The spooky orchestral background and thriller tagline — “Just when you thought it was safe to go back in the water…” — from the 1978 hit movie “Jaws 2” brings out our primal fears that something can attack us even though all appears to be safe and when we least expect it. That’s what is happening now with H-1B visa reform.

As we predicted in previous blogs, it appeared in July that the chances were slim for immigration and H-1B visa reform to be enacted in 2013. And House Speaker John Boehner’s November 13 statement, “Frankly, I’ll make clear, we have no intention of ever going to conference on the Senate bill,” seemed to put an end to the bill.

But there are threatening sharks beneath the surface of Boehner’s statement.  Let’s look at these risks and the timing.

Odds are good for reform occurring in 2014

Boehner wasn’t saying he does not intend to negotiate with the Senate on immigration/visa reform; he was just saying that he plans to take a piecemeal approach to the bill’s language instead of a comprehensive language approach. And instead of using the formal conference process, he will use an informal negotiation process to see where the two parties can reach compromises. He stated, “I want us to deal with this issue. But I want to deal with it in a common-sense, step-by-step way.”

Although it will be done piecemeal, the legislation still will have to go through Senators Durbin and Grassley, who authored the onerous H-1B visa language that targets the Indian service providers.

Because of the high chances of success in a piecemeal approach, we believe there is a 20-45 percent chance that in 2014 Congress will pass into law the proposed legislation with the currently drafted onerous visa provisions.

Politics. Another reason we believe Congress will enact the legislation is that Immigration is one of those rare issues that has strong sentiment in both political parties to get something done, although for different reasons. It has genuine bipartisan support and thus strong alignment of interests, so we believe there is a material chance that legislation will come through next year.

Despite the fact that it’s in the interest of both parties to enact the legislation, the Republicans are key to the outcome. If the Republicans gain strength, we see the legislation going through but shaped more strongly with a Republican bias. If they lose strength, we see legislation still going through but along the current lines of the Senate bill with the onerous provisions for H-1B visa reform. Whether the Republicans gain or lose political ground in upcoming months, it will lead to Congress passing immigration reform.

Our perspective is that the only major threat to the chances for passing the law in 2014 is status-quo politics. If both parties are locked in a standoff, it will negatively impact the chances for passing the law.

Timing. If Republicans and Democrats manage to reach compromises, the House could pass one or more piecemeal bills on immigration reform in February or March 2014. This could lead to Congress voting on the bill after the spring primaries, depending on how immigration plays out in the elections.

Impact on Indian service providers

If Congress does not pass comprehensive immigration reform in 2014, Senators Durbin and Grassley could still push to pass stand-alone H-1B visa reform for high-skilled workers.

Given the political sentiment, pressure is likely to ratchet up for the Indian firms even without a stand-alone bill. They will face an environment of increased scrutiny and have to deal with U.S. Dept. of Labor audits of their visa practices at client firms, higher scrutiny of visa petitions and possible higher risk of rejections, as well as increased scrutiny and due diligence by U.S. firms considering moving work to Indian providers.

Furthermore, you can almost hear the music from Jaws 2 and the shark’s teeth when you think of the ripple effects that are likely from the Infosys investigation into alleged visa abuse. How many times will we hear Durbin and Grassley raise t

he specter of “abuse” of visas? In addition, the U.S. Attorney may launch more visa investigations. And the IRS may decide to pursue INFY for underpaid employment taxes resulting from the provider’s visa practices; this could, in turn, lead to “abuse” investigations of other firms.

With a 20-45 percent chance of Congress passing the immigration with onerous H-1B visa provisions, perhaps the tagline for this continuing saga in 2014 should be from the movie, “The Fly” — “Be afraid. Be very afraid.”

When Infosys’ founder and former chairman N.R. Narayana Murthy returned in June, it was a clear sign that Infosys wanted him to guide the company in reinvigorating growth. But to do that, he would need to change the existing growth strategy.

The new strategy that Murthy has adopted is now clear. He has decided to refocus on Infosys’ great strength in the traditional labor arbitrage talent space and is de-emphasizing the push into platforms. In Infosys 3.0, the growth strategy was to get one-third of their revenue from contracts in the platforms and consulting space. It is not exiting or selling the platforms/consulting business; rather, it plans to give it less attention and will invest less in this space going forward.

The central tenet in Murthy’s strategy aims for a larger share of the labor arbitrage market and aims to capture larger transactions in that market. Accordingly, the company is aligning sales incentives with large application and infrastructure transactions instead of linear growth opportunities in platforms.

In our opinion this is a wise move. As we discussed in a previous blog, the labor arbitrage model is really the only game in town for providers that built their business on this model — and it’s still a huge market. Murthy’s plan also capitalizes on Infosys’ robust and strong reputation —and a proven success strategy of client access — to drive increased focus in this space.

In this focus, Infosys is willing to meet clients where they are rather than create a need for change. Therefore, Murthy’s growth plan emphasizes large transactions more than transformation. That’s not to say that Infosys no longer has an interest in transformation opportunities; it’s just that its focus now is large transactions rather than transformation.

Intended and unintended consequences

There are other consequences of Murthy’s strategy, in addition to realigning incentives.  He is reorganizing the leadership team, reassigning senior leaders to focus on the larger application and infrastructure transactions.

He also brought decision making back into a central organization out of India. So they’ve changed the focus they had on moving down a path of more and more decentralized decision making and have recentralized it.

We can see the results of these tactics already in terms of leadership turnover. Some leaders who have been refocused have choosen to exit. The latest — and sixth exit in the five months since Murthy’s return — is Stephen Pratt, who was head of the consulting practice but was reassigned to utilities. This is understandable as leaders brought in specifically to drive a certain agenda would choose to go elsewhere if reassigned to a different agenda.

But we’re also starting to see the consequences in terms of accelerated growth. The last Infosys growth report showed a modest and welcome step up. So we can see that Murthy’s strategy is starting to have a positive effect in terms of growth. We’re also seeing market shifts happening as the sales teams become more focused on arbitrage opportunities.

Infosys’ premium pricing dilemma

Another change Murthy has dealt with is the historic problem that Infosys had in terms of its premium pricing. They were on the horns of a dilemma — Infosys was proud of having robust industry-leading margins, but that translated to a premium price per hour for resources. They are finding that the market is more competitive now and that premium is no longer consistently available to the Infosys brand. This is certainly not to say that the market has a poor view of Infosys; it’s just that the giant can no longer command premium pricing in a highly competitive marketplace.

This has consequently caused Infosys to change its strategic direction. Although Murthy still maintains going after high margins, the company is achieving that objective by taking costs out of the delivery vehicle rather than trying to achieve a market premium in the space. In this respect, Murthy appears to be taking a page from the TCS playbook in driving lower-cost delivery capabilities. He’s doing that through increased utilization, a broader pyramid and more focus on delivery in offshore locations.

Early returns on Murthy’s new strategy are both interesting and modestly good. We’re seeing consequences in both the firm’s internal leadership and go-to-market strategy. Already we see evidence of a pick-up in competitive intensity of Infosys in the marketplace, and we’re seeing that result in its growth. We look forward with interest to see how Murthy’s strategy will play out in an increasingly competitive marketplace.

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.

Increasing Traction

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.

Company

Mandate

Notable Involvement in Start-ups

Infosys

Has set up a US$100 million fund to invest in start-ups, besides spotting and funding internal innovation

OnMobile, Yantra Corp

Tech Mahindra

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

MindTree

Created a team led by the Chief Strategy Officer to look for start-ups and next generation solutions

7Srata

Wipro

Actively picking up stakes in cloud and big data firms

Opera Solutions, Axeda

TCS

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

Cognizant

Set up an emerging business accelerator

Incubated 20 ideas over the past 18 months

 

Changing Ecosystem

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

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