A lot has been written in recent times about the challenges faced by mid-tier Indian IT companies. IT and media analysts see issues of scalability, and hence limited delivery, as one of the primary reasons for low outsourcing demand. Also, broader offerings and strong onsite presence give larger Indian IT players an edge over mid-size companies.

Some of the mid-tier players are trying to address the issue of scale and onsite presence by focusing on cross-border acquisitions and expansion of existing operations.

According to Venture Intelligence, in 2010, the IT sector saw 115 M&A deals — largely in the small and mid-size IT space. This figure was lower at 92 in 2009. So dire seems to be the need that almost every mid-size company is going public with the intention to acquire companies.

Then there are some technological changes sweeping the IT Industry — the movement to Cloud and SaaS (Software as a Service), the emergence of per user per month models (PUPM), competitors introducing riskier results/value-linked pricing for services, customers' preference to convert capex spend into opex spend, and the ubiquity of mobile and hand-held devices in corporates. The roller-coaster ride is made rockier by competition from other global outsourcing destinations, global biggies becoming biggest hirers in India, the uncertainty of currencies, and rising inflation.

While the managements of tier-two companies address challenges in their own way, what is important is for them to keep reminding themselves that investors have an expectation of better returns from them than larger companies.

So how do we find a plausible path to success and shareholder wealth?

The answer will require revisiting history. While the story of each company will have its own twist, most tier-two companies were born in the last 20 years, with the lucre of fat margins from a sunrise industry. Some, particularly those with lineage in a large Indian company, had the challenge of retaining talent for their own IT needs. Opening an IT services company helped retain talent.

Many of the companies grew and sustained themselves with anchor customers and got a major share of their revenues from these anchor clients for a long time — some still do. Therefore, the success mantra was really ‘building capability around customer'. We see many tier-two companies focussing on one industry or two because they had one or two large anchor customers that provided them the wide experience to become a credible IT supplier.

However, we must not forget the prime reason for these anchor customers (who are among Fortune 100 companies) of the world to pick a newbie IT company from India as a supplier — cost. Having experienced other Indian IT giants, the only way to further reduce their cost of IT was to bring new players in the market who will provide services at more competitive prices. Almost all customers outsource their services to Indian IT companies because of the labour arbitrage and not because of technological innovation. The labour arbitrage becomes significant with scale, hence most large global companies have leveraged offshoring to reduce their IT cost significantly.

This differentiation of low cost will continue for many more years, have no doubt. The point I am driving at is, Indian mid-tier IT companies should always be cognizant that their core reason for being is to make profits and that they can do so only by delivering most of their services from India at low cost. Therefore, any choices of becoming an onsite company with technological superiority or becoming a global company with presence all over the world will invariably only come at very low margins, higher risk, and raising questions on the very premise of the business.

Overcome ‘scale' issue

Let us now take a look at the challenges faced by mid-tier IT Services companies. As mentioned earlier, the key issues of concern are those of scale, limited offerings, no or low local presence, and no differentiation.

‘Scale' is a matter of context. If a large IT outsourcing deal with 5,000 staff is under negotiation, almost no mid-tier player will be considered. However, if there is an SAP Support deal of 100 staff and if there were to be an SAP focussed tier-2 player with 1,000 staff, there is a possibility of the customer considering outsourcing to this focussed player because of the other benefits a mid-tier player brings, such as that of attention, flexibility, agility, and, at times, even lower prices than larger players.

Therefore, a mid-tier company can overcome the ‘scale' issue if it were to focus on fewer industry segments and technology areas. This will demonstrate ‘scale' for the limited service lines, will bring repeatability, thus enhancing quality and improving margins, and also providing flexibility in operations. This, in turn, will help growth further because there is an alignment across the service provider's organisation where everyone — from front-end sales team to youngest delivery team member, to the recruiter, to marketing manager — understands a specific industry or offering or technology, resulting in a multiplier effect.

This also provides stability to the organisation in the face of high attrition as there is internal staff available with the same skill to replace outgoing staff quickly. ‘Repeatability' is a critical requirement of successful and sustainable IT services business as per John McCarthy of Forrester.

Limited offerings, local presence

The issue of limited offerings is faced by everyone, including the largest players, as no one can build competency in every thing.

Tackling the ‘scale' issue will also help mitigate the problem of limited offerings. If one is dealing with one sub-segment of an industry, one can determine the top three key technologies in demand and build competence and business in services around those technologies. There will be umpteen requests from sales team of new skills in new areas. However, it clearly requires organisation-wide understanding and resolve to stick to the strategy.

Local presence is a huge challenge for tier-two companies that has led many of them to spread themselves thin all over the globe! One has to understand the nuances of an effective ‘local presence', particularly in Europe. A European company may spend more for the same service from a local company rather than outsource it to an ‘Indian' company. This is all about the comfort of doing business with someone who lives round the block or the next city, speaks the same language, and is servicing many companies in the neighbourhood. This is the reason for much of the outsourcing deals in Europe going to global or European or local players than Indian IT companies.

This effect is at work all over the world and that is why Indian IT services companies have less than 2 per cent of global IT services market. All this indicates that the ‘local presence' issue plagues even the large Indian IT companies and mid-tier Indian players have company here. Therefore, just opening a registered office with a lone salesperson will not solve the problem of local presence. This is well understood by mid-tier players; many are trying to solve this problem by acquiring local companies in the US and Europe.

Differentiate along these lines

Coming to Differentiation, as mentioned earlier, the key differentiator of offshore companies has been price. However, the competition is now amongst equals as regards pricing as most large and medium-size global and regional IT services companies leverage the India advantage. Therefore, for a large multinational customer, it is a tough choice to make from amongst the best and largest international, regional, local, and Indian suppliers, which can number 10-20 in any deal. Spoilt for choice – cost remaining similar! Will such a customer even care to look at a tier-two Indian supplier?

Yes, under the circumstances listed below, though this list is not exhaustive.

Large players do not provide all specialist services. There could be niche areas where large players do not build competency because the market for such competency is small by their standards. The customer has a size of business to outsource that can be serviced by tier-two players and may not be of much interest to the larger suppliers.

Smaller supplier has an intellectual property which is very valuable in the context of the customer.

The customer is influenced by supplier parent or supplier venture capitalist due to strong business links or the customer has equity stake in the supplier.

Supplier has influential shareholders who drum up business based on their relationships.

The customer has had unsavoury experience , time and again, of the big players, so has decided to work with a smaller supplier.

Alumni affect – when a manager in a customer company has a good experience with a mid-tier company in his earlier employer, he or she vouches for the mid-tier supplier to be selected for an assignment.

What will differentiate between mid-tier players that survive and grow, and the ones that stagnate, will be precision of execution of the chosen strategy and the grit to stay the course while managing the ever changing business and technology dynamics.

The author is a Sr Vice-President at ITC Infotech and based in the UK. Views are personal. He can be reached at >khem.aithani@gmail.com

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