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.
On August 20, 2012, the Alabama District Court dismissed the whistleblower retaliation lawsuit initiated by Jack Palmer against Infosys. Interestingly, the judgment also ordered the plaintiff to bear the court costs, further underlining the emphatic rejection of the lawsuit. Yet in the face of this particular win for Infosys, it is important to understand the implications of the judgment for Infosys customers and investors, and for the offshore IT services industry as a whole. Should all concerned breathe a sigh of relief, leave this chapter behind, and move on to other important business? Unfortunately, no – at least not yet!
Infosys’ legal troubles are far from over. Earlier in August, Satya Dev Tripuraneni, a California-based former Infosys employee also filed a lawsuit against Infosys for whistleblower retaliation. While the judgment in the Palmer case provides encouragement to Infosys, we must take into account that the Tripuraneni lawsuit was filed in a different jurisdiction with a different judge, and has a different set of facts.
The second and more important thing to keep in mind is that the judgment in the Palmer case only exonerates Infosys from any wrong doing in response to the whistleblower’s lawsuit. It does not provide any additional clarity on the underlying issue of visa misuse by Infosys. This is currently the subject of a federal criminal investigation, and the outcome is likely to have a more direct impact on the company and the broader services market.
Unlike the whistleblower case, Infosys is on potentially weaker footing on this issue, as it admitted that the Department of Homeland Security found errors in a significant percentage of Form I-9 employer eligibility verifications with respect to employees working in the United States. An unfavorable outcome from the investigation could prove quite serious, as the consequences extend well beyond a financial fine to possibly include reputational damage, a drop in market valuation and stock price, and a shift of client work away from Infosys. The implications may also impact other Indian heritage service providers with by proxy negative reputation overhang.
The favorable resolution of the Palmer case brings much needed good news to Infosys and other India-based companies, and Infosys itself can take a deep breath and feel somewhat validated in the position it has taken to date. However, the dark clouds of the criminal investigation continue to loom ahead, and Infosys – and by extenstion the industry – is far from out of the woods.
Although five years ago it was difficult to differentiate among the WITCH (Wipro, Infosys, TCS, Cognizant, and HCL) providers, Everest Group last year identified a variety of clearly emerging and meaningful distinctions in its May 2011 examination of the top five Indian IT providers.
Our just released second annual analysis, Report Card for the Indian IT Majors: Pecking Order Analysis of the “WITCH” Group, found that the top ranked provider in each of the dimensions we evaluated – financial performance, industry vertical performance, and geographic performance – remained the same, but the rankings among the five have shifted. While the rankings are not necessarily the most effective gauge of current capability or future success, the position shifts tell important, company-specific stories.
So which of the WITCHes is where in our 2012 (April 2011 through March 2012) analysis? Let’s take a quick look.
TCS retained the top spot in terms of total revenue, exceeding US$10 billion for the 12 months ending March 31, 2012. It also widened the enterprise revenue gap with #2 Infosys by ~ US$1 billion, as compared to last year (the total gap is now over US$3 billion). Cognizant’s 29% revenue growth is significantly higher than that of the other Indian IT majors, and the company, which overtook Wipro on enterprise revenue rankings last year, seems to be on track to overtake Infosys to become the second largest WITCH major. On a quarterly run rate basis, this may happen as soon as the coming quarter.
Infosys continues to be the most profitable. Note: We don’t believe that being the most profitable translates to being the most successful. Sustainable growth and success is rooted in a prudent balance of short-term profitability and longer-term investment priorities.
Industry Vertical Performance
In BFSI, TCS retained its #1 ranking with more than US$4 billion in revenues, Cognizant overtook Infosys’ #2 place at the table, and HCL is showing good momentum. But it’s also important to note here that the Indian IT majors stack up differently in the BFSI sub-verticals. For example, TCS and Cognizant are the leaders in the insurance applications outsourcing space, while Wipro marginally edged out Infosys on recent insurance industry wins, growth, client quality, and investments in domain solutions and intellectual property.
Cognizant again topped the leader board in the healthcare and life sciences space with a practice that is nearly three times the size of second-placed Wipro’s. And although Infosys’ healthcare practice is fourth in terms of revenue (US$385 million), it is also the fastest growing among the WITCH group, with 42% year on year growth. TCS’ rapid growth rate in healthcare indicates that there may be a rank change with Wipro in coming quarters.
In energy and utilities, Wipro not only retained its #1 position but also significantly increased the gap between itself and #2 Infosys, in large part due to its acquisition of SAIC’s oil and gas services business in early 2011. Interestingly, we see TCS inching closer to Infosys in this space.
While TCS won the top spot in both North America and Europe, it’s an interesting mixed bag among the other WITCH players in the two regions. Cognizant has overtaken Infosys in North America, rising to the ranks of #2, and now only lags TCS’ North American revenue by $325 million. In Europe, all providers except Cognizant achieved higher growth than in North America, with Wipro and Infosys coming in second and third, respectively.
To read a detailed analysis of the what’s and why’s of our WITCH group rankings, please download the complimentary report at: Report Card for the Indian IT Majors: Pecking Order Analysis of the “WITCH” Group.