Economy Rostrum

Future of IT Outsourcing Industry and The Road Ahead

The global outsourcing market especially the IT outsourcing market after a few choppy and trying years, hopes to find its lost rhythm back in 2019. Mint newspaper says the sector will grow faster in the year starting 1st April, thanks to twin trends of larger contracts and increased outsourcing. In this background, I am composing my thoughts here on how the Software Services firms especially the small ones in India can reinvent themselves and plan their road ahead.

Source: Statista. After a few choppy years, 2018 stabilized the global market of the outsourced market. 2019 is expected to be a growth year.

Outsourcing is not new to me! My grandfather Sri Krishnaswamy Sarma (Founder of LIFCO in 1929), a publication firm known for regional language Dictionaries, had outsourced as early as the 1950s, the printing and binding of books to third party shops when the prevailing trend followed by other publishers were to do in-house production.

Right out of Engineering college in 1996, I started my IT Services firm, Vishwak Associates. Over the next decade, I grew the business to be able to operate in three countries (India, US and UK), customers in nine markets, a few million in annual dollar revenue and comfortable profits. Though demanding, I enjoyed playing the game and when opportunities came for buying my business, I turned them down.

“How did you go bankrupt?” Two ways. Gradually, then suddenly. Ernest Hemingway in The Sun Also Rises

Then, the global recession came, and the market shakeup, I found myself saddled with debt due to accumulated product development and marketing expenses, and, falling revenues. Determined to see this through, over the next few years I reinvented the offerings and focused on select markets, to become leaner and profitable – then in 2012, Vishwak got acquired by a larger IT services firm. With the new sales and financial power behind us, over the next five years, we kept winning deals from large enterprise clients in the USA and India – our profits too grew healthily year on year. In 2016, we released a mobile app for news. Powered by machine learning, it accurately predicted what news its users would be interested in – without the users having to tell the app anything explicitly. Two years ago, after being in the industry for two decades, I decided to sell completely and cash out.

Now in my role as an investor and advisor, I have taken front row seats to watch the game and be involved in the planning. My honorary role as a Microsoft Regional Director gives me the opportunity to dabble with coding, update myself on the latest in technology and reinvent myself!

Change is not new to the Indian IT Industry. It has revived itself several times over its five decades of existence – to know more read this seminal book by Mr Dinesh C.Sharma titled “The Outsourcer – The Story of India`s IT Revolution (History of Computing)“.

In 2016, Mint newspaper wrote an obituary saying “Indian software dies at 17 from failure to grasp future”. That column led me to research on the subject, it became quickly apparent, that the Industry leaders (including me) were not stupid or unwilling to change, but the change was not easy and we needed modern tools. To address this, I collaborated with the management consultant Mr Sankararanayanan, the creator of an ideation framework for change management called C6. We both conducted a day-long workshop for Nasscom in 2017 titled “Change Management: Rebooting Software Industry for Tomorrow” which included quite a number of interesting case studies across industries. Later that year, I presented to over a hundred of Microsoft MVP’s on “70 Years of Software Development and Change Management for Software Industry”.

“I do not believe you can do today’s job with yesterday’s methods and be in business tomorrow.” Nelson Jackson

Last year, I presented to an esteemed audience of IEEE and CSI members on how the IT industry can reinvent itself by investing in modern trends around DevOps, Digital Transformation and continuous learning. Following this, I conducted a series of talks on what is Digital Transformation?

Now to the present. Gartner in their report “Top 10 Strategic Technology Trends for 2019” talks of three broad trends – Intelligent, Digital and Mesh, these are expected to bring in higher spends from customers.

These trends are positive developments for India’s $167 billion information technology (IT) outsourcing sector. Mint newspaper says “the current fiscal saw IT firms adding more employees and raising salaries of some of them by as much as 40%” and in an article this January, the same newspaper predicts that the sector could grow faster in the year starting 1 April“.

While the above are all good omens, there are strong headwinds that threaten the way the IT Services business works – including increased cost of reskilling the employees, lower margins, changing customer expectations, newer business models, political uncertainties, digital natives joining the workforce and many more. How can a small and medium-sized company operate and thrive in this environment?

The following seven sections will guide you to find your way and gain speed:

1.Funding

Over the last few years, startups in India who are into consumer apps space have seen their valuation skyrocket and investors pouring down money. We have seen many unicorns being created every year. Founders of IT Outsourcing firms need to remember that their industry operates differently to this. Consumer App businesses are built for scale and investors too value them accordingly, whereas IT services is a mature industry and have become a lifestyle business. Gone are the days of 20-30% growth YoY. Today, a well run ‘niche’ IT services firm can expect to grow only in upper single digits (say 8-9%) YoY, with a profit margin only in the range of lower double digits (10-15%). There will be little to no interest in these businesses from an Angel or a VC – so don’t waste your time in courting them. This business just doesn’t work for their model.

“Startups are, by nature, a risky business – this is a feature and not a bug.”

Instead, you need to be bootstrapped, self-funded, or go after HNI (High Networth Individual) investors – there are quite a lot of industry veterans who are deep-pocketed and want to give back, or, be open for the M & A route – larger IT firms are keen at acquihire to quickly ramp their teams with focussed or specialised skills.

Any funding exercise is not going to be an easy one. It is emotionally and physically draining, be open for it. For every successful round of funding, the founders go through multiple rounds of rejections, failures and disappointments. In my own experience in 2011 and 2012, I have had three unsuccessful negotiations (two potential suitors from India and one from the USA) before I was able to close the deal.

Look at this statistic: Dr Thillai Rajan of IIT Madras in presenting the 10th edition of the report on the startup ecosystem says in the period from 2000 to 2017, 1.26 Million companies were registered in India. Out of which the potential for VC funding was for about 275,000 companies, who actually got funded was: 6,214 and those who got an exit was: 1,624.

2.Pricing

More than ever, in 2019 IT Services is a commodity business where you need to have the scale or be extremely nimble and a specialist.

Unlike, in the past business cycles, this time around, the quantum of ask from customers has not increased incrementally, but exponentially. They want their outsourced vendor to provide them with 10 times more features at 10 times lesser price – and what’s more, within the delivery time of weeks, instead of months. Unfortunately, for the service providers, all these demands are fair and doable, thanks to the arrival of newer processes (Agile, DevOps) and technologies (Cloud, AI, Automation). Also, the productivity of service providers has improved phenomenally due to newer platforms and easy availability of mature Open Source toolsets.

If you are NOT going to (or able to) meet these demands from your clients, you can be sure your competition will do it – and if they are good they will be doing it for a profit.

One good thing for the industry has been the Rupee to Dollar exchange rates, which have been favourable for exports and is expected to remain the same, due to the American economy remaining strong with lowest rates of unemployment there.

3.Business Models

Today’s contracts expect the IT service player to be a “true” system integrator and an advisor. They can’t be just scouting for every opportunity to do custom software development from scratch.

We are seeing more of pilot projects, department-scoped projects happening, which are by nature smaller and shorter duration. The good news is that more of these are being created and as Rishad Premji (Chairman, Nasscom) has said: “Digital spend is industrializing a little bit, moving from pilots and PoC (proof of concepts) to big spends.

As applications are moving to the cloud, containers, and to SaaS platforms, the need for typical 24 x 7 support and baseline maintenance is quickly vanishing. For example, an application running on Force.com or Office365 or WordPress.com requires a fraction of engineers for its support and enhancements.

In the case of digital transformation contracts (which are growing now), customers want to pay for the business outcome and not for the project completion – which has NO meaning in 2019. In the past, the IT industry was unaffected for customer’s failing, like in the old joke, “Operation Success, Patient Died”.

‘The snake that cannot shed its skin must die” Friedrich Nietzsche

For existing vendors to transition from their FTE (Full-Time Employee/Equivalent) and T & M (Time and Material) model of pricing to the newer world of outcome-based pricing is going to be tough – there are no manuals available for doing this. All the stakeholders are feeling their way through.

A relevant book for many in the IT Services Industry will “Digital to the Core: Remastering Leadership for Your Industry” by Gartner, containing lots of successful case studies across industries.

4.Talent

Earlier, the IT industry was dependent on hiring fresh engineers in droves and a limited number of experienced engineers. Today, you need more experienced engineers, especially those who are familiar with newer technologies like Automation, AI & Analytics – and hiring them is going to be inherently expensive. So, you need to be super smart on your employee mix and keep improving productivity.

You also need to look beyond engineering graduates. For example, for implementing a typical AI or Data Analytic projects, you require a team with cross-domain skills. That’s why you are seeing CTS, Infosys and others hiring usability experts, behavioural scientists, statisticians, economists and so on. You can’t be depending on the clients to teach your engineers these skills. Today, in all the projects, Privacy and Security are super important – you need experts on these areas to be available as part of every project. It is no more a bolt on.

Even “fresh” engineering graduates are becoming expensive. Product companies and startup today offer Rs.15-30 Lakh ($21,000 – $42,000) compared to the low salaries of Rs.3-5 Lakh ($4,200 to $7,000) that are being offered at Services companies.

The above talents are not going to be available only from say Bangalore/Chennai/Hyderabad/NCR. Please look beyond the top cities. Even if you are a small firm you need to hire talent wherever they are available, which means your culture, collaboration process and toolsets have to be welcoming and have little friction. A great book on building a suitable culture for remote workers will be “The year without pants” written by Mr Scott Berkun, a former Microsoft manager, on his experience of working in the company behind WordPress.

To learn on hiring and retaining talent, check this talk by Mr Mahesh Murthy on “Managing today’s employees – Reinventing HR for the new enterprise” where he says “The true HR of a company is the CEO; I want to hire people who can have significant way with ambiguity; One sign of hiring the right candidates is to call the potential hires and offer them less than what they are getting”.

5.Marketing

Gone are the days, when you could be a Microsoft or an Oracle Partner or an AWS Partner, and if you are good on what you did, you could expect referrals from the principals or sub-contracted work from the biggies.

Today, there are thousands and thousands of IT Services firms in India. Competition is coming from Vietnam, Philippines, Ukraine and Eastern European countries too. Vanilla brute force cold calls have become almost useless. Google Ads, Facebook Ads are now yielding a lower and lower number of leads.

So your costs are increasing, which means you need to be innovative in your marketing and branding, to stand out from the crowd. To do that, get your marketing message/kit made as professional and as clear as possible. Spend “good” money on this, no shortcuts here. Potential clients have no time or energy to look at a shabby email. Be clear whether you are selling a product, a SaaS subscription or a custom development service. Be warned, “we will do anyway you want” is not an offering, no potential customer is searching for that in Google.

If your business plan or strategy reads something like below, stop and watch the brilliant talk by Simon Wardley on “Crossing the river by feeling the stones“.

Our strategy is cloud based. We will lead a collaborative effort of the market through our use of digital business and social media to build a growth. By being both agile and sustainable, our networked approach will drive learning organization throughout the organization. Synergies between our artificial intelligence and virtual reality will enable us to capture the upside by becoming innovative in an open world. These transformations combined with blockchain due to our data leaders will create a revolution through big data and leaders. Source: A generator app – A quick route to building a strategy by Simon Wardley.

Instead of these non-sensical strategies, write something that is direct and short. Your marketing message should clearly answer the questions – what you are selling, how you are charging for it, what does it include and exclude, why should he/she buy from you and not ABC, and, finally, the most important item, address the issue of what’s in it for the reader?

Ms Jessie Paul, a marketing expert and author is passionate about simplicity in marketing. She says in India our businesses complicate on the options presented to their customers. They should make is short easy and less complicated. She advises the audience to come up individually with the following superlatives for their business:

I’m the best at —
I’m the only —
I’m the biggest — and so —
I’m the cheapest — because —

If you are on a tight budget for marketing (who is not?) then grab a copy of this book “Devil Does Care” by my friend Mr Pravin Shekar, on the secrets of doing Outlier marketing with a frugal budget.

6.Geography

When picking up a market, start with only one geography. As an SME you will not have the money for targeting say the USA, Singapore, Germany and India. Remember though the USA as a market is still attractive, it is over-crowded and it is NOT one geography from a marketing perspective. Marketing to the USA is the most expensive, compared to many other markets for a company from India.

Without geography you’re nowhere. Jimmy Buffett

If you have a product/service that has a demand abroad, please focus on that. Domestic (India) market continues to be challenging with the age-old problems of low pricing, lack of maturity on the requirements, unsustainable number of change requests, late payments and so on.

If you are focusing on the US market, then you may want to follow the firms who have succeeded in selling to those markets. In this talk, Mr Suresh Sambandam (Founder & CEO of Orangescape) shares his experience of trade conferences not working, and their sales process is focused on metrics, user behaviour, SEO position & individual salespeople performance.

A few years ago, I wrote about how to “Run a product business in India“, while SaaS pricing model and GST regime have obliviated some of the hurdles, many of the others are still relevant for today.

7. Statutory

Over the last decade, Governments around the world, especially Government of India has become strict on taxes and company law compliances – with the good intention of going after fraudulent and shell companies which finance the bad guys. For lapses as common as mistakes in returns filed, or late tax payments whether it is TDS or GST, the penalties prescribed are draconian and even include a prison term of up to 7 years. We now, hear of the horrors with the Angel Tax, or prosecution notices for delay in deposit of TDS amount, and so on.

“Government! Three fourths parasitic and the other fourth Stupid fumbling.” ― Robert A. Heinlein, Stranger in a Strange Land

First hand, I had spent over ten years in fighting a case with the Income Tax department on the Income Tax Holiday under section 10A/10B meant for supporting STPI units. During the time the case winded its way up the chain of appeals, nearly Rs. One Crore ($150,000) of my hard earned money (in the form of TDS deductions and refunds due) was stashed away by the department – I had to borrow the same amount from banks at huge interests for my working capital needs. Fighting the case in the Indian Tax/Legal system can be extremely draining – for best results, you (as the owner) need to directly interact with the stakeholders and most of them have little understanding of how the knowledge economy works.

Recently, apart from the Angel tax, I have been hearing from my peers in the Industry on notices being issued for many of the IT Services companies on the topic of transfer pricing – this is the price that the foreign arm of an Indian firm pays the Indian company for the services rendered in India and sold by it in abroad – the Income Tax department is taking a strict view that the price charged should be competitive in the open market and be at an arms-length. In one case, the assessing officer even demanded that the USA arm contact its end customer and get a copy of all the quotations received by them from vendors around the world!

I am aware that most of the founders, especially those with non-accounting backgrounds, tend to delegate all aspects of finance, taxes and legal compliance to others. In the initial years, I too did the same, but after my experiences with Income Tax, RoC, and PF authorities, I had to take a hands-on approach. Every fortnight, I personally go through a checklist of compliances and taxes that are due to be paid or filled. There can be no loose ends here.

For every other country that you have a branch or a subsidiary, the above compliances grow exponentially – there are only a few countries in the world which are as difficult to do to business as India – but even in the USA and the UK, the compliance costs are only increasing in recent years. You will do yourself a lot of good by hiring a local expert (the equivalent of our Chartered Accountants/Auditors) in each of these countries even if it will cost you more than doing the filings yourself – also select an auditor and legal advisor in India who is well-aware on cross-border taxations and contracts. There are many small consulting firms run by former entrepreneurs to help you with these.

Areas to invest

Depending on your strength, areas to invest will be Cloud Migration, Legacy Modernization, Security, PWA, Analytics, AI and Automation. Industry verticals where I see growth opportunities for small vendors would be Education, Retail, Health & Wellness, Media and Technology startups.

Summary

Worldwide IT Spending Forecast (Billions of U.S. Dollars) by Gartner (October 2018)

As the above chart shows, Gartner predicts “IT services will be a key driver for IT spending in 2019 as the market is forecast to reach $1 trillion in 2019, an increase of 4.7 per cent from 2018. An expected global slowdown in economic prosperity, paired with internal pressures to cut spending, is driving organizations to optimize enterprise external spend for business services such as consulting”. So it is going to be a mixed bag for the IT Services sector.

On one hand, with Digital Transformation and Mobility, Software has become an integral part of every organization around the world, as a result, the spends on IT will continue to be large. India continues to produce a large number of engineers who can speak English and can learn newer technologies – especially with the rise of immigration restrictions in many of the western countries, which are key markets for the sector, there will be a lot of work for Indian Offshore engineers to do for many more years. On the other hand, the increasing pricing pressure from customers, quick obsolescence of skills and rising marketing costs will test the mettle of the players in the industry – only those who are nimble, resilient and highly productive will survive.

I will end this article, with the below thought for you to ponder over:

India has created several unicorns in the last few years, many of them are funded with several billions of dollars.

If the Indian IT Industry truly has great technology chops, capable of creating world-class products, then why are the likes of Flipkart, Oyo or Ola are not outsourcing a significant portion of their software development? Instead they are doing almost entirely in-house.

Compare that to the Automobile industry where the ancillary industry is many times that of the main OEM, why haven’t we seen a multiple number of IT outsourcing firms being created for every Oyo?Why?

Venkatarangan

Yesterday, there was a panel discussion hosted by TiE Chennai on this same subject, I had the privilege of joining by Mr Swami Nathan (Threshold Partners) and Mr Balaraman (Congruent Solutions) discussing on this. Check it out.

6 Comments

  1. Parthasarathy Reply

    Excellent points sir ! Thanks a lot for sharing your thoughts.

  2. Thanks Venkatarangan. Very valid points and I couldn’t more. Sadly, small companies are in the cusp of loosing their relevance if they continue classic way of doing business and marketing. ISV segment also needs innovative solution but hard to see AI based solution or infused atleast to stay relevant. Big fish eating small fish strategy gonna continue. I believe, service companies might get consolidate or merge leaving few players.

    • Thanks. On the small fish being eaten by the big, while I agree, I see it playing out slightly differently after you take into consideration the pace of change in technology and relentless commoditization of the latest by the giants AMG (Amazon, Microsoft, Google).

      Today the large service providers are able to excel on say Digital Transformation and AI, as they can afford to cross the entry barrier and hire the “rare” talent due to their size and power. But, what about the next big thing in technology – Large firms have inherent inertia and large bureaucracy (however cool they may be) that will blindfold them, that’s the opportunity for a new/small player to come in and fill. Bottom line, I see both small and large always existing, what they do, the pie they choose, will be varied more than ever.

  3. Very well written and covers the trends that are in limelight. More can be added on Reskilling . i.e. if you are in X tech background what could be in the latest that can be more easily reskilled to(in cases where such paralance can be drawn) which can serve as a guide for some confused minds.

    On the second part of the article for budding entrepreneurs this will be a quick sneek peek of what it takes if bitten by the startup bug.. I see the seven area as the Seven Chapters in the book you wanted author.,

  4. Govindarajalu Reply

    Well researched and nicely organised article. Highly useful to fresh graduates planning to become business owners.

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