Are dark clouds hovering over Indian IT companies? Here is what I think are the reasons.
1. Waning competitive advantage: Indian IT companies competitive advantage - ‘cost arbitrage’ is rapidly eroding. A horde of economies – Vietnam, Philippines, and Nigeria - offer better advantage than India – English educated talent at even lower cost! Bottom line – for Indian companies to stay competitive would require them to build new capabilities to capture new opportunities.
2. Regulatory Headwinds: USA is the largest market for the majority of Indian IT companies. President Trump's policy of pushing H1-B is forcing IT companies to hire local people, instead of sending low-cost talent from India. This decision raises the spectre of the higher wage bill, which will inevitably accompany hiring local people. Bottom Line: This move will eat into the already frayed bottom line!
3. Fixed fee revenue Model: Many Indian IT companies charge fixed fees based on time & material. In this revenue model, the IT Company secures its fees & the risk is partially transferred to the client! If they have to become an IT company of choice then they should move towards ‘Outcome’ based revenue model - where payout by a client is linked to results – outcomes promised & delivered! This will involve cannibalising of the existing revenue stream. But if this sacrifice is not done today then it may be too late tomorrow.
4. Operating at the lower end of the value chain: Indian IT companies have captured the lower end of the value chain. They specialised in managing the legacy business. But competition at the lower end of the value chain is getting severe. Profitable opportunity does not reside at the lower end but further up the value chain, namely digital business. This would require Indian IT companies to build new digital capabilities in the area such as Artificial Intelligence, Machine Learning, Natural Language Interface, Analytics, Cloud computing and Mobility to stay competitive. But acquiring digital competencies will come require massive investments, which will adversely impact the IT companies’ bottom line! Moot question? Will the IT companies bite the bullet & invest?
5. People lack ‘new’ skills: Existing people would have to acquire new skills & capabilities. Downside - it would require IT companies to invest in re-skilling its people – which will dent their bottom line further. In addition, they need to attract new talent with new capabilities into the company - this is crucial for long-term success & survival of the business. But there is a hitch. New talent will come at a market price, which is ‘exorbitant’ when benchmarked against what existing people get paid. Even if IT companies attract them by paying market compensation – it will cause friction & disharmony in the company because there will be a huge disparity in compensation between existing & new people.
6. Change in Industry Structure: The industry’s margin is under pressure. To offset it, the productivity per employee has to be increased. One solution being embraced by industry: automation - repetitive (left brained) activities are being automated. Result: machines & algorithm are taking over jobs resulting in job scarcity!
7. Clients face revenue & profit pressure: IT companies’ clients themselves are facing revenue & profit pressure. They are also desirous of reducing expenditure on legacy projects & shift them towards value-creating projects. Currently, Indian IT companies are finding it difficult to service this requirement.
8. Internal conflicts out in open: Slowing down of sales, squeezing of margins & pressure on profit has brought internal conflict into open. Take Infosys. The displeasure of the founders with the current management Team is public knowledge. This public dissent is viewed as a risk factor by the senior management of the company. Bottom line: It is needlessly distracting the management in tough times & making the situation even more challenging
What is the solution? Reset expectations of investors.
The biggest enemies of Indian IT companies have been their past success. For a long time, they recorded gravity-defying revenue growth; reported eye-popping margins & threw up cash that made the investors smile all the way to the bank all the time. Now the industry is showing signs of slowing down.
Why?
To understand that let me share the concept of the Product Life Cycle. Every industry / company has an introductory phase followed by a growth phase. In these 2 phases, the industry / company grows rapidly. Then the ‘maturity’ phase sets in when the sales slow down & margins to come under pressure.
Let us come to IT industry. Till recently it was in ‘introductory followed by growth’ phase, which was resulting in mind-boggling revenue, margin & profit growth. But now it is entering into a maturity phase when its revenues & margin growth will slow down. But the Investors are in no mood to accept this reality. They want this golden hen to continue to lay the golden egg.
The question that must be bothering you – if every industry / company passes through ‘introductory, growth & maturity’ phase & in maturity phase growth slows down, then what explains the rise & rise of companies like Apple?
Companies like Apple have devised a strategy through which they strive to ensure that their products do not enter maturity phase & if they do, then a strategy is drawn to get then back into ‘growth’ phase?
What strategies should Indian IT companies adapt to get them back into ‘growth’ phase? The answer has already been shared. But let me succinctly recap them:
IT companies should invest in:
- Acquiring new competencies so that they move up the value chain
- Re-skill its existing people & attract new talent with new skills so that they can deliver value up the value chain
- Embrace ‘outcome’ based revenue model.
Do Indian IT companies have deep pockets to invest in these initiatives? The big 4 Indian IT companies have a pile of cash sitting on their Balance Sheet. Not to mention the cash that they continue to generate from current activities. Instead of return it to shareholders (TCS just returned Rs. 16000 crores to its investors; Infosys is rewarding its shareholders with a Rs 13000 crore share buy-back & dividends) they should judiciously invest in secure their future! And in no time they will be back to their winning ways!
Bottom-Line: Indian IT companies will have to bite the bullet & make the strategic decision of making investments now which will lower near-term earnings but will ensure that they remain competitive in the long run & regain their mojo!