Product story of Indian IT firms remains a mixed bag

Indian IT services companies’ bet on products and platforms (P&P) remains a mixed bag so far. While some companies are dealing with the seasonality of the P&P business, others are focused on providing productised service offerings to clients for bagging large deals. And competition remains intense from pure play SaaS (software-as-a-service) firms.

With the interplay of these factors, return on investment on P&P business stays below optimum level for most domestic IT companies. Experts are of the opinion that unless these companies hive off their P&P business and imbibe the culture of a product company, true potential of P&P segment will remain untapped. In valuation term, experts say, putting products and services under one umbrella confuse investors.

“There is no doubt that software and platforms present a large and attractive market. However, they require a different operating model, funding mind set and governance model than professional services. Hence most of the services companies’ ventures into this market have proven disappointing,” Peter Bendor-Samuel, chief executive officer of IT analyst and advisory firm Everest Group told DH in an email reply.

“HCL Tech’s acquisition of the IBM software business has proven a drag on both growth and earnings. That is not to say they have not enjoyed some success. Platforms and software are clearly part of both TCS and Infosys portfolio. However, given the investment and ongoing expense of these sectors and when compared to investments made specifically into pure play software firms, performance of these assets is disappointing compared with the rest of the business,” he added.

Seasonality at play

P&P is always vulnerable to seasonality. While some quarters will see higher revenue generation, others may be down. Recent performance of HCL Technologies (HCLT) and mid-tier firm Persistent Systems can be taken as a case in point. For fourth quarter of FY22, HCLT’s P&P segment witnessed 24% decline in revenues at $304 million. However, revenue from this segment stood at $1.39 billion for FY22, a marginal fall of 1.3%. This indicates while some quarters were better, others witnessed a decline. Similar was the case for Persistent Systems whole IP-led revenue declined 3.9% at $90.6 million in FY22 as compared to FY21.

Both HCL Technologies and Persistent Systems have sound P&P portfolio with aggressive focus on this segment. In 2018, HCL Technologies had bought IPs (intellectual properties) from IBM for about $1.8 billion, making it the single biggest investment for any Indian IT player. The company has also carved a separate division ‘HCL Software’ that houses all its products and platforms.

Its peers, TCS, Infosys & Wipro also have sound P&P portfolio. However, many experts feel that these IT biggies are more focussed on using these platforms for winning large deals though they have considerable deal wins from individual products.

“IT biggies like TCS leverage product business to win large deals. Because use of own platforms helps them to drive margins. So, these companies take P&P as solution business that will supplement the margins without driving the price. So, TCS may not separate this segment as they get margin leadership due to these solutions,” said Pareekh Jain, an IT outsourcing advisor and Founder of Pareekh Consulting.

“There seems to be a status quo in terms of P&P business at Infosys. However, HCLT will continue to be product-heavy given their sharp focus to emerge as a different player,” he added.

In revenue terms, TCS’ P&P business is worth around $3 billion, constituting around 12% of its revenue. For Infosys, which has clubbed its product business under EdgeVerve apart from accounting it for large deals, would have a top line of around $1 billion from this business, sources said.

For HCLT, P&P had a revenue of $1.38 billion in FY22, contributing 12% to overall revenue. Mid-tier firm Persistent Systems had a revenue of $90.6 million from IP-led business, which was 12% of its total revenues in FY22.

Hiving off may help

Traditionally, the business models of product and services companies vary. So, the age-old dilemma of clubbing both these under one roof continues. Global giants like HP, IBM separated their product businesses for sharper focus.

Moreover, pure-play SaaS companies have made the competition tough now. Without a good development and sales team, it is no longer easy to compete in the market place. “The DNA of product business is different that from services. Indian services companies don’t see any negative growth (exception of FY21 owing to Covid), which happens in the product business. Currently, services business is growing very fast. So, there is not much of a focus on the products side also,” said Jain of Pareekh Consulting. However, margin on product business is higher than the services.

An HR expert dealing with hiring of engineers for deploying on P&P business of tier-I firms said the need for talent in product companies are different.

“Salaries of product companies are higher than those paid to engineers engaged in services business. IT firms require a different mindset to scale up a product business,” he said.

However, new deal wins now have a significant Cloud-based, SaaS-based platforms component & clients are increasing opting for pay-as-you-use kind of consumption model.

Therefore, the focus on P&P is a must as new technologies like metaverse, 5G and many more are all set to make deep inroad. So, hiving off product business into separate entities can not only raise focus, but it can also unlock value for shareholders.

“If the shareholders of those IT firms want to own software and platform assets, they would be far better-served owning them in separate companies. It seems highly unlikely that shareholders will ever unlock (P&P) full value while embedded in their service company parents,” said Bendor-Samuel of Everest Group.