Think Big, Go West

FOR paranoid swadeshis worried about foreign transnationals gobbling up Indian businesses, here's some food for thought. India is about to see its first breed of truly transnational corporations. And they come, no surprises here, from India's computer software business.

Just look at what the Rs 648-crore Delhi-based information technology company, NIIT, has planned for itself. "We intend to acquire a $50 million software company in the US by September next year. Buying that company could cost us up to $100 million. Organic growth alone cannot sustain our pace of growth," says CEO Vijay Thadani. From an initial list of 150 companies, NIIT's shortlist at last count was down to 15. The company plans to pay for this acquisition through internal resources, but if that doesn't suffice, it could always fork out the money through its proposed American Depository Receipts (ADR) issue, which is expected to be in the range of $75 million.

The world in my pocket: NIIT isn't alone. The Bangalore-based Rs 260-crore Infosys Technologies intends to go one better. It definitely plans to acquire one—perhaps even two—foreign software firms in the near future. "Companies worldwide want to consolidate their information technology vendors. If you want their business, you need to have a huge scale of operations, and it's much faster to acquire than gradually build a business," says Nandan Nilekani, deputy managing director. Infosys managers are currently busy scouring for target companies in Europe, the Americas, southeast Asia and even China. If Nilekani is as good a forecaster as he is manager, Infosys—which should finish this financial year with revenues in the range of Rs 450 crore or around $100 million—should become a $700 million (Rs 3,150 crore) company over the next five years. Infosys, in fact, began working towards its $75 million ADR issue much before NIIT, and should be first off the block.

Then, there's HCL Technologies. Part of the Rs 2,500-crore HCL group, the company was incorporated only last August in Sunnyvale, California. It was formed by transferring the entire software business of the HCL group into this company, which has inherited nine software factories, 10 fully-owned subsidiary companies operating in 14 countries, and three joint venture companies, apart from revenues approximating $200 million (Rs 840 crore). HCL Technologies will be the first Indian-owned company to make an initial public offering (IPO) in the US. While company sources refuse to disclose the money they are hoping to raise, it is expected to be in the range of about $100 million. "Once we have a stock which trades on a US stock exchange, we get the currency for an acquisition," says Ashok Jain, senior vice-president, HCL Technologies. "As part of our growth plans, we need software development centres in the Americas, China and Europe. Some of these might even be acquired."

 What's fuelling this global shift among India's software biggies? Not ambition and ego alone. Necessity is as much a driver. "These are the first signs of the maturing of the Indian software business. Companies will have to sooner rather than later stop pursuing the typical Indian software export model," says Saurabh Srivastava, executive chairman of the Rs 150-crore Delhi-based IIS Infotech, and president of the National Association of Software and Service Companies (NASSCOM). The software export model he refers to centres around cost-based pricing, where Indian software companies garner orders on the basis of their low-cost manpower. "Indian software consultants in the US are today available at $38 an hour, while big US con-sultancies like Andersen Consulting and Price Waterhouse charge in the region of $360," says Jain of HCL Technologies. Thanks to the price difference, foreign firms subcontract software development work to Indian companies, and pocket the margin. So these foreign firms get the jam for the value they add to the development work done by Indian companies, and Indian companies are left with the crumbs.

Higher, stronger, richer: This model has been working just fine till now. The turnover of the Indian software export industry was a mere Rs 125 crore in 1991; it ended 1997-98 at Rs 6,500 crore, a 52-fold growth in just seven years. Over the last five years, India's software exports have seen a compounded annual growth rate of over 54 per cent. And India's top software companies have enjoyed roughly the same rates of growth. Take the Bangalore-based Wipro Infotech. Its software division ended 1995-96 with revenues of Rs 188 crore; 1997-98 saw a turnover of Rs 392 crore, a compounded annual growth rate of 55 per cent. NIIT's software business too saw a growth of 52 per cent last year, with revenues touching Rs 271.2 crore. "Till now, we were selling India as a low-cost offshore software development centre. We found ourselves a convenient niche. However, very soon there will be other countries who will offer even lower cost software development. We need to move up the value chain," says NASSCOM's Srivastava. Already, software developers from Thailand and China are available at a lower cost than Indians. Adds Wipro Infotech group president Ashok Soota: "Salaries are rising at the rate of 25 to 30 per cent every year."

There's another reason why big Indian software companies need to get out of the subcontracting mode. Till 1995, NIIT's largest orders were in the range of $100,000 to $200,000. Today, the maximum order size for NIIT nears $1 million a year. The scenario is roughly the same for HCL. "If we want to maintain similar growth rates in the future, our average order will have to be upwards of $1 million," says Arvind Thakur, director and senior vice-president, NIIT. Adds Wipro's Soota: "We have begun quoting for $2 million to $3 million contracts. In another two years, we will have to start bidding for $5 million to $10 million contracts."

That will come from gaining early entry into the clients' software development cycle. It begins with defining a client's needs, designing and developing the software, followed by implementation and maintenance. Most of the big software services companies in the world go through the entire drill, subcontracting certain parts to others. But the big Indian firms now need to go through the full life-cycle of the software project. Infosys, for instance, currently derives 30 per cent of its turnover from full lifecycle projects.

Looking for the big one: Be it software development or systems integration, large project orders are difficult to come by for Indian companies. Two reasons: first, they are Indian companies. Thanks to that, they will only be considered for what has been their niche area to date. "We are working on building our brand, so that people buy us for what we are, and not because we are Indian and low cost," says Infosys' Nilekani. Second, their relatively small size of operation. "If you are a $50 million company, you don't have a chance of getting a $20 million contract. But if you acquire a $50 million company, then you could. In the US, a company with a turnover of less than $100 million is just not on the map," says NIIT's Thakur. And delivering on a large order for a small company isn't easy. Says HCL's Jain: "Even if you get a large contract, you can't hire 500 people in one quarter. But you can acquire a company which has 500 software developers in that time." Via its acquisitions, Infosys is attempting to do precisely that. Get itself a global delivery model.

That's just one of the many reasons why these acquisitions are so important for the Indian software industry. Says HCL chairman Shiv Nadar: "It is time for Indian companies to become global players. For that you have to play by global rules, and think and feel global." Worldwide, the software industry is a popular playing ground for merger and acquisition specialists. About a third of the software companies in the UK engaged in M&A activities last year.

Think Indian, act local: Through the proposed acquisitions, Indian firms will be able to look local, and leverage the brand of the local company. And this will enable them to charge local rates. "If we acquire a US company, our rates would go up by 70-80 per cent," says Thakur. NIIT plans to use the brand of the US company it will acquire, while Infosys plans to take the tougher route, building on its own brand. Part of the money raised through the ADR issue would probably be diverted to this cause.

Acquired firms also come with existing product and client bases. That's something both NIIT and Infosys are interested in. "If an Indian software company acquires a product company, it can then leverage its software development expertise to upgrade the product. The existing clients are already ready buyers," says Srivastava. Even in the software services business, an existing client base would give Indian firms the opportunity to service them at Indian costs but foreign prices. The margins should thus go up enormously.

While acquiring a local company, the Indian software powerhouses also hope to acquire functional expertise in areas like enterprise resource planning (ERP), telecom, banking and distribution and retail, which would help develop software for these sectors. In world markets, NIIT for instance typically partners with one of the bigger US firms, while developing software for these areas. "Indian software companies would be looking to acquire companies with knowledge of these areas," says Thakur.

But the keys to this entire acquisition ballgame are the ADR issues of Infosys and NIIT, and the IPO of HCL Technologies. That's because most acquisitions today aren't made by doling out cold cash for a company. Instead, stocks are swapped. And since Indian stocks can't be swapped for foreign ones, a listing on a foreign bourse is a necessity. Then, there is also the issue of employee stock option plans. Software companies in the developed world give stock options to their employees. "Assuming we hire local employees in the US, we will have to give them stock options. That's why our ADR issue is a must. It gives us the freedom to go in for an acquisition whenever we need to," says Nilekani.

The future has three faces: As companies like HCL, NIIT and Infosys lead the pack, how far behind are the others? "Every Indian software company with a turnover of over Rs 100 crore needs to use M&A as a growth strategy. A company of that size needs something more sophisticated than mere organic growth," says Srivastava. He talks of a three-tier structure developing among Indian software companies. Right at the top are the companies playing by global rules (those already mentioned above). Then, there are the niche players, who don't compete on size, but on strength. That's by getting into niche areas. And the third category comprises those who do neither. The size of their contracts remains the same, and margins keep getting squeezed.

Wipro Infotech's Soota feels he belongs in the second category. "We have built up considerable expertise in telecom, ERP and finance. Plus, we are putting a lot of effort in building our brand globally. Wipro has also managed to increase its rates comfortably." Soota believes that his company—despite not having any immediate plans for growth through acquisitions—should show a compounded growth of 70 per cent over the next five years.

How does it hope to achieve that? For one, Wipro believes that it has just touched the tip of the business opportunity iceberg. Its international presence has been confined to five US cities and one in the UK, while its Japan office opened just two years ago. "There are lots of markets we need to reach," says Soota. NIIT's Thakur couldn't agree more. "Before you go in for an acquisition you should have achieved critical mass by reaching out to as many markets as possible, and via as many product lines as possible." For instance, most software services companies in India still need to move up the value chain by getting into systems integration. An acquisition prior to that makes virtually no sense. Concurs HCL's Jain: "Most Indian software companies haven't tapped the non-English-speaking areas. Japanese companies are the biggest outsourcers in the world. But they outsource to Japanese firms. Why can't Indian companies overcome the language barrier via joint ventures?"

 Neither have many of the smaller Indian companies looked at developing products, where they have the competitive advantage of time. "Indian software engineers put in more hours per week than anywhere else in the world. Speedy product development is of utmost importance," says Jain. Sound advice. Something the second rung of Indian software companies would do well to listen to, even as they watch the biggies take on the world.