Can a Susan Boyle happen in East Asia?

My learned friend Ananth put this question to his email group. His precise question was: Can Susan Boyle, (58 million views on YouTube), Julian Smith and Diversity happen spontaneously / organically in East Asian societies?

Here’s my answer to him and I just thought I would post it here as well:

I don’t think it can happen spontaneously / organically in East Asian societies. Let me try to deal at 2 levels: — The nature of East Asian society and the issue of culture and specifically creativity.

For such things to happen, society needs to be a genuine melting pot. East Asia may have immigrants, but the practice of assimilation and morphing of identities is only residual. Cultural pluralism may exist on the surface, but politicians and institutions have often curbed growth because they felt the need to retain control or sometimes even believed that they need to architect society, and hence have never allowed cross-cultural pollination to take place freely. Hegemonic practices have often imposed covert forces on the sections of society which have lived on the edge and tried to dominate them. In Western societies there is a not merely an appreciation of diversity, but a collective conscious to make it inclusive.

Now one aspect of spontaneity and organic growth is that it should be possible to have keen debate, not dumb reverence for just great personalities; historical consciousness and self-reflection not adherence to supposedly timeless values; and a continual expansion of a societal canon to match a necessarily unsettled sense of who we are and what we care about. East Asian societies in its singular adherence to Confucian thinking has led to creating a hierarchical and often authoritarian social constructs which has curbed spontaneity. Now add to that, the sheer fixation on commerce and materialism becoming a prime pursuit, it is natural to see less emphasis on experimentation and spontaneity.

Culture is not a package of knowledge, attitudes and customs which can be parceled up, handed over to the child and then passed on intact to the next generation as seem to be the general thinking in East Asia. It has to take deep roots and often allowed to find its own flow.

There is a dialectic between culture and learning which in turn is a manifestation of spontaneity and growth. Creativity thrives when the social substratum has been enriched with diverse experiences and perspectives. And such diversities occasionally produce creative conflicts. East Asian societies have often shunned anything that could even remotely produce a conflict and placed a (undue) premium on compliance.

Now coming more specifically to creative minds (the Susan Boyle of the world), immersion in an environment of cultural ferment is more likely to fuel the selection process. Pablo Picasso is a case in point. He borrowed, stole, and assimilated his way and produced over 20,000 works of art in varying styles because there was a deep cultural ferment during his time. Being surrounded to by contemporary creators often inspires even marginally talented people to attain heights well above what they could possibly achieve in isolation. The individual genius often flowers through cultural interaction.

Creative people by their innate nature often tend to have wider interests and are open to more varied influence. They thrive on ambiguity and have varied interests. They are non conforming and independent minded. They have the capacity to expose themselves to a full range of cultural variants available in their milieu and then choose to adopt a unique subset that develops their talent. In East Asia such creative people do not have much opportunity and hence even if there existed such people, they tend to migrate to environments where their nature is better appreciated.

People have often asked me both seriously and causally about whether India or China can produce the next Google or Facebook. My answer is the same — The chances are very low, because while Indians or Chinese may be smart engineers; the kind of business thinking that needs to envision something novel is not there.

Satyam clearly overvalued

Subsequent to my earlier post where I mentioned that Tech Mahindra seems to have over paid for Satyam, got an email from an ex-Satyam employee(who prefers to remain anonymous) He mentions that Satyam’s annual revenues are more likely to be between $1.3 – $1.5 billion.

If that be the case, then Tech Mahindra has valued Satyam at a revenue multiple of 1X revenues which is quite high by industry standards in the current environment. Even Accenture a blue chip with impeccable credentials is only quoted at 0.7X revenues.

So, it indeed looks that Tech Mahindra has over valued Satyam.

It is also intriguing that since the beginning there were no serious contenders for this business — be it from US or Europe multinationals or even from Indian IT service providers. L&T which was considered the favorite to win was only trying to reduce their average buying price since they had acquired 12% of Satyam for a high price in the past.

Tech Mahindra gets Satyam — Pays more, interesting challenges ahead

Satyam Computer Services ranked as India’s 4th largest outsourcer by revenues (after Infosys, TCS ,Wipro) and which went through some very anxious times following the scandal brought about by its founder has found a new owner.

After a bidding war where only 3 parties participated (Larsen & Toubro, Tech Mahindra and US investor Wilbur Ross), the prize has gone to Tech Mahindra.

Tech Mahindra offer of Rs. 58 per share (U.S $1.16) was 21% higher than the next bidder (Larsen And Toubro who already own a 12% stake) The offer price is also 23% higher than its highest traded price since the news of the scam broke out in early January.

Since the auditors Deloitte and KPMG are in the process of rewriting the accounts it is difficult to value the company. But based on a number of sources, Satyam’s annual revenues are in the range of $1.5 billion -$1.7 billion (down from projected revenues of $2.1 billion for 2008) with an operating margin of 3% while Tech Mahindra’s margins are in the range of 22% with revenues of $900 million. No one knows the extent of liabilities and also the exposure of the firm to some of the class action suits that’s likely to follow in the US.

Hence at the acquisition price, Tech Mahindra has paid a big premium and also brought some big challenges just to add $ 1.2 billion and a 3% margin business. Did Tech Mahindra over value Satyam? I certainly think so.

But as they say Value lies in the eyes of the beholder!

Tech Mahindra will have some big challenges not only in funding the acquisition but also running the Satyam operation. It is one thing to run a business where one client (British Telecom holding a 31% share) accounts for close to 70% of the business and another to deal with a diversified client base with poor operational efficiencies. Tech Mahindra will also have to learn to manage a work force almost twice its own size and dispersed globally.

Tech Mahindra will also have to figure out whether they want to keep this as an independent entity with a different name or do a possible merger. I think the advantages to be gained by an immediate merger may be limited in the short term since there are no synergies to be realized.

None of these challenges are easy. It would be interesting to watch the turnaround.

Satyam caretakers — the interim Board members like Karnik, Deepak Parekh and others did a great job transitioning it from a broken and rudderless ship to finding a good caretaker and owner. The entire Indian IT industry also played a mature role in not poaching Satyam’s clients or its employees.

The HCL bid for Axon

As was reported here, HCL formally launched an acquisition bid for Axon by raising its bid by 8.3% over the Infosys bid. Infosys will now have the opportunity to increase the bid.

It is quite easy for Infosys to enter into the bidding war given that Infosys is sitting on a cash chest of $1.8 billion. HCL is already stretched because it has only $500 million in cash and this acquisition will be funded by raising debt. Given this debt funding, HCL’s net income will be diluted considerably. In fact, with all the offshoring advantage HCL  has, it is valued at about 12 times EBITDA. It is no wonder that HCL shares plunged by about 12% in a market which was already in a downward trend. Further, Morgan Stanley downgraded HCL from overweight to underweight keeping in view the acquisition risk.

Given that Infosys original offer was itself valuing Axon at 24 times EBITDA, this increased bid will make it even higher for a SAP consulting house. Despite the advantages of being in Europe and some of the intrinsic strengths of Axon, I think this may turn out to be an expensive buy for the eventual buyer — be it Infosys or HCL.

Tags: HCL, Infosys, Axon, M&A, bidding war, SAP

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HCL counters Infosys bid

I didn’t expect a bidding war over Axon.  I thought that it was a done deal. In my opinion, Infosys is already paying a big premium for Axon. Now, the Times of India reports that HCL Technologies is offering a 15% over and above the Infosys bid.

Between the two companies, Infosys at least has a better strategic fit and based on limited information that I know both Infosys and Axon have similar values. HCL Technologies may badly need this acquisition to bolster their presence in the SAP space, but given their management style, it is more likely that some cultural clashes could happen. Result — some of the star employees of Axon could just quit.

Will Infosys get into a bidding war?

It would be interesting to see who gets this expensive prize as Axon’s shareholders could still vote for Infosys bid, the higher price of HCL Technologies notwithstanding.

Tags: IT services, Indian IT services firms, M&A, Infosys, Axon, HCL Technologies

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Infosys acquires Axon

Infosys made another acquisition and this time the size of the acquisition was reasonably big. Infosys acquired Axon which is a listed company in the UK.

Infosys paid US$753.1 million in an all cash deal. The surprising thing about this acquisition is that Axon is just another SAP consulting firm though their revenues have grown quite nicely in the last few years based on the financials here.

I wonder what’s the strategic intent of this acquisition made at a P/E of 20 in a kind of slowing economy. Is it because Infosys needs a stronger presence in UK, where Axon has close to 1400 employees? Is Infosys strategy to move work to India and improve margins?

Shouldn’t Infosys make a more bigger acquisition in an emerging area?

Tags: Infosys, M&A, IT services

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Why is the shift to Wave 3 going to be difficult?

I wish I could share Mr. Sudhakar’s optimism about Indian companies just operating a switch to change their mind set to becoming a thought leader from an order taker. As I responded to him (to his remarks that I have a low opinion of Indian companies) the mind set change is not easy.

I was talking to a couple of friends in the industry, when suddenly the brainwave stuck. My thesis is that there seems to be a particular “Indian mind set” just content with supplying raw material and not getting higher in the value chain. Let me elaborate with a few historical perspectives.

For centuries, India has been selling spices to the world. But do we dominate the food market? Someone packages the spices, gives it brand power and occupies the consumer’s mind share. And the market leader in that area is McCormick that has nothing to do with growing spices.

So has it been in several areas — be it textiles, silk, pharmaceuticals and now software. The pharmaceutical industry for one, have been preoccupied with supplying bulk drugs for decades and it is now that they are slowly venturing into branded drugs albeit reluctantly.Even now most pharma companies are happy to do clinical trials for MNC drug companies, or do contract research.

It is not that the spice traders, or the textile manufacturer or the pharma industry did not intuitively understand the Wave model. They did, they saw margins under pressure, they were hungry for more profits, but they were deeply stuck in their raw material or supplier mind set. I would opine that the same is being replayed in the software services space. One can argue that globalization and the newly discovered passion for success amongst Indian entrepreneurs have changed the equation, but that’s only to a point.

Here’s what I posit: Just because one does exceedingly well in a particular position in the value chain, doesn’t guarantee that one can transition to a higher level in the value chain.

Prof Yves Doz of INSEAD has an interesting framework that explains this. He defines 3 layers of business thinking — the adaptive layer, the experiential layer and the existential layer.

The adaptive layer is the layer, where it is purely supply of commodity goods, with very little value addition, and working on a cost arbitrage or sheer availability. The availability of spices and the availability of cheaper manpower for software services fall in this category.

In the experiential layer, the challenge is to step into the shoes of the customer and create valuable products and services. The classic example is of how Nissan creates a new car for the European market. I would also consider TATA’s introduction of the Nano in this category.

The existential layer is going one level deeper — stepping into the minds of the customer. An Apple or a Nike fully understands the consumer mind — and works backwards to create products or services.

Now, if all these layers can be seen as value chains, one can understand how difficult it is to make the transitions from one layer to another. I would reckon that the ability to go from one layer to another is like crossing the chasm, and simple evolutionary mechanisms would be inadequate.

I am not in any way making a value judgment of the superiority of one layer over the other; it is just that the organizational DNA that one needs to be playing in each of the layers are vastly different and people tend to underestimate the kind of effort, energy and risk as they move from one layer to another.

Prof Yves Doz’s theory is appealing, because it captures the locus of capabilities and limitations very well.

Just as an aside: Faced with a possible slowdown in the West, Infosys’ response has been a traditional Wave 2.1 approach than the Wave 3 approach which Mr. Sudhakar passionately advocates. So has TCS with its Latin America operations.

Tags: managerial mind set, Indian IT companies, Yves Doz, thinking layers, value chain, business transitions, strategy, constraints, business model, mind set, Infosys, TCS, Nano

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Wave 3 companies business models for Indian companies

Mr. Sudhakar Ram in a new post has explored different business models for Wave 3 companies. While he has elaborated different options, he has fallen short of making a compelling case for each of the business models. I would also add that some of Indian IT services firms have played in these sand boxes for quite some time, though they haven’t made it their core business.

Secondly, if the Indian IT service firms have to make this transition, it is going to call for a transformational change in approach. It is not that the new business models are flawed, it is the transition that is going to be risky as it would be a roller coaster ride. Since Mr. Sudhakar has opened the dialog here are my comments:

IT Budget owners:

I don’t think the Indian IT service providers have the aspiration to occupy this space, and neither do they have the required ability and bandwidth to do so. Occupying this position needs a lot of lot of domain expertise, breadth and depth of functional knowledge and more importantly the propensity to take risks. Essentially, one has to assume the role of a trusted advisor to the CXO world and may be even to the Board. Even amongst global providers, barring a IBM, Accenture, EDS, CSC and a couple more, few would have the capabilities to stake a claim to become budget owners and take the responsibility to ensure alignment and business impact.

If outsourcing initiatives indeed fail, because of lack of ability of providing alignment and business impact (as Mr. Sudhakar seems to imply), despite the experience and abilities of an IBM or an EDS, I am wondering how would Indian IT service providers fix the problem. Let’s accept the fact that most outsourcing engagements fail, because of a culture clash, the promised cost savings not getting realized and various other conflicts that such a relationship often entails.

Software product providers:

Mr. Sudhakar is right on this one and a number of Indian companies — the likes of Wipro and HCL have been doing it for sometime. Wipro perhaps has a better track record in terms of doing 3rd party software product development right from the 1980s with their InstaPlan product ( a very successful project planning software of the 1980s). They would have easily done this for over 100 companies. This is no different from a typical “IT body shop” (only that it provides higher end engineering services). Yes, Indian companies do enjoy a cost advantage, but these days it is very easy for the overseas company to set up a development outfit in India. So essentially even in this case, it is just labor cost arbitrage, (maybe applied to a different sector), not defining a new line of business.

Software Solution Integrators:

Well, if the track record in the SAP or Oracle or for that matter any package implementation service is any indication to go by, most Indian IT service providers are just routinely satisfied just being SAP certified consultants and “loaning” out people for the major integrators or doing routine SAP implementation. I guess most large multinationals would still trust a IBM, Accenture, Bearing Point to do the higher end work in terms of consulting, process mapping, change management and leave the integration work to Indian companies. In fact, I had the opportunity to analyze the revenue and margin mix at a leading Indian IT service provider and found that over 70% of the revenues and 40% of the profits of the SAP practice team came from maintenance, support service and on-site placement. It is difficult to walk away from such a lucrative, low risk business and ask them to embrace a higher value added, potentially risky segment. In another instance, this Indian IT service provider has a large pool of SAP consultants in a particular area, have done over 50 projects, but still lack the higher end business process knowledge, expertise in change management, maturity in client engagement and related project management capabilities to take on a big consulting firm, despite its track record. They just can’t inspire the necessary confidence and are more more comfortable playing the secondary fiddle.

Platform services:

I agreee with Sudhakar here that it indeed is a very exciting area for Indian service companies. Some like WNS and IBM Daksh have been successful as they developed a complete platform for their respective verticals (travel and insurance respectively), but their ability to expand the platform or build alliances with other players and make it an industry standard has been found wanting. This has deterred other companies from going this route. In fact I would believe this (platform services) would eventually become the natural step in the growth plans for companies which has deep IT skills, domain expertise and BPO capabilities.

As I said in one of my earlier posts, moving beyond Wave 2 to Wave 3 or Wave 2.1 is a business imperative. I know a number of Indian IT services firms are grappling with this issue. Given that they have grown in a reasonable risk averse environment, I do not think they want to adopt something too radical and big, as they are aware they do not have the necessary leadership skills or management expertise to pull this through.

Tags: Offshoring, outsourcing, IT service providers, strategy, Indian IT companies, Wipro, WNS, IBM

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Wave 3 model for Indian IT service providers

Sudhakar Ram of Mastek writes an interesting perspective on the growth options for Indian IT service providers here.

While I agree with his basic premise that most shifts are non-linear, and that they follow the S-Curve, it is not clear what the Wave 3 work would be! He just characterized that as strategic, value-added and non-linear. The examples that he gives — frameworks, components etc. don’t lend themselves to easy monetization. And I guess, that’s one aspect of the dilemma.

The other aspect of the dilemma is that some of the Indian IT service providers did attempt to move up the value chain by providing consulting services. Companies like Infosys and Satyam went that route only to discover that there are critical tensions between managing a IT service outfit and a consulting fit under the same umbrella. The measurement metrics like productivity, bill rates, price realization, competitive positioning done typically by the IT service provider cannot be applied in the same way to consulting. The net result has been that most of the standalone consulting teams in these companies have more or less disappeared.

Hence while there’s an opportunity and a business imperative to move to Wave 3, I am not sure whether the Indian IT service providers can overcome the execution handicaps.

Tags: Outsourcing, growth, critical tension, execution

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Indian IT industry hits another major milestone

The Indian IT and the ITeS (IT enabled industry) hits another major milestone. In fiscal year 2008 (ending March 2008), it is likely to hit revenues of $50 billion. The revenues for the period ending March 2007 was $39.6 billion ($31.4 billion in exports) which indicates that the industry grew by 30% on a year on year basis. (source Nasscom)

Certainly impressive by any standards.

In 2007, the top 3 (Infosys, Wipro and TCS) together accounted for $9 billion while the top 10 IT companies crossed $15 billion. (source Dataquest)

While the growth rates have been impressive, I think the key challenge for the future (as many other observers have noted) is the ability to develop and grow talent. Currently, the industry has to spend a significant money on training and development of new personnel and it is high time that a concerted broad based effort is made by industry, government and academic to solve the manpower crunch.

While Nasscom has repeatedly brought this to the notice of others, there have been little or no initiatives on this front.

Tags: IT, Offshoring, TCS, Wipro, Infosys, software exports, IT services, India exports

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