IT SERVICES LANDSCAPE: Positioning Matters

IT services is enabling corporate technology. Defined, it is

the knowledge resources behind the tools and solutions that power the e-volution.

As suggested by the breadth of the definition, there is great scope and varying

opportunity implicit to the wide range of IT services that can be offered. The

diagram (see below) offers a thematic overview of IT services companies, the

market opportunities, the value-add possibilities, and most importantly, where

Indian companies stand within the global landscape.

Global comparable companies

We group IT services across three major categories–broadline

service providers, e-business services (including systems integration, ASPs,

Internet data hosting services), and consulting/strategic services. While there

is some overlap among larger players, each service provider’s core business,

generating the bulk of its revenues, will generally play the overriding factor

in determining its peer group.

Broadline companies

Broadline IT services providers are large, traditional,

incumbent IT outsourcers that have evolved with technology and offer services

across the full technology spectrum. They include varying degrees of strategy

and consulting, e-business solution implementation, Web hosting, integration,

transaction processing, facilities management, and staff augmentation.

Key companies that dominate this space are large and

institutionalized such as IBM Global Services, Cap Gemini, EDS, and CSC.

Broadline companies are generally large market-capitalization

stocks with multi-billion dollar revenue lines.

All three US-based broadline companies that we profile in

this report–Affiliated Computer Services, EDS and CSC generate large-scale

revenues–ranging from about US$2 billion (AFA) to over US$20 billion (EDS).

E-business services

E-business service providers span a group of companies whose

core business (at least 50% of revenues) revolves around e-enabling/e-frastructure

initiatives. This field is as broad as the Internet, covering service offerings

ranging from complete end-to-end e-business solutions to specific services such

as network/systems integration, applications service provisioning, Web-enabling

solutions, Internet data centers, and managed services provisioning.

As the newest stage of the e-volution many of the companies

that focus on this space are younger and smaller than their broadline peers. As

such they have exhibited higher growth than others within the global IT services

space.

For the purposes of comparison, our US Technology Research

Team recommends three key players spanning the e-business services space:

Sapient Corp, Viant Corp and Diamond Technology Partners.

Strategy and consulting services

E-business strategy and consulting is the highest yielding

segment of the IT services value chain. Key players have typically evolved from

being traditional management consultants that are applying expertise of business

processes and vertical domains to technology initiatives. These include:

Andersen Consulting, Boston Consulting Group, and McKinsey.

Some newer technology service providers are also ramping into

consulting services albeit from the implementation side of the spectrum. Diamond

Technology Partners is a technology company with a dominant core competency in

e-business consulting. Viant Corp. also has a majority focus on e-business

consulting and strategy services, while Sapient is engaged to a lesser extent on

strategy/consulting. The three companies essentially occupy both spaces and are

referred to by our US Technology Research Team as complete ‘e-business

architects’.

As mentioned above, some of the key global broadline

companies such as IBM Global Services, Cap Gemini, and EDS also have e-business

services and strategic consulting units within their broader business

structures.

Global staffing and outsourcing companies. The diagram

includes US-based IT staffing companies with outsourcing operations and some

degree of Indian offsourcing exposure. While there is always the risk of global

players tapping into the ‘offsourcing’ opportunity in India, the success of

these companies (e.g., iGate and CBSI) has been mixed. Operating margins and

growth have lagged India-based leaders due to high infrastructure and overhead

costs overseas. While these companies may be considered similar in structure to

Indian IT services, they do not represent the e-volutionary opportunity and do

not have the attractive financial metrics or technology leadership which Indian

IT services seek.

Implicit in the hierarchy of IT services discussed, the areas

of highest per-capita revenues are e-business strategy and management

consulting.

Broadly speaking, low-end offsourcing contracts involving

coding or maintenance generate about US $20,000 per billable IT professional per

year. High-end work, in the area of strategy and management consulting,

currently yields about US $500,000 per professional annually.

Balancing with long-term revenue streams

Many investors, analysts, and companies themselves pay

particular attention to the yields generated per employee as an overbearing

indicator of a company’s state of e-volution. The issue of ramping up the

value chain and continually squeezing more value out of each billable employee

is an intuitive and fundamental initiative for good IT services companies.

The report advocates caution in accepting yield-increasing

revenue streams. While the intuitive benefits of continually striving for higher

yielding business is obvious, we do not believe enough attention is being given

to the sustainability and long-term viability of these revenue streams. Dot-com

exposure in the US, while very lucrative, has come back to haunt key players

like Viant and Scient.

Time to market still key issue

While speed of implementation is still a core issue,

high-quality customers in particular are figuring out that they have more

options. Strategic service and consulting companies catering to established

Fortune 500 companies and new Dot-coms alike have been able to leverage their

brand names and established traditional consulting practices to generate high

fees in a relatively newly forming–and sometimes intimidating–Internet-enabled

competitive landscape. Runaway vertical demand curves (to some extent–chaotic

demand) for e-business technology and development skills such as Java

development and XML integration was making even the highest priced consultants

hard to find. Overwhelming emphasis was placed on time-to-market and

Internet-speed solutions.

As companies become e-savvy their options open up. As the e-volution

gathers momentum and increasing degrees of maturity, we see an increasing trend

for companies (whether they are founded on bricks or clicks) to take back

control of their core strategies, and play a much more hands-on role in key

mission-critical initiatives.

Mix of strategy and implementation a must

Strategy may trend back to internal IT departments making the

implementation diversification a must. In the US, we are already starting to see

signs of longer sales cycles, which is hurting some of the exclusively

strategy-focused business models with respect to earnings visibility.

Corporate e-experience is complicating outsourcing decisions.

As companies gain a better understanding of e-business technologies and

strategies, they are starting to align strategies developed in various business

units into an overall corporate-wide strategy. This implies that companies are

starting to take bigger bets on what their company-wide Internet strategy will

be.

While this may lead to larger projects with longer

implementation follow-ons, it will also mean that more developed internal

structures within the client organization have been formed. Each engagement with

IT services providers may entail more decision-makers and increasing scrutiny of

details. This could bring both the cost issues and multiple vendor issues to

bear, and is certainly expected to complicate the overall sales process.

Pure strategy companies may feel the initial pinch. Strategy

consulting firms with 6-12 month cycle times are likely to feel the biggest

pinch from this trend, which is why we believe a strong and diverse technology

implementation practice is essential to address this long-term risk.

Higher revenues per employee do not necessarily add up to

better business model. Lower yielding, but more diverse revenue streams are

favorable. IT services provider Sapient, which generates about US $255,000 per

billable employee (annualized from the latest reported quarter) is actually in a

favorable position vis-a-vis some of its higher-value generating peers. Diamond

Technology Partners, which generates about US $412,000 per billable employee,

and Viant at about US $351,000 per billable employee, are more exposed to the

strategy/consulting risk which we have discussed. Sapient’s diverse and

well-established revenue streams, which include a high degree of implementation

work are less at risk than the strategy focused revenues of both Viant and

Diamond Technology Partners.

In this context, Indian IT services companies with their

diversified revenue streams (including geographic and customer diversification)

seem particularly attractive. As clients look for better value and increasingly

diverse propositions to implement e-volving strategies, India cannot be ignored.

We reiterate the importance of Indian IT services companies to increase their

current (very low) levels of consulting and strategy exposure, but believe it

should not be the make-or-break factor in the investment process.

Indian companies offer flexibility, lower cost/capital

liberation opportunities, and world-class technical expertise. This should

encourage global corporations to look at offshore engagements if they have not

already done so. We believe this will also spur a continued migration of basic

IT services away from end-user countries to skill-saturated regions like India.

Multiple diversified vendors

Industry surveys and our own checks of key IT services

outsourcers lead us to conclude that companies are increasingly forsaking the

‘one-stop-shop’ approach for e-business services in favor of using multiple

vendors with a multiple range of expertise.

Information Week’s survey indicated that cost is becoming

increasingly relevant to e-business services decision-making. Companies that

hire strategy consultants are asking themselves how much better the outside

consultant understands their business.

Eastman Kodak, for example, has ended a long-term

relationship with Andersen Consulting in favor of smaller, specialized niche

players offering e-marketplace solutions, and implementation services.

Even in cases where strategy consultants have really

understood the business sand the best ways to maximize the business

opportunities, they invariably finish their assessments, make their

recommendations, and move on to the next job, so there is little or no retention

of knowledge assets.

Several corporate clients were emphatic about keeping the

strategy inhouse. Dot-coms committed to their businesses have to keep an eye on

margins and their path to profitability–expensive one-stop-shop consultants do

not necessarily help this objective. Priceline.com believes it must invest the

time and effort to play a hands-on role in developing its strategy, and use the

most cost effective and highest quality means by which to implement that

strategy. While Priceline.com initially used strategy sessions with key ‘Big

Five’ consultants, it chose to form a long-term partnership with HCL

Technologies to implement its existing strategies and develop new ones.

Courtesy: Goldman Sachs