Nonlinearity Initiatives in Software Testing Services Business Date:   Wednesday , January 05, 2011 In the earlier days, Product companies used to struggle with what is called ‘Box Mentality’. Box Mentality means that companies were getting paid only for the boxes or products they could sell and never paid for installations or system integrations they did. It took a lot of effort on the part of leaders to come out of this mentality and to start charging for their services too. On the other hand, Services organizations had been struggling with ‘Reverse Box mentality’ for quite some time. This means they were only getting paid for the services they deliver and not getting paid for tools and IPs they deliver along. Testing Services organizations were also not different. Over the last few years, there are attempts from top and senior leaders in the industry to reverse the trend. The move is to start charging clients separately for the IPs and this became a new revenue stream as well. This method also resulted in getting more revenue from the same set of employees and thus become part of what is known as nonlinear initiatives. Nonlinearity in a Services organization can be defined as ‘achieving substantial improvements in Gross Margin per employee’. Four things are important here. l We are discussing about Services organizations l Nonlinearity is defined in terms of Gross Margin (GM) which can be measured at project, account or business unit level. l Rate of Gross Margin is defined as GM per employee. Nonlinearity is all about improving this ratio. l ‘Substantial’ is relative to the organization. The target has to be more than the long term average of Gross Margin and also we should aim for an improvement we get as a result of usual systemic improvements. Margin is the difference between Revenue and Cost. So, we can achieve nonlinearity by increasing revenue and / or reducing cost. The methods to achieve nonlinearity is also broadly classified on these lines- 1. Revenue improvement measures 2. Cost reduction measures A brief of different methods to achieve nonlinearity is given below. 1. Revenue Improvement Measures a Product Induced Services i. Productized services ii. Point Solution Sales iii. Lab-on-Hire Models b Specialization induced services i. Specialized testing practices ii. Emerging Technology Testing Solutions iii. Test Consultancy Specialists c Nonlinear Finance Models i. Quality based pricing model ii. Risk based pricing model iii. SLA based pricing model 2. Cost Reduction Measures a Delayering i. Delayered Service centers ii. Sub contracting b Productivity improvements Revenue improvement measures Product Induced Services Productized Services Productized services are those services which are packaged as a product and is charged based on outcome. An example is- delivering 1000 test cases for an insurance application. Here the organization or the client is not considering the number of employees who will work towards this outcome. The rate is defined per test case instead of per employee. This way, the organization benefits from the productivity measures it took internally and also the tools they used. This leads to more revenue from the same or lesser set of employees. Point Solutions Sales Point solutions are those solutions which solve a specific problem. These solutions improve productivity of the team or aid the team in improving the value of the deliverable. Earlier, these benefits were passed on to the customer without any fee. Now, we are successful in positioning these tools as value addition and charge for the added value. An example is a test automation framework for embedded software. Lab-On-Hire Models Certain test infrastructure is very costly to build and not many customers want to build on their own. Instead they depend on the service organizations which have that lab. Here the client is paying for the lab and not for the employees who man the lab and thus achieving nonlinearity. An example is a mobile handset testing lab. Specialization induced Services Specialized Testing Services Specialized testing services like automation testing and performance testing attracts more revenue since they are special compared to the usual functional testing. They command a premium in the market since special knowledge (including that of tools) is required to execute these services. Emerging Technology Testing Solutions Emerging Technology commands premium from scarcity of offerings. Since it is new, not many organizations will be in the game. An example is virtualization testing. Test Consultancy Specialists Even while outsourcing substantial part of their software testing works, clients still need advice on certain aspects of testing. Consultancy services play a role here and this job commands very high premium compared to outsourced services. An example is ‘advise me to bring efficiency in my test team, identify right candidates for outsourcing’ Nonlinear Finance Models Quality Based Pricing Model This is taking over complete testing responsibility of customer’s product. The payment will be linked to the final quality of the product and not the effort spent to achieve the same. For example- payment is linked to l the estimated residual defects in the product at the end of testing or l the field defects during the first 6 months of rollout or l a combination like: 50 percent linked to effort, 25 percent linked to estimated residual defects, 25 percent linked to actual field defects detected in the field during the first 6 months. Risk Based Pricing Model This is actual partnership with the client in designing, developing and testing of the product. The returns are divided between partners. The payment is linked to the risk exposure each partner takes. Usually this happens when a client is getting into untested waters and need the service provider’s help. SLA based model Here a portion of the revenue is linked to the service level agreements the firm signs with the client. There will be penalty as well as reward clauses in the SLA. The firm’s objective is to maximize the reward and bring more revenue with better performance. A services organization gets into this model only in case of services in which it has higher level of competencies. Cost Reduction Measures Delayered Service Centers This idea stems from the fact that not all tasks in a testing project require equally competent, qualified and full time team members. Some of the tasks can be done through differently competent and time-shared team members. Such team members can be part of what is called as ‘Delayered Service Center’. This is known in different organizations with different names such as – flexibility centers, factory centers, industrialization centers etc. These centers will support multiple clients since their activities are defined and selected to be independent of client sensitivities. The time sharing thus achieved combined with lower employee cost results in overall cost push down. Subcontracting This is what is called Outsourcing 2.0. Indian IT service providers themselves will start outsourcing to tier 3/4 cities and also to small firms in the city where they are already in. The objective is to have overall less cost in getting the projects executed. Certain Service organizations have already started thinking in this direction and also we can spot certain small players supporting them in this endeavor. Productivity Improvements In case of Fixed Price projects, the Services Organization can lower their cost by introducing productivity improvement tools and thus achieving the same output from lower number of employees – thus gaining an improvement in the profit per employee ratio. Do or die competition between service providers – home as well as abroad – is putting pressure on billing rates and thus bringing down margins. So it is time to think beyond the traditional employee billing rates and bring in other sources of revenue in the services business. As mentioned in the beginning of the article, it is time to come out of ‘reverse box mentality’. Year after year, the portion of nonlinear revenue has to increase for the organization to be competitive and also to be profitable enough to meet the Street expectations. The Author is the Head of the Testing Competency Team in Wipro Technologies