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

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