HP's Acquisition of 3Com

News that HP has acquired 3Com is news and probably went unnoticed largely. Juxtaposing it with the acquisition of EDS last year, clearly HP has a strategy where these pieces fall into place. While HP cemented its services game plan to meet the challenge from IBM with the EDS acquisition, with the acquisition of 3Com, it is meeting the challenge from Cisco.

Will be interesting to see how the integration of these companies will play out to bring value to HP's revenue and profitability.

"Yes Sir" and No "No Sir"

I was having a lunch conversation with a colleague who has moved from the IT department of an enterprise to an offshore based service provider's organization. He was sharing his frustration on the lack of assertiveness on the part of most team members in the offshore service provider's team (and in that company in general). Since he had moved from an internal IT organization to a service provider, these were frustrating for him when he was in calls with the client where his colleagues mutely accepted whatever the client asked for --- be it additional scope of work, very aggressive timeline commitments or unrealistic service expectations. They just didn't push back!!!

This is in fact a recurring sentiment I have heard from many on both sides of the table -- those who offshore work to IT service providers and those who provide such services working for offshore based IT service providers. This is in fact a very rampant behavior trait which neither party wants to discuss because one is taking advantage of it and the other is being taken advantage of. Worst, most often the team members don't even realize that there is an option to push back. I am not suggesting that the trait should be a "push back all the time and every where" attitude but there are ways to respectfully and collaboratively correct a client's expectation if they are unrealistic or may have issues which they may not be aware of. Most folks in several offshore based companies just do not acknowledge this and this seems to run through the echelons of power in such companies. I have heard of some companies where the relationship manager says " How can I say NO when the customer is asking for it? He is the after all the CUSTOMER!" for situations where what the customer is asking is just not do-able or practical. What is not understood is that in the process incorrect expectations are set and face-off is deferred to a later time when anyway the expectations will not be met or lead to consequences which are not desirable.

Now, the interesting part --- though most customers who offshore take advantage of this cultural trait ( we will delve more on how much of it cultural and how much of it is anything else), in private they acknowledge that they want partners who can challenge them and say NO when the right answer is NO. They do not want to get a submissive YES for everything because then the service provider team is not bringing value in validating what they think. If, whatever the customer think prevails, there is no check or balance to bring in perspective from similar experiences with other customers. Not just that, many even say that they actually would respect an offshore provider more if they see the teams more balanced and responsive and say NO when that is the right answer.

What is the reason for this seemingly foolhardy behavior?:

1. There is a bit of a cultural aspect to this given that such conversations happen across cultures. While at one end are customers from the western world ( mostly Americas and Europe ... and I don't want to get into which ones from these two are more aggressive!) who are more aggressive in general, at the other end is a typical Indian or some times even attributed as an Asian trait of not confronting the client directly in business situations.
2. Another reason and more plausible is also that it just is not there in the DNA of such offshore based IT services companies because they essentially grew through T&M (Time & Material) contracts contributing almost 96% of all their revenues in the last 20-25 years. In a T&M contract, the resources from the service provider works as part of the staff of a manager who is from the customer's side. So, they are essentially executing tasks assigned to them. There is little chance to be asked for opinion in that sense and whatever opportunities exist are not leveraged due to the cultural trait discussed earlier. So, over the years, the organizations have grown on a staple of T&M engagements where their staff has followed what was assigned to them not having much of a chance (or inclination) to speak up to do things differently.
3. Another reason for I have seen is the "Customer is always right" syndrome which is conveniently used as it means whatever the customers asks or says is to be followed and takes away the "burden" of finding what is better or right if that is not known.
4. Another reason, which is again highly debate-able and needs to be understood in the right context has to do with the evolution of most of the offshore based IT service providers. In the early years of their formation, the staff they mostly used were from their base countries. However the IT maturity in these base countries was not to the level of what existed in most of the western world where the customers were located. Hence, while the staff started working, they were mostly on a learning curve for some of the technologies as these were new to them. Hence, in those early years, they also lacked the confidence of knowing that they could have a point to make since they knew that the client teams had worked in these systems for a longer time in the past than them and hence they found it more convenient to follow what was being told due to lack of confidence.
5. Finally, many organizations just do not understand still of what the customer is looking for. They think that by agreeing to what the customer is asking or suggesting, they are making the customer happy and ensuring continued business.
   

However this today is not limited to traditional offshore headquartered IT services companies. Since many of the employees in the offshore units of onshore headquartered IT services companies have been hired from the offshore headquartered companies, they carry these personal traits too with them in their new organization. This has further contributed to their own challenges in meeting expectations at times in their new organization or at times led to further rifting of the great divide that exists in such companies between their offshore units and their base home units set up onshore in the Americas or Europe. That rift is probably a topic for another post though!

But before I conclude this post, I should say that these are typical traits heard from many people on both sides of the story. This however does not mean that all offshore based IT service providers or all the team members of a particular service provider demonstrate this trait. There are many who are highly appreciated and their clients will tell you how they brought value by brining in perspective that were really brilliant. However, for those who found these traits, the above is an analysis on why it possibly happens given that such a behavior does not help either party in the long run.

Tiered Infrastructure Architecture

Thanks to the recession, CIOs are busy but not to support the growing demands of business, but instead identifying how and where to save costs and bring sustained value. When the going is good, it seems to pay better to throw more hardware, software and labor at any business requirement because business is growing and someone will pay for it. Studying delta savings and incremental benefits are more of overheads, where the cost of managing them seems to outweigh the benefits accrued. Not any more in these times!

One of the things I have consistently observed is the lack of a consistent approach to a tiered infrastructure architecture. IT infrastructure is mostly set up as chunks of monolithic or patchy systems with no stratification or gradation of the infrastructure or the service quality provided on top of it. While many banking and other enterprises do have "A Class" infrastructure or service for "A Class" business applications, the rest of the applications and their underlying infrastructure is most often a mix of systems acquired over time. It is often not possible to say that we have three kinds of storage infrastructure --- A, B and C which caters to different kinds of storage requirements in terms of these metrics 1. ..... 2. .... and .. 10. ...

An efficient environment should have an enterprise divide its IT infrastructure into two or three grades. Each component (hardware, software, labor) should fall into one of these buckets. It may not be possible to have an air tight environment with no overlap but having at least 80% discipline from the current 10% (or none) will result in cost efficiencies and better manageability. It will also ensure IT is more responsive and participative in growth --- next time a project estimate is made for (say..) setting up a new back office, the project cost would be more reflective of how critical that operation is to business. IT team would first ask how critical that environment is, operational requirements, redundancy requirements etc. for all aspects of IT environment to plan for an optimal set-up instead of an one-quality-fits-all approach where that "one quality" is often an expensive service requirement.

Emerging New Players in Outsourcing Space

In the last two weeks two major acquisitions were announced in the Outsourcing services space --- Dell acquired Perot systems for $3.9b and Xerox then acquired ACS for $6.4b. These come within a year or so of HP's acquisition of EDS for $13.9b in May 2008.

While each company has its reasons to buy the acquired companies, these deals have few things in common:

• The acquiring companies are primarily hardware manufacturers and the companies acquired were services companies. Xerox or Dell did not have any services business contributing any significant amount to the revenue pie
• Both these recent deals came during the time of recession (or at least the fag end of it if we believe that is the beginning of the end of the recession). In these times if Dell and Xerox spent time, energy and money to acquire these companies, it must surely be a major event in their history. This is surely not one of those Cisco acquiring yet another technology company ( by the way they acquired Tandberg yesterday for $2.96b) where the fitment is obvious. The acquisitions by Dell and Xerox are much more aspirational than others as they aim to start a whole new service line of revenue for their companies. In fact Xerox's acquisition of ACS is even more aspirational than Dell's where the latter at least was in a related business.

Talking of aspirational acquisitions, Oracle's acquisition of Sun for $7.4b which was sure stunner for most industry pundits.

And not so back in the past, IBM had sold its hardware business (ThinkPad) to Lenovo, exiting from a product manufacturing revenue stream -- which helped it focus on services business and improve profitability in a significant way.

These deals are surely going to have some bearing in the future outsourcing services market. Dell is keen to shake off its PC-business image, whereas Xerox realizes that somewhere the printing and copying industry would head to be a sunset industry as over time people have been printing less, copying less on the whole. This will help each company jumpstart into the services space and meet the kind of companies they aspire to compete with.

Interestingly both Perot and ACS have a fair offshore presence in India. With the acquisition, both Dell and Xerox would also get access to these facilities and delivery models. It would be challenging to integrate these acquired companies and find the right kind of management team which can oversee a different business from their traditional manufacturing business.

Pricing Models and Choice of IT Service Providers

Among the various pricing models in vogue with the offshore based IT services providers, the key ones are time and material (T&M) and fixed price (FP) models. While there may not be complete data ( or at least I have not seen), on which ones rule the most --- my personal take is that T&M contracts should be accounting for almost 80% of the contracts if not more. The rest are mostly fixed price. There are some others like device based unit pricing, outcome related pricing which may be there in pockets but mostly T&M rules the chart.

This also shows the nature of engagement --- the customer owns the risk in such contracts -- and probably s/he don't mind it as the nature of work outsourced is chopped and packetized to ensure it follows the technologies, processes and skill requirements that already exist. However as corporations move to a managed services environment, if you can rely on your provider, then to help them realize the full potential of their innovativeness and cost-efficiency, one needs to look at pricing models like fixed price, utility based, transaction based or, outcome based. However, the difference across these models (apart from how you assess the charges and the risk ownership) is also the degree of control you, as the outsourcing enterprise, would wield. So, not only does it require a mature, stable and innovative partner with a track record, but it also needs the outsourcing enterprise to agree to let go control, to varying degrees to completely benefit from outsourcing.

It is not uncommon to see most CIOs embark on a roadmap starting with T&M model, with a stated objective to move to other more deeper models gradually, but somewhere down the road that does not happen -- often fuelled by the outsourcing enterprises' staff's need to retain control or due to the lack of leading-the-curve trait shown by the chosen provider. And then, between the choice of going for a new partner in the hope that it will be different or to continue with the current one but with a lower degree of involvement ( and no transition and a whole lot of other stuff to face) organizations often choose to continue with the chosen provider.

So, it is also important to choose a service provider carefully in the first place before you let them in. It is much more difficult than shifting to a new desktop manufacturer ( which in itself is not easy either!) when it comes to changing service providers for IT services.

Service Provider Consolidation

Many large enterprises over the years find themselves with mulitple IT outsourcing partners who were brought on board at different points in time for different pieces of work. Some times, it is a collated view of opportunistic out-tasking where the cheapest bidder gets small chunks of work till it emerges that the total cost of managing several contracts and service providers, outweighs the benefit of lower cost in siloed contracts.

Among large companies with substantial growth and those with multi-national business spread, it soon becomes apparent that having fewer partners incentivizes them to bring greater value not just with cost but with the quality of work. Clearly, if a customer contributed $5m of revenue, the focus woud be differnt from what it would be if the customer contributed $100m of revenue. It would get greater senior executive review and the outsourcing company would go further to ensure these revenue streams are protected and grow through a partnership.

This, in a free market situation, also acts as an entry barrier for smaller IT outsourcing players ( and actually in any industry with vendor consolidation). .That is why most large companies mature to outsource to few and large IT outsourcing providers only.

In fact, looking at the state of vendor split, size, number of outsourcing providers for an enterprise can actually also reflect on the relative maturity of these organizations in the outsourcing space. Each company has its own journey, driven by its strategy to outsource and its size.

Domestic IT Services Market in India

Offshore based IT Service Providers from India have interestingly a very modest to negligible play in the domestic IT services market in India. With the exception of those which have a hardware based business in India for couple of decades and who do primarily hardware sale and systems implementation, most of the bigwigs have very little revenue coming from India. For those who have, it is in single digits or roundabouts of their total global revenue. Reason?:


- Core value proposition, including but not limited to labor arbitrage does not apply to customers who can also get work for as much as they do
- Access to competent and skilled resources for customers
- Lack of technology maturity in the domestic technology market
- Rampant insourcing in the industry in general
- Long, low value sales cycle. In comparison the same efforts would yield more and higher value (revenue and profit) business in US and Europe

Having spent few years of my earlier life selling in the domestic market, the experience of selling is also different where the customers' buying behavior is much different and not so sales friendly.

Things are changing, moreso with some of the large government or government backed IT spending initiated in recent years. There are also some large and early companies who are looking at total outsourcing

Why Didn't Recession Boost Offshore Services Revenues?

The common speculation that outsourcing and specifically offshoring of IT services would rise dramatically in the recession remained just that -- speculation! In fact in the last two quarters, barring some exceptions, the offshored based IT services companies also saw their revenues from new deals fade just like other industries were hit with recession. This is surely merits a study to understand why this is happening. It looks obvious that an industry thriving on reducing operating cost would only benefit in a situation where bulk of their customers (in US and Europe) move to an environment of severe crunch.

What could be the reason? While an empericial study led by interviews on both sides (customers and service providers) can share some data backed insights, following are some guesstimates based on my interaction with people in the industry:

- Outsourcing and offfshoring activities generally require time to execute through a well defined procurement process if it has to be done at a large scale ( to derive larger value of benefit). Hence this was not considered as an exercise to reduce operating cost since the horizon of initiating, getting a new provider and finally breaking even would be over 24 months --- a time horizon much farther away than the urgency demanded.
- This increase in revenue would have come most from companies who had shied from offshoring in the past and would gain most by unlocking this latent chained value in their operations. However these same companies also shied from offshoring now, which would have resulted in further unemployment in their country. This was not a desirable PR move given the focus on increased unemployment due to recession.
- Many of the companies did outsource but not to offshore based service providers. They outsourced to local American or European IT services companies who offered labor arbitrage close to what the offshored based players offered by having India based centers to deliver work. So, while the offshore based players may have resulted in a marginal better value, enterprieses took a stance to outsource to in-country companies which helped without any negative PR of jobs going to companies from other other countries. Of course, at the back-end these US/Europe based companies leveraged labor in other countries.

Clouds In The Sky

After a long time in the industry has a technology come which people are so excited about – everyone trying to define it and everyone trying to explain what they think it is. It is surprising that still, most articles on Cloud Computing start with defining what the author considers constitutes cloud computing. 

Most however seem to agree that a cloud enabled infrastructure enables:

• Dynamic provisioning
  
• Scalability and flexibility
  
• Universal access
  
• Computing cost as opex with little or no capex expenses
  

What is not talked as much as the hype on the cloud but is bound to get relevant as people get into enabling it for their enterprise are aspects related to:

• Security on the cloud ( yes, there are people already talking of it) is something which needs to be considered at all levels from application layer to infrastructure layer
  
• Very high dependency on the WAN bandwidth for performance of the applications. Until now, for those enterprises with critical applications on computing infrastructure within their enterprise, they were mostly accessing it over a LAN for a large part of the population typically in the head office. Other users would access it over a corporate MPLS network. Now, everyone does the same and while it is possible to get dedicated access and get the same experience, the network charges are bound to go up
  
• The big challenge of application migration where applications will need to move from existing infrastructure in-premise to cloud infrastructure. This will throw up a whole lot of issues where currently running applications for years will need to be unseated and moved to a new environment or even may be get a parallel application environment stood up in the new cloud infra. However as more critical applications start moving on this path, unless these have been recently deployed, challenges will come forth on getting the exactly same environment in the cloud. It is not unheard of, to have critical applications in large enterprises running on hardware or software systems, some of which are end-of-lifed. They continue to run as the cost of finding an alternative or migrating to the new version or system is much higher than running it with higher maintenance for its useful life before retiring them. It may not be easy to re-create environments which require setting up an old out-of-support version of Oracle for a customer who some part of the ERP is connected to an application which runs on this environment. The older the systems and the more customized the applications, the greater would be the barrier to move them to the cloud.
  
• Lack of control for businesses over IT. Now this is something which seems pretty rampant but not discussed so often : it is not uncommon to find businesses running small (or even mid to large) IT departments outside the “corporate IT” for certain applications and systems that they closely work on. In some F500 companies, if aggregated across teams, this is even upto 50% of the size of the corporate systems. In other companies, while businesses use the common services of “corporate IT” they dictate the requirements : “Well, this is a mission-critical application related to blah blah ... and we need a dedicated environment for this application. We cannot have it share computing power with any other application and need a high-end server with ....” With cloud, to some extent, businesses will lose such control and may not be so amenable to have their applications moved to a cloud.
  

Overall the adoption to cloud will happen in a phased manner where enterprises will test the waters or rather test the clouds, with some early applications. That process is bound to take a while, but moving test and QA environments would be a better bet for lot of reasons. That is the subject for another post!

Extending STPI Tax Concessions

15 years back, the Indian government, granted tax concessions (between 5-8%) to enterprises operating under Software & Technology Parks of India (STPI) to give a boost to this (then sunrise) industry. It was considered wise to give this booster shot to help such companies earn more and enjoy a tax concession.

It is now time to decide on either extending or allowing this concession to cease as per the provisions in force. The industry ( which now extends below software companies and includes many ITeS -- IT enabled Services) is rallying to get this extended for another 3-5 years. It will surely help them with a direct impact on their bottomline. If that does not happen, it is likely to adversely impact their earnings by that margin.

While there are no clear clues, it is being widely hoped that the government will extend this concession but negotiate with the industry on the duration. These times of recession are surely not the best to have some more tax outflow but the government has to also look at how this impact tax collections -- which would be a big amount once these tax are brought in force.

For now, the industry groups are waiting for the new government formed to review and come up with a recommendation, but this is surely going to impact most companies operating from India. It is still not clear, if this will impact the pricing levels for future contracts, but surely, it does not help the service providers much and they will then need to take a call if they fork out this extra money from their coffers or try to increase their billing rates marginally -- or most likely as it will be : a little bit of both

Production and Non-Production Support : Experience Matters

One of the other challenges in maturing (and this one in the IT services space) has been that most of the IT services companies based out of offshore have traditionally been engaging with customers in supporting their non-production environment and have little experience managing production systems. In any bank or a large manufacturing set up the production environment is sacrosanct and critical for uptime and performance. However the rest of the non-production systems like Development environment, Test Environment, Staging Environment are not deemed as critical as business depend on them as much as they do on production systems.

One of the key reasons for offshore based IT services companies having little experience managing production systems is that most of the offshore based IT service providers grew on a staple business diet of application development and maintenance. This resulted in these companies developing expertise, best practices and propositions in this space. However almost all of these activities are centered around the non-production systems. When their application (or an enhancement) development, test, QC activities are complete, these were typically handed over to the onshore based service providers who would be running the customers’ production systems for deployment. Offshore based IT services companies have had little opportunity to get into the production environment due to this and probably made little effort as that space was being dominated by the strong, traditional outsourcing service providers. It was easier to get the bucks coming in doing the application development and maintenance work, as they had cracked that part of the puzzle but these companies did not venture out in the production environment space.

This has come haunting these companies when they eyed the IT infrastructure services space. In this area the customer requires companies to manage their IT infrastructure environment, most of which is in the production space. In this space, the offshore based IT services companies have had little past experience and understanding of the underlying complexities. Also, the maturity of the IT systems in the local domestic market and those in US and Europe are not the same ( the latter being more mature and evolved over a longer period of time).

This is where, often in opportunities which involve support of production systems, traditionally onshore based providers have an edge as they grew in that space. Offshore based service providers are now inching towards this space with some having made more stride than others --- but clearly this can be generalized for the class as a whole.

Lack Of Product Focus in Indian IT Companies

While so much is written and read about the IT industry in India, two areas stand out and are conspicuous by their absence in all these discussions. And it is not surprising that these are two areas which otherwise in other parts of the world are in many ways the essence of IT industry. These are:

- The hardware industry

- The software product industry

While it may be incorrect to say that these two sub categories do not exist, fact is that these are hardly mentioned, known or existing the form to be reckoned with globally.

While India has made great strides in the space of IT services, the IT product area has not been something that can be written much about. While there have been hardware products designed to some extent, and there is ample cheap labor ( which can be seen in non IT manufacturing growth), core product design has not progressed much. It requires a different kind of rigor which the IT industry is yet to imbibe. Curiously the same IT services companies are working with leading global IT product companies to help in their IT.

Maturity and leadership in IT technologies will get a big boost when IT products are designed, planned and manufactured in India. This is true of several other economies where this can be seen and India should surely be on this track.

Needed : An Indian SOX

With the Satyam accounting scandal that has not just rocked the Indian IT industry but overall the Indian business community, the need for stricter norms for publicly traded companies is loud and clear. It is surprising that no one is yet talking but just like Enron, Worldcom and other disasters led to the Sarbanes Oxley regulation in the US, this is the right time ( though late) bring about such a regulation to ensure such disasters are never repeated.

That the business of business is business is known, but when businesses go about creating or evaporating wealth by doing pure accounting, the impact is felt across the socio economic levels of not just the country but globally in case of such enterprises.

A lot of Indian IT companies are taking extra pain to demonstrate their transparency and voluntarily going ahead with key disclosures to substantiate their financial position. This is a great booster and helps enhance the credibility of the industry which many perceived to have taken a beating with the events of the past week. 

Satyam - The End of A Beginning or The Beginning of An End?

The events of this week with Satyam Computer Services, India's fourth largest IT services company, has left all shocked and stumped.

Industry associations and government are keen to ensure that this does not in any way dampen the "India story". In a basket of mangoes, there can be a few bad mangoes which does not make the basket bad. Enron did not mean that all American business enterprises indulge in fraud and similarly this is an aberration which needs to be highlighted and quickly addressed.

The customers, employees and shareholders are the most impacted with this. For others, it is more on an "environment news" - but for anyone who is one of these, the damage is closer and devastating for employees and shareholders.

It is good to see that the government has taken up some rare and unprecedented action ( at least to my knowledge) of instilling this confidence by constituting a new board. Once the true state of the finance position is known, the team will chalk out a program to stabilize, recover and then grow.

This is important for Satyam and for the offshoring and IT outsourcing industry from India in general. Something to closely watch and these events just reinforce that nothing can be taken for granted.

Satyam Computer Services : An Acquisition Candidate?

While a lot has been written recently on the developments at Satyam Computer Services in the recent week, clearly with the directors resigning including the high profile Vinod Dham, it has impacted their image. The recent World Bank issue which reportedly banned any business withthem for few years did not help any further either. There is more news tumbling on the nature of holdings by the promoter but this post is not about these developments really, but their possible impact in terms of a possible acquisition.s

So, is Satyam a good candidate for acquisition by either traditional onshore providers (like IBM) or even offshore players (like Infosys or TCS)? It may not be as easy, even when the time comes after the next quarterly announcements which is expected to clear their holding and cash reserve position. Here are some considerations:

1. It is too big with over 50,000 employees for a simpler acquisition assessment
2. It has been aggressive with its pricing, often taking on business with lower margins which may not fit every company's norms
3. It has a very negative image currently with possisble impact on future earning potential which does not strengthen a case for letting it exist as a separate entity after the acquisition
4. It would not bring any differentiator to at least the offshore based providers, except access to a resource pool of their employees and the existing customer base. No major technology or service differntiator would be involved.
5. For onsite based providers, most who wanted an India story have a big India presence already (IBM has over 70,000 employees) and so it may at least appeal to a major onshore based provider which was left behind in building an India story. This probably would be from a European provider as most US based onshore providers already have a big India presence.
6. While always counted among the top 5 of offshore based players, it was probably the one without a professional management team, when looked at by outsiders. There are others also in the Top 5 who are also led by the founder or his family but with all other factors inclcuded Satyam stood out in that count.
7. The current economic climate does not motivate many to look at Satyam for an acquisition in an all-cash kind of deal.
8. There has been a start of exodus and poaching of some of their brighter employees which will only worsen with time, if a promising suitor doesn't move quickly
9. Satyam has played in most segments but does not lead in many and by too much. The best areas known as its SAP practice and to some extent its engineering services practice.
10. The promoters have caused damage with the news trickling and their other interests (in real estate etc.) to make any new company do a thorough scrutiny of its books before deciding on it.

Surely a story to keep tab on in the coming weeks.