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How can Indian IT companies achieve non-linear growth?


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How can Indian IT companies achieve non-linear growth?

  1. 1. How can Indian IT companies achieve non-linear growth? Ramamurthy Prakash B
  2. 2. Howcan Indian IT companies achieve non-linear growth? TOC Table of Contents 1. OVERVIEW............................................................................................................................... 1 2. CUSTOMER EXPECTATIONS...........................................................................................................2 3. INDIA INC’S CAPABILITIES............................................................................................................. 3 4. NON-LINEAR GROWTH ................................................................................................................ 3 4.1. Why a radically new approach? ...................................................................................... 3 4.2. The proposed approach .................................................................................................4 4.3. The Round ABOUT way!.................................................................................................5 4.4. How this approach contributes to non-linearity?............................................................. 7 4.5. Otherimpacts caused by the suggested approach........................................................... 7 4.6. Go to market strategy....................................................................................................7 4.7. Organizational Structure ................................................................................................ 9 4.8. Measuring success of non-linearinitiatives.................................................................... 10 5. CONCLUSION.......................................................................................................................... 11
  3. 3. Howcan Indian IT companies achieve non-linear growth? 1 1. OVERVIEW The Indian software industry has come a long way since it was started as a fledgling industry in the nineties. From US $150 million revenue in 1991-92 the industry has grown at an approximate CAGR of 33% to US $50 billion revenue by 2009-10. According to a recent McKinsey report, Indian software industry accounts for close to 6% of the global IT services and 65% of global IT off-shoring. The business success of the Indian IT firms so far has been due to the accessibility of low cost technical resources – India has skilled manpower whose salary levels were much lower than those elsewhere in the world. So the Indian firms could bid for projects in US and execute them in India, making a handsome profit from the difference in wage rates. In such a model the revenue of an IT firm is directly proportional to the number of projects executed, which in turn depends on the number of resources deployed. However, like any business model, this model is not sustainable forever. As the Indian IT firms aggressively ramped up resources, the revenue per employee started declining perhaps due to the economic law of diminishing returns. The increasing wage rates & foreign exchange fluctuations made the matter only worse. Today, for a firm to go from $2 billion in revenue (60,000 employees) to $10 billion, it has to recruit approximately 240,000 more employees. On the other hand, countries such as China, Russia, Philippines and South Africa are quickly catching up on the low cost model, eroding the competitiveness of India. This is a strategic inflection point for the industry. To continue thriving, the Indian software industry needs to find ways to move away from low-cost based revenue models. There is a need for a new delivery model which is tied to output/outcome and “value added” rather than the number of personnel engaged. At the outset, this paper suggests a new delivery model that can help Indian IT companies achieve non-linear growth. The methodology for arriving at the model is as follows - 1. Identify customer expectations from IT outsourcing 2. Identify core strengths of Indian IT companies 3. Juxtapose the expectations against core strengths to identify Key Performance Areas (KPAs) where significant value can be created 4. Conceive a new model that delivers on the KPAs In capitalist reality, as distinguished from its textbook picture, it’s not the price-based competition which counts but the competition from new commodity, the new technology, the source of supply, the new type of organization - competition which strikes not at the margins of the existing firms but at their foundations and their very lives" - Joseph Schumpeter
  4. 4. Howcan Indian IT companies achieve non-linear growth? 2 2. CUSTOMER EXPECTATIONS 1. Raise enterprise effectiveness: Today, customers are seeking various new capabilities from IT outsourcers. They want the IT service firms to not just lower costs but also participate in business outcomes. Instead of transferring application development to a low cost offshore destination, customers expect suppliers to understand their area of business and help develop customized platforms that can radically improve the overall operational performance. 2. Reduce total cost of ownership: The current off-shoring model entails the following additional costs to the customer –  Validation and verification costs  Project management overheads  Maintenance and upgrading costs  Cost of delays in delivery Customers want these costs to be minimized to the extent possible. 3. Mitigate risks: All new projects are inherently laden with risk. With significant capital going into development and upkeep of information systems, the customer faces risks of not getting sufficient returns from his IT investments. These risks could be due to changes in technology or external economic factors. The IT vendor is expected to mitigate such risks by advising the customer on industry trends & competitiveness. 4. Improve business agility: Customers need a lot more flexibility than before. When the business is growing they would like to scale up, deploy more resources and go to the next operating level as fast as they can. But when there is a slump, they would like to immediately withdraw investments and reduce operating costs significantly. In both cases they need a trusted partner who can give them the flexibility of scaling up and ramping down at the push of a button. 5. Legacy application management: It is not uncommon for some companies, especially in the financial services industry, to have a bunch of legacy applications which fall in one or more categories below:  The technology used to develop the applications is obsolete now  The people who built the applications are not in the organization anymore  No documentation is available for maintaining these applications Companies have a very difficult time managing this kind of applications. They cannot dispose off or redesign these applications because so much of business logic would have been built into the applications over the years that not one person knows how to replicate it. Companies want outsourcing firms to dissect the functionality of such
  5. 5. Howcan Indian IT companies achieve non-linear growth? 3 applications and rebuild them using the latest technologies and following appropriate documentation practices. 3. INDIA INC’S CAPABILITIES The ‘Resource Based Model’ is used to identify the resources and capabilities that led to the success of Indian IT companies. The six major factors identified are summarized below: RBV Analysis Abundant technical resources Low resource cost Quality leadership English language skills Abilityto learn quickly Jugaad : Creative improvisation Appropriability DoesIndia profitfrom value creation? Yes Yes Yes Yes Yes Yes Demand Doesit help meet customer needs? Yes Yes Yes Yes Yes Yes Competitive superiority Yes No Yes Yes Yes Yes Non- substitutability No No Yes No Yes Yes Inimitability Durability Medium term Medium term Medium term Short term Long term Long term Unique No No No No Yes Yes Path dependence Low Low High Low High High Causal ambiguity Low Low Medium Low Medium High Economic deterrence No Yes No No No No 4. NON-LINEAR GROWTH 4.1.Why a radically new approach? Some obvious options for achieving non-linear growth are 1. Switching from services to product development 2. Strategic acquisition of product companies 3. “Moving up the value chain” – Consulting services However, all these methods involve huge investments upfront. Product development requires investment for building IPs, acquisitions need huge cash for buying out and consulting needs money for hiring a pool of reputed consultants. The risks arising out of these choices are also high. More importantly, there are fundamental differences between
  6. 6. Howcan Indian IT companies achieve non-linear growth? 4 the current Services model and these “non-linear” models – be it culture of the organization, estimation methods, people management, pricing and performance management. Last but not the least, the ordeal of transforming hundred thousand employees to think differently is simply gargantuan. In this context the million dollar question is - Is there a new way of bringing non-linearity to traditional service-oriented thinking, gradually and without huge investment outlays and risks? 4.2. The proposed approach We attempt to answer the question by drawing parallels between the business models of Global IT services & Infrastructure sector in India. The conventional execution model in the infrastructure sector has been similar to that followed in IT services sector – 1. The Government lays down the specifications of the structure to be built. 2. The Government calls for tenders and awards the project to the lowest bidder. 3. The contractor executes the project and hands it over to the Government. 4. The Government verifies the work and disburses the payment to the contractor. This approach comes with some significant shortcomings - 1. Since project is awarded strictly based on bid price, the contractor can achieve profitability only by controlling the costs. This can lead to poor quality of construction. 2. Poor planning and last minute changes in specification (“scope creep”) lead to schedule overruns and & increased cost. These issues led to the emergence of an innovative execution model known as the Build- Operate-Transfer (BOT) model. The vital steps in this process are 1. The Government lays down the specifications of the structure to be built. 2. The Government awards the project based on the technical capabilities of the bidder. 3. The contractor executes the project but doesn’t hand over the structure immediately after completion. 4. Under a public-private partnership arrangement, the contractor operates/maintains the facility for a certain period of time. During this time, the contractor will have access to the project cash flows and will share a portion of the cash flows generated with the Government in a predetermined proportion. 5. In effect, the ownership of the asset is jointly held with primary responsibilities of operations and maintenance resting with the contractor. 6. On the lapse of the predetermined timeframe and once the primary objectives of the contract have been met, the contract can either be transferred back to the Government or the arrangement renewed for an extended timeframe. In this approach the contractor’s profitability is derived from the project’s future cash flows. Hence, the contractor takes keen interest in creating value rather than decreasing costs
  7. 7. Howcan Indian IT companies achieve non-linear growth? 5 1. The contractor deploys his specialists who bring in best knowledge and skill-sets 2. The contractor will be in the best position to operate/maintain the construction due to his familiarity of the project The BOT model is considered to be very successful. Konkan railway, Hyderabad International Airport and Delhi Metro are some of the successful projects executed in this model. We feel that the BOT model can be successfully applied to the IT sector as well, albeit with a few minor modifications, to achieve non-linear growth. 4.3. The Round ABOUT way! Every organization has a limited set of resources. It is in the best interests of an organization to deploy its major resources in core activities that directly impact the customer experience and leave the non-core processes to third-party vendors. Let us take the example of an investment bank, whose primary function is to buy and sell securities on behalf of its customers. The formulation of appropriate buy/sell strategies and providing guidance to customers form the core of its operations. The effectiveness of these processes differentiates an investment bank from its competitors. Other activities such as developing a SEC compliance & reporting systems are fairly generic and non-core to the bank’s business. The investment banks understand this pretty well, and so each of them separately engages an IT vendor for that purpose. There are close to 16 full-service investment banks in the world, and each of them separately outsources the development of the reporting system to a different vendor. As a result the same system gets developed by different IT vendors, perhaps in different technologies and architectures. Whenever there is a change in SEC’s compliance norms, these investment banks have to engage the IT vendors again to get the changes incorporated into the system. Add to that expenditure the cost of validation & verification in every iteration, project management overhead and budget creep - the total cost of ownership for each bank skyrockets. If an IT vendor proactively identifies the generic applications in a particular sector, develops them by liaising with a dominant player in the industry, acquires an IP and offers the solution to the other players in the industry then he would have created value for himself as well as for the sector. The crux of the idea is “Same to More” -achieving non-linear revenue growth by building the system once and selling it to multiple vendors. In the process, the vendor company can also transform its purely transactional relationship with the clients into a collaborative relationship and thereby extract more value for itself as well as the clients. We identified the following critical steps involved in this model: Associate A strong association with the client is a prerequisite for applying this model. To start with, vendors provide the customer low-end IT solutions such as routine data processing or legacy
  8. 8. Howcan Indian IT companies achieve non-linear growth? 6 Associate Build OperateUpgrade Transfer system maintenance. As the engagement matures the vendor gets exposed to various aspects of the customer’s IT systems as well as the modalities of doing business with him. Once the vendor gains significant knowledge and trust of the customer, he is ready for the next step. Build The client has sound business knowledge. The vendor has excellent skills in system design and implementation. They both come together and build a standardized application. The client transfers the IP to the vendor by virtue of his strong association with the vendor as well as his willingness to get out of the non-core activities. In return the vendor may discount or waive the cost of development or agree to pay royalties for a certain period of time (depending on the terms of the contract). Operate The vendor maintains/operates the system for a fixed fee and ensures uptime based on pre- defined SLAs. The familiarity of the project enables the vendor to operate or maintain the system more efficiently. Operating the system enables the vendor gain deep expertise in the functionality of the application. This opens up the opportunity of showcasing the model to other players in the same industry. In fact, the client will be interested in promoting the application to his competitors in the same industry – One, because the product matures as more and more companies adopt it, and the client benefits from a matured product. Two, the client makes a tidy royalty in the process. Three, when the rate of adaptation increases and an industry wide norm emerges, the product essentially becomes commoditized – making it easy for the customer to delegate the non-core activity to his partners at non- premium price. Upgrade The vendor will be in a position to provide patches and upgrades as and when there are changes in business rules. This is particularly useful in the financial industry where the regulatory requirements frequently change. On account of wide adaptation of the application, the vendor will also be able to collate the best practices from various implementations and make them part of the solution, creating more value for his clients.
  9. 9. Howcan Indian IT companies achieve non-linear growth? 7 Transfer If the client company chooses to maintain the application on its own, the vendor will transfer the application. However, the vendor still retains the code base, IP and rights to reuse. The association between the client and vendor deepens, leading to more engagement opportunities and value sharing. 4.4. How this approach contributes to non-linearity? As the cycle described above repeats itself, the vendor would acquire significant business knowledge and a portfolio of applications relevant to a specific industry. At that point, the vendor can steer new customers towards their established service foot print and take advantage of the scale benefits, software platform and deep domain knowledge. The profit margin becomes a factor of not the number of employees worked but the number of implementations done, recurring licensing and maintenance fees. Thus the linkage between revenue and number of resources involved is gone. 4.5. Other impacts caused by the suggested approach We frequently hear software engineers quip - “Bugs are our job security!” It sounds funny but at the same time true! Majority of revenues for the IT service companies come from application maintenance & support. At the other end of the spectrum, the poor quality of developed software is one of the biggest concerns for the clients. Indeed the source code shipped is sometimes poorly reviewed and tested. Adopting the ABOUT model makes the project team responsible for the outcome, quality and revenues of the project. This framework also enables the organization negotiate the balance between flexibility, reliability and efficiency to gradually transform into a hybrid product-service company – that provides more customization than a pure play product company and more standardization than a simple services company. 4.6. Go to market strategy Checklistfor goodness offit We believe answering the following questionnaire* helps identify the right candidates for this model. If your answer is “Yes” to 8 or more questions below, it is understood that the case is a good fit to go further with the model. Breadthof Applications Domainknowledge A B OU T
  10. 10. Howcan Indian IT companies achieve non-linear growth? 8 IT Clientele BFSI Top tier clients Mid tier clients Bottom tier clients IT/Telecom Manufacturing Other Sno Check list Answer 1. Are we associated with the client for more than 3 years? 2. Is our average CSAT rating of last two years greater than 5? ( Scale of 1-6) 3. Are the number applications we managed for this client greater than 10? 4. Is our share of the client’s total IT business greater than 30%? 5. Is the application under consideration in the non-core area for the client? 6. Is this a legacy systemthe client is a having a difficult time managing? 7. Is this system a critical bottleneck or source of significant risk for the client? 8. Is the system fairly generic across the industry? (Generic: Once built we should be able to sell it to other vendors with customization efforts not amounting to more than 20% of the original development effort) 9. As a vendor do we have significant competencies in this sector? (Significant competence: Patents, availability of inhouse experts and number of projects executed in this sector better than any other IT vendor of equivalent size) 10. Can the development cycle be reduced by atleast 20% by the use of organizational accelerators? 11. Is the vendor’s IT footprint in the entire sector more than 20%? 12. Does this application frequently require technology & functional upgrades due to changing business rules? (Frequently: A modified code base of more than 20% every year) * Indicative list of questions Segmentation& Targeting Customervalue proposition Each IT firm, based on its significant competencies & current market share, should target an industry that is most amenable for implementing the ABOUT framework. The applications to be targeted are those which are non-core to the business of the customer yet extremely Leverage Items Criticals Generics Bottleneck Items Initial target Low Customerrisk High HighCustomervalueLow
  11. 11. Howcan Indian IT companies achieve non-linear growth? 9 sensitive in terms of the business impact due to a break down. Customers show more willingness to pass on maintenance & enhancements of such applications to the IT vendors. SampleCustomerValueProposition: WordEquation + Royaltypaymentsreceivedpermonth*12 + Numberof releasesinanyear* Numberof testingresources*Billingperday* Numberof daysworkedperrelease + Hours spentonprojectmanagementperyear* Projectmanagersalarycost to companyper hour + Numberof maintenance resources*Numberof billable daysperyear - Numberof reportsgeneratedperyear* Price of each report How is this model differentfromother emerging models? Product/Platform approach Software as a Service Managed services ABOUT Nature of work High end Medium Medium High end Who brings in the domain expertise? Vendor Client Vendor Client Where is the application hosted? Client site Vendor site Client site Client site/Vendor Site Type of applications Business-critical All types Low-end processes – Typically BPO operations & infrastructure maintenance Usually non-core applications - Sweet spot between products & services. Core to the model Domain expertise Resource sharing Low cost Partnering. Growing together up the value chain Business Process flow Vendor defines what the client should do Client decides Client defines the SLAs Generic solutions customized to client needs Who appropriates majority of the value created? Vendor Both client & vendor Client Both client & vendor Pricing model Skimming Penetration Penetration Value based 4.7. Organizational Structure The current organizational structures of Indian IT firms resemble a matrix design – The horizontals comprise technical experts and the verticals consist of project management teams, engineers and business analysts. The new model calls for breaking down the conventional organizational design and adopt a structure that is more suitable for nurturing innovation within the company.
  12. 12. Howcan Indian IT companies achieve non-linear growth? 10 Industry practice Program management Service Team Core Product Team Having said that, we don’t want these structures to become silos. There should be a clear focus and demarcation of tasks, yet the reconfigured systems should be fluid too. The teams should be able to come together quickly to solve problems holistically and disengage without effort. We propose to reorganize the structure into a layered architecture detailed as follows. In this structure, the product team forms the core of the entire hierarchy. The product teams are basically made of technology and business experts working in tandem. Using various market sensing techniques this team identifies various generic features of the product that can add value to the customer. The onus of building in these features and marketing them to the clients also rests on the same team. The service team takes care of customizing the core products to the needs of various customers. The service team usually consists of software engineers and implementation specialists. In terms of the technology and domain expertise the product team contains the best industry talent that can steer the product development in the right direction. The service team is a notch below in that aspect. However the service personnel will be relationship oriented, who front-end the clients during implementations & support. The number of resources in the product & service teams shall be 1:5. The team members should be rotated often between product and service teams so that each of them feels the pulse of the customer and there is an opportunity for greater knowledge and experience sharing. The program management team usually handles a single client. The team will be headed by a “client partner” who works closely with the customer’s IT heads. He understands the client’s world from a business perspective. He looks at the clients systems and the vendor’s offerings (products & services) holistically and identifies more opportunities where his firm can add value. The industry practice stays abreast of the high level industry trends and formulates the medium & long term strategies for its line of business. 4.8. Measuring success of non-linear initiatives Revenue per employee A simple, straightforward measure of non-linear growth is the ratio of revenue to number of employees. Tracking the ratio on a year-on-year basis gives a clear picture of where the company is heading in terms of non-linear growth. However, this is not a lead indicator and at best be measured on a quarterly basis.
  13. 13. Howcan Indian IT companies achieve non-linear growth? 11 Return on Innovation Investment (R2I) Since innovation by its very definition is intangible and not easily measured at the front end (especially at the outset of a new product/service development program), "the logical place to begin is at the end - at the Return on Innovation Investment (R2I). Measuring R2I makes the intangible ‘tangible’, thus providing managers, employees and the investment community with valuable information that can be used in a number of ways." Like ROI – return on investment – R2I also shows return on investment, but only from new product innovation investments, not all investments. It looks at the firm's total profits from new products (cumulative new profits generated from new products launched) divided by its total expenditures for new products. This long-term ratio shows the firm's total return from new products over a three- to five-year period. This number has two uses:  Descriptive: to demonstrate the overall effective contribution of new products.  Predictive: to forecast or set goals for the organization Product to Implementation Ratio This metric compares number of products/platforms developed by the organization and the total number of implementations done. It indicates the level of reusability and so the extent of non-linearity. A pareto analysis of product-to-implementation ratios across various sectors gives the top management a snapshot of the domains contributing major non- linearity to the company. This information can be further used in segmentation & positioning of the company as a product player. Breakeven period Since each of these engagements will involve upfront investments it is important to keep a track of time period required to break even. A typical breakeven period could be three years and each project team needs to be tracked on this metric to ensure that these initiatives are profitable over the long run. Related to this, another important metric is “expected useful life” of an IT system. If expected useful life of the system is less than the breakeven period then such an engagement will not be profitable for the company. 5. CONCLUSION The ABOUT model creates an opportunity for Indian IT companies to develop Industry standard products and services offerings without the investments and risks involved in a conventional product development model. Using this model the IT companies will be able to not only increase revenues per employee but also deepen its current client relationships.