Crossing the Chasm

The nineties had seen technology stocks on a dream run on all international
bourses. But, it ended with shattered dreams for many investors. For example,
the Club 90s was defined as stocks that had lost more than 90% of their value.
In 2004, the phoenix rose from the ashes and software companies took center
stage again. What happened during this period? Was it a new business cycle or
just out of a dip in the original one?

The model

To seek answers, we examine characteristics of Indian offshore opportunity
and its acceptance in world market using Technology Adoption Life Cycle (TALC),
as described by Geoffrey Moore. TALC depicts various stages of acceptance of a
technology by different people over the life of that technology. At each stage
of the life cycle, the technology vendor is confronted by a unique set of
customers-each looking at the product differently. The TALC stages are similar
to product lifecycle curve.

Geoffrey Moore, however, introduced an intermediate stage in the life cycle
called the 'chasm,' which is a period when there is an abrupt pause in the
life cycle. This chasm stage is also known by 'trial by fire' period-and
many fail during this period. The chasm occurs between the early adopters
(visionaries) and early majority (pragmatists). After the initial pick up, the
early majority wants to be sure that the technology is path breaking and truly
worth investing in. Pragmatists do not accept the visionaries' reference very
easily and monitor the early results of implementations to assess the benefits
achieved and hurdles faced. During this period, there can be elongated sales
cycles and often even a dip in revenues and profits. Many vendors fail during
this period, as they are unable to attract the pragmatist buyers or are unable
to survive due to financial or strategic issues.

TALC Stages The Tornado stage

In late 80s, although many global majors moved in-house IT development to
third party IT service providers, few companies (innovators) were ready to test
the offshore waters. And by the mid- 90s, many global corporations, mainly from
BFSI (Y2K opportunity) and Telecom verticals explored Indian offshore potential
by setting up shop in India or tying up with Indian vendors. The visionaries had
started accepting the offshoring proposition.

By 2001, offshoring had hit the chasm as the US economy slowed down, leading
to curtailment of IT budgets. Besides new geopolitical risks like 9/11, Iraq war
and SARS emerged, impacting client visits that in turn lead to drop in business
volumes. Many expected offshore to actually do better in challenging times with
its low cost proposition. But, slowdown hit the business and bourses, as stocks
crashed like ninepins. In fact, the offshore model was put on 'wait and watch'
as the pragmatists put their investment decision on hold.

Stages in Early Majority

During these difficult times, Indian vendors moved to expand their service
offerings, build capabilities of delivering complete end-to-end solutions, set
up reference sites and adopted niche marketing to address specific needs of
pragmatists. In H2 of FY03, when the technology budgets started rising again,
offshoring became mainstream and the flow was so strong that unemployment issues
in the US, even in the election year, could not stop the juggernaut. On the
contrary, it worked in favor of offshoring. This is where, to put it in TALC
terms, 'Offshoring crossed the Chasm.'

In tornado stage

Technology undergoes three sub-stages in the early majority phase: 'bowling
alley,' 'tornado,' and 'main street.' When a small section is
convinced to accept a technology, it is the bowling alley stage. This is
followed by a sharp surge in business when the other corporations adopt the
concept-which is the tornado stage. Main street is a phase when the strong
influx of clients experienced in the tornado starts subsiding and the technology
gets commoditized.

The current market characteristics like sharp surge in volumes, hiring in
hordes, and supply constraints against rising demand clearly indicate that the
offshoring concept is in the tornado stage. The idea of the industry is to
capitalize on the opportunity till the market returns to steady state in main
street stage.

Tornado is also a race for market share and results in three types of
players: 'gorilla,' 'chimp,' and 'monkeys.' Here we differ from the
Geoffrey model and do not look at gorilla and chimp as a single player but as a
set of players.The tornado in offshoring is likely to see large vendors (like
Infosys, TCS, Wipro) as gorillas; niche players (i-flex, Hughes Software,
Geometric) as chimps; and me-too's as monkeys.

Gorillas have the best profile in terms of capabilities and experience and
garner the highest market share. In the past year, these have registered higher
growth than other players in the market. In addition, they usually get the
highest valuation on the bourses. Chimps are niche players who differentiate
their offering from market leaders thereby securing their share of the pie with
less competition and low margin pressure. Even during vendor consolidation by
the clients, chimps find a place in the list because of their specialized
offering. However, the growth for chimps is tied to the growth of the specific
market segment that they specialize in. Chimps are likely to fall in the median
of valuation scale. Monkeys are me-too players who aspire to be gorillas. These
players are large in number and share a fragmented market. Monkeys try to get
business on price, client relationship or tie-ups and benefit in a scenario
characterized by strong demand. However, vendor consolidation hurt monkeys the
most and they usually feature at the bottom of valuation chain.

Nimesh Chandan Research Analyst, Stratcap Securities