IT Services Company transforming into IT Product company – Dream is now Closer to Reality

IT Products have an exponential growth and profit potential. Strong software products earn margins upwards of 80%+, compared to 20%-30% for IT service companies. Margins can exceed 90% if India is the development center and world as the market. However, moving from services to software product requires a significant change in mindset.

• · A service is delivered based on custom specifications provided by the customer. A product is sold to millions of customers based on product requirements gathered, prioritized and implemented by the product company.
• · The use interface designs and functional specifications are no longer provided or approved by the customer, however, they need to be designed by the company based on its own understanding.
• · Creating a product requires in-depth understanding of the domain, competitive offerings, pricing environment, sales channels and support issues. In a services delivery environment, these are low priority or non-issues.
• · Since there is no fixed delivery timeline in a product development environment, it is easy to get lost in constant refining of the product. At the same time, it is important to undertake extensive beta testing program before the product is released.
• · Managing the expectations of customers is equally important. Version 1.0 seldom delivers everything customers want. There is always a plan for ver 2.0 and 3.0 even before the first version is released.
• · Product development requires upfront investment without any contract or customer. It is the biggest mental block service companies need to overcome. Losing short term profitability to build long term dominance in the category requires risk taking which only an entrepreneurial leader can take.

Today, several start-up companies and MNC companies are running their global product businesses from India. In fact, a product which makes less than $20million revenue is no longer viable in the US. Cost of development, sales and support of any software product can exceed $10mn in the US, which in India comes down to $3million.

There are several Indian companies who are attempting to move from services to products. The business reasons are obvious- High margins, customer lock-in, insurance against rupee appreciation and wage inflation. Engineering skills are available in plenty. Program management, product management, user interface design, documentation, installation and licensing technology and skills are also available as several product companies are now present in India.

Opportunity exists! Are you willing to bet your future on product development?

TCS reports better earnings growth than Infosys

TCS reported strong earnings growth in 2Q09, much better than its peer and nearest competitor Infosys. Unlike Infosys, TCS is more diversified in terms of its geographical presence. TCS bids and competes against IBM and other multinational companies for services contracts in the domestic market, unlike Infosys which has been completely missing from the large Indian market. With IBM winning multi-billion dollar deals from companies like Airtel, Indian software companies cannot afford to ignore domestic market anymore.

TCS has done a better job of spreading its development resources across the globe, for example, it has a subsidiary in China. Longer term, Indian software service companies need to spread development resources across all major low cost countries, India, China, Poland, Russia, Brazil and so on. This will become important as currencies become more volatile and pricing becomes uncertain. Currency hedging provides only short term respite, building capabilities across new geographies is the only long term solution. Let's take Walmart or Pharmaceutical companies for comparison, these companies use multiple sourcing base which gives them huge advantage. Indian software service companies should stop being India centric if they want to survive, grow and prosper in the longer term.

TCS is best positioned to take this challenge of geographic diversification. It is time to forego margins for a few years in order to build a global delivery model - not just India based delivery model. If you want a software exposure and believe that Rupee will touch 39 again, TCS is your best bet...... My personal view - as always consult your investment advisor before you make investment decisions.

Indian IT Companies Cannot Rely on Cost Advantage Alone

IT Services is in vogue today. Hardware companies are trying to re-invent their business models. IBM is clearly the most shining example of this strategy. HP, Dell and Xerox are latest imitators of this strategy. Today, IBM has built a services business through organic growth and strengthened it through alliances with partners like Cisco, SAP and with acquisition of Price WaterHouse (Business Consulting) and Daksh(BPO). At the same time, IBM has also shed its hardware business gradually by selling desktop hardware business to Lenevo and hard drive business to Hitachi.

Before the emergence of Indian software service companies, large-scale outsourcing deals were dominated by IBM and EDS. These deals typically have whole IT departments being hived and sold off worldwide and often the vendors absorb 1000s of employees from the customer’s IT department. Some of the strengths of IBM are – its presence across 100+ countries, it boasts of some of the best HR practices (making it easier for employees from organizations to get absorbed) and its experience in handling the most complex and intricate systems. However, huge cost arbitrage between Indian service companies and US based vendors has caused a major shift over the last 6-8 years. At the same time, Indian software companies have acquired companies in US and Europe for specialized domain knowledge (Wipro is a case in point), spread their offerings to span almost all areas of IT services and also invested in geographical breadth and depth. TCS clearly has emerged the torch bearer for global delivery with geographically spread delivery centers.

By 2003, it was clear that US based vendors needed to accept or embrace India as a key delivery center, else they risked losing their key clients. The challenge was enormous, because client facing organizations were reluctant to position the Indian centers. They will often quote based on US/Europe based delivery centers until client brought it one of the Indian vendors to beat down the price. While Indian companies threatened IBM on price, Accenture added IT services to its pre-eminent position in management consulting. That’s when a major shift in strategy happened. IBM acquired PriceWaterHouse to nullify Accenture’s advantage. In addition, over the last few years, IBM, Accenture, EDS and HP have created a major presence in India and their global delivery centers are almost at par with Indian vendors.

While IBM ramped up its global delivery centers in India, Indian service companies acquired companies with specialized domain knowledge and set up delivery centers in countries including China. Despite these efforts, the gap between IBM and Indian service companies still exists. IBM continues to enjoy strong competitive advantage because of its immense experience across hardware, software and services. Having nullified the cost advantage of Indian companies, IBM can bring its domain expertise (from Price WaterHouse) and strong thought leadership in new technological areas. If nothing works, IBM can also steeply discount its software offerings like WebSphere and DB2. Through innovative deals with Airtel and other telecom companies in India, IBM has also demonstrated its ability to take business risks which elevate its status from a vendor to a partner.

While IBM’s competitive edge works well in large and complex IT outsourcing deals, there is little to differentiate when it comes to vanilla projects. Almost all vendors have strong customer references, key skill sets, global delivery capabilities, resources to ramp up delivery and relationship with top clients. The decision in that case invariably happens on price. With rupee threatening to strengthen (after a scare in 2007-2008), Indian companies have a major challenge at hand.

Infosys revenue growth has been muted for last 4 quarters. Now that revenue growth seems to be back, margins appear at risk with rising rupee. What will drive the next phase of growth for Indian IT Service companies? How can Infosys become the next IBM? Do share in your thoughts.

Hi Everyone

Hi Everyone

I am starting this new blog – to share some of my random thoughts, to openly reflect on them on events, strategies, state of business and economy. I am planning to focus on three areas – managing products globally from a remote location (my experience in Adobe), IT industry (my experience in IBM, iSOFT and Adobe) and the global economy (as a citizen, as a student of finance and my experience with ICICI Securities as an equity analyst). I do hope to bring a fresh perspective in some of these areas. Most of my thoughts have been shaped probably by my experience over the last 15 years – it will be a good idea for you to visit my LinkedIn profile .

Cheers

Vivek Jain