Indian ITO: a three-part plan for achieving non-linear revenue growth
Technology has always aimed to change the status quo by making it effective to perform business functions. The success of technology in business is measured by the impact it creates on the top line or bottom line, either by allowing firms to pursue new opportunities or by improving the efficiency of existing operations. Indian IT outsourcing firms have so far adopted the strategy of offering cost-effective services to develop, maintain and integrate software by leveraging cross-border wage arbitrage, quality English-speaking technical engineers and standardised software engineering processes. For about two decades now, this strategy has contributed to strong growth and stock market response with the rise in equity prices of most of the IT outsourcing firms.
Not so long ago, markets rewarded and measured stock prices of these firms on the basis of expected growth in the number of employees, referred as “headcount growth”. With many top firms reaching headcounts above 100,000, stock market analysts are increasingly cautious about how these firms plan to grow, in future, without proportionately adding new employees. At the same time, clients of these firms are pressured with ongoing slow economic growth, forcing them to identify a new way to reduce costs with least or no capital investments in building new technology assets. The combination of markets’ expectations and clients’ requirements in the “new normal” economy is introducing the need of non-linear growth in the IT outsourcing industry. Although firms are implementing various strategies and tactics for non-linear revenue growth, the contribution of such revenue in the overall sales is still low, at around five per cent.
Indian IT outsourcing firms can meet the challenges of non-linear revenue growth by leveraging their industry domain expertise, by creating entrepreneurial organisation and by shifting the market positioning strategy. First of all, firms need to consolidate business process knowledge, which exists inside the organisation, to an extent where the processes can be standardised or disrupted. Secondly, firms need to create entrepreneurial organisation structures to meet the challenge of consolidating their fragmented domain knowledge. Firms can establish venture-style limited partners and general partners, who will provide funding and support to the team of entrepreneurs responsible for identifying, creating and marketing technology assets for non-linear revenue. Finally, firms need to create a market positioning strategy that will safeguard their brand for selling traditional outsourcing services and from any market failure of new technology assets. Firms can establish market and brand positioning of individual vertical-specific technology assets similar to that of the brand strategies of consumer goods companies such as P&G and Unilever.
The three-part initiative will allow IT outsourcing firms to meet the challenges of generating non-linear revenue, reduce the risk of investing in creation of technology assets, establish a superior control in managing non-linear revenue growth and eliminate the brand conflict between providing traditional headcount-based services and non-linear revenue-based industry solutions. In essence, a firm adopting such a strategy can get competitive leadership in generating non-linear revenue that is fast, manageable and sustainable.
The transition to non-linear revenue is inevitable. According to a report titled ‘The End of IT Outsourcing (As We Know It’ by outsourcing practice consultants AT Kearney, IT outsourcing as we know it now will end in three years. The article defines: “traditional IT outsourcing as multi-year contracts based on developing and maintaining custom code and running on the backs of legions of programmers and on-site systems integration work”.
The rationale of such a claim looks both bold and convincing because commoditisation of technology is about to overcome the advantage of wage arbitrage. With firms such as IBM, Amazon, Google and Microsoft creating huge cloud infrastructures, and business applications being built to provide solutions anywhere in the world, it is evident that the industry is changing at a faster pace than it was imagined ten years ago. The legacy applications will continue to exist for a long time, though servicing them may not be sufficient for IT outsourcing firms to sustain their dramatic growth.
The “non-linear” aspect of the new growth comes from the equation of generating revenue without adding the proportionate number of employees, requiring a pricing model based on transactions or outcomes instead of number of employees engaged in projects. So far IT outsourcing firms have made fewer investments in creating, marketing and selling technology assets either as a product or subscription-based service. Firms are mainly engaged in creating assets in clients’ premises by using the investment capital of clients. In essence, firms are providing human capital services to clients.
In addition, during most investor and analyst conference calls, the CEOs of IT outsourcing firms are asked about percentage contribution of non-linear revenue to the overall top line. Essentially, the capital markets are interested in knowing the possibility of sustaining the revenue growth and, as a result, the stock price. If firms grow by continuing to add headcount then most of the top firms will soon have more than 300,000 employees, thus adding to the challenges of managing a large global organisation. Simultaneously, wage arbitrage is not as lucrative as it was ten years ago. Stock market analysts are bound to ask more such questions in the next few years because it is increasingly difficult to sustain profit margins by increasing headcounts when wage pressure in India is rising and the pricing power of firms is not increasing at the same rate.
Finally, the economy has taken a radical shift since the financial crisis of 2008. Banking and financial services clients that were the major portfolio of IT outsourcing firms are pressured by their investors to reduce operating expenses and capital investments. These clients are reluctant to invest new capital for creating technology assets in their premises. More importantly, the decision of build versus buy has tilted towards buy as more technology offerings are available with low-risk subscription-based models. Therefore, the impact of the “new normal” economy in the west is forcing clients to reduce their capital investments and operating expenses by negotiating new models with the IT outsourcing firms.
Throughout the IT outsourcing industry, concepts such as SaaS, PaaS, IaaS, BPaaS, cloud computing and service-oriented architecture are widely discussed as a way to generate non-linear revenue. Firms are also exploring methods to change their commercialisation strategy and thus, creating a value proposition more dependent on the business impacts for clients. The new business impact, which will be created by an IT outsourcing firm, will not merely be a reduction in costs or improvement in software quality but it will challenge the notion of developing a software at the client’s premises.
Although IT outsourcing firms have come with offerings that provide them with non-linear revenue sources, the depth of such offerings for an industry is no way near the extent of services they provide in current linear models, when looked from the perspective of the business processes of an enterprise. Also, some of the large outsourcing deals with transaction- or outcome-based pricing strategies significantly increase the risk of revenue loss for IT outsourcing firms because of the nature of long-term contractual arrangements. Additionally, firms are facing difficulties in marketing new technology assets because of the fear of maintaining dual industry positioning – first, as an onsite-offshore service provider and second, as a business process solutions provider.
The reason IT outsourcing firms may further delay identifying a comprehensive solution with non-linear commercialisation model is that they lack comprehensive initiatives to increase the pie of non-linear revenue.
Firms need to realise that it is their business domain positioning, not their high-tech products and strategy, that has made them successful so far. One of the biggest selling propositions of IT outsourcing companies, with the development centres in India, has been their ability to create industry verticals and align their sales, relationship management, project management and development teams with those verticals. Historically, IT outsourcing firms have talked about their ability to move up in the value chain by acquiring industry expertise. Although such a claim is true, the domain expertise of these firms is highly fragmented. In addition, the challenges of market positioning make it increasingly difficult to convince clients of a firm’s ability to provide standardised business solutions. Outsourcing firms are increasingly taking the route of acquisition but it comes with challenges of integration and sacrifice of capital unless reusable technology assets and a large number of existing clients are acquired, which will in-turn require high acquisition premiums.
There are three key initiatives firms can take to internally create the roads to the non-linear revenue growth:
- Internal Strengths – leverage domain expertise to solve business problems
- Entrepreneurial Organisation – create parallel entrepreneurs-investor organisation
- Brand Shift – create individual brands like consumer goods products
Leverage Industry Expertise
For about a decade now, IT outsourcing firms have been using the concept of vertical and horizontal as their sales tools. Although firms have been able to get some large deals of managing the entire business processes, the industry expertise in most cases is fragmented because of the size and geography of the organisations. Looking back in the late 1990s or early 2000s, firms were small in size and it was easy for management to consolidate the industry expertise to create a sales proposition. However, it is very difficult for a handful of persons within the company to have end-to-end knowledge of enterprise business processes. Firms tried to consolidate industry expertise by creating business consulting around the IT services but that has largely ended up as a supporting team that helps break the ice for sales deals of IT services. Companies need to consolidate business process expertise and integrate processes before creating technology assets.
A business process is defined as “a structured, measured set of activities designed to produce a specific output for a particular customer, customers or market”. “The customer” is the focus of a business process, and looking at a business process requires the point of view of customers. IT outsourcing firms are engaged in business process automation for their clients but have not created value through disruption or standardisation of such processes. From the perspective of technology assets, the key issue is not only the business processes but also the integration points among processes. This understanding leads to defining the boundary of the technology asset that is created to automate the business process. For example, a core banking solution may be comprised of retail banking, customer management, account management and check processing. A bank may implement isolated CRM solutions for customer management but would prefer to have end-to-end core banking solutions to ensure smooth integration of transactional processes. Therefore, defining the boundary of standardised technology assets requires an in-depth and consolidated understanding of the business processes within an industry vertical or sub-vertical.
The situation of business process expertise can also be understood through an example of Lego® blocks. Each team within an organisation has combined individual blocks to create their own assembly parts, and now is the time to look at these individual parts and put them together to form a valuable product. The challenge within IT outsourcing firms is that there is no separate organisation or group that overlooks at the end-to-end business process from the perspective of identifying the scope of changing the status quo of those business processes.
In the context of non-linear growth, there lacks an organisation that can standardise or disrupt the business process. It’s easier to do such a task for a process such as customer relationship management (CRM) or for that matter, some of the ERP in a supply-chain organisation, but it is tough to do so for many industries where business processes are interconnected and real-time technology integration among disparate processes is difficult.
Firms need to boldly think about standardising the business processes of industries they serve. Such a task can only be performed when firms are able to consolidate various activities that are taking place within their teams for an industry. This initiative will allow IT outsourcing firms to leverage their industry domain skills from a problem-solving perspective, which is beyond just a sales pitch. It will also ensure that automation of any business processes align with the top-line or bottom-line performance of their clients. Both macro and micro views of the processes are required to create the financial impacts for clients.
Although not all business processes can be standardised, most of the companies that are founded in the software-as-a-service (SaaS) model have used standardised business processes as their foundation. Moreover, the founding teams of these firms are typically comprised of industry experts with technology background, helping them in standardising, disrupting and automating the business processes of an industry. For IT outsourcing firms, the solution to consolidating the fragmented industry domain expertise within the firm lies in structuring the organisation in a way that will implicitly drive this agenda.
Create “Entrepreneur-Investor” Organisation
The typical structure of an IT outsourcing organisation that is using the onsite-offshore model comprises a team with business development and relationship management at the client location, and the development centre in the location where comparative wages are low. One of the oldest pictures of the onsite-offshore model had an onsite and a corresponding offshore component in which project leaders on both sides collaborated to execute the software development while managers on both sides collaborated for delivery, revenue management and new business deals. To a large extent, this holds true today but with more complexity for moving up in the value chain.
By the middle of the last decade, firms added domain consulting groups and took more complex integration projects in pursuit of increasing value for their clients. The strategy paid off by helping firms break the ice of large IT service deals as well as allowing them to command high pricing for some domain-specific business-technology projects. In a short span of time, the commercialisation strategy of firms changed from a per person hour time and material (T&M) model to fixed-bid pricing, allowing clients to manage operating expenses by offloading some of the risks of changing business requirements for a technology projects. The BPO arms of IT organisations took care of operational aspects of the clients and the concepts such as low-end BPO and high-end BPO developed, classifying call centre and back-office outsourcing respectively in a true sense. In the “new normal” economy clients are looking to offload more risks to service providers, and this time there is the need for clients to manage capital expenditure by reducing or eliminating the creation of new technology assets.
IT outsourcing firms are reorganising to transition towards non-linear revenue growth, and they have developed many different groups and assigned various responsibilities to existing practice heads. Some of these are sales targets for non-linear revenue growth and creating teams that are responsible for this transition. However, the challenge is to identify technology assets that should be created and the investments that need to be made. In addition, practice heads are struggling with managing the priority and trade-offs between linear and non-linear revenue targets.
To resolve these challenges, a proposed organisation in parallel with the current organisation will provide the pay-off. The proposed way of managing such an initiative is to create entrepreneurial organisations within the large company and support entrepreneurs with venture capital general partners for creating the technology assets. The entrepreneurs are responsible for consolidating the business processes, standardising them, conducting market analysis, creating technology assets and taking products to the markets. Using the Lego® analogy, the proposed entrepreneur has the visibility of the valuable product and has the ability to combine individual parts that exist within the organisation. Every new asset which will be created has to have a business plan that will be discussed with the venture investor for securing the funding. The venture investors provide the mentorship, guidance and network support to entrepreneurs in achieving their goals. The return of investments on a particular venture will be the benchmark by which the performance of venture investors will be measured by limited partners.
The critical questions are: who should be the entrepreneur, who should be the general partners, who should be the limited partners, and how their performance should be measured? The entrepreneur should be either identified from within or hired from outside, with experience in an industry domain and with understanding of business process consolidation. Such a person will have experience in developing solutions by standardising or boldly disrupting a business processes. The team of entrepreneurs has well-rounded skills in industry domain, technology and investments management, allowing them to run the full-blown start-up within the organisation. The general partners of the venture investor should be the practice heads that are responsible for generating the revenue for an industry vertical. They are responsible for making investments and providing benchmark returns to limited partners, which is the office of the CFO or corporate strategy group making the financial contributions.
A strong capital budget scenario for non-linear growth can be supported by an organisation that balances the risk-taking with sound capital investment decisions through an entrepreneurial culture. The start-ups are responsible for generating the returns for the company while creating a culture that is more geared towards value-based commercialisation than headcount-based revenue. This structure also encounters the limitations of the traditional cost-centre model because entrepreneurs and investors are responsible for their success and failures. The funding of an idea depends upon the merits that will be determined by general partners who are responsible for generating returns on the money they are managing.
The performance of entrepreneurs will be measured with their ability to get investments for creating a technology asset and their ability to create technology assets that are viable for the revenue growth. The performance of venture investor (or existing practice heads) will have the additional element of the returns they can generate for investments that are made. By opting for such an organisation, firms will be able to manage the following challenges:
- Actively responding to the need of transition towards non-linear revenue growth
- Better control by giving accountability to entrepreneurs and venture investors than chasing multiple practices and people
- Reducing or eliminating the chances of fragmented or repeated investments on creating technology assets
- No pressure of the traditional cost-centre model for acquiring funding
- Leverage business domain competency to solve problems for clients
- Ability to manage non-linear revenue growth as a portfolio of venture investments, ensuring required rate of returns on capital
- IImprove time-to-markets for standardised technology solutions
Create Individual Product or Solution Positioning Strategy
During the first half of the last decade, IT outsourcing firms faced significant challenges in polishing their brand image from a low-cost resource provider to an integrated software service provider. Since the nature of work performed by firms remained as development and maintenance of software assets residing on clients’ premises, the brand transition was well managed and revenue continued to grow. However, transitioning the brand positioning from its current state to the firm that loans technology asset, not the human capital, will be a huge task because of the existing brand image as a cost-effective service provider, better available alternatives to clients and managing dual positioning as a human capital service provider and a business process solutions provider.
One of the foremost challenges of selling technology solutions in a productised or subscription model is to establish an appropriate market positioning to convince clients of a firm’s ability to provide the solution. It would be a great challenge for firms to sell such solutions without showing a committed transition to clients. In addition, there will be times when firms need to partner with clients, or develop solutions in the revenue sharing model, further enhancing the need for showing commitments and the ability to create and market such solutions. While a straight and sudden switch in market positioning is not possible, firms can adopt the model of consumer goods branding strategy, coupled with entrepreneurial reorganisation, to position in the markets. In essence, every new standardised solution created for automating a business process can be marketed as a new brand.
This strategy will allow firms to continue selling the human capital with the brand name of the company while introducing new brands for non-linear revenue generating solutions for standardised business processes. Consumer goods firms have mastered this strategy, capturing the complete benefit of success and reducing risks of failure of their products. While creating technology assets, IT outsourcing firms will almost certainly face failures with some solutions. The individual brand positioning strategy of each solution will reduce the risk of diluting the firm’s brand and thus reduce the impact on both linear and non-linear revenue from other sources.
The other advantage of individual solution positioning strategy is that firms can establish dedicated marketing efforts on each technology assets created for non-linear revenue. Some IT outsourcing firms have adopted the approach of individual solutions branding strategy but they have not realised the potential of marketing because of the lack of the ability to disassociate the company’s brand name from that of solutions created for generating non-linear revenue. Also, firms have not established a focused strategy for marketing the technology assets because of their traditional experience in marketing human capital services. Any such association is required at the financial statement level where revenue needs to be consolidated. However, firms need to disassociate the marketing strategy of traditional services from that of business process solutions because of the difference in the offerings and perception to clients. The individual positioning should be leveraged for aggressive strategic and tactical marketing of solutions that are created for non-linear revenue growth.
In conclusion, the drive to grow revenue without increasing headcounts will involve building or acquiring technology assets and selling these assets to clients, but the speed with which such a strategy will be executed may not provide leadership position to an IT outsourcing firm. While firms might lose in the race of creating technology assets with a risk-averse approach, taking too much of a risk is a loss of investment capital and subsequent drop in market capitalisation for these firms. The three-part plan ensures that the firms put themselves in the path of transition without hurting the existing linear revenue growth during the period of change.
Finally, creating and selling technology assets is a risky task, and the three-part plan is a bold step that will provide higher returns, especially the revenue per employee, if the technology solution is a hit in the market. Although firms are already taking some of the steps highlighted in the three-step plan the most critical question is: can they organise themselves in a way that provides better accountability, superior control and effective results for their journey towards non-linear growth?
About the Author
Sanjeev Sethi is a business technology professional with 15 years of experience in the technology and outsourcing industry. He actively follows the strategy and financial performance of IT outsourcing firms. He worked with Cognizant Technology Solutions and helped US-based clients in managing complex outsourcing initiatives. He also advised CEOs of South American IT outsourcing firms on strategic alliance and practice development. He is an engineer from India, an MBA with a focus on strategy, finance and entrepreneurship from Babson College in the US.