Between cusp and lip

Karthik Ananth, Director (Market Expansion), Zinnov Management Consulting, sounds like an angry young man on the phone. Ask him why some top IT services companies are falling below expectations they set themselves, and he bites back: “Who says they already are? They are at a cusp, of change!”

As IT companies turn the page over fiscal year ended March 2011, they are seeing uneven opportunities in the global marketplace but are also struggling to set right internal issues.

For instance, Infosys has shown an overall QoQ revenue growth (compared with the immediately previous quarter, or Quarter on Quarter) of just over 1 per cent for the quarter ended March 2011. Similarly, net profit growth too didn't measure up to rivals'. Both its North America region and its Banking vertical saw a slump in absolute revenues sequentially. Importantly, its estimates for the current year's profit margins dismayed investors.

It may be recalled that Infosys is going through a management change, by choice. Its current CEO, S. Gopalakrishnan, will take over as executive co-chairman and the COO, S.D. Shibulal, will assume the CEO's mantle in August when chairman N. R. Narayana Murthy retires.

Wipro, whose new CEO, T. K. Kurien, took charge four months ago, disappointed investors with its revenue estimates for its IT Services division for the quarter ending June 2011. Without counting in revenues from SAIC, whose oil and gas practice it acquired in April, Wipro could well lose out in the revenue race to Cognizant, in the June quarter, for the number three spot it held onto for the last decade or so, when it lost the number two position to Infosys.

Meanwhile, Cognizant announced healthy results but said they reflected uneven growth across the world. While its North America practice grew, its European and Asia Pacific revenues slumped sequentially in the March quarter.

So, is there a battle out there among India-based vendors? Ananth says, vehemently, that one isn't even comparing apples with apples here. “Nearly 10 per cent of TCS' revenues came from the India market. Infosys and Cognizant don't do that kind of business in India. Also, one company's strength could be in infrastructure management while another's in the banking vertical. Some of them don't even report revenues from health insurance clients in the same way!” he argues.

Agrees Siddharth Pai, Partner and MD, TPI-India, “Each company has made different choices and its priorities now may be different.” He cites the metric of return on investment (RoI). “Infosys might focus on RoI more strongly than Cognizant would for certain kinds of forays.”

That does not necessarily mean that one company is smarter than the other. His point is this: As much as you would commend Cognizant for its blazing growth rates coming predominantly from the North American markets, “Wipro has made some wise investments in India and the Middle East. When these markets take off, Wipro would benefit, rather than a company whose focus has been outside India.” But, what is common is that all these companies are now at inflection point. According to Pai, “It's time for them to behave like, and become, international companies, MNCs of sorts.” Which means they must offer new services at possibly very different margins than they are used to. He believes factors such as these are more important than being ranked No. 2 or 3.

Changed strategy

Well, so much for comparison between companies. But what if we compare each company's growth with its own performance in the year ago period? Hasn't there been a slump, as is seen from the quarterly growth rates in the attached charts?

Ananth says these companies need at least a year from now to prove that their changed strategy is working. And what is this change in strategy? He explains, “Indian IT companies for long have focused on the depth of their offerings.”

This means infrastructure management, for example, could have been a key focus area. A company would do all it could to offer deep expertise in this area. If the customer did not want it, he could go elsewhere, he says. However, in the last few years, IT services vendors have begun to focus on the customer. “To IT companies no chosen area matters now — it's all about what the customer wants.”

So, he says, companies such as Infosys and Wipro, which are making the change now, need time to deliver on their results. “TCS made this transition successfully three years ago. Cognizant has started doing it recently. Infosys and Wipro are now undergoing the change.”

But how come TCS did not feel such growth pangs even as it made the change? “When you have traditionally had large accounts, in excess of $50 million, you tend to be naturally customer-centric.” TCS' clients who gave it more than $ 50 million in annual revenues numbered 23 in FY10 and 27 in FY11. Compare that with Wipro's 16 and 22 or HCL Tech's five and eight, respectively.

Cost to fresher hiring

For some time now, Indian companies have been using more fresh hands to increase headcount.

Typically, in a bid to keep overall costs down, companies prefer to up training costs so long as wage costs are minimised. For instance, TCS hired on a gross basis, about 50,000 people last year and of this, 44 per cent were employees fresh out of college. It intends to hire 60,000 people the current year and of this 50 per cent would be fresh from college. Likewise, Infosys wants to hire about 45,000 people this year and about 6,500 this very quarter, and of that between 70 per cent and 80 per cent of those would be freshers.

Pai feels that by doing this, companies could make themselves eligible only for some kinds of opportunities, not all. They preclude themselves from some kinds of work, especially those that are not heavily offshore-centric.

The past quarter

TPI's estimates for the quarter ended March 2011 throw up a few surprises. BPO, considered dead for a few quarters now, has shown a resurgence with a 66 per cent year-on-year growth in total contract value. That was a surprise, says Pai. “However, only time will tell if it's sustainable.”

Asked if much of the BPO work was going to captives (that is, wholly owned back office processing units of client companies that did work rather than outsourced third party vendors doing it), Pai says, “That has been happening for a while already. And, the window for acquisitions of these captive units by third party vendors is also closing down.”

In other words, the likes of TCS' purchase of Citi Group's e-Serve or Infosys acquisition of Philips' BPO units may not be seen again for a while.

Looking ahead

TPI's estimates also state that where existing contracts are being renewed or restructured, the incumbents now have a higher chance of retaining the client. “That means they are becoming more efficient in managing the client.”

Though Pai does not have a specific number at hand, he says, “New contracts are now emerging from clients who have never sourced before from outside, forget offshored!” Also, for the quarter, India-based companies that TPI refers to as ‘India heritage companies' so as to include the likes of Cognizant, all had a 20 per cent share of the pie. To put that in context, five years ago, that figure used to be 5 per cent. “That's a significant rise, and now, these India heritage vendors are lapping up much of the market where TCV is $ 20-25 million and below. For Application development and maintenance contracts, these vendors' market share as a category is greater than 40 per cent.”

Zinnov feels that BFSI and Manufacturing continue to remain key growth drivers for Indian IT Services firms. Growth of the telecom vertical has plateaued, it says, and that large IT vendors are focusing on accelerated growth verticals such as Energy & Utilities and Retail.

Interestingly, with vendors aiming for long term relationships with clients, Infrastructure Management Services will see momentum, not to mention client demand and increased availability of these services.

Vendors' view

For the fiscal starting April 2011, Infosys has estimated that even with an 18-20 per cent revenue growth, it might lose up to three percentage points on margins.

Ironically, it used to be criticised by equity analysts for holding on to margins even at the cost of future growth, especially given the negligible number of big-ticket acquisitions it has made. It recently said it is looking to acquire consulting capabilities in Europe and in Japan.

Cognizant has said it would look to grow 29 per cent to $ 5.9 billion for the full year ending December 2011, as against an earlier estimate of 26 per cent. TCS does not give out guidance for the quarters to come but looks best placed to show undisturbed growth.

The company is betting quite a bit on its iON business — launched last quarter, targeting small and medium-sized clients with the cloud model – where clients pay for software used rather than buy software wholesale or for licences. It wants to see 1,000 clients in the next 12 months and revenues of $ 1 billion in five years.

Global company, anyone?

One view that came out strongly from industry watchers was that it was time that Indian companies started behaving like global companies. For this, it was important to leave behind the usual practice of being ‘Indian' in every country in which a company operates. Says an expert, “Why should Indian companies feel the brunt of the H-1B visa backlash? Nobody thinks of Toyota or a Sony as Japanese companies. They are all ‘global' companies in every sense.”

In other words, the Indian IT company culture of doing everything the ‘Indian' way, with an Indian at the head of even a local subsidiary in countries where they operate, takes away from the ‘globalness' of Indian companies. With aggressive acquisitions especially in Europe and Japan, as promised by, for example, Infosys, this could change.

> bharatk@thehindu.co.in

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