The Race to Add Value
Date: Monday , November 17, 2008
The IT services and consulting industry will obviously be affected by the slowdown in the U.S. economy. The only question is how. Some have suggested that Indian IT services firms will go unscathed and even find new prosperity as companies in the U.S. scramble to outsource and cut costs. But the obvious answer is that the vast majority of IT services companies, Indian and non-Indian alike, will be hurt as tech spending and growth decline.
It all seems pretty clear. Consultants are ending up on the bench due to extensive layoffs at companies ranging from Silicon Valley’s tech bellwethers (Oracle, Sun, Cisco) to American corporate mainstays like Proctor and Gamble. Suddenly dozens of contracted knowledge workers aren’t billable, and so they aren’t generating revenues. Do the quick math, and everything points to tough times for those IT services firms that rely heavily on consulting — which, truth be told, is just about everybody.
In India, many low-end staffing companies that fed the ravenous global demand for Indian tech talent are being forced to close up shop. At the other end of the spectrum, even the revenue streams of marquee U.S. consulting firms like Accenture and KPMG that have profited richly, like Indian services companies, from the global growth of corporate IT, will be adversely affected.
So what will be the fate of IT services companies in the near term? And what will it all mean for India’s big IT hopes? Will corporate clients turn away from US-based consulting and embrace offshore outsourcing? Will we have to wait several years before IT services emerge from this dark patch? And how many companies will still be left standing?
The Market Despite the gloomy economic climate, Azim Premji and Narayan Murthy can be relatively optimistic about life as they go to work each morning. After all, the companies they founded, and took public in the US — Wipro and Infosys, respectively — have evolved into recognized global name brands, with stock prices that have held their market capitalization in the billions of dollars. The two companies, as well as companies like Satyam, and private competitor TCS, boast massive client lists that read like a who’s who of corporate America. Their core strength lies in these client lists.
India’s IT consulting and outsourcing giants will no doubt be affected by a slowing US economy, as their consulting revenues are reduced. They will grow less rapidly than they have. But a portion of their core revenue streams will continue to come out of existing client relationships, and given their scale, nobody would suggest that they will be crushed by the new business climate. Krishnan Chettiar, who heads up Ernst & Young’s India Business Group, explains, “the big Indian consulting companies, if they are smart, will utilize this time to capture more market share, because a lot of US companies are cutting back and won’t be able to compete in margins and billing. The top firms can reduce their billing slightly and secure good accounts.” For the large companies, the scenario is relatively simple. It’s time to buckle down and weather the storm.
But the IT consulting industry is much more than just a select few large Indian companies and the big five US firms. The entire picture is much more complex. Pankaj Maheswari heads up Advent Global Solutions, a US-based company of roughly 100 consultants that specializes in SAP, and also does work in the Internet and e-commerce spaces. Maheswari puts revenues for his company at about $10 million a year from about 10 key clients. His company clearly fits in with the time-honored concept of a consulting company: built up organically from a few people, and living off key contracts and services.
Many such companies, of various sizes, have flourished in recent years. They differ considerably from companies like Infosys because they are based in the US, and are generally more focused on onsite consulting than offshore work. What will happen to such smaller companies in the face of IT spending reductions?
Maheswari explains, “On a short term basis, the budgets have been cut and it has impacted us.” But he remains optimistic that his company will pull through when all is said and done. He talks about, for example, suggesting to clients that he will put as many consultants on a job as is needed to get it done without billing for each extra individual — thus more fully utilizing his workforce and accepting lower revenues. His client relationships, he notes, will pull his company through. He emphasizes that clients often seek the more personal relationship that a smaller provider offers. But he also admits that he is seeing more and more demand for offshore projects, an indication that cash-strapped corporations are looking for cost benefits more than anything else.
ONSITE AND OFFSHORE Kumar Mahadeva, chairman and CEO of Cognizant Technology Solutions, a New Jersey-based public company that, unlike many US-based consulting companies, specializes in offshore development, suggests, “Second tier companies are not doing well.” By second tier Mahadeva evidently means the smaller and mid-sized consulting houses. “The field has narrowed,” Mahadeva insists. “Clients want offshore development and not staffing.”
Clearly offshore development has become a major factor in the IT services industry, as body-shopping falls heavily out of favor, and traditional consulting struggles. But most doubt that offshore development will replace on-site consulting as a complete solution. Venu G. Vaishya is executive vice president and COO of India operations in the US for another US-based public IT services company, Covansys (formerly Complete Business Solutions, Inc.) which, like most other companies in the sector, operates somewhat of a hybrid model, using offshore capabilities, but still doing the bulk of the work onsite. “Customers don’t want you to disappear into a black hole for some time and come back and deliver,” he argues. “They want you to provide continuity.”
But Mahadeva counters this assertion, which is a favorite argument of companies that have made only limited commitments to offshore work. Offshore IT outsourcing, Mahadeva points out, has evolved considerably over the years. Companies sending work offshore can monitor the progress and characteristics of the offshore work being done at all times, he explains, in a sense artificially creating the sense of security that having somebody working onsite brings.
Cornell Williams, senior director of IT at clothing retail powerhouse The Gap, is a Covansys customer who has also used Indian firms like TCS to do his IT development work. He explains that he likes to send as much work offshore as possible to reduce costs.
Of course, even Cognizant makes nearly 50 percent of its revenues (which were about $137 million in 2000) from ongoing maintenance on existing projects. It has a large consulting force of its own, so onsite is still very much a reality of business. However, offshore is clearly in vogue, and several companies are increasing their marketing staff in the US to capture the opportunity that they see created by the slowdown. According to Lakshmi Narayanan, Cognizant president and COO based in Chennai, where the company’s offshore development center is located, “Competing consulting companies are increasingly quoting lower prices for their services. Competition is getting intensive, and we are preparing for it by beginning to sell more aggressively.” Simultaneously, companies are ramping up their offshore operations strategically to add value to their offerings. M.D.S. Bosco, COO of Intelligroup Asia, says of his company strategy: “Now that onsite is clogged due to the slowdown, we are strengthening our operations at Hyderabad.”
THE STRUGGLE TO SURVIVE Regardless of the model, how will firms suffer from the market downturn? “You have to identify the core skills that you must retain regardless of whether you have projects or not,” Vaishya explains. Covansys’ benched consultants are kept busy doing R&D or sales support. The company will be affected, but Vaishya assures that his firm has the capital available to easily weather a storm by re-investing available assets into building up its core business.
This is generally the attitude across the board. Executives readily admit that the industry is hurting, but offer a barrage of reasons why their companies will pull through with flying colors. Objectively speaking, the consensus seems to be that everyone will be hurt.
Pawan Kumar, CEO of DSQ software is one of the most optimistic, he explains, “I have not seen my customers cutting down their IT budgets. I think it is a psychological issue rather than a major issue.”
Exinom CEO Suresh Nichani, whose six-year-old 70-person (mostly H1-B workers) consulting company primarily aggregates data for large corporations, argues that his firm will pull through because of its niche focus. “People not moving up the value chain are going to feel the downturn,” he says. By doing focused work for companies like AIG, Merck, Siemens and Avis, Exinom will try to pull through even as other small consulting firms are crushed by the reduction in demand. But a limited scope also makes a company vulnerable to significant corporate cutbacks.
Hiten Patel is CEO of Global Consultants Inc., an $80 million company that employs more than 900 consultants and doesn’t operate an offshore outsourcing model at all. “We were expecting a certain growth level, but we have to slow down,” he says, with no particular urgency in his voice. For him it will be a matter of managing expectations and strategizing according to the shifts in the market. Patel will determine how many consultants he needs to be as efficient as possible and structure his organization accordingly, even if he has to lay off — a reality that, he hastens to add, still hasn’t hit his company.
Patel is blunt when talking about the smaller companies in the market. “Big customers are going to limit the number of companies that they will deal with. All of the small companies ($20 million and below) will get washed out like anything.”
SCALING THE VALUE CHAIN It’s obvious that large Indian firms — and US companies that rely on H1-B employees and offshore centers — derive tremendous strength from the low cost of their services. Indian and India-centric firms also effectively leverage their unique specialties in the IT industry. If a client in corporate America can get quality specialized IT services from Indian firms for a fraction of the cost of using the big five, the cheaper option will be the obvious choice. The proof is the huge traction that Indian services firms have gained in the US market.
So how can big five consulting companies compete if they charge three times more for the same services, especially as the market slows? The answer is that the revenues of dominant US firms, like KPMG, Deloitte Consulting, Accenture, and so on, don’t rely as much on the relatively simple programming and IT integration and implementation services that Indian firms and outsourcers use as the core of their business.
Raj Joshi, global director of alliances for Deloitte Consulting, acknowledges the impressive job that the large Indian firms have done in the US market. But he dismisses the thought that big five consulting firms are worried that they will get out-bid or knocked out of business by the likes of Infosys or Wipro. Joshi frames the situation in terms of value. The most deep-pocketed corporations willingly pay Deloitte high rates because, according to Joshi, Deloitte partners and managers know how to do the high-end strategy work that adds significant value to a customer’s organization. For Joshi, the ability to do this is all about the people whom his company employs, and the maturity of his company. He argues that Indian firms simply don’t have the maturity and level of top personnel to provide competitive services at the highest level.
K. Kalyana Rao, executive vice president of Satyam Computers, who, as in-charge of the company’s business in the telecom vertical market, probably understands the quest for top talent as well as anybody. He speaks of the hacker types that emerge from the hundreds of software engineers that get pumped into the IT industry every year. These are the employees that transcend the basic restrictions of IT work and emerge as visionary project leaders. India’s IT industry will rely on this kind of talent. But, Rao explains, “There are only that many client sites that these technology evangelists can practically visit and create effective solutions for, business is there for the taking. But there is simply not enough talent to rope it in.”
There may be some hope on this front that stems, ironically, from the economic slowdown itself. Chettiar, of Ernst & Young, observes, “H1-B people are going back to India. That creates some opportunities for Indian companies, because they were paying high salaries in the US, and they will be able to pick up some good project managers with five to six years of experience.”
In any event, Infosys, Wipro, Satyam etc., can’t transform into Deloitte or KPMG overnight. Meanwhile, Indian firms will need to rely on their price advantage to grow. The two imperatives make for a delicate balance.
Ranjan Chak, vice president of India operations for Oracle, explains the balance well: “Quality will be the driver for the Indian IT industry; at the same time, it is the attractive economic model that will encourage end-customers as well as software and service suppliers to turn even more towards India in today’s economic scenario.” For now, the quality that Chak is talking about means effectively carrying out specific IT projects at a lower cost. Chettiar points out, “Companies are still skewed toward traditional consulting. Everybody says that they are not a body shop, and that they are a product company. But I doubt that many have a product. They have domain knowledge and experience in a particular software, but are they moving up the value chain? Some of them may be, but most of them aren’t.”
“It’s hard to envision offshore companies doing strategy offshore,” Joshi explains, indicating that the tech-focused India firms have a long way to go before they can really move up in the value chain. But, Cognizant’s Mahadeva counters, “customers use Indian firms to build the systems, and they can use firms like Bain or BCG to do the strategy work.”
What is evident is that a balance can be struck. Joshi insists, “Nobody wants to compete on cost alone.” But it is also true that Indian firms, and other companies that rely on Indian talent and outsourcing, can use the cost advantage that they bring to the table. They can couple it with higher quality offerings to become more than just low-cost providers. The higher companies climb in the value chain, the less vulnerable they will be to cyclical swings in the economy.
Bosco of Intelligroup reports from India: “The big companies are already into high-end business consulting. Companies like us will also have to move up the value chain. The hardest hit today are body-shopping companies.”
This need to add value seems to be the ultimate wake-up call for the many IT services providers (large and small) that thrived during the recent tech boom, when there was so much demand in the market. The exponential rise and rapid fall of US IT services firms like Razorfish, MarchFIRST, and others, show clearly what happens when companies grow on commodity services and are entirely unprepared to handle a drop in demand like the one that followed the Y2K bug frenzy.
Consulting is here to stay because corporations will always crave services. The big five will undoubtedly be around in time for the next surge in demand. But how will the entire market feel the impact of low-cost alternatives, fueled by a huge pool of Indian talent, and how will those companies evolve? Will we one day be talking about the “big seven?” And will the new members of the consulting industry’s elite ranks have names like Infosys, Wipro, TCS, Satyam, Cognizant, or iGate? If current Indian and H1-B-dependent firms don’t strive to add more value, they may be left out in the cold.