TCS has a sophisticated suite of apps and delivery tools. They accept small engagements with the intent to grow those accounts by being reliable and over-delivering. And they’re willing to shift away from their comfort zone. But this isn’t why TCS is a leader in the services industry.
Why are they so successful? To answer this question, we used Everest Group’s framework of six characteristics necessary for success.
Our assessment is that TCS’s success is due to aligning all six aspects in the framework. By doing so, they perfected an industrial global services model in which they are able to take a pragmatic and cost-effective approach to large-scale processes. These processes must have at their core the ability to deploy TCS’s local services offshoring model in a highly repetitive or highly predictable consistent-quality manner.
Using this core understanding of who they are, TCS operates in a wide variety of geographies across a wide variety of industries. They apply this core understanding to a bewildering set of disciplines ranging from applications to infrastructure to F&A to customer service. On the surface, these service disciplines look highly unrelated. But when you dig deeper, they all have in common the ability for TCS to apply an industrialized global services model to the benefit of their clients.
This understanding of their essence and their discipline about applying it has allowed TCS to emerge as a true industry services leader.
Capgemini’s announcement that they have an agreement to acquire iGate is the most recent evidence that the consolidation pace in the services market is picking up. Slowing growth, collapsing margins, and availability of capital with interest rates close to zero are only intensifying the M&A activity. How will the consolidation happen? And which service provider will be acquired next?
At Everest Group, we believe there are three likely scenarios that answer these questions.
Certainly we expect the big to get bigger. We expect the French (CGI, for example) and Japanese providers to continue to grow through acquisition. CSC put itself up for sale at least once in the last year, and that’s likely to happen again. We think Atos and Capgemini have completed their acquisition activities.
We also expect the Indian firms to play a more prominent role in the consolidation activity. Cognizant has demonstrated it’s in the market and will likely strike again. Wipro, Infosys and TCS certainly have the capital to move, and we may see some of these players combining.
And finally we expect some smaller firms to acquire one another and build scale. Potential market consolidators are bound to view EPAM, EXL, Virtusa and WNS as targets. And Syntel is not too big to be sold.
One of the most interesting scenarios to watch will be what happens with Genpact. They must take a “go big or go home” strategy. If they go big and become acquisitive, they will likely buy one or more IT firms. Short of that, Genpact isn’t too big to be sold and will become a highly attractive candidate for acquisition.
Wipro is reportedly looking at headcount and cost-reduction exercise in the realm of $300+ million. Why are they doing this? Is it a good idea? Of a few possible interpretations for wringing out costs, here’s my opinion – starting with my belief that this undertaking was inevitable. The more important question is how will they do it?
Wipro’s action comes on the back of similar news about TCS and IBM and is predicated by the pricing pressures hitting leading service providers. As I blogged recently, pricing pressure has become acute with existing clients looking for significant cost reductions.
In addition, the market is changing and clients are more insistent about requiring onshore resources; this raises operational costs for the Indian firms, which need to invest in a richer set of capabilities on shore. These resources located close to the customer are substantially more expensive for Wipro and other providers than their India-based resources.
It’s a case of when push comes to shove; if Wipro and other providers are to maintain reasonable margins or be competitive, something has to give. That “something” is the necessity to take out costs to allow them to meet the pricing pressures and allow them to hire the onshore resources that clients increasingly insist upon.
How will they achieve the cost reduction?
I think Wipro and others will move further into the industrialized factory model, which relies on an ever-widening pyramid that pushes work down to lower-cost resources and eliminates middle-management roles.
However, I think the strategy of moving deeper into the pyramid model raises the risk of further commoditizing the space and increasing churn. And clients are more and more intolerant of churn. The likely result is that it will open the door for firms like EPAM and others that differentiate around persistent teams of experienced engineers.
I’ve blogged before about consolidation in the services industry, and I believe the industry is now on the cusp of a new round of significant acquisitions. But don’t expect a repeat of the usual M&A strategy. We’ll see a shift from the usual tuck-in acquisition strategy to billion-dollar-capability acquisitions. At this game-changing level, consolidation could have an immense impact on the industry.
Market conditions are ripe for consolidation: a maturing marketplace, the cost of capital is very low and there is a changing perspective in executive ranks toward major acquisitions. As a result, the number of highly acquisitive players has jumped dramatically.
Cognizant led the way with its TriZetto acquisition, which changed the game in terms of size. ATOS acquired the infrastructure arm of Xerox. At Everest Group we also see Capgemini, Fujitsu, Genpact, NTT Data and Wipro as highly acquisitive players. And we wouldn’t be surprised to find others driving consolidation.
It will be interesting to see who these companies acquire – and whether they will acquire each other.
Since publishing our two most recent blogs about the business situation at Infosys (Connecting All the Dots and Silicon Valley company) and comparing those perspectives to our blogs over the past two years, people have asked us: “Why did you change your point of view about Infosys?” Here’s why – it’s because most of what we predicted about Infosys came true.
We have a relentlessly objective point of view, and our blogs over the past couple of years pointed out the internal problems we observed at Infosys. We called the firm out early on its arrogance and hubris in the marketplace, evidenced in its commitment to premium pricing despite the unsustainability of its pricing vis a vis the marketplace, along with its inward-looking focus instead of focusing on customer intimacy.
As the board at Infosys started to understand the same things that we called out, they made some interesting moves; and we’re largely supportive of the moves. If they want Infosys to be a leading high-tech firm, they need to bring in different leadership. They did that by bringing in an external executive as the new CEO in 2014. And it’s clear that the firm’s leadership is now deploying a customer-facing strategy rather than continuing to be inward-looking. This isn’t just a story line; Infosys is backing up its statements with investments in new leadership talent over the past two months as well as in other actions.
Before, we saw a once-proud firm with internal problems, which talked the talk but didn’t walk the walk. We increasingly see Infosys pivot strongly to next-generation leadership, taking steps to give the firm a chance at success again.
It’s too early to say whether the recent moves and strategy will work. And as I said in my earlier blog, execution eats strategy. But the next step in strategy is putting their money where their mouth is, and there is every sign that Infosys is starting to do that. As such, we applaud Infosys’ progress.
As we called out Infosys when we saw problems, we now comment on it as it moves forward. To date, history validated our point of view. Now that Infosys is dealing with its issues and taking consistent actions to move the firm forward, we’ve acknowledged their progress and amended our point of view accordingly.
There is rising concern among the Indian service providers that their arbitrage model is about to go through a significant and abrupt change – and not to their benefit. As I look at the various factors driving their concern, I see a set of challenges that will fundamentally reshape the industry and create new winners and losers. What remains to be seen is how quickly it will happen and exactly how it will affect the providers. Here is my analysis of the situation.
What is driving providers’ concern – even fears for their business?
Challenge to FTE model. Clients want automation, and the providers fear that automation will require far fewer people to deliver services. They now want to buy software-as-a-service rather than people. It’s basically a substitution of technology for labor, which manifests itself as robotics, SaaS and cloud. Growth of the Indian ISP businesses is slowing as the customer demand now is to have a different conversation around capabilities instead of just moving the work to India for labor arbitrage.
Challenge to factory model. We’re seeing increasing commoditization of services. The Indian providers recognize that they built factories that, at the core, break work into different constituent pieces and drive that work to be done with the most junior people possible. But that actually caused commoditization. The client mindset is: “If you can segment the work like that, why not go ahead and automate it?”
Clients today want domain industry knowledge, rare skills, more capabilities on site at the client location and more intimacy from their service providers – and all four of these demands are hard to deliver in the factory model.
Challenge to profit margins. The challenge to the FTE and factory models drive providers’ fear that they won’t be able to maintain profit margins like those in the past built on labor arbitrage.
We’ve known that arbitrage wouldn’t last forever and that providers couldn’t keep extending it indefinitely. It had natural limitations. Now we see the market moving in a new direction. At Everest Group, we believe this will fundamentally reshape the industry.
Important issues in heading in the new direction
I think there are important questions around the reshaping of the Indian ISPs’ businesses.
In what way will the change manifest itself? Will the change in business models result in growth, cannibalism, or both? And to what degree? Will the change, for the most part, only affect where the new growth opportunities are? Or will it cause providers to cannibalize their existing client work?
If it just affects where new work is, it’s much easier for challengers to capture those opportunities. But it’s more difficult for incumbents to transition. For example, in automation they would need to cannibalize the existing work by reducing the number of FTEs, which also will reduce revenue. It will be difficult for incumbents to react to their existing clients’ demands in the change in direction.
There are other questions:
How soon will the changes come?
How will the Indian providers react?
These are unanswered questions today, but they’re very important. How quickly it happens will affect how the incumbents react. And how they react will determine whether they will succeed or whether challengers will reap the benefits of the new direction the market takes.
What do you think? Are we going to watch the implosion of the services model where it clashes in on itself and technology cannibalizes the industry, shrinks the revenue, changes the FTE model to a transaction model and shifts the terms and conditions to favor new players over old players?
What could be the implications for global services from President Obama going to India?
It’s clear what the United States wants. We want to sell technology and nuclear equipment to India. And the U.S. wants to move India out of the China camp geopolitically into the U.S. camp. The U.S. wants trade and joint efforts in the areas of climate change and energy.
What does India want? They’re also focusing on trade. One of the key flagship industries for India has been outsourcing and global services. Of particular interest is protecting the spectacular growth of the Indian heritage firms such as Infosys, TCS and Wipro and allowing the next generation to flourish. In that important area, what could they ask of Obama?
It’s clear that with two years left in Obama’s term without a Democratic congress, there is a limit to what President Obama can agree to. But there is something big he could agree to that’s within his administrative powers. He could agree to direct the U.S. immigration service to be more flexible in how they interpret the visa laws, specifically around H-1B and L-1 visas.
As written, the immigration laws include a great deal of ambiguity, giving much discretion to the immigration services on whether to grant visas and the degree of freedom that companies or individuals have in what work they can do under those visas.
This is an area that is clearly within Obama’s ability to affect, and it would be a substantial win for India. So, Mr. Modi, I don’t know if you have asked for this – but you should.
And in no way would such a move hurt the U.S. It would not only help India but also help the U.S. economy with competitiveness. There simply isn’t enough U.S. tech talent and we have to rely on Indian talent if we’re going to be competitive in driving cloud and other new service models. The agreement could even be constructed to fit in with Obama’s ongoing pressure on Republicans to reform immigration laws.
In observing the global services industry players in recent weeks, I was amazed at how much frenetic activity India’s providers undertook in joint ventures and acquisitions in Q4 2014. What does all this noise signify? Change is coming.
There are signs that let us know seasonal changes are coming. Before winter arrives, we see its signs in leaves changing colors, birds migrating south and days getting shorter. One of the signs of change coming in the services industry is when incumbent providers go on an acquisition and alliance spree.
Let me highlight just some of the spree of activity in the past few months.
Acquired TriZetto, a healthcare software vendor
Acquired Odecee, providing digital solutions to enterprises in Australia and New Zealand
Created an alliance with Top Image Systems to increase its automation capabilities in F&A
Undertaking a significant shift in its M&A strategy. After completing only five acquisitions since its inception, Infosys recently aggressively bid on Trizetto, but lost to Cognizant. And it’s considering several strategic acquisitions with annual revenue of $600-$700 million.
Partnering with DreamWorks animation
Partnering with Tableau Software for big data, visualization and business intelligence solutions
Acquired Lightbridge Communications, a telecom network engineering service provider
Extended partnership with Red Hat for open hybrid cloud solutions
And it isn’t just the Indian providers who are on a spree. Examples:
Acquire BPO acquired Shore Solutions in the Philippines
Capgemini is partnering with NetSuite to provide a scalable cloud-based back-office solution and is also partnering with Adaptra to provide insurance industry solutions in Australia
Citigroup is setting up its own IT arm in India
IBM agreed to acquire Lufthansa’s IT infrastructure unit
Individually, none of these events is particularly important, just as one duck flying south isn’t important. But when the sky is full of ducks, you can be pretty sure the season is changing.
Collectively, this spree of activity, especially by the Indian service providers, is an indication that the services industry is at an inflection point. Change is brewing and the providers are attempting to position themselves for the change.
Today, Cognizant announced the acquisition of TriZetto® (a leading provider of healthcare IT software and solutions) for US$2.7 billion. The deal ties in favourably with Cognizant’s dominant position in the healthcare IT marketplace, with the combined entity having US$3 billion in healthcare revenue. TriZetto has around 3,800 employees across the U.S. and India, who will join Cognizant’s existing healthcare business, which currently serves more than 200 clients.
The acquisition is a landmark deal within the Indian IT service provider community, given the size, scale, intent, and implications to the status quo, but what makes it unique is its focus on industry solutions vs. other services-centric acquisitions.
Indian IT service providers’ notable acquisitions
What it means for Cognizant’s services focus
TriZetto primarily develops and licenses IT platforms and service for healthcare providers and payers, competing with the likes of Allscripts, DST Systems, and McKesson. Cognizant aims to leverage its dominant position in the market–a healthcare IT portfolio in excess of US$2 billion–to provide an integrated portfolio across services and platforms. Investing in products and solutions has been a key area of focus for Indian IT service providers as they look to embed their solutions within enterprises buyers, use technology adjacencies, and leverage the technology-platform model instead of flexing just the labor arbitrage card. This acquisition could be one of the steps allowing Cognizant to cross-pollinate and build an integrated (applications/infrastructure/business process services) services play in an industry in which it has primarily relied on its application services strengths.
What it means for Cognizant’s growth story
Cognizant will get access to multiple software platforms and aims to realize nearly US$1.5 billion of potential revenue synergies over the next five years. TriZetto currently operates at 18.5% margins on a revenue base of US$711 million. The numbers are right in the zone for Cognizant, as it wants to continue to drive its growth-plus-margin story in the high revenue base in which it currently operates. The products, platforms, and solutions play has very unique challenges, opportunities, and operating dynamics. Whether Cognizant can navigate this fundamental transition and still maintain its growth story, will be an interesting study.
How it relates to the way Healthcare IT industry is evolving
The ongoing transformation in the U.S. healthcare system is shaping service provider’s strategies as they look to capture the incremental opportunity that is up for grabs. The focus on driving down healthcare costs, wide-sweeping reforms (driven by Obamacare and ICD-10), and blurring lines between payers and providers, are principally reshaping the healthcare delivery model. Cognizant will aim to drive increased stickiness with healthcare buyers to drive retention in an increasingly complex vendor landscape. It is aimed at garnering a large share of the growth pie, when it comes to the payer and the provider ITO market. This acquisition is an unmatched clear indication that service providers must evolve from a services-only play to a platform-based solutions play, to stay relevant in a market that has an immense potential to grow.
What this means for the competition
The deal will also have myriad implications for the overall healthcare IT services competitive landscape. Most competitors of Cognizant already have a steady revenue stream (large or small) implementing TriZetto solutions, most importantly Facets™, which is used by most payers in the U.S. How this impacts its engagements and partnerships will be tricky. Whether Cognizant will want to (and if so, how) assume a dichotomous role of a partner and competitor will be another interesting area to watch. Additionally, whether Cognizant plans to ultimately absorb TriZetto (thereby dissolving the brand) or leverage its unique positioning is also unclear.
Cognizant is ideally placed in healthcare with few like-sized competitors, allowing it to consolidate. Two things that are definitely salient here–one, Cognizant is going all out to bet big on healthcare; and two, this acquisition has the potential of taking it to a different league altogether! There are already murmurs in the healthcare IT industry equating Cognizant to a new “IBM,” when it comes to its negotiating power at the table. This is another step in ensuring it stays ahead of peers as the competitive intensity in the market increases. The deal definitely has characteristics of a long-term strategic bet than a tactical manoeuvre.
The Q2 earnings reports for Syntel and TCS show not only a strong performance for both companies but, surprisingly, show stronger earnings growth than revenue growth. We’ve seen stronger earnings than revenue results with other providers in the past, but this is surprising. That’s because it reverses a trend the industry has been experiencing.
This strong performance comes at the same time we’re seeing a rupee appreciation, which puts a slight downward pressure on margins and reduces Indian providers’ ability to make money.
But as we dig below the surface for deeper significance, the strong earnings indicate that the industry is maintaining pricing. Amidst competitive pressures, providers are successfully resisting significant price discounting on new work, despite well-documented attempts by procurement organizations to drag pricing down. So the Syntel and TCS earnings reverse a trend of increased pressures on margins.
I think this is a result of further honing their offshore model and flattening their labor pyramid. It’s particularly impressive given that we’ve had modest rupee appreciation during this time frame.
The news is encouraging and bodes well for the industry, particularly given the modest uptick we see in the recovery of the global and North American economies.