State of Technology: Can IT Services Companies Weather the Perfect Storm?

In this series, professionals debate the state – and future – of their industry. Read all the posts here and write your own (use #MyIndustry in the body of your post).

A lethal combination of technological change, new business models and changing customer behavior is rapidly gnawing away at the underpinnings of India’s former superstars – the IT services majors.  As companies move more of their operations into the cloud, the need for IT workers to perform traditional tasks like maintaining networks, servers and applications diminishes. IT budgets are being relentlessly squeezed and enterprises are getting smarter about exploiting the lack of differentiation amongst IT vendors to drive down prices and transferring risk to vendors. Increasingly what CEOs care about is how to use software to transform their business, a question that few traditional IT vendors are capable of answering imaginatively. And advances in artificial intelligence are enabling the automation of a lot of low-end work neutralizing India’s labour-cost advantage.

No wonder that India’s vaunted IT companies are facing disruption, evidenced in slower growth, declining margins and the inability to forecast revenues even one quarter out. The good news is that CEOs of these companies see the coming disruption and are trying hard to embrace the new trends.

However, the track record of companies in navigating disruption is poor.  Kodak. Digital Equipment. Sun Microsystems. Nokia. Blackberry. These are but a few once great companies devastated by technological disruption. Even mighty Microsoft and Intel are struggling to reinvent themselves and stay relevant in a phone-first world. There are vital lessons in these stories for India’s IT giants.

It is easy, but wrong, to assume that the companies that get disrupted were poorly managed. After all, why else did they fail to adapt to changes that we all saw coming?  Disruptive changes are like big storms — they build up slowly and then break with terrifying ferocity. So it is quite easy to spot the brewing disruption.

For instance Kodak developed the world’s first digital camera in 1975 and held all the most important patents pertaining to digital imaging. Kodak realized the impact digital photography would have on its enormously lucrative film franchise and moved early to commercialize digital cameras. But its actions were anemic and the company eventually failed. The story is similar with Nokia, which launched one of the world’s first smartphones — the N Series Communicator in 1995 – but understood too late that the iPhone had shifted the game from devices to competition between ecosystems. These companies had market leadership, enormous resources, most of the technology and many smart managers. They saw the approaching disruption yet failed to cross the chasm.

Challenges in navigating disruptions:

There are multiple reasons why companies find it hard to navigate industry disruptions. One is complacence, even arrogance. The larger and more successful a company, the greater the risk of complacency.  When a company is sitting on billions of dollars of cash, fat margins and good market share, it’s hard to create a sense of urgency and paranoia in the organization and its shareholders.  Another is the “gravitational pull” of the current or legacy business.  The need to deliver quarterly earnings, serve existing customers, maintain profit margins, manage the many daily operational challenges all consume the majority of resources and — more critically — senior management attention. Too little focus goes towards embracing the brewing disruption until it is too late.

A third reason is the fear of cannibalization; the new model is, at least initially, much less profitable than the current business and so there is a big fear of margin dilution. Microsoft’s cloud services for instance have nowhere near the profitability of its old Windows and Office businesses. However some margin is much better than zero margin. The new business model usually requires a very different mindset and new capabilities.

In IT services, for example, success requires the ability to hold a proactive conversation with CEOs and CXOs about the digital transformation of their business rather than simply responding to project RFPs issued by the IT department. Building these capabilities is non-trivial and time-consuming.  

Finally there is governance. Though the Boards of good companies are populated by accomplished leaders, few have independent directors with a visceral grasp of the magnitude of impending changes. It is all too easy then to remain focused on revenue growth and earnings per share until it’s too late. One obvious sign of this is to look at how the CEO is compensated. All too often it is based on the financial performance of the legacy business rather than the momentum of the future business model. Until of course it is too late.

The failure to embrace the next model therefore stems not from corporate incompetence but from a set of factors that are deeply and structurally encoded in the business. India’s IT giants face just such a transition today. They have been immensely successful but face a dangerous combination of technology and business model shift.  The CEOs of these companies are capable leaders who see the looming storm and are nudging their companies to change. But these are huge and still very profitable companies with lots of legacy. And for all the reasons I have stated, change will be extraordinarily tough and risky. 

What can be done?

First and foremost, strategic transformation must be the top priority of the Boards of companies facing disruption. Strategy cannot simply be left to the CEO and management; it has to be a collaborative endeavor.

Second, make it clear that the CEO’s top priority is the strategic transformation, not merely delivering the quarter and align compensation accordingly.

Third, realize that there are two kinds of risk: the risk of omission or doing nothing versus the risk of commission, i.e. trying something different and failing. The risk of commission is better than doing nothing and the urgency and consequences of failure are such that there should be no half-measures.

A significant reason why Kodak and others failed is because their responses to disruption were half-hearted or anemic. This won’t work; to succeed, companies have to be “all-in” or utterly committed to the shift. This may mean making significant acquisitions or bringing in very different talent even though these moves also carry major risk and can blow up too.

It's worth remembering what Darwin said, “In nature it is not the strongest species that survive, nor the most intelligent, but the ones most adaptable to change.” 

Ravi Venkatesan is the former Chairman of Microsoft India and a Member of the Board of Infosys