The U.S. federal government this week announced a settlement agreement with Infosys with a record fine of $34 million — a penalty Infosys agreed to pay in settlement of the investigation related to its I-9 paperwork errors and H1-B and B-1 visa matters. There is both good news and bad news in this settlement. The bad news reaches beyond the Indian heritage firms and affects the entire industry, including multinationals as well as firms that hold GICs, or captives, or have international work.
The good news
From an Infosys perspective the settlement is good news. It allows Infosys to move on, and undoubtedly its management and stockholders are breathing a deep sigh of relief at finally being able to get beyond these immigration issues overhanging operations during the ongoing investigation. There were no criminal charges nor an admission to criminal activity as to the way it brought foreign nationals into the United States to perform work for customers, but Infosys agreed that it failed to maintain accurate I-9 records for many of its foreign nationals in the United States in 2010 and 2011 as required by law.
The settlement involves putting audits and other compliance proofs in place. These measures and the agreement finding no criminal wrongdoing will help Infosys to move on and will help resolve concerns of customers, especially those in the financial services space, which are very gun-shy of attracting any more regulatory scrutiny.
Although the $34 million penalty is a record fine, Infosys can be pleased that it is small compared to its earnings and will be largely immaterial on earnings.
The bad news
On the downside, I think the picture for the broader industry is clouded and even chilling. While Infosys is able to move on, the hoped-for relaxing of visa reform has not arrived. Instead, this settlement indicates that a more intense regulatory environment awaits industry players.
The record fine foreshadows ongoing scrutiny of the visas in general and indicates that the immigration authorities are taking, and in the future, will likely take a very narrow view of how service providers can use visas.
It’s interesting to note that the language currently governing the visas is quite ambiguous, and reasonable people could easily differ in their interpretation. But this settlement and record fine signals that a very narrow interpretation will be used going forward and that the government will use penalties to enforce the regulations.
The forceful, negative response of Congress and Senator Grassley’s reaction (“It’s time that the administration and Congress do more to rein in the fraud and abuse to ensure that both American and foreign workers are protected.”) to the settlement is another indicator of bad news for companies that utilize talent outside the U.S. Rather than celebrating a victory for compliance and the significant enforcement of of law, they are dissatisfied with the outcome and are calling for further regulation.
The Congressional reaction is ominous. It does not bode bode well for future legislation and certainly encourages the bureaucrats in the immigration service to take a very narrow view of visas going forward.
“At times, Indian IT service providers fall behind expectations in new and exciting technology areas that extend beyond the traditional outsourcing paradigm.” – A large MNC buyer of IT outsourcing services
With traditional models of IT outsourcing facing increasing competitive pressures, Indian service providers are looking at a multitude of solutions to drive success and retain competitive advantage. Chief among these are emerging technology solutions from start-up firms. Service providers have realized that to compete and stay relevant in the changing paradigm they have to focus on developing niche and specialized products, boost efficiency, and develop IP. Primary traction themes include data analytics, big data, cloud computing, and enterprise mobility. Niche start-ups with innovative technology solutions help providers augment their existing service offerings.
This echoes the strategy often adopted by multinational technology firms including Cisco, Microsoft, Yahoo!, Intel, and SAP, which back a plethora of emerging firms. Indian providers are now looking to invest and form alliances with ventures in niche domain areas. This is a dramatic shift in the status quo, as Indian IT providers have historically paid minimal attention to start-ups due to their own lack of a proper ecosystem to facilitate such transactions and a fairly low-risk appetite. Yet, of late, they have increasingly set up funds and accelerators dedicated to tech start-up initiatives.
Notable Involvement in Start-ups
Has set up a US$100 million fund to invest in start-ups, besides spotting and funding internal innovation
OnMobile, Yantra Corp
Has established a US$50 million fund exclusively for investments in global technology start-ups
Launched an initiative – i5 Startnet – to scout for firms in cloud, mobility, networking, and vertical-specific technologies
Created a team led by the Chief Strategy Officer to look for start-ups and next generation solutions
Actively picking up stakes in cloud and big data firms
Opera Solutions, Axeda
Formed its Innovation Labs and Co-Innovation Network (COIN) to bring together academic institutions, start-ups, venture funds, strategic alliance partners, multilateral organizations, and clients
iKen Solutions, Perfecto Mobile, Computational Research Laboratories
Set up an emerging business accelerator
Incubated 20 ideas over the past 18 months
Slowly, but steadily, the ecosystem is developing to encourage such start-ups. For instance, in June 2013, NASSCOM announced a program to fund and incubate 25 start-ups to be established by young Indian entrepreneurs. Additionally, it held an event that brought together promising technology start-ups and IT service providers including Infosys, TCS, Cognizant, Wipro, and MindTree. The gathering was an effort to provide young start-ups a platform to showcase their capabilities, connect with leading service providers, and generate investor interest.
Quid Pro Quo
Increasing competitive pressures and changing market dynamics have made Indian service providers truly value innovation, viewing it not just as a buzzword but rather a core operating lever to drive growth. Partnering with start-ups is an effective method of achieving innovative solutions without the allocation of time and resources they can ill-afford. And the mutually beneficial relationship between the two segments can lead to sustainable ecosystem in the long haul.
Recently Infosys posted better-than-expected earnings. But it also indicated an upcoming adjustment in strategy, stating it plans to pursue growth through traditional outsourcing contracts and will deemphasize its focus on software as a source of growth.
Infosys has long been a stalwart of the Indian heritage firms and built its impressive growth and profitability through the outsourcing and services space. However, the company is not as well positioned to drive growth in these areas as it once was.
Historically it was a powerhouse in application outsourcing (AO), and Infosys still maintains this strength. However, AO’s growth rate is slowing and there are fewer large AO opportunities available in the marketplace.
Outsourcing growth has shifted to both the BPO and infrastructure spaces. In these areas, Infosys is not as strong as it is in AO and is not as strong as its competitors.
Therefore, if Infosys looks to drive growth rates above the industry average in large outsourcing transactions, it will need to significantly improve its positioning in either or both BPO and infrastructure. In today’s marketplace, we believe Infosys lacks the ability to grow organically in these areas at the rate required to meet the company’s overall growth objectives.
To execute its growth path, Infosys needs to adopt an acquisition strategy and grow inorganically. Before it can grow, it needs to make a significant move to acquire assets upon which it can build and grow in the attractive BPO and infrastructure spaces.
We believe this is the most effective strategy Infosys can utilize to achieve the necessary growth rates within its investors’ time frame to meet its objectives.
Photo credit: Wikipedia
As most in the global services industry know, the acronym WITCH stemmed from the fact that the large, India-based, offshore-centric service providers – Wipro, Infosys, TCS, Cognizant, and HCL Technologies – had quite similar delivery models, sales strategies, risk appetite, and growth trajectories, which essentially placed them in a single bucket.
However, Everest Group’s recently released annual assessment, “The Changing Pecking Order of the Indian IT Service Provider Landscape,” revealed that the relevance of the collective term WITCH is fast diminishing as market conditions are forcing differentiation among these players.
Indeed, stark divergence among this group, as evidenced by Cognizant’s capture of the number two spot away from Infosys (see chart below), is clearly emerging.
Per the latest financial results released by these offshore majors (ending March 31, 2013), TCS and Cognizant continued to outgrow their peers on a yearly basis – both in terms of size and growth – by adding revenue that was higher than, or almost at par with, the cumulative incremental revenue of Infosys, Wipro, and HCL. Their clear vision and strategic bets, as compared to the prevailing internal confusion of the other WITCH players, is paying off.
What is leading to this segregation within the WITCH group?
- TCS is continuing to excel on the back of its broad-based growth and aggressive penetration in the European market
- Cognizant’s approach of keeping margins lower via a higher investment in sales and marketing spend is fetching benefits
- HCL is capitalizing well on the ongoing churn in the industry, and is exploiting the anti-incumbency against the traditional service providers. While this makes HCL’s growth narrow and focused largely on infrastructure services, it’s paying off for a short-term strategy
- Infosys and Wipro are struggling with their internal, company-specific issues, (i.e., strategic confusion, weakening brand recognition, legal issues, and senior level exits).
The ultimate questions are:
- Will the irrelevance of the collective WITCH term become more visible in the future? Will the different strategic gambles of each service provider lead to huge variances in their success rates?
- Will the return of Infosys’ retired co-founder and former chairman Narayana Murthy help it make a comeback to the levels of TCS and Cognizant?
- To what extent will the ongoing challenges of a few of the WITCH group players create opportunities for mid-sized players – such as Genpact, one of the key players in the FAO space, and Tech Mahindra (the combined entity) which has credible enterprise applications and infrastructure management offerings – to capitalize on their niche capabilities?
We expect to witness further changes over the next few years in the pecking order in the overall industry, and the formation of new groups cannot be ruled out. This is likely to be driven by inorganic growth, key strategic investments, service provider consolidation, and aggressive sales strategies.
For drill-down data and insights into pecking order changes in the Indian IT Service Provider Landscape by size, verticals, and geographies, please see Everest Group’s newly released viewpoint, “The Changing Pecking Order of the Indian IT Service Provider Landscape.”
With over US$4 billion in cash reserves, Infosys had a history of keeping analysts on their toes speculating on the moves it would make. However, after its botched attempt to acquire Axon (which HCL won in a competitive bid), Infosys chose to sit on its money pile for so long that some bored analysts joked that the cash would hatch into chicken!
Infosys has experienced a fair amount of criticism recently due to its below par performance compared to its peers. With good news few and far between, Infosys had to set the ball rolling in the endeavor to resurrect its image as a market leader. Let’s take a look at its acquisition of Lodestone – a Zurich-based management consultancy that advises international companies on strategy, process optimization and IT transformation – fares not only from an overall strategic perspective but also from an image management perspective.
Geography focus: Europe
With three quarters of Lodestone’s revenue coming from Switzerland and Germany, there are no prizes for guessing Infosys’ geographic focus. Alongside European logos, Infosys will acquire local leadership, language skills and reputation in a market (Continental Europe) that has been traditionally tough for Indian service providers. It is not surprising that this acquisition follows Cognizant’s purchase of Galileo earlier this year, which enables it expansion in France, and Wipro’s acquisition of a Citibank’s datacenter in Meerbusch (Germany).
Our verdict: A good move. Infosys was not gaining traction with its strategy of organic growth in Europe. Has it done enough to position itself in Europe? No. It will have to thread together a string of pearls (products, business consulting, systems integration, etc.) through acquisitions to even convey the message that it has truly arrived in Europe. Lodestone is not going to be the silver bullet for all of Infosys’ ailments in the region.
Competency focus: SAP consulting
With a post-acquisition turnover of more than US$1 billion in SAP programs, Infosys positions itself among the top players in this area. SAP is one of the fastest growing programs within Infosys, and this move should help cross-pollinate market access and expertise between Infosys and Lodestone. However, Infosys has demonstrated visible sluggishness in its ability to manage growth with increasing size due to its single-minded focus on margins. Will it fail this challenge too?
Our verdict: Not likely, because SAP consulting is indeed a high-margin business, which makes this acquisition very much in line with Infosys’ stated strategy.
Financials of the acquisition
This is an area in which even the strongest Infosys bashers must give it credit. Looking at the revenue multiples paid by service providers for some of their recent acquisitions:
- HP-Autonomy: 11x
- HCL-Axon: 2.2x
- Wipro-Infocrossing: 2.6x
- TCS-Citi BPO: 1.9x
- Infosys-Lodestone: 1.6x
Our verdict: Cautious, but a good deal. However, it remains to be seen how many successful acquisitions Infosys can make with this scrupulous strategy. I believe Infosys will need to acquire multiple companies to bolster its high-margin strategy; and that will require it to go shopping with an eye on its competitors who have shown themselves to be much more aggressive.
Infosys famously walked out of the Axon deal (and lost out to HCL) by refusing to negotiate its price ceiling. And its intense focus on the premium pricing of its services has led to further entrenchment of this “non-negotiable” image among its clients, as it has chosen to walk away from projects rather than budge on pricing. Burdened by this image, Infosys can pick only one from the following two options:
- Be apologetic about what it has done, and go back to the negotiation tables with competitive pricing for clients and open purse strings for acquisition targets
- Show aggression and speed in acquiring high-margin capabilities, and push ahead with its stated strategy, i.e., to increase its revenue share from value-added, high-margin services
The latter is what its leadership says it is doing. And I think that strategy is spot on. That is why I believe the highlight of this acquisition is not the money Infosys spent on it, but rather more about the message it is trying to send – Infosys is still in the game.
The news on the grapevine is that Infosys already has a lineup of targeted acquisitions in various stages of maturity. It will be interesting to see Infosys’ next move as it attempts to push ahead in what has been a challenging period.