Who needs products? Services are prime

I get a certain question a lot on my visits to India -- when is Infosys going to get into software products?

Some of them forget that we have an excellent product suite -- Finacle -- for banks, but in most part they are right -- we don't have any enterprise software products in our key markets that we could sell alongside our services.

Most of our competitors in India don't either. Informed opinion in the media blames the Indian infotech services industry for not going up the 'value chain' into products.

In fact, one writer recently claimed that companies like Microsoft extract all the value in the IT industry and that Indian companies perform the task of 'cybercoolies' -- doing the low value-add work that no one else wants to do.

Are these expectations fair? Has the Indian IT industry failed at the 'ultimate objective' of any IT company, which is to create world class products?

I am going to answer this question by examining some common myths about the IT industry, both services and products.

Myth #1: The software products business is just an extension of the IT services business.

There are many companies, like Oracle, whose consulting revenues are derived of implementing their own products. But aside from these service models, the products and services businesses are so different, that the odds against a company with a dual strategy are fairly high.

The products business has high fixed costs. Product development costs run high even if you have five customers.

Market visibility and presence require certain minimum outlays to be effective. Typically, over 50 per cent of costs tend to be market related. However, the incremental cost to acquire the next customer is very low. This makes for a high-risk, high-reward financial model.

Once you cross the break-even level of license revenue per quarter, profits quickly start climbing.

IT services companies, on the other hand have high marginal costs. Every hour of billed service delivered has variable costs of salaries, travel and living associated with it. However, fixed costs tend to be lower.

As you can see, the basic financial model is very different for products and services. These differences pile up as you go deeper into the businesses. Skills, processes and practices are all vastly different.

IBM is, perhaps, the only company that has successfully built, both, products and services businesses.

Myth #2: The software products business is a highly profitable business.

Most people look at Microsoft's profitability and assume that all licensed product businesses are as profitable. Today, nothing could be further from reality.

In the table below, you will find that Indian IT services companies Infosys and Cognizant both show far better margins and growth compared to leading software product companies Siebel and PeopleSoft.

Granted, this is perhaps the worst time for companies selling licensed software products, but still, the contrast is sobering.

For the CEO of any of the top-tier Indian IT services companies to go and invest in the risky business of enterprise software when his own business is going gangbusters, guts of steel and a very convincing pitch to his investors would be needed.

	Revenue	EBITDA	Margin	Growth	Market Cap
Microsoft Corp (MSFT)	$32.19 bn	$13.51 bn	42%	14%	$305.25 bn
Siebel Systems (SEBL)	$1.64 bn	$-0.055 bn	-3%	-20%	$5.06 bn
PeopleSoft (PSFT)	$1.95 bn	$0.354 bn	18%	-6%	$7.95 bn
Infosys Tech (INFY)	$753.81 mn	$239.15 mn	32%	38%	$8.67 bn
Cognizant Tech (CTSH)	$229.09 mn	$62.87 mn	27%	29%	$2.33 bn
Notes:
1. Revenue and EBITDA are trailing 12 months figures.
2. EBITDA - Earnings Before Interest, Tax, Depreciation and Amortization
3. Market Cap is based on closing prices on Sept. 12, 2003 on US exchanges.
4. Margin is EBITDA/Revenue

Myth #3: IT services are getting commoditised. The value will migrate to software products.

It is true that in the last two years, rates in the IT services industry have been pummeled like never before. Clients won't pay what they used to simply because their businesses can't afford it.

And then, there's the whole offshore delivery model thing that's turning the industry inside out.

These are not good times in the IT services industry unless you have an offshore delivery model yourself.

But while the offshore delivery model may be rocking the industry, the need for IT services has not diminished in any fundamental way.

Enterprise software, on the other hand, is in a bit of a pickle. Most industry pundits believe that the licensed software sales model needs a serious overhaul. Customers are just not willing to pay large sums of money towards license fees up front.

They first want the software implemented so that they can get the business value the software company claims its software has to offer.

During the IT boom millions were poured into enterprise software licenses. Much of it is still gathering dust on the shelves of large corporations. CIOs have vowed to never let that happen again.

And then there's open source. Open source is the biggest force shaping the enterprise software industry, especially on the tools and platforms side, where some believe open source will suck the value out.

On the other hand, open source or proprietary software, you always need an integrator. Services never go out of fashion.

Myth #4: Indian companies aren't expanding into products because they don't want to invest and take risks to create intellectual capital.

Indian IT services firms understand that getting into software products is like unrelated diversification. Some of them will still go and do it. But, by and large, they will stay away from it.

The services business, on the other hand, offers ample scope for profitable growth through innovation and investing in solutions: by going up the 'value chain', if you will, not into products but into solutions.

Much like the products business, this requires an intimate understanding of your clients' needs and investments in skills and intellectual property to meet those needs. This game is not for the weak-hearted. Only top-tier Indian IT services firms can pull this off.

So the next time someone asks me why my company (Infosys Technologies) isn't being more aggressive with products, I will just put it down to misplaced national pride.

They want India to be known for great software products. It should. But India is already well known for its services companies. And that's something to be proud of.

The writer is Senior Vice President and Head - Worldwide Sales & Retail (North America), Infosys Technologies Ltd. These are his personal views and in no way reflect those of his company's.