Despite Stalled Reforms, India Is an ‘Oasis of Opportunity’ in 2016
Figures of Hindu gods on the roof of a temple.


India exports software, Pakistan exports terrorists! Today more than ever no country is an island entire of itself. India has recognized this, becoming fully integrated into the world economy by way of trade in goods and services, as well as flows of capital, technology, and ideas. And, of course, India’s uniquely large and widespread diaspora is playing a unique role in strengthening its ties with the world.

In June 2017, the $23 billion Vodafone-Idea Cellular merger got the go ahead from the Competition Commission of India. A few days later, the government announced a deal between two public sector undertakings (PSUs) – the Oil & Natural Gas Corporation (ONGC) and Hindustan Petroleum Corporation Ltd (HPCL). The Rs. 28,000 crore ($4.4 billion) merger involves ONGC buying up the 51% government stake in HPCL.

In his Budget earlier this year, the finance minister had spoken of plans to merge the State Bank of India (SBI) with several of its subsidiaries; have four-five large PSU banks through a process of mergers; and a similar proposal to create oil giants. The SBI merger has happened; the first oil giant has been announced; and the other candidates in the size stakes are readying for action. Indian Oil Corporation (IOC) is waiting for permission to acquire Oil India, and the PSU banks — thanks to the new Reserve Bank of India (RBI) norms on bad assets — have begun writing on the same page. In another big league deal – though not a merger — IOC, Bharat Petroleum and HPCL have signed an agreement to set up a $30 billion refinery. The three companies will own 50%, 25% and 25% in the refinery, India’s biggest.

According to assurance, tax and advisory firm Grant Thornton, M&As in India almost doubled in the first half of 2017 to $35.84 billion, over the corresponding period of 2016. This was aided by the Vodafone merger. But, says Prashant Mehra, partner, Grant Thornton India, this is just the beginning.

The trend is not just in government companies, where a merger doesn’t necessarily involve a change in management and ownership. It has spread to the private sector, too. Recently announced was a possible combine of IDFC, IDFC Bank and the Shriram Group. Piramal Enterprises chairman Ajay Piramal had acquired a 20% stake in Shriram Capital in 2014. He also owns similar holdings in Shriram Transport Finance and Shriram City Union Finance, effectively making him top honcho of the group. This proposed merger will create a financial services giant with a market capitalization of $10 billion. Other predators have been prowling around. Kotak Mahindra Bank and IndusInd Bank, both in the private sector, have been going up on the bourses after reports that they were wooing private sector financial services players.

Also in the private sector, another lot is seeking the security of mergers. Telecom companies – confronted with one giant (Vodafone-Idea) and another giant in the making (Reliance Jio, which has now upped the stakes by virtually offering free feature phones to its subscribers) — could be joining hands. The Tata Group and Bharti Enterprises have held exploratory talks to evaluate a mega alliance involving their telecom, overseas cable and enterprise services, and direct-to-home TV businesses.

It is a world in which India today occupies a special position. Whereas many countries – advanced and developing economies alike – are experiencing a growing sense of economic anxiety and even gloom, India is a beacon of hope, positive change, and economic dynamism.

Competitive dynamics are forcing companies to spend more on customer acquisition. Firms are looking at the end-state versus the current state, and based on certain indicators they are willing to take an educated guess that there is light at the end of the tunnel. Since India does not have any firewalls unlike China, Indian entrepreneurs have no option but to up their game, focus more on quality and constantly innovate in order to compete successfully with global players like Amazon and Uber who are investing heavily in India. Other important steps include developing domestic capital and focusing on localization, panelists added.

For the past three years, India has had a reforms- oriented and free enterprise-oriented government and several steps towards reforms and growth have been initiated. In the long term, demonetization will have a very strong positive impact on India’s GDP. The biggest reform, is the goods and services tax (GST). The objective of GST is to replace all taxes levied by the federal government and the states with one central tax.

Private sector mergers have their own watchdogs – shareholder interest groups, activists et al. Public sector mergers are mostly done just to balance the government’s books; the ONGC-HPCL merger is to meet this year’s disinvestment target of Rs. 72,500 crore. And using this method avoids the “selling the family silver” charges from opposition parties.

“We need to question the logic of public sector mergers,” says Ravi Aron, a professor of information systems at Johns Hopkins Carey Business School. “Usually efficiencies are achieved – if ever they are – by eliminating redundant functions and increasing productivity. To achieve these gains, it is necessary to reduce costs through layoffs. But in India retrenchment is taboo – both politically and through law. The Industrial Disputes Act makes it nearly impossible to effect large layoffs in non-managerial workers.”

Exactly what efficiencies will be gained by mergers between public sector companies? “Before we discuss scale economies and synergies, it is important to understand what they mean,” Aron notes. “For scale economies to exist, it is necessary to reduce the average unit cost of production of a product or service with increasing volumes. That reduction in costs of production (more generally operating costs) can happen only if labor costs can be pared down. This is very difficult, given the Industrial Disputes Act. Perhaps they may slow down future hiring and drive some gains through voluntary retirement schemes. These gains are not likely to be very high.”

In a study titled “Making Public Sector Mergers Work: Lessons Learned,” Peter Frumkin, professor of social policy & practice at the University of Pennsylvania, writes: “There has yet to be much systematic thinking about what makes public sector mergers work and how best to carry them out. Beyond the assumption – which remains largely unproven — that government mergers produce greater levels of coordination and lead to cost savings through the reduction of roles and redundancies, the field is still in its infancy.” That is true even today, more than a decade after the study was first published.

But Mehra sees a silver lining. “Since it is all government owned, it helps in leveraging the infrastructure for better returns as it stops the common stakeholder (which is the government) effectively cannibalizing its own business.”

In order to realize the true potential of India, Indians need to do things differently — be it products, processes or business models – in a manner that is suitable to India but can also make a mark globally. India doesn’t need to go through the same cycles as the West but can leapfrog in many areas. The most efficient way to deliver change at scale is to bring about changes at the policy level. However, once a new policy is formulated, there should be a 100% commitment to that policy and there should not be too many riders. One should not have to keep looking at the fine print.

There is a rise of professional entrepreneurs who have a large appetite for taking risks. During the past 10 years, most small and medium businesses (SMEs) have seen their return on equity decline from high double digits to high single digits or at best 14% to 15%. This is forcing them to rethink their business models. Most of these are family businesses, and with the younger generation getting more involved these businesses are now becoming more service-based and productivity-based as compared to the earlier manufacturing and working-capital based entities.

There are very few companies like Freshdesk, Zoho and InMobi which bring innovation to fix business processes and solve actual business problems. India has seen a lot of consumer tech startups. We now need more action in the enterprise space. In this space it is very difficult to get support by way of advice and mentorship, and proving valuations is extremely tough.

There are three factors as critical for building sustainable and world class not-for-profit organizations: Strong emphasis on governance, finding scalable solutions, and relentless focus on quality and excellence.  Cultivating leadership capability is critical. In business one talks of leadership development all the time. We need to do the same in social development, too. Indians need to aggressively recruit top talent and then invest in their development.

Even as India embraces the digital revolution, it is important for it to devise its own models and policies and not simply follow the lead of other countries. Adoption of digital technologies by mature economies has to be seen in the context of their ageing population. Their aim is to ensure that productivity gains due to new technologies outweigh the contractions due to decline in population.

There is a wide disparity in India when it comes it diffusion of digital technologies among different demographics, especially the elderly, the uneducated, and the less affluent populations. Universal digital education and accessibility to digital resources is crucial for a successful digital economy.

After years of sitting on piles of cash, Indian information technology (IT) services firms are suddenly dispensing some of it to their shareholders by way of buybacks. In mid-February, Tata Consultancy Services (TCS), India’s largest IT services firm, which has a cash pile of around Rs.40,000 crore ($6 billion), announced that it would buy back equity shares worth up to Rs.16,000 crore ($2.4 billion). This is TCS’ first buyback scheme since it went public 13 years ago and also the biggest share repurchase program in the country. A few weeks before TCS’ announcement, Nasdaq-listed Cognizant Technology Solutions, which has the bulk of its workforce in India, declared a dividend payout and a share buyback of $3.4 billion.  HCL Technologies said it would buy back Rs.3,500 crore ($340 million) of shares. Others like Wipro and Tech Mahindra are expected to follow suit. On April 13, announcing its results for the fourth quarter of fiscal 2017, Infosys said that up to Rs. 13,000 crore ($2 billion) is expected to be paid out to shareholders during 2018 in dividends, share buybacks or both. In addition, the company expects to pay out up to 70% of free cash flow next year in the same combination. Currently, Infosys pays out up to 50% of post-tax profits in dividends.

The buybacks are a move to boost share price and soothe investor sentiments. They are also designed to make them less attractive to predators. After years of giving high returns, the industry has been delivering below expectations; most Indian IT services firms have been performing below the Sensex, the benchmark stock index. Recent developments like U.S. President Donald Trump’s election and the ensuing controversy surrounding outsourcing and H1-B visas, and technology disruptions caused by digital transformation and automation are in fact threatening the very fundamentals of the $108 billion IT-BPO exports industry. That industry put India on the world map because of its high-quality, low-cost tech talent and a successfully executed offshore-global delivery model. (Indian IT firms use the H-1B temporary work visas in large numbers to fly their engineers to client sites in the U.S., which is their largest market accounting for over 60% of exports.) There are also pressures from other quarters, such as Brexit and the consequent delays in decision making; slowdowns in the banking and financial services sector, and reduced discretionary IT spending.

Jitendra V. Singh, emeritus professor of management at Wharton, says that one must look at the past to draw lessons for the future. He talks about the proposed sale of national carrier Air India. “I believe it would be a mistake to only look at the recent history of Air India and ask what should be done next,” he explains. “It is particularly instructive to look at a 50-year-plus span and learn lessons from the blunders made along the way. These lessons, if learned well, could be of much value to India in the future, if only so that they are not repeated in other settings.” Singh is referring in particular to the Air India-Indian Airlines merger, a marriage which created a money-guzzling monstrosity.

But Jitender Bhargava, former Air India executive director and the author of The Descent of Air India, feels that it would be the wrong example to draw any lessons from. “The Air India merger shouldn’t be used as a benchmark because it was scripted to fail, hastily pursued with malicious intent,” he says. “It was meant to squeeze whatever value was left in Air India to help private airlines.”

“The merger of the two poorly-performing, medium-sized airlines – Indian Airlines and Air India – did not create a large, well-run company,” says Aron. “It created a large drain on public finances and accumulated operating losses running into billions of dollars over several years.”

The other example which case studies are focusing on is SBI. The bank has had repeat experiences; the government had earlier merged it with the State Banks of Jaipur, Bikaner and Saurashtra. Even earlier (in 1969), it was the beleaguered State Bank of Bihar. The more recent mergers are still works in progress. “The merger is seen as a win-win for both SBI and its associate banks,” notes a paper by G.V. Subba Raju of Vasavi College Hyderabad. “There are several economic and strategic advantages to the merged entity. However, it is not free from challenges. In mergers, it is not the two economic entities joining together, but also people with career aspirations and expectations. People’s concerns and their willingness to work with others are mostly ignored during a typical merger.”

”Selecting agencies for a merger, managers (or, in many cases, legislative bodies) need to consider not just the possible short-term cost savings but also the ‘fit’ of the agencies in terms of culture and competencies,” Frumkin notes in his report. “Choosing the right agencies requires careful research and strategic analysis. Public sector agencies provide services and in doing so develop stakeholder groups that demand performance and accountability. Unlike mergers in the private sector, the decision to merge cannot be made by shareholders.”

Expectedly, the SBI merger move has been criticized by the unions fearing automation, redundancy and job losses. According to the All India Bank Employees Association, India needs banks which can touch the common people. Says general secretary C.H. Venkatachalam: “The bigger the bank grows, the less accessible it becomes to the people. Big banks will give big-ticket loans with higher risks. We have seen the Lehman crisis. Lehman Brothers was a-too-big-to-fail bank in the U.S. And it collapsed.”

Mehra agrees on the human side of the picture. “The disadvantages [of a merger] are almost negligible if it’s within PSUs but if it’s between a PSU and a private bank, then cultural issues could bring about post-deal integration problems. Thus, the objective of the merger is defeated.”

Speaking of the Indian context, Aron says that a public sector merger is the wrong solution to the problem of chronic underperformance by government-owned enterprises. “The problem is that the government should exit many of the businesses that it is in.”

The SBI merger “is a case in point,” says Aron. “Consider the vast majority of large government-owned banks in India. In retail banking there is minimal differentiation between them. The banks all offer very similar retail banking products. Why is there so little product differentiation? Four reasons: (1) Incentives – these banks do not have any incentives to compete with each other and target different market segments with different services and prices. They are completely protected and they have access to the public exchequer – the taxpayer’s money. (2) Also incentives. The salaries of the top management are set by the government and not by the market; from there on down to the lowest white-collar worker, almost all salaries are set by bureaucratic procedures. There is no incentive for middle managers to innovate, take risks and try to pull away from the pack. (3) Unions of non-managerial staff oppose cost reduction and headcount-pruning measures – in the late 1980s and early 1990s, when computerization of banking operations began, unions opposed the efforts quite ferociously and delayed every phase of technology implementation by a decade or so. (4) They are controlled by the government – the government uses these banks as a source of cheap capital and for making loans of dubious economic merit but of great vote-buying value; the successive governments in power have converted the paid-up capital of the banks into political capital.”

Aron adds that it is important to distinguish between government ownership and government control. “It is entirely possible to exert control on banks and stop them from assuming too much risk by imposing regulatory control,” he says. “There is no reason for the government to own these banks. Consider the foreign banks in India: Citibank, Barclays, HSBC, Bank of America… They are subject to regulatory control by the RBI and other policymaking bodies.”

Then there is the idea that a group of banks if merged will be able to make larger loans (with a larger asset base). This is an odd rationale: the banks are owned by the government, the government is the guarantor of the bank’s finances. So how does the merger change the ultimate risk exposure profile when all risk is borne by the government? Further, in many countries larger loans are raised by groups of financial institutions that can lend money to an entity and apportion the risk appropriately. Consortia of banks have made large loans in plenty of cases. There is no need to have a single behemoth bank to bankroll large capital intensive projects.

We need to remember a basic tenant of IO (Industrial Organization): Competition between firms benefits consumers and the economy; private sector monopolies benefit owners of capital; and government monopolies benefit their employees.

The question is not which firms should be merged. Rather it is about which sectors the government should exit. The government as the largest shareholder in the boardroom is the 800 pound gorilla that we are afraid to talk about. We need to get that gorilla out of the room.

For several years now, experts have been predicting that the dream run of the Indian IT services industry will soon be over. By all indications, that time has actually dawned now. But this is not the first time that the industry is looking down a long dark tunnel. The Asian Crisis of 1997, the dot-com bubble burst of 2001 and the economic crisis of 2008 were all trying times. Each time, the industry managed to bounce back. So what is different this time around?

The current protectionist regime in the U.S. and the anti-trade mood will result in legislations that may cause some temporary but not very large setbacks. The real problem for India IT services companies is that they occupy positions of very low strategic relevance with their clients.

Several emerging technologies are changing how companies compete, the way they engage with customers and even the nature of work inside the firm. Big Data and analytics, artificial intelligence and robotics are all top of the mind not just for CTOs in corporations but also for all CXOs. When we talk to senior executives, they do not ask us to explain the difference between supervised and unsupervised learning in machine learning. Instead, they ask specific questions about how will machine learning have an impact on predicting customer response to products in retail financial services? Or, how can data mining be used to identify opportunities in new product development by analyzing and classifying patterns from transaction data?

But Indian IT companies are operating on a different model altogether. They expect the clients to tell them what they want from these emergent paradigms and offer to find out a cost effective way of doing it. They are not ready to deal with the ‘what aspects of business can I transform with technology’ question, which is of high strategic relevance.

Essentially, Indian IT firms have been stuck in the middle; they are not low-end providers anymore with low costs, neither have they been able to propel themselves to become high-end providers performing core work and high-margin services. At the same time, on the technology side, automation threatens to render obsolete much of the labor arbitrage work on the lower end; while political changes such as protectionism compound the problem.

Keeping pace with technology and the changing requirements of clients is the most difficult challenge that the Indian IT industry is facing today. The current situation is very unique and we are possibly going through the most interesting phase of evolution in terms of IT services. We see that creative destruction has become a norm for many businesses. Re-skilling people is a big challenge, especially when you have a large workforce. The short supply of skilled labor will be one big inhibitor. Endpoints of the Internet of Things will grow at a CAGR of 32.9% from 2015 through 2020, reaching an installed base of 20.4 billion units. This will drive a lot changes in the business models and business opportunities which need to be tapped. And though tactical innovation is the strength of Indians, in my view, the cultural aspect around innovation is the most difficult change organizations will struggle with.

Indian IT firms could survive the many challenges earlier — whether it was shortage of skills, fluctuating currency, macro-economic factors, growing competition from multinationals and pressure from clients to build skills such as domain expertise, program management and consulting capabilities — because they had the benefit of the TINA (there is no alternative) factor.

But that is no longer true. Now, there are several point solutions available which are part of the enterprise resource planning ecosystem. Many business process providers offer specific business processes as well as cross industry processes on demand. Cloud and software-as–a-service (SaaS) companies are changing delivery and payment parameters. The industry is facing structural changes. All aspects of a solution — what clients are buying, in what format they are buying, how they want to pay, what value they expect, competition — are undergoing change simultaneously. The gaps between what clients are looking for and what the Indian IT firms have to offer is widening. The industry has not faced such issues before.

Even as global IT spending is growing, it’s not coming to India. Instead, most of it is going to other companies. Look at the growth of firms like, Amazon Web Services (AWS) and Workday. Even cloud divisions of Oracle and Microsoft Dynamics have been doing well and so are numerous firms like Tableau, Marketo, etc. There are around 200 or 250 companies which came from nowhere and are today in the range of $200 million to $1 billion.

Indian IT firms were successful in riding multiple waves like the shift from mainframe to client-server, Y2K, internet and e-commerce, social media and the mobile because the core skills needed to succeed didn’t change dramatically — essentially good programming skills plus the ability to manage large teams across geographies. While the programming languages and platforms did change, the ability of Indian companies to train large numbers of software professionals in new programming languages in short timeframes allowed them to stay ahead.

However, the latest wave embracing big data, machine learning and artificial intelligence requires fundamentally different skills. It’s more research-intensive. Many existing employees can’t be re-trained for these requirements. And India’s engineering education will be unable to meet these needs, at least not immediately. More than half of the 3.9 million people employed in the Indian IT sector will become irrelevant in the next three to four years.

The current scenario is a perfect storm created by three forces. The first is digital transformation of clients with applications and infrastructure moving to the cloud and clients asking for new services like mobility, analytics and cyber security which cannot be delivered using the traditional dual shore model. The second is automation of knowledge work, which is seeing traditional manpower intensive offshore services like applications management, infrastructure support and testing becoming automated and reducing or, in some cases, eliminating the need for manpower. Third are the forces of protectionism that is leading to tightening of visas and making cross-border movement of people extremely arduous.

Each of three forces can have severe ramifications for the Indian IT services industry. Digital transformation can take away as much as 20% of existing services volumes, automation can eliminate 30% of manpower and protectionism can reduce revenue opportunities and profitability by at least 10%.

Clearly, the rules have changed for Indian IT firms. The big question is: Can they in fact get back into the game? Only if they differentiate themselves. There are two strategies. One, become a partner that can guide CEOs with strategic initiatives like digital transformation. This will require them to be part of the “what to do” and “why do it” conversations and not just “how to do it.” Two, specialize and build deep expertise in certain areas. For example, CMOs are increasingly spending on IT including custom IT implementations. Another such area is Big Data and analytics. Organizing into divisions or perhaps into sub-brands, each with deep expertise, is the way to go.

While Indian IT firms have been making investments over the past five years in emerging technologies, they now need to scale up those efforts and do so quickly. They need to increase the investments in those areas drastically, and hire top talent from established Western firms and startups alike. At the same time, they also need to leverage acquisitions of small firms and/or build alliances to rapidly increase access to those capabilities and be part of an ecosystem.

Indian firms need to be innovative, agile and flexible. Thinking out of the box will differentiate the winners. They must be able to predict the changes faster and adapt themselves to leverage it much ahead of others.

The most important imperative is to re-skill employees for the new digital challenges at a rapid place. The winners will be those who use technology to enable just-in-time and on-the-job learning and are able to equip their workforce with skills needed to pivot their own careers as well as the organization.

Since Indian IT companies have grown mainly in the era of client-pushed business growth, their corporate functions such as strategy, planning, market research and strategic marketing are not very strong. They need to ramp-up on all these fronts. They need to invest much more on sales and marketing, grow their selling sophistication and competitive positioning. They also need to embrace a truly global delivery model where 40% of resources are placed in on-shore, near shore and other alternate geographies.

While the possible tightening of the H-1B visas in the U.S. is giving most Indian IT firms the jitters, they can in fact turn this temporary adversity to long-term advantage if they can acquire some additional capabilities. First they need to invest in the ability to translate business needs into software features – these are professionals that can talk to users and translate their needs into a set of software features and then create a system of codification that can transfer this to the offshore production location. Such codification capability improved both the output and quality of work and lessened the need for onshore managers.

The blended rate that Indian IT firms offer their clients usually combines a mix of offshore and onshore wages at 70:30 or 80:20 ratios. By developing this capability, Aron says, the onshore presence can be reduced to 2% to 3% of total project capacity. By deepening this capability, Indian IT majors can actually make this a long-term competitive advantage and wean themselves away from the need for large numbers of H-1Bs.

Another way to reduce dependence on H-1B visas is to focus more seriously for business from ASEAN, Middle East and Africa and other emerging markets. Currently, the bulk of their overseas client revenues come from the U.S. and Europe. In ASEAN, the Middle East and Africa, a wave of automation is beginning to take place. IT spending in many of these countries is set to increase by 8% to 22% according to some industry reports. Many of these countries do not have local firms with the ability to strategize and provide consulting services and sell them on top of an ‘IT stack’ – a set of technology solutions that will make the strategies work. The time is right for Indian IT majors to take on these markets.

Of course, the challenge for Indian IT firms is that they need to make all these above suggested changes even while continuing to deliver the services that bring them the revenues at present. Some of them have already started making their moves. TCS, for instance, has been on a massive re-skilling exercise and has trained more than half of its 380,000 employees on digital platforms. Tech Mahindra is looking at its DAVID (digital, automation, verticalization, innovation and disruption) offering to keep pace with the evolving needs of its clients. It is also looking to collaborate and crowd-source instead of trying to build everything in-house and is working with more than 15 startups.

The idea is that we don’t just do what we are told, but in every single project, no matter what it is, no matter how mundane, no matter what area it is in, you do something innovative. You find some problem and you solve that problem, you go beyond the charter of the project and do something innovative to delight the client, and do something that they did not expect. Something bigger than what you were thinking about. The direction is right. Now it remains to be seen if Indian IT reaches the destination.

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