when you look at the sub-billion-dollars, the probability of our chances of winning is very high because that is the bottom of the pile for the big 5, and it is top of the pile for HCL. And the sweetest part lies below $500 million, because their attractiveness tremendously improves. So right now we are at $500 million and below.

So all the deals that you are seeing are $100 million, $360 million and $500 million and all others which we will be announcing this year will be in that sweet part between $100 million and $500 million.

You talk of the $90-billion opportunity. If they go into the RFP mode, then it automatically brings in all the players to the table.

Let's take this case-by-case (from past wins). Autodesk was an RFP where everybody was involved, the final three were two big-five and HCL. In Teradyne, it was finally between HCL and one of the big five. In Dixon, the final three were ourselves with one of the big five and a UK company. We won. So these are samples and one more deal we will be announcing in the next few months.

So in all these cases we are not competing with a single Indian IT company. We were all along competing with the big five. The reason I am constantly telling you is their ability to go after $1 billion deal and the ability to go after the $500 million deal is very different.

As to output-based pricing, some players in the industry have been talking about it. But, except in areas such as mortgage pricing, and some parts of the financial services space, many CIOs don't seem to feel comfortable with the idea. They are very comfortable with the rate per hour model.

We are a unique company that demonstrates its flexibility in moving its entire business to output-based pricing. Most contracts do not start there. But we are pushing most of our contracts to go there. The entire Infrastructure management business is moving towards that end. The entire engineering business is moving more and more towards output-based pricing. In output-based pricing, you are not going to see substantial traction in existing customers. But it may be a refreshing approach for new customers. So if you are poaching for traction in output-based pricing, I don't think that you will find it, but because of your flexibility and output-based pricing model, a lot of people will want to do business with you.

On-site deployment has been substantially moving up over the last few quarters, probably a reflection of recent projects wins. But if we link it to the EBITDA margins, when do you think that the margins could really move up from current levels? ... 22.4 and 21.5 from your own statements?

We are in a state where we have to increase our margins and redeploy those margins as investments in new business models. I believe HCL is in a phase where we have done a phenomenal job over at least a year where we have increased our margins, increased profitability substantially and redeployed that into SG&A, which is currently increasing at a rate disproportionate to our revenues.

For, if you have to change your business model, you have to invest. Despite all this, yes it will increase the margins, but we will redeploy the margins back into the investments because we believe it is an investment phase. So theoretically there can be a margin expansion, but practically we plan to redeploy the margins for out future, for what we call Vision 2010.

Some players feel that there is no scope for expansion for the margins. These are the margins that are already being earned by the business. So the question of reinvestment, since it was being redeployed, whether it is an actual position or not, is not known.

If my SG&A has increased and my EBITDA margins have remained the same, actually they have remained the same, that can only happen if my SG&A margins have increased and my EBITDA margins have also increased. If you take four quarters ago and this quarter, EBITDA margin marginally improved, despite a substantial increase in SG&A, that means there has been expansion at the gross margin level.

But, maintaining the same pace of growth in SG&A for two more quarters, will you be able to maintain the margins at these levels?

We calibrate our SG&A based on margins we are able to generate. We are a listed company and a listed company has to invest in line with market expectations. So as and when we see incremental strategies for market expansion, we will constantly invest more aggressively in the future.

How do you plan to increase the SG&A?

You will see a change with the following three things. First is output-based pricing, second is when you are an MSD, the savings that will accrue from infrastructure and application transformation will accrue to you and not to the customer because you have a gain share program with the customer. Third, as the revenues from new contracts come in, which is the MSD contracts, at higher margins replacing the other margins which used to come from single service contracts. So the margins will also expand. These are the three positive drivers for margins. The negative drivers for margins will be escalating costs, and the fact that we want to invest back into our business. So we balance out. That makes our margins stay in the same zone over the next few quarters.

You have increased the working hours for workers by about half an hour. Are the screws being tightened?

You have to see the increased half-an-hour along with theflexi timings we have given to our employees. We are telling our employees `you can work for any number of hours a day as long as you have worked so many hours in a week.' What we are telling our customers is that we are giving you a flexibility you can't dream of. So that means we will be able to power in and power off manpower virtually on a daily basis so that we can meet your objectives for product launches. So if you see the product developmental cycle and product launches, you need substantial investment in certain periods and times of the day. What we have done is, one, we have increased the number of hours, so that our customers get more hours so that we can substantially reduce the time for launching the product, and two, with the flexibility we have provided to the employee, we are creating a unique business model once again.

Most existing players, with the exception of HCL, continue to talk about new service offerings that open up a huge engine of opportunities for cross-selling. It gives the existing players as much of an opportunity as probably a multi service delivery model gives. Would their ability to move from $1 billion to $50 billion deals be substantially higher?

My competitors are exceptionally bright companies with exceptionally bright talent. It will be quite stupid for me to assume that they do not have a business model which is robust. I believe they have a very robust business model, and I believe that business model for them will give them a substantial growth. I run HCL. In my mind HCL was at a crossroad and it needed a steroid new thinking, new ideas, for it to preserve its growth.

The path that HCL is walking is helping it to grow. Our strategy is different from others. It does not mean the strategies adopted by others are wrong. I believe when you draw a strategy you draw it based on two variables: market opportunities and your strengths. Because our strengths are largely engineering, and remote infrastructure management, the MSD makes immense sense for us. For a large application software company where engineering is not strong, and remote infrastructure management is not strong, maybe consulting is the right way to go. And depending on market opportunities that are large in all areas, and your strengths, you will derive your strategies. So under no circumstances am I saying that HCL strategy is refreshingly new, or is better than anybody else's.

All I am saying is HCL is creating a new market opportunity which nobody else has created, which is driving margin growth, which is driving volume, you can see us amongst the fastest two.

In the investor call, you have talked about acquisitions. This seems to be the first time after a gap. What exactly is the thinking behind it given the fact that even Shiv Nadar, when we met him in July, said that he might consider an acquisition a year or two later?

When we started this transformation journey in April `05, we discovered that there are a lot of things within HCL we had to change. The amount of work required to change the business model and our image in the industry was very large. And that is the reason we decided in HCL that this is not the time we will be able to do acquisition and do justice to acquisition. So despite the fact that our strength has been acquisitions and our growth has come out of acquisitions, I believe that it was very important to demonstrate to the market that HCL can grow organically faster than anybody else. That is the objective we set. We had a three-phase transformation. One was to grow organically faster or equal to the best in the industry. That we believe we had largely achieved and are in the process of achieving and we still have six months to go in our transformation journey. In phase two, we believe value simplicity will dominate over volume simplicity. That means any customer who works with us will be substantially more competitive compared to his working with any of the big 5. So for the same job they will get 2-3 times paid more than anybody else. That is the direction in which HCL is moving.

An example is that the world is talking about SOX Compliance. Assuming like Y2K you could have automated it, and offered it as a service, you would be unique in your offering. And the value you create for the customer is substantially different. So there may be companies around the world, who you could partner with, who you could buy, who you could do joint ventures with, who could provide unique products which helps you provide unique services, which helps you create substantial value for the customers which nobody else can. Hence acquisition becomes an integral part of moving towards that value.

You have talked of transformation. How do you measure transformation?

There are two methods. One, is it reflecting in its results? And whether you have seen that in the results shared with you? In the (last) four quarters, we have been the fastest growing company on a Q1, Q2-basis. The second method is that we launched this global customer meet. There were 300-350 odd customers CEOs, CIOs who flew down across the world to spend three days with us plus one or two days of travelling. So virtually locking out seven days only to discuss transformation, arbitrate pricing, multi service delivery in concept to manufacture.

maverick@thehindu.co.in

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