How Indian IT companies are trying to survive as outsourcing business declines
June, 08th 2018
The first sign that Infosys was dismantling the structure created by its former CEO Vishal Sikka came in October.
One of Sikka’s pillars of growth was to be acquisitions and Infosys would spend as much as $1.5 billion in buying companies. However, his biggest buy–the $200 million acquisition of Israeli firm Panaya–turned out to be his undoing.
When cofounder Nandan Nilekani returned to become the chairman of the Infosys board, he promptly took the axe to the onsite power centre that Sikka had created–Palo Alto. “I think this is a strategy, which has come about by a process of both top-down and bottom-up work. It’s a strategy which everybody has bought into. We see Palo Alto office as a listening post to the latest developments in tech happening in Silicon Valley,” Nilekani said in October.
Nilekani’s step took Infosys back to its roots–to an Indian power centre–a tactic practised by Indian IT companies for decades but one that’s holding them back now. Experts say the same offshoring culture that helped Indian IT companies grow is hurting their plans in the mergers and acquisitions (M&A) market. With global IT consulting firm Accenture spending more than $1 billion a year in acquisitions and growing fast, Indian IT might need to be less ‘Indian’ to succeed.
“The difference between Accenture and Indian IT is in capital allocation. When you buy a company in Tel Aviv or Ireland, you need to retain that management and its abilities and competencies,” Ajit Isaac, chairman of business service provider Quess Corp, told ET. “Indian IT grew on the back of offshoring, so India was always the focus and the nerve centre. So even in an acquisition, the focus did not move to the acquired entity. In that sense, it remained inward-looking.”
Quess, which is building out a technology services division, is one of the most acquisitive companies in India–with more than 22 deals in its 10 years. This, though, does not mean Indian IT companies have not tried. Wipro has had a stringof-pearls strategy and has spent well over $1 bn in deals in the last three years. Cognizant made a bold bet with healthcare platform Trizetto. Tata Consultancy Services, the most averse to flashy deals, has made acquisitions in Japan and France.
But there have been significant stumbles recently. The March quarter saw both Infosys and Wipro write down acquisitions. Infosys is selling Panaya and Skava, which it bought in 2015, saying they are no longer core to its strategy. The company took a write-down of Rs 589 crore on Panaya. Wipro took an impairment on its HPS acquisition. In the past, too, IT companies have struggled to make the best of their deals.
A veteran IT executive, who worked on integrations with two companies, said the problem was culture. “Generally, in Indian IT, what happened is that we tried to sort of impose our own mould on (acquired) companies. That doesn’t give them freedom or space. The news tracks how many companies have been acquired, not how many have been disposed after three or four years because the expectations were not met,” the executive said.
Because IT companies were not greatly acquisitive in the past, the lack of consistent M&A and integration skills was never a great concern. Double-digit growth was a matter of course and deals were there for the taking as multinational players like IBM, Accenture and EDS struggled to compete with the India offshore advantage. “The organisational DNA of Indian IT services companies has largely been about cost arbitrage and not about scale and capabilities. Unlike an Accenture, it may have taken their focus away from capability building,” said Sanchit Vir Gogia, CEO at Greyhound Research.
But now, that playing field has been levelled. The multinationals have either built large outposts in India organically, like Accenture and IBM, or bought their way to offshore scale, like Capgemini. With newer technologies coming in, and large deals no longer the norm, Indian IT companies are fighting tooth-and-nail for access to innovative companies. But their multinational rivals are far more skilled at striking such deals, and have a higher risk appetite.
Take consulting, for instance, an area in which Indian IT companies have tried for years to build scale. Infosys bought Lodestone and HCL Technologies bought Axon, but executives who worked on consulting acquisitions said there was an in-built conservatism at play.
“I think there is also a discomfort in paying the premium that has to be paid for successful consulting business. Even if you set aside the need to impose the India hierarchy, so many deals fell through because companies were uncomfortable with the idea that the asset was a consultant who could choose to walk away,” said a US-based consulting executive with one of the top three Indian IT firms, who was involved in acquisition discussions.
The large Indian IT services companies do not have adequate “innovation quotient” and that to a large extent impacts their ability to effectively use the strengths of an acquired firm, said V Balakrishnan, former board member of Infosys. He believes a comprehensive three-pronged model—strategic venture capital fund, internal platform to identify innovative firms, and acquisitions—involving startups to build capabilities is important.
“The innovation quotient in large companies is always a challenge. The best innovations are happening in the startup ecosystem. The challenge for large IT companies is how to assimilate this innovation and plug it into its own DNA,” said Balakrishnan. The long-standing belief about the Indian IT sector was that as services business they were typically valued equally or marginally higher than their revenue, and so their acquisitions would need to be in the same range. The great Indian love of bargains also governed what deals were made.
“If what you are trying to do is buy your way into a leadership position in a new industry, buying the failing companies which are at bargain prices is highly unlikely to succeed,” said Peter Bendor-Samuel, CEO of IT advisory Everest Group. “Unsurprisingly, it has not worked well for Indian firms. Having said that, they are adjusting their targets and now looking for better properties, but having to pay premiums to land them.”
Now potential targets, with digital capabilities, are able to command far higher prices. In February, Capgemini, which plans to spend $500 million a year on deals, bought digital services company LiquidHub for 400 million euro, which is twice LiquidHub’s revenue. Products and platforms typically command much higher multiples, but with cases such as Infosys’ acquisition of Panaya at six times its revenue, there is pushback.
Former Infosys CEO Vishal Sikka left under a cloud of accusations that the price paid for Panaya was too high and that there were ethical concerns with the deal. Infosys has since tasked veteran Deepak Padaki with managing its M&A strategy. He also looks at the company’s venture capital investments and is the chief risk officer. “They should have hired a banker for that role. You need that connect to drive deals,” the chairman of a services firm told ET.
Cognizant, which is targeting 5-10 acquisitions a year, has hired former Goldman Sachs partner Timothy Crowhurst to lead its acquisition strategy. India’s largest IT firm, Tata Consultancy Services, has taken another path. Though the company says it is active in the M&A market, it refuses to pay over the odds for deals. It also says its M&A team is highly successful.
“If you look at our track record, almost every deal has been executed to perfection. You have to find the right deal and you have to be patient. It is not about whether you swing your bat 10 times, it is about when you swing you should hit a six,” Rajesh Gopinathan, CEO of TCS, told ET. “We have never had to take an impairment on a deal. That’s the success.”
TCS’ M&A unit is headed by Debashis Poddar, who joined the company in 2001 from American accounting firm Arthur Andersen. Infosys did not reply to emailed queries from ET. A Wipro spokesperson said: “We have managed to differentiate our positioning in growth areas such as digital, cloud apps, or crowdsourcing on the back of our acquisitions such as Designit, Cooper, Appirio and Topcoder. Our digital business is growing very well and we will continue to make acquisitions and and investments in this area.”
As the Indian IT sector moves into its next phase of growth, it will have to get better at making acquisitions and will likely need to stop thinking of itself as Indian. “I am not a big proponent of calling us Indian IT,” Nitin Rakesh, CEO of Mphasis and chairman of Nasscom’s IT services council, told ET. “This is an industry that is world-class and at global scale.
Any company that needs to mature and become a global player needs to have the following skill sets—building, buying and partnering. We have been good at building, not so good at buying and partnering, and that will be the next evolution.”