Home / Industry / Infotech /  India’s mid-tier IT sector faces mid-life crisis

In 1981, seven engineers who resigned from their jobs at Patni Computer Systems started a company that would go on to become the face of India’s information technology industry.

Infosys Ltd was not the only one that started its journey in the 80s. The decade, in many ways, laid the foundations of India’s $118-billion IT industry with technology start-ups sprouting up all over the country; a number of them looked promising enough to become billion-dollar successes.

Cut to the present and the picture doesn’t look as rosy, especially for the second rung of companies in India’s IT sector.

Even though a number of those technology firms started around the same time as Infosys, few managed to replicate the Bangalore-based firm’s success. Only a handful of those companies went on to become multinational billion-dollar firms, with listings on Nasdaq.

The rest of the landscape is littered with examples of those that have fallen by the wayside.

As the sector evolved, a number of them including the likes of Mastek Ltd, Geometric Ltd, Infotech Enterprises Ltd and Polaris Financial Technology Ltd, struggled to differentiate themselves and became mini-versions of larger rivals such as Tata Consultancy Services Ltd (TCS) and Infosys, handling back-office software projects for large global companies, according to at least half a dozen experts.

“It’s a me-too syndrome," said Frank Ridder, managing vice-president at technology researcher Gartner Inc. “As long as you start copying someone in a high-growth market, it can work as you can always find someone who can buy your services. But this comes to an end when the big ones really start fighting. And they really fight. They use their muscle power to kill everyone else who is small. At that point, if you don’t have a unique IP (intellectual property), then you’re very much out."

“And that’s the problem with most of the mid-tier firms here—they are me-too companies," said Ridder.

The numbers seem to back the theory. By and large, including the latest December quarter, mid-cap IT firms like Zensar Technologies Ltd, MphasiS Ltd, the recently-acquired Hexaware Technologies Ltd and KPIT Technologies Ltd have lagged larger peers consistently in terms of revenue growth and adding incremental revenue, a measure of market share growth that has evolved as the new benchmark for the Indian IT sector.

In the past eight quarters, most mid-sized IT firms, with the exception of Nasdaq-listed iGate Corp. and Bangalore-based Mindtree Ltd, have seen stagnant or declining revenue growth.

And this polarization between top-tier and mid-tier firms is set to continue in the near term, experts say, with most mid-sized companies (including even Mindtree) grappling with unpredictable profitability and struggling to add new clients.

“These firms, except KPIT and to some extent Hexaware, have too many clients for their size. This means, they have large number of small accounts. Many of them focus more on winning new accounts, as against top players who focus more on growing existing clients," said Sudin Apte, founder and chief executive of outsourcing advisory Offshore Insights, in a recently released report on mid-sized IT firms.

Over the last decade or two, only two mid-tier firms have actually managed to breach the $1-billion revenue mark—MphasiS and iGate. And in iGate’s case the $1-billion target was achieved through its acquisition of Patni Computer Systems.

Most observers say none of the current crop of mid-tier firms looked promising enough to become the next Infosys or TCS.

“Their account practices and sales strategies lag some of the top Indian players and hence their ability to grow existing accounts is low," said Apte.

If the December quarter is any indicator, the lag between growth rates of large and mid-cap firms is set to continue. For the calendar year 2013, the top five Indian IT firms grew at an average of about 11%, while the next rung of companies grew by 7%, according to Offshore Insights.

“These are challenging times for the mid-tier providers, but I believe there are significant opportunities for the ones which get their strategy and focus right—and focus on being agile, aggressive and price competitive in the market," said Phil Fersht, founder of outsourcing advisory HfS Research.

The polarization between top and mid-sized IT firms comes at a time when India’s multi-billion dollar IT sector is facing its biggest transformational period since the dotcom boom of the 2000s, with companies increasingly relying on non-linear growth models that require fewer people on projects and reducing costs by automating many tasks that previously required the presence of engineers.

Experts say the likes of even Mindtree and Hexaware, along with Mastek and Polaris will struggle to adjust to the realities of the present, where top outsourcing customers such as Bank of America and American Express increasingly are opting for pay-as-you-go billing models and asking for fewer people on projects.

“I think it’s fair to say that the chances of any mid-tier firm becoming the next Infosys or TCS are fairly slim. Those models were created in the 90s, and it’s a completely different game now… the commoditized companies trying to be a scale player are in for a disaster. That market is over," said Ganesh Natarajan, chief executive of Zensar Technologies, a mid-sized firm.

Mastek conceded that it went wrong with its strategy of focusing mostly on UK for the better part of the last decade, but added that it was poised to see better times ahead.

Even Mindtree, which has recently fared somewhat better than some of its other mid-tier peers, witnessed a fall in its fortunes after the 2008 recession and failed to reach its target of $1 billion by 2014, as was articulated by its former chairman Ashok Soota.

Mindtree and Polaris did not respond to emailed questions.

“We have had our top customers for 10-15 years, and we haven’t lost a single major customer in the last five years, despite multiple economic times," said Ganesh Ayyar, chief executive of MphasiS.

Experts tracking these companies also said consolidation and mergers in the mid-tier space would help mid-tier firms gain scale and compete better with top-tier rivals.

“A wave of consolidation in this sector would really help—for instance, if a bunch of them were to get together and form a consortium, potentially with outside financing, that would be one route that could work for them," said Sid Pai, partner and president, Asia Pacific, at outsourcing advisory firm ISG.

Some experts, however, disagreed with the notion of a mid-life crisis in the mid-tier space and said the addressable market is still big enough for nice specialists to take advantage of and grow at a comfortable pace.

“The industry’s tradition of linking the perception of a firm’s quality to revenue is arbitrary and not relevant for many customers. Where size is not critical, customers differentiate between firms based on capabilities and maturity. When using relevant and comparable metrics as a measure of goodness, many customers believe that the gap between many tier I and tier II firms has shrunk," said Peter Schumacher, founder of Germany-based Value Leadership Group that advises companies on their Europe strategy.

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