Month: February 2017

The Infosys Dilemma | Sherpas in Blue Shirts

Is Infosys moving in the right direction? At the end of 2014, I blogged that Vishal Sikka, who had been on board as CEO and MD only a few months, had made an effective start in reshaping the company’s strategy. In Q1 2015, I blogged about how Infosys was aligning with the digital direction of the market and rethinking how to optimize its existing services. And a year ago, I blogged about Sikka shifting the company away from the maturing labor arbitrage market with slowing growth and margin compression and into more fertile growing markets. Recently there has been a lot of noise in the media again and a lot of rumors about disagreement among the company’s founders, board members, and activist investors/shareholders. I want to shed some light on their debate, as the Infosys dilemma is really an industry-wide dilemma.

Infosys has been in the press a lot recently, across a number of issues. However, at the heart of many of these stories is a deeper debate that Infosys is having with its shareholders to determine the go-forward vision for the company. At this time, it appears that the two visions Infosys must choose between are “arbitrage first” or “digital first.” Let’s look at these visions from each side’s perspective.

“Arbitrage First” Vision

The vision: Infosys will consolidate its role as the leading labor arbitrage player. It will grow through industry-leading talent based in India and build on its reputation for premium services.

Proponents: Infosys’ founders and activist shareholders advocate this vision, pointing to the fact that this strategy yielded robust margins for many years and gave Infosys its market-leading position. The company they built was aligned against values of personal sacrifice, frugality and expectation of high margins; and they believe the services industry will continue to be dominated by companies that maintain tight cost controls and pricing discipline.

• The labor-arbitrage market is mature, has stopped growing, and margins have been declining. Providers’ current robust margins will not be sustained into the future.
• For the past year, almost all the growth in the services space is in digital and cloud offerings, which currently are growing at over 20 percent.

Under this scenario:

• Under this scenario, Infosys will offset the effects of a maturing market on its stock price with slowing growth by returning substantial cash to shareholders through stock repurchases and increased dividends.
• Management will take steps to protect its margins by controlling sales and overhead expense and increasing the efficiency of Infosys – already an excellent delivery organization.

“Digital First” Vision

The vision: Infosys will transform into a digital company to create a new source of value for its customers. The new digital business models will involve a new talent base be less dependent on labor arbitrage.

Proponents: The Infosys board of directors and CEO Sikka. When Sikka was appointed, he was given a mandate to implement a digital-first strategy. He clearly understands the challenges and has been moving the firm in this direction.

Market realities:

• We estimate digital revenues at 25 percent of Infosys’ current book of business. We also believe that, at this time, digital revenues are not yielding as high a margin as Infosys’ arbitrage business.
• A digital-first vision requires transforming the Infosys culture, rebranding the firm and resetting investor expectations.
• Attracting and retaining digital talent means Infosys must compete with US technology companies and be prepared to match compensation with the tech industry, thus driving up labor cost and changing some of its benefit and talent management policies.

Under this scenario:

• The digital-first vision requires transforming the firm, culture and brand. This transformation is a high-risk strategy, but it could result in substantial value creation for shareholders. Infosys must align investor, founder and board expectations to gain room to execute the necessary change.
• Infosys will need to accelerate investments in new technologies and acquire companies that have already developed a digital business and have a digital talent base.
• Bowing to the pressure of activist investors’ demand that the firm return substantial cash to the shareholders through stock repurchases and increased dividends will handicap the firm’s ability to aggressively invest in mergers/acquisitions.
• Shareholders would need to forego Infosys returning cash now, recognizing the company would be more valuable in the future.

Hybrid Vision

In theory, both visions could exist simultaneously in a “hybrid” version. However, I believe that a hybrid vision inevitably will lead to an arbitrage-first company. I argue that the difficulty of executing the digital-first component will be overwhelmed by the near-term benefits of the arbitrage-first vision. By forcing a clear choice, Infosys will achieve better results in either strategy and avoid the pitfalls of conflicting goals and poor execution.

Implications of the Vision Choice

Both the arbitrage-first and digital-first visions are legitimate. But each will lead the firm to a different place. These choices have far-reaching consequence across all of Infosys’ constituents – affecting board make-up, firm governance, employee talent models and compensation. Investment decisions, whether to return cash to shareholders and the brand and promise that the firm communicates to customers also will flow from the choice in vision.

For now, it appears that the digital-first vision is in ascendancy. However, it remains to be seen whether the shareholders will have the patience to see this through given the activist shareholder agitation.