INDIA (IT) INC. – An Oligopoly? | Sherpas in Blue Shirts

Overheard at a Recent CFO Forum

Mr. M., manufacturing company CFO:  “My Procurement group is asleep at the wheel.”

Ms. B, bank holding company CFO: “Why do you say that?”

Mr. M.: “Well, as you know, we use Cognizant and TCS to do a lot of our IT applications development work – and I am getting feedback from their business customers that they’re doing a pretty good job. We’re thinking of expanding what they’re doing for us, so I’ve been tracking their news. A few weeks ago, they reported earnings and I about fell on the floor. Here we are scraping every nook and cranny for savings to eke out a 4 percent profit margin and TCS posts operating margins over 26 percent and 34 percent Y-o-Y growth. I don’t know what’s going on, but I’m sure as heck going to have a chat with procurement.”

Ms. B.: “Wow, those are impressive results and a very good question for the purchasing folks. As you’ve heard, our core business has been very volatile and driving the level of performance that the Street expects is really tough. We do work with some of the competitors of the firms you mentioned, so I’ve been following them for a while and while those results are extraordinary, they’ve actually been at similar levels for some time! I raised the question of pricing with my folks and they assured me that we’ve got competitive rates – yet they still put up those numbers.”

Given the challenges many industry sectors have faced over the past several years, it is surprising that this type of discussion has not been raised more often. How can a provider drive profit levels that are sometimes an order of magnitude greater than their customers’ – and do so while also setting growth records? How can these service providers sustain very high levels of financial performance when they deliver services that procurement claims are commodity-like purchases (such as software development capacity that includes FTEs with certain levels of skills and experience)? Moreover, why are we are seeing ongoing improvements in performance by some of the India-based IT services providers of these supposed “commodities?” Is the India-based offshore IT services industry acting as an oligopoly?

What is an Oligopoly?

The World English Dictionary defines oligopoly as “a market situation in which control over the supply of a commodity is held by a small number of producers, each of whom is able to influence prices and thus directly affect the position of competitors.” Economists cite numerous examples of oligopolistic markets; for example:

  • Australia banking has only a few key players (ANZ, Westpac, NAB, Commonwealth Bank)
  • Procter & Gamble and Unilever rule the detergent market in the United Kingdom
  • The U.S. wireless telecommunications market is overwhelmingly comprised of AT&T, Sprint Nextel, T-Mobile and Verizon Wireless – explaining much of the angst over AT&T’s bid to acquire T-Mobile
  • The global accountancy market is dominated by The Big Four (Deloitte Touche Tomatsu, Ernst & Young, KPMG, PriceWaterhouseCoopers).

Levers for Sustaining Outstanding Performance

Examination of how India-based service providers are going to market suggests that many are pulling a variety of levers to drive superlative results on an ongoing basis. For example:

  • Some providers are aggressively managing their staffing pyramids to optimize revenue and profitability (for example, in their recent earnings announcement, TCS’ CFO cited efforts to focus and optimize operations by driving utilization and productivity)
  • A few providers have substantially shifted their services portfolio to a more profitable mix, leveraging more standard work, a richer mix of offshore delivery, and optimized pyramid – sharing few of the benefits with customers
  • There are also a number of actions that service providers occasionally employ to drive improved performance (however, it is not clear if these are systematic approaches or deal-specific responses)
    • Use apparently high turnover rates and wage inflation in core delivery centers to argue for modest price increases (or at least thwart customer initiatives to get price reductions)
    • Pursue strategies to bypass traditional procurement processes to acquire sole source business with business unit managers with potentially less scrutiny on pricing negotiation
    • Take advantage of customer initiatives to move time and materials-type work to fixed price projects, adding a modest risk premium to what is essentially nearly risk-free work (based on contract reviews that Everest Group teams have conducted)
    • Continue to push the offshore delivery mix with customers, feigning reluctance when the customer pushes back and “requires” more onshore, premium-priced staff for key projects
    • Redirect the attention to discussions of pricing relative to their competitors (each of which is doing the same), away for their company’s stellar profit and growth performance

An Oligopoly at Work?

Many buyers of IT services see some of these levers occurring in their dealings with IT services providers, regardless of where the provider is based. Despite the fact that most users of these offshore services continue to secure high quality services for a price that is substantially lower than many alternatives, it raises a question of to what extent are IT services providers that are competing in the applications space competing like an oligopoly.

Some debate the underlying differentiation of IT applications services provided by India-based providers. Many examples exist in other industries, particularly in manufacturing where companies’ purchasing groups have been explicitly tasked with attacking the margin “surplus” of their suppliers of commodity items.

Thus, the quest for true and sustainable differentiation that (ironically) all India-based IT services providers are pursuing is clearly the right priority for their senior leaders – as long as they sharply focus their attention on areas that really are meaningful and, therefore, valuable) to their enterprise customers. And discussions with these players and many of their customers suggest a very competitive market exists. Nevertheless, the pricing and performance results indicate the impacts of this competition are not fully represented in the market.

What reference point for pricing these IT services should the industry be using? Is procurement actually “asleep at the wheel” or are we witnessing the free market at work? Who should capture and/or share the “surplus?” To what extent are these commodities really commodities – and, if they are not, what does that imply for the balance of roles across business decision makers and procurement in the purchase of these services?

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