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Krishnan Thiagarajan

There is need for innovative business models to protect margins

APPLICATION development and maintenance, the bread-and- butter activity of the Indian software industry, continued to remain its mainstay in 2002-03 too. No surprises here.

Even as volumes growth was relatively strong, margins suffered at the operating level and are poised to remain under pressure at the gross, operating and net margin levels in the medium term if the current trend continues.

There is no disputing that offshore has become strategic and mainstream for American and European multinationals over the past year. And this has been helped in no small measure by the tough economic environment in these countries. However, on the flip side, this surprisingly strong endorsement and swift maturity of the `Global Offshore Delivery Model' of Indian frontline companies has presented a host of new challenges. Fresh strategies would be needed to tackle these:

Enhance fixed price

For the top two listed players, Infosys and Wipro , fixed price projects accounted for 34-37 per cent of the revenues for 2002-03. There is a need for frontline companies to capitalise on their superior systems and processes and risk-handling capabilities to make a quantum jump in undertaking fixed price projects.

To supplement this, companies need to make the necessary investments in the right solution sets, frameworks or tools to gain competitive advantage in the marketplace. A combination of these will probably help relieve some of the margin pressures, on both offshore and onsite projects.

Acquisitions

Using the inorganic, or acquisitions, route to move up the value chain, strengthening expertise along verticals or filling up gaps in the solutions portfolio appears to be a good strategy. This is despite the inherent risks of integration in acquisitions. Among the frontline companies, only Wipro and HCL Technologies have been proactive in making acquisitions so far.

Over the past six-nine months, Wipro has made reasonable progress in this direction through three key acquisitions. The first was the total outsourcing deal of the R&D business of Ericsson India initiated in September 2002. Then, in November 2002, it acquired the global energy and utilities practice of the US-based American Management Systems (AMS) Incfor $ 26 million. And in end-April, the company announced the acquisition of Nervewire Inc., a management consulting firm focussed on the securities markets, for $18.7 million.

These are expected to strengthen Wipro's higher value-added services, especially consulting and project management in two verticals such as energy and financial services. In addition, it will also offer scope for cross-selling opportunities.

Lock-in customers

From price re-negotiations and volume discounts in the recent past, it seems that all frontline software vendors are being tarred with the same brush irrespective of the nature of assignments.

So far, the industry has always believed that developing end-to-end solution capability will help mitigate both pricing risk and the risk of switching to some other vendor. In reality, the ability of firms to mitigate these risk elements is questionable. Unless software vendors can develop and demonstrate some service line differentiators, exclusive vertical expertise or intellectual-property-based capability which cannot be easily replicated, locking-in customers at a `premium' will be an uphill task.

Productise systems

The Indian software industry has always taken great pride in systems, processes and methodologies for project execution.

But the industry has done precious little in terms of productising them in some form, given the fact that it can be as important as assembly line for automobile manufacture. It is project methodology which helps achieve cost savings in application management or offer time-to-market advantages in application development.

In some form, the top three-five players of the industry will have to translate this into an enduring competitive advantage. This may help stem the recent sharp margin losses to a more calibrated drop in margins over, say, a five-year period.

Ultimately, through these strategies, frontline software companies may be able to alleviate their margin pressures to some extent. But in the process, their business model will shift towards a `high-risk-high-return' framework with limited scope for de-risking. This appears to be the only way forward for companies of this genre.

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