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IT Services - the Rocky Road Revisited Careful management in the short term will enable long-term growth.
Monday, November 17, 2008

Each day, media and analysts saturate the airwaves and newsstands dourly proclaiming the eulogy of the technology industry. The prognosticators who once heralded the golden age of the Internet now predict its downfall. Those who knighted scores of dot-com businesses as the heirs to the Fortune 500, in hindsight, mock those companies’ foolishness. “Tech had a good run, but it’s over now.”
The rest of us are not blind to the effects of the past 12 months. We understand that the dark offices permeating Silicon Valley have more to do with layoffs than the rolling California brown outs. But, on behalf of the entire technology industry — enough already!

I believe that the long-term outlook for technology services is still very positive. Why? Because basic technology development hasn’t stopped. Forward-looking companies like Wal-Mart, Wells Fargo and Citibank use information technology as a competitive weapon. Their peers are forced to play catch-up just to stay competitive. In either case, these companies need the help of external services vendors for expertise in implementing new technology.

This year will separate the men from the boys in the industry. The companies that will survive will be those that focus on execution, on operational efficiency, on cash flow and on profitability. Revenue growth, bill rates and margins are less important as companies try to survive the short term to realize long-term success.

For several years, we saw unprecedented growth in tech spending. In the early 90s, we saw the growth of client-server applications. In the mid-90s, it was ERP and Y2K services. In the late 90s, much of the growth came from e-business services, partly from Internet-based companies, and partly from bricks-and-mortar businesses trying to “keep up with the Joneses.”

Tech-envy was a fact of life during the dot-com boom. Old Economy companies were unwillingly forced to look over their shoulders as the dot-coms tried to move in on their turf. While this was true during the days when all things “e” were cool, the fear factor to compete technologically with upstart dot-com rivals has eroded, and services companies are facing softening demand.

At its core, e-business is not a new way of competing; it’s a better way of competing. Somewhere along the line, too many people expected an Information Revolution. In reality, we’re in the middle of an Information Evolution, and, while the word “evolution” may denote a slow process, we are really in the middle of a rapid and vibrant growth process — in which the current situation is more of a “breather” rather than the start of a long-term slowdown in demand. As it stands, the long-term outlook for technology services looks good.

The E-business Services Sector Will Grow E-business services is a huge market. As I mentioned earlier, large, innovative companies will continue to use technology as a competitive weapon to grow revenues, increase margins and build improved market share. Even in light of the struggles of the last 12 months, the Gartner Group still predicts e-business services spending to reach $527 billion by 2005. This resurgence will come from a number of emerging trends. First, services surrounding procurement software and initiatives will remain hot. AMR Research predicts that businesses will spend $2.8 trillion online in 2004. Don’t expect hand-written PO forms to go the way of the rotary phone just yet, but widespread adoption of eProcurement initiatives is getting much closer.

New technology will play a large role as well. Markets such as wireless enterprise technology, optical networking and peer-to-peer communication will help drive growth. Obviously, wireless technology is very promising. Wireless has been growing slower than expected due to the economic slowdown, but I still believe it’s one of the more exciting areas for the technology services industry.

Customer Relationship Manage-ment is also critical for most companies. This is especially true given current market conditions. With a softening economy, companies are paying more and more attention to getting closer to their customers. Developing customer care technology that effectively links all components of the commerce chain creates a more efficient environment for clients.

The CRM market has seen more than its share of changes and growth in recent years. The market has existed as a known entity for under five years, making its growth and acceptance even more remarkable. In 2000, the CRM market grew by 59 percent; and even in the face of a possible economic downtown, a recent AMR Research study shows that 87 percent of companies plan to leave budgets for CRM initiatives intact or even increase them. The market’s growth shows that companies have finally heard the customer message loud and clear, and they’re buying technology to help them compete and succeed in the customer economy.

Knowledge management will be another growth area for the services industry. Thus far, it’s been more hype than substance, but, done right, knowledge management initiatives can create a collaborative community that harnesses the intellectual capital of a business. Software developers and consultants are still ironing out the wrinkles in effective knowledge management solutions, but the sheer importance of these initiatives will inevitably drive the size of this market.

Offshore services will continue growing, especially in the midst of an economic slowdown. The McKinsey Group reports that IT exports from India have grown more than 55 percent each year for the past five years and are expected to reach $87 billion by 2008. The same study found that 200 of the Fortune 500 companies are customers of the Indian IT industry.

I see this not only as a validation of the offshore delivery model, but also as a tremendous opportunity. If 40 percent of the Fortune 500 currently take advantage of offshore services, then offshore companies have an opportunity with the remaining 60 percent, as well as with other enterprises that now see validation of this approach.

Who Will Win? I think there will be two kinds of winners. First, the handful of large, global systems integrators will thrive. They have the scale, the depth, the breadth, and the client relationships to thrive in good times and survive in the bad. The second set of winners will be the medium-sized and smaller companies that can demonstrate real differentiation from the hundreds (perhaps thousands) of look-alike IT services firms. At the end of the day, this differentiation will come from having expertise in a specific area — companies such as eLoyalty in CRM, Infosys in offshore, and Keane in application management outsourcing.

Also, now more than ever, IT services companies will need industry expertise to be able to provide real value to clients. Companies without such expertise will be viewed as commodities.

Third, IT services firms will need to have, and be able to demonstrate, their ability to successfully complete large, complex projects. The second generation of business consulting projects is complex, and this requirement will again favor large system integrators that have demonstrated capability in this area.

With intense competition in the IT services world, there’s little cushion. Initial innovation loses its value fast, and only streamlined, efficient companies possess the rapid decision-making and execution skills necessary to sell effectively, control costs and establish new service lines.

E-business services companies will need to maintain a solid cash position in order to sustain them through down times as well as re-assure clients of their stability. While in normal times, IT services firms typically generate cash, the current precarious cash positions of several well-known companies in this sector have underscored the importance of maintaining an excess-cash position.

As for IT staffing companies, they will have a difficult time. In that market, we’re seeing a trend by large corporate enterprises to consolidate their vendors in an attempt to get better pricing and international support. At the moment, Goldman Sachs estimates that the top 10 IT staffing companies command only a third of the estimated $154 million global staffing market.

However, I believe that number will rise considerably in the next few years. This consolidation will hurt smaller staffing companies, as larger vendors can offer corporate clients the full-range of services and global support they require, along with significant economies of scale. In addition, the growth of the Application Service Provider model, as well as electronic IT staffing exchanges, is likely to further inhibit the staffing market and reduce the margins of staffing companies.

The past 12 months have challenged the endurance of many companies, but there is light at the end of the tunnel … and it’s not an on-coming train! By focusing on select areas of expertise and managing costs effectively, IT services companies can get through this temporary downturn to reap attractive future returns. We can safely ignore the pundits who are declaring the end is at hand, and be assured that the next generation of the IT Services revolution is on its way.

Sunil Wadhwani is Chief Executive Officer and Co-Founder of iGATE

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