Indian IT/ITES:Reducing Windows or Expanding Vistas?

Over the last two decades, the information technology (IT) and information technology enabled services (ITES) industry has contributed significantly to the Indian economic growth. The industry contributes to over 5% of India’s GDP, earns over US$ 40 billion in foreign exchange and provides direct employment to over 2 million professionals. No less significant has been the ripple effect of prosperity that it has created in various sectors of the economy. Nearly 50% of its revenue of US$ 40 billion is spent in the domestic economy in a host /of sectors and services, covering infrastructure to consumption goods. This spend of about US$ 16 million is estimated in turn to generate US$ 32 billion as output impact across the economy.

In more ways than one, the IT/ITES industry has been the icon of India’s foray into the global economic league, with major growth aspirations. The industry hoped to double its turnover to US$ 80 billion in 5 years and contribute further to the shaping of India as a truly global economic powerhouse. Against this background, the unprecedented global economic meltdown has raised concerns of adverse impact on this vital industry. Although the IT/ITES industry continues to be cautiously optimistic, the industry requires now, more than ever, a new vision and strategy to address the deteriorating economic environment.

Globally, all affected industries have begun to respond to the recessionary trends in certain classic, established ways; cutting down output, reducing inventories, controlling costs, postponing payables, advancing receivables and freezing investments. Though the IT/ITES industry may be tempted to follow this route, the industry has to look also for certain strategic approaches to weather the storm and in the process emerge in a fundamentally stronger frame.

Product Innovation

Typically, several Indian IT majors have comfortable cash positions and, in addition, enjoy good balance sheets to raise additional debt financing. They also have surplus operational capacity in terms of physical infrastructure, be it campus or office space and computing or connectivity capabilities. Such firms should respond to the slowdown by creating a much-needed focus for development of original software products. Redeploying its experienced professionals, inducting fresh manpower and releasing the purse strings, IT majors should aggressively create new product innovation laboratories that are dedicated to different domains and industries.

Success of the Indian IT products has been largely in the banking and retail space. Similar product success stories can be created in the domains of design and development, project engineering and erection, procurement and manufacture, sales and distribution and customer service and relationship management. The domain practice however varies with each industry vertical. For example, the design and development needs of an automobile maker would be quite different from those of a pharmaceutical producer. Customer management in hospitality sector would be vastly different from that in hospitals sector. Each of these five fundamental domain groups combined with industry specific needs would lead to a matrix of several IT products customized for industry-domain combinations. Product development opportunities for the Indian IT majors could be endless, if only they choose to focus on such innovation goals. Conservatively, the IT industry can dedicate a significant share of its current manpower on such innovation laboratories over the next two years.

Indian ERP

Platform software is for the IT industry what steel and automobiles are for the engineering industry. Indian has captured global attention with the highly ambitious yet famously successful attempt by Tata Motors to design and manufacture, on a commercial scale, a Rs 1 lakh Nano small car. Indian IT industry has to also stretch and reinvent itself to design and develop at least one software platform which can serve as the global symbol of India’s true software capabilities. An Indian Enterprise Resource Planning (Indian ERP) system could be one such flag bearer for the Indian IT industry.

Indian firms, and even global firms, are often forced to deploy certain ERP systems which are built around programming robustness rather than process flexibility. From structural nomenclature to business processes, these ERP systems represent a different nativity, when compared to either the US or Indian management structures and processes. On top of it, the need for additional user interfaces and/or the requirement to install additional analytical solutions for management information makes the available ERP solutions less than optimal.

Top-rung Indian IT majors could collaborate to form a special purpose vehicle (SPV) which can be entrusted with a national mission of designing, validating and commercializing an Indian ERP which is practical, flexible and robust and is customized to the Indian and US business processes and tax regulations. In contrast to a model of modular or “foundation now-superstructure later” ERP solution, the proposed Indian ERP solution could be developed as a cost-effective integrated suite that provides a comprehensive coverage from transactions to analytics. Also, instead of aggregating all industrial sectors into one straightjacket model of ERP, the Indian ERP could be developed as a set of customized solutions for individual or groups of industries which have unique or similar business processes as the case may be. Such an Indian ERP could do for the Indian IT industry what a Nano car did for the Indian automobile industry, in terms of global visibility and achievement.

Application software

It is not that only the larger IT majors can survive and grow in the downturn. Small and medium enterprises as well as individual IT entrepreneurs also have their respective niches.

A marvelous development of the recent years has been the proliferation of opportunities for writing application software for new electronic devices and services. This being a highly individualized and creative endeavor, small / medium IT enterprises and IT entrepreneurs are ideally positioned to participate in this space. The Linux Ecosystem has demonstrated how a global community of individual, motivated programmers could create a whole new software architecture that could compete with a massive, monolithic and established software organization. There is therefore tremendous scope for initiating and organizing mini-communities of application developers who could innovate to upgrade existing hardware and software as well as to add new dimensions to emerging products and services. In addition, applications which have significant consumer interface offer additional opportunities for continuous creativity. Mobile telephone applications, gaming applications and various web based internet applications lend themselves ideally to device-specific and consumer-centric application development by individual entrepreneurs.

Web Portals

The World Wide Web has converted the globe into a community of internet connectivity. Firms such as Google have re-defined the Net as the new ‘store, plug and play’ platform for a host of applications. Portal-based initiatives, such as Amazon, Wikipedia, Facebook, Netscape, Yahoo and YouTube, to name just a very few, have created a multi-billion dollar web-based industry. Though India has taken its initiatives in portal technology through web-based sites such as Sify, Rediff and Naukri (again to quote a very few), these have been India-centric than pan-global. India’s much acclaimed IT leadership and manpower pool needs to put its strengths to work to create truly innovative, world-class, pan-global Internet business, economic and social sites that appeal to all global citizens.

From arts to science and from engineering to management, Indian professionals have capabilities that can cater to universal needs and multifarious tastes. These, combined with contemporary telecommunication and information technologies can create sites which are pioneering and unique in their and service offerings. For example, there could be sites where amateurs and professionals can collaborate to learn, teach or experience a wide range of socially positive avocations and hobbies or utilitarian activities like music, education, yoga, self-help and alternative healing and so on.

Domestic Services

IT/ITES industry has grown phenomenally thanks to the international orientation and outsourcing advantage. The services that the IT/ITES industry has offered to its international consumers are equally relevant and required in the Indian setting too. Medium sized IT/ITES companies could have a major role in expanding the Indian market for IT/ITES offerings.

Indian ITES industry in particular can play a pioneering role in bringing industries and their consumers significantly closer. Although banking and telecommunication sectors have been quick to utilize call centres as a tool to stay connected with the customers on a 24X7 basis, a whole range of industries, including consumer oriented retail chains are yet to explore, even partially, the potential of 24X7 connectivity. ITES companies which may be experiencing a bit of downturn due to international recession could diversify into domestic services and even expand their business through vernacular offerings.

In a similar vein, there is an immense scope for the BPO and KPO industries to provide outsourcing services to the Indian industries. Product management, sales and distribution management, intellectual property management, human resources management and legal services management as well as development of knowledge repositories are some of the areas where Indian firms require more extensive and incisive BPO and KPO services.

Summary

The global economic meltdown could be an opportunity for the Indian IT/ITES industry to redefine its global business model in terms of certain new fundamentals of product innovation, platform software, application software, web portals and domestic focus. By redeploying some of its large talent pool, tapping into the streams of bright graduating professionals and allocating some of its financial resources for creative, even if experimental, initiatives, the Indian IT/ITES industry can emerge stronger with diversified capabilities encompassing innovative products as well as generic services. The NASSCOM leadership and the several visionaries that lead the IT/ITES industry today should actively collaborate to define such a new paradigm for the industry at the earliest.

Posted by Dr CB Rao on February 18, 2009

Satyam - Maytas Saga : Governance in Reverse Gear?

By any account, the Satyam-Maytas saga has been a bizarre episode of a blue sky vision for creating an integrated IT and infrastructure group collapsing into a muddled and messy strategic failure. It would be interesting to analyze what was wrong and right with the decision, and its quick reversal, and speculate on the future course of options.

Background

Satyam Computers Services Limited (Satyam) founded by Mr B Ramalinga Raju in 1987 is India’s fourth largest information technology (IT) company with a turnover of US$2 billion. Maytas Infra and Maytas Properties are two companies of the Raju family, managed by his sons operating in the infrastructure and realty sectors. Maytas Infra is a public limited company with a turnover of $450 million while Maytas Properties is a privately held company with an estimated turnover of $90 million.

On December 16, 2008, in a stunning move, Satyam announced its decision to acquire the majority (51%) stake in Maytas infrastructure for $300 million and 100% stake in Maytas Properties for $1.1 billion by buying out the shareholding of the promoters i.e., the members of Mr Raju’s family. The $1.6 billion deal, if it had gone through would have consumed all the cash of $1.2 billion in Satyam’s books and even forced it to raise a debt of $400 million. From a quick look at the financials of the listed entities of the deal, the profitability of the combined entity would have slipped due to the current lower margins as well as the long gestation period and revenue volatility of future projects in the infrastructure and realty sectors.

Teasingly, Maytas is Satyam, with the letter string in reverse order. Satyam’s founders who were in construction business prior to setting up and growing the IT business, probably thought that information technology and infrastructure are two sides of the same coin and decided to re-enter the infrastructure business. Unfortunately for the Satyam Group, all of its investor community, media and public thought otherwise and a spontaneous uproar followed. The Satyam Group was accused of derailing corporate governance through a self-serving, opaque decision which would place a major part of $1.6 billion of Satyam’s free cash in the hands of Mr Raju’s sons and family associates through the buyout. With only around 9 per cent of the stake in Satyam being held by Mr Ramalinga Raju and associates, it was alleged that he had no right to fitter away the Company’s resources without a proper discussion with other major investors and without seeking shareholders’ approvals, that too at a time when companies are conserving cash for their core businesses. Satyam’s ADR, listed in NYSE, lost 53% in a free fall on December 16, 2008. A similar drubbing for Satyam stock was to follow the next day on the Indian bourses.


On the night of December 16, 2008, Mr Ramalinga Raju explained over the investor calls and on the TV networks that the acquisition move was a well thought-out decision that would de-risk the core IT business and enhance long term value to the shareholders. He said that the investors who reacted adversely would calm down once the facts got understood in a proper perspective. Yet, as the chorus of protests went up, Satyam hastily reversed its decision just a few hours later and called off the Maytas acquisition deal on December 17, 2008. Mr Raju said that the decision to abort the proposed deal was taken in deference to the wishes of the investor community. Thereafter the Company has been at pains to mend fences, promising not to diversify out of the IT business and hinting that the Company would take several investor-friendly measures, including share buyback, to shore up credibility and restore investor confidence.

Strategic Purpose

Any decision to integrate, diversify, merge or acquire in related or unrelated manner needs to be inspired by a strategic vision or purpose. In this case, the acquisition of Maytas appeared to have little strategic purpose when announced. Was it to diversify Satyam into a growth sector of India, which infrastructure probably is, or was it to simply create a conglomerate group? If it was to de-risk the IT business, is it reasonable to conclude that IT became strategically risky for Satyam? Per contra, is there any assurance in the era of global meltdown that infrastructure is any less risky? Apparently, there has been no synergistic vision or strategic purpose that would have brought out the rationale of Satyam seeking to acquire Maytas.

Granting for a moment that IT growth has slowed down or the IT business itself has turned risky, given the cash reserves it had, did Satyam truly and sincerely analyze all the options that could have been possible to de-risk the IT business? Various options could have existed; from a merger with or acquisition of another IT behemoth to acquisition of a domain specialist which could strengthen any or some of its verticals. Under the former route, being a predominantly services company, Satyam could have acquired a pure product company or a pure web and search business company. In the latter route, having specialized in verticals such as SAP, engineering or life sciences, it could have joined forces with a design-driven manufacturing firm or a research-driven pharmaceutical firm.

Again, granting for a moment that entry into infrastructure was the best option for Satyam to consider, did Satyam truly compile and evaluate all the infrastructural options that could exist? Would it be appropriate to acquire realty and construction oriented infrastructure companies such as Maytas Properties and Maytas Infra or to consider companies in other infrastructure sectors such as power equipment, engineering & construction competence or alternative energy? Again, it is not clear if such options were compiled and analyzed. Lastly, assuming that realty and construction management oriented Maytas was the best fit, how were valuations arrived at? Were there stand-alone and combined business plans, pre- and post-merger, which demonstrated a superior value that the merger would bring to all the parties to the deal? Silence on the front did indicate that no major analysis was carried out.

Process and Governance

The early thoughts of the proposed acquisition would have been seeded a few months ago but apparently the formal processes happened only over the last two weeks. The Board which comprised several reputed management and industry experts from India and abroad as independent directors did consider the issue without the interested directors being present. Yet, it is unclear if powerful arguments against the deal that are brought out here, and elsewhere in the media, were forecast by the board and balanced by equally powerful or more compelling arguments in favor of the acquisition decision. If so, Satyam should have gone to town with such logic rather than succumb to the adverse market reaction and reverse a decision that was claimed to be well thought-out and debated internally.

Transactions of this nature, especially between related parties required independent valuations of the target companies and an investment advisor (or multiple advisors) to make sure that the transaction was indeed an arm’s length transaction. Clearly, no investment banker of international repute was involved in the deal. Equally importantly the process of management analysis and decision making that preceded the sudden acquisition decision appeared to be deficient.

Given the low promoter holding and the related party nature of acquisition transaction, the founder-family and Satyam on one hand and Maytas Infra and Maytas Properties as the target companies on the other hand should have been extremely cautious in analyzing and pushing through the deal. Such transactions should be conceptualized and conducted, reflecting the adage on Caesar’s wife, in such a manner that the founder family is beyond any suspicion. Unfortunately in this case, governance matters appear to have been given the short shrift. Although the agreed upon valuations technically enabled the Company to move ahead with the acquisition without any regulatory or shareholder approvals, in spirit it was in violation of good governance practices. Given the related party nature of transaction, transparent and threadbare discussion of all issues, including business models of stand-alone and combined entities, valuation options, alternative deal structures, intended use of proceeds and future outlook would have been appropriate. Ideally, a committee of independent directors should have been constituted to make a thorough study of the proposed move and come up with multiple scenarios and a balanced professional judgment.

The justification in terms of de-risking the core IT business also brings to the fore the risk profile of Satyam’s IT business. If the management indeed believed that the core business had stalled it had a duty to incorporate this into its corporate guidance and unveil measures to address it with business strategies relevant to the IT field rather than disclose such slow-down as a justification for the contentious move.

In rescinding its decision as hastily as it has made, Satyam demonstrated little conviction in its own decision and little faith in its own wisdom. Panic in the wake of adverse investor reaction and the subsequent free fall in share price seem to have once again prompted expediency. An urgent consideration of share buy back proposal is now proposed to win back investor confidence. Here again, the assumption seems to be that investors can be placated by financial rewards which will mitigate concerns on governance. This assumption also appears contrary to good governance logic. Fundamentally, reassurances on the IT business model of Satyam, strategic options and measures to reinforce governance are called for rather than immediate shareholder rewards.

From knee-jerk response to strategic resolution

The controversy that has been generated over the Satyam-Maytas saga should not however limit one from analyzing the strategic implications and compulsions of an aspiring firm or a founder group in a professional and dispassionate manner. The fundamental issue is whether the founders of Satyam and the major investors would want Satyam to become a diversified conglomerate, in quest of which entry into infrastructure could be one of the components. If this proposition is accepted, the right company and the right deal with the right timing would become relevant. Though Satyam could theoretically select a non-Maytas option from among the various companies engaged in the infrastructure business, it is fair to assume that none of the established infrastructure leaders would be ready for a sell-out, dilution or even an alliance. Maytas Infra and Maytas Properties are cash strapped to execute projects, given the huge order book of $3billion (plus $4 billion of Metro Rail) and the land bank of 6700 acres that they respectively have on their hands. It is thus in the mutual interest of Satyam and Maytas to concur on the acquisition. The deal structure would follow as the next issue. The controversy related to the movement of the free cash from Satyam to the promoters’ hands through the Maytas buyout could be handled by bringing cash into Maytas Infra and Maytas Properties instead of using it to buy the promoters’ shareholdings. The entire deal would need to be analyzed and valued by independent accounting houses appointed by each of the three parties and the final proposals put through to the investors and shareholders.

If the investors and shareholders see value they would be happy to support such a proposal. For example, there could be significant operational synergy of deploying IT in infrastructure field, from project management to project operations. Satyam could create a new vertical for infrastructure in its core IT business to provide IT solutions in the infrastructure space to Maytas and beyond. Given that Maytas Infra has bagged major projects like Hyderabad Metro and Maytas Properties has pan-Indian property bank, the strong balance sheet of the combined entity could create an infrastructure business in a faster and more expensive manner than would have been normally feasible. Issues of corporate governance could be handled by keeping all the three companies separate and allowing them to function independently with separate boards and management teams. Governance would also be seen to be acted upon in both letter and spirit if the promoters connected with the three companies, Mr B Ramalinga Raju of Satyam, Mr Teja Raju of Maytas Infra and Mr B Rama Raju Jr of Maytas Properties ensure that the executive responsibilities are in the hands of independent professional managers.

The spirit of free thinking and the spirit of corporate governance are mutually reinforcing. The Satyam-Maytas saga has demonstrated how these two vital factors can be ignored by companies and founders only at their peril. Equally, the episode demonstrates to positive thinkers how purposeful vision, clear strategy and transparent governance could enable acceptable solutions for even the trickiest of problems.

Posted by Dr CB Rao on December 22, 2008