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IT firms: Moving up the value chain

Jul 15, 2008

Indian IT companies have witnessed robust growth in the last two decades. Over the years, Indian IT firms have operated on a cost arbitrage model. The value proposition in the IT outsourcing model was based on cost arbitrage with a technical resource pool, which is in short supply in most of the developed markets. Indian IT companies thus positioned themselves as cost efficient players. IT firms have been able to generate high return on investment (ROI) by using this model. However, growing competition from countries like China, Ireland and the Philippines in the outsourcing space, price undercutting and rising salaries might slowdown growth if companies follow the same business model going forward.

In today’s dynamic era it is imperative that Indian IT companies focus on the higher end of the value chain to improve their profitability. IT companies have to move up the value chain and provide higher value-added services as consulting, product development, R&D and end-to-end turnkey solutions.

Shown below is a diagram, which elucidates the value chain of IT industry. It explains what are the complexities in different levels of a firm, what are the skilled required in that particular level and how that can be obtained. The diagram below explains how an IT firm can climb up the value chain. The lowest level represents the firms, which are involved in programming and maintenance service providing. At this level the company only needs technical skills and this can be obtained by augmenting staff in the company. The next level of value chain is project implementation stage, which requires software project management skills and designing skills. The next level is package implementation level, which requires project management skills; above that level is system integration level. At this level, IT companies need to converge system and process by developing IT architecture. The next higher level is the level where an IT firm develops IT led business strategy. At this level of the value chain, the firm needs to assess future trends and develop a business model and process reengineering. The highest level of the value chain is business strategy development for which an IT firm needs in depth domain knowledge.

Measures required Complexity level Skills required
Evaluation of Business Model Business Strategy In-depth domain knowledge
Assessment of future impact of IT on the industry IT led Business Strategy Business modeling Process Re - engineering
Convergence of system and processes System Integration IT architecture development
Automation of Business processes Package Implementation Project management skills
Turnkey Development Project Implementation Software project management / design
Staff augmentation Programming Maintenance Services Technical skill
Source: Infosys

Indian software companies have been able to build substantial domain knowledge by providing application development and maintenance. Indian IT companies have constantly moved up the value chain - from custom software development to standardized products, to business process outsourcing and IT and business consulting. Major IT companies such as Infosys, TCS, Wipro, Satyam etc., have managed to move into IT and business consulting. However, competition is intensifying from global majors such as IBM (International Business Machines Corporation), EDS (Electronic Data Systems Corporation), Accenture, HP (Hewlett- Packard), etc.

Going forward, investors need to watch whether companies’ growth is linked with their value offering i.e. whether they are able to provide high end services or not. In the future only those companies who are capable in moving up the value chain would give superior returns to investors.

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