Published: January 24, 2008 in India Knowledge@Wharton
Infosys Technologies once was a software engineer's dream, with a reputation for creating multimillionaires through its employee stock option program (ESOP). But the days of these nearly instant millionaires may have ended -- or so it seems. Not only has the company stopped issuing ESOPs after new accounting rules that require them to be expensed against profits, but the company's stock price, as of January 22, was at a 52-week low of Rs. 1,212.20 ($30.55). That is down 50% from a 52-week high of Rs. 2,439 in February 2007. The decline in the company's market capitalization has taken some of the sheen off the Infosys brand. But if panelists at the TiE Entrepreneurial Summit 2007, held in Delhi in December, are to be believed, the largest of India's software and business process outsourcing (BPO) companies have little to fear.
The outlook is less benign, however, for medium-size and small companies that provide plain vanilla, me-too IT services with a sole "we do it cheaper" approach. "If you are a small company with an innovative idea in the tech domain then you need to leverage the idea by a rapid scale-up of the business," said Anish Tripathi, chief knowledge officer of KPMG India. The rapid scale-up is imperative for smaller firms to monetize the advantage of being a first mover, according to Tripathi, who noted that opportunities exist in rural tech deployment and in the mobile space.
"Core intellectual property-based product companies can still compete" even if they are small, according to Jai Das, partner at SAP Ventures, the venture capital arm of SAP AG, because these companies' products could enjoy patent, trademark or copyright protection. Even companies founded with intellectual property based on processes and systems can succeed, he noted. While many of these firms may get bought out before they become billion-dollar businesses, entrepreneurs will benefit from the value-creation exercise.
The conference panelists urged smaller firms to take advantage of a trend away from selling software licenses and toward selling software as a service. In this web-based approach, the developer provides and maintains software for clients, who are billed based on usage rather than a fixed, annual per-user license fee. "Ninety percent of companies will want software as a service as they don't want a headache with IT," Das said.
Panelists and other conference speakers noted an enormous domestic opportunity for entrepreneurs. Ajai Chowdhry, chairman and CEO of HCL Infosystems, said the PC penetration in India that he had dreamed of years ago is about to happen. "We are on the cusp, with a digital lifestyle powering growth in urban India and with connectivity in rural India," he said, speaking at an awards reception.
In another speech, Infosys co-chairman Nandan M. Nilekani discussed new benefits of IT for the Indian government. "There's a dramatic adoption of many innovative technologies in India, such as electronic voting machines [used] in the 2004 general elections that made us the only country in the world to use these for electing members to Parliament," he said. Thanks in part to growth in technology infrastructure, he added, India's direct tax collections have risen 30% to 40% in the last two years as tax authorities have been able to analyze intelligence from the tax information network. "India is creating low-cost disruptive technologies for growth, and in four or five years we will have a completely portable national pension system and a common way of identifying citizens via one common number," Nilekani said.
Currently, the cumbersome process of transferring one's employee provident fund account can take several years. India does not have a unique identifier for each citizen. Instead, multiple identifiers are used for purposes including tax payments, pension accounts and voter eligibility determinations. "A national dematerialized system for land records is now being created as well," Nilekani noted, adding that the use of IT in the domestic market would enable targeted delivery of subsidies and other benefits.
'Brand India'
Indian IT firms are focusing on the mass market to expand their market share. Bigger companies that provide application development and maintenance services expect business from North America to grow. "Inorganic growth is seen as a significant driver in addition to organic growth," KPMG India's Tripathi said. This would be a change of strategy for major IT firms, which have so far relied largely on new and existing clients to post high-double-digit growth in revenue and profit. With the rupee's appreciation shaving off almost 15 percentage points in revenue growth over the last year and a half, IT firms have had to focus on getting 2% to 3% price increases and higher labor productivity to protect their bottom lines. And they have hedged their dollar receivables, locking in a fixed exchange rate to protect them from the rupee's rise, as India Knowledge@Wharton has previously reported.
India has become a key market even for global IT software companies such as Germany's SAP, which has sold licenses for enterprise resource planning system software to customers including the $28.8 billion Tata group and Reliance Industries, India's largest private-sector company. "We are now focusing on new application software for small and medium enterprises to grow our base of 2,000 customers in India," SAP Ventures' Das said. SAP Labs already has located its second-largest development center in India (its largest is in Germany), joining other global giants including Microsoft, Intel and General Electric.
Shiv Nadar, chairman of HCL Technologies, pointed out just how competitive and polarized the IT business is becoming. The smallest of the IT firms could enter into aeronautics, which was using outdated technology, said Nadar, speaking as part of a separate TiE panel. "We have already built aeronautics for Boeing's 787 Dreamliner. Now, we can go out and buy sub systems manufacturers and benefit from the long-tailed revenue stream of product sale, support and services that characterizes the $800 billion global aeronautical business," Nadar said. He noted that HCL would acquire a company in this area soon and in the next 24 months would build this up as a significant line of business.
"The Indian IT industry has done what the auto industry did in Japan," said panelist Kris Gopalakrishnan, CEO and managing director of Infosys. "We have adopted global best practices and adapted them for India."
Smaller businesses setting up in India can profit from Indian IT firms' success in the global markets. "In the U.S. and U.K., 'brand India' has arrived. Now Indian companies can hire top talent instead of also-rans from these markets," said Uday Challu, CEO of iYogi, a venture capital-funded tech support company headquartered in Gurgaon, near New Delhi. Given the double-digit wage inflation and benchmarking of Indian mid- and senior-level salaries to global levels, it's becoming easier to hire talent from the developed world, Challu said. Because smaller companies typically need fewer key people, looking beyond Indian shores for key officers may be a practical option, he added. As Russell Parera, CEO of KPMG India, noted, "It's ironic that in a country of a billion people, the single biggest challenge to growth is the availability of talented staff and not customers."
Changes in the investment climate also can benefit smaller companies. "Now, investors don't scoff at rupee revenue components in the business plan," Challu said. "The IT and telecom sectors in India are early adopters of new technologies," so new companies can get their first break right in the domestic market. "What's more, references of an Indian user can now be used for global marketing, too," he noted, elaborating on how entrepreneurs could leverage the India advantage in the tech business. Vispi Daver, partner at U.S.-based venture capital firm Sierra Ventures, added that entrepreneurs could now raise $10 million within the country rather than having to seek it in Silicon Valley.
With a good number of globally renowned venture capital firms now in India, panelists urged entrepreneurs to take advantage of the value addition, guidance and insight that these VCs can provide to companies in which they invest, beyond the capital they contribute.
Tips for Budding Entrepreneurs
Terence H. Matthews, a Canada-based billionaire serial entrepreneur, had some tips for budding entrepreneurs. "The single most important word for success is 'persistence.' I have so far started up to 70 companies, of which I have lost only two," he said, speaking as part of a separate panel. He said he owed his success to hitting the market at the right time with the right technology and the right product. "But there's absolutely no substitute for work ethic and education," he said. He advised entrepreneurs not to become emotionally attached to the companies they found, explaining that 20 of his companies have gone public while several others were acquired. "I don't treat companies as babies that cannot be sold. [Instead,] I set up three new companies every year."
Matthews said his holding company, Wesley Clover, was looking to acquire companies in India to jump-start his plan to develop software products for the world markets there. Twenty tech companies that he is associated with outsource software to Indian firms. "India is at a tipping point, and the time is ripe for it," he suggested. "Outsourcing is not capped and will grow quite fast and move to the next stage of development of products for the world market."
Consolidation in BPO
Just as consolidation has occurred among IT firms in India, the business process outsourcing (BPO) sector is also showing sign of consolidating. The rupee's steady appreciation has put the brakes on smaller and newer players' undercutting established competitors. These challenger firms are being far more discerning in quoting uneconomic rates for outsourced work in the hope of breaking even. "We are already seeing a much easier employee hiring situation as a fallout," said Raman Roy, chairman and managing director of Quatrro BPO Solutions. As firms become more careful in quoting prices, the demand for talent to fuel growth at any cost is moderated, providing a needed breather from the high rates of attrition that have come to characterize the business in India. "Currently, most companies have hedged up to a year's worth of dollar receivables," said Roy, who is widely considered the father of India's BPO business. "The real challenge will come next year, when those hedges run out and we will see a lot of uneconomical companies quickly wither away."
Pavan Vaish, CEO of IBM Daksh Business Process Services, likens the industry's challenges to what happened in Japan years ago when the yen strengthened. "Companies reinvented themselves by investing in technology, R&D and extreme operational excellence. Of course, fewer companies who have the brand, technological capability and the management to make the transition will succeed," Vaish said.
Speakers at the panel discussion "Is the Party Over? The Future of BPO/KPO" were nonetheless bullish about the prospects of the larger companies in the $8 billion sector, whose revenues have been growing at almost 33% a year. Harsh Manglik, chairman of Accenture India, said firms such as his could improve productivity of processes by almost 50% while keeping the same people employed by the client working out of the same locales. "These are benefits we are talking about even before the operation is offshored to another country," he said.
Pramod Bhasin, CEO of Genpact, said India's penetration in the IT enabled services industry has been "minimal" to this point, and human resources is the key to growth. "The demographics of the developed world mean that they aren't going to produce 20- and 30-year-olds in huge numbers. Companies in those geographies will therefore have to find the capacity for growth in other markets. We feel limited only by our ability to hire employees who can provide a very high quality of service to our clients," he said.
The leaders of India's BPO industry have managed to build domain expertise, or in some cases acquire it in chosen areas. This has allowed them to deliver cost savings by reengineering processes rather than just through cost arbitrage based on cheaper Indian labor. Cost savings generated from a fundamental redesign of a process also allow the larger firms to share a part of the savings the client realizes. A lack of deep domain expertise is the reason smaller firms that focus on cost arbitrage are having a difficult time coping with the rising rupee. "Cost arbitrage as a basic reason to exist is over," the Bhasin said. "Now clients come to us because we can give them high-quality service and continuous improvement."
Vaish, of IBM Daksh, said firms will have to focus on delivering greater value, which will call for an enormous amount of investment in research and building domain expertise. Today, "it's very hard to do a [BPO] start-up in conventional areas" such as call center services, he said.
Leading BPO firms are now looking at what departments of top banks and companies they can acquire so they can identify efficiencies and create value by fixing something that is broken and providing the services back to the banks and companies on a contract basis. Focus areas could include such activities as research monitoring in a particular subject area and patent filing work. The biggest BPO firms are also actively exploring opportunities in the local BPO business, as banks, media companies and airlines that are growing revenue by 30% a year are increasingly willing to outsource noncore operations.
Jerry Rao, chairman of MphasiS, said the domestic and international call center business in India continues to grow. Even in a three-decade-old industry, firms are adding value by reducing average handle times per call by 30% to 40% using Six Sigma standards of efficiency. "India now has as many Six Sigma black belts and green belts as any other country worldwide. In five years, we will probably have more of them than the rest of the world combined," Rao said. "There are, however, several other opportunities that domestic entrepreneurs should explore which are allied to the BPO industry. For instance there are lots of opportunities to develop a new recording software used by call centers where an Israeli company currently has almost a monopoly." Rao also illustrated how small entrepreneurs were taking advantage of the growth of the larger players by setting up accent coaching classes to provide trained manpower to the BPO industry. "There are now 150 to 200 such classes in Bangalore alone, and I'm worried that people here will start speaking with a U.S. accent and I will not understand them," he joked.
Panelists pointed out that entrepreneurs need to be prepared for the polishing that graduates of the education system will require to become employable. "Whatever training the government doesn't give, you can provide as an entrepreneur," Rao said.
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Change management issues have become critical for most organizations as they continue to grow fast in a dynamic business scenario. They have to grapple with key issues like cross-cultural complexities, mergers and acquisitions, necessitating restructuring the organization, work allocation, team synergies, remuneration policies, and many such issues. HR personnel are expected to be the key change agents, as they are closest to the globally dispersed workforce across all hierarchical levels. The only problem is the fact that HR managers are not known to be the best change managers. They more often than not fail in their efforts to enable change positively and effectively. The causes require a deeper understanding of their mindset and evident handicaps. 
"When HR is aligned in the very beginning, they can contribute as well as become better aware of the need and impact. In the absence of this, HR managers as change agents are destined to fail"