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IT: Linear v/s Non-linear - Views on News from Equitymaster
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  • Dec 15, 2009

    IT: Linear v/s Non-linear

    Human resources are an IT company's biggest assets. But sadly it is also subject to the unavoidable "law of diminishing returns". This means after a point, even with the addition of more manpower, additional increase in revenues cannot be achieved. The last article of this series tried to explain the concept of non-linearity in IT. Let us further put this concept into perspective with the help of an example.

    The chart shows that Oracle Financial Services (OFSS) beats India's most profitable IT company Infosys in terms of revenue per employee. The revenue OFSS generates per employee has always remained quite above the industry standards. How did it manage to do this?

    The foremost reason is the difference in their business models. Infosys is primarily an IT services company. It derives over 95% of its revenues from IT services. On the other hand OFSS is a hybrid having a healthy mix (60% and 40% respectively) of product and services. An IT product is a software that the company develops and sells or licenses to the customers. It becomes a company's intellectual property. It can generate one-time revenue as well as a recurring licensing and maintenance fee. So the revenues are decoupled from the number of employees deployed to develop it. It can be reused in servicing different clients, just by customizing the same software according to the needs of different clients. So it requires an initial team to develop it and then a smaller one to maintain it, resulting in a lower employee base.

    Infosys does have a banking product called 'Finacle'. But that's pretty much it. This amounts to a negligible product portfolio. Moreover, OFSS' 'Flexcube' outshines all its rivals in terms of brand visibility and performance. In case of Infosys over 50% of revenue comes from normal application development, maintenance and testing kind of work. Its revenues are largely effort based. So they are directly proportional to its head-count.

    We believe that a products-led growth is one of the various ways of achieving non-linearity. To start with, IT biggies having a huge cash surplus can scout for smaller IT product companies. They can also channelise a part of their existing work force in developing products. Inorganic growth through mergers and acquisitions as well as internal product development is a good way of plugging the gaps in their IT offerings at a faster rate. It's no wonder then that the year gone by witnessed a spate of M&As on the global IT landscape. Dell acquired Perot Systems, Xerox acquired ACS and Oracle acquired Sun Microsystems in order to complete their IT products and solutions portfolio. Indian companies too need to take the plunge and get out of their pure play IT services model.

    However we believe this move towards non-linearity will not happen overnight. Products have a long gestation period. Moreover, to ensure optimum quality, a large amount of R&D and training efforts will be needed. A culture for product development needs to be fostered. Also, there are other ways of attaining non-linear growth. We will try to throw some light on these in the subsequent articles in this series.



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