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Grow-Buy-Sell: Maximising Enterprise Value-Fireside Chat with Dr. Ganesh Natarajan, Chairman-5F World & Mr. Douglas Land, Founder & MD-The Chesapeake Group

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Read the transcript of the discussion between Dr. Ganesh Natarajan, Chairman-5F World & Mr. Douglas Land, Founder & MD-The Chesapeake Group.

Ganesh: We’ve all seen in India the phenomenal growth of the IT Sector initially in the 90’s then it kind of tapered off, then we found a new vein of growth in terms of e-commerce, digital etc. And today of course, every company is either posing or is really a digital firm.
So, were do we think we are going? What is the real opportunity in the sector?

Doug: I love your use of the word posing in that question. Because indeed it has been fascinating to us to see so many of the companies we work with have re-branded themselves as digital, when indeed their still doing the exactly what they’ve done in the past.

But coming back to your question, kind of where we see it today? Essentially in the initial growth phases of the business you largely saw the benefit of labor arbitrage and resource availability driving the growth. India had incredible talent and they were able to provide that talent to global enterprises at a very reasonable price.

So those two factors alone, allow for 20 to 30 % annual growth with really very little impediments to stop that growth. I think what you’ve begun to see is that pure labor arbitrage – cost differential is no longer enough to sustain long-term growth in the industry. Firms really are beginning to have to focus on providing specific technological advances, technological specialties; again to combine with an amazing set of resources that are available here in India. There is no other place where the quantity of qualified, really spectacular technical resources are available. But cost differential is just not enough to drive the market anymore.

Ganesh: So what does that mean for mid-tier companies? If I were the CEO of a 200 to 400 million-dollar company, what should I worry about and where would I look at M&A or acquiring companies to really make me more successful in the long run?

Doug: Let me start of by saying, the premise to your question would petrify me. Being a mid-tier 3 to 500 million-dollar undifferentiated IT services company today, I think would be incredibly difficult. I think that the larger firms have gotten much better at really capturing full-market share from their clients. And there are dozens of really exciting smaller firms that are specialized in some of the new technologies. So, that middle market is an extraordinarily difficult place to be right now and I think those are the firms that are really going to need to change their model extensively in order to continue to perform. And I think that’s why I have seen a fair amount of M&A in this space and a fair amount of consolidation.

Looking at two large deals in the last few years with iGate getting taken out of the market and recently other firms of that size have decided to sell out because that is a very tough competitive market. If you are still in that space, I really believe the only way to maintain consistent growth and competitive advantage is to really pick some very specific areas where you’re going to be able to differentiate yourself from either some of the smaller who have specific technologies or specific technological advantages or the giant global SI’s, who really can provide full-service to your clients. That mid-market is probably the most challenging.

Ganesh: So Doug what I hear you say is that, if you’re a medium sized company, there is no point in doing M&A just for bulking up. But it’s probably good to do it either for a location advantage (if you want to enter a new territory) or definitely for a capability advantage if you are looking at a company which has a demonstrated capability in a specific space. So is that the way you should think about it?

Doug: Let me respond two ways. If you are looking to continue to grow and be relevant in the market, absolutely need to focus on some specialization. Either around some very specific industry verticals, because if you can become for instance very specialized around financial services so the clients actually come to you for solutions to their business problems, you can be a mid-size firm and be very successful.

Or if on the other hand, you have some very specific technological specialties around some of the new technologies; for instance, knowing how to leverage the cloud in a very business specific way can also be valuable. But I do want to give one other comment.

While I was somewhat negative on the generic mid-size space, we do know a few firms who are actually bulking up and becoming essentially cash cows. We kind of call them the widowed firms or the old maid firms. They have some very long-term clients and are able to maintain regular relationships with those clients. But they aren’t really growing, they aren’t moving into new technologies but by being incredibly tight with costs, they are able to generate decent cash flows and are actually going to generate decent cash returns over a period of time. They are kind of more in the harvesting or cash cow mode as opposed to leading technology.

Ganesh: Moving to the opportunity for the smaller firms. If I am running a 20 million-dollar company and I have some pretentions or some capabilities in digital, what is the path for the next five years to ensure that the company realizes value for the efforts put into the business?

Doug: Some of the most successful firms in that space are ones that have specialized almost completely. One of our clients, Model Matrix only focused around salesforce and AWS. So it was a cloud-based focused business with salesforce being their primary focus. And they essentially said “no” to most other business. Now they didn’t grow at 30 or 40 percent a year, but their specialization allowed them to be known in the market for what they did and they were able to command a premium pricing, which led to a very successful exit.

So that’s one direction. The other direction would be to really create a portfolio of services around new technology.

Ganesh: So how does Chesapeake work?

Doug: Again, coming back to some of my earlier comments, what we really look for is companies that have kind of laid out a fairly specific strategic plan and have been willing to execute on it, even when its little bit painful. Even when sometimes they go through some bumps in the road but then overcome them.

The one thing I will say is that we are finding that more successes come with companies that are willing to take on some outside capital. The reason being that it gives them a lot more flexibility in making strategic decisions rather than making decisions based in cash flows. Across the board, we’ve seen greater value being created with companies that have been willing to bring in a capital partner and use that capital to leverage their strategic advantage.

Ganesh: So if you’re to give one word of advice to a young entrepreneur who is looking at building enormous value over the next three years and has kind of built a successful company, what I hear you say is – choose to focus, make sure that you have a capital partner, and at some point of time you encourage them to buy more companies smaller than themselves or sell out entirely?

Doug: Both! The answer is that if there is a good strategic fit and there really is an opportunity to enhance the strategic direction that you’ve chosen, M&A is actually generally quite successful in building overall enterprise value.

Coming back to the earlier comment though, I wouldn’t do M&A just to bulk up for revenue. In my view that will only decrease the enterprise value. We represent a number of larger SIs in their acquisition program and those that are really disciplined are the ones that have been the most successful.

Ganesh: That’s very interesting. Do you think that as next few years, we will see a lot more transactions in the space? Young companies will start merging with larger companies and larger companies will actively seek more acquisitions?

Doug: The way Chesapeake looks at it; this is the third phase in the SI maturity market. It is going to be very rare that you are going to see the replication of companies’ like Infosys and Cognizant that started at 25 million and are at 5 billion revenues somewhat organically with M&A along the way. That is not what’s going to happen in today’s market.

That kind of organic growth is just not where this market is. This will result in significantly more consolidation and recognition that you really are often better creating strategic value together than just kind of continue on an organic path.

Ganesh: What I hear you say is that you are still positive about the opportunity for both the small and the medium companies in software and IT services?

Doug: Some of the mid-size companies that have created incredible enterprise value in the last three or four years. We’re seeing those firms commanding market topping prices. It is a little bit surprising to me right now seeing the value that is created if you are a focused operation. Again, on the other hand, for the undifferentiated or generic companies, it is very difficult to even find a buyer today.

However, we don’t know how long this market is going to maintain. This is looking like a little bit of cyclical high but this could last for quite some time because there is a demand for these new technology skills and there is still huge demand for real skills around digital transformation.
Ganesh: Thank you very much Doug. It was a pleasure talking to you.

So what we’ve heard Doug say is very interesting. On one hand he is saying that software services as a sector is changing and there is no pulling back the good old days where you could be a 25 million-dollar company and organically aspire to be a billion or two billion. So you have to take some positive actions.

I think his view is that if you’re a mid-tier company you could either decide to be just a cash flow generating company or you could be very significant to you customers in the digital market place. And for that, there is a value in looking at acquisitions.

His advice to larger companies is to look for the right dance partners who can actually take them into the world of digital.

For the smaller companies, I see a lot of positivism in what Doug has said. Smaller companies should either choose one segment to dominate or a small basket of services where they can create value for customers. They should look at strategic acquisition and not for bulking revenues. And beyond a point, to really release some of that value with their capital partners, they should may be consider selling or raising more funding etc. So I think it’s an interesting journey we are talking about. Clearly, Doug has shown with his wisdom that there is huge optimism in the sector, but I think all of us, people running small companies, medium companies will have to take the right steps. Look at capital raising, look at opportunities to buy and even sell as we grow and become successful companies in the industry.

Demystifying Digital to become Successful: Fireside Chat with Dr. Ganesh Natarajan & Mr. Ramesh Mirakhur

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Read the transcript of the discussion between Dr. Ganesh Natarajan, Chairman-5F World, Mr. Ramesh Mirakhur, Principal Consultant-Kalzoom Advisors

Ganesh: What are you hearing from your clients? I believe young companies are being told “no longer talk to the CIO but talk to the Chief Marketing Officer or the Chief of Supply Chain etc”. So, how are customer dynamics changing in the IT Sector?

Ramesh: If you look at the entrepreneurs in India who have set up IT Services companies; they have modeled themselves on the Big Six – Infosys, Wipro etc. These companies really grew up in the early 2000s where they built their model on whatever the customer told them. Initially smaller companies followed this success mantra. However, in the last few years, the sand is slipping from under their feet.

They are finding that customers believe that this model is old school. Furthermore, the CIOs are no longer controlling the larger part of the budgets. As a result, these companies are not seeing the same growth as their larger peers saw in the early years. This is confusing the young companies

Ganesh: A lot of stuff is being punched as digital, whether it is the cloud, mobility etc. Let’s say you have a client running a 200 crore company and he says in the next 500 crores, I want 90% to be digital. So where do they find the additional 300 crores? What strategies would you advise young companies to take to build successful digital businesses?

Ramesh: First of all, we tell our clients – look at where the budget is going. Is the budget is now going to the Chief Marketing Officers or the Chief Sales Officers and so on? So first of all, follow the budget! That’s a great way to build a business

Then, figure out what value can you provide to them. Let’s say, if one of our smaller clients is pitching to a medium-sized company, let’s say, a 500 million dollar company and then try to understand, what is the vertical segment they are in? Let’s say if they are a mid size insurance company. Then we advise them to understand what is changing in the insurance space? For example: The insurance sector is now going on “pay per use”. So, can you be ahead of the curve and help your client build a business model that addresses the “pay per use” insurance business. So you build a strong competency in the vertical space and help your clients address the entire gamut of the business from producing to selling and build your capability in a way that you get a very strong niche.

The other option is that you can really pick up a horizontal service. For example, you define the user experience. You become the leader in defining the user experience for your industry and then you will find companies mostly in that sector, but you’ll also find companies that learn from this, and say that we want to work with you because you are the ultimate guys in user experience or you are the analytics company.

Ganesh: So if I hear you right, you are saying, there are two opportunities for the 200 crore company to build the next 500 crores. One is to choose a very specific vertical domain and build a whole capability in digital for that domain. And the second option is to choose a core horizontal, build the best width and depth in terms of Technology, Expertise, and Consulting. Are you saying both are equally valid options?

Ramesh: Yes, both are equally valid options. You have to pick one of the two. Generally, we found that most of our companies being smaller, they can’t do both – they can’t be all things to all people. So if they pick one of these two strategies, it generally leads them to success.

Ganesh: That’s a great opportunity for young companies. But then tell me, I was hosting the CEO of one of the most successful digital companies – Globant, which is now 400 million dollar company trading at 1.6 billion on the New York Stock Exchange. Martín Migoya, their CEO was with us and he said that we don’t even have a perfect point of view on digital. When Disney or Southwest Airlines comes to us, we first set up a pod that could be purely based on people with experience in customer behavior. And the next pod we setup may have little more to do with analytics, the third pod would be very heavy technology and the fourth is implementation. So he is saying that literally, like a chameleon, we are changing our colors every time a new customer requirement emerges. So this needs graphics skills, this needs behavioral skills. Do you really think our smaller companies and indeed even the larger companies in IT services are prepared for this kind of change in the profile of the people they employ? Are IT companies prepared for the changing nature of skills required?

Ramesh: Well, you know, no one is perfectly prepared for it. Globant is a great example. They have focused on horizontal specialization. They tell their clients – we don’t know your vertical, but we will learn it fast because we have set up multi-skilled, multi-functional teams that can come in and set up the pods and transfer the learning quickly and efficiently.

However, no one is perfect. Smaller companies have greater opportunities to bring the behavioral scientist that they need or the user experience experts that they need, without the legacy burden that the larger companies have in terms of their compensation structure, the culture and so on.

Ganesh: So, the good news is – there’s opportunity. I think what you heard Ramesh Mirakhur say is “choose your playing field”. It could be a vertical or it could be a specialization that you’re going after.

Don’t think that because you’re a small company your only customers are going to be small and medium firms. There is no reason why young companies can’t compete with the biggest, so long as you have the confidence to be able to go out and define your value proposition and make something happen in a very thoughtful, very sustained and very systematic manner. So all the best to all the smaller companies. It’s still a great market opportunity and I am sure you will be very successful.

A New Race For Leadership

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It will need a concerted effort by the government, academia, research institutions, industry associations and industry to make India a force to reckon with in AI-led growth and enable manufacturing

There are many who believe that China, with its burgeoning costs, is losing out in outsourced manufacturing to more nimble and cheaper competitors such as Vietnam and Thailand and there has been hope that with some concerted investments in the right areas, India too will finally find its place in the global manufacturing sun. However, the time for projecting India’s pool of engineering manpower and ability to do labour-intensive manufacturing at scale and quality is now over and the baton of leadership will pass to those who are truly able to design and build factories of the future, powered by cyber-physical concepts, machine learning and artificial intelligence (AI).

Manufacturing firms of the future will use predictive analytics to estimate demand for each product category based on demand and environment patterns and also develop new products through generative design principles on an ongoing basis to satisfy demand of discerning customers. Virtual agents will interface between information systems and production processes and feed fully automated factories with planning, materials and process inputs on a real-time basis. Materials handling, location of parts and warehouse management and utilisation optimisation with digital aids such as augmented and virtual reality are commonplace today. The real cutting edge will be provided by AI applied to quality defect management through image recognition, process quality prediction and large-scale prescriptive approaches, failure predictions and predictive maintenance including support of self-healing machines. The future is all about maximising throughput with consistent high quality and redefined role of engineering talent in manufacturing.

Jabil, one of the world’s leading designers of digital factories with several successful implementations in Asia and Latin America, enables real-time predictive analytics for its customers by connecting equipment, sensors and people and claims an ever-increasing accuracy level for predicting early equipment and process failure leading to energy, scrap and rework savings and decrease in manufacturing cycle time. Companies such as GE and Siemens, both pioneers in digital manufacturing, have reported success with the use of AI — GE through the deployment of digital twins, which models and tracks the state of the engine and provides continuous analytics and predictive maintenance suggestions and Siemens through a combination of AI with neural technologies in its Gas Turbine Autonomous Controller Optimizer which ensures that every gas turbine has over 500 sensors continuously monitoring temperature, pressure, stress and other variables enabling the neural model to alter the distribution of fuel in the turbine’s burners on a dynamic basis.

Recent studies by PW and BCG place AI and advanced analytics at the core of smart manufacturing

Advanced Analytics at the core of smart manufacturing with recent trends moving beyond traditional inventory optimisation, maintenance and data security usage to intelligent factory operations, the application of digital twins and human robotics collaborative ecosystems. They predict that humans in the future factory will be entrusted with the higher-level tasks of programming, maintaining and coordinating robotic operations. With AI driving advanced predictive and prescriptive analytics and replacing SMAC (Social Media, Mobility, Cloud and Analytics) as the core of digital transformation, it is predicted that AI will also be a valuable tool outside the factory, enabling continuous logistics and supply chain monitoring, providing route optimisation for inward and outward flow of materials and finished products, tracking customer expectations and emotional states through voice analysis at service call centres and providing personalised product recommendations for customers based on deep learning of their previous responses and social media footprint. The use of AI and advanced analytics is limited only by human imagination as newer customer journeys evolve and design thinking enables early anticipation of every need.

The good news is that the adoption of digital technologies in Indian manufacturing firms has been placed by recent research at 27 percent against a global digitisation level of 33 percent and is expected to cross 60 percent in the next five years. It is also heartening that thanks to an increasing awareness of Industry 4.0, leading industry associations such as the Confederation of Indian Industry are making smart manufacturing the core of their agenda, and there is a proliferation of scaling start-ups in the Internet of things and robotics space even Indian SMEs are placing digital and Industry 4.0 at the core of their agenda for the future. Small-scale solutions are being piloted and investment in automation and analytics are beginning to bear fruit.

However, a major commitment at national policy making level and also across industry sectors towards AI is needed to position India as a true leader in new manufacturing solutions. And the competition is already planning this on a gargantuan scale. China has committed to add over $150 billion to its economy through AI by 2030 and many announcements of magnitude have been made including an AI support fund of $5 billion in Tianjin and the Beijing municipal government declaring plans for a $2.2 billion AI development park. The research coming out of China rivals the US in quantity and quality and it will need a concerted effort by the government, academia, research institutions, industry associations and industry to make India a force to reckon with in AI-led growth and enable the manufacturing sector to finally stake its claim to global leadership.