Globonomics!

Consulting|Technology|International business

IT services versus IT products – which is better

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If you ask for my honest opinion, this is like comparing apples with oranges!

Let me elaborate by going into the grassroots of the IT service sector before striking the analogies/differences between an IT service and an IT product business.

What are IT services? Before we get into what IT services are, let us look at what the word “Services” actually means.

Services are intangible benefits offered to customers taking place by means of an interaction between the employees of the service organization with customers that helps achieve the benefits that are offered to the customers by means of those services – those that create a solution for the customer to solve the customer’s problems.

Now, with the above broadbased definition, let us apply this concept to our typical IT service organization.

Obviously, the intangible benefit offered is the IT enabling of some of the functions of the organization so as to fulfil the organization’s IT requirements. This applies to all vertical sectors namely: Financial, Healthcare, Telecom, Insurance etc.

Typically, IT organizations build expertise on the above lines of business (LoB) and map those with a clear line of technology (LoT). Most of the IT service organization’s staff are termed “Consultants” since they are expected to provide solutions to the consumer based on the customer requirements by means of consulting.

ex: This is what you want to achieve, these are the ways you can achieve (a), (b), (c) and so on, this is the best approach to achieve all of your objectives and finally the most important – this is how we will help you achieve those objectives.

Above is what is supposed to happen in an ideal context.

Typically, in the Indian context, IT service firms have been largely confused with the most violated concept of “Body shoppers.” The other day, I heard someone from the US (a consultant) tell me “TCS quotes burger prices”.

So, what is their business model? Typically IT firms charge customers based on an IT worker’s per hour rates. ex: $100 per hour for 8 hours a day. Therefore, for large complex projects that require deployement of a large amount of manpower, the revenues earned bear a high correlation to the # of people working on that project and their “billing rates”. Again, there are vagaries to this model. ex: the invoice currency for most of these IT service firms is in USD (since a majority of their business comes from continental USA/exports) and maybe another huge chunk from Europe and a small fraction from APAC. Margins are dependant on the billing rates, their foreign exchange exposure, the number of people working on the project and the complexity of the project and the involvement of the IT service firms (are they merely extending manpower similar to body shopping agents or are they getting into hardcore consulting?)

While the Indian biggies have moved up the value chain, there is still a long way to go.

For ex: EDS and Accenture have been known to just take over an entire organization’s data centers and manage them effortlessly leveraging on their prior IT service knowhow. These are the biggies in this space (EDS, Accenture, IBM, Cap Gemini etc.)

How did all this begin?

TCS began rather humbly in 1968 and was largely driven by the vision of one man, Dr. Fakir Chand Kohli).

Infosys grew even more humbly in 1981 with the vision of Mr. N R Narayanamurthy.

These are our modern day consulting behemoths with over 80000 people on the payrolls of each consulting major!

To think, less than a decade ago, TCS had fewer than 8000 employees (when I was offered a job by them in 1998). Think about scaling – of massive proportions!

The Indian IT biggies had access to the ERP bubble in the mid 1990’s followed by the Y2K compliance boom in the late 1990’s followed by the dot com bubble in the late 1990’s again.

This led to soaring requirements for the well educated and English speaking Indian graduates in the Western world who had a gross shortage of talent.

Though there was a temporary slowdown in the years following the crash of the dot com bubble in 2001 till mid 2003, there was no letting down for these IT majors that stood to benefit from lower cost wages and higher productivity work being done from their offshore locations.

This led to a spurt in demand for the talented Indian “techies” and supply was simply unable to cope with this burgeoning demand thereby leading to an inflation in salaries (a natural economic outcome).

Today the wage differential between the salaries offered onsite and offshore has reduced but the quality is still good due to which Indian IT services retain their edge over competing low cost locations such as China (primarily a manufacturing hub), Phillipines etc.

The comparison between India and China on these lines is beyond the scope of the current discussion topic.

Coming back to the original discussion thread, what we have learnt so far is that Indian IT service companies have evolved into multi billion $ enterprises today with a lot of hardwork, a little bit of luck (esp. with the underground fiber optic cables etc. linking them to the western world at throw-away costs to them) and a lot of determination.

Whether we accept it or not, the truth is that the Indian IT service firms led by our biggies have stamped their authority on the global landscape of the IT service industry. Mckinsey reports suggest that a small portion of the worldwide IT service pie has been got by these IT service firms thereby proving that there is still a long way to go and a lot of business opportunities lying untapped for them – if they stick to their basics and get the job done right.

Based on the tremedous success of the above biggies (a competitive oligopoly of sorts), smaller players started venturing into the same IT service space. Some did make a mark – MindTree consulting etc. Some didn’t – predictably so for myriad reasons beyond the scope of the current discussion.

So, here we have the foundation laid out for the Indian IT service landscape.

Now, let us shift our attention to the IT product landscape.

This is still in its infancy stage.

What are IT products? We hear of companies such as Ittiam (an IP based company). IP = Intellectual property.

IT products are essentially where you build on a product concept that has a business model for generating revenues and either offer it in flavors such as licensible or subscription based (monthly/yearly) or a combination of both.

Many companies have succeeded on the licensing model –  Oracle, SAP (to name a few). These are global majors.

Many companies have succeeded on the subscription model too – online newspapers/periodicals etc.

Many companies have succeeded on the combination of both the business models – Microsoft being the best example.

Now, what companies typically develop here are essentially IP assets. Intellectual property is like your typical Real Estate property. It is something you (the company or the indivdual) own. This IP can be classified as a Trademark, a Patent or a Copyright.

Description of the above three is again basic and we will not get into that here. Let us move on assuming we know what a trademark, a patent or a copyright mean.

Let us assume that an organization has come out with a concept and has decided to patent it (so no one else infringes on its IP). A classic example of a case where an IP violation resulted in a lot of revenues (via royalty) for a company was when the maker of the business genre, Blackberry i.e. Research in motion – RIM (Nasdaq: RIMM), had to pay royalties to the company that accused RIM of having infringed on its original patented concept (essentially the technology of achieving email push onto a handheld device).

That apart, the crux of the argument is that IT product firms typically build technology solutions and cover those assets strictly under IP rights (if they do not want others to mimic the same technology).

IT products therefore theoretically result in a one-time fixed investment (a high fixed cost) and thereafter, marginal cost to sell that solution. Take Microsoft’s example. They invested close to a billion $ on the R&D efforts of their Windows XP operating system but subsequently their marginal cost was almost zero for every additional copy of Windows XP that they sold to consumers on CD’s. So, margins are higher depending on volume of sales.

If you develop a product and have no one to buy it, all your fixed costs (that are usually high) will go down the drain. So, it is also wrong for the supporters of the blind theory that Indian IT service firms should venture into product development (to preserve IP) to go by their thesis since it is largely dependent on cracking that market space by either a red/blue ocean. Yes, the larger players will have huge IT budgets and sales/marketing/advertising budgets that will help them use their marketing touch points to make a difference but the concept still has to sell and therein lies the challenge. Its definitely not easy.

Therefore, we can conclude that:

1. The business models of IT services and IT products differ – you cannot say margins are higher based on above thesis since the margins are subjective and dependent on the sales of a product (in case of IT products) and the involvement in understanding the customer’s requirements from a domain perspective/billing rates/level of consulting provided by a service (in case of IT services).

On a side note, pure management consulting is a billion $ business by itself and I am not referring to IT consulting. This is the area where there are few players such as Mckinsey, AT Kearney etc.

I definitely hope our Indian IT service players move up the value chain, get into pure consulting and build domain experts than simply technology experts. I can see this happen albeit quite slowly.

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Written by Naveen Athresh

April 1, 2007 at 11:15 am

One Response

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  1. […] Please also look at one more of a related topic posted by me earlier on a similar topic: https://ecofin.wordpress.com/2007/04/01/it-services-versus-it-products-which-is-better/ […]


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