Firstsource Solutions, India’s third-largest pure-play business process outsourcing (BPO) company, has always been slightly ahead of the curve. When every BPO outfit in the country was selling on the basis of cost arbitrage, Firstsource was busy buying or setting up centers abroad. When others were tapping the apparently evergreen banking, financial services and insurance segment, Firstsource foresaw the pitfalls of relying on a single vertical, and diversified into health care. And today it has a first-mover’s advantage in the domestic BPO business.

According to the Financial Times foreign direct investment market index, Firstsource is the largest foreign investor in the United Kingdom in the contact center and shared services sector, and has created more jobs in that sector than any other Indian company over the last three years. Firstsource’s two U.K. offices (Londonderry and Belfast) have become centers of excellence for the telecommunications and media industries. Firstsource also has centers in Manila, Buenos Aires and more than a dozen U.S. cities.

But the sailing hasn’t been completely smooth the last couple of years, largely because of the global economic slowdown. Critics have ascribed falling margins to company strategy. But CEO and managing director Ananda Mukerji says he believes that the company has positioned itself well overall, and that its prospects are good for serving the U.S. health care market.

An edited transcript of an interview with Mukerji follows:

Knowledge at Wharton: You are the number-three pure-play business process outsourcing (BPO) company in India. But Wipro and TCS, which are adjuncts of IT companies, are larger. Does it help to have a parent with whom you can share synergies?

Ananda Mukerji: It certainly always helps to be able to share synergies with a parent or, for that matter, with anyone. The main “synergy” benefit of BPO plays that are adjuncts of large IT companies is their ability to leverage the existing relationships which these companies have built over decades as a source of new business. Pure-play BPO companies have had to start from scratch. But the market opportunity is sufficiently large, and we believe both categories of players will do well in this industry. If one looks at the top 10 BPO companies in India, they include both pure-play BPO companies and IT-BPO players.

Knowledge at Wharton: A lot of people believe that an integrated IT-BPO offering is the way of the future. Do you believe that, and what is your strategy in developing IT capabilities?

Mukerji: I believe technology will play an increased role in the service delivery proposition of BPO companies. I see more and more technology being embedded in the offering whether it is in the form of proprietary “platform-based” BPO offerings or use of tools and applications which sit on top of client applications. For example, most of our transaction processing is done on our own proprietary work-flow management system called Sympraxis or our proprietary CRM system i-Leverage, which today almost a dozen of our customers are using to manage their customer interaction. We therefore need to have strong IT capabilities in-house to develop and deliver these solutions.

However, what I see as less relevant to our service proposition is actually being able to offer IT services, i.e. applications development and maintenance services, as a necessary part of our service offering. There will be some “integrated” deal where the two pieces of business are combined as a single offering, but most companies do [see] it as separate requirements and look for best-in-class service providers for both. This is particularly so in the industry vertical space we are mainly in. Frankly, we are unlikely to be able to compete effectively with the large established IT players for IT services business but can certainly hold our own for BPO services.

Knowledge at Wharton: Your own parent, the ICICI Bank group, still has a 26% stake in your company. There have been rumors that it is planning to sell its stake. Will it affect you in any way if that happens? What sort of hand-holding did ICICI do in the initial days?

Mukerji: Having ICICI Bank as the promoter certainly helped in the initial days as it gave us a great brand to start with and financial stability. However, we have over the years established our own brand and for the past three years no longer carry the “ICICI” brand in our company name. Right from the start we were set up as an independent BPO company with its own board and management team and looked for third-party clients. It is a common misconception that we were set up as an ICICI Bank captive; in reality, at no point did we derive more than 2% of revenue from work we did for the bank and its subsidiaries. ICICI has also reduced its holding in the company progressively from the 100% it owned initially to now 26%. The company is now listed and fairly widely held with a very strong board of directors, so I do not see any shareholding change affecting it.

Knowledge at Wharton: Unlike most of your competitors, you have set up very large operations in the United States and the United Kingdom. First, can you take us through your organic and inorganic growth abroad? Second, how is it helping you? Isn’t this business about labor arbitrage?

Mukerji: When we first started the company we, like most of our peers, viewed the Industry through the “offshore delivery” lens, and our vision was to be a leading BPO company in India. Over the next few years we realized what should have been obvious to us, that this is a very global industry and our customers look at this business globally as well. They want business partners who can deliver services to them across multiple geographies and give them a range of options across the spectrum of price, quality, experience and so on.

So, to view ourselves as an “offshore BPO company” to us seemed self-limiting and eventually possibly self-defeating. We therefore then embarked on our journey to set up a global delivery footprint. Our base and the majority of our delivery and the distinctive value proposition we deliver emanates from India, but we can provide the same value proposition across many different delivery locations. Today we have 26,432 employees — 20,890 employees based in India and 5,542 employees spread across the U.K., the U.S., the Philippines and Argentina. We have over 25 operations centers in India, two in the U.K., over a dozen in the U.S., and one each in the Philippines and Argentina.

Some of this has happened through acquisitions, particularly in areas like credit card collections, health care claims adjudication and revenue cycle management for the health care provider industry. These acquisitions have given us new capabilities which we could not have acquired, either organically or through acquisitions in India. We have, however, also set up greenfield centers in the U.K. and the U.S. and have also taken over clients’ captive delivery centers. Interestingly, the greenfield operations have often been set up at clients’ requests because they wanted us to deliver the same value proposition we do in India in operations in the U.K. and the U.S. So, no, this business is certainly not just about labor arbitrage.

Knowledge at Wharton: You are an early player in the Indian domestic BPO market. Today 12% of your revenue comes from it. Aren’t you worried about compromising margins and lowering profitability?

Mukerji: I would rather pose the counter-question: Can I afford to sacrifice a huge growth opportunity by becoming a prisoner of the margin mind-set? On the one hand, analysts accuse Indian IT services companies of leaving the domestic IT services market wide open for multinationals to capture. Yet when we try to avoid that mistake, we are pilloried by the markets for sacrificing margins.

Clearly, price points are lower in this market, and the operating model therefore has to be different. There is obviously no “labor arbitrage” proposition here, so the value proposition itself has to be much stronger. Margins at this point are certainly lower in this market than in the international markets. But we expect the margins to catch up as the range of services we offer in this market grows and expands and our operating model gets fine-tuned. We also see this as the base from which we can grow our business into other emerging markets. With 20% of the world’s GDP expected to come from emerging markets, it is a very exciting business opportunity.

Knowledge at Wharton: Your Asia business has been consolidated into a strategic business unit. Your other SBUs are the verticals — banking, financial services and insurance (BFSI); health care; and telecom and media. Why is there this special treatment for Asia?

Mukerji: The logic for the international business being organized into industry verticals is because the customer needs and value proposition we offer to them are very different in different industries. In India, however, while there are of course differences across industries, the bigger factor which cuts across industries is the level of maturity of our customers, the nature of our engagement with them, and the operating model. These are very different from our international customers and, given that, it is more logical for us to treat this geography as a single SBU. We, of course, do try to ensure sharing of industry knowledge and expertise between our industry verticals and the Asia business unit.

Knowledge at Wharton: You seem to have gone more toward the vertical market space instead of developing horizontal offerings like most BPO players. Can you explain the strategy?

Mukerji: The India-based BPO companies are relatively recent entrants into the global BPO market, which has been around for many decades. The horizontal spaces such as finance and accounting and HR outsourcing were already mature industry segments dominated by very large players like IBM, EDS and Accenture. We felt it would be a lot more difficult for us to establish a strong and differentiated proposition in this area, particularly for the large outsourcing deals. We therefore decided to specialize and create vertical industry domain expertise and build our proposition in that segment of the market.

In our business, domain expertise is key, and one needs to understand the industry dynamics of our customers. Hence there is a strong need to specialize. The verticals evolved over time for us and today we focus on three industry verticals — health care, telecom and media, and BFSI. These are a fairly significant part of the overall market with an addressable BPO opportunity of around US$200 billion, so we think we have the right balance between a large enough market opportunity and specialization. We have created the right organizational structure for this so as to ensure there is appropriate focus on our customer’s business and on constantly developing and refining our own service proposition to meet our customer’s changing requirements.


Knowledge at Wharton: Your emphasis on health care, while your competitors concentrated on the apparently evergreen BFSI, is paying dividends today. What was the thinking behind this strategy, which you embarked on even before the global financial sector collapse?

Mukerji: We had actually identified the health care industry as a vertical we wanted to enter way back in early 2004. It is a very large industry — In 2009 the U.S. is expected to spend $2.5 trillion on health care, which is 17.6% of the U.S. GDP — with huge inefficiencies. It has a high number of customer touch points and multiple transactions per customer. It is also prey to legacy IT systems and is paper-intensive. All these factors make it an attractive business opportunity for the BPO industry. In addition, it is relatively immune to at least normal business cycles. In fact, it has always been a matter of surprise to me as to why other companies did not see it as an opportunity, but I am not complaining. We first entered the payer side of the business and built relationships with the large private heath insurance companies and provided claims processing and claims adjudication services, and then expanded into the provider side with the MedAssist acquisition.

Today, we are clearly very strongly placed in that market with experience on both the payer and provider side. With the U.S. poised to effect health care reform, with a focus on increasing coverage and lowering costs, we expect both factors to drive increased outsourcing. We believe we are extremely well poised to take advantage of this opportunity.

Knowledge at Wharton: There has been criticism that the $330 million you paid for MedAssist was far too much. Do you think you overpaid? How is the acquisition working out?

Mukerji: First, let me say that MedAssist, as the premier provider of revenue-cycle services to health care providers in the U.S., was highly sought-after. This interest was driven not only by MedAssist’s strong operational and financial performance, but also by the fact that they are uniquely positioned as a solid, platform company with a pan-American presence in a largely fragmented BPO sector.

When you factor in significant compound growth rates in the health care services industry, as well as our existing capabilities on the payer side, the acquisition of MedAssist was clearly the right strategic move on our part. Certainly no one could have predicted the historic economic downturn in the financial markets that occurred on the heels of the MedAssist acquisition and it is quite meaningless to look at acquisition prices on the basis of valuation multiples at a different point in the market cycle. At the point we made the acquisition, the asset was priced fairly based on the then-prevailing multiples.

Had we not done the acquisition, our strategic vision to diversify and to secure a significant stake in the growing health care industry would have been put on hold for at least two to three years. We have made significant progress since the acquisition. The company has been fully integrated. In fact, the erstwhile CEO of MedAssist is now the head of our health care vertical and we have a fully integrated service delivery platform. We have made investments in hiring people in sales and marketing and are seeing accelerated growth. We believe it was a solid investment at the right time that we believe will continue to provide a strong value in the years to come.

Knowledge at Wharton: You have made a big bet on the U.S. health care market. How do you see the prospects?

Mukerji: Our prospects are very positive relative to U.S. health care, both from a growth and market perspective. Through reform efforts underway in the U.S., we see a transformation happening in the health care industry that has given, and will continue to give, significant business opportunities.

We believe that both the payer and provider segments will be challenged to comply with new requirements resulting from reform, as well as the resultant cost-containment pressures. Furthermore, the race will be on to enroll as many people as possible into the new health care programs, and this must be accomplished in an efficient and cost-effective manner as our potential clients will look to do more with less.

We expect health care reform to positively impact growth potential on the provider side as more federal dollars are poured into state Medicaid programs. Currently, our health care vertical has spent considerable time and effort building the platform to capitalize on the anticipated reforms, both at the sales and operational levels. Firstsource is uniquely positioned in the market due to our long history of expertise on both the payer and provider sides, which allows us to bring solutions to both segments.

As the reform measures take shape, it is becoming clear that enrollment and claims-processing skill sets will be very important to the process. Firstsource is recognized across the U.S. as an expert in both of these areas.

Knowledge at Wharton: Your margins have declined over the past couple of years. Is this because of market conditions and do you see this recovering?

Mukerji: Our margins came down from 12.2% to 7.9% from FY07 to Q1 of FY09. The decline is a result of both the deteriorating external environment and investments being made in new business areas like the Asia business unit. The global slowdown affected our industry by reduced volume of work as our customers’ own business momentum slowed down. At the same time, the company also made strategic investments in building an India domestic proposition (Asia business unit) which we believe will be a key growth driver in coming years. We believe as the market stabilizes and some of our new investments in the Asia business unit get to steady state we should get back to our normal margin levels. Since Q3 of FY09 we have expanded our margins for three consecutive quarters now. In Q2 FY10, the operating margins recovered to 10%. We believe there is significant margin improvement opportunity and the improvement trajectory is on track.

Knowledge at Wharton: Your share price fell to less than 20 cents, though it has recovered to 70 cents since. Was there a crisis of confidence? What are you doing about it?

Mukerji: Well, those were the times when there was a broader crisis of confidence in the capital market. The overall near recessionary environment had resulted in negative sentiments in the global equity markets. At the same time, major developed economies’ being in recession had led to a negative mood in the market with respect to export-driven sectors — chiefly IT and BPO. We have also had some large institutional investors selling shares due to redemption pressure at their end, and that created additional selling pressure and negative sentiment on share price.

However, despite the challenging environment and stress, we have stayed on the path of consolidating our position as one of the leading BPO players in India and strengthening our position in the key markets. We have retained our ranking in the Nasscom list among the top BPO players in the industry. During FY09, total income grew by nearly 35%, and we continue to make profits and generate free cash. We continue to hire and have added 4,200 employees in FY2009. Our focus continues to be on performance and delivery, and as we improve our overall performance and once the market recovers, our share price should also improve.

Knowledge at Wharton: How are you dealing with the current downturn? What changes have you made to your business model?

Mukerji: At one level, like every other company, we focused on the existing customers and ensured that we delivered very good performance in these difficult times and also on improving efficiency and productivity. In some sense, this slowdown was a blessing in disguise as it did give us the breathing space to be able to focus internally and improve performance, which we had not had the bandwidth to focus on in the days of 60% annualized growth rates. More strategically, we decided to take advantage of a slow business period to do the major organizational restructuring which we needed to do to position ourselves for growth in the future. We fundamentally changed the way we operate by converting the company into four distinct business units, each with a business head responsible for both evolving the strategy for the business unit and also driving revenues and profits. This not only increases accountability but also makes us much more market-focused and responsive.

It is my belief that in the next wave of outsourcing, customers will be looking at domain-specialist BPO partners rather than generalists or horizontal service providers. Our new structure will be more suited to take on this challenge. As you well know, effecting organizational change of this magnitude takes tremendous planning and communication. The slowdown allowed us to focus on this.

Knowledge at Wharton: Nasscom has just estimated the growth of the domestic IT-BPO market at 21% in 2008-09, reaching $11 billion. It also says that the emerging markets and the Asia-Pacific region will grow at three times the rate in the United Kingdom and the United States. You seem to have your focus bang-on. Do you expect to do much better than your competitors?

Mukerji: We certainly believe we have made the right strategic moves and positioned ourselves well for the future. How we actually do will depend on how well we now execute our strategy and deliver on the ground.