Thanks for all your comments on last week’s post on Local Hiring. Here’s the outline of the key issues we want to tackle in another chapter of the book called The Quest for Higher Bill Rates.
The need for higher bill rates, or rather services/solutions that will yield higher bill rates, is a consequence of two things.
One, with commoditization of major services like Offshore outsourcing, Application Maintenance, Customer service call centers and others (the list gets longer all the time), there is downward pressure on rates. Customers understand the service well and feel that they can manage the vendor to reduce risk. Deal consultants like TPI drive the commoditization even further.
Secondly, with strong growth comes competition for talent. Which leads to wage increases well above the rate increases that can be reasonably expected from clients.
Put together, the pressure on margins is tremendous. It helps that vendor switching costs are high, which mitigates the downward pressure somewhat with existing clients. But the need to do something to protect margins is going to become crucial in the future.
Increasing bill rates can be achieved in two ways. One, by differentiating core services to be able to command a premium over competition. Some services like large scale Offshore Outsourcing deals come with a fair amount of risk. Clients are often willing to pay a premium to a vendor who has a great track record and a solution that meets their needs. Within limits this can work well.
But what really pays dividends is investing in new services. New services are less competitive and the ability to make really high margins is great. For example, in the early days of ERP related services, we weren’t doing end-to-end implementations at Infosys, but revenue growth was strong and the margins were terrific. Why? because there weren’t too many service providers who could do offshore ERP work. The only alternative for clients was to have one of the Big 5 consultants do it for them at exorbitant rates, which left a lot of headroom for offshore service providers.
New services have always made good money. Until of course commoditization sets in. The trick therefore is to be a service innovator. Start early and stay ahead of competition. As the market expands, the early pain pays off in the form of high margin, high growth revenues.
But we are now at a stage in the industry where service innovation by itself is not good enough. The addressable space in new services that are being launched now is much smaller than the markets already being addressed. The impact that the new services can make on the company’s margin is therefore smaller. We may still not be there yet, but within five years, services that are new today will also have seen commoditization and there won’t be enough potential in introducing new services at that time.
This is not to say that the potential for innovation will go away. Quite the contrary. The action will shift from services to solutions – bundled services and IP that tackle a specific business problem. The IP included could be a platform that accompanies the service, or just a deep understanding of the business problem and the experience of having solved similar ones many times before.
By its very nature, each solution will have a smaller addressable space, but in aggregate could offer great potential. Pricing could be traditional time based pricing or it could be by transaction. The key thing is that competition will low and so there will be more freedom in pricing. The client is likely to look at the cost of the solution vis a vis the value it brings to his business.
This is a very profound change for the Indian offshore industry. Their approach to business thus far has been ‘build it and they will come’ – which works fine for services. But for solutions, you have to be out there, in the flow of what’s happening in your clients’ businesses. Identify pain points that can be solved by the combination of technology and services. And then invest the time and money to build a solution. You go from being an expert in delivering a service to becoming an expert on a business problem or process.
It also means that services companies will have to make many ‘bets’. Solutions require investment. How do you decide where to put your money? Or how much. Because of this difficult transition, I think that services companies will largely acquire technology or IP for their first solutions, instead of building it themselves.
How else will this transition from services to solutions affect companies?
Kickbacks? How else (other than sheer expertise/competence) one can charge high?
Basab, Indian companies have to learn to compete better. At this point the competitive strategies are "Ident-i-Kit", with absolutely no creativity. All companies are talking about large account relationships, multi-line-selling and…ahem…non-linear models.
I just asked this question on my blog: Is the salmon-season over for the Indian big bears?
Great points. May I add that ‘solution’ providers need to start thinking beyond their partnerships boxes ? IT service providers truly lost a great opportunity to innovate early on the XAAS stack (Infrastructure/Platform/Software), possibly entirely due to their current linkages with SAP, Oracle,IBM et al. We are yet to see evidence of established service providers having an appetite for taking risky bets at the cost of losing their place in the current value chain.
Commoditization happens only where entry barriers are low. Innovation therefore will have to go the extra mile of delivering nuanced solutions at affordable costs. Copy cats may easily replicate the service, but may not so easily meet the end customer cost if the innovator deploys low cost funds and resources. For an established vendor with significant free cash in its balance sheet (which would otherwise go as large doses of dividend since the management is risk averse) and benched resources, it should be easy to start selling `at cost' to ward off wannabe upstarts. Think of how Times of India, Mumbai keeps all other newspapers at bay as it bundles TOI and Eco Times at Rs.140/- a month, logging huge volume off-take that indirectly promises higher ad revenue because of larger circulation and readership. IT vendors just don't get it because of their excessive margin fixation. The day they shed that and find a better use for their free cashflows by means of serious innovation, they'll get a life.
There is over emphasis on quarterly result and investor reaction. Stock falling 3-4% on day of quarterly results should not be given undue importance. You act on the short term pressure of QoQ topline/bottomline – there is no way you can get out of commodity business.
The pressure on billing rates will exist as long as the customers know the effort involved. Knowing the effort involved gives customers the power to shop around and negotiate rates. Higher billing rates (i would rather call it higher profitability per project team member) can only happen when the effort involved is not disclosed to the customer.
I think there are two ways to do this. One is to comeup with some black box offerings (products, solutions etc) and the other is to have innovative engagement or pricing models (something like what IBM did with Bharti Telecom in India).
In both the above scenarios the customer is guaranteed an end-result, he has no business asking for the total effort, type of effort, billing rate etc.
Here's one example of an innovative pricing model. Wipro runs the helpdesk for all users across India in the company I work for. The pricing is based on the no of assets (desktops, laptops etc) and not on the no of resources deployed by Wipro or on the no. of calls logged. I am sure Wipro can make a much higher profit per resource if they get the execution right.
What would qualify as a good "solution"? As opposed to a service or a product?