No mid-life crisis for mid-size IT firms

*The imminent sale of Patni Computer Systems, the largest of the mid-sized Indian information technology (IT) firms, is a sign for many that a big round of consolidation of smaller or Tier-2 (T-2) firms is underway.
 
*Mindlance, a privately-held Bangalore-based IT firm, has won 48 deals in the last 6 months. Group Chief Information Officer Kamal Sharma, says 21 of them have been taken away from large Tier-1 (T-1) firms.
 
In the IT industry, firms race to get bigger and the larger of them wield an influence disproportionate to their size. More so, in India where the large Tier-1 (T-1) firms – Tech Mahindra-Satyam, Wipro, Infosys, TCS, Cognizant and HCL - contribute a third of the industry’s $60 billion IT services exports. They also rank among the country’s largest private sector employers.

Executives of many IT biggies and analysts in Indian IT industry habitually speculate on the future of the T-2 firms. The recent recession, which was particularly severe on T-2 firms and the buzz around Patni, have revived the talk that T-2 firms would either fade away or get acquired.

But in this hyper-competitive industry for every reasonable opinion there is valid counter point. Polaris Software MD Arun Jain says sheer size is no guarantee of longevity and even giants such as EDS have been acquired. Another CEO says the consolidation talk is merely another sign of media bias against the mid size firms.

To get a clear picture, it is important to cut through the rhetoric. As T-2 firms contribute one-third of India’s IT services exports, if the doomsayers are proved even partially right and if only a handful of giants are left standing, it would be terrible news for industry, customers and of course, employees.

Deccan Herald spoke to several representatives of T-1 and T-2 companies and analysts to try to sense where the T-2 players are heading to.

Market Opp: Does size matter?

The T-1 firms have grown up behaving like their larger peers, the multinationals such as IBM and Accenture. They have developed wide-range of capabilities, operate in different geographies and across several industries.  A T-1 senior executive said large customers who spend billions on IT seek end-to-end services - infrastructure management, application development, BPO, consultancy etc. - from the chosen few. If the trend of customers gathering around a few large players builds momentum, where would that leave the smaller players?

The notion that customers need end-to-end solutions from a handful of vendors is a myth, says MindTree Ltd CEO Krishnakumar Natarajan (KK). With multi-sourcing – buying from several vendors, including smaller ones — on the rise, the era of large vendors winning mega deals is ending, he adds. IT analyst firm TPI says the average size of deals has shrunk from $358 million in 2000 to $105 million in 2010. The smaller deal sizes hint at a growing trend of multi sourcing, which many analysts say help buyers reduce dependence on any particular vendor and get better returns. Ninety per cent of Fortune 1000 firms outsource and of these fifteen per cent multi source, says KK. If the present multi-sourcing initiatives succeed, they would trigger a hurricane of similar deals, he adds. 

Irrespective of these trends, many expect the market to continue to entertain T-2 firms. An Everest report ‘Survival of the Differentiated’ says large customers tap T-2 firms for specialised skills. Smaller customers who may not get the desired attention of large vendors also turn to them.

Scale Vs Specialisation

Till five years ago, customers were mainly focused on cutting cost through outsourcing. But now, in addition to generating savings, they expect their outsourcing vendors to boost growth and profit, bring in agility and innovate. They are also giving shorter ropes to vendors and seeking quicker returns. T-2 firms say it takes specialist vendors to meet the new demands of customers.  “There are many opportunities for smaller companies, provided they differentiate themselves sharply. They can no longer aspire to be similar to the larger players,” says Cognizant Technology Solutions Vice President-Research and Communications R Ramkumar.

”The rise of super specialty hospitals in the medical industry is a sign of things to come in IT as well,” says MindTree’s KK. Other T-2 firms echo the same sentiment. NIIT CEO Arvind Thakur says that end-to-end in everything will be a problem. “Technology is a high risk game. If you don’t differentiate, you die,” says Polaris’ Jain.

While the T-1 players have focused their energy in expanding and broadening, many T-2 players have tried to specialise. Jain says the smarter T-2 firms got the wake up call a few years ago when the customer expectations started changing. Polaris has reportedly spent Rs 400 crore in specialising to help banks modernise their legacy IT systems. Several T-2 have similarly found their sweet spots. Sonata helps airlines manage the extremely complicated task of pricing their seats, a highly perishable commodity. NIIT is a market leader in GIS solutions in India.

Specialisation is helping T-2 firms win deals against large ones. KK says 31 companies – including big MNC and T-1 names - bid for a Rs 30-crore UIDAI project. MindTree outbid other shortlisted finalists, IBM and Accenture, to win the deal.

But specialisation can be a mixed blessing. Experts say if a niche area becomes large and lucrative T-1 players can marshal resources and move in to offer a much larger and competitive solution. The T-1 industry source said, “What we don’t have, we acquire.” Everest Research vice-president Amneet Singh agreed and said some specialisations may prove to be ‘2-minute gold mines’. 

But T-2 firms remain sceptical. “Elephants have power as well as a baggage and may not always match the speed and agility of the deer,” says Jain. “The larger teams at T-1firms cannot match the skills of many small firms in cutting-edge areas such as virtualisation,” adds Sharma of Mindlance.

Specialisation also turns T-2 firms into niche players who are doomed to be small, say many. The T-1 source said T-2 players should build products like Quark Express and not try to become an Adobe or a Microsoft. Their focus should be on profit and innovation and not on scale. Singh says T-2 players may have to gain certain end-to-end capability in their chosen areas to build scale. But T-2 firms dismiss that scale and specialisation may not go hand in hand. The billion dollar T-1 club is not a permanent group. Many T-2 firms have either broken in or knocking on the doors, the CEOs say.

Landscape changing

They also point out that rather than replicating T-2 niche areas, T-1s should focus on adapting to the changing IT landscape. The rise of cloud and the increasing buyer demand for returns is changing the game. Analysts say by 2015 a good number of applications would be delivered through cloud and companies will need to work with smaller customers. “The T-1 players who are used to large accounts would need to transform their business model,” reminds Thakur.

Different companies are taking different routes to the cloud and at the moment it is hard to predict what will click. But companies which evolve flexible business models and create intellectual properties (IP) may stand a better chance.  If the cloud forces T-1 to reinvent, their lucrative legacy may come in the way. Sonata Software CEO B Ramaswamy says, “Building IP is a high risk game, which requires huge investment in marketing and engineering.” Companies which have huge cash flow from legacy business (typical T-1s) may have resources but are yet to deploy them to develop IP. A T-2 CEO said despite the rhetoric of embracing the cloud, not all T-1 firms are investing. “There are two T-1 firms who are not walking the talk and still clinging on to the legacy. They are busy protecting their margins and afraid of cannibalising their existing business,” he said. 

While T-2 companies say that their DNA is better designed to innovate, there are laggards in them also. There are several T-2 players who have not grown beyond generic capabilities of the past. They could be counting their days.

T-2: Tail wind, head wind

T-2 firms say they work with fewer clients and provide better attention to them. Sharma further says T-2 firms are better suited to provide best-of-the-breed solutions as they typically work with lower overheads and margins.

Ramaswamy says eighty per cent of the buyers who visit Sonata campus and take a "deep dive’’ end up striking a deal. “They get impressed by our domain knowledge and also know that the staff they interact with initially will be the staff they would work with eventually,” he adds.  

“The problem, however, is to get the buyers to visit T-2 firms as the media and analysts tend to favour the larger players,” he says. T-2 firms also reportedly suffer from higher attrition. Employees leave smaller for bigger firms, said the T-1 executive. The majority of T-2 firms have seen leadership-level changes in the last two years, he added. The T-2 firms counter by saying they offer more responsibility and authority to talented employees, who do not want to get lost in a sea of humanity within T-1 firms. 

In conclusion, it is not just the T-2 firms which are challenged and there is nothing that makes their fading away or acquisition a karmic destiny. Size seems to be irrelevant in ensuring success or longevity and what matters is how well both T-1 and T-2 innovate to face the challenges. Ramasamy says success comes from an ability to spot opportunities early. “Arrogance can clog visibility,” he warns.