For several years now, analysts have been predicting that the Indian information technology industry is set for a period of consolidation. It hasn’t happened yet.

Four large companies — Tata Consultancy Services (TCS), Infosys, Wipro and Satyam — have established themselves at the top. At the other end of the spectrum are scores of “mom-and-pop shops” subsisting on cut-price offerings and established business relationships. They may survive, but industry analysts don’t see much of a future for them.

According to a study by research firm IDC, while the market will continue to be dominated by large services firms that have the size and scale to deliver both raw infrastructure and business process expertise, smaller companies that build specific expertise in select vertical markets and even within specific business processes will also remain competitive. India Knowledge at Wharton spoke with IT firm managers and other experts to gauge the opportunities and threats confronting mid-tier IT companies as they plan the next phase of their growth.

Apart from the Crowd

The textbook prescription for a market like the current one is an intense phase of mergers and acquisitions that would result in one or more majors emerging. “A lot of people are talking about consolidation in the industry, but I don’t see it happening in a big way,” says Infosys head of global branding, Aditya Nath Jha. It is entirely possible that global companies will acquire Indian companies to gain scale in India, he adds, “But there is a lot of headroom for growth. There is space for everyone.”

That is “a dangerous view of the world” for Indian mid-tier IT companies, says Ravi Aron, senior fellow at Wharton’s Mack Center for Technological Innovation. “Yes, there is room to grow, but it is a great challenge to grow while preserving the revenue-per-employee metric” — or the money firms charge for man-hours spent on client projects.

In the current environment, Aron says that mid-tier IT firms need to build a “strategic differentiation” platform to retain their competitive edge over rivals. “As the company expands, and if it lacks a well-defined basis for strategic differentiation, you will increasingly see that it is forced to deliver more — quality, features and client-specific calibrations of project delivery — for less. This is what the company ‘pays’ to win over a client. The revenue-per-employee metric will at best remain flat and will usually decline as the company begins to scale up.”

It is dangerous for an IT company to let this metric slip, especially in an industry that is “expert labor intensive,” Aron notes. “In a downturn, or when faced with more competition as the IBMs and the Accentures scale up in India, companies will take severe hits to the bottom line. Mid-tier firms do not have the deep pockets of the big Indian IT majors to recalibrate and bounce back with new offerings. Room to grow exists for large companies like Wipro, Infosys and TCS, but that path requires very careful navigation for the middle tier.”

Atul Nishar, chairman of Hexaware, a typical mid-tier company which had revenues of $187 million in 2006, says that his company is working to create niche specialties for itself. “We have no ambition to be among the full-service big companies. We realize that the only way we can compete is by developing areas of excellence.” In the mid-1990s, IT firms focused on “body-shopping,” or placing their engineers at client sites, but Nishar says that is no longer a sustainable niche. He points out that despite a big rush for U.S. H1B visas, or work permits, the bigger demand these days is for “virtual software engineers” who can work for clients remotely from India.

“IT companies must move with the times,” says Nishar, who was chairman of Nasscom (National Association of Software and Service Companies) in 2000. At Hexaware, he has worked to develop a sharp focus on delivering IT solutions for clients in the airline industry, human resources, health care and the so-called “BFSI” space — banking, financial services and insurance.

Aron says Hexaware’s emphasis on its BFSI offerings may not be sufficient to differentiate it from others. “Wipro, Infosys and TCS all get significant revenues from BFSI,” he says. “For some of these companies, BFSI is the single largest industry segment.” An additional problem is that “banking” is too broadly defined. “It is important to define segments within banking, such as ‘testing of retail banking products’ or ‘business intelligence for high-volume retail transactions,'” Aron notes.

Meanwhile, competition is intensifying for mid-tier firms in the BFSI space. TCS has set up a strategic business unit called TCS Financial Solutions, to pitch its suite of financial products. “BFSI is TCS’s largest vertical, contributing 42% of our revenues of $4.3 billion in 2006-07,” says N.G. Subramaniam, president of TCS Financial Solutions. He adds that business volume in this segment is growing at an accelerated pace — 66% in the last fiscal year, compared with 50% in the prior year.

But according to Jha of Infosys, mid-tier companies like Hexaware that build niche specialties “may have a better chance of winning business.” Aron points to i-flex Solutions as one example. “i-flex is able to sell not just its products but also a host of value-added services as a result of its standing in its business segments,” he says. “They are not forced to make costly concessions to win deals.”

Hexaware’s plan — building niche excellence and specialization — “is the right way to go,” Aron says. “Access to larger deals characterized by greater complexity and risk — but also greater potential payoff for the software firm — is greatly diminished in the absence of strategic differentiation.”

Hexaware has relevant experience in managing large IT applications and providing high-value services around packaged enterprise applications such as SAP and PeopleSoft, but growing that plate of offerings is not easy. “It is a Herculean task to add a service line,” says Nishar. “In many [large] companies the management may not even know that a service line has been added.”

Aron agrees. “Sometimes, it is best not to add a service line. For some companies what may seem to be an inviting business target is actually a hidden opportunity cost.” A new service line that calls for senior management attention and marketing expenditure could distract the company from acquiring greater depth and excellence within an area, he says.

Small’s Virtues

Some mid-tier companies attempt to play up the virtues of being small. P. K. Sridharan, executive director at Hexaware, likens his firm’s strategy to the “We try harder” approach of car rental company Avis, with its emphasis on personal attention. “Would you rather be a company’s third client or its three-hundredth?” he asks.

Aron agrees that smaller firms could find a sweet spot for themselves with the Avis approach. “However, that test does not hold up quite so gracefully with larger deals,” he says. “In deals where the size exceeds $20 million or so, larger companies will be reluctant to go with a middle-tier firm over the short run,” because the smaller size of the firm will act as a “risk amplifier.”

To bridge that gap, mid-tier companies should focus on gaining access to the CXO suites at prospective client companies, according to Aron. The big deals are not negotiated by those reporting to chief technology officers or chief information officers at prospective client companies, but CXO-level officers, or heads of strategic business, he says. “Without such access, it is difficult to get in as a principal on big deals. The middle-tier firm might well be in on a deal, but somebody else — a large IT player or consulting firm — would end up being the mid-wife, thus forcing the middle-tier firm toward the less revenue-laden projects within the deal.” Visibility is not the only key with senior executives, he adds: Mid-tier firms must also be able to stake out a strength that is of business relevance.

Some mid-tier companies have adopted partnering as a strategic route to enhance their credibility and bring in more business. Ashank Desai, chairman and co-founder of Mastek, says his firm markets itself through alliances. “Partnerships are key to our approach,” he says. The company has alliances with Capita (the largest BPO in the U.K.), British Telecom and French energy major Areva, among others. More than half of the company’s business comes from partnership-driven projects.

Other mid-tier companies have extended their global network by setting up overseas offices, especially in locations where they have clients. “The key is to have global reach,” says Chennai-based Chandra Sekaran, managing director and executive vice president of Cognizant. Expanding the company’s “footprint in other areas makes good business sense.”

Smaller firms have also taken a cue from their larger counterparts and are increasing their global reach through acquisitions. For instance, i-flex has taken over Mantas, a software company based in Herndon, Va., and BPO firm Equinox of Irvine, Calif., among others. Last November, Hexaware acquired FocusFrame, a Mountain View, Calif.-based firm that specializes in automated testing of ERP (enterprise resource planning) and custom applications. The firm’s Mexico center is being developed as Hexaware’s sixth global delivery center.

Aron has studied i-flex’s Equinox acquisition in detail. “That takeover is an example of a very savvy triple-play,” he says. “One, Equinox offers a natural extension to i-flex competencies; two, Equinox has well-defined competencies in combining technology and expert human intervention in ‘predictive analytics’; and three, the combined service solves several closely related business needs for clients, especially in retail financial services.”

Targeting Clients

Unlike IBM or Microsoft, India’s big IT companies maintain fairly low profiles when it comes to mass media or even niche market advertising. For Jessie Paul, chief marketing officer at Wipro, that makes perfect sense. “At Wipro, our marketing would best be described as lean and zero-waste. It is important to target your clients, so we put our efforts into identifying the decision-makers and influencers in our eco-system. If we broadly define Fortune 1000 companies as our audience and assume that we need to reach 5-10 people per company, it narrows down our target audience to 10,000.”

Srikant Sastri, managing director of Solutions, a marketing services firm that helps technology companies enter South Asian markets, says it is “a level playing field” where “even the bigger IT firms are weak on marketing.” He says that larger firms might do “one big marketing initiative — such as a sponsorship — and some customer seminars, but very little genuine mainline marketing” compared to U.S. firms like Accenture. “The big firms are still riding the India wave, and are backing it with strong sales efforts,” he says. “So, for a smaller firm like Hexaware, some smart marketing can actually provide a cutting edge and brand equity.”

Jha points to another reason for the industry’s preference for narrowly focused marketing: “For Indian IT companies, 90% of revenues come from existing clients,” he says. “So, our principal task is to market into and mine existing clients.”

Media stories on Indian IT companies also help, says Jha. “For every cover story in BusinessWeek or Fortune, there will be a CEO asking: ‘Where is our India strategy?'” The major IT firms also nurture relationships with analysts at research firms like Gartner or IDC. Jha adds that Infosys also participates in major business events including the annual World Economic Forum (WEF) at Davos, the Microsoft CEO summit and the Fortune CEO Strategy Summit.

Aron sees all those marketing strategies as critical for targeting the CXO suite in client companies. “This is what the management consulting firms — McKinsey, Bain and BCG — excel at,” he says. “Participating in forums like the WEF is a powerful way of reaching the C-suite decision makers. The attention and credibility that participating in these forums brings is priceless.”

To enhance their client networks, both large and middle-tier firms have begun sponsoring events that combine work with pleasure. Hexaware, for instance, throws a three-day, all-expenses-paid party in the U.S., inviting its customers from all over the world. “We bring our clients together so that they can share notes,” says Nishar. “If we have goofed in one case, everybody will come to know of it. If we have done well, they will know that too.” Besides golf and other activities, Hexaware’s events also feature speakers such as management pundit Tom Peters and technology thought leader Nicholas Negroponte.

The format varies by company: Jha notes that Infosys stopped paying all client expenses for its annual event a couple of years ago. “The reason why we asked clients to pay is that it is a measure of their commitment,” he says. It had to change one other feature of the event, too — its name. Infosys used to call it “Milan,” which in Hindi means “getting together,” before it realized that people confused the name with the Italian city. It is now more appropriately called “Confluence.”