Mar 29, 2016
If you have been to the Bangalore-based Electronics City headquarters of Infosys over years, there's something reflective about this visit. The corner room from where you half expect founder and former chairman N.R. Narayana Murthy to walk out, is now occupied by the company's first non-founder CEO, 48-year old Vishal Sikka. Nandan Nilekani's - and later Kris Gopalakrishnan and S.D. Shibulal's - room next door now has the Buddhaesque calmness of COO U.V. Pravin Rao.
Neither the interiors nor the rust-coloured upholstery in these haloed corridors has changed in more than a decade, but the $8.7 billion Infosys is being forced to change - rather RAPIDLY. First, by the widespread disruption of the IT services model by digital, cloud and Internet of Things that is debilitating Indian majors; and second, by the burly CEO & MD of 19 months, Vishal Sikka himself.
Splitting his time between San Francisco (where he continues to live), Bangalore and the rest of the world, Sikka has given Infosys a new 2020 goal and introduced fundamental changes to the company's structure, its work culture and its performance. Freshly promoted executive vice presidents have infused a new sense of urgency and informality. For a change, you can wear jeans on the campus, though only on Fridays. For the first time in five years, Infosys may have a realistic shot at regaining its bellwether status in the Indian IT services industry. And the stock market values Infosys 46 per cent higher than it did on the day Sikka's appointment was announced.
Shaking Up Infosys
One of Sikka's earliest moves was to overhaul the organisational structure. Instead of the industry-oriented SBU structure (where verticals are independently responsible for sales and delivery) that the Indian IT services industry now swears by, he consolidated delivery for greater economies of scale and then federated it to industry verticals. In a way, Infosys reverted to the age-old model that the industry followed up until five-seven years ago (the jury's still out on this move).
Then, he gave Infosys a purpose-a 2020 goal to achieve $20 billion ($8.7 billion currently) in revenue at 30 per cent net margin (23 per cent) and revenue per employee of $80,000 ($49,000). To achieve that, he showed them direction: automate and make software do what humans did before; embrace Design Thinking to find solutions to clients' ticklish problems; build artificial intelligence tools for revenue productivity; understand and work closely with clients so as to maintain 'zero distance'; and, among others, an unheard of concept of 'zero bench' by deploying the bench on short or internal projects for productive utilisation of employee skills.
The skills that he thought Infosys lacked were plugged by a spate of four specialist investments/acquisitions totaling $392 million since August 2014. "There was no Infosys story till about a year and a half back. At an extreme, you can say it's a marketing gimmick, but Sikka has given Infosys a story to take to the market," says Pankaj Kapoor, Director, JM Financial Institutional Equities.
The Booster Dose
The results have been instantaneous. In the past few quarters, while industry leader TCS's quarterly YoY revenue growth has slowed from 11 per cent in March, 2015 to 5.5 per cent in December, 2015, Infosys's has shot up from 3.2 to 8.5 per cent, next only to Cognizant's 20-odd.
Analysts, however, don't believe all of this is Sikka's doing. Some point to the uncanny similarities between Sikka's moves and the 'Infosys 3.0' strategy articulated by predecessor S.D. Shibulal who ran Infosys as CEO between May 2011 and July 2014. But given the pace of digital disruption during his tenure, Shibulal may have been the right man in the right place at the wrong time. Infosys 3.0 focused on emerging technologies such as software products and platforms, cloud computing and mobility to garner one-third of Infosys revenues in three to five years but failed in its objectives.
Some of the improvement may have been due to the initiatives taken under Mr Murthy's management, says Pankaj Kapoor of JM Financial Institutional Equities.
"Over six-eight quarters, you would notice that the improvement is almost immediately after Vishal Sikka took over. Obviously, you can't conclude that he was the cause of that because he was barely there for a few months," says the director of a Mumbai-based equity research firm. "There was a momentum anyway in Infosys's favour for whatever reason?for something the previous management did or the environment was changing or some client dynamics changed," he adds.
What nobody disputes, though, is that Sikka has put his stamp on Infosys. Infosys had three main issues before Vishal Sikka. First, it had lost the sales focus after it lost a few key people; two, it was in a vicious cycle with deteriorating employee morale; three, it became too conservative and worked as if technology hadn't changed. "Vishal has achieved some progress, more on one and two. Three is debatable. He has changed the thinking internally, but taken it to the other extreme," says the director of an euity research firm. "His view is that technology, artificial intelligence and automation can solve all problems, which I am a bit sceptical about but the jury is out on that."
According to Arvind Ramnani, Managing Director at US-based Gordon Haskett Research Advisors, who spoke with several current and former executives of Infosys: "(It) has newfound respect in the market. Before Sikka came in, there was a lot of confusion. Infosys had lost its direction. Now, everyone is clear where the company is headed. Some don't necessarily like (it), they've had differences and there have been exits."
Even before Sikka joined, 13 from senior management had quit. Since he joined, some five vice presidents and above have quit. They have been replaced by 18 executives from SAP, the previous employer with whom Sikka built his reputation as a can-do executive by building SAP HANA, a real-time analytics platform. Such inflow of SAP executives has observers alleging a 'clanish' style. "There could be friction. After exits, a lot of people got elevated to the EVP roles. Their elevation has been accelerated and they may not have the experience. These are some of the flashpoints," says an analyst. Mohandas Pai, an Infosys veteran of 17 years and its former CFO says, "A lot of good people have left. He has to carry the whole team together."
The Statis Years
Where Infosys stands today is a far cry from its golden era when it was the industry bellwether with a spunky growth and a fat margin. Just a decade ago, in 2006/07, Infosys's topline was growing at an industry leading 45.9 per cent against Wipro's 41.7 and TCS's 40.9 (see graphic on page 54). In 2014/15, it was a laggard at 6.4, 8.1 and 15.7 per cent respectively. In 2006/07, its net profit was growing at an unbelievable 55.7 per cent versus just 16 per cent last fiscal (see graphic given above).
But sometime after the US-led economic meltdown of 2008, in the last two years of Kris Gopalakrishnan's tenure as CEO, Infosys's growth plummeted from 30 per cent in 2008/09 to 4.8 per cent in 2009/10. TCS too dropped from 23 to 8 per cent but recovered to 24 per cent the following year. Infosys could only get back to 20 per cent.
The IT industry was faced with the precarious transition to digital, automation, cloud, analytics, social media, IoT and robotics. Its sweeping changes caught every Indian IT services firm off-guard.
During S.D. Shibulal's tenure as CEO (2011-14), the role of IT services firms had pivoted from cost saving to revenue driver. The Indian model of labour cost arbitrage went through a nightmarish price erosion. Particularly, the legacy business of software implementation as businesses moved from the premises model to the cloud. Infosys and all its peers faced an existential dilemma. "Most Indian IT majors had modest penetration of tech in their own organisations, even if they were handling technology for global majors," says Abhishek Shindadkar, IT Analyst, ICICI Securities.
"Indian IT services firms are bottom (of the market) leaders. It's very difficult for companies at the bottom to change track. One is a body shop, one is a very low-cost player, another hasn't been able to make any major change to its business model," says Mohandas Pai, former CFO and board member of Infosys.
Recollecting his first brush with Infosys executives in the midst of this disintermediation, Sikka says, "I noticed both in Infosys and in the industry the lack of confidence. Primary feedback from clients used to be that (Infosys was not) being pro-active, innovative, coming up with own ideas".
Infosys was suddenly on the wrong side of history. By 2014, it was growing at barely one-seventh its peak rate of the past decade; profits at less than half. Between October 2014 and September 2015, TCS and Cognizant added $1.5 billion and $2 billion to topline, more than twice that added by Infosys and Wipro. In the past 12 months, Cognizant has overtaken both Infosys and Wipro in quarterly revenue. Its annual revenue is $3 billion more than Infosys's. Perhaps, this stasis was self-inflicted. "The board is to be blamed for prolonging the CEO merry-go-round. The joint CEO strategy also failed - as it did in the case of Wipro," says an IT analyst who didn't want to be named.
The Infosys Moonshot
Sikka is hungry. Very hungry. Events during the week-long stopover at Bangalore are running late as he arrives an hour behind schedule for our lunch meeting in his trademark round neck T-shirt. "I eat local cuisine wherever I am," says Sikka, as he digs into chicken, rice and dal while laying down his strategy.
In the midst of gloom and doom, he needed to focus the organisation towards a goal. So he came up with the target to achieve $20 billion ($8.7 billion in 2014/15) in revenue by 2020 at $80,000 per employee and a net margin of 30 per cent (by all accounts more than half of IT firms in India have net margins of less than 5 per cent). "It's very challenging to increase all these three components simultaneously: a) revenue growth rates; b) margins, and c) utilisation," says Ramnani. "There is an assumption of 50 per cent revenue productivity. It is unclear how Infosys can see such a significant lift." Infosys's revenue per employee stood at Rs 49,442 at the end of 2014/15. In comparison, TCS was at Rs 48,346, Cognizant at Rs 56,094 and Wipro at Rs 47,631.
A former Infosys board member believes it's an impossible task. However, Infosys chairman R.Seshasayee is convinced these are achievable targets. "If you look at the history of this company and the CAGR that has been achieved till 2010, and relay that to the target CAGR, it is well within reach," says Seshasayee.
On his part, Sikka says he's not married to the targets. "I'll be delighted if we achieve those. But I will be happy if we get close to those." Pravin Rao says, "$20 billion is most critical, but if it's Rs 60-65,000 per employee revenue we are happy." Surely, it's not headed that way. Quarterly revenue per employee has fallen from $13,306 in his first quarter as CEO to $12,446 today. Over a 10-year period, the IT services industry's revenue per employee has fallen 10 per cent (largely because the revenue mix has shifted from onsite to offshore).
Seshasayee outlines the three goals set by Sikka and the board: to get back to industry-leading growth; to recalibrate the pace of growth to be able to achieve that; and, to ensure that such growth is sustainable on a long-term basis. "30 per cent net margin is an aspirational target. You have to give something internally to aspire to," says Kapoor of JM Financial.
The biggest thrust is on revenue productivity, says Pravin Rao. "If we are able to hit our aspirational $80,000 per employee, the margin will automatically happen. Automation is the biggest lever and we can do it over 2-5 years but if we are able to operate at 85 instead of 82 per cent that itself will improve revenue productivity to $60000. If we do more in consulting and some of the newer technologies...," says Rao.
Heterogeneity in Homogeneity
Before you consider this the apotheosis of Vishal Sikka, consider the ground reality. The widespread scepticism around Infosys's targets emanates from the homogeneous narrative running through the industry, including Infosys: automation; artificial intelligence; robotics, IoT, social, cloud or analytics.
Change the nomenclature here and there, but the overarching narrative isn't vastly different. If Infosys's AI offering is deliberately Japanese-sounding AiKiDo, Wipro has Holmes and TCS has Ignio. If Infosys has an innovation fund to fund start-ups, so do TCS, Cognizant and Wipro in some form or the other. "All IT services companies are trying to do the same thing. If everybody is doing the same thing you (don't have) 30 per cent margins left on the table," says an equity research firms director.
Conceptually, the Sikka strategy is not vastly different from Shibulal's, though he may have articulated it better. Nor is Infosys aiming to be a software products company. His 'services-only' model is aimed at embracing today's buzzing technologies rapidly, enhancing employee productivity and training employees to innovate harder. And that's worrying analysts who cannot fathom how this model differentiates from peers. "He's provided the market a very ambitious 2020 target but he has not provided the operational roadmap to see the aggressive growth required to realise those targets," says Ramnani. "From the investor perspective it's not a believable number, particularly with the US and Europe investor base. Infosys is unlikely to deliver $20 billion in annual revenue by 2020."
You could argue that the IT services firms offered little differentiation anyways. But Sikka explains that the narrative is homogeneous because his peer set has begun talking the 'Infy' language. "Before Vishal joined I don't think the IT industry in India was talking about AI, collaboration technologies, the way it's been talked," says Ritika Suri, Global Head of Corporate Development at Infosys.
Mohandas Pai contends that the real differentiator will be the execution. Seshasayee couldn't agree more: "Everybody will have the same narrative but the quality of execution and the differentiation that you can bring to the table as a result of the capacity you build internally is going to be far more telling to the client."
That hasn't doused the analyst scepticism. "Almost every company is talking digital but we know digital revenue is only about 6 per cent," says ICICI Securities' Abhishek Shindadkar. So how much of what is being talked about is for effect and how much is reality? "The discussion of artificial intelligence and automation is more for clients than anything for the markets or material impact on commercials," says JM Financials' Kapoor. "These companies are the same about 80-90 per cent. There is no uniqueness," says Kapoor.
"Though the narrative is the same across companies, probably, the belief in the narrative is a bit higher for Vishal Sikka," says the director of Mumbai equity research firm. He appears to be succeeding where Shibulal didn't because Sikka doesn't have to contend with Murthy's towering presence as 'executive chairman'. He is, perhaps, the first CEO to get a free hand other than Murthy himself. Also, as an outsider he could make drastic changes more dispassionately than an insider.
Don't forget he's leveraging his experience of products and innovation at SAP where, besides HANA, he was responsible for all of SAP's applications, cloud and technology solutions as the executive member of its board. Sikka also propounded the concept of 'timeless software' (reinventing products without customer disruption).
Discounting Offerings or Aggressive Pricing?
But what explains the current round of growth? In the Murthy era, and thereafter, Infosys developed a reputation for being stubborn on pricing and margins (around 30 per cent). Not any more. Rivals now bitterly complain that Infosys is aggressively undercutting. "Infosys has been aggressive on pricing. However, others in the industry (Accenture, Cognizant, TCS) are maintaining price discipline (i.e. not discounting aggressively)," says Ramnani of Gordon Haskett.
Whether that means Infosys is discounting offerings or resorting to "aggressive pricing" is anybody's guess. But Infosys pricing in Q3 shrank 1.5 per cent. Blended per capita revenue was down 2.5 per cent due to lower price realisation. As a result, the operating margins during the quarter fell from 25.5 per cent in Q2 to 24.9 per cent in Q3. "Margins were impacted due to the seasonality of price realisation that is typical of the third quarter," says Sikka in the Q3 results analyst call.
That suggests it was a quarter-specific phenomenon. But Infosys watchers do not agree. Based on the trend of the past few quarters, analysts believe that Infosys has taken a call to trade margin for growth. "In the last few years we were not aggressive enough on large deals. We were not flexible enough. We took the philosophy to price to win and then figure out how to make the margins we want over three to five years. In the past we were reluctant to do that," says Rao.
And that is THE biggest change in sales/marketing under Sikka. Perhaps, Sikka realises that he will be measured by the acceleration in revenue and how soon it's back to industry leading status. In the short to near term, though, Infosys will report compression in margins.
The Growth Drivers
If discounting is one trigger for growth, yet another trigger is Infosys doing the kind of business it hasn't done before. Recently, it signed a deal for predictive maintenance of turbines for GE. "We could do this because open source technologies have made it possible to do dramatically larger amounts of computing at cheap prices. The unit cost, the per project cost and the software costs have all dropped dramatically but the number of projects in this area is huge," explains Sikka.
Nasscom President R. Chandrashekhar believes 80 per cent of industry's growth in the next decade will come from digital. "Infosys was a people company. We will evolve into a software-plus-people company," says Ravi Kumar, the Gobal Head of Delivery. "We traded human effort. Now we are trading human effort without humans." Sikka says in the past quarter, Infosys saved 1,000 people worth of work through automation: "We have a simple objective: If a human has done something once, he should not have to do that again."
Then, there is a renewed focus on large deals. While Infosys's average win rate on large deals over 7-8 quarters was $500 million, in the past two quarters it was $800 million and nearly $1 billion, respectively.
Most large accounts stagnate because clients adopt a multi-vendor strategy to de-risk. Infosys has begun mining those by adding more sales people. "In zero distance, we come up with 30-40 new ideas. Even if five ideas get monetised, that's incremental revenue," says Rao. That's something Sikka calls the 'Renew' strategy. At one of the world's largest companies, the Infosys project manager had been deployed for 15 years. He reluctantly approached the client with a couple of ideas to improve productivity, which were accepted. "He said I never thought I could take an idea to the customer," says Rao.
'Renew', says Ritika Suri, is an "existing technology that can help us bring better operational efficiency, productivity through automation, artificial intelligence, natural language processing technologies". It began in a small way but may be gaining momentum. Not all ideas are breakthroughs. There is a value in incremental ideas.
Even Design Thinking workshops have been integrated into Infosys's Mysuru training campus. "We have the world's largest embrace of design thinking: 62,000 employees since October 30, 2014. Other companies talk about a thousad or so. Not just that, they watch a video. This is deeply experiential class where people make prototypes," says Sikka.
Conceptually, it's a workshop for unstructured innovation in identifying unknown problems. "Problem finding will be the next big opportunity rather than problem solving. We are ingraining that at the grassroot level," says Ravi Kumar.
The holy grail of services industry has always been to delink revenue growth from headcount. That's where automation - the other pillar of Sikka strategy - counts. But it's early days. Rao admits the benefits of automation may be visible only after two to five years. "Even in projects with 20-30 per cent productivity improvement, the number of people we may have released would be 15-20 per cent, not 30".
As Infosys moves towards what is paradoxically-named 'zero bench', attrition for 1.93 lakh employees fell further from 20 per cent in Q3, 2014/15 to 13.4 per cent in the past quarter. Utilisation including trainees was 74.2 per cent and 80.6 excluding trainees. Most IT services firms work at an employee utilisation of 78-82 per cent. Around 6-7 per cent are on leave or on training. The rest 8-12 per cent is bench, waiting for projects or transitioning between projects.
The Acquisition Binge
Investors in Indian IT firms have forever complained that they were hoarding cash on their balance sheets by neither rewarding the shareholders nor utilising it for inorganic growth. Infosys, with nearly Rs 30,367 crore in cash and bank balance, too, has been questioned. More so, after growth slowed down.
But that's changing. Even though Sikka says he has no interest in acquiring for size. Because, most firms espouse 'yesterday's technologies'. But what's that? "You know one, when you see one. Anything that continues with the previous generation way of doing things would classify as a past thing," explains Sikka.
For the first time, Infosys has a 'strategy' for acquisitions: niche technologies to plug gaps in portfolio. In February 2015, Infosys bought San Francisco-based Panaya, Inc. for $200 million to strengthen its automation offering. Two months later, its $500-million Innovation Fund took a $2-million minority stake in Airviz, a Carnegie Mellon University spinoff specialising in air quality monitoring over the cloud. That month, it also bought digital commerce firm Kallidus (which owns Skava, a mobile and digital commerce platform) for $120 million. In October, it bought Noah Consulting, an oil & gas information management consulting firm, for $70 million in cash.
That's a bill of $392 million. Yet, less than $60 million of the $500-million fund has been deployed as yet. What gives comfort to analysts is that Sikkas acquisitions are not at variance with his narrative.
The winds of change at Infosys may not be to everybody's liking. Infosys is growing faster, but less profitably. It is embracing new technology, but slowly. It is transforming employee morale, but in pockets. As Sikka quotes from one of his favourite books, Siddhartha by Hermann Hesse, knowledge can be communicated, not wisdom. At Infosys, the quest for that 'wisdom' is on.