Can this one change transform IT Services industry?

Is the season of Consolidation upon us?

The acquisition of iGate by Capgemini was interpreted in some news articles to indicate the onset of consolidation era in the IT services industry. Specific names of the top India based companies was mentioned as next in line. This is what normally follows years of lacklustre growth. Of course there is merit in that hypothesis but there is probably a much better trajectory to pursue which can meet the demands from customers and investors.

IT Services is much younger compared to other industries like Banking, Retail or Manufacturing. When they experienced persistent slowness in growth, investors stepped up pressure for performance. Hectic inorganic growth followed, the survivors derived scale advantage. For example Music industry was disrupted by digital music, after a years of steady consolidation there are just 3 large labels (UMG, Sony and WMG).

That is one side of the picture. On the other hand, for the past few years enterprise customers have been steadily optimizing technology spend for business-as-usual through measures like vendor consolidation and contracts renegotiations. The need of the hour was initiatives that can generate competitive advantage for them. These initiatives needed deep domain appreciation and required vendor participation for the cutting edge capabilities. Some of the side effects were seen in the form of in sourcing, near shore centres and Customer IT captives in offshore locations.

If the industry was just going through a slow down, then a burst of consolidation could well meet what the investors are expecting and it does not disappoint the customers. However there is a major shift in what customers are seeking to achieve and hence simple consolidation is not going to solve the problem.

What can then possibly address the demands from both customers and investors and also light up the path of evolution? 

IT Services Industry Evolution History

Before we talk about the possible way forward, let us quickly trace the path taken so far and learn from that.  It will help make the point that there is a logical next step available which can set us at a higher orbit.

A simple representation of the evolution of IT services over the years can be represented as follows: 

• Stage 1: Customers set up EDP departments in house
• Stage 2: Customers started to augment their teams with flexible workforce of contractors
• Stage 3: Customers started B2B model engagement with IT Services Providers
• Stage 4: Customers started engaging offshore firms
• Stage 5: Customers set up offshore based captive IT units  

Spotlight on Stage 3

Customers entered Stage 3 by embracing a supply chain instead of self-sufficiency and set up a panel of partners. Many of these are the large MNCs we see in the industry now. This has played a major role in the increased adoption of IT. As new waves of products were available, there was a vendor ready to support services on that. In turn it encouraged next versions of the products and even better new products. In effect customers gained a multiplier effect. 

Spotlight on Stage 4 

Stage 4 gave our customers the scale and cost advantage along with benefits of Stage 3. It also ushered in an era of process maturity and connectivity improvements to mitigate the risk of remote execution. World got flatter. The new breed of vendors were mostly from India. Service provider proliferation ensued. There are indications we are at the plateau of what this Stage can deliver as advantages.

While broadly there is respect for deep capabilities it is not seen to translate into market success. How many B$ or even a few 100M$ IT services provider firms do we see which have a sharp focus? To paraphrase it, generalists rule. Every service provider reaches out to and serves the end customer. The cost of customer acquisition is significant and hence they try to maximize the quantum of business done with each customer and in the process go broader. 

Spotlight on Stage 5

Primary motivation for captive units are one or more of these factors: business criticality of processes supported and deep domain know how. Among other things, it reflects a gap in what was available from the vendor partners. 

What could possibly be the next stage of evolution?

The concept of supply chain made of ancillary units which is widely prevalent in other industries can be adopted in IT services industry. For want of a supply chain, everyone from a small to medium to large service provider is forced to be the shop where the buck starts and stops.

Wait! Why will this solve the problem for customers and investors?

It is simply "division of labour" applied to the construct of IT services industry. For the larger players, who want to be the one stop shop, it solves the problem of trying to be the breadth and depth player at the same time. They can focus on owning the customer problem and engage freely with their supply chain for specifics. For those aspiring to be in niche segments, their priorities can remain being deep and not get diluted in market making. They can invest much of their current SG&A back into R&D and capability building. 

What are the possible objections to this? 

Why will Customers agree to this shift? It will increase their risk exposure. 

When the Customers IT evolved to Stage 3 they surely went through the same milestone - "Our business needs to accept this proposal to engage external firms". Even now in certain processes there are restrictions on what type of outsourcing is allowed and we all align to those specific needs and that is a small portion of the landscape. We need to sit down with our customers and discuss merits of this change and how it can help them. 

Most service provider firms now have Verticals and Horizontals. They even have an innovation program overseen by a CXO level sponsor. Why should they rely on yet another vendor instead of building the capabilities in house? 

Just like the customer IT function gained multiplier effect by adopting a supply chain, the proposal is for the primary service provider to adopt the same model and gain multiplier advantage of being able to tap an ecosystem of ancillary units.

Many of the service providers have adopted two dimensional organizations with Verticals which own the customer, focuses on industry capability and Horizontals which develop niche capabilities. When faced with a linear market, manageable pace of change this structure worked out reasonably well. The proof is it is widely adopted.

This quote from the movie The Matrix says it well: "We can never see past the choices we don't understand" and there is a limit to this understanding within any given firm. It does scale as you add to management team but strategic decisions do bubble up and senior management becomes the choking point. 

When a gap in capability is spotted, will acquisition or taking up stake in a few niche firms not solve the need for depth? 

The core point being made is replacing self sufficiency of a service provider with an supply chain model which taps benefits of "division of labour" and encourages specialization. In effect some firms become deep on customer context while others go deep on specific types of problem solving and they collaborate to meet the needs of the customer. 

What are some of the other known challenges which have to be overcome before this model can be attempted?

The point to keep in mind as we browse through this list is the shift should result in the size, taste and quality of the pie is increased significantly. If we don't pro-actively embrace change it gets forced on us.

• Need for changes in the Customer buying process was mentioned earlier. The associated contracting process has to step up to handle the risk of more parties coming together to deliver engagements. The industry generally relies on 1-1 contracts now.
• For the primary service provider the risk increases due to dependence on channel partners to deliver something they were used to being self sufficient on
• For boutiques, direct access to customer gives more visibility and possibly control of engagement compared to being playing as part of the supply chain of a larger provider.
• Attracting best talent: The boutique shops should be able to communicate their value proposition to attract best in class talent and hence justify the tag.

Let us continue crystal gazing

There are serious attempts being made in the industry to discover a break out path. We have had public discussions on some of those attempts. Some good examples are IT + BPO synergies, Platform based services, Outcome based models, Adoption of AI and Automation. This post is a contribution to that discussion and not a critique on the industry. I am proud of what we have achieved as an industry and am excited to see what's in store.

Looking forward to hearing back from you.

Have a great day ahead!