Be different, to survive

The conventional wisdom in the software industry is that new entrants and smaller enterprises have to operate in niche areas because the big boys have a presence in almost every other area. Exactly how valid is this belief?

To some extent it is. But it's not the universally applicable rule that the industry thinks it is. Being just a niche company is, quite simply, not enough.

You might be pardoned for believing that operating in niche segments of the industry doesn't work.

For starters, look at the Chennai-based Ramco Systems, which started operations in 1989 as an enterprise resource planning software product company.

Fourteen years and product revisions later, it claims to have 1,000 customer installations in 30 countries. It's marquee clients include Hyundai, Cisco, Schlumberger and Philips.

Despite this, Ramco's financial performance has been disappointing. Revenues have dropped from Rs 116.10 crore in 1999-2000 to Rs 81.02 crore in 2002-2003.

Turnover for the half year ended September 30, 2003 was Rs 34.95 crore. For two years, the company has been in the red, with total losses now at Rs 27.30 crore.

Kamesh Ramamoorthy, vice president, enterprises solutions, at Ramco offers an explanation: "Over the last few quarters our investments have focused on establishing senior management teams in the US and Europe with local market and management expertise. Also, the investments in the new technology platform have started yielding very positive results. Over the last two quarters we have won large significant orders and they are in various stages of implementation."

The Hyderabad-based VisualSoft Technologies is another example of how a niche focus has helped only to a limited extent. VisualSoft started by offering products that aided software development.

After the tech meltdown, the company reinvented itself as a business applications development company that provides IT outsourcing services to a range of industries.

The change in focus helped to an extent, but the company has had to compete with the big daddies of the industry.

It provides services to the insurance, retail and distribution, healthcare and utilities industries "� all areas catered to by bigger companies. All of them have business divisions focused on these areas and all post substantially bigger revenues.

At the end of the day VisualSoft's shift in focus has ensured that it is pitted against Infosys, Wipro and Cognizant "� and there is not much of a differentiator in service.

To be sure, VisualSoft's revenues have shot up from Rs 67.98 crore in 1999-2000 to Rs 122.97 crore in 2002-2003 (they dipped to Rs 102.04 crore in 2001-2002 but recovered after the restructuring exercise).

But profits have grown modestly, from Rs 28.19 crore in 1999-2000 to Rs 32.23 crore in 2002-2003.

V Krishnan, vice president (finance) at VisualSoft sees it differently.

Says he: "Our products primarily catered to software developers. When the global meltdown happened and fresh software development took a hit, we decided that it is not wise to invest additional money in new technology development and marketing the existing products. Instead, we chose to convert our technology components into frameworks and deliver cost-effective solutions for global customers, which has paid dividends for the company."

Simply put, VisualSoft used the technology components (or products) it developed to deliver solutions to customers.

Other companies like the Bangalore-based Sonata Software (which focuses on the banking, finance and insurance segment) have not delivered on the initial promise they showed.

Sonata has blue-chip clients (Franklin Templeton, for example) and despite being an early starter in the banking, finance and insurance segment revenues have dropped, from Rs 174.35 crore in 1999-2000 to Rs 83.43 crore in 2002-2003. Net profits too have tumbled during the three year period, from Rs 23.40 crore to Rs 15.58 crore.

Sonata executives could not be reached for comment but one explanation for its performance could be the bursting of the tech bubble. It earlier used to develop products and was involved in ecommerce applications and solutions.

But after the tech meltdown, Sonata had to exit these areas and it now is a pure play software engineering services provider. The company is trying to cash in on the slight recovery in tech spending across the world.

Notes Partha Iyengar, vice president, research, at Gartner India, the Indian arm of the global IT data tracking company: "Niche players can grow, but the moment they start expanding their portfolio of services to mirror the larger players, they go out of reckoning. They just cannot compete with the bigger names purely because of the size and scale of operations of the bigger players."

Quite simply, it's pointless trying to take on the big boys who have a presence in every area of the industry.

Yet it is easy to cite the examples of a few niche companies that have not exactly flourished and jump to the conclusion that being in a niche business is a mug's game. Some niche companies have, indeed, prospered.

Take, for example, the Bangalore-based Sasken which operates in the telecom segment and focuses on the wireless business. The company stuck to its core strength.

Even though the global telecom market went through turmoil, Sasken's revenues didn't tumble. They grew, even if modestly, from $ 22.89 million in 2000-2001 to $23.43 million in 2002-2003.

Says G.Venkatesh, head of strategy at Sasken: "If some of the other focused companies are not growing, it only means that they are probably not well differentiated from the competition. In Sasken's case, the focus on the telecom sector, and on the wireless access space, has helped it immensely in creating a strong differentiation, leading to it winning several significant tier 1 customers in the last two years."

Indeed, if there's one thing that software industry veterans are agreed on, it is that simply operating in a niche business is not enough.

Says Sridhar Mitta, managing director, e4e Labs, the $100 million technology holding company: "It is very important to have a substantial differentiator. If that is not there, you are reduced to an also-ran."

Adds Krishnakumar Natarajan, president and CEO, IT services, at the Bangalore-based MindTree Consulting: "Mid-sized companies that are able to differentiate themselves and offer significant value to customers are seeing good growth."

Inevitably, some niche companies claim that their very focus on business segments is what makes them stand out from the crowd. Says Govind Singhal, executive director at Polaris Software: "Polaris' laser-sharp focus on the banking, financial services and insurance sector has been its differentiator and has helped the organisation carve a niche for itself in the global IT solutions marketplace."

Still, for a company to differentiate itself from the competition is easier said than done. For as long as the going was good, no Indian company bothered about being different. Cloning your rival's business model was the safest ticket to success.

The 2000 tech slowdown in the US changed everything. Demand for software dried up. Suddenly, every company, big and small, claimed to offer the same services. So branding became imperative. And building a brand is dependent on how different you are from your competitor.

"In 2000, everyone claimed to be in every business segment and vertical (software industry jargon for offering services or software products to a particular industry). The slowdown ensured that companies like Tata Consultancy Services, Infosys, Wipro and Satyam differentiated themselves from the rest through the sheer size of their operations. The rest were left groping to define themselves," Mitta points out.

Yet the smaller companies tried to differentiate themselves by restricting their operations to fewer segments. The gambit didn't always work.

Agrees Anant R Koppar, chairman and managing director of the Bangalore-based Kshema Technologies, a company that built a reputation for executing work for customers in the telecom space.

"Companies that are focusing on niche segments did indeed have tremendous problems in the recent past. The top five companies in India have more or less dominated the banking, finance and insurance segment. So other companies need choose and develop their niche segments after much deliberation."

Kshema is focussing on healthcare, life sciences and industrial automation, all of which involve a lot of embedded software. "These are the industries where we see tremendous growth potential. Along with the industry we will surely grow," Koppar argues.

To be sure, some in the industry think that niche companies have not yet had their day in the sun but will soon do so, because the software universe is about to undergo tectonic changes. Reason? The smaller and mid-sized US companies will resort to offshoring and outsourcing.

Says Anand Sudarshan, CEO at Netkraft, the Bangalore-based company that focuses on the retail and healthcare segments: "I expect 2004 and 2005 to be years where niche players will blossom."

Sudarshan cites industry analysts who state that offshoring will be extended to mid-sized companies, particularly in the US, and to industry segments other than banking, finance and insurance and telecom.

"These companies will also look keenly at vendors who are able to offer them attention and add value," adds he.

MindTree's Natarajan backs the point: "In this wave of outsourcing, a number of companies that have not been exposed to outsourcing would like to work with service companies that are agile and are able to provide attention and have the ability to work in a partnership. So this is the right time for focused software services companies to accelerate their growth."

What is more, some US-based niche companies want relationships only with niche companies in India.

Says M.K.Padmanabhan, president of Plexion Technologies, a company that focuses on high end engineering services for automotive, aerospace and manufacturing companies: "A few specialised niche players always want niche, focussed partners. In fact, I have heard a number of customers saying, 'In India everyone says they can do everything under a single umbrella!'

True enough. But all this suggests that the fate of niche Indian companies will hinge on whether mid-level companies in the US start offshoring and outsourcing, rather than on them offering a compelling proposition.

"To make the latter happen one would need to invest heavily in sales and marketing and the costs are prohibitive," notes Mitta.

According to Mitta, a boutique company would need to shell out $500,000 per annum just to hire two top sales and marketing professionals. At more than Rs 2 crore per annum, that is a lot of money for small companies.

Last but not least, if niche companies are to grow, they have to do four things "� have a stable big client, bring on board as many clients that sign on for a year as possible, instead of working on just single projects, focus on two or three domains or allied domains, and finally have no cash flow or reserves problems.

Says an executive at a Chennai-based leading software company: "Mid-tier companies that just about beat the recession had a single big relationship with a stable customer in the US. Digital had Compaq, Polaris had Citibank, I-flex had Citibank. Cognizant had support from its parent Dun & Bradstreet and Patni had GE. This helped them ride out the tough times.''

But most Indian niche companies have just managed to do one of these four things, that is, focus on two or three niche businesses.

The problem, of course, is that these often are areas in which the big five also operate. So the gambit isn't working unless the niche companies are really different from the big boys.

If they're not different, expect India's big IT companies to snap them up to acquire even more for scale and size. Gartner's Iyengar sums it best.

"We expect further consolidation. In the next 12-18 months we see a tremendous amount of mergers and acquisitions in the software services industry and there is no scope for new entrants."

Additional reporting by Raghuvir Badrinath in Bangalore and Vasanth Kumar in Hyderabad